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Monday, December 31, 2007
Looking Back at 2007
When 2006 ended, it appeared that oil prices had settled into a range that was just high enough to promote the development of biofuels and other alternatives, but not high enough to cause serious concern about the economy. That comfortable picture didn't last very long, however, as oil became intertwined with the problems of the dollar and the sub-prime credit crisis. WTI headed steadily higher, inflating at over 4% per month since January, despite the unraveling of one of the biggest geopolitical risks built into the market price, the prospect of armed conflict with Iran over its nuclear program. Only the post-Labor Day collapse of refining margins buffered consumers from the full impact of these increases, with US average retail gasoline prices ending 2007 only about half as much higher than they started, compared to crude oil prices. Nevertheless, $3.00 gasoline seems here to stay.
High prices were only half the energy story in 2007, however. If we had just been facing expensive fuel, I'm not sure the Congress would have been able to pass the recent Energy Bill, with its large increases in mandated fuel economy and biofuels production. Climate change came into its own as a mainstream issue for the American public this year, and it was a major factor in the Congressional debate over the energy bill. As I noted last week, "green" is now big, and that's because the scientific concerns about global warming are being matched by images of shrinking icecaps, encroaching sea levels, and drought-abetted fires.
When postings resume after New Year's Day, I'll look at the year ahead, as I did last year. It strikes me that the refurbishing of the ball that will drop in Times Square at midnight tonight with energy-efficient LED lights is a perfect reflection of the cusp at which we stand. Like many of the steps we took this year, it may be largely symbolic--considering how much energy can be saved in a device that only runs for a minute each year--but it could also be a harbinger of more serious measures to come. Happy New Year!
Friday, December 21, 2007
A Greener Christmas
Consider the presents we give and receive. I heard a statistic on the news the other night indicating that Americans would give out $8 billion in gift cards this year. As enthusiastic about emissions trading and voluntary offsets as I am, I don't see emissions credit gift cards overtaking the cash kind any time soon. Then consider the energy profile of some of last year's popular gifts, including those we gave ourselves. As I've noted before, one plasma TV wipes out the energy savings of multiple CFL bulbs. Even more modest consumer electronics such as cellphones, iPods and digital cameras make their own small contributions to higher energy consumption and the growing strain on our electrical infrastructure, particularly when we leave their recharging transformers plugged in all the time.
A truly Green Christmas would be one for which the most popular "gadget" gifts were either energy-saving devices themselves, such as the Kill-A-Watt meter, or more efficient replacements for existing gadgets with high energy consumption. And all gifts would come with clear disclosures of the energy used and emissions released during their production. If we're ever going to begin reducing energy consumption and greenhouse gas emissions in absolute terms, achieving a net carbon-neutral holiday season would be a great place to start.
We are a long way from that now, nor should we necessarily be consumed by guilt over this. A cultural change that deep can't happen overnight. Taking off my Scrooge hat, the good news is that it's not nearly as hard to imagine such a thing as it would have been only a couple of years ago. Perhaps we're starting to see climate change as our all-too-real Ghost of Christmas Future. Today, suggesting a carbon-neutral holiday season probably wouldn't get you laughed at, though it's not going to attract many invitations for eggnog and cookies. In that spirit, I would like to wish all my readers the joys of the season, even if it's not yet as green as it might be.
Energy Outlook will be on holiday break until 12/31.
Thursday, December 20, 2007
California's argument for the waiver is straightforward. The Supreme Court has ruled that CO2 is a pollutant, and California has been granted waivers in the past to regulate pollutants more stringently than the country as a whole. Moreover, California's greenhouse gas emissions are large enough to matter on a global scale, and the state's elected representatives believe they have a mandate from their constituents to address those emissions aggressively and comprehensively. Failure to do so would contribute to the risk of adverse outcomes from climate change in California, with some pointing to reduced precipitation and coastal erosion as early indicators of such damage.
But while my heart is with California in this matter, my head is with the EPA. Even if we accept that CO2 is now recognized as a pollutant--the logic of this escapes me, but I concede my minority status--it still does not result in the kind of direct local impacts that provided the self-evident justification for granting the state's past waiver requests concerning regulation of the "criteria pollutants" that affect air quality and produce smog. Climate change is a global problem, the local ramifications of which cannot yet be predicted reliably. With the US struggling to maintain its competitive edge in a global marketplace for goods and services, should we really desire the further Balkanization of auto and fuel standards?
