Archive for the ‘Energy’ Category

Energy market fail – the case for ordoliberalism

For once David Cameron has done the roughly right thing in restricting the energy companies to only four tariffs although I would have liked to see even fewer.

For years the received wisdom has been that competition – not just in energy, but generally – is a Good Thing; any evidence of that a market isn’t working properly is routinely greeted with calls for more competition.  It’s become so ingrained that almost no-one stops to question why it don’t always work as it’s supposed to.

Unfortunately for market fundamentalists, a growing pile of evidence suggests that their economic theory is wrong because it’s simply not an accurate description of how the real world works and ‘free market’ competition isn’t delivering the goods.  How this has been working (or rather, not working) was discussed on last week’s edition of ‘This Week’  with  guest Martin Lewis of Money Saving Expert (starts at 5:15).  His site has done a survey of its 14 million users and found that 80% don’t want the present system so this is political dynamite.

Martin Lewis pointed out that the energy market works as a regressive tax; affluent, middle class internet users pay the least while those in fuel poverty, disproportionately the poorest and oldest pay more, often substantially more.  He said that, whether or not Cameron really meant to say what he said on the subject recently, what he actually said is exactly what the public want, namely regulated prices.  For consumers competition has failed.

Michael Portillo reflected the uncertainty of many politicians.

“I think politicians reaching the point where they are beginning to lose faith in the ability of competition to produce the best deal for consumers but I think that is a big psychological and, kind of, philosophical moment if that’s what you actually conclude because, you know, for the last 20 years it’s been based on the idea that competition was going to give people a deal and in most things in life that’s exactly what happens. If you go to shops, telephones, if you fly on airlines, competition has brought down prices”

Note the positively baroque construction of his opening,“reaching the point where they are beginning to lose faith …“.  You can almost hear the gears shifting.  Whether he realises it or not he is calling the end of the era of neoliberal belief in the infallibility of free markets which Thatcher ushered in with her general election victory of 1979.   The old paradigm still rules by default in the absence of a better replacement but it’s mortally wounded and can’t stagger on much longer.

Portillo still clings to faith that competition reliably delivers in sectors other than energy.   However, here too evidence is piling up that not all is well with the received wisdom although, inevitably, the picture is complicated so no simple statement suffices.  I see at least three main problems (there are others but that would involve a book, not a blog post).

The first is the problem of ‘market failures’ including that markets don’t factor in externalities and that they reflect short-term supply and demand which makes them terrible where the long-term is important like planning for transport infrastructure or energy.  Market fundamentalists typically claim that market failure is rare and exceptional.  Indeed the whole basis of their faith is that ‘free’ markets (i.e. free of any government regulation) deliver optimal outcomes.

In reality, market failure is the norm.  To result in anything like a good outcome that is stable over time requires a long list of tightly specified preconditions which never, or almost never, occur in the real world.  For instance, any business sector with economies of scale (i.e. almost all) will tend towards concentration and oligopoly until the point is reached where competition is no longer effective.  The board game of Monopoly is a familiar example of how an early advantage drives growing concentration of power and inequality until it’s game over.

The second problem is that ‘free’ markets rarely exist – and then only briefly.  It doesn’t take long for oligopolistic businesses to work out how to influence the levers of power.  It helps the influencers that too many politicians are horribly star-struck and easily succumb to the glamour of money.  It can be revolving doors between companies and government, informal understandings with senior regulators and politicians, participation in standards-setting or even writing legislation.  The ways commercial power wins are limited only by human imagination – which is to say almost unlimited.  The result is the emergence of an interconnected elite.

Moreover, power abhors a vacuum so when government is weak the private sector quickly seizes an opportunity to fill the void.  If government decides not to regulate as a matter of either policy or weakness someone else will step in and the ‘law’ becomes whatever the new Mr Big says it is.   The law ran thin on the frontier of 19th century America so the theme of many westerns is the story of a big rancher employing a gang of thugs to enforce his own self-serving version of the law.  Much the same is true of Wall Street today thanks to the gutting of effective regulation as a policy choice.

The third problem is that real full-blooded competition is simply TOO effective for firms to survive it.  They must find ways of reducing the pressure on them.  The easiest way to do this is to merge with or take over rivals until the market is an oligopoly.  Hence the small numbers of serious players (typically 4 – 6) in a whole range of sectors from banking to supermarkets to energy.

