How Helpless Are We in the Face of Rising Oil Prices?

Oil is rarely not political, and with gasoline prices hitting record levels early in a presidential election year, we shouldn't be surprised that both the President and his challengers have focused on energy policy. President Obama gave what was billed as a major speech on energy at the University of Miami in Florida yesterday. After urging more students to study engineering--a sentiment I would strongly second--he laid out his view of the situation and its solutions. He got a lot right, including the long-term nature of the problem and the value of improving the efficiency of our vehicle fleet. But unfortunately, he also missed the mark in many ways and generally reflected the exaggerated fatalism that his administration has consistently exhibited towards oil prices. Boosting domestic supply is not the only answer, but it could be far more effective in moderating high oil prices and their impact on the economy than the President admitted.

To see why requires a sense of how the oil market works, as well as the uses to which we put oil today, rather than a generation ago. For starters, although the President has worked hard to improve conditions for renewable energy sources like wind and solar power--sources that certainly have an important role to play in our long-term energy mix--these technologies, along with nuclear power, are out of place in a conversation about oil prices in 2012. That's because they produce electricity rather than liquid fuels, and less than 1% of US electricity is generated from oil today, compared to more than 10% in 1980. Electricity from renewable and nuclear power doesn't compete with imported oil or any other kind of oil; it competes with domestic energy sources like coal and natural gas, most of which now comes from conventional and unconventional gas fields, rather than as a byproduct of producing oil. So by all means lets have a conversation about renewables in the context of reducing greenhouse gas emissions today and displacing oil from transportation when there are tens of millions of electric vehicles on the road in the future, but in terms of oil prices now and in the near future, they are a rhetorical diversion.

Fuel efficiency and plain old conservation can play an important role in reducing both our exposure to higher oil prices and in contributing to lower prices, because both attack demand directly, and demand is a big factor in oil prices. The President is right to emphasize this. Americans have cut back on oil consumption to the tune of 1.8 million barrels per day since 2007, and this was a significant factor in the oil price collapse in late 2008 and the generally lower prices we've enjoyed since then. Unfortunately, that happened largely as a result of the recession and financial crisis, rather than a sudden spike in fuel efficiency. If Americans buy the new, more efficient cars that Detroit must make under the administration's stricter Corporate Average Fuel Economy standards, then over the next decades the efficiency of the US car fleet will improve significantly, and even after rebound effects our oil demand and need for imported oil should fall. But let's not delude ourselves that this can happen overnight. There are roughly 250 million cars, SUVs and light trucks on the road in the US today, and even at pre-recession sales levels it will take more than a decade to turn over enough of them to make a serious dent in oil consumption.

President Obama made only a passing reference to biofuels in his speech, and for good reason. At current production levels ethanol displaces up to 600,000 bbl/day of petroleum gasoline, after adjusting for its lower energy content. That's good, but we've essentially played that card already and can't play it again. Almost all the gasoline sold in the US today contains 10% ethanol, the maximum level that most cars can tolerate without damaging their fuel systems or voiding their warranties. There's little appetite among consumers for the 85% ethanol E85 blend that flexible fuel vehicles can use, and there's even less appetite among fuel distributors for the 15% ethanol blend that the EPA blessed in 2010. With ethanol maxed out for now, our focus must shift to biofuels that are much more compatible with gasoline and diesel fuel, and that rely on technologies that haven't yet been demonstrated at commercial scale or competitive cost.

And that brings us back to the potential for reducing our dependence on oil imports and moderating oil prices by producing more domestic oil. Now, it's certainly true that US oil production and consumption are only part of a much larger global oil market, where prices are actually set. The US couldn't control the global price of oil, as it once did, even if we imported virtually no oil from outside North America. However, it's simply not correct to gauge the potential impact of an extra million bbl/day of US production--a figure that is well within the range of what a more aggressive domestic drilling program could deliver--by comparing it to the entire global output of nearly 90 million bbl/day. As with other commodities like grain and coffee, the price of oil is determined by relatively small changes in supply, demand, inventories, and in the case of oil, spare capacity. What really counts is the last few million barrels per day that are traded, whether inventories are rising or falling, and how large global spare capacity is and who owns it. The last three times that oil prices collapsed, in the mid-1980s, late-1990s, and 2008, it happened as a result of net changes in these parameters amounting to less than about 3 million bbl/day.

Yesterday the President cited statistics indicating that US oil production has returned to levels we hadn't seen for several years. That's true, and it's equally true that this modest surge of about 14% is the result of factors over which his administration had no control: oil prices and federal policies in the previous administration and the application of improved drilling technologies in the deepwater Gulf of Mexico and onshore locations like North Dakota's Bakken formation and the Eagle Ford shale of Texas. Moreover, it's only technically accurate to state that he has "opened millions of acres for oil and gas exploration", when the lease sales in question were originally scheduled to have taken place earlier, and were to have encompassed much more acreage, including offshore acreage that has been off limits for decades, such as offshore Virginia. The Deepwater Horizon accident certainly changed the context for the President's previous drilling plans, but his administration's responsibility for the subsequent decline in offshore production, the slower pace of development and tighter geographic constraints on where the industry can look for oil since then must be acknowledged in this discussion.

Then there's that other shibboleth of oil prices, speculation, which was also mentioned yesterday. As I've discussed previously, there are times when speculation can increase some oil prices, at least for a brief period. However, it's worth recalling that for every trader buying futures contracts or options in hopes they will go even higher, some seller must take the position that current prices are high enough and likely to be lower, later. This adds a froth of sentiment to the market, but it can't sustain prices for long if fundamentals aren't supportive and if the physical market doesn't follow. So while politicians see a $10/bbl rise this month in the price of West Texas Intermediate on the futures market as a symptom of speculation, they tend to ignore data like the much larger recent increase in the spot price for Louisiana Light Sweet crude, for which someone must take physical delivery at St. James, Louisiana, rather than just offsetting against another "paper barrel". When you look at physical oil inventories, there's no evidence that speculators are taking delivery of large quantities of oil and storing it so refiners can't buy it.

The key factors driving the recent increase in oil prices are tensions with Iran and the fact that, with production off-line in places like Sudan and still not back to pre-revolution levels in Libya, OPEC's effective spare capacity is below 3 million bbl/day, not much above the level that contributed greatly to oil's near-$150 peak in mid-2008. So despite relatively weak demand growth, the market looks tight now, with the prospect of Iran cutting off sales--or being embargoed via sanctions from buyers--by a volume that would erode that cushion of spare capacity in Saudi Arabia and a few other Persian Gulf producers even further--capacity that mostly sits inside the Strait of Hormuz.

So what levers does this President--or any President--really have with which to try to moderate oil prices over the next few years? It's clearly not renewable energy policy at this point. It could include foreign policy, particularly if you agree with the view of Washington Post columnist David Ignatius that Iran has displayed a clear pattern of backing down in the face of "overwhelming force". Resolving the Iranian threat to Gulf shipping and setting the outlines of a solution to Iran's nuclear program could take $20/bbl off the price of oil in fairly short order, though I wouldn't suggest that looks easy. Yet even though a decision to expand access to US oil resources significantly, along the lines of the President's pre-Deepwater Horizon plan, would not deliver new production quickly, it's wrong to be dismissive about the impact of more drilling on prices or in mitigating the impact of those prices on the economy. And in the case of onshore opportunities for which infrastructure is already in place or in the works--and here I would include the Keystone XL pipeline--it need not take 10 years for the first barrels to reach market. Together with a strong, technology-neutral effort on fuel economy, a new, more expansive approach to exploiting domestic resources would affect the back end of the futures price curve, and that could start to nudge down nearer-term prices, as well. Even if I'm wrong about that, it's still the case that at current prices every additional 1,000 bbl/day we produce here would reduce our trade deficit and the drag on our economy by about $40 million--and there are a lot more thousands of barrels per day we could be producing.

