Spending the Windfall
Ever since oil prices popped up into the stratosphere last year, the market has wondered how the major oil companies would spend the resulting cash windfall. The answer so far has been fairly restrained: stock buybacks, balance sheet polishing, and little to no increases in exploration. Now ChevronTexaco has apparently thrown its hat in the ring in the chase for Unocal, in competition with one of China's state oil companies. It will be interesting to see if the resulting offer for Unocal is in cash, stock, or a blend.

Unocal looks like a good fit with ChevronTexaco's existing portfolio, and the California reformulated gasoline patent I highlighted in my posting of 1/7/05 should be much less of a concern in a domestic transaction such as this, though it could still draw regulatory attention. One of the more interesting angles concerns Unocal's controversial position in Burma. Would ChevronTexaco retain this, or divest it as Texaco did a few years ago?

Although a Chevron/Unocal transaction would make sense from a company perspective, it does not address the fundamental issue facing the industry today. The consolidations of the last decade have enhanced the size and profitability of the global energy companies, but they have not noticeably increased aggregate production. With reserve replacement slipping and the national oil companies preoccupied funding domestic social programs, the global oil industry will continue to struggle to meet the growing demand for petroleum products generated by the development of China and India.

Small, Warm Fusion
For all the interest in useful renewable energy technologies such as wind and solar power, nuclear fusion remains the ultimate "alternative energy", even as it remains a distant prospect. Although the "Cold Fusion" fiasco of 1989 gave the pursuit of small scale fusion a bad name, interesting work is going on in another bench-scale possibility, involving the collapse of bubbles in liquid. A colleague just forwarded the abstract of a peer-reviewed paper on this topic in one of the journals of The American Physical Society. The experimenters are directly addressing the concerns of other scientists who are questioning their earlier results.

The process in this case involves bombarding a bath of acetone and deuterium (heavy hydrogen) with sound waves and neutrons. The authors of the paper report finding evidence of nuclear reactions in the fluid--flashes of light, neutron emissions, and tritium (even heavier hydrogen)--that don't occur when they perform the same experiment on a bath containing only acetone.

This is pretty exciting stuff, even though Fleischman and Pons claimed similar evidence for their cold fusion experiments. As always, the proof rests on whether the results are repeatable, not just by the same team but by other researchers using their own apparatus, and if all extraneous influences, such as gamma rays from space, can be ruled out.

The implications for successful nuclear fusion at low temperatures and with fairly simple equipment would be profound, including all the benefits of large-scale fusion, plus the ability to provide them on a distributed basis without large central generating plants. This is a story I plan on following, with an appropriate degree of skepticism.

Hydrogen Distortion
It's unusual to run across an article that cites a long list of references yet contains an equally long list of errors of fact--or at least of connecting unrelated facts in a way that renders them erroneous. I just received one from a newsletter called EnergyPulse. The title was intriguing, "The Hydrogen Economy - Energy and Economic Black Hole," by Alice Friedemann. This article illustrates how rapidly we've gone from a general view of hydrogen as a perpetual-motion energy nirvana, to a realistic understanding of hydrogen as an energy carrier--not a source--and onward to a growing body of criticism seeing hydrogen as, in Ms. Friedemann's words, "an energy sink." This is a step too far, at least at this early stage.

Now, I certainly agree that you need a good reason for turning some other form of useful energy, be it natural gas, coal or electricity, into hydrogen, because of the energy losses inherent in any conversion process. But this categorically does not mean that sufficiently good reasons don't exist. In the case of the fuel cell cars and trucks currently under development, that reason is the high thermal efficiency of the fuel cell itself, which has the potential to more than compensate for lower efficiencies in other parts of its energy chain.

The fair and objective way to compare efficiencies is on a "well-to-wheels" basis that looks at the entire system of fuel delivery, conversion processes, and vehicle. This analysis looks at the original energy content of the fuel and the amount consumed in every step along the way, enabling direct comparison of a wide variety of energy systems. You can, for instance, compare the efficiency of a hybrid car running on gasoline refined from oil pumped in Kuwait and transported to the US by tanker versus a fuel cell car running on hydrogen extracted from natural gas produced in Louisiana and transported by pipeline to a chemical plant. A number of independent groups have done this for a variety of fuel and vehicle combinations, and the results are available on the internet.

Unfortunately, Ms. Friedemann seems to have selectively chosen the worst news from each separate step and created her own "woe-to-wheels" analysis. For example, she strings together the "efficiency" of a wind turbine with that of hydrogen generated by electrolysis to demonstrate how much energy is lost making hydrogen to run a car. But if the lost wind energy was never available to us in any other form, the whole concept of efficiency becomes meaningless, and the correct multiplier is 1, not 1/3. The article includes at least sixteen other errors of fact or interpretation, or suppositions stated as facts.

While I don't mean to belittle someone who apparently did a lot of research before writing a freelance article, I believe it is important to debunk this kind of pseudo-science, just as it is important to disabuse the public of the notion that hydrogen from the sky will solve all our energy problems. Hydrogen is no one's free lunch, but neither is it a pointless boondoggle. Instead, it is a promising potential pathway for introducing non-fossil-fuel energy into transportation modes currently dominated by petroleum products. It will take years and much effort before this pans out, if it ever does, but it is entirely premature to write it off today.

How Firm a Foundation?
While many factors have contributed to relative energy security for America since the oil crises of the 1970s, the foundation of this stability has been a free market and a diversified supply strategy focused on regional suppliers and away from the Persian Gulf. A pair of articles in the current Economist (subscription may be required) raise questions about the future reliability of two of the principal enablers of this diversification, Mexico and Venezuela.

Prior to the 1979 Iranian Revolution, the US imported roughly 8 million barrels per day (MBD) of crude oil, with two-thirds coming from OPEC and about a quarter of the total from the Persian Gulf. Last year, the volume of oil we bought from OPEC was about the same as in 1978, even though total imports have climbed to nearly 13 MBD. Persian Gulf imports are up about 10% from the late 70s, but still account for less than a fifth of the total.

If Mexico proves unable to increase its production to cover both its growing domestic market and the increased appetite north of the border, and if Venezuela accelerates its political shift from a "Bolivarian Revolution" to "Fidelism" (see my posting of 2/1/05) then even the current volumes we buy from these countries will be at risk. The consequence would be a rapid shift to dependence on imports from the Middle East, in direct competition with China and India.

The problem seems clear, but the solution is not. How much influence does NAFTA give the US in a Mexican political process rooted in sacred-cow nostalgia for a 1930s nationalization that is blocking needed foreign investment in the oil sector? Can we find a way to work with Venezuela's neighbors to contain Mr. Chavez's dogma, without returning the region to the instability it experienced a generation ago? And can we accomplish any of this while preoccupied with terrorism and the democratization of the Middle East? The alternative will require us to get serious about conservation.

Although it's unrealistic to imagine that the US can ever again be self-sufficient in petroleum, maintaining balance and diversity in our oil supplies is possible and desirable, even if our long-term goal is the creation of a non-oil-based economy. Preserving this balance in the face of new challenges, however, will require elevating its priority in our diplomacy and trade relations. That seems unlikely without a clearly articulated national energy policy.

Hybrids By The Hour
One of the biggest problems with introducing advanced technology vehicles such as those powered by fuel cells or hybrid drivetrains is overcoming natural consumer uncertainty about something so new and unproven. A new trend in green rental cars may help to lower this hurdle by making the initial alternative vehicle purchase period hours, instead of years.

My own first experience in an electric car amazed me. Nothing had prepared me for the acceleration, and I think I'd have bought one then and there if they had been more widely available and the infrastructure more convenient. On a smaller scale, I'd never have purchased satellite radio for my car without having first experienced it as a free option in several rental cars. After a couple of drives I was hooked to the point that when I recently went car shopping, there were no models on my list that didn't include satellite radio as an option.

Driving a biodiesel-powered car around Maui may sell on novelty value, but in the process customers will dispel some of their myths and preconceptions about these vehicles. While targeting rental fleets has traditionally been a high-volume, low-profit option for carmakers, they would be smart to use an entirely different set of criteria with regard to advanced technology cars. Rental car companies could be their best form of advertising and mass exposure.

