Too Big To Fail - Or Too Small to Succeed?

A common fallacy in American business in general, and in Colorado’s economy in particular, is:

(A) Most jobs are in small business,
(B) Most new jobs will be in small business, and,
(C) We need to support small business as a key to renewed economic success.

This is fundamental economic nonsense.

Most small businesses are single proprietorships, including many consultants who are marginally employed far below their actual skill level. Armies of accountants, attorneys, therapists and multi-level marketing personnel help to swell the cohorts of small business people, but all are constrained at the level of net productivity. As a rule of thumb, if a person is billing on an hourly basis, they cannot contribute to productivity increases; they can only increase their billing rate – or add to their billable hours.

Nevertheless, the myth persists of small business as a major engine of our economy.

Why?

Small business appeals to our pioneer spirit; from the solo mountain trapper and the cow poke on the cattle drive, to the inventor tinkering in his garage, we see ourselves as a collection of independent spirits striking boldly striking into new territory in technology and creative effort. Our legends conveniently forget the thousands of combined hands that it has taken to build mills, mines, railroads, highways and farms. We like the other versions of the story much better.

But here’s the deal:

(A) The game is rigged;
(B) We need to get in that rigged game;
(C) We need to get bigger – much bigger.

Let’s take it from the top.

Lesson One: That the game is rigged is well known, and ubiquitous.

The recent bank and auto company bailouts, followed by the extreme disinterest in effective regulation and punitive efforts for management incompetence, have underlined the weakness of small business in general, and Colorado small business in particular, to change the rules.

Bailouts and bonuses continue at the top nearly all major corporations involved in the recent financial meltdown, and all indications are that there will be no substantive effort from any quarter to put an end to these practices; all of the political noise we could ever make will simply not change the game, period, full stop.

Lesson Two: Get in the game.

If those of us in nascent industries in Colorado do not get in The Game, we deserve what we get. Colorado urgently needs to improve it’s ability to raise capital, and if it is foreign offshore and overseas capital that we end up raising, fine. Americans sometimes forget that the US built it’s canals, railroads and other industries with foreign investment, primarily from Britain and France. Now we need to be able to tap overseas capital markets again, this time via the Toronto Stock Exchange (TSX) and the London Exchange (AIM). Both of these exchanges could help Colorado become independent of the capital markets in the US that are no longer responsive to our needs, and also improve our leverage when we work with US capital providers by providing us with a choice in capital sources.

A necessary pre-requisite for this effort is to clean up our enforcement of securities and banking laws; if we are not up to international standards of control, we will represent just as a poor a risk as we did during the penny stock days of the 1980s.

Lesson Three: Get bigger.

Nothing brings home the fallacy of ‘small business’ like comparing the business efforts of the growing behemoth firms in Brazil, Russia, India and China, in industries like oil, autos and aluminum, with the puny efforts of American small business men and women. The endless complaints regarding our loss of manufacturing capabilities are generally voiced by people who are not trying to get bigger.

There is often a strange illogical leap into believing that small business is a key to competition with these giant multi-national firms, but few of us stop to think about that could actually work.

Colorado’s Underground Economy

We Need to Start Using the Underground

We talk about the frontiers of space and the world's oceans; we seem to have forgotten that it is the ground beneath our feet which may offer the greatest promise for a sustainable future.

Underground technology in drilling and mining has been ignored in our pursuit of sustainable solutions in energy and transportation. We need to look at these old technologies creatively, with a new set of reference points. The ‘Geolithic Thermocline’ can provide reliable sustainable energy; transit tunnel construction offers weatherproof transit paths lasting for centuries. The early leaders of Colorado, who foresaw the need for water resources, would be disappointed that we have not capitalized on everything we know how to do in mining and tunneling.

Energy First – The Geolithic Thermocline

Humans have understood the ‘Geolithic Thermocline’ since they lived in caves. Adobe and other types of earth construction are modern analogs of living in caves, using earth construction to manage interior temperature for heating and cooling. Ground Source Heat Pump (GSHP) technology uses the earth as a resource for heating and cooling by using water pumped through pipes or drilled wells to collect the ambient temperature of the earth. GSHP (the above ground portion) concentrates the collected energy to heat or cool as required.

