Taxing the Winners

Perusing the papers, national and local, it's clear no one likes oil companies very much. This makes me nostalgic, because it's precisely the environment in which I joined the industry nearly 27 years ago. Oil prices were high then, too, and just as much for reasons beyond the control of either US oil companies or US politicians as they are now. The only bright side in 1979 was that the public hated Ma Bell even more than they did us. The biggest consolation in the current situation is that--so far--we have avoided many of the mistakes we made during the last energy crisis, such as enacting windfall profit taxes, controlling oil and gasoline prices, and rationing fuel on odd and even days. But that could change, soon.

With so many people blaming oil companies for high gasoline prices, the natural constituency inclined to resist popular-but-counterproductive policies is small. It won't deliver many votes in November, so we can't discount the possibility of something foolish being enacted. Right now my top candidate for a plausible-but-dumb response to the current situation is a new windfall profits tax. Before taking a step like that, it's important to consider just what it would mean.

The top 15 US oil companies earned $93 billion in profits last year on sales of just under $1 trillion. This diverse group includes Supermajors such as ExxonMobil and Chevron, independent refiners such as Valero and Sunoco, and large independent producers such as Apache and Occidental Petroleum. It excludes a couple of large, foreign-owned companies with bigger US operations than some of the outfits included here. In any case, $93 billion is serious money, and there's a legitimate argument that these companies are benefiting from factors at least partially beyond their control, no matter how well their management may have positioned them to capitalize on these conditions once they appeared.

What would $93 billion mean to consumers? Well, if it were allocated across all the gasoline, jet fuel and diesel sold in this country, it would account for 41 cents per gallon. That sounds like a big deal, but of course we're not going to tax away 100% of these profits, only the amount we deem "excessive." Ah, but how do we determine what constitutes excessive?

One proposal suggests confiscating all earnings above the equivalent of $45/barrel oil. That would be impractical, because several of these companies don't produce any oil, though they still make substantial profits selling petroleum products. It also ignores the reality that all oil is not created equal. One company may produce oil that is generally similar in quality to the benchmark West Texas Intermediate grade, while another produces oil that is much higher in sulfur and much heavier, on average. This sells at a sizeable discount to WTI, sometimes as much as $14/barrel less. Judging them on the same scale would be unfair to both. The best thing, politically, about pegging a tax to oil prices is that it wouldn't frighten other industries with even higher profit-margins, such as computer software or banking.

When US Senators refer to "obscene profits", I have to believe they are sophisticated enough to base their assessment on more than just the absolute dollars involved, given the mammoth scale of the oil industry. So let's assume they mean excessive relative to their sales. If a 10% margin is excessive, then perhaps 5% might be acceptable. This is about what Exxon earned in 2002, before oil prices went wild. What would happen if we taxed the top 15 companies to cap their earnings at 5% of revenue?

First, you'd only be taxing 12 of the 15 companies. Even in their best years, independent refiners don't achieve above 5% earnings on their revenues. Secondly, you'd be hitting US independent producers much harder than larger international companies like Marathon, which scored barely above 5% in 2005. The average margin of the six large independent producers on this list was a whopping 35%. I suspect, though, that they'd be safe. Punishing US producers who have remained dedicated to finding oil and gas in the country, when their larger brethren were increasingly seeking opportunities offshore, would be economic and political suicide, even in an election year.

After you eliminate the independent producers and the independent refiners, you're left with just four US companies to tax: ExxonMobil, Chevron, ConocoPhillips and Marathon, again ignoring Shell and BP, most of whose profits would be exempt as attributable to their non-US operations. After allowing these four companies a 5% profit on sales, we are left with about $29 billion. Spread out over US petroleum product volumes, this gets us 13 cents per gallon. Not insignificant, but about equal to the swing we see in the oil market from one week's good or bad news out of the Middle East.

Now, I will grant you that $29 billion, if it were retained at the federal level, would cover the entire budget of the Department of Energy, or allow us to more than double it. But if the same funds were raised via a 13 cent per gallon increase in the federal gasoline tax, that would at least help to moderate demand. Unfortunately, a windfall profit tax looks temptingly like a free lunch, or at least one paid for by an incredibly unpopular host.

So where is the downside? Why not skim a little of this cream, just this once? Well, one of the first consequences of such a measure would be a drop in the stock market valuation of the companies in question, and probably a cut in their dividends. That would hurt a whole range of investors. I know I'm not the only person with oil company stock in my 401-K, either directly or via a mutual fund. The bigger issue, though, is the competitive hurdle this would create for the US in a totally globalized industry.

American oil companies, even the biggest, must compete vigorously for global exploration, production and market opportunities against a growing group of rivals, including established European firms and up-and-coming Russian and Asian firms. The price of entry for large energy projects starts at $1 billion and goes up to the tens of billions. Forcing the US majors to borrow, when their competitors can fund mega-projects from free cash flow--or using free state cash--would put them at a real disadvantage. I can't be certain how much that would cost American consumers at the pump, but it would reduce oil investment in the US and damage our standing in a sector in which American companies remain best of class.

Ultimately, we must make up our minds about these companies, and we really only have a few choices. From my perspective, since we would never contemplate bailing them out in tough times, we ought to let them keep the benefit of good times, provided they reinvest it. The alternative is tantamount to converting them into public utilities, subjecting their annual budgets and profit margins to governmental scrutiny and oversight. Personally, I have more confidence I'm paying a fair price for gasoline at $3 than for electricity at 17 cents/kW-hr--or milk at $7/gallon.

Reviewing The Laundry List

Today's New York Times describes a long list of proposals for addressing high gasoline prices. I've already devoted two postings to this issue this week, but I thought it would be worth quickly going through the list and offering my thoughts on each idea, without regard to which party has suggested it:

