Green Power or Green Jobs

Until now I've avoided the debate over a proposed wind project in Texas involving Chinese investors, federal renewable energy stimulus grants and wind turbines from China, mainly because I didn't think I had anything salient to add to the unpleasant mix of protectionism and second-guessing that was unfolding. This morning I read a posting on the subject from the Breakthrough Institute that, while offering a coherent explanation of how we got to this point, convinced me that the real problem still hasn't been addressed. Although the inconsistency of past and present US energy policy is readily apparent, the current concerns arise from general confusion over the benefits of renewable energy, exacerbated by the recent effort to spin these projects and technologies in terms of "green jobs." When we don't really understand why we are doing something, it's easy to make any outcome look like a failure--and there is no shortage of elements from which to craft such a view in the situation at hand.

The chief complaint about the project in question is that it might be eligible to take advantage of a key energy provision of the American Reinvestment and Recovery Act of 2009--this year's stimulus bill--that allows the developers of a qualifying renewable energy project to collect an up-front cash grant from the US Treasury equal to 30% of the cost of the project. In this case much of that money, along with the funds provided by the US and Chinese partners, would go to pay for wind turbines imported from China. As a result, most of the jobs this project would create would be in China, not the US. On the face of it, this looks like a colossal loophole that some high-profile legislators--who incidentally voted for the stimulus bill including this feature--are rushing to plug. However, this only looks like a nasty unintended consequence of a hastily-crafted law if you misunderstand the mechanics and purpose of the Treasury renewable energy grant program.

You have to begin with the renewable energy tax credits that were in place prior to the passage of the stimulus bill. Qualifying wind projects normally received a federal tax credit of 2 cents per kWh generated for ten years after start-up, adjusted for inflation. Along with similar tax benefits for solar and geothermal power and other renewable energy technologies, the wind Production Tax Credit (PTC) was due to expire at the end of last year. Last fall's TARP bill extended this benefit through the end of 2012*. So it's important to note that the West Texas project would have collected a similar amount of money from the government in the form of tax credits over the next decade, even without the option provided by the stimulus bill to convert those credits into an up-front cash grant. The latter merely made the cost of providing this benefit much more transparent. As noted in a report by the Investigative Reporting Workshop at American University, well over 80% of these grants to date have gone to non-US firms.

I can appreciate the outrage this has caused, particularly when this program was so heavily hyped as a way to create new jobs in the US during a recession, and in an industry that many see as holding the key to future US competitiveness in a carbon-constrained world. However, that outrage ought to be tempered by a clear understanding of the principal purpose for establishing the grants. Prior to the failure of Lehman Bros. last year and the subsequent seizing-up of the so-called "tax equity" market, it was customary for project developers to enter into agreements with banks and other parties to exchange the rights to their future PTC benefit stream for up-front cash to invest in the projects generating these credits. When that market became illiquid, new wind project development came to a virtual standstill. With financial markets in turmoil at the beginning of 2009, the Treasury grant program was conceived as a way to jump-start renewable energy project development, until the tax-equity market revived. In that regard it has been fairly successful, as evidenced not least by the sums issued under this program so far.

I can't tell whether the architects of this program failed to work through the consequences of their efforts sufficiently to see that, with domestic turbine makers such as GE Energy accounting for less than half of the US market, a large portion of the grants would end up benefiting foreign manufacturers. Perhaps they saw that potential but didn't appreciate the firestorm of controversy it would create, when someone figured out where the money was actually going. Or perhaps at that moment they were merely hyper-focused on getting legislation passed in order to arrest the apparent free-fall of the US economy. I'll leave that to others to sort out.

There's a deeper issue here, as well. The whole episode evokes memories of the endless debates over "industrial policy" in the 1980s. The US wind industry lags its European competition in market share because European countries chose to subsidize the sector through much more generous and consistent tax benefits and a hidden tax on electricity consumers (a.k.a. the "feed-in tariff".) But while that created an advantage for the European companies involved, it didn't make them self-sustaining or overcome the inherent shortcomings of wind power's intermittent output. In that light it's hard for me to regret that the US didn't invest more money in wind over the last 20 years. Another way to look at this is that European taxpayers and consumers have borne much of the pain of driving down the costs of wind power to a point at which it can begin to compete with power generated from natural gas (and to a much lesser extent from coal) with only the modest subsidies US taxpayers have been willing to provide.

That gets to the essence of the choice we need to clarify if we are to judge fairly outcomes such as the one presented in the proposed West Texas wind farm. Are we investing in these projects and these technologies mainly to create jobs in the US, or are we investing in them to generate low-emission electricity at the cheapest cost possible, in order to run the 90+% of the economy that is not devoted to producing energy?

Selling green energy as a jobs initiative has led directly to the confusion and consternation apparent in the reaction to Chinese investors and Chinese wind turbines in this West Texas wind project. The wind industry has already developed a globalized supply chain, similar to many other industries, and no one should be stunned if wind turbines from China show up in Texas, any more than China should be surprised that its nuclear power plant construction projects are creating jobs in the US. Our assessment of the value of renewable energy sources such as wind power should hinge on their efficacy at providing reliable and cost-effective energy supplies and reducing greenhouse gas emissions, not on domestic jobs creation--even in a recession.

*Correction: A reader reminded me that the TARP bill only extended the wind PTC by one year; the longer extension occurred in the stimulus.

The Way We Drive Now

My posting of October 29th examined two of the ways we risk under-counting the greenhouse gas emissions (GHGs) from favored energy technologies such as biofuels and electric vehicles, with potentially serious consequences. Well, it turns out that the same joint proposal by the EPA and Department of Transportation establishing new fuel economy and vehicle emissions rules incorporates another, subtler distortion that could be even more significant over the next few years than treating electric vehicles (EVs) as if their external power sources emitted no GHGs. Consider the many ways in which personal transportation in the US has changed since the mid-1970s--longer commutes, heavier traffic, and new vehicle technologies--and then ask how it could possibly make sense to embed a vehicle-use statistic set by a 1970s' law at the heart of the new Corporate Average Fuel Economy system. Yet that is precisely what these new rules would do.

My scrutiny of the draft "Light-Duty Vehicle Greenhouse Gas Emission Standards and Corporate Average Fuel Economy Standards" rulemaking was an outgrowth of a recent conversation with Jeff Breneman, Executive Director of the US Coalition for Advanced Diesel Cars. In addition to promoting to an American audience the benefits of the improved engine technologies that have enabled diesel passenger cars to capture over half of the new-car market in Europe, this group advocates an approach to emissions reduction and improved energy security that emphasizes outcomes, rather than "flavor of the month" pathways. That resonates with themes I've been expounding since I began this blog nearly seven years ago.

According to Mr. Breneman, achieving a level playing field for advanced vehicle types such as diesels, hybrids, plug-in hybrids and pure EVs depends on establishing metrics for judging them that reflect "real-world driving." In the case of the draft EPA/NHTSA rules, that means updating their assumption that the average American drives 55% in city traffic and 45% on the highway. That ratio was set by the Energy Policy and Conservation Act of 1975, when there were 100 million fewer cars on our roads, each driving on average about 2,000 fewer miles per year, and the only alternative fuel vehicle I was aware of burned propane. According to the EPA's own data from 2006, current average driving patterns exhibit a roughly 43% city, 57% highway split, even though its 2010 vehicle sticker program is still based on the old 55/45 ratio.

This divergence between current and historical driving patterns has become more significant as the array of available vehicle choices has broadened to encompass technologies such as hybrids that perform best in city driving, but offer little highway benefit, and others such as diesels that are at their best in sustained driving above 45 miles per hour (highway driving by definition in the EPA's split.) For example, the 2010 VW Jetta Diesel is rated at 30 mpg city/42 mpg highway, compared to 41/36 for the Ford Fusion Hybrid.

The two agencies involved indicate they intend to assess carmakers' fleets using the old split until at least 2017. That means that during this crucial transition to stricter fuel economy standards these rules will motivate manufacturers to invest more in vehicle technologies that perform best under the old assumptions--despite the resulting misalignment with how consumers really drive now--in order to meet their tougher corporate targets. The difference gives hybrids an extra edge vs. diesel, over and above any disparity in purchaser tax credits. It would likely limit the choices available to consumers, given the high costs of developing additional models with drastically different powertrains.

