Friday, September 29, 2006

Collateral Brand Damage

I've been wondering how long it would take for the increasingly anti-American tone and actions of Venezuela's president to harm the interests of his country's wholly-owned US affiliate, Citgo Petroleum. Yesterday, that uncertainty became concrete, with the cancellation by 7-Eleven of its 20-year old supply and co-branding relationship with Citgo. 7-Eleven convenience stores with gas pumps will soon fly their own flag, rather than Citgo's. While I'm sure there's a lot of truth behind both parties' claims that this move resulted from diverging business strategies, rather than being prompted by the torrent of invective that Hugo Chavez issued during his recent visit to the US, the timing cannot be entirely coincidental. This could signal the beginning of serious problems for Citgo.

As a subsidiary of PdVSA, the Venezuelan state oil company, Citgo has had an impressive run in this country. They amassed a retail network of approximately 14,000 stations, putting them in the top tier of US gasoline marketers, with brands like Shell and Exxon. As is the case for most major oil companies, Citgo owns and operates few of these stations directly. Mostly, these are independent businesses with contracts for supply from Citgo that allow them to use the company's brand and capitalize on its advertising and network benefits. If those benefits become liabilities, because of a shift in public perceptions by US consumers--as the Washington Post article suggests may be occurring--Citgo could experience a dramatic reduction in the size of its network, as dealers flee to other brands with less baggage, including regional brands or their own brand. Citgo could find itself deprived of the higher margins that usually accompany integration to the retail level.

I have never participated in a gas station boycott, and I have gone out of my way to oppose some that I ran across. They harm local businesses more than the owners of the brands with which they are aligned. As a matter of personal choice, though, I have avoided filling up at Citgo since Mr. Chavez came to power. However small the profit margin that would find its way back to PdVSA, I can't in good conscience criticize Mr. Chavez's policies while supporting them financially. If more Americans come to share my views, today's Citgo retailers will face some tough decisions about their brand, and the corporation may need to sell more than just its interest in one refinery.

Wednesday, September 27, 2006

The $4 Floor

Although it hasn't garnered the headlines that have accompanied the recent drop in gasoline prices, the decline in the natural gas market has been even more precipitous. If it's not getting much attention in the media, it was certainly a key topic at the industry conference I'm attending. In the last month, the futures price for natural gas for October delivery at the Henry Hub in Louisiana has declined from about $7/million BTUs to $4.20, the lowest such price since December 2002. As a result, one US gas producer announced today that it would shut in 6% of its production, which presumably costs more than the current price to produce. That piece of news is indicative of the underlying shifts that have occurred in the US natural gas industry, without much fanfare.

After last year's hurricanes, natural gas prices zoomed over $10/MMBTU, rising steadily to reach $15 in early December 2005. If we look back only a few years earlier, however, gas routinely traded in the $2-$3 range, making the spike in natural gas prices at least as dramatic as what we've seen for crude oil. Anyone hoping to see those levels again would have to bank on a major expansion of low-cost domestic supply, and that is just not in the cards. As I heard in several presentations today, an increasing proportion of our future domestic gas supply will come from wells in deep water and from so-called unconventional gas resources, such as shale formations, coal beds, and other higher-cost sources. The domestic industry's price structure has changed permanently, because there is no longer enough cheap gas available here or in Canada to meet our growing demand. LNG can provide us with significant new supplies, if we build enough infrastructure to receive it, but its delivered cost will not be less than $4, either.

For individual consumers, this may all seem a bit moot. Even if prices rise in the next few weeks to the levels that the futures market currently reflects for winter delivery, around $7, this will still provide significant relief compared with last year. But for manufacturers that have been shutting down facilities and re-selling their gas supplies, because they can't make money when gas is four to six times higher than their imported competition pays, the best they can hope for is a floor price that is still twice what it was in the 1990s. We'll have to see if that is low enough to keep most of our gas-derived fertilizer and
petrochemical industry from moving offshore.


In the immediate aftermath of Hurricane Katrina, a few scientists questioned whether it might be time to evaluate the long-term siting of New Orleans and the mouth of the Mississippi River, which has been trying to shift its main channel for decades and has only been held back by the intervention of the Corps of Engineers. Given the magnitude of the post-Katrina human disaster and the fumbled federal, state and local responses, it seemed impolite to point out that nature was voting against the restoration of the antediluvian status quo. I'm surprised and pleased to see that a group of academics and local experts wasn't deterred, and has been investigating this subject in great detail. They've come out with some very interesting conclusions. The New York Times has a nice multi-media presentation on their report, along with a more detailed article. The group's recommendation sounds like clever engineering combined with a sort of environmental judo, giving in to the river's urge to shift, but focusing it at a point of our choosing.

The importance of this research extends beyond urban planning and land management. An unmanaged shift of the Mississippi to the channel of the Atchafalaya River would strand not only the Port of New Orleans, but also a sizeable fraction of the region's oil and petrochemical processing industry, with consequences for the entire US economy. As the article points out, the strategy of capturing the river sediments currently dumped over the continental shelf and using them to rebuild the region's disappearing wetlands would help New Orleans to withstand future hurricanes better, along with addressing other expected impacts from climate change.

