Breaking Oil's Monopoly on Transportation

I've been thinking about an op-ed in Tuesday's New York Times written by a former National Security Advisor and a former CIA chief. They propose breaking oil's monopoly on transportation fuels by introducing more fuel competition at the point of use. This isn't a new idea, nor is their preferred tactic of requiring all vehicles sold in the US to be flexible fuel vehicles (FFVs) capable of running on a variety of fuels. I looked at this in April, following another op-ed by Mr. Woolsey, and several times previously in conjunction with the Open Fuel Standards Act, a piece of unpassed--so far as I know--federal legislation designed to put such competition into effect. The idea is as interesting as it has always been, though several trends pose new challenges for its ultimate success.

The op-ed was apparently timed to mark the introduction of a new group called the United States Energy Security Council, the membership of which constitutes a who's who of national security and energy leaders. The Council's issue statement is worth a read and stands apart from some other similarly-well-intended efforts for its clear recognition that our energy security problem with oil has nearly nothing to do with electricity, and thus won't lend itself to leverage from renewable electricity sources until large numbers of electric vehicles are on the road. That could take decades, as I've noted elsewhere. However, I wish the group had spent more time pondering the source of oil's natural monopoly in transportation energy, because I think it might have given them pause concerning methanol, one of the competing fuels they're trying to promote.

The sources of that natural monopoly--the reasons oil continues to dominate the transportation energy market 93 years after the introduction of the Model T Ford--owe little to the market power of OPEC, and much to the energy density and convenience of storage, transportation and distribution of petroleum products. Making fuels like E85 ethanol and methanol as readily available as gasoline, and making cars as compatible with them as they are with unleaded gasoline, won't affect the miles per gallon and range advantage that gasoline enjoys. That advantage is especially evident relative to methanol, which packs just under half the BTUs per gallon in gasoline.

Even though the abundance of shale gas could conceivably alter the economics of fuel methanol enough to put it into serious competition with gasoline, it would face an even more serious marketing challenge than E85, with its smaller but still significant range and mpg penalties, and its miles-per-dollar penalty that could expand significantly when the ethanol blenders credit expires at the end of the year--or sooner. Without substantial engine modifications to take advantage of methanol's other properties--modifications that wouldn't be compatible with fuel flexibility, as I understand it--both mpg and range would reflect a similar ratio as energy content. And unless methanol (with all appropriate federal, state and local motor fuel taxes applied) could be delivered to your corner gas station at less than half the cost of gasoline, then not only would its range be inferior, but also the miles delivered per dollar spent. Consumers tend to notice such things after a while. And that is aside from my long-standing concerns about the mass-market use of methanol.

The group's focus on alcohol-based fuels also goes against another recent trend in the biofuels industry towards what are called drop-in fuels: fuels that despite their non-petroleum origins are 100% compatible with engines designed to run on petroleum products. Despite all the hype about cellulosic ethanol, it is looking increasingly likely that the main fuels we will get from non-food biomass could closely resemble today's gasoline, diesel and jet fuel. And drop-in fuels don't require vehicles to be modified as FFVs.

When viewed from a technical perspective, I don't find the Council's arguments for mandating FFVs especially persuasive. However, I think there's a more compelling argument to be made, relying on option value. If it costs $100 to modify a car to run on other fuels besides gasoline, then that investment would still have value even if in practice the car's owner never actually bought those fuels, as has been the case with the vast majority of the cars already capable of using E85. The option still has value because it provides an insurance policy against some future circumstance in which the only fuels available (or affordable) are non-petroleum ones, for whatever reason: an oil embargo, peak oil, pipeline failure, or some weather-related catastrophe, take your pick. That kind of competition for oil doesn't even require large sales of non-petroleum fuels before having an impact in the market. The key question is whether it's worth enough to us as a society to require the collective expenditure of roughly $1.2 billion a year (adapting all new cars) or up to $24 billion (retrofitting the entire light-duty vehicle fleet) to force it to happen, as opposed to leaving this as the consumer and manufacturer choice that it is today.

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The Future Energy Station Arrives

I was very interested to read that Valero, the largest independent refiner in the US, is designing its new gas stations to offer a much wider variety of energy products, including natural gas, E85 ethanol, and potentially recharging facilities for electric vehicles. This is an announcement I've been expecting for more than ten years, and there are good reasons why other companies are likely to follow. At the same time, the economics of doing this now, when the market for non-petroleum fuels is still comparatively small, look challenging. Some will call this a vanity project, and they won't be entirely wrong, even if it also represents the template for the new retail energy facilities that will be built in the next several decades.

