Streetwise Professor

April 29, 2024

Learning by Doing in Solar, Even if Proven, Would Not Imply Solar Was Subsidized Too Little, Too Late

Filed under: Climate Change,Economics,Energy,Politics,Regulation — cpirrong @ 10:01 am

The estimable Francis Menton has noted repeatedly that the “energy transition” has set loose upon the world a host of innumerates who assure us that they know best when in fact they know less than nothing. And perhaps to coin a phrase, I would add that they are ineconimate, i.e., know nothing about economics. Arrogance and ignorance is a lethal combination. Such people will make us poor, and likely shivering in the dark.

Alas, the mind eating virus has even infected many who were once sensible, or at least periodically sensate or sentient. Such as the FT’s Tim Harford. (I am guessing that the brain eating ameobae at the FT have finally gotten to him.)

Harford wrote that instead of saying “I could’ve had a V8” 40 years ago, we should have said “I could’ve subsidized solar and then all our energy and climate problems would have been already solved.”

In a nutshell, Harford invokes learning by doing, which he refers to as Wright’s Law in honor of an aeronautical engineer in the 1930s who first identified this phenomenon. It has since been documented in numerous other areas, starting probably with Liberty Ships in WWII.

Yes, LBD is a thing. It has been part of the theory of economic growth since at least the 1970s, starting most notably with Paul David’s work on the antebellum cotton spinning industry in the US, and earlier than that even with work by Kenneth Arrow. Robert Lucas taught about it in the economic growth undergraduate (!) course I took as a small child at Chicago in 1981, FFS. (What a privilege and experience it was to be in that course.) I was so taken by the subject that my paper for George Stigler’s economic policy course in 1982 (when he won the Nobel Prize) examined empirically learning by doing at the Springfield and Harpers Ferry Arsenals prior to 1860. It’s hardly a new idea, or an unexplored one.

Alas, there are numerous problems with Harford’s application of LBD/Wright’s Law to solar.

One issue is: who is to say that the highly touted reductions in the cost of solar aren’t due to LBD?

That is, since cumulative output in solar panels has indeed increased dramatically over the years, learning would presumably have taken place and that plausibly accounts for some of the cost reductions. Harford himself says “PV is now so cheap that the question is moot.” So, perhaps LBD did its work.

Empirical evidence would be nice. And at most what Harford is saying is that we could have learned earlier. But if the learning has taken place (as evidenced by it being “so cheap”), albeit belatedly, solar should be taking over the world now, without subsidies, right?

Further, if Harford really means that too little learning has taken place, or it has occurred too late, then that would require (a) externalities/spillovers in learning, (b) the large subsidies to solar (which Harford pooh-poohs) were in fact too small and/or too late to generate the right amount of learning at the right time, and (c) market participants were unaware of the spillovers and did not take obvious steps to internalize them. He provides support for none of these.

With respect to externalities, it is not obvious that LBD effects are largely external to firms. Firms may be able to keep the benefits of their experience largely to themselves. To the extent they are internalized, there is no rationale for subsidies, and competitive firms will treat current production in part as an investment in future lower costs and expand output accordingly without need for government support or protection.

(NB. Non-compete agreements may be one way firms attempt to keep the benefits of experience internalized. I will soon write a post on the idiocy of the FTC’s ban of such agreements.)

I have analyzed LBD in the US shale sector in detail. I have found extensive learning effects, but the evidence for learning spillovers is weak. A firm’s own experience contributes more to its productivity than collective industry experience. This is evidence that learning is internalized.

Further, firms respond rationally to spillovers–by trying to internalize them. Mergers, consolidation, and concentration are means of internalizing learning. I note that consolidation is coming to shale only after more than a decade after the industry dramatically increased output and drilling experience.

In shale, it is plausible that much of the learning is done by service firms who internalize the benefits. Thus, even to the extent that industry experience explains productivity improvement, to the extent that service firms who, well, service the industry are the ones who generate this learning, these industry experience effects may be internalized as well.

That is, just because there is learning by doing, doesn’t necessarily mean that there are learning spillovers of the type that justify subsidies (or tariffs) to increase output (and hence learning). And if there are, there are strong economic incentives to internalize them. And if there aren’t, there’s no justification for subsidization. (David’s work on the cotton industry addressed the question of whether tariffs to stimulate domestic cotton cloth output were justified because of learning spillovers.)

All of these factors undercut the argument that the PV industry learned too little, too late. Where is the evidence that PV is unlike shale, and characterized by large learning spillovers which industry participants did not attempt to internalize through merger or other means? (I would also like to highlight the irony that Harford’s argument would imply that shale, for which there is actual evidence of LBD, should have been subsidized decades ago.)

Harford also has a myopic focus on PV cost, and fails to consider the total cost of renewables, including solar. Like other renewables, solar has intermittency and diffusiveness problems. Moreover, it has large and predictable output fluctuations (e.g., the “duck curve” problem in which solar output plunges when the sun starts to set). Due to these inherent features, useful solar will require beyond revolutionary innovations in battery technology (something Menton has analyzed in detail) that are not anywhere on the horizon.

(I note that battery technology has been the subject of massive research. It has also experienced tremendous growth in cumulative output, which has presumably contributed to learning. Yet it is nowhere even close to being an economical way to address output variability for renewables.)

Word to the wise: we are not going to be able to learn our way out of the sun rising, and more importantly setting. Or out of rain, clouds, and hailstorms. Or out of voracious needs for land to site renewables. Or out of the difficulties of disposing defunct panels.

Solar is part of a complex energy system. The cost of solar panels is actually among the least important aspects of the cost of relying on solar as a source of energy.

And talk about hindsight. Harford laments our failure to gaze into the distant future and foresee with precision the obsession with CO2 and climate change, and supersize solar panel output in time to provide cheap solar power when those obsessions became manifest. Yeah, and I should have invested in Apple when Harford says we should have subsidized solar. Or Bitcoin in 2013.

In sum, Harford’s woulda, coulda, shoulda lament in the FT is yet another example–as if more were needed–of the intellectual vacuity of those hyping the “energy transition.” Harford invokes a respectable economic concept–learning by doing–but does so in a superficial way that betrays a complete lack of understanding of it. And in a way that also betrays a lack of understanding of the real challenges of transforming an extremely complex energy system. Cheap solar panels may be a necessary condition for a cheap transition, but it’s hardly a sufficient one, or indeed, even likely an important one.

Alas, learning by doing doesn’t appear to apply in the writing of newspaper columns.

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April 20, 2024

Why Do Governments Repeatedly Engage in Energy and Environmental Boondoggles?

Filed under: Climate Change,CoronaCrisis,Economics,Energy,Politics,Regulation — cpirrong @ 1:34 pm

In the Wealth of Nations, Adam Smith famously wrote:

By means of glasses, hotbeds, and hotwalls, very good grapes can be raised in Scotland, and very good wine too can be made of them at about thirty times the expense for which at least equally good can be brought from foreign countries. Would it be a reasonable law to prohibit the importation of all foreign wines, merely to encourage the making of claret and burgundy in Scotland? (WN IV.ii.15)

This came to mind when reading this Bloomberg article about an “efuels” venture:

At its plant, electrolyzers break down water into hydrogen and oxygen, using electricity generated from nearby wind and solar farms. The hydrogen is then transported to a reactor, where it meets CO2 captured from local refineries, setting off a series of complex chemical reactions aided by patented catalysts. The result is a synthetic fuel with the same chemical properties as its fossil fuel-based cousins.

Yes, this process can create “equally good” fuel as traditional hydrocarbons. But at what cost? Well, they could tell you, but then they’d have to kill you:

How Infinium fits into that future remains to be seen. Schuetzle is tight-lipped about the company’s exact plans. While acknowledging that Infinium’s e-fuel is “more expensive” than conventional fuel, he didn’t disclose the cost difference. 

