Building the Low-Emissions Future

Last week The Economist published a detailed assessment of the state of play for capturing and storing the carbon dioxide emitted by power plants and factories. Although it skirted the assertion of many environmentalists that "clean coal" is inherently an oxymoron, the article's tone was generally skeptical concerning the cost and ultimate efficacy of the technology. Coincidentally, Greenpeace released a study featuring an ultra-low-carbon scenario created in conjunction with the European Renewable Energy Council. It proposes that by 2050 the US could shed all coal-fired power generation, as well as all nuclear power and most natural gas-fired power, along with nearly 80% of the petroleum used in transportation--all replaced by renewable electricity and biofuels. If the Economist regards carbon capture and sequestration (CCS) as "expensive and unproven", I can only imagine the terms it might use to describe the extraordinary transformation required to achieve the outcome Greenpeace envisions. The necessity of reducing greenhouse gas emissions dramatically by mid-century and the serious obstacles to replacing our entire energy economy with renewable energy sources in that time frame reinforce the importance of continuing to pursue CCS, in spite of its uncertainties.

I've been following CCS for a long time, and I've written about it many times on this blog. Without diminishing the technical challenges involved, I see them as being manageable with existing and foreseeable engineering know-how, without a scientific breakthrough. I attribute the prolonged absence of a large-scale demonstration of fully-integrated CCS on energy sources more carbon-intensive than natural gas to the mismatch between its costs and current monetary benefits. Whether the cost proves to be closer to the low or high end of the range of estimates included in the article, from roughly $40-115 per ton of captured CO2, it's hard to imagine a utility or oil company taking on the investment and operating expenses involved without the incentive of a transparent and fairly predictable price on carbon emissions. Whatever the cost of CCS might be, it can't be considered in a vacuum, and that is the biggest shortcoming of the Economist's otherwise thorough analysis.

As the US Congress prepares to embark on its latest effort to enact a greenhouse gas cap and trade bill, it's important to think about where its enormous pool of emissions savings will be found, and at what cost. CCS is only one option among many. Happily, a fair amount of work has been done in this regard, including a study by McKinsey & Co. for the Conference Board a little more than a year ago. A key chart from their report portrays a potential medium-term supply curve for emissions reductions. It indicates that while there might be a number of ways to cut CO2 at low or even negative cost--changes that would pay for themselves--achieving deeper cuts would require the contribution of costlier solutions, including CCS.

It's also worth noting that the current cost per ton of CO2 reductions from some of our current climate change strategies exceeds most estimates for CCS. In my recent posting on the application of energy storage to solar power, I calculated an effective cost of power for a couple of utility-scale solar projects in Florida at around $0.25/kWh. That's a premium of at least $0.20/kWh compared to a coal-fired power plant (without sequestration.) Based on typical emissions of 2.1 lb. of CO2 per kWh generated from coal, that implies an abatement cost of $190/ton of avoided CO2. In the likelier event that the power backed out by solar was generated from natural gas, the effective abatement cost could be even higher, because of the smaller emissions savings involved, despite the higher cost of gas-fired power compared to coal.

That comparison doesn't imply that solar power will always be a high-cost source of emissions reductions, or that CCS represents some kind of silver bullet for climate change. At the same time, coal now accounts for 23% of US primary energy consumption, 49% of our electricity generation, and nearly two-thirds of our baseload-capable generation. The difficulty of replacing baseload power with cyclical or intermittent sources makes me very skeptical of any low-emissions scenario that ignores CCS or assumes we can jettison coal entirely, not to mention forgoing nuclear power, the second-largest baseload power source in the US and by far our largest source of low-CO2 power. My specific comments on the Greenpeace scenario are posted elsewhere. At a minimum, any claims that it proves we can achieve the administration's 2050 emissions goals with only "green" energy options and efficiency gains are unwarranted. As useful as they are, scenarios can only point the way to possible futures. They can't provide firm proof of anything.

That leaves us with the hard work of cobbling together a broad set of climate solutions, in response to a price signal on emissions. In my assessment, that mix is very likely to include awkward elements such as CCS, along with deeply unglamorous things like improved farming and ranching practices. Contrary to the conclusions of the editorial accompanying the article on CCS, the technology is worth pursuing for reasons that have nothing to do with "placating the coal lobby." Nor does the cost of proving its feasibility look so high as to "deprive potentially cheaper methods of cutting emissions of cash and attention," particularly when the administration expects to carve out $120 billion for energy R&D from the proceeds of cap & trade over the next ten years. And even if it did, it's one of the few options that could be applied to reduce directly the emissions from the fossil fuels that still account for 85% of the energy we consume. That could make the difference between a manageable transition to a low-emissions world and an upheaval as bad as the current financial crisis.

Mark to Market

The practice of requiring banks and other businesses to mark their investments to market has drawn increasing criticism in the last several weeks from pundits and high-profile investors who would like to see it at least relaxed, if not rescinded. When I traded commodities in Texaco's international oil trading operation in London in the early 1990s I acquired some first-hand experience with "mark to market." Although I wasn't dealing with multi-billion dollar investments in exotic credit derivatives, the principles are sufficiently similar for me to offer some thoughts on the benefits and risks of this methodology, which appears to be feeding a vicious cycle of asset deflation in the financial sector.

The other night while watching our favorite TV cop show, "Life", my wife and I got a laugh out of the bumbled attempts of several of the characters to explain a derivative, and the confusion that greeted the accurate definition when it was finally given. I suspect the writers were reminding us how few people truly understand some of the financial instruments and regulations at the heart of the current crisis. Mark-to-market accounting likely falls into this category.

In the case of the futures market and physical oil market deals in which I was involved in London, the mark to market (MTM) provided a way to issue a daily report card on each of the trading positions we had taken on behalf of the company. This removed much of the element of surprise, if the value of something we had bought or sold changed significantly before the deal was ultimately completed. It entailed assigning a market-based price to each component of the deal at the end of every trading day, as if the product had been delivered or the position unwound that day, even though that might not actually happen for weeks. When the commodities in which we were dealing were ones for which there was an active, liquid market at all times, this accounting was relatively easy to perform. For some of the more unusual things we dealt in, for which there was no futures market and only occasional, sometimes unreliable reports of recent transactions, it generated uncertainty and anxiety.

The purpose of undertaking this effort, which consumed valuable time and was not exactly popular with the trading team, was to promote accountability and action. If the MTM on a particular trade showed a steady negative trend--particularly if it had moved from an expected profit to a loss--this triggered a discussion with management about why it was happening and what should be done. When handled well, this sometimes led to new insights about the market that we had failed to recognize. It normally resulted in a decision on whether to hang in there a bit longer, because we could justify our view that things would turn our way, or to modify or unravel the position--even at a loss--and regroup. Of course, that wasn't always possible; sometimes the cargo was on the water, bought and paid for, and there was nothing we could do but watch the red ink swell. That gets at the essence of my concern with the application of MTM to the big banks and institutions that the government has been forced to assist, for fear of "systemic risk"--the chance of the whole financial system crashing like the Blue Screen of Death on your PC.

Crucially, the reliability of mark to market depends on the ability to obtain an accurate reading of the value of what you are holding. That requires credible reporting of current transactions--preferably many of them--in something that, if not identical, at least looks enough like your asset to serve as a good proxy. If the only deals reported are distressed sales by desperate firms, you must write down your position to that level, even if you would never willingly sell it for so little. In the worst case a series of such write-downs causes a large enough deterioration in the balance sheet of the firm that it is compelled to sell some of these assets, driving their market value even lower and triggering a cascade of further sales by depressing the MTMs of other institutions.

Throughout the financial crisis, the practice of MTM has been defended as an unpleasant but necessary discipline to prevent an outcome such as was seen in Japan after its property bubble collapsed, with numerous "zombie banks" that were effectively insolvent but kept alive by the fictitious value of assets that were worth only a fraction of the level at which they were carried on the books. That argument still has some merit. However, it seems equally possible to destroy investor (and ultimately depositor) confidence in otherwise profitable, solvent institutions through the steady mechanical deflation of their illiquid assets, the potential buyers for which understand clearly that time is on their side.

Having run this experiment in its pure form until now, I'd like to see the administration test the opposite hypothesis for a few months: suspend MTM for bank capital purposes and restore the "uptick rule" on short-selling, while they're at it. We'd quickly find out whether these steps helped to stabilize the system. If they made things worse, they could quickly be reversed. It wouldn't be the first course correction we've seen during this crisis.

