High Tech Power Grid
Aside from providing a sharp non-US perspective on things, the Economist puts out a good series of periodic reports on various industries and issues. Their latest Technology Quarterly includes an article on "The Energy Internet", describing the potential shape of the power grid of the future.

Before the Enron collapse and the botched California electricity deregulation, the hot buzzword was "distributed power", in which we would gradually shift away from large central power plants and high-voltage lines, and toward a new model relying on small generators, either owned by end-users or sitting very close to them. These generators would use a variety of technologies, including microturbines, wind turbines, diesel generators, and eventually fuel cells. Ultimately, these small devices would not only meet the immediate needs of their owners, but would sell power back into the grid. The result could eventually resemble the internet, with power flowing in and out from a myriad of small nodes.

Along with summarizing the current state of the power grid, the Economist article provides an update on the development of distributed power. Advances have continued, including the development of "microgrids" and new storage options, but we are apparently still some years away from anything resembling an energy internet, however desirable it might be for reducing the risk of blackouts and the volatility of markets.

But although the author correctly identifies politics and regulations as factors retarding progress in this trend, he does not mention the ambivalence of many utilities about losing control over who is allowed to put power into the grid. These companies should consider distributed power in light of their experience in the 1980s and 90s with cogeneration.

Starting in the late 1970s, large industrial facilities began installing their own medium-size power generation, typically using aircraft-derived gas turbines that efficiently provide both electricity and steam for industrial processes. Utilities often resisted buying the cogenerators' excess power, until they were forced to do so by state and federal regulators. But rather than being the threat they feared, cogeneration turned out to be a blessing for utilities, allowing them to defer major investments in new power plants that would likely have earned low returns in the market conditions that prevailed prior to 2000.

In fairness, the cogeneration story may not be 100% positive. The steady stream of cogeneration projects may have lulled utilities and regulators in California into believing that capacity investment could be deferred indefinitely, thus contributing to their problems during deregulation. Despite this, I think the story shows that distributed power could result in unexpected benefits for utilities, and that further analysis is warranted. Perhaps someday the inserts in our monthly utility bills will encourage us to generate our own electricity, rather than buying theirs.

Orphan Cars
In the 1980s and early 1990s, consumers had to worry about buying computers that would turn into "orphans" when their makers went bust or were absorbed into another company. Now it's orphan cars, all-electric vehicles that their manufacturers insist on taking back, once their initial leases are up. This seems like terrible PR on the part of GM and Ford, but it's not hard to envision the conversations between company lawyers and accountants that might have led to these decisions.

A key fact missing from the Times article is that most of these first-generation cars were delivered with conventional lead-acid batteries--dozens of them. Imagine pulling into Sears to buy 26 DieHards in one go. This was one reason the auto firms' chose to offer battery cars only on lease. You also have to wonder what other parts might now be wearing out, with which the average mechanic would have no prior experience. Let's see, my EV-1 breaks down after warranty, and I take it to the corner mechanic, who accidentally comes in contact with a high voltage circuit... The lawyers must have been in a cold sweat at this prospect.

A few years ago I had the pleasure of driving one of these cars. It was a brand new GM EV-1, and I got to take it around the streets of Phoenix, AZ for a few minutes. I was amazed not only by how quiet it was, but by its terrific acceleration. It was great fun leaving a BMW in the dust at a green light, with its owner wondering what on earth I was driving.

However, it was also clear that the car I drove would never be mass marketed. Its range was under 100 miles, and achieving that required either an overnight charge at home, or about an hour and a half at a public, high voltage recharging station, of which there were relatively few. On top of this, it was a 2-seater with limited storage space. Fun, different, but not very practical.

Rather than lament its passing, I'd rather cheer for the few thousand enthusiasts who got to drive the car of their dreams--and consciences--for three or four years, and the car companies that learned a tremendous amount about the practicalities of electric drive. That knowledge is already paying dividends in the new hybrid cars--part electric and part gasoline-powered--and will certainly benefit future electric-based vehicles such as those powered by fuel cells.

At the same time, environmentally-oriented EV owners should remember that the power to recharge these cars must be generated somewhere. For Southern California, where most of these vehicles were leased, the EV-1's "virtual tailpipe" was probably connected to a coal-fired power plant in Four Corners, AZ.

Frontier Outpost
This week the Wall St. Journal Online carried an interview with Amory Lovins, the guru and founder of the Rocky Mountain Institute, an alternative energy think tank. His views on the future of the oil industry and other parts of the mainstream energy landscape are interesting and iconoclastic. They are worth noting as much because of who else is listening to them as for their insights. Mr. Lovins has the attention of global energy and auto firms, among others, a fact that becomes even more surprising when you realize how critical he is of their orthodoxies.

In the interview, along with some good observations about China's growing energy demand, Mr. Lovins compares the oil and airline industries as "a great industry but a bad business." This seems a stretch, considering the highly profitable super-majors dominating the oil and gas scene today. While it is true that these firms and their smaller brethren have not consistently recovered their cost of capital or outperformed the market over time, they are a million miles from the sad state of commercial aviation. As of a few years ago, the latter had delivered a cumulative loss since its inception , and it's hard to see that the post-9/11 world would have improved that score.

Still, Mr. Lovins shines in creating a compelling vision of a future world of clean and efficient energy and transportation, even if I'm skeptical that we can get there in the manner he describes. You need visionaries pushing the frontiers, and he certainly qualifies as one.

Record Gasoline Prices?
A recent article on gasoline prices included a surprising historical graph (you'll have to scroll down a bit to find it.) Gasoline prices have gone up dramatically this year, in line with higher crude oil prices and the replacement of MTBE by ethanol in several states. Here in Connecticut I pay over $2.00/gallon for self-service. Recently I've been thinking I have never paid more, other than on trips to Europe or Asia, but the graph showed I was wrong.

As low as inflation has been for the last few years, it's easy to forget how big the difference can be between nominal prices--prices in today's dollars--and real prices, adjusted for inflation. Nominal gasoline prices after the first oil crisis in 1973-74 averaged $.53/gallon for leaded regular, while those after the Iranian Revolution rose to $1.25/gallon for unleaded. When you adjust for inflation and bring them into 2003 dollars, these figures translate to $1.69/gal and $2.49, respectively.

This is not to say that gasoline isn't unusually expensive at the moment, but even for someone who follows these issues regularly and traded energy commodities for more than 10 years, it's instructive to see that we're still well short of the real record. And if the times we live in are less turbulent than the oil crisis years of the 1970s, it's not by much.

Smart Cars
Anyone who has traveled to Europe in the last several years has probably noticed the tiny Smart cars driving--and easily parking--in the Continent's most congested cities. They come in eye-catching colors and are even smaller than the popular Mini Cooper seen over here in increasing numbers. Last Friday the Smart hit the front page of the NY Times's "Escape" section, which described how enthusiasts are trying to acquire the car in advance of its 2005 rollout in the US.

Many times when I was trying to find a parking space in Manhattan or elsewhere I have wished I were driving one of these little cars, which were designed to fit three to the same parking space as a single Mercedes S-Class. But there were other times on Interstate 95, while being tailgated by an 18-wheeler going 65 and trying to go 75 right through my back seat, that I was glad I wasn't driving one. Clearly the Smart won't appeal to everyone, for every situation.

But I think that is the whole point. Here is a car that can meet a need for practical, economical transportation to the train station or generally around town, even if it's not the car you'd choose to drive from New York to D.C. Also noteworthy is that this car gets 60 miles per gallon without any of the fancy and costly technology of the hybrid cars or future fuel cell vehicles that I and others extoll.

When I see cars like the Mini and the Smart, I can't help wondering if they represent the next big trend in the auto world. Everyone focuses on SUVs now, fans and opponents alike. After all, they have been the hot trend for a decade. But the recent proliferation of extremely large, high-end SUVs such as the Lincoln Navigator or Cadillac Escalade, reminds me of the 1991 Buick Roadmaster station wagon, simultaneously the apex and last hurrah of the American station wagons that created the niche SUVs would later fill. Are we nearing that kind of tipping point, and is the Smart a sign of its arrival?

OPEC Waffles
Last month OPEC ministers decided to reduce oil production in the second quarter, even though the market is currently at historic highs. Their rationale centered on avoiding a glut in the in the upcoming post-winter heating, pre-summer driving season. Dissent now seems to be dividing the ranks before the cuts go into effect, as unnamed members wake up to the political damage that sustained high prices is causing them, and more importantly, to the risk that their actions will slow the economic recovery and reduce demand for the next couple of years.

