The surge in gas costs in Europe threatens to impose massive pain on households and cripple energy-intensive heavy industry. So there has been a lot of urgency on the part of governments to figure out a way to ease the pain. Of course, when the problem is a scarcity of energy itself, you can't just throw money at the problem. You can't print more gas molecules. On this episode, we speak with Isabella Weber, economics professor at the University of Massachusetts Amherst, who has been serving on an independent government commission in Germany to formulate a plan to ease the burden. We discuss her work and how price controls in energy play out in practice. This transcript has been lightly edited for clarity.
Key insights from the pod:
Why do economists seem to hate price caps? — 5:54
Historic examples of price caps — 8:38
Summarizing Germany’s energy crisis — 12:43
Price caps versus taxing windfall profits — 15:34
The Independent Commission for Natural Gas and Heating — 20:42
Impact of price gaps on utility and energy companies — 23:09
The rationing effect of price caps — 29:10
When do you lift price caps? — 24:28
Why energy firms aren’t producing more — 38:05
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Joe Weisenthal: (00:10)
Hello and welcome to another episode of the Odd Lots podcast. I'm Joe Weisenthal.
Tracy Alloway: (00:15)
And I'm Tracy Alloway.
Joe: (00:17)
Tracy, we've talked a lot, obviously, about the big energy crunch in Europe this year in Germany in particular, but we haven't really talked so much about, you know, what governments are trying to do to ameliorate some of the pain,
Tracy: (00:32)
The specific policy options.
Joe: (00:34)
Right. And you know, I think there seems to be an acceptance or widespread view that at least not everyone can be directly exposed to sort of the market rate of energy. It's just too much, it's too damaging to a lot of households, particularly lower income households, but even some of the surges and just like costs and of heating for this year, I mean, an extraordinary increase in costs is expected.
Tracy: (00:58)
Absolutely. Although I was talking to my mother recently and she's over in Austria, and she says, because the weather has been warmer, she hasn't had to turn up the heat just yet. So the weather is bailing some people out so far, but that's not going to be the case all winter. And as you mentioned, for a lot of low income households, this is just an extraordinary burden to be bearing.
Joe: (01:21)
The weather really does matter a lot. It's interesting, you know, actually I think it was the Dutch spot rates [that] briefly went negative last month, but it doesn't necessarily mean, ‘oh, the crisis is over.’ It's just a function of how much supply or how much storage capacity there is right now and some warmer weather. And so you can have these situations and you particularly get them with gas or other forms of energy that can't be stored indefinitely, where one day you could have negative prices, but still be facing a very big potential shortfall and higher cost for everyone.
Tracy: (01:51)
Exactly. And one of the policy options that is on the table and looks like it's currently making its way through various corners of the government, it might even be decided by the time that we actually release this episode. We're recording this on November 1st. It is a price cap on gas or in German, a Gas Preis-Bremse, which I believe translates to -- my German is terrible, especially for someone who's half Austrian -- but I think it's like gas price breaks or gas price stopping. This is the great thing about German policy. Every time there's a new decision, you get a new word to play around with.
Joe: (02:28)
It’s also a new word that is kind of almost English sounding and then something else. And so you can like sort of figure it out 75%. Anyway, little bit of a sidetrack, but yes, there is this proposal in Germany to subsidize a significant chunk of gas consumption for households and businesses. But obviously that raises all sorts of questions. And you know, in particular, if there's a fundamental shortage of the underlying commodity, if there's a fundamental scarcity of the molecules, it's one thing to say, ‘Okay, we're going to subsidize the price,’ but that doesn't necessarily solve the problem of ‘yes, but do we have adequate gas?’
Tracy: (03:02)
Right. And of course, this was one of the big criticisms of the Biden administration's decision to release oil from the Strategic Petroleum Reserve. It was that you are in effect subsidizing the price and you're not actually bringing down demand at a time when the commodity is more scarce. So this is an interesting alternative policy here.
