The Brazil Spill

Late yesterday I saw a headline reporting that Chevron was being assessed more than $10 billion for a spill from its drilling activities offshore Brazil last month. The story was later revised to clarify that the amount in question was associated with a civil lawsuit being filed by a Brazilian prosecutor, rather than an actual fine by the government petroleum or environmental agencies. Either way, the sum involved goes beyond surprising. Given the quantity of oil that actually leaked from an appraisal well at Chevron's Frade platform, it is grossly disproportionate to any objective gauge of the scale of the spill and the effectiveness of the response, which stopped the leak within a few days and reduced the surface oil slick to around one barrel within a couple of weeks, without any oil reaching shore. For a nation that aspires to sit at the top table globally, including a permanent seat on the UN Security Council, the reaction to this event raises questions about due process and rule of law. It could also backfire badly, in light of the substantial foreign investment Brazil is seeking in order to develop the enormous "pre-salt" oil deposits off its coastline.

My purpose in writing about this incident isn't to defend Chevron. I don't have enough of the details of what happened, and my well-known conflict of interest as a former employee and Chevron shareholder would undermine my credibility on that front in any case. From my perspective the noteworthy aspects of this spill are its magnitude and the Brazilian government's hasty and exaggerated reaction to it. In terms of its energy implications, it almost doesn't matter what company was involved, except that it's highly unlikely that a similar spill by Petrobras, the partially-privatized national oil company of Brazil, would have elicited the same response.

Start with the magnitude of the leak. No oil spill is a good spill, but the estimated 2,600 barrels that leaked into open waters about 120 miles offshore was at least two orders of magnitude (100 times) smaller than the kind of worst-case tanker spill that oil companies routinely plan and train to be able to handle. Suggestions by the Brazilian government that a global oil company and its drilling contractor, Transocean, weren't prepared to handle a spill of less than 3,000 barrels--more than one year after the Deepwater Horizon accident--belong in the realm of politics, rather than serious analysis.

In fact, any comparisons to the disaster that killed eleven men and leaked 4.9 million barrels of oil into the Gulf of Mexico over 89 days, fouling beaches and harming birds and marine life in four states must pale. The total cost to BP and its partners in the Macondo well isn't yet known, but between the $20 billion escrow fund for Gulf Coast cleanup and claims, along with the federal fines they face, the bill could come to $40 billion, or 4 times what a Brazilian prosecutor is apparently seeking for a spill roughly 2000 times smaller, that never threatened Brazil's coastline. The Frade leak is also modest in comparison to spills from tankers and other ocean-going vessels. Comparable or larger spills averaged more than 3 per year in the last decade, according to the International Tanker Owners Pollution Federation.

Another interesting feature of the spill is that it didn't result from an uncontrolled well blowout, as BP's did, but from subsea oil seeps that developed during the process of drilling into the complex geology of Brazil's technically challenging pre-salt oil deposits. Although these particular seeps were apparently directly related to the well Chevron was drilling, similar seeps are a common feature of many oil-rich offshore regions. NASA has estimated that the Gulf of Mexico experiences similar, naturally occurring seeps on the order of 500,000 barrels per year.

So if the Frade spill was relatively small and contained in short order, why should anyone other than Chevron's management and shareholders care if Brazil slaps them with large fines or a multi-billion-dollar lawsuit, in an apparent attempt to make an example of them and enforce what amounts to a zero-tolerance policy toward oil spills from its offshore projects? I'd argue that we all have something at stake here, indirectly. Brazil's pre-salt reserves offshore represent some of the largest recent oil discoveries and are expected to contribute 2 million barrels per day or more to global oil supplies by 2020. With output in Latin America's two other largest producers, Venezuela and Mexico, falling due to mismanagement of their otherwise ample resources, Brazil's output could be a key factor in oil prices in this decade and beyond.

Brazil is poised to become a major oil exporter, but Petrobras can't take on the scale and risk of this opportunity on their own, without foreign partners. It's not that they lack the technology; Petrobras is a leader in deepwater development. However, if they have to go it alone because the government's response to this event scares off its potential partners, they will be forced to reduce the size of their program, and oil prices will end up higher than they would have otherwise. While I'm entirely sympathetic to the sentiment behind a "zero-tolerance" attitude towards oil spills, whether from oil platforms, tankers or pipelines, I'm afraid it belongs in the same category as a zero-tolerance toward plane crashes: a standard to aspire to, but not one on which national development policies with global consequences can realistically be based.

Big Energy Stories of 2010

Many of the main energy trends of 2010 were predictable at the year's start, including the growing reliance of renewable energy on government assistance in the aftermath of the financial crisis, the debate over US greenhouse gas legislation, the emphasis on green jobs and competition with China, the delayed arrival of cellulosic biofuels, and the anticipation surrounding the product launches of the first mass-market electric vehicles. As interesting as all this was, the year in energy was dominated by two transformative events: the Deepwater Horizon accident and the multi-million barrel leak that ensued, and the less spectacular but no less profound awakening to the possibilities of the shale gas revolution.

The Deepwater Horizon disaster has been the subject of such extensive coverage and investigation that there's little I can add concerning the facts, other than to note that we have not heard the last word on just how much oil actually leaked into the Gulf of Mexico. The consequences of our response to the spill will be with us for a long time, both in terms of reduced offshore drilling activity and the decline in US oil output that must inevitably follow. The impact will reach far beyond the tens of thousands of workers whose livelihoods are directly or indirectly linked to the US offshore industry. Early in 2010 it looked like the industry would finally be offered access to areas that had been off-limits for decades, and by year-end not only has drilling in the central and western Gulf come to a near standstill, but the prospect of leases in the eastern Gulf and the mid-Atlantic coast has been foreclosed, perhaps permanently.

The psychological impact of the event could extend even farther than its physical and economic fallout. Whatever misgivings many people had about offshore drilling before the accident, the industry had built up trust through an impressive string of technical achievements--pushing the boundaries of resource accessibility from depths of a few hundred feet into nearly two miles of inhospitable ocean--and a solid reputation for safety. In the space of one day and the following weeks, that trust was shattered. Coming on the heels of a financial crisis that destroyed the trust of millions of Americans in the nation's largest financial institutions and markets likely amplified the effect. As fickle as we Americans sometimes seem, I wouldn't bet that this trust can be restored quickly, or to the same degree.