Both sets of arguments are legitimate and compelling. Where I believe the EPA's case fails is in the implied responsibility of turning down California's request. If there were a similarly comprehensive set of federal greenhouse gas regulations in place or waiting in the wings--even if it was not as stringent--the EPA would be right to ask California to follow the federal government's lead. Yet the energy bill provisions cited by the Administrator in defense of his decision don't constitute such a plan. Unless and until something like the Lieberman-Warner Bill, S.2191, passes, the closest thing we have to a national greenhouse gas regulation is an array of voluntary programs. And as the Washington Post pointed out, a list of states accounting for nearly half the nation's cars has lined up behind California, rather than the EPA.
There's an old saying, "Lead, follow, or get out of the way." The last year has seen the publication of an impressive collection of reports on the science of climate change and on the economic consequences of ignoring the problem or tackling it head-on. These reports, including three from the same Intergovernmental Panel on Climate Change (IPCC) that shared this year's Nobel Peace Prize with Mr. Gore, underline the urgency of the issue and provide the real underpinnings of California's waiver request. On these grounds and with the precedent of Mass. v. EPA, I believe the high court will ultimately find in California's favor, but time is wasting in the interim.
Wednesday, December 19, 2007
Rethinking Fuel Economy
Contrary to some disingenuous comments we heard during the debate about the 35 mpg CAFE Standard, it is simply not realistic to imagine that US consumers will be able to purchase essentially the same cars as today, differing only in their ability to achieve dramatically better fuel economy. Consumer expectations of vehicle cost and performance and the engineering solutions necessary to deliver an average of about 10 mpg lower fuel consumption are headed for a minefield of trade-offs. Something must give, whether vehicle size and weight, performance, or sticker price. Two of the main constraints on Detroit are our expectations of being able to accelerate to highway speeds in 10 seconds or less, and traveling roughly 300 miles without refueling, regardless of vehicle size. What could engineers create if those expectations disappeared?
The work of the Vehicle Design Summit (VDS) seems aimed precisely at that conundrum, targeting a developing-country market in which consumers are seeking personal mobility without such preconceptions, and for which the notion of a 12 mpg SUV that can accelerate like a sports car is entirely alien. Their first-stage prototype is anticipated to achieve 100 miles per gallon, using a plug-in hybrid architecture with a small, highly-efficient onboard generator capable of running on a variety of fuels. And because it won't have to go 300 miles at a stretch, the size of the engine and battery pack can be minimized. That reduces both cost and weight, increasing energy economy further. And that's a key point; from what I can tell, VDS isn't just trying to reduce oil consumption, but rather the entire energy consumption of the vehicle, including the "embodied energy" and greenhouse gas emissions of the manufacturing process.
Having cars such as the ones VDS is designing available for developing-country consumers, as they reach the income levels at which car ownership rates take off, will be crucial in managing global emissions and getting the most out of the world's limited supplies of transportation fuels. As daunting as it may sound, it may actually prove easier to create an entirely new concept of the personal vehicle that is capable of achieving an actual 100 miles per energy-equivalent gallon, compared to boosting the current American car to 35 mpg by incorporating energy from electricity or biofuels that is conveniently ignored or under-counted for the purposes of the federal fuel economy regulations.
Tuesday, December 18, 2007
I'm sure some will see the Administration's comments on this event as making the best of a bad situation, but I think this time the President has it right, to this extent: As he stated, “If the Iranians accept that uranium for a civilian nuclear power plant, then there’s no need for them to learn how to enrich.” However, I also think that Tom Friedman of the Times was correct the other day, when he noted that the timing and wording of the NIE have seriously undermined the global coalition to contain Iran's nuclear ambitions. "The peculiar (obtuse?) way the N.I.E. on Iran was framed has deprived all who favor a negotiated settlement of leverage." At a time when nothing in Washington, DC is taken at face value, those who were anxious to foreclose any possibility of a military strike against Iran's nuclear facilities have downplayed the document's description of the very serious risks and uncertainties surrounding the most worrying elements of Iran's nuclear program--uranium enrichment at Natanz and plutonium production from the heavy water reactor at Arak.
