Action Or Futility

My posting on Sunday's Discovery Channel global warming documentary elicited some sharp comments on the efficacy of our available responses. I think this issue merits a posting of its own, building on yesterday's. At issue is whether any program of conservation and transformation aimed at reducing our emissions can succeed at averting further warming, or if these measures are so futile that we should abandon them and either live with the consequences, or focus on counteracting them on the macro level via planetary reengineering. In my view, the answer lies somewhere in the middle.

We should start with what we think we know, as distinct from assumptions and suppositions about political and economic hurdles. My understanding from extensive reading and discussions on the subject is that:

1. Further warming appears to be "baked in", even if we stopped emitting CO2 altogether, because of the delayed consequences of the greenhouse gases we've emitted to date, and the persistence of those gases in the environment. However, this warming would likely not be permanent: temperatures would rise, plateau, and then later fall back to "normal", as excess CO2 is absorbed into seawater and carbonates. Total timeframe, a couple of centuries. That's long for us, but short for nature.
2. Continued growth in global emissions on the current trend line would more than double pre-industrial CO2 levels and likely increase temperatures by much more, up to 10 deg. F on average by 2100, vs. the 1 or 2 degree rise that is essentially predetermined.

That much is consistent with the data and models, though one of the key analyses of the historical, or "paleoclimate," the so-called "hockey stick" graph of Mann, et al, has been challenged again, this time by a panel of statisticians commissioned by the US Congress. Their findings, which are not widely accepted in the climate science community, don't undermine the conclusion that the earth is warming significantly, but they could change our understanding of the context of that warming, particularly if claims that the decade of the 1990s was the warmest in 1000 years turn out to be unsupportable. Even if current global temperatures are no greater than those in the Middle Ages, with part of the last century's warming merely a natural recovery from the Little Ice Age of the 17th-19th centuries, the extent and present rate of increase could still overshoot those earlier highs and take us into some very uncomfortable territory.

The combination of these facts (or at least current conclusions from available data) leads me to think we need a multi-fold strategy:

• Continue to expand our knowledge of climate processes and refine climate models.
• Reduce emissions below the status quo trend-line, in order to moderate the increases and buy time for the development and deployment of truly low-emission energy technologies.
• Investigate and plan adaptation measures to mitigate the impact of unavoidable warming, particularly in low-lying coastal areas and islands.
• Investigate the means of eventually intervening to restore the climate to pre-warming levels, and in particular to short-circuit the feedback mechanisms that some scientists speculate could create a "runaway greenhouse."

The first two measures are underway, guided by the UN Framework Convention on Climate Change and other international and national bodies. The third point remains controversial in some quarters but will probably prove necessary, if we are to avert humanitarian crises that could overwhelm our ability to respond. The fourth strategy is still viewed as fringe, or even irresponsible, but I wonder how many of us would hesitate to attempt this, if the alternative were the breakdown of global civilization or worse.

Ultimately, no one can predict whether we will be able to overcome the political, economic and social obstacles to mounting a meaningful response to global warming, or whether, if we do, it will be sufficient to prevent really bad outcomes. I still think the best way to look at all of this is as a global insurance policy, the premium for which shouldn't exceed the expected value of the cost.

Brokaw on Climate Change

A couple of months ago, in a posting on the release of the film "An Inconvenient Truth," I questioned whether Al Gore was the best person to convince climate skeptics of the reasons for concern and prompt action. At the time, I couldn't come up with an alternative who would be credible to those not already disposed to believe. In retrospect, I'm surprised I didn't consider Tom Brokaw, who hosted Sunday night's Discovery Channel special, "Global Warming - What You Need To Know." His down-to-earth charm and low-key delivery worked well in a two-hour program that combined ominous predictions with striking visuals. If I weren't already convinced, would this show have changed my mind? Quite possibly.

This program, a co-production of NBC News and the BBC, covered four aspects of climate change: the evidence, the contributing factors, the consequences, and, perhaps most effectively, our responses. The producers clearly have a strong point of view that humanity's actions are changing the climate, possibly irreversibly, and that the evidence of this is all around us. They traveled to the Arctic, Antarctic, South Pacific, China, Brazil, Patagonia, Australia, and various other places to put that evidence on film, and they interviewed an impressive array of climatologists and environmental scientists, including such well-known figures as NASA's Dr. James Hansen.

Although I'm not sure I'd call the presentation balanced, since absolute even-handedness clearly wasn't its purpose, it addressed many questions often posed by skeptics, including what makes this round of climate change different from those the earth has experienced in the past--beyond the simple fact that we're here to observe it firsthand. It looked at the degree to which some of the evidence of climate change might equally well be attributed to naturally-occurring cycles, and it also tackled the rapidly growing emissions in the developing world, particularly in China, in a forthright manner. On the whole, though, caveats were few and far between, and serious outcomes such as rising sea levels and mass extinctions were presented as strong likelihoods or virtual certainties. I'd have chosen a greater emphasis on risk, rather than prediction, but that may be one of the many reasons I'm not in the business of producing TV shows.

(As an aside, it occurred to me as I was watching this presentation that attitudes about the predicted consequences of climate change might by affected by one's views on evolution. If you start with a belief that the earth is only 6,000 thousand years old, for example, it might be difficult to fit all this into your worldview.)

The real reward for me--having heard all the arguments before--came in the last few minutes, when some clever animation made the daily "carbon footprint" of an average American family visible as little black chunks of carbon emanating from appliances and spewing out of vehicles, accreting to hover above each home--and later a whole city--as giant (50 tons/year) blocks vaguely reminiscent of the alien spacecraft in "Independence Day." One of the biggest problems associated with climate change is that we're dealing with invisible gases and consequences removed from their emission by many years; making them visible was a brilliant stroke.

Finally and somewhat surprisingly, given the program's deadly serious tone, there was a sustained positive note throughout: it isn't too late; we can solve this if we tackle it now. That worked nicely with Mr. Brokaw's natural, Mid-western optimism. I still haven't seen "Inconvenient Truth," so I can't compare the two. I'm also not sure what it says about NBC's commitment to this message that they chose to air it on the Discovery Channel, rather than on the parent network in prime time. You can catch the reprise this Saturday evening on Discovery.

1973 or 1982?

In light of last week's events, it's getting harder to cling to my frequent assertion that we aren't living through a re-run of the 1970s, energy-wise. Not only are oil prices approaching their all-time, real-dollar highs of the late 70s and early 80s, but the outbreak of hostilities between Israel and Hezbollah raises the specter of past Middle East conflicts and their unpredictable outcomes. As markets try to assess the implications of all this, I find myself wondering if we are in another 1973--on the threshold of a massive global energy shock--or a 1982, a year in which Israel invaded southern Lebanon but the price of oil actually declined.

Nor have the leaders of the developed world come to grips with the core of the problem. Although the New York Times characterized it as heavily oil-centric, the Energy Communique from the weekend's G8 summit in Russia presents a solid list of appropriate longer-term energy focus areas, including data and market transparency, energy diversification and climate change. However, it fails entirely to connect the dots between the "high and volatile oil prices" that it cites as an important challenge, and the current geopolitical crises driving that volatility.

Even if we might be on the verge of another Middle East war, though, it's worth considering what's different, compared to 1973. We have a lot more cars and use a lot more imported oil now than then, as a result of a roughly 50% increase in population and policies that helped keep the price of fossil fuels low for two decades. But while our millions of SUVs get roughly the same fuel economy as the big sedans and station wagons of the early 1970s, many families also own a more economical car. The most popular "economy cars" thirty years ago barely achieved 30 mpg, but there are many models today that beat that figure handily, including hybrids that get up to 50-60 mpg. Nor were telecommuting and online commerce even an option back then. In a pinch, changes in established work and shopping patterns could deliver dramatic reductions in fuel consumption.

We also have a wider variety of available alternative energy options. Although gas- and coal-to-liquids and oil sands are all capital intensive, they are actual hardware today, not just long-term R&D projects. The same is true for wind and solar power, which can contribute by displacing natural gas that could be used to augment transportation fuels. Even if our attention has recently been diverted by hype about corn ethanol, the entire net energy contribution of which is equal to that of one good-size offshore oil platform, the prospect of practical cellulosic ethanol could revolutionize the whole biofuels sector. An oil shock today would cause a lot of economic pain, but it might just trigger the energy transformation that the previous one didn't.

Last week I observed that the fundamentals of the oil market were starting to look a little more positive, but for the moment that appears totally irrelevant. In a market in which between 25% and 50% of the price of oil is determined by risk, its near-term path will have little to do with actual supply and demand. The prospect of another major Mid-Eastern oil producer becoming involved in a war--if rumors of Iranian troops in Lebanon turn out to be true--could shatter all the old records. Or the current crisis will abate, and we will still be left with the riskiness of our ongoing problems with Iraq, Iran, Nigeria and North Korea.

