Disruptions, Energy Markets and “Joseph and the Amazing Technicolor DreamCoat”

On 2014 April 22 as this year’s president of the National Capital Area Chapter (NCAC) of the U.S. Association for Energy Economics (USAEE), I will preside over NCAC’s 18th Energy Policy Conference, which this year has the title “Disruptive Technologies Shock All Energy Sectors.”[1]  These disruptive technologies will require additional infrastructures, such as pipelines, wires, refineries, and generators.  And, since we operate a free market economy in the United States, we will need dynamic markets to handle the effects of these disruptive technologies as we see a change in the way energy flows in North America.

Wind pockets in the Great Plains and West Texas need high capacity lines to transport the energy across space to areas where the need for electricity is greater.  We need ways to pay for those transmission lines.  In response to the intermittency associated with wind, we will need fast response generators and ways to pay those generators to operate only a small fraction of the year.

Some fast response generators will be storage devices.  A high price for storage devices providing electricity for a small fraction of the year will be meaningless unless there are low prices during the portion of the year that the storage devices are being recharged.  This will move electricity across time, using cheap electricity during periods of fat to provide electricity during later periods of lean.

Oil production areas in North Dakota and Montana need pipelines and rail cars to move oil across space to market.  For years, the availability of low cost oil pipelines has reduced the price differential across the U.S.  The lack of sufficient pipeline capacity has depressed the well head price of oil in the Bakken fields, reflecting the higher cost of rail transportation to refineries.  New oil pipelines will reduce this price differential.

The natural gas system has many storage fields.  I mentioned earlier electricity’s growing need for storage.  And petroleum and its refined products also need storage.  During January 2014, there was not enough propane in storage in the Midwest and prices soared.  The shortage could have been handled by more refined products pipeline capacity, but additional storage would also have been an option, perhaps a cheaper option.

Though the conference is about technological disruptions, the shortage of propane in January can be thought of as a weather disruption.  Some people say that we are experiencing climate change.  My first experience with a claim of climate change was in 1990, when Edith Corliss, a physicist with the National Institute of Standards and Technology, a bureau of the U.S. Department of Commerce, told me was that the weather at that time more variable than weather had been since the time of Christ.  Our summers were alternately either (A) hotter and dryer or (B) cooler and wetter.  Or to put it mathematically, we were seeing a greater statistical variance and standard deviation in the measured temperature and the measured rainfall.  The el Niños were getting more intense, as were the la Niñas.  We were not having more of one and fewer of the other, just seeing more intensity in each.

I am reminded of the stage musical  “Joseph And The Amazing Technicolor Dreamcoat.”  The DreamCoat refers to a vision by the pharaoh that Joseph interpreted as a climate disruption.  There were to be seven years of fat followed by seven years of famine.  Joseph then created a physical system and a market to handle this insider knowledge.  He stored grain during the years of fat and used the grain sparingly through the end of the years of famine.  In commercial parlance he bought low and sold high.  In legal parlance, he traded on insider information and made a killing.

We need new infrastructure to handle the growing disruptions created by technological changes.  But we also need dynamic markets and new market mechanisms in our free market economy.  At least that is my Technicolor dream.

[1] See the conference notice at WWW.NCAC-USAEE.org

Pricing Gasoline When the Pumps Are Running on Backup Electricity Supply

I attended the MIT Club of Washington Seminar Series dinner on Tuesday, 2014 February 11, which this year is on the topic of “Modernizing the U.S. Electric Grid,” listening to Michael Chertoff talk on “The Vulnerability of the U.S. Grid.”

Chertoff’s maguffin was a story about a hurricane hitting Miami in about 2005.  Electrical workers couldn’t get to work because they had no gasoline for their cars.  The gas stations had gasoline but no electricity to pump the gasoline.  Back-up electricity generators would have required an investment of $50,000 which was not justified on the razor thin margins on which most gas stations operate.

The gas station owners thought process was that the sales lost during the blackout would just be gasoline that would be sold after the power came back on.  Investment in a back-up generator would not change the station’s revenue and would just hurt its profitability.  My first comment during Q&A was that the same issues were raised after Hurricane Sandy[1] in the New York City area in 2012, and perhaps in many other areas that experience wide spread storm damage.