Valero's new station design, at least as described in the articles I've seen, embodies the result of trends that my former company, Texaco Inc., identified in the late 1990s in a scenario called Multiple Choice Energy. That view included a combination of new vehicle technologies such as hybrids, EVs and fuel cells, as well as a vision of the retail network that would meet their needs. As attractive as the idea was to many of the top executives to which our team presented, it was a tough sell, because retail fuel is such a difficult business. Margins are slim, competition high, and major redesigns of existing facilities--for rebranding or any other purpose--very hard to justify financially. Several companies have dabbled with elements of this vision, including my former employer, but I'm not aware of anyone deploying the full suite of options in one location.

I think this development, and the company pushing it, is significant for several reasons. First, Valero has already made a major commitment to non-petroleum fuels through its acquisition of ten ethanol plants, bought during a period when the US ethanol industry was being squeezed by poor margins and scarce credit. Those facilities contributed 18% of Valero's operating income in the first quarter of this year, even though they accounted for less than 4% of total output by volume. Adding E85, a blend of 85% ethanol and 15% gasoline, at the company's new stations merely completes a supply chain in which it is already well-established.

Incorporating these capabilities when a station is built, rather than adding them later, is also crucial. It saves a significant amount of money by avoiding the business disruption involved in retrofitting later. E85 faces other challenges, as I discussed recently, but this kind of planning overcomes one of the major impediments to its wider penetration in the US market, which already has millions of flexible fuel vehicles capable of running on it. And for this reason it's especially notable that this initiative is being taken by Valero, which has been expanding its retail network and investing in new sites. That's in contrast to the major oil companies, some of which have been exiting retail, either gradually or on an area-by-area basis, to free up capital for more profitable opportunities in exploration and production.

Adding natural gas and electricity to the array of fuels sold at retail sites is a natural evolution of this strategy but financially much riskier, given the small number of EVs and NGVs on the road so far. Although the company can take advantage of generous tax credits for installing some of these capabilities, the return is likely to be low for some time. EV recharging also requires a large footprint and extra caution, to ensure that it can be done safely in proximity to combustible fuels. Local agencies and fire marshals have definite ideas about this, as I learned when I was involved in plans for recharging facilities for GM's earlier EV-1 plug-in vehicle in the late '90s.

As with the market penetration of the alternative fuel vehicles they will serve, it will be some time before most retail stations offer quite as much choice as Valero's new multi-fuel facility. It takes time to roll out such changes, and the infrastructure can't get too far ahead of the demand for it without its owners going bankrupt in the process. Nor will every new fuel succeed. Methanol blends looked like the next big thing in the 1980s, but they never took off. Still, it wouldn't take many such facilities in each market to break the "chicken-and-egg" barrier that any non-petroleum transportation energy alternative faces. The success of this initiative depends on the demand for these fuels actually materializing. Launching when the average US gasoline price is just a couple of cents below $4.00 looks like good timing to me.

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Flex-Fuel Competition for OPEC?

An op-ed in this morning's Wall St. Journal by former CIA Director James Woolsey makes an interesting and seemingly pragmatic suggestion for improving America's energy security. Instead of pushing new energy sources or new fuels, he seeks to break OPEC's cartel power by ensuring that US motorists have more choice at the pump, facilitated by flexible fuel vehicles (FFVs) that can operate on a variety of energy sources. The analogy to the electricity grid, in which no single source of generation can hold the entire market hostage, is clear. The question is whether this is really as useful as it sounds, to the point of justifying legislation that would force carmakers to make fuel flexibility the default, rather than an option on new cars.

Competition can be a powerful force, and Mr. Woolsey is correct that gasoline and other petroleum-based transportation fuels have had little competition at the point of sale to consumers. Even with ethanol making up 10% of most of the gasoline in the US, 94% of the energy we use for transportation still comes from oil. The idea of "multiple choice energy", which was the name of one of the corporate energy scenarios that I helped develop at Texaco more than a decade ago, is alluring. It's not hard to envision consumers being able to choose among gasoline, diesel, ethanol, other biofuels, natural gas (compressed or liquefied), electricity, hydrogen, and even exotic hydrogen-storing compounds such as ammonia borane, which recently appeared on my radar screen. As it has been for decades, however, the central problem is creating a market for these alternatives. That requires both cars and infrastructure.

