naked capitalism

The famed hedge fund investor George Soros has decided to make a serious push into clean energy, not only investing in projects but also forming an organization to weigh in on policy issues. From Bloomberg:

Billionaire George Soros, looking to address the “political problem” of climate change, said he will invest $1 billion in clean-energy technology and create an organization to advise policy makers on environmental issues…

“I want to apply rather stringent criteria to the investments,” said Soros in an e-mailed message. “They should be profitable but should also actually make a contribution to solving the problem.”…

Soros, 79, also will establish the Climate Policy Initiative, a San Francisco-based organization to which he will donate $10 million a year for 10 years.

“It will be part advisory service, part policy developer and part watchdog,” said Thomas Heller, who is heading the initiative. Heller is a professor at Stanford University Law School whose expertise is in energy law and regulation and environmental law.

Its goal is to look after the public interest as policies and programs are created to address climate change. The group will work in the U.S., Europe, China, India and Brazil, he said.

“The problem of global warming is primarily a political problem at this point,” Soros said. “The science is beyond dispute, but how do we achieve the objectives we all know are necessary? That is a political problem.”…

Soros has said he prefers a greenhouse-gas tax because carbon emission-trading systems, which are used in Europe, can be manipulated by investors.

You cannot make this stuff up. The Saudis are lobbying for foreign aid in anticipation of declining oil revenues. Hat tip reader Michael:

Saudi Arabia has led a quiet campaign….demanding behind closed doors that oil-producing nations get special financial assistance if a new climate pact calls for substantial reductions in the use of fossil fuels.

That campaign comes despite an International Energy Agency report released this week showing that OPEC revenues would still increase $23 trillion between 2008 and 2030 — a fourfold increase compared to the period from 1985 to 2007 — if countries agree to significantly slash emissions and thereby cut their use of oil…..

The head of the Saudi delegation Mohammad S. Al Sabban dismissed the IEA figures as “biased” and said OPEC’s own calculations showed that Saudi Arabia would lose $19 billion a year starting in 2012 under a new climate pact….

Al Sabban accused Western nations of pursuing an agenda against oil producers, under the guise of protecting the planet.

This idea of China being ahead of the game in anything environment protection related probably strikes readers as ironic, given reports of extensive industrial pollution, such as air pollution on a scale that is changing weather patterns, large scale lead poisoning, and cadmium in the soil. As Forbes commented recently, “China: Where Poisoning People Is Almost Free.”

But we pointed out in April that China had been out for some time to take the lead in electric cars. Not only has the US fallen behind in battery technology, but we also gave up the know-how for the related drive trains:

h torque DC servomotors are the sine qua non for electric vehicles.

High torque performance is achieved via magnets made of alloys of various so called “rare earth” elements. Prominent among the alloys are samarium-cobalt and neodymium-iron-boron. GM held a majority interest in Magnaquench, an Indiana company with expertise in such materials and magnet fabrication. GM however decided that electric motors did not fit into its “core competencies.”

Ambrose Evans-Pritchard of the Telegraph tells us China is taking ground on other green energy fronts, namely solar panels and wind turbines:

China is running away with the green technology prize. It has conquered a third of the world market for solar cells and is on a breakneck course to build 100 gigawatts of wind turbines by 2020, doubling again the global capacity for wind power across vast stretches of Inner Mongolia and Xinjiang.

But potentially more important, China is on the cutting edge of price performance:

Suntech Power in Wuxi has just broken the world record for capturing photovoltaic solar energy, achieving a 15.6pc conversion rate with a commercial-grade module.

Trina Solar is neck-and-neck with America’s First Solar, the low-cost star that has already broken the cost barrier of $1 (61p) per watt with thin film based on cadmium telluride.

The Chinese trio of Suntech, Trina and Yingling all expect to be below 70 cents per watt by 2012, bringing the magical goal of “grid parity” with fossil fuels into grasp.

The concept of grid parity is subject to fierce debate, mostly revolving around which form of fuel – nuclear, oil, coal, or renewables – enjoys the biggest implicit subsidy, and what the future price of crude is likely to be. Parity has already been achieved in hot spots. First Solar’s 10-megawatt plant in Nevada can produce electricity without subsidies for 7.5 cents per kilowatt hour compared to 9 cents for fossil-based power.