GSHP is available everywhere that a building stands on the earth. Unlike wind or solar, Ground Source Heat Pumps work 24/7, and do not require energy storage to function perfectly. GSHP can be used in every part of the United States, and it is compatible with all existing mechanical equipment via heat exchanger technology. It is completely scalable, and can be installed in single home systems or in large mechanical system installations. GSHP has been reaching rates of installation of 12-15% primarily in new home construction in Texas and Oklahoma over the past decade. Underground collection piping can function for decades with virtually no maintenance, and could conceivably be used efficiently for a century.

Tunneling Creates Safe, Efficient Transit Paths

Tunnels are weatherproof highways for transit systems, perfect for major urban transit solutions, and good for some suburban applications. Trains can be routed in nearly straight paths from station to station. Impacts with surface owners are generally by-passed. Tunnel designs can be optimized to meet the needs of every type of train from light rail through high speed rail, and even maglev. Tunnels and underground transit ways completely and safely separate all surface traffic from the trains, allowing them to run faster and perform without the risk of snow, track debris or incidents with automobiles or freight trains. Best of all, tunnels permit true last mile solutions, delivering the passenger directly to his destination with an elevator or escalator.

Two primary types of tunneling are available, cut and cover, and drilled tunnels using either Tunnel Boring Machines, or more traditional road header cutting machines. Cut and cover is more suitable for areas in open country, some suburban locations and along highway paths. It is cheaper, generally, than bored tunnels, and the first choice of underground construction should be use as much cut and cover tunneling as possible.

Real Sustainability – How Do We Get There?

Real sustainability means forever. As close as we can get to it.

Tunnels are among the most permanent and durable types of construction known to man; piping systems supporting GSHP are similarly nearly permanent. What is missing from our toolbox in the sphere of sustainable economics are the tools we have already, not the uncertain rewards of technologies not developed.

The Colorado School of Mines, CSM, has been leading generations of engineers from all over the world in underground construction. The same skills that CSM’s miners use in mining work equally well in tunneling.

Colorado is also home to dozens of drillers, large and small, with many more available in surrounding states. Drilling technology is many decades ahead of fuel cell and PV technology; shouldn’t we use that technology to pursue GSHP? We don’t necessarily need ‘Black Swan’ scientific discoveries as much as we need breakthrough thinking and organization.

Our solutions are already at hand. Get a shovel.

Sustainability 2.0 - Making Sustainability Sustainable

Renewable energy, ‘Cleantech’ and sustainability have acquired a patina of political bias over several decades of our 20th-21st energy policy development. The current advocates of the Clean, Green economy in Colorado describe a pristine world of the future where we are free of the bad old energy sources in fossil fuels, and renewable energy supports us all. But this advocacy has come with a cost - it has created a political backlash that defeats many efforts toward creating a sustainable energy industry, and makes sustainable energy policy - unsustainable.

The drive for energy independence began in the 1970s under President Jimmy Carter. But beginning with the Reagan administration, the push toward renewables and energy independence was abandoned, then revived under Clinton, lost under Bush, and revived under Obama. Again.

In the ebb and flow of efforts to achieve energy independence, we have been defeated by two essential factors: changes to the political leadership, and periodic troughs in the prices of gas and oil.

A truly sustainable energy policy would be able to hold it's own against these two factors. The requirements for truly sustainable policy are, (A) that it has achieved bi-partisan support, and, (B) that it is economically viable in long term competition with fossil fuels.

Sustainability must mean sustainability during changes political administrations, and during periods of price volatility in the fossil fuel sector. Sustainability means absolutely nothing if every time the governor's office changes parties, the will to construct renewable and sustainable sources of energy evaporates.

The cap and trade program, or carbon taxes, are a step in making renewables more competitive with fossil fuels, but we will be complacent to a fault if we do not -(A) begin looking at the current menu of renewables,(B) start making the harsh evaluations of what seems to be working now, and what remains experimental, and(C) sensibly include fossil fuels in our calculations of future energy sources.

