The Law of Conservation of Bad Ideas

Which way to the clean room?

Back in the mid-nineties, British Petroleum (of recent Deepwater Horizon fame) bought a company called Solarex. BP’s rationale went something like this: “We’re an energy company, and Solarex is in the energy business, so it’s a good strategic fit.” Solarex was bought, and was re-christened BP Solar.

It was a bad idea.

BP may call itself an energy company, but everyone knows that it’s really an oil company. According to the firm’s 2010 Summary Review, BP’s oil business brought in just over US$36 billion. All other lines of business, BP Solar included, yielded a loss of $21 million. So, it’s fair to say that one one-thousandth of BP is non-oil.

The oil business consists of looking for oil (exploration), getting it out of the ground (production), cleaning it up (refining), and selling it (marketing). Successful oil companies get out and explore where nobody else is. They then nail down production rights, squeezing the best possible deal from the country sitting on top of the oil reservoir (and often these are dictatorships that use the revenues to repress their own people or fund wars with their neighbours). BP and its kind then process the oil in big, smelly, dirty refineries, always in a balancing act with their competitors. You don’t make any money without a refinery, but if everyone builds new ones at the same time, the result is overcapacity, and prices drop through the floor. Then, they market the finished products – gasoline, motor oil and the like, and petrochemicals – which are all in such demand that they practically sell themselves.

Contrast that with the solar panel business. It’s much more like the semiconductor industry than the oil sector. It depends on a steady supply of silicon.  There’s a big emphasis on research and development to improve the product and the production process. The cells are manufactured in a clean room environment. Except for the off-grid market, sales are dependent on governments implementing some form of subsidy for renewable energy, like Germany’s FIT program or the Renewable Portfolio Standard in many US states.

The decision-making around refinery capacity bears a passing resemblance to that in solar panel production, but that’s the sum total of the “synergy” between these two businesses. This is why industry commentators did not have very many good things to say about the BP/Solarex deal.

Fast forward a decade and a half to the present day. The latest BP annual report boasts that solar sales in fiscal 2010 were up 60% over the previous year. It describes an interesting new technology to help solar cells perform at high temperatures – this is an important development, since PV cell efficiency drops as the temperature rises. The report also mentions an anti-reflective glass coating which further increases cell efficiency. Exciting stuff.

Yesterday it all came to a screeching halt. Despite all the rosy news last March, the fortunes of BP Solar have suffered so much that the parent pulled the plug. The 40-year history of Solarex has come to an end.

How did Icarus fall back to earth so quickly?

As I wrote six weeks ago, the solar industry is struggling with cyclical overcapacity. This has driven solar cell prices down sharply, and many manufacturers are struggling. Some are selling below cost just to bring in some revenue and keep from closing their doors. However, the key word is “cyclical”. Many industries suffer from the same dynamic – capacity comes online in large chunks, and if too many players move to build or expand plants at the same time, it causes a glut. Nobody can make money, and the competitors with the weakest capitalization end up on the auction block or the chopping block.

Capital is perpetually scarce in the solar industry, so that’s a fair explanation for why some players have gone belly-up. BP, however, has capital coming out the wazoo – or it did, until the Deepwater Horizon spill, which may end up costing as much as US$30 billion. BP Solar is just rounding error by comparison, but it’s clear that the unit would have faced a severe capital crunch for the foreseeable future.

Oh, one more thing.  The people buying solar cells are often motivated by the desire to bring about a better world. Sure, it may be just a ploy to build green credibility around the corporate brand, but the outcome is the same. If you buy solar panels from the company responsible for what Wikipedia calls “the largest accidental marine oil spill in the history of the petroleum industry”, you can’t expect to earn many brownie points with customers and other stakeholders. It would be like buying first aid kits from Lockheed Martin (which topped the defence industry charts by selling US$33 billion-worth of death-dealing weapons in 2009).

We might ask why BP really got into the business in the first place. Perhaps BP strategists saw the writing on the wall even then, reading up on the concept of peak oil, and recognized that the oil majors’ days are numbered. Perhaps their motivation was more sinister – to buy up the renewable energy industry, and smother it so that it would never become viable competition. Perhaps the logic was as simplistic as “Me energy. Solarex energy. Me buy Solarex. Ug ug.”

