Power from Space

Earlier this week a new alliance was announced to promote the exploitation of solar power from space. The Space Solar Alliance for Future Energy (SSAFE,) formed by space advocacy and research organizations, is basing its initial efforts on a just-released study by the National Space Security Office . Collecting solar power in space, where it is available 24/7 and is not attenuated by atmosphere or clouds, remains one of my favorite long-term energy solutions, on a par with nuclear fusion. It has a major advantage over fusion, however. While both offer inexhaustible sources of energy, space solar power (SSP) requires no scientific breakthroughs. Despite that, its engineering and cost challenges make it unlikely that SSP could contribute significantly to terrestrial energy much before 2020.

If you're not familiar with the concepts for capturing solar power from orbit and beaming it to earth--ideas that have been refined significantly since they were first conceived in the 1960s and '70s--I encourage you to download SSAFE's feasibility study. It provides a good overview of the technology and many of the financial, logistical, diplomatic and other factors that must be addressed. Having been personally involved in the late-1990s NASA studies referenced in the document, I must say that I don't find the update to be quite as novel as the report suggests, when compared with the concepts and constraints that we examined 10 years ago. But as it points out, the energy and security context for considering this option have changed tremendously, and that may be enough to alter the ultimate conclusions about whether to proceed with such a large-scale space endeavor.

When I served on the economic evaluation team reviewing the 1990s NASA effort, two obstacles to the commerciality of SSP loomed large. In that period, ground-based power costs were low and falling--and most of the experts and economists we consulted expected that trend to continue. The high cost of power from space appeared difficult to justify outside of a few niche applications. Compounding that challenge, the construction of a fleet of power satellites capable of producing hundreds or thousands of Megawatts of electricity each would require a launch capability far beyond that of the quartet of Space Shuttles--which ultimately proved barely adequate for the current Space Station--or of a second-generation shuttle. But SSP was the only application large enough to justify building such a capability, short of a major effort to colonize or industrialize earth-orbital space. Chicken and egg.

As NASA foresaw in the late '90s, advances in technology have made it possible to contemplate an SSP design that requires fewer, smaller payloads and relies almost entirely on robotic assembly. That will reduce the number of launches and virtually eliminate the need for a parallel ramp-up in manned space activities, thus improving the economics. It's not clear from my perusal of the report whether this new configuration could be placed in orbit by existing commercial launch capacity. Even if it could, the process would be lengthy and very expensive.

And although I'm intrigued by some of the novel applications for power from space described in the report, including chemical synthesis of carbon-neutral hydrocarbons, most encounter another hurdle we identified a decade ago. While there are certainly lots of cool things that you could do with power from space, there are very few applications that actually require it. I routinely receive comments from readers of this blog who are equally keen on hydrocarbon synthesis based on nuclear power, which would almost certainly be more economical that the SSP-driven version.

Finally, although our perspective on national security and its energy security dimensions has expanded since 9/11, the potential linkage of SSP to military applications raises the prospect of international opposition to a project that could probably only proceed as an international initiative. I appreciate the benefits of having an "anchor customer" that puts a high premium on the ability to deliver power to any point on the planet. The advantages for the military would also be significant, given the expense and risk it incurs delivering energy to the "battlespace." However, the basic architecture of SSP will inevitably raise concerns about its inherent military potential, whether that potential is real or merely perceived. This is an issue that would have to be navigated very cautiously, particularly since other nations with anti-satellite capabilities might regard an SSP beaming power to a war zone as a legitimate military target.

I will follow SSAFE's progress with great interest. Space solar power has enormous potential to provide useful increments of zero-emissions energy as either a reliable baseload or as a sequentially-shifting peak supply across the globe. SSP will also benefit from the steady improvements in photovoltaic technology that are making ground-based solar more competitive. It's not a short-term solution, however, and its development still faces many technical, political and permitting challenges. SSP is a valuable future option, and we'd be wise to invest to increase the value of that option and make it easier to exercise, should we ultimately choose to do so.

Plug-In Hybrids, CAFE and LNG

One of my readers pointed out that I missed an opportunity in Tuesday's posting to consider the impact of plug-in hybrid cars (PHEVs) on an increase in the Corporate Average Fuel Economy Standard (CAFE.) It's a great question, and it leads in two different but related directions. First, there's the basic problem of how to tally the energy consumption of a PHEV or any other multi-fuel vehicle, compared to a car that uses only gasoline. But looking at the impact of PHEVs also requires at least a superficial discussion of their electric power needs, from both an energy and capacity perspective. This is another one of those topics that really demands something longer than a 600-word posting, but then that's true of many aspects of our highly-interconnected energy systems.

It's rare to see a reference to PHEVs that doesn't include claims for gas mileage in excess of 100 miles per gallon. Of course, that's only the gasoline consumption, and it's premised on the average distribution curve for car travel in the US, in which a large fraction of all trips would not exceed the 30 or 40 mile all-electric driving range of planned PHEVs, before their gasoline engines kick in. That might be a reasonable way to look at it, if all we cared about were oil. But it makes little sense to ignore the fuel consumption and emissions that occur externally to the vehicle, since those also contribute to our overall energy demand, criteria pollution, and greenhouse gas output. For the sake of brevity, I'll confine this posting to looking at the energy side of this, because the emissions picture is even more complex.

Although my reader asked about the specific impact in New York City, it was easier to find consistent power statistics for the entire state. In 2005 New York's 39,122 MW of summer capacity from all sources generated 147 billion kW-hrs, net, for an average utilization of about 43%. So there's plenty of spare capacity to recharge electric vehicles, if it's managed properly so as not to interfere with peak demand from other sectors. Assuming that the state's nuclear, hydropower and coal-fired generators are usually dispatched first, the incremental demand from PHEVs would be met by natural gas turbines, which make up 42% of total NY capacity. Now put a million PHEVs on the road in New York, driving the national average of 12,000 miles per year. If half those miles were on battery power, at a typical consumption of 3 miles/kW-hr, they would use about 2 billion kW-hrs of electricity per year. That would require 250 MW of generating capacity, well within the state's overall spare capacity. It would also increase New York's annual natural gas consumption by 14 billion cubic feet, or about 1.3%.

What does that mean for the true fuel economy of a PHEV, as distinct from its gasoline fuel economy? Well, assuming the same 50/50 split of battery and engine usage, a PHEV traveling 100 miles would burn 1 gallon of gasoline (if its non-PHEV characteristics were similar to a Toyota Prius) and a quantity of natural gas with an energy content equivalent to about 0.9 gallons of gasoline. That means our "100 mpg" PHEV really gets around 53 mpg overall, counting both its direct gasoline and indirect natural gas consumption.

The obvious conclusion from the above comparison is that the benefits of plug-in hybrid vehicles are highly dependent on the energy source for the electricity they consume, and that will vary significantly on a regional and local basis. Natural gas is close to a worst-case comparison, at least on cost, but it's also a very realistic comparison for the first production PHEVs we expect to see within a few years. Where they will draw on gas-fired power generation--which could be most places, initially--their energy benefits look modest, at best. (Emissions are a different story, for another day.) By the time New York state reaches its first million PHEVs, however, it should have much more renewable power available, in line with the state's Renewable Portfolio Standard. PHEVs look like an excellent outlet for the off-peak power from wind turbines--assuming enough of them are actually built.

In the meantime, if we are looking to PHEVs as a relatively painless way to achieve a new 35 mpg CAFE standard, then we need to think very carefully about the reasons we want a CAFE standard in the first place. Unless PHEVs are rolled out in parallel with large quantities of renewable power generation, we could eventually end up with 100 million of them consuming 1.4 trillion cubic feet of natural gas per year, compared to total current US gas demand of 22 trillion, with 100% of the shortfall translating into additional LNG imports. I'm not sure that would create quite the energy security benefits that many PHEV boosters expect to see.

The Fuel of the Future

Reports on the science behind our energy concerns have become a regular feature on NPR's "Science Friday" program, and downloading its podcasts is now an established part of my weekly routine. Its first segment last Friday focused on the pros and cons of ethanol and biodiesel and their various production techniques. These issues are important aspects of the larger questions concerning the fuel(s) of the future, which might derive from chemistry, synthetic biology, or electricity. Long experience and numerous applications bias us toward liquid fuels, and the current emphasis on biofuels reflects that, though this is not a foregone conclusion, particularly for supporters of plug-in hybrids and electric cars.

