What is an Energy Policy, Why Do We Need One and What Should It Be?

If you’re as old as I am, you’ve heard politicians talk about the need for an Energy Policy since the time of Carter and the first oil crisis. Democrat or Republican, you probably even know what they’re likely to say. If they’re Democrats, the “policy” must be some sort of public subsidy for the use of Solar or Wind Power. If they’re Republicans the “policy” must be tax incentives and fewer regulations to support the expansion of oil exploration and development. Neither policy presents a compelling story, in fact both stories are equally goofy.

The dictionary defines “policy” as a “definite course of action adopted for the sake of achieving a desired result”. One big problem…no one agrees on what that result should be. It’s been the same story for 35 years. Oil only gets harder to find, to develop it we drill in increasingly dangerous and sensitive areas, the best oil fields belong to unfriendly countries, competition for existing oil is increasing and we know at some point the price will go back up. Do we really want to stay on that roller coaster? But consider the alleged alternative. The sun doesn’t always shine, the wind doesn’t always blow; after thirty years of trying, the contribution is miniscule. We can’t store it and even if we could, who wants a wind farm or a solar array in their back yard.

The crux of the divergence lies in the different ways in which Republicans and Democrats look at how societal change occurs. Republicans believe that change happens within the context of the existing structure. Following that line of reasoning, when the time is right for us to transition to a new way of creating energy, the market will show us the way and we’ll move in the right direction organically. Democrats on the other hand believe that the existing structure, especially the large energy companies (think Exxon, BP and Shell), will sabotage any efforts to transition to a new energy reality and that only government has the power to move the country forward in the proper direction. As before, neither point of view presents a completely compelling story.

There is plenty of evidence to suggest that existing energy companies would slow or impede the transition to a new energy reality. They have the understanding and the means to make a change, but as we’ve seen in computer technology, it is nearly impossible for a large company to radically modify its basic way of doing business. Xerox developed today’s computer interface, but it took Apple to popularize and create a business around it. IBM developed the mini-computer and later the business oriented micro-computer, but it took companies like HP, Sun and Microsoft to eliminate the dependency on the mainframe. There is also plenty of evidence to indicate that wind and solar are no sure thing as solutions to the energy problem. Following the afore-mentioned technology analogy, if government had stepped in to place its bets on the technology solutions prevalent in 1985, we’d be using DEC Computers for business and the Internet would still be the government curiosity ARPANET.

Fortunately, the nation’s entrepreneurial, creative development engine is and has been busy in the area of next generation energy development. The venture community has recognized the need and also sees the huge size of the opportunities in the energy market; which in many ways dwarf the opportunities in the computer technology or biotechnology markets. Largely under the radar, significant new energy technologies form the basis for hundreds of new companies. Here is a largely unscientific summary of some of the major initiatives underway:

• Start –up companies are attempting to perfect cost effective ways of converting algae directly into petroleum.
• Start –up companies are attempting to perfect cost effective ways of converting ag waste or otherwise economically useless agricultural products such as switch grass directly into ethanol.
• Start –up and existing Companies are working on next generation chemical batteries with improved energy densities and longer lifetimes.
• Again in a similar vein, start-up companies and researchers are working to create a super-capacitor, a solid state device that functions like a battery but with lower weight, longer lifetime and rapid charging capability.
• A number of start-up and existing companies are beginning to build and deliver credible plug-in electric cars, including most of the major existing automobile manufacturers.
• Start-up and existing companies are building and delivering, “smart” energy devices; devices intended to permit consumers to work collaboratively and cost effectively with their energy suppliers.
• Several major utilities are experimenting with demand driven power pricing and direct load management for their retail consumers.
• Start-up companies are developing, and one is delivering, cost effective fuel cells; intended eventually to be used for small city, business or neighborhood power delivery.
• Along the same vein, several existing and start-up companies are developing small, modular, industrially constructed nuclear plants intended for similar types of application.
• And, of course, there are a large number of companies working on, and in fact delivering, innovative solar and wind energy…even tidal energy solutions.