After the dinner I talked with Matthew, a friend from ExxonMobil who had learned about the Seminar Series from my advertizing it to people who attend events of the National Capital Area Chapter of the U.S. Association for Energy Economics.  Because of that linkage, he makes a point to search me out at each Seminar Series dinner.  Our after dinner discussion focused on how to make the $50,000 investment in a back-up generator profitable to the gas station owner.

Matthew said that many gas station permits including anti-gouging provisions, preventing the gas station owner from increasing the price during emergencies.  My thought was that the investment in back-up power supplies would mean that a temporary price increase could be justified to pay for such an investment.  After all, bulk electricity prices in Pennsylvania on the PJM grid during the cold snap associated with the 2014 January arctic vortex soared to $1,839.28/MWH ($1.84/KWH) from an average of only $33.06/MWH during 2012.  This was a temporary 55 fold (not 55%) change in the base price of electricity.[2]

I believe that prices are sticky.  Once set, prices tend to stay unchanged for significant periods of time.  The independent system operators (ISOs such as PJM) get around some of this stickiness by having elaborate models for setting prices every hour, with the basic mechanism setting a value every five minutes and then averaging those five minute values over an hour to get a price.  The basic mechanism includes (1) bids by suppliers as to the price they want if they are to provide specified amounts of electricity and (2) estimates of the demands that will occur each hour or that are occurring on a real time each five minutes.

Almost 25 years ago, long before the advent of ISOs, I published my first article[3] on using the measured real time imbalance between supply and demand to set the real time price for unscheduled flows of electricity.  Using the measured imbalance eliminated the need for bidding processes, bidding process that can lead to stickiness.  I proposed using the concurrent system frequency for setting the price, calling the concept Wide Open Load Following (WOLF).

For electricity, a surplus of demand will drag down system frequency, which I say warrants a higher price, at least higher than the nominal price.  A surplus of supply will push up system frequency, which I say warrants a lower price, at least lower than the nominal price.  Over longer intervals, imbalances will change the accuracy of wall clocks that use system frequency to determine the correct time.  Thus, WOLF includes the concept of time error in setting the nominal price for electricity imbalances.  The WOLF concept could similarly be used to set prices within each of the five minutes of an ISO dispatch period, or even on a sub-minute basis, modifying the ISO’s sticky five minute nominal dispatch value.

The State of California has variable pricing for its State Route 91 Express Lanes under the rubric of congestion management.

“On July 14, 2003, OCTA adopted a toll policy for the 91 Express Lanes based on the concept of congestion management pricing. The policy is designed to optimize 91 Express Lanes traffic flow at free-flow speeds. To accomplish this OCTA monitors hourly traffic volumes. Tolls are adjusted when traffic volumes consistently reach a trigger point where traffic flow can become unstable. These are known as “super peak” hours. Given the capacity constraints during these hours, pricing is used to manage demand. Once an hourly toll is adjusted, it is frozen for six months. This approach balances traffic engineering with good public policy. Other (non-super peak) toll prices are adjusted annually by inflation.

“Recent customer surveys indicate that 91 Express Lanes users lead busy lives with many hours dedicated to commuting to and from their jobs. About 85 percent of customers are married, with more than half raising children. Many customers choose the toll road only on days they need it most, joining general freeway lane commuters on other days. Customers emphasize they value a fast, safe, reliable commute and the toll policy strategy is designed to support this value.

“The toll policy goals are to:

  • Provide customers a safe, reliable, predictable commute.
  • Optimize throughput at free-flow speeds.
  • Increase average vehicle occupancy.
  • Balance capacity and demand, thereby serving both full-pay customers and carpoolers with three or more people who are offered discounted tolls.
  • Generate sufficient revenue to sustain the financial viability of the 91 Express Lanes.