1. $100 tax rebate - Good idea. Higher gas prices are a drag on the economy, and a little fiscal stimulus is just the thing to keep the consumer sector perking along, especially with interest rates rising. This works out to about $0.20/gallon for the average driver in the average car (not SUV.)
2. Surtax on oil company profits - Bad idea. Although much of their activity has shifted overseas, due to more attractive (i.e. larger in scale) opportunities, taxing oil company profits at a higher rate than they already are, that is to say at the rate all corporations are taxed, will only deter them from investing in the US, where we need it most.
3. Higher mileage standards for cars - Good idea, very slow impact.
4. Curbing gouging - Populism at its worst. The alternative to the smooth functioning of supply and demand matched up by prices is gas lines. We don't want to go there again. Some of you are too young to remember what this was like, but I can assure you it was no fun. We are all better off spending a few more bucks for gas than losing hours of our time waiting in a gas queue, or worse yet, driving for miles to find a station that still has gas.
5. Suspension of federal fuel taxes - Ineffective and wasteful. As long as supply is tight, prices will rise to take up the slack created by the tax holiday, and consumers will be no better off. If retailers are forced to pass it along, drivers will not get the price signal, will drive more, and we will end up with sporadic service station runouts. Meanwhile, the Treasury stands to lose something like $4 billion in revenues.
6. Ceiling on royalty relief - Good in the short run, less so in the long run. Clearly, when prices are over $55/barrel, oil companies do not need relief from royalties they owe for producing oil from leases on government-owned land and in offshore waters. But changing the rules after the fact adds uncertainty to an already very uncertain prospect: drilling for oil that will only start producing 4-7 years after a project begins. Remember that when the offshore platforms that are coming on stream this year were started, oil was under $20/barrel. Royalty relief was an important factor in inducing companies to go ahead with those projects.
7. Opening up the Arctic Wildlife Refuge for drilling - Good idea. I've covered this at length previously, and I continue to believe that Democrats and environmentalists are missing a bet in not trading this for a big concession elsewhere, such as a greenhouse gas cap or dramatically-higher fuel economy standards. Their continued opposition is only sensible if they think it can forestall drilling there forever. I don't think that's a realistic view. If ANWR's oil is going to do any good for the country, it needs to get going--there's a long time lag before it could start delivering--but it needs to be done as part of a comprehensive energy policy that also reduces demand and stimulates alternatives.
8. Repeal of LIFO accounting - Uncertain effect. I opposed this when it was temporary and targeted only at oil companies. However, a permanent ban on LIFO for all companies might not be bad. It would create a one-time hit to corporate profits, but that shouldn't affect the stock market, because analysts would understand it was once only and across all companies. LIFO has created some strange behavior, and eliminating it might help align accounting practices with the real world of just-in-time, real-time inventory management.

The basic problem with all of this is that it took us decades to get into this pickle, and there are no simple answers that are resolvable in a single Congressional or even Presidential term. Gasoline prices are high because of the complex interaction of geopolitical issues, including war, local unrest in producing countries, and OPEC policies on production and access to reserves; environmental policies, including the reformulation of gasoline to reduce air pollution and widespread local variations of the same, along with restrictions on new refinery construction; and a glaring inconsistency in our fuel economy standards that allowed heavy, inefficient SUVs to displace roughly a quarter of the cars on the road. No Act of Congress or Presidential Order can alter even a portion of this overnight, nor should we as voters give our elected leaders the impression that we expect them to be able to do so. Meanwhile, only changes in our own behavior will matter.

Or Higher?

Tuesday's posting focused on the oil supply and inventory influence on gasoline prices. I concluded that the inventory picture suggests lower prices ahead, but that risk-driven speculation could prevent that or keep prices going higher. An opinion piece in today's Financial Times describes the laundry list of energy proposals floating around Washington in unflattering terms. The Congress and state legislatures must be seen to be addressing the problem in the lead-up to the off-term election in November, but most of their current proposals are mere window-dressing, designed to mollify the public by punishing oil companies and investors.

Even the most supply-oriented ideas are looking in the wrong direction, if the goal is to moderate gasoline prices anytime soon. Producing more crude oil from the US--or more accurately slowing the steady decline in US production--by tapping the Arctic National Wildlife Refuge and putting more acreage in the Gulf Coast and other offshore waters in play will help, but not many for years. This does nothing to address our growing shortage of refining capacity. I wrote at length on this topic after Katrina, and nothing substantive has changed. While the main factor determining the level of domestic oil production is geology, over which we have no control, becoming dependent on foreign refineries has been entirely a matter of choice, the direct outgrowth of environmental and permitting restrictions that have been placed on the industry over the last several decades.

Consider the consequences for gasoline prices. During the 1990s, sufficient domestic refining capacity existed to cover our needs most of the time, and US gasoline imports were modest, averaging under 400,000 barrels per day. The average price differential between unleaded gasoline futures and West Texas Intermediate crude oil for that decade was $4.76/bbl. So far this year, gasoline imports are running over a million barrels per day, and the margin between gasoline and crude is at about $16.00/bbl, averaging $8.00 over the last six months . If more refineries had been allowed to expand and new refineries been constructed, we could be paying as much as 35 cents less for gasoline, now. Even recognizing that other factors, such as the balkanization of gasoline specifications and the switch from MTBE to ethanol have complicated the supply & distribution systems of the oil companies, we could have had gasoline at $2.60-2.70/gallon, despite crude oil at $75/barrel.

However, it takes years to design and build a new refinery, especially here, so our available responses to the current high refining margins are limited. As it happens, the only liquid fuel facilities that can be built quickly enough to make a difference are ethanol plants, because they are so much smaller, individually, and face little or no local opposition. Still, it takes an awful lot of ethanol plants to make up for the lack of a single oil refinery, considering that the entire US ethanol output is roughly the gasoline yield of New Jersey's four refineries.

Ironically, circumstances have produced precisely the result that so many have advocated for years: gasoline prices high enough to stimulate conservation. As the FT points out, either high gas prices are good or they are bad, whether they result from OPEC collusion, restrictions on refinery construction, or elevated gas taxes. If they are good only when they result from taxes, but bad when they benefit oil companies and their shareholders, then the current histrionics are revealed as an exercise in populism, rather than the beginnings of a sensible energy policy.

Cheaper Gasoline Ahead?

It's remarkable to see the price of gasoline heading back to levels that we've only seen before in this country in the immediate aftermath of last summer's hurricanes. Gas prices are fueling more suspicion of oil company collusion, and I expect we'll see another round of Congressional hearings. People are talking about $3.50 or even $4.00 per gallon by summer, and I suppose we could see it, though when I look at the fundamentals of supply, the picture is much less clear.

First, look at the components of today's prices. Let's start with the wholesale level, since retail includes taxes, which widely vary from state to state, and dealer margins that are also hardly uniform. The New York Mercantile Exchange showed wholesale regular unleaded gas for delivery in May at $2.17/gal., as of the close of yesterday's trading. It also reflects an essentially flat forward price curve, indicating that traders don't anticipate prices dropping much before the fall. A quick look at gasoline inventories and production, which are both quite low vs. seasonal averages, supports that view.

But of that $2.17/gal. wholesale gasoline price, $1.75 is attributable to crude oil at $73.33 per barrel (bbl) for June. In fact, the crude market is now in contango, with expected forward prices climbing to $74.50 in July and up to $76 by November. There are two ways to look at that information. Superficially, you’d say that it confirms that gasoline prices could keep going up, as many expect. But contango is an unusual condition, as I’ve described before. It typically indicates an oversupplied market, and that’s just what you see when you look at US crude oil inventories, which are far above their seasonal historical average. Contango can flatten in two ways, by the front, or more prompt month prices rising, or by the back, farther out prices falling.

