17/11/2018: California Rooftop Solar Mandate: An example of bad groupthink?

In recent news, California legislators have done a gimmick-trick that has earned the state loud applause from the environmentally-minded consumers and activists: California Energy Commission (CEC) recently voted 5-0 to add a new provision to the state’s building code. This includes a requirement that from 2020, all new house and multi-family residences construction of three stories or fewer, along with all major renovations, must be built with rooftop solar panels. Given that the state currently builds ca 113,000 housing units a year, and rising, this should increase significantly already existent solar generation capacity from 15% of the housing stock, currently.

Solar being mandated on virtually all new houses? Sounds like a renewables nirvana, especially given the fact that the state has huge solar generation potential due to its climate. But, as commonly is the case, there is a catch. Or two... or many more... And this means that California's latest policy mandate may be a poor example to follow, and potentially, a bad policy mistake.

Here are the key reasons.

Rooftop solar is about as effective in reducing emissions as waving a broom into the smog. UC Berkeley’s Severin Borenstein argued this in his note to CEC Commissioner (http://faculty.haas.berkeley.edu/borenste/cecweisenmiller180509.pdf). Note: Borenstein also alleges that CEC has failed to involve experts in energy economics in its decision making process - something that is not a good policy formation practice.

UC Davis economics professor James Bushnell accused CEC of “regulatory groupthink.” (https://energyathaas.wordpress.com/2018/10/22/how-should-we-use-our-roofs/) and offered an alternative to roof solar that can generate far greater environmental benefits. There are, of course, other, more efficient ways for deriding emissions, including: mandating more urban density, raising home and cars efficiency standards, expanding the renewable energy mandate, improving grid efficiencies and transmission expansion, and so on. Once again, CEC did not allow for any independent assessment of the proposed plans economic and environmental impacts.

There is an opportunity cost involved in roof solar: California has a state-wide mandate to achieve 50% renewables generation by 2030. Putting more if this target onto roof solar is simply moving generation capacity from one source to the other. Because too top solar is roughly 4-6 times more expensive than industrially-produced renewables, the substitution involves a dramatic reduction in economics of scale. This will raise the overall cost to California of reaching its 2030 target.

Another opportunity cost, this time much more tangible and immediate than 2030 targets is the problem of California grid ability to swallow all the solar generation being put into place. California has to routinely dump excess solar energy supplies during peak generation times, because it is failing to find buyers outside the state. Worse, given the scale of each roof top generation unit, solar electricity from the roof tops cannot be controlled by the grid companies, because smart inverters needed to do this are too expensive for small scale generators.

There is an argument, however, that economics of scale will kick in from a different side: mandating such a huge increase in atomistic (house-level) installations can result in more innovation and lower costs of new technologies going forward. This means that while costs might be high up front, they can potentially be deflated faster over time than absent the mandate. The same argument might hold for improvements in storage.

Worse yet, solar from one roof panel household competes with solar from another roof panel household. All roof top panels generating at virtually the same time across the same time zone state will be simply bidding down the cost of solar during peak generation, not peak demand. Here is an exchange from two experts on this:

Last, but not least, California roof top solar requirements will add new cost, to the housing in a state that is already in the middle of an atrocious housing crisis. CEC own analysis, not tested by any peer review, implies that homeowners are likely to face additional costs of ca $8,000-12,000. Over the depreciation cycle for housing stock, this is likely to translate into $15,600-$23,400 in current dollars (inflation-adjusted, using 2% inflation rate) increase in the cost of housing per household, once property taxes on new build values are factored in. With average house price in California in excess of $420,000, this is equivalent to raising house prices 3.75-5.57 percent. Of course, CEC promises savings that, according the Commission analysis will be net of higher costs. Problem is, no one actually tested these claims, and we simply do not know how the costs of switching all this roof top solar into the grid are going to be distributed across the households.

Macro level view:

Then there is macro level analysis of the solar energy benefits and costs. And California does not come out pretty in this.

A new NBER paper, tiled "Heterogeneous Environmental and Grid Benefits from Rooftop Solar and the Costs of Inefficient Siting Decisions" by Steven E. Sexton, A. Justin Kirkpatrick, Robert Harris, Nicholas Z. Muller (NBER WP 25241, Nov. 2018: https://www.nber.org/papers/w25241.pdf) looked at "federal and state policies in the U.S." These policies "subsidize electricity generation from 1.4 million rooftop solar arrays because of pollution avoidance benefits and grid congestion relief. Yet because these benefits vary across the U.S. according to solar irradiance, technologies of electricity generators, and grid characteristics, the value of these benefits, and, consequently, the optimal subsidy, are largely unknown."

What does this mean? Across the U.S., "policy, therefore, is unlikely to have induced efficient solar investments." The authors provide "the first systematic, theoretically consistent, and empirically valid estimates of pollution damages avoidable by solar capacity in each U.S. zip code". The also link "these external benefits to subsidy levels in each U.S. state, and [estimate] the share of these benefits that spillover to other states." Finally, the authors measure "the energy value of capacity across the U.S. and the value of transmission congestion relief in California."

