A license to print money?

On the way to equilibrium (Image posted on Flikr by avlxyz)

All things natural tend toward equilibrium. A hot room in your house will eventually find a middle ground of temperature with the cooler rooms – a state called thermal equilibrium. Water falling on highlands will drain through gradually growing watercourses until, ultimately, it reaches the sea – another form of equilibrium called base gravitational potential. When molecules organize to form a mouse, the mouse survives for a time, but eventually dies and decomposes, its once-organized molecules returning to their original chaotic state – in other words, the mouse has come to equilibrium.

As my first-year thermodynamics professor once pronounced with much gravitas, “Sooner or later, all of us come to equilibrium.”

This tendency exists in economics as well. If two products, identical in every meaningful respect, have different prices in different markets, natural forces will drive the prices together. Governments struggle against these forces with taxation policy. For example, as every Canadian smoker fed up with the high tax on cigarettes knows, cheap cigarettes can be found at the nearest First Nations territory. This puts pressure on the government to keep “sin taxes” to a reasonable level. If they do otherwise, retail establishments suffer and their owners vote against the ruling party.

Markets out of equilibrium can be a profitable prospect for enterprising souls. If you can buy the product where it is cheap, and sell it where it is expensive, you can pocket the difference. This is called an arbitrage opportunity.

There is an arbitrage opportunity in the market for electrons. Electricity generated in the middle of the day is worth a lot more – twice as much, on average, if you look at the last five years’ worth of data from Ontario’s Independent Electricity System Operator (IESO) – than electricity generated in the middle of the night. Sometimes, the price of electricity drops below zero – the utility is paying its customers to take the electricity off its hands. This is because its base load is too inflexible to be throttled. One of many drawbacks of nuclear energy.

A keen-eyed arbitrageur will note that if a physicist were to examine a watt of electricity generated at midnight and a watt of electricity generated at noon, she would see no difference. Electrons are electrons. The only reason the price difference exists is because storing those electrons – or, more accurately, storing the energy that those electrons carry – is no easy task.

But it is by no means impossible. Numerous technologies exist to store energy. One that is familiar to all is the rechargeable battery. Mobile phones, cars, iPods, even solar garden lights all rely on the ability to convert electrical energy to chemical energy, where it can be stored for a time. Rechargeable batteries, along with pumped storage, compressed air, flywheels, and other technologies, allow energy to be stored.

The rub is that for every watt that is stored, somewhat less – for some technologies, substantially less – than a watt can be retrieved. Energy storage must forever toil under the tyranny of the Second Law of Thermodynamics. Whenever energy is converted from one form to another, a little bit is lost forever as heat.

The trick is finding an energy storage technology with small enough losses – not to mention other costs of doing business, like financing, machinery maintenance and upkeep, executive salaries, corporate taxes, and so forth – that there is still money left over after buying electrons low and selling them high.

One business that is hoping to do just that is Hydrostor, with its underwater compressed air energy storage technology. The concept is simple. At night, when electricity rates are low, air is pumped into balloons sitting on the bottom of a water body – Lake Ontario just off the city of Toronto, say. This process produces heat, and heat is energy, so the system includes a way to store that heat in an insulated thermal reservoir. During the day, when electricity rates are high, air is released from the balloons and heat is liberated from the thermal reservoir, driving turbines that produce electricity.

In fact, if Hydrostor gets one of those nights when demand is so low that the utility is paying its customers to use electricity, they will make money twice – once when it stores the energy, and once when it spits it back out.

If your raw material is something that a supplier pays you to take off their hands, that’s a good business to be in.

Hydrostor claims their process is 70% efficient. If we go back to our IESO data set, that actually leaves Hydrostor with a pretty narrow window of profitability. If they only run the system for two hours a day – pumping air from 3AM to 4AM and then releasing it from 6PM to 7PM – they will have a gross margin of 57%. If they pump for the six cheapest hours and release for the six most expensive, their margin will drop to 36%. If they do 12 hours on and 12 hours off, the margin is a paltry nine percent. Hydrostor has an odd business model – the more they produce, the less money they make.

So they’re better off somewhere in the middle – probably the six hours in, six hours out option. 36% is still a healthy margin. More power to them, in my view. If the Ontario Power Authority and other agencies like it buy into the idea, investors will follow, and Hydrostor will have a winning ticket.

Arbitrage can be a money-spinner for a time, but it inevitably becomes the victim of its own success. As supply is drained from the cheap market, the price rises there. As cheap supply flows into the expensive market, the price drops there. Eventually the two prices will be driven together – or at least so close together that there ceases to be any profit in the arbitrage. The two markets have come to equilibrium.

