VW Scandal Puts Diesel's Future at Risk

• If the VW scandal sours consumers on diesel cars, the potential winners and losers extend well beyond the auto industry.
• European refineries look especially vulnerable to such a shift, while US refiners, along with manufacturers of electric vehicles, stand to gain.

Whether or not Volkswagen's diesel deception proves to be "worse than Enron," as a Yale business school dean commented, it is more than just the business scandal du jour. Its repercussions could affect other carmakers, especially those headquartered in Europe. And if it triggered a large-scale shift by consumers away from diesel passenger cars, that would have major consequences for the global oil refining industry, oil and gas producers, and sales of electric and other low-emission cars.

The scale of the problem ensures that it will not blow over quickly. Nearly 500,000 VW diesel cars in the US were equipped with software to circumvent federal and state emissions testing, and the company has indicated that 11 million vehicles are affected, worldwide. Even if Volkswagen's retrofit plan passes muster with regulators in the US, Europe and Asia, the resulting recall could take years to complete.

It's also still unclear whether VW's diesel models are unique in polluting significantly more under real-world conditions than in laboratory testing. Regulators in Europe appear to suspect the problem is more widespread. Other companies use similar emission-control technologies--from the same vendors--to control the NOx and particulates from smaller cars equipped with diesel engines. The French government announced plans to subject 100 diesel cars chosen at random from consumers and rental fleets to more realistic testing.

VW faces investigations and lawsuits in multiple countries. While those are underway, the claims of every carmaker selling "clean diesels" and the reputation of a technology that European governments have bet on as a crucial tool for reducing CO2 emissions and oil imports are likely to be under a cloud. How consumers react to all this will determine the future, not only of diesel cars, but of the future global mix of transportation fuels and vehicle types.

Start with oil refining. As long ago as the early 1990s, when I traded petroleum products in London, the European shift to diesel was creating a regional surplus of motor gasoline and a growing deficit of diesel fuel, or "gasoil" as it is often called outside North America. Initially, trade was the solution: The US was importing increasing volumes of gasoline to meet growing demand and had diesel to spare. The fuel imbalances of the US and EU were well-matched, in the short-to-medium term.

As this shift continued, the wholesale prices of diesel and gasoline in the global market adjusted, affecting refinery margins on both sides of the Atlantic. Marginal facilities in Europe shut down, while others invested in the hardware to increase their yield of diesel and reduce gasoline production. US refiners also invested in diesel-making equipment.

The aftermath of the financial crisis and recession increased the pressure on Europe's refiners, as did the rapid growth of "light tight oil" production in the US. Europe's biggest export market for gasoline dried up as fuels demand slowed and US refineries reinvented themselves as major exporters of gasoline.

Diesel cars still make up less than 1% of US new car sales but have accounted for around 50% of European sales for some time. If governments and consumers were now to lose their confidence in diesels and shift back toward gasoline, it would wrong-foot Europe's refineries and leave them with some big, underperforming investments in diesel hardware.  A persistent slowdown in diesel demand would alter corporate plans and strategies as refinery profits shifted. In the meantime, US refineries stand to benefit from a bigger outlet for their steadily rising gasoline output.   

If consumers did retreat from diesel passenger cars--trucks are unlikely to be affected--the shift back to gasoline is likely to be less than gallon-for-gallon, because competing technology hasn't stood still since 2007, when the US Congress enacted stricter fuel economy standards and the Environmental Protection Agency's tougher tailpipe NOx standard went into effect. New gasoline cars are closing the efficiency gap with diesels, thanks to direct injection, hybridization and other strategies. At the same time, the number of new electric vehicle (EV) models is growing rapidly, their cost is coming down, and infrastructure for EV charging is sprouting all over.

EVs still accounted for less than 1% of the US car market last year, but the combined sales of the Chevrolet Volt, Nissan Leaf, Tesla Model S and over a dozen other plug-in hybrid and battery-electric models nearly matched those of the standard Prius hybrid "liftback". EVs are still not cheap, despite generous government incentives that mainly benefit high-income taxpayers. Most still come with a dose of "range anxiety", but they are greatly improved and getting better with each new model year.

Even in Europe, where EVs haven't sold very well outside Norway, a big shift away from diesel would surely help EVs gain market share. If European consumers bought 9 gasoline cars and one EV for every 10 new diesels they avoided, European refiners would soon see not just a shift, but a net drop in total fuel sales. Nor would refineries be the only part of the petroleum value chain to be affected. Global oil demand would grow more slowly as well, bringing "peak demand" that much closer.

For now, this scenario is hypothetical. VW may yet solve its technical problem, bringing the 11 million affected vehicles into compliance with minimal impact on performing and fuel economy. Meanwhile, regulators could find that most other carmakers have been in compliance all along, particularly those selling cars that use the urea-based Selective Catalytic Reduction NOx technology; the rest might only need a few tweaks.

​In that case, the scandal might eventually die down without putting small diesel cars into the grave, as a mock obituary in the Financial Times suggested. Carmakers would have a hard time increasing diesel's penetration of markets like the US, but loyal diesel customers around the world might conclude that these cars still provide them the best combination of value, convenience and drivability. Having driven a number of diesels as rentals and at auto shows, I wouldn't dismiss that possibility too lightly. The jury is likely to be out for a while.

A different version of this posting was previously published on the website of Pacific Energy Development Corporation

What the Congressional Hearing on VW Missed

I made time in my schedule to watch yesterday's Congressional hearing on the VW scandal on C-SPAN. It left me with very much the same sense tweeted by Amy Harder of the Wall Street Journal, though perhaps for different reasons:

Similarly to the Deepwater Horizon hearing, some of the Members of the House Energy and Commerce Committee used the occasion to demonstrate that their outrage over this event equaled or exceeded that of their constituents back home. This is par for the course. But just as when confronted with the highly technical issues of a well blowout in the deep water of the Gulf of Mexico, the committee's members would also have benefited from more technical advice prior to and during the hearing.

In particular, I thought they missed key opportunities to follow up on answers given by the CEO of Volskwagen's US subsidiary, Michael Horn. One example followed Mr. Horn's response to a question about the timeline for attempting to fix the company's non-complying diesel cars from model years 2009-2015.

He explained that the affected models included three generations of engine and emissions treatment technology. The oldest, which he described as "Gen-1" would be the hardest to fix and was clearly not amenable to merely updating the engine management software to remove the "defeat device" code. However, he also indicated that the newest generation might be fixed in exactly that way. That's because they already incorporate the Selective Catalytic Reduction and urea technology used in bigger, more expensive models. The question left hanging in the air but never asked was why VW would have abandoned the exhaust-gas-recirculation (EGR) technology that had been matched to the 2-liter diesel engine since 2009, if it was convinced the cheaper technology was doing the job.

Several members of the committee pointed out to both Mr. Horn and Christopher Grundler, the EPA official responsible for emissions compliance, that although the EPA had indicated these cars were safe to drive and would not be pulled off the road, they would be emitting unacceptable levels of NOx until they were recalled and repaired.  Mr. Horn had already indicated that might take up to two years, which seemed quite realistic.

