Following up on Jad Mouawad's excellent article on Exxon Mobil, Green Is for Sissies, I thought it would be useful to comment on how the "Exxon Way" of discipline, patience, and long-term vision could be put into practice over the next few years to deliver higher returns to their shareholders. Although the article did not provide much strategic insight into Exxon's current investment strategy, it certainly went a long way to explain why a company with $37bln in cash and a pristine balance sheet is sitting on the sidelines while one of the biggest economic opportunities to ever hit the energy sector is beginning to unfold.

This opportunity I am referring to is a chance for Exxon Mobil to use its cash and superior credit rating to enter into the alternative energy space at a time when the credit crisis is making these investments extremely attractive on a rate of return basis.

Indeed, the fact that these opportunities are starting to take shape at a time when Exxon's oil production is declining should give Exxon's investors a reason to be hopeful that the current strategy of using Exxon's oil reserves as an ATM machine isn't the only way forward for the company.  

Exxon's CEO Rex Tillerson claims that Exxon's competitive advantage in a high-priced energy environment has been quite evident. While this was certainly the case when Exxon began shoveling its profits back to its share holders in the form of buybacks and dividends starting in 2003, this $150bln game to cash out on Exxon's reserves is clearly on its last legs.

At the peak of the oil boom this summer when the price of a barrel of oil had risen over 50% on the year, Exxon's stock price was basically unchanged due to concerns that the company's oil production had fallen 8% year over year. If $150/barrel oil prices and $32bln in stock buybacks are not enough to move Exxon's stock price, shareholders should start wondering what it is going to take to make this giant company's stock perform going forward.  

From an opportunity standpoint, while the current crisis is being labeled a household recession, the effects of this downturn on corporations is turning this into a corporate balance sheet recession as well. Companies with the most capital intensive businesses are on the front lines of this slowdown, with GM being only the most visible victim. Alternative energy companies are also under funding pressure as banks struggle to secure their own viability over the coming years. This lack of capital to fund further investments in later stage energy companies is exactly the kind of investments Exxon's CEO has been talking about being agreeable to and Exxon should be making today.

Warren Buffet has remained very "greedy" in terms of his efforts to extract a high rate of return in this environment from his investments and Exxon should be in an even better position than Buffet to exact aggressive terms for their capital investments in alternative energy companies. Private equity and venture capital players are already reeling from the credit crisis, making many excellent opportunities available to Exxon if they so choose.

While Exxon has argued that stock buybacks have been a way to return expensive equity capital to their investors, given the credit opportunities being presented to them in energy space at the current time, their shareholders would be better served by taking that capital and investing it into growth businesses that will offset much of their production declines over the years and decades ahead. Green may be for sissies, but making green isn't and Exxon needs to wake up to that fact. These investments are simply good business, for the sake of Exxon's shareholders as well as for the sake of the planet.

With the fallout from the credit crisis now spreading from the banking sector to the cash starved industrial sector, pressure is now building to provide bailout funding to the domestic auto sector as a way to help secure their economic viability.

The auto industry is clearly on the front lines of the credit crisis with GM effectively borrowing money above 40% interest and their cash reserves expected run dry as early as next summer. While many would argue that these problems were of their own making and we should just let things take their proper course, the fact that up to 3 million domestic jobs may be at stake from a full scale collapse of the sector should give us pause. Given the circumstances, we should at least look to explore all of the available options before allowing Chrysler, GM and their suppliers to be added to the growing list of credit casualties.

In order to honestly explore whether we as taxpayers should play a role in helping to revive our domestic auto companies, we must first look at the problems these companies are faced with. In addition to the overwhelming burden that high financing costs are having on investment in their businesses, the immediate problems faced by the autos are three-fold; 1) they don't supply vehicles their consumers want, 2) they are perceived to be less innovative and have lower quality standards than their competitors, and most worrying from a public funds perspective 3) the market for autos in the US is expected to contract over the coming years due to the economic downturn.

While the first two concerns appear extremely challenging though solvable given the proper incentives, if the third point is correct and the industry as a whole starts to contract, it will be very difficult if not impossible to successfully execute a business as usual bailout for the industry.   

In a recent research report, Goldman Sachs cut their 2010 US vehicle sales forecast by 2mln cars from 16mln units to 14mln units, citing weaker consumer credit conditions and a slowing US economy. The report notes that access to cheaper and better consumer credit has been fundamental to making automobiles more affordable in the US over time. In fact, the study points out that cheap credit explains in many ways how auto sales in the US have managed to grow faster than population or even driver's license registration growth over the past several decades.

The Goldman report concludes that with consumer credit rates starting to tighten, there is now a growing risk of this trend reversing. Consumer credit costs will start to rise, autos will become less affordable as a percentage of a person's income, and auto sales will begin to contract.

