Energy & Society

Some thoughts on the Franco-German plan and financial regulation

2011-02-08T15:25:00.000-08:00

Barry Eichengreen laments about the lack of financial regulation as part of last Friday’s Merkel-Sarkozy proposal, and calls it a mystery. I certainly don't see it as such. The last three years have made it clear that both Europe and the United States have one single powerful coalition in economic policy-making: the financial sector. This must change.

Banks complain that their bashing has gone too far, but if one has followed policy-making around the world, one wonders if any bank-bashing ever even took place. Financial reforms both in the United States and Europe have been ineffective at solving the perverse incentives in banking. The financial sector retains political power in policy-making despite having failed in all of its social responsibilities: in providing liquidity, in allocating capital efficiently, and in managing risk. Providing liquidity, for banks, has meant encouraging over-indebtedness with high transaction costs when times are good, and freezing lending when recessions are nigh. Bankers will offer you an umbrella when, and only when, it’s sunny outside. Capital allocation is also all but efficient. Money has mostly flowed to consumption instead of investments with high returns. I don’t think I even need to mention risk mismanagement.

How is it possible that policy-making has been captured by banks that just caused the greatest recession after the Great Depression? One theory suggests that regulatory oversight by the electorate is a function of the salience and complexity of the issue area. Financial regulation has no doubt been a salient policy issue in the few years, but the complexity of the policy area means that the public is not demanding their elected officials to take any specific measures to regulate the sector. Of course, much of the complexity is just a smoke-screen invented by banks to shed off opposing coalitions to their interests.

The banks’ first preference is to have a global framework for financial regulation because they know that such a framework will produce weak regulation as a result of the least common denominator compromise among countries. However, banks also prefer national regulation over EU wide regulation because they fear that EU-level rules may be too stringent as well as make it hard to affect the outcome through lobbying. Domestic politics is safer because governments take care of their own – that is banks.

If we are to avoid catastrophic crises in the near future similar to the one we just had, as well as complete political capture of our governments by financial elites, we must build coalitions that stand against the financial sector. That simply means demanding more accountability from our elected officials why they have failed to regulate banks effectively. A European Citizens’ Initiative would also be a signal to policy-makers, although EU-wide financial regulation would finally have to be negotiated in the Council. We should not be intimidated by bankers’ threats to pull out their operations to countries with more favorable financial regulation. To the extent that they are managing savings and investments in Western countries, they are forced to follow national legislation, if they wanted to continue operation in those countries. I guarantee you they will. Similarly, money from emerging markets and developing countries should stay in those countries in the first place. After all, if banks claim to allocate capital efficiently, capital should flow to countries where it finds highest marginal productivity. That’s what Adam Smith’s invisible hand would do, if it existed.

More generally, the Franco-German ‘competitiveness pact’ hardly deserves its name. There is nothing in the proposal that will make the Union truly more competitive. Again, Barry Eichengreen is more optimistic than I am. However, I can't see how the productivity differentials can be corrected by abolishing wage-indexation. How does that stop inflation from creeping back to the periphery? It will certainly lower inflation, but in doing so it will drive a wedge between the poor whose income is mainly derived from a monthly salary and the rich who have other income sources.

The duty of journalism

2010-09-16T15:32:00.000-07:00

I was excited today as John Sides directed me to a Harvard project, called Journalist's Resource. The title, Knowledge-Based Reporting sounds like much needed training for journalists. However, the code of ethics disappoints me on a few accounts, namely:

Tell the story of the diversity and magnitude of the human experience boldly, even when it is unpopular to do so.
Support the open exchange of views, even views they find repugnant.
Give voice to the voiceless; official and unofficial sources of information can be equally valid.

Journalists have a great responsibility in explaining phenomena to people in narrative form. In the light of news stories such as Climategate, I would really like to see journalists FIRST assess how 'telling the story of the diversity and magnitude of the human experience boldly' affects the narrative, or how 'the open exchange of views' or 'the voice of the voiceless' helps people understand the phenomenon more accurately. You don't just give equal 'air time' to every person who wants to tell his 'side' of the story. That's irresponsible. You focus on explaining the meaning of the phenomenon. Nick Stern emphasised this (responsibility) well in his talk at LSE earlier this year.

Requiem for the Niger Delta

2010-05-21T06:30:00.000-07:00

According to Aaron Hay, The Financial Times would not publish this Amnesty ad. The accusation is quite plausibly true. The reality may be a bit too ugly to run on the FT. If there is one group of people who have been utterly screwed over by oil extraction, it is the indigenous people of the Niger Delta (for more info, see here, here, here, and here). The environmental concern is one, and it's only partly connected to the economic one. This Oxfam video says it all:

In all fairness, we need to emphasize the responsibility of the Nigerian government and the political elite, and not just blame it all on Shell. Granted, the former is a much more difficult target for us outside Nigeria.

On the Future of the Euro

2010-05-18T01:21:00.000-07:00

I had floated the idea to some friends of Germany temporarily leaving the euro as the least bad of all available options. Edward Hugh seems to share that view:

Having Germany temporarily separate from the Eurozone would, in fact, have a number of evident advantages. The first of these would be that citizens in the South would not need to see their wages slashed, while those in Germany would not be asked to pay for bailouts via their tax bill, or lead to blame Greeks or Spaniards for having their hospitals closed or their pensions reduced: ie it would all be politically much easier to handle at this point.

Evidentally German banks would have to swallow a write-down, as loans paid back in Euros would not be worth the same in (new)marks, but 70% of something (say) is better than zero or 20%, and the big plus would be that as the Euro devalued sharply the peripheral economies could rapidly return to growth, and government finances could be quickly turned round as exports grew, tourists returned, and (in addition) many of those coastal properties that currently stand empty could be sold. At the end of the day, what would be left would be a private sector, and not a public sector, problem, and it was (in part) the private sector who got us all into this mess (wasn’t it?).

Indeed this solution does to some extent coincide with what could be termed the new economic reality, since economic growth in emerging markets mean that these are fast becoming key trading targets for German industry, as consumption in Southern and Eastern Europe looks to be increasingly “maxed out”. In fact, according to the recent March trade report from the German Federal Statistics Office, the rate of interannual growth in exports to ex-EU “third” countries (34.7%, as compared with 15.1% for the euro area) was significant, while the volume of trade (34.2 billion euros as opposed to 35.2 billion euros for the Euro Area) is roughly comparable, and indeed at this rate countries outside the EU will soon replace the Eurozone group as destinations for German exports.

I say I hope this move (if undertaken) would be temporary, since I think in the mid term the German economy is neither so strong, nor the peripheral countries so weak, as many commentators assume. But being out of the zone would give the Germans the opportunity to see this for themselves.

Germany, unlike the PIIGS, could exit the euro without causing "the mother of all banking crises", because the Deutsche Mark would only appreciate as a result. There would be a capital flight out of the euro, but it may only be a minor one, because most assets are presumably European owned, anyways, and there would be uncertainty about the timing of safe repatriation of that capital. The German exit would help correct EU's current account imbalances, and it would allow cost levels to adjust to better match productivity indifferences.

However, this would not solve the core problem. As Hugh points out, but he doesn't deal with it:

one thing seems evident: under the existing set-up the 16 economies are not converging.

One-off devaluation may help in the short-term, but how do you solve the structural differences? We lived under the illusion that a country such as Greece would have its economy restructured as a result of joining the EU and the euro. That never happened. The country still lives out of agriculture and tourism, and there is no reason to believe this will change anytime soon. The euro will keep pushing inflationary pressures to Greece (and Portugal, etc.) through tourism and real-estate, and it's getting increasingly difficult to keep the faith that productivity will radically increase in these countries in the near future. Another major problem is the lack of labor mobility, which is a prerequisite for optimal currency areas. You can't drag a Greek olive farmer to Germany, kicking and screaming, to start a new profession (or vice versa). The language and cultural barriers are too high.

A Fresh Business Idea: A Bank

2010-04-17T14:55:00.000-07:00

In theory, the financial sector is supposed to serve a social purpose in supporting the economy: 1) by allocating capital efficiently, 2) by managing risk, and 3) by providing liquidity. However, banks have lately, fulfilled only the last of these three functions, at most. Moreover, and what the bankers refuse to admit publicly; providing liquidity only hurts the economy when capital is allocated inefficiently, and risk management is out of control. Another common fallacy among bankers seems to be that the financial sector is a part of the real economy, and any growth in the financial sector is therefore good for the economy - Not so. We now know that a significant part of banks' profits in the west during the 21st century have been artificial, and tax payers have picked up the tab after the smoke screen has cleared while bankers themselves walked away with astronomical bonuses. Nothing new here. However, while we're waiting for a financial reform - one that will most likely come in the form of some diluted international compromise; one wonders, if there's a real window of opportunity for a 'new' business model: namely a bank.

A bank that served its three core purposes could increase its social value in many additional ways: it could reward its private customers for sustainable choices (e.g. house builders for environmental solutions, car or house appliance buyers for energy efficient purchases, etc.), it could allocate capital to clean energy projects and energy efficiency investments, or it could offer cheaper credit lines for companies with sustainable business models and/or positive social impact. The possibilities are endless, but there's no compromising on the core functions.

So, what's the catch? Why isn't this a popular business model among major banks? Well, it may just turn out that creating complex financial products and trading them is simply more profitable than for banks to actually fulfill their real purpose. To an extent, we can also call today's banking social banking. After all, we've already socialized the losses of the financial sector.

More on the 'Success' of EU's Emissions Trading System.

2010-04-02T03:12:00.001-07:00

According to The Financial Times, CO2 emissions in the EU declined by 11 % in 2009, thanks to the global economic crisis.

The 11 per cent decline means that companies will be left with millions of euros worth of surplus carbon allowances, which were awarded to them for free by member states. They can either sell those allowances on the open market or bank them for use in later years, when the reduction targets become more stringent.

Such surpluses have kept the ETS carbon price at €13 per ton, less than half what many analysts say is necessary to encourage investments in alternative energy. That has stoked concern that the ETS has gone astray by lavishing windfall subsidies on industrial companies rather than creating incentives for them to invest in low-emissions technology.

Ms Ulset argued that too much attention was being focused on the carbon price. “As long as you achieve the target, it doesn’t matter if the price is low or high,” she said. “As soon as the economy picks up, emissions will, too.”

But the price of carbon does matter. Ms Ulset fails to follow her own logic. As soon as the economy picks up, so will emissions, because the low carbon price has yet again failed to encourage investments into cleaner technologies. There must be a price floor and ceiling in the system, whereby the ECB or another institution buys and sells permits in order to stabilize the price. Moreover, why not aim at exceeding instead of meeting the target when the former is economical, and the market is playing ball? What we have now is another year of free handouts to major polluters in the ETS.

The German Experience in Promoting Renewable Energy

2010-03-31T05:50:00.000-07:00

RWI, a German institute of economic research, recently published an article called Economic Impacts of Renewable Energy Technologies - The German Experience. Although I have no problem with the authors' arithmetic, per say, I do find their logic and therefore conclusions simply unintelligible.

The authors do not deny the astounding success (effectiveness) of Germany's feed-in tariffs in expanding renewable energy capacity:

With a share of about 15% of total electricity production in 2008 (Schiffer 2009:58), Germany has more than doubled its renewable electricity production since 2000 and has already significantly exceeded its minimum target of 12.5% set for 2010.

However, the authors do question the efficiency of feed-in tariffs for wind:

Although wind energy receives considerably less feed-in tariffs than PV, it is by no means a cost-effective way of CO2 abatement. Assuming the same emission factor of 0.584 kg CO2/kWh as above, and given the net cost for wind of 3.10 Cents/kWh in 2008 (Table 6), the abatement cost approximate 54 € per tonne. While cheaper than PV, this cost is still more than threefold the current price of certificates in the ETS. In short, from an environmental perspective, it would be economically much more efficient if greenhouse gas emissions were to be curbed via the ETS, rather than by subsidizing renewable energy technologies such as PV and wind power. After all, it is for efficiency reasons that emissions trading is among the most preferred policy instruments for the abatement of greenhouse gases in the economic literature (Bonus 1998:7).

This is a completely fallacious logic for at least two reasons. First of all, the emissions trading system (ETS) does not automatically and magically turn into emissions reductions. These reductions take place either through lower production levels and higher prices via conventional fossil fuel sources, or through a shift to sources such as wind, which the FIT system is supporting. In the absence of feed-in tariffs, the emissions permits (and hence electricity tariffs on average) would simply be higher. The authors see the low price of permits in the ETS as some sort of merit, but the lower the price, the slower the shift to clean energy sources. Secondly, the price of emissions permits, and therefore the cost of conventional power generation, is dependent on the amount and allocation of permits in the market (in addition to the opportunity cost). The authors continue:

With respect to climate impacts, the prevailing coexistence of the EEG and the ETS means that the increased use of renewable energy technologies attains no additional emission reductions beyond those achieved by ETS alone. In fact, the promotion of renewable energy technologies ceteris paribus reduces the emissions of the electricity
sector so that obsolete certificates can be sold to other industry sectors that are involved in the ETS. As a result of the establishment of the ETS in 2005, the EEG’s true effect is merely a shift, rather than a reduction, in the volume of emissions: Other sectors that are also involved in the ETS emit more than otherwise, thereby outweighing those emission savings in the electricity sector that are induced by the EEG (BMWA 2004:8).

In the end, cheaper alternative abatement options are not realized that would have been pursued in the counterfactual situation without EEG: Very expensive abatement options such as the generation of solar electricity simply lead to the crowding out of cheaper alternatives. In other words, since the establishment of the ETS in 2005, the EEG’s net climate effect has been equal to zero4.