Probably not the 30x of Adam Smith’s Scottish wine, but evidently a large enough multiple to frighten the horses if disclosed.

Because of this cost differential, this industry will come into existence only as the result of heavy-handed government policy, in the form of subsidies, kneecapping competitors (namely traditional fuels), or more likely both. And echoing Smith, the question becomes “is it a reasonable law or policy to rig they system to favor this technology, merely to encourage the making of efuels?”

Smith did not answer his question because it answered itself. And the same is true of mine.

To repurpose an old joke, the government wants to address climate change in the worst way, and it is. Picking technologies that are feasible but exorbitantly costly in order to achieve a putatively desirable objective is a tried and false modus operandi of government. And this has been especially true of environmental and energy policies in the United States going back to the dawn of the EPA in the early 1970s, and the energy crisis of the mid-to-late 1970s.

I recall the “synfuels” boondoggles of the late-70s, e.g., making oil from shale. No, not the shale revolution you might be thinking of that actually resulted in the economical production of vast amounts of crude oil and natural gas, but taking shale rock in Wyoming with embedded hydrocarbons, subjecting it to energy intensive transformations (redolent of those described above for the efuels project) to produce oil at vastly higher cost than even the then-elevated price of conventionally produced oil. The government spent billions back when a billion actually meant something on this effort (and other synfuel efforts). And every dollar was wasted.

And reading the Bloomberg article demonstrates that the government, in its wisdom, is doing Adam Smith one better: it wants to mandate technologies that don’t really exist (unlike Smith’s “glasses, hotbeds, and hotwalls”):

Some regulators seem to agree with that thinking. The EU will phase out government subsidies for e-fuel made with fossil fuel-sourced CO2 by 2041. 

In its place, governments will mandate that efuels be made from CO2 obtained from air capture, a technology that the Bloomberg article describes as “nascent” but is more accurately described as “pie in the sky” (literally, in this case).

This generation of efuels will come into existence only as the result of government diktat, just as the first generation–ethanol and biodiesel–did. And the efuel technological greenhouse forcing is just one small part of an array of mandating of technology choices, all in the name of fighting global warming. The electrification of everything is if anything a more extreme example: the EPA’s mileage mandates (intended to make ICE vehicles uncompetitive with EVs), its emission standards for fossil fuel generation, and the lavish subsidization of inefficient (because diffuse and intermittent) renewables are if anything more egregious than growing the efuels industry like orchids.

But bureaucrats are geniuses, and will only do what’s best, right? Right? To disabuse yourself of such notions, refer back to the synfuels case discussed above. Or consider two more recent examples.

One was the European policy to force the replacement of gasoline engines with diesel ones in passenger vehicles, with the unintended–but totes foreseeable–result of increased particulate emissions (and widespread fraud by automakers to conceal that). Europe had to jettison that policy, so it has substituted another: eliminating ICE vehicles altogether. I’m sure that will work out swell.

Another that I find particularly rich is the sulfur standards for marine fuels introduced in 2020. In another unintended (but again foreseeable) consequence, the resulting reduction in particulate emissions is allegedly contributing to global warming. The irony behind this (compounded by the fact that efuels funder Bill Gates is also a fan of this technology) is demonstrated by serious proposals–recently experimented with–to inject particulates into the atmosphere to, yes, mitigate global warming.

So why do governments repeatedly adopt excessively costly policies to address putative problems? One part of the answer is hubris combined with the knowledge problem: they think they know a lot more than they do. But that’s not the entire answer.

At root, I think the more fundamental driver is public choice-related. Specifically, specific technologies have specific constituencies who would benefit from their subsidization (or other forms of policy support). They exert influence on legislators and bureaucrats to implement policies that favor them. (It is not a coincidence, comrades, that Bill Gates and the like have connections with many of these schemes.)

In contrast the effects of policies such as a carbon tax or cap and trade are much more diffuse and far less predictable because the ultimate outcome would be determined by market processes in a complex system. Adjustments would occur on myriad margins, not just by large firms but billions of individuals. The winners and losers in such a process are unknown, unknowable, and highly diffuse–these are not the concentrated interests that exert disproportionate influence on public policy.

(NB: I am not endorsing a carbon tax or cap and trade. I merely assert that they would be better ways of reducing carbon emissions than subsidizing or mandating technologies to do so. An exercise in the Theory of the Second Worst, if you will.)

In sum, political systems produce bad “solutions” to problems because of the very nature of politics, a nature that Mancur Olson and others pointed out years ago. A nature in which “public choice” means that the public gets screwed.

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March 25, 2024

EPA Delenda Est

Filed under: Climate Change,Economics,Politics,Regulation — cpirrong @ 5:54 pm

It is a challenge to identify the worst of the worst Federal agencies, but the Environmental Protection Agency is clearly a heavy favorite.  (The security organs are in a class by themselves.  Here I refer to civil regulatory agencies.)

In a strong effort to cement winning this dubious distinction, last week the EPA announced new tailpipe standards that reduce by 50 percent allowable emissions of CO2 (relative to an already reduced 2026 level).  This is transparently intended to throttle internal combustion engines (ICE) and jam electric vehicles (EVs) down our throats.

The administration is crowing about this:

“Three years ago, I set an ambitious target: that half of all new cars and trucks sold in 2030 would be zero-emission,” Biden said in a statement, adding that the country will meet that goal “and race forward in the years ahead.”

Biden said in a statement issued in his name—written by someone else, of course, because he couldn’t form these sentences by himself.

 In numbers pulled straight from its collective ass, the EPA claims the reduction in CO2 emissions will produce $100 billion in benefits annually, the vast bulk of which are due to chimerical gains from ameliorating climate change. 

As the much-missed Sonic Charm (still mordant on X, but not in the blogosphere) said: all large calculations are wrong.  And that goes exponentially for any calculation involving alleged climate benefits and costs.  Despite all the claims about scientific consensus (which should make you neuralgic in the aftermath of Covid, where almost all claims about The Science flogged by governments and the media have turned out to be the inversion of the truth), estimates of the impact of changes in CO2 emissions on climate are speculative in the extreme.  And those speculations pale in comparison to estimates of the impact of climate changes on welfare, including effects on wealth, income, and living standards.

Climate is a complex system.  Economies are complex systems.  Only fools and the evil have the hubris to claim to know how small changes in one variable will affect outcomes in the interaction between two complex systems. 

Where does the EPA fit here? Both, clearly. 

It is particularly perverse that the EPA is attempting to socially engineer economic outcomes—namely, what vehicles people drive—at a time when the manifold defects of EVs are becoming clearly manifest.  Their performance sucks in multiple ways, including limited range, declining range over time (as batteries age), poor performance in cold weather, and long recharging times (human time is valuable—did the EPA take that into account? I crack myself up sometimes).  Repair costs are astronomical.  And the putative environmental benefits are dubious when the entire vehicle lifecycle is considered, or when the environmental impacts of mining the myriad materials EVs need are taken into account.  Moreover, there are other environmental costs—notably substantial road degradation and substantially increased particulate emissions from tire wear, both due to the great weight of EVs.

Increased awareness of these effects is turning EVs into the Typhoid Marys of automobiles.  Sales are well below what had been projected as consumers have become aware of the clear inferiority of EVs relative to ICE vehicles in doing the things people want—and need—their vehicles to do.  EVs are clogging dealer lots, and they don’t want to buy more.  Resale values are in the tank.  Insurance costs are prohibitive. 

EVs are far more expensive to drive off the lot, and are more expensive to operate, than ICE vehicles.  Is it any wonder why Ford is drastically cutting its production of electric F-150s, and why every other auto manufacturer is hedging on its previous promises to go all electric in the near future?

Two rental car companies—Hertz and Sixt—have recently pulled the plug on their EV fleets (figuratively and literally) because the economics are so atrocious.  The disastrous Hertz plunge into electrics cost the CEO his job.   

