Thursday, November 30, 2006

GM Plugs In

GM's announcement that it intends to build plug-in hybrid cars can be interpreted in several ways. Clearly, some will see this as mere marketing hype from a company that has so far fielded only "mild hybrids" and one true hybrid that is still in its first model year. On the other hand, it may be a sign that GM understands the degree to which it has yielded the technological lead to Toyota and Honda, which have second-generation hybrids on the road and third-generation hybrids on the drawing boards. Given the growing importance of the Chinese market to GM's profitability, and in light of China's new, tougher fuel economy standards, the company that brought us the Hummer might just be starting to get it, concerning fuel economy.

When journalists mention plug-in hybrids, which supplement a hybrid car's recovery and electrical storage of braking energy with an overnight recharging capability, they usually focus on the batteries. These must be more robust than for a regular hybrid, and some engineers argue that they should employ different chemistry, as well, given the very different charge/drain cycling involved in all-electric driving. The other part of this equation, of course, is the motors. In order to deliver acceptable performance (see yesterday's posting) a plug-in must have a fully parallel drivetrain, powerful enough to accelerate the car safely without constantly resorting to the gasoline engine. That redundancy, along with the heavier-duty batteries and electronics, substantially increases the cost premium over "conventional hybrids"--a term that would have been an oxymoron a few years ago.

It's a long way from the Chevy Silverado Hybrid, with its bigger battery and starter motor that provide instant on/instant off at traffic lights--contributing minimally to powering the car while in motion--to a full plug-in hybrid car or SUV. If these mild hybrids and the new Saturn constituted GM's only experience in this area, the road ahead would be very steep, indeed. However, despite all the grief GM has taken for killing it, including allegations of a conspiracy, the EV-1 battery car of the 1990s established GM's bona fides in the field of electric propulsion. The legendary enthusiasm of those who leased that model while it was available represents a strong vote of confidence in GM's ability to produce a practical and attractive plug-in hybrid in a few years, provided GM can remain solvent long enough to deliver on this promise.

Wednesday, November 29, 2006

Endangered Species?

With the Supreme Court due to hear arguments today on a landmark case covering the authority of the EPA to regulate greenhouse gas emissions as pollutants, the San Francisco Chronicle yesterday addressed the question of whether limits on tailpipe CO2 emissions would spell the end of large SUVs, at least in California. While I agree with their assessment that technology can deliver at least the 30% reduction in fuel consumption implied by the emissions limits, they omitted a crucial factor in this equation: consumer expectations. Instead of heralding the end of the SUV, CO2 limits on cars would probably spell the end of large SUVs capable of delivering the car-like performance that has been a key factor in their success.

The case in question hinges on legal interpretations of existing anti-pollution legislation, over whether CO2 and other greenhouse gases constitute pollution that the EPA should regulate, and on the standing of the states to bring suit in this matter. Court-watchers seem to think it will be a close call. If the court finds for the states, the consequences could be far-reaching. It would certainly affect the kind of cars we will drive in the future, and it could even expose the basic process of combustion to product-defect suits. (I can just picture the caveman from Geico's current ads in the docket, defending whether he knew, when he invented fire, that it could harm the planet.)

With regard to the implications for cars in general, and SUVs in particular, the low-cost efficiency technologies cited by the Chronicle have already been deployed, including better fuel injection, and more advanced engines and transmissions. Although all of these have scope for further development, most of the improvements in these areas so far have been employed in the service of better performance, delivering better 0-60 acceleration and passing power, rather than increased fuel economy. As a result, consumers have been able to purchase 6,000 lb. vehicles that drive more or less like sports sedans. That reflects an expensive and sometimes hazardous consumer expectation that moving up to much larger, heavier vehicles entails minimal trade-offs. It ought to be perfectly possible to produce attractive, practical SUVs that deliver substantial fuel savings at a modest increase in sticker price, without resorting to expensive hybridization. What must give, however, is either weight--and thus size--or acceleration.

If consumers were willing to accept 0-60 times over 10 seconds, there's no reason they couldn't buy Tahoes or Expeditions that conform to a future greenhouse gas emissions limit. They just wouldn't be as nimble or fun. That might even reduce the temptation to drive these vehicles beyond the typical driver's ability to react safely to an unexpected hazard or bend in the road, in the process easing the threat that SUVs pose to smaller cars. I'm sure Detroit's design departments will be watching the Supreme Court proceedings closely.

Tuesday, November 28, 2006

Green Skeptics

My holiday schedule precluded addressing The Economist's cover story on alternative energy when it came out last week, but I still feel obliged to comment on several of its points. The title reveals the article's conclusions: "Green Dreams, The risky boom in the clean-energy business." (Subscription may be required.) While extolling clean energy from a societal perspective, they conclude that it isn't such a good deal for those investing in the companies that make it happen. They are right to point out the serious risks involved, as well as some of the ways that government incentives are distorting the market, but I believe they exaggerate the downside and minimize the upside. We are a long way from a ticking Dot-Bomb, here.

As my regular readers know, I think some skepticism is appropriate, at least with regard to the scale of alternative energy's contribution to the global energy market in the next decade or so. Even at current prices, oil, gas and coal won't be easily dislodged from the dominance they've achieved, and non-hydroelectric alternatives start from a very small base, supplying less than 10 of the roughly 450 quadrillion BTUs the world uses every year. But from an alternative energy investor perspective, that looks like a much bigger opportunity than a problem. It suggests it will be a long time before wind, solar, or biofuels approach market saturation, or start to compete seriously with each other, rather than just with traditional energy.

Take solar as an example. The Economist worries that if photovoltaic module production capacity doubles by 2010, as they indicate Goldman Sachs expects, this could lead to a glut of photovoltaic panels (PV). The International Energy Agency reported total global PV capacity at the end of 2005 at 3700 MW installed, with 2005 additions of just over 1000 MW. But in order for solar additions to continue to grow at the roughly 25% annual rate they've experienced in the last several years--which is presumably built into the current valuations of solar companies--then production capacity must at least double by 2010 to maintain that pace, with extrapolated additions in 2011 calculating out to 2800 MW. Moreover, at that rate by 2010 total cumulative PV capacity would still only be about 12 GW, or less than 3% of projected global electrical generation capacity for that year. Now that's what I call headroom.

If a correction in the alternative energy sector is coming, it is much likelier to flow from the vagaries of government policies, rather than from any lack of market opportunities. The longer countries such as Germany subsidize green power by multiples of the cost of conventional power, the greater the likelihood of an unpleasant surprise, later. Investors should focus on technologies and markets that don't depend on unsustainable subsidies continuing in perpetuity, but neither should they ignore the implicit future value of greenhouse gas emissions reductions, which the article mentions only in passing. And while the rapid changes in clean energy technology increase the risk of backing the wrong horse, that's no different than any other start-up in an immature sector. Ultimately, I'd have thought The Economist's skeptical advice would have been better aimed at governments than investors, who have learned a few things since the 1990s.

