Friday, May 30, 2008

The Right Nudge

I've covered the idea of a government-set floor price for petroleum several times in the last couple of years, so I didn't immediately feel obliged to address the latest such proposal from Tom Friedman in yesterday's New York Times. Enough readers sent me links to his column to convince me that it merited another look. The idea of setting a $4.00 per gallon floor under the average retail price of gasoline in the US has far fewer drawbacks than the previous crude oil floor price proposals I have reviewed, particularly in combination with a suggestion for minimizing the impact of this regressive tax on lower-income Americans. But while it's worth examining it both conceptually and in terms of the mechanics of implementation, it must also be considered in the context of other proposals concerning our use of energy. In that respect it comes up short.

The main benefit of setting a fixed floor under the price of gasoline is that it would reduce uncertainty about future prices. Uncertainty is the enemy of action, and informed consumers must surely be torn between two huge uncertainties about oil prices that have recently been dueling in the media. On the one hand, they are confronted by opinions--backed by some evidence--that global oil supplies are approaching, or have already reached, a plateau beyond which they cannot be increased to meet rising demand, and from which they will eventually decline. Adherents of the Peak Oil Meme see $130 per barrel oil as a bargain, compared to what it might cost in a year or two. Meanwhile, other observers suggest that oil may be experiencing a speculative asset bubble, as investors flee to non-perishable commodities for safety from weak stock markets, low bond yields, and the sliding dollar. The Congress heard testimony to that effect last week. If you accept the Oil Bubble Meme, crude could be back under $70 within a year. How should the average consumer decide which view to believe, in deciding whether to replace that gas-guzzler with a hybrid? A floor price resolves at least half of that uncertainty.

Implementing a gasoline floor price tax would involve several key decisions, including whether to set it nationally or regionally. Since local and regional price variations reflect disparate supply and demand factors--the most extreme examples being found in the California market--any such tax should be imposed as a flat addition to the existing 18.4 cent per gallon federal gasoline tax, so as to avoid creating local distortions. An even more serious question is whether it should only apply to gasoline. The best answer appears to be yes, for now. The price of diesel fuel has a strong, direct effect on economic activity, including agriculture and freight, and propping it up with a tax would reinforce its contribution to consumer price inflation. If singling out gasoline for a floor price resulted in consumers switching to more efficient diesel cars, or to cars running on LPG, natural gas, or other alternative fuels, that wouldn't be a bad thing, unless it created an offsetting rebound in vehicle miles traveled.

How should we determine the right level for such a floor price? A year ago, Mr. Friedman thought $3.50/gal. appropriate, when the average US retail price of unleaded regular gasoline was $2.19/gal. Today, with the average pump price only pennies below $4.00, he sees that as the right target, based on the demand destruction it has triggered. From my perspective, a floor has a better chance to succeed if it is set below the current price level, at least initially. Even $3.50/gal. would send a strong signal that consumers would never again see last spring's $2.50/gal. And if oil is in a bubble, and it did revert to $65/barrel, a floor price tax set at $3.50 could ultimately generate more than $1.00/gal. of revenue, or upwards of $142 billion per year, basis last year's consumption. That raises the equally thorny question of what to do with the revenue.

Because of the uncertainties affecting the fuels market, there is no reliable way to predict whether a gas price floor tax would generate any revenue, some, or a huge amount. So it would be hard to use it to fund a specific initiative, such as payroll tax relief or alternative energy R&D, unless it were done retrospectively, based on the previous year's tax receipts. However the government chose to use the proceeds, it would create a new constituency for this tax, with an interest in ratcheting up the level of the floor price over time, if oil prices rise, to keep the money flowing. That might eventually turn a floor price tax into a European-style fuel tax, and that's where my discomfort with the whole idea really kicks in.

I have generally opposed higher taxes on fuel, originally on principle but more recently because I believe setting a price for greenhouse gas emissions would kill two birds with one stone, and the right bird first. Getting our emissions under control will automatically address our energy problems, but the reverse isn't necessarily true. Although a floor price on gasoline wouldn't inherently conflict with the kind of federal cap & trade system for greenhouse gas emissions that is about to be debated in the Congress, the political prospects of enacting both seem poor, and setting a value on carbon emissions is a higher priority than enacting a floor price tax that might never be triggered. Only if cap & trade or its cousin, the carbon tax, proved entirely unworkable should the floor price tax rise to the top of the agenda.

Wednesday, May 28, 2008

Ending Oil's Monopoly

In yesterday's Financial Times (subscription required for full text) Daniel Yergin suggested that the current oil price spike is creating a historical "break point" for petroleum that will result in the loss of oil's dominance in the global transportation fuels market. The commentary by Mr. Yergin, the Chairman of Cambridge Energy Research Associates articulated a shift that has become increasingly apparent to careful observers of the industry. His conclusion that oil will "share the transport market with other sources as never before" is almost certainly correct, even if oil prices were to revert to $60 per barrel next week. There is an important corollary to Mr. Yergin's analysis that he didn't explore in his FT op-ed: At the same time that gasoline and diesel will have to share the market with other fuels, the primary sources of transportation energy will also become much more diverse, as well. That has important implications for both national energy policy and corporate strategies.

Consider the supply chain for petroleum products. Oil is extracted from underground reservoirs and transported to refineries that separate it into its familiar product categories, while transforming low value portions of the barrel into high-quality fuels and removing sulfur and other impurities along the way. A modern refinery is a complex, expensive set of hardware, but its functions would still be recognizable to an oilman from the 1930s. Even ethanol has retained this model, with corn going in one end of an ethanol plant and ethanol and its byproducts coming out the other end. The new transportation energy market that Mr. Yergin hints at will shatter this model. Oil and its products--and corn and its fuel products--will play an important role for decades to come, but they will compete with synthetic diesel and jet fuel from natural gas, coal and biomass; biodiesel, ethanol and other alcohols from a wide variety of feedstocks and technologies; and electricity and hydrogen from a multitude of conventional and renewable sources, both centralized and distributed.

This new model will break three effective monopolies: of spark-ignition and compression-ignition internal combustion engines, of gasoline and diesel fuel as the dominant energy carriers for delivering transportation energy--and note that ethanol has so far only piggy-backed on gasoline's monopoly, rather than breaking it--and of petroleum as the source of primary energy for most forms of transportation. While the market shares of all three of these monopolies are in the high 90%'s today, the signposts of change are all around us. Biotechnology promises to break down the cellulosic material that gives plants their rigid structure and turn it into ethanol and other fuels, but it could eventually give us plants that excrete market-ready fuels. Better batteries will give consumers the choice between plugging in and filling up, but they could also facilitate the much wider adoption of renewable electricity from intermittent sources such as wind and solar power. And fuel cells running on hydrogen might yet provide a practical and more efficient way to turn chemical energy into useful work onboard the vehicle, powering electric motors that will become increasingly ubiquitous on all ground vehicles.

A decade ago, this scenario was just that, one possible future outcome of a number of competing trends and uncertainties. Now, thanks to the combination of concerns about climate change and energy security, and the practical problems of $130 oil, some version of it seems more plausible than the unchallenged continuation of those three "natural monopolies" for another generation. Whatever its other faults, the "farm bill" just passed by the Congress over the President's veto takes a step in that direction, by reducing the subsidy for corn ethanol, the so-called Blenders' Credit, from $0.51 per gallon to $0.45 and using the savings to fund a $1.01/gal. direct subsidy for producers of cellulosic biofuel.

As Mr. Yergin points out, oil "is not going to fade away soon." It will take time to turn over car fleets and move new fuel processes out of the laboratory, through demonstration-scale testing, and into full commercial production. But as frustrating as the wait for these new technologies and fuels may seem, while Americans pay $4 at the pump and Europeans pay the equivalent of $8 per gallon, this energy crisis--unlike the one of the 1970s and early 1980s--might just put in place the means of averting all foreseeable future energy crises centered on oil, by reducing the status of oil producers to that of merely one transportation energy source among many.

