Archive for July, 2011

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Risks and regulation

July 15, 2011

Lynne Kiesling

I’ve just returned from a conference on regulation in Bulgaria organized by the Istituto Bruno Leoni, a classical liberal think tank in Italy that does a lot of extremely good work developing and applying classical liberal principles and ideas to public policy issues in Italy and Europe. The topics included financial markets regulation, energy, and telecom/internet.

The organizers asked me to comment on risks and regulation with respect to energy and the environment. The topic prompted me to ask: risk to whom, and risk of what? The parties whose risks I analyze are consumers, the end users.

Risk of what? Historically, at least in the US, risks related to reliability of service and bankruptcy of firms have been the primary focus of regulatory policy. Keep the lights on, no matter the cost, and treat that as a uniform standard (by technological necessity, until the invention of good switches). Use economic regulation (rate of return + monopoly service territory for the vertically integrated firm) to ensure the firm’s financial stability. These two objectives have had the consequence of significant infrastructure redundancy at a substantial cost, and increased incentives to firms to build those redundant electro-mechanical infrastructure systems.

More recently, environmental risk has become more prominent, and increased the combined economic and environmental regulatory policy focus on electricity generation. Initially the concern was the “criteria pollutants” such as SO2, NOx, etc., but the focus has shifted in the past two decades to greenhouse gases and carbon policy. The emission policy options range from

  1. Do nothing while we do more scientific research into the complex and little-understood climate system
  2. Price carbon with a tax … but with this policy one cannot control emission quantity
  3. Constrain GHG emission quantities with emission permit markets … but with this policy one cannot control emission price
  4. Traditional command-and-control regulation: emission quotas, renewable portfolio standards … but this approach has high enforcement costs, with centralized decision-making that’s likely to be inefficient because it cannot reflect, as Hayek said “individual knowledge of time and place”

Other important economic risks to consumers include the effects of wholesale and retail price volatility as fuel prices fluctuate, and the mounting effects of the lack of innovation and new technology adoption in the customer-facing portion of the value chain.

That was the setup part of my remarks, and I’ll post the rest in a follow-up … but for now, tell me: what are some other ways to think about the risks associated with regulation, and the attempts of regulation to mitigate certain risks, that face electricity consumers?

Posted in Economics, Energy markets, Environmental policy, Regulation | Tagged , , | 4 Comments »

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Scottish wind power plants paid not to produce

July 13, 2011

Michael Giberson

The Telegraph has reported “six Scottish wind farms were asked to stop producing electricity on a particularly windy night last month as the National Grid was overloaded.” The operators were paid a total of £900,000 to take the night off, likely earning more from not operating than they would have earned from selling power that night.

The payments were discovered by the Renewable Energy Foundation, a green think tank, which accused the Government of building too many wind farms in northern Britain.

John Constable, director of policy and research, said not enough care had been taken to ensure there were enough high-voltage cables to transfer the power to other parts of the UK when it was needed.

“Hasty attempts to meet targets for renewable energy mean some Scottish wind farms are now in the extraordinary position of not only printing money when they generate, but printing it even faster when they throw their energy away,” he told the Sunday Times.

The Renewable Energy Foundation provides additional information on its website:

Posted in Electricity, Energy markets, Environmental policy | Tagged , | 7 Comments »

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Role of independent producers in the early development of California’s oil and gas industry

July 8, 2011

Michael Giberson

The Summer 2010 issue of Business History Review included an interesting article on the role of independent producers in the development of the oil and gas industry in California. In the article, Michael Adamson makes the case that official statistics on oil production overstate the role played by large, vertically integrated oil companies (the “majors”) at the expense of contributions of independent companies. While the majors did produce most of the oil in California, from the early days to the present, they did so in a kind of complex coordination with independents, sometimes cooperating and sometimes competing. Independents were particularly valuable in the high-risk exploration stage and in the championing of the development of regions neglected or deprecated by majors, occasionally turning unattractive prospects into major producing areas. The Summer 2010 Business History Review was a special issue devoted to the oil industry (unfortunately the articles are gated, so you’ll need a subscription or access through a library.)