Monday, November 27, 2006

Nuclear Fusion and Climate Change

Last week, while most Americans were preparing for Thanksgiving, many of the world's leading countries were signing a long-awaited international agreement for an advanced nuclear fusion research program, aimed at producing a commercial fusion reactor within the next half-century. In describing this announcement, the Financial Times cited concerns from environmentalists that the dream of clean (essentially carbon-free, low-radiation) energy from fusion could distract us from the need to address the greenhouse gas emissions from conventional power plants. I suppose I can understand the logic that worries them: climate change is a long-term problem, and fusion is a long-term energy solution, so they might superficially seem well matched. However, that notion doesn't withstand scrutiny, either as a potential advantage of fusion or a drawback of funding this research.

Despite decades of research, we're still a long way from replicating the proton-proton fusion reaction that powers the sun. Fusion researchers have focused on two easier reactions involving heavier forms of hydrogen, the deuterium-deuterium reaction and the deuterium-tritium reaction. The facility formerly known as the International Thermonuclear Experimental Reactor, which still bears the resulting ITER acronym, will employ the latter reaction. While requiring less input energy, it still emits neutrons. So although the radiation from the ITER will be much lower than from a conventional fission power plant, it won't be zero. That will complicate the eventual permitting for any reactor designs that come out of this effort.

Fusion power has always seemed thirty or forty years away, since at least the late 1960s. Producing commercial power from fusion is highly challenging, because it requires solving fundamental problems of science and engineering, not just working the bugs out of existing technology. The nature of these problems makes exact prediction of a breakthrough impossible, as well as rendering the subsequent development timeline highly uncertain. But even if we assume that a commercial fusion plant design will be available by 2045, it might take a further 30-40 years for fusion to displace all coal-fired power plants, and their associated emissions. That's hardly a panacea for global warming.

To make matters worse, climate change involves a high degree of inertia. The carbon dioxide going into the atmosphere today will stay there for a century or more. The recent report from the UK government suggested that atmospheric CO2 concentrations are likely to rise to 550 ppm --double their pre-industrial level--by as early as 2035, without drastic action to mitigate emissions. (While I recently expressed some concerns about the Stern Report's longer-term conclusions, this prediction seems pretty solid.) That means that before nuclear fusion can even become a viable energy option to compete with solar power, wind power, or fission--let alone coal--we will already have emitted enough greenhouse gases to cause serious problems for our great, great grandchildren. In other words, if we're going to solve our climate problem, we must be well on the way before fusion can become practical.

So why bother with it at all? Well, regardless of your views on Peak Oil, fossil fuels are ultimately finite and come with a lot of environmental baggage. While renewable energy sources such as biofuel, wind and solar have tremendous potential, I don't see them replacing the entire energy pie, unless it's a much smaller pie than today's--not just per capita, but in absolute terms. Fusion and space-based solar power constitute our two most promising long-term, large-scale energy options that don't bump into significant constraints from land use, water availability, soil depletion, or aesthetics. Pursuing fusion power ought to be as high a priority as possible, given its very long gestation period and slow progress, irrespective of our concerns about climate change.

Wednesday, November 22, 2006

Thanksgiving 2006

The feature article in last Sunday's Washington Post Magazine struck me as a perfect pre-Thanksgiving topic. It described an environmentally-based "intentional community" called Earthaven, in the Blue Ridge Mountains of North Carolina. Its members practice a low-energy lifestyle to a degree that few of us would willingly embrace, but which they apparently regard as virtually inevitable, based on current trends of environmental damage and oil depletion. The article serves as a reminder of the degree to which the rest of us treat reliable and plentiful--if no longer cheap--energy as an entitlement. We might reflect on that during Thanksgiving celebrations reflecting our remarkable abundance, in global or historical terms. At the same time, I wonder how healthy it would be to focus on energy and its environmental consequences to the extent that the Earthaven'ers have done.

While I'm not about to give up cars, air conditioners, television, and the other trappings of modern life, I respect those who are willing to live out their convictions about reducing their impact on the planet. As I read the article, though, I found myself tabulating the items in their community that wouldn't be available if the whole country followed this path. Laptop computers and rooftop solar arrays, for example are the fruits of a high-energy civilization, not subsistence farming. Although I wouldn't characterize Earthaven as a survivalist community, I was nevertheless reminded of the post-apocalyptic fiction I used to read, in which the survivors of some global disaster cherish their remaining technological tools, knowing they can never replace them. As the article's author points out, it's just not possible for all the world's inhabitants to live this way. We need large-scale agriculture and large-scale industry to support 6 billion people, on our way to 8 or 9 billion.

As much time as I spend focusing on energy and the environment, I hate to think what would happen if everyone were equally focused on these topics. There's got to be a middle ground between obsession and indifference, though, where Americans can incorporate energy and environmental factors into their decisions, without dwelling on them morbidly. The means of doing this, consistent with our market-based society, is to translate their impacts into transparent financial terms. Give people real-time electricity metering with time-of-day pricing, and let them see how much power that plasma TV or old refrigerator is really using, and how much it costs. Give them tools for identifying and offsetting or reducing their greenhouse gas emissions; TerraPass is a great first step in that direction. Posting lifetime greenhouse gas emissions on new car stickers, alongside the EPA gas mileage estimates, couldn't hurt, either: 20 tons of CO2 in 100,000 miles for a Toyota Prius, 40 tons for an average sedan, and 75 tons for a large SUV.

The Earthaven concept is admirable but unrealistic for most of us. That doesn't preclude a moment of gratitude this Thanksgiving for the electricity or natural gas that roasted the turkey, and the petroleum products that fueled the plane or car that took us to grandmother's house--while remembering the contribution that each of those made to warming the earth. That might sound corny, but even a modest increase in energy and environmental awareness might alter our behavior, which remains the biggest near-term factor in addressing our energy and environmental problems--more than any new technology.

Happy Thanksgiving to my US readers. New postings will resume on Monday.

Tuesday, November 21, 2006

New Flight Plan

As one of my readers likes to remind me periodically, those of us who worry about energy consumption and greenhouse gas emissions tend to give air travel--and its growing consumption of jet fuel--a free pass. Whether that has been due to the lack of practical alternatives to burning petroleum distillates in jet engines, or simply the strong relationship between air travel and economic growth, it looks set to change. The proposed European Union plan to cap the greenhouse gas emissions of all airlines flying on its territory represents the first effort to make commercial airlines accountable for environmental impacts other than noise. This milestone should not come as a surprise, given the EU's consistent responses to climate change. As the Wall Street Journal indicated, the aviation emissions cap is shaping up an another trans-Atlantic dispute, but I would not bet on the EU backing down, here.

The impact of all this on the structure of the airline industry is uncertain, affecting startups and incumbents unevenly, and creating further advantages for companies with newer fleets. Since emissions follow fuel consumption in direct proportion, the new regulations could hasten the adoption of the latest generation of ultra-efficient aircraft. Both Airbus and Boeing have been reducing per-passenger fuel consumption by employing fewer, more efficient engines and by replacing aluminum with composites to cut aircraft weight. These strategies have already paid dividends during the last couple years of high fuel prices, but the new 787 and struggling A380 represent the current limits of these trends. Focusing on aircraft emissions may stimulate interest in even more exotic airframes, such as the flying wing described in a recent Economist article, but such changes are more fundamental than even the switch from propellers to jet engines.

