Archive for January, 2008

Perhaps the pivotal challenge facing the environmental community is resolving the apparent conflict between the need to reduce emissions and the widely held desire for continuing economic growth.

This issue came directly to the fore in a recent BusinessWeek article titled “Little Green Lies,” which shows how the green initiatives of Aspen Skiing Company were often bumping into, and in fact prevented by, commercial realities of the business.

I was particularly provoked by the reader comments to the article. One respondent said it did not surprise him because (in his view) reduced consumption is ultimately the only environmental solution, which means reduced travel and reduced skiing, which runs against the profit motive of Aspen Skiing Company. This posting confirmed for another reader that (in his view) environmentalists are inherently anti-capitalist, viewing capitalism as the evil force that has led to climate change and other environmental ills.

To quote Rodney King, “Can’t we all just get along?” The answer, I think, is yes - and the path for squaring the circle is to note that capitalism is not to be confused with materialism or consumerism.

Capitalism is a social system that provides clear price signals and unfettered ability to undertake transactions, thereby enabling economic actors to make individual profit- and utility-maximizing decisions. That, in turn, promotes efficient allocation of capital, maximizes liberty of citizens and businesses, and facilitates private wealth creation.

We aspire to free-market capitalism in the United States, and we come pretty close to achieving it, closer than most countries in the world. And because we are very capitalistic, it is easy to make the leap that American consumerism is inextricably a co-product of capitalism. It is not.

For instance, look at The Economist’s rankings of national economic competitiveness. Sure, the U.S. is well above average, but the top two countries on the list are Denmark and Finland - countries that, unlike the U.S., are not known for their excessive materialism. It is also noteworthy that Denmark is arguably the world leader in actually tackling climate change head-on by minimizing emissions through the mass adoption of renewable energy and energy efficiency.

Capitalism and environmentalism can be reconciled - theoretically, at least - once energy price signals more accurately reflect their environmental costs. Right now, each unit of fossil fuel burned generates greenhouse gas emissions, which have a societal cost, but the consumer faces no burden on their wallet associated with this societal cost.

It is because energy prices do not currently include their full environmental costs that Aspen Skiing (and other companies) can’t increase their profitability by pursuing as many green initiatives as they would philosophically like to do. If energy prices were to fully reflect all environmental costs, then the capitalist system would be free to work its magic in motivating capital and behavioral shifts in the economy to significantly reduce emissions.

Alas, here’s the dilemma: Many environmentalists have qualms about letting markets work to reduce emissions, and most free-market capitalists are leery of policymakers adding environmental externality factors (a euphemism for “taxes”) to energy prices. Unless this gap can be bridged, we’ve got trouble.

Oh yes, customers in Denmark and Finland face much higher energy prices (especially for transportation fuels), including much higher energy taxes, than we do here in the U.S. While Danes and Finns don’t perhaps live “la vida loca” like Americans do, neither do they seem to be collapsing in existential angst or economic depression. The question for Americans is: Do we have the courage to elect leaders who will put us on a deliberate/planned march toward higher energy prices?

A first step for Americans is to appreciate that reduction of consumption to preserve our planet is not necessarily anti-capitalist, but rather anti-materialist. As renowned author Jared Diamond recently argued in a compelling New York Times oped (subscription requred), it is excessive human consumption of resources that is at the root of continued viability for life on Earth.

In the last week of 2007, I predicted that oil prices would finally top $100/barrel. Well, it didn’t take long - two days, in fact. Ironically, it appears that the first time a barrel of oil changed hands for more than $100 was solely because a trader wanted to own that distinction forever.

Nevertheless, those who espouse the so-called “peak-oil” theory will no doubt use the recent climb through $100 as additional evidence that oil production is nearing a crest and will soon move into irreversible decline. Indeed, recent analyses by Energy Watch Group and Earth Policy Institute claim that the peak is imminent, or perhaps already past us.

Now that the psychological threshold of $100 has been broached, and with peak oil production a possibility worth serious consideration, the question is: How high will oil prices go?

One provocative view is presented by Jim Kingsdale in the blog Seeking Alpha. His is the first work I’ve seen that projects oil prices over $200/barrel, with the staggering forecast of $275 to $500 by 2012.

My back-of-the-envelope work suggests that each $10 in oil price increase translates to about $0.40 per gallon more at the pump. If that’s about right, then $500 oil means gasoline at about $16/gallon more expensive than today, or close to $20/gallon.

When asked what will happen to stock prices, J.P. Morgan was once quoted as replying, “They will fluctuate.” That is my sentiment about oil prices - they will go up and they will go down.

I suspect that the long-term trend for oil prices is upward, even beyond today’s $100, but it’s hard for me to subscribe to anything approaching $500. Before prices reach that high, there will be so much demand-curtailment, and so many economic alternatives emerging from the woodwork, that the price-setters in the oil markets (yes, OPEC) will adjust production to maintain equilibrium.

Unfortunately, oil is not a market that lends itself well to rational economic analysis, either fundamental analysis of supply/demand basics or technical analysis of price movements. The optimization calculus of the oligopolists, who control most of the remaining reserves (and the lowest-cost reserves, to boot), is not always to maximize profits but to maximize geopolitical power.

