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Can Finance be an Energy Partner?

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A bubble and crash of unregulated folly. Supine governments just watched.
(1) Lastminute survived the boom.
Rating agencies
A cartoon best shows the extent of the folly, but it was not funny.
(2) Ratings agencies rated junk assets as AAA
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Banks repossessed millions of homes.
(3) Hedge Funds gave Credit Default Swaps
Lehman Bros Times
UK Bank run - bailed out!
(4)Banks crashed through their own mortgage policies.
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The Economist shows an interacting cloud of business creatures.
(5)Macroeconomics should be modelled on interacting agents, not market statistics.
Dake explosives detector
£100Ms spent on detector with no power source or working mechanism. Beliefs vs Science.
(6)How can one measure the depths of technical ignorance?

Finance needs to dig itself out of a deeply negative situation. Banks, Hedge Funds, Globalisation and ruthless searches for profit have clearly failed. Their 'business models' have become detached from the needs of society. We have to understand the history to work out a new future.

Financial institutions are now unable to fund energy projects without government commitments. Development of new concepts requires new forms of funding to succeed.

Click on the left side gallery to follow this story.The navigation links on the left take you to Openers for the Economics Avenue. The links to the right take you to all the Reports for Economics.

The boom

The crash of 2007-8 was preceded by the DotCom boom, a catchy phrase to cover the immense fraud and mis-selling of stocks in internet companies. Only a tiny few of the companies, like (1), had winning ideas and good management. The bubble was huge - click to see - and even cautious fund managers were sucked in because the funds of funds in which they misplaced their faith were buying into the boom. It was plainly fraudulent at the time which says a lot about the ethics and acumen of the players.

Global Financial Crash
The big crash was caused by several things: The property markets bundled good, bad, and awful assets into blocks which were rated AAA by colluding ratings agencies (2). Completely unregulated Hedge Funds laid off the risks with complex derivatives or insurance policies that seemed to make the investments safe come what may (3). The banks invested in these seemingly profitable funds which had insured their own bets in property. This created a cash flow short circuit which would blow if any part failed. It failed, the banks crashed (4).

Economic Modelling

Economic modelling has many unrealistic assumptions. Markets are not self correcting through considered adjustments. Deregulated industry will destroy the environments they exploit. There is no sensible model of human behaviour in economic models. Seeking understanding from the statistics of data mountains is like using a stethoscope to diagnose a car engine.

A completely new approach to economic modelling is needed: here are some excerpts on agent based modelling (5) from a speech by Jean-Claude Trichet, President of the European Central Bank, on November 18, 2010:

"When the crisis came, the serious limitation of existing economic and financial models immediately became apparent. Arbitrage broke down ... markets froze ... market participants were gripped by panic. Macro models failed to predict the crisis and ... [to explain] what was happening ..."

"[In] the face of crisis, we felt abandoned by conventional tools. ... The key lesson ... is the danger of relying on a single tool, methodology or paradigm. The atomistic, optimising agents underlying existing models do not capture behavior during a crisis period. Agent-based modelling ... allows for more complex interactions between agents. ... we need to better integrate the crucial role played by the financial system into our macroscopic models."

"I would very much welcome inspiration from other disciplines: physics, engineering, psychology, biology. Bringing experts from these fields together with economists and central bankers is potentially very ... valuable."
"A large number of aspects of the observed behaviour of financial markets is hard to reconcile with the efficient market hypothesis... But a determinedly empirical approach -- which places a premium on inductive reasoning based on the data, rather than deductive reasoning grounded in abstract premises or assumptions -- lies at the heart of these methods ... simulations will play a helpful role."

It must be better to model the reaction of institutions to their business understanding and behaviour which create statistical financial fluctuations than the other way round.

The Scale of Energy Funding
Electricity and fuel production are very capital intensive and represent a national rather than a corporate investment. Governments like to control these large projects even though they do not usually have the skills and knowledge to regulate them effectively.

Departments which rely on consultants for advice but have no in-house capability of their own are told what they want to hear. Consultants bearing bad news may not be consulted again. A prize example is the absurdly fraudulent explosives detector which sold widely to police and military forces. Another is the notoriously inept I.T. procurement by the UK government through a closed set of major suppliers. On one task a large company quoted £40M but programmers in a small company did the job for £60K (6). It is not unusual for contract programmers to produce code which is 100 times faster than existing programmes.

The world nuclear contribution should be around 10,000 GWe by 2100 just to maintain the status quo. At $7Bn per GW plant, this is around $70Tn. A comparable sum is required for other low carbon supplies, but, being simpler and more modular than nuclear, can involve thousands of companies of various sizes.

New energy enterprises must design their approach to funding groups which can operate at the right levels.

The best way to manage these companies is to give technical and engineering managers a primary or at least an equal role in the top management. One example was the fortunes of Apple computers under a Pepsi-Cola salesman and under one of the world's most ergonomically gifted engineers.

Companies hoping to introduce significant changes to our energy infrastructure must play a skilful game with financial sources to be sure of a successful enterprise.

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