Knowledge Problem

Lynne Kiesling

Today sees a couple more articles about Radiohead's decision to sell their album online, at prices determined by the buyer. This New York Times article highlights one thing that I find interesting: letting the radio listeners themselves determine which songs off the album should be considered the "hit singles":

The Radiohead camp has been reluctant to add to the hype surrounding the album, which has been stoked by breathless blog posts and e-mail exchanges for the past week. Bryce Edge, who manages the band with Chris Hufford of Courtyard Management, stressed that the band’s tip-jar-style tactic “is not a prescription for the industry.” ...

Mr. Edge summed up the pricing pandemonium simply: “Digital technology has reintroduced the age of the troubadour. You are worth what people are prepared to give you in the digital age because they can get it for nothing.”

In another departure from convention, the band declined to send out early copies of the music for reviewers and has not settled on a traditional single to push to radio stations. As a result, programmers are improvising. In San Francisco, for instance, the rock station KITS-FM, Live 105, has the entire album on its Web site (live105.com) and will let fans vote to determine which songs merit airplay.

“We just want to be involved in it,” said Dave Numme, the station’s program director. “We just want to reflect what’s going on out there and give our listeners a chance to tell us what they think of it.”

This Bloomberg article asks whether the music's any good:

Radiohead is open to charges that it has been forced down the Internet route because the band needs the publicity or can't sell its music any other way. Which raises the question, is "In Rainbows'' any good, at any price? ...

It is downbeat, depressing and a relatively rewarding rock experience, all at once. ...

As a single-sentence assessment, one could say this: Radiohead is near the peak of its powers and this is its best effort in a decade, since "OK Computer,'' which is regularly voted by critics as among the best rock albums of all time. ...

Not that this is necessarily saying much. For one thing (and this is a rock heresy rarely spoken), time has shown us that the 1997 album is less than the ground-breaking masterpiece it was originally acclaimed to be. For another, the albums in between saw the band veer off at an experimental tangent. "Kid A,'' "Amnesiac'' and "Hail to the Thief'' were Alternative Rock with a capital A, and varied from the strangely successful ("Pyramid Song'') to pretentious ("Sit Down. Stand Up.'')

I'm not a big Radiohead fan (I've got OK Computer and Amnesiac, but I never choose to listen to them, there's so much stuff out there that I like better), but I am intrigued by this experiment.

By the way, music sold by Magnatune are priced this way, to a point: you pick the price, with a price floor of $5, but you can pay more if you choose. They find that many people do.

Michael Giberson

The Houston Chronicle's Tom Fowler and Janet Elliot have a pair of articles on the Texas power market restructuring experience and current talk about reforming state policy.

From the lede in Sunday's "Many Texas consumers feel competition in the state's energy markets has been a costly failure":

When Texas lawmakers agreed to open the state's power markets to competition back in 1999, one promise was on the tip of many tongues — lower prices.

"Competition in the electric industry will benefit Texans by reducing monthly rates and offering consumers more choices about the power they use," then-Gov.
George W. Bush said at the time.

Then-state Sen. David Sibley, who was a key author of the bill, put the promise more bluntly:

''If all consumers don't benefit from this, we will have wasted our time and failed our constituency," he said.

Eight years later, many consumers are calling deregulation just that — a failed waste of time.

From Monday's "Market fix rests on bright ideas":

Many in the industry say the market is working, particularly for customers willing to shop for the best rates. Two of the state's top three political leaders, House Speaker Tom Craddick and Gov. Rick Perry, share that view.

"As other markets and states face population and electric usage increases, Texas' electric market will continue to prove the model for other states to emulate," Craddick said recently.

The third member of the state's top leadership, Lt. Gov. David Dewhurst, says the state's power markets need some tweaking to encourage greater competition.

"At the same time, I don't want to dramatically re-regulate the industry," Dewhurst said, without elaborating on what measures he believes might stimulate competition.