Prolonged reliance on the outdated 55/45 split could affect actual GHG emissions, as well. A study by the Energy Information Agency earlier this year indicated that the lifecycle emissions of diesel vehicles are typically 15% less than for comparable gasoline-powered vehicles. When fueled with blends containing 20% biodiesel they emit levels of CO2 per mile similar to gasoline hybrids or plug-in hybrids recharged using grid-average power in much of the US. That's a surprising result for a technology option that generally costs somewhat less than hybridization and many thousands of dollars less per car than a plug-in with its expensive batteries.

I don't know whether US consumers would ever warm up to diesels to the extent that Europeans have. But given their attractive fuel economy and emissions benefits, they shouldn't be impeded from trying, merely because of an accounting ratio that was set when I was driving my first car. Nor do I buy the argument that diesels are a dead end, compared to electric vehicles. Interpolating from the EIA data cited above, diesel cars running on advanced biofuel derived from sources that don't compete with food crops or result in deforestation appear no less sustainable than a plug-in hybrid backed by California's low-emission power grid. When the time comes for me to buy my next car, I hope to see a wider array of clean diesel options, including some from GM and Ford, which make wonderful diesel cars in Europe.

Cheap Oil

When the US invaded Ba'athist Iraq, many ascribed that action to a desire to seize the country's vast oil reserves and develop them on terms favorable to us, presumably to keep the days of cheap oil rolling on. After six years of oil prices far above their pre-war level, the last vestiges of that theory should be laid to rest by a careful reading of today's headlines concerning the announced production deal between the Iraqi government and ExxonMobil and Shell. The terms looks anything but lucrative for the Supermajors, which have won the opportunity to revamp output at one of Iraq's largest mature oil fields, West Qurna. However paltry the returns might look for the firms involved, this development could have a bigger impact on oil price--and sooner--than some of the splashier recent announcements concerning big oil finds off Brazil and West Africa.

The reported terms of the deal struck by Exxon and Shell in Iraq continue the trend of allowing access only on the basis of working as contractors, rather than as partners with an ownership interest in the underlying resource via a typical production-sharing contract. According to the story in today's Wall St. Journal, the companies will receive just $1.90 per barrel for their efforts to boost the flagging output of the super-giant West Qurna field, the output of which could increase by more than the current oil production of Texas (including the Gulf of Mexico.) Moreover, because the project entails virtually no exploration risk--the reserves are well-established--and minimal technical risk, and is already connected to infrastructure, the only real limitation on how fast it could begin ramping up is the local security environment and the ability of the firms to line up equipment and workers. This will still require several years, but it should happen a lot quicker than the time required to develop a new field with tricky geology in deep water.

So what does this mean? Well, for ExxonMobil and Shell it offers a relatively quick boost in production and revenue. $1.90/bbl is skimpy compared to what companies can make on their own discoveries, but over volumes this large it could translate into an extra $700 million of annual cash flow for the next 20 years. As attractive as that sounds, though, it comes without the ability to book new reserves, which are so critical to the valuations of oil companies.

The implication for oil prices will depend on many other factors, but the steady growth of Iraq's oil production from the current 2.5 million bbl/day to a level commensurate with the country's reported 115 billion bbls of reserves could at least compensate for some large declines elsewhere and help maintain a reasonable cushion of spare production capacity as the global economy gets back on track. This hardly bodes a return to $20 oil prices--an eventuality that would be much less welcome in the carbon-constrained world we're entering than just a few years ago--but it could buy us enough time for fuel efficiency and vehicle electrification to match Peak Demand to an inevitable peak in global production.

"Carbon Debt"

A new term has entered our lexicon without much fanfare, but that is about to change. When the Conference of the Parties to the UN Framework Convention on Climate Change (UNFCCC) meets next month in Copenhagen, we will hear a lot more about "carbon debt" and the obligation that developing countries believe the developed world owes them for having used the atmosphere as a sink for CO2 and other gases since the Industrial Revolution. From my perspective, this approach looks counterproductive and risks scuttling the principal process for coordinating the actions of independent nations in addressing the most global of problems. The issues of international and inter-generational environmental equity raised by the accumulation of greenhouse gases (GHGs) are serious and complex, but framing them in this way will make it much harder to find acceptable middle ground, unless the delegations show restraint and common sense about how far to reach back into history to assess blame for a warming earth.

It was always going to be tricky reconciling the competing interests of the developed and developing worlds sufficiently to craft a new global climate agreement to replace the expiring Kyoto Protocol. In addition to large differences in per-capita wealth and income, many of the main players fall into one of two key categories: countries with large historical and current emissions of GHGs that are now moderating or even decreasing, and countries with relatively much smaller historical emissions but large and/or rapidly-growing current emissions. The nature of the cumulative climate impact of these GHGs makes that distinction a crucial one and the source of much rancorous debate. I've been thinking about the resulting issues of equity for some time, but I am extremely concerned by the turn that I see the negotiating process that started in Bali two years ago having taken.

The UNFCC doesn't make it easy to follow what's going on. Of all things it took a visit to a climate change skeptic's website to track down a reasonably current version of the negotiating draft that is being prepared for consideration in Copenhagen. That enabled me to locate the document on the UN site once I had its file name. Having scanned through it for references to carbon debt, I can see why they might have wanted to make it hard to find, since the principles embodied there are bound to strike most Americans as at least counter-intuitive. For starters, the notion of carbon debt is introduced early in the draft as a "guiding principle of the Convention", and described as, "historical responsibilities in greenhouse gas emissions and the related historical ecological debt generated by the cumulative greenhouse gas emissions since 1750 and the most recent scientific information." That word "debt" crops up many times in the document, with repeated references to the "emissions debt", "historical climate debt" and "adaptation debt" that developed countries "owe" to developing ones.

Lest you think that this is merely intended as an abstraction governing philosophical discussions of equity, the document makes it abundantly clear that this is about money and who shall pay whom. One of several examples in the text puts this in admirably concrete terms:

"Developed country Parties shall provide financial resources and transfer technology to developing country Parties to make full and effective repayment of climate debt, including adaptation debt, taking responsibility for their historical cumulative emissions and current high per capita emissions."

Unfortunately, as I noted in a lengthy posting on this topic a year-and-a-half ago, matters aren't nearly as clear-cut as this wording suggests. While the consequences of many decades' worth of emissions of CO2 and other long-lived GHGs certainly appear to be putting an unfair burden on developing countries, it would be equally unfair to the citizens of developed countries to tax them for emissions that occurred before the scientific consensus on global warming emerged in the last couple of decades. Arrhenius may have worked out that CO2 could warm the planet a century ago, but the relative importance of that effect amidst the many complex factors influencing the climate was anything but obvious then, and it is still not fully understood. It makes no more sense to burden modern Europeans and Americans for the emissions of our parents, grandparents, and great-to-the-nth grandparents going back 10 generations than it does to tax modern Chinese, Indians and Brazilians for the entire edifice of Western technology that has enabled their present and future development.

We are all in this together, and the only emissions we have control over are those that occur from here on out. Having said that, it's clear that without some recognition that developing countries didn't create this problem--no matter how much they might be contributing to it now--there will be no deal in Copenhagen. The only viable middle ground I see, if not from the standpoint of the inter-governmental delegations, then for the citizenry they represent, would be to recognize the disparities in historical emissions but impose an effective statute of limitations on them. No emissions prior to the establishment of the Framework Convention on Climate Change at the Second Earth Summit at Rio de Janeiro in 1992 should be counted for purposes of allocating emission targets or financial assistance. While such a compromise would greatly diminish the imputed carbon debt of the developed world and allocate a bigger portion of it to large developing countries like China and Indonesia--particularly when changes in forestry and land-use are factored in--it would hardly let the rich world off the hook. The countries of the OECD have collectively emitted on the order of 200 billion tons of CO2-equivalent GHGs since then--roughly half the world's total emissions in that interval.