Tuesday, May 27, 2008

Paying the Bill

The price of oil and gasoline was a popular topic at the neighborhood Memorial Day barbecue. One of my neighbors, a retired executive, was especially concerned about a number he had heard in an interview with T. Boone Pickens, to the effect that the US would spend $1 trillion this year on imported energy. While a web search suggests that the figure Mr. Pickens mentioned was probably only half that big, neither sum is trivial. The real question, however, is not how much we are spending on imported oil and gas, but whether we can afford it. Assessing that is much more complicated, having to do with the value we add to the cost of these inputs. No matter how we look at it, though, it's hard to see energy import spending of this magnitude as sustainable.

At current prices, our annual tab for imported energy, including LNG and petroleum products but excluding coal, for which we are a net exporter, is running at about $600 billion. 94% of that is for crude oil and petroleum products. As impressive as that amount is, it represents only 4.3% of our $14 trillion economy. If we are turning those energy imports into goods and services that contribute to the rest of our GDP, then a 23:1 ratio of energy in to value out doesn't seem too bad. Unfortunately, this superficial analysis glosses over a host of problems, the biggest of which is the rapid rate at which energy's share of GDP has risen in the last few years. It also ignores the impact of these changes on the most energy-intensive segments of the economy, such as airlines and trucking, which are essential to much of the remainder.

A lot has changed since the last energy crisis. As Gerald Seib's column in today's Wall Street Journal points out, the US economy requires only half as much energy per dollar of real GDP as it did in the early 1970s. Even after accounting for the impact of SUVs, today's new car fleet gets more than double the fuel economy of 1973 models, which averaged only 13 miles per gallon. But while these efficiency gains--which still offer plenty of scope for further improvement--have helped dampen the severity of the current oil price spike, they cannot erase the fact that our national energy import bill has gone up by a factor of 4.7 since 2000. We aren't just feeling the pain at the gas pump; every aspect of our economy that uses energy has seen a nearly five-fold increase in costs during a period in which average consumer prices have only risen by 25%. That squeezes businesses even more than consumers, and it explains much of oil's contribution to the present weakness of the US economy, and of the US dollar, which amplifies the pressures on oil prices.

Perhaps the best use of that $600 billion figure is to keep us focused on the scale of the problem and of the solutions it will require. For example, increasing ethanol production from 7 billion gallons per year to 15 billion gallons--about the most we can achieve without the uncertain contribution of cellulosic ethanol technologies--would displace $22 billion worth of oil. Reducing gasoline consumption by 10% would save $44 billion, while increasing domestic oil production by a million barrels per day--a volume entirely within the potential of our existing resource base--would contribute another $48 billion, with additional benefits from the impact of these changes on the global price of oil. Yet all of those actions together wouldn't get us halfway back to what we were spending on energy imports in 2000. If we are serious about getting our energy import bill under control, we must think big, and we must focus our efforts where they will have the most impact, in dollars and in equivalent barrels of oil. Aligning our national energy policy to the scale of that challenge won't be easy, especially when we have mistakenly convinced ourselves that the traditional energy sector has nothing further to offer in this regard.

Friday, May 23, 2008

Oil Panic Attack

After having mostly yawned our way through the first half of oil's amazing six-year ride, we now watch its movements as intently as any futures trader, and our level of concern seems to be building towards a national anxiety attack. Since 2002 we've seen the price of West Texas Intermediate Crude Oil rise from the mid-$20's to the mid-$70s, then retrace to $51 in early 2007, before beginning its remorseless climb past $100 and every other logical stopping point. Some industry analysts are predicting $200 per barrel oil, and warnings of $6, $10, or even $12 gasoline are treated seriously, bolstered yesterday by a new suggestion from the normally-conservative International Energy Agency that we may be approaching a global production plateau. My crystal ball isn't working any better than anyone else's, and thankfully I'm not paid to forecast oil prices. If we want to understand where we're headed, though, we should examine where we've been.

Until fairly recently, oil was regarded as a cyclical commodity, though its cycles didn't necessarily coincide with those of the global economy. It's also an industry that values experience, so its management includes many who have seen several of oil's up and down sequences. That means the senior members of the tribe can recall from personal experience--even if it was early in their careers--the collapse of oil prices in the mid-1980s after the lagged responses to the first energy crisis took hold. Then came the even more devastating drop in 1998/99, in tandem with the Asian Economic Crisis, when WTI bottomed out at just over $10/bbl, pushing the price of most grades of oil into single digits. Many projects that were planned in the late 1980s, when oil finally reached $20/bbl again, started up in a down market that destroyed billions of dollars of net present value. At the same time that oil companies were learning these painful lessons, the OPEC countries that hold most of the world's known oil reserves were attending a similar school, particularly with regard to the perils of over-capacity. The oil price collapse of the late 90s that squeezed the stock prices and investment budgets of the international oil companies created large external deficits for OPEC's members.

Next consider the unexpectedly large expansion of demand. Between 1998 and 2006, global oil demand grew by 10 million barrels per day. At the same time, the natural decline of mature oil fields would have required the industry to replace somewhere between 1.5 and 3 times that much output, just to stay even, in a period when an increasing proportion of the best opportunities were not available to the companies with the biggest incentive to grow production, and the big producing countries were starting to learn that selling more oil may be a less effective way to make more money than selling less, or at least holding output steady in the face of rising demand.

As a result of these factors, when prices began to rise again, breaking through $30 in 2000, oil companies and producing countries had good reasons to be skeptical that the fundamental relationship between supply and demand was on the verge of a permanent shift. That resulted in a crucial delay in funding new projects--crucial because of the time lags involved in the planning, permitting, procurement and construction stages of such projects. In the interim, most of the world's spare production capacity was tapped, and the industry seems unlikely to catch up, short of a global recession that would halt demand growth in its tracks.

Throw in a few other key factors, such as the dollar's decline, an increase in commodity speculation, and the artificially-low petroleum product prices in a number of developing economies, and we have all the necessary ingredients for the quintupling of oil prices that we have experienced in the last six years--doubling in just the last year. Getting out of the deep hole we have dug will require a combination of higher fuel efficiency, increased non-efficiency conservation, more drilling, greatly expanded non-food biofuels and synfuels output, and the partial electrification of personal transport. With the exception of conservation, none of these solutions will make a dent in the problem in this decade.

No one can predict with certainty where oil prices will go from here. It could be to $200, or back below $100. The market is flirting with contango, suggesting it is reasonably well-supplied for now. Despite this week's 5 million barrel drop in US crude oil inventories, days' supply of crude and gasoline are at a fairly healthy 22 days each. Yet the momentum of this market seems unshakable. In the meantime, I suggest prudent conservation and the avoidance of panic. $200 oil would not mean $12 gasoline. In fact, unless refining margins suddenly came back to life, it might not even get us to a $6 national average retail price for unleaded regular. That's not very reassuring, going into the Memorial Day weekend that signals the start of the peak driving season. Our enjoyment of the summer could depend on our level of stoicism.

Thursday, May 22, 2008

Clean Green Wheels

Yesterday I attended the awards ceremony honoring the winners of the Challenge X competition sponsored by the Department of Energy and GM, in which teams from 17 US and Canadian universities vied to produce the highest energy and emissions savings from the same vehicle platform, a Chevrolet Equinox. The 17 cars that pulled up in front of L'Enfant Plaza in Washington, DC provided concrete evidence that we are on the threshold of a much more diverse transportation energy market, and a more efficient one. Equally encouraging was the new engineering talent on display. However, while these cars demonstrate the feasibility of achieving significant fuel economy improvements in vehicles that consumers will want to buy in large numbers, there were no 100 mile-per gallon miracles in evidence.

