THE NEPTUNE PROJECT: The Neptune project is a privately-funded, high-voltage, direct current (yes, DC, not AC!) project to connect Manhattan and Long Island with other areas that have larger supplies of generated power. This type of interconnection of markets is a driving force in reducing transaction costs and increasing efficiency in energy markets. The progress of this project is very important as an indicator of the investment value of new, private transmission, and of the fact that just because electricity transmission is network infrastructure, that does not imply that it must be either provided by government or subject to government economic regulation (I am happy to concede the importance of safety standards in electricity transmission). This story, about TXU joining the investment consortium that is funding the Neptune project, illustrates the investment appeal of competitive electricity transmission to reduce bottlenecks. TXU's development capital will expand the construction to include DC lines connecting Manhattan and New Jersey, which gives Manhattan better access to the liquid and well-supplied PJM (Pennsylvania-Jersey-Maryland) wholesale electricity market. This is a good thing.

GAME THEORY AND HUMAN NATURE: This Wired News article highlights remarks by Martin Shubik, an eminent economist and game theorist, who is advocating pushing the use of game theory in economics beyond its grounding in rationality and strategy, to incorporate such human traits as emotion and error.

Last Wednesday, Shubik told the audience of game theorists with mathematics backgrounds that the next theories have to be hammered out "in concert" with other disciplines. The next theories, he said, have to consider emotions and their consequences, the culture and the context.

"Our simple models are no longer sufficient to answer many of the questions we have raised. The very successes of game theory are forcing us to move on," said Shubik, an economics professor at the Yale University School of Management and a consultant to major corporations and agencies of foreign governments.

Very interesting. Perhaps the technocratic mathematization of my profession is in retreat? I'm not holding my breath, but as more prominent scholars recognize the need for interdisciplinary study of human action, I get more sanguine.

MONOPOLISTS, OLD AND NEW: Microsoft and AT&T are forming a strategic alliance to provide wireless connectivity, particularly in work environments, according to this article.

FERC SETTING MARKET RULES TODAY: According to this Bloomberg News article, FERC will announce rules today to govern cross-regional wholesale electricity sales, including market monitoring and pushing "regulated utilities to cede some authority over transmission lines." This has been coming for a while, with lots of industry and public comment time. I hope Commissioner Massey's quote in the article is not indicative of the policy stance, though:

"We now have enough information to know what works well,'' Massey said in an interview.

What disturbs me most in that statement is the missing "for now" that I wish were there -- we know from history of the past five years what not to do, given existing technological and regulatory environments. But what if FERC's standard market design is not flexible and robust to changes, especially in technology? And what if it doesn't allow for regulatory change that would be mutually beneficial for consumers and for innovative producers? Then I worry that FERC's standard market design will freeze the institutional structure underpinning the industry, and that it will be rigid, unresponsive, and eventually obsolete, but still legally binding, to the detriment of consumers and innovative producers. It could also create vested interests who benefit from the institutional structure frozen in that way, who then have an incentive to lobby and use the political process to stymie change.

The biggest benefit is reduced transaction costs; transaction costs have been a big impediment to regional coordination that will bolster and liquify wholesale markets. See also this Reuters article on the topic.

TECH CENTRAL STATION COLUMN: I have an article on Tech Central Station this morning, on how markets discipline companies who are not transparent and full of integrity.

POPE AND CRANE ON THE ENERGY BILL: Anytime that Carl Pope of the Sierra Club and Ed Crane of the Cato Institute agree on something, it's worth reading. Such is the case with this opinion piece in the Washington Post today.

HOW COOL IS THIS? Also courtesy of Slashdot, this New York Times article (registration required) describes the flywheels that the NY Port Authority has installed in the subway to collect and use the energy given off when subway trains brake. What a win-win -- their energy bills go down, and subway stations are less hot!

A WIRELESS FUTURE? Courtesy of Slashdot, this Business Week article discusses the prospects and hurdles for wireless, "wi-fi" networks. My favorite quote:

Adds Ramesh Rao, director of the California Institute for Telecommunications & Information Technology: "History tells us that we cannot rely on the FCC's ability to anticipate the future and write rules to allow progress."

In the absence of a regulatory rescue, wireless advocates, including Rao, are trying to solve Wi-Fi's problems through technological innovation. Right now, anyone can head down to Radio Shack and, for a few hundred dollars, wirelessly network their laptop to their cable or DSL broadband connection.

JANIS IAN GETS IT; WHY DOESN'T THE RIAA? As Janis Ian wrote in an article on her website, the internet and music downloads can and do benefit artists. This is a well-researched and well-written article. Thanks to my husband for forwarding it to me.

UPDATE: I thought that Glenn Reynolds at Instapundit had mentioned this article before, and he did, here, in reference to Reid Stott's posting and analysis of her arguments.

CRUDE OIL UPDATE: We're drivin', there's political uncertainty in the Middle East, and it's almost August, so U.S. inventories are being depleted in a typical seasonal pattern. Thus, as this Bloomberg News article reports, crude prices have gone up. But they have not gone up much, because the continuing economic malaise is countering the price-increasing factors mentioned above. (Bonus points to those of you old enough to recognize my Carter reference in the previous sentence)

MORE ON HOLLYWOOD HACKING: Here and here are two articles from Wired that are good complements to Dan Gillmor's article referenced below. Not only would this bill have unintended consequences, as the first article discusses, the large media companies would not have to stop their P2P music distribution under this bill.

SCHUMPETER'S PERENNIAL GALE OF CREATIVE DESTRUCTION: This Financial Times article analyzes Dynegy's recent sale of a pipeline it acquired from Enron to bolster its balance sheet and reduce its debt. Dynegy's stock price increased accordingly yesterday. The first paragraph of the article says it well:

When Dynegy snatched the Northern Natural Gas pipeline company from a collapsing Enron for $1.5bn, it did not know how valuable the asset would become. On Monday, it proved to be Dynegy's salvation.