The authors are certainly right to point out that feed-in tariffs in the range of 40-50 c/kWh for photovoltaics are not the most efficient way to expand clean energy capacity, but that does not mean that feed-in tariffs for wind have been inefficient. The fact that there have been "obsolete certificates" only means just that (= there have been too many of them). In essence, the paper builds the whole case against the cost-efficiency of feed-in tariffs for wind by comparing the system to the current or historical prices of ETS permits. Moreover, the argument is based on two assumptions, both of which are false. 1) the current/historical prices of ETS permits reflect the social cost of carbon, and 2) the price of emissions permits would not change in the absence of feed-in tariffs - Wait, let me take that last one back:

These theoretical arguments are substantiated by the numerical analysis of Traber and Kemfert (2009:155), who find that while the CO2 emissions in Germany’s electricity sector are reduced substantially, the emissions are hardly altered at the European scale by Germany’s EEG. This is due to the fact that Germany’s electricity production from renewable technologies mitigates the need for emission reductions in other countries that participate in the ETS regime, thereby significantly lowering CO2 certificate prices by 15% relative to the situation without EEG (Traber, Kemfert 2009:169). In essence, this permit price effect would lead to an emission level that would be higher than otherwise if it were not outweighed by the substitution effect, that is, the crowding out of conventional electricity production through CO2-free green technologies.

It seems that the authors are a little confused, and they can't decide whether low ETS prices are a good or a bad thing, and which is driving the price of which. Never mind. They essentially argue here that the German feed-in tariff system is a subsidy for other countries in the ETS system. This is actually true and not just in the way described above, but also because feed-in tariffs are a form of R&D subsidy for technology companies in renewable energy (and not just for countries in the ETS system, either). However, is this a valid argument against feed-in tariffs? I don't think so. First of all, so far the ETS system itself, in particular phase 1, has been poorly designed as the market has been flooded with too many permits. Secondly, the same logic could be used to argue against fiscal stimulus in that it's not worth it because some of the benefits leak abroad. However, that only calls for a coordinated stimulus, not killing the idea itself.

I am not arguing that the German feed-in tariffs are necessarily at the right level. They most certainly are not. The feed-in tariff for photovoltaics, in particular, is a grossly inefficient R&D subsidy for an immature technology. However, that does not mean that the FIT mechanism, in general, is not well suited to mitigate climate change. We must realize that any system has to be both effective as well as efficient. Efficiency alone is not enough. The ETS and feed-in tariffs are more complements than substitutes. Both are required. FITs have been a tremendous success in terms of expanding clean energy capacity, and in offering investors a safe and stable return on investment. The ETS system, while having lots of potential, needs much more work to induce a similar enthusiasm for clean energy investments. Not only have the permits been priced too low, but the volatility has also been very high, and those who know finance know what that means: higher required returns and hence higher costs of emissions abatement.

Blog and link list created

2010-03-15T03:55:00.000-07:00

I have added my blog roll and links on the right hand side pane. The blogs are not strictly related to energy issues; in fact, only a few are. This may raise the question: why post them here? Well, you might be surprised at how few excellent energy blogs there are in the blogosphere (and I don't count my own pathetic, monthly scribbling among them). In fact, I have yet to discover an energy blog that deals well with both economic and political aspects of global energy markets, and offers updates more frequently than once a week. The content at Resources for the Future comes the closest, but they don't publish that often (and sometimes, they too, disappoint). The EU Energy Blog is quite solid, but they could write more often, as well. It's notable that virtually all of the economic/political analysis on the energy markets comes from occasional academic sources, and there are no dedicated bloggers as there are in the areas of general economics, finance, and climate change. (FYI, if somebody's willing to pay me, I will gladly make this my full time job). For these reasons, I can't create my blog roll from energy blogs alone. Sorry.

Many of my links deal with economics, politics, and philosophy. The world would be a much better place, if people understood better how the society functions, and how it could potentially function. It seems to me that many of us can't be bothered with social change, because we live in more or less collectivist societies, in which we don't challenge social customs, and we're not confronted with personal responsibility for the society around us (Popper). In addition, people tend to think that having excellent cognitive capacities makes one wise, but it doesn't. Wisdom is a product of a disciplined mind, and deliberate effort to acquire and apply knowledge (i.e. being smart has little, if any, value without knowledge). Moreover, if you actually wanted to make a difference for the better, and not just play around with ideas as many modern day philosophers and social commentators do, you also need to care about the truth and have a humble and respectful heart. I don't want to patronize anyone. My only wish is to enrich your life when I have no original ideas of my own. Enjoy!

A World of Uncertainties

2010-02-07T13:27:00.000-08:00

I just ran into some comments that Daniel Yergin made in 2004 at a conference on U.S.-Saudi relations and global energy security at CSIS:

the U.S. really is on the threshold of a new era in natural gas, and this has major implications. In a sense the U.S. is today in natural gas where it was 30 years ago in oil, about to go from being a minor importer to being a major importer, and a decade from now the United States could literally overtake Japan as the world's number one importer of LNG.

I could have imagined myself in the audience taking notes, and accepting anything he had said about the future at face value, as a prophecy waiting to be fulfilled. Daniel Yergin knows the hydrocarbon business probably better than anyone, but even he couldn't see the unconventional gas revolution coming. Nobody could. There was uncertainty about technology, and hence about possible market outcomes. Here are Yergin's comments just over five years later.

I think I'm going to bookmark this post, and refer to it every time in the future when I get something completely wrong. Even the Daniel Yergins do.

To Be or Not to Be

2010-01-10T03:13:00.000-08:00

COP-15 ended over 3 weeks ago. The immediate outcome disappointed many optimistic observers, but the longer term outcome is still unclear (yes, I know what Keynes said). Personally, I expected nothing more. In essence, I think the outcome shows that none of the major emitters, as Shakespeare's Hamlet, consider suicide as a plausible way out. In other words, the real issue is cost-effectiveness and justice, not whether climate change is a real threat. The most important lesson from the conference is that the UNFCCC may not be the right venue for an initial agreement among major GHG emitters.

There's been a lot of harsh criticism about the outcome of the conference, but considering the fact that UNFCCC's decisions require unanimity among its near 200 members; the "noted" Copenhagen Accord is probably as good as it gets. As Robert Stavins has pointed out, it would make much more political sense to initially forge a strict agreement among 20 largest polluters that account for 90 % of all emissions (i.e. a venue such as the Major Economies Forum on Energy and Climate or the G-20). That should be the first step, and it's challenging by itself. Only once that is achieved can the UNFCCC play a meaningful role.

In my opinion, the most realistic analysis on the outcome of COP-15 was offered by Robert Stavins, David Doniger, and WRI's Rob Bradley. Among others, CU Earth institute's Jeff Sachs, not surprisingly, hoped for much more.

On another but somewhat related topic, Ian Parry's recent paper on optimal taxes on highway fuels gives more evidence why corrective Pigouvian taxes make sense (I briefly commented on this topic in last June). Not that the logic requires any more proof. It also applies to all other anthropogenic GHG sources.

Princes of Denmark

2009-12-09T06:25:00.000-08:00

I was on the plane this morning. My favorite moment is always the point when the plane shoots through the clouds. Beyond the clouds, you get the divine view of this planet; and it's a beautiful planet.

It amazes me how few people still understand that all climate change models are built on vast uncertainties, but that it doesn't change any of the logic for the mitigation of climate change. If there was a 50-50 chance that a flight you put your children on crashed; would you put them on the plane anyway? Would you be willing to pay perhaps 1 % of your income to ensure that it didn't happen? Most of us think so; especially, when that 1 % is only a wealth transfer from a wealthy group of people (over-emitters) to a poor group (under-emitters); and the net-cost is actually zero. The earth's ecosystem is currently underpriced; and to say that something is underpriced is another way of saying that it's subsidized. In this case, the subsidy is paid by the developing countries that will suffer the most from climate change.

UN Climate Change Conference (COP15) started on Monday in Copenhagen, but it's already been severely undermined by the lack of political commitment. It's now been said that the likely outcome of the summit will be a "politically binding agreement" as opposed to a legally binding agreement. What does that mean in terms of a time frame for a legally binding agreement? Your guess is as good as mine.

I won't be covering the progress of the conference, but I think The Earth Institute at Columbia University will do a fine job. I can't say anything about the desired outcome that hasn't been said already. If you haven't followed the literature; I can give a couple of recommendations. The Global Deal by Nick Stern is a great cursory work on the negotiations. Saving Kyoto by Graciela Chichilnisky is primarily a defense of the Cap and Trade system. It's also a book that Jim Hansen should've read before trashing the system in public last week. We can't afford to lose our second best solution at this point. I also recommend Architectures for Agreeement (edited by Joseph Aldy and Robert Stavins) for those who want to delve deeper into the political economy of the negotiations.

The emails that leaked from the University of East Anglia have done nothing to undemine the scientific consensus. To say that there's a conspiracy among scientists to make us falsely believe there's such a thing as anthropogenic climate change is tantamount to saying that there's a conspiracy among doctors to make us falsely believe that smoking causes cancer. Yes, there's uncertainty about the magnitude of our impact on climate change, but there are also people who have never smoked who get lung cancer. Our current experiment on this planet is not worth the gamble. We can only hope that our leaders in Copenhagen will realize, as Prince Hamlet of Denmark did, that "conscience doth make cowards of us all".

Now, excuse me. I have to go see about a girl.

On Discount Rates

2009-11-04T13:20:00.000-08:00

RFF has published an article by Cameron Hepburn who confuses pure rate of time preference with consumption discount rate. It's troubling that this confusion still keeps popping up among academics. Hepburn says:

In contrast to Stern’s prescriptive approach, previous research tended to be “descriptive” in assumptions about discounting, focusing on what we actually do, rather than what we ought to do from an ethical point of view. The focus was on market interest rates, which reflect the sum of many individual choices. Historic market interest rates (ignoring past and present financial crises) have averaged around 6 percent, so most previous research applied consumption discount rates at roughly this level.

In finance, pure rate of time preference can be calculated from historical real market returns, or if you will, estimated by using the capital asset pricing model for future flows. However, in economics you have (1) the pure rate of time preference (PRTP), and (2) the consumption discount rate, which is PRTP plus the elasticity of marginal utility of consumption multiplied by the growth rate of consumption. In economics, it's not whether PRTP should or could be about ethics; it is about ethics. It's about the value of future, not the value of a future cash flow to you. It's about intergenerational justice, and if future generations were treated equally to us, PRTP should be zero.

Hepburn continues:

Also, if our ancestors had adopted Stern’s perspective, they would have had to devote more resources (by way of savings and investment) for our benefit, reducing their own consumption, and hence also their welfare. This seems unfair given that our ancestors were significantly poorer than we are today.

If our ancestors had known how rich we'd be, they certainly would've not saved more than they did. The reason why Stern chose a lower growth rate than historically, is because there's uncertainty whether that growth can be maintained. In a GHG world, growth is a random variable, and the left tail of probability distribution is thickened by possible impacts of climate change.

Lastly, Hepburn says:

by assuming the probabilities are themselves uncertain, further bridges the divide between the discount rate of the Stern Review and higher market interest rates. Also, it may be consistent to apply high discount rates for aggregate consumption, and low discount rates for (increasingly scarce) natural capital

And there is no connection between the two? For example, would you expect aggregate consumption to go up, if climate change wiped out a significant portion of all arable land? The consumption discount rate can be positive, zero or, in extreme case, negative.

According to Paul Krugman, Prescott had once boasted that Keynes was never mentioned in their graduate programs. I'm afraid that both Cameron Hepburn and William Nordhaus may have been asleep when Frank Ramsey was mentioned in theirs.

Self-fulfilling Prophecies

2009-11-02T04:08:00.000-08:00

Angela Merkel on Friday:

It is realistic to say that in Copenhagen we will not be able to conclude a treaty

Guardian, yesterday:

"Nobody thinks we will get a full treaty," said a spokesman for the Department of Energy and Climate Change (UK)

...
Lars Løkke Rasmussen, prime minister of Denmark, said: "We do not think it will be possible to decide all the finer details for a legally binding regime."

Hanne Bjurstroem, Norwegian cabinet minister and chief climate negotiator, told Reuters: "I don't believe we will get a full, ratifiable, legally binding agreement from Copenhagen."

Our climate negotiators desperately need psychology 101 before heading to Copenhagen.

While waiting for the results from the vote on Waxman-Markey

2009-06-26T14:07:00.000-07:00

Read this posting by the Earth Institute's blog on turning CO2 into a solid carbonate. Having the first large-scale demonstration facility come online in September is a huge thing. Let's hope it works.

Who wants some limestone?

Message from Detroit to Capitol Hill

2009-06-08T12:52:00.000-07:00

Jim Oberstar, the chairman of US House Transportation and Infrastructure Committee has proposed a higher fuel tax, making many Democrats nervous about what is "too much" in these difficult times. Obama also opposes the tax hike. I'm inclined to question the logic behind the opposition, whether it's populism or domestic realpolitik.

Dave McCurdy, President of the Alliance of Automobile Manufacturers was on EETV today talking about Detroit's challenges on the path to lower car emissions. He said one thing the Obama administration should take heed of:

But I think there has to be price signals, whether it's legislation or whether its regulation. Price signals are important. If you look at the history it's very clear, a year ago this current time frame, we were starting to see four dollar gas. We saw what four dollar gas did. Four dollar gas changed consumer behavior and consumer wishes. We dropped from selling about 55 percent light-duty tracks compared to 45 percent cars to completely the opposite, to 45 or trucks, then the 55 to cars. Now back at $2.50 gas, guess what, it's flipped back the other way.

This comes from the automakers. There's still another, much more powerful lobby group opposing a higher fuel tax, but policy makers should realize that it's the most effective (and by lowering taxes on labor and capital at the same time, the most efficient) way to decrease emissions from transportation. Moreover, the Highway Trust Fund (which is funded by fuel tax revenues) is going broke for the second consecutive year, and the rumor is the US treasury wouldn't mind the extra revenue, either.

No matter how inefficient taxes may be, taxing "bads" (with corrective Pigouvian taxes) is always preferable to taxing goods (such as capital and labor). By off-setting one with the other, the cost is at most zero, if not negative. The only difference is the deadweight loss of the fuel tax and the deadweight loss of the tax (say labor) it replaces, and the distributional effects relate only to those differences. In short, there are no excuses for not taxing economic activities with large negative externalities (here meaning driving Hummer H2s and the like); at least not as long as labor and capital are taxed instead.