Joe: (03:23)
So the other aspect of this, which is really interesting, is that economists as a class seem to really hate price controls when it comes to inflation, when it comes to high prices. You know, expand supply side capacity, you know, let the market do its thing. Let high prices be the cure for high prices, or let the central bank try to reduce demand to bring things into balance. When the subject of price controls comes up, economists get extremely -- the majority of them -- get extremely anxious. And yet there is this political reality that on some level it appears governments in Europe, and I guess in the US, have some role to play in ameliorating severe acute price shocks.
Tracy: (04:03)
Oh, people have strong opinions when it comes to price controls, but as you mentioned, there is a history of politicians actually using them even here in the US which is something that came up very briefly on that previous episode with Josh Younger.
Joe: (04:16)
All right. So we are going to be diving more into a potential plan in Germany specifically to deal with the high price of gas this winter. And we are going to be speaking with someone, actually, we are going to be speaking to a past guest and someone who knows a lot about this topic and is directly involved in this. We're going to be speaking to Isabella Weber, she's a professor of economics at UMass, a fellow at the Berggruen Institute, and she has been a member of the Independent Commission for Natural Gas and Heating in Germany working on this proposal. So Isabella, thank you so much for coming back on the podcast.
Isabella Weber: (04:52)
Thanks so much for having me.
Joe: (04:54)
You've written about, I'm going to just jump into this right away, I remember you wrote a column that I thought was pretty inoffensive last year in The Guardian about, well, maybe we should talk more about price controls as a solution to inflation and, you know, the sort of very serious economist commentators, they just totally flipped out.
Isabella: (05:18)
That's right.
Joe: (05:20)
I guess that's not a question. And I don't know, I'm jumping right into it. It got really messy online, but I'm just setting that up. I'm just getting it right out there.
Tracy: (05:28)
It's an empathetic observation.
Joe: (05:30)
It was an empathetic observation.
Isabella: (05:32)
Thank you very much. Empathy in this regard is much welcome.
Joe: (05:37)
But why do, I mean, what is it about price controls that causes sort of the mainstream economic commentary to really flip out and why do you think, fundamentally, people should be more open to them as a tool to address inflation? What are they all getting wrong?
Isabella: (05:54)
Yeah, maybe it's a good idea to kind of take a step back and try to summarize what I tried to say in that op-ed back in December. Basically the way I saw the inflation debate going was that there was a confrontation between ‘Team Transitory’ who was kind of hoping for inflation to be gone sooner or later and therefore there was not much urgency to act, and kind of the team ‘let's raise interest rates as fast as possible.’
And I was basically asking, suggesting that there was a third possibility, which is instead of kind of risking to push down the whole economy by raising rates or sitting there and hoping that inflation would go away, that there is a history of surgical interventions trying to kind of stabilize the prices that drive inflation in the first place. So I was trying to kind of invoke this history to bring back this perspective of saying, well, if there are specific prices that are shooting up in extreme ways, maybe there's something that we can do about these specific prices without trying to recommend some sort of wartime full flat price control policy or anything like it.
To your question, why it triggers economists so much? I think it's basically the case that in most economic models, if your prices aren't moving freely anymore, your model no longer works . So in some sense, the free movement of prices is really at the core of most of economic modeling and thinking, and therefore it kind of is a total trigger point for economists who are used to that as the main mechanism of coordinating an economy. In many ways, economists think about the market as the movement of prices. If you think of the Marshallian Cross, then what matters there is the price adjustment, right? So the market in some sense is the price adjustment. You don't even know like how big the firms are on Marshallian Cross or how small or how many and so on. But you do know how the price is moving.
Tracy: (08:02)
So can you talk to us a little bit more about specific situations where price controls might make some sense? Because you brought up the sort of wartime analogy and I think when a lot of people hear price controls, well maybe not a lot of people, but some people when they hear price controls, they’ll think back to, for instance, World War II and the price controls that were implemented there as part of America's wartime effort. And that was for a very specific situation. But how would that apply to our current economic environment? Or what is it that you're seeing in the current economic environment where these would make some sense?