Mr. Woolsey and his co-author are focused on the car side of the equation, suggesting that a $100 fix could enable most cars to run "a variety of liquid fuels in addition to gasoline." To make this happen, they espouse the Open Fuel Standard Act, a piece of legislation that has been floating around since at least late 2008 and that would mandate this hardware for all new cars. Then they extend this argument into natural gas vehicles and plug-in hybrid cars, both options costing a great deal more than $100 per car. While plug-in hybrids certainly provide very effective energy competition for oil, their cost and complexity ensure that their market penetration will be a long, slow process, pushing any real competitive benefits perhaps a couple of decades into the future. Nor do the natural gas cars I'm aware of--also much more expensive than simple FFVs--provide such a point-of-sale fuel arbitrage capability, because once converted to run on CNG or LNG, there's no going back to gasoline. (This feat isn't technically impossible, just impractical.) So for the near-to-medium term the main competition available would be from fuels like E85 and methanol.

I've written extensively about E85, a blend of 85% ethanol and 15% gasoline. The gist of it is that E85 has failed to take off so far, not because there aren't enough FFVs that can run on it--there are already millions on the road--but because its availability is limited and, more importantly, because its current pricing represents a poor value proposition for consumers. A gallon of E85 contains 27% fewer BTUs of energy than a gallon of gasoline with its typical 10% ethanol content. In cars not specially tuned to make the most of E85's high octane, that translates directly into a corresponding fuel economy penalty. So for E85 to be attractive to consumers, it should sell for at least 25% less than unleaded regular gasoline. As reflected on an industry website tracking E85 prices, that's only the case in a few locations, with the national discount currently averaging 16%. So on a miles per dollar basis, E85 is currently about 15% more expensive than gasoline. That doesn't sound like something that is likely to cause OPEC ministers to lose sleep.

Why is E85 so expensive? It's not mainly due to its limited availability, although its smaller scale relative to gasoline distribution probably costs it a few extra cents per gallon. Fundamentally, it's because ethanol prices reflect high input costs, including corn. Even at the current futures price on the Chicago exchange this morning of $2.72/gal., which does not include transportation and blending costs that can easily add another dime or more, wholesale ethanol costs 85% as much as wholesale gasoline, equating to 87% on an E85 basis. It's hard to see how you could start there and end up with pricing on the forecourt that offers a big enough discount to compensate consumers for the fuel economy penalty and the more frequent refueling that results from it. And in fact, EPA analysis of refueling data for 2008 found that it "equates to an estimated 4% E85 refueling frequency for those FFVs that have reasonable access to the fuel." So without a fundamental change in the pricing relationship, it's not clear that either more FFVs or even more E85 pumps will result in consumers purchasing large volumes of E85.

Mr. Woolsey's arguments about fuel competition make intuitive sense, although it does not necessarily follow that legislation requiring carmakers to produce more FFVs would achieve the results he suggests, particularly when GM, Ford and Chrysler have already agreed that half the cars they produce will be flex-fuel capable by 2012. $100 per car isn't an astronomical sum for this kind of experiment, but is there really a compelling reason to make it compulsory, rather than a matter of consumer choice?

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Arguing With the Numbers

Over the weekend I read a remark in one of the Wall St. Journal's political columns that resonated with an implicit theme of this blog since its inception in early 2004. In her discussion of the budget crises facing various states and the debates concerning how to resolve them, Peggy Noonan highlighted the benefits of focusing on the numbers involved. "It doesn't matter if you're a liberal or a conservative, it's all about the numbers, and numbers are sobering things." Our national debate on energy would be much more productive if that same rationale were applied to it. That's happening more than it used to, perhaps because blogs are making some of the numbers more accessible, but an example in Monday's Journal reminded me just how far we still have to go in this regard.

In a supplement providing highlights from the Journal's annual "ECO-nomics" session in Santa Barbara, I saw a reference to a discussion of Brazil's sugarcane ethanol model and the merits of trying to apply something like that here, either on a domestic basis or by importing more cane ethanol. Brazil is widely credited for its vision of fueling its cars from domestic renewable sources, largely in response to the oil shocks of the 1970s. As hard as those were on the developed world, they were even more disruptive for developing economies. Today, Brazil consumes more ethanol than gasoline, because so many cars in Brazil run on either pure ethanol or a blend with a much higher proportion of alcohol than the standard US 10% blend. Who could fail to find this attractive, conceptually?