The "Science Friday" segment drew on recent articles in Wired and National Geographic, and included Professor Dan Kammen, the Director of U.C. Berkeley's Renewable and Appropriate Energy Laboratory, whom I've mentioned previously. The discussion provided many interesting perspectives on biofuels, including why it is so difficult to break down the cellulose and lignin in plant material, and how current approaches to cellulosic ethanol differ from those begun in the 1960s and '70s, and are thus more promising. They also considered the utility of ethanol as a fuel, at least during a transition to a more optimized energy carrier for transportation. Yields, energy density, and compatibility with infrastructure and end-use devices are all important considerations, along with whether government or the market will make the ultimate choice.

After listening to the program, I became curious about the relative comparison between transportation energy and food agriculture. Multiplying a daily diet of 2500 Calories by 300 million of us equates to 1 quadrillion BTUs per year. That works out to the energy contained in 500,000 barrels per day of oil. Americans stand at the apex of a vast agricultural pyramid, and its net result supplies our bodies with only about 1/20th of the fuel that our cars use. Now, there are all sorts of inefficiencies on both sides of that comparison, such as those relating to our consumption of animal protein and the use of inefficient engines and other devices. But it still says something about the relative upper boundary of biofuels' potential, compared to the higher energy-density sources on which we currently rely.

And since liquid fuels for transportation still retain a big edge over gases and electricity, we can't ignore the current incumbent. Could the fuel of the future actually be gasoline? Take a look at last week's Economist, before you write me off as a shill for the oil industry. The article covers a variety of biofuel alternatives, starting with ethanol and working its way up the molecular chains, ultimately suggesting that something very similar to gasoline could be produced by advanced biological synthesis, and that this would provide significant advantages over current biofuels, without many of the drawbacks of petroleum products or liquids from coal. Based on my own analysis of ethanol's limitations, I agree, if the synthesis could be done economically--the $64,000 question for any of these alternatives.

Nor should we write off hydrogen entirely, as many energy pundits have. While the cost and infrastructure obstacles it faces are truly Herculean, in the long run all of those could be overcome, if the incentive were large enough. Hydrogen's fate, then, depends on an end-use application that is so superior to the internal combustion engine in performance and cost that it justifies all that extra expense and effort, including throwing away large quantities of primary energy from natural gas, nuclear power or renewables, to produce it. Today's fuel cells don't meet those criteria, but tomorrow's just might. The potential is certainly there. If it can be unlocked, then hydrogen's role as a common-denominator energy carrier made from a wide variety of primary sources--including biological synthesis--could become an advantage, rather than a drawback.

When it comes to predicting the fuel of the future, to replace petroleum and reduce our global carbon footprint, we still lack good answers. The best we can do today is to keep trying out alternatives, along the lines of the "clinical trials" suggested by Dr. Craig Ventor in the Economist article, progressively refining our questions along the way. In the meantime, improving our energy efficiency would greatly reduce the height of the mountain any new fuel must climb.

On November 1, 2007 I'll be participating in a webcast discussion on "Fuels for Now and the Future" with Scott Sklar of The Stella Group, Ltd., hosted by Cleantech Collective. For more information and to register for the webcast, please follow this link.

Lake Wobegon CAFE

In the course of writing yesterday's posting, it occurred to me that the efforts to increase US Corporate Average Fuel Economy Standards (CAFE) face a basic problem. Notwithstanding our concerns about energy security and climate change, some simple mathematical truths have been absent from much of the public discussion on the subject of CAFE, and they have something in common with the "Lake Wobegon Effect," in which all the kids in Garrison Keillor's fictional town are above average. Raising the average fuel economy of the country's light vehicle fleet by 10 miles per gallon doesn't sound very daunting, until you start looking at what the mathematics of averages implies for the type and number of cars consumers must actually buy.

It all starts with how you go about raising the average of any set of numbers to a higher target level. There aren't many options:

1. Add additional members that are above the new target.


2. Remove members that fall below the current average.


3. Various combinations of 1 & 2.

If this seems painfully obvious to you, please bear with me, because applying these simple ideas to the world of automobiles produces some awkward realities. Consider SUVs, which been a major factor in increasing US petroleum consumption in the last two decades. Since 2004, however, sales of large SUVs have fallen. At the same time, sales of "crossover vehicles"--smaller, mostly car-based vehicles that combine features of station wagons, vans, and SUVs--are up significantly. That suggests that consumers have taken the gas price signal to heart and are downsizing their old SUVs. But will that improve overall US fuel economy, let alone move us toward a new 35-mpg standard?

Suppose that John Customer has decided to trade in his family's 2001 Ford Explorer for a 2007 Ford Edge, a fairly typical crossover. The Explorer had an EPA rating of 15 mpg; the Edge gets 20 mpg overall, using the old EPA methodology. John might assume he's doing his small part to improve the US fleet mpg by 5 mpg, while saving some money at the gas pump, but there are two problems with his logic. Since his new car's mileage falls below the current average CAFE, it will actually drag it down further--or negate the efficiency gains from a higher-mpg car sold to someone else. Looking beyond the new car fleet, which is all that CAFE measures, unless John takes his Explorer to the scrap yard on the way to the dealership to pick up his new Edge, someone else will be driving his old 15 mpg SUV for years to come. On balance, then, John's switch to a crossover might look like a modest improvement, but it doesn't even contribute to maintaining the current fuel economy average, let alone approaching a stricter target.

Nor is this problem confined to SUVs. In 2004 I bought an Acura sedan, which provides the 5-star crash safety I was seeking and handily exceeds 30 mpg on the highway. But this car came with an EPA sticker estimate of 23 mpg, and because most of my driving is around town, I have only averaged 21 mpg, despite having a light touch on the accelerator and being very sparing of the brakes. This kind of performance is typical for other popular 6-cylinder sedans, such as the Chevrolet Impala or Malibu, or Toyota Camry.

What does this suggest about the kind of cars we're all going to have to start buying, if the US adopts a 35 mpg CAFE target, on the way to moving the entire US car fleet up to that level eventually? It will require a much bigger change than just switching from SUVs to crossovers. By the millions we'll need hybrid crossovers, diesel crossovers, and maybe even diesel hybrid crossovers. Unless the half of the market buying small and large SUVs does a lot better than its current 22 mpg, then in order to meet a 35 mpg overall target, the other half must achieve Prius-like efficiency of at least 48 mpg--probably requiring some of the passenger car fleet to exceed 60 mpg. And unless we want to wait until 2030 for the performance of the entire US light vehicle fleet to reach these levels, we may also need an accelerated-retirement program for the least efficient cars on the road, based again on the simple math of averages. The bottom line is that we must all shortly start buying cars that are truly more efficient than the average, or we will have to look elsewhere for our energy and emissions savings.

The Dingell Plan

Anyone looking for hints about how the Congress will address the discrepancies between the Senate and House versions of energy legislation and tackle the equally complex problem of our response to climate change should read the Wall Street Journal's extensive interview with Representative John Dingell (D-Mich.) As Chairman of the Energy and Commerce Committee of the House of Representatives, he will have enormous input into the process, and as the Journal points out, he also reflects the middle ground between the status quo and those who see the need for radical changes in the way we produce and consume energy. If Mr. Dingell's primary goal is ensuring the continued prosperity of American industry through the transition ahead, that could be our best guarantee for an approach to climate change that is both effective and cost-efficient.

Mr. Dingell seems to prefer making the costs of reducing greenhouse gas emissions explicit to the public, rather than burying them within wholesale prices via a national cap & trade mechanism. Cents per gallon of fuel would be a lot more noticeable than dollars per ton of emissions. There are good arguments on both sides--I generally come down in favor of cap & trade over a direct carbon tax--but the kind of blended approach hinted at in the interview could have a lot of advantages over either alternative alone. He also wants to stretch out the stricter fuel economy regulations passed by the Senate (35 mpg by 2020) to give US automakers time to find the mix of vehicles and technologies that will work for US consumers. Even if the US auto industry has already wasted a lot of time and false starts in that direction, exporting the remainder of it to South Korea and China would only reduce the US government's leverage on the problem.

It's significant that Mr. Dingell appears somewhat at odds with his party's leadership on many of these issues. The pending shifts in our national politics are setting up a configuration that could resemble that of the mid-1960s or late 1970s, when many of the most important debates occurred across the fault lines within the Democratic Party, rather than between the two parties. Mr. Dingell is a veteran of those periods, and his long experience and present vantage point should enable him to work across these coalitions and put his stamp on legislation enacting tougher fuel economy standards and a stronger US response to climate change.

