How Much Higher Could Oil Go?
After months of watching oil prices edge higher and higher, it is increasingly difficult to imagine a return to lower prices, and correspondingly easier to forecast even higher prices. The Financial Times recently cited Goldman Sachs's suggestion of $105/barrel, as well as mentioning a French bank that thinks oil could go to $350 by 2015. Though the former seems at least plausible, I am skeptical of the latter, having watched similar estimates go down in flames in the past. But I'm also very curious about their assumptions. Those are usually the most interesting element of any forecast, rather than the final number.

What would have to happen for $350 to come true? First, you'd have to guess that the world economy (and especially China and India) will continue to grow at a healthy pace, dragging oil demand along with it. Another decade of 5% growth would expand global GDP by 60%, creating a richer world that might be less price sensitive about oil. The FT article indicated that Caisse D'Epargne sees a global oil supply shortfall of 8%. To make that more concrete, imagine going from today's 84 million barrels a day of demand (and supply) to 102 MBD of demand (2% growth for 10 years) but only 94 of supply. So their world of 2015 is effectively missing the equivalent of Saudi Arabia or Russia.

That would be fine as a disaster scenario, but it's hard to see how you'd ever just grow into a world like this. Supply and demand don't get that far out of whack without some serious substitution or other response that brings them back into line. That might take a few years, but ten? In ten years, with crash programs, the world could close the potential gap with a combination of efficiency savings and non-petroleum energy sources, including oil sands, gas-to-liquids, LNG, and maybe a bit of something more exotic. In fact one risk of this kind of effort is that it would be too successful, forcing oil prices below today's level and making the substitutes uneconomical. When you start looking at things this way, as a dynamic system, it's hard to see $350 oil--which would translate into US gasoline pump prices near $10/gallon--as a viable end state, rather than as a single snapshot out of a longer sequence.

Alternatively, could $350 simply be Goldman's $105 plus a massive dollar devaluation (to something like $4 to the Euro) and a switch from oil being denominated in dollars to the "basket of currencies" concept that OPEC has floated several times in the last couple of decades? The media is currently brimming with commentary from economists who are so concerned about the various US deficits that such an outcome might not surprise them. (I find this a much scarier scenario than the first one.)

In any case, although the last year has brought me around to the idea that high oil prices won't go away soon, I still remember those $100 oil predictions from thirty years ago (in 1970s dollars, not 2005$) that had to be repudiated only a few years later, because they failed to anticipate how consumers and technology might respond. The real wild card in all this is "peak oil", and if that's what le Caisse D'Epargne is thinking, then Mr. Hubbert has won another convert. Whatever their rationale, you have to salute their courage for straying so far from the herd.

Do Giant Planes Matter?
Today marks another aviation milestone, with the first test flight of the enormous Airbus A380 in France. It's been interesting watching the strategic duel between Airbus and Boeing, with the former opting for a super-Jumbo and the latter for the smaller, sleeker, super-efficient 787 Dreamliner. (Boeing wins on looks and name, if nothing else.) I haven't commented on this matchup previously, since there didn't seem to be any energy implications worth noting. Upon reflection, though, the A380 could turn out to be a significant component of new oil demand in the decades ahead.

When you look back on the air travel revolution of the last several decades, you see the impact of large, long-distance planes--principally the 747--making trans-Atlantic and even trans-Pacific flights accessible for the middle classes of America, Europe and Japan, along with the upper-middle classes of many other regions. Deregulation and competition added millions more passengers to this mix. All of this affected jet fuel consumption.

Between 1973 and 2001, global jet fuel sales grew from about 2.4 million barrels per day to 4.5 MBD, or just under six percent of all petroleum products sold. That doesn't sound like much compared to 20 MBD of gasoline (nearly half of it in the US alone), but remember that crude oil prices are "set at the margin"; in other words, it's the last barrel of demand (or supply) that matters most. The current high prices are largely the result of roughly two million barrels per day of unexpected demand, or lost supply cushion, however you prefer to see it.

So where is all this going? Could a new, dramatically bigger airliner open up air travel to a whole new generation of customers who've never flown before, or at least not with any regularity? Could it help unlock the latent demand for international tourism in China and India, without overwhelming existing airports? Airbus certainly thinks so, if you read their marketing materials for this plane. If the A380 were really successful, it seems reasonable that it might increase global jet fuel demand by a further 20% over the next decade. That would add an extra million barrels a day of crude oil demand and require additional refinery upgrades to translate it into jet fuel, without robbing gasoline or diesel production.

The result of this little scenario is a lot of new tourists, putting more pressure on oil supplies and prices. Am I reading too much into one new airplane model? Boeing would say yes, and if their 787 sales so far this year are any evidence, they may have the last laugh.

Another Merger
Yesterday Valero Energy Corp. announced it was buying Premcor Inc. Neither of these companies are exactly household names, unless you live in a part of the country where Valero has service stations. Nevertheless, the combined company will control about 13% of US oil refining capacity. The logic behind this merger is entirely different from that of the recently announced ChevronTexaco/Unocal deal. While the latter is driven by geopolitics and the need to boost oil reserves, this transaction is simply another in a series of consolidation plays by Valero, which will end up with 19 refineries, assuming no significant divestitures are required to gain approval.

Premcor wasn't new to the consolidation game, either. Its Port Arthur plant, for example, was ex-Gulf, ex-Chevron, and ex-Clark Oil (the precursor of Premcor.) Delaware City, its crown jewel in terms of upgrading capacity, was ex-Getty, ex-Texaco, ex-Star Enterprise (Texaco/Saudi Aramco JV) and ex-Motiva (Shell/Saudi/Texaco.) The beauty of this approach was that facilities that cost billions to build from scratch could be had for pennies on the dollar, sometimes for little more than the value of the inventories in their tanks.

Refining earnings haven't always been as strong as in the last couple of years. For most of the 1990s and early 2000s the disappointing returns in this segment induced the major oil companies to reduce their exposure and sell off many of the plants that are now in Valero's or Premcor's inventory. This made sense, because for most of the majors "integration" has been merely notional--essentially just financial--for some time. These plants were often not running the companies' own crude production, nor were they critical to supplying their marketing networks; instead, they were widely seen as a portfolio drag, and the equity analysts were clamoring for disposals. The absence of integration benefits made it possible for Valero and Premcor to buy these facilities and replicate the rest of the value chain through astute trading, running whatever crude oil made sense each day and selling products to a combination of term and spot customers.

The really significant outcome of this deal would have seemed unthinkable a generation ago: the largest oil refiner in the US will be a company without a single oil well or high-profile brand. The future course of Valero will be an excellent test of that idea from a stock market perspective. When refining margins weaken again, or refineries become subject to another wave of expensive environmental regulations, it will be interesting to see how the market then regards this giant one-trick pony.

Where Have All the Engineers Gone?
A recent article in the Financial Times (subscription may be required) highlighted the human resource challenge facing the western oil and gas firms. In the same decade in which they must gear up production to meet growing demand, or find new alternative energy sources, they stand to lose a large portion of their experienced technical staffs. This story resonates deeply for me, having watched wave after wave of downsizing sweep through the industry, and then getting caught up in another one, myself. I don't think the situation is as bleak as the article suggests, because globalization will resolve much of it. But the result will be an industry as transformed as any other on the planet.

When I joined Texaco in 1979, the company had approximately 75,000 employees, operating worldwide. This figure fell after an early retirement package was offered, but ballooned again after the purchase of Getty Oil in 1984. At one point there were well over 80,000 people on the payroll. By 1992, following a series of asset sales, new joint ventures and various downsizing initiatives, the "headcount" had shrunk to 38,000. Texaco was down to about 25,000 employees, excluding joint ventures, when it was acquired by Chevron (35,000 pre-merger employees) in 2001. Today, the combined ChevronTexaco has 47,265 employees.

The picture is similar across the industry. Oil and gas employment in the US peaked at just under 1.9 million in 1981 and was at 1.3 million as of 2002. Of this, the "upstream" sector (exploration and production) has suffered the most losses, about 400,000. Refining and transportation are also down, though retail (gas station workers) is actually up by 100,000, presumably reflecting the shift from old-style service stations to convenience stores.

Sheer numbers aren't everything, though. Technology, productivity and processes have all improved dramatically in the last 25 years. But the same demographics underlying the debate Social Security are taking a toll on the technical workforce of the oil companies. As the FT article indicates, these companies have a big bulge of workers centered on age 50. I was a few years behind that peak, joining the industry at the tail end of the big hiring boom, which was followed by years hiring freezes; for a long time, I was the youngest professional in every work group I joined. The closer that peak gets to retirement, the bigger the challenge for the companies becomes.

