I enjoy a blog called Newmark's Door; it's filled with random musings from an economics professor at Duke. His wife suggested that he ask his students a question, but he decided it was too easy even for an Economics 101 course. Here's the question: "What happens to the price of corn when Congress passes a law mandating increased usage of it?"
The Republic joined the debate on Sunday. "Food producers and politicians have begun blaming rising ethanol production for tipping food prices too far and even helping cause world hunger, but the ethanol industry disputes that."
Politicians decided that a huge chunk of the food supply should be converted into fuel and now people are starving. Is that a big shock? Dude, incentives matter and if you screw them up, people get hurt. I don't usually blog about the energy industry because I have energy clients, but the topic of energy incentives have become the latest rage.
It won't surprise you to know that I'm pretty libertarian on the incentive front. If the mohair industry can't survive without being propped up by the government then it shouldn't survive. The family farm is a myth so most of the farming subsidies go to big corporations. Those subsidies also drive up the cost of food and make third world farms less viable.
However, when properly structured, incentives can do a lot of good. Here's a great example from the Arizona Corporation Commission.
The University of Arizona just won an award for a program that shifts almost all of its air conditioning load to the nighttime. They run a special cooling system at night and freeze huge banks of ice. The next day, they turn the compressors off and the melting ice cools the 176 building on campus--including the University Medical Center down the street. The system uses almost no electricity during peak hours.
What's so important about peak power?
Peak power is really expensive because the utility not only has to pay for the cost of generating the electricity, but they also have to BUILD a plant to generate the peak power. That new power plant may only run a FEW HOURS a year. That means that the plant has to recover an entire year's worth of fixed costs in a few hours. Consumers pay dearly to have that plant available for the peak.
That's where incentives come in. The ACC didn't subsidize the ice plant; the ACC charges customers more for peak power. Those higer charges reflect the fact that peak power is much more expensive. The UA ice system is a great example of the market responding to price signlas. The government didn't build the ice system, Trane built it. And UA didn't build it out of the kindness of their heart, they built it to save money. In fact, the system saves the University $560,000 a year.
More importantly, Tucson Electric Power doesn't have to build a plant to meet the increase in peak demand associated with that massive air conditioning load, so the ice plant saves money for Tucson's other utility customers.
Unlike the ethanol fad, The ACC established the right price signals, and the market responded in creative ways that will lower the costs for everyone.
Ironically, it's unlikely that any of the Corporation Commissioners will be at the ribbon cutting ceremony. That's because the dedication and tour is scheduled for Wednesday morning, May 14th at 10:00...the same day and time that the Commissioners will be deciding the latest TEP rate case.
It's too late for UA's new ice plant to be reflected in the current case, but the next rate increase will be smaller because UA has managed to shift all of its cooling to night.
Incentives matter. When they are done well, people benefit. When they are done badly, people suffer. Too bad some of the folks in Congress haven't learned that lesson.
Congressmen are allowed to send mail to their constituents for free. In the old days, that meant that they sent, you know like "letters" to the people they represent. The constituents could then read the congressman's update in order to learn about what he's doing in Washington. 
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