Details matter. If the EU draws the envelope solely around airline emissions, as seems the case for at least the initial phase--eliminating the possibility of emissions trading with other sectors--then the cost of reducing aircraft emissions will be needlessly steep. Once the maximum practical efficiency of seat-miles per gallon has been reached with the existing fleet, further cuts must come from either reducing seat-miles traveled, or turning over airline fleets. If a doubling of jet fuel prices since 2003 hasn't been sufficient to achieve this, then the effective jet-emission credit price necessary to clear the market could prove to be much higher than the $20-30/ton CO2 we've seen for the reductions required in other sectors, such as utilities and heavy industry.

The US government's response isn't any more surprising than the EU's move to impose an emissions cap on air travel. Rather than trying to block the effect of this change on US airlines, however, we should be working with the EU to improve the design of its cap mechanism, to make it as efficient and low-cost as possible. The clock is running out on attempts to block measures to combat climate change, but that doesn't mean we should accept a high-cost solution.

Monday, November 20, 2006

Energy Inter-Dependence and the Arrow of Globalization

The current California Magazine, published for the University of California's alumni association, features an article on the foreign policy challenges facing the next administration. Towards the end of their interesting analysis, Steven Weber and Michael Zielenziger raise concerns about the inevitability of globalization and its future direction, "There could be at least 3 billion people who believe, rightly or wrongly, that they have nothing to lose, and probably something to gain, from a decline in American influence and a backward trajectory of globalization." If they are right, this would have profound implications for energy, along with the rest of the US economy. Although pundits and politicians of every persuasion are calling for energy independence, our current energy strategy is inter-dependence, and is thus highly vulnerable to upheavals in global trade patterns and markets.

Dr. Weber and his colleague also provide some cogent thoughts about the evolving US relationship with China and offer worrying reminders about how previous emerging powers, such as Germany, were accommodated into the international system. In any case, as the authors point out, China now has as much influence on energy prices as Saudi Arabia. Along with the US, it has benefited enormously from the last twenty years of globalization, but that does not mean it shares our commitment to the mechanisms of globalization. China competes in the global market for access to the same oil supplies that we seek, both at the resource level and at the commodity level. But it is clear that their preference is for long-term bi-lateral agreements, effectively government to government, over the free market trade in oil that has been the backbone of US energy strategy since the 1970s.

If the world retreats from globalization and the smooth, transparent markets it creates-- whether led by the 3 billion disenfranchise people that Dr. Weber worries about, or as a result of populist-inspired protectionism in the developed world--then energy suppliers will default increasingly to the model that favors China, rather than us. That would diminish the ability of the global oil market to rebalance after a hurricane or some other event disrupted our oil supplies, forcing us to rely more on our Strategic Petroleum Reserve, which, as we saw recently, cannot support the West Coast. Until we can turn all of the recent rhetoric of energy independence into reality--a task requiring great patience--we need to shore up, rather than tear down, the global economic system that keeps our energy lifeline flowing.

Friday, November 17, 2006

Peak vs. Plateau

I've been writing about Peak Oil since I started this blog, nearly three years ago. Over that period, three distinct camps have emerged, each with different views of the theory of Peak Oil and its predicted outcomes. The perspective of Cambridge Energy Research Associates (CERA), which issued its latest report on the subject this week, stands roughly halfway between those of the latter-day exponents of M. King Hubbert's landmark analysis and the "cornucopians," who argue that the very concept of a peak is either incorrect or irrelevant. My own agnosticism about a geological peak in global oil production positions me near the CERA camp, but with important distinctions arising from my experience in trading commodities and in planning alternative energy projects and strategies. Even if CERA is right to dismiss the possibility of an imminent peak, we still face potentially severe market dislocations, with barely enough time to plan an adequate response.

Much of this argument boils down to how much recoverable oil was in the earth's crust when we started extracting it, nearly 150 years and 1 trillion barrels of consumption ago. (Now there's a sesqui-centennial to mark.) If the correct figure is 2 trillion barrels, then we're either on the verge of a Peak or have passed it. If it's 4.8 trillion, as CERA suggests, we're not even in the foothills. And if it's 12 trillion, then we'd better worry more about the environmental impact of burning it all than about running short--though many in this camp also see climate change as a non-problem.

Earlier this year, I suggested that Peak Oil was taking on many of the features of Y2K, in its predictions of a global discontinuity and the range of personal reactions to a perceived impending crisis. It also reminds me of the state of play on global warming 10 or 15 years ago, when the science was much less clear and the environmental signals less obvious. In Peak Oil we see multiple competing views of a geological effect that cannot be characterized with precision or certainty until its worst effects are either upon us, or have clearly failed to materialize.

The key event from a market perspective, however, is not the actual peak of production, but the point at which supply can no longer keep pace with demand. After the recent capacity crunch that took us to $80/barrel before retreating, we can begin to guess what that might bode. In that regard, CERA's "undulating plateau," which seems more realistic than the sharp tipping point inherent in most Peak Oil predictions, is potentially almost as catastrophic. Just look at the production graph in CERA's press release on Wednesday. At current growth rates, adding almost 2 trillion barrels to recoverable global oil resources only buys us another 20 years or so of keeping pace with demand. An undulating plateau postpones an immediate geology-driven oil-supply crisis, but it doesn't let us off the hook.

The most important sentence in CERA's press release is this one: "It will be aboveground factors such as geopolitics, conflict, economics and technology that will dictate the outcome." When you contemplate the additional reserves shown in the included table, these factors loom large. Unless the OPEC countries change their policies on access to their reserves, their contribution to incremental production will be modest, at best. Unless Canada's oil sands can be recovered with less environmental impact, in terms of facility footprint and greenhouse gas emissions, only a fraction of those 167 billion barrels will reach market. Unless Venezuela's government adopts a more investor-friendly posture, the many billions of dollars required to produce its Orinoco ultra-heavy oil and convert it into something that a refinery can process won't be forthcoming. Factor in the impact of offshore drilling bans and other restrictions that could spread beyond the US, as global environmental awareness increases, and you have to wonder how much of the 3.74 trillion barrels of potential extra oil will really materialize.

I'm sure that the Peak Oil community will respond to CERA's statements. The Oil Drum is a good place to watch for that. But for me, there's a clear take-away here. Whether we are at the 5-yard line on the Peak Oil side of the field, or on CERA's 5-yard line, the whole field only spans 25 years--and possibly much less--during which the global oil industry can keep pace with the present rate of demand growth, much of which is coming from developing Asia. I have to hope CERA is right, because 25 years is not nearly long enough to displace oil entirely, or for something like nuclear fusion to bail us out, unless the key breakthrough has already been made. In fact, it's just barely long enough to implement enough efficiency and alternative fuel technology--biofuels and electricity, with a dash of H2 thrown in--to stretch out this timeline and avert the hardest landing since the Great Depression.

Thursday, November 16, 2006

Hydrogen Hurdles

Regular readers of this blog know that I'm no fan of hydrogen-powered internal combustion engine cars. BMW is the leading proponent of this strategy, the flaws of which I described recently. That's not why you should read this road test of BMW's latest hydrogen-capable 7-Series sedan in MIT's Technology Review. Rather, it's a great illustration of the many hurdles that remain before any hydrogen car, whether ICE or fuel-cell based, can be truly practical and suitable for the mass market. Echoing the sentiment of the reporter, I wish that weren't so, but it is. This reality shatters some predictions I made eight years ago.

