Archive for October, 2009

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Ostrom’s work lends insight on regulation

October 12, 2009

Lynne Kiesling

At the Wall Street Journal’s economics blog, Phil Izzo draws some insights from Elinor Ostrom’s work that complement my remarks in my previous post:

Ostrom’s work also has something to say about regulation: “The main lesson is that common property is often managed on the basis of rules and procedures that have evolved over long periods of time. As a result they are more adequate and subtle than outsiders — both politicians and social scientists — have tended to realize. Beyond showing that self-governance can be feasible and successful, Ostrom also elucidates the key features of successful governance. One instance is that active participation of users in creating and enforcing rules appears to be essential. Rules that are imposed from the outside or unilaterally dictated by powerful insiders have less legitimacy and are more likely to be violated. Likewise, monitoring and enforcement work better when conducted by insiders than by outsiders. These principles are in stark contrast to the common view that monitoring and sanctioning are the responsibility of the state and should be conducted by public employees.”

Posted in Economics | Tagged , , | 5 Comments »

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More on Ostrom and Williamson, and decentralized coordination

October 12, 2009

Lynne Kiesling

Both Ostrom’s work on governance institutions and common-pool resources and Williamson’s work on governance institutions and the transactional boundary of the firm contribute meaningfully to our understanding of how individuals coordinate their plans and actions in decentralized, complex systems. One of the most important ideas that Williamson has developed in his work is the role of adaptation in a world of necessarily incomplete contracting. In particular, the assumptions of a static environment with zero transaction costs eliminates a lot of the reasons why individuals need to contract, why firms with hierarchical organization can enhance welfare, and why governance structures like vertical integration exist. From Williamson (1971),

… the analysis of transaction costs is uninteresting under fully stationary conditions and that only when the need to make unprogrammed adaptations is introduced does the market versus internal organization issue become engaging.

Organizational form, and changes in organizational form as technology and transaction costs change, are important factors in how individuals can coordinate their actions for mutual benefit.

Ostrom’s work highlights the ability of communities of individuals, using their local knowledge and taking into account their individual preferences and constraints, to develop governance institutions that enable beneficial outcomes to emerge. As I put it in my book on institutional design in electricity,

Given the pervasiveness of incomplete property rights, even in commercial transactions, how are we able to engage in so much mutually beneficial exchange? We achieve it through the design of institutions to govern the commons (Ostrom 1990, 2005). These institutions can specify use rights, means for enforcing those use rights, and penalties for violating those rights. Again, defining and enforcing use rights is costly, but institutional design to do so happens when its benefits are high enough, and the institutional form varies depending on the environment and context.

The Ostrom works cited therein, Governing the Commons and Understanding Institutional Diversity, are full of rich insights that can be applied to environmental policy, regulation, economic development, and many other areas of economics and political science.

Posted in Economics | Tagged , , , | 9 Comments »

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Nobel: Ostrom and Williamson!

October 12, 2009

Lynne Kiesling

Hearty, heartfelt congratulations to Elinor Ostrom and Oliver Williamson for winning this year’s Economics Nobel! From the press release:

Economic transactions take place not only in markets, but also within firms, associations, households, and agencies. Whereas economic theory has comprehensively illuminated the virtues and limitations of markets, it has traditionally paid less attention to other institutional arrangements. The research of Elinor Ostrom and Oliver Williamson demonstrates that economic analysis can shed light on most forms of social organization.

Elinor Ostrom has challenged the conventional wisdom that common property is poorly managed and should be either regulated by central authorities or privatized. Based on numerous studies of user-managed fish stocks, pastures, woods, lakes, and groundwater basins, Ostrom concludes that the outcomes are, more often than not, better than predicted by standard theories. She observes that resource users frequently develop sophisticated mechanisms for decision-making and rule enforcement to handle conflicts of interest, and she characterizes the rules that promote successful outcomes.

Oliver Williamson has argued that markets and hierarchical organizations, such as firms, represent alternative governance structures which differ in their approaches to resolving conflicts of interest. The drawback of markets is that they often entail haggling and disagreement. The drawback of firms is that authority, which mitigates contention, can be abused. Competitive markets work relatively well because buyers and sellers can turn to other trading partners in case of dissent. But when market competition is limited, firms are better suited for conflict resolution than markets. A key prediction of Williamson’s theory, which has also been supported empirically, is therefore that the propensity of economic agents to conduct their transactions inside the boundaries of a firm increases along with the relationship-specific features of their assets.

Few other economists have influenced my thinking as much as Ostrom and Williamson. Congratulations!