Applying Lessons from Iraq to Iran
Today's New York Times includes a disturbing article concerning Iran's nuclear program. Although no "smoking gun" evidence has turned up linking Iran's civilian nuclear power efforts with weapons development, a dangerous pattern is emerging. As I've suggested before, this situation contains the seeds of a catastrophic oil market disruption, and we must hope that the parties involved have learned the appropriate lessons from the buildup to the Iraq War.

For the Iranians, the key lesson relates to the hazards of engaging in a "shell game" with inspectors from the International Atomic Energy Agency. Although it is understandable that they might feel threatened by US rhetoric and wish to protect their expensive equipment, drilling tunnels and shifting centrifuge parts around the country increases our uncertainty, rather than decreasing it. This is exactly the wrong this to do, unless there is indeed a clandestine weapons program that needs to be hidden.

The Europeans and other members of the IAEA, on the other hand, must remember the impossibility of proving a negative--in this case that Iran has no nuclear weapons program. In all likelihood the best solution to this potential crisis would establish conditions to render a weapons program inert, even if it existed. That would require accounting for every gram of Iranian nuclear material and keeping it under strict IAEA scrutiny.

Finally, the US has to recognize the limits of our military power. In the Iraq War we assumed that the US Army would only be engaged for a relatively short time, replaced post-victory by coalition forces, regional forces, or a reformed Iraqi army. Instead, most of the combat power of this country is committed to Iraq for years. A third of the US Army's 37 combat brigades are in Iraq or Afghanistan, a similar number have recently returned for rest and refitting, and a like number are training and equipping for deployment there within the next year. We will have to play an entirely different hand of cards with Iran than with Iraq, or risk losing Iraq--and a lot more--in the process.

Unless all three parties to this situation avoid the mistakes of the Iraq War, we could be headed for a nasty confrontation and a big oil price spike, just when global supplies are already stretched tight.

Hybrid Limits
Ever since it came out earlier this month, I've been scratching my head about a J.D. Power projection that sales of hybrid cars will plateau at about 3% of all cars sold in the US. They are currently about 0.5% of the market, based on only a couple of models from Toyota, Honda and Ford. My concerns about this forecast go beyond the assumptions J.D. Power makes, relating to fuel costs, subsidies and the cost premium for buying a hybrid. In particular, I'd like to know if they thought about more than one scenario for hybrids.

In some respects, hybrid cars represent the first really new vehicle type in decades, powered as they are by a combination of mechanical and electric drivetrains. But in another sense, they simply reflect the continuous evolution of the automobile from the days of Henry Ford. Even ignoring hybrid drive units, cars are increasingly becoming electrical devices, as much as mechanical ones. This has benefits and drawbacks, as I discussed in a recent posting.

This notion of evolution points to ways in with the projection in question might indeed come true, and ways in which it could look downright silly in a decade. For example, what if some of the components that make today's hybrid a hybrid--electric motors, regenerative braking, onboard storage of electricity for propulsion, and power management hardware and software--became as commonplace in mass production cars as the hydraulic innovations of an earlier generation, such as power steering, power brakes and automatic transmissions? In a decade, it might be hard to tell a hybrid car from a non-hybrid. In this case "true" hybrids might indeed account for only a small fraction of all cars, but their influence would be much broader.

Or consider that hybrids may start to branch out by incorporating power plants other than the gasoline internal combustion engine. Diesel hybrids are an obvious choice, and even micro-turbine hybrids look possible. The first fuel cell vehicles will also likely be hybrids, because of the high cost of building a fuel cell stack big enouch to deliver the peak power output required for highway driving. So if hybrids come to include essentially all cars with complex power sources, then it's difficult to imagine that they will reach some natural limit at 3% of the market, even with all the other improvements that non-hybrids will incorporate by then.

The real value of J.D. Power's forecast is not as a prediction, but as something that forces us to think about the issues involved more concretely, including just what we mean by a hybrid in the first place. Considering all this, I give them full credit for having the guts to put this out for everyone else to shoot at.

Timing Is Everything
Today's Financial Times includes a story (subscription may be required) on plans by PTT, the state oil company in Thailand, to merge several of its refining interests and do an IPO with them. This represents a remarkable turnaround in the Asian refining business, which only a few years ago was in truly dismal shape, suffering from a glut of product and depressed margins.

The story of the two refineries in question, the Star Petroleum Refining Co. facility at Map Ta Phut (64% owned by Caltex) and the neighboring ex-Shell refinery at Rayong suggests a word of caution, though. These plants were financed and built with high expectations, in the early 1990s environment of robust Asian economic growth and double-digit increases in Thai fuel demand.

When they started operations, however, Thailand was at the center of the slumping market of the Asian Economic Crisis. These two world-class facilities (I'm a little biased, having been involved with SPRC via my role looking after Texaco's interest in Caltex at the time) struggled financially for years. Though well-built to the highest standards--SPRC, at least, came in on time and on budget--these projects destroyed hundreds of millions of dollars of shareholder equity, because actual market conditions when they started up were drastically worse than anyone had expected.

Now the market has rebounded, with China's growth fueling a new boom throughout the region. The proposed merger of the two refineries must be driven entirely by the appetite for a refinery IPO, since all synergies have already been captured through a joint operating agreement put in place in the late 90s.

The history of these two refineries reminds us that economic expectations don't always pan out. However unlikely it may seem today, it's possible to imagine credible scenarios in which this could happen again, whether through another currency crisis or a "hard landing" for China's economy, which would send shock waves throughout the region. Asia's growth wave could last for twenty years, or it might fizzle next month. Caveat emptor.

Early Consolidation
Most experts agree that a potential "hydrogen economy" is still a couple of decades away, at best. So it might be surprising to see some consolidation this early in the development of the industry, with the recent acquisition of Stuart Energy Systems by Hydrogenics Corp. Stuart, a Canadian supplier of electrolysis-based hydrogen supply infrastructure, had itself recently acquired Vandenborre, another hydrogen technology provider.

Viewed from a purely financial perspective, the merger presumably creates a stronger, healthier company that is better equipped to handle the technological uncertainties inherent in a "pre-Hydrogen Economy", with a broader product and customer portfolio. Both of these companies have been dealing with early adopters in niche markets, such as delivery and transit fleets converting to fuel cell powered vehicles. The combination brings together a lot of practical experience in a field where much of the market is theoretical and prospective.

In addition, this transaction implicitly recognizes the potential of electrolysis--Stuart's core technology--in breaking the "chicken and egg" problem of hydrogen infrastructure. In other words, how do you justify infrastructure when there aren't enough customers on which to make a profit, and how so you encourage new customers without the existence of adequate infrastructure?

Electrolysis, though far from the most efficient way to turn primary energy into generate large quantities of hydrogen, can be done on essentially any scale required, and could be an ideal bridge to larger scale, more efficient technologies as the market for distributed hydrogen grows.

Is ANWR Worth the Gamble?
Yesterday's New York Times carried an article suggesting that the oil industry has lost interest in exploring in the Arctic National Wildlife Refuge in Alaska. ANWR, as it is known, represents a vast potential resource, but the idea of drilling there has attracted opposition across a wide spectrum of environmental groups and members of Congress. I've always thought it would be worth getting a better understanding of just what it is we are foregoing , before deciding, but that's never been a popular position.

Does this perceived lack of industry interest truly translate into a lower estimate of how much oil is in ANWR? Here's the chain of logic from the Times article:

1. Two companies drilled a well in ANWR in the 1980s. (I formerly worked for one of these companies, though I have absolutely no knowledge, insider or otherwise, about what that well might have revealed.)
2. Neither company is now pushing for ANWR to be opened up, and both have withdrawn support from the lobbying group set up to do that.
3. Other oil companies seem equally lukewarm, preferring areas where finding oil seems less risky.
4.. Therefore, there must not be nearly as much oil in ANWR as the government has suggested.

The problem with this construction, of course, is that the same behavior lends itself to a variety of alternative, equally plausible explanations. What if the companies in question have simply become more savvy about high-profile environmental issues, after years of bad publicity, and see equal or better prospects in countries that are easier to operate in? After all, US concerns about energy security don't carry much weight within multi-national energy companies. They view their asset portfolios in the cold light of risk and return, not national interest.

This rationale makes more sense to me than the notion that a single well drilled nearly 20 years ago has given everyone cold feet. The sheer size of ANWR and the incredible advances in seismic interpretation and drilling technology in that timeframe render this argument pretty flimsy. No one will know how much recoverable oil ANWR contains until after some pretty thorough exploration work, but no one should be surprised that the project selection criteria of the major oil companies, which are heavily weighted to rapid development and high returns, should give such a controversial prospect a low priority. But that is not at all the same thing as saying there's not much oil there, or that developing it should be a low priority for this country.

