Growth is green

The New Statesman blog has an interesting article by Dimitri Zenghelis (who waste policy people may remember spoke at the CIWM/ESA conference back in June).

Mr Zenghelis correctly identifies that the economy is currently being held back by a lack of investment. However, he fails to recognise that investment is in turn being constrained by wrong-headed capital regulations placed on the banking sector (as I argue here). This regulatory distortion is a (the?) principal cause of the widespread retrenchment across the economy.

Investors are understandably worried about lending to a "policy-driven sector". Any investment which depends for its long term success on government whim rather than underlying economic fundamentals is bound to operate on shaky ground.

The long term future for the green economy though is bright. Resource efficiency is a widespread and ongoing phenomenon which is not going to go away. At the same time, consumers' preferences for environmental goods and services tend to increase over time as their incomes rise. This means that in the long run, improvements to the environment will lead to welfare gains and an underpinning economic case for them can be made.

In the short run, however, this will be subject to fluctuation and uncertainty. Such uncertainty is compounded when governments intervene by pushing favoured and currently expensive technologies. By trying to run before we can walk, government policy can lead to the early deployment of expensive solutions which crowds out resources from parts of the economy which are currently more productive.

On this basis, one could argue that Government intervention which distorts the market in the near-term may perversely delay the long-run transition to a green economy by slowing growth and delaying consumers' adoption of greener preferences. This is ultimately counterproductive but sadly all too common.

Commissioner calls for landfill bans

Via @APSRG I see that the EU's Environment Commissioner, Janez Potočnik, has apparently called for a complete ban on landfill across the EU.

As I have argued before here and here, I am instinctively against landfill bans. Such restrictions generally lead to sub-optimal outcomes as they impose blanket costs on waste producers which may in some cases outweigh the environmental benefits of restricting a particular material from going to landfill.

A complete ban on landfill would be an extremely short-sighted policy which failed to recognise that increased costs to waste producers (in excess of the environmental damages associated with the management of their wastes) would inevitably depress their ability to generate positive economic returns elsewhere.

During a time when Europe is facing a deep and ongoing economic crisis, introducing anti-growth policies seems particularly perverse.

CBI calls for more waste services outsourcing

The CBI has published a report on open access to public services, which has been produced by Oxford Economics. This includes estimates of the potential savings which the public sector could make from outsourcing those services which are currently conducted in-house by the public sector.

The report highlights the fact that just over half of waste (collection) services remain in-house. It then estimates that there is a minimum of £192 million savings which the public sector could make from a fully open waste services market.

This estimate is based on assumed producitivity improvements of 15% which are then applied to all authorities which currently retain their services in-house. That 15% figure seems to come from primary research with private sector providers.

As one might expect, I am a big fan of outsourcing waste services to the private sector but these suggested savings seem high to me. I feel that a lot of the efficiencies in the waste services market have already been driven through. Margins on waste collections are very tight and further improvements may be more difficult to achieve. I also don't believe that such large savings would be realisable without half of authorities spotting them. It just doesn't seem credible, although I could of course be wrong.

Some local authorities are also apparently in the naughty habit of calling their services to tender before withdrawing once they have received private sector bids. This allows them to pinch private sector method statements and apply them to in-house services, thereby undermining some of the practical case for large savings' estimates.

I also note that the case study cited in the report is from poor old May Gurney who have run into some recent difficulties on their recycling contracts. They appear to have been quite aggressive in their revenue assumptions from recyclate sales. Now that commodity prices are falling their contracts are running into difficulty. Recyclate prices follow those of primary commodities but tend to be even more volatile on a proportionate basis and this is now hurting the industry.

Contrary to the CBI/Oxford Economics proposals, there has been an increasing recent trend for local authorities to bring waste services back in-house. This has been driven by high recyclate revenues on the back of the recent biggest boom in commodities' history. Authorities have seen these high revenues as a potential cash cow in straightened times.

Falling prices mean that this model may be undermined going forward and more authorities will realise that competition between private sector providers does deliver decent potential savings to public sector budgets. But I suspect not as high as 15% for waste services.

Risk transfer - who benefits the most?

I was at the RWM exhibition last week, which apparently again attracted record visitor numbers. These large-scale events give the opportunity to hear some leading industry figures give their views on the big issues of the day, and while these are often banal you can find the occasional nugget of interesting information.

Wednesday's panel debate in the leaders' theatre was a case in point. Much of the discussion centred on concerns about access to finance coupled with falling material prices, both topics which I have covered before. What was interesting for me though was the disagreement between the participants regarding the exact nature of the risk transfer between the public and private sectors. Generally the operators/contractors felt (unsurprisingly) that the private sector had taken on too much risk in their municipal contracts, while an advisor was of the opposite view and suggested that local authorities had retained too much risk.

So, who is right?

In an ideal world different risks would be appropriately shared according to the principle of which party is better able to manage that risk. When discussing residual waste projects we might group the risks into: inputs; process; and outputs.