I see a further benefit from this proposal. It has become almost axiomatic that, despite the growth of our economy and government over the last several decades, America has lost the knack of planning and executing national-scale projects. Successfully tackling the re-channeling of the Mississippi will require an enormous public/private effort, with management to match. If forecasts of the most dire outcomes of climate change are correct, we should consider shifting the Mississippi as a modest test flight for what could be required in the future. I will be following the progress of this effort with great interest.

Tuesday, September 26, 2006

Reconciling Hydrogen Engines

There's a lot of value in periodically reassessing your assumptions. It might not always change your mind, but occasionally you'll find that things have shifted enough to alter long-standing conclusions. I'm at such a point with regard to hydrogen-powered internal combustion engines. BMW is introducing their second-generation hydrogen 7-Series--still not a mass-production model, but a bit closer, with the ability to switch between gasoline and H2. As this article in MIT's Technology Review reminds us, its environmental benefits hinge on how its hydrogen supply is made, and that's been my problem with this concept for many years. Turning natural gas into hydrogen--the primary production method today--and then burning it in an ICE is a pretty dodgy proposition, both economically and environmentally. If that were the whole story, my judgment would remain unchanged: bad idea.

What has changed since the last time I gave this proposition much thought is the prospect of large amounts of intermittent renewable electricity. Before, the best use of that electricity always seemed to be in backing down our use of those electricity sources that contribute the most local pollution and greenhouse gas emissions, typically coal-fired power plants. But if there's more wind power than the local grid can absorb, turning the surplus into hydrogen for cars like the new BMW could make sense.

Let's be clear: an ICE is never going to use hydrogen as efficiently as a fuel cell car would, and many of the advocates of H2 ICEs see them only as a bridge to encourage the necessary refueling infrastructure to develop, while fuel cell developers work towards a product that's cheap enough to compete. It's a way to break the key chicken-and-egg hurdle facing fuel cells, even if BMW doesn't see it this way. In any case, demand for hydrogen in transportation is likely to be modest for many years to come.

Now, in the real world there would be no way to be sure where the H2 fuel for cars like this will come from, day to day, just as you can't be certain that the gasoline you buy won't come from oil produced in Libya, or Venezuela, or some other country whose government you might dislike. But as long as some of the hydrogen came from renewable sources that are truly surplus to power generation, this ought to be good enough to overcome the technical concerns of people like me, who focus on problems that don't trouble the public very much in any case, as we've seen for years with corn ethanol.

Monday, September 25, 2006

Dueling Worldviews

Tomorrow I'll be traveling to attend J.S. Herold's annual "Pacesetters Energy Conference," at which I'm moderating a panel on alternative energy. My postings this week may be more sporadic than usual, but I should return with some new insights. Speaking of insights, this weekend as I caught up on recent op-eds from the New York Times, it seemed as if my two favorite columnists, Tom Friedman and David Brooks, were engaging in an open debate about the future. While the radically divergent worldviews they described suggest very different versions of the years ahead, they are equally challenging for business-as-usual, in energy and everything else.

In an anecdote (Times Select required) reminiscent of his most recent book, "The World Is Flat," Mr. Friedman described how local entrepreneurs in Uruguay have partnered with India's leading technology company, Tata, to create a Western Hemisphere hub of outsourcing activity that peaks when India sleeps. As he explains it, universal access to connectivity and customers creates a dilemma for every business, "Will it be done by you, or to you?" Note how remote this view of the developing world seems from Hugo Chavez's channeled rage of the downtrodden masses: here one third-world country reaches out to lift up another, which possesses the right mix of education and laws to make this possible.

If that's the optimistic view, Mr. Brooks acts as the pessimist foil. His Thursday column provided a stark indictment of the UN and enumerated the risks of the emerging US strategy of containment--rather than confrontation--of Iran and other potential adversaries. He describes a world in which we may be unsure who is fighting against us on a given day. Lacking the means of comprehending their motivations, we attempt to fit them into inapt historical or sociological analogies. It's not hard to extrapolate from this to a long stretch of half-hearted conflict, until some mega-9/11 locks us into the rigid "us vs. them" mindset that has been a vital ingredient in all successful American wars.

These are widely divergent views of the future , with very different consequences for our economy and for energy. The Friedman world is incredibly challenging to American business, or at least to the competitiveness of American employment and wages. At the same time, the application of these ideas to conventional and alternative energy could knock down many current barriers and create a more sustainable energy foundation for global growth. It would also be tough on resource-producing countries that haven't invested enough in their social and physical infrastructure.

The Brooks world looks like 2006 on steroids: an endless sequence of confrontations, terror plots, threats and counter-threats, with energy prices riding the amplified waves of all these signals. America might remain the key global actor here, but it would also still be the central target and easy scapegoat. It's a great scenario for alternative energy as national savior, if investors are prepared to weather the inevitable dips. But it's a really unappealing, stressful ride, reminiscent of the ugly stretches when it appeared we were losing the Cold War.

However interesting these columnists' perspectives might be, reality is rarely so neat, more often yielding a mishmash of events and trends. But what if Friedman and Brooks were both right? Could we end up with the US locked in a long struggle with the various branches of Islamic extremism, while the rest of the world capitalizes on our pre-occupation by building a new global economy from the ground up? Even if we win the War on Terror, our chances of capitalizing on victory in the way we did after 1945, or thought we might after 1991, could be quite small. Transforming our economy--including energy--looks no less urgent than bolstering our security.

