The Dismal Segment
Just as economics is the "dismal science", petroleum refining is the dismal segment of the oil business. I started my career as a refinery process engineer, and it took me years to outgrow the pessimism that my two years there instilled in me. After all, if you are a refinery executive, on your best day the facility is running flawlessly, making some money and churning out product, but it's all downhill from there. It's the rare plant manager who hasn't been awakened at 3:00 AM by a phone call informing him of a serious problem or accident, and refinery accidents tend to be spectacularly attention-getting.
Business Week recently carried an excellent article on the current state of the US refining business and its contribution to high gasoline prices. The short version of the story is that refining capacity has been overextended through a combination of high demand, complex and conflicting regional gasoline specifications, and the impact of environmental regulations on the facilities themselves. It sounds bleak, but it is also generating healthy profits in a part of the business that until a few years ago was a perpetual "dog."
In the past, the normal cycle for the refining industry was that any period of high margins would be followed by heavy investment in new capacity. Rather than new refineries, of which I believe only one has been built in the US since 1971, this usually meant adding or expanding "cracking units", expensive hardware that turns low value byproducts into high value gasoline and diesel fuel. After each wave of capacity addition, gasoline production would increase and--surprise--prices and margins would drop, just as you'd expect in a competitive business. I doubt there were many US refineries that achieved better than a 5 or 6% return on average capital employed in the 1990s, when you could earn that much investing in T-bills.
What appears to be happening now, contrary to the recurring suspicions of collusion mentioned in the article, is the end result of environmental and permitting regulators having achieved their implicit goal of limiting refinery expansions. In the process, they have saved the refinery owners from themselves in a way they could never have done on their own, by breaking the cycle of unprofitable capacity additions.
So when you pull into the gas station and grumble at the high prices, in addition to cursing OPEC, you might make a mental note that you are at last paying a premium for the cleaner gasoline that has helped to improve air quality in many of our metropolitan areas. If you live in Southern California and are old enough to remember Second-Stage Smog Alerts (23 of them in 1978 and not one since 1988), you know exactly what I mean.
Wednesday, March 31, 2004
Tuesday, March 30, 2004
High Tech Power Grid
Aside from providing a sharp non-US perspective on things, the Economist puts out a good series of periodic reports on various industries and issues. Their latest Technology Quarterly includes an article on "The Energy Internet", describing the potential shape of the power grid of the future.
Before the Enron collapse and the botched California electricity deregulation, the hot buzzword was "distributed power", in which we would gradually shift away from large central power plants and high-voltage lines, and toward a new model relying on small generators, either owned by end-users or sitting very close to them. These generators would use a variety of technologies, including microturbines, wind turbines, diesel generators, and eventually fuel cells. Ultimately, these small devices would not only meet the immediate needs of their owners, but would sell power back into the grid. The result could eventually resemble the internet, with power flowing in and out from a myriad of small nodes.
Along with summarizing the current state of the power grid, the Economist article provides an update on the development of distributed power. Advances have continued, including the development of "microgrids" and new storage options, but we are apparently still some years away from anything resembling an energy internet, however desirable it might be for reducing the risk of blackouts and the volatility of markets.
But although the author correctly identifies politics and regulations as factors retarding progress in this trend, he does not mention the ambivalence of many utilities about losing control over who is allowed to put power into the grid. These companies should consider distributed power in light of their experience in the 1980s and 90s with cogeneration.
Starting in the late 1970s, large industrial facilities began installing their own medium-size power generation, typically using aircraft-derived gas turbines that efficiently provide both electricity and steam for industrial processes. Utilities often resisted buying the cogenerators' excess power, until they were forced to do so by state and federal regulators. But rather than being the threat they feared, cogeneration turned out to be a blessing for utilities, allowing them to defer major investments in new power plants that would likely have earned low returns in the market conditions that prevailed prior to 2000.
In fairness, the cogeneration story may not be 100% positive. The steady stream of cogeneration projects may have lulled utilities and regulators in California into believing that capacity investment could be deferred indefinitely, thus contributing to their problems during deregulation. Despite this, I think the story shows that distributed power could result in unexpected benefits for utilities, and that further analysis is warranted. Perhaps someday the inserts in our monthly utility bills will encourage us to generate our own electricity, rather than buying theirs.
Aside from providing a sharp non-US perspective on things, the Economist puts out a good series of periodic reports on various industries and issues. Their latest Technology Quarterly includes an article on "The Energy Internet", describing the potential shape of the power grid of the future.
Before the Enron collapse and the botched California electricity deregulation, the hot buzzword was "distributed power", in which we would gradually shift away from large central power plants and high-voltage lines, and toward a new model relying on small generators, either owned by end-users or sitting very close to them. These generators would use a variety of technologies, including microturbines, wind turbines, diesel generators, and eventually fuel cells. Ultimately, these small devices would not only meet the immediate needs of their owners, but would sell power back into the grid. The result could eventually resemble the internet, with power flowing in and out from a myriad of small nodes.
Along with summarizing the current state of the power grid, the Economist article provides an update on the development of distributed power. Advances have continued, including the development of "microgrids" and new storage options, but we are apparently still some years away from anything resembling an energy internet, however desirable it might be for reducing the risk of blackouts and the volatility of markets.
But although the author correctly identifies politics and regulations as factors retarding progress in this trend, he does not mention the ambivalence of many utilities about losing control over who is allowed to put power into the grid. These companies should consider distributed power in light of their experience in the 1980s and 90s with cogeneration.
Starting in the late 1970s, large industrial facilities began installing their own medium-size power generation, typically using aircraft-derived gas turbines that efficiently provide both electricity and steam for industrial processes. Utilities often resisted buying the cogenerators' excess power, until they were forced to do so by state and federal regulators. But rather than being the threat they feared, cogeneration turned out to be a blessing for utilities, allowing them to defer major investments in new power plants that would likely have earned low returns in the market conditions that prevailed prior to 2000.
In fairness, the cogeneration story may not be 100% positive. The steady stream of cogeneration projects may have lulled utilities and regulators in California into believing that capacity investment could be deferred indefinitely, thus contributing to their problems during deregulation. Despite this, I think the story shows that distributed power could result in unexpected benefits for utilities, and that further analysis is warranted. Perhaps someday the inserts in our monthly utility bills will encourage us to generate our own electricity, rather than buying theirs.
Monday, March 29, 2004
Orphan Cars
In the 1980s and early 1990s, consumers had to worry about buying computers that would turn into "orphans" when their makers went bust or were absorbed into another company. Now it's orphan cars, all-electric vehicles that their manufacturers insist on taking back, once their initial leases are up. This seems like terrible PR on the part of GM and Ford, but it's not hard to envision the conversations between company lawyers and accountants that might have led to these decisions.
A key fact missing from the Times article is that most of these first-generation cars were delivered with conventional lead-acid batteries--dozens of them. Imagine pulling into Sears to buy 26 DieHards in one go. This was one reason the auto firms' chose to offer battery cars only on lease. You also have to wonder what other parts might now be wearing out, with which the average mechanic would have no prior experience. Let's see, my EV-1 breaks down after warranty, and I take it to the corner mechanic, who accidentally comes in contact with a high voltage circuit... The lawyers must have been in a cold sweat at this prospect.
A few years ago I had the pleasure of driving one of these cars. It was a brand new GM EV-1, and I got to take it around the streets of Phoenix, AZ for a few minutes. I was amazed not only by how quiet it was, but by its terrific acceleration. It was great fun leaving a BMW in the dust at a green light, with its owner wondering what on earth I was driving.
However, it was also clear that the car I drove would never be mass marketed. Its range was under 100 miles, and achieving that required either an overnight charge at home, or about an hour and a half at a public, high voltage recharging station, of which there were relatively few. On top of this, it was a 2-seater with limited storage space. Fun, different, but not very practical.
Rather than lament its passing, I'd rather cheer for the few thousand enthusiasts who got to drive the car of their dreams--and consciences--for three or four years, and the car companies that learned a tremendous amount about the practicalities of electric drive. That knowledge is already paying dividends in the new hybrid cars--part electric and part gasoline-powered--and will certainly benefit future electric-based vehicles such as those powered by fuel cells.
At the same time, environmentally-oriented EV owners should remember that the power to recharge these cars must be generated somewhere. For Southern California, where most of these vehicles were leased, the EV-1's "virtual tailpipe" was probably connected to a coal-fired power plant in Four Corners, AZ.
