Why we won’t run out of energy

Just another reminder that the supply of energy is at least partially determined by the price of energy. Therefore, as prices rise, as they have recently on fears of terrorism, claims that we are running of oil, etc., it becomes profitable to develop new sources of energy. So, when crude oil is priced at $60 per barrel, there are any number of opportunities that become financially interesting, including everything from jatropha to shale rock exploration. Not the least of these is the added incentive that oil companies have to figure out ways to get more oil out of their current reserves. One snippet of this comes from a recent New York Times piece on innovations driving the oil industry. The piece ends with a great summary….

“Yes, there are finite resources in the ground, but you never get to that point,” Jeff Hatlen, an engineer with Chevron, said on a recent tour of the field.

In 1978, when he started his career here, operators believed the field would be abandoned within 15 years. “That’s why peak oil is a moving target,” Mr. Hatlen said. “Oil is always a function of price and technology.”

Creation bias

The travails of the ADB reminded me of a fantastic little book by the IFC’s Michael Klein and the FT’s Tim Harford, called The Market for Aid. This book has a great chart which I have uploaded here, though it’s a bit out of focus (I encourage you to go to the original article in which it was published for an explanation and a brief summary of Klein’s and Harford’s views on aid agency competition):

For thoe who can’t make out the chart, it shows aid agency creation over the psat 90 years, aligned by stated development mission. The size of the bubble is equivalent to the size of the budget of the agency. What the chart doesn’t show is how many of these agencies ceased operations. You can guess the answer…. none.

This data is part of a broader phenomenon which I have called “creation bias” (I may have stolen this from another other on development, and if I have, please let me know so I can appropriately footnote). This phrase is borrowed from the world of investing, where measures of performance suffer from survivorship bias and creation bias. In international development, I use the term to refer to two salient features of the development landscape.

First, there is a bias towards creating new programs rather than expanding existing programs. This is due to several factors, including our innate human desire to create, the fact that it’s easier to fund-raise for something new and different, and the fact that creating a new program allows donors, non-profit professionals, and everyone else to forego the difficult task of trying to accurately assess performance of older programs (this is where the similarity to the investment field comes into play).

Second, non-profit organizations in general, and multilaterals in general, rarely if ever exit. They may not expand their budgets, they may alter their missions drastically (e.g., recent discussions about the IMF and the ADB), but they rarely admit that they are no longer useful.

Why? I wish I knew. If I worked for an NGO and we had to close our doors because we had completed our mission successfully, I can think of nothing that would better recommend me for another position, be it in the non-profit or for-profit sector.

Bureaucracy at its best

This is the kind of story that frustrates me…. Today’s FT highlights the travails of the Asian Development Bank (ADB), which has found its programs and its member countries so successful over the past 30 years that it is now no longer necessary. As a result, its current leader, Haruhiko Kuroda, a diplomat from Japan, is casting around for a new role for the bank. He is conducting widespread interviews with member countries in an effort to revitalize the bank and instill it with new purpose. The story goes like this:

When the Manila-based institution was created in 1966, its mandate was to promote the rapid development of Asian economies. More specifically, the ADB was expected to provide public sector lending programmes for countries that found it hard to raise private finance on reasonable terms, in much the same way as the World Bank or regional entities such as the African Development Bank.

At the time, this seemed a laudable role, since with the exception of Japan, most of Asia was short of finance and unable to enter capital markets. The ADB’s “problem” now is that in the intervening decades, Asia has developed far more rapidly than many economists expected. As a result, many of the countries initially considered natural ADB borrowers can easily tap the private markets themselves. Far from fretting about an Asian capital shortage, global economists are concerned about excess pools of capital which have built up in countries such as China, which dwarf the ADB’s $7.5bn in outstanding loans.

A cynic might suggest that these changes imply it is time for the ADB to shut its doors. But that is not an option any Asian bureaucrat is eager to endorse. After all, the institute employs 2,439 relatively well-paid staff, including a number of former government officials.

