The Missing Framework
As the pending Energy Bill gets closer to the final House/Senate conference version that will presumably be enacted, it is shedding provisions like an old jalopy racing down a bumpy road. This shouldn't come as a surprise, being in the nature of our democratic processes, but it is still a disappointment for many. I see it somewhat differently. The way individual proposals such as requirements for a set percentage of renewable energy or the goal of reducing oil consumption by a million barrels per day have gone in and out of the mix merely reflects a lack of consensus on the underlying problems we face. Energy security is an inadequate lens through which to view national energy policy, and the result has been a grab-bag of programs, rather than a coherent plan.

Consider the basic issues that need to be addressed:

1. Despite a reduction in the energy input required for incremental GDP growth, an expanding US economy still relies on steady increases in both electricity and liquid fuels supply.
2. Without fundamental changes in our energy mix, this results in a lock-step increase in greenhouse gas emissions.
3. Improvements in the fuel economy of the US car fleet have stalled as a result of consumer preferences for larger, heavier vehicles with more horsepower and more power-consuming accessories.
4. Demand for petroleum products continues to grow, at the same time that domestic oil production is in steady decline.
5. Domestic natural gas suffers from underinvestment in infrastructure, environmental ring-fencing of resources, and knee-jerk opposition to import facilities.
6. Any expansion of nuclear power hinges on a permanent solution to nuclear waste that has been delayed for decades by largely political concerns.
7. The growth of wind power has been impeded by inconsistent subsidies and local opposition.
8. Our largest alternative energy program, fuel ethanol, objectively contributes little to the overall energy balance of the country and may actually have been not only a financial drain, but an energy drain, as well.
9. The resulting increased reliance on coal shifts more of the burden to our least-efficient, most environmentally-challenging fuel.

At the highest level, then, we see a picture of a multi-trillion dollar energy system on an unguided, unsustainable path. However, without a clear definition of the problem and a clear set of goals and objectives--with accompanying timetables and investment plans--the likelihood of a change in direction is low, and any improvements are likely to occur only around the edges. Focusing on fuzzy notions of energy security doesn't help matters, particularly when relatively benign proposals to inventory the country's remaining unexploited oil and gas resources prove more controversial than an increased emphasis on nuclear power.

Even though a comprehensive approach to climate change has been a bitter pill for this country to swallow, it has the compelling advantage of providing a consistent, all-encompassing way of viewing our energy system and guiding its future development. The introduction of emissions trading in Europe--doubly ironic, considering our market orientation and the idea's US provenance--shows that limiting greenhouse gas emissions need not require the iron fist of command-and-control regulation, or a centrally-planned energy economy with bureaucrats choosing technology winners and losers. Even better, emissions caps based on rigorous analysis of all energy pathways would weed out ineffective measures and enhance energy security as a byproduct. Thus the most effective energy bill I can imagine would not carry that title at all, but rather the designation of Comprehensive Climate Change Legislation.

Diverting the Wind
Another article in last Sunday's New York Times got me thinking about the compatibility of renewable energy in the communities that host it. The article in question described local opposition to a proposed wind power development in upstate New York, with a past and possible future gubernatorial candidate offering financial support for the fight against wind. I would have normally ended up simply labeling this as NIMBY-ism, but for some reason I started considering what it would take satisfy the concerns of all parties in a situation like this.

Unfortunately, not all areas have equivalent wind resources. Developers need to go where the wind is suitable, blowing reliably and strongly at the elevation of the turbine blades. In some respects, this is analogous to lease-level oil prospecting, in which the mineral rights to underground energy deposits are the prize. But even in the heyday of the US oil industry, not everyone sitting on an oil reservoir wanted to see a derrick in his back yard, any more than everyone living near a prime wind resource wants to see 130 foot blades whirling away 250 feet above the ground.

Perhaps the resolution lies in deconstructing the outcomes of a wind power development and thinking about how to repackage them. After all, the output of a wind turbine is essentially an electricity flow and a rate of avoided emissions. Both can be quantified for a given location. From a public perspective, the same result could be achieved in other ways, via energy conservation projects, rooftop solar panels, or conventional power plants matched up with the requisite emissions credits. And given the growing sophistication of the financial services industry at developing tools and products to manage these kind of non-financial factors, there might even be a business opportunity here, to offer to communities that can't stomach wind power.

Imagine a town that objects to a proposed wind farm. Rather than spending money on PR and lobbying, what if they could find a banker or other provider willing to create a package giving comparable power and environmental benefits at a lower cost than the wind project? It might provide the community with a meaningful basis of negotiating with the developer, rather than just presenting petitions and arguments. Turning this into a financial instrument to be bought and sold avoids having it become an easy out, i.e. allowing opponents to say they will come up with the tradeoffs some other way, but then continuing the status quo. This sort of disciplined recognition of trade-offs is notably absent from the opposition to the Cape Wind project off Nantucket.

Now, I don't want my regular readers thinking I was under the influence when I had this idea. I am still opposed to most manifestations of the NIMBY instinct. In the long run, we will need lots of wind farms and solar arrays and conservation, as well as many new conventional (or nuclear) power plants, if we are going to meet our future electricity needs. But we're a long way from having used up all the good wind prospects, and not every town should be forced to take a wind farm, if they don't want it. Even if the notion above is a bit too wacky to work, I still think that market mechanisms offer the best prospect for growing the generating base while still accommodating those who insist on not living in the shadow of a wind turbine. It at least seems a more promising avenue than turning anti-renewable-power NIMBY-ism into a political campaign strategy.

In Whose Interest?
I've already devoted more space to the CNOOC/Unocal/Chevron tussle than I intended, but I can't fail to point out an excellent article on the subject in yesterday's New York Times. In addition to including my favorite quote of the week, characterizing China as "Walmart with an army", it includes concrete proof of something I said earlier this month, concerning the adverse impact of CNOOC's offer on its outside shareholders, who make up 30% of the company's total equity. A fund manager at William Blair & Company, which recently sold its stake in CNOOC, was cited by the Times saying, "If China is going to sell shares in a company like Cnooc to outside shareholders, it should not be run for the benefit of Chinese economic policy." Yet that is precisely what seems to be occurring, and why what should otherwise be regarded as a normal commercial transaction, along the lines of BP's acquisition of ARCO in 2000, has rightly drawn so much opposition.

Frankly, at this point the only parties clamoring for Unocal's board to accept CNOOC's offer are Unocal shareholders, whose enthusiasm for a higher price may be understandable but is too narrowly-based to outweigh larger concerns of national interest and policy. Now that the underlying forces behind this situation are evident, I hope that our lawmakers will consider measures that go beyond an ad hoc response to a single deal, but rather lay out the terms under which Chinese companies would be allowed to buy US companies in any sector of strategic importance. The first principle of such an approach should be reciprocity: CNOOC should not be allowed to buy Unocal until China's laws would permit ExxonMobil to buy Sinopec, or some other large Chinese energy company. That day is probably still a long way off.

Oil and the Yuan
Beware of getting what you ask for. For months the US government has been pressuring China to revalue its currency, to help bring the huge and growing trade imbalance between the two countries under control. Now China has acted, releasing the Yuan from its dollar peg. Even though the initial change is only a 2% increase in the value of the Chinese currency relative to the dollar, the new policy apparently allows Beijing to adjust this rate each day, so over the course of a few months, we could be looking at a significant change. At least in the short run, the new policy is likely to put further pressure on oil prices and may even worsen the overall US trade deficit.

The problem is that under globalization, the financial world is tremendously interconnected and replete with feedback loops of different sensitivity and speed. The obvious goal on the part of the US is to make Chinese goods more expensive in dollar terms, reducing demand for them and reversing the trade deficit. However, this could take a long time, because as the Times article suggests, US retailers of Chinese goods may resist raising prices immediately. And as long as the Chinese government is content to hold the even larger number of dollars it will be receiving, investing them in T-bills or equities, the normal feedback mechanisms of the currency markets will not come into play.

But while we are waiting for demand for Chinese goods to slow, something else will happen almost immediately: the price of oil for Chinese companies and consumers will fall, since oil is denominated in dollars. Cheaper oil will mean faster demand growth, and at the scale we are talking about in China, a small change can result in large volumes, as we've seen in the last few years. This could be enough to forestall or overwhelm the slowing in Chinese oil demand that most analysts were expecting this year. And that means that oil prices will stay higher, longer than otherwise.

Since steeper oil prices translate into a bigger bill for our oil imports, our overall trade deficit will grow until another lagging feedback loop, US drivers' response to higher gas prices, kicks in. As a result, the net short-term result of the Chinese revaluation is likely to be contrary to what was expected. That doesn't mean that it isn't the right thing for everyone in the long run, but it certainly reinforces the idea that there are no quick fixes for our current economic problems.

