Archive for August 8th, 2010

Sustainable Alternative Energy

Sunday, August 8th, 2010

By Ford Peterson  ©2010 (1)

The “free energy machine” (2) is an urban legend that persists today.  Some believe you can get 80 MPG out of an Olds V8 if you use the right carburetor.  Did you know city buses can be designed to run on water?  The 2010 election is filled with urban myths just as fantastic.  The notion of subsidizing business incubators to create alternative energy jobs defies the laws of physics—and economics.  Until the candidates start talking free market solutions, we’re headed for a long list of stone-aged subsidized tax-and-spend disaster programs!  Can a state infuse money into the market to create jobs and solve our energy problems too?  While the candidates are not kidding, like those elusive buses running on water, it is whimsical thinking.  Unfortunately the public is eager to buy-in to a plan—any plan—that gets us heading into a new energy direction.  This is a correct way for government to promote a sustainable alternative energy economy, heaping baskets of money into the street is not one of them.

Do you want “Free” or “Managed” market economics to rule?

The 2010 election speeches contain campaign rhetoric like “business loans” and “education grants” and “incentives” for “renewable energy jobs.”  They try to make you feel warm all over in hopes you will vote for their plan.  The truth?  The energy industry understands that the vast majority of alternative energy jobs are going to be Chinese and German jobs (they own the viable technology).  The quickest way to screw-up what’s left of our capitalistic system is to begin government subsidy of jobs, business income, or revenue—even if it’s for a well-meaning purpose.  Opening the fiscal spigots will cause love and treasure to pour out-of-our-pockets and overseas unless this is done correctly.  Government / Industry entanglements have repeatedly created caustic industry dependencies and economic disasters for those involved.  Many ethanol-from-corn plant investors have found that their original $10,000 stock certificates make great campfire starters. 

Managed economy methods have been tried repeatedly over the years and each time those pencil-pushing-smooth-talking-financiers-of-folly figure out how to game the system into redirecting government’s best intentions into their own pockets.  Attempting to “manage” problem using direct payments in exchange for initiative is simply bad policy.  Ask any sod-busting farmer how their annual cash payments are viewed by the public—most will admit that it’s public welfare for millionaire land barons.  A far better approach would be for people to pay what the food, fuel, or fiber is actually worth.  This is the free market approach.  When government properly exerts its authority to protect the free market from monopolistic abuse, or cannibalistic behavior (more on that later) the market will manage itself and find its own beneficial economies.  Proper structure to the market will mean that society benefits while lining the pockets of the innovators and entrepreneurs willing to bet their treasure on tomorrow using today’s ideas.  The state’s treasuries benefit from the revenue and society benefits from robust thriving markets (read: JOBS).  The best part?  Not one red cent is recorded as coming from the state!

A double helping of “free markets” please!

Before being asked to leave the unemployment line to queue up for your dark-gray government-issued jump-suit uniform with your name on it, you should decide to vote for:  “Maybe the free market approach would be best.”  Great!  That’s real progress!  Vote correctly in November or we’ll be set back 4 years!  And who should receive your support?  I don’t know.  None of the candidates on any side or from any party are making sense on this topic.  I can’t tell you who to vote for.  But I can tell you what they should support—a free and robust alternative energy marketplace.  I can also tell you what the alternative energy market should look like.

The “Feed-In Tariff”(FiT)

Wikipedia has a great description.  While I do not endorse the described approach 100%, I do endorse the concept, which needs a uniquely American solution.  The method is often seen as part of an energy policy with respect to the electric grid.  The technique needs to be applied to all energy sources and uses.

“A feed-in tariff (FiT, feed-in law, advanced renewable tariff, or renewable energy payments) is a policy mechanism designed to encourage the adoption of renewable energy sources and to help accelerate the move toward grid parity.

What does it mean?  It means an energy policy designed to price the consumption of power equitably across all users of said power.  The actual structure of the policy will depend on the category of energy consumption and the fuel source.  Valuing all energy consumption as being equal is not appropriate.  For example, heating your house has different options than powering your car.  Consuming aviation fuel does not equate directly to powering electric lights at the office or at home.  Frankly, one round-trip to the Orient can consume more petroleum (per person) than most families consume in their lifetimes.

I get the need to avoid monopolies, but how can an economy exhibit “cannibalistic behavior?”