Friday, September 22, 2006

Chavez on the Loose

If they didn't carry serious implications for our country, the antics of Venezuela's President Hugo Chavez this week would have been good for some comic relief. "Yesterday, the devil came here," he said theatrically, standing at the rostrum of the UN General Assembly, "Right here. And it still smells of sulfur today." You can't make this stuff up. It's the product of a genuine megalomaniac, and I encourage you to read the full text of his UN speech. Separating out the bombast and excesses, however, his remarks contained important messages for us to ponder. Some may send a chill up your spine:

"What we now have to do is define the future of the world. Dawn is breaking out all over. You can see it in Africa and Europe and Latin America and Oceanea. I want to emphasize that optimistic vision. We have to strengthen ourselves, our will to do battle, our awareness. We have to build a new and better world."
If he is referring to the Latin America of his protege Evo Morales, the Africa of "freedom fighter" Robert Mugabe, or what he saw on a recent visit with Belarussian dictator Alexander Lukashenko, I can't imagine many in the West liking this better world he spoke of.

Repeatedly, he emphasized his rejection of the global political and economic order built in the aftermath of World War II. He evoked a new wave of anti-colonialism, in which the bonds to be thrown off are not those of foreign sovereignty, but of globalization, free trade, and consistent international law. Through rhetorical inversions, he turns the linkages of our liberal world order into chains to be broken, condemning even his host, the UN. While we might be tempted to dismiss this out of hand, there are two distinct challenges here that we shouldn't ignore.

First, we must conclude that the leader of an important oil supplier to the US cannot be relied upon to behave rationally, predictably, or necessarily in what others might consider his own best interests. I hope that the CEO of every international energy company with investments in Venezuela, and especially those contemplating further investments, was listening very carefully when he spoke. I've devoted a good deal of space in this blog to assessing the constraints Mr. Chavez would face in following through on his rhetoric, but we shouldn't fall into the trap of assuming he never will, or that he views those hindrances as we would. In particular, his threat to cut off oil exports to the US in the event of a conflict between us and Iran would, if carried out, greatly magnify the oil price impact of such an event and risk a much wider conflict.

The other challenge is more profound. Although it would be easy to write off Mr. Chavez's representations on the part of the world's poor as delusions or ravings, I'm afraid there's a good deal of truth here, not in his accusations, but in his sense that many people around the world share his perspective. Mr. Chavez is merely the loudest and most flamboyant of a large array of critics of globalization and of America. Is he mistaken in saying,

"And I think I have some inkling of what the peoples of the south, the oppressed people think. They would say, 'Yankee imperialist, go home.' I think that is what those people would say if they were given the microphone and if they could speak with one voice to the American imperialists."
Chavez may be playing to an audience of non-aligned countries, whose leadership he aspires to, and whose support he needs for a rotating seat on the Security Council. But his remarks at the UN and in Harlem reflect the currents and contain the seeds of a larger North-South conflict, about which we have been warned for decades. Fortunately, that conflict is hardly inevitable, if the US, EU and other partners continue to work on reforming the globalization system to make it fairer and more open. Our best defense against the Chavezes of the world lies in proving them wrong.

As a postscript, the stern rebukes of Chavez by House Minority Leader Pelosi and Congressman Rangel were welcome reminders of the days when politics ended at the water's edge.

Thursday, September 21, 2006

The Other Shoe

We have reached a major milestone in our approach to climate change, with politicians of every stripe positioning themselves as leaders on this issue. Earlier this week, we heard former V.P. Al Gore announce a "Carbon Freeze" campaign. Then the Department of Energy issued the Administration's latest plans for technology programs aimed at reducing future emissions of greenhouse gases. Now we see the Attorney General of California filing suit in US district court against essentially the entire US auto industry, both foreign- and domestic-owned, alleging something akin to product liability with regard to CO2 emissions from cars. Is this a coincidence, in a year in which his party is trying to unseat Governor Schwarzenegger, who has pushed through his own greenhouse gas reduction program? But there's more at stake here than a new campaign issue. Ultimately, this concerns how and where climate change policy will be set in this country. That's more than just turf; how this gets resolved will have an enormous influence on the effectiveness of our response to a key global threat.

It shouldn't surprise anyone that this issue is turning up in state legislatures and the courts. The federal government effectively ceded its lead on climate change when it opted out of the Kyoto Agreement, by a 95-0 Senate vote in 1997. Nor can we forget that for decades environmental policy has been shaped as much in the courts as in the Congress. The result has been a mixed bag of conflicting regulations and genuine social benefits. But whatever the past track record of judicial involvement in setting environmental law, the courts have never before dealt with an environmental issue that is truly global in scope, rather than regional or local, or that arises not from some impurity or defect, but as an unavoidable consequence of the combustion of carbon, upon which most of our civilization is based.

Turning CO2 into the next tobacco-style tort bonanza, either by designating it as a pollutant or alleging specific damages, as California is seeking to do, is wrong-headed and will prove counterproductive to any serious effort to address the causes of the problem. Transferring billions from car companies--or oil companies--to state treasuries isn't going to advance the cause of putting more hybrid or fuel cell cars on the road, or ramping up biofuels production. It might just retard this effort.

