Thursday, July 29, 2010

The Incredible Shrinking Energy Bill

When legislation is introduced in the US Congress, most of the discussion typically concerns its specific provisions. Sometimes, as in the case of the "public option" absent from the final healthcare bill, notable omissions vie for attention. However, in the case of this year's greatly-diminished energy bill released this week by Senator Reid (D-NV), most of the controversy seems to be focused on its long list of missing elements, including but not limited to cap & trade, a national renewable energy standard for electricity, and extensions for various expiring renewable energy incentives. That's not to say that what's left doesn't deserve careful scrutiny, particularly provisions affecting offshore oil and gas drilling. But compared to the energy bill that might have been, this draft looks like a pitiful remnant, even at 409 pages.

Although I can appreciate the frustration of those who expected Congress finally to enact cap & trade this year, I find the convoluted tactical arguments and finger-pointing over its failure to reach consensus on this issue to be mostly "inside baseball" rationalization. The clues adequately explaining its omission from the current bill are on display in the bill's title, "The Clean Energy Jobs and Oil Company Accountability Act of 2010". In other words, what happened to cap & trade this year was the recession and the oil spill. The former made the country less receptive to what is at its core a substantial new tax, while the latter scuttled the best chance for a bi-partisan "grand compromise" based on swapping expanded access to US off-limits oil and gas resources for stronger emissions regulations. Even though the taxation underlying cap & trade is intended to recognize a serious unpriced externality of our energy economy, it still represents a significant redistribution of wealth from energy producers and consumers to the government and the purposes for which the government chooses to spend the proceeds: at best a zero-sum game with frictional losses, and at worst--insert Waxman-Markey--a monumentally-distorting boondoggle.

Then there's the missing national renewable electricity standard (RES), which in clear English is a mandate for utilities to obtain a defined and escalating percentage of the electricity they provide customers from selected renewable sources. The American Wind Energy Association (AWEA), the trade association for the US wind industry, sees this as an absolute necessity for their industry to continue growing and was vexed over its exclusion from the current bill--this in spite of the fact that the wind industry's main federal support, the Production Tax Credit, was previously extended through 2012, along with the valuable option to select an Investment Tax Credit instead. I see two practical explanations for this omission, though it's clear from the efforts of AWEA and other groups that it could still find its way back into the bill. First, the RES is really another tax. Instead of being levied on taxpayers by the government, it would be levied by utilities on ratepayers when the costs of the renewable energy projects or the tradeable Renewable Energy Credits they can buy in lieu of buying green power are passed on to their customers. On a more practical level, with 29 states plus the District of Columbia already having equivalent Renewable Portfolio Standards in place, most of the best US wind and solar resources are already covered by such targets. A national RES might not add a lot more of these energy sources, but it certainly would trigger a scramble for the states with limited renewable resources to line up supplies from elsewhere. That might be good for the renewable energy sector, but it's of questionable benefit to a national economy still struggling to emerge from the recession.

Also absent from this draft are the expiring renewable energy incentives highlighted in yesterday's New York Times editorial. These include the $0.45/gal. ethanol blenders' credit, about which I've blogged extensively, and the Treasury renewable energy grants offering up-front cash for the Investment Tax Credits that would otherwise require waiting for next year's tax return--assuming the recipient company had sufficient taxable income to benefit from the entire amount of the credit. These grants look problematic, as I noted last fall, when reports first surfaced that most of the money paid--approaching $2 billion--had gone to non-US firms. As I discussed at the time, this reflects the reality of a wind energy market in which US firms account for less than half of domestic sales, supported by a thoroughly-globalized supply chain, not unlike many other industries. The arguments pro and con too easily reduce to unappealing sound-bites.

That leaves us with what is currently in the bill, which I have so far only had time to skim. It seems to consist mainly of well-intended but overly-politicized efforts--one section is entitled the "Big Oil Bailout Prevention Unlimited Liability Act of 2010--to hold BP accountable for the Gulf Coast oil spill and to address the liability for future spills, while trying to reduce the chances of another one. That sounds like motherhood and apple pie at this point, but as always the devil is in the details; implementing some of these details would leave the US with a much smaller offshore oil capability. That might appeal to environmentalists but would be catastrophic for energy consumers, our trade deficit, and US energy security. And why would you charge the Secretary of Energy with issuing a monthly report, starting in September or October, on the economic and employment impact of a deepwater drilling moratorium that is only intended to last through November? Interestingly, the bill would also establish a Congressional version of the President's oil spill commission, this time with specific technical criteria for appointment to this body. Alternative, compromise versions of the bill's oil provisions are already emerging from within Senator Reid's own party, and with a lot of luck we could end up with measures that would actually make offshore drilling safer and more responsible without killing it--and the roughly 30% of domestic oil production it provides.

In addition to its oil spill provisions, the bill also offers some generous tax credits for converting heavy-duty trucking to natural gas, along the lines of the Pickens proposals I discussed last Friday, plus similar help for vehicle electrification and infrastructure, yet more energy efficiency measures (this time focused on homes), and funding for an old government program to buy up land and waterways for parks and nature preserves. All of this is notionally paid for ("PAYGO") by raising the Oil Spill Liability Trust Fund fee on all the oil produced and used in the US from $0.08 to $0.45 per barrel, which would directly increase the size of the fund to cover future disasters from $1 billion to $5 billion, while indirectly making all the bill's other provisions appear deficit-neutral. The proposed fee increase has the potential to raise an extra $2.5 billion per year.

It's not clear whether even this slimmed-down bill can garner enough votes to pass in the Senate, let alone do so before the summer adjournment. In any case I'd expect the version that comes up for a final vote--if it does at all--to look somewhat different than this draft. It would almost certainly grow much longer, a malady that has afflicted all major legislation in recent Congresses. Whether it will actually make a meaningfully-positive impact on the serious energy challenges the US faces remains to be seen.