But are these true technology achievements, or also a function of cheap currency? These gains are coming at the expense of European rivals, and the often often Euro-bashing (more accurately EU-bashing, but that difference is often lost) Evans-Pritchard has some sympathy:

German pioneers Solarworld and Conergy allege foul play and have called for EU sanctions, accusing Chinese rivals of practices that “border on dumping”. China’s finance ministry says it intends to cover half the investment cost of solar projects. It is a life-and-death moment for the German solar industry, pioneers who provide 75,000 jobs and once led the world. “A large number of German solar cell and solar module producers will not survive,” said UBS’s Patrick Hummel….

Roughly speaking, Chinese firms can undercut the Germans by 30pc. At root, it is a currency problem. China has stolen a march against Europe over the last five years by linking an already undervalued yuan to a weak dollar. While Beijing sheds crocodile tears about the falling greenback, it is deliberately riding dollar devaluation to protect its own export share. What is happening to German solar firms is a revealing case study of the slow-burn damage caused by currency misalignment.

If the global economy continues to be weak, advanced economies will become less tolerant of China’s continued mercantilism. Everyone knows the danger of protecionism, but if China continues to push the boundaries based on the assumption its trade partners will continue not to do much to preserve the system, it may learn to our collective detriment that it overplayed its hand.

John Dizard in today’s Financial Times highlights a news-worthy development that has somehow gone largely under the radar, namely, that the one reasonably well functioning US cap and trade regime has come under a legal cloud, not only to detriment of the market, but also to pollution emissions.

The legal beef is that the EPA exceeded its legal authority in implementing the cap and trade program for power plans emissions of sulphur dioxide and nitrous oxide, aka Sox and Nox. Now we have not been as keen about cap and trade as other have been. For large companies to plan and make investments, price certainty is far more beneficial, and taxes are a better way to achieve that. Even a conservative true believers like Greg Mankiw (and the more centrist Financial Times editorial opinion) prefers taxes to cap and trade, which lead to variable prices of the right to produce the problematic substance. But in the US taxes = bad, while cap and trade sounds more palatable.

Having said that in general, the power plant regime appears to have been well designed and was producing the desired behavior prior to the recent tsuris.

While cap and trade is better than no regime at all, the flip side is that the uncertainty created by the courts may work to the detriment of future cap and trade programs. In this case, rulings that would have forced the program to be tougher in some respects have wreaked havoc with the market, certainly not an intended outcome. Prices for emission rights have plunged, leaving investors in them with considerable losses and producing higher levels of emissions. From the Financial Times:

While the Administration and most of the Congressional leadership have been pouring their attention and political capital into cobbling together a coalition to support a carbon cap and trade mechanism, the one existing such system for air pollution has been coming undone.

For the past several years, the Environmental Protection Administration has operated a market in “allowances” for power plants to emit.

Over time, the way the regulations were set up under the Clean Air Interstate Rule, or Cair, utilities have had to spend progressively more money to buy emission allowances. That has given them an incentive to install scrubbing devices for their smokestacks. If they installed the devices more quickly than required by law, they could sell the extra allowances to other emitters.

So it was profitable to clean up. The industry estimates up to $75bn (£47bn, €53bn) of Sox and Nox controls were built early due to the Cair regulations.

Last July, however, a US Federal appeals court in Washington ruled the Cair regulations gave the EPA more authority than Congress had authorised, while failing to address problems of specific states that are downwind of large Sox and Nox emitters. So it ordered the EPA to try and fix Cair, while setting conditions for doing so that are impossible to meet without the authority of new legislation.

The alternative to a Cair fix by next year would be the zero-ing out of the Sox and Nox markets, and the imposition of an administrative command and control system.

The appeals court ruling had a perverse effect. By ruling that Cair did not do an adequate job, or one justified by the Clean Air Act, the court crashed the Sox cap and trade market, and did considerable damage to the Nox market. Before the court’s decision, Sox allowances traded around $600 to $800 a ton. Now, depressed by the utilities’ and traders’ belief that EPA cannot devise a fix, Sox allowances go for about $60 a ton, creating tens of billions in losses.