Storing Sunlight

An article in MIT's Technology Review on a new liquid battery technology got me rethinking an assumption I've been making for some time concerning the synergy between renewable energy and better batteries. The article's author makes a similar assumption, suggesting that with bigger, cheaper batteries, electricity from solar power might be supplied around the clock. But while this new battery, consisting of a combination of molten metals and molten salts, looks clever, I'm not sure it would make sense to use it to store solar electricity in the way the author envisions. The main impediment to the large-scale application of solar power today is not so much its cyclical nature--which storage can address--but its high cost per generated kilowatt-hour, compared to other technologies. The power likeliest to be stored for later delivery won't be the most expensive, but the cheapest.

My focus here is not on the rooftop solar panels being installed on homes. Storage isn't an issue in most such cases, unless you're in a remote location or insist on grid independence. Net metering--the ability to sell excess electricity back to the grid and buy power from it when the sun isn't shining--typically offers a much better deal for homeowners than batteries, by effectively using the grid as free storage. Since rooftop solar has the inherent advantage of competing with retail, rather than wholesale electricity prices, I'm more interested in the utility-scale solar installations springing up all over. These compete directly with the output of gas-fired simple-cycle turbines, the standard "peaking" power plant technology. Utility solar projects currently cost around $6,000 per installed kilowatt (kW) based on several recent project announcements turned up by a quick web search. Even with the 30% solar investment tax credit and a site in a sunny location, such as Florida, that results in an amortized cost of generation of roughly $0.25 per kilowatt-hour (kWh), based on a 20-year life and 6% interest rate. That might be acceptable for peak demand periods, such as hot, sunny afternoons, but it doesn't compare very well to off-peak wholesale power costs from other technologies, including wind and gas turbines, let alone coal or nuclear power.

Nor is the cost per kWh the only barrier solar power must overcome, in order to be competitive around the clock, even if the cost of storing it were negligible--which is certainly not the case today. The capital involved in amassing enough capacity to serve a given market 24/7 is much higher for utility-scale solar power than for other technologies because solar's capacity factors, reflecting the fraction of time when these facilities are available and generating peak power, often average below 20%. In the Florida example above, a solar array would receive an average amount of sunlight equivalent to 4-4.5 hours of peak sun per day. That equates to a capacity factor between 17-19%. Replacing the baseload power from a 500 MW coal-fired power plant operating at an average capacity factor of 80% would require 2,200 MW of solar power plus a commensurate amount of storage. So at $6,000/kW, a solar power plant capable of generating as many kWhs as a $1.5 B coal-fired plant would cost $13.2 B, excluding the cost of delivering power when needed, instead of when the sun happens to be shining. (It also implies a very high cost per ton for the avoided CO2 emissions.)

With current solar technology, the entire proposition of storing lots of solar power looks impractical and unnecessary. Using large-scale, cheap storage--of whatever technology, whether batteries, compressed air, or pumped water--to time-shift renewable power makes much more sense when applied to lower-cost generation from wind power, the normal output of which also has a much poorer overlap with typical daily and seasonal power demand curves than solar power. In most markets, solar power should be going after the premium associated with the afternoon demand peak. Solar needs little or no storage for that, other than to buffer the effects of cloudiness or extend its output by an hour or two on either side of its natural output peaks. That looks easiest with solar thermal technology, which stores energy as heat, rather than electricity. As a result, developers of new batteries should not pin their hopes on the growth of a market for storing solar power.

The End of the World As We Know It?

The opinion section of the Sunday New York Times made for sobering reading this weekend. While the Times has hardly been a bastion of economic optimism of late, three op-eds stood out for their shared sense that we might be on the brink of truly wrenching change. Tom Friedman invoked an enviro-economic tipping point, citing one expert's prognosis of a "Great Disruption;" a best-selling author saw the risk of "economic cataclysm" in the bursting of Eastern Europe's foreign debt bubble; and another found parallels to the Austria-Hungary of 1913, one year before the war that ended at least three empires and mortally wounded a couple of others. But while the systemic unraveling of the past six months or so makes such possibilities likelier than they would have been just a few years ago, the odds still favor a much less drastic result than revolution or apocalypse. The enormous recent increase in the range of uncertainties we face lends added credibility to the direst scenarios. However, it's important to realize that these predictions are not certainties, unless our responses make them so. That applies to energy, as well.

When I think about the possible paths of energy supply and demand over the next few years, they depend much less on specific energy or environmental trends than on the future state of the economy. Forecasting oil prices has become meaningless without a clear view of growth, particularly in the US and China. Demand may have rebounded recently in the US, but the combination of a crippling financial crisis with a deep cyclical downturn has Americans questioning the future in ways that I haven't seen in decades, other than the immediate aftermath of 9/11. The tangible effects of what noted historian Niall Ferguson has dubbed the "Great Recession" serve to reinforce the hangover of millennial angst from the turn of the century, which manifested in the more extreme views of Y2K and more recently Peak Oil. Layer in the propensity of my own Baby Boom generation to see itself at the epicenter of great events, and the stage is set for receptiveness to the view that we stand on the brink of unprecedented, permanently life-altering change.

When I was involved in my first scenario planning project at Texaco, we came up with three remarkably insightful views of the future of the energy industry, at least two of which have remained relevant far longer than any of us could have guessed. They received wide distribution throughout the company and had the general support of many in upper management. However, that project also came up with the seeds of another scenario, a much darker view involving the rejection of globalization and a growing wave of anti-Americanism around the world. Although in some respects it was no less prescient--or challenging--than the other three scenarios, it went nowhere, because the context for exploring it didn't exist in 1997. The external consultants who guided us through the process advised us not to pursue it, or risk destroying the credibility of the entire effort. That was good advice, even in retrospect, and it served as a useful lesson about the way that assessments of the future interact with our views of the present and our experience of the past. They must also be grounded in reality.

That's certainly true for energy, today. However much we might consider our energy future to be in flux, our views of it must take into account the embedded dominance of fossil fuels in our energy systems. Given the scale of these systems, that dominance will still exist next year and the following year, no matter what policies are enacted in the US or elsewhere. This might all seem to be up for grabs, but that's really only true in the long term. I've believed for a long time that we are on the threshold of a revolution in the ways that we produce and use energy, and it has arguably already begun. But no matter what happens in the economy, short of a massive global collapse, this revolution cannot be completed overnight. It will take decades, and that is equally true of our response to man-made climate change, which took a century to create.

Whenever I watch the news or read the latest statistics about the economy, I worry about what next year might look like. The uncertainties are huge and daunting. But I also know that while the chances of a Great Depression-style collapse or a radical socio-enviro-political transformation have risen, the economic future is likelier to resemble the last few decades, minus the unsustainable levels of personal and institutional debt. In the same way, the energy transformation is likely to play out as a set of big, gradual shifts: away from coal and other carbon-intensive fuels and toward renewable energy and nuclear power, and away from liquid transportation fuels and towards the eventual electrification of most ground vehicles. These transitions will take time, and that means that, whatever their price, a decade from now there will still be electricity and natural gas for the appliances and devices you buy today, and there will still be fuel for the car you buy today. That's one set of uncertainties over which we shouldn't lose sleep.

Raising A Hidden Tax

Since the administration has apparently ruled out an increase in the gasoline tax to cover declining Highway Trust Fund revenues, it's surprising that it appears to be giving serious consideration to a proposal that would raise a hidden tax on gasoline. This is even more perplexing, when you realize that this increase would actually reduce the government's net take on every gallon of gasoline sold, while simultaneously diminishing the value of the product for consumers. As reported in today's Washington Post, the US ethanol industry is petitioning the government to increase the percentage of ethanol allowable for inclusion in gasoline from 10% to 15%. At the current average gasoline pump price of $1.93 per gallon, this would effectively raise the price by 3.4 cents per gallon, while reducing federal tax revenue by 2.2 cents.