Of course the problem isn't entirely due to demography. Attractive early retirement options--in the form of lump-sum pension payouts in a period of low interest rates--have steadily depleted the over-55 ranks, while weak hiring has made anyone under 30 a rarity. The industry's demographic bulge has thus been exacerbated by the unintended consequences of long-standing human resource practices.

It must be a great time to be a chemical or petroleum engineering graduate. Salaries are high, and these skills are in demand. However, it's pretty clear that the key to meeting the ongoing technical needs of the international oil and gas companies won't be found in US or European universities, but rather in the same aspects of globalization that are transforming other industries. Tom Friedman's recent article in the New York Times Magazine talks about a "flat earth," where natural barriers of distance and borders are being erased. Because engineering is focused on the universals of math and science, language is no barrier, either. An Indian engineer sitting in Mumbai or a Chinese geoscientist in Daching can analyze reservoirs and interpret seismic data as well as an American in New Orleans.

For at least the last decade, the leadership of the industry has understood that the international oil companies would have to change to align with the location of the world's remaining oil reserves in the Middle East, Africa and the former Soviet Union. But with the center of gravity of their US and European workforces approaching retirement age, it's a good bet that the shift will happen in ways no one sitting in London, Paris, or Houston would have imagined a few years ago.

Hybrid Humvee
Lately, whenever I see a civilian Humvee or Hummer H2 on the road , I imagine the number of $20 bills it now takes to fill it up (four!) It turns out that this has been on the minds of the military, too. The DOD has had a variety of programs to boost the fuel economy of military vehicles--some relying on pretty exotic technology--and now there's a prototype of a hybrid utility vehicle that could replace the current Humvee. This would be good news for many reasons.

The Army's concerns about fuel economy are different from those of the average consumer. Money is still an issue, but on a different order of magnitude. As we've seen in Iraq, the cost of a gallon of gasoline or diesel fuel delivered into a war zone is much higher than what we pay at the pump, perhaps as much as $17/gallon. Fuel must be loaded at a local refinery or the nearest port and transported with sufficient security to avoid the kind of problem experienced by Jessica Lynch's unit. Dramatically improving the fuel consumption of military vehicles would shrink the security and logistical burden on the supply chain, in addition to cutting operating costs. It might also allow troops to operate further from their supply lines.

As the article suggests, the civilian spin-offs of this technology could enhance the usefulness and durability of hybrid vehicles already reaching the mainstream. I'll bet Governor Schwarzenegger would love to be their first civilian customer.

Offshore Refineries
I missed seeing it the other day, but a colleague pointed out this announcement by Saudi Aramco that it intends to build a new 400,000 barrel per day (BPD) refinery at Yanbu, on the Saudi side of the Red Sea. This would augment the existing, comparably-sized Yanbu refinery joint venture with ExxonMobil and push the Kingdom's total refining capacity over 2 million BPD. The project would have lots of interesting implications, if it goes ahead.

There are at least three reasons why the Saudis might want to build a new refinery now. The first and most obvious is that global refining capacity has gotten extremely tight, and refining margins reflect this. Simple refineries that used to make a dollar a barrel are now earning $3, and more complex plants that made $2 or $3 per barrel are making $6-12. Of course, there's a long industry history of destroying attractive margins by building projects that bid up the price of the inputs and flood the market with products. At the moment it would take more than one new refinery to do that.

A more fundamental reason for the Saudis to expand their refinery capacity comes from Econ 101. Traditionally, the producer of a raw material should integrate up the value chain to capture more of the value added on the product. This argument is somewhat shaky in the case of oil, though, because the global oil market isn't in pure competition; the Saudis are price-makers, not price-takers, and as such, they already extract a healthy "rent" from the resource. Until recently, refining margins were depressed globally and earned pitiful returns on capital. And one of the biggest chunks of value in the entire chain isn't available to them at all. A few years ago, the German government took in more money from gasoline taxes than the Saudis made selling petroleum, and this might still be true, as taxes have followed prices higher.

The third rationale may be the most compelling for Aramco, however. It relates to fundamental differences between the crude and product markets. First, when Saudi Arabia exports crude oil, it is subject to their OPEC quota. Although they've been able to produce above that level recently without any repercussions, that's not always the case. Product exports, however, don't count with OPEC.

In addition, most of Saudi Arabia's incremental wells produce heavy, sour oil. This sells at a discount at the best of times, and when the global capacity to handle the residue from refining it maxes out, Saudi Heavy can be hard to sell at all. A new, complex refinery gets around this problem and makes lemons from lemonade: premium products that are in demand everywhere from a feedstock that isn't attractive without a lot of additional investment. The indicated $4-5 billion price tag for the new plant certainly suggests something more than a simple "topping" refinery.

The one piece of advice I'd give anyone looking to partner with Saudi Aramco on this project is not to expect a quid pro quo in terms of access to upstream oil opportunities. That didn't pan out for Mobil or Shell, when they invested in the Jubail and Yanbu refineries in the 1980s, nor are the companies that have signed up for natural gas projects getting any noticeable consideration on the crude side. But perhaps the likeliest partners for this refinery haven't studied that history, having come from a state-controlled company mentality.

Strategy vs. Tactics
The lead editorial in yesterday's New York Times criticized the pending congressional energy bill for relying on old solutions to energy security and failing to address climate change, which has large implications for energy. But the editors of the Times also missed a key stumbling block, in their eagerness to cite the prescriptions of various recent reports. Before debating the party of government on tactics, one must convince them that their basic assumptions about energy are wrong, or outdated.

The solution to the energy crises of the 1970s was largely economic, and Republicans are right to recall this. With demand mitigated by reduced speed limits, Corporate Average Fuel Economy regulations, and various energy efficiency incentives, the US then deregulated its oil and gas markets. A flood of new oil production followed. The combination hobbled OPEC's market power for two decades, coincidentally turning oil into just another occasionally volatile commodity.

Today even unfettered access to all the remaining oil resources of this country, including ANWR, will only slow the rate of production decline, while our demand continues to grow. The sole deregulation that would have a truly meaningful impact on oil production would have to take place in the Middle East, and our ability to influence that is a work in progress, at best.

Our other trump card in the 1970s was natural gas. Within a decade, most of the fuel oil consumed in this country was displaced by natural gas, and the fuel oil was converted to transportation fuels in upgraded refineries. Unfortunately, there is no longer a "gas bubble" to tap--unless it comes in the form of LNG that must overcome severe infrastructure hurdles--and any "coal bubble" will be constrained by environmental concerns. In summary, the conventional, supply-based solutions available to us will not prevent the US from importing ever more oil, increasing our vulnerability to foreign suppliers.

Has the strategic dimension of oil grown large enough to override market economics? Even ignoring the possibility of an impending geological peak in global oil production, the global distribution of remaining oil reserves is shifting away from market-oriented countries like the US, UK and Norway and toward the Persian Gulf states, with high-political-risk areas like Russia and North and West Africa holding the balance. Venezuela, one of the key Atlantic Basin suppliers for the US, has turned its solidly professional state oil company into the political instrument of a leader who is starting to look like a Castro with oil. Geopolitics have become at least as import as economics in the oil market.

At the same time, the technology options available to us today are dramatically better than in the 1970s. Hybrid cars and renewable energy are more than just a dream, and alternative hydrocarbon technologies such as coal gasification, oil sands extraction, and gas-to-liquids are becoming mature and proven.

The central question for our national energy strategy is whether the situation we face lends itself to repetition of the successful strategies of the last energy crisis, or if the world and our place in it have changed so much that a new approach is essential. If the latter view prevails, we should be optimistic, because we have a wonderful array of options available to us. Either way the current crisis will eventually end, but it's up to us whether its resolution breaks the cycle or plants the seeds of crises to come.

Another Heretic
Stewart Brand is an iconic figure from the 1970s who has succeeded in remaining current and relevant. He is a deep thinker, and a "long" thinker. From his founding of the Whole Earth Catalog, something no true child of the 60s/70s can ever forget, to his role as a co-founder of the Global Business Network, Stewart has long been an influential voice among those willing to question the status quo. Here, with minimal comment from me, is a link to his recent op-ed in Technology Review. In it, he challenges the conventional wisdom of the environmental movement in four key areas. This includes asserting that nuclear power deserves another look, on its environmental merits.

All of this is controversial, but Stewart's environmental credentials are as impeccable as those of the other leaders he cites. Even if you disagree with his arguments, I hope you will agree that this as precisely the kind of debate we should be having right now, as a country, a society, and a global civilization.

Bad Omens
The rate of growth in global oil production over the next two to three years will largely determine whether prices will return to historical levels--in defiance of the current wisdom of the futures markets--or stay in a new, much higher range. Most of the future supply for this period is already "dialed in", with major projects underway in West Africa and the Caspian, and oil sands production ramping up in Canada. The pivot, in my view, is Russia, which has expanded production rapidly over the last few years and has the potential to add more, if it can manage not to scare off everyone with the capital and expertise to make it happen. Current signs aren't good.

