As the US Senate debates its version of the $819 billion economic stimulus bill passed by the House on Wednesday, I hope they will give consideration to a smarter alternative to sweeping income tax cuts, the stimulative effect of which seems questionable. An op-ed in yesterday's Washington Post by economist Martin Feldstein offers a better idea: "a temporary refundable tax credit to households that purchase cars or other major consumer durables." In fact, I'd like to modify Professor Feldstein's idea for a car rebate to ensure that it not only boosts sales, but moves us in the direction of higher fuel economy. Let's offer consumers a one-year, $2,000 per car refundable tax credit, but only for vehicles that exceed the Corporate Average Fuel Economy of the 2008 model new car fleet: 31.4 mpg for passenger cars and 23.6 mpg for the light truck segment that includes SUVs.
Although this criterion stops short of pushing large numbers of Americans into hybrid vehicles, there are good reasons to keep the bar broad, low and technology-neutral, here. In a recession and with gas as cheap as it is, fuel economy is unlikely to be the paramount concern of potential car-buyers, even if memories of $4 gasoline are seared in their brains. Despite high gas prices for much of the year, hybrids only accounted for 2.4% of sales in 2008. Carmakers can't possibly ramp up hybrid production by enough this year for them to affect overall car sales by a meaningful percentage, relative to the crippling industry sales decline of 18% last year. Moreover, there are already tax credits in place for both hybrids and plug-in hybrids, though subsidies for the former are now phasing out. By contrast, roughly half the cars sold last year already beat last year's CAFE performance, and I'll bet Detroit and the imports would be very happy to sell more of those models, even if they didn't generate as much profit per car.
Shifting the average fuel economy of a whole year's sales up by an mpg or two doesn't nearly sound as "green" as doubling the sales of 50 mpg hybrids, but in fact it would save a lot more oil and reduce emissions by a larger proportion, as well. Recall that the biggest, juiciest target for fuel savings is not the shift from 35 mpg subcompacts to 100 mpg plug-in hybrids, but getting drivers out of 15 mpg SUVs and into 25 mpg crossovers and minivans. And if Detroit is going to get back on its feet sufficiently to repay those government loans any time soon, it must quickly resume selling large numbers of the cars it already makes, even as it infuses more energy-saving technology into future models.
We want our stimulus dollars to boost the flagging economy as effectively as possible, without making other problems worse in the future--beyond the unfortunate but unavoidable consequence of larger deficits. Targeted tax credits for efficient cars and appliances make more sense in this context than stuffing $500 into the pockets of every American, who might prudently save it or use it to pay down debt. Those are worthy outcomes in the long run, but not what an urgent fiscal stimulus is intended to accomplish.
Friday, January 30, 2009
Thursday, January 29, 2009
The Ripple Effect
The fallout from the collapse of oil prices in the last quarter of 2008 is still rippling through the economy. Yesterday's announcement of a $34 billion write-off by ConocoPhillips, the third-largest US oil company, is the latest signpost of this phenomenon. It's not confined to the oil exploration and production segment, either. We've seen the earnings of non-integrated refining companies drop, along with the announcement by Valero, the largest US refiner, that it would idle its 225,000 barrel per day Texas City refinery for several weeks. At the same time, ethanol producers continue to struggle with low margins and financing problems. In short, only a quarter after fuel companies were reporting record earnings, the tables have turned and consumers are in the catbird seat, still paying less than half of last summer's pump prices.
Conoco's losses didn't surprise Wall Street, and they shouldn't have surprised my readers, either. In late December I examined the impact of low year-end prices on the oil and gas reserves carried on the books of the oil companies. The reasonable change in SEC regulations for calculating their value, which goes into effect next January, came a year too late to prevent massive accounting losses in the oil patch. However, I missed the impact on the value of acquisitions, to which ConocoPhillips may have been particularly vulnerable, having been assembled not just from one big merger, but from a long string of deals. The bones of Burlington Resources, Tosco, and Unocal's refining and marketing business are all buried in there, somewhere. Tomorrow we'll see whether ExxonMobil and Chevron report similar losses, though it's notable that Shell, which reports earnings under UK accounting standards, saw only a 28% drop in fourth quarter earnings, compared to 4Q07.
Meanwhile, the refining business has returned to a more normal situation, compared to the boom years of a few years ago and the dire straits of last month, when spot gasoline was selling for less than light sweet crude oil. The recent bounce in gasoline prices has put refiners back in the black. Since December, the calculated futures market "crack" spread, a simple estimate of the margin on making gasoline, has improved from a average loss for the month of $1.40/bbl to a profit of around $5.75/bbl, while the "3-2-1 crack", which includes the benefit of higher diesel fuel prices, has improved from about $5/bbl to roughly $10/bbl. Although this is a healthy margin, it won't result in banner profits, when US refineries are running at an average utilization of 82%. That's a lot of idle capacity, whether in the form of entire plant shutdowns, as at Texas City, or of reduced run rates at most plants. It's a reflection of just how far US gasoline demand has fallen that until this week, gasoline inventories continued to build, in spite of such low output.
Ethanol producers aren't faring much better. The operating margin, or "crush spread", that I calculate from today's Chicago Board of Trade corn and ethanol quotes is only $0.25/gal. That's a far cry from crush spreads over $1.00/gal that were routine in 2006 and 2007, and that helped fuel an ethanol plant construction boom that has now gone bust, at least temporarily. A growing number of ethanol producers have filed for Chapter 11 protection, and the largest of these, VeraSun Energy, has been forced by market conditions to idle 12 of its 16 "biorefineries." If it emerges from bankruptcy at all, VeraSun, which had been one of the most aggressive consolidators of the industry, will be much smaller. These are hardly the signs of a thriving biofuels industry, upon which a core strategy of US energy policy rests.
Any temptation to find morbid satisfaction in the diminished fortunes of the transportation fuels industry should be tempered by a clear understanding that its dips carry consequences that reverberate for years, because of the planning and construction lags inherent in its big projects. The oil platforms deferred or canceled this year will squeeze output in the mid-2010's, while the gas wells not drilled in 2009 and 2010 will tighten supplies much sooner. And even on the presumably greener side of the industry, an ethanol sector rocked by corporate bankruptcies and distilleries abandoned before they ever started up will be poorly positioned to deliver on the highly-ambitious renewable fuels targets set by the Congress in late 2007, and mooted for further expansion during last year's presidential campaign. The days of profits some regarded as unearned windfalls have clearly ended; however, if the fuels industry doesn't make "normal" profits this year and next, we will all pay for it down the road.
Conoco's losses didn't surprise Wall Street, and they shouldn't have surprised my readers, either. In late December I examined the impact of low year-end prices on the oil and gas reserves carried on the books of the oil companies. The reasonable change in SEC regulations for calculating their value, which goes into effect next January, came a year too late to prevent massive accounting losses in the oil patch. However, I missed the impact on the value of acquisitions, to which ConocoPhillips may have been particularly vulnerable, having been assembled not just from one big merger, but from a long string of deals. The bones of Burlington Resources, Tosco, and Unocal's refining and marketing business are all buried in there, somewhere. Tomorrow we'll see whether ExxonMobil and Chevron report similar losses, though it's notable that Shell, which reports earnings under UK accounting standards, saw only a 28% drop in fourth quarter earnings, compared to 4Q07.
Meanwhile, the refining business has returned to a more normal situation, compared to the boom years of a few years ago and the dire straits of last month, when spot gasoline was selling for less than light sweet crude oil. The recent bounce in gasoline prices has put refiners back in the black. Since December, the calculated futures market "crack" spread, a simple estimate of the margin on making gasoline, has improved from a average loss for the month of $1.40/bbl to a profit of around $5.75/bbl, while the "3-2-1 crack", which includes the benefit of higher diesel fuel prices, has improved from about $5/bbl to roughly $10/bbl. Although this is a healthy margin, it won't result in banner profits, when US refineries are running at an average utilization of 82%. That's a lot of idle capacity, whether in the form of entire plant shutdowns, as at Texas City, or of reduced run rates at most plants. It's a reflection of just how far US gasoline demand has fallen that until this week, gasoline inventories continued to build, in spite of such low output.
Ethanol producers aren't faring much better. The operating margin, or "crush spread", that I calculate from today's Chicago Board of Trade corn and ethanol quotes is only $0.25/gal. That's a far cry from crush spreads over $1.00/gal that were routine in 2006 and 2007, and that helped fuel an ethanol plant construction boom that has now gone bust, at least temporarily. A growing number of ethanol producers have filed for Chapter 11 protection, and the largest of these, VeraSun Energy, has been forced by market conditions to idle 12 of its 16 "biorefineries." If it emerges from bankruptcy at all, VeraSun, which had been one of the most aggressive consolidators of the industry, will be much smaller. These are hardly the signs of a thriving biofuels industry, upon which a core strategy of US energy policy rests.
Any temptation to find morbid satisfaction in the diminished fortunes of the transportation fuels industry should be tempered by a clear understanding that its dips carry consequences that reverberate for years, because of the planning and construction lags inherent in its big projects. The oil platforms deferred or canceled this year will squeeze output in the mid-2010's, while the gas wells not drilled in 2009 and 2010 will tighten supplies much sooner. And even on the presumably greener side of the industry, an ethanol sector rocked by corporate bankruptcies and distilleries abandoned before they ever started up will be poorly positioned to deliver on the highly-ambitious renewable fuels targets set by the Congress in late 2007, and mooted for further expansion during last year's presidential campaign. The days of profits some regarded as unearned windfalls have clearly ended; however, if the fuels industry doesn't make "normal" profits this year and next, we will all pay for it down the road.
Monday, January 26, 2009
The Big Chunks
In my first posting of the year, I suggested that the new administration faced a big decision about our national energy policy, between making either energy security or our response to climate change its top priority. Whichever they choose, President Obama's team needs a framework for implementing that selection, and I'd like to suggest one that appears to go distinctly against the grain of their current thinking. Rather than focusing mainly on renewable energy, a successful US energy strategy must come at this problem from the perspective of its largest elements--the fuels and technologies that account for more than 90% of our current energy supply--not the smallest current pieces, no matter how rapidly they are growing. Renewables are important and destined to become much more so, but we should assess them in terms of their usefulness in displacing those conventional energy sources that are in most urgent need of substitution, as we proceed to reduce emissions or improve energy security.
Oil is still by far our largest energy source, comprised of two main components, domestic production and oil imports. Together they accounted for 39% of the 101.6 quadrillion BTUs (quads) of energy that the US consumed in 2007, split 28%/11% between imports and US production, respectively, though the latter understates the contribution of domestic oil drilling, which also provides around one quarter of our natural gas output. As shown in the pie chart below, natural gas comes next, followed by coal and nuclear power. These five "big chunks" together make up 93% of the total energy we consume, 91% of our electricity generation, and roughly 99% of the energy used for transportation.
Next consider how large renewable energy is likely to grow over the next two decades. The latest forecast from the US Department of Energy anticipates the contribution of wind, solar, geothermal and biomass, including biofuels and biomass-power, to grow from 3.5% of US energy consumption in 2007 to 7.7% by 2030. This estimate still seems fairly conservative, so let's be generous and assume it could reach 15-20%. I know that won't seem aggressive to the most ardent advocates of renewables, but considering the obstacles that would need to be overcome, including making cellulosic biofuel cost-competitively on an industrial scale and expanding non-dispatchable forms of renewable electricity production such as wind and solar into market segments currently dominated by on-demand power from gas turbines and coal plants, it's plenty ambitious. Thus with hard work, dedication and ample investment in the sector, we just might be able to grow renewable energy large enough in 20 years to replace one of those five big blocks I mentioned earlier. Which one to choose depends on the priority of emissions reductions vs. energy security.
The most popular target today would probably be imported oil, widely regarded as the major source of energy insecurity. While obtaining 20% of our future energy from renewables doesn't quite match up with the current 28% from imported oil, with some help from efficiency improvements it just might do the trick. Of course, that would mean that the energy from wind, solar and other electricity-producing technologies would have to displace petroleum products by means of the mass marketing of plug-in electric vehicles. 21 years is not a tremendously long time for that to happen, given the decade that it has taken non-plug-in hybrids to reach a 2.4% market share, but if we're dreaming, let's dream big. So by 2030 we've displaced foreign oil, captured all that money we used to send overseas, and presumably beggared the Middle East. Unfortunately, we have only made a medium-sized dent in our greenhouse gas emissions in the process. Transportation was the number two source of those, and cutting its contribution roughly in half--which is probably optimistic, given the emissions associated with current biofuels--would reduce our 2006 emissions by 15%.
Another popular alternative would be to go after coal's market share. In theory getting 20% of our energy from renewables ought to be sufficient to cut coal use by about 85%--or perhaps only 70% if we allow that we'd be unlikely to burn liquid biofuels such as ethanol and biodiesel to make electricity. Still, cutting 70% of the emissions from coal would reduce US GHG emissions by nearly 25% (very large file), which would put us well on the way to cutting them by 80% by 2050, as envisioned by the administration and Congress. Unfortunately, the fastest-growing renewable energy technologies, wind and solar power, do not compete very well with coal-fired power plants. The latter can run 24/7, providing baseload and mid-load dispatchable power, electricity that is there whenever someone flips the switch, while wind is intermittent, producing power less than a third of the time--often when demand is low--and solar is cyclical and seasonal, making its best contribution into the afternoon demand peak.
