The Unlevel Playing Field for Energy

An editorial in last weekend's Wall St. Journal led me to a recent analysis by the US Energy Information Agency (EIA) summarizing the costs of the federal government's various "subsidies" for energy from different sources.  This is both useful and timely, since discussions of specific subsidies such as the expiring wind production tax credit inevitably lead to questions about how incentives for renewable energy compare to those for oil, gas, nuclear, and other more traditional sources.  As the Journal noted, the EIA stopped short of comparing these incentives on the basis of the relative productivity of different energy sources, but even without that it's still apparent that the category of new renewable electricity--excluding hydropower--received 21% of the federal energy benefits for 2010, while accounting for less than 3% of domestic energy production that year, when oil and gas, which provided 49% of US energy production, received less than 8% of these benefits.  Whether on an absolute or relative basis, renewables receive much more generous federal support than oil and gas.

Before digging further into the EIA's analysis, I should point out an important distinction between the federal expenses and incentives covered in the report and the externalities that are frequently conflated with them.  It is certainly true that many of these energy technologies involve significant impacts that aren't reflected in their market prices, and that the production and especially the consumption of fossil fuels create serious environmental and security externalities. However, to whatever extent federal subsidies address externalities they do so indirectly, at best, and in many cases inefficiently.  The focus of this posting, just like the EIA report's, is on the federal government's cash outlays and "tax expenditures"--deductions, credits, etc.--that have a direct bearing on the federal deficit and debt burden that are the subject of intense debate in this election cycle.

The tables in the report's executive summary reveal several key facts.  Between 2007 and 2010 federal energy subsidies in constant dollars more than doubled to $37.2 B, with most of the increase going to renewables and energy efficiency, except for a sizable bump in low-income energy assistance payments.   $14.8 B of the increase originated with the 2009 stimulus bill, none of which was directed at oil and gas, but which appropriated nearly $8 B to conservation and efficiency.  Overall, renewables received $14.7 B, split 55/45 between electricity and biofuels, while nuclear received $2.5 B and oil and gas $2.8 B.  The latter figure is lower than you'll see elsewhere, because among other incentives that the EIA chose to exclude from its analysis was the Section 199 deduction for manufacturers, which is budgeted at around $1 B/yr for oil and gas firms.  The logic behind that exclusion seems sound, because US manufacturers of biofuels, wind turbines, solar panels and other renewable energy equipment qualify for the same tax credit, and at a higher rate than oil companies.

I was also struck by the fact that oil and gas received just $70 million out of the more than $4 B spent on R&D. If there's one category in which federal expenditures on renewables should be expected to dwarf those for conventional energy, this is it, and they did so by a factor of more than 20 times.  (Coal R&D received more than $0.6 B, presumably for clean coal technologies.)

It's also the case that while the growth of renewable energy output from 2000-10 was dramatic, the relatively smaller net changes in oil and gas output in that period masked the substantial replacement of depleting resources that would have otherwise resulted in a large drop in output, especially for natural gas.  This is precisely the aspect of the mature oil and gas industry at which these federal incentives are aimed, to enable US projects to compete with the international opportunities to which many of these companies have access.

The authors of the report suggested caution in comparing the allocations of incentives to the energy produced by each technology, because some of these incentives were paid for projects still under construction and in some cases represented the front-loading of what would otherwise have been a 10-year stream of tax credits.  Fair enough.  Yet even with the conservative assumption that the entire $4.9 B of non-R&D subsidies for wind power in 2010 came in the form of cash grants in lieu of the 30% investment tax credit for new wind turbines that would produce for 20 years at a 30% capacity factor, that still equates to a subsidy of more than 16% of the average present wholesale value of all the electricity those turbines will produce, using prevailing industrial sector electricity prices as a proxy for wholesale prices.  By comparison, the $2.7 B of oil and gas tax incentives for 2010 represented just 1% of the wholesale value of US production of these fuels, before refining.

A serious debate about the appropriate level of US energy subsidies should begin with the facts, rather than with misperceptions. It should also focus first on the goals of such incentives, before jumping to the details of this tax credit vs. that one.  What do we want these measures to achieve?  If it's simply the promotion of energy production, then the current incentive system looks too heavily skewed in favor of renewables.  If it's jobs, then we should be realistic about how many can be added by such a capital-intensive sector.  If it's the promotion of both energy security and innovation, then at least parts of the current system look directionally right, though I'd argue that we'd benefit from spending more on renewable energy R&D and less on the deployment of mature-but-expensive technologies like wind.  However, if emissions and climate change are our primary concerns, then these incentives are not a terribly effective way to address them.  My own expectation is that regardless of whether the wind tax credit is extended for another year, most of the tax incentives that the EIA assessed here will eventually be swept away by tax reform focused on reducing corporate tax rates to improve US competitiveness, while eliminating loopholes to make the changes revenue-neutral.

