Focus on Costs

Today's Washington Post and Wall St. Journal both covered the preliminary findings from the government committee investigating last year's explosion at BP's Texas City Refinery. The headline in the Post tells the entire story, "Cost-Cutting Led to Blast At BP Plant, Probe Finds." Or does it? Missing entirely from these articles, and from the Chemical Safety Board's press release, is the context of the sustained cost pressure under which BP and the entire oil industry has operated for many years. It is not surprising to read that BP had cut costs at Texas City by 25% after its acquisition of Amoco, the original owner of Texas City, but neither the media nor the CSB mentioned that those cuts were compounded on previous cuts made by Amoco as part of a general trend of intense industry competition going back to the 1980s, particularly within the historically unprofitable refining segment. Contrary to the public's perception of an industry flush with cash and profits, refineries have been on a starvation diet for decades.

Oil refining is an odd business. Here are these enormous facilities worth billions of dollars each, processing petroleum costing billions of dollars per year, and using vast amounts of fuel, chemicals and electricity in their operations, and yet manpower comprises one of the few truly "controllable" costs on which management can focus its attention. And in an industry in which margins rise and fall on factors beyond the control of the plant manager, the head of refining, or the CEO, keeping the cost structure lean is a critical success factor, a way to stay competitive in a product for which a few cents of cost per gallon make the difference between first-quartile and last-quartile performance. In the conditions that have prevailed since the price of oil collapsed in the mid-1980s, sustained poor financial performance at a refinery prompts increasingly severe responses, starting with management changes and escalating to either the sale or shutdown of the facility. The pressure on refinery bosses to manage costs is intense and personal.

This pressure to hold down staff and expenses isn't just driven by blind greed, starting with investors and equity analysts who believe the industry can and should operate more efficiently and deliver more of the margin to the shareholders. It can also result in genuine efficiencies that flow all the way to the gas pump, benefiting consumers. For example, years ago refineries reduced their permanent maintenance staffs to eliminate positions only needed during major facility maintenance, or "turnarounds." These workers moved onto the payrolls of contracting companies that the refiners hired to help with these tasks--outsourcing before anyone called it that. Everyone benefited, because a smaller aggregate number of workers could do all the major turnaround work for the industry in a region, with less idle time.

The CSB report cites a specific example of cost cutting in the elimination of 70% of the Texas City training staff. However, it's not clear from this statistic whether BP simply reduced training staff to cut costs, or if they changed the way they delivered training, requiring fewer trainers in the process. Training comes in many forms, including some that have been revolutionized by the internet. But in a highly technical industry in which the early retirement of the most experienced operating personnel--at 55 or even 50--has become the norm, good training is absolutely essential to transferring these skills to the next generation of workers. If inadequate training contributed to last year's fatal accident, as the CSB found, then this was a false economy.

Having spent many years in the downstream portion of the oil industry, I saw numerous cost reduction programs at all levels. Some were well-planned and executed, resulting in lower costs with minimal losses--or sometimes even gains--in effectiveness. Others were slash-and-burn operations clearly intended to reduce headcount and the associated cost. All of this was driven by an industry environment in which, whether prices were up or down, the emphasis was on "making your own margin," i.e. delivering results that did not rely on market factors beyond anyone's control. The trick is setting corporate guidelines that still allow good refinery managers to strike the right balance between efficiency and the urgent priority of keeping personnel and facilities safe. When your plant is on fire on CNN, no one will thank you for having saved a few bucks along the way.

How Bad Could It Be?

One of the key factors hampering a more effective response to climate change has been the enormous uncertainty surrounding its future costs. If emissions reductions and other forms of mitigation are equivalent to an insurance premium, as I've suggested for many years, just what is the magnitude of the adverse outcomes against which we're insuring? The release today of a new UK government report addresses just this question. Commissioned by Chancellor Gordon Brown, led by economist Sir Nicholas Stern, and capped off with a presentation to Britain's Royal Society, the study describes a range of consequences that would be catastrophic for global economic output and highly disruptive to the lives of nations and individuals. Although I intend to convey my reactions to the full report in a later posting, once I've had a chance to digest it, I think it's worth noting the publication of these findings as a milestone in the climate controversy.

Although some may argue otherwise, it seems intuitively obvious that altering our industrial and lifestyle patterns to reduce global greenhouse gas emissions will impose the equivalent of a tax on the global economy. If we view this tax as an investment in averting higher costs later, then it's impossible to assess the return--and thus the priority--of these investments without having a good sense of the magnitude of the avoided future costs. The Stern Report indicates that these figures are in the trillions of US dollars, either in terms of the cost of the potential damage or the value of measures undertaken now to mitigate these results. It also puts a cost on the externality associated with unregulated emissions: $85/ton of CO2 equivalent.

One of the surprising aspects of the report is the optimistic tone of the summary. The focus is not just on the downside, as we'd expect, but also very much on the scope for action and the benefits, economic and otherwise, of responding aggressively. Because of the breadth of the issues covered in this study, we should expect that opponents will soon be at work picking it apart, even as advocates of more drastic action cherry-pick its worst-case outcomes. The key contribution here is something we've lacked for some time: a serious cost estimate grounded in the science of climate change but focused on the economy and the consequences of the status quo and various levels of response. This is precisely what policy makers need in order to make appropriate judgments about how to weigh future uncertainties against the certain current costs of emissions reductions. Stay tuned.

The Right Incentives

In between editing yesterday's posting on California's Proposition 87, I ran across an article reporting on the outcome of this year's Wirefly X-Prize Cup, an annual two-day space technology fair that is a spinoff of the X-Prize sub-orbital-flight contest won by SpaceShipOne two years ago. I couldn't help comparing these very different approaches to stimulating technological innovation, one through incentives and research funded by a tax on conventional energy producers, the other a set of contests with a juicy prize for the team that meets the specific performance objectives set by the organizers, but nothing for the losers. I'm not suggesting that we should replace our entire present approach to alternative energy R&D with a contest, but it's worth considering what even a small fraction of Prop 87's $4 billion pot could generate if it were devoted to various X-Prizes for energy milestones. Something like this is already in the works in the Congress for hydrogen energy, and the X-Prize Foundation is working on an Automotive X-Prize, so there's ample precedent.

While I admit that I've always been fascinated by space, going back to a childhood spent glued to TV coverage of Gemini, Apollo and Skylab missions, I don't think it's a stretch to compare the challenges of space and energy innovation. Both involve the development of new--and sometimes radically new--technology for which the market and existing infrastructure might not be ready. Both present innovators with tough competition from entrenched incumbent players. The biggest differences relate to the size of the potential market and the relative urgency involved.

The other appeal of this approach lies in its focus on delivering a pre-determined level of performance, rather than funding research that might go anywhere or nowhere, or generally fall short of commerciality. Even without the winner-take-all reward--which isn't so different from the way the market has been rewarding companies, lately--this rigid focus on results is a nice match with the big problems that our energy policies ought to be targeting. What ultimately counts in climate change isn't clever concepts, but tons of emissions avoided. Likewise for energy security, the currency is BTUs produced or saved at a price that beats conventional sources, after factoring in externalities. These issues lend themselves to performance-based technology objectives, along the lines of sequestering carbon dioxide at a total cost below $20/ton, or producing biofuels for less than $1.00/gasoline-equivalent gallon, before taxes and subsidies.

If California's Proposition 87 loses on November 7, I hope its sponsors will regroup and try again. Their next attempt, though, should avoid pitting alternative energy against conventional energy sources--both of which we will need for the foreseeable future. And they should certainly consider incorporating the ideas of the X-Prize, with its specific R&D targets and highly-leveraged incentives for demonstrated results.