Tuesday, July 27, 2010

BP Shrinks by $16 Billion

I've been going though BP's second-quarter earnings press release and results to get a better sense of the impact of the Gulf Coast oil spill on the company's finances. It's a measure of the scale of a "Supermajor" like BP and the robustness of its underlying cash flows that it could continue to invest more than $6 billion (B) in capital projects and acquisitions in the quarter and even pay down a bit of debt, while recording a charge of $32.2 B against earnings related to the Deepwater Horizon disaster and ensuing oil leak. To put that figure in perspective, it's more than the market capitalization of Exelon Corporation, the largest owner and operator of nuclear power plants in the US. Yet among all of the remarkable and morbidly-fascinating numbers presented here, the one that stood out for me was the net decrease of shareholder equity by $16 B since the end of 2009. Anyone seeking to explain the decision of BP's board to change CEOs should start there.

The media have tended to focus on the impact on BP's market capitalization, which is a more immediate, though also much more volatile measure of shareholder value. As of today, it's down by about $70 B compared to its pre-disaster level. If it remained there and the market believed that the $32 B that BP has just recognized was likely to be the full extent of the impact on the company, a flurry of takeover bids would follow shortly. However, when you read BP's description of how they arrived at that amount, it's clear that there's relatively little upside--mainly from its partners in the Macondo field, if they eventually pay the $1.4 B of costs that BP believes they owe--and a great deal of downside. While including the entire $20 B escrow account set up to cover claims, BP has apparently not reserved extra amounts for the outcome of future lawsuits beyond litigation costs, or for the additional fines and penalties that would follow if it were found to have been grossly negligent.

All of these costs must be balanced somehow. BP's other businesses have continued to generate roughly $7 B per quarter, but the key to finding the money to pay all the claims and damages from the Deepwater Horizon disaster rests with the company's decision to sell up to $30 B of assets, with the first $7 B already sold to Apache, and in its coerced but convenient decision to suspend dividend payments for the balance of 2010. The latter was never really necessary to secure the $20 B escrow account, which BP indicates "will be assured by the setting aside of US assets with a value of $20 billion." No matter what, BP will be smaller in the future as a result of this event, but its management has effectively trimmed the shrinkage by investing some of the shareholders' money--their expected dividends--in projects and activities that might otherwise have been curtailed or sold.

Another figure in BP's results that is attracting some attention is the $10 B tax credit it is recording in conjunction with that $32 B charge. It's simple accounting--the spill-related charges are being incurred pre-tax and will reduce the income upon which BP pays taxes--but this may not sit well with Gulf Coast residents and US taxpayers who have been assured by BP that they will be kept whole. This is as meaningful a source of cash as an asset sale, though it could deliver yet another blow to BP's reputation.

Mr. Dudley has assumed the reins of a company that is still undergoing a near-death experience. Time will tell whether BP's accountants have included a sufficient "haircut" in the second-quarter results to allow him to begin rebuilding the firm's fortunes and restoring the lost shareholder value that was patiently accumulated over many years but destroyed in the course of just a few weeks. I've already seen a fair amount of speculation concerning whether his Gulf Coast roots and American accent will help mollify angry stakeholders, government officials, and Members of Congress, and it's hard to see how he could fare worse in this regard than his predecessor. However, it's going to take a lot more than that to enable BP to retain its access to valuable government contracts and exploration leases, including the extremely thorny decision about whether, when and how to bring up the subject of returning to unlucky Macondo to drill some proper wells and produce a field that some experts seem to think could hold up to a billion barrels of oil, less the several million that flowed into the Gulf.

Friday, July 23, 2010

Pickens Plan, the Sequel

How can you not love T. Boone Pickens? Here's someone who made his fortune in oil, and now he's advising us to switch major parts of the US economy to wind and natural gas. And unlike some of the other concepts for taking a big bite out of our oil consumption, his current idea actually stands a chance of making a significant difference on a timescale of years, rather than decades. At the same time, however, Mr. Pickens has sometimes been a tad bit less than accurate with the numbers he uses to make his points. Remember those ads about the $700 billion per year we were sending overseas to buy oil? Even at its absolute peak in July 2008, reality was more like $500 billion, and the total for 2008 ended up around $385 billion, based on net imports and the average refiner acquisition cost for the year. That's hardly peanuts, but it's roughly half his cited figure. So let's take a look at the key numbers behind his proposal to convert long-distance trucking to natural gas. It's a great idea, though not quite as much of an economic slam-dunk as it might seem when he describes it.

I just finished reading the interview with Mr. Pickens in The American Spectator, published yesterday. The big shift in the Pickens Plan since the first time I examined it in detail is that he has switched his emphasis from using wind to free up natural gas to replace gasoline in cars, to using the abundant natural gas from our enormous shale gas reserves, which are already transforming the US gas and power markets, to replace diesel fuel in big-rig trucks. He is also in the process of lining up the legislative support to nudge this along much faster than market forces alone would. But does it make as much sense as he suggests when he talks about using $4.50 worth of natural gas to replace 7 gallons of diesel fuel at $3 per gallon?

Strictly in energy terms, that 7 gallons might even be a bit low. A million BTUs of gas (roughly 1,000 cubic feet or one MCF) would deliver as much energy to a truck as 7.8 gallons of diesel. And fundamentally, he's right that the recent price relationship between natural gas and crude oil makes gas a tremendous bargain, BTU for BTU. However, the prices he mentions in the Spectator interview constitute an apples vs. oranges comparison from both sides. Even if natural gas remained at a steady $4.50/MCF at the wellhead for the next 20 years, which seems unlikely despite the bounties of shale, that's not what you'd pay at the natural gas pump.