During the whole Yukos fiasco, observers wondered whether the persecution and dismemberment of this company was a unique event, targeting one of the "Oligarchs" who had profited enormously from the Yeltsin privatization, or if this simply reflected an effort to put the entire oil sector back into state--or at least comfortably Russian--hands. Most of the PR out of Russia was aimed at supporting the former interpretation. But with BP's big joint venture, TNK-BP, suddenly hit with a $1 bn tax bill for '01 (and more to come?) those who bet on theory number two may feel vindicated.

The other interpretation currently being pushed is that the problem arises from an out-of-control tax agency. That might be right--though it hardly squares with the picture of Vladimir Putin as the man in charge--but it's hardly reassuring. What good is a profitable Russian venture if it can all be taxed away later?

Sadly, it seems little has changed in ten years. In the mid-90s, the big uncertainties for investors in Russia's oil and gas sector were governance and the fiscal/legal system. If Yukos and TNK-BP fit a pattern, things are no different today. All that oil, walled up behind a government unwilling or unable to match progressive rhetoric with meaningful actions.

So Lord Browne is off to chat with Mr. Putin, and let's hope they can sort out this problem. Otherwise, we may be reduced to hoping that OPEC will either realize they've pushed prices too high or degenerate into squabbles for market share.

Market Shapes
One of the great luxuries of being out of the oil trading segment of the energy business is the ability to go days without looking at a screen to check on the price of oil. There are even times when I only hear about it on the evening news, something that would have been unthinkable when I needed to know what it was practically every minute. This is a long way of saying that I had missed the oil market's recent shifted from "backwardation" into "contango" until a friend emailed me an analyst comment to that effect. What does this change mean, and what does it say about the future trajectory for oil prices?

First, a quick explanation of the terminology. In backwardation, the price of the nearest or "prompt" commodity month on the exchange is higher than that of the next month, and so on. Contango is simply the reverse of this. Generally speaking, backwardation is a sign of strong demand or weak supply (or both), while contango indicates a market that is becoming oversupplied. The current market, which not long ago was fully "backwardated", is actually a bit of both today: contango through this September (with a really big May/June delta), and then mild backwardation as far as the eye can see.

What I find so interesting is not just this unusual hump-backed shape, but the fact that the contracts for five years out, which only a year ago were still in the high $20's and six months ago barely broke $40, are still in the high $40s. In fact, you have to get well into 2007 to find anything below $50. Think about that. Somebody (however many folks are buying oil for delivery in 2009 or 10) is betting that demand will outgrow or match the industry's ability to bring on new production for five years! I don't think there have been many five year periods in the last 100 years when that would have been true, barring the "oil crisis" years from 1973 to the early 1980s or WWII. Either there has been a structural shift in the market, or some speculators are going to get seriously burned.

In any case, the market is suggesting a bit of oversupply at the moment, with the expectation that demand will remain strong. Certainly US crude oil inventories are continuing to grow, sitting right at the top of their seasonal-normal range, and gasoline stocks seem to have stabilized. All of this bodes for weaker crude oil prices ahead, and possibly even wider contango, but that may not translate into much relief at the gas pump this summer, because extra crude doesn't translate into extra products if refineries are running close to flat out.

Which Grade?
As gasoline prices climb higher, buoyed by strong demand and high oil prices, many consumers who have habitually bought premium or midgrade gasoline will wonder if they should switch to a cheaper grade to save money. The simple answer is yes, provided your engine doesn’t “knock” or run on after you turn off the ignition. If you are interested in the more involved answer, then read on.

There are many reasons why consumers choose higher octane gasoline, some accurate and others mere myth. Here are the most typical:

• I will get better gas mileage on premium. This is rarely true. Premium gasoline actually contains a bit less energy than regular, so you might even end up getting slightly poorer mileage.
• My car runs better. If that means it knocks on regular but not on midgrade or premium, then you are right. Otherwise, as long as the gasoline is being smoothly combusted, you won’t notice any difference, especially with modern engines that sense how the engine is running and make minor adjustments continuously.
• My car accelerates faster on premium. Not unless it knocks on regular, or the car's owner's manual specifies that it is designed to operate on premium fuel.
• Premium gas has better additives and will keep my engine cleaner. This used to be a bigger concern, before the EPA imposed regulations requiring all gasoline to include detergents and other agents to reduce pollution from dirty engines. Some brands still put a bit more additive in premium. If you think you need it, it’s probably a better deal than buying regular and dosing it with store-bought additive.

Now, in addition to the obvious cost differential, there’s another reason to buy lower octane gasoline, and it’s one you won’t hear from gasoline marketers but should be hearing from the government: it takes more oil to manufacture premium gasoline than regular. The explanation requires a short discussion of organic chemistry. (Sorry.)

Crude oil consists of vast numbers of little chains of carbon and hydrogen atoms. These chains come in various lengths, measured by the number of carbon atoms included. The molecules in the gasoline fraction of crude oil generally have between 5 and 9 carbon atoms, with varying numbers of hydrogen atoms. Some of these molecules are “straight”, with each carbon atom connected to only one or two other carbons. Others are “branched”, with some carbon atoms connected to three or four other carbons, and correspondingly fewer hydrogens. Some even come in rings, with five or six carbons in a chain that connects to itself and creates a loop.

The reason this matters is that the branched and ring molecules have higher octanes than the straight molecules, which are more prevalent in most crude oil. (The reference standard for 100 octane is a twisty little guy called “2-2-4 trimethyl pentane.) Much of a modern refinery is devoted to changing the proportions of these different molecules in gasoline, and therein lies the problem. The commonest process for turning low-octane straight hydrocarbon molecules into high-octane rings is called catalytic reforming, or “Platforming.” (Remember the old Shell ads: “Super Shell with Platformate!) Unfortunately, in the reforming process up to 10-15% of the “naphtha”, or raw gasoline, feed is converted into small, low-value molecules that can’t go into gasoline.

This brings us back to our concern about oil consumption. Because premium gasoline requires more “reformate” than regular gasoline, and reformate consumes more naphtha in its production, this means premium gasoline uses more crude oil, perhaps as much as 5% more than regular. As a result of all this, buying lower octane gasoline—if your car can tolerate it—not only saves money, it saves oil, too.

Big Wind
Last Friday I highlighted an extreme form of wind power, flying windmills. This update from MIT's Technology Review shows how the state of the art of stationary windmills is advancing, with power output increasing from under 4 MW per turbine to nearly 7 MW. There is a direct relationship between wind turbine size, power output, and the cost per kilowatt-hour of the electricity generated, and the industry has made great strides moving down this curve. Unfortunately, there is another curve that wind developers must keep in mind: the relationship between wind turbine size and negative public perceptions.

While Europe has forged ahead with wind technology as its fastest growing new electricity source, many US wind projects have been delayed or derailed due to public objections against the intrusion of windmills in favored viewscapes. These clashes are unfortunate, because they divide supporters of the environment over a technology with fewer environmental drawbacks than most other ways to generate the electricity we all consume so eagerly. But even in areas that are more receptive to wind power and its visual profile, there must surely come a point at which bigger is simply too big, regardless of its other benefits.

The trick will be finding the optimal size at which power output is high, cost low, and public acceptance good. As wind turbines approach blade diameters of 140 meters (460 feet--more than twice the wingspan of a Boeing 747), we can't be too far from that point. Finding the right balance is important, if wind power is to remain as a viable alternatives to more coal- or gas-fired power plants and and their associated emissions, greenhouse and otherwise.

Climate Opinion
Having followed the issue of climate change during my corporate career and subsequently, I've become convinced that the key issue--at least in terms of action on climate change by the US--is not the science, but the public's perception of the problem. A friend sent me a link to a survey suggesting that the American public remains in a confused muddle concerning global warming and possible responses to combat it. If this is accurate, then the prospects for changing the current policy of relative indifference are poor, barring some catastrophe that can be directly attributed to climate change.

Given increasingly strong evidence that the climate is changing due to human actions, and given consensus in Europe and elsewhere that firm action is required, one might think that our political leaders might be motivated to lead, here. Politicians used to be willing to get out ahead of public opinion on something like this, not just because they thought it was the right thing to do, but because they believed that the personal consequences of inaction would be severe, once the public caught up. However, it's not apparent that our elected officials are at much risk of being voted out of office for having been wrong about something with big consequences. While we may have lots of commissions and embarrass the heck out of them, that's about the end of the line in accountability.