UPDATE: I’ve written a lot about Ostrom’s work in the past, as has Mike; here are previous Knowledge Problem posts about Ostrom’s work, and previous Knowledge Problem posts about Williamson’s work.

Posted in Economics | 5 Comments »

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When good deals go bad for economic development planners

October 11, 2009

Michael Giberson

State and local economic development agencies and assorted politicians like to trumpet their successes in using tax breaks and other incentives to induce companies to locate in their areas. Rarely does anyone report how these deals turn out in the months and years after that initial photo op. From BusinessWeek‘s Management IQ blog, a story on the aftermath of one deal: “Dell’s Plant Closure Raises Anger Over Incentives.”

Do government incentives aimed at luring businesses to a state or city work?

There’s already a body of evidence that they often do not. And news out of North Carolina this week shows just how quickly these headline-grabbing deals can go awry. While the business press on Dell Computers this week focused on its new smart phones and $3.9 billion bid for tech services provider Perot Systems, in North Carolina the news on Dell was all about the closure this coming January of its plant in Forsyth county. The move will put 900 people out of work. And it’s doing collateral damage to the local incentives system that offered the Texas-based computer maker $280 million in potential tax breaks and grants to locate the plant in the state four years ago.

North Carolina’s offer was eventually shown to have been much more generous than other states’.

Dell will repay much of what it’s received so far, including $15.6 million from the city of Winston-Salem and most of the $8.5 million it’s received from the state.

But the closure has become a political embarrassment for local politicians who had been urging the state to go further with incentive packages aimed at luring businesses….

Posted in Economics, Politics | Tagged | Comments Off

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Boom in shale natural gas: Not just for North America

October 11, 2009

Michael Giberson

From the New York Times, “New Way to Tap Gas May Expand Global Supplies.”

Italian and Norwegian oil engineers and geologists have arrived in Texas, Oklahoma and Pennsylvania to learn how to extract gas from layers of a black rock called shale. Companies are leasing huge tracts of land across Europe for exploration. And oil executives are gathering rocks and scrutinizing Asian and North African geological maps in search of other fields.

The global drilling rush is still in its early stages. But energy analysts are already predicting that shale could reduce Europe’s dependence on Russian natural gas. They said they believed that gas reserves in many countries could increase over the next two decades, comparable with the 40 percent increase in the United States in recent years.

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New Economist smart grid article

October 9, 2009

Lynne Kiesling

This week’s Economist has an outstanding and thorough article on the current status of smart grid investments in the electricity industry. It surveys recent developments from a international perspective as well as focusing on some of the specific developments in the U.S. It highlights the peak demand reduction and renewables integration benefits that would come with such an intelligent network:

With peak demand lower, utilities would no longer have to hold as much expensive backup capacity. Mainly because so many of its customers have air conditioners, Pacific Gas and Electric (PG&E), a Californian utility, needs to be able to deliver more than 20,000 megawatts (MW) in the summer months—almost twice the average demand. Eliminating only the top 10% of electricity usage through demand-response and efficiency programmes would save customers more than $100m annually, says Andrew Tang, who oversees the utility’s smart-grid project, one of America’s biggest. PG&E is installing 10,000 smart meters a day and wants to equip 5m homes by the end of 2011.

The article then goes on to describe some of the political difficulties, with regulators “still stuck in the era of the dumb grid” and wanting to “protect” consumers who have no experience with intelligent end-use devices.

The only area missing in this excellent article is a discussion of the political difficulties of retail competition, and how removing entry barriers in retail markets could affect the consumer experience and consumer value propositions. It would be great to have the Economist analyze retail competition, and not just leave it to the local papers; I think we’d see a more balanced perspective.

Posted in Economics, Electricity | Tagged , , | Comments Off

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Oligopoly in Alaska’s wholesale gasoline market

October 9, 2009

Michael Giberson

Last year, as crude oil and gasoline prices went on their wild ride, gasoline prices in Alaska took a somewhat different path than prices in the lower 48 states.  For years, average prices in Alaska were about the same as the U.S. average price.  Higher costs of delivery in Alaska were mostly offset by the nation’s lowest gasoline tax, just 8 cents a gallon, and the result was a price that more or less tracked the U.S. average price.

That pattern changed beginning in June 2008.  Prices had been marching up everywhere, but the price march stalled in the lower 48, while in Alaska (and Hawaii) prices continued to rise for another month.  Prices fell sharply throughout the country from July through December – excepting a short pause during the late hurricane season in the lower 48 – but Alaska’s prices now seemed to track the higher prices of Hawaii rather than returning to the U.S. average. (See this chart at www.alaskagasprices.com.)