The shale gas revolution is a completely different kind of story, though it, too, has arguably been tainted by Deepwater Horizon. As it unlocks a resource that has converted the US natural gas supply outlook from one of scarcity and growing import dependence to expected abundance for decades, the gas industry can't assume it will receive the benefit of the doubt concerning the environmental impact of the drilling techniques that have made this turnabout possible.


Perhaps one reason the impact of cheap natural gas hasn't sunk in yet is that the main market price for gas, the futures price at the Henry Hub in Louisiana, doesn't have much relevance for the average consumer. Residential gas customers don't buy their gas in the million-BTU (MMBTU) lots in which the futures contract is denominated; we buy gas in therms--one tenth of an MMBTU--and by the time we see it on our bills all sorts of handling and distribution fees and mark-ups have been added on. But when you compare the price of traded gas in barrels of oil equivalent (BOE) to the price of West Texas Intermediate crude, the remarkable divergence of the last two years becomes obvious, as shown in the chart above. Between 2000 and 2006 gas and oil tracked each other closely, allowing for the greater seasonal volatility of the former. There were even periods when a barrel-equivalent of gas was worth more than a barrel of oil. Yet while oil and gas prices fell precipitously when the recession and financial crisis burst the various asset bubbles, they have diverged sharply since then, with oil advancing back up to today's $91/bbl and gas settling into the $20-25/bbl range in which we were accustomed to see oil prices a decade ago. Adjust that for inflation and you're looking at an average natural gas price for 2010 equivalent to $20/bbl in 2000.

That might help explain why the developers of renewable electricity sources such as wind have struggled so much this year, despite receiving $3.9 billion in direct cash grants from the US Treasury. They're not competing with $90 oil; the US generated less than 1% of its electricity from petroleum this year, through September. Instead, they're competing with gas at an effective price of $25/bbl or less. But if this is a new obstacle for some renewables, it surely represents a huge opportunity for the country as a whole, as we struggle to find our way out of the fiscal and competitive pit we've dug. Cheap energy has always been a key to growth, and right now, gas is the only energy source offering that without requiring an enormous up-front investment. It's no panacea, and it can't take on every burden without being spread so thin that its price advantage would disappear. But I'd much rather be looking at the possibilities this presents than at the constraints that high-priced oil and natural gas imposed only a couple of years ago.

That's probably as good a note as any on which to end the year. New postings will resume the week of January 3, 2011. In the meantime, I wish my readers a happy holiday season.

Oil Plumes and the Fate of the Spill

I'm as reluctant to insert myself into the debate over what happened to all the oil that leaked from BP's Macondo well between April 22 and July 15--when the second cap stopped the flow--as I was concerning the earlier controversy regarding flow-rate estimates. At the same time, I find the coverage of this story lacking in crucial details that could help us to understand how much of the oil evaporated into the warm air of the Gulf or degraded naturally, how much was collected, and how much potentially remains in the sea. The assessment issued by the National Oceanic and Atmospheric Administration (NOAA) on August 4, 2010 has been disputed by some scientists, and reports of lingering oil plumes add to the public's apprehension that the pieces don't quite add up. But although I don't have nearly enough information to conclude which group is closer to being right, I feel much more confident in pointing out where their arguments seem weak.

Let's begin with the estimate of the total quantity of oil leaked into the Gulf, which lately seems to have become cast in stone at 4.9 million barrels (205.8 million gallons.) This is the crucial starting point for any analysis of how much of it remains in the Gulf. This figure appears to be based on the estimate by the Flow Rate Technical Group of an average rate of around 58,000 bbl/day for the 85 days that the well was leaking. NOAA indicates an uncertainty for this figure of +/- 10%, but with all due respect to the scientists who worked on it, that seems excessively precise for something that was never measured directly.

There are only two ways I know of to measure such a flow, as distinct from estimating it. The most accurate involves gathering all the oil flowing during a given interval--say, a day--and gauging the tanks into which it flowed at the beginning and end of the interval. From a quick review of the transcripts of BP's technical briefings, it appears that the largest quantity of oil that was actually collected in a 24-hour period equated to a flow rate of about 24,000 bbl/day, though this represented only a portion of the total flow, with the remainder continuing to leak into the sea due to containment limitations. So we know the rate must have been higher than that figure, but not how much higher. The other way to measure oil flow is with a flow meter. It's a pity that BP's "Lower Marine Riser Package", the second cap and valve assembly installed on the well, didn't include this capability. I don't even know if it would have been feasible, given the pressures and high flows of oil and natural gas involved.

In the absence of direct flow measurements, the Flow Rate Technical Group had to rely on sophisticated techniques for calculating the flow, based on the observed velocity of the fluid leaving the well and a complex set of assumptions--grounded in a limited amount of actual data--concerning the gas:oil ratio of the fluid, the rapid expansion of the gas coming out of solution within the space over which the velocity was determined, as well as the changing pressure and temperature within this regime. Tricky stuff, particularly considering how much of the observed flow was attributable to gas, rather than oil, as I noted in May. I'd also note that since the estimated 58,000 bbl/day flow rate is at the top of the range of flow rates observed from other oil wells in the history of the industry, it's quite possible that the range of uncertainty for the total amount leaked is not only wider than +/- 10%, but also non-symmetrical, with more downside than upside. I'm sure we will hear much more about this in the future, not least because the size of the fine BP would ultimately pay for the leak depends on it. That's not the concern of the moment, however.

