The Power and the Money

Renewables are not causing blackouts in Texas

Texas and northern Mexico are in the middle of an astonishing cold snap. Conditions are so bad that the bad weather pops out on a national map of traffic conditions:

The cold snap is also prompting blackouts across Texas and northern Mexico. And, of course, that means that politicians in both places are blaming renewables for the failure. In Texas, exhibit A for the prosecution consists of this figure:

Three things happen once the cold snap kicks in. First, wind generation falls up as turbines freeze. Second, natural gas generation spikes up. Finally, coal generation becomes steady as plants fire up to full capacity and stay there to cope with spiking demand. As a result, many observers are concluding that Texas would be just fine if only it hadn’t reoriented its energy mix around windpower.

That would be a correct conclusion if not for the fact that it’s all wrong.

Let’s take it in turn.

First, more coal would not have helped. Coal is lousy in cold weather. Back in 2014 — it seems so long ago, I know — six coal plants consisting of 1.8 megawatts of generation went down in a cold snap. (Here is the ERCOT after-action report for the ’14 cold snap.) The same thing happened during a freeze in February 2011, when ERCOT (the Texan grid operator) had to impose rolling blackouts. In 2014 (and in 2021) natural gas took up the slack, but in 2011 that didn’t work when power cuts hit compression stations.

Second, on paper Texas has more than enough generating capacity right now to handle demand. The state has 75 GW of natural gas capacity alone, to which you can add another 24 GW of coal. The problem is that the capacity is either down for maintenance, in the wrong place, or offline due to the cold, not that it doesn’t exist. In fact, you can see that Texas handled similar levels of demand this summer. The difference is that people expect summer heat waves in Texas. They don’t expect Minnesota-like weather to suddenly roll in from nowhere.

Finally, let’s put points (1) and (2) together and point out that right now the big problem in Texas is due to fossil fuel plants going offline from to the cold. Wells and pipelines are freezing. How much Texas thermal capacity is out, you ask? Well, I’ll tell you:

Thirty gigawatts.

Thirty gigawatts!

Getting the data isn’t easy, but it isn’t that hard either. Go here. Click on “Hourly Resource Outage Capacity.” You will see a long list of zipped CSV files. Open the top one. Look for the column called “TotalResourceMW.” (It’s the first one after the time.) That tells you how much power is out right now. If you read down in the spreadsheet you’ll see how quickly ERCOT expects that power to come on line. (This includes coal, natural gas, oil, and nuclear; as a practical matter, no nuclear is off-line in Texas.) “TotalIRRResourcesMW” is the amount of renewable power capacity that is not producing (for any reason) and “TotalNewEquipResourceMW” are resources that are being spun up but have not yet started to inject power into the grid. As of 4pm CST on February 15^th, 2021, 29.7 GW of thermal power is offline.

Now, it isn’t fair to say that all 29.7 GW are down because of the cold. Some power is always offline. I called up February 8^th, before temperatures started to drop. And as of 11am on February 8^th, some 13.1 GW of thermal was offline. Which means, as a first estimate, the cold knocked out about 17 gigawatts of thermal capacity, roughly ten nuclear reactors.

To be frank, I’m surprised it isn’t more. Coal operators in Texas right now are performing miracles. You’ve got to use anti-freeze on the coal supplies to stop them from icing up (particularly lignite coal, which is 35% water) and keep the fan blades on your cooling towers ice-free. You’ve also got to tightly pack your coal piles to keep water from seeping in and be prepared to smash ‘em with bulldozers in case that fails. (The only coal plants I’ve visited up-close-and-personal were in Colombia and they didn’t do any of these things, obviously.) The fact that coal generation is holding steady is quite the feat.

But the fact is that Texas is hitting problems because it ain’t ready for the cold. Renewables aren’t the problem. The state has a total capacity of 25.1 GW of wind and 3.8 GW of utility solar, so right now the ERCOT data that I cited above means that about 6.5 GW of renewables are hitting the grid. That is abovethe 6.1 GW that ERCOT expects in the winter.  

What can be done? Well, the simple answer is better planning. The more complicated one is better incentives. Texas should set up a capacity market that will give natural gas operators financial or contractual reasons to keep their plants on-line during cold weather. Ditto insuring that wind farms are prepared for the cold. A few more nuclear reactors (which would relegate more natural gas to peakload) wouldn’t hurt either, but isn’t going to happen.

Total decarbonization will not be easy until storage becomes extremely cheap. You will either need peak plants or massive battery banks to cope with the Great Blizzard of 2054. And the former will mean somehow maintaining the natural gas infrastructure despite an order-of-magnitude less demand. But these are all solvable problems which would exist even if we went hog-crazy for expensive and polluting coal plants.

TLDR: Texas would be in trouble even if it had never built a wind farm.  So think about that and stop pretending that you don’t care about your unborn grandchildren.

It is hard to get Manuel Bartlett to understand things when his paycheck depends on him not understanding it

Manuel Bartlett is the corrupt head of CFE, Mexico’s state electricity company. He hates renewables. So he’s trying to kill it with the support of Mexico’s president. From the man himself: “Wind and photovoltaic (plants) don’t pay the CFE for the backup. Do you think it’s fair for the CFE to subsidize these companies that don’t produce power all day? That’s not a free market, it’s theft!”

Do his arguments make sense?

Let’s unpack them. The first argument is that any firm feeding electricity into the grid should pay to transmit the electricity. The second argument is that renewables aren’t on all the time, so somebody has to have backup generators in place and that somebody should get paid. 

The first argument makes little sense. Cenace, the organization that runs the grid (owned by CFE) charges rates to feed in power. Maybe they should be higher for everyone, maybe not, but it isn’t a reason to discriminate.  

There is a technical argument that intermittent power sources raise transmission costs. That technical arguments have been solved. First, the more intermittents you have on the grid, the more predictable it is. Second, weather forecasts are pretty good these days. Third, getting “reactive power“ into the grid when needed is not particularly expensive or difficult. ERCOT, the Texas grid operator, found that you needed capacity about 0.1% of intermittent capacity to maintain grid stability. Internationally, there’s no relationship between the penetration of intermittent power sources and grid stability. Why? Well ... natural gas plants go offline all the time! California’s crisis in 2015 was caused by a leak at a gas storage facility in Aliso Canyon. 

So that’s a nothingburger. But what about the fact that somebody has to keep the lights on when the sun isn’t shining and the wind isn’t blowing? 

That could be a problem. Dispatchable power sources (i.e., ones you can turn on and off at will) suffer cycling costs, the same way that turning a lightbulb on and off every few minutes will raise power use and lower lightbulb life. It’s certainly a problem for CFE! The good news for CFE is that CCGT natural gas plants have relatively low cycling costs. The bad news is that you’ll run them less because solar and wind will eat their lunch during sunny and windy times. CFE will be able to charge a little more but that won’t make up for the loss of business and there will be some increase in cycling costs. 

In short, Bartlett’s argument comes down to the fact that cheap solar and wind isn’t just cheaper than burning hydrocarbons, it also raises the cost of burning hydrocarbons.

But so what? 

Imagine: A cheap airline comes in on a popular route. It steals away passengers from legacy airlines. The legacy airlines’ costs rise b/c they have stranded assets (unused planes) and high fixed costs. So prices on routes operated only by the legacy carriers rise a bit. Would you for that ban low-cost airlines? Or throw a tax on them? Or limit their landing slots? If your answer is no, then you think Bartlett is full of it. 

Yes, CFE has a mandate to keep the lights on. No, it’s not like they’d just turn off their power plants at night if that mandate didn’t exist. They want to make money. Prices will go up for baseload power and CFE will stay in business. It is remotely possible that Mexican electricity consumers will wind up paying so much for baseload power that net electricity prices will rise. Well, remotely possible other than the fact that it hasn’t happened anywhere else. (A decade ago Spain and Germany ran into problems with rising electricity costs because they oversubsidized solar power. But solar power was a lot more expensive back then.)  

The whole thing makes me sad, because I thought AMLO could have been a great president. Instead he’s bad for the Mexicans alive today and very bad for everyone who will be alive in the future. Future generations will revile him. The only reason he won’t be reviled around the world is because Mexico is small and George W. Bush and Donald Trump will outshine him as historical global warming villians.

Once upon a time, back in 2008, I sarcastically joked that (then citizen) AMLO’s terrible energy policy would be good for the world because it would lead Mexico to produce less hydrocarbons and that’s a good thing. What I never expected is that AMLO wouldn’t just want to hobble private hydrocarbon production, he’d also try to hobble anyone who wants to produce electricity without setting anything on fire. 

Anyway, there you have it. Bartlett’s argument has nothing to do with Mexican consumers, who will benefit from cheap solar and wind. Nor does it have to do with keeping the lights on, which is easy to do. It’s just about keeping out cheap competition to benefit CFE. 

The real question is why he feels so strongly about helping CFE and burning Mexican oil. Any answers to that would be greatly appreciated .... 

The Trump administration is not joining OPEC and the deal will not last

The United States is not joining OPEC. The United States is not leading a cartel to raise oil prices. The United States is, to quote my 5-year-old daughter, “not doing nothing.” The President of the United States is posturing.

Right now, the Trump administration is doing absolutely nothing to jawbone U.S. producers into cutting. In fact, it’s made it clear that U.S. “cuts” will come from market forces. It is remotely possibly that the Texas Railroad Commission (RRC) will order production cuts in Texas, but right now only one of the three commissioners supports the move and hearings about the idea have been contentious, to say the least. Moreover, what would be the point? If a putative 9.7 million bpd cut didn’t move markets, why would anything Texas could do make a difference?

It seems to be true that Trump worked the phones to get the Saudis to accept an agreement. But OPEC has no enforcement power and all the low-cost producers have incentives to cheat. Moreover, the deal is almost a sham. Both Russia and Saudi cut from a baseline level of 11 million bpd (the link goes to the OPEC press release) … but Saudi has never hit that level. The supposed highs of 12 million bpd included sales of stored Saudi crude. Ultimately, Saudi production will be down only 1.2 million bpd.

So good luck with enforcing that deal. As with so much of the Trump administration, this is for show. He gets to show off much he’s in with the Saudis and the Russians, and he gets to tell his backers in the oil industry that he went to bat for them. Good for him, I suppose. But it isn’t much of a cartel and the U.S. government isn’t ordering any production cuts at all. With Covid-19 having destroyed oil demand, prices are not going to go up anytime soon, least because of this deal. 

Covid-19 and American oil production, in gory institutional detail

Oil prices are crashing due to Covid-19. So what happens to American output?

Market reactions first, then political ones.

Well, first the oldest building in Dallas, circa 2019:

Yes, my shoes are bright blue.

Now market reactions to the Covid oil price crash.

Market

The “shut-in prices” is the minimum wellhead price operators need to continue producing from a production well. It’s equal to the amount needed to cover ongoing O&M, including where-necessary pumping and artificial lift, as well as water, gas and steam flooding and other secondary recovery costs.

The first wells to shut down are “stripper wells” nearing the end of their useful life. In the U.S. there are about 400,000 of these wells producing about 720,000 barrels per day. (I said they were small.) They usually rely on pumps to get the stuff out of the ground, meaning those famous mechanical donkeys you can still see in parts of California.

Next to go are wells that depend on secondary recovery. For example, in the Golden State companies inject about 400 million barrels of steam every year to get 161 million barrels of oil. (Governor Newsom has banned new wells using this technique.) These wells are high cost, but when shut down they tend to fill up fast with water. Companies that shut them down risk losing the remaining shut-in oil forever. In addition, companies that shut down wells risk losing their land leases. As a result, these wells don’t close immediately once they start losing money.

After that some wells will start to decline quickly in the absence of new drilling. Tight oil wells in North Dakota decline 65% in the first year and 77% over the first two years. That’s the next to go. In their early phase, however, tight oil wells can be easily shut-in and restarted. So tight oil production will decline in two waves, first by natural decline as new drilling collapses and then again as companies shut wells down. Since you can restart unconventional wells in about a week companies won’t be as reticent to stop production … if not for the fact that most of them are highly indebted and desperate for any sort of cash flow to satisfy demanding creditors.

This chart for tight oil plays in the Eagle Ford region of Texas gives you some idea of just how fast this decline can happen. Without new drilling, production would decline by about 700,000 bpd within a year from this play alone:

But production will decline faster than that, because unconventional wells can be shut-in fairly easily during their first year. 

In other words, the current oil price crash will cause U.S. production to drop, and drop fast. That is, it will if it is sustained. That’s not a given: countries have already begun to reopen their economies. Oil demand will recover as a result, possibly to prices that might keep tight oil production alive and stop the shuttering of stripper wells.

Political

Of course, state governments can act via a process called “proration,” whereby they can order well-by-well output cuts. Back in the 1930s, Congress passed the Connally Act, which made it illegal to ship oil across state lines in violation of state output quotas. It also created the Interstate Oil Compact Commission (here is the law), which brought representatives together from oil-producing states to hammer out overall quotas, America’s own little mini-OPEC before OPEC. (For whatever reason, Illinois and California never passed proration laws, although the California government sanctioned a quasi-private commission that functioned outside the law.)

The IOCC still exists, but its powers have withered. It no longer makes decisions by majority vote. And it now includes 31 states, five Canadian provinces, two Canadian territories, plus Egypt (W?) and the other Georgia (WT??) and the Bolivarian Republic of Venezuela (WTF???). Plus, while Arkansas, Colorado, Michigan, New Mexico, Oklahoma, and Texas all passed proration laws, only Oklahoma and Texas still exercise the muscles. (The Rail Road Commission of Texas and the Oklahoma Corporation Commission still publish quotas, set above most wells’ maximum production.) Executive agencies function like muscles: use ‘em or lose ‘em. Those states would need to design regulations from scratch to impose quotas, and they would certainly be challenged in court.

