The Gulf Crisis–Beyond Petroleum–A Game Changer?

“US Offshore Drilling is a Good Thing” A few weeks ago, shortly after President Obama announced an expansion of offshore drilling rights, that was the working title of a post I was contemplating for this blog. The premise was that it would take many years before we weaned ourselves from our use of oil, and production of additional domestic oil and gas  would have some impact on overall prices, increase natural gas usage (reduce CO2 emissions), reduce our dependence on foreign energy sources and have a positive impact on our trade balances. While I was fiddling around with this post and enjoying some late season fishing in Argentina instead of writing, along came the  “Black Swan” Gulf disaster.

The disaster is ongoing as it will be for many years to come. Much has been written and will continue to be on the environmental, human, political and economic consequences of this Inevitable Accident, which is the way it should be referred to.  I have my own somewhat disconnected observations, which I will share. trying to see what, if any, good may come out of an event that some are calling a “game changer.” I expect disagreement and dialogue and hope we get some. I hope none of what I have to say approaches the idiocy of one of our Senators who is willing ro repeat again and again that the Gulf incident is not an environmental disaster. Let’s get to some of the observations.

This disaster was inevitable—the Inevitable Accident.  In the continuing search for and production of carbon-based energy sources we keep stepping up the risk, whether that is in a coal mine in Virginia or China, a shale deposit in Pennsylvania, a tanker on the ocean, a LNG terminal or deep wells offshore  anywhere.  The technology becomes more complex, the measure of risk more difficult, and the cost of mitigating risk too high at today’s prices for carbon to be fully recognized and absorbed.  Maybe this disaster was a good thing. I hesitate to say that because of the loss of life and livelihood for those directly impacted. However, the response to it may prevent other similar or worse disasters. Although, most likely, it will simply delay the next more devastating disaster as the risk-taking outpaces the rule-making in the effort to meet the insatiable demand for energy worldwide.  One example of risk-taking outpacing rule-making is the talk of raising the liability cap from $75 million to $10 Billion.  Odds are this “incident” should cost BP well north of $30 Billion. In today’s dollars Exxon-Valdez cost Exxon about $10 Billion. If a major oil company sees its financial risk as “only” $10 Billion, there are lots of risks one can take that have an expected value substantially higher than that.

Whatever the US does in terms of limiting off-shore or on-shore drilling or raising the cost via rules and regulations, it will likely have limited impact on drilling elsewhere. In fact costs may be lower elsewhere as the supply of rigs available rises. Brazil has some heavy duty drilling ahead of it. Its costs will go down. Whatever steps are taken will also likely benefit the bigger companies relative to smaller participants. OPEC must be jumping for joy as well.

I still wonder why we didn’t bring to bear immediately the best engineering and scientific minds in this country, or the world for that matter, to get in front of this disaster. The attitude seemed to be one of “this is BP’s problem.” There was much more time spent on establishing who was at fault than responding to the problem. Certainly, it made it more difficult for BP to shift responsibility technically and financially. But, this had the makings from the beginning of a potential major human and ecological disaster if things did not go well. When a casual suggestion late in the process from our Secretary of Energy provides a solution to a specific problem (gamma rays to analyze the stuck valve) one can just imagine what might have been in a much more organized effort to bring brainpower to the problem. It doesn’t give one much confidence that our response to the next disaster will be any better.

Maybe this increases the odds of further action by the US on climate change legislation and an increase in incentives for alternative energy sources. There are powerful forces opposed to that with several senators as their mouthpieces, but, maybe this is a game changer. I don’t yet see the outrage though. A few people boycotting buying fuel at a BP service station, which only hurts the owners of the station—not BP—but not much more directed anger. A lot of “isn’t it too bad,” as people drive their gasoline guzzlers to and fro, but no real outrage. Why aren’t consumers demanding that the auto companies (the US government in some instances) substantially increase mileage standards and come up with alternative fuel systems?  The boycott should be against new car purchases unless the mpg rating is at least at China’s standard, 35 miles per gallon on its way to 55 or 60 mpg. As I have pointed out before, once we get the fleet to that level we stop buying oil from other countries except Canada and Mexico—and at some point that should end as well.

One could go on with other observations, but the above are some major ones.  The level of outrage needs to rise nationwide, not just in the areas affected, as does the level of responsive and responsible action. Let’s not waste this crisis.  Let’s not wait for the next Inevitable Accident.

