Sacramento's Role in California's Gasoline Price Spike

How much higher were gasoline prices in California last week than elsewhere?  Enough to raise the national average price for unleaded regular by about $0.10 per gallon.  So while the rest of us were paying an average of $3.75/gal., down slightly from the previous week, gas prices in the Golden State went up by 48 cents, leaving Californians paying nearly a dollar a gallon more than other Americans.  In general the media have done a good job of explaining the direct causes for this spike: a pair of unexpected outages at large refineries in the Bay Area and L.A., combined with the difficulties of supplying the state's unique gasoline blend when local refiners fall short.  Robert Rapier does an even better job of explaining the intricacies of that blend.  But what's missing from all this commentary is an explanation for why the supply for the nation's largest gasoline market, with more than 11% of US sales, should be so tightly balanced that such disruptions would lead to economic hardship for consumers.

As I've indicated before, California is effectively a gasoline island. The product pipelines connecting it with neighboring Arizona and Nevada run out, not in, and the only routes between California and the other West Coast refining center north of Seattle travel over water.  So the principal refineries serving the California market are in California, and obtaining supply from elsewhere that hasn't been prearranged takes time for special batches of fuel to be blended up, tankers to be chartered, and for those vessels to complete their voyages from ports as far away as the Gulf Coast or Singapore.  That entails at least a couple of weeks.

In a posting I wrote in 2007 during a similar price spike in California, I referred to a 2003 study by the Energy Information Agency of the US Department of Energy, looking at an earlier California gasoline spike. (This is a recurring problem.) Among the major factors explaining the higher prices and volatility of the California gasoline market, they found,

"The California refinery system runs near its capacity limits, which means there is little excess capability in the region to respond to unexpected shortfalls."

That also means that there is typically no local surplus from which to rebuild inventories once refinery production returns to normal.  That's a crucial factor in the speed at which prices return to normal.

So much for the diagnosis, but what about the cause?  Tackling the local pollution from large, stationary sources like oil refineries, and from the tailpipes of the state's 31million cars and other vehicles has been a top priority for the state's Air Resources Board (CARB) since the 1970s, for good reason.  However, over the years, CARB's increasingly strict regulations made it harder and less attractive to operate refineries in the state, and more difficult to blend the fuel it allowed to be sold there.  As it happens, I saw much of this first-hand when I worked as an engineer in Texaco's Los Angeles refinery and later when I traded refined products, crude and feedstocks for the company's West Coast operations in the 1980s and early '90s.  I watched one small refinery after another go out of business, and the magnitude of periodic price spikes grow, as the market became more constrained and isolated. I also saw refining margins for the survivors improve relative to those on the Gulf Coast and other parts of the country.  These trends seemed related, since the state, by its actions, was turning California gasoline into a boutique product and effectively blocking competition from outside the state.

The normal response of companies operating in a market such as that, with growing demand and healthy margins, would have been to invest in more capacity--new refineries or major refinery expansions--and collectively to overshoot somewhat.  But by then the prospect of obtaining the permits necessary to build a new refinery in California had gone from difficult to impossible, and most refining investment was focused on the substantial upgrades required to keep up with the state's periodic tightening of product specifications.  And since those investments generally did little to increase output or improve product quality in ways a consumer might notice and pay a premium for, they had awful returns and dragged down the total return on investment for the entire facility. This contributed to refineries shutting down or being sold to independents with less capacity to make further such investments in the future. 

The net result of all these factors is a California refining system that today is 21% smaller than in 1982, at least in terms of crude processing capacity, but must meet gasoline demand that has grown by a third in the meantime, even after shrinking from its 2006 peak.  Now, when an unplanned refinery outage occurs, the result provides as classic and dramatic a demonstration as you'll ever see of the price response to a shift in the supply curve for a good with inelastic demand.

As an ex-Californian and ex-Angeleno there's no doubt in my mind that air quality, especially in Southern California, has improved as a result of many of the regulations imposed on industry and on fuels.  However, you'd have to ask the state's current residents whether that result is worth the high price they periodically pay at the gas pump, or whether some degree of compromise that would have allowed refineries to expand to keep pace with demand, while cleaning up the air almost as much, would have been preferable. 