In the 1980s and early 1990s, consumers had to worry about buying computers that would turn into "orphans" when their makers went bust or were absorbed into another company. Now it's orphan cars, all-electric vehicles that their manufacturers insist on taking back, once their initial leases are up. This seems like terrible PR on the part of GM and Ford, but it's not hard to envision the conversations between company lawyers and accountants that might have led to these decisions.
A key fact missing from the Times article is that most of these first-generation cars were delivered with conventional lead-acid batteries--dozens of them. Imagine pulling into Sears to buy 26 DieHards in one go. This was one reason the auto firms' chose to offer battery cars only on lease. You also have to wonder what other parts might now be wearing out, with which the average mechanic would have no prior experience. Let's see, my EV-1 breaks down after warranty, and I take it to the corner mechanic, who accidentally comes in contact with a high voltage circuit... The lawyers must have been in a cold sweat at this prospect.
A few years ago I had the pleasure of driving one of these cars. It was a brand new GM EV-1, and I got to take it around the streets of Phoenix, AZ for a few minutes. I was amazed not only by how quiet it was, but by its terrific acceleration. It was great fun leaving a BMW in the dust at a green light, with its owner wondering what on earth I was driving.
However, it was also clear that the car I drove would never be mass marketed. Its range was under 100 miles, and achieving that required either an overnight charge at home, or about an hour and a half at a public, high voltage recharging station, of which there were relatively few. On top of this, it was a 2-seater with limited storage space. Fun, different, but not very practical.
Rather than lament its passing, I'd rather cheer for the few thousand enthusiasts who got to drive the car of their dreams--and consciences--for three or four years, and the car companies that learned a tremendous amount about the practicalities of electric drive. That knowledge is already paying dividends in the new hybrid cars--part electric and part gasoline-powered--and will certainly benefit future electric-based vehicles such as those powered by fuel cells.
At the same time, environmentally-oriented EV owners should remember that the power to recharge these cars must be generated somewhere. For Southern California, where most of these vehicles were leased, the EV-1's "virtual tailpipe" was probably connected to a coal-fired power plant in Four Corners, AZ.
Friday, March 26, 2004
Frontier Outpost
This week the Wall St. Journal Online carried an interview with Amory Lovins, the guru and founder of the Rocky Mountain Institute, an alternative energy think tank. His views on the future of the oil industry and other parts of the mainstream energy landscape are interesting and iconoclastic. They are worth noting as much because of who else is listening to them as for their insights. Mr. Lovins has the attention of global energy and auto firms, among others, a fact that becomes even more surprising when you realize how critical he is of their orthodoxies.
In the interview, along with some good observations about China's growing energy demand, Mr. Lovins compares the oil and airline industries as "a great industry but a bad business." This seems a stretch, considering the highly profitable super-majors dominating the oil and gas scene today. While it is true that these firms and their smaller brethren have not consistently recovered their cost of capital or outperformed the market over time, they are a million miles from the sad state of commercial aviation. As of a few years ago, the latter had delivered a cumulative loss since its inception , and it's hard to see that the post-9/11 world would have improved that score.
Still, Mr. Lovins shines in creating a compelling vision of a future world of clean and efficient energy and transportation, even if I'm skeptical that we can get there in the manner he describes. You need visionaries pushing the frontiers, and he certainly qualifies as one.
This week the Wall St. Journal Online carried an interview with Amory Lovins, the guru and founder of the Rocky Mountain Institute, an alternative energy think tank. His views on the future of the oil industry and other parts of the mainstream energy landscape are interesting and iconoclastic. They are worth noting as much because of who else is listening to them as for their insights. Mr. Lovins has the attention of global energy and auto firms, among others, a fact that becomes even more surprising when you realize how critical he is of their orthodoxies.
In the interview, along with some good observations about China's growing energy demand, Mr. Lovins compares the oil and airline industries as "a great industry but a bad business." This seems a stretch, considering the highly profitable super-majors dominating the oil and gas scene today. While it is true that these firms and their smaller brethren have not consistently recovered their cost of capital or outperformed the market over time, they are a million miles from the sad state of commercial aviation. As of a few years ago, the latter had delivered a cumulative loss since its inception , and it's hard to see that the post-9/11 world would have improved that score.
Still, Mr. Lovins shines in creating a compelling vision of a future world of clean and efficient energy and transportation, even if I'm skeptical that we can get there in the manner he describes. You need visionaries pushing the frontiers, and he certainly qualifies as one.
Thursday, March 25, 2004
Record Gasoline Prices?
A recent article on gasoline prices included a surprising historical graph (you'll have to scroll down a bit to find it.) Gasoline prices have gone up dramatically this year, in line with higher crude oil prices and the replacement of MTBE by ethanol in several states. Here in Connecticut I pay over $2.00/gallon for self-service. Recently I've been thinking I have never paid more, other than on trips to Europe or Asia, but the graph showed I was wrong.
As low as inflation has been for the last few years, it's easy to forget how big the difference can be between nominal prices--prices in today's dollars--and real prices, adjusted for inflation. Nominal gasoline prices after the first oil crisis in 1973-74 averaged $.53/gallon for leaded regular, while those after the Iranian Revolution rose to $1.25/gallon for unleaded. When you adjust for inflation and bring them into 2003 dollars, these figures translate to $1.69/gal and $2.49, respectively.
This is not to say that gasoline isn't unusually expensive at the moment, but even for someone who follows these issues regularly and traded energy commodities for more than 10 years, it's instructive to see that we're still well short of the real record. And if the times we live in are less turbulent than the oil crisis years of the 1970s, it's not by much.
A recent article on gasoline prices included a surprising historical graph (you'll have to scroll down a bit to find it.) Gasoline prices have gone up dramatically this year, in line with higher crude oil prices and the replacement of MTBE by ethanol in several states. Here in Connecticut I pay over $2.00/gallon for self-service. Recently I've been thinking I have never paid more, other than on trips to Europe or Asia, but the graph showed I was wrong.
As low as inflation has been for the last few years, it's easy to forget how big the difference can be between nominal prices--prices in today's dollars--and real prices, adjusted for inflation. Nominal gasoline prices after the first oil crisis in 1973-74 averaged $.53/gallon for leaded regular, while those after the Iranian Revolution rose to $1.25/gallon for unleaded. When you adjust for inflation and bring them into 2003 dollars, these figures translate to $1.69/gal and $2.49, respectively.
This is not to say that gasoline isn't unusually expensive at the moment, but even for someone who follows these issues regularly and traded energy commodities for more than 10 years, it's instructive to see that we're still well short of the real record. And if the times we live in are less turbulent than the oil crisis years of the 1970s, it's not by much.
Wednesday, March 24, 2004
Smart Cars
Anyone who has traveled to Europe in the last several years has probably noticed the tiny Smart cars driving--and easily parking--in the Continent's most congested cities. They come in eye-catching colors and are even smaller than the popular Mini Cooper seen over here in increasing numbers. Last Friday the Smart hit the front page of the NY Times's "Escape" section, which described how enthusiasts are trying to acquire the car in advance of its 2005 rollout in the US.
Many times when I was trying to find a parking space in Manhattan or elsewhere I have wished I were driving one of these little cars, which were designed to fit three to the same parking space as a single Mercedes S-Class. But there were other times on Interstate 95, while being tailgated by an 18-wheeler going 65 and trying to go 75 right through my back seat, that I was glad I wasn't driving one. Clearly the Smart won't appeal to everyone, for every situation.
But I think that is the whole point. Here is a car that can meet a need for practical, economical transportation to the train station or generally around town, even if it's not the car you'd choose to drive from New York to D.C. Also noteworthy is that this car gets 60 miles per gallon without any of the fancy and costly technology of the hybrid cars or future fuel cell vehicles that I and others extoll.
When I see cars like the Mini and the Smart, I can't help wondering if they represent the next big trend in the auto world. Everyone focuses on SUVs now, fans and opponents alike. After all, they have been the hot trend for a decade. But the recent proliferation of extremely large, high-end SUVs such as the Lincoln Navigator or Cadillac Escalade, reminds me of the 1991 Buick Roadmaster station wagon, simultaneously the apex and last hurrah of the American station wagons that created the niche SUVs would later fill. Are we nearing that kind of tipping point, and is the Smart a sign of its arrival?
Anyone who has traveled to Europe in the last several years has probably noticed the tiny Smart cars driving--and easily parking--in the Continent's most congested cities. They come in eye-catching colors and are even smaller than the popular Mini Cooper seen over here in increasing numbers. Last Friday the Smart hit the front page of the NY Times's "Escape" section, which described how enthusiasts are trying to acquire the car in advance of its 2005 rollout in the US.