Pre-Summit Poll

The leaders of the G8 group of nations meet this weekend in St. Petersburg, Russia, and energy is a key theme of the summit. That seems appropriate, given the venue and in light of the apparently successful IPO of roughly 20% of Rosneft, the state oil company that absorbed most of Yukos last year. In advance of the summit, the BBC commissioned a poll of residents of 19 countries for their thoughts on energy, and the results are interesting. Large majorities across the globe see energy as a major economic, geopolitical and environmental concern, but as the Beeb points out, their agreement ends with the diagnosis; preferred solutions diverge widely, especially on the subject of higher energy taxes.

Worries about energy's role in climate change and other environmental issues topped the list with 81%, and are probably connected to the strong support (80%) for incentives to promote renewable energy. Unsurprisingly, attitudes toward nuclear power were very country-specific, with support strongest in the US and Asia and weakest in Europe and the former Soviet bloc.

The disparities on increasing energy taxes, which comes closest to a pocketbook issue of anything that was asked, likely reflect a reality not addressed in this poll or its methodology: where do energy and the environment rank among all the things the respondents care about? If people are more worried about jobs, families, and personal safety, will they really demand higher energy taxes? Has energy reached that over-arching point of dominant public focus, as it did in the 1970s? You can't tell from this survey, but the resilience of economic growth to higher energy prices, and the miniscule demand response to those prices, suggest not.

So what message should the G8 emissaries take away from the BBC poll? Maybe it's the one inferred by the Director of the Program on international Policy Attitudes, one of the organizations that designed the poll, who said, "...the way the world is producing and using energy is not viable. People around the world will be looking to the G8 leaders to address this issue and show a readiness to support significant new steps." In fact, the G8 Gleneagles Agreement was a good start on that. Perhaps the best thing the G8 could do this time around would be to concentrate on the geopolitical problems that have heaped enormous risk premia on the prices of oil and competing forms of energy. It's hard to focus our efforts on an enormous, gradual problem such as climate change, when everyone is fretting about terrorism, a widening conflict in the Middle East, Korean missiles and Iranian nukes.

What Goes Up...

Yesterday I looked at the risks hanging over the oil market; today I want to look at the fundamentals, particularly for gasoline. The news is again full of reports of higher gasoline prices and irate consumers. Prices certainly seem to be headed back up, and almost everyone blames higher crude oil prices. Is that right, or is the story more complicated? Answering that requires looking at the supply and demand for both crude oil and for gasoline, and their connection via refining.

Let's start with crude oil. Global production for January-April was up from the same period in 2005 by about 200,000 barrels per day (bpd,) as reported by the Energy Information Agency, on total production of over 84 million bpd. However, US production is down by more than half a million bpd, due to lingering effects of last year's hurricanes, combined with existing depletion trends. Consumption for the first three months of the year appears to have been down, at least in the developed world, though this may have been due more to weather than price-related conservation. US refinery throughput for the first half of the year was down, as well. Taken together, this suggests that global crude inventories should be higher, and we certainly see that in US commercial inventories, which are about 5% above their level in June 2005 and still well above the average of the last five years.

Now let's turn to gasoline. The EIA's latest update shows that gasoline production for the first half of the year was about the same as for the first half of 2005, while demand was up by a bit less than 1%. Despite this, gasoline inventories appear quite normal for this time of year. That's because gasoline imports have risen by about 25% in the same period. The part of the inventory story that has changed, though, is the breakdown between gasoline that is already blended and ready to ship immediately, vs. gasoline that still needs further blending, either at a refinery or a distribution terminal. The former has dropped and the latter increased significantly, as a result of the shift toward ethanol and away from MTBE as a gasoline additive. This correlates with a 60% increase in imported gasoline blending components.

So what does all this tell us? The difference between the crude oil and gasoline market fundamentals suggests a market that is still being driven by growing product demand and a strained refining system, rather than a shortage of crude oil--but with an enormous risk premium overlaid on both. For the first half of this year, US refineries were still dealing with the consequences of the 2005 hurricane season, either in terms of lingering damage or maintenance that had been deferred into the 1st and 2nd quarters of 2006. At the same time, crude oil prices were up by $14.50/barrel, this June vs. last June, driven by the proliferation of risks I discussed yesterday.

If you're looking for signs of just how difficult the refined product end of the market has become, I can't think of a better indicator than an announcement by Citgo, the US subsidiary of Venezuela's state oil company, that it is phasing out supply to 1,900 mid-western service stations, about 15% of its US network, because it can't produce enough gasoline to supply them and can't afford to cover the shortfall by buying the product from others. Geopolitical experts will scrutinize this news for signs of growing US/Venezuelan tension, but I think it could well be exactly what Citgo claims: the result of a very tight market. Most of the major oil companies are in a similar situation, needing to supplement their equity refining output with purchased product. It will be interesting to see if any of them follow Citgo's lead, in trimming marginal parts of their marketing networks.

Even if crude oil looks a bit oversupplied at the moment, with the futures market in contango, the lack of cushion in the downstream quickly translates every dollar increase in the price of crude oil into a comparable bump in gas prices. At the end of the day, although I have consistently looked for signs that the market might be poised to weaken, the combination of international petroleum risk factors and a stretched refined products market could forestall that for some time. It looks to be a long, expensive summer for motorists.

Where Is the Good Scenario?

Living in a different city, I don't read the New York Times as regularly as I used to. I try to keep up with the musings of the "gray lady", though, even if a few days after the fact. That's how I ran across these scenarios for North Korea from last Sunday's Week in Review (Times Select required, unfortunately.) The author's conclusion fits the title, "Four Scenarios, and Not One Ends Happily." That started me thinking about scenarios for the energy market, and how they've been affected by the remarkable accumulation of negative risk over the last several years. It's pretty easy to think of ways things might get worse, but much harder to see what could ease conditions any time soon--and that could be the main reason why the price of oil remains over $70.

If you've read my profile, you know that my paying work is in the field of energy strategy and scenario planning, so anything with the word "scenario" in the title gets my attention, even if most of the time it's used in an almost trivial sense. I don't know how rigorously Mr. Sanger developed his four views of how things could turn out in the latest round of "The Dear Leader" and his followers vs. everyone else. (I haven't chimed in on this, myself, because unlike the confrontation with Iran, there hasn't been an obvious energy angle here, unless it's about nuclear power in developing countries.) I'm not sure he's captured the full range of possibilities, but I'm not prepared to dismiss his choices, either.

Stepping back from Korea to look at the broader array of issues affecting energy, it seems like we've gravitated towards the downside of virtually every situation that's cropped up since 2002. Consider:

• The war in Iraq has kept that country's production stuck at roughly pre-war levels, and they've only managed that with some remarkable ingenuity on the part of the production and pipeline engineers involved. Billions of barrels of untapped reserves await stability.
• Venezuela hadn't even recovered from the aftermath of the 2002-3 oil industry strike, when Sr. Chavez decided that the terms given to the international companies--the same ones whose facilities had kept Venezuelan production from imploding altogether--were too generous, and unilaterally "renegotiated" them.
• Iran seems to believe it can develop nuclear weapons and attract foreign investment to expand its oil and gas sector. This hasn't been entirely irrational on their part, given the way they've played their hand, but the market clearly understands that things could get very ugly, very quickly.
• Nigeria has been one of the real oil success stories of the last decade, but every time you turn around, some group of indigenous people has occupied an oil platform, kidnapped oil workers, accidentally blown up a pipeline, or in some other manner impeded getting the resource out of the ground and to market.
• The growth in Russian oil production played a central key role in holding down prices earlier in the decade, but for reasons that remain open to interpretation, the Kremlin chose to dismantle and effectively re-nationalize the company with the best track record at expansion.
• What are the odds against three major hurricanes in two years plowing through the heart of the US Gulf Coast oil and gas production and processing?
• I could go on, but almost the only thing we haven't had is a major disruption from Saudi Arabia, which a lot of us expected to see in the wake of 9/11.

When you create scenarios, you need to think about the opposing extremes of a given uncertainty, the upside and downside, and the combination of these factors usually creates at least one fairly positive scenario. But any "good scenario" that I could construct from the upside outcomes of the above issues would probably seem unrealistically upbeat, after what we've been through and continue to experience. And yet, experience tells us that we can't keep rolling sevens indefinitely; things could start to turn around, and they are past due to do so. A market so driven by risk, but for which the underlying fundamentals have at least begun to ease, as I'll discuss tomorrow, could drop suddenly and catch a lot of speculators by surprise. What are the odds for that, versus yet another nasty surprise emerging from a long list of possibilities?