EV skeptic Toyota is looking pretty damned smart now, ain’t it?

The inadequacies and defects of EVs are particularly pronounced for anyone who lives outside of a major metro area, and the more exurban or rural you are, the less suitable EVs are for you.  So this regulation represents another front in the war on suburban, exurban, and rural America.

And maybe that is part of the plan.  Recall my post on the war on cars generally.  They want you to walk the road to serfdom, and to jam people into villages (soothingly named “15 minute cities”), just like castellans did in the 11th century. 

Put differently: from the perspective of the progressive, globalist types who want to eliminate personal mobility (for the proles, that is, not for them), all the aforementioned bugs of EVs are features because they drastically raise the cost of mobility. 

Not to mention the strains that increased EV usage will place on already creaking electricity grids and generation systems.  The interaction between this regulation, and the EPA’s equally (or even more malign) regulations of power plants, poses extreme risk to the nation’s electricity system.

To compound the lies, the administration claims that this will be a boon for the domestic automobile industry:

Biden added that U.S. workers “will lead the world on autos making clean cars and trucks, each stamped ‘Made in America.‘”

As. Fucking.  If.  This regulation will wreak havoc on the existing ICE-centric US auto industry (and the entire supply chain for it), with all of the baleful consequences that will have for capital value and employment.  The US industry has shown little prospect of having a comparative advantage in EV manufacturing.  Note the huge losses Ford has racked up on a per vehicle basis on its electronic version of the stalwart F-150.  GM’s EV operation has also frolicked in pools of red ink. 

Trump claimed that the US auto industry would face a bloodbath due to Chinese manufacturing of cars in Mexico.  That is nothing compared to the ensuing bloodbath—economic bloodbath; it’s a metaphor!—if the EPA guts the ICE industry. (“Guts” is a metaphor too! Can’t assume anything these days, right?)

These regulations are beyond sickeningly perverse.  They represent an extreme exercise of arbitrary power in the service of a delusional ideological agenda embraced by a tiny sliver of the citizenry. 

And when I say extreme, I mean by the standards of rational behavior, not by the standards of the current American administrative state. Sadly, what the EPA is doing has strong parallels in what virtually every other Biden administrative agency is doing—don’t get me started on GiGi’s SEC.  Or the FTC.  Or the DoL. 

Extremism in the exercise of administrative power is definitely a vice.  It is the enemy of personal freedom, personal choice, and economic prosperity. 

Rein in the administrative state?  Is that even possible?  Doubtful.  The only sure remedy is the Carthaginian one.

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January 27, 2024

The “Pause” on LNG Permitting: Another Manifestation of “Elite” Hatred of Humanity, and a Monument to Stupidity

Filed under: Climate Change,Commodities,Economics,Energy,Politics,Regulation — cpirrong @ 7:25 pm

The Braindead Administration–sorry, sorry, the Brandon–I mean Biden!–Administration (understandable confusion there)–has announced a pause on permitting on new liquified natural gas (LNG) terminals. And how long a pause? How ’bout to a quarter ’til never:

The review will take months and then will be open to public comment which will take further time, Energy Secretary Jennifer Granholm told reporters in a teleconference.

This policy, if one can dignify it with such an appellation, is a sop to the ecoloonies upon whom the administration depends for support:

The growth [in LNG exports] has set off protests from environmentalists, part of Biden’s base. Activists say new LNG projects can harm local communities with pollution, lock in global reliance on fossil fuels for decades, and lead to emissions from burning gas and from leaks of the powerful greenhouse gas methane.

In brief, the administration (regime, really) wants to kneecap the remarkable energy revolution of the past 20 years, which has seen technological innovations that have turned the US from a nation worried about where its next MMBTU would come from to a natural gas production powerhouse, and which have allowed others to share in its bounty with the world.

But you see, to the ecoloonies that’s the bad news. Really bad. Climate change, dontcha know.

But even evaluated on those (dubious) terms, the policy is demented. Because the ecoloonies don’t understand basic economics. They are myopic, linear thinkers who are incapable of analyzing the ultimate impact of their policy.

In their thinking, less LNG exports from the US equals less fossil fuel consumption equals lowers carbon emissions equals saving the polar bears. Even overlooking the (again dubious) last step in the logical chain (hey, I’m a a generous guy) the analysis is flawed. Where it definitely breaks down is the third, and arguably the second, steps.

Yes, reducing US natural gas output (by choking one source of demand) will reduce world natural gas production. But the resulting higher world price will induce higher output by competing producers (e.g., Qatar, Australia, PNG, Africa, etc.), resulting in a net decline in world gas production smaller than the decline in US production–and it is world production that matters when considering “well mixed” GHGs. Further, some production that would have otherwise been exported will be consumed domestically instead, meaning that a given decline in exports does not result in an equal decline in production.

But more importantly, the rise in the price of gas relative to other fuels–notably coal–will induce substitution towards those fuels. Since those fuels are more carbon intensive than natural gas, it is possible, and indeed likely, that the net effect of the policy would be to increase the output of GHGs.

So at the very least, the amount of reduction in GHGs resulting from this policy will be far smaller than the reduction in US LNG exports that it will cause, and plausibly will result in an increase of GHGs.

Well played! All pain, no gain!

But the economic idiocy of ecoloonies is an old story by now. Perhaps you’ve read of the recent finding that the ban on “single use” plastic bags in New Jersey led to a tripling of consumer plastics consumption because of the substitution effects that the ban induced. Again, myopic, linear, one-step ahead thinking led to a policy that produced perverse results.

The foregoing analysis focuses on only one dimension–GHG output. But one also has to consider the cost incurred to achieve any GHG gains (if there are any, that is). But trade-offs (costs vs. benefits) is not something that ecoloonies do. They are monomaniacs, and monomaniacs don’t evaluate trade-offs.

This policy will also shtup European allies, whom in the aftermath of the Russian invasion of Ukraine Biden promised would receive bountiful supplies of US gas.

To paraphrase Animal House: “You fucked up, Europe! You trusted Biden!”

The administration pinky swears that

the pause would not hurt allies, saying the plan will come with exemptions for national security should they need more LNG.

Yeah, because it’s just like turning the faucet on and off, right?

If you believe what they say, you are truly an idiot and probably believe they’ll respect you in the morning.

But none of this should be a surprise. After all, this is an administration that is infested with members of the “elite,” and which counts on the “elite” for its support. According to a recent Rasmussen poll:

An astonishing 77% of the Elites – including nearly 90% of the Elites who graduated from the top universities – favor rationing energy, gas, and meat to combat climate change. Among all Americans, 63% oppose rationing.

Face it. They hate your guts and want you to suffer. This “pause” on LNG exports is just another manifestation of their hatred.

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September 3, 2023

Shell Has a Come to Jesus Moment: Will the Politicians? Alas, Probably Not.

Filed under: Climate Change,Commodities,Economics,Energy,Politics,Regulation — cpirrong @ 3:22 pm

In 2010, along with my UH colleagues Victor Flatt and Praveen Kumar, I taught what I believe was the first academic carbon trading course in the world. My lectures in the course related to the economic challenges of creating traded commodities, specifically the challenges of merely defining what the commodity is and monitoring adherence to the standards so established.

Now, this may seem trivial, but even something like “wheat” poses challenges due to heterogeneity related to quality (even within a given variety, such as soft red winter wheat) and monitoring whether the wheat traded under a contract adhered to the relevant terms agreed to by the parties. Indeed, as I noted in an early article of mine, the genesis and early development of commodity exchanges like the Chicago Board of Trade and the Liverpool Cotton Exchange was not driven by the desire to trade futures: these were cooperative, private efforts to define property rights and to create a mechanism to standardize commodities and to adjudicate contractual disputes primarily over quality. Only after these challenges were met was it possible to trade futures. Standards (and their enforcement) are obviously a necessary condition for trading standardized instruments like futures.