Ethanol? Doesn't it now look like a farm subsidy? Didn't it always? Bio-fuels? Doesn't that look like a subsidy for research programs in the bio-science sector?

I am not arguing that there should not be farm subsidies, or that we should not support basic research in the biosciences. What I am suggesting, however, is that we need to accurately describe the reason for these types of funding and not get distracted or misled by using the label of the cause de jure for programs that have no real effect in the renewable energy sector or which do not lead to sensible and sustainable energy policies.

No technology in the renewable sector should be abandoned, but all of them should be subjected to sensible economic review and assessment of their prospects for true scalability.

Sustainable means these technologies will not evaporate with the end of the current governor's administration in Colorado, and that a hard-nosed economic analysis will be a part of any advocacy of renewable energy and fossil fuel, going forward.

Zoning Policy is Energy Policy

Have you ever seen a LEED energy efficient building surrounded by acres of parking lots and miles of highways? This LEED structure, admittedly energy efficient, is only accessible by using enormous amounts of energy over the life of the building to use it. It is not a fault of the engineering, which is first rate; it is instead a continuing defect in zoning policy.

Many community zoning codes in Colorado were written for an age when there were fewer Americans using cheaper fuel to go places that were much closer together. Now that the spread of cities and suburbs has shown us a future of expensive automobiles and fuel, hours of time wasted in commutes and continuous potential for violating clean air standards, we may need to rethink the zoning policies that have lead us to put miles and highways between homes, schools, stores, and jobs.

Colorado communities are not alone in these zoning policies; the prevailing zoning codes of most American cities intentionally created residential, industrial and retail districts that were miles apart from each other and which could only be serviced with automobiles. It was a worthwhile objective for the decades before and after WWII, when urban homes and the inner city housing stock were in terrible condition, and the smokestack industries of the past two centuries were hardly anyone’s first choice for a neighbor if they could move to the cleaner, newer suburbs.

Zoning separated suburban homes from everything, except other homes; whatever might detract from an individual home’s value by it’s proximity was banished to remote locations. Cars were cheap then, and incomes were rising. New and used automobiles were inexpensive, credit was cheap, and the total cost of owning a car was relatively low. It was easy to foresee buying at least a used car for each driver in a family, and it was a necessity for many families who lived miles from anything except their neighbor’s homes.

What happened?

Several trends have converged at the same time, some economic, others demographic. Vehicles have become increasingly expensive in initial purchase cost, excise taxes, fuel, insurance, parking and HOV fees, and other costs of urban auto ownership that have made owning multiple automobiles increasingly less desirable. Economics has also led to a declining pool of potential suburban home buyers and hence, automobile buyers, due to lowered expectations in income and lifestyle. A generation just coming of age cannot find jobs that would allow them to purchase homes and cars; they are looking for a lifestyle that will let them live comfortably without an auto.
The suburbs in many areas have often proven to have as many problems as the inner city areas. In turn, inner city zones, after reaching their limit of decline, have been recovering population and a tax base. Efforts to escape from cities on racial and ethnic grounds have been muted by further demographic changes and several generations of a more fully integrated society, along with the influx of newer ethnic populations. Smokestack industries in the cities have been largely replaced, and old structures in urban areas have been recycled with mixed use redevelopment.

These changes in economics and demographics are leading to a change in lifestyles and spending that will not return to previous patterns for the foreseeable future; a wholesale move back to cities seems unlikely, however, and is undesirable. A substantial population move back to cities risks an enormous loss in the value of suburban housing.

For zoning boards, protecting home values in suburban areas should become a primary focus, not by maintaining previous practices, but by permitting the suburbs themselves to evolve with a sensible policy of re-zoning. Suburban communities could actually buy and tear down houses in some areas to create zoned areas that permit walking to schools and retail areas. Zoning policy that encourages mixed use development is critical to making communities desirable from an economic standpoint, and a focus on making communities walkable and liveable without an automobile, is easily the most effective way of creating a sustainable community energy policy.

