Streetwise Professor

May 26, 2022

Save the World: Nuke Davos

Filed under: Climate Change,Economics,Politics — cpirrong @ 5:55 pm

One of the few compensations of COVID was that the World Economic Federation meeting in Davos was canceled for two years. But all good things come to an end, and Davos is back, more malign than ever.

Of course the opening address was given by Klaus Schwab. (Aside: how come poor Appalachian whites are blamed for the evils of slavery, and the son of a for real hardcore Nazi gets a pass?)

He was touting “trust-based and action-oriented cooperation.” Orwellian doesn’t even come close to doing that justice. And nota bene: “cooperation” can be a synonym for conspiracy.

This is also Orwellian:

And finally. When it comes to business and economic activities, Davos is not a place for narrow self-interest. It is instead a place for the implementation of the notion of stakeholder capitalism, a concept I’m fighting for since 50 years. (Emphasis in original.)

A Forum partner is asked to value the contributions not just of shareholders, but of all those other stakeholders who are essential for business to succeed. As I wrote in my book Stakeholder Capitalism, Davos stands for a global economy that works for prosperity, people, and the planet.

“Stakeholder capitalism” is an oxymoron, and it is a synonym for fascism.

It is an oxymoron, because capitalism means that the owners of capital make the decisions on how it is used. Marxists have never liked the way that capitalists used it, which is why they wanted to expropriate it. At least they were honest, and didn’t say they were advocating “socialized capitalism.” “Stakeholder capitalism” means that those who don’t own something can nonetheless dictate how to use it, because they have some self-asserted “stake” in it. Using the word “capitalism” is a clever trick to seduce non-Marxists into believing that what Schwab et al are advocating is just a kinder, gentler version of a free market economy, when in fact their agenda is profoundly anti-capitalism and anti-freedom.

“Stakeholder capitalism” has no limiting principle. It can be used to claim control over anything anywhere anytime based on some Six Degrees From Kevin Bacon theory of somebody having a “stake” in it.

Though I would not recommend claiming that you have a stake in a fancy dinner at Davos. The WEF police (yes, they exist) will arrest you for sure.

It is a synonym for fascism because it is a variant on corporatism, which is the essence of the fascist economic model (as I’ve written before). Note the “cooperation” in the title of Herr Schwab’s speech: cooperation among stakeholders (namely, the state, corporations, and labor unions) was touted as the main virtue of fascist economics and governance. The stakeholders may be a little different (labor, for example, is barely even an afterthought at Davos), but the idea is functionally identical.

Now, Fascism 2.0 does have some differences with Fascism 1.0. The latter was avowedly nationalist, something which the former detests: it is avowedly anti-nationalist, and indeed globalist. “WEF” is more accurately an acronym for “World-Extensive Fascism.” It is the bastard child of world government types and economic fascists.

The WEF is also fascist in its utter antipathy for individual liberty and freedom. The most anti-freedom threat on the horizon–central bank digital currencies–was praised to the skies. And free speech? Well, you know, that needs to be “recalibrated.” (Inman is basically a less crazy-eyed version of Nina Jankowicz.) And you all just need to change the way you eat, got it?

I could go on.

The main moving force behind the WEF agenda is “climate change.” It is the existential threat that “stakeholders” need to “cooperate” on to fight. It is the primary reason why “stakeholder capitalism” has no limiting principle, because everything–I mean everything–supposedly affects climate, so everybody has a stake in it, so our enlightened WEF leaders acting benevolently on our behalf can reorder everything because climate change.

All of the nostrums that are being pushed will make energy and food more expensive. A lot more expensive.

Not that this lot cares. After all, energy and food expenditures represent a trivial fraction of their incomes. So they won’t feel a thing!

You, not so much. And the poorer you are, the more you will feel it.

Of course, these . . . people . . . claim to be acting on behalf of the poor. Because, of course, climate change hurts the poor most we’re told. Except that all of these assertions are highly speculative (at best), and the purported evidence supporting them is based on junk science.

Just like WEF-endorsed COVID policies (e.g., lockdowns), the cost of WEF-endorsed climate change policies will exceed the cost of climate change itself. And the cost difference will be greater, the poorer you are.

These people are your enemies. And the less well off you are, the bigger enemy they are.

You might think that the title of this post is hyperbole. You might want to think again.

Print Friendly, PDF & Email

May 3, 2022

Samantha Power: Speaking of Manure, She’s Full of It

Filed under: Climate Change,Economics,Energy,Politics — cpirrong @ 12:28 pm

In the latest episode of Condescending Lectures From Our Betters: Shut Up, Proles!, Samantha Power (the Lioness of Libya) recently “informed” us that the drastic decline in the supply of chemical fertilizers is actually a good thing, as it will wean farmers off these horrible concoctions, and induce them to use natural alternatives like manure and compost instead:

This is so bat shit delusional I don’t even know where to begin. Following Power’s advice would ravage agricultural productivity and condemn literally billions to starvation. And as if there isn’t a real time, ripped from the headlines case study that proves the insanity–and evil–of her prescription.

