Energy Outlook

Oil's Place in a Kerry-Lieberman-Graham Climate Bill

2009-12-11T14:12:00.000-05:00

The inclusion of support for expanded US oil and gas drilling in a Senate climate proposal issued yesterday is bound to puzzle many readers. If the emissions from oil are responsible for a a major portion of human-induced global warming, how can increasing our production of it contribute to reducing US emissions, as the three Senators involved suggest? The answer requires a clear understanding of where most of the emissions in the oil value chain take place. It also invokes a broader view of climate and energy security that recognizes that oil is not as close to being replaced by renewables as we'd like to think, and that in the absence of higher domestic output, our oil imports could continue to increase, with consequences--and emissions--beyond our control.

The proposed framework from Senators John Kerry (D-MA), Joe Lieberman (ID-CT), and Lindsey Graham (R-SC) was released in the form of a letter to President Obama, outlining the parameters of a climate bill that would include emissions caps and market mechanisms--presumably cap & trade--plus support for nuclear power, clean coal, and oil and gas drilling, along with other provisions to protect consumers and promote job creation by helping manufacturers become more energy-efficient. In the absence of its details, the proposal looks broadly similar to other climate measures, including Waxman-Markey and Kerry-Boxer, but without treating domestic producers of conventional energy as undesirable elements. The trio behind this initiative is also interesting, adding Sen. Lieberman's long-standing credibility on cap & trade (3 previous Senate bills) and the bi-partisan participation of Sen. Graham.

To understand what support for domestic oil drilling is doing in a climate bill, however, you have to look at oil's continuing role in our primary energy mix and the distribution of emissions associated with its production, refining and use. Start with primary energy, with oil accounting for 37% of last year's total US energy consumption, in the form of 19.5 million barrels per day (mbd) of crude oil and refined products. Biofuels can't replace oil anytime soon, and even at its maximum extent in 2022, the entire Renewable Fuels Standard would only displace the energy equivalent of about 1.4 mbd of oil, or roughly 7% of current consumption. Nor can wind and solar power do the job; they will be fully engaged in reducing the average emissions of the US electricity mix, only about 1% of which is generated from oil. Some of that green power will eventually find its way into electric vehicles, which do displace oil, though these aren't likely to make up more than a small fraction of the US car fleet for decades. In any case, the emissions from biofuels and electric vehicles may not be that much less than from oil use.

The inescapable conclusion is that the US will continue to burn oil for a long time. The quantities will decrease as efficiency and substitutes ramp up, but not fast enough to back out all of the oil we import for a very long time, let alone all petroleum from all sources. And that's where the energy security aspects emphasized by the three Senators come in; if we're going to need oil for years to come, as much of it as possible should be produced here.

Then there are the emissions from that oil. When assessed on a full lifecyle basis, most of the emissions from petroleum occur when it is used, not when it is produced. That's even true for oil derived from oil sands, which entails significantly higher upstream emissions than for the conventional oil output this framework would promote. Depending on the crude oil source and the products involved, well-to-wheels analysis suggests that 80-90% of emissions occur at the point of use, with production, transportation and refining accounting for the much smaller remainder. As a result, the point of maximum leverage on the emissions from the oil value chain is not exploration & production, which accounts for only a few percent of emissions, or refineries that are already 90% efficient, on average, but the cars and other vehicles and devices in which we consume it. The most effective strategies for reducing oil-based emissions thus involve vehicle dieselization, hybridization, downsizing, and other efficiency measures, along with non-efficiency conservation, including carpooling, telecommuting, virtual meetings, etc.

Moreover, since climate change is inherently global in nature, it doesn't matter whether the upstream emissions associated with oil occur in the Gulf of Mexico, the Persian Gulf, or anywhere else, except to the degree that domestic conventional oil might displace oil from higher-emitting unconventional sources elsewhere. But while the sources of the oil and refined products we use are largely irrelevant from a climate change perspective, they are most certainly relevant to our energy security. Increasing domestic oil production would pay big dividends in tax revenue, job creation, and the reduction of both our trade and fiscal deficits. (Disclosure: My personal investment portfolio includes oil stocks.)

The Houston Chronicle quoted Senator Graham as saying, "There will be no bill with Lindsey Graham's vote if it doesn't have meaningful offshore and onshore exploration." If he represented Alaska, Louisiana or Texas, you might attribute that sentiment to a desire to protect his home state's energy interests. Instead, it reflects a practical reality that seems to have escaped many in the administration, who appear to equate all oil from all sources with environmental and economic ills, rather than realizing that while we all know we need to use less oil for many reasons, that doesn't preclude us from using more of the enormous oil endowment with which the US has been blessed. If we use it wisely, domestic oil can provide a necessary bridge to the clean energy future we all want, and in a manner that is consistent with reducing global greenhouse gas emissions. I don't know whether these three Senators have found the recipe for breaking the Senate impasse over climate change, but this proposal could represent just the kind of grand compromise on energy and the environment that we have needed for a long time.

The Copenhagen Scenario

2009-12-08T16:36:00.002-05:00

It wasn't supposed to turn out this way. When delegates to the climate conference in Bali in December 2007 agreed on a two-year roadmap culminating in Copenhagen this week and next, they were widely understood to be buying time for the US to elect a new administration committed to much stronger action on climate change, for the remaining scientific uncertainties to be resolved, and for the large developing countries to be brought around to make binding commitments regarding their own growing emissions. Yet while progress has been made on all three fronts, the changes over the last couple of years have manifested in ways that still don't quite deliver the scenario necessary to set up Copenhagen to deliver on all of Bali's promises.

As I noted during the run-up to last year's election, both major US political parties chose nominees who had made climate change a central issue of their campaigns. Neither an Obama administration nor a McCain one was going to look much like its predecessor on this issue. Yet we've also seen that the partisan differences on climate change reflect deeper underlying concerns about the impact of greenhouse gas regulations on parts of the economy that aren't evenly distributed across the states, some of which rely much more than others on the production or consumption of the highest-emitting fuels, particularly coal. Those economic concerns loom larger after what we've been through in the last year or so. Together with the inability of recent Congresses to refrain from festooning every piece of major legislation with grab bags of peripheral regulations and pork, this resulted in a badly flawed House bill on cap and trade--and much else--and a Senate counterpart that is starting to look dead on arrival. With President Obama needing to arrive in Copenhagen armed with more than empty promises, we now get an anything-but-coincidental Endangerment Finding that could end up reducing emissions in the most costly way imaginable.

Then there's the science and even the climate itself, which has hardly cooperated in the two years since Bali. While this decade is still on track to be the warmest on record globally, 2008 was the also coolest year since 2000, and despite some rebound 2009 won't set any new records. And just when the science was looking settled, the emails and computer files hacked--or leaked--from a major climate research center in the UK have raised concerns about the peer review of papers questioning the consensus view, and about the processing of raw data for the "climate proxies" used to recreate historical conditions before the century or so that they have been observed accurately--data that incidentally provide key inputs to the climate models predicting the temperature and other outcomes from steadily increasing levels of CO2 and other greenhouse gases in the atmosphere. The likelihood that the timing of this leak is no more coincidental than that of the EPA's finding doesn't alter the need for these questions to be assessed by someone besides the scientists whose work was involved.

Then there are the large, rapidly growing emissions from China, India and other developing countries, especially when changes in land use are taken into account. As I mentioned the other day, China's announcement that it would reduce the carbon intensity of its economy as it grows is a big first step, but it also falls into the category of things necessary, but not sufficient, to induce the US to commit to deep absolute cuts, particularly in light of polling that suggests the US public is less worried about climate change than it was when the economy was booming a couple of years ago--again, no coincidence.

When I return from my current travels I'll be watching the news from Copenhagen with great interest. I expect to post more on this subject, as developments warrant.

Reconciling Emission Baselines

2009-12-10T13:43:00.001-05:00

As the nations represented at Copenhagen debate proposals for reducing their absolute emissions or carbon intensity, I was reminded that we shouldn't just focus on the percentages being offered, but also on the reference year emissions on which these proposals are based, since these aren't necessarily comparable. That's particularly true for the US and EU, which have consistently referred to 2005 and 1990 base years, respectively. This distinction is crucial in understanding how much of what each party might commit to has already been achieved and how much remains to be accomplished.

Start with the EU, which has proposed a reduction of 20% versus its 1990 emissions levels. Based on a recently-issued report by the European Environment Agency, the 27 countries constituting the European Union today have already reduced their emissions by 10.7% as of last year, compared to 1990. According to this report their collective emissions in 2005 were 9.3% below 1990, so that 20% figure for 2020 really translates to roughly 12% below 2005--and only a bit more than 10% below where they are now--which is substantially less than the 17% reduction that the US has put on the table. However, the US proposal should also be put into context, because of the divergent emissions trends of the two regions since 1990, which was the base year for the Kyoto Protocol that has guided EU policy in the intervening years, but which the US never ratified.

Between 1990 and 2005 total US greenhouse gas emissions increased by 16.5%. After counting net emissions including all sources and sinks--mostly natural processes such as forestry that absorb these gases--the increase was about 14%. So either way, that 17% cut that US negotiators were authorized to take to Copenhagen is really 1990 less about 3-5%. At the same time, 17% vs. 2005 is no slam dunk, even if it appears that the recession helped ax 2% of our emissions as of last year, and this year could be down a bit more. A recovering economy will use more energy and emit more GHGs, even if only from the work commutes of millions of re-employed people.

While I don't expect nearly as much controversy over the choice of baseline years as surrounded the Kyoto negotiations, 1990 and 2005 represent very different worlds, with the former largely pre-dating the collapse of the high-emission Soviet bloc economies, giving rise to all those Russian "hot air" allowances and a major portion of Germany's cuts post-reunification, along with a big shift in UK power generation away from coal and toward natural gas. Although the EU has certainly instituted comprehensive policies to reduce its emissions, including a cap on industrial emissions and a union-wide Emissions Trading System, a large chunk of the reductions for the current membership were achieved before any of these policies went into effect, through the rationalization of the inefficient economies of formerly-communist Central and Eastern Europe. 1990 looks even less relevant to the current economies of large developing countries like Brazil, China and India.

On the other hand, while 2005 has much to recommend it as probably the most recent year for which fully-audited emissions data are available globally, it also represents nearly the high-water mark of a world of easy money and massively-globalized supply chains that may never return in quite the same form. Choosing it might also appear to let the US off the hook for a decade of relative inactivity on climate change, though that ignores the fact that our actual emissions have grown by much less than the 33% business-as-usual increase that was expected in the late 1990s, presumably because of the discipline imposed by the steadily-rising energy prices that accompanied our bubble economy of recent years.

Whatever emerges as the baseline for an agreement or framework coming out of Copenhagen, it ought to be a single year that provides both ease of comparison and a reasonable congruence with the realistic starting point for any actions that countries will commit to undertaking in the years ahead.

Green Energy and Productivity

2009-12-04T10:23:00.002-05:00

In the last year or so the rationale for renewable energy has evolved from emphasizing mainly energy security and climate change to focusing on the creation of "green jobs" and the development of an industry that many perceive as the "next big thing": a new global growth wave along the lines of information technology and telecoms. Unfortunately, neither of these newer justifications withstands serious scrutiny. I've devoted several postings to the shortcomings of the green jobs angle, which founders on the mistaken notion that we should want an energy sector any bigger than the minimum necessary to furnish the energy needed by the rest of the economy. The IT analogy looks harder to dismiss, because it capitalizes on our innate affinity for technology, the newer and trendier, the better. I share that bias and have been fascinated by the technology of alternative energy since my undergraduate years. Yet as inherently cool as the devices for deriving energy from wind, tides, solar radiation, biomass, and exotic forms of nuclear energy are, that doesn't automatically set them up to be the next world-transforming and wealth-creating industry in the manner of IT in the 1980s and '90s.

Understanding where this analogy fails requires delving into the drivers of the IT revolution. It wasn't just that technology was improving by the quantum leaps in processing power and decreased cost described by Moore's Law. Nor was it merely the result of nebulous "market forces", though the market's ability to deploy capital nimbly to the cleverest entrepreneurs helped a lot. Fundamentally, IT took off and continues to grow because it spurred breathtaking improvements in productivity and innovation, not just within the computer industry itself, but more importantly across the entire economy. IT enabled the automation of numerous manufacturing processes, the discovery and exploitation of vast new energy resources, and the launch and sustained growth of entirely new industries, including cellphones, personal electronics and the Internet. Yet while renewable energy holds great potential for reducing our emissions and our unhealthy reliance on imported oil, it cannot offer the kind of productivity revolution that IT delivered.

