Bastiat and green policy

Nineteenth century French economist Frederic Bastiat described the government as “that great fictitious entity by which everyone seeks to live at the expense of everyone else''. This quote may give some insight into the present state of the debate about energy policy in the UK.

The pollsters tell us that the public are in favour of green subsidies and green technology. Reducing our greenhouse gas emissions is seen to be important and worthwhile. But there still seems a large section of the population who think that somehow the big 6 energy companies could or would subsume any additional costs from green energy rather than passing them back to consumers, or that the government would make up the difference.

Evidence seems to suggest that the energy market is reasonably competitive, with margins no higher than other comparable industries, meaning the firms wouldn't absorb the cost—if they did, the public would suffer anyway through their pension funds. And the hope that government could make up the cost ignores the central truth that the government has no money of its own, not due to the economic crisis not but because the state can only ever spend and distribute our money. A case in point is the government recently "lowering" our bills by putting the costs of the social levies into general taxation and away from power. This may or may not be a fairer way of spreading the cost of a greener future, but it doesn't magically make the cost of greener energy any lower.

Bastiat has more to add to our appreciation of UK energy policy. He said that good economic decisions can be made only by taking into account the full picture, by examining the full costs and benefits of the short- and long-term consequences.

Employing increasing amounts of green energy has costs. The debate is complex. But in the absence of dramatically increasing our energy efficiency and therefore cutting our energy use together with a reduction in the cost of green power production, employing low carbon technology will lead to energy prices to continue to rise. This rise may eventually be less than using more fossil fuels in our energy mix, if the costs of fossil fuels increase as many including the Department of Energy and Climate Change maintain. Nevertheless, green energy is currently expensive. Defining the benefits of employing low carbon technologies is even harder to evaluate. The UK emits a small proportion of the world's total CO2 output, and emissions are growing in the developing world. The UK's contribution may be important, but alone it cannot make a huge difference.

Whether or not the cost of reducing CO2 is worth it, we must note that it does have a cost, and it must eventually come from the public, either through taxes, higher energy bills, or lower returns to firms also owned by UK citizens. People cannot all live at the expense of one another.

The bird choppers finally get fined for killing eagles

Interesting news from across the pond:

The U.S. government for the first time has enforced environmental laws protecting birds against wind energy facilities, winning a $1 million settlement from a power company that pleaded guilty to killing 14 eagles and 149 other birds at two wind farms in the western state of Wyoming. The Obama administration has championed pollution-free wind power and used the same law against oil companies and power companies for drowning and electrocuting birds. The case against Duke Energy Corp. and its renewable energy arm was the first prosecuted under the Migratory Bird Treaty Act against a wind energy company. "In this plea agreement, Duke Energy Renewables acknowledges that it constructed these wind projects in a manner it knew beforehand would likely result in avian deaths," Robert G. Dreher, acting assistant Attorney General for the Justice Department's Environment and Natural Resources Division, said in a statement Friday.

There is no possible method of having vast structures like these spinning away on the tops of hills without slicing up some number of birds. Which brings us to one of the great lessons that economics has to offer us.

There is no such thing as a solution: there are only a number of trade offs. You might indeed think that littering the countryside with bird choppers, with the attendant avian deaths, is a decent trade off to gain expensive electricity. Other might think that coal fired plant, with its mercury and radioactive pollution is a better bargian for cheap electricity. Or natural gas for slightly more expnsive but less polluting. Or nuclear, which has zero pollution except when things go very expensively wrong (although we should note that nuclear, even when it goes wrong, kills fewer than either solar or coal in normal operation). Or....well, or whatever.

Given that we always face trade offs it is the complete set of trade offs that need to be considered in any decision making process. Meaning that, yes, we do need to consider the impact of wind power on bird populations. The only regret is that that full set of trade offs wasn't considered before everyone started to build the bird choppers.

Why a carbon tax would work

Yes, yes, I know, I become ever more tedious on this subject. Yet it still is true that if we are to believe that climate change is happening, that it is indeed something we must do about and further, that it is us causing the problem, then the answer is a carbon tax at that social cost of carbon emissions (more accurately, CO2-e).

Why?