Isabella: (08:38)
So the historical analogy that I used in this piece was in fact the transition from a war economy to a post-war economy, which was a process that I had studied for my book, “How China Escaped Shock Therapy,” because the analogy of a transition from a planned war economy to a market post-war economy was very important in the Chinese context.
Now, in late 2021, as you might remember, the Council of Economic Advisors actually invoked the same transition as kind of the closest analogy for understanding the inflation that occurred in the context of the transition to a post shutdown economy. So what happens in such a moment of transition is that you have a very rapid structure shift where you want firms to very quickly change their production behavior, which creates short-run scarcities, which creates a price shock. So in the context of the transition from a war to a postwar economy, you can take off factories that first produce tanks and now as opposed to produce cars. And then there's an interim period in which basically this adjustment is happening.
And if demand is sufficiently strong, then this kind of bottleneck resides in an increase in prices in ways in which these prices would not shoot up if you didn't have this inelasticity of supply. At the time, in the transition from war to a postwar economy, America's most established and most famous, even some of the most conservative economies were arguing that it would be useful to maintain selective price controls in the places where supply was very inelastic and demand relatively strong in order to prevent these prices from shooting up, which would then result in a situation where all the purchasing power would be absorbed by these price hikes, which would then in the next round result in possibly a very sharp downturn. So you would have a short inflationary boom followed by a sharp deflationary downturn, which had in fact happened after the First World War.
So therefore this kind of stood as a warning at this post-war moment. In actual history, the controls were pulled pretty much overnight and there was a very sharp increase in inflation that coincided with a very sharp increase in profits and then a short downturn, which was however, by far not as bad as after the First World War. And there are different reasons that we can discuss. One of them might be the war in Korea. So this is the argument that basically if you have bottlenecks and you have prices shooting up, because supply can simply not adjust in the immediate run to demand because of these physical challenges of changing production structures, then a price liberalization could be useful not only to prevent inflation, but also to prevent such sharp boom-bust cycles.
Joe: (12:00)
When you sort of kicked off this whole brouhaha at the end of last year, you know, war was kind of an analogy for thinking about historical patterns and then not long afterwards, there's the start of an actual war in Europe and we've seen, of course it's come down a bit, but we saw this massive price shock for energy over the summer in Europe and including in Germany. Before we get to your work on this commission, how would you just sort of summarize the challenge or the crisis in Germany? Like if someone was asking you what happened, why did gas prices surge so much or what are the current economic conditions of Europe? How do you sort of diagnose the problem?
Isabella: (12:43)
I mean, first of all, we have to see that already in late 2021, gas prices in Europe were very high, right? In Germany in particular, they were so high that as a matter of fact, the policy proposal that I wrote with my colleague Sebastian Dullien came out still before the war because already then we were estimating that given the enormous increase in wholesale gas prices, that would translate into around 2% increase in inflation if it was handed down into retail gas prices. So even before the war, there was a ‘gas price crisis,’ if you want. But of course it has become much, much more severe.
Now, to answer your question, I think that basically gas is a good that is so essential that all consumers that happen to be heating with gas cannot do without gas. And at the same time, firms that have technologies that rely on gas have to some degree the possibility to do fuel switch[ing], but that is relatively limited or at least not complete. So that again, also in the case of firms, you have a really great dependence on this specific source of energy. So if the price shoots up, you basically have a pretty inelastic demand response. Not completely inelastic, but relatively inelastic up to a point.
So this kind of creates a very dramatic situation where on the household side, as the representatives of landlords were pointing out, as a matter of fact, we have a situation where they are warning of kind of mass private insolvency because people can simply not pay their gas bills if the government wasn't going to step in. And on the part of firms and industries, Germany is of course an economy that is hugely reliant on industrial production. For a rich country, it's around 23% of, of GDP that comes from industry and manufacturing. So that is pretty big given that it's a rich economy. So the whole industrial part of the economy comes under enormous stress if there is both a looming danger of actual physical gas shortages and a price shock.
