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The Economist does not understand market mechanisms

by Jerome a Paris Wed Apr 29th, 2009 at 04:14:47 AM EST


Change is slowly coming to Germany's dysfunctional electricity market

The competition regulator is trying to work out why energy prices in Europe's biggest economy are so stubbornly high, and in some cases still rising, even though oil and gas prices have fallen sharply. It suspects that generators may have been keeping prices artificially high by, for instance, shutting power stations in concert to limit supplies. Finding evidence of that sort of skulduggery may be difficult, and proving it even more so. But regulators need not look too hard to see that Germany's electricity market is broken and that a flawed liberalisation of the market over the past decade seems only to have entrenched many of its problems.

The first sign that the market is not working is in Germany's electricity prices, which are among the highest in Europe, even though it has access to abundant cheap coal.

Setting aside for now the issue as to whether coal is "cheap" (it is under current regulations which do not make coal pay for its externalities), I had to choke here. Market prices are not set by the cheapest source, but by the most expensive: it's called "marginal cost", and it's supposed to be one of the first things you learn in economics class. So coal is almost never the price setting generation source.

That a journalist from the Economist would so blatantly contradict a basic rule of economics had me stunned (yeah, I should know better)


.


Moreover, Germany's electricity prices have remained persistently high even at times when they would have been expected to fall. Analysts at Credit Suisse, an investment bank, reckon the slowing economy will reduce electricity demand by about 5%. Coal prices have dropped by half from last year. Yet there is little sign that either falling demand or lower input costs are leading to cheaper electricity.

There, ignorance is vaguely more excusable - after all, Credit Suisse is quoted, so they have to be right, no? But electricity prices are driven by marginal producers, which are gas-fired plants, and thus electricity prices tend to track gas prices. And gas prices, well - they track oil prices, but with a lag of about 6-12 months. So, given that the high for oil prices was July 2008, it is not very surprising that electricity prices should still be high today.

Basic knowledge of the market suggests that this journalist is plain incompetent.

But of course, that does not prvent him/her from making, tadam, the following point:


The main reason Germany's electricity market is not working as it should is the lack of competition.

But of course! This is also surely why France has the cheapest electricity around...


A second problem is that Germany's biggest electricity generators also own the networks that distribute electricity. Critics argue that this gives them a huge advantage over independent producers, which may struggle to gain access to the networks fairly or, if they do, gain as much information on supply and demand across the grid. The European Commission has long criticised this "vertical integration" but it has had little success in getting its members to agree to force firms to "unbundle" generation and transmission.

Ah, unbundling. The tarte à la crème of energy ideologues for the past 10 years. The separation of the delicate, integrated, highly regulated network from the producers and consumers, which somehow will make things better run (as evey experiment over the world has proven it's not).


And over the longer run, ambitious plans to increase the share of electricity from renewable sources may erode the dominance of the country's four biggest electricity generators. Germany hopes to get as much as 30% of its electricity from renewable sources by 2020, and although few in the industry think the target will be met, there is nevertheless likely to be a huge investment in new generating capacity over the coming decades. Judicious action by antitrust authorities now could ensure that it adds to competition in the electricity market rather than simply entrenching the incumbents' positions. But because of the high cost of renewable energy, even with more competition in the market, Germany's power prices are likely to keep on rising.

Renewables are, for the most part, zero marginal cost producers, ie they reduce market prices when they are available by pushing out the most expensive sources of power and replacing them by (in the short term) very cheap ones. You'd think that an Economist journalist would know that. But no, in addition to the lie that renewables are "high cost" (hydro is the cheapest form of power around, and wind is basically competitive with coal and nuclear today), they pile on with an ignorant misunderstanding of how market work.

And this is the kind of drivel that drives our energy policy.

Display:

Derrière les tarifs il y a, en fait, l'avantage compétitif que la rente nucléaire procure à EDF et qui fausse les règles du jeu de la concurrence. En France, près de 80 % de l'électricité sort des réacteurs d'EDF, l'une des moins chères d'Europe. Si les prix sur le marché libre reflètent plutôt les prix européens, calés sur le kilowatt-heure produit par la dernière centrale construite (souvent un cycle combiné gaz), les prix régulés payés par la majorité des foyers sont assez bas grâce aux centrales nucléaires construites entre le milieu des années 1970 et la fin des années 1990. Au seul bénéfice d'EDF.