The pie chart in NOAA's report indicating the breakdown of the different fates of the oil that leaked has gotten a lot of scrutiny. Some reports have interpreted it as indicating that only a quarter of the oil remains in the marine environment. I wouldn't read it that way. Instead, I'd see three distinct categories for the oil's current status. The first and least ambiguous concerns the oil physically collected directly from the well, skimmed from the surface, or burned off, constituting an estimated--and only partly measured--25% of the uncertain total discussed above. This oil is clearly no longer in the water. The next category is oil that is likely no longer in the water, and that is the portion of the "Evaporated or Dissolved" segment that evaporated. If the oil had all reached the surface, I wouldn't be at all surprised if most of that segment should be attributed to evaporation; this was, after all, light, sweet oil with a high proportion of volatile fractions. The problem is that we don't know how much of the oil that leaked a mile down made it to the surface. The portion that didn't, which in NOAA's parlance was dissolved, naturally dispersed or chemically dispersed--potentially up to 49% of their total estimate--could still be in the water column, along with the 26% "Residual"--less the unknown portion actually broken down by bacteria and other processes. And it's some of this remaining oil that makes up the plumes we've been hearing about.

The undersea oil plume currently in the news was found in June by scientists from the Woods Hole Oceanographic Institute. They describe it as being at least 22 miles long, 1.2 miles wide, and 650 ft. high. The total volume of the plume, assuming it filled that entire rectangular solid, would be about 3.6 trillion gallons. However, the critical data point that I didn't see reported in any of the newspaper accounts I read was the concentration of oil in that water. According to the report on the Woods Hole site, the concentration of specific oil-derived molecules ("BTEX") is "in excess of 50 micrograms per liter". Adjusting for the density of the chemicals in question, that means that they found oil-related concentrations of approximately 57 parts per billion by volume. So by my math, the total volume of these chemicals within the plume is on the order of 200,000 gallons, or under 5,000 bbl. Unless these chemicals are only the tip of the iceberg in terms of oil derivatives in the plume--and Woods Hole hints that there is more--then we're talking about less than 0.1% of the 4.9 million barrels estimated to have leaked into the Gulf. In other words, while a plume like this might be potentially serious for aquatic life, it's not clear how much doubt its existence casts on NOAA's analysis of where all the oil went.

I will be very interested in seeing further refinements of all these estimates in the weeks and months ahead. Perhaps the media will even include more of the details crucial for putting it into perspective.

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.

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.

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.

Expand the Presidential Commission on Deepwater Horizon

Amid the other news this week, including the President's address to the nation on the Gulf Coast oil disaster and his meeting with BP officials yesterday, the announcement on Monday of the five remaining members of the Presidential Commission to assess the "environmental and safety precautions...to ensure an accident like this never happens again" seems to have sunk without a trace. I don't recall seeing it mentioned in either the Washington Post or Wall St. Journal. I ran across it in the New Orleans Times-Picayune online last night. Yet it's clear that the staffing of such a commission has an enormous influence on its approach and ultimate findings, and on both counts I am seriously concerned. From my review of their published bios, I cannot discern that any named member possesses any direct training or experience with the technology and practices of offshore drilling, a field that in its own way is every bit as complex as aviation, terrorism, or other past subjects of similar commissions.

The gold standard for Presidential commissions investigating accidents of national importance was set by the Rogers Commission on the explosion of the Space Shuttle Challenger shortly after its launch on January 28, 1986. The commission--not just its technical staff--was packed to the rafters with figures of national prominence and deep expertise in aviation and space technology and operations. Headed by former Secretary of State William P. Rogers, it included Neil Armstrong, the first astronaut on the moon, Dr. Sally Ride, first American woman in space, Gen. Chuck Yeager, first pilot to fly faster than the speed of sound, Gen. Donald Kutyna, an expert on spacecraft launches and accidents, and Joseph Sutter, the "father" of the Boeing 747, along with an aeronautical engineering professor, an aircraft designer, a solar physicist, and several other leading experts on aerospace matters. Last but never least was Richard P. Feynman, Nobel Prize-winning physicist, quintessential iconoclast, and perhaps the smartest and most inquisitive human being ever to walk the earth, with the possible exception of Albert Einstein. It was, of course, Dr. Feynman whose famous ice-water experiment with the solid rocket boosters' O-ring material uncovered the root cause of the disaster.

Each of the fine individuals President Obama has named to the Deepwater Horizon Commission brings valuable experience and an important perspective, including that of a professional environmentalist, biological oceanographer, an accomplished physicist and manager of science, and a pair of lawyers with past experience in various aspects of the Exxon Valdez spill and cleanup. I have no objection to any of them individually. However, collectively they are not a patch on the Rogers Commission.

The obvious solution to this problem is that the President should immediately expand the commission to include at least two additional members, and preferably four, with deep expertise and experience in oil & gas drilling, geoscience, and offshore industry operations. It is absolutely essential that the commission includes people who understand not just the ocean environment, but also subsea geology, drilling technology, and relevant oil & gas industry practices, first-hand. They should of course have no connections to BP or to any other company that stands to lose or gain from the commission's findings. While that might narrow the field somewhat, it would not rule out the faculties of the leading petroleum engineering and geosciences university departments, or a wide swath of recently-retired experts in these fields. The US is blessed with abundant expertise in this area, and it would be a crime to exclude it from this vital study.

Despite a nearly universal desire to accelerate our shift away from petroleum in the wake of this disaster, we are nowhere near being able to turn our backs on either the energy or convenience we get from oil. As I've shown in a series of postings since the accident occurred, offshore drilling is a crucial component of US domestic energy supplies, and no current alternative energy source operates at either the scale necessary to replace it, or in sufficiently direct substitution for the transportation energy of which oil is our principal provider. The less oil we produce domestically, the more we will have to import.

In this context it is of the highest importance that the commission be given the best chance possible to interpret the findings of the technical investigations of what went wrong on the Deepwater Horizon rig, and to determine how to structure an approach to offshore drilling that reduces the risks posed by human error and technical failures to the maximum degree possible. Every member of the commission has important contributions to make in this regard, but without the match between relevant experience and the nature of the problem exemplified by the Rogers Commission, the Deepwater Horizon Commission will be operating at least partly in the dark.

I don't often urge my readers to take action on the subject of one of my blogs, but in this case, if you share my concerns about the omission of critical experience from the staffing of this commission, you should contact the White House and your Representatives in Congress to express that view.