In the late 1990s, Texaco undertook its first corporate-level scenario planning effort, and one of the key findings--along with the growing importance of climate change as an issue--was the possibility of major changes in transportation energy systems. Fuel cells were front and center in this view of the future, and with them the prospect of an emerging hydrogen economy. No one involved in the project was naive enough to think this could all happen overnight, but there were good reasons to believe that by the middle of the current decade, hydrogen-powered cars could be available to ordinary consumers, who would be attracted by their combination of environmental benefits and novel technology. I expounded that view to Texaco's top management and in sessions with employees at all levels. What happened?

Well, as the TR piece reveals, hydrogen is a tricky beast, a tiny molecule that behaves quite differently than the much larger fuel molecules we're used to handling: methane, propane, or the molecular soup found in a gallon of gasoline. H2 is expensive to make, inefficient to store, and elusive enough to escape from any ordinary fuel system. When my colleagues and I looked at this in the '90s, there were two obvious ways around the storage problem. One involved making the H2 onboard the vehicle out of something easier to handle, such as gasoline or methanol, and never storing it at all. The alternative was storing it chemically, rather than mechanically, through adsorption in a solid metal-hydride material. Texaco funded research on the former path and bought a share of a company with the key technology for the latter, at least partly on the strength of the vision laid out by my team.

Both of these paths are still possible, though you don't hear as much about onboard H2 production or "reforming," because it still entails vehicle exhaust other than water, and it's nice to be able to claim a car is "zero emission"--even if there are lots of emissions upstream of it. Without getting into the technical details, however, neither of these paths is quite ready to compete with cars that use the utterly reliable petroleum products value chain. Frankly, although it's workable today, the liquid hydrogen storage mode chosen by BMW is ludicrously bad. Would you buy a gasoline car if half the fuel evaporated every week and you couldn't park it in an enclosed place? That's what you get with cryogenic H2 storage. You might just as well burn dollar bills. Compressing the H2 to 10,000 psi isn't much better, in terms of the energy cost involved and the perceived safety. And those are the best two options for hydrogen today, in terms of technology readiness.

You would be right to think that my experience with this has made me less sanguine about the inevitability of a hydrogen economy, or the rapid adoption of any radically different transportation energy system. That's not because I'm embarrassed about having made some aggressive predictions that didn't pan out, but because I've learned something from it. Every system has an inherent lag time, and the general public's model of technology change has been overly influenced by the electronics industry. Even there, we've ignored all the years that products like VCRs and cellphones spent in the laboratory and in field trials. Hybrid cars have avoided this trap and done at least as well--so far--as I expected in 1997, because of their compatibility with existing infrastructure, which appears to be the "rate-limiting step" for alternative fuel vehicles. That has implications for the success of biofuels, too.

Wednesday, November 15, 2006

Prospects for an OGEC

An interesting article in yesterday's Financial Times (subscription may be required) raises--and then partially demolishes--the idea that producers of natural gas might band together in a cartel similar to OPEC, in order to control the future supply and price of international gas. Concerns about Russia's intentions seem to be the main driver, here, and at least for Europe, these are quite legitimate. But while the FT accurately skewers the notion of an OGEC from the perspective of the current international gas business, dominated as it is by long-term contracts for pipeline gas and LNG, I wonder if they lack the necessary imagination to see how it could be made to work in the future.

I'm no expert on the history of OPEC, but when it was formed in 1960, the international oil industry looked quite different from today's. Global trade in oil was dominated by the major oil companies--the so-called Seven Sisters of BP, Chevron, Esso (Exxon), Gulf, Mobil, Royal Dutch/Shell and Texaco. In their glory days, these companies controlled proprietary value chains from wellhead to gas station, not unlike today's LNG value chains. The founders of OPEC foresaw a different world, in which nations owned not only the resource in the ground, but also the means of getting it to market and capturing much of its value added. In this regard, they were more accurate forecasters of the future than the corporations whose assets they subsequently nationalized, and which 30 years later had merged down to four survivors in order to compete with the big national oil companies.

Several of the factors the FT cites as hurdles to forming an alliance of gas-producing countries seem either temporary or superficial. Although most LNG is tied up on long-term contracts, many of which are pegged to oil prices, the number of "spot" cargoes is on the rise, as producers de-bottleneck their facilities to squeeze out extra volumes, outside their contractual commitments, and as contract-holders learn to optimize the value of their offtake by taking advantage of arbitrage opportunities. At the same time, having to attract project investors may be less constraining than suggested. The majors have been frozen out of many of the best remaining oil prospects, and they are turning to LNG to create bookable reserves to fill the gap. As long as gas resource owners offer access, and on terms at least as generous as those available for oil, the integrated international companies will sign up.

The biggest impediment to the effectiveness of a future OGEC may be more fundamental. Oil still enjoys a near monopoly on the transportation fuel market, and biofuels and synfuels will be a long time breaking it. Gas has no comparable lock on its markets. Current gas consumers and their suppliers are locked in an embrace that is tantamount to Mutual Assured Destruction, but when, for example, power plant developers doubt the future affordability or availability of gas, they build coal, wind, nuclear, or some other capacity instead, and the associated potential gas demand disappears. Gas left in the ground due to greed is nearly worthless. This difference may not rule out an eventual OGEC, but it implies that it should be more user friendly than OPEC has been.

Tuesday, November 14, 2006

Signs of Change

I almost missed a major signal of the changing energy landscape. The new CEO of Archer Daniels Midland (ADM) has apparently argued that ethanol should not receive special treatment or preferences from governments, in competing with fossil fuels. This is a remarkable statement from a company that made one of the earliest and biggest bets on the sustained value of the US federal government's subsidies for manufacturing ethanol from corn, and that spent quite a bit of money over the years promoting their continuation. If you are still looking for a sign that alternative energy, and ethanol in particular, are becoming mainstream, look no farther. This comment also heralds the coming globalization of alternative energy. That could change the political dimension of biofuels dramatically, expanding it beyond the realm of domestic agriculture and into the minefield of international trade issues.

ADM is already one of the most successful alternative energy businesses in the country, perhaps the world, with the company's ethanol business segment contributing roughly a quarter of their 2006 before-tax profit of $1.9 billion. GE's combined "Ecomagination" package is probably larger in total, but it's spread across a broader range of technologies and businesses, not all of which are truly "alternative." In any case, ADM is by far the largest player in the US ethanol business, but with aspirations to be a global energy leader. That will require a different model.

So what does it mean when one of the largest beneficiaries of ethanol tax credits calls for a level playing field? It's one thing to hear this from Vinod Khosla, who has investments in both conventional and cellulosic ethanol, but quite another coming from ADM. It's certainly consistent with the view that Pat Woertz would have brought with her from her experience running Chevron's global refining and marketing business, but I think there's more to this than just a change at the top. Biofuels is going to be a major global industry, and the US isn't necessarily positioned, either by climate or labor and other input costs, to be the long-term global cost leader in biofuels production. There's no "organic ethanol" angle to leverage premium consumer preferences; as ethanol moves out of the small niche it has occupied, it will encounter the brutal realities of a global commodity business, from which decades of substantial government subsidies have insulated it.