Moral Dilemmas

The recent government crackdown in Burma (a.k.a. Myanmar) serves as another reminder of the perils of doing business in nations run by odious regimes. Oil & gas production in Burma is small by global standards, consisting of a few major gas deposits, and is chiefly of importance to its neighbor Thailand. The main offshore natural gas fields, Yadana and Yetagun, are operated by Total and Malaysia's Petronas, respectively. Chevron Corp., as the only US oil company with a stake in Burma--a 28% share of Yadana--is being harshly criticized for its association with the regime. While genuine and serious moral issues are involved, they are hardly cut and dried. Before passing judgment on these companies, we ought to consider some serious questions about the effect of their operations in such countries, and the consequences of their departure.

The SLORC junta in Burma is one of the worst governments in the world, and its calculated arrogance in brutalizing the country's universally-revered Buddhist monks is breathtaking. With its abuses of human rights, minorities, and democracy, the situation in Burma calls to mind South Africa during the Apartheid era. At that time, my former employer Texaco faced frequent calls for it either to apply more pressure on the government or cease its affiliate operations there. Aside from the obvious financial consequences, there were other impediments to leaving, including the company's responsibility to its local employees and the perceived benefits of remaining engaged. These were ultimately embodied in the internationally-recognized Sullivan Principles, later expanded into the Global Sullivan Principles. While some saw these principles as mere cover for the corporations involved, they were invaluable in helping companies define for their hosts the only acceptable conditions under which they might remain.

In Burma as elsewhere several serious considerations must be weighed, including:

1. Does the presence of the company in the country convey legitimacy to an otherwise illegitimate government and its practices?


2. Do the company's operations conform to international law and accepted standards for engagement in such countries, such as the Global Sullivan Principles?


3. If the company exited the country, which would be harmed more, the regime or the population?


4. If the company exited, would its departure materially impede the functioning of the regime, or would it be replaced by other investors that are less committed to upholding international standards?

Although the oil companies involved in Burma arrive at answers to the first three questions that justify remaining, while their critics assert otherwise, it's the last question that seems most relevant here, because the answer can be arrived at objectively by reviewing recent history. Chevron got its stake in Yadana when it acquired Unocal Corp. in 2005. That acquisition was hotly contested with China's CNOOC. The risk of US government intervention in the transaction ultimately scared off CNOOC. Given China's aggressive pursuit of global oil and gas assets and the country's other investments in Burma, it's very likely that CNOOC would be the top bidder for Yadana, were Chevron or Total to divest. That displacement could not possibly be beneficial for the Burmese people.

So what should Chevron and Total do? Burma isn't South Africa, where the majors' operations focused on refining and marketing, employing tens of thousands of locals and creating opportunities for basic education and management training. A gas field and pipeline employs many fewer people, and the companies' biggest impact is probably through the social investments they have made. Are those substantial enough to justify remaining? In many ways, divesting would be the easiest answer, especially for a non-operator like Chevron. But as a shareholder, I'm not at all sure that's the best course for either Burma or Chevron. Playing a positive role in developing the world's vital resources inevitably takes US companies to countries that don't meet our standards. Whatever shortcomings these companies may have, they are still a lot more transparent and accountable than many of the firms that would inevitably take their place. It may not represent the moral high ground, but staying and doing the good you can is at least a practical answer for a highly imperfect world.

Electric Infrastructure

Coming from a part of the energy industry more focused on molecules than electrons, I don't claim to understand all the intricacies of the electricity transmission business. I heard from more than one attendee at last week's Herold Pacesetters Energy Conference that transmission is a critical and under-appreciated element of solving our energy problems. That rings true. Among other things, expanding the existing transmission network is essential for delivering the large quantities of wind energy needed to meet the growing web of state renewable portfolio standards (RPS.) But under what circumstances should new long-distance lines be built, and when should that take place over local opposition?

A few years ago, it was trendy to suggest that distributed power would soon render long-distance, high-voltage power transmission obsolete, with the coming "smart grid" relying more on small generation close to the load, and less on big central power plants far away. I would have been in that crowd, back when I was convinced that home fuel cells were about to become mass-market. But while rooftop solar is making inroads in that direction, and could someday cover a big chunk of peak residential and business demand, distributed power today is a niche application that only substitutes for the grid on the smallest scale.

My local utility, Dominion Power, is seeking permission to build a new line to bring power into Northern Virginia from Pennsylvania and West Virginia, traversing the rapidly-growing counties of DC's outer ring of suburbs and some historical sites. (I'm learning that you can't go far in Virginia without encountering a historical site.) Yesterday's Washington Post reported that the Federal Energy Regulatory Commission (FERC) had declared the Mid-Atlantic region, including the national capital region of DC, MD and VA, as a National Interest Electric Transmission Corridor. That could lead to Dominion being given powers of eminent domain to obtain the necessary rights of way. Dominion has indicated it will not seek federal assistance and would continue to work through the state's process. Ironically, development is driving the need for more power in the region, but the impact of new power lines on the development potential of the land they would cross is an underlying cause of much of the opposition--along with concerns about the unconfirmed health impacts of high-voltage power lines.

In California, which implemented an aggressive RPS, accessing much of the state's wind resource for power generation will require new transmission lines. Until recently, the big question was who should pay for this. The state Public Utilities Commission ruled in June that it was in the public's interest as ratepayers to provide the up-front funding for power lines to connect these renewable sources to demand. Otherwise, the first wind developer in a new area would have to pay for the entire cost of the line, harming the economics of the entire project and potentially derailing it.

Installing new high-voltage lines to enable renewable energy supplies is quite different from doing so to ensure a reliable supply of cheap electricity, although I suspect that Dominion's management and most of its customers would agree that the latter phrase describes the company's primary mission pretty well. Customers whose property values are affected or who have a special interest in preserving the history and scenic beauty of the region would doubtless disagree, and if the line were going through my neighborhood, I'd be less than thrilled, myself. My regular readers are probably anticipating my usual anti-NIMBY stance, here, and they'd be right, if it were clear that Dominion had been doing all it could to avoid the necessity for this project.

Californians already pay high prices for power, with residential pricing steeply tiered and top rates hitting $.30/kW-hour. They have significant incentives to conserve and invest in efficiency. Meanwhile, I'm paying under $0.10/kWh here, all-in, and the payouts on installing more efficient appliances and lighting are pretty lengthy. Moreover, Virginia's electricity supply is about average in CO2, coming from a mix of coal and nuclear power. The new power line would bring in power from Pennsylvania, which has a similar emissions profile, and West Virginia, which is mostly coal-fired. So there's no argument for new power lines here to promote renewable energy; quite the contrary, I would say.

Unfortunately, the projected capacity crunch occurs in 2011, which is barely enough time to get the power lines built, let alone implement a demand-side management plan on the scale necessary to avert the need. If Dominion can't build this line, it would soon be in violation of the North American Electric Reliability Council (NERC) standards that were developed after the big blackout of 2003, and that could put the power supply for parts of the federal government at risk. Unfortunately, most of our long-distance electric infrastructure dates back to the same era in which most of our interstate highways were built, and is similarly stretched. As with other infrastructure, we tend not to appreciate it until it fails. In light of all that, I believe the best course of action would be to let Dominion proceed--hopefully without the exercise of eminent domain--but conditioned on a serious review of their rate structure and demand-side management efforts, to make sure they aren't in the same situation again in only a few years.

Waiting for Sputnik

Tomorrow's fiftieth anniversary of the launch of Sputnik seems like an odd sort of event for Americans to commemorate, unless the lesson is that we can start out behind and still win. I've seen many Sputnik articles and commentaries in the past week, and one of the better ones, in Monday's Washington Post, included some useful reminders of just how wrong our immediate post-Sputnik predictions about the future turned out to be. We may not have colonies on the Moon and Mars, but, as the author put it, "Sputnik plus the Internet equals Google Maps." That sort of unpredictability of ultimate outcomes might apply equally well to our current perceptions about energy and climate change, for which a wake-up call as dramatic as Sputnik's might yet lie somewhere ahead.

