Category Archives: Transport

Airbus + China + ETS = Prisoner’s Dilemma

Last week saw Chinese officials indicating that Chinese airlines will not buy European airplanes as long as the EU insists on including foreign airlines in its emission trading system. Orders of 35 Airbus A330 planes have been cancelled and another 10 A380’s were in danger of being cancelled because of the ETS. The Chinese argument is that it is not reasonable to charge Chinese airlines taxes at the same time that the plane is made in Europe. China currently buys more than 1 in 5 Airbus planes being produced and the total of Chinese orders amounts to US$9bn. Therefore one could say that the future of Airbus hinges on the ETS. This raises the question of climate change and what are the options that countries face.

Climate Change as Prisoner’s Dilemma
The initial impression from the discussions over climate change is that of a typical Prisoner’s Dilemma and some of the data provided in the Stern Review (2006) can be used to populate the payoff table.

–The cost of tackling climate change is approximately 1% of annual per capita GDP. However, if nothing is done about the issue the cost is estimated to be between 5% to 20% of GDP. So that defines what happens at the extreme of cooperative or non-cooperative behaviour. From the table above, a country that refuses to act, whilst the other cooperates, will experience a free-rider benefit – enjoying the advantage of limited climate change without the cost. On the flip side, any country that imposes limits, when its competitors do not, incurs not just the cost of limiting its own emissions, but also a further cost in terms of reduced competitiveness – estimated here at an additional 3.0%. From the table it seems predictable that countries should prefer to be self-interested: the best national policy, if others reduce emissions, is to defect; likewise, if other countries are not taking action, then it is pointless to be the only sucker to take action, and one should again defect.

Repeated Prisoner’s Dilemma and Cooperation
The dynamics of the prisoner’s dilemma do change if participants know that they will be playing the game more than once. In 1984 an American political scientist at the University of Michigan, Robert Axelrod, argued that if you play the game repeatedly you are likely to see emerging is cooperative rather than defective actions. He identified four elements to a successful strategy which is this case can be applied to climate negotiations:

1. Be Nice – sign up to unilateral cuts in emissions, as deep as your economy and financing capacity allows.

2. Be Retaliatory – single out countries that have not commenced action and, in collaboration, find ways of pressurising them until they do so.

3. Be Forgiving– when non-compliant countries come onboard give them generous applause; signal that good behaviour will be rewarded with even deeper cuts in your own emissions.

4. Be Clear
– let everyone know in advance exactly how you are going to behave – that you will work with them if they take action on emissions, and that you will retaliate if they do not.

It is the belief of Michael Liebreich that this research by Axelrod should be put into practice by the world’s climate negotiators. As treaties on climate change are on-going and therefore become part of the game.

Economies of Scale – Sending a T Shirt from China to Europe for 2.5 cents.

The Economist had interesting piece on the economics of very big ships. If you wanted a good example of economies of scale look no further than sending a T shirt from China to Europe – 2.5cents is the cost. What allows it to be so cheap is the enormous scale of the new container ships that are now being produced – mainly in South Korea.

Maersk container ships transport a considerable percent of the world’s ocean freight and they have a fleet of over 500 container ships that sail every major trade lane. The big ships are 400m long and the ship can carry 7,500 40ft containers each of which can hold 70,000 T shirts – that makes a total of 525,000,000 T Shirts per container ship. Furthermore it only takes 3 weeks for the T shirts to arrive in Europe and the combination of the largest combustion engine ever built and a minimum crew of 13 personel to run the ship leads to signifiacnt economies of scale (see graph below – Point A being the lowest point on the long-run average cost curve LAC).

Given the rising price of fuel many companies feel they need bigger ships to improve efficiency and ultimately improve their margins. Maersk are looking to increase the size of container ship so that it can hold 18,000 x 20ft units. Freight rates have dropped significantly over the last year with the downturn in global demand and the oversupply of container ships in the market – the main players are:

Maersk – Neptune – K Line – Orient Overseas

According to The Economist shippers will seek economies of scale not only from bigger ships but also from mergers.

Emirates reduces fares to fill A380’s

Another hat tip to Andrew Larkey for this piece from the Arabian Business website. It seems that in order to fill their 517 seat A380 Airbus planes Emirates have decided to reduce its fares considerably.

Emirates will resist the urge to cut routes and flights as oil prices threaten the profitability of some destinations and instead aims to stir up demand with cheaper tickets.

It is estimated that 43% of the daily cost to airlines is fuel which is out of their control. However, Emirates believe that capacity reduction is not an option as it has been responsible for the collapse of so many carriers. Industry practice has generally been to halt growth when times are hard and costs high, focusing on the most profitable routes that can sustain higher fares. Emirates will stick with a rapid-growth model based on building Dubai into a high-volume, inter-continental travel hub using a wide-body fleet featuring 90 A380 superjumbos with 45,000 seats.

While cutting fares to sell tickets on the 517-berth planes will push up the occupancy level needed to break even, the impact of government spending cuts in many overseas markets means that strategy is more likely to succeed than one based on curbing capacity and raising fares.

That strategy is not advised as it reduces sales and dampens consumer confidence which ultimately affects, airports, holiday companies and businesses in destination cities, so that traffic often never returns. US-based Trans World Airlines (TWA) and Pan American World Airways are examples of major carriers that went bust by reducing the amount of destinations that they flew to.

Emirates engine overhaul shop – economies of scale

A hat tip to A2 student and airline fanatic Andrew Larkey, for this piece from the Emirates website.

