Archive for Economics

The Elasticity of Electricity Demand

In an attempt to rebut economist Ed Dolan’s support of a carbon tax, I came across a RAND Study done for the Sacramento Municipal Utility District, which estimasted the short term elasticity of residential electricity demand at -0.2 and the long run elasticity of demand a -0.32.

This is a very inelastic market ( |elasticity| << 1 ), and so supports my argument that regulation is likely to be the most economically efficient approach to reducing residential electricity use.

Dolan compiled some numbers that put long run elasticity of gasoline demand at around 0.5, which also implies that regulation has a role to play in reducing gas usage, although it’s high enough that carbon taxes are also likely to be somewhat effective; a combination seems the best approach to me.

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Risk Aversion and Pricing Climate Risk

I felt the “Editor’s Corner” article in the most recent Financial Analysts Journal (Sept/Oct 2011) “Pricing Climate Change Risk Appropriately” does an excellent job explaining why the possibility of extreme climate scenarios justifies a considerably higher price for carbon than would be warranted under the most likely or average scenario: Humans are risk averse.

Equities… have low prices (and high expected returns) because their cash flows are discounted by society at high rates. The reason has to do with the anti-insurance aspect of equities: Their cash flows are highest in good states of nature whereby the value placed on the cash flows is low. In contrast, efforts to mitigate climate change by pricing carbon emissions will be most valuable to society if climate change turns out to have catastrophic consequences for society’s well-being. Because of this insurance aspect, society should be willing to pay higher prices for climate change mitigation.

FAJ Executive Editor Robert Litterman goes on to explain the mechanics behind carbon pricing models and their flaws, as well as why equity analysts are uniquely qualified to do these assessments.

I’ve long thought that financial market theory is uniquely applicable to understanding climate and the measures needed to mitigate climate change. what I don’t understand is why I hear so few analysts talking about it, so it was very refreshing to come across this article applying a deep understanding of economic pricing theory to what the greatest challenge the world will confront in the 21st century.

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Chaos Theory, Financial Markets, and Global Weirding

In my bio,
I usually state

My study of chaos theory led to my conviction that knowing the limits of our ability to predict is much more important than the predictions themselves, a lesson I apply to both climate science and the financial markets.

Despite having written about financial markets and clean energy stocks regularly since 2006, I have never before explained in print what I meant by that.  This summer’s heat wave and stock market turbulence illustrate how my intuition about chaos theory informs both my understanding of the climate and the stock market.

Chaotic Systems and Feedback

Poisson Saturne AttractorThe definition of a chaotic system I use is any system in which a tiny change in initial conditions can lead to a large change in results. 
Most chaotic systems are chaotic because they contain positive feedback.  Positive feedback tends to amplify trends over time, while negative feedback tends to reduce trends over time.  Complex systems such as climate and the financial markets have both positive and negative feedback. 

In the weather, we can see positive feedback when a series of hot, sunny days create a static high pressure system which keeps storms from moving in to cool things off.  When a storm does move in, you can get positive feedbacks cooling things off.  National Weather Service forecaster Daryl Williams said the following about a storm which broke the summer heat wave in Oklahoma: “It’s kind of feeding on itself, cloud cover and rainfall cools the air and the ground.” (italics mine.)

In stock markets, financial bubbles grow with the help of several types of positive feedback.  One such is “The specious association of money with intelligence,” as John Kenneth Galbraith described it in his short and very readable book on bubbles, A Short History of Financial Euphoria: Financial Genius is Before the Fall.  When we see others make money in a stock market rise, we tend to think they must have been smart to have known when to get in.  If we made money recently by buying stocks, we tend to think we are smart for having done so.  In both cases, we’re more likely to think that buying stocks is a smart thing to do, even if the profits were just dumb luck.  Collectively, this leads to more buying, which further raises prices.  Even if those price rises are justified in the beginning, the positive feedback can carry them up far beyond any level justifiable by the value of the underlying companies.  Many other positive feedbacks such as the wealth effect, relative valuation methods, and the increased ability to borrow against inflated asset prices operate in financial bubbles and bull markets.  In contrast, fundamental and value investors produce negative feedbacks by buying when prices have fallen and selling when prices have risen.

As with weather, external shocks to the system can reverse even these self-reinforcing trends, as we recently saw when the US’s political paralysis around the debt ceiling debate and Europe’s inability to effectively deal with their debt crisis recently ended the two year bull market in July.

Lorenz attractor 


Strange Attractors and Regime Change

Highly complex systems which have both positive and negative feedbacks tend not to be chaotic all the time, but rather exhibit chaotic behavior only some of the time.  The system will behave quite predictably in a deceptively regular fashion for a while, but then shift with little warning into another mode of behavior that is
also regular and predictable, but seems to follow a different set of rules.

Such behavior can be mapped with simple chaotic systems and often exhibits a pattern called a Strange Attractor, two of which are pictured with this article. 
As the system moves through such a strange attractor, it will often stay in one set of the rings curves shown for an extended period, before jumping to another set after an unpredictable period.

In the weather, we see this sort of behavior with extended heat waves, cold spells, or periods when it is hot in the morning followed by an afternoon thunderstorm.  Such patterns persist for days or weeks, but then quickly end to be replaced by a new pattern or a period of less predictable weather.