Aside from ushering in the Space Age, Sputnik was one of those remarkable "caught napping" moments in US history. Although I have no recollection of the immediate aftermath, since I was an infant at the time, the shock wave from Sputnik certainly shaped my childhood and influenced my educational choices. Anyone looking for a comparable current influence from energy or the environment would come up short. Even though both of these concerns routinely make headlines, the effect of these issues on our daily lives remains modest. Our children aren't yet growing up in a nation urgently reorganizing itself to meet the challenges these issues represent, as it did around the parallel arms and space races with the Soviet Union. Many still hope they won't have to, and that oil prices will fall and climate change prove illusory.

In thinking about what a Sputnik for energy or climate might look like, it's helpful to consider why neither meets that standard, today. It has taken oil prices roughly four years to triple their former average level, and the increase owes as much to higher demand spurred by economic growth as to supply constraints. That's very different from the oil shocks of the 1970s. As to climate change, while our awareness is growing steadily, the feedback loop of cause-and-effect, response-and-reaction is longer than our attention spans. The fact that there is still argument about our contribution to the problem and what to do about it is strong evidence that we haven't reached the galvanizing moment at which all doubt is cast aside.

So what would qualify? Certainly not just a politician or media figure telling us that one or the other problem is urgent. We hear that ever day about a host of issues. It would have to be something external and dramatic. On energy, the possibilities are easy to imagine: We awaken one morning to discover that Osama bin Laden has taken over a major Middle East producer, or Hugo Chavez has decided to export 100% of Venezuela's oil to China. Or the Saudis announce that their production has peaked, and oil futures soar to $200. On the climate side things are trickier. Most of the big signals only make sense as part of a larger pattern, after the fact. It's impossible to discern whether individual hurricanes, droughts, or heat waves are signposts of global warming or just random weather events. Melting icecaps may be as close as we come, but they still lack the gut-wrenching immediacy of a Sputnik, Pearl Harbor, or 9/11.

As unwelcome as that kind of surprise might be, it almost seems necessary to overcome the complacency of gradual change--the proverbial "boiling frog". Absent a Sputnik moment for energy and climate change, how do we convince the public of the need for action, for the equivalent of a Manhattan Project or Apollo Program to address these problems, if that's what it takes? Perhaps, for a change, we will have to trust in the good judgment of our fellow citizens, if we provide them all the facts--including those that do not align with our view of impending catastrophe--and lay out all of the choices and their likely consequences. That by itself might be as novel and empowering as another Sputnik.

Carrots and Sticks

It's a small thing, but the recent decision by the New York Times to end their Times Select subscription service and provide open access to their op-eds and other content is very welcome. Among other things, it means I can resume citing and critiquing the op-eds of my favorite Times columnist, Tom Friedman, without worrying that most of my readers won't be able to see them. In an op-ed last week, Mr. Friedman lamented the lack of a strong American example on climate change, and how that has influenced countries such as China, which will account for the largest increment of new emissions in the years ahead, unless we can help them find another path. The chicken-and-egg dilemma involving the US and large developing countries remains a major obstacle to an effective response to global warming, and breaking out of that loop is going to require some deft moves, indeed.

While looking for information on China's stance at last week's climate meeting in DC, I ran across a related development that surprised me. The meeting itself wasn't anticipated to produce any breakthroughs and apparently lived up to that expectation. However, it seems we are already considering how to penalize other countries that aren't working to reduce their emissions, even though the US still has essentially no federal response beyond R&D and voluntary measures. This provision would apply to the offshore emissions associated with energy-intensive imports, since domestic producers would otherwise be at a competitive disadvantage under a US cap & trade plan or carbon tax . That strikes me as excellent politics and sound economics, but questionable foreign trade policy, and quite possibly disastrous climate policy.

Just imagine we were back in early-to-mid 2001, when it became clear that the US was never going to implement the Kyoto Protocol on climate change. At that point Europe was just gearing up for emissions trading (an American idea) and European companies were complaining that it would put them at a competitive disadvantage versus US firms that could emit without penalty, at least at home. What if the EU parliament had proposed a compensatory tariff--called something else, of course--to ensure that US products sold in the EU met the same emissions standards? Would that have catalyzed a consensus on this side of the Atlantic towards passing our own emissions regulations, or would it have inflamed US attitudes towards Europe and triggered trade reprisals? I can't be certain, but I don't think it would have gone down very smoothly. Why then should we expect such a policy to be welcomed now in Beijing, Delhi, or Brasilia, even if it's not intended to kick in before 2020?

Although I can appreciate the practical and legitimate reasons for such a measure, the idea of someone as late to the party as we are threatening those who are still later--for what they regard are better reasons than ours--strikes me as counter-productive. If this is going to come down to carrots and sticks, the carrots had better be fat and juicy to make up for sticks like that. By contrast, Mr. Friedman's approach focuses on having the US lead by example, as the proper first step. (His recent op-ed on the spread of American-style energy consumption shows how the counter-example works.) The conversation about what to do with those who don't follow our lead on climate would seem a lot more appropriate, once we've actually implemented some real cuts of our own.

Ethanol Shakeout?

Starting in August, while crude oil prices were breaking out of the high $60s and heading for the $80s, ethanol prices fell off a cliff. The Chicago Board of Trade ethanol contract has dropped from around $1.90/gallon to scarcely above $1.50, and both the New York Times and Wall Street Journal are proclaiming that the ethanol boom has stalled, if not actually ended. As a result oil refiners and gasoline blenders--at least those in the Midwest--can actually reduce their costs by blending ethanol into fuel, though they can't get enough because of various transportation bottlenecks. However, while our grain ethanol energy policy has serious drawbacks, it would be a mistake to conclude from current conditions that we've reached the end of this trend, instead of encountering a routine and entirely predictable outcome of an expansion that got ahead of the underlying demand for its product.

Ethanol producers might not appreciate the comparison to the oil refining business, but having participated in the latter during three decades, I see many familiar features in the margin squeeze that ethanol processors are now experiencing. Investing in capacity to take advantage of high current prices always undermines its own economic driving force, by increasing competition for feedstocks and driving down product prices--unless demand is growing faster than capacity. That's evidently as true for ethanol as it has been for petroleum products. At the same time, though it's not immediately obvious from the way that its capacity costs are quoted, at around $2/gallon of annual output, ethanol has a highly capital-intensive manufacturing process. Translate that figure into oil terms--see Friday's comments on the plague of units of measurement affecting energy--and it exceeds $30,000 per barrel per day of capacity. Ethanol distilleries may come in smaller packages, but their capital cost is on a par with a complex oil refinery.

But while the markets for petroleum products reflect the impact of various fuels regulations, the ethanol market owes its very existence to regulations, including the direct $0.51/gallon blending subsidy and the EPA's renewable fuel standard (RFS) regulation that went into effect this year--a product, incidentally, of the same Energy Policy Act of 2005 that has come in for so much criticism from alternative energy advocates. The problem, however, is that at current annualized production of 6 billion gallons per year, the US ethanol industry has already hit the 2009 RFS target and thus can't look for any help on pricing from that mandate for a couple more years. In other words, ethanol is now in a gap in which market economics dominate.

So aside from all the logistical problems that result from ethanol's incompatibility with the long-haul legs of the petroleum products infrastructure, we are already seeing a classic overcapacity crunch in an industry that has just started gearing up for a much bigger expansion toward the limits of US corn ethanol output, somewhere between 12-15 billion gallons per year. Even if the conference version of Congressional energy legislation doesn't expand the RFS target to 36 billion gallons, as proposed in the Senate's version in June, the market for ethanol has additional headroom, but not until it has digested the recent additions and added enough rail cars and other supply and distribution assets. This timing problem will create severe challenges for startups and under-capitalized firms, and some big opportunities for the scale players. As the Journal suggests, we'll probably see a combination of project cancellations and some industry consolidation, but the survivors will need to think very carefully about the likely future level of ethanol margins, when the fuel will consume up to 30% of the US corn crop. As those who've been around the petroleum downstream for a while can attest, profitable growth can sometimes become an oxymoron.

Every Molecule and Electron

Yesterday's panel discussion on alternative and renewable energy at the annual J.S. Herold Pacesetters Energy Conference covered a wide range of technologies and issues, reflecting the diversity of this growing sector. (The presentations are available on Herold's website.) In my introductory remarks, I cited the importance of energy security and climate change as key drivers of alternative energy, but a couple of comments from one of the panelists really put it all in perspective. Dr. Don Paul, the Chief Technology Officer of Chevron, emphasized that we will need the contribution of every technology--"every molecule," as he put it--to meet growing global demand. That's true, even after factoring in predictable improvements in efficiency.