“The effect of the toll policy has been an increase in customer usage with sufficient revenue to pay all expenses and also provide seed funding for general freeway improvements. Revenues generated by the toll lanes stay on the SR-91 corridor, a significant departure from past practices. Under the previous owner’s agreement with Caltrans, a “non-compete” provision restricted adding more capacity to the SR-91 corridor until 2030. When OCTA purchased the lanes, it opened the door for new improvements on SR-91 by eliminating the non-compete provision.[4]

The free flowing capacity of the 91 Express Lanes is 3400 cars per hour.  When average hourly volume exceeds 3200 cars per hour (about 94.1% of the free flowing capacity), the price increases by $0.75 at the beginning of the next six months.  When average hourly volume exceeds 3300 cars per hour (about 97.1% of the free flowing capacity), the price increases by $1.00 at the beginning of the next six months.  When average hourly volume is less than 2720 cars per hour (80% of the free flowing capacity), the price decreases by $0.50 at the beginning of the next six months.  The flow analysis is done for each hour of the week, producing 168 distinct prices each way on the 91 Express Lanes, that is, for 24×7 distinct hours each way.  But as of 2013 July 1, about 1/3 of the hours are charged the minimum price, that is, they are not considered to be super peak hours.   The flow analysis also is separately done for holidays, nominally as minor as Mother’s Day.

The 91 Express Lanes toll mechanism shows that some jurisdictions, including the notoriously protectionist State of California, allow incentive pricing for congestion management during critical periods, such as a wide spread blackout.  The 91 Express Lanes toll mechanism also provides a mechanism for automatic adjustment of the  price.  The 91 Express Lanes toll mechanism uses explicit measurements of the balance between supply and demand, much like the WOLF mechanism for electricity imbalances.  The 91 Express Lanes measurement is the fraction of the capacity of the 91 Express Lanes, changing the price when the hourly utilization is outside the band of 80.0% to 94.1%.

Based on a review of the 91 Express Lanes toll mechanism, there is some hope that gas stations will be able to afford the major investment in backup electrical supplies.  For gas stations, the measure of the imbalance between supply and demand can be as simple as the length of the line of cars waiting for gas or as complex as including the gasoline inventory compared to the desired level and the estimated time before the inventory is extinguished.



[1] Presentation of Adam Sieminski, Administrator of the U.S. Energy Information Administration at the 2012 October 19 lunch of the National Capital Area Chapter of the U.S. Association for Energy Economics (NCAC-USAEE.org).  Pursuant to its charter as an information agency, EIA created for Hurricane Sandy a real time display of gas stations with internet connectivity, a nominal measure of whether the gas station had electricity.

[2] PJM differentiates prices geographically.  Thus, one local price increased to $2,321.24/MWH and another fell to a negative $391.14/MWH because of transmission constraints.

[3] “Tie Riding Freeloaders–The True Impediment to Transmission Access,” Public Utilities Fortnightly, 1989 December 21.

[4] https://www.91expresslanes.com/policies.asp

Price Pressure on Input Capital Costs

We all know about the high cost of building nuclear power plants.  However, the operating costs are so low that the total cost of power out of a new nuclear power plant is just about competitive in the US electricity market.  According to the World Nuclear Association, as of 2013 October 1[1], there are 100 operable nuclear reactors in the United States and 3 under construction, equivalent to just 3% of the existing fleet.   In overseas markets, where the cost of competitive fuels are much higher, the total cost balance seems to be swinging in favor of nuclear power.  Outside the United States, there are 332 operable nuclear reactors and 67 under construction, or 20% of the existing fleet.

In light of some of these and other statistics, a cynical friend has suggested that the high construction costs are only tolerated because of the low nuclear fuel costs.  He suggested that as we see other fuels become more competitive with the cost of nuclear fuel, we will see price pressure put on the manufacturers of nuclear plants and of their component parts.  For those working in the electric industry, this is almost heresy.  The electric industry and their suppliers have a cost of doing business, a cost that is then recovered in the prices charged to their customers.  A lower price would mean a loss to the manufacturer, a loss they cannot afford.  Thus, the conventional wisdom is that there is little, if any, ability for competition to force prices lower, especially for the prices of capital equipment such as a nuclear power plant.  At least that is the conventional wisdom.

However, the electric industry has always had some competition.  Even small isolated utilities with two or more generators have competition in that the generators have to compete against each other to produce electricity at the least total cost.  This is the ancient concept of joint optimization.  The internal competition carried over with the formation of power pools and now with independent system operators.