Now, Texas is big enough on its own to mandate a production cut. And the Texan authorities are talking about it! But it’s all talk. And there’s no sign of the Trump administration trying to resuscitate the Depression-era laws that let it coordinate oil production cuts, or even coordinating talks among the IOCC states. But production is falling fast, so Trump could claim that he jawboned producers into it.

Hell, he could do that even if production wasn’t falling fast. That’s his M.O.

Conclusion

Which means that the ultimate question is whether OPEC wants to be fooled. If Saudi Arabia thinks that letting Mexico de facto defect while pretending to cooperate will not hurt their cartel agreement, then they’ll accept the bullshit. If they don’t, then they’ll reject the Trump-AMLO bamboozle.  

Some crude nonsense: Trump, AMLO, and OPEC

OPEC has been trying to negotiate production cuts in order to prop up oil prices. Mexico resisted making any cuts. AMLO then declared that he had asked the United States to make part of the requested cuts on Mexico’s behalf. Trump, in a press conference, announced that the U.S. would make the cuts but request “reimbursement at a later date.”

What does it all mean?

1. AMLO really loses his senses when oil is concerned. Right now, Mexico loses money on every barrel it points. Inasmuch as it is geologically possible for Pemex to cut production, Pemex should cut production. But AMLO refuses to accept that. It may be because he believes that he’s linked his reputation to increasing oil production and that failing to do so will hurt him politically. But he believes that then he is a terrible politician … and we have evidence that he is not a terrible politician. Which leaves us with the conclusion that he really like to dig hydrocarbons out of the ground and set them on fire because he likes to dig hydrocarbons out of the ground and set them on fire.
2. President Trump does not have the authority to cut U.S. oil production. Individual state governments do have that authority—the Texas Railroad Commission is famous for controlling production in that state—but there is no sign that the President intends to call in state regulators and ask them to order private producers to shut wells.
3. S. production is crashing anyway. Unconventional oil wells in the United States decline hyperbolically. That means that companies need to keep drilling just to keep up production. When prices are low, they stop drilling, and production falls. The EIA projects that U.S. production will fall by at least 500,000 barrels per day this calendar year and another 700,000 barrels in 2021. This isn’t a hard projection to make, considering as production is already down 600,000 bpd from last week.
4. AMLO is putting on a show for OPEC. He’s trying to get OPEC to pretend that a U.S. production fall that would have happened anyway is actually a deliberate action on the part of the United States to help out Mexico. OPEC knows this is bullshit, but will likely give AMLO the fig leaf he’s looking for.
5. Trump’s demand for compensation is meaningless, but not for the reasons you think. When I was a kid back in New York, we’d talk about the “favor bank.” (Often called the “Irish favor bank” for reasons I don’t understand at all.) You’d pay into the favor bank, you’d make withdrawals from the favor bank. Donald Trump has never played by the favor bank. If he wants something from you, he will do whatever he can to get it from you. If Donald Trump wants something from Mexico in the future then he will ask for it regardless of whatever “favors” he granted now. And he will threaten Mexico in order to get it. In that sense, AMLO’s request was costless.
6. OPEC wanted Mexico on board because reasons. This is the only part of the story that I don’t understand. Why couldn’t OPEC have just ignored Mexico’s posturing.

In other words, this is much ado about nothing.

In fact, if this is right, then it really was about nothing for nothing ...

 

Saudi Arabia plans to issue a statement blaming Mexico for not agreeing to cut its production (by the allocated amount of 400k) #OOTT

— Amena Bakr (@Amena__Bakr) April 10, 2020

Observatorio argentino 41b: Veníamos bien, pero pasaron cosas

I think I should use that quote from Macri for all my Argentine posts. 

So what explains the high electricity prices from the new generation tendered in 2017 and 2018? Short version: these were peaker plants intended to provide capacity when demand spiked. (Why demand spiked in the dead of winter, August is winter in Argentina, is another story. Pasaron cosas, I suppose.)

Consider. In the U.S., the capex per  MWh for a natural gas combustion plant is around $882,000. In August 2018, natural gas prices in Argentina spiked up to 5,931 pesos per thousand cubic meters. That is the equivalent of $7.25 per mmbtu, in American terms. If you assume that peaker plants run about 8% of the time, that gives you a cost per kilowatt-hour of 21.7¢!

Now, reading under Resolution 21/2016 makes it look like these guys intended to provide power for more than just peak demand. In fact, these plants provided 6% of Argentina’s power demand, which is twice what you’d expect peakers to provide. So let’s assume that they run 30% of time, which does happen. Costs would come to around 11.5¢. The chart to the right shows the calculations for coal and natural gas, using Argentine fuel prices in August 2018. (For nerds: I have not included cycling costs for a coal plant operating at 30% of capacity, so the real figures for an equivalent coal plant would be much worse. The $35/ton carbon tax does not exist, which is why it is transparent.) 

In short, the high prices are not a scandal; they are just the cost of peakload electricity in Argentina. 

Macri could have been more up front about this and he could have protected poorer Argentine consumers more. But he made a bet that the economy would do well and preferred to rip off the band aid. It is hard to blame him, but as he said, things do happen. 

It is going to be a tough election this year. 

Observatorio argentino 41a: Veníamos bien, pero pasaron cosas

Given that the name of this blog is “The Power and the Money,” I have to write the following post. 

I am sympathetic to President Macri, I really am. He got hit with a crisis not of his making. But in all seriousness, the fellow went into the crisis with far less goodwill than he should have. Here I am going to lay out one of the missteps Macri made; in the next post I will explain why the poor guy probably did not have another choice. In his own words: “Veníamos bien, pero pasaron cosas.”

Which is probably a good a way as any to sum up Argentine history, but I digress.  

One of the big problems Macri faced when he came into office were subsidized electricity prices combined with a growing power shortage. This needed to be fixed. So he raised prices. That angered people, but the only other choice would have been to let the Argentine grid go the way of Venezuela only without the big dams. One of the reforms consisted of Resolution 21/2016, which allowed the country’s independent system operator, CAMMESA , to contract for new capacity. (An alternative link to the resolution is here.) Basically, new generators were given long-term fixed-price contracts and a promise to buy a minimum amount of power. 

Still, you would think that the folks at CAMMESA would want to keep the price of electricity down as much as possible. Sure, it was an emergency, but if prices gotta rise it behooves you to make them rise as little as possible. So obviously one would expect the wholesale price of power from those sources to be in line with fossil fuel generators in other countries. It certainly should have been in line with the unsubsidized cost of fossil fuel electricity inside Argentina. Call it 4¢ per kilowatt-hour, maybe 9¢. (See Table 53.) 

Well, when power prices under Macri rose and kept on rising, the good people at Risk Event-Driven and Distressed Intelligence (REDD) got curious about how much CAMMESA was paying for these new sources of power. And what did they find? Costs of 18.6¢ in August 2018 and 9.3¢ in February 2019. That compares to 5.5¢ and 4.1¢ respectively for other thermal generators in Argentina in the same period. 

You got it. These new plants, with new technology, coming on-line in 2017 and 2018, cost two to three times what other plants cost. To be fair, they only provided about 6% of Argentina’s electricity demand. But, come on, President Macri! This kind of thing is not helping your case. It looks terrible!!

But wait. Might there be an innocent (or at least sensible) explanation? 

¿Una maquina Morena o una maquina morena?

There is no doubt that AMLO intends to construct a new political machine. The question is whether doing so will degrade the quality of Mexican democracy or Mexican governance. (These are correlated but not the same.) In a couple of different posts, I am going to make the case that AMLO’s machine is unlikely to make either situation much worse — because both Mexico’s democracy and its governance are already highly degraded. Things can always get worse, but AMLO is unlikely to make it so.

For this post, I want to park questions about Mexican democracy under AMLO and consider what might happen to the quality of Mexico’s governance.

Let’s ask, what does a democratic political machine do? It doesn’t blatantly steal elections: that’s a dictatorship. But democratic machine politics is different in kind from regular interest group politics. Interest group politics works by promising veterans higher benefits or auto companies a higher tariff; conversely, it works by cutting veterans benefits or increasing taxes on gasoline. Machine politics works by offering Josefina the Welder a job or Ford Motor Company a special break; conversely, it works by stopping Josefina from getting a mortgage or launching audits against Ford executives.

Successful machine politics does not require stolen elections, but it makes opposition harder to organize, increases the autonomy of machine leaders and weakens democracy’s ability to hold officials accountable or translate public desires into public policies.

The PRI under President Peña used machine politics to implement energy reform in 2013. In order to pass and implement the reform, the Peña administration needed the support of the national oil workers’ union. At the time of the reform the oil industry provided 4% of all public revenue and supported much of the economy in the states Veracruz and Tabasco. A crippling oil strike could sink the party’s position in the midterms or next presidential election.

How to get union support? First, threaten the union leader. Carlos Romero Deschamps happened to be a sitting PRI senator and “enjoyed” second-place on the Forbes list of the ten most corrupt Mexicans. On a monthly salary of US$1,864, Deschamps managed to accumulate a $1.5m “cottage” in Cancún, a son who drove a $2m Ferrari, and a daughter who liked to post Facebook images of her jet-setting her three English bulldogs around the world. In other words, a serious corruption investigation would toss him and his children into jail.

President Peña made it clear to Deschamps that he had no choice but to go along with the reform in the most obvious way: in February 2013 he took the powerful leader of the teacher’s union, Elba Esther Gordillo — number 1 on the Forbes list and head of the New Alliance Party — and had her arrested on anticorruption charges. Gordillo was fortunate enough to be over 70 years old and therefore be eligible for house arrest instead of prison — she owned a rather nice apartment in Polanco, Mexico City’s equivalent of the Upper East Side — but the message was clear. Deschamps brought the union on board with reform.

Alternative facts are not an American monopoly: in a rather startling 2014 declaration, union leader Carlos Deschamps declared that energy reform would bring no lay­offs. Even more startlingly, Deschamps denied that mass firings were taking place even after they began. According to him, only oil workers employed in private companies lost their jobs.

Source: Abad and Maurer (2018).

Unfortunately, the reality was otherwise. Reform let Pemex lay off almost 30,000 employees in a three-year period. (See above.) Layoffs hit unionized and non-unionized workers alike; in fact, the share of union workers declined slightly during the mass layoffs of 2015. But the machine kept that from triggering strikes by (1) concentrating the layoffs in places that were already voting against the PRI—i.e., Tabasco and Veracruz—where workers did protest but the protests could be controlled; and (2) making sure that wages went up dramatically for those workers who kept their heads down, kept their jobs, and accepted the reforms. (See below.)

Source: Abad and Maurer (2018).

Of course, you would be right that this particular exercise of machine politics removed most of the putative fiscal gains from allowing the layoffs. The chart to the right shows payroll costs as a percent of Pemex revenue: they did not fall. 

But that’s how machine politics works. Rents are generated and distributed on one end; individuals and individual group leaders are punished on the other.

Absent the subversion of democracy, it’s hard to see how AMLO could build a machine more effective than the PRI, circa 2012-18. (To reiterate, the PRI circa 1929-1997 was an institutionalized dictatorship masquerading as a political machine, not a genuine democratic political machine.) There is no obvious source of rents that the PRI did not already tap. There are places that have improved — say, competition policy — but where it would be hard for Morena to loosen the rules without pushback. Elsewhere, things are not good, as this OECD report on electricity procurement shows. In that sense, things cannot really get worse.

And a democratic machine, no matter how efficient, can’t stay in power if it really lets things go to hell. The PRI discovered that this year, losing even its heartland in the town of Atlacomulco, Mexico State. In other words, straight-up machine politics means more of the same in Mexico and is self-limiting if it delivers truly bad results — albeit less self-limiting than in democracies free of machine politics.

Morena will try to build a machine. But building a machine is hard and machines themselves do not guarantee that a bad government can remain in power.

The real worry, I think, is democratic backsliding. That is, machine politics plus institutional changes to make the vote less effective and hamstring the opposition. Without democratic backsliding, you might get a maquina Morena, but you won’t get a dark machine.

Thoughts?

Energía solar en la madre patria

Spain, you might have heard, is a sunny place.

Strangely, the designers of Spain’s early renewable policies did not realize this. They established a feed-in tariff, in which utilities have to buy all generated renewable electricity at a fixed price. They set the price based on German policy. But Spain, remember, is sunnier. And the cost of solar power was plummeting. The cost to utilities grew all out of control.

The Socialists pulled off the first walk-back in 2010, when they limited the feed-in tariff to the first quarter-century of a plant’s life and tossed in a  €0.55 per megawatt-hour grid access charge. They were sued, but the investment tribunals found for Madrid.

Then Rajoy gets elected. Rajoy’s gotta Rajoy, and subsidies had hit €3.5 billion, so in December 2012 he reformed the system again. He repealed the feed-in tariff, but made the repeal retroactive. Combine that with a 7% electricity tax, and he managed to push a bunch of solar producers into the red. Spain got sued again, but this time the investment tribunals forced the government to cough up damages. 

Lest you think that the People’s Party would relent, they went yet one better in 2015 and slapped a tax on anyone who installed solar panels. OK, not technically a tax, technically a grid access fee. But effectively a tax. In addition, the law banned anyone with solar panels over 100 kW from selling electricity at all. 

But now Rajoy is out and Pedro Sánchez is prime minister. Moreover, solar power costs less than one-sixth of what it did when Spain began subsidizing it. Noises are being made about repealing the sun tax. At the very least, the sunny country might let market forces rip. Solar costs are down 41% since 2013. (See left: the dotted line is 20¢ U.S. per kilowatt-hour.)

Still, low costs can be a problem for solar producers, especially in Spain, where most renewable producers need to sell on the spot market. When the sun is shining, solar installations can bid the cost down to zero if there are enough of them. They can even drive it negative, if conventional producers are willing to pay customers to take their electricity in order to avoid spinning down their plants. 

