Russia, Ukraine, and all that

Cliff Gaddy and I have posted several pieces on the Ukraine crisis on the Brookings Website.

One article is entitled Ukraine: A Prize Neither Russia Nor the West Can Afford to Win. This post discusses the integration of the Russian and Ukrainian economies.

The second article is entitled "Can Sanctions Stop Putin?" The subject is obvious, and the answer is no. We discuss the difference between the impact of sanctions -- how much pain is induced -- and the effectiveness of sanctions.

A third one will be posted soon.

Who Wins in the Russia-China Gas Deal? All of Us!

The 30-year, $400 billion natural gas deal just agreed to by China and Russia has evoked much commentary. Most of it, however, tries to parse the implications for U.S. foreign policy and geopolitics in general. This leads to much confusion. One day, for instance, ForeignPolicy.com posts an article about “The Deal That Wasn’t” (writing that failure to clinch a deal on the first day of Putin’s visit to China was “a shock, a blow to Putin's objectives, and a reminder of how much China has the upper hand when it comes to gas deals with [Russia]”) and then a day later, “Gas Deal Could Complicate Sanctions Threat Against Russia” (the deal—which, of course, was clinched—was an “important win [for Putin] in his ongoing standoff with the Obama administration and its European allies”).

One day, China is not ready to play ball, the next day China is saving Russia from international sanctions, even though the deal will not start to deliver gas to China for several years.

While everyone tries to figure out who won, there is, however, a much more basic dimension to this agreement—energy security—that makes it beneficial to all of us. Consider that the gas Russia will deliver to China will come from two rather undeveloped fields in eastern Siberia, and that the deal will build new infrastructure for delivery. Then notice that Russia will deliver to China an amount of natural gas equivalent to the annual consumption of the state of New York. This means that China’s demand for gas will be met by new energy supplies. This must be good for everybody. It is not a shift of supply by Russia from Europe to China. It is a net new addition to world natural gas supplies made possible by the investment in infrastructure to deliver from geographically isolated fields.

China is happy that Russia will deliver from fields that are dedicated to them. Russia is happy that it is developing the new fields and has a paying customer to deliver it to. But everyone else should be happy that this means there are 1.4 trillion cubic feet of natural gas available to the rest of the world. This is energy security.

Wellness, again

Austin Frakt and Aaron Carrol had a nice column in Bloomberg on Wellness programs and the PSU program in particular. They point out that, 

Whether wellness programs work as intended or not, let’s recognize what they also do: They increase the cost of coverage for some employees. That saves employers money but by shifting costs to workers. Those who bear the brunt of this increase are the less healthy employees, who also tend to be those of lower socioeconomic status. 

Now let’s consider what wellness programs might do: reduce health-care spending and improve health. In general, the evidence is weak that they will. Why? Conceptually, factors within workers’ control make only a small contribution to rising health-care costs, so there’s only so much such a program can do, even if it works perfectly. Empirically, the track record of wellness programs’ efficacy is mixed at best.

They do not point to the irony of our self-financing system directly. But they note the fact that the research shows that they are ineffective. And they answer the question of why they are so popular with employers.

More rigorous studies find that wellness programs in general don’t save money. With few exceptions, they often don’t improve health, either. The additional screenings that such programs encourage can lead to overuse of care, pushing spending higher without improving health. 

Given all of this, why are wellness programs so pervasive? Our hypothesis is that it’s a form of supplier-induced demand: The wellness industry is doing a good job of pushing its product. Understanding research is challenging, and it’s relatively easy for a marketing representative to cite glorious-sounding results.

Clearly the suppliers of these programs benefit, as PSU employees could see when we took our biometric testing and saw how many people the wellness program hired. I think that PSU is just counting on a lot of dropped spousal coverage. As they conclude, 

Penn State’s plan would hardly be the first time Americans bought something that may not work as well as advertised. Companies should reconsider the reasons that they are so eager to have them and whether they’re really worth the investment.

So Much for Energy Independence

With all the talk about US shale production there is a lot of talk about the US becoming energy independent. But as this report from the FT makes clear, the whole world is still highly dependent on Saudi Arabia, Kuwait, and the UAE. 