Understanding Natural Gas
I just ran across an excellent article on natural gas that I think is worth sharing with my readers. Gas played a crucial role in the resolution of the 1970s energy crises, and is widely expected to play an equally important role in reducing emissions from the electricity sector. However, as the article explains clearly, the ability of domestic gas resources to fulfill that role is in serious question, as a result of persistent underinvestment in infrastructure and governmental policies towards gas drilling in undeveloped areas. Despite the relationship between increased use of renewable energy and natural gas conservation that I pointed out recently, renewables cannot be expected to substitute for natural gas and coal and nuclear (depending on one's politics.)

While covering a lot of important ground, the article misses a few key points that are worth mentioning, to complete the picture:

• Whatever one's views about "peak oil", global gas supplies are nowhere near a geological peak. In fact, gas has really been exploited heavily in only a few selected areas, such as the US and Northwest Europe. The key problems in increasing global natural gas supplies are unrelated to geology, but are rather a function of investment, logistics, markets and regulation.
• An important reason for the current plateau in domestic gas supply is the inexorable decline in oil production here. This is a natural consequence of the depletion of US oil reserves, and it reduces "associated gas"--gas produced in conjunction with oil--in lock-step.
• Remaining gas reserves in the US are huge, not only in the off-limits areas described in the article, but also in Alaska. The "gas cap"--associated gas--of the North Slope field is enormous, and gas production equal to about 10% of total US supply has been reinjected into the reservoir, at least partly for lack of a market. Together with other Alaskan and remote Canadian gas it could fill much of the anticipated supply gap, if sufficient pipeline capacity were built. This is what is at stake in the Congressional debate about a trans-Alaska gas pipeline.
• LNG cannot restore the US to an era of cheap gas, even if an unlimited number of import terminals were approved and built. Imports will play an increasingly important role in meeting demand, but current landed LNG prices, while below today's high levels, are still at least double the historic US natural gas price. The full economic consequences of permanently expensive gas have yet to manifest fully, in terms of the offshoring of gas-dependent petrochemical and other industries from the US to regions with cheaper supply.

For various reasons, natural gas has always been treated as less glamorous than oil and now operates in the shadow of cleaner, sexier alternate energy technologies. However, it provides just under a quarter of the total energy we use, on a par with coal but with less than half the greenhouse gas emissions. It would be a disaster for this contribution to slip, but that is precisely where we are headed without a major reappraisal of our national priorities. The gas provisions of the current Energy Bill are a small but positive step in that direction.

Staying Power
A couple of weeks I ago I looked at some lessons learned from the energy crises of the 1970s. These included the undesirability of direct government intervention in markets, the value of supply diversification, and the nature of the market's response to high energy prices. But one of the lessons I neglected to mention deals with the importance of planning for an unexpected future, when investing in alternative energy projects. This is nicely illustrated by a recent article from MIT's Technology Review on the history of the Dakota Gasification Company.

Dakota started as an energy crisis project to turn coal into synthetic methane. As the article explains, it was built assuming the future price of natural gas in the US would be $9 or $10 per thousand cubic feet. Although it has approached or exceeded that level recently, the company had to survive almost two decades in which it was between $1 and $3. The original buyers of the gas canceled their contracts, the investment was written off, and Dakota essentially went bust. The reason it has survived and now looks like a model for the future is not just high energy prices, but an unexpected benefit from one of the plant's byproducts, carbon dioxide, which was also starting to look like a liability in a world increasingly focused on climate change.

In a classic lemons-to-lemonade story, Dakota is now selling CO2 to a Canadian oil company that will use it to enhance oil recovery from a declining field, and in the process lock up the CO2 geologically, preventing it from entering the atmosphere for millennia or longer. This is only possible because in gasification, unlike conventional coal combustion, the inevitable CO2 exhaust is concentrated enough to be handled in this way and create side-benefits.

Without realizing it, the original investors in this 1970s coal-to-gas plant also purchased an option on future sales of carbon dioxide. And that is precisely the lesson worth remembering for anyone investing in ethanol plants, wind farms, and new generations of alternate energy: the future might not be quite as green, or the price of energy quite as high as you expect. Prepare for volatility, and think about the other options your project can create at little or no cost today, but that might be the difference between success and failure in an unpredictable future. A project that is prepared to capitalize on a wide range of outcomes is a much better investment than one that requires a specific result to be profitable. And that's a lesson that's not just limited to the energy industry.

The G-8 and Climate Change
The G-8 summit in Scotland was overshadowed by the London bombings and dominated by aid for Africa. Climate change, intended by its British hosts to be a major focus, got shorter shrift. However, this relatively upbeat report from the Economist highlights some encouraging news from the meeting. Whatever the geopolitical pressure on America, or the scorn heaped on George W. Bush, the position of the US on the Kyoto Treaty is now largely moot. It's getting very late to have much impact on US emissions in the 2008-12 timeframe included in the treaty, and the attention must begin to shift to the post-2012 world, and to what needs to be a much more ambitious and comprehensive global approach on climate change, if it is to matter.

The EU has certainly embarked on serious measures to reduce the emissions of its member states, in line with their targets under Kyoto, but even if they succeed, their efforts cannot compensate for the growth in emissions in three countries: the US, China and India. Nor can any successor to Kyoto, addressing the post-2012 period, be successful without including them. A Kyoto II agreeable only to the EU and the smaller countries is unimaginable for two reasons. It would be practically irrelevant to halting the increase in atmospheric greenhouse gas concentrations, as the EU's share of global energy usage and GDP shrinks, and it will be unacceptable to EU members, for reasons of economic competitiveness, real or perceived.

So if the recent G-8 has set the stage for new climate change talks engaging all parties on a basis that they are willing to discuss, its work in this area could be looked back on as being of greater significance than its well-intended efforts concerning Africa.

Hybrid Purpose
Few advanced energy technologies generate more interest and excitement than hybrid cars. However, not all hybrid cars save huge amounts of fuel, as explained in this article in Sunday's New York Times. Nor did the Times mention the new "mild hybrid" pickup trucks, such as the Chevy Silverado, that are barely hybrids at all and get little better mileage than their conventional twins. With the federal and various state governments offering tax credits for consumers who buy hybrid cars, should these be restricted to hybrids that deliver substantial fuel savings, or are all hybrids worthy?

In some respects, this is a problem we've created for ourselves, by targeting government support at a specific technology, rather than offering credits based on actual fuel economy--which is presumably the end goal at issue. (We will face the same problem when fuel cell cars hit the road.) But since we're in this pickle, I'd opt for generosity, for two reasons. First, hybrids are a critical tool for retarding the further deterioration of fuel economy in the US. As the Times article noted, the long-term consumer trend has diverted most of the advances in engine technology in the last 20 years and yoked them to hauling heavier and heavier cars with ever greater acceleration. So the context for the Lexus RX-400h luxury hybrid SUV is not just its conventional version, but competing SUV's such as Volvo's XC90, which has just launched its first V-8 engine to meet customer demands for more power. A peppier hybrid six-cylinder is still likely to use less fuel than a V-8 with comparable performance, and is thus a step in the right direction.

In addition, every new hybrid put on the road advances the technology and moves manufacturers down the learning curve. This will result in better and cheaper hybrids in the future. It's important to remember that hybrids are still at about 250,000 cumulative units sold, while conventional cars are well over a billion.

This is an issue that should be resolved sooner rather than later, because within a few years there will be dozens of hybrid models available, with even greater confusion about the benefits provided.

Sticking Point Over MTBE
Once again, final reconciliation of House and Senate versions of comprehensive energy legislation may hinge on whether agreement can be reached concerning protection from litigation arising from the use of the gasoline additive methyl tertiary butyl ether, or MTBE. At first glance, this provision seems to be yet another handout for big business. However, careful consideration of the history of MTBE use and the likely future path of fuels development suggests that some level of industry protection is justified and appropriate.

Widespread use of MTBE, which is soluble in water and can produce strong odors at very low concentrations, began in response to regional air quality regulations and the Federal Clean Air Act of 1990. These rules introduced “reformulated gasoline”, designed to produce the fewest pollutants from cars lacking the latest smog-reduction equipment. In urban areas with high levels of air pollution, this fuel was required to include chemical compounds containing oxygen, in order to reduce carbon monoxide emissions.

To meet this oxygen specification, oil companies had two choices, both of which were approved by the federal government and by most of the state governments involved: ethyl alcohol (ethanol) and MTBE. MTBE was less expensive, even after factoring in the tax subsidies for ethanol. More importantly, gasoline with MTBE could be shipped through efficient networks of regional petroleum product pipelines, while gasoline containing ethanol could not. The choice of MTBE helped consumers by reducing costs and shoring up the reliability and flexibility of the gasoline distribution system.

Thus the companies that used MTBE in their reformulated gasoline did so at the behest of, and with the full approval of the relevant regulatory bodies. It hardly seems fair now to saddle these companies with the entire burden of universal shortsightedness about the consequences.