It would be tragic if the Copenhagen climate conference could only arrive at a new global agreement on emissions by relying on a principle that American voters would ultimately find as unacceptable as the allocation of national emission-reduction targets in the Kyoto Protocol. It is challenging enough for our elected representatives to attempt to match federal tax revenues to our existing obligations, foreign and domestic. I can't imagine any President or Congress wanting to explain to the electorate--particularly with so many of them already exercised over growing deficits and the current tax burden--why they must pay higher taxes to send carbon-debt payments to some of the same countries that are competing for our jobs and industries, on the basis that previous generations of Americans put more CO2 into the atmosphere than past generations of Chinese, Indians and Brazilians. That sounds like political suicide to me.

A Clunkers Look-back

Somehow I missed last week's minor tempest concerning this summer's Cash for Clunkers program (CFC.) It apparently started when auto industry publisher Edmunds, Inc. issued a report indicating that the effective cost to the government of the incremental sales stimulated by the program averaged roughly $24,000, rather than the $4,000 or so per car that participating buyers actually received. That's based on Edmunds' estimate of the sales they conclude would have occurred in the absence of CFC, shrinking its net contribution from 690,000 vehicles to only 125,000. This prompted a snarky response from the White House, questioning not only Edmunds' analysis but also their motives and basic competence, leading to a polite-but-firm rejoinder from Edmunds. Having expressed support for the CFC concept and its reported results in previous postings, I can't resist adding my own two cents on this affair.

Let's start with a basic fact: No matter how rigorously Edmunds or the federal government analyzes car sales data for this year, the number of cars that would have been sold during the months in question without the clunkers program is inherently unknowable, just as it is inherently unknowable how many jobs have been "saved" to date by the total stimulus program, of which CFC was only one small, belated aspect. This dispute hinges on differences of opinion and underlying assumptions, and the statistical projections of both sides must be taken with a grain of salt. However, any notion that it is somehow out of bounds to look back on the outcomes of such a program to assess its effectiveness should be rejected forcefully. Project look-backs, or post-completion reviews, are among the best tools that corporations have to learn from mistakes and improve future performance. These techniques are no less appropriate in the public sphere, particularly when the government is undertaking so many initiatives that would ordinarily be left to the private sector.

It's important to frame any look-back analysis with a clear understanding of what the project in question was intended to achieve. In this case, CFC was meant to boost car sales and consumer confidence at a time when both were at extraordinarily low levels. It was also aimed at improving the fuel economy of the US car fleet by retiring some of the least-efficient vehicles on the road. Judging it on the cost-effectiveness of the incremental sales it generated reflects a subtle but significant distinction in interpreting those goals, though as a taxpayer I'm certainly interested in knowing how CFC measured up against that criterion. Still, on the basic question of increasing sales, even the data presented by Edmunds are unambiguous.

Looking at the monthly car sales figures included in Edmunds' report, it is clear that US new-car sales jumped from a depressed annual rate of around 10 million units pre-Clunkers--a level too low to sustain the North American car manufacturing capacity now in place--to over 14 million, approaching the typical pre-recession sales for the industry. After the program ended, sales fell back to around the 10 million mark. Although CFC hardly restored the industry to good health, it provided the expected temporary boost in sales at a time when the recent bankruptcy filings of GM and Chrysler had raised new uncertainties for consumers. The fuel economy uplift on the average transaction was also significant, though as I mentioned at the time this amounted to a very small change in the overall fuel economy of a vehicle fleet numbering around 240 million cars and light trucks. So while CFC in retrospect looks to have been a very expensive way to help the industry sell more cars, its performance against the metrics most relevant to its conception stacks up pretty much as advertised.

The larger question raised by the Edmunds analysis concerns the degree to which the government can compensate for weak economic conditions in the private sector, and how expensive the incremental contribution of such efforts can prove, compared to the natural recuperative powers of the economy. Their assessment might also have implications for how we should evaluate the ongoing incentives for advanced technology vehicles. In that light, I have to wonder how much of the heat generated by this episode is instinctive bridling at perceived Monday morning quarterbacking, and how much relates to its potential to undermine the case for a second stimulus that is building in some quarters.

Counting All the Carbon

An editorial in this morning's Wall St. Journal reminded me that I had intended to update my readers on the latest installment in the ongoing saga concerning the global land-use impact of biofuels. The Journal's comments referred to a paper in the latest issue of Science entitled, "Fixing a Critical Climate Accounting Error", which concludes that the manner in which the greenhouse gas impacts of biofuels are currently assessed fails to account for significant emissions that occur outside the envelope normally drawn around an ethanol or biodiesel plant and the farms that supply it with feedstock. And if that omission weren't glaring enough, in the course of preparing for a meeting tomorrow I ran across another instance in which regulators appear to be turning a blind eye to the full impact of another popular option for addressing climate change, electric vehicles. As we prepare to re-orient our entire economy around the restrictions embodied in pending climate legislation, it is essential that we account for all of the emissions involved in a consistent way, and on a scale matching the global environmental problem we're trying to solve. This is crucial to making real progress on reducing emissions, rather than just making us all feel good about what we are doing.

When the emailed table of contents for the October 23 issue of Science showed up in my inbox last Friday, I spotted the name of Timothy Searchinger of Princeton University as lead author of the paper cited by the Journal today. Dr. Searchinger was also the lead author of an earlier paper in Science that I highlighted last February, when the debate concerning the global land-use implications of corn ethanol was just getting underway. Dr. Searchinger's collaborators on the new paper are an impressive bunch, including Dr. Dan Kammen, the director of the Renewable and Appropriate Energy Laboratory at U.C. Berkeley.

The report provides further evidence that it's no longer appropriate to assume that just because the carbon embodied in biofuels such as ethanol originated in green plants that absorbed it from the atmosphere, they must therefore be "carbon neutral"--other than the emissions from fossil fuels used in the cultivation, harvesting and transportation of the crops from which they are produced, along with the energy used in their processing. Additional emissions apparently result from the global displacement of the crops turned into energy here, and in some cases those emissions are on a similar order of magnitude to the direct emissions from the combustion of the biofuels--combustion that has gotten a free pass until now.

This is a highly inconvenient result for those engaged in the production of biofuels from food crops, on two levels. First, it puts the climate change justification for the subsidies and mandates responsible for the rapid ramp-up of conventional biofuel production in question. Second, the source of this doubt is no less than one of the same scientific journals in which so much of the peer-reviewed science contributing to the oft-cited scientific consensus on climate change has appeared, and subject to the same level of scientific scrutiny. Casting doubt on the source of this unwelcome message thus risks casting doubt on the entire edifice upon which the current, much-expanded biofuel endeavor rests.

Let's be clear that I don't blame the biofuel industry for promoting a product that many thought would help, but may ultimately turn out to do little or nothing to reduce the greenhouse gas emissions implicated in climate change, any more than we should blame the producers and consumers of fossil fuels for their contribution to the accumulation of those gases before the current consensus on climate change emerged. (I confess that I regard attempts to portray that consensus as having existed as long as 40 years ago as the worst kind of revisionism, since the creation of the consensus depended not on a few key insights, which might have turned out to be wrong, but on mounting evidence from the steady accumulation of peer-reviewed research during that interval.)

Having said that, I have a much harder time understanding the inclusion of an equally serious--and apparently entirely conscious--omission in the new automotive fuel economy and emissions standards jointly developed by the Environmental Protection Agency and the Department of Transportation. I had occasion to browse through the agencies' proposed text (warning: large file) yesterday and was startled to see that for purposes of calculating carmakers' fleet CO2 emission averages, it assumes that electric vehicles (EVs) and the electric usage of plug-in hybrids (PHEVs) have zero lifecycle emissions. Not only that, but the proposed regulation would count each EV as if it replaced two other emitting cars: thus, zero GHG impact not once but twice. Even the authors admit that this is false, and here I must quote,

"EPA recognizes that for each EV that is sold, in reality the total emissions off-set relative to the typical gasoline or diesel powered vehicle is not zero, as there is a corresponding increase in upstream CO2 emissions due to an increase in the requirements for electric utility generation. However, for the time frame of this proposed rule, EPA is also interested in promoting very advanced technologies such as EVs which offer the future promise of significant reductions in GHG emissions, in particular when coupled with a broader context which would include reductions from the electricity generation. For the California Paley 1 program, California assigned EVs a CO2 performance value of 130 g/mile, which was intended to represent the average CO2 emissions required to charge an EV using representative CO2 values for the California electric utility grid."