Tracy: (15:07)
So since you mentioned corporate profit taking, which is a hot topic in many places around the world, you know, in Europe and in the US as well -- can you walk us through the practical differences between a price cap on something versus something like a windfall tax on profits? What are the different effects that those would have on the economy?
Isabella: (15:34)
Maybe if I may, I would like to first briefly comment on why I think profits can go up in unusual ways in the kind of situations that we are talking about. So if there is a bottleneck that typically affects a whole sector or at least a whole line of production, which means that all the competitors in the market are aware that all other competitors have the same kind of issues in keeping their supply chain running. So if you are Honda and I’m Toyota, we both know that we have a computer chip shortage and that this means that we can only produce whatever at whatever level we can produce. So in this kind of situation, if I was to increase my prices, you could not easily take away my market share in the ways in which you could in normal times, right?
In normal times if I was to increase my prices, then you would say, ‘Oh, wonderful, now they are going to lose part of their market share because their stuff is getting more expensive, so let's expand our production.’ But that kind of easy expansion of production is not possible because of the bottleneck that affects all players in the market equally. So in that kind of situation then both companies that are direct competitors can increase prices in ways that would be very harmful to their position in the market in normal times. So this means that prices suddenly can be hiked in ways where they are no longer controlled by competition in the ways in which we would expect them to be.
Now the difference between a price cap and a windfall profit taxes, I think that the price cap basically says that a firm can no longer charge a price that goes above a certain level or that represents an increase by X over a certain historical date. Whereas for the windfall profit, you would need to look at what are the profits that the firm actually made, and then you would want to kind of tax that back, right?
So in the first case, you kind of don't let the windfall profit emerge on the market, and in the second case you would like first have the windfall profits happen and then you want to tax them away. And then you of course hope that firms being aware of windfall profit taxes would kind of anticipate these windfall profit taxes and therefore would not hike prices quite in the way as they would without a windfall profit tax.
But I'm actually thinking of these two policies as being complimentary along the value chain. So I mean, clearly we are not going to impose price caps in in very many areas of the economy, simply because we don't even have the bureaucratic capacity to do that in a reasonable way. But in Europe, and as by now also fellow economists like Paul Krugman and Joe Stiglitz have been arguing, the energy crisis is so severe that various forms of price caps in the energy sector are of course on the table. Now, if you do some form of price cap, and we can talk about the details of the German case later, I suppose if you do some form of price cap on let's say gas, ideally you want that this reduction in cost for firms is somehow translated into a reduction or at least stabilization of the prices for the things that these firms are producing, right?
So here then there could be a situation where an energy price cap could be complimentary with a windfall profit tax, which wouldn't even really be a tax because the price caps that we are talking about in Europe tend to be fiscal price caps in the sense that the government is actually paying should bring down the price. And you could add a conditionality of saying if the firm that got subsidized price, that got that subsidy that enabled it to have access to gas at a lower price, should not in the next round reap windfall profits. If it does, it would have to pay back part of the subsidy or the whole subsidy that it received. So in that kind of scenario, you would have actually a complementarity between a price cap on energy as an extremely important input and a conditionality for the access to that subsidized gas that would follow a windfall tax kind of logic.
Joe: (20:17)
So let's get to the German situation specifically. Why don't you just tell us though, I guess it just wrapped up, what was the Independent Commission for Natural Gas and Heating? What was it tasked to do? Who tasked it? How did you become a member of this group? Why don't you just sort of, before we get even into the details too much, why don't you just sort of talk about your experience, how it came about?