At the same time, it's hard to foresee any slackening in state climate change initiatives until the federal government reasserts its natural primacy in this area, and that will require more than just technology programs. The current pace of technology development and adoption, even with appropriate incentives to make the results more attractive to businesses and consumers, can only shift the future trendline for incremental consumption of fossil fuels. The states are looking for something more fundamental, addressing baseline consumption by existing cars, appliances, homes and factories. Unfortunately, we could end up with 50 different approaches to a problem that affects the whole country and the entire globe.

Wednesday, September 20, 2006

Freezing Carbon

Yesterday afternoon, one of my readers alerted me to an interesting development on the climate change front. At a speech in New York on Monday, former Vice President Gore called for the US to freeze its emissions of greenhouse gases. He is promoting the formation of a movement analogous to the Nuclear Freeze movement of the 1980s, as a way to pressure government to do something immediately, rather than pursuing a gradual and largely voluntary approach to reducing the emissions associated with global warming. After reading the transcript of his earlier comments on his film, "An Inconvenient Truth," I wish Mr. Gore had remained focused on carbon neutrality, which would move us in the same direction, but might be achieved without the kind of economic dislocations an actual freeze would entail.

On the positive side, I'm sympathetic to Mr. Gore's suggestion that incremental responses and far-future targets are unlikely to galvanize the American public sufficiently to create the political will to address this problem. "Carbon Freeze" is a catchy name, even if it sounds like what happened to Han Solo at the end of "The Empire Strikes Back," rather than an environmental policy. Public perception of climate change remains the key hurdle in the US, and something like this might break through a wall of confusion and apathy. At the same time, I'm concerned about the risks this strategy entails, first and foremost to the US economy, but also to our ability to sustain a long-term response to climate change.

With regard to the economy, I realize this has been the principal argument against US participation in the Kyoto Accord and any other emissions-reduction measure with real teeth, up to and including the current proposals for a carbon emissions cap in California and other states. But I'm also cognizant of the relationships between emissions and energy, and between energy and economic output. Freezing emissions means freezing energy usage, and in the short term, that will weaken our economic output, i.e. GDP. In the longer term, substitution of more efficient vehicles, devices, and manufacturing capacity will moderate the impact by further reducing the BTU/$GDP correlation, and possibly even creating energy-free GDP, as advocates claim. Freezing emissions on a crash basis would cost many US jobs--particularly, but not exclusively manufacturing jobs--and we shouldn't delude ourselves about that. If we were truly in a climate crisis, that might be a price we would have to pay.

And therein lies my other concern. Mr. Gore proclaims that we are in a crisis, that we might have only 10 years left in which to reverse the climatic shifts our emissions are inducing, or face terrible, unalterable consequences. Bluntly, while there is indeed a consensus that the climate is warming and that man-made emissions are largely responsible for that warming, there is no such consensus that we face an immediate crisis, at least not in the sense in which most of us would understand that phrase. The world is warming, risks of adverse consequences are increasing, and abrupt climate change of the "disrupted Atlantic conveyor" type remains a possibility. However, we are not in a "runaway greenhouse" and the idea that we entering into irreversible effects is, as far as I can tell, highly controversial. The downside risk of treating this as a crisis, as opposed to a problem to be solved over a couple of decades, is that it puts an enormous burden on the next few years of real climate to deliver unequivocal proof of these claims. Raise the public's concern too high, and a few cooler years could destroy support for the long-term responses that are needed.

Unfortunately, in the political debate that seems likely to follow Mr. Gore's suggestions, we could lose sight of the kernel of good ideas around which he has built this concept. Another decade of the status quo might not kill us, but it would create a much deeper hole to dig out of. And although we can't immediately freeze US carbon emissions, let alone those of the whole world, the tools are emerging for all of us to move towards carbon neutrality. I must sound like a shill for TerraPass, but they have the right idea. Drive the car you have, but offset its emissions by paying for efficiency investments elsewhere. Buy that plasma TV you want, but plant enough trees to compensate for the extra electricity. Run your factory, but pay farmers to capture and burn enough methane to negate your impact on the climate. And while all of that sounds less dramatic than a Carbon Freeze, it can be implemented within the amount of time it will take to recycle all the arguments about whether we should be in Kyoto or not.

Tuesday, September 19, 2006

Choosing a Legacy

When Russia shook off seven decades of Communism in the 1990s, reactions in the West ranged from widespread optimism and hope to somber skepticism. I recall lengthy discussions about this at my old firm, bolstered by some clever scenario planning focused on the future political and economic development of this temporarily-humbled colossus. I don't think any of us imagined, however, that the model that ultimately emerged might be patterned on Mexico, and not the Mexico of today, in which the loser of a closely-run Presidential election can hang on for weeks without admitting defeat. I mean the older Mexico of institutionalized single-party pseudo-democracy and its stagnant, nationalized energy industry. Russia may not be quite there, yet, but the trends are worrying.

For a brief period in the late 1990s it didn't seem to matter how or by whom Russia was led, because the popular wisdom held that the country mattered no more than Norway. That was silly on the face of it, but it was an enticing comparison in a world of cheap energy and quiescent geopolitics. Now it matters very much who leads Russia and how, especially for the global energy industry and its consumers. An op-ed in Sunday's Washington Post looked at the succession process for President Putin, who may indeed retire at the end of his term. The price of that departure, though, will apparently be the right to ensconce his chosen successor.

