Replacing Today's Oil

If money were no object, and we had unlimited access to engineering and construction capabilities and materials, I'm confident we could produce enough synthetic oil from unconventional resources and coal-to-liquids processes to displace the 10 million barrels per day of petroleum that the US currently imports. Wood Mackenzie, a British consultancy, recently released a report indicating that global unconventional oil resources--oil that is either too heavy and viscous to produce normally, or that is bound up in oil shale or oil sands--stand at 3.6 trillion barrels, roughly three times current estimates of proved conventional oil reserves. But as the Financial Times article above describes, producing this bounty will be no simple matter. Even if the technology were fully proved, as it is in case of oil sands and Venezuela's Orinoco heavy oil deposits, there are other significant barriers to reaching this energy future.

Aside from the direct environmental impacts of these conversion processes, which are inherently higher than for conventional oil and gas, and are beginning to receive serious scrutiny, there are fundamental problems of attracting the capital and other resources required to build such complex facilities on the required scale, and doing so rapidly enough to fill the expected gap between conventional oil supply and aggregate worldwide petroleum product demand. Some of this investment is already underway. The output of major new oil sands facilities in Canada has become part of the base-case assumption for global supply over the next decade, and it is already starting to have an effect on petroleum pipeline infrastructure in the Midwest, where much of it will go. But as I've discussed in previous postings on this topic, the oil sands projects also illustrate many of the practical constraints inherent in the large-scale production of synthetic fuels, in terms of their use of land, water and natural gas supplies, skilled labor and even housing. While the US could certainly supply more of these factors than Canada's smaller economy and population are able to, environmental and local permitting seem likely to create bigger hurdles here than up north. Interestingly, biofuels share some of the same potential limitations, as they scale up to compete as the incremental supply into the world's transportation fuels market.

As long as global demand for liquid fuels continues to grow, these challenges will compound. At the same time that geometric growth steadily increases demand, it drives cumulative consumption to levels that will approach even the enormous endowments of coal and unconventional oil within a few generations, while liberating a comparable tonnage of carbon into the atmosphere, which is on track to reach double its pre-industrial CO2 concentration sometime between mid-century and 2100. For these reasons, fuel efficiency remains a critical component of any energy security plan, whether it is based on biofuels, synthetic fuels, petroleum, or a combination of the three. But efficiency, too, will take many years to bear fruit.

Without resorting to central planning and "industrial policy", we will be asking the market to allocate $20 trillion in energy investments over the next couple decades, within a geopolitical context that looks at least as complex as anything we saw in the 20th century. Unless we want to make the problems we face today even worse, the result of all that investment can't just look like a bigger version of the status quo.

Shifting Trades

Trade associations are extremely useful barometers of industry sentiment on key issues. When a cluster of energy trade associations shifts their positions on climate change, it's noteworthy. Today's Wall Street Journal reports that three of the big energy trade groups have recently expressed their support for mandatory federal regulation of greenhouse gases. Since the energy industry sits at the heart of the global warming challenge, it's important to understand just what these decisions are saying about the overall posture of the industry on the issue. The industry's value chain provides the right context for assessing this.

The three trade associations in question, the American Gas Association (AGA), Edison Electric Institute (EEI) and Electric Power Supply Association (EPSA) represent a large portion of the industry's mid-stream. At least with respect to the fossil fuels most associated with greenhouse gas emissions, the members of these groups are neither the primary producers of energy nor its end-users, but rather convert it from fuel into electricity, or transport it from producer to consumer. That doesn't mean their operations and profitability wouldn't be affected by a cap-and-trade system for CO2, or a carbon tax. But most of the utilities and pipeline companies belonging to these groups could reasonably expect to be able to pass along most of the economic impact of these regulations, in higher prices or tariffs. This is a very different position from that of the primary producers of oil, gas and coal.

Looking at the main oil, gas and coal trade associations confirms that view. The American Petroleum Institute (API) represents most of the big upstream and integrated players, the household-name companies that consumers associate with energy. The Independent Petroleum Association of America (IPAA) covers the smaller producers. The National Mining Association includes most of the country's coal producers. The National Petrochemical and Refiners Association (NPRA) is self-explanatory. None of these groups has come out in favor of carbon limits, nor should we expect to see that soon.

For most of the members of these groups--with the exception of companies with a big stake in natural gas--limits on carbon translate into lower future demand, less growth, and lower profits. Petroleum refiners, in particular, have experienced decades of environmental regulations that added significantly to their capital and operating costs, without providing an opportunity to recoup these costs. Because trade associations generally work on the basis of a consensus of their membership, the bigger changes in this sector will occur first at the company level, rather than by the trades. In fact, when we look at the positions of the big oil and gas firms, we see a diversity of viewpoints, including the recent clarification of ExxonMobil's position and the alignment of BP and Shell with groups such as the Pew Center on Global Climate Change, a big supporter of emissions trading.

At the same time, through their contacts in Congress and the Administration, all of the energy trade associations must be seeing the sea change on this issue since the last election, and reporting to their members on the likelihood of federal carbon controls being enacted within the next three years. These groups may find it increasingly difficult to ensure their participation in the shaping of emissions legislation--and the opportunity to inject important considerations such as the relationship between domestic energy production and energy security--as long as they are seen opposing a US carbon cap in principle. While today's story on the move by AGA, EEI and EPSA is an important signpost, the bigger milestone, in which the API, NPRA, IPAA and NMA would throw their support behind emissions trading, depends on the recognition by most of the nation's producers of primary energy that it's better for them and their shareholders to be seen as part of the solution, rather than part of the problem.

Oscar's Reach

I suspect I'm not the only one wondering this morning if it was entirely coincidental that the leveraged buyout of one of the country's largest electricity generators, TXU, came together around a proactive climate change agenda on the same weekend that the film of former Vice President Gore's presentation on climate change collected an Academy Award. The indirect connection is obvious: climate change has become one of the biggest issues of our times, and both of these events reflect that reality. At the same time, it's tempting to see a causal link between the influence of Mr. Gore's documentary and the recognition by KKR and its partners that stakeholder concerns about the global-warming impact of TXU's coal power plant construction program could put their entire transaction at risk.

The New York Times' article on the TXU deal makes fascinating reading. It illustrates the attention that TXU's emissions profile received in the structuring of this private equity transaction, and it describes the contacts between the prospective buyers and key non-governmental organizations, such as Environmental Defense and the Natural Resources Defence Council. Although the deal will still have to be approved by regulators and TXU's shareholders, its case history could provide the template for all future large, carbon-intensive transactions of this type.