In the stock market, we have bull and bear markets.  In bull markets, good news is greeted with euphoria and strong stock buying, while bad news is discounted or ignored.  In bear markets, the opposite is true: good news is often ignored, while bad news leads to repeated bouts of selling.  In his excellent but somewhat
inaccessible book, The Alchemy of Finance, George Soros describes how he tries to spot such tipping points or regime changes as they happen.  Much theoretical work has been done to understand and model such changes, but the lesson I draw from chaos theory is that recognizing such changes in hindsight may be simple, but predicting them in advance is and will continue to be extremely difficult.  That’s probably why Soros did a much better job describing market regimes than explaining how to spot them. 

Nassim Taleb also addresses regime change in chaotic systems in his book The
Black Swan
http://www.assoc-amazon.com/e/ir?t=&l=as2&o=1&a=081297381X&camp=217145&creative=399369&#8243; alt=”” style=”border:none!important;margin:0!important;” border=”0″ height=”1″ width=”1″>.  His Black Swans are events which cannot be predicted solely by studying the past.  Such events occur, he says, because the rules we infer from the observation of events never contain the full range of possibilities.  He applies this lesson to societal events, personal experiences, and financial markets– all of which are chaotic systems.  There are also climatic Black Swans.

Global Weirding

If you accept that the world’s climate is a chaotic system
characterized by a strange attractor and a large number of climate regimes such as ice ages and warm periods, you should also accept that the relatively small changes we are making to the atmosphere have the potential to shift the world’s climate into a new regime where the weather patterns humanity is familiar with are replaced with a new set of patterns that we’ve never seen before in human
history. 

We are already aware of a few positive feedback mechanisms with the potential to amplify the effects of climate change, such as the ability of a release of methane from arctic permafrost and clathrates to rapidly accelerate global warming, or the disruption of the North Atlantic current due to melting polar glaciers.  Such scenarios are chilling enough, but the knowledge that climate and weather are a chaotic system raises the possibility of yet unknown mechanisms that might create rapid climactic shifts.  In a chaotic system, the past is not always a reliable guide to the future.  Climactic past performance is
no guarantee of future climactic results.

“Global Warming” can sound somewhat comforting.  “Climate Change” can sound clinical and distant.  A better description is “Global Weirding:” the climate is not becoming a warmer version of what we’re used to, it’s becoming an entirely new system, with a new set of patterns that will surprise anyone expecting a version of the old climate regime.

Conclusion

There is only one climate, while there are hundreds if not thousands of financial markets operating at any one time.  Financial markets also operate on a much more compressed time scale, with bubbles and busts compressed into a few short years or decades.  Ice Ages, on the other hand, last tens of millions of years. 

This difference financial markets and climate in number and scale means that we know much more about the chaos of financial markets than the chaos of climate.  We’ve probably already seen most possible financial market regimes in at least one of the thousands of financial markets, from tulip bulbs to CDOs, that have operated
over the course of human history.  Although the rules of markets change with new technology and communication, the basic rules of human psychology which govern these regimes have not.  To paraphrase Mark Twain, financial history may not repeat itself, but it does rhyme. 

Climactic history may also rhyme, but we’ve not yet read a full line of the poem: We don’t know what it will rhyme with.  Ice ages and warm periods often last tens of millions of years.  Given the infrequency of shifts between one climactic regime and another, it’s quite likely that the new climactic regime we are heading into will be unlike anything that has prevailed during human history, and possibly unlike anything in the geologic record.

The benefit of the slow pace of climactic history is that we do have a few years or decades during which we will be able to influence the path of global weirding. 

In a chaotic system, a tiny change today can lead to a large change in future outcomes. 

What tiny change are you making?

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The Rebounding Rebound Effect & How to Dodge Jevons’ Paradox

There’s a new paper from the Victoria Transportation Policy Institute looking into the price elasticity of both miles driven and fuel use. The author, Todd Litman, has done an in-depth literature survey which will be of interest to readers who liked my recent look into Jevons’ Paradox.

Jevons’ Paradox, also known as the rebound effect, states that increasing efficiency can lead to increased use of a resource, because the resource is now cheaper. I pointed out that this is only true in elastic markets, where the use of a resource is sensitive to price. In inelastic markets, it makes sense to mandate efficiency, because efficiency will not greatly increase use. In elastic markets, the best policy avenue is to increase the marginal price of usage.

One great example of this is the potential benefits of smart metering. While the early results of smart metering trials were very positive, seeming to show that average people would reduce their energy use by 10-15% when given good data, more recent and broader trials have shown that the actual effect is much smaller. The difference is that the early trials tended to be focused on particularly price-sensitive populations, such as people who had trouble paying their electricity bills who reduced their energy use for Woodstock Hydro. More recent trials have shown much lower reductions in bills because they have been serving the general populace, not just a particularly price sensitive subgroup, like the poor or people who volunteer to have smart meters installed.

Litman’s survey of price sensitivities reaches several interesting conclusions:

1) While the price sensitivity of driving is quite elastic, the price sensitivity to fuel cost is much less elastic because fuel only accounts for about a quarter of the cost of driving.
2) Price sensitivities were temporarily depressed over the last 25 years due to various demographic changes, and now seem to be rebounding. As a result, many policies meant to reduce fuel use (such as higher CAFE standards) are likely to be less effective than expected due to the rebound effect. Better policies would work to increase the marginal cost of driving without increasing the total cost. Such policies include Pay as you drive car insurance and registration.