It’s not that I’m against competition, far from it, but left to their own devices markets aren’t stable and won’t deliver the public policy goods.  Like advanced fighter planes the trade-off for high performance is that they are unstable.  The solution for planes is fly-by-wire systems that react faster than any human pilot ever could.

The solution for markets is the equivalent.  It’s a constant battle to keep them ‘open’ (subject to challenge) and keep them working for the public good.  This is a very different from what neoliberals advocate.

Equally, because full-blooded competition is ruinous it means that government should arrange things so that it is muted, so that there is a gentle pressure to improve and to innovate but not the imperative to eat the seed-corn to survive until next week.  That in turn means limiting pricing ‘freedom’ (aka anarchy) in sectors like energy.  And that is why I think Cameron, for once, is on the right track except I would like it to be even simpler – allow only one fixed and one variable tariff for each company with premiums and discounts for dual fuel or direct debit etc. expressed as a percentage.

This is ordoliberalsim and is the approach of most German liberals.  It’s worked rather well for them.

Cameron’s 2% nuclear deal

The Prime Minister has just been to Paris to sign a deal with France to, as the BBC puts it, “strengthen co-operation in the development of civil nuclear energy” with much happy talk of, “our shared commitment to the future of civil nuclear power, setting out a shared long-term vision of safe, secure, sustainable and affordable energy, that supports growth and helps to deliver our emission reductions targets“.

Translation: we have agreed a deal to buy a number of nuclear reactors from the French nuclear company Areva.

And this is a BIG deal.  According to Radio 4’s Today, the first four reactors will cost a total of £20 billion and will create 1,500 UK jobs.

But enquire a little and it doesn’t start to look too clever.  Interviewed by Evan Davis on Today, the boss of ‘New Build’ for Areva in the UK, was gushing about the potential, “the UK is the most exciting new build opportunity in Europe; it’s one of the most exciting in the world….”   He explained (above link) that, “Rolls-Royce will become our prime manufacturing partner to supply some £100m of key critical components of the reactor for each EPR [next generation nuclear power plant] that’s constructed in the UK“.   Apparently Rolls Royce will build a factory in Rotherham to fill orders flowing from the deal and this will include supplying equipment for orders in other countries.

Uh!

Do the numbers.  Rolls Royce is to get £100 million out of £5 billion per reactor – that’s just 2%.  Other companies will be involved but the Rolls Royce deal alone accounts for 80% of the £500 million identified so far.  And, according to their website, Rolls Royce already supplies “safety-critical instrumentation and control systems to all 58 operating nuclear power facilities in France …”  so it’s not clear how much of this work is actually extra.

And yet we have it straight from Areva’s senior man that this is “the one of the most exciting [opportunities] in the world“.  With that much buying power 2%, is a truly pathetic result.  The percentage will inevitably rise during the construction phase but much of that will be the modern equivalent of navvies.   The strong implication is that most of the high-tech value-added bits are coming from France.

This looks very much like a replay of the trains affair where a £1.4 billion contract was awarded to Siemens with one crucial difference.   This time as a result of years of dithering and confusion in Whitehall there is no domestic competitor;  we built the world’s first commercial reactor but no longer have a fully capable civil nuclear supply industry because the UK simply doesn’t provide a suitable ‘habitat’ for complex, technology companies headquartered here (Rolls Royce is a very rare exception).

£20 billion (and that’s just for the first phase of a bigger programme) is enough to make a big difference to the economy as any Keynesians would point out – indeed that new energy investment would do just that has been the constant refrain from governments over many years (although they normally prefer to talk more of renewables than nuclear).   The trouble is that the economic boost in this case is going largely to France.

Politicians have been grandstanding about how the latest technology was going to ‘jump start the economy’ since Harold Wilson’s “white heat of technology” speech (and probably long before that) but we are slowly and steadily going backwards.   It’s a good idea in principle but they just don’t know how to do it.

And yet the how of it is perfectly discoverable; any number of Asian countries, starting with Japan and later South Korea, Taiwan and others have worked out how to do it.   We could too – I don’t even think it’s terribly difficult – but first we would have to start asking the right questions and as far as I can see no political party is yet doing that.  Why not?