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The American Jobs Act's Poison Pill(s)

I had a completely different topic in mind for today's posting, but I'll have to come back to the energy implications of a potential European financial crisis later. Since President Obama's jobs speech to Congress last week I have been awaiting the text of the actual proposed bill, rather than the summaries I'd been seeing. It finally came out at the end of the day yesterday. I feel obliged to point out a few provisions that haven't been widely advertised, either in the original speech or on the fact sheet that the White House published. These include several measures related to alternative energy, such as the inclusion of some project categories within the purview of the proposed National Infrastructure Bank, or the funding for putting solar panels on abandoned and foreclosed buildings as part of their rehabilitation. However, I'm not sure how much any of this matters, because the bill sent to the Congress also includes a slate of provisions that were certain to be regarded as a "poison pill"--sections that would preclude passing it on the all-or-nothing basis that the President seemed to be pushing for last Thursday. Energy features prominently in these poison pill measures.

I can't do justice to a 155-page legislative draft in the few hours I've had to review it. I'll restrict my comments today to the "offset" provisions that escaped being mentioned in the administration's fact sheet and reserve comment on the other aspects of the bill for a later date, if necessary. It seems clear from reading Sections 431-442 that the architects of this bill view the US domestic oil and gas industry as a declining cash cow, rather than as the source of new jobs and growth that I described in last Thursday's posting. Those sections set out to repeal every single oil and gas industry tax benefit of which I was aware, and a couple I hadn't even heard of. Included are the Section 199 manufacturing tax credit enjoyed by every other manufacturing company in America, along with portions of the tax code designed to prevent US companies from being subject to double taxation on their global income, protections that I believe their non-US competitors enjoy automatically under the territorial tax systems in use in most developed countries. In a different context I wouldn't have found any of this surprising, but rather a measure of consistency, since the administration has pursued the termination of these benefits in every budget proposal since 2009 and in a number of bills introduced by its allies in Congress.

The surprise comes from their inclusion in a bill intended to provide immediate relief for the large number of Americans still out of work, and possibly to avert a double-dip recession--a bill described as consisting mainly of provisions that have been backed by both parties at various times. However, the legislative history and likely fate of the poison pill provisions is abundantly clear: they have failed every time they were proposed, including in the previous Congress in which the President's party held overwhelming majorities in both houses. Along with the other "offset" provisions, such as those limiting itemized deductions for taxpayers making more than $200-250,000 per year, or going after the tax treatment of hedge fund income and corporate jets, it's hard to see their inclusion in the American Jobs Act as anything other than politically motivated. This morning's headlines reflect the entirely predictable reaction to them.

It's not that these measures aren't a legitimate subject for debate and action. However, that debate is part and parcel of the growing bipartisan consensus on the need for comprehensive reform of our convoluted tax code, in which the majority of current deductions and exemptions, including those for energy, would be sacrificed in exchange for the lower tax rates necessary to make all US businesses--not just a chosen few--more globally competitive. Squandering that opportunity to pay for a short-term boost to the economy would, among other outcomes, leave the US energy sector less competitive and the nation worse off in the long run. Meanwhile, when the Congress rejects these poison pills and proceeds to cherry-pick among the bill's headline measures, it might also adopt the American Jobs Act's final provision, which dumps the problem of paying for it in the laps of the Supercommittee appointed to find the remainder of the deficit reductions agreed in the Budget Control Act of 2011--already a pretty tall order.

If there was ever a chance for a "clean" jobs bill to pass intact, the pursuit in this venue of the administration's long-standing agendas with the oil and gas industry, hedge fund managers, and corporate jet owners erases it. Whatever the outcome of the negotiations with and within the Congress over this bill, you can count on hearing a lot more about these issues between now and next November.

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Energy Implications of Tax Reform

I've been thinking about the implications for energy of a major deficit reduction effort along the lines suggested by the co-chairs of the President's fiscal responsibility and reform commission. Our present approach to providing incentives for various energy sources and technologies, new and old, is embedded in a tax code and taxation philosophy that might not survive the upheaval required to bring the US deficit and resulting federal debt back into a manageable range. This goes far beyond the comparatively minor question of extending expiring grants and tax credits that I discussed the other day; under the most stringent of the proposals from Mr. Bowles and Senator Simpson, such things wouldn't even exist. It's not clear how the Administration or Congress would promote favored energy technologies and strategies without these well-established but costly tools.

Start with renewable energy. We currently promote renewable fuels and electricity generation with a combination of mandates--policies such as the federal Renewable Fuels Standard (RFS) and state Renewable Portfolio Standards--and subsidy payments. Until last year's stimulus bill established the Treasury renewable energy grants, for which eligibility is due to expire in a few weeks, most of those subsidy payments have come in the form of reductions in federal taxes, via either an investment tax credit (ITC) based on the cost of a project or a production tax credit (PTC) for actual energy generated. Both of these measures, which have had a checkered history of expirations and extensions, fall into the broad category of "tax expenditures". The Zero Option proposed by Messrs. Bowles and Simpson would permanently eliminate over $1 trillion of such tax expenditures, in exchange for much lower tax rates.

Even if the renewable energy tax credits were reloaded into a streamlined tax code under the "Wyden-Gregg-style" reform presented as Option 2 from the co-chairs, the value of those credits would be reduced--or at least rendered harder to extract--because the corporate tax rate would be reduced from the current 35% to 26%. That means that a higher proportion of companies would likely not pay large enough taxes to take full advantage of the renewable energy tax credits--or have as much appetite for others' credits via "tax equity" swaps. Compounding that, the likelihood of enacting cash grants to get around this restriction would probably be much lower in an environment in which entire herds of sacred cows were being slaughtered in the cause of averting a looming national deficit and debt crisis.