There’s much more. I highly recommend it or anyone interested in policies to reduce our dependence on foreign oil. Blurb follows:

Changing Vehicle Travel Price Sensitivities, The Rebounding Rebound Effect (www.vtpi.org/VMT_Elasticities.pdf ).

There is growing interest in various transportation pricing reforms to help reduce traffic congestion, accidents, energy consumption and pollution emissions. Their effectiveness is affected by the price sensitivity of transport, that is, the degree that travelers respond to price changes, measured as elasticities (the percentage change in vehicle travel caused by a percentage change in price). Lower elasticities (price changes have relatively little impact on vehicle travel) imply that pricing reforms are not very effective at achieving objectives; that higher prices significantly harm consumers; and rebound effects (additional vehicle travel that results from increased fuel efficiency) are small so strategies such as fuel economy mandates are relatively effective at conserving fuel and reducing emissions. Higher elasticities imply that price reforms are relatively effective, consumers are able to reduce vehicle travel, and rebound effects are relatively large. Some studies found that price elasticities declined during the last quarter of the Twentieth Century, but recent evidence described indicates that transport is becoming more price sensitive. This report discusses the concepts of price elasticities and rebound effects, reviews information on vehicle travel and fuel price elasticities, examines evidence of changes in price elasticity values, and discusses policy implications.

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Who’s Afraid of the Big Bad Price Gouger?

Until I started reading Micheal Giberson’s posts on price gouging, I had not given the subject of price gouging much thought.

The main question of debate is “Is it moral for a retailer to charge more for a product when demand surges due to outside circumstances?” A classic example is charging for snow shovels in a snowstorm. In a recent post, Micheal poses the question:


Consider two hardware stores: one prices snow shovels at $15 when there is no snow and at $20 when there is snow; the other maintains a fixed price for snow shovels under both no-snow and snow conditions. In equilibrium, the second store will carry a smaller inventory than the first and offer it a price between $15 and $20. Which pricing policy is more moral?

I have to say that I don’t have a ready answer. I’m tempted to think that both store owners are acting morally, and that morality rests not with the store owner, but with the snow shovel customer.

If the customer plans ahead and receives the low “no snowstorm” price, there is no reason to complain. After all, who ever complains about a sale?

If the customer does not plan ahead, and is forced to buy the $20 shovel from the first store because the second store has run out, whose fault is it? I place the fault squarely on the customer who did not plan ahead for a snowstorm, and if that customer subsequently complains about price gouging, that complaint seems immoral in my eyes.

I think it’s everyone’s right to not plan for disaster if the consequences fall only on themselves. But if they then complain because they are being taken advantage of in the vulnerable position they’ve put themselves in, I have no sympathy. Buyer morality grid

Put simply, the store owners are planning for the snowstorm, and willing to accept the consequences of their actions. Buyers may or may not plan ahead, but it’s only when they are not willing to accept the consequences of their actions that I consider them immoral.

The only circumstance in which I’d place any moral onus on the store owner is when the disaster could not be foreseen. In this case, neither store owner will have snow shovels on hand because there will have been no market for snow shovels before the storm, so the whole question is moot anyway.

On the other hand, if the disaster can be be foreseen, but the consequences of not planning fall on society as a whole, then those who oppose preparing for the disaster are immoral because they are forcing others to share in the consequences of their decision.

If you read this blog regularly, you can probably figure out which coming disaster I have in mind. Are you advocating preparation, or opposing it?

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Drivers’ Rising Price Elasticity

A recent paper from Todd Litman at the Victoria Transport Policy Institute shows that drivers have become more sensitive to changes in the price of driving (and gasoline) in recent years.

Recent estimates of the long-run elasticity of driving are between -0.4 and -0.6, meaning that a 10% increase in the cost of driving should decrease miles driven by 4-6% over time.

There are several policy implications of rising elasticity:

1. People are more able to adjust their driving habits in response to changing prices, so pricing measures such as gas taxes, parking fees, and Pay-as-you-drive pricing are becoming more effective, and they are also more fair to the poor, who are likely to reducing driving more with an increase in price.

2. Vehicle efficiency standards will be less effective at cutting gasoline consumption due to the rebound effect: as the cost of driving drops with increased vehicle efficiency, people will drive more, partly offsetting the gasoline savings.

You can read the full paper here: http://www.vtpi.org/VMT_Elasticities.pdf

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Renewable Energy World Podcast: The Renewables Gap

As a long-time listener to the Stephen Lacey’s weekly podcast, I was happy to join in as he takes an in-depth look at the Renewables Gap: the question of where the energy is going to come from to power the necessary transition to a clean energy economy, an issue I looked at in Managing the Peak Fossil Fuel Transition.

I’m in great company on this podcast, so if you don’t tune in for me, you might want to know what Bill McKibben has to say about it.

You can download or listen to the podcast here.

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Other Objections to PACE Programs

Micheal Giberson over at Knowledge Problem bounced off my article on why PACE financing would be unlikely to damage the mortgage market to mention several of his own worries about how such programs are implemented.

He and I are in agreement that there’s little wrong with PACE programs in principle, but they raise some thorny issues in practice. Here are a few of his worries. Micheal says:

If PACE is just a way for homeowners to scrape up subsidies – i.e. to improve their properties and make their neighbors’ pay for it – then I’m against it.

