Lessons from the Coal Bust

Yesterday's Chapter 11 filing by the largest US coal mining company is the latest in a series of coal bankruptcies. While factors such as regulations and poorly timed acquisitions have played a role, this trend reflects the parallel technology revolutions playing out across the energy sector. Here are a few key lessons from the ongoing coal bust:

• There are many other ways to make electricity, and coal brings nothing unique to the party. In a growing number of markets it is no longer the cheapest form of generation, and it is certainly the one with the most environmental baggage, from source to combustion.
• Coal-fired power generation is in competition with alternatives that are already producing at scale, like nuclear and natural gas generation, or growing rapidly from a smaller base, like renewables. It may not compete with all of these in every market, but few markets lack at least one of these challengers.
• The costs of renewables and gas have fallen significantly in recent years, due to major technology gains. Coal has also benefited from some improvements in scale and end-use technology. Today's ultra supercritical coal plants are more efficient than coal plants of a generation ago, but they are more expensive to build, even without carbon capture (CCS). However, wind and solar power continue to grow cheaper and more efficient, while gas has benefited from resource-multiplying production technologies and advanced gas turbines that can exceed 60% efficiency and ramp up and down rapidly to accommodate the swings of intermittent renewables.
• Despite all of these threats, coal is not on the verge of being forced out of power generation, even in developed countries where all the above factors are at work. Replacing its enormous contribution to primary energy supply and electricity generation will be a very heavy lift, particularly where another major energy source like nuclear power is being phased out. Germany is the prime example of that.

Consider what it would take to replace the remainder of coal in the US power sector. Last year coal generated 33% of US electricity, down from nearly 45% in 2010. Gas picked up 70% of the drop in coal's power output, but that still left coal's contribution at 1,356 Terawatt-hours (TWh) or about 6x the grid contribution of all US wind and solar power last year. (A Terawatt is a billion kilowatts.)

Displacing coal completely from US electricity would require doubling the 2015 output of US gas-fired power generation and a roughly 36% increase in US natural gas production. By comparison, the US nuclear power fleet would have to more than double. If coal were to be replaced entirely by renewables, which in practice probably means gas pushing coal out of baseload power and renewables reducing gas-fired peak generation, the hill looks steep.

Last year the US added 7.3 GW of new solar installations and 8.6 GW of new wind turbines. Assuming they were mostly sited in locations with reasonable solar or wind resources, their combined annual output should be around 35 TWh. At that pace it would take another 36 years to make up what coal now generates. It's true that net annual wind and solar additions continue to grow at double-digit rates, but keeping that up may get harder as the best sites become saturated and earlier wind turbines and PV arrays reach the end of their useful lives in the meantime.

In other words, driving coal from here to zero seems possible but very difficult, even with an all-of-the-above strategy in a market without demand growth. And if electricity demand continues to grow, as it is globally, or resumed growing in the US and other developed countries to enable a big shift to electric vehicles, the prospect of retiring coal entirely recedes into the future.

OPEC's War on US Producers

The comments of Saudi Arabia's oil minister at the annual CERAWeek conference in Houston this week provided some sobering insights into the strategy that the Kingdom, along with other members of OPEC, has been pursuing for the last year and a half. Perhaps the ongoing oil price collapse is not just the result of market forces, but of a conscious decision to attempt to force certain non-OPEC producers out of the market.

Notwithstanding Mr. Al-Naimi's assertion that, "We have not declared war on shale or on production from any given country or company," the actions taken by Saudi Arabia and OPEC in late 2014 and subsequently have had that effect. When he talks about expensive oil, the producers of which must "find a way to lower their costs, borrow cash or liquidate," it's fairly obvious what he is referring to: non-OPEC oil, especially US shale production, as well as conventional production in places like the North Sea, which now faces extinction. If these statements and the actions that go with them had been made in another industry, such as steel, semiconductors or cars, they would likely be labeled as anti-competitive and predatory.

We tend to think of the OPEC cartel as a group of producers that periodically cuts back output to push up the price of oil. As I've explained previously, that reputation was largely established in a few episodes in which OPEC was able to create consensus among its diverse member countries to reduce output quotas and have them adhere to the cuts, more or less.

However, cartels and monopolies have another mode of operation: flooding the market with cheap product to drive out competitors. It may be only coincidental, but shortly after OPEC concluded in November 2014 that it was abandoning its long-established strategy of cutting production to support prices, Saudi Arabia appears to have increased its output by roughly 1 million barrels per day, as shown in a recent chart in the Financial Times. This added to a glut that has rendered a large fraction of non-OPEC oil production uneconomic, as evidenced by the fourth-quarter losses reported by many publicly traded oil companies.

That matters not just to the shareholders--of which I am one--and employees of these companies, but to the global economy and anyone who uses energy, anywhere. OPEC cannot produce more than around 37% of the oil the world uses every day. The proportion that non-OPEC producers can supply will start shrinking within a few years, as natural decline rates take hold and the effects of the $380 billion in cuts to future exploration and production projects that these companies have been forced to make propagate through the system.

Cutting through the jargon, that means that because oil companies can't invest enough today, future oil production will be less than required, and prices cannot be sustained at today's low level indefinitely without a corresponding collapse in demand. Nor could biofuels and electric vehicles, which made up 0.7% of US new-car sales last year, ramp up quickly enough to fill the looming gap.

Consider what's at stake, in terms of the financial, employment and energy security gains the US has made since 2007, when shale energy was just emerging. That year, the US trade deficit in goods and services stood at over $700 billion. Energy accounted for 40% of it (see chart below), the result of relentless growth in US oil imports since the mid-1980s. Rising US petroleum consumption and falling production added to the pressure on oil markets in the early 2000s as China's growth surged. By the time oil prices spiked to nearly $150 per barrel in 2008, oil and imported petroleum products made up almost two-thirds of the US trade deficit.