When we look at the actual numbers involved, however, we see Brazil's cane ethanol and its flexible fuel vehicle fleet in a somewhat different light, in terms of providing a model for the US. Start with the number of cars in the country, comprising around 26 million in a nation of 194 million, or 2/3rds the population of the US. By contrast, the US has more cars and light trucks than there are Brazilians. Next compare Brazil's total ethanol output to US gasoline consumption. With Brazil's annual ethanol yield approaching 7 billion gallons, and factoring in ethanol's lower energy content, the US would need roughly 27 Brazils worth of cane ethanol to fuel our car fleet, after subtracting the 13 billion gallons of corn ethanol we produce domestically, and ignoring logistical and fleet modification issues.

So without trivializing the important question of whether to continue to impose a tariff on Brazilian ethanol imported into the US, or taking anything away from the tremendous biomass conversion inherent in sugar cane grown in the tropics and processed in efficient facilities that make use of essentially every part of the cane plant to produce ethanol, sugar and a modest surplus of electric power, it's hard to see that we could encourage Brazil to ramp up its output enough to displace all the gasoline attributable to imported oil, or gear up US cropland in Florida and Louisiana to produce the equivalent. That conclusion couldn't be gleaned from purely conceptual arguments without the numbers.

This isn't intended as a slam on the Journal's conference or other high-concept confabs--I have attended many, myself, and found them very stimulating--or on Brazil's sugar/ethanol industry. It just seems that if our fiscal problems have finally reached the level of concern at which serious conversations must be grounded in the numbers, then energy deserves no less. And while I recognize that many of the numbers involved are daunting, there are many resources available to make them more accessible. That includes the recently revamped public website of the Energy Information Agency of the US Department of Energy. Although the update to EIA.gov has unfortunately blown up numerous embedded links in my past postings, the result seems to be more user-friendly.

Tomorrow I'll be participating in a webinar examining the energy implications of the unfolding revolutions in North Africa and the Middle East at The Energy Collective. Click here for more information and to register.

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Building a Market for Biofuels

For the first time in many years I find myself in general agreement with one of the major ethanol trade associations on a key matter of energy policy. Last week Growth Energy, which represents a significant portion of the US ethanol and biofuels industry, announced its support for a phase-out of the federal Volumetric Ethanol Excise Tax Credit, or "blender's credit", in preference to using these funds to provide incentives for constructing the infrastructure needed to offer ethanol at every gas station, and to promote vehicles that can safely burn higher-percentage ethanol blends. This looks like a prudent shift for several reasons, and I hope that the Congress is paying close attention.

No, I haven't suddenly abandoned my aversion to ethanol subsidies that have dragged on for more than three decades and are now long overdue for full retirement, at least for ethanol derived from corn and other food crops. The Congressional Budget Office just released a study on these subsidies showing that when applied to volumes of biofuel equivalent to a gallon of gasoline, the current $0.45 per gallon ethanol blenders' credit equates to $0.73/gal., and the full cost to taxpayers of displacing a gallon of petroleum gasoline with ethanol works out to $1.78/gal. That doesn't count any of the actual production costs of the fuel, either. US ethanol output may thus displace roughly 500,000 barrels per day of imported gasoline (or the imported oil from which to refine it) but it's hardly a bargain. However, I'm also aware that the US has made an enormous policy--and political--commitment to biofuels, including advanced biofuels from cellulosic biomass.

We've done this for reasons that transcend economics. But unless we invest smartly to create a bigger market for these biofuels, the Renewable Fuel Standard will shortly collide with the "blend wall", and US biofuels policy will be stymied. That will happen sooner than might otherwise have been expected, because instead of growing at a steady 1-2% per year as they had prior to the enactment of this policy, US gasoline sales have actually shrunk since then. Trying to cram additional amounts of ethanol into this market--and into cars that weren't designed to use more than 10% of it without damage to engines, fuel systems, and emissions equipment--is a dead end. In order to keep growing, ethanol--including cellulosic ethanol--requires an independent outlet. That's where E85, the 85% ethanol/15% gasoline mix that's as close to straight ethanol as can effectively be delivered to the gas station and used in flex-fuel cars, comes in. So far, though, E85 occupies a tiny niche market mainly in the corn states of the Midwest.

Growth Energy appears to have assessed the longer-term environment for their fuel and reached a similar conclusion: paying refiners to blend ethanol into the shrinking space left in each gallon of ordinary gasoline--which is what the current VEETC does--now makes a lot less sense than helping the nation's 100,000-plus service stations (most independently owned) to adapt their forecourts to deliver a wider mix of products. Promoting flexible fuel vehicles--including wider awareness of which cars are already capable of safely using higher ethanol blends--is also an important element of creating a market for these fuels, though to some degree this is already underway through the government's Corporate Average Fuel Economy regulations and voluntary manufacturer initiatives.

