Monday, February 28, 2005

Applying Lessons from Iraq to Iran
Today's New York Times includes a disturbing article concerning Iran's nuclear program. Although no "smoking gun" evidence has turned up linking Iran's civilian nuclear power efforts with weapons development, a dangerous pattern is emerging. As I've suggested before, this situation contains the seeds of a catastrophic oil market disruption, and we must hope that the parties involved have learned the appropriate lessons from the buildup to the Iraq War.

For the Iranians, the key lesson relates to the hazards of engaging in a "shell game" with inspectors from the International Atomic Energy Agency. Although it is understandable that they might feel threatened by US rhetoric and wish to protect their expensive equipment, drilling tunnels and shifting centrifuge parts around the country increases our uncertainty, rather than decreasing it. This is exactly the wrong this to do, unless there is indeed a clandestine weapons program that needs to be hidden.

The Europeans and other members of the IAEA, on the other hand, must remember the impossibility of proving a negative--in this case that Iran has no nuclear weapons program. In all likelihood the best solution to this potential crisis would establish conditions to render a weapons program inert, even if it existed. That would require accounting for every gram of Iranian nuclear material and keeping it under strict IAEA scrutiny.

Finally, the US has to recognize the limits of our military power. In the Iraq War we assumed that the US Army would only be engaged for a relatively short time, replaced post-victory by coalition forces, regional forces, or a reformed Iraqi army. Instead, most of the combat power of this country is committed to Iraq for years. A third of the US Army's 37 combat brigades are in Iraq or Afghanistan, a similar number have recently returned for rest and refitting, and a like number are training and equipping for deployment there within the next year. We will have to play an entirely different hand of cards with Iran than with Iraq, or risk losing Iraq--and a lot more--in the process.

Unless all three parties to this situation avoid the mistakes of the Iraq War, we could be headed for a nasty confrontation and a big oil price spike, just when global supplies are already stretched tight.

Friday, February 25, 2005

Hybrid Limits
Ever since it came out earlier this month, I've been scratching my head about a J.D. Power projection that sales of hybrid cars will plateau at about 3% of all cars sold in the US. They are currently about 0.5% of the market, based on only a couple of models from Toyota, Honda and Ford. My concerns about this forecast go beyond the assumptions J.D. Power makes, relating to fuel costs, subsidies and the cost premium for buying a hybrid. In particular, I'd like to know if they thought about more than one scenario for hybrids.

In some respects, hybrid cars represent the first really new vehicle type in decades, powered as they are by a combination of mechanical and electric drivetrains. But in another sense, they simply reflect the continuous evolution of the automobile from the days of Henry Ford. Even ignoring hybrid drive units, cars are increasingly becoming electrical devices, as much as mechanical ones. This has benefits and drawbacks, as I discussed in a recent posting.

This notion of evolution points to ways in with the projection in question might indeed come true, and ways in which it could look downright silly in a decade. For example, what if some of the components that make today's hybrid a hybrid--electric motors, regenerative braking, onboard storage of electricity for propulsion, and power management hardware and software--became as commonplace in mass production cars as the hydraulic innovations of an earlier generation, such as power steering, power brakes and automatic transmissions? In a decade, it might be hard to tell a hybrid car from a non-hybrid. In this case "true" hybrids might indeed account for only a small fraction of all cars, but their influence would be much broader.

Or consider that hybrids may start to branch out by incorporating power plants other than the gasoline internal combustion engine. Diesel hybrids are an obvious choice, and even micro-turbine hybrids look possible. The first fuel cell vehicles will also likely be hybrids, because of the high cost of building a fuel cell stack big enouch to deliver the peak power output required for highway driving. So if hybrids come to include essentially all cars with complex power sources, then it's difficult to imagine that they will reach some natural limit at 3% of the market, even with all the other improvements that non-hybrids will incorporate by then.

The real value of J.D. Power's forecast is not as a prediction, but as something that forces us to think about the issues involved more concretely, including just what we mean by a hybrid in the first place. Considering all this, I give them full credit for having the guts to put this out for everyone else to shoot at.

Thursday, February 24, 2005

Timing Is Everything
Today's Financial Times includes a story (subscription may be required) on plans by PTT, the state oil company in Thailand, to merge several of its refining interests and do an IPO with them. This represents a remarkable turnaround in the Asian refining business, which only a few years ago was in truly dismal shape, suffering from a glut of product and depressed margins.