Today, oil's share of a somewhat smaller trade imbalance is just over 10%. Since 2008 the US bill for net oil imports--after subtracting exports of refined products and, more recently, crude oil--has been cut by $300 billion per year. That measures only the direct displacement of millions of barrels per day of imported oil by US shale, or "tight oil" and the downward pressure on global petroleum prices exerted by that displacement. It misses the trade benefit from improved US competitiveness due to cheaper energy inputs, especially natural gas.

Compared with 2007, higher US natural gas production, a portion of which is linked to oil production, is saving American businesses and consumers around $100 billion per year, despite consumption increasing by about 20%--in the process replacing  more than a fifth of coal-fired power generation and reducing CO2 emissions. $25 billion of those savings come from lower natural gas imports, which were also on an upward trend before shale hit its stride.

 

The employment impact of the shale revolution has also been significant, particularly in the crucial period following the financial crisis and recession. From 2007 to the end of 2012, US oil and gas employment grew by 162,000 jobs, ignoring the "multiplier effect." The latter impact is evident at the state level, where US states with active shale development appear to have lost fewer jobs and added more than a million new jobs from 2008-14, while "non-shale" states struggled to get back to pre-recession employment. That effect was also visible at the county level in states like Pennsylvania, where counties with drilling gained more jobs than those without, and Ohio, where "shale counties" reduced unemployment at a faster pace than the average for the state, or the US as a whole.

 

If the shale revolution had never gotten off the ground, US oil production would be almost 5 million barrels per day lower today, and these improvements in our trade deficit and unemployment would not have happened. The price of oil would assuredly not be in the low $30s, but much likelier at $100 or more, extending the situation that prevailed from 2011's "Arab Spring" until late 2014. If OPEC succeeds in bankrupting a large part of the US shale industry, we might not revert to the energy situation of the mid-2000s overnight, but some of the most positive trends of the last few years would turn sharply negative.

 

Now, in fairness, I'm not suggesting that this situation can be explained as simply as the kind of old-fashioned price war that used to crop up periodically between gas stations on opposite corners of an intersection. The motivations of the key players are too opaque, and cause-and-effect certainly includes geopolitical considerations in the Middle East, along with the ripple effects of the shale technology revolution. It might even be possible, as some suggest, that OPEC has simply lost control of the oil market amidst increased complexity.  

 

However, to the extent that the "decimation" of the US oil and gas exploration and production sector now underway is the result of a deliberate strategy by OPEC or some of its members, that is not something that the US should treat with indifference.

This is an issue that should be receiving much more attention at the highest levels of government. The reasons it hasn't may include consumers' understandable enjoyment of the lowest gasoline prices in a decade, along with the belief in some quarters that oil is "yesterday's energy." We will eventually learn whether these views were shortsighted or premature.

...and Two Steps Back for Cleantech

• The Better Place bankruptcy ends an interesting effort to circumvent some big impediments to the wider adoption of electric vehicles.
• DESERTEC's original concept would have matched European solar investment with superior North African solar resources, but was no match for European politics.

Within the last week two of the previous decade's Big Ideas for accelerating the shift from fossil fuels to renewable energy--or at least to electricity generated from a variety of cleaner sources--have come up short.  On May 26th electric-vehicle-battery-swapping firm Better Place filed for bankruptcy liquidation in Israel, and just a few days later the DESERTEC Foundation reportedly "abandoned its strategy to export solar power generated from the Sahara to Europe".  Both of these concepts originally looked promising, and I take no satisfaction in their apparent failure.  However, these events must be telling us something.

Better Place was aimed squarely at two of the largest perceived barriers to wider acceptance of electric vehicles (EVs): the limited range of today's EV batteries and the relatively long times required to recharge them, compared to a typical three-minute fill-up at the gas pump.  Better Place's big idea involved the standardization of EV battery packs on a design that could be quickly removed from the vehicle and robotically replaced with a fully charged battery. This required large up-front investments in facilities and hardware, but the firm didn't fail for lack of capitalization. 

Despite having raised around $800 million since its founding in 2008, and convincing French carmaker Renault to produce vehicles designed to work with their technology, Better Place failed to standardize the emerging EV battery market.  Tesla used a different battery configuration from the start and has focused on its own fast-charging technology, while even Renault's global alliance partner Nissan didn't make compatibility with Better Place a standard feature of its Leaf EV in markets like the US or Australia. That led Better Place to invest in building more-conventional EV recharging networks to accommodate other EVs, diluting both its capital and its concept. 

I see two lessons here. First, EVs and related services are still a niche market, and in spite of its aspirations Better Place became a niche within this niche, largely dependent on the success of EV manufacturers at growing their potential market.  That's a poor place from which to launch a business that ultimately depends on achieving high volumes.  The other lesson is that when you can't make sense of a company's revenue and working-capital model, there's probably a good reason.  At this stage in their development, EV battery packs are apparently still too expensive to sit idle in large numbers, waiting for a swap, when the hardware to exchange them requires the same retail footprint as a car-repair bay--all this to support a service arguably only worth a few hundred dollars per year to an EV owner, compared to the normal cost of recharging.

DESERTEC's big idea was even simpler than Better Place's.  A well-sited solar array in North Africa would inherently generate at least twice as much electricity per year as the same array in Germany, the Netherlands, or Belgium.  All else being equal, it would make more sense to invest in solar where the sun shines brightly for more than 6 hours a day, on average, and to send it by wire to the cloudy, northern countries that want more green power.  Of course physics can't always trump politics, and I suspect that this has more to do with DESERTEC's withdrawal from its basic concept than the cited concerns about transmission capacity and grid congestion across Spain and France. 