Start with the fact that it costs something to transport gas from the wellhead, wherever that might be, to market. Based on current pricing relationships, if gas starts out at $4.50, then by the time it's sold to a commercial account, which is probably how filling stations would be classified, it could cost as much as $9. And someone has to invest in the equipment to compress it to 3,000 or 3,600 psi and pump it into an 18-wheeler's tanks. Even with tax credits to help, a station owner will need to make a return on that investment, and some profit, too. Add another buck an MCF to cover that, and we're up to $10/MCF, which equates to $1.28/gal. of diesel. For a reality check on this, I took a look at, which shows the locations and pricing for stations selling compressed natural gas (CNG) for vehicles around the country, expressed in dollars per gasoline-equivalent-gallon (GGE). Prices range from roughly $1.25 to around $2, with a few outliers over $3. Since a GGE contains about 10% less energy than a gallon of diesel, you'd have to bump these prices up by about 10% to get the equivalent for a fair comparison.

Under $2 is still pretty cheap, but you shouldn't compare that to the $2.90/gal average retail price of diesel this week. The latter includes federal excise tax of $0.244/gal. and state excise and sales taxes that range from $0.08-0.49/gal. and average $0.281/gal. As best I can tell, CNG is taxed at the federal gasoline rate of $0.183/gal., while states seem to tax it to a much lesser extent than gasoline and diesel, as for example the $0.085/gal rate in Utah, compared to their state fuels tax of $0.245/gal. However, this is only viable as long as demand for CNG is tiny, relative to other fuels. If Mr. Pickens succeeds in displacing large quantities of diesel with CNG, then it will either need to carry a similar tax burden, or the lost revenues must be collected in some other fashion. If you strip out the taxes to get to an apples-to-apples price to compare diesel to CNG, it works out to around $2.50, give or take a dime or two, depending on location. So while CNG is still clearly cheaper than diesel, it's rarely $1/gal. cheaper on a truly comparable basis. This, together with conversion costs as high as the $65,000 per truck that Mr. Pickens cited, might explain why market forces alone haven't led to a rapid switch to CNG-fueled transport.

I've looked at the House bill containing the natural gas vehicle tax credits mentioned in the interview. It would cover as much as 80% of the incremental cost (over the diesel version) of a truck that can only burn CNG or LNG, up to $80,000, depending on weight. It would also extend the $0.50/GGE tax credit for CNG and LNG through 2027. These changes would drastically shorten the payout of an investment in a natural gas-powered truck, even if the per-gallon advantage of CNG appears to be somewhat less than Mr. Pickens suggests. That could move CNG into the truck-fuel market pretty quickly.

The remaining question is what the $7 billion investment Mr. Pickens wants the government to make in this proposition would buy us. He believes that converting the US heavy truck fleet to CNG would save 2.5 million bbl/day of diesel, or about two-thirds of the diesel and heating oil now sold in the US. That would have a much bigger impact on our oil imports than ethanol, although it's hardly an either/or proposition. I'm surprised that Mr. Pickens didn't go on to suggest that this benefit could be leveraged further by utilizing the resulting surplus diesel in diesel automobiles. Given their approximately 30% improvement in fuel economy vs. comparable gasoline vehicles, that could save an additional 750,000 bbl/day of gasoline, while reducing greenhouse gas emissions on those cars by about 20%. If you play all this out, then just under 5 trillion cubic feet per year of natural gas, or less than a quarter of current gas production, could save more than 3 million bbl/day of gasoline and diesel, or nearly a third of our net petroleum imports.

That sounds like a pretty good deal for $7 billion, though it could be made even better if the vehicle tax credits involved were converted into low-interest loans and loan guarantees, instead. If the main impediment to switching to gas is the up-front cost of natural gas conversions and the time involved in recouping that cost, then let's make it much easier for truckers to borrow the money for this purpose, and for banks to lend to them. Giving everyone taxpayer money to induce them to do what we want makes a lot more sense when the government has plenty of money to spend. With the US running large deficits and the private sector holding lots of cash earning next to nothing, we should use our tax dollars as efficiently as possible to achieve the same outcome. Otherwise, Mr. Pickens seems to be on to a sensible idea, and I wish him luck selling it.

Wednesday, July 21, 2010

How Much Warmer?

If the present global temperature trend continues for the remainder of the year, we're bound to hear a growing chorus of reports about 2010 being the warmest year since records have been kept. The first six months of 2010 already appear to have been the warmest first half on record. Or was it? When you examine the numerical result from the National Climatic Data Center upon which this determination rests, it turns out that January-June of this year apparently topped the previous six-month record set in 1998 by just 0.03°F. Not only is that difference quite small, but there's a good chance it doesn't exist at all and is merely the result of average temperature data being tallied to more decimal places than the accuracy of the instruments recording them warrants. So when someone tells you this is the warmest year ever, you should at least ask for more detail on that assertion.

Before going any further let me clarify that this point doesn't affect the validity of climate change. When I look at the accumulating evidence, including the climate data that's publicly available, I see a decade-by-decade warming trend since the turn of the previous century, with a few time-outs. It's open to debate whether that trend is currently in abeyance; neither the incidence of a couple of relatively-cooler years recently--giving rise to claims of global cooling that at a minimum must be regarded as highly premature--nor a single hotter year this year necessarily alters that, at this point. However, there are good reasons why media-hyped claims about any one year being warmer or colder than another are pretty much irrelevant to the larger discussion concerning climate change. And in at least the current instance they likely rest on a foundation that simply can't bear their weight.

