Energy Crisis Prices Persist

Watching oil prices is a hard habit to break, once formed. They're always moving up and down, sometimes for obvious reasons and sometimes not. It has probably escaped most observers' notice that the magnitude of this year's price moves has exceeded the total nominal price of oil that prevailed not many years ago, yet without the sort of apocalyptic events that one might expect such volatility would require. Perhaps that's because we seem to be stuck in the middle of an ongoing, slow-boil oil crisis from which the financial crisis and the demand contraction that accompanied the global recession only provided a brief respite. In fact, when you glance at the oil price trend in real dollars over the last 40 years, it's apparent that prices are back at the level associated with the peak of the oil crisis of the late 1970s and early 1980s:


One reason I've been paying extra attention to oil prices lately is that I've been observing the impact of the coordinated release from the US Strategic Petroleum Reserve (SPR) and strategic reserves of other members of the International Energy Agency. So far, my initial assessment that it would have little lasting effect seems to have been validated, though I'll reserve judgment until the oil is actually delivered during August, when we might see the market respond to the increase in commercial oil inventories that should result. Robert Rapier had an excellent posting yesterday on the folly of this decision. My view is, if anything, less flattering. Not only was this choice unwise, but it also appears to have been ineffective, which in the current economic climate is an even more damning assessment.

The modest response to this move tells us something about the fundamentals of the market. In the past, an SPR release on this scale would have crushed prices--not just for a few days, but for months at least. Consider the release that accompanied the start of the first Gulf War in 1991. Only about half of the nearly 34 million bbls authorized was eventually sold, but the price of oil dropped by 33% overnight and took 13 years to recover to the peak it had reached during the lead-up to Desert Storm. By comparison, the announced release of 30 million bbls from the US SPR--the sale of which was fully-subscribed--and another 30 million bbls from other IEA members managed to depress the price of oil by only around 5% for a week or so. As of this morning Brent crude, the global marker, is $4/bbl higher than it was on June 22nd. And as of this Monday's survey, the average pump price of unleaded regular in the US was also higher than before the President announced the release.

The market's tepid reaction to the SPR release suggests that oil prices have been driven up by more than just speculators. Speculation may be playing a role, but it's more like the head on a glass of beer. Beneath that froth lies the robust demand growth in the developing world, which has pushed global oil consumption to a record level of 89 million bbl/day this year. On the supply side, some point to incipient Peak Oil, but characterizing the crisis we're in doesn't require a grand theory. In addition to the curtailment of production from places like Libya and Yemen, and OPEC's desire to keep a lid on output to preserve their revenues, there's a fundamental mismatch between the companies that have the capital and the desire to invest in new production, and the willingness of some governments to grant access to the resources, whether in the Middle East or the US. All of this is compounded by the inherent time lags in resource development, which can range from 5-10 years, depending on the technology and permits required.

As different as the causes and symptoms of this crisis are from those of the 1970s, the broad outline of solutions remains quite similar: Reduce demand, increase supplies, and diversify our sources of energy. We have more and better options than in 1979, but still no miracle cures.

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The Results of Energy Policy

The combination of an energy event yesterday in Washington, DC that I was unable to attend and a comment I received on Monday's posting got me thinking about energy policy in the context of the new year and the start of the new Congressional session today. National energy policy has been debated throughout my adult life, whether the policy of the time was clearly articulated and effectively executed or not. The most important question is not what the policy says, but what it does and whether that aligns with what the nation really needs its energy industry to deliver. In my view our current energy policy is on the wrong track, and the new Congress and the spirit of bi-partisan cooperation that emerged in the recent lame duck session provide an excellent opportunity to revise it along more effective lines.

I would summarize our current energy policy as being focused on promoting greater efficiency and the development and deployment of new energy technologies, in order to reduce our dependence on imported energy from unstable or unreliable sources, and to reduce our emissions of greenhouse gases, more than 80% of which are associated with our production and consumption of energy. That sounds fine, but in practice the effect of that policy appears to be replacing low-cost energy with higher-cost energy, while attempting to maximize the employment associated with producing clean energy, rather than minimizing its cost.

What are the results so far? Well, the significant reduction in US oil imports that we've experienced recently is attributable mainly to the weak economy and high unemployment, rather than to improvements in vehicle fuel economy or domestic biofuel production. And the reduction of greenhouse gas emissions that has occurred in the last several years has mainly resulted not from policy-related measures to expand wind power or replace incandescent lights with compact fluorescents, but from two events with little connection to energy policy: the recession--particularly the slowdown in US manufacturing--and the unexpected growth of natural gas production from shale resources. That might not be a fair gauge of what current policies could achieve in the future, but it's clear that an energy policy that depended on economic weakness for its success would be contrary to our national interest.