It's about time. Over the last decade the market has swung back and forth between periods when OPEC could control prices and others in which a lack of OPEC cohesion or tranches of new non-OPEC production left them powerless to prevent a price slide. But as time passes, this game becomes riskier. Alternatives are creating new choices for industry and consumers, and each successive price spike takes a small notch out of future oil demand. These alternatives include not only wind and solar power, but more conventional fuels such as LNG.

As always, OPEC's leaders must find a way to balance the desires of members such as Algeria and Indonesia, whose limited production and reserves drives them to maximize short term revenue, with those such as the Saudis and Kuwaitis, whose reserves will last decades and who must lose sleep over the prospect of losing the market to coal, gas or renewables. But neither can they forget 1998, when the slide in prices due to falling Asian demand became a collapse. Let us hope they realize that this kind of scenario is highly unlikely today, as China booms and the US gets back on a growth track.

The FT quoted the Algerian representative fretting about a possible $7 drop in prices. $30 oil would take about 17 cents out of the gasoline price, and that would be good news indeed for consumers.

Numerators and Denominators
An article in yesterday's New York Times, quoted opponents of oil and gas drilling in Montana's Front Range saying, "How can someone take an area of this magnificence and sell it down the river for a few minutes of natural gas supply?" This perennial anti-development mantra may vary in proportion with the amount of hydrocarbons in question, but it is based on a serious fallacy.

In some ways, the terminology and shorthand of the oil industry helps give rise to this kind of misunderstanding. When experts talk about reservoirs and pumps and express reserve life in terms of reserves-over-production (R/P), a layman could easily conclude that engineers simply dial in how rapidly they want to produce the oil in a given field.

Actual production rates are a function of geological conditions, available technology, and the characteristics of the oil in question, which can vary considerably. There is an optimal rate of production for each well, and exceeding it can damage the reservoir and reduce overall recovery. As a result, production is spread out over many years, with volumes reaching an early peak and then declining. US oil and natural gas production is made up of the contributions from tens of thousands of producing wells, each with its own unique lifespan measured in years or decades, rather than the fanciful minutes or hours indicated.

The "only a few minutes/days/months of supply" fallacy is a wonderful tool for opposing oil or gas development, since through careful choice of numerator and denominator, the value of essentially any oil or gas project--no matter how large, can be made to appear trivial when compared to the environmental consequences that might ensue.

We hear this argument frequently in the case of the Arctic National Wildlife Refuge, which is deemed by opponents to hold only "six months of our national demand". Voters might view it differently if told that it has the potential to supply a fifth of total US oil production for 20 years, based on reserve estimates by the US Geological Survey.

Every oil or gas project such as the Front Range or ANWR has genuine pros and cons, some of them quite complex. But I don't think the debate is enhanced by cynically or ignorantly resorting to the kind of trivialization I have described above. We live in a country with an enormous and insatiable appetite for energy. Without the output of thousands of oil and gas fields--all of which were originally in some other, possibly pristine state--none of us would be able to heat our homes or get to work in the morning.

Making Lemonade
A recent article on the prospect for further tightening of the global market for metallurgical coke, the carbon source for steel production, triggered an odd train of thought. At the same time that this higher quality, coal-derived coke for steel production is becoming pricier, the world is being glutted with lower quality coke derived from petroleum, much of it produced in the US and Venezuela. Simultaneously, the price of natural gas has risen to historical highs in the US. The combination of these two factors creates an opportunity.

Petroleum coke (petcoke) is the byproduct of upgrading heavy oil into lighter oil, as done in a number of projects in Venezuela, or turning the heavy, tarry residue of petroleum refining into more valuable, lighter products, such as diesel fuel. Petcoke is similar in appearance and consistency to coal, and about as desirable from an environmental perspective. By virtue of being the absolute "bottom of the barrel", it concentrates the sulfur and metals from the source oil to much higher levels. As more upgrading capacity comes on line, more coke is produced and prices of this "fuel grade" coke fall.

But petcoke is an ideal source of carbon for the gasification process, in which low value, high carbon materials such as coal, coke, or residual fuel are converted into a so-called synthesis gas, resembling very low-grade natural gas. One of the main attractions of gasification is that contaminants such as sulfur and metals emerge in forms that are much easier to handle and remediate than if the same fuel were burned in a conventional power plant.

Although the resulting synthesis gas is not a direct substitute for the natural gas we burn in our homes, it can displace natural gas used in gas turbines for electricity generation.

Three or four years ago, this kind of "integrated gasification combined cycle", or IGCC, with its high investment cost, was nearly competitive with conventional coal power plants, but quite a bit more expensive than gas turbines running on natural gas. But with gas prices having doubled and tripled, and with cheap petroleum coke widely available as a feedstock, these economics should be reevaluated.

Perhaps we can kill two birds with one stone: helping to alleviate a very tight natural gas market in the US, while reducing the mounting piles of petroleum coke produced by the increasing number of heavy oil upgrading projects around the world.

Reaping the Wind
It seems appropriate to follow a discussion of solar energy with one on wind power, since they share many characteristics, as well as a common source: the sun. Both are intermittent in nature, producing energy only when the sun shines or the wind blows. This means neither can produce reliable power without some means of storing power for use in the dark or calm, or a backup generator. And both are low intensity, in the sense that they require a much larger footprint for producing a quantity of power equivalent to a natural gas or coal-fired central power plant.

But whereas solar power is still a niche product, wind power has moved well into the mainstream. The US added 1700 MW of wind generation last year, moving into second place behind Germany in total installed wind turbines.

Wind has also become a significant source of revenue for family farms in states like Minnesota. Even with the Federal subsidy for new wind power installations in abeyance, due to the stalled energy bill, wind will continue to grow in importance, partly due to state renewable power mandates.

As positive as all this sounds, a collision is occurring between the drive for more renewable electricity and concerns for preserving the environment. The poster child for this dilemma is the proposed wind power installation off Cape Cod. It has divided the environmental community in two, between those who see the benefits of a non-polluting energy source and those who say "not in my viewscape."

The fundamental issue here is the same as the one underlying my posting of March 11 concerning the natural gas that is kept off limits by restrictions on offshore drilling. Everyone wants their appliances and cars, but few indeed want the energy needed to run them to come from anywhere they can see or easily imagine.

We are nearing the end of the time when such views can prevail without exacting a high price in dependability. Last summer's northeast blackout, which added extra anxiety to the birth of my daughter that day, was a signal of how tenuously we are stretching the infrastructure upon which we rely. We may get another signal this summer, in the form of a gasoline price spike related to the Balkanization of state regulations governing gasoline specifications--a topic for another day.

None of this will change until we start, as a country, to connect actions and consequences: mentally linking the flip of a light switch to the spinning of a turbine somewhere, the turning of an ignition key to the drilling of an offshore oil well. The energy industry has made this pretty seamless for a long time, but the seams are beginning to show.

Solar Moves Mainstream
Last week General Electric announced it was buying the assets of the bankrupt solar power manufacturer, AstroPower. This follows GE's success in the wind power business.

In addition to giving GE an entree to a small but rapidly growing market, it may also be a signal that the global solar photovoltaic (PV) industry is approaching a critical threshold. As the scale of manufacturing increases, solar panels should enjoy similar "experience curve" effects as other technologies--though not necessarily as dramatic as Moore's Law for computer chips. Costs will continue to fall, and as they do, solar will expand out of its current niche applications, such as powering remote devices not connected to the power grid.

While the dream of clean solar power replacing large central power plants may never be realized, due to environmental objections to covering the landscape with the vast area of solar collectors that would entail, economical PV could create new markets that are additive, rather than competitive with traditional power. Besides expanding the growing range of options for homeowners and businesses seeking to reduce their dependence on the electric grid, it may find an even larger opportunity in the developing world, where people making only a few hundred dollars a year buy the most expensive form of power on the planet: disposable batteries.

What will be required to develop all these markets? Topping the list are manufacturing excellence, marketing expertise, and financial creativity. GE appears to have all of these skills in abundance, but it has no monopoly on them. Smaller players should see GE's entry to this market as legitimizing in the eyes of investors and potential customers. That can only benefit the industry as a whole.

Oil Reserves vs. Strategy
The Wall St. Journal has done an excellent job of covering the reserves problems at Shell without resorting to sensationalism. On Friday's front page they stepped above the questions of who knew what--and when--to raise a more profound question about the company's strategy.

The overstatement of Shell's reserves as far back as the mid-1990s distorted key indicators such as reserve replacement rates--their success at finding new oil reserves to replace what was pumped in a given year--and finding and development costs--how much they paid for each new barrel in the ground. As a result of these distortions, was Shell lulled into believing that it could deliver the results investors demanded via organic growth alone, when their competitors had concluded they must replace reserves through significant mergers and acquisitions?

