Uncharted Territory

December 8, 2009

Playing the Energy Game

Filed under: Books/resources, Climate change, Energy, Energy policy, Global warming — Tim Joslin @ 7:13 pm

I mentioned last week that I was planning to play the Energy Game based on David MacKay’s book Sustainable Energy Without the Hot Air (SEWTHA) at the Science Museum’s Dana Centre. Well, I’ve been true to my word, although I arrived there slightly breathless after taking the Victorian tunnels from South Kensington tube station. It turns out the Dana Centre is at the other side of the museum, nearer Gloucester Road station.

Anyway, the “game” was worthwhile. It involved adjusting the UK’s energy supply and demand by using two columns of magnetic blocks to represent (decarbonised) energy supply (different flavours of wind and solar power and so on) and demand alleviation measures. We were formed into (moderated) groups to carry out this exercise and then presented our solutions in a final plenary session. All very MBA.

The attendees were all sensible and well-informed. I was therefore quite surprised by some of the outcomes. I also felt the game constrained thinking a little too much. To improve it significantly would require a software implementation and I wonder if the organisers will consider creating one.

The attendees as a whole seemed very accepting of biofuels (not our group, though, but it took quite some discussion) even though the small contribution to our energy supply suggested took up 20% of the UK’s land! There was also a general distrust of carbon capture and sequestration (CCS) and of nuclear power. Partly this was because the constraints of the game allowed only a very small proportion of the UK’s energy to be obtained from these sources, which are not entirely renewable. I felt that the idea that we could only use a small amount of nuclear power because existing known reserves had to be divided equally around the world to be particularly suspect.

Tony Robinson suggested last night that Neanderthal man died out during a previous episode of climate change (a Heinrich cooling event during the last ice age) because he failed to trade, unlike our own ancestors. If we are to solve the energy problem, then it seems to me trade must be at the heart of the solution. For me, the Energy Game as it is now builds in too much UK self-sufficiency (though is inconsistent in addressing the issue, since it does allow desert-based concentrated solar power (CSP) to be a large part of the solution). The UK is an arbitrary market in the modern world, for starters: why not English or European self-sufficiency?

Incidentally, if we are not prepared to build the Supergrid, then those countries poorly endowed with renewable energy relative to their consumption will be obliged to bid up the cost of the world’s uranium supplies and go nuclear. They will end up with more than their “fair share” because other countries will be better off using solar, wind etc. Whether the UK is one of these countries should be for the game to discover.

The game did allow energy price to be taken into consideration. This didn’t stop most groups spending a fortune on rooftop (or other) PV in the UK.

There are several aspects of the Energy Game that could be better captured in a computerised version:

1. An easier and more accurate cost analysis. Costs of demand management actions (e.g. improved insulation of buildings) also need to be included (it wasn’t on Thursday).

2. Warnings, consequences and implicit assumptions. For example, above a certain proportion of wind energy it’s necessary to either store the energy (with some losses) or trade it (also involving costs, e.g. for transmission lines). The game could produce a report detailing technical and political assumptions. In particular, it might highlight the importance of political action to create as wide and as depoliticised an energy market as possible (Europe, North Africa and the Middle East, perhaps). The game should also highlight problems such as how flying is to be powered (our team had no liquid fuel in the mix!), and note the food-supply implications of the use of biofuels.

3. A better appreciation of the time element, which was totally absent on Thursday. Instead of simply adding energy blocks, the team could specify ramp-up and ramp-down rates (and curve shapes – straight line or S shaped) for energy technologies and demand management measures. Costs could also be allowed to evolve over time, e.g. PV in particular might gradually become cheaper, in the same way as other technologies have done in the past. The game could then show you the energy mix at certain dates (e.g. 2020, 2050 – it might have built-in retirement dates for existing power-generation facilities) and give a traffic-light report on whether specific targets have been met (e.g. 20% renewables by 2020, 20% emission reduction by 2020, 80/95% emission reductions by 2050 etc.).

In short, I think you could go to town on this game in a computer programme based on the magnetic version. Your moderators would need a kit consisting of laptops and projectors (and venues would need screens or white walls!), but these are readily available these days.

Nevertheless, the Energy Game is already a worthwhile exercise.

Hansen vs. Krugman: Second (Third and Fourth Order Effect)s Out!

