Solar energy – excitement and challenges

The most exciting, and challenging, economic news of recent days has been that in some parts of the world solar is now lower cost than other forms of energy and that is without subsidies. (One, two, three.) This is exciting because so much of what we call civilization is dependent upon cheap energy.  There are indications that the cost of solar energy will decrease even further and that it will become  available to most of us.

This is also challenging because of the economic changes which will have to be made including the writing off of a lot existing infrastructure.

We must start this discussion by noting that energy is only one input into economic growth.  A shortage of other minerals, agricultural land and over population may make a return to economic growth difficult.

A major problem in adapting to lower electricity costs will be the existing infrastructure. The price of an item is equal to the marginal cost of producing the last unit.  This means that if solar energy can be produced cheaper than other forms of electricity the producers of that energy will have to lower their prices or go out of business.  It may take time to work out but we can anticipate a lot of infrastructure will become obsolete.  Do not be surprised if there are demands for subsidies to protect firms from unfair competition.

The falling marginal cost may be a problem for the production of solar energy.  With fossil fuels we have been used to rising marginal costs which means the owners of cheaper oil have been reaping windfall profits as the price of oil has gone up.  This writer is not aware that much economic thought has been put into dealing with falling marginal costs on this scale but some people will have more expensive solar energy than others or will have to write off their initial investment.

Another interesting feature of solar energy is it is unlikely any corporation will get an exclusive license to use it.  With costs falling to the point where most people will be able afford their own solar collector(s) decision making power will be transferred to individuals.  No longer will bankers and governments be making decisions for us.

I am skeptical that cheap solar energy is going to mean a return to economic growth and the way our economy is currently organized requires growth for most of us to live in comfort.  Changing our economic organization will be far more difficult that introducing solar technology.

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Pricing solar energy – the marginal cost factor

 The costs of solar energy are falling quickly and will probably soon be cheaper than more conventional sources.  Does this mean we will once again have large quantities of cheap energy and a return to economic growth?  Maybe and maybe not.

There may not be an immediate drop in the consumer price of power.

The maybe is because of the economic principle that price is equal to the marginal cost of the last unit produced and sold.This means solar will not influence the grid price until the whole current power infrastructure has been replaced. Until then the price will be set by whatever is the most expensive conventional power still being produced.  

It also means firms producing solar power for the grid  will be able to reap some windfall  profits as their costs of production will be lower and falling. Given the current corporate culture that firms have an obligation to maximize their profits regardless we have to anticipate most firms will take full advantage of the windfall. We observe that lots of oil reserves can be extracted at costs much lower than the current marginal cost for more expensive oil. This means some firms and/or governments are reaping windfall profits

The bright spot will be if and when the cost of solar falls enough for small units to be economical and for consumers to be able to afford them.

A further complication is the debt factor.  How much of the debt used to build the current infrastructure is outstanding?  If a large amount has to be written off, it will probably come out of what is called high power money.  If this declines rapidly  it could affect the money supply and cause some economic decline.

As the price of solar falls no doubt lots of large companies will get involved but sadly most if benefits may go to the one per cent in profits and the rest of us will be left out in the cold.  Expect turmoil rather than growth.

Capitalism, competition and profits

Capitalism is about profits but economic theory tells us price should equal the marginal cost which does not allow for any profit.  It could be there is a contradiction between what we say we believe and the way we actually behave.  Figuring this out may be a major step in understanding our economy.

Price should equal marginal cost, the cost of the last item produced, because profits will attract more producers into an industry until competition forces prices down to the marginal cost level.  For this theory to work there must be perfect competition.  Perfect competition requires easy entry into a business, a uniform product,  that no participant in the market be large enough to influence prices by limiting sales or purchases and that all participants in the market have full knowledge of the market.

In perfect competition there are no profits because competition will force prices down to breakeven point.