If it was the first reason, BP failed. It has made exactly zero progress on an exit strategy to ensure the company can still continue after all the oil runs out.

If it was the second reason, BP failed. The solar photovoltaic (PV) industry – while not thriving – remains a force to be reckoned with, even if you only look at its impressive record of growth coupled with cost reduction. The disappearance of this one competitor will not leave a ripple, and will make the remaining players a tiny bit stronger.

If it was the third reason, BP failed. There are no meaningful synergies between oil and PV. Wildcatters are wildcatters, and silicon wafers are silicon wafers, and never the twain shall meet. If BP or any of its competitors have excess cash, they would do far better to distribute it back to shareholders in dividends or share buy-backs than by investing in an utterly alien line of business. The market is far better at allocating capital. BP and its sisters should stick to their knitting.

Which leads me to my epilogue. Just as BP Solar’s death knell rang out, TransCanada Corporation announced a C$470 million deal with Canadian Solar to buy nine utility-scale solar projects with a combined generation capacity of 86 megawatts. While Canadian Solar deserves kudos for landing this deal, I have my doubts about the buyer.

If you’ve been following the saga of the Keystone XL natural gas pipeline, and you hear the name TransCanada, you probably think they’re all about pipelines. If so, you’re mostly right. However, about one-third of TransCanada’s earnings before interest and taxes arose from its “energy” business.

Before you think that this is another BP fiasco in the making, we’re actually talking about electricity generation here. That’s more closely aligned with solar than BP could ever claim. However, this energy business is mostly “brown” energy – fossil fuel-fired thermal generation plants, nuclear (they own a big chunk of Bruce Power), and large-scale hydroelectric (the sort with a reputation for significant negative environmental impact). Their truly green energy business amounts to two wind farms with a combined capacity of 720 MW – less than 7% of the total. This week’s deal is TransCanada’s first foray into solar.

Compared to operating a combined-cycle natural gas plant, a nuclear reactor, or a hydro dam, keeping a solar farm running is pretty simple stuff. There are no issues with fuel supply, they aren’t a target for terrorists, and their environmental impact is near zero. So although TransCanada’s core business really hasn’t taught them anything helpful, there’s only so much that can go wrong.

Here’s hoping TransCanada will have a better experience than BP did.

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21st century public consultation: A “How Not To” guide

In 2009, the Government of Ontario passed the Green Energy and Green Economy Act (GEGEA). Now, two years in, the Ontario Power Authority (OPA) is taking a moment to reach out to the public, collect their comments, and decide what should be included in a mid-course correction for the Feed-In Tariff (FIT) program.

The GEGEA was intended to stimulate growth in renewable energy, conserve energy at the household level, create jobs, and help mitigate climate change. The future of the FIT program, and indeed the GEGEA, hangs in the balance. Some critical issues threaten the ability of the Act to achieve its goals. The review will surface and clarify these issues.

Ontario is the only province to have taken such an aggressive approach to green energy. Other jurisdictions in Canada and beyond look to Ontario as a bellwether for their own plans. If Ontario gets it right, the result may well be a new green standard that other provinces will strive to meet. If, however, the province gets it wrong, it could set the dream of a green and carbon-neutral future back many years. A lot is riding on this review.

It is encouraging that the OPA has chosen a public consultation process as a tool to help with their decision-making. The GEGEA has elicited a range of reactions among the people of Ontario, ranging from the evangelistic fervour that many acquire once they have solar panels on their rooftops, to the bitter NIMBY zeal that has surfaced in some locations where wind farms are proposed or already in production. Given just how many people actually care about this review – a rarity in this era of voter apathy – it is all the more important that the process draws out all relevant and representative views, and also quantifies these views to avoid the squeaky wheel syndrome.

According to the Ministry of Energy website, the review will consist of an online survey, emailed submissions, and consultations with the renewable energy sector. Does this meet the objective of providing a channel to receive any and all feedback? Definitely. Could the ministry be doing more? Absolutely.

In the past month I’ve participated in – or at least been aware of – three gatherings of stakeholders in the renewable energy sector, initiated by three different organizations. The first organization is the Ontario Sustainable Energy Association (OSEA), the second the Ontario Solar Network (OSN), and the third the Canadian Solar Industries Association (CanSIA).