People who get us into trouble

2009-04-29T15:41:00.000-07:00

I found this latest piece by Robert J. Samuelson via Paul Krugman, who nails some of the most disturbing fallacies in the column:

I don’t think there’s a single thing there that’s right. What on earth do business cycles have to do with it? The models may assume growth based on past trends, but they DO ask whether emissions policy would greatly slow growth — and the answer is no. Consumers aren’t assumed to “quickly” use less — the time frame in these models is decades long. And new supplies don’t “magically” appear — they respond to price incentives, which is what economics usually says.

I don’t especially mean to pick on Samuelson, but this column exemplifies a strange thing about the climate change debate. Opponents of a policy change generally believe that market economies are wonderful things, able to adapt to just about anything — anything, that is, except a government policy that puts a price on greenhouse gas emissions. Limits on the world supply of oil, land, water — no problem. Limits on the amount of CO2 we can emit — total disaster.
Funny how that is.

Ultimately, however it's Samuelson himself who deconstructs his own arguments most accurately:

The selling of the green economy involves much economic make-believe... Actually, no one involved in this debate really knows what the consequences or costs might be. All are inferred from models of uncertain reliability. Great schemes of economic and social engineering are proposed on shaky foundations of knowledge.

Funny because economic make-believe and shaky foundations of knowledge would've probably been the exact words I'd chosen to describe Samuelson's writing with.

The Paradox of Plenty

2009-04-20T17:23:00.000-07:00

Ok, it's been some time since my last post. I'll try to get back to speed with shorter posts on what's happening. Interaction Quarterly of Stanford recently published an article, which reminds us that NOCs (national oil companies) have often neglected new exploration investments, and the oil revenue is rather used for other government expenditure (a recent exception is Brazil's Petrobras). The "sovereign" or political risk in the oil producing countries is often too high for non-NOCs to do exploration solo. There's still plenty of oil in the ground; it's just harder to get to, and new investments are lagging behind because of poverty, corruption, and war. NOCs are instant cash machines, as David Victor calls them.

Why is it so important to get to as many conventional oil sources as possible? Well, because each barrel of conventional oil left in the ground is likely to be replaced with a barrel of non-conventional oil. That's bad news both economically and environmentally, and there's no "paradox of plenty" with regards to either of the two.

IEA's Roles

2009-03-18T10:17:00.000-07:00

It's been almost two weeks since I wrote my last post. I've asked myself why, and there's a really simple logical causal chain. As everyone else, I've been preoccupied with the global economic crisis. I've wanted to comment on the effects of the economic crisis on the energy sector. However, my best source for global energy market statistics is the International Energy Agency, which will publish its 2008 energy statistics sometime in 2010. Hence, the best I can do is to speculate what the effects of the current crisis are.

I understand that not all countries follow or assemble their energy statistics as quickly as others, notably as quickly as the US (EIA). What I don't get is why doesn't the IEA provide up to date summarized statistics for the countries that do publish that data in a timely manner. It can be argued that IEA's purpose is not to offer timely statistic data of the global energy markets. Rather, it's primary role is to provide advice on energy policies. Whether or not you think they've succeeded in that, I think we need an institution that offers timely information of the global energy markets. There are several statisticians at the IEA, and they could be separated from the agency to form a new public agency that serves that purpose. That way the OECD tax payers could get a bit more bang for the buck.

Papers Worth Reading

2009-03-05T06:45:00.000-08:00

The role of carbon markets in preventing dangerous climate change by Karsten Neuhoff (quick read) and David Newbery (a bit more wonkish but more rewarding). There are too many important messages in these papers for me to list them here. By the way, RePEc (Research Papers in Economics) just ranked EPRG as the world's top institution in energy economics, and David Newbery as the top author. Congratulations! Now, some of you may wonder why Columbia University's CEMTPP is not on the list. The answer is that they're trying hard, but so far CEMTPP has served mainly as part of a graduate master's program, not as a research program. The energy center is run by people with professional backgrounds in energy rather than in academia. Most of them hold PhDs, but not all of them.

Dancing Tango Alone

2009-03-01T23:19:00.000-08:00

Jacob A. Frenkel gave us a talk at Columbia last year, and shared his experience of being the governor of the Bank of Israel. Among many of his anecdotes; he said it's like dancing tango with the market. Edward Hugh's post on Jean Claude Trichet and deflation risk is worth reading. When will Mr. Trichet understand that it takes two to dance tango? What if he doesn't?

Solutions to Climate Change

2009-02-24T12:06:00.000-08:00

Joe Romm has started a series of posts (1, 2, and #3 coming soon), where he shares his ideas about what should replace dirty coal once strict CO2 regulation is introduced in the US, and trust me; it will be quite soon.

As the solutions, Joe suggests energy efficiency, wind power, concentrated solar power, and biomass co-firing. Joe's ideas are smart, as always. I just want to comment on efficiency and the use of biomass. Efficiency is on the top of Joe's list, and he points out to California's success in increasing efficiency dramatically. Efficiency is THE key solution to slowing down the growth of world's energy consumption, but I think it's fallacious and dangerous to view it as an energy source. The history teaches that, while most applications of energy consumption have become more efficient over the years, the saved energy has been simply used for other applications. Below, I've made two graphs of California. The first graph shows the trend for per capita energy consumption in California compared to the rest of the US from 1960 to 2007. The second graph shows a similar comparison of CO2 emissions indexed to 1980. I wish EIA had this data starting from 1960, as well, but they don't.

As the first graph shows, California was already using much less energy per capita in 1960 compared to the rest of the US (in other words, before the efficiency programs). The growth in consumption has been much more modest in California, but I'd like to see the composition of industrial activity, and the share of energy intensive industries before making a conclusion of the main driver behind the trend. The second graph shows that the growth in CO2 emissions has been somewhat slower in California than in the rest of the country. However, whether efficiency programs or other factors, such as the availability or price of cleaner energy sources has been driving the trend, remains a question. In addition, California has imported coal powered electricity from the states around it, thereby avoiding the emissions within in the state. In other words, the efficiency programs in California have probably not led to notably lower CO2 emissions. In addition, I'd argue that the estimates of California's energy savings during the past three decades, as Joe Romm presents them, are largely guesses, since nobody knows the counter factual; that is, what the growth in demand would've been, had the alternative option to cheap efficiency been new generation capacity costing several times more. Although efficiency is important, we shouldn't delude ourselves into thinking energy efficiency cleans up our our energy infrastructure - it doesn't. We still need to focus on decarbonizing our energy system.

Biomass co-firing is, in my opinion, another fallacy as a solution to combat climate change. First of all, burning biomass is not necessarily more environmentally friendly than coal, and it may even emit more CO2 per megawatthour. For example, in Finland a standard form of biomass is peat, which emits around 380 kg of CO2/MWh, whereas coal emits "only" about 300 kilos of CO2 per MWh. (In fact, Finland recently had a feed-in tariff for peat based power generation). Burning waste from saw mills is another example; it emits around 500 kg of CO2/MWh (also quite common in Finland). The standard argument for burning of biomass is that it would otherwise decay in nature, and thereby release methane into the atmosphere. That is a fairly weak argument, since there are often many useful applications for biomass other than burning it or leaving it to decay. However, by far the weakest argument is that it's renewable. If you release the CO2 in biomass into the atmosphere by burning it; you've released the CO2 into the atmosphere.

What if the US followed Jim Hansen's advice, and instead of using coal plants for biomass co-firing, as Joe Romm suggests, bulldozed the plants to the ground? (Btw. see this link for March 2. demonstration at Capitol Power Plant with Jim Hansen). Now, the US government is not going to demolish any utility's coal plants. However, given a sufficiently high price of CO2, no free allowances or grandfathering of plants, and/or a competitive and responsive electricity market; the utilities themselves may have an incentive to bulldoze their coal plants. Following IEA:s reference scenario with 0.9 % p.a. growth in coal generation to 2030 (and in the following calculation, until 2039); a back-of-the-envelope calculation suggests that the opportunity cost of CO2 emissions from burning coal in the US could be around $ 3.8 trillion in the next 30 years at a CO2 price of $ 85/tonne (the social cost of CO2 in the Stern Review), using a discount rate of 2 % p.a.. The cost would be around $ 3.3 trillion even without any growth in coal based power generation. Coal retains its 49-50 % share of total generation in 2030 in the IEA reference scenario. That share of power generation is not replaced over night, but the calculation just shows how expensive coal based power generation is in reality.

Silence on the DRC

2009-02-21T10:44:00.001-08:00

How is it still possible? Bob Herbert's op-ed should make us all ask that question:

Women and girls of all ages, from old women to very young children, have been gang-raped, and in many cases their sexual organs have been mutilated. The victims number in the hundreds of thousands. But the world, for the most part, has remained indifferent to their suffering.
"These women are raped in front of their husbands, in front of their children, in front of their parents, in front of their neighbors," said Dr. Denis Mukwege, a gynecologist who runs a hospital in Bukavu that treats only the women who have sustained the most severe injuries.
In some cases, the rapists have violated their victims with loaded guns and pulled the triggers. Other women have had their organs deliberately destroyed by knives or other weapons. Sons have been forced at gunpoint to rape their mothers. Many women and girls have been abducted and sexually enslaved.

I'm appalled by our indifference.

EU Bonds and the European Energy Infrastructure

2009-02-20T06:38:00.001-08:00

On Wednesday, George Soros joined the chorus of calling for EU bonds. Indeed, EU bonds would be a great financing mechanism for co-ordinated counter-cyclical fiscal policies. The mechanism would benefit new and weaker members countries most clearly, however properly designed; it would divide the fiscal burden more equally also among the stronger member countries. A new mechanism for EU bonds could also help solve disputes on who pays for the investments in cross-border energy networks, both electricity and gas. The bonds could be used for new grant and loan facilities created by the European Investment Bank and EBRD to guarantee cost recovery for investments in energy networks together with other necessary regulatory codes and measures. Moreover, the bonds could be used for co-ordinated efforts to mitigate climate change.

Fear the N-Word No More: Part 2

2009-02-18T02:20:00.000-08:00

In an interview yesterday, Alan Greenspan told the Financial Times that some banks may have to be temporarily nationalized to fix the financial system. If Alan is not afraid to use the N-word, then neither should Tim Geithner, Larry Summers, or Barack Obama. Yes, some McCarthyists may label you anti-American, but it's still, as Alan says, the least bad option. It's not "in your culture", but neither is lemon socialism.

Jim Hansen's Op-Ed

2009-02-16T12:14:00.000-08:00

One of our best climate scientists, Jim Hansen submitted this op-ed to the Observer yesterday. Once again, he's calling for a moratorium for new coal plants, this time pleading to the UK government. There's one thing I especially agree with in the letter; although, I'm not sure whether he means it the way I understand it:

The dirtiest trick that governments play on their citizens is the pretense that they are working on “clean coal” or that they will build power plants that are “capture ready” in case technology is ever developed to capture all pollutants.

Pretense indeed. I don't think Jim Hansen expects a country like China ever to bulldoze its coal plants. The country generates over 80 % of it's electricity from coal. It's therefore important that affluent Western countries commit themselves to the development of carbon capture and sequestration technologies that can then be transferred to developing countries. So far, there's no sign of any serious commitment.

Btw. If you haven't read this 2007 MIT study, The Future of Coal, you should.

Renewable Energy 401(k) Tax Credit

2009-02-16T06:18:00.000-08:00

I'm not quite sure of the arithmetic behind this plan; especially small companies receiving a tax credit 10 times higher than large companies. (are their pension dollars worth 10 times more?) Nevertheless, I think the Renewable Energy Task Force of South Denver Chamber of Commerce is after something good. Who knows, if the proposal had been better designed, it could've actually made the stimulus package.

The Political Reality of Climate Change Mitigation

2009-02-06T12:51:00.000-08:00

I feel ashamed for not posting anything in four days. This week has been really busy with work. In addition, following the global economy's downhill takes a lot of time. One thing worth looking into now is how countries, in the case of either uncoordinated or coordinated fiscal stimulus (unlikely to happen), could get the most bang for the buck in terms of decarbonizing the global energy system. That could take more than a few blog postings, but it's worth the try.

First, let's talk about the reality of climate change mitigation with reference to energy. Varun Rai and David Victor recently made a very good point about how dirty coal, thanks to the economic crisis and ironically, environmental groups, may now emerge as the main option for new power generation (for the next decade, perhaps?). The fact, which too few people seem to understand, is that a country such as China is not going stop using coal any time soon. "Clean coal" (yes, the term is an oxymoron) technologies could potentially make the use of coal much more environmentally friendly, although admittedly, not quite so. The development of such technologies will depend on affluent Western countries, especially the U.S. However, U.S. environmental groups are now campaigning against clean coal, thereby possibly ensuring that all of the coming coal plants in developing countries will be plain old dirty coal plants.

Now, let's turn to nuclear power. There's been, once again, a lot of scoffing at the Finnish nuclear project, Olkiluoto 3. The project has been a complete disaster, and it's now 38 months late from schedule, and at least € 1.5 billion over budget. The sponsor of the project, TVO is now sueing the EPC contractors Areva and Siemens for damages worth € 2.4 billion (lost electricity production, lost emissions allowances, etc.). Nuclear power is now being quickly demonized in many places. It's certainly no silver bullet for the mitigation of climate change, but it's one of the solutions. Even Joseph Romm knows this. I'm in favor of all other options (solar, wind, ocean, etc.), but we have to face the reality, take what's offered and plausible, and run with it. If you lobby against all new nuclear and clean coal projects, the chances are, the environment will be the one losing out.

Btw. here's a great recent paper on CCS, also by Rai and Victor.

The Founding Conference of IRENA

2009-02-02T13:38:00.000-08:00

If you missed the founding conference of the International Renewable Energy Agency last Monday; you're not the only one; so did I. It amazes me that the event went below the radar of all major news sources. I had to double check whether any major newspaper or news agency had ran even a small article - and nothing.