Start with the fact that most forms of alternative energy are still uneconomical without government incentives or mandates. If you doubt that, recall that new US installations of wind power, which is generally regarded as the most cost-competitive of the newer alternative energy technologies, were on the verge of grinding to a halt when it appeared that the Production Tax Credit might not be renewed at the end of 2008, and again when the markets for translating those tax credits on future earnings into current cash froze up earlier this year. The wind sector only revived when the government provided a substitute Investment Tax Credit and made it available in the form of direct grants from the Treasury.

Now, there's a strong argument that these incentives are necessary to compensate for the inherent advantages of fossil fuel-based power generation that doesn't pay for the environmental externalities it creates. However, that doesn't alter the fact that the expansion of this industry is not being driven by the underlying wealth-creating force of productivity improvements, but by government funding and regulations. Thus much of the growth of the alternative energy sector comes at the expense of other parts of the economy, or of larger deficits that impair the long-term health of the economy. That might be necessary, but it won't create vast new wealth in the way that IT did.

In fact, as long as wind, solar and other forms of renewable energy require government support or mandates such as Renewable Portfolio Standards to keep them growing, they will tend to reduce the overall productivity of the economy by embedding higher energy costs into everything we do, whether those costs are reflected directly in higher energy prices or indirectly in higher taxes or bigger deficits. Meanwhile, less glamorous technologies associated with energy efficiency offer genuine productivity improvements today and well into the future, though probably still on a smaller scale than those wrought by IT, since energy accounts for only about 8% of GDP. I'd put the electrification of transportation into this efficiency category, too, once the cost and capability of batteries improve enough to make them attractive without massive subsidies.

Renewable energy looks likely to continue its impressive growth, building new companies and making fortunes for some entrepreneurs. It has great potential to contribute an important share of our future energy mix. Unlike IT, however, this transformation will largely be limited to the energy sector, with relatively little impact beyond it. Devices that consume electricity won't run any better on green electrons than on any other kind, and engines won't suddenly begin performing at higher levels on renewable fuels--in fact, the opposite is often the case. So rather than sugar-coating the green energy proposition with inflated claims that are likely to lead to disappointment later, a dose of stoicism seems to be in order, here. If accelerating the growth of renewable energy is the right thing to do for the planet and for our energy security, and if its long-term benefits outweigh the costs, we should dispense with the hype suggesting it will make us all rich and just get on with it.

Half a Loaf

2009-12-02T11:04:00.003-05:00

When I wrote Monday's posting mentioning the impending conflict between the government's requirement to increase the volume of biofuels blended into gasoline and the current approved maximum ethanol blending limit of 10%, I was unaware that the EPA was about to issue a response to the industry group that had requested a waiver to increase that limit to 15%. But while the letter the agency sent to Growth Energy yesterday deferred any ruling until mid-2010, it gave a clear indication that the EPA is considering splitting the baby, in the form of an increase for part of the fleet: those cars built in 2001 or later. Sometimes such a quasi-Solomonic decision reflects wisdom and flexibility; at other times it elevates compromise above common sense. I'm sure you won't be surprised to learn that I suspect this case falls into the latter category.

First, we should applaud the EPA for declining to be stampeded by an interest group into making a decision before its own test results are all in, particularly concerning the impact of blends containing higher proportions of ethanol on the durability and emissions (air pollutants, not CO2) of a representative cross-section of the US vehicle fleet, which numbers roughly 240 million passenger cars and light trucks/SUVs. The agency is right to insist that the science should be clear before the blending limit is increased. Unfortunately, there's more than science involved.

If any group outside the energy industry ought to have a clear understanding of the consequences of fragmenting the marketplace through the creation of Balkanized environmental specifications for fuels, it ought to be the EPA, since they and their state regulatory counterparts have presided over just such a system in the last couple of decades. This is why gasoline blended for use in Oregon or Washington can't be sold in California, and gasoline blended for rural areas can't be sold in metropolitan areas that have been designated as "non-attainment" areas for ozone and other pollutants. This has a direct impact on consumers by raising the cost of suppliers' inventories and deliveries to areas with divergent specifications, and more significantly by delaying the response to local supply outages. If the EPA is seriously considering establishing two blending standards for ethanol, it would further fragment the fuels market, not along geographic lines, but down to individual service stations, because the likelihood of them all carrying Unleaded Regular (E10), Unleaded Regular (E15), Mid-grade (E10), Mid-grade (E15), and so on, in addition to diesel and eventually E85 and whatever else they dream up is essentially zero.

Let's rewind the tape for a moment to recall how the situation the EPA is attempting to address arose in the first place. When the Congress set the new Renewable Fuel Standard as part of the Energy Independence and Security Act of 2007, it was obvious to all involved that even if US gasoline sales had continued to grow at 1-2% per year, as they consistently had prior to the Great Recession, we would rapidly reach the point at which the quantity of ethanol mandated for use would exceed 10% of our annual motor fuel use--long before the mandate reached its 36 billion gallons per year (gpy) target in 2022, including a billion gpy for biodiesel. That wasn't deemed to be a problem, since E85 sales were expected to take off in a big way, soaking up all that extra ethanol. In fact, before it started to shrink the gasoline pool looked like it could accommodate the entire 35 billion gpy of ethanol with an E85 sales percentage as low as around 18%. Today you'd probably have to bump that up to nearly 25%. Unfortunately for this scenario, E85 sales are not on any kind of trajectory to reach that threshold.

One E85 website reports that 2,211 gas stations around the US sell E85. Finding reliable statistics on actual E85 sales is time-consuming, but if all these stations sold at the current Minnesota average of around 4,000 gallons per month, then total US E85 sales are just over 100 million gpy. That's less than 0.1% of US gasoline sales, or just about enough to absorb the output of one typical ethanol plant. These figures also suggest that the roughly 6 million "flexible fuel vehicles" apparently on the road today are consuming E85 less than 10% of the time, either because of availability, or because the average discount between E85 and gasoline is typically much less than the 25% or so necessary to compensate for its lower energy content. And availability is a function of the significant expenses involved for service stations in either converting an existing tank and pumps for a higher-volume product to E85, or investing in additional tanks and pumps--including the downtime involved in such a project.

In other words, the ethanol industry (and the EPA) are in a bind now because the strategy for increasing ethanol use hinged on the expansion of sales for a new blend of ethanol and gasoline that is incompatible with existing service station infrastructure and with most vehicles on the road, and their best solution to the breakdown of that strategy appears to involve introducing yet another new blend of ethanol and gasoline that is incompatible with existing service station infrastructure and many cars on the road. Using this logic, the answer to the financial crisis would have been to launch another wave of new financial derivatives and sub-prime loans. Perhaps it's time for a simpler answer: If the tests by the EPA and DOE indicate that a significant number of vehicles could be harmed by a 15% blend of ethanol in gasoline, or that such a blend would increase local air pollution, then surely it is time to call a halt to the annual increases in mandated ethanol use until a more practical solution can be found.

Unrealistic Goals

2009-11-30T13:15:00.000-05:00

A couple of stories over the long weekend highlighted growing disconnects between major elements of energy and environmental policy and what is actually possible in the real world. The first concerns China's gambit that committing to a carbon-intensity target that could be met with initiatives already under way might be sufficient to induce the US and EU to sign up for deeper cuts in actual emissions--and incidentally release a flood of "carbon debt" payments from the OECD to the developing world. Meanwhile a pair of articles on ethanol highlight the infeasibility of the biofuel mandates established by the US Congress a few years ago and about to be embedded in new EPA regulations. In both cases, practical reality is at odds with the aspirations of regulators in ways that threaten to undermine support for less ambitious but more achievable efforts.

The Copenhagen climate meeting, officially the 15th Conference of the Parties to the UN Framework Convention on Climate Change, begins in one week. Politicians and diplomats have been scrambling to avert the possibility that after two years of work on the details of the framework set in Bali, the meeting might conclude without producing an agreement that could take the place of the Kyoto Protocol, which expires in 2012. Last-minute actions by the world's two largest emitters may have rescued the conference from this fate, in the form of a pledge by President Obama that the US will reduce its emissions by 17% below 2005 levels by 2020 and a commitment by China to reduce its emissions per unit of economic activity by 40-45% below 2005 levels. But while this might save Copenhagen from irrelevance, it illustrates how far the available degrees of freedom for action in countries that must keep their economies moving forward fall short of what would be required to halt the accumulation of greenhouse gases in the atmosphere and begin to reverse it.

As it is, President Obama is taking a considerable risk in offering emission cuts that have not been approved by Congress, which might not be inclined to stick out its neck quite so far going into a tough mid-term election that will hinge on the economy and employment. While China's offer represents a serious first step, a similar focus on "carbon intensity" by the previous US administration was met with derision by environmentalists. The problem is that the level of emissions this would yield if China's economy continues to grow at 8% per year or more is incompatible with scenarios for limiting peak CO2 concentrations in the atmosphere to 450 parts per million and eventually restoring them to pre-industrial levels. If we can't avoid blowing past the 450 ppm limit that was the basis of the Bali framework, then growing efforts to shift the official goalpost back to 350 ppm--a level we passed in 1988--look like King Canute ordering the tide not to rise. Expect a great deal of attention to be focused on these numbers in the next couple of weeks.

The disconnect on US ethanol policy is even more pronounced, because the current path can only be sustained for a few more years. An op-ed in Saturday's New York Times reminds us of the shortcomings of our current reliance on ethanol produced from corn, while comments by the CEO of Shell, a major investor in next-generation biofuels, makes it clear that the extremely ambitious targets for cellulosic ethanol and other non-food-based biofuels that the Congress mandated in the Energy Independence and Security Act of 2007 are extremely unlikely to be met. And even before that shortfall becomes serious, the nation's distilleries will exceed the capacity of current US motor gasoline sales to accommodate all the ethanol they can produce, unless the government also lifts the 10% blending limit.

While we can argue about whether that ought to happen, the bigger issue is that these two developments expose the failure of the key assumptions under which the Congress crafted the Renewable Fuel Standard: E85 has turned out to be a dud in the marketplace for good reasons--consumers have figured out that a fuel that costs more dollars to go fewer miles is a bad deal--and it turns out to be really hard to make fuels on a large scale or at an affordable cost from non-food biomass. The appropriate response when your expectations of the future turn out to be so badly wrong would be to freeze the status quo in place while revamping the standard to reflect more realistic assumptions, not to enshrine the false assumptions in new EPA rules that will drive up fuel costs for consumers without doing a thing to improve the environment.

Counting Our Energy Blessings

2009-11-25T11:08:00.000-05:00

Thanksgiving is a perfect time to reflect on the many energy blessings the US enjoys. While we tend to focus on our problems, which seem numerous and overwhelming at times, there are a number of positives we should also recognize. Here's a short list of them to contemplate over tomorrow's turkey dinner:

The US still produces roughly three-fourths of the energy we consume, well ahead of the EU and Japan, and with prudent investment in energy efficiency and new production of all kinds, that ratio could grow significantly over the next decade.
The energy efficiency of the US economy has been improving steadily. Measured in terms of BTUs per dollar of real output, our energy consumption per GDP has fallen by more than 15% in the current decade. That's one reason that our greenhouse gas emissions increased by much less than expected, even before the recession started.
Only a few years ago, the US natural gas supply and demand balance looked like a slow-motion train wreck. Thanks to a tremendous surge of production from shale gas reservoirs and other unconventional sources, US gas production last year reached the highest level since the mid-1970s. If the incremental production added since 2005 were all turned into electricity, it would equate to the output of 100,000 MW of wind turbines.
Despite the weak economy and extremely challenging financial markets, US wind power capacity is on a pace to grow by more than 7,000 MW this year, surpassing all but last year's record additions, and bringing total wind capacity by year end to over 32,000 MW.
US crude oil production looks set to snap a 17-year trend of annual declines. The API indicates that year-to-date 2009 production is up by 6.8% over last year, as major new projects initiated earlier in the decade when prices began to rise come on stream.

