Saturday, December 21, 2013

Energy Tax Reform is in the Air

Senator Max Baucus (D-Mont), Chairman of the Senate Finance Committee proposed far-reaching energy tax reform. The principles  are solid, to quote:
“It is time to bring our energy tax policy into the 21st century,” Senator Baucus said. “Our current set of energy tax incentives is overly complex and picks winners and losers with no clear policy rationale.  We need a system of energy incentives that is more predictable, rational, and technology-neutral to increase our energy security and ensure a clean and healthy environment for future generations.”
Regrettably, as drafted, it is limited to electrical generation, and thereby it aggravates the problem of confusing incentives that get in the way of maximizing reductions in GHG-emissions. It effectively accomplishes the opposite of its stated goal mainly by locking out the thermal technologies that are so powerful on the demand side of the grid, and can hugely reduce electrical demand, and therefore reduce GHG-emissions.
In its present form it would leave out the huge potential shift in energy production from the supply side to the demand side of the grid, where thermal technologies have the greatest potential. In general, renewable energy generation facilitates a move towards more on-site generation, and thus alleviates the demand on the grid. I addressed this issue earlier in an open letter to President Obama proposing simplifications in energy tax and incentives, including eliminating incentives at the technology/component level, such as is now done with the Energy Star rating system.
We can only hope that the proposal be amended to include ALL ENERGY GENERATING technologies, as well as energy storage, and certain passive energy technologies, insulation, energy efficiency, etc. Careful drafting is in order as to what is in and what is out. At the extreme, some homes and buildings should arguably be scrapped altogether, if they are hopeless energy sinks. However, even if they were replaced with a net zero building, that should probably not be permitted as a tax write off in its entirety as intended in the proposal... or should it? (Think e.g. Zenesis House.)

Utility-scale Projects

For utility-scale projects that continue the old model of the grid, with centralized generation and mass distribution, electrical generation is the way to go, because electricity is easier to transport than process heat. Various technologies can come into play, and we have recently even seen solar thermal win some interesting applications, such as the Ivanpah project. For remote energy generation, the Baucus proposal levels the playing field in the only way that makes sense. But centralized energy generation is of decreasing importance, and the greater reductions in GHG-emissions can be achieved on the demand side of the grid, not on the supply side.

Building Retrofits Include Energy Generation

Building retrofits are different. They are on the demand side of the grid. According to DOE, buildings account for 39% of total energy consumption, and 72% of all electricity. If the incentives are leveled in the spirit of the Baucus Energy Tax Reform proposal but include ALL forms of energy generation as suggested above, HUGE changes are possible. Not only can more electricity be generated in buildings (solar, wind, hydro), but more electrical demand can be replaced with thermal technologies, such as geothermal and solar thermal, thereby reducing the need for remote production in the first place.
This shift is necessary both because of direct environmental reasons, such as GHG-reductions, but also because greater building resilience is becoming mandatory, and in many areas with weather related risks (such as the coastal zones), greater energy independence and micro-grids are becoming very necessary, and laws are already starting to encourage them. Here is where thermal technologies will shine, and need to be on a level playing field with the alternatives.

The Potential Impact of Thermal Technology on GHG-reduction

The advantage of thermal technology when it is implemented at the demand side of the grid is extensive:
  • Greater efficiency, in some cases this is very obvious. For example, solar thermal directly converts the heat of the sun and uses it for heating and cooling, and it can even be used for on-site electrical generation.
  • Ease of storage, whether it is geothermal or solar thermal, storing process heat is much easier. With geothermal heat, preheated hot water used for heating or cooling can be easily stored, With solar thermal you can store process heat in high heat tanks, and downstream you can store preheated hot water.
  • Because there are no transportation losses, and heat can be easily stored for intra-day use on-site. Also, geothermal can easily provide the ability to store energy from wind or solar PV for intra-day use also, which typically provides superior returns compared to selling back to the grid at wholesale levels, and again water storage is more environmentally benign than batteries.

Energy Star Portfolio Manager to the Rescue

Help is on the way from your friendly EPA. The Energy Star Portfolio Manager program is designed exactly to model building performance and plan energy retrofits with an eye to GHG-reduction, in short, the tools for a comprehensive revision of the incentives for ALL forms of energy generation are already in place. The proposed revisions of the energy tax could and should rely on this type of modeling, and it would seem proper if the EPA set the standards. With this type of support in place a simple incentive structure for GHG-reductions is all we would need.