Despite Mr. Grundler's expertise, everyone seemed to treat these emissions as an unalterable circumstance, ignoring the fact that NOx is a traded commodity in the US. In fact, the markets for NOx and SOx emissions credits--overseen by the EPA--have been so effective that they provided the intellectual spark for the whole idea of CO2 cap-and-trade. In light of that, I was surprised that no one suggested that VW, either voluntarily or at the direction of the EPA, should immediately purchase NOx credits equivalent to the excess emissions of the affected cars until they have been brought into compliance.

Of course that wouldn't be a perfect substitute for tailpipe compliance. Unlike CO2, NOx acts locally, rather than globally. However, as I understand it the NOx markets function regionally, and I would be surprised if there wasn't a reasonable overlap between the geographic concentrations of VW diesel car sales and the focus of the NOx markets in the Northeast, Midwest and California. Buying large blocks of  NOx credits would push  up the price for these instruments and prompt more emissions reductions from power plants and other participants in these markets, leaving the air cleaner.

I am sure many of those watching the hearings shook their heads when Mr. Horn expressed his belief that the responsibility for circumventing the cars' emission controls likely rested with a few software engineers, rather than a corporate decision. Representative Chris Collins (R-NY) channeled a lot of frustration when he rejected that idea on the basis that if VW had found software to fix diesel emissions it would have rushed to patent the idea. I'm less certain of that in this age of widespread technology outsourcing. For VW's diesels, much of the key hardware came from vendors, and I would expect the same to be true for software. I was hoping someone would ask whether the "defeat device" software itself had been sourced from a vendor.

Either way, it was clear that Mr. Horn was struggling with the disconnect between his own beliefs about the situation and the facts that had emerged. I experienced something similar when my former employer, Texaco Inc., was embroiled in a scandal over diversity in the 1990s. The newspaper accounts I read of blatant discrimination in closed-door meetings were at odds with everything I knew about a company for which I had worked for two decades. Mr. Horn expressed similar feelings, but I doubt they provided much consolation to those whom VW's actions have harmed.

In that vein, there was a lot of speculation about damages and remedies at yesterday's hearing.  It was clear that most of the committee shared the view of one member, who advised VW to be "aggressively compliant" in responding to its customers and dealers. However, suggestions that the company offer "loaners" to all 500,000 affected customers seemed detached from reality, as did the notion that VW should voluntarily refund the full purchase price of these cars. A quick calculation puts the price tag on that idea in the $10-20 billion range, before paying any of the fines and penalties that seem inevitable in this case. I don't know what compensation I'd want if I had bought a diesel VW, instead of a gasoline model, but I don't think I'd be counting on getting my purchase price back.

Yesterday's hearing had its share of posturing, but on balance I thought it contributed to our understanding of the scandal and the next steps in the process. The panel treated Mr. Horn with remarkable civility, under the circumstances. That is likely attributable to his having been among the first to admit that the company had "screwed up." Perhaps his most telling remark yesterday was that they would have to figure out how to manage a company of 600,000 people differently, after this. "This company has to bloody learn," was how he put it. I imagine we'll be hearing a lot more in the weeks and months ahead about exactly what those lessons are, and how much they will cost.

The Fallout from Volkswagen's "Defeat Device"

• The repercussions from VW's error in judgment seem likely to extend beyond the hit to their reputation and stock price, and the unnecessary extra pollution from these cars.
• This incident will make a useful, fuel-saving alternative to gasoline cars less attractive, at least for now, resulting in higher future oil consumption and CO2 emissions.

I find the revelations concerning Volkswagen's reported efforts to circumvent vehicle emissions rules disturbing, especially as a VW owner and someone who has advocated diesel technology as a tool for reducing oil consumption and greenhouse gas emissions. VW has apparently admitted its colossal error. However, I haven't seen anyone attempt to explore the implicit emissions tradeoffs involved. As bad as this decision was, did it at least, on balance, help the environment?

The details that have emerged so far have focused on a software routine that manipulated diesel engine performance to produce one level of emissions in regulatory testing, presumably on a dynamometer, and different, much less acceptable results in real-world driving. Aside from the obvious questions about ethics and compliance, what did this mean for actual emissions?

For many years regulators have been tightening restrictions on allowable emissions of so-called criteria pollutants from cars. These include oxides of sulfur and nitrogen, particulates, and hydrocarbons, but not CO2. A whole gamut of technology was developed to tackle these pollutants, starting with catalytic converters on cars and deep desulfurization of fuels in refineries. Today's cars are much cleaner than those of a generation ago.

Oxides of nitrogen, referred to as NOx, are combustion byproducts that don't originate in a car's fuel, but from the nitrogen and oxygen in the air in which it is burned. NOx emissions from diesel engines have always been challenging, because they operate at higher temperatures and compression ratios than gasoline engines. Manufacturers that produce diesel vehicles have deployed different technologies to control NOx. As far as I know the VW Group uses at least two, depending on model.

Larger (and more expensive) vehicles appear to use a process called Selective Catalytic Reduction (SCR), in which small amounts of a liquid chemical such as urea chemically react with the NOx. The liquid must be refilled at service intervals. The technical manual for VW's 2-liter diesel engine involved in the current fiasco indicates it uses EGR, or exhaust-gas recirculation, which reduces the oxygen in the engine available to form NOx .

If controlling emissions from diesels is so challenging, why bother with them? Well, a typical diesel car uses up to a third less fuel than a comparably equipped gasoline model. After adjusting for the carbon content of the fuels, the lifecycle CO2 emissions are around 20% lower than for gasoline. Given the shortcomings of similarly priced electric vehicles in range and convenience, diesel provides a useful option. That helps explain why roughly half of European cars today are diesels, in many cases promoted by national fuel- and/or engine-tax policies.

That leads us to the question of whether such a reduction in CO2 might be worthwhile, even if it came at a penalty in NOx emissions, which act locally, rather than globally. To arrive at a ballpark answer let's assume that the 482,000 affected diesel cars couldn't have been sold at all if their engine software didn't fool emissions testers, and that the buyers would have otherwise chosen a comparable gasoline car. For comparison, the EPA rated the 2015 Jetta diesel at 36 miles per gallon (mpg) overall, while the 1.8 L turbo gasoline Jetta gets 30 mpg. At an average of 12,000 miles per year each, the collective annual fuel savings of the cars involved would be 32 million gallons, resulting in avoided CO2 emissions of about 300,000 metric tons per year, or 0.005% of US annual CO2 emissions.

If the tradeoff in extra NOx emissions is based on the reported maximum estimate of 40 times the EPA's allowed level of 0.07 grams per mile, then the affected cars would collectively emit an extra 16,000 metric tons of NOx per year. That's roughly 1% of the annual US NOx emissions tracked under the Clean Air Interstate and Acid Rain Program cap-and-trade markets in 2012. Even recognizing that those programs don't count all US NOx pollution, and that NOx and CO2 are very much apples and oranges in their environmental and health impacts, the relative proportions I calculated don't make this seem like a tradeoff worth making.

Whoever made the decision to circumvent the pollution controls on these cars did enormous damage to VW's brand and reputation. Unfortunately, the response in Europe and Asia suggests that this event has also raised questions about the emissions testing and compliance of the entire car fleet. Resolving them will take time and money, and if they are not seen to be dealt with properly, the impact on the public's trust of these processes on both sides--manufacturers and regulators--could be long-lasting.