The story of the two refineries in question, the Star Petroleum Refining Co. facility at Map Ta Phut (64% owned by Caltex) and the neighboring ex-Shell refinery at Rayong suggests a word of caution, though. These plants were financed and built with high expectations, in the early 1990s environment of robust Asian economic growth and double-digit increases in Thai fuel demand.

When they started operations, however, Thailand was at the center of the slumping market of the Asian Economic Crisis. These two world-class facilities (I'm a little biased, having been involved with SPRC via my role looking after Texaco's interest in Caltex at the time) struggled financially for years. Though well-built to the highest standards--SPRC, at least, came in on time and on budget--these projects destroyed hundreds of millions of dollars of shareholder equity, because actual market conditions when they started up were drastically worse than anyone had expected.

Now the market has rebounded, with China's growth fueling a new boom throughout the region. The proposed merger of the two refineries must be driven entirely by the appetite for a refinery IPO, since all synergies have already been captured through a joint operating agreement put in place in the late 90s.

The history of these two refineries reminds us that economic expectations don't always pan out. However unlikely it may seem today, it's possible to imagine credible scenarios in which this could happen again, whether through another currency crisis or a "hard landing" for China's economy, which would send shock waves throughout the region. Asia's growth wave could last for twenty years, or it might fizzle next month. Caveat emptor.

Wednesday, February 23, 2005

Early Consolidation
Most experts agree that a potential "hydrogen economy" is still a couple of decades away, at best. So it might be surprising to see some consolidation this early in the development of the industry, with the recent acquisition of Stuart Energy Systems by Hydrogenics Corp. Stuart, a Canadian supplier of electrolysis-based hydrogen supply infrastructure, had itself recently acquired Vandenborre, another hydrogen technology provider.

Viewed from a purely financial perspective, the merger presumably creates a stronger, healthier company that is better equipped to handle the technological uncertainties inherent in a "pre-Hydrogen Economy", with a broader product and customer portfolio. Both of these companies have been dealing with early adopters in niche markets, such as delivery and transit fleets converting to fuel cell powered vehicles. The combination brings together a lot of practical experience in a field where much of the market is theoretical and prospective.

In addition, this transaction implicitly recognizes the potential of electrolysis--Stuart's core technology--in breaking the "chicken and egg" problem of hydrogen infrastructure. In other words, how do you justify infrastructure when there aren't enough customers on which to make a profit, and how so you encourage new customers without the existence of adequate infrastructure?

Electrolysis, though far from the most efficient way to turn primary energy into generate large quantities of hydrogen, can be done on essentially any scale required, and could be an ideal bridge to larger scale, more efficient technologies as the market for distributed hydrogen grows.

Tuesday, February 22, 2005

Is ANWR Worth the Gamble?
Yesterday's New York Times carried an article suggesting that the oil industry has lost interest in exploring in the Arctic National Wildlife Refuge in Alaska. ANWR, as it is known, represents a vast potential resource, but the idea of drilling there has attracted opposition across a wide spectrum of environmental groups and members of Congress. I've always thought it would be worth getting a better understanding of just what it is we are foregoing , before deciding, but that's never been a popular position.

Does this perceived lack of industry interest truly translate into a lower estimate of how much oil is in ANWR? Here's the chain of logic from the Times article:

1. Two companies drilled a well in ANWR in the 1980s. (I formerly worked for one of these companies, though I have absolutely no knowledge, insider or otherwise, about what that well might have revealed.)
2. Neither company is now pushing for ANWR to be opened up, and both have withdrawn support from the lobbying group set up to do that.
3. Other oil companies seem equally lukewarm, preferring areas where finding oil seems less risky.
4.. Therefore, there must not be nearly as much oil in ANWR as the government has suggested.

The problem with this construction, of course, is that the same behavior lends itself to a variety of alternative, equally plausible explanations. What if the companies in question have simply become more savvy about high-profile environmental issues, after years of bad publicity, and see equal or better prospects in countries that are easier to operate in? After all, US concerns about energy security don't carry much weight within multi-national energy companies. They view their asset portfolios in the cold light of risk and return, not national interest.

This rationale makes more sense to me than the notion that a single well drilled nearly 20 years ago has given everyone cold feet. The sheer size of ANWR and the incredible advances in seismic interpretation and drilling technology in that timeframe render this argument pretty flimsy. No one will know how much recoverable oil ANWR contains until after some pretty thorough exploration work, but no one should be surprised that the project selection criteria of the major oil companies, which are heavily weighted to rapid development and high returns, should give such a controversial prospect a low priority. But that is not at all the same thing as saying there's not much oil there, or that developing it should be a low priority for this country.