Warren Buffett bought this pipeline for $928 million (note how much less that is than what Dynegy paid in December, a big price decrease, but Dynegy is desperate). This chain of capital transfer, from Enron to Dynegy to Warren Buffet, is a beautiful illustration of the value that Schumpeter's perennial gale of creative destruction has the possibility of creating. Entrepreneurial, opportunistic risk taking (such as buying a pipeline in this market, even if it was at a good price) works with other factors like technological change to create value where no one had anticipated it or considered it before. That's the big reason why our economy continues to thrive.

Interestingly, though, Buffett has been wanting to increase his investments in the electricity industry, apparently because he sees the potential to create a lot of value. He has been stymied in many dimensions by the byzantine and, in many ways, obsolete layers of regulation in the industry. He has particularly hit the wall of PUHCA -- the Public Utility Holding Company Act of 1935, a stultifying relic of the early abuses and lack of transparent financial information in the industry. See also my earlier analysis of PUHCA and the arguments for and against repeal.

HOW MARKETS DISCIPLINE COMPANIES: I don't know whether or not Perot Systems actually did share confidential information about the structure and design of the California electricity market, but as this Financial Times article indicates, what matters is what investors believe, and how they act on those beliefs. As the article says, investors are not convinced by the arguments that Perot Systems has put forth to this point, and they respond by selling in anticipation of some future bad thing happening that would affect the value of the stock. It's those expectations and those actions that discipline companies, and deter them from behaving badly. Prices communicate valuable private knowledge (like how much a given investor believes their arguments) to a wider audience, and induce companies to take those beliefs into account. That's what I call effective regulation.

THIS IS GREAT, BUT ... : In this press release titled "LADWP Funds Innovative Energy Efficient Technology Ideas", the Los Angeles municipal utility announced an initiative to fund innovative energy-efficiency technologies that will particularly reduce peak-load demand. You know, if you just allow for market-based real-time pricing, even just for large industrial users, LADWP wouldn't have to spend $750,000 on this program -- innovative companies would come out of the woodwork and seize the marketing opportunities! Grrrrrr ... why is demand responsiveness so culturally difficult for utilities? Why don't they see the opportunities to earn more money by selling less power? (NOTE: I have to credit Vernon Smith for that last sentence, it's his phrase) I am actually writing a paper in which I try to answer my own questions, so I welcome any suggestions.

HOW DEPRESSING IS THIS? Dan Gillmor on the proposed "Peer to Peer Piracy Prevention Act," under which the music and movie industries would be legally allowed to hack into computers running file-sharing programs. Dan puts it very gloomily.

COMMON SENSE IS THE VICTIM OF UNTHINKING BUREAUCRACY IN AMERICAN AIRPORTS: This OpinionJournal editorial by George McGovern is an incredibly eloquent statement of how ridiculous and unthinking airport security bureaucracy has become. Read it, tell your airlines that you'll avoid flying and they are more likely to go out of business because of this static, backward-looking approach to making us feel safe that instead just makes us, as Senator McGovern said, "flustered, humiliated and exhausted."

I haven't had a bad airport experience since a horrendous one in March in Sacramento, California, but stories like Senator McGovern's just quicken my resolve to stay off of airplanes, and to make damn sure that Southwest, United and American all know why I'm not there as much as I used to be. Videoconferencing technology, anyone?

SPONTANEOUS ORDER DISTRIBUTED NETWORKS IN TELECOMMUNICATIONS: The telecommunications industry is currently in an incredible state of flux -- financial concerns, business model issues, and regulatory treatment are all affecting the industry at once, in this uncertain investment climate. This fascinating InfoWorld article makes a crucially important point about technological change and the future of the telecommunications industry:

Keeping the Internet an open entity will depend largely on users' abilities to set up ad hoc networks among themselves, instead of large telecommunications companies controlling the infrastructure and therefore the bits that travel across it, according to some members of the famed Massachusetts Institute of Technology (MIT) Media Laboratory. ...

"What's going on [in telecommunications] isn't just that phone companies have taken on too much debt," said Nicholas Negroponte, director of the MIT Media Laboratory, in Cambridge, Mass. There are changes under way that could mean the existing model of large telecommunications companies controlling the nation's networks "may not bounce back with the rest of the market because we're going to use telecommunications differently," he said.

I think this is absolutely the case. Look at how much more mobile and autonomous we are with our technology than we were even three years ago. And what's going to become more valuable to consumers as our technologies become more portable will be our abilities to interact and interoperate while mobile. The physical constraints of office and home continue to dissolve.

Negroponte advocates for a different model of spectrum management than I have been, though:

"Telecommunications [companies] are searching for the next generation [of services]; meanwhile, the computer industry is doing something viral on the side," Negroponte said. Eventually, enough users will set up wireless LANs to create a web of interconnected systems that will be "a seamless broadband network built by the people, for the people," he said.

However, before that can happen, lawmakers and regulators must free up more spectrum for use by such unlicensed devices, Negroponte said.

"Spectrum used to be like real estate. [The U.S. Federal Communications Commission] would chop it up and sell it," he said. "We can certainly use a lot of it to have people share it as a common, like 802.11 does."

He is incorrect about the FCC chopping up and selling spectrum. The FCC leases licenses to use spectrum, but retains ownership. Licensees have no property right (which, incidentally, contributes to the transaction costs of dealing with interference through the FCC's bureaucratic, administrative process, but that's a topic I discussed here.). Thus the radio spectrum is still treated as a commons by the FCC. For an analogy, think about medieval agriculture and scattered-strip farming. Villages treated fields as commons, deciding jointly what to plant, when to harvest, etc., but each villager had an allocation of scattered strips that he owned within those fields.

I think this issue is worth exploring in more depth. The 802.11 slice of the spectrum is currently unlicensed, and right now over the short distances and for the uses consumers are choosing, there's not a whole lot of interference. In other words, right now there's plenty of 802.11 to go around because of how it's being used. But as more users enter the commons that is 802.11, we should expect to see increasing interference and congestion problems that characterize the "tragedy of open access." Note that I do not calll this the "tragedy of the commons" as in the seminal Garrett Hardin article, because the tragedy comes from open access with no rules governing exclusion or use of the common property. Most commons in the world, from college campuses to individual homes to parks, are governed by webs of formal and informal rules and norms establishing appropriate behavior. These rules and norms, particularly when they emanate from a spontaneous order process of user/owner interaction, reduce or eliminate the overuse problems that are the tragedy of open access. Thus "tragedy of the commons" is not a theoretically correct way to describe it.

