Tuesday, February 28, 2006

Inside Big Oil

I'm becoming a real fan of Ben Stein's periodic columns in the New York Times. Aside from being impressed by his diverse talents--how many Presidential speechwriters and attorneys go on to become game-show hosts?--his view of business and economics is realistic and practical. No energy "insider", he nevertheless has good insights on the industry's workings. His column in this Sunday's business section focused on the people at big oil companies, and whether they deserve the ire they currently receive. It resonated deeply with my own experiences.

As you know from my bio, I spent over 20 years at Texaco, at the time one of the world's top 10 publicly-traded oil companies, and periodically one of the top 10 publicly-traded companies, period. When oil prices were high, we needed thick skins, because we were about as unpopular as the phone company, back in the days of Ma Bell. When prices were low, as they often were, sympathy for our plight was usually in short supply.

Like most of its peers, the company rewarded experience and required youth to pay its dues. There was a "fast track", but it was glacially slow compared to Wall Street. The corner offices tended to be occupied by grizzled, experienced "company men and women," with a few mid-career outside hires filling out the ranks in the 1990s. Patience and hard work were eventually rewarded with increasing responsibility and pay, but there were long years when all my peers in other industries seemed to make more than I did, particularly in an expensive city like L.A. Although there were many great things about working there, getting rich quick definitely wasn't one.

Whenever I asked myself why I stayed so long--in spite of some pretty attractive offers to work elsewhere--it always came down to the people: the collegiality of relationships, the breadth of knowledge, and the sense of being part of something that was almost a family. Sure, there were politics, and a few bosses along the way who made life miserable for short stretches. But they were always outweighed by truly decent managers and executives from whom I learned a tremendous amount--not just about business--and by peers who were great fun to be around, both on the job and off.

Time has moved on, Texaco is now part of Chevron, and I'm a consultant. Life may be more competitive in these companies, as it is everywhere, but I don't see anything to suggest that the vast majority of folks in Big Oil are fundamentally different than when I was one of them. They work hard, travel exhaustively--often to places you might not care to go--and on the whole are paid well, but no better than many other occupations. When they stay up late, it's not thinking up ways to exploit consumers, but worrying about how to do their jobs more effectively.

While there may be lots of folks getting rich as a result of high oil prices, very few of them work for Big Oil. Fewer than one in a thousand of them make $1,000,000 per year, and if you doubt that, check out the proxy statements. As Mr. Stein rightly describes, most of the profits of these firms find their way back to shareholders, which means to the pension funds and 401k's of millions of Americans. If you're looking for the big bucks, you need to be looking at the investment bankers, commodity traders, fund managers, and equity analysts that service the industry. Meanwhile, the vast majority of oil company employees must be content with decent salaries and benefits and the satisfaction that comes from doing work that's essential to the global economy.

Monday, February 27, 2006

Going the Wrong Way

The war of words with Venezuela is still perking along, with the latest indicator coming in the form of threats by the country's oil minister to steer their petroleum exports away from the US. These aren't hollow threats, but they come with a steep price tag for both sides. Although Venezuela can export its oil anywhere it chooses, it won't find another market as conveniently located or well-positioned to pay top dollar. At the same time, losing this nearby supply could cost the US between one and two billion dollars per year and increase our dependence on imports from the Middle East.

The economic consequences for Mr. Chavez are clear. Instead of selling his oil into a huge market five days' sail from his ports, to refiners with many years of experience processing these generally lower quality crudes--and billions of dollars in upgrading hardware optimized to get the most out of them--he will be selling to customers a 30-day voyage or more away, and with refineries less adaptable to turning this heavy, sour crude into clean transportation fuels. That means deeper discounts against global "marker" crudes like Brent, and even lower netbacks to Venezuela because of the extra freight cost.

But the consequences don't stop there. Mr. Chavez has already squeezed the international companies whose heavy investments in Venezuela have boosted the country's production at a time when the combination of natural decline and the decimation of PdVSA's staff after the 2002 strike were sending it steadily downward. By artificially shutting these "upgraded" crudes out of their natural market in the US, Venezuela will further diminish the attractiveness of these and any future investments by the international majors--whom he is already working overtime to alienate--and lock in a steeper decline curve for the country's total output. Nor is Mr. Chavez in a position to make the next set of investments himself, because he is using the oil profits to fund his social and regional initiatives.

Unfortunately, the consequences for the US look nearly as bad. We currently import 1.3 million barrels per day of petroleum from Venezuela. While it's true that we will find other oil in the market to replace any volumes diverted to China or India, it will have to come from the other side of the world. Because the refineries running Ven crudes are configured to be most efficient and profitable when processing low quality inputs, suitable replacement barrels will probably not come from West Africa or Northwest Europe, where production tends to be lighter and lower in sulfur--and much pricier. The incremental barrels most like Venezuela's are found in the Middle East, in Saudi Arabia and in the Partitioned Neutral Zone between the Kingdom and Kuwait.

This global rebalancing will have a further ripple effect via a double-whammy on volume: for each barrel of Ven. crude diverted from the US to China, another barrel that went elsewhere must come here. With these voyages tying up the tankers involved for much longer charters, because of the greater distances involved, global long-haul tanker rates will rise, perhaps sharply. So not only will we pay more to bring replacement volumes to the US from suppliers far away, but every barrel of oil coming to the US will carry a higher freight tab.

In addition, to the degree that the substitutes may differ in their key characteristics from the Ven crudes they would replace, refinery yields and margins in the US would suffer, reducing the profitability of the sector and possibly requiring higher imports of refined products, one source of which has also been Venezuela.

None of this is insurmountable, but it's hardly helpful, especially when the Administration has just announced a goal of reducing imports from the Middle East. It's easy to forget that forging closer ties with Venezuela was an important component of the supply diversification strategy that we adopted during the energy crisis of the 1970s, and that has served us very well since. The threat posed by Mr. Chavez to that stability is one of the main reasons I have devoted so much attention in this blog to a man who might otherwise be regarded as just another tinpot dictator like Zimbawe's Mugabe or Belarus's Lukashenko.