It is cheaper to buy allowances from devalued existing stock, and emit more acid-rain-causing SO2, than to build new scrubbers or even operate existing equipment.

As one utility lawyer in Washington told me: “I know of utilities that are buying cheaper, high sulphur coal, or running their scrubbers at a less intense rate. I am absolutely certain that SO2 emissions will increase next year as well.”

The EPA’s studies estimate that the crash of the Cair markets will lead to an extra 35,000 deaths over the next couple of years.

You would think this would raise a huge hue and cry, more than a jet crash, though perhaps not as much as a televised amateur talent show. You would be wrong.

The most scarce resource in the political class is attention span, and it seems only one air issue can be dealt with at a given time. This year, it’s carbon dioxide…

Mr [Thomas] Carper [Senator from Delaware] intends to submit a law to replace the Cair regulations, called “3P”, for the three pollutants of sulphur dioxide, nitrous oxides, and mercury….

The provisions would probably be attached to either a climate bill, which faces long odds, or an omnibus energy bill.

One of the Federal court’s main objections, that the EPA exceeded its authority, would be dealt with by imposing rules by law rather than regulation. The other, that downwind states would not have protection from specific emitting plants, could be mitigated by lowering pollution limits very rapidly.

According to Mr Carper: “The EPA agrees on the need for a legislative fix, and they will be our partners on this.”

There is another point that seems to have escaped some of the political leadership. How could industrialists or traders have faith in, or commit capital to, a future carbon cap and trade system if a similar system is allowed to collapse through inaction?

A New York Times article tonight reports that China intends to become a world leader in electric and hybrid cars:

Chinese leaders have adopted a plan aimed at turning the country into one of the leading producers of hybrid and all-electric vehicles within three years, and making it the world leader in electric cars and buses after that.

The goal, which radiates from the very top of the Chinese government, suggests that Detroit’s Big Three, already struggling to stay alive, will face even stiffer foreign competition on the next field of automotive technology than they do today….

To some extent, China is making a virtue of a liability. It is behind the United States, Japan and other countries when it comes to making gas-powered vehicles, but by skipping the current technology, China hopes to get a jump on the next.

The article then goes on to discuss the advantages (cleaner air) and difficulties (lack of public recharging centers, consumer worries about the safety of lithium ion batteries, disincentive of current cheap oil prices).

However, it fails to mention Detroit was once a leader in this technology.

I did a study on advanced batteries, visited Detroit, and drove an electric car made by a GM consortium in 1993. At the time, there was a mandate in California as well as the Northeast scheduled to come into effect in a few years to have 2% of cars sold be electric. Now the idea of forcing a sales goal seems silly, unless you had some obvious targets. The early vehicles were best suited for city use (no worry about your car running out of juice on the interestate), so public transport, delivery services (think the Post Office, UPS, Fedex) and government fleets were logical buyers. But the states did nothing to help create a market.

GM spent over $1.5 billion manufacturing and marketing the EV1, its electric car, despite its ambivalence (at least when I was investigating, which prior to the 1996-2000 opportunity to lease the car in Arizona and California). GM did costly consumer marketing in those states, despite being able to manufacture only 600 cars a year. California also welched on its promise to lease electric cars and trucks in meaningful numbers and wouldn’t install public chargers.

Another issue was the batteries were not ready for prime time (I had looked at all the competing technologies adn recommended against investment for that reason and the lack of enthusiasm for the iniative). Batteries don’t do well in the cold. And electric engines don’t throw off heat the way an internal combustion one does, so the early EVs had small gas fired heaters to warm the passenger area.

However, success also depends on commitment to overcome obstacles, and GM had already divested key bits of relevant technology BEFORE the EV1 launch. Which begs the question, how hard were they really trying to make this work (for instance, did they press the California government when it started waffling?).

We have ceded leadership in battery technology to Asia, and reader Keenan pointed out, also the know-how for the related drive trains:

h torque DC servomotors are the sine qua non for electric vehicles.

High torque performance is achieved via magnets made of alloys of various so called “rare earth” elements. Prominent among the alloys are samarium-cobalt and neodymium-iron-boron. GM held a majority interest in Magnaquench, an Indiana company with expertise in such materials and magnet fabrication. GM however decided that electric motors did not fit into its “core competencies.”.