Two-thirds of Britons are expecting to cut back on heating their home this winter, with more 25 to 34 year-olds likely to turn down the thermostat than pensioners. A new report last night claimed 32 per cent of people will "definitely" turn down the heating or switch off lights over the coming weeks in a bid to save money. A further 35 per cent will "probably" act. Some 88 per cent of households classified among those struggling with the rising cost of living fear they will have no choice but to use less gas or electricity.

Because when prices change people change their consumption habits. Given that this is what we want to happen, consumption habits to change, therefore we want to change prices.

Now I'm aware that many reject the basic layout, that there is a problem that we are causing that something should be done about. But please, let us leave that aside for a moment: think of this as a logical construct, not necessarily a description of the true world around us. Those who do accept that trio of assertions should therefore be in favour of a carbon tax. And yet that is not the consensus among those who do accept those three postulates. And for the life of me I cannot understand why. It is, after all, the main finding of the Stern Review, the very review that is waved around in support of the argument that we do have a problem that we should do something about.

All I can really come up with is the idea that people don't like something so simple as a solution. They'd prefer to witter on about an ecodammerung rather than find that there is a simple and cheap solution.

For a proper carbon tax in the UK would indeed be a cheap solution. As I've pointed out before the UK's emissions are of the order of 500 million tonnes a year. Stern says the tax should be $80 a tonne, or  perhaps £50 a tonne. £ 25 billion a year in emissions taxes. And when you add up the extra fuel duty from the escalator, landfill tax, air passenger duty and so on, we're already paying such an amount in those emissions taxes.

So, actually, we're done, finished, the UK has, as far as the Stern Review is concerned, already put into place the solution to climate change. We can declare victory and go home.

As I say the only reason I can think of that this isn't what we're doing is that there are far too many people invested in the idea that this is a complicated and difficult problem that needs their special skills and jobs to solve, rather than being one that we have already dealt with.

That Kuznets Curve seen in the wild

I'm often amused by people breathlessly reporting something that we would expect to be true. You know the sort of thing, capitalists pursue profits and so on. Here it's the idea that China might clean up some of the pollution it emits because people don't like seeing their children choke on the stuff.

Last week, an eight-year-old girl from China's Jiangsu province was diagnosed with lung cancer, which was caused, according to doctors, by the tiny particle PM2.5 in air pollution that is most dangerous to health. This case highlighted the reality of exposure to high levels of pollution for vulnerable groups such as children. Such headlines about the dangers of PM2.5 have become daily occurrences in China after pollution in cities such as Beijing reached unprecedented levels this year, prompting intense media pressure and public outcry that forced the government to introduce a flurry of contingency plans and bold targets to reduce PM2.5 levels by 25% by 2017.

Well, yes, all good stuff but this is exactly what we would expect to happen. It's called the Kuznets Curve. Quite simply, when people are as poor as Maoist economic stupidity can make them be they'll put up with a remarkable amount of pollution around the place if they can only get a bit more to eat, a change of clothes, that sort of thing. But as those basics (all very much part of Maslow's Heirarchy of Needs) start to turn up in some sort of abundance people then start to think that not having junior cough up his lungs every morning might be a good idea too.

So, we end up with more of the resources of a society that is getting richer being devoted to polluting the environment a little less. There's nothing odd, exciting or even exceptional about this: it's just what we would expect to happen. Which is, as I say, an occasion for amusement to me. Dog bites man, kittens arte cute, water is wet and richer countries become cleaner countries. It might be worth a newspaper piece telling us that China seems to be at the peak of the Kuznets Curve (at something like the income levels we were at when we peaked too, remarkably enough) but to portray it as some mind-boggling divergence seems very odd indeed.

Err, yes, this is how capitalism works

I find myself distinctly confused to read this in the newspaper:

He claimed the Big Six only offered competitive prices to customers once they called to say they were switching to another supplier. He warned that the companies responsible go “unchallenged” by Ofgem, the energy regulator. “A significant number of the Big Six are charging the maximum price they feel they can get away with to the customers that they feel will not switch under any circumstances and then maintaining the illusion of competitive pricing with tariffs targeted towards a very small number of relatively well-engaged customers,” Mr Fitzpatrick told MPs.

I'm not confused by what is being said, of course not. I'm just wondering why anyone thought it worthwhile to put into a newspaper. Seems to fail the dog bites man test to me.