So what do they find? "Environmental benefits are shown to vary considerably across the U.S., and to largely spillover to neighboring states." Which is not a bad thing in itself, but it also means that some states pay for benefits accruing to other states. These transfers are not voluntary to the payers for solar - the households.

Furthermore, "subsidy levels are essentially uncorrelated with environmental benefits contributing to installed capacity that sacrifices approximately $1 billion per year in environmental benefits." Which, broadly-speaking means that subsidies for rooftop solar are not a great way to achieve environmental benefits.

"...California rooftop solar is shown to generate no congestion relief." Or, as noted above, there are severe grid-related costs involved in rooftop solar in California, the state that decided to mandate it.

Putting more detail on the NBER paper: "Total benefits of solar generation—inclusive of energy values — are estimated to be greatest in the Midwest and Mid-Atlantic. They are least in the West, and particularly the West Coast, where approximately two-thirds of systems are located." Why, given the fact that sunshine is more abundant in California than in the MidWest or Mid-Atlantic?

"These differences are primarily attributable to heterogeneity in marginal responding fossil generation." Oh, wait, that is right: the more solar you put in, the more back up generation you need. And that is before you account for the solar installation possible effects of increasing demand for electricity as the second order effect.

"In California, we find no evidence that rooftop solar capacity systematically relieves congestion. Approximately two-thirds of the 900,000 rooftop solar arrays is located upstream from transmission bottlenecks, contributing to congestion rather than relieving it. If capacity were efficiently allocated, congestion relief benefits in California would have been no more than $15 million in 2017—approximately 7% of total energy value."

Cycle back to that California rooftop solar mandate. Does it really make any environmental sense? Because economics-wise, it does not appear to offer much more than a hype and a pump scheme.

Economics 18/05/2009: Wealth-destruction, Moscow, Ireland's Green Shoots

Here (hat tip PMD) is a superb article from WSJ on how to destroy thy country's wealth... too bad the US policymakers have not figured the Brian-Brian-Mary solution to the same problem. Possibly, they are not being advised by the wealth loathing, ever-State-loving ESRI?

On a personal note - I am in Moscow: sunny +25 degrees and the city is blooming (chestnut trees, apple trees, cherry trees and lilacs). Construction sites with no workers in sight, but traffic jams are as bad as ever. Ruble is down and prices are up, but on the net, I would not be surprised if there is a real deflation (prices seem to be up about 15%, while ruble is down ca 34%. They are fretting the latests stats from Europe: EU27 gas imports from Russia down 61% in Q1 2009 and exports of gas to CIS down 50%.

Closer to home problems/solutions: LA Times has a very interesting report (here) on solar energy potential. I will it to you to judge the commercial feasibility of what is being discussed (especially given the business-focused bits at the end of the article), but mark my words - within 10-15 years time we will see the end of the fossil fuels era and the start of a new era. It won't be driven by the environmental considerations (although those will form a secondary return on new technologies). Instead it will be driven by two major factors:

1. Generally prohibitive cost of energy in the long run; and
2. Higher induced volatility (risk) of energy costs when you factor in the pesky nasty regimes around the world who control most of our oil and gas.

Need an illustration of the latter point - see here.

On Green Shoots theory: here is a good commentary from Martin Feldstein (ex NBER) - he is spot on about Europe's prospects (see my earlier, 2008-dated, comment on WSJblogs exactly to the same point). This, of course, is not as optimistic as Peter Orszag's latest drone about US economy not being in a 'free-fall', but... (here). Then again, recall that Orszag is the director of the President's Office of Management and Budget, so how can things be in a free-fall after Mr Orszag pumped more debt into the US economy within the span of just few months than Alan Greenspan managed to do in years? But care to read more? Here Nouriel Roubini (Dr Doom) and Ken Rogoff (Dr Financial Crises) muse as to why the 'Green Shoots' are a delusion. I don't give any heed to Merkel's comments on German economy (here) - I'd rather trust our bankers than politicians when it comes to reading the tea leafs of global economics.

But here is my own contribution to the debate (for those of you who missed in last Sunday Times issue) - this is an unedited version of the article that appeared in The Sunday Times.

“Despair ruins some, presumption many,” said Benjamin Franklin some 250 years ago.

If despair haunted Ireland’s policy and media circles since last Summer, in recent weeks, much of the economic commentary started focusing on the emergence of the ‘green shoots’ in our economic environment. Even abysmal, by any measure, unemployment and Exchequer data for April are being spun as showing signs of improvement.

Are we seeing the proverbial ‘light at the end of the tunnel’? And if yes, do we know at what rate will the conditions improve in months and years to come? Regrettably, these claims may be erring on the presumption side of Franklin’s quote.

First, there is the alleged stabilization in the rate of decline in the Exchequer revenue. The problem with this assertion is that it ignores the other side of the budgetary equation – the expenditure side. Current spending was up 4.5% in the first four months of the year. Factoring deflation, this is a hefty increase. At this rate the
real difference between economic growth and public sector expansion in 2009 can reach some 16%, before the vast NAMA commitments. In household finances this is equivalent to being insolvent and reckless about it at the same time.