Now, Ms. Woertz may not exactly be calling for an end to those subsidies, but in the long run, companies like ADM stand to gain from their elimination in combination with the end of the tariffs that keep Brazilian ethanol uncompetitive in most of the US market. Domestic ethanol will continue to enjoy a logistics advantage in much of the country, but increasing supplies of imported biofuels would help consumers on the coasts and give the industry greater incentives to push ahead with more efficient processes that use energy crops and waste, rather than grain, as their feedstock. The larger question is how this new notion of "equal footing" will mesh with the wave of populism and free-trade skepticism that contributed to last week's electoral triple play.

Monday, November 13, 2006

Lame Ducks

The lead editorial of this morning's New York Times serves as a reminder that the current Congress has unfinished business on energy legislation. While I disagree with the way the Times characterizes the pending offshore drilling bills, they are right to point out the major differences between the Senate and House versions, and to question whether changes as sweeping as those contemplated by the House in HR-4761 should be rushed through in a "lame duck" session. Both Houses will undergo a change of leadership and a significant reshuffling of members in the new session, and neither the new Congress nor the industry will thank the outgoing Congress for provisions that could be quickly rescinded next year. Although it never percolated up to a major election issue, our national policy towards offshore oil and gas drilling is indeed due for a major overhaul, but in order for the results to be durable, this should be done openly, following an exhaustive public debate.

As with so many other energy issues, the American public and our leaders are schizophrenic about offshore drilling. We're happy to allow it to proceed off the Texas and Louisiana coastlines and the Cook Inlet of Alaska, but virtually nowhere else. We're pleased to consume the fruits of offshore drilling in the waters of the North Sea, Nigeria, Angola, Brazil and Australia, but not Florida. We benefit from the existing oil wells off California's coast, but we won't tolerate new ones there. Inconsistency is the rule, not the exception. Nor are our perceptions about the risks of offshore drilling guided much by data on its actual environmental performance, or by the tradeoff between these risks and the risk of oil spills from the steadily growing number of oil tankers bringing the imports that our offshore drilling policies help to foster, let alone the environmental risks associated with oil sands recovery or coal liquefaction. The case for an overhaul is clear; the means and timing are all that are in doubt.

In an interview in Saturday's Wall St. Journal, Senator Schumer suggested that in the 110th Congress, drilling reform might be possible in the form of a compromise involving expansion of the allowed drilling zone in the Eastern Gulf of Mexico, in exchange for stronger vehicle fuel economy standards. In spite of the practical limitations on CAFE standards that I mentioned last week, that's a promising line of thought, and one I've been pushing for some time with regard to the Arctic National Wildlife Refuge. Sen. Schumer, who along with 17 other Democrats voted for the Senate version of drilling reform, S-3711, identified the need for both supply- and demand-based solutions, according oil drilling its legitimate role in enhancing our energy security.

At the same time, it's important to keep in mind the need to balance our risks. Since achieving meaningful energy independence would require decades, our energy security must for now rely heavily on diversification--as it has in the past--and that ought to include diversification against the risks of over-concentration of our energy assets. That's particularly true of our vulnerability to Gulf Coast hurricanes, which climate scientists suggest will grow in intensity, if not necessarily frequency, as a result of climate change. I would feel more secure if revamped offshore drilling regulations opened up some areas that were less prone to storm damage and disruption of the type we've exerienced in two of the last three years.

So the choice is between a radical overhaul of offshore drilling policy in the final moments of the Republican Congress, or a possible compromise including more modest expansion of drilling in the new Democratic Congress. As tempting as the former might be, it could poison the broader energy policy debates that must follow. From my vantage point, having followed these issues for years, if we don't create a genuinely bi-partisan, pragmatic approach to energy, the only certainty will be continued volatility for the industry and for consumers.

Friday, November 10, 2006

Inter-Generational Responsibility

The debate over the recent UK study on the costs of global warming continues. In today's Washington Post, Robert Samuelson--no slouch on economic matters--finds the Stern Report misleading, and describes its findings in the harshest terms. He raises three issues that can't be easily dismissed, whether you accept Dr. Stern's conclusions or not. One, in particular, gets very close to a central dilemma of climate change politics: as Mr. Samuelson puts it, referring to citizens of the developed world, "They have to accept 'pain' now for benefits that won't materialize for decades, probably after they're dead." That puts climate change into the same category of inter-generation equity issues that democracies have struggled with since time immemorial.

Dr. Stern's team, along with others like Vice President Gore, seem to recognize this as the key hurdle in gaining acceptance for prompt action to combat further warming. The former have produced a report that telescopes possible future consequences into very high estimates of the current cost of the emissions that promote warming, while the latter focuses on high-impact but low-probability outcomes in the near future. The risk, as I've suggested previously, is that these approaches inflate our expectations of events that are unlikely to deliver on the foretold outcomes. If these predictions don't come to pass, public patience could abate quickly, just as it has on Iraq.

I'm in my late 40s, but my daughter is three. If NASA determined that there was a 5% chance that the earth would be struck by an asteroid in 50 years, I would do everything possible to make sure that we could divert the orbit of that or any other celestial body that threatened our planet, even if it meant a crash program costing 10% of global GDP. Now, I know that my life expectancy gives me about the same odds of seeing 2056 as the odds I gave that hypothetical asteroid of hitting us, but that wouldn't diminish the urgency of response in my eyes. My posterity would be at stake. The worst potential outcomes of climate change are no less hazardous for my daughter and her descendants. If we frame this issue correctly, presenting the near-term risks as manageable, but the long-term risks as life or death, I think we can get the public interested in doing the right thing inter-generationally, even if we can't get them focused on fixing their own retirements. And by the way, we don't spend nearly enough on averting the risk that killed the dinosaurs.

Thursday, November 09, 2006

Changing the Equation

One of the comments on yesterday's posting--actually a comment on a comment--cited the importance of higher efficiency standards, reminding me that I had focused mainly on energy supply, both conventional and alternative. Demand-side measures such as an increase in the Corporate Average Fuel Economy (CAFE) standards will likely also be in play in the new Congress. For these to be successful, we need to understand the limitations of such measures, and why the existing CAFEs worked to the degree they have. As I've tried to demonstrate periodically through analysis of constraints such as the size of the vehicle fleet and how long it would take to push even modest fuel economy improvements through it, changing standards without changing consumer behavior won't shrink our addiction. It may not even halt its continued growth.

Here's an example of the hurdles we face. The other day, I was surprised by a Wall St. Journal article suggesting that, for those who want one, now is the time to buy an SUV. Unfortunately, on a purely rational economic basis, they're right. Gas prices have fallen, and even if they were to go up again, the discounts offered on large SUVs are sufficient to cover all but the most extreme fuel increases for the life of the vehicle, or at least as for the duration of the car loan. If we can't come up with the arguments or policies that make that calculation much less attractive to consumers, then we face a long wait, indeed, before technology can dig us out of the hole we are creating at the rate of 8 million new SUVs per year.