In Hardin's seminal article, he proposed two policy solutions to solve this tragedy -- regulate it or privatize it. FCC regulation as we have endured in the past 70 years has not exactly fostered a dynamic, thriving, competitive use of our scarce radio spectrum resources. Privatization, or having the FCC sell actual slices of spectrum as fully defined, alienable, transferable property rights has been my preferred approach; fully defined and optimally enforced property rights reduce transaction costs and increase the ability of economic actors to achieve efficient, mutually beneficial outcomes.

The kicker comes, though, and this is where Negroponte's point is interesting, when you think about the transaction costs involved in defining and enforcing those rights, and the benefits that would arise from it. To put it another way, Negroponte's statement is a version of something I have said in other contexts -- the two policy approaches that Hardin articulated for dealing with common pool resources (such as spectrum) are NOT the only two approaches; at the risk of sounding like Tony Blair, there is a third way. That third way recognizes that in the presence of transaction costs, the optimal institutional structure could well be a commons framework with rules and norms, preferably rules defined and enforced in a common law/jury trial deterrent framework as opposed to a regulatory, top-down framework.

I will flesh this model out in the future, based on a working paper that I wrote with my Northwestern colleague David Haddock about property rights evolution and the Black Death (the paper is currently under consideration at a journal).

This article from Wired News gives a nice, concise description of the implications of Covalent's (open-source Apache server's) decision to support Microsoft's .Net technology. This decision will create more choice in the web server market, and also bodes well for the good experimentation consequences of pluralistic technology use and development. However, this NYT article suggests that Microsoft has not dramatically shifted its position on open-source software, given that they characterize us as being in the waning period of the open-source software movement. Just because Microsoft says it's so doesn't make it so. Seeing how the open-source v. proprietary business models debate evolves, and the hybrid property rights mechanisms that arise from these evolutions, will be fascinating.

HONDA TAKES THE LEAD, QUELLE SURPRISE: Honda announced today that they have secured a license from the US and California governments to sell fuel cell vehicles in the US. The article does a nice job of describing the realistic timeframe for the diffusion of fuel cell vehicles, including the pesky issue of the network infrastructure for hydrogen refueling.

Is this cool or what? I'm havin' a fuel cell day!

THIS IS SNAZZY: According to this press release, the municipal utility in Austin, Texas has installed a natural-gas-fired fuel cell combined heat and power system.

Austin Energy installed the 200-kilowatt fuel cell system, which also produces 900,000 BTUs of usable heat per hour, at the Rebekah Baines Johnson Health Center.

Electricity produced by the unit is fed into the Austin Energy electric grid, making it the first fuel cell in Texas to feed power to the grid. The health center is using the heat produced by the unit to heat water for the health center, helping it avoid the cost and the emissions associated with operating a natural gas-fired boiler. ...

A fuel cell is an electrochemical device that combines hydrogen and oxygen to produce electricity, heat and water. Because hydrogen is often not readily available, the PC25 uses a fuel processor to convert hydrocarbon fuels, typically natural gas, into a hydrogen-rich stream that is fed into the fuel cell.

Note the win-win aspect here -- the CHP system reduces both the cost and the pollution of heating water, by using what would otherwise be waste heat from the electricity generation process. Bit by bit, step by step, we get more autonomy and choice in our energy production and consumption. Note also that Texas has some of the best thought out distributed generation interconnection standards in the country, at which they arrived through a very collaborative process which I'll discuss in the future.

They also remind you of good stories about how it is that market mechanisms actually deliver sound environmental policy better than any existing alternatives. My colleague at this Institute for Humane Studies seminar, John Hasnas mentioned in his lectures the case of the Audubon Society allowing natural gas drilling in the Rainey Wildlife Refuge in Louisiana, a piece of property that they own and manage. A PERC op-ed that summarizes the case well indicates that a common law approach to property rights and potential environmental harms does a better job of delivering both environmental quality and economic value.

One of the best things about hanging out with philosphers is that they remind you of cool stuff you read way too long ago, like this quote from John Stuart Mill's On Liberty about the harm principle and individual liberty:

"... the sole end for which mankind are warranted, individually or collectively, in interfering with the liberty of action of any of their number is self-defence ... the only purpose for which power can be rightfully exercised over any member of a civilized community, against his will, is to prevent harm to others."

I'm leaving Saturday morning for Pennsylvania, to teach at a seminar given by the Institute for Humane Studies. Promises to be very good fun, and lots of great brain candy.

Run, don't walk, to Megan McArdle's house for a superb analysis of why Canadian prescription drug prices are lower than in the U.S., and the likely consequences for pharmaceutical R&D. I can vouch for the business reality of her argument; when I worked as a tax consultant I had clients that confronted this painful reality.

While I'm at it, the same website has a good explanation of cheap at half the price, a phrase I use relatively frequently.

Tonight, on the Wall Street Journal Editorial Board show on CNBC, Tunku Varadarajan used the phrase "curate's egg." We could tell in context what he meant, but my husband and I were sufficiently curious to check it out afterward. Here's a translation from British English to ROW English. The essence is "parts of it are excellent", but I leave it to you to discover the rest.

WITH THE BAD COMES GOOD: It's always refreshing to get a little perspective on these accounting and corporate governance issues. Amity Shlaes' column from Monday does so, with reference to both the history of the Industrial Revolution and Trollope, one of my favorite authors. Given my background in economic history and technological change and diffusion, this really resonated with me. I hope it does with you, too.

IS DEMAND RESPONSIVENESS COMING TO CALIFORNIA? Yes, according to a press release and an order instituting rulemaking from the California Energy Commission yesterday. The Energy Commission’s plan is to work in conjunction with the California PUC, which has itself initiated an order instituting rulemaking to craft “policies to develop demand flexibility as a resource to enhance electric system reliability, reduce power purchase and individual consumer costs, and protect the environment.”