By the way, I'd like to address a little housekeeping matter. The number of comments I've been receiving has fallen off significantly in the last month or so, apparently going back to my intervention in a couple of comments I thought were off base. One was a blatant commercial, and the other was an ad hominem response to another commenter, using a euphemism for a portion of anatomy. I erased most of the former and modified the latter, ultimately blanking out the offending term. If this violated some unspoken rule of the blogosphere, I apologize. I never edit comments unless they are profane or obscene, or constitute commercial spam, and I will hold to that standard in the future. On the other hand, if anyone has tried to post a comment and not seen it appear, I would like to know about it. Please email me using the link on this page to inform me of such a sitatuation.

Proposition 87

After a summer in which the threat of windfall profits taxes on the oil industry seemed to grow in direct proportion to the commodity price, that tide has receded--for now--leaving behind only a California ballot initiative that would impose a "severance tax" on oil produced in the state. Proposition 87 provides an excellent example of some of my recent comments on energy policy. After wading through the text of the actual proposition, I concluded that it is essentially a $4 billion plan to cut oil use via the slow path of efficiency incentives and alternative energy investment in infrastructure and R&D. Voters should be asking many questions about this proposition, including whether this is the most effective means of reducing their consumption, how such a program should be financed and administered, and who will ultimately benefit from it.

Having spent the better part of thirty years living in California, I still miss the excitement of its hotly-contested state ballot initiatives. This is the purest form of high-level democracy in our country. Some see it as a great boon and others as support for the Framers' choice of a democratic republic for our national government. In any case, past California propositions have changed the face of the state and sparked broader movements across the nation. The oil industry seems justifiably worried that this one could fall into the latter category.

There are two basic issues here that voters ought to consider. The first is whether Prop 87's stated goal of reducing California's oil consumption by a quarter is achievable by means of its support for more efficient cars, renewable fuel infrastructure, and energy R&D. Since that consumption currently stands at 1.9 million barrels per day, second highest in the US--though first in gasoline and jet fuel usage--a little skepticism seems in order. $4 billion would buy a lot of R&D, but not very much alternative energy capacity. For example, spending it all on building ethanol plants would yield the approximate fuel equivalent of one new oil refinery. If a $4 billion investment could really cut $10 billion from California's annual petroleum bill, that would be remarkable leverage, indeed. Without tackling consumer behavior, this path will take decades to reach its goals. The environmental consequences and national security ramifications of the status quo trends suggest we can't wait that long.

The second question relates to the impact on the state's oil industry, which has generated economic growth, jobs, and taxes of all kinds for more than a century. I wonder if the authors of this initiative understand that of the 630,000 barrels of daily production they cite, the majority is heavy oil--64% of it per the state's 2005 annual report--and much lower in quality and value than the benchmark West Texas Intermediate crude oil traded on the New York Mercantile Exchange. For example, the Midway-Sunset grade of San Joaquin Valley Heavy oil, a key marker crude in California, was selling for $8.72/barrel less than WTI in July, ranging between a $5 and $10/barrel discount over the last five years. What we're really talking about is adding a couple of dollars per barrel in cost to some of the most expensive, least valuable crude oil produced in the US. Now, you might say that oil companies have no better alternatives, but if world oil prices continue to fall, that may not be true in the long run. It's a good bet that the severance tax will accelerate the long decline of California's production and the shrinking of the whole industry.

For that matter, the severance tax language in the proposition is so skimpy and vague that it appears to have been more of an afterthought than an original intent. You can imagine the drafters devoting all their time and energy to carving up the $4 billion for alternative energy and efficiency, and then realizing they had to find someone who would pay for it all--preferably not the voters who must pass it. It is telling that even the state's own legislative analyst office has been unable to parse the exact specification or intent of how the severance tax is to be applied, whether on the entire barrel or by increments up to each price bracket. (I.e., like a sales tax or an income tax.)

The initiative's highly-publicized protection against producers passing the cost of the tax on to the public is even more vague and naive. In fact, the description of this provision in the proposition literature is longer than the relevant portion of the legal text, which is short enough to quote here in its entirety:

42004 (c) The assessment imposed by this part shall not be passed on to consumers through higher prices for oil, gasoline, or diesel fuel. At the request of the authority, the board shall investigate whether a producer, first purchaser, or subsequent purchaser has attempted to gouge consumers by using the assessment as a pretext to materially raise the price of oil, gasoline, or diesel fuel.

Contrary to the above, though, Prop 87 would not revoke the law of supply and demand. Simply put, increasing the cost of California's heavy oil will make it less attractive to produce and less attractive to refiners, who will import more foreign crude oil and/or petroleum products refined offshore. From an energy security standpoint, this initiative goes in exactly the wrong direction, reducing supply today in exchange for the prospect of reduced future consumption, while focusing on a point in the value chain with minimal leverage on reducing current demand. The selection of a severance tax as the funding mechanism for alternative energy incentives appears either arbitrary or cynical, eschewing the more obvious and effective route of a gasoline tax that would at least have a direct effect on demand.

On balance, while Proposition 87 would help alternative energy--and alternative energy investors--the outcome for the majority of California's energy consumers is ambiguous. Because its funding mechanism penalizes current domestic energy production, I can't join with the prominent figures who have endorsed Proposition 87. It might save some oil over the long haul, but it would do so at the cost of speeding the decline of a vital American oil resource in the San Joaquin Valley, while increasing our near-term reliance on foreign oil suppliers. That's a consequence that California's consumers and taxpayers would rue for years to come. Rather than being told that they can have alternative energy but pass the tab to someone else, voters should have been given the opportunity to indicate whether they're willing to pay more at the pump to fund it.

Colossus Next Door

Tom Friedman's column in today's New York Times (Times Select required) looks with concern at Russia's growing domination of Europe's energy markets, in parallel with the political transformation within Russia. He sees the situation reflecting a unified theory of "Petropolitics", in which oil prices and freedom are inversely related in emerging countries. This is thought-provoking and clever, but it all sounds a bit pat. It also obscures important questions of cause and effect, as well as the broader geopolitical context. Are Russia's present political trends worrying because they are increasingly authoritarian, or merely because Russia holds the key to Europe's growing natural gas imports? For me, this is about a lot more than just energy.

There's no question that Russia holds the whip hand on the EU's natural gas supplies, as I've discussed previously. Mr. Friedman worries that Russia already supplies 40% of Europe's gas. It ought to be of even greater concern that it controls 60% of the EU's gas imports. It's worth recalling, however, that the logistics of gas are quite different from those for oil. Without building expensive exports pipelines or LNG plants to serve other markets, Russia can't divert that gas to China overnight. Russia's choice of where to sell its incremental gas ought to be of at least as much concern to Europe as whether the latter will find itself cut off in some future contractual dispute.

There's also a risk of attributing too much influence to energy, and not enough to other factors that will be crucial in determining the nature of Russia's relationship to the West. Is Russia's goverment becoming more authoritarian because it can afford to do so, since oil and gas prices are high, or is it becoming more authoritarian because in the last century, the number of years in which Russia was truly democratic can be counted on the fingers of one hand? Did it really matter that the price of oil was "near $16/barrel" (actually $20) when the Berlin Wall came down? If it had been $35, as it was only a year later--after Iraq invaded Kuwait--would the former USSR have stayed together or gone in a different direction?

For that matter, Russia was one of the main contributors to the low oil prices of the late 1990s and early 2000s, with its tremendous production resurgence, driven by the profit motive for the first time in 75 years. Recent reversals of this, with the consolidation of Russian energy under greater state control, reduced the rate of growth of the country's production and created a crucial supply void that helped drive prices to their recent highs.