And, where, pray tell, is the manure to come from, if we follow another ukase of the ruling class, namely the war on meat and livestock? After all, livestock belch and fart, producing methane–and we can’t have THAT, can we? For example, Ireland is supposed to cull 1.3 million animals, and Northern Ireland another 1 million, to meet GHG emission standards.

No animals, no shit. No shit!

So we are supposed to become vegans, eating gruel produced from plants fertilized by livestock that don’t exist–smart! What would we do without smart people telling us how to live?

And even if meat survives, if you haven’t noticed: (a) collecting the manure of pasturing animals would cost rather a lot, and (b) pastureland and small grains farmland tend to be located rather far apart (because the former is not suited to be the latter), transporting the manure of pasturing animals to the fields would cost rather a lot (not to mention involve the release of massive GHGs–or did I forget that it would be transported in electric vehicles powered from wind and solar generators?)

In other words, Samantha Power is completely full of shit. As if you should have needed me to tell you that.

This is just another example–an egregious one, admittedly–of the utter insanity of those who presume not just to tell us how to live–but who presume to force us to live according to their obsessions. The utter unreality of the “energy transition” is another example.

You could get the idea that these people want to kill us. And in fact, you may be right. Based on the evidence, you cannot reject the hypothesis.

Print Friendly, PDF & Email

April 9, 2022

When People Talk About Zero This or Net Zero That, Zero Is a Good Approximation of Their IQ

Filed under: China,Climate Change,CoronaCrisis,Economics,Politics — cpirrong @ 11:34 am

The optimal amount of any “bad” (e.g., crime, cancer) is very, very seldom zero.* This is because the marginal cost of reducing a harm increases (typically at an increasing, and often rapidly increasing, rate): eventually the cost of reducing the harm further exceeds the benefit, usually well before the harm is eliminated.

Unfortunately, a good fraction of the world is in the thrall of those with Zero obsessions who ignore this fundamental reality. COVID and climate are the two most telling examples.

Countries pursuing “zero COVID” strategies have subjected their citizens to draconian measures that have deprived them of the blessings of normal human interaction, and freedom of thought and movement. Children especially have been brutalized, losing two years of schooling, socialization, and even the ability to speak and understand and interpret the non-verbal due to absurd masking requirements.

This brutality has unsurprisingly reached its zenith (or nadir, if you prefer) in China, a nation of 1.3 billion governed by a despotic regime that has gone all in on Zero COVID. The outbreak of COVID in Shanghai after years of restrictions proves the futility of the objective. The CCP’s response to the proof of the futility shows its insanity.

In response to the outbreak, the regime has locked down a city of over 26 million people. And this ain’t your Aussie or Kiwi or American or Brit or Continental lockdown, boys and girls: this is a hardcore lockdown. Mandatory daily testing, with those testing positive sent right to hospital, symptomatic or no–despite the fact that this has overwhelmed the medical system and is depriving truly sick people of vital care. Children separated from parents. People locked in their abodes, often without adequate food. Pets slain.

It is draconian–and dystopian.

The other prominent example is “Net Zero” carbon emissions. This has become the idol which all the right thinking bow down before, especially in the West. Governments, financial institutions, and other businesses (especially in the energy industry) are judged based on a single criteria: do their actions contribute to achieving “net zero” emissions of greenhouse gases? And woe to those who do not pass this judgment.

It is absurd. And it is absurd because the monomaniacal focus on a single measure immediately banishes all considerations of trade-offs, of costs and benefits. The implicit belief is that the cost of carbon is infinite, and hence it is worth incurring any finite cost–no matter how huge–to achieve it.

And the costs are immense, have no doubt. In particular, the environmental costs–the production of battery metals involves massive environmental costs, for example–are huge. Yet they are ignored by people who preen over how green they are. Because to them, Only One Thing Matters.

This is beyond stupid. Those who will impose any cost, and force others to bear any burden, in order to achieve some Zero reveal that that number is a good approximation of their IQ.

Upon reflection, I believe that the worship of Zero is a mutation of the worship of central planning with dominated the pre-WWII era, and which was supposedly discredited by experience (e.g., the USSR) and intellectual argument (e.g., Hayek, von Mises). Central planning involved the determination by an elite of an objective to be achieved by a society, and the use of coercion–at whatever level necessary–to achieve that objective. Actually, compared to the Rule of the Zeroes, central planning was quite nuanced: it usually did involve some acknowledgement of trade-offs, whereas the Rule of the Zeros does not, with everything–literally everything–being subordinated to the One Zero.

But ultimately, central planning foundered on the reef of its internal contradictions. Attempting to impose a singular objective on a complex, emergent system consisting of myriad individuals pursuing their own idiosyncratic goals was doomed to failure. And it did. But only after inflicting tremendous costs in terms of human lives and human freedom, not to mention human prosperity.

The fundamental inconsistency between emergent and imposed orders meant that central planning required the application of massive coercion. The same is true in the Rule of Zeroes. This has been particularly evident in the case of COVID: what is going on in Shanghai proves this beyond cavil. But the same is inevitable for Net Zero. To impose a centrally dictated objective, and a unidimensional one to boot, on complex societies comprised of billions of individuals with extremely diverse preferences and capabilities is to wage war on human nature, and humanity. Sustaining it necessarily requires the application of massive, and massively increasing, coercion. Because it requires people to “choose” what they would not choose of their own volition.