When we take these factors into account, wind and solar turn out to be most interchangeable with our least objectionable fossil fuel, natural gas. In this regard, at least, Mr. Pickens' Plan is built on solid ground. But would we really want to displace a large portion of the 23% of our energy we get from natural gas with renewables, or back out the 32% of US natural gas used for electricity, in order to substitute it for petroleum products in cars or elsewhere? At a glance, the energy security and greenhouse gas benefits of this seem less compelling than the direct substitution of renewables for imported oil noted above. And I haven't even mentioned the possibility of using renewables to displace nuclear power, because that would at best net us zero in terms of either energy security or greenhouse gas benefits.
What this framework does, then, is to translate our competing energy priorities into their resultant choices about how best to employ the limited quantities of renewable energy we are likely to have within the next two decades, relative to the major elements of our current energy supply and demand balance. In addition, our preferences for which big chunk of conventional energy on which to focus our efforts will determine which particular renewable energy technologies look most advantageous and deserving of government help in the form of R&D, investment and deployment incentives. From where I sit, this looks like a much more sensible approach than the status quo one that assumes all renewables are equally beneficial in our complex energy economy and that supports them all, indiscriminately.
Oil is still by far our largest energy source, comprised of two main components, domestic production and oil imports. Together they accounted for 39% of the 101.6 quadrillion BTUs (quads) of energy that the US consumed in 2007, split 28%/11% between imports and US production, respectively, though the latter understates the contribution of domestic oil drilling, which also provides around one quarter of our natural gas output. As shown in the pie chart below, natural gas comes next, followed by coal and nuclear power. These five "big chunks" together make up 93% of the total energy we consume, 91% of our electricity generation, and roughly 99% of the energy used for transportation.
Next consider how large renewable energy is likely to grow over the next two decades. The latest forecast from the US Department of Energy anticipates the contribution of wind, solar, geothermal and biomass, including biofuels and biomass-power, to grow from 3.5% of US energy consumption in 2007 to 7.7% by 2030. This estimate still seems fairly conservative, so let's be generous and assume it could reach 15-20%. I know that won't seem aggressive to the most ardent advocates of renewables, but considering the obstacles that would need to be overcome, including making cellulosic biofuel cost-competitively on an industrial scale and expanding non-dispatchable forms of renewable electricity production such as wind and solar into market segments currently dominated by on-demand power from gas turbines and coal plants, it's plenty ambitious. Thus with hard work, dedication and ample investment in the sector, we just might be able to grow renewable energy large enough in 20 years to replace one of those five big blocks I mentioned earlier. Which one to choose depends on the priority of emissions reductions vs. energy security.
The most popular target today would probably be imported oil, widely regarded as the major source of energy insecurity. While obtaining 20% of our future energy from renewables doesn't quite match up with the current 28% from imported oil, with some help from efficiency improvements it just might do the trick. Of course, that would mean that the energy from wind, solar and other electricity-producing technologies would have to displace petroleum products by means of the mass marketing of plug-in electric vehicles. 21 years is not a tremendously long time for that to happen, given the decade that it has taken non-plug-in hybrids to reach a 2.4% market share, but if we're dreaming, let's dream big. So by 2030 we've displaced foreign oil, captured all that money we used to send overseas, and presumably beggared the Middle East. Unfortunately, we have only made a medium-sized dent in our greenhouse gas emissions in the process. Transportation was the number two source of those, and cutting its contribution roughly in half--which is probably optimistic, given the emissions associated with current biofuels--would reduce our 2006 emissions by 15%.
Another popular alternative would be to go after coal's market share. In theory getting 20% of our energy from renewables ought to be sufficient to cut coal use by about 85%--or perhaps only 70% if we allow that we'd be unlikely to burn liquid biofuels such as ethanol and biodiesel to make electricity. Still, cutting 70% of the emissions from coal would reduce US GHG emissions by nearly 25% (very large file), which would put us well on the way to cutting them by 80% by 2050, as envisioned by the administration and Congress. Unfortunately, the fastest-growing renewable energy technologies, wind and solar power, do not compete very well with coal-fired power plants. The latter can run 24/7, providing baseload and mid-load dispatchable power, electricity that is there whenever someone flips the switch, while wind is intermittent, producing power less than a third of the time--often when demand is low--and solar is cyclical and seasonal, making its best contribution into the afternoon demand peak.
When we take these factors into account, wind and solar turn out to be most interchangeable with our least objectionable fossil fuel, natural gas. In this regard, at least, Mr. Pickens' Plan is built on solid ground. But would we really want to displace a large portion of the 23% of our energy we get from natural gas with renewables, or back out the 32% of US natural gas used for electricity, in order to substitute it for petroleum products in cars or elsewhere? At a glance, the energy security and greenhouse gas benefits of this seem less compelling than the direct substitution of renewables for imported oil noted above. And I haven't even mentioned the possibility of using renewables to displace nuclear power, because that would at best net us zero in terms of either energy security or greenhouse gas benefits.
What this framework does, then, is to translate our competing energy priorities into their resultant choices about how best to employ the limited quantities of renewable energy we are likely to have within the next two decades, relative to the major elements of our current energy supply and demand balance. In addition, our preferences for which big chunk of conventional energy on which to focus our efforts will determine which particular renewable energy technologies look most advantageous and deserving of government help in the form of R&D, investment and deployment incentives. From where I sit, this looks like a much more sensible approach than the status quo one that assumes all renewables are equally beneficial in our complex energy economy and that supports them all, indiscriminately.
Friday, January 23, 2009
A Painful Adjustment
A quick read through the morning paper reminded me just how much the future path of energy prices and energy sector investment depend on the economy, and on the measures intended to speed its recovery. It doesn't seem like so long ago that the situation was exactly reversed, with the economy faltering in part due to a massive oil price shock. Now, the very things that energy strategists and planners most took for granted--the steady pace of demand growth driven by an expanding global economy and unimpeded access to financing for projects large and small--have become the biggest uncertainties affecting the industry. A random selection of articles and op-eds in today's Wall Street Journal seems to confirm that these uncertainties won't be resolved quickly. Indeed, they cannot be, until the recession has done its unpleasant work of re-directing employment and investment away from sectors that grew unsustainably large during the parallel housing and consumer debt bubbles, and towards new and better uses.
In the Money & Investing section we read, "Oil Rallies on Stimulus Hopes." With the volatile expiration of the February crude oil contract behind us, March West Texas Intermediate settled at $43.67 yesterday. But the rally in question, of four days duration, doesn't change the fact that this same March contract has declined by about 70% since its high last July, and by 10% since last December 31. No one expects a return to last year's peaks, but the hopes for a quick agreement on an economic stimulus package ought to be tempered by the enormity of the task that package is intended to accomplish, and by our questionable ability to sustain the requisite deficits long enough to see its programs through.
The challenge is illustrated by an article that provides the kind of good news/bad news mix typical of a deep recession: "Home Construction at Record Slow Pace." At December's seasonally-adjusted annual rate of 550,000 units, new home construction is apparently at the lowest level since at least 1959, and half its rate of a year earlier. This is clearly bad news for anyone working in home construction and all the businesses that supply it. However, it's good news for current homeowners, since less supply will eventually lead to higher prices. It also reflects the reality that the home construction sector cannot be maintained at the scale it reached during the housing bubble. Too many of the country's resources were devoted to building new and bigger homes, fueled by unrealistically high levels of debt. Finding more productive and sustainable employment for the people and businesses affected is just one task of the stimulus, and of the recession itself. The same is true for a consumer-goods sector, including retail, that also grew unsustainably large, driven by massive home-equity and credit card debt.
For all the hopes pinned on the stimulus, its Achilles heel is the scale of the deficits involved, on top of a preexisting budget deficit and the enormous loans made to the banking sector. While the projected US deficits in 2009 and 2010 might look manageable as a share of GDP, their absolute magnitude raises serious, unanswered questions about funding. "The World Won't Buy Unlimited U.S. Debt," points out one op-ed in the Opinion section. I understand the risks of doing too little and the worries about a liquidity trap, in which monetary policy loses its effectiveness, or entering a deflationary spiral; however, the stimulus carries risks of its own. Nor can we forget that ours is not the only government taking on more debt to fund an urgent stimulus. "Expect the World Economy to Suffer Through 2009," conclude Ian Bremmer and Nouriel Roubini, of the Eurasia Group and NYU, respectively.
We need to keep all of this in mind, as we assess the stimulus package that the Congress and new administration are designing. Every assertion that it should be as big as possible should be balanced by a reminder that, because we will go deep into debt to fund it--with unpredictable consequences--it should not be one dollar larger than truly necessary. In particular, that means that provisions that can't be shown to have a high likelihood of putting people and businesses to work productively in the next 18 months should be deferred until we have a clearer sense of the receptiveness of global lenders for the mountain of Treasury bonds and T-bills the government must issue to pay for them. I'm glad I don't have to make those choices, and I wish our elected leaders the greatest success in this endeavor. Much more than just energy markets hinges on it.
In the Money & Investing section we read, "Oil Rallies on Stimulus Hopes." With the volatile expiration of the February crude oil contract behind us, March West Texas Intermediate settled at $43.67 yesterday. But the rally in question, of four days duration, doesn't change the fact that this same March contract has declined by about 70% since its high last July, and by 10% since last December 31. No one expects a return to last year's peaks, but the hopes for a quick agreement on an economic stimulus package ought to be tempered by the enormity of the task that package is intended to accomplish, and by our questionable ability to sustain the requisite deficits long enough to see its programs through.
The challenge is illustrated by an article that provides the kind of good news/bad news mix typical of a deep recession: "Home Construction at Record Slow Pace." At December's seasonally-adjusted annual rate of 550,000 units, new home construction is apparently at the lowest level since at least 1959, and half its rate of a year earlier. This is clearly bad news for anyone working in home construction and all the businesses that supply it. However, it's good news for current homeowners, since less supply will eventually lead to higher prices. It also reflects the reality that the home construction sector cannot be maintained at the scale it reached during the housing bubble. Too many of the country's resources were devoted to building new and bigger homes, fueled by unrealistically high levels of debt. Finding more productive and sustainable employment for the people and businesses affected is just one task of the stimulus, and of the recession itself. The same is true for a consumer-goods sector, including retail, that also grew unsustainably large, driven by massive home-equity and credit card debt.
For all the hopes pinned on the stimulus, its Achilles heel is the scale of the deficits involved, on top of a preexisting budget deficit and the enormous loans made to the banking sector. While the projected US deficits in 2009 and 2010 might look manageable as a share of GDP, their absolute magnitude raises serious, unanswered questions about funding. "The World Won't Buy Unlimited U.S. Debt," points out one op-ed in the Opinion section. I understand the risks of doing too little and the worries about a liquidity trap, in which monetary policy loses its effectiveness, or entering a deflationary spiral; however, the stimulus carries risks of its own. Nor can we forget that ours is not the only government taking on more debt to fund an urgent stimulus. "Expect the World Economy to Suffer Through 2009," conclude Ian Bremmer and Nouriel Roubini, of the Eurasia Group and NYU, respectively.
We need to keep all of this in mind, as we assess the stimulus package that the Congress and new administration are designing. Every assertion that it should be as big as possible should be balanced by a reminder that, because we will go deep into debt to fund it--with unpredictable consequences--it should not be one dollar larger than truly necessary. In particular, that means that provisions that can't be shown to have a high likelihood of putting people and businesses to work productively in the next 18 months should be deferred until we have a clearer sense of the receptiveness of global lenders for the mountain of Treasury bonds and T-bills the government must issue to pay for them. I'm glad I don't have to make those choices, and I wish our elected leaders the greatest success in this endeavor. Much more than just energy markets hinges on it.
Wednesday, January 21, 2009
Taxing Carbon
While many observers were focused on the most obvious first represented by yesterday's presidential inauguration, I was thinking about another one: Barack Obama is the first US President elected on a platform that included putting a price on our emissions of carbon dioxide and other greenhouse gases to the atmosphere. Although the likelihood of that happening this year has receded somewhat, due to the weak economy, it would be just as momentous in a year or two. Either way, it's not a long interval in which to decide the best way to go about altering a practice that humanity has taken for granted since the discovery of fire. There are some very strong views on each side of the carbon tax vs. cap & trade dilemma.
Last week, the CEO of ExxonMobil made news when he came out in favor of a carbon tax, though in fairness, while Mr. Tillerson's remarks at the Woodrow Wilson Center in Washington, DC reflected a clear preference for a carbon tax over cap & trade, they fell short of advocating the immediate implementation of either. But however one chooses to parse his comments, the concerns he raised about cap and trade are entirely legitimate and must be addressed forthrightly in the political debate on limiting emissions of greenhouse gases (GHGs). One concern in particular seems likely to carry much more weight now than it would have a year or two ago:
"It is important to remember that a cap-and-trade system requires a new market infrastructure for traders to trade emissions allowances. This new 'Wall Street' of emissions brokers will take the emphasis away from the goal of reducing carbon emissions and focus its attention on trading on price volatility. For businesses and consumers, these market gatekeepers and resultant price swings add cost and they create uncertainty."