Light in Varanasi

Varanasi is a very old, very holy city in the eastern part of Uttar Pradesh, India. Named after two of the rivers, Varanu and Assi, flowing into the Ganges, Varanasi, to me represents all of India. A drive through the city unveils all aspects of the country—modern cars, modern buildings, but in small proportion to the masses of hindus, muslims and others using every form of transportation; construction everywhere; the small shops which become dwellings at night; the cows, oxen, pigs, goats, dogs wandering on the streets and occasional monkeys on window sills; families of five on a motorcycle, with only the driver wearing a helmet; groups of seven or 8 in a three-wheeled motorized rickshaw. tuk-tuk or auto depending on the namer’s provenance; horns, the essential driving accessories, blaring as two lanes become 4 or 5. As one crosses the Ganges and heads toward the villages outside of the main city, the rural character of the country exerts itself immediately. Brick, wood, straw and mud homes in clusters sit adjacent to very dry rice fields with ¼ acre rectangles surrounded by 8 inch high embankments waiting the beginning of the monsoon season.
Last year the monsoon season arrived late producing a smaller first crop and lower incomes. This year the season is expected to start early—good for the farmers, not necessarily good for the primary purpose of our visit. We, http://www.duronenergy,com, are selling a solar home lighting system with three LED lights and a cell phone charger. Six to eight hours of sunlight or a charge from the grid when it is working, provides six to twenty hours of light at three locations, depending on the intensity of light needed. It can also power a fairly robust fan for several hours. With electricity from the grid undependable at best and kerosene in use where the grid doesn’t reach, some form of clean light is needed for safety, security, health and, maybe most importantly, education. Two hours studying under a kerosene lamp is all a child’s eyes can take—forget about the long term impact on his or her health.
However, while the next month is prime season for us, the approach of the monsoon season raises questions about whether there will be sufficient sunlight to charge the system. The need may be greater as school begins and the grid becomes even less reliable. But the sale is a bit tougher. We have a dealer network with shops in the small towns that the villagers come to for a variety of goods, but a solar system at 6000 Rupees is not a drop-in sale. So we have the equivalent of Avon ladies or Fuller Brush men going door-to-door and village-to-village occasionally accompanied by a marketing van—not too different from a traveling medicine show. We are not selling elixirs, but something a bit more tangible. We also, fortunately, have a regional bank with branches in most of the locations we are interested in. The government is providing the banks with incentives to finance alternative energy systems. Ours has been a hit with this bank. It helps that the distributor, who manages the dealer network, has worked with the bank to finance his other product line–three-wheeler motorized rickshaws using CNG as the fuel source. He is already selling a product that is more efficient, produces fewer emissions and provides a higher level of income to the buyers. He is excited about another alternative energy product. While the ticket on the rickshaw is higher, sales don’t occur every day. The solar home system, with the right support, will keep his dealers busy and substantially increase their income. As one can tell, this is early days on retail consumer durable distribution in India. Whoever cracks this nut has a big business.

Do We Need a Price On Carbon?

In his January 10 Op-Ed piece in the NY Times, http://www.nytimes.com/2010/01/10/opinion/10friedman.html?scp=8&sq=tom%20friedman&st=cse, Tom Friedman makes several points about where things stand in the Energy Technology race and reaches the conclusion that China may be winning and will continue to win unless the US gets serious about energy legislation and carbon pricing. In recent days, starting with the State of the Union address, we have heard a bit more noise from the current administration on the energy front–nuclear power, additional subsidies, no capital gains on start-ups and maybe, a cap-and-trade system or some form of establishing a price on carbon. Maybe it will happen, and, maybe it is necessary for the developed world, where replacement of existing carbon-based energy is the principal requirement. In China, India, and much of Asia, new energy sources can be put in place to meet demand growth—a very different set of economics. And the markets are big enough to drive prices down a volume-related cost curve in addition to cost reductions from new technologies and systems. It allows room for more experimentation. It is a requirement if one really wants to be energy independent. Last year China did import 4.1 million barrels of crude oil a day, a little less than half of what the US imports. But this is likely to grow as auto sales grow, unless… See the April post, “China and Electric Cars—The Stakes Have Been Raised.”
China doesn’t appear to need a price on carbon today to look for alternative energy sources. It understands the relentless energy demand it faces as its economy grows and the pressure that would put on existing energy prices. And it understands, politically,  it cannot continue to pollute its air and water. In my visits there I have even seen some evidence that it understands the Climate Change risks from continuing CO2 emissions.