This same kind of complicated coordination between independents and majors has existed through most of the history of the oil and gas industry, but it is taking a new turn with the development of oil and gas shale resources. The preliminary work in the Barnett Shale was pursued by independents, as was most of the subsequent development there and elsewhere. Only as the techniques used became better developed and clearly demonstrated have the majors taken significant notice – sometimes pursuing their own shale projects directly, sometimes buying properties from independents, and sometimes buying the independents outright.

Adamson tells his story mostly by focus on one key independent developer, Ralph Lloyd. Here is a bit of the conclusion from “The Role of the Independent: Ralph B. Lloyd and the Development of California’s Coastal Oil Region, 1900–1940” (BHR, 84:2, Summer 2010, pp. 301-28):

Lloyd benefited Associated and Shell as an entrepreneur acting on his conviction that he could mobilize their “static” power to mutual advantage. He cooperated with firms that had the resources to tackle the formidable geology of the Ventura Avenue field. Subsequently, he assumed the risk of drilling its unproven areas. As a result, his Lloyd Corporation became one of California’s leading producers of crude oil. Yet, even as he competed against majors, Lloyd recognized that maximizing his profits required ongoing cooperation with them. Such symbiotic relations constituted an important factor in the oil business: one that is buried under an avalanche of academic and popular literature that pits independents against majors on matters of business and politics.

Statistics on exploratory wells drilled explain why many an independent made its name in the search for oil. … At the same time, the numbers conceal the role of independents in developing extractive regions in cooperation with other firms. After demonstrating the presence of crude-oil reserves in a wholly neglected area, Lloyd and his partners participated for two decades in the development of a gigantic field in ways that do not show up in statistics. This approach to the oil business is underplayed, if not generally overlooked, in the literature. It is entirely absent in the literature on the California industry.

Lloyd’s relation with Associated and Shell illustrates why the oil business during the “gusher age” was in large part “shaped by risk” …  Since the organizational capacities of the “first movers” in the industry were not decisive in the search for oil, companies had an incentive to cooperate in their exploitation.

Posted in Economic history, Energy markets | Comments Off

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Oil markets appear unfazed by announced release of oil from strategic reserves

July 5, 2011

Michael Giberson

Chart showing oil prices in the days surrounding the IEA announcement of oil reserves

The Economist: Oil prices and the Release of Oil from Strategic Reserves

On June 23 the International Energy Agency announced the release of 60 million barrels of oil from strategic reserves held by member governments. Oil prices dipped for a day or two, then recovered more or less to pre-June 23 levels. Overall, it seems, the release merited a collective yawn from the markets.

The following is a somewhat rambling survey of the post-SPR announcement commentary.

According to the IEA press release, the purpose of the release was to respond to “the ongoing disruption of supplies from Libya.” Given that oil prices were already on their way down in the weeks just prior to the IEA announcement, it isn’t clear that the dropoff of Libyan exports remained a real problem.

In the United States, the announcement triggered an immediate round of political peacockery. Democrats and leftist-interventionists crowed that the release of oil was a “clear message … sent to OPEC, Big Oil, and speculators who have been wreaking havoc with American consumers” (in the words of Rep. Ed Markey) that enough is enough. The Sierra Club’s Carl Pope spouted some nonsense about pricking speculative bubbles in the oil market” and taking volatility out of the market. Peak oilers Jan Mueller and Art Berman call it a “bold, price suppressing ‘poke in OPEC’s eye’” and said “Oil prices are likely to be suppressed until the market digests the changed conditions created by the IEA action.” (The nearby chart from The Economist suggests it took the market about three or four days to “digest the changed conditions.”)

Republicans and conservatives tended to complain about an administration attempt to manipulate oil prices for political gains. Former GOP Rep. Bob Beauprez charged the Obama administration action was a re-election minded move that is “creating a national security vulnerability by draining the SPR in exchange for a few cents of relief at the pump.” A letter sent by GOP lawmakers to the President was less direct, only implying that the administration was tapping the reserve to manipulate the price of oil.

