Looking Back at 2007

It's been quite a year for energy. Oil prices started the year in a slump that bottomed out just a shade above $50 per barrel for West Texas Intermediate crude (WTI), and then began a relentless march that matched the inflation-adjusted record price of the early 1980s and brought them within an eyelash of $100 per barrel. In light of all this drama, it seems surprising that the average price for the year will end up only about $6 per barrel higher than last year's average of $66.25. Along the way, though, high energy prices have seeped into the national consciousness, stimulating important new legislation and the beginnings of a major shift in long-established patterns of consumption. At the same time, energy has become even more inseparable from its consequences for the global climate. If 2008 proves half as volatile as 2007, we are in for some ride.

When 2006 ended, it appeared that oil prices had settled into a range that was just high enough to promote the development of biofuels and other alternatives, but not high enough to cause serious concern about the economy. That comfortable picture didn't last very long, however, as oil became intertwined with the problems of the dollar and the sub-prime credit crisis. WTI headed steadily higher, inflating at over 4% per month since January, despite the unraveling of one of the biggest geopolitical risks built into the market price, the prospect of armed conflict with Iran over its nuclear program. Only the post-Labor Day collapse of refining margins buffered consumers from the full impact of these increases, with US average retail gasoline prices ending 2007 only about half as much higher than they started, compared to crude oil prices. Nevertheless, $3.00 gasoline seems here to stay.

High prices were only half the energy story in 2007, however. If we had just been facing expensive fuel, I'm not sure the Congress would have been able to pass the recent Energy Bill, with its large increases in mandated fuel economy and biofuels production. Climate change came into its own as a mainstream issue for the American public this year, and it was a major factor in the Congressional debate over the energy bill. As I noted last week, "green" is now big, and that's because the scientific concerns about global warming are being matched by images of shrinking icecaps, encroaching sea levels, and drought-abetted fires.

When postings resume after New Year's Day, I'll look at the year ahead, as I did last year. It strikes me that the refurbishing of the ball that will drop in Times Square at midnight tonight with energy-efficient LED lights is a perfect reflection of the cusp at which we stand. Like many of the steps we took this year, it may be largely symbolic--considering how much energy can be saved in a device that only runs for a minute each year--but it could also be a harbinger of more serious measures to come. Happy New Year!

A Greener Christmas

I'm fascinated by the shifting emphasis this holiday season towards "greener" practices and greener presents. There's a growing trend toward holiday lights employing LED technology, which is much more efficient than incandescent bulbs, but without some of the drawbacks of the compact fluorescent lights (CFL) that are appearing in millions of homes and businesses. I've even received email solicitations suggesting emissions offsets as suitable holiday gifts. Now, I don't want to sound like the Grinch, here, but although these modest steps are all to the good, I think they still fall short of a genuinely greener Christmas. Efficient holiday lights are fine, but they're not going to halt global warming in a month's usage each year. If we're serious about solving the vast problems of climate change and energy security, the evolution of "green" into a marketing strategy can only be one element in a much larger effort.

Consider the presents we give and receive. I heard a statistic on the news the other night indicating that Americans would give out $8 billion in gift cards this year. As enthusiastic about emissions trading and voluntary offsets as I am, I don't see emissions credit gift cards overtaking the cash kind any time soon. Then consider the energy profile of some of last year's popular gifts, including those we gave ourselves. As I've noted before, one plasma TV wipes out the energy savings of multiple CFL bulbs. Even more modest consumer electronics such as cellphones, iPods and digital cameras make their own small contributions to higher energy consumption and the growing strain on our electrical infrastructure, particularly when we leave their recharging transformers plugged in all the time.

A truly Green Christmas would be one for which the most popular "gadget" gifts were either energy-saving devices themselves, such as the Kill-A-Watt meter, or more efficient replacements for existing gadgets with high energy consumption. And all gifts would come with clear disclosures of the energy used and emissions released during their production. If we're ever going to begin reducing energy consumption and greenhouse gas emissions in absolute terms, achieving a net carbon-neutral holiday season would be a great place to start.

We are a long way from that now, nor should we necessarily be consumed by guilt over this. A cultural change that deep can't happen overnight. Taking off my Scrooge hat, the good news is that it's not nearly as hard to imagine such a thing as it would have been only a couple of years ago. Perhaps we're starting to see climate change as our all-too-real Ghost of Christmas Future. Today, suggesting a carbon-neutral holiday season probably wouldn't get you laughed at, though it's not going to attract many invitations for eggnog and cookies. In that spirit, I would like to wish all my readers the joys of the season, even if it's not yet as green as it might be.

Energy Outlook will be on holiday break until 12/31.

Calling Solomon

Since the passage of California's AB 32 legislation establishing a cap on greenhouse gas emissions, the state has been locked in a struggle with the federal Environmental Protection Agency over the implementation of its provisions on tailpipe emissions. The Supreme Court ruling in Massachusetts v. EPA was expected to pave the way for California to obtain the Clean Air Act waiver it sought, to regulate automotive CO2 emissions--and effectively fuel economy--at the state level. Yesterday, however, the EPA denied California's petition, setting up a court fight that could well find its way back to the Supreme Court, unless the 2008 Presidential Election resolves the matter, first. Both sides are at least half-right, and I don't envy those who will be called to discern where the greatest service to the national interest lies. In the end, I believe California will prevail.

California's argument for the waiver is straightforward. The Supreme Court has ruled that CO2 is a pollutant, and California has been granted waivers in the past to regulate pollutants more stringently than the country as a whole. Moreover, California's greenhouse gas emissions are large enough to matter on a global scale, and the state's elected representatives believe they have a mandate from their constituents to address those emissions aggressively and comprehensively. Failure to do so would contribute to the risk of adverse outcomes from climate change in California, with some pointing to reduced precipitation and coastal erosion as early indicators of such damage.

But while my heart is with California in this matter, my head is with the EPA. Even if we accept that CO2 is now recognized as a pollutant--the logic of this escapes me, but I concede my minority status--it still does not result in the kind of direct local impacts that provided the self-evident justification for granting the state's past waiver requests concerning regulation of the "criteria pollutants" that affect air quality and produce smog. Climate change is a global problem, the local ramifications of which cannot yet be predicted reliably. With the US struggling to maintain its competitive edge in a global marketplace for goods and services, should we really desire the further Balkanization of auto and fuel standards?

Both sets of arguments are legitimate and compelling. Where I believe the EPA's case fails is in the implied responsibility of turning down California's request. If there were a similarly comprehensive set of federal greenhouse gas regulations in place or waiting in the wings--even if it was not as stringent--the EPA would be right to ask California to follow the federal government's lead. Yet the energy bill provisions cited by the Administrator in defense of his decision don't constitute such a plan. Unless and until something like the Lieberman-Warner Bill, S.2191, passes, the closest thing we have to a national greenhouse gas regulation is an array of voluntary programs. And as the Washington Post pointed out, a list of states accounting for nearly half the nation's cars has lined up behind California, rather than the EPA.

There's an old saying, "Lead, follow, or get out of the way." The last year has seen the publication of an impressive collection of reports on the science of climate change and on the economic consequences of ignoring the problem or tackling it head-on. These reports, including three from the same Intergovernmental Panel on Climate Change (IPCC) that shared this year's Nobel Peace Prize with Mr. Gore, underline the urgency of the issue and provide the real underpinnings of California's waiver request. On these grounds and with the precedent of Mass. v. EPA, I believe the high court will ultimately find in California's favor, but time is wasting in the interim.

Rethinking Fuel Economy

The President is expected to sign the compromise Energy Bill today. If sustained $3.00/gallon gasoline hasn't already put fuel economy front and center for American consumers, the bill's landmark 35 mile-per-gallon efficiency standard for the entire new car fleet should do so, as auto manufacturers start to modify their product lines to meet the new target. A recent episode of NPR's Science Friday included a fascinating discussion of what is possible in this regard, but the most interesting portion of the program focused on the efforts of a group of engineering students and faculty who are rethinking the entire concept of the car for new markets. As important as it is for the US to shift toward more efficient vehicles, the opportunity in large emerging markets such as India is even more critical, before consumers' expectations there are locked into a status quo that cannot be sustained, globally.