This must sound pretty cynical, and I suppose it is, but it brings me back to my basic premise that until the US public has a clear enough picture of this very complicated issue to want to undertake significant changes in their own lifestyles, it's unlikely that the federal government will do much to deal with it. Perhaps some of the money being spent lobbying on climate change in Washington would be better spent educating voters.

Green Nukes
Nicholas Kristof's op-ed in Saturday's New York Times was hardly the first expression of renewed interest in nuclear power on environmental grounds, but it is still noteworthy, appearing as it does in the great news organ of the Eastern Liberal Establishment (if such a thing exists.) As Mr. Kristof indicates, a growing group of environmentalists on both sides of the Atlantic is coming to see climate change as a greater environmental threat than nuclear power, despite the risk of radiation release and unresolved waste storage problems. This is a remarkable turnabout.

There's also a recognition here that existing nuclear plants are being operated more efficiently and safely than when the public soured on the idea in the aftermath of the Three Mile Island mishap. The industry has been quietly consolidating over the last decade, with companies like Exelon buying up poorly operated one-off plants and turning them into cash cows.

While nuclear power still represents the ultimate in NIMBY reaction potential, I wouldn't be surprised to see the first new plant in the US proposed within the next year or so, probably adjacent to an existing nuke. That would be a real signal that the tide has turned, both economically and environmentally, and a goad for Congress to get its act together on a long-term waste storage site.

Flying Windmills
If like me you grew up reading Jules Verne, H.G. Wells and Robert Heinlein, then you can't help but love an idea like this. Instead of all those wind turbines cluttering up the landscape, why not put them up in the sky? It may sound like science fiction, but a scientist in Australia is developing Flying Electric Generators (FEGs), as reported by Wired.

The basic premise is similar to that for space solar power. If you want to get the most output from your hardware for tapping a natural energy flow, be it wind or sunlight, then you must place it where the flow is strongest. In the case of wind, that means going to the middle atmosphere, or troposphere.

It's not hard to imagine the objections to this approach. Aside from the visual impact, it's unlikely that the best places for setting up the FEGs will turn out to be entirely uninhabited. Really simple and reassuring safety backups (giant parachutes?) will be essential, because it is far too easy to imagine these things falling out of the sky.

In any case, a company has been established to exploit this idea, though they appear to be having trouble raising capital for it. As the article suggests, though, this is exactly the kind of thing we ought to be considering, because of its enormous energy potential and the absence of harmful emissions or byproducts. And if it seems a bit too much like science fiction, consider how much of today's world would seem like science fiction to someone from the 1950s--even if we still don't have flying cars.

The Best of Times, The Worst of Times
I'm not sure there's any worse job at the moment than running one of the big legacy airlines. As the Financial Times just reported, the global airline industry is expected to lose more than $5 billion dollars this year, with high fuel prices as a major contributing factor. This will bring cumulative industry losses since 2001 to roughly $40 billion. It's hard to think of any business in the world that is so central to modern life and yet so unprofitable.

And it's not as though the business environment has been bad. It's one thing to lose money in a year like 2001, with the economy reeling and a major terrorist event shaking the public's confidence in flying. Instead, we see passenger miles growing nicely on the back of strong global economic growth, and we see airlines starting to queue up to buy the latest offerings from Boeing and Airbus.

Competition has been the real killer, amplified by absolute fare transparency via the internet, not high jet fuel prices. The traditional airlines are unable to raise fares to cover higher costs, because of pressure from established economy carriers like Southwest and upstarts like Jet Blue, which is expanding its transcontinental service. Instead, they subject coach passengers to the indignity of coast-to-coast flights without meals--as wretched as most of those used to be--and instead offer $3 snack boxes with contents worth about 30 cents. Once you've flown Jet Blue, you start wondering how much longer American and its brethren can survive.

Something has to give, but it won't as long as governments allow moribund airlines to remain on life-support. This option hurts everyone except the employees, because it robs shareholders of any opportunity for profit, while subjecting consumers to shabby service. There are really only two choices at a policy level: re-regulation, which would go against the flow of 30 years of history, and radical restructuring. As a first step, the latter requires giving every airline in bankruptcy a deadline for exiting that state, and informing all airlines that their next trip into bankruptcy will take them into Chapter 7 liquidation, not Chapter 11 reorganization.

Perhaps this is one area in which high oil prices will be beneficial, by making the cost of a dysfunctional status quo unsustainably high.

Misguided Effort
A friend recently shared an email advocating a boycott of any oil company importing oil from Saudi Arabia. Whoever sent this chain letter out into the internet had done some homework, spending enough time on the Energy Information Agency website to tally up the quantities of Saudi imports by company. Unfortunately, they had spent no time researching gasoline supply chains or following merger news for the last five years. Otherwise, they'd have seen just how fruitless such a boycott would be.

Let's imagine a successful boycott of company XYZ, which buys dozens of cargoes of Saudi crude each year and refines them at several locations in the US. Since total demand for gasoline wouldn't be affected (heaven forbid that we drive our SUVs less!) the result would be vacant forecourts at every XYZ station, and more demand at stations carrying the Citgo, Sunoco, Phillips, Hess, BP, and other brands deemed to be "Saudi-free." Rapidly, these stations and the distribution terminals supporting them would run out of product, and they would have to turn to...XYZ, which would have plenty of gasoline in its tanks.

So fairly quickly, the virtuous consumers avoiding XYZ's stations would be filling up elsewhere with gas from XYZ, containing those bothersome Saudi molecules. Meanwhile, the folks suffering the most would not be the management and stockholders of XYZ, who would see their retail margins decline slightly, offset by higher refining profits, but rather the independent business people who actually own and operate 95% of the XYZ stations and have no say whatever in where XYZ buys its crude oil.

In reality, the kind of behind-the-scenes product shuffling I described above happens 24/7 across the US, as refiners and marketers loan each other petroleum products to cover temporary shortfalls and dispose of short-term oversupply. The notion that every gallon of gasoline can be traced back to the same company's refineries and ultimately to their proprietary oilfields hasn't been true for decades. The oil companies were doing supply chain optimization before anyone else had heard of it, and they are very good at it.

So if you're looking to blame someone for high imports from Saudi Arabia, Venezuela, or any other country whose policies you don't care for, you should recall the immortal words of Pogo Possum, "We have met the enemy, and he is us."

ChevronTexacal?
A few weeks ago it looked possible that a Chinese oil company would buy Unocal, one of the largest independent oil companies in the US. Now it seems they will become part of ChevronTexaco (my old firm). This partially answers the question of how the Super-Majors will spend the heaps of cash they are amassing as a result of high oil prices, and in the absence of the kind of access they really need to top-tier opportunities in the Middle East.

It's always interesting to see the media parroting estimates of "synergies". The traditional view of merger synergies focuses too much on cutting headcount and selling underperforming assets, and too little on genuine upside. This transaction offers a lot of the latter, in my view, and barely enough of the former to affect the bottom line of a company this size.

Consider the overlaps and the voids. Unocal lacks a US downstream, so anti-trust concerns and forced divestments are unlikely, with the possible exception of some pipeline interests. But that also means no downstream synergies. Unocal is heavily focused on natural gas and on Asia, both areas where ChevronTexaco's portfolio could use some beefing up. The biggest overlaps will probably be in deep water Gulf of Mexico exploration and production--a key play for the entire industry--and in Thailand, where CVX's downstream presence via Caltex should be a nice fit with Unocal's big upstream operation. At $10 per oil-equivalent barrel in the ground, it might seem a bit pricey, but not if you think oil has moved into a new trading range.

This deal won't put CVX into the Exxon/BP/Shell league, though it should move them solidly into fourth place globally among publicly-traded oil companies, ahead of Total.

N.B. If I were an equity analyst, I would have to disclose that I own CVX stock.

Missing Plug
Saturday’s New York Times described a relatively new but intriguing development: the desire of hybrid car owners to be able to recharge them by plugging them in, not just through normal driving, as intended. Americans love to tinker with their cars, and as cars become increasingly electronic, owners are apt to see them as coming under the “open source” revolution sweeping the software world. As the article suggests, some owners are either paying to have their cars modified for plug-in, or doing it themselves.

This practice raises a number of concerns, affecting carmakers, electric utilities, and consumers. Determining whether it achieves hybrid owners’ goal of improving the environmental performance of these vehicles is hardly straightforward.

First, in terms of the cars themselves, their battery packs and power management hardware and software have been optimized around the assumption that they will be recharged in only two ways: by capturing energy when the car brakes, and by tapping the engine as a generator when the charge level gets low. The batteries are chosen for this type of service, which is normally a shallow-discharge, frequent recharge mode, rather than the deep-discharge mode a pure EV needs. In practice, the metal hydride batteries in most of these cars ought to do both reasonably well, but I suspect the carmakers will see plug-in modification as a warranty-voiding event. That’s a big deal, because replacing these batteries isn’t cheap.