The Energy Commission’s press release states that

The program’s goal is to provide all Californians within the next decade with access to advanced electricity metering systems, rate structures that reflect time-of-use rates, and technologies that allow them to respond to changing prices. An example of responsive technology is a thermostat that receives price information from the utility and can automatically raise air conditioning temperatures during times of high prices.

These objectives, and the Energy Commission report on which this rulemaking process is based, are a good, if slow, start. It’s taken almost two years to get to this point, where the two main electricity regulatory bodies acknowledge, and are willing to make policy based on, the idea that consumer responsiveness can discipline the ability of sellers to raise prices. This idea is crucial to creating functioning electricity markets, and contributes to the reasons why a phased wholesale-then-retail approach to competitive markets is less likely to succeed than an integrated wholesale-and-retail liberalization.

While the CEC and the CPUC are saying the right things, finally, about demand responsiveness, it remains to be seen how, and how quickly, they will act on these statements. Will metering become another object for state subsidies, a version of the "pay to conserve" policy that dominates California? Will metering and demand responsiveness go the way of consumer direct access, which the PUC abolished to make sure that the CA Power Authority has a monopoly so it can pay for those pricey long-term contracts? Will the CPUC be flexible enough to allow utilities to offer portfolios of contracts to their consumers from which they can choose?

More generally, how will they encourage utilities to think more openly and broadly about the value propositions to their customers? Utilities will not buy into customer or third-party control of metering until that mental/cultural umbilical cord between load and revenue is broken, or, as Vernon Smith put it when I saw him last week in Washington, utilities have to wrap their minds around the idea that they could make more money by selling less power. This is a huge (yes, I'm going to use the word) paradigm shift for people who have traditionally seen the only way to raise their profits as serving more load (of course, it's by regulatory design that the umbilical cord exists), and controlling the meter is a big part of that culture. And I haven't seen any evidence that the regulatory agencies in California will be effective in facilitating that culture shift, and in themselves thinking more broadly about the value propositions that they as regulators present to the variety of customers they purport to serve.

See also my earlier post on real-time pricing, in which I cite the invaluable work of Severin Borenstein on this topic. His work has played an important role in bringing this policy change to the embryonic beginnings that the CEC and CPUC have initiated. I strongly hope that they can follow through and create a set of flexible, market-based institutions that will unleash the value potential of California's electricity market.

This good TechCentralStation article by Duane Freese lays out the economics and the policy dynamics of nuclear fuel reprocessing as an alternative to schlepping it to Yucca Mountain. Very interesting and thought provoking.

Last night Brink Lindsey picked up on the 100th anniversary of air conditioning, on which there was an article in Wednesday's Washington Post. Certainly, as he says, a triumph of "the Baconian project of power over nature." I hate heat and humidity, and the confluence thereof, so I fully agree, and celebrated yesterday. My only regret from this manifestation of human ingeneuity and creativity is the well-documented consequent growth of federal government because folks don't have to skedaddle from Washington for as long as they used to in the summer.

THE WELL-BEATEN DEAD HORSE IN CALIFORNIA: Yesterday the General Accounting Office released a report on the causes of the wholesale electricity price increases in California August-October 2000. U.S. Representatives Inslee and DeFazio requested the study, which had two objectives: determining whether or not wholesale sellers actually exercised market power to raise price above marginal cost, and determining if the design of California's market enabled those suppliers to exercise market power. In other words, did the state's rules create the opportunities to raise prices, and did the sellers seize on the opportunities presented to them through the bad set of rules? The GAO study answers "yes" to both questions. One of the most valuable aspects of this report is that it reiterates something that most analysts have been saying all along, but has not been reflected in California's response to the situation -- if the sellers did exercise market power, one reason they could was that the set of dysfunctional rules in California created the opportunity for them to amass it and to exercise it.

The GAO compared the hourly pattern of prices in the August-October 2000 period with the same period in 1998, a period that exhibited price patterns consistent with competitive behavior. Through econometric analysis they find that the hourly pattern of price movements in 2000 differed from the 1998 pattern, a result consistent with supplier exercise of market power. The report acknowledges, though, that they did not completely control for the other acknowledged causes of the price pattern in 2000: higher-than-expected natural gas prices, increases in emissions credit prices, the increasingly narrow gap between supply capacity and inelastic demand, the retail price cap that gave no incentives to consumers to shift load away from peak hours, the drought in the Pacific Northwest, and temperature. Without performing an analysis that more fully controls for these variables, this current GAO analysis is not really additionally persuasive beyond the claims of market power put forth in other studies. That said, though, this study is well-done, and the econometric analyses they performed is consistent with the other analyses of the California energy crisis, some of which are cited in the report. (A pedantic presentation criticism: they report coefficient estimates and standard errors, but not the actual marginal effects of the changes in variables, so it's hard to assess the magnitudes of the effects of the variables and compare them to see which had the biggest effect on price).

I found the most interesting result in their analysis to be the effects of the various price caps that the CAISO implemented that affected the period in question -- $750 from September 1999 to July 1, 2000, $500 from July 1, 2000 to August 7, 2000, and $250 from August 7, 2000 to the end of the period covered in the analysis. They found that the $500 price cap in July and early August, as well as the $250 price cap from August 2000, actually raised prices. While some may find this result surprising, it's actually quite consistent with economic theory, and with experimental results. They also found that the $750 price cap raised prices, but with less statistical significance (at 10%). Again, though, we have to take these results with a grain of salt, because once you control for the factors mentioned above, this result might not really exist.

In fact, a Northwestern student whose senior honors thesis I supervised (Terri Kandalepas, now a law student at UCLA) performed a very similar analysis in June 2001. In her analysis, the combination of lagged electricity price in that hour, natural gas prices, emissions credit prices, Stage 1 and Stage 2 alerts, reservoir levels, temperature, and hour of the day accounted for 85 percent of the changes in price. That result means that at most the exercise of market power accounted for 15 percent of the price changes. Given the types of trades we're analyzing here that is still a serious amount of money. Her analysis did not incorporate the net imports and the price caps as the GAO report did, so they are not directly comparable, but it does demonstrate that controlling for these other effects is crucial to performing a thorough analysis that allows us to infer the actual extent of market power.