The global annual temperatures we see reported are really averages of the averages of numerous temperature readings from thousands of weather stations around the world. Such averaged data can only be as accurate as the least-accurate individual readings on which they are based. This reflects a principle called "significant figures" or "significant digits" that is drummed into students of college chemistry and physics. (If you're interested in the details, the USGS has a good overview here.) So if you take three temperatures, say 59.1°F, 56.3° and 58.7°, their average is not 58.03333° (as my calculator tells me), or even 58.03°, in the manner that most of the climate data centers report such figures, but simply 58.0°. Furthermore, if you take the difference of two such averages, that difference can't create greater accuracy than the individual readings. For example, if I subtract from the above figure the global average temperature of 57.2°F for the period 1951-1980 used by NASA's Goddard Institute for Space Studies (GISS), the result is not 0.83333° or 0.83°, but 0.8°.

Applying this common-sense principle becomes even more important when you take into account the actual accuracy and precision (repeatability) of the underlying measurements. A quick Google search turned up a 2004 paper in the Journal of Atmospheric and Oceanic Technology on this subject. After analyzing several sources of measurement error in commonly-used air temperature sensors, the authors found that these devices were accurate to no more than +/-0.2°C over a typical range of temperatures, and less accurate beyond that. So not only are the temperature readings that go into the averages upon which comparisons of global annual temperatures are based only good to one decimal place, but they may not be quite that good. Even if some of this error averages out over the large number of observations recorded (assuming it is random error), we still shouldn't read more into these data than is there, and the second of the two digits in the "temperature anomalies" (differences vs. an agreed average) that are reported should probably only be used to ensure that rounding is done consistently.

What does all this mean in practice? Well, referring to the GISS data it appears the global average temperatures for 1998, 2002, 2005, 2007 and 2009 were all essentially indistinguishable from each other at 14.6°C or 58.3°F. 2010 might be on track to beat that by a full 0.1°C, though it could still easily end up in a tie with these other years. Whether this year sets a new record or not is of little consequence to the climate change discussion. Although not likely to compete with such a finding for headlines, it's much more relevant, important and accurate that the average of temperatures in the 2000s was apparently 0.2°C warmer than the average of the 1990s, which were already 0.1°C warmer than the 1980s, and so on.

Monday, July 19, 2010

Building a Market for Biofuels

For the first time in many years I find myself in general agreement with one of the major ethanol trade associations on a key matter of energy policy. Last week Growth Energy, which represents a significant portion of the US ethanol and biofuels industry, announced its support for a phase-out of the federal Volumetric Ethanol Excise Tax Credit, or "blender's credit", in preference to using these funds to provide incentives for constructing the infrastructure needed to offer ethanol at every gas station, and to promote vehicles that can safely burn higher-percentage ethanol blends. This looks like a prudent shift for several reasons, and I hope that the Congress is paying close attention.

No, I haven't suddenly abandoned my aversion to ethanol subsidies that have dragged on for more than three decades and are now long overdue for full retirement, at least for ethanol derived from corn and other food crops. The Congressional Budget Office just released a study on these subsidies showing that when applied to volumes of biofuel equivalent to a gallon of gasoline, the current $0.45 per gallon ethanol blenders' credit equates to $0.73/gal., and the full cost to taxpayers of displacing a gallon of petroleum gasoline with ethanol works out to $1.78/gal. That doesn't count any of the actual production costs of the fuel, either. US ethanol output may thus displace roughly 500,000 barrels per day of imported gasoline (or the imported oil from which to refine it) but it's hardly a bargain. However, I'm also aware that the US has made an enormous policy--and political--commitment to biofuels, including advanced biofuels from cellulosic biomass.

We've done this for reasons that transcend economics. But unless we invest smartly to create a bigger market for these biofuels, the Renewable Fuel Standard will shortly collide with the "blend wall", and US biofuels policy will be stymied. That will happen sooner than might otherwise have been expected, because instead of growing at a steady 1-2% per year as they had prior to the enactment of this policy, US gasoline sales have actually shrunk since then. Trying to cram additional amounts of ethanol into this market--and into cars that weren't designed to use more than 10% of it without damage to engines, fuel systems, and emissions equipment--is a dead end. In order to keep growing, ethanol--including cellulosic ethanol--requires an independent outlet. That's where E85, the 85% ethanol/15% gasoline mix that's as close to straight ethanol as can effectively be delivered to the gas station and used in flex-fuel cars, comes in. So far, though, E85 occupies a tiny niche market mainly in the corn states of the Midwest.

Growth Energy appears to have assessed the longer-term environment for their fuel and reached a similar conclusion: paying refiners to blend ethanol into the shrinking space left in each gallon of ordinary gasoline--which is what the current VEETC does--now makes a lot less sense than helping the nation's 100,000-plus service stations (most independently owned) to adapt their forecourts to deliver a wider mix of products. Promoting flexible fuel vehicles--including wider awareness of which cars are already capable of safely using higher ethanol blends--is also an important element of creating a market for these fuels, though to some degree this is already underway through the government's Corporate Average Fuel Economy regulations and voluntary manufacturer initiatives.

This won't be easy. Growth Energy expresses confidence that ethanol can compete against gasoline without a per-gallon subsidy, as long as it's widely available and most cars are equipped to burn it. However, the industry must somehow overcome the fact that each gallon of pure ethanol contains just 66% of the energy of a gallon of petroleum gasoline. Most drivers don't notice the impact of this when they use gasoline blended with 10% ethanol, but at 85% ethanol and just 15% gasoline, this effect becomes impossible to ignore. Beyond those customers willing to absorb that hit for reasons of perceived patriotism or environmentalism, E85 must ultimately be priced at a discount that reflects the reality that a tank of it won't take you nearly as far.