But while I appreciate the agencies' rationalization that EVs and PHEVs might be counted as having zero emissions on a purely temporary basis in order to provide incentives for carmakers to accelerate their introduction, I'm also painfully aware that other such "temporary" measures have persisted long after the original justification for them had become obsolete--and here I can't help but think of the ethanol blending credit that is now in its 31st year.

Why do these loopholes in the way we tally greenhouse gas emissions matter enough for me to hammer away at them like this? Consider the proposed vehicle rules. By ignoring emissions that occur outside these vehicles, the government is discouraging carmakers from using less exotic technologies that might actually deliver comparable savings of fuel and emissions sooner, and at a lower cost to taxpayers and consumers. A conventional Toyota Prius hybrid running on gasoline emits only 10% more grams of CO2 per mile than California claims for an EV powered by its greener-than-average state electricity mix. Since the same number of batteries could equip many more Prius-type hybrids, at a much lower cost per car than for a full EV, the benefits of rushing EVs into production seem much less compelling at this point, particularly when the government is also subsidizing the purchasers of EVs and PHEVs to the tune of many thousands of dollars per car. That will amount to billions of dollars of extra subsidies for an incremental emissions benefit that might just be negative for an EV recharged using coal-fired power.

"Start as you mean to go on," goes the old saying. We know that whatever their energy security benefits and general hi-tech niftiness, EVs are not zero-emission vehicles, just as we now understand that it is likely that burning corn ethanol releases roughly the same level of greenhouse gases as the gasoline it is intended to replace. If cap & trade bills such as Waxman-Markey and Kerry-Boxer are to have any integrity as tools for achieving genuine reductions in the global greenhouse gas emissions behind global climate change, then we must count all the emissions from all sources, no matter how politically unpalatable that may be. EPA and DOT might do well to heed this advice, too, before establishing a new, impossible-to-revoke entitlement for the manufacturers of electric vehicles.

Missing the Point on Energy and Jobs

Two emails I received yesterday delivered press releases from two organizations with very different agendas, both emphasizing the impact of energy on jobs. With US unemployment showing little response to the economic stimulus, the rebounding stock market, or the "green shoots" appearing in some sectors, it's understandable that companies, groups and even the government would want to play up the direct employment impact of key initiatives or policies. Yet when it comes to energy, I believe much of this effort misses the mark. Our employment goal for energy should not be to have as many people working in the energy sector as we can, but to have the most efficient and cost-effective energy sector possible, in order to promote job creation and retention in the rest of the economy, where the vast majority of jobs are found. Our decisions about energy policy should not depend on the creation of a few green jobs.

I'm hardly suggesting that energy jobs are insignificant or inconsequential. I've spent my entire career in energy, and I recommend it without hesitation as a field in which one's contributions can have a measurable impact on society, often with better remuneration than in many other pursuits. The Oil & Natural Gas Industry Labor-Management Committee isn't wrong to stand up for the millions of industry-related jobs at stake in the current Congressional debate on energy industry tax benefits, any more than Wind Capital Group is to highlight the 2,500 jobs associated with the supply-chain effects of their Lost Creek Wind Project. But as important as preserving or expanding energy-related jobs appears today, it is even more essential for the long-term interests of the country that we not obsess about this one aspect of energy, to the detriment of others that will affect overall US employment and international competitiveness long after the unemployment rate has returned to its normal range.

Putting this into perspective requires recalling that by its nature energy is a capital-intensive business, rather than a labor-intensive one. One way to gauge that is to look at the labor productivity of energy companies. The latest annual report of my former employer, Chevron, reveals that on average in 2008 its 61,675 employees each accounted for $4.3 million of revenue, resulting in nearly $700,000 of pre-tax net income (after covering their own salaries and all other expenses.) In the utility sector, the comparable figures for FPL Group were $1.1 million and $137,000, respectively. Even a small, rapidly-growing renewable technology firm such as First Solar enjoyed revenue and pre-tax profit per employee in 2008 of approximately $354,000 and $132,000, respectively. With its high labor productivity, the primary employment impact of energy occurs where it is consumed, not where it's produced, because energy is such a crucial input for so many sectors and the sine qua non of more than a few.

When legislation like the Kerry-Boxer climate bill, which includes many provisions that would make energy more expensive for consumers and businesses, is marketed as a jobs bill it merits a skeptical reception. Stimulating jobs in the 6-10% of the economy devoted to energy seems unlikely to compensate for the loss of jobs that would ensue throughout the broader economy, if climate legislation caused energy costs to soar. That may, however, be a necessary evil, and the question we should really be asking is not how many green jobs such legislation will create, but whether on balance its provisions are truly justified in order to address climate change--even if they resulted in a net loss of employment, as I strongly suspect they would. Unless the answer is an unequivocal yes, we could be setting our long-term energy policy on the basis of a metric that is only a minor contributor to either energy costs or total economic activity, for reasons that seem unlikely to stand the test of time.

Sequestration and Education

Yesterday afternoon I began scrutinizing the Senate climate bill, S.1733, widely referred to as the Kerry-Boxer bill. Like the Waxman-Markey bill that the House passed in June, the scope of Kerry-Boxer goes far beyond the establishment of an economy-wide cap & trade system for reducing greenhouse gas emissions, though at a comparatively skimpy 821 pages it has yet to acquire as much baggage as its counterpart accreted on its way to a floor vote. I was struck by the emphasis both bills place on carbon capture and sequestration (CCS), not just as a technology that receives significant support, but as the only viable pathway offered for new coal-fired power generation. However, as I looked through the provisions relating to permitting of sequestration sites and the innocuous-sounding section 812, "Performance Standards for New Coal-Fired Power Plants", I spotted a significant omission. There's nothing here to address what might constitute the largest non-technical barrier to implementing CCS. Public acceptance of it entails a significant educational effort on the efficacy and safety of this new technology. That will require going beyond the details of CCS to provide Americans a primer on basic geology.

The stakes are high. Despite recently losing some market share to natural gas and renewables, coal-fired power plants make up the single largest source of electricity in the US by a wide margin. In the 12 months through July, coal accounted for 46% of US power generation, compared with just 3% for non-hydro renewable energy. Short of simply shutting down every coal-fired power plant and leaving a gaping hole in our national electricity supply that the current generation of renewables can't yet fill, we need to find a way to control the emissions from coal directly. That's where CCS comes in. The coal power performance standards in Waxman-Markey and Kerry-Boxer would require that by no later than 2027 any new coal-fired power plants licensed after 1/1/09 must cut their net CO2 emissions by at least half. CCS looks like the only practical way of doing that--if you can call something that has been deployed so sparingly practical. But how can CCS be implemented if the public isn't willing to have CO2 stored underground anywhere?

CCS is new, but it's not so new that it hasn't already attracted pushback. Earlier this year Shell encountered significant opposition to injecting CO2 into a depleted gas field in the Netherlands. Meanwhile Vatenfall's project at Schwarze Pumpe in Germany is apparently venting its captured CO2 to the atmosphere, because the firm can't get a permit to inject it. "Not in My Ground", is how another article described opposition to carbon sequestration at an Ohio ethanol plant. My Google search even turned up a blog entitled, "Citizens Against CO2 Sequestration." Aside from the technical challenges associated with separating, transporting and injecting CO2 into geological storage sites, do these opponents have a scientific basis for being concerned about the health and safety risks? Perhaps, though an article on the subject cited by the Citizens Against blog that refers to the health hazards of drinking water mixed with CO2 had me rolling my eyes. Perhaps the author was unaware that hundreds of millions of us do that every day; we call it soda pop, and it's a big business.

Rather than dismissing all this as a simple case of uninformed NIMBYism (or as the Guardian newspaper in the UK referred to it, "numbyism", as in not under my back yard) I suspect it reflects a fundamental gap in the public's understanding of what lies beneath its feet. I simply cannot count the number of people I've encountered in the course of my long career in energy who were under the impression that oil was found as pools in giant underground caverns, rather than contained within tiny pores in solid rock strata. If most people so badly misunderstand the geological basis of a technology as established and commonplace as oil & gas drilling, how on earth can we expect them to have a coherent picture of what happens to CO2 when we pump it underground? Of course they're going to fear it could all come right back out and possibly asphyxiate them, in the manner of the volcanic CO2 seepage at Lake Nyos in Cameroon and elsewhere.