Beyond this issue of fairness, turning MTBE into the next asbestos or tobacco litigation bonanza could have adverse longer-term consequences for the environment. The effort to improve the environmental qualities of automotive fuels is an ongoing process, with regulations already on the books to reduce the sulfur content of gasoline and diesel fuel. Looking farther ahead, we will not know the full consequences of using alternative fuels such as methanol or hydrogen on the same scale as gasoline, until we are actually doing so many years down the road. Exposing the motor fuels industry to a wave of product liability lawsuits at the same time we need it to invest in the next phase of gasoline reformulation or the creation and marketing of even more exotic fuels is counterproductive and shortsighted.

The main objection to MTBE tort relief comes from state and local authorities whose jurisdictions face costly cleanups of water supplies that are contaminated with MTBE, at a time when public funds are tight. They need someone to foot the bill and don't want to see the deepest pockets in sight let off the hook. In the final analysis, though, the public benefits derived from the reduction in air pollution attributable to reformulated gasoline outweigh the costs of MTBE cleanup. The air quality regulations of the 1980s and 1990s achieved many of their goals, although with a classic unintended consequence, in the form of MTBE pollution. Shouldn't the ultimate responsibility for the fallout from MTBE rest with--or at least be shared by--the governments and agencies that established the clean fuels mandates and approved MTBE for widespread use, and that can also claim the credit for the improvements it brought? On this basis, giving the energy industry relief from MTBE litigation is a reasonable proposition.

How Strategic Is Unocal's Oil?
CNOOC's bid for Unocal is slated to go before CFIUS, the Committee on Foreign Investment in the United States, where the various concerns about its national security implications will presumably be debated at length. So far, I've focused my comments on the energy and business implications of this transaction, the basis of which leaves me skeptical about CNOOC's motives. However, there's been plenty of commentary both here and elsewhere about the geopolitical aspects. An idea just occurred to me that just might help to crystallize the basic issues at stake, by putting them into quantifiable terms.

The dilemma is that, from a trade standpoint, the laws and regulations of the United States treat oil no differently than any other commodity. If anything, in the post-deregulation era since the early 1980s, the domestic oil industry has received notably less overt protection than steel, textiles, and any number of other products of lesser importance to the functioning of our national economy than oil. We have allowed our indigenous oil supply to wither, as natural depletion reduces the productive potential of resource basins that have been exploited for decades, while we place other known deposits of oil off-limits to drilling for environmental and other public policy reasons. When combined with an unrestrained appetite for increased oil consumption, the inevitable result has been to roughly double the share of imported oil in our energy mix in the last 20 years.

But even as we continue to treat this strategic commodity more or less in accordance with the principles of free-market economics, we are deeply concerned about the possible acquisition of a mid-sized US oil company--the best assets of which lie in Asia--by an Asian company, and in particular a semi-privatized Chinese state enterprise. In the absence of a comprehensive energy policy governing all kinds of investment, it certainly looks like we are talking out of both sides of our mouth.

Is there a way to quantify the national security value of Unocal's production or reserves? I can think of several, but here are two fairly simple approaches. First, look at Unocal's domestic oil production. According to Unocal's 2004 Annual Report, this amounts to 70, 000 barrels per day (bpd), ignoring natural gas that couldn't easily be exported. Let's assume that the long-term price is now $40/bbl and that it costs Unocal $20/bbl to produce this oil. Having to replace that production with imports, in the unlikely event that CNOOC chose (and was allowed) to export it, would increase the US trade deficit by $500 million per year, for a net present value of $3.7 billion at 6% interest over 10 years.

A simpler approach is to consider control as a proxy for the national security value. Comparing the two competing bids for Unocal, the CNOOC offer is higher by about $1.7 billion. This could be thought of as the premium for foreign control, over and above the fair market value established by Chevron's bid, assuming no other US company would have paid more.

Looking at the combination of these two approaches suggests that the value of keeping Unocal in US hands is somewhere between $1.7 and $3.7 billion. The best way to resolve a situation that risks igniting a trade war with one of our largest trading partners might simply be to offer Chevron tax credits or other considerations in the range of $2 billion, to enable them to outbid CNOOC without destroying value for Chevron's shareholders (including me.)

Now, you can argue that this would constitute a form of highly selective corporate welfare, or violate WTO rules, or that $2 billion could be better spent on funding alternative energy research. All of these might be true, but framing the problem this way at least concentrates our thinking about what it's worth to keep Unocal in American hands. After all, simply blocking CNOOC's bid by fiat, on shaky political grounds, seems certain to cost this country much more than $2 billion in the long run.

Voiding the Warranty
Looking forward to my 30th high school class reunion this summer reminds me of a time when my car's engine was simple enough to work on with a crescent wrench and a pair of pliers, instead of looking like a prop from the latest Star Wars movie. I have fond memories of fiddling with my first automobile, a very used '65 V-8 Mustang. I mention this by way of establishing that my heart is with the folks who want to tinker with the way their Toyota Priuses use electricity, including the addition of a plug to recharge them from the grid. This sort of urge is what made this country great. And without innovators like this, providing a little external, unfunded R&D for Detroit and Yokohama, the evolution of cars would be slower than it is. But I must admit that I'm a little offended by the idea of someone charging $10,000 to add a plug and exchange the advanced nickel metal-hydride batteries of the Prius for a bunch of low-tech lead-acid batteries, just for the privilege of driving a few miles in pure electric mode.

I'm sure Toyota isn't kidding when they say this modification would void the warranty on these cars. Given the uncertain future maintenance needs of even a totally stock hybrid car, this risk should not be taken lightly. Notwithstanding the extra cost, swapping out the batteries and power controller (hardware and/or software) seems very likely to shorten the lifespan of of this very sophisticated and hardly inexpensive car.

Nor do the potential fuel savings justify this kind of investment, since $10,000 worth of gasoline at today's prices would take a factory Prius more than 150,000 miles. While it's true that a "plug hybrid" that was driven mostly short distances could stretch its gasoline usage to a truly remarkable degree--100 miles per gallon or more--the electricity it would use instead would be neither free nor non-polluting. The degree to which this would truly benefit the environment depends on the composition of the local grid power, which in many areas is fueled by coal.

Plug capability could make lots of sense for the next generation of hybrid cars, and I would encourage all of the carmakers to pursue this technology vigorously. But modifying an existing car that is already a paragon of fuel economy, greenhouse gas emissions reductions, and practically pollution-free driving makes little sense. It's a nice concept as an engineering prototype, but bad news for environmentally-focused consumers at this point.

Solar Potential
What would it take for solar power to move out of the niches to which it's been confined and start to compete directly as a primary source of energy? Cost is one of the biggest factors, and several new technologies for solar collectors offer the prospect of significant reductions, as described in this article from the San Francisco Chronicle. But the cost of collectors is not the only obstacle solar must overcome. Like wind, solar power is an intermittent source, and this must be factored into how and where it can be used. Even with the potential for lower unit costs described in the article, solar has a ways to go to compete on a level playing field with electricity derived from fossil fuels.

It's also not clear which is the most relevant cost on which to focus. The above article compares only capacity costs (though this is never clearly stated) that relate to the expense of building and installing a power plant or solar array. These costs are measured in dollars per kilowatt (kW) of capacity. This is a poor basis for an apples-to-apples comparison, however. The market tends to look at the price of flowing electricity at various points in the distribution system, measured in cents per kilowatt-hour. Consumers ultimately pay the retail price, while generators and traders deal with various levels of wholesale pricing. Solar is hard to compare on a flow basis, since its costs are essentially all capacity-related, with a negligible ongoing cost. Its pricing on a delivered unit of electricity basis depends on many assumptions, particularly with regard to financing.

For example, a 2 kilowatt solar rooftop array for consumers would cost $2,000, based on the most optimistic figures ($1,000/kW) from the article and ignoring costs of installation, DC/AC conversion, and other factors that would increase the real-world installed cost significantly. This also ignores any tax credits that might be available. In a favorable location such as Southern California, such a system would collect on average 5.5 peak sun hours per day, generating about 3200 kW-hours over the course of the year, after wiring and inverter losses and sun-angle factors. If the cost of the solar panels is amortized over ten years at 6%, this translates to an effective cost of electricity of 8.5 cents per kW-hr.

This figure would be competitive with retail power costs in most of the country, but not with wholesale costs or the prices many large businesses pay. In other words, while a roughly five-fold cost reduction versus the current technology would position solar power nicely in the market for home power--a sizeable market to be sure--it still misses most of the business/industrial market, even ignoring the substantial added costs of turning its intermittent output into a continuous, reliable power source by adding storage (batteries or ultracapacitors) or generating hydrogen for use in fuel cells.

When fully-deployed, mass-market rooftop solar power would have a major impact on utility planning for peak generating capacity needs, without affecting baseload power demand much. Paradoxically, then, this puts rooftop solar in competition, not with coal-fired or nuclear power plants, but with gas-turbine plants that are already among the most efficient and environmentally-benign energy assets out there. In effect, cheap solar panels are really a way to reduce natural gas consumption in the electricity sector, freeing it up for other uses (or reducing future import requirements.) I wonder if this is what most solar advocates have in mind?