While the security implications of all this have become quite muddled, the energy consequences are perhaps even less obvious but no less important. In order for nuclear power to be effective as a strategy to combat climate change, its application can't just be limited to countries that are already part of the nuclear weapons "club", or to developed countries such as Finland that have decided to forgo nuclear weapons. As the climate change roadmap coming out of the Bali conference confirmed, emissions from developing countries must be included in a global solution, with appropriate technical and financial assistance from the developed world. That means that among other things, we must be able to transfer nuclear technology--as Russia has done in Iran--without creating a nuclear weapons proliferation nightmare. Iran's opaque and contrary approach to nuclear power elevates the risks of such transfers and simultaneously undermines the international mechanisms for ensuring that nuclear technology will be used for peaceful purposes. It would be impossible for them to follow this path absent the tremendous influence of their hydrocarbon reserves and exports. Those weigh heavily in the cost-benefit analysis for Russia and China, without whose continued cooperation the diplomatic effort to keep Iran from developing a nuclear-weapons capability will ultimately unravel.
Monday, December 17, 2007
The Greenspan Effect
I don't know if it says more about Mr. Greenspan's extraordinarily long tenure as at the helm of the Fed, or the qualities of his successor, that many continue to regard him as the preeminent voice on the economy and seek out his views regularly. I don't remember quite the same thing occurring after Mr. Greenspan replaced Paul Volcker, whom many credit with eradicating the high inflation of the 1970s. In any case, Mr. Greenspan still has the knack for encapsulating vast economic trends in a few words, and those words can move markets.
For as long as I can remember, observers of the economy have focused on core inflation, excluding food and energy prices, as the key measure of price stability. Until recently, the logic of factoring out volatile energy prices was solid, because oil prices always seemed to revert to a long-term average price in the low- to mid-$20s. Since 2003, however, that rationale has broken down. Over the last five years the key indicator of oil prices, West Texas Intermediate crude oil traded on the New York Mercantile Exchange, has gone up by about 30% per annum--with very large spikes and dips around that trend. Substituting the DOE's record of US refiner crude oil acquisition prices, a broader indicator of the raw material cost of fuels, suggests that oil inflation has been running at 25%. Natural gas isn't far behind, with roughly an 18% inflation rate on wellhead prices since 2003. Mr. Greenspan's remarks recognize that you can't double energy costs every three or four years without swamping many of the other economic factors that the Fed and economists monitor. And as I noted the other day, the alternative energy supplies being promoted by US energy policy are unlikely to provide any price relief.
Mr. Greenspan apparently doesn't envy the task his successor now faces: simultaneously trying to stave off a recession, defend the value of the dollar, and protect against the reappearance of serious inflation, driven by the very factors that the core inflation rate ignores. This may not fit the classical definition of a liquidity trap, but it could be the practical equivalent of one, if the Fed can't reduce interest rates much further--or even if the market merely believes that to be true, validated by voices such as Mr. Greenspan's.
What does that mean for all of us non-economists? Well, for starters, it shifts the burden of averting a recession away from interest rates and toward tax cuts and other fiscal policies--hardly the flavor of the week in a Congress seeking new revenue to offset the cost of new programs and shrink the federal deficit. At the same time, Mr. Greenspan's endorsement of the idea of an approaching peak in global oil output will tend to keep energy prices high by supporting higher long-dated futures prices. That compounds the Fed's problem and could also lead to higher valuations for oil equities (some of which are in my personal portfolio.) To the degree that this all comes down to market expectations about the future, I can't think of a more credible influence on those perceptions than the former Fed chief.
Friday, December 14, 2007
Save the Nukes!
Despite the growth of wind and grid-connected solar power, the nation's 104 operating nuclear power plants generated two-thirds of our CO2-free electricity--and 19% of all US electricity--last year. The newest of these plants entered service in 1996 and the oldest in 1969. Even if the pending applications to build new reactors are approved, the first new plant would not enter service before the licenses for most of the 53 plants built before 1980 would expire, forcing them to shut down if not renewed. That would have severe economic and environmental consequences.
If you regard our energy economy as an artificial ecology, nuclear power occupies a key niche within it, as our largest source of low-emissions, baseload electricity. In fact, only three other currently-available technologies can furnish power meeting both of these criteria: "clean coal" with carbon capture and sequestration (CCS), large-scale hydropower, and geothermal energy. None of these is in a position to substitute for nuclear power at this point, at least in the US. Coal with CCS looks expensive and remains unproven at industrial scales. Essentially all of the sites for large hydro-electric dams have been used, and the trend is toward dam removal. And while geothermal power looks very promising, sites for conventional (natural steam) geothermal are limited, and advanced (dry rock) geothermal is not ready for prime time.
