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Summary:

If only U.S. energy policy had the same economic criteria as most startups. Here’s pet peeve of mine in the energy policy arena: the lack of ROI and ability to measure success.

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If only U.S. energy policy were judged by the same economic criteria we use for startups. While most of the time, I use my blog Infinite to Venture to write about startups in energy and cleantech, I felt the need to address a pet peeve of mine in the energy policy arena: the lack of return on investment (ROI) metric or other meaningful measure of success.

When Becky Quick, host of CNBC’s Squawk Box, recently tweeted that oilman T. Boone Pickens was accepting questions for an interview with her on Aug. 25 through Twitter, I jumped at the opportunity. Incidentally, I didn’t get a question in, but @nelderini did! However, after watching T. Boone promote his Pickens Plan (which has cost $62 million in lobbying dollars to date) I wondered, if we were to somehow pass one of the several energy bills floating around Congress this year, how would we know it was effective ten years down the road?

My fear is we will have no idea what worked and what didn’t, simply because we don’t measure the right things.

Most startups track the results of marketing dollars rigorously, so they know that spending $1 on Google AdWords, for instance, gets them $3 in revenue as a result. Similarly, if a big company spends $1 million on a capital investment, it does so with the expectation of, say, $200,000 of annual savings. If these don’t materialize for some reason, strategies and resources are shifted. Someone might even get fired if the results are way off.

Unfortunately, there’s no analogy in political discourse on energy because almost every politician in favor of a policy focuses on the benefits, while every politician against a policy focuses on the costs. Neither has any relevance on its own, of course.

You’d think that T. Boone, a man who’s experienced financial success beyond the wildest dreams of most, would understand an ROI calculation. Even Pickens, however, made this specious style of argument in favor of converting fleet vehicles to run on natural gas instead of diesel fuel:

If we can move our 8 million 18-wheelers to natural gas, that will cut OPEC in half. We have to move to our own resources.

Really? Even if each 18-wheeler retrofit to natural gas costs tax payers $64,000 in subsidies to cover 80 percent of the cost of conversion? If 1 million of those vehicles are converted each year, it would cost $80 billion for the conversion (most of which is borne by tax payers), which is equivalent to about 3 months of domestic spending on oil imports. OPEC comprises about 53 percent of our net imports, so “cutting OPEC in half” reduces imports by about 25 percent, or about 3 million barrels (bbl)/day.

If oil is at the price of $75 per barrel, those 3 million barrels per day represent $82 billion in curtailed spending per year, but we’d only get there after all 8 million trucks are retrofitted — after 8 years. So, $80 billion of up-front spending on retrofits saves $10 billion in annual OPEC oil spend for 1 million trucks. These trucks run on natural gas, which also isn’t free. Pickens says natural gas costs about one-fifth of the equivalent of diesel, so we need to reduce that $10 billion in savings by 20 percent to pay for natural gas as fuel.

In short, each year tax payers and truck companies together would spend $80 billion for only $8 billion of annual savings: a 10-year simple payback period. Note that, while tax payers bear 80 percent of this cost (or $64 billion), they receive none of the $8 billion of fuel savings, which instead accrues to the truckers. Consequently, the truckers, who only put up 20 percent of the cost (or $16 billion) get an attractive, 2-year simple payback on their invested capital.

That’s a low ROI for everyone but the truck companies, but it’s exactly what these types of arguments tend to hide. When the CNBC guest host pressed on this issue,  Pickens went on in the same vein:

You have a model for this. Southern California did it on trash trucks. The trash trucks 7 years ago moved from natural gas away from diesel….You now have 70 percent of the trash trucks [in Southern California] on natural gas. Long Island has gone from no natural gas trash trucks to over 200, so it will happen because [natural gas is] a better fuel.

Why should it surprise anyone that, when you throw money at the adoption of a technology, it actually gets adopted? Especially when private companies stand to gain so much while riding on the back of the tax payer? Yet, this adoption is often what’s heralded in Washington as successful. You got the benefit you wanted. Forget about the cost.

I propose a new definition of success, one that takes into account the tremendous debt levels we’ve taken on as a country and the financial precipice we continue to teeter over. The cost of capital isn’t 0 percent, especially when the government coffers have already been so depleted. If the goal is to cut OPEC in half, fine. Let’s figure out how to do it with the best ROI overall and go from there.

My recommendation: U.S. government should treat its bank account like a startup does. It should spend money to create the maximal value, and define and measure success.

Alex is a Principal at Highland Capital Partners and invests in startups at the intersection of energy and technology. For his professional background, you can view his bio; or follow him on Twitter. And read his blog at Infinite to Venture.

Image courtesy of CNBC creative commons.

By Alex Taussig

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  1. I see things a little bit differently than how I interpret your post, Alex. In general, if certain expenditures will generate a compellingly positive ROI, then the private sector will provide the capital for those expenditures. In contrast, government intervention occurs where the organization making the investment cannot expect a positive ROI for itself. However, we *hope* that there are positive externalities to the intervention that result in a positive ROI to society. But to expect the government to generate a direct positive ROI on its investments it tantamount to asking the government to play in the private sector.