Yesterday’s NYT includes a right royal spat. Well, online it does, at least. In a piece titled Cap and Fade, James Hansen argues that carbon taxes would be more effective than cap and trade. Paul Krugman responds under the heading Unhelpful Hansen, by first telling Hansen to stay off his turf. Climate scientists shouldn’t dabble in economics, apparently. Tosh. Ideas have to stand on their own merits.

Having highlighted the intellectual ring-fencing which is at the root of many of the world’s problems, Krugman proceeds to un-blot his copy-book. He points out very convincingly that, from an individual consumer’s point of view, it matters not a jot whether gasoline is more expensive because of a tax or because of a cap and trade mechanism.

Krugman is right as far as it goes. But both Hansen and Krugman fail to mention the second, third and fourth order effects of pricing carbon emissions. And it is the second, third and fourth order effects that will determine the effectiveness of policy.

Let’s start at the end, because it’s more fun. The fourth order effect of pricing carbon will simply be a redistribution of spending power in the economy. I’m sure I’ve said it before, but I’ll say it again: money is just a means of distributing resources. The economic system will adjust so that the available resources are used.

Perhaps I should try to explain a little further. Money circulates. There is not a fixed quantity. Let’s imagine we put an astronomical tax on carbon. The money raised by that tax must be spent. Let’s say we decide to spend it on more doctors. Suddenly there will be more doctors to fly off to junkets round the world. Or maybe they’ll spend their money on art (or more expensive houses, or televised sport…). In which case the previous owners of the art (or houses, or sportsmen, their agents and other freeloaders) will be able to afford to fly more…

But before we even get to this unhappy state, we should consider, first, a second order effect of pricing carbon. Pricing carbon will tend to reduce the price of fossil-fuels. All that might happen is that the price of petrol at the pump remains the same, but less of the motorist’s money ends up going to the oil-producer and more goes to the government. Maybe a good thing in itself, but we’re trying to stop global warming here, not change the shares of unearned spoils divided with the Saudis. Sure, depressing the global oil price might have the desirable third order effect of reducing investment in the most expensive fossil-fuels for a while (until the lack of supply pushes prices up again), but we need to reduce consumption of fossil-fuels that cost virtually nothing: coal, in particular.

And unfortunately the second order effect of carbon pricing on the oil price is dwarfed by the third order effects of another second order effect. The second order effect (I’m trying to be rigorous, here!) is that taxes raise money. So does carbon trading. We need to consider the effects of how that money is spent.

Hansen argues that the money should be distributed to the population. This will, at least in the short-term, increase equality. And, unfortunately, when you’re trying to reduce consumption of mass-market products, equality is not your friend. Money will be taken from those whose consumption is not constrained by their financial situation and given to those who would like to spend more. Likely on heating, driving, flying and so on. Oh dear!

But there are problems with carbon trading, too. The precise outcome will depend on how carbon permits are distributed. If they’re given away to power companies, then any excess permits will accrue to these companies’ shareholders in the first instance. (Over time, these profits will encourage new market entrants, although this may not happen if only incumbents are able to access the permits). If permits are auctioned, though, then we reach a situation similar to the carbon tax. The outcome depends on what the government does with the revenue. Simply distributing it to the population would fall foul of the same equality problem as for the tax. Direct or indirect subsidies for renewable energy production would clearly be by far the best policy choice, in the hope that, once renewable energy has a huge cost advantage over fossil-fuels, everyone will switch to clean energy. Maybe.

In perverse support for Krugman’s argument that taxes and cap and trade are equivalent, government could spend tax revenues in the same way as those from auctioning permits. Very similar to Hansen’s position is the idea of tradeable personal carbon allowances. These would have the effect of transferring wealth from the rich to the poor. And remember, equality is not our friend…

Let’s make some tentative conclusions and observations:
1. The indirect ramifications of carbon pricing policies are more important than their immediate effects.
2. Carbon trading is philosophically preferable to carbon taxes, because it at least imposes a limit on total consumption. The problems arise from leakage (the concept is explained in a previous post). Unfortunately, these are very big problems – probably deserving a post of their own.
3. If there is a limit on the carbon price in a carbon trading system, then it becomes almost equivalent to a tax. However carbon is priced, governments must be prepared to push the price up indefinitely. Otherwise, I suggest, the economy will simply adjust to the price.
4. Carbon trading is a superior policy if you’re really serious about reducing fossil-fuel emissions, because government doesn’t have to set a tax at an eye-watering level. It can simply say: “this is all the fossil-fuel we can afford to burn, it’s supply and demand in the market-place which has pushed the price up.”