Monday, February 21, 2005

Does a Flawed Hockey Stick Invalidate Kyoto?
Although I know I've loaded up the blog with a number of postings on climate change recently, I also don’t want to ignore the controversy stirred up by the Wall Street Journal's recent article on the famous (or infamous) climate change “hockey stick” graph. The Journal's editorial last Friday is spot on in its concerns about the politicization of science—though this should hardly be news—and the possibility that we may be embarking on expensive efforts to mitigate a phenomenon that is not entirely proven. But what should we do instead?

In a nutshell, the chart in question has provided a sort of “smoking gun” visual argument in support of the idea that climate change is both real and, coinciding as it does with the rise of industrialization, largely man-made. This chart has come under fire from a small number of scientists and non-scientists on the grounds that it cannot be exactly reproduced from the raw data in question. Reproducibility of results is at the very core of all science. So does this undermine the entire notion of global warming, making the Kyoto Treaty worse than irrelevant?

It's entirely possible that Dr. Mann's graph will turn out to be fatally flawed, though my statistics background isn't quite up to forming a solid opinion. But the chart in question is only one piece—albeit a visually compelling one—in a much larger mosaic of scientific observations adding up to a comprehensive picture of a global climate that appears to be shifting out of its normal range of variance. The evidence includes some compelling recent studies. Just as it is probably no coincidence that this shift seems to correlate with our rising consumption of fossil fuels, neither does it seem coincidental that the rise of our present civilization should occur during a relatively stable and benevolent climatic phase.

As I've indicated before, for me it boils down to risk management. If we accept the Journal’s estimate of the cost of the “insurance” at $150 billion/year, what price tag would we assign to the events against which we are insuring? What would be the cost of irreversible changes in the location of the Gulf Stream and temperate zones, or the permanent loss of even a quarter mile of coastline globally, due to rising sea levels? I don't know, but I can visualize a number with many more zeroes than in the figure cited above. None of this is certain, but neither is the “null hypothesis” that the climate isn't changing--or that it is, but without any human influence. What are we willing to bet?

Friday, February 18, 2005

Where the LNG Will Go
With the approval yesterday of Shell's Gulf Landing liquefied natural gas (LNG) terminal offshore Louisiana, a likely scenario for the development of US LNG infrastructure is taking shape. Although 38 new LNG terminals have been proposed for the US--to supplement the four existing ones--all of those approved so far are clustered along the Gulf Coast, where much of the country's domestic natural gas production is centered, rather than close to the markets for which gas supply has been most problematic. There are both benefits and drawbacks to this pattern.

First, it's important to understand that LNG requires substantial fixed infrastructure in order to re-gasify, store and deliver the gas being received from tankers. These facilities typically range from 0.5 to 1.5 billion cubic feet per day (BCFD)of capacity, determined by economics, logistics and technology. With current US natural gas demand running at around 60 BCFD, a typical LNG terminal can import just under 2% of domestic demand.

Because of the way the US natural gas industry developed, the Gulf Coast has a high concentration of gas infrastructure. This includes pipelines, storage facilities, and gas plants, where the ethane, propane and butane contained in the gas are separated. Bringing LNG into this network reduces the amount of new infrastructure required to reach customers, thus improving the overall economics of LNG supply. It also substitutes nicely for lost production in the same vicinity, as the mature gas reservoirs in the Gulf of Mexico deplete.

The LNG imported by these new terminals will give the large industrial users along the Gulf Coast and mid-continent greater security of supply and somewhat lower gas prices. It will also benefit residential and commercial customers in the southeast. Unfortunately, these facilities will do little to dampen the high prices affecting more distant markets. Gas customers in the northeast, including electric utilities that burn gas to generate power, already pay significant premiums over Gulf Coast prices, because of limitations in the infrastructure for delivering gas over long distances. Only local LNG terminals can provide relief, and all of the proposed terminals that would benefit these customers directly face bitter opposition, as I've described in previous postings.

So the picture that emerges, at least for now, is one in which LNG backfills for declining domestic production along the Gulf Coast, with more distant customers still at the mercy of pipeline capacity constraints. If this scenario holds, we will miss the opportunity to continue displacing dirtier fuels with our cleanest hydrocarbon, gas, which is still in ample supply globally. Even though I remain skeptical that LNG is quite the panacea that some claim it is, our current approach to it can only be described as short-sighted and parochial.

Thursday, February 17, 2005

The Editorial Page
Sometimes it's difficult to come up with a good topic for the day's posting; other days I'm spoiled for choice. Yesterday's New York Times, which I received after I'd already chosen my topic for the day, included two terrific guest editorials that I want to bring to your attention, with little additional comment.

