Market Power

Windfall Profits Taxes

When a high-ranking U.S. senator sounds more like Karl Marx than Adam Smith over the issue of energy prices, it must be an election year.

That's Mark Perry at Carpe Diem commenting on the political theater of Senator Chris Dodd.

MP: If Senator Dodd is concerned about industries making "windfall profits," he might want to start by investigating the 57 industries with profit margins HIGHER than the oil industry (see list above, click to enlarge, profit margin data available here).

Here's the picture from Perry's post.

Let's not forget the another profiteer from oil and gas sales of all:  local, state, and federal governments.   

 

Oil Fact of the Day

With all the doomin' and gloomin' in the news about the high price of gasoline and oil in mind, and with all the talk about poor folks not being able to afford this and that because of energy prices, Michael Giberson has the best paragraph I've read today:

It is also worth remembering, as an anonymous commenter mentioned here a few days ago, that at the root of the rise in the price of oil (and the point applies to food as well) "is a positive development: an unprecedented boom in the world economy" as India, China, and other nations see transformational booms in economic activity.

And rises in the overall standards of living of Indians and Chinese.

People keep waiting for the other shoe to drop with oil prices, likely remembering the 1970's and the adverse effect oil had on world economies.  But as Gary Becker recently noted, the current run-up in oil prices is mostly due to demand-side effects while that in the 1970's was due to supply-side effects.  In the 1970's,world economies responded to shocks in the oil market.  This time around, growing economies are driving the wagon. 

That's not to say that there are no contemporary supply-side effects, but my sense is that the other shoe probably will stay on the other foot

We Economists Don't Emote Enough

So, I'm watching the local news at 6:00, and on comes a story about a local gas station that is having a unique problem with high gas prices.  See, this fella has those old-timey gas pumps, you know:  the mechanical ones.  He's afraid that, with the high price of gasoline, the gears spin so much that they will burn out.

Seriously.

Then the story went on to talk those evil oil companies.  Not much at all about the inner workings of the market.  You know, supply and demand.

Bah.  Who are the real profiteers?

            What about those "obscene" oil company profits we hear so much about?

An economist might ask, "Obscene compared to what?" Compared to the investments made? Compared to the new investments required to find, extract and process additional oil supplies?

Asking questions like these are among the many reasons why economists have never been very popular. They frustrate people's desires for emotionally satisfying explanations.

If corporate "greed" is the explanation for high gasoline prices, why are the government's taxes not an even bigger sign of "greed" on the part of politicians-- since taxes add more to the price of gasoline than oil company profits do?

John.  I told you we don't emote enough!

Another Post On Oil

You've probably seen this over at MR, but just in case, here's Tyler Cowen thinking openly about whether there is an oil bubble:

I've never been one to push the bubble hypothesis to explain the high price of oil but I find this an unusual argument to make against bubbles.  Isn't it easy enough to argue that the relevant hoarding is of oil in the ground rather than oil in strategic reserves or panic stockpiles?  We have lots of state-owned oil companies and maybe their way of speculating is simply to remain sluggish in their exploration and extraction activities, at least for the time being.

I think of a bubble as a market price which is above the fundamental value of the asset, largely for psychological reasons.  But with a commodity like oil the fundamental value of the asset depends on the marginal unit and thus how much oil is supplied.  Fundamental value, at least at the margin, adjusts to the price and in that sense the bubble hypothesis can seem tautologically false if we apply the traditional definition of a bubble. 

The key question, in my view, is how much more the oil-producing nations could bring to the market if a) their state-owned oil companies were not incompetent, and b) they did not tolerate this incompetence as an implicit form of speculation and collusion.  I will not offer an estimate here (I genuinely don't have one) but b) does leave some room for bubbly-like phenomena, whether or not stockpiles of pumped oil are high.  Note that in b) collusion and speculation work together and a) tosses incompetence into the mix.  The whole foul brew is probably easier to sustain in times of rising demand and thus oil price explanations are not going to be very simple, or easily separable, by the nature of the problem.

Another "Threat" to the Supply of Oil?

A worker "shortage" (via Knowledge Problem):

The oil and gas industry may have figured out how to drill in 10,000 feet of water, but it still hasn't solved what may be its biggest challenge in coming years: finding enough skilled workers.

For an industry that expects more than half its employees to retire over the next decade and is struggling to recruit younger replacements, it's the issue that just won't go away.

Quick hits:  how much of this "shortage" has arisen from the fact that major oil fields are located in risky areas and in places with inhospitable climates? 