Many times when I was trying to find a parking space in Manhattan or elsewhere I have wished I were driving one of these little cars, which were designed to fit three to the same parking space as a single Mercedes S-Class. But there were other times on Interstate 95, while being tailgated by an 18-wheeler going 65 and trying to go 75 right through my back seat, that I was glad I wasn't driving one. Clearly the Smart won't appeal to everyone, for every situation.
But I think that is the whole point. Here is a car that can meet a need for practical, economical transportation to the train station or generally around town, even if it's not the car you'd choose to drive from New York to D.C. Also noteworthy is that this car gets 60 miles per gallon without any of the fancy and costly technology of the hybrid cars or future fuel cell vehicles that I and others extoll.
When I see cars like the Mini and the Smart, I can't help wondering if they represent the next big trend in the auto world. Everyone focuses on SUVs now, fans and opponents alike. After all, they have been the hot trend for a decade. But the recent proliferation of extremely large, high-end SUVs such as the Lincoln Navigator or Cadillac Escalade, reminds me of the 1991 Buick Roadmaster station wagon, simultaneously the apex and last hurrah of the American station wagons that created the niche SUVs would later fill. Are we nearing that kind of tipping point, and is the Smart a sign of its arrival?
Tuesday, March 23, 2004
OPEC Waffles
Last month OPEC ministers decided to reduce oil production in the second quarter, even though the market is currently at historic highs. Their rationale centered on avoiding a glut in the in the upcoming post-winter heating, pre-summer driving season. Dissent now seems to be dividing the ranks before the cuts go into effect, as unnamed members wake up to the political damage that sustained high prices is causing them, and more importantly, to the risk that their actions will slow the economic recovery and reduce demand for the next couple of years.
It's about time. Over the last decade the market has swung back and forth between periods when OPEC could control prices and others in which a lack of OPEC cohesion or tranches of new non-OPEC production left them powerless to prevent a price slide. But as time passes, this game becomes riskier. Alternatives are creating new choices for industry and consumers, and each successive price spike takes a small notch out of future oil demand. These alternatives include not only wind and solar power, but more conventional fuels such as LNG.
As always, OPEC's leaders must find a way to balance the desires of members such as Algeria and Indonesia, whose limited production and reserves drives them to maximize short term revenue, with those such as the Saudis and Kuwaitis, whose reserves will last decades and who must lose sleep over the prospect of losing the market to coal, gas or renewables. But neither can they forget 1998, when the slide in prices due to falling Asian demand became a collapse. Let us hope they realize that this kind of scenario is highly unlikely today, as China booms and the US gets back on a growth track.
The FT quoted the Algerian representative fretting about a possible $7 drop in prices. $30 oil would take about 17 cents out of the gasoline price, and that would be good news indeed for consumers.
Last month OPEC ministers decided to reduce oil production in the second quarter, even though the market is currently at historic highs. Their rationale centered on avoiding a glut in the in the upcoming post-winter heating, pre-summer driving season. Dissent now seems to be dividing the ranks before the cuts go into effect, as unnamed members wake up to the political damage that sustained high prices is causing them, and more importantly, to the risk that their actions will slow the economic recovery and reduce demand for the next couple of years.
It's about time. Over the last decade the market has swung back and forth between periods when OPEC could control prices and others in which a lack of OPEC cohesion or tranches of new non-OPEC production left them powerless to prevent a price slide. But as time passes, this game becomes riskier. Alternatives are creating new choices for industry and consumers, and each successive price spike takes a small notch out of future oil demand. These alternatives include not only wind and solar power, but more conventional fuels such as LNG.
As always, OPEC's leaders must find a way to balance the desires of members such as Algeria and Indonesia, whose limited production and reserves drives them to maximize short term revenue, with those such as the Saudis and Kuwaitis, whose reserves will last decades and who must lose sleep over the prospect of losing the market to coal, gas or renewables. But neither can they forget 1998, when the slide in prices due to falling Asian demand became a collapse. Let us hope they realize that this kind of scenario is highly unlikely today, as China booms and the US gets back on a growth track.
The FT quoted the Algerian representative fretting about a possible $7 drop in prices. $30 oil would take about 17 cents out of the gasoline price, and that would be good news indeed for consumers.
Monday, March 22, 2004
Numerators and Denominators
An article in yesterday's New York Times, quoted opponents of oil and gas drilling in Montana's Front Range saying, "How can someone take an area of this magnificence and sell it down the river for a few minutes of natural gas supply?" This perennial anti-development mantra may vary in proportion with the amount of hydrocarbons in question, but it is based on a serious fallacy.
In some ways, the terminology and shorthand of the oil industry helps give rise to this kind of misunderstanding. When experts talk about reservoirs and pumps and express reserve life in terms of reserves-over-production (R/P), a layman could easily conclude that engineers simply dial in how rapidly they want to produce the oil in a given field.
Actual production rates are a function of geological conditions, available technology, and the characteristics of the oil in question, which can vary considerably. There is an optimal rate of production for each well, and exceeding it can damage the reservoir and reduce overall recovery. As a result, production is spread out over many years, with volumes reaching an early peak and then declining. US oil and natural gas production is made up of the contributions from tens of thousands of producing wells, each with its own unique lifespan measured in years or decades, rather than the fanciful minutes or hours indicated.
The "only a few minutes/days/months of supply" fallacy is a wonderful tool for opposing oil or gas development, since through careful choice of numerator and denominator, the value of essentially any oil or gas project--no matter how large, can be made to appear trivial when compared to the environmental consequences that might ensue.
We hear this argument frequently in the case of the Arctic National Wildlife Refuge, which is deemed by opponents to hold only "six months of our national demand". Voters might view it differently if told that it has the potential to supply a fifth of total US oil production for 20 years, based on reserve estimates by the US Geological Survey.
Every oil or gas project such as the Front Range or ANWR has genuine pros and cons, some of them quite complex. But I don't think the debate is enhanced by cynically or ignorantly resorting to the kind of trivialization I have described above. We live in a country with an enormous and insatiable appetite for energy. Without the output of thousands of oil and gas fields--all of which were originally in some other, possibly pristine state--none of us would be able to heat our homes or get to work in the morning.
An article in yesterday's New York Times, quoted opponents of oil and gas drilling in Montana's Front Range saying, "How can someone take an area of this magnificence and sell it down the river for a few minutes of natural gas supply?" This perennial anti-development mantra may vary in proportion with the amount of hydrocarbons in question, but it is based on a serious fallacy.
In some ways, the terminology and shorthand of the oil industry helps give rise to this kind of misunderstanding. When experts talk about reservoirs and pumps and express reserve life in terms of reserves-over-production (R/P), a layman could easily conclude that engineers simply dial in how rapidly they want to produce the oil in a given field.
Actual production rates are a function of geological conditions, available technology, and the characteristics of the oil in question, which can vary considerably. There is an optimal rate of production for each well, and exceeding it can damage the reservoir and reduce overall recovery. As a result, production is spread out over many years, with volumes reaching an early peak and then declining. US oil and natural gas production is made up of the contributions from tens of thousands of producing wells, each with its own unique lifespan measured in years or decades, rather than the fanciful minutes or hours indicated.
The "only a few minutes/days/months of supply" fallacy is a wonderful tool for opposing oil or gas development, since through careful choice of numerator and denominator, the value of essentially any oil or gas project--no matter how large, can be made to appear trivial when compared to the environmental consequences that might ensue.
We hear this argument frequently in the case of the Arctic National Wildlife Refuge, which is deemed by opponents to hold only "six months of our national demand". Voters might view it differently if told that it has the potential to supply a fifth of total US oil production for 20 years, based on reserve estimates by the US Geological Survey.
Every oil or gas project such as the Front Range or ANWR has genuine pros and cons, some of them quite complex. But I don't think the debate is enhanced by cynically or ignorantly resorting to the kind of trivialization I have described above. We live in a country with an enormous and insatiable appetite for energy. Without the output of thousands of oil and gas fields--all of which were originally in some other, possibly pristine state--none of us would be able to heat our homes or get to work in the morning.
Thursday, March 18, 2004
Making Lemonade
A recent article on the prospect for further tightening of the global market for metallurgical coke, the carbon source for steel production, triggered an odd train of thought. At the same time that this higher quality, coal-derived coke for steel production is becoming pricier, the world is being glutted with lower quality coke derived from petroleum, much of it produced in the US and Venezuela. Simultaneously, the price of natural gas has risen to historical highs in the US. The combination of these two factors creates an opportunity.