Unfortunately, I don’t see too many governments around the world that are about to bite the bullet and set an effective carbon price.

December 7, 2009

Lloyds Rights Issue: the Story So Far

Filed under: Economics, Lloyds, Rights issues — Tim Joslin @ 12:11 pm

So good: Lloyds has clearly pitched its rights price – 37p – sufficiently low for the rights issue to succeed. The rights have significant value (around 17p just now) that someone will buy them. Even if shareholders do nothing, the rights (or the shares they represent) will be sold in the market at the end of the process.

Nevertheless, I’d argue that the rights issue itself has had a significant effect on Lloyds’ share price.

I wrote a couple of weeks ago that the theoretical ex-rights price (TERP) can only be calculated based on the closing price before the shares go ex-rights. It is only at this point that the rights issue becomes close to a mathematical exercise. Nevertheless, news-flow will continue to affect the share price.

Lloyds in fact closed at 88.83p on 26th November, compared to the 91.47p closing price on the 23rd that Lloyds used for calculating the discount of the rights issue price to the share price.

Following the same method used previously (but ignoring the non-voting share complication):
(total value of Lloyds after rights issue)/(no. of shares after rights issue) = £((0.8883 * 27,161,682,366) + 13,506,882,774)/(27,161,682,366 + 36,505,088,579)) = £(37634605219/63666770945) = ~59.11p.

The rights price (37p) is therefore at a discount of (59.11 – 37)/59.11 = ~37.4% and nil-paid rights should trade at 22.11p.

The question I’m interested in is how much the rights issue has depressed the Lloyds share price.

It’s worth noting first that the rights price and the share price move in lockstep:

Lloyds rights price 30/11 to 4/12

Lloyds share price 30/11 to 4/12

The only thing that is keeping these prices so closely in step is the behaviour of market participants. Profit-making opportunities arise if the prices of the shares and the rights move out of alignment. It’s a simple “wisdom of crowds” effect.

The above graphs also show that the rights and shares have both traded consistently below the prices implied by the TERP.

The problem is that it is very difficult to separate the effect of the rights issue from the effect of news-flow. And we’ve had a lot of news: the Dubai saga, Bank of America repaying government funds and no end of speculation about the UK’s upcoming pre-budget report (PBR) which could all affect the Lloyds share price. On the other hand, the UK Supreme Court ruling that customers (aka the Office of Fair Trading) could not retrospectively challenge fees and news of the emergency loan to HBoS unbelievably kept secret during Lloyds’ takeover should have been in the share price, as these stories broke during the week leading up to the rights issue.

Nevertheless, only briefly on the first morning of the rights issue did the shares and rights trade above the TERP:

Lloyds share price 27/11

To determine whether the increased supply of Lloyds shares or news-flow because of the rights issue has affected the price, we could try comparing Lloyds price with that of other UK banks:

Lloyds share price vs RBoS' 27/11 to 4/12

Lloyds share price vs Barclays' 27/11 to 4/12

Lloyds, RBoS and Barclays are quite different businesses, but maybe we can tentatively conclude that the rights issue has caused Lloyds share price to fall relative to its peers.

But it could be worse than this. Some shareholders may have sold shares in other banks in order to take part in the Lloyds rights issue. They may be rebalancing their portfolios, whilst keeping the proportion of UK banks the same (i.e. selling some holdings in other banks to raise funds to participate in the rights issue at least for some of their entitlement, thereby keeping their holdings in the same proportions as previously to the total market values of the banks), or they may consider that Lloyds’ share price would be depressed by the rights issue.

More than that, some shareholders may have sold Lloyds shares in advance of the rights issue in order to participate. They may have tried to pre-empt the drop in Lloyds’ share price close to the rights issue.

A final comparison that may therefore be useful is Lloyds’ share price against the FTSE-100 index over the last 3 months:

Lloyds vs FTSE last 3 months

You could choose to attribute the >10% fall in Lloyds’ share price against the FTSE to the upcoming rights issue.

The problem we face is that it is impossible to be sure why people have sold shares. Financial columnists rationalise share price movements, but this is just opinion. The price may have fallen on a particular day because of fears over Dubai, for example, but it may have fallen because more shareholders wanted the money than the shares. Or both.