The idea of setting up a new market that will benefit traders and speculators is bound to raise some hackles, when these are widely viewed as having contributed to last summer's oil-price spike and to the larger financial crisis. If it weren't for one crucial shortcoming of a carbon tax, I would find Mr. Tillerson's arguments for its simplicity and predictability quite compelling, and the other justifications for cap & trade might be reduced to mere quibbles. To see why, let's consider the practical aspects of implementing either approach.
The ultimate goal of either cap & trade or a carbon tax is to reduce GHG emissions, in order to limit the extent of global warming and consequent changes in the earth's environment. These cuts are intended to begin gradually but quickly gather momentum to deliver substantial cumulative reductions in emissions within a few decades. Both cap & trade and a carbon tax would lend themselves to being carefully phased in, and either one could be rendered revenue-neutral, to minimize the undesired economic effects of a policy designed to alter our consumption patterns in fundamental ways, at least with regard to energy-intensive goods and services. In either system, vulnerable consumers and industries with few alternatives could be protected or given more time to adapt. And while cap & trade creates a strong incentive for companies and sectors with the lowest costs for reducing emissions to maximize their cuts and trade the resulting surplus with others who face higher costs, a carbon tax could be modified to allow some trading around the edges, capturing at least part of that benefit for the economy. The biggest distinction may also be the most basic: how is the price of emissions set in the first place?
In effect, the choice between a carbon tax and cap & trade boils down to a choice between the cost of CO2 being set by committee, or by markets. Whatever else disappointed investors might think about them, markets excel at price discovery. While I have little doubt that a blue-ribbon panel of economists, scientists and engineers could come up with a reasonable estimate of the level of carbon taxation required to reduce emissions by the desired amount, I have much more confidence in the logic of setting the desired level of emissions reduction in each year, and then allowing the price to emerge from the interaction of those whose livelihoods depend on meeting these limits, in real time. That preference is rooted in the risks of each approach.
If our hypothetical Carbon Price Committee sets the carbon tax too low, emissions will exceed the goal and they can ratchet the tax higher in the next period. However, if they set it too high, we'll beat the emissions targets, but the economy will shift too rapidly, and jobs and output in energy-intensive sectors will be shed faster than new, "green" jobs and products can be created. The result might look a lot like what we're experiencing today. Cap & trade has its own risks, though they tend to focus more on the effectiveness and efficiency of the program than on its consequences for the economy. Mr. Tillerson is right to identify problems of "verification and accountability," though there is already a large and growing body of experience in managing these issues, from the EU Emissions Trading System and from voluntary emissions trading--and the statutory SOx and NOx trading--that has been going on in the US for more than a decade.
In the final analysis, the decision to put a price on greenhouse gas emissions matters more than how it is implemented. At the same time, the latter choice will determine how effectively those reductions are achieved, and at what cost to the rest of the economy, where most of us will continue to earn our livelihoods and save for our future needs. I hope that the new administration will weigh these considerations carefully, in consultation with the Congress and all affected stakeholders, including our international trading partners, who could be affected in many ways by the result. The idea of a carbon tax deserves a fair hearing alongside cap & trade, once our leaders agree on the timing of limiting our emissions.
Last week, the CEO of ExxonMobil made news when he came out in favor of a carbon tax, though in fairness, while Mr. Tillerson's remarks at the Woodrow Wilson Center in Washington, DC reflected a clear preference for a carbon tax over cap & trade, they fell short of advocating the immediate implementation of either. But however one chooses to parse his comments, the concerns he raised about cap and trade are entirely legitimate and must be addressed forthrightly in the political debate on limiting emissions of greenhouse gases (GHGs). One concern in particular seems likely to carry much more weight now than it would have a year or two ago:
"It is important to remember that a cap-and-trade system requires a new market infrastructure for traders to trade emissions allowances. This new 'Wall Street' of emissions brokers will take the emphasis away from the goal of reducing carbon emissions and focus its attention on trading on price volatility. For businesses and consumers, these market gatekeepers and resultant price swings add cost and they create uncertainty."
The idea of setting up a new market that will benefit traders and speculators is bound to raise some hackles, when these are widely viewed as having contributed to last summer's oil-price spike and to the larger financial crisis. If it weren't for one crucial shortcoming of a carbon tax, I would find Mr. Tillerson's arguments for its simplicity and predictability quite compelling, and the other justifications for cap & trade might be reduced to mere quibbles. To see why, let's consider the practical aspects of implementing either approach.
The ultimate goal of either cap & trade or a carbon tax is to reduce GHG emissions, in order to limit the extent of global warming and consequent changes in the earth's environment. These cuts are intended to begin gradually but quickly gather momentum to deliver substantial cumulative reductions in emissions within a few decades. Both cap & trade and a carbon tax would lend themselves to being carefully phased in, and either one could be rendered revenue-neutral, to minimize the undesired economic effects of a policy designed to alter our consumption patterns in fundamental ways, at least with regard to energy-intensive goods and services. In either system, vulnerable consumers and industries with few alternatives could be protected or given more time to adapt. And while cap & trade creates a strong incentive for companies and sectors with the lowest costs for reducing emissions to maximize their cuts and trade the resulting surplus with others who face higher costs, a carbon tax could be modified to allow some trading around the edges, capturing at least part of that benefit for the economy. The biggest distinction may also be the most basic: how is the price of emissions set in the first place?
In effect, the choice between a carbon tax and cap & trade boils down to a choice between the cost of CO2 being set by committee, or by markets. Whatever else disappointed investors might think about them, markets excel at price discovery. While I have little doubt that a blue-ribbon panel of economists, scientists and engineers could come up with a reasonable estimate of the level of carbon taxation required to reduce emissions by the desired amount, I have much more confidence in the logic of setting the desired level of emissions reduction in each year, and then allowing the price to emerge from the interaction of those whose livelihoods depend on meeting these limits, in real time. That preference is rooted in the risks of each approach.
If our hypothetical Carbon Price Committee sets the carbon tax too low, emissions will exceed the goal and they can ratchet the tax higher in the next period. However, if they set it too high, we'll beat the emissions targets, but the economy will shift too rapidly, and jobs and output in energy-intensive sectors will be shed faster than new, "green" jobs and products can be created. The result might look a lot like what we're experiencing today. Cap & trade has its own risks, though they tend to focus more on the effectiveness and efficiency of the program than on its consequences for the economy. Mr. Tillerson is right to identify problems of "verification and accountability," though there is already a large and growing body of experience in managing these issues, from the EU Emissions Trading System and from voluntary emissions trading--and the statutory SOx and NOx trading--that has been going on in the US for more than a decade.
In the final analysis, the decision to put a price on greenhouse gas emissions matters more than how it is implemented. At the same time, the latter choice will determine how effectively those reductions are achieved, and at what cost to the rest of the economy, where most of us will continue to earn our livelihoods and save for our future needs. I hope that the new administration will weigh these considerations carefully, in consultation with the Congress and all affected stakeholders, including our international trading partners, who could be affected in many ways by the result. The idea of a carbon tax deserves a fair hearing alongside cap & trade, once our leaders agree on the timing of limiting our emissions.
Monday, January 19, 2009
Tempering Optimism with Patience
We've all heard the President-elect mention the need for patience in confronting our economic problems, echoed by countless commentators elaborating on the scale of the challenge involved. If I could offer him one piece of advice on Inauguration Day, it would be to ask the American public for the same degree of patience in transforming our energy economy. It took a century to evolve into its present shape, and its major hardware has lifetimes ranging from ten to sixty years. Despite the great progress and truly impressive growth of alternative energy over the last few years, displacing our reliance on conventional energy is not the task of a few months or years, no matter how much of the planned stimulus package is ultimately devoted to making a down payment on this transformation.
Along with that advice, I would point out two related facts to our new President. First, while doubling our renewable energy production in three years is an appropriately bold initial goal, it would be next to impossible if it included the hydropower dams that make up the largest current component of our renewable energy supplies. Wind and solar power have been growing at rates that should make it quite feasible to deliver a further doubling of their output in three years, if the new administration can find smart ways to restore the flow of financing that is so crucial for these projects. Yet wind, solar and geothermal power still accounted for less than 1.5% of the electricity generated in the US for the first nine months of 2008, while hydro provided 6.7%. Since I don't hear anyone calling for a slew of big, new hydroelectric dams--the trend seems rather in the opposite direction--we would need to double wind, solar and geothermal roughly five successive times to equal the 1.5 trillion kilowatt-hours of electricity generated from coal in the same period. Efficiency and conservation might conceivably reduce the required number of doublings to four; however, each doubling will get progressively harder, as wind and solar grow out of the niches within which their cyclical and intermittent output has been relatively manageable.
The other fact concerns oil and the fuels we derive from it. President Obama might consider asking Dr. Chu a few questions on the subject of why hydrocarbon fuels have been so successful for the last hundred years. The answers have at least as much to do with chemistry and physics as they do with economics and domestic and geopolitics. Each gallon of gasoline delivers 115,000 BTUs, the equivalent of 33.7 kWh. It takes 1.5 gallons of ethanol or roughly 740 pounds of lithium ion batteries to deliver the same amount of energy to a car. The only reason it is even possible to conceive of an electric vehicle with comparable range to a gasoline-powered car is that current internal combustion engines waste about 80% of the energy in gasoline, while electric motors are more than 90% efficient. Petroleum products constitute a remarkable energy source and storage system, albeit a finite one, and replacing both attributes of oil at once will be exceedingly difficult. If we weren't so concerned about the energy security and environmental consequences of their use, it would be hard to justify such an uphill battle at all.
Attaining our energy goals will require healthy doses of both optimism and patience: optimism to remind us that none of the obstacles along the way looks insurmountable in the long run, and patience because those obstacles will not be conquered in four years or likely even eight. I still subscribe to the old notion that "a goal without a plan is just a wish." We need tangible plans to manage the transition from the old energy to the new, and to manage our expectations along the way. That's the best recipe I can offer for avoiding disappointing voters and consumers, when the promised energy transformation isn't complete by the end of President Obama's first term in office.
Along with that advice, I would point out two related facts to our new President. First, while doubling our renewable energy production in three years is an appropriately bold initial goal, it would be next to impossible if it included the hydropower dams that make up the largest current component of our renewable energy supplies. Wind and solar power have been growing at rates that should make it quite feasible to deliver a further doubling of their output in three years, if the new administration can find smart ways to restore the flow of financing that is so crucial for these projects. Yet wind, solar and geothermal power still accounted for less than 1.5% of the electricity generated in the US for the first nine months of 2008, while hydro provided 6.7%. Since I don't hear anyone calling for a slew of big, new hydroelectric dams--the trend seems rather in the opposite direction--we would need to double wind, solar and geothermal roughly five successive times to equal the 1.5 trillion kilowatt-hours of electricity generated from coal in the same period. Efficiency and conservation might conceivably reduce the required number of doublings to four; however, each doubling will get progressively harder, as wind and solar grow out of the niches within which their cyclical and intermittent output has been relatively manageable.
The other fact concerns oil and the fuels we derive from it. President Obama might consider asking Dr. Chu a few questions on the subject of why hydrocarbon fuels have been so successful for the last hundred years. The answers have at least as much to do with chemistry and physics as they do with economics and domestic and geopolitics. Each gallon of gasoline delivers 115,000 BTUs, the equivalent of 33.7 kWh. It takes 1.5 gallons of ethanol or roughly 740 pounds of lithium ion batteries to deliver the same amount of energy to a car. The only reason it is even possible to conceive of an electric vehicle with comparable range to a gasoline-powered car is that current internal combustion engines waste about 80% of the energy in gasoline, while electric motors are more than 90% efficient. Petroleum products constitute a remarkable energy source and storage system, albeit a finite one, and replacing both attributes of oil at once will be exceedingly difficult. If we weren't so concerned about the energy security and environmental consequences of their use, it would be hard to justify such an uphill battle at all.
Attaining our energy goals will require healthy doses of both optimism and patience: optimism to remind us that none of the obstacles along the way looks insurmountable in the long run, and patience because those obstacles will not be conquered in four years or likely even eight. I still subscribe to the old notion that "a goal without a plan is just a wish." We need tangible plans to manage the transition from the old energy to the new, and to manage our expectations along the way. That's the best recipe I can offer for avoiding disappointing voters and consumers, when the promised energy transformation isn't complete by the end of President Obama's first term in office.
Friday, January 16, 2009
Paying Not To Drill
I'm spoiled for choice concerning topics on which to blog , including the first glimpses of the energy provisions of the proposed American Recovery and Reinvestment Act of 2009--better known as the stimulus package--and a rift within the US business community over the best way to set a price on greenhouse gas emissions, between a carbon tax and cap and trade. I'm sure I'll come back to those topics soon, but I must admit the story that most intrigued me this week concerned an event last month, when a young environmentalist disrupted the quarterly oil & gas lease auction of the Utah office of the Bureau of Land Management by successfully bidding on a clutch of leases, the terms of which he at least initially seemed unlikely to be able to fulfill. In the process, he has become a momentary Internet celebrity, with his own website and organization, apparently raising $45,000 with which to make the first payment on the leases and thereby potentially avoid prosecution.
At the outset, let's dispense with all the hyperbole about brave acts of civil disobedience in the cause of saving the planet. Let's also be clear that nothing I say here in any way justifies walking into a duly-authorized auction of a department of the federal government and bidding for mineral leases without the ready means of paying for them. I am not qualified to assess whether Mr. DeChristopher broke the law, but I can certainly relate to the reaction of other bidders when the situation became clear. Nor am I inclined to accept the excuse that the ends justify the means in this case. Having said that, it's hard not to admire the chutzpah that this took, at least a little bit.