I don't think it overstates matters to suggest that "An Inconvenient Truth" played a role in this. Released in a year that was among the warmest on record, less than 12 months after hurricanes devastated Louisiana and Mississippi, the movie did more than just rehabilitate Mr. Gore's public image. It provided a context for the odd weather that Americans are routinely experiencing or seeing on the evening news, at time when the pivotal Baby Boomer generation appears to be going green. I can only wonder how many of the investment bankers working on the TXU deal saw the film in a Manhattan cinema and recognized its business implications. Had it been released a decade ago, it would have been written off as alarmist ravings. Now, with an Oscar under its belt, it could get another run in theaters, and will certainly attract more viewings on DVD, perhaps becoming as embedded in the Zeitgeist as "The China Syndrome" did in the late 1970s.

Last night's award came in the middle of an otherwise lackluster broadcast. But even before the nominees for Best Documentary were read out by Jerry Seinfeld, Mr. Gore took the stage with Leonardo DiCaprio to deliver an environmental message and describe the Academy's efforts to make the production greener--along with teasing the audience about his Presidential aspirations. His message about a manageable climate crisis and the need for political will to address it was delivered to a sea of nods, and if it had a similar effect on the program's enormous global audience, it could cause further ripples beyond Hollywood. Whether there's any causal connection between all this and the structure of the TXU deal, the Global Warming Oscar--for all its pop-culture triviality--joins a growing list of affirmations of the problem, including the Stern Report and IPCC Fourth Assessment Review. Business is clearly taking notice.

Another Third Way

It's not unusual for big energy projects to be canceled, as the key factors determining their ultimate profitability--project cost, start-up timing, and feedstock and product values--shift. We need to be cautious about reading too much into the cancellation of any individual project. Nevertheless, ExxonMobil's announcement this week that it is terminating its planned Gas-to-Liquids (GTL) project in Qatar seems to reflect issues beyond this endeavor's sensitivity to the construction cost inflation that has hit the entire oil and gas industry. It is a signpost of the competition between alternate outlets for natural gas, and an indication of the direction of gas globalization. The outcome of this trend will determine what Americans pay for natural gas and its derivatives in the future, because of our growing reliance on imported gas from outside North America. It is also relevant to the future price of oil.

There's been a good deal of speculation in the industry about which of the two main approaches for bringing remote gas to market would win, or whether they might co-exist. Liquefied Natural Gas (LNG) had a substantial head start over the modern version of Gas-to-Liquids (GTL), which represents another branch of the WWII German Fischer-Tropsch family tree. Both of these processes turn natural gas into a liquid that can benefit from the transportation and marketing flexibility that crude oil naturally enjoys. However, LNG returns to the gaseous state after delivery, while GTL's products compete directly with petroleum products. So what's at stake here is whether gas deposits too distant to be pipelined to customers will end up augmenting gas supplies, or supplementing global crude oil production. With local gas production falling short of demand in North America and Europe, and with growing concerns about future global crude oil availability, this is an important question.

So what does the cancellation of Exxon's GTL plant in Qatar say about this dilemma? Interestingly, it points in a different direction altogether. Certainly it reflects the increased risk that higher construction costs would raise the project's breakeven relative to crude oil and expose Exxon to losses, if oil prices weaken. But the most significant fact here is that GTL didn't lose out to an LNG project. The 1.5 billion cubic feet per day gas feed for this project is apparently going to stay in Qatar, fueling power generation and supplying feed for chemicals and other industries. Viewed from the perspective of consuming countries, this is the worst possible news. This gas won't be turned into ultra-low sulfur diesel, indirectly shoring up oil supplies, or allowed to compete with other LNG projects, and thus holding down global gas prices. Instead, it will end up competing with gas-consuming industries in North America and Europe, which make petrochemicals, plastics and fertilizer and already face severe cost disadvantages.

This outcome shouldn't surprise us. Developing countries need to get the most income from their resources. Exporting the raw material makes sense, if you don't have the capital--financial, intellectual and human--to turn it into higher-valued products, or if you doubt your ability to gain access to foreign markets for those products. But in a world of transparent global capital flows and falling tariffs, going after that extra value added must look very tempting. The forces of globalization are helping to create a truly global natural gas market, on which we will rely increasingly in the years ahead, because we've chosen to constrain our own gas production by restricting gas drilling. But those same forces have the potential to dry up that global supply, simultaneously starving and outcompeting the developed country industries that would use it.

Much Ado About Lighting

The Australian government has apparently decided to start phasing out incandescent light bulbs by 2010, a move California is also apparently considering. This is big news for many reasons, including the fact that it's occurring because of concerns about climate change in a country that hasn't ratified the Kyoto Protocol. I'm a bit surprised, because I always think of "Oz" as the land of rugged individualists. Even here in the US, switching to compact fluorescent lights (CF) that are interchangeable with standard incandescent bulbs has rapidly become a motherhood and apple pie notion. Nevertheless, I'm not sure it's worth all the fuss. In the hierarchy of things we can do to save the planet, residential CF lighting falls pretty far down the list to force it on people. It's a nice thing to encourage, but is mandating it worth the resentment and pushback this could create for more important measures to address climate change?

Here are the numbers: In 2001 residences used 30% of total US electricity generation, and lighting accounted for under 9% of residential consumption. So even if we converted all existing incandescent light bulbs in homes to CFs--ignoring those that have already been switched in the last five years--at an indicated energy savings of 66%, we're talking about a theoretical maximum of 1.8% of our electricity consumption, equating to less than 1% of our total carbon dioxide emissions. That's not insignificant, but there are good reasons why the real-world savings are likely to fall well short of that maximum.

First, unless we mandate it as Australia has, not everyone will switch to CFs, for reasons including aesthetics, cost and convenience. I also wouldn't be surprised to see a version of a phenomenon that has been reported in Europe, where owners of thriftier diesel cars are apparently driving more kilometers, because the cost per km is much lower than for gasoline. As a case in point, I'm fanatical about turning off lights in unoccupied rooms. But I'm a little less likely to take a few extra steps to turn off the CF lights, because I know they aren't costing much to run, and they have that annoying delay when you turn them back on. And as with cars and fuel consumption, what counts most here is not the lower wattage but the actual kilowatt-hours saved. In other words, if a CF bulb is 2/3 more efficient, but I use it twice as much as the incandescent it replaced, the net savings are only half as big, and the payback twice as long.

My other concern is the risk of the government selecting an inferior technology and making it a standard. Based on my scanning of the science and technology media, it's apparent that we are on the verge of a major revolution in lighting. Compact fluorescents are only the tip of the iceberg, with silicon-based LEDs, organic LEDs and other technologies coming on fast, some without CF's drawbacks of start-up lag and harsh light. Superficially, this is similar to the competition between hybrid car models that are available today versus plug-in hybrids that are some years off. The difference is that the incandescent light "fleet" turns over every year or so, the cost of waiting for a better technology is low, and this creates lots of future options. Once most of these bulbs switch over to CFs, however, with their much longer turnover times, the next lighting technology will face tougher hurdles, and consumers will have a bigger investment at stake.