Anyways, so far I'm happy that the organization came into being. The IEA has focused mostly on the issues of its OECD member countries, and there has been a growing need for an organization that pulls together a vision and the policy expertise for a sustainable global energy infrastructure. The IEA has produced great overviews and statistics (though often outdated) of the global energy market, in particular oil, gas and coal. The organization has also published well prepared policy papers of its member countries. However, its main value has been in informing us on how things are, period. Furthermore, the IEA has only recently started to show the kind of attention towards renewables they deserve. Just compare the growth estimates for renewables in WEO 2008 to those in 2007.

There were 75 signatories to IRENA last Monday, and most notably the UK and the US were not among them. The US's part could be explained through the Bush legacy of climate change denial, but I don't get the humpty dumpty politics behind the UK's absence. This document explains in more detail what the role of IRENA will be in context to other orgnaizations.

I've enabled anonymous commenting

2009-02-02T11:44:00.000-08:00

However, all comments will be published at my discretion. Previously, only registered users with Live ID were allowed to leave comments.

The Impacts of Carbon Pricing on the Electricity Sector

2009-01-30T09:07:00.000-08:00

It's time to look at the impacts of the coming carbon pricing on different parts of various energy chains. Let's start with the electricity sector. Electric utilities are responsible for a large part of CO2 emissions globally. In the U.S. the electricity sector accounts for 40 % of the country's CO2 emissions, and the twenty largest electric utilities alone account for about a quarter of the country's CO2 emissions. The share of total CO2 emissions from power generation is similar in China, and the Chinese sector now emits more in absolute terms than its U.S. counterpart. The growth in China's CO2 emissions has been unprecedented, although the economic crisis has slowed down the growth somewhat. A Berkeley study last year suggested that China's CO2 emissions will have grown by at least 11 % per year from 2004 to 2010. I'm hoping that will be true only for the period of 2004 to 2008. In any case, what will be the effect of a potential CO2 price on the operation and emissions of the electricity industry? I'll start with the economist's usual answer: it depends.

The answer depends on the elasticity of demand and supply of fossils fuel generated electricity,which in turn depend on the degree of electricity market deregulation (in particular, tariff setting mechanisms, demand response and the free choice of supplier by small and large customers), the age of current generation generation plants, the availability and price of clean electricity sources (and their supporting policies), the price of fossil fuels and carbon, and how new transmission investments will be managed. All of the previous determine not only the overall effectiveness of the CO2 price in mitigating emissions, but also whether it's the consumer or the producer who pays the additional cost.

In short, for the price of carbon to be effective in mitigating CO2 emissions, the electricity tariffs must be determined freely in the market to reflect true marginal costs. For that to really happen, there must also be demand response (e.g. smart grids with real time metering). Needless to say, all consumers should have the freedom to choose their supplier in order to give electric utilities the incentive to switch to cleaner energy sources. The age of current plants is important as newly built coal plants are unlikely to be bulldozed as Jim Hansen suggests. However, the possible grandfathering of old coal plants would be a huge mistake. The availability of economical renewable energy sources will also be crucial, and this is not only a question of local resources and support policies, but also one of efficient organizational and regulatory frameworks for new transmission investments. Transmission is a major stumbling block all over the world, and most of the current regulatory frameworks don't support the investments required to make carbon pricing effective and cost-efficient. In Europe, the issue is more severe and complicated when it comes to investments in cross-border transmission lines that benefit several member countries. On that more later.

The Internet and Open Society

2009-01-28T06:15:00.000-08:00

I think Karl Popper would be pretty thrilled today, if he saw how the internet has enabled open intellectual debate on a global scale about various social issues. Vox's Global Crisis Debate, in partnership with the UK government has just been opened to allow all professional economists from around the world to share their views on how to fix the global economy and influence the G20 meeting in April at the same time. There are already top commentaries from people on the left, right, and centre. The floor is yours.

The Coming Climate Policies

2009-01-27T14:35:00.000-08:00

There were a lot of news yesterday that signal aggressive climate change policies under President Obama's first year in office. He himself gave a speech where he stated that 'These urgent dangers to our national and economic security are compounded by the long-term threat of climate change, which, if left unchecked, could result in violent conflict, terrible storms, shrinking coastlines, and irreversible catastrophe.' He also said (talking about the economic crisis) that 'At a time of such great challenge for America, no single issue is as fundamental to our future as energy." (Full speech here). At the same time, Hillary Clinton appointed Todd Stern as the administration's chief climate negotiator. He'll be the one flying into Copenhagen this coming November with the intention, according to his own words, to "engage in vigorous, creative diplomacy to dramatically reduce emissions". Yesterday, NOAA also published a pretty shocking study that suggests that climate change would be largely irreversible for 1.000 years after CO2 emissions are completely stopped.

Now, since it looks like aggressive climate policies may finally become reality, I want to talk about how a carbon tax or a cap-and-trade system, which is more likely, would impact different parts of various energy chains. However, for now I want to get some sleep. It's late and I just came back from a trip to the Netherlands.

Traveling for a few days.

2009-01-24T05:40:00.000-08:00

Posting resumes on Tuesday, 27th of January.

IEA's Principles for Effective Policies for Renewables

2009-01-22T12:32:00.000-08:00

While browsing through IEA's books, I noticed two new titles: Deploying Renewables: Principles for Effective Policies for Renewables and Natural Gas Market Review 2008. Both have some interesting findings and deserve a paragraph or two in this blog. Let me begin with the former. IEA's review of the effectiveness of various policy schemes for renewables (summary) strengthens my previous views of the policy drivers and barriers for renewables, especially wind power. The book doesn't suggest that feed-in tariffs alone are superior to other forms of support mechanisms, but the message of their effectiveness is fairly clear: The countries with highest policy effectiveness (Germany, Denmark, Spain, and Portugal) all used FITs. What's more important, the average remuneration levels in these countries were lower (USD 0.09-0.11/kWh) than in countries that had quota obligations for renewables combined with tradable green certificates (USD 0.13-0.17 kWh). I think the UK versus Germany serve as good examples. The former has had used both a tender-based system and later, a quota system. I wrote a paper last year where I compared the overall policy frameworks of the two countries. The chart below tells a lot about policy effectiveness (sorry, I noticed it's hard to read. Blue line is Germany, red line UK. The timeline is 1990-2008e.)

IEA's book suggests, rightly so, that non-economic barriers, "such as administrative hurdles (including planning delays and restrictions, lack of co-ordination between different authorities, long lead times in obtaining authorisations), grid access, electricity market design, lack of information and training, and social acceptance, have a significant negative impact on the effectiveness of policies to develop wind power, irrespective of the type of incentive scheme." This is certainly true, but a quota system leaves full price, volume, and balancing risk on the investor's shoulder, making it much less effective in attracting new investments. At the same time, if the FIT-based system has involved lower tariffs than quota-based systems, it's naturally much more preferable to consumers and a more cost-effective policy for the tax payers. From the viewpoint of the utilities, it's also preferable, because it doesn't erode anybody's competitiveness in particular, and it allows a nationwide allocation of the tariff burden to all consumers. It's notable that UK actually has better wind resources than Germany, and so even a lower FIT than the ones in Germany could induce massive investments in new wind power capacity.

Our President's Inauguration

2009-01-20T09:40:00.000-08:00

Thomas Jefferson said: "every man has two countries - his own and France." These words, as many have suggested, could well be applied to much of the world today with reference to the United States. I'm a Finn by nationality, but more than ever before my life is shaped more by U.S. policies than by Finnish policies. I just watched my new President's inauguration with great attention. Now, he's got to get to work. The list of things to do is endless. God bless America and us all.

Fear the N-Word No More

2009-01-19T11:44:00.000-08:00

I admit I was a little afraid to use the word 'nationalization' myself outside the private dinner table. So far, there's been too little serious discussion about its merits versus its disadvantages. I thought I was missing something obvious by even seriously thinking about it. However, in the past few days at least Willem Buiter, Paul Krugman, and Felix Salmon are seriously considering the temporary nationalization of banks as possibly the only remaining option. Willem Buiter points out that the policies so far (governments providing liquidity with 'strings attached') have, in fact, created incentives against increasing lending. I strongly recommend at least reading Buiter's arguments. We'll just have to see how many policy makers in the U.S. and Europe have the balls to bring up the N-word, even if they saw its merits.

Energy & Society on Alltop.com

2009-01-18T01:01:00.000-08:00

Energy & Society is now listed under three categories on Alltop.com. The categories are Green, Oil, and Economics. So far, they unfortunately lack a general energy topic, but that could soon change. I thank the good people at Alltop.com for putting my blog up there. Thanks also to Santiago for the tip.

If you haven't heard of Alltop.com, it's a convenient tool to track the best blogs of a specific topic. According to their site, it's an "online magazine rack" of popular topics.

American Recovery and Reinvestment Plan

2009-01-17T14:50:00.000-08:00

This week the House Democrats released a summary of the coming American Recovery and Reinvestment Plan of 2009. The energy related provisions of the plan were neatly put into a chart by the think tank Center for American Progress. Let's look at the numbers. The plan is to invest about $ 66 billion in energy efficiency and renewable energy programs (I'm leaving out investments in public transit). Almost $ 30 billion of that total would go into building and appliance efficiency, and if you look more carefully at the $ 13.4 billion going into renewable energy, you notice that there's more money there being provided for efficiency. In fact, only $ 3.4 billion are provided for renewable energy as grants and loans. That's not much. On the other hand, there could potentially be much more allocated to interconnection and transmission upgrades for renewable energy under the $ 19 billion going into "grid/transmission". The section for clean cars has $ 2 billion going into advanced battery loans and grants out of a total of $ 3.5 billion, but so far the plan lacks any infrastructure spending for electric cars. Overall, the plan seems to focus mostly on efficiency. Perhaps the Obama administration is planning another type of federal policy to speed up transition to cleaner power generation. We'll find out soon.

The Future of Banking

2009-01-15T10:14:00.000-08:00

The Group of Thirty published a paper today (summary here) that deals with recommendations for banking regulation and supervision. The project was led by Paul Volcker, and it gives us some idea of what to expect from Barack Obama with regards to financial reform. The recommendations for strict government oversight make a lot of sense, but after reading the recommendations, I face two immediate questions. First, would a system with such a massive public regulatory and supervisory machinery be the most efficient one? Secondly, is the proposed regime sufficient to ensure that the financial sector does its duties? Well, what are those duties? Many would agree that those duties include the efficient allocation of capital, management of financial risks, and mobilization of savings. Probably all would agree that the main duty of the financial sector is to provide liquidity for the rest of the economy. Now, look at the current situation. Policy makers are pushing liquidity into banks in order to get credit flowing again. Where are banks putting that money? In government bonds. So again, what are banks for? I'm not the first person to ask this question.

I'm hopeful that the stimulus plan by President (elect) Obama will increase liquidity sufficiently in the U.S. economy, and that Paul Volcker's recommendations will be embraced to large extent. However, to ensure that we won't have to deal with this kind of crisis anytime soon, I think we should do more. Here's one suggestion: let's make all finance professionals study more economics, and have them go through some kind of "bar examination" to determine whether they qualify to practice finance. (I can hear the crowds roar - at least all investors who've lost their money during this crisis)

Oil Shocks Revisited

2009-01-13T00:19:00.000-08:00

Why didn't the recent price hike in oil have nowhere nearly as devastating effects on the economy as the price hikes in the 1970s? Alan S. Blinder and Jeremy Rudd have the goods. Meanwhile, we're waiting for someone to write a coherent summary of the positive externalities of high oil prices on the demand of cleaner energy technologies, the environment (which is increasingly taken into account in economic growth models. See e.g. Prof. Dasgupta's work), traffic congestion (and the resulting wasted fuel and lost productivity), traffic related deaths, etc.

I was wrong

2009-01-11T14:57:00.000-08:00

firstly, about how soon the gas would flow through Ukraine again (I said latest by Friday), and secondly, about Ukraine giving up the game - they didn't. Reuters reports:

"A copy of the monitoring agreement, seen by Reuters, has the handwritten words "with declaration attached" next to the signature of the Ukrainian government's representative.

The declaration, a copy of which has also been seen by Reuters, stated that Ukraine had not siphoned off any transit gas and that it had no outstanding debts to Russian export monopoly Gazprom -- a central bone of contention between the two countries.

It said Russia must supply volumes of "technical" gas, at no cost, to Ukraine to maintain pressure in the pipeline system -- a demand Gazprom described as "an attempt to legalize the theft of gas."

Whither Ukraine?

The Finals

2009-01-08T13:16:00.000-08:00

Today, Gazprom rejected the agreement mediated by the EU to put independent monitors in Ukraine along the gas transit route. According to FT, Ukraine had no objections. It's starting to look more and more like the remaining players in the game are EU members and Russia (or Gazprom). Ukraine is dropping out.

Game Theory, Anyone?

2009-01-07T12:57:00.000-08:00

If you put the current gas dispute between Ukraine and Gazprom into a game theoretic framework, who would be the players and what would be their options. Personally, I'm a bit puzzled in the midst of the numerous versions of what's going on. The only thing that is certain is that, if you had a two player game in mind, it's only a sub-game of a much larger game, if even that.

One of Gazprom's objectives is no doubt the speeding up of the Nordstream gas pipe line. According to the BBC, Gazprom's deputy chairman Alexander Medvedev said on Friday that they believe "it is necessary to develop, as soon as possible, alternative transit routes. We hope that Europe takes the necessary steps to support this".All in all, what the Russian counterparties, whether that's Gazprom or Kremlin, want to achieve from all this is less of a mystery. To me, the more relevant question is: what is going on in Ukraine and what are their options? It's obvious that Russia should compensate Ukraine for being able to pump gas through Ukraine, but the proposed price of $ 250 per thousand cubic meters may be the best deal Ukraine can get. Eventually, they might end up paying something close to the full market price. Of course, the gas will be flowing again in a day or two, because Russia must honor the bilateral agreements with its European customers. I'm looking forward to what the talks tomorrow between Gazprom, Ukraine and the EU will result in. However, history has taught me not to expect to fully undestand the game I'm watching. Is it purely commercial? Let's start by asking: to whom?