What are the lessons of such a survey? Clearly several trends are being established:

• We are definitely moving from a hydro-carbon based energy economy to one that is based upon electrical power. The reason for the transition is the extreme flexibility afforded by electric power; it can be generated in a wide variety of ways with the same eventual result.
• The major advantage of petroleum for transportation, namely the attractive advantage of high energy density at low weight, will at some point be eliminated by breakthroughs in battery technology.
• In the areas where hydrocarbons cannot be replaced by electricity, such as air travel, fertilizer and plastic manufacturing, we will eventually have the ability to replace petroleum from extraction with ecologically attractive substitutes and petroleum created through renewable and CO2 neutral methods (since both switch grass and algae remove as much CO2 in their development as they release when burned).
• We will eventually move from the current model of large, central power generating stations to a more de-centralized model, much like the transition from the mainframe computer to the PC. This will reduce or eliminate the need for developing a large scale, robust national electric grid.

Why can we be so certain that these trends will occur? Because none of them depend upon a specific technology or solution. In every case there are multiple options available. The strength of the American economic model is that we have the breadth of research, the investment and new business development capability to allow multiple opportunities to effectively compete for market acceptance. This was the strength of the computer technology era; continuing evolution in multiple directions allowed a relatively minor transition from mainframe computing to mini-computer computing to evolve into the Internet centric, network computing revolution we enjoy today. The entire revolution required a little over twenty five years to take place. The problem is, we may not even have that much time for an energy revolution to occur. For the first time in the last sixty years of innovation, we have credible and effective international competition for the technology and the new markets this technology will enable.

Given all of this, what should our energy policy be? Here are the key points:

• Solve the problem discussed above. Our government policy as it relates to the financial services industry must make it crystal clear that the most desirable thing we can do with our formidable economic capability is to invest in credible new business ventures in this area. Nothing else even comes close, given the necessity to create 21^st Century jobs for the nation.
• Actively and aggressively promote the development of the basic technology initiatives which have been the hallmark of government. Successful products ranging from semi-conductors to Tang to the Internet owe some or all of their existence to government research programs. Fortunately, the Obama administration has placed Steven Chu in charge of the DOE. Largely under the radar, Secretary Chu has dramatically focused and enhanced the government’s support for basic energy research.
• Do not try to pick winners and losers. Unlike some, I am not dismayed that others have an early lead in the renewable energy field. The United States has an unmatched and unchallenged skill in being able to define and develop emerging markets. What we know for sure today is that we do not know for sure what the energy future will be tomorrow.
• Be vigilant regarding corporate financial malfeasance. Congress along with government agencies such as the Federal Reserve, the SEC and the FERC need to ensure we do not let situations like the Enron situation derail evolving Energy Policy Development. Enron set back Utility Deregulation and Power Industry restructuring by at least a decade.
• Create some form of a carbon tax. Whether it is “Cap and Trade” or a direct tax, there needs to be an incentive for the appropriate industries to do the right thing and move quickly to a more sustainable, independent and economical energy future for America and the world.
• Make the government a leader in efficient adoption of new energy initiatives. Speak with a single voice across government in adopting new initiatives. Make the government an important “early adopter”.
• Provide enlightened regulation. Sometimes there is a need for a light hand, sometimes need for a heavy hand. In the afore-mentioned Enron situation, a heavy hand by the Federal Energy Regulatory Commission (FERC) could have nipped the problem in the bud and kept energy de-regulation moving forward. In other cases, such as the nuclear power “renaissance”, we may have to step back in order to allow new developments such as modular reactor technology take hold.

The Real Issue With the Financial Industry

It seems to me I haven’t read anything at all about the real issue with the financial industry. Yesterday, a Fox Financial Industry analyst went on about the new taxes that the Obama Administration was intending to impose upon the financial services industry and how they were shortsightedly killing the engine responsible for financing and bringing innovative new companies to market. Oh really? We haven’t had any meaningful investment in innovative new public company formation in nearly ten years. A realistic look at our history is in order.

The growth engine for the US Economy for nearly twenty five years has been innovative new company formation, most of it in information technology and biotech companies. It will be that way for the foreseeable future until rising standards of living cause labor costs to come more into line across the globe. Fortunately, the US has had the world’s premier innovation infrastructure and an economic engine to go along with it for most of the last sixty years. That economic engine broke down with the 1999-2000 “dot-com” implosion. How did that happen? Economic support for technological innovation is a three tier system in this country, one that has worked remarkably smoothly since the early fifties. Basic technological advances come from government and corporate sponsored research conducted by the nation’s premier research universities, from business funded industrial research laboratories, and out of direct government conducted research at places like the NIH (National Institutes of Health). The seed level support necessary to commercialize these advances comes mostly from private financing which is far and away the most important funding source for new technological innovations. Enterprises that demonstrate promise get late stage investment leading to an Initial Public Offerings from Investment Banking firms. It is this late stage private Investment Banking support that has dried up completely since the “dot-com” crash in 2000.