In the absence of such tax credits, renewable energy developers and manufacturers would be forced to rely even more on state-level mandates or a proposed federal renewable electricity standard. The first test of such a mandates-only approach might come in a few weeks, if the ethanol blenders' credit is allowed to expire, while the annual RFS mandate continues to ratchet up. Or companies might simply conclude that without generous tax subsidies for renewable energy deployment here, their best opportunities would be found in markets that are growing much faster than ours, based on actual energy demand, rather than better incentives. Developing Asia comes to mind. That shift might not be the worst outcome, in terms of both the US trade deficit and global emissions reductions.

Conventional energy firms wouldn't escape unscathed, either. They stand to lose significant tax expenditures as well, in the form of oil & gas depletion allowances, the Section 199 manufacturing deduction, and other benefits. However, the oil and gas industry has been paying an effective corporate tax rate above 40% even after all these credits and deductions. A drop to 26% might more than offset the loss of the other benefits, while more importantly bridging the competitive gap between US firms and foreign competitors that operate under lower tax rates and a territorial tax system, rather than being taxed on worldwide earnings, as US companies are today. Bowles/Simpson also proposed increasing the federal gasoline tax by 15¢ per gallon to restore the Highway Trust Fund to solvency. That's a worthy goal, but as I've pointed out previously the Highway fund faces complex challenges as the US car fleet becomes steadily more fuel efficient and increasingly moves away from liquid fuels taxed at the pump. Raising the gas tax is a stop-gap measure, at best, on the way to a different means of collecting road taxes.

With regard to climate policy, tax reform that eliminated tax credits or reduced their value would also tend to nudge the debate back in the direction of putting an explicit price on carbon, either via cap & trade or with an outright tax. Might that prospect suddenly look more attractive as an adjunct to a fairer and simpler income tax system, than it seemed when it would have come as a further complication to an already enormously convoluted tax system that is widely viewed as unfair by both liberals and conservatives? My guess is not, without something else that motivates us to tackle climate change on a much more urgent basis.

Now let's come back to reality. The proposals of the commission's co-chairs have already received a frosty reception or outright hostility from both sides of the aisle, and they haven't yet gotten the buy-in of the rest of their team; the final report requires the consent of 14 of the 18 members. Their ideas must also compete with a growing number of deficit-reduction alternatives, including a widely-reported plan from another bi-partisan group, plus at least one solo proposal from another member of the President's commission. The chances are low for any of these proposals to gain enough traction to be enacted without first being significantly watered down. However, it is starting to look just as risky to assume that the present tax system--and its cornucopia of energy incentives--will continue unchanged indefinitely. A quick glance at the US debt clock ought to make that abundantly clear.

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The Challenge of Scale

This morning's Wall St. Journal featured a front-page article on small-scale nuclear power, highlighting how reactors a tenth the size of current commercial designs could significantly reduce the financial risks associated with these mega-projects. This is one example of the need to think in new ways about scale when addressing our energy challenges. In his talk at this year's TED conference in Long Beach, Bill Gates offered another surprising perspective on scale: "All the batteries we make now could store less than 10 minutes of all the energy [in the world]," he said. Framed between those two examples is the basic proposition that while solving our energy problems may require breaking them down into more manageable pieces, they must still add up to mind-numbingly stupendous sums.

According to figures from the Energy Information Agency of the Department of Energy, in 2008 the US consumed 99.3 quads of primary energy--oil, gas, coal, nuclear power, hydropower, biomass and other renewables--down from 101.6 quads the year before. A quad is one quadrillion times the quantity of energy required to raise the temperature of a pound of water by one degree Fahrenheit, where a quadrillion is 1 followed by 15 zeroes (US definition.) Can you picture that? I can't. If I convert that consumption to barrels of oil equivalent at the rate of 5.8 million BTUs each, we get a value of just over 17 billion barrels--a much more familiar unit, especially when we divide by 365 to get 47 million barrels per day. Millions are much closer to something we can grasp, and if we are familiar with energy data we know that's equivalent to a little more than half the amount of oil produced globally every day. It's still hard to picture, though, until you work out that if it were all put in one place in outer space, it would form a spherical blob roughly 800 ft. in diameter--over half as tall as the Empire State Building--and that's every day.

By comparison the daily output of a 3 MW wind turbine, converted to its energy-equivalent of oil (assuming it backs out natural gas from a gas turbine power plant) would form a ball about 7 ft. across. It would take 1,400,000 such balls to fill the big sphere. Of course we can't really compare the output of 1.4 million wind turbines to the total amount of energy we use each day, for many reasons, though it's a handy reminder of just how big the challenge is, and why building nuclear reactors in increments of 125 MW each might be a smart way to finesse this gap.

