Friday, December 30, 2005

Subtracting Wedges

Since I started following the climate change issue in the mid-1990s, I’ve given a lot of thought to what might significantly change the US approach to the problem. Major signposts, such as weather/climate events, and dramatic scientific findings top the list. But perhaps a new way of looking at the situation could make a big difference, too. A novel conceptual framework from a Princeton engineering professor might just fit the bill, as described recently in The Economist (subscription required.)

Dr. Socolow’s idea is deceptively simple: rather than trying to tackle the whole problem at once, break it down into little pieces and focus on those. In the source article from last December's issue of Environment, he breaks down the emissions “triangle”--the difference between the status-quo greenhouse gas emissions trendline and the total reduction required to stabilize atmospheric GHG concentrations--into smaller, more manageable segments. These segments can be "filled" by improvements in five different areas:
  • Energy conservation
  • Renewable energy
  • "Enhanced natural sinks" (forest- and land-management)
  • Nuclear energy
  • Fossil carbon management (sequestration of CO2 and other greenhouse gases)
Even though all these areas have been widely discussed in the context of mitigating climate change, this framework isn’t as trivial or obvious as it might seem. After all, the fatal flaw of the Kyoto Treaty is that it applies modest reductions against the entire slate of global greenhouse gas emissions, simultaneously going too far for some and not far enough for others--or to make a real dent in the problem. One of the primary arguments against US participation in the Kyoto Treaty is that major developing countries, and in particular China and India, aren’t bound by Kyoto’s reduction targets and would gain competitive advantage vs. our economy.

If the successor treaty to Kyoto for the post-2012 period were made up of nested agreements focusing on individual slices of the problem, we might have a process in which all countries would willingly participate in some segments--and thus contribute towards bringing global emissions down to a sustainable level. For example, the EU might choose to pursue all segments, while the US could opt in for sequestration and nuclear power, but out for other areas. China and India might find renewables and reforestation attractive, while opting out of higher-cost sequestration.

This sounds potentially chaotic, but it aligns nicely with the pragmatic approach being pursued in the G-8 and elsewhere, of focusing on areas of agreement, rather than seeking unattainable universal agreement. It also puts the emphasis on truly solving the problem, rather than on satisfying preconceived notions of what a solution must look like.

Thursday, December 29, 2005

Global Gas

Ever since the hurricanes disabled a sizable fraction of US energy production from the Gulf Coast, I've been worried about the availability of natural gas this winter. So far, unseasonably warm weather has kept prices from spiking, indicating that supply remains adequate. Ironically, it's Europe that appears to be struggling with gas availability, rather than the US.

Natural gas futures prices in the UK are more than double their level of a year ago, actually exceeding US natural gas prices as of yesterday ($16/million BTU vs. $11.50 here.) With North Sea production declining and the UK economy growing, Britain is becoming a net importer of energy. At the same time, Continental Europe could get squeezed by the ongoing gas pricing dispute between Russia and Ukraine, with the former threatening to cut pipeline deliveries in the main line supplying Germany and the rest of Europe. This highlights the EU's critical dependence on Russian gas, as I've noted previously.

The reason for pointing this out isn't to make us feel better about the high prices we're paying for natural gas. Rather, it's to remind us that we are competing in an increasingly global natural gas market, not only with India and China, which are hungry for energy in any form, but with Europe, which has a particular preference for natural gas due to its low greenhouse gas emissions, relative to coal and oil. The focus of this competition will be liquefied natural gas, or LNG, the form in which gas can be shipped all over the world from its origin.

Although a spot market in LNG is starting to emerge, it is still very much a long-term contract business. That's understandable when you look at the cost of a gas liquefaction plant and its associated infrastructure, running into the multiple billions of dollars. Companies don't make these investments without having a large chunk of the future production contracted. This has important implications for the US, as we expand our infrastructure for receiving LNG, against a great deal of local opposition.

