Every fall my natural gas utility asks if I'd like to lock in my gas price for the next 12 months. In some respects the timing for this looks ideal. Commodity natural gas prices haven't been lower than this year's average since 1999. Gas is also historically cheap relative to other fuels. Heating oil recently averaged above $4 per gallon, while the fixed price my natural gas provider is offering equates to $1.36 per gallon, including distribution charges. However, overhanging this relatively simple choice are big uncertainties related to the economy and the potential impact of regulations on shale gas production. To complicate matters further, both of these uncertainties are entangled with the outcome of the US presidential election, and my gas provider wants my answer by next Monday.
When I last looked at this question in detail, in 2010, I concluded that the utility's offer was attractive, after scrutinizing then-current gas futures prices and the historical relationship between the futures market and "city gate" prices for Virginia, where I live. Using the same methodology, this year's offer of $0.62/therm ($6.20/MMBTU) looks reasonable. Much has changed in the interim, though, in ways that undermine the rationale for locking in consumer gas prices. The biggest benefit of a fixed price is avoiding nasty surprises during winter heating season. More than four-fifths of my household's gas consumption occurs from November through March, a period when gas prices used to be alarmingly volatile.
That's less of a concern, now, with US gas inventories high and supply ample. The same shale gas revolution that has increased domestic supply and backed out imports has also reduced volatility and promoted big shifts in demand. Since 2009 residential gas demand has been essentially flat, while demand from commercial and industrial users has grown by 6.5% and consumption in power generation is up by more than 10%, despite a lackluster economy. (Gas for use in transportation grew even faster but still constitutes less than 0.2% of total gas demand.) As a result of these shifts, peak monthly average natural gas prices since the winter of 2009-10 have occurred in summer, coinciding with air conditioning demand. With less winter price volatility, the decision to lock in prices now is mainly a bet on gas prices for the next 12 months. The outcome of that bet hinges on future supply and demand.
On the supply side, will the surge of US shale gas production continue? New regulations are among the biggest potential constraints on output. The EPA has set new rules on emissions during well completion and production, with the most expensive aspect phasing in by 2015. EPA will also issue new rules on wastewater disposal from fracking by 2014. There is growing pressure on the administration to impose federal regulation of most aspects of shale development, superseding management by the states. Thus far, the White House has avoided a sweeping crackdown that would disrupt gas markets, and the EPA administrator is on record opposing comprehensive federal regulation of all wells. However, it's not obvious whether such reticence stems from a basic belief in the national importance of this resource or the simple expedient of not killing the golden goose before the election. Governor Romney has proposed streamlining regulations affecting gas production. Next Tuesday's outcome should resolve this uncertainty.
The other big uncertainty surrounding gas prices concerns demand. High shale gas output isn't the only reason gas is cheap today. Anemic GDP growth such as the 2% rate for the third quarter reported last Friday has helped keep gas prices low. A stronger economy with higher full-time employment would put upward pressure on prices by soaking up much of the surplus production that has depressed them. However, the consequences of failing to mitigate January's "fiscal cliff"--federal budget "sequestration" and the expiration of many tax cuts--would likely drive natural gas back toward the lows we saw this spring. With the economy still the number one issue for most voters, its likely future impact on gas demand is linked with our perceptions of the candidates' economic programs and promises.
My best bet is to convince my supplier to let me wait until after the election to reply. There's nothing like additional information to improve the value of a decision. Failing that, I'm inclined to pass on this opportunity. The possibility of cheaper natural gas next year acts as a modest hedge against the risk of another recession, while the benefits of a stronger economy would more than outweigh any natural gas price increases I might experience on the upside.
Wednesday, October 31, 2012
Thursday, October 25, 2012
Solyndra's Second Chapter
The details of the reorganization plan approved Monday by the judge hearing the Solyndra bankruptcy case reminded me of the admonition of one of my mentors always to beware of unintended consequences. I'm sure the Department of Energy officials who recommended the federal loan guarantee for Solyndra in March of 2009 envisioned that the solar start-up would succeed. As a worst-case outcome, they probably anticipated the loss of the entire $535 million direct federal loan ultimately provided by the Treasury. However, in a remarkable turn of events, the actual extent of the downside for taxpayers has now expanded to nearly $900 million, due to a quirk in the tax code and a subsequent DOE decision in 2011.
This odd sequence of events starts in early 2011 when two venture investors agreed to infuse another $75 million into the already failing Solyndra. In order to facilitate this injection--presumably in hopes of protecting the government's substantial investment in the firm--the DOE agreed to allow the investors' loan to take precedence over the government's if Solyndra went bankrupt. Perhaps they thought that even in that case, they'd still recover most of the government's investment, because Solyndra had a sexy technology and a big new factory in Fremont, CA that could be sold to a competitor for close to full value. They apparently didn't appreciate that Solyndra's high-cost technology had already been bypassed by falling polysilicon prices, and that the factory and its custom equipment wouldn't be of much interest to other solar producers, who were in the process of creating a huge global overhang of solar manufacturing capacity. The Solyndra plant will now apparently be sold to a hard-drive maker for just $90 million.
In the meantime, Solyndra was piling up substantial losses running its plant and selling solar modules below cost, in order to compete with conventional solar panels that had become much cheaper. By the time Solyndra entered Chapter 11 bankruptcy, its cumulative losses apparently totaled $975 million. To put that in perspective, the combined after tax profits of First Solar, the largest US solar producer, for the three years in which the DOE's loan to Solyndra was outstanding, were $1,265 million.
What makes Solyndra's losses relevant is that, contrary to intuition, they didn't disappear in bankruptcy. Instead, via the investors' plan for emerging from bankruptcy, they became an asset. And because the DOE ceded the first place in line to private investors, it is those investors who will control those "net operating losses" retained by Solyndra's reorganized parent company, 360 Degree Solar Holdings, Inc. That company apparently kept none of Solyndra's hardware, but when it acquires other companies--in any line of business--it will be able to offset future federal tax liabilities estimated by Bloomberg at $341 million. Meanwhile, the federal government is likely to recover just 5 cents on the dollar on its "secured loan." The Solyndra loan is a gift that keeps on giving.
Hindsight is 20/20, but it seems pretty clear that the folks at DOE were outsmarted by private investors who had a much clearer picture of the stakes for which they were negotiating. As we were reminded last week, Solyndra wasn't the only investment they made that went bad. Let's hope that the others don't include similarly unpleasant surprises. Meanwhile, I wish the IRS and Alameda County the best of luck in appealing the bankruptcy judge's ruling.
This odd sequence of events starts in early 2011 when two venture investors agreed to infuse another $75 million into the already failing Solyndra. In order to facilitate this injection--presumably in hopes of protecting the government's substantial investment in the firm--the DOE agreed to allow the investors' loan to take precedence over the government's if Solyndra went bankrupt. Perhaps they thought that even in that case, they'd still recover most of the government's investment, because Solyndra had a sexy technology and a big new factory in Fremont, CA that could be sold to a competitor for close to full value. They apparently didn't appreciate that Solyndra's high-cost technology had already been bypassed by falling polysilicon prices, and that the factory and its custom equipment wouldn't be of much interest to other solar producers, who were in the process of creating a huge global overhang of solar manufacturing capacity. The Solyndra plant will now apparently be sold to a hard-drive maker for just $90 million.
In the meantime, Solyndra was piling up substantial losses running its plant and selling solar modules below cost, in order to compete with conventional solar panels that had become much cheaper. By the time Solyndra entered Chapter 11 bankruptcy, its cumulative losses apparently totaled $975 million. To put that in perspective, the combined after tax profits of First Solar, the largest US solar producer, for the three years in which the DOE's loan to Solyndra was outstanding, were $1,265 million.
What makes Solyndra's losses relevant is that, contrary to intuition, they didn't disappear in bankruptcy. Instead, via the investors' plan for emerging from bankruptcy, they became an asset. And because the DOE ceded the first place in line to private investors, it is those investors who will control those "net operating losses" retained by Solyndra's reorganized parent company, 360 Degree Solar Holdings, Inc. That company apparently kept none of Solyndra's hardware, but when it acquires other companies--in any line of business--it will be able to offset future federal tax liabilities estimated by Bloomberg at $341 million. Meanwhile, the federal government is likely to recover just 5 cents on the dollar on its "secured loan." The Solyndra loan is a gift that keeps on giving.
Hindsight is 20/20, but it seems pretty clear that the folks at DOE were outsmarted by private investors who had a much clearer picture of the stakes for which they were negotiating. As we were reminded last week, Solyndra wasn't the only investment they made that went bad. Let's hope that the others don't include similarly unpleasant surprises. Meanwhile, I wish the IRS and Alameda County the best of luck in appealing the bankruptcy judge's ruling.
Wednesday, October 17, 2012
A123 Bankruptcy Casts Doubts on EV Goals
The theory was that the federal government could guide an entire US electric vehicle (EV) industry into existence by orchestrating a constellation of grants, loans and loan guarantees to manufacturers and infrastructure developers, along with generous tax credits for purchasers. That vision was attractive, because EVs have the potential to be an important element of a long-term strategy to counter climate change and bolster energy security. However, yesterday's bankruptcy of battery-maker A123 Systems, Inc. provides a costly reality check. Along with the earlier bankruptcy of another advanced battery firm, Ener1, and disappointing battery-EV sales, it raises new doubts concerning both the government's model of industrial development and the achievability of President Obama's goal of putting one million EVs on the road by 2015.
A123 was built around a novel lithium-ion battery technology developed at MIT. For a time they were the darling of the advanced battery sector, with a market capitalization above $2 billion following its 2009 initial public offering. That IPO came on the heels of A123's receipt of a $249 million stimulus grant from the Department of Energy and $100 million of refundable tax credits from the state of Michigan. Subsequently, though, they experienced low sales and a costly battery recall that contributed to their signing a memorandum of understanding with China's Wanxiang Group to sell an 80% interest in the company for around $450 million. Instead, it now appears that Johnson Controls, a diversified company that was the recipient of a $299 million DOE advanced battery grant of its own, will end up acquiring A123's assets for around $125 million. Johnson is apparently providing "debtor-in-possession" financing for A123's Chapter 11 process. It's not clear whether Johnson would be able to draw down the unused portion of A123's federal grant.
Because of the government's close involvement with A123, and in particular its structuring of aid to A123 in a manner that left taxpayers without any call on the firm's assets ahead of suitors like Johnson Controls or Wanxiang, this event is inherently political. I was a little surprised it didn't come up in last night's presidential debate. If it does become a "talking point" in the next two weeks, however, I'd prefer to see the conversation focus on the real issues it raises. The reasons for A123's failure appear very different from those behind the much-discussed failure of loan-guarantee recipient Solyndra. While the latter ultimately called into question the judgment of officials who loaned money to Solyndra when that company's business model was already doomed, A123 highlights the much deeper challenges involved in attempting to conjure an entire industry out of thin air.
The earlier failure of GM's electric vehicle effort in the 1990s, the EV-1, demonstrated the chicken-and-egg nature of EV sales: Vehicle sales depended on recharging infrastructure that in turn depended on robust vehicle sales to justify infrastructure investment. But at least GM could begin then by relying on a mature lead-acid battery industry. Those batteries turned out to be inadequate to meet consumers' expectations of range and recharging convenience, which led to the creation of another chicken-and-egg dependence for the new EV industry: carmakers needed a reliable supply of advanced batteries from producers who couldn't invest in the capacity to make them, without knowing that vehicle sales would consume enough batteries to turn a profit. So in 2009 the administration set out to short-circuit all those inter-dependencies by simultaneously funding the key elements of these loops, including advanced battery makers. It makes me wonder if anyone involved had any direct manufacturing experience--a natural doubt considering that the entire US auto industry was restructured in 2009 by a task force without a single member who had worked in any manufacturing business, let alone the auto industry.
The main causes of A123's failure appear to have involved basic manufacturing issues of capacity utilization and quality control. The company wasn't selling enough batteries to cover its costs, and too many of the batteries it sold came back in an expensive recall. They weren't the first business to experience such growing pains, but their challenges were compounded by the burden of a manufacturing line that had been sized to meet the demand of an EV market that hasn't yet materialized. US EV sales through September amounted to just 31,000 vehicles, or less than 0.3% of total US car sales. The picture looks even worse if you subtract out sales of GM's Volt and Toyota's plug-in version of its Prius, the gasoline engines of which provide essentially unlimited range, circumventing the limitations of today's batteries. I think there's a strong argument that the government's assistance to A123 was actually a key factor in leading them to bankruptcy, by prompting A123 to grow much faster than could have been justified to its bankers or private investors.