The populism so scorned by the elite is a natural reaction to this fundamental inconsistency. Whether Le Pen prevails in France or no, the mere fact that it is a possibility reveals the seething discontent of large numbers of folks at the presumptions of their betters. And this is just the latest example of the disconnect between the Zeroes who presume rule, and those whom they presume to rule.

It is a disconnect born of a fundamental misunderstanding of the basic social reality that life involves trade-offs, and that different people value trade-offs differently. That supposedly Smart People have Zero understanding of this reality is a shocking commentary on our “progressive” age.

*Note that I do not say “is never zero.” That would be a paradox, no?

Print Friendly, PDF & Email

February 28, 2022

Reality is a Mother

Filed under: Climate Change,Commodities,Economics,Energy,Politics,Russia,Ukraine — cpirrong @ 11:09 am

The Russian invasion of Ukraine has not shocked and awed the Ukrainian military, but it has shocked and awed Germany, fo’ sho’.

In a period of hours over the weekend (and remember, German stores close promptly at 6 and are not open on Sunday), Germany announced that it will:

(a) Increase defense spending to 2 pct of GDP.

(b) Build two new LNG import facilities.

(c) Consider delaying decommissioning its nukes.

(d) Consider all options for energy, including gas, nuclear, and coal: there are no longer any “taboos” on energy sources.

What will Greta say?:

The Germans are saying, in effect: Go away girl. The shit just got real.

I note that (a) and (b) topped the list of Donald Trump’s harangues against Germany, which caused the ruling class to shriek in anger: how dare he insult our dear allies? Actions speak far louder than an apology.

Alas, this reality therapy has not penetrated the thick skulls of the Biden administration. When asked about reversing Biden administration anti-fossil fuel policies, spokesmoron Jen Psaki instead continued to ride the renewables hobby horse. She thereby reinforced the message of the Most Clueless Man in the World, John Kerry, whose big concern about Ukraine is that it might distract Vladimir Putin from focusing on climate change.

Yes, reality is a mother. Enough of a mother to snap even the dreamy Germans out of their green and pacifistic reveries. But not enough of one to do the same in the Biden administration.

Print Friendly, PDF & Email

February 9, 2022

Spin the Bottleneck: The Location of the LNG Bottleneck Is Now Blindingly Obvious

Filed under: Climate Change,Commodities,Economics,Energy,LNG,Politics,Regulation — cpirrong @ 10:36 am

When playing Spin the Bottleneck with my students I say to look at what lies between the price of a transformed and untransformed commodity to identify the bottleneck. In my earlier post on the gaping spread between European (and Asian) LNG prices and the price of US gas (which is on the margin for both destinations) I noted two possible constraints: shipping and liquefaction capacity.

Well, it ain’t shipping.

There is a surfeit of LNG shipping capacity. So much that LNG shipping is effectively free between the US and Europe (down from $273K/day in December). Yet the spread remains very wide. So the binding constraint is definitely liquefaction capacity, in the US in particular. Those who have the rights to that capacity–notably firms that entered into contracts with the likes of Cheniere or Freeport that buy gas at the US price and pay a contractually fixed liquefaction/tolling fee–are coining it. They capture the bulk of the existing spread between TTF or UK Balancing Point prices and Henry Hub. (The LNG companies are benefitting only to the extent that they reserved some of their capacity for their own trading, which is rather de minimis).

So in the short run liquefaction capacity is quite valuable. The question is what will its value be over the longer term? Will current events convince enough financiers to provide capital for a large expansion of US capacity? Given the long gestation period of these projects it is a hard issue for banks and equity to analyze.

One thing to note. Another thing I discuss extensively in my classes is the importance of government/regulatory bottlenecks. Such bottlenecks may be a constraint on expansion of US LNG capacity. Many of the projects under development do not have the requisite federal permits. The Biden administration is unlikely to grant more. Thus, like taxicab medallions in NYC, existing permits likely have a substantial scarcity value–thanks to a government-created bottleneck.

This has interesting implications for financing of US LNG projects. Financiers of a given project face less risk of a glut of capacity coming online in a few years, and this should make them more willing to finance already permitted projects. But, of course, they are taking on political risk by doing so: might a new administration change course post-2024? Or might political pressure induce a change in course by the current administration? There are already a lot of political risks in investing in anything fossil-fuel related (attributable to climate hysteria). This is a US LNG-specific risk.

Print Friendly, PDF & Email

December 26, 2021

No Blood For Batteries?

Filed under: China,Climate Change,Economics,History,Military,Politics,Russia — cpirrong @ 5:46 pm

The latest hyperventilation over Russia relates to the alleged involvement of the Wagner Group–Russian mercenaries/paramilitaries–in Mali. Wagner is run by “Putin’s Chef,” Yevgeny Prigozhin.

Russia denies involvement. Wagner denies involvement. Mali denies involvement. Since none of them are remotely trustworthy, I will accept as true that Wagner (or some other Russian entity) is involved.

