Thursday, January 31, 2008

Cellulosic One-Upsmanship

In the course of sifting through the various energy proposals from this year's crop of presidential candidates, I've been somewhat surprised by the reliance several of them have placed on the as-yet unproven technology of cellulosic ethanol. Without taking anything away from the game-changing potential of advanced biofuels--as distinct from the incremental energy and greenhouse gas benefits associated with corn ethanol--the 2007 Energy Bill's four-fold expansion of the existing biofuels mandate, to 36 billion gallons per year by 2022, already looked like a mighty big bet on a still-theoretical source of supply. Suddenly, a figure of 60 billion gallons per year by 2030 is being bandied about as if it only required the application of some off-the-shelf technology and a bit of capital. Until the first wave of industrial-scale cellulosic ethanol facilities has been started up, debugged, and thoroughly analyzed, we should be cautious about which biofuel chickens we count before they have hatched.

To understand just how ambitious these goals are, you need to dissect the new Renewable Fuel Standard. It increases the ultimate US output of conventional biofuels (corn ethanol and vegetable-oil-based biodiesel) to 15 billion gallons per year (BGY) by 2015, compared to the roughly 6.5 BGY actually produced in 2007. That matches consensus assessments of how much corn ethanol the US could produce, based on current agricultural practices and markets, and the maximum amount of ethanol that can be blended into the national gasoline pool without selling significant quantities of E-85. Importantly, this entire segment is based on modern refinements of basic technology that has been understood for ages, using crops that have been staples of American agriculture since colonial times. While many observers argue about the merits of stretching corn ethanol output that far, few suggest it can't be done at some price--including its impact on global and domestic food prices.

By contrast, the Energy Bill's mandated expansion of cellulosic ethanol and other advanced biofuels takes them from essentially zero volume today to a target equal to four times the 2007 output of conventional biofuels, within 15 years. Because this is not a simple extension of existing, proven technology to a new market, no one should regard the achievement of that goal as a slam-dunk. Consider all of the elements that must come together in order for this to happen:
  • Researchers must find efficient, cost-effective and scalable processes for breaking down plant structures that have evolved for millions of years to resist such digestion.
  • These processes must be applied at scales many orders of magnitude greater than in the laboratory, and ultimately at least comparable to a conventional corn ethanol facility, producing 50-100 million GPY.
  • These new facilities must be technically successful, capable of continuous production with high on-stream availability. They must also be commercially viable, capable of earning a profit for their owners under expected market conditions.
  • Although the quantities of biomass to feed these facilities look feasible, this will require farmers shortly to begin planting and harvesting new crops such as switchgrass and Miscanthus, with which most will have had little experience, while navigating the same uncertainties of climate and market that affect other crops.
  • The capacity for gathering, storing and transporting harvested biomass must expand significantly, as must the capacity for shipping ethanol and its co-products to end-markets, increasing the strain on existing road and rail networks.

We're really describing the creation of an entirely new process industry and agricultural sector within a decade or so. If all of the above steps can be mastered within the next few years, then it ought to be feasible to grow this new industry fast enough to produce the targeted 21 billion GPY of biofuel by 2022, assuming its economics (including subsidies) look attractive enough. At the same time, however, it's not hard to imagine scenarios in which one or more of these elements fails to mature as fast as the others, or worse yet, stalls. I don't think we can even realistically assess the odds of complete success until we see the first commercial-scale plant and begin to get a sense for how the various supply networks that must surround it will take shape.

So if our recently-established biofuel target of 21 billion GPY from non-traditional sources is subject to a wide range of uncertainties affecting its ultimate magnitude and timing, how should we regard the idea of tacking on a further doubling of that target by 2030, before the first cellulosic ethanol plant is up and running? For me, that depends on the stakes involved in that bet. If it's a matter of laying out a possible pathway for reducing oil consumption and emissions, with any decisions about it deferred until after we learn from the experience of the initial commercial-scale non-grain ethanol facilities, then it's a useful option. If, however, it becomes the base-case energy supply assumption and a trumping argument against the need to expand other domestic energy sources, then it looks no more prudent than some of the risky lending practices that have landed the economy in its current pickle.

Wednesday, January 30, 2008

Sequestration On Hold?

Today's Washington Post reports that the Department of Energy may be withdrawing its support for the landmark Futuregen carbon capture and sequestration (CCS) project, which recently announced its selection of a site in Illinois. CCS is widely viewed as an essential technology for managing the growth of greenhouse gas emissions from energy production, and particularly from coal, which has the highest emissions of any fossil fuel. The Futuregen project would be one of the first to integrate all of the elements of coal-power-based CCS under one roof. If the DOE truly intends to cancel its involvement in this public/private project, it should provide a detailed, public explanation of its concerns, rather than vague suggestions that technology has passed the project by, and cost over-runs rendered it unattractive.

Demonstration projects are rarely intended to be profitable, and Futuregen is no exception. Even at its original estimated cost of $1 billion, the effective capacity cost of its planned 275 MW output was already a multiple of that for a comparable conventional coal or gas-fired plant. While cost over-runs can cripple the profitability of commercial projects, that simply isn't a consideration, here. In fact, the international industrial partnership supporting the project is organized as a 501(c)(3) non-profit corporation.

Nor do I find Secretary Bodman's suggestion that he would prefer to support other sequestration projects particularly reassuring. The DOE recently announced support for three such projects, but all of them are focused on the CO2 handling side of the problem. While no one would call CCS proven technology, most of its components have been demonstrated at various scales in industrial projects elsewhere. CO2 from North Sea gas fields is collected and reinjected underground, and the Great Plains Synfuels Plant sends its CO2 to the Canadian oil fields for use in enhanced recovery. The main attraction of Futuregen was that it would be the first large-scale effort to integrate CCS into the up-front design process of a coal-gasification combined-cycle power plant (IGCC).

Each of the DOE's stated concerns deserves to be addressed. With regard to the costs of the project, it ought to be relatively easy to assess whether the cost escalation since the project was announced in 2003 is in line with the general inflation in engineering and construction costs that has affected commercial power plants, oil platforms and refinery projects around the world, with some allowance for the first-of-a-kind nature of this facility. Determining whether newer CCS technology has superseded the design basis of Futuregen is trickier, but not impossible, particularly with reference to the project's original technology goals, which appear to focus more on practical integration, operation and performance measurement, rather than finding the "bleeding edge." And if better technology is available, it may still not be too late to incorporate it.

Finally, this being Washington, the specter of politics always looms over such decisions. In Monday's State of the Union address, President Bush said, "Let us fund new technologies that can generate coal power while capturing carbon emissions." He did not specify where. Two of the sites not chosen for the Futuregen project were in Texas. One was in the Congressional district of the former Chairman of the House Energy and Commerce Committee, Joe Barton (R-TX.) The other was in Odessa, TX, sister city to the President's home town, which is represented by K. Michael Conaway (R-TX,) a former close associate of President Bush. Weighing against that, of course, is that Secretary Bodman himself is a native of Illinois. Without suggesting anything improper, these connections make it imperative that the DOE's decision concerning Futuregen be made in as transparent a manner as possible, on its merits, alone. I share the President's assessment of the importance of demonstrating this technology; if for good reasons Futuregen isn't the right vehicle, then we need to find a better one ASAP.

Tuesday, January 29, 2008

State of the Union

President Bush's final State of the Union address last night included neither new targets for reduced oil consumption, along the lines of last year's speech, nor any lines as memorable as his "addicted to oil" remark in 2006. He acknowledged the passage of a bi-partisan energy bill that incorporated many of his 2007 proposals, and he generally reiterated his support for clean energy technology as the solution to both our dependence on foreign energy suppliers and the challenge of climate change. There was a subtle shift in tone concerning the latter, however, with the President espousing the need for an international agreement to reduce greenhouse gas emissions and an international clean technology fund, to transfer needed technologies to the developing world. While this still falls short of what many believe is required, it at least offers some hope that 2008 need not be a lost year in the long effort to arrest global warming.

