The Unexpected Perspective
The Implications of Darwin and the Big Bang for Christians ... and Everyone Else

Perspectives

The Sage of Omaha and Alternative Energy

Legendary investor Warren Buffett sees the promise of alternative energy

            If any doubts remained about the competitive viability of solar and wind as commercial sources of energy, Warren Buffett, the legendary investor from Omaha, has put them to rest.  Buffett's Berkshire Hathaway has made major investments in electric utility power generation.  Recently, his company announced an integrated plan to build 2.7 gigawatts of wind and 1.8 gigawatts of solar.

            That certainly gives a nod of approval to these two industries, but that wasn't the truly important announcement.  Instead, Buffett said he wants his Mid America energy company to be 100% renewable by 2020 – two years from now!  The company will build no new gas, coal, or nuclear plants!  Of course, that doesn't mean that Buffett will get his companies to eliminate all carbon based energy sources by 2020, but it's an encouraging move nevertheless.

            Making such an announcement is what one might expect from truly visionary or "leading edge" investors – people such as Elon Musk of Tesla.  Warren Buffett has been incredibly successful as an investor – a true legend – but he's built his success on very traditional types of investments.  He's consistently avoided leading edge technologies.  As an example, though he became a very good friend of Bill Gates many years ago, Buffett still consistently avoided investing in information technology, claiming that he really didn't understand technology.  More recently, he's made some investments in technology companies, but long after they were known to be on the leading edge.

            That suggests two things to me.  First, it indicates that alternative energy technologies such as wind and power truly have become mainstream.  Buffett obviously sees that they are better investments than traditional energy sources such as coal and natural gas.  The Sage of Omaha is known to have Democratic leanings, but he also is well known to leave his political opinions and proclivities at the front door of Berkshire Hathaway.  When he goes to work, he's "all business".

            Second, it suggests that he sees wind and power as far better long term investments, even without the subsidies that have been common.  Many people have claimed that wind and solar are only viable because of government subsidies.  Take those subsidies and credits away and the investments become uneconomic.  Well, that was true for a long time, but it isn't true any more. 

            Buffett and his investment partner, Charlie Munger, are clearly shrewd enough to know that tax credits and subsidies can disappear with the snap of the fingers.  I find it hard to believe they would ever make an investment that depended upon the presence, or continuation, of subsidies.  Whatever subsidies and credits remain are likely to be removed, sooner or later, but the bet is that solar and wind will stay highly competitive even without such subsidies.

            If anyone really thinks that Buffett is unconventional in his investment, he also recently announced something that should disabuse anyone of the notion that he's more like Elon Musk than not.  Buffett announced that he supports the electric utility industry's opposition to "net metering".

            Where "net metering" is permitted, customers who generate their own power, typically via a rooftop solar system, will periodically produce more power than they consume during the day.  That extra power can be moved back onto the electric grid for use by others.  In effect, the customer's electric meter spins backward for a time, reducing the customer's electric bill.  The permissibility of net metering, as well as pricing of it, depends upon local rules and regulations.

            Electric utilities as a whole hate net metering.  The reason is because they perceive it will reduce their overall revenue but not reduce their costs.  After all, the utility still has to maintain the electric grid, and all of the costs associated with that.  Moreover, the utilities will lose revenue by this.  As an example, California permits net metering, and it's estimated that public schools and agencies alone in California will save $ 2.5 billion in electricity charges over the next 30 years because of net metering.  Private customers will save a lot more.

            Are Buffett and the electric utility industry right in opposing "net metering"?  In my mind, absolutely not!  Opposing "net metering" is just the latest version of monopolistic thinking by electric utilities.  Instead, net metering should be permitted, and the overall marketplace should decide the price of electricity.  I think Buffett and Munger, once they look closely, will change their minds about net metering.  Let me explain.

            It's pretty clear why electric utilities hate net metering.  After all, they want to preserve the typical monopoly they've traditionally had.  Unfortunately, as anyone who has ever taken an economics course knows, monopolies lead to monopolistic pricing and monopolistic service – meaning a lack of good service.  Frankly, a little competition should benefit all parties.

            Electric utilities say that if net metering is permitted, it will create too much uncertainty, and too many disincentives, for the utility to make the necessary investment. Not only that, they say that net metering places an unfair burden on those who don't generate their own solar power. I say, that's hogwash.  It's merely an excuse to create, or maintain, an unjustifiable monopoly.

            At the same time, the utilities that oppose net metering do have a point.  If the power generated by the rooftop solar system and sold back to the utility is simply "netted" against the customer's electric bill, then the customer has effectively sold back power at a retail price.  The retail price of power includes the cost of all of the transmission grid. 