As of last Friday, ethanol for August delivery traded for $1.61/gal on the Chicago exchange. (That doesn't include freight to market, mainly by rail, which can easily add another dime.) That works out to $2.46 per gasoline-equivalent gallon. Meanwhile Unleaded Regular without ethanol was worth $2.05/gal on the New York exchange (pre-tax.) Nor is this difference anomalous; over the last year wholesale gasoline was consistently cheaper than its energy equivalent in wholesale ethanol, to the tune of roughly $0.90/gal. Unless the ethanol industry figures out how to produce its product at a lower cost, or gasoline prices go up without ethanol prices following, as they did in 2008, then tax credits for distribution and sales infrastructure may not foster as big a market for ethanol as Growth Energy expects, or as profitable a market as I'm sure they'd like. Yet as a matter of policy equity, and from the standpoint of what taxpayers are getting for their money, guaranteeing access for ethanol looks like a better approach than guaranteeing sales, as we do now. It also has the additional benefit of having a logical end-point, instead of the open-ended support we've effectively provided ethanol since 1978.

The current ethanol blenders' credit expires at the end of 2010. The announcement by Growth Energy is even more notable because the Renewable Fuels Association, which represents a larger slice of the industry, has come out in favor of an extension of existing policy through 2015, when the subsidy in question would likely approach $7 billion per year. If this divergence within the ethanol industry is reflected among its supporters in Congress, we could see a surprisingly lively--and fruitful--debate over how best to integrate support for ethanol into a more cohesive national energy framework. Compared to continuing the status quo, Growth Energy's idea of investing to create a mass biofuels market, rather than just paying for space in gasoline, has considerable merit. This approach could also be done for a lot less than the current subsidy, because it wouldn't be necessary to install E85 pumps in every service station in the country. Most of the benefit could be achieved by focusing incentives on strategically-located high-volume outlets, and the rest of the money could go back into the Treasury, where it belongs.

Thursday, July 15, 2010

Moratorium Follies

This week Secretary of Interior Salazar reissued the administration's deepwater drilling moratorium, with a few new twists and a notional six month limit. This happened in spite of loud protests from the states most affected by the spill, some of their representatives in Washington, and even some skepticism from the heads of the President's own drilling commission. The old ban is still in court, and the new one probably will be soon, but this is really all moot, because whether the Salazar moratorium is technically in force or not, the legal battle over it has created a moratorium limbo that few companies would be willing to test, given the costs involved. One irony of all this is that in addition to the obvious indirect winners in OPEC, there's at least one direct winner in this hemisphere: Brazil, which will be quite happy to export to us their deepwater oil that we're inadvertently helping them to develop quicker and cheaper.

When I read the Interior Department press release on the new moratorium, which was presumably crafted to satisfy the federal judge's objections to the original deepwater drilling ban, several points stand out, aside from the redefinition of the ban to cover not water depth, but the kind of rigs that are required to drill in deep water. In the Secretary's statement that he "remains open to modifying the new deepwater drilling suspensions based on new information", he appears to offer greater flexibility and the prospect of case-by-case exemptions or an early termination. Yet when you read the first item on the list of reforms for which the moratorium is intended to buy time, dealing with "companies demonstrating that they have the ability to respond effectively to a potential spill in the Gulf," the implication seems clear. If an unprecedented response to the Macondo spill using the state-of-the-art technology and techniques has been inadequate to meet the government's implied standard--as seems self-evident--then this is a classic Catch 22. If drilling can only resume when the industry can prove it could contain a blowout like this and any oil spilled within a few days, then we could be waiting a very long time, while technology catches up to that new, higher bar.

When you parse through this document and examine the evidence that's been made available so far concerning the causes of the Deepwater Horizon disaster and spill, it's hard to avoid the conclusion that the main driver behind the moratorium is not technological, or even necessarily environmental, given the extremely low risks of a similar event occurring from a properly managed rig equipped with a properly-maintained blowout preventer. It seems due at least to "an abundance of caution"--that lovely phrase we have heard several times this week--if not ultimately from hard-nosed political considerations. If I were a President whose party was facing a tough mid-term election, I'd be tempted to eliminate any possible risk of another blowout between now and November 2, too.

The problem with that approach is that the administration won't pay the short-term price for that abundance of caution. That burden falls on the economy of the region, which has already been affected by the spill, on the domestic drilling industry--a vital national asset, not just a bunch of corporations--and its employees, and eventually on the entire US, as our domestic energy supply will again begin to dwindle. According to a new study, the economic impact of the moratorium already extends well beyond the region, because offshore oil workers, who typically work two weeks on and two weeks off, live all over the country, apparently in more than two-thirds of Congressional districts. Yet while unemployed oil workers might at least be covered by the $100 million fund that BP set aside for that purpose at the administration's request, the local businesses that employ many of them need help with more than just meeting payroll, if they are to survive until the end of the moratorium, whenever that might be. That's not BP's responsibility; it's the direct responsibility of the government that has taken a calculated decision to impose a blanket moratorium on the entire industry, rather than on individual bad actors.

Meanwhile, aside from OPEC, an indirect beneficiary of the moratorium that understands very well that when you stop drilling your existing production begins to fall away, there is at least one direct beneficiary that is about to take advantage of the opportunity the ban has created. Brazil has discovered enormous offshore oil reserves in the deep waters of the Santos Basin and elsewhere along its lengthy coastline. As I've noted before, it's the exploitation of these resources, rather than its effective but comparatively-small cane ethanol program, that has made Brazil energy independent and is turning it into one of the most important new oil exporters in the world, including to the US. Until recently, the companies exploring for oil off the coast of Brazil faced the same problems that Gulf Coast drillers did, of high rig rental costs and a long queue for hiring them. Our response to Deepwater Horizon is mitigating both issues. So while it might be promoting safer drilling in the Gulf, one of the unintended consequences of the suspension of drilling here is that it will simultaneously create a greater need for the US to import oil, while ensuring that countries like Brazil will have more of it to sell us, sooner than otherwise and at a bigger profit.