But some consumer groups and elected officials say the higher rates for residential customers — particularly the poorest Texans — require more drastic measures.

"Yes, you can put the genie back in the bottle," said Rep. Sylvester Turner, a Houston Democrat who is suggesting a return to price controls for residential and small business customers. "If you can deregulate, you can regulate."

Michael Giberson

Tracy Davis, writing at Energy Legal Blog, takes note of the Supreme Court's decision to take on a pair of Ninth Circuit court decisions:

In a pair of decisions issued last December, Public Utility District No. 1 of Snohomish County, WA v. FERC and California Public Utilities Commission v. FERC, the Ninth Circuit held that the long-standing Mobile-Sierra doctrine and its "public interest" standard did not protect contracts from unilateral modification when they were entered in a dysfunctional market that caused prices to exceed a "zone of reasonableness." The Ninth Circuit held that FERC should have reviewed the circumstances under which the contracts were entered, and possibly set those contracts aside if it found the prices to be unreasonable.

Several groups of sellers sought Supreme Court review of the Snohomish and CPUC decisions to determine whether the Ninth Circuit's formulation of the Mobile-Sierra doctrine was appropriate. Many argued the Ninth Circuit's view would upend contract certainty in electric markets, thereby inhibiting investment, if contracts could later be revised because of changes in the market, buyer's remorse, or other circumstances outside of a seller's immediate control.

Also at Energy Legal Blog this morning: Commodity Futures Trading Commission and Federal Energy Regulatory Commission No Longer Playing Nice In Jurisdictional Battle over Gas Futures Market Enforcement.

Lynne Kiesling

Last Thursday we saw De Novo Dahl, Bedouin Soundclash, and Hot Hot Heat at the Vic in Chicago. Punch line: great show, very fun. More below the fold.

Continue reading "Concert review: Hot Hot Heat, Bedouin Soundclash, and De Novo Dahl" »

Lynne Kiesling

Thanks to Jesse Walker at Reason for the link to the Baltimore Sun's Bay & Environment Blog. If, like me, you are interested in environmental issues pertaining to water use, this site looks like it will be quite useful.

The current top post by Rona Kobell prompts me to think about something that I discussed in one of my classes last week:

Two conversations recently have gotten me thinking recently about the environment and the way we live.

The first one: I was introduced to someone as The Sun's Chesapeake Bay reporter, and the person asked, "Are you a greenie?"

The second one: I was on a panel discussion about the environment, and we were talking about farmers and land development being the largest sources of bay pollution. The person leading the discussion pointed out that farmers are just trying to make a living, and everyone needs a place to live, so who's the bad guy here? Who's fault is the pollution in the bay?

I would claim that the "who's to blame?" question is the wrong question to ask, and precisely for the reason that Rona offers: "we're all to blame". But I'd put it another way: given current policy, the Chesapeake Bay is a common-pool resource with ill-defined property rights. The problem with the "who's to blame" question with respect to CPR use with ill-defined property rights is the same as the problem with the existing federal and state water regulations: they do not treat the problem as a problem of multiple conflicting uses of a scarce CPR. They instead treat it as one type of use imposing costs on all other uses of the CPR, when in fact the problem is that the uses conflict with each other.

In other words, they treat the problem as a Pigouvian one-sided externality problem when in fact it's a Coasian problem of reciprocal costs that all uses impose on each other. Until policymakers start thinking about the reciprocal nature of costs that the multiple uses of a CPR create, they will not focus on the underlying problem: the ill-defined property rights and the importance of using policy to devise governance institutions to enable all of these different users to manage their use of the CPR.

Lynne Kiesling

The regulatory policies of the past century in the electricity industry have enshrined the regulatory compact: in return for being granted a monopoly franchise with legal entry barriers, the regulated utility assumed an obligation to serve all customers in their service territory who desired service. The compensation received for this bargain is an estimated normal rate of return based on costs incurred to provide the energy and the service (i.e., the rate base). The costs (rate base) plus the return on those costs from the basis of the retail rate structure, which divides this “revenue requirement” among three customer classes (residential, commercial, industrial) to determine the retail price, or rate, that each type of customer will pay for the service.