Walruses and Wake-Up Calls

I just finished watching today's hearing on offshore drilling operations and safety by the Energy and Environment Subcommittee of the House Energy & Commerce Committee, featuring the CEOs of ExxonMobil, Chevron, and ConocoPhillips and the US heads of Shell and BP. Rather than giving in to the temptation to deliver a rant on the current level of dysfunction in Congress, I want to highlight a few things that stood out for me in the testimony of the assembled chiefs of the largest oil companies in the US, and then focus on the central dilemma that was explored in the hearing.

1. Although couched in careful language referring to the importance of completing the full investigation of the circumstances involved, the heads of the other companies came as close as anyone could reasonably expect to saying that BP's well design for Macondo and the processes for drilling it would not have passed muster in their companies.
2. A series of very interesting questions focused on the prevalence and effectiveness of "stop-work" policies, in which any employee or contractor on a rig can call a halt to drilling if he or she sees something that looks dangerous. BP indicated it had such a policy in place on Deepwater Horizon. However, John Watson, the CEO of Chevron (in which I own stock) pointed out that in order for such policies to be credible, employees who exercise that initiative must be recognized and rewarded. After all that we've learned about the warning signs on this well, I suspect I'm not alone in having difficulty imagining a "stop-work" call having been welcomed in this case. Corporate culture matters.
3. In one sentence, ExxonMobil CEO Rex Tillerson calmly demolished the half-baked notion that every deepwater well be required to have a relief well drilled in parallel, just in case it would be needed. (This was done in such a low-key way that the questioner didn't seem to grasp what had been said.) Instead of mentioning the doubling of cost involved, Tillerson pointed out that this strategy would double the risk of every project. The risks of a parallel relief well would be the same as for the exploration well, because it would be another exploration well.
4. Sometime later Congressman Scalise from Louisiana picked up on this theme with a question that should have galvanized the room, but somehow didn't. He asked BP North America President Lamar McKay if the relief wells at Macondo were being drilled to the same plans as the blown-out exploration well. Answer: yes, with oversight at every step of the way.

I'm sure I'm neglecting other important comments, though I'm also dismissing the first hour-and-a-half of the hearing, which was frittered away in a blather of posturing and wild "gotcha" chases involving extinct Gulf Coast walruses and dead experts' telephone numbers. But despite all of this, I thought the crux of the problem concerning how to address the other Gulf Coast deepwater leases came through in some astute questions and surprisingly candid answers. Many of the members recognized the importance of the resources involved to the economy of the region and to the energy and national security of the country, and the serious damage that the drilling freezes are inflicting. At the same time, they highlighted the breakdown of the public's trust in the industry to extract these resources safely, despite the statistical evidence that, with 14,000 deepwater wells drilled globally, the Macondo well stands as an anomaly at a single company. The industry representatives also made it very clear that the primary defense against the effects of uncontrolled blow-outs such as this one lies in prevention, rather than clean-up, for which the industry was not adequately prepared to handle a spill on this scale. That's a situation that can't be rectified within six months, and possibly not six years, though the innovations and inspiration coming out of this disaster ought to provide a substantial kick-start to bringing spill-response into the 21st century.

That leaves our government with a monumental dilemma regarding the resumption of offshore drilling. One answer is the total risk avoidance of the current freeze, which appears politically motivated, but for which its supporters might point to some of today's testimony. Unfortunately, the freeze will inevitably increase our reliance on imported oil, because as much as we recognize the need to move in the direction of renewable energy and other alternatives, there is currently no other meaningful substitute for the oil that we now get from deepwater, unless we are willing to consider the risk tradeoffs involved in targeting new domestic oil production on onshore and shallow-water resources that are presently off-limits, such as those in the Arctic National Wildlife Refuge. Another, admittedly riskier solution would be to allow companies other than BP, using designs and procedures in conformance with the industry guidelines developed by the American Petroleum Institute and broadly similar to those just recommended by the Department of Interior, to resume drilling on projects already under way, while the investigations and Presidential commission determine the longer-term measures appropriate for new leases. I lean strongly toward a selective resumption, but the responsibility involved is literally awesome and properly resides with our elected leaders.

Winners and Losers from the Gulf Spill

A comment on my recent posting on oil substitution opportunities in the aftermath of the Gulf oil spill got me thinking about potential winners and losers from the broad changes that seem likely to ensue from this disaster. Some of these outcomes would depend on new laws and regulations that could alter the basis of competition within the oil and gas industry, between it and other energy sectors, and between specific energy technologies. However, I also wouldn't discount the possibility of enduring changes in our perceptions of the oil industry and of the ways in which we use oil.

Until President Obama acted to freeze new deepwater leases and drilling permits, and even drilling that was already permitted and underway--a freeze that MMS appears to have used its own initiative to extend to all offshore drilling at any depth--natural gas seemed an obvious winner from any constraints on offshore oil drilling. Now I'm less sure, even if the President is apparently ready to allow drilling in shallow waters to resume. Superficially, gas should come out ahead, because the Gulf of Mexico accounts for a smaller fraction of US natural gas production than oil production, at 11% vs. about 30%. Yet it's also my understanding that offshore gas fields tend to decline more quickly than offshore oil fields, so that gas production in the Gulf of Mexico could drop faster than oil output under a deepwater drilling ban.

More importantly, shortfalls in Gulf Coast gas production could have a bigger impact on US natural gas prices than reduced Gulf Coast oil production would on crude prices. That's because the gas market is still mainly regional, connected by relatively small and expensive global flows of LNG, while oil is a truly global commodity with significant flexibility to work around localized production problems. Although the comparison is only approximate, you can see this effect by examining the impact of Hurricanes Katrina and Rita on the prices for Henry Hub natural gas and West Texas crude oil. Between August 25 and October 5, 2005, the gas futures price spiked by 45%, while WTI actually dropped by 7%, because of the extent of refinery shutdowns caused by the storms. (Gasoline futures shot up by 33% but quickly fell back to where they had been.) In other words, ensuring that gas remains cheap enough to be an attractive substitute for oil in transportation and other uses depends on either restoring gas drilling in the Gulf at all depths pretty quickly, or expanding onshore shale gas production even faster than recently.