While the article highlights the aspects of defense technology, the commercial / industrial side of the business is every bit as important in today’s world of economic warfare.

GM sold Magnaquench in 1995:

Magnequench had a unique expertise in the manufacture of high-powered neodymium magnets, which it pioneered in the 1980s for its parent company, General Motors, to use in airbags and mechanical sensors. When GM restructured in the early 1990s, the company began to divest itself of subsidiaries that were not in its “core competence.” Magnequench, in spite of its high-tech pedigree—and the fact that it provided critical component parts to “precision guided munitions” that were then in great demand by the U.S. Department of Defense—was put up for sale.

Reportedly, Magnequench supplied 85 percent of the neodymium magnets used in servo motors for PGMs,[5] but neodymium magnets are far more important and ubiquitous than their use in advanced weaponry might suggest. They are the sole reason high-speed, high-capacity computer data storage devices can work. They are found in literally every computer in the world, and in 2004, Magnequench, together with its merger partner NEO Material Technologies (and its integrated Chinese joint-venture partners), supplied about 80 percent of the world market share of neodymium and rare-earth oxide powders used in those magnets.[6]

So when GM put Magnequench on the block in 1995, who should come up with the $70 million asking price?[7] An investment consortium headed by Archibald Cox Jr. (son of the illustrious Watergate prosecutor) acting in concert with two Chinese state-owned metals firms, San Huan New Material and China National Nonferrous Metals Import and Export Company (CNNMIEC), which had been pestering GM to sell Magnequench since 1993.[8]…

Magnequench’s Chinese owners cleverly reinterpreted the CFIUS conditions. One Magnequench employee reported that shortly after the Chinese took over, Magnequench’s neodymium-iron-boron magnet production line was “duplicated in China” and that, after the Chinese “made sure that it worked, they shut down” the U.S. production in Indiana. The employee added, “I believe the Chinese entity wanted to shut the plant down from the beginning. They are rapidly pursuing this technology.”[16]

So this vignette reveals the degree to which Detroit helped seal its own fate. It went along with the electric car mandate fully hoping its 2% goal would make it a non-starter (that was the line I heard, anyway, that the cars would be costly enough that the target was pretty certain to be unrealistic) and played the game out, rather than try to influence the legislation so as to get a program that might be viable for the states as well as the carmakers.

At some point in 2009, the government may get past managing the crisis du jour and turn to those nasty, seemingly intractable problems we nevertheless have to address. such as greenhouse gas emissions.

One idea that had been bandied about is the idea of cap and trade, which would allow big bad carbon emitters to buy the right to do so from those who had cleaned up their act. I’m not alone in being less than keen about this regime (the very fact that Wall Street firms are keen to act as brokers should give cause for pause, and even conservative economists like Greg Makniw prefer straight up carbon taxes to cap and trade).

But the cap and trade concept may already have been dealt a near-fatal blow. As John Dizard explains in more detail, a court ruling called the legal standing of these rights in question, and it may not be possible to dispel the cloud around them.

From the Financial Times:

The most serious struggle will be over climate change, or the regulation of carbon emissions. You can forget all the chitchat about finding a consensus on this one: the coal people and the enviros are in this match until one side is carried out….

Wall Street and Chicago always like the creation of trading markets for new assets, especially if they can be inefficiently priced by the professionals. So while the coal people hate climate legislation, a lot of traders see an opportunity.

One of the problems, though, is that there are already government-created markets for sulphur dioxide and nitrogen oxide emissions, and those markets are in trouble. As I have written earlier in this space, a Federal appeals court decision on July 11 of last year appeared to kill the long-term value of credits under what was called the Clean Air Interstate Rule, a set of markets for pollution credits created by the Environmental Protection Agency. At a stroke, some tens of billions worth of rights to emit noxious gases were slashed in value by the court’s ruling that the EPA had exceeded its authority.

The EPA, along with utilities and some enviros, asked the court to modify or reconsider its decision, and, unusually, the court had second thoughts. In late December, the court indefinitely stayed its cancellation of Cair, allowed the trading to remain in place, and told the EPA that it had to come up with a fix, sometime in the undefined future. That is the simple version.