One crucial omission from their otherwise very thorough analysis of the evolution of the California energy crisis was the importance of the strategic behavior of the utilities. Among those of us who eat, sleep and breathe electricity the phenomenon of buyer bid underscheduling into power pools is well known -- in a bifurcated structure like California's Power Exchange for day-ahead and CAISO for real-time balancing, the utilities buying wholesale power have incentives to understate their day-ahead demand, with a goal of lowering wholesale prices. Then they end up buying more in the real-time balancing market, but unless supply is tight they have overall paid less for their power. Interact that with the well-worn arguments for why suppliers have incentives to withold from day-ahead, and you see how so much of the spot market activity in California got shifted into the ISO's real-time balancing market, and at astronomical prices. Plus, the ISO's real-time market priced at what the market would bear, so it was a convenient way to circumvent the price cap. I would like to have seen a discussion of this strategic dynamic in the GAO report.

A good, and very technical, analysis of the exercise of market power in California is by Steve Puller in the Economics Department at Texas A&M University. And I would be remiss if I don't engage in some shameless self promotion by mentioning the qualitative analysis of California's failed electricity policy that Adrian Moore and I wrote in January 2001. The GAO report contains a bibilography containing other analyses of market power.

READ TECHCENTRALSTATION TODAY: There's a lot of good stuff today, including this article by Arnold Kling on the predictive power of Moore's Law and the future of telephone companies, and this article by Ed Driscoll on the opportunities and roadblocks in the dissemination of wireless networks. A lot of folks, including Virginia Postrel, have thought carefully about the development of "third places", and the technology described here is the kind of creative change that will make it happen.

SPEAKING OF TRADEOFFS: Today's LA Times has an article on a controversy over Medicine Lake, which is in a geothermally active area in northern California. Calpine is looking into constructing some geothermal generation plants, but local Native Americans worry that this use of the lake will sap it of its cleansing properties and traditional spiritual energy. It will be very interesting to see how this unfolds, and how they resolve the conflicting uses of these resources. The article makes a point that resonates with my prior post:

Calpine's armada of new plants fired by natural gas remain susceptible to the price swings of a fickle market for fossil fuels. In contrast, power from a geothermal plant comes with no cost for fuel--and produces 26 times less greenhouse gas. Mother Earth does all the work: Deep pockets of subterranean water are superheated by magma, producing steam to turn turbines.

Geothermal is likely to be more costly than fossil fuel generation per megawatt hour for a while yet, because while there is no fuel cost it does not generate power as intensely or as consistently, but it would be useful in enabling the diversification strategy.

DIVERSIFY THAT FUEL PORTFOLIO: RAND has released a report on the consequences of increasingly relying on natural gas as the primary fuel for generating electricity. This very good article in the San Jose Mercury News does a nice job of summarizing the risks inherent in such non-diversification, which the report highlights. Hedge, hedge, hedge; it may mean tolerating spending more for other fuels, or using more dirty fuels than we might otherwise, but when we think about fuel choice we are trading off on lots of dimensions of costs and benefits -- stability of fuel prices and supplies, pollution, and many others that will vary from person to person.

UNEARTHED PYTHON: What a fantastic start to my day! The BBC reports that three previously unperformed Monty Python sketches will be performed at the Edinburgh Fringe Festival this fall by Sketch Club. Now if I can just find a good reason to go ... although I agree with the article's author, who calls the troupe's task in performing them "unenviable". I mean, how many of us will watch them and superimpose the original Pythons in our heads?

Slashdot's online poll today is hilarious: "I name my pets/children after characters from

*Star Wars
*Star Trek
*Battlestar Galactica
*Anime
*SF Books
*Other SF Movies
*What the hell is wrong with you people?
*All my children and pets are named CowboyNeal"

I had to vote, just to see ... thankfully, "What the hell is wrong with you people?" is far, far away in the lead. Although, as a person who named her cat after a dead French fashion designer, I don't have much room for stone-throwing.

DUKE ENERGY'S HAVING A BAD WEEK: 23 online wash trades of $1 billion to influence volumes, a 17 percent decrease in first-quarter net income, an SEC investigation of their trading practices, analyst downgrades of Duke stock. One of these in any week would be bad enough, but this is a pretty overwhelming concatenation of bad news.

Investigating these wash trades should be a complicated and nuanced process. As I've stated before, the system balancing requirements of an integrated electricity network sometimes necessitates wash trades, and it's important to distinguish between the wash trades intended to maintain system balance and the wash trades intended to make the trader look like a more important player in the industry. For those reasons, policies geared toward abolishing all wash trades would be counterproductive and contribute to making electricity networks less stable.

This three-article series on TechCentralStation (first article second article third article) connects the science behind renewables and technological change in energy to policy issues, much along the lines of my earlier post. And Sallie Baliunas is one of the most insightful and articulate physicists I've ever met (and my husband is a physicist, so that's pretty high praise!).

WHY DOESN'T THE RECORDING INDUSTRY GET THIS? When Napster was active and we were all downloading songs like fiends, recording industry revenues and record sales went up. This Wired story from June reports on a recently released study indicating these results:

The Ipsos-Reid study found that 81 percent of music downloaders reported that their CD purchasing either remained the same or increased. That backs up research from Jupiter Media Metrix that concluded that people using file-sharing networks were more likely to spend money on music.

OPTIMISM AND THE FUTURE OF ENERGY: Arnold Kling suggested that I explore the fuel cell future in more detail. I intend to delve further into the economics of such technological change, but for now, here's a compilation of several articles on fuel cell research and how close they are to economic viability. Most current analysts predict about 20 years. This October 1997 Wired story sets the stage by highlighting how hydrogen fuel cells work, what some of their limitations currently are (including cost per horsepower or kilowatt hour, and the infrastructure issue of hydrogen filling stations for fuel cell vehicles), and what kind of research is under way. The author also talks about one of my favorite public relations ploys in hydrogen fuel cells -- drinking the exhaust from the pipe. It's water, good old H2O. I heard a story last fall about BMW's prototype fuel cell sports car, and how they were doing a marketing gig in Los Angeles, at which Jay Leno took the car for a spin and then rehydrated from the tailpipe!

