No, speculation does not explain oil prices

Michael Giberson

Sebastian Mallaby provides a clear exposition of what might be considered the mainstream economics story of why “speculation” is not to blame for the current high level of oil prices.

[A] speculator can buy paper oil only if someone else sells to him. For every trader who bets on a price rise, there must be another who bets the opposite. So an increase in the number of speculative players does not show whether prices will move up or down….

What matters is who those players are: Will they aggressively push the ball up the field, or will they retreat? Sometimes the bulls are more eager than the bears, and prices spiral upward. But this is not some autonomous force that comes out of nowhere. If the bulls have the upper hand, it’s generally because supply and demand favor higher prices. The fundamentals of physical oil drive the psychology around paper oil more than vice versa.

… The uncertain connection between speculation and price trends is clear in recent history. The Commodity Futures Trading Commission reports how much paper oil is bought and sold by commercial users — oil companies, refiners — and how much is bought and sold by speculators. During the first seven months of 2007, speculators as a group tripled the amount of paper oil they owned, buying it from commercial players. But since last August, speculators as a group have not added to their positions — yet this was when oil prices went skyward.

It would be too much to claim that futures prices don’t influence players in the physical market. But to the limited extent that speculators’ influence is real, this is probably a good thing. If speculators see that oil suppliers are headed for trouble and that oil demand is trending up, they express their expectation of a higher price via the futures market. This can deliver a valuable message: Governments and consumers had better adjust before shortages get even nastier.

Tyler Cowen at Marginal Revolution has also been addressing oil prices, most recently seeking to reconcile current high oil prices with a belief in the overall correctness of the Julian Simon view that resource prices would continue to fall in the long run. I don’t find my position listed among Tyler’s list of possibilities – I’m closer to Alex Tabarrok’s view expressed last week: “Finally, on oil – who really cares what the price is? The issue is energy, not oil. I am confident that the long run price of energy will fall.”

Well, many of us care about the price of oil in the short to medium term, after all we have assets (i.e. automobiles, pipelines, refineries, oil rigs, factories) with usefulness tied to the price of oil. But in the long run, as Alex says, it is energy, not oil.

Pigou and the “bad things”

Michael Giberson

Greg Mankiw called it “the Pigou Club in a Nutshell“, quoting the following from Tim Kane:

we should aim to tax the bad things (noise, gasoline, trash, violent crime, evil foreign dictators) and untax the good things (homegrown profits, employment, innovation).

But take another look at that list of “bad things”: noise, gasoline, trash, violent crime, evil foreign dictators. As they used to sing on Sesame Street (and maybe they still do), “one of these things is not like the others.”

Can you tell which one is not like the others?

If you guessed this thing is not like the others, then you’re absolutely…right!

Responding to higher energy costs, the home building version

Michael Giberson

An article in the Washington Post discusses what you can do when building a new home to help keep energy costs low. Here Michael McKechnie of Mountain View Builders in Berkeley Springs, WV, provides a summary:

McKechnie outlined the major steps to building a house with the lowest possible energy costs and perhaps an eye to going off the grid at some point: “Design your house so it uses the sun’s passive energy to its fullest potential, make sure the envelope around your house is tight, invest in renewable energy systems that use the sun and the wind to make free energy, and buy heating and cooling systems that use energy more efficiently.”

Just like it is complicated and less effective to retrofit a ten-year old SUV to be more efficient, it is complicated and less effective to retrofit old homes. (Which doesn’t mean some steps are not cost effective, of course.) The Post article provides a survey.

And what about that ten-year old SUV? Have you considered taking a rickshaw?

Wind power and real-time pricing: Mutual benefits

Michael Giberson

The marginal cost of generation from a wind power generator is essentially zero, which means once the generation is installed you pretty much want to use every bit of wind power generated. A problem, of course, is that wind-based generation is not particularly dispatchable. You don’t tell it when to run, you just try to use as much of it as you can while it is available.

A further wrinkle is that, at least for some wind power locations, the winds are strongest overnight and early morning when the demand for power is lowest. And, when wind power is generated far from the consumers who’d like access to cheap power, it requires adequate transmission capability to move the power to the people. If the transmission system is limited in its ability to move all of the power available, then some of the wind generation capacity will be wasted.

Ramteen Sioshansi and Walter Short observed that there may be mutual benefits available for a power system with a large share of wind generating capacity from also implementing real-time pricing for ultimate consumers. In a paper they describe simulations they ran using data from Texas to examine the potential benefits of real-time pricing for use of wind power resources.

They find useful synergies:

  • Real-time pricing tends to smooth out the normal ups and downs in consumption, because consumers tend to decrease consumption in high cost hours (which are the high demand hours), and to increase consumption in low cost hours. Smoothing out consumption means that the transmission system is less likely to be congested and therefore it is less likely that distant wind generation will be shut in by transmission limits.
  • In addition, because wind power comes at a low marginal cost, whenever it is plentiful it will drive down electric prices. That effect encourages consumers to adapt their consumption to the patterns of wind power availability.