Nor can wind and solar power substitute for nuclear power, should any of the existing plants be shut down, at least not without the provision of power storage on a scale that is simply not yet practical, in order to buffer the intermittent output of wind, and shift the cyclic output of solar to match the power demand, or "dispatch curve." Without cheap storage, replacing the annual generation from Indian Point would require roughly 1,800 3.6 MW wind turbines. That's about 45 times the size of the recently-cancelled Long Island wind farm project.
It won't surprise my readers to learn that I was never "anti-nuke", though like many people I had virtually written off nuclear power on economic grounds for most of the 1980s and '90s. Climate change and the increasing competition for limited oil resources alters that analysis. When faced with the choice between sequestering billions of tons per year of carbon from new and existing coal-fired power plants, or a few thousand tons of radioactive waste, the challenges of the latter look a lot more manageable in the long term. Endangered nuclear power plants aren't as appealing as "charismatic mega-fauna", but the prospect of losing the output of the existing plants looks about as bad as losing the polar bears--and the two are not unrelated.
Thursday, December 13, 2007
Embedding High-Priced Energy
I've devoted a lot of space in the last couple of years to the problem of ethanol's energy return on energy invested. This may seem like an abstract concept with few practical consequences, and it is certainly one that ethanol advocates usually dismiss out of hand, either because they don't understand its implications, or because they understand them all too well. Simply put, the fact that corn ethanol returns only 130 BTUs of energy for every 100 invested in its production means that it can never deliver a fuel that is much cheaper before subsidies than the petroleum products it is intended to replace.
Ethanol's biggest benefit is that relatively little of the energy it consumes comes from oil--mainly the fuel used in cultivation, harvesting and transportation to and from the distillery. The biggest contribution comes from the natural gas used for process heat and to make the fertilizer needed to grow the corn. For all the margin problems that ethanol producers have experienced this year, as corn prices rose and output expanded faster than the market could absorb, they have caught a significant break on natural gas prices. We shouldn't assume that gas will continue to trade at a 46% discount to its BTU value against oil, as it has in 2007, based on a comparison of the relevant futures prices on the New York Mercantile Exchange. Since January 2000, gas has sold at an average of 73% of oil's BTU value, and there have been years like 2003, when it approached BTU parity with oil. In the long run, with imports making up a growing share of North American gas supplies, and as gas's lower CO2 emissions begin to be reflected in its price, it could even command a slight premium over oil.
What does all this mean? Well, at the BTU price implicit in $85/barrel oil, the cost of energy in a quantity of ethanol sufficient to displace a gallon of gasoline would be approximately $1.45/gallon. Add the contribution of corn at $4 per bushel, and you're at $3.50/gasoline-equivalent gallon, before taxes/subsidies and transportation by rail to the blending terminal. That compares to an equivalent wholesale gasoline price of about $2.35/gallon at the tank-truck rack. This comparison doesn't look any better at higher or lower oil prices, either.
The Energy Bill would double the existing mandated target for corn ethanol from 7.5 billion gallons per year by 2012 to 15 billion by around 2017, while adding an additional mandate for 21 billion gallons of non-corn ethanol and other biofuel by 2022. But from the analysis above, whatever this would do to enhance the energy security of this country by reducing our oil imports, corn ethanol cannot reduce the cost of energy to the US economy, even though subsidies and the lower energy content of a gallon of E-85 may superficially mask that effect for consumers. Now, reducing the cost of fuel may not be the top priority of US energy policy, at a time when we are concerned about climate change and our growing reliance on oil imported from unstable suppliers, but it's certainly relevant to businesses and consumers, and it ought to be of some interest to voters. Sooner or later, someone is going to have a lot of explaining to do, once the public figures out that ethanol is not the panacea we have been led to believe.