Perhaps it's some consolation that A123's technology has apparently been snapped up by a competitor, rather than going the way of Solyndra's odd solar modules. Yet that outcome hardly justifies the casual dismissal of A123's fate by a DOE spokesman as a common occurrence in an emerging industry. That sort of talk merely perpetuates the perception of cluelessness fostered by Energy Secretary Chu's failure to hold anyone accountable for the Solyndra debacle. Yes, companies in emerging industries fall by the wayside, but the preferred response would be to examine what happened and apply the lessons learned to the rest of the "venture capital portfolio" with which the administration's industrial policy has saddled the DOE. With EV sales still low and several key EV makers experiencing delays and production problems, a thorough public review of the entire EV strategy is in order.
A123 was built around a novel lithium-ion battery technology developed at MIT. For a time they were the darling of the advanced battery sector, with a market capitalization above $2 billion following its 2009 initial public offering. That IPO came on the heels of A123's receipt of a $249 million stimulus grant from the Department of Energy and $100 million of refundable tax credits from the state of Michigan. Subsequently, though, they experienced low sales and a costly battery recall that contributed to their signing a memorandum of understanding with China's Wanxiang Group to sell an 80% interest in the company for around $450 million. Instead, it now appears that Johnson Controls, a diversified company that was the recipient of a $299 million DOE advanced battery grant of its own, will end up acquiring A123's assets for around $125 million. Johnson is apparently providing "debtor-in-possession" financing for A123's Chapter 11 process. It's not clear whether Johnson would be able to draw down the unused portion of A123's federal grant.
Because of the government's close involvement with A123, and in particular its structuring of aid to A123 in a manner that left taxpayers without any call on the firm's assets ahead of suitors like Johnson Controls or Wanxiang, this event is inherently political. I was a little surprised it didn't come up in last night's presidential debate. If it does become a "talking point" in the next two weeks, however, I'd prefer to see the conversation focus on the real issues it raises. The reasons for A123's failure appear very different from those behind the much-discussed failure of loan-guarantee recipient Solyndra. While the latter ultimately called into question the judgment of officials who loaned money to Solyndra when that company's business model was already doomed, A123 highlights the much deeper challenges involved in attempting to conjure an entire industry out of thin air.
The earlier failure of GM's electric vehicle effort in the 1990s, the EV-1, demonstrated the chicken-and-egg nature of EV sales: Vehicle sales depended on recharging infrastructure that in turn depended on robust vehicle sales to justify infrastructure investment. But at least GM could begin then by relying on a mature lead-acid battery industry. Those batteries turned out to be inadequate to meet consumers' expectations of range and recharging convenience, which led to the creation of another chicken-and-egg dependence for the new EV industry: carmakers needed a reliable supply of advanced batteries from producers who couldn't invest in the capacity to make them, without knowing that vehicle sales would consume enough batteries to turn a profit. So in 2009 the administration set out to short-circuit all those inter-dependencies by simultaneously funding the key elements of these loops, including advanced battery makers. It makes me wonder if anyone involved had any direct manufacturing experience--a natural doubt considering that the entire US auto industry was restructured in 2009 by a task force without a single member who had worked in any manufacturing business, let alone the auto industry.
The main causes of A123's failure appear to have involved basic manufacturing issues of capacity utilization and quality control. The company wasn't selling enough batteries to cover its costs, and too many of the batteries it sold came back in an expensive recall. They weren't the first business to experience such growing pains, but their challenges were compounded by the burden of a manufacturing line that had been sized to meet the demand of an EV market that hasn't yet materialized. US EV sales through September amounted to just 31,000 vehicles, or less than 0.3% of total US car sales. The picture looks even worse if you subtract out sales of GM's Volt and Toyota's plug-in version of its Prius, the gasoline engines of which provide essentially unlimited range, circumventing the limitations of today's batteries. I think there's a strong argument that the government's assistance to A123 was actually a key factor in leading them to bankruptcy, by prompting A123 to grow much faster than could have been justified to its bankers or private investors.
Perhaps it's some consolation that A123's technology has apparently been snapped up by a competitor, rather than going the way of Solyndra's odd solar modules. Yet that outcome hardly justifies the casual dismissal of A123's fate by a DOE spokesman as a common occurrence in an emerging industry. That sort of talk merely perpetuates the perception of cluelessness fostered by Energy Secretary Chu's failure to hold anyone accountable for the Solyndra debacle. Yes, companies in emerging industries fall by the wayside, but the preferred response would be to examine what happened and apply the lessons learned to the rest of the "venture capital portfolio" with which the administration's industrial policy has saddled the DOE. With EV sales still low and several key EV makers experiencing delays and production problems, a thorough public review of the entire EV strategy is in order.
Thursday, October 11, 2012
Sacramento's Role in California's Gasoline Price Spike
How much higher were gasoline prices in California last week than elsewhere? Enough to raise the national average price for unleaded regular by about $0.10 per gallon. So while the rest of us were paying an average of $3.75/gal., down slightly from the previous week, gas prices in the Golden State went up by 48 cents, leaving Californians paying nearly a dollar a gallon more than other Americans. In general the media have done a good job of explaining the direct causes for this spike: a pair of unexpected outages at large refineries in the Bay Area and L.A., combined with the difficulties of supplying the state's unique gasoline blend when local refiners fall short. Robert Rapier does an even better job of explaining the intricacies of that blend. But what's missing from all this commentary is an explanation for why the supply for the nation's largest gasoline market, with more than 11% of US sales, should be so tightly balanced that such disruptions would lead to economic hardship for consumers.
As I've indicated before, California is effectively a gasoline island. The product pipelines connecting it with neighboring Arizona and Nevada run out, not in, and the only routes between California and the other West Coast refining center north of Seattle travel over water. So the principal refineries serving the California market are in California, and obtaining supply from elsewhere that hasn't been prearranged takes time for special batches of fuel to be blended up, tankers to be chartered, and for those vessels to complete their voyages from ports as far away as the Gulf Coast or Singapore. That entails at least a couple of weeks.
In a posting I wrote in 2007 during a similar price spike in California, I referred to a 2003 study by the Energy Information Agency of the US Department of Energy, looking at an earlier California gasoline spike. (This is a recurring problem.) Among the major factors explaining the higher prices and volatility of the California gasoline market, they found,
So much for the diagnosis, but what about the cause? Tackling the local pollution from large, stationary sources like oil refineries, and from the tailpipes of the state's 31million cars and other vehicles has been a top priority for the state's Air Resources Board (CARB) since the 1970s, for good reason. However, over the years, CARB's increasingly strict regulations made it harder and less attractive to operate refineries in the state, and more difficult to blend the fuel it allowed to be sold there. As it happens, I saw much of this first-hand when I worked as an engineer in Texaco's Los Angeles refinery and later when I traded refined products, crude and feedstocks for the company's West Coast operations in the 1980s and early '90s. I watched one small refinery after another go out of business, and the magnitude of periodic price spikes grow, as the market became more constrained and isolated. I also saw refining margins for the survivors improve relative to those on the Gulf Coast and other parts of the country. These trends seemed related, since the state, by its actions, was turning California gasoline into a boutique product and effectively blocking competition from outside the state.
The normal response of companies operating in a market such as that, with growing demand and healthy margins, would have been to invest in more capacity--new refineries or major refinery expansions--and collectively to overshoot somewhat. But by then the prospect of obtaining the permits necessary to build a new refinery in California had gone from difficult to impossible, and most refining investment was focused on the substantial upgrades required to keep up with the state's periodic tightening of product specifications. And since those investments generally did little to increase output or improve product quality in ways a consumer might notice and pay a premium for, they had awful returns and dragged down the total return on investment for the entire facility. This contributed to refineries shutting down or being sold to independents with less capacity to make further such investments in the future.
The net result of all these factors is a California refining system that today is 21% smaller than in 1982, at least in terms of crude processing capacity, but must meet gasoline demand that has grown by a third in the meantime, even after shrinking from its 2006 peak. Now, when an unplanned refinery outage occurs, the result provides as classic and dramatic a demonstration as you'll ever see of the price response to a shift in the supply curve for a good with inelastic demand.
As an ex-Californian and ex-Angeleno there's no doubt in my mind that air quality, especially in Southern California, has improved as a result of many of the regulations imposed on industry and on fuels. However, you'd have to ask the state's current residents whether that result is worth the high price they periodically pay at the gas pump, or whether some degree of compromise that would have allowed refineries to expand to keep pace with demand, while cleaning up the air almost as much, would have been preferable.
As I've indicated before, California is effectively a gasoline island. The product pipelines connecting it with neighboring Arizona and Nevada run out, not in, and the only routes between California and the other West Coast refining center north of Seattle travel over water. So the principal refineries serving the California market are in California, and obtaining supply from elsewhere that hasn't been prearranged takes time for special batches of fuel to be blended up, tankers to be chartered, and for those vessels to complete their voyages from ports as far away as the Gulf Coast or Singapore. That entails at least a couple of weeks.
In a posting I wrote in 2007 during a similar price spike in California, I referred to a 2003 study by the Energy Information Agency of the US Department of Energy, looking at an earlier California gasoline spike. (This is a recurring problem.) Among the major factors explaining the higher prices and volatility of the California gasoline market, they found,
"The California refinery system runs near its capacity limits, which means there is little excess capability in the region to respond to unexpected shortfalls."
So much for the diagnosis, but what about the cause? Tackling the local pollution from large, stationary sources like oil refineries, and from the tailpipes of the state's 31million cars and other vehicles has been a top priority for the state's Air Resources Board (CARB) since the 1970s, for good reason. However, over the years, CARB's increasingly strict regulations made it harder and less attractive to operate refineries in the state, and more difficult to blend the fuel it allowed to be sold there. As it happens, I saw much of this first-hand when I worked as an engineer in Texaco's Los Angeles refinery and later when I traded refined products, crude and feedstocks for the company's West Coast operations in the 1980s and early '90s. I watched one small refinery after another go out of business, and the magnitude of periodic price spikes grow, as the market became more constrained and isolated. I also saw refining margins for the survivors improve relative to those on the Gulf Coast and other parts of the country. These trends seemed related, since the state, by its actions, was turning California gasoline into a boutique product and effectively blocking competition from outside the state.
The normal response of companies operating in a market such as that, with growing demand and healthy margins, would have been to invest in more capacity--new refineries or major refinery expansions--and collectively to overshoot somewhat. But by then the prospect of obtaining the permits necessary to build a new refinery in California had gone from difficult to impossible, and most refining investment was focused on the substantial upgrades required to keep up with the state's periodic tightening of product specifications. And since those investments generally did little to increase output or improve product quality in ways a consumer might notice and pay a premium for, they had awful returns and dragged down the total return on investment for the entire facility. This contributed to refineries shutting down or being sold to independents with less capacity to make further such investments in the future.
The net result of all these factors is a California refining system that today is 21% smaller than in 1982, at least in terms of crude processing capacity, but must meet gasoline demand that has grown by a third in the meantime, even after shrinking from its 2006 peak. Now, when an unplanned refinery outage occurs, the result provides as classic and dramatic a demonstration as you'll ever see of the price response to a shift in the supply curve for a good with inelastic demand.
As an ex-Californian and ex-Angeleno there's no doubt in my mind that air quality, especially in Southern California, has improved as a result of many of the regulations imposed on industry and on fuels. However, you'd have to ask the state's current residents whether that result is worth the high price they periodically pay at the gas pump, or whether some degree of compromise that would have allowed refineries to expand to keep pace with demand, while cleaning up the air almost as much, would have been preferable.
Thursday, October 04, 2012
Election 2012: Romney on Energy
After last week's review of President Obama's energy record and campaign materials on energy, Governor Romney's energy plans present a sharp contrast. They are based on a fundamentally different view of energy and the economy, relying on markets to allocate capital to the most productive opportunities, rather than on government to guide a mix of public and private investments along specific paths towards designated ends. They also emphasize technologies that are already deployed at scale today, not those still under development or striving to attain scale. Implicitly, the Romney plan prioritizes supplying the energy for a robust economic recovery over programs designed to address long-term environmental challenges like climate change. These positions present voters with a serious and consequential choice on November 6th.
The Romney campaign's website on energy arrays the candidate's ideas mainly in words, rather than with the kind of images and interactive features that dominate the Obama campaign's sites. Energy is the first plank of Governor Romney's five-point "Plan for a Stronger Middle Class", though it requires a little work to explore the details of his energy program. A list of bullet points is backed up by a lengthy policy paper with numerous references to external sources, but you have to look for it.