From the taxpayers perspective, a low to no growth scenario such as this would prove disastrous for investment in the business as usual recovery strategies being floated by the domestic automakers. What is needed for a recovery of the domestic auto industry is a completely transformational approach to their businesses. One that is based on best in market technologies that, when deployed to scale, would allow them to compete head to head with their more progressive competitors.

The best way to ensure that this goal of being first in class is achieved is by linking any public financing agreements to the production of dramatically cleaner, higher mileage cars. Cars with a corporate average fuel economy (CAFÉ) that matches or exceeds the goal set by President-elect Obama of 39mpg by 2020. 

How higher CAFE or greenhouse gas performance standards can work to reward consumers is quite straightforward. In broad terms, every mile per gallon of higher average fuel economy translates into roughly $5bln of lower fuel costs for the American consumer on an annual basis. This is a significant dividend to the American consumer and if a decision is ultimately made to rescue the domestic auto industry, higher CAFÉ standards should play an important part to ensure a reasonable return on our taxpayer equity. 

For example, an agreement to accelerate CAFE standards from 35mpg, scheduled to take effect in 2020, to 40mpg would allow the American public to receive $5bln per mile in fuel savings or $25bln annually from their investment. This fuel savings dividend would be additional to the number of jobs saved and created by the innovations needed to bring these more efficient cars to market. 

Indeed, the use of higher CAFE standards is also a critical way to motivating the kind of transformational re-tooling investment needed to vault our domestic auto industry back into a leadership position in the global auto market. Short-term bailout packages could be coupled with longer-term re-tooling incentives in a cap and trade bill, that could be brought forward once the bill is passed, and provide the investment capital needed to make the transition to a first in class, efficiency driven automotive sector that America needs.

Blank checks are not the answer. We have a choice to help GM and others invest in projects like the Volt and become a world leader in the production of dramatically cleaner, higher mileage cars or simply let them carry on with business as usual until they run out of gas. If we choose to use CAFE standards as a way to enhance our investment in a bailout, the American taxpayer could be well rewarded for their efforts.

Twenty-three scientists (a different 23 from this 23) sent similar letters to the EPA and USDA and the California ARB calling on these regulators to "stay the course" in terms including emissions from land-use change in the assessment of emissions from biofuels. As I wrote about yesterday and over the weekend, these letters are part of an ongoing political struggle (well summarized by Stephen Powers in today's WSJ) over whether EPA will comply with the RFS law and include emissions from land-use change induced by biofuels. ARB is dealing with same technical challenge.

Having written a lot about this recently, I'll just touch on one point not covered by the scientists' letter to ARB. This letter focuses on responding to the New Fuel Alliance's letter to ARB. As Brook Coleman from NFA reiterated in his comment to my weekend post, one of the advanced biofuels industry's major concerns is that the idea of indirect or economically mitigated emissions are not being equally applied across all fuels. In personal communications, Brook has also made the important point that in the context of a purely performance bases policy such as the LCFS, even small differences in the carbon intensity of fuels will be reflected in their relative value in the market.

I certainly agree that the concept of economically mitigated impacts needs to be applied evenly, but I also think that they need to be included carefully and only when they have a reasonable chance of being large. The complexity and, yes, uncertainty of putting a value on this type of impact means that we have to be wary of the slippery slope from trying to avoid major unintended indirect consequences from our policies to trying to be omniscient.

Certainly, just less than two years ago, most of us had not thought through the land-use impacts of biofuels, so we should be humble and open to the idea that other fuels have similarly potentially large indirect impacts. So, for now I'm unconvinced that any other potential economically mitigated emissions are worth trying to quantify, but I'll remain eager to hear a compelling case for doing so.

As I mentioned in my post over the weekend, a handful of environmental and conservation groups sent a letter [link fixed] to EPA today calling on the agency to comply with the letter of the law and protect the environment by letting science instead of politics guide the rulemaking to implement the renewable fuel standard. The letter cc's the Secretary of Agriculture since, perhaps unsurprisingly, the bulk of the political back pressure come from that quarter.

Look for more scientists and economists to join the fray soon on the side of using the best available science to guide our actions rather than letting politics run amok. Unfortunately, even after EPA acts, you can be sure that some will feel tempted to try to get Congress to do an end-run around EPA's process.

My sincere hope, though, is that soon leaders in the advanced biofuels industry will decide to get proactively and productively engaged in the debate about how to accurately measure the lifecycle GHG emissions from biofuels. I think the confidence that sort of message would send investors (not to mention the certainty wrapping up EPA and California's rule quickly would provide) is critical to the industry at this point.

Once the industry is back at the table, my hope is that they will focus on three critical parts of the lifecycle methodology: the scope of economically induced emissions, the inputs and models used for direct and indirect emissions, and the treatment of these emissions over time. More generally, I think there could be lots of consensus over the need for EPA (and CARB) to carefully analyze the most promising advanced sources of biomass. Understandably, the advanced biofuels industry is worried that the agencies will just cut and paste corn ethanol lifecycle numbers on to even the industry's innovative options. Developing detailed and well researched numbers for a "Chinese menu" of most promising feedstocks, land-types, management practices, and conversion technologies would give the industry options and clear guidance on paths forward.

