A Folly in US Energy Financing

Ever wonder why gas prices at the pump have held steady around the $4 per gallon mark for the past two years, despite the global economic slowdown? The last time prices reached $4 was just after Katrina. Consumers then underwent sticker shock. Lately prices have pulled back a bit but come 2013, consumers may see $5 to $6 per gallon gas as the US economy rebounds. What is keeping fuel prices so high? Aside from the traditional market forces, there are many other factors that affect fuel prices too.

Certainly the conflicts in the Middle East (i.e. Syria, Egypt, Palestine) and the nuclear threats from Iran play a part. With the slightest inkling of a possible supply interruption, fuel buyers and speculators will jump into a buying or selling frenzy. Wars, threats of war, OPEC news or lack thereof are all likely triggers to set fuel buyers on edge creating havoc for companies and consumers alike. These erratic fuel price swings do more damage to an economy by spawning uncertainty and instability.

An important stabilizer for these lopsided market forces has been improved fuel efficient engine designs that presently deliver up to 40 miles per gallon (mpg). Already some designs are boasting 100mpg with their pilot models! – (ecomotors.com).  But, even if 100mpg cars were introduced to the US market today, fuel prices would most likely continue to rise because in addition to geo-political uncertainties, there are domestic ones as well.

MIT Energy Finance Forum
At a recent energy finance forum last month organized by MIT’s student run energy club (mitenergyclub.org), CEOs, thought-leaders, and entrepreneurs representing various facets of the energy industry discussed the many opportunities and challenges created by higher energy prices. Everyone agreed that moderate price increases backed by sound government policies could help boost a stagnant economy. They go hand in hand such that one could not exist without the other. Higher fuel prices stimulate new research for alternative fuel sources, encourage design engineers to do what they do best, and create public awareness on the importance of conserving energy. On the other hand, comprehensive government policies help companies and investors align their business strategies with US national interests as well as with each other. Having both in synch attracts new investors.

So when I heard panel members at the forum blame the high cost of energy on the Obama Administration’s lack of a national energy policy, I wondered if the Secretary of Energy, Dr. Steven Chu, had lost his way.  In 2012 Chu’s Department of Energy (DOE) invested in over 180 projects with ARPA-E, a new R&D agency for basic renewable energy projects. Chu’s ‘hit or miss’ approach to unveil the ultimate breakthrough without announcing a definitive national energy strategy has overshadowed the rest of the industry. Energy-sector CEOs have had to navigate rudderless relying on politically motivated investment tax credits and subsidy schemes (i.e. Renewable Energy Certificate or RECs) to make ends meet. The following are a few examples of how some have coped with the current situation.

According to Ralph Izzo, the Chairman and CEO of PSEG, a New Jersey based utility company, DOE’s meddling with energy infrastructure projects  and the Obama administration’s lack of producing a national energy strategy have created such a high level of anxiety and uncertainty among investors, that no investor in their right mind would agree to finance the expansion or conversion of an energy plant today without insisting on a list of unfeasible assurances. In fact government subsidies and their tax credit schemes are never included in the financial proformas used to evaluate deals, since investors never know if the laws will survive the next political elections. Elections occur every four years and energy plant deals normally require a 20 year investment horizon. Izzo shared an insightful example of how the price of building a similar nuclear plant had jumped from $450m in 1989 to $10billion today. In his opinion the 20x price escalation was primarily due to the unwillingness of Congress to commit to a national energy strategy.

The uncertainties caused by the US Government’s indecisiveness is affecting not just fuel buyers but their capital investors too. Since renewable investments are so new and have yet to be securitized (packaged into tradable securities), cash-rich pension fund managers who invest for the long term have been barred from participating in non-traditional energy investments. Without more historic data from a broad range of similar investments and the availability of affordable financial tools to hedge against risks of loss, securitization of renewable energy projects has been challenging. Unfortunately, large cash reserves that would otherwise be used to finance infrastructure energy projects currently remain on the sidelines with dim chances of being deployed any time soon.

Ironically, the more the DOE offers incentives to entice private investors to invest in large energy projects, the less likely private funds will participate in a deal. This very issue became part of a fascinating panel discussion with representatives from Siemens, Bechtel, CEIFA, Zanbato, and the DOE itself. The panel suggested the presence of a greater problem where investor expectations needed to be updated in favor of equity investments over debt. They highlighted that the risk profile of an energy-related project is significantly less from that of a bridge and hence should be structured differently. To them, bridges can ‘lead to no where’, while energy sources will always be in demand somewhere on the planet.