This would be great for customers but producers, believing they have a right to profits want to restrict competition.  As producers tend to have more power than consumers there are in our economy lots of restrictions on competition.  There  are many ways to restrict competition but probably the best is to get governments to pass legislation that interferes with the operation of a competitive market. Look at the four requirements for perfect competition in the second paragraph above for ideas how to restrict competition.  Some of the legislation which interferes is patent and copyright, tariffs, subsidies and licensing.

An advantage of legislation restricting competition is that the state and its legal system can be used to enforce it.

Sometimes definitions can be fuzzy and most definitions of capitalism fit this.  The definition of perfect competition (see second paragraph above) is more precise even if it appears unrealistic.  We have jokes about economists making assumptions.  It is not safe to assume that capitalism is perfect competition.

I think the perfect competition model is very useful in that it provides an ideal towards which we could be working.  It provides guidance for policy even though there are lots of forces working against that policy.

Whatever name we apply to our way of organizing our economy, it is important to understand that it is based on governments passing legislation to restrict competition.

 

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Payday loans, slavery and money creation

What is the marginal cost of making a payday loan? Or any other type of loan?  The answer to this question should help to answer a question about interest rates on loans raised in the Buttonwood column of The Economist, November 30, 2013 issue. What interest rates should lenders be allowed to charge?

Unfortunately loans and credit are complicated beyond simple economics because the making of loans is an instrument of exploitation even to the point of slavery and because credit is involved in how we create money.

Economic theory tells us that so long as there is competition the price of a product should be equal to the marginal cost of producing that product.  Therefore for loans the marginal cost would be the cost to the lender of acquiring the money to loan (i.e. the interest paid to the depositor of for payday lenders to their source of funds) plus the operating costs and the cost of loans written off.  The legitimate interest rate to charge on a loan should be easy to calculate and for banks we can compare the rates they pay on deposits and the rates they charge for loans.

It appears the need for credit is almost universal at least in large-scale economies.  I’m not sure about hunting and gathering groups which practice a sharing economy.  It appears there has always been a need for short-term lending of the type done by payday lenders.

The problem is that the making of loans can be an instrument of exploitation.  One of the quickest ways to get control over a person is to lend them some money.  In peasant societies people borrow to put on funerals and weddings and if they cannot repay they sometimes find themselves in slavery.

In our own society there are probably lots of people with dreams of doing something other than the daily employment but they are unable because of their debt load.  All this consumer debt works as an instrument of social control for the one percent.  So long as we are in debt we work to support their goals and interests rather than for our own.  If a person wants to be truly free one should try to live without  borrowing.

As for payday loans Mr./Mrs./Miss/Ms Buttonwood says:

“Provided the terms of the loan are made clear, then it should be up to borrowers to decide whether to accept the costs involved. An interest rate is simply the price of money.”

Once again this is simple economics without the human factor.  For many people there are times when  it may not be easy “to decide whether to accept the costs involved.”

The other complication with lending is that our money supply is based on fractional reserve loans by financial institutions.  As money is essential for the exchange of goods and services it is also essential that we carry a debt load.  Says Buttonwood

“But businesses and consumers are positively encouraged to borrow. Indeed, when debt growth slows, as it has in recent years, an air of panic develops about how to get it going again.”

There are a number of problems with the fractional reserve method of creating money, most of which have been discussed elsewhere on this weblog and especially in the essay “LETS go to market: Dealing with the economic crisis.”  Basically it is a Ponzi scheme which is urgently in need of reform.

The reform proposed in that essay, a national Local Exchange Trading System (LETS) should also help with the need for short-term credit.  It would be a lot less exploitive as no interest would be charged and control over the money supply would be in the hands of all people.  A national LETS system would transfer a lot of economic decision-making from bankers and governments to individuals.

There are consumer loans and there are business loans.  Loans are a transfer of purchasing power from one person  to another and interest is compensation for the transfer.  A LETS system  should take care of the need for short-term consumer  credit.  The compensation for business loans should come out of the profits in which case they should be considered equity.

Back to the question of caps on interest charged on payday loans.  Is it the role of government to prevent some of its citizens from exploiting others?  If yes, then governments should limit interest  rates  charged (marginal cost is a guideline) or find another way of creating money so that the need for short-term consumer credit is easily satisfied.