The larger issue is whether plugging in a hybrid really helps the environment (or energy security, for the Geo-Greens out there.) To answer this you need to know two things: what is the incremental generating source on your local power grid, and to what degree does fully-charging a hybrid reduce its driving-cycle benefit? E.g., if the batteries always start out full, where does the energy recovered from braking go? I don't have enough information on the latter, other than knowing it must reduce the perceived plug-in benefit to some degree.

Answering the power grid question takes you into the world of dispatch curves and Clear Skies legislation. If you assume most of these cars will be recharged at night, and that the base-load power for most local grids will be either coal-fired or nuclear (because these plants are hardest to ramp up and down), plug-hybrid driving could be either truly zero emissions (nuclear), or create more emissions than running on gasoline (in the case of coal.) Either way, it would save oil, because so little power is generated using oil.

If I sound lukewarm on the idea, it’s because I think it’s not quite ready for prime time. A hybrid built from scratch around the plug-in concept would be terrific, particularly for consumers with short urban commutes, but the kind of aftermarket modifications described in the Times seem likelier to tarnish the image of all hybrids by making them much more prone to operating problems. That would result in fewer consumers buying hybrids, negating the tremendous benefits even normal hybrids can provide. Anyone wanting a manufactured plug-in hybrid shouldn’t have to wait more than a few years, though.

Killing the Goose
Last year I described the internal struggles over Bolivia's natural gas resources as an example of the need for a comprehensive approach to sustainable development. Now it appears that the Bolivian Senate sees it as a chance for larceny bordering on expropriation, as reported by the Financial Times (subscription required.) Raising the combined royalty and wellhead tax on Bolivia's natural gas to 50% will leave the companies that risked their capital and expertise to develop this resource with little chance of earning a return.

While I don't know the detailed project economics in question, it's important to understand the difference between producing gas in Bolivia compared to producing it in Oklahoma. Lacking much domestic industry, most of the gas must be piped to neighboring countries to reach a market. A little knowledge of South American geography suggests the challenges this entails; the pipelines to the closest markets for Bolivian gas are long, expensive and costly to operate. By the time you back the pipeline charges out of the delivered price of the gas, which is probably about $2.00/thousand cubic feet (MCF), the wellhead value of the gas could be under $1.00, leaving less than $.50/MCF to cover production costs.

Finding and producing gas in a remote, landlocked country with minimal local infrastructure isn't going to be very profitable at $.50/MCF. (US gas producers are currently netting $4 or $5 at the wellhead.) Even if you are a avowed socialist leading street protests against the evil capitalist exploiters of your country's patrimony, it ought to be self-evident that running off the only folks who can produce this resource is tantamount to killing the golden goose. If the protesters focused more on how to make the best use of reasonable royalties and less on grinding the foreign investors into the dust, they would stand a better chance of actually having a future royalty stream to divvy up.

The Biggest Challenges
I know at times I seem like a shill for Tom Friedman at the NY Times. His piece last Sunday expanding on the "Geo-Green" strategy has had me thinking all week. First, it's a nice summary of a number of critical challenges facing the US and the world. Mainly, it throws down the gauntlet to the President, suggesting that he is ignoring (or mishandling) the single biggest challenge on our plate. Is the intersection of energy, environment, and geopolitics really the top problem we face? Bigger than terrorism or Social Security?

Part of me just wants to quibble with Friedman's proposed solutions, which I've tackled in previous blogs. I also wonder if I'm predisposed to agree with his diagnosis because it ties together the three issues I've spent my entire adult life working on. They cover an awful lot of ground, collectively accounting for a pretty large chunk of world affairs, especially when you include their economic consequences.

On balance, I think Mr. Friedman's assessment is right, at least from a long-term perspective. How we resolve the war on terrorism will have an enormous impact on the next decade or two, but how we deal will the inter-related problems of energy supply and demand and climate change--both of which are intimately connected to geopolitics--will affect global civilization for much longer. The underlying question concerns what will follow the Age of Oil (or Hydrocarbon Age, if you prefer.) Addressing this is about designing the pattern of the next century or so, and that has been done pretty haphazardly so far, considering the stakes.

If You Can't Beat 'Em...
There's a secondary debate with regard to climate change, simmering alongside the main show on whether or not it's happening and to what degree we (humans) are causing it. This other debate, which doesn't get nearly as much media coverage, concerns whether our focus should be on trying to prevent climate change or working on the means to adapt to it. You can view the latter as either contingency planning or pessimism that nothing currently on the table--including the Kyoto Treaty--will slow down climate change, let alone halt or reverse it.

I must admit I'm intrigued by adaptation, even though I have certainly not given up on efforts to slow down the process. For example, I was interested to see that the Swiss have announced a practical measure to retard one of the local effects of climate change: blanketing a glacier to keep it from melting away. If this works, perhaps it could be applied on a larger scale elsewhere, including Greenland, where scientists worry that melting glaciers could tip a delicate salinity balance and shift the Gulf Stream, with disastrous consequences for Northern Europe.

Other possible adaptation measures range from building dikes to slow the loss of coastland, to really large-scale "geo-engineering" that borrows ideas first considered for terraforming other planets, like Mars. This stuff is hugely controversial, partly because it involves projects with potentially enormous unanticipated consequences, and partly because it looks like defeatism on the main environmental agenda of reducing carbon emissions. It can also smack of some of the notions coming from the Greening Earth crowd, i.e. warming is good, and can we have some more, please?

I'd like to think the adaptation and prevention camps could be reconciled. There's a lot that can be done at relatively low cost--or even at a profit--to manage the problem in the way contemplated by the UN Framework Convention on Climate Change, the body behind Kyoto. But we can't put all our eggs in this basket; someone must be working on the things we'll need if warming proceeds faster, with consequences approaching the worst-case predictions. And like it or not, some serious science also needs to be done on the really big, last ditch measures required if we ended up in a "runaway greenhouse," however remote a possibility that might be. I hope we never have to make those choices, but if we do, I'd sure want to have some detailed options to choose from.

Powerful Waves
With the exception of nuclear power and the small quantity of geothermal energy we currently tap, essentially all of our present energy supply consists of some form of solar power. Wind power and photovoltaic cells tap current solar power, while fossil fuels represent solar energy stored over geologic time. With 71% of the earth's surface covered by oceans, which thus receive roughly the same percentage of the solar radiation hitting the earth, ocean energy ought to be a promising component of our future energy supply. This article from MIT's Technology Review highlights one avenue for achieving this, by tapping the power of the waves.

As the article suggests, wave power ought to be less controversial than offshore wind farms, the other main proposal for tapping ocean-based energy, though perhaps the former has simply escaped the notice of the groups that might oppose it. After all, it still represents a form of human interference in the ocean ecosystem, and it could affect shipping and fishing interests, depending on location.

The other issue raised here concerns whether the US government should fund more research in this area, given the apparently strong interest of other countries, including the UK. In the current fiscal environment, it makes sense to be selective about where we invest, as long as someone is pursuing this option. Once the technology gets closer to commerciality, we could provide the same kind of tax benefits currently enjoyed by wind power, which is probably ten to fifteen years ahead of wave power in its stage of technology development. The real advantage in wave power is probably in its application, rather than ownership of the patents.

Overall, the potential for wave power is so large that we should definitely monitor developments in this area closely and weigh them against our other alternatives. Meanwhile, there are other areas in which federal research funds can probably have more impact, including hydrogen and advanced nuclear technology.

Fuel Cell Motorcycle
Another item I missed while I was on vacation was the launch of a hydrogen fuel cell powered motorcycle in the UK. Setting aside some obvious concerns about cost (unspecified), limited range (60 mi.), and low power (6 kW = 8 HP), the thing looks great and could catch on based on sheer coolness alone. Criticizing it for lack of the usual motorcycle roar seems to miss the point, in my book. I doubt they're going to sell many of these to heavy-duty motocross types, anyway, but can't you imagine a fleet of sleek, fast, and quiet motorcycle couriers in cities like London?

I still can't resist picking on the name, though. Calling a fuel cell vehicle of any type "Emissions Neutral" demands a great deal more information about the hydrogen source. Some of the early H2 supply is likely to come from electrolysis of water, using electricity generated by whatever fuels the local grid, including coal. The rest is likely to come from the same place that most hydrogen does today: chemical reforming of natural gas, with definite emissions of greenhouse gases and local pollutants. Just because a vehicle emits only water from its tailpipe doesn't mean it is totally clean.

Despite this, I wish Intelligent Energy well with their nifty gizmo. It represents another small step on a very long pathway towards a possible hydrogen economy.