The Romney energy plan focuses mainly on oil, gas, coal and nuclear energy, which together meet 91% of current US primary energy demand and which the Department of Energy projects will still provide nearly 90% in 2020 under the policies in place today. You won't find much on his campaign's website about the new renewables that generated electricity equivalent to 2% of our energy use last year, beyond a critique of the administration's investment in Solyndra and a commitment to R&D on new energy technologies.
Among the details of his plan are support for expanded offshore drilling, including areas such as offshore Virginia that were originally in the Obama administration's early-2010 offshore development blueprint, along with a comprehensive assessment of US resources using current technology, rather than further extrapolations based on 1980s technology. Governor Romney proposes expanding energy cooperation with both Canada and Mexico and would approve the entire Keystone XL pipeline. His goal of attaining North American energy independence is aggressive, yet recent analysis by Citigroup puts it within the realm of possibility. It appears to be based on an assessment by Wood Mackenzie, a top-notch energy consultancy, indicating that US oil and natural gas liquids output could expand by 7.6 million barrels per day, with 6.7 million of that coming from federal lands and waters currently off-limits to development. That compares to US net petroleum imports of 8.5 million barrels per day in 2011.
Another aspect of the plan aimed at streamlining the permitting of energy projects could be just as useful for utility-scale renewable energy projects as for oil and gas exploration and production. Regulatory and permitting delays are among the key reasons it takes longer and costs more to develop crucial energy and infrastructure projects here than in many of the countries against which our competitive standing has been slipping. Governor Romney also proposes giving states greater control of permitting on their non-park federal lands. That could substantially increase energy access and output, especially in the west, where the federal government owns over 280 hundred million acres, or 37% of those 11 states, net of tribal lands.
There are also some missing elements. I would have liked to see more about how renewables fit into Governor Romney's vision. He apparently supports the Renewable Fuels Standard but is silent about the increasingly urgent need to reform it. He is on record against the extension of the wind Production Tax Credit (PTC), a 20-year old subsidy roughly equivalent to the current price of natural gas, yet misses the opportunity to explain how all types of energy would be treated under his proposal to reduce corporate income tax rates while broadening the tax base--policy-speak for closing loopholes and eliminating incentives. In last night's debate he said, referring to the $2.8 billion in annual tax incentives for oil and gas identified by the Department of Energy, "... if we get that tax rate from 35 percent down to 25 percent, why that $2.8 billion is on the table. Of course it's on the table. That's probably not going to survive (if) you get that rate down to 25 percent." I'd also like to hear more about how Governor Romney would address greenhouse gas emissions once the economy returns to stronger growth.
Superficially, much of the Romney energy agenda evokes a return to the pre-2008 status quo: heavy on oil, gas and coal, light on renewables, and largely ignoring climate change. I see it from a different perspective: When Barack Obama began running for President in 2007, the US was considered by many to be tapped out on conventional energy, with domestic oil and natural gas production exhibiting signs of deep and permanent decline. In that context it made sense to look beyond those resources to the potential of renewable energy and vehicle electrification, even if the transition involved would be lengthy. That approach also appeared synergistic with reducing greenhouse gas emissions, and a strategy was born. In the meantime, however, it turned out that US oil and gas were far from exhausted, and the most productive new energy technology of this decade wasn't wind, solar or biofuels, but the combination of hydraulic fracturing ("fracking") and horizontal drilling that has unlocked hundreds of trillions of cubic feet of shale gas and tens of billions of barrels of shale oil or "tight oil" resources. Since 2008 the expansion of shale gas drilling has added as much new US energy production as over 250,000 MW of wind turbines or solar panels--8x the wind and solar power added in the same interval. To the surprise of many, the big global energy opportunity of the 20-teens is US hydrocarbons. The Romney plan reflects the unexpected energy transformation we're experiencing.
As in 2008, this blog isn't in the business of endorsing candidates. Energy remains an issue that, like the Cold War, demands bi-partisan cooperation and some level of consistency from one administration or Congress to the next. However, that doesn't prevent me from observing that the energy agendas of the two campaigns are not equally well-suited for a period of serious US fiscal constraints and shrinking federal discretionary expenditures, in which our energy security and economic growth will still depend largely on fossil fuels. In that context, it's highly relevant that the "all of the above" credentials of one candidate depend on oil and gas outcomes that his policies did little to support. Of course, energy isn't the only issue that matters, but then you wouldn't be reading this if you didn't think it was important.
The Romney campaign's website on energy arrays the candidate's ideas mainly in words, rather than with the kind of images and interactive features that dominate the Obama campaign's sites. Energy is the first plank of Governor Romney's five-point "Plan for a Stronger Middle Class", though it requires a little work to explore the details of his energy program. A list of bullet points is backed up by a lengthy policy paper with numerous references to external sources, but you have to look for it.
The Romney energy plan focuses mainly on oil, gas, coal and nuclear energy, which together meet 91% of current US primary energy demand and which the Department of Energy projects will still provide nearly 90% in 2020 under the policies in place today. You won't find much on his campaign's website about the new renewables that generated electricity equivalent to 2% of our energy use last year, beyond a critique of the administration's investment in Solyndra and a commitment to R&D on new energy technologies.
Among the details of his plan are support for expanded offshore drilling, including areas such as offshore Virginia that were originally in the Obama administration's early-2010 offshore development blueprint, along with a comprehensive assessment of US resources using current technology, rather than further extrapolations based on 1980s technology. Governor Romney proposes expanding energy cooperation with both Canada and Mexico and would approve the entire Keystone XL pipeline. His goal of attaining North American energy independence is aggressive, yet recent analysis by Citigroup puts it within the realm of possibility. It appears to be based on an assessment by Wood Mackenzie, a top-notch energy consultancy, indicating that US oil and natural gas liquids output could expand by 7.6 million barrels per day, with 6.7 million of that coming from federal lands and waters currently off-limits to development. That compares to US net petroleum imports of 8.5 million barrels per day in 2011.
Another aspect of the plan aimed at streamlining the permitting of energy projects could be just as useful for utility-scale renewable energy projects as for oil and gas exploration and production. Regulatory and permitting delays are among the key reasons it takes longer and costs more to develop crucial energy and infrastructure projects here than in many of the countries against which our competitive standing has been slipping. Governor Romney also proposes giving states greater control of permitting on their non-park federal lands. That could substantially increase energy access and output, especially in the west, where the federal government owns over 280 hundred million acres, or 37% of those 11 states, net of tribal lands.
There are also some missing elements. I would have liked to see more about how renewables fit into Governor Romney's vision. He apparently supports the Renewable Fuels Standard but is silent about the increasingly urgent need to reform it. He is on record against the extension of the wind Production Tax Credit (PTC), a 20-year old subsidy roughly equivalent to the current price of natural gas, yet misses the opportunity to explain how all types of energy would be treated under his proposal to reduce corporate income tax rates while broadening the tax base--policy-speak for closing loopholes and eliminating incentives. In last night's debate he said, referring to the $2.8 billion in annual tax incentives for oil and gas identified by the Department of Energy, "... if we get that tax rate from 35 percent down to 25 percent, why that $2.8 billion is on the table. Of course it's on the table. That's probably not going to survive (if) you get that rate down to 25 percent." I'd also like to hear more about how Governor Romney would address greenhouse gas emissions once the economy returns to stronger growth.
Superficially, much of the Romney energy agenda evokes a return to the pre-2008 status quo: heavy on oil, gas and coal, light on renewables, and largely ignoring climate change. I see it from a different perspective: When Barack Obama began running for President in 2007, the US was considered by many to be tapped out on conventional energy, with domestic oil and natural gas production exhibiting signs of deep and permanent decline. In that context it made sense to look beyond those resources to the potential of renewable energy and vehicle electrification, even if the transition involved would be lengthy. That approach also appeared synergistic with reducing greenhouse gas emissions, and a strategy was born. In the meantime, however, it turned out that US oil and gas were far from exhausted, and the most productive new energy technology of this decade wasn't wind, solar or biofuels, but the combination of hydraulic fracturing ("fracking") and horizontal drilling that has unlocked hundreds of trillions of cubic feet of shale gas and tens of billions of barrels of shale oil or "tight oil" resources. Since 2008 the expansion of shale gas drilling has added as much new US energy production as over 250,000 MW of wind turbines or solar panels--8x the wind and solar power added in the same interval. To the surprise of many, the big global energy opportunity of the 20-teens is US hydrocarbons. The Romney plan reflects the unexpected energy transformation we're experiencing.
As in 2008, this blog isn't in the business of endorsing candidates. Energy remains an issue that, like the Cold War, demands bi-partisan cooperation and some level of consistency from one administration or Congress to the next. However, that doesn't prevent me from observing that the energy agendas of the two campaigns are not equally well-suited for a period of serious US fiscal constraints and shrinking federal discretionary expenditures, in which our energy security and economic growth will still depend largely on fossil fuels. In that context, it's highly relevant that the "all of the above" credentials of one candidate depend on oil and gas outcomes that his policies did little to support. Of course, energy isn't the only issue that matters, but then you wouldn't be reading this if you didn't think it was important.
Thursday, September 27, 2012
Candidates & Energy 2012: Obama
It's curious that energy hasn't been as big an issue in this year's presidential campaign as it was in 2008, the year of "Drill, baby, drill." The price of unleaded regular gasoline has averaged roughly a dime per gallon higher through September than either last year or the same period in 2008, when prices peaked at $4.11 per gallon in July. Gas prices are higher this year because global oil prices are also higher, with UK Brent crude averaging $15 per barrel over its 2008 full-year average, though without a similar spike. One explanation for the reduced focus on energy is that President Obama co-opted his opponents' "all of the above" prescription, while indicators such as US crude oil production and natural gas output and prices have been moving in favorable directions. The Obama campaign and key administration officials routinely draw a strong causal connection between those two facts, forming the basis of their campaign on energy. But is that claim true? Like the Washington Post fact checker's assessment of another frequent presidential assertion about energy, a finding of "true but false" seems appropriate.
Although I had intended to provide a side-by-side comparison of President Obama's and Governor Romney's energy agendas, it quickly became obvious that that was impractical, due to length and complexity. I'll take a look at the challenger's ideas next week. Since any re-election bid is fundamentally a referendum on the incumbent, it made sense to start with the record of an administration that came into office with an unusually clear and clearly articulated vision on energy, experienced some notable victories and defeats along the way, and ended up embracing a pair of big, emerging trends that it had done virtually nothing to foster.
That is readily apparent when it comes to oil production, which must be a core element of any "all of the above" approach, since that "all" implicitly includes fossil fuels along with renewables and efficiency. Go to the Obama campaign web page on energy and you'll see this chart:
Aside from the fact that changing the axis scale makes the trend look much more dramatic, what's entirely missing from both these charts and the websites where they appear is any cogent explanation of why oil production is rising. That requires some context about the industry and oil markets that I've overlaid in the following graphs:
Most oil projects big enough to matter aren't accomplished overnight. The process typically involves acquiring onshore or offshore leases, obtaining the necessary permits, conducting exploration activities that only proceed to the next step based on success, planning the required production wells and processing facilities, competing for internal funding against other company projects, obtaining additional permits, constructing facilities and drilling the production wells. Every step takes time. Depending on the complexity of the project, the overall timeline can span from three to seven years, and that's if no one sues to block the project. To see why oil production has been rising since 2009, we need to ask what was happening in 2003-6. The answer is that after many years of being stuck in a range of $20-30 per barrel--with an excursion down to single digits in the late 1990s--oil prices tripled during that period, mainly due to the combination of global economic growth, especially in Asia, and the lagged effect on oil project investments from that late-'90s price crash. In other words, production went up mainly because five or six years earlier the financial rewards for drilling suddenly got much bigger.
