Solar Power in the US: Sunny today, cloudy tomorrow

This article was originally publicated by Energetica International in May 2014:

http://www.energetica21.com/revistas-digitales/mayo-2014-2014

Solar Power in the US: Sunny today, cloudy tomorrow

 

David Gomez Jimenez[1]

Trade Commission of Spain, Los Angeles, CA

April 2014

Solar power in the US continues breaking records every year. In 2013, 4,751MW of photovoltaic power (PV) were installed, the highest yearly figure so far and up 41% over 2012. Another 410MW of Concentration Solar Power has being added, so the US ended the year with more than 13GW of total operating solar capacity, being within the top 5 countries in the world. The trend is expected to persist in 2014, when analysts predict around 6GW of new installation, growing in all segments, but most rapidly in the residential market, according to SEIA[2].

Despite the good results, very few in the sector would say that the US is a sweet spot for doing business in solar energy. The complexity of the electrical market, the great competition between players pushing prices lower and regulatory drawbacks make solar industry professionals’ work very difficult. Additionally, putting the figures in perspective, solar power still represents less than 0.2% of the total electricity generation in the US[3].

Complexity is due to, among other things, the fact that energy policy in the US is more a state responsibility than a federal one, except for some cross-border issues. This is the heritage of an uncoordinated and scattered development of the power utilities which were born at the beginning of the last century as small and local ventures. They grew at slow pace, becoming monopolies in the areas where they serve due to the nature of electrical distribution. To oversee this market power and avoid abuses as electricity was becoming more indispensable; local or state agencies began to regulate their activities, usually being called Public Utility Commissions (PUCs). So after a century of state regulations, mergers and acquisitions, deregulation attempts and some outrageous blackouts, the market in the US has become a very heterogeneous and complex mix of models, with more than 3,200 utilities (public, private or even co-ops), three independent and asynchronous grids, 8 Independent System Operators and at least 52 legislation bodies to decide the future of the electrical markets.

Nevertheless, if there is something in this mess that they all agree on, it’s to maintain reliability at the lowest prices. This is the pledge that solar, and the rest of the renewable technologies, must make every day. Solar technologies have been well-known for several decades, and they have already demonstrated their capacity of producing electricity from the sun in utility-scale grade, especially thermo solar power that used to be considered experimental. However, as much capacity is installed, utilities and regulators in some places, such as California or Hawaii, are becoming worried that the outdated grid cannot support it, especially for variable PV, whose ramps can be sharp and no efficient storage has been already developed.

Moreover, the cost of energy for solar power is still higher than conventional technologies in most cases, if this comparison can be ever done in a fair manner. Once reliability is assured, and it is nowadays, price is the next barrier for solar. The cost of electricity is the key variable for regulators to grant approval for a utility’s project or raise tariffs for paying it back. The reason that makes PUCs allow more expensive technologies is because they have a superior mandate from state governments to achieve a goal of renewable generation: the so-called Renewable Portfolio Standards (RPS). These objectives of renewable consumption are set only by some states (29 to be exact); for example, 8% in 2025 in New York, 33% in 2020 in California or 40% in 2030 in Hawaii. For achieving a more balanced mix, some states also imposed a carve-out, obligating solar power to be a particular percentage of the RPS.

However, it is the responsibility of the utility and the regulators (PUC) to achieve them in the most cost-effective way. So utilities, pushed or backed by PUCs, launch competitive Request for Offers (RFO) to buy renewable generation from developers (Independent Power Producers, IPPs) or, in few cases, to build their own plants. The deal is closed in the PPA (Power Purchase Agreement), where the price paid by the utility for renewable kilowatts-hour in the next 25 years is defined. These processes are tremendously competitive, especially in the solar sector, so big vertically integrated companies are usually the winners; since they can offer lower prices thanks to scale economies. For instance, FirstSolar, manufacturer and developer, is by far, the number one solar contractor in the country, with more than 1,500MW installed, five times more than the next competitor[4].

RPS are continuously in debate within the States and even the Houses. Raising them seems very unlikely in the short and medium terms, since unconventional fossil fuels coming from shale exploitation have flooded the markets with cheap natural gas, ready for electricity generation. Moreover, these are domestic and also cleaner than the conventional alternative, coal, so the former renewable supporters based on these arguments are now challenged.

In addition to RPS, tax credits given by the federal and states governments act as catalysts in the definition of the PPA price, balancing renewable capacity installation in the short run. The reduced tax amount is translated into lower offers in the PPA price, so they are actually a subsidy to utility and consumers, who buy cheaper renewable electricity. The most important tax credit for solar power is the ITC (Investment Tax Credit), which is available for projects that will be online by 2016, giving 30% of investment costs back as an incentive. Due to the economic downturn and the difficulty of monetizing this credit, for projects that went online between 2009 and 2011, there was the option of receiving the incentive as an upfront grant, under the 1603 program, known as Cash Grant. This option was fantastic for solar projects, since developers did not need tax equity investors and they could reduce their financial needs. It is estimated that over 45,000 individual projects were supported by this program. However, the dream has turned into a nightmare for developers as the Sequestration is reducing the amount of cash grant received, challenging the legal certainty of a country that is supposed to be the hero of capitalism and have a responsible government, with a measure that is close to retroactivity. Since there has not been an agreement in Congress about raising the debt ceiling, the Budget Control Act of 2011 fired the automatic spending cuts in the Federal Budget, causing a reduction of 8.7% in 2013 and a 7.2% in 2014 of the Cash Grant, which will continue over the next years. That has squeezed the small margin of developers, compromising financial viability of projects that are already online, which included the grant in their project financing[5]. It is especially dramatic for the handful of thermo solar projects, due to the size and the huge amount of investment. Many foreign companies are affected, especially the Spanish ones. The situation is chipping away at the country’s credibility.

Nevertheless, despite these difficulties, the solar market continues growing, as mentioned before, driven by cost reductions, financial innovations and improved investor confidence in this long-term venture.

Solar PV in depth

As mentioned, 2013 was the record year on capacity additions, with 4,751MW of Solar PV installed. Annual weighted average PV system prices continued to descend in 2013, reaching a historic low of $2.89/W.

Solar Power in the US

More than a half of this new capacity (2,621MW) was installed in California, which continues being the champion in solar power in the US, followed by Arizona (421MW), North Carolina (335MW), Massachusetts (237MW) and New Jersey (236MW). In cumulative capacity, California is also the leader with more than 5GW running, followed by Arizona (circa 1.5GW) and New Jersey (over 1GW).

By segment, the utility scale broke records too with 2,847MW installed. However, the project pipeline (PPA-signed) in this segment fell from 12.6 GW to 11.7 GW, of which 3.3 GW is currently in construction with expected completion in the next two to three years. This is the first symptom that RPS-demand is starting to wane and the effect of tax credit cuts, since ITC is only available for less than three years (to 2016), for projects that usually need more than two years of development.

Commercial and residential segments, represented 1,112MW and 792MW respectively. The first one grows at a small rate, but the residential is distinguished by its remarkably consistent incremental growth. New financing options (lease, loan and PPAs) are more widely available for homeowners as well as new distribution channels closer to retail markets as partnerships with home improvement stores, electricity suppliers or other home service suppliers such as cable television. SolarCity, the company founded by the cousins of Elon Musk (Tesla), stands out as the leader of the contractor segment, ranking second, after FirstSolar.

Net metering is the battlefield here. Since it is a direct threat to the utility business model, as they are paid by kWh served to customers, a strong debate is taking place in many states about how to manage it. It is not a simple question; as long as homeowners continue to need the grid as a backup and for balancing generation and consumption, while efficient and economic storage is developed. Utilities are lobbying the PUCs for charging high fees to customers arguing that distributed generation (DG) solar users take far more from the grid than they give. Solar supporters alleged that DG can actually be beneficial, since it is closer to consumption and it will avoid new transmission and distribution infrastructure to cope with demand increments. A strong battle will come in the following years.

CSP, stop and hope

Concentrated Solar Power is at the end of a cycle in the US. Between the end of 2013 and the first half of 2014, the largest capacity addition in the history of the country is going online. However, no new commercial project has started construction in the last two years, and the few that are in advanced grade of development, are trapped in permitting or financing phases. Now the Sequestration is adding a new hurdle in the road, as commented.

Around 1,300MW of CSP will be online soon, thanks to the key role of Spanish companies, which have been developers, engineers, contractors or suppliers. These projects are the result of extensive development during the last five years, and they are scattered throughout the southwest of the country[6]: Abengoa, with Solana, already successfully operating for the last six months, and Mojave, in commissioning (280MW each, parabolic trough), BrightSource, with Ivanpah in operation (392MW, tower), Solar Reserve – Cobra, with Crescent Dunes (110MW, tower) and Nextera – Sener, with Genesis (250MW, parabolic trough).

Solana by Abengoa
Solana by Abengoa

Projects in development are Rice (Solar Reserve – Cobra, 150MW, tower) with all permits and PPA but without financing, and Palen (BrightSource – Abengoa, 500MW, tower), that does not have all California Energy Commission permits yet. Both projects are currently on stand-by.