A brief story: In June, 2008, at a UNEP meeting in New York, I was asked if I could name one thing that one country could do that would accelerate the path toward alternative energy adoption and CO2 reduction. I responded “I guess the expected answer would be that the US should do almost anything. But since I do not think it will, my answer would be for China to institute a $50/Ton Carbon tax. This would accelerate the pace of change in China and would likely shame the rest of the world into responding in kind or with a serious cap-and-trade system.” Immediately the Chinese delegate asked to speak. She started with a very logical argument that China was in the early stages of entering the developed world with a low GDP per capita and such a tax would be a burden on many of the people finding their way into its new economy. However, she closed her statement by saying that China could not institute such a tax unilaterally (my emphasis). An interesting choice of words. The truth is, if China did institute an internal carbon tax, it would dramatically accelerate its alternative energy adoption and innovation. The US would spend way too much time figuring out how to respond and would then be in real trouble in Tom Friedman’s race.

At the moment, it is still a race. We shouldn’t require a price today on carbon to stay in the race. It should be apparent that the present value of tomorrow’s prices for carbon and the cost of climate change would justify alternative energy adoption and innovation today. Unfortunately, our system seems to require that the price be explicit before we really get serious. And, maybe, once the Western World as a whole has an explicit price, Asia will get explicit as well. Then we will see if it stays as a race between countries or simply becomes the race to save the planet.

Trade Deficits, Energy Independence and, Oh Yes, CO2 Emissions

Our trade deficit with the rest of the world widened in September to $36.5 Billion, more than was expected.  Oil prices, a weak dollar and a rising deficit with China were viewed as the culprits. To the extent the trade deficit widens it reduces the growth of GDP. So economists are lowering their growth rate numbers for the third quarter and shaving numbers for the future as well. With President Obama’s trip to China in the news, journalists and others have jumped on the “undervalued” Chinese currency as a systemic problem that China must correct to solve the US’s trade problems and maybe those of the rest of the world as well.  It is highly unlikely, in my view, that a rise in the value of the yuan would do much beyond shifting the manufacture of some of the goods the Western world is buying from China to other Asian countries. I also think those countries, which already have strong trading relationships with China, would remain within the Chinese supply chain.  Nominally, our trade deficit with China might shrink, but it would rise with the other lower cost countries within the Asian sphere that are increasingly an integrated  part of the new center of manufacturing for the world. Of course, in the short term, deficits would rise as US companies would not easily shift from the established supply chains they have which are working well. Some combination of profit margins falling and prices rising on finished goods would be the more likely result.

So let’s, instead, turn to something that we control that would over time reduce our trade deficit—eliminating imported oil. I wrote about this in my post “Our Mileage Standards Are a Joke,” but let’s do it again with some refinement.  I apologize for all the numbers but we have to deal in facts if we want to get to a solution:

We are still importing close to 10 million barrels of oil a day, about half from OPEC (with Saudi Arabia and Venezuela the biggest), a fourth from Canada and a little more than 10% from Mexico. We have about 240 million cars on the road traveling about 3 trillion miles a year, consuming 4 billion barrels of gasoline or about 11 million barrels per day. At a scrappage rate of 4.5% a year we will have a new fleet of cars on the road in 20 years.  By the way, the current rate of new car sales is about equal to the scrappage rate.  We aren’t adding to the fleet. If we pushed our mileage standards up to get us to 55 miles per gallon on new cars in 20 years (which is where the rest of the world is going already), our usage would only be 5 1/2 million barrels per day on its way down every year after that as continued scrappage eliminated the lower mileage vehicles. Given what we are seeing already from the new start-up car companies and Ford and GM I think we could blow those standards away. I also think scrappage would accelerate if there was a real breakthrough in miles per gallon on a broader class of new cars.  The eVolt gives us a hint of what could happen.

So what about the trade deficit?  Well, the reduction of 5.5 million barrels per day of oil equivalent at, say, $70 per barrel (pick your price) is a $140 Billion annual reduction in imported oil. That is giving no credit for exports of the technology created to meet these mileage standards if the US government truly supports the development of these technologies within this country. The ARRA and DOE grants to new vehicle and battery companies are a start.  It also gives no credit for a possible share gain by US based auto manufacturers as the new technologies grab hold.

And CO2 emissions? A little more problematic a calculation since it depends on what gets one to 55 miles per gallon.  The simple calculation is the elimination of 83 billion gallons of gasoline at 20  pounds of CO2 per gallon or about 830 Megatons of CO2 per year.