Wednesday, December 12, 2007
The Twelve Days of Bali
The authors suggest that if Bali produces a framework that is little more than a bigger version of Kyoto, it will fail. They base this conclusion on their assessment that most of the countries that agreed to reduce emissions have fallen short of their commitments, at least at this point, and that where reductions have occurred, they resulted mainly from factors unrelated to the Kyoto targets and their implementation mechanisms, such as emissions trading and the Clean Development Mechanism. There's more than a grain of truth to this, but I believe reality is more complicated, and that Kyoto has not been an unmitigated failure. At a minimum, it has served as a global focal point on climate change, and the template on which national emissions reduction efforts--and of states such as California--have been based. Absent Kyoto, it's hard to imagine the same impetus for action.
As to the performance against Kyoto's targets, it is not as bad as often portrayed. However they get there, the EU has a reasonable chance of achieving its target of 2012 emissions that are 8% below what its member countries emitted in 1990. By the end of 2005 its emissions were already 1.5% lower than 1990 for the core 15 nations that signed Kyoto, and almost certainly lower than they would have been, had they not undertaken any of these measures--though one might argue about whether the process has been as efficient or the cost/ton of the cuts as low as possible. Even in the US, which did not ratify Kyoto and has so far avoided a firm commitment on reductions, our 16% growth of emissions since 1990 (14.5% taking the 2006 result into account) is well below the status quo projections I saw in the late '90s, which anticipated emissions growing by around 30%.
The Achilles heel of Kyoto, as most skeptics are quick to point out, is its treatment of the large developing countries. The growth of emissions in China alone, in just the last five years, has been larger than all the cuts that Kyoto asked of the EU and US combined. Nor is there any reason to expect that China's rate of emissions growth is about to turn negative, any time soon. Simply increasing the severity of cuts required of the Kyoto-compliant developed countries and adding the US and Australia to that list seem unlikely to attain the underlying goals that are being discussed in Bali, of ensuring that total global greenhouse gas emissions begin falling within 10-15 years, and that the rise in average temperature does not exceed 2 degrees Celsius.
If a bigger version of Kyoto is insufficient to the task, then what do we need? There are plenty of opinions out there, but I will be encouraged if the 12 days in Bali end with a charge to the negotiators of the details that is flexible enough to allow them to address the widely disparate political and economic circumstances of the world's nations, and particularly of the largest emitters. The key success criterion ought not to be its fit with our preconceptions about the relative importance of emissions cuts, technology transfer, and other key elements, but whether it results in a framework that can be implemented and enforced across all the big emitters, offering a realistic expectation of actually working, not just satisfying our notions of equity.
Tuesday, December 11, 2007
High oil prices and the resulting growth of energy revenues have led the resurgence of Russia's economy during President Putin's second term, and the threatened or actual manipulation of energy flows has become a major lever for projecting Russian political influence beyond the country's borders. By some measures Russia already plays as pivotal a role in global energy supplies as Saudi Arabia. With the world's largest reserves of natural gas, it furnishes roughly 60% of Europe's natural gas imports, and its 2006 oil exports were only 25% below those of the Saudis. While Russia may no longer be a superpower, geopolitically, it has become one in energy terms.
If Russia under Mr. Putin emerged as one of the world's largest petro-authoritarian states, as Tom Friedman puts it, what is it likely to become under the leadership of the chairman of the board of the country's largest energy concern? And am I the only one struck by the added irony of a former German Chancellor playing a key role in the operation of that business? Still, Dmitry Medvedev is not one of the siloviki, and he apparently has legitimate democratic credentials. Considering all the speculation about the likelihood of Vladimir Putin putting forward a non-entity as President, so that he could shift Russia's locus of power to whatever new role he chose for himself, Mr. Medvedev is an interesting choice as Russia's next President.
While the Washington Post focuses on his loyalty and close ties to Mr. Putin, going back to their time together in the former Leningrad, where both served in the mayor's office, Gazprom under Medvedev has been far from passive. Whatever the internal politics of this choice, it is also an implicit recognition of the importance of energy markets to Russia's current and future success, and Mr. Medvedev has participated in a very assertive approach to those markets. Even as Russia's internal growth consumes more of its energy output, it will remain a major force in energy markets for the foreseeable future. With Mr. Medvedev at the helm, energy seems certain to play at least as large a role in the country's economic and foreign policy as it has under President Putin.
