Second Chance for Cold Fusion?
Fifteen years ago a pair of scientists from Utah conducted the classic demonstration of how not to announce a scientific breakthrough. Cold fusion, after a few moments of startling promise, looked like another in a long line of impossible energy devices. But MIT's Technology Review now reports that physicists are taking another look at it, and the Department of Energy is considering exploring it further.

Cold fusion is only one avenue that might deliver an energy surprise. Researchers and inventors with varying amounts of scientific training are pursuing a wide array of exotic energy technologies. Zero point energy is another contender, based on a quirk of physics called the Casimir Effect. Most of these ideas have in common the potential for essentially limitless clean energy. For more information on a variety of "wild card" issues, including energy wild cards, take a look at the Arlington Institute.

I approach such things as a skeptic. In physics, as in most of life, there's no free lunch, and many of these ideas appear to require one, in order to work. Having said that, though, I also absorbed enough history of science along the way in engineering school to appreciate how much of it was discovered by people who were regarded as crackpots before they started generating reproducible results.

I find area of wild card energy intriguing, because if enough people are pursuing enough different paths, the odds of one of them eventually discovering something useful improve. Even a tiny chance of that seems worth a bit of society's time and money. With a cheap, plentiful and clean source of primary energy, an awful lot of other things that look impractical today would make sense, such as a quick transition to a hydrogen economy and a large-scale attack on climate change. Don't hold your breath, and don't sell your oil company stock, but it is certainly entertaining to think about the possibilities, occasionally.

Does Size Matter for Oil Companies?
This question has vexed the industry for years, though the equity markets have clearly cast their vote in the affirmative. Most of the mega-mergers in the industry were greeted favorably by the markets, particularly ExxonMobil and BP-Amoco-Arco-Castrol (now just BP, Beyond Petroleum). But the recent problems at Shell have focused attention on some of the challenges brought about by operating at this scale, as highlighted in this provocative article in the Financial Times.

One of the biggest concerns is over the ability of the so-called Supermajors to replace their oil reserves economically, to underpin production and revenue growth into the future. Every year, these enterprises need to replace the enormous quantities of oil they produce, amounting to 1.5 billion equivalent barrels of oil and natural gas for Exxon alone. But in principle these mammoth companies have at least as many resources as their pre-merger predecessors, in terms of the capital budgets and technical staffs required to find this oil. So on the surface, size should be neutral in this calculation. However, I think size plays a negative role in two important ways.

First and most directly, much of the initial financial benefit of these mergers has come through staff reductions. (Full disclosure: I left Texaco immediately after its merger with Chevron.) Although these reductions are intended to come from overlapping headquarters and support staffs, some technical staff invariably leave for personal reasons including undesirable relocation, diminished promotion opportunities, and lucrative separation packages.

As a result, these mergers invariably trim vital capabilities, along with the intended overlaps. In a shrinking industry, separated workers often find employment in other industries, leaving fewer highly-skilled technical personnel to chase the next oil discoveries. While some of this attrition may be offset by new graduates and improved technology, including information technology, I'm skeptical that you can really replace the value of a 20 or 30 year veteran geoscientist or petroleum engineer this way.

The second problem is a direct result of the size of the merged companies' asset portfolios. These are so large that the threshold of what is material to them changes. If they can only work on x new opportunities a year, then they must be the largest x opportunities. But as the FT article reminds us, there is growing evidence that the largest opportunities have already been found, and in many cases sit within the inaccessible portfolios of state oil companies such as Saudi Aramco.

So would an Exxon be content to chase 1000 smaller opportunities, rather than the 100 larger ones they are structured for and financially biased towards? Not if they want to keep their finding and development costs in the top quartile, an important indicator to market analysts. It is much harder to hold these metrics down if the denominators shrink.

Even though I've chosen to illustrate these issues in the case of a merged Supermajor, I believe they also apply to Shell, which chose not to grow via merger. Instead, they have had to take many of the same steps through internal reorganization that others achieved through their mergers, in order to remain competitive.

Where does all this lead? Probably not to oil shortages, but at least to some significant challenges for the industry in the years ahead. At a time when the global demand for petroleum is advancing steadily, the most successful incumbents in the industry, driven by the financial expectations of the equity markets and by technical factors, have compromised their ability to expand their oil production to keep pace with demand. At the same time, social, political and demographic pressures on national oil companies will make it harder for them to finance and execute the further development of their own vast reserves, without capital and assistance from the international industry.

The solution to this conundrum is breathtakingly simple: allowing the major oil companies to access the reserves of the national oil companies. The trick will be to find a way to do this that does not threaten the proud independence of the latter, while still proving sufficiently lucrative for the former. The whole history of the industry since 1972 is against it, but there are promising signs in places like Venezuela and Libya. I think we'll hear a lot more about this in the future.

Is Sea Level Rising?
Yesterday's blog was about a movie portraying climate change happening in weeks. Of course that scenario is a wild exaggeration, beyond even the most hysterical of expert's claims. An article from this week's Economist looks in the other direction, citing a fascinating study of water wells in Israel over the last 2000 years. The conclusion is that, at least in the Mediterranean, sea level has been very stable until the last century or so, and then rising since, coinciding with the runup in atmospheric carbon dioxide associated with industrialization.