Unlike in Europe, diesels made up just under 1% of new cars sold in the US last year. However, the technology was finally shedding the poor reputation that low-quality diesel cars earned in the 1980s, and the "take rate" was growing, along with the number of models offered.  VW's diesels are among the most affordable in the market. The NOx reduction technologies they use have been proven to work, when they are not circumvented, but that is not the message that this debacle will leave with the average consumer. Carmakers will have to work harder to convince buyers that this driver-friendly alternative to gasoline cars is worth a look, and that has implications for future oil consumption and CO2 emissions.

What Will Fuel Today's Advanced Vehicles?

Last month I attended the annual "policy day" at the Washington Auto Show, which typically emphasizes green cars and related technology. This year it included several high-profile awards and announcements, along with a keynote address by US Secretary of Energy Ernest Moniz.  Yet while the environmental benefits of EVs and other advanced vehicles are a major factor in their proliferation, I didn't hear much about how the energy for these new car types would be produced.

The green car definition used by the DC car show encompasses hybrids, plug-in electric vehicles (EVs), fuel cell cars, and advanced internal-combustion cars including clean diesels. One trend that struck me after missing last year's show was that most of the green cars on display have become harder to distinguish visually from conventional models. For Volkswagen's eGolf EV, which shared North American Car of the Year honors in Detroit with its gas and diesel siblings, and Ford's Fusion energi plug-in hybrid the differences are mainly under the hood, rather than in the sheet-metal.

Of course some new models looked every bit as exotic as you might expect. That included BMW's i8 plug-in hybrid, which beat Tesla's updated 2015 Model S as Green Car Journal's "Green Luxury Car of the Year", and Toyota's Mirai fuel-cell car. The Mirai is expected to go on sale this fall in California, still the nation's leading green car market due to its longstanding Zero-Emission Vehicle mandate focused on tailpipe emissions. 

BMW i8 plug-in hybrid

Toyota Mirai fuel-cell car

Many of these cars have electric drivetrains, increasingly seen as the long-term alternative to petroleum-fueled cars. Although Secretary Moniz pointed out that the US government isn't attempting to pick a vehicle technology winner, there seemed to be a definite emphasis on vehicle electrification and much less on biofuels than in past years.

Another announcement at last month's session addressed where such vehicles might connect to the grid. BMW and VW have partnered with Chargepoint, an EV infrastructure company, to install high-voltage fast-chargers in corridors along the US east and west coasts to facilitate longer-range travel by EV. In making the announcement BMW's representative indicated that EVs will need fast recharging in order to compete with low gasoline prices. With the relative cost advantage of electricity having become a lot less compelling than when gasoline was near $4 per gallon, EV manufacturers need to mitigate the convenience concerns raised by cars with typical ranges of 100 miles or less. 

Getting energy to these cars more conveniently still leaves open the basic question of the ultimate source of that energy.  Perhaps one reason this isn't discussed much is that unlike for gasoline or diesel-powered cars, there's no simple answer. The source of US grid electricity varies much more than for petroleum fuels: by location, by season, and by time of day. However, even in California, which on average now gets 30% of its electricity from renewable sources and has set its sights on 50% from renewables by 2030, the marginal kilowatt-hour (kWh) of demand is likely met by power plants burning natural gas, due to their flexibility. That's especially true if many of these cars will be recharged near peak-usage times, instead of overnight as the EV industry expects.

Based on data from the EPA's fuel economy website, most of the plug-in cars I saw at the Washington Auto Show use around 35 kWh per 100 miles of combined driving. That reflects notionally equivalent miles-per-gallon figures ranging from 76 for the BMW i8 to 116 mpg for the eGolf. On that basis an EV driven 12,000 miles a year would increase natural gas demand at nearby power plants by around 30 thousand cubic feet (MCF) per year. That equates to 40% of the annual natural gas consumption of a US household in 2009. 

To put that in perspective, if we attained the President's goal of one million EVs on the road this year--a figure that may not be achieved until the end of the decade--they would consume about 30 billion cubic feet (BCF) of gas annually, or a little over 0.1% of US natural gas production. With plug-in EVs making up just 0.7% of US new-car sales in 2014, they are unlikely to strain US energy supplies anytime soon. 

It's also worth assessing how much gasoline these EVs will displace. That requires careful consideration of the more conventional models with which each EV competes. While a Tesla Model S surely lures buyers away from luxury-sport models like the BMW 6-series, thus saving around 500 gallons per year, an e-Golf likely replaces either a diesel Golf or a Prius-type hybrid, saving 250-300 gallons per year.  A million EVs saving an average of 350 gallons each per year would reduce US gasoline demand by 22,000 barrels per day, or 0.25%.

At this point the glass for electric vehicles seems both half-full and half-empty. The number of attractive plug-in models expands every year, as does the public recharging infrastructure to serve them. However, they still depend on generous tax credits and must now compete with gasoline near $2 per gallon. More importantly, at current levels their US sales are too low to have much impact on emissions or oil use for many years.

 

A different version of this posting was previously published on the website of Pacific Energy Development Corporation.

Fuel Cell Cars and the Shale Revolution

• Although fuel cell cars have perpetually seemed to be the technology of tomorrow, carmakers’ persistence with them could still pay off, as a dividend from shale gas.

• Significant obstacles remain, including inadequate hydrogen infrastructure and competition from greatly improved vehicle batteries. However, the race is far from over.

As I was working off my reading backlog, I ran across an article in the Washington Post’s “Capitol Business” edition on “Are We Ready for Hydrogen Cars?” Published in conjunction with this year’s DC Auto Show, which I missed, it mentioned a new fuel cell model from Hyundai for the California market, while providing some background on a technology that looked much more like the next big thing a decade ago than it does to many, now.

Any evaluation of the prospects for fuel cell cars to become practical requires discussing the cost of fuel cell components, the infrastructure to deliver H2 to vehicles, and the suitability of various options for storing it safely onboard. However, I was surprised the article failed to mention a new factor that might do more than anything else to improve the odds for this technology: shale gas.

In the mid-1990s, when fuel cell vehicles (FCVs) first appeared on my radar, they seemed like an ideal alternative to the gasoline engines in most passenger cars, offering zero tailpipe emissions and very low lifecycle, or well-to-wheels emissions of all types. Onboard hydrogen (H2) storage, whether as a gas, liquid or chemically adsorbed in another material, enabled higher energy density than then-current batteries, giving an FCV significantly greater potential range than a comparable electric vehicle (EV). And like electric cars, they also provided a useful pathway for bringing energy from a wide variety of sources into the transportation market, which was and still is dominated by petroleum products. Cost and technology readiness were big barriers, along with non-existent retail H2 infrastructure.

Energy remains the key to FCVs, because H2 is an energy carrier, not an energy source. Standing up a competitive fleet of FCV models thus requires plentiful and preferably low-cost energy sources from which sufficient H2 can be produced and distributed. As recently as just a few years ago, this looked like a very tough challenge.

Most H2 used industrially is generated by chemically reforming natural gas. Until recently, US gas production was in decline, resulting in high and volatile gas prices. Generating H2 from electricity looked even worse, because power prices were climbing and seemed likely to increase steadily in the future, as natural gas prices rose and higher-cost renewables were phased in. And with US electricity generation dominated by coal, H2 from electrolysis–cracking water into its components using electricity–looked like a recipe for merely shifting, rather than reducing vehicle emissions.