All these new online projects were possible somehow thanks to the Federal 1705 Loan Guarantee program, where the government securitized up to 80% of the investment, making financing possible at a reasonable price. This program ended in 2011, but now there is a glimmer of hope for new projects, as Ernest Moniz, Secretary of Energy, announced last February during Ivanpah opening. The previous 1703 loan guarantee program is about to open for new applications, allocating up to 4 billion dollars only for renewable energy where CSP funding could perfectly be granted.

Conclusions

Solar PV, especially distributed generation paired with smart grid, has the capability of altering the traditional power industry model that is more than one century old. Technology is becoming so reliable and inexpensive that it is beginning to cause concern among utilities regarding losing their core business: producing, transporting and distributing electricity to customers. The silent revolution has already started and it is more a matter of time when having solar panels on roofs will be as American as apple pie.

In the short or medium term, the market will depend on the cost of solar energy (which is expected to slightly increase as global excess capacity is removed2), availability of government incentives (Sequestration will force developers to revise some PPA prices), and new state and local policies support; with the cheap natural gas looming as an strong alternative for solving the energy puzzle, but with solar net metering being a very reasonable option.

Two challenging moments for solar power are ahead: first in 2016 when the ITC will end and second, in 2020 when RPS compliance dates arrive, especially in California, the first market for solar power by far. Political decisions made for later dates are crucial for the future of solar energy in the next decade.


[1] MSc Engineering (UPM), BA Business (UNED), CGS Sustainability (UCLA). Director of Energy Department.

[2] Solar Energy Industries Association (SEIA): Solar Market Insight Report 2013 Year in Review

[3] See www.eia.gov

[4] See Solar Power World: 2013 Top 250 Solar Contractors

[5] SEIA: Letter to OMB and Treasury on 1603 Sequestration Cuts

I will buy your gas tomorrow

Introduction

Our world and society have changed in the two last centuries more than in the two last millennia. The innovations born at the Industrial Revolution have modified our way of living probably only comparable to the Neolithic Revolution, when humans leaved their nomads lives to settle in cozier places thanks to agriculture.

The turning point that motivated Industrial Revolution was to learn how to dominate heat for generating power and how to use this power. Moreover, the prior changes on the structure of the civil society allowed the raise of innovation and scientific research. The last four or five generations of humans have understood and modified the world more than the hundred generations before. The changes have been so profuse and fast that today we are still catching up.

Nevertheless, probably these changes would not have taken place so quickly without the tremendous energy provided by fossil fuels. As it is known, fossil fuels were formed by natural processes such as anaerobic decomposition of buried dead organisms. Millions of years ago, those organisms processed CO2 and water to create high-energy chemical compounds, through the mechanism of photosynthesis. Those compounds evolved over geological time till what they are today, sometimes exceeding 650 million years. In other words, they are sun energy stored and chemically processed long time ago.

Unfortunately, burning fossil fuels is not free. They have condemned our society to two big issues which are getting worse every day, little by little, and that will probably drive to catastrophic consequences. The first problem is that fossil fuels are not infinite. Despite reserves of fossil fuels are expanding along with new exploration and techniques, some day they will end. Forecasts say that we will have oil for one or two centuries but coal will last three or four centuries more, under current consumption. The second big problem is related to a combustion product, the CO2 (burning is actually reversing the formula that created fuels). That gas is probed to be responsible for the global warming effect. The consequences of the generalized increase of earth temperature are unknown and under discussion, but there is consensus in that it is not prudent to modify a complex system as a planet ecology. This problem is closer in time and there is great literature and possible solutions (sequestration, cap-and-trade, quotas, CDMs…) to avoid or mitigate it, despite no one of the solutions have achieved to be effective enough to solve the problem.

This paper is focused on the first problem, especially oil which is used mainly for transportation. The common response to the issue is related to fuels substitutes. As oil becomes scarce, its price will rise, and today expensive substitutes will be profitable then, addressing to a smooth transition (Simon, 1996). Despite that could be probably true, there are some authors (Meadows, 1972; Barbier, 2005) who warn that this transition can slow down economic growth and cause a miserable crisis for a long time. Nevertheless, our bad decisions today are definitely creating challenging issues for future generations. There is an important intergenerational externality here, which is causing sub-optimal economic decisions from a broad time point of view. There is not only a moral o ethic problem here; I believe that this is an economic problem that should be faced by any responsible social planner.

Our current human generation should not be the only owner of the earth gratitude in terms of resource availability. Similar to a free rider in a public bus, we are taking advantage of the world endowment of energy. In thermodynamic terms, out rate of entropy generation (that is order or energy degradation) is greater than the system order creation (mainly by the sun supply), addressing to a non-sustainable equilibrium.

In this paper, I will try to address this economic problem and pose solutions or elements to take into account to solve it. The ideal conclusion would be to answer the question How much I owe you for using oil today, so avoiding you from using tomorrow?

Intergenerational externalities as a particular case of the Tragedy of the Commons

From my point of view, the biggest problem of capitalism is that the system confuses value with price. The dogma is that the value of the goods is the price that any consumer is willing to pay for it. In other words, for things that does not have price or its price is zero, they have no value or they are useless. For instance, nobody would pay a penny for a can of pure air or for knowing that there is an animal similar to the elephant with a horn in the face. However, nobody would say that clean air or black rhinoceros (an animal about to extinct) are worthless. Worthless means that your utility (or satisfaction) is the same having or not the good. Obviously nobody can be equally happy with clean air than with contaminated, as well as, nobody could say that watching a rhinoceros in a zoo or TV cannot cause someone else´s satisfaction.

Nevertheless, under our current economic and social scheme, these things have not price, or it is very difficult to determine, because, actually, there is not a market for them. That end in economic problems, like depletion, abusing, scarcity or injustice. That is what is known in economics as externalities. The common definition for externalities is a cost or benefit that is not transmitted through prices in that it is incurred by a party who was not involved as either a buyer or seller of the goods or services causing the cost or benefit. Quantify externalities is the hard part and the challenge for our current economic model.

As it has been said, the root of the problem is to set the price for those goods that are not traded in a market. One common resulting issue is what is known as the Tragedy of the Commons, that can be summarized in the depletion of a shared resource by individuals, acting independently and rationally according to each one’s self-interest, despite their understanding that depleting the common resource is contrary to the group’s long-term best interests.

There are many examples of this problem. In the figure below, some examples have been plotted considering the time to suffer the issue and the time required to solve the issue, with the current technology and knowledge, approximately. Note that the scale is logarithmic and that some issues do not have possible solution (or the time to solve them is infinite).

Sustainability issues, time to solve vs time to occur

Moreover, two lines have been projected, marking the area of influence of each human generation, which, for developed countries, could be considered for simplicity around a century. The area between axis and dotted lines (<100 years) is the temporal limit when the acts of a generation can be seen and can be solved within itself. That is to say, issues in that area could be, in theory, easy to solve or avoid for rational consumers, since they personally can see the results of their actions.

That happens in real world. There are successful mechanisms and examples that have solved these issues. For instance, the Montreal Protocol for protect the ozone layer, the cap-and-trade program of EPA for SO2 emissions that provoke acid rain, or toll highways for reduce traffic. In general, problems that can be solved (or regenerated) in less than a century (under horizontal dotted line), can be solved setting up a quota. However, a quota is almost useless for nuclear waste or oil consumption, since the problem will occur sooner or later.

Another important factor is that the time to problem was under the limit when the current generation can suffer the issue or think that they are in charge to solve it (on the left of the vertical dotted line). In this case, it is feasible that different governments achieve an agreement to put a limit in the shared good or, at least, everyone agrees in that the problem does exist. There are still many advocates that doubt about the climate change or even the depletion of fossil fuels (for instance, John Skvarla, secretary of the Department of Environment and Natural Resources in North Carolina), as new reserves or methods (as fracking) are emerging. The common response is to rely on future innovation to get rid of the issue. It seems risky to trust in scientists that are not born yet, for clearing up problems that we have not been able to solve.

There is an ancient implicit psychological factor in all of this. Despite we usually take care of our children, it is very difficult to make decisions thinking in more than two or three generations. The uncertainty of our lives, tend to overvalue the present to the future, and that can represent a failure from the complete timeline view. Our capitalist economy follows this principle, and the rate is the inflation. Money today values more than tomorrow, or translating in goods, a gallon of gas today values more than tomorrow, so, for us, it is worthier to burn it today. But maybe, the demand and human needs of tomorrow are greater than today, so, actually, a gallon of gas could value much more in future than today. This is what happens with exhaustible resources. However, it can be difficult to ask an oil producer to not sell oil today and leave it to his great grandchildren to use it for making more profit.

This type of issues are called intergenerational externalities, that is, cost or benefits that are not transmitted through current prices and are assumed by future consumers. They are, in fact, a Tragedy of the Commons case when more than one human generation is involved.

Current and future generations have limited opportunities for trade or coordinate polices, and, moreover, it would be an asymmetrical negotiation, when the current generation has an advantageous position over the future ones. So, traditional solutions as Coase’s theorem, quotas or prohibitions are ineffective methods, as it can be seen in real world, where the problems on the upper-right corner remain unresolved.