Petroleum coke (petcoke) is the byproduct of upgrading heavy oil into lighter oil, as done in a number of projects in Venezuela, or turning the heavy, tarry residue of petroleum refining into more valuable, lighter products, such as diesel fuel. Petcoke is similar in appearance and consistency to coal, and about as desirable from an environmental perspective. By virtue of being the absolute "bottom of the barrel", it concentrates the sulfur and metals from the source oil to much higher levels. As more upgrading capacity comes on line, more coke is produced and prices of this "fuel grade" coke fall.
But petcoke is an ideal source of carbon for the gasification process, in which low value, high carbon materials such as coal, coke, or residual fuel are converted into a so-called synthesis gas, resembling very low-grade natural gas. One of the main attractions of gasification is that contaminants such as sulfur and metals emerge in forms that are much easier to handle and remediate than if the same fuel were burned in a conventional power plant.
Although the resulting synthesis gas is not a direct substitute for the natural gas we burn in our homes, it can displace natural gas used in gas turbines for electricity generation.
Three or four years ago, this kind of "integrated gasification combined cycle", or IGCC, with its high investment cost, was nearly competitive with conventional coal power plants, but quite a bit more expensive than gas turbines running on natural gas. But with gas prices having doubled and tripled, and with cheap petroleum coke widely available as a feedstock, these economics should be reevaluated.
Perhaps we can kill two birds with one stone: helping to alleviate a very tight natural gas market in the US, while reducing the mounting piles of petroleum coke produced by the increasing number of heavy oil upgrading projects around the world.
A recent article on the prospect for further tightening of the global market for metallurgical coke, the carbon source for steel production, triggered an odd train of thought. At the same time that this higher quality, coal-derived coke for steel production is becoming pricier, the world is being glutted with lower quality coke derived from petroleum, much of it produced in the US and Venezuela. Simultaneously, the price of natural gas has risen to historical highs in the US. The combination of these two factors creates an opportunity.
Petroleum coke (petcoke) is the byproduct of upgrading heavy oil into lighter oil, as done in a number of projects in Venezuela, or turning the heavy, tarry residue of petroleum refining into more valuable, lighter products, such as diesel fuel. Petcoke is similar in appearance and consistency to coal, and about as desirable from an environmental perspective. By virtue of being the absolute "bottom of the barrel", it concentrates the sulfur and metals from the source oil to much higher levels. As more upgrading capacity comes on line, more coke is produced and prices of this "fuel grade" coke fall.
But petcoke is an ideal source of carbon for the gasification process, in which low value, high carbon materials such as coal, coke, or residual fuel are converted into a so-called synthesis gas, resembling very low-grade natural gas. One of the main attractions of gasification is that contaminants such as sulfur and metals emerge in forms that are much easier to handle and remediate than if the same fuel were burned in a conventional power plant.
Although the resulting synthesis gas is not a direct substitute for the natural gas we burn in our homes, it can displace natural gas used in gas turbines for electricity generation.
Three or four years ago, this kind of "integrated gasification combined cycle", or IGCC, with its high investment cost, was nearly competitive with conventional coal power plants, but quite a bit more expensive than gas turbines running on natural gas. But with gas prices having doubled and tripled, and with cheap petroleum coke widely available as a feedstock, these economics should be reevaluated.
Perhaps we can kill two birds with one stone: helping to alleviate a very tight natural gas market in the US, while reducing the mounting piles of petroleum coke produced by the increasing number of heavy oil upgrading projects around the world.
Wednesday, March 17, 2004
Reaping the Wind
It seems appropriate to follow a discussion of solar energy with one on wind power, since they share many characteristics, as well as a common source: the sun. Both are intermittent in nature, producing energy only when the sun shines or the wind blows. This means neither can produce reliable power without some means of storing power for use in the dark or calm, or a backup generator. And both are low intensity, in the sense that they require a much larger footprint for producing a quantity of power equivalent to a natural gas or coal-fired central power plant.
But whereas solar power is still a niche product, wind power has moved well into the mainstream. The US added 1700 MW of wind generation last year, moving into second place behind Germany in total installed wind turbines.
Wind has also become a significant source of revenue for family farms in states like Minnesota. Even with the Federal subsidy for new wind power installations in abeyance, due to the stalled energy bill, wind will continue to grow in importance, partly due to state renewable power mandates.
As positive as all this sounds, a collision is occurring between the drive for more renewable electricity and concerns for preserving the environment. The poster child for this dilemma is the proposed wind power installation off Cape Cod. It has divided the environmental community in two, between those who see the benefits of a non-polluting energy source and those who say "not in my viewscape."
The fundamental issue here is the same as the one underlying my posting of March 11 concerning the natural gas that is kept off limits by restrictions on offshore drilling. Everyone wants their appliances and cars, but few indeed want the energy needed to run them to come from anywhere they can see or easily imagine.
We are nearing the end of the time when such views can prevail without exacting a high price in dependability. Last summer's northeast blackout, which added extra anxiety to the birth of my daughter that day, was a signal of how tenuously we are stretching the infrastructure upon which we rely. We may get another signal this summer, in the form of a gasoline price spike related to the Balkanization of state regulations governing gasoline specifications--a topic for another day.
None of this will change until we start, as a country, to connect actions and consequences: mentally linking the flip of a light switch to the spinning of a turbine somewhere, the turning of an ignition key to the drilling of an offshore oil well. The energy industry has made this pretty seamless for a long time, but the seams are beginning to show.
It seems appropriate to follow a discussion of solar energy with one on wind power, since they share many characteristics, as well as a common source: the sun. Both are intermittent in nature, producing energy only when the sun shines or the wind blows. This means neither can produce reliable power without some means of storing power for use in the dark or calm, or a backup generator. And both are low intensity, in the sense that they require a much larger footprint for producing a quantity of power equivalent to a natural gas or coal-fired central power plant.
But whereas solar power is still a niche product, wind power has moved well into the mainstream. The US added 1700 MW of wind generation last year, moving into second place behind Germany in total installed wind turbines.
Wind has also become a significant source of revenue for family farms in states like Minnesota. Even with the Federal subsidy for new wind power installations in abeyance, due to the stalled energy bill, wind will continue to grow in importance, partly due to state renewable power mandates.
As positive as all this sounds, a collision is occurring between the drive for more renewable electricity and concerns for preserving the environment. The poster child for this dilemma is the proposed wind power installation off Cape Cod. It has divided the environmental community in two, between those who see the benefits of a non-polluting energy source and those who say "not in my viewscape."
The fundamental issue here is the same as the one underlying my posting of March 11 concerning the natural gas that is kept off limits by restrictions on offshore drilling. Everyone wants their appliances and cars, but few indeed want the energy needed to run them to come from anywhere they can see or easily imagine.
We are nearing the end of the time when such views can prevail without exacting a high price in dependability. Last summer's northeast blackout, which added extra anxiety to the birth of my daughter that day, was a signal of how tenuously we are stretching the infrastructure upon which we rely. We may get another signal this summer, in the form of a gasoline price spike related to the Balkanization of state regulations governing gasoline specifications--a topic for another day.
None of this will change until we start, as a country, to connect actions and consequences: mentally linking the flip of a light switch to the spinning of a turbine somewhere, the turning of an ignition key to the drilling of an offshore oil well. The energy industry has made this pretty seamless for a long time, but the seams are beginning to show.
Tuesday, March 16, 2004
Solar Moves Mainstream
Last week General Electric announced it was buying the assets of the bankrupt solar power manufacturer, AstroPower. This follows GE's success in the wind power business.
In addition to giving GE an entree to a small but rapidly growing market, it may also be a signal that the global solar photovoltaic (PV) industry is approaching a critical threshold. As the scale of manufacturing increases, solar panels should enjoy similar "experience curve" effects as other technologies--though not necessarily as dramatic as Moore's Law for computer chips. Costs will continue to fall, and as they do, solar will expand out of its current niche applications, such as powering remote devices not connected to the power grid.
While the dream of clean solar power replacing large central power plants may never be realized, due to environmental objections to covering the landscape with the vast area of solar collectors that would entail, economical PV could create new markets that are additive, rather than competitive with traditional power. Besides expanding the growing range of options for homeowners and businesses seeking to reduce their dependence on the electric grid, it may find an even larger opportunity in the developing world, where people making only a few hundred dollars a year buy the most expensive form of power on the planet: disposable batteries.
What will be required to develop all these markets? Topping the list are manufacturing excellence, marketing expertise, and financial creativity. GE appears to have all of these skills in abundance, but it has no monopoly on them. Smaller players should see GE's entry to this market as legitimizing in the eyes of investors and potential customers. That can only benefit the industry as a whole.
