Energy an Overview PDF

In 2007, world consumption in energy was equivalent to 90 billions of barrels of oil or expressed in electrical output, about 55,000 terawatt hours (1 terawatt is 1000 gigawatts, 1 gigawatt is 1000 megawatts, 1 megawatt is 1000 kilowatts). This is the equivalent of the yearly output of 30,000 normal-sized power plants (600 MW).

80% of world energy is created by fossil fuels: 32% by oil, 21% by gas, and 26% by coal. Hydroelectric and nuclear energy contribute a bit more than 5% each and the burning of biomass (mainly firewood) about 9% (0.46% of which biofuels), leaving 1.9% (2008 figure) from renewable energies such as solar, wind, marine and geothermal sources.

Roughly one-third of the 90 billion barrels of oil equivalent in primary energy consumption is in electricity, of which two thirds is generated by burning fossil fuels. Coal accounts for 42% of world electricity production. Nuclear energy and hydro energy account for roughly 15% each. Biomass accounts for 1.1% and renewable energy sources for 1.3% of world electricity production.

These numbers show that despite the efforts of many major governments since Kyoto 1997, the contribution of renewable energy sources to our energy supply is still negligible.

Many point to a lack of commitment, coordination and political will as the reason for this paltry progress. In energy, as much as elsewhere, decisions are habitually driven by vested interests, frequently based on incomplete or “tailored” information and all too often not in the best interest of the propagated goals.

However, the reasons why so-called renewable energy sources will hardly make a serious dent into carbon emissions for at least another 30 years are not political; there are large technological and economic hurdles.

Any assumptions of us slowing down our total consumption can safely be discarded. The energy needs of an awakening emerging world are a force much stronger than any potential reduction of emissions attempted by all energy saving programs combined. China alone is building 50 to 60 Gigawatts electricity generating power a year, 70% of it with coal. This is the entire production of a large country such as the United Kingdom.

At the same time, all renewable resources have important drawbacks. Hydro and geothermal are not expandable to significant degree.

Solar is technologically not ready and has enormous negative capital and energy balances, i.e. solar still consumes enormous resources to create. The expansion of polysilicon, its main supply has large lead-times, technological hurdles and high capital intensity.

Wind is commercially viable onshore, but the costs and landmass involved to make this a serious alternative are enormous. Additionally, wind – like solar and other renewables – cannot be used as a base-load provider. They suffer from intermittency, and therefore cannot guarantee a stable supply.

If, and admittedly that is quite a big if, the predictions and assumptions of Al Gore turn out to be true, the only real way to deal with carbon emissions is to focus on cleaning up fossil fuel energy, primarily Coal. There are solutions, they are not cheap, but they are ready, tested and in operation.

In addition, coalbed methane may be developed into a sizeable gas provider. The use of gas substituting for coal or oil reduces emissions significantly.

With respect to renewable energy, it looks as if wind-power could become significant fairly quickly (within 20 years) and deliver up to 5% of global primary energy as an auxiliary source. It is, however, important to note that the cost of creating this capacity would in current dollars and technology amount to approximately $500 billion.

Rik And Uncertainty (PDF)

Paul McCulley of Pimco very eloquently describes the mechanics (and contradictions) of the ongoing government orchestrated asset bubble from the Bond market’s perspective.

He also muses about the future of finance, declaring the efficient market hypothesis all but dead and describes the dawn of behavioral finance. Bond guys continue to be, so it seems, much more attuned to the risks we run in our system.

One big unanswered question remains: how do we best frame our financial system to most efficiently handle risk and uncertainty to optimize the stability of our capitalistic financial system?

Correctly, finally, the efficient market theory seems to become recognized as the poison it is. Toxic it is especially in the hands of universal financial superstores who, with the help of this dubious theory have crowded out an atomistic and entrepreneurial institutional landscape. Much of finance needs to be much nimbler, quick footed and the incentive of ownership to handle the all-important but somewhat elusive influence of uncertainty. Of course adequate and independent regulative oversight is important but that is an issue for another time.

Equally, and as repeatedly impressed upon us throughout history, the ability to “handle” uncertainty is strongly correlated with leverage. The higher the leverage, the more volatility and destructive reflexive potential is allowed to grow in the system. This is quite the opposite of what is being portrayed by the risk models inherent the efficient market theory. As Paul McCulley explains, this seeming paradox can be observed live in today’s bond and equity markets. Additional liquidity reduces volatility and the perception of risk in the system. Risk can be handled by government to behave as it likes it to (at least for a while and sometimes for a long while).

On this count both the Fed and our large commercial banks (and not so much the non-bank financials who are in governments’ cross-hairs) are responsible for building up unprecedented leverage in the system. Thereby they increased risks, those real and more long-term risks, and directly reduced the ability of the financial system to deal with the system’s inherent uncertainty.