Energy and the War on Terrorism
In the wake of the London terrorist bombings a spate of op-eds such as this one from the Detroit Free Press are suggesting that energy independence is the key strategy for winning the war on terrorism. The author cites Tom Friedman's Geo-Green editorials and endorses hydrogen as the ultimate answer, in spite of substantial remaining uncertainties about sources, storage and delivery methods. I truly wish it were that simple. I rarely make firm predictions, but I feel safe stating that the War on Terrorism will be over before the US achieves energy independence. As daunting as it seems, dealing with Islamo-fascism and the Al Qaeda death-cult will probably turn out to be the easier of the two tasks, besides being more urgent.

In addition, recent events have undermined the suggested linkage between Middle Eastern oil and the wellspring of terrorism. Trickled-down oil money--and the degree to which it was either sanctioned or ignored by our Middle Eastern allies--may have been a vital ingredient in launching Al Qaeda, but the London bombings, like the Madrid attacks before them, are indicative of more of a "retail model" of terrorism. It draws on grassroots support from a minority of radicalized Moslems in Europe and elsewhere. You don't need oil billions to fund this kind of terrorism, and this fact makes it look somewhat naive to think that putting downward pressure on oil prices will somehow lower the "terrorism index."

Rather than chasing the the chimera of energy independence, there are a host of things we can and should pursue to make our need for imported energy more manageable within a few years, rather than decades. We need to promote energy efficiency, stimulate new energy technologies, and lower the barriers for implementing many projects that require only permits, not R&D. But switching to a hydrogen economy, along with the transformation in primary energy this would require--hydrogen is only an energy carrier, not an energy source--hardly constitutes a quick solution. It could easily take 20 to 30 years, and if the terrorists aren't all in early graves by then, we will have much bigger problems to contend with than a conventional attack on London's mass transit system or the other tactics we have seen so far.

Refueling Safely
One of the positions I held during my 20 years at Texaco involved extensive dealings with the company's Asian refining and marketing affiliates. Self-service gasoline stations were just coming into vogue in Japan, and my department arranged numerous tours for Japanese marketing executives eager to see how self-service worked here. Their biggest concern always ended up being safety: how can so many people refuel their own cars without setting them--and the stations--on fire? At the time, this argument seemed like a smokescreen for a general reluctance to change. Now here's a rare-but-real example, captured on video, of what these guys were worried about: a car in an Oregon service station bursting into flames during a routine fill-up.

The article from the Oregon newsite is undoubtedly correct in blaming static electricity for this mishap. Such incidents occur sporadically, averaging about 1 per month in the whole country, but with wide variability in the data. The data also show that most of these accidents happen in the winter months, though this is probably skewed by the heavy weighting of population in states with high summer humidity. A hot summer day in Oregon would be as good a candidate as a cold winter day in Michigan for the dry conditions needed to generate enough static charge to ignite gasoline vapors.

The good news is that such fires are exceedingly rare, literally about a one-in-a-billion chance event (once per month out of about 4 refuelings each for 236 million registered vehicles.) They are also easy to prevent. Touching the body of your car after you exit the vehicle and before you open the gas cap or handle the fuel nozzle should be sufficient to ground you and prevent any static discharge. This is a good habit to develop, year-round. And while the owner of the Ferrari in Oregon wasn't injured, I don't envy his efforts at convincing his insurance company to cover the repairs.

Mr. Fu's Letter
First and foremost, my sympathy and solidarity goes out to any readers in London, and to those with family and friends there. I rode those trains and buses for two years and can only imagine the shock and literal terror of today's events.

The potential acquisition of Unocal by CNOOC constitutes a sort of Rorschach inkblot for US feelings about China and its growing economic and political muscle. Yesterday's Wall Street Journal carried a lengthy op-ed by CNOOC's chairman, Mr. Fu. This well-written document doubtless reflects the input of CNOOC's team of American advisors, in an obvious attempt to shift public sentiment. The letter touches many of the hot buttons identified by Congress and others skeptical of the merits of this deal: US oil imports and energy security, jobs, CNOOC's track record in international partnerships, and its market orientation. It makes a compelling case. The only thing that I find notably absent is the "industrial logic" of the merger, the concrete value-added for CNOOC's shareholders (Unocal's would simply get cash.)

In laying out his arguments, Mr. Fu allays some of the obvious concerns about the disposition of Unocal's oil and gas: US production to remain here (and grow) and Asian production largely committed to other markets, such as Thailand, or managed by the host country, as in Indonesia. But if all of Unocal's production stays where it is, what does CNOOC--and China--get out of the deal? If all the employees are expected to stay, how will any cost savings be generated, no matter how short-term they might prove to be? Where are the synergies, in all senses of that word, of a deal that entails a substantial premium over Unocal's current market value? In other words, where is the new economic value for CNOOC's shareholders that would compensate them for paying an above-market price for these assets?

Now, on one level, the answer to this question is really between CNOOC, its shareholders and its banker(s). But it does raise questions about the degree to which a transaction like this can truly be all things to all people, and whether all of the promises implicit in this can be met over time. By comparison, the logic of Chevron's offer is self-evident, and I can speak to it from personal experience, as a former Texaco employee. Chevron stands to benefit by the absorption of Unocal's assets and activities into its own businesses, particularly Chevron's own longstanding but growing presence in Asia. Layoffs and operational efficiencies will generate cost savings, and it's a good bet that within two years of the transaction, half of Unocal's original workforce will be gone. Such a package contains pros and cons for Unocal's stakeholders, but it's a pretty clear picture. The CNOOC bid remains a good deal fuzzier, nor has Mr. Fu's letter clarified things.

I don't feel I need to add to the list of geopolitical concerns being raised by others. There is clearly more at stake in this transaction than a simple business merger. But I'm not sure those other issues are as central to the business proposition as this question of exactly how CNOOC expects to benefit without doing anything that someone would object to, whether rightly or wrongly. I'll be listening carefully for the answer in the weeks ahead.


FYI, in the in the interest of full disclosure I should mention that I own Chevron stock and options.

Killing the Goose, or Just Plucking It?
A recurring theme in my blog over the last year and a half has been the challenges facing energy companies in getting access to the reserves of oil and gas necessary to replace their current production and expand for the future. This article from yesterday's New York Times nicely illustrates the problem, which has grown in tandem with higher oil prices. But it also provides a few hints about the potential downside for countries looking to turn the screws a little tighter on companies that are already committed to expensive projects--and reliant on the market capitalization these booked reserves generates. Neither side should forget that oil is a long-term business, and that feasts have been known to turn into famines.

The current combination of high demand, industry consolidation and limited access to new opportunities certainly gives resource-rich host countries extra leverage in negotiating--or renegotiating--contract terms with the international energy companies. For the remaining large players, Exxon, BP, Shell, Chevron, and Total, only very large oil and gas projects are big enough to materially affect their bottom lines and reserve statistics. Only a handful of countries offer such opportunities--setting aside places like Saudi Arabia and Mexico that are essentially closed to foreign investment. At the same time, Chinese and Indian firms, with rapidly growing home country demand, are keen to sign up deals at terms that would make the majors blanch.

Right now, if you are one of these big, resource-rich countries (e.g. Russia, Venezuela, Kazakhstan, etc.) the downside of demanding all sorts of extra benefits and extracting the last dollar in taxes and royalties on your contracts must look negligible, compared to the upside. This is particularly true, if you subscribe to concerns about a potential imminent peak in global oil production and see no limits on the economic growth prospects of Asia. However, in spite of all of these arguments, there might just be a case for reasonableness and honoring previous contractual agreements.

The Economist recently cited a report by Cambridge Energy Research Associates (CERA), a bunch of very smart folks, who tallied up all known global oil projects that are already committed and concluded that oil production could grow by as much as 16 million barrels per day by 2010. This neatly answers a question I've been asking since the start of my blog, about the project-by-project buildup that gets to 100 million barrels per day of production. And although I've not seen the data, CERA is a reliable enough source that I would accept it within the context of its assumptions.

What does this mean for producers and for prices? A potential glut, or if not a glut, at least a return to a more comfortable supply/demand balance with a sizeable cushion in reserve. It would take five years of demand growth over 4% to eat up this kind of additional production, while five years of 2% growth would leave 7 million barrels to spare. Prices would fall, competition for new projects would ease, and companies would have long memories about how they had been dealt with when oil was tight.

Now, if you're Russia, with arguably some of the best conventional oil prospects left outside the Middle East, that may be little cause for concern. On the other hand, if you are Venezuela, with its state-run oil industry in tatters after the post-strike layoffs and the diversion of its cash flow to social programs, relying on investments by international companies just to maintain current production, you might want to think twice before changing the terms of existing deals. And if you are Bolivia, with a little bit of natural gas and a populace apparently dead-set on taxation that approaches expropriation, you could just end up out of the game completely, for good.