None of this means I'm against CF lighting as a green choice. Businesses are choosing it in droves, driven by economics, and this is a big component of the thriving energy services business, making hotels, offices and other public and commercial spaces more energy efficient. That's happening because there's money to be made. Consumers are doing the same thing, when it makes sense. Meanwhile, it will be interesting watching Australia make this switch. Having known more than a few Aussies, I wouldn't be surprised if a black market in imported incandescent lights sprang up, in response.

Cleaning Up Coal Power

Although our concerns about climate change and energy security align neatly with regard to improvements in energy efficiency, coal-fired power plants create a collision between these two issues. Our reliance on coal for power generation is growing, reflecting abundant domestic supplies and high natural gas prices, but the emissions from coal will keep our national greenhouse gas output rising, instead of leveling off. Government, industry and environmental groups all look to "clean coal" technology to resolve this dilemma and provide a way to use our coal reserves without breaking the greenhouse gas bank. An article in today's New York Times highlights the challenges of this approach, based on an upcoming MIT report. It also demonstrates just how much confusion exists about clean coal technology and its capabilities.

The two main competing technologies for turning coal into electric power are "pulverized coal" (PC) and "integrated gasification combined cycle" (IGCC). Nearly all of the coal plants in existence today, and most of the new ones being planned, utilize various forms of PC technology, in which coal is burned to make steam, which in turn drives steam turbines to make electricity. These facilities cost the least to build, even after installing scrubbers to remove pollutants such as sulfates and nitrates from the flue gas. However, PC is less energy efficient than IGCC, which means higher fuel consumption and higher greenhouse gas emissions per kilowatt-hour (kW-hr) produced. And because PC burns coal in air, which is 21% oxygen and 78% nitrogen, the carbon dioxide in its exhaust is diluted. That means that any strategy to capture and sequester it later must first extract the CO2 from this gas stream and concentrate it. That adds to the cost and complexity of carbon sequestration.

But IGCC offers no free lunch in this regard, either. Contrary to the misunderstanding expressed by an opponent of TXU's proposal to build new PC plants in Texas, IGCC does not remove carbon prior to combustion. It works by gasifying, or partially combusting, the coal in pure oxygen. The resulting "syngas", made up of carbon monoxide and hydrogen, is stripped of any impurities (sulfur, mercury, etc.) and then fed into a combined-cycle gas turbine. Because of the higher thermal efficiency of the gas turbine, an IGCC plant produces less CO2 per kW-hr than a PC facility. But because the turbine runs on air, not pure oxygen, the exhaust gas is still diluted by nitrogen, and the CO2 would have to be extracted and concentrated for sequestration, just as at a PC plant. There would just be less of it.

It is possible to build a more extreme version of IGCC, in which the syngas was first reacted with water over a catalyst to yield essentially only hydrogen and a very pure CO2 stream that would be easier to sequester. Perhaps this is what Mr. Smith of Public Citizen was thinking of, though no one has done this on coal, yet. I worked on a unit at Texaco's former Los Angeles refinery that used this process to make hydrogen from fuel oil. It was built in the 1960s, so the basic technology is hardly brand new, though it's expensive, finicky, and expends a lot of energy in the H2 conversion step.

The choice between IGCC and PC for ultimate carbon sequestration comes down to a trade-off between the higher upfront costs of IGCC and what it might save later, once the technology of sequestration is sufficiently perfected to roll out on a wide scale. That creates a serious economic uncertainty around IGCC. From my perspective, however, there is a practical solution to this dilemma. Unless you expect sequestration to be in wide use within a decade, an IGCC plant built today will put significantly less CO2 into the atmosphere over the next ten years. If the economic choice between IGCC and PC is close without paying for the CO2 they emit, then under a national greenhouse gas cap-and-trade system--which seems likelier all the time--the advantage shifts toward IGCC, irrespective of future sequestration options. And the more IGCCs get built, the faster their cost premium over PC will fall. Although I can't say a utility would be wrong to build a new pulverized coal plant, it seems analogous to building a new piston-powered passenger plane after Boeing had flown its 707 prototype.

The Shrinking Pie

Now that oil has settled into a more comfortable range--never mind that it is still double the price at which it traded in 2003--the controversy over Peak Oil seems to have receded, somewhat. Yet although we've gone months without a major headline on Peak Oil in the Wall Street Journal or New York Times, the idea of a Peak--a point beyond which global oil production will start to shrink, instead of continuing to grow--has been percolating into the public consciousness in much the same way that the Limits to Growth meme did in the 1970s. That's certainly good for those in the alternative energy business, because it underpins the energy security concerns that are helping to stimulate technology investment. Today's Wall Street Journal included two articles that ought to cheer up alternative energy investors, because they remind us that a strict geological peak in production isn't necessary to create serious constraints on the future oil exports necessary to meet growing demand in the US and Asia.

On the Journal's front page, we read about the squeeze that Iran's growing internal oil consumption is putting on that country's exports. Iran currently consumes a third of its own production, leaving 2.5 million barrels per day (MBD) available for sale to others. A companion article suggests that the combination of growing demand and stagnating production could end Iranian oil exports within 10-15 years. Nor is Iran the only exporting country with similar concerns. Indonesia has already become a net importer, and Mexico and the UK, at least, seem headed in the same direction over the next decade. The US Department of Energy's base-case forecast indicates total oil production rising from the current 84 MBD to nearly 120 MBD by 2030, with OPEC production increasing from the current 34 MBD to 45 MBD. But even if these optimistic projections can be achieved, world oil markets would tighten, as the pool of exporters shrinks, while the demand for imports goes up.

This is complicated by another key factor, illustrated in the Journal's report on the difficulties in developing a petroleum law in Iraq. Not only can the parties not agree on what constitutes an equitable allocation of oil revenues among Shia, Sunni and Kurdish areas, but they also apparently disagree on the future philosophy of development. And while these issues have received prominent attention, because of our understandable focus on the Iraq War, similar problems are simmering in Nigeria, and Indonesia has only recently resolved a low-level civil war in Aceh, with oil at its heart. These sorts of disputes amplify the political risk of oil projects in countries that are already problematic, and they remind us that the interests of the ultimate resource owners may be quite different from ours, as consumers.

While these two articles illustrate larger, generic problems in the industry, the occurrence of these problems in Iran and Iraq is significant in itself. Together, these two countries hold 250 billion barrels of estimated proved reserves, representing the second and third largest national reserves of conventional oil after Saudi Arabia, with roughly 20% of the world total. If Iran and Iraq aren't going to contribute materially to the required expansion of global oil exports, it will put that much more pressure on the Saudis and their desire to stretch out their production for many decades. It also puts more power in the handful of countries, including Russia, with realistic possibilities of growing their oil exports.