Does a Flawed Hockey Stick Invalidate Kyoto?
Although I know I've loaded up the blog with a number of postings on climate change recently, I also don’t want to ignore the controversy stirred up by the Wall Street Journal's recent article on the famous (or infamous) climate change “hockey stick” graph. The Journal's editorial last Friday is spot on in its concerns about the politicization of science—though this should hardly be news—and the possibility that we may be embarking on expensive efforts to mitigate a phenomenon that is not entirely proven. But what should we do instead?

In a nutshell, the chart in question has provided a sort of “smoking gun” visual argument in support of the idea that climate change is both real and, coinciding as it does with the rise of industrialization, largely man-made. This chart has come under fire from a small number of scientists and non-scientists on the grounds that it cannot be exactly reproduced from the raw data in question. Reproducibility of results is at the very core of all science. So does this undermine the entire notion of global warming, making the Kyoto Treaty worse than irrelevant?

It's entirely possible that Dr. Mann's graph will turn out to be fatally flawed, though my statistics background isn't quite up to forming a solid opinion. But the chart in question is only one piece—albeit a visually compelling one—in a much larger mosaic of scientific observations adding up to a comprehensive picture of a global climate that appears to be shifting out of its normal range of variance. The evidence includes some compelling recent studies. Just as it is probably no coincidence that this shift seems to correlate with our rising consumption of fossil fuels, neither does it seem coincidental that the rise of our present civilization should occur during a relatively stable and benevolent climatic phase.

As I've indicated before, for me it boils down to risk management. If we accept the Journal’s estimate of the cost of the “insurance” at $150 billion/year, what price tag would we assign to the events against which we are insuring? What would be the cost of irreversible changes in the location of the Gulf Stream and temperate zones, or the permanent loss of even a quarter mile of coastline globally, due to rising sea levels? I don't know, but I can visualize a number with many more zeroes than in the figure cited above. None of this is certain, but neither is the “null hypothesis” that the climate isn't changing--or that it is, but without any human influence. What are we willing to bet?

Where the LNG Will Go
With the approval yesterday of Shell's Gulf Landing liquefied natural gas (LNG) terminal offshore Louisiana, a likely scenario for the development of US LNG infrastructure is taking shape. Although 38 new LNG terminals have been proposed for the US--to supplement the four existing ones--all of those approved so far are clustered along the Gulf Coast, where much of the country's domestic natural gas production is centered, rather than close to the markets for which gas supply has been most problematic. There are both benefits and drawbacks to this pattern.

First, it's important to understand that LNG requires substantial fixed infrastructure in order to re-gasify, store and deliver the gas being received from tankers. These facilities typically range from 0.5 to 1.5 billion cubic feet per day (BCFD)of capacity, determined by economics, logistics and technology. With current US natural gas demand running at around 60 BCFD, a typical LNG terminal can import just under 2% of domestic demand.

Because of the way the US natural gas industry developed, the Gulf Coast has a high concentration of gas infrastructure. This includes pipelines, storage facilities, and gas plants, where the ethane, propane and butane contained in the gas are separated. Bringing LNG into this network reduces the amount of new infrastructure required to reach customers, thus improving the overall economics of LNG supply. It also substitutes nicely for lost production in the same vicinity, as the mature gas reservoirs in the Gulf of Mexico deplete.

The LNG imported by these new terminals will give the large industrial users along the Gulf Coast and mid-continent greater security of supply and somewhat lower gas prices. It will also benefit residential and commercial customers in the southeast. Unfortunately, these facilities will do little to dampen the high prices affecting more distant markets. Gas customers in the northeast, including electric utilities that burn gas to generate power, already pay significant premiums over Gulf Coast prices, because of limitations in the infrastructure for delivering gas over long distances. Only local LNG terminals can provide relief, and all of the proposed terminals that would benefit these customers directly face bitter opposition, as I've described in previous postings.

So the picture that emerges, at least for now, is one in which LNG backfills for declining domestic production along the Gulf Coast, with more distant customers still at the mercy of pipeline capacity constraints. If this scenario holds, we will miss the opportunity to continue displacing dirtier fuels with our cleanest hydrocarbon, gas, which is still in ample supply globally. Even though I remain skeptical that LNG is quite the panacea that some claim it is, our current approach to it can only be described as short-sighted and parochial.

The Editorial Page
Sometimes it's difficult to come up with a good topic for the day's posting; other days I'm spoiled for choice. Yesterday's New York Times, which I received after I'd already chosen my topic for the day, included two terrific guest editorials that I want to bring to your attention, with little additional comment.

In the first op-ed, the author offers an impassioned defense of wind power, even in wilderness locations and in spite of local opposition. This is a subject I've covered before (see my posting of 7/20/04), but less eloquently and succinctly.

The second editorial deals with the "Clear Skies" environmental legislation pending in Congress. Gregg Easterbrook writes intelligently on energy and environmental issues, often for New Republic. He suggests that if anyone other than George W. Bush had proposed Clear Skies--a name he and many others dislike--it would be recognized as an improvement over the Byzantine process of enforcing the existing Clean Air Act. He also sees its proposed expansion of the current, regional cap-and-trade systems for limiting sulfur and nitrogen oxide pollutants as a welcome dress rehearsal for greenhouse gas trading, which is already in use in Europe.

I recommend both editorials highly and look forward to seeing what kind of reaction they provoke.

Kyoto Day
Having been ratified by 140 countries representing 61% of applicable greenhouse gas emissions, the Kyoto Treaty on climate change goes into force today. Regardless of your opinion of the treaty, this is a real milestone, because for the first time in history the cost of emitting carbon dioxide and the other greenhouse gases into the atmosphere will no longer be zero, at least in the countries that ratified Kyoto.

That's a big deal, because unlike the sulfur and nitrogen compounds that we have regulated for the last thirty years or so, CO2 is not a pollutant, but rather the primary byproduct of all combustion. Reducing these emissions will require a lot more that catalytic converters, scrubbers, and cleaner fuels. In order to comply, countries must rethink how they generate and use energy, and this may ultimately usher in the end of hydrocarbon fuels, which have been a key factor in the rapid rise of industry and personal mobility around the world.

Kyoto is either the first small step towards a truly different world, or a major obstacle to economic growth, depending on whether you regard climate change as a serious problem, or even real. Although the US has not ratified the treaty, American companies with global operations will be taking steps to bring their international subsidiaries into compliance. In the process, awareness, knowledge and technology for reducing emissions will creep into this country, bit by bit. Kyoto is now a fact of life.

Changing the Game
Many in the oil industry have banked on the continued expansion of Russian oil production and reserves to keep the balance of power from shifting too rapidly toward the Middle East and its huge untapped resources. (See my posting of 9/30/04.) As described in this article from the Financial Times (subscription required) a new ruling in Russia requiring majority Russian ownership for any company bidding on energy and minerals prospects may alter this calculation significantly.

Throughout the course of the effective re-nationalization of Yukos (see my posting of 6/30/04) the key question has been whether President Putin was pursuing a personal vendetta against Mr. Khodorkovsky, seeking to rectify the excesses of the Yeltsin years, or putting down a marker for government control of a strategic industry sector. It is looking increasingly like the latter interpretation is the correct one, unless all three are in fact true.

This is not particularly good news for consumers of oil products around the world. It is going to take solid growth in places like Russia, Africa and Latin America to offset the production decline in the US and North Sea and the reticence of OPEC to boost capacity. Requiring the international major oil companies, which are currently generating gobs of cash, to channel their investments in Russia through minority positions in local companies will at least slow down the rate at which they are willing to invest, if the Yukos affair hasn't scared them off entirely.

Although many Russian companies have done well to restore production to near previous peak levels, they lack some of the technical and project-management skills to handle projects of the scale now on the horizon. For that matter, Yukos was the most successful of the Russian oil companies at boosting production from its reserves, and it is questionable whether the personnel and attitude that made this possible will survive absorption into Rosneft, the national oil company that is merging with Gazprom, the state-owned natural gas giant.

So do all hopes now shift to West and North Africa?