Beginning in the seventies, a two tier investment banking model evolved. First tier Investment Banks filled the need for a mature investment banking presence that could work with the growing venture capital marketplace and provide an “exit model” for well run start-up companies that were ready for the public market. These first tier investment banks survived by providing a steady stream of new companies that both survived and thrived in the market-place after going public. The top tier Investment Banks (e.g. firms like Morgan Stanley and Goldman Sachs) periodically recommended new companies for investment to wealthy individual and institutional investors when the risk profile for new company formation was deemed attractive in comparison to other investments. In the world of start-up companies, this was known as “opening the IPO (Initial Public Offering) window”.

Throughout the eighties, advances in computer technology and developments in creative financial engineering radically changed financial services. Beginning with the Options Market in the late seventies, concepts such as “portfolio insurance” (the cause of the 1987 crash) and junk bonds became popular. Next came derivatives and “off-book” corporate financing, the source of the Enron debacle. Eventually this led to the housing crisis and the current recession, the causes of which are well documented. The last thirty years have possibly been more transformative in the financial services industry than any other. The result has been a radical transformation of investment banking. The most innovative and creative financial products (and some would say the most dangerous) were created outside the traditional financial services industry. Eventually, they became almost the exclusive products of Hedge Funds like Long Term Capital Markets (LTCM), famous for its legendary melt-down. Hedge funds have became so profitable that traditional investment banks have had no choice but to begin to act more like them. Into this mix came the “dot-com” era. The newly empowered “profit above all else” mentality of investment banking, coupled with the irrational appeal of the Internet created a toxic mix. Ironically once the traditional Investment Banks realized how strong the demand was for new internet ventures, they acquired the first tier investment banks and began creating IPO’s for the same unproven companies their new subsidiaries had once worked so hard to screen from the public market. After the crash, like many investments that have gone bad, no one wanted to touch an unproven IPO.

The result; during the last ten years we have had a one third reduction in the growth of wages and new job opportunities when compared with the nineties. This is the so-called “jobless” recovery from the 2000-2003 recession. We are currently facing a similar prospect following this recession. Compare some of the numbers. During the period 1980 through 2000, the number of new jobs created in information technology and biotech almost exactly matched the total number of new jobs created in the entire economy. Throughout that same period, the total amount of venture capital available in the United States averaged about $30B per year. Compare that with the hundreds of billions expended each year in risk-based investments conducted by investment banks and hedge funds. Consider further for a moment what the US economy has gained (or lost!!) as a result of that investment. Finally, look at what has happened to the country’s competitive position. Near the end of the semi-conductor era, analysts wrote off the ability of the US to compete in chip manufacturing; conventional wisdom said that business would go to Asia with lower labor costs. Silicon Valley Venture Capitalists knew better and continued to fund start up ventures in the areas of programmable logic chips and semi-conductor equipment manufacturing. Essentially they recognized and funded the segments of industry reflecting the United States’ lead in intellectual property. These businesses now contribute 20% of the revenue in the chip industry. When the dot-com crash occurred, all domestic investment in internet technology ceased. The sudden retreat opened the door for an entire generation of Chinese and to a lesser extent Indian entrepreneurs. To ensure the continuation of this trend, China, along with most of our other major competitors use state run or “sovereign” investment funds to channel investments into areas deemed important for the growth of the local economy.

This is not a pitch for government picking winners and losers. It is a pitch for appropriate government intervention in the financial markets to level the playing field for financing and bringing innovative new companies to market. I am not sufficiently knowledgeable to know whether the new financial regulations will do the trick, but I suspect they will not. Rumor has it that John Mack, the CEO of Morgan Stanley, has been a proponent of restoring the old two tier investment banking model. That would be a good start. It might also be a good idea to look at the Capital Gains Tax and create a penalty in the form of higher Capital Gains Taxes on financial industry profits created solely through high risk investments in market speculation or derivatives. We could also lower Capital Gains Taxes on profits from new business investment. Or do both. In short, if we’re going to fix the system, let’s do it in a way that helps us continue to lead the world in innovation.