Now, in 2009, governments around the world (led by the Fed) have decided that there is only one way out of it: push on, accelerate, “guns” blazing, i.e. pumping liquidity (leverage) even if it means putting the entire financial system and governments’ financial position at risk. Even when it means that the systemic maltreatment of risk is allowed to continue; even when it means to contradict the steady advice of history. The path taken is not to re-establish markets’ proper functioning but to broaden its unholy suspension.

Unfortunately, this irresponsible policy is not simply a domestic US problem. Global monetary policy is under the leadership of the Fed and a certain Ben Bernanke. Despite grave doubts and resistance, in particular from mainland Europe, there is not much they can do in the current system where the dollar is the reserve currency and most everyone has built a US export dependency. Willingly or not, they all are compelled to follow Big Ben’s lead, a man whose academic rigor and credentials as a central banker are more than just questionable. (Fred Sheehan, Marc Faber on Ben Bernanke. I am not sure whether this global liquidity experiment will be to the advantage of the more timid participants such as Europe; they may end up with the short end of the stick.

One thing is sure; we are not dealing with the origins and root causes of this crisis. Instead we are moving farther and farther away from being able to handle the risks and uncertainties in our system.

Buckle up!

Copenhagen 2009 PDF

In December 2009 Copenhagen will host the Climate Change Conference in what is hoped by many to be the single most important environmental event since Kyoto back in 1997.

Media and politics is dominated by a great deal of half-truths and erroneous beliefs about our global energy economy and its impact on our environment. Above all, the impact on our much revered GDP growth is generally being exaggerated. This is particularly apparent when held against the fall-out created by the irresponsible handling of other issues and industries such as the current hot beds, finance and health. A well-informed, well-coordinated plan to clean up our planet and invest in future energy generation has the potential to create millions of jobs globally and to substantially improve our quality of life.

Whether or not global warming is caused by carbon emissions, the fact is we are polluting our planet. Today’s global energy policies are ill coordinated and mostly ill conceived. An economic analysis of the energy industry—reveals some shocking shortfalls and surprising conclusions. In a series of short articles I will try to provide a basic background to facilitate a more informed discussion on the subject.

Although certain alternative energies hold great hopes for the future, most are unlikely to become a valid alternative to fossil fuels for the foreseeable future. As a group, excluding hydropower, they account for no more than 1.3% of current energy production, and it is unlikely they’ll reach the 5% mark by 2030. An acceleration beyond that point should not be ruled out, but a number of technological and economic constraints are inherent in all currently available alternative energies.

The alternative economy can under no feasible circumstances make a serious dent into fossil-fuel energy production in the next 30 years, nor can nuclear or hydro power. They will remain an alternative for a long, long time, for reasons as various as physical availability, supply channel complexities, technological constraints, intermittency, high capital costs, and high inherent energy intensity.

If we are truly serious about cleaning up our planet decisively and immediately, the only feasible short-term solution I can see is to reduce the polluting qualities of fossil fuels, coal in particular. The cleaning of coal (carbon capture and storage, or CCS) as well as an accelerated extraction of coal-bed methane have a potentially much larger impact on carbon emissions than any renewable energy resource (including wind) over the next few decades.

Coal accounts for one quarter of total global energy consumption and over 40% of electricity production. It is our largest polluter and, according to Westhall Capital, emits 30% more pollutants than oil and almost double the pollutants of gas. Roughly, coal is responsible for 40% of global emissions of carbons and other pollutants. Any realistic and serious attempt to engineer a significant reduction in carbon emissions in the next 30 years will have to include carbon capture and storage (CCS).

Total installed coal capacity on the planet equals approximately 2,500 GW (gigawatts). According to the most recent calculations, retrofitting half of all coal plants on earth, approximately 1250 GW capacity, would cost us somewhere between $1 trillion to $1.5 trillion, plus an additional yearly expenditure of $100 billion to fit each new plant. Within 10 years the world could reduce carbon emissions by 20% for a total cost of about 3% of global GDP and in future build clean coal plants for an annual (additional) cost of no more than 0.2% of global GDP. Both CCS as well as coal-bed methane have reached technological maturity. Coal-bed methane has the added benefit of shifting our energy balance away from oil and away from our most unstable sources of supply. The U.S. holds an estimated 29% of global coal reserves; Russia, China, India, Australia, and South Africa together account for 50%.

For all our great achievements, we have yet to summon the political will to admit and react to the fact that we are abusing the resources of our planet because the market doesn’t force us to pay for some of them. We refuse to reverse a historic tax break for fear of slowing down our GDP growth. So far the scale of political commitment to reduce polluting emissions of energy production has been extremely small: CYKE, an independent research outfit, estimates alternative energy subsidies amount to between $50billion and $100billionn per annum globally (0.1% – 0.2% of global GDP); the market for carbon trading is worth about $120billionn per annum; and carbon taxes, with a few exceptions such as France, don’t really exist yet.