The economics of exhaustible resources

The first economist who studied these issues in depth was Hotelling in 1931. As he stated in the first lines of his article, contemplation of the world’s disappearing supplies of minerals, forest and other exhaustible assets has led to demands for regulation of their exploitation. The feeling that these products are now too cheap for the good of future generations, that they are being selfishly exploited at too rapid rate, and that in consequence of their excessive cheapness they are being produced and consumed wastefully has given rise to the conservation movement. He studied the case from the producer point of view in different market cases as competition, monopoly or oligopoly. The concern, at that time, was to find the appropriate rate of extraction that maximize the ‘total utility’, since restricted exploitation could raise prices over benefiting producers, but excessive production could sink the prices and bankrupt producers. His conclusion is called the Hotelling’ rule: the most socially and economically profitable extraction path of a non-renewable resource is one along which the price of the resource, determined by the marginal net revenue from the sale of the resource, increases at the rate of interest. His work laid the foundation for further research in the field of non-renewable resource economics, and derived from the classic model called cake-eating economy.

Before the 1970s, serious attention was not given to Hotelling’s views regarding economics of exhaustible resources. Great Depression and World Wars recoveries were more impending issues. However, the oil crisis on 70s, and the work of Meadows and the Club of Rome, set off another period of intense public concern for natural resources.

The reality is not so simple as the Hotelling model, since, there are capital and/or technical change that can compensate for the decrease of the resource. That has been deeply studied by economist as Solow (1974), Stiglitz (1974) or Dasgupta and Heal (1974, 1979), who have cared about how to maintain growth in an economy based on exhaustible resources. Under different hypothesis, they conclude that an optimal path of extraction with a positive consumption exists if the discount rate is high enough. Then, the declining use of the resource is compensated for by capital accumulations. In simple words, if the yields of the capital investment (and technology development) are high enough to compensate the lost of the resource, then exhaust the resource would not badly affect the economy. Similar conclusions are posed using the maximum criterion or Rawls’s criterion: if the elasticity of output with respect to capital is greater than that of the resource used, then a sustainable positive level of consumption exists. That introduces the concept of efficiency, meaning that it could be sustainable if what you obtain by using a resource (for instance, a car moving) is greater than the value of that resource (oil) used.

Nevertheless, it is not clear what should be the sustainable discount rate in the case of oil, or what is the actual value obtained for using oil. So the solutions go from not using the resource at all (total conservationism or ‘dictatorship of the future’) to using it at a certain rate (‘dictatorship of the present’).

Moreover, these economic models do not cope with intergenerational equity or altruism questions; and they do not take into account the fact described in previous paragraphs, about the discrepancies between the today decision maker and the future affected. For that reason, the overlapping generations (OLG) framework have been used recently to address the problem. Different models and assumptions have been studied by Howarth (1991) o Gutierrez et al. (2003).

Another interesting example of sub-optimal economic allocation due to intergenerational externalities has been recently studied by Lazkano (2012), using the OLG model and regarding the positive externality of research and development in clean energies. In her work, it is demonstrated that as consumers do not care about the effect of capital accumulation on future pollution, their demand for clean technologies is not sufficiently high to offset the negative effect on the environment. Moreover, the economy’s transition from dirty to clean technologies, […], might not occur because of the insufficient demand for clean technologies. And as a result, when agents care little about the environment, environmental quality not only deteriorates but economic growth can be negative.

That represents a market failure. In the same way, not compensate future generations for consuming an exhaustible resource implies that the current demand of oil can be greater than the optimal and the oil price lower than the optimal. That price probably is not high enough to encourage investigation and investment in substitutes as renewable sources. That results in an inferior rate of substitution and a delay in the transition, letting some future generation to assume these costs and facing lower economic growth.

All of the previously commented models try to find the optimal solution or the best extraction path. Another approach has been currently studied by other economists as Martinet et al. (2006), focusing on feasible solutions, that is, viable development paths that can be or not the optimal. With that, they lower the requisites for achieving a sustainable economy and find interesting conclusions.

Trying to calculate a figure to add to the current price of oil can be hard and it will need more time and effort than the scope of this paper, but, however, I will try to contribute with some ideas with a simple example, in the next section. That quantity should be a tax on the consumption of oil specifically designated to investigate in oil substitutes (increasing technology development) or a ‘green’ fund for future generations (increasing capital accumulation).

The cake of oil

Let’s imagine a simpler and graphical example of what we are discussing here. Imagine a cake that is sliced in 20 pieces. Imagine that there is a cue of 20 people waiting for eat one piece everyone. Each person can take as many as pieces he or she wants and are on the plate at that turn, and they cannot discuss between them, only with the next or two next persons on the cue. They would be happy just eating one piece (1/20), but if they take more, it is ok.

The first person in the line can perfectly take all of the cake, eat one piece and throw away the rest, but he does not so because the second person is watching out and he does not want to be a bully. However, he takes two pieces (2/20), one more just in case he gets hungry again. The second person does the same, and so the third and the rest ones (maybe the ninth and tenth would take only one regarding the almost empty plate, but it doesn’t matter). The problem arises with the eleventh and following, because there is not more cake on the plate. So ten people are more than happy but other ten are very disappointed because they eat nothing; and moreover, the first tenth have already left the fiesta¡

If you have gone to any party, you know that this is possible to happen. Now, just substitute the cake for an exhaustible resource as oil, and each person in the line for a complete generation, and you have our oil-based economy. It is obviously much more complicated in reality, because that cake can produce other outputs, there are substitutes for it, and the price fluctuates pushed by momentary offer and demand. All of these assumptions are considered and studied in the articles mentioned before.

Looking at the historical prices of oil, plot below (inflation adjusted, red line), it can be seen a great stability in prices until the oil crisis, that seems a steady and pace cake-eating model. It reminds me to the first lucky tenth. From the 70’s the prices started to fluctuate, due to the decisions of some of the people to keep some of the cake for rising prices (let’s call them party-poppers?) and the crazy new game called ‘trade the cake’ where the party animals play to exchange pieces of cake betting some money.

History of oil prices without inflation

Maybe, the simple cake example could be solved just by imposing a quota (a sign with ‘please one piece by person’), but imagine an infinite cue with people with bigger or lower necessities. That bring to us to what has been posed in previous paragraphs, how to define an extra price or define the externality for consuming today an exhaustible resource on future generations? How create a market where consumers do not exist yet? It would be difficult to get this number but one thing it is clear, it has to be something.

This type of economic and social justice problems considering generation’s distribution have been addressed by some oil-producers countries and regions. Some countries and regions have established the so-called permanent funds, which are sovereign investment funds where the royalties for resource exploitation are saved and re-invested, letting future generations to enjoy the benefits of the resource endowment. Some examples are the Alaska Permanent Fund, the Alberta Heritage Savings Trust Fund, the State Oil Fund of Azerbaijan, the Future Generations Fund of the State of Kuwait or probably the largest one, the Government Pension Fund of Norway, previously known as The Petroleum Fund of Norway. These funds were not actually created with the objective to allocate benefits among generations; despite it is a consequent benefit. They were created to avoid the problems known as the Resource Curse, Paradox of plenty or Dutch Disease, which refer to the paradox that countries and regions with an abundance of natural resources, tend to have less economic growth and worse development outcomes than countries with fewer natural resources. This is hypothesized to happen for many different reasons, including a decline in the competitiveness of other economic sectors (caused by appreciation of the real exchange rate as resource revenues enter an economy), volatility of revenues from the natural resource sector due to exposure to global commodity market swings, government mismanagement of resources, or weak, ineffectual, unstable or corrupt institutions. That is probably happening nowadays in North Dakota, where the boom of the exploitation of shale oil is creating a great inflation in costs (outsize prices in rents, salaries, etc) that are drowning other non-oil related business. (Dobb, 2013).

The royalties are dedicated to the fund, which give it back to citizens as a yearly dividend (in some cases like Norway, that amount is determined by the Constitution). That resolves partially the inflation effect through sterilization and providing a stable revenue stream. As a consequence, allocate the benefits of exploitation among time, compensating future generations of the country for emptying the resource endowment. Nevertheless, that is not being done in a worldwide basis, creating a future problem of injustice.

Conclusions

In this paper, some relevant problems and ideas related with exhaustible resource exploitation have been posed. It is clear that allocating benefits and cost between different generations drives to economic issues than are not totally resolved. As many other current problems of our society, solutions and decisions should be taken considering the whole world and next generations.

Probably the existing system of resource extraction and consumption is not the best solution and is creating a problem that must be dealt by future generations. How to find the best answers is now under debate by economists. Nevertheless, there are some solutions running as the permanent funds, which should be adopted and considered as a regular basis. Moreover, I think that the investment policy of these funds should be oriented to projects that achieve reduce or eliminate the dependency on the resources that feed them. Otherwise, the future is probably compromised.

So, if we would want to buy the gas of our great grandchildren, we should start to save money now, since, they are actually paying part of our gas today.