Friday, February 24, 2006

Blood and Oil

My posting on Iran last week prompted a series of comments about the war in Iraq and how we got there. In an op-ed in today's New York Times (which annoyingly requires a Times Select subscription to read) Ted Koppel neatly addresses the role of oil in that decision. Mr. Koppel places the Iraq War into the context of many decades of US policy concerning access to Persian Gulf oil, by administrations of both parties. He concludes that it was about oil, but not in the sense of controlling Iraq's reserves, as has been suggested by many critics of the war. His account strikes me as balanced and realistic.

In the leadup to the invasion in April 2003, one of the most common protest signs proclaimed, "No Blood for Oil." I found that slogan extremely frustrating, because most of the folks carrying it seemed to believe that we were going into Iraq to seize its oil fields, turn them over to Exxon, and reap the benefits of cheap oil for years. Not only have things not turned out that way, but it was clear to anyone who understood the structure of the international oil industry that such a plan could never have made sense, particularly not to US administration with more oil expertise than any in recent history. The rationale described by Mr. Koppel rightly identifies stability and access, rather than direct control, as the key goals for US oil strategy for the region. Unfortunately, "Yes, but not in the way you mean" makes a poor soundbite. It will be interesting to see how Mr. Koppel's arguments are interpreted and cited by others.

Although he omits a few details that might enhance his case, it's more important for us to ponder what comes next. If we extrapolate from the history he describes, together with the current situation in the region, our future options look quite challenging. In the same way that the basing of US troops in Saudi Arabia--particularly in the Hijaz--provided a convenient rallying cry for al Qaeda, the costs and benefits of a long-term US presence in Iraq, post-insurgency, must be carefully evaluated.

The other question we need to address is the degree to which the regional security function should eventually be managed by a multi-national organization, such as NATO, rather than the US or ad hoc coalitions. The EU, Japan and China consume the bulk of Persian Gulf oil, with only 2.5 million barrels per day of the region's 22 MBD of production coming here. However, as the world's largest oil importer, the US would be affected more than any of these by the market consequences of any interruption in the flow of oil from the PG.

Ultimately, as Mr. Koppel suggests, it's impossible to remove oil entirely from our understanding of our involvement in Iraq, or from consideration of our options for closing this chapter. Nor can it be extricated from our thinking about how to deal with the potential threat posed by Iran's nuclear program. It was and is about oil, just not in the way some might think.

Thursday, February 23, 2006

Hot Rocks

Geothermal energy doesn't get as much press as other forms of renewable energy--although I guess you could even quibble about the distinction between "renewable" and something that depletes over geologic timescales. When most of us think of geothermal, what we are really talking about is a somewhat rare subset in which nature has kindly brought together both the heat source, hot rock deep in the earth, and a working fluid, water. The problem with this kind of reservoir is that they often occur far from any potential electricity or heating needs. MIT's Technology Review reports on a major advance towards tapping the much larger, more widely dispersed resources of dry rock geothermal energy.

This is exciting, because geothermal energy has many potential benefits, few drawbacks, and is available on a scale that could ultimately meet most of our future energy needs, if it could be tapped efficiently. Unlike wind and solar power, it flows continuously, reducing the development threshold by making expensive power storage capacity unnecessary.

We shouldn't minimize the challenges of scaling up an experimental setup like this, and replicating it in many different locations. Researchers have been pursuing this goal for decades, and there will doubtless be engineering problems to be solved along the way. Still, given the tremendous potential payoff if it proves successful, one wonders why funding for this kind of technology hasn't been a higher priority. Although the European project cited above still appears to have some technical hurdles to overcome, including minimizing its noise impact, it seems like a very promising advance.

Wednesday, February 22, 2006

Not in My Hindenburg

The technology for putting Hydrogen-fueled cars on the road has reached a tricky point: past the glossy stage at which it existed only as shiny possibilities, but a long way from being economically competitive and widely available. In its present limbo, developers are being forced to address the real-world problems of community relations and service station permits without having a compelling product and a clear-cut economic advantage. GM has run into this brick wall in Tarrytown, a community in New York not far from where I live. Thanks to local opposition, it will have to find another city to use as a fuel cell vehicle test market.

We all know that hydrogen has an image problem concerning safety. Over the years I've read dozens of articles debunking this "Hindenburg effect", and yet the public still associates the fuel with a giant fireball consuming an airship, accompanied by the voice of the radio announcer saying, "Oh, the Humanity!" But I'm not sure that this is the whole story. We live in a peculiar time, surrounded by high-tech gizmos we can't imagine living without but deeply suspicious of the infrastructure that keeps them running.

My own town is in the midst of a long-running battle over cellphone antennas. You can't drive anywhere without seeing every other driver with a phone glued to his or her ear--in violation of a 5-month old handsfree law--but heaven forbid that Verizon should put up an antenna near any residential property, to improve the dreadful reception outside the downtown. The latest setback concerns a proposal to attach antennas to a 114 ft. tall water tower, which has been defeated in the state supreme court on the interpretation of the land-use restrictions in a deed.

Imagine trying to start up the gasoline service station network a hundred years ago with this kind of sensibility and a court system willing to facilitate it. It would never have gotten off the ground, and I grow increasingly skeptical that any alternative fuel that can't piggyback on the existing petroleum products infrastructure--or finesse it altogether, as in home battery recharging--can ever become ubiquitous enough to avoid a chicken-and-egg failure. That sounds pretty cynical, but unless communities change their attitudes toward things like LNG, high-voltage power lines, and hydrogen filling stations, we will see our available energy options pruned back to a progressively more restrictive and increasingly unimaginative short list.

Tuesday, February 21, 2006

Novel Influence

The latest controversy in the field of climate change is that President Bush apparently invited Michael Crichton to the White House to discuss the author's last novel, "State of Fear," a polemic against the science of climate change. This is causing ripples all over the blogosphere.