At least one of the President's potential challengers has described a plan for getting gas prices back to $2.50 per gallon. Perhaps this had something to do with President Obama's choice of topic yesterday. I will devote a lot more time to analyzing such proposals once the Republicans have chosen their nominee. However, it's worth noting that as outlandish as $2.50/gal. sounds when the average price of unleaded regular has jumped to $3.59/gal. this week, it works out to an effective crude price of around $70/bbl, after subtracting state and federal taxes and refiner and dealer margins. That's roughly what oil cost in 2006 and 2007 and more than in 2009. It's also a higher price than most oil industry experts even imagined would be possible just a few years earlier.

I don't know if Mr. Gingrich's plan would work, and I suspect that the economics of at least some of the new production necessary to force OPEC to compete on price again, rather than managing the price to suit their own needs, might be challenging at $70/bbl. Yet I'd be much more inclined for us to work towards such a goal than to dismiss it as impossible or irrelevant and fatalistically accept the consequences of $100+ oil for another decade or more. The President should at least be as open to these possibilities as he is to the possibilities of renewable energy for reducing emissions.

Administration's Tax Proposals Would Hamper US Energy Output

The Obama administration is proposing significant changes in US corporate taxes, as reported in today's Wall St. Journal. If enacted, the corporate tax rate would fall from 35% of income to 28%, although the elimination of numerous tax incentives would subject many companies, including most in the energy sector, to higher taxes overall. On the surface, this looks like the kind of tax reform that has been long overdue; however, as always with such efforts, the details matter enormously. In this case, the details would create an even less-level playing field for US energy producers, while doubling down on the expensive tax benefits currently provided to favored sectors and technologies. It's ironic that this is being proposed just when rising gasoline prices have put the administration on the defensive concerning its energy policies. It will do the President little good to point to increasing US oil production--demonstrably the result of energy prices and policies in previous administrations--if he simultaneously jeopardizes that recovery in output by making it less attractive to produce oil and gas here.

The basic principle of cutting marginal corporate tax rates in exchange for the elimination of "tax expenditures", or loopholes, in common parlance, is consistent with the much broader tax reform proposed by the fiscal commission established by the White House in 2010, even if the administration has opted for the upper end of the range of tax rates suggested by Simpson-Bowles. In general, US oil and gas companies wouldn't be worse off for losing the various deductions and tax credits in the current tax code, if the marginal tax rate were reduced sufficiently and if the administration weren't proposing to raise royalty rates on US onshore production by 50% at the same time. However, the combination of the proposed changes, including subjecting part of their non-US income to US taxation, would not only make US oil and gas projects less attractive, relative to projects in other countries; they would also make it less attractive to be a US oil and gas company, instead of a non-US company that operates here. For an administration that is concerned about US competitiveness, this is perverse logic, indeed.

It doesn't take a crystal ball to predict that the combination of higher corporate taxes on energy companies, higher royalties, and the more complex permitting processes instituted by the administration even before the Deepwater Horizon accident will make it much harder to sustain the recent recovery in US oil output beyond the completion of projects that were initiated during the previous administration. New oil and gas production would probably still be profitable here after these changes, particularly if oil prices remain as high as they are now, but company portfolios would begin to shift back towards non-US projects that look more rewarding by comparison, and US companies would lose some of their edge to non-US competitors. None of that would be good for US energy consumers, considering that the oil and gas industry accounts for 62% of the energy we use, including 49% of all energy produced domestically.

Of course, the administration's tax proposals reach well beyond oil and gas. Among other things, they would extend the Production Tax Credit for wind energy by another year, through 2013, as well as extending for another year the Treasury renewable energy cash grants that expired at the end of last year. After 2012, the cash grants would be replaced by refundable tax credits, which essentially means you'd get a check from the IRS, rather than from the Treasury, if the credit were larger than the taxes your firm owes. The net effect of the latter would perpetuate a costly system of renewable energy subsidies that reward the deployment of renewable energy hardware, rather than the actual generation of renewable energy. (That distinction is important whenever the hardware is installed somewhere lacking in good wind, sun, or other renewable resources.)

Then there's the proposal to boost the electric vehicle tax credit to a maximum of $10,000 per car, and to shift the recipient from the purchaser to the seller. That circumvents the problem that under the current $7,500 credit you'd have to earn enough income to be paying at least that much in federal income taxes, in order to enjoy the full benefit of the credit. However, it also makes it much likelier that manufacturers and dealers would pocket a significant slice of the higher credit, instead of consumers. Since it was nearly impossible to justify the $7,500 per car credit on the basis of actual oil or emissions savings, the higher credit looks even less justifiable, other than as a means of raising the odds of achieving the President's arbitrary target of putting a million EVs on the road by 2015--another near impossibility. The pluses I see here include an automatic phaseout based on time, rather than sales volume, and a broadening of the credit to cover other efficient vehicle technologies such as natural gas, though it's not clear whether it would also cover advanced diesels. Still, if the President has his way, we'll be spending more than $10 billion to put vehicles on the road that will save less than 35,000 barrels per day of oil, or about 0.4% of our total gasoline consumption, along with greenhouse gas emissions worth less than $1 billion at market prices--even European market prices.

The proposals include other provisions that would affect the energy sector, including tax benefits for advanced energy manufacturing such as wind turbines, solar panels, advanced batteries, electric vehicles, and an array of other equipment. I'd be much happier with those incentives if they were provided as an alternative to origin-blind deployment incentives, instead of alongside them. And although oil and gas companies would lose the manufacturing tax deduction on their US production, it appears they might get to keep that deduction on US refining, which has been hurt by higher oil prices. That would be small consolation to independent refining companies that have been forced to close several large east coast refineries or that are barely breaking even.

If President Obama is serious about tax reform, the current proposals--flawed as they are--would have carried a lot more weight had they been introduced a year ago, in the immediate aftermath of the Simpson-Bowles report and various other tax reform suggestions, rather than in an election year. And if he is truly serious about the"all-out, all-of-the-above strategy" for energy that he referenced in this year's State of the Union address, the current proposals look like an extremely odd way to execute that, favoring as heavily as they do sources that account for less than 2% of US energy production, while penalizing those that contribute nearly half. The good news is that this is a meal that won't be eaten hot. For now, this package serves as another plank in the reelection campaign platform. Whether it will ultimately be implemented depends not just on who occupies the White House after January 20, 2013, but also on the composition of the next Congress since it has no chance of passage in the 112th.

New Budget Reflects Inefficient Energy Priorities

An editorial in today's New York Times praising the energy priorities included in the President's latest budget is little more than a rubber stamp of a set of policies in serious need of rethinking. The goals the Times espouses, of "reducing America’s dependence on foreign oil and giving American workers a fighting chance in the global competition for clean-energy jobs", are perfectly fine; however, what's entirely absent is any critical assessment of whether the expensive programs they chose to highlight will contribute meaningfully to accomplishing them.

Start with the reauthorization of Treasury cash grants for renewable energy projects. A quick review of the Treasury's own tracking spreadsheet shows that 77% of the $10.4 billion awarded since 2009 under this program went to projects employing wind turbines, a mostly mature technology, half the value of which goes to offshore manufacturers, based on the American Wind Energy Association's own assessment. If the goal is putting Americans to work producing wind power hardware, this is a grossly inefficient way to do it. Moreover, this temporary program was instituted to fill the gap created when the market for "tax equity"--private transactions that exchange current cash for future tax credits--dried up during the financial crisis. Tax equity investors have recently been returning to the market, but they can't readily compete with free money from the Treasury Department. In other words, at this late date the Treasury cash grants are a solution to a problem that their continuation would help perpetuate.

