Economics of Green Energy

Jon makes some great points (see comments on a previous post) about how energy alternatives need to be driven by both economics and environment.

As mentioned, oil sands are significantly dirtier that conventional oil and gas. Take a look at the yahoo financial site of Sunoco (SU), a significant oil sands producer. There you will see discussion of new projects to mine and process oil sands. Both the mining and processing require significant amounts of energy be expended, resulting in increased pollution. And the disruption to the earth and waste products will be significantly higher than for conventional oil and gas. You'll also see much discussion about reducing the environmental impacts, but regardless, the environmental impact will be significant. Others, including BP and Occidental, have experimented with "in-situ" processes, meaning the process takes place in the reservoir itself, by injecting either steam for heating or injecting air to allow underground combustion. The heat introduced into the reservoir helps separate the oil from the sand and makes it flow so that it can be extracted. In my mind, this process is cleaner, resulting in less disruption and waste disposal issues, but the additional energy, and resulting pollution, is still needed.

Beyond oil sands, it is an unfortunate fact that many of the energy alternatives that have potential for a significant effect on energy supplies (nuclear, coal) in the near term have different, but significant negative potential environmental impacts. I would even argue that some of the greener alternatives have largely unrecognized negative impacts. I still remember when nuclear energy was considered the solution to all our environmental problems. This was just a few decades before the industry was run out of business by environmental interests.

And, that brings us to the intersection of economics and environment. Traditionally, environmental issues have not been directly driven by economics, although the issues do often intersect. Traditionally, governments set environmental regulations based on the philosophy in power at the location and time. Then, businesses decide whether it is economic to improve the operation to meet the regulations, and if not, they get out of the business. Many will argue that this is good, but to the extent that the most economic processes are forced out, or the costs are passed on to the customer, our standard of living is negatively effected. And, when it comes right down to it, few will make that tradeoff.

Economics and the environment also meet at the customer. If customers value the environment, they can influence business to change operating practices or to shutdown offending operations by refusing to buy from the offending business. Again, however, the result is a decreased standard of living. Customers and businesses make these decisions daily and with little guidance, and the operations ultimately reflect the preponderance of these decisions.

There have been some efforts to more formally connect the environment and economics by use of a pollutant or carbon trading system. The theory is that such a system will drive the most economic solution to reducing pollution by encouraging those who can most economically reduce pollution and allowing those who have the most difficulty in reducing pollution to buy credits. This would address one of the biggest difficulties in managing pollution, ie deciding who should reduce pollution and by how much to reach the most economic solution. Both governments and consumers are consistently poor at managing this process, equivalent to a doctor trying to make delicate incisions with an axe and little knowledge of where the incision should optimally be placed.

Unfortunately, in practice, pollution trading systems have not been very effective. Since only governments have the power to adopt the system in a mandatory way, the system has been largely voluntary. The result is that those who could easily reduce pollution are eager to do it and sell the credits, but those for whom reductions are more difficult can just ignore the system. Therefore, those who voluntarily use the system are at a competitive disadvantage unless their customers are willing to pay a premium for a green process. Oops, you are back to whatever the customer demands, right where you started.

BP has used the system with limited success internally. By setting a "Value of Carbon" price and using this in the economic model for alternative evaluation they can at least see where reductions in greenhouse gases within their operation make the most sense and track the effect of their projects on greenhouse gases.

The above sounds like gloom and doom, but there is a bright spot that should be discussed. Economics and the environment often are aligned by the intersection between them. When you do something to decrease your energy use driven by economics, you also reduce pollution. When you buy a compact flourescent light bulb, it is both a good economic decision and a reducer of pollution. The same applies to almost all demand reducing projects. This often applies for supply-side projects as well. The additional energy demands for oil sands drive both worse economics and more pollution than for conventional oil and gas. That is why most oil sands are still in the ground, and will stay there as long as there are adequate conventional sources.

Obviously, economics and the environment require a balance, but tools to effectively manage this balance are pretty crude. The question is whether these decisions will be made accurately and soon enough. This is a difficult question to answer, since the effects of today's decisions can be long lasting. And, our understanding of the compensating mechanisms nature may have at her command are even less precise than the tools discussed above. Ultimately, though, I believe the actions will be taken in time, largely because of my faith in the ability of nature to adapt to circumstances. And, when the system gets far enough out of balance, it will be obvious to customers and governments the decisions they must make. That is not to say that the adjustments will not be painful, but I don't believe they will be disastrous in the big picture.

One further point. You mentioned "forcing" companies to change. While this is appropriate in terms of economic and other forces creating change by exerting pressures in various directions, I think it often reflects a basic misunderstanding of the nature of business that is prevalent (and destructive) in today's society. Companies are not monolithic structures independent or opposed to people. They are made up of individuals just like their customers, making decisions based on their incentives, their values, their understanding, just as you and I are. I think it is important, and rare, that we recognize this commonality is much greater than our differences, and that we communicate with and educate each other. This alone can help us resolve our problems in the most efficient way.