Long-time readers may recall that when the book came out last year I provided links to several critiques, including this one by the authors of one of the scientific papers cited in the novel's appendix. I'm not blind to the inferences being drawn in some quarters, but I don't see what can be gained by jumping all over this report. In the current political environment, it would be easy to exaggerate the significance of the meeting in question, especially in terms of any practical difference it might make. I will leave it to others to thrash this out until it has exhausted our feeble attention spans.

Instead, I'd like to make a point about Mr. Crichton and his novel that ought to be less controversial but more meaningful. It goes to the notable failure of those of us who believe we understand the risks of climate change to convince the rest of the country. Michael Crichton may be an important bellwether in this regard.

Contrary to ad hominem attacks on him, he is a smart, educated person. As I pointed out in a comment on another blog, while he may not qualify as a scientist, his training as an MD (Harvard) would have given him a pretty good grounding in the scientific method and the history of science. He can accurately be described as an educated consumer of science, and that's the source of my concern. If a thorough reading of the evidence has failed to convince him of the validity of the scientific consensus, then on what basis can the 99.9% of humanity lacking even this level of scientific training accept or reject climate change, other than as a matter of faith?

It is necessary, but by no means sufficient, that a majority of scientists believes in the threat. If a vast array of scientific papers, conference proceedings and reports from the UN Framework Convention on Climate Change and its periodic confabs can't convince someone with Michael Crichton's background that climate change is a serious problem, how will we win over voters who aren't pre-disposed to the sacrifices that combating it will require--and who may not have taken a math or science class after high school?

As I recall being told many times on my way up the corporate ladder, having the best idea or project in the world isn't worth much, if you can't sell it to management. Despite the efforts of many in the science and NGO community, the explanation of climate change and its consequences is clearly missing some ingredient necessary for convincing the electorate. Finding it may be at least as important as making further refinements in the climate models. Perhaps we should start by asking Mr. Crichton what it would take to convince him.

Sunday, February 19, 2006

Dogbert, Energy Analyst

Several emails called my attention to Sunday's Dilbert comic, which comments on energy security, of all things. In eight panels Dilbert's dog, Dogbert, issues a pithy and substantive critique of the Geo-Green strategy for undermining the financing of Islamic terrorism by reducing our oil consumption, partly through the use of hybrid and plug-in hybrid cars. In the process, Scott Adams takes on Tom Friedman, James Woolsey and other advocates of this approach and aquits himself pretty well.

This prompted me to dredge up two postings from early 2005, with my early reactions to Geo-Green, pro and con:

Monday, January 31, 2005
Is "Geo-Green" The Answer?

Despite my usual soft spot for Tom Friedman and his normally insightful and bold commentary on geopolitics, his editorial in Sunday's New York Times oversimplified a bit too far with its "Geo-Green" energy strategy. Although he neatly describes the paucity of options for dissuading Iran's leaders from pursuing nuclear weapons (see Friday's posting) his prescription for reforming Iran and the rest of the Middle East by driving the price of oil back down to $18 per barrel rests on a shaky foundation.

Based on past oil market behavior, getting oil prices back to this level any time soon would probably require a combination of reduced global demand or increased global production on the order of 4 million barrels per day (MBD). Half of this volume represents a return to OPEC's recent "normal" quota of 25 MBD from its current, essentially flat-out quota of 27 MBD, while the other half mirrors the magnitude of demand drop that sent oil markets into free fall in the 1997 Asian Economic Crisis.

Although some new production will come on stream this year, most of the difference would have to come from the demand side, where Mr. Friedman's "geo-green" options of conservation and substitution via renewables and nuclear power reside. Since most petroleum is used for mobility, while most electricity is used for stationary purposes, the impact of renewables and nuclear on oil demand is fairly indirect and long-term. This leaves us with conservation, which is normally spurred by high prices--at least initially--rather than the low prices Mr. Friedman hopes to achieve. This is something of a paradox, unless he is willing to consider hefty new taxes on petroleum products to raise consumer prices without changing producer prices.

Even if I've overstated what it would take to drive oil prices down, there are other factors to consider. Although a low oil price world would benefit the US economy, along with some of the poorest nations on the planet, it would reduce the incentives to find more oil and to develop the technologies that must ultimately supplant oil. Along these lines, I suspect the likeliest stimulus for another period of low oil prices will come from the market itself. Petroleum is still a volatile and somewhat cyclical commodity, with a history of confounding expectations. Unfortunately for Mr. Friedman's thesis, the last period of $18 oil prices in the late 1990s didn't exactly unleash a tide of liberalization in the Middle East.

Wednesday, February 02, 2005
More Geo-Greens

On Monday I took issue with Tom Friedman's suggestion of a "geo-green" strategy for pressuring Middle East petro-states by reducing oil demand and thus driving down oil prices. Now I find that far from being alone in his views, there's a whole geo-green clique out there, including some neo-conservative heavyweights and keen environmentalists. While I stand by my previous posting on how hard it would be to move the oil demand needle appreciably, it's worth looking at the upside potential.

Start with some history. The last time there was a big push on oil conservation, the result was pretty impressive. After World War II oil demand grew steadily--doubling during the 1960s--until the first oil shock in 1973-74 caused it to stall. It resumed its growth path in the mid-70s, but from 1979, following the Iranian Revolution, to 1989 global oil demand was essentially flat. Along the way, the energy intensity of the US economy dropped sharply, even though the economy continued to grow. Even today, we use fewer BTUs, and certainly fewer barrels of oil, for each million dollars of GDP.

Could a similar drive to efficiency motivated by politics and patriotism, rather than just high energy prices or taxes, slow down or reverse recent trends in energy demand? It's entirely possible, but if we want this to have the maximum benefit, we are looking at the wrong target audience. Although getting Americans to drive more efficient cars and use energy more sparingly would have an impact, we have not been responsible for most of the recent surge in demand. The challenge and opportunity comes from the rapidly growing economies of Asia, and from China, in particular.