The situation for renewables looks much less ambiguous. Even though, as I have pointed out frequently, renewable electricity sources such as wind, solar and geothermal power don't substitute for oil in any meaningful way, at least not without millions of electric vehicles that will take many years to roll out, perception is a good bet to trump hard-nosed realism in this situation. Extending the stimulus benefits for renewables, especially the cash grant program that substitutes for the tax equity market that stalled during the financial crisis, looks a lot likelier today than prior to April 20, despite the massive federal budget deficit. Similarly, the ethanol industry stands a better chance of getting the administration to relax the 10% blending limit on ethanol in gasoline--a limit that would otherwise stall ethanol growth until E85 takes off, if ever. The EPA is expected to rule on this soon.

Nuclear power looks like another big beneficiary of the oil spill, and again not because nuclear power would substitute for much oil in the near-term, though nuclear blogger Rod Adams properly reminded me recently that electricity from nuclear plants could be just as effective at backing out heating oil as natural gas, via efficient geothermal heat pump systems. Electrification could also displace some oil in rail transport, depending on the cost-effectiveness of electrifying long-distance freight tracks and locomotives. But in any case, nuclear stands as the likely surviving "conventional energy" pole of any grand compromise on energy and climate legislation, now that offshore drilling has become a dead weight instead of a vote-attractor in the Kerry-Lieberman climate bill. It is also the only other low-carbon energy source currently available on a scale large enough to substitute for the energy we get from oil, though not for oil's attributes as an energy carrier and storage medium.

Assessing whether the US oil & gas industry wins or loses from all this is harder than it looks. Other than BP--an obvious loser--some companies stand to gain from improved economics and increased emphasis on onshore drilling in places like the Bakken formation, from better onshore gas and LNG economics, or from picking up opportunities that BP won't be offered. Even if they're not barred from bidding on new leases around the world, BP just won't look like anyone's partner of choice, at least for a while. And don't forget OPEC, which from the first day of this disaster looked like the single biggest winner from our misfortune. Anything that makes non-OPEC oil production more difficult or costly shifts more market power to OPEC, which is sitting on top of more than three-fourths of the world's proved oil reserves, much of it still fairly cheap to develop.

With one very large caveat the US public, as both consumers and taxpayers, looks like the big loser from the likely energy outcomes of this spill--as distinct from those whose livelihoods and environment have been affected directly. We'll all pay more for energy, at least in the medium term, and we'll pay more to subsidize alternatives that still need help to become competitive, as well as those that should already have been weaned off subsidies after decades at the trough. We might turn that prospect on its head, however, if the spill drastically changed our attitude towards energy consumption. Until this event, oil was largely invisible. Every day in the US a thousand times as much oil as has been leaking into the Gulf flows through pipelines, tankers, barges, rail cars and tank trucks, and eventually through hoses into the fuel tanks of our cars, trucks, trains and planes, all unobtrusively out of sight. This undersea gusher provides a rare visual hint of the sheer scale of our oil consumption. Could seeing all that oil lead Americans to think differently about how they use energy, and from which sources? Let's check back a year after the well is plugged and the story has moved off the front pages.

The Fate of BP

Yesterday I participated in an online panel (registration required) exploring the implications of the Gulf Coast oil spill. As the panelists were waiting for the webinar to begin, the moderator suggested a few questions he thought might come up. Although we never got to the one on the future of BP, a quick read of today's news suggests this remains a highly relevant question for the public and for BP's investors, retailers, and suppliers. While I'm not ready to hop on the bandwagon in thinking the company might end up being taken over by a competitor, I don't think we can rule out that possibility. In any case, it seems almost certain to end up a very different company than it was prior to April 20, 2010. That could have implications not just for the oil & gas industry, but also for the renewable energy sector, in which BP has been an active participant.

The first article that caught my eye this morning pondered whether Mr. Hayward was likely to survive as the company's CEO. Anyone presiding over a 34% decline in market value within the space of a few weeks--and not as part of an overall market crash--ought to be concerned about his tenure. Still, I would be as surprised as several of the experts the Wall St. Journal interviewed if the company's board saw fit to fire him before the well was secured and the investigations completed, barring credible evidence of serious errors of judgment on his part. In any case, I find the speculation about a takeover of the company much more interesting.

Even in its weakened state, BP is still a mighty big fish for someone else to swallow. As of this morning's trading, its market capitalization stood at $119 billion. As an article in today's Financial Times highlighted, that rules out all but a small handful of possible acquirers. For me the potential of an acquisition hinges less on the relative size of BP and the various firms that might be able to absorb it, than on the underlying "industrial logic." The fact that the firm is about $68 B cheaper than it was in mid-April doesn't make it a bargain, because it has acquired a large new set of liabilities, the value of which can't be accurately assessed, yet. That's true even short of a finding of criminal negligence, which various politicians have hinted at, but that remains entirely speculative at this point. I believe the real issue is whether after all damages and claims are paid the lasting harm to BP's brand and reputation is so severe--and so tangible--that its assets and operations would clearly be worth more within another large energy company.

First consider BP's capacity to cover the costs of the spill cleanup and pay all the claims accumulating against it. The media and politicians have focused mainly on the company's first quarter 2010 profits of either $5.5 B or $6 B, depending on how you measure them, though I believe that its annual cash flow and the disposition of that cash flow provide a clearer picture of its ability to pay for damages. A quick look at the financials in its 2009 Annual Report shows that from 2007-2009, BP's annual cash flow from operations averaged $30 B per year. This was spent roughly two-thirds on its capital projects budget and one-third on paying dividends to shareholders. At the end of 2009 the company held just over $8 B in cash and cash equivalents. I also scanned the report for any indication that BP had external insurance coverage for such events. I couldn't find any, and media reports indicate they were self-insured. However, even without insurance, BP could potentially pay out many tens of billions of dollars of cleanup costs, damages and penalties, if any, over a period of 3-5 years.

