Thursday, May 28, 2009

Sequester Oil Instead of CO2?

I've been following developments in carbon capture and sequestration (CCS) for more than a decade, so I was intrigued to run across a novel suggestion for an entirely different approach, involving the "sequestration" of undeveloped oil instead of the CO2 emitted by power plants and other industrial facilities. Even allowing for the likelihood that this trial balloon by Ecuador is either intended to enhance its government's leverage in negotiations with potential oil developers, or constitutes an outright scam--the resources in question apparently lie beneath a designated national park--the idea of selling emissions offsets based on the carbon content of forgone oil output is just plausible enough to merit a bit of analysis.

The basic idea seems clever. If it's so hard to capture the CO2 from burning fossil fuels and prevent it from accumulating in the atmosphere, why not leave the carbon in the ground and take credit for that by selling emissions offsets? The benefit of such a transaction, in both environmental and economic terms, would hinge on two key parameters: the carbon content of the specific grade of oil involved and the extent of the reservoir holding it. In other words, how many barrels would be spared, and how many tons of CO2 would be avoided for each barrel? Neither figure could be determined with certainty without some actual drilling, but non-invasive seismic techniques might supply an estimate of the approximate size of the potential reserves involved, while the quality might be guessed by analogy to actual producing fields elsewhere in the country. With these estimates in hand, we could arrive at an approximate value for the avoided emissions.

Lacking detailed information on these Ecuadoran oil reserves, I'm going to punt on quantity and focus on quality and its implications for the unit price of the resulting emissions offsets. If there's enough oil there to be of commercial interest, then that ought to be a sufficient starting point to assess the merits of leaving it in the ground as a means of combating climate change. As a first approximation on quality, let's assume the oil is similar to the Oriente crude that makes up most of Ecuador's output. Oriente is a medium-sulfur, medium-gravity crude similar to the oil produced on the Alaskan North Slope and run in many US West Coast refineries. Its API gravity is listed at 29.2, corresponding to a density of approximately 308 lb. per barrel. Applying a little basic chemistry suggests that each bbl burned would emit roughly 1004 lb. of CO2, so if we knew what the oil was worth, we could easily derive a cost per ton of CO2.

Because the oil in question is still under the ground, its price can't be looked up on an exchange. However, companies are bought and sold on the basis of reserves that have yet to be produced. A recent report from IHS Herold and Harrison Lovegrove & Co., Ltd. indicated that the average value of such M&A transactions in 2008 implied a value of $11.51/bbl for proved reserves and $5.25 for "proved plus probable." The latter figure seems more relevant to the current situation, since the reserves in question couldn't be fully proved without precisely the kind of development work this idea is designed to avoid. Applying the lower "2P" figure to the CO2 calculation above results in an equivalent value of about $11 per metric ton of CO2 offset. That's roughly the same as the estimate for the proceeds from cap & trade implicit in the federal budget the Obama administration submitted to Congress and lower than the price at which offsets are trading on the European Climate Exchange.

The basic flaw in this analysis stems from the large difference between what a company might pay for the rights to oil still in the ground, compared to its ultimate value to both the resource owner and society once produced. Fundamentally, that value is much higher than the externality cost of the greenhouse gases that would be emitted along the way. If that weren't true, Europeans wouldn't pay the equivalent of $293/bbl to fuel their cars. Even if the oil in question were only worth today's long-dated futures price of around $75/bbl less production costs and a discount for quality versus West Texas Intermediate, the price of emissions offsets would have to approach at least $100/ton CO2 before the Ecuadoran government would be truly indifferent to leaving it undeveloped. At $100/ton, many other emissions reduction strategies would look more attractive, including the brute-force, industrial capture and sequestration of CO2 from smokestacks. However high the parasitic energy cost of such CCS, it would still allow most* of the energy content of fossil fuels to be applied to providing the global economy with electricity or transportation fuels, until other sources can expand enough to replace them.

The Washington Post article on this story concludes with a quote from a program director at the Nature Conservancy who characterized the idea as "probably ahead of its time." I'd go the next step and suggest that its inherent contradictions render it generally impractical. There are many reasons to forgo the development of some oil, and if Ecuador's Yasuni National Park is truly the marvel of biodiversity and unspoiled wilderness described, then leaving its oil untouched shouldn't require financial inducements extrapolated from guesses about the resources under its surface. At the same time, it's hard to see a country contemplating development of a less sensitively situated hydrocarbon resource being able to raise enough money from the sale of emissions offsets to make up for the opportunity cost of forgone profits, royalties and taxes from a production-sharing contract, not to mention the employment and other benefits to the national economy. Schemes like this shouldn't distract us from the urgent and important work of figuring out how to make true carbon capture and sequestration practical and cost-effective.

*(A good friend pointed out that my use of "most" here could be miscontrued to imply 90% or more. In fact, current estimates indicate that CCS would consume 1/4-1/3 of the energy output of a fossil-fuel fired power plant. That's consistent with the thermodynamics of combustion and CO2.)

Tuesday, May 26, 2009

The Green Lawnmower

I have a new, unexpected hobby: mowing the lawn. For our first few years here in Virginia we opted to have a lawn service cut our grass, so my wife and I could focus on other things, including establishing our respective businesses in a new location. When the economy and stock market tanked, this became an obvious source of savings in our monthly budget, complicated by my determination not to buy a gasoline-powered lawn mower. Since our yard is a little too big for either a corded electric mower or a manual push mower to be practical, I focused on finding a suitable rechargeable mower. My experience so far has left me with decidedly mixed feelings about this relatively new technology. Some of these issues look applicable to plug-in electric cars, as well.

It might seem odd that someone with my industry background would shy away from a gas-powered mower. Among other reasons, small engines produce a disproportionate share of local air pollution, even after the implementation a few years ago of the EPA's Phase I rules for small spark-ignition engines. (Phase II and III are coming along in a few years.) I also gained a healthy respect for this fuel and its properties during my stint in Texaco's Los Angeles refinery (now owned by Tesoro) at the beginning of my career. I am a firm believer that the safest place to store gasoline at home is in your car's fuel tank, particularly in a warm climate. Second-best would be in a lockable shed a safe distance from the house. Lacking one of those and concerned mainly about my young and inquisitive child, I concluded that if I couldn't find a satisfactory rechargeable mower I would grit my teeth and continue to pay the lawn service. Happily, it turned out that several manufacturers now offer rechargeable mowers that aren't just toys.

