Some Chicago Boyz know each other from student days at the University of Chicago. Others are Chicago boys in spirit. The blog name is also intended as a good-humored gesture of admiration for distinguished Chicago School economists and fellow travelers.
Over at Business Week, Karyn McCormack covers some of the same ground that I did in my infamous Family Free-Riders post by asking “Is Raising Kids a Fool’s Game?” It’s worth checking out.
[Related Post: Family Free-Riders, Family Free-Riders Part II, Paying For Productive Adults]
One of the most intelligent guys in the power industry is named Wayne Leonard. I was told that he started in the plant accounting department at Public Service of Indiana (not usually the starting point for CEO’s) and then PSI merged with Cincinnati Gas and Electric to form Cinergy which was then bought by Duke power. Wayne left when they were still Cinergy and went to Entergy, which is a big southern utility based out of shattered New Orleans. I remember seeing presentations by business unit when I was at Cinergy and Wayne’s stuff was over my head while the other divisions were essentially mouth-breathers. I would always recommend watching Mr. Leonard’s actions to see where the industry is heading.
In parallel, readers of this blog have seen my heckling of Exelon for pretending that their local distribution company was a separate entity from their massively profitable power generation entity, such as this post. Readers have also seen my post recommending that the State of Illinois seize the nuclear power plants from Exelon here at this post (I realize that this is odd coming from a libertarian, but there is a method to this madness) – if you are interested just go to LITGM and type “Exelon” in the search box to see more.
The underlying issue is that power companies should be viewed as two main entities 1) distribution companies that purchase power from someone else and serve cities 2) generating companies that make power and sell this power to distribution companies. The value of #2 electricity companies is ALMOST INFINITE – meaning that since no one is creating new base load plants while demand increases, you can sell power for the highest price the market will bear indefinitely. The only blips on the horizon are the fact that at some point you bleed the distribution companies so badly that they go bankrupt and the states start to look around for more desperate solutions (like seizing the assets, the assets that rate payers paid for originally). The value for #1, however, is negligible – they usually make a return on capital and this return is being hacked away by local politicians and governments because more money is going to the generating companies and they don’t want to raise rates. Usually they received about a 10% return on equity and this is going down into the single digits, around 8%. And this 8% isn’t without risk, either.
The investment issue is that many companies are a mix of #1, highly valuable plants, and #2, virtually worthless distribution companies. As integrated entities, you can’t get the value for #1 because the governing authorities make you give a lot of it back by not letting #2 go bankrupt.
What to do? Watch Mr. Leonard. He is proposing spinning off the super-valuable nuclear plants from Entergy to form a separate company (which raised the stock price about 5%). Current share holders will receive shares of this new entity (called Spin-co for now) and this will be their reward, since these shares are expected to be richly valued by the market (and this value will fall to current share holders).
Maybe it is just because I used to be an auditor and am very familiar with financial reporting, but I never seem to stop hearing about how horrible it is that companies have to report their earnings every quarter. The common refrain is that quarterly reporting encourages myopic thinking and makes executives focus on the “short term” rather than invest in long term projects that supposedly could increase America’s competitiveness.
But here, right in our faces, is a clear example of the benefits of quarterly reporting. The CDO market has “seized up”, tied to a liquidity crisis in the credit market which manifests itself in the home mortgage business. In laymans’ terms, the marginal borrowers can’t buy homes, the “packagers” of CDO’s can sell the mortgages to third parties, and the companies that make fees from this process or were sitting on inventory when the music stopped (just like “duck, duck, goose”) all were screwed.
What happened? Well, if companies didn’t have to report earnings quarterly, not much would have happened. Sure, it looks like losses are there for the taking IF companies have to sell now, but an annual reporting company (only) would “hold out” and wait for the markets to turn, if they didn’t have to “fess up” and report their losses on a quarterly basis (tied to an audit with an external accounting firm that has a lot in stake in not approving the financial statements for a company that subsequently “goes bust”).
I spent over a decade working in the energy industry, focusing on electric and gas utilities. These utilities have some key similarities and some differences – they both have transmission (pipelines and overhead transmission lines) and distribution (local lines into your home), as well as customer service (local trucks, service, and billing). Gas companies don’t have “generation” in terms of power plants, but they do have drilling and gathering (within the US) or entry through a liquefied natural gas (LNG) port from a third countries, then into a pipeline.
Gas can be stored under pressure; in the summer gas companies historically injected gas under pressure into the ground, which they then pulled out of storage in the winter when gas demand “peaks”. In the summer, gas prices are at their lowest (maybe $2-$4 / unit) and then they are at their highest in the winter ($8 – $10 / unit). In the olden days (when I worked in the early 90’s) gas wasn’t “marked to market” every day; the gas company was either short or long gas on a given day, and then they trued-up with their suppliers periodically. In my audit I pointed out that the local utility had been “shorted” gas by their suppliers in the winter (when prices were high) and their suppliers made it up in the summer (when prices were low) – by this I pointed out that the local utility was losing hundreds of thousands / year by trading the same commodity in this unfavorable manner (even though the # of units were the same).
Electricity isn’t as widely traded as a commodity because it can’t be stored (at least not effectively). Thus its price can range from negative (it can be more expensive to restart a giant plant than to run it and sell the electricity at a loss) to almost an infinite price if it is a hot day and the transmission lines are overloaded so that only local generation can satisfy the demand. The price would need to be determined by location (city) and then by time; thus electricity can be cheap in one location or overnight and then by sky-high at a neighboring city during 1pm during the heat of the day.
Another element that electricity and gas have in common are “classes of service” – they include residents, government (street lighting), small businesses, and large businesses. Each of these utilities have chronic and continuing arguments to determine how to spread the burden ACROSS these classes of customers; government usually pays the least, but then it goes backwards from large businesses to small businesses and then residents, on a per/unit basis. There are convincing arguments for each class; the big business customers put almost no demand on distribution and customer service but put a huge burden on generation (unless they have their own generation); while individual customers go the other way. The “joke” in the industry was that you could raise rates as long as you didn’t raise them for their rate class (I never said utility people were particular funny).
The point of this isn’t really gas or electricity; it is water. Water is relatively similar to a gas utility with a transmission and distribution network. Water doesn’t have generation but is gathered through wells or collection (dams).
Historically, one cannot find more passionate and consistent defenders of laissez-faire capitalism than most leftist, articulate intellectuals.
Throughout the last two centuries, leftists fought ardently to protect the freedom of producers to create and sell as they thought best, and the right of consumers to purchase the products they thought best served their needs, without fear of government coercion or even informal social sanction. Whenever the unenlightened or economically naive threatened the voluntary choices of producers and consumers, leftists have always been the first in the fight to protect this most basic of human economic rights: the right to choose what one creates and the right to consume what one wishes.