Until we know who the Republican nominee for president will be, it is premature to suggest that a stronger response to climate change in 2009 is pre-determined. It is noteworthy, however, that any of the Democratic candidates and at least two of the Republicans would take office with a much more urgent view of this problem than that to which the current administration has evolved over the arc of the last seven years. The international negotiators at the recent climate conference in Bali took note of that likelihood, and the compromise that saved the meeting from ending in a stalemate over numerical targets for emission reductions was motivated at least in part by the desire to keep the US engaged in the process during this bridge year. But however much the current President and his aspiring successors might differ on the subject of a follow-on agreement to the Kyoto Protocol, President Bush last night offered up a meaningful project that all of them might be able to support in the meantime: facilitating the transfer of clean energy technology to where it will arguably do the most good.

As important as the development and deployment of clean energy technology is for reducing US emissions and fossil fuel consumption, it is even more critical for the large developing countries, which are still rapidly expanding basic infrastructure and capital goods. The power plants, electrical grid, pipelines and refineries that China and India build in the next few years will be in service for many decades, and the more we can do to ensure they are as green and efficient as possible, the less they will contribute to the global growth of greenhouse gas emissions. Given the ultimate scale of these economies and their much higher current energy use per unit of output, the cleantech opportunity there could be even larger than it is here.

Ensuring than the developing world has access to the best energy technology makes enormous sense from a climate change perspective, but it could be a tough sell politically and economically. We already see China and India as competing for US markets and US jobs. Our trade deficit with China is about twice as large in 2007 dollars as our late-1980s deficits with Japan. Giving them access to more efficient sources of energy could make them even tougher competitors in the future, and it won't take a populist demagogue to make that point.

It's natural for Americans to want to capture some competitive advantage from technology that resulted from our public or private investment and years of hard work. It won't be easy to devise a way to transfer that technology, while protecting the intellectual capital involved and providing American companies an opportunity to profit on it. But although an election year might not seem the ideal time to resolve such a dilemma, this issue might provide a useful gauge of the relative priority that the various candidates place on the economy and the environment, and of the creativity they bring to complex problems.

Monday, January 28, 2008

Candidates & Energy: Romney

My push to review all the major candidates before next week's Super Tuesday moves on to former Massachusetts Governor Mitt Romney, the winner of the Michigan Republican Primary and the Nevada and Wyoming Caucuses. The latest poll in Florida shows him in a statistical dead heat with John McCain, going into tomorrow's primary in that state. While he seems to share the general concern of all the candidates about energy insecurity, his views on climate change separate him from Senator McCain, and from all of the Democratic candidates. And while he clearly views energy policy as a major national priority, advocating action on a broad range of options, he speaks about the details more tentatively than most of his competitors.

The format of the energy page of Governor Romney's campaign website reflects his experience in management consulting and strategy. It leads with a video of the Governor outlining his ideas on energy. The site includes a concise statement of the energy security challenge, along with a graph of the growing gap between US oil consumption and domestic production. It lays out a vision of policy leadership, supported by four succinct, high-level strategies, with a bit of detail under each. "Increase Focus On Energy Security" looks like a filler, so it really boils down to three key ideas: more R&D, more nuclear power, and more domestic energy production. Mr. Romney would open up the Arctic National Wildlife Refuge and more of the offshore for drilling, and he's the first candidate I've seen to identify natural gas as a key concern and opportunity. It lacks the masses of detail available on the Obama or Clinton websites, but it's all pretty straightforward, with no radical departures from the status quo.

Discerning Governor Romney's position on climate change took a little more digging. Although he affirms that climate change is occurring, he stops short of apportioning responsibility between nature and humanity. More worrying, he frequently conflates climate change and energy security in a way that goes beyond any of the other candidates I've studied. He appears to believe that any progress on energy security will inevitably help the environment, including turning coal into liquid fuels. Although he mentions the potential of sequestering the CO2 emissions from coal liquefaction plants, it's not clear that he regards that as an absolute precondition for their deployment. Moreover, the idea of a price floor for liquefied coal, mentioned in the video on the campaign site, ignores our experience with the 1980s Synthetic Fuels Corporation; there are better ways to encourage technology than writing blank checks on the Treasury. Ultimately, his climate strategy appears to rely entirely on technology and incentives, without either a carbon cap or carbon tax.

While I applaud the Governor's candor on how long it would take the US to become energy independent, many of his comments on energy reflect a tentativeness and casualness about details that don't match his reputation for exhaustive analysis. Perhaps that should be reassuring. Anyone who hasn't been immersed in the details of energy for a long time ought to be cautious about appearing overly certain concerning matters that even the experts debate. At the same time, though, he has a habit of attributing ideas to others in a way that suggests they could easily be jettisoned later. He could also stand to make a clearer distinction between energy security and climate change and correct some of the misunderstandings that he has conveyed, such as the notion that we must look to France for the technology to build new nuclear power plants or reprocess nuclear waste.

As things stand now, the 2008 presidential election will hinge on the economy--with energy widely viewed as a main contributing factor--and on the perception of change. If Governor Romney became the standard-bearer of his party, he would have to convince voters that his energy plan is at least as detailed and coherent as those of the current Democratic front-runners, while also differentiating it from the policies that have led to the current situation. For many Americans, the time for "no regrets" strategies on energy and the environment has passed.

Friday, January 25, 2008

Renewable Energy and the Economy

Only a few weeks ago, 2008 promised to be a banner year for renewable energy, the companies that are developing it, and investors in those companies. Oil prices remain near historic highs, and the Energy Bill signed by the President in December boosted the country's ethanol mandate almost five-fold. Although the final legislation didn't include a national renewable electricity standard, 24 states plus the District of Columbia already have such standards in place. As a result, ethanol and wind and solar power have been expanding rapidly, with wind turbine installations in 2007 having grown at nearly double the rate for 2006. One might be forgiven for thinking this sector was essentially recession-proof, backed as it was by the happy alignment of fundamentals and regulations. But as the economy weakens, there are reasons to believe the story is not uniformly rosy, and the stock market seems to agree with that assessment.

At the end of 2007, the WilderHill New Energy Global Innovations Index (NEX), a composite of 86 new energy companies covering wind, solar, biofuels, efficiency, and hydrogen, was up by 58%, year-on-year. As of yesterday, however, it was off almost 20% for 2008 so far, compared to a drop of about 8% for the S&P 500. Why would a sector so favored by politicians, environmentalists, and socially-conscious investors suddenly appear to have diminished prospects, just when it seemed perfectly geared for growth? Unfortunately, renewables and the entire alternative energy sector are vulnerable to two of the same principal factors undermining confidence in the economy as a whole: the availability of credit and higher inflation at the wholesale level.

Ethanol and wind power provide two examples of these vulnerabilities. As I noted recently, the phase-in of the Renewable Portfolio Standard in the 2007 Energy Bill expands the domestic ethanol market from about 6.4 billion gallons per year (BGY) in 2007 to 9.0 BGY this year and 10.5 in 2009. But it also provides for refiners and blenders to receive waivers, if the required ethanol isn't available. If the companies building new distilleries cannot borrow enough to complete those facilities, then the capacity to meet the higher mandate may not exist. Meanwhile, rising corn prices, approaching $5 per bushel, will continue to squeeze the margins of new and existing producers. The final outcome of these trends, in a market created by regulations and subsidies, is uncertain.

Now consider wind power. Although developers had hoped the Energy Bill would extend the 2 cent/kWh Renewable Electricity Production Tax Credit (PTC) beyond the end of 2008, this benefit is at least available for projects completed this year. Its impending expiration might even accelerate some projects, as we've seen in previous years when the PTC was set to end. But a typical wind project receives financing in the range of 30-50%, and in recent years the sources of capital have grown more exotic, including Structured Investment Vehicles and "flip" structures. Wind power is thus vulnerable to some of the same credit risks affecting the entire economy, including the potential backwash from credit default swaps and institutional failures. These are hardly the problems you want to be dealing with, if you are scurrying to put steel on the ground before your tax break evaporates. Nor are wind turbine manufacturers immune to the escalating cost of raw materials, including commodities such as copper, which is at five-year highs. It also doesn't help that the price of natural gas, the fuel for wind power's main conventional competition, has recently uncoupled from the price of crude oil. While the oil futures price is 65% higher than one year ago, the same comparison for natural gas is only up by about 7%.

A weak economy has another, broader implication for green energy. As one of my readers mentioned recently, a deep or prolonged recession would very likely delay efforts to put a price on carbon emissions, whether through cap & trade or a carbon tax on fuel. Even if much of the revenue were redistributed to neutralize its regressive effects, anything that increased energy costs beyond their current levels would be a very tough sell. None of these specific or general concerns makes a meltdown in the renewable energy sector inevitable. But despite support from state and federal government, renewable energy companies could experience a disappointing 2008, particularly compared to the sector's performance last year.