Read More

UL Study Raises New Questions About E15

One of the energy stories I've followed with great interest all year concerns efforts to increase the proportion of ethanol blended into ordinary US gasoline. This began last year when Growth Energy, an ethanol trade association, asked the Environmental Protection Agency for a waiver to increase the allowed percentage of ethanol in gasoline from 10% to 15%. In October EPA issued a partial approval of the request, but only for vehicles built in model year 2007 or later. However, a new report from Underwriters Laboratories (UL) indirectly casts doubt, not only EPA's ruling, but on whether the agency was assessing all the relevant issues.

I ran across the UL report on the compatibility of mid-level ethanol/gasoline blends in gasoline dispensing equipment--the pumps, hoses and tanks in gas stations--in a posting on API's EnergyTomorrow blog. It cited the UL study, which had been commissioned by the Department of Energy, as evidence that E15, the 15% blend of ethanol and gasoline that the EPA just approved for use in newer cars, could result in serious failures of gas pumps. Yet when I read the report, I immediately encountered its innocuous-sounding conclusion stating, "The overall results of the program were not conclusive insofar as no clear trends in the overall performance of all equipment could be established." It went on to say that the equipment "generally performed well." If I had stopped reading there, I'd have concluded that API was blowing the whole story out of proportion.

When I read the data included in the report, however, a different story emerged. Of the new and used gasoline dispensers and associated equipment tested, very few exhibited no problems on the 17% ethanol test fuel used. In fact, in UL's long-term exposure test, many hoses, nozzles and swivels leaked. 100% of the meter, manifold and valve assemblies tested leaked or failed to shut off. Perhaps most worryingly, two-thirds of the breakaway couplings tested leaked, failed their pressure tests, or required more than the recommended pull to separate. (A breakaway is designed to pop the hose off the dispenser when a customer forgets to remove the nozzle from his car's gas intake and attempts to drive off. This happens a surprising number of times a year, and before the deployment of breakaways such incidents imposed significant repair costs on dealers, even when the resulting spills didn't cause fires.)

The common denominator in these failures was what the report refers to as "nonmetals", gaskets, seals and parts made from various polymers. From that I would draw two conclusions: First, it ought to be possible to design new dispensers and retrofit existing dispensers with new gaskets, seals and plastic parts designed to withstand higher concentrations of ethanol, just as the fuel systems in flexible fuel vehicles are designed to tolerate blends of up to 85% ethanol. However, considering that the US has between 90,000 and 160,000 gas stations, depending how you count them, the number of dispensers that would have to be modified is at least in the high tens of thousands, if not well into the hundreds of thousands. To my knowledge the ethanol industry has not offered to defray the cost of these conversions for a retail fuel industry that operates with extremely lean margins. Nor is it obvious that dealers would qualify for federal assistance, as they do when they add E85 capability.

My second conclusion--really more of a suspicion--has nothing to do with gas pumps or gas stations, and everything to do with cars. After reading the UL report I went back and reread portions of the EPA's official waiver response, which ran to 58 pages in the Federal Register. From what I can tell, EPA wasn't really looking at whether cars would suffer damage from operating on a higher percentage of ethanol than the fuel for which they were designed. The waiver was granted on the basis of those cars not emitting more pollutants than on the fuel for which they were designed. Quoting from the EPA document:

"For MY 2007 and newer light-duty motor vehicles, the DOE Catalyst Study and other information before EPA adequately demonstrates that the impact of E15 on overall emissions, including both immediate and durability related emissions, will not cause or contribute to violations of the emissions standards for these motor vehicles. Likewise, the data and information adequately show that E15 will not lead to violations of the evaporative emissions standards, so long as the fuel does not exceed a Reid Vapor Pressure (RVP) of 9.0 psi in the summertime control season. The information on materials compatibility and drivability also supports this conclusion."

That's good as far as it goes, but from my perspective this finding reflects a necessary but hardly sufficient standard for putting a new fuel into the marketplace, particularly when the failures of the dispensers in the UL study point to the possibility of similar failures of "nonmetals" in the fuel systems of cars or other devices not designed to run on more than 10% ethanol. Even if the leaks found in the testing of product dispensers didn't result in safety hazards, they would at a minimum increase the evaporative emissions from infrastructure, aside from the automotive impact on which EPA apparently focused. I also find it interesting that a bill was introduced in Congress this summer, as EPA was considering the waiver request, that would appear to make it more difficult for consumers to recover the cost of damages resulting from compatibility problems in approved vehicles or misfueling of non-approved vehicles.