 

 

Fee and dividend – LVT for the environment

Just occasionally an idea comes along that is simply too good not to pass on.  So it is with James Hansen’s proposal for a ‘fee-and-dividend’ solution to controlling carbon dioxide emissions; it’s remarkably similar in concept to Land Value Tax.

Hansen points out that a successful approach must recognise a fundamental truth; that as long as fossil fuels are cheaper than alternatives their use will increase.  Lobbying against them may have some limited effect at the margin but in the scheme of things it amounts to shovelling fog. 

Hence the failure of Kyoto after which the global rate of increase in carbon dioxide nearly doubled according to Hansen.  In Europe the Emission Trading Scheme has been branded a scam after companies profited but emissions have not reduced while in the US Wall Street played a large part in devising the cap-and-trade scheme which is their equivalent and the big banks expect to make billions of dollars trading carbon permits.  These billions (plus the costs of operating the scheme) have to come from somewhere so in effect this is a tax on energy that will redistribute income from ordinary people to inflated City bonuses.  Great!

With the traders in charge its a racing certainty that the US market will prove as volatile and subject to political meddling as it already has in Europe; traders profit from volatility not from stability.  Yet individuals and companies need stability if they are to make sensible plans to reduce their emissions.     Moreover, many of the supposed benefits are illusory; manufacturers can evade the costs by simply moving production to developing countries while ‘offsets’ – alternatives to emission reductions – are often imaginary or unverifiable.  Hansen also argues that, in practice, cap-and-trade actually sets a floor on emissions; if they fall beneath the cap the carbon price collapses removing the incentive for further reductions – which is just what has happened in Europe.

All in all it’s quite unsupportable, especially when there is an alternative which is simple, elegant and avoids these pitfalls.

This is the ‘fee-and-dividend’ approach.  It works like this: the government collects a carbon fee at the mine or wellhead or port of entry for imports for all fossil fuels;  it is a simple, single amount – £x/tonne based on the contained carbon.  The whole of the fee income is then distributed to the public as a citizens’ dividend.  The price of goods would rise in proportion to how much carbon their manufacture, shipping etc. entailed so the public would pay, but only indirectly.    Companies would gain by the certainty and stability of the extra costs they would face and could plan accordingly.   A family with exactly average carbon consumption would net out, their dividend income exactly covering the higher cost of their energy intensive purchases.   Prudent people would gain at the expense of more profligate types by adjusting their lifestyle, choice of car and other purchases.   However, falling carbon consumption would reduce the dividend year by year so even the most prudent would have to keep cutting to stay ahead of the game. 

Hansen calculates that if the US introduced such a scheme and set the fee for contained carbon at $115 per ton it would increase the price of petrol by $1 per gallon and of electricity by 8 cents per kWh yielding a dividend of $3,000 per year to each adult citizen and that around 60% of voters would emerge as winners.  In practice it would be introduced gradually, with the fee escalating each year over perhaps 15 or 20 years so allowing utilities and others time to change their behaviour, build new plant etc. without causing too big a shock to the system so costs and dividends would never reach anything like these levels.

An obvious objection is that in the hands of Labour fee-and-dividend would mutate into just another stealth tax.  This must not be allowed to happen, nor should it be used to reduce National Insurance as some have suggested because this would only muddy the water.  I would even say that government should absorb the administrative costs from existing resources so that, quite literally, 100% of income would be paid out in dividends.  That would be refreshingly transparent!  

Under fee-and-dividend fossil fuel consumption and carbon emissions would fall as fast as new technologies were developed and deployed but there are other advantages that deserve a mention.

Firstly, many of the early winners would be the very people who most need help.  In effect, high consuming, 4×4 driving types would directly help those whose carbon footprint is limited by their poverty.  In other words, it would be a significantly redistributive measure.

Secondly, the certainty of a known and escalating carbon price would incentivize companies large and small to develop innovative low carbon solutions with the winners then ahead of the curve in developing export markets.  Ministers (and their shadows) love to talk airily of how they plan to promote ‘green jobs’ but it’s strictly BS;  laissez- faire policies have failed.  By contrast Germany, which was an early mover in pushing its industry in the right direction, has already got lots of green jobs – for instance the turbines for the London Array will be German while we struggle to persuade foreign firms to set up here.

