Wednesday, August 09, 2006

Risk Mismanagement, or, It's the Infrastructure, ******

by Ken Houghton

The other thing (besides this) that caught my eye in the 29 July- 4 August issue is this Economist story about the Queens blackout (may require subscription) is this 'graf three paragraphs from the end, almost a throwaway:
Indeed, one of the ironies of this week's power failures is that America is at last starting to grapple with the most entrenched problems in its electricity system. After the 2003 blackout, a joint American-Canadian taskforce delivered a withering 228-page report highlighting the failings of the utilities—which, among other things, had not been regularly monitoring the condition of transmission lines [emphasis mine].

It is difficult note to speculate that this situation was caused in no small part by the deregulation of the energy companies. But that's not (directly) what brings me to discussing this.

Rather, in a fortunate dovetail (via Mark Thoma), Brad DeLong notes that "the death of distance" is very dependent on having a functioning infrastructure. As such, one of the advantages of our tax code is that it is structured to ensure that infrastructure is maintained, at least within a given company.

The corollary to a need for infrastructure is our generous Depreciation and maintenance tax credits. Between them, there should never be an infrastructure maintenance issue for any firm that can fairly be described as a "going concern."

Everyone who owns a car or an appliance (including computers) is exposed to maintenance costs. It's a central tenet of the TCO religion that maintenance expenses should be considered before any purchase.

For companies, the compensation for having to replace machinery that is past its value, or to do maintenance is that they get tax credits and are allowed to depreciate the value of their assets. They can then effectively buy and replace capital assets at no net cost to the company (assuming the firm has the cash flows to cover such replacements, but we are talking about going concerns here, not a fly-by-night operation).

So, unlike my household, which "boasts" three 8-track players (one of which works, sometimes), there is no excuse for a company such as BP, whose latest Alaska oil spill came about:
BP discovered corrosion in the transit lines only after the Department of Transportation ordered an inspection following a 270,000-gallon spill in March at another section of the field....

BP officials said the line where the leak was found was last checked for weakness in 1992, using a technology called a "smart pig" in which a device is sent down the tubes to assess pipeline integrity. [emphases mine]

So we have a utility company that doesn't monitor the quality of its transmission lines and an oil companies that doesn't worry about its pipeline (in far from optimal conditions).

I don't monitor every little piece of my car, either--but I know well that Ray's people are going to charge me $65/hour and am willing to take the tradeoff between that and spending a couple of years in auto shop.

Who will charge BP and Con Edison? If the status quo remains, unfortunately, Attaturk provides the answer here.

When I was a wee trader, in the mid-1980s, our firm did its annual "let's-make-fun-of-ourselves-for-the-holidays" reel. One skit had a deal being done in the Cleveland office:
We'll book the profits in Cleveland, the risk in Dallas, and the expenses in Los Angeles.

Apparently, those bankers are now running BP. And Con Edison. And maybe you're infrastructure-dependent firm as well.
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