Environmentalism and Keynesianism

2008-12-30T09:42:00.000-08:00

After yesterday's posting, the thought crossed my mind: what exactly do I mean when I speak of environmentalists. I looked up the word in Merriam-Webster's, and the word environmentalist is defined as "one concerned about environmental quality especially of the human environment with respect to the control of pollution", and the word environmentalism is defined as "a theory that views environment rather than heredity as the important factor in the development and especially the cultural and intellectual development of an individual or group". Oxford dictionary's definition for the word environmentalist is "a person who considers that environment has the primary influence on the development of a person or group". Needless to say, the word environment does not only mean nature in this context. However, for the sake of argument and simplicity, let's take it's meaning as referring to nature, alone.

It's become fashionable to say that we're all Keynesians now, and that claim is mostly true, except for Germany's finance minister, Peer Steinbrück (and a few others). In a similar way, we could also say that we're all environmentalists now (except for Bjorn Lomborg and a few others). Environmentalism is no longer an emotional issue, it's an intellectual issue (to most). What I mean by this is not only that we've understood that preserving the environment has mostly a lower net cost than abusing and destroying it. We've also realized that the environment has more than mere economic value, and those values, such as its aesthetic value, doesn't render the issue emotional. To some people, of course, it still is emotional. Some would like to stop the development of wind parks, because they cause a few bird kills per year. In a similar way, there are guys like Bjorn Lomborg who completely neglect the facts of climate change. However, most people are willing to accept the results of several studies (by McKinsey, IPCC, and IEA) that tell us that stabilizing CO2 concentration to 450 PPM has a net cost near to zero. In that respect, we're all environmentalists now: We're all concerned about environmental quality, and we're all beginning to understand that, in the future, environmental issues will probably have a much larger influence on our development than we previously thought.

Snow Angels near Lapland

2008-12-29T12:48:00.001-08:00

I'm in (update: near) Lapland skiing with my family. Yesterday, I made snow angels after the sauna - naked. FYI.

Today, I read that the Bush administration might not extend the Endangered Species Act protection to arctic seals living in oil and gas rich Chukchi and Beufort seas. This, of course, is just to speed up off-shore drilling in these areas. Now, does off-shore drilling make sense in these areas relative to the environmental risks? It depends what you compare it with. Environmentally, it probably makes more sense than making ethanol from corn in the U.S. or making oil from Canadian tar sands or shale. In a similar way, it probably makes less sense than using clean power generation to charge electric cars during the night when there's no other load in the network. Personally, I think we're wise to deplete all conventional oil and gas resources first, because it's certain that every conventional oil barrel will off-set one barrel of sheer stupidity - whether it's corn ethanol or liquified coal. These are the issues environmentalists should concentrate on instead of off-shore drilling.

Gas OPEC

2008-12-23T07:38:00.000-08:00

Energy ministers from twelve gas exporting countries flew to Moscow today to continue talks about creating a "gas OPEC" (ft.com). It's interesting to see what comes out of it, but a gas OPEC will certainly never effectively set volumes, as OPEC does, or prices since gas markets are much more rigid and based on bilateral contracts between the seller and the buyer. John Stern wrote a good article almost two years ago in which he analyzes the meaning of a gas OPEC to Europe's gas markets.

ENTSO-E and EU's Energy Market Integration

2008-12-21T10:42:00.000-08:00

On Friday, a new EU body was established to help coordinate the development of pan-European electric transmission network (Commission's press release). The responsibilities of the European Network of Transmission System Operators for Electricity (ENTSO-E) will include the coordination of EU's future cross-border transmission investments, analysis of resource adequacy of both generation and transmission, and development of market and technical codes. ENTSO-E's work will be of consultative nature, and ACER (Agency for Cooperation of Energy Regulators) will maintain the market regulator's mandate at the EU level. The establishment of ENTSO-E will thus have no impact until ACER is established and has full power to enforce new game rules that apply to all national regulators. Furthermore, it may be misleading to use the term "full power" since ACER may never really have such a mandate. EU's institutional framework prohibits the delegation of discretionary powers to bodies outside the Community framework. ACER is bound to have a very specific mandate that is not seen as discretionary decision making, per se. In reality, as Martin Godfried pointed out, the Agency will be quite dependent on the cooperation of national regulators to play along. Those regulators must be politically independent and dedicated to the integration of EU's electricity markets.

Rumor: Obama to nominate John Holdren as his science advisor

2008-12-19T03:19:00.000-08:00

Yesterday, Science magazine speculated that President Elect Obama might nominate the Harvard Professor as his science advisor tomorrow. His appointment would be a very clear signal of Obama's aims to respond aggressively to climate change. Joseph Romm speaks more about Prof. Holdren here.

The Return of Depression Economics

2008-12-16T12:45:00.000-08:00

There are many great minds talking about The Return of Depression Economics over at TPM Café, including Paul himself. If you're at all interested in economics or the economy in general, you don't want to miss this one.

Energy Options For Transportation

2008-12-15T09:42:00.000-08:00

Mark Z. Jacobson of Stanford University recently published an interesting article about the merits of various alternative energy sources for transportation. The study omits the costs of different technological solutions and the current real world applications of some of the solutions. Rather, the study takes a look at eleven categories or criteria, including resource abundance, CO2 emissions, and several other factors. The paper is ingenious in showing the relative merits of energy options for transportation, where car batteries could be charged off-peak, but what's a little disturbing is the paper's seeming attempt to extend the findings to apply to baseload power for the grid. After going through the study, especially one odd assumption sticks out.

Jacobson's "opportunity cost emissions due to delays" takes into account the 10 y (update: 8-14 y) longer planning and construction time of nuclear power relative to wind power, and hence nuclear power gets an additional 59-106 g Co2/kWh. I suppose this range is based on some current portfolios of power generation that's needed to grind power while the plant is being plant and built. However in a similar way, there are current and real "opportunity cost emissions due to operation" of wind and solar power that the study doesn't take into account. There are currently several gas and coal plants around the world that are ramped up and down to fill in the intermittency gap of those energy sources. If there Jacobson assumes an ideal zero emission world with interconnected wind parks, energy storage technologies, and intermittency mitigating portfolios of clean power, he should for the sake of symmetry, assume the same world for nuclear power. After all, it takes much more than 2-5 years to plan, permit and build those prerequisites.

To be fair, academic papers have the prerogative of omitting some factors of reality in order to give us even some new insights. Jacobson's paper certainly accomplishes that mission. The transportation sector should indeed be based more on renewable energy sources driving efficient electric motors instead of ineffcient biofuels driving inefficient internal combustion engines.

No Price For CO2 Until 2020 in Europe?

2008-12-13T10:04:00.000-08:00

Yet again, European heavy polluters had a major victory in EU's climate talks in Brussels yesterday. According to the BBC:

"The original plan was for them to start buying all their pollution allowances from 2013. Currently many of these CO2 allowances are allocated for free, with varying national allocations in the 27-nation EU. Under the revised package, exceptions will be made for plants which were only partly or not at all linked up to the main EU power network in 2007 and for plants in poorer EU states still heavily dependent on fossil fuel. They will buy 30% of their CO2 allowances in 2013, and the 100% figure for buying allowances at auction will not be reached until 2020. Exceptions - called "derogations" - will also apply to industrial sectors identified as being at risk of "carbon leakage". That is, industries which EU data suggest could relocate jobs or plant to non-EU countries which pollute more. The Commission now faces a huge job in identifying those "carbon leakage" risks - and there will be pressure from industry lobbies who hope to get derogations."

With possibly a major part of allowances given for free, I wonder how the EU will meet its new target of cutting emissions by 20 % below 1990 levels by 2020, which falls far short of the emissions cuts called for by the IPCC (25-40 % by 2020). The only good news is that the target of increasing renewable energy's share of the pie is set to 20 % by 2020. It may not be a dramatic factor in mitigating climate change, but we'll have to wait until next November to see what Obama's administration will bring to the global mix. The conference in Poznan ended today without any promise of breakthroughs to come, although Elisabeth Rosenthal from The NYT seems to think otherwise. For example, she calls the adaptation fund for developing countries, which according to the BBC currently means about $ 80 million per annum in funding for developing countries, a ground-breaking element. I call that a slap in the face (for developing countries). On the other hand, a slap in the face is always better than a kick in the balls. Right?

The Multiplier Effect of Infrastructure Spending Meets Rationing

2008-12-13T08:43:00.000-08:00

Bob Hall and Susan Woodward recently argued that infrastructure spending has no multiplier effect (i.e. has a multiplier of one), based on military spending's effect on GDP during WW2. Paul Krugman suggests that perhaps the fact that rationing regulated the amount of goods people could obtain had an effect, as well. Good thinking, Batman.

Some things are still relative

2008-12-11T08:24:00.000-08:00

An article in the New York Times has the title "Money and Lobbyists Hurt European Efforts to Curb Gases". However true it might be that industrial lobbyists have watered down the European emissions trading scheme, their U.S. colleagues were so successful that a mandatory ET scheme never got off the ground in the first place. So what's the big news?

I believe the news is that in order for us to respond to climate change, a major change needs to happen either in the relative strength of lobbying coalitions that have a stake in the matter or lobbying must be banned altogether (which is not going to happen). I bet you would get a pretty good idea of where the U.S. energy policy might go in the next four years, if you pulled out the data for sources of campaign funding and lobbying expenditure by various industries. Anyone?

Change in U.S. Energy Administration

2008-12-11T04:35:00.000-08:00

Change is now everywhere. According to the Washington Post, Mr. Obama is going to appoint the 1997 Nobel Laureate in physics, Steven Chu, as the new head of DOE. He'll also place Carol M. Browner, the head of EPA during the Clinton administration, to a new White House post overseeing energy, environmental, and climate policies. These are great news to anyone, who believes we should decarbonize our current energy infrastructure. That includes yours truly.

I'm not going to repeat everything that has already been said about Steven Chu (here, here, here, and here) or about Carol M. Browner (here, and here). To get a first hand view of their views, you can watch them speak about important topics (not about their appointments, though) here (Steven Chu) and here (Carol Browner).

I just want to say one thing. Although this is good news, and it makes us hopeful of what's to come, the responsibilities of both Chu and Browner will be quite limited. Unfortunately, the U.S. energy policy will still remain a democratic and political process, making it slow, painful, and quite possibly, not so radical.

Clean Energy New Deal

2008-12-10T06:11:00.000-08:00

Yes, even the IEA is talking about the New Deal. This came out on Monday, but it went past my radar:

“The current volatility in global energy markets and the broader economic slowdown must not push us off-track from our efforts to address climate change. We must put in place the framework that will guide investment during the recovery and we must start the green infrastructure that will enable the sustainable economy going forward. We think there is an enormous opportunity to develop a ‘Clean Energy New Deal’ to achieve energy security, economic and environmental goals,” Mr. Tanaka stated. “By adopting new energy efficiency measures, constructing green energy infrastructure and taking steps to integrate cleaner energy into the power grids, governments can lock in sustainable technologies and reduce CO2 emissions by almost 40% relative to the projected baseline emissions for 2030.” According to the IEA publication World Energy Outlook 2008 (WEO), greening the energy system requires additional investment of USD 3.6 trillion in power plants and USD 5.7 trillion in energy efficiency over the period 2010-2030. These additional investments correspond to 0.6% of GDP per year, but bring fuel cost savings to consumers of the order of USD 6 trillion.

Sadly, that's the biggest news out of Poznan so far.

Architectures for Agreement

2008-12-08T12:16:00.000-08:00

I just read David Victor's chapter in Architectures for Agreement: Addressing Global Climate Change in the Post-Kyoto World (thanks Furhana), and although the book's been out for over a year now, I wanted to share some of my observations. If you haven't heard of David Victor; he's one of the world's best experts on energy policy and he's written extensively on climate change policies, as well. He is a die-hard realist when it comes to politics, and that makes his writing a bit disturbing - it sometimes seems as if he's so pragmatic that he waters down the Post-Kyoto Treaty when he should leave that to the politicians. Perhaps, he's just ahead of the game after all the game theory he's done at MIT's Poli-Sci department.

In the chapter, David Victor attacks four key elements of the Kyoto Protocol: universal participation, binding targets and timetables for emissions, integrated international emissions trading, and compensation to developing countries. He's right about universal participation. We should focus on getting the top polluters (G8 + 5?) on board first, instead of trying to get everyone to comply. Rome wasn't built in a day, and neither were the EU or the GATT.

In dismissing binding targets and timetables, Victor's reasoning breaks down a bit. He takes the North Sea and Baltic sea regimes as examples of successes in setting nonbinding commitments for reducing emissions. While the cooperation in the case of the North Sea may have been more successful, the Baltic Sea remains one of the most polluted seas in the world, and the pollution's only been getting worse. Leaving that aside, it's easy to agree with Victor that the commitments should not be set in outputs (emissions), but rather in inputs (policies), because the outputs are outside the direct and near-term control of the government. However, I'm yet to be convinced why nonbinding terms would be more effective than binding ones. I just need a practical example of potentially effective nonbinding commitments to mitigate GHGs. I doubt that a nonbinding carbon tax would be very effective, but of course I could be wrong. I realize that countries have different capabilities and interests, but I'm still inclined to think that a global fund to collect carbon tax revenues might be able to address this issue. At the same time, it could bring more accountability, and make the monitoring of commitments easier and less costly.

It's guys like David Victor that the best possible design of the Post-Kyoto treaty and thus our future depends upon. He certainly has the most pragmatic ideas.

Stimulus: Update

2008-12-07T05:56:00.000-08:00

The Washington Post ran a front-page article today about Obama's coming spending program to jump-start the economy. Governors claim they have $ 136 billion worth of public infrastructure projects "ready to go". It's hard to say what "ready to go" really means, but the proposal is bound to have a "use-it-or-lose-it" rule to encourage the speeding up of projects. I hope they put several other rules and strings to the package, as well, to avoid the wasting of money on projects that have low social returns.

