Saturday, 5 May 2018

Floating plug-in power stations are finally here

When I was an undergraduate student, one of the examples that one of my economics lecturers (perhaps John Tressler?) used in class was that of a plug-in power station floating on a barge. This example was used to illustrate how 'specific capital' creates a barrier to entry, especially for natural monopoly firms. Or at least, that's what I remember (who knows? It was a long time ago. It might have been an example used to illustrate a totally different point).

Specific capital is capital that is specific to that particular market (as with many concepts in economics, there's no mystery to the naming of it). If the firm later leaves the market, they lose all of that capital (because it was specific to that market). Some types of capital can be moved or used in other markets, but specific capital cannot. So, if a firm needs to invest in specific capital in order to enter a market, then that will make the firm nervous. What will they do if there is a sudden decrease in demand and they start making a loss in the market, if they can't easily move their capital elsewhere? The nervous firm might decide that it is better not to enter the market if there is a chance that they will waste their specific capital.

Specific capital can be a serious problem for a natural monopoly firm. A natural monopoly firm has economies of scale, and those economies of scale usually arise because there is some large up-front cost that the firm faces (and so, as they produce more or service more customers, that large up-front cost can be spread over a larger market, lowering the firm's average costs - what economists refer to as economies of scale). If the large up-front cost is specific capital (which it often is), it is easy to see that firms will be nervous about making the investment. This is why it is not always a good idea for governments to heavily regulate natural monopolies - it reduces the incentive for the up-front investment.

Aside from the threat of regulation, specific capital is also a problem if the firm is worried that the government might expropriate their specific capital (and especially a problem for natural monopolies). This is a serious problem in many developing countries, where an autocratic leadership might expropriate foreign-owned assets at any time. This makes foreign firms, which have a lot of financial capital, reluctant to invest in large assets in developing countries. An example of a large asset conducive to natural monopoly that foreign firms would be unlikely to want to invest in is a power station. Once the foreign firm has made the investment, the government could simply expropriate the power station, and there is little the foreign firm could do about it. Given this risk, there is less foreign investment in natural monopolies (e.g. large infrastructure projects) in developing countries than would be optimal.

A solution to the problem of specific capital, at least in the case of power stations, is to put the power station on a barge and float it from country to country, simply plugging it into the electricity network. Then, the firm can move it elsewhere if it feels that the political climate becomes too risky. It's still a large up-front cost, so still a natural monopoly, but at least the capital is not specific to the market that the barge is parked in, because it can be relocated. In the past, this solution was almost purely theoretical. But no more, as the New Zealand Herald reported on Wednesday:
If a Russian state-owned company has its way, remote regions of the world will soon see giant, floating nuclear reactors pumping power to port cities and drilling platforms.
It would be a real-life version of the Soviet reversal joke: In Russia, 70-megawatt nuclear reactor comes to you.
The reactor in question is called Akademic Lomonosov. Once the barge is wired into the electrical grid in the Arctic town of Pevek in 2019, it will be the world's northernmost nuclear reactor, capable of powering a town of 100,000 people with what its manufacturer, Rosatom, calls "a great margin of safety" that is "invincible for tsunamis and natural disaster."...
By 2019, the first-of-its-kind rig will provide power for the port town and for oil rigs.
For Rosatom, it is buoyant proof of concept that a floating sea-based reactor can work. Rosatom is already in talks with potential buyers in Southeast Asia, Latin America and Africa, according to Russian television station RT, which estimates that 15 countries have shown interest in the floating plants.
Critics are focused on the potential environmental downside to a floating nuclear reactor, but there is an upside. This could be exactly what is needed to encourage investment in at least some of the infrastructure needs of developing countries.

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