When the CAFE standards were first introduced in the 1970s, the average fuel economy of the US car fleet stood at roughly 14 mpg. From 1977 to 1985, new cars improved to an average of 28 mpg (highway). Over that period the total number of cars on the road also grew from 125 million to 165 million. The net of all that improved average fuel economy for the whole US car fleet to 20 mpg by 1990, ignoring the growing SUV segment, which achieved 16 mpg. (The current figures are 22 and 16, respectively.) So before they stalled out, CAFE standards increased overall fleet fuel economy by about 5 mpg over 15 years. But that's not the whole story; we need to ask whether they did this by themselves, or required some other factor to achieve even this fairly modest improvement.

The answer is that carmakers didn't simply force more economical cars on consumers; consumers had real incentives to drive thriftier cars. Not only had fuel prices almost doubled in real terms between 1973 and 1980--actually tripling in nominal dollars--but motorists had also experienced periodic disruptions in fuel availability, with stations closed, subject to long queues, or employing rationing techniques such as the odd/even license plate system. In other words, buying a car that used less fuel and went farther on a tank was worth both money and convenience. Once deregulation erased those inefficiencies, and collapsing oil prices brought gasoline prices back to earth, the incentives to drive "econoboxes" dried up and progress on CAFE stalled.

So if we increased CAFE standards by phasing in more stringent targets, closing the "SUV loophole", or both, what would motivate consumers to change their habits and buy the efficient cars that automakers will be required to make available? For that matter, what would prompt someone today to buy a 30 mpg car--of which there are plenty to choose from--rather than an SUV getting 16 or 18? What are the economic and convenience factors necessary to balance the current cost-benefit ratio that favors SUVs, while we await the arrival of future vehicles conforming to stricter CAFE standards? And how much better must these new cars be, in order to boost overall fleet fuel economy by more than 5 mpg in 15 years? The history of this program suggests that it can't be effective in isolation; higher CAFE targets must include carrots and sticks for consumers, not just carmakers.

Wednesday, November 08, 2006

The Next Two Years

The Democrats have won the House of Representatives by a solid margin. Control of the Senate may come down to recounts in Montana and Virginia, but even if their lead in both these races evaporates, they end up with a one-vote deficit. Although energy wasn't as large an election issue as it might have been had fuel prices remained where they were in August, it was still one of the main topics on which the Democrats campaigned, and it features in Speaker-presumptive Pelosi's plan for the "first 100 hours" of the new Congress. It's hard to gauge the degree to which energy policy in this country will change without knowing who will run the Senate, but there were clear signals in the Democratic effort to take the House. Superficially, the result looks negative for US oil and gas interests and good for alternative energy.

For the oil industry, and for the Supermajors and large integrated firms in particular, scrutiny on prices and profits will increase, and tax breaks will vanish. During the campaign, Nancy Pelosi talked about rolling back $12 billion worth of tax benefits for the industry as one of her priorities for the first few days of the 110th Congress. If the House can accomplish that without running afoul of a reluctant Senate or a Presidential veto, then it will deprive the industry of incentives that certainly appeared to be frosting on the cake over the last couple of years, but that could prove significant if oil prices continued to drop. It's easy to forget that when some of these measures were granted, including the royalty relief that has become so controversial, oil prices were well under $20 per barrel. Many of the projects that are coming on-stream now were planned during that period.

As disappointing as this outcome might be for many oil and gas companies, the industry is adaptable and will soon figure out how to work with a Democratic Congress, as it has many times before. For the time being, however, the 109th Congress appears to have been the high-water mark for greater access to drilling opportunities in the US. There are still Senate and House versions of drilling bills that must be reconciled in the lame duck session, and whatever comes out of that conference will be as good as it gets for drilling in the next two years. It is noteworthy that a major sponsor of the House offshore drilling bill, Representative Pombo (R-CA) appears to have lost his seat. It hardly seems necessary to add that the chances of drilling in the Arctic National Wildlife Refuge have moved from barely possible to extremely remote.

The picture for alternative energy firms looks brighter. Although I'm not sure that last night's shift improves prospects for wind or solar power, which already benefit from a wide variety of state-level initiatives, including widespread Renewable Portfolio Standards for electricity generation, biofuels look like the big winner. While efforts to add to domestic oil production are likely to stall, aggressive promotion of ethanol and biodiesel will enjoy strong bi-partisan support and seems unlikely to attract a veto. Look for more generous incentives for ethanol, including tax breaks for E85 infrastructure. Still, the defeat of Proposition 87 in California, the largest "blue state", sends some kind of signal about how alternative energy should be funded.

On the environmental front, we should expect the new Congress to push for aggressive enforcement of existing regulations, and no one should be surprised to see legislation for a stronger national response to climate change emerge between now and the Presidential election in 2008.

On balance, the implications of last night's electoral shift may be less significant for energy investment policies, than for demand-side initiatives that have languished for years. Changes to Corporate Average Fuel Economy standards and gas taxes could be back in play, soon. The government's response to a future energy crisis, whether in the form of a cutoff of exports from Iran or Iraq, or another devastating Gulf Coast Hurricane, may also alter. The outgoing Congress was solidly committed to letting the market manage disruptions, and as uncomfortable as fuel prices got for many Americans, we didn't see a repeat of the gas lines of the 1970s. Even though the incoming Democrats reflect a broad mix of populists and fiscal conservatives, a Democratic Congress would be tempted to intervene in a future crisis--or must at least explain to their base why they wouldn't do so.

The next two years should be very interesting for the entire energy industry. I'll be posting much more on this in the next few weeks.

Tuesday, November 07, 2006

Assessing the Assessment

Last week I highlighted the publication of a UK government report on the costs of global warming and the potential benefits of mitigation efforts. I promised to revisit the Stern Report once I'd had a chance to review it in more detail, and I'm still in the process of doing that. 600 page economic studies don't make for light reading, so I'm still wading through the executive summaries and methodology. In the meantime, both the Wall Street Journal and The Economist have taken the Stern Report to task for various shortcomings, the former via an op-ed by Bjorn Lomborg, of "Skeptical Environmentalist" fame, and the latter in a couple of articles (subscription required) in their November 2nd issue, which concludes that the report is largely aimed at bringing America back into the global climate change process. My own concerns relate to my professional pursuits in scenario planning, but although they undermine my confidence in some of the specific findings of the Stern Report, they do not invalidate the entire document.

Scenario planning, which traces its origins to Herman Khan's work on "thinking the unthinkable", grew out of a general dissatisfaction with deterministic forecasting and its inherent limitations, which haven't been erased by the development of increasingly sophisticated models and faster computers on which to run them. The Stern Report's picture of economic models layered on top of climate models, all of them dealing with highly uncertain and, indeed, chaotic relationships, extrapolated 20, 50, 100 and even 200 years into the future, and then discounted back into the present, creates endless opportunities for the compounding of errors. This reminds me of numerous detailed-but-flawed efforts to predict the future price of oil.

