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Why Alternative Energy Needs Government Funding


Because free markets will allocate capital based on trends and not spikes, growth and not events, the government has to be the one to invest in alternative energy.

Allow me to start off by saying that at the core, I'm a free-markets guy. However, when it comes to alternative energy, I firmly believe private investors are not enough, and that the government needs to intervene in the allocation of capital.

My reasoning has to do with a technical term. There are certain asset classes that exhibit different levels of "kurtosis." For those not inclined to open up their college Statistics textbooks, kurtosis is a way of describing probabilities. Ignoring some of the more technical aspects of it, higher kurtosis means that the variance of what is being measured is explained more by extreme deviations (black swans) than what a normal distribution would suggest. In the context of the stock market, kurtosis means that stocks are more likely to downwardly crash than upwardly spike. The extreme deviations are negative.

In the oil market, however, kurtosis means that oil is more likely to upwardly spike than downwardly crash. This generally has to do with the possibility of supply shocks to the flow of oil worldwide. Whenever you hear about an oil pipe explosion, prices jump. A revolution in the Middle East? Prices jump. Because oil is more likely to jump in price than fall dramatically (the opposite of stocks), it is very important to "insure" against the negative implications of higher prices that could be the result of unpredictable and extreme global situations.

The ultimate insurance policy to protect against those extremes is through diversification of alternative energy (wind, solar, nuclear, coal, natural gas, biofuels, etc.) before the extreme occurs. The problem with most of these sources of energy, however, is that the cost per megawatt produced is higher than what would be generated through oil right now. In other words, alternative energy is more expensive than oil to use except when oil prices spike.

However, this is a relative competitiveness issue. If oil prices rose overnight to $300 a barrel (a black swan/kurtosis scenario), than comparatively speaking all alternative energy would be cheaper to use. The issue though is that there would not be capacity or time for that matter to switch from oil to those cheaper sources of energy production.

Because free markets will allocate capital based on trends and not spikes, growth and not events, the government has to be the one to invest in alternative energy knowing that it does so not to make those sources of energy cheaper now, but to effectively pay for an insurance policy of an overnight oil spike.

Of course, good luck getting taxpayers to sign off on spending for an insurance policy on a rare event when all we know is the past, and not the future...

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No positions in stocks mentioned.

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