The US might be drowning in oil, but the world is still dependent on Saudi Arabia.

Indeed, Saudi Arabia is pumping out more crude than at any time since at least the 1970s. In neighbouring Kuwait and the United Arab Emirates meanwhile, oil production levels hit record highs. 

These numbers reflect a profound but easily overlooked trend in the global oil market. In spite of the shale oil revolution in the US, the world has become, if anything, more dependent on a handful of Gulf producers to fill supply shortfalls elsewhere. 

This  is of course great news for Russia. In July, Russian output reached 10.4 million barrels per day, a post-Soviet high. 

The problem is uncertainty of supplies elsewhere. Libyan production is down almost 1 million barrels per day due to turmoil. Iran still faces sanctions, and Nigeria has its own problems. As the world oil market is like a bathtub these are shocks we cannot escape, so Saudi behavior still matters.

Hard to disagree with this conclusion.

The consequences for the global economy – and the world’s biggest oil consuming nations – are significant. Saudi Arabia is already the single largest supplier to many of the large importing countries, including China. But it only sells crude to existing customers, and does not allow buyers to sell on their cargoes. 

For all the talk about the shale boom, then, it is business as usual for the rest of the world in terms of supply. The market will be watching those output data closely.

Wellness Programs

Not being a health economist I had not thought much about wellness programs until Penn State instituted one. I thought only our program was ill-conceived. But it turns out that there has been research on wellness programs, and the main conclusion is that they do not save money. This is discussed at the blog Incidental Economist, which is a great health economics blog.

The main point is that the only way these programs can save money is through cost shifting. But the obese and tobacco users do not expend enough on health care to make the savings significant. Especially with laws that bar health-based discrimination at the workplace. 

This recent study by Horwitz, Kelly and DiNardo in Health Affairs is indicative. The bottom line:

We reviewed results of randomized controlled trials and identified challenges for workplace wellness programs to function as the act intends. For example, research results raise doubts that employees with health risk factors, such as obesity and tobacco use, spend more on medical care than others. Such groups may not be especially promising targets for financial incentives meant to save costs through health improvement. Although there may be other valid reasons, beyond lowering costs, to institute workplace wellness programs, we found little evidence that such programs can easily save costs through health improvement without being discriminatory. Our evidence suggests that savings to employers may come from cost shifting, with the most vulnerable employees—those from lower socioeconomic strata with the most health risks—probably bearing greater costs that in effect subsidize their healthier colleagues.

I wonder why nobody involved with designing our program bothered to speak with a health economist?

On the Economics of the New PSU Health Plan

Thinking About the New Health Plan

Penn State University has adopted a new health initiative. The wellness program requires employees to take a wellness test, schedule a biometric exam, and promise to take a physical or else see their insurance rates go up by $1200 per year. Smokers will see their health care costs rise by $75 per month. The idea, as explained by University President Rodney A. Erickson, is to cut growing health costs. According to Erickson,

“We are implementing a significant set of changes that will help us turn the tide on unmanageable increases in health care costs for our faculty and staff…Higher education is at the crossroads with respect to our responsibilities for greater cost control, and now is the time for decisive action. I have challenged our leadership in human resources to hold annual health care cost increases to the Consumer Price Index plus 2 percent, a goal that will help us to sustain the existing quality of employee health care options while easing pressures on tuition increases that face our students and their families.”

There are many questions about this plan. I am interested in the economics of it, however. Suppose that these wellness initiatives work. How can this plan result in any short-term cuts in health care costs? Penn State is self insured so the only way it saves on health care costs is if the population becomes healthier so fast that expenditures fall in the near term. As Erickson points out:

“Since Penn State is self-insured, we are providing health care benefits to eligible employees with our own funds. This is very different from fully insured plans where an employer contracts with an insurance company to cover employees and their dependents. Because of this self-insured arrangement, we assume the direct risk, but we also can reap substantial rewards when our medical and pharmacy bills (claims) are low. "

If Penn State purchased insurance then one can see how imposing restrictions may make us a better potential client and give the university leverage to reduce premiums. But if we are self-insured then this channel is not available.