According to the article in Monday's Washington Post, Mr. DeChristopher, a.k.a. "Bidder 70" outbid the assembled oil and gas companies on 13 leases totaling 22,000 acres in "the scenic southeast corner of Utah." He bid a total of $1.8 million for these leases, roughly 25% of the total of $7.2 million of winning bonus bids received for the 148,598 acres sold. If he intends to keep these leases, then in addition to coming up with the remainder of the bonuses he bid, he would also need to pay the contractual rental on them, amounting to $33,000 per year for the first five years and $44,000 per year for the balance of the 10-year lease term--not "decades" as the Post's reporter erroneously suggested. $45,000 is a good start, but he and his supporters would have to pony up another $2.1 million over the next decade to keep from defaulting, unless their strategy is merely to tie them up until the new administration halted leasing in the area, as noted in Mr. DeChristopher's letter of January 9 to his supporters.
If we ignore for the moment the part about not having the $1.8 million in hand or in prospect when bidding, this event might actually offer a model by which concerned citizens or groups could preserve onshore or offshore acreage that they prefer not to see drilled, either out of concern for the viewscape or for the environmental consequences of the production and consumption of oil and gas--notwithstanding the implication that it would be produced elsewhere, possibly under less scrupulous conditions. If properly financed, such efforts would be a lot more constructive than tying up the leasing and permitting process in the courts, particularly from the perspective of taxpayers such as myself, who do not share their viewpoint. The outcome might still increase US oil imports, but at least without depriving the government of its income on the leases, although it would forgo the substantial increase in revenue that accrues if oil or gas are found and produced, when modest rental fees are superseded by the 12.5 % royalty rates applicable to such contracts. Oil and gas rents and royalties earned the federal government nearly $13 billion in 2008.
I will be very interested to see how this case turns out, and whether Mr. DeChristopher's idea catches on--with the proviso that there is a crucial difference between backing up one's beliefs with real money and merely gumming up the works at the expense of the rest of us.
At the outset, let's dispense with all the hyperbole about brave acts of civil disobedience in the cause of saving the planet. Let's also be clear that nothing I say here in any way justifies walking into a duly-authorized auction of a department of the federal government and bidding for mineral leases without the ready means of paying for them. I am not qualified to assess whether Mr. DeChristopher broke the law, but I can certainly relate to the reaction of other bidders when the situation became clear. Nor am I inclined to accept the excuse that the ends justify the means in this case. Having said that, it's hard not to admire the chutzpah that this took, at least a little bit.
According to the article in Monday's Washington Post, Mr. DeChristopher, a.k.a. "Bidder 70" outbid the assembled oil and gas companies on 13 leases totaling 22,000 acres in "the scenic southeast corner of Utah." He bid a total of $1.8 million for these leases, roughly 25% of the total of $7.2 million of winning bonus bids received for the 148,598 acres sold. If he intends to keep these leases, then in addition to coming up with the remainder of the bonuses he bid, he would also need to pay the contractual rental on them, amounting to $33,000 per year for the first five years and $44,000 per year for the balance of the 10-year lease term--not "decades" as the Post's reporter erroneously suggested. $45,000 is a good start, but he and his supporters would have to pony up another $2.1 million over the next decade to keep from defaulting, unless their strategy is merely to tie them up until the new administration halted leasing in the area, as noted in Mr. DeChristopher's letter of January 9 to his supporters.
If we ignore for the moment the part about not having the $1.8 million in hand or in prospect when bidding, this event might actually offer a model by which concerned citizens or groups could preserve onshore or offshore acreage that they prefer not to see drilled, either out of concern for the viewscape or for the environmental consequences of the production and consumption of oil and gas--notwithstanding the implication that it would be produced elsewhere, possibly under less scrupulous conditions. If properly financed, such efforts would be a lot more constructive than tying up the leasing and permitting process in the courts, particularly from the perspective of taxpayers such as myself, who do not share their viewpoint. The outcome might still increase US oil imports, but at least without depriving the government of its income on the leases, although it would forgo the substantial increase in revenue that accrues if oil or gas are found and produced, when modest rental fees are superseded by the 12.5 % royalty rates applicable to such contracts. Oil and gas rents and royalties earned the federal government nearly $13 billion in 2008.
I will be very interested to see how this case turns out, and whether Mr. DeChristopher's idea catches on--with the proviso that there is a crucial difference between backing up one's beliefs with real money and merely gumming up the works at the expense of the rest of us.
Wednesday, January 14, 2009
A Gasoline Floor Price for Hybrid Cars
The coverage of this year's Detroit Car Show has focused on hybrids and electric vehicles, with a number of high-profile launches, including the debut of the third generation Toyota Prius. However, as convinced as I am that electric-drive cars represent the future of the car industry and will make important contributions to reducing greenhouse gas emissions and oil imports, the collapse of oil prices has erected a substantial barrier to the rapid market penetration of these technologies. Nor can the answer be simply ratcheting up the nation's Corporate Average Fuel Economy (CAFE) standard, as the New York Times recently suggested. We need a practical way to bridge the gap between consumers' growing interest in electrified vehicles and the economic deterrent posed by the added cost of these complex systems. Rather than taxing fuel itself, as has been widely suggested, we should consider a new hybrid car tax credit based on the price of fuel.
Despite growing interest in hybrids, these vehicles accounted for only 2.4% of the 13.2 million light-duty vehicles sold in the US last year. Although its 2008 sales of around 160,000 units made the Prius the 15th most popular model in the US last year, it did not even make it into the top 20 for December, thanks to slumping gasoline prices and the credit crunch. For that matter, the December monthly figures showed trucks, including SUVs, outselling cars again at 53% vs. 47% of the market, essentially back to their average for 2007. For all of 2008 cars outsold trucks by 51% to 49%, though that included those summer months of $4 gas when you couldn't have given a big SUV away. Perhaps the most encouraging news in this data is that sales of "cross-over" SUVs declined much less than other light trucks to become the largest segment of that market. (Moving someone from a 15 mpg SUV to a 22 mpg crossover saves more gallons of gas than converting a Camry owner to a Prius driver.)
The lackluster hybrid sales at the end of the year shouldn't surprise anyone. Consider the Saturn VUE crossover SUV. The sticker for the hybrid version is $4,880 higher than the base model with the same 4-cylinder engine. Boosting fuel economy from an EPA-estimated combined 22 mpg to 28 mpg saves 117 gallons of gas per year, based on 12,000 miles of annual driving. Yet even if gas were still $4 per gallon, it would take 10.4 years of fuel savings to pay out the hybrid premium. With gas at $1.78/gal., that stretches to 23 years. If the savings at the pump aren't sufficient to justifying spending an extra $5k on the hybrid, a buyer must bet that the combination of higher resale value and lower maintenance costs would close the gap.
How could the government induce more consumers to buy hybrids, even when fuel costs are too low to justify the extra investment? One option is to raise the CAFE standard beyond the 35 mpg target that the industry must meet by 2020. That might force manufacturers to produce more hybrids, bringing their cost down, and sell fewer non-hybrids, which would tighten the market, reducing the effective premium from both ends. The Congress would like to impose that outcome, in any case, as a condition of financial assistance to Detroit. Unfortunately, such a command-and-control approach risks creating another disconnect between car companies and consumers, and the modest fines by which CAFE has been enforced may end up looking more attractive to Detroit than the distortions an unrealistic fuel economy standard could create in their already-strained sales channels.
Another solution would be a big increase in the gasoline tax, or a floor-price tax on gas, to boost pump prices to a level that would ensure high demand for very fuel-efficient cars. As I noted the other day, however, the gas tax looks like a much less effective way to reduce greenhouse gas emissions than a tax on carbon or emissions cap-and-trade that would create a similar disincentive for CO2. Nor does raising the gas tax during a major recession--even if a large portion of the revenue could be returned to taxpayers--look like smart economic policy, when the recent drop in fuel prices is among the few forms of relief actually reaching consumers and smaller businesses.
Perhaps the answer lies in inverting the proposition offered in those car ads we saw when gas prices were rising steadily--the ones that promised your first few years of fill-ups at some low fixed price. To make hybrids more attractive, we could replace the current, expiring hybrid tax credits with a new, fully-refundable tax credit--one that the government pays even if it exceeds your income tax liability for the year--that would create an effective gasoline floor price of $4, but only for the purchasers of hybrid cars. The amount of the credit would be set by the difference between $4 per gallon and the national average pump price for each year, applied to the EPA fuel economy rating of the hybrid purchased. This could easily be made technology-neutral by extending it to any car exceeding the actual new-vehicle CAFE for the previous year, which for the 2008 model year averaged 31.2 mpg for cars and 23.4 for trucks. Even with this modification, the bulk of the subsidy would still flow to the models that save the most fuel.
For example, if we calculated the credit on 10,000 miles of annual usage, a buyer of the new 37 mpg Ford Fusion Hybrid would receive a credit of $600 for 2009, if gasoline remained at last week's average of $1.78/gal for the entire year. Of course, that would be in addition to roughly $260 of actual fuel savings, compared to the 24 mpg non-hybrid Fusion. If gas prices averaged $3 in 2010, this taxpayer's credit would drop to $270, while fuel savings rose to $440. Once gas was back over $4, the tax credit would go to zero.
Despite growing interest in hybrids, these vehicles accounted for only 2.4% of the 13.2 million light-duty vehicles sold in the US last year. Although its 2008 sales of around 160,000 units made the Prius the 15th most popular model in the US last year, it did not even make it into the top 20 for December, thanks to slumping gasoline prices and the credit crunch. For that matter, the December monthly figures showed trucks, including SUVs, outselling cars again at 53% vs. 47% of the market, essentially back to their average for 2007. For all of 2008 cars outsold trucks by 51% to 49%, though that included those summer months of $4 gas when you couldn't have given a big SUV away. Perhaps the most encouraging news in this data is that sales of "cross-over" SUVs declined much less than other light trucks to become the largest segment of that market. (Moving someone from a 15 mpg SUV to a 22 mpg crossover saves more gallons of gas than converting a Camry owner to a Prius driver.)
The lackluster hybrid sales at the end of the year shouldn't surprise anyone. Consider the Saturn VUE crossover SUV. The sticker for the hybrid version is $4,880 higher than the base model with the same 4-cylinder engine. Boosting fuel economy from an EPA-estimated combined 22 mpg to 28 mpg saves 117 gallons of gas per year, based on 12,000 miles of annual driving. Yet even if gas were still $4 per gallon, it would take 10.4 years of fuel savings to pay out the hybrid premium. With gas at $1.78/gal., that stretches to 23 years. If the savings at the pump aren't sufficient to justifying spending an extra $5k on the hybrid, a buyer must bet that the combination of higher resale value and lower maintenance costs would close the gap.
How could the government induce more consumers to buy hybrids, even when fuel costs are too low to justify the extra investment? One option is to raise the CAFE standard beyond the 35 mpg target that the industry must meet by 2020. That might force manufacturers to produce more hybrids, bringing their cost down, and sell fewer non-hybrids, which would tighten the market, reducing the effective premium from both ends. The Congress would like to impose that outcome, in any case, as a condition of financial assistance to Detroit. Unfortunately, such a command-and-control approach risks creating another disconnect between car companies and consumers, and the modest fines by which CAFE has been enforced may end up looking more attractive to Detroit than the distortions an unrealistic fuel economy standard could create in their already-strained sales channels.
Another solution would be a big increase in the gasoline tax, or a floor-price tax on gas, to boost pump prices to a level that would ensure high demand for very fuel-efficient cars. As I noted the other day, however, the gas tax looks like a much less effective way to reduce greenhouse gas emissions than a tax on carbon or emissions cap-and-trade that would create a similar disincentive for CO2. Nor does raising the gas tax during a major recession--even if a large portion of the revenue could be returned to taxpayers--look like smart economic policy, when the recent drop in fuel prices is among the few forms of relief actually reaching consumers and smaller businesses.
Perhaps the answer lies in inverting the proposition offered in those car ads we saw when gas prices were rising steadily--the ones that promised your first few years of fill-ups at some low fixed price. To make hybrids more attractive, we could replace the current, expiring hybrid tax credits with a new, fully-refundable tax credit--one that the government pays even if it exceeds your income tax liability for the year--that would create an effective gasoline floor price of $4, but only for the purchasers of hybrid cars. The amount of the credit would be set by the difference between $4 per gallon and the national average pump price for each year, applied to the EPA fuel economy rating of the hybrid purchased. This could easily be made technology-neutral by extending it to any car exceeding the actual new-vehicle CAFE for the previous year, which for the 2008 model year averaged 31.2 mpg for cars and 23.4 for trucks. Even with this modification, the bulk of the subsidy would still flow to the models that save the most fuel.
For example, if we calculated the credit on 10,000 miles of annual usage, a buyer of the new 37 mpg Ford Fusion Hybrid would receive a credit of $600 for 2009, if gasoline remained at last week's average of $1.78/gal for the entire year. Of course, that would be in addition to roughly $260 of actual fuel savings, compared to the 24 mpg non-hybrid Fusion. If gas prices averaged $3 in 2010, this taxpayer's credit would drop to $270, while fuel savings rose to $440. Once gas was back over $4, the tax credit would go to zero.