If the consumption of gasoline actually cost $2.69/gallon to collect, refine, distribute, store, consume, provide profits to investors, pay tax to governments, mitigate caustic clean-ups, pay the medical costs associated with related pollutants, and pay for the wars (valued in lives and treasure) needed to sustain its use, then there would be equity among the users of gasoline.  If you read the list of ‘costs,’ you will notice that several line-items are not included in any standard cost-accounting formula.  Most notably, the last three items are Humvee-sized loopholes in the system.  “Cannibalistic market behavior” is a term I invented to describe how the markets consume the consumer by foisting hidden costs indirectly on society (the consumer).  In some cases these hidden costs dwarf the actual price paid by the consumer for the fuel. 

Does the cost of gasoline include the cost of accident clean-up?  While some would argue “Yes.”  I would argue that the taxpayer’s support a clean-up by subsidizing the tax deduction of all these costs as common “operating costs.”  Tax law generally prohibits the deduction of government penalties (such as traffic tickets for speeding) but most of BP’s costs are “ordinary and necessary” costs of doing business.  BP likely intends to deduct 100% of their costs associated with the Deep-Water Horizon disaster and get 35% of those costs refunded in the form of cash payments of tax refunds.  My guess is they will land a few choice tax credits along the way for “energy” and “innovation” and “job creation” and who knows what else the D.C. purveyors of pork will provide.  Did the users of gasoline pay for these subsidies?  Some of them did—every American gasoline consumer will pay for 65%.  But every American will pay 100% of the remaining 35% in tax bennies courtesy of your elected representatives in Washington D.C.

What about the degradation in the quality of life caused by pollution created while burning the fuel (gasoline, or diesel, or coal, or wood, or garbage, or nuclear fuel)?  Do the users of gasoline pay to have all the pollution damage to health and property?  Not at the pump!  How about cancer or birth defects?  Did you pay for those at the pump?  Nope!

Most would argue that if it were not for our dependence on foreign oil, we would not be leaving our children’s blood in the sands of Afghanistan, Iraq, Kuwait, or elsewhere.  We would not be spending our children’s otherwise good fortunes using bone crushing deficits.  Did you pay for these costs at the pump?  Nope!  What would have been added to the cost of boat gas you used this weekend if it had included the value of this week’s Afghanistan casualties?  What’s a Marine Private worth to you?  Put a value on that!  Even if you split the difference with the value determined by his widow, you would still have to sell that boat to pay the bill.

Fifth grade economics lesson:

A fifth grader can understand that there are indirect costs associated with the consumption of traditional energy sources (substitute any caustic chemical reaction based fuel source: petroleum, coal, shale, atomic, wood, garbage, etc.) and some of those costs have been foisted on society.  These costs are HUGE and very real.  And they are measurable (with the exception of the loss of a Marine Private, which should be determined by his widow). 

Feed-In and Tariff is not perfect, but it’s a reasonable start.

Feed-In and Tariff should use scientific analysis, along with responsible economic costing, and a healthy dose of common sense thinking, to determine the real price to be placed on consuming a gallon of 100 octane aviation fuel.  Determine the cost of coal by including the cost of fixing (or at least preventing) the damage to our beautiful Minnesota waters caused by acid rain.  Recognize the cost of storing spent nuclear fuel rods for eternity when pricing electricity produced from the destruction of uranium by fission.  Recognize that the cost of refining iron ore into 5,000 lb of steel to make that 5 door SUV entails more energy than that vehicle will consume in the 1st 100,000 miles of its life.  Add a Tariff to each caustic fuel to properly value these consumables and bring parity to the “grid” of the fuel of choice.  Use the revenue to lower the cost of alternative energy sources by reimbursing the favorable producer for the added costs of being “green.”  Include renewable energy in the analysis but include all costs, direct and indirect.  When measured at the meter, or the pump, or the mine, an energy policy can use a free market to launch viable solutions to our economic and energy problems.  The market will determine what’s best if the system is established, monitored, and enforced.  In the end, we all win.

“On budget” versus “over time.”

Candidates seem to feel that they can spend the public’s money to subsidize activities designed to redirect our energy use.  Yet more fanciful thinking.  Private money will sign-on and invest treasure when the ideas make sense.  T. Boone Pickens abandoned his wind farm hopes.  Without public subsidy, the notion simply fails to cash flow.  Properly structured, FiT can provide the long-term element desperately needed to justify many alternative energy ideas because it de-politicizes the process.  The state’s budget will not be a factor in the equation.  A wind farm can take 15 to 20 years (or more) before it ever produces a nickel of net income.  Meanwhile, design weaknesses, damage caused by lightning or storms, or poor maintenance procedures can limit the life of these installations, making them a risky investment.  Photovoltaic installations (solar cells) deteriorate over time (loss of 20% at 10 years is not uncommon) and they are expensive.