Rather than arguing about which is the horse and which is the cart, though, I'd suggest putting Russian energy in its proper perspective. If Putin's Russia is developing along lines that make us uncomfortable and reasserting itself in geopolitics in unhelpful ways, e.g., with respect to Iran's nukes and other issues, then that's where we need to focus. Our energy worries seem more of a consequence than a cause, here. Blaming the situation on high oil prices and attempting to fit Russia into a global "petrolism" movement shortchanges our understanding of events within Russia and leaves us without useful insights for dealing with the EU's big Eurasian neighbor.

Short Attention Span

Suddenly the newspapers are filled with articles on the challenge facing major oil companies in sustaining quarter-on-quarter earnings gains, in light of stalled or falling oil prices. Rather than viewing this as some sort of deep market wisdom, we should see it as a reminder of how fickle market psychology can be. Just as momentum traders have seen the breakdown of the trends that impelled them to pile more and more assets into the energy sector, a wider group of investors is beginning to realize that oil might not hit $100/barrel this year, and that, as an Associated Press headline suggests, the "Oil Patch's Profit Party Is Slowing Down." What is the average shareholder to make of all this, and does it have any bearing on the future price of gasoline?

Oil companies have had an amazing run of profit growth, fueled by the steady increases in oil prices. It's hard to believe that five years ago this week, oil was trading on the New York Mercantile Exchange for $22/bbl, and three years ago it was still only $30. Sooner or later, prices were bound to correct, and when they did, the key earnings-growth engine that these companies have relied on recently would falter. And as many commentators have pointed out, not only are prices not going up, but companies are being caught in a margin squeeze, as the costs of the hardware and services they buy to operate in the exploration and production business continue to inflate. This will put pressure on producer profits in the near future, and the scope for other cost reductions is limited, because most of these companies started pretty lean, and few of them expanded dramatically while the good times rolled.

Although much of this rings true, it ignores some fundamental realities of the business. Equity analysts have generally been conservative in the future prices they've used to value the oil sector. That means that the stock prices of the majors and independents weren't reflecting $80 oil, even at the peak of the market this summer. If they had been, ExxonMobil wouldn't be trading at $70; it would be closer to $90. Likewise for Chevron, ConocoPhillips, etc. With current prices below $60/bbl, but the long-term end of the market still well over that, we're probably in the range that most of the analysts were using, anyway. So the question is not one of over-valuation, but of the magnitude of any further upside.

The other issue here is access to commodity price exposure. Although the stock prices of oil companies are certainly sensitive to the price of the commodity--though to widely varying degrees--the proliferation of market instruments and the growth in investor sophistication have reached a point at which no one needs to buy or sell oil equities to go long or short on oil. Investors can use funds, futures or options that do this directly, and that's been true for some time. So if, as someone told me many years ago, every oil company share is essentially composed of a piece of a giant cash machine plus an embedded option on the future price of oil, it's a pretty expensive way to buy that option. Even if the hedge funds unwind all their oil positions, that shouldn't translate into a dollar-for-dollar decline in oil equity prices.

Having owned oil company shares for most of my adult life, either as a byproduct of employment or as part of my retirement plan, I have become pretty sanguine about their ups and downs. But when I look at the big picture, which includes an unstable Middle East and pre-nuclear Iran, restricted access to more than half the world's remaining oil reserves, and the non-zero probability of an impending peak in global oil production, then these companies still look pretty solid, regardless of their ability to beat this quarter's results next quarter. If the intrinsic value of XOM, CVX, COP and their brethren isn't now a solid multiple of what it was when oil was at $22/bbl, I'll eat my hat.

As to gasoline prices, I don't see any influence from the price of these equities. We should enjoy life near $2.00/gallon but not count on this lasting. That's not because oil companies will try to boost sagging earnings by inflating pump prices; they don't have the power to do that in a market that is more competitive than that for almost anything else that consumers buy. Eventually, though, there'll be another spike in Mideast tensions, or terrorism, or a supply disruption. And if there's not, a new Congress might just find higher gasoline taxes irresistible, either as a consequence of addressing global warming, or as part of a plan to improve our energy security. That could depress the long-term value of oil companies more than anything else I've mentioned today.

Finding Nega-watts

Last week I devoted several postings to the policy options available to improve our energy security, mostly focused on liquid fuels for mobility. After transportation, however, electricity makes up the next largest aspect of energy demand we would need to manage, as part of a comprehensive approach to energy security. Electricity demand has been growing faster than petroleum for years, because of its direct linkage to economic growth and the popularity of increasing numbers of electric gadgets. The policy dilemma here exactly mirrors that for transportation: do you reduce the rate of consumption growth by clamping down on current usage, or do you focus on making new electrical devices more efficient? As with transportation, though, because of the large installed base, the latter represents something of a slow-motion attack on the problem. Fortunately, there are better solutions for reducing electricity usage than there are for reducing oil demand. This week's energy report from the Wall Street Journal listed 10 options that are achievable with existing technology, though not necessarily with existing regulations.

There's been a longstanding debate about whether efficiency, sometimes referred to as negative Watts or "nega-watts," belongs on the supply or demand side of the equation. Though something of a purist on this topic, I'm sympathetic to those who see efficiency as directly equivalent to additional supply. In fact, when we look at primary energy, electrical efficiency has a large multiplier effect, because only a fraction of the energy content of the upstream fuel, be it coal, natural gas or uranium, flows out of the grid as useful electrons. If average overall electric generation and transmission efficiency is about 30%, then every kiloWatt-hour saved translates into three times its energy equivalent in fuel savings at the power plant.

Many of the Journal's suggestions are old news, including efficient lighting--though there's a revolution coming with LED lighting--better electric motors, higher efficiency standards for buildings and appliances, and time-of-day electricity pricing. And this list doesn't even include such blindingly-obvious measures as turning off lights and unused devices. The Journal ignores some of the feedback between different initiatives, though. For example, while time-of-day pricing--which many businesses already have--increases the incentive for changing out old, inefficient motors, it reduces the benefit of replacing home incandescent lighting, which is mostly used when off-peak rates apply. In any case, these effects are unlikely to overwhelm the potential combined impact of these initiatives.

Some of this will happen without intervention by the federal government. What's at issue here is a national effort that goes well beyond the 1 or 2% per year improvement that will occur simply as a result of people and businesses getting smarter about managing their energy costs. Efficiency has never been as glamorous as arguing about the next coal or nuclear plant, but its impact is much broader and takes much less time to be felt. And if we're looking for energy initiatives with unambiguously positive cost/benefit ratios, nega-watts are fertile ground, indeed, compared with the cost of subsidizing alternative fuels or incentivizing new auto technology. If lowering our demand for transportation energy seems difficult and complex, improving electric efficiency looks far easier by comparison. This area seems like an obvious candidate for some quick wins.

The Devourers

Bravo to the New York Times for its clarity in articulating its preferred energy policy. In an editorial yesterday objecting strongly to changes in the royalty rates for extracting oil from shale--of which not a single barrel is currently being produced--the Times came down solidly on the side of conservation, concluding that the alternative was "a nation committed to devouring itself one barrel at a time." This is important, because this view is shared by millions of Americans. Unfortunately, it is entirely at odds with any rational view of energy security or energy independence, which at least one party sees as a viable political issue. Factoring in the impediments to meaningful oil conservation that I highlighted in Wednesday's posting, and even allowing a rapid scale-up of ethanol and biodiesel, we will still consume truly enormous quantities of oil in the next two decades. Where that oil will and ought to come from is a question that won't be answered by clever turns of phrase.

We might start by reminding ourselves where we seem to believe we shouldn't drill for oil. On top of the shale deposits of the West, there's the Arctic National Wildlife Refuge. We have also ruled out vast tracts of our coastlines, irrespective of the quantities of oil either known or suspected to lie under their waters. We're even trying to deny Cuba the right to drill on their own side of the Florida Straights. (Never mind that we have essentially written off most of our own Gulf Coast to being drilled like a pincushion.) Then, lest we turn to our neighbors up north for more oil, the Times has previously pointed out the significant environmental impact associated with oil sands extraction, which is similar at least in concept to oil shale.