So market forces will not be enough without a market redesign making it easier for solar producers to sign long-term contracts with off-takers. It is not merely a matter of removing the burdens the People’s Party placed on the industry. I have no idea how much thought the Socialists have put into this problem or whether their rickety surprise coalition is prepared to enact reforms.

We can hope. 

Environmental disasters are hard to stop, even in the Netherlands

The rash of earthquakes afflicting Oklahoma is old news. The cause appears to be backwash from fracking operations being pumped into old abandoned oil and gas wells. Lubricated rocks slip, and thus earthquakes where none were before. 

But now Groningen, in the Netherlands, is suffering from quakes! I am kind of embarrassed to learn about this now, since I was only recently in Groningen. (Disclosure: I am a Dutch citizen, passport and everything. Yes, I am also a U.S.A. veteran and short and olive-skinned and Spanish-speaking. ¿Tienes algún problema con eso? Daar heb ik geen moeite mee.) 

For those on the wrong side of the paywall: these quakes appear to be due to the rapid depletion of the Groningen gasfield to the east of the city. A 3.6 earthquake in 2012 wrecked thousands of homes (as you might imagine, Dutch houses are not built for tremors); on January 8th of this year another 3.4 did likewise. From the Financial Times:

Gert-Jan Veldink was at home when a 3.4-magnitude earthquake struck the northern tip of the Netherlands last month. First came the tremors, then the chimney broke and floor-to-ceiling cracks appeared in the hallway. Later, an engineer confirmed his 200-year-old farmhouse was filled with carbon monoxide from a damaged gas pipe. “The quake hit our house with all its force,” says Mr Veldink, an academic from the small town of Kiel-Windeweer, near Groningen, the regional capital. “If there’s another earthquake the same as before then the roof will collapse.”

Labor Party politicians estimate the number of houses that need rebuilding at around 90,000. The fields are operated by NAM, a 50-50 joint venture between Royal Dutch Shell and ExxonMobil. NAM has paid out about 80,000 claims, although their value is unknown.

The field has been in operation since 1959, but number of quakes started rising around the turn of the century. For an amazing visualization, click here.

Since 2013, production has fallen precipitously, but the number and intensity of the quakes has remained steady. The implication is that the ground has already been weakened; the number of quakes will fall slowly even if production stops immediately. Of course, if production doesn’t stop, then the quakes will get worse ...

Why does the government let production continue? The industry is highly taxed, with the Dutch state taking 80% of revenues. But that amounts to only 0.8% of total public revenue, down from 5% in 2013. In addition, the Dutch state is highly centralized and subsoil resources are not owned by the surface title-holder, so there is not much of a local lobby pushing for more production the way there would be in most of the United States. 

Which leaves three reasons to keep production going, albeit at a capped level. First, there are legitimate worries that lowering production caps would lead to big variations in monthly production, since NAM would want to sell more in the winter when prices are high. That could lead pressure to fluctuate, making earthquakes worse.

Of course, a total shutdown would solve that problem, but that brings us to the other two problems: 

1. The Netherlands still relies on natural gas for heat and light. Shutting Groningen, at least in the short term, means more imports from Russia. Nobody likes Russia. In fact, Dutch politicians dislike Russia so much that they see votes in lying about their knowledge of Russian “plans to expand the country’s borders and create a ‘Great Russia’ that would include Belarus, Ukraine, the Baltic countries and possibly Kazakhstan.”
2. Lobbying and legal issues. Even with the high government take, NAM makes a lot of money from the gas fields. They will not take it lying down.

So there you have it. Conventional gas production is causing earthquakes in the Netherlands. But even as wind power gets cheaper and more reliable, nobody can quite figure out how to shut it down.

Outside the box #2 for Venezuela: An oil-for-food program?

Foreigners (including Venezuelans in el extranjero) want to find an international response to Venezuela’s descent into dictatorship that won’t kill children. We aren’t yet in a situation where inaction will lead to the deaths of even more children. Which means that a lot of people want to find something new. 

Julian Adams has such a suggestion: imposing an oil-for-food program on Venezuela. Under Oil-for-Food, created in 1995, the the U.N. permitted Iraqi oil exports under its control. Payments for Iraqi oil went to the U.N. and could only be spent on U.N.-approved imports. The idea was to prevent the Iraqi government from being able to finance its war machine without starving the Iraqi people. In the Venezuelan case, the idea would be to prevent the Venezuelan government from distributing oil largesse to its cronies without starving the Venezuelan people.

One problem is that the U.N. is not about to impose such sanctions. Adams points out that most Venezuelan exports go to the United States and India, but he is not quite right that there is no capacity to refine Venezuelan crude elsewhere. In point of fact, Venezuela could find alternative markets, albeit at a large discount. If the regime really believed that oil-for-food threatened its control, then it would find those markets.  

Second,  Iraq managed to collect illegal surcharges on the export of its oil. These surcharges were not that large: Yujin Jeong (American) and Robert Weiner (GWU) found that they came to about 0.8% of the total value of oil exports. Iraq had to discount its oil by 11%, so the surcharges did not match the losses, but they earned Saddam Hussein an additional $91 million per year in 2000-02. The equivalent number for Venezuela would be about $135 million per year.*

But the real problem is that the Venezuelan state would continue to control the internal distribution of food and medicine. That would provide a massive source of largess to distribute. Imports could be given to middlemen and sold on the black market. That might be slightly less efficient that the current way the government redistributes its export income, but when was the Bolivarian Republic ever about efficiency?

It is a very neat idea, but I do not see how it could work. Is there something I am missing?

Uruguay and New Zealand: Never alike?

So here I am in Uruguay! Getting here was a bit more involved than I had hoped. My Copa flight gave me 45 minutes to change planes in Panama City, but thunderstorms delayed our departure from Dulles for about that long, and that was that. Overnight in Panama.

In a previous post, I showed evidence that Uruguay and New Zealand were very similar in terms of their geographic endowment (meaning lots of great grazing lands) but Uruguayan farners failed to adopt technological innovations that their New Zealander cousins took up with abandon. I asked why and got two good hypothesis: Shah8 suggested that New Zealanders were more integrated with Australia and had access to cheaper capital, while Sam pointed out that Uruguayans were far less educated than New Zealanders in 1900.

Well, there is another possibility. In the late 19th and early 20th centuries there were two ways to generate large-scale energy: burn a fossil fuel or dam a river. But Uruguay is flat, with no natural lakes, and it receives only 75% as much rainfall. Moreover, that rainfall is more erratic. Reto Bertoni and Henry Willeband (Universidad de la República) noticed that difference, and gathered hydro cost data for the two countries. And they found this circa 1920 (page 25):

Capital costs for hydropower in Uruguay were triple their level in New Zealand; operating costs (for all electric power plants) were double. And if you consider Shah8’s conjecture that capital was scarcer in Uruguay, then the levelized capital cost relative to N.Z. will be even higher than these figures imply.

New Zealand and Uruguay were very much unalike in one key respect — hydropower resources. But two quibbles. First, hydro was not the only source of power. The Uruguayans could have burned coal. Second, did energy matter that much? Sure, it cost more than in New Zealand, but that does not mean that those higher costs mattered in countries dependent on agriculture. 

Thoughts?

Why did the Trini government stop paying salaries in 2015?

Front page headline in the Sunday T&T Newsday?  “Easter backpay for 16,000 health workers: $636M blessing.” Short version: 16,000 government employees are going to receive US$5,923 per person in unpaid salaries. This in a country where average annual government expenditure on wages and salaries per employee came to US$10,606 in 2015 and US$9,930 in 2016. The arrears are big.

Health workers were not the only ones to go without pay: when I was last here in April, the big news revolved around the way the previous government had randomly suspended salaries. You heard that right: in response to falling oil prices, the government stopped paying salaries.

At first glance, this does not seem unreasonable. Consider the below chart: total government revenues (in millions of U.S. dollars) fell 30% in 2016, from $8.8 billion to $6.1 billion. (Figures are only available through August 2016; data is annualized based on the first eight months of data.) That is one hell of a fiscal adjustment!

But at second glance, it’s crazy. First, in 2014 had Trinidad a debt-to-GDP ratio of only 51%; by 2016, that had risen to only 58%. There was plenty of scope for borrowing to ease the transition. Second, Trinidad could have let the exchange rate depreciate, spreading the pain. Third, the arrears started proliferating in 2015, before the big meltdown in revenue. 

Finally, and here is the kicker: expense on wages and salaries barely went down. The government spent US$1.6 billion in 2015 and US$1.4 billion in 2016. Public employment slid from 150,600 to 144,100. Per worker expenditures barely budged. 

So what the hell?? Tens of thousands of people without salaries in 2015? Where did the money go? 

Obviously, people think corruption. It does not help that Jack Warner (of FIFA scandal fame) said that he witnessed PM Persad-Bissessar accept TT$8.3 million in checks from ... wait for it ... Ishwar Galbaransingh. Now, I would not trust Jack Warner at all about anything ... but the atmosphere here is febrile, considering the apparent mismanagement of the Persad government. 

AFAICT, the new government is on track to meet its commitment of clearing the arrears by the end of this calendar year. But the whole episode is inexplicable. You cannot find much evidence of the arrears in the government accounts (which are putatively on a cash flow basis) and you cannot find much evidence in the audit accounts.

But you can find lots of evidence among the government workers who were not paid and the current politicians who seem to be moving heaven and Earth to make them whole! 

The new government could do a lot more to make its accounts transparent. It is not doing so. So while employees are getting paid (that I can confirm, although contractors are still SOL) there still seems to be no good understanding of just what happened last year. No wonder cynicism is higher than I have ever seen it, and this is not exactly an idealistic trusting place to begin with. 

The border tax and climate change

I am opposed to a 20% tariff aimed at Mexican manufactured goods. I am more ambivalent about the 20% border adjustment tax (BAT) floated by the Trump administration. In fact, I may support it. 

The basic idea is simple. U.S. companies would pay a 20% income tax. Companies could deduct domestically-sourced inputs from their income but not imported goods or services. Those imports would then, in effect, have to be at least 20% cheaper than equivalent domestic competitors. 

The idea is to make the U.S. corporate income tax look like a value-added tax (VAT). If a corporation in Mexico buys an input from overseas, it pays the Mexican VAT on the purchase. If it sells something domestically, then it also pays the Mexican VAT. But if it sells something to a company in France, then it does not pay the Mexican VAT ... but the French buyer will pay the French VAT. Under the BAT, if a corporation in the U.S. buys an input from overseas, then it pays the U.S. BAT on the purchase. Ditto it pays the BAT on all earnings from domestic sales. But if it sells something to a French buyer, then it will not pay the U.S. BAT ... but the French buyer will pay the French VAT.  

As it stands, the BAT will apply to oil imports. So an American refinery that buys foreign crude would have to pay the 20% BAT on those purchases! Right now, WTI trades around $54 per barrel. A refinery using American crude would pay $54; a refinery using imported crudes at a similar grade would pay $65. American oil prices would rise, world oil prices would fall.

And that is good for the world! Higher U.S. oil prices mean less U.S. oil consumption. Moreover, the burden will fall particularly on dirtier forms of oil. Most American crude oil imports (60% in 2015) are heavy grades. Almost half of that consists of heavy crudes from Canada, which  release about significantly more carbon during the production process than other grades of oil. (So much so that the Section 526 of the Energy Security Act of 2007 theoretically banned U.S. federal agencies from purchasing it, although that has had no concrete effect.)

Lower world prices will, of course, stimulate more world consumption. But there are two wrinkles that will reduce that impact. First, transport links lock in most Canadian output to American markets. Last year, the Trudeau government approved an expansion of the Trans-Mountain pipeline from 300,000 to 890,000 bpd, which would allow Canada to divert as much as 28% of its current U.S.-bound exports to other markets. But that will take a long time and is a drop in the bucket of world production. Second, American refineries are optimized to use heavy crudes. They will switch away, but slowly, even if the cost of their primary input rises. Finally, inasmuch as world prices do fall, that will discourage foreign exploration and development, keeping some carbon in the ground for the long-run. 

Winners:

1. Our children;
2. American heavy oil plays, of which there are not many outside Alaska;
3. American light tight oil plays (hooray!);
4. Andrés Manuel López Obrador (see below).

Losers:

1. American oil consumers, who will likely see prices rise about 30₵ per gallon;
2. Refiners who use imported crude oil—although not by very much;
3. Canadian, Ecuadorean, Venezuelan and Mexican heavy oil producers, who are locked into the U.S. market;
4. Mexican consumers, who rely on gasoline produced in the United States from Mexican heavy crude.

As far as energy is concerned, this does not strike me as a bad policy, even if it will impact Mexico quite seriously. At 2015 prices, a 20% BAT would have raised about $2.0 billion from Mexican crude oil imports, although most of that burden would fall on American consumers. The real hit for Mexico is that the increase in U.S. gasoline prices will be passed on to either Mexican consumers or the Mexican government. Inasmuch as the Peña administration hands Mexican voters a second gasolinazo, then it will be another fillip for AMLO’s chances in the 2018 elections.

So a good policy for energy: a net plus for domestic production and a net plus for decarbonization. Probably pretty good Harley-Davidson, as well.

But as far as other products markets are concerned, I’m still undecided as to whether the BAT is a good idea. Thoughts?

Department of corrections: the Gasolinazo did not raise tax revenue

Here I am, in Mexico, as the 45th presidency of the United States begins. The talk among the intelligentsia is about NAFTA and, weirdly, the prospects of a war between the United States and China. So I am going to talk about the gasolinazo. Which still has a lot of people upset, as you can see from the image of this angry soldadera pointing a carbine at President Peña.

Now the notionally right-wing National Action Party is trying to escape blame for the price hike. It isn’t the reform what caused the spike, it’s “the tax structure what obscenely raises the price!” says Ricardo Anaya, the head of the party.