Thirdly, although the climate change argument has provided the primary impetus towards carbon reduction, not everyone is convinced by it.   As it happens, we must in any case reduce our addiction to fossil fuels because of the looming threat of peak oil quite independently of any belief about climate change and this provides the basis for building a broader coalition in favour of action.   Fee-and-dividend will push the economy in the right direction.

One for the FPC I think.

Solar power nears the tipping point

Is photovoltaic (PV) solar power about to reach a tipping point and come of age?   A couple of announcements yesterday imply that it might be – and not just for niche markets and remote locations but for grid power – although sadly only in rather sunnier climes than Britain!

Arizona based First Solar has announced that it has concluded a memorandum of agreement with the Chinese Government to build a massive 2 gigawatt solar plant near Ordos City on the dry steppe of Inner Mongolia about 300 miles west of Beijing.   Construction will start next year with a 30 megawatt demonstration project and then proceed by stages until completed by 2019.  To put this in context that means that, when completed, this single plant will have a capacity equal to the entire UK fleet of wind farms as of January 2007.

Also yesterday, California based Nanosolar announced the opening of a new factory near Berlin to assemble finished panels from their PV cells.  When production is fully ramped up the highly automated factory will produce a panel every 10 seconds for an annual production of 640 MW.  All are destined for utilities and customer committments totalling $4.1 billion to date are claimed.   Nanosolar modules have been designed from the outset to lower the ‘balance-of-system’ costs – i.e. the costs of mounting, connecting etc. so that the overall installation cost is minimised.  They also revealed that their cells achieve up to verified efficiency off up to 16.4% although the median is a litttle better than 11%.  

Now PV has been around for a long time but its high cost has always ruled its use out except for niche applications.   To be a serious player it has long considered that vendors would have to get the capital cost down to around US$1 per watt and produce electricity at a cost of around 10 cents per KWh and yesterday’s announcements imply that both companies believe these goals to be within sight.

First Solar is relatively happy to discuss costs and claims that by the second quarter of this year its module cost had fallen to just $0.87/watt and it projects further declines to $0.52 – $0.63 by 2014.   At the same time it is working to reduce balance-of-system costs and is targeting a cost of $0.91 – $0.98 /watt, again by 2014.

These projected costs possibly explain the phasing of the Chinese project; half the contemplated capacity will be added in the final phase to start construction only in 2014 – i.e. only when costs are rather lower than currently.   In the meantime the Chinese have guaranteed the project’s revenues by means of a feed-in tariff which First Solar considers vital as they drive their costs towards ‘grid parity’ – where they become fully competitive with conventional sources.

Nanosolar uses a different technology and has developed a method of printing a thin film of semiconductor onto a flexible metal foil which it claims is 100 times faster than conventional high-vacuum deposition and which certainly ought to be highly cost-effective.   The company is coy about costs but claims that its utility panels are ‘profitable in a wide range of geographies and power markets’.   According to Wikipedia cell costs have been reported as only 36 cents /peak watt (which Nanosolar declines to comment on);  if even approximately correct this represents an amazing breakthrough and implies that they are already at the tipping point – or as near as makes no difference.

So what does all this mean for us in the UK? 

Firstly, I don’t believe we are going to get a significant development of solar energy in Britain.   We are simply too far north and too cloudy.   However, on a global scale it does begin to provide alternatives that will very quickly become important once grid parity (or even a reasonable approximation) is achieved. 

Secondly, it highlights that an immense immense amount of R&D is going on into alternative energy sources and that some of that is getting very close to commerciality.   While both these companies happen to work in the field of PV, others are making equally impressive progress in solar-concentrating systems (that use sunlight to create steam to drive a conventional turbine) and in nuclear.  I think it likely that 20 years from now electricity will cost less in real terms than currently. 

Thirdly,  the UK needs to do far more to create a favourable environment for R&D led companies.  Even now, while the Chinese are getting in at the ground floor, DECC is still consulting on a feed-in tariff system with a view to it being introduced only in April 2010.  (To be fair to Ed Balls, the announcement of his support in principle for feed-in tariffs was one of his first acts on becoming Minister – but that does not excuse the government’s prior tardiness).

Fourthly,  maybe we don’t need to worry quite so much about carbon dioxide levels in the atmosphere for the future.   We’re not there quite yet but we appear to be getting close to having technical alternatives to carbon-based technolocgies for generating electricity.  Although the total amount of PV out there is miniscule in comparison with conventional capacity, it will ramp up very fast once the economics favour it.