In the first op-ed, the author offers an impassioned defense of wind power, even in wilderness locations and in spite of local opposition. This is a subject I've covered before (see my posting of 7/20/04), but less eloquently and succinctly.

The second editorial deals with the "Clear Skies" environmental legislation pending in Congress. Gregg Easterbrook writes intelligently on energy and environmental issues, often for New Republic. He suggests that if anyone other than George W. Bush had proposed Clear Skies--a name he and many others dislike--it would be recognized as an improvement over the Byzantine process of enforcing the existing Clean Air Act. He also sees its proposed expansion of the current, regional cap-and-trade systems for limiting sulfur and nitrogen oxide pollutants as a welcome dress rehearsal for greenhouse gas trading, which is already in use in Europe.

I recommend both editorials highly and look forward to seeing what kind of reaction they provoke.

Wednesday, February 16, 2005

Kyoto Day
Having been ratified by 140 countries representing 61% of applicable greenhouse gas emissions, the Kyoto Treaty on climate change goes into force today. Regardless of your opinion of the treaty, this is a real milestone, because for the first time in history the cost of emitting carbon dioxide and the other greenhouse gases into the atmosphere will no longer be zero, at least in the countries that ratified Kyoto.

That's a big deal, because unlike the sulfur and nitrogen compounds that we have regulated for the last thirty years or so, CO2 is not a pollutant, but rather the primary byproduct of all combustion. Reducing these emissions will require a lot more that catalytic converters, scrubbers, and cleaner fuels. In order to comply, countries must rethink how they generate and use energy, and this may ultimately usher in the end of hydrocarbon fuels, which have been a key factor in the rapid rise of industry and personal mobility around the world.

Kyoto is either the first small step towards a truly different world, or a major obstacle to economic growth, depending on whether you regard climate change as a serious problem, or even real. Although the US has not ratified the treaty, American companies with global operations will be taking steps to bring their international subsidiaries into compliance. In the process, awareness, knowledge and technology for reducing emissions will creep into this country, bit by bit. Kyoto is now a fact of life.

Tuesday, February 15, 2005

Changing the Game
Many in the oil industry have banked on the continued expansion of Russian oil production and reserves to keep the balance of power from shifting too rapidly toward the Middle East and its huge untapped resources. (See my posting of 9/30/04.) As described in this article from the Financial Times (subscription required) a new ruling in Russia requiring majority Russian ownership for any company bidding on energy and minerals prospects may alter this calculation significantly.

Throughout the course of the effective re-nationalization of Yukos (see my posting of 6/30/04) the key question has been whether President Putin was pursuing a personal vendetta against Mr. Khodorkovsky, seeking to rectify the excesses of the Yeltsin years, or putting down a marker for government control of a strategic industry sector. It is looking increasingly like the latter interpretation is the correct one, unless all three are in fact true.

This is not particularly good news for consumers of oil products around the world. It is going to take solid growth in places like Russia, Africa and Latin America to offset the production decline in the US and North Sea and the reticence of OPEC to boost capacity. Requiring the international major oil companies, which are currently generating gobs of cash, to channel their investments in Russia through minority positions in local companies will at least slow down the rate at which they are willing to invest, if the Yukos affair hasn't scared them off entirely.

Although many Russian companies have done well to restore production to near previous peak levels, they lack some of the technical and project-management skills to handle projects of the scale now on the horizon. For that matter, Yukos was the most successful of the Russian oil companies at boosting production from its reserves, and it is questionable whether the personnel and attitude that made this possible will survive absorption into Rosneft, the national oil company that is merging with Gazprom, the state-owned natural gas giant.

So do all hopes now shift to West and North Africa?

Monday, February 14, 2005

The Wrong Debate?
The controversy over Iran's ostensibly civilian nuclear fuel program aptly demonstrates the linkage between nuclear power and nuclear weapons. While I don't pretend to any particular qualifications for commenting on weapons programs, it doesn't appear that the editors of the New York Times have any, either, based on the confused muddle they published on the subject last week. It won't surprise my regular readers to see me disagreeing with a New York Times editorial, which in this case is probably half right. Unfortunately, the half they are wrong about is downright dangerous.

