16 March 2008

Carbon Trading, Bubble Hysteria

In the past, I thought that carbon trading of the style proposed by the Kyoto treaty could be a positive way to affect change, both from the point of view of climate change and peak oil. I have gradually come to change my mind, and I now favour a vanilla carbon tax with no loop holes. My decision was largely made watching the fallout from the dot-com bust, and now the US mortgage security shenanigan's.

Anything that Wall Street can game to enrich themselves, they will game. These crony capitalists with their derivatives and good-old-boys compensation schemes are really the enemy of free market entrepreneurship. If you bought $50 puts on Bear Sterns on Monday (10Mar2008), you gained a lot of money, but no wealth was crated.

I fail to see any advantage in giving Wall Street access to the carbon market.

A lot of people suspect that the recent run-up in commodities is largely due to money flowing out of mortgage securities and into commodities. I am not convinced of this, due to a number of factors.

Past pump and dumps in commodities — such as nickel — can work because you can store an entire years worth of the world's nickel production in a single large warehouse. On the other hand, a day's worth of oil production is roughly a cube 300 m on each side. It's very difficult to take oil out of the system unless you are a national oil company.

Furthermore, demand remains remarkably inelastic. Predictions of any tipping point where demand suddenly falls off at some price-point haven't panned out. When oil is consumed, it's really gone.

In addition, a huge hunk of the recent run-up in crude oil prices is simply due to the devaluation of the US dollar. The proof is in the US dollar index. So yes, the US is getting hosed on their oil consumption but the majority of the world's consumption is pretty well hedged against this rise.

China even subsidizes the cost of oil to their citizen-consumers. They have to do something with their dollar reserves. So even if we see a lot of demand destruction for petroleum from the USA it's not clear if that will really hammer the price of oil back down to $80 for a sustained period. The twin inflationary and deflationary pressures currently at war between the US Federal Reserve and Wall Street respectively make that an extremely difficult call to make.

I know one thing for sure. I will never hire someone with an MBA on their resume.

This brings up another question, namely is there potential for a bubble in investment in the so-called 'Cleantech' sector?

The world economy is in a slow transition from fossil fuels to alternative sources of energy, true or false? If you answer "true," then your only reasonable explanation for a bubble would be that the alternatives are growing at an unsustainable rate relative to the increase in the price of fossil fuels.

Unlike say, Pets.com or granite counter tops, a wind turbine or photovoltaic power has intrinsic value. They produce electricity, which is a very high-quality form of energy. I can calculate the net present value of a set of photovoltaic panels to a rather high degree of accuracy (~10 %), merely by noting the climate in which they are installed and their age.

The gap between the cost of doing work with oil as your energy source compared to electricity continues to enlarge. Consider, with electricity at $0.09/kWh, natural gas futures at $10.00/MMbtu, and oil at $111/bbl, the value of switching to electrons may pay back quickly. Note: these numbers are changing as fast as I can type this article.



Energy Cost


Energy to Work

Exergy Cost






Natural Gas




Crude Oil




At this point, electrifying train tracks or heating your home with a heat pump looks really good going forward (natural gas isn't nearly as fungible as oil). Look at it this way, there are 153 million employed people in the US, and they consume 19.6 million barrels of oil a day. That's $14.20/day or $5190 a year per (money earning) person at current prices. That's a lot of Starbucks.

There is a potentially enormous sum of money to be made in weaning North America, Japan, and Europe off the oil habit. It's not going to be easy since there is still a massive amount fossil fuels in the Earth's crust. The saving grace of the alternative energy industry is that its costs will go down with time whereas fossil fuel companies will have to extract poorer and poorer quality resources and hence become more expensive.

Of course, not everyone involved in cleantech will be idealists. A number of companies will be formed with the express aim of relieving investors of their capital. These fraudsters will primarily aim at people conceited enough to believe that they understand science, but lack the actual formal education to evaluate what they are seeing in numerical terms. I'm looking at the dot-com millionaires here. Beware the Rube Goldberg machine, or the company with salaries a much higher proportion of their expenses than equipment.

I will say, from personal experience, doing research in a corporate environment where every line of research has to have an immediate application and money for equipment is tight isn't very efficient compared to government funded labs. Now the bureaucracy, well...


Krassen Dimitrov said...

Robert, very nice rant. A few comments:

1. I think the 300m cube is actually twice the daily oil output... However, the more important point is that you don't need to store oil to drive prices up, it is already stored underground, you just pump less of it. There is no question that the world oil producers are not pumping all-out at this point. Whether it is to drive the price up, or just to hoard up reserves is pretty much a matter of semantics...