So at a minimum it's a stretch--mere spin--to claim credit for higher production that is attributable to events and perhaps policies on your predecessor's watch. However, the picture looks worse when we factor in the policies and attitudes that went into effect when this administration took office in early 2009. Recall that one of the first energy decisions of the new administration was Interior Secretary Salazar's cancellation of previously awarded oil leases in Utah. Later that year a senior Treasury official--currently chairman of the President's Council of Economic Advisers--testified before Congress that US policies were promoting the "overproduction of US oil and gas", just as the now-touted production surge was starting. For at least its first several years, the rhetoric and actions of the Obama White House were generally consistent with that view and with Mr. Obama's portrayal of oil and gas as "yesterday's energy" in his 2011 State of the Union address. The brief offshore drilling opening signaled in spring 2010 was quickly retracted following the Deepwater Horizon accident, with the imposition of a six-month offshore drilling moratorium and subsequent "permitorium". Those responses--justified or not--resulted in Gulf of Mexico production falling by 22% since mid-2010, a decline that has been masked by the tremendous success of "tight oil" exploration and production in Texas and North Dakota. (The time lag for the moratorium's effects was negligible, because the deepwater projects that were halted had already been planned and permitted.)
In fact, the President's adoption of "all of the above" is fairly recent, making headlines following his 2012 State of the Union. It represents quite an evolution from Senator Obama's 2008 emphasis on renewable energy and climate change mitigation. President Obama certainly pursued those agendas with vigor, incorporating billions of dollars of federal grants and loan guarantees for renewables in the 2009 stimulus, backing the Waxman-Markey cap-and-trade bill, and at both the Copenhagen and Cancun UN climate conferences committing the US to significant greenhouse gas reduction targets and further negotiations.
It hasn't all worked out as planned, though. Notwithstanding the high-profile bankruptcies of Solyndra--a colossal failure of due diligence by the administration--and other loan guarantee and grant beneficiaries, the output of wind, solar and other non-hydro renewable energy generation has indeed grown by 55% since 2008, increasing from 3.1% to 4.7% of total US electricity generation, equivalent to 1.9% of total energy consumption. Yet sadly the wind and solar manufacturing sectors that were to have produced so many "green jobs" are caught up in parallel waves of excess global production capacity that could take years--or wrenching consolidation--to work off. The overcapacity that has blighted the prospects of many of these companies is largely attributable to the generous incentives provided by the US and other governments from Europe to Asia. Direct wind and solar jobs accounted for just 54,000 of the US "clean economy jobs" tallied by Brookings and Battelle in their study last year, and they look no more secure than non-green jobs.
Climate policy is another area featuring a big disconnect between effort and results. With control of both Houses of Congress, the President backed a climate bill that exhibited all the worst tendencies of that body: 1,092 pages of bloated regulations and carve-outs for favored constituencies. Even to someone who had supported the idea of cap and trade for a decade, it was a dog's breakfast, configured mainly as a production-inhibiting tax on the US petroleum sector. Waxman-Markey failed to pass the Senate, and a more bi-partisan bill died in the aftermath of Deepwater Horizon and the recession. Whatever one's views on the science of climate change, costly climate legislation looked like a bad bet in a weak economy. Actual emissions have fallen, however, as a result not of policy but of another trend that wasn't on the administration's radar screen until it grew too large to ignore: shale gas. Emissions are at a 20-year low, mainly due to fuel switching from coal to cheap natural gas in the utility sector.
Another key trend cited as evidence of the effectiveness of the administration's energy policies is the reduction of oil imports that has occurred since 2008. Yet like the facts on oil production, the causes are only tenuously connected to those policies. From 2008-11, US net petroleum imports fell by 2.6 million bbl/day (MBD), including refined products. That goes a long way toward achieving then-candidate Obama's goal of reducing imports by an amount equivalent to what the US imported from the Middle East and Venezuela. However, the biggest contributor to this reduction was the 1.1 MBD increase in total US petroleum production (including natural gas liquids), followed by a 0.6 MBD drop in demand that had more to do with reduced driving and the weak economy than the early gains from tougher fuel economy rules. Increasing biofuel production associated with the 2007 Renewable Fuel Standard contributed another 0.3 MBD, although that policy now stands in urgent need of reform.
I have watched many elections in my life, and I can't honestly say I'm surprised to see an administration running on something other than its actual energy record, which in this case includes positives such as funding ARPA-E's potentially transformational energy R&D and having enough sense to keep largely out of the way of the shale gas revolution--at least for now. Yet having focused 90% of its efforts on a set of technologies that look important for the future but will still meet less than 10% of our energy needs for some time to come, they have now hitched their electoral wagon to an oil production surge that they didn't help and partly hindered. I can only imagine that this would be deeply disappointing to those who supported Mr. Obama in 2008 because of his vision for alternative energy and the environment. Nor does it provide much comfort to those who found large portions of that agenda ill-considered or premature. The President's 11th-hour conversion to "all of the above" creates great uncertainty about the course he would pursue with regard to energy for the next four years, if reelected.
Although I had intended to provide a side-by-side comparison of President Obama's and Governor Romney's energy agendas, it quickly became obvious that that was impractical, due to length and complexity. I'll take a look at the challenger's ideas next week. Since any re-election bid is fundamentally a referendum on the incumbent, it made sense to start with the record of an administration that came into office with an unusually clear and clearly articulated vision on energy, experienced some notable victories and defeats along the way, and ended up embracing a pair of big, emerging trends that it had done virtually nothing to foster.
That is readily apparent when it comes to oil production, which must be a core element of any "all of the above" approach, since that "all" implicitly includes fossil fuels along with renewables and efficiency. Go to the Obama campaign web page on energy and you'll see this chart:
It's a rescaled version of the chart below, which appears on the WhiteHouse.gov site on gas prices:
Aside from the fact that changing the axis scale makes the trend look much more dramatic, what's entirely missing from both these charts and the websites where they appear is any cogent explanation of why oil production is rising. That requires some context about the industry and oil markets that I've overlaid in the following graphs:
Most oil projects big enough to matter aren't accomplished overnight. The process typically involves acquiring onshore or offshore leases, obtaining the necessary permits, conducting exploration activities that only proceed to the next step based on success, planning the required production wells and processing facilities, competing for internal funding against other company projects, obtaining additional permits, constructing facilities and drilling the production wells. Every step takes time. Depending on the complexity of the project, the overall timeline can span from three to seven years, and that's if no one sues to block the project. To see why oil production has been rising since 2009, we need to ask what was happening in 2003-6. The answer is that after many years of being stuck in a range of $20-30 per barrel--with an excursion down to single digits in the late 1990s--oil prices tripled during that period, mainly due to the combination of global economic growth, especially in Asia, and the lagged effect on oil project investments from that late-'90s price crash. In other words, production went up mainly because five or six years earlier the financial rewards for drilling suddenly got much bigger.
So at a minimum it's a stretch--mere spin--to claim credit for higher production that is attributable to events and perhaps policies on your predecessor's watch. However, the picture looks worse when we factor in the policies and attitudes that went into effect when this administration took office in early 2009. Recall that one of the first energy decisions of the new administration was Interior Secretary Salazar's cancellation of previously awarded oil leases in Utah. Later that year a senior Treasury official--currently chairman of the President's Council of Economic Advisers--testified before Congress that US policies were promoting the "overproduction of US oil and gas", just as the now-touted production surge was starting. For at least its first several years, the rhetoric and actions of the Obama White House were generally consistent with that view and with Mr. Obama's portrayal of oil and gas as "yesterday's energy" in his 2011 State of the Union address. The brief offshore drilling opening signaled in spring 2010 was quickly retracted following the Deepwater Horizon accident, with the imposition of a six-month offshore drilling moratorium and subsequent "permitorium". Those responses--justified or not--resulted in Gulf of Mexico production falling by 22% since mid-2010, a decline that has been masked by the tremendous success of "tight oil" exploration and production in Texas and North Dakota. (The time lag for the moratorium's effects was negligible, because the deepwater projects that were halted had already been planned and permitted.)
In fact, the President's adoption of "all of the above" is fairly recent, making headlines following his 2012 State of the Union. It represents quite an evolution from Senator Obama's 2008 emphasis on renewable energy and climate change mitigation. President Obama certainly pursued those agendas with vigor, incorporating billions of dollars of federal grants and loan guarantees for renewables in the 2009 stimulus, backing the Waxman-Markey cap-and-trade bill, and at both the Copenhagen and Cancun UN climate conferences committing the US to significant greenhouse gas reduction targets and further negotiations.
It hasn't all worked out as planned, though. Notwithstanding the high-profile bankruptcies of Solyndra--a colossal failure of due diligence by the administration--and other loan guarantee and grant beneficiaries, the output of wind, solar and other non-hydro renewable energy generation has indeed grown by 55% since 2008, increasing from 3.1% to 4.7% of total US electricity generation, equivalent to 1.9% of total energy consumption. Yet sadly the wind and solar manufacturing sectors that were to have produced so many "green jobs" are caught up in parallel waves of excess global production capacity that could take years--or wrenching consolidation--to work off. The overcapacity that has blighted the prospects of many of these companies is largely attributable to the generous incentives provided by the US and other governments from Europe to Asia. Direct wind and solar jobs accounted for just 54,000 of the US "clean economy jobs" tallied by Brookings and Battelle in their study last year, and they look no more secure than non-green jobs.
Climate policy is another area featuring a big disconnect between effort and results. With control of both Houses of Congress, the President backed a climate bill that exhibited all the worst tendencies of that body: 1,092 pages of bloated regulations and carve-outs for favored constituencies. Even to someone who had supported the idea of cap and trade for a decade, it was a dog's breakfast, configured mainly as a production-inhibiting tax on the US petroleum sector. Waxman-Markey failed to pass the Senate, and a more bi-partisan bill died in the aftermath of Deepwater Horizon and the recession. Whatever one's views on the science of climate change, costly climate legislation looked like a bad bet in a weak economy. Actual emissions have fallen, however, as a result not of policy but of another trend that wasn't on the administration's radar screen until it grew too large to ignore: shale gas. Emissions are at a 20-year low, mainly due to fuel switching from coal to cheap natural gas in the utility sector.
Another key trend cited as evidence of the effectiveness of the administration's energy policies is the reduction of oil imports that has occurred since 2008. Yet like the facts on oil production, the causes are only tenuously connected to those policies. From 2008-11, US net petroleum imports fell by 2.6 million bbl/day (MBD), including refined products. That goes a long way toward achieving then-candidate Obama's goal of reducing imports by an amount equivalent to what the US imported from the Middle East and Venezuela. However, the biggest contributor to this reduction was the 1.1 MBD increase in total US petroleum production (including natural gas liquids), followed by a 0.6 MBD drop in demand that had more to do with reduced driving and the weak economy than the early gains from tougher fuel economy rules. Increasing biofuel production associated with the 2007 Renewable Fuel Standard contributed another 0.3 MBD, although that policy now stands in urgent need of reform.
I have watched many elections in my life, and I can't honestly say I'm surprised to see an administration running on something other than its actual energy record, which in this case includes positives such as funding ARPA-E's potentially transformational energy R&D and having enough sense to keep largely out of the way of the shale gas revolution--at least for now. Yet having focused 90% of its efforts on a set of technologies that look important for the future but will still meet less than 10% of our energy needs for some time to come, they have now hitched their electoral wagon to an oil production surge that they didn't help and partly hindered. I can only imagine that this would be deeply disappointing to those who supported Mr. Obama in 2008 because of his vision for alternative energy and the environment. Nor does it provide much comfort to those who found large portions of that agenda ill-considered or premature. The President's 11th-hour conversion to "all of the above" creates great uncertainty about the course he would pursue with regard to energy for the next four years, if reelected.
Wednesday, September 19, 2012
The "Four-Gallon Rule": Another Unintended Consequence of Ethanol Policy
The energy field is replete with unintended consequences, and US policy promoting ethanol fuels has had more than its share. The growing competition between food and fuel uses of corn, amplified by the current drought, is a prime example, along with the so-called "dead zone" in the Gulf of Mexico that has been exacerbated by the extra fertilizer used to boost corn yields enough to meet the rising demands of the federal Renewable Fuel Standard (RFS). Most of these effects occur out of the sight of average consumers, but here's a new one that could start showing up at a gas station near you, very soon: the EPA's "four-gallon" rule. As a result of EPA's decision to allow gasoline blenders to sell fuel containing up to 15% ethanol, and in recognition of the adverse consequences of high-ethanol blends for small engines, gas stations will be required to post signs enforcing a minimum purchase of four gallons from certain pumps. This is yet another indication that the EPA has put expediency above prudence in giving its approval to a fuel that is not ready for mass-market distribution.
