The problematic future of U. S. energy investment
Can the current financial system in America help us make the energy infrastructure investment we need for a transition away from fossil fuels?
First, let's look at how things are going right now. As investors have watched like deer in headlights while their stock portfolios melted down in recent months, the many flaws of America's peculiar form of cowboy capitalism have been revealed. Perhaps most telling is that we now know that the swashbuckling traders and bankers of America's new era financial system are not the rugged individualists they purported to be. Instead, they are pampered members of America's ruling teenager class who, having received no ethical guidance or discipline during the boom years, are now being coddled by regulators and bailed out by the country's central bank and the U. S. Treasury Department. All this comes after they have gambled away investors' money on what amounts to a Ponzi scheme in mortgages.
(Incidentally, none of them is being asked to give back the bonuses they earned during the boom years. They take the risks; somebody else gets the bill when things go bad.)
To add insult to injury, the public found out just recently that two of the biggest teenage Ponzi schemers are Fannie Mae and Freddie Mac, the country's two largest mortgage lenders whose names make them sound like a perfectly innocent young couple. While pretending to be freestanding independent organizations for many years, they have always been, it seems, wards of the state. Having been effectively nationalized via a promise from the U. S. Treasury to extend additional credit and buy equity in the firms if necessary, taxpayers may now pay for the crimes of both institutions.
This then is the American capitalist system that is supposed to allocate capital to the areas of highest return which are presumably the areas of highest need. But as we have seen, high returns can be manufactured--that is, for a time--and thus attract vast pools of capital to areas already suffering from a glut. So, what does this portend for the future of energy investment?
Let us think for a moment about where Americans have their savings, that is, the raw material for investment. Some $22 trillion is tied up in real estate (a figure which is now declining). Financial assets make up $44 trillion of which $12 trillion are in pension funds and $9.6 trillion are invested in mutual funds and directly in stocks. These are stupendous numbers, and one would think that America would have more than adequate savings to fund future energy investment.
Now let's look at the incentives for investing that money in something energy-related. Certainly, investors have been well-rewarded if they put their money in all manner of fossil fuel-related investments. Oil, natural gas and coal have all skyrocketed in price in this decade. Investors have also been rewarded if they picked the right wind and solar companies although funds which invest in alternative energy have not fared as well compared to fossil fuel investments. While the American Stock Exchange's Oil Index has vaulted more than 200 percent in the last five years, a sampling of alternative energy investment funds shows returns ranging from 50 percent to just under 100 percent.
Both industries' returns were dwarfed by that of major American coal names such as Peabody Coal and Arch Coal, and metallurgical coal producer Fording Canadian Coal Trust, which rang up 5-year returns (as of July 31 including dividends) of 876 percent, 468 percent and 1,294 percent respectively. (To see a comparison chart, click here.)
Of course, investments in these stocks and funds didn't necessarily put money directly into the companies themselves. That only happens during an initial public offering or private placement. But investor interest in stocks and mutual funds does provide a positive backdrop for those wanting to raise capital. Clearly, the most favorable backdrop has been for the fossil fuel industry.
This makes sense since 86 percent of the world's energy comes from fossil fuels. Since all fossil fuels deplete, it is imperative that new supplies be found and developed. But that, of course, doesn't help the United States or the world make a transition to a renewable energy economy. At least the profits of fossil fuel and alternative energy companies are not "manufactured" in the way they were for subprime mortgages. And, there is some hope that as the cost of fossil fuels rise, investment in alternatives will become even more attractive and profitable.
But this, of course, only deals with questions of supply. Two other important questions, demand and infrastructure, are largely outside the purview of the American financial system. True, high prices will to a certain extent ration demand. But existing public and private infrastructure puts lower limits on how much energy can be saved. And high prices alone do nothing in particular to facilitate a transition away from fossil fuels.
As for the public infrastructure, the construction and maintenance of roads, for example, on which so much of our fossil fuels are consumed, is as much of a political decision as an economic one. And, right now the political climate in the United States continues to favor more consumption of fossil fuels. Road building remains a priority over public transportation. The electrification of transport, which could significantly reduce oil use, is largely absent from funding priorities.
The key question about investment is how quickly it must be made to insure a smooth transition away from our fossil fuel energy system. There are those who believe the marketplace will mediate this transition by raising fossil fuel prices to a level that encourages investment in alternatives while reducing demand. To a certain extent this is already happening. But those market believers had better hope that Robert Hirsch, author of what is now commonly referred to as the Hirsch Report, is wrong about the lead time we need to make a transition away from oil-based liquid fuels. He suggests it will be necessary to launch a crash program for alternative liquid fuels 20 years prior to the worldwide peak in oil production to avoid economic disruptions. But the peak is looking much closer than that and right now there is no crash program even being mentioned in the halls of government or corporate power. The market believers must also hope that Hirsch is wrong that our experience with regional peaks in oil production is not a harbinger of what the world peak will look like, namely a sharp, unanticipated peak with a high decline rate. If Hirsch's fear proves correct, the most important market mechanism will be demand destruction for oil even as substitutes remain elusive.