At one level, one could answer “So what?” or even “Good!” Western militaries, notably American and French, have been involved in the Sahel for years. The US involvement has been marked by some tragic events, notably the destruction of a US Army Special Forces team in Niger and a murder of a Green Beret by other US special operations members in Mali. France recently withdrew its troops from Mali after 8 years of inconclusive fighting that resulted in the deaths of 52 French soldiers, including a highly decorated special operator. (And which also saw two coups in Mali. So much for creating stability.)

The American and French efforts had little effect on Muslim insurgents. So why not let the Russians have a go, if the real objective is to kill Salafists–and the objective isn’t worth American or French lives?

But this level is likely a very superficial one, and that is likely why there has been such alarm at Russian involvement. West and central Africa, including the desolate Sahel region, are now the cockpit of a 21st century version of a “great game” not so much because of ISIS or Al Qaeda, but because of . . . batteries.

And unlike the Great Game of the 19th century, which involved Russia and Great Britain, the 21st century game in Africa involves Russia, the West (especially but not exclusively the US), and notably China. The largely desolate and desperately poor region which the world’s richest nations are contesting is of increasing importance because it is disproportionately endowed with materials like lithium, copper, and cobalt, all essential for the manufacture of batteries or other components for electric vehicles that the alleged green elites in the West claim will be our climate salvation.

And don’t think that the Salafists are solely motivated by religious fervor–they no doubt understand the economic calculus as well. If oil made Saudi Arabia, another otherwise desolate and impoverished region, what economic power could control over lithium, copper, and cobalt create? Oil fueled Wahhabism. EV materials could well fuel another radical Islamist movement.

A rallying cry of the left, and especially the environmentalist left, from the 70s onward was “no blood for oil!” No doubt their CO2 monomania, and the resultant obsession with electrifying everything and especially electric vehicles, has blinded them to the inevitable if unintended consequences of their idée fixe.

Specifically, realizing their vision will require vast amounts of materials. Put aside the environmental consequences of mining for these materials. Focus on the geopolitical consequences. These minerals are found disproportionately in vast, violent, and largely ungoverned spaces. Control over them can be achieved only by violence, and even if violence was not necessary, the incentive for unscrupulous governments and corporations to utilize violence to capture the rents these resources promise (especially in an electronic world) is great indeed.

Furthermore, the powers contending for these resources are facing off on every continent, and are armed with nuclear weapons. What starts in Africa is unlikely to stay in Africa. And something could very well start in Africa. Great Power conflicts almost erupted in Africa on several occasions in the era of imperialism, when the economic stakes were far smaller: what did Fashoda matter, really? Yet Britain and France almost went to war over it. The stakes are far larger now.

Especially in a world obsessed with replacing petroleum with electricity.

Methinks that the evident panic over Russians in one of the world’s armpits really has little to do with the stated reasons: again, why would France or the US mind if Russians killed Salafists, and took the casualties necessary to do it? Instead, the panic is over the prospect of an impending struggle between the US/Western Europe, China, and Russia over a vital economic resource in an ungoverned region that requires organized violence to control it.

Environmentalists are so absorbed in their monomania that they are oblivious to the unintended consequences thereof. They have lectured us for years about no blood for oil. What about blood for batteries? Because that is the inevitable consequence of replacing the former with the latter.

They need to be forced to face this reality and to own the consequences of their obsessions. Now.

Print Friendly, PDF & Email

July 12, 2021

Elon’s On Fire!

Filed under: China,Climate Change,Cryptocurrency,Energy,Tesla — cpirrong @ 6:29 pm

No. Wait. That was a Tesla in Taiwan City.

But Elon did ignite some (metaphorical) pyrotechnics in a Delaware Chancery courtroom with his fiery defense of the Solar City deal of 2016. My criticism of the deal at the time–which inspired some of my better lines, IMO–is the gravamen of the shareholder lawsuit against Musk. Namely, that the Tesla purchase of Solar City was a bailout of a sinking Solar City, mainly driven by Elon’s desperation to avoid a blow to his reputation as a visionary genius.

Nothing in what I’ve read about Elon’s testimony changes my mind. Ya sure the Tesla board was totes independent of him. Ya sure he did not dominate the board. Ya sure the deal made sense on the merits. Whatever, dude.

All that said, I surmise that the plaintiffs have a difficult hill to climb. Proving, legally, in court, what we all know to be true is sometimes a very difficult thing. That’s probably a good thing, but that’s a statement about the average–not any particular case.

That said, since the Solar City deal Tesla’s stock price, unlike Elon, has gone to Mars. It’s about 20 percent off its all time high in January, but still about 15 times above its June, 2015 price, which I thought was inflated then. So what do I know?

The most logical explanation to me is that $TSLA is not so much a bet on Tesla qua Tesla, or Musk qua Musk, but on government policies around the world that seem hell bent on forcing us all to drive electric cars, never mind fire risks (and Taiwan City is not a freak event), or the environmental costs of mining, or the insanity of renewables, or the increasing inability of electrical grids to handle existing demands let alone massive new ones such as that arising from electric autos, or on and on and on and on. Tesla is a first mover in electric vehicles, governments are compelling the shift to electric vehicles regardless of all the myriad problems, so Tesla stock booms. It’s not an efficiency story or an innovation story. It’s a wealth creation (for Tesla shareholders) by wealth destruction (the rest of us) story.