A 125 MW reactor, if it operated with the same reliability that large nuclear plants have achieved, would produce as much power every day as 125 of those 3 MW wind turbines. And while we doubtless couldn't build these reactors as fast as wind turbines, I'll bet we could add nuclear power capacity faster in these increments than with 1,200-1,500 MW reactors, because of the advantages of being able to manufacture more of each facility in a factory, rather than constructing them on-site. Even if that translated into total project timelines only half as long as for large-scale nuclear plants of the kind for which the administration just awarded federal loan guarantees, that could be worth a lot to the utilities and merchant generating companies building them. It would greatly reduce project risks of the kind that can ruin the economics of big investments--delays, cost over-runs, accidents--and that give companies' bankers and shareholder chills. These aren't the kind of risks the government is offering to defray, by the way.

Of course that doesn't make small nuclear an either/or proposition vs. large-scale nuclear, any more than wind and solar are an either/or proposition vs. oil & gas platforms or big gas-fired power plants that can operate efficiently 24/7. There's room--and need--in our national energy economy for all of these, as our energy diet shifts from a heavy reliance on fossil fuels to a lighter, more sustainable diet in the future. At the same time, it's clear that we can't fill the gap exclusively with small-scale energy sources, without a sizable contribution from sources at least as big as these small reactors. "Drill, baby, drill" only captured one aspect of this concern. More accurately, our energy policy must deliver "scale, baby, scale."

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Cap & Trade, Gas Prices and Uncertainty

Over the weekend a New York Times editorial critical of the energy industry for trying to stir up opposition to the Waxman-Markey climate bill prompted some further thought on the potential impact of the legislation on gasoline prices. The Times appears to accept the government's analysis suggesting that the increase would amount to no more than 20 cents per gallon by 2020, though this conventional wisdom collides with common sense, since such a low price on carbon seems unlikely to stimulate sufficient conservation and investments in efficiency to deliver on a steadily-shrinking national emissions cap. In particular, the Times seems unfazed by the way the bill's allocation of free emission allowances is stacked against the oil industry, suggesting that it, of all industries, can surely afford the extra burden. Yet it's precisely that distortion that I believe could throw all of the official estimates of future permit prices--and thus gas prices--into a cocked hat, when you consider the possible dynamics of a market established along these lines.

Let's start by stating the obvious: I don't have a detailed computer model of the energy markets and US economy to query on the likely outcome from the cap & trade system that would be instituted under Waxman-Markey, though I could probably come up with some drastically-undervalued credit default swaps for anyone who believes in the infallibility of such models. My assessment relies instead on logic and the experience of a career that included a long stint in energy commodity trading, including futures, options and derivatives. Based on that experience, I believe the crucial starting point for any attempt to understand how a new market might function is supply and demand: who has the commodity in question and who needs it.

Begin with demand. The Department of Energy's recent "flash estimate" of US CO2 emissions indicates that the electricity sector accounts for 41% of emissions, followed by transportation with 33%, and the non-electricity-related emissions of the industrial sector a distant third at around 17%. These three segments thus account for 91% of our CO2 emissions, by far the largest component of our greenhouse gas output. Under cap & trade, every ton of those emissions would have to be matched with a corresponding emission allowance, or the emitter would be liable for penalties at a multiple of the going price for allowances. Anyone who is given fewer allowances than their current emissions must thus either reduce their emissions directly or purchase allowances from others. But who are the likely sellers? A careful reading of the bill provides strong hints

Under President Obama's original concept of cap & trade, in which 100% of emission allowances would have been auctioned by the government to the emitters that needed them, all sectors of the economy would have been in the same position of needing to cover their entire shortfall in the market. The government would have been the primary seller, though as the market evolved, companies that found cheap ways to reduce their own emissions would have ended up reselling allowances they had bought earlier, at a profit. Under Waxman-Markey, by my tally roughly 60% of the emission allowances would be handed out to emitters such as utilities, refiners and other industrial firms. Another 30% or so would be doled out in lieu of cash to fund efforts such as renewable energy R&D and deployment, climate adaptation and assistance to low-income consumers. Something less than 10% would be auctioned by the government itself to fund deficit reduction and other initiatives.

So on a given day, who would be selling and who would be buying? Consider the utilities and merchant power generators. As generous as the bill's authors were to this sector, it would still be short allowances from day 1, with a gap between actual emissions and free allowances equal to roughly 4% of US emissions. Non-energy industrial firms probably wouldn't be selling, either, at least unless the price got high enough to stimulate the big investments in energy efficiency that haven't risen to the top of their capital budget priorities so far. Initially, they would need to acquire allowances equal to around 5% of all emissions. And that brings us to refiners, who under Waxman-Markey would be responsible for their own emissions plus all of the emissions from the end-use of their products by non-regulated consumers, yet would receive only a 2% allocation of free allowances. Depending on how upstream production and oil imports are counted, the gap that refiners would need to cover could amount to more than 31% of all US emissions, or 3/4ths of the allowances given to non-emitting entities or auctioned directly by the government. At the same time, they have only modest scope for further reductions in their own emissions, considering that they are already 90% energy-efficient, on average. Who would be likely to have the advantage in such a situation? It sure looks like a "sellers' market" to me.