I agree, but with a caveat: one justification for subsidies for energy efficiency is that energy efficiency has positive externalities, and creates societal benefits. To the extent that energy efficiency subsidies are societal payments for societal benefits, there is no problem with using PACE to scoop up as many as possible. In fact, it should be encouraged.

Here are some of the societal benefits of energy efficiency:

1. Lower energy consumption reduced the need to build and upgrade energy infrastructure, a cost which is borne by all.
2. Lower greenhouse gas emissions.
3. Predictable energy bills reduce bankruptcies and foreclosures, lessening the need for social services and raising property prices.
4. Less money spent on energy assistance programs.
5. Local jobs from the economic multiplier when money is not spent on fossil fuels imported from outside the region.
6. Reduction in local air pollution from local power plants.
7. Lower water use in electricity generation.
8. Lower energy prices because of reduced energy demand.
9. More total jobs because energy efficiency improvements tend to be more labor-intensive than capital-intensive energy production.

Micheal goes on to say:

If my local government was proposing such a program, I’d worry that mismanagement would lead to future obligations for non-participating taxpayers. What is the mechanism that ensures civil servants will be effective loan officers? Will they get bonuses for doing good work or just be paid the same salary and promoted on schedule whether or not the loans they approved achieve intended results?

I agree with Micheal on this one, but this all depends on the particular implementation, although I just finished reading Micheal Lewis’s excellent book The Big Short: Inside the Doomsday Machine
on the Wall Street’s role in the subprime mortgage meltdown, and so I’m compelled to point out that civil servants would be hard pressed to do a worse job extending loans to unqualified buyers than any of dozens of mortgage lenders from 2005 to 2008.

And finally:

Maybe the more interesting question is how and why the retail energy and home mortgage marketplaces became so bollixed up that a municipal-government-sponsored home-improvement-lending tax authority work-around is seen as a promising way to help consumers make sensible energy-related improvements to their homes.

Now that’s a great question. If you want to know why the mortgage market is so messed up, I highly recommend The Big Short, a book that makes highly technical subjects easy to understand. I can say that because I had to learn exactly how CDS’s on CDO’s work in order to pass my Chartered Financial Analyst exams, and I wish this book had been around back then… it would have made the task much simpler.

As for why the energy market is bollixed up, I think it has to do with lack of just about everything that improves market efficiency. The consumer energy market has limited price transparency, a lack of price information and real-time pricing, a single monopoly supplier, a lack of knowledge on the part of the consumer, regulated prices, a cost-plus pricing model for most suppliers, and subsidies for the purchase of energy for many classes of customers. With all this going against it, it’s no surprise at all that the market is so dysfunctional that civil servants as loan officers starts to sound like a good idea.

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Green Jobs Demystified

I read a lot of Green Jobs reports over the last couple of months, and the research culminated in three articles. One is for the next issue of Smart Energy Living, and will be published in the Fall ’09 issue, but the other two are available now.

In the first, I look at the differences in the potential clean energy sectors to create jobs (they’re all a lot better than fossil fuels), while in the second I analyze the arguments against a green stimulus.

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Todd Litman on Pay as You Drive Insurance

A couple weeks ago, I suggested to Bill Paul at Energy Tech Stocks that he interview Todd Litman of the Victoria Transport Policy Institute.

As an investor, I have yet to figure out a way to make money from Mr. Litman’s ideas, but as a citizen of the planet, I see his ideas as the best ones available for quickly and painlessly imporiving our society’s well-being while also reducing emission and oil consumption.

So I’m happy to say that now there is one more place you can read about pay as you drive insurance, and other Win-Win emission reduction strategies.

Part II: Get Paid for NOT driving to work
Part III:‘Congestion Pricing’ to Include Entire Regions

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Economics of Carbon Capture and Storage

Both Carbon capture and storage (CCS) and Enhanced Geothermal Systems need research and development to reach their full pormise of baseload power without significant emissions. What will be the costs of this research, and what will be the costs of the eventual elctricity production?

I take a look at these questions in my AltEnergyStocks column. Given limited funding, what would you choose?

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Corn is For Ethanol, Grass is for Cows

Last year my wife and I read Michael Pollan’s The Omnivore’s
Dilemma
, and it changed we eat.  My wife was greatly affected by how animals are mistreated in production farming, while I was attracted by the health
benefits of eating grass fed beef
and other foods grown in the manner to which they are evolutionarily adapted, as well as by the lower degree of harm to the environment.  We haven’t become all-natural, all-organic, all-the-time at the Konrad household, but we’re now much more willing to pay more when we have the opportunity to do so for food which we consider healthier and more environmentally and morally sound.  For a world-class tightwad like myself, being willing to pay more is a considerable step.

In any case, the book also got me thinking more sympathetically about the ethanol industry, because it serves as a relatively benign outlet for the mountain of corn produced by America’s insane farm policies.   I find rising price of corn and other grains is more a cause for celebration than despair, because I see current prices more as a return to sanity rather than a likely cause for starvation.  Even in the third world, low agricultural productivity is (in part) due to a lack of incentive to compete with subsidized first world production, rather than an inability to grow enough food.  The market for corn has been massively distorted by oversupply caused by too many subsidies.  Ethanol represents a new source of practically inexhaustible demand which is restoring balance to a market too long out of kilter.