This won't be easy. Growth Energy expresses confidence that ethanol can compete against gasoline without a per-gallon subsidy, as long as it's widely available and most cars are equipped to burn it. However, the industry must somehow overcome the fact that each gallon of pure ethanol contains just 66% of the energy of a gallon of petroleum gasoline. Most drivers don't notice the impact of this when they use gasoline blended with 10% ethanol, but at 85% ethanol and just 15% gasoline, this effect becomes impossible to ignore. Beyond those customers willing to absorb that hit for reasons of perceived patriotism or environmentalism, E85 must ultimately be priced at a discount that reflects the reality that a tank of it won't take you nearly as far.

As of last Friday, ethanol for August delivery traded for $1.61/gal on the Chicago exchange. (That doesn't include freight to market, mainly by rail, which can easily add another dime.) That works out to $2.46 per gasoline-equivalent gallon. Meanwhile Unleaded Regular without ethanol was worth $2.05/gal on the New York exchange (pre-tax.) Nor is this difference anomalous; over the last year wholesale gasoline was consistently cheaper than its energy equivalent in wholesale ethanol, to the tune of roughly $0.90/gal. Unless the ethanol industry figures out how to produce its product at a lower cost, or gasoline prices go up without ethanol prices following, as they did in 2008, then tax credits for distribution and sales infrastructure may not foster as big a market for ethanol as Growth Energy expects, or as profitable a market as I'm sure they'd like. Yet as a matter of policy equity, and from the standpoint of what taxpayers are getting for their money, guaranteeing access for ethanol looks like a better approach than guaranteeing sales, as we do now. It also has the additional benefit of having a logical end-point, instead of the open-ended support we've effectively provided ethanol since 1978.

The current ethanol blenders' credit expires at the end of 2010. The announcement by Growth Energy is even more notable because the Renewable Fuels Association, which represents a larger slice of the industry, has come out in favor of an extension of existing policy through 2015, when the subsidy in question would likely approach $7 billion per year. If this divergence within the ethanol industry is reflected among its supporters in Congress, we could see a surprisingly lively--and fruitful--debate over how best to integrate support for ethanol into a more cohesive national energy framework. Compared to continuing the status quo, Growth Energy's idea of investing to create a mass biofuels market, rather than just paying for space in gasoline, has considerable merit. This approach could also be done for a lot less than the current subsidy, because it wouldn't be necessary to install E85 pumps in every service station in the country. Most of the benefit could be achieved by focusing incentives on strategically-located high-volume outlets, and the rest of the money could go back into the Treasury, where it belongs.

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The Wrong Flex-Fuel

An article in today's Wall St. Journal highlighted another of the more obscure provisions of the mammoth climate bill recently passed by the House of Representatives. The section in question relates to the "Open Fuel Standard", which would authorize the Secretary of Transportation to require auto makers in the US to build a specified proportion of "fuel choice-enabling automobiles", including flexible fuel vehicles (FFVs) that can run on fuel blends containing a high percentage of methanol, as well as the more common E85 ethanol blend. This harkens back to previous efforts to launch methanol as a consumer fuel. Fortunately, those failed to gain traction, and we should hope that continues to be the case. Methanol makes a fine racing fuel but is entirely unsuited for mass market application.

I'm perplexed why one member of Congress would be quoted as saying he wouldn't have supported the Waxman-Markey bill without its methanol provision. A simpler alcohol than ethanol, methanol is produced mainly from natural gas, rather than from biomass, and it is a common industrial chemical. Because its economics depend on low-priced sources of natural gas, much of the world's methanol is produced in the Middle East, and some plants in North America have closed. It's not clear that increased US methanol demand would be met by either domestic or non-hydrocarbon sources, so its efficacy in addressing either energy security or climate change looks questionable. That's just as well, because methanol offers an inferior way to deliver energy to vehicles, even compared to ethanol, and its toxicity makes it a poor choice for a consumer fuel.