Dr. Paul also a threw out a mind-boggling figure that describes the scale of the challenge better than any other I've heard: one trillion gallons per year. That's the quantity of energy we currently get from petroleum (it's actually 1.3 trillion) which supplies about a third of total global primary energy, the energy we turn into electricity and fuels to do useful work. That isn't intended to make the hundreds of millions or low billions of gallons of biofuels appear trivial, but it serves as a useful reminder of just how remote the prospect of replacing petroleum entirely is, today.

It also illustrates how the traditional units of measurement in different energy segments get in the way of appreciating the big picture. Oil people talk about barrels per day, in the thousands or millions, while the US gas industry refers to millions or billions of cubic feet per day--or trillions per year. And then there's the rest of the world, including the LNG trade, which talks about millions of tons per year and billions of cubic meters. Along come ethanol and biodiesel, and for some odd reason their producers chose the same unit as American consumers: gallons. Perhaps that explains part of ethanol's appeal, along with its farm origins.

In my geeky, idealistic youth I was a fanatic about metric conversion, and the Systeme Internationale or "SI", in particular. Kilograms, meters and Joules seemed much more sensible than pounds, feet and BTUs. The life-cycle of that movement in this country roughly paralleled that of leisure suits, and I am skeptical either could be revived any time soon. But wouldn't it be nice if energy people could agree on a few common units, one for molecules and another for electrons? If we're going to need every last one of each--and I fervently believe we will--then we at least ought to be able to add them up easily. Don't hold your breath, though. It probably won't happen until some other form of energy has pushed oil and gas off center stage, and then the industry will have to learn to speak in someone else's units.

Disclosure: Chevron Corp. is a client and I own Chevron stock.

Dark Clouds

Two of yesterday afternoon’s panels at the Herold Pacesetters Conference really epitomized why I love to attend sessions like this. They dealt with geopolitical risks to energy supplies and the “megatrends” facing the entire energy industry and the wider world. In the interest of time, since I’ve ducked out of another session to write this posting, I’m just going to list some of the insights and sound-bites that caught my attention from these panels:

• The panel on geopolitical risks included a presentation on an interesting tool for quantifying those risks objectively, and I plan to come back to that in a later posting. But another presenter provided some useful advice about not getting so focused on understanding the risks that we fail to plan our responses to common outcomes that could arise from a number of different events. If the market is short a million barrels per day, how important is it that it happened because of country X’s policies or because of a natural disaster, compared to making sure we can handle such a shortfall from any cause?
• Cliff Kupchan of the Eurasia Group provided some insights into the upcoming transfer of power in Russia, suggesting that President Putin may surrender the Presidency, but that wherever he ends up may become the new center of power. This has implications well beyond energy.
• Mr. Kupchan also discussed Iran. He sees two competing clocks ticking down in that country, the nuclear clock and the reform clock. Whether we end up with an application of “kinetic policy”—a euphemism for military force—may depend on which clock is running faster.
• In the panel on megatrends we heard about resource depletion and the prospects for Peak Oil, which hinges not just on the oil in the ground but on the capacity to produce it. If the international oil companies can’t access those resources, and OPEC lacks the internal funding or motivation to build capacity, we could end up with a peak, regardless of the remaining reserve levels.
• One indicator of the progress towards such a state is the steepening curve for per barrel capital costs in the oil industry. This suggests diminishing volumetric returns ahead, and the prospect of really severe price increases to destroy the demand that can’t be met. That could be especially painful for the US, since so many consumers around the world are buffered from oil price changes by controlled markets and high taxes.
• There was also a brief discussion of a recent prediction that oil prices could be about to peak and return to $45/barrel, though that view didn’t get much credence on the panel or with the audience.

If this all sounds like doom and gloom, that’s the nature of the way we tend to look at risks. If there are bright spots in this outlook, they may have to come from non-conventional hydrocarbons and alternative energy, the subject of my panel this morning, which I’ll cover in tomorrow’s posting.

Two Industries

In the first day of the John S. Herold Pacesetters Conference, most of which was focused on the exploration and production portion of the global oil and gas industry, I heard many interesting comments and themes, but I was struck by a contrast between the typical external picture of an industry beset by political and environmental challenges, and the companies on display here, which are working on real growth opportunities and generating real value for their shareholders and the economy as a whole. Anyone expecting this industry to fade quietly and get out of the way of emerging energy sources such as wind, solar and biofuels, is bound to be disappointed. Yet the industry would be equally wrong to ignore the future competition those new sources represent.

In some respects, this contrast arises from something one of yesterday’s panelists observed, that there isn’t one oil & gas industry, but really two. On the one hand, we see the eight or so world-scale companies that are household names across large portions of the globe, while on the other, a constellation of smaller companies that belie the stereotype of an industry that values financial engineering as much as the physical kind. While no one should be surprised to see such companies at an investment conference touting their companies’ stories, the underlying facts are impressive: these smaller companies are generating real production and reserves with the drill-bit-- rather than just buying each other--generating healthy profits along the way.

But as yesterday’s lunch speaker made clear, even the smaller companies don’t necessarily fly under the political radar. The CEO of Chesapeake Energy, one of the largest independent producers of natural gas in the US, shared a remarkable set of correspondence with the audience, in which the Governor of Connecticut accused his company of manipulating the gas market, to the detriment of consumers, by constraining production. She has asked for a Congressional investigation of this practice, and in the current environment she will probably get one.

You don’t have to take Mr. McClendon’s word concerning the inaccuracies contained in Ms. Rell’s allegations; they are easily discernable in the price and inventory storage data maintained by the Energy Information Agency of the Department of Energy. It certainly leaves open the question of how much due diligence the Governor’s office conducted before leveling these charges. More fundamentally, however, it’s not clear why any state government might think it appropriate to criticize a decision by a private company in another state to cut production that has become unprofitable because of falling prices. If natural gas producers can be taken to task for this, can ethanol producers faced with falling margins be far behind?

Finally, I heard some interesting thoughts about what the shape of the current futures markets for oil and natural gas is telling us. When you ignore the fluctuations at the front end of the market and focus on the further-out contracts, the pricing of low $70’s for crude oil and $8 for natural gas are in line with the prices implied by the incremental oil and LNG projects now under development. While that doesn’t preclude the possibility of a collapse back to $50 or $60 oil and $5 natural gas, it does suggest that such drops wouldn’t be permanent—unless producers are forced to produce flat out regardless of price.

Global Energy Overview

I’m back in Connecticut this week, attending the annual Pacesetters Energy Conference of John S. Herold, Inc., which sponsors this blog. The conference brings together the oil & gas and investment communities, focusing on the major trends in the energy industry and their financial consequences. This year it is taking place against a backdrop of relevant events nearby, as the UN meets in New York and the President convenes an international conference on climate change in D.C. The UN session includes the visit of Iran’s President Ahmadinejad, the walking personification of political risk. It’s going to be an interesting week.

The opening panel of the conference provided some interesting statistics on the publicly-traded energy companies that Herold tracks. The industry spent $400 billion in “upstream” capital investments last year, apparently constituting the seventh consecutive increase and exceeding the total cash flow of the sector for the first time since the 1990s—when that cash flow was much lower. But because of limited access to resources around the world—a theme I’ve touched on many times—aggregate oil reserves have increased only modestly, and much of that has come from the Canadian oil sands. And the combination of weaker natural gas prices and rising costs are putting pressure on the industry’s profit margins—not something you expect to hear with oil at $80/barrel.

These are serious issues, to be sure, but in his videotaped message at the start of the conference Ron Mobed, the President and COO of IHS Energy, which recently acquired Herold, mentioned the “environmental and climate change concerns that are currently the biggest drivers of change in operating practices in the industry today.” Given the magnitude of the other challenges, such as political risk and access to resources, I thought this statement was remarkable.

Thursday morning I will be moderating a panel discussion on alternative energy, with participation from a major oil company, an ethanol technology startup, a large consultancy, a coal processor, and the US Department of Agriculture. Alternative energy is going to play an increasingly important role in connecting the energy industry to climate change. Not only is it a principal avenue for reducing emissions, both globally and for the industry’s own operations, but it could prove essential for making the product slate of energy companies compatible with a world of constrained carbon emissions and effectively constrained hydrocarbon production.