Well, call me a cynic. I know very little about ADB, its successes and failures, or its staff, but this stuff captures perfectly the tension in the international development. I think the ultimate goal of all multialterals (and all non-profits, for that matter) should be to work themselves out of a job. Unfortunately, most multilaterals do exactly the opposite, chasing the “hot” topics and donor funding (witness the UN’s Year of Microcredit in 2005, after microfinance had already proven its commercial viability) to keep their staff busy and employed. This is rational behavior at the micro-level, but leads to irrational outcomes, and inefficiency, at the macro-level.

An explanation of global imbalances from Harvard’s fund manager

Mohammed el Erian and and Michael Spence offer a great microeconomic perspective into what is causing global trade and fiscal imbalances in Saturday’s Wall Street Journal. While you should read through their lucid and concise explanation of how simple, rational microeconomic choices have led to a macroeconomic outcome which is best described as a puzzle, I will repeat verbatim their predictions for the future, which I believe are both accurate and scary in their implications:

Over time, emerging markets will inevitably divert more of their assets to more sophisticated investments abroad. That shift will have many effects, some of which depend on the decisions taken by emerging economies while others depend on the evolution of the global context. One effect will surely be to put upward pressure at some point on the cost of capital in the U.S., as the incremental demand for treasuries declines.

While the shift is inevitable, it would be unlikely that the emerging economies as a group would deliberately take actions that directly undermine global economic markets. There will also be domestic pressure on policy makers in emerging countries to gradually shift their emphasis away from the producer and towards the consumer. That will mean lowering the savings rate relative to investment, increasing consumption and letting it assume a more important role (relative to exports and global demand) in driving growth.

Under this state of the world, domestic consumption in the rest of the world picks up over time, facilitating the needed adjustment in the U.S. The result is a gradual journey to a more normal relationship between assets and income returns, with savings moving to a more normal long-run pattern.

But this process is not automatic and faces significant disruption risks; and it is particularly sensitive to “policy mistakes.”

Uh oh.

Among these policy mistakes, protectionism measures in the U.S. would derail the global adjustment So, too, would the inability of emerging economies to navigate their complex policy challenges.

So, we just have to put our faith in continued support for free trade and sophisticated policy-making by emerging markets.

Geopolitical shocks would also be a problem, as they could undermine the free flow of goods and services. Finally, significant “market accidents” that, in the past, have been associated with excessive leverage and triggered sudden and large portfolio changes and credit rationing, would add to the policy complexity.

So where does all this leave us? The current configuration of global imbalances, while highly unusual is not a real puzzle. It is the result of a series of individual decisions in both advanced and emerging economies that were largely rational when considered at the micro level.

These decisions reflected individual self interest, and happened to coincide. The aggregation of these decisions at the national and international levels raises considerable challenges, as does the ability to maintain an orderly global reconciliation process over time. The fundamental question, therefore, is whether these global considerations will be sufficient to minimize the risk of “policy mistakes” in a world that is subject to geo-political risk and bouts of excessive leverage.

The point about “market accidents” is an interesting one to me. An “accident,” to me, is defined as an unexpected misfortune. It’s unclear from the authors phrasing whether the believe these accidents will happen, or whether they believe there is a chance of an accident. To me, there is a virtual certainty that market accidents will occur as interest rates rise, firms de-leverage, and the private equity boom calms down. I hope, like the authors, that we have the policy expertise to overcome these and the other challenges that lie ahead as the U.S. unwinds its unprecedent fiscal imbalances.

Thanks for the reference, Dosh.

Global imbalances and reverse foreign aid

An interesting, if not entirely accurate, article in the NYT magazine this weekend highlights the extent to which poor countries are “subsidizing” rich countries. Tina Rosenberg argues that developing countries subsidize rich countries through the following methods:

- By holding excess foreign-denominated assets, especially U.S. Treasuries, in their reserves

- By agreeing to WTO-enforced standards regarding intellectual property rights enforcement

Consider the World Trade Organization’s requirements that all member countries respect patents and copyrights — patents on medicines and industrial and other products; copyrights on, say, music and movies. As poorer countries enter the W.T.O., they must agree to pay royalties on such goods — and a result is a net obligation of more than $40 billion annually that poorer countries owe to American and European corporations.