I won't argue that this is anything more than another data point in a very complex picture. And I don't want to beat the climate horse to death, since I have devoted a fair amount of space in my blog to this topic. However, it occurred to me that I've never stated why I think this issue is important and worth doing something about. It's time I remedied that.

The view of climate change that most of us get from the popular media has the world warming gradually, by a few degrees Celsius over the next century. If that were all there was to it, I would resign myself to needing a few more Hawaiian shirts. Even the concerns about how this could alter regional and local weather patterns and expand the ranges of infectious diseases are all within the realm of things we could cope with, at some cost. (Clearly these effects would cause greater hardships in developing countries, and I don't mean to be callous about it.)

In a gradually warming world, adaptation is a perfectly reasonable strategy. After all, the planet was warmer than it is now several times in the past, without life vanishing. What has me worried, though, is a much more dangerous possible path of climate change.

To a large degree, the earth's climate is self-correcting. If you shine more sunlight on it, extra water evaporates, some of that drops out as snow at the poles, which expand and get whiter, reflecting more sunlight, and we come back into some kind of balance. (Any physicists or climatologists out there are cringing at this simplistic view of the mechanisms involved.)

Anyway, all of this functions like a sort of buffer. But like the chemical buffer systems you might have played with in your high school chemistry class, that allowed you to add acid or base without changing the overall acidity of the solution very much, this effect only works over some range. You can overwhelm it, at which point you no longer get nice, gradual changes. And that in a nutshell is what worries me about climate change: after some unknown--and possibly unknowable in advance--amount of warming, we might move out of the smooth buffering zone and into a zone of unpredictable, non-linear responses.

There has been a fair amount of talk about disruptions of the North Atlantic current as a possible mechanism for sudden and unpredictable climate change. This is one example of how a non-linear response to climate change could happen. If it occurred, it would be bigger than any natural disaster or combination of disasters that we have dealt with since the dawn of civilization. It has the potential to change our world faster and more dramatically than our ability to adapt could handle. The implications for governments and businesses would be profound.

Abrupt, non-linear climate change would therefore be very bad, but no one can predict whether or when it will happen. I see this situation as very similar to the question of whether I should insure my home against fire. I know it's highly unlikely, and I can look at statistical averages to estimate how much I should pay for insurance. But for the individual, statistically-derived expected values aren't very useful. If it happens and I'm not insured, it will affect my family in ways that are unacceptable.

In my mind, the Kyoto Treaty and similar measures, which would clearly impose costs on our economy, act as an insurance policy against something we simply can't afford to deal with, were it to occur. Even if all we can do is delay it or keep the change in the range of gradual shifts, that would be worth a lot. And if it never happens, well, we've paid for an insurance policy that we are happy not to have to collect on.

A Major Motion Picture?
Do movies influence public opinion? The best recent example I can think of is "Wag the Dog", which became part of the vernacular during the Clinton administration. I'm sure a movie critic could think of others. As I mentioned in my blog of March 2, 2004, this Memorial Day weekend features the release of an action film about the effects of sudden--really sudden--climate change. Some fear it could have a similar impact, while others hope that it will.

Sunday's New York Times reported that NASA had issued a memo to employees asking them not to comment publicly on the science behind "The Day After Tomorrow". Climate change is always politically sensitive, but this year it has the potential to become an election issue.

As a public agency, it may be appropriate for NASA to eschew a role that could turn political, though as one of several federal agencies receiving funding to work on this issue, it also has some responsibility to improve the public's knowledge on the subject. To NASA's management, this must look like a good way to get into a crossfire. At the same time, the article indicates that some supporters of urgent action to combat climate change worry that this film could trivialize the subject, rather than galvanizing the public.

In reality, I suspect neither side has much to worry about. After all, "Deep Impact", a fairly serious movie about a comet hitting the earth--backed up by solid research--didn't energize support for programs such as NASA's Spacewatch any more than did its silly competitor, "Armageddon."

At any rate "The Day After Tomorrow" looks like a lot of fun and has a good pedigree in the action film world, coming from the director of "Independence Day". Will it stir up the debate on global warming and the potential for sudden climate change? Only time and audience polling will tell.

Surprise Courtship
Today's Financial Times reported that Total of France (formerly TotalFinaElf) has the backing of Russia's government in acquiring a 25% stake in Sibneft, which is in the process of unwinding its merger with Yukos. This comes as something of a surprise on this side of the pond, considering that ExxonMobil and ChevronTexaco were widely seen as the leading bidders, with moral support from the US government.

Total is hardly a household name in America, having exited its modest refining and marketing presence here some time ago. In fact, its production levels and sales and profitability (at current dollar/euro exchange rates) put it in a dead heat for size with ChevronTexaco, behind ExxonMobil, BP, and Royal Dutch/Shell.

Total is also well-positioned to take advantage of the current geopolitical situation, in which some governments may be looking for an alternative to American or British companies. In bidding for Sibneft, Total looks to benefit from the closer relationship that was forged between France and Russia in the leadup to the Iraq War. Although the French government no longer hold its "golden share" in Total, the company still enjoys a unique level of government support and sympathy, as the sole standard bearer in this key industry.

Besides being the largest refiner and marketer in Europe at the moment, they have clear aspirations to become more global, complete with a new logo meant to symbolize global activity and multiple forms of energy. I suspect we'll see more moves like the Sibneft stake in the future.