That's not to say that all of that cash flow would be available for such purposes--some maintenance investments would be required in any case--or that this could be done without a significant impact on both the market valuation of the company or its underlying long-term enterprise value. In effect, this is probably a big part of what the market is discounting into the stock price: a sort of rough consensus estimate of the expected value of the impact on the company of the likely payouts. This includes things as simple as the reduced value to investors of a stock paying a lower dividend (or none, as several lawmakers have suggested) to the consequences of constraining its reinvestment in hydrocarbon production that depletes a little bit every day. Other concerns weighing on the value include the perceived effect of any consumer boycotts--there's apparently one gathering strength on Facebook and in multiple YouTube videos--or the loss of government contracts as a result of the possible findings of the various investigations. That could run the gamut from losing contracts to supply the US military with fuel to losing leases to develop new resources. These are also some of the elements that any potential acquirer would assess, to gauge how much of the discount on BP is attributable to factors that could be quickly reversed under other management and an untainted brand.

Based on my experience working at Texaco, Inc. following the Pennzoil verdict, which led to the company's bankruptcy and the payment of a multi-billion dollar settlement, even if BP weren't subject to an acquisition in the short term, its future trajectory might still be so altered by this event and its costs that it would eventually end up much smaller, or perhaps as the subject of an acquisition much later. I see several relevant analogies to Texaco/Pennzoil. First, this matter will continue to occupy the attention of management long after the well is finally plugged. Claims and lawsuits will drag on for months and probably years, and top executives will be testifying before a series of investigations, tort actions, and perhaps even criminal trials. Day-to-day operations probably wouldn't suffer, but it would be very difficult to keep the firm's strategy sharply focused under such conditions. I'd also be surprised if BP didn't miss out on critical opportunities along the way.

Then there's the question of how to pay for claims and damages. At some level, if they exceeded cash on hand and easy borrowing capacity, it would likely make more sense to management to sell assets--or transfer them directly to plaintiffs--rather than funding payouts at the expense of the investments on which the future of the company would depend. The firm will also be under considerable pressure from investors to continue paying out strong dividends, or to resume them if they are suspended at some point in the process. But regardless of how BP chooses to cover its spill-related liabilities, its future capital budgets seem likely to be constrained, and projects with longer payouts or less attractive returns would fall below a higher cutoff line. Given the relative returns of renewable energy projects compared to oil & gas projects, BP's renewables could be an early casualty, unless they are deemed crucial to rebuilding the company's reputation.

While an acquisition will remain possible as long as BP's stock is this depressed, it seems likelier that the company will survive and eventually rebound, though perhaps not to former levels. But even if none of its competitors is willing to take on the big risks an acquisition would entail, let alone navigating anti-trust regimes that are likely to be much less flexible in the wake of the financial crisis, this possibility will have BP's management looking over their other shoulder--the one that the US government isn't already camped out on, adjacent to the "boot on the neck"--until this entire episode is behind them.

I'd like to close with a reminder that a consumer boycott of BP stands a much bigger chance of harming one of your neighbors than it does of hurting BP. Most of the service stations in the US aren't owned and operated by the company whose brand you see on the polesign; they are mainly independent businesses that have a supply contract either directly with the company, or with a regional distributor who has such a relationship. So if you boycott your local BP station, chances are you are not affecting BP, which will resell the product on the wholesale market, but a local business owner who is struggling in a very tough business with slim margins. And in the case of BP, many of these retailers didn't even choose BP. Depending on how long the site has been in their families, many would have originally signed up with Amoco, ARCO, or even Sohio (Standard Oil of Ohio, which BP acquired in two stages in 1978 and 1987.)

Setting Energy Goals

With the failure over the weekend of BP's "top kill" effort, the odds that the oil will continue flowing until relief wells can be completed--in months, rather than days--have gone up considerably. In addition to the accumulating economic and environmental consequences, that also means that media attention on the oil spill and the questions it raises about US energy policy will remain front and center for at least that long. In the absence of any formal effort to guide the discussion, we're likely to end up with the usual array of random energy musings and rants, built around an understandable, if unrealistic message of ending our reliance on oil now. That would be a shame, because this sad situation gives us a unique opportunity to refine our thinking about our energy future when much of the country is focused on it.

One comment that I've heard frequently in the last few weeks is that this spill serves as a reminder that oil companies are drilling in depths of a mile or more of water, far offshore, because the easy oil is mostly gone. There's more than a grain of truth in that view, though the full picture turns out to be rather more complicated. While it's certainly true that the mature oil regions of the US have been drilled like a pincushion for 150 years, and that many of the large, important undeveloped oil resources we know about are on the Outer Continental Shelf, there's still a lot of oil in other places, both onshore and in the nearer offshore, in shallower water, that we've chosen not to exploit. Access has driven development at least as much as geology in the last decade or two. In the US, we've made an implicit decision to focus oil and gas development on the Gulf Coast, not because it had the most resources--though it has plenty--or because it was less-densely populated , but presumably because it had already been developed so extensively. In effect, this approach sacrificed the Gulf Coast--whether that sacrifice was ever envisioned in quite the terms we're seeing today--to give us the oil we needed while preserving the beaches and viewscapes of our other coasts.

There's also an international dimension to this issue of access. At the same time the US offshore oil industry has been constrained in a box with only one open end pointed toward ever deeper water, the publicly-traded international oil companies have been progressively squeezed out of world-class oil opportunities elsewhere, as a result of full or partial nationalization and through competition with national oil companies that are guided not by market forces, but by geopolitical ones. As a result of these parallel trends, the major oil companies have focused their efforts where they retained both access and some key advantages over many of their state-owned competitors, usually in the form of technology or management of complex projects. In other words, they've been pushed to the frontiers, such as the deepwater Gulf of Mexico.

While many lament the powerlessness of the US government to plug the leaking well, and some like Admiral Allen ponder whether the government should acquire that capability for itself--a topic for a future posting--we shouldn't ignore that even without banning deepwater drilling the federal government has the power to shift the industry toward less-risky opportunities by expanding its access to onshore and near-offshore resources that are more attractive and less difficult, but have been restricted for years.

