Tweening Around the Tworld!

Below is my letter opposing the City of Austin’s investment of $2.3 billion in a biomass power plant in Nacogdoches, Texas.

The Austin-American Statesman’s Editorial of Sunday, August 17th provides some context.

__________

Mayor Wynn,

As a former Resource Management Commissioner, I wish to register my objection to our City signing a power purchase agreement to build a biomass plant in Nacogdoches, Texas before the end of August, 2008.

There are two issues that need to be considered before approving this power purchase agreement.

First, it does not appear that competing bids were solicited to build or operate this plant. Other builders of these plants offer lower cost per MWh or lower construction costs. For example, without too much effort on my part, I have found one vendor, American Biorefining and Energy, Inc., who gave me a budgetary quote of $80/MWh. This is significantly below the $131/MWh ($2.3B / (20 yr * 8,760 h/yr * 100 MW)) cost of the proposed power purchase agreement. While many factors go into calculating the cost of a power plant, the $131/MWh price gives me pause. This price exceeds the cost of solar power as determined by Austin Energy’s 2006 Value of Solar Study of $104/MWh. This price was seen as too high in 2006. Yet it is less than the biomass plant’s power prices. While Mr. Duncan justifiably claims that a biomass plant allows Austin Energy to dispatch power to control its costs and improve system reliability, is that feature really worth a $27/MWh premium over the price of solar power and an even higher premium over the price of wind power? I have been told that engineering studies claim that an energy generation system can be reliably operated with less than 30% of non-dispatchable, renewable power. The other generators can provide enough flexibility for reliable operation of the system. Perhaps, because we have less than 30% of our power from non-dispatchable sources, it is too early in our energy mix to pay a $27/MWh premium for a biomass generating plant?

I have found a second vendor, Energy Products of Idaho, who gave me a budgetary quote of $170 M to build 3 33 MW plants or about $1,700 per kW of generation capacity. They expressed to me that the $131/MWh operating expense seemed high to them.

Since no competitive bidding was performed, I am justifiably concerned that we are significantly over paying for this plant. Of course, if we can get a price closer to $80/MWh, most of my objections except the below point are withdrawn.

Second, it is not clear from what I have seen whether we are locking in the price of fuel in this power purchase agreement. Considering the volatility in all fuel prices and the dramatic increase in the price of corn-derived ethanol over the last 2 years, I am concerned that we are exposed to an increase in the cost of fuel. Frankly, as a businessman, I would be very surprised if Nacogdoches Power would provide a 20 year fixed price without a fuel price escape clause. Since our staff believes that a biomass plant is a good idea, will every other power generator in the country jump on this bandwagon too? This would bid up the price of fuel thus driving up the price of our generated power. Since I cannot see the economics behind our purchase agreement, I cannot assess how vulnerable we are to fuel price increases.

Finally, if Council chooses to delay this agreement, I, as a former Resource Management Commissioner, would like to join a task force to examine our biomass and other energy generation options in more detail.

At lunch the other day, a friend asked, “how does Bush’s weak dollar hurt the U.S.?”

Not an easy question to answer but here’s my shot at it:

Does Bush’s weak dollar hurt the U.S.?

The economists are clear on one thing - the increase in jobs from weak dollar advantaged exports offset the roughly comparable loss of jobs in domestic production. This first order analysis is correct but doesn’t take into account a huge structural advantage that the US enjoys and which a weak dollar undermines - oil is priced in dollars. (Yes, North Sea Light Brent Crude is priced in dollars and not pounds or kroner.) A non-trivial amount of the increase of oil prices is driven by the weakness in the dollar, ≈ 10+%. A huge threat to our well being is the threat of switching away from dollars. Our friends, the Iranians, are trying to start an oil bourse priced in euros. Because of our place as the world’s reserve currency, this is unlikely to succeed but it points to the strategic threat to our way of life. In a country which imports 60% of its oil and runs on the rapid, inexpensive transportation of goods, every increase in the cost of oil hurts our productivity.

Presuming you agree with the above that there is a real world effect due to a weak dollar on today’s economy, is Bush responsible for this weakness? Suffice to say that during John Snow’s tenure as Treasury Secretary, the Bush administration made an explicit decision to stop supporting a strong dollar policy. They chose to stop defending the dollar and now here we are with a weak dollar. So, Bush is responsible for a ‘not strong’ dollar but has he done anything to weaken the dollar? This is a more difficult question but there is a lot of circumstantial evidence that Bush administration policies contributed to a weak dollar. (Considering the competency deficit the Bush administration shows in almost everything it does, I am surprised that the below indicators are not stronger. This may be due to the Republican party recruiting leaders from finance and large business community.)