If I only looked at crude inventories, I’d conclude that oil prices ought to start dropping soon, and by a lot. After all, oil was trading at $60/bbl only a couple of months ago. That would take gasoline price down by 30 cents/gal., ignoring the well-documented constraints in our refining system and the substitution of scarce ethanol for MTBE as a component of reformulated gasoline.

So what is driving this market? In my opinion, speculation, driven by the uncertainties surrounding the Middle East and Iran, in particular. You can argue the virtues and vices of speculation, but it is as American as apple pie. And there’s something people tend to forget about it: speculators are sometimes prescient, but when they are wrong, markets can correct very rapidly and the speculators lose fortunes. So if the Iran nuclear situation keeps simmering, we shouldn’t expect much relief at the gas pump. But if there were some positive development, the market fundamentals could kick in with a vengeance, as speculators started to bail out. That would head off the climb towards $4.00 and be very welcome for consumers. I'm sure I'll be coming back to this topic in the months ahead.

Boiling Frogs and Drowning Bears

Yesterday's New York Times Week in Review included a lead op-ed that does a nice job of explaining the state of certainty vs. speculation on climate change, in layman's terms. It highlights the difficulties involved in sifting through our observations of current weather and weather events--such as melting polar ice and multiple major hurricane strikes in the US Gulf Coast--and attributing them to climate change or randomness. In the process, the author points out some of the risks of alarmism, a position that is likely to be controversial. In my view, he's right to worry that some of the ways we are trying to get the public's attention could backfire, by relegating global warming to to the "CNN cycle" of news and hype, followed by exhausted indifference.

I was also pleased to see Mr. Revkin promoting the importance of adaptation, not just as a survival strategy, but as a way of making an extraordinarily abstract and potentially remote-seeming issue more tangible and immediate. Adaptation to climate change deserves as much attention as mitigation, because it's not clear we can react quickly enough, on a large enough scale, to prevent major consequences from the lagged effect of changes that are already "dialed in."

The article also includes the findings of a recent opinion poll placing environmental issues far down the list of concerns for Americans, and climate change well down the list within environmental concerns. I'm not sure it's irrational, though, for people to worry more about immediate problems such as war and terrorism. Instead, I think it's encouraging that well over half of respondents saw climate change as both real and a source of concern. Campaigns such as the Ad Council's new tv spots on climate change should continue to shift public awareness in that direction.

Market Power

Economists used to talk about “market power” in terms of the ability of a dominant supplier to set prices. The EU is beginning to get a taste of a different kind of market power, as Russia’s monopoly natural gas company, Gazprom, issues thinly-veiled threats about Europe’s future access to Russian gas. The context is Gazprom’s mooted acquisition of Centrica, a UK utility. A response along the lines of the US reaction of the CNOOC bid for Unocal, or even some of the recent cross-border energy transactions within the EU, could jeopardize long-term supplies of natural gas for the Continent.

How realistic is this threat? Well, from the European side, it has to be worrying. Local supplies of gas are mature and either in decline or poised to fall off in the next decade. Europe’s commitment to meeting its greenhouse gas emissions targets under the Kyoto Agreement, combined with the aversion outside of France and Scandinavia to more nuclear power, makes gas and wind the only viable alternatives to coal in the power sector. And the EU is already building about as much wind power as they can handle. Russia is both Europe's largest gas supplier today and its logical incremental supplier, as well.

But could Russia make good on a threat to divert future, incremental supplies to other markets? Having the world’s largest natural gas reserves, by far, does you little good if they aren’t connected by dedicated infrastructure to a market that can pay. What should give the EU pause here is that Russian gas, much of which will be coming from the East, is a natural fit for fueling the expansion of China. Some of it is also well-situated to supply the West Coast of the US via LNG. All of this takes capital in large doses, but Gazprom is flush with cash, and you can’t tell me that European banks wouldn’t line up to help finance Russian pipelines and LNG facilities, even if they weren’t intended to supply the EU.

Russia is still learning this game, and its moves so far seem a bit ham-handed. Playing hardball with your biggest, richest current customers isn’t very good business, as I’ve suggested before. But however undiplomatically Gazprom has been conveying its message, European business and policy leaders need to pay attention and give serious thought to the kind of relationship they want to have with Russia, as the latter emerges from its temporary basket-case status of the 1990s.

Public Potshots

The oil and auto industries have generated lots of headlines in the last several years, but rarely for taking public jabs at each other. Yet that's exactly what is happening now, as described in this article from the Detroit News. A Chrysler executive took oil companies to task for failing to invest in alternative energy, after an ExxonMobil ad suggested that much more could be done to improve the efficiency of automobiles. It's worth spending a few minutes looking at the claims of each side.

Although I can see why it wouldn't have pleased the US auto makers, the Exxon ad seems less inflammatory that the response it provoked. It states--correctly, I believe--that while automobile engine technology has improved tremendously since the first oil crisis, few of those gains have translated into better fuel efficiency. They single out increasing vehicle weight as the key culprit, but neglect to mention the competition to provide consumers with dramatically improved performance in the form of horsepower plays a large role, too. The commentary also ignores the fact that, while US automakers have benefited tremendously from the SUV trend, consumer choice has been driving this trend.

Chrysler VP Jason Vines responded by attacking high oil executive salaries, share buybacks, and tardy investment in new production, both conventional and alternative. There is something to these arguments, but he, too, includes factors either beyond the industry's control or generally pervasive in US business. Retiring Exxon CEO Lee Raymond's compensation has made headlines, and there's no question it is exorbitant. At least he received it for guiding his company to unparalleled success, in contrast to the lavish pay many CEOs have received for riding their firms to ruin. The salaries of other major oil company CEOs seem pretty much in line with those of comparably-sized businesses in other sectors, which means they are at very high multiples of the salaries of average workers. This is a societal concern, not an energy issue, per se.

As to reinvestment, the major oil companies were late realizing the magnitude of China's demand growth and the impact of chronic supply disruptions in West Africa and the Middle East. They were also probably overly influenced by painful memories of the last down-cycle in the late 1990s. I believe they have generally redressed these issues with expanded investment budgets. The larger question is whether they have sufficient access to the world-class opportunities necessary to shift the supply/demand balance back in favor of lower, more sustainable prices. The jury is out.