A couple of other Tesla/Musk-related comments that have struck me recently but not sufficiently to catalyze a post.

Tesla is having problems in China. Musk assiduously courts China. Musk makes huge sunk investments in China. China shtups Musk.

This storyline alone is sufficient to make you question Musk’s acumen. Did he really think that China would not act opportunistically? FFS. Opportunism ‘R Us is the CCP motto. Look at how the CCP is shtupping domestic tech companies (and those foolish enough to invest in tech company IPOs). If that’s what they do to “their” companies, what can foreign devils expect? Foreign devil Elon apparently thought he was special. He ain’t.

Crypto. Elon’s pronouncements can cause massive movements in cryptocurrency prices. This alone is enough to demonstrate the utter arbitrariness of crypto. Why should the value of anything depend on the musings of a mercurial and megalomaniacal individual other than the things that individual can control? Especially when said mercurial and megalomaniacal individual no doubt derives immense glee from watching people jump to his tune? That incentivizes him to say ever more outlandish things. Which the KoolAid drinkers respond to, which just incentivizes him more.

Why do his musings matter? Because people believe they matter.

In coordination games sunspot equilibria exist. In sunspot equilibria, values/prices change in response to a variable that people think matters, even though it is totally unrelated to fundamentals. Currencies–including cryptocurrencies–have a coordination game aspect where expectations matter. The value of currency (or a cryptocurrency) depends on what people think its value is, or what they expect it to be. If people believe that variable X–e.g., what Elon Musk tweets–matters, then X will matter.

That is apparently the case with crypto: whatever Elon says, cryptos do, at least to a considerable degree. What is more bizarre is that whereas “sunspots” are exogenous, Elon’s pronouncements are endogenous–he says what he says almost surely based on the fact that he knows that what he says will move prices. Yeah, that’s exactly the kind of power you want to give a megalomaniac.

Exogenous/extrinsic uncertainty can lead to excessive volatility. Crypto suggests that endogenous uncertainty a la Musk creates massive excess volatility.

So you want to “invest” in crypto why, exactly? To speculate on Elon’s mood swings and narcissism? To speculate on how other speculators speculate on Elon’s mood swings and narcissism? To speculate on how other speculators speculate on how speculators speculate on Elon’s mood swings and narcissism. (To complete this post, continue ad infinitum.)

Print Friendly, PDF & Email

June 29, 2021

Betting on Time Inconsistency: Glencore Will Profit When Reality Intrudes on Renewables Reveries

Filed under: Climate Change,Economics,Energy,Politics,Regulation — cpirrong @ 6:01 pm

In his swan song at Glencore, the soon to retire Ivan Glasenberg doubled down on coal:

In what’s likely to be the final deal announced by outgoing Chief Executive Officer Ivan Glasenberg, Glencore agreed to buy stakes owned by BHP Group and Anglo American Plc in the Cerrejon thermal coal mine for about $588 million, subject to purchase price adjustments.

Glencore is filling a void left by two mining giants:

The sale completes Anglo’s retreat from thermal coal and extends similar efforts by BHP, amid investor pressure. However, Glencore has committed to run its coal mines for another 30 years, potentially allowing it to profit as rivals retreat. It’s already the biggest shipper of the fuel, and gaining full control of Cerrejon gives the company even more exposure just as prices trade at the highest level in years, buoyed by strong demand as the global economy rebounds.

In my opinion, this is a very canny contrarian bet. The panicked flight from coal by the Anglos and BHPs and others of the world is directly attributable to political and policy pressure. Hydrocarbons bad. Renewables good. Hydrocarbon companies are evil. You will be punished you carbon spewing bastards! Your CEOs will be snubbed by righteous people. Oh Noes!

But these policies are predicated on a collective delusion about renewables. Bloomberg can preach all it wants about how renewables are as efficient as conventional generation, but the fact is and will remain that dispatchable, reliable, continuous conventional generation, producing power from cheaply stored chemical energy, will remain much cheaper that non-dispatchable, intermittent, unreliable renewables that will have to rely on expensive battery storage. Bloomberg’s “levelized cost” metric is total bullshit because it leaves out all of the costs associated with reliability, transmission, and intermittency–details, details!

Renewables will never be able to handle current electricity demand at reasonable cost, but policymakers in the grip of the delusion are adding to electricity demand by forcing the electrification of other energy consumption, including transportation and home heating and cooking.

And it is almost certain that Glasenberg recognizes these delusions for what they are, and knows that in five to ten years time reality will rear its ugly head–recognition of reality can be postponed, but not forever. And Glasenberg recognizes when that reckoning comes, and electricity costs spike and reliability plunges, countries around the world will come begging for dependable electricity sources. And thus, they will come begging to Glencore for its coal.

The payoff will be all the bigger because Anglo, BHP, and others will not invest, leaving a capacity void. Price will rise to ration the limited supply.