References

  • Barbier Edward B., Natural resources and economic development, Cambridge University Press, Cambridge, 2005
  • Dasgupta, P., Heal, G., The optimal depletion of exhaustible resources, Poceedings of the Symposium on the Economics of Exhaustible Resources, 1974
  • Dasgupta, P., Heal, G., Economic Theory and Exhaustible Resources. Cambridge University Press, 1979
  • Dobb, E., The New Oil Landscape. National Geographic, 2013
  • Gutierrez, M.J., Agnani, B., Iza, A., Growth in overlapping generation economies with non-renewable resources, Journal of Environmental Economics and Management, 2003
  • Hotelling H., The Economics of Exhaustible Resources, The Journal of Political Economy, 1931
  • Howarth, R.B., Intertemporal equilibria and exhaustible resources: an overlapping generations approach, Ecological Economics 4, 1991
  • Meadows Dennis L., The limits to Growth, Pan Books Ltd, 1972
  • Lazkano I., Intergenerational Externalities and Sustainable Growth, 2012
  • Schilling M., Chiang L., The Depletion of Non-renewable Resources for Non-sustainable Externalities as an Economic Development Policy, CPSA Annual Conference, 2009
  • Simon Julian L., The Ultimate Resource, Princeton University Press, Princeton, 1996
  • Solow, R.M., Intergenerational equity and exhaustible resources, review of economic studies, Proceedings of the Symposium on the Economics of Exhaustible Resources, 1974
  • Stiglitz, J., Growth with exhaustible natural resources: efficient and optimal growth paths, Proceedings of the Symposium on the Economics of Exhaustible Resources, 1974

Volunteering at Grid Alternatives. Installing PV for low-income

I have always believed that the technology has to serve the citizens as a way of prosperity and social equilibrium. In that sense, I have participated in one of the best experiences of my live as engineer and specialist in energy: volunteer for installing solar PV panels for a low-income family in Los Angeles.

The brilliant idea of the nonprofit Grid Alternatives is to bring the benefits of solar technology to communities that would not otherwise have access, providing needed savings for families, preparing workers for jobs in the fast-growing solar industry, and helping clean our environment. So, they address all of the triple bottom line’s objectives. They basically install solar PV for free on low-income roofs. Panels and equipment is finance by donations at manufacturers’ special prices, and the labor comes from volunteers.

I knew about them at UCLA and I loved the idea. Several months ago I registered and I did the orientation session, where they explained basic safety and installation issues. I was surprised because the majority of the volunteers are unemployed people who want to gain experience on solar PV installations, to get a job. It is ironic that, at the end, the most generous persons are those who are more needy.

After several months of being waitlisted (they have more volunteers than projects to accommodate), I could get a spot. The home was located very closed to Compton, which is sadly infamous in LA for its heavy concentration of gangs and gang violence, ranked as the 8th most dangerous city in the country by FBI, but being the place where probably gangsta rap sub-genre born (Ice Cube, etc). Nevertheless, it did not seem so dangerous to me, it actually has a very similar look to many parts of my home town, Madrid.

The house was one story with a back and a nice front yard. We installed 20 panels of the brand Sun Power, probably E-19 series(245W/each), in two racks of 14 plus 6. The first day we installed the footers and rails where the panels would be fixed, on the second day, with the electrical connections. It is frankly surprising see how the panels generate voltage between the two terminals when you measure it with a multimeter, even if they are not facing the sun. Such a wonderful technology¡

After two days of pace and relaxed work, drilling holes, screwing bolts, joining wires and pouring glue, the work was finished, and the installation running¡

Solar PV Installation in Compton - Grid Alternatives

Donations to Grid Alternatives

Energy Policies for US from a Public Health, Environmental & Economic viewpoint

1.     Introduction

The US faces important challengers for defining their energy policy. The US has a strong dependence on fossil fuels, and despite it is one of the biggest producers of them, they are, by far, the biggest consumer, so it relies greatly on imports. That implies geopolitical issues as well as security concerns. From the environmental and health point of view, a combination of economic liberalism, plenty availability of natural resources and ‘not-in-my-backyard’ policies have lead the young country to not concern about environment so much as European countries where these problems are perceived closer. That can be seen, for instance, in the high level of pollution of some places in the US, the lack of commitment with the Kyoto protocol or the individual car-based transportation system.

Nevertheless, the good availability of resources and the adequate economic situation (maybe not the best nowadays, but for sure better than the rest of the world) could facilitate the necessary change to a greener economy if the political will is strong enough.

In the graph bellow, the sources and sinks of the energy consumption of the US can be seen. Almost 80% of the energy comes from dirty and finite fossil fuels, mainly petroleum. The two main consumers sectors are Transportation (27%) and Electric Power (38.6%). 

Sources and Use of Primary Energy in the US

Transportation is a big contributor to the energy, environment and health issues in the country. There are many policies which can be implemented in this area but the dependence on liquid fuels and the spread US neighborhood development are two important obstacles for the development of a new transportation system.

The first difficulty is partially solved by current technology. There are available new types of fuels but all of them still have relevant difficulties to trigger a change in the market. Hydrogen is not produced in enough quantities yet, in addition of the security concerns related with the great inflammability of the gas. Biofuels are already introduced, but the competition with food markets and the difficulties for introduce biodiesel in the US market (lack of diesel fleet and gas stations network) are important issues yet. Natural Gas (NG) vehicles face the same problems; despite the low price of NG makes interesting this fuel for transportation, mainly feasible for trucks. Electric Vehicles (EV) are in the radar nowadays as the solution, but they will need a change in the electric sector first, to be a real environmental and energy solution (since an EV today is actually powered by coal, NG, nuclear and a little bit of renewables). In addition, the less autonomy issue is an obstacle for consumers, despite technology is improving it very fast.

The spread US neighborhood development is a great difficulty for setting up an efficient and economically feasible public transportation system in mostly cities within US. Some important programs are being implemented nowadays, as Los Angeles metro expansion, high-speed rail in California, and others, but it seems difficult that they will imply a great change in energy consumption in the whole picture. They are actually more focused on solve traffic congestion and local pollution problems.

So, despite Transportation has an important role in the US energy puzzle, it might be very difficult to produce important changes through policies in a short term. However, actions in Electric sector could be more effective and relevant in modifying the energy consumption pattern. Indeed, Electric sector is the biggest consumer with a 38.6% of the total energy usage. Electric sector consumption comes mainly from the activity of ‘Generation’, that is actually, the transformation of primary fuels into electric fuel or electricity, easier to transport and use for innumerable machines. Generation also is responsible for the majority of the air pollution and green house gases (GHG) emission in the sector. (Some emissions are produced in transportation due to SF6 gas used in switchgear, but we can avoid it in this whole picture).

Generation is an activity pursued mainly by electric utilities and some independent power producers (IPP) and, despite there are some thousand of power plants, it could be easier to regulate and address them than convince almost 200 million drivers to switch to brand new EVs or public transportation. In addition, technical solutions to deal with the problem are already plenty available.

This paper is going to be focused on it, trying to propose policies for the Electric power sector for addressing the energy issue in the US. First, the current situation of electric generation is going to be exposed, as start point for posing policies recommendations. In addition, forms of implementation are going to be suggested, extremely important in a huge country where federal, state and local administrations share the authority on the power sector.

2.     US Electric power sector

The U.S. electric power grid serves more than 143 million residential, commercial, and industrial customers, through more than 6 million miles of transmission and distribution lines owned by more than 3,000 highly diverse investor-owned, government-owned, and cooperative enterprises; resulting in probably the biggest and complex machine in the world.

Nevertheless, there is not a unified national policy on power sector, and the majority of the competences are held by States in a very heterogeneous way, and only some general interest and security issues are responsibility of the Federal government (through FERC and DOE). Important issues as the generation mix, rates, utilities regulation are State competences. (in many cases, even counties or cities competences).

The current market organization is the result of more than 100 years of evolution. The first electric system was set by Thomas Edison in New York in 1882 for serving 59 light consumers in Wall Street. The plant which powered that system was called Pearl Street Station and it generated DC current from a coal-fired steam generator. From that, the market was growing pushed by technology innovation. Regulations and laws were catching up when they were required for ordering the market and provide a scheme through clients and companies were protected, or when terrible blackouts occurred (for example in 1965 and 2003).

The resultant model today, is a complex system where the vertically-integrated utility is the most usual model, but liberalized markets also exist. Vertically integrated means that the utility is a little monopoly in the zone where it serves, doing generation, transportation, distribution and supply of electricity. The oversee of this monopoly is assigned to state regulators, called Public Utility Commissions (PUC), or municipal governments (as the case of LADWP). These regulators set the rates and approve new plants and lines, among other functions. There are about 3,200 utilities, 2,200 Publicly-owned but only represent 17% of sales and 818 are cooperatives with 12% of sales. The 242 remaining are Investor-owned, and they are most important ones since they represent almost 60% of sales.

US Sources of Electricity Generation About power generation, currently the main source continues being coal (42%). Natural gas represents a 25% and nuclear plants the 19%. Renewable are the 13%, being 8% hydro power, 3% wind, 1,4% biomass, 0,4% geothermal and solar less than 0,1%. So, despite the great political and media coverage of new renewable technologies, they actually represent a little bit of the cake. Just to compare, in countries like Spain, around 20% of the electricity in a year is only produced by the variable wind.