Where does that leave us? At best--and believe me, this is a stretch--US oil production will continue on its current plateau of between 5 and 6 million barrels per day, depending on how many hurricanes the Gulf gets in a given year. Throw in natural gas liquids, and we're up to almost 8 million, or roughly 38% of the total of 21 million barrels per day of total petroleum products we consume. Reduce consumption by 10% and boost biofuels from their present 1.5% contribution to 10%--neither of which is a trivial proposition--and we still have a heck of a gap, with nowhere else to turn to fill it but the same folks who held a little supplier's conference in Doha yesterday.

If we are serious about energy security and an end goal that might approach energy independence, then we should be cautious about which domestic hydrocarbon options we take off the table on principle. While it's true that we can't drill our way to independence, as you will hear often from critics of shoring up our domestic production, neither can we get anywhere close to independence without a substantial amount of further drilling. And just whose resources should we "devour...a barrel at a time" to keep Americans' cars on the road?

OPEC's Relevance

Some of the headlines about the OPEC meeting in Qatar today give the impression of an organization in disarray, as the oil market falls off a cliff. I think we could use a bit of perspective, here. OPEC functioned perfectly well, from their perspective, while prices rose steadily. Discipline was unnecessary, as members sold every drop they could produce--barring civil unrest, pipeline accidents, or running short of the grades of oil the market actually needed. In effect, from 2003 until recently, OPEC was irrelevant to both consumers and themselves. Things are shifting back into a more normal mode for OPEC, as demand slows and inventory creates a bit of headroom. I suspect that they and we are unaccustomed to that, after three years of ascending on auto-pilot.

Putting prices into their proper context, yesterday's closing level of $57.70/barrel on the New York Mercantile Exchange, while $20 lower than this summer's highs, is still roughly twice the historical average nominal oil price. It is also higher than the averages for 2005, 2004, 2003, or any previous year you care to examine. Even in real dollars, you have to go back to the tail end of the last energy crisis, in the early 1980s, to find a higher real price.

Of course, that's what's on OPEC's minds. They remember the price collapse of 1985-86, when sellers had to come up with creative ways to induce buyers to take their oil, and one of those clever mechanisms--the netback price--created a positive feedback loop that accelerated the collapse. They also remember the 1990s, when prices dropped from $20 in November 1997 to bottom out under $11.00 a year later. They know that after several years of very high prices, consumers start to adjust their habits, and non-OPEC producers find new ways to eke out more production. The market is moving off auto-pilot, and the cartel must think about trying to set a new course.

Watching this from the vantage point of the gas pump, it's easy to magnify OPEC's problem. We've seen US average gasoline prices drop by 80 cents per gallon, or almost $34/barrel, but roughly $15 of that has come from the collapse of refining margins, which doesn't affect OPEC directly--but has hammered pure-play refiners such as Valero. The real story here is that crude oil and petroleum product inventories are well above their seasonal averages, and the risk of war with Iraq over its nuclear program has apparently receded. OPEC needs to trim by a million barrels per day or so to bring supply and demand back into balance. If they can't achieve that now, prices will fall farther and they risk needing a larger cut later, just when the winter demand really kicks in. That could produce a very nasty whipsaw in the market.

In any case, no matter how much they might wish to be seen that way, OPEC is not the Federal Reserve Bank, and the measure of an OPEC meeting isn't in its concluding press release, but in the reports of actual deliveries four to six weeks later.

Reducing Oil Demand

Continuing on from Monday's posting on the political dimensions of US energy security, let's look at the demand side of the equation, leaving supply for a subsequent posting. Although we frequently talk about energy security and energy independence, we usually mean oil security, because that's where we have our greatest exposure to imports, unstable regimes, the Middle East, depletion, and all the other things that make us nervous about our energy future. And when we talk about oil usage, we really mean transportation, because that's where about two-thirds of America's oil consumption ends up. So the demand side of the energy security question boils down to whether and how we can reduce the amount of oil we use in transportation. The US has struggled to answer that question for my entire adult life, because it goes to the heart of not just our economy, but our way of life.

As complex as this question is politically, it breaks down into two very simple elements, which I've discussed on this blog many times: reducing current consumption by changing consumer behavior, and reducing future consumption by improving the efficiency of our oil-based transportation systems. Both of these paths face enormous obstacles, but every initiative designed to address oil demand must incorporate at least one of them. It's a tossup which poses the tougher challenge: the socio-political inertia around our present patterns of fuel use, or the high capital costs and slow turnover of our large base of existing vehicle fleets, both personal and commercial.

In terms of changing behavior, our society responds best to economic signals. This summer we got a clear signal that gasoline was tight, and we reacted by driving less and buying fewer heavy, inefficient vehicles. Right now, we're receiving a signal that gas is more plentiful, and while SUV sales may not rebound, it's a good bet that discretionary driving will. Policy makers have multiple tools available for altering these signals and the behavior that follows them--some low-tech, some high-tech--including higher fuel taxes, oil floor-price taxes, parking taxes, congestion taxes, time-of-day road tolls, GPS-based mileage charges, horsepower taxes, engine displacement taxes, and that's only a sample. Every single one of these measures is possible and practical, but would face intense opposition on the basis of regressiveness, invasion of privacy, erosion of business competitiveness, and unintended consequences. Anyone wishing to take on short-term transportation fuel demand won't lack for policy tools, but they'd better be tough and determined.

It's no surprise that politicians have largely steered clear of these thorny measures, as described in today's Washington Post, though it's less obvious that many of them truly understand what they're foregoing. Trying to change Corporate Average Fuel Economy standards and introduce incentives for new automotive efficiency technologies has hardly been a walk in the park, politically, but the impact of improving the gas mileage of some of the 16 million new cars bought each year pales in comparison to changing the way all 230 million cars on the road today are used, more or less immediately. But if incrementalism is all we're left with, there are some fine technology options, including hybrids and plug-in hybrids, about which we've heard a great deal recently, and the new diesels, about which we should hear much more, shortly.

Every carmaker in the European market, including GM, Ford and Daimler-Chrysler, offers superb diesel engines that produce performance quite similar to gasoline engines, but burn about 30% less fuel. Consider Honda's Accord i-CTDi, featured in the New York Times this week. This car capitalizes on the ultra-low-sulfur diesel fuel that is now required across the US, along with some very clever engine tweaks and catalyst chemistry, to deliver gas-like performance in a 40+ mpg, stylish-yet-affordable package. And while there are lots of smaller improvements that are possible with existing technology, 40 mpg is about the minimum new-car mileage improvement necessary to shift average US fleet fuel economy (currently 20 mpg, including SUVs) by enough to affect our oil imports within a decade.

European-style diesels offer two important advantages over hybrids. First, because their cost premium over standard gasoline cars is lower than that of hybrids, they could become mass-market much quicker. Toyota hopes to sell 60,000 Hybrid Camrys within a few years, but we'd need millions of hybrids or diesels, soon, to make a material difference in our total oil consumption. We know this level of market penetration is possible, because European diesels captured half the new car market in roughly a decade. When I shopped for a new car two years ago, the Passat Diesel was on my short list and dropped out mostly due to lack of availability.

The other nice feature of diesels is their ability to run on some of the most interesting petroleum substitutes out there. That includes blends incorporating biodiesel, which many see as a better alternative than ethanol, but it also includes the ouput of gas-to-liquids and coal-to-liquids processes. We'd need fewer highly-efficient cars running on low-petroleum or non-petroleum fuels to move the needle on imports. Would the Congress or Administration be willing to give diesel cars the same kind of tax incentives that they have provided to hybrids, or better yet, broaden incentives to cover all high-efficiency options? That's what it would take to make a real dent, if consumption remains untouchable and we must go by the "slow road."