To what degree do current oil markets reflect this impending collision between export supply and the demand for oil imports? In theory, efficient markets "bake in" this sort of information. I'd love some reassurance on that from someone who currently trades the long-dated end of the oil market. From my own extensive but outdated experience in this area, I'm skeptical. I just don't believe that the market is moving based on abstract discussions like this; I see it driven primarily by near-term supply and demand fundamentals and the perceptions of how those are likely to shift over the next few years. And that's why I don't believe we can wait for the market to tell us it's time for alternative energy. Whether the future discontinuity is the arrival of a Peak, or simply the consequence of the trends we can see today, I doubt the market will forecast the crunch, any more than it foretold today's conditions four years ago.

Living with the Bomb

With the media churning on the reports of Iranian IEDs in Iraq and fears of a slide into war with Iran over its nuclear program, it's worth spending a few minutes thinking about a different outcome, in which Iran ultimately gets the Bomb, and we enter a new kind of Cold War in the Persian Gulf region. That's what Zbigniew Brzezinski seemed to be hinting at, in his recent testimony on Iraq before Congress, and it's consistent with a new report from the EU on the likelihood of Iran producing enough fissionable material to build a nuclear weapon. As unappealing as the prospect of devoting years or decades to containing a nuclear-armed Iran may seem, it is starting to look more palatable than a wider war in the Middle East, which would have to be prosecuted by a tired and over-extended US military, and probably without allies. And that doesn't even begin to cover the energy implications of such an event.

Two years ago, I put together a lengthy report on Iran's nuclear ambitions. After looking at the relative economics of nuclear power and Iran's vast untapped hydrocarbon reserves, it seemed hard to credit that Iran's efforts were as innocent as they claimed. I concluded that buying time was the best of a batch of poor choices. Unfortunately, although the EU-3 talks with Iran have done just that, we find ourselves with no better options now than then, and if anything the military option looks even less workable. Oil prices have remained high, preserving Iran's economic leverage and the implicit threat of an embargo. Instead of settling down and releasing our deployed forces as a potent and proximate threat against Iran, Iraq is more chaotic, continuing to grind up US troops and equipment. And whatever its strategic and tactical merits, the Surge exacerbates the strain on our over-committed forces.

The most positive development has been the achievement of UN sanctions against Iran for its nuclear efforts. However weak they might seem to some, they demonstrate that even Iran's closest friends on the Security Council will not give it carte blanche. The sanctions have also complicated Mr. Ahmadinejad's life at home, by highlighting the price Iran pays for pursuing nuclear enrichment and drawing attention to his failure to deliver on the economy. In contrast, an attack on Iran's nuclear facilities by either the US or Israel would shatter the international alignment against Iran and shore up Ahmadinejad's shaky base.

So what might a Cold War with Iran look like? Perhaps not much different from what we see today, if we recall that the West bought oil and natural gas from the USSR, at the same time the latter was funding and arming insurgencies around the world. As then, successfully containing a nuclear Iran would require deft diplomacy, and it would hinge on a credible deterrent--which in the odd logic of mutually assured destruction is equally dependent on the willingness of the subject to be deterred. The US can certainly supply the former, on planes, submarines and ICBMs, though there's legitimate doubt about how deterrable a theocracy might prove. A clear shift to a strategy of containment could actually reduce tensions in the region, but it's never going to suppress all the other simmering grievances in the way the old Cold War with the Soviet Union did. And in this world there won't just be an Iranian Bomb; we could eventually see an Egyptian Bomb, a Saudi Bomb, and so on.

Dealing with a rising Islamic power--at least in their own eyes--would doubtless present some unique twists, compared with containing a decaying--though we didn't realize that until later--superpower. The other parties in the region understand the game, too, having participated before, and we might be surprised and disappointed at who lines up on which side. Nevertheless, we can do this, because we've done it before on a much larger scale. No matter how much Iran's leaders might think they've gone to school on that era, they didn't live through it with their fingers on the Button, as we did.

Perhaps the biggest challenge to the viability of a containment option for Iran is creating an enduring bi-partisan framework for it in Washington. We aren't living in the days of Truman and Vandenberg, who didn't have to contend with 24-hour news cycles, bloggers, or the complete breakdown of secrecy. It's worth trying, though, because the alternative to a mini-Cold War is another hot one, with victory neither quick nor certain, and consequences no one can predict.

Low-Key LNG

It's been some time since I've posted on the subject of liquefied natural gas (LNG), and some interesting developments have occurred in the interim. A couple of new US LNG receiving facilities have recently been approved, including one off Gloucester, MA that connects to tankers 13 miles offshore and relies on re-gasification facilities on the delivering vessel, rather than onshore. That significantly reduces the investment in the LNG terminal, while also lowering the handling risks that form the basis of local environmental and citizens' group opposition to traditional LNG terminal projects. I'm not sure this is the ultimate solution to our growing, long-term gas supply crunch, but it looks like an important component in the transition from North American gas self-sufficiency to year-round LNG imports. In between, there will probably be many years in which LNG imports will be seasonal and opportunistic, and this kind of infrastructure is ideally suited to that situation. It's also very helpful in the development of a global LNG spot market.

Despite its unpopularity in some quarters, LNG offers significant environmental and energy security benefits. While its life cycle of production, transportation and end-use emits more greenhouse gases than domestic pipeline gas, the net emissions are still lower than for coal. And although it represents additional energy imports, it contributes to energy security via diversification. Even if it didn't get us a more reliable group of suppliers than we have for oil, it creates a different supplier mix, and as long as that is not perfectly correlated to the oil side, it diversifies the risk of our overall energy supply portfolio.

The company behind the Gloucester terminal, Excelerate, also operates a fleet of the special tankers necessary to deliver into this kind of minimalist terminal. They own a second terminal on the Gulf Coast that uses the same design, and which entered service two years ago. Another facility in the UK using this technology has just received its first cargo. This design is well-suited to seasonal or occasional use, because it costs much less than a standard onshore re-gasification terminal: under $100 million, versus $ 0.5-1 B for the standard variety. No one can't afford to sink a billion dollars in a terminal that will only be used a few times a year, but a tenth of that cost might make sense, particularly if it contributes to creating a "network effect" for a more flexible LNG market.

There's no free lunch, of course, and the downside of this approach is the higher cost of the special ships that are needed for this trade. As volumes through the Excelerate facilities go up, it's not clear that total shipping and throughput costs would ever be quite as low as those associated with the more traditional arrangement of a simple LNG tanker discharging into an onshore re-gas terminal. But in a country that has not yet come to grips with the true extent of its natural gas problem, and that regards LNG as something alien and scary, this low-profile value chain probably has an edge. By comparison, Shell's Broadwater project proposed for the middle of Long Island Sound remains mired in controversy. Like it or not, the US is going to need more LNG, and Excelerate's approach makes more sense than building the terminals in Mexico and sneaking the gas across the border when no one is watching.