Contrary to some disingenuous comments we heard during the debate about the 35 mpg CAFE Standard, it is simply not realistic to imagine that US consumers will be able to purchase essentially the same cars as today, differing only in their ability to achieve dramatically better fuel economy. Consumer expectations of vehicle cost and performance and the engineering solutions necessary to deliver an average of about 10 mpg lower fuel consumption are headed for a minefield of trade-offs. Something must give, whether vehicle size and weight, performance, or sticker price. Two of the main constraints on Detroit are our expectations of being able to accelerate to highway speeds in 10 seconds or less, and traveling roughly 300 miles without refueling, regardless of vehicle size. What could engineers create if those expectations disappeared?

The work of the Vehicle Design Summit (VDS) seems aimed precisely at that conundrum, targeting a developing-country market in which consumers are seeking personal mobility without such preconceptions, and for which the notion of a 12 mpg SUV that can accelerate like a sports car is entirely alien. Their first-stage prototype is anticipated to achieve 100 miles per gallon, using a plug-in hybrid architecture with a small, highly-efficient onboard generator capable of running on a variety of fuels. And because it won't have to go 300 miles at a stretch, the size of the engine and battery pack can be minimized. That reduces both cost and weight, increasing energy economy further. And that's a key point; from what I can tell, VDS isn't just trying to reduce oil consumption, but rather the entire energy consumption of the vehicle, including the "embodied energy" and greenhouse gas emissions of the manufacturing process.

Having cars such as the ones VDS is designing available for developing-country consumers, as they reach the income levels at which car ownership rates take off, will be crucial in managing global emissions and getting the most out of the world's limited supplies of transportation fuels. As daunting as it may sound, it may actually prove easier to create an entirely new concept of the personal vehicle that is capable of achieving an actual 100 miles per energy-equivalent gallon, compared to boosting the current American car to 35 mpg by incorporating energy from electricity or biofuels that is conveniently ignored or under-counted for the purposes of the federal fuel economy regulations.

Bad Timing

Iran's nuclear program is in the news again, with Russia finally deciding to deliver the fuel for the idle nuclear reactor at Bushehr, which was built with Russian technology. This action is an inevitable consequence of the recent US National Intelligence Estimate (NIE) on Iran. But while the timing is unfortunate, since withholding the reactor fuel was part of the international diplomatic pressure on Iran, today's New York Times report is misleading, when it characterizes the Bushehr plant as being "at the center of an international dispute over its nuclear program." If anything, that facility and its fuel represent precisely the kind of nuclear power program that the international community has been encouraging Iran to pursue, in lieu of the indigenous fuel cycle it is developing. That's where the security risk arises, not from an internationally-supervised civilian reactor fueled by Russia.

I'm sure some will see the Administration's comments on this event as making the best of a bad situation, but I think this time the President has it right, to this extent: As he stated, “If the Iranians accept that uranium for a civilian nuclear power plant, then there’s no need for them to learn how to enrich.” However, I also think that Tom Friedman of the Times was correct the other day, when he noted that the timing and wording of the NIE have seriously undermined the global coalition to contain Iran's nuclear ambitions. "The peculiar (obtuse?) way the N.I.E. on Iran was framed has deprived all who favor a negotiated settlement of leverage." At a time when nothing in Washington, DC is taken at face value, those who were anxious to foreclose any possibility of a military strike against Iran's nuclear facilities have downplayed the document's description of the very serious risks and uncertainties surrounding the most worrying elements of Iran's nuclear program--uranium enrichment at Natanz and plutonium production from the heavy water reactor at Arak.

While the security implications of all this have become quite muddled, the energy consequences are perhaps even less obvious but no less important. In order for nuclear power to be effective as a strategy to combat climate change, its application can't just be limited to countries that are already part of the nuclear weapons "club", or to developed countries such as Finland that have decided to forgo nuclear weapons. As the climate change roadmap coming out of the Bali conference confirmed, emissions from developing countries must be included in a global solution, with appropriate technical and financial assistance from the developed world. That means that among other things, we must be able to transfer nuclear technology--as Russia has done in Iran--without creating a nuclear weapons proliferation nightmare. Iran's opaque and contrary approach to nuclear power elevates the risks of such transfers and simultaneously undermines the international mechanisms for ensuring that nuclear technology will be used for peaceful purposes. It would be impossible for them to follow this path absent the tremendous influence of their hydrocarbon reserves and exports. Those weigh heavily in the cost-benefit analysis for Russia and China, without whose continued cooperation the diplomatic effort to keep Iran from developing a nuclear-weapons capability will ultimately unravel.

The Greenspan Effect

I was struck by a comment on energy from former Federal Reserve Chairman Alan Greenspan last week. As quoted in the weekend Wall Street Journal, he said, "The notion of core pricing is fading in importance as: One, food prices driven by increased long-term demand for meat and milk rise with the growth of China and other developing countries, and as; Two, global oil supply peaks lower and sooner than has been contemplated earlier." You could write a dissertation for a Ph.D. in economics based on that sentence. In one thought, Mr. Greenspan suggests that measuring inflation without factoring in energy price increases is an outdated notion, and that high energy prices are likely here to stay. The absolute accuracy of such an assertion may matter less than the market's response to an utterance from someone with such impeccable credibility.

I don't know if it says more about Mr. Greenspan's extraordinarily long tenure as at the helm of the Fed, or the qualities of his successor, that many continue to regard him as the preeminent voice on the economy and seek out his views regularly. I don't remember quite the same thing occurring after Mr. Greenspan replaced Paul Volcker, whom many credit with eradicating the high inflation of the 1970s. In any case, Mr. Greenspan still has the knack for encapsulating vast economic trends in a few words, and those words can move markets.

For as long as I can remember, observers of the economy have focused on core inflation, excluding food and energy prices, as the key measure of price stability. Until recently, the logic of factoring out volatile energy prices was solid, because oil prices always seemed to revert to a long-term average price in the low- to mid-$20s. Since 2003, however, that rationale has broken down. Over the last five years the key indicator of oil prices, West Texas Intermediate crude oil traded on the New York Mercantile Exchange, has gone up by about 30% per annum--with very large spikes and dips around that trend. Substituting the DOE's record of US refiner crude oil acquisition prices, a broader indicator of the raw material cost of fuels, suggests that oil inflation has been running at 25%. Natural gas isn't far behind, with roughly an 18% inflation rate on wellhead prices since 2003. Mr. Greenspan's remarks recognize that you can't double energy costs every three or four years without swamping many of the other economic factors that the Fed and economists monitor. And as I noted the other day, the alternative energy supplies being promoted by US energy policy are unlikely to provide any price relief.

Mr. Greenspan apparently doesn't envy the task his successor now faces: simultaneously trying to stave off a recession, defend the value of the dollar, and protect against the reappearance of serious inflation, driven by the very factors that the core inflation rate ignores. This may not fit the classical definition of a liquidity trap, but it could be the practical equivalent of one, if the Fed can't reduce interest rates much further--or even if the market merely believes that to be true, validated by voices such as Mr. Greenspan's.

What does that mean for all of us non-economists? Well, for starters, it shifts the burden of averting a recession away from interest rates and toward tax cuts and other fiscal policies--hardly the flavor of the week in a Congress seeking new revenue to offset the cost of new programs and shrink the federal deficit. At the same time, Mr. Greenspan's endorsement of the idea of an approaching peak in global oil output will tend to keep energy prices high by supporting higher long-dated futures prices. That compounds the Fed's problem and could also lead to higher valuations for oil equities (some of which are in my personal portfolio.) To the degree that this all comes down to market expectations about the future, I can't think of a more credible influence on those perceptions than the former Fed chief.

Save the Nukes!

As I was mulling over a story in the Wall Street Journal the other day, concerning the difficulties faced by companies seeking to re-license existing nuclear power plants in some parts of the country, it occurred to me that the nuclear industry might be missing a key message in this effort. Rather than merely portraying these facilities as beneficial producers of clean electricity, perhaps they should consider describing them as members of an endangered species, one that fills a vital ecological niche. When you consider the intensity of the campaigns against facilities such as Indian Point in New York State, the licenses for which expire in 2013 and 2015, "endangered" seems like a fair characterization. However, I don't expect to see many cars plastered with "Save the Nukes!" bumper stickers.