After reading many reviews I chose the Solaris S21HB, made in Canada by Linamar Consumer Products. It is a beast, weighing about 110 lb. with batteries. Several family members remarked that pushing it around our yard would provide a nice alternative to one of my weekly gym workouts. I suspected that would be true even before I acquired my current familiarity with the actual grade of much of our lot. The main reason this machine is so heavy is directly relevant to a periodic topic on this blog: our old friend energy density. The Solaris's two 24V lead-acid batteries contribute about 30 lb. (The only Lithium-ion battery mower I could find, made by Bosch, is not yet sold in the US.) Their combined 40 Amp-hours of storage equate to the energy content of less than 4 ounces of gasoline. Even if it uses its stored energy 3-4 times more efficiently than a gasoline engine, the mower's range is still substantially less than from the typical 1-quart fuel capacity of a gas mower. As a result, I must adapt my lawn mowing to the limitations of my new, green device. Since I can't cut all the grass in one session, I have to split it into two tasks at least 8 hours apart, to allow enough time to recharge the batteries. My alternative is to invest $100 in a second set of batteries, which are currently out of stock.

As much as I enjoy the relatively quiet and odor-free operation of the battery mower, I sometimes find myself envying my neighbor's gas mower and wondering if I made the right choice. While mowing the lawn recently it occurred to me that this situation appears similar to that of owning a plug-in electric car without an onboard backup engine. Battery technology is still not up to providing a driving range comparable to a car powered by liquid fuels at an acceptable cost or weight premium. Buyers of such cars face a choice between adapting their lifestyles to match these limitations or relying on future services such as the on-the-fly battery swapping model envisioned by Better Place. As a consumer, I doubt I'm up for either one. Barring the overnight commercialization of the latest fast-charging battery technology--which would still require truly enormous currents and voltages to deliver as much effective energy in a comparable interval as filling 10 gallons of gasoline--I'll lay odds that my next car will be either a diesel or a conventional hybrid. At this point, like it or not, petroleum remains the best energy carrier we have.

Wednesday, May 20, 2009

CAFE Convergence

I would be badly remiss if I didn't comment on yesterday's announcement by President Obama of a comprehensive framework for vehicle fuel economy and greenhouse gas emissions. While I'm not sure I'd go quite as far as one Congressman, who compared it to solving the "energy and economic policy equivalent of a Rubik's Cube", this represents an important step for reducing our oil imports and improving our energy security. At the same time, the corporate average fuel economy standard (CAFE) remains more of a goal and tracking system than a mandate with sharp teeth. By itself, a stricter CAFE won't force Americans to buy different cars, though it will doubtless alter the slate of choices available to them. It's also a little less clear that this measure is quite such a big win on climate policy, as I'll explain, though it does neatly finesse California's emissions-based request for a precedent-setting waiver to effectively set its own CAFE standard. Car companies may not be delighted to have to deliver an average of 35.5 miles per gallon by 2016, but they must be relieved to face one consistent set of rules in all 50 US states.

The most important question to ask about a change of this magnitude is whether it can be accomplished in the required timeframe. In this case, the answer appears straightforward: 35.5 mpg and the accompanying emissions standard of 250 grams of CO2 per mile in 2016 are very close to the 160 g/km average that the European car industry meets today. Of course, it does so with a very different mix of cars from that sold here, with very few trucks and large SUVs. Our new 39 mpg passenger car target equates to around 142 g/km--equal to the current performance of the most efficient European brands, Fiat and Peugeot/Citroen. Europe is also helped greatly by the fact that half the cars sold there are diesels, which get around 1/3 better fuel economy than conventional gasoline cars. As keen as I am on them, I have a hard time imagining that half our new cars will be diesels in seven years--or hybrids, for that matter, considering that hybrids made up less than 3% of our mix last year. Many other technologies can help boost fuel economy, including gasoline direct injection, more energy-efficient transmissions, and more extensive use of turbocharging, a strategy that was widely employed here the first time the CAFE standards started to bite, in the 1980s. All of this costs money, and the US car industry, which stood shoulder-to-shoulder with the President yesterday, estimated an extra $600 per car from this rule, on top of $700 per car from changes already in the works. It's those costs that lead to a more objective assessment of yesterday's announcement.

To gauge the change in CAFE standards as energy or environmental policy, we must know our starting point, the status quo ante. According to the NHTSA CAFE database, the 2008 model year US new car fleet averaged 27 mpg. Compared to that, the average car would save around 890 gallons of gas under the new 2016 standard over 100,000 miles of use. At $1300 per car that works out to $1.46 per avoided gallon on an undiscounted basis. That looks pretty good from a consumer perspective. When expressed in barrels, at $61 it is less of a bargain but still compares favorably with the $79/bbl at which oil futures for 2016 were trading yesterday, though I hasten to remind my readers that futures prices shouldn't be construed as a forecast. After factoring in the likelihood that many cars will last longer than 100,000 miles, the cost trade-off looks even better.

Unfortunately, the news isn't quite as good in emissions terms, because of the thermodynamics of engines and CO2, for which there is most definitely no free lunch. Each gallon of gasoline saved spares just under 20 lb. of CO2 emissions at the tailpipe. That means that our $1300 per vehicle premium versus the status quo is effectively purchasing 8.9 tons of CO2 reductions. That works out to $146/ton, or about ten times the price of emissions permits that the administration and Congress have told us to expect in the same timeframe. Even if you only count the $600 estimated to be directly attributable to yesterday's announcement, the resulting $67/ton of CO2 still makes this a pretty expensive way to reduce emissions.