Whoever follows Vladimir Putin, he is likely to share similar views on the ownership of Russia's key resources, including energy. While one can write off the entire Yukos matter as the internal settling of an old grudge, the current harassment of Shell and Exxon, which are investing billions of dollars to unlock the enormous reserves of Russia's Far East, suggests that the political component of access to Russian resources will always outweigh the economic.

Russia is hardly the only place in which we see that, but it's one of the largest. The resulting throttling back of its long growth trend is going to make an enormous difference in the global oil balance. It's much harder to piece together an optimistic scenario of long-term oil supplies without Russia sitting firmly in the "open" category, rather than the "closed" column.

If Russia were trying to build up its oil and gas technology into world-class competitors, it had a great opportunity with aggressive private firms such as Yukos to take the lead, instead of semi- or re-nationalized firms such as Rosneft and Gazprom. Post-Yukos, we see a clear strategy built around firm control of the resources and their logistics, and the steady application of state power to reduce the influence that international firms gained during the Yeltsin years. That approach will keep world oil prices higher than they would otherwise be, making alternatives more attractive. But how well equipped is Russia to play the game that must eventually follow, in a more energy-efficient world dominated by electricity and liquid fuels from oil sands, coal and biofuels?

So as Mr. Putin ponders his legacy, he might do well to consider another country with bountiful oil riches, but which by its policy choices relegated itself as the perpetual junior partner to a more populous, economically-overwhelming neighbor. If he likes what he sees in Mexico, then he's on the right track. If he prefers to keep Russia in the first rank of nations, then he must change course and pursue greater openness and an environment that is conducive for foreign investment. Big as they are today, Russia's energy revenues are insufficient to transform it into a 21st century leader.

Monday, September 18, 2006

The Louder Message?

Today's Washington Post includes an op-ed on energy policy by Representative Sherwood Boehlert (R, NY,) chair of the House Science Committee. He argues that our approach to energy has been all talk and little action, and he draws an analogy to BP's recent problems in Alaska and elsewhere. He concludes that the market won't deliver conservation without being forced by government to produce more efficient products, by means such as more stringent Corporate Average Fuel Economy (CAFE) standards. I wonder, though, if such a move would send any louder message than the one currently being delivered by the voluntary decimation announced by Ford Motor Company last week.

Rep. Boehlert is mistaken in several details, but his assessment of the big picture is justified. It's incorrect to say that consumers haven't had the choice of more efficient cars for many years, or to think that simply changing CAFE standards will alter the industry's sales mix in ways that fuel prices haven't. He also mis-characterizes the long-overdue reassessment of a federal ban on offshore oil and gas drilling that was founded on 30-year old environmental assumptions and is simply incompatible with any notion of US energy security. But he is correct that merely promoting domestic production doesn't constitute an energy strategy, which must include a comprehensive view of the demand side, as well.

However, rather than remaining aloof from the issue, the market has sent a powerful message about the importance of efficiency. Sustained high gas prices utterly demolished the product strategy of the second-largest US carmaker, which was overly reliant on sales of big SUVs and pickup trucks and lacked sufficiently attractive cars and crossovers, to an even greater extent than its slumping US counterparts. Ford's massive employee "buyout" program was prompted by massive financial losses and a 3-year slide in their equity value, to levels that would put the company into play--if anyone else wanted to be saddled with their problems. Their present action will staunch the bleeding, but it's a poor and tardy substitute for the kind of efficiency-based product strategy Toyota launched nearly a decade ago, and that is carrying them to within striking distance of the #1 spot in the global auto industry.

I also don't believe that stricter CAFE standards would have averted this situation. Rather, two quirks in CAFE have contributed greatly to the present, sorry state of the US car business. The well-known "SUV Loophole" paved the way for building highly-profitable but grossly inefficient truck-based SUVs, and the Flexible Fuel offset, by which inexpensive ethanol compatibility turned millions of SUVs into sub-compacts on paper, delayed more meaningful responses. CAFE standards alone, even if they were simplified to eliminate all loopholes--a hard prospect to imagine in contemporary politics--are no substitute for sending consumers the signals that will change their buying habits. Nor do they replace sound strategic planning on the part of auto makers, when the signposts of rising oil prices have been evident for years.

The stricter CAFEs that Rep. Boehlert advocates won't force consumers to buy efficient cars; they will merely stimulate a wider array of choices. Let's hope that Ford's painful lesson has been learned by all, and that it won't just be Japanese, Korean and Chinese auto makers that benefit. As it was in the 1970s, it is too late for GM, Ford and Chrysler to get ahead of this curve and turn these trends to their advantage. Let's hope it's not too late for them to catch up, at all.

Friday, September 15, 2006

Studying Peak Oil

As I've noted previously, Peak Oil has become a mainstream idea in a remarkably short period, no doubt helped along by high oil prices. The subject generates great interest and heated debate both inside and and outside the oil industry, and has spawned many blogs devoted to monitoring its implications and supporting evidence. Yesterday's news included two indicators of this controversy. The Wall Street Journal reminded us that nearly a year ago, the US Secretary of Energy gave the National Petroleum Council the task of comparing the conflicting estimates of oil supply and demand. And at the OPEC meeting in Vienna, Mr. Jum'ah, the head of the Saudi state oil company, dismissed the notion entirely, suggesting that oil resources would be adequate for a hundred years' supply at current production rates. I would be very surprised if the NPC study confirmed that estimate.