If we're serious about energy security, then this is a big part of what it must look like: large numbers of Americans driving large numbers of ultra-efficient cars that leverage their use of petroleum with biofuels or synthetic fuels, driving a lot less, or both. Achieving that won't be easy. Price tag? Maybe a couple hundred billion dollars over 10 years, compared to an oil import bill over that period of $1.5 Trillion, even at $40/barrel.

Pulpit Denied?

If Hugo Chavez had made his case calmly and rationally at the opening of the UN General Assembly in New York a few weeks ago, the outcome of yesterday's vote to fill a Latin American vacancy on the Security Council might have been different. Despite a transparent effort to buy UN member countries' votes with aid and trade deals, Venezuela couldn't garner as many votes as Guatemala, which had no petro-dollars to lavish on its supporters. After 10 rounds of voting, Guatemala was leading, but not by enough to win the seat. UN watchers expect a compromise candidate to be put forward today. While the outcome is already being portrayed as the result of a strong-arm campaign by the US, Sr. Chavez has only his poor impulse control to blame. And if yesterday's full-page ad in the Washington Post--and presumably many other US papers--is any indication, the UN isn't the only place where Chavez has damaged his country's reputation.

The management of Citgo Petroleum has found it necessary to "set the record straight" concerning the expiration of its marketing agreement with 7-Eleven and their relationship with the Venezuelan government. I doubt the clarification of ownership and "alignment with the global energy policy" of PDVSA, as they put it, will provide much comfort to Citgo's retailers or concerned customers. Although the ad, which is based on an earlier press release, didn't mention by how much sales were off, its publication suggests that the various boycotts of Citgo are having more effect than the "buy-cott" that one of my readers highlighted in a comment.

My sympathies are with the Citgo retailers, here. While retail boycotts are one of the few channels by which consumers can express displeasure with an oil company's policies, they harm retailers more than the parent company, which can sell any resulting surplus product on the spot market. When most of these small, independent businesses signed their contracts with Citgo, its government-owned parent company was precisely the reliable supplier of long standing that the Citgo ad characterizes them as being.

Going forward, Citgo retailers must assess whether the benefits of the Citgo brand and supply contract will outweigh the inherent risks of economic and social hardship that could follow future comments or actions by Sr. Chavez. Unlike the publicly-traded, multinational companies that have frequently been portrayed as insufficiently loyal to their national homes, a state oil company must ultimately hew to the policies of the government that owns it, thus sharing the global reputation of that state, for good or ill. As long as Hugo is at the helm, there's more downside than up. If I were a Citgo retailer, I'd be looking seriously at other options.

Campaign Slogans

In one of his columns last week, Tom Friedman (Times Select required) relayed a conversation with Democratic strategist James Carville about energy. Both men see a tremendous opportunity for the Democrats—or really for either party—in the public’s concern about energy security. However, it’s worth recalling that the current administration brought in more energy expertise than almost any previous one, but could not hit a home run with it. That illustrates the complexity and the scale of the challenge involved. If energy security is going to work as a campaign issue, candidates must clearly differentiate what they’re going to do from what’s been tried unsuccessfully in the past.

For starters, they can’t just replay the tired old slogans about “energy independence.” Americans have been hearing this since the 1970s, while the goal recedes farther from the realm of possibility every day. In 1975 we imported 36 % of our oil and 16 % of our total energy needs. In other words, we were 84% self-sufficient in energy, though you’d never have guessed that from the level of panic the oil shocks caused. By 2005, however, those imports had expanded to encompass 60 % of oil and 30 % of total energy. In other words, today we are 1/6th less energy independent than when the phrase was first coined, in spite of numerous government and private initiatives to close the gap.

The political opportunity may be great, but it’s going to require some icon-breaking for both sides, if we want real progress, rather than well-intended but impractical remedies. I plan to suggest some concrete examples during the next couple of weeks, but topping the list is the need to mesh our energy and environmental priorities in a way that treats all primary energy sources—i.e. those that create net new BTUs, rather than changing them from one from to another—equally, and differentiates between them based on their total environmental impact, with greenhouse gas emissions as first priority. That means coming up with a systematic way to evaluate the life-cycle environmental consequences of a wide range of energy sources, including ethanol and other biofuels, clean coal, nuclear, oil sands, offshore drilling, photovoltaics and wind power, and then prioritizing our efforts.

Embarking on such a path will step on some toes, particularly if it turns out that more conventional approaches such as offshore drilling—at least for natural gas—can deliver meaningful increments of energy security at a smaller environmental price than such high-tech methods as coal liquefaction and oil sands recovery, or faster than some of our renewable energy alternatives.

Being pragmatic about energy security also means recognizing the tremendous inertia involved in moderating our demand without destroying the economic activity that’s linked to it. In transportation, that inertia results less from the reluctance of the auto industry to produce more efficient cars than from the size of our existing vehicle fleet, and our propensity to drive it farther every year. Any policies for near-term demand impact will have to be driven by behavior first, investment second, and this will probably require higher fuel taxes.

Solutions such as these are bound to become intensely political, because of the interests they challenge. They also require having the guts to risk offending either party’s base, but doing so in a way that will still allow the creation of a post-election, bi-partisan consensus on energy that has been absent at the national level for some time. So while there’s certainly an opportunity for a candidate or party to use energy security to distinguish itself from its opponent, this won't necessarily be any easier than tackling Social Security reform or Iraq.

Surplus Energy

An old friend and reader of this blog sent me a link to an article on biodiesel at an engineering magazine's website. Despite the technical qualifications of the author, he chose to quote uncritically from a widely-cited, but nevertheless misleading energy comparison between ethanol and gasoline. Since this specific piece of data has come up many times in the comments posted to this blog, it's worth examining its central fallacy. The study in question, from Argonne Labs, indicates that ethanol returns over 1.3 BTUs for every BTU of input, while gasoline returns only 0.8. On this basis, it concludes that ethanol is a more efficient fuel than gasoline. In fact, the same data can easily be used to show that gasoline is more efficient, merely by choosing the correct system for comparison. Getting this right is more than just a detail; it has implications for the future quantity of primary energy available for the global economy.

The first real Chemical Engineering class I took--as distinct from such scintillating pre-requisites as differential equations and organic chemistry--focused on accounting for all of the inputs and outputs of mass and energy in a system, and doing so consistently. It turns out that where you draw the "envelope" around a system largely determines the result you get. The researchers in the Argonne study chose a perfectly reasonable place to draw the envelope around ethanol, evaluating all its fossil energy inputs, including fertilizer and the fuel used in cultivation, harvesting, transportation and distillation. I don't doubt the validity of the positive balance they obtained. If you add up the fossil fuel that goes into making it, ethanol looks like a decent extender, especially if you have coal and natural gas to spare. Hamburger Helper for gasoline, in effect.

The problem comes from the choice of an arbitrary and--at least from an industry, rather than academic perspective--inappropriate way to draw the envelope for assessing gasoline's energy efficiency. Dr. Wang counts all the BTUs that went into producing the oil, getting it to a refinery, and processing it into gasoline. So far, so good, but then he adds the BTUs that were in the oil in the ground. This is analogous to tallying up the BTUs of sunshine falling on a desert. They're there, but what else are you going to do with them? This approach might be more defensible if there were important uses of petroleum that didn't involve refining it into fuels and other products. But we don't burn much unrefined oil, or use it for paving or anything else, since the days when it was sold in little bottles as "patent medicine." We nearly always refine it into fuel, lubricants, and other byproducts, and in this country we turn many of those byproducts into gasoline, too.