Last fall the State of Alaska initiated an investigation, and in January 2009 they concluded that oligopoly was to blame.  No illegal acts were discovered, but the report suggested that with relatively few players involved competitive pressures can be weak and prices above the competitive level can be sustained for some time.

Explanation from the report, 2008 ALASKA GASOLINE PRICING INVESTIGATION:

The fewer the number of sellers in a market, the easier it is for each to observe the other and develop expectations as to the way in which each will likely react to the other’s decisions regarding output and prices. In these markets, each seller will naturally take into account the potential impact of its own actions on market prices, including the potential responses that its actions might elicit from other sellers. This type of “competitive” behavior is often referred to as oligopolistic pricing or “oligopolistic interdependence” because the decisions that each make are “dependent” in part on the expected actions (or reactions) of other sellers. In this environment, it is easier for sellers to develop a “live and let live” attitude toward their rivals that would not be possible to maintain in competitively structured markets with more sellers. As a result, oligopolistic or interdependent behavior can result in prices that are above competitive levels over extended periods of time.

Interdependent behavior on the part of sellers is not generally regarded as a violation of antitrust law as long as firms develop and implement their pricing and output decisions independently.

… Alaska’s gasoline markets can fairly be characterized as oligopolies at the wholesale level. Oligopoly markets can produce a wide range of prices, high or low, without there ever being any illegal behavior or collusion by sellers. …. [The ability to keep prices high] is dependent on the existence of some sort of entry barrier that prevents non-incumbent suppliers from entering the market and taking advantage of the higher profit opportunities. As discussed above, these entry barriers exist in parts of Alaska, limiting competition from outside suppliers, particularly during short-term periods or periods such as the second half of 2008 characterized by extreme market volatility and uncertainty.

Posted in Economics, Energy markets | Tagged , | Comments Off

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Judge says Kentucky’s anti-price gouging law is constitutional; Virginia newspaper says “legalize it”

October 8, 2009

Michael Giberson

Over two years ago, the state of Kentucky filed suit against Marathon Oil claiming the company engaged in price gouging in the wake of Hurricanes Katrina and Rita. (Cynics noted that the lawsuit was filed shortly before a primary election in which the Attorney General at the time was running for Lt. Governor.)  Marathon has argued that the Kentucky anti-price gouging law is unconstitutional because it violates the due process clause of the 14th amendment, because it allows too much discretion by the administrative branch of the state government, and because it impedes interstate commerce.

A state district judge has ruled that the state’s anti-price gouging law is constitutional, and therefore the state’s case against Marathon can go forward. (Marathon tried and failed to move the case into the federal courts.)

Meanwhile, in Virginia, about a month ago the state Attorney General’s office announced legal action against one Salem, Virginia gasoline station and settlements with two others arising from post-Hurricane Ike gasoline price increases.

Virginia’s Price Gouging Act, which requires a declared state of emergency to activate, went into effect July 1, 2004. Since then, the Attorney General’s Office has sued eight gas stations (three after Hurricane Katrina and five after Hurricane Ike). Today’s action against Main Street Citgo in Salem is the first where an agreed settlement, known as an Assurance of Voluntary Compliance, was not filed at the same time.

The settling stations are required to set aside money for consumer restitution. They also have agreed to make contributions to the American Red Cross Disaster Relief Fund, in lieu of paying civil penalties.

The Richmond Times-Dispatch responded recently with an editorial urging repeal of the anti-price gouging law:

Hurricane Ike caused disruptions in the supply of gasoline. For that reason, [Virginia Gov. Tim] Kaine suspended rules that normally require the selling of certain types of specially reformulated gasoline blends — thereby enabling retailers to sell blends they would not have been able to at the time. The decision amounts to an implicit admission that supplies of reformulated blends were running short.

Demand also was soaring. News reports related tales of “panic buying” as “motorists began topping off their tanks and filled cans of gasoline for their personal reserves.” Many stations ran out of gasoline, as WSLS-10 reported on Sept. 15, 2008: “Ike sent prices soaring and put people in a frenzy. In fact, the Pure gas station on Franklin Road is one of the many stations in our area that ran out of regular unleaded gas….”

When demand greatly exceeds supply, either prices go up or shortages occur. Unlike the stations mentioned above, the Bucko’s Pantry[*] stations that briefly jacked up prices to stem the panic buying did not run out of gasoline.

