Wednesday, December 12, 2012

Parkinsons' Laws and Beyond

Parkinson's Law was first articulated by Cyril Northcote Parkinson in a humorous essay published by The Economist back in 1955. Cyril was a man after my own heart. The essay is a quick and highly recommended read. The Law’s first formulation was simply.

·       Work expands so as to fill the time available for its completion.
A more generalized version of the original goes something like:

·       The demand upon a resource tends to expand to match the supply of the resource.
A notable corollary to Parkinson’s Law is the Bennett Hypothesis which was first put forth in 1987 by then Secretary of Education William J. Bennett. The Bennett Hypothesis comes out of this controversial scribble in the New York Times.

·       If anything, increases in financial aid in recent years have enabled colleges and universities blithely to raise their tuitions, confident that Federal loan subsidies would help cushion the increase....Federal student aid policies do not cause college price inflation, but there is little doubt that they help make it possible.

The Sec Ed festered the nest on a hunch but solid research has come along to back him up. For an in-depth analysis of the Bennett Hypothesis see Introduction to the Bennett Hypothesis 2.0 by Andrew Gillen.

The solar corollary to Parkinson's Law and the Bennett Hypothesis is a two parter.

Part I, Return of the Parkinson:

·       Solar subsidies tend to set the price of solar. Who’s gonna bell the cat?
Setting subsidy levels correctly is an essential element of a successful subsidy program. The basic idea is that if you know the cost of a product (within reasonable bounds) you can set the subsidy such that it delivers the desired price. The trouble is that setting subsidies is a dynamic process in the best of times and solar has been an extraordinarily difficult product to price over the last 8 years. Solar prices dropped regularly year over year for several decades until 2003 only to rise consistently from 2004 through 2007 and then nose dive from 2008 through 2012. How does one subsidize this sort of a product? It’s a magician’s task – a game of pin the tail on the donkey.
The difficulty of setting subsidies over the last 8 years in the solar industry led to many markets setting reasonable subsidies for the 2004 to 2007 time frame which became over generous subsidies from 2008 on. This generosity led to development booms and overextended budgets. The busted budgets coincided with macroeconomic shit from the Credit Crisis which in turn led to sharp subsidy curtailments most notably in Spain. When you aggressively de-subsidize an industry before it’s ready to compete you kill that industry. Historically, many de-subsidized industries have seen this play out. The markets in Spain, Portugal and Hungary are case studies in how this part of the story applies to solar.
Part II, Parkinson’s Curse:
·       Subsidies create constituencies (AKA: BUREAUCRACIES) that work to lock in subsidies. Complex subsidies create complex constituencies.
Solar subsidies have generally been applied in Tiers or categories The idea behind categorizing incentives is to counterbalance economies of scale, favor specific technologies for growth and/or incentivize some social good such as environmental rehabilitation or local employment.

In FiT markets such as Germany, Italy and Australia the Tiers are generally structured like so:
·       Small systems: A cents/kWh.
·       Medium systems: B cents/kWh.
·       Large systems: C cents/kWh.
·       XL systems: D cents/kWh

In Quota markets such as the US the Tiers are more confusingly structured.
·       Small systems may get X cents/kWh and/or net-metering and/or a buy down subsidy in the form of a direct payment or a tax credit.
·       Medium systems may get some combination of the above plus depreciation and/or accelerated depreciation.
·       Large and Very Large systems get some portion of the above plus grants, PPAs, RECs and RPS carve-outs.

Both simple and complex subsidy Tiers inherently result in small, medium and large solar constituencies – neighboring rivals with each their own rules and advantages. It bears repeating here that the incentives provided to each Tier are meant to be relatively balanced but in practice things never quite balance as expected.

We also must remind ourselves that the First Principle of solar subsidies is to jumpstart a sustainable competitive market. With any solar subsidy scheme the plan from the start is to eliminate subsidies over time in a smooth and predictable way as the underlying product becomes more competitive. The subsidy reduction plans have worked in Germany, Italy and Australia. The plans have faltered in the US. What's the difference? In a word - BUREAUCRACY. Some markets leash their solar bureaucracies and others allow them to run wild.