There's an asterisk on this assessment, however, related to enforcement. I haven't seen any details of what is being proposed in that department, but unless the system of fines in the current CAFE standard is overhauled, too, the cost of missing the target would remain pretty small. When I looked at this last year, it worked out to around $55 per car for each mpg over the annual goal. That adds up when spread out over hundreds of thousands or millions of vehicles, but it could still be lost in the rounding for an industry that even in this depressed year will sell on the order of $250 billion worth of product.

All in all, I regard the new CAFE standard as a positive development, although it doesn't stand on its own. The specifics of how it will be enforced will ultimately determine its success in altering the car-buying habits of Americans. At the same time, it's worth noting that future increments of fuel economy beyond 35.5 mpg will cost much more and save many fewer actual gallons, because of diminishing returns. The same European car industry that has demonstrated that our new standard can be met has estimated that the cost of going from their present level of 160 g/km to the EU's 120 g/km standard--equivalent to 46 mpg--would likely increase vehicle sticker prices by approximately $4,900 per car. When translated into dollars per barrel of oil saved or per ton of CO2 avoided, that looks prohibitively high. The implication is that yesterday's move on CAFE should be our last tweak to fuel economy standards until technology has changed dramatically.

Monday, May 18, 2009

How Many Miracles?

Over the weekend I was catching up on articles, and one from Technology Review last week caught my attention. It was a brief interview with the new Secretary of Energy, Dr. Chu, covering nuclear power and fuel cells. In the back half, Secretary Chu explained why the DOE has cut funding for fuel cell R&D, suggesting that fuel cell cars were always a long shot, because they required "four miracles" to happen. Although I haven't mentioned fuel cells very frequently here in the last few years, I must say it's hard for me to consider the commercialization of something that I've already driven as requiring quite so many miracles as that. At the same time, I don't trivialize the obstacles that explain why fuel cell cars are still not available in large numbers, despite previous expectations--including my own--that they would be by now.

Dr. Chu helpfully breaks down the challenges facing fuel cells into four categories. Start with his concern about the principal source of hydrogen (H2) today, via extraction from natural gas. This route certainly undermines the "zero emissions" claim often attached to fuel cells. In practice, that means zero tailpipe emissions, but hardly zero emissions overall. Still, it's worth considering what else we could do with the natural gas in question. We could compress it and burn it in a modified internal combustion engine (ICE). T. Boone Pickens is quite fond of that idea, and it's not as foolish as some suggest, since it can displace a lot of petroleum and reduce emissions by 15-20% compared to a conventional car, on a well-to-wheels lifecycle basis. We could also use the Fischer-Tropsch process to convert natural gas to top-quality synthetic diesel at a somewhat smaller emissions savings, because the higher efficiency of a diesel engine is largely offset by the energy lost in fuel synthesis. Or we could produce H2, which as Dr. Chu notes involves throwing away about a third of the original energy in the gas by the time we've compressed the resulting H2. Yet the latter is the only one of these pathways that, despite the high energy price paid in producing H2, affords the opportunity to cut our overall lifecycle vehicle emissions in half, because producing electricity in a fuel cell is inherently so much more efficient than burning a fuel in an internal combustion engine. It's not perfect, but it's far from awful--unless you put the H2 into an ICE--and no miracles at all are required to make the H2.

Miracle number two involves H2 storage, and this looks a bit tougher. I am not keen on carrying around compressed gases at 5,000 or 10,000 psi in the same vehicle with my family, and that is no irrational fear. In my refinery days I saw examples of how much mechanical energy even 2,000 psi held, and I will never trust a Kevlar-wrapped tank enough to be fully comfortable with this option. Moreover, I don't think Dr. Chu is entirely correct that "compressed hydrogen is the best mechanism." ECD, a company that my former employer once invested in, has a technology for storing H2 via chemical absorption in metal hydrides, and you can buy canisters that use their technology today. The advantage of this system is that it doesn't involve high pressure. The disadvantage is that these hydrides are heavy, a drawback shared by the nickel-metal-hydride batteries (same basic technology) used in the Toyota Prius and other non-plug-in hybrids. None of these systems yet stores energy at the equivalent density (and thus driving range) of gasoline, but then neither do Lithium-ion batteries.

The third challenge concerns distribution, and this is a doozy. Transporting H2 in tube-trailers is fine for servicing demonstration refueling stations, but can't be scaled up to handle millions of cars. That may not be necessary, because the "reformers" that extract H2 from natural gas can be built on a scale that fits into a service station dispenser, drawing feedstock from local gas lines and delivering fuel without any need to transport it as H2, other than in the car. Installing such devices in thousands of locations would be a massive undertaking, but frankly the same can be said for the goal of installing E85 pumps at 10% of service stations, compared to about 2000 today. To me, cost-effective H2 distribution is a matter of engineering and economics, not scientific breakthroughs.

That leaves us with the one item on Dr. Chu's list that might qualify as requiring a genuine miracle: bringing the cost of a fuel cell stack down to a level comparable to an internal combustion engine, or at least to a point not so much more expensive as to render a fuel cell car inherently unaffordable. Fuel cells still cost over $1,000/kW--implying that just the fuel cell stack for a real car would cost more than an entire luxury car today. Forecasts that this would fall to anywhere near the roughly $35/kW of today's car engines remain theoretical, relying mostly on learning-curve effects analogized from other industries. Given the current state of the car industry, manufacturers will struggle enough just absorbing the initial high cost of low-volume plug-in hybrid car production, without taking on tens of thousands of dollars in losses per car for vehicles like the Honda FCX Clarity. Absent a breakthrough, an investment like that might truly require a miracle.

Whether making fuel cell cars a practical reality requires four miracles or only one, I have to agree with Dr. Chu's conclusion that their commercialization looks neither imminent nor assured. It's important to recall that hydrogen is merely another energy carrier, like electricity, rather than an energy source like petroleum or biofuels. The smart money today is on battery-electric cars, including plug-in hybrids. In order to beat them an automotive fuel cell stack must cost less than the battery pack required to give drivers the 250-300 mile range they seem to want, because in every other respect that matters a fuel cell vehicle is an electric car. However, we must keep in mind that the smart money is not always right. Cutting back federal R&D on fuel cells to a level that puts a higher priority on other options that can deliver meaningful results sooner seems prudent, as long as we don't abandon this option entirely, or cede our competitive position to others.

