MORE ON FUEL CELL RESEARCH SUBSIDIES: An editorial in the Wall Street Journal today on the proposed fuel cell subsidies (subscription required) cuts right to the heart of the matter:

But politics aside, this is bad public policy. Hydrogen fuel cells are an encouraging field of research. So encouraging, in fact, that the finest minds in the private sector -- auto makers, oil companies, private technology firms -- have been studiously working on them for decades. These smart innovators have had some notable technical breakthroughs; car companies such as Honda even have produced (very expensive) prototypes.

Which is all the more reason taxpayers shouldn't be forking more over to the effort. Granted, there are areas where government research funding serves a purpose -- particularly in fields where there is little or no commercial market to drive development. But private companies clearly think they stand a chance to make money from fuel cells; if a market exists, they'll find it, without Washington throwing money at them.

The real challenge facing the industry today is whether it can make fuel cells affordable. Even the most efficient prototype fuel cells generate electricity at a cost of between $800 and $1,000 per kilowatt hour, when the magic affordability number needs to be closer to $12. The best chance to lower these numbers is to let industry run its own course, experimenting with smaller, more manageable uses for fuel cells such as in laptops or mobile phones -- rather than rushing as one to make the President's miracle car.

Very well said. Think about the opportunity cost -- why should we subsidize efforts that private companies are willing to undertake, when resources are scarce?

Reason Public Policy Institute has published an article by Pierre Desrochers, of the Montreal Economic Institute, examining how creating institutions, rather than mandates, will increase sustainable reuse of industrial by-products.

In Tuesday's State of the Union Address, President Bush proposed increasing federal subsidies to hydrogen fuel cell research. His administration had made similar recommendations in its national energy policy proposal in May 2001, to supplement the existing energy technology research subsidies.

Such technology subsidies, particularly to get renewable energy technologies to the point where they are commercially viable, overlook an important point: the fact that these technologies are not commercially viable may mean that they are not economically efficient. If entrepreneurs and investors do not think that these forward-looking investments make economic sense, then for the government to override this decision with subsidies is almost certain to be wasteful and more costly than need be.

My colleague Adrian Moore and I analyzed the administration's national energy policy proposals in a Congressional Advisory titled National Energy Policy: In Need of a More Dynamic Approach for the Institute for Research on the Economics of Taxation.

Many of the Bush proposals and methods, including their flaws, were reflected in the energy bills passed by the House and the Senate in the last Congress. These energy bills are likely to be resurrected in some form in the new Congress. Both versions of the bill included pervasive subsidies, government management of economic activity, and inadequate attention to market processes. If energy bill proposals in this Congress retain these flaws, the best possible energy bill may be no bill at all.

While the Bush approach appears innovative and less prescriptive than traditional "command and control" energy and environment regulation, it retains too much government manipulation of markets, and does not recognize the range of institutional approaches available to address energy challenges. A more dynamic approach to energy policy would focus on the removal of regulatory and institutional disincentives to competition and entrepreneurial discovery of opportunities and focus government policy on the margins, possibly to aid the transition to competitive markets.

HYDROGEN FUEL CELLS: After Tuesday's State of the Union Address, everyone's in a tizzy about the prospects for increased funding of hydrogen fuel cell research for vehicles. See, for example, this Financial Times article discussing the increase in price in platinum markets yesterday. Platinum is currently the best catalyst for making hydrogen fuel, which is also one reason why hydrogen fuel cells are currently 100 times as expensive as internal combustion engines. See also this BBC article, this Financial Times article, and this LA Times article (registration required). Note also the stock market response, with fuel cell companies rising, as reported in this AP story.

RICHARD EPSTEIN ON REGULATORY TRANSITION: Richard Epstein's Financial Times article on Wednesday lays out some problems that arise when you try to change the regulatory approach in a network industry in which technological change happens. He's discussing telecom and the "deregulation" in the 1996 legislation, but as Keith at Liberty Lover points out, Epstein's analysis has important insights for electricity deregulation as well. As Epstein says in his opening paragraph:

The world is always in flux, and nowhere is this more evident than in high technology, where innovation almost always counts as improvement. The legal arrangements that surround such technical advances are a quite different matter. It is tempting to think that the regulatory framework must always be adjusted to keep up, but the transition from one set of institutions to another is fraught with hidden perils that all too often undermine the success of the overall operation.