            A more fair way to do this is to permit the rooftop solar system to sell power back to the utility but only at a wholesale price.  That price might be the same as what the utility could buy solar power from another utility or from a power wholesaler.  That wholesale price would definitely be lower than the retail price.  As an example, the wholesale price might be 2.5 cents/Kwh and the retail price might be 8.0 cents/Kwh.  Thus, the rooftop solar customer would pay the following for electricity: a) nothing for the power generated during the day and used by the customer; b) the retail price of 8.0 cents for power purchased at night from the utility; and c) the utility would credit the customer 2.5 cents/Kwh for the power that the rooftop solar system sold back to the utility.

            Using this approach should overcome the utility's objection to having to pay a retail price for power purchased from the rooftop solar system.  Now the utility may still object, saying that it makes things too complicated.  Again, I think that argument is hogwash.  Electric meters, and utility accounting systems, are sufficiently robust that one can easily make these calculations.

            The other big objection utilities have had about net metering is perceived instability it will create in the electric grid.  That used to be a problem, but recent evidence suggests the technical problems have been overcome.

            How should the wholesale price of electricity be determined?  Various data are published regularly.  The utility commission that governs rates for the electric utility can monitor this.  It will probably vary over time, but it's easily trackable.

            The opposition to net metering by electric utilities is short-sighted.  In fact, I think Warren Buffett will change his mind and embrace net metering in the future, especially if states embrace my proposal of having rooftop solar customers sell power back at wholesale rates.  The reason has to do with peak loading.

           Managing peak loads is the real problem that utilities have.  Historically, electric utilities have had to maintain standby capacity.  The standby capacity in northern climates tends to get used in the wintertime in the evenings.  In hotter climates, it tends to get used during the summertime.  Maintaining those standby units is usually very expensive.  In fact, it may be so expensive that the idea of getting excess energy generated by rooftop solar is appealing.  To the extent the utility can purchase excess power at wholesale rates from rooftop solar, it will reduce the need to maintain expensive standby peak load capacity.  Old, expensive standby plants can be shuttered.

            It makes more economic sense to get rid of as much standby capacity as possible and rely more on power generated by customers, especially if the utility can buy that power at wholesale prices.  But in a peculiar way, utilities have been dis-incentivized from doing that.  Instead, they have traditionally been rewarded for being more asset intensive rather than less asset intensive.  That's because they're provided a rate of return on the asset base.  The larger the asset base, other things being equal, the higher the price they can charge consumers.

            What public utility commissions should do instead is reward the utilities for seeking out less expensive sources of power.  There are a number of ways they can do that.  One way is to measure what I'll call the "capital efficiency of power generation".   A simple measure of this is to take the total capital investment of the utility and divide by the number of kilowatt hours produced in a given time period.  That will provide a simple metric: invested capital per kilowatt hour of power generated.  The lower that number, the more capital efficient is the company. 

            If electric rates were set with such capital efficiency in mind, electric utilities would be more likely to try to reduce their capital expenditures in order to produce a given amount of power.  Under traditional utility ratemaking, those companies have absolutely no incentive to be more capital efficient. 

            Imagine, however, if the public utility rate makers took capital efficiency into consideration when setting rates?  It would likely mean that the utilities would have less incentive to buy more assets.  The utilities might be less likely to want to own the solar assets and more likely even want to encourage purchasing power from third parties.  This would likely include rooftop solar.  Capital efficiency should also benefit shareholders.   If anything, they should be pleased if the utility can generate a given amount of kilowatts using less capital.  Utilities can in fact do this, and be more efficient at the same time, if they purchase power from the most efficient sources.  Warren Buffett and Charlie Munger are just the guys to understand such economics.

            Industrial scale solar plants are certainly likely to be more efficient than rooftop systems owned by individual consumers.  Not only that, but it is likely that the consumer will pay less for industrial scale solar power than power generated by rooftop solar.  However, if governments give electric utilities a monopoly in solar and wind power generation, it will discourage investment by others.  The utilities will win but consumers will lose. 

             Let the marketplace decide which makes better sense.  Faceless bureaucrats aren't going to make better economic decisions, and electric utilities are interested in doing things that provide their owners better results, often at the expense of the public.  At the same time, utilities should not be forced to buy power from small generators at retail rates.  Everyone can win using the approach I've outlined.

             So the interest of Warren Buffett and Charlie Munger certainly validates the premise that alternative energy is a smart business decision.  Just so long as the Sage of Omaha and his behind the scenes business partner in Los Angeles aren't "mentally captured" in old-fashioned thinking by the employees in their electric utility subsidiaries.

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Carl Treleaven is an entrepreneur, author, strong supporter of various non-profits, and committed Christian. He is CEO of Westlake Ventures, Inc., a company with diversified investments in printing and software.

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