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<td width="75%" valign="top"><b><font face="Arial" size="6">RENEWABLE ENERGY
RESOURCES ADVICE: STOP WHINING AND START HUSTLING</font></b>
<p><font face="Arial"><strong><big>by Leonard S. Hyman, CFA<br>
</big></strong></font><b><span style="font-size:11.0pt;mso-bidi-font-size:10.0pt;font-family:Palatino;
mso-fareast-font-family:"Times New Roman";mso-bidi-font-family:"Times New Roman";
mso-ansi-language:EN-US;mso-fareast-language:EN-US;mso-bidi-language:AR-SA"><font face="Arial">Senior
Industry Advisor<br>
Salomon Smith Barney</font></span></b></p>
<p><font face="Arial">(<em>originally published in the <b>Strategic
Planning for Energy and the Environment</b>. For subscription information,
call (770) 925-9388</em>)</font></p>
<p class="MsoNormal"> </p>
<p class="MsoNormal"><font face="Arial">Earlier
in my career, I applauded regulatory mandates designed to fix market
imperfections caused by other regulatory mandates, until I figured out that
the fixes caused additional market imperfections that required additional
fixes, and I concluded that the better course was to eliminate the original
regulatory mandate. I even accepted the notion that millions or billions of
people made bad decisions because they were too stupid to understand what
some renewable energy gurus understood, so the government had to force all
those people to do what was good for them.<o:p>
</o:p></font></p>
<p class="MsoNormal"><font face="Arial">At
least I believed that until I met some of the gurus.<o:p>
</o:p>
</font></p>
<p class="MsoNormal"><font face="Arial">What
will be the fate of renewable energy in a competitive market? Let�s
consider how renewables reached their present position in the market, which
is, basically, nowhere. In the days of the Energy Crisis, when the Club of
Rome and M.I.T. academics and a plethora of doomsayers contemplated
Malthusian demographics combined with the rapid depletion of our oil and
gas reserves, environmentalists decried the establishment solutions, which
were to burn more coal and build nuclear power plants.<o:p>
</o:p>
</font></p>
<p class="MsoNormal"><font face="Arial">(I�m
leaving out the military-wacko-solution, which was to invade and capture
the Middle East, and the Texas-oilman-solution, which was to let them
freeze in the dark, although the latter wasn�t far from some
environmentalist-pure-preferences, usually espoused by California
environmentalists, who could comfortably offer that advice to others.)<o:p>
</o:p>
</font></p>
<p class="MsoNormal"><font face="Arial">With
the price of oil headed to $ 100 per barrel, a number of firms launched
green power or synthetic fuels projects, often with help from government
grants, and governments launched their own efforts, as well. With the
passage of energy legislation in the waning days of the Carter
Administration, the government presented renewable energy firms with a sure
shot at markets. Large utilities sponsored renewable projects, and they had
to purchase renewable energy from private producers at prices set by the
state.<o:p>
</o:p>
</font></p>
<p class="MsoNormal"><font face="Arial">All
the producer had to do to make a profit was to keep its costs below that
price. The government granted tax credits to renewable producers, too, to
make the economics more competitive. Some states set aside portions of the
market just for renewables. That was 20 years ago.<o:p>
</o:p></font></p>
<p class="MsoNormal"><font face="Arial"><b>WHAT
HAPPENED?<o:p>
</b>
</o:p>
</font></p>
<p class="MsoNormal"><font face="Arial">Well,
the Reagan Administration, followed the Carter Administration. suspect
that free market-Reaganites didn�t like the government meddling in market
decisions, or at least didn�t like the government pushing an ideology
espoused by environmentalists, hippies, left-wing types, movie stars and
others of that ilk. But forget about ideology. Two economic events dimmed
the future of renewables. The price of oil collapsed. And the deregulation
of natural gas pricing expanded natural gas supply unbelievably.<o:p>
</o:p>
</font></p>
<p class="MsoNormal"><font face="Arial">In
addition, technology dealt another blow to renewables. Manufacturers
developed and refined the gas turbine, a small and increasingly efficient and economical electric generator. Now,
manufacturers are working on miniturbines, which would extend the market
for gas turbines. And, right behind them, other manufacturers backed by the
government and by the automobile giants, are racing to put fuel cells on
the market. That stuff is clean, and mass production will make it cheaper.<o:p>
</o:p>
</font></p>
<p class="MsoNormal"><font face="Arial">Renewable
resources often had a high initial cost, high fixed costs and low or no