A little background is necessary to understand how we reached this point. In 2007 the Congress passed the Energy Independence and Security Act that included the RFS, mandating dramatic increases in the quantity of ethanol blended into gasoline. Unfortunately, its passage coincided with a sea change in the gasoline market. Prior to the financial crisis and recession, US gasoline demand had been growing by 1-2% per year for decades, and on that pace there should have been ample future gasoline demand growth to accommodate all the additional ethanol that Congress was instructing the EPA to require refiners and gasoline blenders to add, by means of the standard blend of 90% gasoline and 10% ethanol. Instead, gasoline sales fell by more than 3% in 2008 and still haven't recovered their 2007 peak, running about on par with 2002 this year. When you do the arithmetic, that means that instead of being able to absorb over 15 billion gallons of ethanol this year, the market can only handle around 13 billion gallons--barely enough to satisfy the 2012 mandate level and 2 billion short of the amount required in just three years. (This ignores cellulosic ethanol requirements, which have been revised downward each year as commercial production fails to appear.)
With sales of 85% ethanol E85 trickling along at levels too low to stave off the approaching "blend wall", the ethanol industry applied in 2009 to be allowed to increase the ethanol dosage in gasoline from 10% to 15%, requiring an EPA waiver of existing regulations. That waiver was granted in 2010 for cars made after model-year 2006 and later extended for cars made after model year 2000, in spite of continuing concerns about its impact on the engines and fuel systems of all cars not labeled as "flexible fuel vehicles", as well as testing by UL indicating that some existing gasoline dispensers failed in dangerous ways when ethanol blends above 10% were introduced.
The four-gallon rule is part of the EPA's ongoing contortions, in the form of gas pump labeling and "misfueling mitigation plans", to make sure that E15 doesn't get into the wrong vehicles, or worse yet, into small engines--lawn mowers, string trimmers, boats, etc.--where it has been found to cause potentially serious problems. So in addition to labels indicating that E15 is only approved for 2001 and later automobiles, the EPA is instituting a minimum sales quantity rule to prevent someone from filling a gas can for use in a small engine with E10 from a "blender pump"--one that can dispense either E10 or E15 on demand. That's because even after the pump is switched to E10, enough higher-ethanol fuel could remain in the hose to skew the ethanol content of the first few gallons delivered. (I'd suggest that this ought to be of concern to motorists, as well.)
I'm sure the EPA sees its new four-gallon rule as a sensible measure to protect the owners of small consumer or industrial engines from damaging their equipment. Yet from my perspective outside the bureaucracy it looks like another symptom of an E15 policy that falls short of the prudence necessary when dealing with the retail distribution of motor fuels and borders on regulatory malpractice. At some point in the process someone in EPA should have held up his or her hand and pointed out that the obvious solution was not layering increasingly impractical and downright weird regulations onto already overburdened gas station operators, but to call for a fundamental reexamination of a Renewable Fuel Standard that has been overtaken by unforeseen events. And that's without even considering that the lower energy content of the extra ethanol equates to a new $0.07 per gallon tax on gasoline at current prices. The publicity surrounding this issue provides an ideal opportunity for one or both presidential candidates to commit to suspending the E15 program, pending a thorough review of the RFS and its implementation.
A little background is necessary to understand how we reached this point. In 2007 the Congress passed the Energy Independence and Security Act that included the RFS, mandating dramatic increases in the quantity of ethanol blended into gasoline. Unfortunately, its passage coincided with a sea change in the gasoline market. Prior to the financial crisis and recession, US gasoline demand had been growing by 1-2% per year for decades, and on that pace there should have been ample future gasoline demand growth to accommodate all the additional ethanol that Congress was instructing the EPA to require refiners and gasoline blenders to add, by means of the standard blend of 90% gasoline and 10% ethanol. Instead, gasoline sales fell by more than 3% in 2008 and still haven't recovered their 2007 peak, running about on par with 2002 this year. When you do the arithmetic, that means that instead of being able to absorb over 15 billion gallons of ethanol this year, the market can only handle around 13 billion gallons--barely enough to satisfy the 2012 mandate level and 2 billion short of the amount required in just three years. (This ignores cellulosic ethanol requirements, which have been revised downward each year as commercial production fails to appear.)
With sales of 85% ethanol E85 trickling along at levels too low to stave off the approaching "blend wall", the ethanol industry applied in 2009 to be allowed to increase the ethanol dosage in gasoline from 10% to 15%, requiring an EPA waiver of existing regulations. That waiver was granted in 2010 for cars made after model-year 2006 and later extended for cars made after model year 2000, in spite of continuing concerns about its impact on the engines and fuel systems of all cars not labeled as "flexible fuel vehicles", as well as testing by UL indicating that some existing gasoline dispensers failed in dangerous ways when ethanol blends above 10% were introduced.
The four-gallon rule is part of the EPA's ongoing contortions, in the form of gas pump labeling and "misfueling mitigation plans", to make sure that E15 doesn't get into the wrong vehicles, or worse yet, into small engines--lawn mowers, string trimmers, boats, etc.--where it has been found to cause potentially serious problems. So in addition to labels indicating that E15 is only approved for 2001 and later automobiles, the EPA is instituting a minimum sales quantity rule to prevent someone from filling a gas can for use in a small engine with E10 from a "blender pump"--one that can dispense either E10 or E15 on demand. That's because even after the pump is switched to E10, enough higher-ethanol fuel could remain in the hose to skew the ethanol content of the first few gallons delivered. (I'd suggest that this ought to be of concern to motorists, as well.)
I'm sure the EPA sees its new four-gallon rule as a sensible measure to protect the owners of small consumer or industrial engines from damaging their equipment. Yet from my perspective outside the bureaucracy it looks like another symptom of an E15 policy that falls short of the prudence necessary when dealing with the retail distribution of motor fuels and borders on regulatory malpractice. At some point in the process someone in EPA should have held up his or her hand and pointed out that the obvious solution was not layering increasingly impractical and downright weird regulations onto already overburdened gas station operators, but to call for a fundamental reexamination of a Renewable Fuel Standard that has been overtaken by unforeseen events. And that's without even considering that the lower energy content of the extra ethanol equates to a new $0.07 per gallon tax on gasoline at current prices. The publicity surrounding this issue provides an ideal opportunity for one or both presidential candidates to commit to suspending the E15 program, pending a thorough review of the RFS and its implementation.
Wednesday, September 12, 2012
Jet Fuel from Trees (or Almost Anything Else)
Out of the dozens of press releases that hit my email inbox in the last week, one that caught my eye was for a gathering of a group called the Northwest Advanced Renewables Alliance (NARA) in Missoula, Montana this Thursday. Their agenda is focused on "challenges to develop a residual woody biomass to jet fuel and valuable co-products industry in the Pacific Northwest." Somewhat more snappily, their website calls this "from wood to wing." With oil prices (UK Brent) persistently over $100 despite the weak global economy, the appeal of such an effort is not hard to understand. Whether it's feasible at an acceptable price remains to be seen.
Making fuels from waste or non-food crops is an attractive idea, and aviation fuels look like an especially promising market for bio- and synthetic fuels, for several reasons. Unlike the markets for motor fuels--gasoline and diesel--you wouldn't have to convince millions of customers of the efficacy of using a new fuel. You'd only have to convince the fuel buyers and chief engineers of a handful of airlines and aircraft leasing companies, along with the even smaller universe of engine suppliers. Certifying that your fuel meets all relevant specifications is a key step in that process, though in some respects that should also be easier than for gasoline and diesel engines. If you doubt that, just consider the current fuss over increasing the ethanol content of gasoline from 10 to 15%. Of course, having your car engine fail on the interstate is a very different proposition than having both engines shut down at 40.000 ft--or during take-off.
Fortunately, turbine engines are very reliable and fairly flexible. The best proof of the latter is that the turbine at the heart of a natural-gas-fired power plant is essentially just a bigger version of the ones hanging under the wings of a Boeing or Airbus aircraft, which burn a close cousin of kerosene, a simple distillate refined from a wide variety of crude oils. Turbines on ships burn a fuel similar to diesel. Many of the specifications that jet fuel must meet have more to do with the conditions under which aircraft operate than the specific sensitivities of jet engines. One example of that is the temperature at which a jet fuel becomes difficult to flow, just before it freezes solid. That's one reason that many oilseed-based biojet fuels require essentially oil-refinery levels of processing. Stepping back from such details, however, I'm skeptical that crop-based biofuels are the long-term solution to the fuel-diversification needs of aviation, for many of the same reasons we see playing out with regard to corn ethanol during the current drought.
Supporters of various biojet efforts often focus on two main benefits of renewable jet fuel. The first is the reduction of greenhouse gas emissions, since the principal alternative available to airlines or military aviation is further efficiency improvements, which face diminishing returns, or reduced operations. The other benefit that I often see cited is potential cost savings versus petroleum, though I regard this as largely illusory, at least on the level of the fuel customer. As I've described at length, the output of even a captive biojet facility is worth its price in the market--set by petroleum jet fuel--not its cost of production. That argument should also hold true for airlines buying oil refineries. However, to the extent that biojet could be scaled up enough to apply competitive pressure on the 6 million barrel per day global jet fuel market, or in isolated regional markets, that would benefit both airlines and consumers. Production at that scale will require feedstocks that are readily available in large quantities.
Many companies and researchers are pursuing renewable jet fuel pathways that don't rely on food- or food-competitive crops. The RenewableJetFuels.org website of the Carbon War Room provides a portal into some of these efforts, including fuels based on factory waste gases, algae, and various other approaches. Some of these have progressed to demonstration-stage production and fleet certification, though as we've seen with cellulosic motor fuels, scaling up to truly commercial production represents a much higher hurdle that could shake out many of these contenders. For that reason, it's encouraging to see the NARA effort, nor should they worry about being too late to the party.
Making fuels from waste or non-food crops is an attractive idea, and aviation fuels look like an especially promising market for bio- and synthetic fuels, for several reasons. Unlike the markets for motor fuels--gasoline and diesel--you wouldn't have to convince millions of customers of the efficacy of using a new fuel. You'd only have to convince the fuel buyers and chief engineers of a handful of airlines and aircraft leasing companies, along with the even smaller universe of engine suppliers. Certifying that your fuel meets all relevant specifications is a key step in that process, though in some respects that should also be easier than for gasoline and diesel engines. If you doubt that, just consider the current fuss over increasing the ethanol content of gasoline from 10 to 15%. Of course, having your car engine fail on the interstate is a very different proposition than having both engines shut down at 40.000 ft--or during take-off.
Fortunately, turbine engines are very reliable and fairly flexible. The best proof of the latter is that the turbine at the heart of a natural-gas-fired power plant is essentially just a bigger version of the ones hanging under the wings of a Boeing or Airbus aircraft, which burn a close cousin of kerosene, a simple distillate refined from a wide variety of crude oils. Turbines on ships burn a fuel similar to diesel. Many of the specifications that jet fuel must meet have more to do with the conditions under which aircraft operate than the specific sensitivities of jet engines. One example of that is the temperature at which a jet fuel becomes difficult to flow, just before it freezes solid. That's one reason that many oilseed-based biojet fuels require essentially oil-refinery levels of processing. Stepping back from such details, however, I'm skeptical that crop-based biofuels are the long-term solution to the fuel-diversification needs of aviation, for many of the same reasons we see playing out with regard to corn ethanol during the current drought.
Supporters of various biojet efforts often focus on two main benefits of renewable jet fuel. The first is the reduction of greenhouse gas emissions, since the principal alternative available to airlines or military aviation is further efficiency improvements, which face diminishing returns, or reduced operations. The other benefit that I often see cited is potential cost savings versus petroleum, though I regard this as largely illusory, at least on the level of the fuel customer. As I've described at length, the output of even a captive biojet facility is worth its price in the market--set by petroleum jet fuel--not its cost of production. That argument should also hold true for airlines buying oil refineries. However, to the extent that biojet could be scaled up enough to apply competitive pressure on the 6 million barrel per day global jet fuel market, or in isolated regional markets, that would benefit both airlines and consumers. Production at that scale will require feedstocks that are readily available in large quantities.
Many companies and researchers are pursuing renewable jet fuel pathways that don't rely on food- or food-competitive crops. The RenewableJetFuels.org website of the Carbon War Room provides a portal into some of these efforts, including fuels based on factory waste gases, algae, and various other approaches. Some of these have progressed to demonstration-stage production and fleet certification, though as we've seen with cellulosic motor fuels, scaling up to truly commercial production represents a much higher hurdle that could shake out many of these contenders. For that reason, it's encouraging to see the NARA effort, nor should they worry about being too late to the party.
Thursday, September 06, 2012
What If Saudi Arabia Became an Oil Importer?