Despite the growth of wind and grid-connected solar power, the nation's 104 operating nuclear power plants generated two-thirds of our CO2-free electricity--and 19% of all US electricity--last year. The newest of these plants entered service in 1996 and the oldest in 1969. Even if the pending applications to build new reactors are approved, the first new plant would not enter service before the licenses for most of the 53 plants built before 1980 would expire, forcing them to shut down if not renewed. That would have severe economic and environmental consequences.

If you regard our energy economy as an artificial ecology, nuclear power occupies a key niche within it, as our largest source of low-emissions, baseload electricity. In fact, only three other currently-available technologies can furnish power meeting both of these criteria: "clean coal" with carbon capture and sequestration (CCS), large-scale hydropower, and geothermal energy. None of these is in a position to substitute for nuclear power at this point, at least in the US. Coal with CCS looks expensive and remains unproven at industrial scales. Essentially all of the sites for large hydro-electric dams have been used, and the trend is toward dam removal. And while geothermal power looks very promising, sites for conventional (natural steam) geothermal are limited, and advanced (dry rock) geothermal is not ready for prime time.

Nor can wind and solar power substitute for nuclear power, should any of the existing plants be shut down, at least not without the provision of power storage on a scale that is simply not yet practical, in order to buffer the intermittent output of wind, and shift the cyclic output of solar to match the power demand, or "dispatch curve." Without cheap storage, replacing the annual generation from Indian Point would require roughly 1,800 3.6 MW wind turbines. That's about 45 times the size of the recently-cancelled Long Island wind farm project.

It won't surprise my readers to learn that I was never "anti-nuke", though like many people I had virtually written off nuclear power on economic grounds for most of the 1980s and '90s. Climate change and the increasing competition for limited oil resources alters that analysis. When faced with the choice between sequestering billions of tons per year of carbon from new and existing coal-fired power plants, or a few thousand tons of radioactive waste, the challenges of the latter look a lot more manageable in the long term. Endangered nuclear power plants aren't as appealing as "charismatic mega-fauna", but the prospect of losing the output of the existing plants looks about as bad as losing the polar bears--and the two are not unrelated.

Embedding High-Priced Energy

As the revised Senate version of the energy bill passed by the House of Representatives heads to another vote today, moving closer to a possible Presidential veto, it's ironic that arguably its worst element remains the least controversial, with both Houses of Congress and the White House aligned behind it. Despite my grumbling about the bill's lack of attention to conventional energy supplies, I believe the expanded Renewable Fuels Standard constitutes a serious error of judgment. Not only would this enlarge a policy with consequences for global food supplies that The Economist calls "reckless," but it embeds expensive energy in the US economy in ways that will be hard to unravel in the future.

I've devoted a lot of space in the last couple of years to the problem of ethanol's energy return on energy invested. This may seem like an abstract concept with few practical consequences, and it is certainly one that ethanol advocates usually dismiss out of hand, either because they don't understand its implications, or because they understand them all too well. Simply put, the fact that corn ethanol returns only 130 BTUs of energy for every 100 invested in its production means that it can never deliver a fuel that is much cheaper before subsidies than the petroleum products it is intended to replace.

Ethanol's biggest benefit is that relatively little of the energy it consumes comes from oil--mainly the fuel used in cultivation, harvesting and transportation to and from the distillery. The biggest contribution comes from the natural gas used for process heat and to make the fertilizer needed to grow the corn. For all the margin problems that ethanol producers have experienced this year, as corn prices rose and output expanded faster than the market could absorb, they have caught a significant break on natural gas prices. We shouldn't assume that gas will continue to trade at a 46% discount to its BTU value against oil, as it has in 2007, based on a comparison of the relevant futures prices on the New York Mercantile Exchange. Since January 2000, gas has sold at an average of 73% of oil's BTU value, and there have been years like 2003, when it approached BTU parity with oil. In the long run, with imports making up a growing share of North American gas supplies, and as gas's lower CO2 emissions begin to be reflected in its price, it could even command a slight premium over oil.

What does all this mean? Well, at the BTU price implicit in $85/barrel oil, the cost of energy in a quantity of ethanol sufficient to displace a gallon of gasoline would be approximately $1.45/gallon. Add the contribution of corn at $4 per bushel, and you're at $3.50/gasoline-equivalent gallon, before taxes/subsidies and transportation by rail to the blending terminal. That compares to an equivalent wholesale gasoline price of about $2.35/gallon at the tank-truck rack. This comparison doesn't look any better at higher or lower oil prices, either.

The Energy Bill would double the existing mandated target for corn ethanol from 7.5 billion gallons per year by 2012 to 15 billion by around 2017, while adding an additional mandate for 21 billion gallons of non-corn ethanol and other biofuel by 2022. But from the analysis above, whatever this would do to enhance the energy security of this country by reducing our oil imports, corn ethanol cannot reduce the cost of energy to the US economy, even though subsidies and the lower energy content of a gallon of E-85 may superficially mask that effect for consumers. Now, reducing the cost of fuel may not be the top priority of US energy policy, at a time when we are concerned about climate change and our growing reliance on oil imported from unstable suppliers, but it's certainly relevant to businesses and consumers, and it ought to be of some interest to voters. Sooner or later, someone is going to have a lot of explaining to do, once the public figures out that ethanol is not the panacea we have been led to believe.

The Twelve Days of Bali

I have been following with great interest the news out of Bali, where the thousands of delegates to the 13th Conference of the Parties to the UN Framework Convention on Climate Change have been meeting. Unlike the session in Kyoto ten years ago, the meeting in Bali is not intended to deliver a new climate treaty, but rather the guidelines for another couple of years of negotiations on an agreement to pick up where the Kyoto Protocol leaves off at the end of 2012. As such, the concluding statement out of Bali on Friday may not be terribly dramatic, unless the next couple of days produce a breakthrough on the issue of binding emission reduction targets. Although I disagree with its authors' interpretation of the data, a Wall Street Journal op-ed critical of the whole process asks the right question about the Bali outcome, in terms of how it will relate to an objective assessment of the success or failure of Kyoto.

The authors suggest that if Bali produces a framework that is little more than a bigger version of Kyoto, it will fail. They base this conclusion on their assessment that most of the countries that agreed to reduce emissions have fallen short of their commitments, at least at this point, and that where reductions have occurred, they resulted mainly from factors unrelated to the Kyoto targets and their implementation mechanisms, such as emissions trading and the Clean Development Mechanism. There's more than a grain of truth to this, but I believe reality is more complicated, and that Kyoto has not been an unmitigated failure. At a minimum, it has served as a global focal point on climate change, and the template on which national emissions reduction efforts--and of states such as California--have been based. Absent Kyoto, it's hard to imagine the same impetus for action.

As to the performance against Kyoto's targets, it is not as bad as often portrayed. However they get there, the EU has a reasonable chance of achieving its target of 2012 emissions that are 8% below what its member countries emitted in 1990. By the end of 2005 its emissions were already 1.5% lower than 1990 for the core 15 nations that signed Kyoto, and almost certainly lower than they would have been, had they not undertaken any of these measures--though one might argue about whether the process has been as efficient or the cost/ton of the cuts as low as possible. Even in the US, which did not ratify Kyoto and has so far avoided a firm commitment on reductions, our 16% growth of emissions since 1990 (14.5% taking the 2006 result into account) is well below the status quo projections I saw in the late '90s, which anticipated emissions growing by around 30%.

The Achilles heel of Kyoto, as most skeptics are quick to point out, is its treatment of the large developing countries. The growth of emissions in China alone, in just the last five years, has been larger than all the cuts that Kyoto asked of the EU and US combined. Nor is there any reason to expect that China's rate of emissions growth is about to turn negative, any time soon. Simply increasing the severity of cuts required of the Kyoto-compliant developed countries and adding the US and Australia to that list seem unlikely to attain the underlying goals that are being discussed in Bali, of ensuring that total global greenhouse gas emissions begin falling within 10-15 years, and that the rise in average temperature does not exceed 2 degrees Celsius.

If a bigger version of Kyoto is insufficient to the task, then what do we need? There are plenty of opinions out there, but I will be encouraged if the 12 days in Bali end with a charge to the negotiators of the details that is flexible enough to allow them to address the widely disparate political and economic circumstances of the world's nations, and particularly of the largest emitters. The key success criterion ought not to be its fit with our preconceptions about the relative importance of emissions cuts, technology transfer, and other key elements, but whether it results in a framework that can be implemented and enforced across all the big emitters, offering a realistic expectation of actually working, not just satisfying our notions of equity.