Politics enter the story in two main ways.  Renewable energy in the EU is deeply entangled with industrial policy and green jobs. From that standpoint, it's even better if a PV panel in Germany produces half the output as one in Morocco, because you can sell twice as many, all installed by local firms and workers. Then there's the interaction between the EU's generous solar subsidies and the solar manufacturing incentives in Asia and elsewhere, resulting in enormous overcapacity, relative to demand, and a now-global wave of solar bankruptcies and defaults.  This has pushed PV module prices down to a level at which the other costs of solar energy, including installation and transmission, begin to outweigh the module costs. That erodes North Africa's solar advantage relative to its northern neighbors. Throw in the lingering effects of the financial crisis, and a once-big idea looks like an unworkable dead end, at least for now.

Neither the failure of Better Place, which might yet find a bargain-hunting savior, nor the retreat of DESERTEC looks like a mortal blow to the long energy transition now underway.  However, they do suggest that the timeline is a little less likely to be shortened by the kinds of big leaps they offered.  EVs will have to gain market share the hard way, with better, cheaper batteries and ample recharging infrastructure--plus continued taxpayer subsidies--while inefficient solar subsidies continue to divert investment away from some of the world's best renewable energy resources, keeping the technology's global contribution smaller for longer.    

Solyndra's Second Chapter

The details of the reorganization plan approved Monday by the judge hearing the Solyndra bankruptcy case reminded me of the admonition of one of my mentors always to beware of unintended consequences.  I'm sure the Department of Energy officials who recommended the federal loan guarantee for Solyndra in March of 2009 envisioned that the solar start-up would succeed.  As a worst-case outcome, they probably anticipated the loss of the entire $535 million direct federal loan ultimately provided by the Treasury. However, in a remarkable turn of events, the actual extent of the downside for taxpayers has now expanded to nearly $900 million, due to a quirk in the tax code and a subsequent DOE decision in 2011.

This odd sequence of events starts in early 2011 when two venture investors agreed to infuse another $75 million into the already failing Solyndra.  In order to facilitate this injection--presumably in hopes of protecting the government's substantial investment in the firm--the DOE agreed to allow the investors' loan to take precedence over the government's if Solyndra went bankrupt. Perhaps they thought that even in that case, they'd still recover most of the government's investment, because Solyndra had a sexy technology and a big new factory in Fremont, CA that could be sold to a competitor for close to full value.  They apparently didn't appreciate that Solyndra's high-cost technology had already been bypassed by falling polysilicon prices, and that the factory and its custom equipment wouldn't be of much interest to other solar producers, who were in the process of creating a huge global overhang of solar manufacturing capacity.  The Solyndra plant will now apparently be sold to a hard-drive maker for just $90 million.

In the meantime, Solyndra was piling up substantial losses running its plant and selling solar modules below cost, in order to compete with conventional solar panels that had become much cheaper. By the time Solyndra entered Chapter 11 bankruptcy, its cumulative losses apparently totaled $975 million.  To put that in perspective, the combined after tax profits of First Solar, the largest US solar producer, for the three years in which the DOE's loan to Solyndra was outstanding, were $1,265 million.

What makes Solyndra's losses relevant is that, contrary to intuition, they didn't disappear in bankruptcy.  Instead, via the investors' plan for emerging from bankruptcy, they became an asset.  And because the DOE ceded the first place in line to private investors, it is those investors who will control those "net operating losses" retained by Solyndra's reorganized parent company, 360 Degree Solar Holdings, Inc. That company apparently kept none of Solyndra's hardware, but when it acquires other companies--in any line of business--it will be able to offset future federal tax liabilities estimated by Bloomberg at $341 million.  Meanwhile, the federal government is likely to recover just 5 cents on the dollar on its "secured loan."  The Solyndra loan is a gift that keeps on giving. 

Hindsight is 20/20, but it seems pretty clear that the folks at DOE were outsmarted by private investors who had a much clearer picture of the stakes for which they were negotiating.  As we were reminded last week, Solyndra wasn't the only investment they made that went bad.  Let's hope that the others don't include similarly unpleasant surprises.  Meanwhile, I wish the IRS and Alameda County the best of luck in appealing the bankruptcy judge's ruling.

A123 Bankruptcy Casts Doubts on EV Goals

The theory was that the federal government could guide an entire US electric vehicle (EV) industry into existence by orchestrating a constellation of grants, loans and loan guarantees to manufacturers and infrastructure developers, along with generous tax credits for purchasers.  That vision was attractive, because EVs have the potential to be an important element of a long-term strategy to counter climate change and bolster energy security. However, yesterday's bankruptcy of battery-maker A123 Systems, Inc. provides a costly reality check. Along with the earlier bankruptcy of another advanced battery firm, Ener1, and disappointing battery-EV sales, it raises new doubts concerning both the government's model of industrial development and the achievability of President Obama's goal of putting one million EVs on the road by 2015. 

A123 was built around a novel lithium-ion battery technology developed at MIT.  For a time they were the darling of the advanced battery sector, with a market capitalization above $2 billion following its 2009 initial public offering. That IPO came on the heels of A123's receipt of a $249 million stimulus grant from the Department of Energy and $100 million of refundable tax credits from the state of Michigan. Subsequently, though, they experienced low sales and a costly battery recall that contributed to their signing a memorandum of understanding with China's Wanxiang Group to sell an 80% interest in the company for around $450 million.  Instead, it now appears that Johnson Controls, a diversified company that was the recipient of a $299 million DOE advanced battery grant of its own, will end up acquiring A123's assets for around $125 million.  Johnson is apparently providing "debtor-in-possession" financing for A123's Chapter 11 process.  It's not clear whether Johnson would be able to draw down the unused portion of A123's federal grant.