What happens when you draw the envelope around the gasoline system to reflect the inputs that went into producing the oil and running the refinery, but not the energy content of the oil in the ground, and weigh them against the gasoline coming out? Well, from the same presentation giving the oft-cited 1.36:1 ratio for ethanol, we see that producing 100 net BTUs of gasoline only requires about 25 BTUs of energy input, yielding an energy return ratio of roughly 4:1. That doesn't mean we should always prefer gasoline over ethanol, because in a world of expensive oil and unstable suppliers, we may need both. However, it does clearly show that gasoline is higher up the energy food chain than ethanol, which might explain why it beat ethanol hands down in the competition to fuel those new-fangled internal combustion engines a century ago.

Ardent supporters of corn ethanol will argue vehemently that I'm looking at this incorrectly. Instead of turning arabesques refuting this fairly simple calculation, though, perhaps they should focus on the need to close the substantial gap it reveals. Improvements in areas such as ethanol plant integration and bio-engineering of seed corn should steadily push the corn-ethanol balance toward a 2:1 energy return, even without the major improvements that practical cellulosic ethanol could bring. At the same time, the gasoline energy balance will deteriorate, as the world's oil supply shifts toward highly energy-intensive production sources such as oil sands, ultra-heavy oil, and ultra-deep water fields. As this energy gap narrows, the magnitude of the subsidy required to make biofuels competitive will shrink, and that'll be good for consumers and for taxpayers.

The bad news is that if that gap shrink faster from the top than the bottom, it will mean that our society's energy surplus is shrinking with it. In the same way that it took the creation of an agricultural surplus to free our ancestors from slavery to crop cycles and give them the time and spare workers to create a civilization, our civilization requires an energy surplus, in the form of sources of primary energy that return much more net energy than we put into their production. Biofuels have a long way to go to catch up to oil and gas in this regard.

Oil Conspiracies

I seem to be the last one in America to see any popular movie, so it’s awfully late to mention “Syriana”, last year’s oil conspiracy movie. However tardy, though, it certainly fits nicely with the recent spate of political cartoons implying that the timing of the recent fall in gasoline prices--so close to the November elections--is no accident. The Washington Post took on this subject recently, and they did a nice job, debunking a variety of skewed notions about how the energy industry functions. But when you watch a film like “Syriana”, you realize how deeply-embedded some of these ideas are, particularly with regard to Middle East oil in the post-9/11 world. I’ll bet there are a few energy executives who secretly wish that things really worked this way; their lives would be simpler and more exciting.

Human beings love conspiracy theories; it must be hard-wired into our brains, perhaps going back to some aspect of life on the savanna. Somehow, though, I didn’t inherit those genes; I got the skeptical ones, instead. I see the strongest argument against conspiracies in the incredibly rapid dissemination of secrets in our society. Of course, there are obvious exceptions to this, such as those exploited by Al Qaeda, which relies on the classic “cell” structure and often seems to “hide in plain sight”. But if you can’t keep something secret, you can’t pull off a conspiracy. And that’s the problem with most of the oil conspiracy theories: too many people would have to know about them, and would leak it out by phone, email, text, or carrier pigeon.

For those who haven’t seen it, “Syiana” is a tense, vivid thriller built around two conspiracies between oil companies and government officials: one involving the disposal of an inconvenient Middle Eastern prince, and a related cabal working to ensure the approval of a big oil company merger. Although Iraq never comes up, it’s hardly an accident that a story like this would show up during a war that many thought was motivated by “ blood for oil,” or making the world safe for oil companies. It’s a good movie, but as a critique of international energy business it falls flat, requiring nearly as much suspension of disbelief as the “Da Vinci Code.”

Ironically, the only documented oil conspiracy of recent years attracted relatively little attention and even less public outrage. High officials and shady businesses deliberately and systematically undermined the UN’s Iraq Oil for Food program, or looked the other way as more than a billion dollars in kickbacks and fraudulent transactions enriched Saddam’s regime, at the expense of providing food and medicine to poor Iraqis. If you want to read about a real conspiracy, rather than watch an imaginary one, check out the final report of the Volcker Commission.

That 70s Blog

As I've mentioned in previous postings, I'm intrigued by what the past can tell us about the challenges that lie ahead. Two months ago I highlighted a Wall St. Journal op-ed that drew clever analogies between the current world situation and several pivotal years in the 20th century, including 1938, 1942, 1948 and 1972. As appealing as I found the 1948 perspective, I've lately been leaning toward 1972 as the better comparison. The last couple of months of news have generated an atmosphere that feels uncomfortably reminiscent of the Seventies. Having come of age in that confused and conflicted decade, I had hoped sincerely never to see its like again. Unless we avoid some fairly obvious traps, though, we could find ourselves just as powerless to improve our situation as we seemed back then.

No analogy is perfect, but here are some disturbing points of correspondence:

• A war on the far side of the world has brought our international standing to a multi-decade low point, and anti-Americanism is rampant. The consequences of withdrawal look at least as bad as those of staying and failing.
• American politics are fractured by partisanship and scandal, undermining the effectiveness of government in addressing the large problems we face.
• Despite current strength, trade and fiscal deficits cast a pall over the economy and the dollar. It's worth recalling that the Dow Jones Industrial Average broke 1000 for the first time in late 1972--and didn't see that level again until nearly four years later, when 1000 was only worth about $735 1972 dollars.
• International terrorism is again a major factor in our lives. Besides the tragic loss of life, this has triggered responses that make air travel even more of an ordeal than it already was.

Why is any of this worth mentioning on a blog devoted to energy? Well, even though oil prices have been falling since August, and gasoline is back down to $2.26/gallon, our underlying energy problems haven't disappeared. The best-case scenario for conventional energy would hold domestic oil and gas production level, putting the burden on coal and renewables to stem the otherwise inevitable growth of energy imports. Although we certainly have much better energy technology and market options than we did in 1973, capitalizing on them calls for a confident and coherent bi-partisan approach.

Ironically, while two energy crises contributed considerably to the economic malaise of the 1970s, we've weathered three years of unusually high energy prices with minimal disruptions. Perhaps we learned a few things the last time, because however much we groused about it, we let the market do its job, thereby avoiding gas lines and odd-even-style rationing. In any case, energy plays a smaller role in the economy today, and that's a healthy development. But if we don't manage today's other big challenges and restore confidence in our government and economy, we won't have the wherewithal to reduce our steadily increasing reliance on imported fossil fuels. Frankly, I'd much rather hear where the candidates for elected office stand on that, than all the current posturing about which party is better equipped to attend to housekeeping matters within the Congress.

Axis Two-Step?

North Korea's test of a nuclear weapon doesn't seem to be worrying the oil market, perhaps because its implications are so unclear, both in North Asia and for Mr. Kim's fellow nuclear aspirant, Iran. Uncertainty about the latter remains the biggest wild card for oil prices, and only a couple of months ago the risk of conflict with Iran over its nuclear program was a key component of $70 oil.

Informed speculation about the small apparent size of the blast suggests that the Korean bomb didn't work as well as expected, perhaps by an order of magnitude. Although there have been a few suggestions that the test might have been a hoax perpetrated with chemical explosives, pulling that off sounds nearly as complicated as building a nuclear weapon. A few other commentators have proposed another worrying possibility, that the device tested was actually a tactical-size warhead, along the lines of the old US nuclear artillery shells. Something like that could be even more useful to a regime that appears to expect to fight another war on the peninsula.

Iran will focus on the world's reaction to North Korea. If the consequences for Pyongyang--which has no strategic commodities such as oil--are light, or limited to condemnations without action, the mullahs will conclude that the Security Council members are unwilling to inconvenience themselves to block proliferation. This is likely already their working hypothesis, based on observing their negotiating tactics with the EU-3. A weak reaction to the North Korean bomb will increase the risk of a confrontation with Iran within a few years.