Russia, Inc.

The overnight reaction to yesterday's endorsement by Russian President Putin of the Chairman of Gazprom as the next President of the Russian Federation reminds me of Lady Thatcher's comment after her first meeting with Mikhail Gorbachev, "We can do business together." I am struck by the deep weirdness of this announcement, which will surely have important implications for energy. It's impossible to imagine an American analog to such an event. Perhaps in some alternate universe President Bush is so popular that he could designate the Chairman of the country's largest energy company as the Republican nominee to succeed him, and have his choice be seen as a virtual shoe-in to become the 44th President of the United States, but this certainly has no counterpart in our reality. Yet that is effectively what seems to be playing out in Russia, in the wake of a landslide victory by Mr. Putin's party, United Russia.

High oil prices and the resulting growth of energy revenues have led the resurgence of Russia's economy during President Putin's second term, and the threatened or actual manipulation of energy flows has become a major lever for projecting Russian political influence beyond the country's borders. By some measures Russia already plays as pivotal a role in global energy supplies as Saudi Arabia. With the world's largest reserves of natural gas, it furnishes roughly 60% of Europe's natural gas imports, and its 2006 oil exports were only 25% below those of the Saudis. While Russia may no longer be a superpower, geopolitically, it has become one in energy terms.

If Russia under Mr. Putin emerged as one of the world's largest petro-authoritarian states, as Tom Friedman puts it, what is it likely to become under the leadership of the chairman of the board of the country's largest energy concern? And am I the only one struck by the added irony of a former German Chancellor playing a key role in the operation of that business? Still, Dmitry Medvedev is not one of the siloviki, and he apparently has legitimate democratic credentials. Considering all the speculation about the likelihood of Vladimir Putin putting forward a non-entity as President, so that he could shift Russia's locus of power to whatever new role he chose for himself, Mr. Medvedev is an interesting choice as Russia's next President.

While the Washington Post focuses on his loyalty and close ties to Mr. Putin, going back to their time together in the former Leningrad, where both served in the mayor's office, Gazprom under Medvedev has been far from passive. Whatever the internal politics of this choice, it is also an implicit recognition of the importance of energy markets to Russia's current and future success, and Mr. Medvedev has participated in a very assertive approach to those markets. Even as Russia's internal growth consumes more of its energy output, it will remain a major force in energy markets for the foreseeable future. With Mr. Medvedev at the helm, energy seems certain to play at least as large a role in the country's economic and foreign policy as it has under President Putin.

Sine Qua Non

In order to function, a market must have both buyers and sellers. That point seems trivial, but in the context of an article in Sunday's New York Times, it has great significance for the global trade in oil. The Times picked up on a quiet trend that could dramatically alter the oil market, and with it, the global economy: the rate at which the economies of oil-exporting countries are soaking up their oil surpluses, due to a combination of subsidized consumption and the growth stimulated by high oil revenues. Even if this trend does not dry up the exports that currently satisfy the world's many oil importers--with the US topping the list--it will alter the competitive forces affecting both energy prices and the contractual terms for new production. It should also lend urgency to the national debate on energy policy.

Since participating in Texaco's first global energy scenario project ten years ago, I've been following the evolution of the industry's access to resources, one of three big energy trends identified by our scenario team. Increasingly, the international oil companies have been frozen out of the big reserve plays around the world, or forced to take secondary roles involving much less control. But within the last year, I've grown much more concerned about the potential impact of a factor that compounds the problem of access. As oil-rich developing countries grow, they consume more of their own oil, leaving less to export. And as often as not, much of that incremental consumption is driven by internal petroleum product prices that are well below international market prices, leading to inefficiency.

The 15 countries on the Department of Energy's list of the biggest oil exporters accounted for 90% of total global oil exports of 43.2 million barrels per day (MBD) in 2004, out of total consumption of 82.3 MBD. As the figure in the Times article shows, consumption in the largest of these exporters is growing at a multiple of the global rate, at a time when it has slowed or stalled in developed countries. (The decline shown for the US between 2005-2006 is somewhat anomalous, because it appears to be attributable not to products like gasoline or diesel fuel, which are still growing, but to the disposition of the bottom of the barrel, perhaps into additional coking capacity or exports.) In fact, the growth of consumption in oil-exporting countries may matter as much to the future of the oil market as the growth of China and India, which has received a lot more attention in the last several years.

This trend has a number of important implications. At the highest level, as the Times notes, a reduction of exports will put more pressure on prices, and thus on consumption in importing countries, effectively hastening the effects of Peak Oil. At the same time, a reduction in the number of net exporters, as countries with historic surpluses move into balance or deficit, will alter the dynamics of the market, as will shifts within the top rank of exporters. The resulting fewer major exporters will have more market power, and that will affect not only the market for their output, but also the competition for access to new oil fields. Meanwhile, the incentives for current oil importers to reduce consumption and develop more domestic production will grow, encompassing biofuels and hydrocarbons from conventional and alternative sources. In this light, the present high US reliance on oil imports looks even less sustainable, and a comprehensive energy plan addressing both supply and demand even more essential.

It isn't for us to tell oil-producing nations what to do with their own resources. We have no inalienable right to consume other countries' oil, unless they sell it to us willingly. Nor are we in a strong position to advise them about inefficiency, at least until we put our own house in order in this regard. That suggests the need for us to plan for a world, not necessarily with less oil, but with less of it available for us to import. Considering the scale of those imports and the present modest contribution of alternatives, the definition of energy independence we should all be able to agree on would focus on achieving sustained year-on-year reductions in our oil imports and creating enough new options to provide real leverage with our remaining suppliers. That's a very different notion from self-sufficiency.

The Missing Ingredient

Yesterday the House of Representative passed compromise energy legislation, an amended version of the previous HR.6 that the Senate passed earlier in the year, by a margin of 235-181. The bill now goes to the Senate for a final vote, which could take place this weekend. In her remarks closing the debate, Speaker Pelosi referred to the bill as a "shot heard 'round the world for energy independence for America." I wish it were so. While the bill contains many useful elements, including the 35 mpg fuel economy provision on which I've commented recently, on balance its thousand or so pages seem unlikely to worry the Middle East oil producers at whom this rhetoric is aimed. Because it fails to promote additional oil and gas production, it could actually reduce domestic energy production in the near term, worsening our reliance on imports. If anything, with its focus on the technology and production of renewable energy, the Energy Bill should raise more eyebrows on Wall Street and in Silicon Valley than in Caracas, Riyadh, or Tehran.

The renewable energy sources covered by HR.6 are going to be extremely important for the energy future of this country. Cellulosic ethanol, wind, solar and geothermal power constitute important new resources that also provide significant benefits for tackling our greenhouse gas emissions. We need them to become competitive and expand rapidly, in order to meet the challenges posed by climate change. However, they won’t supplant oil and gas or make the US independent of its foreign energy suppliers within the timeframe considered by this legislation. What is needed, then, is a transition from the current, fossil-heavy energy mix to a future diet built mainly around renewable energy and nuclear power. By excluding the most obvious source of new energy production available to us, this bill will make that transition more arduous and expensive than it has to be. Anyone expecting this bill to drive down the price of gasoline or heating oil within the next several years is bound to be disappointed.

Given the kitchen-sink nature of the "Energy Independence and Security Act of 2007", including the tougher CAFE standard, an expanded renewable fuel standard, a controversial 15% national renewable electricity standard, and assorted other subsidies and a few earmarks, it's hard to understand the absence of truly meaningful supply provisions. CAFE, ethanol and renewable electricity do not add up to energy independence, not by a long shot, though the demand-side measures in the bill should begin to slow the rate at which our energy dependence is growing.

One of the speeches I caught on C-SPAN's coverage of the House debate provided a clue as to why such a massive omnibus energy bill would rule out expanding US oil and gas production, which account for almost half of our present 71% level of energy independence. Representative Hinchey (D-Ithaca, NY), recited as part of the bill's justification the well-worn "3-25 Fallacy": Although it is accurate that the US consumes 25% of the world's oil, while possessing only 3% of global proved oil reserves, this ignores the fact that we have produced 1 out of 5 barrels of petroleum ever extracted and still contribute 10% of global production, ranking third behind Saudi Arabia and Russia, but ahead of Iran and Venezuela combined. And while our output is declining because of the mature nature of most of our oil fields, this is also occurring because we have chosen to leave many billions of additional barrels--barrels that would really get OPEC's attention--untouched.

