Sparks Will Fly

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Isn’t it lovely to see how this dismal science we’re so fond of ignoring comes back and bites us in the posterior? And we’re not talking the kind of Chihuahua nip here, no you should think more Rotweiller mauling.

Well, the story goes—and we must thank (h/t) the Streetwise Professor for this as we’re not natives of the Big Apple. Yeah, we’ve been there once or twice but we live on the east side of the big pond where, well, if we are honest, we’re doing the same nonsense as those nice politico types in Albany led by Governor Andrew M. Cuomo.

What has happened is that these thoughtful (snark) politicos have decided that coal should be confined to the seventh circle of Dante’s Inferno (for those of you who are interested, we’ll say third ring, which is the Great Plain of Burning Sand). But we digress.

Must keep focused.

Well, good ol’ governor Cuomo wants to save the planet from turning into that plain of burning sand. In his recent State of the State address, this is what he said:

Governor Andrew M. Cuomo today announced that at his direction, the New York State Department of Environmental Conservation released proposed regulations to require all power plants in New York to meet new emissions limits for carbon dioxide (CO2), a potent greenhouse gas that contributes to climate change. The regulations, a first in the nation approach to regulating carbon emissions, will achieve the Governor’s goal to end the use of coal in New York State power plants by 2020.

And blah, blah, blah:

Delivering on the Governor’s 2016 State of the State pledge to go coal-free by 2020 and his 2018 State of the State directive to DEC to develop the rules to fulfill it, the proposed regulations will tighten the state’s CO2 Performance Standards for Major Electric Generating Facilities by establishing CO2 emission rate requirements for existing major electric generating facilities

OK, we hope you get the idea. Save the planet. Must cut carbon. We’ll set a good example even if that sinner Trump is in coal’s pocket. This’ll show ‘em, sort of thing.

Well, we’re all for helping the environment here. Both the natural one and the one we live in. But if you don’t understand the dismal science stuff, decisions can have unintended and unpleasant consequences.

Please bear with me, we’ll get back to the politicos in a moment.

Tim, you’re not allowed to answer this. What happens when you curtail supply?

Yes. Go to the head of the class, the price rises. And it has. Well, not today’s price. The price after they stop generating with coal.

According to a Bloomberg report, the forward price of electricity in New York has risen.

OK, we’re going to have to really blow your brains out with this dismal science stuff. A bit like those wonderful chemistry experiments. Should just mention, we loved the subject at school, the teacher was an expert at destroying lab equipment. We always clapped at his successes.

Sorry, must stay focused.

When it comes to buying and selling things—and the sparky stuff is no different to your normal detergent, though a bit more necessary, so has a very inelastic demand function—there’s the little matter of expectations. The easy way to understand this is that if you thought the price of detergent will rise, you’d buy now to avoid paying more later. Ah ha! There is going to be a bit less leccy after the C-ban, so buy the electricity for a couple of years ahead now.

Um. Slight problemo. We have nowhere to store the sparky stuff.

That’s where our wonderful human ingenuity comes in and us economists can go play with our models and stuff and gain wonderful publications. We’ll tell you more about them in another post because we really, really must, stay focused.

Because electricity producers and consumers have skin in the game, buyers want to avoid having to pay too much for said sparky stuff in the future. So, this has led to “forward markets” in electricity. The buyers and the sellers simply agree a price for “future delivery” at some predetermined date.

Because we’re not storing the sparky stuff, the market is purely anticipatory. That is, it’s an expectations market. It’s what those buyers and sellers think the price for said sparky stuff will be at the date that they connect the wires and they have da juice.

Now the Streetwise Professor has some numbers (sorry, we’re gonna have to put some figures on this). New York leccy generation (production) is in the order of 137MWh of which coal was 4.6MWh—that is 3.4%.

On the face of it, cutting out this supply shouldn’t be onerous (but remember demand is inelastic; who wants to be without leccy—just ask the South Australians), only Bloomberg reports that those forward agreements for dates when they stop supplying the sparky stuff with coal has jumped by 30%! Something like $7/MWh.

Wow!

Yep.

Now we could go all Cournot on you.

Oh! You have no idea what we are talking about, do you?

Well everyone understands competition until they meet economics. You see, there’s more than one kind. There’s the Bertrand kind and then there’s Cournot kind.

Depending on lots of stuff we don’t really want to go into here, the electricity market is a Cournot market. Being so, there are some predictions made about how such a market works. One is that firms in such a market have an incentive to form a cartel. Well, that’s illegal but there’s other ways of skinning the cat. Cut competition. What better way to do it than by colluding with those politicos and get them to kick out some leccy suppliers by sending them to the seventh circle ring three?

Now back to those forward market thingies.

If our leaders are so keen to save the earth by messing around in the leccy market (and we in the UK have real form in this—we’ll talk about the nice little supply problem in another post if there’s enough demand for such a sparkling topic) to cut supply, here’s what we propose.

We want to align incentives and get said politicos to do their homework before they propose to pass legislation and make up those rules and regulations that Tim writes so eloquently about. To align incentives, we want them to have skin in the game. To ensure they do the best for us (that is consumers and voters) they should have large positions in those wonderful forward markets.

Do you think if Andrew M. Cuomo had, say, half a million forward contracts to supply leccy in 2020 at the pre-announcement price, he’d be so keen or pleased in his decision? At a 30% pop, he’d be $3.5 million the poorer.

What’s not to like?