The major intended takeaway from my lectures in 2010-11 was that the problems of standard definition and especially standard enforcement were even more daunting in carbon than in traditional commodities like wheat or cotton, and that this was especially true with respect to carbon offsets–things like contracts to plant trees to capture carbon.

How do you define what is being bought and sold? How do you monitor whether the offset contracted for performs as agreed? How do you address contract performance failures? The Chicago Board of Trade struggled for years to overcome these issues in wheat and corn and oats in the post-Civil War era, even though the trade was relatively geographically concentrated, the contracts were of relatively short duration (typically for a single consignment), and the commodity was relatively simple.

All of these challenges are far greater for carbon, let alone for offsets. Sources of carbon emissions are numerous and diffuse and costly to monitor. With respect to offsets, they are highly heterogeneous; have very long lives; require continuous investment and upkeep; and have highly unpredictable performance (e.g., the forest that you plant may burn down, or be ravaged by insects). These contracts are far more complex than a deal to buy 10,000 bushels of SRW winter wheat for delivery in Chicago next month. Moreover, many offsets are located in countries with weak–and sometimes close to non-existent–legal systems.

Furthermore, the incentives of the parties to these agreements can be perverse, especially for “voluntary” offsets. A buyer who pumps its ESG score by purchasing offsets that turn out not to perform seldom suffers serious adverse consequences (although there is some backlash against “greenwashing”), and the seller has a strong incentive to collect the cash and not make the necessary expenditures to ensure that the offset performs as promised.

I taught the class in the immediate aftermath of the Global Financial Crisis, and I suggested that there were a lot of similarities between offsets and the kinds of deals that wreaked havoc in the banking system in 2008-2009, where bankers paid their bonuses upfront based on imagined profits predicted by highly speculative models to be realized over several years churned out garbage securities.

In 2010 I was therefore extremely skeptical about the viability of markets for offsets. And the defects that I talked about have been increasingly recognized in the last year or so.

I believe that the actions of Shell during the last week represent an authoritative recognition that these predictable–and predicted–problems have come to pass. Like other (especially European) energy firms. Shell made ambitious carbon reduction pledges that it intended to meet largely through the use of offsets. But reality has reared its ugly head, and Shell is all but abandoning this strategy. Other companies (e.g., Microsoft) say that they are still committed, but if they are even remotely interested in spending their shareholders’ money wisely, they will eventually have the same come to Jesus moment as Shell.

A Shell-funded mangrove restoration project in Senegal (Bloomberg).

This represents another grievous blow to the ambitions of the Net Zero fanatics. Offsets are a major component of Net Zero plans. Renewables are another part–and reality is catching up with that too (as the travails of Danish renewables developer Orsted and German turbine manufacturer Siemens demonstrate).

But will the fanatics be deterred? Alas, it appears not. Indeed, they appear to be doubling down, as illustrated by lunatics like Michael Gove:

Net Zero and the policies intended to bring it about–including extensive reliance on renewables and offsets–are a guaranteed recipe for an impoverished future. This was predictable–and predicted–more than a decade ago. But when will the madness end? I am guessing not before these policies cause economic catastrophe.

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August 15, 2023

Want to Mess With a Warmist’s Head?

Filed under: Climate Change — cpirrong @ 12:04 pm

Ask him/her (but please inquire about pronouns first!) whether the Hunga Tonga eruption accounts for a significant proportion of this summer’s supposedly historically high temperatures. This puts the warmist on the horns of a dilemma a la the famous meme:

The likely answer you’ll get is no, because the warmist desperately wants to attribute this year’s weather to anthropogenic causes. (NB: weather is climate when it advances their narrative, but isn’t when it doesn’t.). Suggesting a natural driver of warm temperatures this year would undercut that narrative.

But! Unlike terrestrial volcanoes which have an often powerful cooling effect (due to their release of sun reflecting aerosols, especially H2SO4), Hunga Tonga is an undersea volcano: its eruption resulted in the release of substantial quantities of water vapor into the atmosphere. Water vapor is a powerful greenhouse gas.

Therefore, denying the impact of Hunga Tonga on 2023 summer temperatures is. . . wait for it . . . CLIMATE DENIAL! Because this would entail denying that greenhouse gasses materially impact global temperatures.

So if they say “No!” then point at them like Donald Sutherland in Invasion of the Body Snatchers and scream “DENIER!”

On a more serious note, Hunga Tonga does seem to provide a fairly clean natural experiment to measure the climate sensitivity coefficient empirically in a way that does take into account feedbacks. If the amount of water vapor released into the atmosphere can be measured with some accuracy, the forcing can be calculated. Combining this with the measured temperature anomaly is an empirical measure of sensitivity that does not require a layer cake of modeling assumptions about feedback.

But that’s a job for scientists. In the meantime, you can entertain yourself by putting warmists on the hot seat.

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July 14, 2023

The Hydrogen Economy, or The Hindenberg Economy? Or, Gosplan Goes Gassy

Filed under: Climate Change,Commodities,Economics,Energy,Politics,Regulation — cpirrong @ 12:32 pm

The Biden administration, courtesy of the delusionally titled Inflation Reduction Act, has made a huge spending commitment on alternative fuels, and in particular “clean” hydrogen, i.e., hydrogen not produced from fossil fuels (such as methane). Most of the “green” hydrogen stimulus involves supply-side subsidies (especially a $3/kg production tax credit, but also loans to be doled out by the administrative state). The Infrastructure Law sets aside funds for hydrogen electrolysis and hydrogen “hubs” (like that just announced for Germany). The administration is also attempting to make “the economic case for demand-side support,” such power purchase agreements (PPAs), contracts-for-differences (CFDs), advanced market commitments (made by whom?), and prizes (funded by whom?).

It’s hard to know where to begin in criticizing this mess. The biggest problem is that it attempts to address the climate issue (which I will take as a given, focusing on means not ends) by picking technologies. This almost never ends well. First, there is the knowledge problem–bureaucratic governments do not possess the information to make these technology choices. Second, there is the rent seeking/corruption problem–which exacerbates the knowledge problem, as interested parties exploit the ignorance of bureaucrats and funders, and their political connections, to induce investments based not on their economic virtues but instead on political influence.

There are also serious doubts about whether hydrogen qua hydrogen is the right alternative fuel given that it poses numerous problems and costs. The first is that using renewable energy to produce green hydrogen is extremely expensive. The second is that, well, hydrogen is highly explosive: I distinctly remember my 8th grade science teacher, Mr. Fisch, using electrolysis to fill a test tube with hydrogen, putting in a piece of chalk, then lighting a match to set off an explosion that sent the chalk flying across the room. You didn’t have Mr. Fisch as a teacher, but perhaps you’ve heard of the Hindenberg:

Explosiveness creates hazards, of course, and mitigation of them is expensive. Hydrogen is also extremely expensive to transport and store and requires a new and distinct transportation and storage system.

We are talking trillions of dollars to create “the hydrogen economy”–something even its boosters admit. Hell, they brag about it.

Hydrogen “carried” with carbon, in the form of ammonia or methanol, pose fewer problems (although ammonia in particular is nasty stuff). They are also costly, and it is clearly uncertain whether “green” forms of these hydrogen carriers are economical ways to reduce carbon emissions from fuels for transportation and power generation.

But the administration (and Europe too) have gone all in on hydrogen. Why? Maybe because their extreme antipathy towards carbon leads them to disdain fuels with any carbon in them.

Having chosen its technology, for better or more likely worse, now the administration is focused on how to force its adoption. The supply-side incentives are clear enough, so now there is a pivot to the demand-side, as expressed in the appallingly shoddy Council of Economic Advisors document linked above.