As I've noted in my previous postings on this topic, I'm sympathetic to the box into which altered circumstances have placed both the ethanol industry and the federal government with regard to ethanol blending. US gasoline sales, which stagnated after the financial crisis and are only growing by a historically modest 0.7% this year (through November) according to API's latest statistics, are not expanding fast enough to accommodate the output of all the ethanol plants that have been built or are under now construction. When the Renewable Fuels Standard was enacted as part of the Energy Independence and Security Act of 2007, the bill's architects presumably expected that E85 sales would take up any slack. The fact that that hasn't happened does not justify creating a new outlet for additional ethanol in automobiles not designed to accommodate it, any more than it would justify running a new fuel through infrastructure that has been shown not to be up to the challenge. If EPA doesn't revisit the more comprehensive aspects of this question as part of its deferred decision on allowing E15 for cars made before 2007, then perhaps it's time for another government agency with a broader charter to take over this issue.

Read More

California Prop. 23 vs. A.B. 32

Aside from the question of which party will control the House and Senate for the next two years, next month's mid-term elections also feature a number of important state contests, including California's closely-watched Proposition 23, a ballot initiative that would suspend enforcement of the state's major greenhouse gas legislation, Assembly Bill 32. Prop 23 has national implications, since California has taken a leadership position on emissions regulations at a time when national climate policy has become deadlocked. Yet as I've watched the coverage of Prop 23 in the blogosphere and mainstream media, I've been amazed by the consistent mischaracterization of precisely what is at stake in this initiative, most recently in Tom Friedman's column in yesterday's New York Times. Californians surely deserve a better assessment of the issues involved.

When the loudest objections to any candidacy or initiative are focused on vilifying its financial backers, this often indicates that its opponents' arguments on its merits are weak. The fact that several oil companies with refineries and other operations in the state are supporting Prop 23 shouldn't trump the pros and cons of the actual initiative, any more than the fact that much of the funding for the anti-Prop 23 effort apparently comes from venture capitalists and companies that stand to profit if Prop 23 is defeated. For example, the portfolio of VC firm Kleiner Perkins Caufield & Byers, one of whose prominent partners is reported to have donated $2 million to oppose Prop 23, includes investments in biofuels, wind, solar and geothermal power, along with other green technologies, many of which would benefit if A.B. 32 were upheld. From my perspective, this whole line of argument is a colossal red herring. Valero, Tesoro and the other oil company supporters of Prop 23 are part of a $50 billion-a-year California refining industry that employs thousands of Californians and fuels more than 99.9% of the state's 33.6 million registered motor vehicles. The initiative's cleantech-based opponents are part of a smaller but growing sector that has emerged as an offshoot of Silicon Valley and the state's premier research universities. All of these entities have a stake in the outcome, and an equal right to take a position. Their involvement shouldn't constitute a compelling argument for or against Prop 23.

So what is this really all about? Contrary to one of Mr. Friedman's assertions yesterday, it is most certainly not about "making the state a healthier place". The conflation of the greenhouse gas emissions (GHGs) that A.B. 32 explicitly addresses with local air quality is probably the most misleading aspect of the entire debate. Perhaps this was an inevitable consequence of the US Supreme Court decision that labeled GHGs as pollution, but it is a most unfortunate one, because it obscures the crucial differences between a law that was intended to restore California's GHG emissions to their 1990 level by 2020--thereby reducing the state's impact on global climate change--and the extensive state, federal and local laws and regs targeting the causes of the smog for which parts of California became infamous. As a long-time California resident during the period when most of the latter were implemented, I can attest to their effectiveness at cleaning up the state's air, despite the enormous growth in population and vehicles that has occurred in the meantime. However, voters should understand clearly that none of this progress, and none of those existing measures regulating the emissions of SOx, NOx, carbon monoxide, unburned hydrocarbons, and the other contributors to local air pollution is at risk on November 2nd. Simply put, both A.B. 32 and Prop 23 deal with climate change, not local pollution.