Start with the energy side of these drawbacks. Turning natural gas into methanol consumes around 1/3 of the energy content of the gas, similar to producing hydrogen from natural gas. As with H2, there's no way to recover those losses when burning methanol in an internal combustion engine, so while direct emissions might be lower, indirect emissions negate most of that benefit. We'd be much better off just putting the natural gas directly into cars. Then there's fuel economy. Even after you modify a car to run on a 50% (M50) or 85% blend (M85) of methanol and gasoline, you can't compensate for its lower energy content without precluding operation on ordinary gasoline. While a car running on E85 typically uses 40% more fuel per mile than on gasoline, you'd need 75% more M85 to go the same distance, because methanol's energy content is 25% less than ethanol's and less than half that of petroleum gasoline. So a Ford Fusion FFV that gets a combined 21 city/highway mpg on gasoline and 15 mpg on E85 would deliver a paltry 12 mpg on M85. Even with the car's generous 17.5 gallon fuel tank, its range on M85 would be barely 200 miles.

As if these practical considerations weren't a sufficient disqualification, methanol's handling risks ought to put it out of the running for our future fuel mix. The basic problem is that, unlike gasoline or ethanol, methanol is a neurotoxin. Ingesting even a small quantity can lead to blindness or death, as described in the Material Safety Data Sheet from Methanex, one the world's largest methanol producers. Its vapors aren't much safer, and it can even be absorbed though the skin. These properties create serious concerns for both bulk handling and at the point of sale. Gasoline is hardly as safe as water, but at least if you spill some on your hand, you don't need to be hospitalized. While methanol can be handled safely by trained personnel in industrial facilities and storage terminals, that doesn't extend to the gas station forecourt, where it would pose a hazard to both customers and employees.

Consumers have rejected methanol fuel before, and I am pretty confident they'll do so again, but possibly not before the government imposes another expensive mandate on an automobile industry that surely doesn't need such distractions. The inclusion of this half-baked idea in the House climate bill is a further indictment of its managers' approach of garnering votes one special interest at a time. The Senate has an opportunity to avoid this trap by stripping out all these extraneous provisions and sending a bill to the eventual House/Senate conference committee that focuses squarely on reducing emissions without making concessions to every member's pet idea.

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Open Fuel Standard

One of the energy-related email lists to which I'm subscribed recently alerted me to an interesting piece of pending legislation in the US Congress, the "Open Fuel Standard Act of 2008", S.3303. The bill would require automakers to increase the proportion of their cars that are able to run on non-petroleum fuels to 50% by 2012 and 80% by 2015. Its title might be intended to conjure up analogies to high tech software standards, and its supporters may cite national security considerations, but its main purpose is to plug a gaping hole left by previous Congressional energy legislation. And while it mentions other fuels such as methanol and biodiesel, it is first and foremost about ensuring the future market share of ethanol.

The main focus of the "OFS Act" is Flexible Fuel Vehicles, cars that are factory-equipped to consume fuel containing high proportions of alcohol, which might otherwise damage their fuel systems and other components. Most of the 240 million cars in the US are only certified for alcohol blends of up to 10%. The few million FFVs already on the road were produced under a provision of the Corporate Average Fuel Economy regulations that allowed carmakers to offset them against low-mpg conventional cars, such as large SUVs. Considering that most FFVs burn gasoline most of the time, instead of the alternative fuels they were credited with enabling, this actually reduced the real-world fuel economy of the US new car fleet and increased US petroleum imports, a fact that was recognized and rectified when Congress passed the Energy Independence and Security Act of 2007. That bill established the new, higher national Renewable Fuel Standard (RFS), while progressively phasing out the CAFE benefit from FFVs by 2020. In the process, it set carmakers and fuel suppliers on a collision course, with the wreck now likely to happen several years sooner than it otherwise would have, because gasoline demand is falling.

Until this year, US gasoline demand was growing by about 1% per year. Starting from its 2006 volume of 141.8 billion gallons per year (GPY), the gasoline pool could have been expected to accommodate the quantities of ethanol required under the new RFS until at least 2014 without exceeding the maximum 10% blending rate (E10) for standard cars or requiring significant sales of E85, the 85% ethanol/15% gasoline blend that is the closest thing to pure ethanol that seems to be compatible with our fuels distribution system. But instead of growing by 2% since 2006, US gasoline demand in 2008 has dropped by around 3.5%. A similar decline next year would shrink gasoline sales to about 132 billion GPY and cause the RFS to bump into the E10 ceiling in 2012. That would require either selling E85 to large numbers of FFVs, or delaying the ethanol ramp-up until the fleet's flex-fuel capabilities caught up. Even bumping up the E10 limit to 11 or 12%, which is currently under consideration, would only buy us another year or two.