So, the price of the right to emit one ton of sulphur over the next year, which had been up to $600-$800, fell back to as little as $100 after the initial decision, and has now, after the court’s reconsideration, risen to $150-$200. At $600, utilities found it economic to build new pollution control systems before they were required by law, since they could sell for a lot of money the emission credits they earned…..

Now, though, the court ruling, and the wider realisation that allowances under cap-and-trade are not really property rights, has chilled such markets. Risk management committees for corporate buyers and trading houses are likely to hesitate before buying pollution permits that could lose value.

So any new market-based emissions controls had better have more certainty than the flawed Cair. In leaving Cair in place, the court seemed to reason it would retain its effectiveness in reducing emissions over the next couple of years, but that is not the case. Instead, the EPA’s pollution allowance market people believe the low prices created by the uncertainty over the future of Cair will have the perverse incentive of inducing utilities to use up existing pollution allowances by emitting more than they would have, while postponing building new controls. Or so the agency’s economic models say…

The Cair mess shows that it is easy to get market design wrong. With mortgage and derivatives markets, that costs billions. With Cair, it costs shortened lives.

Now, of course, it is possible that a new, bullet-proof version of trading rights could be devised. But it would probably be subject to serious scrutiny before anyone invested in the hope of being able to sell the resulting carbon rights.

The oil-rich countries of the Middle East have some advantages in pursuing the “green” energy market. First, they have pools of investment capital they can turn to this purpose. Possibly more important than access to money is that the funding sources may be willing to take a longer term horizon and lower returns than US investors.

Second, diversifying out of oil is a strategic imperative for the Gulf, and energy is a logical target The US may aspire to leadership in this field, but it does not appear that we have a Manhattan Project or Sputnik response level of urgency.

Offsetting this is the fact that the area is not known as a breeding ground of innovation, but if the Gulf States can attract a critical mass of talent, they might be able to turn that around. The New York Times article describes that they are forming relationships with top schools such as MIT.

From the New York Times:

….even as President-elect Barack Obama talks about promoting green jobs as America’s route out of recession, gulf states, including the emirates, Qatar and Saudi Arabia, are making a concerted push to become the Silicon Valley of alternative energy.

They are aggressively pouring billions of dollars made in the oil fields into new green technologies. They are establishing billion-dollar clean-technology investment funds. And they are putting millions of dollars behind research projects at universities from California to Boston to London, and setting up green research parks at home.

“Abu Dhabi is an oil-exporting country, and we want to become an energy-exporting country, and to do that we need to excel at the newer forms of energy,” said Khaled Awad, a director of Masdar, a futuristic zero-carbon city and a research park that has an affiliation with the Massachusetts Institute of Technology, that is rising from the desert on the outskirts of Abu Dhabi.

These are long-term investments in an alternative energy future that neither falling oil prices nor the global downturn seems likely to reverse….

This new investment aims to maintain the gulf’s dominant position as a global energy supplier, gaining patents from the new technologies and promoting green manufacturing. But if the United States and the European Union have set energy independence from the gulf states as a goal of new renewable energy efforts, they may find they are arriving late at the party.

“The leadership in these breakthrough technologies is a title the U.S. can lose easily,” said Peter Barker-Homek, chief executive of Taqa, Abu Dhabi’s national energy company. “Here we have low taxes, a young population, accessibility to the world, abundant natural resources and willingness to invest in the seed capital.”…

To hedge their positions, then, an increasingly sophisticated generation of largely Western-educated leaders in the Middle East are seizing on green business opportunities, by seeding research in faraway nations.

The crown prince of Abu Dhabi, the wealthiest of the seven emirates that make up the United Arab Emirates, announced last January that he would invest $15 billion in renewable energy. That is the same amount that President-elect Obama has proposed investing — in the entire United States — “to catalyze private sector efforts to build a clean energy future.”

Masdar, the model city that will generate no carbon emissions, is tied to the crown prince’s ambitions. Designed by Norman Foster, the British architect, it will include a satellite campus of the Massachusetts Institute of Technology, as well as a research park with laboratories affiliated with Imperial College London and other institutions.

In Saudi Arabia, the new state-owned King Abdullah University of Science and Technology, or Kaust, gave a Stanford scientist $25 million last year to start a research center on how to make the cost of solar power competitive with that of coal. Kaust, now in its first grant cycle, also gave $8 million to a Berkeley researcher developing green concrete.