Behind teh regulated tariffs , one finds, in fact, the competitive advantage provided to EDF by nuclear, and which distorts competition. In France, 80% of electricity is produced by EDF, one of the cheapest producers in Europe. If free market price are closer to European prices set on the price of the most recently built plant (usually a combined cylce gas plant), regulated prices paid by most households are pretty low thanks to the nuclear plants built in the 70s to the 90s. For EDF's sole benefit

The number of errors or omissions in one paragraph is quite stunning:

  • a low-cost producer distorts competition. That's an interesting notion, to say the least;
  • so what's bad about owning cheap nuclear? Is it that it's not rally cheap? (apparently not) Is it the technology (doesn't seem so)? Is it that is was built by a State-owned company? Is it that private sector competitors can't make money in France and are complaining loudly?
  • the market price is not that of the most recently built plant, but of the one with the highest marginal cost needed to respond to demand; again, the stunning ignorance of economics by economic journalists. Why am I still surprised?
  • that French consumers have cheap electricity is to "EDF's sole benefit." Aren't the consumers happy too? Or is it that only profits matter, and those do not go to EDF's competitors?
  • EDF is 87% State-owned. So what goes to EDF goes to French taxpayers (which also paid for said nuclear plants 20 years ago). Why is that bad?


In the long run, we're all dead. John Maynard Keynes
by Jerome a Paris (etg@eurotrib.com) on Tue Apr 28th, 2009 at 06:38:46 PM EST
But it's so much easier to blame European civil servants' innate, structural neoliberalism.

In the long run, we're all dead. John Maynard Keynes
by Jerome a Paris (etg@eurotrib.com) on Tue Apr 28th, 2009 at 06:39:02 PM EST
[ Parent ]
but of the one with the highest marginal cost needed to respond to demand

Aha - much clearer than in the main text.

by det on Wed Apr 29th, 2009 at 04:29:28 AM EST
[ Parent ]
Acutally, since EDF exports lots, 80 % of electricity produced in France comes from nuclear power, but only 65% of electricity consumed in France comes from nuclear power.

/nitpicking.

Rien n'est gratuit en ce bas monde. Tout s'expie, le bien comme le mal, se paie tot ou tard. Le bien c'est beaucoup plus cher, forcement. Celine

by UnEstranAvecVueSurMer (holopherne ahem gmail) on Wed Apr 29th, 2009 at 08:05:06 AM EST
[ Parent ]
Yep; I might add that would it not export, the domestic figure would be about the same...

*Lunatic*, n.
One whose delusions are out of fashion.
by DoDo on Wed Apr 29th, 2009 at 10:02:27 AM EST
[ Parent ]
It hadn't crossed my mind to make the counter factual. Thanks.

Rien n'est gratuit en ce bas monde. Tout s'expie, le bien comme le mal, se paie tot ou tard. Le bien c'est beaucoup plus cher, forcement. Celine
by UnEstranAvecVueSurMer (holopherne ahem gmail) on Wed Apr 29th, 2009 at 11:48:40 AM EST
[ Parent ]
When I'm a high-priced producer I hate the distortion of the market by low-priced producers.  Well, it does tend to make things difficult.

NYT says we've lost 5 million jobs here since the "recession" started.

"I said, 'Wait a minute, Chester, You know I'm a peaceful man...'" Robbie Robertson

by NearlyNormal on Wed Apr 29th, 2009 at 01:54:16 PM EST
[ Parent ]
a low-cost producer distorts competition. That's an interesting notion, to say the least;

It is perfectly understandable if you understand "competition" as a PR activity designed to mask optimal exploitation of a finite market by a small group of "competetors" who do not wish to have their profits limited by the marginal cost of the highest cost producer.  Why not instead empirically determine just how high prices can go before attracting negative attention from legal authorities?

This appeared to be the case in Southern California in the '90s.  One major company raised its prices for gasoline and waited.  If the other majors didn't follow suit they could rescind the increase.  But the others followed suit.  No one had the capacity to replace the supply of another major so why compete at the margin if you could get more.

The increases were noteworthy for not being accounted for by increases in the prices of crude or the availability of refined product for the local market.  An uncouth business writer for the LA Times wrote an article on the phenomenon.  The large vendors learned to be more subtle.  Articles appeared with greater frequency explaining the peculiarities of the California gasoline market, refineries came to be more prone to outages during the peak season, etc.  

As the Dutch said while fighting the Spanish: "It is not necessary to have hope in order to persevere."

by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Thu Apr 30th, 2009 at 01:32:32 PM EST
[ Parent ]
pricing is at the highest level that can be borne by a given level of demand, when demand is not very elastic.

It's just not usually explained like this: people tend to find average cost of production more "logical" a pricing mechanism, which means that market pricing is actually rather counter-intuitive.

But it's never explained properly.

In the long run, we're all dead. John Maynard Keynes

by Jerome a Paris (etg@eurotrib.com) on Thu Apr 30th, 2009 at 02:58:37 PM EST
[ Parent ]
But it's never explained properly.

