Energy bills: rentiers vs entrepreneurs

Everybody knows that soaring utility bills will plunge millions of people into desperate poverty in the autumn. Even those who don’t care about those on low incomes, however, should worry – because such huge price rises are a threat to economic dynamism, entrepreneurship and the free market.

I say so for a trivial reason – that if we are handing more cash over to utility companies, we’ve less to spend elsewhere. Even if you are on a decent income, having to spend an extra £150 a month on gas and electricity will cause you to cut your discretionary outgoings.

For some, these outgoings will be savings or pension contributions: they will pay for their electricity by working later into life. For others, it will mean less spending on goods and services. Already people are cutting subscriptions to streaming services whilst non-petrol retail spending has fallen steadily over the last 12 months. Such cut-backs will intensify in the autumn. I wouldn’t want to be a publican or restaurateur facing the double danger of soaring costs and falling discretionary spending.

What we’re seeing, then, is a transfer of real resources away from competitive entrepreneurial sectors of the economy towards rentiers – those who can get rich merely by owning scarce assets such as gas and oil fields.

This could reduce economic dynamism and productivity, simply as more of our spending goes on sectors with low productivity growth and less on higher-growth sectors.

My chart provides context here, showing real wages since 2000 relative to some CPI items. The point is that there have been enormous changes in relative prices, even before October’s leap in utility bills. Relative prices of goods such as clothing, TVs and phones have fallen sharply this century – so much so that an average wage will now buy almost twice as many of them as it did in 2000. Prices of gas and electricity (and to a lesser extent petrol) have, however, risen sharply, so that wages buy only half as much of them as they did in 2000*.

As we spend more on the latter, however, the weight in the economy of dynamic sectors declines. The upshot is that productivity and dynamism dwindle.

What I’m suggesting here echoes an old idea – David Ricardo’s theory of rent and profits. As the population expands, he said, so too will demand for food. That means that the most fertile land would become more scarce, allowing its owners to charge monopoly rents:

By bringing successively land of a worse quality, or less favourably situated into cultivation, rent would rise on the land previously cultivated, and precisely in the same degree would profits fall; and if the smallness of profits do not check accumulation, there are hardly any limits to the rise of rent, and the fall of profit.

In a similar way, growing economies need more gas and oil, which means that worse-quality gas and oil fields must be employed – those where the products are more difficult to extract or those located in hostile countries such as Russia. The result is a transfer of real resources to the rentiers who own better-quality fields and away from incomes in the rest of the economy. The effect of that might well be to “check accumulation” – to depress growth. As Ricardo said:

The interest of the landlord is always opposed to the interest of every other class in the community.

Which is why I say that anybody who values dynamism, entrepreneurship and a thriving market economy should be alarmed by soaring oil prices – even if they don’t give a damn about the poor. They are also a threat to all non-energy businesses, especially if they use a lot of energy or are dependent upon discretionary consumer spending.

The danger isn’t only at the economic level, however. It’s also political. Soaring energy prices will bring into question both the fairness and efficiency of our neoliberal** system. So far, the discontent is manifesting itself only in pockets of wage militancy, but it could spread further.

So, what’s the solution?

The government could freeze the energy price cap: give households more cash: or cut VAT or green levies. The first entails energy suppliers borrowing during the crisis, the other two government borrowing. Both, however, are predicated upon assuming that high energy costs are only temporary. Yes, they might be, but such an assumption overlooks the fact that real wages were stagnating (and falling relative to gas and oil prices) before Russia invaded Ukraine.

Nor is nationalization, in itself, an answer. It is, at best, a device for ensuring that energy companies serve socially-determined ends. To do this, however, we need to decide what those ends are: for example, do we want high prices to encourage people to economize on fuel alongside income support; do we want lower prices and the greater energy usage they stimulate; how much extra investment do we need, and in what?

There is, though, something else – something in the spirit of Ricardo. For him, the problem was that landlords were owners of a monopoly asset (fertile land) and so could extort high rents. The answer to this, he thought, was to weaken that monopoly either by technical progress which improved less fertile land or by allowing the free import of corn. Both, in effect, created competition to that best land and so reduced its monopoly power ***.