Wrong Place, Wrong Time
This week's Economist provides an interesting update on a project I had lost track of. Going back to the mid-1990s, the state oil company of Vietnam had planned to build a refinery--the country's first--in the middle of their long coastline at Dung Quat. Despite the departure of all its foreign partners, PetroVietnam apparently won't give up on this idea, and now seems to want to build not one, but two refineries. The Economist correctly points out the dismal prospects of such a facility ever generating a return on its multi-billion dollar cost.

State enterprises have no monopoly on poorly-chosen projects. Several other refineries in the region were built by international companies to excellent designs, but only made sense under the rosiest of forecasts. This was an easy trap to fall into in the boom years of the 1990s, and I bear my own small share of the guilt. But during my time in the energy business in Asia-Pacific, I saw many examples of the pernicious nationalism that the Dung Quat project exemplifies.

Nearly every country in the region at one time or another has wanted a flagship petroleum project. For countries without a lot of oil or gas, that typically meant a refinery. These projects were explicitly tied to national prestige, as well as optimistic demand forecasts. Of course since refineries take a long time to design, fund, and build, your economics have to rely on forecasted demand. However, you cannot ignore forecasts of alternative supply, as too many such projects appeared to do.

Against a backdrop of globalization, refining capacity surpluses in other regions, and a developing surplus of refined products in Asia-Pacific, could the outcome of these projects been other than disappointing? We are talking about the destruction of billions of dollars of shareholder value for the industry, and the creation of large non-performing loans on the books of developing countries. The stigma of having to import your fuel needs from Singapore or Korea can't be worse than that.

This is the reality the PetroVietnam planners--and their World Bank investors--need to face. Isn't this what gives large-scale economic development such a bad name?

Missed Signals
Every day brings new headlines concerning Shell's booking of oil reserves. This is the typical pattern for scandals of this type. While I've made the odd comment along the way, here, there have generally been enough other topics to talk about, and the FT, WSJ, and NYT are generally doing just fine covering the story. When I thought about it this morning, though, I finally realized what had bothered me most about the revelations concerning Shell's top management. It wasn't just that Shell had a solid reputation in the industry. My discomfort stems from what I do for a living.

For the last seven years I have been involved in scenario planning, initially within a major oil company and now as an independent strategy consultant. In the world of scenario planning, Shell was the great groundbreaker, developer of many of the techniques still used, and most visible and vocal corporate practitioner of the technique. Just go to their website and look at all the information and articles devoted to the subject, as well as current and past scenario output.

The disconnect is not that Shell didn't have some previously worked out scenario dealing with a corporate scandal--they might--but that an organization that so rigorously analyzes the major social, political, and economic trends and forces shaping the world in which they do business should have failed to internalize the learnings from that work at the highest levels in the company.

In particular, consider their concept of TINA, "There Is No Alternative." As I understand it from reading their publicly available material, TINA would include the increased need for transparency, something Shell has embraced in the context of corruption. But somehow that didn't translate into elevating transparency with shareholders into a deeply-held value at the top. The principles are the same.

My purpose is not to pillory Shell. Rather, this should be another loud wake-up call to business across the board, as if Enron, WorldCom, Parmalat, et al weren't adequate clarions. Simply put, it's what so many managers derisively refer to as the "soft stuff", the things that constantly get trumped by the expediency of meeting this quarter's numbers. Getting the soft stuff wrong can cost you far more than any deficiency in your basic operations.

Having processes, programs and standards in place is not sufficient, if the leadership does not live by the principles behind them, and apply those principles equally to areas that were not their original focus. All the scenario planning in the world is pointless, if the human beings who commission it and participate in it are unwilling to accept what it tells them about the changing external world.

Clean Air
Last Wednesday (4/14) I commented on an article in the NY Times Magazine concerning the New Source Review policy of the Environmental Protection Agency. Yesterday's NY Times carried an editorial by David Brooks that also mentions New Source Review, as part of an overall report card on the Bush administration's environmental record. Brooks's basic conclusion is that things have improved pretty dramatically in the last couple of decades, but there are still some important gaps, notably on climate change. My view is pretty close to his.

To see why, you have to turn the clock back to the first Earth Day in 1970 and then fast forward to the present. It makes for an interesting movie. Watch the US population grow from 203 million to 293 million, and the number of vehicles on the road climb from 111 million to 235 million, each driving 19% more than their 1970 predecessors. Gross Domestic Product zooms from $3.8 trillion to 10.2 trillion, in year 2000 dollars. Against this background, a major focus on improving the environment delivers air that is cleaner in many places, and water that is generally purer. The dire predictions about the environment from the 1970s fail to materialize, because of hard work, tough policies and a large amount of investment. This brings us to to where we are today.

If we want to extend this improvement trend, should we continue the same policies as in the past--the ones that got us the benefits we can see--or do we need to try something different? Most environmentalists would probably say stick with what we know, but make it tougher. But this flies in the face of some awkward facts.

Consider vehicle tailpipe pollution. Modern cars emit only a small fraction of the pollution of a 1970 model, thanks to changes in fuel quality and engine technology, and the addition of catalytic converters. But the benefits of these advances are partially offset by the dramatic increase in total miles traveled, a trend that seems set to continue. Short of eliminating fossil fuels or replacing the internal combustion engine--either of which will take decades--we are approaching the point of rapidly diminishing returns.