This is a critical question, because by now the best opportunities of this kind have been snapped up by others. Amoco, Texaco and Mobil are gone, and only Marathon, ENI, and ConocoPhillips--itself the result of several mergers--remain in this size category. In order to be material to a company of Shell's size, growing reserves through M&A would now likely require buying multiple smaller firms, against a background of significantly higher oil prices than obtained when the transactions creating ExxonMobil, BP-Amoco-Arco (pronounced "BP"), and ChevronTexaco took place.

It may be that Shell's existing asset portfolio can deliver the desired growth, and that most of the reserves recently un-booked can be restored with time and prudent investment. If not, the shareholders of Royal Dutch and Shell Trading & Transport will have grounds for second-guessing management's decision to go it alone.

In response to my earlier comments on this situation, one colleague responded as follows:
"Reassessment is a painful and long process. They could've said that they were not in compliance when they first knew, but they probably could not have estimated the amount of the change without a rigorous survey of all the reserves.

Texaco had a similar problem in the 1990’s as management found out it may not be anywhere near its production growth targets. Even the analysts, in that case, knew that the forecasts were off. But it was only after a rigorous survey that took the better part of a year that a better picture emerged."

Finally, on the non-energy front, I am trying to digest the implications of the Socialist's come-from-behind win in yesterday's election in Spain. I don't understand all the complexities of Spanish politics, but it appears on the surface that the terrorists succeeded in scaring voters into a more isolationist view. Should we now expect a similarly aimed attack here in early November?

Nuclear Genie
Nuclear proliferation has been in the news a lot lately, between concerns about North Korea's weapons program and the even more worrying revelations about Dr. Khan's Pakistani nuclear Home Depot. Wednesday's NY Times featured N. Kristof's bleak editorial on a potential Nuclear 9/11 ,and last week's Economist carried their depressing, good news/bad news assessment of the situation. As they commented, "...the only real difference between a civilian nuclear fuel-cycle and a military nuclear fuel-cycle is one of intent."

What does this mean for the future of nuclear power? Roughly 450 nuclear power plants in 33 countries currently supply 6.5% of the world's primary energy (8% for the US alone.) They represent an enormous capital investment and an important base load of electricity. Barring the advent of economical nuclear fusion (see my posting of 2/13/04) or some new energy source with similar characteristics, they won't go away soon on economic grounds.

But that's the problem. Traditional economics does a very poor job of evaluating low risks of truly catastrophic outcomes. Previous conventional wisdom saw the nuclear industry's long-lived waste products as its biggest problem and assumed that proliferation was essentially under control. Surely that assumption must now be revisited.

We also need to be clear about the precise nature of our concern. Public speculation about terrorist use of a radiological device, or "dirty bomb", has created the impression that radioactive material is so ubiquitous that controlling it is beyond anyone's ability. But to paraphrase a friend's favorite Mark Twain quote, the difference between a nuclear bomb and a "dirty bomb" is the difference between lightning and a lightning bug. While a radiological explosion in an urban area would be a deadly disaster with serious aftereffects, a nuclear explosion, with its much larger effects of blast, heat, and radioactive fallout, would be a nightmare orders of magnitude worse.

That means that the real issue is not controlling all radioactive material, but rather fissionables, the uranium used to fuel reactors and the plutonium byproduct they produce. Is it possible to create a foolproof, ironclad global system that would deny any country not already in possession of both nuclear fuel and fuel processing technology access to either or both, while also severely restricting the activities of countries already in the club? President Bush has proposed one approach, while the International Atomic Energy Agency has its own plan. While it's not clear that either approach goes nearly far enough, neither is it clear that the will exists to go even that far.

Fundamentally, we must either find a way to control this trade, or it must be stopped entirely, with the massive economic consequences that would entail. Any other alternative risks creating a world order infinitely more dangerous than the nuclear roulette of the Cold War.

Unintended Environmental Damage
This fascinating article by a former Greenpeace activist details some of the unintentional fallout of concerted opposition to genetically modified crops around the world. Although Mr. Moore's focus is on biotechnology, it could just as well have been on energy.

Consider the bans on offshore oil and gas drilling imposed in areas such as California and Florida. Although targeted mainly at preventing drilling-related oil spills, such as the one that blighted Santa Barbara's beaches in 1969, they make no distinction between drilling for oil and drilling for gas, which incurs little or no risk of spills. As a result, billions of cubic feet of natural gas that US consumers and industry desperately need today are not being produced.

In the case of Florida alone, the resources in question appear sufficient to supply all of that state's gas needs for the next twenty-plus years. We know what these bans are intended to prevent, but what are their unintended consequences for the environment?

Well, for one thing, with natural gas prices extremely high today, the incentive to produce electricity from coal goes up dramatically. Coal plants are run harder, gas turbines less so, and this means more acid rain precursors and greenhouse gases are emitted into the air. Similarly, home heating oil looks more attractive relative to gas, and although it is not as dirty as coal, it is certainly not as clean as gas. So again, air pollution increases, because of policies that keep known reserves of gas locked underwater.

Finally, demand for gas imports goes up, too. Since new supplies from Canada and Alaska will require major new pipelines (with their own environmental impacts, which may prevent them from being built), the incentive to import liquefied natural gas (LNG)increases. We are currently seeing a media blitz on the virtues of LNG, which is indeed a clean fuel in and of itself.

Of course, when we evaluate the benefits of LNG, we don't typically factor in the energy that was used to liquefy it, a process that consumes 10-20% of the original gas, with accompanying emissions of greenhouse gases. Once it is in a tanker on the water, it requires a terminal near its final market in which to receive and regasify it. A number of companies are currently discovering the complexities of siting such facilities near anyone or anything.

So we begin with a set of values that declare natural gas to be cleaner and thus the fuel of choice, but then other values make it next to impossible actually to produce a good chunk of the gas that's right here in the US. The consequences are more pollution from burning other fuels and, in effect, "outsourcing" the negatives that concern us to some other country that will produce gas for us, turn it into LNG and put in on a tanker.

So in a manner not so different from the opponents cited by Mr. Moore, a number of prominent people who appear smart enough to understand the big picture relating to natural gas supply and demand have deliberately chosen not to, for reasons of ideology or political gain, resulting in a substantial increase in air pollution and worsening of the US balance of trade. They are entitled to their views, but they should not continue to masquerade as friends of the environment.

Proven Oil Reserves?
The ongoing shakeup at Royal Dutch/Shell over the recent restatement of their oil reserves is beginning to acquire the whiff of scandal, with coverage shifting from the business section to the front page, and with headlines verging on the sensational: "Oil Giant's Officials Knew of Gaps in Reserves in '02".

Whatever the ultimate outcome of current investigations at Shell, the end result will restore the company to conformance with SEC standards for the booking of oil reserves, which are meant to indicate an oil company's future production potential. Instead of viewing this situation through the lens of Enron/Worldcom/Parmalat paranoia, one could actually see it as an example of the system working, albeit a bit slowly. In any case, it offers an important caveat for international oil investors.

As the energy business becomes increasingly global, and as the number of players from outside the traditional circle of US and European majors--where standards such as the SEC's hold sway--expands, it is useful to remember that not every foreign company's reserve estimation processes would withstand such scrutiny. Before piling into shares of Russian and Chinese oil companies, for example, or partially-privatized entities such as India's ONGC, investors should make sure they truly understand what they are getting for the price.

While it is disconcerting to find that an established firm like Shell overstated reserves, a similar revelation about a company just coming into the world market would be disastrous for anyone who had bought into it. I suspect a lot of hard questions will be asked in the next weeks and months, in places that are less accustomed to that kind of transparency.

Venezuelan Politics
This short but insightful article from the Financial Times covers another electoral process that Americans should be watching with great interest this year: the effort by the opposition parties in Venezuela to recall President Hugo Chavez. Venezuela is the US's second largest foreign oil supplier--ignoring our NAFTA partners--and only a little over a year ago provided a vivid reminder of the impact of political instability on oil markets. A similar crisis today would send oil prices to the stratosphere.

Last week, it appeared that the efforts of the opposition to hold a national referendum on President Chavez had failed. The FT points out the hazards facing the opposition if they abandon their goal of a democratic solution to the current problem. President Chavez is popular with the poorer segments of the country and has a firm grip on the military.

Of equal concern is how he might react to any pressure the US might seek to apply, if the electoral process were derailed. Chavez is famous for his volatility and anti-American rhetoric, even as he relies on US and other international oil firms to grow his country's sagging oil production. Those companies will need to manage this relationship with particular care and sensitivity, while prudently managing their risks.

Image vs. Environment
The NY Times carried an amusing post-Academy Awards article over the weekend, contrasting the stars who drove Hummers to the Oscars against those who drove more economical and environmentally benign hybrid cars. The Toyota Prius and the Hummer represent completely opposite views of what car-buyers want, and the challenge for Detroit, Yokohama, and Stuttgart is how to weave these strands back together.