For decades the de facto energy policy of the US promoted cheap and abundant energy to sustain economic growth. We live in more complex times, but focusing most of our current energy efforts on solutions that are still small-scale and high-cost seems unlikely to do much for the economic recovery. If we were really serious about fueling the recovery, we'd be at least as interested in promoting abundant, low-cost energy at a scale suitable for the needs of a $14 trillion economy, and for which employment gains in the energy industry didn't come at the expense of productivity. A study on the trade-offs between resource access and new taxes on the oil & gas industry that was prepared in conjunction with the release yesterday of API's "State of American Energy" report provides a case in point.

An international energy consultancy analyzed the potential production and employment gains associated with expanded access to the domestic resources that are currently off limits in places like the eastern Gulf of Mexico, the Atlantic and Pacific coasts, and the Arctic National Wildlife Refuge. They also looked at the federal revenue and employment impact of higher taxes on the US oil & gas industry, along the lines of a series of proposals from the administration and Congress in the last two years. They found that access to off-limits oil and gas could yield up to an extra 2.8 million barrels per day of oil and gas liquids and 6.6 billion cubic feet per day of gas by 2025, with direct and indirect gains in employment of more than 500,000 workers. By contrast, increasing taxes on the industry would not only reduce production and employment, as domestic opportunities become less attractive than those elsewhere, but also reduce total federal revenues from taxes, royalties and leasing, following a brief uptick in the initial period after their introduction. Although I'm not sanguine about the chances for increasing access when the administration has just reversed its earlier expansion, that would at least be more consistent with an effective energy policy than raising taxes on the production of energy.

We have a long, bi-partisan tradition of well-intended but ineffective energy policy, and the current policy continues that trend, even if its shortcomings differ significantly from those of past policies. The good news is that we have many more options and choices than we did when the US energy policy debate began in earnest in the 1970s. What we need now is a policy that recognizes that most of these sources, old and new, are important for our present and future energy security, but that what we chiefly require is abundant low-cost energy to fuel an economic revival strong enough to help shrink our enormous federal, state and local fiscal deficits and resulting massive debts, which also have solid bi-partisan pedigrees. It should also put us on a path to lower emissions from whatever sources can deliver them on a meaningful scale and at a cost that we can afford.

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Setting Energy Goals

With the failure over the weekend of BP's "top kill" effort, the odds that the oil will continue flowing until relief wells can be completed--in months, rather than days--have gone up considerably. In addition to the accumulating economic and environmental consequences, that also means that media attention on the oil spill and the questions it raises about US energy policy will remain front and center for at least that long. In the absence of any formal effort to guide the discussion, we're likely to end up with the usual array of random energy musings and rants, built around an understandable, if unrealistic message of ending our reliance on oil now. That would be a shame, because this sad situation gives us a unique opportunity to refine our thinking about our energy future when much of the country is focused on it.

One comment that I've heard frequently in the last few weeks is that this spill serves as a reminder that oil companies are drilling in depths of a mile or more of water, far offshore, because the easy oil is mostly gone. There's more than a grain of truth in that view, though the full picture turns out to be rather more complicated. While it's certainly true that the mature oil regions of the US have been drilled like a pincushion for 150 years, and that many of the large, important undeveloped oil resources we know about are on the Outer Continental Shelf, there's still a lot of oil in other places, both onshore and in the nearer offshore, in shallower water, that we've chosen not to exploit. Access has driven development at least as much as geology in the last decade or two. In the US, we've made an implicit decision to focus oil and gas development on the Gulf Coast, not because it had the most resources--though it has plenty--or because it was less-densely populated , but presumably because it had already been developed so extensively. In effect, this approach sacrificed the Gulf Coast--whether that sacrifice was ever envisioned in quite the terms we're seeing today--to give us the oil we needed while preserving the beaches and viewscapes of our other coasts.

There's also an international dimension to this issue of access. At the same time the US offshore oil industry has been constrained in a box with only one open end pointed toward ever deeper water, the publicly-traded international oil companies have been progressively squeezed out of world-class oil opportunities elsewhere, as a result of full or partial nationalization and through competition with national oil companies that are guided not by market forces, but by geopolitical ones. As a result of these parallel trends, the major oil companies have focused their efforts where they retained both access and some key advantages over many of their state-owned competitors, usually in the form of technology or management of complex projects. In other words, they've been pushed to the frontiers, such as the deepwater Gulf of Mexico.