Between 2000 and 2004, China's oil demand grew by 2 million barrels per day (MBD), compared to an increase of about 1.3 MBD for the whole industrialized world. As its richest provinces reach the "take-off point" at which the demand for personal mobility soars, this trend will only accelerate. The time for cooperation on conservation is ripe, since China appears at least as concerned about its energy security as we are about ours (see my posting of 1/21/05.)

Getting China and India to develop along a more efficient path is the real prize, and it ought to be a money-spinner, since putting in the best and most efficient technology at the start should be much cheaper than retrofitting them here. In the process, this would do a lot to reduce the rapid growth of greenhouse gas emissions from developing economies, and it may turn out that the Clean Development Mechanism of the Kyoto Treaty is a handy way to transfer these technologies at a profit.

In essence, being geo-green could be quite beneficial and sensible, as long as our concept of "geo" encompasses the entire globalizing world.

Friday, February 17, 2006

Royalty Relief

As if the oil and gas industry didn't have enough trouble defending its record profits for 2005, the media is stirring the pot with displays of outrage over "lost" oil and gas royalty payments from the same companies, under "royalty relief" laws passed in the late 1990s to encourage drilling in the deep waters of the Gulf of Mexico. Careful reading of the case presented in the New York Times and elsewhere reveals the basic flaw in the argument: current relief is a lagged effect from a period when the price of oil was much lower.

If the companies benefiting from royalty relief today had had any notion then that the price of oil would be $60 today, not only would they not have needed--or wanted--royalty relief, but they would have gone deep into debt to drill every conceivable prospect and build all the new production platforms they could. Remember, these companies were struggling to stay afloat with oil below $20 per barrel for all of 1998 and half of 1999, when the most extensive royalty relief was granted by the Clinton Administration.

If we were to revoke this relief now, retroactively, the companies in question would survive. What would not is the future availability of this kind of policy tool to encourage other risky energy endeavors, whether involving long-distance natural gas pipelines, synthetic fuels plants, or biofuels. Having seen the experience of deep water royalty relief, companies might just ask for cash up front, rather than promises of lower taxes later. Who could blame them? You don't have to like these companies to see the importance of keeping our word to them. This argument applies to the threatened revocation of their foreign tax credits, as well.

Note: I will observe Monday's Presidents' Day holiday with a relevant re-run and resume new postings on Tuesday.

Thursday, February 16, 2006

Merci, Monsieur

However unhelpful France was in the final UN Security Council confrontation with Saddam Hussein, all may soon be forgiven. Now that the French Foreign Minister has publicly scorned Iran's pretense that its nuclear program is purely peaceful, the options available to Iran have narrowed, and the chances of success for their nuclear gambit have diminished.

I don't pretend to any special expertise on nuclear weaponry, or even on the detailed workings of nuclear power plants--beyond what any engineer outside that specialty possesses. However, my own assessment of the relative economics of Iran's fossil energy resources and the cost of constructing nuclear reactors, let alone an entire nuclear fuel cycle, led me to eliminate most other explanations for Iran's recent behavior in this area. It's good to have this suspicion confirmed by another government besides ours, and one whose credibility is not affected by the intelligence failures on Iraq's WMD.

It remains to be seen whether this move will induce Iran's government to return to serious negotiations, or, as President Ahmadinejad suggested the other day, it will simply withdraw from the Non-Proliferation Treaty (NPT) altogether. Unless they find a way to back down soon, though, Iran's leaders will find that most of the remaining paths lead to international sanctions. Exiting the NPT could produce an even more direct response. Either outcome would push energy markets to new highs, and this risk will affect the price of oil as long as the situation remains unresolved.

Meanwhile, China rushes to close a deal on developing one of Iran's largest oil fields, before sanctions spoil the game.

Wednesday, February 15, 2006

In the Details

Here’s an article from MIT’s Technology Review filling in some of the gaps in analyzing the President’s proposals on fueling our cars with ethanol produced from crop waste and energy crops. The upshot is that we need to be alert to overly optimistic assumptions and possibly conflicting goals. The strategy is fine, but the details matter.

Last week I suggested that measures to reduce greenhouse gas emissions would automatically move us in the direction of greater energy independence. However, as this article points out, the converse isn’t necessarily true. As our largest domestic energy resource, coal has an important role to play in both areas, but employing it in ways that will make it nearly impossible to capture and sequester its greenhouse gas emissions in the future--as a source of small-scale process heat in renewable energy plants, for example-- could exact an unnecessarily high environmental price for reduced reliance on imported oil.

Cellulosic ethanol has truly exciting potential. Unlike some of the other future energy pathways we’re pursuing, it is a new net source of primary energy, something we will need badly in the years ahead. Despite this, we need to pay careful attention to the associated issues of land management and the environmental impact of fertilizer and other inputs, before pronouncing this the solution to our energy needs. There’s a long history of creating new problems in the process of solving the old ones, and we need to learn from that experience.

Tuesday, February 14, 2006

Accumulating Renewables

I've written a lot about time lags in the last few weeks, in terms of how long it will take for new forms of energy to come into the system, once we commit to invest in them. I believe the word I used to describe this was "daunting." The key to overcoming these lags, however, is our old friend compound growth. Wind power in Europe provides an excellent example, having reached a milestone figure of over 6,000 MW of new installations last year, a level that apparently wasn't expected to be reached until 2010. That brings total EU wind capacity to over 40 GW, about as much as ten nuclear power plants, after allowing for the intermittent contribution of wind. That still works out to less than 3% of Europe's total electricity generation last year, but it's on its way to becoming much more significant.

The growth rates that have been sustained for a decade have been astonishing. Additions have been growing at over 20% and capacity at over 30%. When you look ahead, though, you have to make some adjustments in your expectation of further growth. For one thing, unless the rate of additions increases, the growth in total wind capacity will gradually slow down. In fact, it will be hard to sustain even the current rate of growth in capacity additions, because of the growing scale of capital and other inputs this would require. Simply put, a big industry rarely grows as fast as a small one, and wind is on its way to becoming big.