The arguments over Peak Oil quickly become esoteric. At the highest level, they revolve around how much oil resides within the earth's crust in locations and geological structures that are conducive to recovery with current or anticipated technology. The recent giant Gulf Coast deepwater discovery indicates how much of a moving target the latter is, since it would have been essentially impossible to find, drill and produce this kind of structure a decade ago. It's not hard to imagine vast future quantities of untapped oil, if you factor in the prospect of further such discoveries, in deeper and deeper water, along with the vast known hydrocarbon resources tied up in oil sands, oil shale, and ultra-heavy oil. But there's more to this story.

The deeper argument arises from the characteristics of the many thousands of oil fields that comprise our current supply. A mere hundred or so of these account for about a third of global production, and many of these giants are getting long in the tooth. Believers in Peak Oil question the industry's ability to bring on enough large new fields, fast enough, to counteract the inevitable decline of today's big producers--mirroring on a global scale the peak and decline experienced in the US in the 1970s. Even though the issues of total endowment and the pipeline of new projects are related, geopolitics and industry structure make the latter a true potential choke point, almost without regard to whether total recoverable oil stands at 1 trillion barrels or 5.7 trillion.

The NPC's website indicates their study should be finalized by mid-2007. Having an authoritative estimate of whether and when our supply of oil will reach a geologically- or geopolitically-constrained peak or plateau will be very helpful. But as long as the national oil companies that hold the majority of the world's reserves are less forthcoming with data than their privately-owned competitors, we will be forced to discount their claims. Greater transparency on the part of OPEC's members would help enormously, and an independent audit of their reserves would allay more fears than any number of studies, as I'm sure Mr. Jum'ah must realize.

Thursday, September 14, 2006

Mood Swings

The steady drop in gasoline prices, week after week, must come as a great relief to most Americans, after a seven-month stretch in which the market seemed to know only one direction. The latest weekly figures from the Energy Information Agency of the Department of Energy show regular gasoline averaging $2.62/gallon, 42 below its summer high. If the futures market is any indication, prices could slide another 15-20 cents in the weeks ahead. It's worth remembering, however, that seasonal variations and a period of better news haven't changed the long-term fundamentals. Every year, the US grows more dependent on imported crude oil and more reliant on the willingness of foreign refineries to produce fuels meeting our stringent specifications. Unfortunately, while we obsess about gasoline prices, we tend to ignore their underlying drivers.

The oil and product market fundamentals have been moving in a bearish direction for a while, at least in the US. The latest EIA report shows inventories of crude oil, gasoline and diesel all well above last year's levels, and above the average range of the last several years. With Iran at least temporarily making nice, the peak of the summer driving season behind us, and the winter heating season still several months off, it was time for some of the air to come out of this balloon. You may not want to buy that new Tahoe or Expedition just yet, however.

Even if crude prices stay where they are or go a bit lower, refining margins are unlikely to remain this low. If you look at the difference between the wholesale prices of gasoline and crude oil on the New York Mercantile Exchange, it's currently below 4 cents/gallon, and it rarely stays that small very long--20 cents has been more typical for the last couple of years, and 14 cents historically. At the same time, the futures contracts for gasoline and crude are both in contango, i.e. prices for future months are higher than next month's, and that condition rarely persists long, either. Essentially the market believes that we are oversupplied for the time being, but it doesn't expect that situation to persist. Without a collapse in oil prices--which OPEC is apparently beginning to worry about--we could see $3 again, before we see anything below $2.

All of this leaves policy makers and politicians in a quandary. Those who have denounced high gasoline prices as an affront to consumers--and possibly the result of oil company collusion--must either switch messages or risk appearing churlish. Those who were merely waiting for prices to fall, in order to propose higher gasoline taxes to reduce consumption and put more of the high price of fuel in the pockets of Uncle Sam, rather than OPEC or Big Oil, have their opportunity, along with an endorsement from the head of the International Monetary Fund. Will they dare, with mid-term elections less than two months away? My best advice to both camps is to focus less on volatile prices that are the outcome of a very complex set of interactions, and more on the underlying factors.

There are a host of energy issues that merit serious discussion at the highest levels, even if they seem more esoteric and of less immediate interest to consumers/voters than gasoline prices:
  • How can the US reduce oil imports, when we put so much of our unexploited domestic oil resources out of reach for development?
  • Can the production of ethanol and other alternative motor fuels ramp up fast enough to fill this gap--or to prepare us for the day when the European refineries upon which we depend for a good chunk of our imported gasoline finally redress the fundamental imbalance caused by the shift of new cars in Europe to diesel?
  • Who will absorb the burden of the carbon emission cuts that the transportation sector must inevitably make?

This is just a sampling of the serious problems stemming from current trends in US petroleum supply and demand. As long as our attention span waxes and wanes with the up-again, down-again price of gasoline, how likely is it that we'll solve any of them?

Wednesday, September 13, 2006

Climate Blues

Still catching up on last week's news, there's another aspect of the recent Gulf Coast deep water oil discovery that's worth considering. This story in the Financial Times (subscription may be required for full access) caught my eye, with its reference to equity analyst concerns about the risk of climate change brewing up more hurricanes that could impede the development of this new oilfield. If anyone is wondering how, in spite of the official US position on the Kyoto Protocol, global warming could become an important issue for US corporations today, this is a prime example.