I give Dr. Stern and his colleagues all benefit of the doubt for their expertise, seriousness, and skillful application of their chosen methodologies, but ultimately there's a world of difference between accuracy and precision, as the report acknowledges. For all the report's talk about accounting for risk, it's not yet obvious to me that this has been done in line with state-of-the art approaches that would explicitly incorporate scenario planning and/or Real Options. The "scenarios" referred to in the report's discussion on methodology look more like forecast sensitivities or "cases", which are not the same thing at all in either construction or use.

Pending a more thorough review of how the report's figures were derived, I suspect they exaggerate the likely benefits of aggressive greenhouse gas mitigation--while possibly also underestimating the worst-case impacts, the prevention of which would have nearly incalculable value for society. That's not because of a bias on my part, but due to the way extreme outcomes get blended into probabilistically-derived expected values. As a result, I regard the report as strongest not in the numerical findings that were its raison d'etre, but in its practical, common-sense recommendations about how to go about reducing the risks of adverse climate outcomes. Nor does it see investment in strategies to adapt to a warming planet as antithetical to emissions reduction, but rather views the former being necessitated by the time lags inherent in the latter.

The report also makes it clear that we can't solve this problem via the back door of energy security, because existing hydrocarbon stocks are more than ample to create atmospheric GHG concentrations consistent with the highest, most worrying temperature projections. In other words, shifting away from conventional oil and exploiting oil sands, shale and coal for transportation fuels without addressing the greenhouse gas consequences of these high-carbon alternatives will put us deeply in the soup, with no easy way out later.

Interestingly, the Stern Reports ends up being a de-facto argument for further globalization, because its prescriptions for the kind of truly international effort required to address climate change rely heavily on increasing the interconnection and transparency of global markets for climate-related financial flows, both of investments and of derivative instruments such as tradeable emissions credits, along with channels for the transfer of technology.

Unexpectedly, the greatest value of the Stern Report is probably in its effort to shift the climate debate out of the bailiwick of the physical sciences and insert it into the political economy. That doesn't mean that the science won't or shouldn't advance, or that there won't continue to be unresolved concerns about the science, such as those regarding the "paleoclimate" described in this lengthy article in today's New York Times. But while the scientists must advise on them, they aren't going to be the ones implementing the solutions. That falls into the equally complex realm of governments that must juggle the health of economies, the well-being of populations--human and otherwise--and at least in the case of the democracies do so in a manner consistent with the wishes of their electorates. Whatever the ultimate consensus might be on the "social cost of carbon", in the sense of carbon emissions to the atmosphere, it is no longer and never again will be zero. Our political systems must catch up with that fact.

Monday, November 06, 2006

Unintended Disincentive?

A few weeks ago, I looked at the prospect for near-term oil savings and suggested that diesel cars, which have languished for years in this country, might be ready for prime time, thanks to some fuel and engine technology upgrades. Diesels could even beat hybrids, because they deliver the most valuable tranche of fuel efficiency at a much lower up-front cost premium. Unfortunately, that argument failed to consider that traditional price relationships between gasoline and diesel fuel might be shifting. If diesel remains as expensive relative to gasoline as it is today, carmakers' plans to sell hundreds of thousands of European-style diesel cars and diesel-powered SUVs may be frustrated, along with the efficiency gains they would have delivered.

Over the last five years, a gallon of diesel fuel has cost, on average, 5 cents more than a gallon of regular conventional gasoline--the grade sold everywhere except our most polluted metropolitan areas and California. In the last 12 months, however, diesel has averaged almost 17 cents higher than gas, and today that differential stands at +31 cents. Some of that current premium results from seasonal patterns associated with accumulating heating oil inventories for the winter, but much of the year-on-year increase can be attributed to the rollout of the new ultra-low-sulfur diesel. The new fuel contains no more than 15 parts per million of sulfur, in contrast to the previous standard, which allowed up to 500 ppm of sulfur.

The new sulfur standard was introduced to reduce emissions of particulates--a.k.a. soot--from existing diesel engines and to facilitate new diesel technology that could reduce diesel engine emissions to levels comparable to modern gasoline engines. However, if the price differential between diesel and gasoline remained at current levels, much of the economic incentive for motorists to switch to more efficient diesel vehicles would disappear. The average motorist driving 12,000 miles per year in a car getting 25 miles per gallon will spend $1,100 per year on gasoline, at current prices. A comparable diesel car would get 33 mpg, using 115 fewer gallons of fuel, but if diesel fuel cost 20 cents more than gas, the total annual savings would only amount to about $190. You'd never pay out your investment in a more expensive diesel engine at that rate.

The new Congress will have to decide how best to promote more efficient automobiles. Diesels represent an attractive option, but like hybrids, they may need a bit of help getting into the fleet in large enough numbers to reduce our overall oil consumption, both through their direct efficiency gains and by enabling the wider use of biodiesel blends. I've often cited the example of Europe, where diesels represent half of new car sales, but it's worth noting that many EU countries have nudged this transition along by taxing diesel fuel at a much lower rate than gasoline. The last time I rented a car in Germany, the savings worked out to almost $0.50/gal. As of 2004, it was $0.64/gal (large .pdf file) and about the same in France and Italy--though not in the UK, which appears to have the most expensive diesel fuel in the world.

With all the talk of raising gasoline taxes, it might be worth considering reducing diesel taxes to put diesel and gasoline closer to parity. That would at least neutralize the disincentive on sales of new diesel cars that was created by the government's policy choice on diesel fuel standards, at least until a more rational system based on relative greenhouse gas emissions could be introduced. The lost revenue could be made up by a modest hike in gasoline taxes, which would further reduce the diesel premium. While I've always been squeamish about such market tinkering, this represents a modest intervention, compared to what may be required as part of our larger response to climate change and energy security.

Friday, November 03, 2006

Wind, Wind, Go Away

Earlier this week one of my readers sent me a link to a long, interesting article describing Denmark's experience with wind power. The Danes are leaders in both wind power technology and its application, so hearing about the practical concerns and problems of this highly wind-power-intensive country is valuable, as we expand our own use of this renewable resource. However, the more I contemplated the surprisingly skeptical tone of this piece, published in New York Newsday, Long Island's largest daily paper, the more I wondered about its subtext.

The Long Island shoreline off Jones Beach is slated for one of the largest offshore wind power projects in the US, so it's natural for Newsday to think its readers might want to know how this has worked elsewhere. There's also no question that, while providing a growing source of clean electricity, wind power has some unique problems. Intermittency of supply is the main concern, along with the visual and noise signature of the turbines, to which many people react negatively. But of the numerous issues raised by the Newsday article, many only apply at a much higher concentration and market penetration than we will see here for many years. Others, such as the worry that accommodating wind power may require backing down other forms of carbon-free electricity, are peculiar to Scandinavia's heavy mix of hydro-electric power, and just not relevant to Long Island.

At 13,300 Megawatts of capacity, the entire Danish electricity system is roughly the size of the New York City/Long Island system, but it consumes only a fraction of the total demand managed by the New York Independent System Operator (NYISO,) which hit a peak of nearly 34,000 MW this summer. Even Newsday admits that the 40-turbine, 140 MW capacity wind farm proposed for Jones Beach is tiny, when compared to Denmark's thousands of wind turbines. The intermittent output of the Jones Beach project would represent less than 1% of what NYISO handles, compared to the roughly 20% of Denmark's power that comes from wind. And the modest amounts of power backed out by Jones Beach would come chiefly at the expense of natural gas, coal, or even a bit of oil--depending on the time of day--rather than hydro or nuclear. That means that every kW-hour the wind turbines produced would indeed reduce the region's greenhouse gas emissions.