The East Could Be Green

When China launched its first satellite in 1970, it broadcast a simple recorded message around the world: "The East is Red." China has changed a great deal since then, becoming more mercantilist than communist. It is now effectively one enormous, dirty factory: consuming vast coal reserves to become the low-cost exporter to the world, and spewing out billions of tons of soot and greenhouse gas in the process. An article in yesterday's Wall Street Journal suggests a very different approach to energy could be in the offing within China. The potential impacts on China of the negative consequences of climate change are apparently gaining the attention of China's more foresighted leaders. If they connect the emissions spawning climate change with outcomes that impede their economic growth, water management, and the other paramount concerns of the state, things could shift quickly.

Because of its rapid growth and reliance on coal, China is on a path to exceed US greenhouse gas emissions within a few years. Although a signatory to Kyoto, it is not bound by emissions reduction targets, and its preferred metrics for comparing emissions--on a per-capita or economic-output basis, rather than in absolute terms--suggest that it doesn't see an obligation to cut its current emissions to make up for our past emissions. Unfortunately, that viewpoint sets up as much of a losing game for the world as the one in which the US and China eventually face off over a shrinking pool of internationally-traded petroleum, to fuel our respective, growing oil-import needs. China seems much likelier to address its emissions if it sees an advantage in doing so, and a large-scale push on renewable energy that drives these technologies rapidly down their cost curves could be just the ticket. The country's Renewable Energy Law, which went into effect last year, represents a modest but important starting point.

It's worth recalling how post-war Japan absorbed the teachings of manufacturing-excellence gurus such as W. Edwards Deming, and turned them into the means of beating American industry on its home turf. Any number of experts and pundits are making the case now for renewable energy as a strategic, rather than merely tactical response to problems of energy security and climate change. While hardly ignored here, these ideas mesh well with two key Chinese advantages in implementing them faster: extensive state intervention in the economy, facilitating a much quicker re-prioritization of national effort, and a rapidly growing infrastructure network, into which renewable energy could be deployed without having to compete with incumbent suppliers or old, fully-amortized facilities. It's hard enough to compete with China's low labor costs, though we can rationalize that they will eventually have to rise. What if they also had renewable energy technology that gave them both lower emissions and lower energy costs, and a head-start in deploying it?

I find the comparison of China's rise with Germany's a century ago fascinating: two large, vigorous countries, each having emerged from a period of internal consolidation, and each challenging the established leader of a globalized world. We know how Germany's competition with Great Britain ended; China's challenge to us needn't to turn out the same way, particularly if the basis of competition turned toward an inherently stabilizing field without a winner/loser dynamic: greener energy.

Atmospheric X-Prize

I am a big fan of the X-Prize approach to stimulating new technology. A relatively modest sum can bring forth remarkable achievements, without the offerers of the prize needing to specify the pathways or methods, only the desired outcome. Two readers sent me links to reports of this announcement by Sir Richard Branson, establishing a $25 million prize for the first person or group to remove a billion tons of carbon from the air annually. I must have been distracted when I read it (twice!) to have missed the full significance of its wording. Unlike the Kyoto Protocol, which focuses on reducing emissions, Sir Richard's prize is reserved for a new technique for removing carbon that's already in the atmosphere, after having been emitted. This is a truly paradigm-breaking notion, and a very healthy sign of how far we've come on the subject of climate change.

As I've pointed out periodically, if climate change is as serious as all present indications suggest, then it's not going to be sufficient to reduce our emissions by a few percent--or merely to reduce their rate of growth, which seems about the most that our current approach might achieve. Averting the risks of the most serious consequences of climate change will require dramatic steps, and going beyond our focus on emissions to address the actual inventory of greenhouse gases in the atmosphere represents a significant new strategy. If successful, it would multiply the effectiveness of our efforts to reduce emissions, and put the goal of stabilizing or even reducing atmospheric concentrations of CO2 back into the realm of the possible.

Now, I'm not quite sure where the figure of a billion tons comes from. I've perused the Virgin Earth Challenge website and cannot find any reference to it. Instead, the goal is stated as "the net removal of significant volumes of anthropogenic, atmospheric greenhouse gases each year for at least 10 years without countervailing harmful effects (the “Removal Target”). " A billion tons of carbon per year would certainly fit that description, representing as it does about 0.13% of the total level of carbon in the atmosphere, or 14% of our current global greenhouse gas emissions. If neither of those figures sounds very impressive, consider that the net annual accumulation of carbon is on the order of about 5 billion tons. Cutting that by a fifth would be quite dramatic and meaningful, but by itself insufficient to solve the entire problem.

Kudos to Sir Richard for this great idea, and for putting his own money behind it. However, it doesn't let governments off the hook for figuring out how to reverse the current trends on greenhouse gas emissions, nor does it absolve us as individuals of the ultimate responsibility for the emissions associated with our lifestyles. And as Fareed Zakaria points out in Newsweek's current issue, we still need to tackle the unglamorous and controversial work of adaptation, because all of our efforts to reduce global warming could still fall short. Cracking this problem is going to require innovative work on may fronts, and we might need a few more clever X-Prize-type efforts along the way.

Defusing One Crisis?

Energy again appears to be central to diverting the nuclear aims of the Democratic People's Republic of Korea (DPRK). Yesterday's Washington Post described the state of the current negotiations for the shutdown of the North's Yongbyon nuclear complex and a resumption of international nuclear inspections. Along similar lines to the original 1994 deal, it looks like it will take some combination of fuel oil supply and the provision of Western-style civilian nuclear power to get Mr. Kim to give up his nuclear ambitions. However, even if this solution proves mutually agreeable, Pyongyang would still end up with nuclear fuel that might cause problems later, while the five guarantor nations would face a big bill and a long timeline for building the new reactor(s). Why not substitute a package of wind and solar power, instead, along with transferring the technology necessary to make the best use of them? This solution would be at least as beneficial to the DPRK as what is currently on offer, and it could be implemented much faster--while simultaneously allaying many concerns about Pyongyang's real motives.

The typical objections to renewable energy relate to its scale and intermittent output. These would pose less of a problem in North Korea, which is much less highly developed than its southern neighbor. Nor do I imagine NIMBY concerns about viewscapes or "flicker" would become an obstacle. Much of the DPRK's power already comes from another renewable source, in the form of large-scale hydroelectricity. Together with existing coal-fired plants, this would provide the base-load capacity that intermittent wind and solar power would complement, while retaining the country's oil-fired thermal plants to use as backup for days when neither wind nor solar is adequate to meet demand.

1000 current-generation 3.5 MW wind turbines could supply the entire non-hydro portion of the DPRK's reported electric demand of about 4000 MW, assuming a load factor of 30%. At current hardware prices, that would cost somewhere in the neighborhood of $4 B, which might still come in less than the cost of the pair of light-water nuclear reactors agreed to back in 1994.
Making all of this mesh would clearly require a good deal of grid modernization, and that would have to be part of the package. A pilot wind project was installed in Unhari, DPRK in 1999, through the efforts of a California think tank, and this experience might provide a useful starting point for mapping out the details of a wider renewables strategy for North Korea.