The strength of the dollar is measured against a basket of other currencies - yen, pounds, euros, etc. This value is set by a market mechanism of buying and selling dollars. A longer term value is set by the interest rates paid by borrowers in the US for foreign dollars. Currently, American interest rates are not attractive with respect to the other choices available in a global economy. Hence, the need to purchase dollars to loan to US businesses and consumers is down. The Bush administration via the Fed controls the floor of interest rates charged in the US. Here is a direct control mechanism. To stimulate the economy Bush is keeping interest rates low. Low interest rates reduce demand for the dollar. Why loan money for a low interest rate when you can get a better deal in another country? A weak dollar makes oil more expensive slowing the economy. Q.E.D. Bush has mismanaged the economy and is exacerbating it with a weak dollar policy.

In an indirect form, the Bush administration is prolonging the financial mess they allowed to develop over their 7 year tenure. By bailing out Bear Stearns, they are enabling a severe moral hazard to investment by Wall Street investment banks. This has further undermined the international opinion on the value of the dollar. The fact that we exported our junk subprime mortgages to investment banks around the world is hurting us.

Hence, I think there is an unequivocal argument that Bush has mismanaged the dollar and directly hurt US economic interests.

Tom Myer and I made a video supporting Barack Obama.

New Hotness

I’m an invited blogger at Worldchanging Austin.

Here are links to blog entries I’ve done:

Energy Efficiency Charrette II Today!

Geothermal Power for Austin Now!

World Without Oil Game Goes Live…

Agenda for Austin Energy’s Energy Efficiency Charrette II

Austin Energy’s Energy Efficiency Charrette

Last Night at the Resource Management Commission…

Our society seems to have made a jump towards energy sanity.

On January 19th, capitalists signed up to do the hard work of environmental mitigation.

Industry is beginning to understand that, not only must we change our energy usage patterns, we will make money in the process. They now understand that conservation is about profit maximization.

I’m declaring victory in this battle. The war will take a little longer but the tide is on our side.

Where I will try to focus my efforts will be lobbying for a real carbon cap and trade system with credits for early adopter organizations, such as Austin Energy.

Today’s Austin Chronicle (07/27/2006) has a good article about the current situation with Austin Energy’s ‘Value of Solar Study’. I was quoted extensively. I hope this helps us move all of the environmental balls forward. The climate crisis is real and the economically prudent thing is to start early and modify all of our investment decisions to minimize our impact on the climate.

My favorite quote is:

“The study’s number one flaw is that it doesn’t appropriately value conserving fuel like natural gas,” said Andrew Donoho, a member of the city’s Resource Management Commission, which advises the city on renewable energy issues as well as energy and water conservation. Since natural gas cost was such a major factor in the study’s calculations, critics erupted, calling the research’s figures specious when the utility refused to make its cost-projection models public. Donoho said that while solar’s long-term costs are apparent, the uncertainty of gas’ cost and largely imported supply should have added more value to solar. The study’s numbers, he said, might as well be based on “voodoo and chicken entrails.”

The future is uncertain.

Therefore, we need to adopt prudent strategies to purchase all of our energy sources. I have attached a presentation which I made at the Electric Utility Commission on July, 17th and the Resource Management Commission on July 18th.

My argument is pretty simple:

1. Because natural gas is sold on an international market, the Value of Solar Study (VoSS) is speciously certain about the future price of natural gas.
2. The VoSS appears to have chosen a pricing regime that places natural gas at the low end of its likely range. In other words, the value is highly likely to increase over time.
3. The price of solar PV panels are likely to decrease as the volume of panel production increases.
4. The City of Austin allocates funds to purchase capital goods annually.

These four items lead me to bring an idea from financial planning - dollar cost averaging. When an investor dollar cost averages, he purchases a regular dollar amount of a volatile investment. In our case, we are investing in something that has a volatile value due to gas prices and ever reducing panel costs. The regular purchasing of PV lets us average our costs while starting to immediately capture energy production and reducing our exposure to volatile fuel prices by not purchasing gas.

In detail, my proposal is pretty straightforward:

1. Let out an annual RFP for a fixed dollar amount.
2. Choose the winner based upon quantity of megawatts offered at that price and other engineering appropriate issues.
3. Achieve Austin’s 100 MW of solar power by 2020 goal in 14 annual purchases starting in 2007.

I would also add that the methods in the VoSS can be improved upon. I would like to see an annual recalculating of the value of the natural gas component of VoSS. Furthermore, I would want a comparison of the error in both the market determination of gas prices and the Austin Energy model. By empirically observing this error, policy makers can continue to make prudent purchasing decisions while encouraging Austin Energy to improve their model to better guide the policy choices.