The competition was not just an internal optimization but was also external.  Utilities buy and sell electricity with their neighbors on a competitive basis.  Most investor owned utilities are interconnected with two or more other utilities, with the interconnected utilities always attempting to sell electricity to their neighbors, which requires the selling utility to be cheaper than the price being offered by other utilities.  These prices would often be quoted for large blocks of power[2], and until recently didn’t have the finesse that has been attributed to power pools and independent system operators.  But the external transactions are still forms of competition.

So the concept of competition is not foreign to electric utilities, competition in the construction of nuclear power plants just hasn’t been in the forefront of the minds of utility executives, perhaps because of the small number of power plants that have been built.

Another friend, perhaps also a cynic, claims that drilling rig operators set their prices to extract much of the consumer surplus out of gas and oil fields.  He claims that the charge for drilling wells is greatly influenced by the expected profitability of the well.  Quoted prices are always low enough so that the field owner can expect to earn a return of his investment in about five years but are high enough so that the field owner can’t expect a return of his investment in less than three years.  My gas and oil friend’s claim is essentially the same as my cynical nuclear friend, that the construction costs go up and down based on the investment level needed for the facility to be profitable, whether it is a nuclear plant or a well expected to produce oil or natural gas.

This cynicism suggests that the United States should defer committing to new nuclear plants until the overseas rush as died down.  The nuclear industry has some limits on the ability to build new power plants.  The high price of fuel in overseas locations has made these locations to be more tolerant of high capital costs, more tolerant than in the United States, explaining some of the disparity mentioned above between the 3% growth in the United States versus the 20% growth overseas.  As the overseas nuclear building boom declines, maybe the cost of new nuclear power plants will decline, making them once again very competitive in the United States.



[1] http://www.world-nuclear.org/info/Facts-and-Figures/World-Nuclear-Power-Reactors-and-Uranium-Requirements/#.Uk2PQ1vD_IU

[2] “Electricity Is Too Chunky:  The Midwest power prices were neither too high nor too low.  They were too imprecise,” Public Utilities Fortnightly, 1998 September 1.

Oil Storage

During the Arab oil embargo of 1973, some people speculated that the US had a strategic petroleum reserve in the form of gasoline sitting in the driveways of most suburban homes.  The speculation was that many people made a point to refill their gas tanks as soon as ¼ of the tank had been consumed.  At that rate, the average amount of gasoline in this mobile storage was 7/8 of the tank.  By some calculations that was the equivalent of a month’s usage of gasoline.  Whether the mobile storage was indeed the equivalent of a month’s usage of gasoline or was much less, the storage capability was quite large.

 

During the question and answer period after Adam Sieminski, Administrator of the US Energy Information Administration talked to the National Capital Area Chapter of the US Association for Energy Economics on 2012 October 19 on the EIA Winter Fuel Outlet, I asked Adam about the possibility of oil supply interruptions in the Northeast, which is the area most heavily dependent on residential heating oil.  I included in my question a reference to the gasoline shortage in California that had pushed gasoline prices there more the 50 cents a gallon above the national average.

 

Part of Adam’s response included a discussion of the high elasticity of demand for gasoline, the time it took for tankers to move gasoline from other parts of the country, or from overseas, and that historically such price spikes lasted about five or six days, much less than the fourteen days necessary to ship gasoline the requisite distance.  Later I wondered about my above musings, about the mobile inventory of gasoline.

 

Do people respond to gasoline price spikes by a partial depletion of their individual mobile inventory?  Does the average gas tank level drop from 7/8 to ¾ to ½, or even lower, by only having partial fill-ups?   After all, some newspaper articles included interviews of workers who changed their fueling practices in include partial fill-ups.

 

How could we estimate the size of the partial drawdown of this mobile strategic petroleum reserve?  Or even the size of the mobile strategic petroleum reserve before the drawdown?  Does EIA have sufficiently fine data to make these estimates?  And how would a drawdown of this mobile reserve effect the elasticity estimates that Adam identified?

The Oil Spill Commission–Lessons Learned

I attended a dinner last night that included a presentation by William Reilly, co-chair of the Oil Spill Commission, who discussed their report, which is available with the following URL

http://www.oilspillcommission.gov/final-report

Reilly almost began with a comment that the Three Mile Island Commission report had effectively killed nuclear power in the US, in that the US has not built a nuclear power plant in over 30 years.  He didn’t want the Oil Spill Commission report to have a similar effect on drilling in the Gulf of Mexico.  We will see if it does.  I guess that the appropriate metric for that would be the number of new drilling rigs that are added in the Gulf, which would be the metric comparable to the metric of the number of new nuclear power plants added (or not added) over the last 30 years.