It sounds complicated, though in practice it would merely be a hedge contract on the price of fuel--in the opposite direction from the ones typically offered to heating oil customers--conferring the equivalent of a set of annual put options on gasoline at $4. It probably would not be any more difficult to implement than a floor-price tax for all gasoline sold, even if the latter were politically feasible or economically desirable. It would also have the benefit of a built-in phaseout, as overall fleet fuel economy increases and future gas prices rise.
Perhaps someone can think of a simpler way to reduce the uncertainty of hybrid car buyers about future fuel prices than by issuing federal gasoline floor price tax credits. What we can't do is merely to hope that gas prices will recover enough to make hybrids and other advanced technology vehicles attractive on their own merits, or to assume that consumers will remain so stunned by last summer's high gas prices that they will buy the most efficient cars possible, even if they don't promise a financial return. This discussion will turn distinctly non-theoretical as soon as the government considers another round of financial assistance for a Detroit that it insists must build as many hybrids as possible.
Monday, January 12, 2009
Another Tumultuous Year?
Whether or not next week's inauguration of the 44th President of the United States marks the true start to the 21st century, as a Washington Post columnist recently suggested, 2009 could herald momentous changes in long-term energy trends. While a return to the extraordinarily high oil prices we experienced last summer looks improbable, we could yet see a significant price spike as a result of geopolitical events--or a further slide towards $30 per barrel. Developers of alternative energy technologies and projects will be watching Washington intently, in hopes that the expected stimulus bill or separate energy legislation will boost their fortunes and unlock access to persistently tight credit. And against that backdrop, the behavior of consumers in a new economic environment bears watching, as the ultimate source of energy demand.
In no particular order, here's my list of energy trends and events to watch as the year gets underway:
In no particular order, here's my list of energy trends and events to watch as the year gets underway:
- Oil prices are being squeezed between the weight of accumulating inventories, especially at the Cushing, OK storage that comprises the New York Mercantile Exchange's main delivery point for West Texas Intermediate crude oil, and the anticipation that a combination of OPEC discipline and resurgent demand will tighten markets appreciably later in the year. The resulting contango remains very wide. The prompt contract, for delivery in February, has fallen below $40 per barrel, while oil for delivery in July sells for well over $50/bbl, with next year's crude going for more than $60.
- As I noted on Friday, the gap between oil and natural gas has closed, even as gas has fallen below $5.50 per million BTUs, a level that is providing an energy-price stimulus for industrial and utility customers similar to the one that sub-$2 gasoline gives consumers. Gas is in contango, as well, though hardly as steep as oil. How long will the present US gas supply bubble persist, given the rapid decline rates of many gas wells and the weak finances of many of the big producers?
- The influence of government over energy looks certain to expand this year. Will the stimulus bill satisfy the wish list of alternative energy and environmental advocates, including assistance for struggling ethanol producers, cash subsidies and loan guarantees for wind and solar firms, and big investments in infrastructure, including new long-distance power transmission and a down payment on the "smart grid" of the future?
- An article in this morning's Wall Street Journal raised the prospect of a new wave of energy industry consolidation, similar to the one that created the "Super-Majors" (Exxon-Mobil, BP-Amoco-ARCO, Chevron-Texaco, Elf-Fina-Total) starting a decade ago. The industrial logic is probably there, though any merger would play out in a political context that seems much less likely to be receptive to such combinations, even if the publicly-traded oil companies do account for less than 10% of global oil reserves and less than 20% of production.
- If the financial crisis has pushed geopolitical risk into the background, the conflict in Gaza and the revelation over the weekend that Israel had asked for US assistance in an attack on Iran's nuclear complex should remind us that it hasn't vanished entirely. Although the oil market is in a much better position to forgo Iran's oil exports than it would have been for the last several years, taking 2 million barrels per day off the market--a likely response to any attack on Iran--could still be good for a quick pop of $15-20/bbl, or an extra $0.40 or so per gallon at the pump.
- Last year's weakness in the US dollar contributed to the summer's high oil prices, and the late-year dollar rally helped to unwind the residue of that spike. As the US deficit expands past $1 Trillion next year and into 2010, between fiscal stimulus and falling tax revenues, could the dollar begin falling again, and if so, what would that mean for energy prices? Economists tend to view these deficits as a manageable fraction of GDP. However, in absolute terms they are enormous, and they will compete with deficit spending all over the globe, taking us into uncharted territory.
- Finally, we can't forget about consumers. If the sharp drop in demand--around 6% year-on-year--was the pin that popped the oil-price balloon, will low gas prices begin to revive it? But while today's average pump price for regular gasoline of $1.68/gal. is a whopping $1.42/gal. less than last January and $0.62 lower than the same week in 2007, it surely doesn't look quite so cheap as a fraction of average purchasing power, between declining home values that have dried up the home equity loans with which many consumers were supplementing their income, and rising unemployment. It will take some time to see whether the weak economy and vivid memories of $4+ gasoline have altered consumption patterns permanently, or just temporarily. That will have important implications for environmental policy, too.
It's going to be interesting, for good or ill, and I look forward to continue sharing my perspective on energy and related environmental matters with you, as Energy Outlook begins its sixth year.
Friday, January 09, 2009
Alternative Energy And Natural Gas
At the end of the first full work week of the new year--a week I suspect I am not alone in having found a bit of a slog--a pair of articles in MIT's Technology Review got me thinking about the under-appreciated relationship between alternative energy and natural gas.
In the first, TR looks back at the energy technology developments of 2008. After noting the volatility of oil prices, they paint a picture of steady progress on many fronts. Nothing stands out as a major breakthrough, though several items, including concentrating solar cells and the scheme for storing solar power using catalyzed room-temperature electrolysis, hold breakthrough potential, if they can be scaled up cheaply and efficiently. With a typical lab-to-market time lag, either one might be a major factor by the late 'teens--or not.
Their emphasis on oil prices suggests that TR, like many others with a keen interest in alternative energy, pays too much attention to the influence of oil prices on alternative energy, and too little to natural gas. Other than psychologically, the price of oil really only matters when competing directly with its products, as biofuels do. If you're generating power from wind, sun, or geothermal heat, it's the price of power from the incremental electricity source that matters, and for the immediate future, that's still the gas-fired turbine. Even electric vehicles, which would certainly displace oil, will depend partly for their attractiveness on the price of electricity, which in many markets will be set by gas-fired power. (I know they're supposed to recharge overnight on under-utilized wind power, but I can't help wondering how many consumers will insist on recharging them as soon as they get home.) The scarcely-noticed Big Surprise of the crude oil spike of 2007-8 was the uncoupling of oil and gas prices. Oil's collapse has restored the premium for its BTUs over those in gas to the level of around 25% or so that prevailed from 2002-2006, after peaking at 150% in August. In order for renewable electricity to thrive, it needs high natural gas prices, not just high oil prices.
The other story in TR that caught my eye also concerns gas, but more directly. It features a company that has investigated bacteria that digest coal underground and turn it into methane. They have figured out how to coax them to produce more of it, faster. If this can be made to work commercially, it could dramatically boost the output of coal-bed methane, which now accounts for 9% of US gas supplies. Moreover, it could help solve the conundrum of how to capitalize on the energy potential of the world's vast coal reserves without derailing efforts to reduce greenhouse gas emissions. This technology might prove especially attractive, once the slowdown in gas drilling caused by the financial crisis deflates the current "gas bubble"--the supply spike resulting from the shale-gas bonanza of the last few years. The success of coal-eating gas bugs, however, would not be good news for renewable power.
Wednesday, January 07, 2009
An Ethanol Stimulus?
As the new Congress and incoming administration scramble to craft a stimulus package to lift the country out of the deepening recession, it's understandable that a variety of industries and their trade associations would be lobbying for their share of the expected federal assistance. Many struggling businesses no doubt feel at least as deserving of help as GM and Chrysler. With jobs at stake and pragmatism standing in for principle in this crisis, the Obama team and the Congressional leadership must make some tough calls in a very short span of time. One call that should not be difficult, however, is to rule out any further federal assistance for the struggling ethanol industry.
I'm late to the party commenting on a prospective ethanol bailout. Before New Year's, the Wall Street Journal and Business Week both reported that the Renewable Fuels Association and its members are seeking $1 billion in short-term loans and $50 billion "to develop ethanol technology and new biofuels," though I couldn't find anything on the RFA's website to confirm those figures. Backed by the lobbying muscle of Archer Daniels Midland, their chances of getting at least a portion of their request don't look half bad.
In order to see why a bailout ought to be unnecessary, let's remind ourselves of the federal assistance the industry already receives, summing the amounts for 2009 and 2010 to put them on a comparable basis to the stimulus:
I'm late to the party commenting on a prospective ethanol bailout. Before New Year's, the Wall Street Journal and Business Week both reported that the Renewable Fuels Association and its members are seeking $1 billion in short-term loans and $50 billion "to develop ethanol technology and new biofuels," though I couldn't find anything on the RFA's website to confirm those figures. Backed by the lobbying muscle of Archer Daniels Midland, their chances of getting at least a portion of their request don't look half bad.
In order to see why a bailout ought to be unnecessary, let's remind ourselves of the federal assistance the industry already receives, summing the amounts for 2009 and 2010 to put them on a comparable basis to the stimulus:
- The largest item is the Volumetric Ethanol Excise Tax Credit, also known as the blender's credit. The 2008 Farm Bill reduced this benefit from $0.51/gal. of ethanol to $0.45/gal, unless the quantity sold falls below 7.5 billion gallons per year, in which case it reverts to $0.51.
- The Energy Independence and Security Act of 2007 (EISA) substantially increased the quantity of ethanol required to be blended into gasoline. Multiplying the minimum volumes for 2009 and 2010 by the blender's credit yields a combined $10.1 billion in assistance. While the ethanol producers don't receive this money directly, it supports the price of ethanol in the market and compounds the demand creation from EISA's Renewable Fuels Standard (RFS).
- Domestic ethanol producers are also protected from foreign competition by virtue of an ethanol tariff of 2.9% and import duty of $0.54/gal. The Farm Bill extended that benefit for another two years.
- As for assistance for advanced biofuels, EISA also authorized at least $595 million for R&D grants covering advanced biofuels, cellulosic biofuels, and biofuel-enabling infrastructure. Meanwhile, the Farm Bill provided a "producer's credit" of $1.01/gal. for advanced biofuel(i.e., not produced from corn starch.)
It's also relevant to consider why the ethanol industry is in trouble, just now. After being squeezed between spiking fuel and grain prices for the first two-thirds of the year, it faces a shrinking motor fuels market, in direct competition with a glut of wholesale gasoline that for weeks was selling for less than crude oil. But although these circumstances might appear at first glance to have been beyond the control of the industry, that's not entirely true. If ethanol producers had expanded at a slower pace over the last two years, instead of outracing the rising RFS mandate, there would be no ethanol surplus, their margins would be higher, and they would have less debt to service.
So that leaves us with an industry that will receive nearly $11 billion of federal assistance without a dime from the stimulus, and whose customers are required by law to buy most of their output. The excess capacity that is crushing its margins looks more like a manifestation of classic manufacturing boom-and-bust cyclicality than a result of the financial crisis, per se. If anything, the current slow-down might be an excellent time to prune the oldest, least efficient ethanol plants, to prepare the industry to compete with the next generation of biofuels from non-food sources, for which R&D is already well-funded by the government, venture capital, and the oil industry. That shakeout won't happen if producers are propped up with still more taxpayer money.
Monday, January 05, 2009
Choosing A Priority
The new year brings no shortage of energy concerns, even though oil prices are much lower than last January. Instead of enumerating those that I think merit particular attention, for today I'd like to focus on an over-arching energy policy choice facing the US. The recent flurry of calls for a quick increase in the tax on gasoline highlights the need for us finally to decide whether energy security or climate change constitutes the higher priority for urgent action. Altered circumstances have undermined the natural linkages between these two problems, and the financial crisis and recession make it not just impractical, but undesirable to attempt to tackle both with equal vigor.
During the holidays I received emails from friends and other readers pointing out various op-eds calling for a big increase in US gas taxes. The arguments in favor of such a measure include reducing US oil imports from unfriendly nations and making fuel-efficient cars and other advanced energy technology more attractive for consumers and investors. The current low gas prices would allow such a tax to be imposed with much less pain than only a few months ago. Yet as Tom Friedman's New York Times column on the subject recognized, this entails an explicit choice between taxing gasoline and taxing the greenhouse gas emissions linked to climate change. Friedman has been a consistent supporter of higher gas taxes, and he still comes down on that side of the argument. For many reasons, I disagree, but it's even more important to choose one strategy or the other than to continue assuming that we can do both, if we wish.