Thursday, January 24, 2008

Sailing Ships and Resid Conversion

The romance of the Age of Sail, with iconic "tall ships" like the Cutty Sark, stands in stark contrast to the dull container ships and tankers that carry the world's trade, today. However, with fuel costs rising and wind turbines gaining market share for electric power, it shouldn't be surprising that entrepreneurs are looking at ways to enable cargo vessels to derive some of their motive power from the ocean breezes. Yesterday's Wall Street Journal described one such effort, by SkySails AG. In the long run, this could have implications beyond just reducing operating costs and emissions for ship owners. The tighter global crude oil supplies become, the more attractive the fuel that powers these ships today will look as a feedstock for making gasoline, diesel and jet fuel.

Although most of the world's warships employ either nuclear energy or powerful and efficient gas turbines, cargo vessels still generally run on heavy fuel oil that is the residue of the oil refining process. A major technology shift occurred in the 1980s, when the cargo fleet converted from boilers and steam turbines to enormous diesel engines requiring fuel oil with a lower viscosity than that burned in the old steamships. While somewhat higher in quality than bunker fuel, this oil is still made up mostly of refinery leftovers, and it normally sells at a significant discount to crude oil. For example, the current price of IFO380, a common grade of marine fuel, equates to about $70 per barrel in Los Angeles, or about $6.50 per barrel less than the posted price of the San Joaquin Valley heavy crude (plus freight) from which it is most likely derived.

For many years, the refining industry has had the technology to convert this low-quality material into higher-value fuels, limited mainly by the economic return available on the large capital investments involved. With the steady growth of US "resid destruction" capacity since the 1970s, more than 2 million barrels per day of this material finds its way into delayed coking units, resid hydrocrackers, and residuum fluid catalytic crackers, reducing the amount of crude oil required to produce a given slate of gasoline, diesel and jet fuel, and leaving only about 700,000 bpd for the marine and other heavy fuel oil markets.

A recent report from Cambridge Energy Research Associates (CERA,) a sister company of my sponsor John S. Herold, Inc., suggests that the rate of decline in production from the world's existing oil fields is 4.5% per year. This is somewhat less than has been feared but still substantial, requiring the replacement of essentially an Iran each year. Given the risk of project delays and the relatively flat recent non-OPEC output, this figure seems unlikely to allay fears of an impending peak in global oil production. Whenever Peak Oil occurs, the incentive to convert more residual fuel should increase, perhaps rendering it too valuable as a feedstock to continue burning in large quantities onboard ships. If it makes sense to spend $100 billion on the hardware to exploit remote oil sands deposits and convert them into synthetic crude oil, how much sense does it make to sell large volumes of comparable hydrocarbons that are already inside existing refineries?

Although the amount of marine fuel freed up by the application of high-tech sails to cargo ships appears to be modest, it looks too important to ignore, as crude oil output struggles to keep pace with demand. It's timely for the shipping industry to explore its options for higher efficiency and alternative propulsion now, before they are forced to do so by further shifts in the global oil supply and demand balance.

Wednesday, January 23, 2008

Candidates & Energy: Clinton

Among all the candidates I've scrutinized so far in this year's presidential election campaign, energy independence has emerged as a common theme. Each of the candidates approaches it with different emphasis and solutions, but the worries about our reliance on unstable regimes for our energy supplies span both parties, as does the concern that our remittances for imported oil are funding our enemies in the War on Terror. My systematic review of the 2008 presidential aspirants now turns to one of the best known candidates on either side, Senator Hillary Clinton (D-NY,) winner of the New Hampshire Democratic Primary and the Nevada Democratic Caucuses. She treats energy policy as a key issue and combines it with a focus on stronger measures to address climate change.

Anyone curious about Senator Clinton's views and proposals on energy and the environment needn't look much farther than her campaign website, which includes a summary page and links to a 14-page energy plan, other policy documents, and speeches. It would take me a week's worth of postings to enumerate and evaluate all of the details, which include expanding US biofuels production to 60 billion gallons per year, increasing fuel economy to 55 mpg, and phasing out incandescent lights. Knowing the intellectual resources at her disposal, I'm not surprised by the granularity of the Senator's proposals. At the highest level, all of these ideas support three goals that she articulates consistently: reducing greenhouse gas emissions by 80% by mid-century, reducing US oil imports by two-thirds (compared to current projections of approximately 13 million barrels per day) by 2030, and building a green-energy sector that will provide millions of new jobs. Unlike the goals of complete energy independence or oil independence that other candidates have announced, Senator Clinton's oil import target just might be achievable, leaving us importing 3-4 million barrels per day of crude oil, about what we get from Canada and Mexico today.

The centerpiece of her plan is the creation of a "strategic energy fund" amounting to $50 billion over 10 years for expanding R&D on energy efficiency, renewables and other alternative energy sources. This figure includes significant funding for demonstration projects to prove the feasibility of applying carbon sequestration to "clean coal" power plants, which would apparently be the only kind of coal facilities she would allow to be built. But when Senator Clinton says that she knows where to get the money for this fund, you know what is coming next. As described in a key speech on energy, the money would come from "ending the tax breaks that oil companies receive to maintain the existing oil dependence economy" and by enacting some form of a windfall profits tax on the oil industry. It would also receive revenue from the greenhouse cap-and-trade system she envisions, with 100% of emissions allowances auctioned, rather than allocated to existing sources. Additional funds for emerging energy would come from new "Energy Independence Bonds."

Concern about climate change shapes all of Senator Clinton's energy proposals, resulting in programs intended to reduce energy dependence while also reducing emissions. This includes an idea from former Vice President Gore, for the establishment of a "carbon-neutral mortgage association" or "Connie-Mae," that would finance home improvements that reduced energy consumption and emissions.

Although many of these ideas and proposals are well thought-out and address urgent problems, particularly with regard to tackling energy security and climate change simultaneously, I am concerned about the Senator's adversarial approach to the existing energy industry, which must play a key role, if her goal of reducing our reliance on imported oil is to be achieved. I don't see how we can close the enormous and growing gap in our energy supplies, while taking away financial resources from the industry that accounts for 45% of domestic energy production. I'm sure Senator Clinton understands that, because she voted in 2006 to expand offshore drilling in the Gulf of Mexico. In addition, although not explicitly anti-nuclear, she has apparently ruled out any role for new nuclear power in reducing greenhouse gas emissions or providing the power for the plug-in vehicles that she sees as a key strategy for reducing oil use.

On the "experience vs. change" scale, Senator Clinton's proposed energy policies represent significant departures from the status quo. Her team has taken a systematic approach to energy and the environment, connecting technologies such as renewable power and advanced biofuels to the smart-grid and flexible-fuel infrastructure needed to maximize their usefulness. Although her target for reducing oil imports is less ambitious than that of Senator Obama, her emphasis on climate change matches his, and the specificity of her energy proposals exceeds that of any other candidate I've reviewed to date. At the same time, I have been surprised by the populist tone of much of her campaign rhetoric. It extends to implying that oil refiners collude to drive up prices, a charge on which the industry has been exonerated numerous times. This doesn't match the seriousness and pragmatism she has applied to her Senate role over the past seven years, but it certainly reflects the dynamics of the current three-way race for the Democratic nomination.

Tuesday, January 22, 2008

Energy and the Economy

We're currently being provided with an uncomfortable reminder that the economy trumps all other issues, when it's doing badly. Energy has been a big part of this story, at least in terms of perception. However, in part because weak refining margins have sheltered consumers from the full impact of $90 oil, and because natural gas has temporarily uncoupled from oil prices, on average Americans still pay less for energy than we did during most of the 1960s, 1970s and into the 1980s. Of course, that's cold comfort for those who have seen their fuel outlays double in the last four years. The important question now is how energy will affect a weakening economy, and vice versa. In lieu of a comprehensive answer that would tie up a team of economists for weeks, here are a few thoughts on the subject.