From my own perspective, the existence of enormous natural gas reservoirs--confusing terminology, perhaps--constitutes a sufficient proof of concept by demonstrating that gases can be stored safely underground for intervals as long as millions of years. If impermeable cap rock can seal in billions or trillions of cubic feet of methane, the molecular diameter of which is smaller than that of CO2, then once the CO2 is down there, the vast majority of it is going to stay there. But just as telling people that a flu vaccine is safe apparently leaves large numbers of them unconvinced, I conclude we need to invest a fair amount of time, attention and resources into educating the public about the science and safety of injecting CO2 under the ground, before we can base our national energy strategy on this technique.

The Weak Dollar

Oil prices have trended upward recently, spurring renewed speculation that only speculation could account for such a shift in the face of relatively weak fundamentals of supply and demand. It's certainly true that inventories of crude oil and refined products remain high, while demand is still well below the levels of just a couple of years ago, and OPEC is sitting on millions of barrels per day of spare capacity that could be deployed quickly if consumption spiked. But although it can't account for 100% of recent price movements, one factor stands out for its contribution to oil's lurch towards $80 per barrel after months of stability around $70: the further weakening of the US dollar relative to the Euro and other strong currencies. The future path of the dollar will be determined by a complex set of factors, including the relationship between US and other nations' interest rates, trade balances, current inflation, and expectations of future inflation. However, it's worth noting that the dollar's recent deterioration is hardly anomalous; it is part of pattern going back decades.

The above chart displays the price of West Texas Intermediate crude oil on the New York Mercantile Exchange since the beginning of August. I've added another line showing the same price in Euros, based on exchange rate data for the period. It's pretty clear that although oil priced in Euros has also been trending upward slightly, perhaps in response to reports that the global demand for other commodities is picking up--indicating that at least some parts of the world are recovering from the Great Recession--the recent upswing in oil prices looks much more muted than when expressed in dollars per barrel. That got me thinking about the long-term exchange rate trends, and where they might take us in the years ahead.

Having lived overseas and traveled extensively, I've been aware of exchange rates for most of my life. That's given me a clear perspective that the dollar isn't just weaker now than it was a few months ago or a couple of years ago, but has been deteriorating more-or-less steadily for a very long time. From my childhood I can recall when a dollar was worth roughly four Deutschmarks, and even my father's salary as a junior Army officer went pretty far on the local economy. As an adult I worked in Germany for a few months in the early 1980s, when a buck still bought more than 2 Marks. With the Deutschmark having been subsumed into the Euro, with its extremely short and volatile history, it's easy to lose sight of the dollar's gradual slippage, which has resulted in an equivalent Deutschmark/Dollar rate today of 1.30:1. Fully appreciating this trend requires examining the longer history of exchange rates between the dollar and more stable currencies such as the Deutschmark and the Swiss Franc, which is now trading at virtual parity with the greenback. It's not a pretty picture, and it has significant implications for a country with such large structural import requirements, not just for energy, but for so many other products.

While I'm not advocating a return to the gold standard or even necessarily dismissing the benefits that a weaker dollar has provided at times, I find the long and bumpy, but nevertheless steadily-downward slope of the dollar's value worrisome. Moreover, it's hard to see what could stem this trend in the near term, with the federal government committed out of necessity to holding short-term interest rates at essentially zero to avoid putting the economy back into a tailspin, while other countries still offer positive interest rates and some have even raised them slightly. Nor do trillion-dollar fiscal deficits seem conducive to a stronger dollar any time soon. What would dollar-denominated oil prices do if the dollar continued to fall past $1.50 per Euro toward the 2:1 level, all other things being equal? $100/bbl probably isn't a bad guess, along with everything else that goes with it.

"Feeding Frenzy"

An article in today's New York Times offers more detail on the manner in which Congressional climate legislation has fractured the energy industry into competing groups of haves and have-nots, based on how companies and sectors were treated under the Waxman-Markey bill and their hopes for receiving a better deal in the pending Kerry-Boxer bill in the Senate. Not only has it fragmented utilities along the axis of their emissions intensity, but it has also opened gaps within the oil & gas industry between companies that produce primarily natural gas and those that produce or process mainly oil. I don't know whether the authors of Waxman-Markey saw this potential in their design for allocating emission allowances, though some supporters are bound to see it as a beneficial feature. I regard it as a worrying symptom of the distortions inflicted on the basic concept of cap & trade, which remains the best option for guiding the economy toward a lower-emission future, but now seems likely to underperform its potential in a very costly way, as a result of these flaws.

As recently as a couple of years ago, few energy companies were enthusiastic about the prospect of cap & trade, because it was bound to raise their costs and reduce demand for their output, at least from energy sources with substantial emissions of CO2 and other greenhouse gases. If the bill passed by the House had treated all emissions from all sectors equally--a level playing field--we'd still see visionary companies diverging from the industry's stance, but their numbers would probably be a lot fewer for the simple reason that there wouldn't be nearly as much financial gain in it for them. When no-nonsense companies like Exelon and several of its utility peers break ranks with the US Chamber of Commerce on this issue, it's a good bet that they see a direct strategic advantage that will put money in their shareholders' pockets. Simply put, this is as good a deal as they're going to get. But while I find their support of cap and trade perfectly rational and even laudable, it should by no means be read as a sign that the Waxman-Markey approach is the best means of addressing climate change.

As I've noted in previous postings, Waxman-Markey was excessively generous in handing out emission allowances to the electricity sector, at the expense of the transportation sector. It also lavished allowances on non-emitting sectors and favored causes and groups in lieu of cash--a form of largess that fundamentally undermines the accountability of these benefits, because no one knows or can know what they will be worth when they are eventually received. Yet although this is bad policy on many levels, I see many people holding their noses and supporting the W-M approach, because they conclude that once the free allocations have phased out in 2030, we'll be left with a more or less pure cap & trade system enforcing a steadily tightening cap on emissions. The problems with this thinking lie in the enormous distortions and unnecessary economic hardship those uneven allocations will create over the next 20-plus years and the opportunity cost of the emissions reductions that could have been achieved more quickly and cheaply.

My strong preference has been for an even-handed cap & trade system that would include the broadest possible collection of emissions sources, providing great diversity of abatement costs and thus great scope for emissions trading to minimize the cost of achieving our emission reduction goals, and with most of the proceeds rebated directly from the government to taxpayers. Unfortunately, the ship has sailed on that approach--at least for now--and anyone supporting cap & trade for the elegant simplicity of its mechanism for squeezing out emissions is left hoping that the legislative excesses of one chamber of Congress will cancel out those of the other, and that somehow two bad bills will beget a good one.

Regulating EV Recharging

A feature on the New York Times website tipped me off to a debate that's brewing in California concerning whether and how the state's Public Utilities Commission (PUC) should regulate facilities and firms that will recharge the electric vehicles expected to dot California's roads within a few years. From my own experience in attempting to involve my former employer in the recharging infrastructure for the old GM EV-1 in the late 1990s, I knew this wouldn't be a simple matter, but I had little appreciation for the complexities that have emerged in the last decade. How this gets resolved will have enormous implications for automakers and incumbent utilities, as well as for start-ups such as Better Place that some would like to treat as regulated utilities.

The discussion with the PUC hinges on some very thorny questions: Is a company that buys electricity for resale to consumers for the purpose of recharging electric vehicles--which takes in both battery-electric vehicles and plug-in hybrids--more like a utility or a gasoline distributor or retailer? Who should pay for installing recharging facilities, and how--and from whom--should these parties recover their investment? Should a consumer who already uses large quantities of electricity at home and pays at the top rate tier, which can hit $0.40/kWh in some areas, qualify for discounted power to recharge an EV? How should a customer be billed when recharging outside the service area of the utility from which he normally buys power? The list of such questions is long, and looming behind them are larger questions about how best to gauge the effect of EV recharging on greenhouse gas emissions and air quality concerns, and to manage its impact on the regional generating mix, and on grid stability and reliability. Many EV advocates assume that EVs are inherently grid-stabilizing and renewable power-enabling, though it's not hard to construct scenarios in which the opposite could be equally true, if they're not implemented properly.

