Friday, February 20, 2009

Will there be any "green" in a Green Economy?

Not sure if this has much finance content. More of an editorial. Sorry, but I dislike when a major variable is left out of the analysis of things.

From Clusterstock: Green Economy Not Yet Ready For Primetime... But It Will Be Soon:
"The WSJ throws around some scary subsidy numbers, saying the government pays too much for renewable energy, and its still not cheap. The Journal says that if we try to hit Obama's mandate for 25% of our energy from renewables we will kill manufacturing. The high price of alternative energy means factories will go under as they struggle to pay the outsized electricity bills....The flaw in this argument is the time frame: Obama only wants to raise our current level of alternative energy consumption from 1% to 10% over the next four years. And then hit the 25% mark by 2025....Also, as long as we keep investing in green technology, technology improvements should rapidly reduce the cost of green power. In the next two years, for example, solar power could reach grid parity"
Let me state up front that I am biased. Not because of any stock holdings. Not because I have forgotten all of my economics (at least I hope not!) But because as a runner/cyclist/outdoors aficionado/citizen worried about the future, I really hope "The Green Economy" takes does well. Why? For a reason that both the WSJ and Clusterstock seemingly ignore: the externalities of traditional energy sources.

Externalities are those costs that the user of the product do not bear. For instance, I can drive around all day in a car that pollutes the atmsophere and yet most of that cost of pollution falls on others. Externalities are notoriously difficult to measure so often we assume them away. But they are real and in any economically correct discussion must be included.

All energy comes with costs. And it is definitely true that "Green" sources have externalities as well (locally there is a major controversey about wind power right now). But I believe (and this is something that can not be proven since we each may have different probabilities on future events) that the expected present value of the externalities from "Green" energy appear to be lower than those of other sources of energy.

Of course this is just my opinion and your mileage may vary.

To compare differing power sources, we really want to be comparing apples to apples and this is not being done.

The question that needs to be answered convincingly is whether government subsidies (which are easily measurable) are greater than or less than the the externalities (largely not measurable) that accompany more traditional energy sources?

What are these "difficult to measure" externalities? To name a few: pollution (carbon and other), reliance on oil from politically sensitive areas, drilling in pristine wilderness areas, risk of spills, poor diversification of supplies (if I could steal from Taleb "over optimized") which leads to excessive volatility etc.). These externalities are generally not priced in oil (and hence oil is priced "artifically" low), so oil is used more than is strictly optimal in an economic sense.

But "what about nuclear?" some may say. "Look at France. They use much nuclear and have had very few problems" And at some point these nuclear activists have a point. But while the unpriced costs are different, they still exist. The easiest is to understand is the risk of a catastopic event (meltdown etc.). Oh sure the odds are low, but remember Black Swans do happen. And the true cost of that has to be borne in advance.

Why should it be borne in the present you ask? Doesn't this appear to be very similar to the idea of paying large bonuses for good earnings when looming off in the distance was a financial meltdown? Only if the costs are considered a priori will be make the correct decisions. Or in simpler terms, just because something has not happened, does not mean it won't. And if it can, we have to include that in our decisions today.

[Here the reader can flash back a few years to an imaginary conversation at a large investment bank: "Look at Bear Stearns. They take big risks and are heavily levered and they have had very few problems. The cost of debt is lower than the cost of equity. Why don't we do the same? "]

So what should be do? I do not know. I do not think anyone knows for sure, but I will argue long and hard that externalities (both current and future) are as much a cost as the billions of dollars of subsidies for green energy and should be factored into any analysis. Otherwise we are comparing apples and kiwi fruit.

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