As a consequence of the regulatory compact, utilities focus narrowly and conservatively on investments and business strategies that they can be sure regulators will include in their rate base; this approach reinforces the construction of the types of physical assets used over the last century – generation capacity, wires, and mechanical substations, for example. The cost recovery basis of the regulatory compact, coupled with ex post prudence review by regulators, has stifled utility incentives to explore and invest in other types of assets, including distributed digital technology that could enhance the resilience of the physical grid, reduce operating costs and increase the ability to identify faults proactively, and enable the development and sale of differentiated products and services to end-use consumers.

From the perspective of consumers, the regulatory compact was intended to protect consumers, particularly the residential consumers who are also voters. It has done so by creating a policy environment in which the sole value proposition that regulators recognize as being “in the public interest” is one of keeping prices (rates) low and stable. In other words, a consequence of the regulatory compact is that the concept of consumer benefit in the electricity industry is narrower than in any other industry. By regulatory fiat, consumers only benefit from low, stable rates. The regulatory compact rigidifies the definition of consumer benefit, despite the fact that in many other industries, technological change and economic growth have created consumer benefit through innovation, new products and services, and product differentiation. As long as the regulatory compact has retained the idea that consumer benefit in this industry derives only from low, stable rates, it prevents electricity consumers from having access to potentially valuable new products and services associated with electricity consumption, because it stifles innovation.

So here's a question: what purpose does the regulatory compact still serve? If its negative effects are outweighing its positive effects, but if there are influential parties who like the status quo and want to retain the regulatory compact, how do we modify or eliminate the regulatory compact?

Michael Giberson

It seems I may have left off a critical point in my comment on regulation and the apparent rebirth of nuclear power. Following the insightful commentary in Loren Steffy's column in the Houston Chronicle, I highlighted that in many cases stockholders would assume the risks of cost overruns or poor performance, rather than retail ratepayers. According to this morning's Washington Post, another factor is a significant subsidy, courtesy of the Energy Policy Act of 2005: "tax credits of up to $125 million for eight years, loan guarantees for up to 80 percent of a plant's cost, shared application costs and insurance that would cover the costs of regulatory delay."

Those benefits were "the whole reason we started down this path," [NRG Energy's David] Crane said after filing NRG Energy's license application. "If it were not for the nuclear provisions in there, we would not have even started developing this plan two years ago."

Michael Giberson

A few months ago I posted notice here of the Arizona Corporation Commission's decision to reject a proposed powerline from the middle of Arizona into southern California. Commissioners were saying things like they refused to "hurt Arizona utility customers to benefit Californians" and opposed the idea of becoming "an energy farm for California." (This despite Arizona importing much of its energy supplies from out of state. The corporation commission apparently doesn't object to New Mexico and Texas, among others, serving as energy farms for Arizona.)

That decision is back in the news as the U.S. Department of Energy has declared 10 counties across Arizona and southern California to be part of a National Interest Electric Transmission Corridor. The declaration is a step toward possible issuance of a federal permit for transmission construction. More information from USDOE is available here.

(HT to Scott Gustafson at Arizona Economics)

Michael Giberson

A great deal of energy is currently being expended in Europe debating the merits of further unbundling of vertically-integrated electric utilities in the EU. "This is unfortunate," said Jean-Michel Glachant and François Lévêque, in a post on the EU Energy Policy Blog, on two grounds. First, because the economics of the matter are fairly settled and favor unbundling, and second, the topic isn't the most pressing current issue.

In general Glachant and Lévêque assert that the benefits of vertical integration have already been lost, and that the current vertical systems - mostly limited by country boundaries - impedes more effective transmission system coordination across the continent. They write, "The optimal industry structure for electricity transmission in Europe does not correspond to 33 transmission grid companies. Cross-border alliances, mergers and acquisitions would improve the management system operating." Such cooperation among transmission systems would be facilitated by a divorce between transmission and generation.

