Monday, January 19, 2009

Collapse of Utilities in 1929 Portends Financial Collapse in 2008

While going through my PhD thesis, I came across the following section written in 2005, which describes how the utilities helped plunge the US (and the world) into the Great Depression. It reads just like it happened now, but in the financial sector.

Do two things while reading this. Replace 'utilities' with 'financial firms and mortgage brokers' and you'll find out, how through the gaps in the regulatory process crisis occurs.

...This tight government regulation at the higher ‘state’ scale did not mean the private utilities lost out (public utilities stayed mainly within their municipal boundaries). In fact, as Samual Insull, one of the founding moguls of private electricity in America, remarked in 1913, “there is one great advantage that must follow regulation, and that advantage is protection” (Hirsh 1999: 30). There are a number of different reasons that the state enacted regulations over the industry forming a new consensus between government institutions and chiefly private electricity companies.

As a key element of the utility consensus, regulation [agreement by all parties for existence of a ‘natural monopoly’ and its regulation] constituted a social experiment typical of other reforms of the Progressive era. In drafting legislation that established state commissions, elite groups recognized the need to curtail abuses of large, technology-based companies that offered vital public services. At the same time, they realized that these companies could provide great value to society as a result of their size and technological prowess. The laws therefore reinforced the truth that companies were natural monopolies, and they outlined the commissioners’ responsibilities to enforce the obligations and maintain the rights of utilities (Hirsh 1999: 30).

By the early 1920s, two-thirds of states had established public utility commissions, in addition to the existing municipal authorities. Ever since, this division of powers in the US has come to play an important part in states maintaining regulatory control over electric companies.

States are closer to the electricity customers, sensitive to local economic and environmental concerns, the source of electric company franchises and rights of way, and… staffed sufficiently to regulate hundreds of electric companies (Kelly 1995: 127).

While there are advantages in this proximity of regulators and companies, there are also disadvantageous that involve the bounded geographic reach of states. At the same time that states erected regulatory commissions, the owners of electric companies continued their spatial-scale expansion throughout America, by establishing a complex maze of private holding companies with numerous local electricity companies.

Holding companies were initially created in the late 1800s to help smaller electrical companies purchase and operate the expensive equipment to generate electricity. In return for the equipment manufacturers (such as General Electric or Westinghouse Electric) or financial firms would receive bonds or stocks, and thus a stake in the new electricity companies. As these stocks were often bundled into one company, such as the Electric Bond and Share Company, these became known as ‘holding companies’(Hirsh 1999: 35), thereby financed against the capital investment of a company and not its projected income.

Involvement in a holding company, for smaller companies, held advantages. The larger holding companies would provide management and technical expertise that the smaller firms would not be able to afford on their own.

However, if two holding companies were merged and new securities issued the securitized value of the new holding company (and the stocks issued) could exceed the total capitalization of the operating firms. Despite this risk (and the harm it would later cause) investment bankers on Wall Street focused on the benefits for the smaller electrical companies. For GE and Westinghouse, they benefited from selling their products and through their investments. “Put simply, as more parties benefited from the existing structure of the utility system, they helped create substantial momentum” (Hirsh 1999: 37).

Eventually holding companies became known for their abuses, including the artificial inflation of stocks and the subsidization of rates in one state or region to allow lower rates in more competitive markets.

State regulatory agencies failed in efforts to track costs and profits that could be shifted across state lines, or into a blur of bookkeeping transactions between affiliated companies. [Companies] found that the largest profits were not to be made in the operation of power companies, but in padding out charges for financing, engineering, fuel and equipment services (Ridley 1996: 18).

A constant financial shell game developed between states so that by 1928, 16 major electric companies controlled 85 percent of the electricity produced in the US (Ridley 1996: 17). The utility entrepreneur Insull who pushed for state regulation to ensure monopoly status had also made another (short-term) winning assumption.
In the dizzying stock market climb of the late 1920s, speculation on utility stock ran wild. Some of the holding companies would trade stock back and forth between subsidiaries, inflating its value with each exchange. Based on rampant speculation, Insull’s personal fortune increased from $5 million in 1927 to $150 million in 1929. (Ridley 1996: 18)

The jurisdictional limit of state regulators was thus exposed. The establishment of state commissions had been seen as an effective way to regulate expanding utilities, but the continued scaling up of utilities and the development of national financial markets, exposed the jurisdictional limits of state regulators.