Well, not quite. On January 6th, I reported that the price rise was essentially a tax hike. Turns out that is wrong. All of the rise is going to Pemex, to cover the costs of refining or importing the stuff. 

El @gobmx no recibirá ni un centavo por el incremento en el precio de la gasolina⛽️ pic.twitter.com/JaQZ2f9Mpv

— SE México (@SE_mx) January 7, 2017

Moreover, decontrol of gasoline prices was part of the reform that the PAN did indeed vote for. Now, it is true that the price of gasoline in Mexico is now higher than in the United States. But that is because Pemex is a mess, both in terms of refining the stuff at home and transporting it from the United States at a reasonable price. 

Right now, taxes on internal fuel sales serve as a buffer against price swings. When the international price rises, government revenues fall and vice versa. The plan, logically, is for those swings to now be passed on to the consumer. Government revenue will stabilize. 

The problem is that Mexican voters, well, they liked price stability. Still, even with the recent riots, I suspect that the administration will follow through on its plans for full liberalization. 

⛽️ What have they go to lose? Besides the next election, but that ship, I suspect, has already sailed.

 

Riots in Mexico

Mexico has been beset by widespread looting and demonstrations over the past five days. So far, there have been 987 arrests and two deaths. The incidents devolved into outright riots in Ixmiquilpan, Hidalgo, and Monterrey, N.L.; but stores have been sacked and roads blockaded all over the country. I heard about the looting from friends living in Ecatepec, Mexico State, a poor suburb of Mexico City, but it has now made its way into American news.

The trigger? The Peña administration decided to raise gasoline prices on January 1st. Prices rose to heretofore unseen levels in real terms. The below figure show the retail price per gallon for Magna gasoline in Mexico and the equivalent blend in the United States, measured in real pesos of November 2016. 

Why the rise? It was essentially a tax hike. As you can see, Mexican retail gasoline prices have been above American ones since the middle of 2014. U.S. prices have risen recently, but Mexican prices remained lower.

The hike was not about raising Mexican prices to equal American prices. Rather, the Mexican government wanted to raise prices now in advance of its plan to fully liberalize prices later this year. The higher prices are in advance of liberalization, the more room the government has to impose a high excise tax. Since the current administration has promised to freeze said tax once it is introduced, it wants to be able to set the initial tax as high as possible.

As policy, none of this is a bad idea. Price liberalization will save the government money and excise taxes should be high. But as politics, it is terrible. A more popular government facing a better economic situation could have gotten away with raising gasoline prices. But the Peña administration is not popular and the economic situation is not good. 

The latest blow to the Peña administration has been the recent re-emergence of the man behind Trump’s visit to Mexico during the presidential campaign. Trump, as you can imagine, is not popular south of the border. Public opinion was horrified that the Peña administration invited him to meet the Mexican president. There was some hope that President Peña intended to lure candidate Trump into a trap, but instead Peña allowed Trump to roll all over him in a joint press conference. (The rules were no questions, but Trump invited them anyway; then Peña neither shut Trump down nor called out the GOP candidate when he contradicted what Peña said had gone down in the meeting.) 

The meeting was such a disaster that President Peña felt he had no choice but to fire Luis Videgaray, the man who had planned it.

But now Videgaray is back as the new foreign minister ... precisely because Peña believes that Videgaray can curry favor with President Trump. So this government brings the man who sold them out to Donald Trump and then turns around to raise gasoline prices? 

The economic situation makes the situation worse for the Administration. The “gasolinazo” happened while Mexican inflation is rising. (See the below chart.) Why is inflation rising? Well, the value of the peso is collapsing, driving up the price of imports. Why is the peso collapsing? Well, in one word, Donald Trump. The fear that he will impose trade barriers on Mexico causes investors to sell pesos, and so drives down the exchange rate.

But Donald Trump is a man whom many Mexicans believe would never have won election had President Peña had the cojones to humiliate him in that press conference way back when.  

But Donald Trump is a man whom many Mexicans believe would never have won election had President Peña had the cojones to humiliate him in that press conference way back when. 

Let us add it up. The Peña administration curries favor with candidate Trump. Trump wins the election, indirectly causing inflation to accelerate in Mexico. The Peña administration then pours fuel on the inflationary fire by hiking gasoline prices while bringing back the sellout who arranged the Trump meeting in order to curry more favor with the U.S. president-elect. 

Result: rioting.

Andrés Manuel López Obrador cannot believe his luck. 

(Filed under “2016 American election” because Donald Trump is not yet president and the roots of the crisis date back to his campaign.)

A flickering point of light in the Trump cabinet

There is not a lot to like in the Trump administration’s cabinet picks. But there is one who, jokes aside, might be a reasonably decent pick: Rick Perry.

I know, he wanted to abolish the agency he will run. And most of what Energy does involves nuclear weapons. But hear me out. Short version: Rick Perry has a surprisingly good energy record in Texas, and I speak as a deep green. If he embraces it and pushes it inside the Trump administration, then he will leave a great legacy. Sadly, that is not how I would bet, since the Governor has shied away from his biggest accomplishment.

Long version: Governor Perry has a surprisingly good record in Texas. The centerpiece of his accomplishments is a massive infrastructure plan called CREZ: the “Competitive Renewable Energy Zone.” In 2005, the legislature empowered the Public Utility Commission of Texas (PUCT) to create zones prioritzing the construction of long-distance power lines. The resulting infrastructure allowed the state to blow through all its targets for green energy. It hit its 2025 target in 2009. As of October 2016, wind had generated a bit over 12% of all utility-scale electric power in the state: not too far behind Germany at 17%. In fact, on November 27, windpower supplied 45% of total electricity demand. 

A Texan energy guy I speak to (wind or oil? You guess!) said that Perry was instrumental in finishing CREZ. Perry wasn’t the mastermind of the legislative push — with unanimity in the Senate and 91-14 in the House, and Troy Fraser pushing it in the Senate, that wasn’t the hard part. Rather, the SB 20 was a short act. (The link goes to the text; the legislative analysis is here and the whole legislative history is here.) It instructed PUCT to approve applications for CREZ power lines within 180 days, but that left a host of political and legal obstacles that would have killed the project in many other states. (I’m looking at you, Golden State.) 

What Perry did was, in the words of my acquaintance, “pull together folks from the various agencies, along with members of the House and Senate, and said, ‘All right, here’s a series of challenges that need to be addressed.’” In 2008, for example, it looked like the project was going to stall out, but Perry kept pushing. It got done, one of the most impressive infrastructure projects of the (pathetic) 21st-century United States. 

Could Secretary Perry take this national?

Yes! One of the great unheralded accomplishments of the second Bush administration (along with Medicare Part D) was the Energy Policy Act of 2005. First, it had a decent name rather than one of these stupid cutesy acronyms or idiot propaganda titles. Second, Section 216 empowered the Department of Energy (DOE) to “designate any geographic area experiencing electric energy transmission capacity constraints or congestion that adversely affects consumers as a national interest electric transmission corridor.” The Federal Energy Regulatory Commission (FERC) could then authorize power lines, which would grant the operating utilities the right to exercise eminent domain. 

Now, none of this would be easy.

First, Perry would need to coordinate with Agriculture, Commerce and Interior.

Second, the courts have hamstrung the Act, holding that FERC cannot overturn a state refusal to permit a transmission line. (There is some pin-dancing, of course: that interpretation hinges on what Congress meant by the phrase  “withheld approval.” See page 96.) So Perry would need to get Justice on his side and make some persuasive legal arguments. Or he would need to get the President back a new Energy Policy Act clarifying federal authority. That would not be unprecedented: the Natural Gas Act of 1938 gives FERC the power to use eminent domain to build interstate pipelines. The Energy Policy Act of 2005 did the same for LNG terminals. 

Now, one might imagine that the current President-elect would be open to this sort of thing. Call them the Trumplines, hand out tax credits, use eminent domain with abandon, limit court appeals. Back to the 1930s! Green energy but with cronyism! What is not to like? 

Well ...

... third, Governor Perry hasn’t exactly owned his accomplishments. In the words of Tom Smith, director of the Texas office of Public Citizen, speaking in 2014: “Perry is bipolar on wind. He plugged into when he saw he could get a political benefit. And now that the winds have changed in the Republican Party, he’s unplugged himself from one of his greatest environmental victories.” In fact, there are now serious moves in Texas to end the CREZ: Troy Fraser himself pushed to repeal the legislation, just as a new expansion of power lines is needed. (Luckily, it failed.) 

To conclude: Governor Perry has a great energy infrastructure record in Texas. He could take that national, get a lot of power lines built and greatly expand wind and solar without ever uttering a word about global warming or carbon emissions or whatever. And it would be an approach that his chief executive should like. Moreover, there is not a whole lot that Perry could or would do at DOE to hurt renewables. So consider it an upside bet.

A far-fetched one, considering that taking his legacy national would require political courage that Perry has never (AFAIK) demonstrated. But who knows? Hope springs eternal. And unlike some of the other cabinet picks, this one at least will probably do no harm. 

Liberals against carbon taxes ... seriously

There are some interesting contests out there this year that do not involve a fat crybaby! With ColoradoCare sinking in the polls (for understandable reasons) all eyes turn to the other Washington for initiatives worthy of the great laboratories of democracy. There we have Proposition 732, the brainchild of the same economist who gave you this presentation. Prop 732 would:

1. Impose a $15 per ton carbon tax in 2017 and $25 in 2018;
2. Raise the tax thereafter at the rate of inflation+3.5% until it reaches $100 per ton (2048 at current inflation);
3. Cut the state sales tax from 6.5% to 5.5%;
4. Cut the business and occupation (B&O) tax on manufacturers or research from 0.484% to 0.001% of gross receipts;
5. Raise the sales-tax refundable credit for low-income families rises from 10% of the federal EITC to 25%. For a family of four earning $40,000 per year, that would come to about $500, up from $200. For the same family at the poverty line ($24,000) the credit would be almost $800, up from a little over $300.

The idea is to replace some of the state’s most onerous business taxes with carbon taxes, while subsidizing the poorest citizens to protect them from rises in their electricity and gasoline bills. According to the state fiscal impact statement, the net result would be a small tax cut: by 2021,  carbon tax revenues of $2.2 billion would replace lost B&O taxes of $470 million, lost sales taxes of $1.7 billion, and tax credits of $300 million, for a total tax cut of $250 million per year. For what it is worth, using the projections laid out in the impact statement, the loss would reach $620 million per year in 2048, when the carbon tax maxes out. 

In fact, revenue losses will be greater, if the carbon tax leads to greater-than-expected cuts in the use of fossil fuels. But this should be measured against total state tax revenues, which are currently around $19 billion and should reach $25 billion (nominal) by 2021. 

Okay, then! This sounds like a dream reform. Republicans get big cuts in taxes they hate and an overall tax cut. They also get rebates for the poorer GOP voters out in the eastern reaches of the state. Moreover, Washington has lots of hydropower (see picture). Including transport, it uses fossil fuels for only 53% of its energy. Power generators won’t like it, of course, but they can pass on most of the additional costs to consumers. Poorer consumers and industrial operations are protected. The middle class will lose economically, but help the environment.

Of course, I am sure most of you are now snorting. “Hah!” you think. “The GOP would never be so reasonable, not even up in deep blue Washington. And middle class people when push comes to shove won’t want to pay to save the environment. This is, like ColoradoCare, just a phantasm.”

You would be half right. There is opposition. Only ... and this is hard to believe ... it is not from the GOP or the middle class. The GOP is neutral. (Which is not to say that GOP voters are neutral; they oppose the initiative 48%-35%.) No, the goddamned opposition is from the Democrats. 

Whaaaaa? No, really. The Democrats are angry that there will be a net tax loss, no matter how small. They do not think that a carbon tax should be offset at all. The Sierra Club is angry that the revenues are not used to subsidize renewables. Other lefty groups are angry because ... oh, who knows? 

In short, with lukewarm Republican opposition, a carbon tax would sail through if the left supported it. But big groups do not, either because they have an anti-tax cut religion or because they want the revenues to buy their own pet rocks. How in the name of God you justify that position, I do not know. I invite a member of the Washington Sierra Club or Democratic Party to school me.

Mexico’s refining industry is a mess

 Details here. I would like to see more on profitability, but I suppose I can go look at the damn filings myself.

The basic problem is that the refineries are not optimized to produce higher grade fuels. That is fixable, but fixing it costs money, and money is not what Pemex has right now. 

It makes the hubbub about oil imports from the U.S. a little ironic, since those imports were intended to help optimize refinery output. 

The real question is whether a deep-pocketed buyer would find the refining business attractive. Pemex refining is earning a positive refining margin. The “refining margin” is less useful than it sounds. It is difference between total revenue from refined product sales and total costs of all crude oil, divided by the number of number of barrels of product sold. It ignores interest, transport and administrative costs. Add in those, and Pemex refining is losing money. (Page 20.) 

But still, one imagines that a buyer could be found. The business seems far from terminal. I would like to know what Merlin and Dwight think.

Sunny days in Mexico

 I lost a Cinco de Mayo post, straight from Mexico City. So while I try to recover it, let me talk about solar power. The title of this post is ironic, since last week in the D.F. was far from sunny, in the worst possible way.

The picture is from last November, not last week.

Background: Mexico recently passed a new environmental law. Details here. Last month, the Comisión Federal de Electricidad (CFE) bid on clean energy certificates. Basically, the bids were to buy 20 years of clean electricity. In concrete terms, that was for about 6.2 million megawatt-hours (MWh) per year for two decades. 

By itself, that is less-than-impressive. Mexico’s gross electricity production in 2015 came to about 299 million MWh. Total domestic sales came to about 212 million MWh. So six million more? Whatever.

But the amount ain’t the kicker. That was baked into the law. No, the kicker is everything else.

