Positive Externalities Still Missing in Academia for Power
I was made aware of this study during a dialogue on a LinkedIn group – http://www.aeaweb.org/articles.php?doi=10.1257/aer.101.5.1649 To see the context of dialogue please click here.
There is a huge assumption made by the authors. And that is the current price of power holds all the value of power in it. The authors fail to realize power markets are not based on personal value of power but mainly on power COST plus a fix return – particularly in regulated markets. In de-regulated markets perhaps one could argue to some extent, but I would contend there are no completely de-regulated markets yet. Many markets still have legacy regulated assets in them.
When goods are sold below their personal value (the price someone would pay in order to balance the value they receive from it) many academia market models will fail. First the mere fact a good would sell below their personal value breaks some of the free market model. Typically a good will sell below their personal value because of excess supply and governmental involvement. Clean water is a simple example. The personal value of having clean water is quite high – you get to live and not be sick. We could probably all individually boil water and everyone would probably have different levels of clean water. Or we could have governmental/regulated entity treat water and make it convenient, standardize, and accessible for everyone. Society then pays a price for this which typically is based on COST plus a return not personal value to each individual.
In the case of electricity, the cost of individual electricity production is quite high and dangerous – everyone can’t simply boil water like in the water example. It would have been out of the reach of so many. Therefore the utility model was built – A guaranteed return on investment on a COST basis, so that people may have access to power on a cost effective and safe basis. Once again it is not priced at the personal value that a person is getting from power. Ask yourself if access to power was limited and it was auctioned on ebay how much would you pay and outbid your neighbor? In times of blackout that value is quite high. Certainly worth sacrificing your monthly cell phone, internet, and cable bill since without power the phone, internet, and cable is meaningless. Because electricity is sold at a cost plus basis there exist many positive externalities beyond the simple cost of power. The personal value generated by having electricity will vary by individual. To the simple mundane person who does nothing with electricity, but indulges one-self with entertainment perhaps the personal value caps out at the value of that individuals disposable income. However if we use the authors example of a Berry farmer perhaps that value is much higher.
The author takes a very pessimistic view point of the value of electricity and ONLY views electricity production as having negative externalities. I do acknowledge the negatives do exist, but I am also a political and pragmatic to realize inherit personal value being derived by electricity beyond the cost paid. In the case of the berry farmer example, which they start to discuss on page 5, they only note the negative cost that power production has on the farmer. I acknowledge this does exist. However the gain not mentioned is the availability of cheap power. Clearly the market choice was to take the cheap power and deal with some of the consequences and in return the cheap power will deliver value beyond the cost. For example, it could have enabled the berry farmer to create an electronic packing system which doubles his productivity. If it wasn’t for the environmentally damaging, but cheap generation the cost of electricity may have been out of reach to install and operate this new packing system.
In an ideal world perhaps he could have BOTH cheap power and clean energy, but the laws of nature did not make it so. We can easily create a scenario that the pollution caused from the generation may reduce his production by 20%, but having an electronic packing system more than made up for his losses; as getting his product to market in efficient time before the berries expired was a crucial step. In addition because electricity is available for the masses in relative cheaper cost, more people have more disposable income to purchase berries vs. the 99 cent menu at the local fast food store.
The access of cost effective electricity allows internet and commerce to grow. If we add a global view to it – the berry farm and their access to low power enabled them to be competitive from farmers from S. America. If the cost of power was greater the farmer may not be able to compete. Having cleaner air by itself does the berry farmer no good if his livelihood is eliminated. Clearly the Berry Farmer would pay a lot more for power – particularly in hindsight given all the economic gains he may have not imagined. They simplified the problem too much and focused only on the negatives of generation. There are positive externalities not shown in the price perhaps as much as negative externalities. Both of the externalities are hard to discuss.