The Hummer is all about potential, and it epitomizes the dominant theme in auto design over the last ten-plus years: building cars with the potential to go faster, accelerate quicker, and carry more payload, further offroad, than the miserable cars foisted on us in the 1980s. The consumer who buys such a car wants to be going 70 mph by the end of the offramp, even if he knows he will have to jam on the brakes to avoid crashing into gridlock. She wants to be able to take the whole family and a week's gear to a base camp in the wilderness, even as she realizes her car will rarely carry more than her briefcase to the office. It is the triumph of image over practicality and economy.

The Prius represents something very different. It's a reminder that car technology has not stood still for 20 years, and that if we hadn't been so focused on adding speed, throw-weight and endless power gizmos to cars over the years, we would today have a car fleet averaging well over 30 miles per gallon and delivering reasonable comfort, safety and reliability, with all that entails for the environment and energy security.

But even if a new administration were to ramp up the minimum Corporate Average Fuel Economy (CAFE) standards--and close the SUV loophole in those standards--most consumers will still want it all: performance plus safety, economy plus spaciousness. How else do we explain the Hummer buyer who is dismayed to discover it gets less than 12 miles per gallon? Perhaps the new generation of hybrid SUVs currently under design will start to address this.

Cheap Oil?
A friend forwarded a recent article in Business Week that suggests the era of cheap oil is over, due to a combination of increased demand and greater OPEC cohesion. The industry has a rich history of seeing the future as a continuation of the present: when prices crashed in the late 1990s, due largely to the Asian economic crisis, it was hard for even seasoned oil executives to imagine a return to prices over $20/barrel any time soon. I believe the technical term for this is "availability bias."

We are clearly in an alignment that favors the producers at the moment. The US economy is recovering--whatever the politicians may say--and China is booming. At the same time, exports from Iraq have been sporadic and well below expectations for this stage of the occupation. Venezuelan production is probably less than officially stated, due to lingering aftereffects of last year's strike and production shut-in.

So in the short term, prices look very firm and have some upside. And in the long term, as I've discussed several times in this blog, there is the prospect of supply being unable to keep up with demand, due to the combination of depletion of mature basins and problems in bringing on new fields rapidly enough. But that leaves the all-important medium term, from a year to five years out. And the lesson of the 90s is that a swing of less than 5% from short to long can drop the market by multiple dollars.

In less than five years Iraq could start to have a real impact in the market, with existing production and infrastructure rehabilitated and new fields starting to come on. There are a number of other projects around the world that will be reaching the market in that period, including major projects in West Africa, the Caspian, and possibly Iran. And that ignores any demand-side impact a new US Administration might have. Combine these factors, and a couple of years from now we could just as easily be looking at $18-20 oil and wondering if OPEC can hold it together. And a few years after that, we could be back to scarcity.

The real lesson here is understanding the difference between true structural changes and temporary market conditions. And the kind of structural changes I'm talking about would be at the level of economical alternatives, new regulations, geological or capital constraints, or major new discoveries. However tempting it is to proclaim that things have changed for good and we are now looking at permanently high/low prices (take your pick), the incredible complexity of the factors involved has a way of overtaking such predictions in a remarkably short time.

China Big
The People's Republic of China recently passed a significant milestone: it now imports more crude oil than any country other than the US, at roughly 5.5 million barrels per day. This is remarkable to me, since I can recall when China routinely exported crude oil and refined products, because its domestic market was so small.

Last week's Economist described the impact of growing demand from China across a wide range of commodities, including metals, plastics, and energy. In essence, China's appetite for imported raw materials, whether driven by export industries or growing consumer demand, has become a force to be reckoned with in the same way as the US's.

This is a new thing in the world, and it is the opposite of what people typically meant a decade ago when they uttered the phrase in today's title. Back then, "China Big" was the standard justification for entering into any kind of deal with a local Chinese partner, since the market was bound to be so enormous later. A number of companies destroyed a great deal of shareholder value following that logic, and others will have to be very patient about their returns. But that's all beside the point.

China has graduated into a very exclusive club. At least in sectors like energy and mining, they have attained the size at which global firms simply can't afford not to be engaged with them in some way. An inevitable consequence is that we will see Chinese firms grow to truly global scope (and maybe scale), on the back of this.

The question is whether they will be content to follow the Japanese model of buying small shares of other people's projects, as in their recent purchase in the liquefied natural gas arena, or will prefer originating their own projects and truly competing with the majors globally. The answer to that question may say a great deal about the composition of the global energy industry of the 2010s.

Fire or Ice?
Two recent articles in the New York Times highlight growing concerns about the possible consequences of climate change, generally referred to as global warming. In the first, investors are becoming more assertive in asking energy companies to quantify their exposure to future regulation of greenhouse gases, which are associated with the observed warming trend of the last century or so. A number of firms, including mid-sized US upstream-only companies, are facing shareholder resolutions along these lines.

The second article compares the upcoming action film, "The Day After Tomorrow", by the director of "Independence Day", with an extreme climate change scenario commissioned by the Pentagon. The scenario was developed by Peter Schwartz, the founder of the Global Business Network, a leading scenario planning group. However one might assess the likelihood of such a scenario occurring, involving drastic cooling of Northwest Europe and the Northeast US as a result of interference with the North Atlantic warming current, such an event would certainly have major security implications.

Given the criticisms by both of the Democratic frontrunners of the Bush Administration's handling of global warming and the Kyoto Treaty, and with a blockbuster movie that could elevate the public's awareness, climate change could become a hot issue this year. If so, let us hope that this stimulates a meaningful national debate on the subject, rather than a rush for a quick fix. After all, even the most ardent supporters of Kyoto would agree that it was only intended as a first step in dealing with a problem that could be with us for the next century, or longer.

In Whose Orbit?
Interesting to see US Secretary of Defense Donald Rumsfeld visiting Kazakstan the other day and making security overtures to the Kazak government. Since the collapse of the Soviet Union, the countries around the Caspian Sea have been seen by some as a sort second Middle East. While the area's proved reserves of oil are still not on the scale of even Kuwait, by itself, it has upside potential and is an increasingly important supplier.

The Secretary's visit is notable for what it signals about the changing nature of US interest and involvement in a region that until recently was under the more-or-less exclusive influence of Russia, their "Near Abroad." Once Western companies began to establish themselves--ChevronTexaco set up operations in Kazakstan in 1993--closer governmental ties were bound to follow.

Russia is likely to view this relationship as unwelcome, and it is important to note that our interests and those of the Russians don't align well in the Caspian. Russia wants a big share of the infrastructure for getting Caspian oil to market, while the US prefers multiple routes involving smaller neighboring countries, such as Georgia, with its new pro-US government. This greatly oversimplifies the complexities of Caspian pipeline issues, about which books could be (and probably are being) written.

All in all, this is an area to watch, particularly as Russia becomes more self-confident and assertive in the wake of the likely landslide re-election of President Putin next month.

Democratic Energy Policies
As Super Tuesday approaches and the contest for the Democratic Party nomination enters its final phase, I thought it would be worth taking a look at the two leading candidates and where they might differ on energy policy.

The John Edwards campaign website has no separate energy page, but includes a number of energy issues on its environmental page. In general, he is for strengthened Corporate Average Fuel Economy standards, against drilling in the Arctic National Wildlife Refuge and in offshore areas currently off limits, supports research into alternative vehicle technologies, and supports ethanol. (This won't win him my vote, as anyone reading this blog will be able to guess, but at least he singles out the potential for "biomass ethanol", which promises to be much more efficient than corn-based ethanol.) He also appears to support the Kyoto Treaty, though perhaps not in so many words.

Frankly, there's very little detail here (which is my impression of the Edwards campaign, in general), particularly for an issue that he has raised frequently on the campaign trail.

Turning to John Kerry, though he covers many of the same issues as Edwards, his program is much more detailed and appears fairly well thought-out. It addresses the need for improved natural gas infrastructure, proposes aggressive targets for renewable energy and hydrogen, and endorses a major investment in clean coal technology. His plans focuses on tax incentives for consumers and businesses, not new regulations. He apparently supports the Kyoto Treaty, though his criticism of President Bush in this area mainly chides him for not trying to renegotiate it.

Though most of Kerry's plan is still fairly high level, it gives the impression that whoever drafted it at least spoke to some people who understand the energy industry and its issues. While I'm not exactly endorsing John Kerry, his energy policies are much better grounded than those of John Edwards.