One of these hidden perils is the all-too-real fact that regulatory agencies, which are supposed to have specialized knowledge that better enables them to implement beneficial institutional change, also have their own interests and preferences to satisfy. Satisfying their own interests can, and usually does, create institutional change that does not map onto the institutional change that best serves other interests, such as "consumer welfare", dynamic competition, or the ability to adapt to unknown and unanticipated changes.

The column concludes with

The overall lessons from this debacle are two: first, regulatory transitions are always perilous because there are too many points of slippage between the design of a new scheme and its implementation; and second, systems that rely on forced purchases are especially dangerous, because the choice of price is not likely to be made correctly in face of the multitude of political pressures and agendas that exist.

There are many reasons to dislike the status quo ante. But one reason to like it is that it avoids a set of transition costs whose magnitude is discovered only when it is too late.

As the electricity industry continues its regulatory evolution we should certainly bear these lessons in mind. We should not, however, give in to status quo inertia because of these transition costs. We are trying to move away from the regulatory status quo because it is inefficient, and does not respond well to dynamic market processes and technological change. In the transition we have to be conscious of, and try to minimize, the likelihood that these costs can nullify all of the benefits from deregulation.

LOSSES CONTINUE IN THE ELECTRICITY INDUSTRY: CMS Energy won't issue dividends in 2003 in an attempt to improve its liquidity, American Electric Power declared a 4th quarter loss and will cut jobs and investment, and these developments led other utility stocks lower this morning.

This is the continuing fallout from the collapse of the energy trading sector of the industry, and hopefully we're on the home track toward being done with the fallout. But what remains to be seen is where the energy trading business model will head this year. Regulatory innovation and change that encourages competition and choice, at both the federal and state levels, will be a key component of unleashing the value potential in energy trading. But that's a slow, evolutionary process.

A ROUGH MEASURE OF INCREASED PRICES INDUCING ENTRY: One of the most important dynamics in market processes is how high prices induce suppliers to either enter the market or, if they're already in the market, to invest in expanding their production capacity to capture the profits available due to higher prices. In the current environment with high and volatile oil prices, you'd expect some investment in exploration and drilling, especially in the US and Canada. And indeed, the number of exploratory rigs in the US and Canada has increased. Interestingly, the number in the Gulf of Mexico has decreased, while the most substantial increases in exploratory activity in North America are in Oklahoma and New Mexico.

ATHENA'S GIFTS: I've got a review of Joel Mokyr's The Gifts of Athena on Tech Central Station today. Read the review, read the book.

VENEZUELA RESOLUTION? Is the strike almost over? Is Chavez going to prevail? Apparently Chavez has fired 3,000 oil company (PDVSa) executives, but Chavez opponents are meeting with officials from other Latin American countries and the US to see if they can persuade an international coalition to work on their behalf. The resumption of tanker shipments this week has increased the flow of Venezuelan oil into world markets, which had some dampening effects on prices and somewhat offset the war premium effects on prices.

BRRRRR chilly! It's a good day to work at home, swaddled in polarfleece and homemade alpaca socks. Bonne Marie Burns at ChicKnits certainly knows how to approach a Chicago cold spell. For her the tough wear mohair, for me the tough wear alpaca (and high-tech soft goods made of Gore windstopper fleece). And drink lots and lots of tea.

A GOOD ARTICLE ON OIL MARKETS, WITH A SOUPCON OF SELF PROMOTION: While I'm tooting my own horn, I should mention this Philadelphia Inquirer article by Akweli Parker on the prospects for oil and gas prices and supplies if we do go into Iraq and Venezuela continues to be unpredictable. He interviewed me as well as a host of much more knowledgeable people, and put together a good story.

MORE ANALYSIS AND DRAMA IN THE NEVER-ENDING CALIFORNIA ELECTRICITY CRISIS: This article from Tuesday's Orange County Register summarizes where we are in trying to get beyond the electricity policy failures in California. The article cites the $8.9 billion in refunds that California policymakers think they are owed, a number I discussed in reference to FERC Judge Birchman's estimate of refunds in this post. Also today, this analysis by Christopher Weare at the Public Policy Institute of California of the causes and consequences of the electricity crisis was released. This Bloomberg News story summarizes the study, which I will analyze in more detail once I've had the chance to read all 121 pages. From my cursory examination it appears to be a balanced approach.