While many lament the powerlessness of the US government to plug the leaking well, and some like Admiral Allen ponder whether the government should acquire that capability for itself--a topic for a future posting--we shouldn't ignore that even without banning deepwater drilling the federal government has the power to shift the industry toward less-risky opportunities by expanding its access to onshore and near-offshore resources that are more attractive and less difficult, but have been restricted for years.

Another common response to the spill relates to the incentives for moving away from oil. If we just had more incentives for biofuels and for electric vehicles, goes this thinking, we could quickly wean ourselves off oil and not only do away with the need to import it, but also to drill for it in such challenging locations close to home. While many of my recent postings have been aimed at showing why this can't happen quickly, I want to disassociate myself from what Tom Friedman calls the "petro-determinist" approach. I'm not here to tell you that breaking our addiction to oil is impossible; if I thought that I wouldn't have spent much of my career working on or promoting alternatives to oil. At the same time, with the current euphoria for cleantech and green jobs, someone needs to remind us that if breaking our oil addiction requires a 12-step program, we are only on about step 2. More importantly, it matters how we get there: Not all paths are equally valuable, and we don't have good enough information to determine which ones will work best in replacing a hydrocarbon-based energy system that evolved over the better part of a century.

Consider vehicle electrification, which depends on batteries. If the goal is putting the largest number of mainly-electric vehicles on the road in the shortest time, then we might be on the right track, handing out extremely generous tax credits for consumers to buy fully- or partially-electric vehicles, along with billions of dollars in manufacturing tax credits, grants, loans and loan guarantees for the factories to build those cars and the batteries they require, in addition to installing the recharging infrastructure they'll need. But if our goal is to reduce oil consumption and the emissions that accompany it, then this approach could be counterproductive, particularly if growing concerns about the availability and sourcing of the crucial raw materials necessary to build today's state-of-the-art electric vehicle batteries are correct. Simply put, the batteries in a Prius-style hybrid that never plugs in save many more annual gallons of oil per kWh of onboard storage than the batteries in a plug-in hybrid (PHEV) or full EV. That's true for two reasons that are a function of physics, rather than economics: a) fuel economy is subject to diminishing returns, in which moving from 25 mpg to 50 mpg saves twice as much total fuel as going from 50 mpg to 100 mpg and b) PHEVs and EVs require a lot more battery capacity per car than conventional hybrids.

What both of these examples share in common is that focusing on specific paths instead of outcomes can be counterproductive and multiply risk, instead of reducing it. An oil policy that started with the recognition that we must produce significant quantities of oil domestically during a lengthy transition to alternative and renewable energy sources, and that asked where the best-placed resources were to provide that supply with the least risk, might arrive at a different answer than one that resulted from a series of isolated decisions to place a growing sequence of oil resources off-limits. Likewise, a fuel economy and emissions-reduction strategy centered on annual fuel savings, rather than rewarding consumers and carmakers for concentrating the largest number of batteries into each vehicle, would better leverage vehicle-electrification technology to reduce our reliance on oil. That's particularly relevant when batteries look like a short-to-medium term constraint and their raw materials might impose longer-term limits until we have better battery technology based on cheap and plentiful raw materials.

If the Gulf Coast spill represents another crisis too important to waste, then it's also one that is too important to relegate to unfocused wishes for an oil-free world within the next few years. The best "use" of the spill is to convene a concrete national conversation on how to provide the US with energy that is as affordable and environmentally-acceptable as we can realistically make it in the in the short, medium and long-term. That will require examining all the trade-offs involved, as well as how the balance between conventional energy and renewables and other alternatives is likely to shift in the years ahead. If that did nothing else but get us clearly focused on outcomes, rather than picking our favorite pathways, then it might constitute a positive outcome from an otherwise miserable episode in our nation's energy history.

FYI, tomorrow (June 2) at 1:00 PM EDT I'll be on a webinar panel hosted by The Energy Collective to discuss the implications of the oil spill for the future of energy. If you're interested, please sign up using this link.

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A Self-Fulfilling Bet on Biofuels?

An article in today's Financial Times (registration required) raises a worrying possibility concerning the plans of the US and other oil-consuming countries to rely on biofuels for an increasing fraction of future fuel needs. What if oil-producing countries took those plans seriously and reduced their investment in new oil capacity, on the assumption that it wouldn't be needed? In some respects, that's exactly what we have in mind. However, if biofuels then failed to materialize in sufficient quantities to fill the gap between oil supply and total fuel demand, or proved to be economically or environmentally unsustainable, then we might inadvertently create precisely the sort of crisis these efforts were intended to avert. It would be easy to dismiss this argument as OPEC-inspired propaganda, if global oil production didn't require enormous ongoing investments to counteract the natural decline rates of producing fields, and if producing-country governments weren't already under internal pressure to spend their oil profits on programs other than reinvesting in future production.