Current government energy policies around the world are not time consistent. Political coercion to achieve a utopian outcome will result in more costly and less reliable energy that will not be politically sustainable. Ivan Glasenberg recognizes that time inconsistency, and as his parting gift to Glencore’s shareholders–and the world, frankly, when it comes to his senses–is an investment that will pay off handsomely when reality intrudes on renewables reveries.

Print Friendly, PDF & Email

February 21, 2021

Touching the Third Rail: The Dangers of Electricity Market Design

In the aftermath of the Texas Freeze-ageddon much ink and many pixels have been spilled about its causes. Much–most?–of the blame focuses on Texas’s allegedly laissez faire electricity market design.

I have been intensely involved (primarily in a litigation context) in the forensic analysis of previous extreme electricity market shocks, including the first major one (the Midwest prices spike of June 1998) and the California crisis. As an academic I have also written extensively about electricity pricing and electricity market design. Based on decades of study and close observation, I can say that electricity market design is one of the most complex subjects in economics, and that one should step extremely gingerly when speaking about the topic, especially as it relates to an event for which many facts remain to be established.

Why is electricity market design so difficult? Primarily because it requires structuring incentives that effect behavior over both very long horizons (many decades, because investments in generation and transmission are very long lived) and extremely short horizons (literally seconds, because the grid must balance at every instant in time). Moreover, there is an intimate connection between these extremely disparate horizons: the mechanisms designed to handle the real time operation of the system affect the incentives to invest for the long run, and the long run investments affect the operation of the system in real time.

Around the world many market designs have been implemented in the approximately 25 year history of electricity liberalization. All have been found wanting, in one way or another. They are like Tolstoy’s unhappy families: all are unhappy in their own way. This unhappiness is a reflection of the complexity of the problem.

Some were predictably wretched: California’s “reforms” in the 1990s being the best example. Some were reasonably designed, but had their flaws revealed in trying conditions that inevitably arise in complex systems that are always–always–subject to “normal accidents.”

From a 30,000 foot perspective, all liberalized market designs attempt to replace centralization of resource allocation decisions (as occurs in the traditional integrated regulated utility model) with allocation by price. The various systems differ primarily in what they leave to the price system, and which they do not.

As I wrote in a chapter in Andrew Kleit’s Energy Choices (published in 2006) the necessity of coordinating the operation of a network in real time almost certainly requires a “visible hand” at some level: transactions costs preclude the coordination via contract and prices of hundreds of disparate actors across an interconnected grid in real time under certain conditions, and such coordination is required to ensure the stability of that grid. Hence, a system operator–like ERCOT, or MISO, or PJM–must have residual rights of control to avoid failure of the grid. ERCOT exercised those residual rights by imposing blackouts. As bad as that was, the alternative would have been worse.

Beyond this core level of non-price allocation, however, the myriad of services (generation, transmission, consumption) and the myriad of potential conditions create a myriad of possible combinations of price and non-price allocation mechanisms. Look around the world, and you will see just how diverse those choices can be. And those actual choices are just a small subset of the possible choices.

As always with price driven allocation mechanisms, the key thing is getting the prices right. And due to the nature of electricity, this involves getting prices right at very high frequency (e.g., the next five minutes, the next hour, the next day) and at very low frequency (over years and decades). This is not easy. That is why electricity market design is devilish hard.

One crucial thing to recognize is that constraints on prices in some time frames can interfere with decisions made over other horizons. For example, most of the United States (outside the Southeast) operates under some system in which prices day ahead or real time are the primary mechanism for scheduling and dispatching generation over short horizons, but restrictions on these prices (e.g., price caps) mean that they do not always reflect the scarcity value of generating or transmission capacity. (Much of the rest of the world does this too.) As a result, these prices provide too little incentive to invest in capacity, and the right kinds of capacity. The kludge solution to this is to create a new market, a capacity market, in which regulators decide how much capacity of what type is needed, and mandate that load servers acquire the rights to such capacity through capacity auctions. The revenues from these auctions provide an additional incentive for generators to invest in the capacity they supply.

The alternative is a pure energy market, in which prices are allowed to reflect scarcity value–and in electricity markets, due to extremely inelastic demand and periodic extreme inelasticity of supply in the short run, that scarcity value can sometimes reach the $1000s of dollars.

Texas opted for the energy market model. However, other factors intervened to prevent prices from being right. In particular, heavy subsidies for renewables have systematically depressed prices, thereby undercutting the incentives to invest in thermal generation, and the right kind of thermal generation. This can lead to much bigger price spikes than would have occurred otherwise–especially when intermittent renewables output plunges.

Thus, a systematic downward price distortion can greatly exacerbate upward price spikes in a pure energy model. That, in a nutshell, is the reason for Texas’s recent (extreme) unhappiness.

As more information becomes available, it is clear that the initiator of the chain of events that left almost half the state in the dark for hours was a plunge in wind generation due to the freezing of wind turbines. Initially, combined cycle gas generation ramped up output dramatically to replace the lost wind output. But these resources could not sustain this effort because the cold-related disruptions in gas production, transmission, and distribution turned the gas generators into fuel limited resources. The generators hadn’t broken down, but couldn’t obtain the fuel necessary to operate.