Another common response to the spill relates to the incentives for moving away from oil. If we just had more incentives for biofuels and for electric vehicles, goes this thinking, we could quickly wean ourselves off oil and not only do away with the need to import it, but also to drill for it in such challenging locations close to home. While many of my recent postings have been aimed at showing why this can't happen quickly, I want to disassociate myself from what Tom Friedman calls the "petro-determinist" approach. I'm not here to tell you that breaking our addiction to oil is impossible; if I thought that I wouldn't have spent much of my career working on or promoting alternatives to oil. At the same time, with the current euphoria for cleantech and green jobs, someone needs to remind us that if breaking our oil addiction requires a 12-step program, we are only on about step 2. More importantly, it matters how we get there: Not all paths are equally valuable, and we don't have good enough information to determine which ones will work best in replacing a hydrocarbon-based energy system that evolved over the better part of a century.

Consider vehicle electrification, which depends on batteries. If the goal is putting the largest number of mainly-electric vehicles on the road in the shortest time, then we might be on the right track, handing out extremely generous tax credits for consumers to buy fully- or partially-electric vehicles, along with billions of dollars in manufacturing tax credits, grants, loans and loan guarantees for the factories to build those cars and the batteries they require, in addition to installing the recharging infrastructure they'll need. But if our goal is to reduce oil consumption and the emissions that accompany it, then this approach could be counterproductive, particularly if growing concerns about the availability and sourcing of the crucial raw materials necessary to build today's state-of-the-art electric vehicle batteries are correct. Simply put, the batteries in a Prius-style hybrid that never plugs in save many more annual gallons of oil per kWh of onboard storage than the batteries in a plug-in hybrid (PHEV) or full EV. That's true for two reasons that are a function of physics, rather than economics: a) fuel economy is subject to diminishing returns, in which moving from 25 mpg to 50 mpg saves twice as much total fuel as going from 50 mpg to 100 mpg and b) PHEVs and EVs require a lot more battery capacity per car than conventional hybrids.

What both of these examples share in common is that focusing on specific paths instead of outcomes can be counterproductive and multiply risk, instead of reducing it. An oil policy that started with the recognition that we must produce significant quantities of oil domestically during a lengthy transition to alternative and renewable energy sources, and that asked where the best-placed resources were to provide that supply with the least risk, might arrive at a different answer than one that resulted from a series of isolated decisions to place a growing sequence of oil resources off-limits. Likewise, a fuel economy and emissions-reduction strategy centered on annual fuel savings, rather than rewarding consumers and carmakers for concentrating the largest number of batteries into each vehicle, would better leverage vehicle-electrification technology to reduce our reliance on oil. That's particularly relevant when batteries look like a short-to-medium term constraint and their raw materials might impose longer-term limits until we have better battery technology based on cheap and plentiful raw materials.

If the Gulf Coast spill represents another crisis too important to waste, then it's also one that is too important to relegate to unfocused wishes for an oil-free world within the next few years. The best "use" of the spill is to convene a concrete national conversation on how to provide the US with energy that is as affordable and environmentally-acceptable as we can realistically make it in the in the short, medium and long-term. That will require examining all the trade-offs involved, as well as how the balance between conventional energy and renewables and other alternatives is likely to shift in the years ahead. If that did nothing else but get us clearly focused on outcomes, rather than picking our favorite pathways, then it might constitute a positive outcome from an otherwise miserable episode in our nation's energy history.

FYI, tomorrow (June 2) at 1:00 PM EDT I'll be on a webinar panel hosted by The Energy Collective to discuss the implications of the oil spill for the future of energy. If you're interested, please sign up using this link.

The Panic Button

I suppose it was inevitable that we would arrive at the moment in the ongoing oil spill crisis at which the baby would be thrown out with the bath. That moment came at about 7 minutes into President Obama's press conference on the spill yesterday. After announcing the suspension of offshore drilling in Alaska, the cancellation of planned lease sales for the Gulf of Mexico and Virginia, and the extension for six months of his administration's moratorium on new drilling permits for deepwater wells, he ordered a halt to 33 exploration wells currently being drilled in the Gulf, excluding the two relief wells for the leaking Macondo prospect. Everything up until that point could be considered as reasonable, prudent, and expected responses by an administration faced with an unprecedented and still-unfolding environmental and economic disaster. But while stopping work on the 33 projects already underway might look like prudence to some, it could ultimately have economic consequences rivaling those of the spill.

The President's order is based on the recommendations of the 30-day investigation of offshore drilling carried out at his request by the Department of Interior. The report recommended a number of new standards for equipment and procedures for use in deepwater drilling, and it follows that it will require some time to implement all of these changes, both on the part of the drilling industry and in the government agencies charged with regulating and inspecting these activities. Absent from this report and from the President's order is any path for companies with rigs already drilling wells in deep water to quickly demonstrate that they are already sufficiently in compliance with these recommendations--which I must add have been issued without the final results of the various investigations into the actual causes of the accident, and thus must make significant assumptions concerning the relative importance of equipment failure, procedures, and human error.

I understand that the President has an obligation to protect the residents, businesses and environment of the Gulf Coast region from further harm. Another blowout or leak could turn disaster into total catastrophe. Yet the safe drilling record of the other firms operating in the Gulf does not give us any reason to expect that allowing the projects in question to continue would constitute such an unwarranted risk. It's also worth recalling that all of the drilling projects now required to suspend operations have already passed the emergency inspections the President ordered in the immediate aftermath of the Deepwater Horizon explosion and sinking. These inspections were completed on May 9.

What does this order mean on a practical level? A number of companies that paid for leases conveying the right to explore for and develop hydrocarbons in the Outer Continental Shelf, and that subsequently invested significant effort and expense in planning and obtaining permits for the exploration of these leases--instead of other leases offshore Angola, Brazil, or elsewhere--and that signed contracts with drill-ship operators and many other suppliers must now abrogate those contracts, declare force majeure, or pay off their suppliers and abandon these wells as if they were all dry holes. It is simply not realistic to imagine that any of these companies can afford to leave these rigs and crews in place for six months, waiting for the government to either show them a way forward or deliver another moratorium extension. Instead, the companies will scramble to redeploy this equipment and some of these workers to projects outside US waters, while arguing urgently with the government--and probably in court--that they should either be allowed to complete these projects or awarded substantial damages.