The financial and market shenanigans of private utilities, despite the oversight of state regulatory authorities, finally led to the federal government stepping in to fill the regulatory gap, triggered by the spectacular crash of utility companies at the start of the Great Depression. This put society on skid row, politicians up a tree and the economy in the gutter.

Friday, January 9, 2009

Hungary Offers a Cannister of Gas to Freezing Serbia

Hungary has decided to send a little gas Serbia's way. While this is certainly a good thing, it can be seen as a reluctant step to help out a freezing neighbor. The question is should Hungary send more to a neighbor that has no reserves and is freezing its butt off now. That is since heating has been turned of for some residential customers? Also, how does contribute to CEE/SEE regional cooperation Hungary has called for?

The amount of gas that Hungary is sending to Serbia between 1 to 2 million cubic meters is just about the same amount that is being sent from Austria to Hungary (1.5 million cubic meters as of Weds. MTI-subscription only). While it is stated that amount being sent is also equal to the amount that Hungarians conserves (spongy estimates in a cold snap). So in reality the reluctance of the Hungarians to send gas and to make it seem that they are giving charity to Serbia is lame since they are only 'taking' Austrian reserves and sending those through to Serbia.

In crisis situations there should be a willingness to help out ones neighbor. And even then, there should be an attempt to make some sacrifice to ensure your neighbor is not freezing to death. For Hungary to offer the bare minimum, which only is equal to the amount not consumed in Hungary - and related to what is being sent from Austria, is similar to sending half a life jacket to your drowning friend while you sit in the boat.

The final point here is also, the idea of regional cooperation. The NETS project organized by MOL is being established which in a situation like this could help out by operating a regional gas reserve. There will no doubt still be national gas reserves, but under infrastructure improvements and greater coordination, reserve requirements and places for storage can be spread throughout the region. Moving gas between countries when external supplies are cut off is a key element for increasing the security of supply in the CEE and SEE region. NETS is being built with this partially in mind. But success can only come if mutual trust and a willingness to help out exist - Hungarian actions do not qualify.

Wednesday, January 7, 2009

Why being Green-ish may not pay with Russia

I like the following article for the sheer fact that in this case, the old gasoline and diesel is still reliable.

In Bulgaria's top ski resort, Borovetz, which relies on natural gas for heating and energy they are now a bit concerned about getting enough gas. So they sent a letter to the

state-owned gas monopoly Bulgargaz asking them to secure the necessary quantities of natural gas for the top ski resort where all the hotels and other tourist establishments rely on gas-fueled heating. At the same, Bulgaria's other top winter resort Bansko is not affected at all by the gas shortage as all of its facilities are running on gasoline and diesel, the Bansko Mayor Alexander Kravarov announced as quoted by the Pari Daily.

I guess my only comment on this is how much does it cost to run a ski resort on gasoline and diesel? While no doubt a change over to gas and/or with some renewable energy would be expensive, there must be some cost savings in there. But then aren't they lucky that they didn't have to operate during last year's price spike.

Tuesday, January 6, 2009

Looking for the Golden Gas Route

The cold seeping into the house can put your mind to work if you imagine what it would be like to have no heat, no gas, and a low alcohol supply. The New Year seems to bring with it not just its seasonal cold but the Russian/Ukraine gas dispute. What is known this is not a new dispute (good article and worth a read). But what I think is new this year is the emphasis in the media about a 'reliable' supply route that avoids the Ukraine.

For Russia to make the claim that both the North Stream and South Stream need to progress in order to have secure gas supplies misses European understandings. In Europe the current conflict, whether an annual event or not, underscores the need to diversify away from Russia. There is no doubt that the Ukraine is not an innocent victim here, but will a gas network that goes around the Ukraine really make a difference?

Recently, there has been greater impetus given to the Nabucco project from the EU Commission, it remains to be seen whether this will be enough to move along this gorilla of a project. If all options are considered, then Nabucco can help the EU diversify its supply, which simply translates into greater security of supply.

When you have the Russian President being the CEO of Gazprom, is there a better symbol of cooperation between a country's politics and economic spheres? Gas is an economic weapon, the only question is whether the EU (and in particular CEE countries) want to reduce the damage such a weapon can do.