Because of the government's close involvement with A123, and in particular its structuring of aid to A123 in a manner that left taxpayers without any call on the firm's assets ahead of suitors like Johnson Controls or Wanxiang, this event is inherently political.  I was a little surprised it didn't come up in last night's presidential debate.  If it does become a "talking point" in the next two weeks, however, I'd prefer to see the conversation focus on the real issues it raises.  The reasons for A123's failure appear very different from those behind the much-discussed failure of loan-guarantee recipient Solyndra.  While the latter ultimately called into question the judgment of officials who loaned money to Solyndra when that company's business model was already doomed, A123 highlights the much deeper challenges involved in attempting to conjure an entire industry out of thin air.

The earlier failure of GM's electric vehicle effort in the 1990s, the EV-1, demonstrated the chicken-and-egg nature of EV sales: Vehicle sales depended on recharging infrastructure that in turn depended on robust vehicle sales to justify infrastructure investment.  But at least GM could begin then by relying on a mature lead-acid battery industry.  Those batteries turned out to be inadequate to meet consumers' expectations of range and recharging convenience, which led to the creation of another chicken-and-egg dependence for the new EV industry: carmakers needed a reliable supply of advanced batteries from producers who couldn't invest in the capacity to make them, without knowing that vehicle sales would consume enough batteries to turn a profit.  So in 2009 the administration set out to short-circuit all those inter-dependencies by simultaneously funding the key elements of these loops, including advanced battery makers.  It makes me wonder if anyone involved had any direct manufacturing experience--a natural doubt considering that the entire US auto industry was restructured in 2009 by a task force without a single member who had worked in any manufacturing business, let alone the auto industry. 

The main causes of A123's failure appear to have involved basic manufacturing issues of capacity utilization and quality control.  The company wasn't selling enough batteries to cover its costs, and too many of the batteries it sold came back in an expensive recall.  They weren't the first business to experience such growing pains, but their challenges were compounded by the burden of a manufacturing line that had been sized to meet the demand of an EV market that hasn't yet materialized. US EV sales through September amounted to just 31,000 vehicles, or less than 0.3% of total US car sales.  The picture looks even worse if you subtract out sales of GM's Volt and Toyota's plug-in version of its Prius, the gasoline engines of which provide essentially unlimited range, circumventing the limitations of today's batteries.  I think there's a strong argument that the government's assistance to A123 was actually a key factor in leading them to bankruptcy, by prompting A123 to grow much faster than could have been justified to its bankers or private investors.

Perhaps it's some consolation that A123's technology has apparently been snapped up by a competitor, rather than going the way of Solyndra's odd solar modules.  Yet that outcome hardly justifies the casual dismissal of A123's fate by a DOE spokesman as a common occurrence in an emerging industry.  That sort of talk merely perpetuates the perception of cluelessness fostered by Energy Secretary Chu's failure to hold anyone accountable for the Solyndra debacle.  Yes, companies in emerging industries fall by the wayside, but the preferred response would be to examine what happened and apply the lessons learned to the rest of the "venture capital portfolio" with which the administration's industrial policy has saddled the DOE.  With EV sales still low and several key EV makers experiencing delays and production problems, a thorough public review of the entire EV strategy is in order.

Candidates & Energy 2012: Obama

It's curious that energy hasn't been as big an issue in this year's presidential campaign as it was in 2008, the year of "Drill, baby, drill."  The price of unleaded regular gasoline has averaged roughly a dime per gallon higher through September than either last year or the same period in 2008, when prices peaked at $4.11 per gallon in July.  Gas prices are higher this year because global oil prices are also higher, with UK Brent crude averaging $15 per barrel over its 2008 full-year average, though without a similar spike.  One explanation for the reduced focus on energy is that President Obama co-opted his opponents' "all of the above" prescription, while indicators such as US crude oil production and natural gas output and prices have been moving in favorable directions.  The Obama campaign and key administration officials routinely draw a strong causal connection between those two facts, forming the basis of their campaign on energy.  But is that claim true?  Like the Washington Post fact checker's assessment of another frequent presidential assertion about energy, a finding of "true but false" seems appropriate.

Although I had intended to provide a side-by-side comparison of President Obama's and Governor Romney's energy agendas, it quickly became obvious that that was impractical, due to length and complexity.  I'll take a look at the challenger's ideas next week.  Since any re-election bid is fundamentally a referendum on the incumbent, it made sense to start with the record of an administration that came into office with an unusually clear and clearly articulated vision on energy, experienced some notable victories and defeats along the way, and ended up embracing a pair of big, emerging trends that it had done virtually nothing to foster. 

That is readily apparent when it comes to oil production, which must be a core element of any "all of the above" approach, since that "all" implicitly includes fossil fuels along with renewables and efficiency.  Go to the Obama campaign web page on energy and you'll see this chart:

It's a rescaled version of the chart below, which appears on the WhiteHouse.gov site on gas prices:

Aside from the fact that changing the axis scale makes the trend look much more dramatic, what's entirely missing from both these charts and the websites where they appear is any cogent explanation of why oil production is rising.  That requires some context about the industry and oil markets that I've overlaid in the following graphs:

Most oil projects big enough to matter aren't accomplished overnight. The process typically involves acquiring onshore or offshore leases, obtaining the necessary permits, conducting exploration activities that only proceed to the next step based on success, planning the required production wells and processing facilities, competing for internal funding against other company projects, obtaining additional permits, constructing facilities and drilling the production wells. Every step takes time.  Depending on the complexity of the project, the overall timeline can span from three to seven years, and that's if no one sues to block the project.  To see why oil production has been rising since 2009, we need to ask what was happening in 2003-6.  The answer is that after many years of being stuck in a range of $20-30 per barrel--with an excursion down to single digits in the late 1990s--oil prices tripled during that period, mainly due to the combination of global economic growth, especially in Asia, and the lagged effect on oil project investments from that late-'90s price crash.  In other words, production went up mainly because five or six years earlier the financial rewards for drilling suddenly got much bigger.