fuel cost. They had an advantage when conventional alternatives that
involved low fixed costs had high and rising fuel costs. To put in
renewables, considering the economics, you had to be a true believer, you
had unusual needs, or you did it because the government made you do it, or
you operated with a different economic view of the world than almost
everyone else. Whatever the reason, though, a small market did develop, and
a few large enterprises did invest in the production of renewable energy.<o:p>
</font></p>
<p class="MsoNormal"><font face="Arial">I
am not arguing, incidentally, that renewable energy producers failed to
make technological progress or reduce costs. They made significant
progress
and the cost trends show it. The problem is that they did not make enough
progress, relative to price drops and technological innovation shown by
competing energy products.<o:p>
</o:p>
</font></p>
<p class="MsoNormal"><font face="Arial"><b>A
NEW AGE<o:p>
</b>
</o:p>
</font></p>
<p class="MsoNormal"><font face="Arial">Now,
we are about to enter another new age, not one characterized by beads and
scented candles, but rather by websites, driven energy traders and
marketing calls at dinnertime. Customer choice will come to the energy
market. That phenomenon has frightened many environmental activists. It
should.<o:p>
</o:p>
</font></p>
<p class="MsoNormal"><font face="Arial">Previously,
alternative energy (and energy conservation) activists sold their ideas to
one main customer�the government�which then told the utilities what to
buy, and how much energy conservation to back, and the utilities did not
have to worry whether the green productor energy conservation cost more or
less than conventional energy, because they passed all costs on to their
captive customers.<o:p>
</o:p>
</font></p>
<p class="MsoNormal"><font face="Arial">What
happens when customers can choose? They might pick the cheaper alternative,
ignoring all the supposed benefits to the planet that price does not
capture. We can�t let that happen, can we? So, environmental activists
moved fast in some places to assure that people buying through the central
marketplace had to buy a given percentage of their needs from
environmentally correct sources.<o:p>
</o:p>
</font></p>
<p class="MsoNormal"><font face="Arial">See
the Clinton Administration�s new energy bill. Can�t trust the market.
Can�t trust people to do the right thing.<o:p>
</o:p>
</font></p>
<p class="MsoNormal"><b><span style="font-size:10.0pt;font-family:Palatino-Bold"><font face="Arial"><font size="3">I
view this attempt to secure a piece of the market as the laststand of the
central planners.</font><o:p>
</o:p>
</font>
</span></b></p>
<p class="MsoNormal"><font face="Arial">I
think that renewables have suffered from a lack of market orientation,
from
having one big customer: the government, in that the government decreed who
would buy and how much, and from having a customer that did not pay for the
product. The renewables industry has had the equivalent of 20 years of
infant industry protection. That�s enough. Infant industry protection
didn�t work for steel mills. It fostered inefficient industries that
never got efficient enough to compete.<o:p>
</o:p>
</font></p>
<p class="MsoNormal"><font face="Arial">N</font><font face="Arial">ow
let me return to the issue of markets. The government chose a market share.
The direct purchasers, unwilling utilities run by unsympathetic managers,
bought the minimum forced down their throats, and never considered going
over that minimum unless doing so served some regulatory or public
relations purpose. Government agencies fitted out energy efficient
buildings for themselves, but other real estate properties seemed to ignore
energy, for reasons of ignorance or economics.<o:p>
</o:p>
</font></p>
<p class="MsoNormal"><font face="Arial">The
renewable industry, in the future, may have to deal directly with
customers, who have no preconceptions about what constitutes the best
energy source, and who don�t own any power plants or oil wells that
produce a competing energy source. Renewable energy providers haven�t
been that successful selling directly to consumers. Well, neither has
anyone else, in most places, because of the way the politicians and
regulators set the rules, but we�re learning, and the market barriers
have finite lives.<o:p>
</font><font face="Arial"><o:p>
</o:p>
</font></p>
<p class="MsoNormal"><font face="Arial">What�s
the problem? Renewables are too expensive? Is that an inherent defect or
the result of inadequate scale and poor business practices? Renewables
could start by offering a menu to consumers. They might decide to take some
percentage of their energy from renewable seven if renewables cost more,
and this percentage, alone, might increase the size of the market.