Dirty Hydrogen Cars
Today's Wall St. Journal contains an excellent article highlighting findings of a soon-to-be released study by the Argonne National Laboratory on the effects of running an internal combustion engine car on hydrogen. Apparently the study will support earlier work by a number of researchers indicating that, unless the hydrogen in question is produced entirely from renewable sources, such as wind or solar power, the net result for the environment is no better than burning reformulated gasoline in an ordinary--and much less expensive--car.

BMW has been pushing its hydrogen-powered, internal combustion 7-Series for several years. This should come as no surprise, since the original technology to do this was developed in Germany in the 1930s.

The problem with this approach is stunningly simple: when you add the emissions from making hydrogen from natural gas--the way 99% of all hydrogen today is generated--to the emissions from burning it in an engine, the result is essentially the same as for a conventional car. This kind of analysis is called "well-to-wheels", and it is a much superior way of assessing total environmental impact than the traditional approach of simply measuring what comes out of a car's tailpipe.

In fact, even supplying hydrogen from renewable sources would not improve the picture very much for cars like the BMW 745H, since the electricity produced by the windmills or solar panels might be better employed backing down much dirtier generators, such as coal-fired power plants. This sounds like confusing and circular logic, but it reflects the reality that today's energy networks are highly inter-related.

This is why other manufacturers, such as General Motors, are eschewing the route BMW has chosen and concentrating on fuel cells. Although the same logic chain of "well-to-wheels" is equally applicable to fuel cells, they win in a number of areas. First, vehicles powered by fuel cells would truly have zero tailpipe emissions, unlike hydrogen powered internal combustion cars. In addition, their efficiency is inherently 2-3 times greater, so that the amount of hydrogen they will consume per mile is much less, and thus the amount of natural gas used--with its associated emissions--is much less.

Even if fuel cells never become economically viable, the true standard of comparison for a hydrogen-powered car should not be a conventional car, but the hybrid cars that are already available, such as the Toyota Prius, with many more hybrid models due on the market in the next two years. Hybrids are cleaner than conventional vehicles, from both a tailpipe and "well-to-wheels" standpoint, and they create a competitive bar that no hydrogen-powered internal combustion engine car can match.

The bottom line is that it is expensive to produce hydrogen and difficult to store it and use it on board a car. It only makes sense to go to these lengths if the hydrogen can be used in the car in a way that truly improves both the environment and our energy balance.

Saudi Shortfall?
The subject of oil depletion keeps cropping up. Yesterday an article in the New York Times confirmed what I had heard from colleagues in the upstream oil business a few years ago: production from the largest Saudi oilfields is declining, perhaps irreversibly.

We should not overreact. Saudi Arabia is not running out of oil, nor is the world, notwithstanding the arguments of the disciples of King Hubbert. But there is a very serious issue here, with implications for the economies of all oil-importing countries. For decades we have relied on Saudi Arabia as the "swing producer" within OPEC, able to make up for shortfalls elsewhere, such as when most of Venezuela's production was shut in at the end of 2002. The future of that role is now in doubt.

No one questions the Saudis' enormous reserves. They still rank #1, with 260 billion barrels of proved reserves, roughly a quarter of the world's total. Nor do they lack the necessary technical expertise to find and develop the new oil reservoirs needed to make up for the depletion of their venerable supergiant fields. But they do have the same problem as many smaller producing countries: the social demands of their growing population are competing away the internal funds necessary to revitalize their oil industry. In this light, the Kingdom's persistence in keeping out all foreign investment in the oil sector is a luxury that neither they nor we can afford.

The message the US and other G7 countries need to send the Saudis, consistently and with emphasis is, "Our oil companies have the capital you need, and together we have the expertise. Open up your oil sector, or we will do whatever we must to wean ourselves off the need for your oil. If you maintain your current posture, your oil reserves will end up locked under the sand, worthless to you or your descendants."

Without access to Saudi and Iraqi reserves, which can be developed quickly and relatively cheaply, the international oil majors will spend their investment dollars on increasingly remote and technically more challenging opportunities elsewhere, drilling in ever deeper water and finding ways to make smaller and smaller fields economical.

The same dollars that would unlock millions of barrels per day of Saudi oil will yield half or a quarter as much oil elsewhere and with longer lead times, creating the possibility that the majors will not be able both to meet growing demand and compensate for the decline of mature fields. That would lead to the kind of supply/demand collision I've referred to before, and to much higher oil prices as far as the eye can see.

In any case, this news heralds the importance of developing and deploying meaningful alternatives to oil. This must include renewable forms, such as wind and solar and the hydrogen-based technologies that would allow them to displace petroleum products, as well as fossil-based alternatives, such as gas-to-liquids and coal gasification. These actions can't replace Saudi oil anytime soon, but they would speak louder than all the diplomats we can send to Riyadh.

Ethanol Double-Dipping
The Department of Transportation this week announced that it would extend the benefit for so-called dual fuel cars. Under this program, carmakers get credit against their Corporate Average Fuel Economy targets (see last Friday's blog) for producing cars that are theoretically capable of running either on gasoline or a mostly-ethanol fuel blend. (You may have seen the little "FFV" logo with its green leaf on rental cars such as the Ford Taurus; it stands for Flexible Fuel Vehicle, qualified under the rule in question.) Only a tiny fraction of these cars ever actually run on ethanol.

This regulation adds insult to real injury. It is not enough that taxpayers massively subsidize the production of ethanol, which consumes, rather than saves fossil fuels in its manufacture (see my blog of 1/19/04). It is not enough that we force refiners to add ethanol--with little or no benefit for reducing air pollution--to reformulated gasoline by phasing out its only competitor, MTBE. In addition we must provide carmakers with another loophole in the CAFE standards through which tens of millions of SUVs have already driven, thereby further undermining whatever value this program is intended to have.

At a time when the nation is focused on the trial of Martha Stewart for stock fraud and clamoring for investigations into Halliburton's alleged overcharging on government contracts, isn't it high time for an independent investigation into the decades of intense lobbying that have made ethanol so unassailable--a virtual third rail in Congress--and perpetuated this extravagantly expensive and useless "energy" program, which costs more than $1 billion/year in direct subsidies and foregone federal fuel excise taxes and state highway taxes?

If this sounds strident, just consider how difficult it has been to get any kind of energy legislation passed, despite self-evident needs for improvements to our electric and natural gas infrastructure, and streamlining of access to the reserves of clean natural gas so necessary to reduce the consumption of more polluting fuels. All the while, ethanol masquerades as a bulwark of energy security, creating the false impression that at least something is being done to make us less reliant on imported energy.

Marine Air Pollution
The NY Times carried an interesting guest editorial on Saturday, raising concerns about the level of air pollution attributable to ocean-going vessels. The author, Russell Long, correctly identifies this as a significant source of pollution in certain areas, but his distortions and inaccuracies undermine the credibility of his message.

First, he refers to the fuel burned by these ships as "the dregs of the oil barrel". While marine fuels are heavier and more viscous than the gasoline or diesel we burn in our cars, they are no longer simply the final residue of the oil refining process. Most of the vessels afloat today are powered by giant marine diesel engines, which require higher quality fuels containing a larger fraction of refined oils and fewer pollution-forming contaminants such as sulfur and heavy metals.

More importantly, Mr. Long ignores a relatively simple solution already in practice in some ports, including the San Francisco Bay Area. Vessels trading there must carry fuels of two different qualities, one for use on the high seas and one for use in designated air pollution control zones. The proposed global regulations he derides would establish this kind of two-fuel solution for a number of sensitive regions around the globe.

Although this appears to leave the high seas at risk for pollution, Mr. Long's assertion that the "atmospheric scars of international shipping are causing concern among scientists studying global warming" is overstated. In fact, experts are divided over whether oceanic clouds caused by sulfate pollution (the kind these ships generate) promote global warming or retard its progress by reflecting sunlight off into space, thus easing the global heat balance. In any case, marine air pollution is not exactly "low hanging fruit" in the fight against global warming.

In the future freighters and tankers could be designed to operate on fuels similar to those that we put in our cars, or even on liquified natural gas, but these improvements would increase their cost/mile significantly. And here is where Mr. Long's most bizarre distortion comes into play.

He ends his editorial by portraying the entire issue as some odd manifestation of globalization run amok, with "foreign flagged ships ...responsible for almost 90% of the pollution in United States ports". He ignores something of which he should be well aware, as a "former shipping industry executive": marine fuel is supplied locally, as vessels refuel in the ports where they discharge cargo. So the burden of cleanup, rather than resting on foreign shippers, would also fall on the US refiners that produce these fuels and on US consumers, who would pay higher prices for the imported goods these ships carry.

Significant and costly changes to reduce marine air pollution may ultimately be justified, but not by the hodgepodge of tenuous facts and de-contextualized statistics put forward in Mr. Long's editorial.