So at a minimum it's a stretch--mere spin--to claim credit for higher production that is attributable to events and perhaps policies on your predecessor's watch.  However, the picture looks worse when we factor in the policies and attitudes that went into effect when this administration took office in early 2009.  Recall that one of the first energy decisions of the new administration was Interior Secretary Salazar's cancellation of previously awarded oil leases in Utah.  Later that year a senior Treasury official--currently chairman of the President's Council of Economic Advisers--testified before Congress that US policies were promoting the "overproduction of US oil and gas", just as the now-touted production surge was starting.  For at least its first several years, the rhetoric and actions of the Obama White House were generally consistent with that view and with Mr. Obama's portrayal of oil and gas as "yesterday's energy" in his 2011 State of the Union address.  The brief offshore drilling opening signaled in spring 2010 was quickly retracted following the Deepwater Horizon accident, with the imposition of a six-month offshore drilling moratorium and subsequent "permitorium". Those responses--justified or not--resulted in Gulf of Mexico production falling by 22% since mid-2010, a decline that has been masked by the tremendous success of "tight oil" exploration and production in Texas and North Dakota. (The time lag for the moratorium's effects was negligible, because the deepwater projects that were halted had already been planned and permitted.)

In fact, the President's adoption of "all of the above" is fairly recent, making headlines following his 2012 State of the Union. It represents quite an evolution from Senator Obama's 2008 emphasis on renewable energy and climate change mitigation. President Obama certainly pursued those agendas with vigor, incorporating billions of dollars of federal grants and loan guarantees for renewables in the 2009 stimulus, backing the Waxman-Markey cap-and-trade bill, and at both the Copenhagen and Cancun UN climate conferences committing the US to significant greenhouse gas reduction targets and further negotiations. 

It hasn't all worked out as planned, though.  Notwithstanding the high-profile bankruptcies of Solyndra--a colossal failure of due diligence by the administration--and other loan guarantee and grant beneficiaries, the output of wind, solar and other non-hydro renewable energy generation has indeed grown by 55% since 2008, increasing from 3.1% to 4.7% of total US electricity generation, equivalent to 1.9% of total energy consumption.  Yet sadly the wind and solar manufacturing sectors that were to have produced so many "green jobs" are caught up in parallel waves of excess global production capacity that could take years--or wrenching consolidation--to work off.  The overcapacity that has blighted the prospects of many of these companies is largely attributable to the generous incentives provided by the US and other governments from Europe to Asia.  Direct wind and solar jobs accounted for just 54,000 of the US "clean economy jobs" tallied by Brookings and Battelle in their study last year, and they look no more secure than non-green jobs.

Climate policy is another area featuring a big disconnect between effort and results. With control of both Houses of Congress, the President backed a climate bill that exhibited all the worst tendencies of that body: 1,092 pages of bloated regulations and carve-outs for favored constituencies.  Even to someone who had supported the idea of cap and trade for a decade, it was a dog's breakfast, configured mainly as a production-inhibiting tax on the US petroleum sector.  Waxman-Markey failed to pass the Senate, and a more bi-partisan bill died in the aftermath of Deepwater Horizon and the recession. Whatever one's views on the science of climate change, costly climate legislation looked like a bad bet in a weak economy.  Actual emissions have fallen, however, as a result not of policy but of another trend that wasn't on the administration's radar screen until it grew too large to ignore: shale gas.  Emissions are at a 20-year low, mainly due to fuel switching from coal to cheap natural gas in the utility sector.

Another key trend cited as evidence of the effectiveness of the administration's energy policies is the reduction of oil imports that has occurred since 2008.  Yet like the facts on oil production, the causes are only tenuously connected to those policies.  From 2008-11, US net petroleum imports fell by 2.6 million bbl/day (MBD), including refined products.  That goes a long way toward achieving then-candidate Obama's goal of reducing imports by an amount equivalent to what the US imported from the Middle East and Venezuela.  However, the biggest contributor to this reduction was the 1.1 MBD increase in total US petroleum production (including natural gas liquids), followed by a 0.6 MBD drop in demand that had more to do with reduced driving and the weak economy than the early gains from tougher fuel economy rules. Increasing biofuel production associated with the 2007 Renewable Fuel Standard contributed another 0.3 MBD, although that policy now stands in urgent need of reform.

I have watched many elections in my life, and I can't honestly say I'm surprised to see an administration running on something other than its actual energy record, which in this case includes positives such as funding ARPA-E's potentially transformational energy R&D and having enough sense to keep largely out of the way of the shale gas revolution--at least for now. Yet having focused 90% of its efforts on a set of technologies that look important for the future but will still meet less than 10% of our energy needs for some time to come, they have now hitched their electoral wagon to an oil production surge that they didn't help and partly hindered.  I can only imagine that this would be deeply disappointing to those who supported Mr. Obama in 2008 because of his vision for alternative energy and the environment.  Nor does it provide much comfort to those who found large portions of that agenda ill-considered or premature. The President's 11th-hour conversion to "all of the above" creates great uncertainty about the course he would pursue with regard to energy for the next four years, if reelected. 

More Lessons from Solyndra

I'll bet that those working and investing in renewable energy are even more tired of the steady stream of headlines from the unraveling Solyndra mess than the rest of us are. Today's crop includes more evidence of the political linkages to the overall process for determining the company's suitability for federal backing and the revelation that an investor in Solyndra was advising the US Navy to sign a contract with them, even as the firm was on the verge of collapse. None of this has done either the industry or the administration any good, and there is much to be learned from this episode. That includes lessons concerning direct government support for the full-scale deployment of renewable energy and other technologies.