For example, if new wind power additions continued to expand at 20% per year, wind's total contribution would grow from 3% of EU electricity generation to 10% by 2014, and to 20% by 2018. At that clip, it would hit 50% in 2024. If that sounds incredible, you're right. However, even if the growth in new wind capacity, i.e. the number of new wind turbines delivered each year, slowed from 20% to 10% by 2008, wind could still be generating 15% of the EU's power by 2020. For comparison, the EU's target for all renewable electricity in 2010 is 22%, but that includes hydropower, which already accounts for about 10%.

I think this example nicely illustrates both the potential for change and the inertia of the status quo. The figures above are on a par with the contribution of nuclear power in the US, which required several decades of development and construction and many billions in public and private funds. But it also shows that even an established technology such as wind, starting from a small but non-zero baseline and growing at double-digit rates, will take decades to make more than a modest dent in our energy problems. A brand new technology, starting from zero, will probably take longer.

I draw several lessons from this. First, it's going to take more than one "killer ap" to change the energy equation, just as we rely on multiple forms of energy today. We need several new energy technologies--growing at these kinds of rates--if we want to see dramatic change in the decade of 2010-2020. Second, the impact of these technologies will grow in much the way that the balance in a retirement account grows: gradually at first, and then faster, as the yearly additions gather steam. So, as I've suggested several times in the last week or so, the only material changes in the next five years or so will have to come from behavioral shifts, not technology. Add it all up and you see that we need policies that simultaneously foster serious conservation, aggressively promote new energy technology, and sustain the growth in conventional energy sources, including oil and gas production, to get us to a point at which new technology can have a material impact.

Monday, February 13, 2006

Conservation Code

Whatever your view on the energy initiatives President Bush proposed in this year's State of the Union address, their biggest contribution may be in stimulating an overdue debate about energy. And while countless citizens and pundits have remarked on the absence of conservation measures from the President's list of recommendations, I haven't seen many detailed suggestions of just what that would involve, if it is to make any noticeable difference in the next few years.

When most of us talk about energy conservation, what we really have in mind is investment-driven initiatives such as more efficient cars, buildings and appliances, or new technologies for generating electricity. But we need to understand that all of these require more than just a few billions in R&D spending; they entail investment in capital stock and vehicles in the trillions of dollars. Although they hold great potential to reduce our energy consumption in the future, the time lags involved are daunting, as I described in last Monday's posting. Cars and appliances last up to two decades, and buildings last longer. We should begin moving in this direction, but it's very much like the college savings plan you open when your child is born; she won't enjoy the benefits for years, and you have to support her in the meantime.

So if we want rapid progress on any of the energy goals that are being espoused, whether it's achieving full independence, drying up oil imports and our payments to OPEC, or simply getting the price of oil and its products back into a more comfortable range, the only way to have any real effect in the near term is through a change in our behavior as consumers. This could take the form of the self-discipline I referred to recently, or it could be imposed through heavy taxes.

How about some specifics? Well, in addition to the sensible and relatively painless suggestions you'll find at Save-a-Gallon, it would involve steps such as eliminating unnecessary travel, or shifting it to more efficient modes. If you think flying is the most efficient way to get somewhere, guess again. Trains are generally more frugal, and a family of four driving cross-country in a sedan uses less fuel than they would by flying to their destination. Cancel that coast-to-coast business trip and replace it with a tele-, video- or web-conference, saving 100 gallons of jet fuel. Consolidating errands helps, but shopping from home over the internet or by phone saves even more energy. Because our lives are so energy intensive, there's tremendous scope for savings, without having to invest and wait years for results. If it's worth investing billions or trillions in efficiency, why wouldn't we undertake all these non-investment measures, as well?

There's a downside to some forms of conservation, though. While a significant amount of energy can be saved without harming the economy--beyond lost margins for utilities, refiners and retailers--other cuts would ripple far beyond their source. That cancelled business trip affects an airline, hotel, rental car or taxi company, restaurants, and many other service providers. A few bucks worth of jet fuel can quickly turn into the "for want of a nail..." factor that reduces corporate profits and employment. For this reason, we need to clarify just how much conservation we really want.

Are we calling for the kind of comprehensive effort that would prioritize energy far beyond its market price and put the whole economy on an energy-war footing? Or, when we mention conservation, are we committing to the no-pain measures promoted by groups like Save-a-Gallon, but acknowledging that we'll have to be very patient waiting for the larger, investment-driven changes in our cars and homes to begin to bite? That policy choice ought to be an outcome of our national debate on the subject.

Note: I'll be traveling on business for several days, so new postings will be less frequent.

Friday, February 10, 2006

A Theory by Another Name

A posting at TerraBlog on a recently-publicized controversy at NASA got me thinking about the way the word "theory" has morphed from a neutral scientific term into a dismissive criticism. How often do you hear references to climate change that end with something along the lines of, "But of course it's just a theory"? Well, it is exactly that, which makes it neither more nor less true. Now, words change their meanings all the time; this is part of the beauty of a dynamic language like English. But some changes are unhelpful and should be resisted, because rather than increasing our understanding and clarity of expression, they hinder it. I'd argue that "theory" is a prime example.

According to the definition I learned in endless science classes on the way to an engineering degree, a theory is a hypothesis that fits the observed evidence and can be tested by experiment. The Wikipedia entry on the subject is a bit longer but boils down to pretty much that. So it is factually correct to refer to climate change, the Big Bang, evolution, gravitation, quantum mechanics, and a host of other things as theories. However, that description shouldn't be construed as calling these concepts into question, without reference to some specific evidence that contradicts them.