What this suggests to me is that we should celebrate our achievement of the last two decades, scrutinize its history for what worked well and what didn't, and formulate new policies based on that learning and on the recognition that the problems we face have evolved and our old levers to move them have become less effective, as a direct result of their past success. Is it possible even to float such an idea, let alone get it enacted, in light of the quasi-religious zeal exhibited by both extremes of the argument? It would be close to heresy, and you know what they do to heretics.

Gas Taxes
In my April 9 posting I referred to remarks by the Chairman of Ford Motor Co. concerning higher gasoline taxes. This Sunday's New York Times business section carried a longer analysis of the issue, placing it in a useful historical and international context.

It was particularly interesting to see the comments by spokesmen for the Sierra Club and Union of Concerned Scientists, both of whom dismissed the auto industry's apparent endorsement of higher taxes as frivolous. This strikes me as ungracious. When your opponent concedes one of your major arguments, for whatever real or imagined reason, shouldn't you give him a little credit for it? In addition, the rebuttal by Mr. Friedman of the UCS is a little like the old one about trees falling in the forest; if we "save consumers money by raising fuel economy standards" on cars they don't actually buy, who benefits?

The article also cited Mr. Friedman's concern about the impact of higher gas taxes on the poor without mentioning the numerous solutions to this proposed in the past, such as income tax credits for fuel taxes paid, up to some income threshold. But this is a minor cavil.

At the heart of the question of higher fuel taxes is a serious objective, reducing our consumption of petroleum and its products. But behind that objective is a lot of fuzzy thinking and no consensus at all. Why do we want to reduce petroleum consumption? To protect the environment? To avert climate change? To increase national security? To reduce our trade deficit? Is oil just another input to the economy, or is it somehow different and special?

The current presidential campaign is as nasty as any I can recall, and at an earlier stage. It is probably not the ideal setting for trying to resolve some of the questions I've raised in the paragraph above, but at a minimum we should be comparing the substance of the two candidates energy plans, rather than debating the merits of a proposal that everyone agrees neither man is likely to implement.

Just Another Scandal?
We must be growing inured to scandals. After revelations concerning Enron, WorldCom, Parmalat, and even staid companies like Shell, where does the scandal concerning the corruption of the UN's Iraq Oil for Food office fit? As William Safire notes in today's New York Times, a number of high profile individuals are implicated, including several very close to Secretary General Kofi Annan. At the same time, President Putin of Russia seems intent on hamstringing the proposed independent investigation. This suggests that Putin sees more potential for damage in what such an examination might uncover than in the appearance of guilt created by his stonewalling.

Pressing Russia and other foot-draggers will risk international relationships that are only starting to recover from their pre-Iraq War. And what will we learn? That some unscrupulous people lined their pockets at the expense of poor people in Iraq? That sort of thing happens every day, right?

I believe there are compelling reasons for exposing the full extent of malfeasance in administering the Oil for Food fund, and the most important concerns the future, rather than the past. Politicians and talking heads across the spectrum are calling for the US to turn over responsibility for civil administration in Iraq to the UN. If the UN takes on this role, we must aggressively manage the risks this will entail, and one of the largest of these is for corruption on a vast scale.

The Oil for Food program, which marketed Iraq's oil exports under sanctions, must have created tremendous temptations. After all, it involved billions of dollars of oil, relief supplies, and authorized replacement parts flowing through a system cluttered with bureaucrats and middlemen. But if that program had inherent incentives to cheat, just imagine the opportunities for corruption involved in running the entire country and administering not only oil, but contracts for reconstruction, education and infrastructure development, to name a few.

Before taking on such a task, the UN must empty its closet of all the baggage associated with Oil for Food. Anyone who took part in corrupting that program must be either dismissed or banned from future participation in Iraq. The UN leadership must signal strongly that such behavior will not be tolerated, and this must be clear not only inside the UN but also to every organization with which it would have dealings. Doing this will require new rules on transactions.

When you look at the kind of deals in which the Oil for Food program engaged, it is easy see how things went astray. While the international oil markets include many pure traders, along with producers and true end-users, the number of Oil for Food contracts in the hands of middlemen is a red flag. Among these middlemen were companies facing indictments in the US for past misdeeds. From this standpoint, Oil for Food seemed better structured to administer "baksheesh" than relief aid. Any UN Iraq mandate must be founded on transparency and a bias for dealing directly with suppliers and end-users, eliminating entirely any "brother-in-law" deals.

Finally I think it is important to remember the larger cost of the subversion of the Oil for Food program. It was set up to alleviate the impact on Iraq's population of the UN sanctions that enforced the ban on Iraq's post-Gulf War rearmament. Not only did corruption take food from the mouths of Iraqis, but it also gave Saddam Hussein the funds to invest in arms, palaces, and the personal largesse that kept him in power. In short, this corruption seriously undermined the effect of the sanctions and weakened the best alternative to war. Anyone doubting this should look at the recent, muich more positive outcome in Libya.