Then there's the matter of the wind production tax credit, which I looked at in some detail recently. While I agree that it's neither fair nor appropriate to drop the industry off a cliff by allowing this benefit to expire all at once, it is high time that the 20-year-old tax credit for wind power be reduced to account for the maturity of onshore wind technology, and then gradually phased out on a firm schedule. The Times makes no mention of any of this.

It's also important to understand that whatever the technologies covered by these two programs may contribute to reducing greenhouse gas emissions, they don't save a barrel of imported oil, because the US generates less than 1% of our electricity from oil, and much of that in island or other remote locations that can't easily get reliable electricity through other means. That makes it doubly ironic that the only "subsidies" the Times opposes are the current tax benefits for oil and gas companies, arguably the only program mentioned in their editorial that actually does help reduce US imports of foreign oil.

The President's 2013 budget, which has little chance of adoption as proposed, includes a number of other energy provisions. Some of them are very worthy, including increased support for energy R&D that is too risky or long-term for industry to undertake on its own. However, it also includes an extension of the loan guarantee program that gave us Solyndra--a program that should not be renewed without much stronger oversight than the DOE has provided to date, beyond just hiring a "chief risk officer". It also mentions "enhancements to the existing electric vehicle tax incentive", a $7,500 per vehicle credit that benefits mostly higher-income taxpayers and does little to reduce either emissions or oil imports. What I don't see in these proposals is any recognition that many of the programs they seek to extend or expand have either outlived their usefulness or fallen short of delivering the benefits on which they were originally justified, and that every dollar spent inefficiently in this manner adds to our $1.3 trillion deficit, the necessary narrowing of which keeps getting pushed ever further into the future. The administration's latest energy priorities would have us spending as though it were still 2006.

Biofuels Battle Value vs. Volume

I was only partially surprised to read in MIT's Technology Review that Amyris, a biotechnology company developing renewable diesel and jet fuel from sugar cane, was backing away from the biofuel market to pursue more lucrative products. Fuels are a highly competitive, low-margin business, and it's hard enough to make money refining them even with established technology and a ubiquitous feedstock like crude oil. This is a great, under-appreciated challenge facing every company that seeks to produce new, greener fuels from biomass using processes that haven't yet reached commercial scale or are only just arriving there. The key is either to produce something for which customers will pay better-than-commodity prices, yielding a high margin per gallon, or on such a vast scale that you can survive with a thin margin.

When I listened to the replay of the investor call Amyris held last week, I picked up some nuances missing from the Technology Review article. Confining its biofuels efforts to joint ventures with Total and with Cosan, a large Brazilian sugar and ethanol producer, probably makes sense for Amyris for many reasons. However, the discussion of value vs. volume segmentation on the call pointed to the need to attain a scale in fuels that would likely be beyond the wherewithal of a firm its size, investing on its own. As it is, the total cane ethanol production of its Brazilian partner Cosan--via the latter's JV with Shell--is still less than the throughput of all but a handful of US oil refineries, and only about one-tenth the volume by which Shell's Motiva joint venture is expanding its Port Arthur, TX refinery. Biofuel refineries needn't reach that scale--they probably couldn't due to the limitations of their feedstock logistics, in any case--but they still need to crack the challenge of repaying big capacity investments while making low-margin products, in addition to any technical challenges they face.

Last week I ran cross a clever plan to circumvent this challenge, in conjunction with meeting the 36 billion gallon per year US Renewable Fuel Standard (RFS). Jim Lane of Biofuels Digest proposed a scenario for meeting the 2022 RFS target using mainly existing corn ethanol and biodiesel facilities. He suggests converting the former to produce higher-value biobutanol, and then capturing and converting their CO2 emissions--after correcting a typo that pegs them at 90 million lb. per year instead of 90 billion lb.--into additional fuels using algae or solar energy. Mr. Lane gets full marks for ingenuity and for coming up with a pathway that doesn't depend on the widespread adoption of E15 and E85 ethanol blends that the public hasn't embraced and might never. However, in my view it relies too much on promising but unproven technologies and on the durability of a price premium for butanol in chemical markets that would be completely swamped by fuels-scale output. I'd expect any shift from ethanol to butanol to proceed only about as far as it took to crush the price differential between butanol and wholesale gasoline.

The advance biofuels industry has made enormous strides in the last decade and proved that you can start with biomass or even CO2 and produce fuels that are chemically identical or otherwise broadly compatible with the petroleum-based fuels that remain the world's primary source of energy for transportation. What it hasn't yet achieved is to prove that it can do so at a cost that competes with that of oil, even when the latter is over $100 per barrel, notwithstanding the cumulative trillions of cubic feet of rhetoric asserting that it can do so as soon as it scales up. The experience of companies like Amyris, which is refocusing its wholly-owned activities on high-margin speciality products, rather than fuel, and of cellulosic dropouts like Range Fuels, reminds us just how hard this will be.

Why Are Gasoline Prices So High in February?

US gasoline prices are setting records for this time of the year, with the current price apparently the highest ever for February, at least in nominal dollars. In fact, the monthly average US retail price for unleaded regular has set new records every month since last October. That isn't quite as dramatic as it might seem, because based on the Department of Energy's data, the previous records for those months were set just a year earlier. Yet it's still a significant drag on the economy--an anti-stimulus, as I've noted previously. Unfortunately, some of the explanations I've seen for these price levels, including the ones offered in last night's CBS Evening News, focus too much on minor factors such as refinery maintenance and commodity speculation, while ignoring the most basic influence: the price of oil. That's understandable if they're watching the wrong oil price.

If you've been reading this blog for a while, you know why the most-watched oil price in America, the one for West Texas Intermediate crude (WTI), is no longer representative of the broader US oil market, at least for now. The best domestic grade to follow at the moment is probably Louisiana Light Sweet (LLS), which is of similar quality to WTI but not subject to the persistent transportation bottleneck at Cushing, OK. It tracks closely to UK Brent crude, which has largely taken over the role of global oil price indicator. The "spot" price of LLS was $119 per barrel today, accounting for 94% of the price of prompt gasoline futures on the New York Mercantile Exchange (NYMEX) today. And the $16/bbl increase in LLS since February 9, 2011 explains nearly 80% of the increase in the wholesale gasoline price over that interval. So while refinery outages might be having some impact, particularly in the local and regional markets served by the affected facilities, they are not the main show, nor is speculation in gasoline futures, the effect of which beyond the New York area covered by the NYMEX contract should be rather attenuated.

So with gas prices this high, this early in the year, how high might they be when the summer driving season arrives? That also comes down to crude oil, prompting questions about why oil prices are so high today, despite relatively weak demand. Many analysts attribute oil's strength to worries about Iran's threat to close the Strait of Hormuz as the sanctions noose tightens, along with rumors that Israel may be preparing to strike Iran's nuclear sites on its own this spring. But as with any such risks, they will either manifest or they won't, and the more time that goes by without these feared events occurring, the less influence they are likely to have in propping up oil markets, absent a surge in underlying demand due to a strengthening global economy. If none of that takes place, then oil prices could ease, resulting in summer gas prices not much worse than what we see today. However, I'd be wary of reversing that logic: Keeping gas prices low is not a sufficient reason to back away from addressing the risks posed by what the International Atomic Energy Agency refers to as the "military dimensions" of Iran's nuclear program.

B.C. Aims to Sell Cleaner LNG

I just ran across British Columbia's new provincial natural gas strategy, which includes a specific strategy for expanding liquefied natural gas (LNG) production as a way to mitigate global climate change. That might sound odd to those who are worried--unnecessarily--that gas might be even worse than coal, emissions-wise, but the province seems to have a good grasp of the benefits of replacing coal combustion in Asia with cleaner fuels like natural gas. They've also come up with a unique selling point for their LNG, on the basis that it would be produced using low-emissions electricity and thus have an emissions edge over other LNG sources. Whether this will confer an advantage on B.C.'s LNG by enabling it to collect a premium or capture a larger share of rapidly growing global LNG trade remains to be seen.

