How to get energy breakthroughs which change the game

DOE has recently issued a "request for information" which basically asks:

"How could new research from our new agency, ARPA-E, have the maximum benefit to larger national goals,

including energy security, greenhouse gas reduction, and prosperity in general?"

This is an extremely important question, because -- as Secretary Chu recently told us -- new technology has the potential to change the game here far more than all the rest of what people are doing. Thus I worked pretty hard to condense and put together

all the best of what I know about the answer, relatively briefly. For a brief summary, and links

to the details (including the request itself), see:

http://www.werbos.com/E/breakthrough_energy_research.htm

I did want to list DOD as a potential partner to DOE and NSF in the specific new activities, but

certain colleagues (NOT AT NSF) asked me not to name any other agencies until and unless they express interest.

setting carbon price to avoid gross manipulation and risk

At 11AM last Friday, there was a public briefing at the Senate Visitors' Center with three speakers – Michelle Chan of Friends of Earth (FOE),

Tyson Slocum of Public Citizen (and an advisor of sorts to the Commodities Futures Trading Commission, CFTC), and Adam White of Wall Street (head of http://whiteknightfxi.com/system.html) . They addressed the same issues of market manipulation with allowances and offsets that the Energy Committee discussed, but arrived at different conclusions.

White said: under Waxman-Markey, allowances prices would be guaranteed to rise at least 5% in value every year, and would be bankable forever. Under those conditions, Wall Street is guaranteed to flood the market with far more money than the core emitters provide, and create incredible volatility. There is some analogy to oil – but it would be far better if price discovery for present allowance prices were not perturbed by Wall Street, and if Wall Street were limited to two functions: (1) providing finance for actual clean energy projects; (2) creating a futures market outside of the allowance market per se, regulated by CFTC, and largely restricted to trades over exchanges.

All three speakers called for narrow price collars, to prevent speculation, and avoid the situation in Europe where excessive volatility made it hard to get the needed real-world investments. Strictly speaking, narrow price collars could be adapted, perhaps by a formula which raises them when the US is behind its reduction targets, and lowers them when we are ahead.

All three said we should limit banking to a year or two, because the net effect of banking is to increase speculation and volatility. The speakers have all worked on regulatory issues surrounding world oil prices – but they say that even the best regulatory solutions for the price of oil as such are of limited power, and that we are better off simply avoiding volatility altogether in the price of allowances as such. They also recommended adding one critical word in Waxman Markey: instead of saying allowance trading is open to folks who are NOT covered entities, make it covered entities only.

They said that the acid rain cap-and-trade system did not include offsets and had no significant involvement by noncovered entities.

Chan repeated FOE’s position that offsets – at least international offsets – should be reduced as much as possible, or,

better, eliminated. Under the projects-based approach to offsets, a project is a PROMISE – a kind of derivative, with all the risks that trading in derivatives implies. Credit Suisse has already started to package POSSIBLE offset projects in a bundle,

before any approval, using the same risky procedures that were used with mortgages, leading to last year’s economic meltdown.

White cited a recent Goldman-Sachs analysis of Waxman which pointed to four really big winners:

(1) Exelon and Entergy, because of their heavy nuclear portfolio and the way the allowances are written;

(2) Chicago Mercantile Exchange (CME) and ICE international exchange… because of the large volume of speculative trading expected. But, he said, there would be three other big winners they chose not to report – Goldman Sachs itself, J.P. Morgan and Morgan Stanley, because those banks would run the unregulated over-the-counter trades where most of the money would change hands, and where their insider information would let them get a big edge.

Everyone agreed that Wall Street is like a “Houdini,” that could not be kept out in any case. Chan: if we can’t keep them from the party, we can at least make the party (allowance price setting as such) less attractive to manipulation and fraud,

by making it AS SIMPLE AS POSSIBLE with the minimum possible insider aspects. She praised the Cantwell bill.

White noted a lot of internal conflicts of interest getting in the way of a rational market (especially at the five big winners),

and noted that a lot of the people who used to work for Enron have moved to those companies, taking similar business plans, discussed in recent conferences he cited.

Slocum of Public Citizen said we really should never lose sight of the really important milestone which matters here –

setting a global price for carbon.