2. You should not dismiss all entrepreneurs and inventors of unworkable technologies as fraudsters. Sometimes they themselves are blind to the pitfalls of their invention and are the first victims of their own "scam".
Ultimately, if institutional money is being invested, it is up to the money managers to put them to work wisely. However, the way they do business is not very different from what you describe on Wall Street: absence of risk to manager leads to lack of responsibility on their part. If they fail, it is their LP's money that is lost (usually pension funds and college endowments), they still get their management fees.

3. I hate to stereotype, but you are probably right about hiring MBAs... I have hired not one but in my lifetime, and it easily turned out to be the biggest mistake I have ever made.

Keep up the good posts!

Robert McLeod said...


Thanks for the comments.

On 1., 84 million bbl/day, each bbl is 0.159 m^3, which works out to a cube 240 m on each side. So yeah, you're right.

The point I was trying to make however, is that only the nationals can really withdraw capacity from the market. A hedge fund simply doesn't have the infrastructure.

I'm not convinced anyone is actually withdrawing capacity from the market, a la the 1970s, however. Certainly there's a labour shortage in the oil industry, and that's slowing the development of new projects.

On 2., ok, let's call them "willfully blind." Scientists have families to feed too. I still maintain that you can learn a lot about an R&D company by looking at their books.

Krassen Dimitrov said...

Oh, I see now what you mean by speculation. What I meant to say was that the big players: nationals indeed, and pseudo-nationas (think Russia) are not eager to add capacity and are happy to hoard reserves and see prices go up.
Will there be a "dump"? You bet! Oil production costs are still a very small fraction of the price. Any sign of renewables starting to make a dent and you'll see capacity added in a hurry, to bring the prices down and to suppress the renewables. When production costs are in the single digit percentages, nobody would let a costlier competition steal market share. We are around the peak, for sure, however there will be fluctuations. We'll see $70 before we see $200.

Mark Lazen said...

...Which is why we need a tax policy that helps keep the price of oil high enough to reflect some degree of it's true high cost.

Robert--love your blog. Drop me a line at mark@socialmediatoday.com if you would. I'd like to talk about getting you to lend a feed to http://www.theenergycollective.com.


Anonymous said...

Good post. One quibble: the 35% efficiency factor for oil appears high, especially for the US, where the average vehicle gets about 21 MPG, equal to about 1.5 KWh per mile, vs an EV which might get .35 KWH per mile (for the current fleet's weight & size distribution).

That suggests about 20% efficiency to me.

Krassen Dimitrov said...

Nick, this is interesting... are those comparable size vehicles?

Anonymous said...


.25KWH/mile for a small sedan, .35 for standard, .45 for a light truck (SUV/pickup).

.35 for the current US fleet weight and size distribution.

35 KWH/gallon divided by 21 MPG gives about 1.67KWH/mile, so 21%.

Robert McLeod said...

I personally wouldn't consider drag losses, tire losses, transmission losses, etc. as a part of oil's efficiency. I simply was comparing the amount of work you get out of a given quanta of energy.

The appropriate comparison to make is a stationary diesel or gasoline generator.

Anonymous said...

"I personally wouldn't consider drag losses, tire losses, transmission losses, etc. as a part of oil's efficiency. "

That's why I compared electric vehicles to ICE vehicles: those losses are the same in both.

"I simply was comparing the amount of work you get out of a given quanta of energy."

So was I. The point is, small ICE's are very inefficient.

"The appropriate comparison to make is a stationary diesel or gasoline generator."

The correct comparison is the actual power production efficiency in vehicles. If you electrify vehicles you reduce BTU consumption by 80% compared to the actual US fleet in use today.

Cyril R said...

Valid points, Robert, but even you have to admit that carbon trading is better than doing nothing to price GhG emissions!

How about carbon trading AND a vanilla no loophole carbon tax on top of that? With carbon trading made more scarce over the years, and the carbon tax increased over time as well.

Lots of bureaucracy, but that comes with the menu.

Cyril R said...

I've been thinking about it some more, and have to agree that the carbon tax would be better overall. Feasibility is a different issue though.

Have you considered recycling the carbon tax revenue back into the economy via income tax rebates?

That way, the money gathered from the carbon tax could be mostly returned to those that suffer most from it, allowing them to buy more expensive but efficient stuff. While simultaneously improving macro economical equity and cost-effectiveness, and providing a favorable and stable, no-bubble&bust investment climate for alternative energy and efficiency in general.

The only disadvantage would be that carbon intensive industries could lose out a bit. But overall, a huge improvement in economic efficiency, mitigation of GhG emissions and peak oil, improvements in local and regional air quality and human health, and macro-economical equity. Perhaps a small tax reduction based on best-performance allocation could amend the burden for carbon intensive industries.