All we know is that there was an equilibrium between buyers and sellers of Lloyds’ shares (and rights) at a share price of 88.83p last Thursday (equivalent to 59.11p) and 54.28p right now.

It’s a question of judgement whether 59.11p, 54.28p or some other figure truly represents the long-run value of Lloyds’ shares.

Personally, I’d certainly argue that Lloyds’ share price is depressed by the rights issue. It follows that if I don’t participate in the rights issue, I have to accept that depressed share price for my rights. That’s why it seems to me that the best thing to do is to subscribe to the rights issue, even if I intend to sell the shares in a few months time.

Note that if you do nothing, the rights will be sold for you in the market and you will receive the funds raised.

December 4, 2009

Why Expedient Offers of Energy Efficiency Improvements must be Rejected at Copenhagen

Filed under: Concepts, Economics, Energy policy, Global warming — Tim Joslin @ 7:01 pm

Earlier this year New Scientist foolishly tried to grab readers’ attention with a cover proclaiming that “Darwin was wrong”.  He wasn’t, of course, and a right old furore was the inevitable result.  It seems misleading headlines are an inevitable symptom of the editing process employed by magazines and newspapers.  The journalist – perhaps keen to be accurate – relinquishes control to editors with entirely different priorities. A large part of their job is to tempt us to buy their product, and, once we have, to read articles they may not have had time to properly digest.

An article in this Thursday’s Guardian (p.11) caught my eye with: “India: Last of ‘big four polluters’ sets target of curbing CO2 emissions by a quarter”.  As I’m paying a lot of attention to the climate change negotiations, I realised that this seemed very unlikely, so read further (the online version linked to has a more sober title).  Many readers will no doubt have been misled by the headline.

It turns out, of course, that India is not offering to reduce carbon emissions at all:

“…[India] could curb the carbon emitted relative to the growth of its economy – its carbon intensity – by 24% by 2020.  … emissions would continue to rise… , but by less than currently predicted.”

This is similar to the action China is proposing.

The Copenhagen offerings to global public opinion from both China and India are entirely inadequate.

First, it’s not yet clear how binding the commitments are.

Second, the targets may not be difficult to meet. For example, I noted recently that:

“China uses four times as much energy as the U.S. per dollar of economic output, and more than 11 times that used in Japan.”

But simple gains in efficiency may even be counter-productive, as I’ve discussed before. In particular, Jevons’ Paradox, or the Rebound Effect, notes that as we improve the efficiency of a technology, the internal-combustion engine, for example, we tend to consume more of it, because we are increasing the value – measured in this case, perhaps, as the distance travelled – that we can obtain for one unit of resource (petrol, aka gasoline, say). Increased driving would, in this example, offset any efficiency gains, and, over time, could even exceed them!

The Rebound Effect considers demand for a technology. But the efficiency problem is worse than that. There is also a supply-side aspect. The more efficient a technology – the internal-combustion engine, for example – becomes, the greater the hurdle to replacing it, with electric engines, perhaps.

Martin Wolf, writing in the FT this week, refers to a paper from the Bruegel think-tank, which discusses the issue in depth. Wolf finds the paper’s argument that “merely raising prices on carbon emissions would reinforce the position of established technologies” to be “persuasive”. The paper, which is well worth a read, suggests that, as well as setting a carbon price at “an appropriately innovation-inducing level”, the “EU should stimulate new technologies more vigorously” by “subsidising the diffusion of existing technologies” and increasing its funding of green R&D.

It seems to me that the basic green technologies we are going to need already exist. They require “D” rather than “R&D”. And, as every entrepreneur knows, the best way to fund product development is through the income from sales. I’m somewhat sceptical that a few billion euros of government support will allow new technologies to overcome the refinements made possible by – depending on the technology in question – 10s or 100s of billions or even trillions of euros of historic sales of fossil-fuel based products.

Worse, why won’t we use both fossil-fuels and renewables? Dirty industries might simply become more and more efficient alongside green industries reliant on subsidies. We might simply consume all the fossil-fuel based and renewable energy that we can produce.

The only way to wean ourselves off fossil-fuels is to target their overall consumption, maybe by breaking the problem down into national allowances.