There are good reasons for countries to respect intellectual property, but doing so is also an overwhelming burden on the poorest people in poorer countries. After all, the single largest beneficiary of the intellectual-property system is the pharmaceutical industry. But consumers in poorer nations do not get much in return, as they do not form a lucrative enough market to inspire research on cures for many of their illnesses. Moreover, the intellectual-property rules make it difficult for poorer countries to manufacture less-expensive generic drugs that poor people rely on. The largest cost to poor countries is not money but health, as many people simply will not be able to find or afford brand-name medicine.

- By offering tax incentives for foreign investors from the developed world

The hypercompetition for global investment has produced another important reverse subsidy: the tax holidays poor countries offer foreign investors. A company that announces it wants to make cars, televisions or pharmaceuticals in, say, east Asia, will then send its representatives to negotiate with government officials in China, Malaysia, the Philippines and elsewhere, holding an auction for the best deal. The savviest corporations get not only 10-year tax holidays but also discounts on land, cheap government loans, below-market rates for electricity and water and government help in paying their workers.

Rich countries know better — the European Union, for example, regulates the incentives members can offer to attract investment. That car plant will most likely be built in one of the competing countries anyway — the incentives serve only to reduce the host country’s benefits. Since deals between corporations and governments are usually secret, it is hard to know how much investment incentives cost poorer countries — certainly tens of billions of dollars. Whatever the cost, it is growing, as country after country has passed laws enabling the offer of such incentives.

- By allowing their highly trained professionals to emigrate and practice in developed countries

Human nature, not smart lobbying, is responsible for another poor-to-rich subsidy: the brain drain. The migration of highly educated people from poor nations is increasing. A small brain drain can benefit the South, as emigrants send money home and may return with new skills and capital. But in places where educated people are few and emigrants don’t go home again, the brain drain devastates. In many African countries, more than 40 percent of college-educated people emigrate to rich countries. Malawian nurses have moved to Britain and other English-speaking nations en masse, and now two-thirds of nursing posts in Malawi’s public health system are vacant. Zambia has lost three-quarters of its new physicians in recent years. Even in South Africa, 21 percent of graduating doctors migrate.

The financial consequences for the poorer nations can be severe. A doctor who moves from Johannesburg to North Dakota costs the South African government as much as $100,000, the price of training him there. As with patent enforcement, a larger cost may be in health. A lack of trained people — a gap that widens daily — is now the main barrier to fighting AIDS, malaria and other diseases in Africa.

- By disproportionately bearing the costs of climate change

Most costly to poor countries, they have been drafted into paying for rich nations’ energy use. On a per capita basis, Americans emit more greenhouse gases into the atmosphere — and thus create more global warming — than anyone else. What we pay to drive a car or keep an industrial plant running is not the true cost of oil or coal. The real price would include the cost of the environmental damage that comes from burning these fuels. But even as we do not pay that price, other countries do. American energy use is being subsidized by tropical coastal nations, who appear to be global warming’s first victims. Some scientists argue that Bangladesh already has more powerful monsoon downpours and Honduras fiercer cyclones because of global warming — likely indicators of worse things ahead. The islands of the Maldives may someday be completely underwater. The costs these nations will pay do not appear on the global balance sheets. But they are the ultimate subsidy.

These arguments frankly anger me. All of her observations are true. But by labeling these costs “subsidies,” Rosenberg implies that they are implemented as part of active government policy and that they are avoidable. I find neither of these arguments to be true. I could piece through each point made by the author, but I will leave it to the reader to think through, for each of these points, what are the costs and benefits of an alternative policy? What costs would be associated with the alternative (e.g., what if we stopped enforcing intellectual property rights?) Unfortunately, capitalism has its costs–but so do its alternatives, as evidenced by the downward spiralling North Korean regime.