Meanwhile, it seems as if the car industry is going to get money from the government, after all, to avoid filing for bankruptcy. I fully support a large scale fiscal stimulus for the economy, but I think it's the government's responsibility to spend money on goods that they believe ARE likely to be in demand, not on goods nobody clearly wants. Filing for Chapter 11 would've forced the car makers to reorganize their businesses and focus on models where they could still be competitive at (large pick-ups?). Yesterday, another article in The Washington Post stated the following:

"The sums being discussed by lawmakers and the White House fall well short of the automakers' request. Democratic aides said they are talking about providing $15 billion to $17 billion, which would be expected to see GM and Chrysler through the end of March, when president-elect Barack Obama would be in position to take over long-term plans for returning the industry to profitability. "

Come again. Say, who's going to restore the industry's profitability? I doubt that's Mr. Obama's job, and I think he'd agree with me.

Stimulus: How Much, Where, and When?

2008-12-05T01:36:00.000-08:00

Everybody's looking into the U.S. right now to see, if they can still jump start their economy before taking a nose dive into a much deeper recession and everybody else with them. There are now three related questions: how big of a stimulus package is sufficient (can it be too big?), to what sectors should it be directed, and in what time frame can we expect it to have an effect on the economy?

How much is sufficient? Sufficient for what? To fill the gap in declining private spending? Well, if the U.S. GDP is bound to drop by 7-9 %, we're probably in the one trillion range over the next two years. (Update: If you take into account the Keynesian multiplier, a stimulus of $ 600-700 billion could make up the gap.) But can the stimulus package be too large, and lead to massive inflation? According to guys like Paul Krugman, the Fed should be able to fight it off simply by raising rates. I've heard some opposing views, but they don't seem very credible considering the seriousness of the situation. Inflation is the last thing we need to worry about now. We don't want to see deflation similar to The Great Depression.

To what sectors should it be directed? If I had an agenda, I might easily argue that the right way to spend it is by putting a large part in decarbonizing the energy infrastructure, but unfortunately there are some contenders, especially the financial and health care sectors, and of course general infrastructure. The money must be spent in a way that maximizes long-term returns. There's been talk about pouring $ 15 billion per year into "greening the economy" as part of the coming stimulus package. Recently, Senator Jeff Bingaman gave a talk at CSIS about the energy priorities of the new administration. To those of you who don't him, he's the chairman of the Committee on Energy and Natural Resources.

The time frame for seeing any impact of the stimulus package is another interesting issue. There are reasons to be believe that the package will come too late to have any effect for the coming year of 2009. Infrastructure projects take time to go from paper to shovel-ready, and projects ready to be built are relatively few, possibly only worth a few tens of billions of dollars. If the U.S. started losing half a million jobs per month, next year is not looking bright. Government expenditure in the financial sector will probably bring the quickest response in the short term.

Casting for I am Legend: The Sequel

2008-12-04T23:50:00.000-08:00

Looking at the depressed faces on the streets of Helsinki cracks me a bit. Some of them look exactly like the nocturnal zombies in the movie I am Legend. In fact, if I didn't know that the zombies in the movie were computer rendered, I would guess the cast came mostly from Finland. If they're making a sequel, they should definitely look into my country. Using Finns wouldn't even require make up.

Time for Universities to Reflect upon Their Finance Curriculums

2008-12-03T08:08:00.000-08:00

I warned you when I started this blog that some of my postings would not deal with energy, but society in general. One phenomenon I've wanted to comment for a while now is the skill set of people working in finance, and how finance curriculums should be improved. Mark Thoma put it well in his blog today:

"All over the world, it has become fashionable for Universities and Colleges to offer Masters degree programs in quantitative finance or financial engineering (FE), a code word meaning the solution of the Black-Scholes option pricing differential equation in as many ways as possible. To do so, students are taught to use basic techniques in numerical analysis whenever the equation is either non-linear or does not lend itself to the standard analytical solution. As a precursor to this main task, the program usually includes a course in stochastic calculus during which Ito's celebrated lemma is discussed, proved and used."

My suggestion to improve finance curriculums includes courses in
1) critical thinking (i.e. philosophy: logic, political philosophy, ethics)
2) economics (both macro and micro, the key is to understand the balance sheet and dynamics of the economy, and the policy tools and their effectiveness)
3) public finance (yes, this is still economics, but the finance people don't know that)
3) international capital markets (ok, many programs already require this)
4) much more case studies (many about the current financial crisis)

I'm not going to suggest we should abandon the BS formula or portfolio theory. I just wouldn't want anyone to leave university with only these tools. In fact, I'd rather have them read just one book: The General Theory.

People, read about the economy!

2008-12-02T13:53:00.000-08:00

It seems that people at Frost & Sullivan share my view of the impact of the economic crisis on wind development, at least for Europe. That's great - especially, if their view is based on hard facts, unlike mine. Talking about hard facts, I recently had a worrying discussion about the economy with a person, who should know much better what's happening around the world. Everyone should be following the economy closely now, and if you're wondering what the best sources for analysis are, here are couple:

Blogs:
- Our latest Nobel Lauriate, Paul R. Krugman (see also link to his columns): http://krugman.blogs.nytimes.com/
- Brad DeLong: http://delong.typepad.com/

Bloomberg (for the best podcasts On The Economy): http://www.bloomberg.com/tvradio/podcast/cat_economics.html

Books:
- John Maynard keynes (that's right, we're all Keynesian now): The General Theory of Employment, Interest and Money
- Paul Krugman: The Return of Depression Economics and the Crisis of 2008

Yes, I assume you read newspapers, but if that's not the case, start with FT.com

The Air in Poznan

2008-11-30T11:43:00.000-08:00

A two week long UN conference on climate change will start tomorrow in Poznan, Poland. It will set the stage for the post-2012 climate treaty negotiations taking place in Copenhagen next year. In Poland, the aim is to 1) agree on a "plan of action" for the final negoation year, 2) "make significant progress on a number of on-going issues... including capacity-building for developing countries, reducing emissions from deforestation (REDD), technology transfer and adaptation, 3) advance understanding and commonality of views on shared vision for a new climate change regime, 4) and strengthen commitment to the process".

I believe 3) (finding a shared vision) is probably the most important thing, and that will require especially China's commitment to the treaty and faith in Obama doing his part, although his new administration will not yet be the official representative of the U.S. in these talks. We could get a glimpse of this shared (or unshared) vision during the "high-level segment" of the conference on the 11th and 12th of December when representatives from key countries will give their national statements. Although the current economic crisis might take out some proposals on near-term actions off the table, it shouldn't affect the treaty's long-term commitments and mechanisms. On the upside, there may also be some new brilliant proposals presented in Poznan. The program for the conference can be found here. Personally, I'm very excited to see where this will go.

There will be blood during the sixth technology revolution (soundbite).

2008-11-28T04:54:00.000-08:00

I loved NYT's piece yesterday on land leases for wind farms in Wyoming. It draws an analogy between the current wind farm development and the oil patch land guys of the old days in the U.S. There's a rush to get the best land, but landowners are often seeing offers that aren't even close to a fair compensation. The landowners are responding by establishing cooperative associations to use collective bargaining strategies and to share information. I wonder which developers are mostly ranked as crooks and cronies among landowners and which companies get higher remarks.

On another note, last week Merrill Lynch published a report where they estimate that cleantech will be "the sixth technology revolution" after IT. To most of us this isn't real news. But now we know why Merrill Lynch didn't suffer as badly from subprime mortgages as some of its peers. It wasn't that they were too smart - they were simply too slow. The report is a fun read. For example, it quotes Tom Friedman's column on estimates of global energy demand in 2050. Why not just ask Britney Spears? The result is that the report tells you that the "the world used 13 terawatts (TW) of energy in 2000 rising to at least 26TW by 2050". Of course, a terawatt is a measure of power, not a flow of energy. The truth is that we used about 14.000 terawatthours of electricity alone in 2000 (according to the IEA), and the total primary energy supply was about 10.000 Mtoe (about 116.700 terawatthours). To me the report is another great example of what's happened to critical thinking and our approach to information in the 21st century. It's a soundbite document made up of several insignificant or irrelevant sources. These guys should hire someone from Columbia's IEMP program. (Not me, I'm done with the financial sector)

Recession Specials

2008-11-25T10:50:00.000-08:00

In Chinese, the word crisis combines a sign for danger and another sign for opportunity. Recently, the news about the global economy have been consistently bad for investments in energy and particularly in new clean power generation. Yesterday, an article in The New York Times suggested that the economic slump would slow down the measures to mitigate GHG emissions significantly, since "heads of government have other things on their minds". Several investments in energy infrastructure have been delayed.

Although there are many reasons to be pessimistic about the economy's near-term prospects, it's not all doom and gloom for our attempt to decarbonize the global energy infrastructure. It was only recently that wind turbine manufacturers had an order backlog of two or three years. Demand outstripped supply, and equipment manufacturers had substantial pricing power. Now, major equipment manufacturers such as the Spanish Gamesa are shutting down factories because they've fulfilled their orders for the year, indicating that prices for turbines are finally declining to more reasonable levels, closer to what they were five years ago. The prices of commodities such as steel and cement have declined, and will decline further (unfortunately so will oil, gas, and coal). The cost of hiring construction workers for new projects should be more reasonable, as well. Going into 2009, electric utilities and developers with extra cash will be able to make deals that can be viewed as bargains compared to deals just a year earlier. No doubt, the situation benefits large utilities with massive war chests the most. The bargains will be found at all stages of development from untapped greenfield projects to operational assets. In addition, Barack Obama's team has been contemplating about announcing a massive stimulus package for "green economy" next year, and such a move could well inspire other countries to follow suit. We've stopped, and so we might as well think and try to see the opportunities.

Equity in GHG Emissions

2008-11-23T08:59:00.000-08:00

The UN climate change conference in Copenhagen next year will have to deal with two major questions: 1) what's the agreeable level of GHG concentration in the atmosphere, considering the costs and benefits of mitigating climate change, and 2) how can the cost of emissions abatement be allocated in an equitable and efficient manner, so that a treaty ratified by at least the world's largest emitters can be achieved. I have previously expressed my preference for a carbon tax over a cap-and-trade system. However, a carbon tax, although avoiding the immediate dispute over allocation of emissions allowances, would not avoid the question about efficiency and equity altogether.

I've been inclined to change my opinion about how the tax revenue should be used. I used to think every country should be able to decide for its own how to use the tax revenue (e.g. to lower taxes on labor or capital). However, a global fund for collecting carbon tax revenues could be a wiser choice at least in two respects: 1) the proceeds could be invested directly to emissions abatement where it's most efficient, and 2) the fund could act as means to transfer wealth to poorer countries with a higher marginal utility of consumption. There could be five year periods, after which the tax could be adjusted based on required level of emissions abatement and required amount of wealth transfer to compensate developing countries for their loss of wealth (stemming from the carbon tax) . The wealth transfers would not only be a matter of equity, but also one of efficiency as Chicilnisky and Heal (1994) and Sheeran (2006) have shown. There could be some graduation criteria, such as a GDP level, beyond which money would no longer transferred to a developing country. Of course, this solution raises other interesting questions which I'll deal with another Sunday.

World Energy Outlook

2008-11-21T05:37:00.001-08:00

The IEA published its latest annual World Energy Outlook last week, and the summary can be downloaded here. I find many of their forecasts more realistic than last year. In particular, their estimates of future renewable energy supply has increased dramatically from last year, and they have decreased their estimate of OPEC's oil supply in 2030 by about 8 mb/d. Of course, this all remains to be seen. What's more interesting are the implications of their different scenarios (Reference, 550 PPM, and 450 PPM scenario) on what is required to meet the increasing demand of energy, and at the same time, mitigate climate change. (they had a somewhat similar break-down last year, as well, but I wasn't writing this blog then.)

The Reference scenario is a laissez faire scenario in terms of demand growth, efficiency, and emissions. The global demand for energy increases by 45 % from 2006 to 2030. Fossil fuels account for 80 % of total primary energy supply with coal seeing the highest increase of any energy source in absolute terms. In the 550 PPM scenario, the global energy demand increases only by 32 %, and the required shift from fossil fuels to renewable energy and investments in energy efficiency will require an additional investment of $ 4.1 trillion between 2010 and 2030 (equal to 0.24 % annual world GDP). Compared to the 550 PPM scenario, another $ 5.1 trillion will be required to meet the 450 PPM target (equivalent to 0.55 % of annual world GDP). This might not sound like too big of a sacrifice, but the challenge is enormous. The global emissions in the 450 PPM scenario in 2030 are less than the projected emissions for the non-OECD countries in the reference scenario. In other words, even if the OECD countries cut their emissions to zero, the target would still not be achieved. In addition, some of the technology required to meet the challenge (in particular, carbon capture and storage technologies) are not yet fully proven or commercial.

The world leaders will meet in Copenhagen in November 2009 to discuss the post-2012 climate treaty. Any bets on the outcome? Maybe next time I could write about the political reality of equity in global emissions.

Europe's Gas Market(s)

2008-11-19T05:44:00.000-08:00

Ok, now it's finally time to start writing much shorter and more frequent postings. I hope these will be short enough for people to actually read them. I'll try to throw in some new thoughts every other day, maybe about three times a week. If I didn't have something meaningful to say at least that often, I might as well go and bury my head in the sand.

The other week, Pierre Noël sent me a link to his yet another excellent piece on European gas markets on ECFR's website. I hope the French and German policymakers will give his advice serious thought. Again, he's calling for an integrated gas market, and in particular, he's suggesting 1) a clear political mandate for the Agency for the Cooperation of Energy Regulators (ACER) to force national regulators towards common rules and their implementation. 2) A key goal should be the removal of long-term procurement contracts, and as the first step, unused capacity rights should be auctioned (so called "use-it-or-lose-it" rule) to boost liquidity. 3) The acquisition of transmission and storage assets by suppliers such as Gazprom should be screened by ACER or another EU regulator, since Gazprom has a vested interest in segmented markets, and such acquisitions clearly pose a risk to market integration. 4) The union should help the Russia-dependent central and eastern European countries to devise an action plan for energy security, and 5) Europe shouldn't waste too many resources on its external energy policy, of which Nabucco serves as a grave example.