When it comes to input (feedstock/volume) risk we might think that authorities would be able to better manage that as they are the ones directing householders through collections. But contractors tend to take a view which they build into their assumptions. They then rely on being able to substitute commercial waste for municipal waste to be able to make up for any shortfall. (It is of course a shortfall we want as this would indicate that residual municipal waste has been minimised and is below expectations.)

Where there may be a potential antagonism is where authorities demand (rightly) priority access to a facility when volumes are high but do not give the contractor the freedom (perhaps through non-compete clauses for commercial waste) to be able to make up for a shortfall when volumes are low. In this way we may find that the contractor ends up being unable to manage their exposure to volume risk appropriately.

When it comes to process/technology risk, this is undoubtedly something which it seems to me should rest with the contractor. Some disagreement may however arise concerning the differing risk profiles of the construction and operational phases of a facility. The construction (and commissioning) phase is high risk and fraught with potential technical problems. The operational phase however tends to be relatively straightforward and lower risk.

Early PFI contracts saw some big gains to contractors who were able to refinance on favourable terms and make relatively large returns once projects were into the operational phase. This was seen by the public sector as unfair profiting at their expense. The contractors would probably argue that the rewards they gained were commensurate with the risks they took, but this is certainly a controversial area. It is also an area where the rules on refinancing were subsequently tightened so that any potential upside to the private sector is now effectively capped.

This has therefore now become another area where contractors feel that they are exposed to large potential downside losses while their upside is capped, i.e. the risk transfer has now swung in favour of the public sector.

The other area of risk is on outputs/offtake. This is again an area where the contractor is going to have to take a view and hope that they are able to manage resulting price volatility over the life of the contract. We may find increasingly that some contractors (perhaps more applicable for recycling contracts) have overestimated potential offtake revenues and run into trouble.

From the above, I find it difficult to conclude that local authorities are retaining too much risk and instead would agree with contractors who suggest that they offer good value for money to their local authority customers. This may not always have been the case and those who managed to secure favourable terms in the early days of PPP/PFI agreements may have done well out of them. But right now being a waste management contractor is a difficult place to be with both volumes and prices falling. These are conditions which could place severe pressure on some industry participants.

Shadow Minister claims reducing profits will create jobs

Labour's Shadow Minister for the Environment, Gavin Shuker, has apparently claimed that the UK is losing out on jobs and growth because reprocessors are importing material (while at the same time collectors are exporting).

On the contrary, it seems to me that the reprocessors are getting a better deal by importing material which presumably matches their requirements better than that which comes from domestic collectors. At the same time, the collectors are getting a better deal by exporting material to overseas reprocessors who are willing to pay a higher price for theirs.

In this way, both domestic reprocessors and collectors are exploiting overseas markets and everyone's a winner. Government intervention which eliminated the most profitable opportunities for domestic organisations and instead forced these two groups to exchange directly with one another would inevitably lead to lower aggregate benefits all round.

Lower benefits means lower growth and fewer jobs. Somehow the Shadow Minister manages to reach the opposite conclusion. I disagree and think that the Government should not meddle with these open markets.

Policy wonks vs operators

The big annual waste shindig has been taking place at the NEC for the past couple of days. I intend to post  on some of the conference later, but my first initial observation is that there seems to be a growing divergence  in views expressed by policy wonks and those by waste operators facing reality on the ground.

In particular, via @Greendipped I see that Gavin Shuker expressed ongoing concerns about scarcity (something regular readers would know I don't see as a problem), while at the same time Steve Lee gave a presentation on the first day titled "understanding the potential impact of resource scarcity and escalating commodity prices".

I have pointed out before that in reality (non-food) commodity prices are falling, and it was concern about these falling prices that was the main message to come from waste operators at the conference (see also e.g. this story). It is these operators who are facing the actual conditions at the coal face and I would certainly trust their experience more than the hypotheticals coming from others with less direct day to day experience of reality.

The waste industry is going through a very difficult period of transition. Waste volumes are down and recycling prices are falling. Policy and regulation are designed to drive the waste industry away from the traditional stable landfill based model with low capital outlay towards high up-front capital investment and large exposure to cyclical global commodity markets. Managing this transition will be difficult and there will likely be some who don't do it well.

As long as policy makers don't understand the reality of cyclical markets they are unlikely to be able to come up with a policy framework that will help the industry navigate its way in the world.

Labour suggests need for more HMG bureaucracy

I see Gavin Shuker is jumping upon suggestions to create an Office of Resource Efficiency. As I have previously said, I don't know what this office would be expected to do beyond working to keep global markets open. This is the best way of securing access to resources.

Mr Shuker also seems unaware that it isn't materials which facilitate growth but innovation. The total material requirement of the UK economy has actually fallen since peaking in 2001, a period during which the economy has grown by almost 50%.

As before, I am unable to conclude from the available evidence that we have a resource scarcity problem. Markets are the best method we have for allocating resources and should be allowed to do their job.