Overall, companies need to recognize that they are dealing with sovereign entities with more complex needs and new alternatives, while countries should see that companies need reliable contracts and consistent terms, along with a good share of the occasional upside that offsets the lean times that have traditionally followed. Excessive greed on either side can have disastrous results, later.

Decarbonization Model
Despite President Bush's statements about the lack of quid pro quos on climate change vs. Iraq, global warming will be an important topic at the G8 summit getting underway at Gleneagles, Scotland. Two related stories out of the UK caught my eye this weekend. The first item described the UK's provisions for importing LNG, as it becomes a net gas importer for the first time in more than a decade. The second announced the construction of a new kind of power plant in Scotland, in which natural gas will be converted to hydrogen and fed into a gas turbine, with the resulting carbon dioxide piped into an underground reservoir. Building this kind of power plant in the knowledge that Britain will have to import a growing share of its gas needs says a great deal about the country's commitment to reducing greenhouse gas emissions.

Natural gas is already one of the cleanest fuels for power generation, in terms of both traditional pollutants such as oxides of sulfur and nitrogen, as well as carbon dioxide emissions. Converting gas to hydrogen consumes about a third of its energy content, turning it into heat that will be difficult to recover and use. As a result, while the hydrogen-fired gas turbine will produce emissions-free electricity, it won't win any prizes for efficiency. That means that it will consume more natural gas to produce the same amount of electricity as a conventional gas-turbine plant. There's nothing inherently wrong with that, but it's a remarkable choice in a country that is at the end of its long run of energy self-sufficiency, as production from the North Sea oil and gas fields declines. (Norway built a similar plant a few years ago, but it remains a large gas exporter.)

The energy situations of the UK and US are clearly different on a number of fronts besides just scale. But as the leaders of the industrial West discuss these issues this week, President Bush should be aware of the degree to which Prime Minister Blair is "putting his money where his mouth is" on climate change.

Happy Independence Day

The Wrong Lessons?
Last night over dinner with friends we discussed some of the differences between the oil crises of the 1970s and our current situation. Given editorials such as this one from Wednesday's Wall Street Journal, it's apparent that the lessons from that earlier period need to be assessed and updated to account for the changes of the last several decades.

Some of the key learnings from the 1970s have held up well:

• Direct government intervention in energy markets to affect prices is counterproductive, in both the short- and long-term.
• Diversification of supply is a top priority for enhancing energy security, balanced against proximity and reliability of major suppliers.
• The price-elasticity of demand for oil products is not zero, but the response takes time, as consumers and industry readjust their practices to accommodate higher energy prices.

But, as exemplified by the WSJ editorial, much of the conventional wisdom about alternative energy needs to be revised. It is fair to say that government investments in alternative energy technology (e.g., wind and solar power) or production (e.g., shale oil) played little or no role in ending the energy problems of the 1970s. Decontrol and the free-market stimulus to new production, along with a good deal of fuel-switching to natural gas, effectively neutralized OPEC's market leverage by the mid-1980s. But that does not mean that the alternative energy provisions of the pending Energy Bill in Congress should be likened to the Synthetic Fuels Corp. and other Oil Crisis dead ends.

We find ourselves in very different circumstances from those of 1979. Alternative energy technologies that were clearly not ready for "prime time" then are today moving into the market, some with subsidies but others on their own merits. Wind power is almost competitive with gas-fired power plants, on an incremental basis, and Canada already produces 40% of its oil from oil sands deposits. While continued taxpayer investment in major new systems such as hydrogen is still necessary, other alternative energy sources would benefit more from legislation to streamline the permit approval process. This is particularly true for LNG and wind power.

At the same time, conventional oil supplies offer no silver bullets. At their peaks, the North Slope and North Sea contributed over 8 million barrels per day to non-OPEC oil production. The Caspian Sea region and the Arctic National Wildlife Refuge might provide a bit more than half that much in new production.

Finally, the Strategic Petroleum Reserve, a cornerstone of 1970s energy policy needs to be totally rethought. It still serves as an insurance policy against a catastrophic disruption in oil imports, and the Administration has been right to resist calls to release SPR oil to moderate prices. However, commercial stocks have fallen as a function of increases in SPR levels, because the present structure of the SPR creates a disincentive for holding commercial inventories of oil. Providing positive incentives to increase the latter would do more to dampen price volatility, while positioning oil precisely where it would be needed in the event of a supply shortfall.

Simply put, while the current energy market bears some similarities to the oil crises of the 1970s, dealing with it effectively requires critical reassessment of what we think we learned from our previous experience with high oil prices. Much has changed in the intervening thirty years, and we have new tools available to us.

Energy and a Nuclear Iran
The Islamic Republic of Iran has a new President, and he seems fully committed to seeing Iran's nuclear program through. This is hardly surprising, given the "bipartisan" support that nuclear power apparently enjoys in Iran, but it is still worrying. I recently wrote an analysis of Iran's nuclear ambitions for Geopolitics of Energy, a Canadian energy journal. The complete text of the article follows. Note that this is much longer than my usual postings.

APRIL 2005/GEOPOLITICS OF ENERGY
An Energy Perspective on Iran's Nuclear Program by Geoffrey Styles

Although the controversy over Iran’s alleged development of nuclear weapons has featured prominently in the news, the interplay between this issue and the global energy industry has generally been neglected. This is surprising, considering Iran’s status as the second largest oil producer and exporter within OPEC. There are two aspects of the relationship between Iran’s nuclear program and the energy industry that merit further consideration. The first deals with the positioning of nuclear power within Iran’s energy portfolio, while the second relates to the unique leverage that current oil market conditions give Iran in withstanding international pressure. Taken together, they suggest that the world could soon have to reckon with a nuclear-armed Iran.

An Odd Choice
Iran makes an unusual candidate for civilian nuclear power, compared to other countries with nuclear power. Most of these fall into either of two categories: those that lack other energy resources to support their economies, such as France, Japan and South Korea, and resource-rich countries that developed nuclear power as a consequence of their pursuit of nuclear weapons, including the US, former USSR, UK, and arguably China. Blessed as it is with hydrocarbon reserves, Iran does not fall into the former category, and it claims not to fall into the latter. Does it represent a unique case?

The dichotomy described above can be attributed at least in part to the large development costs associated with nuclear power plants, compared to their fossil fuel alternatives. For example, the capacity cost for a current-generation nuclear plant is between $1400 and $2000/kilowatt(1), while a natural gas combined cycle plant can be built for approximately $600/kW of capacity(2). That means that a 2,000 MW nuclear complex would cost between $2.8 and $4 billion, even though the same electricity could be produced by a gas turbine plant costing around $1.2 billion. In a country with limited capital for investment, this difference translates into less generating capacity being built over time.

Advocates of nuclear power would argue that fuel savings largely offset the high upfront costs of nuclear power over the life of a plant. Where natural gas is expensive, this would indeed be true. But natural gas is so plentiful in Iran that a more apt comparison would simply add the investment cost of developing another natural gas field for dedicated power plant supply to the cost of the combined cycle units.

At a conservative heat rate (3) of 7,000 BTU/kW, such a power plant would consume 336 million cubic feet per day of natural gas, requiring a gas field on the order of 3 trillion cubic feet (TCF) to supply it. If Iran’s finding and development cost for gas is under $.50 per thousand cubic feet, as seems likely, then the incremental capital component for gas supply would be below $1.5 billion, bringing the total gas-fired equivalent of a nuclear power plant to $2.7 billion, slightly below the low end of the nuclear estimate.

While this simple comparison might seem unfair, because it omits the costs of pipelines and other gas infrastructure, it also leaves out the much more substantial costs of nuclear fuel processing plants, spent fuel reprocessing plants, and waste storage facilities, all part of the complete fuel cycle Iran is building. In short, on the most favorable basis possible, nuclear power is more expensive than natural gas-based power, in a gas-rich country like Iran.

The Displacement Argument
A more sophisticated argument for nuclear power relies on using nuclear plants to support Iran’s hydrocarbon economy by freeing up oil or gas that could be exported to earn hard currency. The validity of this argument hinges on whether Iran’s oil and gas industry is running short of reserves or the ability to develop them.

Iran’s domestic energy consumption has been growing steadily. From a total energy consumption of 1.5 quadrillion BTUs (quads) in 1980, Iranian domestic energy use has expanded to almost 6 quads by 2002 (4), for an average growth rate of about 6% per year over this period. In fact, Iran now consumes over a third of its oil production of 3.9 million barrels per day (MBD), leaving only 2.5 MBD for export (5), though the consumption figure includes some petroleum products that are exported from Iran’s large refineries.

In spite of higher domestic use, Iran seems in no danger of running out of oil. From 1980 to 2003 its reported oil reserves grew from 58 billion barrels to 90 billion barrels, jumping again to 125 billion barrels in 2004 (6). This puts Iran’s reserves in the same league as Iraq’s, near the top of the list for both OPEC and the world as a whole. Iran is also attracting investment from a diverse group of countries to develop these resources. This includes Japan, which is helping develop the giant Azadegan field, and France’s Total and Italy’s ENI, each with stakes in major oil and gas projects (7).