Another Gordon Brown sell-off

Another cunning plan from Gordon Brown as he sells off British Energy to EDF for £12.4bn.  Pierre Gadonneix is ‘delighted’ with the deal.  I’ll bet!

(Readers may recall that in an earlier cunning plan Gordon Brown sold off 395 tonnes of our official gold reserves at an average of just $275.6 per oz between 1999 and 2002.  As I write gold is $889.)

The background to this is of course that he is increasingly desperate to find a way to keep the lights on after circa 2015 in the complete absence of an energy strategy.  And of course the £4.3bn for the govt’s stake represents a useful bung for his fast-depleting coffers.

So, the grand strategy of privatising the old state-owned CEGB ends up with it back in government hands – except that this time it is a foreign government.  Some libertarians will probably say, “So what?  Ownership per se doesn’t matter.” but I think in this case it does because we are not playing by the same rules.  There is not a cat in hell’s chance that a UK company would ever be allowed to take a controlling stake in French electricity generation, EU or no EU.   Certainly the public is not impressed as the BBC’s ‘Have Your Say’ discovered (click on the ‘Readers Recommended’ tab for the majority view).  I’m with the crowd on this one.

There should be recriprocity; acquisitions here should be allowed only if they would have been allowed the other way round.  That’s fair and transparent.

The End of Oil

We are now counting down the months to the end of the oil era – the age of convenient, cheap and abundant oil-fueled energy that has made the World we know today.  This evolving energy crunch will shake the World to its foundations and bring almost unimaginable change over the next five years.  Ajusting to a post-oil World presents governments with far and away their greatest policy challenge; the credit crunch is a mere blip in comparison.

In short, we are at (or as nearly at as makes no difference) ‘Peak Oil’ – the time when Earth’s ability to produce this finite resource peaks before starting its inevitable decline.  Of course oil will still be produced in a hundred years’ time, but quantities will be tiny.  What is different about this moment in history is that it is from now (or about now) that oil must start to reduce as a source of energy.  There is simply no alternative.

The market has been signalling the coming crunch through the price trend over the last few years as shown in figure 1 (from The Oil Drum blog) below (click for a better view).

Figure 1

Figure 1

 The wiggly black line shows oil prices since January 2000, the blue diamonds show a trend line rising at 30% per year superimposed on to the oil price, and the yellow arrows shown the size of various temporary declines on the way.  The fall of the last few weeks turns out to be actually rather modest compared with recent history.   In fact, as the comments thread to the original article notes, a +30% trend, if sustained, means that the oil price doubles every 2.3 years and gets us to a price of $200 per barrel sometime in 2010.  Scary!  

I will return to the likely future price later, but first it is necessary to consider some of the supply and demand trends that will influence it.

Commodity market prices (including oil) are highly sensitive to small imbalances between supply and demand.  When supply exceeds demand (as it did until recently) market forces bid the price down until marginal supply (in principle the most expensive to produce) get squeezed out because it isn’t profitable.  Conversely, when demand exceeds supply then either supply must expand or marginal demand must be squeezed out.  That, in a nutshell, is what started to happen in ernest a few months ago.  Since supply didn’t increase much prices rose relentlessly until demand reduced.  (Obviously this is a simplified account which ignores stock changes and complications arising from different grades of crude etc. but none of these change the big picture I am outlining here.) 

So the first question is, “Can producers increase oil supplies?” to which the answer is a depressing, “Not materially.”  Figure 2 (also from the Oil Drum blog) shows gobal production for the last few years.

Figure 2

Figure 2

This shows an increase from roughly 2002 to 2004 (mainly due to Russian output recovering in the post-Soviet era) but since then it has been bumping along on a plateau despite the soaring prices which would surely bring any available new supplies to market.  In fact, without the slight up-tick in supply in late 2007, one would probably conclude that the trend since 2005 was one of gentle decline. 

The bumpy plateau is the result of the interplay of new supplies coming onstream and declining production from mature oil producing regions like the North Sea.  Yet as figure 3 shows global oil discoveries peaked in the sixties.

Figure 3

Figure 3

As a general rule peak production in a newly discovered region occurs around 35 years after its discovery if there are no untoward technical or political impediments to production.  In the real World such impediments often exist so the lag is slightly longer (think, for example, of the multiple problems of getting oil out of central Asia!). 