Friday, May 15, 2009

Auto Restructuring Implications

An article in this week's Economist does a good job of explaining the global nature of the restructuring of the automobile industry, and in particular the role that Fiat wishes to play in aligning with the weakest US carmaker, Chrysler, and GM's ailing European arm, centered on Adam Opel GmbH in Germany. Fiat sees a global consolidation coming, driven by the need to rationalize vehicle manufacturing overcapacity. The enthusiasm of the US government for this match-up is driven by factors that go beyond Fiat's apparently providing the only viable option for extracting Chrysler's assets and employment base from Chapter 11, rather than progressing to liquidation. We've heard a lot about Fiat's fuel efficiency technology, with little specificity about what that means, other than the occasional photo of Fiat's cute retro-style 500 model. I believe the US government, with its new focus on climate change, sees the opportunity to transform America's least energy-efficient domestic car line into its greenest. That seems at least partially feasible, though it depends as much on changing Chrysler's US sales mix as on the infusion of technology the carmaker could probably have acquired just as easily from third-party vendors such as Bosch.

A quick review of the March 2009 corporate average fuel economy data on the NHTSA website reveals that for model year 2008, Chrysler had the lowest fleet average of the Big 3 at 25.4 mpg, compared to 26.3 for Ford and 25.8 for GM. Although final sales for the 2009 model year aren't in yet, the gap appears to have widened, with GM and Ford's passenger car lines improving by about 1 mpg, while Chrysler's fell from 29.5 to 28.3 mpg. Although they have all focused heavily on trucks and large SUVs in recent years, GM and Ford also had a better selection of more frugal models for consumers to shift to, when fuel prices spiked last year. Compare that to Fiat's fleet fuel economy for 2007 of roughly 42 mpg, and the appeal of the Fiat/Chrysler transaction for the US administration seems clear.

In fact in the latest report I found, Fiat tied Peugeot/Citroen for the best fuel economy in Europe, although it's not reported in quite those terms. Instead of fuel economy standards, the EU has tailpipe CO2 emission standards. They have been coming down steadily, from the recent voluntary standard of 160 grams CO2 per 100 kilometers to 140 and eventually to a mandated level of 120 g/100 km--equating to an average of 49 mpg. Fiat's 2007 performance on this measure was 141 g/100 km, and GM-Europe came in at 156 (37.9 mpg). So far, so good. But when you look at how these companies achieve these levels of efficiency, it's not so obvious how much of that will be transferable. Start with size. Fiat sells a wide range of cars in Europe, but few of them are as big as the most popular models Chrysler has been selling, like the 300 sedan--a very well-behaved car that I've enjoyed as a rental--Dodge Caravan mini-van, Durango SUV, and Ram trucks. Fiat's line includes a few larger, van-type models like the Doblo and the 26 mpg (combined city/highway, after converting to US gallons) Multipla, but it is strongly skewed towards the compact and sub-compact classes. Does the White House imagine a future Chrysler model range that looks like this?

Next, consider engine technology. The number one fuel efficiency strategy in Europe has been dieselization. I've commented on this periodically, highlighting the excellent performance and near-hybrid fuel economy improvements enabled by the common-rail turbocharged diesels in wide use there. But converting American consumers to diesel still looks like a tall order, other than for brands with a loyal diesel following like VW, or for large pick-up trucks, where it's prized for its towing torque. Diesel fuel is widely available, and Ford and GM could have brought this technology over from Europe--where half their sales are diesels--any time they wanted. I have yet to hear either one announce a diesel passenger car model for the US, and I can only wonder what their consumer research on this topic has told them. (And by the way, recent losses by Toyota and Nissan should put paid to the notion that US carmakers have been uniquely myopic about market trends.)

So what should we and our leaders realistically expect from a marriage between Fiat and Chrysler? First and foremost, we ought to see a leaner company that is more attuned to younger car buyers, exemplified by Fiat's clever "eco-drive" software that monitors driving habits. We're also likely to find a much deeper infusion of European design and fuel economy philosophy than Chrysler received from Daimler-Benz, which currently ranks worst of European makers on their grams CO2/100 km scale. It's not clear whether Fiat could qualify any of its current models for sale in the US faster than it could remake Chrysler's model line, but in any case the end result will probably include a bit of both. However, the hybrid company will still be selling into a US market that until quite recently has chosen acceleration and roominess over gas mileage, hands down. We also can't forget that Fiat left the US market in the 1980s with an abysmal reputation for quality and reliability. How far the ultimate outcome of this deal will go towards delivering on the government's apparent expectation of a new, green Chrysler will depend heavily on consumer preferences, and on whether the folks who have bought the company's distinctive offerings in the past will see its new Italian flair as appealing or off-putting.

Wednesday, May 13, 2009

The Non-Tax Tax

When President Obama campaigned in 2007 and 2008, cap & trade was the centerpiece of his strategy on climate change. The latest iteration of cap & trade legislation is being developed by the House Energy and Commerce Committee, within the broader Waxman-Markey Bill. After numerous hearings and comments, the revised bill is expected to be released later this week and put to a committee vote by Memorial Day. In the process, its approach to cap & trade has apparently evolved from an assumption that 100% of the emissions permits would be auctioned, to the current expectation that a large fraction of them would be allocated for some period at no cost to current emitters, particularly in the electric power sector. In some quarters, the potential impact of this change on the federal deficit is being viewed with alarm and treated as tantamount to a tax cut--never mind that the tax being reduced does not yet exist. For that matter, many politicians can't even agree on whether cap & trade constitutes a tax. I'm sympathetic, because while it has many of the same effects and features of a tax, it differs in at least one important respect: the revenue it raises is incidental to achieving its primary purpose.