For now, there are few enough players in the energy storage market that there is no danger that Hydrostor and its ilk will make a meaningful impact on the diurnal variation in the price of electricity. But technology will advance, more players will enter, and eventually – who knows when – a high-noon electron will cost almost the same as a midnight one.

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Unnatural but unavoidable

Wind energy has become the favourite whipping boy in the renewable energy world. However, solar energy has its critics as well. Wind energy opponents are usually current or prospective neighbours of turbine installations. Solar energy naysayers are typically actual or would-be economists.

“Why should we invest in solar photovoltaic systems? They aren’t cost effective.” This is akin to asking, “What use are seeds? You can’t eat them.” No, solar PV is not cost-effective. Yet.

Actually, that’s not entirely true. Solar PV is already a highly competitive option in cases where the solar resource is plentiful, or alternative power sources are expensive, or both. However, there are still relatively few situations where solar PV can compete against coal, natural gas, nuclear, or hydroelectricity without subsidies.

Why should we care? Subsidies cost the taxpayer (or, in the case of feed-in tariffs, the ratepayer). The cost cannot be justified unless it brings some benefit. So what benefit do solar subsidies provide?

First, it’s worthwhile examining what will happen in the absence of subsidy. Fossil fuel energy sources are limited to however much is stashed away in the earth’s crust. As time goes on, these sources are being depleted. That is why the price of oil and coal has been climbing inexorably. Occasionally a new technology such as hydraulic fracturing (“fracking”) comes along which offers up a large amount of new supply, but such events only postpone the inevitable.

As traditional energy sources climb in price, there appear more and more marginal cases in which solar becomes a cheaper option, and the market for solar PV grows. As the market for solar increases, industry capacity increases to meet the demand. As production volumes increase, companies work their way up the learning curve and drive costs out of the process, bringing the price down. Since competing technologies are rising in price, it is an inevitable consequence that the price of solar will drop, and the market for solar will grow.

So what’s the problem? Why not leave well enough alone, and let the solar market evolve naturally?

One would do as well to ask, “Why should I leave the Titanic and get into your lifeboat? I’m not wet yet.” Yes, we’re not wet yet. But the ship is sinking, the water level is rising, and time is running out.

Fossil fuel combustion produces greenhouse gases, and greenhouse gases are altering the Earth’s climate. The damage is getting worse as time goes on, and many disastrous effects won’t even appear for many years yet. We do not have the luxury of waiting. We need to reduce greenhouse gas emissions now.

There are two ways to accomplish this. The first is to continue burning fossil fuels, but reduce or eliminate the greenhouse gases they emit. The second is to stop burning fossil fuels, and deploy non-polluting energy sources to pick up the slack.

Option #1 can be accomplished through Carbon Capture and Sequestration (CCS) technologies. However, such technologies won’t attract investment if there is no money to be made. Until carbon taxes or carbon cap-and-trade regimes are in place worldwide, there won’t be any market for CCS and the technology will continue to be a hammer looking for a nail.

Even if a CCS market springs up, it still won’t be enough. Too many fossil fuel applications don’t lend themselves to CCS, most notably automobiles. Converting the automobile fleet over first to hybrid technology and then to all-electric drives will be a mammoth undertaking requiring massive investment. It will also necessitate replacing the energy of gasoline and diesel fuel with yet more electricity.

If you run down the list of alternative energy technologies – wind, solar, geothermal, wave and tidal, biomass, whatever else is out there – and ask which of these is going to solve the energy crunch, the answer is “Yes”. None is a silver bullet. We will need all of them, including solar PV. And we will need them sooner than will be possible if market economics is the only thing driving the agenda.

Market interventions are a bad-news-good-news story. The bad news is that feed-in tariffs, renewable portfolio standards, carbon taxes, or other policy options – are a necessary evil if we are to avoid catastrophic climate change. The good news is that these interventions don’t need to last forever. They are not a life sentence. It is helpful to think of them as being like raising a child rather than owning a car.

The car will cost you as long as you own it. Loan payments, repairs and maintenance, fuel, insurance – they never go away. Clean energy interventions are not like that. They do not last forever.

A child is utterly dependent when first born. A parent must commit to providing care 24 hours a day, seven days a week, 365.25 days a year. But the level of care declines over time. First the child starts schooling. Years later they get their driver’s licence. Eventually the parent is lucky if they get a phone call once a week.

Renewable energy subsidies are the same. At the outset, they look like a significant commitment, although the miniscule size of the market and the industry ensures that the total cost is actually not that great. Over time, the market increases in size, but simultaneously the costs are driven down and the subsidy can be as well. Then the first major milestone is reached – retail grid parity, where the technology can provide energy at the point of use for the same cost per watt as the retail price. Finally, nirvana – wholesale grid parity, where the technology competes on the same level as any other source that is feeding energy into the grid. At that point, the subsidy has done its job and can be eliminated.