Conclusion: Include All Energy Generation

As drafted. the Baucus proposal for energy tax reform is a step in the right direction, but it would accomplish the opposite of its stated goal by leaving out thermal technologies, and the sector that is capable of such dramatic GHG-reductions: building retrofits with on-site energy generation. We can only hope that the same simplification of incentives should be extended to all forms of energy generation, active, and passive, instead of applying to electricity generation alone.

Saturday, December 7, 2013

Energy Efficiency, Handmaiden of the Koch Brothers

We are still in an alternate reality, as in: "down the rabbit hole" in Alice in Wonderland, where planning the green future is concerned. Basically, we are stuck repeating the mistakes from 40 years ago, based on assumptions that might have been more valid than now. Be that as it may, they are no longer valid today. A new plan is in order.

When the grid was still THE GRID and Energy Efficiency the solution

Back in the day of the first serious energy price shocks, economists pretty quickly surveyed the energy landscape at the macro level, and figured out that the marginal dollar is more effectively spent on reducing demand than increasing supply. From that time forward the energy industry (oil companies plus the utility sector), adopted energy efficiency as an objective and participated in attempts to achieve those demand reductions, in order to keep its products economically viable.
After environmental damage (Green House Gas (GHG-) emissions) became more known as a cost of carbon energy, the energy industry hi-jacked the renewable future, co-opting green energy with a substitution of energy efficiency for renewable energy. Thereby "green" was now good for the shareholders of the energy companies, for it extended the franchise, and the do-gooders in the environmental movement fell for the snow job, and became the best allies of the carbon cowboys under the auspices of energy conservation, energy efficiency, or whatever other moniker will serve, anything that made people feel like they were sacrificing for the good cause...
All of this had its roots in a time when we thought that economic use of energy was the problem, and before it was widely known that GHG-emissions were the problem, and renewable energy the answer, but we have never adjusted our policies. Most importantly, what has also changed in the last 40+ years is the rapid development of renewable energy solutions that can be installed in properties, on the demand side of the grid.

The Energy Star Program takes the cake

The Energy Star program is the epitome of the problem of dysfunctional energy policy, because it focuses on the component level, not on the systems level. This may be valid when it comes to selecting a new fridge or microwave, but anything that is even potentially part of the permanent energy infrastructure of a property needs to be looked at on a systems level. Unfortunately, only too often these days, there are tax-credits for specific items of Energy Star rated equipment, and all-too often these get specified by bookkeepers and accountants even when the engineers know they make no sense.

The Energy Efficiency Trap

Energy Efficiency is actually an economic trap, and it is also an environmental trap, as is very convincingly argued by Prof. Steve Hallett in the book The Efficiency TrapEconomically and financially, energy efficiency is a trap because of the phenomenon of diminishing returns, which creates the perfect trap with which to lure suckers into uneconomic and eventually self-destructive behavior. Here is how it works:
  1. In year one we finally grab some subsidized program that will offer us energy efficiency. So we did a certain amount of weather-stripping and insulation, a set-back thermostat perhaps, and other low dollar, high impact fixes. It reduces our bills somewhat.
  2. In year two or three the bills went back up, because of price increases, so our "investment" in weather-stripping has been wiped out,
  3. However we now look at what inefficient equipment we have and with help from the Energy Star program we figure out how we can further reduce our energy use. In reality we get that new fridge we always wanted, and some other gadgets, but we save energy, so we can shop without guilt. Nobody is calculating what the return on investment is.
  4. Another year later, it's time to get serious, we have cumulatively spent a lot of money on energy efficiency, with little to show for it. But we know our water heater is coming to the end of its life, and the boiler should be replaced in a few years. So let's do the water heater this year. In comes a happy salesman with a tankless hot water heater. Energy Star rated, good for a 30% tax credit, and with a ten-year guarantee, and 5 year financing so we are spending less than the energy we now buy to heat water. Miracle of all miracles: a self-liquidating proposition. The salesman loves saying that, and we like it too: "Sign here, press hard, three copies!"
  5. Two years hence we finally have to replace that boiler, so we shop for new Energy Star rated boilers (what else!). Our old boiler was 60% efficient, and the new one is going to be 95% efficient. More tax incentives, and self-liquidating financing propositions. Finally we're spending less on energy, but we're still paying off this equipment. By this time we may have a 25-35% reduction in energy consumption compared to the year we started working on this issue. Our oil or gas bills are going down, but our electrical bill is still stubbornly high.
  6. The next year there seems little left to do. Replacing the windows? A twenty-five year payback convinces us otherwise. But, wait a minute, here comes another sales person, now with a solar PPA, for less than our average monthly electric bill, we can now really go green and help the environment, not to mention impress the neighbors. And we're saving 10% compared to paying the electric bill, and we already know the rates will go up anyway...
By the time you add all this up, we have spent a fortune on energy savings, and our energy savings result in an energy bill that is only slightly less than when we started taking into account the various payments. Our utility company and our oil company love us. They even send us certificates to congratulate us on how "green" we are. But the problem is, every next investment was bigger than the last one, culminating in the solar panel that was an $35,000 investment, and 10% reduction of the electric bill was only a 4% reduction of the overall energy bills, and we're paying for it over 20 years, but the actual payback is very slow, and in the meantime, the remaining energy portion of our bills keeps going up.