Energy and the economy are deeply intertwined. Economic growth pushes up energy demand, though at a much slower rate than in the past. Energy prices rise in turn, and that stimulates supply, albeit with a significant lag. In this cycle we've seen the impact of supply constraints from infrastructure, resource nationalism, and the availability of equipment and experienced technical staff. Now throw in the rapid economic transformation of China, India and the rest of Asia, along with the undetermined effects of unprecedented levels of financial speculation in oil. Prices haven't self-corrected as we might have expected, and the result has been dramatic energy price inflation of a type very different from the energy crisis of the 1970s. The financial flows this has created are enormous: a billion dollars per day, from the US alone.

So what happens next? That depends on how much influence the US market has on an increasingly globalized energy market. Even with the economy still growing, we've seen total US oil consumption has plateau for three years, now, and our imports of oil and petroleum products have been essentially flat since 2005. We're responsible for less than 15% of the 5 million barrel per day spurt of demand since 2003 that has used up most of the world's spare production capacity. If our consumption fell this year, that might not affect oil prices much, unless the US economic slowdown triggered a global economic contraction. Consider China, where rapidly increasing oil consumption has been led by domestic consumers, who are insulated from world oil price changes by regulated petroleum product prices, and by export industries that supply developed countries, including the US. Because China uses much more energy per unit of GDP than we do, a slowdown there would have a more dramatic impact on oil prices.

But if $90 oil represents a significant drag on the US economy, how much would oil prices have to fall in order to stimulate economic growth? That's hard to say, because during most of the run-up from $30 per barrel to $70 or so, our economy appeared to be immune to the consequences of higher oil prices. Right now analysts and markets seem most concerned about consumers, for whom the increase in gasoline prices since last January has added an average of about $65 per month in cost per household. Reversing that would require getting oil back to the mid-$50s, barring a big increase in refining margins, as refiners cut back on output that is losing them money.

How might oil revert to $50 per barrel this year? We can rule out the influence of alternative energy, in the short run. Biofuels output can't grow fast enough to make that kind of dent in demand. I also doubt we can convince OPEC to open their taps wide; they are unlikely to see that as being in their best interest, unless they thought it was the only option for preventing a global collapse that would shrink their revenues even more. That leaves speculation and demand. There's no consensus on how much of the current oil price is attributable to speculation. As the yields on other asset classes drop, are speculators more or less likely to invest in oil commodities? And how many of them will need to liquidate commodity holdings to cover losses on other positions? Even if the contribution of speculation dropped by $10 per barrel, we're still only talking about roughly $20 per month per household.

That leaves demand, though this is an example of the worm eating its tail. Demand growth is widely viewed as the biggest contributor to the increase in oil prices since 2003, so a global drop in oil demand of a couple of million barrels per day would probably deflate oil prices sharply. But in the short term, we can't create that big a fall in demand through higher efficiency alone. The scenario that comes closest to being able to deliver that looks similar to what we experienced in the Asian Economic Crisis of the late 1990s, when the combination of falling regional demand and rising global production cut oil prices in half. However, the global economy has become much more inter-dependent in the last ten years, and this kind of cure would almost certainly be worse than the disease.

Although oil prices have contributed to the current crisis, they didn't cause it. While oil prices will likely fall, if the US goes into recession and the global economy contracts, that by itself won't do much to restore the economy to sound health. Oil looks like a lagging, rather than leading indicator, here, and we need to turn elsewhere to solve the financial mess that has resulted from the popping of the US housing bubble and the debt problem that has created. Later this week I'll take a look at what this might mean for alternative energy.

Monday, January 21, 2008

Coal Fights Back

It was inevitable that the US coal industry would answer last year's "Coal Is Filthy" ad campaign with a campaign of their own, and here it is. The Washington Post describes this effort as focused on key primary states, with the aim of enhancing the image of coal and stirring up opposition to legislation on climate change. Although the ads' tag-line isn't quite as visceral as that of coal's opponents, their appeal to energy security seems timely, and the assertion that coal is "the fuel that powers our way of life" is more accurate than many Americans would like to acknowledge. In 2006 coal generated 49% of US electric power, while all zero-emission sources, including nuclear, large hydropower, wind and grid-connected solar only accounted for 29%. But although the campaign touts the potential of coal to produce emissions-free power in the future, thanks to the technology of carbon sequestration, that will only happen if the government regulates CO2 emissions in some fashion. Without putting a value on greenhouse gas emissions, the economic incentive to increase the capital and operating costs of coal facilities in order to capture those emissions won't exist.

Contrast this with the potential of energy efficiency. Engineers and scientists have always known that we waste more of the energy from our primary fuels than we actually use. Efficiency experts argue that if the standards in the Energy Bill and various state regulations were applied consistently, we wouldn't need any new, large power plants for years to come. Among other things, the Energy Bill has written the epitaph for the incandescent light bulb, as we have known it, but it has done so without banning the bulb, but by means of lighting efficiency standards that conventional incandescents can't meet. Even today's compact fluorescent lights must eventually improve or give way to LEDs or other tech. However, our experience with efficiency so far has been that any net reduction in demand is likely to prove temporary. We love our gizmos too much, and it has usually been easier to add new power plants than to convince everyone to invest in better appliances, insulation, and other energy-saving measures. Climate change could be about to alter that balance, and it's getting harder to build new distribution infrastructure, too, but the jury is out.

Now factor in the rapid growth of renewable electric power, admittedly from a very small base, compared to coal. Last year US wind capacity grew by an amazing 45%. Although that additional 5,244 MW of wind generation will only produce about as much electricity as 1,700 MW of gas, coal or nuclear capacity, wind continues to grow at sustained rates that make it more consequential each year.

All of this makes for a very challenging planning environment for coal producers and the states that are home to the country's enormous coal reserves. Efficiency is reducing the size of the total future power market, renewables and a resurgent nuclear industry are competing for its future market share, and the gathering response to climate change will likely erase most of coal's cost advantage in levelized electricity costs. Those are daunting uncertainties, and no amount of PR can neutralize them.

Friday, January 18, 2008

Candidates & Energy: McCain

As I continue to evaluate the positions of the presidential candidates on energy and the environment, I'm finding the process quite different than in past elections. Access to video resources on the web, and in particular on, makes it much easier to get a feel for the candidates that goes beyond their published positions and televised speeches. That's as true of a veteran campaigner like Senator John McCain (R-AZ) as for relative newcomers such as Messrs. Obama and Huckabee. Since I'm tackling them more or less in the order in which they won primaries, and alternating between the parties, it's now Senator McCain's turn. Like many other candidates, he favors strong measures to increase our energy independence, but his focus on climate change as an organizing principle for energy policy, rather than just another issue, differentiates him from the entire Republican field.

It's a good thing that Youtube and Google convey ample information on Senator McCain's views about energy and the environment, because his campaign website is a bit sparse on both topics, particularly compared to the level of detail provided by Senator Obama. From his comments in various speeches, town halls, and small events, it's clear that he is very concerned about our dependence on foreign oil, on both economic and national security grounds. He emphasizes the instability or governmental hostility of many of the countries from which our imports flow, frequently citing Nigeria, Venezuela and Russia as examples. I wasn't surprised to see him make the "funding both sides of the War on Terror" argument in the principal energy policy document on his website. National security is Senator McCain's strong suit, and he places energy squarely within this context.

The measures he proposes for improving energy security cover the same themes as many other candidates, including wind and solar power, higher fuel economy standards, electrification of transportation via plug-in hybrids and batteries, and biofuels. He also strongly supports nuclear power, based on its low greenhouse gas emissions. Surprisingly, given the intensity of his views on energy independence--which seem to include an unrealistic expectation of how soon it could be achieved--he would leave offshore drilling to the discretion of the nearest affected states, and he opposes drilling in the Arctic National Wildlife Refuge. I think he is missing a bet, there, but it's consistent with the theme of environmental stewardship that runs through the whole McCain campaign.

Climate change is a major element of that theme, and of the Senator's legislative agenda. He has criticized the Bush administration's approach to global warming, and together with Senator Joe Lieberman (I-CT) he sponsored a greenhouse gas cap-and-trade bill that was the precursor of the Warner-Lieberman bill currently under consideration in the Senate. It's not hard to find video clips of the Senator talking about climate change and the inter-generational responsibility he feels in this regard. (I look forward to reviewing Governor Romney's position on this issue, since the Romney campaign has labeled Senator McCain's approach to climate change as "radical" and "wrong-headed.")