Wind power remains a bit more expensive than many conventional sources of electricity--a comparison that has improved steadily for two decades--and some people regard it as unsightly. It's important to have a balanced view of it, as we look at expanding its use in this country. However, turning inapplicable comparisons into implied obstacles, and presenting interference with air-traffic control and defense radars as a potentially insurmountable problem, don't constitute genuine balance in my book. In light of New York's existing "renewable portfolio standard" (RPS), which commits the state to obtaining 25% of its electricity from clean sources such as wind by 2013, one might think that Newsday would prefer that all that power be generated in the Adirondacks or on the shores of Lakes Ontario and Erie, rather than from the outstanding wind resources adjacent to its reader's homes. That kind of upstate/downstate rivalry could put the state's wind assets on the wrong side of a transmission bottleneck and create real obstacles to meeting the state's RPS goal.

Thursday, November 02, 2006

How Much Is Left?

One of the key uncertainties associated with the potential for an imminent peak in global oil production is how much petroleum remains to be discovered, on top of identified resources and proved reserves. A respected oil and gas consultancy, Wood Mackenzie, has just released a study on Arctic oil and gas that will bolster Peak Oil concerns and confound those who believe that there are still trillions of barrels left to find. Although smaller than many had hoped, however, the resources identified by Wood Mac and their study partners, Fugro Robertson, are still significant at 166 billion equivalent barrels . But their work contains two bitter pills: most of these hydrocarbons are gas, not oil, and bringing them to market will take decades, because of technical and logistical challenges. This figure would also push downward the estimates of total global undiscovered oil, reducing our options for future non-OPEC supply. If accurate, this report could change the way the industry looks at its future opportunities for growth and profitability.

There's something here for everyone. To those worried about Peak Oil, this is confirmation that we will encounter the limits of conventional oil production sooner rather than later. Environmentalists and other advocates of alternative energy will see further justification for aggressive development of biofuels that can provide liquid fuels to substitute for petroleum products, and for a crash program to improve the efficiency of the entire transportation sector. Geostrategists will see confirmation of the centrality of the Middle East in the world's energy future, for at least the next twenty years. At the same time, oil and gas companies will see opportunities.

As a Wood Mac VP makes clear in an interview covering the study, oil and gas companies will find attractive opportunities in the arctic regions of Alaska, Canada, Greenland, Norway and Russia. These oil and gas fields won't be easy to access and develop. Their peak productive potential of 3 million barrels per day or so makes them important potential contributors to global oil supply, but hardly large enough to impede the looming dominance of OPEC. And if the best conventional oil and gas projects to which the Supermajors have access in the arctic and ultra-deepwater are expensive to find, expensive to develop, and expensive to transport, then it will make the massive unconventional hydrocarbon resources locked in oil sands and oil shale more attractive. We're already seeing this in the oil sands boom in Canada.

I'm sure there will be a lot more commentary on this report in the weeks and months ahead, but it tends to confirm something that Chevron's CEO has been saying for a while: the era of cheap oil is ending. The technical challenges of extracting the remaining oil in the parts of the world to which access is relatively open will make that oil more expensive to produce than the sources we've relied on for the last century. In combination with higher demand in more countries, as a result of globalization, this will put increasing pressure on oil, and create increasing incentives to find practical alternatives. However, it doesn't rule out occasional periods of lower prices, as economic cycles and lumpy supply additions interact unpredictably to produce price dips such as the one we're experiencing now.

Wednesday, November 01, 2006

Our Stake in Iraq

If Iraq is truly the top issue on voters' minds going into next Tuesday's mid-term election, as polls suggest, then it's perplexing that there is so little discussion about the impact of the conflict and its ultimate resolution on Iraq's oil production. Just last week, the Iraqi oil ministry announced that production was finally approaching pre-war levels, which averaged 2.5 million barrels per day (MBD). This is remarkable, given the chaos and sectarian violence we see in daily reports from the country. Since every incremental barrel is exported, higher Iraqi output has contributed to the recent global oil inventory build and accompanying price declines. But if the Iraqi government were to collapse, or the conflict escalated into an all-out civil war, Iraq's oil exports would dry up and oil prices would head back to last summer's highs.

I recognize there are many people around the world who believe we invaded Iraq to get access to its oil. Although I still don't agree, that is academic, today. However we got there--whatever you believe about the influence of oil in the government's calculations--the status of Iraq's oil must be a key factor in our strategic decisions going forward, along with important questions of America's reputation and competing priorities for our armed forces. Anyone who argues that no vital US interests are at stake there ignores the importance of Iraq's oil in a global market that is finally coming back into balance.

It's significant that none of the parties in the Iraq conflict has so far inflicted permanent damage on the country's oil assets. Although much of the violence appears nihilistic to Western eyes, the participants clearly see the oil industry as something that either benefits them or constitutes part of the prize they're fighting to control. There's no guarantee that this forbearance would continue, should the stakes change significantly. And while the resourcefulness of the Iraqi oil industry has nearly equaled that of the Rumanian engineers who kept the Ploesti oil complex operating in spite of massive allied bombing during 1943 and 1944, there's a limit to what clever engineers can accomplish against determined saboteurs.

I'm sure you've seen the worst-case scenarios about a rapid US retreat that opens the door to a wider conflict, with all of Iraq's neighbors involved to various degrees. But while a regional Middle East conflict would be disastrous for global energy supplies and oil prices, a full-blown civil war in Iraq would be almost as bad. Because Iraq exports a higher proportion of its oil production than Iran, at 1.7 MBD vs. Iran's 2.4 MBD, the impact of a collapse in Iraqi production would be nearly as bad as the Iran conflict/embargo scenario that had the market so worried earlier this year.

It's not all downside, though. One of the main reasons for suspicion about US war motives is Iraq's tremendous potential for increasing its oil production. The country's current output is still far less than what would be possible if its 115 billion barrels of reserves were fully exploited. Ironically, US companies may not be the main beneficiaries of a major Iraqi expansion, unless peace breaks out suddenly. Chinese companies are already queuing up to do the work we regard as too hazardous and risky, and that oil could flow east, rather than west. Still, in a global market, it's the overall supply that counts. Doubling Iraq's production would make a big difference in the future price of oil.

Factoring in oil, the stakes in Iraq are even higher than most Americans think. That's not code for "stay the course" or "a new direction," though I do think it is a strong argument that any exit strategy must include leaving behind an Iraqi government capable of controlling its territory and resources. After hearing Vietnam analogies for three years, I think we need to recognize one way in which this conflict is entirely unlike the one that ended three decades ago: if a US withdrawal from Iraq ended up resembling the Fall of Saigon, the impact would be felt immediately at every gas pump in the US. While that fact may not favor the views of one political party over the other, some of the individual candidates for the Senate and the House of Representatives don't seem to grasp the full implications of their prescriptions for Iraq.