Any orchestrated plan that involves a legislature or congress to appropriate future funds is simply unworkable.  Government cannot be a trusted partner.  A better approach is for the utility to contractually guarantee cash flow for the future production of energy.  Viable installations should be eligible to receive a binding contract on future production.  Produce the electricity and guarantee a payment for (as an example) 20 years.  This makes the system predictable while providing a preferred method of production.

An example is in order.  Let’s consider a grid-tied 20 KW photovoltaic (solar cells) system.  Let’s assume an initial investment of $60,000 with an expected life of 20 years.  Let’s further assume said installation can produce 60,000 KWH per year.  The only other operating costs are repairs ($1,000/year) and insurance ($500/year).  Expected market rate for electricity is $0.07/KWH.  Return on investment is 8%.

If the utility creates a transfer payment of $0.0651/KWH ($0.07 plus $0.0651 for a total of $0.1351) to the producer of solar power, and initiates a target of 20% energy from solar PV cells, the assessment on all users of the grid would be $0.013/KWH, an increase of 18.6%.  In the event the array lasts longer than 20 years, 100% of those remaining profits would go to the investor since the transfer payment would have returned 100% of his equity, with 8% interest added.  (assumed tax rate = 0%)  Drawback to this is the initial investment of $60,000.  (I’m ignoring the federal and state tax credit subsidies for this discussion.  What I’m offering here for discussion is an alternative approach to the current system.)

What if that initial investment is reduced to $22,500?  Borrow $48,000 at 6% for 15 years, spend $60,000, but expect a return of 8% over the 20 year life?  The additional total cash outlay is increased from $60,000 to $70,500 but the extra equity is needed to cash flow the operation in years 6 though 15.  The transfer payment would be $0.0628%.  A goal of 20% energy from PV suggests an assessment of $0.0126/KWH, or a 17.9% increase in the rate.

Now these cash flows are based on reasonable assumptions I invented for illustration purposes.  An excel spreadsheet is available HERE.  Perhaps after public debate it’s decided that a 2% return is all society is willing to support.  Using debt and all other assumptions being the same, the new transfer rate for 20 years would be $0.0455, or a surcharge of $0.0091/KWH, a 13% increase.  For most homeowners, that suggests an annual assessment of $171, or about $14/month.  Even more impressive is that the total cash investment drops from $22,500 to $16,000, making this a much more plausible facility.

Similar cost accounting methods can be applied to coal, nuclear, wind, tidal, etc.  The winner is the energy consuming public.  What is important is that the utility could be compelled to enter into a 20 year contract to guarantee a rate.  In the event technology develops to out-perform the contracted method, the investor is still able to recoup the initial investment by completing the project and carrying it the full expected life of the system.  If done properly, this contractual arrangement can facilitate bank financing.  It also eliminates the politicians from the equation.  Future budget blow-ups will not prevent the producer from being paid.

It is the long-term nature of the guarantee that introduces the magic.  Current political rhetoric, if executed, puts the investor square in the middle of every year’s budget battles.  No investor will be willing, and no banker will finance, when the only benefit available is a future government grant.

Net Metering versus Feed-in Tariff (FiT)

Minnesota is a net metering state.  This means that the power utility must buy, at the retail price, whatever power produced by the consumer over-and-above what is used.  While this produces a side-effect of making tax-free income, it also ensures the consumer that they are, at a minimum, receiving retail values for the excess electricity produced while continuing to pay retail market rates for what they consume. 

Under a typical FiT arrangement, a consumer producing power using preferred methods (solar, wind, etc.) would sell all power produced at a premium rate to the utility.  What power can be consumed is charged back at normal retail rates.  In my example, a 60,000 KWH household would receive approximately $0.13/KWH or $7,800/year, and spend approximately $0.08/KWH or $4,800 per year in electricity costs.  The excess would cover repairs, original investment, etc. (3)

In Summary:

Dialogue involving tax credits, job creation, and education grants, are not viable alternatives to developing a workable Feed-in Tariff program for not only the electric grid, but other forms of energy consumption.  Using a free-market approach is a preferred method of bringing meaningful changes to our energy needs.  De-politicizing the industry will go a long way towards eliminating the financial risks associated with government / industry partnerships.  Providing long-term solutions augmenting production is preferred to subsidizing initial installations, which can later under-perform for any one of a number of reasons.  The notion of ‘grid parity’ should be emphasized for not only the electric power grid, but all forms of energy consumption—including transportation.

 1 This document can be quoted, copied, and published granting proper attribution.


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