Last week General Electric announced it was buying the assets of the bankrupt solar power manufacturer, AstroPower. This follows GE's success in the wind power business.
In addition to giving GE an entree to a small but rapidly growing market, it may also be a signal that the global solar photovoltaic (PV) industry is approaching a critical threshold. As the scale of manufacturing increases, solar panels should enjoy similar "experience curve" effects as other technologies--though not necessarily as dramatic as Moore's Law for computer chips. Costs will continue to fall, and as they do, solar will expand out of its current niche applications, such as powering remote devices not connected to the power grid.
While the dream of clean solar power replacing large central power plants may never be realized, due to environmental objections to covering the landscape with the vast area of solar collectors that would entail, economical PV could create new markets that are additive, rather than competitive with traditional power. Besides expanding the growing range of options for homeowners and businesses seeking to reduce their dependence on the electric grid, it may find an even larger opportunity in the developing world, where people making only a few hundred dollars a year buy the most expensive form of power on the planet: disposable batteries.
What will be required to develop all these markets? Topping the list are manufacturing excellence, marketing expertise, and financial creativity. GE appears to have all of these skills in abundance, but it has no monopoly on them. Smaller players should see GE's entry to this market as legitimizing in the eyes of investors and potential customers. That can only benefit the industry as a whole.
Monday, March 15, 2004
Oil Reserves vs. Strategy
The Wall St. Journal has done an excellent job of covering the reserves problems at Shell without resorting to sensationalism. On Friday's front page they stepped above the questions of who knew what--and when--to raise a more profound question about the company's strategy.
The overstatement of Shell's reserves as far back as the mid-1990s distorted key indicators such as reserve replacement rates--their success at finding new oil reserves to replace what was pumped in a given year--and finding and development costs--how much they paid for each new barrel in the ground. As a result of these distortions, was Shell lulled into believing that it could deliver the results investors demanded via organic growth alone, when their competitors had concluded they must replace reserves through significant mergers and acquisitions?
This is a critical question, because by now the best opportunities of this kind have been snapped up by others. Amoco, Texaco and Mobil are gone, and only Marathon, ENI, and ConocoPhillips--itself the result of several mergers--remain in this size category. In order to be material to a company of Shell's size, growing reserves through M&A would now likely require buying multiple smaller firms, against a background of significantly higher oil prices than obtained when the transactions creating ExxonMobil, BP-Amoco-Arco (pronounced "BP"), and ChevronTexaco took place.
It may be that Shell's existing asset portfolio can deliver the desired growth, and that most of the reserves recently un-booked can be restored with time and prudent investment. If not, the shareholders of Royal Dutch and Shell Trading & Transport will have grounds for second-guessing management's decision to go it alone.
In response to my earlier comments on this situation, one colleague responded as follows:
"Reassessment is a painful and long process. They could've said that they were not in compliance when they first knew, but they probably could not have estimated the amount of the change without a rigorous survey of all the reserves.
Texaco had a similar problem in the 1990’s as management found out it may not be anywhere near its production growth targets. Even the analysts, in that case, knew that the forecasts were off. But it was only after a rigorous survey that took the better part of a year that a better picture emerged."
Finally, on the non-energy front, I am trying to digest the implications of the Socialist's come-from-behind win in yesterday's election in Spain. I don't understand all the complexities of Spanish politics, but it appears on the surface that the terrorists succeeded in scaring voters into a more isolationist view. Should we now expect a similarly aimed attack here in early November?
The Wall St. Journal has done an excellent job of covering the reserves problems at Shell without resorting to sensationalism. On Friday's front page they stepped above the questions of who knew what--and when--to raise a more profound question about the company's strategy.
The overstatement of Shell's reserves as far back as the mid-1990s distorted key indicators such as reserve replacement rates--their success at finding new oil reserves to replace what was pumped in a given year--and finding and development costs--how much they paid for each new barrel in the ground. As a result of these distortions, was Shell lulled into believing that it could deliver the results investors demanded via organic growth alone, when their competitors had concluded they must replace reserves through significant mergers and acquisitions?
This is a critical question, because by now the best opportunities of this kind have been snapped up by others. Amoco, Texaco and Mobil are gone, and only Marathon, ENI, and ConocoPhillips--itself the result of several mergers--remain in this size category. In order to be material to a company of Shell's size, growing reserves through M&A would now likely require buying multiple smaller firms, against a background of significantly higher oil prices than obtained when the transactions creating ExxonMobil, BP-Amoco-Arco (pronounced "BP"), and ChevronTexaco took place.
It may be that Shell's existing asset portfolio can deliver the desired growth, and that most of the reserves recently un-booked can be restored with time and prudent investment. If not, the shareholders of Royal Dutch and Shell Trading & Transport will have grounds for second-guessing management's decision to go it alone.
In response to my earlier comments on this situation, one colleague responded as follows:
"Reassessment is a painful and long process. They could've said that they were not in compliance when they first knew, but they probably could not have estimated the amount of the change without a rigorous survey of all the reserves.
Texaco had a similar problem in the 1990’s as management found out it may not be anywhere near its production growth targets. Even the analysts, in that case, knew that the forecasts were off. But it was only after a rigorous survey that took the better part of a year that a better picture emerged."
Finally, on the non-energy front, I am trying to digest the implications of the Socialist's come-from-behind win in yesterday's election in Spain. I don't understand all the complexities of Spanish politics, but it appears on the surface that the terrorists succeeded in scaring voters into a more isolationist view. Should we now expect a similarly aimed attack here in early November?
Friday, March 12, 2004
Nuclear Genie
Nuclear proliferation has been in the news a lot lately, between concerns about North Korea's weapons program and the even more worrying revelations about Dr. Khan's Pakistani nuclear Home Depot. Wednesday's NY Times featured N. Kristof's bleak editorial on a potential Nuclear 9/11 ,and last week's Economist carried their depressing, good news/bad news assessment of the situation. As they commented, "...the only real difference between a civilian nuclear fuel-cycle and a military nuclear fuel-cycle is one of intent."
What does this mean for the future of nuclear power? Roughly 450 nuclear power plants in 33 countries currently supply 6.5% of the world's primary energy (8% for the US alone.) They represent an enormous capital investment and an important base load of electricity. Barring the advent of economical nuclear fusion (see my posting of 2/13/04) or some new energy source with similar characteristics, they won't go away soon on economic grounds.
But that's the problem. Traditional economics does a very poor job of evaluating low risks of truly catastrophic outcomes. Previous conventional wisdom saw the nuclear industry's long-lived waste products as its biggest problem and assumed that proliferation was essentially under control. Surely that assumption must now be revisited.
We also need to be clear about the precise nature of our concern. Public speculation about terrorist use of a radiological device, or "dirty bomb", has created the impression that radioactive material is so ubiquitous that controlling it is beyond anyone's ability. But to paraphrase a friend's favorite Mark Twain quote, the difference between a nuclear bomb and a "dirty bomb" is the difference between lightning and a lightning bug. While a radiological explosion in an urban area would be a deadly disaster with serious aftereffects, a nuclear explosion, with its much larger effects of blast, heat, and radioactive fallout, would be a nightmare orders of magnitude worse.
That means that the real issue is not controlling all radioactive material, but rather fissionables, the uranium used to fuel reactors and the plutonium byproduct they produce. Is it possible to create a foolproof, ironclad global system that would deny any country not already in possession of both nuclear fuel and fuel processing technology access to either or both, while also severely restricting the activities of countries already in the club? President Bush has proposed one approach, while the International Atomic Energy Agency has its own plan. While it's not clear that either approach goes nearly far enough, neither is it clear that the will exists to go even that far.
Fundamentally, we must either find a way to control this trade, or it must be stopped entirely, with the massive economic consequences that would entail. Any other alternative risks creating a world order infinitely more dangerous than the nuclear roulette of the Cold War.
Nuclear proliferation has been in the news a lot lately, between concerns about North Korea's weapons program and the even more worrying revelations about Dr. Khan's Pakistani nuclear Home Depot. Wednesday's NY Times featured N. Kristof's bleak editorial on a potential Nuclear 9/11 ,and last week's Economist carried their depressing, good news/bad news assessment of the situation. As they commented, "...the only real difference between a civilian nuclear fuel-cycle and a military nuclear fuel-cycle is one of intent."
What does this mean for the future of nuclear power? Roughly 450 nuclear power plants in 33 countries currently supply 6.5% of the world's primary energy (8% for the US alone.) They represent an enormous capital investment and an important base load of electricity. Barring the advent of economical nuclear fusion (see my posting of 2/13/04) or some new energy source with similar characteristics, they won't go away soon on economic grounds.