CAFE Standards vs. Fuel Savings
Earlier this week, a NY Times editorial written jointly by representatives of the Sierra Club and United Auto Workers union argued against an administration proposal to revise the Corporate Average Fuel Economy (CAFE) standards governing the auto makers' average vehicle miles per gallon. Not surprisingly, their main arguments focused on the environmental and employment consequences of the proposed change, which would break down MPG limits by weight categories, with heavier vehicles allowed higher fuel consumption.

We have traveled far afield from the original intent of the CAFEs, which were imposed in the wake of the 1970s oil shocks. They were designed specifically to reduce imports of foreign oil, and they were initially very successful at this. Oil imports in the 1980s declined as more efficient cars entered the national fleet, and this trend remained more or less stable until the SUV explosion of the 1990s.

Without rehashing the pros and cons of SUVs, it is clear that the present CAFE standards are stalled in a confluence of trade and industrial policy, regional politics, and consumer behavior. The simple truth is that even at $2.00/gallon, the price of fuel is only a small and declining fraction of total vehicle operating costs, and at best a minor factor in car selection for most Americans.

Ultimately, even the fuel economy improvements inherent in new technology such as hybrid cars and "mild hybrids" (conventional cars with starters capable of shutting off the engine at traffic lights and restarting it instantly, without the driver noticing) seem likely to be swamped by the steady growth in annual vehicle miles driven, and thus unable to stem the growth in overall fuel consumption and imports.

So we are left with another 1970s stopgap program (see my Wednesday comments on the Strategic Petroleum Reserve) that should be rethought from first principles, not just tweaked. While any changes to CAFE would carry environmental and employment consequences, as the Sierra Club and UAW assert, we must be clear about what is driving our desire to manage fuel consumption. If it is still meaningful to be concerned about growing dependence on imported oil, at a time when we produce only 37% of the oil we consume, then perhaps it is time to consider new approaches that would address when, where and why we drive, and not just how.

The Lessons of Enron
This morning's big news was former Enron CEO Jeff Skilling turning himself in to the authorities in Houston. The prosecutors' strategy appears to have been to work their way up the chain of leadership, cut the deals to get at the next level up, then repeat. Will Mr. Skilling now do a deal to give up Ken Lay in turn for some kind of reduced charges? The courts will have their say in all this, and Enron will live on for years in our vocabulary as a prime example of ruthless, unethical business practices. But should that be the whole story?

With numerous books now available on the subject, the facts of Enron's rise, decline and fall are essentially a matter of public record. Where a lot of the commentary has gone wrong, however, is in seeing this case solely as a model of how not to run a company. Any other lessons have been shoved aside as either unimportant or invalidated by the larger picture of misbehavior.

Enron must also be viewed in the context of its times, in order to separate the chicanery from genuine innovation. It is easy now to forget that the Enron mystique of the late 1990s arose not just from its earnings and stock price growth--both now seen as the result of overly "sharp" financial engineering--but from a variety of genuinely novel and clever (in the best sense) approaches to an industry that was going through major changes, some of which were not readily apparent to its largest players.

It was one of the few firms in the energy industry during the Tech Bubble that did not have its stock price pummeled for being too traditional and asset-laden. For a few years, all the other energy players had to look at Enron and wonder what they themselves were doing wrong. It is too comforting and facile to now write off that whole period as an anomaly based only on legal and accounting transgressions.

We should also remember that Enron created markets and products for which there was genuine demand, and it appeared to possess the laudable knack of learning from its mistakes without becoming paralyzed by them. It would be fascinating to see someone reconstruct the financials of the real business, minus the swindles created to pump it up. The whole thing sank when Enron committed the cardinal sin that any trader can make--and Enron was fundamentally a trading company. A trader can never, ever do anything to make the people he is dealing with doubt his credibility. The moment their financial house of cards started to collapse, it became impossible for them to sustain their trading volumes, and the death-spiral began.

There is something seductive and reassuring about watching successive Enron executives do the "perp walk", as we endow them in our minds with all the Seven Deadly Sins. Beyond the headlines, though, is what I believe to be a much more interesting and complicated story of a company that went out of its way to hire smart and clever people, gave them their run, but then let them down badly by never learning (or bothering) to rein them in when their ideas went out of bounds.

A Better Strategic Petroleum Reserve?
Following on from yesterday's posting about the Strategic Petroleum Reserve, rather than asking about the timing of adding oil to the existing SPR, Senators Levin and Collins might instead have asked whether the SPR itself is the most efficient way to provide the desired protection from supply disruption.

The tricky aspect of such a strategic reserve is that it sends two signals: the intended one to suppliers about our ability to do without them in extremis, and an unintentional signal to the market affecting the overall psychology of holding inventory. In the last twenty years commercial crude oil stocks--in absolute terms and particularly when measured in days' supply--have declined significantly. While this might be coincidental, the mere existence of the SPR has reduced the risk of holding lower inventories.

In addition, President Clinton's decision in the fall of 2000 to release crude oil from the SPR to try to hold down home heating oil prices sent a particularly confusing signal, since it directly undermined the incentive for companies to build inventories during low demand for use in periods of higher seasonal demand and prices.

The basic issue is providing an adequate backstop in case of actual disruption of supply, not trying to run the SPR for a profit or using it as a political tool to influence prices. This can certainly be done by a combination of government-owned storage and iron discipline on when to release stocks, as with the current SPR, but it could also be achieved or augmented by making commercial inventories less onerous for companies to hold.

Refiners are conservative people by nature. They are rewarded for running their facilities safely and profitably, and they work hard to avoid anything that interferes with that. Left to their own devices, they would hold lots of inventory, because it increases their flexibility and reduces the risk of running short of crucial inputs. But their accountants have been telling them for years that holding more inventory than absolutely necessary has dire tax and working capital consequences, and reduces the rates of return on their huge capital base. If companies were given incentives that eliminated these detriments, refinery managers would happily increase their inventories.

The other benefit of a scheme like this would be to circumvent the limits on how quickly the reserve could be drawn down when needed. The current limit on the SPR is 4.3 million barrels/day (MBD). At this rate, it would take almost six months to draw down the entire 700 million barrels on hand today. Holding equivalent volumes in hundreds of facilities, instead of a handful, would avoid this bottleneck.

Of course no one foreign supplier sells the US this much oil today, so one could argue that the likelihood of needing to draw down more than 4.3 MBD is low. But the loss of Saudi Arabia--not so hard to imagine in today's world--would take much more oil out of the world market and create major disruptions as traders tried to rebalance supply and demand.

But a side benefit of moving to a commercialized, incentivized structure would address precisely the concern of the two Senators. Decisions on when to add to inventory would be made by managers who are actively in the market, routinely making such decisions, rather than by government bureaucrats. Could such a system be gamed, a la Enron? Perhaps, but the incentives could be structured to minimize such behavior.

In many respects, though useful and better than blind faith, the SPR is an anachronistic holdover of a period of extreme regulation--remember the wage & price controls of the 1970s? Given the waves of deregulation that have swept industry after industry, it might be timely to look at this relic in a new light.

Strategic Reserve Role in Prices
Over the weekend, the Financial Times carried a story highlighting criticism of the Administration by two US Senators, Levin of Michigan and Collins of Maine, for adding to the Strategic Petroleum Reserve (SPR) when oil prices are high. The senators cited various estimates of the cost of this policy to consumers, from $4-8 dollars per barrel (or 9.5-19 cents/gallon of gasoline).

The DOE's statistical service, the Energy Information Agency, indicates in its weekly reports that about 100,000 barrels per day went into the SPR last year. If the goals cited in various reports are correct, the rate would increase to about 150,000 barrels per day for 2004. To put that into perspective, US refineries processed 15.3 million barrels/day (MBD) last year, of which only 37% came from domestic production.

So the two senators and the economists backing their arguments assert that a volume amounting to less than 1% of total US oil supply, or only 0.2% of total global supply is sufficient to drive up global crude prices by more than 10%.

By comparison, during the national strike in Venezuela, nearly 3 million barrels/day, 4% of global supply and 20 times as much as oil as is being put into the SPR, were taken off the market for almost 3 months. By the end of the strike, prices for West Texas Intermediate crude oil had risen by $10/barrel, in a period that coincided with the runup to the Iraq war. A month later, prices were back at the pre-strike level, even though Venezuelan production took many months to restore fully.

Oil prices are volatile and nearly impossible to predict in the best of times, with many complex factors interacting chaotically. But it seems a safe bet that there is more politics than economics in the argument of Senators Levin and Collins that continuing to fill the SPR is seriously pinching consumers at the gas pump.

Happy Presidents' Day!
No posting today.