The need for a choice between the two is rooted in our basic energy balance and the trade-offs that a carbon tax or a gas tax would stimulate, and in the potential of alternative energy sources to displace coal, oil, or both. Oil today accounts for 39% of US primary energy consumption and 15% of US energy production--more like 23% if natural gas produced from oil fields is included. Coal makes up another 22% of energy consumption and nearly 33% of production. Simply put, we can't grow the 1% of current US energy production from wind, solar and geothermal power fast enough to replace the 62% of energy consumption supplied by both oil and coal in the foreseeable future, never mind the enormous problems of technology and capital turnover involved in trying to substitute renewable electricity for the liquid transportation fuels, lubricants and petrochemicals that account for all but a small fraction of our oil consumption. Even doubling current ethanol production, which hinges on as yet uncommercial cellulosic biofuel technology, would only back out around 2% of US oil use, at 2008's reduced rates. We also need to be clear that putting a price on carbon emissions will have a much bigger impact on our coal use than on our oil imports.
Throughout 2007 and into 2008, as oil prices climbed and concerns about climate change mounted, while the economy remained surprisingly resilient, it was hard to choose between the importance of reducing oil imports and reducing greenhouse gas emissions, and it looked possible to do both. Moreover, energy security and climate change appeared positively synergistic, with reductions in oil consumption expected to reduce emissions and emissions-reducing policies seen as cutting oil consumption, as a side-benefit. But while those physical synergies still look attractive, the rapid decline in oil prices has drastically reduced the urgency and near-term economic benefits of tackling our oil dependence, particularly during what is shaping up to be the deepest recession since World War II. That makes the emissions reductions associated with reducing our oil imports more expensive, compared to other reductions.
Taxing gasoline, rather than carbon, would certainly reduce the greenhouse gas emissions from our use of petroleum, but it could easily result in largely offsetting emissions increases elsewhere, as industry turned increasingly to coal and natural gas for feedstocks, and as biofuels--which would likely be exempted from the tax increase--would mainly be produced in the near term from food crops that require significant inputs of energy-intensive fertilizer and cultivation. Sales of efficient cars would be helped, no doubt aiding a Detroit that seems certain to be forced to make more of them, as a condition of further federal assistance. However, the accompanying fleet-efficiency gains will occur slowly, as long as total car sales--and thus the total fleet turnover rate--remain depressed by a weak economy.
That brings us to the direct economic impact of a gas tax. Until a federal stimulus is passed and actually reaches consumers and businesses, cheap gas and diesel fuel are the stimulus, to the tune of roughly $37 billion/month compared to July/August 2008 prices. I take suggestions that a higher tax on petroleum products could be made revenue-neutral--that is, returned dollar-for-dollar to consumers/taxpayers through cuts in other taxes--with more than a grain of salt. With all due respect to the incoming Congress, that institution has not demonstrated the requisite spending restraint, faced with the prospect of a major new revenue source, in many years. It certainly wasn't on display in last year's debate on the Boxer-Lieberman-Warner emissions cap-and-trade bill.
Although I expect oil prices to recover, once the economy does, the recession presents us with a unique opportunity to begin realigning the entire economy, not just to use less oil as it returns to growth, but to be much less carbon-intensive, overall. With greenhouse gas emissions from the electricity sector exceeding those from transportation by at least 20%, and with renewable power sources looking much more viable and sustainable than current-generation biofuels, focusing on climate change and the gradual and systematic de-carbonization of the economy now seems like a better priority than "energy independence," which has remained unattainable for more than a generation. It will be hard enough for the Obama administration to determine how aggressively to pursue climate policies in the current environment, without the distraction of a gas-tax debate. And while energy security remains vitally important, in its broader definition, it can be achieved for now through the same strategy of supplier diversification that served us so well after the energy crisis of the 1970s-80s.
During the holidays I received emails from friends and other readers pointing out various op-eds calling for a big increase in US gas taxes. The arguments in favor of such a measure include reducing US oil imports from unfriendly nations and making fuel-efficient cars and other advanced energy technology more attractive for consumers and investors. The current low gas prices would allow such a tax to be imposed with much less pain than only a few months ago. Yet as Tom Friedman's New York Times column on the subject recognized, this entails an explicit choice between taxing gasoline and taxing the greenhouse gas emissions linked to climate change. Friedman has been a consistent supporter of higher gas taxes, and he still comes down on that side of the argument. For many reasons, I disagree, but it's even more important to choose one strategy or the other than to continue assuming that we can do both, if we wish.
The need for a choice between the two is rooted in our basic energy balance and the trade-offs that a carbon tax or a gas tax would stimulate, and in the potential of alternative energy sources to displace coal, oil, or both. Oil today accounts for 39% of US primary energy consumption and 15% of US energy production--more like 23% if natural gas produced from oil fields is included. Coal makes up another 22% of energy consumption and nearly 33% of production. Simply put, we can't grow the 1% of current US energy production from wind, solar and geothermal power fast enough to replace the 62% of energy consumption supplied by both oil and coal in the foreseeable future, never mind the enormous problems of technology and capital turnover involved in trying to substitute renewable electricity for the liquid transportation fuels, lubricants and petrochemicals that account for all but a small fraction of our oil consumption. Even doubling current ethanol production, which hinges on as yet uncommercial cellulosic biofuel technology, would only back out around 2% of US oil use, at 2008's reduced rates. We also need to be clear that putting a price on carbon emissions will have a much bigger impact on our coal use than on our oil imports.
Throughout 2007 and into 2008, as oil prices climbed and concerns about climate change mounted, while the economy remained surprisingly resilient, it was hard to choose between the importance of reducing oil imports and reducing greenhouse gas emissions, and it looked possible to do both. Moreover, energy security and climate change appeared positively synergistic, with reductions in oil consumption expected to reduce emissions and emissions-reducing policies seen as cutting oil consumption, as a side-benefit. But while those physical synergies still look attractive, the rapid decline in oil prices has drastically reduced the urgency and near-term economic benefits of tackling our oil dependence, particularly during what is shaping up to be the deepest recession since World War II. That makes the emissions reductions associated with reducing our oil imports more expensive, compared to other reductions.
Taxing gasoline, rather than carbon, would certainly reduce the greenhouse gas emissions from our use of petroleum, but it could easily result in largely offsetting emissions increases elsewhere, as industry turned increasingly to coal and natural gas for feedstocks, and as biofuels--which would likely be exempted from the tax increase--would mainly be produced in the near term from food crops that require significant inputs of energy-intensive fertilizer and cultivation. Sales of efficient cars would be helped, no doubt aiding a Detroit that seems certain to be forced to make more of them, as a condition of further federal assistance. However, the accompanying fleet-efficiency gains will occur slowly, as long as total car sales--and thus the total fleet turnover rate--remain depressed by a weak economy.
That brings us to the direct economic impact of a gas tax. Until a federal stimulus is passed and actually reaches consumers and businesses, cheap gas and diesel fuel are the stimulus, to the tune of roughly $37 billion/month compared to July/August 2008 prices. I take suggestions that a higher tax on petroleum products could be made revenue-neutral--that is, returned dollar-for-dollar to consumers/taxpayers through cuts in other taxes--with more than a grain of salt. With all due respect to the incoming Congress, that institution has not demonstrated the requisite spending restraint, faced with the prospect of a major new revenue source, in many years. It certainly wasn't on display in last year's debate on the Boxer-Lieberman-Warner emissions cap-and-trade bill.
Although I expect oil prices to recover, once the economy does, the recession presents us with a unique opportunity to begin realigning the entire economy, not just to use less oil as it returns to growth, but to be much less carbon-intensive, overall. With greenhouse gas emissions from the electricity sector exceeding those from transportation by at least 20%, and with renewable power sources looking much more viable and sustainable than current-generation biofuels, focusing on climate change and the gradual and systematic de-carbonization of the economy now seems like a better priority than "energy independence," which has remained unattainable for more than a generation. It will be hard enough for the Obama administration to determine how aggressively to pursue climate policies in the current environment, without the distraction of a gas-tax debate. And while energy security remains vitally important, in its broader definition, it can be achieved for now through the same strategy of supplier diversification that served us so well after the energy crisis of the 1970s-80s.
Monday, December 29, 2008
Energy Lessons of 2008
A year ago, I looked back on 2007 and ahead to 2008, a year that has defied the predictions of most observers. Although I can't claim to have foreseen the possibility that oil would break $140 and $40--from opposite directions--in the same year, I worried about energy market volatility and cautioned that risk cuts both ways. That seems equally appropriate advice today, when markets are focused on the downside, and "confirmation bias" is such a powerful force. But while we shouldn't expect a repeat of the wild ride of the year now ending, the experience has provided some expensive lessons about energy markets. The following is a non-exhaustive list of those that struck me:
- Demand matters as much as supply in determining prices. The difference between oil at $145 per barrel and $40 is only a couple of percent of global demand, or more precisely a swing between steady growth of 1-2% per year and a shrinkage of similar magnitude.
- Speculation can amplify prices and market volatility, but it can't override a dramatic shift in the underlying fundamentals of supply or demand. Leverage increases not only the magnitude of speculative gains and losses, but apparently also the speed of the shift from one state to the other.
- When prices have been rising steadily, commodity price hedging can look like a sustainable revenue source--almost a perpetual motion machine--until the trend breaks. Then we see that the main benefit of hedging is to smooth out cash flows and enable firms to take on risks they couldn't bear otherwise. Used improperly, it's just an elaborate form of speculation, and as risky at Las Vegas.
- Fundamental price imbalances between commodities that are substitutes for each other, however imperfect, don't persist indefinitely. For much of the year, natural gas traded for less than half the energy-equivalent price of oil. As of Friday, this relationship had closed to about an 11% discount for gas vs. oil.
- High oil prices don't automatically make alternative energy sources competitive. For the last several years many alternatives faced higher construction costs, as they competed for some of the same inputs (materials and workers) as new oil and gas projects, while alternatives with low "net energy" or Energy Return on Energy Invested (EROEI) saw their operating costs rise in tandem with oil and gas prices.
- In particular, investors in corn ethanol production found they were making two bets: one on the difference in price between food and fuel and another on the difference between petroleum products, with which ethanol competes, and natural gas, of which it consumes large amounts, directly and indirectly. (See #4 above.)
- Government incentives and mandates can help to create a market for alternative energy, but they cannot guarantee its profitability, particularly when capacity is added faster than mandated targets rise, or than existing infrastructure can accommodate. The recent Chapter 11 filings of VeraSun and several other ethanol producers are evidence of this.
- The cost of capital turns out to be as important as the cost of oil for the expansion of all forms of energy, conventional and alternative alike.
I'm sure I've missed some important learnings in this quick tabulation. Next week I'll look at what the coming year might bring, or at least what bears watching. In the meantime, I wish my readers a happy, healthy, and more prosperous New Year. Let's hope the economic consensus is as wrong about the length and severity of the contraction we're in, as it was about the prospects for a soft landing from the bursting housing bubble.
Tuesday, December 23, 2008
December Surprise
A month ago an old friend--in fact a former boss and mentor--hinted that the recent collapse of oil prices might lead to revisions of the oil & gas reserves that companies carry on their books. I recalled his suggestion a week ago, when the Wall Street Journal published an article on the subject of potential reserve revisions, indicating that "big chunks" of reserves might have be to declared "uneconomic", harming company valuations and potentially their ability to raise capital. This came into even sharper focus last Friday, when the January 2009 crude oil futures contract on the New York Mercantile Exchange (NYMEX) plunged sharply on its last day of trading, ending at $33.87 per barrel--the lowest oil price since February 10, 2004. I can only imagine how intently the reserves accounting groups of oil and gas companies must be scrutinizing the performance of the February contract, wondering how badly it might swoon by December 31, when the price for determining year-end "proved reserves" is established. The comparable price from which the 2007 year-end reserves were calculated was $95.98 per barrel, the highest ever. The subsequent slide puts reserves booked as long ago as 2004 at risk.
My friend knows more about oil & gas reserves and their reporting, from personal experience, than I ever will. It's an arcane subject. Despite the general designation of "reserves accounting", this task is normally carried out not by accountants, but by engineers under the supervision of a very senior and highly-experienced petroleum engineer or geoscientist. Tallying up how much oil and gas a company's leases are likely to produce involves consideration of a large array of technical and economic factors, including the market value of the future production these fields could yield. I'm sure there are other differences between the current SEC regulations, under which these figures are disclosed as part of a company's annual financial statements, and the standard industry approach set by the Society of Petroleum Engineers. The most important for the purposes of this posting is that under the SPE guidelines, the economic viability of the potential production from an oil deposit is assessed against the prevailing prices over the last 12 months, while also taking the firm's forecast of future prices into account. The SEC requires reserves to meet its standards for "proved" status at the price in effect as of the assessment, in this case at year-end.
When the price of oil was relatively stable, there wasn't much difference between these two perspectives, and thus between reserves determined under SEC or SPE guidelines. Even in the last several years, as prices rose dramatically from their roughly $20-25 per barrel range of the previous two decades, the 12-month averages were typically not drastically different from year-end prices, as for example the $66.25/bbl average for 2006, compared to $61.05/bbl on 12/29/06. However, if prices remain where they are today, we could see a $60/bbl difference between these two metrics for 2008, and a year-on-year decline of over $50/bbl. That would require any reserves that were booked at a price above $40 or so--not just this year, but going back as much as four years--to be reevaluated. (Natural gas has fallen, too, though by much less than crude oil.)
This situation is complicated by a bigger underlying question: what is the value of oil likely to be in the future, rather than at a moment in time or over some past interval? Reserves are future production, after all--in some cases extending over 20 or 30 years, or even longer. The market for prompt delivery might be glutted, and the outlook for the next year might appear pretty bleak, but without reading too much into the present steep "contango" in oil prices, there is every reason to believe that when global economic growth resumes, the fundamental conditions that pushed oil prices beyond $100/bbl will reassert themselves.