In the same vein, what we need is greater competition to gas and oil suppliers. As Eric Lonergan has brilliantly shown, we need to create substitutes for them by greatly stimulating the supply of renewable energy and technologies that use less carbon such as electric cars:

You need perfect substitutes and a small price advantage, or near-substitutes and a large price advantage, to dramatically affect behaviour…. We need to mobilise investment in substitutes, ensure they are ‘close’ enough for the user and that they are priced more favourably than the emissions intensive option.

This, I suspect, requires a broad spectrum approach including tax incentives, state aid and an attack nimbyism: there’s no reason why our motorways shouldn’t be lined with windmills or solar panels. The point is to attack the monopoly power of rentiers whose interests are “opposed to the interest of every other class in the community.”

In this sense, Tories face the same question now that they did in the 1840s when the conflict described by Ricardo fuelled fierce debate about whether to abolish the corn laws; are they on the side of rentiers who are blocking economic growth, or that of entrepreneurs? Not only are they not answering this question, however, they do not even seem aware of its existence.

* You might wonder what’s happened to rents. The answer is: not much. These have risen roughly as much as wages over time – perhaps because landlords have always charged as much as they can.

** I know some of you don’t like that word. But I can’t think of better: what we have now is certainly not a free market system.

*** Ricardo saw free trade and better technology as being very similar. Which they are: both give us cheaper access to things that were previously expensive or unobtainable. 

Comments

[D]

Might more expensive energy drive innovation in energy?

Also, might the same nominal productivity growth in the energy sector be worth more - in
terms of human flourishing/well being - than in some other sectors?

[aragon]

The British Government believes the market fairy will provide.

Before you dismiss Nationalisation you should be aware of what a psycho drama the UK energy 'Market' is...

https://www.theguardian.com/commentisfree/2022/jul/31/lost-in-space-and-broken-energy-market-blame-it-on-tories-small-state-stupidity

"Our broken energy market is a case in point. British consumers face among the highest energy bills in Europe. It should be no surprise: the approach embodied by the OneWeb deal has been applied to the electricity market. The electricity tariff is not the average price of electricity produced by varying power generators, as it was when directed by the “big state” Central Electricity Generating Board, ensuring no violent spikes in prices. Amazingly, our bills are pitched at whatever price is needed to bring the most expensive producer into the grid to complete the necessary base load – not reflecting the contribution from low-cost renewables and nuclear. Consumer tariffs are thus the highest they could possibly be, reflecting the rising spot market price of gas.

Nor does the market madness stop there. Unlike a car or a TV or a new dress, electricity doesn’t vary with the producer: it is invisible. There is nothing to differentiate electricity; it is the least apt material with which to constitute a market. But in the Tory small-state mindset, markets are always best, so the doctrine is that varying producers – wind farms, nuclear energy, gas-fired power stations – form a market selling electricity to one another within a short time frame. Long-term contracts? Averaging out the costs across all generators, rather than being keyed into the highest cost generator? That implies too much big state."

Read on, IU don't necessary approve of all solutions, and had a seven barrage of some description been on line, or new Nuclear builds.

And yes, social and inverted tariffs. Long term planning/demand
all available from a Nationalised system.

Energy is critical to people and industry (not money).

We want a system that works at least as well as the CEGB and has many legs to the stool.

My electricity bills doubled shortly after privatisation, and if the green systems are beneficial they should not need subsidy (rent seeking tarrifs).

Ditto Chinese and Indian owned steel. The parent companies should fund the investment.

Free markets more like Crony Capitalism and a do nothing Neoliberalism.

[Blissex]

«is a transfer of real resources away from competitive entrepreneurial sectors of the economy towards rentiers – those who can get rich merely by owning scarce assets such as gas and oil fields.»

But oil and gas fields (or farm fields) have limited productivity because there are costs to extracting oil and gas (or farming foodstuff), so surplus is limited, and eventually oil and gas (and often farm field fertility) can get exhausted.

Compare instead with residential or commercial land property: it has zero costs, so all the revenue is income, which means it has infinite productivity. Also since its profits depend on an abstract quality, "location", that quality in principle can last a very long time.