Finally, here's a non-energy statistic that surprised me. Even after contracting by 3% from last summer's high point, US real GDP has grown this decade by an amount that exceeds the entire GDP of Brazil, and our nominal GDP is up by an amount roughly equal to the entire economy of China. That shouldn't make us feel complacent, as both of those countries are growing at much faster rates than we are, but it should at least provide some perspective on the discouraging comparisons we're accustomed to hearing.

Energy Outlook will observe the traditional long weekend and resume postings early next week. Happy Thanksgiving!

Do Leaked Emails Undermine the Scientific Consensus?

2009-11-23T13:53:00.000-05:00

For the last couple of days I've been ruminating about what to say concerning the emails and other data apparently leaked by hackers who penetrated the computer systems at the University of East Anglia's Hadley Centre Climate Research Unit, one of the major global sources of climate change data and analysis. It's clearly premature to attempt to draw sweeping conclusions about the implications for climate science and policy from the few tidbits that have been leaked to the press or published on the websites of leading climate skeptics, some of whom have already characterized the story as "Climategate." At the same time, it strikes me as naive--and perhaps ultimately counterproductive--of those in the "true believer" community who imagine that the publication of such interactions would not naturally lead to serious questions about the scientific basis of some very expensive proposed policy actions to address global warming.

Start with the official statement from the University of East Anglia. While I'm naturally sympathetic to their concerns about the breach itself and the resulting release of sensitive personal information of university employees, it is also worth recalling that the institution in question is funded by UK taxpayers and is not exactly covered by the Official Secrets Act. If laws have been broken, the perpetrators should be pursued and prosecuted. However, if university officials believe they can confine their response to the theft of data and easily dismiss the content of the material that was revealed, they are getting poor advice. I'm sure that the items that have been published so far have indeed been taken out of context, as they contend, but is that not the standard claim by nearly everyone who has suffered a similarly embarrassing exposure in the last couple of decades? The response of the University of East Anglia to date is simply inadequate in the modern era of information, and if I were in their shoes I'd at least announce a full and immediate academic inquiry into whether the emails have unearthed practices that were contrary to university policies and the normal standards of data integrity and peer review. They'd be much better off tackling this proactively than waiting for it to be forced upon them, or taken out of their hands as a result of a Question asked in Parliament--however unlikely that might be in the current political climate.

Next, consider email as a medium of discussion. In my career I have seen many emails that their senders would have subsequently preferred to see deleted from all systems, and I have probably written one or two myself. But that's not the reality of a world in which anything you write on a networked system can be divulged later as part of the discovery phase of a lawsuit or in a government investigation. The best advice I've heard on the subject is the lesson some of the authors of the Hadley emails have just learned the hard way: "Don't write anything you'd be embarrassed to see printed on the front page of the New York (or in this case the London) Times."

That doesn't mean I'm naive about how people--even scientists--interact with each other. Anyone who has spent five minutes peering behind the veil of academic politics wouldn't be terribly surprised at some of the caustic, small-minded, and downright vindictive comments that pepper the Hadley emails that have turned up around the Internet. Nevertheless, most of us aren't involved in work that is integral to a global effort to understand and avert the worst outcomes of something on the scale of climate change. These folks are expected to hold themselves to a higher standard, and if they don't, it jeopardizes not just their own reputations but the public's perception of the findings of the larger body of climate science. When I read an email in which one noted climate researcher asks another not to refer to a particular subject in his reply, but just say yes or no, or another indicating the author would delete some data points from a graph showing a recent change in the trend, I'm reminded of some precautionary advice I received at the very beginning of my oil trading career: "Avoid even the appearance of evil."

The basic issue here that many of those responding from the climate change community seem unable or unwilling to grasp is that their real problem is not how particular individuals or groups might exploit this information, but how the information itself could undermine the faith of the public in the integrity of climate science. I use the word faith deliberately, because for most of us it boils down to that. The number of people actually equipped to read the scientific papers in question and ascertain whether the manipulation of charts and data implicated in some of the leaked emails is serious or not is vanishingly small, compared to the much larger number of us who must simply take it on faith that the scientists studying the climate and reporting on alarming changes in it are behaving in a fair, transparent, and unself-interested way, to the greatest extent humanly possible. It would be hard for most of us to read the emails in question objectively and not have that faith shaken, at least a bit.

Now, it's possible this entire episode could blow over in a news cycle or two and have no impact on the impending negotiations in Copenhagen or on the Congressional debate on climate legislation. I wouldn't bet on that, because what little has come out so far fits neatly into the preexisting view by some of climate science as a conspiracy, or at least a process that has been politicized by the funding and bureaucratic power that large sums devoted to climate research have bestowed. If the climate science community wants to put this episode behind it without derailing the public's trust in the scientific consensus on global warming, then the researchers and institutions that are leading this effort should be calling loudly for a full airing of Hadley's linen, and an assessment of the center's practices by an unbiased panel, preferably one well-staffed with scientists from other disciplines. Any perception of a cover-up will only reinforce suspicions that conduct at Hadley wasn't what it should have been, and that at least one pillar of the climate change argument looks shakier than it did just a week ago.

Energy Principles

2009-11-20T11:43:00.003-05:00

My critique of a proposal for expanded tax credits to promote the electrification of transportation prompted some interesting comments. It also got me thinking again about an underlying problem that leads to the kind of scramble for government favor and largess that is exemplified by such efforts and by the badly-flawed Waxman-Markey climate bill. We have seen endless debates on energy policy, energy strategy and energy tactics, but far too little on energy principles. It would save much time, effort and money if we had a guiding principle that eschewed favoritism toward any particular technology, in favor of technology-neutral regulations and federal investments in broadly-useful energy infrastructure. Even more importantly, we would benefit from a clear principle of focusing policy and incentives on our desired ultimate outcomes, such as reducing emissions or oil imports, rather than on individual pathways for achieving them.

Take the example of electric vehicles (EVs) and their infrastructure. The US government has no business promoting a single-focus solution like this. It does, however, have a vital interest in promoting much more energy-efficient cars, based on any technologies that achieve that result. If handing out consumer tax incentives for new cars is necessary to further that goal, they should be given on the basis of total energy consumption, using a comprehensive metric like the MPGe of the Automotive X-Prize, which counts all energy in all forms delivered to the car. The higher the MPGe, the bigger the incentive. That would make a lot more sense than doling out tax credits in proportion to the size of a car's battery. Along with the proposal by the EPA and Department of Transportation to let carmakers count EVs twice towards their new corporate fuel economy and tailpipe emissions targets, that would create a perverse incentive similar to the old "SUV Loophole", possibly setting the stage for a new generation of large, inefficient battery SUVs.

Shifting transportation energy from oil to electricity makes more sense if that electricity is used efficiently, particularly since low-emission sources still account for less than 1/3 of our electricity supply, and the wind power most often mentioned in connection with powering EVs accounts for just 1.6% of US generation this year. On that basis, investments in the smart grid and long-distance transmission lines would probably be as helpful in supporting future EV deployment as underwriting specific EV recharging infrastructure, while avoiding the risk of becoming orphaned if EVs don't catch on.

On the generation side, whether intentionally or not, the stimulus bill passed early this year helped put wind, solar, and other renewable energy sources on a more technology-neutral basis by making them all eligible for the same 30% federal tax credit previously available only to solar power. Yet this provision still contains at least one glaring omission, because it was established under a very specific definition of renewable energy, rather than encompassing all energy sources meeting criteria for very low emissions that would also include nuclear power. Putting nuclear and renewables on a common footing would go a long way toward ending protracted arguments about which technology receives more (undeserved) government support and which is most commercially competitive, and it would foster a future generating mix offering similar depth and flexibility to the one we have now, without undesirable greenhouse gases.

Ultimately, whether you like my choice of principles or prefer different ones, we need a common set of criteria for making the energy decisions we face, instead of treating each as an ad hoc opportunity for one option or technology and its backers to win at the expense of the others--and often at the expense of taxpayers. While we certainly need to get on with deploying lower-emission ways of producing and using energy, it is premature to bet the ranch on any one option. We should still be creating new options and pruning them along the way, based on principles aligned with the basic problems we are trying to solve. While that might sound idealistic to some, it strikes me as intensely practical and much more useful in the long run than the prevailing plague of energy "answer-itis", in which everyone wants to push a specific answer before we even agree on the right questions to ask.

Paying the Bill for Electric Vehicles

2009-11-18T11:57:00.000-05:00

Perhaps it's merely a sign of the times, when a billion is the new million and firms in many industries have found it easier to get capital from the government than from bankers, bondholders and shareholders, but the price tag implicit in the recommendations of a new cross-industry group formed to promote electric vehicles is startling even in this context. Although I couldn't find the total anywhere in the lengthy report from the Electrification Coalition, the Washington Post tallied the combined cost of their proposals at $124 billion in new government incentives, over and above the billions already being spent under the stimulus bill and other programs to support the R&D, manufacturing, and infrastructure for plug-in electric cars, and to subsidize consumer purchases of them. The frustrating part of this is that I'm in general agreement that electric vehicles probably represent the long-term future of cars. However, I don't believe anyone can know this with sufficient certainty, any more than they knew a few years ago that fuel cell cars were the answer, or in the late 1990s that diesel hybrids were the answer. The report also raises basic questions about how new industries should be built, and at whose expense.

Without dissecting the entire document, the justification for its recommendations appears to hinge on a few key arguments concerning our current use of oil, which the Coalition is hardly alone in regarding as excessive. Although they go a bit overboard focusing on the $900 billion Americans spent on petroleum products last year--roughly half of which represented the value of domestic production, refining margins, and federal, state and local taxes collected on product sales, all of which are part of GDP and thus a plus, not a minus for the economy--they eventually get around to mentioning last year's oil import tab of $388 billion. (That figure is currently running at around $250 billion per year, based on the September refiner acquisition price applied to our average monthly net imports, but it is still a lot of money.) Yet as attention-focusing as that sum is, vehicle electrification is hardly the only way to go about reducing it, and from what I can tell it is almost certainly not the most cost-effective means of doing so.

Aside from the diesel options I discussed the other day, there are a variety of strategies available to improve fuel economy significantly without merely shifting our transportation energy consumption from one category (oil) to another (electricity generated from a mix anchored by coal.) Our approach to reducing oil consumption must also take into account the diminishing returns to increasing fuel economy. Doubling the average car's fuel economy from 25 mpg to 50 mpg saves twice as much gasoline as going from 50 mpg to 100 mpg--and it still saves more than achieving the fancifully hyperbolic mpgs we've seen quoted for various plug-ins and EVs that ignore the energy required to generate grid electricity. The avoided fuel cost effectively sets a ceiling on the financial rewards available from the notional fuel economy of grid-based vehicles. Because fuel savings can't justify today's high up-front cost of battery-powered cars, the Coalition proposes consumer tax credits for plug-in hybrids or EVs that could top $10,000, compared to the current $7,500 maximum. By comparison, for ten grand you could fuel a Prius for 100,000 miles at $5/gallon, or a pair of them at current gas prices.

Nor do I find the suggestion of providing federal tax credits to cover 75% of the cost of EV-recharging infrastructure (50% in later phases) appealing, other than as a gift to the member companies of the Coalition that paid for this study. Infrastructure is an expensive investment, and I'm quite familiar from my experience of the EV-1 rollout with its importance in breaking the chicken-and-egg market dynamic associated with battery cars. However, I don't see sufficient justification for taxpayers to pick up this much of the tab--and risk--for infrastructure for which the demand will be so small and uncertain for years to come.

Even measured against the scale of the bailouts of GM, Chrysler, and the big banks, $124 billion is a huge price tag to impose on taxpayers who have just begun to wake up to the likely consequences of the enormous debts that our deficits are piling up. While vehicle electrification might reduce our trade deficit in oil, it's not obvious that it won't replace it with offsetting deficits in cars, batteries and the scarce strategic materials they require. Nor does it seem equitable to ask average taxpayers to furnish other, perhaps higher-quintile taxpayers with EV tax credits so generous that they would exceed the depreciated value of the average car on the road.