The winning team from Mississippi State University replaced the standard gasoline engine of its Equinox with a 1.9 liter direct injection turbo-diesel--a common engine type in Europe, but sadly missing from the Big Three's US lineups, thus far. The car was then hybridized with a 45 kW electric motor drawing on a metal hydride battery pack, and it ran on a 20% biodiesel blend. In fact, although the competitors included a wide variety of powertrains, and even one fuel cell-powered car, the top three configurations were all diesel-hybrids. According to the DOE, the winning team's vehicle achieved a 38% improvement in fuel economy and a 44% decrease in greenhouse gas emissions. With the stock Equinox rated at 20 mpg combined, that suggests a result for the Mississippi State car of 28 mpg. As impressive as that is for this "crossover" class, it certainly puts into perspective the suggestions by some politicians that the recently-mandated 35 mpg fuel economy standard can easily be exceeded by cars that match our current expectations. The winner of the ongoing Automotive X-Prize competition will probably not look much like a showroom-ready crossover SUV.

The biggest challenge of improving the fuel efficiency of real cars may not be the technological one so ably addressed by these university teams. Rather, it is making those improvements cost-effective. Combining an up-to-date diesel engine with the energy recovery of a hybrid is a sure bet, in terms of fuel savings. But there's a reason we haven't seen this setup in a production car, yet: it's expensive. Gasoline-powered hybrids already carry a premium of several thousand dollars over the comparable conventional vehicle, and switching one from gas to diesel entails an even higher up-front cost. At $4 per gallon and 12,000 miles per year, the undiscounted fuel savings associated with going from 20 mpg to 28 mpg add up to $4,800 over seven years. Could a manufacturer sell a diesel hybrid for $4,000 over a standard model and make a profit? Would customers line up to buy it? The answer to both questions is not clear, partly because of the extremely limited experience of American consumers with 21st century diesels.

In a brief conversation with a GM official attending yesterday's event, I got the strong sense that the company was as interested in the teams of creative, eager students as in their cars. Competition X thus serves as a pipeline to talent, not just technology. What better way to identify and nurture a new generation of automotive engineers who are motivated by the challenge of making cars more efficient and environmentally sustainable, rather than just more stylish or powerful? Considering that within a few decades China could add as many cars as the US now has, and with oil prices continuing to rocket upward, that is the only realistic way forward for the auto industry.

Wednesday, May 21, 2008

Sunshine in Germany

I'm still catching up on the news, after a long weekend in a remote location. Among the articles I missed was one in Friday's New York Times on Germany's subsidies for solar power. Although the country's system of "feed-in tariffs" and the rapid growth in solar power to which they have contributed are the envy of renewable energy advocates around the world, some German legislators have concluded that the structure is too expensive for the small amount of clean electricity it generates: 0.6% of a mix still dominated by coal. If you dissect the arguments and view the environmental elements rationally, the debate is essentially over industrial policy, rather than energy policy. It provides a lesson that we should study carefully, in light of ambitious proposals at the federal and state level to emulate the German approach.

Although the Times article included a wealth of data, it neglected to mention the magnitude of the subsidy embedded in Germany's solar feed-in structure, which obligates utilities to purchase power from various renewable energy technologies at a set price for 20 years. The current law reduces that rate each year, though a more aggressive decline has been deferred for a couple of years. The cost of acquiring this power is allocated across all rate-payers, and many analyses focus on the relatively modest impact on each household--just a few Euros per month, so far. But that allocated cost is only small because the amount of electricity being generated is quite small, not because the tariff is. In fact, the feed-in tariff for electricity generated from photovoltaic modules is eye-poppingly generous: about 50 €-cents per kWh, which at current exchange rates translates to $0.78/kWh. Compare that to the $0.06-0.08/kWh cost of US wind power cited in the recent DOE study. Even if coal-fired electricity cost as much as €0.10/kWh in Germany, the effective cost of the carbon emissions saved by solar power at these prices equates to a staggering €440/ton, or about 17 times the going rate for emissions credits on the European Climate Exchange.

The Times noted that Germany receives fewer hours of sunshine each year than many other places, calling the growth of solar power in spite of this deficiency "all the more remarkable." Other adjectives come to mind, "silly" being one of the kindest. It is sometimes easy to forget that even Munich, Germany's southernmost metropolis, is farther north than Bangor, Maine or Quebec City. The combination of high northern latitudes and frequent cloudy conditions results in very low annual "insolation", the amount of solar energy delivered per square meter. The best regions of Germany for solar power receive less than half the solar energy of the US Southwest, and the worst get about a third. Of all the forms of renewable energy that Germany might have chosen to subsidize so generously, solar power seems the least suited to the country's physical geography.

When taken together, these two factors suggest strongly that Germany's support for its solar power industry has very little to do with either energy or environmental policy and everything to do with national industrial policy--creating industrial champions and the so-called green-collar jobs about which we have heard so much during the US presidential campaign. However, even without a recession, Germans are apparently now beginning to wonder about the cost-effectiveness of such an approach, which has loaded up a cloudy, northern country with solar panels that rarely see the sun. The German PV miracle should be a cautionary tale for US politicians and regulators, not a model to copy.

Tuesday, May 20, 2008

Crossing the Rubicon?

Although I haven't made any great study of the history of shareholder revolts, I suspect that it is fairly unusual for one to occur when a company is enjoying record earnings, not only relative to its own past performance, but when compared against the performance of any firm in any industry at any time. And yet, that's where ExxonMobil finds itself today, with no less a group of stakeholders than the descendants of the firm's founding dynasty weighing in on the subject of its investment choices, particularly with regard to alternative energy. The Rockefellers have been joined in this effort by other investors and shareholder advisers. Whatever you may think about the shareholder resolutions in question, or indeed about the issues that they raise, the corporation's Annual Meeting is precisely the right venue for addressing them.

You might recall that when I wrote about a recent Congressional hearing on oil prices, I wasn't terribly sympathetic to the way that Chairman Markey pilloried ExxonMobil for pursuing alternative energy less enthusiastically than some of its competitors, or than the Congress might wish. When the Congress or the President can direct the portfolio decisions of publicly-traded companies on matters that do not involve their compliance with any known law or regulation, our political and economic system will have lost all resemblance to the one established by the Founders. However, the management and board of a corporation are still answerable on such issues to their shareholders, however silent the latter may be most of the time, especially when a company's fortunes are prospering.

Many of my readers regard investing in renewable energy as an obvious choice at this juncture, in light of the uncertainties of climate change and Peak Oil, more restrictive access to resources, and the rapid technological changes sweeping the global energy sector. I have long believed and advised that any integrated energy corporation that doesn't participate in the development of alternative energy puts its future success and image at risk. However, that doesn't mean that a company's management can't weigh all of these factors and conclude that it is still better off focusing on the areas in which it has excelled, a strategy that the landmark business text, "In Search of Excellence" referred to as "Sticking to the Knitting"--one of a handful of key lessons the authors gleaned from their study of successful companies. (Among other things, Peters and Waterman also extolled "A Bias for Action" and experimentation.)

The question that ExxonMobil's shareholders are effectively posing is whether its otherwise admirable capital discipline prevents management from seeing the long-term potential of a set of developments that could prove as significant as the original oil boom 150 years ago. John D. Rockefeller's vision of the growth of an oil-based economy, and how to capitalize on it, made Standard Oil--the precursor of the modern ExxonMobil--one of the most successful organizations in history, even after being broken up and only partially reassembled in the late 1990s. Even if you are skeptical, as I am, that we are on the verge of ending oil's key role as a source of primary energy and a superior energy carrier, it seems quite likely that the winners of the ongoing competition to crack the challenges of biofuels, solar power, and other alternatives will make new, Rockefeller-scale fortunes. A company should only turn its back on that kind of opportunity after some serious soul-searching and a frank discussion with its owners.

Some perspective seems necessary, as well. While the shareholder challenge to Exxon's management is a significant event within the larger trend of the greening of business, it would be a mistake to view it as a crusade. If the proposals currently being voted on by ExxonMobil's owners succeed, they will not end America's addiction to oil or bring the millennium. If they fail, that will not signify that we have passed the baton of moral or technological leadership to any other country or group of countries. The alternative energy revolution will stand or fall on its own merits, with or without Exxon. The company's shareholders must now decide whether or not the reverse is also true. Although I'm not endorsing any of these resolutions, I sincerely hope that both sides treat this as a unique and valuable opportunity to rethink their assumptions, scenarios and strategies concerning the future of energy.