According to the CEA–and not just the CEA, as will be seen shortly–the problem is that “[r]eal or perceived risks around clean energy projects can raise the cost of accessing capital,  which could slow the rate at which projects like those in the hydrogen hubs program achieve commercialization..”

Well, I should hope so! That is, I should hope that risks are taken into account when allocating capital!

John Kerry flogged the risk issue on MSNBC (h/t Powerline):

“What’s preventing it is, to some degree, fear, uncertainty about the marketplace. People who manage very significant amounts of money have a fiduciary responsibility, an obligation to the people they manage it for not to lose the money, but to produce returns on that investment. Pension funds, many of them, are very careful about those investments in order to make certain they have the money to pay out to the pensioners who work for that money all their lives. So, there are tricky components of making sure that you have taken the risk away from these investments. And energy, which is what the climate crisis is all about, it’s about energy, it’s about how we fuel our homes, how we heat our homes, how we light our factories, how we drive and go from place to place.”

Damn those money managers for taking into account the risks and rewards of the money their investors entrust to them! Don’t they understand that John Effing Kerry knows what is right for humanity????? After all, he flies around the world in a private jet sharing his wisdom (and then dissembles about it before Congress).

I loved this part: “So, there are tricky components of making sure that you have taken the risk away from these investments.” Does John Kerry have a magic box into which he can make the risks disappear? Do tell!

Of course he doesn’t. What he means, clearly, is that the government must somehow absorb the risks inherent in the technology that they have already decided upon–apparently without analyzing those risks fully or carefully, or wondering whether maybe these damned investors might know something they don’t. (Of course they don’t wonder that! They are all knowing, right?)

At least the CEA attempts to put lipstick on the pig and raise some economic arguments to justify the need for demand-side support. There are market failures! Government never fails, but markets do, right?

In my experience the concept of market failure is most likely to be advanced when the market fails to do what someone thinks should be done, or wants to be done, based on their own vision. That is, when the market disagrees with someone, the market has failed! Especially when that someone is a member of what Thomas Sowell calls “The Anointed.”

The CEA basically cites to some theoretical possibilities. At the core of their argument is that learning by doing, including learning-by-doing that “spills over” among companies, can lead to inefficient investment. The CEA advances a couple of reasons.

One is a contracting failure. LBD–moving down the learning curve–reduces costs, meaning that prices are expected to fall. So, according the CEA, potential buyers are unwilling to enter into long term contracts for fear of agreeing to pay a price that will turn out to be too high: “if rapid declines in technology costs are expected, the willingness of private sector end-users to seek out such contracts with clean energy developers will be limited” (emphasis added). Without such contracts, hydrogen project developers can’t secure financing, so plants won’t get built, no learning takes place, and costs don’t fall. The Curly Equilibrium, in other words:

Really? If costs are expected to fall, market participants can enter contracts with de-escalator clauses, i.e., contractual prices that fall over time. Apparently the CEA only envisions contracts at a fixed price that extends through the life of the contract. But even then, given anticipated cost declines, the developer would be willing to sell at a price below the initial cost, basically, at the average cost expected over the life of the contract.

The CEA mentions the risks of of the magnitude of cost declines, but again, that should be a material consideration in any contracting and investment decision. Is the CEA arguing that the risk compensation demanded by borrowers will be excessive? They don’t say so explicitly, but that’s what you would need to argue that the prices in these contracts would be “too low” and thereby stymie investment.

I’d also note that indexed prices, widely used in a variety of commodity off-take agreements, eliminate the risk to buyers of locking in too high a price. They also address the asymmetric information problem that the CEA frets about. If the developer has better information about the likely trajectory of price declines, then yes, buyers looking at fixed price deals or deals with mechanical (non-market based) price de-escalators face a “winners’ curse” problem: the developer will agree to terms that overestimate his (better) forecast of future prices, and reject deals that underestimate.

I think in fact that the issue is that there is considerable uncertainty among all parties, developers and buyers alike, regarding what the future cost trajectory will look like. That is, there is a real risk here, and that risk should be taken into consideration when deciding whether hydrogen investments make sense. And market participants are far better at assessing the risks, and the pricing of those risks, than the government, which is clearly taking a “Damn the risks, full speed ahead!” Approach.

Sorry, but John Kerry et al don’t inspire confidence like Admiral Farragut at Mobile Bay.

One of the proposals under discussion is Contracts for Differences (“CFDs”) in which the government would (perhaps through a non-profit intermediary) provide a guaranteed revenue stream to a developer and absorb the price risk. To work, CFDs require indexing to some market price–and the market price for H2 hasn’t really been created. Further, they require some mechanism to set the guaranteed price, a non-trivial task given the very information asymmetries that the CEA worries about. The government-appointed third party (or the government for that matter) will certainly be the less informed party in any negotiations with developers, and will almost certainly overpay. (Not that they will mind–not their money!) Meaning that the asymmetric information problem the CEA frets about is present in spades in one of their preferred means of addressing it. Further, CFDs have already presented performance issues, with the sellers (those getting the guaranteed revenue stream) treating these contracts like options rather than forwards, and spurning their CFD commitments when market prices rise above the guaranteed price (as has happened with with generators in the UK when power prices spiked).

The CEA also invokes capital market imperfections also driven by asymmetric information that may impede financing if developers know more about the economics of projects than the financiers. This is a hoary old story that has been used to identify alleged market failures since time immemorial. So long ago, in fact, that when Stigler wrote “Imperfections in the Capital Market” (JPE) 56 years ago, he (in typical Stigler fashion) drolly started thus: “The adult economist, once the subject is called to his attention, will recall the frequency and variety of contexts in which he has encountered ‘imperfections-in-the-capital market.'” That is, “capital market imperfections” were an old joke decades ago.

Here’s another one, George! Based on long experience, George was a skeptic. Based on even longer experience, I am too, in this case in particular.

And let’s look at the empirical record. Learning by doing is a ubiquitous phenomenon. Dynamically declining costs in industries with potential information asymmetries abound. Yet industries have developed and thrived nonetheless.

Some examples.

I recently finished a piece describing extensive learning-by-doing in the shale industry, including evidence of learning spillovers and dynamic cost reductions. Yet, the shale sector has not faced problems getting capital or expanding rapidly. Hell, if anything, a common criticism is that shale drillers have obtained too much capital and drilled too much, not that they are starved for capital and drilled too little.

Does the CEA (or John Kerry!) believe the shale sector in the US is too small?

Insofar as spillovers is concerned, the fact that the costs of firm A decline when firm B produces more output is a necessary, but not a sufficient condition for an externality. One plausible outcome in oil (as identified in a paper on LBD in conventional drilling by Kellogg in the QJE) is that service firms are the ones that do the learning, and capture and internalize it.

LBD is well-documented for computer chips, which have seen relentless cost and price declines over the years. Yet computer chip factories have been built, and companies especially in the US and Asia have attracted the capital necessary to build these very expensive facilities and build new chip lines nonetheless. (In this industry too, there have been chronic complaints about overcapacity, rather than undercapacity. I am not commenting on the validity of those complaints, just noting that their existence contradicts the notion that dynamic scale economies and price declines due to LBD starve an industry of capital.)

The LNG industry has many of the characteristics that the CEA attributes to hydrogen. Yet this industry has expanded apace for well over 50 years now.

I viewed a presentation by DOE people today in which LNG was raised several times, and as an example not to be followed. DOE advisor Leslie Biddle (ex-Goldman) mentioned LNG several times (“I keep going back to the LNG analogy”), and in a negative way. LNG took 30 years to move to a traded market, dontcha know. And we don’t have that time! We need to create such a market in a year! (DOE’s Undersecretary for Infrastructure David Crane was more generous, giving us all of 5 years.) (Crane was also hyping the idea of hydrogen for everything, including home heating–apparently oblivious to the fact that even Net Zero fanatical Britain has just recently determined that H2 is too dangerous to heat homes.)