In addition, as Iran’s energy consumption has grown, much of the incremental demand has been met by natural gas. While accounting for only 15% of energy use in 1980, gas now covers 45% of Iran’s total energy needs (8) and continues to expand, as well it should. Iran’s natural gas reserves, at 940 TCF (9), are second only to Russia’s and would last 350 years at current rates of production. These reserves have attracted China’s interest, resulting in a $100 billion commitment for future LNG sales (10).

From a purely economic perspective, Iran’s investments in nuclear power must be considered in competition with investments to develop its ample untapped oil and gas reserves. Iran’s finding and development costs for oil and gas must certainly be lower than the average of those facing the international oil companies, which operate in increasingly difficult geological and political environments. As a result, though lacking the actual figures known by the Iranian government, it is hard to imagine that the implied cost of natural gas displaced from the electricity sector by nuclear power would compete with incremental gas development.

Considering its resource base and the relative costs, Iran’s best alternatives for energy development consist of new oilfields for exports, new gas fields to fuel combined cycle power plants, and new gas fields to fill LNG export plants. In short, Iran’s assertion that it needs nuclear power to support its energy needs does not stand up to scrutiny.

Other Reasons
There are two other possible rationales for pursuing nuclear power, beyond weapons development. The first relates to reducing greenhouse gas emissions. Climate change has become an issue of global importance, and the ratification of the Kyoto Treaty by Russia in late 2004 put the treaty into effect in those countries that had previously ratified it. Unsurprisingly, Iran is not on this list (11).

In fact, much of Iran’s present and future economy remains tied to energy sources that emit large quantities of greenhouse gases, both in their production and ultimate consumption. While a growing body of environmentalists is coming to the realization that climate change may be a bigger environmental concern than nuclear power, which emits no greenhouse gases, this argument would not be very credible coming from Iran.

Another motivation that cannot be dismissed so lightly is national prestige. There is probably a large component of this in Iran’s nuclear power ambitions, going back to the time of the Shah. However, there are better and cheaper ways to raise prestige than building nuclear power plants and a complete nuclear fuel network. As The Economist recently noted, “The only real difference between a civilian nuclear-fuel cycle and a military nuclear fuel cycle is one of intent.” (12)

What If It Is A Duck?
In considering Iran’s nuclear program, it is important to learn some lessons from the recent experience with Iraq. In hindsight, Saddam Hussein’s post-UNSCOM program for weapons of mass destruction was a Potemkin village, a combination of external bluff and internal corruption. Therefore, it is vital to consider alternative explanations for “obvious” facts. A beast that waddles and quacks like a duck is not always a duck.

At this juncture, the evidence of a covert nuclear weapons program masquerading as a civilian nuclear power program is entirely circumstantial. The same evidence might support a scenario based on the logic of Iraq’s Ba’athists, that it is beneficial to have one’s neighbors believe one will soon have genuine WMD capabilities. But as Saddam learned to his chagrin, engaging in a "shell game" with inspectors from the International Atomic Energy Agency can be hazardous. Although it is understandable that the Iranians might feel threatened by US rhetoric and wish to safeguard their expensive equipment, drilling tunnels and moving centrifuge parts around the country (13) only increases international uncertainty, rather than decreasing it. This is exactly the wrong thing to do, unless there really is a clandestine weapons program that needs to be hidden.

From an energy and economic perspective, however, as discussed above, the visible parts of Iran’s ostensibly civilian nuclear program do not make a great deal of sense. Even divorced from Iran’s record in regional politics and its support for terrorism, the energy picture alone is sufficient to raise suspicions that Iran’s intent may be other than its leaders have stated. If these suspicions are indeed correct, then it is essential to understand just what leverage the US and EU might have over Iran, and vice versa, and much of this depends on the energy markets.

In negotiating with Iran, there are two main threats that could be brought to bear, in addition to an array of possible incentives. The first threat is that failure to open up the entire country to inspection will be met with military action. This is the same threat that was made with Iraq, and because that threat was executed in 2002, the ability of the US and its allies to carry out a similar campaign in a larger, more populous country has been greatly diminished.

In the Iraq War the US government apparently assumed that its combat forces would only be engaged for a relatively short time, replaced post-victory by coalition forces, regional forces, or a reformed Iraqi army. Instead, most of the combat power of the US remains committed to Iraq and to Afghanistan for years to come. Short of attacking Iran from Iraq, and thus risking the hard-won gains of the Iraq War, there appear to be few military options beyond air strikes. Their effectiveness would be reduced by the degree to which Iran has dispersed its nuclear facilities, and they might not be worth the attendant political costs.

The more credible threat would appear to be economic sanctions. However, the US has had economic sanctions in place against Iran since the 1980s, and they have been effective mostly against US companies, because their foreign competitors weren't under such constraints. Little impact on Iran is apparent. Any action to restrain Iran would have to be multilateral and strongly enforced, although the prospect of UN sanctions is complicated by the growing relationship between China and Iran, which includes energy, arms and consumer products (14).

Even if the European Union were willing to join the US in imposing sanctions and cutting off its substantial trade in oil and goods, the likelihood that such a threat could be carried out without Iran resorting to some form of oil export embargo is low, and all parties must surely understand this. Could the world do without Iran's oil and gas just now, if international sanctions were imposed? The current alignment of global oil supply and demand make such a disruption almost unthinkable. Iranian leverage over global crude oil markets is at a 25-year high.

Three years ago the global energy supply could and did lose production equal to Iran's without creating a severe price spike. When Venezuela's oil workers went out on strike, eliminating 2.3 million barrels per day of oil exports, other producers quickly filled the gap. Prices went up for a few months, and then came back down. Since then, though, the combination of rapid demand growth, persistent production problems in several countries, and a conservative approach to new oil investments has eliminated that cushion.

Incremental global crude oil production capacity is near zero, reflected by prices for West Texas Intermediate crude over $50, and Iran's leaders know this. They also remember the events of 1979, when the loss of Iranian exports as a result of the Islamic Revolution sent oil prices to levels that have not been matched since, in real dollars. Given a $50 dollar per barrel starting point, it is not so hard to imagine another Iranian embargo sending prices to $80 or even $100, at least until strategic reserves were tapped and markets rebalanced.

So far, the global economy has been remarkably resilient in the face of large demand-driven oil price increases, largely because it is much less leveraged to oil as an input for economic activity than it was thirty years ago. But at some level, the impact would become severe, particularly for developing countries, some of which still subsidize petroleum products for their population.

There is no denying that international economic sanctions and an oil embargo in response would exact a large cost on Iran. But just as high oil prices have raised the stakes of such an action for all parties, they have also enhanced Iran’s ability to weather such an economic storm for a period of time. Several years of higher-than-average oil prices have built up the country’s foreign exchange reserves and kept external debt low (15).

Nor do incentives appear to offer the solution, considering that Iran’s Foreign Minister was recently quoted as saying that no incentive can replace Iran’s legal right to use nuclear technology (16).

The largest uncertainty in this mix may be the potential internal political consequences of a confrontation with the international community over nuclear development. Would Iran’s reformers close ranks with the ruling mullahs or seize the opportunity to evict them from office? How would the population react? The answer seems inherently unknowable, as the post-invasion experience in Iraq suggests.

Learning to Live with It
With the negotiating options of the US and EU hampered by threats that either lack credibility or invite a trumping response, is there any real alternative to acquiescing and simply hoping that Iran’s leaders are serious when they say they have no interest in nuclear weapons? In the short run, perhaps not. And if Iran is in fact closer to achieving a functional nuclear weapon than anyone suspects, the short run could be the whole game.

In the longer term, however, time is not on Iran’s side. History suggests that high oil prices will lead to both greater energy efficiency and to new production capacity, either of conventional oil or unconventional alternatives, such as oil sands and renewable energy. Any combination of higher production and lower demand that restored a capacity cushion of 2-3 million barrels per day would not only ease prices, but also undermine Iran’s negotiating strength.

In addition, every positive development in Iraq, including the expansion of Iraq’s trained military and police forces, restores a bit of credibility to the military threat, by turning the US troop presence in Iraq from a liability into a strategic asset.

Considering how these balances might shift over the next several years, the best current option appears to be playing for time. The current US/EU “carrot and stick” approach can thus be successful, even if it does not result in the desired concessions from Iran. Simply remaining engaged and postponing the timing of any international crisis over Iran’s nuclear development opens up degrees of freedom that don’t exist today.

This approach may turn out to be nothing more than an updated version of the subtitle of the classic 1960s film, “Dr. Strangelove, Or How I Learned To Stop Worrying And Love the Bomb.” (17) However, all the other obvious approaches rely on either a much greater degree of certainty about Iran’s intentions than anyone currently possesses, or a larger appetite for enduring substantial economic pain than is evident in either Brussels or Washington, D.C.

