Friday, July 29, 2005

Longer Days
In my discussion of the pending Energy Bill on Wednesday, I neglected to mention a provision that may actually have a greater impact on Americans than all the others combined: the extension of Daylight Savings Time (DST) by a month, starting next year. While its supporters argue this will reduce electricity demand by 1%, recent experience suggests that the net energy savings may be more modest and chiefly come in the form of load-shifting that would benefit areas where peak generating capacity is tight. But aside from its debatable energy benefits, the larger impact of extended DST may be symbolic, and I worry about the message being sent.

Anyone over 40 probably remembers the last time this step was taken. Daylight Savings Time was extended by President Nixon in the wake of the Arab Oil Embargo of 1973-74. Other responses to that emergency included the 55 mile per hour speed limit and the establishment of the Strategic Petroleum Reserve. But we're not really in an "energy crisis" now, but rather a market-driven adjustment to capacity constraints. What kind of signal does extended daylight saving time send, compared to the signals already being sent by higher energy prices?

More importantly, I'm concerned about the subtext of the message. "We're in a fix and the best we can do is reach back to a thirty year old emergency measure" doesn't really cut it for me. As I've suggested many times in this blog and in conversation with friends and colleagues, the most striking difference between the energy crises of the 1970s and the situation in which we find ourselves today is the wealth of options we now have: our sources of oil are more diverse, we have hybrid cars that can get more than 50 miles per gallon, natural gas is becoming a diversified global business--thanks to technology and cost improvements in LNG--and renewable energy, especially wind power, is ready for prime time. None of this was true in 1973 or 1979.

If adding a few more hours of evening daylight--and morning darkness--in March and November alerts Americans that we should be more efficient in our use of energy, that's great. But if it shifts our focus away from the real solutions that are now available to us and tells us that we are back in the same box as the 1970s, then it will merely be a counterproductive annoyance.

Thursday, July 28, 2005

The Sierra Club and Ford
Hats off to the Sierra Club and Ford for finding a way to work together. While other environmentally-focused non-governmental organizations (NGOs) may feel that the Sierra Club has taken leave of its senses in helping Ford to promote a hybrid SUV, the Mercury Mariner, I think this represents a positive step towards addressing climate change and energy security in a context that will be palatable to most Americans.

It is certainly true, as a spokesperson from a more radical NGO--the Rainforest Action Network--implied, that even greater fuel economy and emissions reductions could be achieved if everyone just bought existing sub-compacts like the Ford Focus. However, the only way to make that happen would be by legislative edict. It hasn't even been possible to line up a majority of Congress to tighten the longstanding Corporate Average Fuel Economy standards for cars and light trucks, so don't expect a "mini-car mandate" any time soon.

As Amory Lovins of the Rocky Mountain Institute indicated in an interview in the Wall Street Journal's special section on the Car of the Future on Monday, the answer must lie in using technology to improve the performance of the cars people actually want to buy and drive. His suggested approach relies not only on hybrid engines, but also extensive use of carbon fiber materials to reduce the weight of cars without sacrificing safety. He makes a good argument that these interim measures would actually lower the hurdles that fuel cells must overcome for commercialization, and hasten a production fuel cell car.

Whatever the ultimate technology solution, which should be accompanied by effective policies to encourage Americans to reduce the number of miles they drive, it is important to get more cars like the Mariner on the road. If an endorsement from the Sierra Club helps that along, that's great.

Wednesday, July 27, 2005

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

Consider the basic issues that need to be addressed:

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

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

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

Tuesday, July 26, 2005

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

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

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

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

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

Monday, July 25, 2005

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

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

Friday, July 22, 2005

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

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

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

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

Thursday, July 21, 2005

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

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

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

Wednesday, July 20, 2005

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

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

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

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

Tuesday, July 19, 2005

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

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

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

Monday, July 18, 2005

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

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

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

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

Friday, July 15, 2005

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

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

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

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

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

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

Thursday, July 14, 2005

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

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

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

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

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

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

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

Wednesday, July 13, 2005

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

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

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

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

Tuesday, July 12, 2005

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

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

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

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

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

Monday, July 11, 2005

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

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

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

Friday, July 08, 2005

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

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

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

Thursday, July 07, 2005

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

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

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

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

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

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

Wednesday, July 06, 2005

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

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

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

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

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

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

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

Tuesday, July 05, 2005

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

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

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

Monday, July 04, 2005

Happy Independence Day

Friday, July 01, 2005

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

Some of the key learnings from the 1970s have held up well:
  • Direct government intervention in energy markets to affect prices is counterproductive, in both the short- and long-term.
  • Diversification of supply is a top priority for enhancing energy security, balanced against proximity and reliability of major suppliers.
  • The price-elasticity of demand for oil products is not zero, but the response takes time, as consumers and industry readjust their practices to accommodate higher energy prices.

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

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

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

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

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