Speaker Pelosi described the effect of the energy bill as being, "as immediate to them as the price at the pump they face when they fill up their tanks." Given the long phase-in of renewables and higher fuel economy standards, that is surely an exaggeration. As urgent as the problems of energy and the environment are, there is still time to get this right, and that ought not to be dictated by the legislative or electoral calendar. The question facing the Senate and, should they pass it, the President, is whether the many positive aspects of this bill are sufficient to outweigh its negatives, including its notable failure to increase domestic conventional energy production by opening up new areas for drilling or making it easier to add new refining capacity. No legislation is ever perfect, and we urgently need stronger energy policy. Nevertheless, a bill constructed on the premise of moving us towards energy independence--however unattainable that goal may be--should include more robust supply provisions than doubling our already problematic output of corn ethanol. While the country's former energy policy has been too oil-centric for years, this new policy is not oil-centric enough, when petroleum still accounts for 98% of the energy we use for transportation. If opening up additional offshore tracts and federal lands to drilling is a bridge too far for this Congress, then at least they ought to ensure that the 2007 Energy Bill is oil-neutral.

The Momentum Shifts

What a difference a few weeks makes. A month ago, I was contacted by a TV news producer who was lining up "talking heads" for the day when oil broke $100/barrel--then expected at any moment. Subsequently, instead of breaching that level, the most-watched oil price has receded by more than 10% and the entire shape of the market has changed. Yesterday in Abu Dhabi, OPEC apparently concluded that the risk of a price collapse exceeds that of killing demand and held its quotas steady. What has changed since early November, and is the current weakness any likelier to persist than the market's flirtation with the inflation-adjusted all-time high price did?

While I share the general sense of momentary relief that oil prices are heading back into more comfortable territory for the economy--no one can call $85/barrel normal--I'm also oddly disappointed, and not just because I missed a chance to be on TV, for now. Breaking $100/barrel would have sent an important signal about the fundamental shifts that have taken hold in the global oil market in the last few years, and it would have underlined the need for consumer behavior to change, while we wait for more efficient cars, homes, and devices to become mainstream. It also would have set a new record oil price, settling the annoying controversy over what the 1980-81 historical high means today. That no longer seems likely, at least for the next few months.

Media analysis of the change seems focused on slowing global economic growth, oil inventories, and the new intelligence on Iran's nuclear program. You almost have to smile at the perversity of some of this, when traders take the otherwise bullish news of OPEC's failure to increase quotas as a signal that economic growth must be so weak that oil demand will fall, and prices with it. This contrasts with the fall in reported US oil inventories this week, which puts them right in the middle of their seasonally-adjusted historical average range, hardly a bearish indicator.

From "This Week in Petroleum", December 5, 2007, Energy Information Agency

The most significant change, other than the absolute price level, is the dramatic decrease in "backwardation", the difference between the price of the prompt oil futures contract and those of succeeding months. Less than a dollar per barrel now separates the January 2008 and April 2008 contracts. A few weeks ago that spread was $3/bbl. This shift reflects a market that is in much better balance. That could be a function of easing physical supply and demand, a reduction in speculative pressure--as OPEC would have it--or a bit of both. Either way, the impetus that was driving prices ever higher seems to have crested for the moment, and we might even see a return to "contango", if the prompt market becomes oversupplied.

One of my futures trading mentors liked to say, "The trend is your friend, until it ends." As oil approached $100/barrel--a level with more psychological than real significance--the price seemed to have a life of its own. You can ascribe that to the impact of speculation, or the degree to which most global oil consumption is insulated from day-to-day changes in oil prices, requiring truly big spikes to bring demand back into line with supply. But whether speculators lost heart and chose to take profits, thus ending the trend, or the prospect of record oil prices finally cast a large enough pall over the global economy, prices have returned to where they were in October. The one certainty in all of this is volatility. Global supply and demand remain tightly balanced, and depending on the nature of the events ahead, we could soon be on verge of $100 again, or of $50. That's hardly reassuring for those investing in alternative fuels.

No Nukes?

Interesting topics for blogging abound this week, including the election results in Venezuela and Russia, both of which have implications for energy. But the most important news may be the release of the new National Intelligence Estimate (NIE) on Iran’s nuclear ambitions, concluding that the country’s active weapons program was put on hold in 2003. I have been following this issue for some time, partly because of its importance for the future stability of the oil-rich Middle East, but also because it is so inherently fascinating. The key questions about the NIE are how likely it is to be correct, this time, and how it could alter diplomatic efforts to constrain Iran. At least based on the reporting I’ve seen so far, this report changes nothing and everything, simultaneously.

First, consider the conclusions of the new NIE. It reflects a dramatic shift in the consensus of the US intelligence community away from the notion that Iran has an active nuclear weapons program extending beyond the uranium enrichment we’ve been observing for several years, to a posture that the New York Times refers to as “agnosticism” about Iran’s nuclear ambitions. To paraphrase the old hair-color ads: do they or don’t they; only their leaders know for sure. The similarities to the pre-war intelligence about Iraq are striking, particularly because it’s not clear how much of this is based on reliable intelligence assets on the ground in Iran, instead of analysis of data gathered by means of electronic and satellite reconnaissance.

I am in no position to doubt the findings of the NIE with regard to any specific programs within Iran. The fact that its findings appear to coincide with the conclusions of the International Atomic Energy Agency certainly lends it additional credibility. So let’s assume that the NIE is correct, and that all actual work on weapons, including design, fabrication, and enrichment to the concentrations necessary for a bomb, has ceased. That still leaves us with the enigma of a major oil and gas exporter spending so much money on an energy source that is clearly more expensive than developing its vast unexploited hydrocarbon reserves. I looked at this in some detail in 2005, and I haven’t encountered anything that changes my conclusion that the best explanation for Iran’s nuclear activities involves nuclear weapons somewhere down the road. Even if Iran’s visible uranium enrichment program is entirely peaceful, it still constitutes an option on a future bomb effort. If anything, the NIE’s conclusion makes it all the more remarkable that Iran would create this option at such a high diplomatic cost, without actually planning to build a bomb.

Whatever I may think about this finding, however, what really matters is how it is interpreted by the US Administration, the Congress, and especially by the international community, including the UN Security Council and the key three European participants in the diplomatic effort to contain Iran’s nuclear program, Britain, France and Germany. While the NIE report is hardly a clean bill of health for President Ahmadinejad and the ruling mullahs, it is bound to undermine support for maintaining the current level of sanctions and other pressure on Iran, let alone stiffening them. And here at home, by rendering the nuclear threat from Iran more remote, the report should strengthen the hand of politicians arguing for engaging Iran’s leaders, rather than confronting them.

The NIE should also lead to lower oil prices. As the consequences of this report play out, and as pressure on Iran begins to ease, the oil market risk premium based on the possibility of military conflict with Iran should begin to abate. It could also contribute to higher oil production capacity in the long run, by easing the restrictions on international investment flowing into Iran’s energy sector. That ought to be good for a few bucks off the current oil futures price, not just in the front months, but all the way out to 2012 and beyond.

What are left with, then? With or without an active nuclear weapons program, Iran remains generally hostile to US interests and is actively engaged in manipulating the outcome in Iraq to suit its own regional geopolitical aims. Even if it is not on a path to achieving nuclear weapons in the next few years, it is laying the groundwork for being able to do so some time in the future, as noted in the NIE. While this report ought to come as a relief to everyone, it’s less obvious that it justifies pushing the “reset” button on our entire Iran strategy. That’s what I expect most of the arguing to focus on, in the weeks ahead. In the meantime, this news ought to reinforce the other bearish factors in the oil market.

Energy Bill Compromise

Well, the Congressional leadership has apparently arrived at a compromise energy bill that includes a 35 mile-per-gallon fuel economy standard. It remains to be seen whether the concessions involved will be sufficient to garner a filibuster- and veto-proof majority, or whether the resulting legislation has been stripped of enough anti-industry provisions to win over the Administration. As I’ve noted previously, however, public expectations about effective energy policy are unlikely to be met, since the measures involved in this bill will take years to bring relief either at the gas pump or on the emissions front.

