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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Happy Presidents' Day!
No posting today.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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