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Fossil fuel reserves

An article in this week’s The Economist talks about reserves of fossil fuels and points out existing reserves exceed what can be burned if governments stick to plans for controlling climate change.  It seems many people in the business don’t expect governments to hold the line.

regelatwork_Oil_rigAnother factor which may limit the value of these deposits is the marginal cost of extracting them. As we extract the most easily accessible of resources the cost of extracting the remaining resources increases.  Perhaps we should calculate the costs in terms of energy.  How many units of energy does it take to extract 100 units of energy?  As this figure goes up it is going to reduce the energy available for other economic activity and is certain the have a negative influence on economic growth.

Those who have a religious-like faith in economics will say innovation and technology will save the day and we are bound to return to economic growth.  They could be right, or partially right, but it might be wise be a little skeptical.

The costs of extracting fossil fuel reserves should be considered in determining their value and evaluating their potential contribution to the economy

There are still lots of energy resources in the crust of this planet and the energy companies will probably identify more of them.  What isn’t so clear is that these resources will be available either because of government policy on climate change or the economics of extracting them.

Economic salvation from shale gas?

A lot of people believe economic salvation depends upon economic growth and some people believe that salvation will come as a result of shale gas.

It could be true.

However, in a previous reincarnation I was a charter member of the skeptics club.  A more likely scenario is that shale gas may give us a temporary reprieve.  There are environmental and economic concerns.

The environmental concerns relate to global warming and earthquakes.  Also the current availability of cheap shale gas is interfering with the development or renewable energies such as wind and solar.

The economic concern relates to marginal cost.  (Marginal cost is the cost of extracting the last unit sold.)  If shale gas is going to be our salvation, then the marginal cost of extracting it will have to decrease as more gas is taken.  If the marginal cost increases, then it will only slow down the rate of economic decline.

The exploitation of shale gas is the result of high oil prices and the development of new and expensive technology.  It takes a lot of energy to get it out of the ground.  Certainly the gas currently being extracted is the easiest and cheapest.  There is some probability that future extractions will be more difficult and expensive.

Another concern about the potential for a return to economic growth is what is happening to the marginal cost of other minerals and resources such as topsoil and copper.

Rather than seeking a return to economic growth we might be better off to adapt our lives and our economy to zero or negative growth.  For some ideas about how to do that please see my essay: LETS go to market: Dealing with the economic crisis.

Here are links to three articles on shale gas. One, two, three.

 

If you liked this post your are invited to comment, press the like button and/or click  one of the share buttons. If you disagree you are invited to say why in a comment.  While I like the idea of sharing this platform, my personality is such that I don’t reply to many comments.

Gasoline, oil sands and marginal cost

The price of gasoline at our local gas station has gone down by 11 cents a liter in the last couple of days.  This coincides with this article about concerns for the future of the Alberta oil sands project.

Oil from the Alberta tar sands is expensive to extract and illustrates the workings of marginal cost.  As everyone knows price is equal to marginal cost, the cost of producing the last unit.

As demand for oil has increased the price has gone up making it economic to go after more difficult deposits such as the tar sands.  This may keep up production but I fear that rather than allowing economic growth to continue it just slows down the rate of negative growth.  Economic growth would be more likely if marginal cost were falling with increasing production.

It also means a reallocation of financial resources to maintain our energy use which must be causing problems throughout the rest of the economy.  The more we spend on oil the less we have for other products.

We should not assume that the cost of exploiting the oil sands is consistent through the whole deposit.  It could be the marginal cost will keep increasing as the easiest of the deposits is depleted.

A further problem for oil sands producers is that if the price of oil falls as a result of an economic slowdown, then they may not get enough to cover their costs and will have to stop production.

Probably most of us Canadians benefit from the oil sands but we shouldn’t be too complacent.

If you liked this post your are invited to comment, press the like button and/or click  one of the share buttons. If you disagree you are invited to say why in a comment.  While I like the idea of sharing this platform, my personality is such that I don’t reply to many comments.

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