OSEA’s webinar was a follow-up from its November Community Energy 2011 conference, where some initial feedback was gathered from a selected group of attendees. OSEA members include people who have already completed renewable energy projects, or hope to, or help either of the first two camps in some fashion (be it by providing financing, cooperative ownership structures, insurance, or even just moral support). Feedback collected at the conference was synthesized into a slide show and presented by the OSEA Executive Director, Kris Stevens, and well-respected industry commentator and consultant Marion Fraser. If anyone from the Ministry was present for the webinar, they did not reveal themselves. While Chris Bentley, the Minister of Energy, spoke at the conference, as far as I know he did not involve himself in any dialogue or consultations.

The OSN event was a town hall-style meeting on the University of Toronto campus, which began with presentations from members of the OSN’s FIT Review Coalition and concluded with questions from the assembled constituents. Most attendees were installers – small business owners that actually build solar energy systems of various sizes. The feedback from attendees was plentiful, broad-ranging, and animated. The Ministry was not represented at the session at all.

CanSIA represents the Canadian solar industry, including both PV and thermal. However, it is dominated by the very largest players – solar panel manufacturers like Canadian Solar and Q.Cells, developers like SkyPower and SunEdison, and an assortment of well-heeled firms providing financing, insurance, and legal counsel. During its annual Solar Canada conference last week, CanSIA hosted a closed-doors meeting between the Deputy Minister of Energy and a very small, select group – mostly CanSIA board members, if I understand correctly. As at the OSEA conference, Minister Bentley gave a speech, but as far as I know he did not engage with the conference attendees in any way.

Three facts are consistent across each of these events. First, each was a spectacular gathering of people with a deep knowledge of the renewable energy sector, the GEGEA, and the FIT program. Second, because of this, each event presented a tremendous opportunity for the Ministry to consult with a highly knowledgeable group of FIT program stakeholders.  Third, the Ministry did not make any meaningful effort to capitalize on any of these opportunities.

Instead, each of these groups is expected to make its submission to the FIT review in the same way as anyone else – write it up and email it in.

This is the 21st century. Technology has advanced. So has understanding on the most effective ways to consult the public. Why does the FIT review look essentially identical to something that could have taken place a hundred years ago?

What could have been done to improve the whole undertaking?

First, the Ministry should have seized the opportunities presented by Community Power 2011, the OSN FIT Review town hall meeting, and Solar Canada 2011 to wring out every possible drop of insight from the very richest sources available. Second, the Ministry should have convened a much more visible public consultation process, involving a series of town hall meetings like the OSN one. This would allow a broad spectrum of the public to make submissions, but what’s more, one person could build on the ideas of another. It would hence build much more valuable insights than would be possible when each person must submit their ideas in isolation. Third, the Ministry should have taken the process online, providing an open forum where everyone could see what everyone else was saying, and where brainstorming, synergy, and mutual inspiration can take the discussion to another, higher level entirely.

It’s 2011. We know better. And we can do better.

Moving target

In October, Ontario’s Green Energy and Green Economy Act dodged a bullet.

The opposition Conservative party claimed that the Feed-In Tariff (FIT) program, the Act’s most visible component, was sending electricity bills sky-high. On the face of it, the idea makes sense. Since the Ontario FIT rate for small-scale rooftop solar is 80.2 cents per kilowatt-hour, and the peak retail rate is 10.8 cents, doesn’t that mean our bills will be, like, nearly eight times what they are now?

Not even close. The Ontario Long-Term Energy Plan has targeted a measly 1.5% of all power in the province to be supplied by solar photovoltaic (PV) by 2030. If that goal were reached entirely at the 80.2 cent small-scale rooftop PV rate (not, say, large-scale ground mount, which commands half that), it would mean the FIT program would cause prices to rise by less than 10% over the entire 20-year life of the program. That equates to an annual increase of less than half a percentage point, or about 50 cents a month for the average Ontario household. In fact, the increase will be much less, as small-scale rooftop PV makes up only a small portion of the generation capacity currently in the program pipeline.

PV won’t make a noticeable impact on hydro bills. The reason is not that PV is cheap – it isn’t, at least not yet. It’s because the province has set a target for PV that is so low it’s laughable. Seriously, if all the PV industry can expect to accomplish is to reach 1.5% of total generation capacity over a twenty-year period, what’s the point?

1.5% is way, way too low.