In particular, their assessment of the adverse implications of designing a new generation of US nuclear warheads seems based largely on wild assertions and wishful thinking. Who can argue that the US isn't at least a bit cynical and hypocritical to push strict non-proliferation at the same time we engage in research on new warheads? But it's foolish to think that Iran and North Korea are seeking nuclear weapons because the US contemplates replacing some of our aging bomb stockpile. These countries are motivated by nationalism, religious or quasi-religious fervor, and a quest for regional advantage, and they would be on this path even if we were disarming much faster than we have been since the end of the Cold War.

The Times chooses to ignore that the warheads deployed on US missiles and submarines today were built before the fall of the Berlin Wall, as their own reporters highlighted in this recent article. This is important, because the designers of these weapons would have reasonably expected them to be superseded in a decade or so--it was an arms race, after all--by newer versions. Durability would have taken a back seat to yield, size and weight, and other operational characteristics. Gradually replacing these aging warheads with new ones explicitly designed to last for many decades would enhance international stability, rather than undermining it, by reducing uncertainty about the integrity of US nuclear weapons .

In focusing their attention on speculation about new warheads, the Times distracts us from the genuine need for a public debate on the proper role of nuclear weapons in the overall US defense posture. Although Russia or China might pose a small strategic threat today, each still possesses a significant nuclear arsenal, as do several of our closest allies. Absent a new cold war, our nuclear arsenal still constitutes an important deterrent against future contingencies. The value of such a deterrent is directly tied to the perception that it would be effective if used. Even if the Congress determines that we should reduce our nuclear weapons inventory by a further 90%, the reliability of the remainder must be as unquestioned fifty years from now as it is today.

Friday, February 11, 2005

Climate Confusion?
The debate over climate change stirred up by the publication of Michael Crichton's new thriller, "State of Fear", continues. (See my postings of 1/11 and 1/27/05.) The Economist (subscription may be required) has chosen an interesting way to put their oar in, not by supporting or refuting the specifics of Mr. Crichton's views, but by attempting to give a sense of the arguments still raging within the scientific community over the details of climate change. After reading their commentary, anyone worried about monolithic conspiracies should come away relieved, but those of us looking for a clearer indication of what might happen and what should be done about it may well worry a bit more.

As anyone close to it will tell you, science is messy and as laden with politics as any human institution. But that by itself is insufficient cause to dismiss the consensus that has emerged concerning the potential for dangerous climate change (or global warming, or global weirding, whichever description you think comes closest to characterizing a very complex set of phenomena.)

The most serious deficiency in the entire debate--not just over Mr. Crichton's book, but on climate change in general--is a clear explanation of exactly what is truly known about climate change and what remains highly uncertain. This explanation should be understandable by reasonably-educated non-scientists and must come from someone with minimal conflicts of interest on the subject. That rules out politicians and bureaucrats, as well as most environmental groups and the media, which has preferred to focus on the most sensational and spectacular predictions. In short, where is the Carl Sagan of climate change, capable of telling this vital story simply and clearly to a wide audience?

Thursday, February 10, 2005

How Much Wind?
Wind power deserves most of the accolades it has garnered as the most attractive green power source. This technology has improved dramatically in the last two decades, to the point that in some locations it is nearly competitive with power from incremental fossil-fuel power plants, even without the subsidies it usually enjoys. But as this article from The Economist describes (subscription may be required), there are other limitations to its spread beyond the NIMBY-ish opposition I've highlighted previously. (See my posting of 5/6/04, for example.)

There are two further potential challenges, depending on how the local power market is set up. The first relates to the difference between the rated capacity of the installed wind turbines and the actual average output, based on local wind conditions that differ from what was expected. The second is a function of the ability of the local power grid to manage the natural variability in the output of wind farms without having to pay for conventional backup capacity that runs up the cost to customers and reduces the effective benefit of wind. The fact that grids are typically public utilities and most new power projects are operated by unrelated companies amplifies this problem.

It should disturb both wind power advocates and potential developers that E.ON, the big German utility, is quoted in the article as experiencing a six-to-one shrinkage of theoretical versus actual wind power due to the combination of the factors above. This suggests that much better planning and coordination are required before new wind farms are built, so that they are put in the locations with the best combination of wind conditions and flexible grid accommodations. Otherwise, the experience of wind farm and grid operators is likely to deter many new installations, forcing utilities back towards more traditional generation sources, such as coal.

Wednesday, February 09, 2005

Finicky Cars
A recent article in the New York Times highlighting the drawbacks of onboard electronics should be mandatory reading for anyone designing advanced technology cars, such as hybrids--or anyone considering buying one. It raises two basic issues: More sensors and actuators (tiny electronic motors) result in more things to break down, and in addition, "Some complaints turn out to be not failures, but features that are difficult to use." Both of these problems can damage customer satisfaction and erode market share and profitability.