Another issue is the rising cost of servicing public debt (up 21.4% in year on year terms in April). In the longer term, our growing over-reliance on less than 1 year maturity borrowings to finance current expenditure simply means that instead of taking a quick dose of painful medicine today we risk ending up on a drip therapy of minor cost adjustments. This would make the disease of overspending immune to future policies. Should interest rates rise in 2010-2012, as any sane market observer would expect, the Exchequer will be forced to
refinance a mountain of fresh borrowings at an even higher cost to the taxpayers.

Another recent sighting of ‘green shoots’ relates to the unemployment data. While it is true that the pace of increases in the Live Register is abating, the pace of jobs destruction remains furious. And, given the dynamics of rising layoffs in the services sectors, just as the previous wave of unemployment might be subsiding a new one is already heading our way.

Purchasing Manager’s Index (PMI) for April, published by the NCB Stockbrokers, shows employment in services bouncing around the bottom and in manufacturing contracting at a pace only slightly slower than in January – the worst month on record. Layoffs in Business Services accelerated in April, extending the current decline to fourteen consecutive months. Financial Services companies shed jobs at the sharpest pace in history last month.

So things are getting worse, not better on the unemployment front and its now the better quality higher-paying jobs that are being destroyed the fastest. If a loss of an average construction sector job implies a net loss to the economy of some €60,000 per annum, an average Business and Financial services job destroyed takes some €140,000 out of the economy.

At the aggregate unemployment data level, if January-April ‘stabilized’ pace of jobs losses continues to the end of the year, we are looking at 515,000 or more on Live Register by 2010 well above the 384,113 currently. Even more worryingly, this week’s data from CSO, discussed in the box-out below, is showing that the long-term unemployment is rising at an accelerating rate.

Following a marginal improvement in March, April current consumer confidence index fell to 75.1 from 76.2, although the expectations index rose to 27.7 compared to 22.5. Again, as with other ‘stabilizing’ indices this is temporary correction, not a lasting improvement. The so-called consumer ‘misery’ index – a standard measure of forward-looking indicators determining future consumer confidence – went deeper into red in April and is now poised for a further decrease in May based on the data to-date.

When it comes to the PMI data, April business activity in services recorded “an acceleration in the pace of decline”, according to the NCB Stockbrokers. In fact, April figures were so bad, that only February 2009 showed a deeper contraction. The steepest fall-off occurred in the highest value-added sector of the Irish economy – Business Services – down for the eleventh month in a row and falling at the fastest pace since January. Financial Services posted the steepest contraction in its history. And companies are expecting further drops in demand for their services in months ahead.

The story is not that much different in manufacturing. April manufacturing sectors PMI showed a further considerable deterioration of operating conditions. Output in the sector continues to contract at a near-record rate while jobs were cut sharply and new purchasing fell off the cliff. Any ‘green shoots’ in the cycle must involve an increase in planned future purchasing activity by companies and a restart of the investment cycle. This is clearly not on the minds of the majority of Irish managers.

So in the short run, there is no evidence of significant signs of improvement or stabilization in the downward spiral of our real economy.

This does not bode well for our future growth capacity. On Friday, ESRI published an excellent paper titled Recovery Scenarios for Ireland looking at the prospects for our economy through 2015. Under optimistic assumptions, the ESRI forecast is for the Irish income per capita to reach 2007 levels by 2015 implying a round-trip to the peak of 8 years.

Even more significantly, ESRI concluded that “as a consequence of the recession, the potential growth rate of the economy is likely to have fallen from 3.6 % per annum to 3% per annum”.

For all its merits, the paper assumes no changes in the long-run trend for the foreign direct investment inflows into Ireland. This issue is non-trivial. With vast majority of our exports generated by the MNCs, we simply cannot ignore the changing nature of the future international investment cycles on our economy. Looking over the recent years, vast majority of Ireland-based MNCs have chosen not to locate new products and services here. Only a handful elected to put higher value-added R&D and management activities in Ireland. This is a problem, as many MNC-produced goods and services are nearing the end of their life cycle. In time, failure to attract new products and services will spell an irreversible decline of the large share of our trade flows.

My own analysis, based on parameterising a recent IMF model of economies experiencing simultaneous shocks to housing markets, GDP growth and credit creation, predicts that the ongoing contraction in the Irish economy will bottom out at ca 16-18% decline in GDP per capita by the beginning of 2011. My estimates also show that it will take the economy until the middle of 2017 to fully regain, the levels of income per capita enjoyed in 2007.

Over 60% of the recession-related fall-off in our output will be captured by domestic factors: the property markets bust, fiscal policy debacle and rising structural unemployment. Adding to this a possibility that our multinationals-dominated sectors can experience a severe contraction in future investments can reduce our potential GDP growth rate to below 2.5% per annum. In this case, a recovery to 2007 income per capita levels might take us well into 2020.