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Eye on the Market | November 21, 2011 J.P Morgan Topic: The quixotic search for energy solutions Another Don Quixote Thanksgiving. Every year at Thanksgiving', we look in-depth at an issue that affects markets and portfolios. Last year, we examined the unraveling situation in Europe. Unfortunately, most concerns we expressed last year have been borne out, and are getting much worse (I spent the weekend reading legal documents on a Eurozone break-up, just in case). Like Don Quixote, Europe went on its journey for all the wrong reasons, adopting a half-pregnant monetary union to support a political objective that had arguably already been achieved by 1955”. This year, a look at something just as worrying in the long run as the fiscal problems of the West: the search for energy solutions. This journey has been fraught with similarly quixotic dead ends, fairy tales and blunders ignoring economic (and thermodynamic) realities. This is important to us, since energy cost and availability is central to how we think about growth, profits, stability and our portfolio investments. As part of this effort, I made a pilgrimage to Manitoba to spend a day with Vaclav Smil. Vaclav is one of the world’s foremost experts on energy, and has written over 30 books and 300 papers on the subject (he’s #49 on Foreign Policy’s list of the 100 most influential thinkers). Vaclav’s book “Energy Myths and Realities” should be required reading for politicians or regulators impacting energy policy. We start with an unflinching look at these realities before turning to solutions, and some potentially encouraging developments, which have less to do with how electricity is generated, and more to do with how it might be stored. “A dream is a wish your heart makes” (Cinderella) Over the last 50 years, a lot of proposed solutions have not panned out as expected. While the process of discovery and invention always includes large doses of failure, energy policy is different than say, cell phones or VCRs, since more public money, time and effort are spent on them. Hopes are raised, and as a result, less flashy but more reliable solutions are sometimes postponed or avoided altogether. Here are a few memorable predictions of our energy future: e 1945, Oak Ridge National Laboratory nuclear physicists Weinberg and Soodak predict that nuclear breeders will be man’s ultimate energy source; a decade later, the chairman of the US Atomic Energy Commission predict it would be “too cheap to meter” e /973. “Let this be our national goal: At the end of this decade, in the year 1980, the United States will not be dependent on any other country for the energy we need to provide our jobs, to heat our homes, and to keep our transportation moving.” Richard Nixon e 1978. “Through modeling of supply and demand for over 200 US utilities it was projected that, by the year 2000, almost 60% of US cars could be electrified, and that only 17% of the recharging power would come from petroleum.” 1979. An influential Harvard Business School study projects that by 2000, the US could satisfy 20% of its energy needs through solar 1980. Physicist Bent Sorenson predicts that 49% of America’s energy could come from renewable sources by the year 2005 1994. Hypercar Center established, whose lightweight material and design would yield 200 mpg cars with a 95% decline in pollution 1994. InterTechnology Corporation predicts that solar energy would supply 36% of America’s industrial process heat by 2000 1995. Energy consultant and physicist Alfred Cavallo projects that wind could have a capacity factor of 60%, which when combined with compressed air storage, would rise to 70 — 95%" 1999. US Department of Energy hopes to sequester | billion tonnes of carbon per year by 2025 e 2000. Fuel cell companies announce 250-kilowatt production plants that can fit into a conference room and produce energy at 10 cents per kilowatt hour, with the goal of 6 cents by 2003 e 2008. “Today I challenge our nation to commit to producing 100% of our electricity from renewable energy and truly clean carbon-free sources within 10 years. This goal 1s achievable, affordable and transformative.” Al Gore e 2009. Gene scientist Craig Venter announces plans to develop next-generation biofuels from algae in a partnership with Exxon Mobil How have things turned out? There are no commercial nuclear breeders on anyone’s horizon; global nuclear capacity is only 20% of the Atomic Energy Agency’s 1970 forecast; the Hypercar is nowhere to be seen; solar and wind make up a miniscule portion of US electricity generation; wind capacity factors range from 20%-30%; the US is reliant for 50% of its oil from foreign sources; 70% of US electricity generation comes from coal and natural gas; fuel cells haven’t worked as expected; hybrids are 2% of US car sales; ‘“‘clean coal” is mostly a blueprint; and Venter announced that his team failed to find naturally occurring algae that can be converted into commercial-scale biofuel (they will now work with synthetic strains instead)’. " Some clients tell me it is helpful to have something to read this weekend, when/if family gatherings become unwieldy, or aggravating. * A few years ago, Swedish and Dutch politicians mobilizing support for the EU Constitution referred to “Yes” votes as necessary tribute to the dead from the Second World War, and more urgently, to avoid the pre-war divisions which led to it. Conflict between European empires existed for hundreds of years (1871-1914 was the only period of peace until 1945), so the idea of a united Europe would have seemed appealing in 1945. However, conditions for securing a lasting peace within Western Europe were arguably already in place by 1954. * A 2005 paper from Stanford raised expectations further by estimating theoretical wind power at 72 TW, 30x global electricity production. * Algae are inefficient photosynthetic reactors (they do not consume CO, when the sun isn’t shining), and allocate only a tiny fraction of captured solar energy into lipid production. A 2007 study by Krassen Dimitrov at the University of Queensland predicted GreenFuel’s demise in advance, claiming that the company estimated its photosynthetic efficiency at almost double the maximum theoretical rate, and could only be profitable at $800 per barrel of oil. Genetic improvements of plant life have historically focused on disease resistance and modifying the split between production of “fruit vs. stem”; it is used less often to increase growth rates of biomass itself. HOUSE_OVERSIGHT_030814