Tag Archives: Energy

Should you invest in the world’s poor, Iraq, or in your heating closet? Three new consulting reports

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Most consulting companies have newsletters; the goal of these newsletters is to convince you to try and hire the company. Many newsletter articles focus on investigating new markets. From a business point of view, this makes sense, because the consulting firm is positioning itself as an expert on the new market, firms will have a learning curve any time they enter a new market, so it’s natural for a firm to want to hire some help. Here are three recent examples of consulting firms telling you where you should invest:

The world’s poor
(Source:McKinsey & Financial Access Institute: Half the world’s poor are unbanked)
The report notes that tons of the world’s poor don’t have access to formal credit, and that the regulatory climate for microfinance firms is mixed. This is part of the “double goal” of providing social services to the poor.

Quality of the report: There are many poor people without access to formal financial services – are you surprised? What is perhaps surprising is that the poor are already sophisticated borrowers and lenders. As Daryl Collins et al.’s new book, Portfolios of the Poor, explains, most poor people have uneven incomes, but need to be ready for emergencies, save for big expenditures (weddings, school fees), so they turn to credit and savings out of necessity. Most lending is done with a neighbor or a savings club (a neighborhood group) although microfinance is becoming more prevalent.

Business Opportunity: Storing cash with neighbors is risky and not useful over long periods of time (5-10 years) for instruments like term life insurance. There’s an opportunity for microfinance firms to start profitable, and helpful, businesses if they can provide a reliable service, flexible repayment schedules and logistical support to get to poor neighborhoods.

At the same time, the poor are poor, and while there’s a huge volume of people demanding financial services, and the potential to charge high interest rates, the margins per customer served are small. Furthermore there’s bound to be excessive rent-seeking from people and firms who aren’t worried too much about profits.

Iraq
(Source: McKinsey Quarterly, interview with Paul Brinkley of the Department of Defense)
Paul is charged with managing and growing business in Iraq. I like Brinkley because he’s a realist, and willing to embrace things that have worked in Iraq, instead of staying beholden to an ideology. For example, state controlled enterprise has worked better in the short term than free market “shock therapy.” Paul says:

“I honestly believe Iraq is one of the last great “ground floors” we will ever have in the world. China in the late 1980s and early 1990s was a ground floor—if you got in at that time, you did very well. India followed. Iraq today is a ground floor. It doesn’t have the population of China or India, but it has a huge amount of mineral wealth, oil wealth, and agricultural wealth. Geographically, it is positioned to become one of the most prosperous countries in the world. And I don’t think that ground floor is going to stay open for too much longer. I think we have a few more months, and then the acceleration of investment in Iraq will take place. I expect that to happen during 2010.”

Quality of the report: It’s clear that Brinkley has his head screwed on straight but it’s difficult to evaluate the opportunity, because I know zero about the current state of Iraq. How has Vietnam done after the war? Afghanistan? Former British colonies have done remarkably well, but that was a completely different situation than we are in today. Many countries that are rich in resources use them to become rich and don’t invest in other parts of their economy (Venezuela, Uganda, Iran). Dubai has tried but that’s still being worked out.

Cutting energy costs.
Boston Consulting Group and MIT Sloan,
The Business of Sustainability. Industry leaders are going green, and by going green I mean reducing their energy use, not engaging in wasteful signaling. However, the managers that do look into the issue are often surprised by the large amount of possible savings.

Quality of the report: As a survey of people actually involved in the industry, I’m likely to trust the included findings.

Business opportunity: This one’s actually pretty strong. Because the IPCC’s estimates of oil reserves are too high world oil supply may start to decrease sooner than most people estimate, and world demand for energy will only increase, potentially leading to higher prices (certainly high demand for energy-reducing devices).

There’s lots of politics surrounding the issue and many managers don’t think there’s much profit there. Because of the politics, it’s difficult for managers to evaluate the actual opportunity; if managers aren’t strong believers in global warming then they won’t be stirred by the global warming argument. However the stronger argument is that firms can save a ton of money by going green.

Words like “sustainability” are not helping. “Sustainability” implies lots of beliefs about global warming and a rather strict interpretation about how much energy you should be using. They discourage managers from approaching the issue as they would any other relevant cost-saving opportunity.