Until China and India are prepared to accept national limits on their emissions they will not be contributing to the task of avoiding dangerous climate change. Carbon-intensity targets are no substitute for emission cuts.

December 3, 2009

Problems with Wood Chips: Why Copenhagen’s Piecemeal Approach to Preserving Forests will Fail

Filed under: Forests, Global warming, International climate deals — Tim Joslin @ 4:30 pm

We all share the same atmosphere. Wood is an internationally traded commodity. How is it, then, that, simultaneously, governments in East Asia are urging their citizens to reduce their consumption of wooden chopsticks whilst wood-burning boilers are being promoted in the UK?

Such a lack of consistency is typical of attempts to preserve forests, including the proposals apparently being discussed in the lead-up to the Copenhagen climate-change talks.

I’m finding literature supplied by the NGOs to be a lot more useful in understanding the Copenhagen discussions than anything I’ve seen in the mainstream media. A WWF “Pocket Guide” to “The New Copenhagen Climate Deal” was included with the Guardian early this week. I immediately turned to the section on forests (not apparently available online, but with some overlap to this page on WWF’s site). I highlighted the following passage about REDD which, according to WWF stands for “reducing emissions from deforestation in developing countries”:

“There is no point paying to protect one forest, if the loggers and farmers simply go somewhere else and tear that down (in the jargon, this is called ‘leakage’) – or come back in a couple of years after REDD has paid out (the challenge of ‘permanence’).”

Very succinctly put.

Why, oh why, then would we even contemplate a REDD framework that does not meet the conditions of avoiding leakage and ensuring permanence?

As far as I can tell, Copenhagen is likely to spawn a variety of different schemes for preserving forests. These seem to fall into 3 main categories:

1. Carbon-trading REDD schemes

Specific areas of land are ring-fenced from deforestation (and/or reforested or afforested) and the amount of carbon “saved” compared to “business as usual” (i.e. if the land had not been protected). This carbon is then amortised over a number of years and traded as carbon credits for each of those years.

I don’t think I’m pre-empting a lot of discussion by suggesting that such schemes meet neither of the two criteria of avoiding leakage and ensuring permanence.

2. Preservation of specific forest areas

Despite New Scientist’s flippant headline, a scheme in Ecuador to preserve part of the Amazon rainforest (which happens to sit on a lot of oil) makes considerable sense:

“Ecuador said it would abandon plans for drilling in Yasuni National Park, one of the few pristine regions of Amazon rainforest remaining, if it was paid half of the $7 billion that it expected to earn from tapping the oilfield.”

The critical point is at the end of New Scientist’s report:

“…the UN Development Programme is expected to announce plans to hold contributions in a trust fund, passing along only the fund’s interest to Ecuador. … this will give future Ecuadoran governments an incentive not to start drilling for oil, while also encouraging other nations to pay up.”

This model could at least meet the challenge of permanence.

3. National commitments to reduce deforestation rates

The Copenhagen talks are unfortunately turning into a battle between the “developed” North and the “developing” South. This artificial distinction has spawned a counter-productive “them and us” mentality. It makes it even more difficult to define, let alone agree, sensible solutions to the problem of global warming.

Likely we are past the point where reducing deforestation rates is enough. Ultimately, we will probably need to significantly increase the forested area of the planet to absorb carbon that’s already in the atmosphere. But let’s put that issue to one side for now.

The problem with the “North” buying reductions in the rate of deforestation from countries in the “South” is the leakage criterion.

WWF has defined REDD as “reducing emissions from deforestation in developing countries”. This makes absolutely no sense. We need to preserve temperate and boreal forests as well as tropical forests. You can’t assume a lot when it comes to the increasingly baroque Copenhagen negotiations, but I’d wager that none of Russia, Canada and the Scandinavian and Central European countries, not to mention Australia, Japan and New Zealand are classified as “developing”. It seems to me that the best that could happen under schemes aimed at reducing some national deforestation rates is that timber exports from those countries decrease, whilst they increase from countries not included in the scheme.

What is actually needed is a global Forest Endowment Fund which provides an income stream in perpetuity to any and all custodians of the world’s forests (and other ecosystems, in particular wetlands) in approximate proportion to the carbon stored in their trees and soils, as long as the forest remains in a defined state. Only this way is it possible to meet the key criteria, correctly identified by WWF, of avoiding leakage and ensuring permanence.

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