It's entirely understandable that the ethanol industry would seek such a change. Having overbuilt capacity just as demand for the fuel into which their product was blended collapsed and the easy credit that enabled their expansion tightened drastically, ethanol producers aren't in much better shape than Detroit. Several are already in bankruptcy, and others are idling capacity because of poor margins and tight cash flow. And if that weren't bad enough, the primary market for their product--"E10" gasoline, a blend containing 10% ethanol--is approaching saturation at current production levels. Nor have E85 sales grown sufficiently to relieve the pressure created by the combination of a steadily-escalating federal Renewable Fuel Standard and weak motor gasoline sales. However, even if there were no risk of higher ethanol blends damaging the engines and fuel systems of cars not designed as Flexible Fuel Vehicles, increasing the ethanol limit in gasoline would cost us all at the pump.

A gallon of ethanol contains one-third less useful energy than a gallon of petroleum gasoline. This dilution effect is already at work in the standard E10 blend, which contains 3.4% fewer BTUs than "E0". E15 would increase this gap to 5.1%. The Oak Ridge National Laboratory of the Department of Energy recently tested a representative group of cars on fuel blends containing up to 20% ethanol and confirmed a fuel economy loss proportional to the energy dilution effect. An average car driving 10,000 miles per year would require an extra 7 gallons of fuel, compared to one using E10. The extra cost at current pump prices works out to the $0.034/gal cited above. The loss of tax revenue is even more straightforward. Every gallon of ethanol blended into gasoline confers a $0.45/gal excise tax credit on the blender. Blend 10% ethanol and get $0.045 for every gallon of gasoline; blend 15% and receive $0.067.

The long-term success of the government's ethanol policy hinges on increasing the sales of E85 into Flexible Fuel Vehicles, not on foisting inferior mid-level blends of fuel on the public in the guise of "gasoline" without a price discount to reflect its poorer fuel economy, such as has evolved for E85 in most markets. If a soft-drink bottler or beer brewery were watering down its product, while charging the same price, the outcry would be deafening. Yet that's precisely what the government would be encouraging fuel marketers to do, by raising the blend limit. As consumers and taxpayers, we have more than a nickel per gallon at stake in this decision.

Altered Terms

While I've devoted my last two postings to the climate change aspects of the administration's first budget, some of its other provisions could also have a significant effect on our energy economy--perhaps more, considering their potential impact on a source that still contributes one-third of our total energy diet: domestic oil and gas production. The President's budget seeks to alter many of the financial parameters under which this energy is produced and processed, ultimately affecting the energy prices consumers pay. It's not even clear that these changes would result in a net revenue gain for the federal government, after all their offsetting consequences are tallied.

Let me start by stipulating that the proposed modifications, to the extent they don't breach contractual obligations, are the government's prerogative as the custodian of the public's interest in the resources and activities involved. That's certainly true in the case of oil and gas produced from public lands and the Outer Continental Shelf (OCS). All governments change tax rates and tax benefits periodically, as circumstances change, and businesses shouldn't be surprised or offended by this. (Altering the terms of existing contracts, or enacting punitive taxes to achieve the same result after the courts have upheld companies' legal rights, is a different matter.) What's at issue here is not the government's authority to make these changes, but the wisdom of its doing so, and the ultimate consequences for a nation that still relies on petroleum for 95% of the energy we use in transportation. When it proposes singling this industry out to bar it from taking the manufacturing tax deduction, or ending the expensing of intangible drilling costs, these issues can't just be viewed as isolated line items, without examining their broader implications. In several cases, the changes likely wouldn't even raise overall government revenues.

Consider a provision in the budget to impose a new annual fee on Gulf of Mexico leases not currently producing oil or gas. This is clearly an outgrowth of last summer's spurious "idle leases" debate, which arose from a fundamental misunderstanding of the mechanics of oil and gas leasing and the way that companies determine which prospects to drill first. In any case, the $115 million per year the government hopes to raise with this fee only reflects its direct revenue, without considering the lower bid premiums on new leases that would ensue.

With the exception of the enormously controversial late-1990s leases subject to royalty relief, companies have bid for OCS leases under rules that specify that after paying the bid premium, they must pay rental fees until a property is developed, after which they would owe a 1/6th royalty on any production. (Note that both parties to these contracts have significant incentives for the deals to yield substantial production, and both are harmed when they don't.) The new fee would increase costs for leases that turn out not to have sufficient quantities of hydrocarbons to merit commercial development--over and above the cost of learning that bad news--or that simply never rise to the top of a company's constantly-evolving project list before they expire. Since neither of these outcomes is unusual, the "non-producing lease" fee would become an important consideration in calculating how much to bid in the first place. Net result: decreases in new lease bids would offset the revenue from the new fee, and in the worst case we'd see a significant drop in overall oil & gas "bonus bid", rent and royalty revenue that contributed $23 billion to the federal budget last year. Most of the budget's other energy provisions entail similar risks.

It's not my intention to be naive, here. Other than their employees and stockholders, most people consider oil companies as at best a necessary evil. After another year in which many of these firms turned in more record profits--probably their last for a while--and with few other sectors looking as healthy, they make an inviting target for new taxes and fees. But whether the intention is merely to help stanch the red ink in the budget or to punish these companies for their success when everyone else was hurting, the outcome could be doubly counterproductive, reducing tax revenues by shrinking an activity we already tax pretty thoroughly. It's hard enough for companies to justify maintaining their drilling programs in a period of low energy prices, without making the fiscal terms under which they operate less attractive. How does that align with the administration's goals for energy independence, to which doubling the output of wind, solar and geothermal energy, from 1% to 2% of consumption, can only provide a partial answer?

Implicit Carbon Price

My posting last Friday on greenhouse gas cap & trade prompted some interesting reader comments and questions, one of which got me thinking about the price of carbon implied by the revenues included in the budget submitted to Congress. Estimating this required an examination of our recent greenhouse gas track record, along with some assumptions about how rapidly emissions would be reduced. The result appears to suggest that surprisingly modest CO2 permit prices in the initial period would be sufficient to generate the revenues shown in the budget.

President Obama campaigned on a pair of high-level greenhouse gas targets, to reduce emissions to 1990 levels by 2020, and to 80% below 1990 by 2050. That would entail a somewhat easier transition than the previous cap & trade legislation submitted to Congress, last year's Boxer-Lieberman-Warner bill, but a stricter long-term cap. Expressed in terms of tons of CO2-equivalent emissions per year, as of the most recent US greenhouse gas estimates from the Department of Energy, the President's goals would require a net reduction of slightly more than one billion tons per year (tpy) from 2007 levels by 2020, and a further 5 billion tpy in the subsequent 30 years. If emissions were flat between now and 2012, when the budget suggests reductions would begin, and the cuts proceeded in a linear fashion, cumulative emissions from 2012-2019 would be 54.1 billion tons, down from a baseline of 58.3 billion tons. Based on the $645.7 B in expected revenue from auctioning cap & trade permits over that period, the implied price per ton emitted works out to a surprisingly low $12/ton. Since this is well below the $20/ton that many experts expect to see initially, I took a look at my math and then my assumptions.

The biggest assumptions concern how much emissions might grow between 2007 and the start of cap & trade in 2012, and how rapidly they would be reduced subsequently. I initially assumed no growth to 2012, considering that emissions have increased at an average rate of 0.4% per year since 2000, spanning both the previous recession and the asset booms of the last few years. More realistically, I would expect 2008 emissions to reflect a drop from 2007, based on high energy prices in the first half and the effects of the recession in the second half, with 2009 emissions likely even lower. If we factored in a 5% cumulative drop through 2012, that would reduce the severity of cuts required to achieve 1990 levels by 2020, while also reducing the cumulative emissions over the 2012-2019 period, slightly increasing the effective cost per ton CO2e required to deliver the same revenue. Phasing in reductions more slowly would increase cumulative emissions and drive down the effective dollars per ton, perhaps to $11/ton. In other words, within reasonable bands of uncertainty about how emissions might change from 2007 levels before cap & trade started, and how rapidly the annual caps tightened toward achieving 1990 levels by 2020, the implied cost per ton of CO2 equivalent looks pretty modest in this period--the equivalent of roughly 1 cent per kWh for coal-generated electricity or 11 cents per gallon of gasoline.

Cap & trade still faces many hurdles, including the chance of a significantly different concept emerging from Congressional debate or a postponement due to the weak economy. However, at least in terms of the assumptions built into the budget, my back-of-the-envelope estimate indicates that it might not cause dramatic increases in energy prices in the first few years of the program, although the sums collected across the entire economy would still be material.