A better title for this article might be, “Why it Stinks to be a Poor Country.” Yes, it does. Point well argued.
A simple case in point is the author’s first and one of her more powerful examples, the excessive holdings of foreign-denominated assets by developing country governments. not surprisingly, a recent body of economic research has arisen to suggest that this is not necessarily such a bad thing. The Economist recently highlighted a study suggesting that the weak local financial markets of many developing countries encourage both private and public investors to hold overseas assets.

Ricardo Caballero and Emmanuel Farhi of the Massachusetts Institute of Technology, as well as Pierre-Olivier Gourinchas of the University of California, Berkeley… point out that emerging economies have been frantically accumulating real assets, such as assembly lines and office towers, but their generation of financial assets has not kept pace. Thanks to weak property rights, fear of expropriation and poor bankruptcy procedures, many newly rich countries are unable to create enough trustworthy claims on their future incomes. Lacking vehicles for saving at home, the thrifty buy assets abroad instead. In China, Mr Caballero argues, this is done indirectly through the state, which buys foreign securities, such as Treasuries, then issues bonds of its own, which are held by Chinese banks, companies and households.

Because emerging economies’ supply of financial instruments is so unreliable, people may hoard more of them as a precautionary measure. Firms and households fear they will not be able to borrow to tide themselves over bad times, therefore they choose to save for a rainy day instead. Because they cannot transfer purchasing power from the future to the present, they must store it from the past.

This is only part of a broader argument that investors are less worried about the state of global imbalances. While it’s not clear whether these theories are simply ad hoc explanations of what is really a disaster waiting to happen or really improved explanations of how the world works, at the very least they suggest that there is a reasonable rationale for developing countries to hold significant foreign reserves. While this may result in “lost income,” clearly the cost of this lost income is less than the perceived benefit.

Thanks, Brian, for the NYT reference.

Gotta give props to the Invisible Hand

Everything has its price…..

Ethanol and free trade

As one veteran observer of Washington farm politics put it recently: commodity prices are high, ethanol is boosting demand and farmers are happy, so there has never been a better time to reform agricultural subsidies. Then again, commodity prices are high, ethanol is boosting demand and farmers are happy, so there has never been a worse time to reform farm subsidies.

Today’s FT highlights a point I’ve been trying to hammer home about ethanol for awhile now– while there are many reasons to love ethanol (increased energy security, reduced carbon footprint, increased agricultural livelihoods)– it is being opportunistically seized upon by politicians, who wish to use ethanol as the latest in a long series of excuses for why we need to subsidize American farmers. The FT goes on to note that farmers, traditionally free traders looking for new export markets for their subsidized corn and other staples, now are focused on the internal market, and therefore, more focused than ever on maintaining their subsidies and protection from imports where possible.

As evidence, witness this from Barack Obama:

In Brazil, it has been reported that President Bush is expected to join with President Inacio Lula de Silva to announce greater ethanol cooperation between the United States and Brazil. Together, the United States and Brazil are the world’s largest ethanol producers and consumers. Brazil’s more than 30 years of renewable fuel technology investments allowed it to achieve energy independence last year. Ethanol now accounts for 40 percent of Brazil’s fuel usage. More than 80 percent of cars sold in Brazil today are flex fuel vehicles—capable of running on gasoline, ethanol, or a mixture thereof.

Greater Brazilian production of renewable fuels could boost sustainable economic development throughout Latin America, and reshape the geopolitics of energy in the hemisphere, reducing the oil- driven influence of Venezuela’s Hugo Chavez. The more inter- hemispheric production and use of ethanol and other biofuels occurs, and the more such indigenously-produced renewable fuels are used to replace fossil fuels, the better it is for our friends in the hemisphere.