Last week Chevron and its project partners Devon and Statoil announced a very significant discovery in the deep waters of the Gulf Coast, as I mentioned in yesterday's posting. Initial indications are that the Gulf of Mexico's "Lower Tertiary" layer, to which the Jack field belongs, could yield from 3-15 billion barrels of oil. This is what a "gusher" looks like in the 21st century oil world. In spite of Jack's great potential, though, two factors have put a bit of a damper on the market's enthusiasm about this news:

  • Although the 2006 hurricane season has yet to cause serious disruptions in Gulf Coast oil and gas activities, we're coming off two consecutive years in which storms disrupted both current production and new construction activity, leaving a backlog of damaged infrastructure and delayed projects, along with inflated drilling and construction costs.
  • At the same time, climate scientists have suggested that global warming will result in more frequent severe hurricanes, if not more hurricanes in general. This has been picked up in the media and is well on its way to becoming conventional wisdom.

Thus, we have a major hydrocarbon discovery, the value of which both our recent experience and our view of the future biases us to discount. In other words, analysts will update their financial models of the companies involved to reflect the Jack discovery, and the ultimate booked reserves and cash flow it should create, but they are likely to apply higher risk factors on the pace of project development and peak annual production than they might otherwise have done. This could cost Chevron and its partners hundreds of millions in market capitalization, even if they never experience the NPV-eroding delays that the market fears.

So while films and TV specials focus on the kind of climate risks that concern us as individuals and voters, businesses are contending with an entirely new layer of risks, arising not just from the physical challenges of operating in a warmer, more turbulent world, but also reflecing investors' current assessments of the expected financial consequences of those changes.

Tuesday, September 12, 2006

The Great Arbitrage

Whenever I want to convey how big the global energy industry is, I compare it to the only other human endeavor on a similar scale, agriculture. In an op-ed in Sunday’s Washington Post, a noted environmentalist expressed concern about the connection between the two, manifested in the growing demand for biofuels. In “Starving the People To Feed the Cars,” Lester Brown of the Earth Policy Institute sees great dangers for the world’s poor in the prospect of diverting crops to power our transportation and industry. While I would dispute his conclusions, he offers some useful insights for how such competition might actually work.

This topic comes up periodically in my coverage of renewable energy and in comments from my readers. Typically, these remarks have focused on the degree to which constraints on arable land, water resources, or other agricultural inputs might limit ultimate biofuel production. As Mr. Brown implies, though, the main interaction between energy and food will play out in day-to-day, season-to-season decisions about which crops to grow, and whether to commit them to ethanol or biodiesel manufacture, or to animal feed or human food. Those choices will largely be guided by the relationships between the various commodity futures markets. As a result, whatever the long-term impact on total global agricultural capacity and distribution channels, expanding our capacity to turn crops into fuel must inevitably drive up the price of the former, as long as demand for the latter remains high.

Mr. Brown goes on to draw analogies to the downfall of previous societies, along the lines of Jared Diamond’s “Collapse,” suggesting that high oil prices and our desire to replace oil with ethanol might be signposts of a looming systemic breakdown. This view appears to bias his interpretation of last week’s news of Chevron’s dramatic oil discovery in the deep waters of the Gulf of Mexico. He’s not alone in missing its importance in demonstrating new technology that enables companies to drill deep and accurate wells under salt domes and other obstacles. If this is truly the beginning of a new oil trend, rather than a lucky one-off, then it could force us to revise upward our estimate not just of US oil reserves, but of the total global oil endowment, perhaps by enough to stave off Peak Oil for an extra decade.

In opposing the shift to biofuels, the op-ed falls back on the efficiency default used to counter so many other energy projects: if we only saved a little of the vast amounts of energy we use today, we could forego biofuels--or drilling in the Arctic, or coastal LNG terminals, or anything else of which we disapprove. Unfortunately, the international trends in population and economic growth make it clear that these are false dichotomies: we will certainly need more energy and greater efficiency, in order to avoid a larger future crisis. The future energy mix must be broader than today's, and we must use it more wisely.

Meanwhile, energy experts will have to educate themselves about agriculture, and those who follow agricultural trends must learn to keep energy markets firmly on their radar screens. While this growing interconnection may raise the stakes for disruptions in either market, it should also provide some great opportunities, and not only for market speculators and rich investors. Rather than hurting the global poor, it might just provide them with better outlets for their products, and the capital with which to invest in producing more food and more fuel.

Monday, September 11, 2006

Five Years Later

Within a few days after the attacks of 9/11/01, a small group of my colleagues in Texaco's long-range strategy group gathered to consider their implications. It wasn't an official project, as the company was within a few weeks of being absorbed into the larger ChevronTexaco, and correspondingly focused on merger issues. I'm not sure whether our results ever found their way to the new company's management, as our earlier, higher-profile scenario work had. But over the ensuing years, I've been repeatedly reminded of the insights that emerged from our effort. I attribute them more to the genius of the scenario process than to any brilliance on our part. Even when done with little preparation, minimal external inputs and a team preoccupied by enormous personal uncertainties, scenarios can provide remarkable glimpses of the future.