Before investors panic at the prospect of publicly-traded oil companies writing down hundreds of millions or billions of barrels of "proved reserves" for accounting disclosure purposes next year, they need to consider where the volumes in question will have gone. Were they merely shifted from the "proved" to "probable" category--thus not affecting the amount of oil that would ultimately be produced--by a temporary oil glut arising from a global recession, or did their existence depend on an oil-price bubble that is unlikely to reflate? And even if these conditions do prove to be temporary, there's a good chance that a number of oil and gas projects, including some fairly large ones, will have been deferred in the meantime, if not canceled entirely. That affects reserves in the most fundamental way possible, as well as altering the future global production profile. Since my own portfolio includes oil & gas equities, I face the same uncertainties in this regard as anyone else, as both an investor and a consumer. At the very least, this situation highlights the urgent need for a major revision of the SEC regulations covering the reporting of reserves, along the lines the Commission has already proposed, to put reserve estimates on a more meaningful and less volatile basis.
Energy Outlook will be on holiday break until next week. Merry Christmas, Happy Hanukkah, and Seasons Greetings, as appropriate!
My friend knows more about oil & gas reserves and their reporting, from personal experience, than I ever will. It's an arcane subject. Despite the general designation of "reserves accounting", this task is normally carried out not by accountants, but by engineers under the supervision of a very senior and highly-experienced petroleum engineer or geoscientist. Tallying up how much oil and gas a company's leases are likely to produce involves consideration of a large array of technical and economic factors, including the market value of the future production these fields could yield. I'm sure there are other differences between the current SEC regulations, under which these figures are disclosed as part of a company's annual financial statements, and the standard industry approach set by the Society of Petroleum Engineers. The most important for the purposes of this posting is that under the SPE guidelines, the economic viability of the potential production from an oil deposit is assessed against the prevailing prices over the last 12 months, while also taking the firm's forecast of future prices into account. The SEC requires reserves to meet its standards for "proved" status at the price in effect as of the assessment, in this case at year-end.
When the price of oil was relatively stable, there wasn't much difference between these two perspectives, and thus between reserves determined under SEC or SPE guidelines. Even in the last several years, as prices rose dramatically from their roughly $20-25 per barrel range of the previous two decades, the 12-month averages were typically not drastically different from year-end prices, as for example the $66.25/bbl average for 2006, compared to $61.05/bbl on 12/29/06. However, if prices remain where they are today, we could see a $60/bbl difference between these two metrics for 2008, and a year-on-year decline of over $50/bbl. That would require any reserves that were booked at a price above $40 or so--not just this year, but going back as much as four years--to be reevaluated. (Natural gas has fallen, too, though by much less than crude oil.)
This situation is complicated by a bigger underlying question: what is the value of oil likely to be in the future, rather than at a moment in time or over some past interval? Reserves are future production, after all--in some cases extending over 20 or 30 years, or even longer. The market for prompt delivery might be glutted, and the outlook for the next year might appear pretty bleak, but without reading too much into the present steep "contango" in oil prices, there is every reason to believe that when global economic growth resumes, the fundamental conditions that pushed oil prices beyond $100/bbl will reassert themselves.
Before investors panic at the prospect of publicly-traded oil companies writing down hundreds of millions or billions of barrels of "proved reserves" for accounting disclosure purposes next year, they need to consider where the volumes in question will have gone. Were they merely shifted from the "proved" to "probable" category--thus not affecting the amount of oil that would ultimately be produced--by a temporary oil glut arising from a global recession, or did their existence depend on an oil-price bubble that is unlikely to reflate? And even if these conditions do prove to be temporary, there's a good chance that a number of oil and gas projects, including some fairly large ones, will have been deferred in the meantime, if not canceled entirely. That affects reserves in the most fundamental way possible, as well as altering the future global production profile. Since my own portfolio includes oil & gas equities, I face the same uncertainties in this regard as anyone else, as both an investor and a consumer. At the very least, this situation highlights the urgent need for a major revision of the SEC regulations covering the reporting of reserves, along the lines the Commission has already proposed, to put reserve estimates on a more meaningful and less volatile basis.
Energy Outlook will be on holiday break until next week. Merry Christmas, Happy Hanukkah, and Seasons Greetings, as appropriate!
Friday, December 19, 2008
Open Fuel Standard
One of the energy-related email lists to which I'm subscribed recently alerted me to an interesting piece of pending legislation in the US Congress, the "Open Fuel Standard Act of 2008", S.3303. The bill would require automakers to increase the proportion of their cars that are able to run on non-petroleum fuels to 50% by 2012 and 80% by 2015. Its title might be intended to conjure up analogies to high tech software standards, and its supporters may cite national security considerations, but its main purpose is to plug a gaping hole left by previous Congressional energy legislation. And while it mentions other fuels such as methanol and biodiesel, it is first and foremost about ensuring the future market share of ethanol.
The main focus of the "OFS Act" is Flexible Fuel Vehicles, cars that are factory-equipped to consume fuel containing high proportions of alcohol, which might otherwise damage their fuel systems and other components. Most of the 240 million cars in the US are only certified for alcohol blends of up to 10%. The few million FFVs already on the road were produced under a provision of the Corporate Average Fuel Economy regulations that allowed carmakers to offset them against low-mpg conventional cars, such as large SUVs. Considering that most FFVs burn gasoline most of the time, instead of the alternative fuels they were credited with enabling, this actually reduced the real-world fuel economy of the US new car fleet and increased US petroleum imports, a fact that was recognized and rectified when Congress passed the Energy Independence and Security Act of 2007. That bill established the new, higher national Renewable Fuel Standard (RFS), while progressively phasing out the CAFE benefit from FFVs by 2020. In the process, it set carmakers and fuel suppliers on a collision course, with the wreck now likely to happen several years sooner than it otherwise would have, because gasoline demand is falling.
Until this year, US gasoline demand was growing by about 1% per year. Starting from its 2006 volume of 141.8 billion gallons per year (GPY), the gasoline pool could have been expected to accommodate the quantities of ethanol required under the new RFS until at least 2014 without exceeding the maximum 10% blending rate (E10) for standard cars or requiring significant sales of E85, the 85% ethanol/15% gasoline blend that is the closest thing to pure ethanol that seems to be compatible with our fuels distribution system. But instead of growing by 2% since 2006, US gasoline demand in 2008 has dropped by around 3.5%. A similar decline next year would shrink gasoline sales to about 132 billion GPY and cause the RFS to bump into the E10 ceiling in 2012. That would require either selling E85 to large numbers of FFVs, or delaying the ethanol ramp-up until the fleet's flex-fuel capabilities caught up. Even bumping up the E10 limit to 11 or 12%, which is currently under consideration, would only buy us another year or two.
The Flexible Fuel Vehicle Club of America--who knew?--claims there are 7 million FFVs today. If every last one of them used nothing but E85, they would consume about 5 billion gallons per year. But that would require something like 7,000 retail locations selling at least 60,000 gallons per month of the fuel, instead of the current 1,600 stations selling a few thousand gallons per month each, totaling perhaps 150 million gallons per year. It would also probably require a much bigger discount for E85 vs. regular gasoline than the $0.17/gal reported by AAA currently. (Their calculation suggests E85 costs motorists $0.30/gal more than gasoline at today's prices, after adjusting for mileage effects.)
My long-time readers know that it wouldn't break my heart if the ethanol build-up came to a screeching halt. Ethanol is an inferior fuel in many respects, with an energy density a third lower than gasoline, translating into reduced vehicle range and fuel economy. This is confirmed by the government's own fuel economy ratings. Its environmental attributes are a distinctly mixed bag, and that extends to lifecycle greenhouse gas emissions that may be no better than gasoline's, when global land-use changes are included. Nor does it seem likely that ethanol from non-food sources, including cellulosic plant matter and waste, will be available in large quantities for some time, embedding fuel-vs-food competition into the economy for years to come. Its main selling point is that it is mostly home-grown--never mind the greater efficiency and environmental benefits of sugar-based ethanol from Brazil and the Caribbean. Because of its importance to US agriculture, it is highly unlikely that any US government, Democratic or Republican, would choose to back away from it without compelling evidence of harm--or unless it started to pile up at ethanol plants because there weren't enough FFVs to consume it.
So if Congress remains committed to increasing ethanol use and to denying carmakers the CAFE credits they formerly earned for selling cars that could burn E85, they must pass the Open Fuel Standard act or something like it, far enough in advance of the impending train wreck in 2012 or 2013, to get sufficient FFVs on the road to absorb the surplus ethanol beyond E10. Given the Big Three's other problems, it's hard to imagine the $100 or so in extra expense per car becoming the straw that breaks Detroit's back, but I wouldn't be surprised if they asked for a tax credit to cover the cost.
The main focus of the "OFS Act" is Flexible Fuel Vehicles, cars that are factory-equipped to consume fuel containing high proportions of alcohol, which might otherwise damage their fuel systems and other components. Most of the 240 million cars in the US are only certified for alcohol blends of up to 10%. The few million FFVs already on the road were produced under a provision of the Corporate Average Fuel Economy regulations that allowed carmakers to offset them against low-mpg conventional cars, such as large SUVs. Considering that most FFVs burn gasoline most of the time, instead of the alternative fuels they were credited with enabling, this actually reduced the real-world fuel economy of the US new car fleet and increased US petroleum imports, a fact that was recognized and rectified when Congress passed the Energy Independence and Security Act of 2007. That bill established the new, higher national Renewable Fuel Standard (RFS), while progressively phasing out the CAFE benefit from FFVs by 2020. In the process, it set carmakers and fuel suppliers on a collision course, with the wreck now likely to happen several years sooner than it otherwise would have, because gasoline demand is falling.
Until this year, US gasoline demand was growing by about 1% per year. Starting from its 2006 volume of 141.8 billion gallons per year (GPY), the gasoline pool could have been expected to accommodate the quantities of ethanol required under the new RFS until at least 2014 without exceeding the maximum 10% blending rate (E10) for standard cars or requiring significant sales of E85, the 85% ethanol/15% gasoline blend that is the closest thing to pure ethanol that seems to be compatible with our fuels distribution system. But instead of growing by 2% since 2006, US gasoline demand in 2008 has dropped by around 3.5%. A similar decline next year would shrink gasoline sales to about 132 billion GPY and cause the RFS to bump into the E10 ceiling in 2012. That would require either selling E85 to large numbers of FFVs, or delaying the ethanol ramp-up until the fleet's flex-fuel capabilities caught up. Even bumping up the E10 limit to 11 or 12%, which is currently under consideration, would only buy us another year or two.
The Flexible Fuel Vehicle Club of America--who knew?--claims there are 7 million FFVs today. If every last one of them used nothing but E85, they would consume about 5 billion gallons per year. But that would require something like 7,000 retail locations selling at least 60,000 gallons per month of the fuel, instead of the current 1,600 stations selling a few thousand gallons per month each, totaling perhaps 150 million gallons per year. It would also probably require a much bigger discount for E85 vs. regular gasoline than the $0.17/gal reported by AAA currently. (Their calculation suggests E85 costs motorists $0.30/gal more than gasoline at today's prices, after adjusting for mileage effects.)
My long-time readers know that it wouldn't break my heart if the ethanol build-up came to a screeching halt. Ethanol is an inferior fuel in many respects, with an energy density a third lower than gasoline, translating into reduced vehicle range and fuel economy. This is confirmed by the government's own fuel economy ratings. Its environmental attributes are a distinctly mixed bag, and that extends to lifecycle greenhouse gas emissions that may be no better than gasoline's, when global land-use changes are included. Nor does it seem likely that ethanol from non-food sources, including cellulosic plant matter and waste, will be available in large quantities for some time, embedding fuel-vs-food competition into the economy for years to come. Its main selling point is that it is mostly home-grown--never mind the greater efficiency and environmental benefits of sugar-based ethanol from Brazil and the Caribbean. Because of its importance to US agriculture, it is highly unlikely that any US government, Democratic or Republican, would choose to back away from it without compelling evidence of harm--or unless it started to pile up at ethanol plants because there weren't enough FFVs to consume it.
So if Congress remains committed to increasing ethanol use and to denying carmakers the CAFE credits they formerly earned for selling cars that could burn E85, they must pass the Open Fuel Standard act or something like it, far enough in advance of the impending train wreck in 2012 or 2013, to get sufficient FFVs on the road to absorb the surplus ethanol beyond E10. Given the Big Three's other problems, it's hard to imagine the $100 or so in extra expense per car becoming the straw that breaks Detroit's back, but I wouldn't be surprised if they asked for a tax credit to cover the cost.
Wednesday, December 17, 2008
Oil Shock II
As OPEC's members and friends meet in Algeria to agree on deeper cuts in oil output, the effectiveness of their actions will depend greatly on the nature of the demand slump to which they are responding. If it proves to be merely a dip in the long-term growth trend, similar to the one associated with the Asian Financial Crisis of the late 1990s, then their current decline in revenue will likely be short-lived. If, on the other hand, the response in consuming countries is similar to that following the energy crisis of the 1970s and early 1980s, then OPEC and indeed all oil producers face protracted problems. In that case, they might have to hope that the chief economist of the International Energy Agency is correct in his new assessment that the credit crisis will hasten an expected peak in global oil production, perhaps sending oil prices beyond their summer 2008 highs within a few years.