Alternative energy is another area in which the industry has been slow to invest, though several firms have put substantial sums into this area, going back to the 1980s and 1990s. But if I were to criticize them for shyness concerning alternative energy, I would hardly focus on ethanol, which until quite recently was widely regarded as having a negative energy balance and providing more assistance to agricultural interests than to consumers or energy security. The auto industry is falling in love with ethanol as a way to hedge its environmental exposure, but the fuel cannot deliver on its supporters' claims until the next generation of biotech-based production processes become mainstream.

Our energy problems will persist as long as we focus exclusively on either supply- or demand-based solutions, rather than combinations of these strategies. As a result, we will require full cooperation between the oil and auto sectors, not suspicion and confrontation. Carmakers need to design efficient vehicles that consumers will buy in large numbers, and the energy industry needs to help by optimizing fuels to the new engine technologies, and investing in the necessary infrastructure. Resorting to a public hay-throwing contest will not advance this agenda.

Coal-to-Chemicals

With oil prices passing $70 per barrel, it's easy to lose sight of the fact that our energy problems encompass more than just petroleum. Natural gas is trading at triple its historical average price, and if that's bad for consumers and power companies, it's been disastrous for chemical manufacturers. Increasingly, they are forced either to send their manufacturing offshore, where gas is cheaper, or shut down operations that can no longer compete with imports. But others, as this informative article from the New York Times describes, are looking at coal as an alternative feedstock. This is much more practical than it sounds, and at current natural gas prices, it ought to be profitable, as well. At the same time, though, it raises new challenges for the chemical sector to address.

Much of the fertilizer in this country is produced from ammonia derived from natural gas. These ammonia plants were mostly built in an era when natural gas cost between $1.00 and $2.50 per thousand cubic feet, compared with its recent monthly range of $5.00-10.00. Some of these plants have found it more profitable to shut down and resell their contracted gas supplies to others, than to continue producing fertilizer that is undercut by imports from countries where gas still costs about what it did here 20 years ago. But if gas is available from processing coal at $4.00, as the article suggests, the US fertilizer and chemicals industry can reconfigure itself around a raw material that is still abundant in this country.

There are two pitfalls associated with this strategy, and neither of them is technology-based. The process for gasifying coal and other high-carbon feeds such as petroleum coke and the other residues from oil refining has been in continuous use for decades, all over the world. My own gasification experience in the early 1980s was at a Texaco-licensed gasification pilot plant at a German petrochemical complex. Building a gasifier to supply fertilizer or chemical plants is straightforward, but it isn't cheap. These are significant capital projects, and as such, they expose their owners to a number of risks, including the risk that natural gas prices will fall back to a level that would make gasification unattractive. Given the protracted problems of the US gas industry and the difficulties and cost associated with importing gas in liquefied form (LNG), I think this risk is quite modest.

The bigger risk is environmental. Although the gasification process is very clean, providing simple and inexpensive ways to clean up the typical byproducts of coal combustion, such as sulfur and nitrogen oxides and mercury, it does not by itself address the higher greenhouse gas emissions associated with using coal instead of natural gas. These depend very much on the chemical processes being fed, some of which would incorporate the coal's carbon into the final chemical product. But in the case of fertilizer, in which ammonia is made through the classic Haber process, significant quantities of CO2 emissions would accompany the production of hydrogen from coal gasification.

In a world increasingly focused on climate change and its projected consequences, chemical companies investing in coal gasification as an alternative to using natural gas as a raw material must be prepared to manage greenhouse gas emissions in a systematic way, involving both emissions trading and future technology options such as sequestration, which is ideally suited to work with gasification. Many of these companies are already quite proactive in these issues, but some of the smaller competitors may not yet appreciate the full implications of switching from gas to coal.

How High A Priority?

A comment on yesterday's posting concerning hybrid cars and ways to encourage fuel efficiency started a train of thought that seems worth a posting of its own. We talk a lot about wanting to reduce our oil consumption and imports. In support of this, we cite geopolitical concerns and local and global environmental issues. Rarely, though, do we attach a value to this desire or attempt to prioritize it relative to other issues. High fuel prices elicit so many consumer complaints--I was subjected to a barrage of them at a family Easter celebration over the weekend--because gasoline is central to so much of what we do. Then why is it that, when we talk about reducing our oil consumption, we usually neglect to tally up the economic consequences of using less of this vital input? The leverage effect of energy in our economy creates great potential for unintended and disproportionate consequences of policy in this area.

This is something that doesn't get nearly enough attention, though it's neither as obvious or trivial as it might seem at first. Nor is it a way to rationalize irresponsible consumption, as some might suggest. I'm quite prepared to accept that there's a fair amount of waste involved, in terms of unnecessary travel that could be consolidated or eliminated. Most of the time, however, when people drive somewhere it is to do something, whether it's work, shopping, or something else that generates economic activity. We need to be careful when cutting fuel consumption that we don't eliminate the economic value it generates.

There are three main ways to reduce fuel consumption: 1) maintain presents cars so as to maximize their fuel economy, 2) buy more efficient vehicles, and 3) change behavior and patterns to drive present vehicles less far and/or less often. Of these, the first is the easiest all around; it costs little and harms no one. The second is more difficult. Only about 7% of the cars on the road are replaced in any year, despite chronic overcapacity in the car industry. Buying a more efficient car is great for the economy, and increases your fuel economy immediately, but chances are your old car didn't get sent to a crusher, so it's still around burning gas, too.

The third option is potentially the most trouble for the economy. Whether voluntarily or as a result of government-sponsored incentives or penalties, driving less to save gas risks reducing GDP, and I'm not just talking about the earnings of oil companies. To see why that's so, think back to Econ 101. We tend to consume things up to the point at which their marginal benefit equals their marginal cost. So that extra trip in the car was worth at least as much to the person who took it as the marginal cost of doing it. In fact, it was worth much more, because the cost of operating a car goes well beyond fuel.

If you take an average car getting 25 miles per gallon, gas at $3.00/gallon makes up only 27% of the 44.5 cents per mile operating cost, using the 2006 IRS mileage allowance as a proxy for fleet average operating cost. That means that even if the time required for the trip had zero value, the cost of that marginal one-gallon trip--and thus its marginal benefit--would equate to about $11.00 on a gallon-equivalent basis. (I realize that marginal costs are likely to be lower than average costs and would welcome any comments providing a better approximation for this.)

So in simple terms, saving $3.00 worth of gas could cost the economy another $8.00 in GDP somewhere outside the petroleum value chain. If the goal were backing out 1 million barrels per day of imported oil, about 5% of our consumption or 10% of imports, that would save the US about $25 billion a year at current prices. But it could also reduce GDP by something like $120 billion/year, using the above estimate. If that sounds high, remember that saving a million barrels per day of oil means cutting energy consumption by about two quadrillion BTUs/year, or about 2% of the total energy consumption of a $12 trillion economy. That has to have costs, as well as benefits.