Increasing the cost of electricity could put electricity out of the reach to the common man. At a point, air pollution becomes a subsidy for the wealthy. I would contend the current air standards in the US are suffice for the majority of society if they were given the option to allocate money into either housing, food, healthcare, and even transportation versus better/cleaner air. I do believe the air could be cleaner, it is just a question of priorities. The inverse to the US, I would contend is probably China. The pollution is so bad there that it is at the tipping point that priorities need to shift. It is good to have a job, but if you can’t live very well what is the point. In the US we prioritized the environment later in our industrial revolution. Did you know – US sulfur dioxide emissions are below 1890 levels now!? http://atmos-chem-phys.net/11/1101/2011/acp-11-1101-2011.pdf
When will it be enough? To believe that you have infinite amount of money/resources and can effectively solve everything is not reality. Perhaps we are designed to listen to the squeakiest wheel versus helping the truly needed. The nation needs to prioritize and make some sacrifices. This has been proven over time.
Please do consider All Energy Consulting for your energy consulting needs. We offer well-rounded pragmatic solutions to your issues.
Your Pragmatic Energy Analyst,
614-356-0484
It’s not the end of the world – Climate Change& Quantitative Easing (Printing Money)
I have wanted to write about the similarity between the two most potentially transformative societal issues confronting us, Climate Change & Quantitative Easing (AKA Printing Money). Of recent the latest debacle in a spreadsheet error by Rogoff and Reinhart in their paper “Growth in a Time of Debt” has led my writing astray. However this issue further substantiates the similarity. I am sure my readers know that there was also an issue with climate change data. The most famous was the hockey stick graph presented in the IPCC report. The graph originally came from a report done by Michael Mann in the paper “Northern Hemisphere Temperatures During the Past Millennium: Inferences, Uncertainties, and Limitations”. (One difference is the climate change titles are much longer than economic papers!)
Though the recent debacle includes a simple spreadsheet error the biggest difference from what was reported to what is being challenged by Thomas Herndon, Michael Ash, and Robert Pollin is based on how one treats data and what one excludes or includes. Mr. Herndon and team believe since more data was available for other countries they should be weighted more no matter the differences in economy or time period. Many of the same arguments were made to refute the Mann graph. In the end, BOTH data sets from Mann and Rogoff can be presented to be less dramatic than what both authors presented. However in BOTH cases it does not eliminate the issue that both have presented. In Rogoff case, Mr. Herndon and team state and their own data shows that high debt does not likely lead to better outcomes relative to a lower debt situation. The Herndon and team did conclude there is no magic number that leads to a NEGATIVE growth. However they do note that growth is much less than it would be when debt levels grow above the 90% level. In Mann case, one could argue the graph he presented was on the high-end of uncertainty but the end message no matter what statistical approach you use there is some warming relative to the last 1000 year perhaps just not as dramatic as Mann’s graph.
We can ignore both the issues just because of some technicalities and potential showmanship or we can pay attention to these both very critical points because they contain some probability. We can argue to death to the extent of probability, but there is some threshold that action becomes required no matter what. I believe we have crossed that threshold a while ago in both issues. In terms of actionable items I am not as extreme as some could be since everything is a probable outcome in my mind. Actions need to be commensurate with the probability and timing of the impact. And both issues probability and timing may change as more information and responses are made.
Getting back to the discussion of similarity, both are issues that rely on sacrifice of the future for the current state. Clearly it is “easier” and “cheaper” to continue to burn fossil fuel versus transform the economy. The consequences may be dire, but they are many years off. It is also easier and politically more appealing to increase the money supply driving investments now and have the savers and the future generation deal with the pain later. In each case one could argue we don’t really know the future and perhaps even solutions in the future we cannot predict now will come to fruition. However I would attest that is very poor planning.
There are measures we do each day thinking of the future. Some are simple and have been engrained in society – such as buckling up. We buckle up because it can save our lives. The odd of getting into a serious car accident in your lifetime is 30%. I am not arguing for you not to buckle up, but to show we do act when probabilities are not as great along as the action can be commensurate with the risk and its probability. I am sure you can find many climate deniers to admit there is a 20-30% probability they are wrong – of course that means they are 70% confident it is not. Nonetheless this would argue for action at SOME level if one cared about the future.
Both climate change and quantitative easing are actions that are not apparent at the moment similar to indulging on funnel cake and other unhealthy foods. It feels good now but eventually you will likely get obese and have health issues not worth the gains gathered from the near term enjoyment of sweets. In fact, it will typically be better to emit and print money now. The ultimate consequence of each of them requires a view over many years if not hundreds of years.