Hard to believe that my last post was more than a month ago. Things have been happening so fast and furiously as of late that it feels just like yesterday and also like years ago. Now that the election is over, we have an historic opportunity and challenge in moving our economic and environmental policy forward, but we also face a real risk of the Bush administration in its last flailing gasps derailing foundational policies that we will need to chart our way forward. This is especially true in the area of biofuels.

The renewable fuel standard is far from a perfect policy tool, but it does include groundbreaking lifecycle GHG standards and renewable biomass sourcing safeguards. The lifecycle emissions accounting especially is a fundamental tool that we need to get right if we are to have any hope of knowing if the biofuels we're developing are part of the climate solution or part of the problem.

Recently there have been a spat of articles (e.g. this and this) about how EPA is coming under political pressure to ignore a major source of GHG pollution--emissions from changes in land-use induced by biofuels. Much of this pressure has come in the form of letters from industry groups (Bio's letter, Soybean Growers' letter) and a few academics. Even the Brazilian government has sent a letter. Some would have EPA simply have EPA ignore these emissions--also known as emissions from indirect land-use change (ILUC). Others would have EPA only propose a method for calculating these emissions and not any draft values.

So far these letters have been met by two countervailing letters from environmental groups. One is from and Clean Air Task Force, Environmental Working Group, Friends of the Earth and is general, and the other is from Conservation International, Defenders of Wildlife, and National Wildlife Federation and addresses some technical issues.

On Monday, EDF, FOE, UCS, NWF, and NRDC will send EPA (and cc USDA) another letter making the following points:

• By law EPA must include the emissions from ILUC (this post has the specific language)
• ILUC is real and big for certain sources of biomass, and thus EPA must include these emissions to ensure that biofuels produce real GHG benefits instead of increased pollution
• EPA has been engaged in a rigorous rule making process that has drawn on the best available science and economics and the rule will continue to improve through the notice and comment process
• There is ample biomass that incurs little or no ILUC emissions to launch the advanced biofuels industry and comply with the RFS requirements

These arguments are also being played out to OMB, where industry and environmental groups have made their case, and out in California where the Air Resource Board is wrestling (here's ARB's website on the LCFS) with exactly the same challenge in terms of developing a lifecycle GHG accounting protocol. (The letter debate to CARB started this summer as I've written about before.)

In many ways, it's this letter to CARB signed by many in the advanced biofuels industry under the auspices of the New Fuels Alliance that I find most disturbing. The letter freely mixes good points that could serve as helpful, constructive input into a good ILUC accounting with philosophical arguments for ignoring emissions from ILUC with misleading claims about the science, scale, and importance of including these emissions. The letter real deserves a post all its own, but let me just address a few examples of the type of arguments made:

• The letter makes a good point that accounting for ILUC should take particular care to assess the impacts of some of the most promising ways of minimizing and avoiding these emissions so that we can identify the best paths forward for the industry.
• The letter make much of the uncertainty surrounding precise estimates of the ILUC emissions from different sources of biomass, but uncertainty is not an excuse for inaction. This same argument has been made by opponents of action on global warming and have put our world at great peril. The science and economics are certain enough for a high degree of accuracy about the relative scale of these emissions and CARB and EPA are drawing on the best science and modeling.
• Finally the letter spends a lot of time making claims of injustice and risk because indirect emissions from petroleum have not been included in CARB's draft. While certainly economically mitigated emissions for all fuels should be included, to the best of my knowledge no one has done any analysis to suggest any such source of emissions related to petroleum is large or even presented a logic for how such a source might be large. Heck, I want to believe, but I can't think of a source (not saying much, I'll readily admit) and we should not ignore now what we know can be large because we might in the future come up with one.

Two last points: one, as I've said before the first best way to deal with ILUC emissions is to regulate them directly. We need an international cap on GHG emissions that includes emissions from land-use change. And when we get one, we should stop regulating these emissions from biofuels. At that point those emissions will be capped and any increase caused by biofuels will have to be offset elsewhere in the system. But let's be honest, such an agreement is years away and in the meantime the biofuels industry will invest billions of dollars (I hope) in facilities and feedstocks. Federal and state mandates and incentives should be spent making sure these investments have the greatest chance of providing real benefits and surviving under such a future cap.

And two, I continue to believe that the advanced biofuels industry is missing an opportunity to distinguish themselves in the eye of the public and investors from the first generation industry by not embracing ILUC accounting. The news has been full of articles about the first generation of ethanol investment struggling. If enough of the industry keeps insisting to regulators that it can't survive if the emissions from ILUC are part of the criteria for public support, eventually everyone is going to believe them and that will spell the end of public support, investment and one of the industries main reasons for being.

It's time for industry leaders to stop trying to convince EPA and CARB to ignore ILUC emissions and to start signing on to letters that say "Yes we can, and here's how."