White then said that preventing manipulation and fraud for a truly global cap-and-trade system would be nearly impossible, as their recent experience with the world oil market has taught them. He would prefer a global price set by some other process. To reduce problems in the futures markets, he likes a bill by Wyden – not the energy storage bill, but another bill to cut out inappropriate tax breaks for trading in futures markets which provide perverse incentives amplifying speculation.

They also discussed examples of past manipulation and fraud in energy markets, who is investing where and why,

and what kind of people are being hired.

==================================

So far as I know, there is no nation of earth which is really including these issues/possibilities

in preparations for Copenhagen. I have asked many of the people who work on "border adjustments" for the US about putting in EXIT CRITERIA. They all say: "We just want to use judgment about what is or is no comparable."

I would say: "When you go to a store to offer to buy something, do you say 'Give it to me,

and I'll use my judgment what to pay'? The international carbon price is what matters here, and to get to the kind of treaty we need, any US law must be clear and straightforward

about a simple way to turn off these border adjustments (by treaty)." And then... there are crucial details, but not any conversations yet allowing discussion of them!

Could salmon at costco be the best hope for the coal industry?

Seriously.

As some form of carbon fee or price takes hold, many believe that carbon capture and sequestration

(which SOME think is the same as "clean coal") is the best hope to continue the coal industry,

and delay the shutdown of coal-fired powerplants which now provide half

of our electricity. But it basically does not compute. A mere $30 per ton carbon price is not nearly enough to pay for what is $60-$100 per ton in the real world. That's why the folks who really want to do CCS

want a complex system of "free allowances" (unlike the President, who has called for no free allowances),

in order to provide the kind of double-payment needed to fund that kind of technology.

But in the meantime... what might happen at a mere $20-30 per ton? It would be worth finding out,

before we too far overboard. We should be open to the possibility that a lot

may happen, even without those kinds of side payments to selected "winners."

Among the obvious new alternatives... are the technologies exemplified by two California companies, Calera and Aurora, who have come to the Senate several times to testify, with well-deserved blessings from Senator Boxer. (Calera has links to Stanford, and Aurora to Berkeley, but they are basically neighbors.)

Calera is relatively straightforward. They convert CO2 in flue gas to building materials, and expect they could

profitably dispose of about half the flue gas from coal plants in the US if carbon prices are in the range $20-30. Conservatively.

But Aurora is a bit trickier. They use algae to convert CO2 to hydrocarbons, which can be used as a barrel-for-barrel substitute for crude oil. There has been growing (legitimate) enthusiasm about algae for fuel,

not only for CO2 reduction but for energy security. But the fine points are important.

One fine point I did not know about... only about 35-40% of the CO2 gets into biocrude.

That's a fine point that got missed in the House Act; I thought the House Act gave fair (if grumbly) accounting to algae fuel, but apparently not. It seems that about 60% goes to...

fish food. High-protein stuff. It sounds as if this could be used to support a higher level of aquaculture,

such as the salmon fish farming which leads to relatively low salmon prices at Costco and other places.

And so... I just now checked page 581 of HR 2998, the House Act (just prior to the last minute additions).

It does offer people a choice -- either to cover ALL the CO2 input to the algae (which would be unfair I claim),

or to cover just the CO2 associated with combustion of the fuel produced from algae (which would be fair, and much much less). The point is that fish, unlike cars, are not mobile emitters of CO2 to the atmosphere.

In fact, if EPA were consistent... if it somehow charges "land use penalties" for biofuel production "which encourages people to grow more corn and emit more CO2 in other nations," perhaps it should

offer land-use payments to these fish farmers, who reduce fish sequestration in other nations.

But realistically, maybe all these land use leakage measures should be politely dropped at this time.

Another interesting aspect is that Aurora is using open ponds, unlike some of their competitors,

who use bioreactors. In effect, they are inputting solar energy through the back door, to enhance the fuel.

That's basically a good thing... but it tends to push them towards sunny climates, like Florida, not

cloudy areas where it's more expensive. HOWEVER, that implies a kind of natural complementarity

between Aurora and Calera; Calera could fill in in regions where Aurora is less viable. The bioreactors

may or may not be less far along... but we should be prepared to see more from them as times goes on,

if a decent level of R&D is carried out.