On the point of obesity, it clearly shows society is not ready for problems requiring long-term thought. Obesity in the US is very high. This is a matter of caring about what you eat and the long-term issues involved with your choices. We are a society designed for Carpe-Diem and keeping up with the Jones. It may be quite pointless to argue the science of climate change and/or long-term impacts of quantitative easing when society could really care less. It amazes me to see such low savings in both general and retirement savings. So much of society is living on debt. By that logic people don’t really focus on the long-term. I can see somewhat the rationale for many religions to eliminate interest charges – usury. Most religions are focused on maintaining/reducing our vices – e.g. Ten Commandments. I think they realize debt living is not healthy. Living on debt makes you feel good in the moment, but any day it can overwhelm you with a change in your life. A humble lifestyle is too easily gone with the ability to borrow money. We cannot solve these two very large issues without changing society to think longer term. If people do not care about their own lives and cannot plan even their meals to live healthy, do we really expect them to be able to comprehend and plan for climate change which impacts us significantly in 100 years?
Climate change to me seems more tangible and more discussed with various opinions across academia compared to quantitative easing. This may be based on my career largely in the energy space. However I do read quite a bit and find much more literature on climate than quantitative easing impacts. Climate change certainly seems to have much more historical data with ice core samples thousands of years old. The oldest data set Rogoff and Herndon was working with was 1830. Given this I thought I put some graphs up from various recent reports just so you see why I am alarmed with quantitative easing even though the “market” is doing well.
We are in a world so dependent on debt and fossil fuels. Current trends on climate change and quantitative easing cannot be changed until we change the mindsets of people to think ahead. Planning is gone for Carpe Diem. I like the concept to live for the moment, but what if the next moment depends on how you live in this moment. Do you want more moments? We do not live in Hollywood we live in reality. Please take care of yourselves – eat healthy – do not over-extend your finances – reduce the temptation to keep up with the Jones.
The world will not end because of climate change and quantitative easing. However the world could be very different and potentially less inhabitable and stable if we don’t start dealing with some of our issues which require thought. The probabilities of significant harm to society may not be significant (+50%) but given the extent of outcomes it does make it worthwhile to do some actions similarly as we buckle up.
Your very concerned and thoughtful Energy Analyst,
614-356-0484
“What is the hardest thing in the world – To think” Ralph Waldo Emerson.
AEO 2013 Early Release – Arbitrage Remains
The EIA released an early release of the AEO 2013 in December. I have been so busy, I haven’t got a chance to note some of the changes (Once again, not complaining but very grateful). As I mentioned in my previous blog of the AEO 2012 release, the first thing I like to look at is the relationship changes.
In this release, it looks like the arbitrage remains for someone to capitalize on the difference between natural gas and diesel. They did narrow the spread relative to last year which I believe is directionally correct. The difference continues to be large on the scale of over $15/mmbtu in the next decade plus. The propane difference is over $10/mmbtu. With this spread premium, one really needs to question the science and economics of Gas to Liquids (GTL). GTL is possible, though costly, as proven by Shells Qatar Pearl facility. With the economics presented from Shell, you would need your input price below a dollar to make the project worth its large capital cost ($19 billion) and the associated market risk.
The opportunities exist for Shell to learn from this large venture to see if they could lower the cost and/or improve the yield or perhaps, Shell technology is just not the way to go. This could be a worthy consideration for research from the US government and universities. GTL could be the game changer which would bolt on perfectly with the game changer shale gas. I have spent much of my time as Chemical Engineering examining this area. The cost is what I believe really shifted the spread to be so large; $19 billion for 1.6 bcf/d of conversion is incredible. Perhaps. Shell is scaring the competitors away from researching this?
Jumping to the next relationship, Gas – Coal; we see they have narrowed the spread more in this year’s AEO 2013. Essentially they have lowered the gas price relative to last year by around $1/mmbtu. I cannot agree with their 2014-2017 outlook. I believe they have gone too far down. If you look at the balance, it would not make sense that 2015 gas demand in the power sector would be lower than it was projected in 2013 with lower gas prices in 2015. I understand as new gas units come into the power stack, you get an improvement in efficiency for gas units.