And it has other agreements as well, with Caltech, Cambridge, Cornell, Imperial, La Sapienza, Oxford and Utrecht, to name just a few.

In November, the Qatari government signed an agreement with Britain’s visiting prime minister, Gordon Brown, to invest £150 million, or more than $220 million, in a British low-carbon technology fund, dwarfing the fund’s investments from home…

“The impact has been enormous,” said Michael McGehee, the associate professor at Stanford who received the $25 million Saudi grant. “It has greatly accelerated the development process.”

The idea that reducing carbon emissions is bad for investors is in at least in part an urban legend. In an earlier post, we noted:

In 1997, British Petroleum decided to lower its carbon emissions below the 1990 level by 2010. It achieved the goal in 3 years rather than 13 at a cost of $20 million. Oh, and it happened to save $650 million. With that sort of calculus, you’d think that every big corporation would be on the emissions-reduction bandwagon.

While the savings for other companies may not be as dramatic, other analyses have found that investing in energy savings is attractive:

A study by the McKinsey Global Institute (MGI) found that an annual global investment of $170 billion in energy productivity through 2020 could half the global energy demand—an amount equivalent to 64 million barrels of oil per day. This investment would create energy savings with an average internal return rate of 17 percent, or $29 billion. MGI said the most cost-effective method for reducing global greenhouse gas (GHG) emissions is through energy productivity. Additionally, the report says the investment would cut CO2 emissions to about 550 parts per million—the amount needed to stabilize the gas at the safety limit set by the Intergovernmental Panel on Climate Change.

In order to achieve this, MGI said the global industry sectors need to invest about $83 billion per year, residential sectors would need to invest about $40 billion, and the transport and commercial sectors must invest $25 billion and $22 billion per year, respectively. Diana Farrell, director of MGI, said “the vast majority of global executives say fixing global warming problems can boost profits…. We’ve identified huge opportunities to reduce energy demand and carbon emissions through improved efficiency.”

This study was published in early February 2008 (see here for the full report).

Reuters today (hat tip reader Jorgen) reports that institutional investors are calling for faster, more aggressive action to reduce greenhouse gases:

Global institutional investors holding more than $6 trillion in assets pushed policymakers Tuesday to quickly hash out a binding agreement to cut greenhouse gas emissions and promote clean technology.

More than 130 big investors, including London Pensions Fund Authority, want countries to agree to reduce the climate- warming emissions by 50 percent to 80 percent by 2050.

Those numbers are in line with global warming policy favored by U.S. President-elect Barack Obama, who supports an 80 percent reduction in carbon emissions by mid-century.

The investors also want policymakers to set long and medium term emission reduction targets for developed countries and to provide for an expanded and more liquid global carbon market…

They have also called on the U.S. Securities and Exchange Commission to force publicly traded companies to disclose climate-related risks along with other factors that affect their business.

“As institutional investors, we are concerned with the risks presented by climate change to the global economy and to our diversified portfolios,” said Mike Taylor, chief executive of London Pensions Fund Authority….

The group of global investors want countries to sign on to a new binding agreement to succeed the Kyoto Protocol climate pact, which set binding targets for industrialized countries to cut greenhouse gas emissions.

The European Union is aiming to cut greenhouse gas emissions 20 percent by 2020 and increase the share of wind, solar, hydro, wave power and biofuels in their energy mix by the same date.

The United States is alone among major industrialized countries in rejecting the Kyoto Protocol, but is participating in discussions to craft a follow-up global agreement.

“It is time to put an agreement in place where the United States is involved,” said Mindy Lubber, the president of Ceres, a coalition of investors and environmental groups working on climate change issues.

The global group of investors is hoping its voice is heard ahead of a December climate change convention in Poland.

We haven’t written much about the environment since the credit markets got to be so much fun, but in the early days of the blog we did give it more attention than we do now, so this post isn’t as off topic as it might seem.

With all the tooth-gnashing about oil, food, and greenhouse gasses, the critical resource is shortest supply is water. However, the one advantage water has over all those other scarce resources is that it can be reused. Nevertheless, a tremendous amount of water is wasted though leaking distribution systems (this is no joke, the losses are massive), evaporation, and good old fashioned profligate habits.