Spending Cap & Trade's Proceeds

The new administration submitted its first federal budget to Congress yesterday. It projects a cumulative deficit of $8 trillion from 2009-18, even after the inclusion of two substantial new revenue sources: It increases taxes on the top quintile of income-earners, who already account for 86% of the revenue collected by the personal income tax, and for the first time it includes revenue from the auctioning of permits for greenhouse gas emissions under a cap and trade system, the enabling legislation for which has yet to be drafted, let alone introduced. Since this is an energy blog, not a tax policy blog, I will focus on cap & trade, the full implications of which for the economy hinge on the details of its implementation and the disposition of funds it collects.

Seeing that cap & trade has become sufficiently imminent for it to be included in the federal government's income and expense budget evokes an odd feeling. I've been thinking about cap & trade for more than a decade, and I've been writing about it for at least the last five years. Yet as convinced as I am of the necessity of setting a price for carbon dioxide and other GHGs emitted to the atmosphere, and of a market as the best means of determining that price, I can't avoid the sense that the timing is off. We had all better hope that the economy will be recovering strongly by 2012, when the President's budget assumes auctioning of emissions permits will begin. Yet if that were truly certain, the significant expenditures beyond the 2009-10 period in the recently-passed economic stimulus bill would have been unnecessary. The degree of risk posed by this new tax--which it surely is, no matter how it is labeled--depends on how its revenues are recycled into the economy.

The President's budget contemplates spending $15 billion per year of the proceeds from cap & trade on energy research, development and deployment, with the lion's share going to renewable energy and the so-called smart electricity grid. (The assumption of higher taxes on oil and gas production reinforces my concern that the administration misunderstands the importance of new hydrocarbon sources in enabling the transition to a greener energy economy.) The budget proposal also indicates that much of the balance will be returned to taxpayers and to lower-income Americans who would be most affected by the energy price increases that cap & trade will cause. Congress may have other ideas, however, as evidenced by the debate over last year's Boxer-Lieberman-Warner cap & trade bill. And therein lies the problem.

In a perfect world, the sole purpose of cap & trade would be to monetize the environmental externality cost associated with GHG emissions, and then to refund 100% of the revenue to taxpayers, resulting in no net drain on the private sector. Advocates of this approach call it "cap and dividend." In the context of trillion-dollar deficits and expanded social programs, I am skeptical that consumers, who will ultimately pay the new levy on carbon in higher prices for energy and a wide variety of goods and services, will get much of it back in tax cuts or rebates. The political dynamic now in place makes that unlikely; the need to fund new programs and the urgency of reducing the budget shortfall will probably prove irresistible to the diverse coalition within the majority party, including a key swing group of deficit hawks.

If cap & trade will not be implemented as cap & dividend, but as a new source of funding for government programs, the timing of its onset looks crucial for ensuring the sustained recovery of the US economy. I understand the urgency behind enacting cap & trade. Concerns about the risks of climate change are increasing, and the administration would like to be able to demonstrate tangible US leadership at December's Copenhagen climate summit. Yet if our economy continues to shrink, we may not need cap & trade to meet the President's near-term climate goals, and if cap & trade is seen as harming the economic recovery, it would be less likely to be preserved by subsequent administrations. Better to delay the auctioning of permits for a year or two, or make it contingent on a threshold level of economic growth--with negligible incremental impact on the environment--than to wager the sustainability of tough climate policy on a premature start date.

Energy Omission

When President Obama spoke about energy in last night's address to a joint session of Congress, his focus was on renewable energy. There was no mention of last year's hot-button issue of drilling for more oil off the coast of the US, and I doubt that this struck many listeners as odd. After a 72% drop from last July's peak oil price and the onset of a global recession and financial crisis, offshore drilling must seem like yesterday's news. The world is now awash in oil for which the expected demand has receded, and many Americans are convinced that the passage of an economic stimulus package that included $77 billion for energy--mostly renewables and efficiency--has put us on a path to achieving energy independence. But while the conditions that gave rise to last summer's mantra of "Drill, Baby, Drill" have altered beyond recognition, the continued development of the nation's oil endowment turns out to be as important to our economic future as the infrastructure investments that were included in the stimulus, or the wind, solar power and biofuels that the President cited in his remarks. That's because renewable electricity doesn't displace oil; our output of biofuels is still relatively small; and before the high-mileage vehicles we've been promised are on the road in large enough numbers to matter, natural decline will have pared the output of the oil fields upon which we rely today by at least a third--more than the energy contribution of all these new programs combined.

Start with non-hydroelectric renewable power--wind, solar, geothermal, and the other means of tapping natural, perpetual energy flows. They are essential contributors to the lower-emission energy economy we must have in the future, and they enhance our energy security, but aside from supplying only a small fraction of our current energy needs, they have next to no effect on oil demand, at least in the US. Last year only 1.1% of the electricity we used was generated from oil, so there's not much left to displace from the power sector. That work was done in the 1970s and '80s by nuclear power and natural gas turbines. Instead, intermittent or cyclical renewables such as wind and solar power will largely displace natural gas, while geothermal can take the place of some baseload coal power.

Biofuels are a different story. Liquid biofuels compete directly with oil, and the Congress has committed us to using an increasing volume of them every year through at least 2022. However, even ignoring the substantial quantities of fossil energy required to produce them, their contribution is still on a small scale, compared to current US petroleum consumption. For example, last year's record output of approximately 9.2 billion gallons of ethanol, the energy equivalent of 6.1 billion gallons of gasoline, made up only 4.4% of our 2008 gasoline consumption on a BTU basis. By comparison, the nation's oil wells produced roughly 76 billion gallons last year, despite significant disruptions from Hurricane Ike. And because of its lower energy content, every gallon of ethanol blended into gasoline increases our overall fuel demand. In a recent study, the Oak Ridge Laboratory of the Department of Energy found that cars running on a blend containing 20% ethanol--a level currently under consideration for reasons I could devote an entire posting to explaining--required an average of 7.7% more fuel to travel the same distance as on a gallon of petroleum gasoline.

That brings us to improved fuel economy and vehicle electrification, which together probably constitute our best hope for reducing oil consumption by large quantities in the long run. Unfortunately, the median age of US cars has been rising for the last decade, even before the car industry suffered an 18% drop in sales last year. So while the total fleet of 235 million cars and light trucks is likely to grow more slowly than in the past, it will also turn over at a lower rate than previously. Even if the fuel economy of new cars improved by 1 mpg per year--four times the recent rate--the whole fleet might still only be about 10% more efficient than today's within eight years. Do that and double ethanol output over the same interval, and we'll still need a lot of oil to fuel our transportation sector.

Where will that oil come from? Well, few Americans want to increase our reliance on the Middle East, which holds roughly 60% of the world's oil reserves. And our safe, reliable suppliers close to home are going to be challenged just to continue to supply what they already do. Canadian output depends heavily on oil sands production, which is highly capital-intensive and does not compete well at current prices. Production in Mexico is falling off a cliff, with the sharp decline of the super-giant Cantarell field. These two countries together accounted for 33% of our net oil imports in 2007. It's not all bad news; Brazil has discovered vast new oil deposits--in deep water offshore--and plans to ramp up production in the next few years. However, the global oil industry needs to bring on between 3 and 5 million barrels per day of new production every year, just to keep pace with the inexorable depletion of existing fields. When investment slows, decline wins out, and last week the CEO of Total, the French oil super-major, indicated that this effect could cap global output at 89 million barrels per day, providing scant headroom once the global recession ends.

There's no doubt that the US oil sector is the world's most mature, having produced a cumulative 200 billion barrels since Col. Drake's first well in 1859. But that doesn't mean that there aren't significant quantities of oil left to extract, both in the large untapped deposits onshore and offshore, and in oil fields abandoned under earlier extraction methods. Even if pessimistic estimates that accessing the former would only add 200,000 bbl/day of new oil are correct--defying logic, experience, and any reasonable assessment of likely reserves-to-production ratios--the increment would still contribute as much net energy as our entire recent ethanol expansion, while creating many jobs when they're most needed. And instead of requiring subsidies, tax incentives, and federal grants to get this effort going, it could begin with a signature and ultimately contribute many billions of dollars in royalties and income tax toward paying down the crippling debt we are taking on to ease the recession.