Too many of us have experienced the first problem category. I once owned a Toyota Camry with an intermittent electrical fault that periodically shorted out the power to all the accessories, including the air conditioning. It took half a dozen dealer visits to isolate the fault to a single defective chip. Now, this sort of thing is annoying in a car with an otherwise bulletproof reputation for reliability, but it could be a mortal blow to an entirely new model, especially one with a novel powertrain.

The second concern stems from engineering hubris; some carmakers mistakenly believe that if they can do something, they should. Despite a few obvious refinements, the basic "user interface" of steering wheel, pedals, and dashboard knobs and buttons hasn't changed much in fifty years, for good reasons. At 70 miles per hour or on a congested city street, any control that isn't immediately intuitive is a dangerous distraction. Contrast the Toyota hybrid drive screen, which has gotten high marks from critics and owners for the way it displays power status, versus those all-in-one displays that require "joystick" navigation through multiple sub-menus just to change the climate setting.

The introduction of entirely new powertrains, such as hybrids and fuel cells, will create a new set of reliability hurdles, since neither system enjoys the billions of vehicle-years of experience that the standard internal combustion engine (ICE) has behind it. Although the reliability of these new car types should improve quickly--and in the case of fuel cells may ultimately exceed that of the ICE--much of the consumer's experience of owning these cars will be governed by the user interface and accessories, in addition to the new drivetrain, so they present a dual reliability challenge to designers.

While I'm skeptical about the quote from IBM suggesting that within a decade all cars will have essentially the same mechanical systems and differ only in software, it underscores the need for automobile software to be more like that of an Apple computer and less like a Windows PC. After all, on a crowded Interstate highway, the dreaded "Blue Screen of Death" could be just that.

Tuesday, February 08, 2005

Following Through
I'm heartened to see the UN wasting no time following through on the preliminary findings of Paul Volcker's investigation of the Oil for Food Program. With the suspension of the two officials implicated for corruption and wrong-doing, Secretary-General Annan is acting responsibly to salvage the credibility and reputation of the UN in a role for which no other international organization, whether supra-national or non-governmental, has the necessary capacity.

In many respects this is no longer an energy issue, since Oil for Food ended with the US occupation of Iraq. Nor is there any meaningful way to compensate either the Iraqi people or the international community for the great harm committed through the subversion of this critical program. The key issue now is ensuring that future UN efforts on this scale, of which the coordination of tsunami relief is likely only the first example, are scrutinized much more carefully and held to higher standards.

Whether you think Mr. Annan acted from principle or under pressure, he deserves credit for doing the right thing here, and we should see further action following the internal administrative processes. The real test for Mr. Annan may come later, however, depending on how close to home Mr. Volcker's subsequent findings hit.

Monday, February 07, 2005

Earmarked for Whom?
There was another article in the New York Times this weekend citing the tremendous reserves of oil sands in Canada, putting them just behind Saudi Arabia in total oil reserves. (Someone's PR firm is doing a good job, here.) While I still quibble with counting these reserves in the same way as conventional oil reserves, since so much more is required to extract them, there's an even more interesting development suggested in this article in today's Financial Times. A Chinese firm appears interested in purchasing some of these reserves.

Although Canada is hardly the 51st state, I suspect that many of us have assumed that any excess energy production in the Great White North above their local demand will end up down here, as part of the "North American Energy Grid" concept that the Department of Energy has been pushing for the last several years. After all, Canada has been our primary supplier of natural gas imports and an important supplier of crude oil for decades. But as conventional Canadian oil & gas reserves begin to deplete, the high investment costs of extracting the unconventional reserves suggest that they will go to whoever can pony up the cash.

I think there's another unwarranted assumption, concerning the number of facilities that can be built to extract the enormous quantity of hydrocarbons tied up in Canadian oil sands. As the Times article reminds us, oil sands production is energy intensive and emits large quantities of greenhouse gases in the process of making synthetic crude oil, which will emit additional greenhouse gases when it is refined and consumed. Canada is a signatory to the Kyoto Treaty, and at some point Canadians may balk at adding to their emissions pool for the benefit of foreigners, even if the foreigners in question are their neighbors to the south.

So while Canadian oil sands may not exactly be a zero sum game, in which a contract to sell oil to China would displace a comparable volume of sales to the US, they probably aren't an infinite game, either.