Most of these responses popped up in the days immediately after the announcement. Yesterday at The Economist‘s Free Exchange blog, with the benefit of a bit more market reaction, they observed if the motivations for the release were to push down prices and punish speculators then it may have already failed. (See chart above from the Free Exchange post.) Indeed, rather than punish speculators, if the release signals the injection of more-politicized management of the SPR then it just gives speculators one more angle on which to play the market.

Craig Pirrong explores this angle in a long post at Streetwise Professor, suggesting that politicized management of the SPR will at the margin tend to discourage private holdings of oil. Note that smaller inventories will, other things being equal, lead to greater rather than lesser price volatility. Pirrong has additional comments here and here.

James Hamilton, Econbrowser, explains some oil market dynamics in the course of suggesting the SPR release may depress oil prices a little over a several months.

Cato Institute analysts Jerry Taylor and Peter Van Doren had a piece at Forbes.com under the title, “Obama was right about the SPR release,” though reading the column leaves the impression that they think Obama was right for the wrong reasons. They want to drain the SPR not “in exchange for a few cents of relief at the pump” or to send “clear messages” to OPEC, et al., but rather to drain it entirely and get the government out of the strategic oil stockpiling business.

I’m in favor. The recent announcement of a release marks only the third time that the SRP has been drawn down – the other two times were in 1991 during Operation Desert Storm and in 2005 after Hurricane Katrina. But we’ve had other oil market disruptions of similar size without releases from the SPR, and we’ve managed to survive them. Remember the Oil Strike in Venezuela of the Winter of 2002/2003? It resulted in about the same drop in world oil production as the Libyan conflict, but oil markets swallowed up the disruption with barely a hiccup and not strategic reserve releases. Hurricanes Gustav and Ike caused some serious damage in the Gulf, and a few weeks of higher gasoline prices in the eastern United States due more to infrastructure damage than reduced supply, but the industry recovered and prices resumed falling.

As Taylor and Van Doren explain, “there will never be a ‘supply emergency’ as long as markets are allowed to allocate crude oil via freely functioning prices. As long as you’re willing to pay the market price for crude, you can have all you like.” (Even during the 1973 oil embargo, the most visible consequences of the “oil shock” were likely the results of President Nixon’s domestic economic policies which hampered oil distribution and not the embargo per se.)

We’ve used the SPR a few times, we haven’t used it in similar conditions a few other times, and with or without it the market disruptions are relatively modest. So if it is a tool of no real consequence, why do we bother? The U.S. Department of Defense should maintain whatever reserves judged reasonable and proper for it to carry out its defensive responsibilities, and otherwise the government should get out of the strategic petroleum reserve business.

Posted in Energy markets, Politics | 4 Comments »

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Walmart Express, market definition, and local politics

July 5, 2011

Lynne Kiesling

Recently Walmart announced that they would begin operating small-format stores called Walmart Express, the first two of which opened in June in Arkansas. If you look at the portfolio of earlier Walmart stores, they range in size from the 185,000 square foot Supercenter (the big kahuna) to the 42,000 square foot Market (with a smaller range of items, focusing on groceries and pharmacy). At 15,000 square feet, the Walmart Express store is a different beast:

Walmart Express has been created to offer low prices every day in a smaller format store that provides convenient access for fill-in and stock-up shopping trips. The stores give Walmart flexibility in serving customers, especially in rural and urban areas where shoppers may not have access to larger stores.

The Walmart Express test stores average 15,000-square-feet and offer groceries and general merchandise, including an assortment of fresh produce, dairy and meat, dry goods, consumables, health and beauty aids, over-the-counter medicines and more. Many have pharmacies as well.

From a shareholder value perspective, developing this smaller-scale store is a sensible market development strategy in light of the economic challenges retailers have experienced during the recession — maintaining positive comparable-store sales numbers during recessions is tricky, even for a low-cost leader. If Walmart can see positive profit margins at these stores, that will provide more evidence that their real competitive edge is not the economies of scale associated with big-box retail, but is rather the supply chain logistics and operations management for which they have become famous (or infamous, depending on your perspective). Essentially, I think they are “leveraging” (sorry for the jargon, but I think it’s correct here) all of the supply chain logistics efficiency and cost-cutting they have generated in their larger format stores to make the economics of the smaller store more attractive.