I expect to post over the course of the summer on ideas for what it would take to get our government and the rest of the country comfortable with resuming drilling, although some indications suggest that most of our fellow citizens are already there. This is complicated by an opportunistic PR campaign from environmental groups suggesting that this is the moment to get the US off oil entirely, rather than figuring out how to drill more safely. However desirable that might sound, for many reasons, at this point it's about as feasible as suggesting to a hospital patient that this is the moment for him to try living without blood. For good and ill, oil is still the lifeblood of our economy. We should absolutely work on reducing our dependence on it, but we're going to burn many billions of barrels of oil getting there, and that will require continued drilling in the US--unless we're happier than I think to go back to our former pattern of importing more and more of it from other countries. Stay tuned.

Wednesday, July 14, 2010

Small Nuclear Gets Real

The quote of the day, as far as I'm concerned, comes from the head of Babcock & Wilcox Nuclear Energy. "Bechtel doesn't get involved in science projects," said Mr. Mowry, in reference to news that Bechtel Corp., one of the world's largest engineering & construction contractors, is joining Babcock's effort to get its small modular nuclear power plant certified and ready to deploy in large numbers. The addition of Bechtel lends further credibility to an initiative that already draws significant authority from Babcock's long experience building small reactors for naval vessels, as I noted when they launched this program a year ago. Bechtel's participation and investment in small nukes signals that interest in this idea is growing and narrows some of the uncertainties about its future. Perhaps it's time to start giving some serious thought to how small nukes might fit into the complex ecology of electricity generation and its transformation under constraints on greenhouse gas emissions.

The latter is a key issue, because if this year's effort to put together an energy bill results in a low-carbon electricity standard, instead of a renewable electricity standard, we might see renewables and small nukes eventually going head-to-head for shares of that protected sub-market. Depending on their ultimate cost, small nukes might also provide an equivalent low-emissions alternative to expensive carbon capture and sequestration retro-fits of existing coal plants. They might even compete with larger combined cycle gas-turbine power plants intended to operate in baseload, rather than on-demand, though this depends heavily on expectations of future natural gas prices that have been depressed by shale gas availability.

The unit's 125 MW scale is also an interesting feature. While this is much smaller than most commercial nuclear power plants, it's similar to many large wind farms, now that wind has grown up. A quick scan of last year's US wind farm completions showed at least 23 at this scale or larger. And of course a nuclear reactor with 90% or higher availability produces far more actual kilowatt-hours than a similarly-sized wind installation with a typical capacity factor of 30% or so--perhaps enough to compensate for the substantial difference in up-front costs, particularly when the reliability and dispatchability of nuclear is factored in. That doesn't mean nukes would push wind entirely out of the market, even if government policy treated them equally in terms of their greenhouse gas reductions and energy benefits. The pros and cons of each are different enough that we're likely to end up with a diverse energy mix, just as we have a diverse mix today. And in any case, renewables have become just as politically-entrenched as other energy sources--perhaps more, relative to their energy contribution--and are unlikely to be abandoned by their patrons just because another new flavor of energy comes along.

I understand that small nukes still face a number of hurdles, including concerns about security, waste handling and proliferation. However, I don't see any intrinsic show-stoppers, compared to larger nukes or some other alternatives, and I see plenty of advantages in terms of standardization, experience-curve effects, and financeability, once the first few have been built and demonstrated sufficiently. That's where Bechtel's involvement could be extremely valuable, in bridging the large gap between the world of naval power, which Babcock & Wilcox has down cold, and land-based power generation, in which Bechtel has decades of experience with a variety of technologies, including but not limited to large-scale nuclear. This combination should give Babcock's plans a healthy boost, particularly compared to the small-nuke aspirations of start-ups without this experience.

Monday, July 12, 2010

Whither Cap & Trade?

Just a year ago it seemed a near-certainty that the US would eventually adopt some form of cap & trade mechanism for greenhouse gases (GHGs). After repeated failed attempts to pass cap & trade legislation in the Senate, the House of Representatives narrowly passed the Waxman-Markey bill, HR-2454, and the Senate was expected to follow, bolstered by a filibuster-proof Democratic majority and urged on by a popular new President. Then came the divisive debate over healthcare legislation, the off-year election of Republican Scott Brown in Massachusetts, Climategate, and an oil spill that among other things derailed the latest bi-partisan (tri-partisan?) Senate climate bill. Today, the prospects for climate legislation remain highly uncertain, while the clock runs out on the current Congressional session. And if all that weren't enough, the EPA has just issued new regulations covering interstate emissions of conventional air pollutants that could effectively terminate the highly-successful sulfur-dioxide market upon which cap & trade for GHGs was based. Can cap & trade survive these travails, and should it?

Time will tell whether Waxman-Markey represented the high-water mark of cap & trade in the US, or if the hiatus since then has merely been a pause in a long process of refining and ultimately adopting this approach. Heaven knows W-M was a highly-imperfect vehicle for cap & trade, with its allocation of emissions allowances skewed to the highest-emitting sector and with hundreds of pages of extraneous provisions that could set up all sorts of unintended or undesirable consequences. The last year has also seen a proliferation of variations on cap & trade that call into question the original formulation of an economy-wide cap on emissions implemented by means of requiring emitters to purchase allowances from a gradually-shrinking national pool of emissions credits, with the proceeds doled out by Congress for purposes including clean energy R&D and deployment, deficit reduction, and mitigation of the impact on consumers and selected businesses. The Cantwell-Collins bill, for example, proposes returning most of the allowance revenue directly to consumers, while the Kerry-Lieberman bill would exclude the transportation fuels sector from cap & trade, but impose on it a sort of carbon tax based on the price of traded allowances. Both of these approaches have complex pros and cons, and as with original cap & trade their effectiveness at reducing emissions without imposing crippling costs on the overall economy depends critically on their detailed provisions, negotiated exceptions, and how they would actually be implemented.