The emissions aspect becomes even more interesting in light of the views I saw expressed in a PUC filing by Tesla Motors, Inc., a Silicon Valley manufacturer of high-end electric sports cars that recently qualified for a half-billion dollars in low-interest expansion loans from the federal government. Tesla sees the generation of tradable credits under either cap & trade or the state's Low-Carbon Fuel Standard as a significant source of revenue for the owners of EV recharging facilities, and they might be right, though when I converted the federal estimates of emission allowance values under Waxman-Markey of around $15/ton of CO2 to cents per kilowatt-hour, using California's natural gas-dominated average generating mix, I came up with a value of less than a penny per kWh. I have to wonder how excited utilities will be to take on the cost and risk of putting in EV rechargers for such a small reward, if they can't also make a profit selling power to EV drivers.

The whole notion of regulating resellers of electricity to EVs as utilities also raises serious questions about the alternative business models now under consideration by companies such as Better Place. Would offering EV services on a cents-per-mile basis, rather than cents per kWh, be deemed sufficiently transparent, and would they have to negotiate their profit margins and investment recovery with the PUC? That sounds like a great way to make it harder for anyone new to the scene to compete with traditional utilities in this area.

Fairly soon the California PUC will resolve most of these questions and in the process largely define the environment in which EVs will emerge in the biggest early market for them in the US, potentially setting the standards for their use throughout the US and beyond. I don't have a horse in this race, but I will be watching the outcome with great interest.

The Necessity of "All of the Above"

I've devoted a lot of space in this blog to explaining why we need all of the energy choices currently available to us, including energy efficiency, in order for our economy to have the energy it needs to grow. Although we can't drill our way to energy independence, as some might wish, it's equally clear that the point at which renewable energy sources could enable us to dispense with fossil fuels is still a long ways off. I have no idea how many words I've written in service of this argument, but it's certainly many more than the clichéd 1,000:1 exchange rate vs. the picture that I suddenly realized I've never supplied. Today's posting is a modest attempt to rectify that omission: a simple graph showing how a significant shift in our energy consumption and production patterns might play out between now and 2020.

This picture starts with our total primary energy consumption in 2008 of 99.3 quadrillion BTUs (quads.) Nearly three-fourths of our needs, or 73.7 quads, were produced domestically by a mix of 79% coal, oil and natural gas, 11.5% nuclear power, and a bit over 3% hydropower. Non-hydro renewables--the wind, solar, geothermal and biomass power plus biofuels that constitute the primary focus of US energy policy today--made up the remaining 6.5% of domestic energy production. Now add the 26% of US energy consumption supplied by imports, mainly crude oil and petroleum products, and we have the breakdown shown at the left hand edge of the graph. The rest of the picture is the result of a highly simplified set of assumptions based on phasing out fossil fuels and replacing them with the non-hydro renewables that have been growing so rapidly. It ignores such important considerations as reliability and intermittency, compatibility with infrastructure, and turnover of vehicle fleets.

According to the Energy Information Agency's data, while wind and solar power have been growing at roughly 30% per year each, the total renewables category has been growing at a somewhat slower pace, even after separating out hydropower, which has actually declined significantly since the 1990s. While the average growth rate for all the non-hydro renewables since 2000 has been around 4%, I've more than doubled this for the purposes of my projection to 10%. Renewables would do very well to sustain that kind of pace over the next 11 years, because the bigger they get, the more capital they will require each year to add the next year's increment of growth, and the more hurdles they will face, particularly from NIMBY or "energy sprawl" concerns. 10% compound growth would see these renewables more than triple by 2020, providing plenty of room for biomass/biofuels to double and for wind and solar to double several successive times.

I've also assumed a steady improvement in energy efficiency of 1% per year. If that doesn't sound impressive, compare it against a pre-recession trend of 1% annual growth supporting population growth of around 0.7% and economic growth of 2-3%. 1%/yr. would reduce total energy consumption by almost 12% by 2020, reflecting an improvement in BTUs/$GDP over this interval on the order of around 35%. A recent study by McKinsey & Co. indicated that if the US invested $500 billion in energy efficiency, we could cut our energy consumption by 23% by 2020, so my view is only a little more conservative, reflecting my experience that such things tend to take a bit longer than we expect.

As for nuclear, I think we'll do well to maintain the output of the existing fleet without seeing retirements outweigh additions in this timeframe. Most of the new plants now being discussed would probably only affect the last couple of years of this scenario, in any case.

The biggest impact in the graph above comes from my assumption that domestic fossil fuel production would fall by 5% per year. That will probably seem extreme to some and timid to others. It certainly looks extreme in the context of the recent surge in natural gas production and the stable output of US coal mines. Even US oil production has staged a bit of a comeback recently, thanks to successes in the portions of the Gulf of Mexico where drilling is allowed. However, in the absence of strong sustained rates of oil and gas drilling--drilling that requires both access to resources and a supportive regulatory climate, neither of which appears to be forthcoming--these successes will fade and the high intrinsic decline rates of the mature US hydrocarbon basins would take over. And with new coal-fired power plants being canceled and older ones facing tough competition from gas turbines and renewable power, along with restrictions on practices such as "mountaintop mining" and the prospect of either a Congressionally-mandated or EPA-imposed cap on emissions, a decline in coal output would accompany drops in oil and gas.

All of these growth and decline rates working together produce the picture above, showing fossil fuels tailing off faster than renewables can backfill for some time. That results in net US energy imports growing through 2016, then tapering off gradually as renewables finally gather momentum, but with us arriving at 2020 even less energy independent than we are today. That outcome explains my strong conviction that it is premature for us to give up on the valuable contribution of domestic oil and gas, particularly when we take into account the form that most of those growing energy imports is likely to take: imported oil. Naturally, this is just one scenario among many--though I'd argue it's likelier than some--and it illustrates that no single solution, neither renewables, nor efficiency, nor even greatly expanded drilling, is likely to be capable of delivering the energy we will need without increasing our vulnerability to foreign energy suppliers. They must all work together, if we're to make meaningful progress toward greater energy self-reliance.

Meme Watch: Peak Demand

To whatever degree the oil price spike of 2007-8 was driven by speculation, the latter was riding on a wave of concern about Peak Oil, which anticipates an imminent decline in maximum global oil production. For the moment, the weak global economy has eased such worries, though they have hardly vanished, as I noted two months ago. Lately, however, conventional notions of Peak Oil are increasingly being challenged by a new meme, or contagious idea, called Peak Demand, which suggests that oil consumption is reaching a plateau from which it will soon decline, mitigating the worst consequences of Peak Oil. Neither of these memes would attract much interest if they weren't supported by a welter of statistics, however selective those might seem to their critics. And just as Peak Oil was much less credible and worrisome before we saw super-giant oil fields like Mexico's Cantarell go into precipitous decline, the logic of Peak Demand would have been much less compelling before US oil demand dropped by nearly 6% last year.

Earlier this week, a friend shared a copy of a report from Deutsche Bank Global Markets Research describing their view of the future oil market shaped by coinciding--and related--peaks in global oil supply and demand. Unfortunately, the report doesn't seem to be available on DB's public website, though it was recently summarized on the Wall St. Journal's Environmental Capital blog. While I spotted several possible weak points in their analysis, they make a strong case that the combination of improved efficiency and the electrification of vehicles will result in the global demand for oil stalling and eventually falling, roughly around the same time many analysts expect global oil supplies to peak.

Perhaps I was predisposed to accept this logic. My presentation on the Alternative Energy panel of the recent IHS Herold Pacesetters Energy Conference included a graph highlighting the ongoing compression of US petroleum gasoline demand between falling motor fuel consumption and rising biofuels supplies, a topic that was subsequently reported in the Journal's "Heard on the Street" column. At that same conference I also heard the Managing Director of CERA's Global Oil Group describe his firm's rigorously researched view of an impending peak in global oil demand. Peak Demand can't easily be dismissed as a "fringe" theory, because it is based on a combination of hard data and thoughtful analysis and forecasting.