The Wrong Debate?
The controversy over Iran's ostensibly civilian nuclear fuel program aptly demonstrates the linkage between nuclear power and nuclear weapons. While I don't pretend to any particular qualifications for commenting on weapons programs, it doesn't appear that the editors of the New York Times have any, either, based on the confused muddle they published on the subject last week. It won't surprise my regular readers to see me disagreeing with a New York Times editorial, which in this case is probably half right. Unfortunately, the half they are wrong about is downright dangerous.

In particular, their assessment of the adverse implications of designing a new generation of US nuclear warheads seems based largely on wild assertions and wishful thinking. Who can argue that the US isn't at least a bit cynical and hypocritical to push strict non-proliferation at the same time we engage in research on new warheads? But it's foolish to think that Iran and North Korea are seeking nuclear weapons because the US contemplates replacing some of our aging bomb stockpile. These countries are motivated by nationalism, religious or quasi-religious fervor, and a quest for regional advantage, and they would be on this path even if we were disarming much faster than we have been since the end of the Cold War.

The Times chooses to ignore that the warheads deployed on US missiles and submarines today were built before the fall of the Berlin Wall, as their own reporters highlighted in this recent article. This is important, because the designers of these weapons would have reasonably expected them to be superseded in a decade or so--it was an arms race, after all--by newer versions. Durability would have taken a back seat to yield, size and weight, and other operational characteristics. Gradually replacing these aging warheads with new ones explicitly designed to last for many decades would enhance international stability, rather than undermining it, by reducing uncertainty about the integrity of US nuclear weapons .

In focusing their attention on speculation about new warheads, the Times distracts us from the genuine need for a public debate on the proper role of nuclear weapons in the overall US defense posture. Although Russia or China might pose a small strategic threat today, each still possesses a significant nuclear arsenal, as do several of our closest allies. Absent a new cold war, our nuclear arsenal still constitutes an important deterrent against future contingencies. The value of such a deterrent is directly tied to the perception that it would be effective if used. Even if the Congress determines that we should reduce our nuclear weapons inventory by a further 90%, the reliability of the remainder must be as unquestioned fifty years from now as it is today.

Climate Confusion?
The debate over climate change stirred up by the publication of Michael Crichton's new thriller, "State of Fear", continues. (See my postings of 1/11 and 1/27/05.) The Economist (subscription may be required) has chosen an interesting way to put their oar in, not by supporting or refuting the specifics of Mr. Crichton's views, but by attempting to give a sense of the arguments still raging within the scientific community over the details of climate change. After reading their commentary, anyone worried about monolithic conspiracies should come away relieved, but those of us looking for a clearer indication of what might happen and what should be done about it may well worry a bit more.

As anyone close to it will tell you, science is messy and as laden with politics as any human institution. But that by itself is insufficient cause to dismiss the consensus that has emerged concerning the potential for dangerous climate change (or global warming, or global weirding, whichever description you think comes closest to characterizing a very complex set of phenomena.)

The most serious deficiency in the entire debate--not just over Mr. Crichton's book, but on climate change in general--is a clear explanation of exactly what is truly known about climate change and what remains highly uncertain. This explanation should be understandable by reasonably-educated non-scientists and must come from someone with minimal conflicts of interest on the subject. That rules out politicians and bureaucrats, as well as most environmental groups and the media, which has preferred to focus on the most sensational and spectacular predictions. In short, where is the Carl Sagan of climate change, capable of telling this vital story simply and clearly to a wide audience?

How Much Wind?
Wind power deserves most of the accolades it has garnered as the most attractive green power source. This technology has improved dramatically in the last two decades, to the point that in some locations it is nearly competitive with power from incremental fossil-fuel power plants, even without the subsidies it usually enjoys. But as this article from The Economist describes (subscription may be required), there are other limitations to its spread beyond the NIMBY-ish opposition I've highlighted previously. (See my posting of 5/6/04, for example.)

There are two further potential challenges, depending on how the local power market is set up. The first relates to the difference between the rated capacity of the installed wind turbines and the actual average output, based on local wind conditions that differ from what was expected. The second is a function of the ability of the local power grid to manage the natural variability in the output of wind farms without having to pay for conventional backup capacity that runs up the cost to customers and reduces the effective benefit of wind. The fact that grids are typically public utilities and most new power projects are operated by unrelated companies amplifies this problem.

It should disturb both wind power advocates and potential developers that E.ON, the big German utility, is quoted in the article as experiencing a six-to-one shrinkage of theoretical versus actual wind power due to the combination of the factors above. This suggests that much better planning and coordination are required before new wind farms are built, so that they are put in the locations with the best combination of wind conditions and flexible grid accommodations. Otherwise, the experience of wind farm and grid operators is likely to deter many new installations, forcing utilities back towards more traditional generation sources, such as coal.

Finicky Cars
A recent article in the New York Times highlighting the drawbacks of onboard electronics should be mandatory reading for anyone designing advanced technology cars, such as hybrids--or anyone considering buying one. It raises two basic issues: More sensors and actuators (tiny electronic motors) result in more things to break down, and in addition, "Some complaints turn out to be not failures, but features that are difficult to use." Both of these problems can damage customer satisfaction and erode market share and profitability.

Too many of us have experienced the first problem category. I once owned a Toyota Camry with an intermittent electrical fault that periodically shorted out the power to all the accessories, including the air conditioning. It took half a dozen dealer visits to isolate the fault to a single defective chip. Now, this sort of thing is annoying in a car with an otherwise bulletproof reputation for reliability, but it could be a mortal blow to an entirely new model, especially one with a novel powertrain.

The second concern stems from engineering hubris; some carmakers mistakenly believe that if they can do something, they should. Despite a few obvious refinements, the basic "user interface" of steering wheel, pedals, and dashboard knobs and buttons hasn't changed much in fifty years, for good reasons. At 70 miles per hour or on a congested city street, any control that isn't immediately intuitive is a dangerous distraction. Contrast the Toyota hybrid drive screen, which has gotten high marks from critics and owners for the way it displays power status, versus those all-in-one displays that require "joystick" navigation through multiple sub-menus just to change the climate setting.

The introduction of entirely new powertrains, such as hybrids and fuel cells, will create a new set of reliability hurdles, since neither system enjoys the billions of vehicle-years of experience that the standard internal combustion engine (ICE) has behind it. Although the reliability of these new car types should improve quickly--and in the case of fuel cells may ultimately exceed that of the ICE--much of the consumer's experience of owning these cars will be governed by the user interface and accessories, in addition to the new drivetrain, so they present a dual reliability challenge to designers.

While I'm skeptical about the quote from IBM suggesting that within a decade all cars will have essentially the same mechanical systems and differ only in software, it underscores the need for automobile software to be more like that of an Apple computer and less like a Windows PC. After all, on a crowded Interstate highway, the dreaded "Blue Screen of Death" could be just that.

Following Through
I'm heartened to see the UN wasting no time following through on the preliminary findings of Paul Volcker's investigation of the Oil for Food Program. With the suspension of the two officials implicated for corruption and wrong-doing, Secretary-General Annan is acting responsibly to salvage the credibility and reputation of the UN in a role for which no other international organization, whether supra-national or non-governmental, has the necessary capacity.

In many respects this is no longer an energy issue, since Oil for Food ended with the US occupation of Iraq. Nor is there any meaningful way to compensate either the Iraqi people or the international community for the great harm committed through the subversion of this critical program. The key issue now is ensuring that future UN efforts on this scale, of which the coordination of tsunami relief is likely only the first example, are scrutinized much more carefully and held to higher standards.

Whether you think Mr. Annan acted from principle or under pressure, he deserves credit for doing the right thing here, and we should see further action following the internal administrative processes. The real test for Mr. Annan may come later, however, depending on how close to home Mr. Volcker's subsequent findings hit.

Earmarked for Whom?
There was another article in the New York Times this weekend citing the tremendous reserves of oil sands in Canada, putting them just behind Saudi Arabia in total oil reserves. (Someone's PR firm is doing a good job, here.) While I still quibble with counting these reserves in the same way as conventional oil reserves, since so much more is required to extract them, there's an even more interesting development suggested in this article in today's Financial Times. A Chinese firm appears interested in purchasing some of these reserves.

Although Canada is hardly the 51st state, I suspect that many of us have assumed that any excess energy production in the Great White North above their local demand will end up down here, as part of the "North American Energy Grid" concept that the Department of Energy has been pushing for the last several years. After all, Canada has been our primary supplier of natural gas imports and an important supplier of crude oil for decades. But as conventional Canadian oil & gas reserves begin to deplete, the high investment costs of extracting the unconventional reserves suggest that they will go to whoever can pony up the cash.