The Flexible Fuel Vehicle Club of America--who knew?--claims there are 7 million FFVs today. If every last one of them used nothing but E85, they would consume about 5 billion gallons per year. But that would require something like 7,000 retail locations selling at least 60,000 gallons per month of the fuel, instead of the current 1,600 stations selling a few thousand gallons per month each, totaling perhaps 150 million gallons per year. It would also probably require a much bigger discount for E85 vs. regular gasoline than the $0.17/gal reported by AAA currently. (Their calculation suggests E85 costs motorists $0.30/gal more than gasoline at today's prices, after adjusting for mileage effects.)

My long-time readers know that it wouldn't break my heart if the ethanol build-up came to a screeching halt. Ethanol is an inferior fuel in many respects, with an energy density a third lower than gasoline, translating into reduced vehicle range and fuel economy. This is confirmed by the government's own fuel economy ratings. Its environmental attributes are a distinctly mixed bag, and that extends to lifecycle greenhouse gas emissions that may be no better than gasoline's, when global land-use changes are included. Nor does it seem likely that ethanol from non-food sources, including cellulosic plant matter and waste, will be available in large quantities for some time, embedding fuel-vs-food competition into the economy for years to come. Its main selling point is that it is mostly home-grown--never mind the greater efficiency and environmental benefits of sugar-based ethanol from Brazil and the Caribbean. Because of its importance to US agriculture, it is highly unlikely that any US government, Democratic or Republican, would choose to back away from it without compelling evidence of harm--or unless it started to pile up at ethanol plants because there weren't enough FFVs to consume it.

So if Congress remains committed to increasing ethanol use and to denying carmakers the CAFE credits they formerly earned for selling cars that could burn E85, they must pass the Open Fuel Standard act or something like it, far enough in advance of the impending train wreck in 2012 or 2013, to get sufficient FFVs on the road to absorb the surplus ethanol beyond E10. Given the Big Three's other problems, it's hard to imagine the $100 or so in extra expense per car becoming the straw that breaks Detroit's back, but I wouldn't be surprised if they asked for a tax credit to cover the cost.

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Natural Gas Limelight

A decade ago, natural gas looked like the certain winner of a shift to lower-emission energy sources, as concerns about greenhouse gas emissions grew. The path to that outcome has been much bumpier than expected, however. Rising natural gas prices and supply concerns coincided with another shift, this one among environmentalists who identified gas as a key element of a "carbon economy" they were driven to transform, rather than the least-emitting fossil fuel. These dynamics are shifting again, and the future again looks positive for the US gas industry, thanks in part to the increased visibility created by the Pickens Plan and a new industry PR campaign. Its improved supply outlook and relative pricing against oil are helping, as well.

Since 1998 demand for natural gas in the power sector has grown by 50%, and gas-fired turbines now account for 41% of US generating capacity and 21% of net generation. But by 2004 US gas production had dipped by about 5% from its recent high in 2001--a slump that was deepened in 2005 and 2006 by the lingering effects of Hurricane Katrina. As a result, natural gas prices are running at about four times their 1998 level of around $2 per million BTUs, and winter spikes to $10 or higher have become the norm. As recently as a couple of years ago, many analysts saw natural gas as the country's quiet energy crisis, with our import dependence beginning to mirror that of oil.

Today, that perspective has been dramatically altered by the success of the US gas industry in tapping unconventional sources, including coal-bed methane and the shale plays that are driving the success of companies such as Chesapeake Energy. BP is purchasing a 25% interest in Chesapeake's Fayettville Shale assets. Although it comes too late to save many of the gas-intensive industries that moved offshore in search of lower input costs, and while I'm skeptical of claims that the US might become a net natural gas exporter, the resurgence in US gas production could not come at a better time, given our intertwined concerns about energy security and climate change.

The greenhouse gas advantage of natural gas for power generation looks significant, compared to coal. In 2000 the average US gas-fired power plant emitted nearly 40% less CO2 per kilowatt-hour than the average coal-fired plant. But with wind and solar power booming, this glass was increasingly viewed by environmentalists as 60% full, rather than 40% empty. That did not stop gas from gaining market share at the expense of coal, but its green image hasn't held up as well as its supporters expected. Some of that luster is being restored by the attention generated by Mr. Pickens, who casts gas as an environmentally-friendly bulwark of US energy security. Recent remarks by Speaker Pelosi and Senator Obama suggest that this approach is working.