My postings for the remainder of the week will include some of the key insights from the conference, along with my comments on any noteworthy developments from NY and DC.

Tapping the Rest

I started writing this posting several weeks ago, with the idea of presenting some straightforward projections on the quantity of potential domestic oil production that the US has chosen to place off-limits to drilling. But while there are accepted estimates of the quantity of resources under the ground in the offshore and onshore areas that oil companies can't access, translating those figures into expected production--the number that really counts--turns out to be pretty difficult. So there's a lot of uncertainty surrounding how much oil we're forgoing and how quickly it could come onstream, if all drilling moratoria were dropped tomorrow. That makes the entire subject much harder to broach when the Congress, at least, has shifted from a paradigm in which increasing production was a key element of our energy and national security, to a stance that regards it as a futile distraction from the urgent task of promoting efficiency and alternatives.

Let's start with the resource estimates. Last year the Minerals Management Service of the US Department of the Interior issued a mean estimate of 85 billion barrels of "undiscovered, technically recoverable" oil under the federal waters of the Outer Continental Shelf, including the portions of the Gulf Coast currently open for drilling. Of that, they indicated at least 66 billion barrels of oil "resource" at a 95% confidence level--in other words a 95% chance that the quantity was at least that big. That compares to total current proved US oil reserves of just under 22 billion barrels, a figure that hasn't changed much in over a decade, despite annual production of around 2 billion barrels per year.

But resources are not reserves, which are based on how much of the oil or gas in the ground can likely be extracted economically with existing technology and at current prices. That means we can't look at the MMS estimate and conclude that we could produce as much from these undiscovered resources as we do from our current reserves. As the technical experts at the API pointed out to me when I asked them for help interpreting this, trying to arrive at a reasonable production profile for the portion of these resources that are off-limits is complicated not just by access, but by permitting requirements, proximity to existing infrastructure, and the availability of drilling rigs and experienced personnel. In addition, there would be a delay of at least 5-7 years in bringing new production on line from the time access was granted, nor could we develop it all at once.

The recent energy study by the National Petroleum Council also considered this issue. The study's supply team examined a variety of estimates and concluded that roughly 40 billion barrels of oil were currently off-limits to drilling in the US, including--as best I can tell--the resource estimate for the Arctic National Wildlife Refuge (ANWR). They also reported estimates that the offshore portion of roughly 18 billion barrels could generate additional oil production of one million barrels per day by 2025 and displace roughly 2.8 billion barrels of imports in the interim, with corresponding benefits for our trade balance and royalty revenues. (Please note that I participated in a different aspect of the NPC study as a paid consultant. While the data in this paragraph are taken from the published study, the opinions expressed in this posting are mine and do not represent those of the Council or its membership.)

Without heroic assumptions, it appears that our conscious choices about the undesirability of oil drilling outside the presently-permitted portions of the Gulf of Mexico, as well as on various onshore federal lands, are holding back domestic oil production in the range of 1-2 million barrels per day, or an extra 20-40% of current production. That is the equivalent, adjusted for energy content, of 22-44 billion gallons per year (BGY) of ethanol, a range that includes within it the entire expanded renewable fuels mandate passed by the Senate a few months ago. It is also a multiple of most estimates of the maximum quantity of corn ethanol the nation can produce.

I have heard some people suggest that our policy of restricting access to these resources is wise, because they will be worth more in the future, after conventional oil production has peaked. Even if that were true, I think it is very likely that if these volumes are not developed within the next decade, they never will be, because our industrial capability to extract them will atrophy and attitudes against drilling will harden further. While that might be welcome news to some, it should not be to anyone who is genuinely concerned about US energy security.

I'm not arguing that we can drill our way to energy independence. Given our low current oil production, relative to demand, that remains impossible under any scenario I can envision. But neither can we farm our way to energy independence, or conserve our way there any time soon. I believe politicians are ignoring the potential benefits available from adding more conventional oil production into our future energy diet. The combination of an extra million barrels per day of oil, 36 BGY of various biofuels, and a 35 mpg fuel economy standard might not quite achieve true energy independence, but together they would make a sizable dent in our oil imports. And this approach would produce substantially fewer greenhouse gas emissions than adding a comparable quantity of coal-to-liquids, oil sands, or shale oil production.

The Oil-Dollar Price Loop

Positive-feedback loops have become a familiar concept, thanks in part to the science of climate change. A warmer atmosphere melts icecaps and glaciers, which in turn reflect less sunlight back into space, causing the atmosphere to warm further, and repeat. Such relationships exist in many systems, and an article in yesterday's Wall Street Journal started me wondering if we are experiencing such a loop involving oil prices and the value of the US dollar. If so, the practical limit on the dollar price of oil could be much higher than we might otherwise expect.

Over the last several years I've discussed many reasons why oil prices have increased so dramatically, compared to their level prior to 2004. It's a long list, including the shift in power from commercial oil companies to national oil companies, and from non-OPEC producers to OPEC, geopolitical tensions, the growth of Asia, inventory, speculation, and even the lagged impact of the late 1990s oil price collapse. At first glance, though, because oil is normally traded in dollars, the value of the dollar itself might not seem to belong on that list. In a world awash in oil, it probably wouldn't. However, a dollar that is shrinking relative to other major currencies has at least two effects on oil, in a market that is already tight.

First, it reduces the income of producers, who sell in dollars. That leaves them less cash to reinvest in new production. At the same time, it makes oil cheaper in the currencies of other consuming countries, relieving the pressure on them to consume less and helping them to out-compete us for the world's available oil exports. Each of these factors alone would tend to drive up the dollar price of oil; with the oil market being driven by supply constraints (OPEC quotas) and rising demand, both effects operate. More importantly, they appear to work in a self-reinforcing fashion, linked back through their impact on the dollar.

So imagine a closed loop, and follow it around a cycle:

1. The value of the dollar drops.


2. Non-US demand rises and supply tightens, as discussed above.


3. The dollar price of oil increases.


4. The US trade deficit worsens, and foreigners hold more dollars than they need to buy US goods or assets.


5. Return to step 1.

Events such as this week's interest rate cut by the Fed also feed this cycle, by weakening the dollar while propping up our economy and thus our oil demand. Of course, none of this happens instantaneously or in isolation. Many other things influence oil prices, exchange rates, and the other components of this highly-simplified feedback loop.

There's also a natural point at which these loops start to de-couple, and we could be nearing it. The growth of China and other large developing countries may be driving global oil demand, but we still import a quarter of all the oil that's exported around the world. Once the price gets high enough to dampen US oil demand and imports--or when the underlying factors weakening the dollar have the same effect--then this loop starts to run down. But at what oil price does that occur? I expected it long before we reached $80 per barrel, and there are signs that demand is slowing. Total petroleum products supplied in the US, one measure of demand, was down by about 0.5% for the last six weeks, compared to the same period last year, and total crude oil and petroleum product imports were down by a larger fraction. Time will tell whether this is a trend, or a random fluctuation. Meanwhile, I'll be watching exchange rates more closely than I used to.

Oil's Pogo Problem

Yesterday I participated in another in a series of blogger conference calls hosted by the American Petroleum Institute (API.) This one covered a study commissioned by API and conducted by Dr. Robert J. Shapiro, a former Undersecretary of Commerce for Economic Affairs, examining the ownership of US oil and gas companies. The study's findings dispel the notion that the oil industry is owned by a few insiders, rather than by a broad cross-section of the public via our mutual funds, pension funds, and direct equity investment. In fact, the owners of these companies look a lot like those in other industries. While that might not surprise many of my readers, it highlights a significant disconnect in some pending energy legislation. Anyone familiar with the late Walt Kelly's cartoon possum, referred to in this posting's title, knows where this is headed.

The study looked at the ownership of oil & gas company shares, among management, individuals, and various institutional investors. Although these owners don't make the day-to-day decisions that guide these companies, they are entitled to all of the firm's earnings, whether paid out as dividends or reinvested. Out of every dollar of oil company pre-tax profit, roughly 35 cents cents goes to Uncle Sam and another 7 or 8 cents to the appropriate state tax authority. Of the remainder, Dr. Shapiro's study suggests that approximately 57 cents ends up in someone's IRA, 401-K, life insurance policy, or pension fund, leaving under a penny for "corporate insiders." That seems very much at odds with public perceptions about oil companies.