Certainly, this is not the only thing we can do to reduce the trade deficit, but it provides a partial solution to existing geopolitical, economic and climate change problems that we don’t really seem to be addressing.

A123 Succeeds and the Real Financiers March On

Well, the A123 IPO has to be considered a success, certainly for the company and for those who participated in the offering.  The company expected to raise about $200 million—somewhat short of the matching funds required to access the ARRA and DOE loans.  Because of the demand from public equity investors, the size and price of the offering were raised and the company ended up more than doubling its initial expectations, exceeding the matching funds required for the ARRA and DOE money.

The stock rose almost 50% from its offering price on the first day of trading. If one participated on the IPO one is up about 50%. If you bought it on the close at the first day you are about flat, almost the same as the S&P 500 for that period. That the deal got done with a bit of a splash is good news for the IPO market, good news for the M&A market and good news for venture capitalists. Maybe it will encourage the VCs to put some of the reserves they set aside for the potential economic hurricane that was going to rain down on their portfolio companies into new ventures. I certainly hope so.

In the meantime the other real financier, the federal government, continues to put capital at risk.   The DOE agency, ARPA-e, the Advanced Research Projects-Energy, modeled after the DOD agency, DARPA, announced grants totaling $151 million to a variety of entities to fund very early stage technologies in the clean energy space. If you want to get excited about what can happen on the carbon reduction front, go visit http://arpa-e.energy.gov and read about the 37 high risk, but big ideas the government is backing. Arpa-e has another $250 million to put to work over the next year or so, and has 263 already fully-formed ideas to choose from.  It would be interesting to expose those ideas and the other 3300 less-well-formed ideas it has received to the venture capital community. Few will pass the rigorous screens of the seasoned venture funds, but the process itself could trigger an excitement and reinvigoration of the creative and competitive juices that the venture community can bring to bear when it looks beyond the valley (if you’ll pardon the expression).

Let’s recall the role Darpa played in seeding the last two venture cycles, microchips and the Internet.  Darpa is also playing a role in nanotechnology as well.  Even A123 in its early days was a beneficiary of military money.  On Point Technologies, an Army-backed venture fund managed by Arsenal Venture Partners (look it up!), was an investor in A123 in 2004, in its second round. For those military conspiracy fanatics, isn’t it a strange coincidence that A123’s headquarters are located in the old Arsenal building on Arsenal Street in Waltham? I like the conspiracy I see developing:  Our current Secretary of Energy, Dr. Chu, was part of a National Academy of Sciences committee calling for the creation of Arpa-e.  Three Senators, Clinton, Reid and Bingaman, proposed establishing it in early 2007. It was created but not funded during the Bush Administration. Steven Chu became Secretary of Energy and the financial crisis led to funding through ARRA of Arpa-e. Whatever works.  Let’s just get on with it before these big ideas find a home away from home.

A123–The Real Financiers May Be Standing Up

A123  just filed to go public,  http://sec.gov/Archives/edgar/data/1167178/000104746909008218/a2193887zs-1a.htm. The underwriting group is being led by Goldman Sachs and Morgan Stanley.  A123 makes energy storage systems (batteries) using nanotechnology, interesting manufacturing techniques and some proprietary chemical formulations.  By using microparticles to coat the anode and cathode of its lithium-ion batteries, A123 appears to be able to reduce the form factor (size) and weight, increase efficiency, extend battery life and enhance safety. This can have application in many markets, but electric or hybrid vehicles, electronic devices and intermittent energy storage are certainly big potential markets. This is a company I first got to know in its infancy, although I was not able to make an investment.  The existing investors didn’t need anybody else, then.  I guess I will now have a chance to do so in the public equity market, if I so chose, at a  higher valuation than most of the early private rounds. I could go on about the company, but the company, itself, is not the subject of this posting. I would urge everyone who is interested in clean technology–particularly batteries–, the history of a venture-backed technology company and the equity markets to read this prospectus in its entirety.  Pages 10-45 must be read to get a full understanding of the risk factors associated with such a company, and pages 72-79 give one a good education of the various battery technologies and the markets they can serve. This posting in no way represents an offering to sell this security or a recommendation to buy it.

What this posting attempts to do is point out what may be a phenomenon of our time regarding the source of financing for innovation in this country, particularly in the clean-tech space. July 26th, I wrote a post in this blog titled “Where’s the Money–Will the Real Financiers Please Stand Up.” It was basically a rant that much of the venture capital industry, which has been an incredible strength of the US industrial system, is in retreat. This generation of  vc’s appears not to have the patience, maybe not the capital nor the foresight to invest strategically in new big ideas. Having grown up in the heady days of the dot-com era, many seem to have a sense of entitlement and an expectation that returns need to be forthcoming in very short time periods. Longer—what I would call normal—investment cycles and the illiquidity produced by the current economic malaise seem to have produced paralysis.  