The good news here is that biofuels have reached a scale at which they actually matter in the global oil supply and demand balance. That wasn't the case during the oil crises of the 1970s, and they were still only a marginal factor when oil prices last peaked in 2008. The latest publicly-available issue of the International Energy Agency's Oil Market Report indicates that biofuels now contribute the equivalent of 400,000 barrels per day (bpd) of oil, before including US and Brazilian ethanol volumes that together equate to another 650,000, bringing the global total to just over a million bpd. That might not sound like a large share of a total market of 85 million bpd, but it's enough to influence the global price of oil, which is set at the margin. Doubling or tripling biofuel output would certainly cost oil producers money, if they ignored this factor in their capacity planning.

So far, this is only a problem for oil producers. It becomes a problem for the rest of us when the biofuel plans and targets of consuming countries are based on unproven technology that may not be able to deliver in time, or possibly at all. Unfortunately, that's the position in which we find ourselves. Consider the Renewable Fuel Standard (RFS) enacted by the Congress in 2007 and refined in new regulations issued by the Environmental Protection Agency. Out of the 36 billion gallon per year target for 2022, only around 16 billion gallons is accounted for by corn-based ethanol and first-generation biodiesel--both of which have been amply proven, however much they depend on generous subsidies to remain competitive. 20 billion gallons per year must come from cellulosic ethanol and other advanced biofuels, none of which are in truly commercial production today, in spite of the hype that has been generated by a handful of "demonstration facilities."

One indication of just how unrealistic these targets might be is that EPA was forced to reduce the cellulosic biofuel target it will enforce for 2010 from 100 million gallons to 6.5 million gal.--the equivalent of just over 400 barrels per day of oil--due to lack of supply. And while the agency attributes that shortfall to delays in starting up new facilities using a variety of new technologies, a careful reading of their analysis suggests the problem might be more serious than that. Two firms account for nearly a third of the 694 million gallons of cellulosic biofuel capacity they expect will be in operation by 2014, Cello Energy and Range Fuels. Unfortunately, last year Cello was ordered by a federal court to pay $10 million for defrauding investors concerning its technology claims. Meanwhile blogger Robert Rapier has documented the problems that Range Fuels has experienced in scaling up its process for producing ethanol from gasified biomass. Until both of these firms have demonstrated they can actually do what they claim, at full scale, it's not prudent to bet the ranch on their production forecasts.

Problems such as this are probably just the tip of the iceberg when it comes to scaling up a myriad of new processes for producing motor fuels from non-food biomass, not because it's impossible or because the firms involved don't have sufficient smarts--though one or both of those factors will turn out to apply in at least a few cases--but because it is intrinsically hard. Scientists have been working on cellulosic biofuels and biomass-to-liquids processes for decades, yet the sum total of all that work, up until this point, has only yielded enough fuel production to cover the annual consumption of about 13,000 average American cars. That doesn't mean that companies and investors are foolish to pursue these technologies, or that ExxonMobil is wrong about the potential they apparently see in algae-based fuels, another hot biofuels sector. What it does mean, however, is that when dealing with technologies that can't be made to appear on command and are subject to a number of serious, unresolved technical and logistical challenges, neither consumers nor our governments should base their plans for the future on the assumption they will mostly succeed on schedule.

How realistic is it that the oil-producing countries that control access to the vast majority of the world's oil reserves would be so convinced by our rhetoric concerning biofuels replacing oil, that they will cut back their investments in new capacity? Part of the answer lies in the narrative of Peak Oil that generated headlines when oil prices were spiking a couple of years ago, involving the high decline rates of mature oil fields and the relatively low investment rates of many producing countries. When the government of Venezuela must borrow money from China despite $80 oil, that's one signpost that they might not have enough to reinvest in exploration and production. We can argue about the likely date of a peak in global oil output, but anything that provides governments an excuse to spend less sustaining their oil industries brings that date closer--and that's equally true for a US administration that appears so confident of the success of its biofuels and fuel economy programs that it can allow the timing of the next offshore oil leasing cycle to slip further and further.

Oil is still the lifeblood of our industrial civilization, but it's also a business requiring enormous investments premised on the likelihood of future demand. That doesn't mean we must remain helpless hostages to foreign oil suppliers; fuel efficiency and biofuels are both sensible--even necessary--strategies for us to pursue. But we have an even larger stake in ensuring that the biofuel goals and plans we communicate, not just among ourselves but simultaneously to our oil suppliers, are based on reality. If both we and they are betting on supplies of advanced biofuels that could well fall significantly short of our expectations, then it is we who will suffer the consequences at the gas pump.