I'm old enough to remember when there were two competing cosmological theories--in addition to Creation. It turned out that the Big Bang fit the evidence much better, nor has it been disproven by anything we've seen. The competing "Steady State" theory is now all but forgotten. Even when they are superseded by more advanced theories, though, some theories remain valid as limited cases. It took Einstein to plug the gaps in Newton's Theory of Gravitation, but the latter still adequately describes the behavior of essentially every physical object in our world, from dropping a ball to programming a missile. At the same time, we should recall that the history of science is littered with utterly failed theories, such as the ether theory of electromagnetic propagation and the phlogiston theory of burning.

No one today can state with certainty into which category the theory of climate change will eventually fall: unchallenged, valid but limited, or ultimately false. All we can say--and this is what I think the current "scientific consensus" means--is that it fits the observed behavior of the climate over the period in question better than any alternative yet proposed. It also means we haven't found anything that conclusively disproves it. And until refined or disproved, we have no better way of predicting the future behavior of the climate.

I'd love to see an education campaign on the proper meaning of this useful word, to reclaim it from those who misuse it out of ignorance or ideology. This is not a slap at people of faith, of which I am one. If someone doesn't believe in climate change, evolution, the Big Bang, or quantum mechanics, he is entirely within his rights. But at the same time, simply referring to any of them as theories should not undermine it in the eyes of an educated person.

Thursday, February 09, 2006

Allocating the Profit Pool

The Financial Times reported that BP expects to return up to $65 billion to shareholders over the next five years via dividends and share repurchases, if oil prices remain close to current levels. The same article suggested that the aggregate figure for Exxon, BP, Shell, Chevron and Total could reach $250 billion, based on estimates by UBS. This presumably represents a similar allocation of profits to 2005, when these companies collectively sent shareholders roughly 1.5 times as much money as they plowed back into the business. Politicians will draw their own inferences from these decisions, particularly given the magnitude of alternative energy programs these sums could fund. Nor do I believe the story here is as simple as a shortage of good opportunities for reinvestment. The response of the stock market plays a role, too.

While some company oil stocks did well over the last 12 months, with Exxon and BP outperforming the S&P 500 by about 4%--though Chevron has recently fallen back to even vs. a year ago--this is hardly the stock price performance you'd expect from companies generating the earnings and cash that these are, with no end in sight. Moreover, the valuations of these stocks clearly don't reflect today's oil prices continuing out into the future, even though that's just what the futures market shows. It's hard to account for this inconsistency, although futures prices are not a particularly good forecast of future prices. (Perhaps the best analogy is to quantum physics, with the futures contract behaving like a collapsed Schrödinger wave function.)

Back in the real world, you have a system of executive pay that has been carefully aligned by successive generations of compensation consultants to track the performance of each company's stock. Holders of large numbers of options, in particular, need to see steady appreciation in stock values, to cash in on their contingent pay. Now, if the market doesn't trust its own best estimate of the future price of the primary driver of cash flows for these firms, might it see a commitment by management to return large amounts of future cash to shareholders as less uncertain than risky oil prices, and could that give stock values the nudge that oil markets haven't?

I'm not suggesting that this fully explains the way oil companies are spending their profits. For the last two years I've been writing about the factors that make it hard for the Supermajors to replace reserves and production, including access to resources, materiality of opportunities, and queuing of technical capabilities. These all still loom large. But I certainly wouldn't discount the importance of smart people trying to succeed by the rules that have been set up for them. If we want them to do something different, such as investing in large-scale alternative energy, then we need to change the metrics for which we reward them, rather than browbeating and berating them.

Wednesday, February 08, 2006

The Big Picture Is Half Full

While Googling on "climate change" I ran across this column in a UK magazine. It highlights growing concerns about the consequences of climate change and frames a number of big, energy-and-environment issues as potentially conflicting with, or distracting attention from efforts to reduce greenhouse gas emissions. Although there's no shortage of important issues in front of policy makers these days, I think it's unnecessarily pessimistic to view energy security, "peak oil", and clean coal technology as somehow interfering with action on climate change.

Consider energy security. As I've argued repeatedly in this blog, greenhouse gas emissions provide an entirely complementary and efficient pathway for addressing energy security. Rigorous analysis of emissions entails a thorough examination of all the energy flows in the system. This approach also allows us to differentiate between marginally-useful and expensive energy solutions such as corn ethanol and distinctly positive ones, such as cellulosic ethanol. It also gives us the means of objectively comparing the net benefits of the plug-in hybrids I discussed in Tuesday's posting with alternatives such as more efficient internal combustion engines, or fuel cells running on hydrogen produced from fossil fuels.

As to peak oil, to the degree this is an imminent threat--and here I remain a skeptic--it is hard to imagine any serious effort to reduce greenhouse gas emissions that would not automatically defer and moderate the impact of a global peak in oil production, as a direct consequence of reducing the growth in petroleum consumption.

Likewise for clean coal, even without sequestering the CO2 emissions from coal-fired power plants, implementing technology such as Integrated Gasification Combined Cycle (IGCC) would dramatically reduce greenhouse gas emissions per kW-hour of electricity, while providing necessary baseload power to complement the small but growing contribution of intermittent solar and wind power.

So, without detracting from or minimizing the healthy debate surrounding each of these issues, it's false to see them as unrelated or in competition with one another. Managing climate change is going to take a lot more than a push for renewable energy--the author's implied hobby horse--just as addressing energy security must include more than reducing our oil imports. Far from competing, I think all these issues fit together in a large, complex pattern of interconnected energy and environmental concerns.

Tuesday, February 07, 2006

Super Bowl Ads

It's hardly news that millions of Americans pay more attention to the ads in a Super Bowl broadcast than to the game itself. I've been monitoring these ads informally for years, as a sort of barometer of trends and things to come. Blame it on the famous Apple "1984" ad, which prompted me to buy my first home computer, and also launched the whole genre of Super Bowl ad spectaculars. So what did this year's show provide--other than a streaking sheep--and how is it relevant to the theme of this blog?