Start with the ethics issues. No one should be surprised that investors in Solyndra were lobbying the DOE and White House in support of the company's application for a federal loan guarantee. That was hardly unique to Solyndra or renewable energy. And I'm perfectly willing to accept, unless proven otherwise, that both the DOE advisor whose wife works for a law firm representing Solyndra, and the venture capitalist who apparently advised the Navy to buy Solyndra's technology in his capacity with the Pentagon's Defense Venture Catalyst Initiative, thought they had done everything necessary to resolve any potential conflicts of interest in this matter. Yet in both cases it seems clear that even if nothing improper was done, the appearance of impropriety is very hard to dispel after what seemed like a routine transaction turns into a front-page scandal.

Whenever I see this sort of thing I can't help recalling the early training I received as a petroleum products trader for Texaco, which took anti-trust compliance very seriously. The lawyer who advised our Supply & Distribution department on such matters always reminded us to think about how our dealings with other companies might look if we had to explain them from the witness stand in a court of law. He invariably advised going beyond mere compliance; his mantra was, "Avoid the appearance of evil." That's a lesson that it seems many of the officials involved in the Solyndra debacle either forgot or never received, even if they believed they were in full compliance with existing ethics policies.

When you step back from such details it becomes apparent that these are precisely the sorts of conflicts that result, when the government involves itself so deeply in transactions of a magnitude that would normally be handled in the commercial sector--which even when it makes mistakes does so with shareholder dollars, rather than tax dollars. And make no mistake, if Solyndra had gone broke after receiving $500,000 from Uncle Sam, rather than $535 million, none of these other issues would matter or have seen the light of day.

It's perfectly appropriate--even necessary--for the government to make modest-sized bets on new technology in key areas, particularly when they require greater patience than most corporations are capable of. And it's to be expected that many or even most such bets will turn out to be dead ends, as Solyndra did. The problem is that while a few million dollars will buy a lot of renewable energy R&D, they will buy only a negligible amount of deployment. While the government can afford to make numerous small bets that don't turn out well but advance our knowledge in the process, it can only afford to make a small number of bets on the scale of the Solyndra loan. That ought to be especially true when the deficit and debt loom as large as they do, unless you're a firm believer in the "broken windows" theory of stimulus, or Lord Keynes's suggestion that the government could productively bury bottles of money and let people dig them up.

The easy question is whether the Department of Energy should have backed Solyndra. I have concluded the answer is no, and not just based on after-the-fact information. The much harder question is whether the US government should be in the business of providing this level of support for large-scale manufacturing or deployment, rather than just R&D. And even if it should, can it develop the necessary expertise and processes, not only to make such decisions at least as well as its commercial counterparts would, but also to insulate the decision-makers from the political influence that such high stakes are bound to attract. Answering that depends on a lot more than just one's political or economic philosophy.

Will Solar Bankruptcies Be Different From Ethanol's?

The solar equipment business appears to be undergoing a shakeout, as three US solar firms have declared bankruptcy in the last few weeks. The most prominent of these was Solyndra, which was notable for its receipt of a $535 million federal loan guarantee. Joining Solyndra in bankruptcy filings were Massachusetts-based Evergreen Solar, which had been ailing for more than a year, and former Intel spin-off SpectraWatt. These failures raise many questions, but one that I haven't seen discussed much is whether these companies' assets will merely be absorbed into other, more successful solar firms, or effectively sold for scrap. I suspect the outcome will be quite different from that of the ethanol bankruptcies that followed the financial crisis.

Observers of these firms might be tempted to look to the ethanol industry for a model of how their bankruptcies could turn out. After all, ethanol represents another green industry--or at least one with green aspirations--the growth of which has also been entirely predicated on government subsidies and mandates. And in a pattern similar to the current situation in the global solar industry, US ethanol producers had invested aggressively in capacity expansion ahead of actual demand and were faced with high costs that couldn't be recovered in the marketplace, particularly when growth slowed and the price of their product fell during the aftermath of the financial crisis. The shakeout that ensued saw a number of ethanol producers, including one the largest, VeraSun, enter bankruptcy with the intention of reorganizing, though most ended up in liquidation. With the exception of a few small facilities, the vast majority of the ethanol plants that were idled by these business failures were acquired and restarted by larger, better-capitalized entities such as refiner Valero. The buyers paid $0.30-.50 on the dollar for the assets, and most now have profitable ethanol businesses, after the legacy cost overhang was removed.

Unlike ethanol, however, the output of solar manufacturing is anything but a commodity. Solar cells, modules and panels are differentiated products and still quite costly, compared to conventional energy sources. Solyndra's cylindrical modules were very different from FirstSolar's thin film modules and SunPower's crystalline silicon modules. It's much harder to envision the assets of Solyndra, Evergreen and other failing solar manufacturers being snapped up by more successful competitors, for several reasons. First, technology differences likely make the idled facilities of little use in the manufacturing processes of the survivors. The location of the capacity is also an issue, because the winning solar suppliers have mainly adopted a strategy of shifting manufacturing to Asia, where costs are lower and supply chains possibly better integrated. So I doubt there's a Valero waiting to put these plants and their employees back to work quickly, nor do current economic conditions give much hope of these facilities being quickly repurposed for some other product. I would like to be proved wrong about that.

Because of the low likelihood of recovering more than a tiny fraction of its investment in these companies, it's crucial that the Department of Energy and its Congressional overseers immediately assess the lessons from Solyndra and ensure that the DOE's Loan Program Office doesn't sow the seeds of further expensive failures in its rush to issue additional loan guarantees before the appropriations for them expire at the end of the month. And just to clear up some confusion in the terminology, although the government's role in Solyndra is usually described as a loan guarantee, suggesting some future, contingent loss if Solyndra doesn't make good on its debts, the actual lender in this case was the US Treasury's Federal Financing Bank. There is nothing contingent about the losses that taxpayers face in this bankruptcy. Those losses will be even harder to stomach if the firm's nearly new factory and production lines aren't put to some good use.