    So there must be some other metric that we can use to measure the success of energy policy. For example, we could measure jobs created in the energy sector, or oil imports offset, or energy savings due to efficiency gain, etc. I suspect that there should actually be different measures for the different interventions. While, I don’t have the answer to the performance metric, I don’t see how a simple ROI calculation would be appropriate to measure the success of loan guarantees, tax credits, rebates, and mandates. We’ll have to continue thinking about it…

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    1. Thanks for your comment, Ed.

      Government investment should be at least partially directed towards social value creation, which I agree can have lower financial ROIs than those projects that would be undertaken solely by the private sector. In fact, sometimes a financial ROI isn’t the right metric to use at all.

      However, that doesn’t give pundits and politicians an excuse for not evaluating different options against one and other with some degree of quantitative measure, using whatever that relevant metric may be. Like I said, the cost of capital isn’t 0%. If there are 10 different ways to cut OPEC in half, then show me which gives the tax payer the best ROI – financial and otherwise.

      That’s the point of this post: if you only consider one option, and even more myopically only consider the benefits of one option, you’ll be doomed to make bad decisions.

      -Alex

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  2. I agree that some amount of “policy scoring” could be helpful if made available to the public. Still, you’ve got to admit that long-range economic impact analyses are highly subjective and easily manipulated for partisan purposes. This is particularly true when applied over the types of time periods that are relevant in the altenergy markets. For example, how confident are you in Pickens’ assertion that oil will be 5x the cost of nat gas for the next 10 years? What discount rate would you apply when comparing long-range costs versus near term job impacts?

    We saw the challenges of “fact-based” policy marketing in the healthcare debate last year. John Q. Public doesn’t want to get into the weeds and policy advocates will parse facts to serve their self-interest. It is unclear that “the facts” improved the quality of the debate or minimized the special interests. Arguably the opposite happened.

    While I’m no fan of our current political system, I do think the CBO does a reasonable job of scoring policy under serious consideration in a non-partisan fashion.

    Perhaps what you are arguing for is an expanded role of the CBO – to perform basic analysis at an earlier stage of any given policy process? There could conceivably be value to that – though often early-stage policy is so weakly developed that it could have multiple interpretations and therefore multiple financial/nonfinancial consequences.

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  3. I agree that some concept of “policy scoring” could be helpful if made available to the public. Still, you’ve got to admit that long-range economic impact analyses are highly subjective and easily manipulated for partisan purposes. This is particularly true when applied over the types of time periods that are relevant in the altenergy markets. For example, how confident are you in Pickens’ assertion that oil will be 5x the cost of nat gas for the next 10 years? Also what discount rate would you apply when comparing long-range costs versus near term job impacts?

    We saw the challenges of “fact-based” policy marketing in the healthcare debate last year. We found that John Q. Public doesn’t want to get into the weeds and policy advocates will parse facts to serve their self-interest. It is unclear that “the facts” improved the quality of the debate or minimized the special interests. Arguably the opposite.

    While I’m no fan of our current political system, I do think the CBO does a capable job of scoring full-formed policy (pre-vote) in a non-partisan fashion.

    Perhaps what you are arguing for is an expanded role of the CBO – to perform basic analysis at an earlier stage of any given policy process? There could conceivably be value to that – though often early-stage policy is so weakly developed that it could have multiple interpretations and therefore multiple financial/nonfinancial consequences.

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    1. Ben,

      All great points here, and thanks for making them.

      I agree that the numbers are tough to calculate, and I’m all for avoiding the false precision that comes from trying to predict 10 or 20 years out. Just compare any EIA Annual Energy Outlook to the one from the prior 5 years, and you’ll see just how bad we are at doing this.

      However, there are certain metrics (like “energy-return-on-investment” [EROI], which is often triumphed over at TheOilDrum.com) that can lead to smarter policy. If you told me we needed to “get off foreign oil” and presented me with the choice of ramping up subsidies for corn-based ethanol or tar sands, I’d ask for the EROI and quickly learn that the former gives me less than one unit of energy for each unit of energy I put into recovering it. While the latter isn’t a great option either, it’s still a better choice…at any price of oil.

      Now for the practical issue. Do voters care about the numbers? I believe they do. (I do, at least.) The problem is that voters are never given a chance to evaluate their options. Instead, they’re given the benefits or the costs, but almost never both, and rarely across more than one option. You’ve also identified this above.

      There are ways to simplify complicated topics so that John Q. Public can understand them and make them relevant to his day-to-day life. We do this in business all the time. Charm and rhetorical skills don’t always get budgets approved and PO’s signed. Sometimes, you gotta run the numbers, even if they’re only 80% accurate. We need to do this on the Hill as well, even if it’s difficult.

      Perhaps it is the role of the CBO to run the numbers, and they do a decent job. But, like any data set, it’s only as relevant as the hands you put them in. Getting those numbers run earlier in the process may be wise, and getting additional non-partisan organizations involved may be a good idea as well.

      That being said, I don’t think the problem is that someone isn’t running the numbers somewhere. The problem is that the decision-makers don’t know what they are, probably don’t care, and aren’t going to tell the American public in any case. That’s the problem.

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  4. If the end goal is less consumption of diesel fuel, then shouldn’t we add a distillate fuel tax to help pay for this subsidy? Incentivize the positive direction, tax the negative. I don’t know the exact numbers, but I’m sure it would end up being a pretty minuscule tax per gallon.

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