Paul Hunt on rent-seeking and regulation in gas and power

Paul’s talk at the DEW in Galway is now available. It is worth a read for all interested in energy markets, and for all who argue, wrongly, that regulatory reform is not a priority for stimulating economic growth.

Paul got limited coverage in the media: Independent; Times

Incentives to work

Callan, Keane, Savage, Walsh and Timoney have a new paper on the incentives to work in Ireland. This is an important topic and I am glad to see continued research on this.

For the first time, Callan et al. include the cost of working in their analysis. We showed earlier that this is an important consideration. Our paper was primarily intended to address a blind spot in labour economics (which disregards expenditure patterns); our calculations were illustrative only. Unfortunately, what was meant to be an academic contribution became a public issue.

Nonetheless, it is useful to compare numbers. Callan et al. use the latest available data, and their earnings and benefits data is the best available. Earlier McGuinness and O’Connell showed that our wage equations, which omitted age as that was absent from our data, were severely biased. Callan’s estimates of the costs of childcare are from the same source as their income data. More importantly, they have information on the age composition of the household, whereas we had to work with average costs for a typical family. In these regards, the new analysis is superior to our work.

The main difference, however, is due to transport costs. There, Callan et al. run into the same problem that we did: The primary data are incomplete and one needs to rely on secondary data. This introduces all sorts of biases.

I am not convinced that Callan et al. got this right. They include only the cost of commuting, disregarding extra school runs, social calls associated with work etc. They ignore that commuters would own a different car than people who stay at home. In our paper, we compared travel costs in work and out of work, correcting for income, regardless of whether travel was from home to work and back.

Callan et al. use three methods to compute the typical cost of travel to work.

Method 1 is distance times cost per kilometer. They find 17 euro per week. But that is for the cheapest car. The range is 17-41 euro per week.

Method 2 is public transport: 14-25 euro per week.

Method 3 is based on the National Travel Survey. The starting point is an unreferenced 78 euro per week in travel costs. They then attribute 1/3 of this to commuting, and find 25 euro per week. The language is vague, but 1/3 strikes me as the national average rather than the average of those in work.

I suspect that Callan et al. underestimate the travel cost due to work. According to their Table A1.1, travel costs in the range of 15-25 euro per week, increase the fraction of people who would be better off on the dole from 4% to 5% (a 25% increase). Extrapolating, this would be 6% for a cost range of 50-100 euro per week (a 50% increase).

Childcare raises the fraction of people who would be better off on the dole from 4% to 6% (for all) and to 12% (for those with children).

Combining childcare and transport costs, 6% x 1.5 = 9% (for all) and 18% (for those with children).

McGuinness and O’Connoll found 9% (no children) and 19% (1 child under 5).

I therefore think that, although the new estimates by Callan et al. are more carefully done than our initial estimates, the new numbers are too optimistic.

Note that all of these calculations ignore undeclared income.

Energy could be so much cheaper

Gas interconnection

The Celtic Tiger died five years ago. The economic crisis hurts. The end of the pain is not in sight. So you would think that the government would do everything it can to keep prices low. For energy prices, you would be wrong.

Natural gas is an important fuel for heating homes and cooking. It is also used to generate electricity. The gas used in Ireland comes via two pipelines. Bord Gais Eireann (BGE) owns and operates both interconnectors. BGE cannot abuse its market power because the Commission for Energy Regulation (CER) regulates the price. Each year, total costs are divided by the volume of gas transported. BGE is allowed a modest profit.

This simple rule was fine when there was one source of gas only. That will change. Eventually, the gas from Corrib will be brought onshore. There are advanced plans to build an Liquefied Natural Gas (LNG) terminal in Kerry. With LNG, Ireland would no longer depend on the European market, where gas is dear. Gas is cheap in North America because of the abundant shale gas. As gas transport is expensive, it would be cheaper still to exploit the Irish shale reserves.

The costs of interconnection with Great Britain are largely fixed. If another source of gas captures a small part of the market, BGE will spread its costs over a smaller volume. That is, BGE would raise its price. The competition would thus capture a large share of market, and be able to raise its price at the same time. BGE would be forced to raise its price again.

The CER anticipated this and has changed the price regulation. The CER should be praised. It is not often that a government agency locks the door before the horse bolts. However, the new regulations are not good for consumers.

In the future, the right to transport gas over the interconnectors will be auctioned. There is overcapacity now and probably in the future, so the highest bid will not be very high. Therefore, there will be a reserve price. And if BGE still makes a loss, a levy will be imposed on all importers and producers of gas. This levy will be passed on to consumers.

This arrangement guarantees the profits of BGE. It drives up the price of gas and electricity. And because it hurts would-be importers and producers of natural gas, competition is hampered and prices go up again.

Indeed, the Shannon LNG project was stalled earlier this week, primarily because of the new price rules. The CER in effect shielded BGE from competition at the expense of anyone who buys gas or electricity.

BGE is largely state-owned, but a minority share is owned by employees, who will directly benefit from the new CER regulation. The exchequer could benefit too, but state-owned companies in Ireland have a poor track record of paying dividends. Instead, profits are diverted to vanity projects of managers and politicians.

It would therefore be better if BGE gradually writes down the capital invested in the gas interconnectors, and compete in the market on the basis of its variable costs only. Gas and electricity would be cheaper.

The new pricing rules are not yet set in stone. It will be a few years before households will pay more for their gas and electricity. People will complain bitterly to Pat Kenny and #gasprice will trend on Twitter. But then it will be too late to change the rules. The CER should reconsider now.