Let’s look at some statistics on PV. According to the International Energy Agency, the global authority on energy matters, we can expect to see a reduction of 18% in total installed cost for PV systems each year. At that rate, PV will reach parity with today’s off-peak retail price of 6.2¢/kWh in 2022 – just a little over ten years. Retail rates, of course, will continue to rise rather than remaining constant, so retail grid parity will actually come sooner than that.

At this week’s Solar Canada 2011 conference presented by the Canadian Solar Industries Association (CanSIA), Skypower CEO Kerry Adler opined that 1GW of new contracts per year would be necessary to maintain a sustainable solar PV industry in Ontario. The LTEP target is less than 5GW of total installed capacity by 2030, or less than 250MW installed per year – not even a quarter of Mr. Adler’s projection. Although other industry commentators differed with Mr. Adler, it is clear that industry capacity is far larger than is required to deliver the LTEP goal. Either the industry has to rationalize, or the LTEP goal has to be revised upward.

Another discrepancy will have to be addressed. The response to the FIT program has been much greater than anticipated. However, the program did not include any mechanism to control the volume of applications, and the unexpectedly large number is putting the program under serious budgetary pressure. The OPA is now considering a cap on the number of megawatts-worth of PV contracts that are signed.

Such a measure would be extremely damaging to the nascent PV industry. Business thrives on predictability, on regular production volumes, and on a consistent rate of growth. If the industry is permitted to produce up to an arbitrary cap and no more, what is to be done? Are staff to be laid off, supplier contracts to be suspended, and production lines shut down until the next equally arbitrary reopening of the contracting window? That is no way to run a railroad.

There is another mechanism, a much more natural one than placing a ceiling on installed capacity. It is price.

It is a basic assumption in FIT programs that rates will be reduced rates over time – price digression, as it is called. In some countries, this price reduction is automatic. Hence, nobody that has followed FIT programs at all should be surprised that the Ontario FIT rates will be reduced. However, there are serious flaws in the way that the Ontario Power Authority has conducted the review.

The OPA has telegraphed that the rates will drop, but they have not indicated by how much. That much is not a problem. However, when the OPA announced the review, they also mandated that all applications received thereafter – and, worse, any that were in-process but had not yet reached the contract stage – will be subject to the new, unknown pricing. This means that businesses that negotiated deals and submitted applications assuming a certain price now have no idea if they will lose their shirts on those deals.

The OPA’s approach is understandable. If they’d left the door open, and allowed applications to continue under the old pricing, they would have had a stampede on their hands – everyone would have been falling all over one another to get their applications in under the old, higher rates. Instead of taking the hit themselves, the OPA let the industry take the hit instead. And the industry is hurting.

An automatic digression schedule would have avoided this conundrum. In the future, the OPA should specify a recognized industry metric to use as the basis for price digression. It should publish this metric on a regular basis. And, it should reduce FIT rates according to that metric on as regular and frequent a schedule as is practical. This will ensure that the industry remains competitive, and that FIT rate reductions don’t send it into a tailspin every couple of years. It will also avoid the need for the OPA to set an arbitrary cap on installed capacity.

However, this scenario will result in an organic pattern of growth that will not respect the target in the LTEP.

The Plan was based on what was thought possible at the time it was written. It already appears that the target for PV is too timid. The goals for other renewables may prove likewise. It is important that the Ontario Ministry of Energy not shackle itself to the targets contained in the LTEP. It must retain the flexibility to revise the figures for renewable energy upward if the industry demonstrates that it is capable. It must find ways to buy time, to postpone the huge, irreversible, and open-ended commitment of taxpayer cash required to refurbish Ontario’s aging nuclear plants.

Nobody knows just what renewable energy can do. As the picture becomes clearer, the Ministry must do everything it can to keep its options open.

The buck stops…where?

485px-William_Shatner_James_Kirk_Star_Trek_1967The original Star Trek television series offers an interesting take on leadership. In episode after episode, Captain Kirk is taken out of commission by some incident or other. The crew struggles valiantly to avert disaster, but to no avail – inexorably, without the security of having Kirk in command, the crisis deepens until all hope seems lost. Then, just in the nick of time, the captain is cured/freed/retrieved, then he strides onto the bridge with his customary bravado, pulls some cosmic rabbit out of a subspace hat, and saves the day.