The plenty availability of coal in the US (second producer after China) joined with its low price (comparing historically with gas) and ease of use (few operation risk than nuclear), have ended in being the most preferred technology. However, the implications of its use on emissions are important, since coal-firing is the worst air polluter, locally and globally. Due to its solid condition and chemical composition, burning coal produces bad gases as NOx, SO2 and particles. Some poisoned mercury is also liberated due to its minimal presence in coal. All of them provoke well-known air pollution and health issues in the plant surroundings, and even farther problems as acid rain. Those issues are partially hidden by locating coal plants in remote and low populated zones. Nevertheless, the global impact as a GHG (CO2) producer is even greater. Since coal formula is mainly carbon, when reacts with oxygen, CO2 is greatly produced. NG and petroleum formulas contain more hydrogen instead, so the combustion produces less CO2 and more H2O (which is not considered a problem in global-warming curse). Burning NG generates between 40-50% less CO2 emission than coal and 25-30% less than oil. (The real average data for the US are: NG 1,135 lbs CO2/MWh, coal 2,249 lbs CO2/MWh, oil 1,672 lbs CO2/MWh, from EPA).

It means that considering the current mix and making some simple calculations, for every 1% of coal generation which was switched for NG generation, a reduction of around 1% of GHG emission will be achieved in the electric power sector, caeteris paribus. In addition, burning NG is more efficient due to the higher temperatures which can be reached (the young genius Carnot demonstrated it in 1824 with his famous equations), so for the same electrical output, less fossil fuel will be needed. Switching to nuclear or renewable will be even better, since it will produce a reduction around 3.5% in emissions per 1% of coal taken out. Switching to oil makes no sense, since oil is more valuable for transportation as liquid fuel.

So, it seems that coal is a bad guy in the US energy and environmental problems. In next section, some policies will be posed to deal with it.

Another difficulties has to be considered in power polices definition. The current power market model of regional monopoly-supervision is probably not the most adequate for introducing strong reforms which try to solve a national problem (type of tragedy of the commons here). The main concern of the regulators (PUCs, municipalities) is to guarantee supply and keep rates lower in its area, since problems related with both of them are politically sensitive. That does not leave a big margin to make experiments or push for changes, despite the California market reform in 2000 was a pretty remarkable example but a sad fiasco. The system is destined to be conservative in the investments and the results are a problematic lack of capacity in transmission lines and an old and obsolete equipment. Difficulty in building new transmission lines (owned by utilities) is a big issue in developing renewables, since, unfortunately, the places where the resource exists, are not the same where consumption is. Transmission lines usually go through territory of different utilities, regulators and States, and it is not clear how to allocate the costs of the lines in such heterogeneous jurisdiction scheme, despite the Federal Energy Regulatory Commission (FERC) is trying to deal with it (Order 1000).

3.     Policy recommendations

So, with all the tough restrictions those have been presented before, the definition of the US energy policy should be cautious but smart, introducing mechanisms which allow easy and small changes every year but addressed in the right direction to produce a big change in next decades scope. Small steps in the right direction lead to destiny, as a good pilgrim knows.

The principles or restrictions which drive the policy definition have to be cost-effective, politically realistic and objective-oriented. The goal is clear: reduce fuel imports, reduce emissions and allow economic prosperity.

Taking into account this, the energy policy should be focused in one simple thing: Reduce generation from coal and replace it for a combination of NG and renewables.

Local and global range emissions would be obviously reduced, and the rest of goals would be achieved without exceed the restrictions. Coal is greatly mined in the country and is relatively cheap, so doing that change cost-effective and from autochthonous sources is the challenge. Nuclear is discarded due to the great investment costs, the growing opposition after Fukushima disaster and political issues. Moreover, it is not recommended despite it does not contribute to global-warming because of the greater health risks that implies, and the unsolved solution for the nuclear waste disposal. Only one nuclear plant is being built nowadays in the US, the Vogtle project in Georgia, which will need 10 years of development and it will be the sole new nuclear project to become online since Three Mile Island accident in 1979.

Promoting renewable technologies has obvious benefits to reach the target: they do not produce emissions, they do not need import energy, they do not jeopardize lives in case of failure, and they create jobs and industry. In this sense, there is much work to do, since the current percentage of renewables in the mix is lower. However, the cost of energy produced by renewables is still considerably higher than coal, in spite of technology innovation is lowering this price every day. Till grid parity was achieved (cost of renewable equal market reference), regulators, utilities and consumers probably will not be eager to pay more for electricity. Moreover, the grid upgrades and back-up generation that they need, pushes the balance against them.

However, this over-cost can be easily minored by increasing NG generation, which also contributes to reduce emissions from the current situation. Increasing NG generation would require almost nothing new investments. In the figure below, it is presented the current coal generation (the less efficient plants in green); and in blue the generation potential of NG combined cycles already online but currently not working at plenty capacity. (in fact, these plants are working much less hours than those for they were conceived).

Fully Dispatched NGCC potential

As it can be shown, there is a great potential of switching coal to NG, at very low cost. Underutilized NG combined cycles do not need infrastructure upgrades since they are already connected to the grid and the gas supply network is more than enough to deliver all the plants. The reason why they are not plenty utilized is because coal used to be cheaper and because, in reality, utilities decide their generation program regarding their own interest (many times not lowering the cost since they are going to recover it through the negotiated rates with PUCs).

US Natural Gas ProductionUS Natural Gas and Oil price evolution

The price of natural gas has been historically growing every decade, since it used to be tied to oil (so it is in the rest of the world). But the discovery of the new ways to make profitable natural gas from shales, have revolutionized the market. The great increasing in shale gas production has sunk the prices in the last few years, and the projections predict that the availability of NG will increase in US.

However, a warning has to be done here; this fortune’s gift can become a curse if it is used as a substitute for renewables instead of for replacing coal. That would be a strong temptation unless appropriate regulation and policies were set, since in absence of GHG control, cheap gas can be converted in cheap electricity, good for utilities’ revenue and politician’s image.

To conclude, the successful energy policy would be to change coal for renewables and natural gas, balancing this combination depending on the evolution of the generation cost of both technologies and the efforts that consumers were willing to assume.

4.     Policies Implementation

It is not only important to recommend energy policy, but to suggest how implement it. And that is crucial in a country with such complex and distributed jurisdiction in power markets. Here, some ideas are going to be given to address with the practical sense of the energy reform. They are directed to different administrations, federal, state and local:

  • The definition of the strategic energy plans are nowadays responsibility of the departments of energy of every State according with its PUC. It could be more convenient that these plans (where the switch from coal to NG/renewals can perfectly be included) were agreed with a federal agency as the Department of Energy (DOE) and FERC. It makes sense since the effects of the electricity production not only involve a sole State, but the whole country (regional and global emissions, imports of fuels…)
  • Since Federal agencies have a narrow margin to impose legislation to States (litigation can convert the planning process in a nightmare), the Federal agencies can try another strategy. They can offer conditioned funds (for example those from ARRA) to those States which achieve the objectives set by Federal, for example, to reach a certain level of renewables, to coordinate energy plans, to open market for transparency, to coordinate lines with neighbor States, etc. The State have the option, not the obligation, to do the things right and get the funds (politicians would love to win them). It is making and incentive and leave competition works.
  • Municipal and local utilities should be under control of State regulators of PUCs, and the municipality governments should endorse it. Despite we respect personal freedom, it is totally unfair and biased that municipal utilities (as LADWP) do not have the obligation of the State Renewable Portfolio Standard, and they can arrange their generation structure as they want. It is unfair that, for example, in Los Angeles, consumers pay less for their electricity than in Orange County, because LADWP generates more with coal and do not have the obligation of buying renewables as SCE. And it is unfair because emissions from this decision affect equal both consumers.
  • Maintain and update the tax incentives to renewables. Without cancelling all subsidies (including those oil, gas and coal have), that it is not a bad idea at all; it is better to maintain, at least, the current incentives for renewables, as Investment Tax Credit (ITC) and Production Tax Credit (PTC). Moreover, a long term strategy should be done, to avoid the stop and go in investments that the sector suffers. Wind power is a good example, and just this year we are seeing the same stop as 2004 because the PTC has not been renewed yet for 2013. These ups and downs do renewables more expensive because companies and banks need higher loan rates to compensate the variable regulation risks.

5.     Conclusions

As it has been explained, Transportation and Electric Power sector are the two main causes of the energy consumption in the US, and both of them rely so much on fossil fuels. Transportation is mainly dependant on petroleum (94%) because, however it could be hard to understand when you visit the gas station, it is actually the cheapest liquid fuel that can be found today, with the current logistic chain. For sure that there are alternatives, but it is difficult its introduction due to the great upfront investments they need. Even the EV will not be the solution unless Electric power sector changes before.

However, decisions taken in the Electric sector can be more effective and reduce emissions and consumption. Energy efficiency improvements has not been considered in the paper, despite they are totally recommendable, because they will be probably compensated with the increase in energy demand due to population and economic growth (forecasts say that the increasing on demand will be around 1% every year, and the energy per capita will decrease slowly till a 20% of current in 2035).

In Electric sector, the most obvious action seems to be reducing dirty coal and introducing renewables (zero emissions, zero imports but still expensive) with a combination of natural gas (less emissions, no imports thanks to shale gas and cost-effective). Achieving the changes is a challenge with the current market organization and regulation, so the political determination has to be strong enough to go together in the right direction and leave apart lobbies and particular interests in order to fulfill the general interest.