One key feature of taxation shared by cap & trade is its potential to transfer large sums of money from taxpayers to the government. In that respect, cap & trade fits many people's definition of a tax. Since it would fall heaviest on consumers and productive industries, both of which are reeling from the effects of the current recession, I've argued for deferring its collection until economic growth has resumed. Even then, the more of its proceeds are recycled back to taxpayers in the form of relief on other taxes or simple rebates, the better the chances that it would not undermine a fragile recovery. Granting free allowances to current emitters--a form of temporary grandfathering--merely reduces the amount that would need to be recycled, as well as the risk that large portions would be diverted to other purposes. Although conventional wisdom has it that a similar allocation to the power sector and other industries in the first phase of the European Emissions Trading Scheme resulted in a windfall for utilities, the same result is far from certain here, because the structure of our power sector is different. But whether the value of these permits is captured by industry, government, or no one at all is ultimately immaterial to the real purpose of cap & trade, which is to put a tangible price on the marginal unit of carbon emitted. That's what will alter investment decisions and consumer behavior.

This is where cap & trade differs most from its first cousin, the simple carbon tax. A carbon tax would apply the same price--set by the government--to every ton of CO2 and other greenhouse gases (GHG). Since the US emitted 7.2 billion tons of GHG in 2007, the most recent year for which we have data, a carbon tax wouldn't have to be very high to raise a lot of money--but it also couldn't be so low that it didn't influence behavior. A tax of $20/metric ton of CO2-equivalent would add on average about $0.22 per gallon of gasoline and $0.012/kWh of electricity, while raising nearly $150 billion per year. If it took $100/ton to achieve the desired emissions reductions, that revenue could swell to over $700 billion per year--almost enough to close the budget gap, but also enough to be a serious drag on the economy. Cap & trade could deliver the same marginal cost of carbon, but with a significantly smaller net burden on the economy, by allocating a portion of the allowances at no cost.

The key to making that work would be to ensure that the total number of allowances auctioned and allocated each year created a shortage in the market; that's why you do this, anyway, as a means of shrinking emissions year after year. That shortage is what gives the allowances their value. If you issued exactly as many allowances as the tons of GHG we expected to emit next year, their value would be zero. But you also need to make sure that you don't grandfather so many emissions that no one needs to buy or sell allowances. If everyone can meet the target themselves, allowances would become worthless. So the trick is to give out just enough free allowances--reducing this allocation annually--to avoid creating a shock analogous to an oil price spike, but not so many to any participant or sector that they can opt out of trading and deprive the aftermarket of the liquidity it needs to function properly.

The problem today is that we already have a federal budget built upon the assumption of a certain level of revenue ($646 billion over the next 10 years) from the auctioning of emissions permits from a new system, the enactment of which remains uncertain. Once that revenue is in the budget, even if it has never been collected before, anything that reduces it risks throwing the whole edifice into disarray. This bit of aggressive planning has empowered two powerful constituencies: those who see cap & trade as a massive, and thus undesirable new tax, and those who see any weakening of it as a threat to fiscal stability. I will be watching with great interest as these groups grapple with cap & trade in the weeks ahead.

Monday, May 11, 2009

Offshore Wind Potential

Last month the Interior Department issued its framework for developing the offshore wind potential of the US Outer Continental Shelf (OCS.) In a speech on Earth Day Interior Secretary Salazar highlighted the enormous opportunity that offshore wind represents, tapping a perpetually renewable resource to provide large increments of low-emission electricity, particularly in proximity to the populous East Coast, where the National Renewable Energy Laboratory of the DOE has apparently identified a million megawatts of developable wind potential. Offshore wind could provide an important segment of the renewable energy growth necessary to reduce US greenhouse gas emissions and achieve the ambitious goals of the proposed federal Renewable Electricity Standard. At the same time, it's essential to put this potential into perspective, particularly if the development of offshore wind and offshore oil and gas resources should conflict in the future. While offshore wind offers a somewhat more reliable supply option than its onshore cousin, its energy contribution is still significantly less than that of the conventional sources it is intended to displace.

In remarks early in April Secretary Salazar suggested that a million MW from offshore wind would dwarf the power currently generated by coal-fired power plants. Last year the US generated just under 2 trillion kilowatt-hours of electricity from coal, from power plants with a combined capacity of 336,000 MW. Generating the same number of kWhs from wind at a typical average capacity factor of 33% would require nearly 700,000 MW of wind capacity. So if we ignored the distinction between baseload power and the intermittent output of wind turbines, we might say that the Secretary only slightly exaggerated the potential of offshore wind, which appears to be on roughly the same order of magnitude as coal. But this comparison becomes more suspect when you break down wind's potential contribution into realistic projects, such as the much-delayed Cape Wind project in Nantucket Sound. Cape Wind would consist of 130 turbines with a total capacity of 420 MW. Replacing coal with offshore wind would require no less than 1,642 offshore projects the size of Cape Wind. To put that in perspective, consider that the UK Crown Estate--roughly equivalent to our Minerals Management Service (MMS)--is currently evaluating 40 bids for projects totaling 25,000 MW, to add to the roughly 1,100 MW of offshore wind currently on line or under construction there. That would lead Europe's offshore wind sector. I'll let you draw your own conclusions about the feasibility of replacing coal power with offshore wind anytime soon.

Since the MMS will administer the new offshore wind leasing program in parallel to its long-standing oil and gas leasing on the OCS, we must trust that they also have a firm handle on the relative energy contribution of these resources and would factor this into any future offshore resource conflicts. Consider Cape Wind, again. The approximately 1.2 billion kWh of electricity its 420 MW should generate annually could displace gas-fired power generation consuming roughly 10 trillion BTUs of natural gas per year. That sounds simply enormous, until you convert it to barrel of oil equivalents (BOE). It works out to about 4600 barrels per day, about what a single well on an offshore oil platform might produce. Compare that to Chevron's new Gulf of Mexico platform, Tahiti, which just began production and is expected to ramp up to 137,000 BOE per day. (Disclosure: I am a Chevron shareholder.) Tahiti apparently cost $2.7 billion to build. Wind farms capable of producing a comparable amount of energy (via displacement of natural gas at a gas turbine heat rate of 8,000 BTU/kWh) would cost somewhere on the order of $25 billion.