At a time when we are looking increasingly to renewable energy as a way to address global climate change, it would be a real bonus if it could help resolve the equally worrying prospect of wider proliferation of nuclear weapons, in increasingly unreliable hands. It could also create genuine win-win outcomes, if the learnings from adapting the DPRK's antiquated electricity infrastructure to handle renewable energy turn out to be applicable--and marketable--elsewhere in the developing world.

A Better Floor

Does Tom Friedman of the New York Times read my blog? After reading his column on Wednesday (Times Select required) I have to wonder. Last month, he proposed instituting a $45/barrel floor price for crude oil, as a way to stimulate alternative energy investment and reduce US reliance on oil imports, especially from the Middle East. I posted a lengthy critique (1/18/07) of this idea, concluding that it would be too difficult to administer and do little to promote conservation. Now, Mr. Friedman has apparently switched from a floor price for crude oil to a $3.50/gallon floor price for gasoline. Although it would probably be even harder to achieve politically, the latter doesn't have nearly as many drawbacks as a crude price floor, and it would probably contribute more--and more quickly--to our energy security than any other single idea currently under consideration.

Why would a floor price on gasoline work differently from one on crude oil? First and foremost, it would spare US businesses an increase in their energy and raw material costs that their international competitors wouldn't face. It would give consumers an incentive to be more efficient, without disrupting the international markets and flows of oil and its products, which trade on a pre-tax basis and are essential for responding to sudden changes in supply, such as after Hurricane Katrina. In addition, although many different formulations of gasoline are sold across the US, because of differences in local environmental regulations and regional "attainment" status under the Clean Air Act, these distinctions are not nearly as great as those between crude oil grades. Once you set a floor price for conventional unleaded regular gasoline, the market will sort out the relative value of costlier grades and formulations.

Like any idea of this type, a gasoline floor price doesn't lack for complications. For example, how should it apply to imported gasoline--of which we buy more each year--as a tariff, or when it leaves the blender's terminal? Even thornier, should the same floor price apply across the entire US, or should it take into account the differences in regional markets and state taxes? If we were to impose such a tax this week, prices on the East Coast would rise by $1.33/gallon, while those in California would go up by $0.97. Finally, a floor price is still a form of gasoline tax, and just as regressive as a flat per-gallon tax. Buffering its impact on low-income Americans would be tricky, because the level of the tax would vary continuously with fluctuations in the wholesale markets, which reflect crude prices, refining margins and many other factors. Unlike a flat-rate tax, however, it would make consumer fuel prices much more predictable and stable (see Tuesday's posting,) reducing the uncertainty involved in the decision to buy a hybrid or some other fuel-efficient car.

The prerequisite for any substantial new tax on gasoline, however, is the recognition that all of our technology options for improving vehicle efficiency and producing oil substitutes will take more than a decade to reverse the current trend of our oil imports. We would also have to conclude that that timeframe is not adequate--or exceeds our patience--to address the energy security or climate change risks that lead us to want to reduce gasoline consumption in the first place. Combining those realizations would lead us to conclude that we must tackle the consumption of today's entire vehicle fleet. Only then would a gas tax rise to the top of the list of options. Now compare that sequence of events to the current state of play concerning Corporate Average Fuel Economy standards. What external events would we have to see, before Congress and the Administration would be ready to take on something as radical as Mr. Friedman's floor price?

Ethanol Tariffs and Trade

Today's Washington Post reports that US and Brazilian officials are meeting this week in talks on a new biofuels energy partnership, with the aim of increasing biofuels use and trade between the US and Latin America. This seems a laudable goal, in light of our commitment to increase our ethanol use and given the greater efficiency of producing ethanol from cane in the tropics. Although you might guess that one of the key topics of conversation at this trade session would be the $0.54/gallon US tariff on imported ethanol, the article indicates this is not on the table. There's a good reason for that. The tariff is an integral part of the US ethanol incentive system, which is here to stay. Repealing the tariff would create a loophole that would effectively subsidize Brazilians to compete with American farmers. Imagine the headlines and sound-bites that would generate.

Our ethanol subsidy structure has evolved over the nearly 30 years since it was created. The current $0.51/gallon federal Volumetric Ethanol Excise Tax Credit (VEETC) was established by the American Jobs Creation Act of 2004 and reinforced by the Energy Policy Act of 2005. Under this system, the tax credit is issued to those who blend ethanol into gasoline at any fraction, including but not limited to the popular 10% (E-10) and 85% (E-85) blends. US ethanol producers benefit indirectly by charging a higher price for their product than they otherwise could, effectively receiving the 51 cents without having to file to get it. The current tariff prevents a blender from importing cheaper foreign ethanol, selling it at the domestic market price, and pocketing a subsidy that was intended to help US agriculture. The other way to look at this is that the net tariff on imported ethanol is really a modest 3 cents per gallon, after the blender collects the VEETC.

Our ethanol imports from Brazil have reached 1.7 billion gallons per year (110,000 barrels/day) in spite of the tariff, and that probably has as much to do with the cost of transporting domestic ethanol from the Midwest to coastal markets as with any inherent US ethanol shortage, which will rapidly disappear as new capacity comes online in the next year or two. It also reflects the lower cost of producing ethanol from sugar cane, which contrary to some assertions about its environmental impact, can apparently be grown in a sustainable fashion, with a higher energy return on energy invested (EROEI) than for corn ethanol, or even for fossil fuels.

I hope the Brazil/US ethanol discussions are fruitful. This is the kind of trade we should be promoting, and it adds at least in a small way to the diversification of our energy supply, which has been the most successful energy strategy we have pursued since the 1970s. More importantly, market pressure from expanding ethanol trade with Brazil, along with the prospect of having to compete with cellulosic ethanol later, should give US farmers and corn-ethanol producers ample incentives to become much more efficient, reducing their energy inputs and consuming a smaller fraction of a larger corn crop. That should help minimize ethanol's looming impact on food prices, while improving its contribution to reducing greenhouse gas emissions.

Hold Harmless

As I was reading a column on business and climate change in today's Wall Street Journal, it occurred to me that an important word is missing from the lexicon of the CEOs leading the growing movement within US businesses to address climate change: indemnification. That may turn out to be more important in the long run, especially for manufacturers, than the eventual details of a cap-and-trade system for greenhouse gas emissions. The Journal column quotes Caterpillar's CEO on the desirability of business having "a seat at the table," as climate policy is developed. While I applaud Mr. Owens's foresight and that of the other corporate chiefs showing leadership on this issue, the business community needs to be very clear about its priorities for using any access they gain. Closing the door on potentially crippling future tort fights over past emissions should top the list.