There are precedents in the Denver area for teardown and reconstruction of communities, most recently in the shopping malls, and many communities could purchase houses at the current market value to tear them down and redevelop the resulting vacant land for mixed-use.

Communities that engage in ‘suburban renewal’ could qualify to receive substantial revenue from carbon cap and trade policies; re-zoning can create permanent reductions in their carbon footprint, and under the current program proposed in congress would qualify for monetization. Permanent energy sustainability is within each community’s grasp in it’s zoning policy.

The Utility Revenue Model Restrains Distributed Energy Development

Utilities and the Revenue Model

Advocates for clean, renewable, and sustainable energy sources are often unaware of the reasons for utility industry opposition to renewable and distributed energy. It is useful to explore a couple of the utility rate issues in the regulated utility industry and begin to formulate approaches that deal with utility opposition to distributed energy generation.

Utilities and the Regulatory Compact

The Regulatory Compact (RC) is an agreement by the utility to provide service on demand, with fines imposed for failure to maintain adequate service. Under the RC, the utilities are granted a monopoly by state regulators to supply electricity and natural gas to clients in their service area. The utilities also agree to build and maintain generation facilities and a distribution network and to pay for all initial invested capital costs (CAPEX). The utility is then allowed to operate the utility for an ‘all costs in’ operating expense (OPEX) – plus a return to investors.

The problem is with the current model for utility revenue generation

Utilities only make money for selling gas and kilowatts. Conservation in the present model actually encourages the utilities to raise rates because they do not earn any revenue on kilowatts and therms of gas that never get sold, and the remaining service base of utility customers carries a proportionately larger percentage of CAPEX. Conservation does help reduce additional CAPEX in generation, but reducing consumption for existing generation facilities means that under current regulations, the utility is allowed to recover CAPEX across fewer units sold, which translates into a higher cost for service.

Stranded Costs & Grid Connection Fees

Not only do remaining ratepayers pay higher costs, but the utilities believe that they should be able charge distributed energy generators using renewables charges for stranded costs, i.e., the costs of plants and distribution who’s costs are not being defrayed via the normal rate structure, and connection fees related to being connected to the grid, even though they customer may be net neutral or even adding power to the grid.

The RC extends to the effect on CAPEX of mandating a percentage of generation from wind and solar power. Until a reliable and cost effective means of storing electrical power is developed, the usefulness of these two prominent, renewable, but intermittent, energy sources will be limited.






Why?

The regulatory compact requires the utility to provide power even when supplies of wind and solar are not available, and forces the utility to build redundant generation capacity that would not be required without the mandate.

For example, if 20% renewables is required by mandate, then the utility builds the renewable facilities, equal to 20% of their demand, plus 100% normal capacity, for a total build out of 120%. Combining reduced demand through conservation with a declining base of ratepayers due to distributed generation, means the remaining ratepayers are required to pay for the entire 120% of capital construction, according to current regs.

I’d like to hear any proposal regarding updating the utility revenue model to reflect conservation and distributed generation. The current iteration is a major obstacle in the path in the path of adopting sustainable, renewable energy.

Accounting for Sustainable Infrastructure - The Need for a Realistic Approach

We are beginning to face the contradiction between the need for personal savings and investment on one hand, and a consumption based economy on the other. Increasing personal savings decreases disposable income; with less disposable income, people buy fewer consumer goods, and in our current measures of economic productivity, any decline in consumption decreases economic indicators. Without personal savings, we need to borrow to purchase consumer goods.

Borrowing is useful when the economic life of what you buy exceeds the period required to pay it off. Issuing bonds to build a road that lasts over 100 years, when the bonds are repaid in 20 years, is a pretty clear economic win; 80 years of benefit from the road. The benefit is not nearly as clear when the economic life of what you’ve purchased is less than the period of the loan. Everyone knows that cars depreciate as soon as you drive them out of the showroom. Who knew that homes could do the same thing, declining in value as Adjustable Rate Mortgages drove home payments through the roof?