Prices are signals. Sharply higher prices send the message that consumers should buy no more than they need, so that some of the limited supply will be available to others. They are an efficient means to say: No hoarding. Indeed, emergencies are precisely the times when price spikes ought to be expected. It’s time Virginia repealed its irrational price-gouging law — and gave the lawyers charged with enforcing it more productive work to do.

[* Bucko's Pantry had settled with the AG in response to charges of price gouging earlier in the year.]

[HT to Matt Zwolinski]

Posted in Economics, Energy markets, Politics | Tagged | Comments Off

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“Battery Investing for Beginners”

October 8, 2009

Michael Giberson

John Petersen has written a four-part series of articles on “Battery Investing for Beginners” at AltEnergyStocks (and mirrored at SeekingAlpha).

Don’t miss Petersen’s “How PHEVs and EVs Will Sabotage America’s Drive for Energy Independence.”  I don’t care much one way or another about a “drive for energy independence”, but I love contrarian wisdom well-supported by facts and analysis.

Posted in Electricity | Tagged , | Comments Off

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The future of natural gas prices: a view from October 2009

October 7, 2009

Michael Giberson

A short Associated Press item from last week provides a perfect illustration of the near-meaninglessness of the daily post-market story interpreting price moments.

Natural gas prices tumbled yesterday after the government reported the United States is using so little that it has more in storage now than at any other time on record.

The report was welcome news for homeowners who use natural gas. Suppliers already have cut rates in many parts of the country, and a continued drop in natural gas prices should convince others to cut prices. Natural gas for November delivery fell 34.7 cents, or 7.2 percent, to $4.49 per 1,000 cubic feet in New York.

The November futures price for natural gas spent most of last week between about $4.80 and $5.00, and that “welcome news” for homeowners was just a one-afternoon price dip.  The next day prices were back around where they had been two days earlier.  Sure, prices are well below their 2008 peak levels, but they have been below $5 most of the year.

What’s more, the $4.49 price is higher than the prices that have prevailed since February. It is the slow creeping up of prices that is welcome news, but for producers, not homeowners.  While natural gas prices usually pick up in October as the temperatures turn colder, short term supply and demand side issues make the “usual pick up” a little less certain than usual.

The real welcome news for homeowners (and select producers) is in announcements such as contained in this Houston Chronicle story: “Mammoth Discovery: Companies bet big on South Texas gas find.”

Last October, just as the economy was tilting into crisis, a small oil and gas company in Houston quietly announced the discovery of a mammoth natural gas field in South Texas that at any other time might have garnered bigger headlines.

Petrohawk Energy’s find, however, did not go unnoticed in the oil and gas industry — and it didn’t take long before oil companies large and small began making their moves.

Today, though the economy and natural gas prices remain weak, the Eagle Ford shale remains one of the hottest prospects in North America, and energy companies are moving forward there even as they’re pulling back elsewhere.

That’s because of what some companies suggest is a virtually recession-proof combination of highly productive wells and low drilling costs they say can yield profits even as natural gas prices hover near seven-year lows.

Emphasis added.  Good news for natural gas consumers and for those producers who are in on the development.  More:

Recently discovered U.S. shale plays, including the Haynesville in Louisiana and Marcellus in Pennsylvania, are expected to provide a major boost to U.S. natural gas supplies in coming years. The dense rock formations, once thought too difficult to explore, have been unlocked with the help of recent advances in drilling technology.

The core areas of the eight largest U.S. shale plays may contain 475 trillion cubic feet of recoverable resources, according to an estimate by Ross Smith Energy Group, an industry research firm in Calgary, Alberta. That’s roughly ten times the size of Texas’ famed Barnett shale play in the Dallas-Fort Worth area, which supplies nearly 10 percent of U.S. natural gas production, excluding Alaska.

$3.88 break-even point

While the Eagle Ford is among the smallest of the group, with some 19 trillion cubic feet of natural gas remaining, the economics is among the best, the firm said.

Producers in the Eagle Ford can break even when natural gas is priced as low as $3.88 per million British thermal units, the firm said, versus break-even prices of $5.18 in the Barnett, $3.74 in the Marcellus and $4.49 in the Haynesville.

While market prices for natural gas will continue to bounce around due to seasonal changes, storage dynamics, and various macroeconomic conditions affecting demand, it seems hard to believe that prices could stay above the mid $5 range for long anytime in the next decade.

UPDATE via Forbes: “[Pritchard Capital Partners] forecasts natural gas will average $6.50 in 2010.” But overall, the Forbes piece fits my outlook; the article ends by noting the EIA “expects the annual average spot price to rise from $3.85 in 2009 to $5.02 in 2010.”

Posted in Energy markets | Tagged | 2 Comments »

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