Delays in approving US LNG projects, due to lawsuits and local permitting problems, preclude the companies involved from signing contracts for the gas to supply these facilities, until the uncertainties are resolved. As a result, they may miss out entirely on the output of a new LNG production plant in the Middle East, Nigeria, Australia or Indonesia, because others are prepared to commit when we aren't. Since these contracts typically run for 20 years, which may be close to the life of the underlying gas reserves, there are typically no second chances. Missing out on the "base-load" output of new plants forces us to compete for unreliable "spot" market supplies, typically at higher prices.

With US natural gas production stagnating at least partly as a matter of choice--with substantial gas reserves placed off-limits for development--and with gas demand continuing to grow, we have no choice but to play the LNG game. But if this isn't to become another source of energy volatility for our economy, we must learn to play it astutely, and that means resolving our infrastructure schizophrenia, so US companies can compete effectively for new, long-term gas supplies in a market with many other players.

Wednesday, December 28, 2005

Local vs. Global Solutions

Climate change is a global issue. The consequences of greenhouse gas emissions manifest on a greatly-delayed basis around the world, rather than in direct changes to local conditions. Accordingly, it's not the kind of problem that lends itself easily to state-by-state measures, or even clusters of states acting together. But that is exactly what is happening, because the federal government has opted out of the international Kyoto process. A group of northeastern states, most of them participants in the regional acid-rain program, banded together to set their own emissions targets, and predictably one of these states has bailed out at the last minute.

The decision by Governor Romney of Massachusetts to withdraw from the seven state plan may be politically motivated--what isn't, these days--but it reflects the difficulty of trying to tackle global warming on your own, when your neighbors aren't subject to the same rules. Any governor has a responsibility to weigh environmental vs. economic impact in a situation such as this, and with interstate commerce and relocation--not to say offshoring--of offices and factories so common, this is a tough call even with regard to the local pollutants that cause smog.

But it's not a perfect world, and the same rationale can be used to justify inaction at any level, including internationally. The aggregate economy of the seven states in question is larger than all but a small handful of countries, so scale can't be the issue here. I suspect that most of Governor Romney's concerns could by alleviated by including access to emissions trading outside the Northeast, not as a fallback, but as a primary mechanism to keep costs down. Emissions trading works best when it can tap into the widest possible pool of available offsets, rather than a narrow trading pool of industries with very similar (and high) costs of achieving reductions.

Ultimately the message here should be that significant portions of the country want to tackle the problem directly, rather than waiting for R&D to produce lower-emission power plants and cars. That signal, combined with the inefficiency of a Balkanized approach similar to that for reformulated gasoline, should provide the impetus for stronger federal measures on climate change.

Tuesday, December 27, 2005

Access to Resources

Two stories in last week's news provide perfect counterpoints of the challenge facing the international oil industry with regard to gaining access to explore and produce oil and gas resources around the world. Both illustrate the degree to which these firms, despite their enormous cash flows and commensurate influence, are subject to the changing moods of host governments. The Bolivian election seems to be closing the door in that country, while changes in Kuwait's posture towards international participation in its oil sector seem much more positive.

As this op-ed from the New York Times suggests, it would be easy to over-react to the election of an avowed socialist as President of Bolivia. Evo Morales could never match the threat to US interests that Venezuela's President Chavez poses, but the rise of a similar anti-capitalist democratic sentiment in a resource-rich country such as Nigeria could be disastrous. Bolivia is a good example of the shortcomings of the current globalization system. It is in everyone's interest that these failings be addressed in a way that makes free markets beneficial for as many as possible, and not just for elites.

Kuwait is a very different story. As this excellent article from Friday's NY Times explains, Kuwait's desire to expand its production and optimize the income from its petroleum before alternatives cap the market can only be facilitated through foreign investment and expertise. Opening up Kuwait's undeveloped fields to international companies, even on terms that won't allow the latter to book the associated reserves, would represent an important breakthrough with positive implications for future oil supply and moderating prices for the next decade.