First, the CFE got offers for 102 million MWh. All that with a $71 per MWh price ceiling. (The price ceiling is a little complicated. Basically, CFE offered to pay a certain amount for the electricity plus a certain amount for a certificate insuring that the energy was green. The electricity had a price ceiling of $47 and the certificate a ceiling of $24. $47 + $24 = $71.)

Second, solar projects won 74% of the 5.4 million MWh ultimately bought. Projects here. That was unexpected!

Third, the average price for the solar bids was $50.7 per MWh ... without any subsidies! The lowest clocked in at $35; the highest at $68. We don’t have data on the cost of generation in Mexico, but we do know average retail prices (or at least we can calculate them from Sener data): $87 per MWh.

Now, don’t get too excited just yet. You can look up the wholesale price of electricity in the PJM region of the U.S. here. At this writing, it came to about $22 per MWh for PEPCO. But $51 is well-within the yearly range paid by American utilities. And it is within striking distance of the average $39 per MWh cost of your typical fossil steam plant in 2014, although natural gas prices were quite a bit higher then than now. (Coal, not so much.) 

Moreover, there are going to be problems in execution. These projects need to get up and running by 2018. Some may be late and some may wind up losing money.

But it is, overall, great news ... and a great source of data, since these projects are not subsidized. ¡Viva México!

Natural gas exports to Mexico

 ... are a big deal. Our earlier take here. The link goes to the Financial Times, where a good article discusses the fact that the real impact of Mexico’s energy reform is in the rapid growth of pipelines linking it to the United States. Even considering the overly-optimistic projections for U.S. LNG exports, exports to Mexico will outpace them. 

Mark to market: natural gas prices have been astonishing low for almost two years, yet American production continues to grow. I have some ideas, but unlike the persistence of tight oil production, it is not what I expected. 

How big is the threat that oil exports will be seized in a Venezuelan default?

 It is pretty clear that oil exports could be attached if PDVSA defaulted on its bonds. It would work as follows. PDVSA would sell oil to a refinery in the United States. Creditors would sue. The refinery would still get the oil, but a U.S. court would attach its payment to PDVSA and transfer it to the creditors. PDVSA, therefore, would get nothing from its exports.

If the Venezuelan government defaulted, however, the legality would get a bit dicier. It is possible that American courts would “pierce the corporate veil” and conclude that PDVSA is an instrumentality of the Bolivarian Republic, but that is not certain. Still, it is the way many investors and lawyers (inclduing myself) would bet. 

So in theory sovereign default would lead to a fall in oil prices, as exporting countries with state-owned companies cast around for alternative markets.

In practice, however, the courts are slow and (as mentioned above) the legalities are far from certain. It is quite possible that a defaulting country would merrily continue selling oil while its buyers merrily continued buying. After all, the buyers might not care. They would still get the oil; what do they care if the seller wouldn’t get its money?

But the seller would still want its money. It would likely therefore sell to middlemen who would demand a discount and then resell the oil at some legal risk to themselves. In other words, the price of oil exports would certainly go down.

The empirical question, however, given all the legal uncertainties, is how quickly it would go down. It is quite plausible that the export price of a country’s oil would not be affected by default for months or years.

Well, Ecuador provides a nice test of that question!

Let me walk you through the data. This is going to be a little chart heavy, so I ask readers to comment if it is ever unclear or you lose the chain of the argument.

Ecuadorean oil generally trades a discount to the WTI benchmark price. That is because its oil is heavier than WTI and needs to travel from Ecuadorean fields to (mostly) Californian refineries. The below chart shows the percentage discount on Ecuadorean oil between the start of 2006 and the end of 2009. It shows a very steep fall in November 2008.

That seems convincing, until you add a control. Mexico also exports heavy oil to the United States. Its discount on WTI also widened in November 2008, although Mexico did not default.

Still, the increase in the discount on Ecuadorean oil was greater than the discount on Mexican oil. Might that have something to do with the default? Certainly! But to be sure of that, you need to also account for the fact that Ecuador and Mexico sell into two different geographic markets. Ecuadorean oil goes primarily to refineries in California, whereas Mexican oil goes overwhelmingly to the Gulf Coast of the United States. The price of crude oil can vary by several dollars per barrel between the two locations, given transport costs and varying demand conditions. 

The below chart, therefore, compared the export price of the two countries’ blends to the price paid by refineries in California and the Gulf Coast (60% in Texas), respectively. Once you account for the fact that the price of oil in California fell more than the price of oil on the Gulf Coast, then the oil price dynamics in the two countries look pretty similar between 2006 and the end of 2008. This chart compares the price received by the exporting countries and the price paid by their primary customers:

 

The dynamics look similar when you express the discounts in dollar terms, rather than as percentages of the sale price. The stark increases in November 2008 go away completely, as artifacts of the general fall in oil prices. Mexican crude is a bit more volatile in the lead-up to November, but otherwise looks similar to Ecuadorean:

It is true that Mexican oil recovered faster than Ecuadorean oil. In fact, after January ‘09, Pemex managed to sell its oil for roughly the average price paid by all Gulf Coast refineries, elimating a long-standing discount. PetroEcuador also managed to improve its position relative to the pre-crisis era, but it took rather longer. 

I do not know what happened in the Gulf Coast oil market. There are two hypotheses to explain the Ecuadorean recovery, however. One is that the Ecuador announced the form of its default in mid-2009 — a form brilliantly and perfectly designed to leave creditors without legal recourse. Freed of fears of attachment, therefore, the discount fell.

The other is that May is around when PetroEcuador began selling its oil to state-owned Chinese middlemen at a significant premium. The discount on Ecuadorean oil fell because Chinese companies absorbed it. 

It is still possible, of course, that without the default Ecuadorean oil prices would have bounced back in January 2009 like Mexican ones and without the need to involve the People’s Republic of China. But there is no direct evidence for that story.

The next thing to do would be to nail down an explanation for the disappearance of the Mexican discount in January 2009. If an explanation for that can be found that Ecuador could not possibly have replicated, then the hypothesis that the Ecuadorean default affected the export price of its oil is likely incorrect. On the other hand, if the strategy employed by Pemex was one that Ecuador was prevented from using because it was in default, then the default cost Ecuador.

To be frank, my prior is that whatever happened to Mexican oil in January 2009 was likely idiosyncratic. I doubt that Ecuador suffered in oil markets for its big sovereign default.

Now, this is not to say that default would be costless for Venezuela. It could prove very costly! Eventually, Venezuelan receivables would probably be attached; sooner if PDVSA debt goes into default rather than Venezuelan sovereign debt. But in both cases Venezuela could continue to sell oil.

In short, the evidence from the Ecuadorean default of 2008 is not completely clear-cut ... but the preponderance of the evidence seems to be that any fall in oil prices will take some time to manifest.

Sources tell me that Venezuelan ministers fervently believe that default will lead to cut off in immediate oil exports, or at least a drastic fall in realized oil prices. I suspect that they are wrong ... but it is a good thing for creditors that they do not know that they are wrong.

And now for something completely different

 Venezuela! An economy in such bad shape that the Economist is now comparing it to Zimbabwe circa 2001.

The immediate question is: will Venezuela default? Ricardo Hausmann says yes. The markets say maybe. And Francisco Rodríguez says no. 

Here is the logic behind a “no.” Venezuela has $52 billion of liquidatable external assets. It has internal assets that include 7,000 tons of gold deposits, worth about $274 billion. (Admittedly, that is gold under the ground.) Moreover, while Venezuela is importing a lot, the level of those imports is due to the country’s distorted exchange rate. 

Of course, the Bolivarian Republic would default if default were costless. But it’s not. First, the country has a lot of external assets that creditors could try to seize. Second, Venezuela would run the risk that the receipts from its oil exports could be attached. According to Rodríguez, Ecuadorean oil prices fell almost 20% against Brent when that country defaulted and did not rise again until the 2009 buy-backs. He estimates that something similar happening to Venezuela could cost the country $5.2 billion per year. Third, if the price of Venezuelan oil goes back to $42, the country will be fine, and that will happen within a year or so.

If oil prices stay low, Venezuela will need to finance $25.4 billion in 2016. If they rise, those needs will drop to $20.3 billion. Either way, they can be financed, as this table shows:

2016 oil price	$ 24.9	$ 41.3
External financing needs (bn)	$ 25.4	$ 20.3
Sources of financing:
Chinese fund renewal	$ 5.0	$ 5.0
Use of existing Chinese deposits	$ 2.5	$ 1.5
Mining concessions	$ 2.5	$ 2.0
Bond swap	$ 3.1	$ 3.1
Asset-backed loans	$ 5.0	$ 3.5
Sale of Petrocaribe trade credits	$ 2.0	$ 1.0
Net bond sales	$ 0.5	$ 1.2
Change in reserves	$ 4.8	$ 3.0

Not all of these would be easy. Mining concessions means mining concessions granted by a government with a long history of expropriation. Asset-backed loans means issuing loans against assets (like Citgo refineries and stations) that might be attached in event of default. And as for the cost of default, well, I do not think Francisco is correct when he argues that Ecuadorean oil prices took a hit when the country failed to pay.

I suspect that Venezuela will avoid default his year, because it can. But in the next two posts, I will explain why it won’t be easy to take loans out against Citgo and show that Ecuadorean oil prices suffered no hit when that country defaulted. In other words, Venezuela will put off default for another year, but the costs will be higher and the benefits rather lower than Francisco calculates.

I don’t understand West Virginia

 I don’t understand western Virginia either, but that’s a post for another day.

West Virginia is in the middle of a budget meltdown from low commodities prices. The governor does not want to further tap the rainy day fund, which has $784 million. I can understand that. But I do not understand the politics behind legislators in a poor and racially homogenous state refusing to countenance any tax hikes. The alternative is “closure of eight State Police detachments and 87 trooper layoffs; 350 jobs eliminated across colleges and universities and closure of at least four community college campuses; and layoffs of 166 workers at state hospitals.”

The state Senate passed a series of taxes imposed on tobacco, driving and professional services: dead so far in the House. Where they are mulling a $100 million tax break for oil and gas, the same industry which created the problem. Tax revenue from coal and gas falls, so cut revenue further from coal and gas, in the hope that the industry comes back for a future increase in fiscal dependency on coal and gas. Huh?

I am astounded to say this, but West Virginia could learn from Ecuador. 

But the real question is: what’s driving anti-tax mania in West Virginia? Somehow I doubt that it’s Keynesianism, which makes little sense in the context of economies as open as the typical American state. And I have trouble imagining that voters can be bamboozled by slick campaign ads when they see cuts affecting services they need. So what’s going on?

It almost makes you think nobody believed commercial fusion power was possible ...

 Courtesy of Will Baird:

So back in 1976, the USERDA published some projections about how much money they needed to get a demonstration fusion reactor running by 1990, 1993, 1998 and 2005 respectively. They all expected outlays to multiply. Instead they fell.

Either this is one of the most short-sighted budget savings in the history of the United States, or even back in 1978 nobody really thought that this unicorn would be found.

Did the world just change?

 Oh, hell yes, if this report pans out. Not only will the energy sector change, but many of those who defend our current system of intellectual property will need to rethink. 

But remember, it is preliminary.

Mexico sees silly environmental lawsuits as well

 By now, everyone is aware of the legal challenges to the Clean Power Plan in the United States. Well, Mexico also has a new environmental law (albeit one passed by their Congress, which is far more functional than ours). It is called the Energy Transition Act. The Act:

1. Mandates a clean electricity portfolio standard of 5% this year, rising to 25% by 2018, 30% by 2021, and 35% by 2024, 45% in 2036 and 60% by 2050, with clean energy being defined as emissions less than 100kg of carbon per MWh*;
2. Creates a market for clean energy certificates to meet the standard, which will be auctioned off beginning in 2016;
3. Adds some small mandates for rooftop solar and other distributed power sources;
4. Strengthens the Comisión Nacional para el Uso Eficiente de la Energía (CONUEE) by giving it the power to fine public entities and local governments (but will not set mandatory standards for the private sector).

This is a good law, but it ain’t bringing the revolution. First, consider this picture:

OK, that picture is of the Monument to the Revolution, and has nothing to do with this post, other than the word “revolution”. (But it is a good picture!) No, I mean consider this picture, from page 10 of the original bill:

Yup, electricity from fossil fuels is still expected to rise. It is probably a good thing that natural gas will replace fuel oil, but that depends on how much methane escapes into the atmosphere during the course of production and commercialization. 

Second, remember that only 21% of Mexico’s greenhouse gas production comes from electricity generation. (See page 60 for the 2006 estimate.)

And finally, the steel lobby has already managed to get an injunction against the law! You can read their policy arguments here. (Yes, they are bad arguments.) But they are now arguing that the law is unconstitutional.

I am not a lawyer (IANAL!) but I do not think that their case will hold up. Still, for all our differences, we share so many similarities with our southern neighbors, and throwing political disputes into the courts is one of them.

(Our courts work better, but at least Mexico has a national legislature that, you know, legislates.)

* Yes, Mexico is already at 24%. The law will not bind until 2018. 

Is Ecuador’s resource nationalism hurting it in the oil price crash?

 In comments, reader Cad points out that Ecuador’s oil policy has a downside: the same fixed-price policy that lets the country take all of a price windfall exposes the government to large losses in the event of a price crash. 

Under the best-known service contracts, the Ecuadorean government pays private companies a fixed price per barrel. It then resells the oil at the market price. In other words, it takes all the upside from price rises. (This new policy was the cause of several of the country’s big expropriation disputes.) A subset of service contracts allow private companies to help Ecuador’s state-owned companies (Petroamazonas and Petroecuador) extract oil, also at a per barrel fee.

Finding out Ecuadorean operating costs has proven remarkably hard, although there is some rough evidence that costs have recently risen rather dramatically. What we do know, however, is how much money crude oil extraction has generated for the Ecuadorean state. That revenue, in real terms, has fallen 55% since 2013. On a per barrel basis, revenue for the state has fallen 56%.