Isabella: (20:42)
So basically I have been arguing that we have to think about a form of non-linear pricing for natural gas since earlier this year. So I've been kind of in conversation with economists in Germany on this issue for a while, and the government had been trying out all sorts of policies in the last months, including transfers. And so, I mean like transfers of money and there are other forms of policies in the current crisis, but eventually they realized that the gap, the pressure that comes from the gas price shock is so intense that they had to do something that directly tackled this price shock. So they set up a commission in late September that has been called upon by the Chancellor's Office and the Ministry of Economic Affairs, and we received the mandate to develop a policy that would basically be this gas price brake, which is this funny German word that you already mentioned earlier.
Tracy: (21:48)
I love how literal German is sometimes. I really do. ‘Put the brake on gas prices.’ It makes sense,
Isabella: (21:55)
There’s also this strange fashion around using ‘brake’ for so many things like the debt brake and so on. But anyways, that's a different topic. So they set up this commission. There were six other economists, myself and various representatives from industry from utility companies, unions, environmental groups, like a charity organization and so on to kind of be an independent commission to try to come up with a policy package that could kind of square the circle of having at the same time a crisis of actual physical gas shortage and a crisis of inflation and skyrocketing energy prices on top of what looks more and more like a recession.
Tracy: (22:42)
So one of the criticisms of the proposal has been that maybe this will heap even more pressure on utility suppliers who are already pretty strained. Uniper for instance, I think it's on course to be nationalized by the end of the year, but what do you say to that criticism? What is the actual impact that price caps would have on energy suppliers or gas suppliers?
Isabella: (23:09)
Yeah, interesting question. So we had four representatives of utility companies on the commission, and one of the elements of the policy package is actually to provide more liquidity to these companies and the way that the gas price brake, which is an impossible word in English, will work is that basically the utility providers, they get funds from the government which will allow them to give a rebate on gas bills for households and firms. And it's a nonlinear pricing scheme with a savings bonus. And I'm happy to explain the technical details of this.
Joe: (23:49)
Feel free, our listeners love technical details, so feel free to dive into that.
Isabella: (23:55)
Yeah, the basic philosophy is to say there's one part of gas demand that is pretty inelastic, and there's another part of gas event that is considerably more elastic. So therefore there's a quota that everybody gets with a price that is lower than the market price. And that quota for the household sector and all the firms that kind of have a gas account like you and I, is such that this quota is based on 80% of your estimated use. And for this 80% you will pay 12 cents. And if you use more than this 80%, then you will have to pay whatever your retail price is on your gas contract. Now, if you manage to use less than 80%, there's actually this additional feature of this policy, which is that you will still have your rebate. So this means that if you use less, the price will actually fall because your rebate will be larger proportional to your usage. So this is to say that there's a savings bonus if you use less than 80%.
So that's the policy on the kind of what we call the SLP customers. So those with like a nonindustrial gas account. And on the side of industry, it's kind of a similar scheme, but the price would be 7 cents because it's like taxes and so on are not accounted for on the industry side. And the quota would be 70% instead of 80%. And then there has been like a lot of debate [about] whether industry firms can or cannot trade the gas that they get at this discounted price in the market. And this has probably been one of the most hotly debated issues and still is one of the most hotly debated issues because from a pure, like ‘let's have price signals reign all the way through’ perspective, it would be desirable to have firms trade gas in the market from the perspective of kind of price stability and also not encouraging firms to kind of switch from producing whatever they are producing to getting cheap gas and selling it on the market and kind of using this as their business model perspective, this like trading of subsidized gas on the market is not a very desirable feature.
The way that the commission report stands as of now is that it actually does allow for industrial firms to sell the subsidized gas on the market. I'm a bit skeptic about this as a kind of general rule. I can see a use for having a reverse auction or a model where basically the state sets up a marketplace to buy back some part of this gas in a defined volume. But as a kind of a general policy for all industrial firms in Germany to have this like basically minimum margin that is defined by whatever a firm can make by selling the subsidized gas on the market, I think this sets somewhat problematic incentives because it seems likely that this will be in particular attractive for firms that are at the beginning of the value chain and that are very gas intensive and have relatively low margins, which could then create all sorts of cascading effects. Like, let's say producers of basic metals or basic chemical components decide to buy and sell gas instead, then this will of course create, or not necessarily create, but make a shortage more severe, which could then have all sorts of ripple effects along the supply chain. So in my mind, it would be more desirable to have a policy that kind of spreads the burden of saving gas more equally.