Solar Convergence

If there's one alternative energy sector to which I've given short shrift in this blog, it's solar power. That's not because I think it lacks great potential. Instead, I've generally focused on fuels issues, since they are in the news more frequently and seem more urgent. Absent large numbers of battery-electric cars or solar-generated hydrogen, solar power won't affect the transportation energy markets for many years. Despite this, I'm intrigued by the apparent increase in important developments in solar technology, at least as reported in the news sources I follow. They suggest the beginnings of a technology convergence that could make solar power at least as important as wind power within a few years.

Wind and solar power diverged, when wind technology improved to the point at which it became essentially competitive--given modest subsidies or incentives--with conventional alternatives for generating electricity, such as gas-fired turbines. Solar has progressed, too, but remains farther from this kind of commerciality, even though its price hurdle is less difficult than wind's: solar power need only compete with the retail electricity prices that businesses and consumers pay their local utilities for delivered power, while wind must compete at the tougher wholesale level, which typically affords less than half the retail price.

So why has solar started to look more promising? It relates to developments in the same two key areas that moved wind out of the novelty category. First, there seems to be a sudden proliferation of new technologies that promise higher output at lower cost, enabling solar to be deployed in a wider market. More importantly, the capacity to produce solar cells or panels is being boosted by new manufacturing processes and by new cell technology that facilitates easier manufacturing at larger scales, with fewer bottlenecks of the kind that crystalline silicon has posed lately. More and larger "fabs" mean cheaper cells, which means higher demand, which drives the construction of more "fabs", in a virtuous cycle. There's some price at which you penetrate the full consumer power market (rather than small niches within it) and the cycle really takes off.

Here are some recent news items that I'd take as signposts of this kind of gathering momentum. Hardly a week goes by without something along these lines:

• A company called Nanosolar, Inc. has devised a new way to produce thin-film solar cells--an alternative to traditional crystalline silicon cells--using a process similar to newspaper printing. They announced the construction of a new facility that by itself would boost global solar manufacturing capacity by roughly 25%.
• Holograms may provide an inexpensive way to focus more of the sun's rays on collector, reducing the size--and thus the cost--of a solar array for a given power output and saving on manufacturing cost, as well.
• Entirely new materials such as quantum dots could pave the way for a third generation of solar cells, which will be both more efficient and lower cost than current approaches.
• A survey of the sector by a German tech analyst indicated that there were 50 companies working on new solar technologies, with significant new capital coming into the sector.

At the same time, the market for new solar arrays is being primed by a combination of high energy prices, growing environmental awareness, and big-budget incentive programs such as California's solar roofs initiative. The trick will be to get prices low enough to expand demand rapidly enough for it to become meaningful in terms of our total energy consumption, without drying up the profits that will be needed to fuel the continued expansion of the solar industry. That means that technology must continue to set the pace, and keep driving costs down.

There are many positive signs for solar, but we still need to keep them in perspective. Wide-scale implementation of photovoltaic arrays, particularly when combined with net-metering that allows excess solar power to be sold back into the grid, will reduce the call on peak-power generation from natural gas-fired turbines. That should free up gas for other uses. But without a breakthrough in the cost and efficiency of batteries, solar isn't going to have much impact on the demand fro big, base-load power plants, which in this country means coal. Until we can effectively shift solar power from where and when it's most abundant to where and when it's needed most, its contribution will be at the margin, not at the heart of our energy economy. That's still a pretty big market opportunity for today's solar startups.

Practical Limitations

Only a couple of years ago, Canada put itself near the top of the petroleum world by adding 174 billion barrels of oil sands to its proved oil reserves. This was accompanied by a deft PR initiative that included front-page articles in impressive media such as the Wall St. Journal and New York Times, touting Canada as second only to Saudi Arabia. There's no question that Canadian and international energy companies are investing billions of dollars to boost oil sands production dramatically, from roughly one million barrels per day to three or four in the next decade. Now, however, we're starting to see signs that the expectations surrounding this expansion may have been overly optimistic, as practical limitations set in. This has implications for how we look at all forms of alternative energy.

Extracting oil from oil sands is more difficult and expensive than producing the same quantities from conventional oil reservoirs, even those is deep water, far offshore. The oil in oil sands must be mined like coal, separated from its source minerals, and upgraded in refinery-like plants to turn the heavy "bitumen" into something roughly comparable to a medium-grade crude oil. As a result of all this extra effort, oil sands are inherently more capital-, labor-, and energy-intensive than conventional oil. So it shouldn't be surprising that as production ramps up, bottlenecks are showing up in all these areas: Shell is reporting inflation in the cost of the capital equipment necessary to expand its oil sands operation, and Fort McMurray, the hub of the Alberta oil sands infrastructure, is experiencing labor and housing shortages. There are also environmental limitations, which I've commented on previously. When we factor in all these real-world problems, Canadian oil sands look less like another Saudi Arabia--which has its own untapped heavy oil--and more like a second Venezuela, with comparable technical challenges but much lower political risk.

My purpose here isn't to denigrate the potential of oil sands. They're going to be tremendously important, particularly in helping to forestall a peak in oil production. But they also provide a classic illustration of what happens when we attempt to expand a new energy source to a multiple of its former output in a very short time. For oil sands, the bottlenecks are in labor and hardware; for ethanol they may well be in land use and railroad tank car capacity. Other new sources exhibit other limitations, including electric transmission line congestion, wind turbine production capacity, and shortages of raw materials for solar panels. That means that in addition to investing in the new energy sources themselves, we must expand the means to build them and connect them to markets, adding extra costs and delays.

Many of us are walking around with a false, "revolutionary" model of how energy will change in our lifetimes. It's been put there by the media, politicians and activists, many of whom were advancing an agenda or simply lacked the technical knowledge to appreciate the enormity of the task at hand. Watching the expansion Canada's oil sands provides the real-world challenge to this model of sudden, dramatic energy shifts. We need to understand this instead as an inexorable but gradual process, with revolutionary changes in technology--hybrid cars, for example--feeding into its margins at periodic intervals. That will challenge our patience with high prices, and it makes the aggregation of our personal choices about energy consumption as important as any new technology or project.

Another Trading Scandal?

It seems at least mildly ironic that the news of BP's alleged propane market manipulation should break only a few days before Ken Lay died. You might see this as an instance of, "The evil men do lives after them..." or as something that's simply part and parcel of energy trading, and of commodities trading in general. I take the latter view. Enron didn't invent market manipulation, and the lore of trading is replete with stories about this or that trader or company that managed to "corner" the market in some commodity, for some short period. Rather than citing this as justification for the regulation of over-the-counter trades, which typically involve transactions too esoteric or illiquid for the formal exchanges to bother with, I regard it as just one more example of personal greed, and one that our current laws are perfectly adequate to sort out.

I'm frankly a little surprised to see BP in the cross-hairs on this. Despite the descriptions of BP's more aggressive trading style, the major oil companies generally keep a tight rein on their traders, because of their aversion to adverse publicity and the recognition that their size attracts much higher levels of regulatory scrutiny than smaller firms enjoy. It is instructive to see how quickly BP responded here, and to note the titles of the individuals who've been fired or suspended. They did not shoot mere minions here, but rather some highly-compensated, senior business unit executives.

The other interesting aspect of this story is the participants' choice of the mid-continent propane market. While it's certainly not as large as the WTI market, it's not an itty bitty market, either. These guys would have been running a sizeable risk of getting stuck with some seriously over-priced product (or holding the high price end of a derivative on a market that could go south, with no one to bail them out.) The experience apparently cost them $10 million, an outcome consistent with most previous attempts to corner markets.

From my perspective of a decade of hands-on trading experience in a variety of physical, futures, and over-the-counter energy commodities, I'd conclude that you can't have thousands of bright, highly-motivated individuals chasing commodity trades literally 24/7--interrupting meals, sleep and even dates to work on deals--without this kind of thing happening occasionally. (Note the distinction between that and an operation that routinely and systematically exploited regulatory loopholes.) The economic and societal benefits of energy trading far outweigh the cost of the occasional trading scandal, by making US energy markets the most efficient in the world and genuinely reducing the costs consumers and businesses pay for energy products.

Putting All The Choices On The Table

Yesterday's New York Times business section featured a lengthy article on turning coal into synthetic gas or liquid fuels, as an alternative to importing more foreign oil and gas. It highlights a company called Rentech, whose technology for coal-to-liquids is an update of the old Fischer-Tropsch process, which supplied Germany with synthetic fuel during World War II. There's great potential in this process, particularly with oil prices so high and coal prices relatively lower. The article properly identifies the problem of managing the large greenhouse gas emissions inherent in this approach, but as I so often find in such pieces, it's more interesting for what it fails to mention that for what it includes.