The Voice of Authority?
Today's New York Times Op-Ed page is a doozy. Under the overall caption of, "What Happens When the Oil Runs Out" (more apparent in print than in the electronic version) are three guest editorials on the subject. The first, by Kenneth Deffeyes, relates to an impending peak in oil production. The second, jointly written by the head of a non-governmental organization and a scientist at Lawrence Livermore Labs, suggests the use of other fossil fuels, coupled with carbon sequestration. The third, by Dr. Oliver Sacks, is a paean to hybrid cars. All three are interesting, but I want to focus on the peak oil question.

Dr. Deffeyes identifies himself as a colleague of King Hubbert, who pioneered the theories on "peak oil." Mr. Hubbert accurately predicted the 1970 peak of US production several decades earlier. However, the application of this approach to global oil production is problematic, because the actual amount of oil originally in place is not known. Estimates of this figure have been rising steadily since Mr. Deffeyes made his first predictions years ago. (See my posting of 9/22/04, for more information.)

Setting aside his arguments concerning the Arctic National Wildlife Refuge, I was startled to see Dr. Deffeyes boldly predict that the peak of world oil production is at hand, within the next couple of years. This is among the most aggressive predictions of this type that I've seen. In effect, he is suggesting that the current spike in oil prices, driven by the recent failure of new oil production to keep pace with the growth in demand in Asia and the US, is actually tied to a geological limitation on oil production. This is an irresponsible assertion.

The roots of the current problem are clearly economic and geopolitical, rather than geology-based. The countries with the most promising reserves of untapped oil are reluctant to invite foreign investors in to help develop these resources (see my posting of 12/15/04), and the companies with the greatest expertise and capital have been slow to reinvest (see my posting of 10/27/04). The result may well be a sustained period of market tightness until this logjam can be broken, but this is not indicative of a geological peak in production.

What to do when oil runs out is indeed an important question, but even if a peak were imminent, this would mean that production would plateau for some years and then gradually decline, rather than falling catastrophically. A peak is indeed somewhere ahead, but the track record of predictions in this area is such that we will not know we've reached it until we're on the other side of it. This could happen in five years or fifty. While suggesting it is close at hand makes for sensational headlines and may help drum up support for alternatives, it risks crying wolf prematurely and setting up a conservation-and-rebound response similar to what we saw after the 1970s oil shocks.

Tightening the Screws
The unfortunate explosion yesterday at BP's Texas City refinery is already sending ripples through the market. In addition to the tragic loss of life, the damage will impede gasoline production at one of the country's largest oil refineries. With oil markets already extremely tight and hanging on every news story, the immediate reaction will send prices higher, whether it should or not.

In the immediate aftermath, it's hard to ferret out exactly what happened. Reporters and first responders often don't know the difference between a crude still and a cat cracker, and companies tend to be slow in specifying details. In this case, the most detailed report I could find this morning suggests the explosion occurred in the refinery's 30,000 barrel per day catalytic isomerization unit, which upgrades light gasoline components to higher octane. This unit is less essential to running other parts of the plant than the catalytic reformers or catalytic crackers.

So what is the impact of this event, which will probably slow overall run rates and production from the whole refinery? Generally speaking, this should actually depress crude oil prices slightly, because less refinery capacity is available to turn crude into products. However, with overall refinery utilization running at about 90%, it's possible that other refiners could boost production a bit to make up the shortfall from BP. On balance, the impact on crude is probably neutral, though a nervous market will likely see it as an excuse to go higher.

Product inventories are a crucial factor in assessing the impact on gasoline prices, as discussed in my posting of March 10. Although total US gasoline stocks are 7 million barrels lower than a month ago, they remain at the high end of their seasonally-adjusted range. That means there's a reasonable buffer to allow refiners and traders to respond without creating a serious supply crunch. If repairs can't be effected quickly, the shortfall will have to be covered from imports. In that case, retail gasoline prices will eventually go up a by a little more than they would have anyway.

Whenever an incident like this occurs, it reminds us that refineries--no matter how well run--are dangerous places that subject flammable liquids and gases to extremes of temperature and pressure. The human toll of accidents like this is part of the cost of keeping our cars, trucks, buses and boats running. We should pause periodically and reflect on that.

Addendum - 1:00 PM EST
I just watched a live press conference on this event from Texas City. Normally, you'd expect the plant manager to be acting as the main company spokesman. In this case Lord Browne, BP's CEO, was on hand, saying all the right things and fielding questions. This is impressive crisis management, assuming he must have jumped on a plane in London right after hearing the news.

Lord Browne also confirmed that the explosion occurred in the Isomerization unit, which was being restarted following annual maintenance. Startup and shutdown are always the diciest times in refinery operations, and despite extra precautions and extra manpower--presumably the reason the casualties were so high on a unit that would normally have had an operating staff of maybe a half-dozen--accidents do happen. It will be interesting to see what the inquiry turns up.

What Does Mass Transit Cost?
I'm still catching up with articles published while I was on vacation. P.J. O'Rourke's ironic blast at mass transit funding from last Wednesday's Wall St. Journal is funny but also raises serious questions. Presumably, every one of the mass-transit projects he cites was approved on the basis of favorable economic analysis, but slicing and dicing the same numbers differently suggests they are massively wasteful of taxpayer money. Who is right?

I periodically ride MetroNorth from Connecticut into Manhattan. I always try to avoid peak commute hours, when the trains are packed. Yet despite steadily rising fares and constant calls for new subsidies, this system cannot seem to afford even proper routine maintenance, let alone provide for the replacement of seriously aging rolling stock. If MetroNorth and operators like them had to account for their results on a replacement-cost basis, instead of riding a legacy asset into the ground, the result would be a public scandal on a similar scale to those that have rocked the business world in recent years.

However, there are two obvious problems with viewing mass transit in purely economic terms. First, the consideration and comparison of alternatives gets incredibly complicated. Do you compare one mass-transit mode to another, such as buses, or is the real alternative more highway miles or lanes, or merely more congestion on existing highways? If so, how do you reckon the logistical and environmental impact of putting all those folks in cars, factoring in "diamond lanes" and other car-pooling incentives? How do telecommuting and e-meetings affect the demand for physical transportation? None of this is beyond analyzing, but as with any economic analysis, the choices and assumptions you make up front largely determine the outcome.

The other problem may be O'Rourke's real point. On economics alone, mass transit has probably been a loser for decades, even with all conceivable externalities included. But mass transit is as much about social values and choices as it is dollars. Without mass transit, what do those who can't drive or can't afford cars do, and how does that change society? And after all, isn't sitting in a train reading the paper or listening to your iPod a lot more pleasant than being honked at by impatient motorists trying to merge into bumper-to-bumper traffic?

These systems ought to be as efficient and well-thought-out as possible, but they're not just about cost. I suspect that the only way to get this balance totally right would be to build new towns and cities from the ground up, the way they do in Singapore.

Geo-Greens Against ANWR
Bless Tom Friedman of the New York Times for being willing to challenge conventional wisdom on the Middle East, China policy, and lots of other things. Unfortunately, his discussion of drilling in the Arctic National Wildlife Refuge on St. Patrick's Day rested on some pretty shaky assumptions, even if his source was Philip Verleger, Jr. As I understand the so-called Geo-Green argument against drilling, it boils down to, "Don't do it because we might find a lot of oil there."

Let's address a few of the errant assumptions:
1. Oil from ANWR will benefit China and Japan more than the US, because it is in the wrong place. Fortunately, the oil market is global, and putting a million barrels a day of new oil into it would dampen prices globally, whether the actual barrels go to San Francisco or Shanghai. However, if you consider the declining production profile of the Alaskan North Slope (see yesterday's posting) and the time lags involved in producing any discovery in ANWR, you have to see ANWR as backfill for the North Slope, rather than as incremental supply for the West Coast. In other words, it would likely create a longer, gentler plateau for overall Alaskan production, rather than a big spike in production. That means the beneficiaries would be the same folks that receive Alaskan North Slope oil, now.

2. Finding oil in ANWR would discourage conservation and promote more greenhouse emissions. Perhaps so, but no more than finding oil anywhere else. ANWR will not by itself bring back $20 oil, and it probably wouldn't be profitable at $20. Conservation and additional supply are not competitive; we need them both.

3. The US will still be vulnerable to Saudi Arabia and Venezuela. Certainly, but our energy strategy should focus on actively managing that vulnerability, not fantasizing about eliminating it anytime soon. A combination of supply enhancement and demand restraint could keep our import needs near the current level for decades, but they aren't going to drive them to zero without a technology breakthrough or a Depression.

Even though I support drilling in ANWR, I recognize that there are valid reasons not to. But in order for them to be considered on a level field, the alternatives should all include practical proposals for coming up with the equivalent amount of energy in new supply or new savings elsewhere. Simply saying "no" is a guarantee that our import dependency will keep growing.