 

6.     References:

AB32: the weapon against climate change

In 2005, California Governor Arnold Schwarzenegger signed Executive Order S-3-051 setting long-term greenhouse gas (GHG) reduction targets, with a final target of 80% below 1990 levels by 2050. Nevertheless, the Executive Order did not say how to achieve these reductions. They were establish in 2006 trough California Assembly Bill 32, also called the Global Warming Solutions Act or simply AB32. It set a target of reducing GHG emissions in the State to 1990 levels by 2020. The AB32 bill provided for the State the organization to implement these reductions, including the option of market-based compliance mechanisms such as a cap-and-trade program. AB32 designated the California Air Resources Board (ARB), which depends on the California Environmental Protection Agency, to implement the legislation. The program that has resulted includes both a cap-and-trade component as well as a variety of complementary and direct regulatory measures. Another remarkable achievement of the bill is to set the Renewable Portfolio Standard to 33% by 2020, which means that the 33% of electricity consumption has to be generated from renewable sources by this time. That applies to the big utilities of the State and has converted California to leader of renewable generation in the country.

At the end of 2010 ARB adopted a cap-and-trade program to place an upper limit on statewide greenhouse gas emissions. This is the first program of its kind on this scale in the United States. The program had a soft start in 2012, with the first required compliance period to start 2013. Emissions are to be reduced by two percent each year through 2015 and three percent each year from 2015 to 2020. The rules apply first to utilities and large industrial plants, and in 2015 will begin to be applied to fuel distributors as well, eventually totaling 360 businesses at 600 locations throughout the State of California. Free credits will be distributed to businesses to account for about 90 percent of overall emissions in their sector, but they must buy allowances (credits) at auction, to account for additional emissions. The auction format used will be single round, sealed bid auction. A preliminary auction was held August 30, 2012, and the first actual quarterly auction took place on November 14, 2012.

In this Presentation, more details are provided about this leader bill to fight against climate change in the US:

Meeting with Arkansas Governor Mike Beebe

We had the opportunity to met with the Arkansas Governor Mike Beebe during WindPower trade show. He was the opening speaker in the conferences and was so kind to meet with a Spanish delegation formed by CEOs of the top renewable companies and the Trade Commission of Spain. (Actually my friend Lenka from EDC and me have been working in this meeting for almost a year).

Meeting Arkansas Governor Mike Beebe and the Spanish delegation

The Governor explained to us the possibilities and opportunities of Arkansas for the foreign investment. It is a little State (no more than 3million of population) but very well located just in the middle of the the wind belt region. Despite they have not established a Renewable Portfolio Standard yet, they are working on it. The problem is that they want to make the renewable support cost-effective, which it sounds very difficult considering that Arkansas has a great reserves of Shale Gas which they are drilling now. Nevertheless they have some concerns about the explotation, since a curious fact that Mr Beebe told us, the biggest earthquake in US happened in AK, decades before the infamous disaster in San Francisco. It was not metered then but some historians have described that the waters of the Missippi river go back due to this earthquake.

From the side of the companies, Iberdrola, Acciona, Idom and Dragados were present. All of them showed its interest and appreciated the meeting.

Meeting Arkansas Governor Mike Beebe and the Spanish delegation

A monopsony is also a market failure: WalMart

Wal-Mart is one of the biggest companies in the world and the first one company in retail sales in the US. It is so big that it could be the 20th country comparing sales with GDP. So, the power and the influence of this company is measure in a world basis scale. Their sustainability policies are under discussion because it is not clear if they are really concerned about the problem or only they are washing its image with ‘green’ water.

WalMart monopsony is a market failure

Wal-Mart has been pointed as the responsible of many laid-offs of American workers because its suppliers have had to outsource their production overseas. The reason is because Wal-Mart squeezes the suppliers’ margins till insane levels.

From my point of view, it is a clear case of monopsony, which is a market form in which only one buyer (Wal-Mart) faces many sellers (suppliers). Probably is more a case of oligopsony, where few buyers faces many sellers, but the power of Wal-Mart is so big, that we can be considered a monopsony in many cases. (Remember that the rest of retail marketers are so far from Wal-Mart than it can push the price of many products in the wholesale market)

Monoposy is an example of imperfect competition, similar to a monopoly, in which only one seller faces many buyers. As the only or majority purchaser of a good or service, the ‘monopsonist’ may dictate terms to its suppliers in the same manner that a monopolist controls the market for its buyers.

The figure below shows the effect of a monopsony in a market. The price and quantity of a competitive market are tagged as Pc and Qc respectively, being the cross between the suppliers curve (S) and the demand curve (blue). Without entering in more theoretical details, the monopsonist can force the market to move according its Average Expenditure curve (Ae). Doing that, they reduce the amount of product that they buy (Qm) but, most important, they can shrink the price to Pm. The result is that they win the green area in terms of savings however they lose the red area because they buy less, but it is not a problem since red area is smaller than the green one. The suppliers lose the blue area because the sell cheaper and less quantity than the optimum. The general result is a social loss of the red and blue areas, marked with stripes. The social loss means that the society, as a whole, is away from the optimum, so it is losing welfare due to the greedy action of the buyer.

Monopsony is a market failure
Monopsony is a market failure

In the real world, this social loss is the unemployment generated by the bankruptcy of many US companies that Wal-Mart is causing. Obviously, Wal-Mart knows that, and I think they are trying to use some of the extra income they obtain with the monopsony to wash its public image with sustainability strategies, in many cases, impossible to satisfy. (For example 100% consumption from renewable, it sounds pretty ambitious in a country where the 45% of the electricity comes from coal)

Due to Wal-Mart is pushing continuously the suppliers to reduce their prices; many of them have to outsource the production to other countries, as China or India. That is not bad by itself. In fact, it is really good from an ideal framework. David Ricardo, a world famous economist, demonstrated in the XIX century that the international trade is always beneficial for both countries, since each one specializes in the products it makes better. This is called the Comparative Advantage theory. In this case, it is clear that all Americans have taken advantage of low prices that Wal-Mart offers. The inflation has maintained low thanks in part, to the big retailer strategy. That is ok in an ideal world, but the problem is that these low prices in China are not caused they are better manufacturing products, it is because they generate enormous externalities that are not reflected in the price: pollution, unfair labor conditions, etc.

So, at the end, the fail in the wholesale market is creating a social loss that compromise the long term for wining in the short term. That is the opposite definition of sustainability. Wal-Mart has not much to say or to do in sustainability without solving its ‘little’ problem with competition before.

That is market failure, and as well as the monopolies, should be regulated. The cases of monopsony are not so well-known by regulators as monopolies, but there are Acts against them. The famous Sherman Antitrust Act (1890) says in the Section 2 ‘Every person who shall monopolize, or attempt to monopolize, or combine or conspire with any other person or persons, to monopolize any part of the trade or commerce among the several States, or with foreign nations, shall be deemed guilty of a felony’. The subsequent Clayton Act (1914) declares illegal: sales on the condition that the buyer or lessee not deal with the competitors of the seller or lessor or the buyer also purchase another different product but only when these acts substantially lessen competition (Act Section 3, codified at 15 U.S.C. § 14).

So the problem is known and the laws are already prepared to deal with this, so why is not being solved yet? It might be because the money that Wal-Mart uses doing lobby. According to www.opensecrets.org,  in the last four year they have expended more than 25 millions of dollars in lobbying.

http://www.opensecrets.org/pacs/lookup2.php?strID=C00093054

To sum up, I think that in the case of Wal-Mart we are not facing a problem of believing or not in the good promises of a big company about sustainability, we are facing a market failure, that it will not be solved only with some unhappy customers quitting from Wal-Mart, and launching a sustainable strategy to become ‘the most competitive and innovative company in the world’.

Shale Gas: The Black Revolution

Introduction

In the last 40 years, important changes were occurred in the traditional scenario of the energy sources. First, the crisis of petroleum in 1973 was the first warning about the problems of fossil fuels. More closely, the important economic development prior to 2008 pushed the markets of energy resources due to the growing demand. With traditional sources of energy as oil, gas and coal raising prices, alternatives sources which were unprofitable before, started to seem more attractive. Also, the dependency of the developed countries on the resources of foreign countries, many of them not very trustable, converted the issue in terms of national security.

Among these alternative sources, renewables, especially wind and solar, have been the main character of the play. Not absolutely new, since they had a little bright in the 80’s, now they have experienced a very strong development worldwide. A new industry has been created only five years ago. The benefits of the renewables are tremendously obvious. They do not consume fuels susceptible to expire to get energy from nature, and they almost do not affect the environment, do not pumping CO2 or other gases into the atmosphere or compromise any region with nuclear risks. On the other hand, these technologies are still not cheap enough to compete with the conventional sources. The price of energy is a key variable in the economic growth and any country try to keep it low for achieving more competitiveness and more economic expansion.

But these efforts in finding alternatives to traditional sources, also has applied to investigation in fossil fuels. Since the end of the 19th century, it is known that there are fuels buried into the ground which are not in the conventional geologic formations. These fuels are in structures which permeability is very poor to make the normal drilling process profitable. They are called non-conventional fossil fuels. Many research resources have been expended in investigating new techniques or technologies to get these fuels from earth in a profitable way. Now, it seems that it has been achieved.

These difficult geologic formations, which until very recent years were unprofitable, have different names as shales, tights or sands. From them, currently gas natural and oil are being obtained, and because of its origin, they receive the nickname of shale gas, tight gas or shale oil. At present, the most important one is the Shale Gas, because there are huge reserves of natural gas in shales and because this last 5 years the production of Shale Gas has shooted up. The raise of these new sources of fossil fuels is being named for some people as, ‘The Black Revolution’.