Although very much concerned with the ultimate implications for the energy industry and our company, Texaco's approach to scenarios invariably began with a rigorous look at the larger world in which we operated, consistent with the methodology that the scenario gurus at the Global Business Network instilled in us. In the case of 9/11, we identified two primary uncertainties that have proved quite durable: the means chosen to defend the Western world, and the choices of Islam's majority. As early as September 2001, it was clear that the future would largely be shaped by the perceived legitimacy of the ways in which the US and our allies responded to the attacks.

The implications for energy were less clear. Many of our guesses haven't panned out, but we believed that the events set in motion by 9/11 would greatly complicate the industry's access to resources, and that view has been vindicated by the disruptions and risks that have driven oil prices to heights that were unimaginable only a few years ago. Recall that on September 10, 2001, West Texas Intermediate crude oil traded for $27.63 on the New York Mercantile Exchange, a level that seemed medium-high at the time.

Where do we go from here? Well, if al Qaeda makes good on its latest threats against the Persian Gulf and Israel, the recent drop in oil prices could prove a very short respite. Such threats have been made before, though, and attacks in Saudi Arabia itself failed to inflict the damage their authors intended. Our supply lines may prove more resilient than even we think, but let's hope this isn't tested soon.

There have been numerous editorials and op-eds in the last week concerning whether 9/11 truly "changed everything." I know that it changed me. My wife had phoned to alert me about the first impact, so I was watching TV and saw United 175 hit the South Tower in real time. Without thinking I told a colleague, "This is war," and so it was and still is. On that beautifully clear September morning, everyone in my office 15 miles away in White Plains could watch the smoke rising above lower Manhattan, as we waited for the next blow to fall. I doubt we all agree today about the path we have followed for the last five years, but none of us will forget that day.

Sunday, September 03, 2006

Labor Day Week

I'm taking advantage of the Labor Day holiday to spend some family time out west. Energy Outlook will be on vacation this week, resuming new postings next Monday, September 11. In the meantime, here are some links to vintage postings that newer readers may not have encountered, along with links to some recent articles I found interesting, but didn't get around to posting on:

Anyone wondering what a wider war in the Middle East might look like, in the aftermath of the recent war in Lebanon, should peruse this article from MIT's Technology Review on the proliferation of cruise missiles in the region. It describes a key aspects of Iran's conventional armament, and goes into the tactical and strategic implications of this development. It also includes comments from John Arquilla, a brilliant thinker on the topic of "netwar" and other revolutionary military developments. The article was published in two parts, each spanning several pages:

"The Missiles of August: Part I"
"The Missiles of August: Part II"

I hesitated to include a link to an article that requires a subscription to the New York Times' Times Select service, but I believe this long piece on the challenge and opportunity posed by America's deteriorating physical infrastructure merits inclusion, anyway. The author highlights our reliance on assets built by previous generations and not properly renewed, and identifies the costs imposed by this failure. He calls for a bi/non-partisan consensus on infrastructure, and makes an interesting point about the need to sharpen ours skills in this area, in a warming world that is likely to test them more frequently and persistently.

"Things Fall Apart: Fixing America's Crumbling Infrastructure"

Posting Re-Runs

With control of at least the House of Representatives up for grabs in the fall, energy and environmental policy may expand to focus more on vehicle efficiency or new fuel taxes. Here's an alternative that would achieve many of the same objectives, while preserving and expanding consumer choice:

A Tax on "Excess" Horsepower

Even as debate over what to do about climate change--and who's responsible for it--continues, I'm seeing more references to a novel and pragmatic approach to tackling the problem: breaking it down into smaller, more manageable segments:

"Subtracting Wedges"

The prospect of Peak Oil continues to alarm some and intrigue many others. Comparing this looming potential crisis to a similar prospective crisis in the recent past, Y2K, provides some useful insights:

"Peak Oil Millenarianism"

Friday, September 01, 2006

Seeing Corners

After 12 months of bad news on the energy front, we've finally had a pretty good week. Ernesto, which seemed destined to turn into yet another juggernaut threatening our Gulf Coast energy infrastructure, veered off and is instead dousing the eastern seaboard with rain. In Alaska, the latest view of repairs to the Prudhoe Bay oilfield gathering system indicates that production will remain higher, and return to normal sooner than originally expected. The market has taken this on board, and prices for the "front month" NYMEX oil futures contract dipped below $70 for the first time in two months. At the same time, gasoline prices across the US fell by 15 cents in two weeks, with only the West Coast averaging above $3.00/gallon. It's premature to say we've turned a corner, but when you think about what a corner might look like, this could be as close as we get for a while.

I've been watching oil markets for a long time, and I can't remember many occasions when prices dropped like a stone because of some piece of good news. Conversely, we can probably all think of numerous events that caused it to spike up. Major declines tend to be composed of equal parts of big energy news--failed OPEC meetings, the start of the Gulf War--and the gradual accumulation of fundamentals in the form of higher production and inventory and sliding demand. All that may be required for a gradual decline from current heights, however, could be an extended period without a lot of bad news, plus a few positive developments such as those we saw this week. It's worth recalling that as recently as May 24, 2005, the price of oil was under $50/barrel, and a bit more than a year earlier it was under $40.

The cautionary note to all this appears on today's front page: "Iran Defies Deadline on Nuclear Program." Any reprieve in oil and gasoline prices will be temporary, if the forthcoming UN Security Council debate on sanctions for Iran becomes deadlocked and sets us on a path to a wider, unpredictable conflict in the Middle East.