Like many other aspects of the North American energy scene, this picture has changed radically in the last several years, mainly due to the shale gas revolution. We now have abundant gas at reasonable prices, and this is holding down electricity costs. (Renewables are also reducing wholesale electricity prices, though not necessarily the full cost of electricity, because they still depend on subsidies and mandates that don’t show up in wholesale prices.)

These developments create the potential for cheaper H2 sources than fuel cell developers expected. Moreover, US natural gas prices have diverged from oil prices and are now at a significant discount to oil. Wellhead gas today trades for the equivalent of $25 per barrel, compared to oil at over $100. Gas-derived H2 could end up with advantages in both cost and end-use efficiency over gasoline.

Of course the availability of natural gas isn’t the only thing that has changed for fuel cells in the last decade, from a competitive perspective. Automakers such as GM, Toyota and Honda have introduced various new fuel cell models. The most recent one I had an opportunity to drive was a fuel-cell version of the Chevrolet Equinox compact SUV in late 2007. In the meantime, though, EV models are proliferating.

Unfortunately for fuel cell developers, H2 distribution has had a somewhat checkered history, as the Washington Post article notes. Providing fuel for FCVs is a much more involved and expensive undertaking than setting up a network of recharging points for EVs. How many H2 stations will suppliers build before FCVs appear in large numbers, and how many FCVs can carmakers sell before sufficient infrastructure is available to serve them? California still has just a handful of public H2 stations, after years of development.

Energy trade-offs dominate the competition between FCVs and EVs. The former have longer ranges between refueling than moderately-priced EVs–the Tesla Model S has excellent range–and can be refueled in much less time than even high-voltage EV recharging can achieve. However, FCVs are much more dependent on refueling infrastructure than EVs, which can recharge at home. And thanks to robust federal support for battery R&D and production, including from the 2009 stimulus, along with extremely generous federal and state EV tax credits, EVs have gained significant awareness and initial market penetration since the current administration took office and scaled back federal support for fuel cells.

EVs may have an edge over fuel cell cars, for now, but EV sales remain disappointing and they must compete with more convenient, mainstream hybrid cars, with and without plug-in capability. They must also compete with conventional gasoline and diesel cars that are becoming more efficient every year, reducing EVs’ advantages in operating costs and lifecycle environmental impacts. Given all that, there’s still ample time for another technology like FCVs–or natural gas vehicles (NGVs)–to scale up, if they can reduce costs quickly enough and overcome infrastructure hurdles. Those are big ifs.

Nor is it the case that EVs and FCVs are mutually exclusive in the automotive market. Fuel cell cars are fundamentally electric vehicles, too, and most will likely be offered as hybrids, with regenerative braking and traction batteries. So advances in EV architecture, battery capacity and cost, and safety also benefit FCVs. That makes it seem even likelier that our future vehicle mix will be quite diverse, with EVs and FCVs coexisting with NGVs, various hybrids, and much more efficient gasoline and diesel models than today’s.

A different version of this posting was previously published on Energy Trends Insider.

Could Natural Gas Fuel a Trucking Revolution?

• Natural gas occupies a tiny niche in transportation energy, dwarfed by oil. Conditions are now right for that disparity to begin to change.
• Heavy-duty trucking looks like the logical beachhead for gas, with higher usage intensity and more manageable infrastructure needs than light-duty vehicles.

The International Energy Agency (IEA) released its latest Medium-Term Gas Market Report in St. Petersburg, Russia last month.  Although the IEA sees the growth of gas in the power sector slowing, they also cite its emergence as "a significant transportation fuel."  What really caught my eye was their projection that gas over the next five years would have "a bigger impact on oil demand than biofuels and electric cars combined," in light of the US shale gas revolution and tougher pollution rules in China.

That's quite an assertion, considering oil's longstanding dominance in transportation energy.  As I noted in March, Italy, Pakistan and several other countries already have well-established demand for compressed natural gas (CNG) for passenger cars.  Despite these hot spots only 3% of gas is currently used in transportation, globally, based on analysis from Citigroup.  The IEA is forecasting that transportation growth will consume 10% of the projected global gas production increase of roughly 20 trillion cubic feet (TCF) per year by 2018.  That's 2 TCF per year of additional natural gas demand in the transport sector, equivalent to 1 million barrels per day of diesel fuel.

I'd be more skeptical about that figure if I hadn't seen a presentation from Dr. Michael Gallagher of Westport Innovations at the Energy Information Administration's annual energy conference in Washington, DC last Monday.  Westport specializes in natural gas engine technology for heavy-duty trucks and played a major role in implementing the LNG vision of the ports of Los Angeles and Long Beach, CA a few years ago. 

Dr. Gallagher made a strong case for gas in heavy-duty trucking, starting with the low cost of US natural gas compared to oil and its products. Initial growth rates in several segments look encouraging, including transit buses and new trash trucks, for which natural gas now has around half the market.  Growth in China has apparently been even faster, with LNG vehicles increasing at over 100% per year (from a small base) and natural gas refueling stations growing at 33% per year since 2003.

In the US, trucking companies can save $1-2 per diesel-equivalent-gallon in fuel costs, while new heavy-duty trucks equipped with natural-gas-compatible engines and fuel tanks cost from $50-75,000 more than conventional diesel trucks. A successful transition to gas for trucking will require  a combination of fuel availability, including retail infrastructure, along with high utilization to defray those up-front costs.

Gas supply looks ample for the purpose. The IEA's forecast includes an increase in US dry natural gas production (gas with the liquids removed) from 24 TCF last year to 28 TCF by 2018.  That's an increase of a little more than 11 billion cubic feet per day (BCFD.) Based on the latest assessment from the US Energy Information Administration, US gas resources equate to 87 years of production at that higher rate. 

From my perspective achieving this scenario depends less on the availability of the gas than on the ability of new transport-sector users to compete with other segments that are equally eager to use more gas.  In the last 4 years gas demand for power generation has grown by 6.8 BCFD, mainly at the expense of coal, and there are many who would like to see that trend continue.  The IEA report also cited US LNG export projects totaling more than 5 BCFD that already have either Department of Energy approval or signed contracts.  New gas supplies won’t wait around for transportation demand to emerge.

The biggest advantage that gas’s new transportation customers have is the value they stand to gain, compared to other gas users.  US LNG projects are selling into increasingly competitive global markets paying up to three times the US wellhead price of gas of around $4 per million BTUs (MMBTU).  However, exporters must cover the cost of liquefaction and shipping, so their netback over wellhead prices might not be that large. Meanwhile gas's encroachment on coal in the utility sector has been driven mainly by its low price.  As the IEA notes, we've already seen this trend slow and reverse somewhat as US natural gas prices recovered from last year's lows. 

Against that, the US retail price of diesel fuel through mid-June of this year has averaged $3.96 per gallon, equivalent to $31/MMBTU.  With retail LNG currently available at a small but growing number of locations for under $3 per gallon, the incentive for truckers to switch fuels looks substantial.  And with a typical heavy-duty truck burning more than 10,000 gallons per year of fuel, each gas conversion is equivalent to the consumption of several dozen automobiles.