I'm not opposed to electrification or the companies behind this initiative. In fact, I wish them well and look forward to someday having the choice of buying an attractive and affordable electric car. What I do oppose is another massive handout to another chosen industry on the basis of a highly uncertain scenario of future market development, bypassing all of the competitive pressures that should shape such a revolutionary change along the way. The first few million grid-powered EVs would have a negligible impact on the nation's energy consumption, emissions, and oil imports, yet even their advocates suggest they will cost a bloody fortune to put on the road. As you read the Coalition's analysis and their proposals for who should foot the bill for all this, I encourage you to consider who stands to benefit the most from it in the next ten years. Taxpayers should insist that the early adopters and the companies that will garner most of the value of these developments pay their own way, as was the case for personal computers, cellphones, and most other successful new technologies of the last several decades.

Indexing Crude Prices

2009-11-16T13:30:00.000-05:00

Although oil trading hasn't been my primary focus for many years, the recent announcement by Saudi Aramco that it is switching its price mechanism for oil delivered to the US caught my attention. Instead of basing its formula for deliveries here on the price of West Texas Intermediate crude oil, it will apparently reference the new Argus Sour Crude Index (ASCI.) While that lends substantial credibility to this new index and may gain Argus more than a few new subscribers, the implications for the widely-traded NYMEX WTI contract and the dynamics of the broader international oil market seem much less clear. In particular, I am skeptical of suggestions that this move could ultimately reduce whatever influence non-commercial financial participants--speculators, in common parlance--have on oil prices.

The question of how best to price crude oil for buyers and sellers is a perennial problem, particularly for oil that differs significantly in quality from the light, sweet grades behind the extremely liquid WTI and ICE Brent futures contracts. US refiners, in particular, have invested many billions of dollars in the hardware required to turn lower-quality oil into high-quality petroleum products. Any time the peculiarities of these contracts drag up the prices of the grades of oil they prefer to run, they grumble about basing deals on WTI. Likewise for sellers of sour crude, foreign and domestic, who suffer when the WTI price moves out of sync with world prices, such as when storage at its nexus at Cushing, OK fills up, as it did earlier this year. However, after listening to the Q&A podcast concerning the ASCI on Argus's website and reading the background document there, I'm skeptical that this index will settle the sour crude market's discontent, because it won't change the way this oil is traded by nearly as much as it might appear.

Without getting into all of its details, as I understand it the ASCI is effectively a composite daily report of the deals done for three specific streams of offshore Gulf of Mexico crude oil, all of which trade at a differential to WTI. In calculating a daily price, Argus will add the average daily discount or premium vs. WTI from the transactions it learns of to the daily price for WTI to come up with a single price in dollars per barrel. The Argus podcast was very clear that NYMEX WTI is still as the heart of the new index, not just because this reflects the way deals are done with reference to WTI, but also because WTI remains the highly-liquid futures contract that the buyers and sellers of the ASCI oil streams use to hedge their market risk. In other words, the new ASCI index is not a substitute for WTI-based pricing, but merely a more transparent gauge of the relationship between WTI and the sour crude market--though an index you have to pay to read falls a bit short of the kind of transparency currently provided by WTI itself.

What would happen if speculators drove up the price of WTI by $30/bbl? In theory, ASCI would reflect any disconnection between the fundamentals-based pricing of its included sour crude streams and the financially-driven WTI market by remaining more or less unchanged, after summing the combination of correspondingly wider discounts for the ASCI grades to the inflated daily WTI prices. Only by looking at the differentials themselves would we see any indication of distortion of the market by non-commercial players. But is that realistic? Consider that between January 2007 and July 2008, when the price of WTI rose more or less steadily from the mid-$50s to nearly $150/bbl, the discount between WTI and the monthly average refiner acquisition price for imported crude only widened from around $4.75/bbl to roughly $9/bbl. If WTI was being driven by speculation in that interval, differentials-based trading of the kind that ASCI will measure hardly insulated refiners from its effects.

That historical result might merely indicate that speculation had little real effect on the market in that period--a view to which I'm sympathetic--but it might just reflect the inertia of negotiated crude differentials. Either way, if you're Saudi Aramco and you're selling crude into the US based on ASCI, I'd conclude that your prices would still go up more or less in tandem with the NYMEX, despite the superficial "arms-length" mechanism flowing through ASCI. Perhaps I've missed some subtlety in the mechanism.

From what I can tell, neither ASCI nor the prospect of new futures contracts based on it addresses the underlying concerns I have had since the industry migrated to pricing based on differentials against the WTI and Brent futures contracts, and away from negotiating actual "fixed and flat" prices for each cargo or pipeline deal, back when I was trading oil in the 1980s and early 1990s. While that shift made life much easier for risk managers and took a lot of heat off traders to strike the best deal on any given day, it also opened the door to a host of other influences on pricing that I still don't think we entirely understand.

The market will pass its own judgment on ASCI and other new tools like it. If it proves useful to traders and risk managers, it could become the new industry standard, as Argus must hope, having made such a big splash over its launch. If it's not useful, it will fade into the background, becoming just another dataset in an already bewildering sea of energy-related information. With Gulf of Mexico output booming and more discoveries yet to be made, it looks like a reasonable bet to join other useful physical crude indices around the world. But anyone hoping it will shine a beacon on speculators in the next oil price spike is likely to be disappointed by the core of a system still rooted in WTI, the speculative influences over which remain uncertain and possibly unprovable.

Green Power or Green Jobs

2009-11-12T14:01:00.003-05:00

Until now I've avoided the debate over a proposed wind project in Texas involving Chinese investors, federal renewable energy stimulus grants and wind turbines from China, mainly because I didn't think I had anything salient to add to the unpleasant mix of protectionism and second-guessing that was unfolding. This morning I read a posting on the subject from the Breakthrough Institute that, while offering a coherent explanation of how we got to this point, convinced me that the real problem still hasn't been addressed. Although the inconsistency of past and present US energy policy is readily apparent, the current concerns arise from general confusion over the benefits of renewable energy, exacerbated by the recent effort to spin these projects and technologies in terms of "green jobs." When we don't really understand why we are doing something, it's easy to make any outcome look like a failure--and there is no shortage of elements from which to craft such a view in the situation at hand.

The chief complaint about the project in question is that it might be eligible to take advantage of a key energy provision of the American Reinvestment and Recovery Act of 2009--this year's stimulus bill--that allows the developers of a qualifying renewable energy project to collect an up-front cash grant from the US Treasury equal to 30% of the cost of the project. In this case much of that money, along with the funds provided by the US and Chinese partners, would go to pay for wind turbines imported from China. As a result, most of the jobs this project would create would be in China, not the US. On the face of it, this looks like a colossal loophole that some high-profile legislators--who incidentally voted for the stimulus bill including this feature--are rushing to plug. However, this only looks like a nasty unintended consequence of a hastily-crafted law if you misunderstand the mechanics and purpose of the Treasury renewable energy grant program.

You have to begin with the renewable energy tax credits that were in place prior to the passage of the stimulus bill. Qualifying wind projects normally received a federal tax credit of 2 cents per kWh generated for ten years after start-up, adjusted for inflation. Along with similar tax benefits for solar and geothermal power and other renewable energy technologies, the wind Production Tax Credit (PTC) was due to expire at the end of last year. Last fall's TARP bill extended this benefit through the end of 2012*. So it's important to note that the West Texas project would have collected a similar amount of money from the government in the form of tax credits over the next decade, even without the option provided by the stimulus bill to convert those credits into an up-front cash grant. The latter merely made the cost of providing this benefit much more transparent. As noted in a report by the Investigative Reporting Workshop at American University, well over 80% of these grants to date have gone to non-US firms.

I can appreciate the outrage this has caused, particularly when this program was so heavily hyped as a way to create new jobs in the US during a recession, and in an industry that many see as holding the key to future US competitiveness in a carbon-constrained world. However, that outrage ought to be tempered by a clear understanding of the principal purpose for establishing the grants. Prior to the failure of Lehman Bros. last year and the subsequent seizing-up of the so-called "tax equity" market, it was customary for project developers to enter into agreements with banks and other parties to exchange the rights to their future PTC benefit stream for up-front cash to invest in the projects generating these credits. When that market became illiquid, new wind project development came to a virtual standstill. With financial markets in turmoil at the beginning of 2009, the Treasury grant program was conceived as a way to jump-start renewable energy project development, until the tax-equity market revived. In that regard it has been fairly successful, as evidenced not least by the sums issued under this program so far.

I can't tell whether the architects of this program failed to work through the consequences of their efforts sufficiently to see that, with domestic turbine makers such as GE Energy accounting for less than half of the US market, a large portion of the grants would end up benefiting foreign manufacturers. Perhaps they saw that potential but didn't appreciate the firestorm of controversy it would create, when someone figured out where the money was actually going. Or perhaps at that moment they were merely hyper-focused on getting legislation passed in order to arrest the apparent free-fall of the US economy. I'll leave that to others to sort out.

There's a deeper issue here, as well. The whole episode evokes memories of the endless debates over "industrial policy" in the 1980s. The US wind industry lags its European competition in market share because European countries chose to subsidize the sector through much more generous and consistent tax benefits and a hidden tax on electricity consumers (a.k.a. the "feed-in tariff".) But while that created an advantage for the European companies involved, it didn't make them self-sustaining or overcome the inherent shortcomings of wind power's intermittent output. In that light it's hard for me to regret that the US didn't invest more money in wind over the last 20 years. Another way to look at this is that European taxpayers and consumers have borne much of the pain of driving down the costs of wind power to a point at which it can begin to compete with power generated from natural gas (and to a much lesser extent from coal) with only the modest subsidies US taxpayers have been willing to provide.

That gets to the essence of the choice we need to clarify if we are to judge fairly outcomes such as the one presented in the proposed West Texas wind farm. Are we investing in these projects and these technologies mainly to create jobs in the US, or are we investing in them to generate low-emission electricity at the cheapest cost possible, in order to run the 90+% of the economy that is not devoted to producing energy?

Selling green energy as a jobs initiative has led directly to the confusion and consternation apparent in the reaction to Chinese investors and Chinese wind turbines in this West Texas wind project. The wind industry has already developed a globalized supply chain, similar to many other industries, and no one should be stunned if wind turbines from China show up in Texas, any more than China should be surprised that its nuclear power plant construction projects are creating jobs in the US. Our assessment of the value of renewable energy sources such as wind power should hinge on their efficacy at providing reliable and cost-effective energy supplies and reducing greenhouse gas emissions, not on domestic jobs creation--even in a recession.

*Correction: A reader reminded me that the TARP bill only extended the wind PTC by one year; the longer extension occurred in the stimulus.

The Way We Drive Now

2009-11-10T11:33:00.002-05:00

My posting of October 29th examined two of the ways we risk under-counting the greenhouse gas emissions (GHGs) from favored energy technologies such as biofuels and electric vehicles, with potentially serious consequences. Well, it turns out that the same joint proposal by the EPA and Department of Transportation establishing new fuel economy and vehicle emissions rules incorporates another, subtler distortion that could be even more significant over the next few years than treating electric vehicles (EVs) as if their external power sources emitted no GHGs. Consider the many ways in which personal transportation in the US has changed since the mid-1970s--longer commutes, heavier traffic, and new vehicle technologies--and then ask how it could possibly make sense to embed a vehicle-use statistic set by a 1970s' law at the heart of the new Corporate Average Fuel Economy system. Yet that is precisely what these new rules would do.

My scrutiny of the draft "Light-Duty Vehicle Greenhouse Gas Emission Standards and Corporate Average Fuel Economy Standards" rulemaking was an outgrowth of a recent conversation with Jeff Breneman, Executive Director of the US Coalition for Advanced Diesel Cars. In addition to promoting to an American audience the benefits of the improved engine technologies that have enabled diesel passenger cars to capture over half of the new-car market in Europe, this group advocates an approach to emissions reduction and improved energy security that emphasizes outcomes, rather than "flavor of the month" pathways. That resonates with themes I've been expounding since I began this blog nearly seven years ago.