But, in their view unbundling does not deserve the spotlight, it is a second tier issue. They said, "Improving the management of interconnections and balancing services, reinforcing regional cooperation of TSOs and planning their joint investments, making national regulators working and thinking pan-European, and setting a market surveillance committee come first."

Michael Giberson

Power from the people, story from the Christian Science Monitor:

For two architecture students at the Massachusetts Institute of Technology in Cambridge, Mass., the sound of footsteps is an echo of energy gone to waste. They figure that the stomp of every footfall gives off enough power to light two 60-watt bulbs for one second.

"Now imagine how many people walk through a train station each morning, or walk down the street in Hong Kong," says James Graham, who, with fellow MIT graduate student Thaddeus Jusczyk, is helping to develop the growing field of "crowd farming."

Train station? I'm thinking dance hall. If the music is no good, people stop dancing and the band loses electrical power. Like the music? Better keep dancing. (HT Peter Klein at Organization and Markets.)

From Norway comes a plan to generate electricity from the amazing power of osmosis.

Norwegian utility Statkraft said it would build the world's first prototype osmotic power plant next year, tapping a promising new renewable and clean energy source....

In an osmotic power plant, sea water and fresh water are separated by a membrane. The sea water draws the fresh water through the membrane, thereby increasing the pressure on the sea water side. The increased pressure is used to produce power.

I don't quite get it, but since they're not spending my money on development, I don't have to get it. According to the news article:

"The global technical potential for osmotic power production is estimated at around 1600 Terawatt hours, including around 200 TWh in Europe and 12 TWh in Norway, or 10 percent of Norway's current power production," Statkraft said on Wednesday.

Michael Giberson

Discussions of internal corporate prediction markets have sometimes pointed out that open, anonymous participation can lead to better information flow within the corporation. See, for example, Jed Christiansen’s write-up of the recent Consensus Point conference on prediction markets, particularly his notes on the presentations of Dave Perry and Fortune Elkins.

A lot of business research has been devoted to the topic of communication within an organization. An article from HBS Working Knowledge tries to sum up the current state of research into roadblocks to communication within an organization.

This propensity to maintain silence, a flaw at once personal and organizational, is "widespread and problematic" in both the public and the private sectors, says HBS professor Amy Edmondson, who chairs the Doctoral Programs and teaches in the Technology and Operations Management unit.

"To cite one example, former HBS doctoral student Jim Detert and I interviewed some 200 people of all ranks and functions in a high-tech multinational. We found to a very significant degree that people did not speak up about things they deemed important. Most of those were not 'bad news' things; to our surprise we found that people were reluctant to voice what they perceived to be good ideas, unless they were extraordinarily confident they would be well-received. And this in a firm that lives and dies by its ideas."

Edmondson says this reluctance to speak up stems variously from fears that superiors will not like the idea or that it may appear to criticize the status quo, which most people find reassuringly familiar or dangerous to challenge. Edmondson sums up the mental calculation this way: "The potential costs to me for speaking out seem reasonably certain and somewhat immediate; the potential benefit to me for speaking out seems rather uncertain and definitely long-range."

The article cites HBS professor Max Bazerman to the effect that “within organizations, candor should be rewarded and incentives designed to encourage [it],” though the article does little to elaborate on the idea.

Instead, the article urges business executives to “develop disagreement” and suggests installing “a team at the top where high contention is demanded and rewarded.” During decision-making processes, according to one professor quoted, executives should ask probing questions and insist that managers “present each situation in objective terms, rather than with a positive spin.” The article sums up with, “What's required in an organization is honest, thorough, and ongoing self-criticism, which, after all, is at the heart of continuous improvement.”

Part of the problem with the article is that it is exactly the old-style managerial approach that apparently doesn’t work. For how many decades have business executives been told to encourage honest disagreement, to reward challenges to the status quo? Saying “challenge the status quo” is the status quo. If it worked, then information would already always flow smoothly within corporations.