Of course, there are a lot of potential benefits to such technologies all over the world.

China, for example, could use a new low-cost supply of building materials and of protein food.

But I doubt that the Asia-Pacific Partnership will be stressing this kind of technology,

or that these companies would accept the very limited guarantees that companies like

GE have accepted in APPA.

=============

After this posting, someone said that salmon form fish farms has unacceptable levels of PCB.

"Stop buying that stuff from Costco or you will be poisoned." I wonder what Costco would say about that. I don't plan to change... yet. BUt I may ask. HOWEVER: where would PCBs come from? From impure fish food? (I doubt they have old leaky transformers in fishponds.)

If so, this new organic fish food might solve the problem...

preventing Enron disaster in new carbon markets

Many serious people worry that the new carbon markets that would

be created by the Waxman-Markey Act would lead to trading disasters like what caused

last year's economic collapse. The Senate Energy Committee held a hearing on this recently,

but last Friday (September 18) there was a public briefing at the Senate which got a bit deeper into the risk, and what we could do to prevent it. Here is my personal view of what I heard and what it means:

=================================================================

At 11AM today, there was a public briefing at the Senate Visitors' Center with three speakers – Michelle Chan of Friends of Earth (FOE),

Tyson Slocum of Public Citizen (and an advisor of sorts to the Commodities Futures Trading Commission, CFTC), and Adam White of Wall Street (head of http://whiteknightfxi.com/system.html) . They addressed the same issues of market manipulation with allowances and offsets that the Energy Committee discussed, but arrived at different conclusions.

White said: under Waxman-Markey, allowances prices would be guaranteed to rise at least 5% in value every year, and would be bankable forever. Under those conditions, Wall Street is guaranteed to flood the market with far more money than the core emitters provide, and create incredible volatility. There is some analogy to oil – but it would be far better if price discovery for present allowance prices were not perturbed by Wall Street, and if Wall Street were limited to two functions: (1) providing finance for actual clean energy projects; (2) creating a futures market outside of the allowance market per se, regulated by CFTC, and largely restricted to trades over exchanges.

All three speakers called for narrow price collars, to prevent speculation, and avoid the situation in Europe where excessive volatility made it hard to get the needed real-world investments. Strictly speaking, narrow price collars could be adapted, perhaps by a formula which raises them when the US is behind its reduction targets, and lowers them when we are ahead.

All three said we should limit banking to a year or two, because the net effect of banking is to increase speculation and volatility. The speakers have all worked on regulatory issues surrounding world oil prices – but they say that even the best regulatory solutions for the price of oil as such are of limited power, and that we are better off simply avoiding volatility altogether in the price of allowances as such. They also recommended adding one critical word in Waxman Markey: instead of saying allowance trading is open to folks who are NOT covered entities, make it covered entities only.

They said that the acid rain cap-and-trade system did not include offsets and was not open to noncovered entities.

Chan repeated FOE’s position that offsets – at least international offsets – should be reduced as much as possible, or,

better, eliminated. Under the projects-based approach to offsets, a project is a PROMISE – a kind of derivative, with all the risks that trading in derivatives implies. Credit Suisse has already started to package POSSIBLE offset projects in a bundle,

before any approval, using the same risky procedures that were used with mortgages, leading to last year’s economic meltdown.

White cited a recent Goldman-Sachs analysis of Waxman which pointed to four really big winners:

(1) Exelon and Entergy, because of their heavy nuclear portfolio and the way the allowances are written;

(2) Chicago Mercantile Exchange (CME) and ICE international exchange… because of the large volume of speculative trading expected. But, he said, there would be three other big winners they chose not to report – Goldman Sachs itself, J.P. Morgan and Morgan Stanley, because those banks would run the unregulated over-the-counter trades where most of the money would change hands, and where their insider information would let them get a big edge.

Everyone agreed that Wall Street is like a “Houdini,” that could not be kept out in any case. Chan: if we can’t keep them from the party, we can at least make the party (allowance price setting as such) less attractive to manipulation and fraud,

by making it AS SIMPLE AS POSSIBLE with the minimum possible insider aspects. She praised the Cantwell bill.