Reilly discussed a Report Card mechanism that the nuclear industry now has in place, with the power plant operators evaluating each other, a peer review program.  The executives of the plants that have the worst performance evaluation are effectively the subject of ridicule by the rest of the operators while the executives of the plants with the best performance evaluation are effectively given bumper stickers that say “My child is an Honor Roll student at . . .”  So they have created a system of bragging rights.

From what I have heard about the nuclear power industry, their performance metrics have dramatically improved over the last thirty years.  Plants are operating at much higher capacity factors.  That improvement could be attributed to the Report Card process.  I have also heard people say that the industry restructuring has given better (more) financial incentives to operators.  I am sure that the answer lies at neither extreme of this spectrum and probably includes other dimensions as well.  Whatever is the source of the improvement, the economy is better off with the improvement, even though we have not yet built a new nuclear power plant.

I commented during Q&A that the electric control area operators used to have such an Honor Roll system (they even identified utilities as being on the Honor Roll, using that term) for Area Control Error (ACE).  ACE is a metric brought about by the socialization associated with interconnecting competing power systems, about which I have written on my blog.  I then commented that the Energy Policy Act of 2005 instituted mandatory performance standards which are administered by NERC.  Reilly was unaware of the control area Honor Roll concept.  I haven’t participated in the process run by NERC, but have heard intimations of a peer review process for electric operations, which could be another Honor Roll.

I found interesting parallels between Reilly’s comments on the Mineral Management Service (now Bureau of Ocean Energy Management, Regulations, and Enforcement) and the three companies involved with the process.  MMS (now BOEMRE) did not have the budget to develop the expertise and manpower to do in depth inspections, seeming to accept the reports produced by drill rig operators.  Indeed, MMS (now BOEMRE) has many fewer inspectors per hundred wells in the Gulf than does California for wells on land in that state.  Similarly, BP seemed to accept the expertise of Halliburton and the drill rig owner. Both MMS (now BOEMRE) and BP relied heavily on the expertise of the group doing the work.  Afterwards an attendee commented to me that he was disappointed that Reilly did not identify a black hat or evil doer.  Maybe that reflected Reilly’s bent to avoid destroying the industry or major players in the industry.  I am reminded that the indictment of Arthur Anderson killed that company in the Enron fiasco of 2001.

During Q&A, Reilly compared prescriptive regulation with the peer review process.  After two or three years rules and regulation will be out of date and could actually be detrimental instead of just ineffectual.  In contrast, the continuing peer review process is always using best practices as those practices change continually.

The Market Can Handle “Peak Oil”

On Friday, 2010 December 17, I attended the NCAC-USAEE lunch with Robert Hirsch as the speaker.  Hirsch’s study of the petroleum industry has led him to accept the “Peak Oil” theory advanced by Matt Simmons, in which the world is running out of the supply of petroleum.  As Hirsch and others pointed out after the presentation, “Peak Oil” hysteria has occurred before, such as during the embargoes of the 1970’s, during the 1920’s, and even as early as 1860 when Pennsylvania said that Colonel Drake’s well, which began producing in Titusville in 1859, had only a few months of production.  Hirsch acknowledged the possibility of the fable of the “Boy Who Cried Wolf,” that again the doom and gloom might be overstated, though he feels this time is different.  But he finished with the reminder that the wolf finally did eat the shepherd boy.

Hirsch’s showed three specific Administrative Mitigation mechanisms, Rationing, Forced Carpooling, and Forced Telecommuting, and then spoke about the need for non-conventional supplies.  He also expressed a doom and gloom effect on the world economies as petroleum became scarce and prices rose.  Considering that the presentation was in Washington, D.C., it is almost understandable that the first mitigation measures Hirsch identified were Administrative.  But have lived through the “shortages” of the 1970’s, I am not sanguine about the feasibility of Administrative Mitigation.  I also believe that the market is more robust than is suggested by his doom and gloom prognosis, if only the market is allowed to operate without Administrative Mitigation.