If the international community wishes the UN to be the vehicle for stabilizing Iraq, then it must be willing to purge the UN bureaucracy of those responsible for the Oil for Food debacle, as a prerequisite to assuming responsibility for nation-building and reconstruction in that country. Failing to do so will reduce the UN's credibility and guarantee a less effective, and likely unsuccessful effort. None of us can afford that.

Biofuels and Oil Reserves
Two articles from this week's Economist caught my attention. The first discusses the application of biotech to fuels and related products, such as plastics. Although I've been critical of the current US ethanol policy, there is tremendous potential in tapping the energy content of agricultural waste. New enzymes and "bio-refineries" are making this possible, but as the article points out, the economics still hinge on the price of oil.

The second article poses some useful questions for the current debate on how oil companies book their oil and gas reserves. This measure serves two important purposes, one of which is important primarily to a company's investors, the other of broader interest.

First, reserves are a measure of the firm's potential for future value creation through the exploitation of assets it already controls, as well as providing insights into the relative competitive efficiency of its operations for finding and producing oil and gas. Both are of critical importance to stock prices.

The second purpose of the reserves data is more basic, as a snapshot of the company's ability to sustain its current production volumes of oil and gas. This has implications not only for shareholders, but for those concerned with the ability of the industry to cope with growing energy demand, shifting geopolitics, and industry restructuring. For instance, in the aftermath of the industry consolidation of the 1990s and early '00s, are the collective reserves of the merged companies greater or lesser than the sum of the parts that went into them? If claims of synergies are to be taken as more than ephemeral cost savings, they should manifest in an increased capability to convert probable reserves to proved reserves and reserves to dollars.

The standards that support a uniform view across all companies in the industry need to take both of these perspectives into account, as well as the issues of changing technology and markets identified by the Economist. I doubt this concern will fade as Shell gets its house in order.

Oil's Impact on the Economy
The latest Consumer Price Index (CPI) figures for the US indicated an increase for March of 0.5%, with core inflation excluding food and fuel of 0.4%. Even though the current high gasoline prices are not part of the core inflation rate, it looks like we are beginning to see the result of sustained high prices for the oil and natural gas inputs used by businesses in the goods they sell to consumers. Is this a real threat to the economic recovery?

The price of crude oil has been high for over a year, and natural gas has been well above its historical average since the end of 2002. This hasn't prevented the economy from growing so far, even though that growth hasn't generated many jobs, for a variety of reasons. In fact the Wall St. Journal's reporting of DuPont's recent announcement of 3,500 layoffs cited the high cost of natural gas as a contributing factor, since it is a major input in its basic chemicals business.

If the impact of higher energy prices is starting to show up in higher consumer prices for non-fuel goods, though, then this will influence policy decisions, such as the actions of the Fed's Open Market Committee, which sets interest rates. This week the stock market fell in anticipation of an increase in interest rates by the Fed next month. In effect, there is a delayed feedback loop by which high oil and gas prices increase inflation, which raises interest rates, which slows the economy.

None of this should be surprising. Crude oil and gasoline prices today are at about the level they were, in inflation-adjusted dollars, after the first Oil Shock in 1973-74. (See my posting of March 25 in archives.) The US economy is very different today than it was then, and the amount of energy required for each dollar of gross domestic product is lower. So barring a radical jump in oil prices from here, it's hard to imagine the same kind of economic malaise resulting from the current price levels. But that doesn't mean there's no impact.

Much will depend on how consumers will respond. If, for example, we were to change our driving habits, consolidating trips, carpooling, and shifting more travel to cars with better fuel economy, demand would start to moderate and that would ease prices fairly quickly. This would take some of the pressure off companies that produce goods for sale.

If, on the other hand, we ingore the gasoline price signal and continue the remarkable growth trend in miles traveled each year, and instead cut back our purchases of goods with a large energy component, then the economy will slow first, which will eventually result in lower fuel prices.

So even though it is natural to see the entire problem as being well beyond anything we can individually control, the reality is that the sum of all our actions as individuals will have a lot to do with how bad high energy prices end up being for the economy. So blame OPEC if it makes you feel better, but don't ignore what you are doing about it, yourself.

Smoke Screen
I've been remiss in waiting this long to mention Bruce Barcott's interesting article on the Bush Administration's environmental policy in the NY Times Magazine of April 4, 2004. In "Changing All the Rules" (which has now gone into the NYT archives), he describes the impact of changes in "new source review" rules for the electric power industry. Under this provision, power plants can perform necessary maintenance, but any upgrades or expansions trigger a requirement to meet current emissions rules and install the best available emission control technology. Mr. Barcott's article focuses on past violations of this standard and the new administration's efforts to make it less onerous for industry.

I'm not in a position to verify all the information in the article, but at least one fact that underpins his argument that environmental regulations have not stifled the expansion of generating capacity to meet demand, requires further clarification. The "fact" in question relates to the California power crisis of 2000-01. The author states, "We now know that California's energy shock was largely caused by market manipulation (by Enron, among other companies) and regulatory breakdown, not by a drought in supply." This is not a fact, but rather an assertion. An examination of the facts would reveal that two other major factors contributed to California's problems, in addition to those he cites.