Fuel transitions take time.  One of Dr. Gallagher’s charts showed that it took more than 40 years for diesel to displace gasoline from heavy-duty trucks in the mid-20th century.  A lot could happen along the way to a multi-decade shift from diesel to LNG and CNG, including new cellulosic biofuels or battery breakthroughs.  For now, though, gas looks like a strong contender to provide a cleaner, cheaper fuel with sufficient energy density to be practical for long-distance trucking.  This is a trend worth watching.

A slightly different version of this posting was previously published on the website of Pacific Energy Development Corporation.

Green Car Tech: Workhorses Trump Thoroughbreds?

Fisker Karma at 2013 DC Auto Show

Yesterday I made my annual trek to the Washington Auto Show, which hosts a media day before opening to the public.  Between the show's focus on policy--a natural draw inside the Beltway--and the opportunity to connect with OEM contacts, it's always worthwhile.  Besides, the cars never look the same on a screen or printed page as they do in person.  Yet despite all of that, this year's show left me with what I regard as a healthy form of disappointment: Unlike past years, which provided my first opportunities to see--and sometimes drive--cutting-edge cleantech cars like the Chevy Volt and Nissan Leaf, I saw ample signs of evolutionary change but no new revolutions in the offing. 

A few data points to support that conclusion: First, the Fisker Karma, undeniably sleek and reminiscent of my favorite Hot Wheels® car of long ago, was arguably the most exotic car there.  It sat unattended and largely ignored.  More significantly, the 2013 Green Car Technology Award announced at the show by Green Car Journal went to Mazda's "SkyACTIV" suite of technologies.  These include improvements in engines, transmissions and chassis that Mazda plans to roll out across its fleet, along with the North American launch of a clean diesel version of its Mazda6 sedan later this year.  Among the other finalists were Ford's stop-start and EcoBoost technologies, Fisker's "EVer" plug-in hybrid powertrain, and Fiat's Multi-Air gasoline engine efficiency package.  Half the candidate technologies related to EVs and hybrids, while the other half focused on making conventional cars incrementally more efficient--in the process raising the bar that EVs and hybrids must vault.   

Yesterday's policy day also provided a chance to meet with the team from Robert Bosch, LLC, which among its many business lines supplies under-the-hood gear for clean diesels and efficient gasoline cars, as well as hybrids.  Our conversation focused on clean diesel, which remains the least-appreciated big-bang fuel efficiency option in the US, despite its wide adoption in Europe, where diesels enjoy about a 50% share in "take rate", reflecting consumers' choices when more than one fuel option is available in a given model.  Diesel take rates range from 30-60+% here, too, but with only 20 diesel models available in the US last year--many of them German luxury models--overall diesel penetration in new cars was just under 1%.  That could start to change this year. Bosch's Andreas Sambel, Director of Diesel Marketing and Business Excellence, indicated 22 new models slated for 2013 introduction, with the total increasing to 54 models by 2017. 

We also discussed future improvements in diesel passenger car technology.  Bosch sees ample opportunities to maintain diesel's edge over steadily improving gasoline-engine efficiency.  Possible enhancements include engine downsizing, higher injection pressures (already 29,000 psi), the addition of stop-start, and combustion improvement via something called "digital rate shaping"--my jargon takeaway of the day.  I was surprised to hear that diesel-hybrid models are already available in Europe, since conventional wisdom holds that doubling down on two expensive efficiency strategies can't be cost-effective.  Mr.Sambel offered the view that hybrids are becoming a distinct market segment, and that fuel choice within that segment will appeal to some buyers.  I'll have to watch for further signs of this intriguing development.  I certainly concur with his take that there is unlikely to be a one-size-fits-all solution.  Don't expect an imminent winner among the proliferating powertrain and fuel choices available to motorists, including biofuels and CNG/LNG.

This year's DC Auto Show includes a wide selection of nicely sculpted steel and glass, but at least from a "green car" perspective the technologies that made such a big splash a few years ago are becoming a bit mundane.  That's just as well.  EVs still haven't taken off, yet, with only 53,000 sold in the US last year out of a much-recovered 14.4 million car total, despite lavish tax incentives.  However, with oil prices stubbornly high and US gasoline prices on the verge of setting new records for this time of year, the evolutionary improvements in fuel economy that were honored and displayed at the DC Convention Center will find plenty of takers.  For the near-term they'll contribute far more to saving oil and reducing emissions than a few more EVs could.

Could Diesel Fuel Made from US Natural Gas Compete with CNG and LNG?

The announcement last month of a $21 billion project to capitalize on abundant, low-cost US natural gas should have caught the attention of everyone interested in this resource. As reported in the New York Times, Sasol, a South African energy company, intends to build a 96,000 barrel-per-day gas-to-liquids (GTL) plant in southwestern Louisiana, in conjunction with a new gas processing plant and ethylene cracker. The synthetic diesel fuel produced by this facility would provide a different pathway for shale gas to displace imported crude oil in the US transportation sector, in competition with compressed or liquefied natural gas (CNG or LNG.)

GTL involves a two-step conversion of the methane that makes up the bulk of natural gas into synthesis gas and hydrogen, which are recombined into liquid hydrocarbons by means of the decades-old Fischer-Tropsch (FT) process. GTL is also energy-intensive, with an overall efficiency around 60%. South African companies have vast experience with such synthetic fuels. Sasol are partners in the Oryx GTL plant in Qatar, and their coal-to-liquids plants in South Africa utilize a similar syngas step and the same FT process as GTL.

With the US suddenly perceived to be sitting atop a century's worth of natural gas, mainly in the form of unconventional gas from shale, tight gas formations and coal-bed methane, T. Boone Pickens isn't the only one to see an opportunity to displace imported oil with gas. Yet as attractive as that sounds for reasons of energy security and trade, it isn't obvious whether the public or even fleet operators are willing to switch on a larger scale to a lower-density gaseous fuel requiring both new distribution networks and new or modified powertrains. Only 0.1% of the natural gas consumed in the US now finds its way into vehicles, equivalent to less than 0.1% of US oil demand. Under the circumstances, it would be surprising if someone weren't looking seriously at GTL, one of the few practical ways to circumvent the mechanical and logistical barriers that have impeded the fueling of more US cars and trucks with natural gas.

When I read about Sasol's proposed project, I immediately thought of another, less well-known South African synfuels facility. Since 1992 the Mossel Bay GTL plant has been turning natural gas into gasoline, diesel and other fuels, drawing first on the Mossel Bay gas field and then on newer fields as the original one depleted. Although owned by another firm, the ongoing struggles to keep the "Mossgas" plant supplied are well-known in South African energy circles. I can't imagine Sasol embarking on a project like the one in Louisiana if they had any doubt about their ability to keep it supplied for decades.

Of course volume and price are two very different aspects of supply. A decade ago, conventional wisdom held that GTL required a gas cost of around $1 per million BTUs to be viable. Even with the shale bonanza today's US natural gas price is well above that level. What now makes it possible to conceive of GTL in the US is that the price of the crude oil used to make diesel and other fuels has risen so much higher than that of natural gas. That comparison is more obvious when one converts natural gas prices into their energy equivalent in crude oil. Today's US natural gas price is below the $23 per equivalent barrel that it was in 2001. Meanwhile crude oil has increased from about $26 to $95 per barrel. The drastically improved attraction of GTL becomes even clearer when comparing ten years of wholesale US Gulf Coast diesel prices to natural gas prices using the approximate GTL conversion rate of 10 million BTUs of gas per barrel of liquid product.