Bigger Americans, Bigger Cars?

I've been thinking about an article (subscription may be required) in last Wednesday's Wall St. Journal, in which columnist Holman Jenkins made a surprising--though hardly illogical--connection between the widely-discussed American "obesity epidemic" and the expansion of SUV sales in the last 15 years. Before my comment page fills up with irate mail, let me clarify that I'm not endorsing the view that only overweight people drive SUVs. However, if there is anything to the notion that Americans are larger than Europeans in several dimensions, then it would bolster the view that the average American car will never look just like the average European car, no matter how high gasoline prices--or taxes--go. That's a conclusion worth pondering, even though Mr. Jenkins' extension of this argument to deride hybrid cars doesn't follow nearly as logically as his earlier leap.

I wasn't previously familiar with the Civilian American and European Surface Anthropometry Resource cited in the Journal. What a fascinating idea! However, having spent several years living in Germany and the UK and traveling extensively across the Continent, I had already drawn my own conclusions about the differences between us and our trans-Atlantic cousins--though never once connecting this to the cars we drive. Before we repeat this clever bit of automotive analysis at the next cocktail party, we should consider a few other factors that might also influence Europeans to own smaller cars, and drive them less than we do ours:

• The difference in fuel prices tops the list. If our recent excursion to $3.00/gallon was enough to send SUV sales into a tailspin, it can't be irrelevant that Europeans are shelling out roughly 1.30 Euros per liter, or about $6/gallon, with the difference mostly attributable to taxes.

• In addition, many countries tax engine horsepower or displacement, either at purchase or annually. Bigger cars require bigger engines, and in Europe you pay for that twice: at the gas pump and in your tax bill.

• You hear a lot about differences in mass transit, but for me the best example of this is found in a segment mostly absent from America, outside Amtrak's Boston-Washington corridor: comfortable, reliable inter-city trains for the distances over which air travel--with its increasing pre-flight arrival times and security disruptions--is a poor competitor to driving.

• Parking is difficult and costly in many American cities, but you don't know what parking pain is until you've tried to park a car in central London, Rome or Paris. Care to try it with even a medium-sized SUV?

I think there's a strong argument here that Europeans drive smaller cars because it makes sense, not just because they're shorter or slimmer on average than we are. That's not the same as saying our tastes are similar, at least in the mass market segments. It's clear that most of us aren't ready to trade in our ride for VW's latest Polo or Fox.

I agree with Mr. Jenkins that this doesn't let us off the hook on automotive efficiency; we need thriftier cars that US consumers will enjoy owning, and that won't bankrupt them in their quest for greater fuel economy. Unfortunately, many of the "available technologies" he mentions, such as variable valves and cylinder de-activation, have already been deployed in US models. Doing more of this will not move enough efficiency into the car fleet quickly enough to counteract the trends in increasing annual mileage and curb weight, which together with increasing population will keep US oil consumption and imports growing well into the future.

If we want to make a dent in energy security, climate change, or both, it will require bigger changes in vehicle technology such as hybridization, which will still take a decade or two to roll through the whole fleet. Until then our biggest lever is changes in usage, but that seems to be much harder to achieve.

Two Faces of Globalization

With political scandals dominating our news, I wonder how many Americans have heard about the recent deaths and injuries in Ivory Coast, attributed to the careless dumping of hazardous waste from a Greek tanker chartered to a Swiss company. The New York Times published a lengthy article on the incident, which brought down the Ivorian government and produced civil unrest and a customs strike. The episode remains something of a mystery, with the full analysis of the unidentified waste material as yet undisclosed. My experience tells me that there is more to this than has been revealed so far; the investigations under way in Europe and Africa could have far-reaching consequences for the oil and chemical industries.

When I first heard the story on BBC satellite radio news last week, the details were so sketchy that it sounded like another case of people in the developing world being injured while stealing fuel (or something they thought was fuel) that they were too poor to buy, as happens all too frequently in Nigeria. Instead, some party in a lengthy international chain of disposal dumped hazardous waste in residential neighborhoods and ordinary refuse facilities in Abidjan, rather than processing it for incineration or burying in sealed containers in a reputable toxic waste dump.

From the description in the Times, it's hard to tell precisely what this substance was. "Tank washings" from ships can be unpleasant but are rarely so toxic or noxious. The theory that the ship had been used as some sort of floating refinery, with the waste comprising the leftovers of such a process, makes even less sense. More plausibly, it could have been refinery "tank bottoms", the residue from onshore oil storage tanks that have been in service for years and accumulated sludge containing high concentrations of the worst components from literally millions of barrels of petroleum. A Dutch professor who analyzed a sample of the waste found two substances that are consistent with this interpretation: hydrogen sulfide (H2S) and mercaptan, another sulfur compound.

Exposure to high concentrations of H2S without proper safety equipment could prove fatal. However, if H2S were the culprit, I'd have thought this hazard would have been greatest for the crew of the vessel and the employees of the waste company that offloaded it. The particle filter masks typically used in waste handling--pictured in the Times--would be useless against H2S. You'd need self-contained breathing gear of the type fire departments use. With or without H2S, though, the presence of mercaptans would certainly explain the terrible smell that the witnesses described. The key chemical in a skunk's spray is a mercaptan, and synthetic versions are routinely used in low concentrations to odorize natural gas and other fuels. These are organic sulfur compounds with intense, putrid odors, but they're not considered toxic enough to kill people. Until the investigations are complete, these are reasonable guesses, but they are no substitute for knowing exactly what caused such havoc, and who is to blame.

In the meantime, it's easy to play up the victimization and collective guilt angle, because innocent people died. Those who see this as a "dark tale of globalization" are missing the equally important benefits of globalization that this sad situation demonstrates. They ignore the strides we've made in disposing of most hazardous waste in a more responsible, sustainable fashion, due to much stricter environmental and health regulations around the world. If anything, it is largely the extension and application of global standards in the developing world--something that is part and parcel of globalization--that has exposed this incident to international scrutiny and enforcement. With expanding global governance, the responsible parties can be held accountable, not just via their agents in Ivory Coast, but in their countries of incorporation and beyond. That's a serious disincentive for reckless behavior. And given the sensitivity of the EU to this sort of thing, we should see even tighter regulation of the international hazardous waste business follow.

Shifting the Burden

For some time, it's been evident that Canada has a problem meeting its greenhouse gas emissions targets under the Kyoto Protocol, to which it is a signatory. That problem originates in the oil sands deposits of northern Alberta province, which are being exploited at a rapidly increasing rate to meet growing North American and global oil demand. Current oil sands production of a million barrels per day is likely to double in the next 10 years. Until now, it wasn't obvious how Canada would respond to this disconnect, whether by clamping down on the oil sands operations that have turned Calgary into a boom town, by purchasing offsetting emissions credits, or altering its Kyoto commitments. Today's Washington Post reports on a different approach, in which the burden of reducing emissions would be shifted to Canada's auto industry in Ontario, by imposing California-style emissions regulations on cars. The politics of such a shift look daunting, and it's hard to imagine that at least some of the responsibility for these emissions won't end up with the oil producers.

Unlike conventional crude oil, which comes out of the ground under its own pressure, or with help from pumps, the oil sands must be mined and heated to separate the oily part from the sand. This requires the expenditure of between 500,000 and 1.2 million BTUs of energy per barrel extracted, the equivalent of 3.5 to 8.4 gallons of oil for each 42 gallon barrel, depending on which of the two available techniques are appropriate for each deposit. All of this extra energy input generates greenhouse gas emissions, before the oil even goes into the pipeline.

