Solyndra's Second Chapter

The details of the reorganization plan approved Monday by the judge hearing the Solyndra bankruptcy case reminded me of the admonition of one of my mentors always to beware of unintended consequences.  I'm sure the Department of Energy officials who recommended the federal loan guarantee for Solyndra in March of 2009 envisioned that the solar start-up would succeed.  As a worst-case outcome, they probably anticipated the loss of the entire $535 million direct federal loan ultimately provided by the Treasury. However, in a remarkable turn of events, the actual extent of the downside for taxpayers has now expanded to nearly $900 million, due to a quirk in the tax code and a subsequent DOE decision in 2011.

This odd sequence of events starts in early 2011 when two venture investors agreed to infuse another $75 million into the already failing Solyndra.  In order to facilitate this injection--presumably in hopes of protecting the government's substantial investment in the firm--the DOE agreed to allow the investors' loan to take precedence over the government's if Solyndra went bankrupt. Perhaps they thought that even in that case, they'd still recover most of the government's investment, because Solyndra had a sexy technology and a big new factory in Fremont, CA that could be sold to a competitor for close to full value.  They apparently didn't appreciate that Solyndra's high-cost technology had already been bypassed by falling polysilicon prices, and that the factory and its custom equipment wouldn't be of much interest to other solar producers, who were in the process of creating a huge global overhang of solar manufacturing capacity.  The Solyndra plant will now apparently be sold to a hard-drive maker for just $90 million.

In the meantime, Solyndra was piling up substantial losses running its plant and selling solar modules below cost, in order to compete with conventional solar panels that had become much cheaper. By the time Solyndra entered Chapter 11 bankruptcy, its cumulative losses apparently totaled $975 million.  To put that in perspective, the combined after tax profits of First Solar, the largest US solar producer, for the three years in which the DOE's loan to Solyndra was outstanding, were $1,265 million.

What makes Solyndra's losses relevant is that, contrary to intuition, they didn't disappear in bankruptcy.  Instead, via the investors' plan for emerging from bankruptcy, they became an asset.  And because the DOE ceded the first place in line to private investors, it is those investors who will control those "net operating losses" retained by Solyndra's reorganized parent company, 360 Degree Solar Holdings, Inc. That company apparently kept none of Solyndra's hardware, but when it acquires other companies--in any line of business--it will be able to offset future federal tax liabilities estimated by Bloomberg at $341 million.  Meanwhile, the federal government is likely to recover just 5 cents on the dollar on its "secured loan."  The Solyndra loan is a gift that keeps on giving. 

Hindsight is 20/20, but it seems pretty clear that the folks at DOE were outsmarted by private investors who had a much clearer picture of the stakes for which they were negotiating.  As we were reminded last week, Solyndra wasn't the only investment they made that went bad.  Let's hope that the others don't include similarly unpleasant surprises.  Meanwhile, I wish the IRS and Alameda County the best of luck in appealing the bankruptcy judge's ruling.

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What If Saudi Arabia Became an Oil Importer?

I've seen numerous references in the last several days to a Citgroup analysis suggesting that Saudi Arabia might become a net oil importer by 2030.  The premise behind this startling conclusion seems to be that economic growth and demographic trends would continue pushing up domestic Saudi demand for petroleum products and electricity--generated to a large extent from petroleum--until it consumed all of that country's oil export capacity within about 20 years.  Even if this trend didn't proceed to conclusion, its continued progression could significantly alter both global oil markets and the context for the current debate about the desirability of achieving North American energy independence.

I'd be a lot more comfortable discussing this news item if I had access to the report on which it's based.  Unfortunately, none of the dozens of references to it that I found on the web included a link to the source, which is probably on one of Citi's client-only sites.  The Bloomberg and Daily Telegraph articles seemed to be the most complete, with the latter including a couple of charts from the report.  As best I can tell, the analysis falls into the category of "If this goes on" scenarios--extrapolations of currently observable trends to some logical conclusion.  That doesn't make it simplistic, because I'm sure the author sifted through volumes of data to flesh it out.  The fact that many oil-producing countries have gone through a similar cycle lends it further credibility.  For that matter, the US was once an important oil-exporting country, until the growth of our economy overwhelmed the productivity of US oil fields early in the last century.  The gradual conversion of the remaining oil exporters to net oil consumers is a basic plank of the Peak Oil meme.

This presents a real conundrum, both for the Saudis and for us, because although many of the means by which this result could be averted are obvious, they aren't all feasible within the current political situation in Saudi Arabia, or indeed many other producing countries.  Start with per-capita energy consumption, which a chart in the Telegraph article shows to be higher than in the US. Consumption is also high relative to GDP. Energy efficiency opportunities should be ample, but it's hard to make those a priority when retail energy is heavily subsidized and thus cheap.  The Citigroup report apparently suggests reducing energy subsidy levels, but that might lead to the same kind of unrest that we've seen in other countries that have cut subsidies.  That seems to leave mainly investment-based options for substituting other energy sources for oil, to preserve oil for exports.  The Kingdom has already embarked on some of these, including nuclear and solar power.  When combined with additional natural gas development, the Saudis certainly have the means and the motivation to shift the current trend of rising internal oil consumption, along with the cash to fund the infrastructure investment involved.

