Thursday, April 03, 2008

Financial engineering, LNG and CCS

You probably know about what you paid per gallon last time you filled your gas tank. But, do you know what you paid per kilowatt hour last month to keep your lights on?

If you don’t know, you’re not alone. Unfortunately, when it comes to paying attention to electricity, most people would rather, well, not. But, here’s the catch. If you don’t know what electricity costs, you can’t place a market value on it. And, if you can’t place a value on it, how can you possibly know whether or not you’re getting a good deal.

Today, in fact, you’re not getting a good deal. Plus, I believe the deal is going to get a lot worse because, at least in the near term, we are likely to be relying not on coal, not on nuclear, not on renewable energy, but on exorbitantly priced natural gas.

To understand why, let’s look at what’s happening across the country. In reaction to CO2 concerns, coal plants are being cancelled or postponed. In reaction to nuclear energy fears, new plants can’t get past the initial permitting stage, and, even if they could, the earliest we could get a new unit on line is about 2017. Wind energy is getting built and financed, but slowly, and turbines run, at best, only 35% of the time. There have been several recent success stories for high-profile solar projects, but, if our appetite continues to grow, our electricity infrastructure won’t be able to satisfy the demand for high-quality, reliable, 24/7/365 electricity.

But let’s go back to coal for a moment. Citi, JPMorgan Chase and Morgan Stanley made big news recently with the announcement that they will not finance new coal plants without carbon capture and sequestration. Their reluctance may be due to stated concerns about global warming. However, the same financiers are also skittish about providing the debt financing for nuclear plants which don’t produce any CO2. The skeptic in me began wondering about their sudden desire to go green and got me thinking about what else might be at stake for Wall Street.

To understand what else might be driving the financiers, it is instructive to review a couple of things that happened in the wake of the California Energy Crisis and Enron meltdown. First, Wall Street firms picked up a fleet of gas-fired power plants for pennies on the dollar. Those plants represent about 80% of the generating capacity owned by Wall Street, which turns out to be about 5% of the total generating capacity in the U.S. Secondly, most of the electricity trading operations picked up stakes and moved from energy-based firms in Houston to financial firms on Wall Street. Third, Wall Street has begun salivating at the prospect of trading carbon credits and allowances.

We know that corporations and investment firms have a fiduciary duty to act in the best interests of their shareholders. In this case, that fiduciary duty has conveniently converged with the growing movement to limit CO2 emissions from coal, lingering fears of nuclear energy, dominance of the electricity trading market and, by extension, dominance of any proposed cap and trade system, and a portfolio of gas-fired plants.

I don’t think it’s farfetched to guess that some very smart financiers see that if no new coal or nuclear plants come on line, and reserve margins continue to shrink, then the best way to reliably keep the lights on is with electricity generated at gas-fired plants. Seen from this vantage point, it makes perfect sense that the financial firms suddenly care about reducing CO2 emissions. If you (1) own the gas-fired power plants, (2) control the trading of gas and electricity, and (3) acquire and control the carbon credits, going green is, in fact, your fiduciary duty.

As a bonus, going green means more transactions. A carbon cap and trade system will generate more transactions, which generate more fees, which, in turn, create “transactional value,” which is, it is important to note, very different from intrinsic value. Wall Street, we must remember, specializes in financial engineering, not infrastructure engineering.

So, Wall Street is driving the financial push toward lower CO2 emissions while also pushing for a transaction-based cap and trade system which they will control. The catch is that rather than investing for the long-term with more sensible options such as renewables with storage, no-CO2 nuclear, or even so-called clean coal, we’re served up increasingly expensive electricity from gas-fired plants with a shiny, new cap and trade system on top.

Whether you think carbon capture and sequestration is the answer or not, the bottom line is there’s money to be made by not investing in it. The big money is in natural gas-fired electricity. At least for the short-term. And in a transaction society, the short-term is all that matters. In the long term, however, we will all pay the price—in higher rates, lower service, greater dependence on imported natural gas, reduced investment in low-CO2-producing generation, and the continuing, long-term neglect of our electricity infrastructure.