First, the Pacific Northwest, from which California imported a significant portion of its incremental power, was experiencing a water drought that curtailed hydroelectric generation. More germane to the issues in the article is the trend leading up to the period of "deregulation", in which the state's power reserve was steadily eroded by the rapid growth of demand in the 1990s and the difficulties utilities faced in getting new plants permitted and constructed. From an industry perspective, the balance between environmental protection and the provision of energy critical to economic growth and personal comfort had swung too far in one direction.

The latter point encapsulates much of my discomfort with Mr. Barcott's approach. He raises issues meriting serious concern, and his observation about major changes in environmental policy being driven by bureaucratic fiat, rather than by Congressional action, is essentially correct, though hardly unique to this administration. However, his overall argument is undermined by the breathless tone of conspiracy that comes across in much of the piece.

While it is tempting to see the insertion of so many people with energy industry connections into the EPA and Dept. of Energy as simply putting the fox in the henhouse, there is another perspective on this. What I recall from my two decades in the oil industry was the relentlessly adversarial approach taken for most of that time by environmental regulators who had little appreciation or concern about the benefits the industry provided, seeing it only as a massive polluter.

When the Bush Administration took office, there was a sense in the parts of the industry with which I was involved of finally having someone in Washington who understood the complexity of the country's energy systems and who might be willing to listen to the input of those who actually run the machines that deliver power and fuel to a country that cannot do without them. Quite possibly this was taken too far, and the balance has swung in the opposite direction from the last twenty years. An article that presented both sides of the story would have been fairer but probably far less gripping and politically useful in an election year.

Desires vs. Markets
A couple of recent articles have speculated about the role that the demographics of Saudi Arabia will play in keeping the price of oil high in the years ahead, including this one in the Financial Times (subscription required.)

There's little doubt that the Saudis, in particular, and the Arab world in general, face a demographic crisis, and that much of the political unrest we see in that region is driven by a large and growing youth population. With a median age below 20 and high unemployment, the Saudis will need sustained high oil revenues to meet the demands on their social services.

However, desires alone don't drive markets. Clearly the US desires much lower oil prices, but our wishes don't make it so. The question is what other conditions need to exist in order to facilitate keeping prices high, since not even the Saudis can set the price of oil arbitrarily high just to suit their own needs, without disrupting the market. I see at least three other necessary conditions:

First, demand for oil would have to remain strong. This may seem like a foregone conclusion today. After all, the US economy is recovering, American driving patterns appear impervious to higher gasoline prices, and China is going great guns. But any number of things could dampen demand in the years ahead, such as another Asian economic slowdown, or unexpectedly rapid market penetration of fuel saving hybrid cars or clean diesel engines.

Second, the Saudis would have to convince the rest of OPEC that it is in their interest to adhere closely to quotas and avoid cheating, i.e. overproduction by individual members. That, too, seems like a slam dunk, in light of the recent success of this strategy. But once Iraq stabilizes, any new government there will have an enormous incentive to expand production, and they have the potential to blow huge holes in OPEC's dam, given enough time. Libya may be in the same position much sooner, as I indicated last week. However, these countries will have to compete for investment with opportunities in other countries.

This brings us to the third key factor; to sustain high oil prices, the growth of non-OPEC oil production would have to slow or stall. That, too, seems like a reasonable bet, with North Sea production plateauing and US production well past its peak, but it does not reckon with the potential of Russia, West Africa, and the countries in the Caspian region to add enough production in the next 3-5 years to ruin OPEC's calculations. But this, too, depends on the strength of demand, availability of capital, and OPEC policy.

So although understanding the impact of demographics can give important insights into Saudi oil policy, no issue, in isolation, will dictate the global price of oil. This complex and dynamic market has stymied numerous past attempts at prediction and control. As I've indicated in recent blogs, I think the willingness of the Saudis and other Middle Eastern producers to invite in foreign capital and capabilities will have at least as much influence on the future supply and price of oil as the Arab demographic bubble, unless it results in a full-blown revolution in the Kingdom.

The Other Gas for Cars
Yesterday's NY Times carried an article on celebrities converting their SUVs to run on compressed natural gas (CNG), as a way of reducing the environmental and energy security guilt associated with driving big, heavy cars. It raised several interesting questions about the advantages of natural gas powered vehicles that are available now, compared with hydrogen fuel cell cars that may still be ten years away. These are the kind of questions we should be asking, since any fuel conversion will entail major changes in our infrastructure and primary energy choices.

Other questions that should also be on the table include the following:

Although the Times cites natural gas as a domestically-produced fuel, most analysts including the government's Energy Information Agency anticipate that any growth in US natural gas demand will have to be met through increased imports, because US gas production has stagnated in recent years. This will require construction of a number of LNG (liquefied natural gas) import terminals, a new pipeline from Alaska or Canada, or both. Are incremental gas imports best used for transportation, or as the cleanest fuel for electricity generation?

Compressed natural gas cars are currently cheaper to fuel than their gasoline counterparts, largely because natural gas carries no transportation taxes. If more than a small fraction of the cars on the road converted to natural gas, some alternative means would have to be found for collecting taxes for highway repair and the other items funded by the state and federal fuel taxes. If natural gas for road use were taxed at the same rate as gasoline or diesel, much of its advantage would disappear. Should CNG receive this kind of subsidy because of its environmental benefits?