Ontario’s renewable energy sector is desperately in need of a Captain Kirk.

Three stumbling blocks will persist as long as the leadership vacuum continues. The first is the huge discrepancy between the number of MicroFIT applications and the ability of OPA and Hydro One to process them. The second is the huge variation in fees, procedures, and rules across Ontario municipalities. The third is the faint-hearted goals that Ontario’s Long-Term Energy Plan has set for solar and other forms of renewable energy.

According to the OPA’s FIT program summary released last week, over a thousand new MicroFIT applications were received during the two-week reporting period. During the same period, only 75% of that number (786 applications) reached an end state – rejected, withdrawn, denied, or – dare I say it – connected and in production. One-third more projects are going in than are coming out. That means a growing backlog.

When you look inside the process, things get even worse. The Distribution System Code mandated that LDCs (Local Distribution Companies – Hydro One and its local counterparts like Toronto Hydro) take no longer than 15 days to respond to completed applications, either by refusing the request or extending an Offer to Connect. Once all the approvals were in, LDCs would have at most five days to connect the project.

If the LDCs keep up at the rate their going, it will take seven months to get through the pile of projects awaiting approval, and seventeen months to clear the backlog of projects that are approved and are just waiting to be hooked up. In other words, if nothing changes, a person submitting a MicroFIT application today can expect to wait at least two years before supplying their first watt to the grid. The Green Energy Act envisioned a period of twenty days (or 65 days if the project was not using an existing grid connection). The discrepancy is astounding.

Hydro One addressed this issue by asking that their regulator exempt them from the timeline stipulations, and instead permit them to work on a “best efforts” basis.

One of the main objectives of the GEA was to stimulate investment and create jobs in Ontario. When installers have to wait as long as two years between the time that they make a sale and the time that they install the system (and collect their revenue), it is difficult to imagine how they can stay in business. The inability of Hydro One and the other LDCs to stick to reasonable timeframes for approvals and connections is driving a stake right through the heart of this nascent industry, and making it impossible for the GEA to achieve one of its key objectives.

Whoever is in charge of the GEA – whether it’s the Ministry of Energy, the OPA, or the OEB – needs to solve this problem. On the one hand, they need to hold LDCs’ feet to the fire and demand accountability for timelines. On the other, they need to devise some way of throttling the number of applications, or at least giving applicants a reasonable estimate on how long the process will take.

One interesting characteristic of the solar energy system installation business is its regionality – or lack thereof. I’ve spoken to quite a few installers, and although they would prefer to stick to one area, the vagaries of OPA/LDC approvals have forced them to travel all over the province in search of sales. This means that most installers work in multiple municipalities, and have direct experience with just how dramatic are the variations in treatment between different cities and towns. In some, there is a specific fee just for pouring the concrete pad which forms the foundation of a ground-mount solar tracking array. In others, there are other arbitrary and inconsistent fees. This imposes huge costs and administrative hassle on installers.

Whoever is in charge of the GEA needs to start banging some heads together. There is no reason for so much variation between municipalities. With a little bit of effort, these inconsistencies could be eliminated and the approval process could be harmonized. This would remove a completely unnecessary barrier to efficiency in the industry.

Finally, there is the big-picture issue of objectives. The Ontario Long-Term Energy Plan envisions that solar PV will supply a paltry 1.5% of the province’s energy mix by 2030. This is a pittance. A study by the Queen’s University Applied Sustainability Research Group indicates that solar farms on marginal land in 14 counties south-eastern Ontario alone could supply 90 GW of peak power, or roughly 80% of the projected energy demand in 2030. The cost of solar energy is dropping dramatically each year, and by some estimates is expected to be comparable to that of fossil fuels and nuclear well within the timelines of the LTEP.

Why is the Ministry of Energy setting its sights so low? Currently, installations are being done on a first-come-first-served basis without regard for the relative societal value inherent in each project. With genuine leadership and a coherent plan, solar installations could be stimulated in the highest-value locations – urban rooftops. Then, as the industry grows and prices drop, installations could be extended to lower-value locations such as the marginal land in the Queen’s study.

Who is really in charge? Isn’t it time that somebody take command, shake things up, and demonstrate that there is so much more that could be done to make the GEA live up to its potential?

Captain Kirk to the bridge.