I think there's another unwarranted assumption, concerning the number of facilities that can be built to extract the enormous quantity of hydrocarbons tied up in Canadian oil sands. As the Times article reminds us, oil sands production is energy intensive and emits large quantities of greenhouse gases in the process of making synthetic crude oil, which will emit additional greenhouse gases when it is refined and consumed. Canada is a signatory to the Kyoto Treaty, and at some point Canadians may balk at adding to their emissions pool for the benefit of foreigners, even if the foreigners in question are their neighbors to the south.

So while Canadian oil sands may not exactly be a zero sum game, in which a contract to sell oil to China would displace a comparable volume of sales to the US, they probably aren't an infinite game, either.

How Much Hydrogen?
Although my postings have been pretty petro-centric for the last few weeks, I still intend for this to be an energy blog, not just an oil blog. Where better to seek a bit of balance than with hydrogen, which was in the news frequently last year? On another blog I ran across a recent article from the Financial Times discussing the likely connection between nuclear power and a hydrogen economy. There's also a feature article on this subject in the latest issue of Wired. On the surface, this is hardly welcome news for those who see a hydrogen future as being synonymous with green energy. A few quick calculations will indicate why people might be thinking along these lines.

Let's begin with the assumption that we'd like to replace 100% of gasoline consumption with hydrogen in twenty years. This is highly ambitious but nicely frames the scale of the challenge. The US currently consumes about 9 million barrels per day of gasoline from domestic and foreign refineries. The energy content of all that gasoline is roughly 16 quadrillion BTUs (quads for short) per year. If the hydrogen-powered cars of 2025 were to use energy three times more efficiently and drive about 60% more total miles per year than today's cars (based on long-term trends in vehicle miles traveled), then we'd need to produce 8.6 quads a year of hydrogen for them to run on.

Almost all of the hydrogen used today is produced from natural gas, at an efficiency of about 70%, i.e. 30% of the energy content of the gas is lost in the process. If that still held true in 20 years, then we'd need an incremental natural gas supply of 34 billion cubic feet per day for hydrogen production. This quantity is more than half of current US natural gas consumption. So even with the efficiency improvements inherent in the hydrogen fuel cell, a true hydrogen economy--even just the transportation component of it--will require an enormous new source of primary energy from fossil fuels, renewables, or nuclear power.

Staying with natural gas for the moment, the North American gas industry will have its hands full simply maintaining current supply levels for current uses--electricity generation, home heating and industry--over that timeframe, without adding anything for hydrogen. Since liquefied natural gas (LNG) is the industry's current answer to its supply problems, it's worth noting that the amount of gas cited above for future US hydrogen needs is equivalent to the output of 40 new LNG plants such as this one planned for Indonesia, or about 5,600 fully-loaded LNG tankers per year. Importing even a fraction of this much LNG will be a big challenge, given the resistance that most proposed LNG receiving facilities are meeting (see for example my postings of 11/15/04 and 5/17/04.)

So if natural gas isn't the long-term energy source for the hydrogen economy, what is? Frankly, it's daunting to contemplate getting the approvals necessary to install sufficient new capacity of any kind to fill this gap, whether we are talking about LNG, wind turbines, or solar arrays. All of these, at this scale, will encounter enormous opposition. Of all the options, nuclear power would require the fewest new facilities in the smallest number of locations. Perhaps this explains its attraction for some hydrogen advocates.

State of Energy
Last night's State of the Union address to Congress was dominated by Social Security reform and the war in Iraq, but also included the following remarks on energy:

"To keep our economy growing, we also need reliable supplies of affordable, environmentally responsible energy. Nearly four years ago, I submitted a comprehensive energy strategy that encourages conservation, alternative sources, a modernized electricity grid, and more production here at home -- including safe, clean nuclear energy. My Clear Skies legislation will cut power plant pollution and improve the health of our citizens. And my budget provides strong funding for leading-edge technology -- from hydrogen-fueled cars, to clean coal, to renewable sources such as ethanol. Four years of debate is enough: I urge Congress to pass legislation that makes America more secure and less dependent on foreign energy."

Now, one can argue about priorities and the proper balance to strike between conservation, R&D, and new production of current energy sources, but it is high time we brought this to closure. Although it wasn't specifically mentioned, the deadlock over the Alaska National Wildlife Refuge (ANWR) is central to the impasse on energy policy and reflective of the competing philosophies involved. The potential now exists for a grand compromise involving tightly controlled drilling in places like ANWR, in exchange for something of comparable value to environmental concerns--something facing comparable opposition from conservatives.

If the gloomier scenarios concerning oil markets are correct, we face a long period of volatile and high prices, due to strong demand growth from the developing world and inadequate additions to reserves and production. Against this backdrop, it is hard to imagine that ANWR's oil will not eventually be exploited. If that is so, does it now make sense to concede on this issue, in return for increased corporate average fuel economy standards, limits on carbon dioxide emissions, or dramatically increased investment in renewable energy?

Our last real oil crisis was resolved through a combination of market efficiency, significant new discoveries in the North Sea and West Africa, and greater reliance on stable suppliers close to home, such as Canada, Mexico and Venezuela. The world is changing again, as China and India compete with traditional markets, as non-OPEC oil production matures and declines, and as some of those regional suppliers begin to look less reliable. The balance of power is shifting back toward OPEC. With or without ANWR, we require clear national priorities on energy, and they will be much more durable if they can be set in a bipartisan way. We can't afford to wait another four years.

More Geo-Greens
On Monday I took issue with Tom Friedman's suggestion of a "geo-green" strategy for pressuring Middle East petro-states by reducing oil demand and thus driving down oil prices. Now I find that far from being alone in his views, there's a whole geo-green clique out there, including some neo-conservative heavyweights and keen environmentalists. While I stand by my previous posting on how hard it would be to move the oil demand needle appreciably, it's worth looking at the upside potential.

Start with some history. The last time there was a big push on oil conservation, the result was pretty impressive. After World War II oil demand grew steadily--doubling during the 1960s--until the first oil shock in 1973-74 caused it to stall. It resumed its growth path in the mid-70s, but from 1979, following the Iranian Revolution, to 1989 global oil demand was essentially flat. Along the way, the energy intensity of the US economy dropped sharply, even though the economy continued to grow. Even today, we use fewer BTUs, and certainly fewer barrels of oil, for each million dollars of GDP.

Could a similar drive to efficiency motivated by politics and patriotism, rather than just high energy prices or taxes, slow down or reverse recent trends in energy demand? It's entirely possible, but if we want this to have the maximum benefit, we are looking at the wrong target audience. Although getting Americans to drive more efficient cars and use energy more sparingly would have an impact, we have not been responsible for most of the recent surge in demand. The challenge and opportunity comes from the rapidly growing economies of Asia, and from China, in particular.

Between 2000 and 2004, China's oil demand grew by 2 million barrels per day (MBD), compared to an increase of about 1.3 MBD for the whole industrialized world. As its richest provinces reach the "take-off point" at which the demand for personal mobility soars, this trend will only accelerate. The time for cooperation on conservation is ripe, since China appears at least as concerned about its energy security as we are about ours (see my posting of 1/21/05.)

Getting China and India to develop along a more efficient path is the real prize, and it ought to be a money-spinner, since putting in the best and most efficient technology at the start should be much cheaper than retrofitting them here. In the process, this would do a lot to reduce the rapid growth of greenhouse gas emissions from developing economies, and it may turn out that the Clean Development Mechanism of the Kyoto Treaty is a handy way to transfer these technologies at a profit.

In essence, being geo-green could be quite beneficial and sensible, as long as our concept of "geo" encompasses the entire globalizing world.

The Other "Bad Boy"
President Hugo Chavez seems determined to chart a course for Venezuela that brings it increasingly into opposition to the US and our friends in Latin America. He is even finding common cause with Iran, to which I devoted the last couple of postings. Several US oil companies with interests in Venezuela are experiencing contractual difficulties, leading to speculation that Mr. Chavez intends to strengthen energy ties with China and other markets at the expense of the country's historically close ties to the US market. How realistic is this?