This July 2001 Wired story specifically addresses the prospect of fuel cells in transforming not just how we generate power, but how we organize the infrastructure of the entire energy network. The story focuses on the distributed resource research done at EPRI an electricity research consortium.

In recent years, a series of technological breakthroughs - and, more important, a critical mass of scientific ideas - has begun to coalesce around a new model for an energy system that would better serve the needs of the near future, while enabling power producers as well as consumers to lessen their impact on the environment in the long term. Both privately and publicly, many at the institute express concern that the policy thrust of the current administration will lock out the most promising set of innovations to emerge in the energy community since the creation of the existing grid in the first half of the 20th century. The end result, they fear, may be to freeze us into high-emissions power pathways for decades to come. ...

The smarter energy network of the future, EPRI believes, will incorporate a diversified pool of resources located closer to the consumer, pumping out low- or zero-emissions power in backyards, driveways, downscaled local power stations, and even in automobiles, while giving electricity users the option to become energy vendors. The front end of this new system will be managed by third-party "virtual utilities," which will bundle electricity, gas, Internet access, broadband entertainment, and other customized energy services. (This vision is reminiscent of Edison's original ambition for the industry, which was not to sell lightbulbs, but to create a network of technologies and services that provided illumination.)

This vision, which I share, promises to deliver a more robust and flexible energy network. It is also consistent with something I've been thinking more about and talking about with several industry folks -- a biological/ecosystem metaphor is a better model for a forward-looking, robust, flexible, efficient energy network than the traditionally mechanistic, engineering-focused model of an energy system. Engineering and mechanics are clearly important parts of creating and understanding a dynamic energy network, but we are likely to make some serious policy mistakes if we think only about them.

This abstract of a January/February 2002 Technology review article (access to full article available to subscribers) addresses the role of fuel cells in the electricity grid. It also makes a point that I have emphasized in my own work, although it doesn't make it explicitly: fuel cells and distributed generation will make electricity transmission contestable. That means that transmission will face potential competition, which will serve as a discipline on the transmission owner's ability to raise transmission prices, because if they raise prices consumers will be more likely to say, "thanks but no thanks, I'm going to buy and install a combined heat and power system for my production facility, so please take me off the grid." That's a much better way to discipline the pricing decisions of transmission owners than the traditional rate-of-return regulation that we've had for most of the past century, and in the past decade with stock market returns outpacing the regulated rate of return on transmission investment, has contributed to the dearth of grid network that we are confronting right now.

Now, the cool futuristic stuff: this March 2002 Wired story talks about thermoelelectrics -- using heat to generate electricity. This abstract of a November 2001 Technology Review article talks about methanol-powered fuel cells for cellphones -- 20 hours of portable talk time from methanol!!! How cool is that? This abstract of a January/February 2002 Technology Review article discusses how new plastics may contribute to making solar power more economically competitive with fossil fuel generation.

The big-picture punch line: our expectations of the future, including technological changes and how soon they are likely to become economically viable alternatives, are very important determinants of our current investment and consumption decisions. And current policy decisions can have large impacts, either positive, negative or mixed, on the future paths of these technological changes. But the problem is that these policy decisions are not made in a vacuum, nor are they made in an environment of certainty about the future. For all of these reasons, a lighter-handed, more flexible approach to energy regulation and energy policy is more likely to result in a robust, reliable, flexible, efficient energy network that behaves as well as a highly evolved natural system.

WHY DOESN'T THE FCC JUST ESTABLISH SPECTRUM PROPERTY RIGHTS? This story is not a tale of a successful privatization program, but is instead a cautionary tale of how regulation has created a worse outcome than privatization could. Technological innovation is enabling us to use the radio spectrum more intensively than before. This innovation is placing pressure on regulation and property rights issues in the management and use of the radio spectrum. The current Federal Communications Commission (FCC) licensing system for spectrum, in which the government retains ownership rights to spectrum, is creating some conflicts and problems that would not arise in a privatized spectrum system. As a political process, it is also more prone to manipulation.

For most of the past century the federal government, usually through the FCC, has retained ownership of rights to transmit in various parts of the radio spectrum. For most of the twentieth century the FCC allocated spectrum use through either an application procedure or through a lottery; both of these allocation methods allowed the FCC to choose the potential licensees, in keeping with the FCC remit to govern broadcasts based on a public interest objective (this public interest remit for the FCC is increasingly coming into question, too).

As early as 1958, economists Ronald Coase and Arthur DeVany recommended privatizing the radio spectrum, selling it through an auction process. Privatization would create well-defined property rights in specific locations on the spectrum, and would enable spectrum owners to transfer rights, and importantly, to determine how much value they place on having adjacent owners far enough away to remove some, most, or all likely interference. Privatization could also involve a judicial system of legal recourse in the event that some owners believed that interference from someone else’s spectrum property harmed their use of their spectrum.

Since 1994 the FCC has auctioned spectrum transmission rights. The FCC retains ownership of the spectrum itself, but has been auctioning ten-year licenses conveying the rights to use spectrum for specific purposes. These licenses are not transferable between uses or between license holders. Retaining spectrum ownership enables the FCC to continue regulating broadcast, cable, telephone, wireless cable, and two-way analog and digital (such as analog and digital telephones and pagers) communication uses. However, a turgid system of enabling but regulating radio spectrum use, such as the FCC has been following since its inception, could slow or deter technological change itself, particularly in the burgeoning wireless technology industry.

New wireless devices such as Wi-Fi, Bluetooth, and HomeRF have become popular over the past year as people expand their network capability with wireless access through laptops, phones, PDAs, and other new wireless devices. These devices transmit in the 2.4 GHz (gigahertz) frequency, 2.4-2.483 GHz across short ranges. This portion of the spectrum is popular for several reasons, including the fact that the 2.4 GHz frequency is unlicensed. Thus regulatory hurdles in using this frequency are minimal relative to the other parts of the spectrum. Devices in this frequency also do not generate a lot of interference for each other because of the short ranges over which they transmit and because they generally operate as spread spectrum devices, which decreases the potential for interference. Customers have received a lot of value out of the increased use of this frequency, and these wireless devices have brought information access to many rural and underserved communities.