Furthermore, the gas component of VoSS also directly applies to decisions to purchase wind energy. It should also be used in calculating the long term costs of purchasing another gas, coal or nuclear plant.

Austin Energy’s Value of Solar Study presentation the other night drove home to me how few people actually think critically about almost any issue. A few of my fellow commissioners showed a strong grasp of the issues and asked penetrating questions. Nonetheless, almost all of this process demonstrated poor critical thinking skills from almost everyone.

This discussion on critical thinking would help all of us.

Here is its summary:

It is naive to expect social-science education, natural-science education, or education in general-at least in their present forms-to elevate critical thinking to something more than a pedagogical fashion that everyone applauds but few conceptualize very deeply. This leaves the skeptical community. We identify ourselves as champions of science and reason. But this is a broad mandate. We should avoid concentrating our skepticism too narrowly on the realms of superstition, pseudoscience, and the supernatural-for the ultimate challenge to a critical thinker is posed not by weird things but by insidiously mundane ones. If we hope to realize the promise of critical thought, it is important that skeptics affirm a multidimensional definition of critical thinking — reasoning skills, skeptical worldview, values of a principled juror — that exempts no aspect of social life.

Austin Energy has commissioned a study to determine the economic value of generating large quantities of electric power from current solar technologies (known colloquially as the Value of Solar Study or VoSS). This is a laudable goal. The study is available here and its economic development counterpart is here. It does a very good job of enumerating different costs of solar energy generation and how solar can benefit a municipal utility.

The real measure of any study though is how reliably does it guide policy makers to choose wisely amongst their options? In this area, due to a single glaring methodological flaw, the VoSS is almost useless in guiding Austin City Council. Lets examine this flaw in some detail.

One of the largest economic benefits of solar and wind energy is the benefit of avoiding the cost of fossil fuels. While we can easily calculate this for the current year based upon the avoided cost of Natural Gas priced by the commodities futures market, this problem becomes much more complex over the projected 30 year lifetime of the solar generation hardware. The futures market only looks five years into the future. Therefore, we have to develop a model for years 6 through 30 of the study.

The one thing we know about the future is that we don’t know what the future holds. But we can estimate it.

The VoSS

Austin Energy provided the VoSS authors with a confidential proprietary model of future gas prices. Normally, this might be a problem. How can you critique that which you cannot see? There are some pretty simple questions that any study needs to be able to answer that, without disclosing proprietary details, can give policy makers some confidence in its results. They are:

1. How long has this model been in existence?
2. How many other organizations depend upon the output of this model to make their policy decisions?
3. Since the VoSS uses the model to predict prices for natural gas from 6 to 30 years into the future, we need to see how effective the model has been in predicting the present price of natural gas. Therefore, just using data from five years ago, did the model predict today’s prices on the natural gas market?
4. If the model missed predicting today’s price (as it almost certainly did), how much was it wrong by? In other words, what is the difference between the model and reality? For bonus credibility, what has been the model’s standard deviation of its error over the period of five years ago to the present?

All of these questions are asking for aggregate measures of the model’s predictive efficacy and if policy makers are placing ‘money bets’ on its predictions. Most folks who are knowledgeable about statistical methods would agree that the above questions do not disclose proprietary information about the construction of the model.

For Comparison: A Public Natural Gas Price Model

The below image is an example model output commissioned by the U.S. Government’s Energy Information Administration.

Please note the range of values, the blue band, predicted for natural gas prices. This is the kind of output that should be driving the conclusions made by our VoSS. Yet, the VoSS has no error bars in its price projections.

Any public discussion of long term investments must take into account the uncertain nature of the future.

Why are Models Complex and the Results Uncertain?

So that we can all understand the complexity a model must manage and, hence, difficulty it has in predicting the future, lets look in depth at issues the VoSS’s model must manage.

As we all dramatically saw in late August 2005, hurricanes, such as Katrina, can create havoc in both the oil and natural gas markets. For example, as a result of Katrina, I am told that 10% of the natural gas formerly produced in the Gulf of Mexico (GoM) is now ’shut in’ or stranded. The pipelines that used to deliver this gas on to shore are broken and, because the volumes of gas are so low, it is no longer economically viable to fix those pipelines. In economic modeling talk, Katrina was an exogenous event. What other exogenous events might an effective model consider?