It is certainly arguable that Texas should have recognized that the distortion in prices that arose from subsidization of wind (primarily at the federal level) that bore no relationship whatsoever to the social cost of carbon made it necessary to implement the kapacity market kludge, or some other counterbalance to the subsidy-driven wrong prices. It didn’t, and that will be the subject of intense debate for months and years to come.

It is essential to recognize however, that the underlying reason why a kludge may be necessary is that the price wasn’t right due to government intervention. When deciding how to change the system going forward, those interventions–and their elimination–should be front and center in the analysis and debate, rather than treated as sacrosanct.

There is also the issue of state contingent capacity. That is, the availability of certain kinds of capacity in certain states of the world. In electricity, the states of the world that matter are disproportionately weather-related. Usually in Texas you think of hot weather as being the state that matters, but obviously cold weather matters too.

It appears that the weatherization of power plants per se was less of an issue last week than the weatherization of fuel supplies upstream from the power plants. It is an interesting question regarding the authority of ERCOT–the operator of the Texas grid–extends to mandating the technology utilized by gas producers. My (superficial) understanding is that it is unlikely to, and that any attempt to do so would lead to a regulatory turf battle (with the Texas Railroad Commission, which regulates gas and oil wells in Texas, and maybe FERC).

There is also the question of whether in an energy only market generators would have the right incentive to secure fuel supplies from sources that are more immune to temperature shocks than Texas’s proved to be last week. Since such immunity does not come for free, generator contracts with fuel suppliers would require a price premium to obtain less weather-vulnerable supplies, and presumably a liability mechanism to penalize non-performance. The price premium is likely to be non-trivial. I have seen estimates that weatherizing Texas wells would cost on the order of $6-$9 million per well—which would double or more than the cost of a well. Further, it would be necessary to incur additional costs to protect pipelines and gas processing facilities.

In an energy only market, the ability to sell at high prices during supply shortfalls would provide the incentive to secure supplies that allow producing during extreme weather events. The question then becomes whether this benefit times the probability of an extreme event is larger or smaller than the (non-trivial) cost of weatherizing fuel supply.

We have a pretty good idea, based on last week’s events, of what the benefit is. We have a pretty good idea of the cost of hardening fuel supplies and generators. The most imprecise input to the calculation is the probability of such an extreme event.

Then the question of market design–and specifically, whether weatherization should be mandated by regulation or law, and what form that mandate should take–becomes whether generation operators or regulators can estimate that probability more accurately.

In full awareness of the knowledge problem, my priors are that multiple actors responding to profit incentives will do a better job than a single actor (a regulator) operating under low power incentives, and subject to political pressure (exerted by not just generators, but those producing, processing, and transporting gas, industrial consumers, consumer lobbyists, etc., etc., etc., as well). Put differently, as Hayek noted almost 75 years ago, the competitive process and the price system is a way of generating information and using it productively, and has proved far more effective in most circumstances than centralized planning.

I understand that this opinion will be met with considerable skepticism. But note a few things. For one, a regulator’s mistakes have systematic effects. Conversely, some private parties may overestimate the risk and others underestimate it: the composite signal is likely to be more accurate, and less vulnerable to the miscalculation of a single entity. For another, on the one hand skeptics excoriate a regulator for its failures–but confidently predict that some other future regulator will get it right. I’m the skeptic on that.

Recent events also raise another issue that could undermine reliance on the price system. Many very unfortunately people entered into contracts in which their electricity bills were tied to wholesale prices. As a result, the are facing bills for a few days of electricity running into the many thousands of dollars because wholesale prices spiked. This is indeed tragic for these people.

That spike by the way, is up to $10,000/MWh. $10/KWh. Orders of magnitude bigger than you usually pay.

It is clear that the individuals who entered these contracts did not understand the risks. And this is totally understandable: if you are going to argue that regulators or generators underplayed the risks, you can’t believe that they typical consumer won’t too. I am sure there will be lawsuits relating in particular to the adequacy of disclosure by the energy retailers who sold these contracts. But even if the fine print in the contracts disclosed the risks, many consumers may not have understood them even if they read it.

One of the difficulties with getting prices right in electricity markets which has plagued market design is getting consumers to see the price signals so that they can limit use when supply is scarce. But this will periodically involve paying stratospheric prices.

From a risk bearing perspective this is clearly inefficient. The risk should be transferred to the broader financial markets (though hedging mechanisms, for instance) because the risk can be diversified and pooled in those markets. But this is at odds with the efficient consumption perspective. This is not a circle that anyone has been able to square heretofore.

Moreover, the likely regulatory response to the extreme misfortune experienced by some consumers will be to restrict wholesale prices so that they do not reflect scarcity value. That is, an energy only market has a serious time consistency problem: regulators cannot credibly commit to allow prices to reflect scarcity value, come what may. This means that an energy only market may not be politically sustainable, regardless of its economic merits. I strongly suggest that this will happen in Texas.