Even worse, if radical forces gain control of the key supplies (e.g., a coup in Saudi Arabia), they won’t be afraid to turn off the spigots, because they’re perfectly happy living in the 12th century and they want to see the developed Western powers fall back into the Dark Ages.

If the Middle East shuts off the oil tap, the sky’s the limit for oil prices, and maybe Mr. Kingsdale’s forecast will turn out to be too low.

As has become my custom, with the year drawing to a close I now look in the rearview mirror and try to distill what I see. In no particular order, here are my top 10 reflections on 2007:

1. Popping of the ethanol bubble. Not long ago, it seemed like anyone could get an ethanol plant financed. Now, no one will touch them. Why? Corn prices have roughly doubled, and producers can’t make money selling ethanol into the fuel markets having to pay so much for feedstock. With the increasing realization that public policy to build ethanol markets has largely been for the financial benefit of big agri-businesses such as Archer Daniels Midland, ethanol has now become a dirty word to many. Progress on cellulosic ethanol technologies may not happen fast enough to redeem seriously diminished public perceptions about ethanol.

2. Continuing photovoltaics bubble. For illustration of this phenomenon, let’s take a look at First Solar. Nothing whatsoever against the company; indeed, they make a very fine product. It’s just that their share price has increased by a factor of 10 - from $27 to nearly $280 - in one year. At current levels, the company’s market cap is $20 billion, at a P/E ratio of more than 200. I know the solar market is hot, but geez, c’mon. A 10x return in one year on a publicly traded stock is simply not supposed to happen.

3. Increasing costs for wind energy. For many years, wind energy has become more competitive, as the industry matured and production efficiencies were sustained. However, with increasing prices for virtually all commodities (e.g., steel, copper, plastics) and a weakening dollar against the Euro (note that most turbines are made in Europe), the economics of wind are unfortunately moving in the wrong direction right now.

4. Gore as rock star. First, an Oscar for “An Inconvenient Truth.” Then, the Nobel Peace Prize. To top it off, becoming a partner at top-notch venture capital firm Kleiner Perkins. What next for the could-have-been 43rd president? Whatever it is, at least the cleantech sector now has its iconic poster child.

5. Cheers to Google. Google has gotten into the cleantech game in a big way by creating an initiative to develop and launch renewable energy technologies that produce electricity more cheaply than coal. Once that aim is achieved, renewable energy will rapidly become ubiquitous, and we really will start getting on a path to serious carbon emission reductions.

6. Death of the incandescent lightbulb. Early in 2007, Australia led the way to ban incandescents to force a shift to more energy-efficient lighting technologies (fluorescents for now, perhaps eventually LEDs). Amazingly quickly, the U.S. followed suit, passing an energy bill by year-end that effectively phases out incandescents by 2014. This should have a major energy efficiency impact and yield a big cut in greenhouse gas emissions in a relatively short amount of time.

7. Tightening CAFE - finally! After decades without change, Congress finally acted to impose more stringent corporate average fuel economy (CAFE) standards for auto/truck manufacturers. The main milestone is a 35-mpg combined car/light truck standard by 2020. For the first time, trucks are now part of the CAFE equation, closing the loophole that helped propel SUVs to prominence. Strengthening CAFE is probably the most important thing that American politicians could do to make a meaningful dent in reducing dependence on Middle Eastern oil.

8. Uncertain future for coal. MIT released a major study titled “The Future of Coal” that compels a radical R&D push to commercialize technologies for carbon capture and sequestration (CCS), underscoring the reality that coal-fired electricity generation is going to be a major factor for a long time. On the other hand, I don’t see any such coal R&D push actually happening, nor even that much progress on CCS. A recent statement by the U.S. Department of Energy concerning its oft-touted FutureGen program for piloting CCS technology indicates a possible retrenchment. Meanwhile, Pacificorp - which is owned by Warren Buffett’s legendary holding company Berkshire Hathaway - recently cancelled a coal CCS project in Wyoming, with a spokesman quoted as saying that “coal projects are no longer viable.” Ouch.

9. Oil at $100/barrel. Starting the year at about $60/barrel and then promptly falling to near $50, oil prices increased steadily from February to November, reaching the high-90s. I suspect we’ll see $100/barrel sometime in 2008. I don’t suspect we’ll see oil below $40/barrel very much anymore. Even at prices not long ago considered absolutely stratospheric, it appears that there’s been very little customer/political backlash so far. The world doesn’t seem to be ending for most Americans.

10. Serious dollars betting on energy technology. There has been a lot written about the big surge in venture capital invested in new energy deals. I find even more intriguing the increasing amount of corporate and public sector investment in new energy R&D. As perhaps the most prominent example, in the U.K., the government has pledged up to $1 billion over the next 10 years in matching support to private investments in the Energy Technologies Institute, which includes the participation of such leading corporate lights as BP, Shell, Caterpillar, Electricite de France, E.ON, and Rolls-Royce. That’s a lot of money and corporate weight in the mix. I can’t imagine that such an initiative will produce nothing of use.

Best wishes to you and yours for 2008. Let’s hope it’s a good year, even better than the one wrapping up.