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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2 thoughts on “The Law of Conservation of Bad Ideas”

  1. Thanks for the oil industry to renewable industry review. As I read, I realized one other reason Trans Canada and other oil companies would purchase these renewable energy projects. For the accelerated capital depreciation opportunities – 50% per year. So if you have an oil company (or any company) that is making a good profit, purchasing a RE project has excellent tax implications.

    Citizens or start up solar co-operatives investing in solar projects cannot access these tax incentives. Hopefully Ontario’s Green Energy Act review takes into account that community projects should have priority access to the grid, so that we all have input on where projects are developed as well as who benefits.

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    1. Thank you for your comment, Steve.

      I’m not sure if the accelerated CCA is that much of an incentive for the oil companies to get into RE, seeing as they get this subsidy already for their non-renewable capital items. KAIROS issued a fascinating (and for me, infuriating) report on the many ways Canada and other countries continue to subsidize fossil fuels.

      The FIT review should definitely change the GEGEA to facilitate community energy projects more vigorously and more directly. Priority grid access is an excellent start, but reforms should include tax and other incentives for renewable energy cooperatives, elimination of municipal-level disincentives (taxes, fees, and unjustifiable rules and other red tape), and explicit programs to encourage more urban rooftop solar PV installations. The only way that green energy will capture the public imagination – and foster a healthy “keeping up with the Joneses” mentality – is if it is visible everywhere you look.

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