I’ve probably posted more frequently on the impact of corporate average fuel economy (CAFE) standards than any other subject for the last several months. At this point, all I’ve seen on the energy bill compromise is the report from the New York Times, because I’ve been bedeviled by Wi-Fi problems for the last couple days. If the Times has the gist correct, then new car buyers could be in for some frustrating years ahead. Congress has chosen a path that relies on pressuring the car industry to improve fleet fuel economy dramatically, particularly for SUVs, but has stopped short of augmenting the pressure that $3 gasoline exerts on consumers to choose more efficient cars. Closing that gap will boost car prices significantly within each class, as manufacturers add expensive technology, and force the sales mix to shift towards smaller, lighter vehicles. Because we’ve been telling consumers that Detroit can achieve all this without requiring any sacrifices of them, car-buyers will expect 35 mpg SUVs that accelerate like Porsches, and they are bound to become frustrated with the real-world choices they will encounter.

Moreover, if the deal delivering a 35 mpg CAFE relies on a bigger ethanol mandate, as the Times indicates, then the food-price inflation that the existing corn ethanol program has triggered will likely increase, draining additional billions from consumers’ wallets at the same time that ethanol subsidies tap additional tax dollars and CAFE drives up new car prices.

Given the dual challenges of high energy prices and steadily growing greenhouse gas emissions, strong legislation addressing these issues is necessary and inevitable. Perpetuating the status quo is not an option. Nor will any such legislation be perfect, requiring the usual horse-trading of provisions to gain passage. But just as the Energy Policy Act of 2005 failed to deliver energy security, the present bill will not conquer climate change or bring oil prices back to a more comfortable level. It’s an imperfect, but probably necessary prelude to the tougher, more effective measures that we’ll require in the years ahead.

Due to travel constraints, I won't post again until Wednesday.

Another Castro, With Oil?

Roger Cohen’s column in yesterday’s New York Times called attention to Venezuela’s impending constitutional referendum, which is expected to cement Hugo Chavez’s aspirations as President-for-Life, giving him effective control of the few levers of government that he had not yet consolidated. The following is excerpted from a posting I wrote in August 2006, examining some of the implications for Venezuela and the US:

As Fidel Castro fades from view and Venezuelan President Chavez accretes ever more power to himself, the speculation about Sr. Chavez’s ability to assume the mantle of Castro's revolutionary leadership grows. That would be worrying enough, geopolitically, if Venezuela weren't also our fourth largest oil supplier. Oil is the only thing that makes Chavez's "Bolivarian Revolution" economically feasible, though it's worth recalling that Chavez's own actions had previously put Venezuela's future oil revenues into a death spiral, by breaking the 3-month strike of the national oil company, PdVSA, and firing 18,000 managers and workers. By a quirk of fate or good luck, this was just about when oil began its long march to $75/barrel, with the US invasion of Iraq. So even though Venezuela's oil production has never entirely recovered from the strike, its oil revenue has risen dramatically.

According to the Oxford Institute for Energy Studies, Venezuela's oil export revenues in 2000 were $27 billion, but their net from that was only about $11.3 billion, after accounting for tax and royalty rates that were intended to make the country's challenging oil reserves more attractive to international investors. At current (2006) prices, gross revenue on today's lower volumes should be roughly $50 billion, but their net take has probably tripled, after factoring in the recent changes in terms. That's quite a track record, but where does it go from here? While oil may yet hit $100, that won't necessarily add another $25/barrel to the price of the heavy oil Venezuela specializes in. We are into diminishing returns, here. Venezuela has only a few more levers to pull on oil revenues:

• Completing the recent partial nationalizations. However, if companies like Chevron actually do know more about running these complex facilities than PdVSA's downsized staff, production would fall again.


• Expanding production via more international investment, presumably with a different group of companies, since the political risk models of the folks who've already been semi-nationalized must be flashing all sorts of warnings. Unfortunately, those same companies are the ones that best understand the intricacies of Venezuela's Orinoco Belt geology and the necessary upgrading technology. There's also a significant time lag involved in bringing new upgraders on-line.


• Cutting off oil exports to the US. They'd have to hope that the resulting rise in world oil prices would more than offset the much higher freight costs to Venezuela's alternate markets in Asia or Europe, and that this could be done without triggering a direct response from us. This looks like a fool's bet.

So, unless the adherents of the Peak Oil theory are correct and global production will never again outpace demand growth, Mr. Chavez could just be looking at the high-water mark of his oil revenues, at the same time that he has committed himself to foreign activities and transactions that will tie up an increasing share of them, on top of an ambitious domestic social agenda. There's no better antidote to good luck than hubris, and an extra $20 billion or so of oil money only goes so far in a region with an aggregate GDP of $2-4 trillion.

Energy Politics

This week I'm enjoying being the "accompanying spouse" at a professional conference that my wife is attending. Once my table-mates at the spouse's breakfast found out what I do, I could hardly finish my meal, because I was bombarded by questions. I've had a lot of practice explaining why oil and gasoline are so expensive, and whether one energy technology is more attractive than another. The toughest questions to answer are those that address the apparent absence of national political will to solve our energy problems. There has been a lot of talk about energy policy in the last few years, but far too little about energy politics.

When I started this blog, I made a conscious decision to maintain a non-partisan tone. I firmly believe that any effective national energy policy must be bi-partisan, and that the divergence of approach of the two major parties on energy has been a great hindrance to creating the kind of consistent, long-term environment that is essential for attracting the hundreds of billions of dollars of additional private-sector investments in technology and infrastructure that will be necessary. Energy investments require some stability over multiple election cycles.

As we get closer to next year's presidential election, I'll devote more time to the specific energy proposals of the candidates on both sides. In the meantime, what I keep hoping to hear one of them say--and I am not holding my breath, here--is that setting clear, consistent goals and strategies for energy is a necessary prerequisite to enacting the tactics. I also want to hear that, if we want to solve the immense, intertwined challenges of energy and climate change, all of the options need to be on the table. That includes standard energy issues such as fuel economy, nuclear power, energy taxes, offshore drilling, ANWR, and renewables, but it should also extend to some of the fundamental drivers of energy demand, including the growth of long-distance commuting, McMansion-style homes, electricity-guzzling appliances such as plasma televisions, and all of the other things that have helped increase total US energy consumption by roughly 25% since the early 1980s. In this context, even immigration is an energy issue.

The candidate who is willing to tackle all of the above would almost certainly get my vote, but I suspect he or she would become instantly unelectable, by virtue of losing the support of the many advocacy groups that are working overtime to take many of these same options off the table, or to prevent them from being considered in the first place. Simply recognizing that our energy and environmental problems lack quick and easy fixes, and that "energy independence" is exactly the wrong way to think about these issues, would go a long way. It might even be possible to articulate that without alienating all of the groups that actually get candidates elected.

Googling Renewable Energy

I see that Google has announced a new effort to make renewable energy as cheap as power from coal--a worthy goal, but one that I think reflects a misunderstanding of the barriers to the outcome they seek. If the cost of delivered electricity is being used as the catch-all for the competitive challenges faced by renewables such as wind and solar power, then it obscures fundamental issues that have less to do with the cost of generating power, and more to do with the infrastructure required to deliver clean energy reliably and consistently, around the clock.

There are plenty of people promoting renewable energy who understand the intermittent or cyclic nature of the highest-profile forms of "new" renewable energy, wind and solar power, and the difficulties involved in transmitting that energy from where the wind blows hardest and the sun shines strongest, and then leveling that output to match the diurnal and seasonal patterns of power demand. Coal wins in today's market not just because of cost--in fact its capacity cost is higher than that for natural gas turbines--but because of the combination of low-cost fuel, high reliability, and consistent output, plus the energy storage inherent in the coal itself.. That's why coal power plants, along with large-scale hydroelectric dams and nuclear plants, supply most of the baseload power dispatched in electric grids around the world.