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As the chart above reveals, this theoretical GTL margin has exploded since 2009. Yet it also shows that if gas prices returned to the levels we experienced just a few years earlier, the proposed project would encounter significant risks. Perhaps that helps explain Sasol's concept of a larger integrated gas complex with multiple sources of margin, capitalizing on the waste heat from the GTL process and the lighter hydrocarbons it yields as byproducts.

It remains to be seen whether GTL will prove an attractive means of leveraging the US shale gas revolution to back out imported oil. However, if Sasol and others proceed with US GTL projects, anyone eyeing our gas surplus for other purposes, whether in manufacturing, fertilizer production or power generation, would face serious competition linked to the global oil market. That includes potential LNG exporters, who passed an important hurdle with the publication of a favorable analysis by the Department of Energy.

A slightly different version of this posting was previously published on the website of Pacific Energy Development Corporation

D.C. Auto Show Focused on Efficiency

Last week I attended the media preview of the Washington Auto Show. With its dual focus on cars and energy policy, this is always a high point of the winter for me, even if this year's display lacked a draw of the magnitude of the pre-production Chevrolet Volt I drove at the 2010 show. Instead, I was pleased to find that the emphasis on fuel economy and technology in carmaker presentations was matched by a broad array of efficient and attractive new products. They still don't quite constitute the new car fleet needed for the 54 mile-per-gallon target the federal government requires them to meet by 2025, but in my opinion they're off to a very good start.

No one listening to the presentations I sat through last Thursday could have missed the shift in focus from previous years. Performance and drivability were still mentioned prominently, but in most cases the innovations allowing those attributes to be delivered along with improved fuel economy, instead of at its expense, received top billing. I heard about Ford's nine models that achieve at least 40 mpg, including the new C-MAX Energi plug-in hybrid that received Green Car Journal's Vision Award for 2012. GM touted a number of efficient new models, including the upcoming Chevrolet Spark subcompact, which will later be available as a full EV. In some respects I found the 2013 Malibu Eco with "e-Assist" even more impressive: With the new Malibu and this year's Buick LaCrosse, GM is building family-sized gasoline-powered sedans that achieve 36 or 37 mpg on the highway. And thanks to Fiat's MultiAir technology, Chrysler had its new 40 mpg Dodge Dart on display.

I was particularly interested in the VW press conference, where they debuted the 45 mpg 2013 Jetta turbo hybrid. The head of VW's US division introduced the car as part of his company's Think Blue sustainability drive, which with this latest model encompasses hybrids, clean diesels, efficient non-hybrid gasoline engines, and soon EVs. With all this technology to talk about, including the new, larger Passat sedan--where's the wagon?--built in VW's new Chattanooga, TN plant and sporting a diesel engine delivering 43 highway mpg (31 city), the biggest surprise was the amount of time he devoted to VW's partnership with Bikes Belong, a cycling safety group aimed at getting people out of their cars. That certainly reflects a bigger-picture view of vehicle sustainability.

My visit to the car show also included a meeting with Lars Ullrich, marketing director of Bosch Diesel Systems North America, and Jeff Breneman of the US Coalition for Advanced Diesel Cars. They updated me on the progress that diesels have been making in the US market, particularly in light of the greater cost-consciousness of consumers, post-recession. In the last five years, the willingness of consumers to consider diesels has nearly tripled to around one-third, while diesel sales passed the 100,000 mark for 2011--still less than 1%, but about where hybrids were just a few years ago. Clean diesel models are expected to double by 2014. Models with announced future diesel versions include the Chevrolet Cruze, Jeep Cherokee, Dodge Dakota, and a Mazda crossover. Will diesels ever reach the level of popularity here that they've attained in Europe, where half of all new cars are diesel-powered? They must wage an uphill battle against fuel economy regulations that are anything but fuel-neutral, legacy perceptions formed by the dirty diesels of 20 years ago, and federal and state fuel taxes that still assume that all diesel fuel is used by heavy-duty trucks that wear out our highways. That's a shame, because this is a terrific technology that could be every bit as attractive to many consumers as more expensive hybrids.

Another noteworthy item I gleaned from the manufacturers' presentations was that several of them are forecasting a return to annual US car sales of 16 million within a couple years. That would be good for the industry and employment, but it's crucial for shifting the fuel economy of the entire light-duty vehicle fleet. One of the unnoticed consequences of the low car sales of the last several years is that the US fleet has been aging faster, notwithstanding the small blip from the Cash-for-Clunkers program of 2009. The difference between sales of 16 million a yar versus 12 million is an average turnover of 15 years, instead of more than 20, and faster turnover should translate to quicker improvements in average mpg.

For years we heard that the biggest obstacle to improving the fuel economy of the US car fleet was the auto industry, which only wanted to sell us big SUVs that carried higher profit margins. That excuse was always overly simplistic, and it has been relegated to the ash heap by a new generation of cars and light trucks featuring innovations delivering steadily improving efficiency, even in mainstream sedans and SUVs. Getting the entire fleet to 54 mpg won't be easy, but if what I saw at the D.C. auto show is any indication, the attainment of that goal now depends at least as much on sales mix as on the availability of efficient models. Within a few years, virtually every segment of the market will include hybrid, diesel and EV options that will put a big dent in both fuel bills and emissions, albeit at the expense of higher sticker prices. That means that future fleet mpg will likely be determined mainly by the decisions of consumers, rather than carmakers.

The Next Big CAFE Loophole

The great pitfall of government policies, no matter how well-intended they might be, is their inevitable unintended consequences. When those are truly surprising, it's hard to attach much blame to the legislators or regulators involved. However, that degree of indulgence shouldn't apply when the unintended consequences are as obvious as the ones inherent in the new fuel economy regulations that were announced with such fanfare last week. After all, an earlier generation of CAFE standards gave rise to what might just be the classic unintended consequence of recent times: the "SUV loophole" that fed a 20-plus-year SUV fad and dug the nation's oil consumption hole much deeper than it needed to be, affecting oil prices, trade deficits and energy security. Now regulators are proposing the creation of a similar loophole for electric vehicles.

I'm not surprised that the coverage I have read on the latest CAFE debate didn't remind the public of the ongoing consequences of treating pick-up trucks and delivery vehicles differently than passenger cars when the first CAFE standards were established in the 1970s. (That loophole was mostly closed just a few years ago.) Who could have guessed that a provision intended to help small businesses would blow up, because an entire generation embraced deluxe versions of such vehicles as their primary transportation--by the tens of millions--undermining the purpose of the CAFE standards to reduce gasoline demand? When I looked at this several years ago, I estimated that SUVs had increased US gasoline consumption by over 400,000 barrels per day, or roughly 5% of total demand, equivalent to the energy contribution of around 10 billion gallons per year of ethanol.