Well, maybe we are starting to find the real financiers.  Under normal circumstances A123 would not be attempting to go public at this stage. Its current backers—experienced vcs, successful entrepreneurs and GE–, would be putting up more funds and finding other sources of private capital to take this company closer to a less risky future.  Instead, the next risk capital is expected to come from two other sources—the federal government and the public equity market.  Through the ARRA (American Recovery and Reinvestment Act) and the ATVM (the DOE’s Advanced Technology Vehicles Manufacturing Loan Program), A123 can get its hands on about $484 million to fund construction of a plant in Livonia, Michigan. The State of Michigan has also made a small ($10mm) grant in support of this facility. A123 has to put up some of its own money (dollar-for-dollar for about half and one-for-four for the other) and meet some other requirements, but this dwarfs the capital committed by the vc investors to date. A123 hopes to net about $200 million from the public offering, which I believe also exceeds the capital put at risk by the vc’s.

So the new investors are the government and, more importantly, public–as opposed to private– equity investors. In spite of the risks associated with a company at this stage in its development, the addition of liquidity and the chance to be an investor at an earlier stage in a venture may be enough to justify buying in at almost a $900 million valuation for a company with $43 million in sales and $40 million in losses for the first 6 months of this year.  As I said, read the prospectus, the registration statement and anything else you can get your hands on.

I do hope this offering succeeds.  If it does, it may signify the opening of a capital window that is critical at this time to continue the innovation efforts of many companies in clean tech and other technologies and services.  The timing may be right, or even essential, since China is creating a Growth Board within the Shenzhen Stock Exchange to make it easier for small companies there to go public. Under their current proposals, A123 wouldn’t qualify, but I wouldn’t be surprised to see those qualifications change. I can think of several companies in this country (and China and India)  that have metrics similar to or better than A123 who need capital and are well-positioned in markets of a size similar to the one A123 is going after.  Some of these companies may not even require 35 pages of risk factors to file for an offering.  Even if they do, it may be time to test the public’s appetite for the degree of risk and reward associated with this generation of new companies. In many instances the funds required to get to lower risk may be more than even the experienced venture capitalists can put up. The government and the public may have to be the sources.  One way or another, we must get capital behind these companies if the US is going to play a significant role in this global marketplace.

Cash for Clunkers is a bit of a Clunker

On one level “Cash for Clunkers” (CfC) is viewed as a big success. The first $1 billion was used up in a month and 245,000 new cars, 45% from the US car companies,  were purchased.  Congress looks like it is adding $2 billion more to the program, which the government now believes will be spent in another month.  This compares to its initial forecast that the first billion would not be spent fully until November, when the program was scheduled to end.  The seasonally adjusted annual rate (SAAR) of sales in July was 11.2 million. According to Reuters, 994,000 new cars and light trucks were actually sold in July, down 12.1% from a year ago, but up 30% from the previous month.

Without going into great detail, here is a shorthand review of the CfC program. If one trades in a car less than 25 years old that gets a rated 18 miles per gallon or less, one can get a reduction in the price of $3500 if the car purchased gets at least 22 miles per gallon and the pickup in mpg is 4 to 10 mpg. If it’s over 10 mpg the reduction is $4500. One can further negotiate with the dealer on the value of spare parts in the car.  The actual engine block and other critical parts of the car have to end up in the scrap heap. The dealer has to certify a number of elements of the transaction before receiving the rebate. The money is being diverted from a loan program related to green energy.

This seems like a pretty good deal for a new car buyer, particularly if he or she was preparing to trade in or sell a used car anyway. It’s an easy calculation to determine whether the CfC provides a better deal than a straight trade-in.  11.2 million SAAR of sales is about at the minimum replacement rate for scrappage one would expect from the existing fleet of about 240 million cars and light trucks. No doubt, this did accelerate some car sales, likely borrowing from the future but reducing inventories—some might say too much—, providing traffic and cash flow to the dealers, preserving some jobs and boosting the economic statistics. Combined with some other factors, such as better employment stats, maybe this provides a boost to consumer confidence, which is an important factor in getting the economy moving in the right direction. I’m just not sure that the numbers really add up. Let’s look at a few.

