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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