Friday, February 04, 2005

How Much Hydrogen?
Although my postings have been pretty petro-centric for the last few weeks, I still intend for this to be an energy blog, not just an oil blog. Where better to seek a bit of balance than with hydrogen, which was in the news frequently last year? On another blog I ran across a recent article from the Financial Times discussing the likely connection between nuclear power and a hydrogen economy. There's also a feature article on this subject in the latest issue of Wired. On the surface, this is hardly welcome news for those who see a hydrogen future as being synonymous with green energy. A few quick calculations will indicate why people might be thinking along these lines.

Let's begin with the assumption that we'd like to replace 100% of gasoline consumption with hydrogen in twenty years. This is highly ambitious but nicely frames the scale of the challenge. The US currently consumes about 9 million barrels per day of gasoline from domestic and foreign refineries. The energy content of all that gasoline is roughly 16 quadrillion BTUs (quads for short) per year. If the hydrogen-powered cars of 2025 were to use energy three times more efficiently and drive about 60% more total miles per year than today's cars (based on long-term trends in vehicle miles traveled), then we'd need to produce 8.6 quads a year of hydrogen for them to run on.

Almost all of the hydrogen used today is produced from natural gas, at an efficiency of about 70%, i.e. 30% of the energy content of the gas is lost in the process. If that still held true in 20 years, then we'd need an incremental natural gas supply of 34 billion cubic feet per day for hydrogen production. This quantity is more than half of current US natural gas consumption. So even with the efficiency improvements inherent in the hydrogen fuel cell, a true hydrogen economy--even just the transportation component of it--will require an enormous new source of primary energy from fossil fuels, renewables, or nuclear power.

Staying with natural gas for the moment, the North American gas industry will have its hands full simply maintaining current supply levels for current uses--electricity generation, home heating and industry--over that timeframe, without adding anything for hydrogen. Since liquefied natural gas (LNG) is the industry's current answer to its supply problems, it's worth noting that the amount of gas cited above for future US hydrogen needs is equivalent to the output of 40 new LNG plants such as this one planned for Indonesia, or about 5,600 fully-loaded LNG tankers per year. Importing even a fraction of this much LNG will be a big challenge, given the resistance that most proposed LNG receiving facilities are meeting (see for example my postings of 11/15/04 and 5/17/04.)

So if natural gas isn't the long-term energy source for the hydrogen economy, what is? Frankly, it's daunting to contemplate getting the approvals necessary to install sufficient new capacity of any kind to fill this gap, whether we are talking about LNG, wind turbines, or solar arrays. All of these, at this scale, will encounter enormous opposition. Of all the options, nuclear power would require the fewest new facilities in the smallest number of locations. Perhaps this explains its attraction for some hydrogen advocates.

Thursday, February 03, 2005

State of Energy
Last night's State of the Union address to Congress was dominated by Social Security reform and the war in Iraq, but also included the following remarks on energy:

"To keep our economy growing, we also need reliable supplies of affordable, environmentally responsible energy. Nearly four years ago, I submitted a comprehensive energy strategy that encourages conservation, alternative sources, a modernized electricity grid, and more production here at home -- including safe, clean nuclear energy. My Clear Skies legislation will cut power plant pollution and improve the health of our citizens. And my budget provides strong funding for leading-edge technology -- from hydrogen-fueled cars, to clean coal, to renewable sources such as ethanol. Four years of debate is enough: I urge Congress to pass legislation that makes America more secure and less dependent on foreign energy."

Now, one can argue about priorities and the proper balance to strike between conservation, R&D, and new production of current energy sources, but it is high time we brought this to closure. Although it wasn't specifically mentioned, the deadlock over the Alaska National Wildlife Refuge (ANWR) is central to the impasse on energy policy and reflective of the competing philosophies involved. The potential now exists for a grand compromise involving tightly controlled drilling in places like ANWR, in exchange for something of comparable value to environmental concerns--something facing comparable opposition from conservatives.

If the gloomier scenarios concerning oil markets are correct, we face a long period of volatile and high prices, due to strong demand growth from the developing world and inadequate additions to reserves and production. Against this backdrop, it is hard to imagine that ANWR's oil will not eventually be exploited. If that is so, does it now make sense to concede on this issue, in return for increased corporate average fuel economy standards, limits on carbon dioxide emissions, or dramatically increased investment in renewable energy?

Our last real oil crisis was resolved through a combination of market efficiency, significant new discoveries in the North Sea and West Africa, and greater reliance on stable suppliers close to home, such as Canada, Mexico and Venezuela. The world is changing again, as China and India compete with traditional markets, as non-OPEC oil production matures and declines, and as some of those regional suppliers begin to look less reliable. The balance of power is shifting back toward OPEC. With or without ANWR, we require clear national priorities on energy, and they will be much more durable if they can be set in a bipartisan way. We can't afford to wait another four years.