As for health effects, any connection between the emissions that A.B. 32 regulates and public health in California is tenuous, at best. Understanding why depends on the numbers involved. In 2007 California emitted just over 400 million metric tons of CO2, the primary greenhouse gas implicated in climate change. This constituted 6.7% of total US CO2 emissions, an enviable performance considering that the Golden State accounts for about 12% of US population and roughly 13% of US gross domestic product (GDP). But on a global basis--and climate change is very much a global problem--California emits just 1.4% of the world's anthropogenic CO2. The state could stop emitting CO2 altogether and the global climate would never notice the difference. That doesn't justify doing nothing about the problem or shirking responsibility for the state's contribution to climate change, but it does mean that tracing the future health impacts of the expected future warming of California to the highly attenuated effects of the state's current emissions stretches cause and effect to the breaking point.

Then there are the economics that are at the heart of Prop 23's proposal to delay implementation of A.B. 32 until the state is in better financial shape, and of the opposition's arguments concerning the current law's benefits in fostering a clean energy economy in California. It's noteworthy that when the legislature passed A.B. 32 in 2006, California's economy was booming. Nominal state GDP in 2006 grew by over 6%, on top of 7% growth in 2005 and 8% in 2004. And while Mr. Friedman notes that the state's unemployment rarely falls below the 5.5% threshold on which Prop 23 would make the implementation of A.B. 32 contingent, that's precisely where unemployment was when the law was passed, and for the following year. I don't think that's a coincidence or an arbitrary choice. Whatever its merits--and it has more than a few, in my view--A.B. 32 is the kind of thing you take on when an economy is healthy, not when it's on its knees. That's because it cannot help but increase the cost of energy and the cost of doing business.

California has been down this road before. Starting in the 1980s the state imposed some of the most restrictive specifications in the world on gasoline and other fuels sold there. It also made it much more difficult for refiners to expand operations to keep pace with the growth in fuel demand in a state with a rapidly growing human and vehicle population. This turned California into a virtual "gasoline island", which has contributed to consumers in the state paying an average of 25 cents more per gallon--or 11% more--than the national average for gasoline over the last decade. With the implementation of the Low Carbon Fuel Standard (LCFS) included in A.B. 32, it will become even costlier to make gasoline in California, and this price differential could expand significantly. Considering that the state consumes 42 million gallons of gasoline each day, this already amounts to an extra $3.8 billion per year in costs. Increasing that disadvantage is not a trivial consideration. It won't even do much for the domestic ethanol industry, since much of the ethanol produced in the US won't qualify as "low-carbon" under the LCFS's definitions. This is a matter over which the ethanol industry is currently suing California.

With regard to the "green jobs" and cleantech growth that Prop 23's opponents cite, I am skeptical that these will result in meaningful growth in overall employment and output, as the pressure on the rest of the state's economy increases with the ratcheting-down of A.B. 32's emissions cap and LCFS. The recent experience with green-energy deployment incentives at the national level suggests caution in assessing how effective these measures will be in stimulating green jobs in California or the rest of the US, as opposed to offshore, where much of the green energy hardware that is being installed is manufactured. A recent article in MIT's Technology Review also questioned whether the consequences of Prop 23's passage would be quite as severe for the state's emerging cleantech sector as opponents suggest, because other incentives would remain unaffected. Ultimately, the market that matters most for California's cleantech companies is the global one, where they must compete with manufacturers from Asia and Europe. Creating a bubble market on their home turf will do little to advance that cause, as German photovoltaic firms are currently learning to their regret.

When we dispense with all the questionable arguments concerning who is for and against this initiative, whether it will alter the quality of the air Californians breathe, and how many green jobs it might affect, the choice becomes clearer. Proposition 23 asks voters to decide whether California should proceed with the nation's most aggressive effort to curb the greenhouse gas emissions implicated in global warming now--despite high unemployment, low growth and deep deficits--or whether that effort should be postponed until the state has returned to growth of the kind that prevailed when the law was passed, before the housing collapse, financial crisis and recession. The context of this choice should be equally clear, consisting of a complex global environmental challenge that California's efforts can't solve alone, but might help to influence at the margin. Having spent so much of my life in the state, including my entire education, I can easily understand that many Californians would believe it was their responsibility to move ahead at any cost, even if no one else followed. However, I can also envision that many of the state's voters would conclude that, for the moment, the costs and risks associated with A.B. 32 look too high. This is a difficult and consequential decision, even if some choose to portray it as a one-sided no-brainer.