Although President Chavez's Bolivarian Revolutionary politics may motivate him to move in this direction, energy economics will make this a costly and difficult proposition. Venezuelan oil is typically much heavier and more viscous than oil from the Middle East, West Africa, or other major exporting regions. This makes it more difficult to extract, requiring large, capital-intensive facilities similar to those involved in extracting Canadian oilsands. Following the crippling 2002-3 strike by employees of the state oil company, PDVSA, a growing share of Venezuela's production has come from these internationally-financed joint venture facilities.

The poor quality of Venezuela's oil also makes it more expensive and less attractive to refine, yielding less gasoline and high-quality diesel per barrel than that of its competitors, without significant prior investment in upgrading facilities. The last time I looked, few refineries in China were set up to run Venezuelan crude oil profitably.

The largest concentration of refineries configured to run Venezuelan crude is in the US Gulf Coast. In fact, a large portion of the Venezuelan crude sent to this country goes to supply PDVSA's subsidiary, Citgo, which has one of the largest service station chains in the US. Diverting exports away from the US would cost Venezuela several times: in lower netbacks on crude sales due to higher freight costs to more distant markets, in larger discounts versus competing oil grades, and in reduced profitability at its US subsidiary, which would have to line up other supplies.

Rather than expecting a move by Mr. Chavez to nationalize US investments or cut off crude supplies to us, I continue to believe that the largest element of political risk involved for US investors in Venezuela's oil industry lies in the prospect that our own government would take action to precipitate a crisis with Venezuela, in response to Mr. Chavez's growing activism in Latin America. Only companies with broad and deep portfolios should be taking on these risks today.

Is "Geo-Green" The Answer?
Despite my usual soft spot for Tom Friedman and his normally insightful and bold commentary on geopolitics, his editorial in Sunday's New York Times oversimplified a bit too far with its "Geo-Green" energy strategy. Although he neatly describes the paucity of options for dissuading Iran's leaders from pursuing nuclear weapons (see Friday's posting) his prescription for reforming Iran and the rest of the Middle East by driving the price of oil back down to $18 per barrel rests on a shaky foundation.

Based on past oil market behavior, getting oil prices back to this level any time soon would probably require a combination of reduced global demand or increased global production on the order of 4 million barrels per day (MBD). Half of this volume represents a return to OPEC's recent "normal" quota of 25 MBD from its current, essentially flat-out quota of 27 MBD, while the other half mirrors the magnitude of demand drop that sent oil markets into free fall in the 1997 Asian Economic Crisis.

Although some new production will come on stream this year, most of the difference would have to come from the demand side, where Mr. Friedman's "geo-green" options of conservation and substitution via renewables and nuclear power reside. Since most petroleum is used for mobility, while most electricity is used for stationary purposes, the impact of renewables and nuclear on oil demand is fairly indirect and long-term. This leaves us with conservation, which is normally spurred by high prices--at least initially--rather than the low prices Mr. Friedman hopes to achieve. This is something of a paradox, unless he is willing to consider hefty new taxes on petroleum products to raise consumer prices without changing producer prices.

Even if I've overstated what it would take to drive oil prices down, there are other factors to consider. Although a low oil price world would benefit the US economy, along with some of the poorest nations on the planet, it would reduce the incentives to find more oil and to develop the technologies that must ultimately supplant oil. Along these lines, I suspect the likeliest precursor to another period of low oil prices will be the market itself. Petroleum is still a volatile and somewhat cyclical commodity, and the market has a history of confounding expectations. Unfortunately for Mr. Friedman's thesis, the last period of $18 oil prices in the late 1990s didn't exactly unleash a tide of liberalization in the Middle East.

Persian Puzzle
With hindsight, Iran's nuclear program appears to be more sophisticated and dangerous than anything going on in Iraq after UNSCOM dismantled Saddam's last attempt to get the Bomb in the mid-1990s. The country we invaded turned out to be a Potemkin village full of walking booby traps, and our presence there has eroded the leverage available to us in dealing with the threat posed by Iran. The approach suggested in yesterday's New York Times editorial is probably as good as any still available to us. It advocates relying on collaborative diplomacy with sizeable carrots and sticks. Unfortunately, this ignores the energy dimension, which remains Iran's trump.

Three years ago the global energy supply could and did lose production equal to Iran's without creating a severe price spike. When Venezuela's oil workers went out on strike, eliminating 2.3 million barrels per day of oil exports, other producers quickly filled the gap. Prices went up for a few months, and then came back down. Since then, though, the combination of rapid demand growth, persistent production problems in several countries, and a conservative approach to new oil investments has eliminated that cushion. Iran's leaders know this.

Although it is just possible that the US and EU could put aside our present differences in order to present a common front to Iran, it is hard to imagine that Iran would sit still for the imposition of joint sanctions without playing the oil card. The existence of this option reduces the likelihood that Iran would take the threat of sanctions seriously enough to abandon its nuclear efforts. In effect, Iran already holds something nearly as good as a nuclear deterrent: the ability to throw a world oil market that is balanced on a knife edge--at twice its historical average price--into chaos.

Unfortunately, the diplomatic stalemate described above raises the odds of an eventual military confrontation. The consequences of a crisis over Iran's nuclear program are unpredictable and potentially disastrous, but in spite of that, the crisis seems all but inevitable.

Climate Fiction?
Two weeks ago I posted some comments concerning Michael Crichton's latest novel, "State of Fear" (see posting of January 11.) One of the scientific papers cited by Dr. Crichton in support of his novel's arguments against climate change and the global response to it was by Dr. Gregory Benford, a physicist who is also a noted author of thrillers and award-winning science fiction. Now he and one of his collaborators have weighed in with an editorial in the San Diego Union, rebutting Dr. Crichton's interpretation of their peer-reviewed paper in Science, the journal of the American Association for the Advancement of Science.

The editorial by Drs. Benford and Hoffert is worth reading for its contribution to the controversy over the Crichton novel, but the source article struck me as much more interesting. If you are willing to tolerate a fair number of chemical equations (or like me, actually enjoy them), you will find it a fascinating overview of the relationship between energy and climate today, and as it might be in the decades ahead.

Dr. Benford and his collaborators discuss the evidence for a man-made greenhouse effect and the magnitude of the challenge it poses. They also show just how difficult it will be to avert its consequences. Along the way, they provide an excellent survey of the long-term prospects for renewable energy, including land- and space-based solar power, for nuclear power, and for truly clean fossil fuel use. Nor do they think small, covering every option I've ever heard of that could meet our energy needs, while stabilizing global warming. This includes strategies as exotic as using nuclear fusion to breed fuel for lots of new fission reactors.

Their conclusions are simultaneously sobering and optimistic, focusing on the need for major research and development efforts in a number of areas to make sure that we can actually produce greenhouse-free energy on a massive scale in the future, rather than merely having many interesting but unproven ideas in the laboratory or on paper. To this I would add something that they only hint at: we will also need an awful lot of fossil fuels to get us to the point of such a transition without putting the global economy into a nosedive that would hit developing countries hardest.

Unfortunately, the latter sounds a lot like what the opponents of climate change are saying, too. The trick--and the opportunity--is to tie the first proposition to the second. We could, for example, link drilling in the Arctic National Wildlife Refuge (ANWR) with doubling the research budget for renewable energy and nuclear fusion, funded by a surtax on ANWR oil. This kind of thing would have every vested interest on both sides howling, but it might just offer a workable pathway between irresponsible myopia toward the future and an impractical disregard for the needs of the present.

Windfalls
Well, it was bound to happen. I'm actually surprised it took this long, considering the sustained strength of energy prices and energy company earnings. Critics in the UK have started calling for a windfall profits tax, at least on domestic natural gas production, citing the level of oil company earnings exemplified by Lord Browne's comment in the Sunday Times that BP's profits for last quarter and last year would be "staggering."

We've been down this path before, and having started in oil trading just as the old system of price controls and oil windfall profits taxes in the US was being wound down, I saw first-hand how poorly such regulations work, and the kind of gross inefficiencies and distortions they promote. (Some other time we can get into "old oil" vs. "new oil" and how that was exploited by unscrupulous middlemen.) However, I must say with equal vigor that the industry is currently doing itself no favors in this regard by its conservative approach to capital investments.

It would be easier to quiet this chorus, which will only grow louder should prices rise again this year--or at least not moderate noticeably--if energy firms were seen to be reinvesting most of the cash flow thrown off by high prices. They need to increase their reserves and expand their production bases to keep pace with the growth in current and anticipated demand. Share buybacks and special dividends do little to dispel the notion that the industry is effectively taxing the entire economy and ought to be taxed in turn.