White noted a lot of internal conflicts of interest getting in the way of a rational market (especially at the five big winners),

and noted that a lot of the people who used to work for Enron have moved to those companies, taking similar business plans, discussed in recent conferences he cited.

Slocum of Public Citizen said we really should never lose sight of the really important milestone which matters here –

setting a global price for carbon.

White then said that preventing manipulation and fraud for a truly global cap-and-trade system would be nearly impossible, as their recent experience with the world oil market has taught them. He would prefer a global price set by some other process. To reduce problems in the futures markets, he likes a bill by Wyden – not the energy storage bill, but another bill to cut out inappropriate tax breaks for trading in futures markets which provide perverse incentives amplifying speculation.

They also discussed examples of past manipulation and fraud in energy markets, who is investing where and why,

and what kind of people are being hired.

==================================

So far as I know, there is no nation of earth which is really including these issues/possibilities

in preparations for Copenhagen. I have asked many of the people who work on "border adjustments" for the US about putting in EXIT CRITERIA. They all say: "We just want to use judgment about what is or is no comparable."

I would say: "When you go to a store to offer to buy something, do you say 'Give it to me,

and I'll use my judgment what to pay'? The international carbon price is what matters here, and to get to the kind of treaty we need, any US law must be clear and straightforward

about a simple way to turn off these border adjustments." And then... there are crucial details, but not any conversations yet allowing discussion of them!

Could China participate in strong global carbon treaty

There was news today about a US-China trade dispute about tires, which led someone to

ask what this shows about China's ability to join or live up to any CO2-control treaty with real substance to it. My reply:

The tire case was actually discussed the day before the Administration decision in the Financial Times (FT).

FT argued very strongly that taking action as provided for in existing... treaties... would actually be a pro-trade

constructive action. Certainly there have been "retaliation" actions in trade which have been steps towards

reduced global trade and cooperation. But the FT argued that this was the opposite kind of case, where

simply not doing anything would itself be an anti-trade act. I have no idea whether the Administration decision

was influenced by that kind of input, but it might have been.

China's ability and willingness to be part of the WTO treaty is a crucial part of why I think it would be feasible for

China -- IF IT CHOSE TO -- to be part of global treaty to impose a user fee on carbon emissions. That by itself is enough to establish the fact... but there are a lot of important stories connected to this.

One peculiar part of the situation here is that a lot of the discussions between China and the US have been discussions between people (on the US side) who want to solve the global CO2 problem by agreeing to a set of hard quotas for

each nation's CO2 emissions, with people from the old international/military/party-heavy wing of China who still

feel more comfortable thinking in terms of quotas for all economic activity. (In a way, it reminds me of stories about how

Russia used to hammer out its five-year plans and quotas for what each factory will produce.) But the overall leadership

of China and India has been extremely clear that it will not sign off on such a system binding on China.

Curiously -- last time I was in China the press was full of news about gthier new internal measures, which sounded a bit like replacing cap-and-trade with cap-and-guillotine: each local leader had to arrange a 20% cut in CO2 in his district by X year, OR ELSE. Some say that China really is imposing hard quotas on CO2, but will not be bound by them on an aggregate level for .. odd... reasons. On the other hand, China's national analysis reports more realistically that it will be hard for them to reconcile their present rate of economic expansion and the technology they know with any reduction at all, except in transportation.

There is a real irony here. Years ago, when President George Bush I set up our first cap-and-trade system (for acid rain), he put it forward as an ALTERNATIVE to the command and control quotas for serparate states or companies which had been used in the past. He invoked the principle from basic economics that efficiency demands a single PRICE,

and the separate quotas for separate players tends to be grossly inefficient. The people in power pushing a cap-and-trade bill for the US repeat that lesson learned (the great success of acid rain cap-and-trade) over and over again...

YET AT THE INTERNATIONAL LEVEL they are basing all their planning on separate quotas, or on

the hope of creating a system of mutual moral suasion without a common legal framework for most of the emissions.

Last night I had dinner with a Chinese (nongovernment) guy, and we got into some of the realities here.