In the podcast interview that accompanied API's press release on the study, John Felmy, API's chief economist, made an astute observation. Referring to recent legislation increasing taxes on the industry, he said, "They seem to be predicated on the notion that people believe that no one owns the oil companies, and somehow if you take money from an oil company, no one gets hurt." The data paint a very different picture; the people who own those large profits we want our representatives to tax away are mainly the same ones who elected them: us. When I asked him about this, Dr. Shapiro was careful to make a distinction between the composition of the electorate and of the owners of financial assets. The latter group is skewed toward the upper half of income, compared to the whole population, though the electorate probably is to some extent, as well. However you slice it, though, raising taxes on oil companies means taxing the nest eggs of America's middle class.

In that light, the only practical difference between raising federal revenue by taxing the oil & gas industry, in preference to some other broad or narrow target of corporate income taxes, lies in reducing the amount available to invest in producing more energy, rather than materially shifting the pockets from which the funds will ultimately come. Surely that is counterproductive to the cause of reducing our reliance on imported energy, even if some of those profits would otherwise be spent on share repurchases or mergers. When we argue that we want to tax oil companies, because we have more confidence in the government to invest in alternative energy, we are really saying we want to tax our own savings and those of our parents, friends and neighbors to fund energy R&D. When you look at it that way, that's just not a very enlightened policy, compared to a tax on energy consumption or carbon, either of which would do far more to reduce demand, improve efficiency, and reduce greenhouse gas emissions.

Nuclear Freakonomics

Several weeks ago a reader of this blog commented to me on the contrast between the periodic calls for a new Manhattan Project to tackle our energy problems and the results of the actual Manhattan Project sixty years ago, which have matured to provide large quantities of economical base-load electricity in the US and many other countries. Several recent articles have addressed the revived prospects for nuclear energy, including one in last week's Economist and another in last Sunday's New York Times Magazine. In the latter, the authors of "Freakonomics" examine America's sudden shift away from nuclear power and the consequences that has had for our greenhouse gas emissions. I couldn't resist quantifying their observations.

What if the Three Mile Island accident had never occurred, or if it hadn't coincided with the release "The China Syndrome", which amplified the public's perception of the event? Would nuclear power plants have still encountered the project delays that drove up their construction costs, contributing to the roughly 20-year hiatus in new plant activity? Any answers to these questions would be purely speculative, but if the industry had continued expanding at its previous rate, then instead of the current 104 reactors, we might easily have 200, contributing 40% of our total electricity supplies. Coal-fired power plants would supply only 32% of our power needs, instead of 50%, and we'd emit roughly 650 million tons less CO2 per year. That's over 10% of our current CO2 emissions.

Or what if the US Congress had voted in 1997 to ratify the Kyoto Protocol on greenhouse gas emissions, and the country had embarked on a major expansion of nuclear power to meet our commitments under the treaty? The first new reactors would have started up a few years ago, and we'd be on a path to meet our target of reducing our emissions below 1990 levels by 2012--or at least come a lot closer to that than now seems likely.

While these scenarios ignore real-world complications such as nuclear waste and proliferation, they underline an important point. Choices have consequences, and our decision a generation ago to leave nuclear power in limbo has added billions of tons of CO2 to the atmosphere since we made it, while constraining our options for addressing the challenges we face. The decisions we make now could have similar consequences, because while renewable energy technologies such as wind and solar power can add important quantities of low-emissions electricity in the decade ahead, they cannot match nuclear's baseload characteristics and 90% onstream capacity factor. As impressive as the addition of 2,454 MW of new US wind power capacity last year was, the resulting increase in net power generation is still less than that from one new nuclear reactor.

When we assess nuclear power as an option for dealing with our energy security and emissions concerns, we ought to consider what a new fleet of reactors would enable, in terms of reducing our reliance on coal--with its implied dependence on future carbon sequestration--and providing large quantities of reliable off-peak power for the plug-in hybrids and all-electric cars that look like our lowest net-environmental-impact alternatives for displacing gasoline in the medium term. Are those benefits significant enough to warrant a more pragmatic approach to nuclear power and its byproducts? I believe so, and there are at least a few environmentalists who share that view. On balance, the risks of nuclear power look more manageable than the uncertainties of climate change or an unstable Middle East.

Zero Net Energy

An article in today's San Francisco Chronicle provides another example of California taking the lead on connecting energy and environmental policies. The state's Public Utilities Commission wants to require developers to build homes so energy efficient that they will require no net energy from the grid by 2020. This is consistent with the state's goal of drastically reducing greenhouse gas emissions, and it would also shrink the infrastructure burden associated with adding six million additional residents between now and then. Timing is sometimes as important as substance, however. It would be hard to imagine a worse time to impose such a potentially expensive new requirement on the housing sector.

As my regular readers know, I'm hardly unbiased about California, having spent three-fifths of my life there, including my entire education. Californians have long believed that they are about 10 years ahead of the rest of the country, and that what you see there today, you will see everywhere else eventually. It's probably more accurate to say that California represents a useful testing ground for new ideas, giving the rest of us a preview of some of their consequences, intended and unintended. Not all of these experiments have turned out well, as evidenced by the state's botched electricity deregulation a few years ago, and the impact of unregulated immigration on a massive scale.

The concept of zero-net-energy housing has much to recommend it. The technology to do this is certainly available, at least for homes in an area with as benevolent a climate as California's. It also makes a lot of sense to incorporate features such as solar roofs, extra insulation, and efficient appliances into original construction, and thus into the mortgageable purchase price of a home. A decade ago, my Texaco colleagues and I suggested that this was the most logical way to implement distributed generation technologies such as home fuel cells, including long-term supply contracts for the natural gas these devices would use. But whether it's fuel cells or solar panels, they are easier to incorporate into a house when it is built than as a retro-fit, and the economics work better, too.

Unfortunately, timing matters. You would have to be living under a rock to have missed the implications of the sub-prime mortgage crisis for home construction in California, one of the worst-affected states. Putting a major new requirement such as energy self-sufficiency onto developers at this juncture looks like a recipe for failure. The engine of easy credit and bootstrapped home equity from strong, steady appreciation has stalled and gone into reverse in California, where home sales are down and property values are declining. No one knows how long this situation will last, but it could take the California housing bubble years to deflate and return to normal growth.

I don't fault the PUC for wishing to align California's large housing sector with the state's overall emissions and efficiency targets. Floating this proposal now seems a bit tone-deaf, though. Hopefully, the California Energy Commission and the legislature will take a bigger-picture view and shelve this idea until conditions become more propitious. That shouldn't affect existing incentive programs for solarization and efficiency, nor would it preclude developers from packaging these systems as selling features. After all, there's nothing wrong with this idea, other than making it mandatory. In the meantime, California should seek big emissions reductions in less distressed sectors, since all such cuts are equivalent in their impact on climate change.

Common Interests

An op-ed in today's Washington Post got me thinking about the ways that the US and China would benefit from greater cooperation on energy. As energy security increasingly becomes a global, rather than merely national concern, there are big incentives for the world's two largest oil consumers to work together. Mr. Mallaby is right that both countries share a common interest in ensuring stable, affordable oil supplies for our economies, though he neglects to mention the opportunities created by the very different stages of development reflected in each. Applying US technology to China's energy challenges could help address our own.

On the supply side, while China produces significant quantities of oil--about as much as Iran or Mexico--its oil industry is not as mature as America's. China's large territory has not been explored to nearly the same degree as ours, nor has the latest technology for finding oil and gas been applied to the same extent. That means that there is still some upside in China's own production, even as the country seeks to secure supplies abroad. And while the rapid growth of its oil imports, relative to production, makes the idea of Chinese energy independence as elusive as it has been here, every extra barrel they produce is one for which they will not have to compete in the global market, driving prices up.

More importantly, the relative size of China's current installed base of energy-using devices--cars, appliances, etc.--is still modest relative to its ultimate potential. Efficiency technologies introduced now would have dramatic effects on future consumption, because the key factor is still growth, rather than turnover. 2007 car sales, estimated at 9 million units, will contribute between a quarter and a fifth of all the cars that will be on their roads next year. US car sales haven't had that kind of leverage on the characteristics of the total fleet since at least the 1950s, with current sales running at less than 7% of existing vehicles. If every new car in the US and China were a hybrid starting tomorrow, within five years China's fleet would be mostly hybrids, while ours would still have a large majority of less efficient vehicles.

