Chapter 14 – Nerds Gone Green – Nerds on Wall Street, off Wall Street



Clean Energy and Nerds off Wall Street

This book closes with another chapter that, like the previous two, I didn’t expect to be writing. Recent headlines (Wall Street layoffs could reach 200,000, Citigroup is cutting 50,000 jobs) imply that many nerds on Wall Street (NOWS), mostly innocent bystanders in the meltdown, may soon find themselves on the real street. The scramble to create electronic markets for the stealth securities that caused the mess will allow some to find their way back to applying their experience in finance, but many NOWS will not.

Technology has a way of spreading outside its original zone of application. The Internet started out as a way for the Department of Defense to link military computers. Similarly, there are future uses for market technology that may rival those involving CUSIPs.(1) Efficient environmentally sound use of energy is one of the most important. We hear from voices as diverse as Thomas Friedman, T. Boone Pickens, and Ted Turner that energy technology is the next big thing. The last two so-called next big things, dot-coms and extreme finance, turned into fabulously bursting bubbles, so pessimists may want to stockpile long-dated batteries.

There is no denying that clean energy is a critical issue for the future. Actually, though, that is only true in the reality-based community. The Governor Caribou Barbie wing of the Republican Party maintains that global warming is just a run of bad weather caused by Al Gore and gassy polar bears, but the rest of us remain concerned and want to do something about it. The area of the energy and environmental complex where financial market technology is likely to have the largest payoff is the electric power sector. There are some strong commonalities across electricity and financial markets.

Financial Market Technology and the Electric Power Sector

First, innovation is accelerating. We are just beginning to see the decentralized use of information technology in this industry. The laws of Moore and Metcalfe are only now starting to be felt outside of the control room. Go look at your electric meter. It is probably just like the meter your parents had, a spinning disk device with dials. This won’t be the case for your kids.

Second, there are multiple buyers and sellers. The multiple buyers obviously include everyone who gets an electric bill. The multiple sellers side is more subtle. Most of us can only find one place to purchase electricity. At a household level, today, this is true. In many states, the distribution and generation of power are separate, so distribution and generation firms already participate in a market. Recall the tapes of the Enron power traders cackling as they manipulated prices paid by distribution utilities.

A proliferation of small and cottage-scale providers is emerging as solar, wind, and other technologies that produce a small amount of power become more important. No one builds a small nuclear reactor or coal plant, but just about anyone can have a wind generator in the yard, or an array of solar cells on the roof.

Third, regulators loom large. People who complain about the fragmented regulation of the securities industry by the Commodity Futures Trading Commission and the SEC will get little sympathy from the electric power people. There are 50 state agencies to deal with, many with an independent streak, with the feds at the Environmental Protection Agency (EPA) and the Department of Energy thrown in as well. Much of the regulatory structure is badly in need of rethinking. Many states create incentives for exactly the wasteful behavior we want to eliminate. The Electric Power Research Institute reports that “in all states except California and Hawaii, utilities are now, in effect, rewarded for selling energy and penalized for reducing customer sales. . . . Profits must be decoupled from energy sales. We need to provide incentives to utilities to lower customer energy use so that energy efficiency can be measured as part of a profitable business.”(2)

Fourth, there are so-called fat tails that are extremely significant. Over the past 10 years, an investor who was fully and broadly invested in U.S. stocks (the Wilshire 5000) would have gained 13 percent (up to the end of October 2008). If he or she missed the market’s 20 best days, the portfolio would have lost 57 percent — a minus 70 percent difference just by missing the market’s 20 best days. That is a fat tail in the distribution of returns.

Electrical Energy Consumption and Peak Load Demand

A Brattle Group discussion paper(3) describes a similar fat tail effect in electricity markets: “The demand for electricity is highly concentrated in the top one percent of hours [during a year]. In most parts of the U.S., these 80 – 100 hours account for roughly 8 to 12 percent of the maximum or peak demand. In the 12 Midwestern and Northeastern states . . . they account for 16 percent.” Note that these percentages are not referring to total energy consumption , but to the level of total power (the rate of delivering energy) that has to be provided over the year. In the electric world, this is called lowering the peak of the load duration curve.

Understanding load duration curves is the first lecture in Power 101 class. If you want to understand bonds, you need to know about the yield curve. The load duration curve is equally important if you want to understand electricity. Figure 14.1 shows a load duration curve and how it would shift with the use of the technologies discussed in this chapter. Lowering the peaks on these curves is important economically, environmentally, and geopolitically, because the plants needed to meet them are expensive, and often oil fueled.