Australia makes for a particularly interesting case, since water has never been abundant there. The reason it has a land area close to that of the continental US with only 20 million people is the lack of any inland river systems save the Murray-Darling. 70% of the nation’s irrigation systems are connected to it and the farms that use its water provide roughly 40% of the nation’s food.

Far and away the biggest use of Australian water is agriculture (when I lived there a few years ago, the estimates were 75%), yet a detailed model of Australia that looked at its physical inputs and outputs concluded that the country was not adequately compensated for the water contained in its agricultural exports. And Australia’s problems are affecting commodity prices. The country is in the throes of a multi-year drought, and exports of wheat and rice have fallen dramatically, putting pressure on grain prices.

Australian economist John Quiggin provides a short overview of the choices that now face Australia and underscores that failure to take actions that were called for years ago have now left the country with unattractive options.

From Quiggin:

The best water policy in the world is useless when there is no water. We are now finding this out, as we struggle with yet another year of near-record low inflows to the Murray-Darling river system.

The most immediate crisis is that affecting Lakes Albert and Alexandrina at the mouth of the Murray River. Flows in the lower section of the Murray River have been low, or non-existent,most of the time since 2002. However, water in the lakes has been maintained, until now through a system of barrages constructed in the 1930s.

As water levels have continued to fall, however, the lakes have become unsustainable in their present form. Lake levels are now below sea level. If current conditions continue, it is likely that drying will result in the formation and exposure of acid sulfate soils, causing severe and permanent environmental damage.

It is become increasingly likely that the only feasible response is to remove the barrages and allow the lakes to be flooded with seawater. This would require the abandonment of irrigation in the area, and imply a loss of supply for urban water users.

Some commentators have argued that removing the barrages would represent a return to natural conditions. This is, at best, half-true. The barrages converted an estuarine system which fluctuated between fresh water, brackish and saline conditions into a purely freshwater system,.

But the barrages were themselves a response to an increase in the frequency of low flow conditions arising from earlier interventions upstream. Removing the barrages without restoring natural flows is a recipe for environmental disaster.

The problem is that there are no realistic options left for increasing flows. There have been calls to acquire water upstream, for example by buying large irrigation farms in Queensland, the best known of which is Cubbie Station. But conditions are so dry in the Darling and Murray systems that, according to the Murray-Darling Basin Commission, 80 per cent of any water released upstream would be lost to evaporation or absorbed into the water table along the way.

Things didn’t have to be this way. When I started working on this issue in the that we were taking too much water out of the system. As biologist David Paton, the leadng expert on the Coorong, has pointed out, the well known rule of thumb that management of a healthy river requires the maintenance of 30 per cent of natural flows was being put forward as a basis for management in the early 1990s.

These proposals were ignored. A subsequent study suggested that restoring flows of 1500 GL (a little less than 15 per cent of natural flows) would be needed to give the Murray a moderate chance of recovery. The nation’s leaders, meeting at COAG, promised 500. GL.

Years of inaction followed, with no move towards buying back irrigation rights. Finally, the Rudd government has spent $50 million to buy back water rights. Unfortunately, in most cases, these are general security rights that will receive a zero allocation while the drought continues.

The restoration of some environmental flows would not have prevented low flows in the current drought. But it would avoid the situation where low flows are the norm, and an extended drought is sufficient to push the whole system over the edge.

At this point, calls for compulsory purchase of irrigation rights are growing louder. Unless there are significant inflows of water soon, it is hard to see how the voluntary market-based approach can be sustained.

The desperate choices now facing us with respect to the Murray Darling Basin are a small indication of what we will face if the world fails to act quickly to control emissions of carbon dioxide and slow the rate of global warming. Sooner or later the necessity for action will become undeniable, but by then the relatively easy options available today will have been foreclosed.

Instead of market-friendly options like emissions trading, we will be looking at command-and-control measures like the water restrictions now prevailing in most Australian cities. As far as the environment goes, the kind of triage operation now being applied to the icon sites of the Murray will be routine. Some vital ecosystems will be saved, at the cost of abandoning others.