I don't own any ExxonMobil stock, except in the manner in which millions of Americans do, as a component of various mutual funds.

Friday, May 16, 2008

Counting Electrons and Molecules

The electric vehicles are coming. Whether they are to be plug-in versions of hybrid cars, along the lines of the eagerly-awaited Chevrolet Volt or plug-in Prius, or the pure EVs recently promised by the CEO of Renault and Nissan, Carlos Ghosn, we will soon have significant numbers of cars on the road for which fuel economy metrics must track kilowatt-hours, in addition to or instead of liquid gallons. As I noted in my posting a few months ago on the usefulness of a possible "miles per dollar" metric, we haven't yet developed the vocabulary for comparing the efficiency of such vehicles to that of the traditional cars they are meant to replace.

If I told you that Car #1 gets 58 miles per gallon and Car #2 gets 4.5 miles per kWh, would you know which one was more efficient, and could you even assess that without including some factors that are external to the car, such as how its electricity was generated? Now complicate matters by considering Car #3, a plug-in hybrid touted by its manufacturer to achieve 100 mpg overall. But does that figure include or exclude the electricity it used when it wasn't using its gasoline engine, and if so, on what basis? The people running the Automotive X-Prize have made a very good start on a practical way to answer these questions, by creating a metric they call MPGe, for "miles per gallon equivalent ." I can't improve on their explanation for what this does:
"Basically we ask: how much energy was delivered to the vehicle, and how far did
it go? We convert the energy to the number of gallons of gasoline containing
equivalent energy, and we express the result as miles per gallon."
The value of such a formula is that it enables us to compare on a consistent basis the performance of any car running on any fuel, including gasoline, diesel, ethanol, biobutanol, natural gas, hydrogen, and/or electricity. And when the only fuel involved is gasoline, the formula collapses into the familiar equation for calculating plain vanilla mpg. Best of all, this results in a single, easily-comparable number for each car model.

Unfortunately, when I thought about this in the context of the wind power study I discussed in Wednesday's posting, I realized that the MPGe formula has a flaw. A competition aimed at creating the most efficient production car possible might properly convert electricity to BTUs at the standard energy-equivalent rate of 3,412 BTUs/kWh, without regard to the energy used in generating it. However, with wind turbines and photovoltaic arrays generating only a small fraction of the power we use today, most of the kWh's flowing through our power grids took a lot more than 3,412 BTUs to create. Because this factor occurs in the denominator, under-counting BTUs/kWh at their theoretical equivalent makes a transportation system based on electric vehicles appear more efficient than it really is, from the perspective of the overall economy. With national energy security a major driver of alternative energy, this is a problem.

Consider California, a key market for EVs and plug-in hybrids, because of its air quality regulations. Over 40% of the electricity generated there comes from natural gas, consuming anywhere from 7,000 to 10,000 BTUs per kWh. Using the X-Prize formula, the MPGe for an EV that gets 4 miles per kWh would drop from 136 to 66, if we substituted 7,000 BTU/kWh for the textbook conversion. That's not entirely fair, because it ignores the upstream energy losses associated with turning crude oil into gasoline, which are in the range of 10-20%. Nor are we including distribution losses for electricity, which can be significant, or the shifting generation mix at different times of the day or year. The proper basis of comparison involves a full "well to wheels" analysis, specific to each location and for every segment of the power dispatch curve. That's neither realistic nor very useful for future consumers.

Ultimately, I still prefer miles-per-dollar, or better yet, dollars per 100 miles, because it avoids these complexities and deals with the two factors that are of primary interest to drivers: cost and distance. However, I'm also realistic about the likelihood of replacing miles per gallon as the standard of comparison any time soon, particularly since that's the basis of the recent major revision to the Corporate Average Fuel Economy standard. MPGe represents the natural evolution of that metric, if we can agree on the appropriate way to compare electrons to molecules.

Thursday, May 15, 2008

$4 In Sight

As of yesterday's market close, the price of light sweet crude oil on the New York Mercantile Exchange (NYMEX) was up 29% since December 31, 2007. In this environment, prognostications about the market become obsolete almost as fast as they're written, mine included. Ten weeks ago I assessed the prospect of $4 per gallon gasoline this spring and concluded that it would require a combination of unusual circumstances. Instead, after another $20+ increase in oil prices, the average US retail gas price stands at $3.72, with California at $3.92. That means that polesigns showing $4.00 or more for unleaded regular are already a common sight in many communities. In a normal year, I would suggest that we are probably only a few weeks away from the peak price for the year, but this has been anything but a normal year.

Aside from the unprecedented crude oil prices, refining margins have not followed their usual seasonal pattern, in which margins rise as refineries shift out of heating oil production and perform annual maintenance, while gasoline demand builds toward its summer level. But using the difference between NYMEX gasoline and crude oil futures as a proxy for margins, they are running at $0.42/gal. less for April-May than the average of the second quarters of 2006 and 2007. This reflects weak demand, which may now be rebounding. Refineries are operating at somewhat reduced rates, compared to this time last year, and diesel production is a bit higher and gasoline output a bit lower than normal, all driven by weak gasoline margins and the surprising strength of diesel fuel. If normal seasonal factors were superimposed on today's high oil prices, we'd already be paying well over $4/gal. for gas.

I wish I could point out some factor that promised imminent relief. The only candidate I see is the recent decline in the "backwardation" of oil futures. A few weeks ago, the first or "prompt" contract was worth about $2.00/bbl more than the contract for delivery four months out. Today, this premium is around $0.40. That suggests a market in better balance. A further shift into "contango", when prompt oil is worth less than oil farther out, would indicate a surplus and signal refiners and traders to rebuild inventories. Of course, it wouldn't take much in the way of bad news to resume our march toward $130 or higher.

For good or ill, the only element in all of this that consumers control is demand, which is a function of miles driven and fuel efficiency. After falling in the first quarter, it now seems to be running at about the same pace as last year. Americans may be driving less, but the highways speeds I observe others driving imply that for all our complaints about the high price of fuel, we still value our time more. Will the psychological impact of paying $4 per gallon alter that? If a 70% increase in the pump price of gasoline over the last three years hasn't done the job, then I doubt that another $0.30/gallon will.

Wednesday, May 14, 2008

How Much Wind?

Yesterday the Department of Energy released a major study on the potential of wind power in the US, suggesting that by 2030 it could supply 20% of our electricity needs, at little incremental investment over and above what would be necessary anyway, to keep up with the growth of demand. This is an encouraging result for those who see renewable energy as a vital component of any effort to reduce greenhouse gas emissions and improve our energy security. While I can't possibly do justice to a 200-page report in a brief posting based on a quick skim-through, several interesting assumptions and observations leaped out at me. While they don't necessarily undermine the headline results, they serve to emphasize that the report is a finding of feasibility, not a forecast.

To an engineer, the wealth of data contained in a document such as this is irresistible. My first instinct was to dig out my calculator and start comparing the numbers to each other, and to current actual data. The report states that the quantity of wind power capacity required to supply 20% of US electricity demand in 2030 is 305,000 MW, or 305 GW. That reflects an 18-fold expansion of 2007 year-end wind capacity, for a compound annual growth rate of 14% over the next 22 years. Compared to an average growth rate of 36% over the last three years, that figure seems modest, but then it will get progressively harder to sustain double-digit growth as the installed base grows larger. But that's not the most interesting figure. That honor goes to the report's assumption of a 50% improvement in the capacity factor for wind--representing the ratio of actual output to nameplate capacity--from roughly 30% today to 45% by 2030.