Ethanol is one aspect of energy policy on which McCain differs with many of his rivals. You have to admire someone who campaigns seriously in Iowa on a platform of ending subsidies for corn ethanol, and in Michigan on higher fuel economy standards. Still, when confronted with the charge that he has "flip-flopped" on this issue--that he was entirely against ethanol previously but now only opposes subsidies for it--his response was somewhat less convincing than it might have been. In any case, his aversion to subsidies is apparently not confined to ethanol, extending beyond energy to agricultural commodities, consistent with his overall emphasis on free markets and fiscal conservatism. He expects alternative energy to advance on a "level playing field"--leveled further by monetizing the climate externality via market-based mechanisms.

For someone whose candidacy was written off not long ago, Senator McCain appears to have as good a chance of capturing his party's nomination in this wide-open contest as any of his competitors. With former Senator Thompson, he also represents the last shot at the White House for his generation, which experienced World War II as children and came of age in the 1950s, but has yet to produce a President. Although he occupies the Senate seat formerly held by Barry Goldwater, John McCain's ideas on energy and the environment are up-to-date and would not be out of place among this year's Democratic candidates--with the possible exception of his unwavering support for nuclear power. His proposals reflect both change and experience. My long-time readers would be forgiven for noting a high degree of overlap between many of Senator McCain's positions on energy security and climate change and the themes that I've been writing about here for four years. That shouldn't be construed as an endorsement, however.

Thursday, January 17, 2008

Raising Fuel Taxes

At the same time that I was writing about the demand response to higher fuel prices on Tuesday, a Congressionally-appointed commission was meeting in Washington to propose an increase in the gasoline tax that would raise those prices further, in order to maintain the nation's highways. Last summer's bridge collapse in Minneapolis delivered a warning about the condition of America's road infrastructure. Without an increase in the federal highway budget, and in the 18.4 cent per gallon federal gasoline tax that funds it, the situation will get worse. This proposal will test our attitude towards a tax that has long been regarded as untouchable. It will also have implications for the US response to climate change.

Every year that goes by without an increase in the road tax, the purchasing power of the revenue it generates shrinks. If the new 35 mpg CAFE standard succeeds in reducing fuel consumption, then that tax revenue will begin to decline in nominal terms, as well. The recommendation of the National Surface Transportation Policy and Revenue Study Commission for a series of annual 5 cent-per-gallon tax increases suggests that we will be in catch-up mode for some time. But without diminishing the important safety concerns underlying the commission's work, the road tax is the tip of the iceberg. The necessity of reducing greenhouse gas emissions from the transportation sector makes it likely that some form of additional fuel taxation, either directly, in the form of a carbon tax, or indirectly, through a cap-and-trade system, will be a key component of national climate change policy within a few years.

As a new study from the Congressional Budget Office confirms, higher fuel prices stimulate changes in driving behavior and habits, along with consumer preferences for more efficient cars. Considering the amount by which we must reduce emissions over the next several decades, and the changes in consumption necessary to achieve those reductions, this will take a lot more than an extra 5 or 10 cents per gallon, on top of what is required to bring the highway trust fund back into the black. If the cost of CO2 credits under a greenhouse gas cap-and-trade plan reaches $20 or $30/ton, then in fairly short order consumers would see gasoline prices rise by 20 or 30 cents per gallon, dictated by the simple chemistry of hydrocarbon combustion and the increase in producers' costs. Depending on the severity of cuts desired, $100/ton--or $1.00/gallon--is possible.

None of this will be easy. Even without predictable opposition from groups that object to higher taxes of any stripe--a position to which I'm normally sympathetic--it will not be popular to tell Americans who have already seen retail gasoline prices double in the last four years and triple in the last ten that they still aren't paying enough. The burden will fall disproportionately on lower-income folks, and that will complicate both the politics and implementation. Throw in a looming recession, and the obstacles become formidable. Nevertheless, if we want to keep our roads and bridges in good repair, improve our energy security, and reduce greenhouse gas emissions, higher motor fuel taxes now seem unavoidable.

Wednesday, January 16, 2008

Turning Up the Heat

Climate change hasn’t generated much controversy in the US presidential campaign, yet, but that could change, based on the latest observations of the global climate. In separate reports, preliminary tallies of the average global temperature in 2007 place it among the warmest years since records have been kept, while scientists conclude that the Antarctic icecap is melting faster than previously thought. When combined with the recent conclusions of one of America’s best-known climate scientists, the pressure on politicians to lead a more aggressive response to the problem could intensify this year.

It’s understandable that the issue hasn’t attracted more attention, so far. All of the Democratic front-runners espouse aggressive action to deal with climate change, so it hasn’t been a major differentiator among them. And while the Republican candidates offer a more diverse set of views on climate, the issue hasn’t become a major point of contention, as has immigration. At the same time, climate change has generally been subsumed within the more prominent, “hot button” subject of energy policy, driven by sustained $3 per gallon gasoline and oil prices hovering in the neighborhood of the inflation-adjusted record high.

Although climate change might rise to greater prominence in the election campaign naturally, once the primaries are over and the two parties’ nominees face each other—presumably exposing larger differences in emphasis and proposed policies—the issue could heat up even sooner, as the recent climate news percolates through the media and public awareness. Even subtler and more worrying than the news about Antarctic ice and a warm 2007 are the concerns of NASA scientist James Hansen, who has apparently concluded that the atmospheric concentration of carbon dioxide and other greenhouse gases already exceeds the level at which it must eventually be stabilized, in order to avoid catastrophic consequences. If his view becomes the consensus, it has serious implications.

The positions of many of the non-US delegations to the recent Bali conference on climate change reflected the goal of stabilizing atmospheric CO2 at 450 parts per million (ppm,) which climate models suggest would probably limit the global temperature increase to 2 degrees Celsius. With the actual concentration currently at 385 ppm and global emissions still increasing, as the industrialization and deforestation of the developing world proceeds, 450 ppm is a challenging goal, but one that might still be achieved without wrecking the global economy. 450 is no one’s idea of a “soft landing”, but the fact that we are still 65 ppm away, while increasing at 2 ppm per year, appears to leave us some headroom, particularly if we allow for a bit of “overshoot.” Unfortunately, Dr. Hansen, whose views have garnered significant attention in the past, now believes that 450 ppm is too high, and that the safe target ought to be 350 ppm, which we passed in the late 1980s.

The point of all this isn’t to argue whether 350 or 450 ppm is the right target for atmospheric CO2, or whether either one is even feasible. Rather, it is that people take Dr. Hansen seriously, and this development, together with observed changes in the climate, could significantly ratchet up the urgency of taking strong action to tackle the US contribution to global warming—with unpredictable political consequences. The conventional wisdom seems to be against pushing the Warner-Lieberman greenhouse gas cap-and-trade bill to a vote in the Senate, which would effectively put both parties on the record on the issue in an election year. Will that assessment hold up, if the public latch onto the latest developments in a big way, or one of the presidential candidates uses them to turn up the heat? Or will bad economic news drown out anything short of an immediate environmental crisis?

Tuesday, January 15, 2008

The Demand Response

An article on the relationship between oil prices and oil demand in today's Wall Street Journal reveals that data to be released shortly by the International Energy Agency will show a slight decline in oil consumption among the OECD countries during 2007. The article also quotes Department of Energy figures showing that US consumption for last year was up slightly, by 0.2%. Compared to our average annual increase from 2000-2006 of 0.8%, this appears to reflect some response to higher oil prices, though as the article notes, it is disappointingly small, compared to the dramatic reduction in demand experienced in the late 1970s and early 1980s. But while data at this extremely high level of aggregation are relevant to global oil supply and demand, and thus oil prices, they mask some very interesting details, including the impact of our increasing use of ethanol.

The article doesn't provide any information on gasoline demand, and the online database of the Energy Information Agency of the Department of Energy still only reflects actual supply and demand through October 2007. When I combine the EIA's monthly data for gasoline supplied with their weekly estimates for November and December, gasoline consumption for the year seems to have increased by about 0.5%. That shouldn't be too surprising, because despite the big run-up at the end of last year, average retail gasoline prices for 2007 were only about 20 cents per gallon higher than in 2006. It's worth noting, however, that 2007's retail gasoline prices were a full dollar per gallon higher than the average for 2003-2004, when many of the new models being launched at the current Detroit Auto Show were planned.