I don't doubt that refiners could probably scoop up some relatively cheap allowances from groups that get handed these tickets and don't quite know what to do with them, though market sophistication--and for-fee advice on such matters--might spread quickly. But refiners wouldn't just need to sweep up the stragglers, here. They'd require the entire allowance streams of many of the legislation's chosen beneficiaries for years to come, nor could they risk coming up massively short in any year. To me that suggests an average acquisition price for allowances that could rise well above the notional $15-$20/ton expounded by the EPA and DOE, considering that the effective price ceiling provided by brute-force CO2 reductions such as carbon capture and sequestration is probably north of $50/ton, equating to 50 cents per gallon of gasoline. While an increase that high might not be the likeliest outcome, it is at least plausible, and it would be added not to current gas prices, which have been depressed by the recession, but to those that would prevail after the legislation went into effect, when the economy--and perhaps even fuel demand--was presumably growing again. It doesn't take a leap of imagination to combine these factors to get to the $4 per gallon that the Times appears to dismiss.

From the last sentence of the editorial, I have to conclude that the Times doesn't understand the rationale for cap & trade nearly as well as they think they do. The point of this approach and any well-structured legislation implementing it is not to wean the US off of petroleum, but to reduce our emissions of the greenhouse gases implicated in climate change. While that certainly implies lower emissions from the oil sector, and thus lower consumption, it is perverse and counter-productive to shelter higher-emitting sectors that have greater flexibility for reducing emissions. The Congress may have judged that consumers would complain more about higher electricity bills than about increases at the gas pump, which could always be blamed on other factors--and on a singularly unpopular industry. But in creating such a wide disparity of demand for allowances among business sectors, they risk driving the price of those allowances much higher than otherwise, imposing an unnecessary drag on the economy. Even if their protests are motivated by self-interest, the oil industry and oil consumers are right to point this out.

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What Does Tiber Tell Us?

Like many bloggers this week, I've been thinking about the implications of BP's big, new oil find in the Gulf of Mexico. Some analysts suggest that the Tiber field might contain as much as 3-4 billion barrels of oil, though much of it might never be recovered. The Wall St. Journal's Environmental Capital blog suggests that such discoveries serve as a kind of Rorschach test, with the various interpretations of it telling us more about the observer than the thing being observed. Fair enough. Without venturing into grandiose conclusions about whether the Tiber-1 deep water well refutes--or in some convoluted fashion confirms--the central hypothesis of the Peak Oil theory, this discovery provides a handy opportunity to remind my readers of a few principles and themes about oil exploration and production that I've been discussing here for the last six years:

1. There's still life in the old dog. While the US has been drilled like a pincushion for 150 years, we have still not found every barrel of oil that nature provided us. Don't be misled by proved reserves data that seem to show that we have less than 12 years of oil left at current production rates. In point of fact, the US has produced a cumulative 200 billion barrels of oil from reserves that never exceeded 40 billion barrels. Not only do we continue to find new resources in the manner of Tiber-1, but we continually learn how to extract more oil from the reservoirs we've already found, revising their reserves steadily upward over time.
2. A discovery like Tiber doesn't mean we've merely added two weeks worth of production to reserves. US oil production, like global production, is comprised of the contributions from thousands of oil fields and hundreds of thousands of oil wells, with the most productive 20% or so accounting for roughly 87% of output. If initial guesses of recoverable oil are right, then the Tiber field could yield on the order of 100,000 bbl/day of oil for 20 years--2% of US production for a generation. If we turn up our noses at that, then we surely ought to think twice about wind power. In 2008 all the wind turbines in the US generated 52 billion kilowatt-hours, backing out natural gas power generation equivalent to just 245,000 bbl/day of oil, or 5% of US oil output.
3. We've heard a lot from skeptics about how inconsequential the oil in areas that have been off limits to drilling would be, whether we're talking about offshore California, the eastern Gulf of Mexico, or the Arctic National Wildlife Refuge. Yet without actually exploring these areas using the kind of technology that found the Lower Tertiary trend of which Tiber appears to be a part, in a place that just a few years ago would have seemed both inaccessible and highly improbable, we can't know what's really there, waiting to be discovered. In that light, the official estimate of 18 billion barrels of "undiscovered, technically recoverable" oil in these areas must be regarded as an extremely conservative lower bound, based on totally obsolete 1970s technology.
4. Although finding more oil may look problematic from a greenhouse gas perspective, oil is not our worst fuel, and it remains the hardest to displace, because of its unique combination of energy density and portability. I share the vision of many for a future made up of electrified cars and low- or no-emission power plants, but we're going to burn many billions of barrels of oil getting there. For reasons including national security, national pride, and our balance of trade, it matters whose oil it will be, as we make the long transition to a more sustainable energy economy. If we ignore that principle, we're likely to end up even more reliant on unstable foreign suppliers, before we arrive at the elusive promised land of energy independence.

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150 Years of Oil

As I noted in my first posting of the month, August 2009 marks the 150th anniversary of the first commercial oil well. Edwin Drake's well in Titusville, PA hit "paydirt" on August 27, 1859, and the world has never been the same since, though it took decades for oil production to grow beyond levels that would seem trivial today. In its early years the price of oil was even more volatile in real terms than it has been recently, as new sources of supply and new markets repeatedly swung the industry from boom to bust and back again. That led to numerous business failures, consolidations, and the eventual domination of a few large players. Although the world is quite different today, and history rarely repeats itself exactly, there might still be some lessons for alternative energy firms in the early history of the incumbent industry they are attempting to unseat.