Now, these comparisons are somewhat simplified, and I've completely ignored the greenhouse gas emissions from the conventional power plants that offshore wind would displace. However, there's no imaginable cost of carbon that could close the value gap between offshore wind and the energy and economic contribution of offshore oil and gas projects. While I'm not suggesting that offshore wind inherently conflicts with oil & gas, I do think it would be helpful for the administration to temper some of its hyperbole on renewable energy with the kind of pragmatic, numbers-based analysis of which the staffs at both the Interior Department and the Department of Energy are capable. Offshore wind promises to be a useful element of our future energy mix, but it is still a very long way from replacing the primary energy sources upon which we rely today.

Friday, May 08, 2009

A Very Incomplete Story

I've watched CBS's "60 Minutes" periodically since I was a teenager. Over the decades they've aired fascinating character studies and uncovered dirt in high and low places. But there's one style of reporting that I'd be surprised if they haven't patented by now, because it's so effective at getting viewers riled at their chosen targets. You know the setup: innocent victims wronged by a Bad Company, camera angles and backdrops carefully chosen to reinforce the reactions they seek to evoke, and the reasonable-sounding correspondent getting evasive-seeming answers from some corporate official. They're very good at this, and I confess I have no more immunity to such manipulation than most viewers, except in the case of the lead segment of last Sunday's program, which I finally caught up with on TiVo. I got mad all right, but this time at "60 Minutes", because the story in question, concerning a lawsuit against Chevron for alleged environmental damage in Ecuador, is one that I know well enough to spot just how skewed the coverage was. In its eagerness to pillory Big Oil, the segment's bias let the real culprit, the national oil company of Ecuador, off the hook.

I want to be very clear about my inherent conflict of interest here, which also provides the basis for my knowledge about the facts of this case. For more than 20 years I was employed by Texaco, Inc., a subsidiary of which was the partner of the Ecuadoran state oil company, Petroecuador, in the Oriente oil fields of Ecuador from 1964 to 1992. I am also a shareholder of Chevron Corporation, which acquired Texaco in 2001--thus inheriting a lawsuit that had already been dismissed by courts in multiple US jurisdictions. I never traveled to Ecuador or worked in the divisions of the company that were directly involved with the producing operations there, but I had colleagues that did. So although I have no first-hand knowledge concerning the evidence put forward by either the plaintiffs or the defendants, I picked up enough information around the water cooler to have a good sense for what was missing from Mr. Pelley's reporting of this story.

The first questions that anyone digging into this story should have been asking concern the history and structure of the agreement governing the oil producing consortium in Ecuador. It started as a 50/50 arrangement between Texaco and a unit of Gulf Oil, one of the other "seven sisters". During the global wave of resource nationalism of the early 1970s, the state oil company of Ecuador acquired first a 25% share of the Consortium and then Gulf's entire remaining share, giving them 62.5% of the operation. (I am sure there were many times that my former employer wished that the government had simply nationalized the whole thing, back then.) This means that while Texaco collected 37.5% of the profits from the Oriente fields, Petroecuador and the government that owned it received not only the bulk of the profits, but also 100% of the royalties and taxes paid throughout the term of the concession. Even in those days, that amounted to many billions of dollars by the time Texaco's interest terminated in 1992, two years after Petroecuador became the operator, not just the majority owner of the field. The company's estimate is that Ecuador received nearly $25 billion over the life of the contract. That's consistent with production of roughly 200,000 barrels per day in that period, at an average price somewhere around $20/barrel. Out of that, Texaco earned about $0.5 billion in total, a figure that wouldn't surprise anyone familiar with oil concession contracts of that era. That equates to less than a penny per gallon of oil produced.

Now, if Texaco were responsible for all the damage alleged in Ecuador, it might not matter so much that it only earned a fraction of what it is being sued for in an Ecuadoran court. However, the allocation of revenue is extremely relevant to attempting to understand who would have benefited from cutting the corners that the plaintiffs claim were cut in the operations there. Cui bono? The answer is glaringly simple, and not just for the period after Texaco ceased acting as operator: Petroecuador--which by all rights should have been sitting in Mr. Pelley's hotseat last Sunday. Petroecuador, a company with a less than sterling reputation for operational excellence, even now. The reason they are not there is that Ecuador refused to waive its sovereign immunity in the case, and thus could not be sued even though it controlled the ongoing operation of the field since 1990, has been the main beneficiary of the region's oil wealth, and bears all responsibility for the poor state of the sanitary and healthcare infrastructure that contributed greatly to whatever ills the indigenous people have experienced. The logic of suing Texaco was inescapable: sue the party you can reach, whatever their share of the responsibility, and go for the deep pockets.

If you've read this far and still have an open mind about the case, then you might be interested in looking at Chevron's side of the story. My purpose here is not to make their case or to suggest that Texaco operated the Ecuadoran fields in the 1960s, '70s and '80s to the standards that prevail today, decades later. But I do feel the need to point out that there is another side to this story that you didn't see last Sunday, and it is not remotely the black and white tale of a big corporation behaving badly that "60 Minutes" portrayed. I am disappointed that CBS allowed itself to be used to paint such a one-sided picture, sullying the reputation of a company I knew inside and out, and of the tens of thousands of fine, responsible people who worked there--not a gang of environmental criminals. I know "60 Minutes" can do better.

Wednesday, May 06, 2009

Cash for Guzzlers

Congress appears to be moving closer to providing financial incentives for Americans to trade in older cars for more efficient new models. There are good reasons to support such a measure--and a few caveats--though the longer it takes to implement, the less relevant its benefits might seem. That argues against incorporating it as yet another element of the mammoth American Clean Energy and Security Act of 2009--the Waxman-Markey Bill. (Monday's posting examined another aspect of that legislation.) If this provision were enacted quickly, the US would join Germany and the UK, both of which have instituted similar, temporary "cash for clunkers" programs to spur car sales that have been devastated by the recession and credit crisis. This has important implications for the recovery of ailing US automakers, including the Fiat/Chrysler alliance that is expected to result from the latter's bankruptcy filing.

