A Response to The Economist's July 16th 2022 Piece: "Europe's Coming Winter Peril"
Bad Econ 101 Analysis from The Economist
My wife and I are print subscribers to The Economist. In this entry, I will discuss one piece from the July 16th 2022 issue titled; Europe’s Coming Winter Peril: A bitter energy crisis is in prospect. Europe needs to act now.
A quote from the piece:
“Next is the need for a common hierarchy governing rationing, applied across the continent: intensive energy users should suffer first, consumers last. Countries need to share storage capacity and guarantee free movement of gas.”
Do you see the word rationing in the middle of this quote. Econ 101 offers a simple lesson for how to avoid rationing; allow the price of the resource to rise and the market will eventually reach a situation where supply and demand are in balance. This is the point of this blog post.
Europe will adapt to this anticipated winter shock if it follows Texas in summer 2022 and expands its incentives for enrolling in critical peak pricing. Permit me to explain. First some links; here is the new news about the Texas effort to maintain electricity grid stability during peak demand. Texas is offering $ incentives for major electricity consumers to volunteer to enroll in critical peak pricing. In the immediate aftermath of the February 2021 Texas Freeze, I argued that this is the most cost effective approach to adapt to expected scarcity.
NBER economics research has explored the microeconomics of enrolling customers in critical peak pricing without infringing on their freedom (so an opt-in design). I will return to this in a moment.
Let’s return to the expectation of shortages of natural gas in Winter 2022 in Europe.
Europe’s natural gas companies such as Germany’s Uniper usually make money by buying Russian natural gas at low prices and selling the gas at higher prices to German industrial and residential consumers. This firm sold long term contracts that exposed it to wholesale price spikes while its retail prices were locked in. The firm is now losing money as wholesale prices spike.
Going forward, Uniper can use its Big Data on consumer demand for natural gas to offer targeted conservation incentives. Uniper’s data reveals the price of energy and the customer specific consumption in different months and years for each of its consumers. It can use these data to estimate a demand curve at the individual consumer level to identify the subset of large consumers who are price sensitive. This subset of consumers can be offered a $ opt in incentive to face a higher price for natural gas this winter. Those entities who opt in can use the $ transfer they receive to prepare for the higher energy prices this winter or these entities can just shut down for over the winter. These actions will make the aggregate demand curve for natural gas in such European nations more price sensitive (i.e price elastic) and this will mean that Europe won’t have resort to rationining!
I am amazed that the Economist Magazine just jumps to rationing (a very costly and perhaps deadly allocation) rather than using basic econ 101 ideas for how to adapt to an anticipated challenge.
If you agree with my logic, take a look at my 2021 Yale Press book ; Adapting to Climate Change. Markets offer us many strategies to adapt to climate change if we allow prices to reflect scarcity and use our Big Data to design new contracts.
Matthew, I'm an actual Electrical Engineer in Atlanta; and I can tell you that you are out of your league when it comes to the power grid problems in Texas, as when we studied it in the grad-level Power Grid Stability class at Georgia Tech 40 years ago, our prof told us about ERCOT “this is exactly NOT how to design a grid,” as it's not connected to either nationwide grid. Actually, the far west in the state is now connected, as are parts of east Texas; but 90% of their customers are connected to the rickety ERCOT grid.
What happened in the February 2021 Deep Freeze is that when the wind turbines froze, snow covered the solar cells, and most importantly, NatGas compressors ran out of power and couldn't pump to the power stations, they had a cascading grid collapse.
Texans can't buy their way out of their shortage, even at FIVE DOLLARS PER kWh, as $5k/MWh is an artificial limit imposed by ERCOT; and until they connect to the nationwide grids to “wheel in” power, they will continue to have problems.
Please see my Public Facebook post here, and comments are open to anyone:
https://www.facebook.com/DLS4U.T/posts/pfbid02Cc9oymwHjz5hpnDnkL7J8bPB2nDcXDwvMUfmZ3sKpkJX132czFzzgJZXr4tf9w65l ~