But that's the problem. Traditional economics does a very poor job of evaluating low risks of truly catastrophic outcomes. Previous conventional wisdom saw the nuclear industry's long-lived waste products as its biggest problem and assumed that proliferation was essentially under control. Surely that assumption must now be revisited.
We also need to be clear about the precise nature of our concern. Public speculation about terrorist use of a radiological device, or "dirty bomb", has created the impression that radioactive material is so ubiquitous that controlling it is beyond anyone's ability. But to paraphrase a friend's favorite Mark Twain quote, the difference between a nuclear bomb and a "dirty bomb" is the difference between lightning and a lightning bug. While a radiological explosion in an urban area would be a deadly disaster with serious aftereffects, a nuclear explosion, with its much larger effects of blast, heat, and radioactive fallout, would be a nightmare orders of magnitude worse.
That means that the real issue is not controlling all radioactive material, but rather fissionables, the uranium used to fuel reactors and the plutonium byproduct they produce. Is it possible to create a foolproof, ironclad global system that would deny any country not already in possession of both nuclear fuel and fuel processing technology access to either or both, while also severely restricting the activities of countries already in the club? President Bush has proposed one approach, while the International Atomic Energy Agency has its own plan. While it's not clear that either approach goes nearly far enough, neither is it clear that the will exists to go even that far.
Fundamentally, we must either find a way to control this trade, or it must be stopped entirely, with the massive economic consequences that would entail. Any other alternative risks creating a world order infinitely more dangerous than the nuclear roulette of the Cold War.
Thursday, March 11, 2004
Unintended Environmental Damage
This fascinating article by a former Greenpeace activist details some of the unintentional fallout of concerted opposition to genetically modified crops around the world. Although Mr. Moore's focus is on biotechnology, it could just as well have been on energy.
Consider the bans on offshore oil and gas drilling imposed in areas such as California and Florida. Although targeted mainly at preventing drilling-related oil spills, such as the one that blighted Santa Barbara's beaches in 1969, they make no distinction between drilling for oil and drilling for gas, which incurs little or no risk of spills. As a result, billions of cubic feet of natural gas that US consumers and industry desperately need today are not being produced.
In the case of Florida alone, the resources in question appear sufficient to supply all of that state's gas needs for the next twenty-plus years. We know what these bans are intended to prevent, but what are their unintended consequences for the environment?
Well, for one thing, with natural gas prices extremely high today, the incentive to produce electricity from coal goes up dramatically. Coal plants are run harder, gas turbines less so, and this means more acid rain precursors and greenhouse gases are emitted into the air. Similarly, home heating oil looks more attractive relative to gas, and although it is not as dirty as coal, it is certainly not as clean as gas. So again, air pollution increases, because of policies that keep known reserves of gas locked underwater.
Finally, demand for gas imports goes up, too. Since new supplies from Canada and Alaska will require major new pipelines (with their own environmental impacts, which may prevent them from being built), the incentive to import liquefied natural gas (LNG)increases. We are currently seeing a media blitz on the virtues of LNG, which is indeed a clean fuel in and of itself.
Of course, when we evaluate the benefits of LNG, we don't typically factor in the energy that was used to liquefy it, a process that consumes 10-20% of the original gas, with accompanying emissions of greenhouse gases. Once it is in a tanker on the water, it requires a terminal near its final market in which to receive and regasify it. A number of companies are currently discovering the complexities of siting such facilities near anyone or anything.
So we begin with a set of values that declare natural gas to be cleaner and thus the fuel of choice, but then other values make it next to impossible actually to produce a good chunk of the gas that's right here in the US. The consequences are more pollution from burning other fuels and, in effect, "outsourcing" the negatives that concern us to some other country that will produce gas for us, turn it into LNG and put in on a tanker.
So in a manner not so different from the opponents cited by Mr. Moore, a number of prominent people who appear smart enough to understand the big picture relating to natural gas supply and demand have deliberately chosen not to, for reasons of ideology or political gain, resulting in a substantial increase in air pollution and worsening of the US balance of trade. They are entitled to their views, but they should not continue to masquerade as friends of the environment.
This fascinating article by a former Greenpeace activist details some of the unintentional fallout of concerted opposition to genetically modified crops around the world. Although Mr. Moore's focus is on biotechnology, it could just as well have been on energy.
Consider the bans on offshore oil and gas drilling imposed in areas such as California and Florida. Although targeted mainly at preventing drilling-related oil spills, such as the one that blighted Santa Barbara's beaches in 1969, they make no distinction between drilling for oil and drilling for gas, which incurs little or no risk of spills. As a result, billions of cubic feet of natural gas that US consumers and industry desperately need today are not being produced.
In the case of Florida alone, the resources in question appear sufficient to supply all of that state's gas needs for the next twenty-plus years. We know what these bans are intended to prevent, but what are their unintended consequences for the environment?
Well, for one thing, with natural gas prices extremely high today, the incentive to produce electricity from coal goes up dramatically. Coal plants are run harder, gas turbines less so, and this means more acid rain precursors and greenhouse gases are emitted into the air. Similarly, home heating oil looks more attractive relative to gas, and although it is not as dirty as coal, it is certainly not as clean as gas. So again, air pollution increases, because of policies that keep known reserves of gas locked underwater.
Finally, demand for gas imports goes up, too. Since new supplies from Canada and Alaska will require major new pipelines (with their own environmental impacts, which may prevent them from being built), the incentive to import liquefied natural gas (LNG)increases. We are currently seeing a media blitz on the virtues of LNG, which is indeed a clean fuel in and of itself.
Of course, when we evaluate the benefits of LNG, we don't typically factor in the energy that was used to liquefy it, a process that consumes 10-20% of the original gas, with accompanying emissions of greenhouse gases. Once it is in a tanker on the water, it requires a terminal near its final market in which to receive and regasify it. A number of companies are currently discovering the complexities of siting such facilities near anyone or anything.
So we begin with a set of values that declare natural gas to be cleaner and thus the fuel of choice, but then other values make it next to impossible actually to produce a good chunk of the gas that's right here in the US. The consequences are more pollution from burning other fuels and, in effect, "outsourcing" the negatives that concern us to some other country that will produce gas for us, turn it into LNG and put in on a tanker.
So in a manner not so different from the opponents cited by Mr. Moore, a number of prominent people who appear smart enough to understand the big picture relating to natural gas supply and demand have deliberately chosen not to, for reasons of ideology or political gain, resulting in a substantial increase in air pollution and worsening of the US balance of trade. They are entitled to their views, but they should not continue to masquerade as friends of the environment.
Wednesday, March 10, 2004
Proven Oil Reserves?
The ongoing shakeup at Royal Dutch/Shell over the recent restatement of their oil reserves is beginning to acquire the whiff of scandal, with coverage shifting from the business section to the front page, and with headlines verging on the sensational: "Oil Giant's Officials Knew of Gaps in Reserves in '02".
Whatever the ultimate outcome of current investigations at Shell, the end result will restore the company to conformance with SEC standards for the booking of oil reserves, which are meant to indicate an oil company's future production potential. Instead of viewing this situation through the lens of Enron/Worldcom/Parmalat paranoia, one could actually see it as an example of the system working, albeit a bit slowly. In any case, it offers an important caveat for international oil investors.
As the energy business becomes increasingly global, and as the number of players from outside the traditional circle of US and European majors--where standards such as the SEC's hold sway--expands, it is useful to remember that not every foreign company's reserve estimation processes would withstand such scrutiny. Before piling into shares of Russian and Chinese oil companies, for example, or partially-privatized entities such as India's ONGC, investors should make sure they truly understand what they are getting for the price.
While it is disconcerting to find that an established firm like Shell overstated reserves, a similar revelation about a company just coming into the world market would be disastrous for anyone who had bought into it. I suspect a lot of hard questions will be asked in the next weeks and months, in places that are less accustomed to that kind of transparency.
The ongoing shakeup at Royal Dutch/Shell over the recent restatement of their oil reserves is beginning to acquire the whiff of scandal, with coverage shifting from the business section to the front page, and with headlines verging on the sensational: "Oil Giant's Officials Knew of Gaps in Reserves in '02".
Whatever the ultimate outcome of current investigations at Shell, the end result will restore the company to conformance with SEC standards for the booking of oil reserves, which are meant to indicate an oil company's future production potential. Instead of viewing this situation through the lens of Enron/Worldcom/Parmalat paranoia, one could actually see it as an example of the system working, albeit a bit slowly. In any case, it offers an important caveat for international oil investors.