I think it's notable that three of the dozen or so car advertisements I counted were for hybrids. OK, many of the others were for giant SUVs or pickup trucks, but surely it says something about hybrids becoming more mainstream. Interestingly, the approaches taken by Ford and Toyota couldn't have been more different. Ford chose to cast its hybrid efforts, led by its Hybrid Escape small SUV, as environmentally friendly, playing on Kermit the Frog's familiar "not easy being green" theme. Toyota's ad for the hybrid version of its top-selling Camry went after inter-generational responsibility, economy and the growing immigrant market. My hunch is that Toyota, by being less overt in its environmental message, came off slightly better. However, they haven't had to respond to the same pressures on environmental issues as Ford, so I can understand the basis of both choices.

Ironically, the ad that looked like it was launching a breakthrough in advanced energy technology turned out to be for a razor. It says something about us that Gillette spent about as much developing and promoting its new Fusion shaver as the US government is putting into the clean coal, wind and solar technology R&D this year. Consumer values still trump societal benefits, and anyone working on or investing in alternative energy had better not rely on virtue as the main selling point.

Monday, February 06, 2006

Clear Energy Goals

The President's comments about oil addiction have stirred up every commentator with any interest in oil, from every political, geopolitical, environmental, and economic perspective. Nicholas Kristof's column in the Sunday New York Times (Times Select subscription required) is a good example, seizing on the potential of plug-in hybrid cars to reduce oil dependency by delivering 100 miles per gallon or more, using nearly off-the-shelf technology. But not only does this exemplify the appeal of technology as a solution to our energy problems (see Friday's posting,) but it also reflects the current muddle of unclear and conflicting energy visions. Are we trying to save oil, emissions or energy in general?

Plug-in hybrids are a fascinating technology with great potential. But while offering one answer to our concerns about rising oil consumption, they raise a host of unanswered questions about our enormous energy economy and systems. Shifting the burden of powering cars from petroleum products to electricity only makes sense, if we believe that we can generate and deliver electricity at a lower cost than the energy equivalent of gasoline, with lower overall emissions--including not just local pollutants but also greenhouse gases--and without imposing unmanageable stresses on our already-strained electricity grids.

When you delve further into those issues, you run into all sorts of other problems, including tight domestic supplies of natural gas, with most gas import options, such as LNG and trans-continental pipelines, facing financial and NIMBY obstacles; Clean Coal power plant technology that is available, but can't be easily retrofitted to existing plants; nuclear power, with all its pros and cons; and chronic underinvestment in electric infrastructure. Considering these complexities, it's essential to state our energy goals clearly. It's fine to push for reducing our oil imports, as the President suggested, but we need to understand that this will not resolve our larger energy problems, without a more comprehensive plan.

For example, Geo-green advocates see the potential for using plug-in hybrids as a reverse oil weapon against Islamic extremism. That's a worthy goal, but I wonder if they appreciate what a slow-motion weapon this would be. Annual US car sales of 17 million units only represent 7% of the country's car and light truck fleet. If 10% of all new cars sold were plug-in hybrids--a sales goal it would take years to reach, once the technology is ready--it would still be another decade before they displaced 10% of the current fleet. So even if they got 1000 miles per gallon, they would only improve our fleet fuel economy by 10%, or about 2.5 mpg over 20 years. That's not trivial, but it won't reverse our oil import trends without broader changes in how we use the vehicles we already have.

The economics of all this begins to look shaky, too, when you consider that the more economical you make a car, the less benefit the next tranche of fuel economy provides. Consider a basic hybrid car costing $3,000 more than a conventional model and improving fuel economy from 20 mpg to 40 mpg. That saves the average driver $900 per year at $3/gallon but requires almost four years to pay for itself, ignoring tax credits that only shift who pays. Now let's say a plug-in option is available to take it from 40 mpg to 100 mpg. The additional annual fuel savings, however, only amount to $540, and that ignores the cost of off-peak electricity that, though cheaper than gasoline--partly because it isn't taxed--most definitely isn't free. So unless the plug-in upgrade is cheaper than the basic hybrid option, the payout for this extra level of fuel savings will be much longer.

We face huge, complex problems across the entire energy spectrum, and although they will yield to patient solutions, there are no quick or cheap fixes. Oil isn't a bad place to start, but this can't be done in a vacuum, without understanding and accounting for all the knock-on effects. Otherwise, we risk making the broader picture worse, particularly in the area of greenhouse gas emissions. Whether our long-term personal transportation will be based on plug-in hybrids or hydrogen fuel cells, we require a comprehensive strategy for the natural gas, renewables, coal and nuclear power that will generate the electricity and hydrogen upon which they would depend.

Friday, February 03, 2006

Lagged Effects

Comments on this blog and in the media have pointed out that energy technology investments proposed by the President will not bear fruit for years, and will have little impact on reducing oil consumption this decade. This theme was anticipated in an article in MIT's Technology Review, contrasting the substantial funding for hydrogen-related energy research with the paucity of money for improvements to the internal combustion engine. It's worth considering whether the implied priorities are really appropriate.

Take one specific technology that the President mentioned Tuesday evening, better batteries for hybrid cars and electric vehicles--presumably including the promising plug-in hybrids. While probably nearer-term in its impact than hydrogen fuel cell cars, this is an area that has been under intensive development for years, yielding steady improvements but not the hoped-for quantum leap. That might still come, but it's hard to predict when. So even though hybrids are becoming mass market, with Toyota having sold 500,000 worldwide, it will still take years for their improved fuel economy to nudge our oil consumption trend-line, let alone for models with the anticipated "better batteries" to have a larger impact.

That's not an indication of futility, but it is a reality check as we ponder where to invest federal money and where to encourage private investment--and where little encouragement at all is needed. Looking at timelines alone is too simplistic. We also need to factor in potential impact, barriers to implementation, and costs of conversion, along with some gauge of the likelihood of success.