In this paper, it is going to analyze why the Shale Gas is so important in the new era of energy, what are the important environmental and social issues of its production and what can we expect in the evolution of the energy mix in the US and worldwide.

What is the Shale Gas?

As it has been introduced, Shale Gas refers to natural gas that is trapped within shale formations. Shales are fine-grained sedimentary rocks that can be rich sources of petroleum and natural gas and whose porosity and structure does not permit to get the fuels with the traditional ways.

The advent of large-scale Shale Gas production did not occur until Mitchell Energy and Development Corporation experimented during the 1980s and 1990s to make deep Shale Gas production a commercial reality in the Barnett Shale in North-Central Texas. They used a combination of techniques invented for other purposes, the horizontal drilling in conjunction with hydraulic fracturing.

 Extraccion del Shale Gas

As it can be viewed in the figure, natural gas is incorporated into the Shale Gas formation, not is in a bag as conventional gas. Moreover, shales are ordered in horizontal layers. Conventional drilling is totally useless in these formations. The new drilling technique consists of:

  1. A vertical well is drilled
  2. The drill turns to continue horizontally. In this manner, the horizontal drilling permits to make a hole along the shale
  3. Water, lots of chemicals and sand are pumped into the well to unlock the hydrocarbons trapped in shale formations by opening cracks (fractures) in the rock and allowing natural gas to flow from the shale into the well.

As the success of Mitchell Energy and Development became apparent, other companies aggressively entered the play, so that by 2005, the Barnett Shale alone was producing nearly 0.5 trillion cubic feet of natural gas per year. As producers gained confidence in the ability to produce natural gas profitably in the Barnett Shale, with confirmation provided by results from the Fayetteville Shale in Arkansas, they began pursuing other shale plays, including Haynesville, Marcellus, Woodford, Eagle Ford, and others.

Economic vitality

Although Shale Gas production started ten years ago, only in the past 5 years has been recognized as a “game changer” for the U.S. natural gas market. The proliferation of activity into new shale plays has increased dry shale gas production in the United States from 1.0 trillion cubic feet in 2006 to 4.8 trillion cubic feet, or 23 percent of total U.S. dry natural gas production, in 2010. Wet shale gas reserves increased to about 60.64 trillion cubic feet by year-end 2009, when they comprised about 21 percent of overall U.S. natural gas reserves, now at the highest level since 1971. Oil production from shale plays, notably the Bakken Shale in North Dakota and Montana, has also grown rapidly in recent years.

Something is considered as a ‘game changer’ if it has the ability to change the price of good. That has happened in the case of the Shale Gas.

As you can see in the figure on the left, due to the more offer of gas natural in the market, and also the contraction of the demand, the price of natural gas has dramatically fallen down between 2005 and 2010. Moreover, the projection shows that thanks to the influence of the Shale Gas, the evolution of the prices (blue line) will be below the prior projections which did not considered the new gas. That has huge implications in energy markets. For example, less natural gas prices imply less electricity prices and more difficulties to renewables to achieve grid parity.

To better understand the importance of this new source of gas, let compare it with the actual figures of the natural gas market in the US. Of the total natural gas consumed in the United States in 2009, 87% was produced domestically; thus, the supply of natural gas is not as dependent on foreign producers as is the supply of crude oil (only 51% domestic), and the delivery system is less subject to interruption. The availability of large quantities of Shale Gas will further allow the United States to consume a predominantly domestic supply of gas.

According to the EIA Annual Energy Outlook 2011, the United States possesses 2,543 trillion cubic feet (Tcf) of potential natural gas resources. Natural gas from shale resources, considered uneconomical just a few years ago, accounts for 862 Tcf of this resource estimate, more than double the estimate published last year. At the 2010 rate of U.S. consumption (about 24.1 Tcf per year), 2,543 Tcf of natural gas is enough to supply over 100 years of use. Shale Gas resource and production estimates increased significantly between the 2010 and 2011 Outlook reports and are likely to increase further in the future. The Shale Gas represents about 37 years of supply considering the US consumption of 2009.

Reservas de Shale Gas de EEUU

The US plays of Shale Gas are spread around the country but there are some formation especially important located in Barnett shale (Texas), Bakken Shale (North Dakota and Montana), and the most important is Marcellus Shale (Pensilvania, New York and others).

The Shale Gas is being extracted in rural zones, and that is causing important changes in these villages. There are some important environmental implications, due to the extraction of Shale Gas is not perfect and can affect aquifers. Moreover, the social equity in the villages is changing since the owners of the lands where the gas is extracted are earning much money for royalties they had imagined feeding cows and growing plants.

Ecological Health

Local effects

The extraction of Shale Gas is not as simple as it was presented above. As many industrial activities, important bad externalities are generated. The amounts of water and chemicals pumped for the hydraulic fracturing are huge. Drilling a typical deep shale natural gas and oil well requires between 65,000 and 600,000 gallons of water. Not only the consumption of tons of water is something to be considered from an environmental position, also the composition of the chemicals is important. The problem is that the actual composition has not been revealed because is considered an industrial secret. About a 2% of the mixture is chemicals. They are crucial for the Shale Gas extraction and include acids, anti-bacterial agents, breakers, clay stabilizers, corrosion inhibitor, crosslinker, friction reducers, gelling agents, iron controls, pH adjusting agents, and scale inhibitors, between others.

The huge amount waste water of the process, full of chemicals, sand and muddy has to be treated. Analysis performed to this waste water shows that it contains some components that are carcinogenic and even nuclear radioactive. The treatment of this water is done in the States with the more lax regulation. Many of them do not have equipment to remove these chemicals out of the water, which is pumped in rivers. Nobody knows what will be the effects of these chemicals in the environment in a long term, because this new type of extraction is almost new.

But maybe, this is not the worst problem. When the drill punches the land, in many cases, some of the layers crossed are aquifers. In some places of Pennsylvania and other States, the tap water has been contaminated by the waste water and even by the gas. The problem was shown in the documentary ‘Gasland’ by Josh Fox, where it is possible to see incredible images of taps running with flammable water. Also, it presents some cases of people living near the drills with terrible and strange diseases, animals dead, bad water contamination and other health issues. A ‘silent law’ seems to be happening because many people of these farms are earning lots of money with the royalties of the gas and also they have disclosure contracts with the drilling companies.

As named above, the Shale Gas production started in Texas ten years ago. I had the opportunity to speak in October 2010 with Keith Sheedy, Chief Engineer’s Office from the Texas Commission on Environmental Quality. He basically explained that in Texas, no water contamination have occurred in this ten years of commercial exploitation. The cases of Pennsylvania are due to bad practises in the drilling process. When the hole is not properly cemented, then some of the gas running through the hole can pass to aquifers and contaminate the tap water.

Anyway, drilling has been doing for decades in similar industries, so regulations should have existed about water uses and disposal, but why is not the Shale Gas drilling regulated by environmental rules as the rest of industrial activity? Because, The Congress, pushed by Vice President Dick Cheney, exempted gas drilling from EPA Clean Water Act regulations in 2005. It is something curious that Cheney was former CEO of the Halliburton Company, one of the biggest driller and Shale Gas extractor in the US. After 2005, Shale Gas drilling boomed.

There are other collateral effects in Shale Gas extraction. Fracturing is changing the structure of the geologic formations. In the drilling zones some earthquakes has been occurred in recent years, and the seismic activity is above the average. In addition, the great amount of water used, generates large truck traffic to this normally quiet populations.

Global effects

The global effects of the boom of Shale Gas are similar to the rest of fossil fuels usage. As fossil fuel, CO2 are generated in its combustion. The CO2 is a greenhouse gas that contributes to the global warming, which diverse effects in the environment. Even, during the Shale Gas extraction, many other greenhouse gases, more powerful, as CH4, are liberated due to bad practises in the drills and the lack of regulation.

Moreover, it is an exhaustible fuel. That means that there will be a day when there will not be more.

The usage of fossil fuels generates strong externalities for the rest of the world, and they are not incorporated in the cost of its use. As indirect effect, the boom of the natural gas or the reduction of its price is bad for renewable energy because is a substitutive product. As lower is the price of fossil fuel generation, more difficult is for renewables to achieve grid parity and be competitive by their own.

At the end, the more usage of natural gas, despite is greener as other fossil fuels as coal or oil, address our world to a very tough scenario, with a society dependant of scarce fuels and an earth that had suffered non-return changes in its ecosystem.

Social Equity

In the past five years, many drills have been done. In the next figure it is possible to see the evolution of the Shale Gas drills (red spots) in the Barnett shale during the last decade.

 

The economic benefits for the owners of the land have been important. Signing its gas lease about $1,000 per acre and a royalties of 12.5% for the gas produced, can make them to earn between $1,500 and more than $500,000 per year during the term of the extraction, which can last some years. This is much money for people used to feeding cows and growing plants for fringe benefits.

This disparity of earnings is generating some social equity problems within farmers but more between ‘county folk and city people’. The city people are not earning anything with the drilling but they suffer the problems of water contamination, truck traffic and risks from the unknown effects of the activity. They are against drilling but farmers, in general, are in favor of it. Disputes are increasing in these, up to now, calm and little populations.