Cap & trade has also come under fire on more fundamental grounds. Some critics have questioned the desirability of creating a vast new financial market for emissions when the shortcomings of other financial markets have caused so much harm, while others have suggested that investing in innovation to make low-carbon energy and efficiency much more cost-effective has greater potential to reduce emissions in a world in which developed-country emissions are being eclipsed by those in developing Asia.

Against this backdrop EPA Administrator Jackson's repeated assurances that she prefers legislated cap & trade to enforcement under the Clean Air Act have become increasingly divorced from reality. Her agency's determination to proceed with enforcement next year if no bill is passed, coupled with its newly-issued rules for power-plant pollution, serve mainly to remind the market that emissions allowances are not a new form of fiat currency, with intrinsic value backed by fractional reserves and the full faith and credit of the US government, but a fragile construct, the value of which can be eroded or erased at the whim of this and other regulators or the courts. Today's Wall St. Journal describes the impact of the new air pollution rules on the SOx market. Any potential participant who imagines that something similar couldn't happen to a future greenhouse gas allowance market is not paying attention.

So despite the apparent enthusiasm of the majority party's Senate caucus for enacting some kind of comprehensive climate and energy bill this year, presumably including elements of cap & trade, we're left with serious questions about whether this is an idea whose time has come and gone. From my perspective, putting a price on GHG emissions is still an essential step if we're serious about reducing them by more than the amounts that have resulted from the inadvertent combination of the recession, cheap natural gas, and existing incentives for renewable energy and efficiency. Cap & trade still has significant theoretical advantages over an arbitrary carbon tax as a means of imposing such a price, but as we've seen the likelihood of cap & trade being enacted in such a pure form seems low in the messy world of US politics--perhaps as low as the chances of a pure and simple carbon tax.

The odds against cap & trade look long at this point. Realistically, the time left for bringing a full-blown climate bill to a vote in the Senate is measured in weeks, rather than months, before the dynamics of the mid-term election campaign take over. Notions of passing an energy-only bill and then grafting on Waxman-Markey's climate provisions via a House-Senate conference committee seem even less likely to produce a mechanism that could survive the political upheaval that the mid-terms appear likely to produce. Nor should anyone be considering the last-gasp option of trying to pass climate legislation in a lame-duck session after the November election. As the Congressional Budget Office recently determined, any sort of controls on emissions are likely to reduce overall US employment--"green jobs" notwithstanding--so getting this right must be treated as more important than just getting something through before the current window closes. I will be watching developments in the weeks ahead with great interest.

Thursday, July 08, 2010

Rejecting Reactive Energy Policy

I see that BP now thinks it might be able to cap its leaking Macondo well this month, rather than sometime in August, barring a major hurricane or other disruption. That can't come a moment too soon, and not just for the obvious reasons. Every day that the well continues to spew oil into the Gulf of Mexico contributes to the mounting appearance of panic among policy makers, who have allowed--willingly or otherwise--the oil leak to hijack our progress towards a sensible energy policy that addresses both energy security and greenhouse gas emissions, based on a rational assessment of the tools available now and the timing of future options. The sooner the oil spill is off the front page, the sooner work can resume on that effort.

One of my old commodity-trading mentors liked to remind his more junior colleagues to "sell the news and buy the facts." By this he meant that those who get carried away by the emotion of current events are liable to be whipsawed when reason returns with a little time and perspective. More than a few members of Congress and the administration could benefit from that insight right now, as the understandable reaction to the oil spill whips up exaggerated rhetoric concerning our addiction to oil and the prospect of ending it sometime soon. Funny that we don't hear much about Europe's addiction to oil, which at least in terms of its relative reliance on oil imports looks even more serious than ours, despite astronomical motor fuel taxes and an emphasis on biodiesel that nearly matches our focus on ethanol. Since Europeans have consistently focused on this problem for years, perhaps it's just not as easy to solve as some Representatives and pundits imagine. If that's true, does it make sense to divert our focus away from a comprehensive approach to both emissions and broadly-defined energy security, in order to zero in on the most daunting element of both concerns?

First consider the oil-security portion of the problem, which in many ways was clearer in 2008, when oil prices zoomed past $100/bbl and headed for $150, until both they and the economy broke later that year. Americans got the message that conservation and efficiency were the top priorities for dealing with the cost of our oil addiction. The oil spill doesn't alter that. Although prices have come down considerably since mid-2008, they remain well above the pre-2004 level of $20-30/bbl or so, when gasoline was consistently under $1.75/gallon. As a result of those pressures, motorists cut back on their driving, and the Congress enacted--and this administration implemented--the most significant increase in Corporate Average Fuel Economy requirements in a generation, taking the new-car average CAFE standard to 34 mpg by 2016, including both passenger cars and light trucks/SUVs. Based on forecasts by the Energy Information Agency of the DOE, these rules, along with prudent conservation, should reduce US gasoline consumption by 2.6 million barrels per day by 2030, compared to pre-CAFE forecasts. And although I've disagreed with some of the specifics of these regulations, particularly for failing to correct outdated assumptions and allowing carmakers to double-count the benefit of electric vehicles, these new standards will eventually transform the US vehicle fleet and the energy it consumes.

We also shouldn't allow our revulsion at the oil spill to blind us to the emissions implications of our energy choices. In 2008 oil accounted for over 37% of US primary energy consumption and 35% of our greenhouse gas emissions, while coal contributed 22.5% of primary energy but 30.5% of emissions, including a whopping 91% of the CO2 emissions from the electric power sector. That distinction is crucial, because while we still have limited and only partially-effective substitutes for oil in transportation, where most of it is used, we possess a wide array of options for reducing the emissions from electricity generation, which consumed just 1.3% of total US oil demand last year. Several of these are economically viable today, though most require some level of subsidies or incentives. Nuclear power and geothermal energy are effective low-emission alternatives for baseload generation, while natural gas and renewables are already making significant inroads into coal's market share of overall power demand. And if implemented on a large-scale, integrated basis, carbon capture and sequestration could enable coal to continue to compete in a low-carbon electricity marketplace.