That is basically why, as I reported in an earlier posting, there are relatively few of the megaprojects that can make a difference in the development pipeline.  While the precise rate of decline from mature fields is difficult to forecast, the decline is inevitable and remorseless.  In fact, production is already declining in most oil producing regions of the World.  Oil is, after all, a finite resource.

Quoted reserves of any natural resource, including oil, always have an important caveat whether it’s explicitly stated or not – they are what it is judged feasible to produce based on existing technology and extraction economics.  Thus, figure 3 above refers only to conventional crude.  It does not include, (a) ‘unconventional crude’ (of which by far the most important are the Athabasca Tar Sands of Alberta), (b) the oil shales found at numerous locations around the World, (c) oil thought to exist under the ice of the high Arctic, or (d) in very deep water on continental margins. So the next question is, “Will changes to economics or technology make a difference?” and the answer is, “Yes, but not enough or soon enough to matter.”

The Athabasca Tar Sands are currently being developed at a hectic space but at a monstrous environmental cost and using huge quantities of natural gas.  Thus, although the quantities in the ground are sometimes quoted as being comparable with all the oil in the middle east or similar, the amount that can ever be produced is far smaller.  As a very rough approximation the Tar Sands should eventually produce enough for Canada’s own needs plus or minus a bit.

Oil shales are simply not economical with any known extraction technique and are unlikely to become so.

The cost of extracting conventional crudes from frontier areas (the high Arctic and deep sea) will, however, undoubtedly account for a growing share of World oil production in the years to come – but it’s growing from a low base as it is only recently that high prices have made it economical.  Moreover, there is a great shortage of just about everything required – skilled people and drilling rigs in particular.  Orderbooks for existing deep sea drillships are full for five years ahead and prices for new ones were raised by $100 million to $500 million per vessel (!) last year according to the NY Times so that even existing discoveries like those off Brazil cannot be properly developed for the moment.

Yet even if the Arctic and deep sea frontier areas could be exploited without delay they would not be enough to plug the growing gap from the decline of mature areas – we would have to discover the oil equivalent of a new Saudi Arabia every few years – and nobody thinks that likely.

In yet a further complication, oil production is not the same as oil available for export.  OPEC members are experiencing a massive economic boom on the back of high oil prices and booms mean more and bigger cars so their exportable surpluses are under pressure as shown by figure 4.  Here the downward trend of the last three years is unmistakable even with the recent up-tick in production.

Figure 4

Figure 4

 Moreover, two countries – the UK and Indonesia – have switched from being net exporters to net importers in the last few years.  This trend will continue with the result that remaining exportable supplies become more and more concentrated – almost all in unstable parts of the World.

The net result is that we have between 18 months and 5 years before the remorseless decline of mature fields swamps all the other trends and the World’s oil production tips irrevocably into decline.  It really isn’t possible to be more precise about timing because the statistics are dreadful and chaos theory rules.  We should plan for the worst case but hope for a better one.

So what of future prices?   There will be limited new supplies but it’s clear that massive new supplies will not, like the proverbial US Cavalry, come to the rescue in the nick of time.   The main burden of adjustment will therefore have to come from the demand side and in the short term the twin pressures of economic recession and high prices at the pump (especially in the USA) are doing just that and causing prices to fall back.

In the slightly longer term – say two years – the only sensible strategy is to implement policies that reduce demand while developing substitutes for oil.   If we succeed in limiting consumption oil prices might remain tolerable.  If we don’t succeed in shrinking consumption, market forces will take over and enforce reductions through sky-high prices.  I don’t imagine that the UK economy (or any other for that matter) could withstand $200 oil for very long without plunging into a severe recession that would be far more damaging than planned reductions.

In the coming weeks as time allows I hope to set out my view of how this could be done.  Watch this space!

Nick Clegg on World at One

Nick Clegg gave an excellent interview on the collapse of EdF’s bid for British Energy on today’s World at One.

He welcomed the collapse as an opportunity to rethink the whole [energy] strategy instead of selling off British assets at a cut price to pursue its nuclear strategy.  He also commented that, as I have argued in previous posts, there is simply not enough competition in the UK energy market with too much power concentrated in too few hands.

Quite right!