One practice which the massive flood of cheap grain begat was feeding corn to cattle.  In my AltEnergyStocks
column this week, I look at one way I think the market may be starting to find its equilibrium again.  As corn prices rise, there will be less incentive to fatten cattle in feedlots (or Concentrated Agricultural Feeding Operations, CAFOs ad Michael Pollan calls them), and more to feed them grass.  I believe that long before we can perfect the art of using energy crops such as switchgrass to make cellulosic ethanol on a commercial basis, the rising price of corn will make it economic to feed those same energy crops (i.e. grass) directly to cattle, more than doubling the amount of corn currently available to the ethanol industry.

Click here to read the entire column.

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Modern Portfolio Theory and Electricity Generation Planning

I mentioned on Saturday that I had gotten some ideas which I planned to use in testimony before the Colorado Public Utilities Commission Least Cost Plan.

Yesterday, I ran my ideas by my friend Morey Wolfson, who is currently serving as head of the utilities program at the Govenor’s Energy Office. Like many members of the local energy advocacy community, Morey was recently tapped by Governor Ritter to help jumpstart Colorado’s New Energy Economy.

I hit the jackpot by talking to Morey, because he turned me on to the work of Shimon Awerbuch, who has been thinking along these lines for years. I’ve just read the first couple pages of his working paper Applying Portfolio Theory to EU Electricity Planning and Policy Making and I’m confident that he’s done a lot of the hard work for me. Here’s one great quote:

    Least Cost procedures are roughly analogous to trying to identify yesterday’s single best performing stock and investing in it exclusively for the next 30 years. Clearly, modern finance theory offers better tools.

Dick Kelley, are you listening? I have a hunch Ron Binz will be….

So what’s the big deal?

I almost forgot to say why this is such a big deal: According to Awerbuch and me, renewable energy and energy efficiency projects deserve a lower discount rate than conventional generation when projects are being evaluated, due to the fact that their costs have low (or even negative, in the case of solar) correlation with electricity prices in general. To use the stock valuation metaphor again, renewable resources are like low and negative beta stocks: the benefits in reduced risk to your portfolio justify paying a higher price for the same level of earnings or dividends.

What this means when evaluating utility projects is that the typically relatively high up-front costs of renewable energy resources do not have to be justified solely by their lower operating costs, but it gives a methodology for taking into account the benefits of reduced risk. This is something that renewable energy advocates have been arguing for a long time. The relatively new part is this gives us a way to quantify those benefits, and utility commissions are very fond of numbers to back up thier decisions.

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Visual Comparison of Electricity Generation Technologies

I just put together a couple graphs for a talk I’m giving on Monday to give people a visual feel of the various technologies for generating electricity.  These come with a gigantic caveat: the numbers are far from precise.

With changing technologies, it’s impossible to represent any of this with a single number anyway.  I’m trying to show how the technologies compare to each other, and I used four parameters:

  • Cost ($/MWh),
  • Availability (better the closer the profile of the technology matches a normal demand curve (wind is bad, baseload is okay, dispatchable is best, solar),
  • Emissions (and I count waste storage when it comes to nuclear),
  • Bubble sizes represent the size and durability of the resource (I’ve tried to combine in one number how much power we can get from the resource, but also how long supplies of fuel will last.) 

In both charts, the “best” technologies are in the upper left (low cost, low emissions, and available when we need them.)

I know that I’m going to upset a lot of people because I was too harsh with their favorite technology, so feel free and comment on the numbers I’m using, but also please provide references for where you get your numbers.  Most of these are off the top of my head, so their accuracy is admittedly questionable.   Here are the numbers I used to make the graphs.

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The Psychology of Energy Efficiency

Efficiency is unquestionably the largest, cheapest, and cleanest wedge among the many we need decarbonize our energy economy.  Energy efficiency tends to cost just 1 to 3 cents per kWh saved, far less than even coal-fired generation.   Every renewable technology, from wind to solar, to biomass, has trade-offs.  At the very least, we have to decide if the energy we are using for one purpose is not better used for something else.

Energy efficiency is the exception to this rule: you can not use a kilowatt-hour or a BTU over and over again.  Given these advantages over generation, it’s amazing that energy efficiency is nevertheless so extremely cheap.  Given an even moderately efficient [pun intended] market, you would expect that all the cheap energy efficiency measures would long ago have been taken until the marginal price of the next efficiency measure was above the marginal price of added electricity generation.

So why hasn’t it? 

Why is TXU trying to build a half dozen coal fired power plants in the face of broad opposition from the community when, for a fraction of the cost, they could instead pay to help people insulate their homes, change to more efficient air conditioners, and replace energy efficient lighting and save as much power as they plan to generate with the coal plants without any cost for fuel and harm to the environment from mining and emissions?

For that matter, why don’t TXU’s customers (and the rest of us) take these steps ourselves, when the internal return on investment is many time what we can rationally hope to achieve in the financial markets, and in many cases is even higher than the interest borrowers with the worst credit ratings pay on their credit cards.  (Like most financial advisors, I hate debt, especially credit card debt, but even if you’re drowning in $30,000 of credit card debt at 25% APR, it still makes sense for you to buy a pack of CFL’s at $3 each on that high-interest credit card, and replace every incandescent light bulb in your house that you use more than 2 hours a day.)

Here’s a blog which does a good job outlining the usual answers: lack of financing, perverse incentives, and disinterest on the part of people for whom energy is only a tiny part of the budget (all of which are true.)  He goes on to outline perscriptions that will undoubtably help to break down the barriers to the adoption of many Energy Efficiency measures.