A Geothermal Bankruptcy

I just caught up with last week's bankruptcy filing by Raser Technologies, Inc., a small developer of geothermal power plants. Burdened with excessive debt, Raser is filing for Chapter 11 protection to restructure its liabilities and continue operating under new ownership. In the process the current shareholders will see their much-diminished equity wiped out. This outcome is further evidence of just how challenging it is for small, poorly capitalized companies to exploit what is arguably the best, most reliable renewable energy technology in the world, other than hydropower.

Raser's bankruptcy hardly comes as a surprise. The company has been highly leveraged for a long time, and investors were losing patience with the firm. Last year its stock price fell below the minimum listing requirements of the New York Stock Exchange, and it moved to the over-the-counter market, effectively becoming a "penny stock." In the year prior to delisting, Raser had lost more than 80% of its market capitalization, or about $100 million. With only one operating asset generating cash--a 10 MW plant in Utah built with the help of a $33 million renewable energy grant from the US Treasury--and a number of projects under development consuming cash, Raser was losing the race to bootstrap its way into profitability.

Why is it so hard for start-ups to succeed in this space? It's not an accident that the world's largest geothermal operators are mainly big, well-capitalized firms like Chevron, Calpine, or the Green Power spinoff from Italian utility Enel. (Disclosure: I am a Chevron shareholder.) Geothermal developers face some fundamental challenges that require financial flexibility to manage. First is the capital cost of the assets, compared to other power generation technologies. The last figures I saw suggested that the cost of new geothermal capacity per installed megawatt was up to twice that of a wind farm and 4x that of a natural gas turbine. One reason the cost is so high is that it includes a lot more than the above-ground generating hardware.

Geothermal reservoirs must first be discovered, assessed, and drilled. That's why I've long thought that this technology is a natural for oil and gas companies, since it involves many of the same core skills. Geothermal exploration introduces not just additional cost, compared to wind power development, but also a daunting array of risks, including the possibility that the resource won't turn out to be as large as expected, or that its geology won't permit commercially attractive flow rates of steam and/or hot water. In the worst case, this results in the equivalent of a "dry hole", but even if it merely reduces the amount of power a given well can generate, that has a significant impact on project economics that depend on producing power predictably and reliably for decades. In effect, geothermal has all the up-front risks of oil and gas exploration without the quick payoff of a successful oil or gas well.

Geothermal power provides clean energy production for the power grid on a nearly 24/7 basis, something that neither wind nor solar power can match without energy storage capabilities that remain prohibitively expensive today, in most cases. However, it is both capital-intensive and risky to develop. The handful of publicly traded geothermal companies left after Raser's Chapter 11 filing, including firms such as Ormat Technologies and Magma Energy Corp., are doing yeoman work. However, it's hard to envision geothermal energy achieving its full potential without much greater participation from much larger, better-capitalized firms that could pursue such opportunities on a completely different scale.

Reliving Bankruptcy

As GM files for bankruptcy today, I can't help thinking about my own experience with corporate bankruptcy 22 years ago. The Chapter 11 filing of Texaco, Inc. in 1987 still ranks among the top five non-financial corporate bankruptcies in the US. After adjusting for inflation and the likely discount on GM's stated asset value they seem roughly comparable in scale. Although the causes were quite different--seeking relief from a crippling court judgment in one case, and the collapse of sales and cash flow on the other--the outcomes of Texaco's bankruptcy might provide some useful insights into what could lie ahead for GM.

This morning's Wall St. Journal included an example of the numerous recent articles speculating on the shape of a New GM that might emerge from bankruptcy this summer. Some of the elements are already evident: the sale of 65% of Opel and Vauxhall in Europe, along with the previously-announced decision to eliminate the Pontiac brand and sell or eliminate Saturn, Hummer and Saab. The new GM will be smaller and presumably leaner. That was true for Texaco, as well, which made a similar choice to sell mature assets in favor of retaining its growth platform in Asia-Pacific, in order to raise the cash to pay the $3 billion settlement with Pennzoil that allowed it to emerge from Chapter 11. So Texaco sold its German and Canadian operations, along with a 50% interest in its US refining and marketing business in the eastern half of the US. The latter formed the Star Enterprise joint venture with Saudi Aramco that later evolved into Motiva Enterprises LLC after a subsequent JV with Shell.

Even during bankruptcy, Texaco became leaner and nimbler. Corporate management was preoccupied with legal concerns, so local managers were empowered in ways that would never have been possible in the old, highly-centralized corporate culture. The company that ultimately emerged from Chapter 11 was lighter on its feet, more competitive, and less bureaucratic and paternalistic. It was also fatally flawed, in ways that took many years to manifest and that the architects of the future GM might do well to consider carefully.

The first problem was scale. Overnight, Texaco went from rough parity with its historical peers--other than Exxon, which was a giant, even then--to a sort of in-between status: much bigger than the second-tier integrated oil companies such as ARCO, Marathon, Conoco, and Phillips, but notably smaller than Shell, BP and Chevron, and consequently less able than these to participate in every market or new opportunity. The company struggled in this role for a dozen years, until the aftermath of the oil-price collapse of the late 1990s set up the industry consolidation in which Texaco was acquired by Chevron in 2001. The new GM might face a similar outcome. It will be much smaller than Toyota and possibly even smaller than Ford, and it must be nimble indeed to end up on the right side of the global car industry consolidation that many experts see coming. It would be truly ironic if GM, which in its first decade consolidated half the US car industry, survived Chapter 11 only to be gobbled up in a few years by a bigger fish.