Is it not time to finally and in earnest start to internalize the external costs of our energy production? It will cost the GDP economy, but it will benefit the GQP (gross quality product) economy.

In all of it, it is crucial for the USA to understand that the world needs it to reclaim its leadership role in energy. Who else but the largest, richest, strongest, and most-polluting economy can stand up and change the game, and then elevate it to the next level? A committed participation is likely to bring in other important polluters such as China and India. Energy policy must finally receive the top priority it deserves.

Strategically, we must come together as a global community and step beyond the special interests that dominate local politics. We must better coordinate our investment in the future energy economy and agree on a system (cap and trade and/or taxes) that puts a price on the resources we are squandering today.

Tactically, to reduce carbon emissions in the short-run the only realistic choice we have is to clean coal.

Mother of all Asset Bubbles (PDF)

On November 1, Nouriel Roubini published a must read article in the Financial times titled “The Mother of all Carry Trades”.

He describes excellently what is going on in the markets and how another globally synchronized asset bubble is created by the reckless policies of the US Fed. Roubini Mother of all Carry Trades PDF, Link.

In short, Mr. Roubini explains how the financial markets have figured out a way to orchestrate an asset boom that is even more divorced from the real economy than the prior bubbles. The Fed has held interest rates near zero since Dec 2008 and has stated on Nov 4, 2009 that it will only consider raising rates if it sees a pick-up in “inflation” (which to Fed is the core CPI) or “resource utilization” (presumably employment). It also pursues quantitative easing via asset purchases that expanded its balance sheet from $800 billion in 2008 to now $2’000 billion.

In essence the Fed has created a situation where one can borrow at hugely negative interest rates (zero nominal rates coupled with a dollar depreciation) in the comfort of contracting risk premia (contracting “risks” are a happy byproduct of liquidity pushes in the world of modern finance, irrespective of and detached from real risks). The Fed is thus successfully stemming a deflation of assets with a supercharged version of its policies that created the credit mountain and asset bubble pre 2007.

Many will think to themselves that this is folly, wrong, even reckless, on so many fronts but what is the alternative? All alternatives are painful. It is very naïve, even irresponsible to assume that current policies wont be painful merely because our leaders’ horizon doesn’t extend beyond their next election cycle.

The Fed, Wallstreet and political authorities continue to hope that eventually their liquidity pushing will result in renewed economic growth. But what evidence is there that their policies are working or have ever worked?

Since 1999, in the greatest expansion of credit in human history, total credit in the US economy alone more than doubled in size from $25 trillion to now more than $55 trillion. This is close to 4 times US GDP and in relative terms 2.5 times more than prior the Great Depression.

This huge expansion in liquidity was not recognized as hyper-inflationary, as the choice of measure for inflation was and continues to be the core CPI, which for the time being continues to be only marginally affected by the liquidity generated. It was primarily asset markets such as stocks and properties that expanded at breakneck speed, despite visible deterioration of economic strength.

In the credit mania up to 2007 the American consumer still participated, somewhat. But he is done, no more expansion for him. Although his real income had hardly expanded throughout the past decades, rising property and stock prices allowed him to expand his demand by increasing debt and push consumption relative to GDP to a record 73% (USA). That compares with global averages in the low 60ies.  However, as we can guess, the great leveraged boom was almost completely void of real economic substance.

In the period from 1999 to 2007, to create one dollar of real economic growth, more than seven dollars of credit was needed. Compare that to approximately 1.5 dollars of credit needed for every dollar of real growth generated back in the 1960ies.

John Mauldin shows that without mortgage equity withdrawals, the average annual growth in the US economy from 1999 to 2007 would have averaged a measly 0.5%.

Today, two years into the crisis, the Fed and politician are still trying to convince themselves that if they only push more and more credit, no matter in what form or shape, the economy will revive eventually. After 10 years of reckless monetary expansion, they simply up the ante, creating conditions for the mother of all asset bubbles without regard to history and foolishly convince themselves to know how to land this supernova of credit softly in the arms of the next economic expansion.

Is there any doubt that the US consumer has to reduce spending and leverage in the coming years and adjust his demand to levels in line with real income pattern? This will be doubled down by huge demographic effects that are starting to kick in just about now.

Is there any doubt about the real economic impact of these inevitabilities?

The American economy has been weakening to near exhaustion with ever larger liquidity infusions necessary to keep it alive. Last quarter’s positive real GDP growth of 3.5% is not the sign of recovery that is happily cheered on by a Fed and a market hell-bent to ignore the quite obvious internal weakness of this figure which is driven by an inventory cycle and silly fiscal schemes such as the “cash for clunkers” program which merely borrowed a little more consumption from the future.