Although offshore drilling seems unlikely to become a cause célèbre again, until oil prices spike on the other side of the recession, it has an important role to play in a balanced energy strategy for the country. Domestic oil and renewable energy aren't mutually exclusive; bridging our oil supplies will be essential for a smooth transition to the cleaner and greener energy and transportation mix we all want. Nor have low gas prices sapped the public's interest in proceeding with development. A new poll indicates that 61% of those who voted in last November's election still support more drilling. The administration should take note, and clear the way for responsible access to the billions of barrels of oil that were kept off limits for decades.

Logical Disconnect

According to a story in Saturday's Washington Post, the new Secretary of Transportation stepped out of line when he suggested that collecting the road tax based on miles traveled might be preferable to taxing sales of motor fuel. This is a complex issue, and I hope that Secretary LaHood won't let the matter drop, there. More importantly, the curt response from the White House signals a potential logical disconnect at the heart of the new administration's energy and transportation policies, which are aimed squarely at reducing oil imports and greenhouse gas emissions from the transportation sector by making cars much more efficient and shifting large numbers of them to electricity. If these measures succeed, they will surely dry up revenue for the Federal Highway Fund and leave our infrastructure in an even worse state than the "D" grade it recently received from the American Society of Civil Engineers. On the other hand, if the White House believes this funding source remains sound, they implicitly acknowledge that the vehicle efficiency and electrification transition will take a lot longer than Americans have been led to expect.

At first glance, this disconnect seems quite minor in the context of arresting a recession we are constantly told is without precedent in the post-World War II era, and of the equally daunting project of getting the country's greenhouse gas emissions and "oil addiction" under control. After all, the current federal excise tax on gasoline is only 18.4 cents per gallon, and it wouldn't take a very large increase to offset the revenue lost from annual sales declines on the order of the 3% or so the US experienced last year, which equated to about a $1 B drop in tax receipts. The problem, however, is that the energy and environmental policies on which President Obama campaigned envisioned reducing oil consumption not by a few hundred thousand barrels per day, but by millions, with most of that coming out of gasoline demand.

I don't underestimate the difficulties involved in rethinking the present system. We can't tax fuel efficiency without making it less attractive than it already is, when gasoline sells for $2 per gallon. Nor do I think consumers would be as welcoming of new "smart" electricity meters, if they thought they were opening the door to paying a tax on the power used to recharge the plug-in hybrid or electric cars they might hope someday to own. I also got a small taste of the privacy concerns entailed in taxing actual miles driven by means of GPS-based technology, in the form of some very pointed comments when I wrote favorably concerning that option several years ago. But even a purely mileage-based system might not be sufficient to avert a decline in road tax revenues, if last year's reversal of the trend in Vehicle Miles Traveled turns out to have been a true inflection point in the long-term trend.

However difficult it might ultimately be to resolve this emerging challenge, dismissing it out of hand is a mistake. Such a response risks undermining the image of an administration meant to be filled will serious people who carefully think through all the consequences of their actions. Whatever the White House thought about Secretary LaHood's comments about the road tax, it would have been far better to have acknowledged that this is something that must eventually be approached with prudence and creativity. There is still time for that, even if this issue must wait on the back burner while the nation deals with bigger, more urgent problems. If the response to low gas prices that I highlighted in last Thursday's posting persists, federal highway tax receipts might actually rise this year, though I wouldn't bank on that trend lasting long enough to negate Mr. LaHood's worries.

Demand Rebound

For a long time, it appeared as though US gasoline consumption was impervious to increasing prices. Last year we learned again that the price elasticity of gasoline demand, while low, is not zero, as the combination of $4 prices and a weakening economy triggered a change in America's driving habits, turning the vehicle miles traveled and fuel use trends negative for the first time in years. However, price elasticity works in both directions. Gas prices are now not only lower than their average for all of 2008; despite recent increases this week's average pump price of $1.96 per gallon remains cheaper than the same-month comparisons for 2006 and 2007, as well. This was bound to have an effect on demand, and the API statistics for January reflect the first year-on-year increase in monthly gasoline consumption since 2007. Even if this reversal is ultimately overwhelmed by the contraction of the economy, it provides one piece of evidence that structural demand might not have changed as much as some might like to believe. That has implications for future oil demand and prices, once the hoped-for economic recovery begins, and for what consumers should be factoring into their decisions.

Other than for gasoline, the API stats contained few surprises. Total petroleum product demand was down 3.1% from last January, on the back of big declines in diesel, heating oil, and jet fuel consumption--sure signs of the weakness of the economy. US oil production ticked up slightly, reflecting the lagged benefits of all the investment that has gone into the sector since prices started rising. Nor should the gasoline figures have startled anyone, since the Department of Energy's weekly estimates have been pointing in this direction for some time, as noted recently in the excellent R-Squared Energy Blog. Surprising or not, January's demand blip should put an end to wishful thinking about permanently altered lifestyles and consumption patterns.

What does this mean for government policy and for consumers? It points to a return to higher oil prices within a relatively short time after the economy resumes growing, and everything that goes with them, including high gas prices that will strain household budgets, just as they would be getting back into balance, and a bigger oil-import bill for the country, putting pressure on the trade deficit, the dollar, and our ability to finance the vast debt we are accumulating to combat the recession and financial crisis. Nor can we rely on big improvements in vehicle fuel economy to keep demand low. New cars built to meet higher corporate average fuel economy standards will feed into our fleet of 245 million cars and light trucks slowly, at best, particularly if Chrysler's pessimistic forecast of sales at the 10 million car/year level for the next four years proves correct.

That doesn't mean we should wait passively for the next oil price spike. If we want to keep oil imports as low as they are now, we'll need to produce more of it ourselves, because until there are millions of plug-in cars on the road, all those renewable energy projects that the stimulus bill should help advance will have no effect on our oil use. That means offshore drilling, like it or not. On a personal level, if you're buying a car, factor in the likelihood that gas won't remain at $2/gal. for more than a year or two. If you're taking advantage of the slump in housing prices to buy a home, minimize its distance from your workplace, rather than trading more miles for more square feet, as many Americans did for the last decade--and remember that every extra square foot will cost more to heat and cool in the future, too. In short, enjoy the near-term benefit of today's low prices, but act on the assumption they will go back up, again.

Energy Cornucopia

I've just spent the last several hours scanning through the conference version of the American Recovery and Reinvestment Act of 2009, a.k.a. the "stimulus bill." This is the final version of the bill that President Obama will sign into law in Denver, Colorado, later today. Anyone who was fretting that the stimulus would not place sufficient emphasis on energy should be reassured--unless they include nuclear power within their definition of energy. Among its many other features, the bill provides a cornucopia for renewable energy and efficiency. Merely summarizing all of the energy provisions of the bill would take up a week's worth of my blogging. After skimming it, however--all that could be done in the time available--I can't help wondering how much of it can actually be spent rapidly enough to have a noticeable effect on the recession in which we find ourselves.

Perhaps as a result of the urgency surrounding its passage, the Congress's stimulus bill process was hardly a model of constituent transparency. As of this writing, neither of the sites upon which I usually rely for legislative text, http://www.govtrack.us/ and the Library of Congress's http://www.thomas.gov/ site, displays the final conference version of the stimulus bill. The White House website has links to the bill at the US Government Printing Office, split up into 5 separate downloadable files. It's not clear whether Members of Congress or their staffs had machine-readable versions of the final bill prior to the House vote on Friday. As it is, I was starting to worry about repetitive strain injury of my index finger, simply clicking through a document search on "energy" in these files.

The highlights include $16.8 billion under the heading of "Energy Efficiency and Renewable Energy", with $3.2 B for energy efficiency & conservation Block Grants, $5 B for the Weatherization Assistance Program, $3.1 B for state energy programs, $2 B for grants to advanced battery manufacturers in the US, $2.5 B for applied research, development and deployment, along with another billion split among alternative fuel vehicle pilot projects, transportation electrification, and energy efficient appliance rebates and Energy Star. And this is only a fraction of the money for energy. There's $4.5 B for Electricity Delivery and Energy Reliability, $3.4 B for Fossil Energy R&D (including clean coal and carbon capture and sequestration), $6 B for loan guarantees for renewable and transmission technologies, and another $1.6 B for energy-related "science"--not further described. I also saw money for the federal government to buy energy efficient motor vehicles, for energy efficiency and renewable energy career training, and more references to "energy and green retrofits" of buildings and facilities than I could count, with significant dollars attached.