The issue is fairly simple, though I've rarely seen it articulated in popular articles on alternative energy. It's wonderful that we have a widening array of choices for creating alternatives to conventional--which increasingly means imported--oil and gas. But when we look at the environmental consequences of producing synthetic gasoline or diesel fuel from coal or oil sands, we ought to compare them not just to other alternative energy processes, many of which have their own challenges in scaling up or avoiding unintended consequences, as this recent piece on ethanol reminds us. We also need to compare them to the simpler alternative of expanding the areas available to the industry for drilling conventional domestic oil and gas.

I know that offshore drilling is a hot-button issue. There's been a flurry of legislation trying to address it, and our best available compromise may be to treat drilling for non-associated natural gas differently from that for oil, thus avoiding at least some of the problems generating opposition. But however you view the drawbacks of offshore oil or gas drilling, whether from pollution risks to water, beaches, or "viewscapes," it's hard to see that they are worse than the consequences of producing the same amount of energy by turning additional surface-minded coal into gasoline. The biggest difference appears to be that the latter occurs somewhere in the heartland, while the former affects upscale beach communities. I'm not big on "environmental justice" as an issue, but the situation above seems like a classic example.

In the long run, I believe we'll need a significant contribution from every energy option now on the table, including LNG, gas-to-liquids, coal-to-liquids, oil sands, ethanol (preferably cellulosic,) wind, solar and advanced nuclear power. What's really at stake is the future energy mix and its overall environmental impact. As new options ramp up, though, we can't afford to be obtuse about how we compare them to the default option of increasing supplies from conventional sources by altering boundary lines that were drawn for social and political reasons. While we can't drill our way to independence, the downside of producing oil and gas reserves from areas currently off-limits looks lower than that of some of the alternatives we're considering.

Is Jet Fuel Next?

Over the weekend I had a chance to catch up on some of the articles that have languished during my recent relocation. It'll be a while before I feel fully caught up on events in the industry and the world, but at least I feel less out of the loop. One of the articles that caught my attention was this excellent report in the Economist on the environmental issues facing global aviation, particularly the growing focus on fuel consumption and greenhouse gas emissions from this sector. The article includes some interesting comparisons of the emissions from air travel relative to other modes, a topic that's come up in this blog from time to time. Their conclusion mirrors what I've said for years: aviation has gotten a relatively easy ride on the environment, but that won't last forever.

Air travel has been a great boon to mankind and is probably the signature innovation of the last century. But as it expands, so does its environmental impact, particularly when it is adding net new travel over long distances, rather than displacing existing travel via road or rail. The Economist cites EPA figures indicating that aircraft account for only about 3% of all greenhouse gas emissions, which is consistent with its roughly 4% share of total energy consumption, based on a share of just under 10% of total petroleum usage. But that modest share will rise, as air travel expansion outpaces other forms of energy consumption. It's startling to read that the growth in aviation emissions might offset more than a quarter of the EU's other emissions reductions by 2012, the end of the first Kyoto compliance period.

And while the Economist looks mainly at the impact on climate change, that's not the only issue the industry--both commercial aviation and its fuel suppliers--must worry about. For example, jet fuel has escaped most of the anti-pollution scrutiny and reformulation of the last couple decades. At 0.3% (3000 parts per million) its sulfur content, which was once comparable to that of diesel fuel, is 200 times higher than the ultra-low-sulfur diesel specification that has just gone into force in the US. While most of the sulfate emissions associated with burning jet fuel occur outside of urban pollution-control areas, they have long been thought to influence such climate-related issues as cloud formation. Oxides of nitrogen are even harder to avoid, given the high combustion temperatures in turbine engines.

I don't see any easy solutions. As the article points out, air travel is tightly linked with economic growth, and there's no handy alternative to kerosene-based jet fuel, unless it's the synthetic distillate from coal- or gas-to-liquids processes. These will have similar or even greater environmental implications, at least in terms of greenhouse gas emissions. At the same time, it's hard to imagine that air travel will get another "bye" in future climate change negotiations, as it did in the Kyoto Treaty. Stay tuned.

Snob Appeal

Last Friday's posting about Ford's canceled hybrid car target generated some interesting comments. They go to the heart of how consumers choose cars, and they raise important questions about whether hybrids are just another car fad, or have the staying power necessary to contribute meaningfully towards improving overall fleet fuel economy.

One reader suggested that the main appeal of the Toyota Prius is social: driving one is seen to be cool and "with it", while the other hybrids that aren't doing so well don't carry that cachet. Rival automakers have made some very different choices in this area. Toyota chose to build its flagship hybrid as an all-new model, available only as a hybrid. If you see a Prius, you know it's a hybrid; if you see a hybrid Honda Accord or Ford Escape, you have to look hard for the badge identifying it as such. Not much potential snob appeal there. But is a hybrid a car or a feature? Even Toyota seems of two minds, pushing the Prius and its "hybrid synergy drive", but also touting the hybrid Camry (to be introduced shortly,) Highlander, and Lexus RX400h and GS450h, all variants of existing conventional models.

And if snob appeal or some form of "early adopter" behavior isn't the main driver, what is? The economics of hybrids are still shaky, though as another reader reminded us, the resale value of Priuses has held up very well. If we want economics to guide us, then we have to look beyond fuel costs and compare cars on their annual cost of ownership, which includes fuel, maintenance, depreciation and insurance. I'm not sure how many folks actually choose cars on that basis, however. If they did, would SUVs have ever become quite so popular?

I have enormous respect for the way Toyota has managed the Prius project, which must be viewed as a success, even though it will probably never turn a profit. However, for hybrids to matter, their future must be as a feature, rather than as the raison d'etre of a car. The jury is still out on whether consumers will adopt it on that basis, as they have things like air conditioning and automatic transmissions in the past.

Energy Outlook will observe Independence Day tomorrow. I wish my American readers a happy Fourth.

Hybrid Setback

Ever since Toyota introduced the Prius in the late 1990s, gasoline-electric hybrid cars have been the benchmark technology for improving the fuel efficiency of internal combustion engine cars, at least in the US market. All major carmakers now offer hybrid models, or will introduce them shortly. Ford made headlines last year when it announced it would build 250,000 hybrids per year by the end of the decade, and they have just made headlines again by retracting that pledge. I'm not sure this is as bad for hybrids and automobile fuel efficiency as it may seem, but that depends largely on what actual steps follow this announcement.

The problem seems to be low sales for hybrid models other than the Prius. With a Ford Escape Hybrid (small SUV, 4WD) carrying a sticker price of $27,845, roughly $3,000 over the comparably equipped 6-cylinder gas model, it would take nearly 7 years for the hybrid's 8 mpg gas mileage improvement to pay out, on an undiscounted basis and ignoring tax credits. That's a tough sell, even with gasoline prices around $3.00/gallon. The Washington Post article linked above cites a JD Power survey indicating hybrids account for only 1% of all US car sales today.

So does it mean anything that Ford has backed off their earlier estimate of how many hybrids they'd sell? If they cancel plans to add hybrid options on future models, then the answer is clearly yes. And if, as they Post suggests, they shift their emphasis to flexible-fuel models, then not only will the growth of hybrids be compromised, but the whole push for reducing petroleum product consumption through quantum-leap technology. That doesn't mean that better transmissions, direct injection and other less costly fixes won't eke out a few more mpg, but these could easily be overwhelmed by persistent consumer preferences for larger, faster, heavier vehicles. The only other technology we can be deploy today that yields fuel savings in the class of hybrids is the diesel.

It's too early to write off hybrids, just as it's too early to conclude they will be the ultimate winner in the brisk competition to determine what will be under the hood of the average car in 2020. The next generation of hybrids is likely to be cheaper and may include the much-touted "plug-in" feature that would allow limited all-electric usage, with zero gasoline consumption. Or consumers may suddenly decide that the trendsetters who've been buying hybrids for the last several years are the folks to emulate, rather than those who've been buying ever-larger SUVs. But Ford's move at least dims the prospects that the next big trend in US cars will be led by a US auto maker.

Globalization and the Windfall

Some advocates of a crash effort on US energy independence have as an explicit goal of driving down the price of oil, and thus drying up the oil wealth fueling Al Qaeda and Islamo-fascism. Implicit in this argument, however, are assumptions about how oil dollars are being spent that may not be entirely accurate. As this article from today's Financial Times suggests, large portions of the Persian Gulf oil windfall are financing the industries and business sectors intended to create a post-oil, or at least post-high-oil price economy in the region.

Most of us who remember the first oil crisis also recall extravagant spending by "oil sheikhs" on Rolls Royce cars, private jets, and Beverly Hills mansions. This time, the picture is more complicated, with at least some of the money supporting terrorists. But that's clearly not the whole picture. The sums in question are large enough to finance nearly anything we can imagine, and possibly large enough to begin addressing the serious problem of un- and under-employed youth in Saudi Arabia and elsewhere around the Gulf.