Although I eventually found the support for that assumption in Chapter 2 of the study, I backed into it by comparing the 1,200 terawatt-hours (1.2 trillion kWh) of generation required to cover 20% of US demand in 2030 to the 305 GW of wind capacity. Although the study describes how this improvement could be achieved through a combination of advanced turbine technology, increased turbine size, and aggregation of the output of many turbines across a wide area, it goes beyond the capabilities of current turbines and what I have read of the experience of high-penetration European wind operations, such as Denmark. The reason this is important is that, if this significant improvement fails to materialize, then either a much higher level of wind installations will be required to supply 20% of US electricity in 2030, or the 305 GW proposed here would only deliver 800 terawatt-hours per year, or about 20% of 2006 demand.

Another interesting aspect of that 1,200 terawatt-hr figure is that it highlights the report's assumption of a 50% expansion in US electricity demand over the next 22 years. That works out to 1.8% per year, which seems reasonable based on past experience, but might not be compatible with efforts to reduce US greenhouse gas emissions significantly in the same period, unless it also assumes that a significant portion of new electricity demand will come from displacing petroleum from transportation via electric vehicles. The only mention of such substitution that I found in a full-document search was of plug-in hybrid cars as a potential outlet for off-peak wind generation. If 20% market penetration represents a practical upper bound, and electricity growth were only 1.1%/year, then maximum wind capacity in 2030 would be 258 GW, instead of 305 GW, still 15 times today's level.

The report also includes a set of wind power supply curves, showing the levelized cost of tapping all potential US onshore and offshore wind resources, ranging from 6 cents per kWh to over 14 cents. If I've interpreted it correctly, the incremental cost of the last land-based portion of that 305 GW in 2030 would be about 8 cents/kWh, while the offshore component would run between 10 and 11 cents, in current dollars and excluding the Production Tax Credit (PTC) that is currently up for renewal. This doesn't quite live up to the suggestion of some wind power advocates that it will be cheaper than coal, unless the coal power in question is from advanced generating plants with carbon capture and storage, or paying a substantial cost to emit CO2. At a minimum, the supply curve suggests that wind power will continue to need assistance on the order of the current 2 cent per kWh PTC, to penetrate beyond a small number of sites with the best economics.

The idea that wind power might someday supply a fifth of US electricity demand won't startle anyone who believes that the experience of Denmark could be translated to a much larger country. However, rather than viewing the DOE's "20% Wind Energy by 2030" study as confirmation of this notion, it should be recognized as a detailed scenario describing what would be necessary to reach that threshold. It spells out in considerable detail the improvements in wind turbine technology, transmission capacity, and load management that would be required. Much hard work remains to be done, to turn feasibility into practical possibility.

Tuesday, May 13, 2008

Half Full

Senator McCain's remarks on climate change yesterday are drawing predictable responses from both sides of the issue. While environmentalists may see it as a collection of half-measures, climate skeptics, including the editors of the Wall Street Journal, regard it as a sellout to those same environmentalists. I'll leave it to others to analyze the Senator's remarks line by line, but I think it's worth a couple of observations that might otherwise be screened out by the partisan filters and instinctive discounting to which any presidential campaign speech is subjected. In particular, the Senator's proposals deserve to be scrutinized for how they align with the key criteria of a risk-based, cost-minimizing approach to addressing climate change. This should not, however, be construed as a political endorsement.

Start with some basic principles. If you accept that human emissions of greenhouse gases are the key driver of long-term climate change--and this is the basic conclusion of the vast body of peer-reviewed science analyzed and summarized by the Intergovernmental Panel on Climate Change (IPCC)--then any plan to address this problem must tackle those emissions head-on. With atmospheric concentrations of CO2 and other greenhouse gases well above pre-industrial levels and continuing to climb, it is no longer adequate to call for an eventual freeze in emissions. We must begin to roll them back and make deep cuts as soon as possible and practical. However, arguing at this point over whether US emissions in 2050 should be 60%, 70% or 80% below today's is a red herring. Any of these figures should be viewed as a placeholder, until we've actually begun and can see how the necessary technology is developing and being taken up. How well could we have determined our 2008 emissions in 1966?

The debate about the economic consequences of reducing emissions has barely begun, and it is already polarized. At one extreme are those who see these cuts as potentially crippling--a dead loss to the economy--particularly if the large developing countries do not follow the lead of the EU and US in this regard. Others suggest that cutting emissions will produce a veritable cornucopia of industry-seeding and job-creation, yielding high returns on our investment. While I hope the latter view proves correct, we can't bet the country on it. That means making sure that our approach to emissions puts a high priority on eliciting the most cost-effective reductions, and by definition those will come from outside the industrial sector, excluding energy-efficiency gains that will largely be self-financing. So we need to cast a wide net that includes reductions from agriculture and consumers, not just big companies. The cheaper the reductions, the more of them we can afford, and the sooner we will meet our targets. In my view, economy-wide cap and trade is the best way to make the necessary cuts at the lowest cost.

The third key aspect of a successful climate policy is that it must integrate internationally. The US is a big emitter, and we need to regain the leadership position we held on this issue when the original UN Framework Convention on Climate Change was signed at the Earth Summit in Rio de Janeiro in 1992. That means negotiating in good faith on the successor agreement to the Kyoto Protocol, and opening our doors to emissions offsets from other countries, provided they are truly additional and not incidental or illusory. But it also means ensuring that US businesses are not placed at a competitive disadvantage to companies in countries not subject to these requirements. We need to reduce emissions, not merely shift them offshore.

Senator McCain's speech matches up well on these three principles, as do the climate proposals of his Democratic opponents. They have another six months in which to debate the particulars and win over the American people on this critical issue. However, while his opponents are in the mainstream of their party on this issue, Senator McCain deserves some acknowledgement for going against the grain within his, dating back at least to his co-sponsorship in 2003 of a cap and trade bill with Senator Lieberman. This stance looks even riskier today, when the skeptics have gone beyond arguing against global warming to promote the notion of global cooling. His supporters must now reconcile that political courage with the apparent contradiction of his support for a summer gas-tax holiday that undermines the notion of taxing energy more, not less, to bring down emissions.

As I've noted previously, it is remarkable that out of two original fields of candidates that included such a broad spectrum of views on global warming, the three finalists--and thus the two parties' ultimate nominees--are not just expressing concern in the abstract, but have issued calls for concrete action to deal with climate change. This is a necessary precondition for a meaningful national debate on a set of measures that would permanently alter our economy, with implications for the entire world.

Monday, May 12, 2008

Bubble or No Bubble

The controversy over the influence of speculation on oil prices is gaining momentum, spurring congressional hearings and a steady patter of op-eds, including Paul Krugman's column in today's New York Times. The idea that oil prices have been artificially elevated beyond a realistic, market-clearing level is of interest to more than just consumers. Biofuel producers have so far failed to reap the bonanza from high oil prices that they must have expected, because of steady increases in the price of grain, oilseeds and other inputs. A sudden oil-price collapse back to $60 or less could do many of them in, particularly with large increments of new capacity coming on later this year. Gauging the future price of their principal competition has become more challenging than ever, when the futures market has proved such an unreliable source of predictions.

Professor Krugman makes a solid argument that today's high oil prices exhibit few of the signs of past speculative bubbles, especially in regard to the level of oil inventories around the world. They don't reflect the degree of hoarding that would be expected, as speculators stored oil in anticipation of selling it at a higher price later. But while I agree with Dr. Krugman that assertions of an oil bubble going back several years owed a lot to wishful thinking, I wonder if he underestimates the influence of an oil futures market that didn't even exist during the energy crisis of the 1970s. This goes beyond the simple notion that a large, liquid market in oil futures allows investors to speculate on the future price of oil without having to take possession of it, and at a much lower carrying cost than if they had to pay for it all and lease a tank in which to store it. The connections between the physical market and futures market have become pervasive, and they tend to reinforce the upward pressure on prices from rising global demand and restrictions on access to resources.