As much as the oil companies tout their impressive technology for locating and extracting oil in hard-to-reach places, their ability to navigate local responses to globalization could have a bigger impact on future energy supplies.

Friday, December 23, 2005

Deferred Again

The Congressional opponents of drilling for oil in the Arctic National Wildlife Refuge (ANWR) won another battle this week in their long war of attrition against the majority that thinks drilling should proceed. I don't have anything new to say on the underlying issue and continue to believe that time is running out on the opportunity to trade a concession on ANWR for major improvements in energy efficiency or a national cap on CO2 emissions. I'll confine my comments today to the process by which ANWR came up for its most recent vote.

The major objection seems to be that the provision to allow drilling was attached to a vital defense spending bill in a "procedural trick." But isn't defeating it by a minority threat of a Senate filibuster, rather than an up-or-down floor vote, just as much of a "trick"--at least from the perspective of an average citizen?

It's also fascinating that so many Senators took umbrage at linking ANWR to a defense bill, given the mileage that Democratic candidates have gotten connecting America's unconstrained appetite for energy to our global defense posture and expenditures. I've never entirely bought that argument, but I have to admit that with troops deployed in the heart of the Middle East, it is hardly a non-sequitur to talk about increasing domestic oil production in the same breath.

Where I agree wholeheartedly with some of the opponents is that ANWR is big enough and important enough to deserve a fair hearing on its merits--and I would add, shorn of all the posturing and pandering that has attended it over the years. Those who see ANWR merely as a gift to the oil companies have been drinking too much of their own Kool-Aid, and anyone who was high-fiving and crowing at this outcome ought to gain some sobriety contemplating his or her future remorse, should the result eventually go the other way with nothing to show for a two-decade holding action.

Well, I suppose that's an awfully cynical note to attach to my holiday greetings. Nevertheless, I'd like to wish all my readers a Merry Christmas or Happy Hanukkah, and a happy Boxing Day (which I've celebrated ever since my stint in the UK.) Postings will resume on 12/27.

Thursday, December 22, 2005

Fat vs. Skinny Branches

No sooner had I posted yesterday's blog on the economics of hybrid cars than I ran across an article on an entirely new hybrid technology, developed by no less than the Environmental Protection Agency. Hybrids are a long way from being a mature technology, so it shouldn't bother anyone that this entirely mechanical system might go into production to compete with the hybrid-electrics currently on the market. The only risk I see in this development resembles that of the Betamax vs. VHS video format wars of the 1980s: the best technology might not win out.

When comparing different technologies, it's useful to think about the further options they create. The whole advanced energy technology field looks like a giant decision tree, loaded with branches, many with multiple sub-branches. An advance at one level of the tree can create new branches or terminate old ones. Nor are all branches equally "thick", in the sense of how many other branches they affect. Viewed this way, the hybrid-electric technology behind the Toyota Prius, Ford Escape, et al constitutes a particularly thick branch, and that makes the technology pretty robust.

For example, the power electronics and battery systems developed for this type of hybrid will also benefit work on fuel cell cars, and vice versa. Battery advances will not only improve the performance of today's hybrid models, but will also facilitate bringing to market "plug-in" hybrids with substantial electric-only range. For that matter, the growing real-world experience with hybrids would be applicable to a new generation of all-electric cars, if a cost or performance breakthrough in batteries occurs. So you can see how these various branches of hybrids, batteries, and fuel cells twist around each other and support each other. In other words, hybrid-electrics represent the thin end of a wedge that could allow electricity to substitute directly for gasoline, an option we don't have today.

By comparison, the hydraulic hybrid vehicle system being developed by the EPA represents a lone, skinny branch. It would have to rely on an initial cost advantage to capture market share, either from hybrid-electrics or from conventional cars. Now, don't get me wrong; the fuel economy improvements touted for this technology are substantial and would have a real impact on US oil demand if widely adopted. However, when you compare the two technologies in the way I suggested above, hydraulic hybridization starts to look like a dead end or potential "orphan" in the future. That could result in a consumer backlash against all hybrids and other new technology cars.