There's also a practical question about the number of miles an owner would have to travel annually in order to defray the investment in conversion to CNG, even if the fuel retains its road tax exemption. The Times indicated a conversion cost of $10,000, which seems high. Even at $5,000, I suspect that only fleets of high use vehicles, such as taxis, delivery vehicles would find this advantageous, and in fact, it is mostly these kinds of vehicles that have already made this switch.

I'll leave the safety concerns for others to highlight, except to say that I don't personally fancy the idea of driving around with a high-pressure tank in the back of my car, even if it is wrapped in Kevlar and has been dropped off the Empire State Building in tests. I spent enough time in refineries to have a very healthy respect for the amount of mechanical energy stored in a gas at 2000 psi or higher pressure.

At the same time I don't want to dismiss this idea out of hand. It has some merit and may make sense for some consumers, even if it does nothing more than assuage their consciences. And if our government saw enough benefit in this idea to be willing to open up some of the gas fields currently off limits (see my posting of March 11 in archives), then we might actually see domestic natural gas prices come down enough that this could be a real winner.

A New Tradeoff?
Ever since taking the helm at Ford Motor Co., William Clay Ford has been a controversial figure. He has spoken publicly about a strong environmental agenda, although some have criticised Ford for failing to follow through. This week, he threw his support behind the idea of higher fuel taxes couples with incentives for high-efficiency vehicles such as hybrids.

The tradeoff between taxes on consumers and fleet mandates at the manufacturer level is one that was settled in the US two decades ago. Europe has chosen to rely on high fuel taxes and taxes on engine displacement as a way of keeping cars efficient and moderating their oil imports. That approach was rejected here in favor of the CAFE standards I discussed earlier in the week (see Monday's posting.) Perhaps the time has come to reopen this debate.

The advantage of taxes is that they allow the market--consumers--to select the makeup of the car fleet and avoid the kind of loopholes and gaming that mandates such as CAFE are prone to. However, with consumers already complaining about gasoline prices that have skyrocketed due to market factors, how would they welcome a $.50/gallon tax increase on top of this?

Even if Mr. Ford's remarks are somewhat self-serving, since Ford has invested in hybrid technology and is launching the hybrid version of its small Escape SUV this year, this is still a national conversation worth having.

First Fruits
With Iraq's instability showing no signs of abating, it could be a long time before international oil companies see an atmosphere conducive to pursuing new exploration and production opportunities there, beyond pre-existing deals such as Lukoil's. The less heralded return of Libya to the international fold looks like it will bear fruit much sooner.

The Financial Times recently estimated that the oil sector in Libya would need up to $30 billion over the next 10 years as the country seeks to expand production capacity from 1.6 million barrels per day (MBD) to 3.0 MBD. Shell has already announced a gas exploration agreement with the Libyan government.

The terms required to lure more companies back will need to be attractive, and these opportunities will have to compete with others elsewhere. But they start with two key advantages: proximity to the large markets in Mediterranean Europe and the prospect of crude oil qualities matching those of Libya's current production, which is lighter and sweeter (lower in sulfur) than most Middle Eastern oil.

On balance, although Iraq has much greater long-term potential, the re-opening of Libya could have a bigger impact on the market in the medium term.

Trading Carbon Credits
Even though the Kyoto Treaty on climate change lacks the required number of signatory countries to go into effect, the European Union is moving ahead with measures to reduce emissions of carbon dioxide and other "greenhouse gases" (GHGs). At the same time, some EU leaders are expressing concerns about the competitive handicap these limits may create. The latest Economist includes an update on where emissions trading, which can reduce the cost of compliance, fits in the EU's plans.

In this type of trading, parties that can achieve reductions in emissions at relatively low cost are able to sell their excess reductions to others facing higher costs. This is classical economics at its purest, and it produces benefits not only for the participants, but for society as a whole, as the total cost of achieving the same reductions is driven down to its most efficient level.

The application of trading to environmental issues was first demonstrated in the US, with the establishment of a market for acid rain and smog-causing sulfur emissions. This program has not suited everyone, with some Northeastern states downwind of plants that purchased credits in lieu of reducing their own emissions complaining and passing laws to limit trading. Still, it has arguably reduced overall power plant pollution, while keeping electric rates lower than if all generators had been required to reduce their own emissions.

Emissions trading is ideally suited to addressing the concerns of climate change, because it is truly a global issue. A ton of CO2 emitted in Brazil is exactly equivalent in its impact on the climate to a ton emitted in Boston. The regional and "downwind" issues that have bedeviled sulfur and nitrogen oxide trading are simply irrelevant to GHGs.

The larger EU emissions market now under discussion is a follow-on step to a number of national programs, starting with the UK's, which has been in effect since 2002. As the Economist points out, it is ironic that Europe is now proceeding to implement emissions trading, while it is off to a slower start in the land of its birth.

Here, without a firm cap on output driven by government policy, trading has so far been limited to a modest number of forward-looking companies that see it as an attractive hedge against potentially much higher costs of cutting their GHG emissions in the future. The importance and value of emissions trading is likely to grow significantly, should a Democratic administration take office next January.

And a follow-up from a colleague concerning yesterday's posting:
NPR carried this story concerning opposition to a promising gas discovery in New Mexico.

How Many Back Yards?
A colleague forwarded a report indicating that two proposed LNG import terminal projects have been cancelled or suspended, one in Maine and one in Northern California, due to strong local opposition.