This story caught my eye because it fit neatly with one theme of a webinar in which I recently participated at The Energy Collective. Although most greenhouse gas emissions from fossil fuels occur at the point of combustion in a car, truck, plane, train, ship or power plant, the upstream emissions aren't insignificant and can be reduced in some cases by employing renewable energy in their production. Examples I cited in the webinar included an enhanced oil recovery demonstration project in California that employs concentrated solar power to produce some of the steam used to extract oil from an old oil field, and another project to extract geothermal energy from hot fluids brought to the surface as part of the oil production process.

The case that B.C. makes for reducing greenhouse gas emissions from LNG production by relying on the province's bountiful hydro- and wind power resources is a different application of the same principles. That's because whether the energy for cooling billions of cubic feet per day of natural gas to its liquefaction temperature of -162ºC comes from a local electricity grid or from burning some of the gas in a dedicated cogeneration facility, in most locations this adds significantly to the lifecycle emissions of the LNG. One study that I found on the California Energy Commission's site, produced by PACE Consultants, indicates that liquefaction accounts for around 10% of the lifecycle emissions of LNG converted to electricity in an efficient gas turbine power plant. Eliminating those extra emissions by powering a liquefaction plant with green electricity would bring the emissions from LNG much closer to those from pipeline natural gas and increase its advantage versus coal.

So now what B.C.'s LNG projects need is customers in Asia who will put a premium on "cleaner LNG"--presumably in countries that have committed to large greenhouse gas emission cuts that they can't achieve with indigenous fuels. Japan comes to mind, but I'm sure there are others. These customers would also have to be willing to deal with the longer voyage times from Kitimat, northern B.C. to Asia, compared to competing projects in Australia. That extra 1,000 miles or so translates into higher freight costs and a larger tanker fleet, along with somewhat higher emissions from transportation--though not enough to negate the liquefaction advantage. With so many new and expanding LNG projects around the world competing for market share, I'll be very interested to see whether B.C.'s new strategy pays off.

Cleantech Firms Paying the Price for Subsidies

In observing the recent struggles of various segments of the global cleantech industry, including renewable energy and advanced energy technology firms, a pattern is emerging. Today's Wall St. Journal reports "Wind Power Firms on Edge," as the US wind industry hunkers down pending the renewal or expiration of a key subsidy at the end of 2012. A maker of electric-vehicle batteries that received a federal grant to build a factory in Indiana is reorganizing via bankruptcy, wiping out the equity of its original investors. Meanwhile, the US International Trade Commission may be on the verge of imposing retroactive tariffs on imported Chinese solar power equipment. Each of these stories has unique features, but what they share in common is the consequences of renewable energy policies around the world that promoted overcapacity in manufacturing and fierce competition in deployment, effectively setting up some of their past beneficiaries for failure or at least a period of very low margins. Depending on your perspective, this is either an indictment of such subsidies or collateral damage on our way to a brighter future.

One blogger from an advanced battery trade association noted that "Ener1 Is No Solyndra", and I tend to agree. As I've noted previously, the decision to award Solyndra a $535 million federal loan was ill-advised, not just because of competition from other solar manufacturers, but because at the time the government approved the loan the failure of Solyndra's business model was essentially already predetermined. Solyndra didn't contribute much to the global overcapacity in solar modules and panels, because its technology was never competitive. By contrast, Ener1's problems appear more fundamental. Like much of the global wind industry and solar industry, it was induced to invest in new capacity, the market for which depended almost entirely on subsidies and regulations that governments might not be able to sustain as these technologies scaled up, and that has gotten significantly ahead of demand.

The best examples of that are probably the various solar feed-in tariff (FIT) subsidies in Europe, which until recently were so generous that they not only supported the intended growth of an indigenous solar industry to capitalize on them, but also gave rise to an entirely unintended new export-oriented solar industry in Asia that had essentially no local market when it started, yet has since gone on to dominate global solar manufacturing and eat the lunch of the European solar makers and developers who got fat off the earlier stages of the FITs.

Or consider the US wind industry, including the imported equipment that still supplies around half of the US wind turbine value chain, according to the main US wind trade association. If the 2.2¢ per kilowatt-hour (kWh) Production Tax Credit (PTC) is renewed, and if wind generation grows from the current level of 115 billion kWh per year to 141 billion kWh by 2021, in line with the latest Department of Energy forecast, then over the next 10 years the wind industry would collect up to $30 B, with much of that locked in for projects that have already started up, less the amount generated by projects that opted for the expired Treasury cash grants in lieu of the PTC to the tune of $7.9 B from 2009-11. Yet based on these figures, wind would supply just 3.2% of US electricity in 2021. The industry now seems to be arguing that it needs just one more renewal of the PTC in order to become competitive. As of 2012, this benefit has been in place on an on-again, off-again basis for twenty years.

Although the theory that underpins such subsidies doubtless has some validity--that governments can help new technologies to develop quicker than markets alone would support, create markets for them by stimulating demand, and thereby move them down their learning curves to earlier competitiveness with conventional technologies--in practice such policies also have the serious shortcomings we are seeing. Because they do not operate in Soviet-style centrally planned economies, none of these governments can tell manufacturers precisely how much production capacity to build, or how much they will sell when it comes on-stream. In the absence of such powers--which in any case proved to be over-rated--companies and their investors are at the mercy of the boom-and-bust cycles such policies generate, with the normal, self-correcting mechanisms of industry consolidation dampened by continued intervention. Nor do the policies now in place seem very successful at creating industries that can survive without them. If you doubt that, ask the US wind industry for their forecast of new installations next year if the two-decade-old PTC is not renewed. According to the Journal, it would be somewhere between 0% and 30% of 2011's 6,810 MW, which was itself a third below the 2009 peak of 10,000 MW, despite the late-2010 extension of the cash grants to cover last year's projects.

The appropriate response to all of this depends on one's politics and the firmness of one's belief that these technologies are essential tools for combating climate change. Falling between the extremes of "just say no" and "look the other way" is the view that governments at least have an obligation to learn from the past and avoid the temptation to yield to demands that they leave existing subsidies in place until their beneficiaries decide they are done with them. If wind tax credits are extended, it should be at a level that recognizes the narrowing competitive gap with conventional energy and phases them out on a schedule. Electric vehicle subsidies should also be reassessed so that we don't find ourselves still providing upper-income taxpayers with incentives of $7,500 per car, even after sales have taken off and sticker prices fallen significantly. And solar subsidies ought to be fundamentally rethought to make it less attractive to install solar panels in regions with low sunlight, such as New York and New Jersey, than in those with abundant sun. And we shouldn't do that just for the benefit of taxpayers and in response to trillion-dollar budget deficits, but in the interest of producing healthy, globally competitive companies in these industries.

D.C. Auto Show Focused on Efficiency

Last week I attended the media preview of the Washington Auto Show. With its dual focus on cars and energy policy, this is always a high point of the winter for me, even if this year's display lacked a draw of the magnitude of the pre-production Chevrolet Volt I drove at the 2010 show. Instead, I was pleased to find that the emphasis on fuel economy and technology in carmaker presentations was matched by a broad array of efficient and attractive new products. They still don't quite constitute the new car fleet needed for the 54 mile-per-gallon target the federal government requires them to meet by 2025, but in my opinion they're off to a very good start.