Furthermore, if the adoption of mechanical hybrids ended up slowing down or aborting the broader trend of electrification of cars, the short-term fuel economy gains would not be worth the loss of long-term, non-hydrocarbon transportation energy options. And I'm not sure you can rely on the market to sort this out, since the playing field isn't exactly level in this case. Someone may actually have to make a tough call, based on a careful assessment of the complex issues involved.

Wednesday, December 21, 2005

Hybrids Down to Earth

Lately I keep running into articles and commentaries (subscription required) suggesting that hybrid cars are a disappointment and simply not worth their price premium over conventional cars. Most of these critiques miss some fundamental aspect of the hybrid value proposition, but taken together they provide a useful reminder that hybrids will achieve full success--wide popularity that translates into a large market share--only if they can satisfy large numbers of consumers.

The chief complaints seems to focus on a basic cost/benefit analysis of gasoline savings. Taking the most popular hybrid, the Toyota Prius, as an example, the car costs $3,280 more than a base-model 4-cylinder Camry. I've seen others compare it to the Corolla, but it's really closer to the former, based on passenger room and cargo space. The Camry is rated at 28 miles per gallon, versus the Prius at 55. With gasoline now at $2.26 per gallon on average in the US, and assuming the national average usage of 12,000 miles per year, the non-discounted payout for the implied hybrid premium is 7 years, or about the average time most folks keep a car that they buy, instead of leasing.

But I don't think this tells the full story, for two reasons. First, if you think about a hybrid's value in terms of consumer utility, only part of this relates to fuel savings. At least for environmentally-minded consumers, some of the utility derives from the Prius's lower emissions of greenhouse gases and tailpipe pollutants. The value of the former can be quantified by looking at the alternative of buying emissions offsets from TerraPass at $50 per year. This shortens the hybrid's payout period by at least a few months. Finally, if the buyer is of the "Geo-Green" persuasion, he would also derive some utility from the knowledge that he is doing his bit to reduce our dependence on imported oil, including oil from the Middle East. I don't know how to put a value on that.

The other problem is that you need to make an assumption about how much of the initial premium will persist in the car's resale value. Resale values from Kelly Blue Book give us early estimates of this, recognizing that the market for used hybrids is pretty thin. Comparing a 2001 base Camry to a 2001 Prius with the same mileage, the Prius is worth $5,000 more, based on KBB's "private party value." That suggests that the added cost of buying a hybrid might not be more than the time value of money on the up-front premium. It may even be negative, if hybrids consistently retain more of their initial value than their conventional counterparts.

Finally, we need to recognize that hybrids are still pretty new, and part of their high cost relates to the relatively low volume built so far. Eventually, hybridization should effectively become an option on most models, rather than creating a separate and distinct models. In that way, it will end up being priced like more traditional options, such as automatic transmissions and air conditioning, which have declined substantially as a fraction of total car purchase price since they were first offered. At that point, the tradeoffs involved in buying a hybrid should be simpler and more transparent.

Tuesday, December 20, 2005

The Next Oil Crisis

Yesterday I suggested that we are seeing signs of the fundamentals for oil starting to weaken, setting up the possibility that oil could finish next year quite a bit lower than this year, possibly under $40/barrel. Now let's turn to the flip side. Other than the usual production problems, contract disputes and strikes that have amplified the oil-price roller-coaster ride for the last couple of years, there are two geopolitical situations that contain the seeds of a genuine oil-supply crisis. I've been talking about both for a while: Venezuela and Iran. As much as I've been on President Chavez's case, my gut feeling is that we will find a modus vivendi with him; I'm much less sanguine about Iran, and less sure than I was previously that time is on our side, there.