Crucially, however, personal expenditures and income figures remain weak, as is employment. Investment continues to decrease as is lending, accelerating its contraction from 3.9% yoy in September to 6.8% in October. Who would expect rising  investments when capacity utilization is at record low levels? Equally weak were the internals of an overall positive, but largely meaningless ISM report.

Banks, commercial banks that is, are tuned into the economic realities and they have been forced to adjust their assessment of risks and outlooks for cash flow generation. History teaches us that they will only start to lend again when they can see the cash flows well on track to recovery. As the consumer has to scale back there is no reason to expect these cash flows to come even close to the levels of the height of the boom.

But if lending is not possible or profitable in the real economy banks, that is their “hedge fund” like divisions simple leverage themselves up in a hugely profitable carry trade and pay themselves handsome bonuses, completely ignorant (or defiant) of the risks they accumulate yet again. After all, they can safely assume that in the next crisis we, the government will be there to pick up the pieces yet again.

It is very clear where Ben Bernanke, the head and brains behind this operation is leading the US and the world economy. For him, debt doesn’t matter, even if it is deployed completely divorced from any economic reality whatsoever. As long as asset prices measured in dollars are keeping up all is well for him and those who derive their income from turning those assets for a fee.

Mark Faber, one of those countless marginalized professionals who have been right every step of the way puts it as follows, “Personally, I think the future will be a total disaster….massive government debt defaults, and the impoverishment of large segments of Western society. But what I don’t know is whether this final collapse, which is inevitable, will occur tomorrow, or in five or ten years, and whether it will occur with the Dow at 100,000 and gold at US$50,000 per ounce or even confiscated, or with the Dow at 3000 and gold at US$ 1000.”

Reforming Banks II, United Kingdom

UK authorities have announced that they will break up two of its banks, the ones it now controls, Royal Bank of Scotland (RBS) and Lloyds. Back in 2006, RBS was the world’s largest bank as measured by the size of its balance sheet, which then amounted to $3’700 billion. RBS was also by far the fastest growing large bank in the years up to the crisis. No wonder it is in trouble, again. RBS and Lloyds are to be supplied with a total of $88 billion in capital, almost $50 billion from government funds.

Rightfully, the government should start to influence how these banks are run. However, the direction this influence takes doesn’t follow sound logic but advice from these banks’ competitors and supposedly pressures from the European Union competition authorities.

According to the Financial Times, RBS is held to sell its insurance businesses (Direct Line, Churchill and Green Flag), its small business operations in England and Wales, and its Global Merchant Acquiring business and Sempra, a commodities trading business. Lloyds will be forced to sell some of its retail banking operations and its Intelligent Finance online business.

Most everyone agrees that our financial superstores will have to be reduced with the goal to eliminate the hazard of businesses that are too big to fail. It is however preposterous to sell this effort with arguments of competitive policies which are nowhere near the center of our issues we have with banking today. Simplistically reducing bank’s size doesn’t change the fact that these banks run business lines for which they lack competence and institutional structures. The issue is not that that we have had commercial banks dominating a particular area or of commercial banking or too much concentration in any area of finance.

The issue is that our largest financial businesses try to run every kind of banking and financial service there is and are, not surprisingly, in over their heads.
Of course and without any delay, compatriot Joe Ackerman, CEO of Deutsche bank and supposed spokesman for our financial superstores has taken a stand against the “totally misguided” downsizing, calling it “unacceptable”.

He is right in one thing, the problem of too big to fail will not be solved by asking a bank with a $3’700 billion balance sheet to sell some branches and fringe businesses in which competitive authorities find “too much” concentration. It will still resemble an over-sized hedge fund, itself larger than the global hedge fund industry combined. RBS will remain intertwined and interconnected in the globally fungible world of finance. It will still run businesses for which it is utterly unqualified. And it will continue to do so with risk management tools that are sophisticated only to a non-mathematician and wholly inadequate, to put it very mildly.

Even though Mr. Ackerman is right, UK authorities are “totally misguided” in their action, his outrage only counters the advice given by his colluding peers across the aisle in a farcical charade that diverts attention from the real solutions, which would arguably be much more drastic for Mr. Ackerman and his peers.

I for one do not want to hear from Mr. Ackerman again until he explains how he manages his bank and its risks and tells us how his sophisticated models have failed him and his peers so miserably. I want him to explain the more than controversial concept of Value at Risk (VAR) to the public and why he believes he can be everything to everyone: an Investment Banker, an Asset Manager, a Private Banker, an Insurer, a Commercial Banker, a Derivatives Trader, a Broker and an Adviser on most everything the world of finance has to offer today.

Unfortunately, as long as government is being advised by the very banks it ought to reform, I guess we are fools to expect any independent logic in policy decisions. Even heads (and former heads) of central banks, i.e Mervyn King and Paul Volcker do not seem to have the gravitas to redirect the fateful course we are on.