But how do these figures look if we adjust for the contribution of ethanol? As of October, ethanol use in 2007 was on a pace to reach 6.8 billion gallons for the year, compared with 5.4 billion gallons in 2006. If we back the difference out of the approximately 143 billion gallons of motor gasoline supplied in the US last year, then on a comparable basis our consumption of petroleum-based gasoline actually shrank by about 0.5%. Making the same adjustment to the aggregate crude oil and petroleum product demand figure cited by the Journal suggests that total oil demand in the US might have actually declined by 0.2% last year. That's consistent with the proportionally larger apparent drop in US imports of crude oil and petroleum products.

I want to be careful about drawing sweeping conclusions from the hodgepodge of actual and estimated data I have relied on above. However, a couple of things seem reasonably clear. Although fuel prices in the US are high enough to cause consumers serious pain, they aren't yet high enough to stimulate dramatic changes in consumption patterns, even if they seem to be driving consumers in the direction of choosing more efficient new cars. US motor fuel demand is still increasing, but apparently at a rate slower than the growth of the population. At the same time, for all its shortcomings, our only consistent alternative fuel strategy for the last two decades--corn ethanol--is finally growing fast enough to affect the country's overall oil supply and demand balance. These two observations offer a ray of hope that the combination of higher biofuels production and fuel economy mandated by the recent Energy Bill will be able to reverse--however gradually--the steady increase in US oil imports that we have experienced since the late 1980s.

Friday, January 11, 2008

Candidates & Energy: Obama

Continuing my look at the energy proposals of this year's presidential candidates, let's turn to the other winner of the Iowa Caucuses, Senator Barack Obama (D-IL.) Where Governor Huckabee's proposals for energy and the environment appeared broad and somewhat generic, Senator Obama's are quite detailed, including specific targets for emissions, fuel economy, renewable energy and vehicle technology and performance. Despite this contrast, however, the Senator's views reflect a very similar concern about the security and environmental implications of our energy use. Although I'm skeptical about some of Mr. Obama's energy goals, such as eliminating oil imports by 2030, he has clearly devoted much thought and attention to these issues.

Energy and the environment have been consistent themes of the Obama campaign from the start. Youtube has numerous clips of his comments on energy from speeches in many different venues, along with this historical primer on energy independence, highlighting the consistent, bi-partisan failure to deliver on this goal since the 1970s. It suggests that Mr. Obama knows how to achieve it, where others before him--including two Democratic administrations--didn't. Could politics and an absence of plain speaking really be the only reasons this goal hasn't been met?

The main pathways that Mr. Obama promotes for improving energy security and reducing emissions are clean energy and efficiency. He advocates much greater use of solar, wind and geothermal power--measured against a 25% renewable electricity standard for 2025--and more biofuels, including conventional ethanol, biodiesel, and cellulosic ethanol. He would expand the Renewable Fuel Standard in the 2007 Energy Bill from 36 billion gallons in 2022 to 60 billion gallons per year by 2030. And recognizing that none of this will spring from thin air, he proposes an Apollo Program-like R&D effort to advance a broad range of energy technologies, along with capacity-building measures such as cleantech job training and manufacturing conversion.

Unsurprisingly for a Senator from Illinois, Obama supports the development and deployment of clean coal technology. However, I couldn't find any mention of nuclear power on his campaign's website. When asked about nuclear power at an event, his carefully calibrated response indicated that he doesn't regard nuclear as an important element of his energy strategy. He implied that waste and safety concerns haven't been adequately met, though he failed to cite politics as a key obstacle in addressing the former. The part of his answer that I liked best was when he said, "There is no perfect energy source. Everything has some problems right now."

With regard to climate change, the Senator calls for a stricter version of the Warner-Lieberman greenhouse gas cap-and-trade legislation currently working its way through the Congress, referencing the earlier Sanders-Boxer Bill (S.309,) which he co-sponsored. His plan differs from Warner-Lieberman in requiring deeper cuts by mid-century and auctioning 100% of the emission allowances, rather than allocating a portion to various industries and organizations. It's a simpler approach, though when MIT compared Sanders-Boxer to, among others, the McCain-Lieberman cap-and-trade bill that was the precursor of Warner-Lieberman, they concluded that the former would result in a significantly higher CO2 cost, equivalent to adding about $1.00 per gallon onto then-current gasoline prices by 2030 and $2.00/gal. by 2050.

As with his other positions, Senator Obama articulates his views on energy in a forceful and compelling fashion. He conveys a sense that he understands the challenges, has a comprehensive plan for addressing them, and knows how to create the bi-partisan political and public momentum to get it done. But although he doesn't suggest this will be cheap--citing billions of dollars for his new Apollo Program--he does imply that it will be easier than Americans ought to expect. For example, when he talks about advancing automobile fuel efficiency to 43 miles per gallon, 8 mpg above the new CAFE standard for 2020 that emerged from the arduous negotiations for the 2007 Energy Bill, he says, "That is something that we can do, right now." Perhaps, if every car were a Prius-sized hybrid. Even Toyota's Camry hybrid--a model more similar to what most Americans actually purchase--only averages 34 mpg, and all but the smallest SUV hybrids are still in the 20s. Attaining 43 mpg across the whole fleet would be tough, and it would require significant changes in vehicle technology and in the kind of vehicles we drive. As I've noted before, even plug-in hybrids aren't quite the silver bullet they appear to be, in total energy terms. That's even more true for flexible-fuel vehicles.

As bold and comprehensive as Senator Obama's energy proposals are--certainly satisfying any definition of change--they don't break with party orthodoxy or embrace some pragmatic options that could accelerate his timetable for eliminating oil imports. He ignores the option of natural gas as a lower-emission, lower-cost alternative to oil, and he has dismissed the potential of our large, untapped oil and gas resources. In 2006 he voted against even a modest expansion of the allowed area for offshore drilling in the Gulf of Mexico. Although Mr. Obama prides himself on telling people what they need to hear, rather than just what they want to hear, I don't see much that might be unpopular with the party's base.

You can't watch Senator Obama speak without understanding his infectious popularity, especially with new voters and those jaded by partisan politics, pessimism and gridlock. In my corporate career and subsequent consulting, I have seen how difficult it is to strike a balance between the old and the new, between the things that provide the lifeblood of the organization today, and those that will be needed to sustain it into the future. Senator Obama has a big chunk of the latter down pat, when it comes to energy and the environment. Perhaps my age is showing, however, when I worry that a campaign that is so focused on new ideas and change could have a hard time accepting that some of those ideas might not be workable, or taking a fact-based look at why some elements of the energy status quo cannot be rejected out of hand, without disrupting the supply lines on which our economy depends. It's that sort of tempering that I'll be watching for, in the weeks and months ahead.

The Oil Price Tax

An article in today's Washington Post compared the recent rise in oil prices to a $150 billion dollar-per-year tax on the US economy, enough to negate the various economic stimulus plans being discussed by the Congress and White House. It's a shocking figure, and it helps feed the forecasts of recession, which tend to be at least partially self-fulfilling. But before we accept that $150 million figure at face value--despite its impressive pedigree--it's worth spending a moment on a few ballpark validations. Above all, we should remind ourselves that if high oil prices are a tax, they tax producers, not consumers, who rarely purchase crude oil to use in our homes or vehicles.

The article cites a 2004 comment from Fed Chairman Bernanke noting that firms don't always have the ability to pass on the full effect of a commodity price shock to their customers. At least for oil refineries, now is such a time. Most of last year's oil price appreciation occurred following the end of peak driving season, after Labor Day. Between August and December, the average monthly futures price for West Texas Intermediate crude oil on the New York Mercantile Exchange went up by $19.38 per barrel. The average for January so far would add another $5 to that, so let's call it $25/bbl. With US refineries running at 15.5 million barrels per day, and using the increase in WTI as a proxy for the change in the oil prices actually paid by refiners, their costs have gone up by about $11.5 billion/month. That's close to Professor Nordhaus's $150 billion annualized pseudo-tax.

As I noted above, however, consumers don't buy oil; they buy gasoline, diesel fuel and heating oil. Although the prices of all those products have gone up considerably since Labor Day, only retail heating oil has gone up by as much as crude oil. So far, the average retail price of diesel fuel has risen by about $20/bbl and gasoline by only about $13/bbl. At current consumption rates, the direct impact on consumers is thus around $6.6 billion/month, or $80 billion per year. That ignores increases in the cost of plane tickets, plastics, food and many other things that consumers buy that include a significant energy component, but then, the prices of those goods and services are influenced by many other factors aside from the price of energy. That indirect impact has been further buffered by the relatively low price of natural gas, which supplies a large fraction of the energy and feedstock for the broader manufacturing, chemicals and power sector, and which has been virtually unaffected by the recent change in oil prices.