As it relates to our country’s drive toward energy independence, it does not serve our national and economic security to replace imported oil with Brazilian ethanol. In other words, those who advocate replacement of US-based biofuels production with Brazilian ethanol exports however well intentioned they may be, are both misunderstanding our long term energy security challenge and ignoring a valuable foreign policy opportunity. The U.S. needs to dramatically expand domestic biofuels production, not embrace a short term fix that discourages investment in the expansion of the domestic renewable fuels in industry. Also, accelerating technology advances and transferring the technology to our neighbors in the Caribbean and South America will help them employ their own resources to produce environmentally clean ethanol to reduce their imported oil bill, thereby promoting economic stability in the Caribbean and South and Central America and strengthen the U.S.-Brazil relationship.

Mr. President, it is vital that President Bush keeps the Congress involved each step forward in a U.S.-Brazil relationship based on renewable fuels. This relationship must be structured so as not to hamper the domestic production of renewable fuels, or the development of new technologies here at home that can enhance our energy security.

A carefully crafted, yet ultimately protectionistic call to arms. We should drop the import tariff on Brazilian ethanol — and while we’re at it, increase the carbon tax on gasoline at the pump.

Vimo: Competing to reduce health care costs

It’s a bit off my usual topics, but I couldn’t resist highlighting a new service which I have been clamoring for for years. Vimo, launched in early 2006, offers comparison price shopping for a wide variety of health-care services and medical procedures. They describe themselves as:

… the nation’s first integrated comparison-shopping portal for healthcare products and services. On January 24, 2006 we launched a website that allows businesses and consumers to research, rate and purchase health insurance plans and Health Savings Accounts (HSAs), and choose doctors from across the country. Vimo brings together a variety of private and public data sources so that shoppers can find a physician and compare hospital prices for medical procedures. Vimo users can read and post reviews about any of the services or products available.

The above is a bit too “Web 2.0″ for my liking– basically, Vimo is trying to put more power in the hands of the consumers of medical care. They are doing privately what many of us have been pushing the federal government to do it– create an environment that encourages medical care providers to compete for the ever-increasing amount of dollars we spend with them each year. I will save my rant about how doctors never know the cost of the procedures they recommend. I don’t know if Vimo will succeed or fail– I have my doubts about their revenue model, despite the fact that it plays to an ever-growing customer base of elderly people who spend a lot of time on-line– but I love it when entrepreneurs begin to find a way to solve privately a problem that government has failed repeatedly to tackle.

For those of us who love data, Vimo is also full of fun facts. Check out my sample search.

Questioning the viability of biodiesel and ethanol….

Looks like the boys from the Economist and U.S. News and World Report got together for drinks over the weekend to discuss renewable energy. Both raised concerns recently over ethanol and biofuels, though with a different take.

US News ran a recent cover piece taking the “small farmer perspective” on ethanol. The piece trots out the usual arguments that ethanol can be a panecea, solving our farming crisis (aka the disappearance of small farmers in the U.S.) and our energy independence crisis at the same time. However, the article brings some nuance to the claims made by ethanol advocates, for example, noting the pressure on prices of basic foodstuffs as a result of increasing prices for ethanol inputs.

The Economist raises concerns which many of us have had over the true “climate friendliness” of biodiesel, if farmed intensively. It’s a good article, with some sobering facts about the economics of ethanol. As someone with some experience in palm oil, I will take issue with one small point. The do the following math:

[D]estructive farming practices in exporting countries sometimes do more damage to the environment than burning oil or gas. Last year a Dutch study found that draining Indonesian swamps to make way for oil-palm plantations resulted in 33 tonnes of carbon dioxide emissions for each tonne of palm oil produced, by speeding up the decomposition of the peaty soil. Yet burning a tonne of palm oil instead of fossil fuel saves only three tonnes of emissions. Faced with these findings, the Dutch government has apologised for promoting palm oil, and several Dutch firms have vowed to stop using it.

This paragraph is misleading. Replacing fossil fuel with palm oil-based substitutes is not a one-year effort, but rather an investment. Palm plants last for 20-30 years, and every tonne of palm oil that replaces a ton of fossil fuel saves 3 tonnes of emissions, every year. So that’s a life-cycle savings of 60-90 tonnes of carbon dioxide over the life of the plant.