Leashed Bureaucracy

In Germany’s case, leashing bureaucracy meant moving from a Six Tier FiT system to a Four Tier system, eliminating loopholes/abuses and steadily reducing the subsidy rates over time. Italy and Australia are both following the same basic course – fewer Tiers, tighter rules and lower subsidies. The reasons to reduce subsidies and eliminate loopholes are obvious. The reasons behind streamlining the Tiers are slightly more complicated.
The first Subsidy Category that’s been repeatedly targeting for restriction and/or elimination has been the 10+ MW Tier. The general pattern we’ve seen in Germany, France and Italy is to first see restrictions which limit development on agricultural land followed by support for these projects being eliminated altogether. The reason for this Tier being restricted first is because it’s the most prone to over-heating.
Another driver behind consolidating the number of Tiers has been the flattening of economies of scale between project sizes. A generic subsidy scheme might initially be set up with graduated subsidies for systems sized W to X, X to Y and Y to Z. If the unit costs of X to Y projects converge with the costs of Y to Z projects you end up over-subsidizing the X to Y projects. The solution to this problem is to consolidate the Tiers with converged pricing.
As it turns out, reducing subsidies and consolidating Tiers are interrelated mechanisms. When you eliminate a Tier you eliminate a constituency pulling for favors. The reduction in bureaucracy makes it easier to subsequently lower and/or modify subsidies for the remaining Tiers because there’s less balancing required.
Bureaucracy Rum Amok
The US has allowed a wide variety of subsidy programs to populate the solar landscape. The interaction of subsidies at the federal, state and local level has resulted in a stacked deck that has favored certain solar constituencies over others. Two solar constituencies in particular deserve special attention: Mega Solar and Third Party Solar.
Mega Solar
For some reason the US never put the brakes on Mega Solar in the way the Europeans did. By my count there are at least 9 mega-solar projects currently under construction in the US that are over 100 MW in size.
·       Desert Sunlight – 632 MW
·       Topaz Solar Farm – 632 MW
·       Blythe Solar Power Project – 575 MW
·       Agua Caliente – 333 MW
·       California Valley Solar Ranch – 287 MW
·       AV Solar Ranch One – 264 MW
·       Quinto Solar – 126 MW
·       Mesquite Solar Phase 1 – 124 MW
·       Henrietta Solar Project – 115 MW
The Europeans had already identified the Mega Solar strategy as overly expensive and were eliminating support well before any of the US projects mentioned above broke ground. The US government apparently didn’t get the memo. If they did they said meh… America! Fuck Yeah!
These days it’s looking like the era of Mega Solar may finally be coming to an end but a terrible amount of damage has already been done. We’ve committed billions to a dead end strategy all the while neglecting First Principles. Instead of focusing support on competitive deployment strategies the US Federal Government single headedly created a solar constituency which has sucked up much more than their fair share of the pie and worked to undermine development in competing Tiers. The US walked right straight into Parkinson’s Curse.
Third Party Ownership
Third Party Ownership has been hailed as the bestest thing on the block by all the solar rags. TPOs operate as sub-category players in the Small and Medium sized solar space. Problem Numero Uno with TPOs is that their competitive edge is founded on accounting tricks which border on fraud. Problem Numero Dos is that the accounting tricks need the Investment Tax Credit to pencil. If SolarCity’s failure to launch is any indication the TPO play is also coming to an end. This is good news but again the damage has already been done. Here’s a short list of least favorite things about TPOs. 
  • SunRun, a prominent TPO, worked behind the scenes to hamstring PACE
  • TPO companies have been a source of distracting anti-ownership propaganda
  • TPO companies don't have a sustainable business model
The Law of Demand
Subsidies are useful but they need to be built and maintained with careful attention. A few points are worth repeating here.
·       The First Principle of solar subsidies is to choose strategies that lead to sustainable markets.
·       With any solar subsidy scheme the plan from the start is to eliminate subsidies over time in a smooth and predictable way as the underlying product becomes more competitive.
·       If your subsidy scheme isn’t showing a reduction in installed costs you’re doing it wrong
If we build our subsidy programs correctly we activate the Law of Demand. Here’s what Wikipedia says about the Law of Demand.
The law of demand is an economic law, which states that consumers buy more of a good when its price is lower and less when its price is higher (ceteris paribus)
Here are the ceteris paribus criteria
·       Habits, tastes and fashions remain constant.
·       Money, income of the consumer does not change.
·       Prices of other goods remain constant.
·       The commodity in question has no substitutes or is not in competition by other goods.
·       The commodity is a normal good and has no prestige or status value.
·       People do not expect changes in the price.
·       Price is independent and demand is dependent.

I underlined factor six specifically because the U.K. market has seen flattish demand in 2012 despite significantly lower prices. I suspect the combination of all the bad press in the market following the FiT cuts coupled with factor six has flattened demand. It’s a temporary problem but a problem just the same.
In conclusion, if a subsidy program results in lower prices (ceteris paribus) it should also lead to higher demand. The higher volumes drive efficiencies which result in even lower prices which then drive higher demand – a virtuous cycle. This is how we should do solar.

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