It is not surprising that so many people in the UK instead of betting on the uncertain and meager rewards of work or business prefer investing in the far more productive and pretty much government guaranteed asset of residential and commercial land. As we seeing now, property prices are also inflation proof, as they are rising much faster (15-20%) than the CPI (9%) or the RPI (12%).

Indeed investment in property in the UK by far and away exceeds that in oil and gas (which amounts only to a half a dozen billion per year), but foolish wasters still invest in low productivity assets.

This country will not experience a productivity boom until people and government stop putting their money into unproductive hobbies like education, hospitals, oil&gas, roads, and focus only on the most productive investment, property!

:-)

[aragon]

You are missing the point. The Electricity market was designed by the Mad Hatter. Do not assume it is sane!

I could be wrong but...

The price paid to all generators in the market is determined by the spot price needed to meet demand.

The UK was able to avoid its homes and businesses going black by paying an unprecedented £9,724.54 (about $11,685) per megawatt-hour — more than 5,000% above the average price.

Sets the price for all generators at the time!

Everyone gets paid the 5000% (peak) price (for the duration).

Even i I have misunderstood, the peak pricing.

Here are the gory details from 2016.

https://www.oxfordenergy.org/wpcms/wp-content/uploads/2016/02/Electricity-markets-are-broken-can-they-be-fixed-EL-17.pdf

"The underlying higher costs have to be recovered somehow. In practice, they are simply loaded on to
consumer bills, which have been going up, along with costs, at a time when wholesale market prices
have been going down, as illustrated in the graphic above. The effect is to produce two ‘wedges’: first,
a gap between market prices and underlying costs and, second, a gap between wholesale market prices
and consumer prices. The overall outcome is to prevent markets from giving meaningful signals."

We could have a hybrid model with domestic users are served by a centrally planned (4.2) body but heavy industry able to (optionally) make it's own arrangements with generators. Allowing for comparisons.

The grid remains publicly owned and managed.

Domestic users get a socially determined model of electricity supply.

Blissex, property is only productive in terms of capital gains due to manipulation of interest rates by the state.

Energy is productive in terms of doing work! (in a physical sense i.e. Extracting/Moving/Transforming/Heating etc).

Of course finance is only interested in short term currency gains. Not increasing wealth.

[aragon]

I don't like the conclusions in the Oxford Energy report. e.g. Not providing a consistent supply to domestic users.

Intermittent suppliers should fund the costs of connection, and backup (continuous) supply.

Then all supplies can be treated as base load and dispatched on merit (cost).

If large industrial uses wish to offset the intermittency that is their prerogative, as is choice of supplier.

[rsm]

《But oil and gas fields (or farm fields) have limited productivity because there are costs to extracting oil and gas (or farming foodstuff), so surplus is limited, and eventually oil and gas (and often farm field fertility) can get exhausted.》

Is this just warmed-over Malthus?

Did Masanobu Fukuoka show anyone can grow enough food to feed a family on a quarter acre without needing fuel, pesticide, fertilizer, or irrigation inputs, while building up soil fertility? If capitalism can't even meet that yield anymore, is that a glaring indication of capitalism's failure to allocate resources efficiently?

《The price paid to all generators in the market is determined by the spot price needed to meet demand.》

By how many orders of magnitude does capricious, arbitrary markup exceed actual cost of extraction?

《"The underlying higher costs have to be recovered somehow. 》

Since the underlying costs are the product of an insane market, why not simply print money faster than prices rise and give it to individuals so they notice no increase in their real expenses due to nominal inflation?

[rsm]

I have a question for "hard energy" folks:

https://transmission.bpa.gov/business/operations/Wind/baltwg.aspx

[Graph from the Bonneville Power Administration, showing hydropower supply far outstripping demand]

Why does hydropower generation drop at night? Does the stream's flow drop, or are they disconnecting the generators?

If they wanted, could they run power generation at the top point on the graph continuously?

In short, doesn't this electric utility's graph show that they way overproduce electricity?

[marshall]

Did Ricardo actually look to technical progress that would specifically make less fertile land more fertile (i.e. reduce differential rent by reducing the differential)? It makes sense, given his corn model but if he did, have you a reference for this?