Remember, too, though, that you are selling a differentiated product, not a
commodity. Even though all electrons are the same, all electrons are not
equal. Consumers out there pay more for natural cosmetics, organic foods,
bottled water. They�ll pay for green electrons, too. Somebody has to get
out there and sell them, though.<o:p>
</o:p>
</font></p>
<p class="MsoNormal"><font face="Arial"><b>HOW
DOES SOLAR FIT INTO THIS NEW BUSINESS SETTING?<o:p>
</b>
</o:p>
</font></p>
<p class="MsoNormal"><font face="Arial">It
does and it doesn�t. To the extent that photovoltaic manufacturers get
their costs down, then the owners of the panels could sell into the grid to
supply buyers of renewable energy. Not too exciting? Well, then, consider
that electricity prices will become volatile in the new market, and the PV
owners might discover that their maximum production comes when prices are
highest. The key to getting the best price resides in the metering.
Distributed solar could turn into an effective hedge against intolerable
price volatility, which might make it a more economic proposition.<o:p>
</font><font face="Arial"> <o:p>
</o:p>
</font></p>
<p class="MsoNormal"><font face="Arial">The
new era will put more pressure on passive solar manufacturers because new
retailers of energy will offer their services to consumers far more
aggressively than did the utilities. They will put together energy cost
minimization packages. Solar sellers will have to do better than those
packages or become part of those packages.<o:p>
</o:p>
</font></p>
<p class="MsoNormal"><font face="Arial">In
one sense, solar sellers may stand a better chance than before, if they
offer products and services that make economic sense, because the energy
retailers will know how to calculate costs and present values, unlike many
individual consumers. If energy retailers and managers get in on the ground
floor of real estate projects, they might incorporate passive solar as part
of the package, and finance the entire energy component of the project in
return for the equivalent of a long term virtual utility subfranchise.<o:p>
</o:p>
</font></p>
<p class="MsoNormal"><font face="Arial">But
we have to face up to three issues: the fragmentation of the real estate
development market, the fragmentation of the energy services market, and
the fragmentation of the solar markets. Big firms talking to big firms can
make things happen faster, and they can raise money a lot more easily. In
other words, assuming that solar economics stand up to scrutiny, solar
producers need to insert themselves in the distribution and energy
management channels that will emerge during the transition period. If the
new energy managers don�t fit solar into their plans soon, they may never
fit it in. Even new businesses get set in their ways.<o:p>
</o:p>
</font></p>
<p class="MsoNormal"><font face="Arial"><b>THERE
IS ANOTHER CHANGE COMING, THOUGH<o:p>
</b></font><font face="Arial"> <o:p>
</o:p>
</font></p>
<p class="MsoNormal"><font face="Arial">Remember
small gas turbines and fuel cells? Those devices will open the market to
distributed resources. Consumers could put together a package of resources
custom designed and independent of the electric system. To further
complicate matters, I believe that the transitional regulatory regime will
have an unexpected consequence: a substantial reduction in infrastructure
spending by utilities, which will also encourage the growth of distributed
resources.<o:p>
</o:p>
</font></p>
<p class="MsoNormal"><font face="Arial">I
think that entrepreneurs in the renewables business have to embrace size,
raise capital in the markets based on prospects, and go for broke,
spending that money to put in infrastructure and develop products. Not
easy? No, it�s not. But biotechnology firms and competitive local
exchange carriers, to name two recent examples, did it, and they are
burning up money rapidly in their efforts to get to the market. Why is a
new or better energy technology less exciting?<o:p>
</o:p>
</font></p>
<p class="MsoNormal"><font face="Arial">Perhaps
too many people look upon the renewable industry as more of a crusade than
a business, maybe even as a religious vocation. Renewables, for instance,
could do so much to help the 2.5 billion people on this earth who use the
most primitive energy technologies, and do a great deal of environmental
damage in the process. Unfortunately, you can�t make a profit selling