I've seen numerous references in the last several days to a Citgroup analysis suggesting that Saudi Arabia might become a net oil importer by 2030. The premise behind this startling conclusion seems to be that economic growth and demographic trends would continue pushing up domestic Saudi demand for petroleum products and electricity--generated to a large extent from petroleum--until it consumed all of that country's oil export capacity within about 20 years. Even if this trend didn't proceed to conclusion, its continued progression could significantly alter both global oil markets and the context for the current debate about the desirability of achieving North American energy independence.
I'd be a lot more comfortable discussing this news item if I had access to the report on which it's based. Unfortunately, none of the dozens of references to it that I found on the web included a link to the source, which is probably on one of Citi's client-only sites. The Bloomberg and Daily Telegraph articles seemed to be the most complete, with the latter including a couple of charts from the report. As best I can tell, the analysis falls into the category of "If this goes on" scenarios--extrapolations of currently observable trends to some logical conclusion. That doesn't make it simplistic, because I'm sure the author sifted through volumes of data to flesh it out. The fact that many oil-producing countries have gone through a similar cycle lends it further credibility. For that matter, the US was once an important oil-exporting country, until the growth of our economy overwhelmed the productivity of US oil fields early in the last century. The gradual conversion of the remaining oil exporters to net oil consumers is a basic plank of the Peak Oil meme.
This presents a real conundrum, both for the Saudis and for us, because although many of the means by which this result could be averted are obvious, they aren't all feasible within the current political situation in Saudi Arabia, or indeed many other producing countries. Start with per-capita energy consumption, which a chart in the Telegraph article shows to be higher than in the US. Consumption is also high relative to GDP. Energy efficiency opportunities should be ample, but it's hard to make those a priority when retail energy is heavily subsidized and thus cheap. The Citigroup report apparently suggests reducing energy subsidy levels, but that might lead to the same kind of unrest that we've seen in other countries that have cut subsidies. That seems to leave mainly investment-based options for substituting other energy sources for oil, to preserve oil for exports. The Kingdom has already embarked on some of these, including nuclear and solar power. When combined with additional natural gas development, the Saudis certainly have the means and the motivation to shift the current trend of rising internal oil consumption, along with the cash to fund the infrastructure investment involved.
This leaves us with important strategic questions: To what extent should our own energy policy rely on Saudi Arabia succeeding in preserving its oil export capacity by means of substitution or efficiency gains? And if internal Saudi consumption removed just another 2-3 million barrels per day of exports from the market, how would that affect oil prices and the functioning of the global oil market, in which Saudi Arabia has often acted as a moderating force within OPEC? Considering that a narrowing between demand and available supply of about that magnitude was a key factor in the oil-price run-up of 2006-8, this should cause us serious concern.
That brings us to US energy independence, a tired mantra that has been proclaimed by a long succession of US Presidents, despite most experts for the last several decades having regarded it as unrealistic. To be clear, when Americans speak of energy independence, we are referring to oil, because as a practical matter that's the only form of energy we import to any significant degree, if you don't count natural gas from Canada. Yet suddenly energy independence no longer looks like a pipe dream, because of the combination of resurgent domestic oil production and improvements in vehicle fuel efficiency. An earlier report from Citigroup sketched the outline of potential future North American energy independence based mainly on those elements. It's hardly guaranteed, but it's not a fantasy, either.
Despite the risks of a much more unsettled oil market in the future, I continue to see a great deal of misunderstanding about what energy independence could mean for the US. Although it wouldn't cut us off from the global oil market--perish the thought--it would give us a much more flexible and influential role within it, while taking advantage of the benefits of continued trade. No longer being a net oil importer wouldn't insulate us from future oil price movements--it's still a global commodity--but oil prices would be lower than otherwise as a direct result of the substantial additions to supply required to shrink US oil imports to near zero. Prices would be weaker even if OPEC slashed output to compensate, because the resulting increase in spare production capacity would still reduce market volatility. Moreover, while US energy independence would not preclude the possibility of future oil price spikes, the consequences of those would be very different. For starters, they wouldn't entail weakening our economy by transferring tens or hundreds of billions of dollars offshore. Most of the extra oil revenue would stay in the US, and a large slice of it would be captured by state and federal taxes and royalties. Contrast that with what happened in 2008, and is still ongoing to a lesser degree.
The Saudi analysis from Citigroup proposed a fascinating scenario, with many interesting implications, although I'd argue that it's also subject to the simple advice of Herb Stein that "If something cannot go on forever, it will stop." By coincidence, it's also relevant to the energy debate underway between the US presidential campaigns. Although it's highly uncertain that Saudi Arabia's oil exports will dry up by 2030, we shouldn't assume such an outcome to be impossible, any more than we should base US energy policy on the outdated assumption that it's impossible for us to come close to eliminating the need for oil imports from outside North America. It might be uncertain whether we have sufficient resources accessible with the latest technology to reach that goal, but it is essentially certain that the growing but still tiny contribution of renewable energy and the eventual conversion of the US vehicle fleet to electricity couldn't get us there for multiple decades.
I'd be a lot more comfortable discussing this news item if I had access to the report on which it's based. Unfortunately, none of the dozens of references to it that I found on the web included a link to the source, which is probably on one of Citi's client-only sites. The Bloomberg and Daily Telegraph articles seemed to be the most complete, with the latter including a couple of charts from the report. As best I can tell, the analysis falls into the category of "If this goes on" scenarios--extrapolations of currently observable trends to some logical conclusion. That doesn't make it simplistic, because I'm sure the author sifted through volumes of data to flesh it out. The fact that many oil-producing countries have gone through a similar cycle lends it further credibility. For that matter, the US was once an important oil-exporting country, until the growth of our economy overwhelmed the productivity of US oil fields early in the last century. The gradual conversion of the remaining oil exporters to net oil consumers is a basic plank of the Peak Oil meme.
This presents a real conundrum, both for the Saudis and for us, because although many of the means by which this result could be averted are obvious, they aren't all feasible within the current political situation in Saudi Arabia, or indeed many other producing countries. Start with per-capita energy consumption, which a chart in the Telegraph article shows to be higher than in the US. Consumption is also high relative to GDP. Energy efficiency opportunities should be ample, but it's hard to make those a priority when retail energy is heavily subsidized and thus cheap. The Citigroup report apparently suggests reducing energy subsidy levels, but that might lead to the same kind of unrest that we've seen in other countries that have cut subsidies. That seems to leave mainly investment-based options for substituting other energy sources for oil, to preserve oil for exports. The Kingdom has already embarked on some of these, including nuclear and solar power. When combined with additional natural gas development, the Saudis certainly have the means and the motivation to shift the current trend of rising internal oil consumption, along with the cash to fund the infrastructure investment involved.
This leaves us with important strategic questions: To what extent should our own energy policy rely on Saudi Arabia succeeding in preserving its oil export capacity by means of substitution or efficiency gains? And if internal Saudi consumption removed just another 2-3 million barrels per day of exports from the market, how would that affect oil prices and the functioning of the global oil market, in which Saudi Arabia has often acted as a moderating force within OPEC? Considering that a narrowing between demand and available supply of about that magnitude was a key factor in the oil-price run-up of 2006-8, this should cause us serious concern.
That brings us to US energy independence, a tired mantra that has been proclaimed by a long succession of US Presidents, despite most experts for the last several decades having regarded it as unrealistic. To be clear, when Americans speak of energy independence, we are referring to oil, because as a practical matter that's the only form of energy we import to any significant degree, if you don't count natural gas from Canada. Yet suddenly energy independence no longer looks like a pipe dream, because of the combination of resurgent domestic oil production and improvements in vehicle fuel efficiency. An earlier report from Citigroup sketched the outline of potential future North American energy independence based mainly on those elements. It's hardly guaranteed, but it's not a fantasy, either.
Despite the risks of a much more unsettled oil market in the future, I continue to see a great deal of misunderstanding about what energy independence could mean for the US. Although it wouldn't cut us off from the global oil market--perish the thought--it would give us a much more flexible and influential role within it, while taking advantage of the benefits of continued trade. No longer being a net oil importer wouldn't insulate us from future oil price movements--it's still a global commodity--but oil prices would be lower than otherwise as a direct result of the substantial additions to supply required to shrink US oil imports to near zero. Prices would be weaker even if OPEC slashed output to compensate, because the resulting increase in spare production capacity would still reduce market volatility. Moreover, while US energy independence would not preclude the possibility of future oil price spikes, the consequences of those would be very different. For starters, they wouldn't entail weakening our economy by transferring tens or hundreds of billions of dollars offshore. Most of the extra oil revenue would stay in the US, and a large slice of it would be captured by state and federal taxes and royalties. Contrast that with what happened in 2008, and is still ongoing to a lesser degree.
The Saudi analysis from Citigroup proposed a fascinating scenario, with many interesting implications, although I'd argue that it's also subject to the simple advice of Herb Stein that "If something cannot go on forever, it will stop." By coincidence, it's also relevant to the energy debate underway between the US presidential campaigns. Although it's highly uncertain that Saudi Arabia's oil exports will dry up by 2030, we shouldn't assume such an outcome to be impossible, any more than we should base US energy policy on the outdated assumption that it's impossible for us to come close to eliminating the need for oil imports from outside North America. It might be uncertain whether we have sufficient resources accessible with the latest technology to reach that goal, but it is essentially certain that the growing but still tiny contribution of renewable energy and the eventual conversion of the US vehicle fleet to electricity couldn't get us there for multiple decades.
Monday, August 27, 2012
Exports Raise the Bar for US Strategic Petroleum Releases
I've seen a number of Tweets suggesting that the US will release oil from its Strategic Petroleum Reserve (SPR) sometime in the next month or two, perhaps in tandem with other member countries of the International Energy Agency. Although circumstances might provide several possible rationales for such a release, including the implementation of tougher sanctions on Iran's oil sector and the possibility that Hurricane Isaac will disrupt some production in the Gulf Coast, it's hard to avoid a political interpretation, as well. As we head into a close Presidential election, gas prices are rising again, and that's never good for an incumbent. Selling oil from the SPR is one of the few levers available that might affect short-term energy prices. However, much has changed since the Clinton administration released 30 million barrels (via exchange) in the lead-up to the 2000 election. In particular, the country's switch from net importer to net exporter of petroleum products implies that a release in response to events other than a physical disruption in oil supplies could result in some of the benefit of such a release being exported, as well.
When it comes to uses of the SPR, I'm a purist, probably because I can recall sitting in gas lines and participating involuntarily in the bizarre "odd-even" rationing-by-license-plate scheme introduced during the oil crisis following the Iranian Revolution. The SPR was designed to provide a backstop for our vital energy supplies in a true physical emergency, not as a tool for price manipulation. I've also suggested for some time that the SPR is overdue for a comprehensive reassessment of its structure. Our energy situation has changed significantly since the mid-1970s, when the present SPR was established, and we are in the midst of the biggest changes in US energy supply and demand patterns in decades. We ought to invest the time and money required to bring this institution into the 21st century. Earlier this year, I also suggested an alternative mechanism for leveraging SPR inventories without depleting them. These are tasks for after the election, whoever wins. For now, we have what we have, and we should think carefully about the implications of using it in situations less compelling than a war in the Persian Gulf or an unanticipated disruption in North American or global supplies.
One of the changes that must be taken into account is our recent shift in refined product exports, about which I've written previously. US refineries are capitalizing on the expansion of domestic oil production in a period of weak US demand to continue to operate at high utilization rates and export the resulting surplus output to growing economies in Latin America and elsewhere. This is generally a good thing, because it helps preserve capacity that might otherwise no longer be available when our own economy eventually resumes healthier growth. It also sustains employment we would sorely miss in a terrible job market. Furthermore, we have benefited greatly in reliability and flexibility from participating on both sides of the global market in refined products. Still, although I view our petroleum product exports as generally positive--just as I do Boeing's exports of jetliners--I wouldn't advocate using petroleum stockpiles purchased with tax dollars to drive down oil prices to give these refiners an even bigger export advantage. Yet because of its temporary nature, in contrast to new pipelines or new production, that's exactly where at least some of the benefit of SPR oil released in the absence of a serious supply crisis would go now.