Why Energy Efficiency is a trap

In the six steps to energy efficiency above, there were several thresholds that were crossed. Instead of upgrading the boiler, we could have chosen a solar thermal solution, except it seemed expensive, and we had just eliminated the water tank two years earlier, not realizing that it could provide "free" energy storage, so what were we to do? Write off our brand new tankless hot water heater and scrap it? Of course not! So we upgraded the boiler. In short, we walked a path of successively larger investments, with less and less energy savings, and we still have an energy bill that is well over 50% of what we started with.
If we had done a systematic analysis at the outset, taking into account when various equipment would run out, we might have ended up with a new energy plan in which we perhaps also did some insulation first, but saved up some money to install either geothermal or solar thermal for HVAC and Domestic Hot Water (DHW). And we got some tax credits on those as well, but we ended up reducing our energy bills by 70-90%. Moreover, we eliminated most major sources of indoor air pollution (boiler, DHW), leaving only the stove. We could now convert to electric cooking, and replace the windows with new triple glazing, and get some heat-exchange ventilation. And we could end up with our old house being near net zero, certainly if we could combine geothermal with solar PV. Site Derived Renewable Energy (SDRE) permanently replaces subscription energy from the grid. It is also permanent part of the plant and equipment of our property, and raises the value.

Ten years later Site Derived Renewable Energy wins

In these two alternate realities for our lives, the energy-saving alternative had us walking into the efficiency trap. We reduced our energy but at a staggering cost, and we still have a significant energy bill left, and it keeps going up. In the second alternative, we bit the bullet and invested significant money in the early years, but it looked better with every passing year, for the payments did not go up, unlike the energy bills of the neighbors. This is the effect of Site Derived Renewable Energy (SDRE). In short, the value of the property goes up, and we are helping the environment by eliminating 70, 80 or 90% of direct carbon emissions from the house. Not only that, but a new development of net zero homes was going up nearby, and we were approaching that level for our own home, so the value of our property should hold up.

Conclusion: SDRE wins

SDRE means permanently replacing the monthly energy bills with our very own generating capacity, which we only buy once. It could be solar thermal, geothermal, wind, solar PV, various passive energy solutions, or a combination etc. It adds to the value of the property. In fact, our property's value now goes up with energy prices, and we won't have to worry about the carbon tax when it comes. Site Derived Renewable Energy should be prioritized over energy efficiency, and ratings of components should not distract us from the total design concept.

Sunday, December 1, 2013

The Voodoo Economics of Energy Efficiency

Recent reports continue to draw attention to the notion that energy efficiency predicts lower mortgage default rates. Indeed, it seems obvious that energy-efficient homes are worth more, and that mortgage default risk on such properties should be lower. This is the same kind of analysis that was previously used to promote PACE bonds. It may be superficially right, in the sense that the relationship is observable and provable, but it misses the point, simply because a more categorical understanding is possible. Or, while these relationships may exist and seem statistically significant, correlation does not imply causation. There is no consistent approach to underwriting risk for energy efficiency, nor is there an analytically sound approach to explaining why or to what extent the risk of defaulting on home loans is reduced under energy efficiency. The following attempts to fill that gap by means of a simple example.