Of course, prices have also fallen. Ecuadorean exports fetched $95.63 per barrel in 2013, $84.14 in 2014, and $42.00 in 2015. (Those are weighted averages.) That is a ... 56% decline, which is the same as the per barrel decline in state revenue. 

So not much evidence that resource nationalism has hurt revenues from those data.

What about international comparisons? Sadly, the data for Colombia only runs through 2014, but the Mexico data is available through 2015. In Mexico, oil revenues declined 55% in 2013-15. Revenues per barrel, however, declined by only 50%. So Mexico did slightly better than Ecuador at squeezing the upstream oil sector. (These figures do not count revenues from excise and value-added taxes on refined products.) 

In short, Ecuador’s oil policy has not led the country to do worse than would be expected given the crash in oil prices ... but it is possible that an alternative policy would have kept government revenues from falling quite as far. 

Now, Mexico’s oil tax policy is not particularly recommended. It is fiendishly complex, but it essentially boils down to a tax on Pemex’s gross revenues. The result is a company starved of resources and declining production. (Down 10% on 2013, whereas Ecuador is up 3%.) It is not clear that Mexico is an example to emulate.

But at least from these data it appears that Cad was incorrect when he wrote, “Mashi Correa’s greedy and short-sighted gamble was a disaster and now the people of Ecuador stand to suffer.” Rather, thus far his oil policy seems to be holding up remarkably well both in comparison to the price crash and to at least one benchmark comparison. Colombia may have done better; when we have the numbers, I will analyze them.

Ecuador and falling oil prices

 In comments, reader Cad points out that Ecuador’s oil policy has a downside: the same fixed-price policy that lets the country take all of a price windfall exposes the government to large losses in the event of a price crash. 

Evaluating the size of the problem means constructing a counterfactual: how much income would the government be taking in under a different fiscal regime? As of this moment, I do not yet have the data to construct that counterfactual.

We do, however, have the data to get a general idea of how the oil price crash has affected Ecuadorean public finance. Now, it should be noted that Ecuador is much more oil-dependent than Mexico. In addition, it does not have its own currency. As a result, an oil price crash will hurt Ecuador through channels other than public finance. That said, public finance is still the main channel; it is also the main way in which Ecuador’s policy of paying companies a fixed price to extract the oil will hurt the country should oil prices crash.

This post is not going to evaluate the cost of Ecuadorean resource nationalism. It is just going to lay down the fiscal context for such an evaluation.

So how is Ecuador doing? So far, surprisingly well considering that (unlike Mexico) the country has neither hedged oil income nor imposes any significant domestic petroleum taxes. Here are the basic figures for government revenue, in current dollars:

Oil income has plunged since 2012, but the government has made up for it via other taxes. (Of course, those taxes do impose a burden on the domestic economy, so it is not a free lunch.) Oil revenue is down 63% since 2012 (a fall of $3.8 billion), replaced by a 43% hike in income taxes (raising an additional $1.4 billion), an 18% increase in VAT ($1.1 billion), a 30% rise in tariffs ($0.8 billion), and a whopping 92% increase in other nickle-and-dime taxes ($1.4 billion). 

This is painful, but it is responsible. It also explains much of why President Correa causes such outrage among a certain class of Ecuadoreans: taxes on wealthy people really have increased quite substantially during his administration, especially in the last three years. His opponents are not responding to his rhetoric. They are responding to real economic pain that he has imposed upon them, although it is worth noting that even now income taxes in Ecuador raise revenue equal to only about 5% of GDP, up only a single percentage point since 2012 and two percentage points since Correa took office in 2007. 

On the spending side, the decline in oil income has cut the country’s ability to borrow. (In comments, Federico and I discussed this point in July 2015) Nominal public spending fell by 10% in 2015, with most of those cuts falling on fixed capital investment. (I.e., roads, bridges, railroads, buildings, sewers, etcetera.) This chart shows the basic outline:

In short, the adjustment to lower oil prices in Ecuador has been hard but not catastrophic. It is not immediately obvious what other course the government should have taken; in fact, if you take 2012 as a starting point, the situation has been well managed. 

Of course, it is not unreasonable to take 2007 as a starting point. Perhaps Ecuador should have spent less during the boom, but that is at best unclear: the country’s physical infrastructure was in woeful shape and has improved substantially. Its Human Development Index went from 0.698 in 2005 to 0.732 in 2013. The improvement is not stunning, but it is not terrible. (It is roughly the same proportional rise as in Mexico.) Perhaps Ecuador could have achieved that without the run-up in public spending, but that is not clear. 

What is clear is that Ecuador is not Venezuela.

Which brings us back to Cad’s implicit question: could Ecuador have avoided the 63% fall in oil revenue after 2012? We will take that up in another post; but first, any comments?

Do countries pay arbitration awards? Ecuador and Occidental

 International arbitration is a potentially powerful tool for investors. They can use it to attack governments that have changed contractual terms. Sometimes those defenses are battles by robbed investors against unfair expropriation; sometimes they are attacks by international oligarchs on the democratic rule of law. Usually, they are both.

But there is a problem for investors: arbitration is slow and expensive. This is true even after a decision comes down. To enforce you need to go to national courts and start chasing down assets and sales. That is doable, but it is not easy.

As a result, most arbitrations are settled after a decision comes down, simply to spare the investor the hassle. What we do not know is the gap between the awards granted and the amount paid.

In 2012, ICSID ordered Ecuador to pay Occidental Petroleum $1.77 billion plus interest.  In total, that came to $2.26 billion as of 2012, compounded at 4.188%. After that, the award accrued interest at the 6-month LIBOR (compounded monthly), which would put its total value at $2.29 billion as of November 2015.

That month, a second ICSID panel granted a partial annulment, reducing Ecuador’s liability to $1.07 billion. (Page 133; explanation here.) With interest, that would make the November 2015 value of the award $1.38 billion. 

And how much will Occidental get? $980 million. ($979.9 million, to be exact.) That is a full 29% discount off the arbitral award. In short, Occidental decided that $980 million now was worth an additional $379 million after who knows how many years and legal battles. (I also suspect that Ecuador also agreed to let Occidental back into the country, although that option won’t be worth much until oil prices rise.)

In short, yes, countries pay arbitration awards. They pay those awards because private companies can impose very real sanctions if they do not pay. But the system is slow and expensive ... to in this case almost a third of the headline value. Whether that is a feature or a bug probably depends on your politics. 

Reconciling Mexico’s public spending numbers

 Close readers have noticed that this post about Mexico’s public finances labeled federal revenue at around 18% of GDP. Conversely, this earlier post about the recently announced budget cuts said that the Mexican government took in roughly 28% of GDP. What explains the difference?

Well, the 18% number comes from the Mexican finance ministry (SHCP, for its initials in Spanish). It includes only revenues earned by the federal government the way most people would think of it. The 28% number, on the other hand, comes from the IMF and it includes all public entities, including Pemex.

So what does that mean? Well, the SHCP numbers include only the tax payments that Pemex makes to the federal government. The IMF numbers, on the other hand, include all Pemex gross revenues. That is, they include every single penny of hydrocarbon sales. The same applies to other state enterprises, including the Comisión Federal de Electricidad ... meaning that every penny of retail electricity sales is also counted as government revenue under the IMF reckoning.

For the purposes of each post, the relevant number is used. 

Why is Mexico cutting budgets?

 Last year, Mexico spent $1.09 billion to hedge its oil sales at $49 per barrel. (In 2014, Mexico spent $773 million to hedge at $76.40.) The current budget assumes $50 per barrel and production of 2.247 million barrels per day. That is, it assumes $41 billion in gross oil revenue. The remaining $1 per barrel is hedged by a federal savings fund.

Right now, this is looking like a pretty good bet. Mexican crude is trading around $25 per barrel. The below figure (from SHCP) shows Mexican federal revenues as a % of GDP from 2000 to 2015. It would look much worse in 2015 without the hedges:

But if revenues are holding up and revenues are hedged, it does make the announcement of small cuts discussed here even more mysterious. Why?

Well, there would seem to be three reasons. The first is stupid, although I suspect that Mexican policymakers believe it: they are chasing the confidence fairy.

The second reason has more serious implications. The government may believe that low prices will persist for more than a year. If that is true, then it setting the stage for more serious cuts ahead. The good news is that they are also setting themselves to be pleasantly surprised if oil prices rebound.

But the third possible reason is the most serious of all. Despite the efforts of the past two CEOs, Pemex is an institution in trouble. The company has been losing money after taxes; now prices are so low that it is just plain losing money. That is why the administration replaced the administration two weeks ago. Emilio Lozoya was out; José Antonio González came in from heading up the Social Security Institute. Lozoya reorganized the company into clear upstream and downstream subsidiaries (making analysts lives much easier!) and squeezed out some inefficiencies. But he could not put the company in the black. 

González is not going to have it any easier. In fact, falling prices may have a terrible feedback: less revenue leading to declining investment leading to even less revenue. There are many costs to be cut in Pemex, but those involve taking on powerful unions ... and layoffs would not go over well in the states of Hidalgo, Tamaulipas and Veracruz, both of which are holding state elections this year. So the government might be thinking that Pemex is unfixable. In the long run, that is fine. But over the next few years, it poses a serious problem for the federal government.

Pemex accurately claims that its lifting costs are around $10 per barrel, but that does not take into account the money the company needs to spend to keep up its reserves. That would drive costs up to something more like $23 per barrel. 

In short, the government may be thinking that even if oil prices rebound, revenues from Pemex will do so more slowly. 

Mexico is coping remarkably well with cheap oil

 Maybe I should be more specific in my choice of headline: the federal government is coping remarkably well. This is what you would expect, of course, if you had read this excellent Brookings report from 2014.

Why has the oil price crash not been a disaster? Simply put, Mexico is hedged. So while the price of the Mexican mix has crashed to $26 per barrel (last week it flirted with $18) the Mexican government is actually earning $79. Insurance well bought! In fact, $79 is barely below the $86 that the Mexican mix fetched in 2014.

Still, the headlines are full of portents of doom, caused mostly by the fact that the peso has been falling fast. The government aggravated these fears when it announced 124 billion pesos in budget cuts for 2016. Oh noes!

But what really are we talking about? Of the cuts, fully half come from Pemex. Now, spending is spending so the cuts are still contractionary, but they won’t immediately affect the general public. Another 10% of the cuts are to Mexico’s national electric utility, the Comisión Federal de Electricidad (CFE). Those will also be contractionary (and CFE certainly needs investment) but they won’t have an immediate impact. 

Moreover, in absolute terms, we are talking about 0.7% of GDP. Last year the country’s GDP deflator rose by about 4.3%. Assuming that figure holds for 2016, then the real size of the cuts is about 1.8% of GDP. (Counterfactual 1 in the figure.) If you add projected real growth from the OECD to that, then the size of the cuts expands to 2.4% of GDP. (Counterfactual 2.)

That is not nothing, but extreme austerity it is not.

To be honest, I suspect that Mexico could probably borrow an additional 1.9%-2.4% of GDP without any adverse financial market impact. It seems to me that Los Pinos is chasing the confidence fairy rather than responding to an inescapable economic reality. But either way, given the incredible collapse in oil income, the federal government is coping remarkably well so far.

Another year of $30 oil, though, maybe not such ...

Saudi Arabia will not win its war on fracking

 At Fivethirtyeight, Ben Casselman suggests that Saudi Arabia may finally be winning its war on fracking. In his words:

Recently, though, there have been signs that the Saudis’ strategy might be working after all. On Monday, Chesapeake Energy, once the highest flier of the U.S. oil boom, had to deny publicly that it was preparing to file for bankruptcy; some 60 oil companies have already done so, and the research firm IHS estimates that as many as 150 companies could follow suit. On Wednesday, The Wall Street Journal reported that private-equity giant KKR & Co. was backing away from risky bets on oil companies. Industry leaders are starting to sound desperate: The New York Times quoted the head of a Texas oil group as telling his members that “today our goal is to survive.”

I have some doubts. But let’s say bankruptcies take hold across the sector and production does crash. What then?

Well, the rigs won’t be dismantled. The oil workers won’t lose their skills. The infrastructure won’t disappear. And drilling and completion of a known site takes only one month and costs about $6 million. (Page 13.) Even if you add in all pre-drilling activities you’ve got only about six months to complete a well.

In other words, once prices rise American production will shoot back up even faster than it falls. So what in the name of God does it mean to say that Saudi Arabia is “winning” its war on American production? You need one weird model of the oil market, in which removing American production sends prices up but bringing it back on does not cause prices to fall. (In that model, I should point out, Saudi Arabia would be doing the American industry a favor by forcing it to temporarily cut production.) Or one in which Saudi Arabia would be unable to sell as much oil as it wanted to in the face of full American production. Neither sounds particularly plausible.

Perhaps I am missing something, but the idea that the Saudis are warring on U.S. unconventional oil production does not make sense to me. It is a mighty expensive war and one that they cannot win. So why would they try?

Shocking Supreme Court stay on the Clean Power Plan

 I have no idea why I did not finish and publish the previous post. I am a bit annoyed at myself for failing to finish the post because today, in a partisan vote, the Supreme Court delayed implementation of the Clean Power Plan. (On the other hand, if you were a student in the seminar I taught at Hoover that summer, then you already know all about this!)

We do not know why the Republican justices decided to delay implementation. It could be worried about one of the first two arguments that I mentioned in the previous post. Or it could be that bit of bad drafting that I averred to but did not discuss. 