Is Fusion Even Worthwhile?
This week's Economist carries an acerbic analysis of the rivalry over where the International Thermonuclear Experimental Reactor should be sited. While their insight into the tussle--as a proxy for the rift over the Iraq War--rings true, their conclusion that fusion research has no value is shortsighted and poorly reasoned. Fusion could be a valuable, even an essential, component of the future post-hydrocarbon energy mix.

The article observes that practical nuclear fusion--which releases energy by combining lightweight atoms, in contrast to the splitting of heavy atoms achieved in nuclear fission--has always appeared 30 years off. Fair enough; I would have said 40. But in dismissing it as permanently uneconomical and marginal, they ignore the benefits that have convinced a number of governments to fund research in this area for decades, despite the absence of a home run.

Fusion offers the potential of limitless, clean power. Even when one reins in this nirvana-like vision, fusion gives us a realistic possibility of high density, cost-competitive power generation with very little in the way of the emissions or radioactivity that make all of today's central power plants unattractive. This sounds like something well worth pursuing, at least at the relatively modest sums that are being contemplated. But what is missing here and what the Economist has ignored entirely is a vision of where fusion might fit in a future global energy system.

The most frequently mentioned alternative to our hydrocarbon-based energy system is a hydrogen economy. But a hydrogen economy still needs an energy source to produce the hydrogen. In the long run, that means doing so without creating more of the kinds of emissions that impel us to want to switch to hydrogen in the first place.

The only options meeting this criterion today would use electricity from wind or solar power to break water into hydrogen and oxygen. This approach suffers from two serious shortcomings:
- Generating the necessary quantity of electric power from these sources would require covering vast swaths of territory with windmills or solar collectors. There is ample evidence of environmental pushback to this.
- It may not be possible to build wind and solar installations fast enough to keep up with growing demand for electricity, let alone being able to replace the energy content of petroleum fuels.

Moving the solar collectors into orbit could solve both of these problems, but it would require a much larger and cheaper (in terms of cost per pound in orbit) space program than anything our politicians seem willing to support.

So what is needed to make a hydrogen economy not only possible but desirable in the long run is a concentrated, essentially zero-emission source of electricity that doesn't blight the landscape. Conventional nuclear power plants or their advanced technology offspring might fit the bill, but they would still leave us mired in endless debates about nuclear waste, as well as vulnerable to further nuclear weapons proliferation.

Ultimately, if the suggested timescales are finally right, and fusion research delivers an economical product by around 2040, it would provide an ideal means for converting a hydrogen economy begun with hydrogen from natural gas and other fossil fuels to a permanent, non-fossil energy source. If the nations of the world aren't willing to come up with $10 billion to fund a bet like that, maybe we could raise the money on the Internet.

Depletion Book
Last Sunday's NY Times Book Review carried this review of "Out of Gas", by David Goodstein, a Cal Tech physicist. Although I haven't read the book, it would appear to move the topic I covered in last Friday's blog out of the technical press and into the mainstream. This should enlarge the debate, and that seems healthy.

Nevertheless, I can't help feeling that there are a lot of folks out there trying to pin down something that is inherently unknowable until you can look back and say, "Yes, that was the peak of oil production." If I have understood all the analysis, arguments, and evidence, then there probably is a geologically-determined peak of production looming somewhere ahead, whether this decade or 50 years from now. However, as I said earlier, I believe we could experience a practical peak with higher certainty and sooner than the theoretical peak.

This is a little like the oft-quoted remark by Sheik Yamani, the former Saudi oil minister, "The Stone Age came to an end, not because we had a lack of stones, and the oil age will come to an end not because we have a lack of oil." My paraphrase of this would be that we won't run short of oil because there isn't enough left in the ground, but because it won't be politically or economically feasible to produce as much as people want.

The distinction between my argument and the depletion crowd's view may seem esoteric and trivial, but I think it matters for the following reason: Because no one can predict precisely when a geology-driven decline will happen, it makes it very difficult to justify taking any action now, particularly an expensive one such as switching to an alternative energy source. Conversely, because we can monitor the economic and geopolitical factors that would create the kind of practical oil peak I suggest, we will have more advance warning of such an event and can also contemplate action to stave it off through changes to trade policy, industry structure, tax regulations, and contractual terms between companies and sovereign countries.

The latter approach has the added advantage of avoiding the kind of wolf crying that has been going on for at least the last 50 years, with every generation of oil professionals signalling an imminent decline. It is one thing to tell people we are running out of oil and quite another to say that, due to industry consolidation, low returns relative to other investments, and political squabbling over pipeline routes, it appears we may not be drilling enough wells and building enough infrastructure to ensure that the oil (and natural gas) we will need in the future can be brought to market quickly enough to avoid a shortfall.

OPEC's Ballet
The papers and newsites are full of OPEC's announced 10% production cuts. In response, West Texas Intermediate crude oil futures are trading close to their contract highs for the year.

We've seen this dance before: OPEC struggles to rein in overproduction by its members to stave off a possible future price collapse, even though prices appear robust at the moment. It is always a tricky maneuver, and this time the possible consequences of guessing wrong are particularly high for both the industrialized world and for the oil producers.

Coming at a time when US industry is already under pressure from high natural gas prices, and when gasoline inventories are tight, OPEC's cut risks undermining the US economic recovery and compound the problems that the rise of the Euro against the dollar have created for European firms. I don't doubt that they have thought about these possibilities.

OPEC must always try to walk the line between prices that are too low to support the social programs its members fund with oil revenues, or so high that they reduce demand and stimulate non-OPEC producers to increase their output, not just in the short term but for years to come. This year they should consider another possible outcome of prices that are too high: the election of a US President less likely to understand their concerns and empowered to introduce measures that would begin to cut into US demand for imported oil.

A number of commentators have suggested a crucial difference between a new Democratic administration and that of Bill Clinton. Whatever his personal faults, Bill Clinton believed in free trade and free markets. Whichever Democrat wins his party's nomination--and it's looking increasingly remote that it will be anyone other than John Kerry--he will run on a platform that sees free trade as an obstacle to employment and growth, and that views oil--imported or otherwise--as a necessary evil to be minimized by whatever means necessary, whether market-based or not.

This would not be a happy outcome for OPEC, or for the Saudis in particular. As the stewards of the largest oil reserves on earth, they have a vested interest in oil remaining the transportation fuel of choice for the rest of the 21st Century. If they have been paying attention, and I believe they have, they must realize that the technologies and tools for beginning to wean the world off its dependence on oil are much closer to practicality than they were even a decade ago.

We should know by summer whether the OPEC ministers were prudent or shortsighted in their decision.

Top 10
Yesterday's Wall Street Journal included its annual "Top 10 Trends in 10 Industries". Their rundown for the oil industry was well done, but totally conventional. It included concerns about the decline of oil production in North America, the shift to greater reliance on potentially unstable suppliers and to resources in deeper offshore waters, as well as the growing interest in LNG.

I suppose it's understandable that with so many big shorter term concerns to cover, neither alternative energy nor the environment were mentioned, beyond the shift from MTBE to ethanol as a smog-fighting gasoline additive. But it isn't hard to imagine how different the list would have looked had it been produced by one of the Journal's European competitors. Certainly, the impact of government actions to reduce greenhouse gas emissions would have made the list. Sustainable development and the growing interest in alternatives to petroleum-based fuels, whether biodiesel, methanol, or hydrogen would also have contended for one of the top spots.

There's a natural tendency for us still to see oil as a US-dominated industry, and surely that's what the Journal is reflecting. But in a world with global capital markets, in which 3 of the top 5 publicly traded oil and gas companies are European (BP, Shell, and TotalFinaElf), that view seems somewhat myopic and outdated.

I don't dispute that the issues the Journal chose are significant, nor do I wish to attach more importance to this Top 10 list than it deserves. But at the same time, given the tremendous credibility of the WSJ, it will reinforce the thinking of US executives who would just as soon ignore the other issues I mentioned. At the end of the day this only perpetuates a peculiar insularity in the midst of one of the most globalized businesses on the planet.

Hydrogen Pessimism
Last Friday's New York Times carried a story reporting the release of a study by the National Academy of Sciences on the prospect for a rapid transition to a hydrogen economy. The study concludes that such a transition is decades away, with minimal impact in the next 25 years.

Rather than seeing this as a pessimistic criticism of the Administration's hydrogen policy, or of countless hydrogen enthusiasts and entrepreneurs, I believe it is a useful reminder that huge uncertainties will influence the future evolution of our energy systems, and that it is impossible to conclude today how this will turn out. Those who posit a robust hydrogen economy in 2020, running on fuel cells powered by hydrogen generated by clean sources, are no more or less likely to be right than those who suggest that the status quo can survive unchallenged and unchanged.