Tobacco-style litigation for carbon dioxide and other greenhouse gases might sound far-fetched today, but the harbinger is already working its way through the California courts. While it might have been easy to attribute former State Attorney General Lockyer's lawsuit against six auto makers to an election year, the decision by his successor to pursue it should give business leaders pause. Anyone dismissing Jerry Brown as the old "Governor Moonbeam" doesn't understand him or California. Mr. Brown is a very savvy politician, one of the most durable and successful the Golden State has ever produced: the son of a former state attorney general and two-term governor, and himself a former Secretary of State, two-term governor, two-term mayor of Oakland, and now the AG. If you read his career as a bellwether of big, shifting trends over time, the carmakers and any other CO2-intensive firms in the state should worry. Throw in an adverse outcome in the pending US Supreme Court case on whether CO2 is a pollutant, and you'd have all the ingredients to lure the big tort-law firms away from asbestos, MTBE and other pursuits. CO2 would be the mother-lode.

Given our national predilection for rooting for the underdog and delighting in seeing the mighty brought low, many people would take pleasure in seeing oil, coal, chemical, utility, and car companies all having to defend their past greenhouse gas emissions in court. But anyone genuinely interested in tackling the causes of climate change should fear that possibility. We will make a lot more progress, much faster, if business and industry participate willingly and bring the weight of their technical and financial resources to bear on the problem. Distracting them with lawsuits over whether and when they should have known greenhouse gases were harmful won't reduce their emissions, unless it's by putting them out of business.

The Perils of Price Stability

If I had seen last Friday's New York Times op-ed on "Praying at the Pump" earlier, it might have preempted my thoughts on European fuel economy standards. The author, a former Clinton Administration official, makes a very well-reasoned, contrarian argument that our biggest energy problem is not our vulnerability to unstable foreign oil suppliers, but the economic consequences of oil's inherent price volatility. He goes on to suggest that even a large and successful effort on domestic oil substitutes would not be sufficient to insulate us from the influence of the global oil market. That's counter-intuitive, but probably right. His op-ed contains many good insights, so it's a shame that I can't agree with Mr. Minsk's ultimate conclusion. By setting oil price stability as the ultimate goal of good energy policy, he mistakenly dismisses the benefits of freely-functioning markets and ignores much of the history of artificially-stabilized energy prices.

This argument might all sound rather esoteric, but I believe it is of more than academic interest. Our growing concern about climate change is likely to result in a major energy market intervention, whether in the form of an emissions cap-and-trade system or a carbon tax. It is crucial that in the process of recognizing the environmental externalities of our oil use, we should not impede the ability of the market to respond rapidly to changes in supply and demand.

There are two basic problems inherent in any effort to stabilize oil prices. The first is the one that every first-year Economics student learns: prices are the means by which supply and demand are re-balanced, when supply or demand change. We've seen this demonstrated in the short run, when price increases after Hurricanes Katrina and Rita prevented catastrophic runouts and long gas lines. We've also seen it work in the longer term, when higher oil prices from the mid-1970s to early 1980s--even after being filtered through federal gasoline price controls--promoted enough efficiency to break OPEC's hold on the market within 10 years. And we've seen the result when prices weren't allowed to adjust quickly enough in the late 1970s: gas lines and non-economic rationing.

The other problem with enforced price stability is that once you create its mechanism, you have to decide at what level to stabilize prices. While I suspect the future prices to which Mr. Minsk alludes are meant to be stable and high, it might not work out that way. The political temptations to stabilize at lower-than-market levels would be enormous. In the mid-1990s, when I looked after Texaco's interest in its Caltex alliance in Asia-Pacific, several of the countries in the region had "oil price stabilization funds", including Korea and the Philippines. Originally intended to buffer consumers from the fluctuations of the market, they ultimately subsidized consumption, contributing to rapid demand growth that outstripped local refining capacity. That led to higher petroleum product imports and a wave of premature and unprofitable refinery construction and expansion. The lesson here is that when you control the price of something the whole economy depends on, you are effectively controlling the economy.

We've seen this effect closer to home, as well. Regulated electricity prices are a model of stability, with consumer prices set by state regulators after public hearings and impeccable justifications. But while everyone now seems to blame the California energy crisis of 2000-2001 on Enron and other traders manipulating the new electricity market, the deeper problem was that the so-called deregulation did not unfetter consumer prices. As a result, utility customers never got the signal that the state was out of spare generating capacity, until wholesale prices reached astronomical levels, putting one--and nearly both--of the state's largest utilities into bankruptcy.

Now, I'm not sure that Mr. Minsk had the creation of an oil price stability fund in mind; he certainly never mentioned one. But there are only so many ways to stabilize prices without controlling them. We could try to create a large supply surplus, either by accelerated efficiency measures to dry up demand, or with lots more oil drilling. Either of these paths would take time, though, and patience isn't our greatest virtue. Once we got our minds set on oil price stability, I suspect we'd find a way to create it, no matter what the consequences--anticipated or otherwise. So while more stable oil prices and the economic benefits they would bring might be a valuable by-product of good energy policy, elevating price stability to a higher priority than reducing imports or cutting greenhouse gas emissions would be distinctly counter-productive.

The Verdict

Last Friday the Intergovernmental Panel on Climate Change (IPCC) concluded its meeting in Paris with the release of the Summary of its Fourth Assessment Report (4AR.) There's not much I can add here to what is being reported about the significance of its findings on the connection between greenhouse gases and climate change, and of the likely course of the latter over the rest of the century. I think I contribute more in two areas that haven't gotten a lot of attention in the media blitz over the 4AR: the value of the engineering approach for problems at this stage, and how best to regard the remaining climate skeptics.

Even though I haven't done much actual engineering in the last 25 years, my engineering training provided a framework for problem-solving that informs everything I do. Engineering is all about turning the results of science into practical things in the real world, and that is increasingly relevant to the problem of climate change. With the release of the full 4AR over the next several months--last week's output was just the executive summary of the first of the three main Working Groups--we're reaching the point at which the main focus must shift to action, rather than more analysis. That doesn't mean the scientific investigation of climate change should stop, or that we know everything we need to know about climate change; rather, in the manner of the solution to Zeno's Paradox, we know enough to get started. It's time to turn the engineers loose on this problem and move the scientific debate off to the side.

Making our energy systems more climate-friendly will be the centerpiece of that work. There are many competing blueprints for how to do that, and another one was also released last week by the American Solar Energy Society, with some impressive institutions and individuals behind it. Although I wonder how rapidly their proposed solutions could actually be ramped up, the report provides a good picture of the magnitude of response necessary to avert the consequences that the 4AR describes. (The IPCC will apparently contribute its own thoughts along these lines in the upcoming reports of the second and third Working Groups.) And we shouldn't limit ourselves to devising new ways of generating electricity or making cars more efficient. It may turn out that the only means of arresting the uncontrolled science experiment we've been running for the last century is with some truly large-scale engineering, and we ought to have options for that in our back pocket, in case we encounter a "runaway greenhouse" effect. I recognize that some will find that idea nearly as worrying as the climate problem itself.