It is true that the effects can be small, but even with some conservative assumptions in the simulations, the authors found that usage of wind power could be increased by more than 80 percent. Don’t get hung up on that number, which very much relies upon the assumptions going into the simulation. Take away the idea that a series of small marginal adjustments in consumption, responding only to price signals, can have significant effects on the use of low marginal cost renewable (or any other form of) power generation.

The authors also note that many political analysts object to the idea of exposing consumers to highly variable real-time power prices. They re-ran the simulations limiting the real-time pricing regime solely to commercial and industrial consumers. Commercial and industrial consumers represented a little over 60 percent of the demand in their historical data, and the new runs of the simulation showed that just about 60 percent of the benefits were retained with the more limited application of real-time prices.

(Like the Hogan talk mentioned yesterday, the Sioshansi and Short paper was presented at “The Economics of Energy Markets” conference at IDEI.)

Electricity market pricing and how to think about it

Michael Giberson

Recently, William Hogan gave a presentation at IDEI and the Toulouse School of Economics titled Electricity Market Design: Coordination, Pricing and Incentives, or, as he more colloquially puts it early in the talk, “Electricity market pricing, and how to think about it.”

The 42 minute video is available from the EU Energy Policy Blog. Slides from the talk are also available.

Hogan’s presentation was part of a conference on “The Economics of Energy Markets“, the 2008 version of the annual Conference on Energy at IDEI. Papers from the conference are also available.

Cheaper solar power?

Michael Giberson

That is the goal. Few numbers show up in the Christian Science Monitor article to support that claim, but the people discussed are launching a business with the goal of improving the design further and then go to production. The key innovations appear to be in the cheaper process to produce the appropriately shaped mirrors and build the supporting structure.

Whether they ultimately succeed or not, the article comes with a video showing a board bursting into flames, so at least the designers are having fun:

Out on a lawn at the Massachusetts Institute of Technology with joggers and traffic passing nearby, Spencer Ahrens is demonstrating what looks like either the future of solar power – or perhaps a death ray.

Thrusting a 12-foot board up into the air in front of a large mirror-covered satellite-type dish, Mr. Ahrens, an MIT graduate student, waves the board, looking for an elusive sweet spot where reflected sun rays converge.

With three student teammates looking on, he steadies the board once its tip begins to glow. Shining white in the reflected solar rays, the wood suddenly bursts into flames. Students laugh as smoke billows in the breeze.

This burning-board trick may seem like a YouTube stunt, but it’s actually a visceral demonstration of a device with a serious purpose: to make super-cheap solar heat.

KP vacation: biking the Lewis & Clark Trail

Lynne Kiesling

I’m outta here for a couple of weeks of bicycling! Sunday night we will arrive in Pierre, South Dakota, from whence we bike east along the Missouri River to St. Charles, Missouri. We are biking the first one-third of the Lewis & Clark Trail in reverse, accompanied by their journals and other history-relevant readings. Should be fun!

If you would like to keep up with our journey, I’ve created a blog, L&C Bike Tour, as our online journal. We will post as often as Internet access permits.

I am also using this trip as an opportunity to raise awareness and funding for the Melanoma International Foundation. The Melanoma International Foundation funds patient assistance programs, providing reassurance and understanding on the journey of having the disease as well as providing free screening and awareness events. They provide education through their professionally moderated forum and helpline. Melanoma can be fatal, especially if not caught early. But there’s also a lot of low-hanging fruit in melanoma prevention — broad-brimmed hats, protective clothing, staying indoors or in the shade during the most intense midday hours.

I am using this bike ride to request pledges and donations to support the excellent and important work of the Melanoma International Foundation. In particular, your pledges here will support the Leroy Coolbreeze Fund at the Melanoma International Foundation.

The Leroy Coolbreeze Fund honors the memory of Ian Copeland, a legendary music agent and bon vivant who brought great joy to many people throughout his too-short life. Along with his brothers Stewart (best known as the drummer in The Police) and Miles (who, among other things, managed The Police and founded IRS Records), Ian brought music into being that changed my life and thrilled me starting in the late 1970s. Their work continues to thrill and excite me to this day. Ian died from melanoma in 2006. My request for your support is a testimony to the value the Copeland family has brought to my life, and the joy I experience daily through listening to and playing the music that they have created.

As my friends and I ride along the Lewis & Clark Trail, please give to this worthy cause. If you can specify the “Leroy Coolbreeze Fund” and “Lynne” in your donation, then the great MIF folks will take it from there, and will know that our Lewis & Clark Trail bike tour is raising your awareness of the importance of melanoma outreach and research, and enabling them to do even more of this important work.