In the Executive Summary of the NAS report--as far as I've read at this point--the authors skirt what I think is a more interesting policy question. If a hydrogen economy is indeed so distant and impeded by so many obstacles, should the government be moving the country in that direction now?

This is really the old "industrial policy" question writ large: should government be in the business of picking technology winners and losers? The view that it should was much in vogue in the 1980s, following the success of Japan's Ministry of International Trade and Industry (MITI), but went out of favor in the 1990s, when the "unguided" approach of the US seemed so manifestly superior and Japan drifted off into post-bubble doldrums.

If we start with a premise based on energy security concerns and a potential shortfall in future oil production (see my posting of 2/9/04), then perhaps what is needed--along with a certain amount of hydrogen-related federal R&D--is a more general approach that lowers the barriers for any new energy technology. This could include tax and accounting changes to make it easier to change out old infrastructure, expanded and non-technology-specific fleet mandates for alternative fuel vehicles, and a variety of other incentives to encourage business and industry to try out new energy technology.

The markets must play a role, too. One measure of success would be reaching a point at which "Technology Stocks" no longer referred just to IT and telecom stocks, but also to energy-related stocks. We are already beginning to see a blossoming of energy ventures, many of them wacky and bizarre, but some having real economic potential.

The outgrowth of all this activity could well be a hydrogen economy--and sooner than the pessimistic assessments would allow--or it could be something completely different and impossible to anticipate now, but that would achieve the same goals of enhanced energy security and environmental protection that have made the notion of a hydrogen future so alluring.

Is A Peak in Global Oil Production Looming?
I've alluded several times to the subject of oil depletion, decline curves, and the controversy over a possibly imminent peak in global oil production that would presage an eventual decline. While I don't have the geology background to weigh in on the Hubbert/Deffeyes/Campbell argument, my own experience in the planning, economics, and logistics side of the industry suggests a useful qualitative way to look at the issue. In this view, serious consequences don't depend on a geological limitation on the amount of oil that can be extracted from the ground, but rather from a set of practical and much more mundane constraints.

Oil demand has increased in the last decade and looks set to continue doing so, not incredibly fast, but steadily, about 1-2%/year. Efficiencies in the established economies are likely to be offset by new demand, as countries like China and India develop. As a result, even if global oil production doesn't hit a theoretical peak and start to decline, it could well reach a point at which it can't keep up with the growth in demand. Depletion plays a significant role in this story, but in a subtler way.

Start with current oil production--and demand--of roughly 80 million barrels/day (which I will abbreviate as MBD). Experts see this figure growing steadily towards 100 MBD in the next decade or two. Now add up all the places that can bring on new production to deliver the required incremental 20 MBD. Clearly this would have to include countries such as Saudi Arabia, Iraq, Russia, Nigeria, Angola, Venezuela, and the Caspian Sea region. Now factor in the need to find new production to replace the amount by which current production will have slowed down by then, which could be as much as 30-40 MBD.

In other words, in order to reach 100 MBD in 20 years, we will have to find NEW production that amounts to more than half of current production. That is an enormous challenge, and I'm skeptical it can be done in the real world, when you factor in the kind of practical constraints the industry faces, such as:
- Disputes and delays affecting pipeline routes, e.g. for Caspian oil
- Government policies in the Middle East and Mexico that keep out international oil companies and their capital
- Legal and human rights challenges to new oil and gas projects all over the world
- Environmental and land use restrictions that put some reserves out of bounds (e.g. offshore Florida and the Arctic National Wildlife Refuge
- Capital markets that see opportunities and returns in other industries as more attractive than those in the oil industry

Oil economics are also peculiarly shortsighted, for such a long-term business. The commodities markets focus on today's supply and demand picture, rarely looking more than a couple of years out. And the farther you go out into the future, the thinner these markets become. If there is a production peak or supply/demand gap sitting out there, whether due to geology or geopolitics, and if it's not blindingly obvious until you have actually hit it, than the economic signals from the oil markets telling you to find an alternative are going to come pretty late in the game, too late to provide time for a transition to something else.

Most of us who have looked seriously at a potential hydrogen economy believe it will take a minimum of 15-20 years, and possibly as long as 30 years, to make that kind of transition, because of fleet turnover issues and the high costs and low returns associated with much of the required infrastructure. Even government edict probably couldn't force it through in less than a decade, under nearly wartime discipline.

So if there's a peak in oil production or a serious supply shortfall in the years ahead, then the market will go through a true discontinuity when it occurs. That is, prices on the far side of such an event will be much higher than prices on the near side, probably permanently. These kinds of discontinuities change the world, just as the perceived oil crisis of the 1970s would have, had it lasted more than a few years.

More Oil Depletion
The Wall Street Journal recently carried a short piece citing Matt Simmons, who runs an energy-focused investment bank, on the signs of depletion in some of Saudi Arabia's largest oilfields. This topic and and its relationship to a possible imminent peak in oil production comes up periodically.

I'll comment at greater length tomorrow on the subject of such a peak in production, but while I don't doubt that there is evidence that Saudi Arabia would struggle to increase its production above current levels, it is still hard to imagine that reserves in the Kingdom could be so overstated that they could be close to actual decline.

A somewhat different issue is whether the Saudis can deploy sufficient capital and technology to bring on new production as fast as needed. The Saudi monarchy is under tremendous pressure, both political and demographic, to maintain public services for a rapidly growing population. With oil providing the main revenue stream for the country, can they plow enough money back into exploration and production to avoid using up their margin of "reserve" production? The same issue has hampered Venezuela's oil industry, as they siphoned off oil money for social programs. And the Saudis may have to turn in the same direction that the Venezuelans did: the oil majors.

There is a very strong case that the international oil companies have exactly the capital and technology that the Kingdom needs, if it is to avoid this self-imposed trap. Can they break with their own past sufficiently to offer up the prize of access to the world's largest stock of untapped, low-cost oil reserves? Perhaps the prospect of the same companies diving into Iraq once a government is in place will shake them out of their complacency.

Brand New Markets
On a flight back from the West Coast yesterday, I was again struck by the way in which so many things are limited by the poor power density of rechargeable batteries. Laptops, cellphones, MP3 players, etc. would all be more useful with a longer-life power source. There are plenty of companies working hard to do just that, particularly with fuel cell-based approaches.

But turn that logic around for a moment. What new devices might fuel cells or some other order-of-magnitude improvement in power storage enable, that aren’t even possible today? What could emerge, once we have a “battery” (and a fuel cell is really just an open-ended sort of battery) that is good for multiple days of heavy use, not hours or minutes? This is only one example, and I suspect there are a number of others in development, including some for customers who would rather keep their existence quiet.

Putting fuel cells in laptops and cellphones may not do much to speed the day when you can buy a practical and affordable fuel cell car. But entirely new devices that capitalize on the potential of fuel cells to put out more power for longer periods, particularly if they create a premium price market for larger fuel cells, could be the missing enabler. Something like a giant, autonomous fuel cell vacuum cleaner, ten times the size of the Roomba and capable of cleaning an auditorium instead of your living room, might actually be the way to hasten the arrival of fuel cell cars.

What Will $4.5 Billion Buy?
ExxonMobil was in the news several times last week. They reported earnings for 2003 of roughly $21.5 billion, a startling figure in any business at any time, but about what you might expect from the world's biggest oil company in a year with high prices for both oil and gas. The other main story related to a revised judgment against them for the massive oil spill in Alaska from the tanker Exxon Valdez. The judge set $4.5 billion in punitive damages, and the New York Times suggests that Exxon should pay and move on.

At a time when the nation is running deficits of nearly half a trillion dollars, this amount seems paltry by comparison. And Exxon's assets are worth over $150 billion, so it might seem large but not unmanageable, right? In short, it is easy to lose touch with the value of this kind of cash to a real company and its shareholders.

For example, Exxon produced 900 million barrels of crude oil in 2002. If their cost to find and develop new reserves to replace each barrel they produced that year--to keep their production from declining in the future--were $4.50/barrel, then the proposed penalty is on the same order of magnitude as one of Exxon's largest and most important activities.

Another useful comparison: Exxon annually pays out over $6 billion in dividends to shareholders. In fact, when you subtract out their dividends and all capital and exploratory investments, what you have left out of the $21.5 billion of profit is about what they paid out in 2002 to repurchase shares of their stock, which presumably increased the stock price for their investors.

Let me state clearly that I am no apologist for Exxon. The Valdez disaster gave a black eye to the entire industry, and it was preventable. Exxon should pay for all the damage it caused, and some amount above that. But judges should also carefully examine the true value of the penalties they impose, and resist the easy temptation to read no further than a company's quarterly earnings press release. Setting the punitive damages so high merely ensures that the award will be appealed for years, further delaying any payout to those whose interests were actually harmed in an incident that took place in 1989.