However, at the same time, we do have a retiring coal fleet plus the “must-run” coal plants to manage the safety of the coal piles will be going away over time. I believe it is possible to see gas demand higher than in 2012, even with higher gas price. For the very reason that coal units were running more than economically reasonable to manage inventories, under coal contracts which were contracted years back. To the coal industry own doing, the coal contracts were shortened to be no greater than 5 years. This would mean many coal contracts are in negotiation at the lowest need time period for coal generators. I suspect as much as coal generators over bought in the contracts over the past 5 years, they will under buy now. Coal “must-run” units to manage inventory will be a thing of the past over the next 5 years. I will take the bullish position on coal spot prices.
As a commodity forecaster for many years, when the general equilibrium fancy models catches up to your outlook, you know that you now have to take a difference stance. I believe gas prices in the AEO 2013 are too low now. This belief is driven from the fundamentals of economic demand creation from low gas price in both the industrial and power sector. I believe coal prices in the spot market will be stronger than most think, as the most likely outcome is under-contracted coal volumes.
I hope to have more time to review the final report which is expected to be released in the spring. Does the report come sooner now since Punxsutawney Phil saw no shadow and predicts an early spring?
Please do consider All Energy Consulting for your energy consulting needs from forecasting to planning to actually doing hands on work in creating models, we are here for our clients.
Your Energy Consultant,
614-356-0484
ERCOT Modeling Issues – Scenarios vs. Sensitivities
ERCOT released a new 10 yr system assessment. The big news among the renewable community is a “scenario” labeled BAU All Tech with Updated Wind Shapes. In this “scenario”, they have updated the wind profile (capacity factors) for the wind technology option. The surprise from the output was the large swing from the BAU case to install 17,000 MW of wind, which did not occur in the base. In addition, the combined cycle units fell by 10,000 MW. Also solar added 10,000 MW into the system versus the BAU. I have nothing against renewable, in fact I am pro renewable in many ways, however I am skeptical on these results. My skepticism is focused on the one supposed change made by the modelers for this “scenario”. By changing just windshapes, they were able to produce these dramatic swings from the BAU case.
I have been modeling power systems for over 10 years and I cannot rationalize this outcome without more knowledge than what was presented in the paper. Let me start out with the basic concerns before moving over into the technical realm. The BAU case vs. this new wind case drops gas consumption by around 40%. If this wind profile enhancement was driven by turbine technology, then the rest of the country would also add to the lessening of natural gas demand. Anything greater than a 10% change in natural gas demand will surely impact the price of natural gas. A true scenario would iterate and or rationalized this issue. This type of analysis seems to be more of a sensitivity analysis versus a real scenario development. Another fundamental concern is the extent of wind development and the on-going production tax credit (PTC). At some point in the wind penetration, the PTC would be removed. I am sure the non-wind blessed state would like to stop subsidizing states, particularly whose economy is much better off.
Another fundamental missing piece is any discussion on rates. More capital is being spent in the wind shape case than the BAU. This is simple math, as the cost of capital of wind and solar for each MW is greater than gas units. The balancing act is the long-term fuel cost will balance the additional capital. However large capital investments usually require some guarantees. This comes in the form of Power Purchase Agreements with the local utility. The PPA’s are signed and prices set based on the current markets as that time of the contract. Even though wholesale market prices may come down it does not mean rates will change as PPA contracts are typically fixed in order for the investor to know they will recover their capital investment. Over time the PPA deals will begin to look worse and worse as wholesale markets fall. Eventually industrial and commercial customers could become wise and remove themselves from the utilities poor PPA arrangements by creating distributed generation. This then lead to higher residential rates in the face of low wholesale power. This then leads to limited PPA deals. With more than half of the wind and solar build after 2020 one would need to seriously doubt the extent of those developments becoming real, assuming PPA is the mechanism for development.