If you want to see a very good analysis of many of the metrics on this program you can read Matthew Wald’s piece in the August 8, New York Times, “Doing the ‘Clunker’ Analysis”: http://www.nytimes.com/2009/08/08/business/08clunker.html?scp=1&sq=doing%20the%20Clunker%20calculus&st

I will paraphrase some of what he says and add a bit to it.  It looks like the stats on the clunkers are that they averaged about 16 mpg while the new cars purchase averaged close to 26 mpg. If, on average, these cars were driven 12,000 miles per year there would be a savings of about 280 gallons of gasoline per car. That’s about 1.6 million barrels of gasoline a year for the 245,000 cars or maybe $202 million less spent on gasoline (at $3/gallon x 42 gallons/barrel). Since a gallon of gasoline emits about 20 pounds of CO2, the 67 million fewer gallons of gasoline consumed reduces CO2 emissions by 670,000 Tons per year. Over a 25 year life that would be 16.75 million Tons of CO2.  Without taking into account the cost of money over 25 years that still comes out to about $60/Ton of CO2 that was eliminated from the atmosphere. Is this the target price for cap and trade or a tax? Granted, as discussed above, this program is doing more than just reducing CO2.  But, ultimately, at the lowest cost possible, reducing CO2 emissions is what has to happen. We found that the program worked better than expected.  Why not raise the bar to a bigger spread between the clunker and a new purchase.  Every purchase done today will be producing emissions for close to 25 years.  What if the spread would have been 15 mpg rather than ten?  Of course, at that spread the US car companies would not have gotten 45%.

I did have an interesting e-mail dialogue with a terrific car dealer in Wisconsin, Frank Hallada, who has both GM and Ford dealerships.  His experience is anecdotal, but somewhat telling.  I will quote him direct:   

“The “Cash for Clunkers” has certainly spurred interest in the car business.  The incentive is to the consumer with the clunker….. We have been giving the customer credit for the monies, much like a rebate.  We have currently delivered 13 new vehicles and have yet to receive an approval status from the government.  The paper work is the responsibility of the dealer and the dealers are finding it to be a bit complicated.  We have been told that we would receive payment in 3-7 business days of an approved claim.  We have 7 claims that are a week old and are still in the under review status.  I spoke with 3 dealer friends on Saturday and none of them have received payments.  We will be required to trash the motor of the clunker 7 days after payment from the government.  We will then sell the vehicle to an authorized salvage yard for no more than $50. 

I believe the program could have been successful with a $2,500 rebate.  All but two of our clunkers have a value of $1000 or less.  The demand has slowed in the last few days.  I think the biggest problem with continued success,will be the availability of new vehicle inventory.  I have sold out of the most popular models at both the Ford and GM store.”

I am not sure that the program is really accomplishing what it was expected to. It has been a nice gift to those with clunkers, particularly if Frank’s experience is typical. But, it is truly replacement demand, not new demand.  And, it probably means that the buyers took on additional debt to buy the new car, or used a substantial amount of cash that might have been available for other uses. $60/Ton of CO2 reduction, at best, seems a high price to pay, particularly if the loan program, which was primarily for capital stock which results in real growth, is not replenished.  If the additional $2 Billion is used up in this quarter, it will make the quarter look quite good, but the fourth quarter will look less good.  Another example of unintended consequences. And, no real step forward in true carbon reduction.

A Local Problem or a Global Problem? The Monsoon Was Not Soon Enough.

India is now in the midst of its annual monsoon season. 80% of India’s rainfall occurs during this season and is critical to its agricultural system. However, in many places it started 3-4 weeks late.  Cumulative rainfall appears to be catching up, maybe now only 18-20% below normal in many places, 40% below normal in others. Daily rainfall is now running 50 to 80% above long term averages although June had the lowest cumulative rainfall in more than 80 years. In some spots, Uttar Pradesh (UP) being one, the lower rainfall is being characterized as producing “drought conditions.”  In a parochial sense, I care about UP.  Our company, DWP, sells solar systems to the farmers there (see on this blog, “600 Million Points of Light…”). A late start to the rain meant easier logistics selling in the area in June.  However, if this means lower plantings and shorter harvests—which it does—the farmers won’t have enough income to buy the systems later in the season. And, the price of certain foodstuffs will likely rise, further reducing spendable income. If this occurs countrywide—which is the case—it could mean demand for foodstuffs on the world market will rise as India tries to feed its people.