Oil statistics back to 1859 are a little shaky, though this chart of oil's annual production history provides a useful overview of the early trends, if we ignore the portion devoted to projecting future output. From its current position of energy dominance, it's easy to forget that the initial success of oil was hardly a foregone conclusion, and its biggest early gains were matched by serious setbacks. While oil has never relinquished the lubricant markets it captured early on, kerosene met a very different fate. It was the most important oil product for several decades, rapidly penetrating illumination markets and displacing whale oil, which was facing its own imminent Peak Oil by then. However, it's no accident that one of the most important early markets for my former employer, Texaco Inc., which along with many other firms grew out of the great gusher at Spindletop, TX more than 40 years after Drake's well, was "oil for the lamps of China." By the early 20th century the US lighting market was already being swept by electrification. Oil was rescued from impending oblivion when a relatively unimportant byproduct called gasoline found its "killer ap" in the early automobile.

As impressive as the growth rates for wind and solar power have been over the last few years, they still fall short of the early growth of car ownership. Between 1901 and 1916, annual US car registrations grew from a few thousand units to over one million, a sustained compound average growth of around 40% per year. Over the same interval, oil production more than quadrupled, led by the combination of soaring demand for gasoline, which was produced by simple distillation of petroleum in "tea kettle" refineries, and the discovery of numerous large oil fields. This remarkable growth wasn't spurred by government incentives or economics that made oil and its products merely a little better than their closest competition. It was the result of a quantum leap in personal mobility facilitated by oil's extraordinary inherent advantages in convenience. Huge surpluses of energy could be extracted from the ground and delivered relatively easily and cheaply to cars in the most remote corners of the country.

The difference in oil's success in the transportation and illumination markets is clear. In modern terms we'd say that two transformational technologies competed head to head, with each ultimately dominating the market in which it had clear advantages of better/faster/cheaper. Kerosene, which lost to electric lighting, is only important today because it turned out to make a wonderful fuel for a device that didn't exist in Drake's time, the jet engine. And it has taken a further century for the technology of electricity to advance to the point at which it is again competitive in transportation, having once lost that battle definitively a century ago, with the mass production of the Model T.

The lessons for today's energy situation are worth contemplating. For example, ethanol has just experienced a boom and bust cycle that the early oil barons would readily understand. Over-investment in capacity still destroys margins, and distribution remains a serious constraint. More importantly, perhaps, ethanol lacks a better/faster/cheaper edge as it fights for market share with petroleum products. Must true success for biofuels await innovations that will turn cheap cellulose into molecules that carry energy at least as efficiently as those in oil, or for the mass production of new conversion devices (engines or fuel cells) that can overcome ethanol's shortcomings relative to gasoline? Oil's history poses similar questions for wind and solar power, which for all their environmental benefits remain costlier and less reliable than conventional sources of electricity. Subsidies and regulations seem anemic substitutes for the inherent advantages of cost and convenience that can sweep away incumbent technologies within a decade or two. I can't help wondering whether the story of today's alternative energy technologies will more resemble that of oil's experience in illumination or in transportation.

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Electric Cars vs. Oil in Hawaii

Ever since last week's announcement of a deal to roll out Project Better Place's model for recharging electric cars in Hawaii, I've been curious about how it would work out, if the supplies of new renewable electricity needed to wean the Islands' million or so cars and light trucks off of oil were not forthcoming, or at least didn't materialize as quickly as the company and state hope. If I've done my sums right this morning, it appears that electrifying Hawaii's passenger cars would still save large quantities of oil and reduce greenhouse gas emissions significantly, even if every kilowatt-hour (kWh) to run them was generated from the state's oil-fired power plants.

Since the late 1990s, I've been convinced that in the long run, the majority of cars would be some form of electric vehicle (EV), whether in the form of hybrids, with power generated onboard from engines or fuel cells, or battery EVs tapping external sources of power. The rate at which this transformation takes place, however, remains highly uncertain, with conventional, Prius-type hybrids still accounting for less than 3% of the US car market, and battery EVs other than golf carts as rare as hen's teeth. I've followed the plans of Better Place with great interest, since their mobility-based business model could provide a key ingredient for accelerating the electrification of personal transportation, even while the high cost of batteries makes EVs more expensive to purchase than their gasoline-based competitors.

As Better Place founder Shai Agassi noted in an interview published in Sunday's Washington Post, Hawaii looks ideally suited to be an early adopter of this technology. With no indigenous production, all of Hawaii's oil, including that from which its gasoline needs are refined, must be imported. In that context, the benefits of the Better Place plan look obvious, until you realize that powering a million cars on renewable electricity would require on the order of 3 billion kWh of electricity per year, the equivalent output of more than 400 wind turbines of 2.5 MW each. Ignoring issues of transmission and intermittency, that's about 16 times the state's currently-installed wind power base. Year-to-date through August, 75% of the state's electric power was generated from oil, and less than 7% from various renewables. So at least for now, if this model is going to work in Hawaii, it has to make sense assuming that most of the incremental power for electric cars would be generated from oil.