Monday, December 10, 2007
Sine Qua Non
Since participating in Texaco's first global energy scenario project ten years ago, I've been following the evolution of the industry's access to resources, one of three big energy trends identified by our scenario team. Increasingly, the international oil companies have been frozen out of the big reserve plays around the world, or forced to take secondary roles involving much less control. But within the last year, I've grown much more concerned about the potential impact of a factor that compounds the problem of access. As oil-rich developing countries grow, they consume more of their own oil, leaving less to export. And as often as not, much of that incremental consumption is driven by internal petroleum product prices that are well below international market prices, leading to inefficiency.
The 15 countries on the Department of Energy's list of the biggest oil exporters accounted for 90% of total global oil exports of 43.2 million barrels per day (MBD) in 2004, out of total consumption of 82.3 MBD. As the figure in the Times article shows, consumption in the largest of these exporters is growing at a multiple of the global rate, at a time when it has slowed or stalled in developed countries. (The decline shown for the US between 2005-2006 is somewhat anomalous, because it appears to be attributable not to products like gasoline or diesel fuel, which are still growing, but to the disposition of the bottom of the barrel, perhaps into additional coking capacity or exports.) In fact, the growth of consumption in oil-exporting countries may matter as much to the future of the oil market as the growth of China and India, which has received a lot more attention in the last several years.
This trend has a number of important implications. At the highest level, as the Times notes, a reduction of exports will put more pressure on prices, and thus on consumption in importing countries, effectively hastening the effects of Peak Oil. At the same time, a reduction in the number of net exporters, as countries with historic surpluses move into balance or deficit, will alter the dynamics of the market, as will shifts within the top rank of exporters. The resulting fewer major exporters will have more market power, and that will affect not only the market for their output, but also the competition for access to new oil fields. Meanwhile, the incentives for current oil importers to reduce consumption and develop more domestic production will grow, encompassing biofuels and hydrocarbons from conventional and alternative sources. In this light, the present high US reliance on oil imports looks even less sustainable, and a comprehensive energy plan addressing both supply and demand even more essential.
It isn't for us to tell oil-producing nations what to do with their own resources. We have no inalienable right to consume other countries' oil, unless they sell it to us willingly. Nor are we in a strong position to advise them about inefficiency, at least until we put our own house in order in this regard. That suggests the need for us to plan for a world, not necessarily with less oil, but with less of it available for us to import. Considering the scale of those imports and the present modest contribution of alternatives, the definition of energy independence we should all be able to agree on would focus on achieving sustained year-on-year reductions in our oil imports and creating enough new options to provide real leverage with our remaining suppliers. That's a very different notion from self-sufficiency.
Friday, December 07, 2007
The Missing Ingredient
The renewable energy sources covered by HR.6 are going to be extremely important for the energy future of this country. Cellulosic ethanol, wind, solar and geothermal power constitute important new resources that also provide significant benefits for tackling our greenhouse gas emissions. We need them to become competitive and expand rapidly, in order to meet the challenges posed by climate change. However, they won’t supplant oil and gas or make the US independent of its foreign energy suppliers within the timeframe considered by this legislation. What is needed, then, is a transition from the current, fossil-heavy energy mix to a future diet built mainly around renewable energy and nuclear power. By excluding the most obvious source of new energy production available to us, this bill will make that transition more arduous and expensive than it has to be. Anyone expecting this bill to drive down the price of gasoline or heating oil within the next several years is bound to be disappointed.
Given the kitchen-sink nature of the "Energy Independence and Security Act of 2007", including the tougher CAFE standard, an expanded renewable fuel standard, a controversial 15% national renewable electricity standard, and assorted other subsidies and a few earmarks, it's hard to understand the absence of truly meaningful supply provisions. CAFE, ethanol and renewable electricity do not add up to energy independence, not by a long shot, though the demand-side measures in the bill should begin to slow the rate at which our energy dependence is growing.
One of the speeches I caught on C-SPAN's coverage of the House debate provided a clue as to why such a massive omnibus energy bill would rule out expanding US oil and gas production, which account for almost half of our present 71% level of energy independence. Representative Hinchey (D-Ithaca, NY), recited as part of the bill's justification the well-worn "3-25 Fallacy": Although it is accurate that the US consumes 25% of the world's oil, while possessing only 3% of global proved oil reserves, this ignores the fact that we have produced 1 out of 5 barrels of petroleum ever extracted and still contribute 10% of global production, ranking third behind Saudi Arabia and Russia, but ahead of Iran and Venezuela combined. And while our output is declining because of the mature nature of most of our oil fields, this is also occurring because we have chosen to leave many billions of additional barrels--barrels that would really get OPEC's attention--untouched.