Please don't imagine that I'm inviting you to a pity party for the oil industry. While some of the firms involved, particularly those with minority, non-operating stakes in these projects, are smaller players, most are big international firms with global operations and multi-billion dollar capital budgets. This move will be a financial setback for them, but they will recover and shift their efforts elsewhere, to the extent they can. When the moratoria end--if they do under the current administration--they will step back into the Gulf of Mexico OCS, but probably much more tentatively, as appropriate for the significantly higher "above-ground risk" involved--essentially a measure of the relative reliability or capriciousness of the legal and regulatory system in which they're dealing. They will not be the big losers from this decision. That honor is reserved for many of the individuals and businesses along the Gulf Coast that have added jobs and made investments to serve this growing market. In other words, the President's decision will compound the economic damage to a Gulf Coast already reeling from the impact of the spill.

We should take some consolation that the President didn't shut down the 591 deepwater wells that are already producing oil and gas in the Gulf. The mere fact that this was reported suggests it had probably been under serious consideration. As I've noted on numerous occasions in the last several weeks, the oil and gas we produce from the Outer Continental Shelf is a crucial source of domestic energy and vital to our energy security. However, that importance also extends to our offshore drilling capacity, which was put at risk by this decision.

After an event like this spill, no one should expect things to continue exactly as they were. However, the New York Times is right to call the President's response "partly a political exercise aimed at showing that his administration is on top of the unfolding disaster in the Gulf of Mexico." Instead of singling out the companies that were directly involved in the Deepwater Horizon accident for this time-out to prevent further spills, he has chosen to punish the entire industry and all its stakeholders in the region, including the most safety-conscious and diligent operators with unblemished records. Halting all of BP's projects, or even all projects involving Transocean, could have been defended as a sensible precaution. Freezing everything looks like the act of an administration that is so out of its depth in this situation that its fundamental instinct is to eliminate any possibility of another problem from this source on its watch. Unfortunately, American energy consumers will be paying for years for this extreme level of risk aversion.

Disclosure: My portfolio includes investments in Chevron, which appears to be the operator of several of the projects affected by this order.

Preparing for the Next Big Spill

In the last few weeks numerous industry experts and outside observers have pointed out that the technology for dealing with major oil spills has advanced much more slowly than the technology for finding and producing oil under increasingly marginal conditions. That's an important insight, because if all the leaking oil were being safely and efficiently collected and processed, our main focus would be on the circumstances of the tragic accident that destroyed the Deepwater Horizon and killed 11 workers, rather than on the slow-motion disaster looming off the Gulf Coast. As it debates raising the oil spill fee collected on all the oil the US produces or imports, the Congress should consider setting aside a portion of any incremental revenue to fund research on improved oil spill remediation methods and technology, rather than just accumulating more money to spend in the future on today's relatively ineffective technology, should another large spill occur.

I have no doubt that the assessment of the factors contributing to the Deepwater Horizon accident and the ensuing spill in the Gulf will lead to new regulations on offshore drilling. With some luck, those will contribute to reducing the risk of a recurrence, though regulations can never eliminate the possibility of someone making a bad decision, with tragic consequences. But even if President Obama imposes an extended moratorium on deepwater drilling, there will eventually be another big spill, somewhere--if not from a deepwater well, then from one of the many additional supertanker cargoes the US would require when domestic oil production resumes the long slide that deepwater drilling had arrested and was beginning to reverse. Either way, it's not too early to start thinking about the next spill, while this one is still fresh in our minds.

There's no shortage of ideas for dealing with the oil slick off the Gulf Coast. Online innovation sites are gathering suggestions, and the former head of Shell's US operations, John Hofmeister, has one of his own concerning the use of supertankers to skim and collect the oil. Even actor Kevin Costner has a technology to offer. Decades of offshore drilling without a major accident like this, but with plenty of spills from oil tankers, other vessels, and ports, pipelines, and other facilities, have not prepared the industry to handle the current leak, the rate of which can't even be measured precisely. But even for the spills they were designed to address, the present array of booms, skimmers, and chemical dispersants, plus bags and shovels for what eventually reaches the shore, seems decidedly low-tech. It's hard to conceive of anyone finding the current approaches truly adequate to the task.

Pending legislation in Congress would raise the ceiling on payments out of the Oil Spill Liability Trust Fund from $1 billion to $5 billion per incident, to be funded by increasing the per-barrel fee assessed on oil produced in or imported into the US from $0.08/bbl to $0.34/bbl. (This is the same bill that would extend unemployment benefits and a dog's breakfast of expiring tax benefits, including a retroactive extension of the $1.00/gallon biodiesel production tax credit back to 1/1/10, when it expired.) It's not clear how this would apply to the current situation, particularly since the Constitution seemly unambiguous in its prohibition on ex post facto laws. In any case, the House Ways and Means Committee estimates that the higher fee would raise an extra billion dollars a year for future oil spills. It wouldn't take very much of that to fund the R&D necessary to bring oil-spill containment and remediation technology into the 21st century, through a combination of targeted tax credits and direct funding of good ideas.

Even though this fee is levied on oil companies, we should understand clearly that consumers will eventually pay most of this increase at the gas pump, to the tune of about a half-cent per gallon. US refiners, who are experiencing low margins, are in no position to absorb it, and the market will pass it on to us. If it's going to come out of our pockets, then shouldn't at least some of it go to making sure that future oil spill response efforts have much better tools to work with? I'll bet the folks in Louisiana wish that some of the $1.5 billion currently sitting in the Oil Spill Liability Trust Fund had been invested that way over the last 20 years.

FYI, next Wednesay, June 2, at 1:00 PM EDT I'll be on a webinar panel convened by The Energy Collective to discuss the implications of the oil spill for the future of energy. If you're interested, please sign up using this link.