That’s the beginnings of a value story for the producer side’ now, what about the consumer side? Pay attention to how Walmart is framing the Walmart Express store: “The stores give Walmart flexibility in serving customers, especially in rural and urban areas where shoppers may not have access to larger stores.” In rural areas, they might site a Walmart Express store in a community that is too small to sustain a larger store. In urban areas, high population density means that the constraint is not market size, but is rather land scarcity and prices. So the constraint is on a different margin, but the smaller store format may serve the small rural and dense urban market (with local differences and customization in merchandise, to be sure). If Walmart can leverage their supply chain logistics to bring their low-price model to these markets, this could expand the market while increasing competition, all of which benefits consumers. And, in a city like Chicago with low-income neighborhoods that qualify as “food deserts”, a store like Walmart Express could provide retail access to fresh food in such areas.

Thus it shouldn’t surprise you that Chicago is one of the target markets for Walmart Express, at least three of which are scheduled for development during 2011. Two of them are in my southeast-extended Lakeview neighborhood, one at 2840 North Broadway (an area that, while not low income, is definitely not well served by retail grocery establishments) and a second one mile north at 3636 North Broadway. Both of these sites are 14,000-ish square feet and have been empty (in the more northern one, empty for four years!).

The siting of the second one is economically curious, because while five blocks from Wrigley Field and thus full of foot traffic (not to mention the high population density and economic and demographic diversity), this area is not bereft of grocery options: Jewel at 3531 North Broadway (a traditional grocery store, on the small side), Treasure Island at 3460 North Broadway (a Chicago institution, christened by Julia Child as the “most European grocery store in America”), and Whole Foods at 3640 North Halsted, about one block from the proposed Walmart Express. It’s also directly adjacent to a dingy and somewhat dilapidated Walgreens, which announced this week that it would revamp and build more produce-carrying stores in Chicago, targeting food desert neighborhoods.

What to make of this? I think it reflects the model I suggested a few years back about evolving grocery retail competition among Whole Foods, Trader Joe’s and Costco — this is a market characterized by simultaneous rivalry and product differentiation. The market in that neighborhood is big enough for all of those players, and if you made a Venn diagram of their target markets, you’d see some overlap, but not that much. Jewel has so-so produce and does the traditional coupon/loss leader competition, TI is smaller and gourmet focused, Whole Foods is healthy eating at a higher price point. I anticipate Walmart Express will use their existing supply chains for meats and produce, which are strongly imbued with environmental sustainability practices at their trademark low prices. My analysis of this particular market is that those who want better produce and meat but struggle to afford Whole Foods will be the target Walmart Express shopper — making them better off and generating profits for Walmart with little, if any, diminution of profit for Whole Foods. I’m not as sure about the outcome with respect to packaged grocery items and Jewel relative to Walmart Express; we’ll have to watch and see!

Of course, there’s also a local political story here, as described in this Crain’s Chicago Business story. Although the site does not require any zoning change, newly-elected alderman James Cappleman is miffed at having not been consulted directly by Walmart well in advance:

Alderman James Cappleman (46th), whose ward includes 3636 N. Broadway, says he heard about the deal from residents at a community meeting last week and was first contacted by Wal-Mart on Tuesday afternoon, after Crain’s initial inquiry.

“One of my concerns is I’m just now finding out about it,” says Mr. Cappleman, who was elected earlier this year and says he will seek input from the local chamber of commerce and neighborhood groups. “I’ve been very clear from the very beginning that I’m an alderman that works with the chambers and community organizations. We need to hear from any interested business very quickly so we can make decisions about what’s best for this community.”