For yes, of course, any and every suppiler will charge their customers the maximum they think they can get away with. It's rather the lifeblood of this production thing, trying to gain as much as possible for one's production.

It's also true that the ability of any one supplier to gouge their customers in this manner is limited by the fact that the gougee has an option to switch to another supplier of whatever it is. This is the competition part brought in by having a market structure.

Which leads us to the point that surely everyone has got by now. That it is the freedom of markets that limits and curbs the ability of the capitalist to rook the consumer. Which also leads us to our corollary that markets are a much more important point than is the capitalism or capitalist thing. Imagine that we had a socialist economy, producers were owned by cooperatives or the State. We'd still want, indeed need, those markets to curb the power of the producer to rook the consumer.

As, actually, we found out when the State did own the electricity and water companies and did have us all over a barrel on pricing and we had no market competition to moderate their demands upon us.

Why is everyone shouting that the nuclear deal is so expensive?

I have to admit that I'm not really getting all this screaming about how expensive the nuclear deal is. Just not getting it at all:

Seven years ago, I collected all the available cost estimates for nuclear power. The US Nuclear Energy Institute suggested a penny a kilowatt hour. The Royal Academy of Engineering confidently predicted 2.3p. The British government announced that in 2020 the price would be between 3 and 4p. The New Economics Foundation guessed that it could be anywhere between 3.4 and 8.3p; 8.3 pence was so far beyond what anyone else forecast that I treated it as scarcely credible. It falls a penny short of the price now agreed by the British government.

And there's any number of people out there shouting that at £92 per MWhr Ed Davey has agreed to pay twice the current price for the electricity that will be generated. Or, as George Monbiot points out above, that 9.2 p or so per kWhr.

Sure, this is indeed more expensive than the current costs of electricity but here's the bit that I'm not getting. These complaints, they're over something that is vastly cheaper than all of the other things that are being done with the full agreement of those currently complaining.

This strike price, it's the same as a feed in tariff in its effects. And here's the list of the feed in tarifs on other technologies. Solar at 14.9 p, Hydro at 21.65 p, wind at 21.65 p again. This nuclear scheme, the one that people are complaining so hard about, is under half the cost of wind power. So, either nuclear is amazingly cheap or it's grossly expensive and wind power is twice as bad either way around.

So, as I say, I don't really get it. How can people complain about the costs of this nuclear deal and then go on to support alternative technoligies which are twice as expensive?

Summary

It might not be nuclear power station costs that are the problem

We've the news that the Chinese are to be allowed to put their hard earned cash into providing us with electricity through the medium of nuclear power stations. Something that I'm just fine with I have to say: I'm absolutely delighted when other people invest their money to provide me with things I desire. But it's worth mentioning something important about all of this:

$22 billion for two EPR reactors in Europe (France and Finland) is about triple the $7.5 billion for the two Chinese EPR reactors.

It really is true that the two reactors being built in Europe are three times the price of the two being built in China. So, at first pass, we might think that getting the Chinese to build ours will be cheaper. Sadly, that is to make an error. For these are not cheaper Chinese reactors being built at all.

In fact, the important thing to note here is that this is the same reactor being built four times in different places. It would thus be more sensible to assign the cost differences to where they are being built rather than what is being built. We've even got much the same engineering companies doing and or overseeing the work in the different locations.

At which point I'd offer an hypothesis. And it's only that, not a theory, only a little more than a supposition. I see it in my own day job too. If I were to wish to build a small plant (and I do mean small, processing a few tonnes of basic material a day) here in the EU it would take me perhaps 18 months to gain the environmental licence to do that. In that same time I've seen competitors in China go from idea to full production.

No, I don't suggest that we all adopt Chinese environmental standards, not at all: but I would just like to point to the costs that such have. And I think that what we're seeing here in the nuclear costs is very much the same thing. It costs two to three times more to build a reactor in Europe as it does to build the same reactor in China. And no, labour costs are not the reason why. And the reason is the way in which we here in Europe try to regulate the building of reactors.

Or, as a certain nuclear engineer of my acquaintance is known to say, the majority of nuclear building costs are regulatory, nothing else.