In sum, as the title of the book I mentioned earlier indicates, electricity market design is about choices. Moreover, those choices are often of the pick-your-poison variety. This means that avoiding one kind of problem–like what Texas experienced–just opens the door to other problems. Evaluation of electricity market design should not over-focus on the most recent catastrophe while being blind to the potential catastrophes lurking in alternative designs. But I realize that’s not the way politics work, and this will be an intensely political process going forward. So we are likely to learn the wrong lessons, or grasp at “solutions” that pose their own dangers.

As a starting point, I would undo the most clearcut cause of wrong prices in Texas–subsidization of wind and other renewables. Alas, even if stopped tomorrow the baleful effect those subsidies will persist long into the future, because they have impacted decisions (investment decisions) on the long horizon I mentioned earlier. But other measures–such as mandated reserve margins and capacity markets, or hardening fuel supplies–will also only have effects over long horizons. For better or worse, and mainly worse, Texas will operate under the shadow of political decisions made long ago. And made primarily in DC, rather than Austin.

Print Friendly, PDF & Email

February 18, 2021

How Low Can Prices Go, and Why?

Filed under: Climate Change,Economics,Energy,Politics,Regulation — cpirrong @ 6:04 pm

A quick follow up to the previous post.

I noted that negative prices have been a thing in Texas for years. Indeed they are in every market with substantial renewables penetration.

This is particularly true in the US, where the Production Tax Credit pays qualifying renewables facilities $23/MWh to produce, regardless of prices. Meaning that a recipient of the PTC will continue to produce even if prices are -$22.99/MWh.

So why do prices go negative? In particular, why do other producers who do not get the credit continue to produce even when there are negative prices? Why don’t enough of them cut output to make sure that prices don’t fall below variable cost?

The answer in a word is: indivisibilities. Or, if you prefer, non-convexities.

Specifically, many thermal generators incur costs to shut down or start up. These are basically fixed costs, of the avoidable variety. A unit currently operating can avoid shutdown costs by continuing to operate. A unit currently idle can avoid startup costs by remaining idle. Minimum run times and ramping constraints are other examples of non-convexities.

So, for example, when demand is low and wind turbines continue to blend birds (and generate electricity), prices can go negative but a gas or coal or nuke plant may continue to operate (and incur fuel costs as well as incremental O&M) because it is cheaper to PAY to sell output (and pay variable costs as well) than it is to shut down.

If the cost of adjusting output of a plant to or from zero was zero, whenever prices fall below marginal operating cost the plant would shut down. This would put a floor on prices equal to marginal cost. However, if there is a fixed cost of adjusting output to or from zero, it can make sense to continue to operate even when prices do not cover variable costs–and when prices are negative–in order to avoid paying this cost of shutting down (and/or the cost of starting back up again when prices are higher).

Generation technology is such that efficient baseload plants (i.e., units with lower per MW variable costs) tend to have higher shutdown and startup costs, and more acute operating constraints that give rise to other forms of non-convexity. As in all things in life, there tends to be a trade-off: low variable costs must be traded off against higher avoidable costs/less flexibility to adjust output. Thus, negative prices hit such units especially hard. They are faced with the bleak choice between paying to sell what they produce, or paying a cost to avoid producing. Obviously this choice is bleaker, the costlier it is to avoid producing. For many, the cost of shutting down is big enough that they continue to spin even when prices are negative.

Economists have long known that non-convexities can interfere with the operation of a price system. If you look at classic Arrow-Debreu proofs of the welfare theorems (i.e., that competitive prices call for the efficient level of production and consumption), you’ll see that they assume that production technologies are convex. That is, they assume away things like shutdown and startup costs. When production technologies are characterized by non-convexities (e.g., fixed avoidable costs), the proofs don’t go through.

Indeed, an equilibrium in prices and output may not exist if indivisibility problems are sufficiently severe: in my earliest academic life, my work on applying core theory focused on this issue. If an equilibrium does exist, it may be inefficient.

Put simply, the invisible hand can get really shaky if indivisibility problems are severe.

Liberalized electricity markets (e.g., PJM and other ISOs) have devised various means of addressing these indivisibilities. The results are not first best, but the mechanisms allow an energy market with prices approximately equal to marginal cost to survive.

The subsidization of wind, especially through the PTC, greatly exacerbates indivisibility/non-convexity problems because its effects fall with particular force on generating units with more pronounced indivisibilities. These tend to be the most efficient, and also the ones most essential for maintaining reliable system operation.

This means that although renewables subsidies punish investment in thermal generation generally, they punish investment in units that operate nearly continuously at low cost with particular severity. Having these units available nearly 24/7/365 is vital for keeping electricity prices low, and for ensuring a highly reliable power system.

So the distortions caused by renewables subsidies, particularly of the pay-to-produce variety, are more severe than “we have too much renewables capacity and too little thermal capacity.” Yes, that’s a problem, but the distorted price signals also distort the types of generation invested in. In particularly, they are particularly punitive to generation with more acute indivisibilities. Since these also tend to be low operating cost, high reliability technologies, that is a very costly distortion indeed.

Print Friendly, PDF & Email

Next Page »

Powered by WordPress