A sort-of-true story: a few weeks ago, the diplomats arranged a great visit between leading Chinese and US Senators, aimed at creating the kind of mutual communication and understanding that could lead to a treaty...

But when they arrived, the Chinese met the Republicans, and discovered that they had a lot in common, including their total disdain of cap-and-trade. Certain Republican Senators were downright gleeful about what they had learned from their new friends, vindicating their position and providing new ways to express it.

In particular, at an EPW hearing a few weeks back, Senator Voinovich said he agreed with the position that the way we really solve this CO2 problem is by injecting new technology, not new laws and regulations. Thus he introduced a new bill,

essentially a Republican-Chinese alternative to cap-and-trade, which would expand the Asia-Pacific Partnership (APPA) in a number of ways.

In discussing this with my friend... I pointed out that this bill, sadly, will not do the kinds of things China would want,

not for technology, nor for energy security, nor for CO2 reduction. The problem is that this vehicle has tended to become a kind of "high level stakeholders" promotion activity. Some APPA activists have said "There is no Intellectual Property issue

in the US-China technology exchange... all of our participants are quite happy...." But in my experience, every one

of the new companies with emerging breakthrough technologies to really change the game here is concerned to some serious degree about the IP issues; many feel they need to become more established first in the US or Europe

before it would be safe for them to work with China. In many cases, unfortunately, that could imply a delay of decades.

Ironically... a simple carbon price of $20 per ton in China might be the most effective international

kind of thing China might do (in parallel with its usual investment incentives) to get at least a few of these companies

to change their minds. Joint US-China research programs (open to other nations as well) in the "ARPA-E" space

could also do a lot of what they really want. And then somehow streamlining the physical paperwork needed

for people to actually travel between the US and China in such activities. At least, that's what camwe to the top of my mind last night...

In the end... trying to reduce CO2 either by binding national quotas or by mutual moral suasion is

is an ineffective stragegy (as a way to try to reduce CO2) for many reasons. One is the Prisoner's Dilemma effect.

Another is that natural fear of all players (especially competitive manufacturing groups) in an ill-defined

ambigious situation that they will not be treated fairly, and will suffer in competition with others, in

part because of fear of backroom deals. (This is not unrealistic. Looking at what came out in the Waxman Act,

where some get paid two or three times and others get exempted... ) The beauty of a common

global carbon price is that it puts those fears of unfairness to rest... SO LONG AS the nations

are capable of living within WTO oversight to be sure the treaty is being followed. China can do that.

In a fair environment, there is no doubt that China can continue its economic growth.

But will it happen? That I do not know.

I have to admit that I share a lot of the pessimism about the present trends on climate change negotiations and legislation.

But I keep reminding myself of a few basic points --

1. Almost everything really important I know of went through a long stage (multiple stages really) of seeming

impossible, usually for a lot more than one year (though determination to move with all deliberate haste towards the real target was crfucial to eventual success).

2. Success WITH A RATIONAL TREATY really would be very important for multiple reasons:

a. Until we get this "off our chests" to some degree, it will be hard to get as much attention as we need

for more urgent life-or-death energy issues still on the shelf. (Though of course we should not wait for climate.)

b. Even in the middle-of-the-road case, it is rational to take at least moderate action here. More precisely --

if we neglect the "almost no impact case" (which IPCC rightly assesses as having a 5% probbaility or less, based on what we now know) and the "sixty feet sea level catastrophe, due to Antarctic melting" (which seems to have 5-20% probability)... I tend to agree with Michael Canes (no left winger!) and with Tol (whom he cites) that an extra ton

of CO2 emission would cause about $30 worth of damage, in the middle case. Market economics says that

we will make better, more efficient decisions if "polluters" (emitters?) who "impose a burden on the global commons"

are required to pay a user fee equal to the amount of damage they cause -- which would be $30 per ton. But because

our planet is not entirely ready to adapt well to that high of a price as yet, I believe it would be better at $12 or $20, at least for now.

IN PARTICULAR -- at $20 per ton, some exciting things can start to happen. For example, I know of one very credible new company, Calera, firmly rooted in the private sector (unlike certain companies dedicated to extracting public money),

which estimates that $20 per ton would be enough to let it profitable convert half the coal plant flue gas in the US to useful

"aggregate" material. This is a rough estimate... but we know it would be a huge and visible change in the game.