At the current OPEC "basket price" and with regional production running at 23.4 million barrels per day, the flow amounts to over a half trillion dollars per year. But even if oil prices fell to $20 per barrel, a figure that seems hard to imagine today but that is much closer to the long-term average oil price, the Persian Gulf would still be drawing in $170 billion per year, which seems more than adequate to finance the other side of the War on Terror. The losers from that scenario probably wouldn't be Al Qaeda, but rather average Arabs.

Skeptics would be right to point out that we've been down this road before. The 1970s-1980s modernization slowed dramatically when oil prices fell back, and it created tremendous wealth disparities within and between the Gulf countries. Nor did it prevent the rise of the anti-American and anti-Western sentiment that blossomed into the present terrorist campaign. But at least two circumstances are different today, offering some hope for a better outcome. The enormous transfer of wealth to oil producers is occurring within the context of rapid globalization and the development of a world-class economy next door: India. It is also able to build on the investments in education and training that have been made in the last several decades, a condition that didn't exist to nearly this degree in the '70s.

None of this means I'm happy with the current state of affairs or prefer $70 oil to, say, $30 oil. I can think of lots of good reasons to reverse the present trends of rising demand and falling production that I discussed yesterday, but I don't include in that the impoverishment of the Arab world. Even if we succeed in reducing our oil imports--a worthy goal, though not at the expense of US economic growth--we all must hope for the success of this round of oil-financed Arab modernization. A prosperous Persian Gulf, with a more diversified economy, may just be our best strategy for an ultimate victory in this protracted conflict.

Breaking the Trends

Senator Kerry's recent proposal on energy independence got me thinking about how we could make a truly meaningful dent in our oil balance over the next decade. At the moment, everyone seems focused on variations of essentially the same tools, aimed either at reducing demand or increasing supply, including supplies of alternative fuels. But this is like encircling the enemy, while leaving a gaping hole through which he can retreat. What's needed is a pincer movement: one jaw focused on cutting the growth of petroleum product demand, the other on stemming the decline in domestic oil production. Neither side alone will do, because either, unchecked, will overwhelm the other over time.

Consider demand management. Over the last year or so, I've commented on endless proposals for gasoline taxes, taxes on engine displacement, taxes on road usage, and tax incentives for efficient cars. The huge size and low turnover rate of the fleet limit the impact of efficiency, and new net taxes would be extremely difficult to pass in a Congress of either party. Nevertheless, only higher fuel prices have been proved to restrain demand, and it's clear from the experience of this year that $3.00/gallon, however painful for many, isn't high enough to reverse our growth trend.

I've really struggled with the idea of higher gas taxes, as regular readers may recall, but I'm not sure there's a better option than to impose a gas tax that is roughly neutral for the average driver, and skip everything else, including all the expensive incentives. $1.50 per gallon, offset by a rebate of $700 per licensed driver/vehicle combination, ought to be enough to do the trick. Under this scheme, someone driving a Chevy Impala 12,000 miles per year would roughly break even. A Hummer owner with the same usage would be out about $900 per year, while a Prius owner would net $375, on top of the inherent economic benefit of driving a 55 mpg vehicle, which already amounts to roughly $800 vs. the average car at $3.00/gallon. If we wanted to make the net impact more positive or more negative, we need only tweak size of the gallon tax and rebate.

But slowing the growth of demand isn't enough; without some prudent deregulation, US oil production will continue to slide, and imports will grow inexorably. In the past, I've characterized the US as the most heavily explored and exploited petroleum province in the world, and that's certainly true, but it applies primarily to the lower 48 states and the near offshore waters. Alaska and the protected segments of the outer continental shelf offer the prospect of another Texas, in aggregate. We can't afford to pass up on that, because almost everything else we have is either in deep decline or headed there. We are simply not going to reduce our imports if we allow domestic production to decline from 6 million barrels per day to 3 or 4 in 20 years' time.

As to funding more energy R&D, I'm all for it, but we need to understand technology development cycles and fleet-turnover and infrastructure-replacement dynamics. Technology alone can't solve this problem--by which I mean deliver actual reduction in consumption in the millions of barrels per day--within this decade, and will just begin to contribute in the next. That means the near-term solutions must come largely from within our current energy suite. So, like it or not, we're stuck with producing more oil where we can, and providing strong encouragement to use less of it. That's not the popular answer, but it's the one with the best chance of making progress towards an independence goal that is roughly 30 years old at this point.

Backed into a Corner

A new city means a new daily newspaper, and my first local Washington Post (free registration required) greeted me with three stories relevant to the themes of this blog. In the first, it seems Senator Kerry has called for concrete and measurable (2.5 million barrels per day by 2015) steps towards "energy independence", but has alas tied this to increasing use of fuel ethanol, which in this timeframe must come largely from corn. On the same page, we see further warnings of impending, abrupt climate change, heralded by the rapid melting of tropical-latitude glaciers. Either of these items merits an entire posting, but the news that caught my interest was the agreement by the Supreme Court to hear a case in which a group of states and municipalities is suing the federal government to have carbon dioxide defined as a pollutant under the Clean Air Act. While I sympathize with the motives behind this case, finding in favor of the states here would be a grave error. It would raise the cost of reducing greenhouse gas emissions, and thus limit the impact of long-term mitigation efforts.

I know this probably sounds like more oil-mentality obstructionism, but it goes to the heart of whether we can actually reduce emissions by enough to avert irreversible and deleterious global warming. Reducing emissions at their source, i.e. from automobile tailpipes and factory and power plant smokestacks, will have to be done to some degree, but these reductions are among the costliest available to us. That's because carbon dioxide is not the result of fuel impurities, as are most of the pollutants we've spent the last three decades bringing under control. Rather, it--along with water--is the principal combustion product of all hydrocarbons. So we're not dealing with the consequences of something that is only present at the level of parts per million or even a few percent, but of 100% of the fuel involved. And that doesn't even get into the chemistry involved in separating and capturing CO2, and disposing of it somewhere other than the atmosphere.

Unfortunately, this is exactly where a victory by the states in this case will take us, down the path of trying to reduce CO2 emissions in the same way we've reduced sulfur dioxide and other true pollutants. If they are successful and CO2 becomes a pollutant, it won't just mean higher fuel prices. It will mean much higher prices for everying that includes energy in its manufacture or provision, up to and including the cable- and phone-based ISPs that enable you to read my comments. We'd be infinitely better off setting a cap on emissions and letting the market allocate where to achieve the reductions, particularly given the relative abundance of reductions available from agriculture, forestry and other non-industrial, or at least non-combustion-process, offsets.

So why are the states even going down this path? I can't be the only one who sees the pitfalls of this approach. It all comes back to the reticence of the federal government to address climate change on more than a voluntary basis. If the US had instituted something like the emissions trading scheme that our negotiators persuaded the EU to accept as part of Kyoto, we wouldn't now face the prospect of a Supreme Court ruling that could either dramatically increase the cost of cutting emissions, or set back the cause of US action on climate change by years.

Still Recovering

Today's Financial Times (registration required) carries a pertinent reminder that US oil and gas production still haven't recovered from the impact of last year's hurricanes, or the year before's, for that matter. We are in the 2006 season already, and it's anyone's guess whether another storm will set back repairs further. Even after all of the facilities--minus those that will never be rehabilitated--are back on line, our future vulnerability to this sort of event will remain high, and our present policies perpetuate this state.

Although I believe there's much scope for improved energy efficiency and alternative energy development, particularly at today's high prices, we must continue to develop new oil and gas reserves to replace those that are declining. This isn't about "drilling our way to independence," as the New York Times suggests, but about prudently managing our remaining resources in order to maximize their leverage on global market conditions, to our advantage. Simply put, we need to enlarge the box in which we've placed the offshore oil and gas industry, in order to slow the decline of US production and spread the risk of disruption from events such as Katrina over a much wider area, preferably including areas that are less hurricane-prone. Representative Pombo's bill to lift the federal ban on offshore drilling appears to be a good starting point.

The title of today's posting also applies to my own post-relocation situation. My office in our new Virginia home is piled high with boxes, and my fax/printer remains MIA. I hope to post on a more regular schedule this week, but I'll appreciate your patience if my comments seem briefer than usual.

Moving Week Re-Runs

For the next week, I will be surrounded by boxes and movers, as we pack up our Connecticut home/office and migrate to northern Virginia. During this period Energy Outlook will go on vacation hiatus, barring an event demanding immediate commentary. As I've done in the past, I'm furnishing some links below to previous postings that still seem relevant, particularly for newer readers who may not have seen them before. I'm also posting links to a couple of recent op-eds I found interesting but haven't time to comment on at length. New postings should resume the week of 6/26.

Please also note that my email address has changed.