In the context of the discussion of a grand government plan to transform the energy system, I couldn’t help but think of Gosplan, or Stalin’s race to industrialization (e.g., the Magnitogorsk Steel Factory). We will inevitably–inevitably–meet the “Dizzy With Success” phase in hydrogen, mark my words.

I note that LNG production grew substantially before it became a traded market, which actually undercuts Biddle’s argument. Even though there was not a liquid traded market for LNG in the first decades of its growth and development, long term contracts, usually using crude (no pun intended) indexing features (like tying prices to Brent), contracts were agreed to, financing was obtained on the backs of these contracts, and liquefaction plants were built.

Oil refining faced many of the conditions that worries the CEA about hydrogen. Kerosene was a radical product early on, with a lot of uncertainty about market adoption. But Rockefeller dramatically expanded output and reduced costs: the cost of kerosene by 2/3rds in 10 years (1870-1880), in large part due to extensive learning and research on all aspects of the value chain. Standard Oil’s supposedly predatory acquisitions of were actually ways by which SO’s knowledge could be combined with physical assets to improve their efficiency.

The co-evolution of gasoline refining and the adoption of the automobile represents another example of investment and falling prices in a new market in a capital intensive industry.

I note that the early refining examples occurred when capital markets were far less developed than is currently the case. I further note that large energy firms (IOCs and NOCs like Aramco in particular) can potentially finance hydrogen (and other alternative energy projects) with cash flows generated by their legacy fossil fuel investments: this would largely eliminate any asymmetric information problem between developer and financier (because the developer is the financier) and developer and customer (because the developer could finance without securing a long term price commitment).

Another example. Electricity generation. Beginning with its inception in the early-1880s, electricity generation was highly technologically dynamic, with substantially declining costs. Yet in a few short years most urban areas in the US were electrified, with numerous private companies competing with government utilities. This was another industry in which overbuilding, rather than under-building, was widely discussed. The movement to price regulation occurred well after the industry developed, and was a reaction to intense price competition: regulation effectively cartelized electricity generation.

One more. Aircraft. LBD was first identified in the production of airframes. This phenomenon was first documented by Wright in 1936, and was subsequently observed in myriad other industries (e.g., Liberty Ship construction in WWII). LBD and the associated cost declines have continued in aircraft construction ever since. And aircraft have been built and aircraft manufacturers have been able to attract the capital to design and build new aircraft that benefit from these cost declines.

In the face of all these examples, the CEA and others making these market failure arguments should identify an industry that died aborning due to the alleged chicken-or-egg problem that makes demand side support of hydrogen investment necessary.

The CEA document has echoes of some rather common, but unpersuasive, arguments for government support of industry, such as the infant industry argument and the big push development literature. The latter has been demolished by practical experience: the list of its dismal failures is far too long. There are more than echoes of this discredited approach in the CEA document. It links to a paper that credulously recycles the old, bad, discredited theories.

What is amazing about the infant industry argument is how often it is invoked, and how little empirical evidence supports it. One of the few empirical papers, that of Krueger and Tuncer, rejects the argument in the case of Turkey.

A paper by Juhasz is often touted to support the theory. It shows that after the stimulus of the cotton spinning industry in France due to Napoleon’s Continental system, post-1815 the industry was competitive with the British, indicating that it had moved down the learning curve. Again, at most this identifies a necessary condition for protection–learning–but not a sufficient one. Even if LBD occurs, and even if there are spillovers, the cost of protection may exceed the benefits. A simple story demonstrates this. If the protected industry achieves cost parity with the first-mover (e.g., the UK in cotton), the protected firms merely displace firms in the first-mover country, leaving post-parity total costs unchanged. So in equilibrium, protection is costly but generates no benefits.

All in all, the CEA document reminds me of a rather conventional undergraduate econ paper, repeating textbook wisdom about externalities and market failures. It completely ignores the Coasean insight that market contracting methods are far more sophisticated than those in the textbooks, and that market participants have incentives to find clever ways to contract around what would be market failures if market transactions were limited to the forms considered in textbooks. It also ignores the historical record.

In other words, rather than writing off the difficulties of securing “bankable” contracts to secure funding for H2 developments to “market failures” or the excessive risk aversion of market participants, the government should step back and consider whether this alleged hesitation reflects a more sober and informed evaluation of risks than our betters in DC have undertaken.

I crack myself up sometimes.

In sum, the administration’s entire approach to hydrogen is utterly flawed. It attempts to pick technologies based on a pretense of knowledge it does not possess. It views flashing red lights warning of risks as signals to be suppressed rather than considered when making policy and investment choices. It engages in simplistic analyses of how real markets work, and how they have worked historically, to conclude that market failures requiring government intervention to fix abound in hydrogen.

All of these government failures could be eliminated by cutting the Gordion Knot, pricing carbon, and letting markets and private enterprise develop the technologies, products, contracting practices, and market mechanisms to trade off efficiently the benefits of reducing CO2 emissions. Decentralized mechanisms discover and utilize information, including information about new technologies, far more efficiently than governments. Decentralized mechanisms incentivize learning and innovation–including contracting and organizational innovations that can be instrumental in developing and adopting new technologies, products, and techniques.

In the case of hydrogen, pure or “contaminated” with carbon, priced carbon would address the problems that the CEA frets about, in particular the contracting problem. A carbon price would make it straightforward to index prices in contracts. A formula related to NG prices (because blue hydrogen is likely to drive the price of hydrogen at the margin, and because methane is likely to be the substitute at the margin for H2 in many applications) and the cost of carbon would send the appropriate signals and eliminate the need to fix prices in advance.

What the price of carbon should be and how it should be determined is a whole other question. But it would be far more productive, and not just in regards to hydrogen, to focus on that problem rather than leaving it to the John Kerrys of the world to pick technologies and then devise the coercive mechanisms necessary to force the adoption of those technologies.

Alas, we are on the latter path. And it will not take us to a good place. Probably figuratively, and perhaps literally, to the fate of the Hindenberg.

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April 17, 2023

Fixing Texas’ Electricity Market: The Theory of the Second Best In Action

Filed under: Climate Change,Economics,Energy,Politics,Regulation — cpirrong @ 6:05 pm

The Texas legislature meets every other year, meaning that 2023 is the first session in which legislation to address the issues that became apparent with the near death experience of the Texas power grid during Winter Storm Uri in February 2021 can be considered. The Texas Senate has passed two bills. Senate Bill 6 mandates the building of 10,000 MW of thermal generation (with on-site fuel storage), to be paid for via an “insurance” mechanism that guarantees a 10 percent rate of return to be funded by uplift charges to transportation and distribution utilities. Senate Bill 7 effectively creates an ancillary services market that allows dispatchable generation to sell reserves (e.g., spinning reserves) on a day ahead basis.

Opponents of the legislation state that it represents backsliding from the ideal of competitive energy markets:

Opponents immediately created the false narrative that the Texas bills are proof that Texas politicians “no longer have faith that competitive markets can adequately and economically satisfy the electricity need of Texas citizens,” said Beth Garza, a consultant for the think tank “R Street Institute.”

Well, the bills do represent major departures from Texas’ “energy only” market design. But this raises the question of what undermined the energy only market in the first place. And the answer to that is clear: subsidies for renewables. Past subsidies have wreaked havoc for years. Future subsidies, especially those in the Green New Deal in Drag, AKA the Inflation Reduction Act, threaten to wreak even more havoc in the future.

As I’ve written, this problem was evident years ago, in the mid-2000s. Even then, the penetration of renewables was undermining the economics of thermal generation, leading to exit of such capacity, thereby pressuring reserve margins and compromising–seriously–reliability. The process has continued inexorably in the past 15 years or so, leading to the precarious situation that culminated with Uri–and which has led to chronic concerns about blackouts during every cold snap and heat wave since.