In 1990, Congress passed two contradictory versions of an amendment to Section 111(d) of the Clean Air Act. The House version said that the EPA could not regulate power plant emissions under this section if it had already regulated another pollutant from these plants. The Senate version allowed the EPA to issue rules on new pollutants even from plants that were already regulated. For those of you interested in the exact language:

• House version: rulemaking will proceed for “any air pollutant … not … emitted from a source category which is regulated under Section 112.” E.g., no future regulation of new pollutants from sources that are already regulated.
• Senate version: rulemaking will proceed for “any air pollutant . . . not included on a list published under . . . 112(b).” E.g., only certain specific pollutants are excluded from future regulation.

Congress, however, screwed up. Instead of choosing one version or the other, the conference committee somehow managed to insert both into the final bill. The “Section 112 exclusion,” therefore, is a contradictory mess. If you want to kill the Clean Power Plan, then you want to argue that the House language applies.

The requests for a stay can be found here. Most of them seem to hinge upon some version of the “beyond the fence” argument and the confused language of the Section 112 exclusion. 

Shades of King v. Burwell! For those of you unfamiliar with Supreme Court cases, King v. Burwell was an attempt to kill Obamacare that hinged upon a single badly-drafted line. 

The D.C. circuit rejected the applications for a stay of the plan, but now the Supreme Court has stepped in. We will have to see, but I feel pessimistic about the Clean Power Plan’s chances. Although the legal arguments presented in these last two posts are not particularly powerful, they are also far from specious.

Larry Tribe, on the other hand, has presented a specious case against the Plan based on the Fifth and Tenth Amendment. If you want to see an avowed liberal tie himself in weird knots in order to justify a conservative outcome because he is being paid to do so, go click the link. 

Unpublished post from August 14, 2015: Challenges to the Clean Power Plan

 I’m in Palo Alto, enjoying the lack of humidity and thinking about the Clean Power Plan. What else would you think about in California?

What might kill the plan in the courts? Well, I have been talking with some libertarian-leaning lawyers, and here is what they tell me. In order from least plausible to most:

1. The “wrong target” argument:  The Clean Power Plan (CPP) does not regulate power plant operators directly. Rather, it enjoins state governments to limit their overall CO2 emissions from all power plants. That is new; the regulations should be targeting the emitters directly. A challenge on these grounds seems unlikely to succeed; at worst it would force the federal government to write the state plans, which even now it will do if a state refuses to come up with a plan.
2. The “beyond the fence” argument: This is very similar to the above argument.  By imposing state-level limits, the CPP is acting “beyond the fenceline” of the power plants that it is regulating. After all, some power plants might not be affected at all, should a state decide to join one of the existing cap-and-trade systems. This argument is a little stronger, but does not seem to have much basis in either the Clean Air Act or in constitutional law.  
3. The fact that the law, like the Affordable Care Act, is terribly written and contains its own contradictions. 

Let me briefly unpack that last one. 

Carbon capture is hard

 Carbon capture and storage (CCS) is one of the holy grails to combat climate change. (Cheap utility-scale electric storage is another. Cheap and safe small-scale nuclear is the third.) In theory, it sounds easy. Take the exhaust from a big fossil fuel plant, extract the CO2, and send the CO2 somewhere besides the air.

The obvious rub is: where do you send the CO2? Fortunately, there are answers. CO2, for example, is useful in the secondary recovery of liquid hydrocarbons. (It can also be used for natural gas.) So you can site CCS-equipped coal plants near old oil fields and sell them the CO2. 

So the Mississippi Power Company decided to build a CCS-equipped coal plant near some older oil fields in the state. Ignore, for the moment, whether anyone wants to try to extract oil from old Mississippi wells at current prices; you can still always pump the CO2 underground regardless.

Well, Mississippi Power just announced another $142 million overrun on the project, taking the cost up to $6.6 billion from a projected $2.9 billion. With a capacity of 582 MW, this may well be the most expensive power plant in the world. The recent overruns were due to problems with the coal gasifier unit which turns soft lignite into natural gas (well, synthetic natural gas, which sounds oxymoronic) and extracts carbon dioxide. Earlier problems had to do with linings on the tubes carrying gas heated to 1800 degrees. And before that they just plain underestimated the amount of tubing needed and the cost of installing it. A 2013 filing blamed overruns on “abnormally wet weather and lower-than-planned construction labor productivity.”

Nuclear power has not overcome similar problems.

So I would not bet on CCS to save us.

Shorty’s investment wisdom

 From the Rolling Stone article by Sean Penn: “He is interested in the movie business and how it works. He’s unimpressed with its financial yield. The P&L high side doesn’t add up to the downside risk for him. He suggests to us that we consider switching our career paths to the oil business. He says he would aspire to the energy sector, but that his funds, being illicit, restrict his investment opportunities.”

This is fascinating for two reasons.

1. It jibes with Alejandro Hope’s hypothesis that cartels pile up lot of their money in cash. It also jibes with my hypothesis that high costs mean that they overinvest in criminal activities: on the margin, they will accept a negative return from violent enterprises as long as the negative return is less than the cost of laundering money.   
2. Shorty clearly knows very little about the energy business (in blue, versus the overal S&P in red):

The energy business isn’t quite as profitable as Shorty Guzmán thinks it is. Nor are movies as bad. Starting in 2012 the S&P added a Movies & Entertainment subindex (in yellow below, compared to blue for energy and red for the overall S&P 500). When you do the comparison ...

... movies look pretty good!

Moral: don’t take investment advice from a capo.

Update to a mild defense of Mexican fuel subsidies

 I have no idea why I did not publish the previous post two years ago.

Here is a longer view of the difference between U.S. and Mexican gasoline prices. It makes it clear that Mexican policy has been to smooth energy price fluctuations, rather than provide a blanket permanent subsidy. 

The main way the policy worked was via a variable excise tax on gasoline, in addition to controls on the underlying fuel price. When fuel prices rose, the excise tax dropped. The end result was greater stability in prices and presumably insulation against price shocks.

Of course, saying that the policy brought benefits is not the same as saying that it had no costs. Below you can see them estimated for 1998-2012. They fell, of course, in 2013-14 and fuel tax revenues likely exceeded subsidies again in 2015.

Anyway, the policy is on its way out. In 2013, it did not look as though the Mexican fuel retail sector would be liberalized. But it will be! Look for non-Pemex stations coming your way. And starting this year fuel prices will be allowed to fluctuate in a 3% band around in the inflation rate, with the base price linked to the gasoline price on the U.S. Gulf Coast. The variable excise tax will be replaced by a fixed tax of  US$1.01 per gallon for Magna, 86¢ for premium and $1.11 for diesel. I have no idea why the tax varies so much between grades. I guess somebody wants people to buy high-octane fuel.

The fixed tax is a terrible idea, but maybe Mexican politics will be less sclerotic than American. Anyway, free imports will be allowed next year and all price controls are due to be scrapped in 2018, so the incoming administration will want to come up with a new tax plan anyway.

On balance, I support price decontrol. But as I argued in the last post, there were benefits to the Mexican system of price smoothing. The rub was that Mexico is an importer of refined products, so the controlled prices had an impact on the government’s cash flow, which in the real world is far more problematic than a subsidy paid for by incurring an opportunity cost. 

Unpublished post from December 2013: In (mild) defense of Mexican gasoline subsidies

The Dallas Fed published a paper decrying Mexican fuel subsidies.

The problem with the paper is that Mexico doesn’t have fuel subsidies as commonly conceived. Unlike Venezuela, Mexico does not sell gasoline below its cost to refine. Nor is the price of gasoline consistently below that in the United States. In fact, right now the price of gasoline in Mexico is higher than in the U.S. Nor is this a new phenomenon: the price was higher than in the U.S. before 2004:

What Mexico does have is a system designed to protect Mexican consumers from price volatility. When crude prices spike, Mexican gasoline prices rise with a delay; when crude prices fall, Mexican gasoline prices do not.

Volatility is costly.In 2005, James Hamilton summarized the findings about the effect of oil shocks on the U.S. economy. The estimates, as you might imagine, varied quite a bit. The Oak Ridge National Laboratories summarized the findings as a GDP elasticity between −0.1 and −0.8; that is, for every doubling of oil prices, GDP falls between 0.1% and 0.8%. From that, they derived a volatility cost between $2.18 and $7.81 per barrel of crude oil. That translates more-or-less into a volatility cost between 11¢ and 42¢ per gallon.

During the 2006-11 period of subsidization, Mexico’s oil subsidies averaged 40¢ per gallon. (See page 11.) That is near the high end of the Oak Ridge estimates of the volatility cost to the United States.

This is not an airtight defense of the policy! The estimates of the impact of an oil price shock could be very different for Mexico. (Someone should write a paper!) Moreover, unlike in the U.S., additional income from gasoline sales goes right to the government, which could choose to spend it. Finally, if protecting the economy from volatility is the goal, then Mexico should let gasoline prices slowly increase to European levels and only then keep them stable.

It is to say, however, that there is a benefit to Mexico’s policy. More study is needed to show that the benefit does not outweigh the costs.

Postscript: Mexico can, like Brazil, continue to control the price of gasoline even it chooses to liberalize the retail sector ... which so far is not part of the energy reform.

A happy Christmas present from Paul Ryan

 I have many pieces of fashion advice for American males, but one is above all. If you do want to have to think about the impression you are making ... if you have no desire to engage in mental calculus about appropriate accessories ... if you truly detest thinking about the audience but know that they matter ... then base your wardrobe on Republican elected officials. (While they are in office, of course.) They have done all the complex calculus with the lowest common denominator in mind. If they can wear it, then so can you, in pretty much any circumstance. 

And so, I would like to thank Paul Ryan for finally bringing the trim goatee into the mainstream. And I mean the total mainstream, killing any last bit of edginess or risk. Mazeltov, Mr. Speaker! 

I would also like to thank Speaker Ryan for the recent budget bill. First, how can I possibly thank you enough for tossing out the shibboleth of balanced budgets? I cannot! And given your own history, my thanks goes double. 

Second, we now have a five-year extension on the windpower production tax credit! And the solar ITC for six years! Hoo-ah!

Not one, not two, but three gifts from the Republicans! Wind, solar, and beards. (I am going to grow one right now.) Sometimes, America works.

I invite opposing views in comments, particular from the people arguing with me about my recent GOP-love in our respective inboxes. 

Higher penalties will not stop oil theft

 Hydrocarbon theft is a huge and growing problem in Mexico. Pemex recognized accounting losses from theft reached $1.3 billion in 2014. That is not a huge factor for a company that enjoyed sales of $108 billion (page 18), but it made up a big part of the company’s net loss of $18 billion. In the past, the main thefts were of natural gas condensate taken from the Burgos fields. Pemex shut that down by suing American refineries who bought the stuff. (See this blog from 2012 and this law review article from May 2014.) Victory!

Except, well, the thieves turned to stealing natural gas and refined products, which can be flogged directly on retail markets. So now we have a new law (the link goes to the text, courtesy of Dwight Dyer) that ups the penalties for stealing oil. Prison terms will rise as a function of the amount stolen. Moreover, anyone abetting theft by revealing operational details of midstream operations will be punished ... as will anyone owning land upon which theft takes place or anyone failing to report criminal activity. Hell, the new law punishes underinvoicing.

Awesome. But as Dwight Dyer points out, the law is only as good as enforcement. Only 33 Pemex employees have been arrested in the past three years of the Peña administration ... as compared to 66 arrests during the six years of the Calderón administration. So Dyer is skeptical.

And I would like to add an additional problem with relying on a new law. Criminal organizations in Mexico have a way of making people offers that they can’t refuse. Unless (say) the Zetas are rendered unable to credibly threaten Pemex employees and local landowners, then harsh new penalties on the people they are threatening won’t accomplish a whole lot. 

Color me skeptical.

Observatorio Argentino 30: Why Big Oil loves Kircherismo

 The first round of the Argentine presidential election threw up a surprise: the center-right mayor of Buenos Aires, Mauricio Macri, came within a hairs-breadth of Daniel Scioli, the candidate of the leftist ruling coalition. The result forced the election into an unexpected run-off between the two leading candidates. Macri is now believed to have a very good chance of winning the run-off tomorrow. Macri and Scioli are far apart on many issues. The markets, certainly, think that the election matters: Argentina dollar-denominated bonds due in 2017 jumped 10% on the first-round election results. The Merval stock market index rose almost 5%. Analysts have predicted an additional rally of as much as 30% if Macri pulls out a victory.

In other words, this election matters. And one of the ways it matters is in energy policy. But the way it matters is a little odd. Actually, a lot odd.

Short version: if you like big oil companies, then you should love Peronism! The Kirchners are the best thing for Big Oil since, I don’t know, the Iranian Revolution? 

Longer version: The Kirchner administration (2003-07) and the first half of the following Fernández administration (2007-date) did everything they could to make life difficult for the upstream sector, culminating the nationalization of Repsol YPF in 2012. Since then, though, the Argentine government has been running hard in the other direction, handing out windfall past subsidy to the upstream sector. (The government resolved the Repsol expropriation in a way that satisfied the oil companies.) In petroleum, those windfalls run pretty far downstream.

A bit more detail:

1. Argentina controls the oil trade. Exports are allowed only when the international price is below $77; imports are banned. When world prices were high, Argentine producers hated this. But now that world prices are low they love it: Argentine crude oil producers currently sell domestic crude similar to WTI for $85 per barrel at a time when their American counterparts are lucky to receive $42. As an added sweetener, whenever prices are below $81 ($66 for some fields) the government will hand them a $3 per barrel direct subsidy.
2. Argentina controls retail gasoline prices. In October 2015, Argentine gasoline prices averaged $4.96 per gallon. The pre-tax price averaged $3.00. (Calculated from data on page 79.) Argentine refineries paid an average of $77 per barrel. Well, the last time that crude cost $77 in the United States was November 2014, at which point American gasoline prices averaged … wait for it … $3.00 per gallon. In other words, the petroleum industry ain’t hurting.
3. Natural gas producers now get $7.50 per MMBTU for production from new sources. This at a time when the landed price of liquefied natural gas in Argentina is $6.77! Not too shabby. While we’re at it, Scioli, the left-winger in the race, has promised to raise the domestic price for new natural gas production to $12.50.