I reject Cappleman’s top-down “I’ll be the judge of what’s good for the community” attitude. Just because he’s the elected alderman of the neighborhood does not make him the ultimate arbiter and gatekeeper for what is “good for the community”. Sadly, in Chicago (and I suspect other places too), aldermen have developed an entitlement attitude on this subject, and often act as gatekeepers for the protection of the political class in their ward, rather than the largely silent distributed community. I’ll be interested to see the consequences of this evolution.

Posted in Chicago, Economics | Comments Off

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Richard Epstein on a “declining United States”

July 4, 2011

Lynne Kiesling

The Independence Day holiday is a good day to reflect on the values and principles that animated the American Revolution and the origins of the United States. Given the continuing erosion of our civil liberties, including economic liberties, this year that reflection is more important than ever; as I’ve done before I’ll invoke Thomas Jefferson on this subject: “All tyranny needs to gain a foothold is for people of good conscience to remain silent.”

So Richard Epstein’s essay last week about Derek Jeter and a “declining United States” resonated. Epstein argues that at a policy level (and, by implication, culturally as well to some extent) we are exhibiting the indecision, the tweaking, the second-guessing that aging athletes attempt to regain some of their peak capabilities. I don’t necessarily agree with Epstein’s entire argument in this piece, but given how gloomy my outlook has been on this front for the past few years, I want to look for reasons for optimism, and to highlight what I see as Epstein’s salutary vision for a thriving, successful, rejuvenating nation:

The secret of success for those nations that are in their prime is that they do a few tasks confidently and well. They run a strong military to keep peace at home and to help stabilize matters abroad. They worry about the maintenance of a simple tax system with low rates, a system intended to create a certain and friendly environment that maximizes returns to capital and labor. They know the importance of the security of contractual transactions and the dangers that come from erratic efforts to jump-start an economy. They praise their inventors, authors, and innovators. They treat excellence as an imperative. They take care of their unfortunates, but do not easily accept excuses for poor performance.

Remaining true to these guiding principles pays large social dividends. It helps shrink the size of government, and it reduces the level of political intrigue that saps the vitality of a nation with one gimmick after another. … It embodies a quiet efficiency that spurs individual achievement and wealth creation, which in turn sets the stage for a new round of innovation and improvement.

In broad brushstroke, this is a vision worth keeping in mind as we grapple with the policy, Constitutional, and public finance challenges facing us.

Posted in Liberty | Comments Off

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Protesting the crime of cycling while skirted

July 3, 2011

Lynne Kiesling

I’ll give you three guesses what I’m planning on today — bike bike bike bike bike! The forecast looks promising, and I can’t think of a better way to spend a long holiday weekend than outside on my bike, in my kayak, etc. So today’s post is bike themed.

In late May, a Dutch tourist was cycling around New York City while wearing a skirt. A police officer stopped her, asked for her ID, and reprimanded her for cycling while skirted … because she was distracting drivers! As Gothamist put it, biking while sexy. Whether this was a ludicrous overextension of authority or a ludicrous case of projection on his part (or he was just trying to hit on her in a lame sort of way), it was indeed ludicrous since she was allegedly obeying traffic laws in her two-wheeled perambulations. From the Gothamist article:

As we noted yesterday, it is decidedly not illegal to wear a skirt while cycling. You won’t even find that “violation” under the NYPD’s questionable “cheat sheet” for cyclist rules, which is part of their massive cyclist crackdown.

Happily, a grassroots protest to this event emerged, which led to a cycling while skirted protest ride in New York on Thursday evening. Look at those delightful photos! How many strong, stylish, happy women (and one man) cycling in skirts! The first photo is of Jasmijn Rijcken, the Dutch cyclist who returned for the event, and who is also general manager of the VANMOOF bicycle company. As noted in New York Press’s post-ride post:

According to those involved with the Skirts on Bikes ride last night, over a hundred cyclists participated to show support for stylish (and potentially skimpy) riding. Jasmijn Rijcken, who was the Dutch cyclist allegedly stopped by a police officer in early May while riding her bike dressed in a skirt, traveled back to New York City to join the cause. ”Usually you feel fragile on a bike, last night we felt powerful,” Rijcken said. “It’s what bicycling should be: positive, friendly and joyful.”