This Orange County Register editorial from 3 January also mentions some drama in Governor Davis' demotion of PUC chairman Loretta Lynch, who has presided over the regulatory agency during the fiasco. In the spirit of shameless self-promotion, the editorial also quotes me about the importance of realizing that the California experience is not representative, and that states such as Texas and Pennsylvania have restructured their electricity regulation in ways that have delivered real benefits to customers.

While I'm making reading recommendations, let me belatedly recommend this Reason Online article by Jonathan Rauch on fuel cells. He's a fantastic writer (this article is very much in the same tone as his outstanding April 2002 Atlantic Monthly article on computer-generated artificial societies as a tool to understand migration and the demise of Anasazi settlements), and in this article he describes conversations he had in Japan with fuel-cell folks at Honda and Toyota. Honda and Toyota have started a fuel cell vehicle production and commercialization pilot, as I mentioned in this post. An excerpt from the article:

It would be a mistake to make too much of this. The Honda and Toyota cars are very, very expensive to manufacture. How expensive? "I can only say the expense is enormous," said Shinichi Yamaguchi, of Toyota's environmental-affairs division, during an interpreted interview in Japan's Toyota City, near Nagoya. Each company plans to produce only one or so of these precious jalopies a month for the next year or two. Still, the problem of stuffing big fuel cells into little cars is now officially solved.

Again, read the whole thing.

BAYESIAN FILTERING AND DYNAMIC PROCESSES: This spectacular article by Arnold Kling in Tech Central Station today analyzes the roles that content intermediaries play, and how those roles evolve over time and with technology. He succinctly captures the dynamics of the situation with the concept of Bayesian filtering, and he also points out (accurately, I think) that one particularly valuable role that weblogs play is precisely the informed filtering that their authors do. Read the article, it's superb.

CHICAGO, CITY OF THE CENTURY: I am generally not an overly sentimental or romantic person, but when it comes to my adopted hometown (I'm from Pittsburgh originally, so yes, I was depressed Saturday night) I tend to wax lyrical and poetic. For me Chicago symbolizes much of what is important, valuable, and beautiful about human creativity and the human spirit (those of you who want to be snarky and invoke Al Capone, machine politics, etc. here should just get over the fact that humanity is complex).

I'm not the only one, and starting tonight, Chicago: City of the Century will be celebrated in a three-part documentary on PBS. The good and the bad, politics, economics, culture, architecture, arts, science, sports; Chicago has had a pivotal role in the American experience in the 19th and 20th centuries. I think this documentary will celebrate all of that. From the website:

City of the Century chronicles Chicago's dramatic transformation from a swampy frontier town of fur traders and Native Americans to a massive metropolis that was the quintessential American city of the nineteenth century. The film tells how innovation, ingenuity, determination and ruthlessness created empires in what was a marshy wasteland and describes the hardships endured by millions of working men and women whose labor helped a capitalist class reinvent the way America did business. Along the way, this program revels in Chicago's triumphs -- among them the architectural experimentation that gave the city one of the world's most distinctive skylines -- and delves into the heart of Chicago's painful struggles. Bringing to life the Windy City's rich mixture of cultures, its writers and journalists, its political corruption and labor upheavals, this film bears witness to the creation of one of the most dynamic and vibrant cities in the world.

Dynamic and vibrant indeed.

OPEC RAISES PRODUCTION QUOTAS: As expected, yesterday OPEC members chose to raise their production by 1.5 million barrels/day.

ELECTRICITY COMPETITION IN ILLINOIS, FINALLY? Illinois nominally opened its electricity generation to competition for all consumers as of May 2002. Have we seen much entry? Heard much consumer education? Seen any advertising from competitors? No. It's been staggeringly disappointing.

But that may change soon. Peoples Energy, our less-than-impressive natural gas former monopoly utility, has contracted with Hess Microgen to provide distributed generation through cogeneration at customer sites. It's about bloody time. DG, particularly cogeneration, makes both economic and environmental sense because it recycles and uses waste heat created in the electricity generation process. Many regulatory and incumbent monopoly power barriers exist to the extension of DG, even to large industrial consumers who can use cogen to recycle waste heat to heat their facilities, so this is a welcome piece of news. We'll see how much of an effect it really has.