On a technical basis the major issue lies in how the modelers are treating wind generation. As a panel of experts, including me, in a report done for the Northwest Power & Conservation Council noted wind generation, when sufficiently large relative to the market, should be viewed in a risk analysis as much as in the price of natural gas is commonly analyzed. The dependence on wind to the level seen in this new wind shape case will likely caused some dramatic grid events when the weather decides to not co-operate. This event may be 1 in 10 years to 1 in 100 years, but the point is not if, but when. Given the nature of weather and the sub hourly nature of electricity markets, I would suspect the issue will be closer to 1 in 10 years than 1 in 100 years. It is certainly possible to expect a weather front changing the landscape of wind generation in particular day, adding on top of that a drought situation limiting nuclear and fossil generation. In a stress case, the grid will likely fail in the new wind shape case. The value of the combined cycle will likely be re-gained in risk analysis. This once again will limit the number of wind builds presented by ERCOT in this new wind shape case.
As noted in the NWPCC report, I have had extensive experience in modeling power systems for market forecasting and planning purposes. If you are beginning your resource plan or are looking for another perspective, please do consider reaching out to me for assistance.
Your Energy Consultant,
614-356-0484
Power Dispatch More than a Supply Stack
The most used tool for new comers to the power market is the dispatch stack. The dispatch stack is basically the variable cost of production of power by each generating unit, stacked from least cost to most cost. Clearly units with low fuel to no fuel cost will be the lowest to the least efficient, highest fuel cost being the far right. EIA put out the hypothetical 2011 stack – http://www.eia.gov/todayinenergy/detail.cfm?id=9430
Those not directly involved in power markets will first take note of the low cost of renewables. However, you will also note nuclear being near zero cost. The stack does not take into account the capital cost portion of the project. As economic nature would have it, the high capital cost projects typically have the lower fuel cost and vice versa. The best of both worlds is very hard to achieve, hence a complicated process of developing a cost effective resource plan to balance the various tradeoffs. Besides the stack not accounting for capital cost therefore the typical dispatch cost does not account for operational issues.
Once again economic nature also produces higher variable power cost units as the unit becomes more flexible (the ability to turn off and on and ramp quickly). Case in point, most coal or nuclear plant cannot quickly ramp or turn off and on rapidly to account for the fluctuations of the market whereas inefficient gas units have extreme flexibility, but it comes with much higher power cost. If the market had constant energy level than perhaps supply stacks would be useful tools for analyzing power markets. However that is not the case as documented in my other blog. A deeper analysis is needed for the power markets – http://allenergyconsulting.com/blog/2012/06/05/levelized-cost-of-electricity-lcoe-analysis-potentially-misguides-you-in-the-power-markets/
Detailed analysis is needed on at least an hourly basis to really understand what is going on in the power markets. Another important feature of the power market due to the instantaneous issues is how the market gets priced. In the power market, all generators get the marginal price. As an example, if we had a system with 500MW of demand with only three power plants. Each power plant is sized at 200MW of capacity. Plant A bids at $50/MWh. Plant B bids at $5/MWh. Plant C bids at $35/MWh. If we assume a flat load the following outcomes occur based on varying demand.
Demand 550MW – Plant A gets to dispatch 150MW. Plant B and C gets to dispatch at 200MW each. They all get $50/MWh.
Demand 300MW – Plant B gets to dispatch 200MW. Plant C gets to dispatch 100MW. Plant A does not get dispatch and gets no revenue. Plant B and C get $35/MWh.
With this bidding mechanism, many of the renewable plants given that they only get their tax credit when they produce power will actually bid into the market to a NEGATIVE $22/MWh to ensure they are dispatched to collect their tax credit. Renewable plants typically already have a fixed power purchase agreement with the rate payer typically paying the bill. This dispatch price just impacts the wholesale market. The only concern utilities should have is when the wholesale price diverges so far away from the arranged power purchase contracts. At this point commissions should step up and question the decision making from the utilities and perhaps even their own mandates. This difference is really the true cost impact of renewables on society. Calculating wholesale power price as the cost to society from renewables is misleading and misrepresenting reality given most renewable deals are fixed. Another potential outcome of large digression between wholesale prices and retail prices is further push for more de-regulation.