None of this suggests a return to the pre-spill status quo. The impact of the spill on the oil industry and the regulations that govern it will be significant and long-lasting, as it should be. At the same time, it would be hard to assess all of the public evidence assembled so far and not conclude that the accident that destroyed the Deepwater Horizon rig and led to the uncontrolled leak of many thousands of barrels per day of oil into the Gulf was entirely preventable--not by a ban on drilling in deep water, but by prudent adherence to sound operating principles and practices and the consistent enforcement of regulations to ensure that adherence by even the least-cautious operators. Yet as necessary as creating a universal culture of safety and caution in offshore drilling is, we can't let this urgent task divert our attention from the important long-term drivers of US energy policy and the actions--many already underway--necessary to address them. Good energy policy can handle all of this, while overly-reactive policies focused on the Macondo spill and the political opportunity it presents risk misallocating our priorities and creating a legacy that would make our long-term energy situation even more challenging than it already is.

Tuesday, July 06, 2010

Putting Energy Security At Risk

In catching up on a week's worth of news after my vacation, several stories caught my eye. The US Congress is apparently renewing its effort to cut tax breaks for the domestic oil & gas industry, while the administration intends to reinstate the offshore drilling moratorium that had been set aside by a federal judge in Louisiana. At the same time, 50 members of Congress have written to Secretary of State Clinton asking her to block a new pipeline to carry crude produced from Canadian oilsands to US refineries. However, even when you factor in the energy contribution of new initiatives such as the $2 billion in loan guarantees for solar power projects announced last week, the net result of all of this would be to undermine two of the central pillars of US energy security for the last several decades: producing more energy here at home and importing energy preferentially from stable and friendly neighbors like Canada and Mexico. For all the lip service about energy independence prompted by the Gulf Coast oil spill, these actions would ultimately make us more reliant on OPEC and unfriendly regimes.

Start with the industry subsidies, which Representative Blumenauer (D-OR) indicates are worth $6 billion per year. Setting aside the important context that these represent reductions in industry tax rates that even after these benefits are still higher than those most other US industries pay, this works out to an average of just $0.18 per million BTUs worth of domestic petroleum and natural gas production, or about $1.05/bbl. Compare that to $18.90/bbl in subsidies for corn ethanol and the equivalent of $2.60 per million BTU for electricity from wind and other renewable sources. As I've noted many times, oil & gas subsidies amount to a lot of money--though ethanol subsidies will come close to exceeding them in aggregate this year--not because they're overly generous, but because the scale of oil & gas still dwarfs all renewables combined.

I'm not a big fan of any of these subsidies, and I think it's high time that the ethanol subsidy, in particular, be brought more in line with its net energy contribution. At the same time, if we want a domestic energy industry that can make a meaningful contribution to covering our needs, then some level of tax breaks and other benefits appears necessary. And while the oil & gas industry is certainly mature and profitable, relative to biofuels and renewable electricity, it is also a global industry that competes with producers around the world, many of which are owned by the same OPEC members that have set the current oil price through effective constraints on their own production. And when drilling eventually resumes off the Gulf Coast, it is guaranteed to be much more costly. Adding higher taxes to these higher costs and tighter regulations must inevitably result in fewer wells being drilled and more oil imported--and from where?

Not from Canada, if the signers of the oilsands letter get their way. Oilsands production raises legitimate environmental concerns, both locally and globally. Producing oil from these deposits results in higher greenhouse gas emissions, though environmentalists usually fail to mention that tripling the emissions from production, compared to conventional oil, raises the total lifecycle emissions of the oil by just 17% compared to the average barrel refined in the US, because the vast majority of those emissions occur when the resulting petroleum products are burned, not when the oil is produced or processed. Now, a 17% increase in emissions is not nothing, but it must be weighed against two other factors. First, if oil prices are high enough, this oil will likely be produced anyway, even if we don't take it. Canadian companies have already signed deals to send oilsands crude to China, and they would do more of this if we turned up our noses at the stuff. Secondly, there's no guarantee that the oil we'd import from elsewhere would result in substantially lower emissions. That's particularly true for crude produced from heavy oil deposits in Venezuela and elsewhere, which average 14% higher lifecycle emissions.

Canada has been our largest foreign oil supplier for years, but with oilsands making up a steadily-growing share of Canadian output, restrictions on our oilsands intake would torpedo that relationship. With Mexican production going into steep decline, we would have to import more from Russia and the Middle East to make up the difference. That doesn't sound like a recipe for energy security to me.

Nor can greener sources close this gap any time soon. If you doubt that, take a look at Abengoa's Solana concentrated solar power project, which the Department of Energy just awarded a $1.45 billion loan guarantee. This technology uses the sun's energy to generate steam for electricity production, and its thermal storage allows it to do so more reliably, and over a longer portion of the day than photovoltaic cells. This is one of the most promising renewable energy technologies available, though at an effective cost of over $5,000 per kW of capacity it's hardly cheap. Yet when you convert its annual power output into equivalent barrels of oil (via the quantity of natural gas it would likely back out) it works out to less than 3,000 barrels per day. Replacing the energy contribution of Gulf Coast drilling or Canadian oilsands imports would require hundreds of such facilities, along with tens of millions of electric cars to enable their output to substitute for oil, very little of which is used to generate electricity in the US.

While renewable energy sources must inevitably meet a growing proportion of our energy needs in the years ahead, for the present US energy security still hinges on oil, which accounts for 92% of our net energy imports. If the Congress is serious about enhancing US energy security, then it should focus its efforts on reining in consumption, rather than erecting further barriers to oil produced here in the US or by our most reliable foreign supplier.