So, what about government initiatives? Certainly, the U. S. government could provide much greater incentives for say, the installation of wind and solar. It could mandate net metering that is highly favorably to homeowners to encourage them to install wind and solar on their homes. And, it could greatly increase funding for public transit including an vast expansion of intercity rail. But all of this would have only a modest effect on the consumption of petroleum fuels unless transportation is electrified. For that we would need a wholesale transformation of our transportation infrastructure. This would likely mean much more public electrified transport rather than private automobile transportation.
But perhaps the most profitable use of government dollars would be to encourage large energy savings at home. Businesses react to energy prices quite a bit more easily than homeowners. Spending money up front makes sense to business owners when the payoff in energy efficiency also means a payoff in financial savings sufficient to fund the efficiency upgrades and create ongoing savings. But quite often homeowners who would like to make their homes more energy efficient simply can't get the needed upfront money. Modest energy efficiency measures may be affordable to many, but a so-called deep retrofit that can reduce energy use by two-thirds can cost $20,000 or more. A reduction of this magnitude would make a huge difference in energy demand since about one-fifth of all energy use in the United States is residential.
But instead of recognizing how precarious North American supplies of natural gas are, instead of acknowledging how close the peak in world oil production might be, and instead of making preparations for an energy transition away from fossil fuels, the financial institutions in the United States with the blessing and encouragement of federal authorities and their policies have spent the better part of the last decade bankrolling one of the largest suburban expansions in history. That wouldn't be so bad if we could now take the institutions we used to do that and turn them toward making our economy more energy efficient.
At some point in the past it might have been possible for say, Fannie Mae, the huge mortgage lender mentioned earlier, to administer a loan program in conjunction with utilities to do deep retrofits of America's homes. The lender might have tapped into the giant pool of private capital available by issuing guaranteed bonds that would pay for it. The loans themselves would have to be set at low rates and payable over a long period, perhaps through utility bills. As such they would require a modest government subsidy to bring the return up to market levels to attract investors. But doing this could have unleashed large amounts of capital looking for a safe, steady return and thereby allow even average investors to participate in an extremely important energy infrastructure project.
Instead, the gamblers at Fannie Mae have now nearly bankrupted it (which is what forced the government to acknowledge explicitly its backing of the company). Its sister organization Freddie Mac, the other huge mortgage lender is suffering the same hangover from a night at the mortgage casino and is also in no shape to embark on a new, ambitious program.
The U. S. federal government itself has been hobbled by tax cuts and expensive wars which have been financed by huge borrowings (much of it from abroad) that have almost doubled the national debt in that last eight years. Of course, the country and its leaders could decide that the tax cuts were unwise and that the defense budget ought to be slashed dramatically and money reallocated for an emergency energy program. But this seems highly unlikely no matter who controls the U. S. Congress or the presidency. Nor does it seem at all likely that lenders, especially foreign lenders, would, absent some showing of fiscal discipline, be willing to loan the government money for a major new initiative involving energy.
Meanwhile, back at the casino that now passes for the American financial system, average investors have little to say about where their money is invested. This is especially true if they don't manage their own retirement savings. But even if they do manage it, the choices they have are often limited. It is well-nigh impossible for amateur, part-time investors (which is what most Americans with savings are) to know which companies in the alternative energy race will be winners or to be able to invest in them if those potential winners are traded overseas. And, it would be imprudent of these investors not to diversify and especially not to include companies that benefit from the rise of fossil fuel prices, companies that are easy to identify and have a steady, mature base of business.
One thing that average investors can almost never do is invest in socially and economically wise infrastructure development such as the deep energy retrofits described above. There simply aren't institutions set up to make this possible.
So, what we are left with is a federal government fiscally unable to act in ways that respond effectively to the growing energy crisis (even if it now wanted to), a financial system under tremendous stress that is geared primarily to moving funds into investments that encourage further dependence on fossil fuels, and a public that collectively has enormous amounts of capital it cannot effectively move into areas that will reduce fossil fuel dependence or create an infrastructure that runs on renewable energy.
We have in essence a dysfunctional investment system, both public and private, that seems to be providing the equivalent of very expensive end-of-life care to the moribund fossil fuel economy without much consideration for what comes afterward.
The market fundamentalists will say, of course, that this will all sort itself. Just give it some time. But this sidesteps two key questions: How much time will it take to sort itself out and, more important, how much time do we have?
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