The upshot of the process is an electricity system with a decidedly suboptimal generation mix. Too much intermittent, non-dispatchable renewables, too little dispatchable thermal. The Senate bills are attempts to address that distortion.

This is a great example of the “theory of the second best,” in which one policy that would be suboptimal in the absence of any distortions is welfare-improving in the presence of other distortions. The massive past, present, and prospective subsidies for renewables have distorted the operation of an energy only market. The past subsidies cannot be undone, and the future subsidies are also largely out of the control of Texas and ERCOT. So subsidies for thermal generation that would otherwise be objectionable can improve economic efficiency because they counterbalance the effects of these other subsidies.

It is clear that persisting with the EO market would be a recipe for future disaster. Subsidy to offset subsidy is a second best approach, but the first best is unattainable due to the renewable subsidy induced distortion.

Are there other policies that might be preferable? The only real alternative I can see is a capacity market (another departure from energy only), with capacity obligations clearly directed at dispatchable resources. I am skeptical about the credibility of capacity commitments, and the ability to tailor them to address reliability concerns in particular. Furthermore, political economy considerations threaten capacity markets: renewables operators will lobby to qualify for capacity payments.

SB6 is focused on encouraging investment in dispatchable, reliable capacity. It is likely the MW will be forthcoming. The main challenge is whether the MWh will be there when needed, that is to ensure that the new generation is maintained so as to be able to supply surge demand with a high probability. To provide the incentive to make it so the EO market has to allow generators to earn high prices when supplies are tight. Political economy may again be the main obstacle to this. The new generation will earn high returns–perhaps well above 10 percent–during the periods they are most needed. This will create political pressure to claw back these profits: “windfall profits tax,” anyone? The prospect for clawback undermines the incentive of the new generation to be optimized to supply power in times of short supply.

In sum, renewable subsidies distorted the EO market. Some second best measure (the first best being no renewable subsidies) is necessary. These must effectively subsidize investment in reliable, dispatchable, thermal generation. Between the two main alternatives on offer–guaranteeing a return on investment on such generation, or a capacity market–the former seems superior. But regardless of which is chosen, it is essential to keep in mind what requires the choice: the distortion that compromised the reliability of the Texas grid in the first place, namely, renewables subsidies.

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March 20, 2023

The Termite Years: Ideologues Eating the American Military From the Inside

Filed under: Climate Change,Military,Politics — cpirrong @ 6:09 pm

Progressivism is destroying the United States military and putting the nation’s security at a grave risk.

I could probably write a book on the subject–a long book–but two examples provide chilling illustrations of the general thesis.

The first is the military’s obsession with climate change:

Secretary of the Navy Carlos Del Toro said he sees fighting climate change as a top priority for the Navy as the Biden administration proposes shrinking the fleet by two ships and worries grow about how the U.S. Navy stacks up to China’s.

“As the Secretary of the Navy, I can tell you that I have made climate one of my top priorities since the first day I came into office,” Del Toro said March 1 in remarks at the University of the Bahamas.

And this:

“We view the climate crisis much the same way as damage control efforts on a stricken ship. This is an all-hands-on-deck moment,” he added.

An all-hands-on-deck moment? Well, that’s exactly the problem. At the rate of decline in the ship count in the United States Navy, there won’t be any decks for the hands to stand on.

The Navy’s job is not to save the world environment, let alone save it from a highly speculative (and arguably chimerical) danger–as if it can do anything about it anyways. The Navy’s job is to secure control of the seas, and deny that control to its enemies. That requires ships and trained sailors and officers and logistical support and munitions.

All of those things have been eroding relentlessly in recent years, and the Biden administration wants to accelerate the decline:

This year, the Biden budget called for the decommissioning of 11 ships and the construction of just nine ships, for a net loss of two vessels. That budget proposal was met with skepticism from members of Congress, which has acted in the last two years to spare the Navy from cuts to the fleet proposed by the Biden administration.

All hands should be on deck to stop and reverse those troubling and extremely dangerous trends.

But no, we have a gasbag SecNav blathering about greenhouse gasses:

“There is not a trade-off between addressing climate security and our core mission of being the most capable and ready Navy-Marine Corps team,” he said. “The exact opposite is true. Embracing climate-focused technologies and adopting a climate-informed posture strengthens our capability to stand by our partners and allies.”

Del Toro said worrying about climate change would lead to new technologies that the Navy can use to create a “virtuous cycle of energy efficiency, cost savings, maritime dominance and climate security.”

This are merely unsupported assertions–and wildly implausible ones to boot. Just how does “embracing climate-focused technologies and adopting a climate-informed posture strengthens our capability to stand by our partners and allies”? Just how will “embracing climate-focused technologies and adopting a climate-informed posture” improve our ability to win a naval conflict against China in the western Pacific?

And anyone who says “there is not a trade-off” is either a liar or an idiot–or more likely both. There is always a trade-off. Every dollar spent on climate unicorns is a dollar that doesn’t go to a ship or a sailor or a missile.

The other example is DEI in the military, especially at the academies.

It’s bad–really bad–at all the academies. When I attended the Superintendent’s call at my USNA reunion a few years ago it was diversity this and diversity that. That was clearly the Supe’s overriding concern (other than bragging about managing COVID, especially the issue of disposing of all the extra trash from packaging of the meals that Mids were forced to eat in their rooms–Bravo Zulu, dude!).

Navy is bad, but I think Air Force is the worst. USAFA has embraced CRT and is all in on the trans agenda.

A diversity and inclusion training by the United States Air Force Academy in Colorado instructs cadets to use words that “include all genders” and to refrain from saying things like “mom” and “dad.”

The slide presentation titled, “Diversity & Inclusion: What it is, why we care, & what we can do,” advises cadets to use “person-centered” and gender-neutral language when describing individuals.

“Some families are headed by single parents, grandparents, foster parents, two moms, two dads, etc.: consider ‘parent or caregiver’ instead of ‘mom and dad,'” the presentation states. “Use words that include all genders​: ‘Folks’ or ‘Y’all’ instead of ‘guys’; ‘partner’ vs. ‘boyfriend or girlfriend.’”

When confronted about this, Superintendent LG Richard Clark executed a classic motte-and-bailey maneuver:

“The recent briefing on diversity and inclusion is being taken out of context and misrepresented; the slide in question was not intended to stand alone,” Clark said. “First and foremost, the briefing centered on respect for others and the warfighting imperative of leveraging diverse perspectives to solve our nation’s most difficult national security problems. Our strategic competitors are doing the opposite. Our American diversity is a strategic advantage and opens the door to creative solutions, providing a competitive edge in air, space, and cyberspace.”

“The slide on ‘inclusive language’ was intended to demonstrate how respect for others should be used to build inclusive teams, producing more effective warfighting units,” Clark continued. “Understanding a person’s context shows respect. Until you know a person’s situation, we should not make assumptions about them.”

Clark smoothly retreats from the bailey (don’t say “mom or dad”) to take refuge in the motte of vacuous blather that asserts rather than proves the warfighting utility of these endeavors: “The slide on ‘inclusive language’ was intended to demonstrate how respect for others should be used to build inclusive teams, producing more effective warfighting units.”

These assertions–del Toro’s and Clark’s–unsupported by any evidence are characteristic of justifications of these progressive policies. Clark is especially prone to asserting things like “diversity is a strategic advantage and opens the door to creative solutions” but alas he is not alone. And saying it doesn’t make it true.

If diversity–as used by Clark and others–is so effective at creating “strategic advantages,” why was the really, really “diverse” Austro-Hungarian army the worst (by far) among major combatants in WWI, rather than the best? Why was the decidedly and almost uniformly pallid United States Navy able to wage the most stupendous and victorious naval campaign in history 1942-1945?