As I noted in a recent posting on wind power, the Production Tax Credit (PTC) for wind and other renewable energy was extended by three years beyond its slated expiration at the end of 2009. By itself this provision guarantees that "stimulus" spending--or in this case revenue reduction--will continue through at least 2023. As expected, developers of projects eligible for the PTC were also given two other valuable options. They can either make a one-time election to receive a 30% energy investment tax credit (ITC) in lieu of the PTC, shifting the tax benefit from future actual generation once a project is up and running to the year of construction, or they can apply to the Treasury Department for a tax-free "Section 1603" grant equivalent to either the PTC or the ITC amounts, during 2009 or 2010. There's also a new 20% tax credit for energy research. The big loser here was nuclear power, with the Conference striking $50 B in loan guarantees for new plants.

You don't have to be a big believer in the merits of a fiscal stimulus to see that if all this money hit the ground this year and next, it would certainly have a big impact on the energy industry in general, and on renewable energy, in particular, including investors in the sector. But if the above sums conjure up images of new electric power transmission lines to carry all that new renewable power to where it's needed, an article in today's Washington Post ought to impart some caution. Among other projects, it looks at the Sunrise Powerlink of the San Diego Gas & Electric Co., which was proposed in 2005 and might be finished in 2012. And the Wall Street Journal recently examined the track record of the Department of Energy, which will have authority over large portions of these appropriations, in distributing loan guarantees under a 2007 program. Setting up the approval and accountability systems to manage and monitor additional billions of dollars will be a huge undertaking in its own right, entailing the twin risks of creating impassable bottlenecks or funding scams and scoundrels.

I encourage my readers to browse the bill, if you have the time. You'll find plenty of language in there about oversight and periodic reports to Congress, and I'm sure your Congressman and Senators would be delighted to receive an email from you, emphasizing the need for them to follow through on these requirements. They might also want to think about granting fast-track permitting authority and immunity from frivolous lawsuits for any projects funded under the stimulus, to prevent this from becoming the American Recovery and Reinvestment Act of 2016, instead of 2009.

The Other Stimulus

A short item on gasoline prices in today's Wall Street Journal had me scratching my head this morning. It suggested that the recent modest recovery of gasoline prices has essentially ended the economic stimulus that cheaper gas has provided to the economy. The article's author, Mark Gongloff, has covered energy for some time. He ran the Journal's "Energy Blog", before it morphed into the current "Environmental Capital" blog, and he did it well and with insight. However, in this case, he's off by a country mile, because the stimulative effect of gas prices doesn't depend on their continuing to drop, but rather on the comparison with prices last year. Moreover, when average pump prices bottomed out at $1.61 per gallon a few weeks ago, wholesale gasoline futures were cheaper than crude oil. That wasn't sustainable, and we're now seeing the correction. The real end of the cheap gas stimulus is probably at least a year or two off, when the resumption of economic growth sends demand higher, just as global oil supplies start shrinking due to the accumulation of unchecked decline rates.

Although at this week's national average for unleaded regular of $1.93 per gallon, gasoline is up by a quarter a gallon since the first week of January, it is still a buck cheaper than this time last year--when it was just beginning a run-up that peaked at $4.11 after the Fourth of July. That translates to a current year-on-year savings of $40 per month for the average motorist--about equal to the "Making Work Pay" tax credit that most Americans will receive as part of the stimulus package. And unless gas prices spike much higher in the weeks ahead, the scale of the savings vs. the prior year should keep growing throughout the first half of 2009. We all know this can't last, but it's been a nice bridge, while we waited for Congress and the new administration to decide how to take on the recession.

The reasons why the stimulus from cheap gas won't endure are starting to pile up. Although demand has fallen faster than OPEC can cut current output, resulting in a big accumulation of oil in storage tanks and oil tankers, OPEC has announced that it would delay 35 new oil projects. We've also seen a few major oil companies and many large independents cut their capital programs--some because the projects don't make economic sense at $40 per barrel, and others simply because their cash flow is down and they can't borrow easily in today's market. At the same time, the new US Secretary of the Interior has announced a six-month delay in plans to allow drilling in previously-banned areas of the Outer Continental Shelf. All of this will have a delayed effect on production, because of the time involved in planning and executing big oil projects. We might even see output grow for another year or two, thanks to the lagged effect of projects that were initiated when oil prices were on the way up. But fairly soon reduced drilling will be unable to hold back the steady depletion of existing reservoirs, and an underlying decline rate estimated at least 4.5% per year will assert control. At a current global production rate of 85 million barrels per day (MBD), that's nearly 4 MBD per year of new oil production that must come on every year, just to maintain present capacity, and it won't happen if drilling falls off a cliff.

Meanwhile, the benefits of cheap gas should last at least long enough for the economic effects of the stimulus bill to kick in. I'll take a closer look at those, once I get the text of the version that came out of the House/Senate conference committee and should be voted on in the next few days.

Tell California No

One of the most eagerly-awaited environmental decisions of the year is currently in the hands of the new Administrator of the Environmental Protection Agency. California has requested a waiver under the Clean Air Act to regulate CO2 as a pollutant from cars, based on the Supreme Court decision in Massachusetts v. EPA that confirmed that the EPA had the authority to regulate greenhouse gases. When I examined this issue in late 2007, I expected California to prevail in its request, and I still do. That doesn't mean, however, that there are not compelling reasons why it shouldn't. I can't think of a better signal the Obama Administration could send concerning the new federal direction on climate change than telling California, "Thanks for keeping the torch burning, but we'll take it from here."

There are two good reasons to turn down California's request to regulate tailpipe emissions, which would result in a de facto standard for Corporate Average Fuel Economy (CAFE) much more aggressive than the federal standard enacted by the Energy Independence and Security Act of 2007. The first reason is unlikely to gain traction, because frankly this boat has already sailed. I mention it only because I still believe it has merit. Simply put, based on engineering principles, the Supreme Court was wrong to designate CO2 as a pollutant, and any extension of the Clean Air Act (CAA) to cover it is based on a misunderstanding of the origins of this greenhouse gas.

Although it's widely accepted that CO2 emissions are a primary cause of climate change, that doesn't make CO2 a pollutant. Too much CO2 is bad, but then so is too much water, if you are drowning or standing downstream of an approaching flood. That doesn't make water a pollutant. CO2 emissions are not the result of a fuel impurity or a byproduct of combustion in engines and boilers, like the smog-forming pollutants the CAA was designed to regulate. It is a fundamental, inescapable consequence of all combustion and many natural processes, and the vast majority of it is recycled into plants and rocks, or dissolved in the oceans. The steady accumulation of the small remaining excess in the atmosphere creates the central problem in global warming. Unfortunately, we can't eliminate CO2 from car exhaust with filters, catalytic converters, additives, or more intensive fuel refining, but only by changing the way cars use energy, and by changing the way we use cars. That goes well beyond any reasonable interpretation of the intent of the CAA, though I suspect this point is no longer of any concern to policy makers.

What ought to be of great concern to policy makers is another, more pragmatic reason to turn down California's request, and by extension that of the thirteen states that wish to opt in to the California standard. Climate change is a global problem, and the science of predicting its local consequences is still in its infancy. Managing our greenhouse gas emissions must ultimately be addressed globally. Until that happens, they need to be tackled at the largest level of aggregation available, because the consequences of climate change will affect us all, directly or indirectly, and because the industries and consumption patterns involved in reducing emissions are so fundamental to the economy. Changing them will require resources and innovation on a national scale. I know that California is larger than many countries--I used to trot this point out regularly when I lived there--but that does not alter the nature of its connection to and interdependence with the rest of the country. In particular, while California has a few bits and pieces of the US car industry, in the form of an assembly plant or two, some parts suppliers, and design centers, the primary impact of its regulation of CO2 would be felt not in the Golden State, but in states such as Michigan, Ohio, Kentucky, Alabama and North Carolina. The effect on interstate commerce and the absence of overridingly unique local impacts should put regulation of CO2 explicitly within the purview of the federal government, not the various states.