There is much to discuss in how power markets work, but in a nutshell I tried to explain at high-level the dispatch stack and the realities of the market place. If you have further questions or are in need of examining the power markets please do consider All Energy Consulting.
Happy New Year – May you have a prosperous year!
Your Energy Analyst,
614-356-0484
Energy Independence Misguided Focus
A recent article posted in the NY Times by Michael Levi highlights my past concerns about Energy Independence talk. Amazingly enough I wrote about Energy Independence last December – http://allenergyconsulting.com/blog/2011/12/15/energy-independence-really/
I want to fine tune my message.
I do see Michael’s perspective in being concerned that we are mistaken about being energy independent as allowing the US to be ambivalent to the worlds energy markets. Clearly, the energy markets are global and will likely to be in the distant future. The theme I think Michael leaves out is the real message politicians and the like need to focus on, versus the concept of being energy independent – that is being productive with the resources we have.
I disagree with many about allowing exports of natural gas. If we are under full employment and the economy is humming along perhaps I could change my mind. However, since this is not the case, we need to think long and hard about why we can’t use our resources in a productive manner. The focus needs to be on stimulating manufacturing. We need to grow America to regain some of what we have lost over the last 30 years.
I like to note, manufacturing is not a path to riches for people, but it is a path to productivity and opportunity. What we have in this country is binary thought. If the working class can’t get a standard of living that allows 40-60K in income plus benefits, we shall accept nothing. It is no doubt a global economy for better or for worse. I have a very contentious thought about wealth which I mulled around with and discussed at bars with my most educated friends. I believe wealth is just like mass. It cannot be created or destroyed. There is a finite wealth in this world. Wealth is discrete globally and when one does better the other will have to do worse.
Let me define wealth more generally than just buying power, but also influence, and the ability to make others act. I believe my thesis holds water when you think about global economic growth. China and much of Asia, at one time, was thought as “third” world; they have grown to become an economic power.
With my thesis in place, the US and Europeans have slowly lost some ground to them holding the economic wealth in balance. The direct impact is the shift in “lower” end jobs in manufacturing. Time would eventually not allow a person making $60K plus benefit with the sole purpose to screw in 4 bolts to be able to compete with people in Asia, making less than $1 dollar a day. Likewise, let me not focus just on the lower income case. CEO’s in the US who do not add value but perpetuate the same concepts and ideas from previous CEO’s that are increasingly making more money than past CEO is also unsustainable. The competing landscape and the wealth balance that will occur, will produce sacrifices to allow others in the world to rise. In a holistic way and perhaps Altruistic – people living in such low standards of living for prolong time becomes inhumane and the sacrifices made from the developed regions have promoted a better lifestyle for them.
However as I point out to my kids that nothing in life is free. The sacrifices have been real and have been exaggerated by the binary thought – all or nothing. In order to balance wealth so that there is reasonable living standards for the masses, the developed country will need to reduce the standards of living, as their standards must compete with the other parts of the world standards. Alternatively one can be stubborn and go with the nothing attitude and live off the state, but this will lead to a very unstable society. I go back to my first point the value of manufacturing is not wealth building. The value comes from volume of employment it can produce. The ability to give masses something to do from 8 to 5 Monday thru Friday. Without this there will be trouble.
The US needs to innovate and take advantage of the abundant resources by creating efficient process to produce things the world uses from fertilizers to plastics to even vehicles. The abundant energy along with sacrifices from the top can ease the lowering of standard of living for the masses as parity is met with the rest of the world. Once again, let me stress both the low paying and high paying jobs. Both tails of the economic spectrum will have to sacrifice; a message that no politician can give since they need funding (high income) and volumes of vote (low income).
Happiness is not derived from money, but money is a requirement in today’s society. In addition, happiness does not come from consuming. We need to move off the binary thoughts and allow compromise. The US should move away from consumerism and regain our productivity focus. Letting any of our resources be exported is giving up on the American dream without fighting for it.
I wish all a safe and Happy Holiday. God bless this country and may we make the right choices.
Please do consider All Energy Consulting for all your energy consulting needs.
Your Energy Consultant,
614-356-0484