Last December the noted oil expert Philip Verleger testified on oil prices before a joint hearing of two Senate committees. As part of his compelling argument concerning the disproportionate impact of the government's policy of putting additional sweet crude oil into the Strategic Petroleum Reserve, he described how a relatively obscure technique called "delta hedging" could reinforce an upward trend in the futures market. He used the example of Southwest Airlines buying call options on crude oil at a strike price of $51/bbl. through 2009. As the price of oil increased, the financial firms that sold these options to Southwest would have had to purchase increasing quantities of oil futures contracts, in order to manage their exposure, as the options got ever deeper "in the money." The higher the price of oil goes, the more oil futures the call option seller must buy to stay neutral, in a classic positive reinforcing loop pushing up the demand for oil futures, and thus their price. I wish I had noticed his testimony at the time, because Dr. Verleger accurately foresaw the market move past $100 to $120.

This example offers an important insight for those who are focusing on the role of speculation in oil prices. Rather than viewing speculation as the driver of a bubble along the lines of the Dot Com or recent housing bubbles, it makes more sense to view it as an amplifier inserted into the circuit that runs between the energy futures, options and derivatives markets and the markets for physical oil. As long as demand growth continues in spite of high prices--with modest reductions in US demand offset by growth in countries that insulate their consumers from high market prices--speculation will continue to amplify negative supply news and push the market to new heights. However, if new production or conservation suddenly began to overwhelm demand growth, producing a short-term surplus, that signal would be amplified just as effectively, unraveling speculation at a record pace. The "delta hedging" mechanism described above works in reverse, too.

That doesn't mean that alternative energy firms should be overly concerned that oil prices will drop below $60 per barrel and remain there indefinitely. While oil above $100 per barrel has failed to crush global demand, at least so far, oil below $60 would surely stimulate it. The long-term fundamentals remain strong, as oil heads for an effective ultimate limit on global output--whether that limit is 85 million barrels per day, 100 MBD, or even 120 MBD. It does, however, suggest the need for financial flexibility: balance sheets healthy enough to withstand a few quarters of low or negative margins and weak sales. More importantly the possibility of a temporary oil-price dip should not blind the management of these firms to a much larger emerging threat, the prospect that a perceived global food crisis will unravel support for the government subsidies and mandates that have been the principal engines of the industry's growth for the last two decades.

Friday, May 09, 2008

The SPR Debate

The ongoing oil price spike is attracting renewed attention to the government's policy of continuing to fill the Strategic Petroleum Reserve with extremely pricey oil, which I mentioned in Wednesday's posting. Members of Congress and various commentators are calling for a reassessment, as I've done since last October. We're also seeing suggestions such as the one in today's Wall Street Journal for ways to use the SPR not just as a hedge against catastrophic supply disruptions, but as a tool for managing oil prices. A new administration will take office in eight months, and energy is likely to be a key focus of its new policies. I can't imagine a better way to kick off a fresh look at the nation's energy problems than with a complete rethinking of the basis and design of our strategic oil inventories.

The op-ed in today's Journal applies a combination of common sense and questionable judgment to the problem. The author, the chief economist at a firm that supports independent financial planners, is right to point out that $120 oil is too dear to squirrel away against the low likelihood of a massive disruption in oil supplies, the likes of which we haven't seen since the SPR was created in the 1970s. Unfortunately, the rest of his proposal for reducing the scale of the SPR and using it to set a price ceiling for oil relies too much on economic theory and too little on the geopolitical and logistical realities of the situation in which we find ourselves. More importantly, it does not start with a fundamental reexamination of the challenges the SPR was intended to address, and how those have altered in the last three decades.

Consider that when the first barrel of oil went into the SPR's Gulf Coast storage caverns in 1977, the US was relatively self-sufficient in petroleum refining capacity. Crude oil imports accounted for only 45% of the supply to those refineries, compared to 66% last year. At the time, the West Coast was essentially autonomous in crude oil and refined products, with its refineries amply supplied by California's production, which would shortly peak at over one million barrels per day, along with the growing output from Alaska. Much has changed. In addition to importing much larger volumes of crude oil, our refinery capacity hasn't kept pace with demand, resulting in steadily growing imports of gasoline and gasoline blending components. And in the interim, oil production in Alaska and California has fallen into deep decline, requiring substantial crude and product imports into a maxed-out West Coast refining system.

So instead of a strategic reserve designed to provide a back-up supply of crude oil to Gulf Coast and Mid-continent refineries serving the entire US east of the Rockies, our needs have expanded to encompass oil and refined product imports on all three coasts. And with more of our domestic production shifting to the deep waters of the Outer Continental Shelf, the risks against which an SPR must insure us also include potential domestic supply disruptions. We saw that after hurricanes Katrina and Rita shut down much of our Gulf Coast production, and again when pipeline problems in 2006 idled half of the Alaskan North Slope field. These altered circumstances strongly suggest the need for a more diverse and dispersed SPR, perhaps modeled along the lines of the federal Northeast Heating Oil Reserve. Nor do I believe that the only practical model of such a reserve entails government ownership and custody of the hydrocarbons in question. Other countries achieve the same end with a requirement for oil companies to maintain mandatory minimum inventory levels, at no direct cost to taxpayers.

Unfortunately, the risks we face have also evolved in the last thirty years, and that must be factored into our understanding of the necessity and nature of an effective SPR. No one expects his house to burn down in a given year, but most of us still buy fire insurance, because the consequences of that low-probability event would be so disastrous. An SPR works the same way. While Mr. Anderson looks to the pattern of past SPR releases to suggest that as little as 120 million barrels of oil might be adequate to cover any likely contingency, it is all too easy to imagine low-probability/high-impact scenarios that would require the SPR to cover a sudden shortfall exceeding two million barrels per day for longer than a month or two, at a time when global spare production capacity has shrunk to virtually nothing, or sits on the wrong side of a bottleneck. Full-scale civil war in Iraq, conflict with Iran, revolution in Venezuela or Nigeria, or a terrorist attack on the oil export facilities at Ras Tanura would do the trick.

It is high time to re-think the Strategic Petroleum Reserve, more than three decades after it was conceived. Global patterns of oil supply and demand have changed enormously, and so have the patterns of oil use within the US. The nature of the risks that an SPR should insure against have changed, too. We need a vigorous debate on all this, infused with new ideas and new options made possible by technology that didn't even exist in the 1970s. But we also need to be clear about the scope of such a debate, which should not include managing day-to-day oil prices, adding layers of complexity to the problem and a host of unintended consequences into the global energy market. So by all means, let's stop filling it, until we figure out the kind of SPR we really need. In the meantime, we must resist the temptation to expend these reserves on rash schemes to control the price of a commodity of which we only produce 10% of the world's supply.

Wednesday, May 07, 2008

Practical Remedies

The price of oil has set consecutive record highs this week, with no end in sight. This energy crisis that has crept up on us over the last four years, doubling the historical average price of oil, doubling it again, and in the widely-reported view of Goldman Sachs heading for a third doubling, is now provoking a sense of panic. You can see this in the flurry of proposals for providing short-term relief from retail gasoline prices that have increased by nearly 60% in the last 18 months. But while most of these ideas would likely be either ineffective or counter-productive, there are a few options that could make a difference this year, without having to wait for infrastructure to be built, fleets to turn over, or new production to come on line.

In order to see what might work, we need to start with a clear understanding of what has driven prices well beyond most experts' expectations, including mine. Rising prices have failed to halt the steady growth of global demand, because many of the countries in which demand is increasing fastest insulate their consumers from the global energy market. Nor has $100+ oil stimulated a flood of new production, because too much of the world's resource base is locked up by nationalist or environmentally-inspired barriers. To make matters much worse, important suppliers such as Nigeria are under-producing due to unrest, while Mexico and Russia are allowing their output to slip because of domestic politics. Instead of giving in to our frustration at these seemingly intractable problems, we can still have a positive impact on them, if we focus our efforts intelligently.