The incentives of up to $4,500 per car are intended to promote the sale of up to a million new, more energy-efficient cars at a time when total US car volumes are down by roughly a third from their pre-crash levels. Despite a drop in the market share of large SUVs, the resulting slower turnover of the US car fleet will delay efforts to make the fleet more efficient, with a corresponding impact on both oil consumption and emissions. The measure also targets the most valuable segment of available fuel economy gains: "gas guzzlers" for which every one-mpg improvement can translate into 40-75 gallons per year in savings for the average driver, compared to gains of less than 10 gallons per year for each one-mpg increment above 35 mpg. While it's not clear that the implied price of oil associated with these subsidies could justify the outlay, it at least stands a much better chance of delivering a financial payout for taxpayers and consumers than devoting subsidies of many thousands of dollars per car to chasing the rapidly-diminishing returns on fuel economy above 50 mpg.

At the same time, we should be clear about what such a program can and can't do. While it could provide a well-timed boost to help struggling carmakers get back on their feet, the program's one-year timeline risks merely accelerating car sales that would happen anyway, leaving Detroit in an even bigger hole next year, after the benefit expires. It is a stop-gap, not a substitute for the sales growth that should accompany the eventual economic recovery. Nor would the old cars traded in disappear from the fleet, unless the final legislation required their scrapping. That compromises the measure's fuel-efficiency benefits in two ways, by keeping the same guzzlers on the road, just in different hands, and by depressing used car prices, making other older, less efficient cars more affordable, relative to the more efficient new cars the measure is intended to promote.

It also can't summon into existence vehicles that don't yet exist. That means it probably won't help the Euro-style economy cars that Ford is gearing up to produce in a converted truck factory, because they likely wouldn't be ready in time. It can't help GM with the launch of its new Chevrolet Cruze 40-mpg subcompact, which is apparently still over a year away. And it certainly won't affect the retooled cars Chrysler is supposed to build using Fiat's technology--they will still be on the drawing board when this benefit ends. The cars (and carmakers) that will benefit the most are the ones already on offer. While it should help Toyota reverse the slide in Prius sales that accompanied lower oil prices and the expiration of its eligibility for hybrid car tax credits, most of the cars likely to benefit will be solid, mid-mpg models like the Honda Accord and Chevy Malibu. A revolution in fuel economy is not in prospect with this legislation.

My advice is to view this measure as a belated addition to the economic stimulus package that might also do a bit of good in reducing oil consumption and emissions. And unlike some of the slow-acting and less-well-defined elements of the February stimulus--which I've recently heard referred to as the "porkulus"--this program appears to be prompt, precisely targeted, and well-bounded.

Monday, May 04, 2009

Setting Green Power Goals

Much of the attention on the pending climate legislation in Congress has focused on its inclusion of the latest effort to establish a national cap and trading system for greenhouse gas emissions. However, a quick review of the table of contents of the Waxman-Markey Bill reveals a host of other energy provisions, beginning with "Title I, Subtitle A, Renewable Electricity Standard", which would set aggressive goals for the rapid deployment of renewable power throughout the country by 2025. Although this builds on the numerous state-level Renewable Portfolio Standards already in place, it would supersede their inconsistent targets and definitions. After comparing the bill's numerical targets, which would kick in as soon as 2012, to the current level of generation from its included renewable sources, I can only wonder whether the bill's authors actually expect the US electricity sector to attain these goals, or regard the RES as yet another source of future government revenue, when suppliers that fall short pay the penalties the legislation would impose.

The key language in the entire section delineating the national RES is found in the definitions of what constitutes a "Renewable Resource": wind, solar, geothermal, biomass power, landfill methane, marine & hydrokinetic energy, and "qualified hydropower." The latter limits the contribution from our largest current renewable electricity source to "electricity solely from increased efficiency achieved, or additions of capacity made, on or after January 1, 2001..." The US now has 77,885 MW of hydropower capacity, about 1% less than in 2001. Last year these dams generated 250 million MW-hours of electricity, 6.1% of 2008 total US generation. That large baseline quantity would be excluded from the RES, which would only count new hydropower capacity. The latest tally by the DOE indicates that between now and 2012, when Waxman-Markey would require 6% of the nation's power to come from renewable sources, only another 236 MW of hydropower is expected to come into service. They might as well not have counted it at all.

It's also worth noting that, appropriately enough, the bill counts actual annual generation, not capacity in place. That works very much against energy sources with low capacity factors--those that generate power much less than 24/7. That notably includes the fastest-growing renewable sources, wind and solar power. Last year, the average US wind turbine produced only about 28% of its rated output, based on actual generation and the simple average of reported year-end 2007 and 2008 wind capacity figures. And the theoretical maximum for solar is even lower, at around 23% even in a sunny locale such as Southern California. That means you need lots of wind and solar capacity to produce the same amount of power as from coal-fired power plants, which generated at an average of 73% of rated capacity last year.

Without counting existing hydropower, it is difficult to see how the country will achieve the 2012 RES goal, let alone the much loftier "25 by 25" target. The total contribution of wind, solar, geothermal, biomass power and landfill methane last year was 124 million MWh, or 3% of net generation. Reaching 6% by 2012 would require a sustained average annual growth rate of 19% per year. The 8.5% goal for 2014 would extend that requirement for another 2 years. Yet in the last four years, encompassing a period of remarkable growth from wind and solar power, the broader category of renewable electricity defined by Waxman-Markey grew by 8.1%. In effect, year after year we would have to beat last year's stellar growth rate of 17.5%--reflecting the high fossil-energy prices and credit bubble of the previous several years--and get further help from energy efficiency and conservation, which could help to shrink the denominator of this fraction. The most recent data-point we have is the first-quarter performance of the wind sector, which added 2,836 MW of new capacity. On an annualized, capacity-factor-adjusted basis, that would increase total renewable power output by about 22% this year. It remains to be seen whether the tax credit and grant provisions of the stimulus bill will be sufficient to sustain such high rates, without the infusions of "tax equity" from investment banks and other financial institutions that helped fund the projects now coming online. Nor do we know whether these growth rates could be sustained, once the transmission bottlenecks inherent in the current electric grid structure--which cannot change materially within the next six years, despite all the recent hype about a "smart grid"--begin to bite.