Maybe this is just one of those statistical events.  After all, the last four seasons have produced bumper crops in India. Or maybe, those climate change folks are right.  They have been saying that one manifestation of climate change could be changing weather patterns with shorter, but more intense “seasons.”  Some of them pointed to Katrina a few years back as an example of what could happen. Of course, that faded when the next year proved to be a mild hurricane season in the Atlantic/Gulf region. I will bet that some of them will point to this year’s monsoon season as supporting their case.  In any event, weather/climate will likely force India to add food shortages to its list of problems this year.

India is taking somewhat of a wait and see attitude on Climate Change—as are many people. If nothing else, India believes that the western world should not be asking it to reduce carbon emissions when the developed countries are the ones that have put most of the carbon into the system up to now. On one level India is right.  The western world needs to take some very aggressive steps to reduce its use of carbon. On another level, all the evidence says that India will likely suffer the most of any major country if global warming does occur—and there is some evidence that some of the effects of emissions are quite local.  In addition, moving countries toward energy independence and fueling (if you will pardon the expression) a new technological wave, it is possible that pro-active steps to reduce carbon emissions may actually save lives and add to economic growth. If I felt there was a significant risk to humanity from the carbon path we are on—and I do—and I could change my position geopolitically—which I also believe—I would be doing everything I possibly could as a country to be a major participant in this carbon reduction cycle. As I said in my first post on this blog, we may be 10 years away from a more universal recognition that we have a problem.  We are getting some early signals. How many do we need?

Where’s the Money–Will the Real Financiers Please Stand Up?

We have entered into a different cycle of entrepreneurship and opportunity.  That doesn’t mean the last cycle is ending.  The internet, the delivery of content at faster speeds and lower cost, the parsing of that content for greater benefit will present enormous opportunities for our health care systems, our energy systems and almost every other system of importance to humanity.  At the same time the world has embarked on a path of carbon reduction engendering new technologies, new challenges and new opportunities.  While the elements of previous cycles will be incorporated, as always, into the new cycle, this one has the added requirements of the intense application of the physical sciences, brute force engineering and re-engineering and real capital.

Over the last several years I have visited many alternative energy and clean-tech start-ups and reviewed many business plans of potential ventures in this area. At the same time I have continued my paticipation in some personal investments and others’ investments in ventures from the last cycle. There is a difference. Business models involving the movement of bits and bytes lend themselves more easily to continuous adjustment, typically have a lower capital requirement and have historically had shorter periods to failure or liquidity events, although that is changing as the industry matures. I take nothing away from the ingenuity or management talent required to succeed in these ventures, but it certainly seems different from some historical venture cycles and the carbon-reduction cycle we are now in.

Twenty years ago, Tom Doerflinger and I published a book, “Risk and Reward-Venture Capital & the Making of America’s Great Industries.”  The book detailed the start-up history of several industries–Steel, Railroads, Telephones, Autos, Computers and Biotechnology—in an effort to draw out some lessons about success or failure as it related to the role of venture capitalists/financiers.  While there were many lessons a primary one related success or failure to the relative patience of the financiers–the more patient and unintrusive the financiers the higher the rate of success.  For the most part, these were industries that required commitments of significant capital, time and technological and engineering innovation. In its early days the Auto industry may have come the closest to the characteristics of internet-related investing—small amounts of capital, quick evidence of success or failure, high gross margins and growth. After early years of high and rising prices for the products, it also experienced the pattern of declining prices and improved performance. There were many start-ups pursuing different technological paths (including electric) and distribution models.  We think of the industry today as made up of a small number of behemoths. In the early days there were many companies. A study at the time said that between 1900 and 1908, 485 car companies were started with over half failing during that period and many more in years to come. Sound familiar?

What some of the carbon reduction entrepreneurs are doing is truly amazing.  Those ventures that are moving ahead include first class engineers and scientists as well as experienced businesspeople. Watching how they deal with the typical (and some atypical) engineering problems that such operations confront daily in start-up and production modes is a real testament to these individuals and the academic and real-world training they bring to bear. It is inspiring and gives one great hope that there are solutions that will be funded, produce substantial returns and make a difference.

For the most part—and I admit this is an overstatement—the generation of venture capitalists that got their experiences only in the last cycle, don’t quite get the time and capital equipment and the technologies that have to be applied in this cycle.  Or, maybe they do, and this is just not where and how they want to invest.  Some companies are getting funded, but many promising ventures are struggling and some will disappear or at best go into hibernation. If we are counting on the classic venture capital industry as the source of funds for carbon reduction technologies and companies, the pace of innovation and implementation in the United States in particular, may be too slow for the country to be a leader in this space. Is there a new model that must emerge or will it simply be the case that the smaller number of companies that do get funded in the next few years will produce some of the best vintage year returns that we will see in this decade? That, likely, will not make us the leader, but at least we will be a participant.