If capital spending doesn't soon pick up in line with market expectations of sustained high prices and demand, the oil companies are going to be in a major PR battle over where the money should go, instead. Wake up and smell the coffee, folks.

More Orphans
Last spring I wrote about the problems GM was having as the leases on its electric car, the EV-1, were running out and it was taking back the cars to scrap them (see posting of 3/29/04.) EV-1 lessees were not happy with this, preferring in many cases to keep the cars longer. Ford has encountered similar problems with its electric Ranger EV pickups, but it appears to have resolved matters more positively, now allowing lessees to purchase the vehicles.

The actual number of vehicles involved is tiny, only a few thousand, but this decision has much larger implications. All the big carmakers have advanced vehicle programs underway, involving hybrids, fuel cells, hydrogen internal combustion engines, or other technologies. Not all will pan out, but in order to avoid having that become a self-fulfilling prophesy, the auto companies must create a high level of trust that anyone who buys one of these cars will be treated fairly down the road, even if it turns out to be an "orphan."

It's also important to recognize that the bar for this is now much higher than in the past. Someone buying a 1959 Edsel would at least have been able to find mechanics who could fix it when it broke down; that might not be the case if BMW decided to stop servicing the hydrogen 745h, for example. Few consumers will buy a car they don't think will be supported, and the carmakers will only be able to recoup their enormous investments in their advanced technology vehicle programs if they turn out mass-market models at some point.

This creates a host of practical problems and could make the rollout of a totally new technology car even more expensive than it already is, by requiring a larger parts inventory than "just in time" programs would suggest, but it is all part of the price of entry and an investment in future success.

Beneficial Globalization
For the last several years globalization, shorthand for an incredibly complex and loosely-connected set of trends and actions, has taken a lot of hits for promoting environmental and damage and threats to endangered species, among other complaints. But here's a wonderful example of several key components of globalization--global finance and the application of global standards to local projects--being used to protect those same interests.

The proposed trans-Siberian pipeline project is of major importance to Russia and to energy consumers on both sides of the Pacific Rim. However, it will not be built without international financing, most likely from Japan, and that financing is much less likely to materialize if the local Russian authorities insist on locating the pipeline's terminus in the middle of a pristine tourist destination and wildlife habitat. They might not see it that way, yet, but I would put money on their having to revise their plans before the first Yen, Euro, or dollar is transferred.

What I find encouraging about this story is the apparent attitude of the environmental groups involved. The Japanese branch of Friends of the Earth--no friends of oil development in general--appear to understand that the project as a whole will likely go ahead and are focused on the terminal site decision. The executive director of Pacific Environment sums it up nicely in his quote, "The pipeline will be a test case of whether or not Russia can meet the top level environmental standards that the public expects from oil and gas projects around the world."

The potential of globalization to distribute human rights and environmental protection--as well as prosperity--much more widely makes it more of a blessing than a curse. I have a lot more sympathy for those who focus their criticism on specific facets or manifestations of globalization than for those who claim to be against it as a whole.

The Other Face of China
The energy world has been preoccupied with China's rapid growth in oil demand and the impact this has had on markets for the last year or two. This phenomenon is not unique to oil, with the prices of many commodities having shot up dramatically on the back of Chinese demand. But this week we had two reminders of another face of China, the political one often obscured behind its economic dynamism.

First, as a New York Times editorial yesterday pointed out, one of the main architects of China's recent growth died without fanfare, under house arrest. Nor did China's current leaders want Zhao Ziyang to be remembered with a state funeral, giving in on this only under pressure, because he chose the wrong side of the Tiananmen Square protests in 1989. So even as the world rushes to invest there, China is still waiting for its Gorbachev.

Another sign of China's less commercial face turned up in a Defense Department planning document describing the country's diplomatic and military efforts to shore up its energy supply lines, as part of a significant naval buildup. Now, this sort of thing is subject to multiple interpretations. One of my favorite books last year, The Pentagon's New Map, makes a strong case that China is likelier to be a great partner for the US in extending and solidifying globalization's benefits in Asia, rather than an adversary with which to start a new Cold War. Are their current actions just an expression of understandable insecurities, or do they portend a future conflict? I'd rather stay on the optimistic side of the fence, for now.

It's also worth recalling that history provides numerous examples--some quite recent--of countries that built huge fleets but failed to create a great navy, something that requires generations and a lot more than just ships and men. The very name of the "People's Liberation Army Navy" might offer a reassuring hint along these lines.

The takeway is that for all our current focus on trade and investment, we can't lose sight of the fact that China is a country, not just an economy, and a big, complicated one at that. It is likely to be at least as important in this century as Japan was in the last, but let us hope more along the lines of Japan in the second half of the Twentieth Century, rather than in the first.

Executive Options
The FT reports that BP will alter its executive compensation plan to eliminate options and focus on stock grants (presumably restricted for some vesting period, or until retirement.) Although this is seen as improving the alignment of interests between management and shareholders, the article is silent on what may be the most important reason that some firms have seen options lead to behavior very much out of synch with shareholder value.

It's easy to forget how options derive their value. Many commentators, and even some option recipients, focus on the value of the shares into which the options are converted when the target or "strike" price is exceeded. Instead, as demonstrated by Messrs. Black and Scholes, the value of options comes from the amount of time remaining before expiration and the volatility of the underlying asset, in this case the stock price. The longer to expiration and the more volatile the stock price, the more valuable the option. This is very different from the benefit accruing to the stock itself, which must see prices rise steadily to generate attractive returns for its holder.

As attractive as options have been as a low-cost--at least initially--way to reward top employees and give them a "piece of the action", they actually reward the creation of stock cycles of seesawing prices; the wider the swings, the better. While this has not been a problem at BP and other major oil companies, it is prudent for them to move toward rewards that motivate the behavior they really want. After all, people are remarkably adept at figuring out how to maximize their benefits under any given compensation system, no matter how poorly it lines up with the goals you are trying to achieve.

All Those Flares
A headline in the Financial Times today caught my eye: Shell Faces Penalties Over Flare Deadline, with the first paragraph going into the environmental damage caused by flaring. When you evaluate the situation carefully, though, there is both more and less here than meets the eye, besides additional bad publicity for Shell.

The basic issue is simple. The production of most oil is accompanied by varied quantities of natural gas. Historically, much of this was "flared", or burned off at the wellhead in what amounts to a giant candle. I recall hearing astronaut accounts of flares in Saudi Arabia being visible from orbit. It's easy to forget that for decades natural gas was considered a valueless byproduct, and flaring was the best and cheapest way to dispose of it.

You see very little oilfield flaring in developed countries, not just because pollution standards are stricter, but because the gas is closer to markets in which its value more than offsets the costs of gathering it up and sending it through a pipeline to heat homes and run factories and power plants. It can also be compressed and reinjected into the oilfield, to keep well pressures up and enhance production. The problem for Shell and other producers in Nigeria is that there is no handy domestic market to consume and pay for the gas, and the cost of reinjection doesn't always have sufficient offsetting benefits.

In the 1990s the Nigerian government passed regulations requiring all producers to cease flaring by 2008. This seems fairly proactive from an environmental standpoint, but the greenhouse gas properties of methane, the main constituent of natural gas, make this less obvious. Since methane is 21 times more potent in its global warming potential than carbon dioxide, the greenhouse gas that gets the most attention, burning it and turning it into CO2--thus cutting its impact on climate change by a 95%--is not necessarily the worst thing one can do with it.

What Nigeria gets out of all this is a chance to earn royalties on some additional production of gas that might not otherwise be counted, and some brownie points from the EU and non-governmental organizations that are most concerned with climate change. In the process, the oil companies incur some additional production costs, and they are effectively forced to aggregate all this gas and do something useful with it in the market, either as LNG or using gas-to-liquids technology to convert it to clean diesel fuel. Along the way, they will generate some greenhouse gas offsets they can either trade or apply to their emissions elsewhere. None of this is bad, unless you think a difference of a percentage point or two in project economic returns, and ultimately in shareholder value, is awful.

While putting an end to flaring seems like a no-brainer, it is much more complicated and somewhat less beneficial than one's intuition might suggest.