The debate over US fuel economy regulations remains brisk, because auto makers face large investments to improve a vehicle attribute that has been a low priority for consumers until quite recently. However, if those investments could be spread across both the highly-competitive though slow-growing US car market, and the rapidly-growing Chinese market, the cost/benefit balance would shift. GM's plug-in hybrid (PHEV) technology, eagerly anticipated here, might be just the thing for China's big cities, particularly if, as some claim, the architecture GM has chosen reduces vehicle cost below that of conventional hybrids, and perhaps eventually below traditional cars. Buick is already the top brand in China, and PHEVs could cement that lead.

In that context, negotiating with China to align our respective CAFE standards might be a good way to reduce global oil demand, create opportunities for US companies, and attack climate change, all at the same time. Trade deals with China aren't exactly the flavor of the month, right now, so it's not obvious that expanding the issue this way would improve the political prospects of tougher CAFE standards in the Congress. But reframing it to address a broader definition of energy security, recognizing the common interests of consuming countries when OPEC's hold on oil markets seems unassailable, might look like very savvy leadership.

Nearing the Old High?

Whenever the price of crude oil breaks its previous record in nominal prices, we see comparisons to the all-time high of the early 1980s, adjusted for inflation. When it passed $80 the other day, I saw several such comparisons. Only one problem: they differed by more than a dollar per barrel among them. That's more than a rounding error, considering that price data are given to the penny, and the GDP deflator commonly used for such calculations goes out three figures beyond the decimal point--five when you realize it's quoted as a percentage. What could be causing these disparities, and what is the true, inflation-adjusted oil price high? That turns out to be a decidedly non-trivial question, and there's really no single correct answer. The best I can come up with is around $91/barrel, which is much lower than recent estimates over $100/barrel that probably rely on the consumer price index.

Explaining why this isn't nearly as simple as it looks requires a bit of background on the different grades of oil, how the market works now versus how it worked in the early 1980s, and what we mean by inflation adjustment. This isn't intended as an economic dissertation, however, so I'm going to paint it in broad strokes:

Start with oil, itself. There are probably more different types, or grades, of it than there are rock bands with funny names. The grade the media generally refer to is West Texas Intermediate (WTI), a generic mix of light, sweet domestic crude oil streams (plus a few specified import grades) with sulfur content below 0.42% and API gravity (a measure of density) between 37 and 42 degrees. While it has been the primary benchmark crude oil type for the US and the world for a very long time, it's not particularly representative of what most refineries actually run, though it was more representative 25 years ago.

Now consider the market. Today, the WTI price usually refers to the settlement price for the front-month futures contract on the New York Mercantile Exchange. Unfortunately for anyone trying to compare current and historical oil prices, the NYMEX only started trading crude oil in 1983, a couple of years after the price had peaked. To compare WTI before 1983, you must look at "first purchaser" wellhead prices. The best publicly-available proxy for those that I could find is "posted prices", which are not actual transaction prices, but price schedules published by companies soliciting offers to sell them oil. To complicate matters further, actual transactions typically occur at a premium to postings, referred to as "P-plus". For example, "XYZ agrees to buy 10,000 barrels per day of WTI at Cushing, OK for the month of June 1987 for P-plus 50 cents." As quaint as that sounds in an era of real-time electronic trading, I understand that a fair amount of crude is still transacted on a P-plus basis, for various reasons.

Next consider what we mean by inflation. How relevant is the commonly-used consumer price index to the wholesale price of a primary industrial commodity? Not very, even if oil isn't just any commodity. I'm a lot more comfortable using the GDP deflator, which is a very broad measure of the impact of inflation on nominal prices across the entire economy. It might be equally legitimate to argue for using some other index, such as nominal GDP per capita or relative share of GDP.

The highest posted price for WTI during the first energy crisis was $39.50/barrel from April-July 1980. (While there's better data available for imported crude oil in the same period, trying to equate that to current WTI requires all kinds of additional assumptions, and I'd prefer to avoid those.) Applying the ratio of GDP deflators to the posted price yields $87.92 in 1Q2007 dollars. If we assume that actual transactions in the peak month of 1980 were probably done at P-plus $1.00--about as much as the market would take before competitive forces pushed the postings up--then we get to $90.14. But that's still a wellhead price, so we'd need to add something for gathering, handling and transportation to arrive at a figure that equates to NYMEX WTI at Cushing, OK. Call it a buck, and we're at $91 and change.

If I've done my sums properly, we're closer to the all-time high oil price than some analysts are suggesting. The puzzle, of course, is how prices can be this high for this long without putting the economy into a deep recession, such as we saw in the previous energy crisis. Part of the answer is found by translating that July 1980 oil price based on its relative share of the 1980s GDP, compared to today's, rather than using the deflator. On that basis, oil at $80 still has a long way to go to match its equivalent of $187/barrel in 1980.

Update, 11/7/07: The Washington Post described similar difficulties in coming up with an inflation-adjusted all-time high, reporting different results from three groups, the IEA, CERA, and the Energy Information Agency of the US DOE. The EIA's figure comes closest to mine at $93.48. They applied the same GDP deflator, though they used a different starting point, the average monthly refiner acquisition price in Jan. 1981. CERA used WTI postings, as I did, but inflated at the CPI to arrive at $99.04.

What About Iraq's Oil?

Congressional hearings are often as interesting for what is not said as for what is. After watching hours of C-SPAN's coverage of the House and Senate hearings on Iraq this week, I only heard the subject of oil come up a few times, and only in the context of how oil revenue was being shared between the central government and provinces. If you didn't know that this war was being fought in the heart of the world's largest concentration of oil and gas, you'd never have guessed it. Perhaps it has become impolite to mention the importance of Iraq's oil, when so many critics have convinced themselves that the whole war was about oil in the first place. Or maybe it's just assumed to be understood as part of the shorthand reference to "vital interests in the region." Either way, the result of the war in Iraq will have a significant influence on global oil markets, and part of my interest in the hearings was in trying to glean whatever I could about the likely outcome.

In his column in today's Washington Post, David Ignatius asks how this war will end, echoing a question that General Petraeus apparently asked in 2003. It's still the right question today, of course, and not just because of the Americans and Iraqis who are being killed or maimed. At the risk of seeming insensitive to those much greater costs, oil remains the lifeblood of global civilization, at least for now, and we can't ignore the pressure that the Iraq War has exerted on oil markets since it began. That pressure has short and long-term components.

At least part of today's $80/barrel price is the result of production lost to sabotage and corruption, and the Iraqi industry's inability to restore production to pre-war levels, along with the risk the war represents to the broader producing region across the Middle East. But in the long run, it is the delay in developing Iraq's enormous untapped reserves that matters most. Few countries have the potential to double or triple their current production, and as long as global oil demand continues to grow, incremental output from the few places with both the resources and the willingness to provide access to them is essential. That won't happen without the appropriate national and provincial legal framework--even if oil revenue is being shared equitably on an ad hoc basis, as Ambassador Crocker indicated--and certainly not until the violence has subsided to the point at which international geoscientists and engineers can work there safely. Hunt Oil's recently-announced agreement in the Kurdish north of Iraq is a special case, rather than a signpost, even if it stands up to scrutiny.

Many analogies have been drawn between the Vietnam War and Iraq, but the one that seems most relevant lately has both positive and ominous overtones. When General Creighton Abrams replaced William Westmoreland as commander of US forces in Vietnam in 1968, he altered the failed strategy of his predecessor and replaced unwarranted optimism with pragmatism. Unfortunately, although his new strategy largely succeeded on the ground, it came too late to redeem the war in the eyes of the media, public and politicians back home. Too much American blood and treasure had been spent learning what didn't work. In many ways General Petraeus looks like the General Abrams of this war, at a point when the country's patience has worn similarly thin.

The possible outcomes in Iraq, however, look very different from any Vietnam comparison, for energy if for nothing else. If Iraq collapses after we leave, and its 1.6 million barrel per day oil exports cease, $80 oil will look cheap. If it stabilizes, reconciles its "ethnosectarian" groupings, and starts to develop new oil fields, prices could start dropping, and no one can say for sure where they'd land. And if Iraq became a satellite of an expansionist Iran, all bets would be off, and the current "risk premium" on oil could expand even further. Whatever this Administration, the Congress and all the presidential candidates imagine about the ultimate end of the Iraq War, they cannot lose sight of its enormous energy implications.