Emirates Airline has unveiled plans for the construction of the most technologically-advanced Engine Overhaul Shop in Asia. The state-of-the-art Engine Shop will complement the present Test Cell Facility in Dubai and will be constructed on a 90,000 square meter piece of land at an estimated cost of US $120 million. The growth of the Emirates fleet and the subsequent number of operating engines have necessitated the need for an in-house Engine Shop in Dubai to provide the most cost-effective, efficient engine maintenance.

The Engine Shop will have the capability of performing 300 engine repairs per annum for the GE90 and GP7000 engines fitted to the B777 and A380 aircraft. Emirates has signed a Letter of Intent with General Electric (GE) to oversee the design and construction of the Shop using the most advanced technology, equipment and best practices in the industry.

A contestable market gone wrong – Taxis in South Africa

Just covering contestable markets with my A2 and came across a relevant article in the Otago University EcoNZ@Otago magazine. Up to 1987 the transit authority in South Africa had a monopoly on public transport. It was near impossible for private taxi firms to operate and the use of public transport was very expensive – many spent 20% of their incomes on the commute. In this context the demand for taxi services was high and many illegal operations started to appear. The government, believing that a more deregulated transport market would improve its effectiveness, eased restrictions on private taxis.

A huge number of taxis appeared on the market of which the majority were large 15-seat vehicles (aka Kombis) and they ran late-night and rural services, and travelled to locations that busses and trains did not. However in order to reduce the running costs of the Kombi the road-worthiness of vehicles became a concern whilst passenger numbers grew considerably. With the transport authority basically giving a ‘free reign’ to operators and displaying no control over operation location or price, operators banded together and formed ‘taxi associations’ to compete over taxi drivers and routes. By 2003 60% of South African commuters used the taxi industry which was believed to be worth approximately R12 billion (NZ$2.2 billion) each year. Rivalry amongst taxi firms got out of hand and many resorted to violence and blackmail in order to secure rights over the most profitable routes. In fact the industry became more like something out of the ‘Sopranos’ with the hiring of hit men against rival associations.

By 1999, in response to this on-going problem, the South African government increased spending on public infrastructure and overhauled the taxi industry.

Taxi-related violence and deaths in South Africa – 1991-1999

Libya and world oil

In 2008, at the height of the financial crisis, a barrel of oil reached $147 and amidst the turmoil in the Middle East there are concerns that this figure will reach over $200 a barrel. If this transpires there is a real risk of a double-dib recession especially in the US and Europe – if not New Zealand. In Libya, as rebels took control of the port of Tripoli its critical oil supplies remained squeezed, production from most of Libya’s oil fields was down to very low levels. The country’s wealth largely comes from oil and whoever controls the oil fields will ulitmately control the country.

Libya in the Global Oil Market

The Economist website has some good statistics about the oil industry. Libya sends 1.4m barrels/day to global markets which is around 2% of global demand. This makes Libya the thirteenth largest oil exporter. Saudi Arabia the worlds biggest exporter, and country with significant spare capacity, is already pumping an extra 600,000 barrels per day to make up for the shortage on world markets.

A recovering global economy had convinced traders that demand for oil was going to rise by about 2 percent in 2011. Some industry experts and Wall Street visionaries were predicting a gradual return to $120 and even $150. The thinking was that investors would pour money into the commodity markets. This was due to the huge increase in demand from developing countries which was threatening to obliterate OPEC’s spare capacity – see graph below.

If prices keep climbing, consumers will in all likelihood tighten their belts. If prices stay high for long, the impact could be severe: every oil shock of the past 40 years has helped push the global economy into recession. Nariman Behravesh, senior economist at IHS Global Insight, said that every $10 increase in the price of a barrel of oil reduces economic growth by two-tenths of a percentage point after one year and a full percentage point over two years – New York Times.

However, as the world is so dependent on oil there is little room for supply disruptions. Spare capacity is at 5 million barrels a day which is approximately 6% of what the world consumes every day. Although this is 4% higher than in 2008 it is still worringly low when one considers the demand pressures coming from developing countries like China and India. However that is not even taking into account the loss of about one million barrels a day exported from Libya. If Libyan oil was to be removed from the oil market it would represent the 8th largest oil shock in history – see graph below.
Much now hinges on what happens next in the Middle East. The price spikes that accompanied the two Persian Gulf wars did not have deep impacts because of they did not last long enough. But several oil price increases have preceded economic downturns. The biggest shock followed the 1973-74 OPEC embargo, which quadrupled oil prices and helped produce stagflation, a period of slow growth, high unemployment and inflation. The 1979 Iranian revolution caused another shortage, and again American motorists were forced to wait in long lines for gasoline. Oil prices surged, but they did not stay elevated for long, as Mexico, Nigeria and Venezuela expanded production and OPEC lost its unity. Oil prices remained low for years, and the economy through the later half of the 1980s and most of the 1990s was generally strong. New York Times

The long road to Beijing

You might have read about the huge traffic jam along a highway leading into Beijing – at one point over 100km long and lasting for 11 days. With the growth of the middle class and the subsequent increase in demand for energy and other goods there is huge pressure on the country’s infrastructure – in 2010 China has budgeted $11.8bn for transport infrastructure. However as the Chinese economy grows and the new motoring class emerges is this a sign of the future – more massive traffic jams. The major concern here is that in recent years rising vehicle ownership has outpaced the growth of China’s express highway – see graphic below from The Economist