That doesn't mean I regard rising oil or gasoline prices as harmless to the economy. Consumers are facing the highest pump prices heading into Labor Day weekend since 2008, and that could have a ripple effect throughout the economy. But even if one ignores the longstanding bi-partisan principle that the SPR is intended only as a crisis-management tool, its effectiveness at moderating oil-price volatility is limited. Last year's coordinated SPR release, prompted by the Libyan revolution, had little persistent effect on either oil or gasoline prices. A release now is likely to be no more effective when US refineries are already running above 90% utilization and the current 4-week averages show 3.6% of US gasoline production and 23% of diesel output being exported. None of these statistics suggest refiners are experiencing difficulties in obtaining feedstocks, other than on price. Putting SPR oil into such a market might boost refiners' margins for a while, but it's doubtful it would do much for the product prices that matter to consumers.
There are sharp differences between President Obama and Governor Romney, not least on energy policy. We're sure to hear more about energy from both campaigns in the weeks ahead, and I plan to analyze their positions closer to election day. However, one factor this election doesn't need is a release of oil from the SPR that appears to be aimed at dampening gasoline prices that often decline after Labor Day without intervention, rather than being justified by a tangible threat to US oil supplies, and that fails to take into account the added complexity of net product exports. That wouldn't serve the interests of voters, taxpayers or consumers, and it would come at the expense of a little bit of our collective energy security.
When it comes to uses of the SPR, I'm a purist, probably because I can recall sitting in gas lines and participating involuntarily in the bizarre "odd-even" rationing-by-license-plate scheme introduced during the oil crisis following the Iranian Revolution. The SPR was designed to provide a backstop for our vital energy supplies in a true physical emergency, not as a tool for price manipulation. I've also suggested for some time that the SPR is overdue for a comprehensive reassessment of its structure. Our energy situation has changed significantly since the mid-1970s, when the present SPR was established, and we are in the midst of the biggest changes in US energy supply and demand patterns in decades. We ought to invest the time and money required to bring this institution into the 21st century. Earlier this year, I also suggested an alternative mechanism for leveraging SPR inventories without depleting them. These are tasks for after the election, whoever wins. For now, we have what we have, and we should think carefully about the implications of using it in situations less compelling than a war in the Persian Gulf or an unanticipated disruption in North American or global supplies.
One of the changes that must be taken into account is our recent shift in refined product exports, about which I've written previously. US refineries are capitalizing on the expansion of domestic oil production in a period of weak US demand to continue to operate at high utilization rates and export the resulting surplus output to growing economies in Latin America and elsewhere. This is generally a good thing, because it helps preserve capacity that might otherwise no longer be available when our own economy eventually resumes healthier growth. It also sustains employment we would sorely miss in a terrible job market. Furthermore, we have benefited greatly in reliability and flexibility from participating on both sides of the global market in refined products. Still, although I view our petroleum product exports as generally positive--just as I do Boeing's exports of jetliners--I wouldn't advocate using petroleum stockpiles purchased with tax dollars to drive down oil prices to give these refiners an even bigger export advantage. Yet because of its temporary nature, in contrast to new pipelines or new production, that's exactly where at least some of the benefit of SPR oil released in the absence of a serious supply crisis would go now.
That doesn't mean I regard rising oil or gasoline prices as harmless to the economy. Consumers are facing the highest pump prices heading into Labor Day weekend since 2008, and that could have a ripple effect throughout the economy. But even if one ignores the longstanding bi-partisan principle that the SPR is intended only as a crisis-management tool, its effectiveness at moderating oil-price volatility is limited. Last year's coordinated SPR release, prompted by the Libyan revolution, had little persistent effect on either oil or gasoline prices. A release now is likely to be no more effective when US refineries are already running above 90% utilization and the current 4-week averages show 3.6% of US gasoline production and 23% of diesel output being exported. None of these statistics suggest refiners are experiencing difficulties in obtaining feedstocks, other than on price. Putting SPR oil into such a market might boost refiners' margins for a while, but it's doubtful it would do much for the product prices that matter to consumers.
There are sharp differences between President Obama and Governor Romney, not least on energy policy. We're sure to hear more about energy from both campaigns in the weeks ahead, and I plan to analyze their positions closer to election day. However, one factor this election doesn't need is a release of oil from the SPR that appears to be aimed at dampening gasoline prices that often decline after Labor Day without intervention, rather than being justified by a tangible threat to US oil supplies, and that fails to take into account the added complexity of net product exports. That wouldn't serve the interests of voters, taxpayers or consumers, and it would come at the expense of a little bit of our collective energy security.
Wednesday, August 22, 2012
The Unlevel Playing Field for Energy
An editorial in last weekend's Wall St. Journal led me to a recent analysis by the US Energy Information Agency (EIA) summarizing the costs of the federal government's various "subsidies" for energy from different sources. This is both useful and timely, since discussions of specific subsidies such as the expiring wind production tax credit inevitably lead to questions about how incentives for renewable energy compare to those for oil, gas, nuclear, and other more traditional sources. As the Journal noted, the EIA stopped short of comparing these incentives on the basis of the relative productivity of different energy sources, but even without that it's still apparent that the category of new renewable electricity--excluding hydropower--received 21% of the federal energy benefits for 2010, while accounting for less than 3% of domestic energy production that year, when oil and gas, which provided 49% of US energy production, received less than 8% of these benefits. Whether on an absolute or relative basis, renewables receive much more generous federal support than oil and gas.
Before digging further into the EIA's analysis, I should point out an important distinction between the federal expenses and incentives covered in the report and the externalities that are frequently conflated with them. It is certainly true that many of these energy technologies involve significant impacts that aren't reflected in their market prices, and that the production and especially the consumption of fossil fuels create serious environmental and security externalities. However, to whatever extent federal subsidies address externalities they do so indirectly, at best, and in many cases inefficiently. The focus of this posting, just like the EIA report's, is on the federal government's cash outlays and "tax expenditures"--deductions, credits, etc.--that have a direct bearing on the federal deficit and debt burden that are the subject of intense debate in this election cycle.
The tables in the report's executive summary reveal several key facts. Between 2007 and 2010 federal energy subsidies in constant dollars more than doubled to $37.2 B, with most of the increase going to renewables and energy efficiency, except for a sizable bump in low-income energy assistance payments. $14.8 B of the increase originated with the 2009 stimulus bill, none of which was directed at oil and gas, but which appropriated nearly $8 B to conservation and efficiency. Overall, renewables received $14.7 B, split 55/45 between electricity and biofuels, while nuclear received $2.5 B and oil and gas $2.8 B. The latter figure is lower than you'll see elsewhere, because among other incentives that the EIA chose to exclude from its analysis was the Section 199 deduction for manufacturers, which is budgeted at around $1 B/yr for oil and gas firms. The logic behind that exclusion seems sound, because US manufacturers of biofuels, wind turbines, solar panels and other renewable energy equipment qualify for the same tax credit, and at a higher rate than oil companies.
I was also struck by the fact that oil and gas received just $70 million out of the more than $4 B spent on R&D. If there's one category in which federal expenditures on renewables should be expected to dwarf those for conventional energy, this is it, and they did so by a factor of more than 20 times. (Coal R&D received more than $0.6 B, presumably for clean coal technologies.)
It's also the case that while the growth of renewable energy output from 2000-10 was dramatic, the relatively smaller net changes in oil and gas output in that period masked the substantial replacement of depleting resources that would have otherwise resulted in a large drop in output, especially for natural gas. This is precisely the aspect of the mature oil and gas industry at which these federal incentives are aimed, to enable US projects to compete with the international opportunities to which many of these companies have access.
The authors of the report suggested caution in comparing the allocations of incentives to the energy produced by each technology, because some of these incentives were paid for projects still under construction and in some cases represented the front-loading of what would otherwise have been a 10-year stream of tax credits. Fair enough. Yet even with the conservative assumption that the entire $4.9 B of non-R&D subsidies for wind power in 2010 came in the form of cash grants in lieu of the 30% investment tax credit for new wind turbines that would produce for 20 years at a 30% capacity factor, that still equates to a subsidy of more than 16% of the average present wholesale value of all the electricity those turbines will produce, using prevailing industrial sector electricity prices as a proxy for wholesale prices. By comparison, the $2.7 B of oil and gas tax incentives for 2010 represented just 1% of the wholesale value of US production of these fuels, before refining.
A serious debate about the appropriate level of US energy subsidies should begin with the facts, rather than with misperceptions. It should also focus first on the goals of such incentives, before jumping to the details of this tax credit vs. that one. What do we want these measures to achieve? If it's simply the promotion of energy production, then the current incentive system looks too heavily skewed in favor of renewables. If it's jobs, then we should be realistic about how many can be added by such a capital-intensive sector. If it's the promotion of both energy security and innovation, then at least parts of the current system look directionally right, though I'd argue that we'd benefit from spending more on renewable energy R&D and less on the deployment of mature-but-expensive technologies like wind. However, if emissions and climate change are our primary concerns, then these incentives are not a terribly effective way to address them. My own expectation is that regardless of whether the wind tax credit is extended for another year, most of the tax incentives that the EIA assessed here will eventually be swept away by tax reform focused on reducing corporate tax rates to improve US competitiveness, while eliminating loopholes to make the changes revenue-neutral.
Before digging further into the EIA's analysis, I should point out an important distinction between the federal expenses and incentives covered in the report and the externalities that are frequently conflated with them. It is certainly true that many of these energy technologies involve significant impacts that aren't reflected in their market prices, and that the production and especially the consumption of fossil fuels create serious environmental and security externalities. However, to whatever extent federal subsidies address externalities they do so indirectly, at best, and in many cases inefficiently. The focus of this posting, just like the EIA report's, is on the federal government's cash outlays and "tax expenditures"--deductions, credits, etc.--that have a direct bearing on the federal deficit and debt burden that are the subject of intense debate in this election cycle.
The tables in the report's executive summary reveal several key facts. Between 2007 and 2010 federal energy subsidies in constant dollars more than doubled to $37.2 B, with most of the increase going to renewables and energy efficiency, except for a sizable bump in low-income energy assistance payments. $14.8 B of the increase originated with the 2009 stimulus bill, none of which was directed at oil and gas, but which appropriated nearly $8 B to conservation and efficiency. Overall, renewables received $14.7 B, split 55/45 between electricity and biofuels, while nuclear received $2.5 B and oil and gas $2.8 B. The latter figure is lower than you'll see elsewhere, because among other incentives that the EIA chose to exclude from its analysis was the Section 199 deduction for manufacturers, which is budgeted at around $1 B/yr for oil and gas firms. The logic behind that exclusion seems sound, because US manufacturers of biofuels, wind turbines, solar panels and other renewable energy equipment qualify for the same tax credit, and at a higher rate than oil companies.
I was also struck by the fact that oil and gas received just $70 million out of the more than $4 B spent on R&D. If there's one category in which federal expenditures on renewables should be expected to dwarf those for conventional energy, this is it, and they did so by a factor of more than 20 times. (Coal R&D received more than $0.6 B, presumably for clean coal technologies.)
It's also the case that while the growth of renewable energy output from 2000-10 was dramatic, the relatively smaller net changes in oil and gas output in that period masked the substantial replacement of depleting resources that would have otherwise resulted in a large drop in output, especially for natural gas. This is precisely the aspect of the mature oil and gas industry at which these federal incentives are aimed, to enable US projects to compete with the international opportunities to which many of these companies have access.
The authors of the report suggested caution in comparing the allocations of incentives to the energy produced by each technology, because some of these incentives were paid for projects still under construction and in some cases represented the front-loading of what would otherwise have been a 10-year stream of tax credits. Fair enough. Yet even with the conservative assumption that the entire $4.9 B of non-R&D subsidies for wind power in 2010 came in the form of cash grants in lieu of the 30% investment tax credit for new wind turbines that would produce for 20 years at a 30% capacity factor, that still equates to a subsidy of more than 16% of the average present wholesale value of all the electricity those turbines will produce, using prevailing industrial sector electricity prices as a proxy for wholesale prices. By comparison, the $2.7 B of oil and gas tax incentives for 2010 represented just 1% of the wholesale value of US production of these fuels, before refining.
A serious debate about the appropriate level of US energy subsidies should begin with the facts, rather than with misperceptions. It should also focus first on the goals of such incentives, before jumping to the details of this tax credit vs. that one. What do we want these measures to achieve? If it's simply the promotion of energy production, then the current incentive system looks too heavily skewed in favor of renewables. If it's jobs, then we should be realistic about how many can be added by such a capital-intensive sector. If it's the promotion of both energy security and innovation, then at least parts of the current system look directionally right, though I'd argue that we'd benefit from spending more on renewable energy R&D and less on the deployment of mature-but-expensive technologies like wind. However, if emissions and climate change are our primary concerns, then these incentives are not a terribly effective way to address them. My own expectation is that regardless of whether the wind tax credit is extended for another year, most of the tax incentives that the EIA assessed here will eventually be swept away by tax reform focused on reducing corporate tax rates to improve US competitiveness, while eliminating loopholes to make the changes revenue-neutral.