When the thing that stops an employee from speaking up is a mental decision calculus that compares relatively certain and immediate costs to uncertain future gains, as described by Edmonson, “demanding and rewarding high contention” just seems to raise the stakes. Raising the stakes seems like it would be counter-productive.

Maybe contentious meetings aren’t a good approach for eliciting honest revelations. So if what is said about prediction markets is true – if they can help information be gathered and processed in cases in which traditional ways of gathering and processing information fail – then they can be wonderful things. What was the example that Christiansen cited (from Perry’s presentation), a “forecasting team was trading against their official forecast”? That example shows information flowing more smoothly through prediction markets than through traditional channels.

The article hints at some of the reasons that prediction markets can improve information flow. With private, anonymous trading, the choice to disclose information via the market dramatically revises the mental decision calculus involved. The trader is rewarded if right and penalized if wrong, but in either case the disclosure and net reward is a private matter rather than social event. (At least until you brag about it around the water cooler.)

As the article said, candor should be rewarded and incentives designed to encourage it. Prediction markets provide incentives for candor. Not only that, but over time the traders with useful candor are encouraged by accumulated gains, while blowhards find their accounts diminished.

It is true that prediction market prices present relatively limited signals. Prices may go up or down, but they never say why. But with a signal, at least someone knows to start asking “why” and that is better than not knowing.

(Cross posted from Midas Oracle.)

Lynne Kiesling

As has been pointed out here, at Environmental Economics, and elsewhere, the ethanol subsidies included in the Energy Policy Act of 2005 have wrought a host of unintended consequences: the shift in demand increased corn prices, inducing farmers to substitute out of growing soybeans and into growing corn. This production substitution was not sufficient to bring corn prices back down (plus you have to add in the effects of the protectionist tariff on imported cane-based ethanol), so livestock feed prices have gone up and food prices have gone up, in the U.S. and elsewhere (notably Mexico, where much food is corn-based). The combination of these effects has led to a general rise in commodity prices (and to pigs eating junk food, which is gross).

Then yesterday the Wall Street Journal reported that small ethanol-only firms are not faring well in the market (link is to WSJ energy blog); there's a glut of ethanol (imagine that! subsidizing something leads to excess supply ... who'd a thunk?), ethanol prices have fallen, and only the larger firms like ADM (rent seekers to the world) and Cargill have a sufficiently diversified production portfolio to be able to absorb this situation. Furthermore, ethanol production costs have risen because of the aforementioned increase in corn prices.

Have I mentioned that I derive gleeful enjoyment, if not schaudenfreude, from unintended consequences coming home to roost like this? I'm not necessarily proud of that, but there it is ...

Then today the WSJ reports that Heinz has developed a genetically-modified tomato that is sweeter than a normal tomato (subs. required).

With prices for corn syrup and other ketchup ingredients going up faster than Heinz can raise its own prices, the Pittsburgh-based condiment king is overhauling its breeding operations to help compensate. Heinz is developing sweeter tomatoes that could cut down on its need for corn syrup, as well as varieties that resist disease, stay fresh longer and produce a thicker consistency. "The new seed work is all about creating the perfect tomato," says Mr. Ozminkowski, the company's manager of agriculture research.

The ethanol industry's consumption of corn is just one factor driving up its price. Rising global demand for meat is also boosting prices, since corn is a key ingredient of animal feed. The cost of a bushel of corn has risen to around $3, about 40% higher than it was a year ago, putting pressure on many food companies. Meats producer Tyson Foods Inc. recently lowered its fiscal-year earnings forecast due, in part, to high corn prices.

The price Heinz pays for corn syrup has risen 25% in the past year, and the cost of growing tomatoes has risen by 33% in the past year. So getting more input bang out of your tomatoes looks like an important cost management strategy.

Even though many of us were able to anticipate lots of the unintended consequences of the ethanol subsidies, this move was one that didn't occur to me. But it makes great sense.