Joe: (28:00)
Right. So in theory, the fear of allowing almost like a cap and trade system but for subsidized gas, is an industry that's low margin rather than producing the goods that other players on the value chain might need, might just sell at a substantial markup their discounted gas. Can you just talk a little bit more, I mean, look, obviously the issue with something like dealing with high gas prices is yes, the price is high, but there's also, you know, the whole issue is there's a scarcity of the commodity itself.
Talk to a little bit more about the rationing effect of this plan. How does it sort of create an incentive to perhaps curtail use or discourage use in less economic ways? And then talk a little bit more about the redistributive effects because, you know, in terms of subsidizing households etc., it seems sort of clear that okay, you want to sort of make sure that some households don't freeze, that the poorest households in particular can afford to keep the heat on over the winter. But at the same time, if you subsidize everyone, you still run into the same capacity shortfall.
Isabella: (29:10)
Yeah, absolutely. First of all, there is still a strong savings incentive built into this scheme, right? Above 80% you have the extremely high market prices -- 12 cents is still almost twice as much as people would've been paying in 2021 and prices in 2021, they're already very high. So 12 cents should still have a lot of savings incentives. But on top of it, we have this savings bonus scheme, which ensures that from a like price incentive perspective, there's still a lot of incentive to save gas. Then we have kind of come up with a number of complimentary measures like information campaigns, like advisory services on how households can actually save gas and so on. But there is a big question of distribution here because of course, I mean you used the word ‘ration.’ So what we are doing here in some sense is rationing price capped gas, right?
Because everybody gets a quota of price capped gas, which is obviously desirable because it's cheaper. So it's not a physical ration, but it's a kind of a ration for an entitlement to price capped gas. Now, the rule that we are using is based on the consumption estimate that every household or firm would have based on their utility providers estimates. This of course, has the big difficulty from the perspective of what are the distribution outcomes of this policy that if you used very little gas you would get a small quota and if you used a lot, you would get a big quota, right? Because obviously 80% of a small estimate is much less than 80% of a big estimate, and your estimate would be somehow based on your past consumption and what kind of house you're living in and so on.
Now this is an issue, especially for the households that are using huge amounts of energy, which can be very rich households that have facilities like pools and so on. So one of the demands that we actually are debating right now is whether there could be kind of an upper bound to this 80% rule so that you get 80% but not more than let's say 20,000 kilowatt hours, or something like that. This then goes into the whole question of data availability on the part of utility providers, which I'm happy to go into detail if this is of interest, but basically the situation is, in Germany, that a utility provider does not know whether behind any utility bill is like one huge villa or an apartment building with 150 flats or a business. So therefore, in order to have such an upper bound, we would need a better database, which I think would be desirable in any case because if we are talking about looming gas shortages, it would be good to know whether there are 100 households or five households behind any one gas account.
So there is this whole big question of what are the distribution implications. I think one way of justifying what we are doing is to say this policy is taking off the extreme spikes in gas prices. So it's not trying to do social policy or transfers or whatever, but it's taking off the spikes in the price of gas, which is a result of the war in Ukraine. So therefore it doesn't really make sense that whoever happens to have a gas account is the one who is paying for the cost of war compared to someone who happens to have an oil heating system or whatever else they might have. So this is I think, one way of kind of justifying this approach. But of course there are still issues of distribution. We are also recommending for the kind of implicit subsidy that comes from having access to this price cap gas to be taxed. So that part of this distribution issue is kind of elevated by then like taxing whatever the rebate is in in in the next round. We have also set up kind of, or we have recommended to set up a fund for households in need where they could get additional support with their heating bills.