Recent Op-Eds:

A remarkably (dangerously?) optimistic view of where the balance of oil power lies in the confrontation over Iran's nuclear program:
Over a Barrel, WSJ, 6/2/06

A novel alternative to higher gasoline taxes from a noted economist. This sounds excessively complicated, but it may contain useful elements:
Tradeable Gasoline Rights, WSJ, 6/5/06

Does America need a third party to address comprehensive energy and environmental policies?
Seeds for a Geo-Green Party, Tom Friedman, NYT, 6/16/06 (Times Select may be required to access.)

"Classic Postings" from Energy Outlook:

China is more than a competitor for energy, jobs and markets. It's a large, complex country, the future course of which remains highly uncertain:
The Other Face of China

The media tends to focus on the supply of raw petroleum, but for the last several years the absence of spare refining capacity, particularly in the US, has had as much influence on the prices we pay at the pump. Despite strong commitments in the wake of last year's hurricanes to redress this, little has changed. US refining growth will be largely incremental, while new international capacity will focus predominately on Asia, not us:
Shining a Light in the Corner
Offshore Refineries

Our future demand for oil and gas will depend heavily on some fundamental choices concerning how we will provide motive power for transportation:
Protons vs. Electrons
Electrons vs. Molecules

The Sum of the Parts

One of the best indicators of the increased emphasis on new energy technology is how difficult it has become to monitor even a fraction of what's going on. This article from MIT's Technology Review is a perfect example. It came out in April, but it's taken me this long to get to it and consider its implications. The innovation in question is a novel auto engine design that boasts hybrid-like efficiency by capitalizing on ethanol's combustion properties, to allow greatly increased engine pressures with gasoline. This is really clever, and it could have sweeping consequences, if it worked out.

Compare gasoline and diesel engines. Although diesel fuel actually has a slightly higher energy content than gasoline, the bigger reason diesel cars go farther on a gallon is that their engines operate at pressures that would have a gasoline engine tearing itself apart from pre-detonation (a.k.a "knocking.") That extra pressure translates into higher thermal efficiency. The MIT engine apparently delivers the best of both worlds: diesel-like efficiency from cleaner gasoline fuel. The trick is injecting separately stored ethanol into the engine cylinders at key times, allowing much higher compression ratios from turbocharging, and smaller cylinders--and thus smaller, lighter and thriftier engines for the same output.

The author considers this system's requirement for delivering and storing ethanol separately as a big hurdle to overcome, and it could be, but part of that problem has already been solved. One of the biggest issues refiners have with adding ethanol to gasoline is that it forces them to ship sub-par gasoline through the long-distance pipelines, and then blend in the ethanol at distribution terminals close to the final point of sale. That's because ethanol creates serious problems in petroleum product pipelines, including corrosion and product contamination. This is the main reason most refiners opted for MTBE when they could, because it had none of these drawbacks. Instead, ethanol is shipped via rail and road, meeting up with gasoline only at the terminal.

So by the time MTBE phaseout is complete, most gas stations will have neat ethanol as close as the distribution terminal that supplies their gasoline and diesel. They'd still need to add an extra tank and pump--and protect it all from water contamination, but this is no different than the problems faced by dealers wishing to sell E85. Refiners, meanwhile, would save by eliminating the RBOB, as the pre-ethanol gasoline blend is called. That would relieve some of the inventory congestion that has contributed to higher prices and sporadic product outages.

What I find so appealing about this notion is that we're already blending ethanol into gasoline in large volumes, for environmental and political reasons. But if we can maximize the benefit from each component by separating them, this could simplify distribution and go a long way toward offsetting the high costs and meager energy benefits of our current grain-based fuel ethanol program. This idea will have to compete with many others, before it can reach the market, but it has a kind of engineering elegance you don't see every day.

The Whiff of Conspiracy

Last week's edition of NOW on PBS featured excerpts from a new documentary on the failure of battery-powered cars in the 1990s, structured as an interview with the film's director, Chris Paine. Throughout, there was the whiff of conspiracy: car companies and oil companies working together to kill the electric car in the marketplace, including junking all the ones already leased to consumers--and some that had never left the car lot. But having participated in this episode of automotive history in a very small way, myself, I could only shake my head at the glaring misinterpretation of facts. The EV-1 wasn't killed by corporate greed or collusion, but by simple market economics.

As I've mentioned several times over the course of my blogging, I had a chance to drive GM's EV-1 battery powered car. It was wonderful; not quite the flying car I'd been promised for the 21st century, but still very high-tech, sleek, powerful and quiet. I can fully appreciate the almost fanatical devotion of EV-1 owners--lessees, really, since none was ever sold outright--and their sense of outrage when GM took the cars back at the end of their 3-year leases. So what went wrong, and why didn't these cars take off and thrive?

There were two fundamental problems, one of which has been done to death in the media: the limited range of battery cars. The first EV-1's were equipped with 26 conventional lead-acid batteries and could go 50-60 miles in real-world driving. The second generation, which came out a year or two later, had nickel metal-hydride batteries and could go about twice as far before needing to be recharged. Now, we can argue about how much of our actual driving would fit nicely within this range, and how terrific these cars would be for urban lifestyles, but only a tiny handful of consumers seemed willing to look past this limitation.

The bigger issue, which went hand-in-hand with the range problem, was the challenge of developing a recharging infrastructure, and this is where my own small contribution came in. I worked with Texaco's marketing department in Southern California to set up EV-1 recharging at a few selected service stations, in order to gain experience with the technology. The cost of buying and installing one "quick" recharger, which would give an EV-1 about a 1/3 charge in 15 or 20 minutes, was around $30,000. Service station owners weren't interested in paying for this, since they didn't expect enough battery car traffic to recoup their investment, so the corporation had to pick up the tab. Even worse, the rules under which the electric car was launched prohibited charging customers a fee to recharge them. So the economic incentive for the service station business to adopt this new technology was nil.

As if that weren't bad enough, fire codes prohibited putting a high-voltage charging facility near the gas pumps. So even if a retail site was willing to host a recharger as a public service, it had to be large enough to provide enormous separation between the gasoline and electric operations. We only found a couple of sites in our network that would have been suitable.

Meanwhile, a competing network of recharging stations was springing up--mostly paid for by the state or city--with rechargers at parking garages, Saturn dealers, libraries, and even a few restaurants. I think there were a hundred or so by the time the program ended. They never reached a sufficient extent to assure consumers that their battery car wouldn't strand them somewhere on the way to work or home. This was the deal-killer, as far as I could tell. Total EV-1 "sales" on a cumulative basis were about 1100, much worse than that of the Edsel that is synonymous with auto industry failures.

Finally, I'd like to report on attitudes within a large oil company about this threatening innovation. Texaco's Chief Technology Officer at the time was fascinated by the EV-1 and was the one who got me involved in the project. The response of our marketing people to our plan to help recharge them ranged from moderate interest--largely as a PR initiative--to cold skepticism. The reaction at corporate headquarters was indifference. I want to stress that I didn't encounter a single manager who saw battery cars as a threat to the core business of finding oil and gas and selling their products to customers.

As to GM, although the documentary makes much of the company's half-hearted efforts to sell the EV-1, every GM official I met at the time was quite gung ho on the technology. And while they might now regret their decision to kill the EV-1 after investing hundreds of millions in it, what corporation in any line of business could afford to sustain such an expensive but remarkably unsuccessful effort? Conspiracy titilates us, but the truth is often more mundane. The EV-1 failed as a product launch, not as an idea that threatened vested interests.

Scramble for Access

A good article in Business Week nicely illustrates several of the key challenges facing the upstream side of the oil industry. Angola is one of the few remaining places with the combination of good exploration prospects, open access to international firms, and relatively attractive contract terms. The result is a bidding war for exploration rights, and the prospect of reduced future returns.

Ah, Those Subsidies (Re-Run)

Reading a couple of comments on last week's postings, specifically on the question of whether today's fuels are over- or under-priced, reminded me of a piece I wrote on the subject of fossil fuel subsidies and externalities at the end of 2004. Since fuel prices are higher today, the amount of tax revenue generated by their sales is now significantly higher than the figures I cited:

Ah, Those Subsidies (November 5, 2004)
Periodically I'll run across an article on renewable energy, whether solar, or wind, or something more exotic, in which the author will downplay the importance of government subsidies in making them more competitive with traditional energy by citing the "hidden subsidies" that fossil fuels enjoy. They then go on to assert that if fossil fuels had to carry the full burden of those hidden subsidies, renewables would either compete now, or be on the verge of being fully competitive. This kind of thinking holds back the development of renewable energy, rather than advancing it.

Let's start by considering what might be included in such subsidies. Given current events, some sort of security subsidy seems like an obvious and important component. A lot of oil comes from a part of the world where the US has to maintain a big military presence to ensure continued access, the Middle East. By comparison, renewables are mostly homegrown, so they impose no such burden.