During the early 1970’s, President Nixon’s administration developed wage price controls.  This concept was based on the wage price controls on which Nixon worked while in the Army during World War II.  Wage and price controls didn’t work well during the war, nor did they work well during the 1970’s.  Perhaps I am jaded in that respect because I got my first job after getting an SM from MIT’s Sloan School of Management in 1971 and for five years was told that I had to stay at the bottom of the pay scale because of the wage price controls.

But we also had oil embargoes that nominally created shortages in the US.  The government developed various forms of rationing, the most famous of which were limitations based on one’s license plate.  Odd license plate numbers were allowed to get gas on some days and even license plate numbers on other days.  Another time the federal government implemented regional allocations.  A friend tells of finding a gas station in DC and filling his car on a Friday.  On Saturday, he drove his wife to the Shenandoah region of Virginia, with his mind set being driving until his gas tank was down to half, and then turning around.  Because of the regional allocation, there was a surplus of gas in the Shenandoah, even sales at the gas stations.  So my friend was able to forget about his plan of driving only until his gas tank was down to almost half.  There was plenty of gas to get back to DC.

I don’t know whether Hirsch is correct about “Peak Oil” occurring in 2010-2012.  But if it does, I am optimistic about the market being able to handle it, certainly much better than the federal government did with odd/even license plates, regional allocations, etc.  “Peak Oil” would certainly cause some sort of a shortage, but the economy will respond, if we allow a market to operate.  The growth in the spot market for petroleum has been impressive, at least I keep hearing about the size of the spot petroleum market.  Some say that the market is three to five times the amount of petroleum that is delivered, depending on who you listen to and what is being measured.  Others point out that a significant portion of all petroleum deliveries are intra-company, not actually be sold in the spot petroleum market but transferred from Exxon’s production company to Exxon’s refineries.  The spot market may influence that transfer price, but such transfers are not part of the spot market.

2010 World Energy Outlook by International Energy Agency

Yesterday, December 3, I went to the International Energy Agency’s presentation of its 2010 World Energy Outlook in Washington, D.C.  I ended up with two takeaways, a claim that the demand for petroleum was less price-responsive than it had been and a claim about the huge fossil fuel subsidies being provided around the world, especially by those governments that are major exporters of fossil fuel.  Iran was identified as the leading “offender.”  These takeaways were reinforced after the presentation in talking with people I knew in the audience.

I mentally challenged the issue of a lowering of the price responsiveness of petroleum demand.  During the great petroleum price spike of 2008, the US made a political decision to finish filling the Strategic Petroleum Reserve.  This political decision was likely to distort any estimation of the price responsiveness of petroleum demand.  This was part of the reason I mentally challenged the claimed lowering of the price responsiveness of petroleum demand.  As an aside, two days earlier a friend had commented about testifying against the decision to finish filling the SPR, so that nugget was in my mind.  Also, I remembered a presentation about that time that China had also been making political decisions during the same time period that could have influenced the demand for petroleum further distorting the price responsiveness of petroleum demand.

I believe that the use of storage has a major impact on the price of commodities, whether the petroleum discussed specifically in this blog entry, or natural gas, electricity, and wheat.  I remember the Soviet agricultural crisis in the 1970s (?).  The federal government allowed the Soviets to export US wheat in large quantities.  Our wheat storage was full, almost overflowing.  Too late it became known that much of the wheat in storage had already been bought by the Soviets, who just needed the export licenses.  The wheat prices soared once people realized that the wheat in storage was not owned by domestic speculators but was owned by the Soviets intent on exporting the wheat.  Thus, I am sensitive to the amount of a commodity in storage, as well as the amount going into and out of storage, in determining the price of the commodity.  And when those decisions on storage are political, should that be considered a change in the price responsiveness of demand?

After the presentation, an Iranian I know came up to me quite incensed.  He said that the claimed decline in the price-responsiveness of petroleum was in conflict with the call for Iran to reduce the “subsidies” for fuel.  Further, they had the numbers wrong. 