GROWTH, CALIFORNIA STYLE: Read Megan McArdle's post on Gray Davis' suggestions for federal economic policy. The comments are also particularly illuminating, including the one that points out that California's budget deficit is larger than the combined deficit of all of the rest of the states.

The comments also have a discussion of the extent of Enron's culpability in California's economic woes. Most commenters dismiss their importance, which is in keeping with the recent ISO report I discussed in this post, and will analyze in further detail in the very near future.

THIS IS INTERESTING: According to the Washington Post, the US will join the mediation effort of the Organization of American States to bring a quicker end to the instability in Venezuela.

DUH: Gas prices to rise by summer, government says. Gas prices always rise by summer, it's called seasonal demand variation. But this AP article is more substantive than that (I realize that they are hard-pressed to come up with pithy headlines), discussing how the current supply problems from Venezuela are likely to lead to a higher-than-average increase in retail gasolline prices, because refiners are likely to have trouble buying enough crude oil to meet their production expectations. The retail prices are likely to be highest in the Midwest, because of the combination of three factors:

1. We usually get most of our crude from Venezuela, comin' up the Mississippi
2. The Midwest is still plagued with refinery capacity constraints, so if there's a breakdown or an outage we have very little fault tolerance
3. The combination of the federal reformulated gasoline regulations and local boutique fuels, which fragment markets and raise refining costs

So those of us who live here should start living by the great Queen song, "I like to ride my bicycle, I like to ride my bike".

VAMPIRE BAT SALIVA FOR STROKES? How cool is this: vampire bat saliva has a clot-busting compound that could lead to new drugs to prevent strokes.

NEW REPORT SAYS ELECTRICITY RESTRUCTURING IS WORKING IN TEXAS: According to the Alliance for Retail Markets, Texas's restructuring law is working. They measure that success by consumer switching, which at 6.5 percent is high relative to switching experience in other states, and by estimated consumer savings of $6-14/month for those who have switched. I have quibbles with these measures of success, because it does not capture the extent to which the incumbent utilities have changed their pricing and service offerings to remain competitive with entrants. But the Texas PUC publishes a monthly report card on the status of electricity restructuring; their September 2002 report card includes two other indicators of success:

1. Consumers in all regions have substantive, meaningful choices
2. Over 80% of "non-price-to-beat" customers are receiving service under a competitive contract

That second point captures the extent to which incumbents are offering attractive competitive alternatives to try to retain market share. The report card also indicates market shares, which in the 5 regions are about 80% for the incumbents and 20% for the entrants. That's certainly better than we've seen in telecom!

And the consumers are better off.

UPDATE: Here's a Dallas Morning News article on the first year of electricity restructuring. Thanks to my colleague Bob Poole for forwarding the article.

CA ELECTRICITY PRICES RESULT OF MARKET POWER, NOT GAMING? Such is the conclusion of a California Independent System Operator report released Monday. This Wall Street Journal article (subscription required) and this LA Times article (subscription required) discuss the report, but interestingly, they have different slants. The LA Times article has the tone of "here's a list of companies that did what Enron did" and "it's just a matter of time before they discover market manipulation". In contrast, the Wall Street Journal article says

The results support the agency's long-held claim that the bulk of power overcharges during the state's 2000-01 electricity crisis didn't come from market manipulation or gaming strategies, but from the abuse of market power. Market power refers to a company's ability to use its market share to influence prices.

"We have said all along that the greatest dollar amounts of damage come from (parties) charging high prices because they had the power to do so," Fishman said. "Still, that doesn't take away from the importance of addressing gamesmanship."

The ISO report was submitted last October, per request, to the Federal Energy Regulatory Commission. FERC is handling California's request that suppliers refund $8.9 billion to the state for charging "unjust and unreasonable" power prices during the energy crisis, when blackouts and price spikes were frequent.

FERC has given California officials until Feb. 28 to submit evidence of market manipulation in the refund case. A FERC judge has already recommended the refund amount be set at $1.8 billion, but the final decision rests with the commission board.