According to Mr. Breneman, achieving a level playing field for advanced vehicle types such as diesels, hybrids, plug-in hybrids and pure EVs depends on establishing metrics for judging them that reflect "real-world driving." In the case of the draft EPA/NHTSA rules, that means updating their assumption that the average American drives 55% in city traffic and 45% on the highway. That ratio was set by the Energy Policy and Conservation Act of 1975, when there were 100 million fewer cars on our roads, each driving on average about 2,000 fewer miles per year, and the only alternative fuel vehicle I was aware of burned propane. According to the EPA's own data from 2006, current average driving patterns exhibit a roughly 43% city, 57% highway split, even though its 2010 vehicle sticker program is still based on the old 55/45 ratio.

This divergence between current and historical driving patterns has become more significant as the array of available vehicle choices has broadened to encompass technologies such as hybrids that perform best in city driving, but offer little highway benefit, and others such as diesels that are at their best in sustained driving above 45 miles per hour (highway driving by definition in the EPA's split.) For example, the 2010 VW Jetta Diesel is rated at 30 mpg city/42 mpg highway, compared to 41/36 for the Ford Fusion Hybrid.

The two agencies involved indicate they intend to assess carmakers' fleets using the old split until at least 2017. That means that during this crucial transition to stricter fuel economy standards these rules will motivate manufacturers to invest more in vehicle technologies that perform best under the old assumptions--despite the resulting misalignment with how consumers really drive now--in order to meet their tougher corporate targets. The difference gives hybrids an extra edge vs. diesel, over and above any disparity in purchaser tax credits. It would likely limit the choices available to consumers, given the high costs of developing additional models with drastically different powertrains.

Prolonged reliance on the outdated 55/45 split could affect actual GHG emissions, as well. A study by the Energy Information Agency earlier this year indicated that the lifecycle emissions of diesel vehicles are typically 15% less than for comparable gasoline-powered vehicles. When fueled with blends containing 20% biodiesel they emit levels of CO2 per mile similar to gasoline hybrids or plug-in hybrids recharged using grid-average power in much of the US. That's a surprising result for a technology option that generally costs somewhat less than hybridization and many thousands of dollars less per car than a plug-in with its expensive batteries.

I don't know whether US consumers would ever warm up to diesels to the extent that Europeans have. But given their attractive fuel economy and emissions benefits, they shouldn't be impeded from trying, merely because of an accounting ratio that was set when I was driving my first car. Nor do I buy the argument that diesels are a dead end, compared to electric vehicles. Interpolating from the EIA data cited above, diesel cars running on advanced biofuel derived from sources that don't compete with food crops or result in deforestation appear no less sustainable than a plug-in hybrid backed by California's low-emission power grid. When the time comes for me to buy my next car, I hope to see a wider array of clean diesel options, including some from GM and Ford, which make wonderful diesel cars in Europe.

Cheap Oil

2009-11-06T11:43:00.000-05:00

When the US invaded Ba'athist Iraq, many ascribed that action to a desire to seize the country's vast oil reserves and develop them on terms favorable to us, presumably to keep the days of cheap oil rolling on. After six years of oil prices far above their pre-war level, the last vestiges of that theory should be laid to rest by a careful reading of today's headlines concerning the announced production deal between the Iraqi government and ExxonMobil and Shell. The terms looks anything but lucrative for the Supermajors, which have won the opportunity to revamp output at one of Iraq's largest mature oil fields, West Qurna. However paltry the returns might look for the firms involved, this development could have a bigger impact on oil price--and sooner--than some of the splashier recent announcements concerning big oil finds off Brazil and West Africa.

The reported terms of the deal struck by Exxon and Shell in Iraq continue the trend of allowing access only on the basis of working as contractors, rather than as partners with an ownership interest in the underlying resource via a typical production-sharing contract. According to the story in today's Wall St. Journal, the companies will receive just $1.90 per barrel for their efforts to boost the flagging output of the super-giant West Qurna field, the output of which could increase by more than the current oil production of Texas (including the Gulf of Mexico.) Moreover, because the project entails virtually no exploration risk--the reserves are well-established--and minimal technical risk, and is already connected to infrastructure, the only real limitation on how fast it could begin ramping up is the local security environment and the ability of the firms to line up equipment and workers. This will still require several years, but it should happen a lot quicker than the time required to develop a new field with tricky geology in deep water.

So what does this mean? Well, for ExxonMobil and Shell it offers a relatively quick boost in production and revenue. $1.90/bbl is skimpy compared to what companies can make on their own discoveries, but over volumes this large it could translate into an extra $700 million of annual cash flow for the next 20 years. As attractive as that sounds, though, it comes without the ability to book new reserves, which are so critical to the valuations of oil companies.

The implication for oil prices will depend on many other factors, but the steady growth of Iraq's oil production from the current 2.5 million bbl/day to a level commensurate with the country's reported 115 billion bbls of reserves could at least compensate for some large declines elsewhere and help maintain a reasonable cushion of spare production capacity as the global economy gets back on track. This hardly bodes a return to $20 oil prices--an eventuality that would be much less welcome in the carbon-constrained world we're entering than just a few years ago--but it could buy us enough time for fuel efficiency and vehicle electrification to match Peak Demand to an inevitable peak in global production.

"Carbon Debt"

2009-11-04T13:17:00.002-05:00

A new term has entered our lexicon without much fanfare, but that is about to change. When the Conference of the Parties to the UN Framework Convention on Climate Change (UNFCCC) meets next month in Copenhagen, we will hear a lot more about "carbon debt" and the obligation that developing countries believe the developed world owes them for having used the atmosphere as a sink for CO2 and other gases since the Industrial Revolution. From my perspective, this approach looks counterproductive and risks scuttling the principal process for coordinating the actions of independent nations in addressing the most global of problems. The issues of international and inter-generational environmental equity raised by the accumulation of greenhouse gases (GHGs) are serious and complex, but framing them in this way will make it much harder to find acceptable middle ground, unless the delegations show restraint and common sense about how far to reach back into history to assess blame for a warming earth.

It was always going to be tricky reconciling the competing interests of the developed and developing worlds sufficiently to craft a new global climate agreement to replace the expiring Kyoto Protocol. In addition to large differences in per-capita wealth and income, many of the main players fall into one of two key categories: countries with large historical and current emissions of GHGs that are now moderating or even decreasing, and countries with relatively much smaller historical emissions but large and/or rapidly-growing current emissions. The nature of the cumulative climate impact of these GHGs makes that distinction a crucial one and the source of much rancorous debate. I've been thinking about the resulting issues of equity for some time, but I am extremely concerned by the turn that I see the negotiating process that started in Bali two years ago having taken.

The UNFCC doesn't make it easy to follow what's going on. Of all things it took a visit to a climate change skeptic's website to track down a reasonably current version of the negotiating draft that is being prepared for consideration in Copenhagen. That enabled me to locate the document on the UN site once I had its file name. Having scanned through it for references to carbon debt, I can see why they might have wanted to make it hard to find, since the principles embodied there are bound to strike most Americans as at least counter-intuitive. For starters, the notion of carbon debt is introduced early in the draft as a "guiding principle of the Convention", and described as, "historical responsibilities in greenhouse gas emissions and the related historical ecological debt generated by the cumulative greenhouse gas emissions since 1750 and the most recent scientific information." That word "debt" crops up many times in the document, with repeated references to the "emissions debt", "historical climate debt" and "adaptation debt" that developed countries "owe" to developing ones.

Lest you think that this is merely intended as an abstraction governing philosophical discussions of equity, the document makes it abundantly clear that this is about money and who shall pay whom. One of several examples in the text puts this in admirably concrete terms:

"Developed country Parties shall provide financial resources and transfer technology to developing country Parties to make full and effective repayment of climate debt, including adaptation debt, taking responsibility for their historical cumulative emissions and current high per capita emissions."

Unfortunately, as I noted in a lengthy posting on this topic a year-and-a-half ago, matters aren't nearly as clear-cut as this wording suggests. While the consequences of many decades' worth of emissions of CO2 and other long-lived GHGs certainly appear to be putting an unfair burden on developing countries, it would be equally unfair to the citizens of developed countries to tax them for emissions that occurred before the scientific consensus on global warming emerged in the last couple of decades. Arrhenius may have worked out that CO2 could warm the planet a century ago, but the relative importance of that effect amidst the many complex factors influencing the climate was anything but obvious then, and it is still not fully understood. It makes no more sense to burden modern Europeans and Americans for the emissions of our parents, grandparents, and great-to-the-nth grandparents going back 10 generations than it does to tax modern Chinese, Indians and Brazilians for the entire edifice of Western technology that has enabled their present and future development.

We are all in this together, and the only emissions we have control over are those that occur from here on out. Having said that, it's clear that without some recognition that developing countries didn't create this problem--no matter how much they might be contributing to it now--there will be no deal in Copenhagen. The only viable middle ground I see, if not from the standpoint of the inter-governmental delegations, then for the citizenry they represent, would be to recognize the disparities in historical emissions but impose an effective statute of limitations on them. No emissions prior to the establishment of the Framework Convention on Climate Change at the Second Earth Summit at Rio de Janeiro in 1992 should be counted for purposes of allocating emission targets or financial assistance. While such a compromise would greatly diminish the imputed carbon debt of the developed world and allocate a bigger portion of it to large developing countries like China and Indonesia--particularly when changes in forestry and land-use are factored in--it would hardly let the rich world off the hook. The countries of the OECD have collectively emitted on the order of 200 billion tons of CO2-equivalent GHGs since then--roughly half the world's total emissions in that interval.

It would be tragic if the Copenhagen climate conference could only arrive at a new global agreement on emissions by relying on a principle that American voters would ultimately find as unacceptable as the allocation of national emission-reduction targets in the Kyoto Protocol. It is challenging enough for our elected representatives to attempt to match federal tax revenues to our existing obligations, foreign and domestic. I can't imagine any President or Congress wanting to explain to the electorate--particularly with so many of them already exercised over growing deficits and the current tax burden--why they must pay higher taxes to send carbon-debt payments to some of the same countries that are competing for our jobs and industries, on the basis that previous generations of Americans put more CO2 into the atmosphere than past generations of Chinese, Indians and Brazilians. That sounds like political suicide to me.

A Clunkers Look-back

2009-11-02T14:19:00.000-05:00

Somehow I missed last week's minor tempest concerning this summer's Cash for Clunkers program (CFC.) It apparently started when auto industry publisher Edmunds, Inc. issued a report indicating that the effective cost to the government of the incremental sales stimulated by the program averaged roughly $24,000, rather than the $4,000 or so per car that participating buyers actually received. That's based on Edmunds' estimate of the sales they conclude would have occurred in the absence of CFC, shrinking its net contribution from 690,000 vehicles to only 125,000. This prompted a snarky response from the White House, questioning not only Edmunds' analysis but also their motives and basic competence, leading to a polite-but-firm rejoinder from Edmunds. Having expressed support for the CFC concept and its reported results in previous postings, I can't resist adding my own two cents on this affair.

Let's start with a basic fact: No matter how rigorously Edmunds or the federal government analyzes car sales data for this year, the number of cars that would have been sold during the months in question without the clunkers program is inherently unknowable, just as it is inherently unknowable how many jobs have been "saved" to date by the total stimulus program, of which CFC was only one small, belated aspect. This dispute hinges on differences of opinion and underlying assumptions, and the statistical projections of both sides must be taken with a grain of salt. However, any notion that it is somehow out of bounds to look back on the outcomes of such a program to assess its effectiveness should be rejected forcefully. Project look-backs, or post-completion reviews, are among the best tools that corporations have to learn from mistakes and improve future performance. These techniques are no less appropriate in the public sphere, particularly when the government is undertaking so many initiatives that would ordinarily be left to the private sector.

It's important to frame any look-back analysis with a clear understanding of what the project in question was intended to achieve. In this case, CFC was meant to boost car sales and consumer confidence at a time when both were at extraordinarily low levels. It was also aimed at improving the fuel economy of the US car fleet by retiring some of the least-efficient vehicles on the road. Judging it on the cost-effectiveness of the incremental sales it generated reflects a subtle but significant distinction in interpreting those goals, though as a taxpayer I'm certainly interested in knowing how CFC measured up against that criterion. Still, on the basic question of increasing sales, even the data presented by Edmunds are unambiguous.