Tracy: (34:06)
So one question I had is if you impose price controls, what is the trigger or the necessary conditions for the price controls to revert or be taken off – for gas price gas pedals to come into effect? I don't know, like when do you hit the gas on gas prices again?
Isabella: (34:28)
Yeah. Maybe I should say that there is a controversy amongst economists whether we should be calling this a price control, a price cap, and kind of this whole language of gas price brake is a way of circumventing that discussion because at the end of the day, this policy is not a traditional price control. The utility providers are not being simply ordered to charge lower prices, but they are asked to charge lower prices and are being paid in return, right? So it's kind of a fiscally-funded price cap, if this makes sense. And then there are all these other features that I've talked about, but back to your question.
So the way that we have set the prices in the gas price brake is such that if you look at the average price that would emerge from this 80% at 12 cents and 20% at an average of around 20 cents retail price, you get a price of around 14 cents, which is the price that, based on the best guesses that we had in the room, would be the kind of ‘new normal’ once this gas crisis is no longer as severe as it is right now.
So the idea is that we are not kind of stabilizing prices back to a pre-crisis level, but we are stabilizing prices on a level that is consistent with what we expect the market prices to be in about two years’ time. This means that at least in theory, if these guesses aren't completely off, which is of course totally possible, firms that would be taking decisions based on these prices that they have now should also be viable in the future because similar kind of market prices should emerge in the future. Households should not experience another price shock when the gas price brakes stop stepping on the brake on gas prices.
Tracy: (36:39)
[Laughing] We're laboring this analogy a bit too much, aren't we?
Joe: (36:42)
The brake of the brake? Yeah, you know, I just want to, I guess it's Devil's Advocate for a second, but when we talk about price caps or ceilings or brakes or windfall profit taxes, you know, for 10 years the energy business was not a particularly good business to be in and a lot of firms did not have much pricing power. The stocks did not do too well, poor profits, there were a lot of gas companies that went out of business or exploration companies and so forth. And then of course in the middle of Covid and then in this period, their fortunes turned around.
But part of me wonders, well, it's like, okay, the shareholders of these companies suffered for, you know, underperformed for years and years and then finally there's a surge and then the surge happens in prices. The windfall profit comes after like 10 years or longer, and suddenly politicians say, ‘Oh, we're going to tax it away.’ And so I kind of feel when I look at this, it's like, well there's, yes this year or maybe over the last two years there's been these extraordinary profits, but it's not taking into account the entire long cycle, which saw many years of underperformance. Why shouldn't the shareholders or the investors in these industries be compensated for the other part of the cycle, so to speak? Why do they only get the profits clipped and not the downside clipped?
Isabella: (38:05)
I mean, in the German case, there's none of that happening, right? Because all the, I mean, the price cap is financed by public money. So therefore, basically it wouldn't affect profits on the part of utility providers anyway. But of course we also don't have a lot of local sources of fossil fuels, right? So therefore this whole debate that's happening in other countries of basically taxing the fossil fuel industry to then finance fiscal price caps is not really an option here. But to go back to your question, I kind of have a suspicion, which I would be interested in fact to hear what you think about if this is a possibility, but let me put it differently. I mean one way of thinking about the price hikes that we have seen in the fossil fuel industry is to say that a lot of oil production capacity went off the grid during the pandemic where you kind of had of course this collapse in demand, which allowed companies to downsize their production in ways in which they would not downsize their production if there wasn't such a gigantic demand shock, right?
And then after the pandemic, yes, some production has returned to the grid, plus a few companies based on their earnings scores have been quite explicit that they are taking a discipline approach to investment. And what they saw happening is basically that prices skyrocketed and costs were down because they had shut down the most costly production facilities. Obviously if you have to choose which production line to shut down, you would shut down the one that is most costly and least profitable, right? This then means that you have a situation where this constrained supply actually suddenly becomes extraordinarily profitable. And this is of course a problem because I mean, we would expect based on Econ 101 that if prices go up, supply would go up, right? But now we have a situation where actually prices go up and supply doesn't really go up by as much because firms see that prices go up, profits go up. And that's actually great because they are making record profits that are in some cases higher than they have ever been in the long history of these companies, right? So why would anyone choose to produce more to bring the prices down and to earn less? So that is kind of the conundrum that we find ourselves in, I think.