Tuesday, August 07, 2012
Are Films the Answer to Understanding Energy's Complexities?
The issues and choices surrounding our use of energy have rarely been more complex than today, yet our main channels for information about them are discouragingly shallow. The web is often more effective at spreading misperceptions than fact-based analysis. When our visual media focus on energy, it's usually to flash bad news before flitting on to the next story, leaving behind images of burning oil platforms or blacked-out cities. One bright spot is the recent wave of documentary films on energy topics. Films engage us on a deeper level, and the energy challenges we face deserve such longer-form treatment. August seems like a perfect time to suggest a few of them to you. If you're reading this blog, then I'm betting you might at least consider watching a movie about energy instead of the latest summer blockbuster.
Although it was hardly the first serious film about energy, the recent trend seemed to start with "Gasland". For all its inaccuracies, which have been documented by groups outside industry, that film helped start a national conversation about the right way to develop the enormous unconventional oil and gas resources that new combinations of technology have unlocked. In the spirit of making that dialog more constructive and even-handed, you should also know about two other documentaries covering the same topic and region from a different angle. To many of the farmers and other landowners in depressed counties of New York and Pennsylvania, fracking is not a curse but an actual or potential lifeline. Seeing "Truthland" and "Empire State Divide" might not convert fracking skeptics into gas industry supporters, but it should at least fill in some of the gaps left by the "Gasland's" starkly one-sided portrayal of shale gas.
Another energy film I recently ran across, "spOILed", offers a timely reminder that despite oil's many problems it remains an essential ingredient of our global civilization, providing affordable mobility and a host of products that have made our lives much easier than those of our ancestors--or of people in countries that still lack reliable access to energy. "spOILed" is also very much a movie about the dangers of Peak Oil, which envisions a world in which declining oil production, rising demand in developing countries, and geopolitical risks create persistent and growing shortages of oil. This is particularly sobering when combined with a sense of just how challenging it will be to obtain the services that oil now provides from other energy sources. Unfortunately, the film's message was undermined by occasionally jarring choices of visuals, some hyperbolic claims--no indoor plumbing without oil?--and by political overtones that might limit its effectiveness with the wider audience it appears to target.
The energy film project that I'm most excited about is one aimed consciously at finding and cultivating "The Rational Middle" in the energy debate. According to its director, Gregory Kallenberg, it started with a TED talk following his previous film, "Haynesville", which examined the impact of shale gas in Northern Louisiana. As I understand it, the current project consists of 10 short videos on energy, four of which have been released on the group's website so far. From the episodes I've seen, Mr. Kallenberg's team assembled an impressive group of experts, including Amy Myers Jaffe of the Baker Institute at Rice University, Michael Levi of the Council on Foreign Relations, former Energy Information Agency Administrator Richard Newell, and Dr. Michael Webber of the University of Texas. The series is being launched with a road show featuring panels of some of the same experts interviewed in the films, starting with a session at this year's Aspen Ideas Festival. The films are focused on information and process, rather than on selling one point of view. Aside from a few assertions in a couple of interviews, the factual presentation in the initial videos was very sound. I expect to have more to say about The Rational Middle as additional episodes become available.
If the we are to develop effective energy policies for the 21st century, the public's desire for clean, secure, reliable and affordable energy must be grounded in facts and figures that help us to differentiate realistic expectations from wish fulfilment. I'm encouraged that a growing number of filmmakers seems willing to explore energy issues in the depth they deserve, with production values that will connect with today's audiences, rather than turning them off. Enjoy!
Although it was hardly the first serious film about energy, the recent trend seemed to start with "Gasland". For all its inaccuracies, which have been documented by groups outside industry, that film helped start a national conversation about the right way to develop the enormous unconventional oil and gas resources that new combinations of technology have unlocked. In the spirit of making that dialog more constructive and even-handed, you should also know about two other documentaries covering the same topic and region from a different angle. To many of the farmers and other landowners in depressed counties of New York and Pennsylvania, fracking is not a curse but an actual or potential lifeline. Seeing "Truthland" and "Empire State Divide" might not convert fracking skeptics into gas industry supporters, but it should at least fill in some of the gaps left by the "Gasland's" starkly one-sided portrayal of shale gas.
Another energy film I recently ran across, "spOILed", offers a timely reminder that despite oil's many problems it remains an essential ingredient of our global civilization, providing affordable mobility and a host of products that have made our lives much easier than those of our ancestors--or of people in countries that still lack reliable access to energy. "spOILed" is also very much a movie about the dangers of Peak Oil, which envisions a world in which declining oil production, rising demand in developing countries, and geopolitical risks create persistent and growing shortages of oil. This is particularly sobering when combined with a sense of just how challenging it will be to obtain the services that oil now provides from other energy sources. Unfortunately, the film's message was undermined by occasionally jarring choices of visuals, some hyperbolic claims--no indoor plumbing without oil?--and by political overtones that might limit its effectiveness with the wider audience it appears to target.
The energy film project that I'm most excited about is one aimed consciously at finding and cultivating "The Rational Middle" in the energy debate. According to its director, Gregory Kallenberg, it started with a TED talk following his previous film, "Haynesville", which examined the impact of shale gas in Northern Louisiana. As I understand it, the current project consists of 10 short videos on energy, four of which have been released on the group's website so far. From the episodes I've seen, Mr. Kallenberg's team assembled an impressive group of experts, including Amy Myers Jaffe of the Baker Institute at Rice University, Michael Levi of the Council on Foreign Relations, former Energy Information Agency Administrator Richard Newell, and Dr. Michael Webber of the University of Texas. The series is being launched with a road show featuring panels of some of the same experts interviewed in the films, starting with a session at this year's Aspen Ideas Festival. The films are focused on information and process, rather than on selling one point of view. Aside from a few assertions in a couple of interviews, the factual presentation in the initial videos was very sound. I expect to have more to say about The Rational Middle as additional episodes become available.
If the we are to develop effective energy policies for the 21st century, the public's desire for clean, secure, reliable and affordable energy must be grounded in facts and figures that help us to differentiate realistic expectations from wish fulfilment. I'm encouraged that a growing number of filmmakers seems willing to explore energy issues in the depth they deserve, with production values that will connect with today's audiences, rather than turning them off. Enjoy!
Wednesday, August 01, 2012
Last Hurrah for the Wind Power Tax Credit?
Ahead of Thursday's meeting of the Senate Finance Committee, a bipartisan deal has apparently omitted the expiring production tax credit (PTC) for wind power from a package of "tax extenders"--various expiring federal tax provisions, including the annual "patch" for the Alternative Minimum Tax. This development might surprise some of the industry's supporters, but the politics of wind have changed since I last examined this issue in February. A measure that once enjoyed solid bi-partisan support is now caught between two presidential campaigns that hold diametrically opposed views on its fate.
A quick review of the PTC seems in order. This tax credit, which covers a variety of technologies but with wind as the main beneficiary, dates back to 1992--interrupted by several past expirations but then revived in essentially its present form. That's significant, because during the same 20 years in which the PTC has been escalating annually with inflation--from 1.5 ¢ per kilowatt-hour (kWh) to the present level of 2.2 ¢/kWh--the cost of wind turbines and their output has fallen significantly. In the same period, US installed wind capacity grew from 1,680 MW to nearly 49,000 MW as of the first quarter of 2012. So in effect, we're subsidizing today's relatively mature onshore wind technology by a larger proportion than we did when it was in its infancy. That makes no sense, especially in the current environment.
The US wind industry has received substantial government support in recent years. When the long-standing tax credit against corporate profits proved to be much less beneficial during the financial crisis, the administration gave wind developers a better option within the stimulus: a 30% investment tax credit that could be claimed as up-front cash grants, instead of having to wait until power was generated and sold over the normal 10 year period of the PTC. From 2009-11 the wind industry received a cumulative $7.7 B, in addition to ongoing tax credits on older projects, manufacturing tax credits for new wind turbine factories, and loan guarantees for selected wind farms. And even with new turbine installations in 2012 running well below their record rate of 10,000 MW in 2009, the wind projects that qualify for the PTC this year could receive a total of $4.5 B over the next decade.
Many people seem to want to equate the tax breaks that wind and other renewable energy technologies receive with the controversial tax benefits for the oil and gas industry, without realizing how unfavorable that comparison truly is for renewables. Subsidies for technologies such as wind are much higher per unit of energy produced, consistent with their intended purpose of bridging the competitive gap vs. conventional energy. Yet since the total output of new renewables is still relatively small, the disparity in total subsidies is much larger than it appears. One way to illustrate that is that if the oil and natural gas produced in the US received tax credits at the same rate per equivalent kWh as wind power, then the annual oil and gas tax preferences that the Congress and President Obama have been sparring over for the last three years wouldn't be $4.8 B per year, but around $100 B per year.
As the Reuters article makes clear, there will be other opportunities for the PTC to be reinserted in the extenders bill or other legislation. However, by persistently arguing for extending the existing credit without modification, the wind industry and its supporters may be misreading the public's appetite for such generous subsidies in a period of protracted economic weakness, notwithstanding the recent Iowa poll. Despite its rapid recent growth wind still contributes less than 4% of the nation's electricity and just 1% of our total energy consumption, and the green jobs angle is wearing thin. Last year's expiration of the ethanol blenders credit set a precedent for ending another large, generous subsidy before its beneficiaries agreed they were done with it. If congressional Republicans line up behind their party's standard bearer on this issue, the wind industry will have missed its opportunity for a graduated, multi-year phaseout of the PTC, instead of stepping off a cliff in 2013.
A quick review of the PTC seems in order. This tax credit, which covers a variety of technologies but with wind as the main beneficiary, dates back to 1992--interrupted by several past expirations but then revived in essentially its present form. That's significant, because during the same 20 years in which the PTC has been escalating annually with inflation--from 1.5 ¢ per kilowatt-hour (kWh) to the present level of 2.2 ¢/kWh--the cost of wind turbines and their output has fallen significantly. In the same period, US installed wind capacity grew from 1,680 MW to nearly 49,000 MW as of the first quarter of 2012. So in effect, we're subsidizing today's relatively mature onshore wind technology by a larger proportion than we did when it was in its infancy. That makes no sense, especially in the current environment.
The US wind industry has received substantial government support in recent years. When the long-standing tax credit against corporate profits proved to be much less beneficial during the financial crisis, the administration gave wind developers a better option within the stimulus: a 30% investment tax credit that could be claimed as up-front cash grants, instead of having to wait until power was generated and sold over the normal 10 year period of the PTC. From 2009-11 the wind industry received a cumulative $7.7 B, in addition to ongoing tax credits on older projects, manufacturing tax credits for new wind turbine factories, and loan guarantees for selected wind farms. And even with new turbine installations in 2012 running well below their record rate of 10,000 MW in 2009, the wind projects that qualify for the PTC this year could receive a total of $4.5 B over the next decade.
Many people seem to want to equate the tax breaks that wind and other renewable energy technologies receive with the controversial tax benefits for the oil and gas industry, without realizing how unfavorable that comparison truly is for renewables. Subsidies for technologies such as wind are much higher per unit of energy produced, consistent with their intended purpose of bridging the competitive gap vs. conventional energy. Yet since the total output of new renewables is still relatively small, the disparity in total subsidies is much larger than it appears. One way to illustrate that is that if the oil and natural gas produced in the US received tax credits at the same rate per equivalent kWh as wind power, then the annual oil and gas tax preferences that the Congress and President Obama have been sparring over for the last three years wouldn't be $4.8 B per year, but around $100 B per year.
As the Reuters article makes clear, there will be other opportunities for the PTC to be reinserted in the extenders bill or other legislation. However, by persistently arguing for extending the existing credit without modification, the wind industry and its supporters may be misreading the public's appetite for such generous subsidies in a period of protracted economic weakness, notwithstanding the recent Iowa poll. Despite its rapid recent growth wind still contributes less than 4% of the nation's electricity and just 1% of our total energy consumption, and the green jobs angle is wearing thin. Last year's expiration of the ethanol blenders credit set a precedent for ending another large, generous subsidy before its beneficiaries agreed they were done with it. If congressional Republicans line up behind their party's standard bearer on this issue, the wind industry will have missed its opportunity for a graduated, multi-year phaseout of the PTC, instead of stepping off a cliff in 2013.
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