My purpose in mentioning Peak Demand now isn't to debate its merits in depth; that's a matter for another day. Rather, on the basis of my conviction that there's at least a reasonable case for such an outcome, I thought I'd spend a moment musing on the consequences of the proliferation of this meme in the marketplace of ideas related to energy. After all, the Peak Demand meme challenges two key pieces of conventional wisdom about oil, one or both of which are central to the rate at which Peak Oil (supply) might be approaching. First, it undermines the notion that once the US economy finds its way back to meaningful growth, oil demand will resume its former trajectory, which had seen gasoline demand growing by 1-2% per year and diesel demand growing at an even faster pace. With a major new emphasis on miles per gallon and the demise of the SUV fad, the fuel economy of the total US car fleet doesn't need to improve by very much each year to outpace our underlying population growth and a modest resurgence in vehicle miles traveled. Secondly, the same dynamic might even hold true for large developing markets, if electric vehicle demand grew rapidly enough, undermining the notion that whatever happens in the US and EU, oil demand from China and India constitute an unstoppable juggernaut.

With spare global oil production capacity effectively used up by 2007, the logic of Peak Oil helped to provide the narrative support for an oil market that ran up from the low $50s to $145 per barrel in the course of 18 months. How different might a future oil price spike be, if instead of a widely-shared view that oil was on the verge of becoming truly scarce--rather than merely expensive--there were an equally widely-held expectation that in the long run that scarcity might become irrelevant as a result of the demand for the commodity gradually unwinding of its own accord? Such dueling memes, together with painful memories of oil's collapse down to $33 last winter, might give some traders pause, before again buying into the notion that $100 oil would soon give way to $200, $300, or $500 per barrel.

Setting Ethanol Free

The Government Accountability Office (GAO) recently issued its report assessing the impact of the production and use of biofuels in the US. Among its recommendations was a call for the Congress to reassess whether corn ethanol still needs the support of a $0.45 per gallon blenders' credit, when its use by refiners and gasoline blenders is now mandated under the federal Renewable Fuel Standard (RFS) that was set by the Energy Independence and Security Act of 2007 (EISA). As you might imagine, this has set the cat among the pigeons and prompted a terse and dismissive response from the Renewable Fuels Association, the trade group representing the US ethanol industry. Along with several points that I interpret as making at least as good a case for dropping the subsidy as keeping it, their main defense boils down to a combination of historical precedent and envy of the industry that is its primary customer. Neither justification stands up to scrutiny.

Consider the historical argument first. There's no doubt that without the subsidies provided by the federal government and various states over the last thirty-plus years, the ethanol industry would not have grown to a sufficient scale to take on the new challenge set for it by Congress in the EISA. From the landmark establishment of a $0.40/gal. excise tax exemption for ethanol blended into gasoline under the Energy Tax Act of 1978, it took the industry 14 years to grow to the 1 billion-gallon-per-year (BGY) mark (equivalent to 43,000 barrels per day of gasoline) and another decade to reach 2 BGY. When EISA was passed at the end of 2007, the industry was already producing around 6 BGY and had built enough capacity to produce nearly 8 BGY, or around 5.5% of US gasoline demand that year, by volume. That was already more than the 7.5 BGY required under the previous RFS established by the Energy Policy Act of 2005. But as ambitious as the goals of the newly-enacted RFS seemed in 2007, the industry continued building capacity at a rapid pace, and by the start of this year had enough ethanol plants built or under construction to satisfy 97% of the 15 billion gallon target (and ceiling) that Congress set for corn ethanol.

Two things seem clear from this history: First, the combination of a generous blenders' credit, which until the start of this year paid $0.51/gal., and two successive federal biofuel standards led to over-expansion of the ethanol industry relative to demand, either mandated or economic. That harmed the industry and led to many ethanol plants being sold or mothballed in the last year, with a number of ethanol companies going bankrupt, including VeraSun, which had been an industry leader not long before its demise. Other important factors certainly contributed to these business failures, including the spike in corn and oil prices in 2007 and 2008 and the sudden collapse of the latter last fall; however, the over-extension of these companies as they went deeper and deeper into debt to build new capacity left them particularly vulnerable to volatile commodity markets and the emerging credit crisis.

In addition, the above figures make it very plain that the US corn ethanol industry doesn't need to grow further, because it is already within striking distance of the target set by the government, which also appears to represent the maximum prudent level of output for a fuel source that makes such heavy use of water and fossil energy sources in its production, and that ultimately competes with the consumption of corn as food or feed, here and abroad. In other words, the work of the subsidies and mandates for corn ethanol is complete, and the government has shifted its focus to cellulosic ethanol and other advanced biofuels, which enjoy their own distinct--and more generous--subsidies. It hopes these sources will expand from essentially zero to cover the remaining 21 BGY of the current RFS by 2022.

The argument that corn ethanol is somehow entitled to perpetual subsidies on the basis of an inaccurate comparison to the tax benefits currently enjoyed by the oil & gas industry--tax benefits that are currently under threat, themselves--is equally unpersuasive. In the posting in which I recently examined the Treasury Department's arguments for dismantling those oil & gas tax benefits, I compared the level of incentives for conventional fuels with those provided to ethanol. That $0.45/gal. ethanol blenders' credit swells to the equivalent of about $0.77/gal. after accounting for the lower energy content of ethanol. That compares to incentives of around $0.12/gal. for US oil production. And that doesn't even take into consideration the fact that producing a gallon of ethanol requires much more energy from other sources, such as natural gas, than producing a gallon of crude oil or gasoline. Thus ethanol receives at least six times the subsidy per delivered BTU that domestic oil does, even though their energy security benefits per gallon are identical.

The GAO report estimates the cost to the Treasury of the ethanol blenders' credit at $4 billion last year, growing to $6.75 billion by 2015, if not sooner. Although at a time of trillion-dollar deficits that may look no more significant than a rounding error in the government's books, continuing this outdated and unnecessary incentive sends a bad message to the developers of other, less mature alternative energy sources. It tells them that they don't need to worry so much about making their technologies competitive with conventional energy, because the government is likely to subsidize them until the end of time--or until the Treasury runs out of money, a date that will surely arrive faster, the more unnecessary subsidies it hands out. After having been extended by last year's Farm Bill, the present Volumetric Ethanol Excise Tax Credit and the tariff on imported ethanol that mirrors it are due to expire at the end of next year. After 30 years of assistance--spanning my entire career in energy--it's time to find out whether this industry can survive and compete on its own.

Gasoline Stimulus Update

Although it doesn't appear among the statistics that economists and market participants routinely track to assess our recovery from what some have been calling the Great Recession, a quick check on the status of the "gasoline stimulus" I described in June seems in order. Year-to-date, the retail price of regular gasoline has averaged $1.31/gallon below its price in the same week of 2008, leaving the typical American household with roughly an extra $110 per month of disposable income to spend on other goods and services, compared with last year. However, barring another dramatic collapse of crude oil prices from their present level of just under $70/barrel, that benefit should disappear within the next few weeks. Last October gas prices fell by more than a buck a gallon and began November 2008 below their current level. Once these lines cross over, any stimulus benefit from cheaper gas will be erased, with uncertain consequences in an economy in which unemployment is still rising.

The fact that average US gas prices topped out at only $2.69/gal. this year, far below last year's peak of $4.11/gal., was mainly a reflection of the weakness of the global economy. US gasoline demand through July was running at around 1% below the same period a year earlier, on top of 2008's roughly 3% drop. Together with very weak diesel demand, that also contributed to much lower refining margins this year, compared to the last couple years. However, even if refining margins averaged zero for the rest of this year, it would take a crude oil price drop on the order of $15/bbl to send gasoline prices below $2/gal., where they were last Thanksgiving. And we'd probably have to see oil down around $40/bbl to end the year close to the $1.61/gal. reported last December 29.

As I noted early in the year, although this gasoline stimulus was helpful while the federal stimulus effort was gearing up, it was always going to be short-lived. And just like the fiscal stimulus, we'll never know how many jobs it saved or helped create, though it's clear that we'd have been much worse off had this year's gas prices reprised their 2008 levels.