Looking at the monthly car sales figures included in Edmunds' report, it is clear that US new-car sales jumped from a depressed annual rate of around 10 million units pre-Clunkers--a level too low to sustain the North American car manufacturing capacity now in place--to over 14 million, approaching the typical pre-recession sales for the industry. After the program ended, sales fell back to around the 10 million mark. Although CFC hardly restored the industry to good health, it provided the expected temporary boost in sales at a time when the recent bankruptcy filings of GM and Chrysler had raised new uncertainties for consumers. The fuel economy uplift on the average transaction was also significant, though as I mentioned at the time this amounted to a very small change in the overall fuel economy of a vehicle fleet numbering around 240 million cars and light trucks. So while CFC in retrospect looks to have been a very expensive way to help the industry sell more cars, its performance against the metrics most relevant to its conception stacks up pretty much as advertised.

The larger question raised by the Edmunds analysis concerns the degree to which the government can compensate for weak economic conditions in the private sector, and how expensive the incremental contribution of such efforts can prove, compared to the natural recuperative powers of the economy. Their assessment might also have implications for how we should evaluate the ongoing incentives for advanced technology vehicles. In that light, I have to wonder how much of the heat generated by this episode is instinctive bridling at perceived Monday morning quarterbacking, and how much relates to its potential to undermine the case for a second stimulus that is building in some quarters.

Counting All the Carbon

2009-10-29T15:12:00.002-04:00

An editorial in this morning's Wall St. Journal reminded me that I had intended to update my readers on the latest installment in the ongoing saga concerning the global land-use impact of biofuels. The Journal's comments referred to a paper in the latest issue of Science entitled, "Fixing a Critical Climate Accounting Error", which concludes that the manner in which the greenhouse gas impacts of biofuels are currently assessed fails to account for significant emissions that occur outside the envelope normally drawn around an ethanol or biodiesel plant and the farms that supply it with feedstock. And if that omission weren't glaring enough, in the course of preparing for a meeting tomorrow I ran across another instance in which regulators appear to be turning a blind eye to the full impact of another popular option for addressing climate change, electric vehicles. As we prepare to re-orient our entire economy around the restrictions embodied in pending climate legislation, it is essential that we account for all of the emissions involved in a consistent way, and on a scale matching the global environmental problem we're trying to solve. This is crucial to making real progress on reducing emissions, rather than just making us all feel good about what we are doing.

When the emailed table of contents for the October 23 issue of Science showed up in my inbox last Friday, I spotted the name of Timothy Searchinger of Princeton University as lead author of the paper cited by the Journal today. Dr. Searchinger was also the lead author of an earlier paper in Science that I highlighted last February, when the debate concerning the global land-use implications of corn ethanol was just getting underway. Dr. Searchinger's collaborators on the new paper are an impressive bunch, including Dr. Dan Kammen, the director of the Renewable and Appropriate Energy Laboratory at U.C. Berkeley.

The report provides further evidence that it's no longer appropriate to assume that just because the carbon embodied in biofuels such as ethanol originated in green plants that absorbed it from the atmosphere, they must therefore be "carbon neutral"--other than the emissions from fossil fuels used in the cultivation, harvesting and transportation of the crops from which they are produced, along with the energy used in their processing. Additional emissions apparently result from the global displacement of the crops turned into energy here, and in some cases those emissions are on a similar order of magnitude to the direct emissions from the combustion of the biofuels--combustion that has gotten a free pass until now.

This is a highly inconvenient result for those engaged in the production of biofuels from food crops, on two levels. First, it puts the climate change justification for the subsidies and mandates responsible for the rapid ramp-up of conventional biofuel production in question. Second, the source of this doubt is no less than one of the same scientific journals in which so much of the peer-reviewed science contributing to the oft-cited scientific consensus on climate change has appeared, and subject to the same level of scientific scrutiny. Casting doubt on the source of this unwelcome message thus risks casting doubt on the entire edifice upon which the current, much-expanded biofuel endeavor rests.

Let's be clear that I don't blame the biofuel industry for promoting a product that many thought would help, but may ultimately turn out to do little or nothing to reduce the greenhouse gas emissions implicated in climate change, any more than we should blame the producers and consumers of fossil fuels for their contribution to the accumulation of those gases before the current consensus on climate change emerged. (I confess that I regard attempts to portray that consensus as having existed as long as 40 years ago as the worst kind of revisionism, since the creation of the consensus depended not on a few key insights, which might have turned out to be wrong, but on mounting evidence from the steady accumulation of peer-reviewed research during that interval.)

Having said that, I have a much harder time understanding the inclusion of an equally serious--and apparently entirely conscious--omission in the new automotive fuel economy and emissions standards jointly developed by the Environmental Protection Agency and the Department of Transportation. I had occasion to browse through the agencies' proposed text (warning: large file) yesterday and was startled to see that for purposes of calculating carmakers' fleet CO2 emission averages, it assumes that electric vehicles (EVs) and the electric usage of plug-in hybrids (PHEVs) have zero lifecycle emissions. Not only that, but the proposed regulation would count each EV as if it replaced two other emitting cars: thus, zero GHG impact not once but twice. Even the authors admit that this is false, and here I must quote,

"EPA recognizes that for each EV that is sold, in reality the total emissions off-set relative to the typical gasoline or diesel powered vehicle is not zero, as there is a corresponding increase in upstream CO2 emissions due to an increase in the requirements for electric utility generation. However, for the time frame of this proposed rule, EPA is also interested in promoting very advanced technologies such as EVs which offer the future promise of significant reductions in GHG emissions, in particular when coupled with a broader context which would include reductions from the electricity generation. For the California Paley 1 program, California assigned EVs a CO2 performance value of 130 g/mile, which was intended to represent the average CO2 emissions required to charge an EV using representative CO2 values for the California electric utility grid."

But while I appreciate the agencies' rationalization that EVs and PHEVs might be counted as having zero emissions on a purely temporary basis in order to provide incentives for carmakers to accelerate their introduction, I'm also painfully aware that other such "temporary" measures have persisted long after the original justification for them had become obsolete--and here I can't help but think of the ethanol blending credit that is now in its 31st year.

Why do these loopholes in the way we tally greenhouse gas emissions matter enough for me to hammer away at them like this? Consider the proposed vehicle rules. By ignoring emissions that occur outside these vehicles, the government is discouraging carmakers from using less exotic technologies that might actually deliver comparable savings of fuel and emissions sooner, and at a lower cost to taxpayers and consumers. A conventional Toyota Prius hybrid running on gasoline emits only 10% more grams of CO2 per mile than California claims for an EV powered by its greener-than-average state electricity mix. Since the same number of batteries could equip many more Prius-type hybrids, at a much lower cost per car than for a full EV, the benefits of rushing EVs into production seem much less compelling at this point, particularly when the government is also subsidizing the purchasers of EVs and PHEVs to the tune of many thousands of dollars per car. That will amount to billions of dollars of extra subsidies for an incremental emissions benefit that might just be negative for an EV recharged using coal-fired power.

"Start as you mean to go on," goes the old saying. We know that whatever their energy security benefits and general hi-tech niftiness, EVs are not zero-emission vehicles, just as we now understand that it is likely that burning corn ethanol releases roughly the same level of greenhouse gases as the gasoline it is intended to replace. If cap & trade bills such as Waxman-Markey and Kerry-Boxer are to have any integrity as tools for achieving genuine reductions in the global greenhouse gas emissions behind global climate change, then we must count all the emissions from all sources, no matter how politically unpalatable that may be. EPA and DOT might do well to heed this advice, too, before establishing a new, impossible-to-revoke entitlement for the manufacturers of electric vehicles.

Missing the Point on Energy and Jobs

2009-10-27T11:19:00.002-04:00

Two emails I received yesterday delivered press releases from two organizations with very different agendas, both emphasizing the impact of energy on jobs. With US unemployment showing little response to the economic stimulus, the rebounding stock market, or the "green shoots" appearing in some sectors, it's understandable that companies, groups and even the government would want to play up the direct employment impact of key initiatives or policies. Yet when it comes to energy, I believe much of this effort misses the mark. Our employment goal for energy should not be to have as many people working in the energy sector as we can, but to have the most efficient and cost-effective energy sector possible, in order to promote job creation and retention in the rest of the economy, where the vast majority of jobs are found. Our decisions about energy policy should not depend on the creation of a few green jobs.

I'm hardly suggesting that energy jobs are insignificant or inconsequential. I've spent my entire career in energy, and I recommend it without hesitation as a field in which one's contributions can have a measurable impact on society, often with better remuneration than in many other pursuits. The Oil & Natural Gas Industry Labor-Management Committee isn't wrong to stand up for the millions of industry-related jobs at stake in the current Congressional debate on energy industry tax benefits, any more than Wind Capital Group is to highlight the 2,500 jobs associated with the supply-chain effects of their Lost Creek Wind Project. But as important as preserving or expanding energy-related jobs appears today, it is even more essential for the long-term interests of the country that we not obsess about this one aspect of energy, to the detriment of others that will affect overall US employment and international competitiveness long after the unemployment rate has returned to its normal range.

Putting this into perspective requires recalling that by its nature energy is a capital-intensive business, rather than a labor-intensive one. One way to gauge that is to look at the labor productivity of energy companies. The latest annual report of my former employer, Chevron, reveals that on average in 2008 its 61,675 employees each accounted for $4.3 million of revenue, resulting in nearly $700,000 of pre-tax net income (after covering their own salaries and all other expenses.) In the utility sector, the comparable figures for FPL Group were $1.1 million and $137,000, respectively. Even a small, rapidly-growing renewable technology firm such as First Solar enjoyed revenue and pre-tax profit per employee in 2008 of approximately $354,000 and $132,000, respectively. With its high labor productivity, the primary employment impact of energy occurs where it is consumed, not where it's produced, because energy is such a crucial input for so many sectors and the sine qua non of more than a few.

When legislation like the Kerry-Boxer climate bill, which includes many provisions that would make energy more expensive for consumers and businesses, is marketed as a jobs bill it merits a skeptical reception. Stimulating jobs in the 6-10% of the economy devoted to energy seems unlikely to compensate for the loss of jobs that would ensue throughout the broader economy, if climate legislation caused energy costs to soar. That may, however, be a necessary evil, and the question we should really be asking is not how many green jobs such legislation will create, but whether on balance its provisions are truly justified in order to address climate change--even if they resulted in a net loss of employment, as I strongly suspect they would. Unless the answer is an unequivocal yes, we could be setting our long-term energy policy on the basis of a metric that is only a minor contributor to either energy costs or total economic activity, for reasons that seem unlikely to stand the test of time.

Sequestration and Education

2009-10-23T13:45:00.001-04:00

Yesterday afternoon I began scrutinizing the Senate climate bill, S.1733, widely referred to as the Kerry-Boxer bill. Like the Waxman-Markey bill that the House passed in June, the scope of Kerry-Boxer goes far beyond the establishment of an economy-wide cap & trade system for reducing greenhouse gas emissions, though at a comparatively skimpy 821 pages it has yet to acquire as much baggage as its counterpart accreted on its way to a floor vote. I was struck by the emphasis both bills place on carbon capture and sequestration (CCS), not just as a technology that receives significant support, but as the only viable pathway offered for new coal-fired power generation. However, as I looked through the provisions relating to permitting of sequestration sites and the innocuous-sounding section 812, "Performance Standards for New Coal-Fired Power Plants", I spotted a significant omission. There's nothing here to address what might constitute the largest non-technical barrier to implementing CCS. Public acceptance of it entails a significant educational effort on the efficacy and safety of this new technology. That will require going beyond the details of CCS to provide Americans a primer on basic geology.

The stakes are high. Despite recently losing some market share to natural gas and renewables, coal-fired power plants make up the single largest source of electricity in the US by a wide margin. In the 12 months through July, coal accounted for 46% of US power generation, compared with just 3% for non-hydro renewable energy. Short of simply shutting down every coal-fired power plant and leaving a gaping hole in our national electricity supply that the current generation of renewables can't yet fill, we need to find a way to control the emissions from coal directly. That's where CCS comes in. The coal power performance standards in Waxman-Markey and Kerry-Boxer would require that by no later than 2027 any new coal-fired power plants licensed after 1/1/09 must cut their net CO2 emissions by at least half. CCS looks like the only practical way of doing that--if you can call something that has been deployed so sparingly practical. But how can CCS be implemented if the public isn't willing to have CO2 stored underground anywhere?