Speaker Pelosi described the effect of the energy bill as being, "as immediate to them as the price at the pump they face when they fill up their tanks." Given the long phase-in of renewables and higher fuel economy standards, that is surely an exaggeration. As urgent as the problems of energy and the environment are, there is still time to get this right, and that ought not to be dictated by the legislative or electoral calendar. The question facing the Senate and, should they pass it, the President, is whether the many positive aspects of this bill are sufficient to outweigh its negatives, including its notable failure to increase domestic conventional energy production by opening up new areas for drilling or making it easier to add new refining capacity. No legislation is ever perfect, and we urgently need stronger energy policy. Nevertheless, a bill constructed on the premise of moving us towards energy independence--however unattainable that goal may be--should include more robust supply provisions than doubling our already problematic output of corn ethanol. While the country's former energy policy has been too oil-centric for years, this new policy is not oil-centric enough, when petroleum still accounts for 98% of the energy we use for transportation. If opening up additional offshore tracts and federal lands to drilling is a bridge too far for this Congress, then at least they ought to ensure that the 2007 Energy Bill is oil-neutral.
Thursday, December 06, 2007
The Momentum Shifts
While I share the general sense of momentary relief that oil prices are heading back into more comfortable territory for the economy--no one can call $85/barrel normal--I'm also oddly disappointed, and not just because I missed a chance to be on TV, for now. Breaking $100/barrel would have sent an important signal about the fundamental shifts that have taken hold in the global oil market in the last few years, and it would have underlined the need for consumer behavior to change, while we wait for more efficient cars, homes, and devices to become mainstream. It also would have set a new record oil price, settling the annoying controversy over what the 1980-81 historical high means today. That no longer seems likely, at least for the next few months.
Media analysis of the change seems focused on slowing global economic growth, oil inventories, and the new intelligence on Iran's nuclear program. You almost have to smile at the perversity of some of this, when traders take the otherwise bullish news of OPEC's failure to increase quotas as a signal that economic growth must be so weak that oil demand will fall, and prices with it. This contrasts with the fall in reported US oil inventories this week, which puts them right in the middle of their seasonally-adjusted historical average range, hardly a bearish indicator.
The most significant change, other than the absolute price level, is the dramatic decrease in "backwardation", the difference between the price of the prompt oil futures contract and those of succeeding months. Less than a dollar per barrel now separates the January 2008 and April 2008 contracts. A few weeks ago that spread was $3/bbl. This shift reflects a market that is in much better balance. That could be a function of easing physical supply and demand, a reduction in speculative pressure--as OPEC would have it--or a bit of both. Either way, the impetus that was driving prices ever higher seems to have crested for the moment, and we might even see a return to "contango", if the prompt market becomes oversupplied.
One of my futures trading mentors liked to say, "The trend is your friend, until it ends." As oil approached $100/barrel--a level with more psychological than real significance--the price seemed to have a life of its own. You can ascribe that to the impact of speculation, or the degree to which most global oil consumption is insulated from day-to-day changes in oil prices, requiring truly big spikes to bring demand back into line with supply. But whether speculators lost heart and chose to take profits, thus ending the trend, or the prospect of record oil prices finally cast a large enough pall over the global economy, prices have returned to where they were in October. The one certainty in all of this is volatility. Global supply and demand remain tightly balanced, and depending on the nature of the events ahead, we could soon be on verge of $100 again, or of $50. That's hardly reassuring for those investing in alternative fuels.
Wednesday, December 05, 2007
First, consider the conclusions of the new NIE. It reflects a dramatic shift in the consensus of the US intelligence community away from the notion that Iran has an active nuclear weapons program extending beyond the uranium enrichment we’ve been observing for several years, to a posture that the New York Times refers to as “agnosticism” about Iran’s nuclear ambitions. To paraphrase the old hair-color ads: do they or don’t they; only their leaders know for sure. The similarities to the pre-war intelligence about Iraq are striking, particularly because it’s not clear how much of this is based on reliable intelligence assets on the ground in Iran, instead of analysis of data gathered by means of electronic and satellite reconnaissance.