Where does that leave us, if it will take decades to replace our present car fleet with a much more efficient one, and if immediate, behavior-driven changes in fuel consumption risk damaging the economy? I don't take this as evidence that we can't do anything, or that sensible conservation is bad, and it certainly doesn't justify someone buying a 7,000 lb. SUV getting 12 miles per gallon on the basis that this will create some wonderful ripple effect in the economy.

Rather, I believe the logical conclusion to draw is that wholesale measures to dampen fuel use--and in that I include any substantial increase in gasoline taxes--ought to be undertaken only after the most thorough analysis, going far beyond the fuel sector, and that targeted incentives are likely to be more cost-effective, overall, than across-the-board measures. It also says we need to be very clear about where reducing oil consumption fits in the overall hierarchy of our priorities, including economic growth, balances of trade and payments, international relationships, and environmental stewardship. Setting priorities is really the first priority of leadership, isn't it?

Bad Hybrid?

It’s always interesting to follow the path of perceptions concerning a new technology. Hybrid cars have enjoyed a classic halo effect since the first Toyota Prius was sold in the US in 1999. Now, though, we’re increasingly hearing about “good hybrids” and “bad hybrids.” This week’s Sunday New York Times included a lengthy op-ed on the subject. While it did a reasonable job of describing the pitfalls of hybrids, it somehow avoided the two most important aspects of this issue, consumer choice and outcome-driven policy.

Until gasoline prices hit $3.00/gallon last summer after Hurricane Katrina, fuel economy was a minor factor in most consumers’ car purchase decision. Even post-Katrina, only 20% of women car-buyers identified fuel economy as the primary factor influencing their choice, in a poll by cars.com. Nor is that entirely irrational, considering the relative contribution of fuel costs in the overall cost of owning a car. At $3.00/gallon this accounts for about 12 cents/mile for a car averaging 25 mpg, compared to the 44.5 cents per mile deduction allowed by the IRS for business use of a car.

When carmakers offer hybrids such as the Lexus GS 450H, which emphasize performance over fuel economy, they are catering to customer demand, rather than misusing an efficiency technology. I can understand the frustration of those who would rather see hybridization used to turn 30 mpg cars into 60 mpg cars, but I doubt that the typical buyer of a Lexus GS sports sedan would be in the market for a Chevy Aveo (35 mpg) instead. At least the Lexus V-6 hybrid will get substantially better gas mileage than the 18 city/25 highway of the V-8 model it displaces.

If we accept that consumers know what they want and are unlikely to make fuel economy their top factor in picking a car at current gas prices, then the real question is how to structure the government incentives intended to elevate the priority of efficiency. We get into trouble when we reward a technology, rather than the outcomes that technology can produce. While I firmly believe that hybrid cars are tremendously important in reducing our future fuel demand, it’s silly to pay people to buy them.

If we’re serious about boosting fuel economy, then that’s what we should reward. Offering graduated tax incentives for buying cars that achieve better than the Corporate Average Fuel Economy actual results, currently 30.0 mpg for cars and 21.8 for light trucks/SUVs, makes more sense than indiscriminately giving out incentives to hybrids that get anywhere from 14 to 60 mpg. Until these incentives are reformed, however, we can’t blame consumers and manufacturers for using them.

We can take some consolation from the fact that every hybrid sold, whether economy- or performance-oriented, moves the technology down the experience curve, thereby reducing its cost and improving its reliability. Meanwhile, consumers wanting top fuel economy are getting a wider range of hybrid and non-hybrid choices, including the new Toyota Yaris, Honda Fit, and the Geely CK, which looks set to be the first Chinese car offered in America.

Rebuilding Framework

If climate scientists are right about the potential consequences of a warming globe, then New Orleans won't be the last major American city we will have to rebuild after a catastrophic weather event. It matters a great deal how we approach this, because of the precedent it sets for the future. In that vein, the guidelines that the federal government has just issued for the reconstruction of housing in New Orleans and repairs to the levee system provoke both disappointment and relief.

Many outside New Orleans would have preferred that houses in the lowest-lying portions of the city not be rebuilt at all, not just because of the recent flooding, but in light of the challenging prospect of holding back the Mississippi indefinitely. (The river is at the point of shifting its channel, as it has repeatedly over millions of years, laying down the enormous delta structure we see today. The Corps of Engineers has been fighting a rearguard action against this for years.)

Given the demography of home-ownership in New Orleans, a draconian rule was not in the cards. Instead, the guidelines require that houses rebuilt in the flood plain be elevated at least three feet off the ground, though it's not clear whether that would have been enough to prevent much of the damage from last summer's flooding. A better approach might have been modeled on that used in Galveston, TX, which prior to Katrina had suffered the worst hurricane damage in US history. The height by which buildings there must be elevated is gauged against the "base flood elevation", or the water level in a typical flood, rather than an arbitrary height above ground. Let's hope that other vulnerable coastal communities look to Galveston, rather than New Orleans, for their standards.

The good news here is the government's commitment to strengthening the levee system. This is a skill that we need to master, for potential application to other areas. The Corps of Engineers does a fine job on projects like this, but before beginning this task, they should undertake a bit of best-practice benchmarking with other flood control projects around the world, including the Thames Barrier and the Netherlands, which constitutes a country-sized sea-level management project.

Even if climate change turns out to be an exaggerated threat, we will assuredly face large hurricanes in the future, and New Orleans stands to be hit again. The new federal rebuilding standards are not ideal, but they are better than abandoning this historic city to its fate.

Practical Nano-Biotech

Better batteries remain an important, but thus far elusive, component of the future energy mix. And for years, nanotechnology has been held up as a sort of modern Philosopher's Stone, holding the promise of building self-replicating devices that can assemble almost anything we'd want, virtually atom by atom. This article from Technology Review brings both of these threads together in a remarkable development, in which advanced batteries have been built by a trained virus. The result, if it can be repeated on a larger scale, could revolutionize both energy and manufacturing.

Even on a more focused level, this is a truly fascinating process. It harnesses a different, possibly more practical and achievable variety of nanotechnology, grounded in DNA, rather than atoms and bits. That has far-reaching implications for a host of other device types, including computer chips, solar cells, and bio-medical hardware. It could change the cost basis and even the structure of entire industries, within our lifetimes.

At the same time, it is noteworthy that this viral process has not just built a battery, but it has apparently built one that can only be built in this way, improving its efficiency and power density through a radical redesign of the electrodes. Although the most interesting early applications seem to be in cases where the battery can be conformed to the shape of a device, providing both small size and high usability, as in a cellphone or remote sensor, the same approach might be applicable on a much larger scale to turn a car's entire body into a battery. That could dramatically improve the performance of of all types of hybrid cars, and at the same time lower the performance threshold required for economical fuel cell vehicles. The possibilities are truly mind-blowing.