Footnotes

1 “The Economics of Nuclear Power”, Uranium Information Centre, Ltd., October 2004.
2 “GridWiseTM: The Benefits of a Transformed Energy System”, Appendix A, Table A.1 “Generation Scenario Assumptions and Sources”, Pacific Northwest National Laboratory, September 2003.
3 Siemens Westinghouse website, Combined Cycle Plant Ratings.
4 Energy Information Agency, US Department of Energy, International Energy Annual 2002, Table E1 “World Total Primary Energy Consumption”.
5 Energy Information Agency, US Department of Energy, “Top Petroleum Net Exporters 2003”.
6 Energy Information Agency, US Department of Energy, “World Proved Crude Oil Reserves, January 1, 1980-January 1, 2005 Estimates”.
7 Energy Information Agency, US Department of Energy, “Country Analysis Brief, Iran”, March 2005, 5-7.
8 op. cit., Table 2.4 “World Dry Natural Gas Production, 1980-2002”.
9 Oil & Gas Journal, December 20, 2004.
10 op. cit., 20.
11 UN Framework Convention on Climate Change website, “Kyoto Protocol Status of Ratification”, 19 April 2005.
12 “A World Wide Web of Nuclear Danger,” The Economist, February 26, 2004.
13 Elaine Sciolino and David Sanger, “Pressed, Iran Admits It Discussed Acquiring Tools for Nuclear Arms”, New York Times, February 28, 2005.
14 Frederick Stakelbeck, “The Growing Tehran-Beijing Axis”, In the National Interest, January 2005.
15 International Monetary Fund, “IMF Concludes 2004 Article IV Consultation with Islamic Republic of Iran”, Public Information Notice No. 04/109, September 27, 2004.
16 “No economic incentive can replace Iran’s rights”, IranMania News, http://www.iranmania.com/, March 15, 2005.
17 Dr. Strangelove, Dir. Stanley Kubrick, Columbia, 1963.

Relying on Arabia
I just read a review in the Wall Street Journal of a new book on the reliability of Saudi oil reserves. The author, Matthew Simmons, is one of the leading skeptics about the ability of the Kingdom to increase--or even maintain--its oil production in the future. Despite new pipelines bringing new oil onto the market from the Caspian Sea region and West Africa, Saudi oil remains essential to the maintenance of an oil-based global economy, even if we intend to replace oil with some other energy source in the next twenty years. Mr. Simmons doubts the Saudis can continue to play this role, even ignoring the political frictions within Saudi society. How worried should we be?

Mr. Simmons may be right to question the condition of the half dozen key producing fields in Saudi Arabia, including Ghawar, the largest oil field in the world. However, recent Saudi presentations on their production plans look solid, at least to this (non-geologist) engineer's eyes. For me, though, the key uncertainties reside in the historical data on OPEC's reserves.

If you look at reported oil reserves in the 1980s, it's clear that something odd was going on within OPEC, particularly among its Persian Gulf members. In 1985 Kuwait increased its reported reserves by about 1/3. In 1988 Iran and Iraq doubled their reserves, while the UAE tripled theirs. And in 1990, Saudi Arabia increased its reported oil reserves from 172 billion barrels to 258 billion, about where they stand today. Now, it's not unusual for companies or countries to restate their reserves. But you don't need a suspicious mind to wonder how the state oil companies of the Middle East could have suddenly found a quantity of oil equal to the total that Saudi Arabia claims to have today, all in the span of a couple of years. And if memory serves, OPEC was embroiled in serious internal disputes over quotas in the same period, with reserves playing a role in how much each member got to produce, in a market that was suddenly flooded with oil.

For the sake of argument, then, let's postulate that this upward revision was spurious, and that Saudi Arabia hasn't found a drop of new oil since 1980--an extremely conservative assumption. Since then, Saudi production has averaged a bit over 7 million barrels per day. That means they have produced a cumulative 66 billion barrels of oil, leaving them with about 100 billion barrels of their 1980 reserves. By comparison, the US produced roughly the same quantity of oil as Saudi Arabia over this period, from reported reserves that never exceeded 30 billion barrels and that have slipped to 22 billion barrels today. In fact, only if Saudi Arabia has mis-stated its reserves going all the way back to its early 1970s, pre-nationalization figure of 137 billion barrels would we have real cause for concern about the level of aggregate reserves.

Despite the compelling arguments of Mr. Simmons and others about the reliability of Saudi reserve data, I continue to believe that we should be more focused on the factors of geopolitics and industry economics that might cause future oil production to fall short of demand.

Fighting Climate Change, One Car At A Time
When I worked at Texaco, several colleagues and I tried to sell the company on the idea of packaging emissions credits with the fuel we sold. The idea was simple: selected service stations would feature a "green pump", at which prices would be a couple of cents per gallon higher. This premium would go to planting trees and engaging in other activities that would offset the greenhouse gas emissions from the gasoline sold at these pumps. We didn't get very far, but now another colleague has sent me a link to a company that does something similar, dealing directly with consumers.

TerraPass sells an annual membership to car owners. The proceeds are invested in a variety of projects that reduce emissions through energy efficiency, renewable energy, or conversion of methane to CO2 (which reduces its global warming impact by a factor of 20.) If you aren't sure how much your car emits, and thus how much you need to offset, the TerraPass website includes a calculator that helps you figure this out. Although it didn't include my specific model and year, it included one similar enough to estimate that I was responsible for 6500 lb. of CO2 per year.

This is a terrific idea, for two important reasons. First, each of us needs to take greater responsibility for our own impact on the climate. It's all too easy to blame big companies and expect them to clean up the world, but I'm the one making the choices about when and how I drive my car. Second, unlike traditional air pollution, greenhouse gas emissions uniquely lend themselves to the kind of approach TerraPass is taking. Planting a tree in Bolivia to remove a pound of CO2 from the atmosphere is exactly equivalent to not emitting that same pound in Los Angeles. This is the principle at the heart of carbon trading, of which the TerraPass concept is a specialized, mass-market form.

I wish them well, and have just signed up for the recommended $39.95/year Efficient TerraPass.

Too Big To Ignore
After several weeks of reruns and sporadic postings due to travel, EnergyOutlook is back to its normal schedule. On my return, two stories caught my interest. The first involves the potential geopolitical ripples surrounding the belated bid by CNOOC for Unocal, exemplified by yesterday's lead editorial in the New York Times. The second is captured in a headline in the Financial Times, suggesting that high energy prices are finally starting to bite. I don't have much new to say about Unocal, having commented on this recently. The impact of high oil prices is another matter.

There's been lots of debate over whether we are in an energy crisis. While I still come down on the side of the nays--it looks to me more like a dress rehearsal for a crisis--it seems unlikely that energy prices could double and then plateau without forcing a significant realignment of the global economy. This was less obvious when the futures markets were steeply backwardated, that is, when prices for delivery a few years out were much lower, suggesting an imminent return to historical averages. But the price curve has long since flattened--with future prices close to current levels all the way out to 2011--and increasing numbers of analysts and industry executives are suggesting that current prices are here to stay, at least for the next several years.

The US economy is less leveraged to energy now than in the 1970s, particularly in terms of the energy input required for each dollar of GDP, but that doesn't mean that economics have been repealed. A sustained, long-term increase in energy prices puts energy- and transportation-intensive sectors at a disadvantage to those that use less energy. This should be even truer in rapidly growing countries where GDP additions require more energy, as, for example, in China.

This brings us to a conundrum that appears relevant to the pending Unocal transaction. If you look at the equity values of the major oil companies, including Chevron, they do not reflect $50 oil prices going out into the future. If Chevron's share price is built on a lower implied future price, how much over that price can they offer for Unocal's assets without incurring the wrath of the market? Should we be surprised that a Chinese company, reflecting policy concerns about the security of its home country's energy supply, might value Unocal's oil and gas reserves at a higher level than the US equity market--or Chevron's bid? Cutting through all the potential political maneuvering, this contest will likely boil down to a difference in views over the future value of the underlying commodity. It will be interesting to watch this game play out in the weeks ahead.

Climate Politics Signal
Because of the position of the current administration on ratification of the Kyoto Treaty, climate change has generally been viewed as a Democratic cause. But there are signs that this partisan divide may be breaking down, particularly in light of recent statements by Senator Pete Domenici (R-NM). It's worth recalling that the Rio Treaty, which laid the groundwork for Kyoto, was negotiated under the first Bush Administration. For that matter, the original Clean Air Act, along with other key environmental legislation, was enacted under another Republican administration (Nixon.) Protection of the environment must by definition be a bipartisan issue, even if the two parties disagree on how to go about it. It's high time for this administration to consider at least the kind of modest, "no regrets" approach suggested by Senator Domenici. Not only would it generate economic benefits in this country, but it should provide some necessary common ground with our friends across the Atlantic, who regard our current approach as irresponsible and downright un-neighborly.

Energy Outlook will return to its normal 5-day per week posting schedule next Monday.