And is there really a "shortage" per-se.  That is, at the going rate of pay, are there really not enough workers?  If so, why aren't wage rates climbing to clear the shortage (and to pay a compensating difference for the two unpleasant features mentioned in the last paragraph)?

If pay rates have been climbing, how much of the recent surge in the price of oil is due to the increase in pay rates of oil workers?

Ethanol Standards

From John Whitehead's blog:

From the inbox:

Dr. Soren T. Anderson of the University of Michigan will be presenting a paper entitled "The Demand for Ethanol as a Gasoline Substitute" at the [Triangle Resource and Environmental Economics] workshop today (Thursday, February 28).

The abstract indicates that ethanol standards are a bad idea:

This paper considers the role of household preferences in evaluating policies designed to promote ethanol as a substitute for gasoline. I develop a model of household production with inputs of a polluting good and a clean good that are perfect substitutes from the household’s perspective. The key parameter in this model is the relative price at which the household is indifferent between the two inputs. I aggregate households and then use the model to formalize the link between the distribution of household preferences for the clean good and the response of aggregate demand to price changes. I estimate the model using data for ethanol sales volumes at a large number of retail gasoline stations during 1997–2006. I find that demand for ethanol is sensitive to relative prices, with elasticities that range from 2.5–3.0 in magnitude. I use the distribution of preferences implied by my estimates to simulate the effects of a national minimum ethanol content standard for gasoline. I find that the efficiency cost of a 25% standard is about $50 billion annually. Costs are half as large as when I naively assume that households have identical preferences based on ethanol’s fuel economy performance relative to gasoline, as is done in previous studies. Costs are lower because households with particularly strong preferences for ethanol are induced to purchase the fuel with less severe distortion of market prices. The policy remains quite expensive, however, with implied costs per gallon of gasoline saved or ton of carbon emissions avoided exceeding most conventional estimates of marginal external damages.

Emphasis mine.

Mr. Anderson is a PhD candidate at the U. of Mich.  Here is his paper.

 

From the inbox:

Dr. Soren T. Anderson of the University of Michigan will be presenting a paper entitled "The Demand for Ethanol as a Gasoline Substitute" at the [Triangle Resource and Environmental Economics] workshop today (Thursday, February 28).

The abstract indicates that ethanol standards are a bad idea:

This paper considers the role of household preferences in evaluating policies designed to promote ethanol as a substitute for gasoline. I develop a model of household production with inputs of a polluting good and a clean good that are perfect substitutes from the household’s perspective. The key parameter in this model is the relative price at which the household is indifferent between the two inputs. I aggregate households and then use the model to formalize the link between the distribution of household preferences for the clean good and the response of aggregate demand to price changes. I estimate the model using data for ethanol sales volumes at a large number of retail gasoline stations during 1997–2006. I find that demand for ethanol is sensitive to relative prices, with elasticities that range from 2.5–3.0 in magnitude. I use the distribution of preferences implied by my estimates to simulate the effects of a national minimum ethanol content standard for gasoline. I find that the efficiency cost of a 25% standard is about $50 billion annually. Costs are half as large as when I naively assume that households have identical preferences based on ethanol’s fuel economy performance relative to gasoline, as is done in previous studies. Costs are lower because households with particularly strong preferences for ethanol are induced to purchase the fuel with less severe distortion of market prices. The policy remains quite expensive, however, with implied costs per gallon of gasoline saved or ton of carbon emissions avoided exceeding most conventional estimates of marginal external damages.

Emphasis mine.

Mr. Anderson is a PhD candidate at the U. of Mich.  Here is his paper.

 

Science Study: Biofuels and Greenhouse Gasses

From Science:

Most prior studies have found that substituting biofuels for gasoline will reduce greenhouse gases because biofuels sequester carbon through the growth of the feedstock. These analyses have failed to count the carbon emissions that occur as farmers worldwide respond to higher prices and convert forest and grassland to new cropland to replace the grain (or cropland) diverted to biofuels. Using a worldwide agricultural model to estimate emissions from land use change, we found that corn-based ethanol, instead of producing a 20% savings, nearly doubles greenhouse emissions over 30 years and increases greenhouse gases for 167 years. Biofuels from switchgrass, if grown on U.S. corn lands, increase emissions by 50%. This result raises concerns about large biofuel mandates and highlights the value of using waste products.

Lynne Kiesling has thoughts here.  I haven't read the study, but it seems to be a reasonable attempt to account for seen and unseen effects.  Here is a retort from the Minnesota Corn Growers' Association.