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2010 and Beyond

The start of my seventh year of blogging on energy and its related environmental concerns coincides with the start of a new decade, unless you're of the traditional school that believes the twenty-teens don't really begin until next January 1. Over the holidays I was struck by the number of retrospectives focused on the amply eventful, but profoundly disappointing decade that was ending. Having spent several years reassuring my readers that we weren't reliving the 1970s, in retrospect I'm not so sure. Yet as bad as the '70s were on so many levels, they gave birth to the '80s, which brought revitalization and tremendous technological developments, and culminated in the end of a Cold War that most of us had considered perpetual. There's cause for guarded optimism about the decade ahead, particularly for energy, which is still in the early stages of a massive transformation. The 'Teens will test the capacity of current energy systems to support a return to rapid economic growth and of new energy technologies to go from niche to mainstream.

I could fill the rest of this posting with grandiose predictions about the next ten years, but instead I want to focus on two stories that could provide early clues about energy in the crucial 2010-2020 period. The first almost escaped notice in the energy retrospectives I read last week. Many of them, including one in the Wall St. Journal, attributed the recovery of oil prices in 2009 mainly to the stabilization of the financial system, yet scarcely mentioned the essential role of OPEC's self-restraint. According to the figures in the latest public version of the International Energy Agency's Oil Market Report, between May 2008 and February 2009 OPEC reduced its output by more than 10%, taking well over 3 million barrels per day (MBD) off the market in response to a 3% drop in global oil demand. Despite the usual cheating on its official quotas, its members have avoided the competition for shares of a shrinking market that crashed oil prices from the $30s to $11/bbl in the mid-1980s and set up a decade of low oil prices.

In the process, OPEC's spare production capacity has expanded from less than 2 MBD to roughly 6 MBD. That's quite a buffer against a big price spike as the economy recovers, though it's also the reason oil isn't drastically cheaper than it is today. While we can't know precisely what would have happened if, for example, Saudi Arabia had tried to squeeze the output of its new, Texas-sized Khurais field into the market on top of its existing sales, it's a good bet that oil wouldn't be trading anywhere near its current $81/bbl. The reason this is relevant for the decade ahead is that OPEC could be forced to accommodate even bigger increases from the production agreements recently signed in Iraq, along with more reliable output from Nigeria, if that country's ceasefire with rebels in the Niger Delta leads to a lasting resolution of the problems there. With many of the world's best onshore oil prospects currently off-limits for anyone else to develop, OPEC's members and their continued cohesion hold one of the main keys to oil prices in this decade.

Meanwhile the growth of renewable energy faces a number of important tests as it expands beyond the scale at which it can be tucked safely out of sight and out of mind. We've already seen large solar projects in California's Mojave Desert--one of the most reliably sunny spots on the planet--canceled or relocated to accommodate concerns about wilderness preservation, and now I read that the long-suffering developers of the Cape Wind project off Cape Cod are at risk of having the project's location declared a Historic Site by the National Park Service. With all due respect to the local tribes that apparently consider Nantucket Sound to be sacred, it's worth recalling some of the other history of the region that ought to bear on such a finding. In its heyday Nantucket Island was the center of the global whaling industry, made possible by a fleet of tall-masted sailing ships that used wind power to harvest a key energy resource of the time, from the slaughter of whales for their oil. It's hard to think of a better way to recognize that history--and in a more environmentally-sound 21st century way--than by putting up offshore wind turbines to harness the wind for direct energy production.

And while the permitting for America's first offshore wind farm drags on interminably, the UK government is expected to announce the results of its Third Round of offshore wind bids this week. The new installations would add 25,000 MW of new capacity to a base of offshore UK wind farms in operation or under construction that is already about four times larger than that contemplated for Nantucket Sound.

Oil prices and the expansion of renewables are only two of many factors that will determine the shape of the world's energy economy in 2020, though they rank high on my list of things to watch as the decade begins. Tight oil supplies and high prices would do a lot to promote energy efficiency and new vehicle technologies, while lower, more stable prices might result in a return to the complacency we saw in the late 1980s and '90s. And although renewable power sources are hardly the only means for reducing greenhouse gas emissions and rendering our steadily-growing energy use more sustainable, much depends on the capability of wind, solar and geothermal power to continue their recent impressive expansion. That's true whether you are banking on cleantech and "green jobs" to turn around the US economy or merely interested in the size of the potential opportunity for our suddenly-ample natural gas supplies. I look forward to sharing my observations about these and other trends in the months and years ahead.

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