Thanks to one of my former Texaco colleagues for bringing this item to my attention.

Quicker Solutions?

With gasoline prices climbing back toward $3.00/gallon--and over it in a few areas--the public is growing frustrated by the enormous gap between the paltry measures we can take now to improve fuel economy and the promise of future technological solutions. While inflating tires to the proper pressure and driving more moderately can help a bit, it will take years to move enough hybrid cars into the fleet to change our fuel consumption materially. So, for now, we're stuck; or at least that's the conventional wisdom. An email from a reader started a chain of thought suggesting there might be a practical way we could have a larger impact on the problem without having to wait decades.

You don't have to do much highway driving in urban areas to realize that traffic tends to form waves, with jams bunched up around exits and onramps, and by accidents. This paper by an engineer in the Seattle area describes how this works and explains a scheme he hit on that effectively "cancels the waves." His approach starts with some pretty counter-intuitive notions, including the idea that closing the gap with the car ahead of you, to prevent late merging from other lanes, is one of the worst things you can do when traffic gets heavy. Clearly, his analysis is largely empirical and qualitative, but he makes a good case that some simple changes in driver behavior could reduce or eliminate most traffic jams and allow highways to carry a volume of traffic closer to their designed limits.

Why does this matter, and what does it have to do with high gas prices? Well, as I was reading the article it occurred to me that, although truly major improvements in fuel economy will depend on changes in both consumer preference--fewer large SUVs--and technology--more hybrids and smaller engines--every car on the road already has an impressive efficiency improvement waiting to be unlocked: the difference in mpg between city and highway driving. When cruising at the speed limit, you should achieve close to your car's EPA highway rating, but when you get stuck in stop-and-go traffic, your car is demoted to its city rating, or worse. In the case of the typical sedan, a Toyota Camry, that difference amounts to 10 mpg. For a typical SUV, a Ford Explorer, it's 4-6 mpg. So if we could find a way to eliminate traffic jams entirely, and enable traffic to flow smoothly at a lower speed, we could boost the fuel economy of every car involved by about 40%.

What kind of overall impact would this have? The 2004 Urban Mobility Report of the Texas Transportation Institute at Texas A&M estimated fuel wasted due to traffic congestion at 5.7 billion gallons per year in 2002. That equates to 370,000 barrels/day, or about 4% of total US gasoline consumption. To put that in perspective, all the ethanol used in gasoline in this country only amounts to about 2.5% of the total. Or, looking at it another way, saving the fuel wasted in traffic jams would be the equivalent of putting a couple million hybrid cars on the road.

How can we make this happen? Well, as persuasive as Mr. Beaty's reasoning might be, I'm not convinced that a few "anti-traffic" drivers in each city would be sufficient to eliminate traffic jams, although I'm intrigued by the idea that the highway patrol could achieve the same thing. Nor is it clear how to get millions of people to change their driving behavior in fundamental ways, without changing either laws or some key part of the technology involved, such as the addition of a radio-controlled "idiot light" on the dash, telling us when to speed up or slow down. However, if you've ever driven the New Jersey Turnpike and are among the minority of drivers who pay attention to the system of remotely controlled speed limit signs and traffic warnings, you know how few people slow down when the "Congestion Ahead" sign comes on.

As complicated as traffic seems, the potential energy savings surely justify some investment to go beyond measuring it to actually trying to change the way it flows. And even if the fix requires new technology, or modified road signage, we could see meaningful results from this long before the vast US car fleet turns over enough to make hybrids and other high-mileage vehicles the norm and not the exception. Meanwhile, when you see that constellation of brake lights ahead of you, don't wait until the last second to slow down. Leave a few car lengths and see what happens.

Credible Threats

Watching the progress of the confrontation over Iran's nuclear program generates more than a touch of deja vu for those who lived through the Cold War. This report from the Washington Post is full of the move-counter-move thinking that dominated strategic debates in the long US/USSR nuclear stalemate. Confining my focus to the energy risk implications, Iran remains the biggest--though hardly the only--risk in the oil market today. The state of play between Iran and the EU/US indicates it will be difficult to avoid realizing at least some of that risk, although it could still take a year or two to materialize.

While the larger issues of war, peace and international stability are certainly of interest, the question I'm most concerned with today is whether speculation about a military option against Iran's nuclear facilities, apparently based on leaked Pentagon plans, increases or decreases the risk of an oil market response by Iran. And while I realize that some of my readers are skeptical that Iran intends anything beyond building a civilian nuclear power system, we are in much the same pickle as we were vis a vis Iraq: Iran can't prove a negative, and its past behavior fuels the growing perception of unacceptable security risks.

The key point here seems to be separating the possibility of an actual military strike, which would have grave consequences not least on oil markets, from the threat of one--or at this point an implied threat--which could be a positive factor in reinforcing the diplomacy that provides the only realistic hope of defusing the present tension. If Iran believes the threat is hollow, they will be less likely to make meaningful concessions, while if they believe it is real, they might either give in, or be motivated to up the ante and threaten a preemptive oil embargo or export cutback. Nor is it far-fetched to wonder if their leadership might actually wish to be attacked, in order to solidify their control and maximize solidarity with the rest of the Islamic world.

The current administration didn't invent the practice of leaking information as a way of sending strategic signals. As a country, though, we don't seem overly adept at this, given the number of commentators and investigative reporters questioning the notion that we could actually pull off a strike on Iran's nuclear facilities. Note that I do not include in this the understandable denials of US and allied officials, who cannot be seen to endorse such an option openly. (This reminds me of a wonderful BBC series some years back about a crafty politician whose stock phrase was, "You might well think that; I couldn't possibly comment.")

At the same time, the demonstration in Iraq of our willingness to intervene when our interests seem to demand it now creates fear at home and abroad that we might attempt the same thing in Iran, while the Iranians--with their unique window on the Iraq conflict--could easily see it as a good reason why we wouldn't. So we're left with a presumed leak of an implied threat to attack Iran that is probably taken more seriously in Europe and the "blue state" sections of the US than it is in Tehran. Unfortunately, Middle Eastern leaders seem to be no better at reading our tea leaves than we are theirs, and if there's anything to the notion that wars start through miscalculation, then they could be setting up a classic case now.