No one listening to the presentations I sat through last Thursday could have missed the shift in focus from previous years. Performance and drivability were still mentioned prominently, but in most cases the innovations allowing those attributes to be delivered along with improved fuel economy, instead of at its expense, received top billing. I heard about Ford's nine models that achieve at least 40 mpg, including the new C-MAX Energi plug-in hybrid that received Green Car Journal's Vision Award for 2012. GM touted a number of efficient new models, including the upcoming Chevrolet Spark subcompact, which will later be available as a full EV. In some respects I found the 2013 Malibu Eco with "e-Assist" even more impressive: With the new Malibu and this year's Buick LaCrosse, GM is building family-sized gasoline-powered sedans that achieve 36 or 37 mpg on the highway. And thanks to Fiat's MultiAir technology, Chrysler had its new 40 mpg Dodge Dart on display.

I was particularly interested in the VW press conference, where they debuted the 45 mpg 2013 Jetta turbo hybrid. The head of VW's US division introduced the car as part of his company's Think Blue sustainability drive, which with this latest model encompasses hybrids, clean diesels, efficient non-hybrid gasoline engines, and soon EVs. With all this technology to talk about, including the new, larger Passat sedan--where's the wagon?--built in VW's new Chattanooga, TN plant and sporting a diesel engine delivering 43 highway mpg (31 city), the biggest surprise was the amount of time he devoted to VW's partnership with Bikes Belong, a cycling safety group aimed at getting people out of their cars. That certainly reflects a bigger-picture view of vehicle sustainability.

My visit to the car show also included a meeting with Lars Ullrich, marketing director of Bosch Diesel Systems North America, and Jeff Breneman of the US Coalition for Advanced Diesel Cars. They updated me on the progress that diesels have been making in the US market, particularly in light of the greater cost-consciousness of consumers, post-recession. In the last five years, the willingness of consumers to consider diesels has nearly tripled to around one-third, while diesel sales passed the 100,000 mark for 2011--still less than 1%, but about where hybrids were just a few years ago. Clean diesel models are expected to double by 2014. Models with announced future diesel versions include the Chevrolet Cruze, Jeep Cherokee, Dodge Dakota, and a Mazda crossover. Will diesels ever reach the level of popularity here that they've attained in Europe, where half of all new cars are diesel-powered? They must wage an uphill battle against fuel economy regulations that are anything but fuel-neutral, legacy perceptions formed by the dirty diesels of 20 years ago, and federal and state fuel taxes that still assume that all diesel fuel is used by heavy-duty trucks that wear out our highways. That's a shame, because this is a terrific technology that could be every bit as attractive to many consumers as more expensive hybrids.

Another noteworthy item I gleaned from the manufacturers' presentations was that several of them are forecasting a return to annual US car sales of 16 million within a couple years. That would be good for the industry and employment, but it's crucial for shifting the fuel economy of the entire light-duty vehicle fleet. One of the unnoticed consequences of the low car sales of the last several years is that the US fleet has been aging faster, notwithstanding the small blip from the Cash-for-Clunkers program of 2009. The difference between sales of 16 million a yar versus 12 million is an average turnover of 15 years, instead of more than 20, and faster turnover should translate to quicker improvements in average mpg.

For years we heard that the biggest obstacle to improving the fuel economy of the US car fleet was the auto industry, which only wanted to sell us big SUVs that carried higher profit margins. That excuse was always overly simplistic, and it has been relegated to the ash heap by a new generation of cars and light trucks featuring innovations delivering steadily improving efficiency, even in mainstream sedans and SUVs. Getting the entire fleet to 54 mpg won't be easy, but if what I saw at the D.C. auto show is any indication, the attainment of that goal now depends at least as much on sales mix as on the availability of efficient models. Within a few years, virtually every segment of the market will include hybrid, diesel and EV options that will put a big dent in both fuel bills and emissions, albeit at the expense of higher sticker prices. That means that future fleet mpg will likely be determined mainly by the decisions of consumers, rather than carmakers.

State of the Union: "All-Out, All-of-the-Above Energy"

Anyone expecting the announcement of big new energy initiatives in this year's State of the Union address was disappointed last night. What was new, however, was a welcome shift in the President's emphasis on conventional energy--the fuels he referred to as "yesterday's energy" in last year's speech. Never mind that the resurgent oil production for which Mr. Obama took credit is demonstrably the result of events and policies that preceded his inauguration, or that his administration has pursued policies that have held back faster development. If his remarks signal a return to federal energy policy that expends more than 10% of its effort on the sources that account for more than 80% of the energy we use, we should applaud him. The other new ingredient last night was an effort to ground the rationale for greater support for renewable energy in the argument that it took federally sponsored R&D to make the shale gas revolution possible--R&D that ironically wouldn't have occurred under the research priorities this President has set for the Department of Energy. I hope President Obama is serious about an "all-out, all-of-the-above strategy" for energy, because that's precisely what we need.

The best way to put that in perspective is with the figures in the 2012 Early Release of the Annual Energy Outlook from the Energy Information Agency of the DOE. It was released just in time for the President's speech, and there are few coincidences in today's Washington. The reference case of their forecast for 2035 shows the US consuming 10% more energy within 24 years--an improvement from the 16% predicted in last year's Outlook. It also shows the contribution of renewable energy in the mix increasing from 6.7% today to 8.3%, including mature hydropower. So even after two more decades of strong emphasis on clean energy, oil, gas and coal would continue to provide 80% of our energy. It's clear that there's a disconnect between the lofty rhetoric of last night's speech and the analysis of the government's energy experts. I'll leave it to you to assess whether the discrepancy is due to unrealistic expectations, inadequately ambitious forecasting, or some combination of the two.

A couple of other points from the State of the Union are worth noting. The President called for Congress to "Pass clean energy tax credits," presumably a reference to the Production Tax Credit (PTC) for wind and other renewables that expires at the end of this year. Yet he didn't devote a word to whether the PTC should be restructured and gradually phased out in light of the steadily narrowing competitive gap between renewable and conventional power, let alone the kind of major tax reform he alluded to later in the speech. Mr. Obama also called for a Clean Energy Standard in lieu of a comprehensive climate bill. This is small beer when most of the states with attractive renewable energy resources already have fairly aggressive state-level Renewable Portfolio Standards. Meanwhile, the development of 3 million homes' worth of clean energy sources on public lands that he is directing his administration to allow equates to less than 1% of US electricity demand--helpful, though hardly transformational.

With little likelihood of a divided Congress enacting much that is new on energy this year, the President's remarks last night are mainly interesting for what they suggest about the energy platform on which he will run for reelection this fall. In terms of clean energy, that seems to mean more of the same from 2008 and the last three years, but with much less emphasis on climate change than we heard in his last campaign. The new element is his pivot to embrace rising oil production and the possibilities created by shale gas, even as he cautiously distances himself from the technologies (hydraulic fracturing and horizontal drilling) that make these two trends possible. Although this might appeal to independent voters, it's also vulnerable to deflation by fact-checking and stands in tension with his rejection--for now--of the Keystone XL pipeline. And if tensions in the Persian Gulf or some other oil hot spot were to increase, so would the scrutiny applied to the administration's energy policies. I'll take a much closer look at those policies when the campaign heats up.

Applying Innovation to Oil & Gas

This Friday at noon Eastern Time I'll be participating in a webinar on The Energy Collective covering the application of innovation to the emissions from oil and natural gas. The topic is timely, not just because of the current debate over the fate of the Keystone Pipeline, but because despite the growing importance of renewable energy, oil and gas will constitute a major part of our energy diet for decades to come. As I was thinking about my remarks, it occurred to me that the best starting point might be a refresher on how the industry's current emissions are distributed along the value chain. For all the heavily-publicized concerns about higher emissions from the extraction of unconventional hydrocarbons such as oil sands crude and shale gas, combustion by end-use applications accounts for the biggest slice, to the tune of 80-84% of the average lifecycle emissions from gasoline, diesel and jet fuel. Even for fuels refined from oil sands, our tailpipes still put out more than two-thirds of the total emissions attributable to oil. The proportions are similar for natural gas.