But how do you convince Germany and France of the benefits of an integrated gas market?

Thoughts on the financial crisis and deregulation

2008-10-20T13:51:00.000-07:00

My last posting about deregulation may have had an unfortunate timing in the midst of the current financial crisis. Many people, especially pro-deregulation politicians such as John McCain have tried to blame the crisis on “greed on Wall Street”. However, as Michael Walzer recently pointed out in Dissent Magazine, there’s always been greed on Wall Street. It was already Adam Smith who noted that the motivation of an individual in the economy is one’s own gain. That includes bankers. This is one of the main reasons why free markets don’t often function for the common good. The limitations of free markets must be understood and supported by correct and adequate regulation. The financial crisis can’t be solved by getting rid of greed on Wall Street as McCain would like to think.

One of the reasons behind the current financial crisis is flawed banking regulation. Prof. Walzer suggests that it was the main reason, but I believe that massive international capital flows and low interest rates that fed the housing boom and inflated housing prices to unsustainable levels also played a significant part. Wrong incentives in the financial markets certainly played a role, as did the overtly complex financial instruments that, in the end, nobody could put a value on. But let’s get real. At the end, the housing boom was created by house buyers, not banks. Don't get me wrong, I believe in George Soros' theory of reflexivity in financial markets, and I believe that lenders helped to inflate the housing prices. We can (and should) blame the lenders for not managing risks and misallocating capital, but the borrowers are guilty, as well. We have some personal responsibility to manage our own financial risks, as well. With or without strict banking regulation, you can always live beyond your means, and that’s exactly what Americans have been doing. It’s critical that the next President gets this message through to the public. (Had there been someone else in the White House during the last eight years, he might have understood the basic business cycle economics of building a fiscal surplus during a boom.)

But turning back to deregulation; there are cases of failed or flawed deregulation in many electricity markets around the world. Those failures and flaws teach us many lessons, of which the most important is probably that the process of deregulation, and indeed, the regulation of deregulated markets is never finished – It’s an everlasting process. The most famous case of deregulation is perhaps that of California’s. Let’s talk about the lessons from that crisis.

First of all, the crisis in California was not only due to failed deregulation, but also due to an abnormal demand and supply imbalance. Except for two months during 2000 and 2001, demand was higher than ever between 1993 and 1999, leading to severe shortages. Secondly, there was a decrease in hydro generation during that period. Thirdly, there was nuclear capacity out of service during some of the period (some claim this was strategic gaming). This meant that more expensive gas and oil fired units had to come online. In turn, higher gas prices affected the crisis, as well. But prices were capped, and there was no pass through of utilities’ cost increases, such as fuel costs. In short, there was no demand response. Thus the first lesson is: don’t deregulate into a supply shortage. Second, regardless of whether you do that, you always need mechanisms to address supply and demand imbalances. In California, there was no hedge against the spot price, and utilities were not allowed to enter into bilateral contracts.

Furthermore, there was no single agency overseeing the whole market change in California, and there still isn’t one. It can be expected that trading arrangements and regulatory arrangements don’t mesh well, if they’re not designed under the same roof. This problem is not only native to California. The role and responsibilities of FERC and state public utilities commissions are not clear - at least, not to me. In California, the trading arrangements were faulty in part, because the municipal utilities did not join the ISO. In addition, the ISO was not permitted to resolve congestion at the scheduling stage, only at the dispatching stage.

Deregulation does not work, unless it’s accompanied with well-designed and rigorous regulation that oversees the deregulated market. In California, no agency had the mandate to monitor the various operators in the market, and to stop strategic gaming that was harmful to the market. Neither was there any punishment (explicit or implicit) for breaking the rules. In the long-term, there’s clear evidence that deregulation has eventually improved incentives for efficiency in operation and development in California. But we should learn from previous mistakes with short-term success in mind, because as John Maynard Keynes famously said: In the long run, we’re all dead.

A final note: I’m not a free-market fundamentalist in terms of privatization, either. When considering privatization, one should always consider the general public’s interest, one which the U.S. privatization process of the USEC (Uranium Enrichment Company) didn’t take into account! Some basic services are also better in public hands or at least in mixed markets, because the state retains direct control over quality and price of the service. Privatization only increases welfare in the economy, if the root problem is ownership, and even then the resulting increase of profits may only increase the society’s dead weight loss (i.e. benefit only the owners). If the root problem is not ownership, then organizational reforms may achieve better results than privatization. The main benefits of privatization are often seen as stemming from aligning incentives and separating commerce from politics, although the latter is not always even possible (e.g. with utilities). However, the principle-agent problem is common to both public and private companies. Both can also become corrupted, and both may have soft budget constraints as the recent bail-out of large private banks again shows.

Deregulation of electricity markets. Phase 1: Privatization of the generation segment

2008-09-16T19:45:00.000-07:00

As the concluding posting to the “Primer Series”, I wanted to discuss the state of deregulation of electricity markets around the world and the key lessons thereof. However, one thing that I’ve learned while writing this blog is that my postings are too long. This time, I will focus on the privatization of the generation segment, and I’ll return to the deregulation topic several times again in the future. Deregulation is only justified from the efficiency point of view. In the developed world, deregulation has been driven by high operating costs and retail prices, construction cost overruns, and technological innovation. In developing countries, deregulation has been associated more with the need to build more capacity. Historically, privatization of generation has been often the first phase in the creation of competitive electricity markets, although there are some exceptions, which we’ll discuss further later.

There’s a general text-book model for deregulation that has been followed successfully by many countries, and experience shows that departing significantly from the model has lead to performance problems in the electricity market, as in much of continental Europe and Japan (Joskow, 2007). The standard architecture for competitive markets involves the following components (see Sally Hunt, 2002):

1. Privatization of state-owned electricity monopolies to create high-powered incentives for performance improvements and to make the pursuing of political agendas through these entities more difficult;

2. Vertical separation of potentially competitive segments (generation and retail) from segments that continue to be regulated (distribution, transmission and system operation) to avoid cross-subsidization and discriminatory behavior that affects access to the network.

3. Horizontal restructuring of the generation segment to create adequate number of competitors to mitigate market power.

4. Horizontal integration of network operations to create regional wholesale markets, and the designation of a single independent system operator to schedule the dispatch to meet demand, to maintain the physical parameters of the network, and to guide investments, through price signals, to new infrastructure, where those investments are needed the most.

5. The creation of voluntary wholesale spot energy and operating reserve market.

6. The development of active demand-side to let consumers react to real prices of energy production.

7. The establishment and enforcement of supporting regulatory rules, e.g. to efficiently allocate scarce transmission capacity

8. The unbundling of retail tariffs from the regulated transmission and distribution charges

9. If retail competition is not introduced, alternative suppliers must be obligated to serve these customers, by purchasing power in the wholesale market.

10. The establishment of regulatory agencies that have good information and are able to regulate and monitor the competitive and regulated market (transmission and distribution) efficiently.

11. Necessary transition mechanisms from old to the new system.

There are several lessons to be learned from the past decades of electricity market reform, and one is that the text-book model really is a robust guide for reform. The most successful reforms have followed the model fairly closely, and market performance has mostly increased in terms of costs, network losses, generator availability, quality of service, and price levels and structures. This is not to say that retail prices will always fall following liberalization. In some countries, prices were too low before deregulation, which discouraged investment and encouraged wasteful consumption.

Privatization of generation segment is a key factor to creating a competitive market. England has, eventually, become one of the best examples of a successful reform program. However, it failed initially because of the decision to create only three generating companies out of the state-owned CEGB, leading to severe market power problems for years. The market has become competitive only after the entry of new generators and divestitures by incumbent producers. Unlike England, Argentina immediately put a serious effort in generating a structurally competitive generation market, and the results have been excellent. The experience shows that no market design will function well, unless there’s an adequate amount of competitors and the market power of dominant firms has been mitigated in some way.

On the other hand, Australia, the Nordic countries, Ontario and Brazil have proceeded with liberalization without fully privatizing their generating segments. This has raised some very interesting issues regarding both short run market performance and long run investment incentives. Namely, investments in new generating capacity based on non-market incentives by the public sector seriously undermines the incentives for the private sector to do investments, because it doesn’t have similar support in form of direct or indirect subsidies. Since China is trying to create appropriate incentives for new investment in generating capacity, the mixed public-private generating sector is a serious issue. In fact, it should be realized that the reason why most of continental Europe didn’t privatize the generation segment in the first place, was because most of the countries had significant excess capacity at the time of liberalization.

Policymakers may fear that private sector’s commitments to build new capacity are inadequate, but this should be dealt as more of market design issue, not as obstacle to privatize the generating segment. The regulator can impose resource adequacy or forward contracting requirements, or it can provide capacity payments to generators to restore those incentives. Above all, private investors are looking for stable market rules and longer term contractual commitments, and the more there’s redesign of the market reforms, the more costly will the transition be to the society. Therefore, a strong political commitment to the reform is necessary.

The general lesson from privatizations in other countries is that success which brings efficiency gains and other benefits requires strong institutional and regulatory capacities (Banks, 2006). Moreover, the transformation of government’s role from the caretaker and provider of electricity to a mere regulator and/or system operator is extremely challenging in a top-down, state managed economy, such as China. It requires a lot of commitment from the reformers to convince the state apparatus and the public of the benefits of privatization. This is not only due to the powerful local interests among public generators, but also due to general public concerns, such as employment, which may be quite coveted in government enterprises. These are concrete political and economic issues, and no doubt there are losers in every privatization.

The distributional effects of privatization are surely a concern to many. According to Birdsall and Nellis (2003), there doesn’t seem to be much association between the amount or speed of privatization and increase in inequality. They find method of divestiture, type of new owner, sequencing of other reforms and the institutional framework before, during and after the privatization as more plausible reasons behind increasing inequality. They conclude that the key factor for avoiding harmful distributional effects is the creation of an independent regulatory regime that designs and monitors contracts and introduces rational and enforceable rulings. Where this key factor has been emphasized, the privatization has led to increased access, especially for the poor.

Primer - Part 2. Critical Aspects to Post-Kyoto Negotiations

2008-07-21T22:42:00.000-07:00

It’s been over a month since my last posting, and I feel a little ashamed of it. However, it’s summer, and I’ve needed a break from the professional Me. Over the past year, I’ve been building up a pile of (non-energy related) books that I’ve only now had the chance to read. I’m also visiting my home country, Finland, and friends and family take up half of my time here. I love every moment of being here, but I know I have to return to the real world soon. Finland is a country that doesn’t share most of the real world’s problems. The education, health care, and social security systems are some of the most lavish of any country in the world. Our economy and geopolitical security are on par with the rest of EU-15, and according to some (very narrow-minded) studies we’re one of the few countries to even benefit from climate change. And yet, we’re leading the global statistics in violence, suicides and depression. I guess when you don’t have problems; you have to make them up. Or perhaps Albert Camus was partly right: maybe the struggle itself is necessary (though not enough, as he claimed) to fill a man’s heart. What makes the Finns depressed and violent is the lack of struggle.

I’ll continue with my primer to the blog, and I’ll briefly discuss the main aspects of global equity in GHG emissions and energy consumption, and take a look at different pricing mechanisms for CO2. These are enormous issues, and I plan to return to them many times again in this blog. For now, I just want to raise up the most central aspects to them. Next time, I’ll wrap up this primer series with a look at where electricity market deregulation has been going in different areas of world, and what we’ve learned from the experience.

There’s hardly a more important and challenging global policy issue at our hands than the Post-Kyoto negotiations for a new global climate treaty. The UN Conference in Copenhagen in late 2009 will be the critical point, but the drafting of the text for the new framework is planned to begin this summer. Nicholas Stern has been writing extensively on the subject of the new treaty, and his views should be taken very seriously. After all, at the moment he’s probably the most influential economist on the subject, and his opinions weight heavily on policy makers’ decision making. His recent paper, Key Elements of a Global Deal on Climate Change outlines some of the critical issues that need to be considered in the process, but his policy implications change quite dramatically, if one assumed more strict emissions cuts. His paper is based on calculations of bringing GHG emissions down by 50 % by 2050 relative to 1990 levels, leading to a CO2 concentration of 500 ppm. However, the recent studies of one of our leading climatologists, Jim Hansen, suggest that the goal should be as low 350 ppm, implying global emissions reductions on the scale of 80-90 %. The latter target would require reducing emissions in the OECD countries practically by 100 %, throwing one of Stern’s basic principles, efficiency (reduce emissions where they’re cheapest) out the window. If one is to believe Hansen, we need to reduce emissions everywhere, regardless of the costs.

In addition to the required level of global emissions reductions, the two other major issues of debate in the climate treaty include equity in emissions allowances and the optimal pricing mechanism for CO2. Since I’m not a climatologist, I should have more to say about these issues than about the required level of CO2 abatement. After realizing the magnitude of the required emissions reductions, global equity in energy use and emissions might sound like a mere philosophical question. But to policy makers it’s a real issue, which must be solved in the Post-Kyoto negotiations. If the people in the developing countries are entitled to the same living standards as the people in the West, it means that people in the West have to change their living habits tremendously to reduce their emissions – and they do. To abate the equity dispute, Stern proposes binding emissions reductions for developed countries immediately post-2012, while developing countries would not have to commit to binding reductions until 2020. The point of binding commitment could also be tied to certain “graduation criteria”, such as a given per capita GDP, beyond which binding commitments would have to be taken. Until 2020, developing countries would benefit from a one-sided trading system, in which they could sell emissions credits, but would not be required to buy them. In other words, they would be rewarded for mitigating emissions, but they would not be punished for failing to do so. In light of the current emissions, projected GDP growth rates, and the required abatement figures, this all sounds a little too lax to me. I’d rather remain a realist regarding what must be done, and inspire optimism in policy makers for what can be done. After all, China is already emitting 5 tons of CO2 per capita today, and the Chinese economy is projected to grow by 10-16 fold by 2050. Even in Stern’s conservative 500ppm scenario, the global average per capita CO2 emissions should be as low as 2 tons per annum by 2050. China must start decarbonizing its energy system at the same time as developed countries, as do India, Brazil and the rest of the developing world. I don’t see any way around this fact, if we are to seriously mitigate climate change – we simply cannot rely on non-binding commitments. Coal is just too cheap to burn to leave it in the ground without a real opportunity cost. As the only robust and real opportunity cost, I see an immediate (post-2012), universal and binding price for carbon. The compensation for developing countries must be dealt with in other ways than encouraging them to increase emissions until 2020, and we’ll discuss those ways in more detail later. Needless to say, they are financial.