By the way, this would be even more useful in China, where the need for new building material is greater.

But there are greedy people who want more than $20 per ton, instantly, and who want various kinds

of double-dipping just for them. I get more and more worried about whether we can get past the forces of greed, who are trying to control the entire conversation (or rather prevent a real conversation) -- and are willing to risk

screwing up the whole thing for the sake of their hope of a gigantic Christmas Tree with money for their personal friends. In my view, that is the main story on free allowances and on offsets. (Caveat: the folks who want stronger domestic offsets,

based on the flows of carbon sequestered PER YEAR in farms and forests, to be managed by the USDA, using procedures which BYPASS the silly concept of "additionality," are offering a substantial well-justified improvement

in the legislation. In effect -- people who put a burden on the global comons should pay, while those who reduce that burden snhould be paid in equal measure; THEIR annual contributions should also be assessed as accurately as possible.)

The issue of "border adjustments" (which may include free allowances to folks worried about foreign competition) has become a major probable show-stopper. (In my view, there are three show-stoppers which absolutely need to be overcome

in order to have hope here -- fixing the free allowances, fixing the offsets, and fixing the system of border adjustments.)

The other day I heard that large parts of the public would be happy with a carbon control law... IF other nations

also were subject to the same thing. The issue of other nations has become really central and decisive. If it's not handled right -- no law, no treaty. And it's not being handled right. There MUST be border adjustments for now -- BUT WHEN DO THEY GO AWAY?

Apparently, when the Waxman bill was being written, some folks thought it would be wise not to give clear, simple objective criteria about what other nations have to do to avoid being hit by border restrictions. Why not wait and use holistic judgment? Sounds good. It's great if you are the ruler of the universe and want to preserve your rulership.

BUT... if we wanted any kind of strong global carbon control treaty (without which most believe a US law would

be pointless)... we need a clear, simple signal on how to turn off these things. In fact, even a treaty must deal with the issue of how to handle those outside of the treaty. It's really important to understand that there is a kind of equivalence here. We need to bite that bullet, and purge the blockages which keep us from facing up to the question.

And so... if we do not have clear conditions spelled out, reasonable minimum conditions for a global carbon control treaty,

that would automatically turn off all the border adjustments (including free allowances for trade-impacted industries),

a strong treaty will be harder to get. (Caveat: I would consider even a $12 per ton global carbon fee a strong treaty,

though it would be unrealistic to ask US trade-impacted energy-intensive industries to pay more than the global fee.)

If a strong treaty remains visibly unlikely... and strong border adjustments are enshrined without a clear sunset provision...

the US law itself become far less likely. Of course, the State Departmlent will say they are following the Bali path..

and they are working harmoniously with all the other happy well-fed diplomats of the world to get us eventually

to a beuatiful well-written enobling treaty which provides --

1. China and India and most others will happily do whatever they were going to do anyway

2. The US is firmly internationally bound to do much more

3. We all get to praise each other's existing efforts

4. In return for the right to praise what others are already doing, we pay them many billions

of additional dollars every year

Actually, it's a little worse than that -- but 67 votes from the Senate for that? If that's the best plan in operation right now,

and if a US law is nonproductive without new international action... we could improve the odds

of eventual success both with law and with treaty a WHOLE LOT by struggling to get out of the box.

But will the forces in play now tolerate such an effort?

By the way, I have heard Republicans recently say the new law really ought to be a lot more clear about turning off the possibility of ad hoc additional EPAS regulation of greenhouse gasses as such. I don't see why not -- but I have no

idea whether anyone else even notices.

In the end.... I wouldn't want to be too technical here... but I think that the faulty

strategies here are based in part on a lack of understanding of game theory. The present approach to CO2 negotiations

internationally basically creates a kind of prisoner's dilemma or tragedy of the commons effect.

A common global carbon price (at least for treaty ratifiers which should cover at least 80% of the emissions)

would break that prisoner's dilemma problem. One could write a well-deserved book on this effect, using this case study. But not this morning.

Best of luck,

Paul

P.S. As always, just my own views, not representing anyone else.