The data I'm using come from a presentation of the National Energy Technology Laboratory, which is part of the US Department of Energy, and the NETL reports on which it was based. I could have chosen other sources, but they all reach pretty much the same conclusions, and I liked the way this one displayed the differences among various source crudes. It also goes beyond dividing the total "well-to-wheels" lifecycle (WTW) into well-to-tank (WTT) and tank-to-wheels (TTW) sources, those that happen before the fuel gets to your car and those that happen in your car, respectively. The former category was further broken down into segments of extraction, crude oil transport, refining, and finished fuels transport. All of these are amenable to improvements through innovation, and I plan to focus on the four WTT categories on Friday.

However, as helpful as it would be from an emissions perspective to get oil out of the ground with less expenditure of energy and less leakage of methane and other gases, and then to transport and refine it as efficiently as possible, the most effective emission-reduction strategies by far are those that address vehicle emissions from transport. That includes all the ways we normally think of to improve fuel economy, including hybridization and dieselization, which reduce CO2 emissions in direct proportion to fuel savings. Yet it also includes a whole gamut of strategies for reducing vehicle miles traveled, which are currently below the record set in 2007 but remain about 10% above year-2000 levels. Trip consolidation, telecommuting, carpooling, and using public transport can all make an important dent in emissions, and in the long run they eliminate upstream WTT emissions, too, as less oil is required for the same economic activity.

I'm sure that most of this is old hat to those who are well-informed on energy issues, but it's important periodically to remind ourselves of the basics, before we get overly enamored with all the exotic technology we could apply to other portions of the value chain. Deploying wind and solar generation in oil fields, generating geothermal energy from the hot fluids brought to the surface with oil and gas, and making the liquids shipped through pipelines slipperier can all contribute to reducing greenhouse gases, but we should understand clearly that these techniques can only tackle the 20% of emissions that happen before the fuel gets to the local gas station.

Playing Games with US Energy Security

Well, that didn't take long. The administration issued its decision denying the Keystone XL Pipeline application today, rather than using the remaining 34 days in the Congressionally mandated timeline to attempt to find a better solution. This is a prime example of what frustrates so many Americans of all political affiliations about how the nation is being governed. If you read the carefully drafted press release from the State Department, which had been given responsibility for determining whether the pipeline was in the national interest, it explicitly states that today's decision was neither final nor on the merits of the project. Implicit in this document is that today's move is exactly that, the latest move in the game that the President and Congress have been playing with a project large enough to affect the energy security of this country for decades to come. It is unseemly, and it didn't have to be played this way, despite the White House's protests that the 60-day timeline was unrealistic--after three years of study.

Here's a different statement the President could have issued, which might not have satisfied either side of the argument but would have left his administration looking like one with a bias for action and answers, instead of delays and obstacles:

"Today I have instructed the State Department to issue a pro forma finding against the application for the Keystone XL Pipeline project, with the clear understanding that this decision is a temporary expedient to provide the time necessary to resolve the remaining outstanding issues, as quickly as humanly possible. I hereby commit that my administration will do everything in its power to work with the government of Canadian Prime Minister Harper and with Governor Heineman of Nebraska to reach a mutually satisfactory solution that will allow this critical project strengthening the energy bonds between our two nations to proceed, while finding meaningful ways to address the concerns that many Americans have about the project's potential local and global environmental impacts. With renewed tensions in the Persian Gulf and with millions of Americans still out of work, we can do nothing less, even as we remain committed to protecting the environment that benefits us all. I have directed Secretary Clinton to work closely with Energy Secretary Chu and EPA Administrator Jackson and with their counterparts in Canada to develop a solution that addresses these needs, and to report back to me within 90 days with its outline ."

I don't diminish the political challenges of issuing such a statement when key parts of the President's support base have been so vocal in opposing this project. All you have to do is look at the latest set of talking points against the project from the Natural Resources Defense Council (NRDC). As disappointingly illogical a mishmash as they may be, based on misinterpreted data and a bizarre defense of cheap oil for the Midwest, they still reflect heartfelt, even visceral, reactions to the Keystone project--or more accurately to the oil sands development that it was expected to enable. Fair enough. I respect their right to an opportunity to provide input and guidance toward an eventual compromise, but not to a veto over US energy policy.

Nor should the opponents of the Keystone XL project fool themselves. Today's decision was guided by expediency, just as the future, possibly quite different decision for which the door was left open would be, perhaps at a point in time when the political calculus has shifted in favor of the project due to some external event. A decision based on principle would have looked quite different. "The Department’s denial of the permit application does not preclude any subsequent permit application or applications for similar projects." Whose move is it now?

More Long-Term Pressure on Oil Prices

A pair of items in today's Financial Times could signal a longer run of high oil prices, even if Europe were to slip into recession and economic growth elsewhere slow. The first article (registration required) reported that Saudi Arabia has raised its target oil price to $100 per barrel, up from the $75 level that King Abdullah had previously endorsed as "fair." Meanwhile, Venezuela has announced that it would withdraw from a World Bank body for arbitrating contractual disputes, preferring them to be resolved within its own judicial system. That can't be welcome news for companies that had been considering new investments in the country's oil and gas sector. Taken together, these stories suggest both less future supply and a greater likelihood that OPEC would respond to any significant weakness in oil prices by restricting output.

With markets currently tense over the prospect that Iran might make good on its threat to close the Strait of Hormuz, the prospect of Saudi Arabia boosting output if necessary to keep prices from going much beyond $100/bbl must seem welcome, at least in the short term. But as the FT explains, the choice of that figure, rather than a lower one, reflects the fiscal realities of a broad group of Middle East producers. The Saudis, Iran, Iraq, and the UAE all require oil prices north of $80/bbl in order to balance national budgetary requirements. Considering that the cost of producing much of this oil is likely still in either the single digits or low double-digits, that is an extraordinary commentary on just how much these countries depend on oil revenues to fund the social expenditures that maintain their respective domestic status quos. So while Saudi oil minister al-Naimi may have intended his comment to convey a comforting price ceiling, it probably said as much about his government's view of where the floor should be. With UK Brent crude currently trading at roughly the same $111/bbl level that set a full-year price record last year, I'm not sure how many of us would find that reassuring.

The decision by Venezuela's dictator to exit the World Bank arbitration mechanism shouldn't have come as a surprise, with an estimated $40 billion in international claims outstanding for his past actions in nationalizing assets and arbitrarily altering contractual terms in a variety of industries. The recent ruling by the International Chamber of Commerce in favor of an ExxonMobil claim might just have been the final trigger. Yet despite the obvious expediency of such an exit, it seems grossly counterproductive in the context of a producing country that depends increasingly on foreign investment to stem a long-term decline in output. Since President Chavez punished his nation's oil industry by firing its most capable managers and engineers following a strike in 2002-3, Venezuelan oil production has fallen by at least 15%, and it only avoided a larger drop due to the contribution of the big Orinoco production and upgrading projects built by foreign firms such as ExxonMobil, Chevron, ConocoPhillips and Total--some of which are now seeking compensation for expropriation of assets and other grievances.

Requiring disputes to be resolved within a court system that has been stacked with Chavez loyalists hardly seems like the recipe for reducing political risk and reassuring companies that have already seen past investments turn sour. While companies that have too much at stake to leave will try to make the best of this, others would be well-advised to steer clear. However this turns out for the industry, the likely outcome for Venezuela is lower production in the future and even greater support for hawkish price policies within OPEC, to prop up the oil revenues upon which Chavez's redistribution policies depend.

Of course none of this guarantees high oil prices in perpetuity. After all, OPEC was unable to prevent prices collapsing to below $40/bbl in late 2008, though it did restrain output enough to get them back to around $80 within a year. However, both stories should remind us that in a world in which oil prices are set to suit producers better than consumers, our primary focus should be on actions and policies that enhance our energy security. That means substituting plentiful natural gas for oil and its products where we can, promoting conservation and efficiency, pursuing cost-effective renewables, and ensuring that we have access to as much oil from domestic and trusted international sources as possible. Rejecting the Keystone XL Pipeline, instead of committing to find a way to make it work while addressing reasonable concerns about it, would be nothing less than a gift to OPEC.