The 2.4 GHz frequency is right next to a licensed slice of spectrum; the FCC has licensed it to satellite radio operators. One of these satellite radio operators, Sirius, is concerned that consumers who use a mobile device in their cars will create interference over short distances with their satellite radio transmissions to those consumers, particularly in urban areas where buildings can create problems for satellite radio transmissions to automobiles. In a privatized spectrum system, Sirius and the device makers in the 2.4 GHz neighborhood could negotiate a mutually beneficial compromise; in the FCC regulated hybrid system we have now, though, Sirius has petitioned the FCC to force mobile devices in the 2.4 GHz frequency to operate at the lowest possible wattage, which is below the electric energy of the engine running the car. If the FCC grants this petition, the market value of wireless devices to consumers would probably fall.

Sirius appears to be using the regulatory process to increase the value of satellite radio to consumers. The Sirius and 2.4 GHz interference situation is an illustration of the wasteful incentives inherent in using regulation and the political process to mediate spectrum border disputes. Regulation creates incentives for companies to engage in expensive rent seeking. Privatization would favor uses of the radio spectrum that make the most sense for consumers, while regulation favors uses whose developers are better at manipulating the political process. The FCC’s continuing ownership and regulation of spectrum gives spectrum users an opportunity to use FCC petitions to mediate disputes instead of a judicial process based on law.

Because of the politics of spectrum rights and the lack of private spectrum ownership, resources might not get to move to higher-valued uses. The FCC is not going to be as impartial a rights arbiter as the combination of well-defined spectrum ownership and a court system using the rule of law. The absence of spectrum privatization may slow or deter potentially beneficial technological change, and leaves in place a political process more prone to financial and other manipulation than one based on markets and law.

YES, I'M A BIT OF A FUTURIST OPTIMIST: Economically viable hydrogen fuel cells are coming. Not quickly, but they are coming. And that expectation of future applications of technological change should be causing the electricity industry to rethink the value propositions it is presenting to its customers, because it's going to become cheaper and easier for customers to say "we're outta here". This story, about the installation of a residential hydrogen fuel cell system in Georgia, illustrates the possibilities the future holds.

More evidence that the OPEC cartel production ceiling is unsustainable collusion. From May to June, OPEC production increased by almost 100,000 barrels per day. Check out the table at the bottom of the article to see who was able to cheat, and by how much, according to these estimates from Platts. Furthermore, this Reuters story suggests that

... extra demand will be accompanied by a continued rise in supplies from nations independent of OPEC, leaving the cartel little room to manoeuvre in easing output restraints if it wants to keep oil prices near its $25 a barrel target.

"Economic recovery should be in full swing next year so we're projecting global demand growth of 1.3 million barrels a day," said Adam Sieminski of Deutsche Bank.

"But we expect non-OPEC growth of about 800,000 barrels a day and that will put a lot of pressure on Saudi Arabia to hold OPEC discipline together."

This article from yesterday's New York Newsday also discusses the changing mindset of Russia's energy entrepreneurs, seen through the lens of their evolving relationship with Iraq.

FASHION LEADS THE WAY: Bravely diving into the breach, what what, Burberry goes ahead with its IPO. Investor confidence wavers today, but consumer confidence in a dynamic business with a well-defined and forward-looking brand and brand evolution persists! They offered at the low end of the estimated capital value of the company, which makes sense in this environment, but the road to capital markets is littered with many less-than-successful IPOs (like Donna Karan, which earned me a good capital loss tax deduction a couple of years ago; that's why I've moved to mutual funds entirely!). I'll be interested to see how long-lived their brand capital and their profitability are, and the corresponding share values.

LINDOWS AND WAL-MART BRING CHOICE TO COMPUTER CUSTOMERS: An interesting story on National Public Radio this morning:

Lindows is a new computer operating system that's being sold with PC's for under $300. Its main selling point is its "click and run" application that allows users to easily download software. Although Microsoft and computer industry experts don't think Lindows and Windows are competing for the same market, Microsoft has taken Lindows to court complaining the names are far too similar. A judge has allowed it for now, pending a trial next year.

Lindows has been developed using the open-source Linux operating system by Michael Robertson, the entrepreneur who was behind mp3.com. He has paired with Wal-Mart to offer $300 personal computers with Lindows installed. The consumer goes home, fires up the computer, and can go to a site to download three free applications (i.e., spreadsheet, word processor, presentation program) that are Microsoft-compatible and are in a user-friendly graphical interface (GUI). The business model is that access to the software and upgrades comes with an annual subscription of $99. Robertson said that the interface is so simple that his 4-year old son, who can't read, can successfully download games and fire them up. The story does point out that the binding constraint on the success of this business model is the download speed for such software, given the 20% penetration of broadband. Another commentator in the story said that he doubts that Wal-Mart shoppers are the people who actively want operating system alternatives to Windows. Not only do I find this statement somewhat arrogant and condescending to Wal-Mart shoppers, who don't need to follow USDOJ v. Microsoft to know that Microsoft is everywhere, but it totally misses the point of where the value proposition is here for consumers, and how essential that proposition is to Schumpeter's perennial gale of creative destruction that keeps competitive pressure on companies like Microsoft. By partnering with Wal-Mart, whose business model has been the retailing sector's "killer app" for the past decade, and offering customers a low-price, user friendly product, customers don't have to think about or care about whose operating system it is, as long as the applications are interoperable and the entire integrated product works.

This is the beauty of entrepreneurship and the dynamic ways that market processes help unleash human ingeneuity. $300 computers at Wal-Mart. Life is so good.

HAVIN' A HEAT WAVE: From the California newspapers, yesterday and today ... the LA Times describes the conditions leading to the first Stage 2 alert (when reserves go below 5%); the San Francisco Chronicle attributes the stress, at least in part, to a breakdown in conservation.