So what is the optimal pricing mechanism for CO2 emissions? An efficient pricing mechanism for carbon emissions would involve low transaction costs, it would minimize additional negative market distortions, avoid perverse incentives and protectionism, and furthermore it should be transparent, credible, durable, and lastly: effective. I’m inclined to think that such a system is a global carbon tax, and not a cap-and-trade system which now seems to end up being the ultimate choice of the global community. The better transparency, credibility and effectiveness of the carbon tax can hardly be disputed, but there are other reasons, as well. First of all, the tax would dismiss most of the debate on distributing emissions, because no allowances would be allocated. France with its history of “clean” electricity production would face the same marginal cost of emissions as would Germany. Trust me; this is not a trivial issue even among developed countries. Secondly, a tax-based system would remove negative market distortions by making it possible to lower taxes on capital and labor. Every country could choose how to use its tax revenues the best way it saw fit. The transaction costs of a cap-and-trade system would also be much higher than a tax-based system, something that the global financial sector would welcome with open arms. But however important the liquidity improving role of the financial markets is in other cases, I just cannot see liquidity as a decisive factor in CO2 pricing. After all, we need to decrease emissions by 80-90 %, which means decreasing them everywhere. Furthermore, the social cost of CO2 emissions is the same universally, and individuals and firms alike should pay their full marginal cost.

We’re living in exciting times as decisions regarding these issues are about to be made. Our children and grand-children will one day judge, if there was one thing we managed to do right. I hope so.

To be continued.

Europe does indeed need a single market for natural gas

2008-06-18T11:59:00.000-07:00

Pierre Noël recently wrote in Financial Times about the need for a single market in natural gas in Europe. In fact, it’s already been a month since, but I was too busy to respond to it then. I liked his piece, but I feel compelled to emphasize some points which he doesn’t bring up at all. At the same time, I see his claim about Europe already enjoying a diversified gas supply as extremely misleading. The only country in Europe that has a diversified gas supply is Spain. While the country gets 40 % of its gas from Algeria, it also imports LNG from Qatar, Nigeria, Libya, Oman and Trinidad and Tobago. The rest of Europe gets their imports mainly from Russia and some from Algeria. Moreover, Algeria’s Sonatrach and Gazprom have signed a “memorandum of understanding” that will potentially see the two companies engage in joint ventures and asset swaps in third countries. This trend is bad news for Europe’s attempts to diversify its gas sources to new independent producers.

Dr. Noël is right to point out that the political debate is too much focused on Nabucco. The pipeline is not only unlikely to be built and supplied with gas, but even if built, it’s relatively little of comfort on a larger scale. One estimate of future gas demand calls for additional imports of 250 bcm/y by 2020, while Nabucco could only bring in 30 bcm/y of new capacity. On the other hand, I see much more potential for new LNG imports. Although countries such as Iran might be out of scope for investment for a long time, there should be room for additional imports from Qatar which has the fourth largest proven gas reserves in the world. The country already exports over 5 bcm of LNG to Spain.

As Dr. Noël points out, the main reason why there’s no competition in Europe’s gas markets is not because of Russia’s domination by its market share, per say. However, he doesn’t exactly say why there is no competition. More importantly, he doesn’t say how the “integrated and flexible” gas market should be created. Policymakers will need detailed instructions.

To my understanding, there’s no competition because most of the supply (by some estimate over 90 %) is based on long-term agreements. As long as this is the case, no other producers will be seriously interested in the European gas market. Ignoring opportunities in the spot pricing market is the reason why Europe doesn’t have a flexible gas market. European policy makers defend their state-owned national champions and long-term agreements with the argument that unbundling the market into small players would lead to less negotiating power with the large gas producers, particularly Gazprom. But as long as the long-term agreements cover over 90 % of the total procurement, there will be neither competition nor diversification of supply.

Gas markets, like electricity markets should be technically much easier to liberalize in Europe than in the U.S., because the market has a small number of large state-owned companies. In the U.S., the market structure was much more complex prior to liberalization. The European market structure and the regulatory framework needs urgent revision to encourage third party access, if future demand for gas is going to be satisfied in a reliable and efficient manner.

A primer – my view on some of the most pressing issues in energy - Part 1

2008-06-13T02:48:00.000-07:00

I’ll start my blog by commenting briefly on currently the most disputed issues in energy, because it’s only fair for you to know where I stand on these issues. These are my beliefs based on the knowledge I currently have, and I’m not afraid to admit I was wrong at a later stage. As the most debated issues in energy, I see 1) the future energy technology portfolio and the key energy sources, 2) future pricing mechanisms for carbon emissions, 3) energy and equity, 4) and optimal electricity market design. The debates around these issues may seem to be stuck because of differences in people’s motives or intellect, but there are also genuine differences in people’s perspectives and frameworks. For many of these issues, optimal solutions are local, meaning there is no universal solution. Moreover, all of these issues carry institutional dimensions, and social and economic institutions vary by country and culture. These institutional differences must be respected when higher principles are applied in local contexts.

Let’s start first with the technology debate. In the SIPA magazine in 2007, Steven Cohen, the director of the Environmental Science and Policy program at Columbia University called nuclear power “a discredited, mid-20^th-century mistake”. The statement bears some truth in it. The technology is no doubt dangerous and involves the use and production of toxic fuels and waste. However, I’m afraid it’s a mistake we’ve already made. First of all, proliferation of nuclear technology and arms is not an issue of the future, but one of past and present. One can easily argue that the technology is already in the wrong hands – whatever that means! Secondly, the currently operating nuclear plants are much more tempting targets for terrorist attacks than potential new plants, which can be made much safer. The waste issue must also be solved whether we stop using nuclear power today or not. In other words, the construction of long-term repositories can be considered de facto sunk costs. The building and decommissioning costs of nuclear power are extremely high, but nuclear power is the only proven energy technology which can provide reliable base load power on large scale without emitting greenhouse gases. After internalizing the cost of CO2 emissions, the cost of nuclear power seems relatively modest. Even if the price of CO2 was as low as $ 20 U.S., compared to a coal plant, the avoided CO2 emissions over the lifetime of the plant almost fully cover its building cost. Am I a fan of nuclear power? No, I’m not, but we’d no doubt be in much worse trouble in terms of climate change, if we had used coal power in the place of nuclear power for the last 50 years.

What about fossil fuels then? China is building something between one and two coal plants every week, and the country has coal reserves for hundreds of years, as do the USA, Russia, India and Australia. These countries rely heavily on coal powered generation, especially China which generates over seventy percent of its electricity from coal. Coal is so important, abundant and cheap that it would be naïve to believe that these countries will stop using it as an energy source. The only relevant question is at what cost we can capture the carbon emissions from these plants. At the end, it’s the price if CO2 that dictates whether carbon capture and sequestration (CCS) technologies will be used in these plants. I will deal with carbon prices and pricing mechanisms later. However, since CCS technologies are still quite inmature, we should focus on building more combined cycle gas generation instead of coal plants, because gas powered plants have much lower CO2 emissions than coal plants. For example, a modern CCGT with an efficiency of 51 % results in CO2 emissions that are only 38 % of those of a modern coal plant with an efficiency of 34 % (if the carbon contents are 14.5 and 25.7 kgC/MBtu, respectively). The second major benefit of modern CCGTs, and one that is much less thought about in energy policy, is the shorter start-up time of a CCGT compared to a conventional steam turbine. The start-up time for a conventional ST is approximately 4 times longer (12 hours vs. 3 hours) than for CCGT. This means that when new wind power (with a capacity factor of say 22 %) is backed up with coal plants (78 % of the time), these coal plants aren’t shut down at all, but the output is only ramped up and down, depending on the wind speed.

Another trendy topic is peak oil. The term was coined by Marion King Hubbert who in 1956 estimated that the US oil production would peak (normally distributed) around 1970. He was right. He then made a similar estimate for the world oil production with an estimated peak in 1995. However, the global oil production has not peaked yet, although the production in OECD Europe is starting to decline. It’s quite possible that we’ll run out of conventional and cheap sources of oil in the following decades (except for Saudi Arabia), but I dare to argue it’s not a very relevant issue. Different hydrocarbons can be converted into various forms (coal into oil and gas, etc.), and at current oil prices these conversions are very profitable. In fact, it’s been estimated that coal liquefaction projects can offer positive returns even when the price of oil is as low as $ 30-35 US/barrel. Globally, the total reserves of various fossil fuels amount to almost 1700 gigatons of oil equivalent (Gtoe), and the estimate for unproven resources is around 3400 Gtoe. To put this figure into perspective, we consumed 291 Gtoe during 1860-1994. In other words, we’re not running out of oil in some time. The more relevant question is whether we’ll really engage ourselves on a large scale in such foolishness as coal liquefaction or the conversion of tar sands into oil. These conversions require energy and/or fresh water, and they release greenhouse gases, leading to a double-whammy to the environment.

I often find peoples’ opinions about science and technological progress solving all our problems amusing. It’s amusing (and sad), because we already have the technological solutions to many global problems, and yet we don’t solve them. One of such issues is famine, as Jeffrey Sachs keeps pointing out. It’s clear that the challenge with famine lies to larger extent in institutional and political issues, not in technical or economic challenges. Although the mitigation of climate change also faces political challenges, I’m more optimistic about the power of technological solutions here. The development of carbon capture and sequestration (CCS) technologies from air seems very promising. James Hansen, the director of the NASA Goddard Institute at Columbia University and one of the world’s leading experts on climate change thinks that we’ve already crossed the dangerous threshold of CO2 concentration in the atmosphere. We’re now at 380 part per million, whereas we should be below 350 ppm in order to avoid dangerous anthropogenic effects of climate change. This means that we should not only stop emitting CO₂, but we should in fact be able to suck out the excess CO2 out of the atmosphere. Klaus Lackner, the director of the Lenfest Center for Sustainable Energy at Columbia University has been involved in the research for carbon capture from air and his team also studies ways to safely store the CO₂. A small prototype of the carbon capture device has already been built, but apparently a large scale demonstration still requires more research and cost reductions. His team has also studied the storage of CO2 in magnesium silicate. The mineral seems to bind CO2 spontaneously, without requiring an external source of energy. The only problem is that the natural reaction takes hundreds of thousands of years. Lackner and his team are trying to make it happen in thirty minutes.

What is the role of renewable energy in the future energy portfolio? Of all the different alternatives, I see (direct) solar energy as having the biggest potential. The earth receives more energy as solar radiation in one hour than what we humans consume in a year. Approximately half of this radiation is reflected back into space from the atmosphere, clouds and the earth’s surface. Solar energy can be captured for electricity and heat production through various techniques. Direct ways include photovoltaics, concentrating solar power (CSP) and other solar thermal technologies. Indirect forms include wind energy, wave energy, biomass, and hydro. So far, the most popular and cheapest technology is wind power, but I believe that the decreasing costs of solar panels and increasing efficiencies will eventually lead to direct solar power becoming the dominant renewable energy technology. Moreover, solar panels don’t have the aesthetic issues of wind turbines. I believe that other renewable energy technologies will remain marginal. However, I still believe they’re all needed in the fight against climate change.

To be continued.

Introduction to my blog: Energy & Society.

2008-06-13T02:46:00.000-07:00

Welcome to my blog, Energy & Society. I started this blog, because I often find the discussion in energy, especially in energy policy, being derailed to issues of little significance, while more important issues are being completely ignored. This couldn’t be truer now when we’re facing the challenge of decarbonizing our current energy system in order to mitigate climate change. At the same time, the global energy demand is estimated to grow by 50 % in the next twenty years (IEA).

This blog will deal with topics such as energy and climate change (especially pricing mechanisms for CO₂), electricity market design, energy and development, and various other economic and social issues relating to energy. I will try to keep the blog casual in style, but I don’t want to just share my personal opinions, knowing that everybody has them. Instead, I want to lay out the facts, look at different perspectives to the issues, ask relevant questions, and then form rational conclusions. I know this sounds like an outline for an academic paper, but academic papers attempt to give you answers - I don’t.

At the time of starting this blog, I’m finishing my studies in the world’s best interdisciplinary energy program (PEPM-IEMP) at Columbia University in New York City. It’s an intensive one year master’s program that combines economics, policy and business perspectives to the energy markets. My previous working background is in financial consulting (M&A, valuations, risk analysis), and I also hold a master’s degree in business from Helsinki School of Economics. As that may indicate, I’m a Finn by nationality. One of the reasons I’m starting this blog, is because I need to reflect back on this year at Columbia to see what I’ve learned and how the year has shaped my thinking about energy markets.

In my view, it’s the responsibility of every person to contribute to the solving of local and global problems in the ways everyone can: in spoken and written words, in actions and in choices. These issues may just be the personal problems of your friends or neighbors. The everyday challenge in one’s life is to live a life that makes a difference, and does so for the better. While actions are important, words have often much more power in influencing your neighbors, and in a broader context, the public and the coalitions that hold political power. Some say that talk is cheap, but it’s really the most valuable asset we’ve been granted. In fact for some people, words are the only thing they possess. Some problems may be solved through one man’s actions, but most global problems require the building of new coalitions or changing the current ones. This can be only achieved through words and fruitful discussion. There’s no easier way to get one’s voice out than starting a blog.

I’ve named my blog Energy & Society not only because of the vast linkages between the energy markets and the society, but also because it allows me to write articles once in a while that may in fact only deal with society in general. I welcome everybody’s comments to my writings.

Yours truly,

AVS