products to people who cannot pay for them, and the international energy
financiers seem to prefer colossal projects, instead. That means that
renewable entrepreneurs have to think more in prosaic terms, such as
offering products to people who can pay but also have alternatives.<o:p>
</o:p>
</font></p>
<p class="MsoNormal"><font face="Arial">You�ve
probably heard all this garbage about how that all-knowing market solves
all problems, but the market won�t work here, because pricing doesn�t
take into account all the costs to society of using the wrong energy
sources. I think that argument is correct, and the government could correct
the problem through taxation or a trading regime, if the political will
existed to do so, assuming that there was political agreement on the need
to do so, which there isn�t. I think the renewables industries are
betting on Kyoto. Absent that government action, renewables can either try
to expand their niche through government mandate, or produce a product that
the consumers want. Maybe the time has come to do the latter. As an
investor, I don�t want to put my money in a firm whose sales depend not
on the marketer, factory manager and engineer, but rather on the firm�s
lobbyist.<o:p>
</o:p>
</font></p>
<p class="MsoNormal"><font face="Arial"> <o:p>
</o:p>
</font></p>
<p class="MsoNormal"><font face="Arial">To
sum up, the renewable energy industry can enter a new age. It can sell its
product, bundle it with other products, deal in a market in which the
incumbents lose their grip. It can raise money to develop new products. But
it will have to sell: on the basis of economic value, or cleanliness, or to
help people save the world or salve their consciences. To get beyond a
niche market, the renewables industry has to learn to sell.<o:p>
</o:p>
</font></p>
<hr width="98%" color="#FFFF00" size="1">
<p><span style="font-size:10.0pt;font-family:Arial;mso-bidi-font-family:"Times New Roman""><font face="Arial" size="3"><b>ABOUT
THE AUTHOR<br>
</b></font></span><i><span style="font-size:10.0pt;font-family:Palatino-Italic">
</o:p></span></i><font face="Arial" size="3"><br>
</font><font face="Arial" size="2">
Leonard
S. Hyman, CFA, is
a senior industry advisor to Salomon Smith Barney. Previously he was
managing director of Fulcrum International Ltd., as well as an independent
consultant specializing in the economics and finances of energy and
telecommunications utilities.<o:p>
</o:p>
</font></p>
<p class="MsoNormal" style="punctuation-wrap:hanging;mso-vertical-align-alt:auto"><font face="Arial" size="2">From
1978 to 1994, as head of the Utility Research Group and first vice
president at Merrill Lynch, he supervised and maintained equity research
on foreign and domestic energy and telecommunication utilities. He was a
member of privatization teams for offerings of British, Spanish, Mexican,
Argentine and Brazilian utilities and consultant for other restructuring
studies. Prior to joining Merrill Lynch, he was a partner at a New York
Stock Exchange member firm and an officer at Chase Manhattan Bank.<o:p>
</o:p>
</font></p>
<p class="MsoNormal" style="punctuation-wrap:hanging;mso-vertical-align-alt:auto"><font face="Arial" size="2">Author
of America�s
Electric Utilities. Past, Present and Future, author of The New Telecommunications Industry: Evolution and
Organization and
editor of The
Privatization of Public Utilities, he has contributed to other books and to
professional journals.<o:p>
</o:p>
</font></p>
<p class="MsoNormal" style="punctuation-wrap:hanging;mso-vertical-align-alt:auto"><font face="Arial" size="2">For
more than a decade, Mr. Hyman was cited by <span style="font-size:10.0pt;font-family:Palatino-Italic">Institutional
Investor </span>as
one of the leading research analysts in his field. He is a Chartered
Financial Analyst (CFA). He holds a BA from New York University, where he
was elected to Phi Beta Kappa, and an MA in economics from Cornell
University, where he majored in industrial organization<o:p>
</o:p>and
minored in Latin American studies.<o:p>
</o:p>
</font></p>
<span style="font-size:10.0pt;font-family:Palatino-Italic;mso-fareast-font-family:
"Times New Roman";mso-bidi-font-family:"Times New Roman";mso-ansi-language:
EN-US;mso-fareast-language:EN-US;mso-bidi-language:AR-SA"><font face="Arial" size="2">Salomon
Smith Barney, Inc., 388 Greenwich St., New York, NY 10013; 212-816-8508.</font></span>
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