Wednesday, February 02, 2005

More Geo-Greens
On Monday I took issue with Tom Friedman's suggestion of a "geo-green" strategy for pressuring Middle East petro-states by reducing oil demand and thus driving down oil prices. Now I find that far from being alone in his views, there's a whole geo-green clique out there, including some neo-conservative heavyweights and keen environmentalists. While I stand by my previous posting on how hard it would be to move the oil demand needle appreciably, it's worth looking at the upside potential.

Start with some history. The last time there was a big push on oil conservation, the result was pretty impressive. After World War II oil demand grew steadily--doubling during the 1960s--until the first oil shock in 1973-74 caused it to stall. It resumed its growth path in the mid-70s, but from 1979, following the Iranian Revolution, to 1989 global oil demand was essentially flat. Along the way, the energy intensity of the US economy dropped sharply, even though the economy continued to grow. Even today, we use fewer BTUs, and certainly fewer barrels of oil, for each million dollars of GDP.

Could a similar drive to efficiency motivated by politics and patriotism, rather than just high energy prices or taxes, slow down or reverse recent trends in energy demand? It's entirely possible, but if we want this to have the maximum benefit, we are looking at the wrong target audience. Although getting Americans to drive more efficient cars and use energy more sparingly would have an impact, we have not been responsible for most of the recent surge in demand. The challenge and opportunity comes from the rapidly growing economies of Asia, and from China, in particular.

Between 2000 and 2004, China's oil demand grew by 2 million barrels per day (MBD), compared to an increase of about 1.3 MBD for the whole industrialized world. As its richest provinces reach the "take-off point" at which the demand for personal mobility soars, this trend will only accelerate. The time for cooperation on conservation is ripe, since China appears at least as concerned about its energy security as we are about ours (see my posting of 1/21/05.)

Getting China and India to develop along a more efficient path is the real prize, and it ought to be a money-spinner, since putting in the best and most efficient technology at the start should be much cheaper than retrofitting them here. In the process, this would do a lot to reduce the rapid growth of greenhouse gas emissions from developing economies, and it may turn out that the Clean Development Mechanism of the Kyoto Treaty is a handy way to transfer these technologies at a profit.

In essence, being geo-green could be quite beneficial and sensible, as long as our concept of "geo" encompasses the entire globalizing world.

Tuesday, February 01, 2005

The Other "Bad Boy"
President Hugo Chavez seems determined to chart a course for Venezuela that brings it increasingly into opposition to the US and our friends in Latin America. He is even finding common cause with Iran, to which I devoted the last couple of postings. Several US oil companies with interests in Venezuela are experiencing contractual difficulties, leading to speculation that Mr. Chavez intends to strengthen energy ties with China and other markets at the expense of the country's historically close ties to the US market. How realistic is this?

Although President Chavez's Bolivarian Revolutionary politics may motivate him to move in this direction, energy economics will make this a costly and difficult proposition. Venezuelan oil is typically much heavier and more viscous than oil from the Middle East, West Africa, or other major exporting regions. This makes it more difficult to extract, requiring large, capital-intensive facilities similar to those involved in extracting Canadian oilsands. Following the crippling 2002-3 strike by employees of the state oil company, PDVSA, a growing share of Venezuela's production has come from these internationally-financed joint venture facilities.

The poor quality of Venezuela's oil also makes it more expensive and less attractive to refine, yielding less gasoline and high-quality diesel per barrel than that of its competitors, without significant prior investment in upgrading facilities. The last time I looked, few refineries in China were set up to run Venezuelan crude oil profitably.

The largest concentration of refineries configured to run Venezuelan crude is in the US Gulf Coast. In fact, a large portion of the Venezuelan crude sent to this country goes to supply PDVSA's subsidiary, Citgo, which has one of the largest service station chains in the US. Diverting exports away from the US would cost Venezuela several times: in lower netbacks on crude sales due to higher freight costs to more distant markets, in larger discounts versus competing oil grades, and in reduced profitability at its US subsidiary, which would have to line up other supplies.

Rather than expecting a move by Mr. Chavez to nationalize US investments or cut off crude supplies to us, I continue to believe that the largest element of political risk involved for US investors in Venezuela's oil industry lies in the prospect that our own government would take action to precipitate a crisis with Venezuela, in response to Mr. Chavez's growing activism in Latin America. Only companies with broad and deep portfolios should be taking on these risks today.