Europe was a particular problem for Texaco, and it could be for GM, as well. Texaco hung onto its strong, integrated UK business, Texaco Ltd., along with marketing operations in the Benelux countries, Scandinavia and Spain, but the sale of Deutche Texaco put it at a permanent competitive disadvantage to the European majors and Exxon. It also left the company without an effective springboard into Eastern Europe once the Iron Curtain fell, and the shrinkage continued with a series of one-off asset sales. GM faces different challenges in Europe. Aside from the sheer size of the European market, it is the only place in the old GM's universe that already meets fuel economy restrictions as tough as the ones just imposed by the US administration. Although it will retain a 35% interest in Opel and Vauxhall, I anticipate that GM will struggle to extract technology and share model platforms with the alliance led by Magna International, which also supplies parts to GM's competitors. Ford and Nissan/Renault should have a clear edge in this regard.

I learned a lot about such alliances, when I led Texaco's alliance management group from 1994-97. Texaco's JVs in the US and Asia-Pacific enabled it to fight above its weight, giving it a much bigger footprint than it could have maintained alone. Our stake in Caltex allowed us to enjoy the financial gains from the rapid growth of Asian "tigers" S. Korea, Singapore and Thailand, along with near-tigers such as the Philippines. However, this came at the expense of quick decision making, cohesive brand management, and periodic turf wars and self-defeating instances of competing with ourselves. Even in a 50/50 relationship with another oil company, creating consensus wasn't easy. I can only imagine what this might be like dealing as a minority holder with a Russian bank and a car-parts maker, neither of which are likely to have much in the way of common interests to build on.

My sympathy goes out to the GM employees and managers today. The personal uncertainties of working for a company in Chapter 11 will be nerve-wracking, even if they've been anticipated for the last year or two. For their sake, I hope GM's ride through Chapter 11 proves smooth and quick--more like Chrysler's and less like the year that Texaco spent there. At the same time, as one of the 155 million new "shareholders" in GM, I would prefer that the company not put a higher priority on achieving a hasty exit from Chapter 11 than on ensuring the New GM can compete effectively in a global car industry and market for the long run. That means building reliable cars that consumers will be eager to own, and not just because they meet the new corporate average fuel economy and tailpipe greenhouse gas emissions standards.

Ethanol Bust

The world doesn't stop when you're on vacation, and I will be playing catch-up for some time, between the implications of the US election, a report from the International Energy Agency on chronic under-investment in new oil and gas capacity, and several other noteworthy developments. Although it doesn't quite rank with a new US president, the Chapter 11 filing by ethanol giant VeraSun seems like a good place to start, because it represents an important warning sign for a sector that was already badly strained by rapid expansion and weak margins, even before the financial crisis and accompanying precipitous drop in commodity prices put it on the ropes. The corn ethanol industry owes its existence to government policy, but policy alone can't shore up its inherent shortcomings, or give it the resilience to withstand the kind of shock that is currently propagating throughout the economy.

In many ways VeraSun exemplifies the US corn ethanol sector under the present system of federal renewable fuel mandates and price subsidies. In 2006 VeraSun operated two ethanol plants with combined capacity of 230 million gallons per year (MGY) of ethanol. After an aggressive program of new construction and its 2007 acquisition of US BioEnergy Corp., its capacity stands at 1,420 MGY from 16 plants, with another still under construction. That's 250% compound growth over two years. During the same interval, the price of corn spiked from $3 per bushel to $7 this summer, and then fell back below $4, while gasoline prices went from the low $2s to over $4 per gallon, recently returning to the mid-$2s. The combination of rapid growth and falling, volatile margins explains the company's current status.

Any number of companies have operated successfully during Chapter 11 and emerged to restored profitability. VeraSun has at least gotten off to a good start, lining up the financing that will be necessary to enable its facilities to continue buying feedstock and paying their bills. However, the larger question is whether the underlying factors that put VeraSun into bankruptcy will change sufficiently to allow them eventually to emerge, or if this measure can only keep them on life support until a better-capitalized firm can take over its assets. The prospects are decidedly mixed.

As long as the economy remains weak, fuel demand is unlikely to pick up, and so the price of the commodity for which ethanol is intended to substitute, gasoline, could remain around current levels. Pipeline gasoline from Gulf Coast refiners now sells for under $1.50/gal. Ethanol is currently over-supplied, relative to the mandated blending requirement, and unless a number of plants now under construction are delayed or halted, that situation could persist for several years. In addition, the blenders' credit is due to drop from $0.51/gal. to $0.45/gal. in January. None of this bodes well for the return of healthy "crush spreads", the margins ethanol plants earn from turning corn into fuel.

At the same time, ethanol remains a cornerstone of federal energy policy, and that role could expand in the new administration. During the campaign, Senator Obama spoke many times of the need to increase biofuel production, in order to reduce our reliance on imported oil. While much of that increase is intended to come from advanced technologies that turn non-food biomass into fuel, most of those processes are still either experimental or extremely expensive, relative to $60 oil. It remains to be seen how they can contribute the expected 21 billion gallons per year by 2022, or whether conventional ethanol will have to expand beyond its contemplated 15 billion gallon maximum to achieve the overall 36 billion gallon biofuels target.

So we have the paradox of a product that we've decided is essential for energy security and environmental reasons--as well as for the continued viability of the US agricultural sector--but that might not be profitable to produce in the desired quantities, at current prices. The government has already raised the possibility of federal assistance for ethanol producers that made bad bets on corn futures. If VeraSun were unable to continue operations during bankruptcy--and its is only the biggest of several recent ethanol bankruptcies--an ethanol shortage could develop, forcing the government to intervene. While it has the authority to issue waivers to oil refiners and gasoline blenders to sell fuel with less than the mandated quantity of ethanol, that was intended as a temporary measure. Perhaps I'm the only one to see a possible parallel to banks that are considered "too big to fail", or to the way the Federal Reserve has engaged in matchmaking to put failing banks into stronger hands, but I see the possibility of much larger ethanol subsidies ahead. At the very least, the combination of $60 oil and tight credit has called the architecture of the government's future renewable fuel policy into question.