Disclosure: My portfolio includes investment in Chevron, which is mentioned above and owns projects and facilities that could be affected by these events.

Because That's Where the Emissions Are

Yesterday the Environmental Protection Agency released its tabulation of greenhouse gases (GHGs) from large facilities in the US. In perusing the data I couldn't help thinking of the quote attributed to Willie Sutton concerning why he robbed banks. Even if he never actually said, "Because that's where the money is," the simple logic of that analysis transfers neatly to the question of why we might be interested in assessing and ultimately managing GHG emissions from such installations. While there are other important sources, notably including motor vehicles and aircraft, the more than 6,000 sites reported in the agency's online registry account for roughly half of all US GHG emissions. Furthermore, just a quarter of these sites--power plants--contribute nearly three-fourths of US emissions from large facilities. That's where the emissions are and where US climate policy should focus.

Although that doesn't dictate that we should entirely ignore all the other facilities, it certainly raises serious questions about the threshold of reporting for the hundreds of installations emitting less than 10,000 tons of CO2-equivalent gases per year, compared to the top-100 facilities, the smallest of which emitted nearly twice that much every day.

It should also challenge the belief systems of some members of Congress concerning the relative importance of different sectors. The highest-emitting oil refinery in the country is also one of the biggest in the world by throughput capacity, at 573,000 barrels per day. Yet it comes in at #45 on the list, with only one other refinery appearing in the top 100. The entire refining sector, comprising 145 plants, emitted around 5.7% of the total GHGs represented in the registry, and thus less than 3% of the US total. Why does that matter as more than an industry talking-point? Because reducing emissions from refineries by 10%--no easy task when they are already roughly 90% efficient in terms of their total energy output vs. inputs--would be lost in the rounding in our national emissions statistics. We won't get very far chasing expensive diminishing returns.

By comparison, reducing emissions from the 1,555 power plants on the list by an average of 10% would reduce US emissions by more than 3%. And because we are blessed with many more processes for generating electricity than for refining oil, this could be achieved in a variety of ways, nor does 10% represent any kind of ceiling for what might be possible. One option would be to retire the least-efficient coal-fired plants and take up the slack at existing gas-turbine power plants, plus some additional renewables. That may happen anyway, as a consequence of other EPA regulations. We could also replace the worst coal plants with near-zero-emission nuclear power plants of advanced design, such as the AP-1000 reactor that won NRC approval late last year, or the various modular nuclear reactors now under development. Capturing and sequestering the CO2 from coal-fired power plants would be another option, if it can be perfected at a reasonable cost.

I would never suggest that climate policy could be truly simple, but the numbers the EPA just reported, combined with what we know about the lifecycle emissions from the petroleum value chain, indicate that the scope of the US climate policy debate could usefully be narrowed to focus on just two main emissions sources: power plants and the end-use combustion of hydrocarbon fuels. On the scale of overall US emissions, almost everything else is noise. Of course that leaves plenty of room for discussion and disagreement on the most effective ways to address these emissions at the lowest cost and least disruption to an already-fragile economy. We can still argue endlessly about the relative merits of putting a price on emissions, providing incentives for emission-reducing technologies, and setting command-and-control regulations. Yet when we contrast the potential effectiveness of such a limited approach with the intricacy and distortions entailed in "comprehensive" efforts like the failed Waxman-Markey climate bill of 2009, it looks like a very helpful simplification to pursue.

Petroleum Prices Set Records in 2011

Without much fanfare, the Energy Information Agency of the US Department of Energy released a report on 2011 energy commodity prices yesterday. It confirmed that crude oil and key petroleum products set annually averaged price records last year. This largely snuck up on us, because it occurred without the kind of dramatic price spike we experienced in 2008 or in the oil crises of the 1970s. Prices rose early in the year, during the Libyan revolution, and they didn't fall much, subsequently. The situation was also masked by the ongoing crude oil bottleneck in the US mid-continent, which depressed prices of the grade of US oil that for decades had been regarded as the best indicator of global oil prices, a role in which it has recently fallen short. These record prices for oil and its products are of more than just statistical interest; they help to explain the persistent weakness of the economy, representing an incremental drain of roughly $100 billion, compared to 2010, based on our net petroleum imports. That's roughly half the impact of the social security payroll tax holiday over which Congress and the administration have been sparring.

The EIA reported that UK Brent Crude, probably the best gauge of global oil prices at the moment, averaged over $111 per barrel last year. That's 40% higher than in 2010, and $14/bbl over 2008, the year in which West Texas Intermediate came very close to $150/bbl before ending the year at $45. Of even greater interest to most Americans, the pump price for unleaded regular gasoline in 2011 averaged $3.52 per gallon. Although in contrast to 2008 it only broke the $4 mark in a few regional markets like California, New England and Chicago, and even there only for a month or two, it beat the 2008 national average by more than $0.25/gal. through sheer persistence. And for the most part that didn't happen because the US is now a net exporter of gasoline and other petroleum products. It happened mainly because the global crude oil market was influenced more by the instability in North Africa and the Middle East than by worries about the US economy and the fate of the European Union and its currency, the Euro.

Of course all of the above prices are in nominal dollars, so I thought it was worth taking a quick look at real prices. After adjusting for consumer price inflation, that $3.52 mark for gasoline ties 2008's real-dollar all-time annual record, and it exceeds the average for the peak oil-crisis-year of 1981 by about 28 2011 cents. It's a little harder to gauge whether last year's Brent price set a record for crude oil in real dollars, but it seems likely. Either way, what's remarkable about these price levels is that they occurred despite weak economic growth in the developed world and slowing growth in key developing countries like China. That raises ample questions about what we should expect this year.

I've seen a wide range of estimates for where oil prices will settle out this year. The fundamentals of oil itself seem on the bearish side, with US production growing, thanks to unconventional plays like the Bakken and the Eagle Ford shale, and Libyan output gradually returning. Demand growth could also ease, especially if Europe falls into recession. Arrayed against those factors are a fairly cohesive OPEC, which benefits when oil prices are as high as possible without actually throttling the economy, and the standoff brewing between tougher Western sanctions on Iran and Iran's threats to close down the Strait of Hormuz, through which something like 40% of global oil exports flow. Election-year politics might have an influence, too, recalling the administration's willingness last year to release oil from the US Strategic Petroleum Reserve for reasons that were rather less than compelling at the time. All in all, when we've spent the last several years lurching from one crisis to the next, it's not hard to imagine another crisis just around the corner. Let's hope that 2012 surprises us with stability.

"Energy Reality"

Earlier today I attended a luncheon and press conference rolling out the annual "State of American Energy" report from the American Petroleum Institute. API's President and CEO, Jack Gerard, also used the occasion to launch a new "Vote 4 Energy" campaign, which he described as a non-partisan effort intended to start a conversation about energy during a key election year. He also touched on a number of issues that are very familiar to readers of this blog, including the Keystone XL Pipeline decision, the need for greater access to US energy resources, along with energy security and jobs. A phrase that Mr. Gerard used in his remarks, and that recurred several times during the press conference, was "energy reality." This struck me as an apt encapsulation for the energy policies that should be addressed by President Obama and whomever his Republican challenger turns out to be, from the shrinking pool of candidates.