While I disagree with Charles Krauthammer well over 50% of the time, I believe his Wall St. Journal op-ed on Iran (subscription required) is 100% right. The country's duly-elected president is a rabid nut-case, though unfortunately not without like-minded support in the region. And based on what the IAEA has reported, the chances of his having access to nuclear weapons within his term of office are uncomfortably high. President Ahmadinejad is literally a Wild Card.

Furthermore, I have little faith that the international diplomatic processes now underway will succeed in denying Iran the means of developing nuclear weapons. Given the nuclear technology that has circulated in black-market channels and the state of Iran's missile programs, the only missing ingredient is weapons-grade Uranium or Plutonium, and that is precisely what Iran's present nuclear program appears designed to deliver. The relationships Iran has cultivated with Russia and China virtually guarantee they will be allowed to complete their work.

Although the other regional and global ramifications of that development are highly uncertain, the implications for oil markets are clear. Whether as a response to serious international sanctions--which I consider unlikely to be imposed--or to a pre-emptive strike against Iran's weapons complexes, the likelihood of Iran's oil being withdrawn from the market at some point is very high. That would send oil prices to record highs. Ironically, the real-dollar highs that would be broken would be those from the last Iranian oil crisis, back in 1979.

So what's the probability of this happening in the next twelve months? Without any scientific basis I'd say at least 25%. If it happens, it could provide just the kind of crash-program impetus that supporters of alternative energy have been looking for. At the same time, it makes the shares of oil-company stocks a pretty interesting option play, even at their current high prices.

Monday, December 19, 2005

Too High or Too Low?

One of the deep truths about oil prices is that they are impossible to predict even a year out, and that they have a historical tendency to change direction dramatically, as markets over-correct to changing circumstances. Last week's OPEC meeting ended with unchanged quotas and the hope that the cartel could keep the price propped up over $50 indefinitely. The gradual abatement of at least two of the three main factors underlying current high prices--low inventories in the wake of the Gulf Coast hurricanes, a global production capacity cushion near zero, and soaring global demand--may make it harder for OPEC to pull that off than most of us would guess today. However, even as the first real glimmer of the fundamentals that would take prices lower begin to appear, there are a lot of other folks besides OPEC rooting for prices to stay high.

First, the companies that have benefited with record earnings and cash flows may be reluctant to see prices drop, though as the Economist recently suggested, it is price uncertainty, rather than absolute price levels, that weighs heaviest on oil companies' future production planning calculations. Most of these companies would still do very well at $35-40/barrel, and their growth prospects would benefit greatly if oil settled into a more stable range of $35-45, rather than the $20-70 we've seen over the last four years.

Environmentalists and those concerned about energy security, though, are pulling for higher prices for other reasons. In the absence of a consensus to raise US gasoline taxes to European levels, the only mechanism that is likely to constrain the growth of demand while providing enough incentive to develop alternative fuels is high market prices, even if the main beneficiaries are the multinational oil companies and OPEC, rather than US taxpayers. And I can understand this concern, as the retreat of gasoline prices to the low $2's has restored much of the apparent energy compacency of the American public.

I can't help wondering if this lies behind some of the opposition to drilling in the Arctic National Wildlife Refuge (ANWR), which the current Congress is doing its darnedest to approve. After all, couldn't finding another North Slope and injecting a million-plus barrels per day into America's oilstream postpone the advent of renewables and synfuels for another decade? No one should worry on this account. As strongly as I've supported ANWR, for what I believe are very good reasons, its peak output in the mid-2010s would only provide some valuable negotiating leverage in international markets. It would take a lot more than ANWR to change the global supply/demand balance enough to hold back the coming wave of alternatives, including oilsands, gas-to-liquids, and renewables.