Even if the cost of generating electricity from wind or sun fell to the same level as that from coal, those renewables could not substitute for coal in its baseload role today. I saw a good example of that yesterday afternoon, driving into the Los Angeles Basin from Phoenix. I-10 near Palm Springs is surrounded by hundreds of wind turbines, but more than half of them weren't spinning yesterday, including most of the smaller, older models. What is urgently needed for renewables to compete head to head with coal is not just lower capacity costs--since their fuel is free--but a low-cost way to store up their output and deliver it to the grid when it's needed.

The cost of generating power from wind, in particular, has fallen so much in recent years that it is only a penny or two higher than coal generation. That gap is being filled by the federal renewable generation credit and other state and federal incentives. But without cheap energy storage, wind will max out well before it reaches the scale of coal or natural gas-fired generation. Advanced grid technology can help, though we are many years away from a practical version of the "vehicle-to-grid" (VTG) scheme that would leverage the storage in electric cars to buffer the output of wind and solar power. If Google wants to make electricity from coal obsolete, they should focus their efforts not on bringing down the cost of solar panels or wind turbines, but in allowing large portions of their output to be stored at a cost below one cent per kilowatt-hour. That would truly change the world.

Equalizing the Cost of Emissions

One of the few benefits of air travel these days is the opportunity to catch up on one's reading. This trip I took along a few back issues of the Economist, the most recent of which included an article criticizing a key aspect of pending US climate change legislation as "Green protectionism." While I often agree with its editorial positions, I think the Economist misses the mark on the Lieberman-Warner Bill, which I examined here a couple of weeks ago. If viewed purely as trade policy, they might be correct about its provision to assess an emissions charge on imports into the US. However, they assign too little importance to its role in neutralizing US critics of climate agreements. This could prove to be the key to enabling a more aggressive US response to climate change.

The Economist strongly supports the idea of pricing carbon emissions by means of cap & trade mechanisms, but they raise two reasonable arguments--one stronger than the other--against the imposition of a trade barrier along the lines contemplated in the Lieberman-Warner climate bill. They see little incentive over the long-term for emissions-intensive industries to flee a cap & trade system, on the basis that environmental regulation has not been bad for economic growth in the past. Fair enough, though regulating the primary byproduct of combustion works on a vastly different scale than dealing with fuel or exhaust impurities. They also appear to doubt the necessity of external financial pressures to compel China and India, among others, to regulate their emissions, arguing that the US is not now approaching emissions regulations because of such pressure from Europe.

However, it is precisely the need to break the who-goes-first deadlock between the US and developing Asia with regard to binding commitments on emissions reductions that the trade element of Lieberman-Warner seems both pragmatic and sensible, even as a short-term measure that could be phased out once all major emitting countries are on board. And by denying domestic climate change critics the cover of rapidly growing emissions from China and India, it could finally clear the way for a federal emissions policy as tough as that of some of the states, and also for full US participation in the follow-on agreement to the Kyoto Protocol.

The Economist is right to be concerned about the protectionist rhetoric emanating from several of the presidential campaigns and from influential groups such as labor unions, but I believe they err in attributing this aspect of Lieberman-Warner to the populist-protectionist camp. The cap & trade mechanism is aimed squarely at a major unpriced externality in our market system, and emissions-equalizing import assessments would merely globalize the treatment of that externality, closing an obvious loophole. And while some believe that China and India would bow to the moral authority of a US government that has joined with other developed countries to regulate our own emissions, the more pragmatic path to their necessary participation lies in helping to monetize that same externality for them.

Lessons from the First Energy Crisis

Periodically, it's good to reflect on what we learned from the energy crisis of the 1970s and assess the continued relevance of these lessons for our current situation. While some of the insights gained during that turbulent decade have held up well, the world has also changed in important ways, and hanging onto outdated assumptions and solutions won't help us cope with the steady rise of energy prices. Because high oil prices have come on more gradually than in the dual supply shocks of three decades ago, there's not even a consensus on whether today's conditions qualify as an energy crisis. If not, it wouldn't take much to propel us into one.

The energy problems that began with the Arab Oil Embargo in October 1973 and peaked after the Iranian Revolution in 1979 were resolved through a combination of responses, including energy efficiency improvements, fuel switching, diversification of suppliers, and a wave of non-OPEC oil production from places like the North Slope and North Sea. However, despite large public and private investments at the time, the contribution of alternative energy sources to bringing oil prices back to earth was essentially nil.

Some of these strategies look as useful today as they did then, while others are either unavailable or were essentially one-time plays. For example, in 1973 US refineries produced 2.8 million barrels per day (bpd) of residual fuel, much of which was consumed in power plants. Since then, refinery upgrades have turned most of that output into additional gasoline and diesel fuel, while a combination of coal, natural gas and nuclear power assumed oil's place in electricity generation. With current resid production running below 700,000 bpd, and most of that used as marine fuel or road asphalt, that trick can't easily be repeated. Nor is there a groundswell of new crude oil production waiting in the wings. As a result of federal and state drilling bans and limits on access to foreign reserves, combined with rising drilling costs and shortages of key personnel, it's unlikely that we could swamp today's high prices with higher volumes.

The good news lies elsewhere. Efficiency and conservation still offer tremendous scope opportunities, and diversification of supply looks as useful now as it did then, though we need to update our definition of supply to encompass a wider array of liquid fuels and sources. Efficient, low-cost ethanol from Brazil and the Caribbean looks like a helpful counterweight to obstreperous or unreliable oil suppliers. In fact, the current geographical distribution of our energy imports is in need of rebalancing, as political risk in Venezuela--one of our supply anchors for two decades--increases, and production from Mexico's largest oil field, Cantarell, falters. Brazil may be able to help there, too, as its output expands.

That brings us to alternative energy, a.k.a. "cleantech." Despite skepticism about how rapidly it can scale up to displace meaningful quantities of traditional energy--an issue I think has been under-appreciated within the growing cleantech community--alternatives are in a much better position to contribute now than they were in the '70s. What we really need is clear policy guidance on where these alternatives would best fit in a shifting energy diet: covering incremental energy demand, displacing coal and its high greenhouse gas emissions, backing out imported oil, or substituting for nuclear power that might otherwise be expanding at the same time. Whether this is done explicitly, or implicitly through an emissions cap & trade mechanism or "renewable energy standards" that allocate a share of a specific market to renewables, we should understand that alternatives are decades away from being able to substitute for all of these other energy sources at once. Setting priorities will help us maximize the benefits from renewable energy and other alternatives.

Because the roots of our current energy circumstances are different from those of the 1970s' energy crisis, we shouldn't expect the solutions to be identical. Some of the old winning strategies still work, while others face new constraints, the largest of these being the need to reduce greenhouse gas emissions. As daunting as all this sounds, I'm optimistic about the end result, given adequate supplies of stamina, focus and innovation.

Energy Paragon

Today's Wall St. Journal profiles Japan's efforts to reduce its reliance on imported oil over the years. It's a compelling story, and the accompanying figures show remarkable progress between 1975 and 2004, presumably the last year for which all the comparable data was available. The author concludes that, as a result of these changes, Japan is better positioned to weather the economic impact of sustained high oil prices than other countries. The only problem with this analysis is that by many of the same criteria, the US is in even better shape than Japan.

I wouldn't want to take anything away from what Japan has done to reduce its vulnerability to oil shocks, and to make its economy more energy-efficient. It reduced its oil imports by about 4% in the last 15 years, while US oil imports were growing by an average of 4% per year. This is all the more remarkable, considering that Japan produces less oil than Wyoming. In the process, Japan has achieved one of the lowest levels of greenhouse gas emissions per unit of economic output, though because of the size of its economy, it ranks 5th highest among emitting nations.

Two of the factors contributing to this excellent energy performance might not be worth emulating, however. First, the period of comparison coincides with the flattening of population growth in Japan, resulting in one of the world's most rapidly aging populations and all the economic worries that brings. It also overlaps with the protracted recession that followed the collapse of the "bubble economy." Over the same period, US economic growth was robust, while our population increased by nearly half.

Nor does the US look so bad, in energy terms. The Journal extols Japan's 40% improvement in energy use per GDP, compared with 1975, yet in the same interval, the US reduced its BTUs/$GDP(real) by 44%. And while Japan imports 82% of its total energy needs, with oil making up 46% of the total, the US is still 71% self-reliant in energy, with oil making up 40% of the mix, down from 45% in 1975. For all of our problems, I wouldn't trade our position for theirs.