That sounds counter-intuitive, until you consider the relative efficiencies of centralized power generation versus the gasoline engine under the hood of your car, combined with the inherent efficiencies of electric drive. Comparing the fuel consumed by Hawaii's oil-fired power plants to the power they generated, I found that each gallon of fuel oil yielded roughly 15 kWh of electricity. If the typical electric cars that will be sold in Hawaii travel 3-4 miles per kWh, that equates to an average effective fuel consumption of around 47 miles per gallon, after allowing for 10% transmission losses. That's 43% lower than the 26.8 mpg of the 2008 model year average for the US new-car fleet, and it would reduce greenhouse gas emissions by roughly the same proportion. Although that's no better than the fuel economy of a Toyota Prius, that comparison would improve, as renewable power gradually displaced oil-fired power.

So at least from an oil-consumption and importation perspective, this idea appears to make sense in Hawaii. I can't speak to its economics, or to how practical it is today for regions such as California's Bay Area, where in recent years increasing numbers of workers have been driving in from communities such as Modesto, Tracy and Stockton--commutes that would have seemed unthinkable 25 years ago--in order to beat the high cost of housing near the coast. I wish Better Place well, and I would certainly appreciate having the choice of an attractive, economical electric car, when it comes time to replace my current sedan in a few years.

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All Those Green Jobs

A full-page ad appearing in today's New York Times, Wall Street Journal, and Washington Post reminded me of a topic I've meant to cover for some time. Frequently during this election campaign, including the primaries, we have heard candidates extol the employment benefits of a switch to renewable energy. In Tuesday night's debate, Senator Obama suggested a figure of "5 million new jobs" from clean energy, and Senator McCain also mentioned "millions of jobs" in this context. It sounds alluring. A rapidly-growing energy sector providing good jobs here in the US is just what the economy could use at the moment. But while recognizing the potential benefits, we should also examine these claims critically. What would 5 million green energy jobs imply about future US energy costs and competitiveness?

The ad in today's papers is entitled, "The Unshaken Pillar", and it describes the US energy sector as a solid foundation for the whole economy at a time of great uncertainty, emphasizing the need for improved energy efficiency and conservation, along with expanded production of both oil & gas and alternatives. Signed by the CEOs of Chevron, AEP, FedEx, and Dow Chemical, it cites employment as an example of the domestic energy industry's benefits. This suggests a basis for putting those hypothetical 5 million green jobs into perspective. As of last year, the US oil and gas industry employed 1,772,000 workers in all categories, spanning exploration & production, refining, transportation and distribution. Nor are they all engineers and highly-paid drilling specialists. Nearly half this figure was associated with employment in service stations. Collectively, these 1.8 million people produced, processed and delivered fuels carrying 33 quadrillion BTUs of energy, or "quads", to US consumers and businesses. That's a third of total US energy consumption and 46% of US energy production. On average, it equates to 18.6 billion BTUs per worker, or 3,100 barrels of oil equivalent each, annually.

In order to come up with a comparable productivity metric for renewable energy, we need to make some assumptions about how much this sector will produce when it reaches its anticipated employment of 5 million Americans. It must be a lot more than the 1% or so of electricity and 7% of gasoline currently supplied by wind, solar power and ethanol. If we combine the 36 billion gallons per year of biofuel targeted for 2022 under the federally-mandated Renewable Fuel Standard with the 20% of net electricity generation from wind by 2030 posited by a recent DOE study, as a proxy for all new renewable electricity, the total equates to roughly 14 quads per year. And that's giving the kilowatt-hours from renewable electricity the benefit of a gas-fired turbine heat rate, rather than the normal engineering conversion, which is 2/3 lower. The resulting productivity figure works out to 2.8 billion BTUs per green energy worker, or 470 barrels of oil equivalent per year.

On that basis, we should expect that the average energy productivity of this huge new renewable energy sector would only be about 15% of the productivity of the current oil and gas industry. To understand the implications of that for the economy and for US international competitiveness, we must translate these figures into dollars. If the average "green-collar" job envisioned by those emphasizing the employment benefits of renewable energy pays the current average US wage of $47,000 per year, then the result is an effective energy cost of $100 per barrel, before considering capital expenses--and renewable energy is still at least as capital-intensive as conventional energy. Using the above figures, the comparable calculated labor expense for oil & gas is around $15 per barrel.

There are many good reasons for the US to pursue renewable and other alternative energy technologies aggressively, including addressing climate change, improving our energy security, and reducing the influence of petro-authoritarian states. Adding good jobs would belong on this list, too, as long as we keep our eye on productivity. In order to remain competitive, we shouldn't desire the largest energy sector possible, but rather the smallest one that does the job of providing the clean energy needed by the rest of the economy, where the vast majority of the goods and services we consume are created. With that in mind, let's all hope that the 5 million green jobs we keep hearing about are merely another example of election-year pie-in-the-sky, and not a realistic estimate.

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NIMBY vs. TANSTAAFL

It is encouraging that our reaction to the current energy crisis has reached the stage at which we are beginning to see concrete plans for addressing it systematically, rather than via the grab-bag approach employed in last year's energy bill. The same applies to the related, but not quite parallel problem of climate change. But whether voters ultimately gravitate towards the Pickens Plan or to Mr. Gore's more dramatic goal of eliminating fossil fuels, such approaches are likely to run afoul of the same factors that have hampered the ability of the US conventional energy sector to keep pace with demand. Real progress in this area will require us to confront the collision between our desire for abundant energy and our distaste for the means of providing it.