11th Hour
It remains to be seen whether the China National Offshore Oil Corp. (CNOOC) will make a last-minute effort to outbid Chevron for Unocal. CNOOC has been interested in Unocal, with its heavy weighting of Asian oil and gas reserves, for months. They would have to top Chevron's $16+ billion dollar offer, and in doing so would raise a number of significant questions about the compatibility of their motives with their status as a partially privatized state enterprise. This is a deal that makes sense only to Beijing's Politburo, not to CNOOC's
shareholders, who stand to lose significant value.

The track record of national oil companies acquiring energy assets outside their home countries is poor. When you consider only the national oil companies of oil consuming countries, the picture gets even worse. Japan is a good example. In the wake of the 1970s oil crises, the Japanese government spent billions buying into oil projects around the world. All they have to show for this effort is a concession off Saudi Arabia's Neutral Zone and a few other dribs and drabs. Meanwhile, Japan has purchsed 99% of its oil needs in the open market.

Aside from any geopolitical concerns a CNOOC purchase of Unocal might raise, this investment would do little to guarantee more oil for China. If Unocal's oil makes sense for China, it will go there anyway, regardless of who owns it. That's how the global oil market works. Otherwise, it will end up elsewhere, unless CNOOC's management is willing to destroy economic value for their public shareholders by suboptimizing the value of its production. CNOOC's outside directors should focus squarely on this issue, as they consider whether to trump Chevron.

Informal Hybrid Tally
Some people count state license plates on long road trips; I count hybrid cars. On our current family trip to the Midwest, I can report that since leaving the New York Metropolitan Area, and including our travels around Minnesota’s Twin Cities, I’ve seen exactly three hybrids, two Toyota Priuses and one Honda Insight. Though hardly statistically significant, I think this still indicates the magnitude of the challenge facing us, if we want to reduce petroleum consumption.

Geo-greens such as Tom Friedman see hybrids and their variations (including plug-in hybrids) as a key technology for improving gas mileage and reducing our dependence on the Middle East. While I believe the Geo-greens are confronting the right issues, they must also recognize just how steep the hill is that they are climbing, and how long it will take. Our past energy choices are deeply embedded in our culture and physical infrastructure. There are no quick, easy fixes.

Nor can we confine our focus to vehicle fuel economy or think that shifting from petroleum to electricity will solve all our problems. As I suggested recently, our driving habits matter as much as our choice of cars--perhaps more, because it takes a generation to change the characteristics of the total car fleet enough to make a difference. We desperately need a national debate on all of this, but also we need to understand the parameters and define the boundaries correctly.

Sooner or later, we will face another real energy crisis, whether as a result of geopolitics or geology. The last eighteen months have included several features of such a crisis, without being a full-blown crisis. This should have served as a kick in the pants, but it hasn’t. There is still time, but not much, because it will take so long to effect change, unless it is imposed on us.

The Missing Natural Gas
Last Wednesday the New York Times carried a lengthy article on the need for imported liquefied natural gas (LNG) to fill the growing gap between US domestic natural gas production and steadily growing demand. While the Times painted a clear enough picture of the dilemmas posed by LNG--in terms of safety and security of supply--their analogy between the need for LNG imports and the historical growth of our oil imports fails in one important respect: we have chosen to restrict our domestic natural gas supply for reasons having little to do with energy policy.

The US natural gas situation is quite different from the greatly depleted state of our oil reserves, from which we've already pumped out 80-90% of the original oil that we can extract with current technology. In contrast, the DOE reports proved natural gas reserves of 189 trillion cubic feet, some 13% larger than they were in 1992. In fact, they are the second largest outside the Middle East.

As is usually the case for natural gas, though, the problem arises not so much from the underlying resource as from infrastructure and investment, complicated by restrictions on access. The US gas industry has been starved of investment dollars for the infrastructure needed to bring more gas to market, and of the ability to drill in places where we know there is more gas. Consider the bans on offshore oil and gas drilling imposed in areas such as California and Florida. Although targeted mainly at preventing oil spills, such as the one that blighted Santa Barbara's beaches in 1969, they make no distinction between drilling for oil and drilling for gas, which incurs little or no risk of spills. As a result, billions of cubic feet of natural gas that US consumers and industry desperately need today are not being produced. In the case of Florida alone, the resources in question appear sufficient to supply all of that state's gas needs for the next twenty-plus years.

If our demand for natural gas continues to grow--something I regard as positive, because of its lower emissions of greenhouse gases, compared to oil or coal--then sooner or later we will need to import more of our needs from outside North America. But with sensible stewardship of the domestic resource, including differentiating between the risks of offshore gas drilling and offshore oil production, that time needn't have come so soon.

The normal evolution of energy-producing devices typically involves many iterations of technology development and scaling up, until the device produces enough power to be both useful and economical. Wind turbines are a good example of this path. But an article in MIT's Technology Review describes an interesting technology that has followed a very different path, effectively waiting until the power needs of potential applications become small enough to match the modest output of the energy source. It won't be running your car--or even your cell phone--anytime soon, but it could be the key to unlocking the vision of tiny, ubiquitous radio-frequency sensors for civilian and military applications.

Beta radiation, in which radioactive substances emit electrons as they decay, was discovered over a century ago, but it has taken this long to find an application that matches the relatively low electric currents that can be produced by harnessing this kind of radiation. These "betavoltaics" are entirely different from the nuclear batteries that have been used on unmanned spacecraft for decades. Those worked by turning the heat produced by the decay of a radioactive isotope, usually Thorium, and turning it into electricity.

While betavoltaics may end up being useful only for battlefield sensor networks and their non-military analogs, you never know. Perhaps some other nifty new technology will come along that will only be possible with this kind of power source, and that we won't be able to live without. But just as millions of people today believe that cell phones and power lines cause cancer, putting anything powered by beta-decay into our homes could be a pretty tough sell.

What Might Have Been (Reprise)
Since many of the energy options available to us, including next-generation nuclear power plants, LNG import terminals, and even wind and solar power, have drawbacks that many among us find unpalatable, greater efficiency remains as an important option. However, as I pointed out in this posting from last October, the end result might not be quite what we'd expect.

Several weeks ago, the New York Times printed an article comparing US and French energy policies and energy efficiency over the last several decades. The article was subsequently picked up by the International Herald Tribune, from which this reprint was taken. While interesting in its own right, I think it also provides a fascinating glimpse of a world that might have been, had energy efficiency remained a core value of this country after the resolution of the oil crises of the 1970s.

In fact, such a world is not entirely fanciful, since many commentators have suggested that the US should have imposed high gasoline taxes in the aftermath of 9/11, in order to wean the country off imported oil and to dry up the ultimate funding source for many terrorist groups.

Using France as a proxy for a more energy-efficient USA, we can draw some interesting conclusions. For example, from 1971 to 2001, oil's share of total energy in France dropped from roughly 2/3 to just over 1/3, with nuclear power taking up most of the slack. Over the same period, oil reliance in the US dropped from about 48% to 40%. Had the US followed the French pattern, even if the energy alternatives chosen were different, we would today use about 5 million barrels per day less oil than we do, and our oil imports about would be roughly half of the current 10 million barrels per day.

The intervening 30 years would have looked very different. Among other things, the SUV trend would probably never have happened--with signficant consequences for US carmakers--and we would be driving smaller, less powerful cars. We might even be living in smaller homes, watching smaller TVs, and so on. On a larger scale, the geopolitical implications might have been dramatic, too, including a different relationship with the Middle East.

There's a catch, of course. Over the last 30 years, a side-by-side comparison of the French and US economies (using OECD data) shows that ours grew by an additional 20% of GDP, creating more jobs and greater wealth in the process. While there are complex reasons for this, setting an artifically high value on energy in France, compared with its real-world cost, in this period no doubt contributed to the difference in performance. ( Persistent high unemployment also seems to have been a key factor in the recent French "no" vote on the EU constitution.)

Hardly anyone doubts that the US could become much more energy efficient if we chose--or had to--but we should keep in mind that we would also be choosing a different economy, with different outcomes, some better and some worse.

Justice, At Last
When Unocal first appeared to be destined for a Chinese buyer, I remarked on my concern about the fate of its obscure but pivotal patents on reformulated gasoline. When Chevron announced it was buying Unocal, my concern eased, because at least these patents would be in US hands, although they seemed to present a thorny problem for a company that had campaigned and litigated against their enforcement. Now, the best possible outcome seems to have been reached, with the FTC consent decree for the acquisition including Chevron's agreement to cease enforcement of the patents for the remainder of their lives.

For many of us who have followed this issue since its inception, the granting of those patents represented both an injustice against a group of companies that had cooperated, with government approval, to try to create the most cost-effective means for achieving California's stringent gasoline quality specifications relative to reducing air pollution. Although I wasn't involved in this directly, I worked in the downstream in California at the time, and people I respected were adamant that Unocal had patented work done by and with others, then turned around and attempted to collect royalties from the same companies that had contributed to the knowledge and formulations behind the patents. In this vein, the waiving of future rights under these patents--and perhaps even Unocal's absorption (and disappearance) into a larger company--seems like just desserts.