The other major category of subsidy usually cited is environmental. The use of fossil fuels emits oxides of sulfur and nitrogen into the atmosphere, along with a bit of heavy metals and gobs of carbon dioxide. In addition to the high cost of mitigating these at the source, which is paid directly by the producer or user, this pollution imposes costs on society via effects such as smog, acid rain, and their consequences.

All of this can be estimated and quantified, and a number of academic studies have done so. The resulting value of the "hidden subsidies" for fossil fuels ranges from fractions of a cent to roughly 12 cents per gallon. (This figure could be even higher, depending on how much of the annual defense budget you want to attribute to oil security.) Even if you quibble with some of the methodologies in question, it's pretty obvious that the figure isn't zero, and that economic decisions about our energy systems ought to take this into account.

But if we're going to look at the full economic cost of using fossil fuels, we should also consider the offsetting penalties built into the current system. Most of these penalties come in the form of taxes, and they are significant.

Consider the taxes on road fuels. In the US these include both federal and state excise taxes, and state sales taxes. In theory the revenue from these taxes is meant to fund highways and roads, though in reality it often disappears into general funds. Federal tax collections from road fuels totaled $32.4 billion in 2001. States collect anywhere from 8 cents to 26 cents per gallon (yielding another $30.3 billion in 2001), plus sales taxes, which go up with rising fuel prices. So even in the US, with much lower fuel taxes than Europe, we're in roughly the same ballpark as some aggressive estimates of the hidden subsidies.

So what is the point of all this? I assure you it's not just another argument for the status quo, although I suppose some might see it that way. After all, gasoline is cheaper than bottled water, and it will be a while before any practical alternative can make the same claim. My point is that the whole argument about hidden subsidies is a red herring, because the case is highly debatable, at best.

If we decide that it is worthwhile to subsidize alternative and renewable energy, then we should just get on with it, rather than rationalizing that the competitive bar is kept higher than it might otherwise be, because of some sneaky subsidy for fossil fuels. You're not going to displace fossil fuels on economics alone, no matter how many "externalities" you include; what is needed is something that is at least as practical and convenient, but that also supports our other, non-economic values.

Moving South

Over the next several weeks, postings will become more sporadic, and I may resort to a re-run or two. My family is relocating from Connecticut to the Washington, D.C. metro area, and we must deal with the usual disruptions that accompany a move. Although there are many things about New England and the Northeast that I'll miss, the local attitude towards energy isn't one of them. This was reinforced by an article in yesterday's New York Times, describing reactions to the findings of a federal commission investigating the impact of de-commissioning the Indian Point nuclear power plant, a two-reactor facility on the Hudson River north of New York City. I can only conclude that this area is in for a rude awakening, energy-wise, and when it comes, help will be years off, due to construction time lags.

The Indian Point situation exemplifies several trends that I've focused on since the inception of this blog two-and-a-half years ago. First, there's the inherent incompatibility of economic growth facilitated by increasing energy consumption with regulatory policies that make it extremely difficult to build new energy facilities near population centers. This is compounded by the sort of NIMBY-ism that takes no account of the economic benefits of the facility in question. Add to this the current strain of unprioritized environmental concern, and you have a recipe for disaster. While nuclear power is a mixed bag, environmentally, it is undeniably the largest source of greenhouse-gas-free electricity that we have. Climate change poses a much bigger problem than nuclear power, as many people are starting to realize, including some notable environmentalists.

It's also important to remember that opposition to Indian Point didn't begin on September 12, 2001. Although the current campaign to shut down the facility focuses on the risks of a radiation release resulting from terrorism, opponents have been working to shut down the plant for much longer. Their campaign has polling data that suggests most local residents want the facility shut down, and I don't doubt that. How many of us actually worry about where the current comes from, when we flip a switch?

The federal report on Indian Point suggests it would be very difficult to replace the 2,000 MW capacity of these plants, and I don't doubt that either, because alternative generation (and its fuel sources) won't get permits, and the mooted efficiency projects-- which certainly have the potential to displace the load being served by Indian Point--have a way of never materializing or being swamped by new demand.

Sadly, I continue to believe that we are headed for a national train wreck on energy, and there's every indication that this part of the country will experience it before many others. That's not why I'm moving my family south, but it's a nice side benefit.

My next new posting probably won't happen until next Tuesday or Wednesday.

Junk-a-Guzzler

One of the biggest impediments to making the US automobile fleet more fuel efficient isn't technology; it's the turnover rate. With 243 million cars and light trucks on the road, and car sales running at about 17 million vehicles each year, this is a very slow ship to turn--even if the trend favored efficiency over size and weight, which it hasn't until very recently. As I've suggested before, the length of time that consumers hold cars before replacing them isn't a constant. Although it has increased from 6.5 to 9 years since 1990, hardly anyone seems to treat it as a variable, and that could be a missed opportunity. How might consumers be encouraged to trade up to newer models at a higher rate, perhaps even approaching the 4-5 year average we saw in the 1960s? One possibility would be to provide direct incentives, mirroring localized programs used to get the worst polluting cars off the road. Call it "Junk A Guzzler."

In order to accelerate a shift to fuel efficiency, the buyback program would have to result in the destruction of a large number of the least economical cars on the road. Simply trading them in wouldn't be sufficient, because a used car gets sold on to someone else and could easily remain on the road another decade or more. That means that the program would have to purchase cars for more than they would be worth as trade-ins, probably by at least 10%, though even offering straight Kelley Blue Book could bring in a lot of cars in worse-than-average condition.

The program would also have to include restrictions on the kind of replacement vehicle toward which the buyback voucher could be used--I'm not advocating handing out cash. A good starting point would be to require that the new vehicle--and it ought to be new, not used--must get at least the automobile CAFE average for the year, currently 27.5 mpg. Upgrading a million 15 mpg SUVs this way would increase average fleet fuel economy by 0.25 mpg and save 375 million gallons of gas a year, or about 25,000 barrels per day. That doesn't sound like much, but our total production of ethanol is only 10 times larger than this volume. If this were done every year, the benefits would compound.

Clearly, this wouldn't be cheap, if it were done on a large enough scale to matter. Keeping the costs down probably requires targeting cars older than 5 years. There's probably a "sweet spot" in terms of maximizing the number of gas-guzzling cars junked at the lowest cost. That would have to be determined. We can make a rough guess by looking at the Blue Book values of 7-year-old SUVs. A 1998 Ford Explorer 4x4 in good condition with 72000 miles on it would fetch between $4-6,000. Junking a million such SUVs would thus cost more than $5 billion. That's not small, but it could be covered by increasing the federal gasoline tax by just 3.5 cents per gallon.

Aside from the obvious gas mileage benefits, this program would be a bonanza for struggling US car manufacturers. Even if GM, Ford and Chrysler weren't able to increase their market share against imports, they would still sell nearly 600,000 more cars than otherwise, with accompanying benefits for profitability, employment, and pension contributions. The combination of an expanded market for efficient cars and higher gas taxes would give carmakers greater incentive to develop more efficient models.

I admit that this idea is still in the half-baked stage, and I'd welcome suggestions for improving it. However, with all the ideas floating around for what to do with the proceeds of higher gasoline taxes--for which there's more support than there has been for at least a decade--this approach could prove as practical and effective an energy conservation measure as anything else under consideration.

How Warm Was My Arctic?

Of the big energy-related news items last week, the US overture to participate directly in talks with Iran over its nuclear program deservedly got top billing. Another item might claim comparable long-term significance, though: evidence that the Arctic Ocean was much warmer 55 million years ago than scientists previously suspected--up to 18 degrees F warmer. This has implications for our understanding of climate feedback mechanisms, especially at the extremes. The simultaneous indication that conditions then might have been right to deposit enormous quantities of oil under the Arctic seabed will be a lot less welcome in quarters where the temperature finding is viewed with alarm, and vice versa.

One of the major uncertainties in the analysis of climate change relates to the degree of response by the climate to the inputs that influence it, including our greenhouse gas emissions. Over how broad a range of greenhouse gas concentrations is that response proportional, and at what point do the "reinforcing loops"--mechanisms such as methane emissions from melting Siberian permafrost, which results from past warming but could accelerate future warming--kick in and lead to disproportionate responses? The evidence of past conditions falling well outside the bounds of what climate models would predict ought to ring alarm bells.

While some will see this as invalidating--or at least undermining--existing models, it at least suggests that the models haven't nailed down these reinforcing loops fully. I.e., future warming might be much greater--or much less--than the couple of degrees predicted by the end of the century. In layman's terms, the scale of climate risk just got bigger.

The other part of this finding, the possibility of large oil reserves under the Arctic, could raise quite a ruckus. One of the researchers commented about the negative reaction among his colleagues, because of the large source of atmospheric carbon these potential oil reserves represent. The presence of valuable resources under the Arctic could also put more urgency into the resolution of conflicting sovereignty claims. It might take decades to produce any oil found in the deep Arctic Ocean, but a review of the rapid development of deepwater drilling technology favors an optimistic outlook. For those who think that running out of oil is our best insurance against climate change, this won't be good news.