As the article notes, the oil sands operators have an option for reducing emissions themselves, by capturing and sequestering the carbon dioxide produced from burning natural gas to make the steam and process heat used in oil sands extraction and processing. But sequestration isn't cheap or fully proven, though it looks very promising. And although there are plenty of oil and gas reservoirs in Alberta into which to inject the CO2--with some offering enhanced oil recovery benefits in the bargain--requiring oil sands to be emissions neutral would add to the cost of an already expensive oil substitute and reduce the ultimate extent of production, unless oil prices remained at or above current levels.

The other interesting aspect of this situation is that it's the reverse of what we see occurring in the US. Here, states such as California and New York are seizing the initiative from a cautious federal government, pushing through greenhouse gas emissions caps and trading schemes, and setting standards for new car emissions. Although the Canadian government isn't wrong in thinking that it can obtain the necessary emissions reductions from any sector or province it chooses, because of the global equivalence of these emissions, that may not turn out to be politically viable. I'd be interested to hear what my Canadian readers think about this idea.

Getting More from Less

Last week was a case of competing conferences. While I was engaged moderating a panel on alternative energy at the J.S. Herold Energy Pacesetter’s Conference in Stamford, CT, MIT was holding its annual Emerging Technologies Conference in Cambridge. I wish I could have attended both. Technology Review provided this summary of the energy discussions at the MIT event, and it’s worth reading this short item for the way it frames our long-term energy challenges. Specifically, one of the presenters pointed out that, in order to meet forecast demand without permanently altering the climate, we must effectively double total energy production within a half-century, while emitting less than the current quantity of greenhouse gases. That’s a tall order.

Now, there are still a few folks out there who think we can sustain—or even grow—our present levels of oil, gas and coal production for another 50 years, but this is rapidly becoming the minority view. Even the most credible detractors of Peak Oil, such as Dan Yergin and his colleagues at Cambridge Energy Research Associates, have shied away from this sort of “cornucopianism”, as some label it. Their 20-year “undulating plateau” is a far cry from, “Steady as she goes until 2060.”

As the article suggests, the inescapable conclusion--provided you accept the premised growth in potential demand--is that meeting it will require two things in massive quantities: energy efficiency and carbon-free energy. Doubling efficiency sounds especially daunting in light of present US trends toward bigger cars and hungrier gizmos, but when we consider that only 37% of the 100 quadrillion BTUs of energy per year we consume ends up performing the work for which we are paying, it seems more achievable. If we focus on transportation, our current efficiency is below 20%. Doubling that alone would recover almost 9% of our total primary energy usage, the equivalent of 4 million barrels per day of oil.

The zero-carbon portion of this challenge also looks tough at first glance, but we have many options, including technologies that are already commercial or near-commercial, including nuclear and wind, others that are a bit more expensive, such as solar, and the ultimate leverage of being able to sequester the carbon emissions from burning fossil fuels. But even if you dismiss the risks of climate change, we would need many of these new sources to make up for oil and gas reserves that will have declined, or to which we won’t have access, and to contain the environmental impact of over-reliance on coal.

As Robert Samuelson's column in today's Washington Post points out, all of this must be accomplished against a backdrop of increasing global and US population. The latter is noteworthy, because of our position close to the top of the per-capita energy use ladder. Demographics alone would increase our energy use and emissions 40% by 2050, even without any change in per capita GDP. The EU has an easier task, because its core countries--"Old Europe"--have reached ZPG, the "zero population growth" target that was a buzzword in the sixties and seventies.

While we could argue about whether we wisely used the cheap energy of the last 20 years to expand the global economy, or wasted a generation that could have put us well on our way to meeting our long-term goals, our options going forward are narrowing. The chances of having another 20 years of cheap energy are low, and the environmental risks associated with using it if we did have it are rising. My daughter’s generation will have all the energy it needs, but only if we can navigate our way through the difficult choices of the next decade or so, and avoid the seductive dead ends that will crop up along the way.

Heavy Hybrids

One of the main drawbacks of hybrid cars is their cost premium relative to conventional cars, compared to the value of the fuel savings they offer, unless gasoline prices rise significantly. However, this analysis goes out the window when we look at high-mileage commercial vehicles. Although hybrid passenger cars get more attention, a hybrid van looks like an even better proposition, in terms of its annual cost savings. In addition, its ability to accommodate extra batteries more easily than a sedan makes it a likely choice for early demonstrations of plug-in capabilities, as in this Daimler-Chrysler prototype featured in Sunday's New York Times.

Plug-in hybrids offer even higher levels of fuel savings than regular hybrids, by recharging at night and providing an initial interval of gasoline-free driving, say 20 miles. However, as I've shown previously, the extra increment of gas savings is typically worth a good deal less than that the initial improvement from regular hybridization, going from 20-ish to 40-ish miles per gallon. These figures look somewhat different for a delivery van, though, because the starting point is much lower.

If a van driven 25,000 miles per year could get 5,000 of those miles from stored electricity, its effective fuel economy on gasoline or diesel fuel would increase by about 25%. Even if the baseline fuel economy were 15 mpg--and it's probably closer to 10--those savings would amount to roughly $1000/year at $3/gallon. The EPRI estimate of 2500 kW-hours of electricity consumption cited in the Times would cost only a fraction of that, even in high-electricity-cost regions such as the one I just moved from. That would leave the business owner with $600 to $700 of annual pre-tax savings to defray the extra cost of the plug-in. If the business depreciated the vehicle on a normal 5-year schedule, it could afford to pay up to $3,000 for the plug-in feature, even in the absence of an investment credit or hybrid incentive. By comparison, taking a car from 45 mpg (hybrid) to 100 mpg (plug-in hybrid) is only worth about $2,000 in added up-front cost, based on typical usage, even if the cost of electricity were zero--which it's clearly not.

What all this means is that, as unglamorous as delivery vans are, they are an ideal testing ground for the new technology of plug-in hybridization, and they look like its most attractive application, as well.

Markets and Attention Span

When oil was over $70/barrel not long ago, it appeared that Congress might pass meaningful measures to enhance domestic energy production, as well as addressing long-overdue efficiency improvements in the US automobile fleet. Now, the combination of sagging energy prices and entrenched positions has trapped pending legislation in the limbo between their House and Senate versions, in the pre-election recess. This sends a bad signal. If prices fall farther, will we begin unraveling subsidies to alternative energy or hybrid cars? Just as oil companies don't change their investment decisions with every rise or fall of a volatile commodity market, our national energy strategy shouldn't hinge on today's price of oil or natural gas.

It's understandable that we should feel relieved that the price of gasoline at the pump has dropped to a more comfortable level, with last week's national average at $2.38/gallon. And I'm as happy as anyone that natural gas looks to be cheaper this winter than last, since my move to Virginia has left me with two homes to heat, at least until the other sells. But we can't forget that it took years to create the supply and demand conditions that, with the addition of a couple of devastating hurricanes and some serious geopolitical risks, took us to the recent highs. $75 crude oil had its roots in the global oil price collapse of the late 1990s, when companies were forced to slash their drilling programs.

If we want to change the path we're on, we must grasp the time lags inherent in this critical industry. Our actions today will have a great deal of influence on what we will pay for energy five to ten years from now, but very little on prices next week or next month.

Regardless of the outcome of the mid-term elections, it would send a positive signal if the current Congress ended its session with a compromise on the stalled drilling legislation. The most promising, if least obvious, avenue lies not in ruling entire coastlines in or out, but in drawing a distinction between oil and non-associated natural gas, which entails lower risks and greater benefits for the environment. In any case, the shape of the ultimate compromise matters less than sending a message that the government will remain engaged with our energy problems, regardless of the current price of West Texas Intermediate on the NYMEX.