I see other barriers that lie behind these.  Not just a failure of normal market forces, but conceptual problems.   While energy in general is a fuzzy concept to most people, using less energy is even less tangible.  You just can’t drop energy efficiency on your foot.  You’re not even at risk of electricution from it.

The pernicious consequence of systems of measurement is always that things we can’t measure go unnoticed.  If you have a hammer, everything looks like a nail, but even more insidiously, things that will never look like nails no matter how hard you squint dissappear from your vision altogether.  It is this psychological quirk that makes energy efficiency go unnoticed.

What image comes to your mind when I say “wind power”?  If you’re anything like me, you probably had a image of a forest of giant wind turbine blades turning gracefully on the horizon like ballet dancers.  Or, you might be like my wife, who would also have an image of a wind farm, but thinks they are ugly (although not so ugly as the haze from a distant coal plant) despite recognizing their necessity.  She wishes they were painted to camouflage them into the background.   Whatever your attitude towards wind power, you probably saw an image.

 Now try “energy efficiency.”  It’s a lot trickier, isn’t it?  I think about energy efficiency all the time, the way a teenage boy thinks about sex (okay, maybe not quite that much), and even I can’t settle on an image.  My mind flashes from the act of replacing an incandescent bulb with a compact fluorescent lightbulb (CFL) to an industrial scale combined heat and power facility, to closing the blinds at night to keep the heat in.

Not only is energy efficiency hard to picture, it’s also hard to measure.  To compute the energy savings from any activity, you have to establish a baseline: how much energy would you have used if you had not changed your methods.   Even in the simplest case of replacing a CFL, we don’t really know that the bulb we replace would really have stayed in the socket until the CFL breaks: A CFL can easily last 10 years, and by that time, we may be replacing all our bulbs with LEDs.  And that does not even begin to account for the effects on our HVAC systems.

Is your mind spinning?  That’s my point.  It can be so hard to get our minds around all the impacts of energy efficiency that, for most people, the most people, it may actually be rational to waste a little energy in order to avoid the headache that trying to get their mind around efficiency may entail.

The problem is, that decades of conserving brain power has left us as a society that wastes energy egregiously.

My prescriptions, designed to make thinking about efficiency easier:

  1. Measure energy use at every opportunity.  Many Prius drivers report that the real-time MPG gauge on the dash causes them to change their driving habits to grive more efficiently.  Getting a Kill-a-Watt energy meter makes us think more about our next electronics purchase.   Getting to know your electric meter can also motivate you to track down wasted energy.  A radical idea: on new homes, the electric meter should be inside, along with the circuit breakers.  New meters can be read (and even turned on and off) remotely, so there is no reason any longer to have them on the side of the house where we never see them. 
  2. Another thing we need to measure is when we use our electricity, not just how much.  Wholesale electricity prices can vary from a few cents per kWh to 30 cents or more during peak consumption.  As we move to a grid based on renewable energy supplies, most of which are intermittent and non-dispatchable, we need to get used to paying the real-time price of the energy we’re using.  Wide-spread adoption of time of use metering will drive the invention and adoption of appliances that can adapt themselves to changing prices.  There are direct, immediate benefits to the system by shaving peak loads, but the real benefits will come when people adopt new ways of doing things and new devices that will cause our appliances to run and our devices to charge when electricity is plentiful, and runonly the most essential uses of electricity when it is scarce.   Xcel is currently doing a pilot study on Time of Use Pricing in Colorado.  The preliminary result are that the right pricing scheme encourages customers to change their energy use much more than they had anticipated… but it still would not be “economic” to change out meters for more sophitocated models capable of handling this sort of billing.  Their definition of “economic” almost certainly does not include the benefits of the creativity which realistic pricing would unleash. 
  3. Allowing utilities to profit from selling less rather than more.  This concept, known as decoupling, is covered well here.  It’s important to remove (or even reverse) the incentive of utilites to sell us more electrons when we really want them to help us use less.

Finally, I do call this blog EE/RE Investing, so here are the sectors that I see benefiting from these recommendations as they are adopted:

  1. Companies selling advanced metering devices, and control systems that adapt to changing electric rates.
  2. Companies that sell building management systems.
  3. Energy storage technologies, such as as advanced batteries, flow batteries, and compressed air energy storage.
  4. Broadband over power lines technology, to handle the increased flow of information.

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Holistic Approaches to Energy Problems

H. L. Mencken said, “For every human problem, there is a neat, simple solution; and it is always wrong.”  When it comes to solving the problems of peak oil and global warming, I also think that the loudest barking is up the wrong tree.  We look for the quick fix, trying to find a substitute energy source that allows us to change the way we do things little as possible, when the real problem is actually what we’re doing, not how we’re doing it.   We need holistic solutions, not quick fixes.

Too abstract?  Here are some concrete examples:

 Problem: Peak Oil

Quick fixes: Ethanol and slight increases in vehicle efficiency standards.

Holistic solutions: Change our driving culture and infrastructure, by changing the way car use is priced from fixed charges to a per mile basis (“Pay as you drive”).   Removing subsidies to use cars when other forms of transport are available, and redesigning our cities to make them easier to get around on foot, bike, and public transport.  Like other holistic solution, all these steps increase safety and reduce congestion, reduce obesity and associated health problems, as well as reducing the use of gasoline.

Problem: Wind and Solar are intermittent resources, but coal produces too much CO2 and natural gas prices are rising rapidly.