Given the demographics of the United States, the military will inherently be “diverse,” and especially after the tumult of Vietnam, it worked assiduously to address that diversity in the proper way: to find ways to create a cohesive fighting force. But the crucial thing about this effort was that it was avowedly meritocratic in nature, and focused on reversing the non-meritocratic elements of an explicitly and then implicitly segregated military.

The progressive version of diversity is inimical to this. CRT–which the USAFA, the other academies, and other elements within the military have embraced to one degree or another–creates division, not cohesion, and therefore poisons military culture: it segregates rather than unites, and drawing invidious distinctions between people based on race, caste, or class undermines the effectiveness of military units at every level. It is avowedly anti-meritocratic, viewing any “disparities” as the result of some “systemic racism” that only the gnostics who practice it can see it.

In short, one could not think of a better way to undermine the effectiveness and lethality of a combat organization–except its lethality to itself. Cf. the Austro-Hungarian army mentioned above.

The fact is the del Toro and Clark and far too many in the civilian and uniformed hierarchy are unduly focused on progressive political agendas that not only fail to contribute to America’s war fighting capability, but are positively antithetical to it. If del Toro is so intent on going to battle stations, how about doing so to fix, say, the Navy’s utterly dysfunctional procurement process? Or the serious recruiting issues the service faces? Instead he establishes as a priority something that the Navy can’t do jack shit about–except, perhaps, by devastating the world’s largest emitter of greenhouse gases. The capability to do so, alas, is eroding by the day.

The lapsing of the Soviet threat allowed the military and the civilians who control it to indulge their ideological fancies, and to use the military as a laboratory for social experimentation, in contravention of its real purpose. The post-Cold War reverie is clearly over. The military is insufficiently prepared for a return of peer competition, and the unmilitary priorities of the likes of del Toro and Clark will undermine the nation’s ability to restore the capabilities that have atrophied so dramatically over the past 30 years.

Churchill lamented the 1930s as the “locust years” when feckless politicians and military officials failed to recognize rising threats and consequently failed to prepare against Hitler’s Germany. Today the United States is experiencing something worse: termite years, where destructive ideologies are eating at the American military from the inside.

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September 17, 2022

Gary Gensler Does Crypto. And Clearing (Again). And Climate.

Gary Gensler has long lusted to get his regulatory hooks into cryptocurrency. To do so as head of the SEC, he has to find a way to transform crypto (e.g., Bitcoin, Ether, various tokens) into securities, as defined under laws dating from the 1930s. Although Gensler has stated that crypto regulation is a long way off–presumably because it is no mean feat to jam an innovation of the 2010s into a regulatory framework of the 1930s–he thinks that he may have found a way to get at the second largest crypto, Ether.

Gensler pictured here:

Sorry! Sorry! Understandable mistake! Here’s his actual image:

Crypto Regulation. Excellent!

Ether just switched from a “proof of work” model–the model employed by Bitcoin–to a “proof of stake” model. Gensler recently said that Ether may therefore qualify as a security under the Howey test, established in a 1946 Supreme Court decision–handed down when computers filled large rooms, had no memory, and caused the lights to dim in entire cities when they were powered up.

Per Gensler:

Securities and Exchange Commission Chairman Gary Gensler said Thursday that cryptocurrencies and intermediaries that allow holders to “stake” their coins might pass a key test used by courts to determine whether an asset is a security. Known as the Howey test, it examines whether investors expect to earn a return from the work of third parties. 

“From the coin’s perspective…that’s another indicia that under the Howey test, the investing public is anticipating profits based on the efforts of others,” Mr. Gensler told reporters after a congressional hearing. He said he wasn’t referring to any specific cryptocurrency. 

To call that a stretch is an understatement. A huge one. Because the function of proof of stake is entirely different than the function of a security.

Proof of work and proof of stake are alternative ways of operating an anonymous, trustless crypto currency. As I’ve written in several pieces here and elsewhere, eliminating the need for trusted institutions to guarantee transactions does not come for free. Those tempted to defraud must incur a cost if they do in order to be deterred. A performance bond sacrificed on non-performance or deceit is a common way to do that. Proofs of stake and work both are effectively performance bonds. With proof of work, a “miner” incurs a cost (electricity, computing resources) to get the right to add blocks to the blockchain: if a majority of other miners don’t concur with the proposal, the block is not validated, the proposing miner gets no reward, and sacrifices the expenditure required to make the proposal. Proof of stake is a more traditional sort of bond: you lose your stake if your proposal is rejected.

A security is something totally different, and serves a completely different function. (NB. I favor the “functional model of regulation” proposed by Merton many years ago. Regulation should be based on function, not institution.). The function of a security is to raise capital with a marketable instrument that can be bought and sold by third parties at mutually agreed upon prices.

So with a lot of squinting, you can say that both securities and staking mechanism involve “the efforts of others,” but to effect completely different purposes and functions. The fundamental difference in function/purpose means that even if they have something in common, they are totally different and the regulatory framework for one is totally inappropriate to the regulation of the other.

This illustrates an issue that I often come across in my work on commodities, securities, and antitrust litigation: the common confusion of sufficient and necessary conditions. Arguably profiting from the efforts of others could be a necessary condition to be considered a security. It is not, however, a sufficient condition–as Gensler is essentially advocating.

But what’s logic when there’s a regulatory empire to build, right?

I’m also at a loss to explain how Gensler could think that proof of stake involves the “efforts” (i.e., work) of others, but proof of, you know, work doesn’t.

Gensler’s “logic” would probably even embarrass Sir Bedevere:

“What also floats in water?” “A security!”

Gensler might have more of a leg to stand on when it comes to tokens. But with Bitcoin, Ether, and other similar things, hammering the crypto peg into the securities law hole is idiotic.

But never let logic stand in the way of Gary’s pursuit of his precious:

GiGi is not solely focused on crypto of course. He has many preciouses. This week the SEC released a proposed rule to mandate clearing of many cash Treasury trades.

Clearing of course has always been a mania of Gary’s. His deep affection for me no doubt dates from my extensive writing on his Ahab-like pursuit of clearing mandates in derivatives more than a decade ago. Clearing is Gensler’s hammer, and he sees in every financial problem a nail to be driven.

The problem at issue here is the periodic episodes of large price moves and illiquidity in the Treasury market in recent years, most notably in March 2020 (the subject of a JACF article by me).

Clearing is a mechanism to mitigate counterparty credit risk. There is no evidence, nor reasonable basis to believe, that counterparty credit risk precipitated these episodes, or that these episodes (whatever their cause) raised the risk of a chain reaction via a counterparty credit risk channel in cash Treasuries.

Moreover, as I have said ad nauseum, clearing and the associated margining mechanism is a major potential source of financial instability.

Indeed, as I point out in the JACF article, clearing and margin in Treasury futures and other fixed income securities markets is what threatened to turn the price (and basis) movement sparked by Covid (and policy responses to Covid) into a systemic event that required Fed intervention to prevent.

I note that as I discussed at the time, margining also contributed greatly to the instability surrounding the GameStop fiasco.

Meaning that in the name of promoting financial market stability Gensler and the SEC (the vote on the proposal was unanimous) are in fact expanding the use of the very mechanism that exacerbated the problem they are allegedly addressing.

Like the Bourbons, Gensler has learned nothing, and forgotten nothing. He has not forgotten his misbegotten notions of the consequences of clearing, and hasn’t learned what the real consequences are.

Of course these two issues do not exhaust the catalog of Gensler’s regulatory imperium. Another big one is his climate change reporting initiative. I’ll turn to that another day, but in the meantime definitely check out John Cochrane’s dismantling of that piece of GiGi’s handiwork.

As Gideon John Tucker said famously 156 years ago: “No man’s life, liberty or property are safe while the Legislature is in session.” Nor are they when Gary Gensler heads a regulatory agency.

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