In short, the left-wingers in the Casa Rosada are in the midst of engineering a massive wealth transfer from Argentine consumers to hydrocarbon producers. ¡Viva Kirchnerismo!

So where is the populism in modern-day energy Peronismo? Electricity. Electricity prices have been controlled since the 2002 crisis. The government authorized a 72% rise in 2013, but that still left average retail prices around 1¢ (U.S.) per kilowatt-hour. At those prices, the only way to keep the lights on has been to pump public money into electricity generators and distributors. (See below; the 2015 figures are my estimates from Argentine nominal GDP data provided by a private consultancy combined with data on electricity subsidies for the first six months of the year.) They have been more successful than Venezuela’s monumental incompetents, but there have been growing brownouts and the utilities are facing bankruptcy despite the subsidies.

There are subsidies and they are not unaffordable … but like most electricity subsidy schemes, they benefit the middle class and the rich rather more than the poor.

Scioli would keep the hydrocarbon subsidy schemes in place. That would be awesome for oil companies. He would also likely keep the electricity subsidies in place for as long as the country can afford it. Which could be a long time, if he gets public spending in order elsewhere. It isn’t how I would spend the national fisc — and it begs the question of how you limit consumption in the absence of price signals — but it won’t arrive at Bolivarian levels of crazy for a few years yet.

Macri would scrap the upstream subsidies. His chief energy adviser is Juan José Aranguren, the head of Shell Argentina, and Macri has said that he intends to appoint Aranguren to a cabinet-level post if he is elected. Aranguren is long-standing critic of the Fernández administration’s energy policies. I’ve met the man — he has a refreshingly German level of bluntness about him — and I have little doubt that he will unwind the web of controls and subsidies.

Argentina being Argentina, this is one of the few cases around the world where an openly right-wing policy immediately redistribute billions of dollars downward. ¡Viva Aranguren!

Electricity policy under Macri is less clear. His political party, the Republican Proposal, has an in-house think tank called Fundación Pensar, and Fundación Pensar’s energy policy head, Sebastián Scheimberg, has publicly stated that electricity subsidies need to be removed. But that would hurt a lot of people very quickly, including a lot of poorer people. (Saying that the subsidies benefit the middle class and rich more is far from saying that they don’t also help the poor. They do. A lot.) And Macri got burned from a price hike during his time as mayor of Buenos Aires. Since punting and waiting for another opportunity to score is an option, then I think that is exactly what he will do. He might surprise with a social tariff, but I do not think it will be a priority. 

Happy election watching tomorrow!

Did Russia cause the decline in oil prices?

 No.

But some Russian observers believe that it did. (Hat tip: Randy McDonald.) Short version: the Russians did not offer to cut production enough back in October 2014. This sent the Saudis into a fit of pique and crashed oil prices.

Oh gosh. First, Russia is not a swing producer. It is hard for the Russians to cut production, especially in winter. Only the Saudis and Emiratis have the capability to shut down millions of barrels per day of production simply by turning a bunch of valves. 

Second, the Saudis really do not act out of pique. Not with billions of dollars at stake. We know exactly what they are trying to do, because they have told us. In June, Saudi Arabia increased production by 500,000 barrels per day. They did not do that because they were worried that the Russians might free ride on a production cut. They did that because they wanted oil prices to stay low for a while. 

Sure, in October the Russians might have tried to counteract the Saudi production hike. (Operative word: tried. Moscow is not lying when it says that such a cut would be technically impossible unless you were willing to risk permanent damage to the fields.) But why in the name of God would they have bothered? Just a few months before, the Saudis had jacked up production. The Saudis could have taken production down by 2½ million barrels per day (the 2010 level); five times what Russian critics think Moscow should have done. 

And the Saudi and Russian oil ministers talk to each other. The Russians would have known Saudi intentions. The Saudis would have known Russian technical capabilities. This is not the Vietnam War; the two sides do not have to communicate via the energy market equivalent of strategic bombing. 

Russia is a big important country. But the oil price decline, that one was caused by the dynamic duo of the United States (hooah!) and Saudi Arabia. The world’s weirdest superhero and sidekick. But there nonetheless.

Sorry, Russia. You are not that important. 

A depressing Thursday thought about global warming

 The Clean Power Plan proposed by the President is a very important step forward for climate change. According to the Energy Information Administration, the American power sector will emit almost half a gigaton less carbon into the atmosphere by 2024 than otherwise would have been the case. That is almost a quarter of all power-sector emissions!

Globally, the picture looks like this through 2021:

To be fair, the graph misses a full third of the reduction, which will happen in 2022-24. I guess that makes it better?

The problem is that electricity generation produces only 40% of the carbon dioxide emitted in the United States. 24% × 40% = 9.6%, which does not look as impressive. (And only 7.2% by 2021.) Add to that the fact that the United States is not the only country on the planet and things look even less impressive.

A start is better than nothing. But it is only a start.  

Ecuador is still not a colony of China

 Now that the New York Times has breathlessly put Chinese imperialism in Ecuador on the front page of its Sunday edition, I feel like I must point out that China is securing neither physical supplies of Ecuadorean oil nor favorable prices. And it is certainly not earning rents on the money it lends the Ecuadorean government. China may be buying goodwill and it may be buying the rights to develop some of the last untapped conventional oilfields on Earth ... but it is getting neither cheap.

We covered physical shipments back in 2012. Nothing has changed. Most of the molecules pulled out of the ground in Ecuador wind up in Californian refineries.

What about price? The oil might physically end up in California, but most of it passes through Chinese ownership. In theory, that would give the Chinese middlemen monopsony power. In practice, it does not. In fact, the Chinese overpay for the oil.

Up until 2012, the loans-for-oil deals required the Chinese lenders to take Ecuadorean oil in repayment valued at a premium over the WTI price. In December 2012, Ecuador stopped charging a premium for its oil. That sounds like maybe perhaps now the Chinese were finally taking advantage of their position ... but such a conclusion would be wrong. Traditionally, Ecuadorean oil traded at a discount under WTI because it was of low quality and could only be sold to California refineries unless it was shipped through the Panama Canal. In 2012, however, for the first time ever, Ecuadorean crude sold at a premium over WTI around US$4 per barrel. (Californian refineries needed that heavy oil.) The Chinese buyers did not wish to pay a premium over the premium, and so the Ecuadoreans agreed to deliver the oil at the market price.

Maybe the contracts were just folderole? Perhaps canny Chinese traders managed to squeeze out monopsony profits regardless? Well, we can check that. PetroEcuador sells its oil mostly to Chinese buyers. The private companies operating in Ecuador do not. (They technically turn their oil over to the Ecuadorean government for a per-barrel fee, which then sells it back to them, at which point they sell it again at a further markup upon which they pay taxes.) The prices at which PetroEcuador and the private companies sell their oil is publicly available. And what do those prices tell us?

The blue line shows the difference between the price charged by PetroEcuador (which sells to the Chinese) and the price charged by the private producers. PetroEcuador generally receives more money per barrel. In fact, PetroEcuador managed to take advantage of a spike in Californian prices in early 2011 that passed the other producers right by.

The red line shows the difference between the price received by PetroEcuador and the landed price of oil in California, which is the relevant market. It shows no trend: the increase in oil sales to Chinese middlemen does not drive up the spread between the price paid by Californian refineries and the price received by PetroEcuador. (The spread does increase at the end of 2014; that is an effect of the general oil price crash, as all Ecuadorean producers tried to keep up their market share.) 

OK, then. The oil is still going to California and the Ecuadoreans are receiving a good price. So maybe the Chinese are charging extortionate interest on their loans? It certainly could be. But again, that is easy to check. 

How do the terms on the Chinese loans stack up against those offered by private creditors? The red bars show the lending rate on the Chinese loans. The blue bars show the yield on Ecuador’s 2015 bond at the time the loans were made. In every case, the red line is below the blue line. The last loan, from the Chinese Ex-Im Bank, uses Ecuador’s new issue due in 2024 as a benchmark ... which brings home just how incredibly cheap that last loan happens to be. 

The New York Times article mentions “steep interest payments” on the Chinese loans. I have no idea what they are talking about.

The Times article also states, “Along with taking the bulk of oil exports, the Chinese companies also collect $25 to $50 in fees from Ecuador for each barrel they pump.”

What it does not tell you is that said fee is in fact a triumph of Ecuadorean resource nationalism. Remember how private oil producers (Chinese and Western) in Ecuador turn over their production to the government and then buy it back? Well, that fee is what the government pays them for their oil. The difference between that and the market price is pure rent for the Ecuadorean state. It is the exact opposite of imperial exploitation. (The contracts are quite clever; the newest ones give the companies a higher price if they reduce costs.) The government also takes 70% of the profit on oil sales. (Page 178.) 

The article’s phrasing, however, makes it seem as though Chinese companies take the oil for free and then charge a fee on top of that. Very misleading.

The article also says, “China’s terms are putting countries in precarious positions.” But that doesn’t make any sense! The terms of the loans are great for the borrowers. Falling oil prices are what is putting Ecuador in a precarious position. As for China’s ability to threaten trade or other sanctions should Ecuador default ... well, tell that to the Argentines or the Greeks. Western creditors, public and private, are also pretty good at that sort of thing. (I wrote a book about it!) 

Ditto the way that China forces the recipients of its finances to buy its products and contract with its companies. My co-blogger knows more about development aid than I ever will, but from what I saw on the ground in Afghanistan and Africa that sort of thing seems to be the rule ... even if it is technically disallowed. (Doug?) And I must also admit that while the anecdotes about Chinese labor and environmental practices are quite telling, I also doubt that they are much worse than the Western record. (Setty?)

Finally, love it or hate it, the Refinería del Pacífico is a purely Ecuadorean idea. If it turns out to be a bad one (I suspect it is) then perhaps one could blame the Chinese for going along Ecuadorean desires. But the refinery is not a boneheadedly stupid idea. There are real reasons to support it; opponents (like myself) are making a judgment based on the risk of failure; reasonable people can disagree about whether the potential reward is worth the risk. Moreover, most of the debt for the refinery will be effectively collateralized. Many of the losses will fall on Chinese banks.

The above, I think, is the opposite of imperialism. Ecuador sold the refinery idea to China and looks as though it might get the Chinese to put up most of the money and take on most of the risks. 

If this is a Chinese empire, it makes the American empire look well-run and logical. Which is saying a lot.

Worthy Jamaican experiment

 Before pulling out for personal reasons, I was involved in a consulting job in Albania. The goal was to reduce electricity theft. One of our recommendations was kind of obvious: to reduce theft, you need to make it hard for people to steal. You need to get out and yank illegal connections and keep yanking them.

Would that it were so easy. The tricky part is twofold: (1) Getting the money to pay the people who need to check and yank; and (2) getting the political will to cut people’s electricity. 

But now it seems as though Jamaica’s utility is doing just that! 

Jamaica’s sole electricity provider says crews have pulled down nearly 10,000 illegal connections to the power grid and police have arrested over 300 people for theft so far this year. In a Sunday statement, the Jamaica Public Service Co. says it is “relentlessly pursuing” electricity thieves in neighborhoods where a tangle of illegal wires can often be seen tapping into power lines. In one town in Jamaica’s St. Catherine parish, residents fled their homes last week to avoid arrest as power crews removed about 850 illegal connections.

Now, to be fair, total losses in Jamaica are just 26%, way less than in Albania. But still, the experiment bears watching. 

What is bad for oil could be good for natural gas

 Natural gas prices in the United States have been below estimated production costs for quite some time. Why then has production remained so high?

Much of the answer has to do with what is called casinghead gas. (Aka “associated” gas.) That is, natural gas produced as part of oil drilling operations, and separated at the casing head. I do not know of good national figures for this, but Texas keeps good records. You can see from the below chart how natural gas production has declined with low prices, but the boom in unconventional oil has caused casinghead gas production to skyrocket. The end result has been stability in total output despite the low prices:

What happens if oil prices stay low for a prolonged period of time? New oil drilling will fall off — this has already happened. If prices remain low for more than a year or two, then production oil will fall. Associated gas will fall along with it. And that will drive gas prices up.

In short, a prolonged period of low oil prices will cause natural gas prices to rise.

The problem is that all this operates with long and uncertain lags. Which means that I cannot predict when prices will rise or how long they will remain high. What I can predict is that low oil prices mean more volatility in the natural gas market. 

Buckle your seat belts!

Methane hydrates are the fuel of the future and will be for a long time

 The Financial Times had a piece last year about Japanese attempts to develop methane hydrates. I am not convinced that these will ever be commercialized.

The Caribbean can survive the collapse of Petrocaribe

 There has been a lot of worry that the increasingly penurious Venezuelan government may cancel the Petrocaribe program that helps Caribbean nations (and El Salvador) buy Venezuelan oil. The fear is that fragile Caribbean economies will collapse if Caracas withdraws its support.

I think these worries are misplaced.

Petrocaribe finances Caribbean oil purchases on a sliding scale. When the price is between $30 and $40 per barrel, it will finance 25% of the purchase price. When the price is $90 per barrel (as it was back in July), Petrocaribe finances 40% of the purchase price. The terms are laid out in Article IV the Petrocaribe Cooperation Agreement. 

Upshot: the price of Venezuelan oil is currently $39 per barrel with no subsidy. Six months ago, Caribbean countries had to shell out $59 in cash for a barrel of oil valued a hair below $99. It is true that if Petrocaribe holds the Caribbean countries will have to stump only $29 in cash ... but at the end of the day, $39 < $59.

Meaning that even if Venezuela abandons its Bolivarian ideals and dumps its Caribbean allies, the Caribbean countries will still be better off than they were last year.