CCS is new, but it's not so new that it hasn't already attracted pushback. Earlier this year Shell encountered significant opposition to injecting CO2 into a depleted gas field in the Netherlands. Meanwhile Vatenfall's project at Schwarze Pumpe in Germany is apparently venting its captured CO2 to the atmosphere, because the firm can't get a permit to inject it. "Not in My Ground", is how another article described opposition to carbon sequestration at an Ohio ethanol plant. My Google search even turned up a blog entitled, "Citizens Against CO2 Sequestration." Aside from the technical challenges associated with separating, transporting and injecting CO2 into geological storage sites, do these opponents have a scientific basis for being concerned about the health and safety risks? Perhaps, though an article on the subject cited by the Citizens Against blog that refers to the health hazards of drinking water mixed with CO2 had me rolling my eyes. Perhaps the author was unaware that hundreds of millions of us do that every day; we call it soda pop, and it's a big business.

Rather than dismissing all this as a simple case of uninformed NIMBYism (or as the Guardian newspaper in the UK referred to it, "numbyism", as in not under my back yard) I suspect it reflects a fundamental gap in the public's understanding of what lies beneath its feet. I simply cannot count the number of people I've encountered in the course of my long career in energy who were under the impression that oil was found as pools in giant underground caverns, rather than contained within tiny pores in solid rock strata. If most people so badly misunderstand the geological basis of a technology as established and commonplace as oil & gas drilling, how on earth can we expect them to have a coherent picture of what happens to CO2 when we pump it underground? Of course they're going to fear it could all come right back out and possibly asphyxiate them, in the manner of the volcanic CO2 seepage at Lake Nyos in Cameroon and elsewhere.

From my own perspective, the existence of enormous natural gas reservoirs--confusing terminology, perhaps--constitutes a sufficient proof of concept by demonstrating that gases can be stored safely underground for intervals as long as millions of years. If impermeable cap rock can seal in billions or trillions of cubic feet of methane, the molecular diameter of which is smaller than that of CO2, then once the CO2 is down there, the vast majority of it is going to stay there. But just as telling people that a flu vaccine is safe apparently leaves large numbers of them unconvinced, I conclude we need to invest a fair amount of time, attention and resources into educating the public about the science and safety of injecting CO2 under the ground, before we can base our national energy strategy on this technique.

The Weak Dollar

2009-10-21T12:45:00.001-04:00

Oil prices have trended upward recently, spurring renewed speculation that only speculation could account for such a shift in the face of relatively weak fundamentals of supply and demand. It's certainly true that inventories of crude oil and refined products remain high, while demand is still well below the levels of just a couple of years ago, and OPEC is sitting on millions of barrels per day of spare capacity that could be deployed quickly if consumption spiked. But although it can't account for 100% of recent price movements, one factor stands out for its contribution to oil's lurch towards $80 per barrel after months of stability around $70: the further weakening of the US dollar relative to the Euro and other strong currencies. The future path of the dollar will be determined by a complex set of factors, including the relationship between US and other nations' interest rates, trade balances, current inflation, and expectations of future inflation. However, it's worth noting that the dollar's recent deterioration is hardly anomalous; it is part of pattern going back decades.

The above chart displays the price of West Texas Intermediate crude oil on the New York Mercantile Exchange since the beginning of August. I've added another line showing the same price in Euros, based on exchange rate data for the period. It's pretty clear that although oil priced in Euros has also been trending upward slightly, perhaps in response to reports that the global demand for other commodities is picking up--indicating that at least some parts of the world are recovering from the Great Recession--the recent upswing in oil prices looks much more muted than when expressed in dollars per barrel. That got me thinking about the long-term exchange rate trends, and where they might take us in the years ahead.

Having lived overseas and traveled extensively, I've been aware of exchange rates for most of my life. That's given me a clear perspective that the dollar isn't just weaker now than it was a few months ago or a couple of years ago, but has been deteriorating more-or-less steadily for a very long time. From my childhood I can recall when a dollar was worth roughly four Deutschmarks, and even my father's salary as a junior Army officer went pretty far on the local economy. As an adult I worked in Germany for a few months in the early 1980s, when a buck still bought more than 2 Marks. With the Deutschmark having been subsumed into the Euro, with its extremely short and volatile history, it's easy to lose sight of the dollar's gradual slippage, which has resulted in an equivalent Deutschmark/Dollar rate today of 1.30:1. Fully appreciating this trend requires examining the longer history of exchange rates between the dollar and more stable currencies such as the Deutschmark and the Swiss Franc, which is now trading at virtual parity with the greenback. It's not a pretty picture, and it has significant implications for a country with such large structural import requirements, not just for energy, but for so many other products.

While I'm not advocating a return to the gold standard or even necessarily dismissing the benefits that a weaker dollar has provided at times, I find the long and bumpy, but nevertheless steadily-downward slope of the dollar's value worrisome. Moreover, it's hard to see what could stem this trend in the near term, with the federal government committed out of necessity to holding short-term interest rates at essentially zero to avoid putting the economy back into a tailspin, while other countries still offer positive interest rates and some have even raised them slightly. Nor do trillion-dollar fiscal deficits seem conducive to a stronger dollar any time soon. What would dollar-denominated oil prices do if the dollar continued to fall past $1.50 per Euro toward the 2:1 level, all other things being equal? $100/bbl probably isn't a bad guess, along with everything else that goes with it.

"Feeding Frenzy"

2009-10-19T11:36:00.002-04:00

An article in today's New York Times offers more detail on the manner in which Congressional climate legislation has fractured the energy industry into competing groups of haves and have-nots, based on how companies and sectors were treated under the Waxman-Markey bill and their hopes for receiving a better deal in the pending Kerry-Boxer bill in the Senate. Not only has it fragmented utilities along the axis of their emissions intensity, but it has also opened gaps within the oil & gas industry between companies that produce primarily natural gas and those that produce or process mainly oil. I don't know whether the authors of Waxman-Markey saw this potential in their design for allocating emission allowances, though some supporters are bound to see it as a beneficial feature. I regard it as a worrying symptom of the distortions inflicted on the basic concept of cap & trade, which remains the best option for guiding the economy toward a lower-emission future, but now seems likely to underperform its potential in a very costly way, as a result of these flaws.

As recently as a couple of years ago, few energy companies were enthusiastic about the prospect of cap & trade, because it was bound to raise their costs and reduce demand for their output, at least from energy sources with substantial emissions of CO2 and other greenhouse gases. If the bill passed by the House had treated all emissions from all sectors equally--a level playing field--we'd still see visionary companies diverging from the industry's stance, but their numbers would probably be a lot fewer for the simple reason that there wouldn't be nearly as much financial gain in it for them. When no-nonsense companies like Exelon and several of its utility peers break ranks with the US Chamber of Commerce on this issue, it's a good bet that they see a direct strategic advantage that will put money in their shareholders' pockets. Simply put, this is as good a deal as they're going to get. But while I find their support of cap and trade perfectly rational and even laudable, it should by no means be read as a sign that the Waxman-Markey approach is the best means of addressing climate change.

As I've noted in previous postings, Waxman-Markey was excessively generous in handing out emission allowances to the electricity sector, at the expense of the transportation sector. It also lavished allowances on non-emitting sectors and favored causes and groups in lieu of cash--a form of largess that fundamentally undermines the accountability of these benefits, because no one knows or can know what they will be worth when they are eventually received. Yet although this is bad policy on many levels, I see many people holding their noses and supporting the W-M approach, because they conclude that once the free allocations have phased out in 2030, we'll be left with a more or less pure cap & trade system enforcing a steadily tightening cap on emissions. The problems with this thinking lie in the enormous distortions and unnecessary economic hardship those uneven allocations will create over the next 20-plus years and the opportunity cost of the emissions reductions that could have been achieved more quickly and cheaply.

My strong preference has been for an even-handed cap & trade system that would include the broadest possible collection of emissions sources, providing great diversity of abatement costs and thus great scope for emissions trading to minimize the cost of achieving our emission reduction goals, and with most of the proceeds rebated directly from the government to taxpayers. Unfortunately, the ship has sailed on that approach--at least for now--and anyone supporting cap & trade for the elegant simplicity of its mechanism for squeezing out emissions is left hoping that the legislative excesses of one chamber of Congress will cancel out those of the other, and that somehow two bad bills will beget a good one.

Regulating EV Recharging

2009-10-15T13:58:00.000-04:00

A feature on the New York Times website tipped me off to a debate that's brewing in California concerning whether and how the state's Public Utilities Commission (PUC) should regulate facilities and firms that will recharge the electric vehicles expected to dot California's roads within a few years. From my own experience in attempting to involve my former employer in the recharging infrastructure for the old GM EV-1 in the late 1990s, I knew this wouldn't be a simple matter, but I had little appreciation for the complexities that have emerged in the last decade. How this gets resolved will have enormous implications for automakers and incumbent utilities, as well as for start-ups such as Better Place that some would like to treat as regulated utilities.

The discussion with the PUC hinges on some very thorny questions: Is a company that buys electricity for resale to consumers for the purpose of recharging electric vehicles--which takes in both battery-electric vehicles and plug-in hybrids--more like a utility or a gasoline distributor or retailer? Who should pay for installing recharging facilities, and how--and from whom--should these parties recover their investment? Should a consumer who already uses large quantities of electricity at home and pays at the top rate tier, which can hit $0.40/kWh in some areas, qualify for discounted power to recharge an EV? How should a customer be billed when recharging outside the service area of the utility from which he normally buys power? The list of such questions is long, and looming behind them are larger questions about how best to gauge the effect of EV recharging on greenhouse gas emissions and air quality concerns, and to manage its impact on the regional generating mix, and on grid stability and reliability. Many EV advocates assume that EVs are inherently grid-stabilizing and renewable power-enabling, though it's not hard to construct scenarios in which the opposite could be equally true, if they're not implemented properly.

The emissions aspect becomes even more interesting in light of the views I saw expressed in a PUC filing by Tesla Motors, Inc., a Silicon Valley manufacturer of high-end electric sports cars that recently qualified for a half-billion dollars in low-interest expansion loans from the federal government. Tesla sees the generation of tradable credits under either cap & trade or the state's Low-Carbon Fuel Standard as a significant source of revenue for the owners of EV recharging facilities, and they might be right, though when I converted the federal estimates of emission allowance values under Waxman-Markey of around $15/ton of CO2 to cents per kilowatt-hour, using California's natural gas-dominated average generating mix, I came up with a value of less than a penny per kWh. I have to wonder how excited utilities will be to take on the cost and risk of putting in EV rechargers for such a small reward, if they can't also make a profit selling power to EV drivers.

The whole notion of regulating resellers of electricity to EVs as utilities also raises serious questions about the alternative business models now under consideration by companies such as Better Place. Would offering EV services on a cents-per-mile basis, rather than cents per kWh, be deemed sufficiently transparent, and would they have to negotiate their profit margins and investment recovery with the PUC? That sounds like a great way to make it harder for anyone new to the scene to compete with traditional utilities in this area.

Fairly soon the California PUC will resolve most of these questions and in the process largely define the environment in which EVs will emerge in the biggest early market for them in the US, potentially setting the standards for their use throughout the US and beyond. I don't have a horse in this race, but I will be watching the outcome with great interest.

The Necessity of "All of the Above"

2009-10-13T12:19:00.000-04:00

I've devoted a lot of space in this blog to explaining why we need all of the energy choices currently available to us, including energy efficiency, in order for our economy to have the energy it needs to grow. Although we can't drill our way to energy independence, as some might wish, it's equally clear that the point at which renewable energy sources could enable us to dispense with fossil fuels is still a long ways off. I have no idea how many words I've written in service of this argument, but it's certainly many more than the clichéd 1,000:1 exchange rate vs. the picture that I suddenly realized I've never supplied. Today's posting is a modest attempt to rectify that omission: a simple graph showing how a significant shift in our energy consumption and production patterns might play out between now and 2020.