Quick Fixes: Nuclear power and “Clean” Coal.

Holistic Solutions: Shift our demand for electricity to times when it is available, by using time of use pricing, energy storage and demand alignment, and distributed energy storage such as plug in hybrid vehicles.

Investing opportunities:On thing that’s striking about these examples is it’s much easier to find investment opportunities in the quick fixes than in the holitistic solutions.  To invest in ethanol, you can just buy ADM or one of the multitude of ethanol stocks that have been going public recently, but I have yet to come up with a satisfactory way to invest in better urban planning (except buy a house in a walkable community, which is something I’m planning on doing this summer.   Stapleton is the community.  I currently live there, but I’ve been renting and waiting for the end of the housing bubble.  I actually don’t think that housing is going to go up again any time soon, but I’m tired of waiting.) 

The investment landscape is a little better when it comes to energy management.  Itron and Siemens both have divisions that help utilities manage their grids better, and there are many battery and other energy storage companies to choose from.  Still, it’s a lot harder to pick through battery companies than to just buy a nuclear powered utility or uranium miner.

Holistic solutions, by their nature, have weak boundaries… the benefits tend to be diffuse, and spread over society as a whole, so it is difficult to charge fairly for them.  This, I think, is why there are so few companies pursuing them when they can pursue a quick fix that they can charge for up front.  

Companies have an obligation to their shareholders to make money.  It’s our job, as human beings, to work towards regulations that make it easier for companies to make money with holistic solutions that actually solve the problem than it is to make money with quick fixes that just cover the problem up.

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Win-Win Auto Insurance

On Thursday, I attended NREL’s Energy Analysis seminar, which this week featured Todd Littmann of Canada’s Victoria Transport Policy Institute, on Win-Win Transportation Solutions.

As an economist focused on policy, Todd Littman Photo of Todd Littmanhas done a lot fo thinking about what are the costs to society of transport, and what sorts of perverse incentives are there that are making these costs much higher than they would be otherwise.  He has a ton of extremely interesting ideas which will be useful to reduce transportation energy use for little or no cost, by simply removing perverse incentives.  I’m only going to go into a couple that I thought were most surprising or innovative here, so I urge you to read the whole paper on which his talk was based on VTPI.org.

One surprising result for me was that the greatest costs to from driving may not be the costs of gas, pollution, or global warming, but the cost of accidents, which are infrequent, but can be extremely expensive.  Even before adding in additional costs of congestion, wear on roads, etc., you do not need to be concerned at all about global warming to want to reduce vehicle miles traveled.

 And reducing vehicle miles a is far more effective and quick way of reducing transportation energy use (as well as vehicle accidents) than improving vehicle efficiency.

He has many ideas on cost neutral ways to reduce vehicle mileage, from broadly discussed ones such as smart growth, price shifting fuel taxes, and road and congestion pricing, and he does analysis on how cost effective all of these are.

What really got me to sit up and pay attention was an I dea I had heard no where else, which was all the more interesting because he feels it is the most cost effective (in fact, cost-negative: it pays more than it costs) method of reducing vehicle use: Pay-As-You-Drive pricing.  The idea is simple: instead of paying vehicle registration and auto insurance based on how long we have the car, we should pay based on how far we drive it.  

Since the safest place for out vehicle is in our garage (including theft and hail damage) this makes more economic sense than the current monthly payments for auto insurance, and since the costs we place on the transport system also increase the more we drive, it also makes sense for vehicle registration fees.   Because rich people with fancy cars not only tend to drive more than the poor, but because their registration fees are also already higher than those for inexpensive cars, this may even make the fees more progressive than they currently are, but some fine-tuning may be needed.

Since this is a purely regulatory reform, costs of implementation are minimal, consisting of only an annual odometer audit after the system is set up; an audit which could easily be combined with other scheduled service to minimize the cost.

According to his numbers, pay as you drive insurance and registration would average about 21 cents a mile for most people (about twice the cost of gasoline,) which I can easily see as enough to make most people think harder about how to maximize how efficiently they drive, or even consider public transport where it is an option… most public transport would become much more cost effective for people, without adding to their financial burden.

You might worry that people with long commutes and no public transportation might be unduly burdened by this shift, but we need to remember that they already pay more for auto insurance, because these are questions the auto insurance company asks.  The big difference is that there would be an increased marginal cost of driving, and it is the marginal cost of an activity that has the greatest effect on behavior, not the average or total cost.

The Vattenfall Institute recently found that the cost of stabilizing the United States’s share of CO2 concentrations at 450 ppm by 2030 would actually be negative, and it’s innovative solutions like those coming out of VTPI that let us get paid to cut emissions.

What are we waiting for?

Links: Victoria Transport Planning Institute: www.vtpi.org

Win-Win Transportation Solutions

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Vestas coming to Northern Colorado

It now looks likely that Vestas, the world’s largest wind turbine manufacturer will build a blade manufacturing plant in Nortern Colorado, near Windsor.  I’d guess that some of the factors that made Danish Vestas consider locating here are:

  1. The proximity to NREL’s Wind Technology Center for turbine testing.
  2. Amendment 37, which will require large investments in wind farms in Colorado.
  3. The State’s central location, making it easy to ship blades anywhere in North America.
  4. Political support for wind, especially from newly elected Bill Ritter and the Democratically controlled state legislature.
  5. Colorado’s excellent wind resource.