While it awaits for more favorable winds from Congress, the energy sector growth in the US has had to rely on internal financing along with many clever and unconventional energy financing partnerships.

Public-Private Partnerships in Energy
One way long term projects such as city metros and highways are financed is through the formation of a Public-Private Partnership or PPPs. How successful have PPP’s been with large energy projects? The truth is that not all PPPs are the same. In fact the lack of a reliable template that is easily transferable from one project to another was deemed ‘very difficult’.  Each deal had to be tailor-made from scratch to satisfy a long list of specific requirements. When compared to each other, PPP’s were no more than a name plate suggesting some form of a collaborative involvement among large players including the government.

A ‘public green bank’ operated in Connecticut under CEIFA (Clean Energy, Investment and Finance Authority) uses public funds to attract private investors into jump-starting small renewable energy projects. Directors of this new bank hope to show small success stories where their combined investments will eventually be pooled into a bond product and securitized for sale to larger players, possibly even to pension funds. Citing the Solyndra debacle, the CEIFA representative recommended that the US Government avoid large projects and instead focus on smaller ones that can be aggregated into securitized debt instruments.

A panel member from Siemens offered another PPP example involving three partners, an equipment manufacture, which in this case was Siemens, a methane gas buyer, which was Kimberly-Clark, and a client who produces methane gas (3-Rivers Solid Waste). To close the deal, Siemens had to front the equipment to the methane gas producer and agree to absorb 100% of the project risk. In turn Kimberly-Clark agreed to a floor price in the event the market of natural gas were to collapse. 3-Rivers Solid Waste leveraged tax exempt financing rates and loaded back end debt payments to Siemens during periods of maximum production. As you can see, each partner had to give up a little to make this deal work. (Additional details are listed at http://1.usa.gov/12FKdaS.)

Siemens impressed the audience further with another example of unconventional energy financing for a proposal to build 100 train coaches for Amtrak. In this deal Siemens agreed to underwrite the entire amount, if Amtrak, a US government owned entity, would agree to partially by-pass the open-bidding requirements and automatically award Siemens with one-quarter of the order. Government officials cited a possible violation to the fair bidding process, which according to the VP of Government Affairs, David McIntosh, has kept the deal tabled for now. Clearly Siemens is not happy with these and other similarly unconventional and risky arrangements, but noted that there are no better alternatives in the energy financing environment today. The Company hopes that its aggressive sales approach and patience will eventually pay off in the ‘very’ long run, while, it waits with the rest of the industry for the DOE to reassess its myopic R&D focus and introduce a comprehensive national energy strategy.

‘Big Data’ – Indigestion or Innovation?

With Facebook having recently logged in its billionth user, social networking has undoubtedly become the ultimate source for ‘Big Data’. Does the possession of gargantuan amounts of data provide a guarantee for success or failure? …success from getting the right information to the right person at the right time or failure from not knowing how to manage so much data?  

To get an idea what ‘Big Data’ means to Facebook, visualize a system that handles 6 million photo uploads, 160 million newsfeed stories, 5 billion realtime message exchanges, 10 billion profile photos shown, and 108 billion queries — every 30 minutes! Impressive by today’s standards, but not for long, for what is coming next, better known as the ‘Industrial Internet’ as opposed to the ‘Social Internet’, will very likely generate orders of magnitude more data than the social-driven ‘Big Data’ we have today.

Facebook vs ‘Panelbook’
For the sake of argument, let us consider a machine-version of Facebook, one that we will call ‘Panelbook’, where ‘Panel’ refers to the ‘face’ or screen used to operate a machine. At ‘Panelbook’, machines rather than people would ‘socialize’ with their fellow machines by exchanging lots of data,  24/7. For example, a smart meter in your home would collect data from your appliances and relay messages back to the manufacturing plant (i.e. GE) where more machines using algorithms to assess its condition might issue alerts to yet more machines including, perhaps, the homeowner’s smartphone. Don’t expect uploads of photos of machine-tikes in diapers any time soon on ‘Panelbook’, but you can get the point.  ‘Big Data’ in the ‘Industrial Internet’ will undoubtedly dominate ‘Big Data’ from the ‘Social Internet, a trend that CEOs and industry leaders should take close heed when allocating corporate resources.

At a recent annual technology conference called EmTech 2012, CEO’s, innovators, investors, academics, entrepreneurs, and major industry players gathered at MIT’s Media Lab to hear the industry’s thought-leaders share their best practices, comment on trends, and recommend new ideas. I felt that their various presentations on ‘Big Data’ barely scratched the surface of what potentially lies ahead. ‘Big Data’ is more than just an onslaught of information to be managed and disseminated but is also the fluid mosaic of the constantly changing faces of the Internet, its increasing number of users, and its collective implications on our growing societies.