There was a time when these projects would have been welcomed as valuable sources of jobs and local tax revenue. Today, even as we bemoan the offshoring of manufacturing jobs, it is clear that much of the country has adopted a distinctly post-industrial mindset toward any facilities that exude smoke and steam. That includes the infrastructure facilities upon which our lifestyles depend.

In contrast to the rather depleted state of our petroleum endowment, we still have sizable untapped resources of natural gas in North America. However, it is strictly verboten to drill into this gas if it happens to lie in places we value for their pristine appearance. The result is a growing reliance on imported natural gas.

That is a legitimate, values-based choice as far as it goes. Paradoxically, though, it is also apparently verboten to build facilities for importing gas from overseas. Having outsourced the production of the gas, do we now wish to outsource its importation, as well, perhaps to Mexico or Canada?

The inherent conflict between our insatiable appetite for things that consume energy and our recently-acquired sensibilities towards our surroundings is a slow-motion train wreck that has already begun. Americans usually prefer to solve our problems after they have reached crisis proportions, but in this case we need to be aware of how long it will take to respond, once we realize we have not built enough pipelines or LNG terminals, or drilled enough gas wells to keep the heat and lights on at a price we like.

Both Wrong?
In their lead editorial today, the New York Times castigates both the President and his challenger, Senator Kerry, for arguing about short-term fuel prices and ways to address them, rather than promoting a national debate on the underlying issues of energy use and how it might affect our national security. The Times would have done well to quit after making this excellent point, rather than weighing in for specific solutions, themselves.

Their preferred answer appears to be to tighten the Corporate Average Fuel Economy (CAFE) standards that were imposed in the 1970s, and about which I've written in the past (see my posting of 2/20/04.) A major drawback of CAFE is that it ignores consumer preferences, imposing instead a limitation on the average fuel economy of each manufacturer. Ignoring the loophole that has allowed ever larger SUVs to bypass the intent of the CAFE standards, it is not at all clear that large numbers of consumers will opt for smaller, thriftier vehicles, or willingly pay the higher prices necessary to pay for technology that could reduce fuel consumption.

The Times also chooses to ignore the vital role the market played in mitigating the supply crises of the 1970s, and the way in which the sources of this country's imported oil have diversified in that period, even as demand grew and domestic production declined. We are less reliant on OPEC today than we were in 1975, according to the government's own statistics on imports. The recent growth of production in Russia and the Caspian Sea region offers opportunities to maintain a diversified supply for at least the next decade or so, even though the preponderance of reserves in the Middle East must eventually shift that balance.

While markets have their limitations, and though their results are not always popular--as with current gasoline prices--they do some things much better than command-and-control approaches can. Surely this, too, must be part of the debate the Times presumably endorses.

SPR in the Crosshairs
I'm traveling on business, so no new blog Friday. Meanwhile, if you have been following the debate over whether we should still be adding oil to the Strategic Petroleum Reserve with oil and gasoline prices as high as they are, and if you have not previously read my posting of February 17 on this subject, you'll find it in archives. It is as relevant to what the presidential candidates are saying on this topic as it was to the Senate debate six weeks ago.

Iraq's Oil Patrimony
We are approaching the first anniversary of the fall of Baghdad. If you can believe the polls or the evidence of recent anti-war demonstrations, much of the world still believes the US went to war in Iraq to seize control of its oil resources. I never shared that view and could nominate several other countries whose actions in the UN Security Council suggested that they were influenced to a much higher degree by oil than was the US. Now, as we anticipate a handover to an Iraqi government in June, there is growing and legitimate concern about how Iraq's oil will be managed. There is a great opportunity here to benefit both the Iraqi people and the world.

Regular readers have seen my past comments on global oil depletion and a possible imminent peak in production. If we are facing a peak, it has to shift closer without open access to Iraq's 112 billion barrels of proved reserves, which could reasonably be expected to support production of at least 5 million barrels per day, compared to the current 2.5.

Achieving that won't just require access for US companies, or for companies in countries that joined our coalition. Rehabilitating Iraq's dilapidated oil industry and increasing production sustainably is such a big task that it will take expertise and investment from many sources. In the process, companies should find attractive opportunities, perhaps more attractive than some current and prospective projects they are pursuing elsewhere in the world. I can think of some countries that should be worried about that, with Venezuela topping the list.

However desirable it might seem to some, Iraq could never accomplish such an expansion on its own, without international help. Recall that the existing infrastructure was a shambles before Coalition troops crossed the border, and the repairs funded by the US are geared primarily to addressing acute and chronic problems, not building new capacity. And because the new Iraqi government will need oil export revenues to finance rebuilding their country, that money will not be available for reinvestment in the oil industry in the short or medium term. Finally, Iraq has missed out on at least a decade's worth of technical development in a very high-tech industry. They will need help just to get back to where they were, let alone move ahead.

Security, government & governance, and terms of access must all be settled as a prerequisite, and this will be a major undertaking in itself. The new government will also have to figure out how best to feed oil money into the system, to avoid perpetuating the Resource Curse seen in so many other oil-rich, institution-poor countries. Their success in this undertaking is very much in the self-interest of every energy consumer in the world. If they fail, we just might have no choice but to give up our SUVs.