As the energy business becomes increasingly global, and as the number of players from outside the traditional circle of US and European majors--where standards such as the SEC's hold sway--expands, it is useful to remember that not every foreign company's reserve estimation processes would withstand such scrutiny. Before piling into shares of Russian and Chinese oil companies, for example, or partially-privatized entities such as India's ONGC, investors should make sure they truly understand what they are getting for the price.
While it is disconcerting to find that an established firm like Shell overstated reserves, a similar revelation about a company just coming into the world market would be disastrous for anyone who had bought into it. I suspect a lot of hard questions will be asked in the next weeks and months, in places that are less accustomed to that kind of transparency.
Tuesday, March 09, 2004
Venezuelan Politics
This short but insightful article from the Financial Times covers another electoral process that Americans should be watching with great interest this year: the effort by the opposition parties in Venezuela to recall President Hugo Chavez. Venezuela is the US's second largest foreign oil supplier--ignoring our NAFTA partners--and only a little over a year ago provided a vivid reminder of the impact of political instability on oil markets. A similar crisis today would send oil prices to the stratosphere.
Last week, it appeared that the efforts of the opposition to hold a national referendum on President Chavez had failed. The FT points out the hazards facing the opposition if they abandon their goal of a democratic solution to the current problem. President Chavez is popular with the poorer segments of the country and has a firm grip on the military.
Of equal concern is how he might react to any pressure the US might seek to apply, if the electoral process were derailed. Chavez is famous for his volatility and anti-American rhetoric, even as he relies on US and other international oil firms to grow his country's sagging oil production. Those companies will need to manage this relationship with particular care and sensitivity, while prudently managing their risks.
This short but insightful article from the Financial Times covers another electoral process that Americans should be watching with great interest this year: the effort by the opposition parties in Venezuela to recall President Hugo Chavez. Venezuela is the US's second largest foreign oil supplier--ignoring our NAFTA partners--and only a little over a year ago provided a vivid reminder of the impact of political instability on oil markets. A similar crisis today would send oil prices to the stratosphere.
Last week, it appeared that the efforts of the opposition to hold a national referendum on President Chavez had failed. The FT points out the hazards facing the opposition if they abandon their goal of a democratic solution to the current problem. President Chavez is popular with the poorer segments of the country and has a firm grip on the military.
Of equal concern is how he might react to any pressure the US might seek to apply, if the electoral process were derailed. Chavez is famous for his volatility and anti-American rhetoric, even as he relies on US and other international oil firms to grow his country's sagging oil production. Those companies will need to manage this relationship with particular care and sensitivity, while prudently managing their risks.
Monday, March 08, 2004
Image vs. Environment
The NY Times carried an amusing post-Academy Awards article over the weekend, contrasting the stars who drove Hummers to the Oscars against those who drove more economical and environmentally benign hybrid cars. The Toyota Prius and the Hummer represent completely opposite views of what car-buyers want, and the challenge for Detroit, Yokohama, and Stuttgart is how to weave these strands back together.
The Hummer is all about potential, and it epitomizes the dominant theme in auto design over the last ten-plus years: building cars with the potential to go faster, accelerate quicker, and carry more payload, further offroad, than the miserable cars foisted on us in the 1980s. The consumer who buys such a car wants to be going 70 mph by the end of the offramp, even if he knows he will have to jam on the brakes to avoid crashing into gridlock. She wants to be able to take the whole family and a week's gear to a base camp in the wilderness, even as she realizes her car will rarely carry more than her briefcase to the office. It is the triumph of image over practicality and economy.
The Prius represents something very different. It's a reminder that car technology has not stood still for 20 years, and that if we hadn't been so focused on adding speed, throw-weight and endless power gizmos to cars over the years, we would today have a car fleet averaging well over 30 miles per gallon and delivering reasonable comfort, safety and reliability, with all that entails for the environment and energy security.
But even if a new administration were to ramp up the minimum Corporate Average Fuel Economy (CAFE) standards--and close the SUV loophole in those standards--most consumers will still want it all: performance plus safety, economy plus spaciousness. How else do we explain the Hummer buyer who is dismayed to discover it gets less than 12 miles per gallon? Perhaps the new generation of hybrid SUVs currently under design will start to address this.
The NY Times carried an amusing post-Academy Awards article over the weekend, contrasting the stars who drove Hummers to the Oscars against those who drove more economical and environmentally benign hybrid cars. The Toyota Prius and the Hummer represent completely opposite views of what car-buyers want, and the challenge for Detroit, Yokohama, and Stuttgart is how to weave these strands back together.
The Hummer is all about potential, and it epitomizes the dominant theme in auto design over the last ten-plus years: building cars with the potential to go faster, accelerate quicker, and carry more payload, further offroad, than the miserable cars foisted on us in the 1980s. The consumer who buys such a car wants to be going 70 mph by the end of the offramp, even if he knows he will have to jam on the brakes to avoid crashing into gridlock. She wants to be able to take the whole family and a week's gear to a base camp in the wilderness, even as she realizes her car will rarely carry more than her briefcase to the office. It is the triumph of image over practicality and economy.
The Prius represents something very different. It's a reminder that car technology has not stood still for 20 years, and that if we hadn't been so focused on adding speed, throw-weight and endless power gizmos to cars over the years, we would today have a car fleet averaging well over 30 miles per gallon and delivering reasonable comfort, safety and reliability, with all that entails for the environment and energy security.
But even if a new administration were to ramp up the minimum Corporate Average Fuel Economy (CAFE) standards--and close the SUV loophole in those standards--most consumers will still want it all: performance plus safety, economy plus spaciousness. How else do we explain the Hummer buyer who is dismayed to discover it gets less than 12 miles per gallon? Perhaps the new generation of hybrid SUVs currently under design will start to address this.
Friday, March 05, 2004
Cheap Oil?
A friend forwarded a recent article in Business Week that suggests the era of cheap oil is over, due to a combination of increased demand and greater OPEC cohesion. The industry has a rich history of seeing the future as a continuation of the present: when prices crashed in the late 1990s, due largely to the Asian economic crisis, it was hard for even seasoned oil executives to imagine a return to prices over $20/barrel any time soon. I believe the technical term for this is "availability bias."
We are clearly in an alignment that favors the producers at the moment. The US economy is recovering--whatever the politicians may say--and China is booming. At the same time, exports from Iraq have been sporadic and well below expectations for this stage of the occupation. Venezuelan production is probably less than officially stated, due to lingering aftereffects of last year's strike and production shut-in.
So in the short term, prices look very firm and have some upside. And in the long term, as I've discussed several times in this blog, there is the prospect of supply being unable to keep up with demand, due to the combination of depletion of mature basins and problems in bringing on new fields rapidly enough. But that leaves the all-important medium term, from a year to five years out. And the lesson of the 90s is that a swing of less than 5% from short to long can drop the market by multiple dollars.
In less than five years Iraq could start to have a real impact in the market, with existing production and infrastructure rehabilitated and new fields starting to come on. There are a number of other projects around the world that will be reaching the market in that period, including major projects in West Africa, the Caspian, and possibly Iran. And that ignores any demand-side impact a new US Administration might have. Combine these factors, and a couple of years from now we could just as easily be looking at $18-20 oil and wondering if OPEC can hold it together. And a few years after that, we could be back to scarcity.
The real lesson here is understanding the difference between true structural changes and temporary market conditions. And the kind of structural changes I'm talking about would be at the level of economical alternatives, new regulations, geological or capital constraints, or major new discoveries. However tempting it is to proclaim that things have changed for good and we are now looking at permanently high/low prices (take your pick), the incredible complexity of the factors involved has a way of overtaking such predictions in a remarkably short time.
A friend forwarded a recent article in Business Week that suggests the era of cheap oil is over, due to a combination of increased demand and greater OPEC cohesion. The industry has a rich history of seeing the future as a continuation of the present: when prices crashed in the late 1990s, due largely to the Asian economic crisis, it was hard for even seasoned oil executives to imagine a return to prices over $20/barrel any time soon. I believe the technical term for this is "availability bias."
We are clearly in an alignment that favors the producers at the moment. The US economy is recovering--whatever the politicians may say--and China is booming. At the same time, exports from Iraq have been sporadic and well below expectations for this stage of the occupation. Venezuelan production is probably less than officially stated, due to lingering aftereffects of last year's strike and production shut-in.
So in the short term, prices look very firm and have some upside. And in the long term, as I've discussed several times in this blog, there is the prospect of supply being unable to keep up with demand, due to the combination of depletion of mature basins and problems in bringing on new fields rapidly enough. But that leaves the all-important medium term, from a year to five years out. And the lesson of the 90s is that a swing of less than 5% from short to long can drop the market by multiple dollars.