Trading ANWR
With the Senate having narrowly approved drilling in a portion of the Arctic National Wildlife Refuge (ANWR), this issue has moved to the front burner for all parties concerned. I hear the same old canards about its insignificance to our energy needs, but no one is talking about what kind of quid pro quo might be possible, if ANWR were to be opened up for exploration.

Let's start with the canards. "It's only six months' worth of oil" is simply the wrong way to look at this, as I've explained previously. The best analogy is to the development of the Alaskan North Slope, which was also controversial in its day. The same insignificance argument might have been made about that field, which was originally thought to contain about 10 billion barrels of oil, comparable to current estimates for ANWR. From 1976, when oil started pumping, through 2000 the North Slope and nearby fields had produced 13.3 billion barrels--about 14% of all US oil production over this period--and was a key factor, along with the North Sea, in limiting OPEC's market power in the 1980s and 90s. Though now in decline, the North Slope area still produces nearly one million barrels per day.

No one seriously suggests that ANWR can give us energy independence, but even if its potential is only half that of the North Slope, this must still be reckoned as significant.

Turning to the kind of "practical environmentalism" I discussed in Friday's posting, the challenges of expanding global oil supplies to keep up with economic development in Asia, along with the timelags inherent in a transition to any other form of energy, make it very likely that ANWR's oil reserves will eventually be developed. If so, then environmentalists may never again have as much leverage as they do now to extract concessions in exchange for going along with opening up ANWR to limited drilling.

If that sounds cynical, consider that ANWR, however large and majestic, is only one small, remote corner of this vast country. Would getting something that benefits the entire nation or the world, such as a cap on US carbon emissions or tougher fuel economy standards, be worth conceding a bit on ANWR--with proper safeguards to ensure that the best technology is used? There's no easy way to evaluate such a tradeoff, but surely this would be a better outcome than having ANWR developed without any offsetting benefit, which I consider a very plausible scenario.

Resolving Environmentalism's Contradictions
After a week on the west coast, Nicholas Kristof's interesting New York Times op-ed on the demise of traditional environmentalism really resonated with me. He cites the argument of a widely discussed recent article on "The Death of Environmentalism" that suggests its traditional approach must give way to something entirely new, if it is to survive and be effective. Although Shellenberger's and Nordhaus's concerns revolve around overcoming the challenges posed by climate change, I have a different take on the problem. How can environmentalism succeed without reconciling itself with the aspirations of billions in the developed and developing world for a better material existence?

Perhaps this is an obvious concern for someone with my background. I spent more than 20 years working for a major, international oil company, Texaco, and yet I always considered myself an environmentalist--as did many of my colleagues. But while much of the formal "Environmental Movement" has set itself in opposition to development, or has at least been perceived as doing so, many practical environmentalists have focused their efforts on reducing the environmental impact of inevitable--and generally beneficial--economic development.

So while Messrs. Shellenberger and Nordhaus worry about how the world can prevent climate change, I worry just as much about how we can help China and India achieve something close to a Western level of development without wrecking the planet in numerous ways. Just as their growing economic mass is altering the orbits of other economies, their appetites and emissions are starting to influence the global environment.

Dealing with this problem in a positive way has the potential to create new markets, along with new perspectives, that can benefit the developed world, too. The ugly alternative is to consign these countries to some kind of Rousseau-esque happy primitivism, along with Africa and the rest of the developing world. That would be unconscionable and about as effective as King Canute's desire to hold back the tide.

Vacation Substitute
I'll be traveling for the next week or so--a chance to escape the snow!--and opportunities for blogging will be few and far between. As I usually do when I can plan for it, I've dredged up a few postings from the archives. If you didn't catch them the first time around, they should be worth a look.

Storage options for nuclear waste:
Yucca Mountain vs. Buying Time (11/16/04)

In defense of emissions trading to manage climate change:
Deliberately Obtuse? (12/13/04)

Is energy independence a worthy goal:
Energy Independence? (12/21/04)

How quickly could more efficient cars have an impact?
The Hidden Variable (1/17/05)

Self-Fulfilling Prophecy?
Crude oil prices have trended up for the last several weeks, but retail gasoline prices haven't kept pace. Several commentators, including one in USA Today, have predicted that pump prices could soon jump 24 cents per gallon to catch up with crude. While it's possible that pump prices have simply lagged crude prices by that much, it's equally likely that this story could create a self-fulfilling prophecy. To see why, you have to understand the relationship between inventory and demand.

The Energy Information Agency (EIA) of the US Department of Energy tracks week-to-week statistics for crude oil and petroleum product production, imports, exports and inventory. For example, the EIA shows current stocks of gasoline at 224 million barrels, 10% higher than a year ago and well above the typical range for this time of year. Inventories aren't this high because refiners produced unusual amounts of gasoline; they mirror the relatively weak demand that is typical in the winter months, currently running at 8.9 million barrels per day. (This may explain why prices haven't gone up in line with crude.)

But getting a handle on true demand is difficult, because no one is measuring how much gasoline we actually burn every day. Instead, the EIA looks at how much was produced or imported each week, and how much inventories went up or down. This still doesn't get at end-user demand, because the volumes leaving refineries and large distribution terminals reflect deliveries to local distributors, who watch sales at the gas stations they serve and adjust their own inventories in anticipation of rising or falling demand and prices.

Even the demand at service stations is distorted by a final level of inventory: the amount of gasoline sitting in our cars every day. It gets little attention, because it rarely changes in aggregate. Assuming every car in America has a fourteen gallon tank, usually half full, this hidden inventory amounts to 40 million barrels of gasoline, equal to 20% of the primary stocks the EIA measures. If consumers all decided to keep an extra 3 or 4 gallons in their tanks, apparent demand would increase by 10-20% for a few weeks and send a false demand signal to distributors.

So if we all go out and tank up because we think gas prices are about to jump 24 cents, are we making such an increase more or less likely?

Empire of Corn
Today's Wall Street Journal has a front-page story (subscription required) on the drive to expand ethanol capacity in the US Midwest. The article, which has a strong human-interest theme, reveals that the impetus for additional fuel ethanol production derives mostly from the economics of small farming communities and only incidentally from the nation's energy needs. In effect, ethanol is driven by values, not value.

Blending ethanol into gasoline has been controversial since it was first subsidized as part of the nation's response to the oil crisis of the 1970s. As I discussed at length last year, its production consumes more energy of other types (including oil and gas) than the ethanol returns when burned.
Turning food crops into fuel yields one of the poorest energy returns of the various biofuels alternatives, though this balance can be improved dramatically by using crop waste and advanced enzymes to make "lignocellulosic ethanol".

The Journal article paints a stark picture of declining Midwestern towns grasping for any means of preserving a way of life that goes back more than a century, investing in ethanol plants to try to eke more value out of their crops. The risks these small investors are taking on could bankrupt them if overexpansion creates an ethanol "bubble." While it's hard not to sympathize with family farmers, the reader is left wondering whether the billions of dollars in federal and state subsidies propping up the ethanol value chain might be better spent elsewhere, on programs with a bigger impact on clean air, energy security, or farm modernization.

Reserve Accounting
A comment on yesterday's blog raised the issue of petroleum reserve accounting, which has become highly contentious in the wake of Shell's problems and the publication of an industry-sponsored report calling on the SEC to change its reserve accounting procedures. While admitting that I am hardly an expert on this complex subject, I hope I can shed a little light on the basic issues involved.

The present system of reserve accounting revolves around two fundamental, investor-focused concerns. First, with oil and gas reserves seen as a key source of the future value of an energy company, investors need to know that a firm's stated reserves have a high probability of turning into actual oil and gas production in the future. Second, they need to know that company A and company B used comparable methods to calculate their reserves, so they can properly choose which equity to buy. These two concerns sound similar, but their implications are quite different.

For one thing, comparability does not require absolute accuracy in assessing the basis for future production, as long as this is done the same way for everyone. It also ignores subtler differences in the quality of reserves. All barrels are not equal: some firms have more heavy oil, which is less valuable and requires more processing, while others have more gas, needing more infrastructure to bring it to market. Despite these shortcomings, which require greater investor sophistication to sort out, I would still argue that comparability is the crucial concern for the stock market.

For public policy, however--and arguably from a management perspective--absolute accuracy is more important. Each company must see how its future production would fare under expected conditions of price and resource access, in order to know where to invest its exploration and production budget. For quite some time now, most of the annual additions to reserves shown by the major oil companies have not come from finding new fields, but from reassessing what their existing fields can economically produce in light of expected prices and available extraction technology. So as technology improves, reserves go up without finding a single new field. This has its limits, though, and new fields must be eventually be found, a process that is always unpredictable and sporadic, leading to "lumpy" reserves additions.