Figure 14.1 Reshaping the load duration curve. Bonds have the yield curve. Power has this. Source: GridPoint.

Figure 14.1 Reshaping the load duration curve. Bonds have the yield curve. Power has this. Source: GridPoint.

Software applied to the electric grid offers unprecedented flexibility in reshaping the load duration curve. Utilities can either reduce customers’ nonessential loads or discharge distributed stored power, separately or in concert, to manage peak periods in a cost-effective, energy-efficient manner. Lowering the peaks (on the left of the chart) has tremendous value in cutting both cost and carbon emissions.

The commonalities between electronic financial markets and electronic energy markets suggest that skills in the former can be applied in the latter. The state of both means that there are likely to be more than a few readers contemplating this transition. This last chapter is a gentle introduction to and a survey of more in-depth resources on this topic.

Accelerating Innovation in Green Technologies and Peak Electrical Demand

There are over a million hybrid Toyota Prius vehicles on the road, and in Berkeley, California, it often seems that they are all parked on the same street. With only one model and a handful of colors, you need a distinctive bumper sticker to find yours. “Obama ’08” does nothing to help here. “Support Your Right to Arm Bears” with a rifle-toting polar bear is a little better, but still not that unusual in these parts. “2B or D4” is more distinctive.(4)

The current generation of hybrids makes its own electricity using a small generator under the hood. They have no impact on the demand for electricity from utilities. The next wave of fully electric vehicles and plug-in hybrids will be different. A movie trailer for a scenario from the Union of Concerned Scientists ( www.ucsusa.com ) might be “Imagine a society with ten million electric cars. Suddenly, they all pull into their garages between 5:30 and 7:00, and plug in to recharge. Imagine the 160 new power plants we need to keep the lights on while this happens.

Be afraid. Be very afraid. “Drill, baby, drill!” Something has to give. In this case, the “something” is immediacy for the consumers of power. A simple timer system, spreading out the scheduled power over 10 night hours (allocated by last digit of street or IP address) reduces the number of power plants needed by an order of magnitude. …

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All notes for this chapter about Clean Energy, Electrical Energy Consumption, and Peak Load Demand

1. CUSIPs are issued by the U.S. Committee on Uniform Security Identification Procedures; they are nine-character alphanumeric security identifiers. See www.cusip.com for more than you need to know.

2. Brent Barker and Lucy Sanna, “Turning on Energy Efficiency,” EPRI Journal (Summer 2006): 4 – 13, http://mydocs.epri.com/docs/public/000000000001013720.pdf

3. Ahmad Faruqui, Ryan Hledik, Samuel A. Newell, and Johannes Pfeifenberger, “The Power of Five Percent: How Dynamic Pricing Can Save $ 35 Billion in Electricity Costs,” Electricity Journal , October 2007, www.brattle.com/Publications/BooksArticles.asp?PublicationID=922

4. This book’s title does start with the word nerds . In hexadecimal, D4 is the complement — negation — of 2B, so this is “To be or not to be.”

5. “Engineers Push Fuel Economy to Front Seat at Auto Summit,” Detroit News , April 11, 2005, www.detnews.com/2005/autosinsider/0504/12/A01-146552.htm

6. Some things that seem to never change, change. Dingell has been replaced by Henry Waxman as chair of the House Energy and Commerce Committee.

7. “Market Mechanisms for Competitive Electricity: Final Report,” Shmuel Oren, Project Leader, University of California, Berkeley, Power Systems Engineering Research Center, Publication 02-42, November 2002, www.pserc.org/ecow/get/publicatio/reports/2002report/oren_marketmech_finalreport.pdf

8. David Leinweber, “Real Time Pricing and Deregulating the Electricity Market,” RAND Paper P-6448, www.rand.org/pubs/papers/P6448/

9. If anyone reading this has a copy of “The Tumescent Threat,” please contact me. The fact that this footnote is here says it all about how effectively this has been vanished, and about the sorry state of my garage filing system.

10. “Rogers Calls for ‘Paradigm Shift’ to Realize Full Potential of Energy Efficiency,” Edison Electric Institute press release, February 2007.

11. Faruqui et al., “Power of Five Percent.”

12. http://cift.haas.berkeley.edu/

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