This leaves us with important strategic questions: To what extent should our own energy policy rely on Saudi Arabia succeeding in preserving its oil export capacity by means of substitution or efficiency gains? And if internal Saudi consumption removed just another 2-3 million barrels per day of exports from the market, how would that affect oil prices and the functioning of the global oil market, in which Saudi Arabia has often acted as a moderating force within OPEC?  Considering that a narrowing between demand and available supply of about that magnitude was a key factor in the oil-price run-up of 2006-8, this should cause us serious concern.

That brings us to US energy independence, a tired mantra that has been proclaimed by a long succession of US Presidents, despite most experts for the last several decades having regarded it as unrealistic.  To be clear, when Americans speak of energy independence, we are referring to oil, because as a practical matter that's the only form of energy we import to any significant degree, if you don't count natural gas from Canada.  Yet suddenly energy independence no longer looks like a pipe dream, because of the combination of resurgent domestic oil production and improvements in vehicle fuel efficiency.  An earlier report from Citigroup sketched the outline of potential future North American energy independence based mainly on those elements.   It's hardly guaranteed, but it's not a fantasy, either. 

Despite the risks of a much more unsettled oil market in the future, I continue to see a great deal of misunderstanding about what energy independence could mean for the US.  Although it wouldn't cut us off from the global oil market--perish the thought--it would give us a much more flexible and influential role within it, while taking advantage of the benefits of continued trade.  No longer being a net oil importer wouldn't insulate us from future oil price movements--it's still a global commodity--but oil prices would be lower than otherwise as a direct result of the substantial additions to supply required to shrink US oil imports to near zero.  Prices would be weaker even if OPEC slashed output to compensate, because the resulting increase in spare production capacity would still reduce market volatility.  Moreover, while US energy independence would not preclude the possibility of future oil price spikes, the consequences of those would be very different.  For starters, they wouldn't entail weakening our economy by transferring tens or hundreds of billions of dollars offshore.  Most of the extra oil revenue would stay in the US, and a large slice of it would be captured by state and federal taxes and royalties.  Contrast that with what happened in 2008, and is still ongoing to a lesser degree.

The Saudi analysis from Citigroup proposed a fascinating scenario, with many interesting implications, although I'd argue that it's also subject to the simple advice of Herb Stein that "If something cannot go on forever, it will stop." By coincidence, it's also relevant to the energy debate underway between the US presidential campaigns. Although it's highly uncertain that Saudi Arabia's oil exports will dry up by 2030, we shouldn't assume such an outcome to be impossible, any more than we should base US energy policy on the outdated assumption that it's impossible for us to come close to eliminating the need for oil imports from outside North America.  It might be uncertain whether we have sufficient resources accessible with the latest technology to reach that goal, but it is essentially certain that the growing but still tiny contribution of renewable energy and the eventual conversion of the US vehicle fleet to electricity couldn't get us there for multiple decades.

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A Sign of Sanity in Solar Manufacturing

I've been writing for some time about the chronic overcapacity in global solar manufacturing and the consolidation this is likely to produce.  Now here's a sign that at least one company realizes how bad the situation is.  GE is apparently delaying the construction of its previously announced Aurora, Colorado, thin-film solar panel factory, and "taking this opportunity to re-look at our solar strategy."  I couldn't find a GE press release to back this up, but it's been reported by RECharge and confirmed by Forbes.  It's easy to read too much into a single event, but I think this looks significant, particularly in the wake of Monday's Chapter 7 bankruptcy filing by Abound Solar, incidentally another recipient of a sizable federal renewable energy loan guarantee.

If this information is correct, GE is backing away--for at least 18 months--from building a 400 MW thin-film photovoltaic (PV) solar line in Colorado.  That suggests that they have concluded that even a brand new facility using the latest technology and large enough to compete on scale with thin-film leader First Solar wouldn't be able to earn an attractive margin in this market.  And as a global competitor, GE would presumably regard the new US tariffs on China-based PV manufacturers as insufficient to resolve global PV overcapacity that appears to be stuck at about the same magnitude as demand, despite the continued rapid growth of the latter.

In the last year I've seen numerous articles and blog posts attributing the recent PV price declines to the predicted scale-related effects that have long anchored the industry's central narrative: If we build and deploy enough PV, the cost will fall to the point at which it will be competitive with conventional electricity generation.  That may still be true in the long run, but few of these advocates seem to have understood that the industry was getting ahead of its own narrative--that a big slice of the recent price declines was the result of intense competition among producers who over-expanded and whose margins have contracted sharply or turned negative in the process.  That's a good reason for GE to hit the pause button and focus on improving its technology in the lab, rather than the fab, while other, less well-capitalized firms struggle to survive long enough to participate in the expected growth surge when solar reaches "grid parity" on a sustainable basis.

PV is an important energy technology with a bright future, but its present doesn't look so great.  It's not unusual for manufacturing industries to experience boom-bust cycles, though in my experience those are more common in commodities like chemicals and fuels.  However, it is distinctly unusual for governments to contribute so much to the inflation of the boom part of the cycle through a wide array of incentives, loan guarantees and loans to manufacturers and with subsidies--in some cases extravagantly generous ones--to the industry's customers.  Such interference may have been necessary to jump-start PV supply and demand, but it will almost certainly make for a harder and messier landing for companies, investors and employees, and in cases like that of Abound Solar for taxpayers.  

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