Read More

Earth Day Cold Turkey

I was perusing the 2010 Earth Day website and ran across its online petition in support of comprehensive energy and climate legislation. Aside from the expected references to green jobs, energy independence and solving climate change, I was struck by the tone of the declaration, which called for "sending a powerful message to the polluter lobby: we've had enough of dirty power, the time for change is now." I might have had a different reaction to this on another day, but for some reason it occurred to me today to wonder what would happen if the energy industry immediately capitulated to this demand. What would it mean if every power plant burning coal, oil or natural gas shut down today and remained idle? The short answer is chaos and social collapse, but let's take a quick look at why.

Before getting into the underlying numbers I can't resist the opportunity to point out that this kind of language is an understandable consequence of the decision by the Supreme Court to label greenhouse gases as "pollution." Pollution is inherently awful and emotionally energizing, while emissions are, well, more complicated and nuanced. Unfortunately, while the risks that go with climate change pose very serious problems, the solutions are not nearly as simple as the solutions to the kinds of pollution that we've been accustomed to dealing with under the legislation and regulations that the first Earth Day and its anniversaries helped to trigger. I admit this distinction has become a lost cause, but no one should be surprised by the passion and vitriol concerning greenhouse gas emissions that has resulted from this choice.

So what if we took the Earth Day petition at face value and bypassed the whole decades-long transformation that cap & trade, a national renewable electricity standard, and various other pending emissions regulations would set in motion? What if we simply shut down every fossil-fuel-burning power plant today? After all, we have all these new wind turbines and solar panels--record amounts of which were installed here last year--and we still have thousands of hydroelectric dams and 104 nuclear power plants. Together they produce vast amounts of electricity, and surely with a bit more efficiency we could make do with that, while building more wind, solar and geothermal capacity as fast as possible to keep the economy growing. Well, as it turns out, all renewable sources plus nuclear generated a bit over 1.2 trillion kilowatt-hours (kWh) last year. That's certainly more than the entire electrical output of many other countries. According to data from the Energy Information Agency, it exceeds all the power generated in 2008 in Japan, or in France and Germany combined. Unfortunately, it's also less power than the US has generated in any year since 1966.

On the face of it, that's not a fair comparison. Although we still have plenty of room for improvement--energy efficiency remains one of the most promising sources of emissions reductions available--the US actually uses energy much more efficiently today than it did in '66. One measure of that is energy consumption per dollar of real GDP. On that basis, it takes just half as much energy to produce the same output as it did when "Eleanor Rigby", one of my favorite Beatles songs, debuted. If we adjust for energy:GDP, then 1979, with its net generation of 2.25 trillion kWh, looks like a more appropriate basis of comparison to the economic work that our current zero-emission power output could do. The problem is that the US population has grown by 84 million people since then, and our economy, expressed in constant dollars, is more than twice as big as in '79--even after last year's contraction. It might even be worse than that, because we've electrified a lot of things that were previously run directly by some sort of fuel, so that slashing our power output by 70% wouldn't just cut our economy by half; it would probably force us to choose among some very high-priority uses for power that might not include the PC or other device on which you're reading my words. To say that electricity rates would have to go up dramatically is an understatement, and we haven't even accounted for the intermittency of wind and solar, which can't replace baseload coal power or on-demand gas-fired power.

There's no need to stretch this highly-simplified scenario any farther. Like it or not, we can't yet live without the power we get from all those nasty fuels we're still burning, and the day when we can is not just around the corner. After all, the wind, solar and geothermal power sources we've focused intensely on expanding accounted for just 2% of the electricity we used last year. Double them, and then double them again (10 years?) and that's still only 8%, compared to the 69% we got from fossil-based generation last year. The Senate climate bill that's expected to be released in the next week or so might well move us in the direction that the signers of today's Earth Day petition want, but that evolution can't happen nearly as fast as many of them have been led to expect.

Read More