When we consider the net impact on the entire US economy, we see an increase in the price we pay for imported oil and petroleum products on the order of $9 billion/month since September, or $108 billion/year. Consumers have experienced about three-quarters of that, with businesses absorbing the rest, for now, along with the residual higher cost of domestically-produced oil. If the price of oil remains at this level, more of the increase will flow through to consumers, particularly with the seasonal return of higher gasoline demand in the spring.

$100 billion is not a trivial sum, particularly when it's added to the ongoing expense of two wars and the ultimate cost of repairing the damage caused by the sub-prime debt meltdown. In particular, taking the annualized equivalent of $80 billion out of consumers' disposable income has to worry any business hoping to sell them some product or service this year. But in an economy with nearly $10 trillion of consumer spending, it's the rough equivalent of a 1% tax. Consumers, businesses and policy-makers might want to keep that in perspective, before they panic.

Thursday, January 10, 2008

The Context of Efficiency

Here's a nice example of the vital distinction between consumption and efficiency. If I told you that a company was about to introduce a new car model that was expected to average 56 miles per gallon, and that it was going to be so cheap that nearly anyone could afford one, that would sound like great news, wouldn't it? Perhaps it depends on the context in which that car is introduced, and our assumptions about what it will displace. The car in question is Tata Motors' eagerly-awaited "1-Lakh" car--referring to its 100,000 Rupees price equating to $2546 at yesterday's exchange rate--and the target market is millions of Indians who haven't been able to afford a car yet. Even at an expected efficiency of 56 mpg, though, the Nano, to give its proper name, will create incremental consumption of petroleum products and new greenhouse gases emissions.

At an initial 60,000 units per year, the Nano will hardly alter the global oil supply and demand balance overnight. If driven 5000 miles each, the entire first year's production would consume only 350 barrels per day of fuel, or about as much as 11,000 average American cars. Of course, we're talking about a potential market of tens of millions of such cars, and as today's Wall Street Journal reminds us, there are a number of carmakers and models competing for that market. Selling 50 million such cars here would increase our fleet average efficiency to 32 mpg and save over 800,000 barrels per day of gasoline and 120 million tons per year of CO2. Selling 50 million of them in India, however, could increase consumption by 300,000 barrels per day, while adding 42 million tons per year of CO2.

While efficiency is probably the single most powerful tool available to us in trying to bring global energy use and emissions under control, it doesn't tell the whole story. Consumption is what counts, and at least in the case of Tata's new model, every new car out the door adds to consumption, no matter how many miles per liter it gets, because at the entry level it's displacing bicycles, mass transit, and walking. That isn't the case in the US, where the market is mature and most new cars replace older cars. Here the fuel economy indicated on a new car's sticker is only one variable that will determine its ultimate consumption, along with the city/highway driving mix, total miles driven, and the owner's driving style and maintenance habits.

You might also expect a car powered by a 32-HP engine and weighing 40% less than Toyota's smallest US offering, the 36 mpg Yaris, to do even better than 56 mpg. Unfortunately, $2,500 won't buy much in the way of sophisticated engine efficiency upgrades, let alone pay for the kind of hybrid approach used in the Prius. In this light, the 100 mpg initial target that the MIT-led Vehicle Design Summit is working toward for an entry-level car for India looks pretty ambitious.

Value judgments about this sort of thing are complex. At the same time we recognize that the expansion of personal mobility in developing countries complicates the energy and environmental challenges we all face, we might also experience a vicarious thrill at the benefits it should bring, provided that Indians don't feel obligated to repeat every mistake we've made in the one hundred years (this October) since the first of 15 million Model Ts rolled off Mr. Ford's assembly line. Sharing the lessons we've learned about transportation may be every bit as important as the technology sharing that was a major theme at the Bali climate change conference last month.

Wednesday, January 09, 2008

Candidates & Energy: Huckabee

With the Iowa Caucuses and the New Hampshire Primary behind us, and Super Duper Tuesday less than a month away, it seems timely to look at where the major presidential candidates stand on energy and energy-related environmental issues. I'd like to start with a candidate whom I would have relegated to the also-ran category prior to his impressive win in Iowa, former Arkansas Governor Mike Huckabee. Mr. Huckabee's positions on energy represent an interesting mix that doesn't neatly match the "conservative" label with which he is generally tagged. Some elements are refreshing, while others strike me as naively unrealistic--although not necessarily more than those of other, more prominent politicians. This isn't meant to be a comprehensive examination, nor should it be construed as any kind of endorsement.

Mr. Huckabee's official website,, identifies energy independence as a key issue for his campaign. It proclaims, "We will achieve energy independence by the end of my second term," and lays out a broad agenda that includes conservation, technology, oil exploration, biofuels, renewable electricity, clean coal and nuclear power. It alludes to a "comprehensive plan for energy independence," although it is not clear whether this already exists or would be created early in a Huckabee administration. Without the specifics, we have only the site's rhetoric from which to surmise that the plan would rely heavily on market-based solutions and federal R&D support, rather than mandates. Among other things, he is on record supporting drilling in the Arctic National Wildlife Refuge.

Governor Huckabee's approach to energy seems generally consistent with the Geo-Green movement that's been percolating for a while in policy circles. He explicitly links energy and the War on Terror, citing the widely-heard "funding both sides" argument. His suggestion that he'd like to "treat Saudi Arabia the same way I treat Sweden" will be popular with voters who see Middle East oil--of which the US actually consumes relatively little--as the root of all evil.

The obverse of the security focus in the Geo-Green framework is environmental policy, and here Mr. Huckabee stands out, along with Senator McCain, as being most aggressive among the Republican candidates on the subject of climate change, which he accepts--though he tends to sidestep the question of its anthropogenic origin. On moral grounds he supports a cap and trade approach to greenhouse gas emissions and places this in a broader context of environmental stewardship. Despite this, I could not find a direct reference to climate change on his campaign's website.

So how does all this strike me? It's hard for me to get past the choice of energy independence as a focal point for his energy policy. Even if this goal were technically possible and desirable--both points are debatable--the idea that it could be done within eight years simply isn't credible. When you consider the legislative, permitting, capital, and engineering & construction elements of such a timeline, it would be quite an accomplishment if the first wave of major facilities envisioned in such a plan--nuclear power and coal liquefaction plants, arctic oil wells--were onstream by the end of his second term in office. Perhaps it's meant metaphorically and not literally, as it seems. I've also never been very comfortable with the "beggar-thy-neighbor" tone of some of the Geo-Green arguments. I see strong synergies between energy security and climate change, but those benefits stand up quite well without being put into an adversarial, anti-Arab context.

On balance, Governor Huckabee's approach to energy fits the climate change/energy security template that has become increasingly mainstream in the last few years and that ought to appeal to independent voters and some Democrats, while emphasizing markets in ways that won't alienate Republicans. There's not a lot of depth evident, however, and if Mr. Huckabee ultimately wants to compete with Democrats who have developed extremely detailed energy proposals, his staff has a lot of work ahead of them.

Tuesday, January 08, 2008

OPEC's Strategy

For many years there was a general sense in the oil world that OPEC had learned an important lesson from the energy crisis of the 1970s: let the price get too high for too long, and their customers will find ways to reduce their demand, by becoming more efficient and switching to other fuels. Until recently, analysts and pundits liked to guess at whether $50, $60 or $70 per barrel constituted the level at which that worry would kick in again, and the floodgates of supply would open. A snippet in Sunday's Washington Post started me wondering whether this paradigm were not only outdated, but has actually been supplanted by a new strategy of near-term revenue maximization. What if, aside from the serious challenges impeding the construction of enough new production capacity to keep up with rapidly growing global demand, OPEC has considered the implications of our growing concerns about climate change and energy security, and concluded it only has a few decades left in which to extract the most value from its resources?