Energy policy isn’t about helping the environment

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It’s worth remembering that lots of our environmental policy is wasteful or distortionary. Virginia Postrel writes about California’s new law banning incandescent light bulbs:

What matters, from a public policy perspective, isn’t any given choice but the total amount of electricity I use. If they’re really interested in environmental quality, policy makers shouldn’t care how households get to that total. They should just raise the price of electricity, through taxes or higher rates, to discourage using it.

Instead, the law raises the price of light bulbs, but not the price of using them. In fact, its supporters loudly proclaim that the new bulbs will cost less to use. If true, the savings could encourage people to keep the lights on longer. (via)

In 2009 I wrote about a similar California proposal to ban high-energy-use TV’s.

Will America have to spend money to cut emissions? McKinsey says no

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><br /> This <a href=McKinsey Global Institute report from 2007 discusses the growth in US demand for energy. They collected a ton of data on how firms and consumers use energy around the world, and created a model of world demand for energy out to 2020. In line with this, they researched current best practices for energy efficiency around the world and described the gains that could be had if everyone upgraded to top-of-the-line equipment.The bottom line of their report is that cutting down on energy use and saving money go hand in hand. In the USA at least, we can have our cake and eat it, too.

Purchasing new energy products often provides a return of 10% or more on investment. The report states that if consumers switched to the latest major applicances, upgraded their heating and cooling systems (installing high-efficiency heat pumps, more insulation, and/or switching to water heating), installed compact fluorescent lighting, and had small appliances switch to standby, they could enjoy significant savings on their energy bill.

There are pennies on the ground here; why aren’t they being picked up? Everyone likes saving money but the returns to investing in new appliances might not be completely clear. For one thing, utility bills don’t provide any data to consumers that would help them cut down on energy use. Furthermore, utilities don’t have much of an incentive to get consumers to use less energy; as public companies, more energy means more revenue and bigger budgets. Furthermore, people and firms move from place to place, so it might not make sense to invest in a new fridge, for example, if you think you are going to move in less than a year. I’m encouraged that most of the savings in the report are possible through the positive-IRR decisions of firms and consumers, and that they don’t require a government subsidy.

Methodology: I’m concerned about how they estimated consumer and firm current energy demand and the returns to investing in top-of-the-line equipment. On aggregate across all households, the IRR from upgrading all of your household appliances might be very high. But it may be the case that some houses have an IRR of 30% or more and most have an IRR of about 5%, in which case they might not want to invest in new energy technology, especially if they’re planning on selling the house soon.

On the whole, however, their estimates are probably biased low. They estimated a base case of $50/barrel for oil, which David Rutledge and I think is unrealistic. They also described best energy practices circa 2007, whereas the technology is bound to improve vastly over the course of thirteen years.

Business Opportunity: There are clearly pennies on the ground here. I’m wondering why firms aren’t going around offering consumers free or discounted new appliances in exchange for a cut of the savings on their energy bill. Maybe there are firms doing this and I’m not aware of them, because I don’t pay an energy bill. Most firms that I know are focused more on sexier green products, like solar power.

For someone who laments people who discuss global warming and possible solutions without including any sort of cost/benefit analysis, this report is helpful. The data in the report is edifying, providing breakdowns of energy use across the economy, and the predicted growth in each field.

The environmental movement as a signaling mechanism

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David Roberts writes:

The most puzzling behavioral phenomenon to understand when it comes to building efficiency is that Most People Won’t Do Sh*t (MPWDS). “Most people” includes people who could make money by doing sh*t, people who say they will do sh*t, even people who have promised to do sh*t. I’ve heard from people who write about energy efficiency for a living, know exactly what to do to make their homes more efficient, and still don’t do sh*t. It’s hard to disentangle the reasons why—some mix of status quo bias, hyperbolic discounting, and loss aversion to begin with—but it’s clear that public surveys and polls about this tend to be misleading. What people say they’re willing to do and what they demonstrate they’re willing to do are very different things. Attitudes don’t translate into actions.

We care much more about what others think than we do about the environment. Case in point: when homes in California were outfitted with special devices, showing a happy face if energy consumption was lower than the neighbors, or a red sad face if it was higher than the neighbors, overall energy consumption dropped 40%.