Europe's Gas Dilemma
Natural gas is the fuel of choice for power generation, at least when it is available and its price is in rough parity--on an energy equivalent basis--with oil and other fuels. Europe, in particular, will see steady growth in gas consumption in the power sector as nuclear power stalls everywhere but France and as EU adherence to the Kyoto Treaty's greenhouse gas emissions targets makes coal unattractive. Fortunately, Europe sits at the doorstep of the world's largest gas exporter, with far and away the largest natural gas reserves on the planet: Russia. But therein lies the dilemma, as increasing reliance on Russian natural gas coincides with an assertive and increasingly autocratic Russian government.

Europe (EU-25) already imports 6.7 trillion cubic feet (TCF) of natural gas per year net of exports, with 4 TCF of it coming from Russia. This will only increase as North Sea oil--and its associated gas--dwindles and the continent's mature gas fields, such as the enormous Dutch Groningen field, deplete. Algeria, already a major supplier to Europe, can do more, but on a smaller scale and chiefly for countries fronting the Mediterranean. This leaves the Middle East as the only real alternative, with its attendant challenges.

How worried should Europeans, and especially Germans (as noted recently in the Financial Times) be about relying on Russia for the lion's share of their future natural gas needs? From a purely economic perspective, this seems as much of an opportunity as a challenge, since it would leave Russia with lots of Euros for either investment or consumer goods imports. But politically it could create a subtle form of veto that some might argue has already been exercised to give Russia a free hand in Chechnya.

In the long run, the situation gives Europe as much of an incentive as the US for the creation of a thriving global market for liquefied natural gas (LNG), and for the construction of the infrastructure necessary to import it. This might not displace Russian gas supplies, but it would help keep prices in balance with world levels and give traditional suppliers some healthy competition.

The Hidden Variable
Whenever you contemplate dramatically improving the gas mileage of cars in America, whether through new technology such as hybrids or by closing the loophole that led to the dominance of SUVs, you must confront two seemingly immovable obstacles: the size of the domestic vehicle fleet (236 million) and its very slow rate of turnover. The former will only increase, but what about the latter? This is the key to future transportation energy savings, in my view.

Conventional wisdom is that Americans will continue to turn cars over every 8 years, on average, or even longer (measured in terms of mean age of household vehicles). Only a few decades ago, that figure was closer to five years. Along the way, several things happened: cars got more expensive (though not by much as a fraction of average income--see below), families wanted to own more cars at the same time, and--with time out for bad behavior in the 1970s and early 80s--cars got progressively better and more reliable.

For years I've been asking what it would take to get us to turn our cars over more frequently, which would incidentally allow more efficient vehicle technologies to have a bigger impact much quicker. There are several possible answers, some of which have already come up short, such as leasing. My favorite is still technology-related coolness, which may explain part of the appeal of the Toyota Prius. But the sample size is too small so far to suggest whether this is changing how long people hold onto a car.

The best contender is probably a return to pizazz, as suggested in this Wall Street Journal guest editorial. I'm old enough to remember a time when the arrival of the new car models in the fall was a really big deal, whether you were in the market for one or not. Based on the steady increase in annual miles driven, cars command an even more central role in our daily lives now than back then, but they have relinquished much of their hold on our imaginations, perhaps partly for that very reason--familiarity breeds contempt.

If you are passionately concerned with reducing the amount of oil Americans use to run their cars, then paradoxically you should be thinking like a real marketer about how to get Americans much more excited about new cars. Could really bold styling, combined with more efficient technology, push that average turnover figure down to six or even five years again? That's what it would take to move America's miles per gallon into the same range as Europe's in our lifetimes. (Some other time we'll talk about what happens to the old cars, which don't all disappear into the crusher the way they used to.)

Note: In 1970 a middle-income family earned just under $10,000 and a new car averaged $3,500, or 36% of a year's income. In 2000 a middle-income family earned about $50,700 and an average new car cost a bit over $20,000, or 40% of a year's income.

Let's Keep It Clean
As I was going through some of my postings from last year, I ran across one from the early days of the UN Oil-for-Food scandal publicity. (See posting of 4/19/04.) My concern then was for a potential handover of Iraq to UN administration, but the parallels to the current tsunami relief effort are obvious. In particular, excerpting some of what I said then:

I believe there are compelling reasons for exposing the full extent of malfeasance in administering the Oil for Food fund, and the most important of these concerns the future, rather than the past. As the UN takes the lead role...we must aggressively manage the risks this will entail, and one of the largest is for corruption on a vast scale.

Although the current effort may be a better fit with routine UN activities than Oil for Food was, anyone who has done business in South Asia understands the temptations that those administering aid on this scale will face. Resolving the Oil-for-Food scandal promptly and publicly punishing those at fault--along with establishing strict new standards for contracting--will go a long way toward keeping the aid administrators out of trouble.

While I am not suggesting replacing the Secretary-General unless he is directly implicated, there are plenty of others who should clearly go, or at least be removed from any position involving contracting or funding. It would be a great shame if two or three years from now we learned about a "tsunami relief scandal", further compounding a tragedy of already staggering proportions.

Transparency of Reserves
Yesterday I discussed the prospect of a peak in oil production. The scarcity of good data on global oilfield performance has fueled much of the uncertainty in this area, and nowhere is this truer than for Saudi Arabia's enormous reserves, which underpin both the present and future of global petroleum supply. Many have suggested that the Kingdom and its OPEC brethren stand to benefit from greater transparency (see my posting of 7/30/04), in effect reassuring their global customers of their longevity. This week's Economist (subscription may be required) suggests that the Saudis' historic reticence has begun to dissolve. That is welcome news, indeed.

This prompted me to do a little Googling, which turned up recent presentations on Saudi oilfield management practices, along with some pretty interesting scenarios for future production growth, relying to various degrees on undeveloped and unproved, but "probable and possible" reserves. Reading between the lines suggests that anyone expecting Saudi Aramco to double its production is dreaming, while the most vocal skeptics of Aramco's ability to sustain its current production well into the future, such as Matthew Simmons, are probably wrong, as well.

So the good news is that Saudi Arabia appears to have both the reserves and the expertise to crank out 10 million barrels per day as far as the eye can see. The bad news is that they don't seem to contemplate contributing more than another 2-5 million barrels per day (MBD) toward the roughly 20 MBD of incremental production required to meet projected global oil demand a decade from now. (And this ignores all the new production needed just to replace the natural decline in current production over that timeframe.)

There are two implications to draw from this. The first is that the Saudis might be extremely conservative about their production potential, to avoid depressing future prices. If so, can we count on this? The second and more definite implication is that it is going to take a lot of money and hard work to dig up the rest of that incremental production elsewhere. We will need Russia, Iraq, Iran, Libya, and the Caspian, plus a bunch of places hardly anyone has heard of to make up the difference. Or just a lot of synfuels and alternative energy.

Given the lead time required for either path, the major oil companies had better be thinking very hard about their project selection criteria and future production profiles.

The End Is Near...Or Is It?
I was surprised to see an article in MIT's Technology Review suggesting that global oil production may have already started to decline. On further reading, it is mostly a rehash of the same Hubbert Curve arguments about which I wrote extensively last year. (See, for example, my post of 9/22/04.)

Global oil production and demand are already at about 82 million barrels per day (MBD), up from roughly 75 million a day a few years ago. The entire industry, both supply and demand sides, seem to be working under the assumption that this will grow to roughly 100 MBD within a decade. So if we were actually to start falling off from 82 MBD, instead of tracking towards 100, that would suggest one hell of a disconnect on the part of a very large number of analysts, both inside and outside the industry.

My regular readers know that I have a healthy skepticism that production can keep up with growing demand indefinitely, but not because of the geology-based concerns of Deffeyes and Hubbert's other disciples, but simply because it's not clear that the industry (both OPEC and publicly-traded companies) has invested in enough projects to make that happen, while simultaneously compensating for the inherent natural decline of the fields already in production. (I'd be happy to be proved wrong on this, by the way, so if any of you has a field-by-field, country-by-country buildup of real projects that gets to 100 MBD, I'd love to see it.)

That is a far cry from saying that the peak is here, as this MIT article flirts with. For that matter, if production were actually going down globally, rather than up, would the price of oil really be retreating from its $50 highs of last year, or would it instead be well on its way to $75 or $100? From this I conclude that we have time, not for complacency, but to come up with the right set of alternatives with which to fill the gap when production of conventional oil can truly no longer keep expanding.