The 500 high-paying jobs will be ones wind advocates can point to when talking about the benefits of renewable resources over fossil fuels.

UPDATE:

It’s official. According to this follow-up article in the Rocky Mountian News, transport was indeed crucial to winning the bid. In particular, they wanted a site with rail service.

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Banking decisions: Returns or Environmental Responsibility?

Follow-up on my 1/15/07 blog entry

I heard back within an hour when I emailed New Resource Bank… I still have not heard back from Eco-Bank, two days later, so they are out of the running for my business. 

I have to admit, I’m leaning against going with New Resource anyway, and looking into local banks so that I have the added convenience of local ATMs.   I believe that it is good to put our money where our morals are, but that we should not pay too much to do so…  If I go with New Resource, I effectively tie up $4000 of my money at zero interest, vs. $1000 tied up at the local credit union. 

If I go with the local credit union, the $3000 difference will naturally be invested in projects that help the environment AND are likely to earn good returns, but $1000 is tied up, possibly financing someone else’s Hummer. 

If I go with New Resource, my $4000 minimum earns no returns, but is still invested in projects that help the environment.  Is the loss of earnings on the $3000 worth the fact that the other $1000 will be invested in an environmentally sound manner?

I think I’ve talked myself out of using New Resource… For me, my money is better deployed elsewhere.  For you, the calculation could easily be different: my job is to find investments that are both good for the environment and good for the pocketbook… so I always have more environmentally sound opportunities than I have money to put into them.  

For most people, the opposite is true.   Finding sound investments is extremely difficult (and usually harder than it seems), but complicating things with the added requirement that the investments also be environmentally sound moves the task totally out of reach.  So, given that you are probably not a green investment professional, you will be giving up less potential earnings on the account minimums, and using them for your banking needs is an easy way to ensure that your money is being used responsibly.

Keep in mind, this entire discussion is based on the requirements of New Resource’s Business Checking accounts…. the account minimums are much lower for their personal checking accounts, and so the trade-offs there are not so dire.  Unfortunately for New Resource, I am not in the market for personal banking services… I have an excellent deal through my broker (a deal which they are unfortunately unable to extend to my business account.)

See comments for a response from Peter Liu, New Resource VP & Founder.

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Energy’s Place in Economic Theory

I recently started studying for the second (in a series of three) CFA® examinations (I passed the first one last June.)  The CFA charter is a credential often used by stock analysts and money managers.  In addition to an industry work requirement, there are 3 tests, which are administered once a year, covering a curriculum including Statistics, Economics, Financial Theory, Ethical standards, markets and the like.    

I expect to study about 200 hours for the exam, which is in June. By the way, if there is anyone reading this in Denver who also is studying for the Level II exam, I’d be interested in getting together to work through some of the problems and share study materials.

I just finished a reading on theories of economic growth, a chapter from Economics by Michael Parkin, which is probably one of the best basic Economics text books out there.  It’s been a long time since I took an Economics course, and so I had forgotten how economic growth theory is taught.   

I was disappointed. 

Why?  Because the role of energy use in labor productivity is almost completely ignored. (Labor productivity is simply the sum of all economic activity divided by the number of hours worked.  Since the number of hours worked is relatively easy to measure, growth in labor productivity is the key factor which needs to be understood in order to understand economic growth.)  All three theories covered attempt to explain labor productivity through the interaction of two factors: the ratio of capital to labor employed, and technological change.  As a short aside, the role of energy use is given a slight nod, because the drop in productivity growth in the United States in the 1970s is attributed to the Energy Price Shocks of ’73-4 and ’79-80, in addition to a diversion of effort for coping with environmental problems.  To me, that sounds eerily familiar.  Those are precisely the same problems I expect the world will be trying to cope with for the next decade and beyond.   It’s not that economists as a whole fail to recognize the role of energy use in keeping our economy going.  For example, the effects of the recent rise in energy prices have been widely discussed, and many pessimists (myself among them) have been surprised at how little effect rising energy prices have had on the economy.   The explanation for the lesser effect on economic growth is that our economy has become (partly as the result of the ‘70s price shocks) much more efficient, requiring less energy per unit of GDP. What bothers me is that energy is dealt with as an aside, not as one of the major factors in determining economic growth.  For most of the 20th century, we were blessed with energy supplies which we could increase at will to meet increasing demand, so supply constraints were seldom a factor in determining the growth rate.  In a sense, economist theory is like military strategy: there is too much emphasis on figuring out how to win yesterday’s battles, not tomorrow’s.  Tomorrow’s economic battles, as I see them, will be learning to cope with diminishing supplies of fossil fuels.  Economists, who are the ones who will be helping society plan those battles, should be taught the role of energy in economic growth as part of their framework of understanding, not as an aside or afterthought.  This brings to mind the other aside in the chapter: The other cause given for the slowing of productivity growth in the 1970s was due to the expansion of laws and resources devoted to protecting the environment.  This is perhaps a graver weakness of economic dogma than the minor role for energy.  Because we measure only economic growth, and do not count natural resources like clean air and water among our assets, destruction of those assets is much more likely to be overlooked or minimized by policy makers than it would be otherwise.   This concept is known as Green GDP, and is still very much a fringe theory in economics, in large part because it is fiendishly tricky to measure accurately.  Unfortunately, what isn’t measured is usually ignored, and, like the unmeasured risk of terrorists flying airplanes in to skyscrapers, is likely to come back to haunt us in time.

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