Update: Kip comments:

From the Minnesota rebuttal:

"In Minnesota, where the biofuels revolution has been underway for more than a decade, that major shift has not occurred to date, not even in the past year despite record jumps in crop prices and land rental rates."

I'm so relieved to learn that Minnesota's tropical rain forests are not being cleared to plant ethanol-dedicated corn fields.

Even if we do take the Minnesota rebuttal at its word, then what explains the result of the study?  Either the authors are wrong or someone else is altering land for use in biofuel production.

 

The Role of Prices

Economist Edward Lotterman nicely explains the role of prices in an economy, with particular attention given to the crude oil and copper markets:

Few consumers like high oil prices. Do-it-yourselfers like me wish copper pipe and fittings had not gotten so expensive. But such high prices do illustrate how markets work.

Prices in an economy function to transmit information and motivate actions. High prices tell producers to produce more and consumers to use less. They also tell people to discover better ways to produce the high-priced product or to find acceptable substitutes.

...Moreover, high commodity prices increase the "reserves" of such raw materials even if no new physical discoveries are made, since they increase the proportion that can be extracted profitably.

Make sure you read the whole thing.  Lotterman tells of oil deposit discoveries that underlie a point that I (see here, here, and here) and others have made:  as long as markets are allowed to function, we will never run out of oil.

Damming A River - Water Still Seeks the Deep

This Consumer Reports article on the performance of washers has been making the rounds recently:

Not so long ago you could count on most washers to get your clothes very clean. Not anymore. Our latest tests found huge performance differences among machines. Some left our stain-soaked swatches nearly as dirty as they were before washing. For best results, you’ll have to spend $900 or more.

What happened? As of January, the U.S. Department of Energy has required washers to use 21 percent less energy, a goal we wholeheartedly support. But our tests have found that traditional top-loaders, those with the familiar center-post agitators, are having a tough time wringing out those savings without sacrificing cleaning ability, the main reason you buy a washer.

...Today most top-loaders only get a good washing score, and some had the lowest scores we’ve seen in years. One washer, with an overall score of 19 (out of 100) is one of the lowest-scoring washers in this and past reports. Several major manufacturers are meeting the new energy standard by lowering wash water temperatures. But doing this often lowers the washing performance.

Nice.  Environmentalists have been able to get government to further regulate washing machines so people won't use as much energy.  If you can't persuade consumers to do what you think they should be doing, a common step is to get government to force them to do it.

People are not inanimate objects.  Like water flowing around a barricade, people find ways around regulations - ways that may make things worse than before.  Alex Tabarrok points out a possibility:

Ironically, the law could well reduce cleanliness and increase energy use.  If the new washers are as bad as Consumer Reports say they are people will just start to wash everything twice.

If a person uses X "units of energy" to wash clothes without the regulation, they'll use X' = 0.79X units of energy to wash clothes with the new regulation.  If that person feels he must wash clothes twice, he'll use 2X' = 1.58X units of energy, or over 150% more energy than before.  That doesn't count the cost of the extra water and soap nor any external costs of the added wash.

Or, as AT also implicitly points out, others just won't have shirts as clean as they'd like.  Some will no doubt end up buying clothes more often than before.

Update: In doing some research for a class, I ran across this quote from Adam Smith's Wealth of Nations Book 4, Chapter 2 in the same paragraph as the "invisible hand" description): 

"I have never known much good done by those who affected to trade for the public good."

Some Bad Effects of Ethanol Policy

When government subsidizes the production of ethanol and slaps tariffs on imported ethanol, what are the probable effects? 

Corn prices have already begun to soar. A rush to turn more acres into corn production could decrease supplies of other commodities, driving up prices of them as well.

Ag land has alternative uses.  When the return earned from producing one commodity is bolstered by subsidization, farmers will, all else equal, plant more of that commodity and less of another commodity when the amount of land used in agriculture is fixed.  Another possibility in areas like mine (a small, growing midwestern city surrounded by farmland) is that property values, and the prices of new homes, could be pushed up as subsidization raises the return from using land for agricultural purposes.

The resulting higher market prices could then dampen the public's support for government subsidies that are designed to help farmers reap profits when markets are down.

I'll believe subsidy decreases when I see them.

Sunding envisioned a scenario in which price supports for farmers are replaced by another government program — one to purchase food to keep prices affordable and prevent hunger.

There's nothing quite like mestastizing government policy.