Michael Giberson

Earlier this week, NRG Energy filed an application to build two new nuclear power plants adjacent to the existing South Texas Project (STP) plants. It is the first such application submitted to the Nuclear Regulatory Commission in nearly 30 years. Loren Steffy, business columnist at the Houston Chronicle, appreciates the subtle irony in the story.

STP, of course, is a monument to the nuclear fiasco of the 1970s, a steel-reinforced tribute to cost overruns, construction delays and a kaleidoscope of federal regulations that made the idea of building a new nuke, well, radioactive.

The deregulation we have today was born, in part, from the outrage over the runaway costs of STP and its North Texas counterpart, Comanche Peak. Frustrated lawmakers argued that ratepayers shouldn't have to foot the bill for the confluence of poor project management and cumbersome regulation.... Houston-area customers paid dearly — and are still paying — for STP.

Back when STP was built, the old Houston Lighting and Power expected to recoup its cost from customers. But the bill for STP grew so huge that HL&P; realized it would never earn back its investment.

These "stranded costs," as the industry called them, presented a conundrum under deregulation.... Ultimately, those costs were included in the more than $2 billion that CenterPoint was allowed to recover from ratepayers as part of deregulation.

They are now factored into the costs retailers pay for electricity transmission and then, in turn, pass on to us. The stranded costs have helped make Houston's electric rates the state's highest and among the highest in the nation.

(If I may interrupt to make a point. When you see comparisons between prices in "regulated" and "deregulated" states, ask whether stranded costs left over from the pre-deregulatory days are still being recovered from consumers. -MG)

This time, though, it will be different.

NRG's investors, not ratepayers, will assume the risk for the new nukes. If they're a flop, if construction falls behind schedule, if the government meddles, it's not our problem.

"We don't have ratepayers paying for plants anymore," said Brett Perlman, a power industry consultant and a former member of the Public Utility Commission. "That's one of the benefits of the market."

... NRG is building the new plants adjacent to STP, that monument to everything that didn't work in the old days.

"Here you have two regulated units that ratepayers paid for — and are still paying for — and right next to it you will have two units that shareholders paid for," Perlman said.

By the way, Steffy's column is a bit more nuanced than the extracted portions suggest. You should read the original.

Not everyone is thrilled about the resurgence of nuclear energy. As this Scientific American story notes, some see it as part of a response to global warming but others prefer other technologies and worry about waste disposal and other safety issues. But the practical alternative to building nuclear plants is probably building coal plants, and coal comes with its own waste disposal and safety concerns.

For the moment, though, leave the cost-benefit analysis aside, and just enjoy the historical irony. Nuclear power helped bring down old-style regulation -- in fact the mis-management and cost overruns epitomized exactly what many economists said was wrong with the regulatory model. And now, phoenix-like, we have nuclear energy rising from the ashes.

A final note: The only thing spoiling the pureness of the irony is awareness that the resurgence of nuclear power is not limited to deregulated companies risking only shareholder money. Federal power entity TVA, and companies operating under more-or-less traditional regulatory models like Duke Energy and Progress Energy also are expanding or planning to expand their nuclear power output. The resurgence of nuclear energy in the United States can't be tied exclusively to changing retail rate regulation. A Baltimore Sun story suggests that a convenient regulatory re-interpretation of the word "construction" by the NRC has been a big help in Maryland. But that's another story.

Lynne Kiesling

Today sees a good article from the aforementioned Jonathan Adler on regulatory barriers to innovation and implementation of renewable energy. His conclusion:

To promote alternative energy development, there’s no need for more handouts. Instead the government should get out of the way. If the goal is to increase actual alternative energy production, and increase the proportion of renewable energy that supplies electricity to American consumers, the best thing the federal government can do is reduce or remove regulatory obstacles to energy entrepreneurship and innovation. If renewable energies are to capture a sizable share of the energy market, what they need, more than anything else, is regulatory room to compete.