The controversy over food vs. fuel is an example of how tangled this mess has become. Governors and Senators worried about food prices have asked for relief from the aggressive Renewable Fuel Standard put in place by last year's Energy Bill. As sensible as that may seem for addressing consumer-level inflation and an unfolding global food crisis, it could push oil even higher. The market expects a couple of billion gallons of additional ethanol this year, the equivalent of about 100,000 barrels per day of oil. Curtailing that would hardly help high oil prices. So what could we do?

Start with ethanol. For all its many faults, it is an effective oil extender, because most of the energy that goes into making it comes from natural gas, not oil. The most immediately helpful action Congress could take on this front is not a reduction in the ethanol mandate, but a temporary suspension of the $0.54 per gallon ethanol import tariff. That might even address both fuel and food costs, by allowing in more Brazilian ethanol and shutting down the least efficient US ethanol plants. As I've noted previously, dropping the tariff would effectively mean subsidizing foreign ethanol producers, because of the way our ethanol blenders' credit is doled out, but this would cost only a fraction of the lost revenue associated with a summer fuel tax holiday. The volumes involved are small, in oil terms, but with oil prices determined at the margin, every little bit helps.

There might also be more practical and productive uses of America's international influence than prosecuting OPEC for anti-competitive behavior. Instead of pleading with or pressuring Gulf oil producers to increase output, we might talk to them about ending retail subsidies and letting their domestic fuel prices rise to market levels. That would slow down some of the fastest demand growth rates in the world, which are starting to erode oil exports from the Middle East. And if we treated the problems in the Niger Delta with the same urgency we apply to other geopolitical crises, we might be able to mediate a solution that would bring most of the half-million barrels of Nigerian production shut in by rebel action back online. Recent signals from the rebels have suggested that possibility. That would have a salutary effect on the oil market, which has a terminal case of the jitters these days.

Then there's the Strategic Petroleum Reserve. With oil at $120/bbl., it has become an absolute "no-brainer" to stop filling it. Even better, this is one of the few measures that could be accomplished virtually overnight, and it is entirely within the President's power to do so. The switch by the government from buyer to seller--putting the barrels acquired under its most recent royalty-swap contracts back into the market--might not knock $10/bbl. off the oil price, but in combination with a requirement to suspend SPR additions until oil is back under $100/barrel--or better yet, $80--it could help cool off speculation.

Assuming these remedies would actually have the desired effect, we still face an important dilemma with regard to energy prices. As important as fuel price relief seems in an economy already battered by the housing slump and accompanying credit crisis, our goal can't be reducing gasoline and diesel fuel prices to a level that stimulates demand that can't be met without lighting a new fire under crude oil. Furthermore, with a new administration likely to institute climate change policies that will increase energy prices, either directly or indirectly, the chief objection to high oil prices within policy circles is not that they are too high, but that the revenue is going to the wrong people: producing countries and oil companies, rather than the US Treasury. Consumers see this matter quite differently, and until we resolve that divergence of aims, our actions are likely to be as disjointed as our politics on this matter are schizophrenic.

Tuesday, May 06, 2008

False Dichotomy

The fate of the renewable electricity production tax credit (PTC), which provides incentives for power generated from wind, solar, and other alternative energy sources, is apparently still in doubt. Last month the US Senate approved a one-year extension of the credit as an amendment to a housing bill, but the House of Representatives is balking at the provision's cost. Previous efforts to extend the credit and pay for it by revoking tax benefits for the oil industry failed. With oil companies earning record profits, the temptation to tax them to pay for alternative energy seems overwhelming, but it reflects a profound misunderstanding of the nature of our energy problems and the relative scale of the available solutions. We need more wind power and more oil, not one at the expense of the other.

To understand why taxing the oil industry to subsidize wind and solar power won't advance US energy security--never mind energy independence--consider the contribution of additional wind power to the US energy balance. In 2007 the US wind industry had a banner year, adding 5,244 MW of new wind capacity, expanding the installed wind power base by 45%. This represents an important increment of renewable energy that will help reduce our future greenhouse gas emissions. At an average capacity factor of 30%, the new wind turbines added last year will generate approximately 14 billion kilowatt-hours each year they are in operation. That's a substantial amount of electricity, though it represents only 0.3% of the 4 trillion kWh of electrical energy the US consumed in 2006. More relevant to the wind vs. oil competition created by Congress, however, the equivalent BTUs saved by that extra wind power (assuming it displaces gas-fired power generation) equate to only 63,000 barrels per day of oil--the output of a single medium-sized oil platform. If imposing higher taxes on US oil producers resulted in only one oil project being deferred or canceled, then the energy contribution of an entire year's worth of wind capacity additions would be negated.

When we prioritize our current energy challenges, the most urgent among them is the large volumes of high-priced oil we must import, in competition with the developing economies of Asia and the Middle East. This expands our trade deficit, drives inflation, and puts further pressure on the dollar, in a vicious cycle. We have many options for generating electricity, but few for producing transportation fuels, particularly with ethanol facing serious concerns about its competition with food--and emerging worries about its water consumption. Until we have large numbers of plug-in hybrid cars or other electric vehicles, electricity is not a substitute for oil in transportation. Nor is renewable energy our only option for reducing greenhouse gas emissions.

I'm not arguing that we should allow the PTC to expire. That would be a bad outcome for many reasons, not the least being the number of US jobs potentially at stake in a weakening economy. Instead, I am convinced that we need both a thriving renewable energy industry and a thriving domestic oil industry. Pitting one against the other is a terrible idea, if we really care about energy security and reducing the economic and geopolitical consequences of US oil imports. It creates a false dichotomy that owes everything to politics and nothing to a cold assessment of the facts. If the Congress cannot find $6 billion of earmarks that could be cut to fund the PTC for another year, without putting future US oil production at risk, then our problems are even bigger than they appear.

Monday, May 05, 2008

Going It Alone

The quest for US energy independence might just be the biggest and most persistent bad idea in the last several decades of energy policy. I've been railing about this subject since I started this blog more than four years ago, and I have acquired a deep understanding of what it means to swim against a strong tide. A few years ago, pointing out the impracticality of energy independence was treated as a mild eccentricity; since then it has become a form of political incorrectness verging on heresy. I'm glad to have some company in this effort, from the author of a comprehensive examination of the subject, "Gusher of Lies," by Robert Bryce. It provides a useful counterpoint to a seemingly endless stream of books and articles extolling the virtues and relative ease of shaking off our oil habit and thumbing our noses at the global energy market. But while I agree wholeheartedly with the main thrust of Mr. Bryce's book, I feel obliged to mention a few quibbles.

The subtitle of "Gusher of Lies" provides a good sense of the author's perspective on America's energy problems. "The Dangerous Delusions of 'Energy Independence'" sets it at odds with many of the statements about energy that we've heard from candidates in the current election cycle. Among the strongest chapters in the book are those placing our desire for energy independence in the context of the long energy history of this country, and explaining why many common assumptions about the mechanisms for attaining independence--and its ultimate outcome--are either mistaken or unwarranted. That's particularly true concerning the Middle East, which would continue to hold most of the world's oil endowment--and thus remain of paramount strategic importance to the global energy economy--regardless of the level of US energy imports.

As I've pointed out here periodically, energy independence is unattainable for the US at an acceptable price through any strategy, technology, or combination of them currently available to us, nor is it especially desirable in a world that is increasingly interdependent for basic commodities, manufactured goods, financing, and to a growing degree, for services and intellectual capital. Mr. Bryce shares this perspective, and he demonstrates it in many pages of facts and figures, scrupulously referenced in 50 pages of footnotes. Among the many sacred cows he takes on, he scorns corn ethanol and expresses skepticism about the chances of large-scale reliance on cellulosic biofuels. Nor is he enamored of coal-to-liquids or wind power, which he regards as "the electricity sector's equivalent of ethanol." Whether you accept his arguments or not, they provide a useful opportunity to ponder the likelihood that a transition away from oil-based transportation fuels and their valuable byproducts will be arduous, protracted and expensive, while failing to deliver the utopia that many expect.