This picture starts with our total primary energy consumption in 2008 of 99.3 quadrillion BTUs (quads.) Nearly three-fourths of our needs, or 73.7 quads, were produced domestically by a mix of 79% coal, oil and natural gas, 11.5% nuclear power, and a bit over 3% hydropower. Non-hydro renewables--the wind, solar, geothermal and biomass power plus biofuels that constitute the primary focus of US energy policy today--made up the remaining 6.5% of domestic energy production. Now add the 26% of US energy consumption supplied by imports, mainly crude oil and petroleum products, and we have the breakdown shown at the left hand edge of the graph. The rest of the picture is the result of a highly simplified set of assumptions based on phasing out fossil fuels and replacing them with the non-hydro renewables that have been growing so rapidly. It ignores such important considerations as reliability and intermittency, compatibility with infrastructure, and turnover of vehicle fleets.

According to the Energy Information Agency's data, while wind and solar power have been growing at roughly 30% per year each, the total renewables category has been growing at a somewhat slower pace, even after separating out hydropower, which has actually declined significantly since the 1990s. While the average growth rate for all the non-hydro renewables since 2000 has been around 4%, I've more than doubled this for the purposes of my projection to 10%. Renewables would do very well to sustain that kind of pace over the next 11 years, because the bigger they get, the more capital they will require each year to add the next year's increment of growth, and the more hurdles they will face, particularly from NIMBY or "energy sprawl" concerns. 10% compound growth would see these renewables more than triple by 2020, providing plenty of room for biomass/biofuels to double and for wind and solar to double several successive times.

I've also assumed a steady improvement in energy efficiency of 1% per year. If that doesn't sound impressive, compare it against a pre-recession trend of 1% annual growth supporting population growth of around 0.7% and economic growth of 2-3%. 1%/yr. would reduce total energy consumption by almost 12% by 2020, reflecting an improvement in BTUs/$GDP over this interval on the order of around 35%. A recent study by McKinsey & Co. indicated that if the US invested $500 billion in energy efficiency, we could cut our energy consumption by 23% by 2020, so my view is only a little more conservative, reflecting my experience that such things tend to take a bit longer than we expect.

As for nuclear, I think we'll do well to maintain the output of the existing fleet without seeing retirements outweigh additions in this timeframe. Most of the new plants now being discussed would probably only affect the last couple of years of this scenario, in any case.

The biggest impact in the graph above comes from my assumption that domestic fossil fuel production would fall by 5% per year. That will probably seem extreme to some and timid to others. It certainly looks extreme in the context of the recent surge in natural gas production and the stable output of US coal mines. Even US oil production has staged a bit of a comeback recently, thanks to successes in the portions of the Gulf of Mexico where drilling is allowed. However, in the absence of strong sustained rates of oil and gas drilling--drilling that requires both access to resources and a supportive regulatory climate, neither of which appears to be forthcoming--these successes will fade and the high intrinsic decline rates of the mature US hydrocarbon basins would take over. And with new coal-fired power plants being canceled and older ones facing tough competition from gas turbines and renewable power, along with restrictions on practices such as "mountaintop mining" and the prospect of either a Congressionally-mandated or EPA-imposed cap on emissions, a decline in coal output would accompany drops in oil and gas.

All of these growth and decline rates working together produce the picture above, showing fossil fuels tailing off faster than renewables can backfill for some time. That results in net US energy imports growing through 2016, then tapering off gradually as renewables finally gather momentum, but with us arriving at 2020 even less energy independent than we are today. That outcome explains my strong conviction that it is premature for us to give up on the valuable contribution of domestic oil and gas, particularly when we take into account the form that most of those growing energy imports is likely to take: imported oil. Naturally, this is just one scenario among many--though I'd argue it's likelier than some--and it illustrates that no single solution, neither renewables, nor efficiency, nor even greatly expanded drilling, is likely to be capable of delivering the energy we will need without increasing our vulnerability to foreign energy suppliers. They must all work together, if we're to make meaningful progress toward greater energy self-reliance.

Meme Watch: Peak Demand

2009-10-09T11:20:00.000-04:00

To whatever degree the oil price spike of 2007-8 was driven by speculation, the latter was riding on a wave of concern about Peak Oil, which anticipates an imminent decline in maximum global oil production. For the moment, the weak global economy has eased such worries, though they have hardly vanished, as I noted two months ago. Lately, however, conventional notions of Peak Oil are increasingly being challenged by a new meme, or contagious idea, called Peak Demand, which suggests that oil consumption is reaching a plateau from which it will soon decline, mitigating the worst consequences of Peak Oil. Neither of these memes would attract much interest if they weren't supported by a welter of statistics, however selective those might seem to their critics. And just as Peak Oil was much less credible and worrisome before we saw super-giant oil fields like Mexico's Cantarell go into precipitous decline, the logic of Peak Demand would have been much less compelling before US oil demand dropped by nearly 6% last year.

Earlier this week, a friend shared a copy of a report from Deutsche Bank Global Markets Research describing their view of the future oil market shaped by coinciding--and related--peaks in global oil supply and demand. Unfortunately, the report doesn't seem to be available on DB's public website, though it was recently summarized on the Wall St. Journal's Environmental Capital blog. While I spotted several possible weak points in their analysis, they make a strong case that the combination of improved efficiency and the electrification of vehicles will result in the global demand for oil stalling and eventually falling, roughly around the same time many analysts expect global oil supplies to peak.

Perhaps I was predisposed to accept this logic. My presentation on the Alternative Energy panel of the recent IHS Herold Pacesetters Energy Conference included a graph highlighting the ongoing compression of US petroleum gasoline demand between falling motor fuel consumption and rising biofuels supplies, a topic that was subsequently reported in the Journal's "Heard on the Street" column. At that same conference I also heard the Managing Director of CERA's Global Oil Group describe his firm's rigorously researched view of an impending peak in global oil demand. Peak Demand can't easily be dismissed as a "fringe" theory, because it is based on a combination of hard data and thoughtful analysis and forecasting.

My purpose in mentioning Peak Demand now isn't to debate its merits in depth; that's a matter for another day. Rather, on the basis of my conviction that there's at least a reasonable case for such an outcome, I thought I'd spend a moment musing on the consequences of the proliferation of this meme in the marketplace of ideas related to energy. After all, the Peak Demand meme challenges two key pieces of conventional wisdom about oil, one or both of which are central to the rate at which Peak Oil (supply) might be approaching. First, it undermines the notion that once the US economy finds its way back to meaningful growth, oil demand will resume its former trajectory, which had seen gasoline demand growing by 1-2% per year and diesel demand growing at an even faster pace. With a major new emphasis on miles per gallon and the demise of the SUV fad, the fuel economy of the total US car fleet doesn't need to improve by very much each year to outpace our underlying population growth and a modest resurgence in vehicle miles traveled. Secondly, the same dynamic might even hold true for large developing markets, if electric vehicle demand grew rapidly enough, undermining the notion that whatever happens in the US and EU, oil demand from China and India constitute an unstoppable juggernaut.

With spare global oil production capacity effectively used up by 2007, the logic of Peak Oil helped to provide the narrative support for an oil market that ran up from the low $50s to $145 per barrel in the course of 18 months. How different might a future oil price spike be, if instead of a widely-shared view that oil was on the verge of becoming truly scarce--rather than merely expensive--there were an equally widely-held expectation that in the long run that scarcity might become irrelevant as a result of the demand for the commodity gradually unwinding of its own accord? Such dueling memes, together with painful memories of oil's collapse down to $33 last winter, might give some traders pause, before again buying into the notion that $100 oil would soon give way to $200, $300, or $500 per barrel.

Setting Ethanol Free

2009-10-07T13:36:00.003-04:00

The Government Accountability Office (GAO) recently issued its report assessing the impact of the production and use of biofuels in the US. Among its recommendations was a call for the Congress to reassess whether corn ethanol still needs the support of a $0.45 per gallon blenders' credit, when its use by refiners and gasoline blenders is now mandated under the federal Renewable Fuel Standard (RFS) that was set by the Energy Independence and Security Act of 2007 (EISA). As you might imagine, this has set the cat among the pigeons and prompted a terse and dismissive response from the Renewable Fuels Association, the trade group representing the US ethanol industry. Along with several points that I interpret as making at least as good a case for dropping the subsidy as keeping it, their main defense boils down to a combination of historical precedent and envy of the industry that is its primary customer. Neither justification stands up to scrutiny.

Consider the historical argument first. There's no doubt that without the subsidies provided by the federal government and various states over the last thirty-plus years, the ethanol industry would not have grown to a sufficient scale to take on the new challenge set for it by Congress in the EISA. From the landmark establishment of a $0.40/gal. excise tax exemption for ethanol blended into gasoline under the Energy Tax Act of 1978, it took the industry 14 years to grow to the 1 billion-gallon-per-year (BGY) mark (equivalent to 43,000 barrels per day of gasoline) and another decade to reach 2 BGY. When EISA was passed at the end of 2007, the industry was already producing around 6 BGY and had built enough capacity to produce nearly 8 BGY, or around 5.5% of US gasoline demand that year, by volume. That was already more than the 7.5 BGY required under the previous RFS established by the Energy Policy Act of 2005. But as ambitious as the goals of the newly-enacted RFS seemed in 2007, the industry continued building capacity at a rapid pace, and by the start of this year had enough ethanol plants built or under construction to satisfy 97% of the 15 billion gallon target (and ceiling) that Congress set for corn ethanol.

Two things seem clear from this history: First, the combination of a generous blenders' credit, which until the start of this year paid $0.51/gal., and two successive federal biofuel standards led to over-expansion of the ethanol industry relative to demand, either mandated or economic. That harmed the industry and led to many ethanol plants being sold or mothballed in the last year, with a number of ethanol companies going bankrupt, including VeraSun, which had been an industry leader not long before its demise. Other important factors certainly contributed to these business failures, including the spike in corn and oil prices in 2007 and 2008 and the sudden collapse of the latter last fall; however, the over-extension of these companies as they went deeper and deeper into debt to build new capacity left them particularly vulnerable to volatile commodity markets and the emerging credit crisis.

In addition, the above figures make it very plain that the US corn ethanol industry doesn't need to grow further, because it is already within striking distance of the target set by the government, which also appears to represent the maximum prudent level of output for a fuel source that makes such heavy use of water and fossil energy sources in its production, and that ultimately competes with the consumption of corn as food or feed, here and abroad. In other words, the work of the subsidies and mandates for corn ethanol is complete, and the government has shifted its focus to cellulosic ethanol and other advanced biofuels, which enjoy their own distinct--and more generous--subsidies. It hopes these sources will expand from essentially zero to cover the remaining 21 BGY of the current RFS by 2022.

The argument that corn ethanol is somehow entitled to perpetual subsidies on the basis of an inaccurate comparison to the tax benefits currently enjoyed by the oil & gas industry--tax benefits that are currently under threat, themselves--is equally unpersuasive. In the posting in which I recently examined the Treasury Department's arguments for dismantling those oil & gas tax benefits, I compared the level of incentives for conventional fuels with those provided to ethanol. That $0.45/gal. ethanol blenders' credit swells to the equivalent of about $0.77/gal. after accounting for the lower energy content of ethanol. That compares to incentives of around $0.12/gal. for US oil production. And that doesn't even take into consideration the fact that producing a gallon of ethanol requires much more energy from other sources, such as natural gas, than producing a gallon of crude oil or gasoline. Thus ethanol receives at least six times the subsidy per delivered BTU that domestic oil does, even though their energy security benefits per gallon are identical.

The GAO report estimates the cost to the Treasury of the ethanol blenders' credit at $4 billion last year, growing to $6.75 billion by 2015, if not sooner. Although at a time of trillion-dollar deficits that may look no more significant than a rounding error in the government's books, continuing this outdated and unnecessary incentive sends a bad message to the developers of other, less mature alternative energy sources. It tells them that they don't need to worry so much about making their technologies competitive with conventional energy, because the government is likely to subsidize them until the end of time--or until the Treasury runs out of money, a date that will surely arrive faster, the more unnecessary subsidies it hands out. After having been extended by last year's Farm Bill, the present Volumetric Ethanol Excise Tax Credit and the tariff on imported ethanol that mirrors it are due to expire at the end of next year. After 30 years of assistance--spanning my entire career in energy--it's time to find out whether this industry can survive and compete on its own.