A good impact of the drilling activity is the job creation. According to a recent study by Pennsylvania State University, the industry has created 23,000 jobs, including employment for roustabouts, construction workers, helicopter pilots, sign makers, Laundromat workers, electricians, caterers, chambermaids, office workers, water haulers and land surveyors.

Another controversial topic is the unequal tax policies to the drilling activity. Currently, companies operating in Pennsylvania pay no tax to extract gas. (Governor Tom Corbett reportedly received at least $1 million in campaign donations from gas interests). Corbett recently introduced legislation that would levy fees that critics say would amount to a tax of 1% per well on gas extraction, significantly lower than Arkansas (3.45%) and Texas (5.4%). It is not very fair to tax differently the activity between States, since the basins extends along vast territories of different States and the problems of the activity are affecting people in the same way.

Conclusions: my personal vision

An important change in the energy world is happening. The important economic implications of the availability of domestic natural gas are something to be considered for any country. The US has been the first country to exploit the benefits of the Shale Gas, but it is expanding through the world. You can see in the next figure the worldwide reserves.

 

The new distribution of the sources of energy changes the game of power. No dependency from Middle East could be a fact that changes the course of international policy.

Apart of the good benefits from the economic point of view, there are other aspects in the sustainability analysis that have to be considered. The local effects on the environment are not trivial. Public health and environment ecosystem is endangered. Nobody knows what will be the effects of the chemicals used for extraction in the long term but, my impression is that many companies are working as fast as they can to get the maximum amount of gas before the effects will be public. Responsibility from the Government must be priority to avoid this, but as another market failure, the current democracy system permits the regulator be supported by the companies which he has to regulate.

At a local scale, the social problems of inequity will convert stronger in future years. Ronald Coase, a famous economist, states that if trade in an externality is possible and there are no transactions costs, bargaining will lead to an efficient outcome regardless of the initial allocation of property rights. In this case, this bargaining is not happening and that will push unfortunate people to fight for its rights.

From a global sustainability point of view, the raise of the fossil fuels has huge impact on the world. If the fossil fuels come to be cheap again, the efforts in renewables will stop and we will experience something similar to the 80’s, when the first renewable plants were built and no more were set up until 20 years later. At the end, it is to delay the inevitable, but in a worse scenario. We will have a warmer earth, more population and more bubble, because we have been growing with more energy than we can produce in our present time.

In a more practical way, the implications for the US energy mix or the electricity energy mix are obvious. The current 45% of coal will be substitute by gas, cleaner and not much more expensive now. If you see the predictions of new electrical capacity added from EIA, you can figure out:

 

 After knowing more about the Shale Gas, I understand better the words by President Obama during the State of the Union discuss in 2011, when he claims for a new goal for America’s energy future, saying 80 percent of electricity should come from clean energy sources by 2035. He considers clean, among others, wind, solar, nuclear and natural gas. 

References

 

Energy Information Administration (EIA): www.eia.gov

Josh Fox, Gasland, the movie: www.gaslandthemovie.com

The Economist, ‘We will frack you’ November 22, 2011: www.economist.com

Chesapeake, Hydraulic Fracturing Facts: www.hydraulicfracturing.com

New York Times, ‘The Fracturing of Pennsylvania’ November 17, 2011: www.nytimes.com

 

Minimizing externalities

The electricity generation has important externalities issues. An externality happens when the price of a good doesn’t reflect all the costs that are generated in its manufacturing. That is because some of affections of the product manufacturing has no cost for the company because the price is zero, for instance, there are no price for the clean air or for a not-nuclear-risky generation. In the electrical generation, the product is very homogenous: electrical energy, measured in kWh. But, obviously, it is not the same for the planet how you obtain this energy. But the market, the wholesale market by own, doesn’t reflects all of these affections. So, in electricity markets, both negative externalities and positive externalities happen at the same time. In these two pages, I will analyze the two most popular methods of internalizing the benefits of the positive externalities of the renewable generation: Feed-in Tariffs (FiT) and Renewable Portfolio Standards (RPS), and I will focus on two country examples: Spain (FiT) and the US (RPS). There are also methods for internalize the negative externalities as the carbon cap and trade for CO2 emissions, but I will not consider them in this article.

So, the promotion of the renewable energy, as solar, wind or biomass, is an issue of how to internalize their positive externalities into the market. These benefits are well known. The clean or renewable energies, do not pollute, do not contribute to climate change, do not imply resources depletion, do generate local employment, do promote the national industry, do improve the energetic independence, and more. All of these benefits are not include in the Levelized Cost of Energy (LCOE) or the price of the electricity. Because of that, these technologies are not competing in the same conditions as the conventional generation. That makes that the price of them is above the average price of the electricity in wholesale market, and as a consequence, the utilities do not want to build this expansive plants or to purchase expensive energy to others. This is because the benefits of the renewable energy do not go to them, but to society. That is a market failure and that is because they need the regulation or the support from the Government.

In a market, even the Government can not control the quantity and the price of a product at the same time. If you fix the price for the renewable generation (as FiT does) you do not know what will be the amount of renewable generation that you will obtain. The same, if you fix the quantity you want (as RPS does); you do not know what will be the price for this generation. The price plus the quantity is the key point, because that will be the cost for the electricity customers who are also your voters. So you have to be careful with that because otherwise you can make your citizens to pay so much for the electricity if the price plus the quantity is too high or you can make them not to gain the benefits of renewals if the renewals were not developed due to low prices which do not make the investments profitable. The two methods are good if they are well designed, but that is not the common case.

The Feed-in Tariffs
In the Feed-in Tariffs option, the government decides what will be the price of the renewable generation. That has enormous advantages for developing the market because it is very easy for developers, investors and financial institutions to know what will be their retribution and the Internal Rate of Return (IRR) for their investments. It is easy to calculate the IRR and if the FiT is well calculated -the price will be a bit more than the cost of capital- then the development of renewable is smoothly and a reasonable cost for ratepayers, being the society awarded with the benefits of clean generation.
Spain has become a power in renewals thanks to FiT. The government support has been very strong and determined. Spain has been successful implementing some FiTs, for instance in the case of wind, but has made huge mistakes in solar PV. Spain started to use FiTs in 2000, and ten year later, the 35% of the total generation is using renewals (2010).

In the following graph you can see the average cost of electricity in the wholesale market (black line), the LCOE of wind power (blue line) and the FiT (yellow and red line). As long as the FiT is above the cost, the investment is interesting. This FiT was well calculated to make the investor obtain a 5-7% IRR.

Spanish Fit in wind

In the following graph you can see the objective in wind (red bars) and the actual development (blue bars). As you can see, the development has been constant and progressive.

Spanish wind development vs objective

That is the successful example. But what did it happen in solar? In the following graph you can see the average cost of electricity in the wholesale market (black line), the LCOE of solar power (red line) and the FiT (yellow line). As you can see, the FiT was much more than the cost, so the investors obtained more than 11% IRR.

Spanish Fit in solar PV

What was the result? An over investment in solar PV power. Government wanted 400MW and they obtain more than 3,000MW. That implied a huge cost for citizens, and, as a result, the FiT has been reduced dramatically.

Spanish solar PV development vs objective

Renewable Portfolio Standards
With this method, the Government fixes the quantity of renewable generation that it wants, but not the price. That makes that the developer, the investor, and the most important, the financial institution that is going to put the money on the table, they do not know what will be their IRR before they start to promote a plant. So they have to deal with a lot of risk if they want to build a renewable plant. That is crucial, because at the end, the development of the renewals results too slowly.

You can see the example of the US. The US was the first country in building renewable plants in the 80’s, but now, only the 10% of the total generation is renewable (being 7% big hydro). So they have thirty years of expertise in renewable and only 10% as a result.

The US uses the RPS. That is an objective that some states try to achieve. For example, California has a RPS of 33% renewable in 2020. This objective becomes an obligation for the utilities, which have to provide a 33% of their portfolio using renewals.

Not bad, but then why have they achieved so few renewable generation up to now? Because two things: first of all, they make auctions to know the price of generation (trough Request for Proposals) and due to the competition, many of the bidders offers a price below the real cost, thinking that when they will build the plants, the technological development will made the cost reduced. But that not happened, and now there are a lot of projects that will not be ever built because the developers offered a very low price. Second, because, in fact, the utilities are not penalized if they do not comply with the RPS. So they do not have real incentives to buy more expensive energy that will make their ratepayers to pay more. As a result, the real price of renewals is not revealed.

Conclusions
We have seen to examples of trying to internalize a positive externality. But it is not easy because it is extremely difficult for a legislator to put a price for all of these things that are not in the market. Nevertheless, from the errors, we learn, so, these experiences will improve Government thinking. Benchmarking is also good thing to do for legislators to learn from the errors of the neighbours.

Spain: A Renewable Kingdom :: POWER Magazine

I have been mentioned in this article from POWER Magazine, by Sonal Patel. I think it sum up very well the current situation in the spanish electricity market, however, they are not mentioned some details which could be important for understand all the problem. The Government is not the unique guilty for the struggling tariff deficits.

Spain: A Renewable Kingdom :: POWER Magazine :: Page 2 of 6.