Drill baby, drill: fracking just got cheaper

As regular readers will know I have something of a bee in my bonnet about the costs and benefits of jobs. To those who have a job it is a cost of gaining the income which they desire from having a job. To those actually doing something having to hire people to do a job is of course a cost of getting that thing done. Jobs are, on both sides, therefore a cost, not a benefit of something being done.

Unfortunately those who pretend to rule us are entirely ignorant of this simple fact:

Shale gas drilling across Britain could create just a third of the jobs David Cameron hoped for, the government has been warned. The Prime Minister insisted the country could benefit from 74,000 new jobs and could not afford to miss out on ‘fracking’, the controversial process used to release gas trapped deep underground. But a study produced for the energy department suggests that just 24,000 full-time roles could emerge even when the industry is at its ‘peak. The prediction could be a major blow to Mr Cameron’s argument in favour of shale gas.

Whether you want to think that it is the Daily Mail that rules us, David Cameron or the energy department makes no difference here. All three are arguing exactly the wrong way around.

That fracking for shale gas will produce fewer jobs than was formerly thought is good news. For it means that the costs of fracking for shale gas have just gone down. This is therefore an argument in favour of fracking: we will get more energy for a lower cost.

Hurrah! and drill baby, drill.

Which leaves us with only one question. Whichever of the three of them you do think rules us on this matter, why is it that none of them know enough economics to be able to negotiate their way out of a wet paper bag?

It's not entirely obvious that the power firms are ripping consumers off

My reaction to Ed Miliband's proposal to introduce price caps on energy was not, I'm sorry to say, something that was printable in a respectable place like this. So I'll spare you that and look instead at the basic contention that is being made.

Clearly, Miliboy must believe that the energy firms are ripping off consumers if he thinks that their prices need to be capped. If they were indeed ripping off consumers then we would see it in their profits. They would be making excess returns, profits well above their cost of capital and well above the rest of the market as well.

From the FT:

Last time I looked the cost of capital to a publicly traded firm was in the 8 to 10% range. They're making around and about that return on the capital they're employing meaning that there's just no room there for  excess profits. And if there are no excess profits then they cannot be unfairly ripping off the consumer.

So the whole idea falls over for lack of evidence that there is in fact the problem originally identified.

Freezing energy prices could be disastrous

Having worked in the energy industry in the UK since the beginnings of market liberalisation in the 1990s, I found myself somewhat alarmed by Ed Miliband's pledge to freeze on energy prices between 2015-17 if elected. Labour's standpoint seems based on some fundamental misunderstandings about the energy market.

Many outside the industry appear to be dismissing the security of supply issue, as if this were mere scare tactics by the energy companies. But it is a very real problem. When energy demand increases during cold winters, such as those we have experienced recently, a minor supply shock such as a unscheduled gas platform or pipeline shutdown can cause prices to spike.

If energy companies are prevented from passing on these increased costs in consumer price rises, how will they stay solvent? It could come down to a choice between cutting investment, returns to investors, or staffing costs. Given that energy companies' largest shareholders include UK pension funds, none of these options are appealing.

Another area where there is a great deal of misunderstanding of the way the industry works is the way energy companies buy the gas and power they need to supply their customers. Politicians and the press are very vocal about issue of wholesale price falls not always being passed on to consumers. This ignores the fact that energy companies do not buy most of their gas or power at the wholesale spot prices quoted on any given day. It is far too risky for a company to leave themselves exposed on price until the day of delivery, so they buy tranches of their gas or power up to two years in advance.

Energy firms also use long term contracts whose prices can be fixed or floating. The spot market is often only used to balance requirements when there are changes in the portfolio of supply or demand. As such, the price paid for gas or power by energy companies will be a basket of different types of prices, not simply the wholesale spot price of the day of delivery. Therefore, an energy company may not be able to respond to a reduction in the wholesale price as its commodity costs are not based solely on this spot price.

While I agree wholeheartedly that our energy companies should be subject to close scrutiny to ensure that they are delivering fair value to UK consumers, context is important, too. In the UK, domestic consumers pay the least of all EU15 countries for gas and we are the fifth cheapest for electricity. A safer method than price fixing of cutting UK energy costs would be to reduce the levels of tax paid on North Sea gas production, which can be as high as 81%. Cutting taxes would reduce distortions in the energy market: freezing prices could make those distortions disastrous.