If you must oppose ANWR, please do so out of concern for what you fear it will do in Alaska, not out of some game-theoretical calculation about its effect on alternative energy programs. The recent CERA presentation to Congress on peak oil made it clear that meeting future energy demand growth will call for a bit of everything, including some things they didn't mention, such as wind, solar and other renewables. Improvements in technology are lowering the cost threshold of many of these alternatives, so that they won't need $70 oil to be competitive, and their very success will act to depress future oil prices. We need to advance to the point at which we are pursuing alternative energy in spite of oil prices, not because of them.

Friday, December 16, 2005

If Not There...?

Highlighting the destructive and counter-productive nature of the NIMBY-ism that is so prevalent today has been a consistent theme of this blog since its inception. Nowhere are these contradictions more evident than for wind power projects, which while producing some of the cleanest energy in our entire national portfolio, nevertheless have been opposed by a variety of groups including prominent environmentalists. The Cape Wind project off Nantucket is the leading example of this, as demonstrated by today's New York Times op-ed by Robert F. Kennedy, Jr., one of the project's most vocal opponents.

Developing wind power is like exploiting oil or gas reservoirs in the sense that you have to go where the resource is, not where you wish it were. That means that wind developers do not have an infinite choice of suitable locations. In a country of 300 million people, and especially in the heavily populated Northeast, the chances of finding a prime wind location that won't affect someone--whether in terms of livelihood or aesthetics--are low. Mr. Kennedy suggests that Cape Wind go elsewhere, but his suggested alternative of deep water further offshore contradicts his own earlier argument about the high cost of offshore wind compared to land-based developments.

I think Mr. Kennedy also overplays the term "wilderness" in this context. The area in question may indeed be a national treasure, as he suggests, but it fails any common sense definition of wilderness, based on the real estate, commercial and transportation interests he cites as being at risk. Having recently passed through Santa Barbara, CA, which can make equal claims to natural beauty, I also have to question his estimates of lost tourism. It certainly wasn't apparent that Santa Barbara's economy has suffered from the offshore oil platforms that dot its coast, and wind turbines are arguably more attractive than oil rigs.

In any case, I continue to believe that in the current environment of high energy prices and concerns about pollution and climate change, the only reasonable basis for shutting down a project such as Cape Wind would be for its opponents to assemble a package of equivalent clean energy or efficiency projects, so that the net result of stopping Cape Wind isn't simply burning more coal in someone else's back yard. Mr. Kennedy should understand as well as anyone the importance of securing clean, domestic energy sources, given the recent involvement of his brother's company, Citizens Energy Corporation, with Venezuelan President Huge Chavez's "energy charity" to New England.

Thursday, December 15, 2005

Congress Examines Peak Oil

One of the topics to which I've devoted considerable space in this blog in the last two years is that of an imminent peak in oil production. This idea has emerged from a technical argument in the journals of the industry to become a topic of considerable interest to the general public, particularly to those concerned about our future supplies of energy. The percolation of this notion has finally reached the top, with a recent Congressional hearing devoted to the subject.

On December 7 (unintentional irony?) the Energy and Air Quality subcommittee of the House Committee on Energy and Commerce heard testimony from two panels, including a presentation by a senior representative of Cambridge Energy Research Associates (CERA). As I've mentioned previously, CERA's detailed analysis of oil projects under development or in planning stages indicates that production will continue to grow to meet--or exceed--demand. That means no peak within the project planning horizon of the energy industry, going out 15 to 20 years. However, I don't anticipate that these figures--even if they prove entirely accurate--will dispel concerns about Peak Oil. The Peak Oil meme is uniquely suited for the times in which we live, which one of the New York Times' regular op-ed contributors recently referred to as an Age of Skepticism.

The combination of the Iraq War, the Enron scandal, and Shell's reserve accounting snafu last year sets the stage for deep skepticism about any analysis suggesting that running short of oil needn't concern us for a generation. After all, it's been a fundamental assumption since the 1970s that oil was finite and would run out, possibly within the lifetime of the Baby Boomers. But it's also worth noting that some of the production streams deferring a peak in oil production are pretty unconventional, at least by 1970s standards. Without the contribution from oil sands and heavy oil, ultra-deepwater drilling, and the liquids associated with higher global natural gas production, we would be in deep trouble very soon.