One caveat: even though it’s a hairstyle buzzkill, they should all be wearing helmets, any time they’re riding, no matter how short or slow the ride.

HT: Courtney Knapp (thanks, Court!)

Posted in Sport and fitness | 4 Comments »

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New York regulators take steps toward allowing fracking for natural gas production

July 1, 2011

Michael Giberson

Today the New York Department of Environmental Conservation took a few steps toward permitting fracking of natural gas wells, a process necessary to produce natural gas from underground shale formations. Regulatory processes being as they are, it likely means fracking will remain off-limits in the state for some time.

News reports include favorable reactions from both industry-group Energy in Depth and an attorney at the Natural Resources Defense Council, which seems like a sure indication that something is wrong. ;-)

Posted in Energy markets, Environmental policy, Regulation | Tagged , | Comments Off

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Antitrust as the enemy of innovation, and therefore the enemy of consumers

July 1, 2011

Michael Giberson

Antitrust regulators at the FTC have taken adverse interest in Google’s activities. At Regulation2point0, Robert Hahn and Peter Passel comment (links in original, highlighting added):

… perhaps the FTC probe may prove to be just another minor bump on the road to riches.

But there are reasons to believe that it will prove to be a big distraction. The investigation will apparently focus on the search-advertising business, which is Google’s bread and butter. And the specific concern – that the company is using its pre-eminence in searches to direct consumers to Google-related enterprises – could be problematic because it potentially threatens Google’s ability to exploit economies of scope and scale.

This doesn’t necessarily mean, of course, that the rest of us should identify with Google’s worries. But the parallels with the global assault on Microsoft’s dominance in PC operating systems and Internet browsing, which in the end served hardly anybody’s interest, are troubling.

For starters, serial run-ins with regulators have a way of changing New Economy corporate cultures, and not for the better. An army of lawyers and consultants, who are paid not to think outside the box, gain influence over strategic planning. Why risk the wrath of government in the next acquisition, or the next challenge to other established enterprises? And along with the lawyers come the lobbyists, who in the process of speaking money to power further pollute American politics and policymaking.

This might all be worth it (from the public’s perspective), if one could count on antitrust policy to put the interests of consumers first. But antitrust is built on models of slow-changing markets in which the name of the game is to prevent sellers from charging more than costs. By contrast, high technology in general and information technology in particular is all about charging more than costs – that is, earning amazing returns on amazing innovations. And market concentration says more about who’s king of the hill now than who has the power to stop others from becoming king of the hill tomorrow.

Microsoft, you may recall, was pilloried for its “impregnable” advantage in Internet browser software thanks to the dominance of its Windows operating system. But somebody forgot to tell hundreds of millions of PC users, who turned to Firefox, Safari and Chrome when Microsoft became complacent – or too distracted by regulation to defend its turf with improved versions of Internet Explorer. Today, IE is down to 55 percent of the market – and its share is still falling in spite positive reviews for the latest version.

Ah, but Google really does have a hammerlock on web searching, you say.  Look again. In the past year, Google has lost 10 percentage points of the market, ironically, almost all of it to Microsoft’s Bing. Moreover, the mojo that made Google seem invincible seems to be wearing off. Yes, the Android operating system has made a giant splash in mobile devices, but not at the expense of Apple’s iPhone. Yes, Google’s efforts to move computing and information storage to The Cloud may yet pay off. But any number of competitors in the cloud, including Amazon, Netflix and Apple, are doing just fine.

Antitrust isn’t an idea whose time has come and gone. But it has entered a phase in which the old ways apply awkwardly, at best, to new industries. And the consequences of missteps – especially for economies like ours, whose only shield against senescence is innovation – are growing. Does it make sense to take Google down a peg? We’ll probably only find out when it no longer matters.

Antritrust regulations are too frequently the means by which imagined harm to consumers is used as a tool by one (or more) companies to hobble a more successful competitor. Maybe it isn’t “an idea whose time has come and gone,” but consumers would be better of if it were on the decline.

Posted in Economics, Politics, Regulation | 2 Comments »

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