Although the narrative concerning the present financial crisis and global recession is bound up in the collapse of the US housing market and the vast global debt bubble that fueled it--a bubble that had to burst sooner or later--it seems remarkably coincidental that it would begin to deflate just as oil prices raced past their previous inflation-adjusted peak of around $90 per barrel. Because that price rise took place over several years and was driven as much by demand as by supply constraints, the resulting oil shock wasn't as sharp or obvious as the one triggered by the Arab Oil Embargo of 1973 or the Iranian Revolution of 1979. But between 2003 and 2007, the US net oil import bill rose from around $100 billion per year to $300 billion, based on refiner acquisition costs. It crested at an annualized rate of $500 B per year in July. This added significantly to the US trade deficit, and the resulting sustained double-digit inflation in consumer energy costs helped push the annualized consumer-price inflation rate past 5% this summer. With the energy spike having folded, the November 2008 annualized CPI rate has fallen to 1.1%.
If in retrospect these indicators describe a true oil price shock, then what might OPEC and other oil producers expect in the years ahead? Well, in the aftermath of the last oil crisis, from 1979-83 global oil demand fell by 10%, the current equivalent of over 8 million barrels per day (MBD), based on last year's global consumption of 85.8 MBD. It didn't reach its 1979 level again until 1989. The effect on OPEC was devastating. With demand lower and non-OPEC output expanding steadily, OPEC's oil was squeezed out, losing a third of its former market share. Oil prices remained low for another fifteen years, contributing to the growth of the exurbs and the SUV fad.
History rarely repeats exactly, and it would be simplistic to think that we're likely to replicate the oil price environment of the mid-to-late 1980s. There's no tidal wave of non-OPEC conventional oil coming from places like the North Slope and North Sea, which looked technically challenging at the time but seem relatively easy, compared to today's opportunities. Biofuels have added the equivalent of around 0.5 MBD in the last several years, and Canadian oilsands a similar amount, but production in most non-OPEC countries is peaking or in decline, notably in Mexico and Russia. And as the IEA's Dr. Birol notes, tight credit and low prices will slow additions to supply from all sources, while natural decline erodes today's base production. That makes demand the crucial factor, particularly the behavioral elements of demand. Although rarely discussed in these terms, vehicle fuel economy faces diminishing returns. Boosting US fleet average miles per gallon from 13 to 25 under the original CAFE standard in the 1970s and '80s saved three times more fuel per mile than the mandated increase to 35 mpg will--in fact more than moving the entire fleet to 100 mpg plug-in hybrids would. Vehicle miles traveled have recently declined in the US. Along with the appetite of Asian consumers for their first cars, this will have as much impact as fuel economy on total oil consumption, and thus on prices.
Although the oil price shock of the last several years can't be blamed for the full extent of the mess we're in, it is at least a plausible candidate for the trigger that caused the debt bubble to pop now, rather than a few years from now. That has important implications, because current conditions may be setting the stage for another, possibly sharper oil shock shortly after the economy begins to recover. Although we face a drastically altered set of energy concerns going into 2009, energy policies that promote both conservation and increased supply look just as essential as they did a year ago.
Although the narrative concerning the present financial crisis and global recession is bound up in the collapse of the US housing market and the vast global debt bubble that fueled it--a bubble that had to burst sooner or later--it seems remarkably coincidental that it would begin to deflate just as oil prices raced past their previous inflation-adjusted peak of around $90 per barrel. Because that price rise took place over several years and was driven as much by demand as by supply constraints, the resulting oil shock wasn't as sharp or obvious as the one triggered by the Arab Oil Embargo of 1973 or the Iranian Revolution of 1979. But between 2003 and 2007, the US net oil import bill rose from around $100 billion per year to $300 billion, based on refiner acquisition costs. It crested at an annualized rate of $500 B per year in July. This added significantly to the US trade deficit, and the resulting sustained double-digit inflation in consumer energy costs helped push the annualized consumer-price inflation rate past 5% this summer. With the energy spike having folded, the November 2008 annualized CPI rate has fallen to 1.1%.
If in retrospect these indicators describe a true oil price shock, then what might OPEC and other oil producers expect in the years ahead? Well, in the aftermath of the last oil crisis, from 1979-83 global oil demand fell by 10%, the current equivalent of over 8 million barrels per day (MBD), based on last year's global consumption of 85.8 MBD. It didn't reach its 1979 level again until 1989. The effect on OPEC was devastating. With demand lower and non-OPEC output expanding steadily, OPEC's oil was squeezed out, losing a third of its former market share. Oil prices remained low for another fifteen years, contributing to the growth of the exurbs and the SUV fad.
History rarely repeats exactly, and it would be simplistic to think that we're likely to replicate the oil price environment of the mid-to-late 1980s. There's no tidal wave of non-OPEC conventional oil coming from places like the North Slope and North Sea, which looked technically challenging at the time but seem relatively easy, compared to today's opportunities. Biofuels have added the equivalent of around 0.5 MBD in the last several years, and Canadian oilsands a similar amount, but production in most non-OPEC countries is peaking or in decline, notably in Mexico and Russia. And as the IEA's Dr. Birol notes, tight credit and low prices will slow additions to supply from all sources, while natural decline erodes today's base production. That makes demand the crucial factor, particularly the behavioral elements of demand. Although rarely discussed in these terms, vehicle fuel economy faces diminishing returns. Boosting US fleet average miles per gallon from 13 to 25 under the original CAFE standard in the 1970s and '80s saved three times more fuel per mile than the mandated increase to 35 mpg will--in fact more than moving the entire fleet to 100 mpg plug-in hybrids would. Vehicle miles traveled have recently declined in the US. Along with the appetite of Asian consumers for their first cars, this will have as much impact as fuel economy on total oil consumption, and thus on prices.
Although the oil price shock of the last several years can't be blamed for the full extent of the mess we're in, it is at least a plausible candidate for the trigger that caused the debt bubble to pop now, rather than a few years from now. That has important implications, because current conditions may be setting the stage for another, possibly sharper oil shock shortly after the economy begins to recover. Although we face a drastically altered set of energy concerns going into 2009, energy policies that promote both conservation and increased supply look just as essential as they did a year ago.
Monday, December 15, 2008
Steel on the Ground
2009 is shaping up as the Year of the Stimulus. The consensus for a massive fiscal stimulus of the US economy, in the form of direct government spending and targeted tax breaks, grows daily. The biggest remaining questions focus on how much and how quickly. Estimates of the magnitude under consideration range from $400 billion to over a trillion, spread out over two years. Some would even like to see a stimulus bill ready for President Obama's signature on Inauguration Day. As urgent as the need to kick-start the economy appears, however, there are good reasons to spend at least as much time considering what to stimulate and how to go about it. That's particularly true of the energy economy, where the results of a stimulus will be felt for the next forty years.
An essay in Sunday's Washington Post highlighted some of the pitfalls of past government spending on infrastructure. Despite the best of intentions, our elected and appointed officials don't appear to have any keener insights into the future than corporate executives. It's inevitable that some of the stimulus will end up funding inefficient and ineffective projects, and in the interest of avoiding an economic implosion and a deflationary spiral of job cuts, demand reduction, price cuts, output reduction, and more job cuts, that might not be the worst outcome. But we need to ensure that the lion's share of the stimulus is focused on things that really need doing and that the private sector, even in the best of times, has difficulties undertaking. My top candidate for this is a major upgrade of our electricity infrastructure.
It's going to be very tempting for the federal government to invest directly in energy technology deployment--not just R&D--and even in private firms. The $350 million loan sought by Tesla Motors, the Silicon Valley electric car start-up that has just sold its 100th $100,000 electric sports car, comes to mind. We need clear guidelines that avoid putting tax dollars into companies that operate in markets that are already distorted by federal mandates and subsidies, such as those supporting biofuels production. But while I would not wish the government to invest in wind and solar power developers or their projects, the infrastructure necessary to make those projects more effective and competitive is a different story.
The case for increased federal investment in our power grids is similar to that for the Interstate Highway system in the 1950s, as another great enabler of economic transformation. Ever since the northeast blackout of 2003, we've known that the grid must become more resilient and reliable, and utilities and the grid operators have been working hard on that. But it also needs to be able to accommodate a much larger number of generators, ranging from rooftop solar arrays to widely dispersed utility-scale solar power installations and wind farms. Moreover, we need more long-distance transmission, particularly from the ten or so states that are home to roughly 80% of US wind power potential. Our best solar resources are similarly concentrated. If we're serious about reducing greenhouse gases from the electricity sector, which contributes a third of US emissions, this will require a better-integrated, higher-capacity, faster-reacting electrical grid to ensure that we make the most of distributed and intermittent renewable energy sources. It is also the sine qua non of the eventual mass electrification of our transportation systems, which account for another 28% of our GHGs and two-thirds of our petroleum consumption.
Unfortunately, we must also be realistic about how much can actually be accomplished, or in stimulus terms, spent on this task within the next two years. Although we might like to imagine a massive, Works Progress Administration-like marshaling of the nation's unemployed to undertake great tasks, those Depression-era efforts faced nothing like the modern regulatory requirements for permits and environmental impact reports. I've been associated with a fair number of large projects in my day, and the practical obstacles for quickly revamping the power grid boggle my mind. For starters, it would require setting aside all of the existing regional, state and local permitting processes and handing someone--a "grid czar"?--sweeping powers even greater than the power to designate "National Interest Electricity Corridors" that was given to the Federal Energy Regulatory Commission under the Energy Policy Act of 2005. Even if permits were no problem and plans already in place, I wonder how much actual "steel on the ground" we'd see by the end of 2010, beyond "last-mile" investments, such as smart electricity meters. Perhaps the best we can hope for in this timeframe would be to fund the planning and design process and get all of the environmental impact studies done. That might stimulate a lot of engineering and consulting firms, but it wouldn't necessarily put many construction folks to work. I can't help wondering how many other aspects of a federal stimulus beyond energy will be subject to similar constraints.
An essay in Sunday's Washington Post highlighted some of the pitfalls of past government spending on infrastructure. Despite the best of intentions, our elected and appointed officials don't appear to have any keener insights into the future than corporate executives. It's inevitable that some of the stimulus will end up funding inefficient and ineffective projects, and in the interest of avoiding an economic implosion and a deflationary spiral of job cuts, demand reduction, price cuts, output reduction, and more job cuts, that might not be the worst outcome. But we need to ensure that the lion's share of the stimulus is focused on things that really need doing and that the private sector, even in the best of times, has difficulties undertaking. My top candidate for this is a major upgrade of our electricity infrastructure.
It's going to be very tempting for the federal government to invest directly in energy technology deployment--not just R&D--and even in private firms. The $350 million loan sought by Tesla Motors, the Silicon Valley electric car start-up that has just sold its 100th $100,000 electric sports car, comes to mind. We need clear guidelines that avoid putting tax dollars into companies that operate in markets that are already distorted by federal mandates and subsidies, such as those supporting biofuels production. But while I would not wish the government to invest in wind and solar power developers or their projects, the infrastructure necessary to make those projects more effective and competitive is a different story.
The case for increased federal investment in our power grids is similar to that for the Interstate Highway system in the 1950s, as another great enabler of economic transformation. Ever since the northeast blackout of 2003, we've known that the grid must become more resilient and reliable, and utilities and the grid operators have been working hard on that. But it also needs to be able to accommodate a much larger number of generators, ranging from rooftop solar arrays to widely dispersed utility-scale solar power installations and wind farms. Moreover, we need more long-distance transmission, particularly from the ten or so states that are home to roughly 80% of US wind power potential. Our best solar resources are similarly concentrated. If we're serious about reducing greenhouse gases from the electricity sector, which contributes a third of US emissions, this will require a better-integrated, higher-capacity, faster-reacting electrical grid to ensure that we make the most of distributed and intermittent renewable energy sources. It is also the sine qua non of the eventual mass electrification of our transportation systems, which account for another 28% of our GHGs and two-thirds of our petroleum consumption.
Unfortunately, we must also be realistic about how much can actually be accomplished, or in stimulus terms, spent on this task within the next two years. Although we might like to imagine a massive, Works Progress Administration-like marshaling of the nation's unemployed to undertake great tasks, those Depression-era efforts faced nothing like the modern regulatory requirements for permits and environmental impact reports. I've been associated with a fair number of large projects in my day, and the practical obstacles for quickly revamping the power grid boggle my mind. For starters, it would require setting aside all of the existing regional, state and local permitting processes and handing someone--a "grid czar"?--sweeping powers even greater than the power to designate "National Interest Electricity Corridors" that was given to the Federal Energy Regulatory Commission under the Energy Policy Act of 2005. Even if permits were no problem and plans already in place, I wonder how much actual "steel on the ground" we'd see by the end of 2010, beyond "last-mile" investments, such as smart electricity meters. Perhaps the best we can hope for in this timeframe would be to fund the planning and design process and get all of the environmental impact studies done. That might stimulate a lot of engineering and consulting firms, but it wouldn't necessarily put many construction folks to work. I can't help wondering how many other aspects of a federal stimulus beyond energy will be subject to similar constraints.
Subscribe to:
Posts (Atom)