I am in no position to doubt the findings of the NIE with regard to any specific programs within Iran. The fact that its findings appear to coincide with the conclusions of the International Atomic Energy Agency certainly lends it additional credibility. So let’s assume that the NIE is correct, and that all actual work on weapons, including design, fabrication, and enrichment to the concentrations necessary for a bomb, has ceased. That still leaves us with the enigma of a major oil and gas exporter spending so much money on an energy source that is clearly more expensive than developing its vast unexploited hydrocarbon reserves. I looked at this in some detail in 2005, and I haven’t encountered anything that changes my conclusion that the best explanation for Iran’s nuclear activities involves nuclear weapons somewhere down the road. Even if Iran’s visible uranium enrichment program is entirely peaceful, it still constitutes an option on a future bomb effort. If anything, the NIE’s conclusion makes it all the more remarkable that Iran would create this option at such a high diplomatic cost, without actually planning to build a bomb.
Whatever I may think about this finding, however, what really matters is how it is interpreted by the US Administration, the Congress, and especially by the international community, including the UN Security Council and the key three European participants in the diplomatic effort to contain Iran’s nuclear program, Britain, France and Germany. While the NIE report is hardly a clean bill of health for President Ahmadinejad and the ruling mullahs, it is bound to undermine support for maintaining the current level of sanctions and other pressure on Iran, let alone stiffening them. And here at home, by rendering the nuclear threat from Iran more remote, the report should strengthen the hand of politicians arguing for engaging Iran’s leaders, rather than confronting them.
The NIE should also lead to lower oil prices. As the consequences of this report play out, and as pressure on Iran begins to ease, the oil market risk premium based on the possibility of military conflict with Iran should begin to abate. It could also contribute to higher oil production capacity in the long run, by easing the restrictions on international investment flowing into Iran’s energy sector. That ought to be good for a few bucks off the current oil futures price, not just in the front months, but all the way out to 2012 and beyond.
What are left with, then? With or without an active nuclear weapons program, Iran remains generally hostile to US interests and is actively engaged in manipulating the outcome in Iraq to suit its own regional geopolitical aims. Even if it is not on a path to achieving nuclear weapons in the next few years, it is laying the groundwork for being able to do so some time in the future, as noted in the NIE. While this report ought to come as a relief to everyone, it’s less obvious that it justifies pushing the “reset” button on our entire Iran strategy. That’s what I expect most of the arguing to focus on, in the weeks ahead. In the meantime, this news ought to reinforce the other bearish factors in the oil market.
Monday, December 03, 2007
Energy Bill Compromise
I’ve probably posted more frequently on the impact of corporate average fuel economy (CAFE) standards than any other subject for the last several months. At this point, all I’ve seen on the energy bill compromise is the report from the New York Times, because I’ve been bedeviled by Wi-Fi problems for the last couple days. If the Times has the gist correct, then new car buyers could be in for some frustrating years ahead. Congress has chosen a path that relies on pressuring the car industry to improve fleet fuel economy dramatically, particularly for SUVs, but has stopped short of augmenting the pressure that $3 gasoline exerts on consumers to choose more efficient cars. Closing that gap will boost car prices significantly within each class, as manufacturers add expensive technology, and force the sales mix to shift towards smaller, lighter vehicles. Because we’ve been telling consumers that Detroit can achieve all this without requiring any sacrifices of them, car-buyers will expect 35 mpg SUVs that accelerate like Porsches, and they are bound to become frustrated with the real-world choices they will encounter.
Moreover, if the deal delivering a 35 mpg CAFE relies on a bigger ethanol mandate, as the Times indicates, then the food-price inflation that the existing corn ethanol program has triggered will likely increase, draining additional billions from consumers’ wallets at the same time that ethanol subsidies tap additional tax dollars and CAFE drives up new car prices.
Given the dual challenges of high energy prices and steadily growing greenhouse gas emissions, strong legislation addressing these issues is necessary and inevitable. Perpetuating the status quo is not an option. Nor will any such legislation be perfect, requiring the usual horse-trading of provisions to gain passage. But just as the Energy Policy Act of 2005 failed to deliver energy security, the present bill will not conquer climate change or bring oil prices back to a more comfortable level. It’s an imperfect, but probably necessary prelude to the tougher, more effective measures that we’ll require in the years ahead.
Due to travel constraints, I won't post again until Wednesday.