To make some sense of  ‘Big Data’ today (indigestion or innovation), I organized four presentations from the event in a specific order to emphasize their complementary roles in the ongoing transition of ‘Big Data from ‘social’ to ‘industrial’ data. They are mission critical data, faster access to data, and organically generated data to trigger innovation.  Notice in each description how each role has influenced areas of society that have had to react to an ever growing number of new capabilities. As one might expect, these roles will continue to evolve, causing even more changes, as nothing on the Internet remains in its current state for long.

Siemens – Mission Critical Data
Leading the charge for ‘Big Data’ was none other than the CEO of Siemens Industry Sector, USA, Dr. Helmuth Ludwig who spoke of the crucial role ‘Big Data’, played with the Curiosity vessel that landed on Mars earlier this year. On the vessel are thousands of probes that monitor more probes that eventually release a signal back to NASA’s base station where receiving probes are monitored by more probes. Managing massive amounts of data from probe to probe is one challenge, but doing so flawlessly so tasks are performed perfectly each time, requires a well-trained and coordinated workforce of global experts who must use a common digital platform to share their data. For example, some of the parameters released by NASA to its contractor JPL and others for Curiosity’s landing on Mars included an entry speed of 13,000 miles per hour with an atmosphere one hundred times thinner than earth, a time frame of less than 7 minutes to touchdown and only a two-week window per year for launching from earth.

According to Ludwig, more and more projects will resemble the risk profile of Curiosity and the type of workforce needed to execute mission-critical projects. To that end Siemens currently spends over $500 million to train 1.2 million students per year. They also sponsor $100,000 rewards for innovation contests to encourage STEM (Science Technology Engineering Mathematics) career interest at both the high school and college levels.

Qualcom – Faster Access
Less on mission critical data and more on making room for more data through existing resources, Qualcom’s CTO, Matt Grob, focused on catapulting today’s 3G, 4G, and WiFi data capacities to 1,000 times faster access speeds by collating a clever topography of mini cell towers controlled by readily available  interference management technology. Overlapping signals from one tower to another would be automatically tweaked at just the right time to deliver an optimal throughput. The amounts of ‘Big Data’ to get the signals just right, are truly a task for machines. One can only imagine what new apps will emerge from an almost incomprehensibly faster mobile web connection, 1000x faster!

Iridium – Mission Critical Data and Faster Access
For ‘Big Data’ to be mission critical and responsive Matt Desch, CEO for Iridium, discussed his firm’s challenges with a global phone service that relies on an interconnected canopy of 66 orbiting satellites.  No matter where a call originates with an Iridium global phone, an Iridium satellite is no further than eight minutes away to pickup incoming signals and relay them to a central base station in Phoenix Arizona where calls are connected.

Iridium has reserved seven rocket launches from SpaceX to replace its aging fleet of satellites. The new fleet due by 2016 will unleash exciting apps including a top-down aircraft surveillance system that can save fuel by allowing planes to fly closer together and away from bad weather systems. At the end of his presentation, Desch held up a thumbnail-size ‘Iridium’ chip that enables any device to connect to its network including existing mobile phones. Perhaps, in the not too distant future, airline passengers will be able to make calls from their ‘Iridiumized’ mobile phones while in flight.

Xerox – Using ‘Big Data’ to Innovate
‘Big Data’ is not just about the collection of random data but also about the organic creation of more data.  The CTO at Xerox, Ms. Sophie Vandebroek, taps on ‘Big Data’ for innovation by treating its workforce as data points and deliberately mixing and matching unlikely pairs of experts to see what can happen. Xerox believes that innovation evolves when experts from different fields of study can look inward at a problem and lend a relevant suggestion. However, hitting a home run is analogous to winning a lottery ticket. For this reason, Xerox and other companies like Shell International with their “Game Changer” program encourage their participants to be critical from the out start and seek the fastest routes to failure before committing to a new idea.

In Summary
‘Big Data’ offers so many options for companies that without a clear set of objectives CEOs could run up huge losses from negative investment returns. Similar to chasing the end of a rainbow, ‘Big Data’ can become elusive, misleading, and overwhelming. One distinction that became clear from the EmTech 2012 conference was the growing importance of the Industrial Internet where machines communicate with other machines. Although the social data is useful for understanding markets and spotting new trends, industrial data is by far the platform-of-choice for what soon will become the ‘BIGGER DATA’.