So what does this mean for the price of oil? In my view, a favorable outcome--defined as one that avoids not only war but also an oil market crisis--depends on three essential elements, the resolve of the EU to carry through with sanctions if negotiations fail, the credibility of US force in the event sanctions fail, and an Iranian recognition that, in combination, these factors make the pursuit of their nuclear aims too costly. The current muddle around the effectiveness of a US military option should convince Iran that they don't need to throttle back oil exports preemptively, but it could also lure them into taking a harder line in negotiations, and thus increase the likelihood of a more serious confrontation later. That suggests the "Iran risk" for oil markets won't dissipate soon, though it probably won't turn into another price spike this year.

Splitting the Difference

It's remarkable that eight months after two hurricanes ripped through the heart of the offshore oil and gas drilling industry in the US, and with 14% of Gulf of Mexico natural gas production still shut in, we continue arguing about opening up other areas to drilling. Sunday's New York Times describes the controversy, which pits state against state, and against the federal government. When Florida's Senator Bill Nelson says, "They're using the fear of gas shortages in the aftermath of Katrina to get their way," it's clear that he just doesn't get it, nor is he alone. There's no fear of shortage; there is one, a real one, and it explains why natural gas is still going for over $6.00/million BTUs in April, instead of the $3.00-5.00 that would be more normal for this time of year.

In some respects it's too bad we had a much warmer than normal winter, because the weather bailed us out in ways that weren't apparent to those outside the industry. Even though natural gas prices peaked at just under $15.00, that's a far cry from what we'd have seen if January hadn't been 8 or 9 degrees above normal. We were headed for serious shortfalls and possible curtailment to industry, to keep residential customers supplied, and we dodged a bullet. But because the public and politicians have no idea how close we were to a crisis, they can focus on election year politics and argue over whether drilling 100 miles from Florida's coast is too close for the tourism and real estate interests that are driving this debate.

What these short-sighted concerns fail to address is the fundamental difference between falling short of domestic oil production and falling short of natural gas. When bad weather and ongoing depletion drive our oil production down to levels we haven't seen since the 1940s, we just dial OPEC and pay up. But when natural gas runs short, and we haven't built the LNG terminals that provide the only possible international safety valve, then not only do prices go up, but the people with whom we compete for scarce gas are all Americans. In other words, your local utility must compete with fertilizer and petrochemical plants, and regardless who wins, the US economy loses.

I only see one answer in the short run, and it's one that I suspect my industry friends won't like any better than my environmentalist friends: redefine all the offshore drilling bans to exclude natural gas. We may debate the economic and environmental impact of lower offshore oil production versus the higher imports that naturally follow, but we have left ourselves with no choice but to drill the hell out of every gas deposit we can find. Remember that all of the things people dread about offshore drilling are associated with the oil side. There are no "gas spills" to pollute the shoreline, nor tankers to run aground. You can't see a platform 100 miles away. Lumping offshore gas drilling in with oil drilling is irrational and destructive. It's past time to split our differences and agree to disagree on oil drilling, but turn natural gas loose.

Bio vs. The Plug

A pair of articles in this week's New York Times "Drive Times" e-newsletter frame an interesting energy dilemma. The first piece provides more detail on the "plug-in" hybrid cars being advocated by many commentators. The Times focuses on who makes them today--as modifications to existing hybrid models--and how some of the original equipment manufacturers view that. The other article, from Automobile.com, describes Saab's ethanol-powered all-wheel-drive hybrid prototype. Between them, they illustrate a central dilemma for alternative energy planners: upon what primary energy sources should future cars draw, other than petroleum?

The future energy and environmental impact of transportation energy will hinge on whether motive power is generated onboard or remotely, and from which fuel. The plug-in hybrid answers that in two ways, by relying on an internal combustion engine and by storing up power from the grid. That means its primary fuel is supplemented by some combination of coal, natural gas, nuclear, hydroelectric, and wind, depending on the local power grid's dispatch curve. Note that many of these fuels result in additional, offline emissions of both local pollutants and greenhouse gases, in addition to the emissions from the car's engine.

The "bio hybrid" represents a different philosophy, opting for all-onboard power, but utilizing a biofuel with minimal net greenhouse gas impact. Grain-based ethanol only returns 20% more energy than went into its production, and burning it in an internal combustion engine is less efficient than producing electricity from natural gas in a combined-cycle gas turbine. But despite this, it is not an inherently worse pathway than the plug-in hybrid. Depending on the mix of natural-gas-derived fertilizer and fossil-fuel based process heat that went into making it, it may still produce fewer of the emissions that are linked to climate change than the gasoline and grid-based electricity supply for the plug hybrid.

Even if you fill up the plug-in hybrid with ethanol or some other biofuel, you can't escape the environmental consequences of its external power source. Weighing those against a pure bio-hybrid requires a detailed well-to-wheels analysis, for each market in which the cars would be sold. That's orders of magnitude more complicated than the miles per gallon testing currently done for each car model and powertrain combination. If nothing else, this is a good illustration of just how murky and confusing our future energy choices may get. Although aiming at global problems, the answers could still vary considerably, based on local conditions.

The Other Side

Iran's ambassador to the UN explains their nuclear program in today's NY Times. I saw him interviewed on CNN recently, and he's quite articulate and smooth. After the Iraq WMD fiasco, we can't entirely discount the possibility that things are as they claim, but I stand by my earlier conclusions that nuclear energy makes no economic sense for them, with one new proviso. If Iran's oil and gas reserves had been enormously inflated for the purpose of gaming OPEC's quota system or deceiving investors, then they might have a greater need for the kind of program they are currently pursuing. The implications of that for global energy markets would be highly significant.

A Methanol Economy?

If you step back from the details, a hydrogen economy is a way to get non-oil energy into the transportation segment, in particular, with minimal emissions of either tailpipe pollutants or greenhouse gases. Hydrogen represents only one of many possible pathways for doing this. A recent article in Technology Review focused on another possibility, methanol. It suggests that improvements in methanol manufacturing and advances in fuel cells that convert methanol directly into electricity, without first having to produce hydrogen, could bypass the hydrogen economy model and give us an alternative fuel that can be made cheaply from many different sources. I'm not sure things are quite so rosy, however. Methanol could also deliver a classic case of unintended consequences.

Methanol is made industrially today from natural gas in a process that consumes a significant portion of its energy content, between 25-35%. That's why cutting out the methanol-to-hydrogen step required for current fuel cells is important. Even though methanol is a liquid fuel with an acceptable energy density--about half that of gasoline--and avoids the complications of storing hydrogen on a vehicle at high pressures or low temperatures, turning it into hydrogen incurs further energy costs. If methanol can be made from non-fossil energy sources, such as wind or nuclear power, as the article suggests, then at least its greenhouse gas balance, if not its energy balance, could be significantly positive.