A little more than a year ago I reluctantly conceded that California's desire to regulate CO2 from cars was justified by application of the notion of "lead, follow, or get out of the way," in the absence of any immediate prospect of the federal government's taking that lead with respect to climate change. The election has drastically altered those circumstances. It is inconceivable that the Obama Administration, with strong majorities in the Congress, will fail to enact sweeping federal measures to address climate change urgently and aggressively. It looks very likely that we'll have cap & trade within the next year or two, and if tighter CAFE standards are part of the solution--though I remain skeptical of their efficacy without a strong price signal to drive consumer behavior--they should cover the whole country, not just a few states. If we want Detroit to invest in emissions-reducing technologies, then it must have a national market for them. It ought to be instructive that Europe has done precisely that with a tailpipe emissions standard for the whole EU, not member by member.

Administrator Jackson has promised an "impartial review" of California's request, complete with public hearings. Her decision should follow the public comment period that will apparently end April 6. I hope that her finding will signal the end of a long period in which states were forced to blaze the trail on climate change, but can now yield leadership back to the federal government that must speak with one voice in the negotiations toward a global climate agreement in Copenhagen, this December.

Diesel Economics

Over the weekend I was thinking more about the diesel cars I test drove at the Washington, DC Auto Show last week. They certainly performed at least as well as their non-diesel counterparts--better if you count the big boost in torque from a diesel, compared to a gasoline engine of comparable size. The economic advantages of owning one weren't quite so obvious, particularly in light of the persistent price premium for diesel fuel over gasoline. While many see diesels as a less-expensive alternative to hybrid cars, I think it's more accurate to view them as offering an entirely different value proposition that must be evaluated on its own merits.

Diesel cars provide significantly better fuel economy than their gasoline-powered peers, but as with a hybrid, this comes along with a somewhat higher purchase price. Anyone contemplating buying one must go through a similar assessment of likely economic return, including the complicating factor of tax credits. I chose to make this comparison for the VW Jetta TDI diesel that I drove, which is conveniently available in a similar non-diesel version. According to the EPA's fuel economy website, and using a standard 55% highway, 45% city driving mix, the Jetta TDI averages 35 mpg, compared to 25 mpg for the standard 2.5 liter gasoline engine version, when both are equipped with automatic transmissions. Based on these figures, and despite diesel fuel currently costing nearly 20% more than gasoline, on average, this translates to 15.6 miles per dollar for the diesel model, compared to 13.2 mp$ on gasoline. At 12,000 miles per year of driving, the TDI would save around $140/year. VW's website indicates a base price for the TDI of $22,270, or $2,175 more than the most comparable non-diesel model, the Jetta SE. While that premium is about half as big as the typical hybrid/non-hybrid premium, the simple payout is a disappointing 15 years. Factor in the $1,300 tax credit for clean diesels, and it shrinks to about six years.

So much for the basic economics. Where the discussion gets more interesting is in the uncertainties involved. Someone buying a hybrid car today would be unlikely to cite current gasoline prices as a key influence. Hybrid sales fell dramatically at the end of last year, as gas prices plummeted. However, few people expect gas prices to remain this low indefinitely. Either they will rise in tandem with a recovering economy, or they will increasingly reflect the environmental and energy security externalities of oil, in the form of a higher gas tax, a carbon tax, or the pass-through of emissions costs under cap & trade. In effect, a hybrid car is a bet on future gas prices, combined with an assessment of the value of its reduced CO2 emissions. Diesels offer a similar bet on CO2; dieselization has been the EU's main CO2 reduction strategy for transportation for the last decade, facilitated by tax incentives at the pump in many countries. They represent a somewhat different bet on fuel prices, however.

As with gasoline, the price of diesel fuel varies with the price of crude oil. Since the phase-in to Ultra-Low Sulfur Diesel (15 ppm S, max) in mid-2006, the wholesale price of diesel fuel in the US has averaged about 120% of the price of light, sweet crude oil, based on futures prices on the New York Mercantile Exchange. Pump prices for diesel over the last two years have averaged around 170% of crude oil, but with a wider variation than for wholesale prices, ranging from a low of 150% at last summer's peak of oil prices to around 220% today. As oil prices go up, diesel prices go up, too, though not quite as fast. When oil prices fall, diesel prices fall, but not as fast or as far. Buying a diesel car thus provides a partial hedge against oil prices through improved fuel economy, though the diesel buyer is making another bet that the hybrid buyer isn't: that the gap between diesel fuel and gasoline won't expand and erode the cost benefit of diesel's fuel economy edge. On average, diesel sold for 17% more than gasoline last year, on par with the current premium. It's hard to gauge the prospects for that relationship in the current economy, when demand for everything looks weak. But with Europe still shifting its passenger car fleet toward diesel, and diesel becoming the fuel of choice globally--if not yet in the US--I certainly wouldn't bet on that differential narrowing appreciably any time soon, even if some big refinery expansions on the Gulf Coast are focused on improving diesel yields.

I continue to regard clean diesels as an attractive alternative, and I wish more of them were available in the US, including from GM and Ford, which offer some very nice diesel models in Europe. If I were considering buying one, I would make sure to look beyond its fuel economy benefits, which might end up little better than a wash, to consider its other pros and cons. That includes well-to-wheels CO2 emissions that are roughly 20% lower than from a comparable gasoline-based vehicle, improved range, which translates into fewer trips to the gas station, and demonstrated durability and resale value. Depending on where you live, diesel might be a bit harder to find than gasoline, though not nearly as hard as finding E-85. Rather than seeing diesels as a direct competitor to hybrids, I think they broaden the market for highly fuel-efficient cars, by appealing to a different segment that is more focused on value and perhaps less worried about a return to $140 oil.

Wind Power Stimulus

As reported by the American Wind Energy Association, the US added 8,358 MW of new wind power capacity last year, beating the previous year's record additions by 60%. Some of that surge in capacity likely resulted from developers racing to get their projects on-line before December 31, 2008, when the Production Tax Credit (PTC) for wind was due to expire, before it was extended in October for another year. Either way, it's a remarkable effort, and it would be tough to beat, even if the problems in the financial markets weren't undermining the ability of developers to obtain loans and attract investors looking for a stake in the tax credits that wind and other renewable energy projects generate. AWEA and the industry it represents are looking to the pending federal stimulus bill for help. However, because of the way the tax credits for renewable energy are structured, assistance for the wind industry is a microcosm of the issues surrounding the entire stimulus and its speed of delivery.

The US wind power sector faces two key challenges during this recession. First, the PTC for wind power, which after adjustment for inflation is worth 2.1 cents for each kilowatt-hour of electricity generated, is again due to expire at year end. And if that weren't bad enough, it has become much harder to capture the full value of that 2.1 cents, because it is not a cash payment, but rather a non-refundable tax credit against income taxes. If a wind generation company isn't making a big enough profit, some or all of the tax credit could be left on the table. Wind developers have historically gotten around this limitation by transferring their future tax credits to investment banks and other profitable companies with big tax liabilities, in exchange for cash or a stake in the project known as "tax equity." Lehman was a big player in this market, prior to its demise, and the financial crisis and recession have dried up many other sources. That's why the industry has been asking for Congress to make the PTC "refundable"--payable even to firms without any tax liability.

The problem with this is that the PTC lasts for 10 years, once a project that qualifies for it starts up. The current stimulus package, both the House bill that passed last week and the Senate's version, as best I can tell, would confer the PTC on wind projects put into service through the end of 2012--and even longer in the case of other renewable power technologies, such as geothermal, biomass power, and tidal and incremental hydropower. While extending the PTC would certainly increase the amount of new wind capacity added in the next several years, only a small fraction of the federal funds involved would be parceled out this year and next. However, it will reduce federal tax revenue each year until 2022. Even if wind capacity only increased at its 2007 rate of 5,000 MW per year for the next four years, and the PTC was allowed to expire in 2013, this would add around $1 billion to the annual federal budget deficit for up to a decade after the recession ends. As numbing as the long strings of zeroes in the current stimulus figures might be, we will eventually be back in a world in which every billion counts. The justification for taking on such a lasting burden for wind power looks especially shaky, in light of a recent study indicating that up to two-thirds of the "green jobs" associated with new US wind projects would be created offshore.