What happens if the electric power industry falls short of these ambitious goals? Referring again to the discussion draft of the Waxman-Markey Bill, we see, "A retail electric supplier may satisfy the requirements of paragraph (1) (as modified, where applicable, under paragraph (3)) in whole or in part by submitting in lieu of each Federal renewable electricity credit that would otherwise be due, a payment equal to the lesser of—‘‘(A) 200 percent of the average market value of a Federal renewable electricity credit for the previous compliance year, as determined by the Secretary; or ‘‘(B) $50, adjusted on January 1 of each year following calendar year 2009 based on the Gross Domestic Product Implicit Price Deflator." That $50 per MWh equates to 5 cents per kWh, or roughly half of the prevailing average retail price of electricity last year.

The House Energy and Commerce Committee has been holding hearings on this bill for the last several weeks, and the final bill reported to the House could look quite different, though many of its critics seem much more interested in the initial allocation of tradeable credits under its greenhouse gas provisions than in the RES. If passed by the House, the bill is likely to alter again once the Senate has its turn. I hope both bodies will take a serious look at its definitions of renewable resources and the timing of initial targets that depend mainly on our ability to continue expanding wind power at high growth rates and integrating its non-dispatchable, intermittent contribution into an existing power distribution network that will become increasingly strained, until its own expansion and updating really get under way. Missing these targets wouldn't only impede our environmental progress; it would result in a hefty new tax on electric power, over and above the effective tax from the likely cap & trade system.

Friday, May 01, 2009

Is the Energy Crisis Over?

A quick check of Google Trends this morning confirmed my gut feeling that, other than from government officials, references to an ongoing energy crisis have fallen significantly in the last year. Google's statistics show that searches on this phrase have fallen back to about where they were in 2004 or 2005, though still somewhat higher than 2007. Their track of news references shows this trend even more strikingly. Without graphing the correlation, it appears to go hand in hand with energy prices that have fallen to levels that are no longer adding to our economic pain and in some respects provide significant relief. Does our waning interest in an energy crisis reflect the archetypal fickleness of the American psyche, or has the energy crisis that generated such a fever pitch of concern last year truly abated, and if so, will it soon return? A quick tally of some key statistics provides a mostly positive assessment, at least for now. While this doesn't justify complacency, it seems like a genuinely positive indicator at a time when good news has been in short supply.

The question I posed would have been a lot easier to answer if the Energy Information Agency's handy one-page summary of US primary energy production and consumption had been updated since 2007, when about the best one could say was that our net energy imports had stabilized at just under 30% of total consumption. But looking at the major components of US energy supply and demand in 2008, we see more than a few "green shoots." Net imports of crude oil and petroleum products, a much more useful measure of our dependence on foreign suppliers than just looking at crude oil imports, have fallen steadily from a peak of 13 million barrels per day in the summer of 2006 to around 11 million barrels per day. That didn't occur because US crude production was up--it's not--but because of the lagged but profound response of demand to higher prices.

Even if petroleum imports begin growing again as the economy recovers, they will do so in a global market that for at least the next several years will have ample spare capacity--a crucial measure of the market's ability to meet higher demand without creating another severe price spike. In a webcast earlier this week, Global Insight, CERA and IHS Herold (the sponsor of this blog) presented analysis suggesting that the combination of lower demand and higher output have lifted global spare oil capacity from its minimum of barely a million barrels per day in 2005 to more than 6 million this year, or nearly 8% of demand. Together with high oil inventories in consuming countries, this should cap the eventual recovery of oil prices well below the levels we saw last year. It remains to be seen whether $80 oil would prove as harmful to the weak economic recovery most economists expect next year as $140 oil did to an economy teetering on the brink of collapse.

Natural gas presents a remarkable and more uniformly positive story. A few years ago I was seriously worried that a steady decline in US gas output, coupled with strong demand supported by environmental regulations were setting us up to become major importers of gas from outside North America, putting the US in much the same position for gas as we were already in for oil. What a difference a couple of years makes. As detailed in a recent Wall St. Journal article, gas production has rebounded sharply as a result of the exploitation of enormous deposits of gas in deep shales that until recently had looked inaccessible. Marketed gas production last year was up 7% over 2007 and a whopping 13% above its 2005 trough. As a result, imports are down, especially in the form of LNG. This mini "gas bubble" could deflate, if the low gas price and tight credit continue to depress drilling activity, particularly by the independent gas producers who were mainly responsible for the recent surge in production. But as the Journal notes, the underlying resource looks robust enough to carry us well into the future. Whatever its other pitfalls, the Pickens Plan would not fail for lack of natural gas.

If anything, the electricity picture is even more encouraging. Demand in 2008 was essentially flat, compared to the prior year, and the composition of generation shifted modestly away from coal (down 1%) and other fossil fuels (down 4%), while electricity from nuclear, hydro and other renewables expanded by 2%, led by a 51% increase in wind power output. Wind, solar and geothermal power accounted for just 1.6% of all generation, but the broader group of low-emission sources, including nuclear, made up nearly 29% of the total. This looks set to continue growing, as long as the current nuclear fleet, which accounted for 2/3 of that figure, stays on line and eventually expands.

I recently ran across an interesting analysis examining the extent to which the economic crisis might have been precipitated by an oil price shock--the primary feature of the energy crisis that attracted so much attention in 2007-08. I expressed similar suspicions last December, if in less elegant economic terms. Which was the chicken and which the egg is of more than merely academic interest, because if the energy crisis was a principal contributor to the bursting of a financial bubble that couldn't last forever, rather than merely another manifestation of that bubble, then it seems that the chances of another devastating energy price spike in our near future ought to be a little lower. That would be another piece of good news to add to a generally positive current view of energy.