No Good Choices

I find myself in a foul mood concerning climate change, after a week that has seen US choices for managing our greenhouse gas emissions narrow to a trio of unappealing options. The long-awaited draft of a Senate bill on climate change issued by the Environment and Pubic Works Committee turned out to mirror most of the bad features of the distorted Waxman-Markey bill narrowly passed by the House in June. Adding insult to injury was the announcement by the Administrator of the EPA that her agency was preparing to regulate the greenhouse gases from large emitters--power plants, refineries, and other industrial facilities--as point-sources under the Clean Air Act as soon as next year. This leaves us with three poor choices: 1) a cap & trade system harnessed to the yoke of Congressional patronage and pork, 2) command-and-control regulations likely to extract emissions reductions from the highest-cost sources and thus having the most adverse impact on the economy, and 3) a status quo that will likely result in our emissions resuming their steady climb, once the economy recovers.

With regard to the Kerry-Boxer bill, designated as the "Clean Energy Jobs and American Power Act"--no catchy "ACES" acronym there--I haven't had time to wade through its 801 pages, so I'll keep my comments brief. Contrary to the conclusion reached by the editors of the Washington Post, the bill does include a cap & trade mechanism for greenhouse gas emissions, though I can understand why they might not have looked for it under the obscure rubric of "Pollution Reduction and Investment Program". From my quick scan of that section, it strongly resembles the cap & trade aspects of Waxman-Markey, with the crucial difference that the allocation of emission allowances among various sectors has been left to other Senate committees to fill in. The only allocation clearly specified is that 25% of allowances should be auctioned, with the proceeds to go toward deficit reduction. As laudable as that sounds, I would merely note that every dollar raised by cap & trade that is not returned to taxpayers constitutes a new tax by another name and should be counted in the total tax burden on the productive economy.

Now let's turn to the EPA announcement, which has me even more concerned. Last week I received an emailed article from the Institute for Policy Integrity at NYU suggesting that under the Clean Air Act the EPA could create its own cap & trade system for greenhouse gases without requiring additional authorizing legislation. That briefly buoyed my hopes for a more pristine version of cap & trade, without the unseemly scramble to siphon off its proceeds to fund every pet project and cause of every Member or Senator whose vote was needed to pass the thing. Then I read Administrator Jackson's remarks describing the approach she has in mind, and I knew the EPA was applying its old pollution-abatement mentality to climate change, facilitiated by a Supreme Court ruling that unhelpfully labeled CO2 and other GHGs as pollutants. The new rule would impose New Source Review criteria on the greenhouse emissions from power plants, refineries and factories when they expand or modernize, and it parallels the Best Available Control Technology requirement that is at least logical for local air pollutants like SOx and NOx that result from fuel impurities and combustion byproducts, but that makes little sense when dealing with the results of the primary chemical reaction of combustion: C + O2 --> CO2.

With all due respect to Administrator Jackson, a fellow chemical engineer who I'm sure understands the technical side of this issue as well as I do, her remarks betray a deep misunderstanding of the economic consequences of regulating carbon this way. The key phrase in her comments, which focused on minimizing the impact on the small businesses she seeks to exclude from this ruling was, "...all without placing an undue burden on the businesses that make up the better part of our economy," as if that "better part" didn't consume the electricity, fuels and raw materials produced by the part she proposes to regulate--presumably the "worst part" of our economy. The reality is that the costs imposed on large emitters will inevitably fall on those same small businesses when they pay their utility bills, buy fuel and other inputs, and when they seek to sell to consumers and other businesses equally burdened by these new, higher energy costs.

There is simply no getting around the fact that regulating greenhouse gas emissions, which amounts to charging a fee for something that has been free since the discovery of fire, is going to impose a burden on the entire economy. The principle behind cap & trade is the effort to make that burden as small as possible, by encouraging those parties with the lowest costs of emissions abatement to make the biggest cuts. Industrial emissions reductions are inherently more expensive than those in many other sectors, and we need a solution that unleashes the cheapest CO2 cuts, instead of forcing the most expensive ones to be done first.

I haven't given up entirely on the hope that the final outcome from the Senate might restore some sanity to the cap & trade provisions that Messrs. Waxman and Markey so deftly used to co-opt the biggest emitters into supporters, as we've seen with the recent fracturing of the US Chamber of Commerce on this issue. Utilities like Exelon, PG&E, and PNM Resources must realize that they are unlikely to get a better deal on emissions than under Waxman-Markey, and I don't blame them for advancing their interests. But that doesn't make this the best solution for the economy, or more importantly the best way to go about reducing the emissions responsible for humanity's contribution to climate change. And if the White House needs the threat of new EPA rules to have at least one flag to wave at the global climate conference in Copenhagen in December, in case the Congress fails to pass a Waxman-Markey/Kerry-Boxer hybrid by then, I understand that, too. However, that doesn't justify actually implementing those regulations and making the task of reducing our emissions harder and more costly.

Resolving Iran Oil-Price Risk

It hasn't been easy keeping up with all the recent developments related to Iran's nuclear program, which still looms as a large, unresolved risk embedded in the global price of oil--though you would never know it from the behavior of oil markets in the week since Iran's hidden nuclear enrichment site was revealed. It's not clear whether traders have concluded that the exposure of the Qom site strengthens the hand of the US, Britain, France and Germany sufficiently to make a diplomatic solution likelier--and conflict correspondingly less likely--or the impact of this story has been overwhelmed for the moment by weak market fundamentals. After all, this is merely the latest phase of a crisis that has been simmering for a number of years; a wait-and-see attitude looks prudent, particularly in light of the market's current capacity to adjust for the temporary loss of Iran's oil output, should that ensue. However, I believe that we are also approaching the point at which much of this uncertainty resolves, because fairly soon the US and its allies must choose either to act decisively to prevent Iran from acquiring nuclear arms, or relinquish those options and focus on containing the threat.

Our relative torpor on the subject of Iran's nuclear enrichment program and that country's ultimate nuclear ambitions has been jolted by a succession of events this month. First, President Obama announced his intention to abandon the development of land-based anti-ballistic-missile sites in Central Europe, the main purpose of which was to intercept Iranian ICBMs on their way to targets in Europe or the US, in favor of a sea-borne strategy focused on shorter-range missiles. Then came the announcement at the G-20 meeting in Pittsburgh that Iran was building a secret uranium enrichment site that could start operations as soon as next year, potentially capable of producing roughly one atomic bomb's worth of weapons-grade material a year. Neither the fact that the US and its allies have apparently known about the Qom site for several years nor the last-minute disclosure of the facility by Iran to the International Atomic Energy Agency seemed to dampen the shock effect of the announcement. After customarily glib excuses, the Iranian regime's next step was to test-fire short- and medium-range missiles. The US has demanded immediate inspections of the new facility, and the UN Security Council meets tomorrow to take up these matters.

So where does this leave us, other than with nerve-wracking reminders of the pre-war situation with Iraq? If we've been paying attention, the latest revelation shouldn't have come as much of a surprise. As I explained at length in 2005, the arguments that Iran's enrichment efforts were aimed at anything other than a nuclear weapons capability were always pretty weak. Stripping away the diplomatic language of the US and its allies and the lame obfuscations from Tehran, the uncovered Qom facility leaves scant room for doubt concerning the determination of the Iranian government to militarize its nuclear program. Whether or not it is also currently developing warheads that would use the uranium enriched at sites like the one at Qom, there is no other plausible reason for building a nuclear facility in secret under a military base. And common sense tells us that, as with mice, where there is one there are very likely others.

What I conclude from all this is that we are approaching a set of distinct decision points, after a long and intricate dance that probably served the interests of both parties. The passage of time has allowed Iran to make steady progress on enrichment and missile technology, but it has also opened up options for us. As I noted last fall, lower oil prices have created a window for a set of actions--truly crippling sanctions, a naval blockade, or air attack on the facilities in question--that would have been unthinkable when oil was marching steadily toward $100/bbl and beyond. That window will begin to close once the global economy resumes growing rapidly enough to erode the healthy cushion of spare global oil production capacity that now stands at 5.5 million barrels per day--a buffer that would also erode from the other direction if new oil projects fail to keep up with oil's intrinsic decline rates. In other words, if the situation isn't resolved one way or another within the next year or so, the strategy of containment of a nuclear-armed Iran in a new kind of Cold War could become the only viable option left to us.