The current debate over offshore drilling exemplifies many of the same obstacles that renewable energy sources will face, as we attempt to scale them up to a level that can compete with oil, gas and coal. Too many advocates of alternative energy cite our inability to drill our way out of this energy crisis--kicking a dead dog, if there ever was one--without realizing that the sensibility that opposes oil exploration off our coasts or in Alaska is not so different from the one raising lawsuits against the transmission of concentrated solar power from the desert to coastal markets.

Whether we are talking about oil wells, refineries, wind farms, or uranium mines, most Americans would prefer them to be far enough away from us that we can't see, hear or smell them. Until recently, it has been just barely possible to satisfy both our demand for energy and our state of denial about its origins, because the energy sources we have relied on are so concentrated. One mid-sized offshore oil platform contributes as much net energy production as the entire US ethanol program did in 2006. But as we shift toward renewable energy, it will become increasingly difficult to shield our sources of energy from our view. Generating the electricity necessary to displace natural gas from the power sector into transportation, as Mr. Pickens suggests, would require between 90,000 and 200,000 wind turbines, using current technology. In order the make that a reality, the viewscapes of millions more Americans must include either wind turbines or the new transmission lines necessary to bring their output to market.

Breaking this tension between NIMBY and TANSTAAFL--the popular acronym about free lunches that restates the Laws of Thermodynamics--will require a willingness to set clear national priorities and make the compromises necessary to turn them into practical reality. Does our desire to become energy independent, or at least reduce our reliance on unstable oil suppliers and the financial drain that accompanies it, exceed our preference for keeping big, ugly infrastructure out of sight and out of mind? Does our concern about the potential consequences of climate change trump the ability of small, vocal minorities to block essentially any project that doesn't fit their vision? Or has this energy crisis finally become painful enough to force us to grapple pragmatically with the consequences of solving it?

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Changing Our Energy Diet

Over the weekend I participated in a panel discussion on space-based solar power (SSP) at a space-development conference, for the second time in as many months. My presentation focused on what it would take for a new source such as SSP to find a place in our energy diet, which will be changing at the same time that the technology for producing power in space and sending it to markets here on earth develops. The audience of entrepreneurs and space professionals was quite engaged by the idea that SSP couldn't just be a space project; it had to be a viable energy project, too. These same challenges apply to any new energy technology with a long development period, including some that are much more established than SSP. But with politicians, pundits, and experts of all stripes telling us we must rapidly shed our addiction to fossil fuels, the inertia of our present energy diet remains the under-appreciated elephant in the room.

I began my brief remarks with a simple pie-chart showing US energy consumption for 2007, based on data from the Energy Information Agency of the US Department of Energy. As replicated below, it showed the breakdown of our primary energy supply--the raw energy going into power plants, factories, and oil refineries for further processing into fuels, electricity and materials, along with the contribution from nuclear power plants and those energy sources that produce electricity directly, such as hydroelectric dams, solar panels and wind turbines. Despite the recent, breathtakingly-fast growth of wind and solar, and the tremendous success of the nuclear industry at squeezing more output from its 104 existing reactors, the low-emission portion of our energy diet only accounts for 15% of our primary energy needs, and less than a third of our electricity demand, with 93% of that coming from mature hydropower and nuclear sources.

US Primary Energy Supply

As in a diet, not all calories are equal or interchangeable. The 39% of this diet supplied by oil cannot be replaced by renewable sources of electricity without a lengthy and dramatic change in our vehicle fleets, because oil accounts for less than 2% of our electricity generation, and there's very little of it left to displace from the power sector. Nuclear power and natural gas already accomplished that task over the last several decades. The much bigger challenge now is to shift the roughly 97% of transportation energy currently derived from oil to other sources--either electricity in the view of Al Gore, Dr. Andrew Grove and others, or natural gas, as suggested by T. Boone Pickens. But as we make that shift, we can't leave the portions of our economy that will still depend on oil high and dry. We must continue to provide enormous quantities of petroleum, even as we work aggressively to shrink its share of our diet and expand the portion supplied by sources that don't emit greenhouse gases or contribute to our trade deficit. It is fundamental to the nature of oil production that if you don't keep drilling, its supply quickly dwindles.

Tom Friedman's column in Sunday's New York Times drew a parallel between Mr. Gore's ten-year goal for ending our use of fossil fuels and President Kennedy's commitment to reach the moon in a decade. Unfortunately, this analogy breaks down once it gets past the R&D stage. I regard our accomplishment of landing two men on the moon 39 years ago yesterday as the pinnacle of the 20th century. It was a remarkable feat, requiring billions of dollars and hundreds of thousands of scientists, engineers, and support staff of every description, yet it ultimately only put 12 Americans on the lunar surface. We're talking about displacing 85% of the current energy diet of a nation of 300 million people that accounts for between a fifth and a quarter of global GDP. Doing that within a decade wouldn't just be moonshot-impressive; it would require a flat-out miracle.

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