Atlantic oil

After a long absence, oil exploration companies returned to Irish waters. There is oil in the Atlantic. Now that experience is growing with the ultra-deep oil off Brazil and Angola, there is increasing confidence that the oil in the Irish Atlantic too may be commercially exploited – although the water is colder and choppier.

This is good news. Oil exploitation brings well-paid jobs and welcome royalties. It is early days though.

Some commentators and politicians have jumped to the conclusion that there is an immense richness under the Irish seabed that is being plundered by foreigners, and have called for punitive taxes.

Fact is, a few companies are exploring for oil. They are losing money at the moment, and it will be ten years or more before they would see a return on this investment, if any. There are plenty of other oil provinces that look just as promising as Ireland. Shell’s troubles in Mayo are well known in the international oil industry, and the story of Shannon LNG is making the rounds. Talk of high taxes, even nationalization, may well scare off the next round of would-be investors in Irish oil. The goose will be slaughtered before it has laid its first egg, perhaps golden.

Wind for England

England has a problem. Power plants are aging, and no one is willing to invest in new ones. The European Commission has imposed stringent targets for renewable electricity. The plan is now to build a great many wind turbines in the Irish midlands, and transmit the power to England.

The wind blows harder in Ireland than in England, but this does not justify the extra cost of long distance transmission. Rather, locals effectively use the English planning regulations to block new wind turbines.

Transmission will be over a dedicated grid. EirGrid would not have to invest even more than it already does, and English wind would not be eligible for the generous subsidies on Irish wind.

So what does Ireland get out of this? Some construction jobs, fewer maintenance jobs, and more wind turbines to look at. It seems that England struck the better bargain.

Wind power should pay royalties, just like oil and gas pay royalties. England would contribute money to the Irish exchequer if they still want to go ahead.

Royalties would make wind power more expensive in Ireland too, another reason to switch to cheaper gas for power generation.

Paul Hunt had excellent comments on an earlier version.

An edited version (part 2, 3) appeared in the Independent. Without byline online but on paper there is apparently a picture and a wrong email address.

UPDATE: John Mullins, CEO of BGE, disagrees.

Gas interconnection, decision made

I blogged earlier about the draft decision of the CER on the pricing rules for the gas interconnectors.

The decision is now final. I find the document hard to read, because it assumes that you are familiar with the draft decision, and it rambles between the actual decision, decisions that might have been, justification of the decision, and responses to comments to the draft decision. This is what I think was decided:

  1. The interconnector will be moved, legally, from offshore to onshore.
  2. Interconnector capacity will be auctioned.
  3. There is a reserve price for the auction.
  4. The reserve price is the long-run marginal cost.
  5. If the auction does not cover the costs of the pipe-formerly-known-as-the-interconnector, the difference will be split over ALL gas suppliers.

I am not sure whether there will really be an auction, or whether the reserve price will always hold.

The contentious point, however, is the long-run marginal cost. This implies that Bord Gais will have a guaranteed income on its assets.

Instead of forcing BGE to take a hit on what might turn out to be a bad investment in interconnection, the CER forces gas consumers to make up the difference.

This is wrong in principle. It is a transfer from gas users to the owners of BGE. And it distorts competition.

Exporting electricity

UPDATE2 Over on Twitter, Antoin argues that the plan as interpreted by me would violate EirGrid’s statutory monopoly.

Minister Rabbite yesterday announced plans to export wind power to Great Britain. This is a result of the energy summit organized shortly after the last elections. It now appears ready for public discourse.

The plan is simple. Build a load of wind turbines in the Midlands, where the relative lack of wind is made good by the relative lack of tourists and nature reserves, on land owned by Bord na Mona and Coillte. Build dedicated transmission lines to Great Britain. (The Spirits of Ireland hope that there will be pumped storage as well.)

The plan makes half sense from an English perspective. It is hard to get planning permission for onshore wind turbines in Great Britain. Onshore in Ireland plus transmission is cheaper than offshore in British waters. On the other hand, the plan is driven by the EU renewables target, which is pretty tough on the UK. With Germany abandoning its green energy plans (following earlier such decisions by Portugal and Spain) and with Theresa May wishing to ban Greeks from the UK, it is not immediately clear why the UK obeys the EU with regard to renewables.

It is not clear what is in it for Ireland: English-owned turbines generating power for England, transported over English-owned transmission lines. Dedicated transmission means that there are no benefits for Ireland in terms of supply security or price arbitrage. If the new transmission would be integrated into the Irish grid, Irish regulations would apply — and subsidies too, so that you Irish would sponsor my electricity bill. Ireland does not have royalties on wind power or transmission (and if it would, the same royalties should be levied on Irish turbines and power lines). That leaves some jobs in construction, fewer in maintenance, and 12.5% of whatever profits are left in Ireland for taxation.

It may well be that this plan is a quid pro quo for the UK contribution to the bailout of Ireland.

I am not convinced that the plan will go ahead. The English power market is in turmoil, and the companies may not be interested in an Irish adventure. Recall that the UK government also confidently announced that private companies would build new nuclear power. Well, they did not. The comparative advantage of Ireland in this case is the relatively lax planning regulations. Pat Swords may have put an end to that. But even the current planning regime can be used to block to an English adventure with no Irish spoils.

It is early days for this project still. It is worrying that the minister seems to think that more state intervention is required, and that the state still has money to waste. UPDATE: Paul Hunt points out that it is indeed the Government’s plan to intervene and subsidize: See the new energy strategy.

More academic thoughts on interconnection are here.