I was pleased to hear Mr. Gerard cite the need for a full range of energy solutions, with renewables, nuclear energy and energy efficiency prominently mentioned along with the expected references to oil and gas. That is precisely the energy reality we should be pursuing: tapping the hydrocarbon riches with which the US is endowed, in order to reduce our dependence on unstable foreign suppliers, even as we ramp up the wind, solar, biofuel and other renewable energy sources that must take over the energy burden in the long run, and with all of it used more efficiently than today. Yet energy reality should also take account of the tremendous disparities of scale that still exist between conventional energy and renewables, and that are likely to persist for some time. After a decade of rapid growth, wind power accounted for less than 3% of the electricity generated here last year, and solar for much, much less than that--with neither displacing any meaningful amount of imported oil, since less than 1% of our electricity is generated from oil.

Energy reality came up again in the context of a question about the EPA's Renewable Fuel Standard, which was recently finalized for 2012 to require the use of 8.65 million gallons of cellulosic biofuel--a reduction of 98% from the 500 million gallons previously specified for this year in the RFS enacted by the Congress in 2007. Biofuel from corn, soy and animal fat has expanded to contribute nearly 10% of the US gasoline supply and a smaller fraction of diesel fuel. However, a law requiring the use of advanced fuels that don't yet exist in commercial quantities--and may not for many years--and forcing refiners to purchase credits in place of these non-existent gallons is certainly out of touch with objective energy reality and ultimately constitutes another tax on consumers.

I would argue that the decision that the President now has less than 60 days to make on whether to allow the Keystone XL Pipeline to go ahead also hinges on his understanding of energy reality. He must choose between the urgent concerns of employment and energy security articulated repeatedly in Mr. Gerard's answers to numerous questions on the subject, and an objective assessment of the environmental impact it might cause. Stripping away the various red herrings that sprang up in the course of the debates and protests over the pipeline, the latter boils down to the incremental greenhouse gas emissions from the extra oil sands production that the pipeline would facilitate, compared to the emissions from the conventional crude we would otherwise have to import from the Middle East or elsewhere. I've seen some wild exaggerations about that, including the doozy I ran across over the holidays from former Vice President Gore, to the effect that a Toyota Prius running on fuel refined from oil sands crude would have emissions equivalent to a Hummer. (When you do the math, it actually works out to the equivalent of a Ford Fusion hybrid.) In fact, the incremental emissions at stake in the Keystone decision amount to around 0.3% of total 2009 US emissions. That's the basis of the trade-off Mr. Obama must make, and no matter which side he chooses he will infuriate those supporting the other side.

As the 2012 presidential election approaches, I expect to find many opportunities for comparing campaign rhetoric to this kind of energy reality barometer. Elections tend to focus on the differences between candidates, and I have little doubt that the differences on energy will be significant. However, when the dust settles on November 7th it will be high time to start work on a new bi-partisan consensus on energy policy that might actually survive the next change in administrations, unlike the disruptive pattern we've been in for the last five cycles or so. Not reality? Perhaps, but certainly worth aspiring to. Happy New Year!

2011 in Energy: The Year of...

At the start of 2011, I thought the hallmark of the year's energy events and trends might involve regulation, with the White House seeking to implement measures that couldn't garner enough support in Congress to become laws. But for every major new regulation issued, such as last week's release of the new Mercury and Air Toxics Standards for power plants, others were delayed or deferred, including the EPA's effort to regulate greenhouse gases under the Clean Air Act and the agency's proposed ozone standard. Outside of the utilities and other industry groups directly affected by these rules, it seems likely that 2011 will instead be remembered for big, unpredictable events like the Fukushima nuclear accident and the Solyndra bankruptcy scandal, along with several major trends that reached critical mass this year. Anyone attempting to pick the energy story of the year is spoiled for choice.

In my search for a catchy title for this year's final posting, I toyed with "The Year of Solyndra", "The Year of Shale", "The Year of Fukushima", "The Year of Exports", and various other combinations of the energy buzzwords that percolated into our consciousness this year. In some ways, they'd all be apt choices. Here's a quick rundown on why they might merit that kind of recognition, with links to previous postings providing more details on each:

• If 2011 is the year of Solyndra, it's not because of the possibility that the government's $535 million loan to the firm was the result of political influence (cue Major Renault), or even that the Department of Energy is unlikely to recover more than pennies on the dollar in the firm's bankruptcy. Instead, it's because Solyndra highlighted the much broader and deeper problems of a global solar industry that, despite continued demand growth that other industries would kill for, now faces overcapacity and the fallout from the winding down of unsustainable government support. Germany's Solar Millennium is just the latest victim of this trend. Along with BP's exit from the solar business after 40 years, it provides a further reminder that renewable energy firms must succeed not just as technology providers, but as businesses that can earn consistent profits and continue to attract investors.



• Shale gas was hardly new to the scene in 2011; it has been expanding rapidly for several years and now accounts for up to a third of US natural gas production. However, the controversy surrounding drilling techniques like hydraulic fracturing that make its exploitation possible became much more widespread this year, while some scientists raised questions about its contribution to greenhouse gas emissions. Shale gas has the potential to transform nearly every aspect of our energy economy, and probably sooner than renewable energy sources could. That has some folks nervous, while others are eager for shale gas to displace coal from electricity generation, compete with oil in transportation, and revive the domestic petrochemical industry. I suspect we'll see all of those to some extent, provided we don't regulate shale out of the running.



• The aftermath of Fukushima could prove equally transformational, though it remains to be seen whether the ultimate result is safer nuclear power or a global retreat from one of our largest sources of low-emission energy. All but 8 of Japan's 54 nuclear power plants are currently idle, and that nation must shortly decide whether it will eventually restart those units that weren't critically damaged, or shut down the rest and attempt to run its manufacturing-intense economy on a combination of renewables and much larger imports of fossil fuels. The German government's post-Fukushima decision to phase out nuclear energy entirely could provide an even quicker test of the same proposition.



• Another major shift that has been in the news recently involves exports. Although the US has long exported coal and various petroleum products, we could shortly become a bigger, more consistent exporter of many fuels, including liquefied natural gas (LNG), gasoline and diesel. As the reaction in a CBS news segment last week demonstrated, the US public doesn't know quite what to make of this, yet. Becoming a major energy exporter while still importing a net 9 million barrels per day of crude oil is very different than the picture of isolated self-sufficiency that four decades of "energy independence"rhetoric has evoked. We shouldn't be surprised that energy can provide a boost, and not just a drain on our trade balance. This topic requires more public discussion and education, before we see serious proposals to ban such exports--proposals that would make no more sense than banning exports of corn, tractors, or aircraft in an attempt to keep their US prices low.



• It's also tempting to call this the Year of Oil Price Confusion. The news media gradually woke up to the huge gap that had developed between global oil prices and the oil price that Americans tend to watch most closely, the one for West Texas Intermediate crude. Yet despite numerous stories on the storage and pipeline crunch and supply glut at Cushing, Oklahoma, few reporters and networks seemed able to follow through by breaking their old habit of treating the NYMEX WTI price and its gyrations as if it were still the best indicator of the overall oil market. Fortunately, the problem is in the process of being resolved, as pipelines are reversed and more tankage built.



• Finally, there was the administration's non-decision on the Keystone XL pipeline. Observers can read much into this, including the growing influence of citizen activists mobilized via social media. However, if it does nothing else, the Keystone controversy should put to rest the superficial fallacy that anything that improves greenhouse gas emissions is automatically good for energy security, instead of requiring difficult trade-offs. In that context, the prospect that the administration might ultimately turn down the permit for Keystone would be easier to stomach if the net greenhouse gas savings involved amounted to more than a paltry 0.3% of annual US emissions, based on the emissions from incremental oil sands production the pipeline might facilitate, compared to those from the conventional imported oil it would displace.

It was a busy year for energy, and if my short list of top stories missed something crucial, please let me know. 2012 promises to be just as interesting, with a Presidential election, in which energy issues could feature prominently, added to the mix. In the meantime, I'd like to wish my readers in the UK and Commonwealth a happy Boxing Day, and to all a Happy New Year.