It also helps that the Pickens Plan focuses on increasing natural gas consumption in transportation, where its emissions benefits and cost savings align nicely. A natural gas vehicle emits about 25% less CO2 per mile, measured from "well-to-wheels", than the comparable gasoline car, and it appears to be slightly greener than a flexible-fuel vehicle running on E85. Factor in the substantial price discount for compressed natural gas, compared to gasoline, and this ought to be a winning proposition for consumers, particularly if legislation to provide incentives for buying or converting a car to run on compressed natural gas passes.

Let's put all of this in perspective. Higher US natural gas production should provide economic and environmental benefits for the entire country, even if it doesn't result in a gas glut, but it is still no panacea. At 23 trillion cubic feet (TCF) per year and growing, US gas consumption still exceeds the highest previous level of US production, 22.6 TCF in 1973. And with US electricity demand having grown by 78 million MWh last year--a multiple of the additions from wind and solar power--and with new coal-fired plants being canceled left and right, natural gas consumption in the power sector seems likely to increase, not decrease, at least for the next several years. That means that in order for gas use for transportation to grow large enough to have an impact on US greenhouse gas emissions, it must compete for its share of growing production, or rely on imports, undermining its perceived energy security benefit. Moreover, politicians tempted to nudge the market in the direction of more natural gas cars should keep in mind that much of the nation's gas is consumed in ways that would have a large and fairly direct impact on consumers' wallets, should increased competition for it drive up its price.

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Loophole Whiplash

The Corporate Average Fuel Economy (CAFE) standard is back in the news. One of the main results of the Energy Independence and Security Act of 2007 (EISA) was to increase the overall US new car fleet CAFE target to 35 miles per gallon by 2020. Now the National Highway Traffic Safety Administration, which administers the CAFE program, must establish the milestones for stimulating and measuring progress toward that goal. Today's Wall St. Journal reports that auto manufacturers that had previously embraced last year's CAFE compromise are now objecting to a 2015 interim standard of 31.6 mpg. As obtuse as this may seem, in light of consumers' recent and dramatic shift toward more efficient cars, it is a consequence of two past regulatory failures associated with CAFE: the well-known "SUV Loophole" and the much more obscure rules promoting the manufacture of "Flexible Fuel Vehicles" (FFVs.) Carmakers haven't just been slammed by high fuel prices; they also have a bad case of loophole whiplash.

To the surprise of many observers, last year's energy legislation finally closed the much-debated SUV Loophole, which had subjected "light trucks" to a different, lower fuel economy standard, compared to "passenger cars." This was a classic case of good regulatory intentions gone wrong. When the CAFE standard was originally established in 1975, Congress and the Ford administration recognized that the pickup trucks and delivery vans used by businesses could not attain the same fuel economy as personal cars using the technology of the day. Forcing them to do so would have made a bad US economy worse. Without rehashing how this sensible policy morphed into the SUV fad, the result is that 33 years later, the 2008 model (scroll down to March 2008 report) passenger car fleet came within 0.2 mpg of meeting the proposed 2015 target, while new SUVs and pickups still averaged only 23.4 mpg. So not only have SUVs become albatrosses on cardealers' lots, thanks to $4 gasoline, but the same federal program that promoted them in the first place has now turned them into a huge regulatory liability.

A less-publicized aspect of the 2007 energy bill has a bearing on this problem, as well. Previously, FFVs were treated as an even more privileged category under CAFE, and an FFV SUV was a precious commodity. As NHTSA's CAFE FAQ page explains, a model getting 13 mpg on E85 and 16 mpg on gasoline would be counted towards a carmaker's CAFE quota as though it were a sort of 50 mpg hybrid on paper. An automaker could meet up to 1.2 mpg of its overall fleet target this way, in another example of US alternative fuel policy gone awry. Under EISA 2007, this benefit will be phased out between 2014 and 2019. The result only amplifies the SUV pain for US carmakers.

Although the timing of all this could not have been worse for Detroit, it was never going to be otherwise. Only another energy crisis could produce the political coalition necessary to close these loopholes, guaranteeing that this would coincide with market conditions that would punish US carmakers for the past success they enjoyed by taking advantage of them in the first place. There is no doubt that GM and Ford, at least, can field entire new car fleets capable of meeting the 35 mpg standard. The technology exists today, and their 2006 European models already delivered the equivalent of the ultimate US target. In the EU they will be required to beat 40 mpg by 2012. The question is whether they can retool quickly enough to pull off the same trick, here, with a sales mix reflecting the expectations of US car-buyers--expectations that are currently in flux but still differ markedly from those of consumers in the UK or Germany.

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