Thus we arrive back at the point that I laid out in this post, where we have to confront the question of how these companies achieved market power in the first place. First, the California restructuring mandated that utilities sell their fossil-fuel generation facilities to these companies. Then the legislation mandated that the utilities buy from these companies in the state-created "faux market" pool, and only day ahead and day of. Gee, d'ya think the legislation gave the generators market power and put the utilities over a barrel?

BACK TO ALGERNON SIDNEY: Now the Venezuelan opposition is encouraging citizens to stop paying taxes. Again I raise the question: has Chavez abrogated his constitutional responsibilities to his constituents? If so, then you could argue either the Locke argument that citizens have the right to rebel, or the Sidney argument that citizens have the responsiblity to rebel.

The extent to which Venezuelans do indeed stop paying taxes will indicate both the risks they are willing to take to get rid of their democratically-elected despot and the probability that those people assign to the downfall of the Chavez government.

Now there's even the possibility of a a two-day bank strike in Venezuela.

THE CONSEQUENCES OF VENEZUELA'S OIL STRIKE: Venezuela's iron and steel industry is in virtual shutdown because of the (natural) gas shortage brought on by the strike. Gas is a by-product of oil production, so it's been shut down too. It turns out that Venezula is the world's largest producer of hot briquetted iron, which is an input in the production of steel, so world prices for hot briquetted iron have risen.

I HATE TO SAY "I TOLD YOU SO," BUT ... OPEC is having an emergency meeting Sunday to discuss the extent to which they should raise output. Furthermore, their proposed increase of up to 1.5 million barrels/day is a large increase for them, and drove down crude oil futures prices. Some news reports have argued that this is a dramatic policy shift for OPEC, but I disagree; OPEC's stated policy is to produce in amounts that lead to a benchmark price of $22-28/barrel. It's entirely likely that they are looking at Venezuela and their expectations for what and when in Iraq, and they think that 1.5 million bpd is a number that will keep prices at least close to that, if not in the range precisely.

Even furthermore, OPEC is encouraging non-OPEC members to increase their production too, because decreased production in two major producers simultaneously could create a supply shortfall that OPEC could not satisfy alone and keep prices close to the target range. Russia has agreed that it will produce at a level to keep prices "reasonable",, but I saw a news article yesterday that said that Mexico had no intention of raising output. I can't find the article now, though.

Why is OPEC doing this, you may ask. Well, they make a lot of money selling oil at these high prices, and by selling more at these prices that are still above their target range they also generate goodwill and good reputation capital, which is sorely needed. Plus, "OPEC members are keen not to let Russia increase its market share at their expense".

MORE ON CALIFORNIA ELECTRICITY: Many thanks to Robert Musil for posting a link to this paper by Susan Pope on electricity price spikes and California. I've not looked over it in much detail, as I'm blogging from a Kinko's and in between sessions at the AEA, but it looks clear, wonderful, and correct. So Davis et al are deeply unlikely to pay a lick of attention to it.

And thanks to Robert Musil for calling me both astute and babelicous. Shucks. Wait 'til I can start posting pics of my cat, then you'll really see babelicious!

OIL PRICES CONTINUE TO SWING: Not to beat a dead horse, but oil price volatility will continue to exist for the forseeable future. Today's markets in London experienced opened 2.2 percent higher today, after the American Petroleum Institute announced a 9 milliion barrel drawdown in inventories last week. That's a big inventory decline, so it's no surprise that prices are rising today.

This article in today's New York Times (registration required) provides a nice summary of the current state of oil markets, as well as a discussion of the decision facing the administration regarding whether or not to release oil from the strategic petroleum reserve. It also points out how attempts to raise prices have changed in 25 years:

But most analysts agree that whatever disruptions might occur, they will probably not come in the form of oil embargoes like those of the early 1970's, which still haunt many people in the West.

"People have to stop thinking that oil markets will be affected by embargoes, because embargoes are a thing of the past," said Moisés Naím, a former Venezuelan minister of trade and industry and now editor of the journal Foreign Policy.

"The problem is failed states," Mr. Naím said. "It's a harbinger of things to come: when internal political turmoil limits oil to world markets."

A primary reason why embargoes are a thing of the past is the growth of non-OPEC supplies in countries like Russia, Mexico, Norway, and in the Caspian and West Africa countries.