Wouldn't want to rile up the masses.  Better to confound them with marginal pricing theology, lest they turn to seeking mechanisms that could reduce "the highest level that can be borne by a given level of demand."  Better also run some more articles about the bounty currently provided for all by the wonders of the market to distract support from those who would point out that the small number of players and the nature of the supply and the demand mean that this situation doesn't really satisfy normal definitions of a market.  Point out that (some) alternatives could be worse, but don't mention that some might be better.  Alternatives are comples and scary.  

As the Dutch said while fighting the Spanish: "It is not necessary to have hope in order to persevere."
by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Thu Apr 30th, 2009 at 03:29:01 PM EST
[ Parent ]
Uh...complex and scary.

As the Dutch said while fighting the Spanish: "It is not necessary to have hope in order to persevere."
by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Thu Apr 30th, 2009 at 03:30:25 PM EST
[ Parent ]
Are we not confusing economics as an attempted science, and economics as a popular ideology?  Those popular neo-cons and neo-libs who extol the virtues of "the magic of the markets" in popular tracts may know but certainly do not care to explain the mechanisms of marginal pricing.  The purpose of free market ideology/economics is to serve the private interests of the few as opposed to the public interests of the many.  So why muddy the waters with tiresome technical detail?

notes from no w here
by Frank Schnittger (mail Frankschnittger at hot male dotty communists) on Wed Apr 29th, 2009 at 06:35:55 AM EST
They are doing economics as an ideology, by hiding under the cloak of science. Thus showing their technical incompetence is a good way to underline the point that they are not objective observers but partisan hacks.

In the long run, we're all dead. John Maynard Keynes
by Jerome a Paris (etg@eurotrib.com) on Wed Apr 29th, 2009 at 06:45:25 AM EST
[ Parent ]
Except they'll just redefine incompetence as the new competence, call you names for being both French and European, and that will be that.

Blistering but measured ridicule might be more effective than careful factual debunking.

by ThatBritGuy (thatbritguy (at) googlemail.com) on Wed Apr 29th, 2009 at 08:25:06 AM EST
[ Parent ]
... a branch of mathematics, hiding under the cloak of scientism?


I've been accused of being a Marxist, yet while Harpo's my favourite, it's Groucho I'm always quoting. Odd, that.
by BruceMcF (agila61 at netscape dot net) on Wed Apr 29th, 2009 at 12:54:39 PM EST
[ Parent ]
It's not very good as mathematics, either...

Most economists teach a theoretical framework that has been shown to be fundamentally useless. -- James K. Galbraith
by Migeru (migeru at eurotrib dot com) on Wed Apr 29th, 2009 at 12:55:38 PM EST
[ Parent ]
... who'd say a rock group tribute band is not as good as the original.

Seriously, there is some very high level economic modeling would be suitable for a Masters in Mathematics. Though when there is nothing there but the math, I guess that scoffers might ... uhh, scoff.


I've been accused of being a Marxist, yet while Harpo's my favourite, it's Groucho I'm always quoting. Odd, that.

by BruceMcF (agila61 at netscape dot net) on Wed Apr 29th, 2009 at 01:04:03 PM EST
[ Parent ]
They are doing economics as an ideology, by hiding under the cloak of science.

Oooooooh the irony!

The natural scientist must be a modern materialist, a conscious adherent of the materialism represented by Marx, i.e., he must be a dialectical materialist.

- V.I. Lenin.

:: ::

Which just goes to show that ideology is a circle; stray too far into the wastelands of the left and you'll end up in the wastelands of the right, and vice versa.

Peak oil is not an energy crisis. It is a liquid fuel crisis.

by Starvid on Wed Apr 29th, 2009 at 01:32:17 PM EST
[ Parent ]
Starvid:
Which just goes to show that ideology is a circle
Or, in a "political compass" model, a sphere with a single point at infinityidiocy.

Most economists teach a theoretical framework that has been shown to be fundamentally useless. -- James K. Galbraith
by Migeru (migeru at eurotrib dot com) on Wed Apr 29th, 2009 at 01:34:46 PM EST
[ Parent ]
A sphere?

Have they added a third dimension to it, beyond right<->left and anarchistic<->authoritarian?

(Or whatever they used to call it)

Peak oil is not an energy crisis. It is a liquid fuel crisis.

by Starvid on Wed Apr 29th, 2009 at 01:36:45 PM EST
[ Parent ]
The surface of one.

Most economists teach a theoretical framework that has been shown to be fundamentally useless. -- James K. Galbraith
by Migeru (migeru at eurotrib dot com) on Wed Apr 29th, 2009 at 02:32:35 PM EST
[ Parent ]
Jerome a Paris:
They are doing economics as an ideology, by hiding under the cloak of science.

one step further: they're cloaking a modus operandi with an 'ideology' (bow head before grand poobahs), further dressed up as 'science'.

and the motive is all, namely take as much, give as little as you can

the more you profit the cleverer you are, you may be a human rat, but you're such a clever little rat just the same...

it's a creed, change the first letter and you have it's real name.