Renewable energy subsidies are costly, make no mistake. But leaving the clean energy market to evolve at its own natural pace will lead to planet-wide ecological catastrophe.

Life is hard, but it beats the alternative.

Treasure trapped

Short-term thinking is the bane of the energy world. It has been so since the early days of the oil business, and it remains so with today’s market for solar photovoltaic power generation. In the former case, oil producers were guilty of the flawed thinking. In the latter, it is the producers of public energy policy.

An oil reservoir is typically found in a permeable stratum sandwiched between two impermeable ones. As the oil is extracted, the pressure it exerts on the layer above is reduced. As a result, the overburden subsides.

At some locations in the reservoir, the stratum between the two impermeable layers may be quite thin. The subsidence phenomenon may be pronounced enough that the impermeable layers squeeze off the flow of oil at some points. Entire sections of the reservoir may be cut off in this way, leaving pockets of oil that are too small to merit a dedicated well, but large enough that their loss is painful to the producer.

There is a solution, literally and figuratively. The producer can inject water into the reservoir some distance from the well. The injected water displaces the oil, forcing it toward the extraction borehole. It can also provide enough pressure to keep the adjacent strata separated, preventing portions of the reservoir from being choked off. This is called secondary recovery.

There are a few of reasons why secondary recovery hasn’t always been used. For one, the methods were only developed in the 1930’s, so any oil extraction prior to that was possible only while the reservoir pressure remained above a certain critical level. Even after secondary extraction techniques were developed, some oil production companies simply did not bother to invest – once the well stopped producing, they simply moved on.

Here’s the rub. If they didn’t use secondary extraction during production, there is often no going back – the oil is trapped irreversibly. For each barrel of oil extracted, one to six barrels were left in the ground, forever out of reach.

In the movie Dances with Wolves, Lieutenant John Dunbar and his Cree friends come across a scene of heartbreaking carnage. Dozens of dead buffalo litter the prairie, killed by white hunters only for their hides, leaving the massive skinless carcasses to rot in the sun. The Cree are devastated at the horrific waste of their most precious food source.

Like the buffalo corpses, mismanaged oil wells are a grim monument to greed and short-term, get-rich-quick thinking. And history is repeating itself with the solar energy market.

In Ontario, a Feed-In Tariff (FIT) program implemented in 2009 has offered property owners the opportunity to generate their own electricity, feed it into the grid, and receive (at least until recently) lucrative compensation for it. However, built into the FIT program was the incentive to recreate the same waste as oil well mismanagement and wanton buffalo slaughter.

In this case, the resource is not oil nor buffalo, but rooftop space. The highest FIT rate was for rooftop solar photovoltaic generation projects. However, the rate dropped off dramatically once the installation exceeded a generation capacity of 10 kilowatts (kW). The rate structure was such that once the generation threshold was exceeded, the lower rate applies for the entire project.

Hence, the FIT program contained a built-in incentive to keep a project under the 10kW threshold.

The result is easy to see. All across the province are rooftop solar arrays which cover only a fraction of the available space. For example, the array on the roof of Dublin Street United Church in Guelph leaves a considerable margin of bare roof on all sides. The array as installed has a capacity just under 10kW.

Like the oil reservoir, once the array is built, the die is cast. Nobody is going to go back to a completed installation and make it bigger. The wasted space will remain wasted. Yet another resource is left to sit idle, unused, and unusable.

There is another way.

The perverse incentive to stop just short of 10kW could be removed if a blended rate were used. Until the program was frozen in October 2011 for a review, the top rate for rooftop PV was 80.2¢/kWh.  If the installation exceeded 10kW capacity, the rate dropped to 71.3¢/kWh. It would have been a simple matter to make the higher rate apply to the first 10kW of capacity, and the lower rate for capacity above that (at least until 250kW, the next rate break point).

It’s all a moot point now. As a result of the FIT review completed last month, the rate for rooftop solar will be slashed to 54.9¢/kWh for arrays up to 10kW, and 54.8¢/kWh for arrays from 10kW up to 100kW. A tenth of a cent is not going to affect decision-making very much. The days are over when FIT (well, to be terminologically correct, MicroFIT) projects would sneak in just under the 10kW limit to secure the higher rate.

In fact, the days of MicroFIT projects may be over altogether. It remains to be seen whether industry players can still turn a profit now that rates are nearly one-third less than they were.

In any case, there is a clear message to any jurisdiction that may be considering a FIT program: You have a valuable resource in rooftop space. If you don’t set up your rate structure correctly, you could be setting yourself up to waste an awful lot of that resource.

From buffalo, to oil, to solar rooftops – you’d think we’d learned. Clearly we haven’t yet.