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Energy and Environmental Reality Check

By: Peter Fusaro

May 30, 2007

Transforming an advanced industrial economy takes time. Too often, we lack patience, since there are no quick fixes to our energy and environmental problems. It took decades to create them and will take decades to ameliorate them. Time is necessary to develop, deploy and scale environmentally benign technology. What we need is not the Silicon Valley IT solution. It is "iron in the ground" and advanced engineering solutions that are needed and the nascent carbon trading markets may become the "missing link" in accelerating clean energy technology deployment.

From this historical and institutional perspective the trendy focus on biofuels, particularly ethanol, is not the answer we need and frankly, it's misguided. While a palliative to politicians, biofuels do not offer a long-term solution on how the US uses energy and how it needs to transition to a less carbon intensive economy.

The United States is not Brazil, and its biofuels industry is not analogous to the US situation, despite the photo opportunities. Brazil has a sugar cane based ethanol industry that has taken 30 years to mature. Brazilian ethanol consumption is 200,000 barrels/day or 5% of US gasoline consumption. (The US burns up 9.5 million barrels per day of gasoline in the summer). A saner solution would be to create more market-based incentives for the rapid deployment of hybrid cars and trucks as well as next generation plug-and-play hybrids. This would clip gasoline demand by 4 million barrels per day instead of pushing a listless "alternative fuels" platform that is more hype than reality

The Infrastructure Gap
Let's recall that these same flawed arguments for alternative fuels were heard about compressed natural gas (CNG) in the late 1980s. Advocates for CNG crowed about how CNG would power America's cars and trucks, but that didn't move the needle. CNG today is used mostly for buses and fleet vehicles totaling 150,000 vehicles compared to 250 million vehicles in the US using gasoline and diesel fuel. CNG failed to capture the fuel market because there wasn't any credible distribution infrastructure. This "infrastructure gap" is also the fatal flaw for both the "hydrogen highway" and biofuels. Without the infrastructure the product can't be moved and marketed. The reality is that we have a gasoline and diesel fuel infrastructure in place that cost hundreds of billions to build and maintain. Deal with it or alterative scenarios won't fly.

Delving more deeply to US infrastructure problems we bump into the reality that today the US is underinvesting $1.6 billion in our energy, water and telecommunications infrastructure. Only Senator Dodd has paid attention to this issue. It is just not sexy in Washington to talk about the basics. Our infrastructure is crumbling and needs reinvestment. Why not marry that opportunity to greener technology choices? Moreover such a reinvestment strategy will create jobs and new businesses for Americans in engineering, construction, financial services and other venues. This would be a good way to close many gaps.

Incenting Green
To get our economy greener, we first need a regulatory policy framework on climate change. We are finally coming closer to that goal at the federal level. The next step will be to let the markets work their magic by incenting innovation. Mandatory carbon "Cap and Trade" will do that, while credible financial penalties need to be in place for confronting noncompliance.

We did exactly this with acid rain and it worked. We took a financial instrument from the mortgage-backed securities market and applied it to air quality. We created a commodity called SO2 allowances. Carbon dioxide emissions are now following that commodization path but on a global scale this time. The same is beginning with water markets.

Establishing viable markets take time; most energy projects take 4 to 7 years to implement. We also need to look seriously at making significant energy efficiency improvements in buildings, which also have a significant carbon footprint. However, since most energy efficiency in building design and green buildings is associated with new construction, we need to incent the building retrofit market once again to deploy more existing, energy efficient technology.

Carbon Markets Today
The global carbon footprint today is 26 billion tonnes of carbon dioxide emissions and that is growing by over 1 billion tonnes per year as more fossil fuels are consumed. The Kyoto Protocol was the start of an attempt to limit greenhouse gases to 5.2% by 2012 but we know now that this target will not be met. The US emits 23% of the world's greenhouse gas with China second at 18%. On January 1, 2008, we will see the beginning of the real global greenhouse gas market, the EU ETS. US multinationals will be taking part in that market in 172 countries under the Kyoto Protocol. This should help to speed up the development and introduction of the kinds of technologies and infrastructure improvements outlined above.

Turning to the US, in 2009, the Northeastern states will launch RGGI, their own CO2 trading regime, California will follow in 2012 and there is hope for federal mandates on greenhouse gases. Recall that both acid rain and urban ozone programs began at the state level and eventually were federalized. The same could now happen with carbon. Federal mandation on greenhouse gases would bring the regulatory certainty that is needed to create a market with common rules and standardization, and bring an uplift to clean energy technology investment in the capital markets. On the investment side of the equation, there will be an "environmental or carbon kicker" which will reduce capital costs and generate greater deployment of clean technology across the energy value chain.

What's an "environmental or carbon kicker"? The monetization of carbon and other emissions reduction credit streams i.e. carbon finance projects are long-term and will generate credits for several decades. This helps reduce the cost of capital for cleaner energy projects.

There are now over forty hedge funds trading carbon as well as all banks in the EU. Morgan Stanley, JP Morgan Chase, and hedge fund are also major trading players in the SO2 market where these traders provide that market with liquidity. They will do the same in carbon trading and finance. To go a step further, they are needed liquidity providers for markets, and cannot be banned from participating in markets as some advocate.

The rationale for investing hundreds of billions of dollars on clean energy technology will be pushed forward by formal US carbon standards. The capital is already there. What's lacking is the regulatory framework to make this market soar. Going further, emissions trading will prove to be the "missing link" in cleantech investment. The point is that marrying cleaner technology with carbon is where the markets are heading. Today cleantech investment in the US is $9 billion and rising. Carbon trading globally is $30 billion and rising. We are going to see a $3 trillion carbon commodity market in trading and probably a larger market in energy investment of $20 to $30 trillion in the next 25 years estimated by the International Energy Agency in Paris. This is just the beginning of a major market transformation. It is the "greening" of the $5 trillion energy business and will take decades to implement. But we have to start now!

Peter C. Fusaro, is best selling author of What Went Wrong at Enron and Chairman of Global Change Associates, a New York energy and environmental financial market advisory. He runs the online portal the Energy Hedge Fund Center.
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