The fault is not in the systemic risk we facilely blame for the current economic crisis, but in our accounting practices, and in our economic treatment of infrastructure. We make only hazy distinctions between economic activity with long term benefits, like building roads, schools, and sustainable energy infrastructure, and the consumption of candy bars and flat screen TVs.

Although the useful life of these expenditures are vastly different, we lump them together as economic activity primarily because the effort to categorize them has appeared to be too much work. Along with this is the limitation in practice of the useful life of infrastructure by current accounting standards, and public sector infrastructure does not get a treatment of depreciated value or beneficial use that it should. On the books of the public sector, the initial cost is all that is carried as the value, and no viable tools are available in GAAP to define the long terms benefits of infrastructure that lasts for decades.

This problem with our economic metrics leads to a failure to effectively distinguish long term, beneficial economic activity from short term, consumptive activity. The entire period of benefit of the goods purchased should be included not at cost, as they are now, but valued for the depreciated replacement cost over the entire period of benefit, less maintenance expenses.

With all of the efforts toward sustainable infrastructure of various types in the built environment, we need a mature accounting standard for the long term benefit and value of sustainable systems.

200 years might be a good start, and a change in accounting and economic practices could move many sustainable greentech projects into the positive category for financing and investment.

Public Private Partnerships, and Tolerance for Risk (and Failure)

In the private sector, 6 out of 10 new venture capital investments end in failure; some investors say the rate is even higher.

In the public sector, new ventures never fail; they simply get more money.

A flood of ink has been spilled in the past year or two regarding the need for and the virtues of Public-Private partnerships. Not much thought seems to go into what that actually means, however.

There is a drive to engage the public sector in many new business ventures, especially in the renewable energy and clean tech sectors, but little understanding of the risks, and almost no comprehension of the penalty for failure. In large part this is due to the point of view that risk of failure does not exist for the public sector projects.

At first, this would seem to be an argument of Libertarians and Conservatives to rally around the goal of smaller government, but it is not - far from it, in fact. The objective instead is to put in place standardized metrics and include processes in public-private partnerships with respect to goals, stakeholder interests, and pre-project risk assessment. Then, with eyes wide open, proceed with projects when the risk assessment is outweighed by the potential rewards.

The public sector already takes on the riskiest projects, in space exploration, research, and a multitude of other projects; it is, in fact, taking on many more risks than the private sector, because it needs to and can afford to, both points based in the public interest.

What is missing, however, is a non-partisan approach to analyzing project performance, (benchmarking) and determining a sensible course of action when public sector projects fail. The current position in the public sector is to use money to paper over a project failure. The project gets completed, and the public sector managers keep their positions, in spite of the failure. In many cases, the failure is not recognized or studied, and the failure is forgotten.

This amnesia in the public sector is unfortunate; many critical lessons learned are available in failed projects, and our collective project performance could be vastly improved by studying them. Engineers routinely study every failure, and failure analysis, 'test to failure' and a host of other disciplines are standard tools of engineers in their Best Practices. Why doesn’t the public sector do the same?

In the public sector the most telling risk management question you can ask is, ‘what rate of failure is acceptable to you?’. When the manager does not look at you like you have just grown another head, their response is generally, "we don't have any failures". We know they do, and knows they do. The solution, however, of ‘ spend more money’ has obscured the real issue and simply led to a superficial debate over the cost of the government sector.

(Don’t believe it? Look at the DIA baggage claim project)

Regulated utilities may represent the best example of a public private enterprise; the utility is granted a monopoly and all rates and charges are reviewed and approved by the regulating authority. A second example is quasi-private enterprises which involves establishing and government sponsored entity that then functions like a private company. Here in Colorado, Pinnacol Assurance is the most public example, but there are others. Tennessee Valley Authority (TVA) comes to mind, as do many of the Rural Electric Associations.

For new and risky tech sectors, the utility approach, and the quasi-private approach, will generally not work. If we are going to try to foster small business growth and technical innovation, the public sector will need to adopt a mature understanding of risk and failure, and adjust it's tools and metrics accordingly. We can invest public funds in the new business and risky ventures, but it needs to occur with some good sense regarding benchmarking, process management and best practices.

Just as it should in the private sector.