In this case the problem starts with the evolution of Corporate Average Fuel Economy standards from a tool intended solely to improve US energy security by reducing the consumption of petroleum products in transportation, to one encompassing the greenhouse gas emissions implicated in climate change. Although there are important overlaps between these two goals--keeping a chorus of pundits employed touting them--they are not identical in operation or effect. Consider the specifics of the new CAFE proposal.

The "supplemental notice of intent" from the National Highway Traffic Safety Agency (NHTSA) of the Department of Energy, the body that along with the EPA designs and enforces the CAFE standard, spells out the special treatment accorded EVs in the rules that will be forthcoming. It states that EPA intends to give manufacturers multiple credit for each EV, plug-in hybrid (PHEV) and fuel cell vehicle they sell, starting at a multiplier of 2.0 for EVs and fuel cells and declining to 1.5 by 2021, as if these cars somehow canceled the emissions of more than one vehicle. They also intend to treat EVs and the electric portion of PHEVs as having zero emissions, regardless of how the power they use is generated. So in order to meet the tough greenhouse gas standards that accompany the 54.5 mpg CAFE standard, carmakers will have every incentive to produce as many EVs they can. Unfortunately, it's not obvious that this will reduce emissions in the real world, except in the rare instances when EVs recharge exclusively from renewable or nuclear power, which provide only 30% of our electricity mix today, up from 28% in 2005.

One needn't assume that EVs might be recharged using only coal-fired power to see that they aren't always a big improvement, emissions-wise, over non-plug-in Prius-type hybrids or clean diesels. Using the average US grid CO2 emissions of around 1.3 lb/kWh, a Nissan Leaf getting 3 miles per kWh is responsible for the emission of roughly 200 grams of CO2 per mile traveled. By comparison, a 2011 Prius with its 50 mpg EPA average emits around 196 g/mi. A more rigorous comparison would require a full well-to-wheels lifecycle assessment, but that is precisely what the new CAFE rules eschew in the interest of leaning on the scales to help today's preferred vehicle technology.

Subject to further refinement, this back-of-the-envelope analysis suggests that skewing the new CAFE regulations in favor of EVs isn't going to do much to reduce greenhouse gas emissions. Its main advantage is in reducing oil consumption, since less than 1% of our electricity is generated from oil. But if we only cared about oil and not emissions, producing gasoline from domestic coal--in the same manner as a sizeable fraction of South Africa's fuel supply--would be equally effective at backing out oil imports. Meanwhile, a gallon of gasoline saved by an advanced internal combustion engine with stop-start technology and other low-cost efficiency features would be worth exactly as much as a gallon saved by an EV, while costing dramatically less. That's especially true when you factor in the $7,500/car EV tax credit, which I can't help thinking will be a prime target when the joint Congressional committee on deficit reduction established by the debt limit bill passed by the House of Representatives last night and by the Senate just a few minutes ago sets up shop this fall.

The unintended consequence that is easily envisioned from this special treatment of EVs is a massive over-investment in a particular and still very expensive vehicle technology, at the expense of other, less costly and more cost-effective technologies. I certainly accept that EVs represent a major long-term trend in cars, but I don't believe that their development requires fiddling with the CAFE rules in this way. Nor is it obvious that US manufacturers enjoy any particular competitive advantage in producing EVs, which depend on ingredients such as rare earths for which we are even more import-dependent than for oil. If saving oil and emissions is what we really care about, then we are entitled to expect that new fuel economy regulations would focus squarely on those outcomes, without being diverted by the industrial policy fad of the moment. Perhaps this will be one of the topics taken up by the House Oversight and Government Reform Committee of the Congress as it investigates the new CAFE rules.

Deploying Extra Power for Japan

Just over two weeks after the earthquake near Sendai in northeastern Japan, which I'm increasingly seeing referred to as the "Great Tohoku Earthquake", the impact of the resulting disruption to various supply chains is being felt around the world. From car factories in Europe that rely on Japanese electronic components to producers of flat-panel displays and solar cells, several industries are feeling the pinch. This appears to be due more to the reduction in Japan's electricity-generation capacity than from actual damage to factories in the zone most affected by the disaster. With more power plants than just the troubled Fukushima Daiichi nuclear complex affected, the scale and potential duration of electricity shortages could result in a significant increase in the demand for smaller-scale generation, both conventional and renewable.

As reported in today's Wall St. Journal, the electricity shortfall resulting from the quake and tsunami is severe and affects both consumers and businesses. The Japanese government is exploring a number of emergency measures to mitigate the problem, including increasing electricity prices, instituting Daylight Savings Time, and calling on customers to conserve power. At the same time, the government appears to understand that Japan's scope for large-scale energy-efficiency improvements is limited. With an energy intensity in BTUs per dollar of GDP already 37% lower than that of the US, only the UK among large developed countries is more efficient. Efficiency and conservation will be helpful, but they can't cover the massive shortfall Japan faces now.

One of the most detailed analyses of the impact of the quake and tsunami on Japan's electricity sector that I've seen so far suggests that as much as 15,000 MW of generating capacity in the Tokyo/Tohoku region is offline and likely to remain so for durations ranging from a few months to several years--or permanently, in the case of most of the reactors at Fukushima Daiichi. This is something like 20% of the pre-quake generating capacity of the two main utilities serving the region, not counting the pumped-hydro storage capacity used for meeting peak demand. As a result, that part of Japan is experiencing an electricity deficit that will likely grow as the summer peak demand months approach, and that could persist even after the least-damaged facilities return to service. Nor can surplus power from southern Japan provide much assistance, because the northern and southern systems are relatively isolated from each other, with limited interconnections, and run on different frequencies--60 cycles for the south and 50 cycles for the north. Back-up and distributed generation appears to be the only real alternative to a protracted economic slowdown caused by insufficient electricity for Japan's businesses and industries.

We've seen this pattern before, if from different and less-catastrophic causes. In the early 1990s the Philippine grid was chronically unreliable, and many businesses bought or leased diesel generators to fill the gap, including barge-mounted units that could be brought in quickly and moved around coastlines and rivers as demand shifted. More recently, diesel demand in China increased substantially in the lead-up to the 2008 Summer Olympics, as the central government idled large, dirty power plants in order to reduce air pollution, and a number of factories chose to generate their own power, rather than shutting down.

For Japanese factories and other businesses facing the same dilemma, cost is unlikely to be the major factor in deciding whether or not to become more energy self-sufficient. Factory managers can often justify paying a lot more for power if their only other option is to slow production or shut down. They have several choices available, including some renewable power options, and I expect to see a surge in solar power installations. However, that's probably a better medium-term rather than short-term option, not just because the entire world didn't install enough solar panels last year to make up for the lost output of the Japanese nuclear plants, but because while solar can help with supply, it can't provide the reliability that is crucial right now. That makes diesel generation the leading contender to backstop Japan's idled power plants in the short term.

I can't speak to the availability of diesel generators, although I can easily envision suppliers and leasing agents scrambling to meet frantic Japanese orders. However, if enough generators are available to cover even 3,000 MW of the shortfall, running just half the time, they would require around 65,000 barrels per day of incremental diesel fuel, or roughly the entire diesel output of a medium-sized refinery. Whether that represented an increase in overall Japanese diesel consumption requiring additional imports would depend on the extent of the other economic consequences of the Tohoku disaster, and on when Japan's refineries return to normal operations.

