Streetwise Professor

October 17, 2012

Ignorance Plus Arrogance on Energy

Filed under: Commodities,Economics,Energy,Politics — The Professor @ 12:53 pm

The jaw-to-jaw square up moment during last night’s Presidential Debate was over energy policy, of all things.  Politicians discussing energy is usually less than edifying, and last night was no exception.  But Obama took the prize for ignorance, complete with a huge dollop of arrogance-always a charming combination.  But it is his métier, non?

Specifically, in response to Romney’s attacks on administration policy regarding drilling leases on public land, Obama lauded the administration’s move to “use-it-or-lose-it” leases.  So let’s get this straight, absent his genius, oil companies would spend money to buy leases, and just sit on them out of spite?  Or something.

A lease is essentially an option.  It is an option to explore, develop, and produce.  There is optionality within each of these steps.  For instance, a leaseholder can undertake some preliminary exploration, and conditional on the results of that, decide to engage in additional exploration.

The value of this option depends on its maturity.  It also depends on the uncertainty regarding the geology.  Crucially, it depends on market prices-the price of oil or gas, the price of inputs needed for exploration, development, and production.  It also depends on the volatilities of these prices-which is true of any option.  It also depends on the amount of time required for each “sub-option”, e.g., each step of the exploration process.  This depends on the particular property at issue.

Use-it-or-lose-it basically means to shorten effective lease terms.  This reduces the value of the option.   By how much depends on all the factors I just mentioned.

So to the extent that “use-it-or-lose-it” means anything, it means that the administration is shortening the effective maturity of leases.   This reduces the value of the option . . . which reduces the amount companies will pay for leases . . . which reduces government revenue.  So Obama is bragging about a policy that reduces government revenue.  Got it.

Indeed, some companies will figure the leases are worth zero under the restrictions.  So leasing will decline.

There’s another way to see why this policy is so wrongheaded.  The E&P business is pretty competitive.  And E&P companies are not in the business of leaving money lying around.   If there’s money to be had by leasing a property and developing it optimally, a lot of companies will compete to do that.  In this competitive environment, lease prices will reflect pretty well the value of the property and the value of the options to develop it.  Inefficiently constrain those options, and competition will force down the prices of leases.

But we know that Obama has no clue as to how businesses, competition, and markets work.  This is just another superfluous data point in that empirical exercise.

That’s not all.  When you look at output, and the pattern of output over time, inefficient restrictions on the terms of options will lead to lower production, and inefficient exploitation of resources over time.  Some resources will be developed too quickly.  Others too slowly, or not at all.

This will, in turn, tend to increase prices.

And a bonus: inefficient production of hydrocarbons fro public lands will reduce government royalties from production.  Another revenue hit.

In summary: Obama bragged about a policy that is completely counterproductive.

But he is the smartest president EVAH.  Just ask him!

Idiocy updates: Some other Obama energy gems from last night.

The complete dodge on the Keystone XL pipeline:

And with respect to this pipeline that Governor Romney keeps on talking about, we’ve — we’ve built enough pipeline to wrap around the entire earth once.

That’s called bait-and-switch: asked about one thing, he answers about something else.  Furthermore, the other pipelines are neither here nor there.  Keystone should be evaluated on its own merits, which are quite strong.  And who is this “we” he is talking about?  Are he and Valerie and Michelle moonlighting on pipeline construction crews?

Favoring throwing good dollars after bad renmibi and Euros.  With respect to renewables, he said:

Because China, Germany, they’re making these investments. And I’m not going to cede those jobs of the future to those countries.

Yeah, they’re making these investments.  And losing money hand over fist on them.  Note to Barry: you don’t gain “jobs of the future” by taxing people engaged in wealth-creating activities to pay subsidies to those who engage in wealth-destroying activities.  Yeah, you might see the guy working on the wind farm (but don’t look at the dead bats!) but you don’t see the people who aren’t working, or who are working less, or who are working less productively because of the deadweight losses of taxes needed to finance the Green Unicorns.

It is beyond pathetic that solar companies-in China, the US, German, Spain, wherever-can’t make money even if they are subsidized.

This is something to imitate?  No.  This is something to observe-and avoid like the plague.

But the Genius President knows bettah.

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  1. With respect to the renewables, I suspect that the German calculation of the value of their investments has a variable that differs in your calculation. The Green Party has a significant presence in the Bundestag and there are a lot of laws in Germany in favour of ecology, including fines for not recycling goods that can be recycled and laws against un-necessary packaging. The Germans are presumably assuming that there is a significant risk of man-made climate change that would have a severe cost. By adding this variable, a small loss now (that they may consider to be affordable) is better than a catastrophic cost later. If you agree that this is a possibility, those investments are incredibly sensible.

    Comment by DVWilliams — October 18, 2012 @ 7:59 am

  2. @DVWilliams. Where to start? I know that my calculations differ from those of the Green Party, because those of the Green Party are cracked.

    A crucial distinction here is between command-and-control based on limited knowledge, and harnessing markets. Germany has gone the former route, and it is an exorbitantly costly way to achieve the environmental objectives you identify. (I’ll get to those objectives momentarily. For now I’ll take it as given that reducing CO2 produces benefits.)

    Germany has embarked on an elaborate “Energiewende” program that grows costlier by the day. It is ambitious, centrally directed, and almost certain to fail. It involves things like putting windmills in deep water and developing new transmission technology to move the power to the mainland and the construction of new transmission lines to reach consuming areas, such as Bavaria-about as far from where the power is produced as you can get in Germany. The cost of this program has already driven up electricity costs for Germans more than the government promised when they embarked on this. Moreover, it is running up against obstacles. For instance, it requires a vast increase in transmission capacity but local resistance is preventing the building of this capacity. So there may be windmills in the North Sea with no way of getting the power to Fritz in his lederhosen in Bavaria. Renewables-generated power is also clean in terms of emissions, but extremely dirty in terms of the quality of the power. High tech German firms have suffered costly breakdowns due to voltage variations (drops and surges) that are inevitable with renewables like wind and solar because there are drops and surges in wind and sun energy reaching the earth. So many are installing backup generating capacity with expensive control equipment. Where the generators are diesel powered, by the way.

    So even if you think the Green goals are laudable, this is an outrageously inefficient and control-freaky way to achieve them.

    If you think CO2 is a problem don’t dictate technology. Price CO2 and let individual decision makers find the optimal trade off between CO2 emission and the benefits of energy consumption, and to find the best ways to change that trade-off.

    And the Euros did that. Because of their economic malaise, emissions are down, and the price of carbon is very low.

    One more thing. This applies to California as well as Germany. These are large entities, but even if they reduce their emissions dramatically, it will be a drop in the bucket in light of increased emissions in China, India, and other EMs. So the Calis and Germans are imposing huge costs on themselves in the name of saving the earth, and will achieve nothing meaningful. Nothing. Even if Energiewende is fully implemented, its impact on global climate will be virtually nil. If we are doomed to catastrophic climate change if we don’t change, we are doomed to it with such elaborate and expensive measures. All pain, no gain.

    That’s why this seems to be a sort of ritualistic masochism, inflicting self-harm to prove to the world how morally superior you are.

    The ProfessorComment by The Professor — October 18, 2012 @ 11:51 am

  3. Thanks for the detailed reply. It’s clearly an area where laudable aims don’t fit with market dynamics and so incentives are put in place to try to tip the balance. Unfortunately, these attempts seem to have unforseen outcomes that don’t match the original intention, with practices that may end up doing more harm than good, as you have outlined.

    Comment by DVWilliams — October 19, 2012 @ 2:56 am

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