While I read with amusement the satirical conspiracy report from former CIA Director James Woolsey in the Post's Outlook section, I don't imagine OPEC frets much about the prospect of food-based biofuels eroding their market share and profits. The entire 15 billion gallon-per-year "conventional biofuel" (a.k.a. corn ethanol) mandate in the new US Renewable Fuel Standard will add less than 400,000 barrels per day of oil-equivalent volume to a world market currently running at 85 million barrels per day , and cellulosic ethanol is not yet ready for prime time. OPEC can do their sums as well as we can, and they can see that with China and India growing as rapidly as they are, there is ample room for both oil and biofuels. However, they might not be so sanguine about the prospect of a serious effort to reduce greenhouse gas emissions by 70 or 80% by mid-century in the US and Europe.

What would emissions reductions of that magnitude mean for oil producers? Well, the EU and California--assuming it wins it suit against the EPA--are targeting specific tailpipe CO2 reductions that would require cars to consume 20-30% less fuel than the current fleet, within a few years. That will be achieved through a combination of hybridization, dieselization, downsizing, and the incorporation of other efficiency technologies. If the rest of the US follows California's lead, or even just meets the new 35 mpg CAFE standard, then together with Europe we're looking at several million barrels per day less consumption in 10-15 years, and that's just the beginning. Furthermore, the introduction of plug-in hybrid cars opens the door to a more serious potential competitor to oil than biofuels: electricity. And since oil accounts for a small and declining share of the world's electricity generation, that's a game in which OPEC won't participate, though it will benefit some OPEC countries like Iran and Algeria that are also large exporters of natural gas.

So if OPEC is facing a demand curve that may be going up today, but looks like it might peak within a decade, how worried should we suppose they are about the possibility that high prices might prematurely destroy some of that demand, compared with maximizing their cumulative oil revenue before the carbon era ends? If greater fuel efficiency and lower oil consumption are inevitable in the long run, anyway, why wouldn't they want to generate the highest possible income today, even if it accelerated that trend?

An editorial in this week's Economist suggests that high oil prices owe more to "peak nationalism" than Peak Oil. That's a theme to which I've devoted a lot of space for the last four years. Resource nationalism has been building for at least a decade, for reasons having little to do with concerns about climate change. But having found their way to a world of oil prices higher than they could have realistically hoped for not long ago, producers have ample reasons--including the idea that oil might go out of fashion sooner than previously expected--to want to remain there. We shouldn't delude ourselves that OPEC's interests and ours are aligned.

Monday, January 07, 2008

The Biofuel Gap

When I was writing last Wednesday's posting on the year ahead, I was tempted to call 2008 the Year of Biofuel. That's wasn't because I think biofuel will necessarily be the most important energy development of the year, but because, of all of the provisions of the recently-enacted Energy Bill, its greatly expanded renewable fuel standard (RFS) will have the most immediate impact on domestic energy markets, and not all of it good. The new standard requires an increase in ethanol use in 2008 that could not be met by the domestic production facilities existing at the time of the bill's passage, or with current levels of imports, which already face a substantial tariff barrier. So while some ethanol producers struggled in 2007, with margins squeezed between rising corn prices and flat wholesale prices to blenders, it's hard to see how their fortunes could fail to improve this year.

The phase-in of the RFS in the Energy Bill instantaneously increased the size of the US ethanol market, starting on 1/1/08. The RFS previously in effect called for 5.4 billion gallons of renewable fuel to be used in 2008--well below the 6.4 billion gallons of ethanol the industry was on track to deliver in 2007. The new law hiked that to 9 billion gallons per year (GPY) of "conventional biofuel"--mostly corn ethanol--this year and 10.5 billion next year, increasing to 15 billion by 2015. With domestic production running at just over 7 billion GPY in October, the last month for which data is available, and imports contributing perhaps another half billion GPY, meeting the federal target this year will require a lot of new facilities to start up, or a lot more imports. In other words, demand suddenly exceeds supply, by mandate, and that ought to translate into a healthy increase in ethanol margins, once the EPA gears up to administer the new standard.

On the surface, this doesn't sound like much of a problem. After all, doesn't every additional gallon of ethanol reduce the amount of foreign energy we have to import and benefit the environment by reducing greenhouse gas emissions and local pollution? For a thorough answer to that question, I refer to you the excellent article on biofuels in the current issue of MIT's Technology Review, available in three parts on the Internet. But even if ethanol were as beneficial as its most ardent advocates claim, the Congress and President cannot sweep away with the stroke of a pen the logistical bottlenecks involved in getting ethanol from distilleries to gasoline blending terminals all over the country. Those problems helped depress ethanol prices last year and will have to be overcome on the ground, in order to expand the use of ethanol beyond the oxygenated fuel markets from which it has successfully displaced MTBE, which has fallen out of favor due to product liability concerns, or where its supply has been cheap and reliable enough to compete as a separate product, in the form of E-85 for "flexible-fuel vehicles."

As I understand it, companies unable to secure enough ethanol to meet their new quotas would have to purchase blending credits from other companies that blended in excess of their quotas--something that would only be possible if shortages were local, rather than national, and that could run afoul of the current 10% upper limit (E-10) on ethanol/gasoline blends into conventional cars. That would also increase the cost of fuel in areas that can't easily be supplied with ethanol. The alternative would be to apply for a waiver of the portion of the RFS that couldn't be filled practically. That could prove controversial, if the production from new ethanol facilities--however remote from the actual demand--were going begging. When I ponder what this is likely to mean for the business of getting motor fuel reliably to over 100,000 retail sites, I don't envy my former colleagues in the supply and distribution segment of the oil industry.

However unenthusiastic many of us are about corn ethanol, the new RFS is a fact, and our focus should be on minimizing the disruptions it could create in fuel markets. At least until the logistical problems can be addressed by new infrastructure, the best outcome would probably be for as much as possible of the incremental ethanol requirement to be consumed in the form of E-85 in the Midwest, where most corn ethanol will continue to be produced, thus minimizing the cost and constraints associated with distributing it to the most remote corners of the country for E-10 blending. One can only hope that the painful experience gained from this exercise will be useful in smoothing the way for the eventual introduction of cellulosic ethanol, which should be more economical and environmentally-beneficial, and for which a separate RFS quota starts to ramp up in 2010.

Friday, January 04, 2008

Blaming the Buck

The lead editorial in today's Wall Street Journal (subscription required) attributes much of the recent increase in oil prices to the weakness of the dollar, and to the monetary policies of the Federal Reserve. As evidence for this argument, they present a chart of the relative value of oil in dollars, Euros, and gold for the last eight years. Although the editors make the obligatory nod to the growth of demand and problems of supply, they contribute to the general sense that our energy problems can be blamed on some unaccountable party: OPEC, oil companies, or now the Fed. This absolves us from the contribution of our personal consumption habits, while failing to differentiate cause from effect.

The Journal is hardly the first to notice the inconvenient relationship between a depreciating dollar and higher commodity prices. Among others, I suggested a few months ago that this might constitute a worrying feedback loop, with higher oil prices further weakening the dollar, a weaker dollar driving up oil prices, and so on. A closer look at the relative value chart in the editorial provides a sense of the relative importance of this factor among the many affecting global energy prices. Using gold as the measure of price stability ignores its status as an important industrial commodity, participating in the same global commodity trends affecting steel, copper, grains, and other goods affected by the sustained rapid growth of China, India and other developing countries. If instead we choose the Euro as our proxy for stable value, we see that the real price of oil has at least doubled since 2000, reflecting the 11% increase in global oil demand that consumed the surplus production capacity that had been left after the collapse of oil prices in the late 1990s, along with virtually every barrel of new capacity put into service since then. A weak dollar exaggerates but did not create this trend.

The other implication raised by the editorial is that Federal Reserve policy might offer a mechanism for pushing oil prices back to more comfortable levels. There's something to this, though the cure might be worse than the disease. A couple of interest rate hikes could pull the dollar out of its current slump, and lower oil prices would likely follow, not just because the dollar would be more valuable, but because the US economy would be pushed into recession, thereby reducing estimates of future US demand and easing speculative pressure on oil. That's hardly an appealing scenario, however.

What we're left with, then, is an interesting observation about another consequence of US policies that have generally promoted consumption but not production--and not just for oil--but one that offers no real help in addressing the problem. That lies with the fundamentals of supply and demand, more sensible energy policies, and the creation of a public consciousness that connects the results of policy and personal choices with the price at the pump--whether denominated in dollars, Euros, or ounces of gold.