Energy Efficiency is Secondary

First, energy efficiency is not a primary objective, but a secondary one. The first order of business is a make-or-buy decision about on site generation with renewables (Site Derived Renewable Energy) versus a carbon energy subscription. The easiest way to see this, is to realize that you cannot save yourself rich, something everybody knows and understands. Let's look at four people, property owners all, and their different approaches, Mr. Tinkerer, Ms. Efficiency, and Mr. Analyst, and Ms. Intuition.

Mr. Tinkerer - Energy Efficiency Flying by the Seat of your Pants

  • Mr. Tinkerer begins by "saving" energy without thinking, and thereby accepts the status quo. In his single family home he has an $300 electrical bill and an $700 oil bill, for $1,000/month combined.
  • He then buys some gadgetry that reduces energy consumption and some insulation, and his bills goes down to $900.
  • A year or two later, after some energy price increases, and more wear and tear, he is back to paying $1,000 a month.
  • He keeps tinkering and spending money on Energy Star appliances and other energy-efficient products, but never realizes why he's not achieving serious energy efficiency.
This is a case of casually pursuing energy efficiency, and it is probably the most common. Mr. Tinkerer operates from the unexamined belief that he can save himself rich, but all he does is overpay for "energy saving" devices, without ever realizing that energy savings are not additive. Most of us dabble in energy efficiency in similar ways, it's a way to shop without guilt. It probably is a wash in the beginning, we spend as much as we save, but in the long-run we spend way more than we "save." Sometimes it's a lot more, for the savings do not add up, EVER.

Ms. Efficiency - Energy Efficiency by the Book

  • Ms. Efficiency really goes hog-wild, and does everything she can to reduce energy consumption, year after year. The first year she spends $3,000 and creates a 20% reduction, i.e. she enjoys a 15 month payback on her investment.
  • The second year (she still have 3 months to go to earn back that first investment), she spends $6,000 for a further 10% reduction. Simplistically, 10% of the remaining $800/month energy bill is $80, and therefore she now enjoys a 75 month payback, or 6.25 years.
  • The third year she can't find anything else to do, she wants to do something major, and now she talks to SolarCity (or any other similar provider of solar pv on a PPA- or lease-basis), and they can provide her with a solar panel (nothing down!!!) and reduce her electrical bill by 10% (she's already very efficient), for a further 3% of her overall energy bills. It's a 20 year Solar PPA. So now her monthly energy bills are down to $698.40 in constant dollars, but there were a few price increases, so she's at $750/month for the year. However, now her roof is covered with a beautiful shiny solar panel! She sends a Christmas card to her mother, to show off the solar panel, and mom is duly impressed with how green her daughter has become.
  • However, once she analyzes the figures correctly, that solar panel is a 20 year investment of $40,000 for a 3% reduction in her energy bills (10% on electricity alone), which means a payback of 154 years.
  • She's still paying $750/month in energy bills (including the $200/month solar lease), and the prospects remain that prices will go up for the remaining $550 "energy" portion of her monthly payments. What has she won? To a financier it seemed things have improved, for $750 now is less than $1000 a few years ago, but that PPA commits $40,000 of her borrowing capacity, and the panel locks out most of her roof, for any alternative uses that might prove to offer better results.
  • The residual energy portion of her monthly obligations continues to be above 50% of her starting figure.
In short, a categorical make or buy decision has to be made first before anyone starts on efficiency: do we continue to buy energy, or can we economically make our own. On site renewable energy generation is the alternative to buying energy in perpetuity. Energy efficiency only comes into consideration AFTER we make that make or buy decision, or else we falsify that decision, which is now commonly the case.

Energy Efficiency and Diminishing Returns

The example above shows the effects of diminishing returns, the successive investments show less and less savings, because the base is growing smaller. Ms Efficiency started out investing $3,000 with a return of $200/mo then $6,000 with a return of $80/mo, and finally $40,000 with a return of $21.60/mo (clearly she is paying more for every successive improvement, while here additional savings decrease). This is a losing battle, and it is the battle home owners are losing all around the country, as long as they believe in the "savings" paradigm.
Short-term, yes cash flows are improving, but a few energy price hikes can wipe that out, and the result is that eventually the improvements prove minimal or non-existent within a few years.