"Gusher of Lies" does a good job explaining why the vast scale of our energy consumption and the trends of history, economics and geology work against the prospect of reducing by very much our reliance on other countries for primary energy. Unfortunately, the author's apparent neutrality on the subject of climate change creates a bias for the status quo that leads him to underestimate the incentives for greatly expanding our use of renewable energy forms such as wind power. And while he describes in some detail the geopolitical shifts that are marginalizing the formerly-dominant publicly-traded oil & gas companies, I didn't sense much concern about the way that bilateral arrangements between national oil companies of producing and consuming countries are undermining the vitality of the global free market for energy on which he urges us to rely for our energy security. As a result, he misses an obvious role for productive involvement by the federal government in bolstering the efforts of publicly-traded companies to gain access to global resources locked up behind nationalistic barriers.

Two other quibbles:
  • Although the principal messages of "Gusher of Lies" aren't tied to any particular political ideology, Mr. Bryce's digressions on the evils of neo-conservatism and the errors of certain well-known media pundits became tiresome and distracting, undermining his main focus.

  • The last section offering potential solutions to our energy challenges that avoid the independence trap seemed a little light. That's a shame, because several of his suggestions, such as simplifying the current nightmare of conflicting gasoline formulations and creating a "superbattery prize" look beneficial and relatively uncontroversial, and could be accomplished with the stroke of a pen.
Don't let these minor shortcomings deter you from reading "Gusher of Lies." The higher oil prices go--and oil company profits with them--the greater the temptation to seek miracle cures for our energy problems. Mr. Bryce reminds us that as important as energy is, it does not stand apart from a national economy that is deeply connected to the rest of the world, any more than it can be divorced from the laws of thermodynamics. Nor should his informed skepticism be mistaken for cynicism or a sense of futility. His realistic portrayal of our energy situation is timely and important, dismissing widespread notions of quick-and-easy solutions and making a strong case that the current yearning for energy self-sufficiency, while understandable, is both unattainable and inconsistent with the basis of much of our post-World War II success. You can read the first chapter here.

Friday, May 02, 2008

What Europe Pays

With American consumers reeling from gas prices that have gone up by fifty cents per gallon since the beginning of the year, it occurred to me to wonder what Europeans are now paying. Although the decline of the dollar has amplified the impact of recent increases in oil prices, Europe hasn't been immune, either. Crude oil expressed in Euros or Sterling is roughly 75% and 110% higher, respectively, than it was in January 2007, and this has boosted the price of fuels that were already much more expensive than those sold here. While searching for European fuel price data, I was surprised to discover proposals for gas tax cuts similar to those being debated here. Consumer displeasure with petroleum product prices is increasing the pressure on governments on both sides of the Atlantic to respond.

Having lived in both Germany and the UK, I chose them as my basis of comparison--one inside the Euro zone, the other outside. As of today, Normalbenzin (regular gasoline) averages €1.457/liter, or €5.51/US gallon. So whether you assess the dollar/euro exchange at its market rate of $1.55 to the Euro--which gets you to $8.55/gal.--or adjust it based on purchasing-power parity, or even the Economist's Big Mac Index, which was close to 1:1 last summer, gasoline in Germany is a darned sight more expensive than it is here, thanks to Europe's stout taxation of motor fuels. And while diesel is taxed at a lower rate, to promote the use of diesel automobiles as a means of reducing oil consumption and greenhouse gas emissions, €5.26/gal. ($8.15/gal.) is hardly a bargain. Petrol is not much cheaper in the UK, either. At a current average of 110 pence per liter, or £4.18/US gallon ($8.25/gal.), even filling up your Mini would set you back $80.

Of course, it's not only the absolute fuel price that counts, but the magnitude and rate of its recent change. A big part of our problem is that most Americans are still driving cars that were purchased when gasoline was under $1.50/gal., to commute between work and home locations that were chosen when fuel was even cheaper. As of this week, nominal US retail gasoline prices have gone up by 25% in the last year and by 130% in the last five years. How does that compare to other countries? Well, motorists in the UK are experiencing prices that are now 25% higher than the average of last year, and 42% higher than five years ago, but gas hasn't been cheap in Europe for more than a generation. Buffered by the strong Euro, gasoline in Germany has increased by a smaller percentage, 19% vs. the 2007 average and 29% over five years.

Although proportional fuel-price increases have thus been smaller in Europe than here, the high absolute price level is still causing serious discomfort and prompting calls for governments to act, particularly by reducing fuel taxes. Consider that while it accounts for more than 70% of the US retail gasoline price, crude oil makes up less than a third of the gas price in Germany. Because most of the difference is attributable to taxes, the scope for reducing the retail price via tax relief is enormously greater than here. A member of the German coalition government has suggested instituting a cap on gasoline, diesel and heating oil prices, adjusting the tax rate periodically to hold prices steady. Other proposals include rolling back the 3% increase in the value-added tax that kicked in on 1/1/07, which at current prices is worth as much as the entire US federal fuel excise tax that Senators McCain and Clinton wish to suspend this summer. The arguments against lower German gas taxes are similar to those economists have raised here: fuel supplies will tighten even further, and government revenues will fall.

It's small comfort, but high gasoline prices are a global phenomenon, unless you live in a major oil exporting country, such as Kuwait or Venezuela. Consumers in Europe are no happier about this than we are. But instead of waiting for our governments to decide whether higher fuel prices or lower tax receipts are more harmful to the economy, we could follow the advice on fuel conservation from the Alliance to Save Energy. As reported in yesterday's Wall St. Journal, a combination of six strategies could save the average household up to $600 per year, or at least 20 times the expected benefit from a summer gas tax holiday. And instead of protesting in Washington, truckers might achieve more by posting "Slow Down" signs on our highways. Even the airlines are reducing aircraft speeds to save fuel.

Thursday, May 01, 2008

Warming or Cooling?

As if the politics of addressing global climate change weren't already daunting enough, a new paper published in Nature this week suggests that the Northern Hemisphere, where most of humanity lives, could be due for a cooling trend, thanks to shifting ocean currents. Coming at a time when the idea of global cooling has been making the rounds on the internet, the prospect of a break in the observable warming trend greatly complicates the task of policy makers who are answerable to their electorates. It would be much harder to contemplate jarring changes to the economy to reduce greenhouse gas emissions, if the polar ice were to stop retreating and glaciers stabilized, or even began to grow again.

The new prediction is based on modeling work described in today's New York Times. It also prompts comparisons to predictions that global warming might trigger even more dramatic cooling, by altering the strength and path of the Atlantic thermohaline current, or "salt conveyor". Once again, we are reminded that global warming has always been a highly imprecise term for the complex processes now at work. That's why I prefer "climate change"--not as a euphemism, but as a more accurate description of the outcomes we face. Some even prefer "global weirding."

But while environmentalists may embrace this new scientific view of climate change as more volatile than the steady warming many have expected, climate skeptics will see it as a glaring inconsistency, particularly if the global rise in temperature stalls. That matters because it seems unlikely that the public's growing worries about climate change result from having absorbed the scientific consensus embodied in the reports of the Intergovernmental Panel on Climate Change (IPCC), rather than from media coverage of melting icecaps, shrinking glaciers, unusual heat waves and droughts, and the other evidence that fits a pattern of warming. If the visible evidence began seriously to diverge from that trend, I am skeptical that faith in science would sustain the public concern that must underpin any serious regulatory efforts, whether we're talking about emissions cap and trade, a carbon tax, or even the milder sector-specific targets that the President recently proposed.

Those who approach climate change with a quasi-religious fervor are likely to become apoplectic at any suggestion that a few cooler months or years might derail the growing policy momentum to institute the means of dramatically reducing emissions. But while they might be comfortable dismissing out of hand a winter that was 0.5 degrees Celsius colder than the previous one--punctuated by a sharp rebound in March--the rest of us might prefer a polite and practical conversation about how such variability could still be consistent with the overall trendline. Ultimately, our understanding of climate change must always remain incomplete, and so we must remain flexible enough to incorporate the new knowledge we will inevitably turn up along the way. Isn't that the essence of science?