1. The effects of demand destruction due to price increases/volatility on gas prices?
2. The effects of Liquified Natural Gas (LNG) plant construction on gas prices?
3. The effects of competition for LNG from western Europe on gas prices?
4. The historical high in the number of severe hurricanes in the GoM over the next 15 years?
5. The political risk of depending upon Qatari or Russian natural gas?
6. The reliability of uncharacterized ‘proven reserves’ in Qatar and Russia?
7. The shortage of rigs to drill replacement wells?
8. Do Qatar and Russia have enough rigs to meet the demand from Europe and the US?
9. Are there enough liquefaction plants being constructed near the stranded gas?
10. Our dependence upon politically unstable Nigeria?
11. Terrorist attacks on the gas infrastructure?

Lets remember that I am not a natural gas industry professional. Anyone who actually models the gas market for a living can imagine many more exogenous events. For example, Matt Simmons, a natural gas investment banker, contends that natural gas wells have a very different depletion curve than oil wells. That natural gas wells stop producing gas in a dramatic, sudden fashion. Mr. Simmons believes that the industry is incorrectly modeling gas well depletion and, hence, will be caught by surprise when the wells flare out.

As an example of the political risk we are taking by depending upon natural gas, the above picture lists the worldwide reserves of natural gas. Yes, it says we have 60 years of reserves at current consumptions levels. With both China’s and India’s appetite for energy growing at a phenomenal rate, that 60 year estimate will be wrong soon. In fact, there is a very good chance that energy consumption will double over the 30 years that VoSS covers. Is this challenge to gas pricing factored into the VoSS’s model?
It is truly a complex world out there. Reducing an investment decision to a single static number is wrong.

Perhaps after the VoSS hearing on Monday, June 26th, I may change my opinion but the Austin Energy consultant will have to work very hard to convince me otherwise. (We’ll see how good of a tap dancer he is.)

Summary

The VoSS addresses many issues and makes many good, sound economic assumptions. Yet, because it projects a single value for the costs of natural gas over the next 30 years, it is not a useful guide to policy or as a benchmark price for soliciting RFPs for purchasing solar derived energy. It is essentially useless to guide the City of Austin’s policy makers, the City Council. As I write this, I cannot in good conscience recommend to Council that they base policy decisions on this document.

One SolarAustin Board Member’s View…

SolarAustin recently hosted our City Council candidates to lunch for a briefing on the energy issues facing Austin.

We proposed multiple methods to manage the emerging energy crisis and preserve our environment. Yet, all of our advice can be distilled into a simple proposition: invest early in renewable energy to reduce our long term energy costs and preserve our quality of life.

In detail, we proposed that Austin needs to honor Mayor Wynn’s acceptance of the Energy Freedom Challenge to get Austin using renewable energy sources for 50% of its energy needs by 2025. In the face of rising oil and gas prices, this is the economically prudent thing to do. To reach this goal while Austin is growing requires a major shift in thinking, we need to shift all of our energy investments into renewable sources. We already have enough coal, gas and nuclear power till 2025 and beyond.

Furthermore, like many of the large companies that have made the ‘Green Choice’ for prudent economic reasons, Austin city government needs to make the ‘Green Choice’ too. While Austin has been a leader in procuring renewable energy, the City, itself, has been a laggard user of that energy. In particular, Austin’s Water Utility uses close to 60% of all energy purchased by city government. Clean, potable water takes significant amounts of energy to deliver to citizens. While Austin Water will push back and complain that ‘Green Choice’ is ’sold out’, we citizens need to understand that they chose not to buy ‘Green Choice’ energy when they had the chance. What did other large businesses in Austin understand that Austin’s city government did not? That renewable energy provides price stability in an uncertain world. Our city government should be managing our costs much better than they are.

Finally, the Texas Gas Service franchise is up for renewal this year. Many of our citizens are caught in the ‘gas trap’. The ‘trap’ is that prices are going up and they cannot afford the up front investments in insulation and solar water heating to escape the trap. Solar water heating can reduce upwards of 50% of your annual natural gas bill. The franchise agreement used to contain a conservation fee. If that fee was still in effect, it would have produced a conservation fund of over $2,000,000 dollars a year. Because energy conservation hurts Texas Gas Service revenues, we are not surprised that they renegotiated the 1986 franchise agreement to basically eliminate conservation efforts. (TGS spent $257,000 last year versus $2,000,000 on conservation.) SolarAustin wants the conservation fee reinstated and to have the proceeds directed towards low income individuals for insulation and solar water heating. (Citizens of higher economic means can take advantage of a Federal solar water heating tax credit.)

SolarAustin wants to encourage responsible, prudent renewable energy investments. We encourage you to ask City Council candidates how they intend to invest your tax dollars in our long term energy future.