China and Plastic Bags–Another Chip on the Table

Credit Suisse and the author, Henry Mo, have given me permission to paste some of Henry’s remarks on his recent visit to China in our blog. Dr. Mo is a member of the well regarded CS economics team based in New York. The observations he makes reinforce a view expressed earlier in this blog, that China, for many reasons, will be an active participant in the reduction of carbon usage.  The risk to the US is that China will make reductions that the US appears incapable of making and will leapfrog the US technologically, if and when it chooses.  We are getting many wake-up calls but seem to keep pushing that snooze button. Please read Henry’s remarks and go back and read “China and Electric Cars—The Stakes Have Been Raised.”

“I have visited China periodically over the past few years and have observed palpable buoyancy in the country every time. My recent trip is no exception, and the impression is even stronger with China being one of the few major economies that will likely expand this year. However, what impressed me the most this time was not the beautiful skyscrapers in Lu Jia Zui Financial Center in Shanghai, nor the stunningly gorgeous Olympic stadiums in Beijing, but the improvement in soft infrastructure, especially related to environment protection.

My first impression is the ban of super-thin plastic bags, introduced on June 1, 2008 to protect the environment and cut waste. Under the rules, the state forbade the production of ultra-thin plastic bags and banned supermarkets, shops, and open markets from supplying free bags to customers. Obviously, persuading 1.3 billion people to give up plastic bags is not an easy job. Equally, any success would make a big difference in protecting the environment when multiplied on a China scale.

One year after the ban, I observed a lot of changes in consumer behavior. Many shoppers now carry their own bags. Not being aware of this policy, I had to buy plastic bags at my first shopping trip during this visit. To save money, I brought bags with me when I went shopping next time. According to a survey released on May 20 by the China Chain Store and Franchise Association, plastic bags used in supermarkets have been reduced by 66% nationwide since the ban.

This means that about 40 billion plastic bags have been saved, or the equivalent of 1.6 million tons of petroleum. It is well known that the Chinese government is very good at building hard infrastructure, such as roads, airports, ports, etc. It strikes me that the government is equally efficient at building soft infrastructure, if it chooses and is willing to do so.

Despite the fact that all three cities that I visited still have massive construction sites, especially Shanghai, who will host the World Expo next year, I could smell the improvement in air quality. To be sure, air quality is still poor by western standards, but it has been better since my last visit. I also observed more blue sky and less smog, and noted that there were more “green zones” and rivers reserved or built among the newly constructed office and community buildings. 

In Beijing, the air quality improvement is also due to driving restrictions adopted for the Olympics and further extended after the Games.  To curb emissions from transport, cars are now banned from metro roads one day per working week, depending on the last digit of their license plates. From a micro point of view, the number plate-based measure may not be efficient, as it takes 930,000 of Beijing’s 3.6 million cars off the roads on a daily basis. But it is effective on a macro level. Indeed, daily emissions have been reduced by 10% since the ban, according to the China Daily. It has also been reported in the press that the city will ban all non-green vehicles from the city centre beginning in June. 

In Chengdu, the capital city of the Sichuan province in southwestern China, the air quality improvement appeared to be significant since my last visit in late 2007. As per my conversations with local officials, the primary reason for the improvement is that Chengdu has placed more emphasis on balancing environmental concerns with development after being selected by the Central government as one of the two pilot reform cities to deliver coordinated rural and urban development in June 2007 (the other city is Chongqing, also located in southwestern China). In addition, the wide use of CNG (compressed natural gas), an alternative energy that is virtually emission-free, also contributes to the improvement in air quality. It has been reported in the press that almost all taxis and buses, plus an increasing number of private cars are now using CNG as fuel. In addition to being environment friendly, CNG costs less than half the price of petrol, as a local taxi driver told me.

While China has made some progress in environment protection, there is still a long way to go for China to improve its soft infrastructure, such as legal, regulatory, and financial system, etc. The economic payoffs from building up soft infrastructure may not show up in the GDP figures in the short term, but will be reflected in the long-run growth, as well as the quality of growth, and eventually lead to more sustainable growth.”  Henry Mo  henry.mo@credit-suisse.com