All of these comparisons are superficial, because the US and Japan are very different countries, with important economic, social and historical distinctions. Rather than touting the energy improvements of one against the other, the more useful conclusion is that both of these large industrial economies--and most others, by extension--became a lot more efficient after the energy crisis of the 1970s and are thus in a better position to absorb high energy prices without falling into severe recession. That helps explain why the virtual doubling of oil prices this year hasn't been catastrophic for the world economy, thus far. The longer oil prices remain high, the more these countries will invest in efficiency, making them even less vulnerable in the future, with accompanying benefits for the fight against climate change. Japan isn't alone in knowing how to do this.

I'd like to wish my US readers an enjoyable Thanksgiving. Postings will resume on Monday, November 26th.

Oil and Water

There is no such thing as a good oil spill. Nevertheless, some spills are much worse than others, though that bit of perspective would not be particularly welcome in my former home state of California, just now. Anyone following the coverage of the Cosco Busan spill, for with legislators are now seeking a federal investigation of the response, might naturally conclude that it ranks among the larger spills in recent years. Seeing the volume cited in gallons--58,000 of them--certainly reinforces that impression. While the environmental damage to the shoreline and marine life of San Francisco Bay saddens me, this spill from a container vessel was relatively modest, as such things go, and until we can replace oil's 150 quadrillion BTU annual contribution to global energy consumption, an attitude of zero tolerance to spills is bound to be disappointed.

Contrary to widely-held perceptions, the number of large oil spills--defined as exceeding 700 metric tons--around the world has declined in each decade since the 1970s, even though oil shipments and seaborne cargo trade have both grown significantly since then. More importantly, the volume of oil spilled in such incidents has also fallen dramatically, particularly over the last dozen years. In 2006, there were 14 spills between 7 and 700 tons and only 4 spills over 700. Statistics from the US Coast Guard reflect similar trends to those of the International Tanker Owners Pollution Federation (ITOPF). For comparison purposes, the Busan spill tallies at about 212 tonnes, a far cry from the Exxon Valdez at 37,000 tonnes, or a monster like the Amoco Cadiz at 223,000 tonnes (69 million gallons.)

That doesn't mean that, since this wasn't a giant spill, we should make light of it, or overlook negligence on the part of anyone involved. It doesn't take very much oil to foul beaches and harm wildlife. But what stands out here is the diminishing tolerance for spills, in spite of the evidence that their frequency and severity are declining. In the post-Katrina US, it is not hard to imagine the outcry that would accompany a truly major oil spill in our coastal waters or a harbor. That has implications for offshore drilling, pipelines, barge and tanker operations, and cargo lines. The number of places from which oil could spill is increasing, and the industry's success at bringing down its spill statistics, while reflecting a lot of hard work, won't win accolades in a world that regards any spill as one too many.

The 5% Solution

Two news items from the last week stand out, energy-wise. First, the OPEC summit in Riyadh ended without any consensus on the need to ramp up production dramatically, to provide consuming countries with price relief. Meanwhile, the IPCC, which recently shared the Nobel Peace Prize with Mr. Gore, has advised that global warming is worse than we thought, and global emissions must begin falling within 15 years to avert serious consequences. Taken together, these events suggest that we face a future in which oil production is likely to fall short of demand, with high-carbon alternatives such as coal liquefaction, oil sands, and shale constrained by emissions limits. Conservation remains one of the few solutions to both problems that could be both quick and cost-effective, though it is probably our least politically-appealing option.

When we think about energy conservation, we naturally tend to jump to efficiency, which is an important subset of conservation. Raising CAFE standards is a good example of this kind of thinking. But even if efficiency looks cheaper than many of the alternatives, it still doesn't always offer quick payouts on the required investments, even with oil at $95/bbl and gasoline over $3/gallon. And whatever else it is, it's not quick, because of the time required to turn over fleets and installed capital equipment. There's another side of conservation that could be both quick and cheap, though addressing it is unpopular, because it goes to the heart of how Americans live now: residing farther from work to afford a nicer home or earn a bit more, driving the kids all over town so they can participate in every activity that interests them, and so on. I'd argue that we focus on CAFE precisely because no one dares to take on the deeper issues.

As the chart below illustrates, Americans do respond to higher gasoline prices, up to a point. The rate of growth of gasoline consumption has fallen from 1.5-2.5% per year to less than 1%, which is roughly equal to the rate of population growth.





Reduced growth, however, does not yield an absolute decline in consumption. We haven't experienced that since the recession of 1990-91.

What if we could reduce demand by 5% within one year, without a higher gas tax and without having to wait for carmakers and consumers to respond to a new 35 mile-per-gallon CAFE Standard that entails either switching to much smaller existing car models or opting for hybrids and European-style diesels in large numbers? We could eliminate almost a half-million barrels per day of oil imports--roughly the production-quota increase that OPEC will discuss at their December meeting. The chart above suggests that price alone won't get us there, at least not without doubling again.

The only practical way to achieve such an outcome quickly would be voluntary conservation, asking the average American to drive about 12 miles less per week. It would be truly refreshing to hear the presidential candidates suggesting such a simple--and politically risky--measure, instead of competing to propose the highest future CAFE standard. It would also confront the reality that the responsibility for consuming 142 billion gallons of gasoline per year rests not only in product-line decisions made in Detroit, Japan and Germany, but chiefly in the daily choices of hundreds of millions of our fellow citizens. If we're seriously concerned about the impact of high oil prices and impending climate change, that's where the discussion must focus. I think politicians underestimate us, by shielding us from that particular truth.

Closing the SUV Loophole

We've had several reminders this year that, when it comes to energy and environmental policy, the executive and legislative branches of government aren't the only ones that matter. First it was the Supreme Court ruling that carbon dioxide could be regulated as a pollutant--defying a common-sense definition of the term--and now the 9th Circuit Court of Appeals is telling the administration that its 2006 update to fuel economy standards for SUVs and light trucks didn't adequately justify treating them differently from passenger cars--in which role most of them are actually used. Even though this ruling is bound to be appealed, it seems likely to influence Congressional thinking on the form that stricter CAFE standards ought to take. If it turns out to be illegal to treat cars and SUVs differently, then the debate over a new 35 mile per gallon standard could get even tougher.

Although the arguments with which the 9th Circuit justified its ruling seem a bit strained, the so-called SUV loophole should have been addressed years ago. It is a classic example of unintended consequences overwhelming the good intentions behind a regulation. While it may have initially benefited businesses that used such vehicles for truly commercial purposes, holding light trucks to a lower standard--even as sales of this class exploded--has increased total US gasoline consumption by approximately 440,000 barrels per day , or about 5% more than would have been the case, had the SUV fad never taken off. The cumulative fuel impact of the SUV loophole exceeds the entire contribution of our costly corn ethanol strategy over the same period.

Closing the SUV loophole might not be as dire as it sounds for auto makers, however, because the average fuel economy of new passenger cars in 2007 is running well ahead of its current target of 27.5 mpg, even though "light trucks", including SUVs, come in very close to their required minimum of 22.2. As of the latest posted report, the entire new car fleet was averaging 26.4 mpg. Achieving 27.5 for all vehicles would only require SUVs to improve by 1.8 mpg, or the sales mix to shift by 7 points of market share toward passenger cars averaging 31 mpg. And if they don't get there right away, the fines to which carmakers would be subject aren't severe.

Ratcheting the entire new vehicle fleet up to a uniform 35 mpg standard would be a very different proposition. Getting another 4 mpg out of passenger cars wouldn't be difficult, using a variety of affordable technologies. Boosting the average for SUVs by more than 50%, on the other hand, would require wide application of the best available technology, which still might not be sufficient. Compare the hybrid and non-hybrid versions of Ford's Escape small SUV, and you only get a 33% uplift. Closing the gap across the entire new vehicle fleet would thus require pushing passenger cars well beyond 35 mpg, boosting SUV efficiency as much as possible, and reducing SUVs' share of the sales mix significantly. In this light, the 40 and 50 mpg CAFE standards that some presidential candidates are espousing could legitimately be characterized as plans for the virtual elimination of SUVs, unless they are only counting the petroleum consumption per mile and banking on biofuels and plug-in hybrids. If so, that could create even more unintended consequences than the SUV loophole did.