"We can all be prosperous but we can't all be rich." Ian Welsh

by melo (melometa4(at)gmail.com) on Thu Apr 30th, 2009 at 07:07:50 PM EST
[ Parent ]
One more proof that the faith in "unbundling" etc. trumps any intellectual consistency or claim to touch with reality over at The Economist.

I would suggest that it is not that they don't understand market mechanisms, they just don't care about them except where they serve their existing agenda.

by Metatone (metatone [a|t] gmail (dot) com) on Wed Apr 29th, 2009 at 06:38:23 AM EST
It may even be more cynical than that.
by ThatBritGuy (thatbritguy (at) googlemail.com) on Wed Apr 29th, 2009 at 06:40:01 AM EST
[ Parent ]
and even more cynical than this...

notes from no w here
by Frank Schnittger (mail Frankschnittger at hot male dotty communists) on Wed Apr 29th, 2009 at 06:44:17 AM EST
[ Parent ]
[ThatBritGuy rule on cynicism]


They are even more cynical than you think, even taking into account the ThatBritGuy rule on cynicism



In the long run, we're all dead. John Maynard Keynes
by Jerome a Paris (etg@eurotrib.com) on Wed Apr 29th, 2009 at 06:46:47 AM EST
[ Parent ]
So how cynical are the Economist people? Deregulation of electricity seems to be about creating situations where private interests can build cheap and easily financed gas plants which they then use to skim of the the top of the market.

But are the journalists, once again to use Lenin, purely evil or ar ethey just useful idiots? Or something in between?

Peak oil is not an energy crisis. It is a liquid fuel crisis.

by Starvid on Wed Apr 29th, 2009 at 01:35:05 PM EST
[ Parent ]
is all about giving business to financiers and assorted parasites (lawyers, accountants, consultants).

As I say regularly (including at conferences), European energy policy can be summed up in two sentences:


  • "what is our gas doing under your toundra?"
  • a jobs programme for the City of London


In the long run, we're all dead. John Maynard Keynes
by Jerome a Paris (etg@eurotrib.com) on Wed Apr 29th, 2009 at 02:09:51 PM EST
[ Parent ]
Germany hopes to get as much as 30% of its electricity from renewable sources by 2020, and although few in the industry think the target will be met

Which industry? The renewables industry, or the members of VDEW?...

*Lunatic*, n.
One whose delusions are out of fashion.

by DoDo on Wed Apr 29th, 2009 at 10:03:53 AM EST
That depends - which one gets more respect from Serious People.

The fact is that what we're experiencing right now is a top-down disaster. -Paul Krugman
by dvx (dvx.clt št gmail dotcom) on Wed Apr 29th, 2009 at 10:46:51 AM EST
[ Parent ]
"I'm going to buy an orange.  I'm going to buy another orange.  I'm going to buy another orange...."

Be nice to America. Or we'll bring democracy to your country.
by Drew J Jones (pedobear@pennstatefootball.com) on Wed Apr 29th, 2009 at 10:49:38 AM EST
The price will be determined by the marginal cost of producing the third orange....

notes from no w here
by Frank Schnittger (mail Frankschnittger at hot male dotty communists) on Wed Apr 29th, 2009 at 01:10:31 PM EST
[ Parent ]
... costs by the time the harvest is ready, so in the short term and except for the cost of harvest, in the conventional price theory its more the marginal willingness to pay.

And of course in the long term the price theory elements are only one part of a set of determinants including habitual behavior and technological change, both of which are beyond the scope of the conventional price theory.


I've been accused of being a Marxist, yet while Harpo's my favourite, it's Groucho I'm always quoting. Odd, that.

by BruceMcF (agila61 at netscape dot net) on Wed Apr 29th, 2009 at 02:42:52 PM EST
[ Parent ]
Only if the seller has perfect information on buyer behaviour. If the seller believes that there will be no more purchases after purchase # 2, then the marginal cost of producing orange # 3 is irrelevant. (And all of this assumes that the market is competitive, coherent and reasonably homogeneous, all of which are highly non-trivial assumptions...)

- Jake

Austerity can only be implemented in the shadow of a concentration camp.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Wed Apr 29th, 2009 at 07:06:27 PM EST
[ Parent ]
"hydro is the cheapest form of power around"

Maybe, but i think you're not counting externalities, too.
In Portugal, for instance, there are plans to build a dam for hydro production in one of the last wild rivers in Europe. I just can't put a price tag on a thing like that.

by Torres on Thu Apr 30th, 2009 at 03:54:00 AM EST


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