Personally, I remain skeptical about the Peak Oil theory, worrying less about the Hubbert Curve than about the "above-ground risk" issues to which CERA alluded. These encompass all of the things--strikes, hurricanes, coups, terrorist attacks, and changes in contractual terms--that happen in the real world to keep oil in the ground from being delivered to customers. Add to this the inevitable and worrying enhancement of OPEC's market power implicit in CERA's projections, and we ought to have all the incentive anyone would need to diversify our energy sources to include more natural gas, renewable energy, and nuclear power.

Wednesday, December 14, 2005

How Did Natural Gas Get to $15?

The futures contract for natural gas for delivery in January 2006 is currently over $15 per million BTUs. The same contract traded under $8 this time last year, and that was high compared to historical averages of $2-3/MMBTU. Its current price equates to $90/barrel crude oil and suggests that our natural gas supplies are even tighter than for crude oil, since the two commodities were trading at a rough energy-equivalent parity until recently. While this is partly a function of icy cold weather in the Northeast and the extended recovery from this year's hurricanes, the causes go much deeper.

The switch by industry and utilities from oil to natural gas played a key role in resolving the energy crises of the 1970s and early 1980s. US gas demand has grown steadily ever since. Natural gas now accounts for 18% of total US electricity generation--50% more than in 1991--and has dominated new electric generating capacity construction for more than a decade, as a result of the tremendous improvements in combined cycle gas turbines and the impact of environmental regulations restricting power plant emissions. This will be an even more important factor in the future, because of the low greenhouse gas emissions of natural gas-fired power plants.

Unfortunately, investment in gas resource development and pipeline infrastructure has been more sporadic, and this wasn't helped by industry forecasts as recently as 1999 that anticipated ample future supplies to meet the expected rapid growth in demand. When power plant developers chose gas-fired technologies over coal or other alternatives, they did so with reasonable assurances that the gas would be there for them at an affordable price. Calpine was one of the companies that placed big, strategic bets on this proposition, and those bets are now coming due.

So over the course of a few years, we've gone from an expected surplus to a serious shortfall, and that didn't just happen because of some hurricanes in the Gulf Coast. The decline of US oil production and the oil industry's understandable shift to looking overseas for larger production opportunities is an important factor. Reduced domestic oil production decreased the potential for "associated gas", i.e. natural gas produced from crude oil reservoirs. Combine that with more rapid decline rates from mature gas fields and the drilling bans and other restrictions I've been railing against since I started this blog, and we have the perfect setup for a gas crunch. The twin storms of 2005 merely hastened its arrival by a year or two.

The only mitigating factor today is that the key gas-consuming industries in the Gulf Coast were as badly affected by the hurricanes as the gas production itself, with the result that the levels of gas in storage for winter have been about normal for this time of year. That stored gas won't last long, though, if industrial demand returns to normal while supplies remain shut in. I doubt we'll experience residential supply interruptions, but companies that rely on gas may face actual interruption of deliveries, not just high prices. After a few months of that, I suspect those proposed LNG import terminals won't look nearly so scary.

Tuesday, December 13, 2005

Revolving Tür

Another item from the last week that caught my attention was the announcement that the recently-former German Chancellor Gerhard Schroeder had accepted a management position with a subsidiary of the Russian state natural gas company, Gazprom. Russia is one of Germany's largest energy suppliers, so to put this in perspective for a US audience, it would be tantamount to George W. Bush accepting a position with Saudi Aramco in February 2009. Can you imagine the political fallout that would create?