It will take some time for climatologists and geologists to digest the findings of this report and subject it to the usual peer review. If it proves out, then climate change should be viewed as even more serious than we suspected, requiring more emphasis on both mitigation and adaptation. At the same time, finding another North Sea or Gulf of Mexico under a warming Arctic could change the global oil balance, pushing Peak Oil out another decade.

BioTown Independence

I was intrigued by an article in Sunday's New York Times concerning a town in Indiana that aims to become energy independent by harnessing the energy potential of hogs, soy and corn. They intend to replace their gasoline "imports" with ethanol, diesel with biodiesel, and natural gas with methane from manure. With only 533 people in town, Reynolds, Indiana might just succeed, and I wish them well, especially if they take this to its extreme and actually close all the open loops implied by this approach. At the same time, Reynolds provides a cautionary tale in our present concerns about energy. As bizarre as it may sound coming from a blog called Energy Outlook, I see a real risk that we're placing entirely too much importance on energy and losing our perspective.

Consider the challenge faced by the people of Reynolds. Not only must they grow enough crops to produce about 250,000 gallons per year of fuel, based on average per capita consumption in the US, and convert enough manure to displace the natural gas used by all their homes and businesses, but if they want to do this right, they also have to generate enough excess gas to run their ethanol and biodiesel plants and to replace the natural gas that went into making all the fertilizer this operation is going to require. This is a useful experiment, because it would finally settle a question that has dogged the fuel ethanol industry since its inception: how large is the energy surplus it creates? The latest estimate is 20%, but if skeptics are right, there's a net deficit and any attempt to "close the loops"--at least using traditional, rather than cellulosic ethanol--will fail.

There's another way to look at this endeavor, though. The scale of the challenge for the self-proclaimed "BioTown" is enormous, not because energy companies have gotten us addicted to cheap energy and then squeezed us to maximize their profits, as some suggest, but rather because the energy surplus created by fossil fuels is so large. BioTown, which the governor of Indiana apparently sees as "a stunt," might just succeed at becoming self-sufficient in energy, but scaling this up across the entire country would stand the whole economy on its head.

In our worries about the stability and cost of imported oil, we can't afford to lose sight of the fact that energy isn't an end-result for a country like ours; its very importance derives from its key position near the beginning of so many value chains, as a key input in much of our economic activity. In order to be cost-effective, our sources of energy much be highly leveraged. In other words, they need to return large quantities of energy for modest energy inputs, to provide the energy surplus to fuel our GDP. That's not an argument against renewable energy, per se, but it does provide a tough criterion that some of our current alternative energy efforts could not pass. If every town in America followed Reynolds in becoming energy self-sufficient, we'd have all the energy we need for our homes and cars, but nothing to sell to the countries that make our computers, TVs, iPods, and all the other goods we import.

Tacking Against the Wind

While catching up on last week's Wall Street Journal op-eds, I was surprised to see one that was highly critical of the proposed Cape Wind project in Nantucket Sound. I've written several postings on this project, mostly focused on what I saw as the inconsistency of the opposition, which seemed to focus more on aesthetics than on the economic or environmental benefits it could bring. William Koch's opinion piece (subscription may be required) should be mandatory reading for anyone interested in alternative energy projects, either pro or con. It views the offshore wind farm in purely economic terms, and the result is highly instructive.

Mr. Koch knows more than a thing or two about energy projects. Aside from being a member of the family that founded Koch Industries, one of the largest privately-owned energy companies in America, he has been a major energy investor in his own right for decades. The fact that he was personally invited to invest in Cape Wind and apparently owns property in the area lends added spice to the story.

If you can access the article, you'll read a detailed economic breakdown of the projected costs, returns and risks of Cape Wind. Mr. Koch concludes his analysis with a firm rejection of the project on its merits. The issues he addresses must be factored into any serious long-term energy policy for this country. First, he identifies the financial exposure created by the failure of the Congress and states to provide alternative energy incentives of a duration matching the investments. A major capital project such as an offshore wind farm requires many years to pay out; a wind tax credit that is renewed on a year-by-year basis just doesn't meet the investors' and developers' needs. (The same is true of a solar credit in California, under which PG&E is already approaching the 0.5% of capacity cap on solar power purchases.)

We also see the impact of the protracted delays this project has experienced, due to local opposition. Slipping 2 or 3 years would severely impair the returns of a conventional energy project, such as an offshore oil platform, because the first revenues arrive so long after the first investment is made. Cape Wind may be even worse off, as its construction costs skyrocket in the midst of a global boom in construction materials, while the approval process drags out. According to Mr. Koch, a project that could have been built a couple of years ago for well under a billion dollars would now cost roughly 100% more. Moreover, he suggests that the local grid is awash in excess capacity, indicating that power from Cape Wind might not even be dispatched at the prices it would have to charge to make a profit. This is a truly devastating critique.

I'm sure the developers of Cape Wind will respond with their own figures. Things may not be quite so bleak, and I suspect they would not regard Mr. Koch's comparison to a coal-fired alternative as truly equivalent to offshore wind power. The price of natural gas has also more than doubled in the four year interval that Mr. Koch considered, raising the costs of wind's nearest real competitor. But the message here is clear: if we want the private sector to step up the pace on alternative energy, these projects must pass the same sort of business criteria as conventional energy projects. So if they depend on government incentives, then those incentives must last at least as long as it takes to generate a return on investment that exeeds government bonds. They should also be approved or rejected promptly, to keep attractive up-front economics from being drained away by opposition groups, rather than through exposure to the market risks that any energy project must withstand.

The Default Option

Life is full of assumptions, both explicit and implicit. In my experience as a scenario practitioner, we don't question them nearly often enough, and when we ignore them, we often end up with results we didn't expect and may not like very much. An article from the Washington Post via MSNBC about the environmental consequences of oil sands mining in Canada provides a good example of this. I've discussed this aspect of oil sands production before, when the NY Times printed a similar article last year. Whether you look at it in terms of tradeoffs, as I did then, or implicit assumptions that don't even recognize we're making tradeoffs, I believe it explains how we create a world in which we wish for hydrogen, but get oil sands instead.

Consider some of the assumptions implicit in US energy and environmental policies and consumer behavior of the last couple of decades. Few of these were ever articulated this way, but I think they're all defensible as being logically consistent with our actions. If some of them seem mutually contradictory, that's because they are. In general, we have behaved as if:

• Oil and gas, and their resulting products, would be as plentiful as we might wish, regardless of the restrictions we place on the industry that finds and produces them.
• If sufficient oil can't be produced in this country, someone else would sell it to us at a price we would be happy to pay.
• If sufficient natural gas can't be produced in this country, someone somewhere else (not here) would import it for us.
• If oil prices got high enough, environmentally beneficial substitutes would flourish and displace petroleum.
• If energy prices got high enough, consumers would conserve by changing their behavior and investing in more efficient devices.

Oil sands production is one of the most important "alternative energy" technologies on the planet today, in terms of its economic and net energy contribution over the next decade. In it we see the simultaneous breakdown of several of the above assumptions:

• The production of conventional oil has failed to keep up with demand, in part because we've fenced off places like the Arctic National Wildlife Refuge (ANWR,) and because the foreign owners of most of the world's remaining oil reserves have chosen to restrict access for developing more production capacity, and thus limited supply and driven up prices.
• High energy prices have not throttled back demand very much, because of the time lags inherent in turning over fleets and capital stock--including homes far from jobs--and because oil at $75 still generates significant economic value when it is consumed.
• High energy prices have helped advance some clean alternatives, such as wind power, but they have lit a rocket under oil sands production.

As regular readers of this blog have probably discerned, I regard oil sands as a vital component of the supply buildup necessary for avoiding an imminent peak in oil production. But I also find it ironic that the technology that could have the biggest impact on reducing the price Americans pay at the pump combines the worst elements of oil drilling and strip mining. We've effectively traded off the petroleum development of selected parts of the US--ANWR and the outer continental shelf outside the western Gulf of Mexico--in favor of the much larger environmental footprint of developing the unconventional oil reserves in our northern neighbor. Canadians and Canadian companies will make a mint off our choice.

I'm still optimistic about the pace of development of alternatives to oil and other fossil fuels, but I'm also realistic about the quantity of oil we're going to burn before things like biofuels, hydrogen from wind and solar power, and other clean technologies can grow large enough to capture even the annual growth in transportation fuel demand, let alone eat into oil's current 97% market share. In that light it ought to matter to us where and how that oil is produced, and that means realizing that our past assumptions about the likely alternatives to ANWR and offshore drilling have been naive, at best.