Instead of making the PTC refundable, the current version of the stimulus bill would allow developers to make an "irrevocable election" to receive a 30% "Section 48" energy investment tax credit (ITC) in lieu of the "Section 45" PTC, for the life of the project. Although the Section 48 credits aren't refundable, either, allowing wind and other technologies to opt for the ITC front loads their tax benefits, compensating for the shrinkage of the tax equity market. They also appear to qualify for the bill's generous "carry-back" provisions. In the process, this front loads the crucial stimulus spending without affecting future federal budgets, other than by the interest payments on the larger debt. I would be even more comfortable with this solution, if the only extension offered for wind power were for projects electing the ITC conversion, with no hangover of lost tax revenue beyond the recession. After all, the purpose of assisting wind power within the stimulus is to create "green jobs" now, and to keep the industry going through a rough patch, not to contribute to the enormous post-recovery budget deficits we must expect. If the Congress wishes to extend the regular PTC, it should do so outside the stimulus and under the "pay-go" rules that would require the cost to be offset elsewhere.

Building Bridges to Greener Wheels

It's a heck of a time to hold a car show, when new figures indicate car sales last month were off 37% compared to the prior January, and with a brand new administration for which cars must surely seem to be a much bigger problem than opportunity. But then the 2009 Washington Auto Show, with its theme of "The Automotive Seat of Power", had a very different feel from most of the car shows I've attended in the past. While there was no shortage of glitzy new models and concept cars, the emphasis was squarely on making cars much more efficient and environmentally-friendly. Visiting dignitaries included the new Administrator of the Environmental Protection Agency. In remarks at a presentation on the new EcoCar competition--the follow-on from the Challenge X competition I described last year--one of her deputies emphasized three overarching imperatives for the industry: economic stability, energy security, and emissions reduction. The auto company officials I spoke with were already on board with that message.

I can't fit all my experiences and a proper assessment of the issues involved into a single posting, so instead I'll just recount the highlights of attending the media-only preview of the show, and a dinner for a small group of bloggers organized by General Motors the previous evening. I hope to expand on much of this in subsequent postings.

The GM dinner was certainly a highlight. I met the head of the Chevrolet division and had a lengthy conversation with Tony Posawatz, who leads the design team for the Chevrolet Volt plug-in hybrid, the latest prototype of which was on display at the show. I had a chance to ask all of my questions about the Volt's configuration and how it will perform once its approximately 40 mile electric-only range is exhausted. I was particularly impressed with the Chevy team's underlying philosophy on the eventual electrification of most vehicles, which would greatly diversify the sources of transportation energy, and by their understanding of the complexity of the larger energy and environmental challenges involved. Cost remains a crucial hurdle for EVs and plug-ins, with battery packs still tremendously expensive and fuel so cheap, just now. I was assured that the Volt is on-track for its launch in the latter part of 2010.

A brief conversation at the Honda display underlined that cost concern, in the context of Honda's redesigned Insight hybrid, which is aimed at reducing the price premium of hybrids over non-hybrids and making them more affordable for a mass market. The new Insight has more than a few styling similarities to the Prius--"The same equations have the same solutions", as the great physicist Richard Feynman once said--and has no non-hybrid version to compare with. Both are probably smart moves on Honda's part. I also saw the new, third-generation Prius, which will apparently get even better fuel economy than the current model. If you liked the look of the old one, you will probably find this version sleeker and more graceful. Otherwise, it's yet another jellybean.

The other big highlight for me was the opportunity to drive three different European-style diesel cars, courtesy of the folks at Bosch, which makes the components that transform today's diesel engine from the smoky, noisy, balky device that Americans normally associate with this fuel into a smooth, clean and relatively quiet powerplant. The Mercedes ML320 and VW Tuareg and the 41 mpg (highway) Jetta TDI were all fun to drive, and their advanced particulate control systems meet the air-pollution requirements of all 50 states. I was also impressed with the Jetta's "double clutch" electronic transmission, which shifts almost imperceptibly. This model, which qualifies for a $1,300 fuel economy tax credit, will certainly be on my short list when I next go car-shopping. The other treat provided by Bosch was a ride in a test car that integrates advanced safety features with radar-based adaptive cruise control. If you haven't experienced it before, it's a bit eerie watching the cruise control handle city traffic, coming to a full stop without driver intervention. We are rapidly approaching the point at which computers can drive our cars better than we can, or at least make better use of their capabilities, including achieving the car's maximum fuel economy potential.

The emphasis on fuel economy and green credentials yesterday was pervasive, if not necessarily in all the models filling the DC Convention Center's halls, then at least in the ones that the companies emphasized. I found it remarkable that Chevrolet's new Camaro was touted for the 27 mpg (highway) fuel economy of its standard V-6--an engine unlikely to have been of much interest to the car's target demographic prior to last year's fuel price roller coaster--rather than its acceleration. And the new 40 mpg Cruze non-hybrid compact, already on sale in Europe, garnered as much attention. The proximity of so many cars delivering appreciably better mileage than most of those on the road in the US today to the really high-tech cars such as the Volt, Fisker Karma, Tesla Roadster, and Mini-E kept reminding me of a phrase I heard several times from the engineers from Bosch, in the context of their diesel technology: a bridge to the future, in the form of cars built with the best of today's technology, at an affordable cost, while the engineers and early adopters drive down the cost of the next generation everyone wishes we could all have now, but can't.

Cooler Is Relative

Well, it's official; the average global temperature for 2008 was 14.44° C (57.99° F.) That's 0.13° C (0.23° F) cooler than 2007's 14.57° (58.23° F.) In fact, according to NASA's Goddard Institute for Space Studies (GISS), 2008 was the coolest year since 2000. However, it was also the 9th warmest year since at least 1880, and warmer than any year on record prior to the mid-1990s. The average temperature for the current decade is running 0.2° C warmer than the decade of the 1990s, and 0.3° C warmer than the 1980s. Being as objective as possible, I have a hard time interpreting last year's slight dip as providing much support for the notions of "global cooling" that I began noticing on the Internet a year ago. That's a pity, considering last week's sobering report from the National Oceanic and Atmospheric Administration (NOAA) on the likely duration of the effects of global warming on the climate, even after we eventually get greenhouse gas emissions under control.

As I noted in my posting on the subject last February, the global cooling hypothesis rests not just on the observed slight decline of average temperatures since the peak year of 2005--including a sharp monthly drop last January, compared to January 2007--but also on concerns about tardy sunspots and the recent decline in solar output. NASA's graph of "solar irradiance", the energy in sunlight reaching the earth's orbit, confirms that the sun's activity is at a periodic low point within the approximately 11-year sunspot cycle. It also indicates that this cyclical low is somewhat lower than recent lows, and that it seems a bit overdue for a cyclical uptick. (To put this in perspective, we are currently receiving about 0.02% less solar energy than average.) However, unless the scientists at a recent conference on solar activity were wrong in concluding that were are not headed into a sustained solar minimum of the kind associated with the Little Ice Age, then the implications of this graph and of GISS's commentary on solar irradiance look ominous in the other direction: We could be in for some sharply warmer temperatures in the next decade, a few years after sunspot cycle #24 reaches its peak, when the "non-negligible effect on global temperature" of variability in solar irradiance would reinforce, rather than partially canceling out the effects of greenhouse warming and the Southern Oscillation (El Nino/La Nina.) As a result, my money is still on warming, not cooling.

That makes the NOAA findings worrisome, even if one doesn't expect to be around to see whether their assessment that the adverse consequences of global warming could persist for as long as 1,000 years after our emissions have completely ceased proves correct. On a more personally-relevant timescale, however, it suggests that we shouldn't expect the climate to return smoothly to the previous "normal" after we stop nudging it, whenever that might be. That kind of systemic irreversibility is distinct from the idea that plant and animal species that become extinct along the way won't be retrievable; it speaks to the basic hospitableness of the earth to the levels of human population we're asking it to carry. (If you think that sounds extreme, you should read James Lovelock's recent thoughts on the subject.)

If the aim of policy makers is to create a sufficiently robust public consensus to support a cap on carbon emissions and a big investment in low-carbon energy over the span of time necessary for them to have the desired results, then their explanation of the problem must encompass the variability inherent in the interaction between greenhouse gas emissions and the complex cycles and systems that governed the climate long before the first factory began burning coal, or the first Model T was built. "Global warming" implies a steadier process than we are likely to experience. Some years will be cooler than others, as we've just seen, but the decade-by-decade trend still points higher. Our growing understanding of the consequences of that ought to make this harder to shrug off, even if we assign it a probability lower than 100%. I don't know if we'll end up burying biomass-derived charcoal as Mr. Lovelock suggests, in order to suck CO2 out of the atmosphere, but the longer we delay action, the more dramatic the options we may be forced to consider.