To spice things up a bit more, only a few months ago Herr Schroeder was instrumental in pushing through a new gas pipeline route from Russia to Germany that will traverse the Baltic Sea and bypass Poland and the former Baltic republics of the USSR, vexing them all. In his new capacity, Herr Schroeder will apparently supervise the division of Gazprom responsible for building this pipeline. Rumors to this effect were vigorously denied when they surfaced back in October. In the US, this kind of revolving-door hiring of someone directly involved in a controversial contract would generate all kinds of investigations and Congressional outcry. The German reaction so far seems focused on creating a code of conduct for ex-officials.

Absent the appearance of impropriety, Schroeder's appointment might have been seen as a clever move from both the German and Russian perspectives. It provides Gazprom with a bit of international leadership credibility in advance of a partial privatization--if that ever really materializes--and it helps cement a very important trade relationship for Germany. But can an event like this really be viewed in such a narrow context, particularly given the lingering frictions between Germany and France, and the new EU members that were Soviet satellites as recently as 1990? Surely this presents the new German coalition government with an unwelcome intra-EU political challenge, as well as a distraction from their efforts to institute meaningful economic reforms.

However the situation turns out, including the possibility that he may yield to critics and withdraw from this new post, you have to hand it to Gerhard Schroeder. He didn't hesitate to oppose the US over Iraq for personal political gain--aiding his reelection but alienating his country's most important ally in the process--and he isn't shy about seeking personal gain out of office in a move laden with conflicts of interest.

Monday, December 12, 2005

Voluntary Mechanisms

There are several topics from my week's absence that I could comment on, including the pending difficulties of Calpine and the prospects for a change in OPEC quotas at today's meeting, but the item with the longest-term implications may be the inconclusive climate change talks that wrapped up on Saturday in Montreal. Although they agreed to begin discussions on what should follow the Kyoto Treaty after it expires in 2012, the major blocs remain divided on whether the response to climate change should be based on voluntary or mandatory targets. It is hard to divorce these competing approaches from underlying views on the urgency of action.

The UN Framework Convention on Climate Change and the specific Kyoto Treaty that grew out of it require periodic global meetings on the issues, of which the Montreal meeting was only the latest. One of Montreal's most visible goals was to lay the groundwork for an agreement subsequent to the 2008-2012 "measurement period" of the current Kyoto Treaty--the so-called "son of Kyoto." Now, it might seem premature to ring alarm bells about a process that wouldn't even take effect for another 7 years. However, given the difficulties in the Kyoto negotiations, which ultimately missed including the US or large developing countries such as China and India, it is imperative that any successor treaty have all the parties on board, or risk total irrelevance in the real world. That means finding a way to bridge the gap between voluntary emissions reductions--which the US favors--and the mandatory reductions agreed to by the Kyoto signatories such as the EU, Russia and Canada.

The other impetus for early agreement on a successor to Kyoto stems from a growing recognition that the Kyoto Treaty itself falls far short of the dramatic reductions that would be required if climate change were proceeding along anything like a worst-case path. Nor is it clear that the reductions agreed to by the countries that signed on to Kyoto will actually be achieved. "Son of Kyoto" must make broader and deeper cuts for the long-term, or we should forget about the UN climate process and focus on adapting to a warmer world, with unpredictable local consequences.

This sounds bleak, but there've been lots of positive indications recently, including the G-8 Gleneagles agreement and a similar Asia-Pacific approach, focusing on areas of agreement, rather than differences. Technology is the key to this approach, based on a recognition that the greenhouse gas emissions reductions necessary to stabilize the atmospheric concentration of these gases cannot be achieved with current vehicle and power plant technology and global economic growth.

Former-President Clinton may have said it best in Montreal, when he indicated that while firm targets were essential to the creation of a viable carbon-trading market, those standing outside firm targets could still focus on the things--e.g. technologies--that would have to be done to achieve reductions. "Disagreements (over specifics) shouldn't be a reason to do nothing." The ultimate shape of any consensus on this issue will probably be influenced by a combination of real-world experience putting Kyoto into action during 2008-12, and on the visible environmental indicators of actual climate change.