So the use of diesel generators to make up for damaged or otherwise unavailable generating capacity in Japan could provide another modest boost to global oil demand, which already appears to have exceeded the record level set prior to the recession and financial crisis. And since much of that increased demand is for diesel, rather than gasoline, the impact of Japanese generation needs could affect diesel prices disproportionally. As a result, consumers around the world could see diesel prices rise, as the ripples from the events in Japan spread.

French Strikes and US Gas Prices

My reaction to the ongoing refinery strikes and fuel depot blockades in France was probably best described as bewilderment, until it occurred to me that they could have a significant effect on what consumers elsewhere pay for gasoline and diesel, including here in the US. That's clearly a much smaller inconvenience than French consumers are having to endure, but it at least provides a good reason for Americans to pay closer attention than we usually do to what happens on the other side of the Atlantic. You can't shut down a dozen refineries anywhere in the world without affecting global fuel markets, let alone in one of the main regions on which the US relies for its considerable gasoline imports.

I don't pretend to understand the intricacies of the pension reforms apparently motivating the strikes by French refinery, transport and other workers' unions. Like many European countries, France faces serious demographic and fiscal challenges, and an editorial in today's New York Times suggests that raising the retirement age is a necessity, whatever the politics involved. Either way, that is something for the French to work out. However, by selecting the nation's fuel infrastructure as the focus of their "industrial action" French unions have chosen a strategy with both regional and trans-Atlantic implications. That's because European and US fuel markets are connected by significant trade flows in both directions. The ripples caused by these strikes are likely to affect the economics of petroleum products on both sides of the pond in the weeks ahead.

Much of this connection is due to the complementary overlap between the US appetite for gasoline and our long-term shortage of refinery capacity, and Europe's strong preference for diesel-powered cars, despite a refining system that was built to accommodate much higher gasoline demand. Last year the US imported an average of 940,000 barrels per day of finished and unfinished gasoline, and about 40% of that came from Northwest Europe and Spain--though little of it directly from France. In return, a similar fraction of the 587,000 bbl/day of diesel the US exported last year went to these same countries, about half of it in the form of ultra-low-sulfur road diesel. But while some of this product flows day in and day out on long-term contracts, a significant portion is in the form of "spot" cargoes, which depend on transitory price differentials between markets opening wide enough to cover freight costs plus a bit of profit. I haven't looked at freight rates recently, but I doubt these costs are much less than the $0.06-0.08/gal. that was typical when I executed transactions like this from Texaco's London trading room twenty years ago.

According to the International Energy Agency's statistics, France consumes about 1.5 million bbl/day of petroleum products, mainly supplied by the country's dozen refineries, with some help from imports. It's not clear from the news stories I've read whether all of these refineries are now shut down or operating at reduced rates, but it seems clear that even with many of its service stations running out of product, France is consuming much more petroleum product than it is now producing or importing, with the shortfall being made up from "compulsory stocks"--their equivalent of our Strategic Petroleum Reserve, with the key difference that it's mostly held in the form of refined products in the storage tanks of companies that are required to maintain a 90-day inventory cushion for eventualities such as the current one. After the strikes end and the refineries are back to normal operations--and assuming no accidents occur during all these start-ups--these stocks will have to be replenished. That seems likely to affect the US market in two ways.

The most obvious one is that if re-stocking French fuel inventories causes prices there to spike, as you'd expect, then France will absorb many of the cargoes that would otherwise have made their way across the Atlantic, particularly from the UK and the enormous refinery hub at ARA (Amsterdam/Rotterdam/Antwerp). And if the differential gets wide enough, we could see gasoline cargoes and additional diesel cargoes leaving the US for France, motivated by the arbitrage opportunity, or "arb." The combination of these mechanisms would feed into fuel prices on the US east coast and Gulf Coast, supporting the recent upward trend. And because French consumption is skewed so heavily towards "gasoil" (diesel), that's where we should see the biggest impact.

Although some reports suggest it has helped to prop up crude oil above $80/bbl, this effect isn't yet apparent in the futures prices of refined products. This morning November diesel was trading on the NYMEX at $2.23/gal, while November gasoil on London's ICE was at $703.50/ton, equating to about $2.26/gal. That's not wide enough to constitute an arb, but then this shift probably won't kick into gear until traders at least know that French ports will be open to receive and unload their cargoes. The bottom line is that if you were hoping for some relief at the gas or diesel pump in the next few weeks, you shouldn't be surprised to see prices going even higher for a while, instead, thanks to the current mess in France.

Diesel Hybrids Arrive

Regular readers know I'm a fan of diesel cars, having test-driven some terrific models at recent car shows, as well as renting them on past trips to Europe. For drivers who travel mainly highway miles, the fuel economy benefits of dieselization can approach those of hybrids at a much lower initial cost premium. However, at least in the US, combining the two technologies to achieve even greater fuel savings has been cost-prohibitive, while in Europe, where fuel prices are much higher, interest in hybrids languished until fairly recently. Now, two auto makers have announced they will take that step and launch European hybrid-diesel models next year, with impressive fuel economy and emissions results.

Carmakers have known about the efficiency potential of diesel hybrids for a long time. This was the architecture chosen by the Clinton-era Partnership for a New Generation of Vehicles, a US government/industry consortium pursuing the goal of an 80 mpg car. As both Mercedes and Peugeot have determined, there is no technical barrier to building such a car, and the two models announced, although falling somewhat short of the old PNGV goal, are expected to deliver the equivalent of 62 mpg and 57 mpg. That would be respectable for small hybrid sedans competing with the Prius, but it's remarkable for a small crossover SUV and an E-series sedan, respectively. And in addition to fuel efficiency, Peugeot claims its diesel hybrid will emit just under 100 g/km of CO2, roughly matching the lifecycle emissions of an EV recharged on average US grid electricity. I'm also intrigued by the potential for highly-efficient four-wheel drive it creates.

The problem with this configuration, and a primary reason it has faced resistance in the US, results from the combination of relatively low US fuel prices and the diminishing returns to increasing fuel economy. Converting a gasoline model to either a hybrid or a diesel captures the largest, most valuable increment of fuel savings, leaving less fuel--and less money--to be saved by the other technology. As the article in Technology Review notes, achieving an attractive return on the pairing of powertrain technologies requires fuel prices much higher than the roughly $3 per gallon we pay here. So it shouldn't surprise anyone that the first place we'd see this configuration is in Europe, where diesel cars are already well-established--to a much higher degree than hybrids are here. With the average retail price in the EU currently around $6.06/gal. for gasoline (with a range of $5.00-7.11/gal.) and $5.53/gal. for diesel, the incremental savings for going from 40 mpg to 60 mpg still amount to over $500 per year, compared to less than $300 in the US.

The New York Times recently quoted research from the University of Michigan suggesting that cars could achieve 74 mpg by 2035 without drawing energy from the electric grid. With the US new car fleet struggling to reach 35 mpg within a few years, that sounds fanciful, until you see real cars like the Mercedes and Peugeot diesel hybrids. However, unless fuel prices end up rising significantly between now and then--which many expect but is far from certain--the biggest obstacle won't be technology, but justifying the cost, as the performance of baseline vehicles continues to move down the curve.