Unfortunately, this doesn't reckon with the challenges of distributing methanol on a large scale. The basic problem is that, unlike gasoline or ethanol, methanol is a neuro-toxin. Ingesting even a small quantity can lead to blindness or death. This is a concern for both bulk handling and at the point of sale. Now, gasoline isn't exactly water, but at least if you spill it on your hand, you don't need to be taken to a hospital. In a perfect world, no one would ever be exposed to either liquid gasoline or methanol, but we know that storage tanks, pipelines and tankers occasionally leak, and most of us have spilled a bit of gasoline while refueling our cars.

Now, methanol accidents wouldn't automatically be disastrous. In the presence of enough water, methanol dilutes quickly. Naturally occurring bacteria would break it down before it would have an opportunity to do much harm. It's much less clear, though, what happens in the case of a methanol spill concentrated enough to kill off the bacteria and remain in the environment for an extended period. There's not much in the literature on this.

A methanol economy is an intriguing notion, providing many of the benefits of a hydrogen-based energy system, but with somewhat fewer complications. The toxicity issue is a potential show-stopper, though, and deserves careful attention and rigorous field tests--as opposed to laboratory-scale experiments--to see what would happen should large quantities spill under real-world conditions.

Note: due to business travel, there won't be any posting tomorrow.

The Chavez Way

It might be tempting to view the creeping nationalization of Venezuela's oil industry as an appropriate re-assertion of indigenous ownership of natural resources, taking them back from a greedy international oil industry dominated by rich European and American companies. President Chavez's energy minister, Sr. Ramirez, explains these actions by saying, "...this country and this government do not allow themselves to be blackmailed. We don't want companies that do not adjust themselves to our laws in our country." Unfortunately, this is a classically inverted piece of propaganda, in which the blackmailers claim to have been blackmailed, and the thieves complain they are the victims of theft. Herr Goebbels would recognize the emulation, conscious or not.

I don't need to recite my earlier comments about the degree to which Sr. Chavez's present power and growing political influence are largely the result of sophisticated oil processing hardware built and paid for by the same multi-national companies that have become his scapegoats. You can read those elsewhere, if you like. Instead, I think it's more important to contemplate the implications of the latest round of oil asset seizures for the global energy market.

Venezuela may not be Saudi Arabia, but in energy terms it is in the same league, in terms of its direct impact on the US energy situation. We rely on Venezuela for 12% of our oil imports, along with additional supplies of gasoline and distillate. The country has 48% of the western hemisphere's oil reserves, not counting reserves of unconventional oil--the ultra-heavy Orinoco deposits--that are on a par with the much-touted Canadian oil sands. At the same time, a wholly-owned subsidiary of the Venezuelan state oil company supplies 10% of the US gasoline market. How many Americans realize that 14,000 Citgo stations provide are the local face of an increasingly hostile foreign government?

The re-direction of Venezuela's oil wealth has immediate consequences, raising the stakes in an already frothy, risk-driven oil market. It also has two less-direct, longer-term outgrowths. First, although I remain skeptical about the prospect of an imminent peak in global oil production, the peak in non-OPEC production is in sight, as mature basins in North America and the North Sea run down. The world will increasingly need to draw on the oil resources of OPEC countries, and access to that oil on commercial terms is key. Venezuela's actions remind other producers of the temptation, especially at times of high prices, of enjoying 100% of the proceeds of investments made in their countries by Exxon, Shell, et al, rather than having to share them. We have been down this path before, and its benefits are largely short term, as countries such as Libya and Kuwait have begun to realize. A return to the large-scale nationalizations we saw in the 1970s would guarantee the premature arrival of Peak Oil.

The other geo-political concern is not specific to energy. Surging oil income gives a disproportionate heft to the distorted economics of President Chavez's Bolivarian Revolution and make it more attractive and influential throughout Latin America. What he portrays as a fairer system is nothing more than the re-distribution of billions of dollars in resource rent. However, that may not be immediately obvious to the millions in poverty for whom his philosophy appears superficially more attractive than the international system of globalized trade, as we saw in Bolivia's recent elections.

While much of our attention is focused on dealing with Islamo-fascist adversaries in the Middle East and elsewhere, we cannot ignore the dangers of an emerging petro-fascism to our south. Mr. Chavez has ways to hurt us of which Al Qaeda can only dream.

Alternative Aircraft Fuel

There are many possible ways to power cars that don't require petroleum products: ethanol, biodiesel, hydrogen, and electricity seem to be the leading contenders today. But there aren't many viable alternatives for fueling jet aircraft. Kerosene-based jet fuel provides a great balance of high energy density, low freeze point, and ease of handling. An article in Technology Review, however, suggests a nifty way to use a byproduct of processing coal into coke for industry that could stretch petroleum-based fuels and possibly even allow for optimized turbine design. If practical, it might even be implemented quickly enough to provide struggling airlines with a bit of relief on fuel prices.

The method described is much simpler than the standard way to turn coal into oil substitutes, as was done in Nazi Germany and still practiced in South Africa today. That approach involves gasifying the coal and creating the desired hydrocarbons from scratch, using Fischer-Tropsch synthesis. The approach suggested in the article goes back to an earlier coal technology that simply cooks liquids out of the coal. Some of the first cars were powered by coal-derived fuels a century ago, particularly in Europe, where petroleum was less plentiful than in the US.

Although this doesn't sound nearly as sexy as some of the alternative fuel technologies people are pursuing for cars, it addresses a segment of oil demand for which other substitutes are lacking. Although planes can be designed to run on liquid hydrogen, as an early design of the SR-71 Blackbird reconnaissance jet was in the late 1950s, its lower energy density by weight and handling difficulties make is much less practical than petroleum distillates. Jet fuel accounts for roughly 8% of US oil consumption, so this is a large and growing demand segment.

There are two problems with the technology suggested in the article, and the author identifies one: very limited supply, relative to the volumes of oil-based jet fuel required. The other is potentially even trickier, namely metals contamination. The refinery "cycle oils" with which the coal oil is to be combined are produced in the fluid catalytic cracking units that are the "upgrading" heart of a modern refinery, at least in markets with high gasoline demand such as the US. But cycle oils carry off small quantities of the catalyst from the cracking units. Although this is a much bigger problem in the "heavy cycle gas oil", even the light cycle oil will contain a bit of catalyst, and that quantity may be too much for a high-performance turbine engine. The coal oil may have similar contamination problems, depending on the quality of the source coal. This issue would need to be thoroughly assessed, before jet engine manufacturers would certify such a fuel for use in their turbines.

So what we have here is a clever, relatively low-tech solution to one of the trickier challenges in any beyond-oil scenario. It needs more evaluation, and it may not be the total solution, but it certainly seems worth pursuing.