Now to the skeptics. Although the strengthened scientific consensus of the 4AR will change the landscape for them, no one should expect the skeptics to disappear, nor would that be desirable--and here I draw an important distinction between genuine skepticism and self-interested obstructionism. That doesn't mean the skeptics should be driving the agenda, but having to answer their hard questions will clarify our thinking. Fundamentally, if they are going to challenge the IPCC view, they must do so in the only way that has worked throughout the history of science: by creating a better hypothesis that can be demonstrated to fit more of the available data and observations. Until that should happen, we must assume that man-made greenhouse gases are warming our planet, and act accordingly.

Life is going to get progressively harder for the skeptics. Their sources of funding will start drying up, and they may find themselves persona non grata, even among those whose support they could count on in the past. With the future of the planet increasingly seen to be on the line--and the fate of our descendants with it--the non-scientists' view of climate science is taking on attributes of religious dogma, and skeptics are being cast as heretics. That isn't healthy, but it's understandable. We need to preserve a level of continued funding and access to the mainstream of science for skeptical scientists, on the off chance that the consensus might prove to be wrong in some important way. If it turned out that the main driver of climate change were something other than man-made greenhouse gases--be it the cosmic ray/cloud hypothesis or something else--it would be nice to know that before we've spent trillions of dollars on a crash effort to decarbonize our energy systems and transform the global economy.

As the 4AR has made quite clear, waiting for the last lingering doubts about climate change to be resolved is a losing game that risks highly detrimental, potentially irreversible changes in our environment. Now we must see what the scientists can convince the policy makers to engage the engineers and financiers to do. I don't think we're going to have to wait long to find out.

Euro CAFE

It's hardly news that Europe and the US have different approaches on energy and the environment. Some of that may be changing, but in the area of automobile efficiency standards, the differences are fascinating. The US has had federal fuel economy regulations since the 1970s: the Corporate Average Fuel Economy standards, or CAFEs. I'm not sure how many people realize that the closest European counterpart to this hasn't been a government regulation, but rather a voluntary pact that the auto industry made with the EU in the late 1990s. Perhaps the EU assumed that with fuel taxed to more than double its price in the US, consumers would naturally find their way to more efficient cars. Although the target looked pretty strict, equating to 40.5 miles per gallon for new cars by 2008, it had no teeth. That is about to change, and the new EU rules on vehicle CO2 emissions are likely to be noticed on both sides of the Atlantic.

Despite a growing European emphasis on energy security, it is clear that concerns about climate change are driving the bus. Even the old, voluntary efficiency target was expressed in terms of grams of CO2 emitted per kilometer (km), rather than the normal European fuel economy units of liters per 100 km. The EU and carmakers are currently debating a new, official target at a level severe enough to create serious concerns for the manufacturers of Europe's larger cars, many of which come from Germany. BMW, Mercedes and Audi will have a very hard time getting their fleet averages down to the 120 or 125 gram/km level proposed for new cars sold in 2012. Since a gallon of gasoline emits 20 pounds of CO2, that works out to 45-47 mpg. Converting to diesels only takes you so far, and hybrids haven't yet hit the mainstream, as they are starting to here.

Unsurprisingly, the few carmakers that are on track to meet both targets generally make smaller cars than those that are lagging, though even VW probably won't meet the 140 gram voluntary limit for next year. But as if the prospect of a tough official target with penalties for failing to meet it weren't enough, many of Europe's top auto firms and import brands are being subjected to scathing ads and adverse publicity for their lack of progress under the voluntary system. To put this in perspective, the average fuel economy of several of the companies identified as "failing"--including GM's European subsidiaries Opel and Vauxhall--already meets the 2017 level of the revised US CAFEs proposed in the State of the Union Address.

This is going to be a real test for the EU's commitment to climate change, since car manufacturing is the mainstay of the German economy, and the recovering German economy is critical to overall EU economic growth. France and Italy, whose biggest carmakers look set to achieve the new standard, are unlikely to concede their lead easily. It presents a nice little conundrum for Chancellor Merkel during her turn at both the EU and G-8 Presidency. And if the European Commission can push through its proposed 120 gram/km standard, regulators in California and elsewhere may be tempted to go for a bigger stretch goal in this area than they might otherwise have done.

Ethanol Supply Chain

Because of the problems involved in transporting ethanol in petroleum product pipelines, the key piece of infrastructure for our chosen fuel of the future is the railroad. Who would have guessed that the 21st century would owe such a debt to the 19th? Today's Wall Street Journal includes two articles describing the transportation hurdles and import barriers that ethanol will have to overcome to expand to the extent contemplated by the White House and Congress. High energy prices and environmental concerns are providing rail companies with wonderful new opportunities, but I hope their strategic planners are thinking carefully about where this could lead. Somewhere along the road to 35 billion gallons per year, the conventional wisdom about ethanol and pipelines will be challenged, perhaps in ways no one expects.

In some respects the development of ethanol is recapitulating the growth of petroleum a century ago. Although pipelines came along fairly early in the history of the oil industry, rail transport was a key supply chain link from its start in Pennsylvania, and it never went away. My first assignment after joining Texaco's Supply and Distribution department in the early 1980s involved trading LPG in tank car lots, and later I dealt with unit-trains of crude oil going from Bakersfield to Los Angeles. As interesting as all this was, I quickly discovered that trains are a lot more expensive and less reliable than pipelines, and I'm sure the ethanol industry is learning the same lessons. The incentives to shift from rail to pipeline will only grow, as ethanol volumes increase.

Besides its well-known incompatibility problems, ethanol faces other hurdles in shifting to pipelines. As crude oil production in the key ethanol producing region, including states like Illinois, Indiana, Kansas and Nebraska, declined from a million barrels per day in 1980s to less than half that today, existing oil pipelines were reversed and new ones built to supply the region's refineries with imported oil from Canada or the Gulf Coast ports. And the main petroleum product pipelines in the mid-continent flow north from the Gulf. That means that most of pipeline capacity between the Midwest, where ethanol is produced, and the Gulf Coast, where a third of America's gasoline is made, is going the wrong direction to help ethanol producers. As long as ethanol accounts for less than 2% of the country's liquid fuel supply, it can't win that battle.

As it grows, however, this impediment will turn into an opportunity, and some clever entrepreneurs will figure out that ethanol pipelines can share a right-of-way with crude and products lines going the other way. How big is the incentive? Ignoring transshipment costs and tank car rental fees, shipping ethanol from St. Louis to Houston by rail costs about 12 cents/gallon. Shipping gasoline from Houston to St. Louis on the Explorer Pipeline costs 3.5 cents. 8.5 cents per gallon would pay for a lot of pipe. And with ethanol being totally biodegradable, they might even be able to use cheaper materials to build their pipelines and the gathering systems needed to collect the ethanol from its widely dispersed sources. In any case, ethanol pipelines would face a significantly easier permitting process than anything involving oil or its refined products. If I were running a railroad, I'd enjoy those tariffs while I could, and start thinking hard about laying dedicated ethanol pipe.