Moreover, Erickson claims that this program is being initiated to cut expenditures by roughly 10%. How is this possible, given that the program relies on behavioral changes, aside from the smokers tax? At $900 per year, this would require 24,000 employees to admit to smoking to earn the required savings. With only 8,800 full and part time faculty this will be a hard target to reach.

It is not even clear that cost will fall at all in the near term. Suppose that I did not see my physician twice a year for physicals and take appropriate medicine and lab tests. Then this plan could lead to new information about my health that could seriously impact my long-term health trajectory. If I began to see a physician and take appropriate medicine now expenditures would rise, they would not fall. How then do we achieve the 10% savings? In the near term expenditures should rise as more health care is consumed due to learning about how sick we are. Moreover, even if wellness plans improve health in the long term it is not clear how much of those benefits PSU will even realize. If it improves health outcomes after age 65 it may be great for Medicare expenditures but its not clear how it helps PSU. At a minimum we would need to have a clearer picture of which segment of the employee population is generating the largest increases and then ask if wellness programs will affect them in the near term.

The only way the plan can cut expenditures in the near term is to induce people to leave the plan. If enough employees are annoyed, and if their spouses have competitive plans, perhaps they will leave our plan. This would reduce total health expenditures for PSU by reducing the size of the employee pool that is covered. This could reduce health expenditures.

Given that we are self-insured an obvious policy to reduce expenditures would be to increase co-pays. Presumably health care costs are rising because we are consuming too much health care. Make us pay a bit more. Then we will be more careful at the margin. This would lead to direct savings for a self-insured group. Why they did not choose this idea is not exactly clear.

Hedging and Thin Markets

The Financial Times had an interesting article about the problems plaguing independent shale oil producers trying to hedge price risk. Rising production of shale oil has led to a huge increase in US oil production. As producers invest in new production they typically sell oil forward to lock in prices so that they can obtain credit. But as they do this the price for future delivery declines. As high prices are the basis on which unconventional oil production makes sense, this is problematic:

Since the start of 2011 crude production from the Bakken field in North Dakota, the most prolific US shale oil field, has nearly tripled. During the same period the price of benchmark West Texas Intermediate three years ahead has tumbled from more than $105 a barrel in April and May 2011 to as low as $81.51 by June this year.

That is a worry for the independent companies that dominate US shale production. To attract the credit they need to keep drilling, most of these companies sell futures contracts to show lenders they have locked in an oil price that is higher than their cost of production.

...The principal reason for the downward drift in prices, say analysts and traders, is the hedging activities of shale oil producers themselves. As the volume of production in the hands of independent producers grows – EOG, a bellwether independent oil producer, doubled crude and condensate production between 2010 and 2012 – so does their hedging activity. 

The problem is that the futures markets tend to be quite thin as you move out into the future. Users of oil do not engage in significant amounts of hedging three years and further out into the future. So the actions of producers tend to have large effects on price. 

Hence, we have the situation where the markets signal a large future decline in the price of oil, based on a boom caused by high prices of oil. Hence, we have a situation where the markets signal a large future decline in the price of oil, based on a boom caused by current high prices. The increase in supply has been caused by high oil prices. Clearly, if oil prices were really expected to fall by $20 a barrel in the next couple of years, many shale plays would no longer be profitable.

Two points seem important here. First, the futures market may not be giving us the best signal of what prices may be no matter how efficient it is, simply because it is too thin. Second, oil producers cannot use futures markets to significantly hedge price risk. 

This point is all the more important if we think of conventional oil producers who also must make huge investments on a very large scale. When we talk about the implications of price risk for investment in East Siberia economists often ask why Russia does not hedge the risk in the futures market. Now ask yourself: if the actions of independent shale producers can depress futures market prices, what would happen if Russia tried to hedge its production? Ten percent of Russian oil production is about the size of the entire annual production from the Bakken shale!

With markets so thin producers cannot hedge price risk with futures or options. Risk sharing must take other forms. I will talk about this in future posts.