The above description doesn't convey the complexity involved in this issue. There seems to be as much art as science to reserve accounting, and the majority of knowledge about this arcane practice resides within these companies, not in the SEC. For this reason, the recommendations of the industry report published by Cambridge Energy Research Associates should be evaluated carefully and with an open mind. While it is true that the oil companies might benefit from more favorable rules on reserve accounting, they will benefit more from greater transparency and investor confidence in this area, and I think most of them understand this.

Spending the Windfall
Ever since oil prices popped up into the stratosphere last year, the market has wondered how the major oil companies would spend the resulting cash windfall. The answer so far has been fairly restrained: stock buybacks, balance sheet polishing, and little to no increases in exploration. Now ChevronTexaco has apparently thrown its hat in the ring in the chase for Unocal, in competition with one of China's state oil companies. It will be interesting to see if the resulting offer for Unocal is in cash, stock, or a blend.

Unocal looks like a good fit with ChevronTexaco's existing portfolio, and the California reformulated gasoline patent I highlighted in my posting of 1/7/05 should be much less of a concern in a domestic transaction such as this, though it could still draw regulatory attention. One of the more interesting angles concerns Unocal's controversial position in Burma. Would ChevronTexaco retain this, or divest it as Texaco did a few years ago?

Although a Chevron/Unocal transaction would make sense from a company perspective, it does not address the fundamental issue facing the industry today. The consolidations of the last decade have enhanced the size and profitability of the global energy companies, but they have not noticeably increased aggregate production. With reserve replacement slipping and the national oil companies preoccupied funding domestic social programs, the global oil industry will continue to struggle to meet the growing demand for petroleum products generated by the development of China and India.

Small, Warm Fusion
For all the interest in useful renewable energy technologies such as wind and solar power, nuclear fusion remains the ultimate "alternative energy", even as it remains a distant prospect. Although the "Cold Fusion" fiasco of 1989 gave the pursuit of small scale fusion a bad name, interesting work is going on in another bench-scale possibility, involving the collapse of bubbles in liquid. A colleague just forwarded the abstract of a peer-reviewed paper on this topic in one of the journals of The American Physical Society. The experimenters are directly addressing the concerns of other scientists who are questioning their earlier results.

The process in this case involves bombarding a bath of acetone and deuterium (heavy hydrogen) with sound waves and neutrons. The authors of the paper report finding evidence of nuclear reactions in the fluid--flashes of light, neutron emissions, and tritium (even heavier hydrogen)--that don't occur when they perform the same experiment on a bath containing only acetone.

This is pretty exciting stuff, even though Fleischman and Pons claimed similar evidence for their cold fusion experiments. As always, the proof rests on whether the results are repeatable, not just by the same team but by other researchers using their own apparatus, and if all extraneous influences, such as gamma rays from space, can be ruled out.

The implications for successful nuclear fusion at low temperatures and with fairly simple equipment would be profound, including all the benefits of large-scale fusion, plus the ability to provide them on a distributed basis without large central generating plants. This is a story I plan on following, with an appropriate degree of skepticism.

Hydrogen Distortion
It's unusual to run across an article that cites a long list of references yet contains an equally long list of errors of fact--or at least of connecting unrelated facts in a way that renders them erroneous. I just received one from a newsletter called EnergyPulse. The title was intriguing, "The Hydrogen Economy - Energy and Economic Black Hole," by Alice Friedemann. This article illustrates how rapidly we've gone from a general view of hydrogen as a perpetual-motion energy nirvana, to a realistic understanding of hydrogen as an energy carrier--not a source--and onward to a growing body of criticism seeing hydrogen as, in Ms. Friedemann's words, "an energy sink." This is a step too far, at least at this early stage.

Now, I certainly agree that you need a good reason for turning some other form of useful energy, be it natural gas, coal or electricity, into hydrogen, because of the energy losses inherent in any conversion process. But this categorically does not mean that sufficiently good reasons don't exist. In the case of the fuel cell cars and trucks currently under development, that reason is the high thermal efficiency of the fuel cell itself, which has the potential to more than compensate for lower efficiencies in other parts of its energy chain.

The fair and objective way to compare efficiencies is on a "well-to-wheels" basis that looks at the entire system of fuel delivery, conversion processes, and vehicle. This analysis looks at the original energy content of the fuel and the amount consumed in every step along the way, enabling direct comparison of a wide variety of energy systems. You can, for instance, compare the efficiency of a hybrid car running on gasoline refined from oil pumped in Kuwait and transported to the US by tanker versus a fuel cell car running on hydrogen extracted from natural gas produced in Louisiana and transported by pipeline to a chemical plant. A number of independent groups have done this for a variety of fuel and vehicle combinations, and the results are available on the internet.

Unfortunately, Ms. Friedemann seems to have selectively chosen the worst news from each separate step and created her own "woe-to-wheels" analysis. For example, she strings together the "efficiency" of a wind turbine with that of hydrogen generated by electrolysis to demonstrate how much energy is lost making hydrogen to run a car. But if the lost wind energy was never available to us in any other form, the whole concept of efficiency becomes meaningless, and the correct multiplier is 1, not 1/3. The article includes at least sixteen other errors of fact or interpretation, or suppositions stated as facts.

While I don't mean to belittle someone who apparently did a lot of research before writing a freelance article, I believe it is important to debunk this kind of pseudo-science, just as it is important to disabuse the public of the notion that hydrogen from the sky will solve all our energy problems. Hydrogen is no one's free lunch, but neither is it a pointless boondoggle. Instead, it is a promising potential pathway for introducing non-fossil-fuel energy into transportation modes currently dominated by petroleum products. It will take years and much effort before this pans out, if it ever does, but it is entirely premature to write it off today.

How Firm a Foundation?
While many factors have contributed to relative energy security for America since the oil crises of the 1970s, the foundation of this stability has been a free market and a diversified supply strategy focused on regional suppliers and away from the Persian Gulf. A pair of articles in the current Economist (subscription may be required) raise questions about the future reliability of two of the principal enablers of this diversification, Mexico and Venezuela.

Prior to the 1979 Iranian Revolution, the US imported roughly 8 million barrels per day (MBD) of crude oil, with two-thirds coming from OPEC and about a quarter of the total from the Persian Gulf. Last year, the volume of oil we bought from OPEC was about the same as in 1978, even though total imports have climbed to nearly 13 MBD. Persian Gulf imports are up about 10% from the late 70s, but still account for less than a fifth of the total.

If Mexico proves unable to increase its production to cover both its growing domestic market and the increased appetite north of the border, and if Venezuela accelerates its political shift from a "Bolivarian Revolution" to "Fidelism" (see my posting of 2/1/05) then even the current volumes we buy from these countries will be at risk. The consequence would be a rapid shift to dependence on imports from the Middle East, in direct competition with China and India.

The problem seems clear, but the solution is not. How much influence does NAFTA give the US in a Mexican political process rooted in sacred-cow nostalgia for a 1930s nationalization that is blocking needed foreign investment in the oil sector? Can we find a way to work with Venezuela's neighbors to contain Mr. Chavez's dogma, without returning the region to the instability it experienced a generation ago? And can we accomplish any of this while preoccupied with terrorism and the democratization of the Middle East? The alternative will require us to get serious about conservation.

Although it's unrealistic to imagine that the US can ever again be self-sufficient in petroleum, maintaining balance and diversity in our oil supplies is possible and desirable, even if our long-term goal is the creation of a non-oil-based economy. Preserving this balance in the face of new challenges, however, will require elevating its priority in our diplomacy and trade relations. That seems unlikely without a clearly articulated national energy policy.

Hybrids By The Hour
One of the biggest problems with introducing advanced technology vehicles such as those powered by fuel cells or hybrid drivetrains is overcoming natural consumer uncertainty about something so new and unproven. A new trend in green rental cars may help to lower this hurdle by making the initial alternative vehicle purchase period hours, instead of years.

My own first experience in an electric car amazed me. Nothing had prepared me for the acceleration, and I think I'd have bought one then and there if they had been more widely available and the infrastructure more convenient. On a smaller scale, I'd never have purchased satellite radio for my car without having first experienced it as a free option in several rental cars. After a couple of drives I was hooked to the point that when I recently went car shopping, there were no models on my list that didn't include satellite radio as an option.

Driving a biodiesel-powered car around Maui may sell on novelty value, but in the process customers will dispel some of their myths and preconceptions about these vehicles. While targeting rental fleets has traditionally been a high-volume, low-profit option for carmakers, they would be smart to use an entirely different set of criteria with regard to advanced technology cars. Rental car companies could be their best form of advertising and mass exposure.