Better batteries look like a reasonable bet across most of these criteria. They would facilitate the large-scale use of electricity--and thus non-oil electric sources--in transportation in a way that's not possible today. They require lengthy fleet turnover, and perhaps some new infrastructure for home recharging, but they seem to have fewer barriers to overcome than, say, hydrogen. There's an important limitation to consider, however. So far nothing in the improved-battery hybrid car energy chain offers the potential for breaking through the thermal efficiency limitations imposed by the use of heat engines. That's why hydrogen is so alluring, if we can overcome the problems of making, storing and transporting it. A hydrogen fuel cell can double or triple the efficiency of an internal combustion engine, and that justifies a lot of patient R&D funding in this area.

Compare this with a better internal combustion engine. The potential impact would be quick but incremental. The area under the curve--total system fuel economy gains--could well be bigger than for improved hybrids within the next 10 years, though the benefits flatten out quickly. Barriers to implementation are low, as are relative costs of conversion, and likelihood of success is high. Given all that, why invest scarce federal R&D dollars in this, rather than providing some tax credits to manufacturers and letting them get on with it?

But however one apportions the mix of R&D funding, there is a hard truth that must be reckoned with: there is no new technology that can reduce our oil consumption by millions of barrels per day by 2010. The only factor that can bring about a major change within that interval is behavioral change, whether it's voluntary or stimulated by economics--prices, taxes and/or incentives. The silver bullet at this point is self-discipline, not some cool design.

Thursday, February 02, 2006

Breach or Bluff?

Today the governors of the International Atomic Energy Agency will determine whether or not to refer the case of Iran's nuclear programs to the UN Security Council. I will be surprised if either side proves willing to risk a full breach at this point, notwithstanding the bellicose statements emanating from Teheran. Iran's threatened response should probably be seen as further positioning, rather than anything final. But the danger in this school of negotiating lies in the chance that, at some point along the way, they will do something that the other side will see as irrevocable and set the world on a path to disaster.

The seriousness of this confrontation is underlined by the reported discovery of nuclear warhead plans in Iran, or at least of plans for fabricating the atomic trigger for a warhead. Even if this was only a promotional "freebie" from the A.Q. Khan nuclear technology smuggling ring, it suggests that Iran possesses the motive and means for building nuclear weapons, and presently lacks only the opportunity. Denying them that at an acceptable cost is the bottom line for the international community.

In that light, President Bush's remarks about Iran in Tuesday's State of the Union address seemed firm but much more measured than his "Axis of Evil" comment of a few years ago. At the same time, the EU-3 (Germany, France and the UK) have demonstrated remarkable resolve, so far. It would be much easier for them to waffle here, than to stand firm and take the consequences.

The situation is further complicated by the Russian processing offer, as described in a thoughtful op-ed in yesterday's New York Times. The authors, from the Wisconsin Project on Nuclear Arms Control, are concerned that this option will play into Iran's hands and allow them to finesse the IAEA and fracture the Security Council. But unless the Security Council is prepared to put teeth in any finding from the IAEA, this may still be the best option available, as a way to defer an actual crisis until we are in a better position to call Iran's bluff.

Wednesday, February 01, 2006

Finding the Right Mix

A year ago, the energy focus of President Bush's State of the Union address was on the stalled energy policy bill, which finally passed the Congress last summer. This year, energy was one of the centerpieces of the speech, with the President emphasizing the importance of reducing our dependence on imported oil, especially from the Middle East. As this morning's New York Times reminds us, we've heard this refrain before, from presidents going back to Richard Nixon. Is reducing imports really possible, or is it mere rhetoric?

The challenge looks imposing, when you consider the recent direction of the two components that together determine the need for imports: our oil demand and domestic petroleum production. These two trends have been heading in opposite directions for years. Our oil consumption has been growing at 1-1/2% since the early 1990s--but more like 3% in 2004. Meanwhile, production is declining by about 4% per year, even before last year's hurricanes, which reduced US oil output in 2005 to the lowest level since 1949. In other words, the size of our "independence gap" is increasing by about 6% every year. Any realistic program for taming the growth of that gap, let alone reversing it, will require a combination of dramatic improvements in energy efficiency, additional alternative transportation fuels, and expanded conventional oil production. Last night's speech addressed the first two components of this mix.

President Bush highlighted several specific technologies for tackling our import dependence, including biofuels and other renewables, zero-emission coal power plants, and advanced hybrid cars. Although I still believe our primary focus should be on outcomes--specifying specific targets for energy savings and emissions reductions, rather than choosing technologies-- the solutions mentioned last night at least have a high likelihood of being important elements of our future energy system, and they all bear on our oil imports, either directly or indirectly.

I was particularly pleased to hear the President highlight the potential of advanced, biotechnology-based fuels. The grain ethanol we've relied on so far is simply not the answer to our energy problems. As I've mentioned previously, its energy contribution is uncertain--either modestly positive, or actually negative--and it certainly doesn't justify the billions of dollars in subsidies it has received. Technology will change that, as new processes offer the potential of both lower cost and much higher efficiency, while consuming crop waste, rather than crops.

Unfortunately, there was no mention of how the Advanced Energy Initiative will be funded. Initial estimates suggest it represents an increase of at least $700 million over energy programs already in place. Given growing calls for higher gasoline taxes, the President should at least have indicated why he has chosen not to raise the money for his energy initiative from that source, considering that less than a penny a gallon would have done the trick.

I suspect that once all the pundits have weighed in, the energy portion of the State of the Union will have pleased few of them. Those who have been calling for drastic measures will see it as too incremental and patient. Proponents of market-based solutions will bridle at further investment in technologies that remain highly uncertain, and are not yet competitive. As for me, I think it's a step in the right direction. Although I still regard energy independence as both practically unattainable and inconsistent with our trade-based economic system, there are many good reasons for getting our oil imports under control, and all the measures President Bush cited would help do just that, though it will take years to see the results. In addition, the highlighted energy technologies would all cut greenhouse gas emissions; if our response to climate change must wear the livery of energy independence, so be it.