[D]

@rsm

Short answers
- they can't produce the top continually because some hydro plant can't produce all the time
- the graph does not show they way over produce electricity. They need to be able to meet demand which is lower at night and higher during the day

Longer answer
There's a number of hydro plants producing that power. Some will generally be able to produce their full capacity all the time, some won't.

It can be pumped hydro, in which case they're pumping water back up a hill during the night. This is a means of storing excess energy from, eg, wind (or solar if they pumped during the day). They can't run this continuously and is often used as fast response balancing load (ie load that's available quickly when the system needs it)

It can be conventional hydro, where water flows from a reservoir behind a dam - they can adjust the amount of water that flows, stop the flow and/or let it flow such that it doesn't turn the generators. This can be run continuously so long as there's enough water and often is used for base load.

Hydro's rarely from the flow of a streams or river without some kind of damn involved. Streams and rivers don't flow less at night.

[aragon]

rsm, Even better, all that wind and solar, electricity saving use expensive Gas.

Well it is intermittent so Gas (CCGT) is kept running in case the wind or the solar drops off.
(i.e. wind and solar without storage just becomes an extra cost and distorts the wholesale prices).

And the Gas is expensive because the we use the same spot price model for European Gas as we do for Electricity.

Storage, long-term supply contacts? Why would you? When you can discover the spot price every fifteen minutes and gamble, with paying through the nose, in a tight market.

Don't mention under/mal-investment, planning and security of supply. That too is for wimps.

Let the distorted, short term, market decide!

[aragon]

If only it was Satire:

https://www.theguardian.com/politics/2022/aug/05/kwasi-kwarteng-attacks-bank-of-england-with-inflation-predicted-to-hit-13

"Kwarteng told Sky News: "The job of the Bank was to deal with inflation. They’ve got a 2% inflation target, that’s actually their mandate. And now inflation is getting double digits. So clearly, something’s gone wrong.""

Kwarteng: Minister for Business, Energy, Industrial Strategy.

Whose own mandate is presumably for:

A dysfunctional, inflationary and chaotic energy market.

[...]

"I would quite rightly say something’s gone wrong. We’ve got to look at how you’re performing."

I couldn't resist the irony. Someone who might be our next chancellor and thinks we are all slackers!

See:
Mathew:Chapter 7 Verse 5.

[rsm]

Aragon, can we agree on the noisy irrationality of energy prices?

But whereas your solution is control and punishment (i.e. violence), simply printing money faster than prices rise also solves the problem but nonviolently?

D said: "the graph does not show they way over produce electricity."

How can anyone not cognitively captured by the economic assumption of scarcity look at that graph and not see huge, obscene overproduction? When transmission wires hum, is that because there is so much surplus in the grid, the electrons are trying to escape into the air?

[aragon]

rsm, My solution is public ownership (of at least the grid) and therefore control through ownership and/or price signals/contracts. And a more rational policy than the current chaotic one.

[D]

@rsm

I don't understand your point. I'm not sure if it's one of us not understanding what the graph is showing.. but I'm genuinely interested!

As I understand it, it's simply showing what type of generation is used to meet demand at different times.

Is your idea one of the following?
- that we have too much capacity (as a lot of the time the capacity isn't used)
- that too much energy is being demanded by consumers
- that we're actually producing more energy than is demanded

[Blissex]

«if we are handing more cash over to utility companies, we’ve less to spend elsewhere»

BTW, I can no longer hold back that I reckon that in first approximation it is a moronic argument: if the customers of utility companies have less money to spend, the executives and shareholders of those companies have more money to spend, so it's a wash, as far as the national economy goes (again, in first approximation).

Same for house prices and rents: if the price of a house booms by £100,000, the buyer has £100,000 “less to spend elsewhere”, but the seller has £100,000 more, so it's a wash, as far as the national economy goes (again, in first approximation).

The main case where redistribution has a first approximation overall impact is when the higher price of something goes to someone abroad, and the secondary case is where the higher price goes to someone with a higher liquidity preference (not a higher savings rate, as the neoclassics claim).