PACE Bonds and Mortgage Default Risk

The rationale for the creation of PACE bonds was to provide building owners with a means of financing major capital investments up front to do material retrofits in the energy infrastructure of properties. Unfortunately, the PACE bond camp has been hi-jacked by the energy savers also, and thus they have become yet another customer retention program for the energy companies, and the vendors of energy saving widgets, which was not the original idea. PACE bonds were designed to overcome the capital intensity of the switch to renewable energy, not to squander money on energy efficiency enhancements. Investment in renewable energy moves energy from liabilities to assets, and therefore would structurally reduce underwriting risk, if the economics are solid.

Enter Mr. Analyst - Investing in Site Derived Renewable Energy first

Here is how it should work: Mr. Analyst, with the same $1,000/month energy bill, invests significant money (maybe $140,000), and gets 20-year PACE financing that costs him $900/month, but he wipes out 85% of his energy bills. He gets a geothermal heat pump that provides his HVAC, and a solar panel that offsets most of the electrical load. The first year he gets a 30% tax credit on some of that investment, etc., which helps, but he ends up in a similar situation to his neighbor Ms. Efficiency. She went the energy savings route for the first 3-5 years, but then gradually Ms. Efficiency observes her bills nudging above $1,000 again. Mr. Analyst stays steady at $900/mo in payments, and his residual energy bill of $150 grows a little bit, but not a lot. And Mr. Analyst looks better with every passing year. Let's assume that equipment lasts 30 years. By that time the energy profiles of the two homes will be vastly different.

Ms. Intuition - Thinking Long-Term

Ms. Intuition in the meantime may be even smarter, she gets the same geothermal heat pump, and puts it on a time of use meter, running it mostly at night. She reads the papers, and she sees that solar panels today are 15-20% efficient, but there's some new invention every few months that promises a great breakthrough. She waits a few years, until solar panels have gone from 15-20% efficiency to 35% efficiency, and she now installs a solar panel that completely offsets her electrical use, and she ends up with zero energy bills. In short, she "ate" the electricity cost for a few years, but she gained a technology advantage compared to Mr. Analyst. Geothermal heat pumps are already 400% efficient -- returning 4 joules for every 1 joule you supply -- and are not likely to get any better. With solar PV there is another patent announced every week to increase the conversion efficiency, so it was a reasonable guess to expect that the efficiency of that technology would increase in coming years, and that waiting could be prudent. Notice also that the solar panel here enhances the investment in the geothermal heat pump and improves the value of that energy price hedge even further.
These are just examples. The numbers are rough, to show orders of magnitude, but the principles are clear. They show that the passive stance of "energy efficiency" and "energy savings" is often bested by a focus on generating your own energy wherever it is economical.
  • We can't save ourselves rich, and energy efficiency might reduce underwriting risk somewhat, but there are better alternatives, such as investing in Site Derived Renewable Energy (SDRE) instead of energy efficiency.
  • Energy efficiency is an operational expense, not an investment, it is short term in nature and mostly not part of permanent plant, but subject to wear and tear.
  • Energy generation with renewable sources is an investment that adds to property values, by moving energy from liabilities to assets.
  • Logically, in the short-term "energy efficiency" might be a self-liquidating proposition, which by definition would reduce the underwriting risk and the chance of mortgage default by the amount cash outflows are reduced, however these effects don't last, for easily provable reasons.
  • Site Derived Renewable Energy (SDRE) is a clear and lasting energy price hedge, certainly if more than 50% of the energy requirement can be economically generated on site. In this case the performance of the property improves with every energy price hike, and thus there is a long-term reduction in underwriting risk, and we can expect a commensurate, but lasting reduction in mortgage defaults.
  • SDRE also offers protection against a carbon tax, if it ever were to come. Again, energy efficiency cannot do that, even if it may temporarily reduce mortgage default risk. 
Current research into the issues of mortgage default rates fail to distinguish these structurally and financially very different alternative scenarios, while it is analytically clear that the one has a short-term effect, and the other adds lasting value to a property.

Conclusion - Investment in SDRE wins out over Energy Efficiency

Energy efficiency can be shown to produce improved cash flows in the short-run, and therefore should reduce underwriting risk and mortgage defaults. However, for good analytical reasons the longer term value of energy efficiency alone is uncertain, and a better option is renewable energy generated on site (SDRE), that is justified not only by the marginal savings of the equipment, but also by the lasting improvement of property values.