  • If indeed the demand for petroleum is not price-responsive, why would a government’s decision to subsidy the price of petroleum products matter, such as in Iran.  His argument seems correct, at least if the concept of a decline in price-responsiveness had finally reached zero, which had not been the claim of the IAE, at least not that could be determined from the presentation.
  • IAE said that the price of gasoline in Iran was $0.08/liter.  The Iranian claimed the price was almost 40% higher, $0.11/liter.  In English units, these prices would be about $0.31/gallon and $0.40/gallon, perhaps an eighth of the price of gasoline in the US and much less than a tenth of the price of gasoline in Europe.  He didn’t seem to mind that his quibbling was about a factor of 1.4 when others were talking about factors of 8 or 10.

We also talked about “smuggling,” people buying tanker trucks full of gasoline in Iran (whether at the $0.08/liter price of the $0.11/liter price was irrelevant) and selling the gasoline across the Turkish border.  I thought that the transfers of a legal commodity across the border made sense, in that it should reduce the price of gasoline in Turkey, or at least that region of Turkey, and raise the price of gasoline in Iran, at least in that part of Iran.  The Iranian’s ire seemed to be directed toward the concept of violating government policy, one of not exporting gasoline from Iran, or at least not allowing small entrepreneurs to make money from the practice.  I guess his point was that the practice should be limited to licensed vendors.

This week Iran had shut down most of Tehran on three different days because of severe pollution, nominally caused by gasoline driven cars.  Shades of Los Angeles, Denver, and parts of China.  Eliminating the Iranian gasoline subsidies would reduce driving in Iran, including Tehran, at least if the IEA claim of reduced price sensitivity could be ignored.

During the presentation on subsidies, I began to wonder how subsidies should be defined.  My work on utility rate cases would often identify subsidies as relating to paying one’s fair share of the cost of the operating the utility.  Fair share included subjective decisions about cost allocations, so there were debates as to whether industrial customers were subsidizing residential customers or vice versa.  But these debates had as an underlying premise that the measurements were to be relative to the cost actually incurred by the utility.  Under that mind set, was the Iranian government recovering all of the cost it incurred in producing oil?  Yes, the world price for gasoline was much higher than the Iranian price, but did the enterprise as a whole lose money?

I have heard that Iran is currently considering raising the price of gasoline and of other energy supplies.  The revenue generated by this process would be used to provide Iranians with cash.  One thought is that the cash would be distributed equally per person, much as Alaska distributes cash to its residents from the taxes on oil production.  Last Wednesday, another friend had said that beneficiaries of the very low gasoline prices were those few Iranians driving huge gasoline guzzling SUVs.  Thus, the reform of gasoline prices, when coupled with an Alaskan style distribution, would hurt a few, the owners of the gas guzzlers, and benefit many, anyone who doesn’t own a car and uses little energy. 

The conversation about Turkey and the huge price differential between Turkish gasoline and Iranian gasoline made me think about the people who would really be severely hurt by an increase in Iranian gasoline prices, the smugglers.  It would make sense for them to be very adamant about keeping the status quo, much as the illegal gambling industry sought to prevent legislation legalizing sports gambling in the Bruce Willis movie The Last Boy Scout.

The IEA discussion about subsidizing fossil fuel commodity prices left undiscussed other subsidies that exist in the energy industry.  In the electric industry, renewable resources are heavily subsidized, whether by the tax credits offered by various governments, the renewable portfolio standards of various US states, or the feed-in tariffs that exist in many European countries.  My concern as an electrical engineer is that such subsidies are making the supply of electric energy to be less price responsive than it had been, perhaps even more so than the effect on the demand for petroleum.  Last year I looked at the prices paid for electricity generated in ERCOT, the Electricity Reliability Council Of Texas.  (See “Renewable Electric Power—Too Much of a Good Thing: Looking At ERCOT,” Dialogue, United States Association for Energy Economics, 2009 August available for free download on my web page.  Just register your name and data.)  For a quarter of the month of April 2009, the prices in West Texas, with a lot of renewable generation, were negative.  The wind generators had to pay ERCOT to take the electricity off their hands.  And the negative prices reached Houston for about 1% of the month.

The concept of negative prices in juxtaposition to the concept of subsidies leads to the issue of taxes on energy, essentially negative subsidies.  These negative subsidies have led to very high gasoline prices in Europe, though according to the IEA less sensitivity to price analysis, these high gasoline prices are no longer restraining the consumption of gasoline in Europe. 

I wonder!?