Today's LA Times story also points out the lower conservation than last June, and the importance of the 3,000 megawatts of additional (peaking) generation capacity in the state since May 2001. Not only does additional capacity stave off alerts and blackouts, it helps change the relationship between supply and demand in ways that keep prices lower and less volatile. The story in today's San Francisco Chronicle actually does a nice job of pointing out that in these heat waves, the price cap in the California market can become binding, and has encouraged power providers outside of the state not to offer power in the state, because they can't cover their costs at the capped price. Another simple, yet good, economic lesson: the people who benefit from price caps are the ones who can actually find a supply and purchase; the ones who are harmed by price caps are both the suppliers who have higher costs but would have supplied profitably at a market-clearing price, and the buyers who get foreclosed from buying because they can't find suppliers who can afford to produce at the price cap. Do California politicians who favor price caps realize that this policy harms buyers, which translates into harms for some of their voters?

Today's San Jose Mercury News story hits the same notes, including the unexpected outage of a plant in Southern California; the outage was due to a fan breaking, which is easier to distinguish from strategic witholding than the types of overuse outages that lots of peaking plants experienced in 2000 and 2001 (the distinction between engineering tolerance outages from overuse and "economic witholding" continues to be a major issue in the California electricity crisis post-mortem). Interestingly, the headline refers to the state's request to reduce electricity use, but nowhere in the article is there a single reference to the fact that big users used to have good price signal incentives to cut peak use, when they had direct access contracts with generators and had more ability to use metering and something approximating real-time pricing. But last fall the California PUC abolished direct access, unabashedly stating that the state needed large users to buy their power from the state's new power authority, because they had to earn revenue to pay for those high-price contracts signed in spring 2001. A few large users are on interruptible contracts, but that's a drop in the bucket. So now the only ways to get large users to cut back during peaks is to issue public pleas for conservation. Gee, you know, I think price signals to the large users would do the job a heck of a lot better, with less hand-wringing.

I was going to spend some time today writing about the heat wave in the West, and how the California electricity network and "market" are responding to this first big stress in a very long time. Then I read Charles Oliver's outstanding editorial from yesterday on EnterpriseEconomy.com (link courtesy of Instapundit, thanks Glenn), and now I have some free time to think about other things! Charles' editorial reminds us that much of the ongoing sturm-und-drang in California's energy environment is the consequence of bad, highly politicized rules and policy decisions.

But it's important to remember that this activity [alleged generator manipulation of markets] didn't take place in a free market but in a highly regulated artificial market. State regulators designed that "market," set the rules and ran the exchange. They forced utilities to divest their own generating plants, and they kept the utilities from making long-term contracts. And they prevented new construction of power plants. The government set in place all of the conditions that led to a crisis.

California's energy crisis has given energy deregulation a black eye. But two dozen other states have also deregulated their power markets, and they haven't had the problems California has...

Other states didn't force utilities into state-run power exchanges. Instead, they left them free to buy power from whomever they wanted. That created competition and increased supplies and helped keep prices down. Pennsylvania started its deregulation program shortly after California "deregulated" its market. Pennsylvania has some 200 wholesale sellers of electricity. California had just 20.

Finally, other states generally did a better job than California at adding new generating capacity. They didn't wait for a crisis to start building new plants. They anticipated growing demand for new power. Texas alone has built 22 power plants since 1996 and has 15 more in the pipeline.

In short, these states gave more than lip service to deregulation. They actually cut red tape.

California officials want to blame the state's power woes on deregulation instead of their own misguided rules and regulations. It would be a shame if they were allowed to discredit a policy that has worked successfully elsewhere, a policy that they never really tried.

For those who still want to revisit the causes of last year's massive energy policy failure in California, here's the study that my colleague Adrian Moore and I did in January 2001 (one of the first thorough analyses of the situation, by the way), and here's the version of my study of other states and countries that the Texas Public Utility Commission republished in their consumer education efforts accompanying their deregulation.

The punch line: no U.S. state has really, truly deregulated the electricity industry. Even Texas and Pennsylvania, the jewels in the electricity restructuring crown, have retained retail price caps and other regulatory hangovers as part of the political bargain to get restructuring legislation passed (from the "half a loaf is better than none" school of political compromise). That said, though, they have done a far sight better at delivering efficiency gains and choice than could ever have been possible in the California regulatory environment. And they are continuing to push the envelope and apply an entrepreneurial, dynamic, open-minded perspective on the ability of competitive electricity markets to provide value and choices to consumers safely and reliably.

In my relaxed perusals of the news this holiday weekend, I found two extremely good analyses by the typically good Amity Shlaes of the Financial Times. In her 27 June column she made a very important point about tipping in restaurants and a recent Supreme Court decision:

In the Fior d'Italia case, summed up on restaurant.org, the National Restaurant Association webpage, the IRS reviewed the restaurant's credit card receipts, finding a tipping rate that averaged a little over 14 per cent. Then it presumed the same rate on cash revenue, and concluded that workers had failed to report $304,000 in income for a two-year period. It charged the restaurant for back taxes of $23,262 (FICA of 7.65 per cent).

In its 6-3 ruling, the high court gave the IRS the authority to go after such unreported cash by estimating the amount of cash tips that go to employees.

She points out something very important -- the effect that this ruling will have at the margin on the quality of restaurant service. In her 1 July column, Shlaes pointed out another potentially detrimental unintended consequence of a legal/regulatory change, this time addressing the timely question of the accounting industry's ability to monitor its actions and enforce them without new legislation. Read both columns; they are good.

The IAEE conference was very good -- lots of interesting papers, and I was fascinated by the similarities and the differences of the issues and approaches across this very international group of economists. In the next couple of days I'll be posting a summary of remarks from Lord Nigel Lawson, who was Chancellor of the Exchequer in Margaret Thatcher's administration. He gave a speech about electricity and natural gas privatization in Britain in the 1990s. I'll also highlight a couple of interesting papers and avenues of research about which I learned last week. But right now I'm off to Washington DC to teach some seminars.