Perhaps, when this happens, those who have urged inaction will be called to account. Or perhaps, as with the Murray, most of those responsible will have moved on, and their successors will be left to pick up the pieces.

Paul Kedrosky highlights a New Scientist article that contends there isn’t, or more accurately, shouldn’t be a water crisis, that there is enough water if we manage it properly. But the Australia illustrates that even a country that has long had limited water supplies got religion too late in the game. Even if New Scientist is right in theory, I harbor serious doubts as to how right it will be in practice.

Alan Blinder in today’s New York Times, argues for an ostensible stimulus package (hey, since more stimulus packages are probably in the offing, better register your preferences early) that will help the environment. But what I like about it is that it would cost so little that it barely rates in the “let’s goose the economy” category.

The idea is that the government buys old cars of types that are just about certain to be heavy polluters. This is the dirty secret of auto emissions: the vast majority of the damage is done by a comparatively small percentage of cars. The program is means tested, so only those of middle and lower incomes can participate.

Although this initiative would do nothing to remedy America’s dependence on the internal combustion, it’s an interim measure that yields tangible benefits at a comparatively low price.

From the New York Times:

Cash for Clunkers is a generic name for a variety of programs under which the government buys up some of the oldest, most polluting vehicles and scraps them. If done successfully, it holds the promise of performing a remarkable public policy trifecta — stimulating the economy, improving the environment and reducing income inequality all at the same time. Here’s how.

A CLEANER ENVIRONMENT The oldest cars, especially those in poor condition, pollute far more per mile driven than newer cars with better emission controls. A California study estimated that cars 13 years old and older accounted for 25 percent of the miles driven but 75 percent of all pollution from cars….

MORE EQUAL INCOME DISTRIBUTION It won’t surprise you to learn that the well-to-do own relatively few clunkers…

AN EFFECTIVE ECONOMIC STIMULUS With almost all the income tax rebates paid out, and the economy weakening, Cash for Clunkers would be a timely stimulus in 2009…

Here’s an example of how a Cash for Clunkers program might work. The government would post buying prices, perhaps set at a 20 percent premium over something like Kelley Blue Book prices, for cars and trucks above a certain age (say, 15 years) and below a certain maximum value (perhaps $5,000). A special premium might even be offered for the worst gas guzzlers and the worst polluters. An income ceiling for sellers might also be imposed…

Cash for Clunkers is not the pipe dream of some academic scribblers. Local variants are either now in operation or have been tested in California, Colorado, Delaware, Illinois, Texas, Virginia and several Canadian provinces. So there is no need for a “proof of concept.”…

Here’s a high-end cost calculation for a national program. Suppose we took two million cars off the road a year, at an average purchase price of $3,500 (the top price in the Texas program today). Including all the administrative costs of running the program, that would probably cost about $8 billion. Compared with other nationwide income-transfer or environmental policies, that’s a pretty small bill. For stimulus purposes, it would, of course, be better to run the program on a larger scale, if possible. There are over 250 million cars and light trucks on American roads, and some 30 percent are 15 years old or older. That’s at least 75 million clunkers. At five million cars a year — an ambitious target, to be sure — the program would cost less than $20 billion, still cheap compared with the $168 billion stimulus enacted in February.

And what would all this money buy? First, less pollution. The Texas program estimated that clunkers spew 10 to 30 times as much pollution as newer cars. Second, the subsidy value (the 20 percent premium in my example) is a direct income transfer to the owners of clunkers, who are mostly low-income people. Third, these folks would almost certainly spend the cash they receive — not just the subsidy, but the entire payment, giving the economy a much-needed boost.

One has to be mindful of perverse outcomes. A large-scale version of the program would drive up the cost of clunkers and over time distort blue book values. There is also the problem of what do you do for transportation once you’ve sold your cheap old car? It’s not as if a 20% premium is going to enable sellers to trade up to a much better car. They’ll most likely be trading out of a very old car to a slightly less old car.

It’s the need to obtain some replacement form of transportation that would enable the program to stimulate the economy. Although this year’s rebate checks were not targeted at lower income groups, economist Gary Shilling estimated that 80% of the proceeds went to savings, not spending. For the less affluent, that might take the form of getting some headroom on debt payments (reduction of indebtedness is a form of savings)