In less than five years Iraq could start to have a real impact in the market, with existing production and infrastructure rehabilitated and new fields starting to come on. There are a number of other projects around the world that will be reaching the market in that period, including major projects in West Africa, the Caspian, and possibly Iran. And that ignores any demand-side impact a new US Administration might have. Combine these factors, and a couple of years from now we could just as easily be looking at $18-20 oil and wondering if OPEC can hold it together. And a few years after that, we could be back to scarcity.
The real lesson here is understanding the difference between true structural changes and temporary market conditions. And the kind of structural changes I'm talking about would be at the level of economical alternatives, new regulations, geological or capital constraints, or major new discoveries. However tempting it is to proclaim that things have changed for good and we are now looking at permanently high/low prices (take your pick), the incredible complexity of the factors involved has a way of overtaking such predictions in a remarkably short time.
Wednesday, March 03, 2004
China Big
The People's Republic of China recently passed a significant milestone: it now imports more crude oil than any country other than the US, at roughly 5.5 million barrels per day. This is remarkable to me, since I can recall when China routinely exported crude oil and refined products, because its domestic market was so small.
Last week's Economist described the impact of growing demand from China across a wide range of commodities, including metals, plastics, and energy. In essence, China's appetite for imported raw materials, whether driven by export industries or growing consumer demand, has become a force to be reckoned with in the same way as the US's.
This is a new thing in the world, and it is the opposite of what people typically meant a decade ago when they uttered the phrase in today's title. Back then, "China Big" was the standard justification for entering into any kind of deal with a local Chinese partner, since the market was bound to be so enormous later. A number of companies destroyed a great deal of shareholder value following that logic, and others will have to be very patient about their returns. But that's all beside the point.
China has graduated into a very exclusive club. At least in sectors like energy and mining, they have attained the size at which global firms simply can't afford not to be engaged with them in some way. An inevitable consequence is that we will see Chinese firms grow to truly global scope (and maybe scale), on the back of this.
The question is whether they will be content to follow the Japanese model of buying small shares of other people's projects, as in their recent purchase in the liquefied natural gas arena, or will prefer originating their own projects and truly competing with the majors globally. The answer to that question may say a great deal about the composition of the global energy industry of the 2010s.
The People's Republic of China recently passed a significant milestone: it now imports more crude oil than any country other than the US, at roughly 5.5 million barrels per day. This is remarkable to me, since I can recall when China routinely exported crude oil and refined products, because its domestic market was so small.
Last week's Economist described the impact of growing demand from China across a wide range of commodities, including metals, plastics, and energy. In essence, China's appetite for imported raw materials, whether driven by export industries or growing consumer demand, has become a force to be reckoned with in the same way as the US's.
This is a new thing in the world, and it is the opposite of what people typically meant a decade ago when they uttered the phrase in today's title. Back then, "China Big" was the standard justification for entering into any kind of deal with a local Chinese partner, since the market was bound to be so enormous later. A number of companies destroyed a great deal of shareholder value following that logic, and others will have to be very patient about their returns. But that's all beside the point.
China has graduated into a very exclusive club. At least in sectors like energy and mining, they have attained the size at which global firms simply can't afford not to be engaged with them in some way. An inevitable consequence is that we will see Chinese firms grow to truly global scope (and maybe scale), on the back of this.
The question is whether they will be content to follow the Japanese model of buying small shares of other people's projects, as in their recent purchase in the liquefied natural gas arena, or will prefer originating their own projects and truly competing with the majors globally. The answer to that question may say a great deal about the composition of the global energy industry of the 2010s.
Tuesday, March 02, 2004
Fire or Ice?
Two recent articles in the New York Times highlight growing concerns about the possible consequences of climate change, generally referred to as global warming. In the first, investors are becoming more assertive in asking energy companies to quantify their exposure to future regulation of greenhouse gases, which are associated with the observed warming trend of the last century or so. A number of firms, including mid-sized US upstream-only companies, are facing shareholder resolutions along these lines.
The second article compares the upcoming action film, "The Day After Tomorrow", by the director of "Independence Day", with an extreme climate change scenario commissioned by the Pentagon. The scenario was developed by Peter Schwartz, the founder of the Global Business Network, a leading scenario planning group. However one might assess the likelihood of such a scenario occurring, involving drastic cooling of Northwest Europe and the Northeast US as a result of interference with the North Atlantic warming current, such an event would certainly have major security implications.
Given the criticisms by both of the Democratic frontrunners of the Bush Administration's handling of global warming and the Kyoto Treaty, and with a blockbuster movie that could elevate the public's awareness, climate change could become a hot issue this year. If so, let us hope that this stimulates a meaningful national debate on the subject, rather than a rush for a quick fix. After all, even the most ardent supporters of Kyoto would agree that it was only intended as a first step in dealing with a problem that could be with us for the next century, or longer.
Two recent articles in the New York Times highlight growing concerns about the possible consequences of climate change, generally referred to as global warming. In the first, investors are becoming more assertive in asking energy companies to quantify their exposure to future regulation of greenhouse gases, which are associated with the observed warming trend of the last century or so. A number of firms, including mid-sized US upstream-only companies, are facing shareholder resolutions along these lines.
The second article compares the upcoming action film, "The Day After Tomorrow", by the director of "Independence Day", with an extreme climate change scenario commissioned by the Pentagon. The scenario was developed by Peter Schwartz, the founder of the Global Business Network, a leading scenario planning group. However one might assess the likelihood of such a scenario occurring, involving drastic cooling of Northwest Europe and the Northeast US as a result of interference with the North Atlantic warming current, such an event would certainly have major security implications.
Given the criticisms by both of the Democratic frontrunners of the Bush Administration's handling of global warming and the Kyoto Treaty, and with a blockbuster movie that could elevate the public's awareness, climate change could become a hot issue this year. If so, let us hope that this stimulates a meaningful national debate on the subject, rather than a rush for a quick fix. After all, even the most ardent supporters of Kyoto would agree that it was only intended as a first step in dealing with a problem that could be with us for the next century, or longer.
Monday, March 01, 2004
In Whose Orbit?
Interesting to see US Secretary of Defense Donald Rumsfeld visiting Kazakstan the other day and making security overtures to the Kazak government. Since the collapse of the Soviet Union, the countries around the Caspian Sea have been seen by some as a sort second Middle East. While the area's proved reserves of oil are still not on the scale of even Kuwait, by itself, it has upside potential and is an increasingly important supplier.
The Secretary's visit is notable for what it signals about the changing nature of US interest and involvement in a region that until recently was under the more-or-less exclusive influence of Russia, their "Near Abroad." Once Western companies began to establish themselves--ChevronTexaco set up operations in Kazakstan in 1993--closer governmental ties were bound to follow.
Russia is likely to view this relationship as unwelcome, and it is important to note that our interests and those of the Russians don't align well in the Caspian. Russia wants a big share of the infrastructure for getting Caspian oil to market, while the US prefers multiple routes involving smaller neighboring countries, such as Georgia, with its new pro-US government. This greatly oversimplifies the complexities of Caspian pipeline issues, about which books could be (and probably are being) written.
All in all, this is an area to watch, particularly as Russia becomes more self-confident and assertive in the wake of the likely landslide re-election of President Putin next month.
Interesting to see US Secretary of Defense Donald Rumsfeld visiting Kazakstan the other day and making security overtures to the Kazak government. Since the collapse of the Soviet Union, the countries around the Caspian Sea have been seen by some as a sort second Middle East. While the area's proved reserves of oil are still not on the scale of even Kuwait, by itself, it has upside potential and is an increasingly important supplier.
The Secretary's visit is notable for what it signals about the changing nature of US interest and involvement in a region that until recently was under the more-or-less exclusive influence of Russia, their "Near Abroad." Once Western companies began to establish themselves--ChevronTexaco set up operations in Kazakstan in 1993--closer governmental ties were bound to follow.
Russia is likely to view this relationship as unwelcome, and it is important to note that our interests and those of the Russians don't align well in the Caspian. Russia wants a big share of the infrastructure for getting Caspian oil to market, while the US prefers multiple routes involving smaller neighboring countries, such as Georgia, with its new pro-US government. This greatly oversimplifies the complexities of Caspian pipeline issues, about which books could be (and probably are being) written.
All in all, this is an area to watch, particularly as Russia becomes more self-confident and assertive in the wake of the likely landslide re-election of President Putin next month.
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