Joe: (40:38)
Yeah, that definitely sounds like an accurate characterization of the existing conundrum. Isabella Weber it's so fascinating to talk to you because it's such a treat to talk to someone who has such a deep background in theory, but then also in the position of working on putting these things into practice,.
Tracy: (40:55)
Actually making the policy.
Joe: (40:57)
Yeah, and so hearing you talk about the sort of practical realities of how do you ameliorate the pain while, you know, having some rationing effect and so forth, it’s really fascinating. Really appreciate you coming back on the show.
Isabella: (41:08)
Thanks so much for having me. This is a lot of fun.
Joe: (41:10)
It was a lot of fun. Really appreciate you taking the time and looking forward to having this one coming up.
Tracy: (41:16)
Thanks Isabella. That was great.
Joe: (41:32)
Tracy. I really like that episode. I mean, I guess sort of for the reasons we are just talking about, because it is rare for something that's this sort of the theoretical topic economists often, you know, they often do theory and not so much practice and then it's like, okay, let's put it into practice. Let's, let's do what we can do.
Tracy: (41:50)
Yeah, I was also kind of just thinking about how quickly things have changed between the time that Isabella published that op-ed and now. It seems like things that were once unthinkable are certainly being thought through and maybe even implemented.
Joe: (42:04)
There's so many funny little details that she talked about. You know, the idea of like making a market in the subsidized gas is very funny to me because, you know, it's just like, right here's the idea. We want to just sort of put this ceiling of some sort on gas, but of course economists, you know, I think there's a certain type of economist whose first thought is like, ‘Great, let's have an auction mechanism for the subsidized gas.’ Like, immediately goes back to the market mechanism for this.
Tracy: (42:31)
You know, someone somewhere is proposing a Dutch auction for that.
Joe: (42:34)
Yeah, it's immediately, it's like, ‘oh, well, should, should firms be forced to actually use the subsidized gas? What if they can sell it more profitably to another firm that needs more subsidized gas because their margins are higher?’ It's so funny how it always sort of will seep into these debates.
Tracy: (42:50)
Yeah. The other thing I thought was interesting was just the discussion of historical price controls and also why you can see prices spike during a supply-constrained environment. And I know, intuitively it seems kind of obvious, but this idea that suddenly everyone has pricing power at the same time because of scarcity in the thing that they're producing. Again, I guess it's obvious, but it kind of crystallizes that point for me.
Joe: (43:19)
Yeah, absolutely. And also look, I was really interested to hear about how there still has to be some rationing mechanism, otherwise what are we doing here? Because the issue is there is a fundamental, as you said, there's a fundamental scarcity of the molecules, the natural gas molecules themselves. So how do you get that balance where yes, you're ameliorating some of the pain, particularly for smaller households etc., but also trying to sort of recreate some sort of scarcity mechanism. And it was interesting even, you know, she was talking about utility level data, which people get really anxious about that. And it's come up in of our conversations with Jigar Shah for example, about, well, what if we just had more data about use, but then people get really anxious about privacy.
Tracy: (44:05)
But it is kind of crazy when you think about it, that we're trying to solve these problems without necessarily having a lot of granular data or as much granular data as we could, right?
Joe: (44:14)
Because if we had the data, you think, okay, well yeah. We’re not going to give the subsidy to people with pools, right? Because pools aren't as essential. Heating a pool isn't as essential as cooking or heating a pool isn't as essential as keeping a house warm. But you know, we don't have that data.
Tracy: (44:30)
Shall we leave it there?
Joe: (44:31)
Let's leave it there.
You can follow Isabella Weber on Twitter at @IsabellaMWeber.