Ethanol and the Gulf Spill

The implications for the oil industry from the ongoing Gulf of Mexico oil spill are already taking shape, with the administration calling for a Challenger-style investigation and rewriting the playbook for oil & gas leasing and the issuance of safety and environmental permits for offshore drilling. It's less clear how the spill might affect other aspects of energy, beyond boosting the public's interest in pursuing clean energy options. However, it would be ironic if a problem perceived to have arisen because of a "cozy relationship" between oil companies and regulators resulted in an even cozier relationship between the government and the ethanol industry that depends on it for both financial support and the rules that mandate the use of its product. Yet that's exactly what could happen as the administration decides whether to increase the allowable percentage of ethanol in gasoline.

Perhaps you've seen the new ads from Growth Energy, an ethanol trade association: "No beaches have been closed due to _____ spills", with the word "ethanol" fading slowly into view. Then there's "We won't have to wait millions of years to replenish our _____ reserves," and other statements emphasizing ethanol's employment and energy security benefits. It's a clever campaign, and well-timed. On one level, using more ethanol in gasoline seems an obvious response to concerns about our dependence on oil. For all its many shortcomings, ethanol remains the most successful oil substitute in the US market, thanks to the combination of a $0.45 per gallon blenders' tax credit and the steady ratcheting-up of the annual federal renewable fuels standard. Ethanol currently displaces the equivalent of approximately 500,000 barrels per day of gasoline that would otherwise be imported or refined here from imported crude oil. The problem is that the market penetration of ethanol is rapidly approaching the 10% blending limit that has been approved as safe for use in engines that haven't been modified to run on higher-percentage ethanol blends, such as E85. And because E85 has so far failed dismally to take off--accounting for just 0.01% of US gasoline sales in 2008, based on EPA's analysis--any additional ethanol would have to be squeezed into ordinary gasoline, at least in the near term.

Our proximity to this threshold, referred to as the "blend wall", is determined by two factors, in addition to the federally-mandated ethanol blending volume: total US gasoline sales and US ethanol output. Last year Americans bought just under 138 billion gallons of gasoline (including the ethanol blended into it), a reduction of about 3% from the 2007 peak. Without further growth in demand, 10% of that would be 13.8 billion gallons per year (gpy). According to the Renewable Fuels Association, another ethanol trade association, the capacity of existing US ethanol facilities plus those under construction already totals 14.7 billion gpy. In other words, once all the ethanol plants now being built are finished, the industry could supply more than 10% of US gasoline demand without breaking a sweat. But without either a higher blending limit in gasoline or a sudden, unexpected surge in E85 sales, any additional ethanol beyond that level would have no home in the US fuels market. Nor is it obvious that corn ethanol exports represent a viable long-term outlet. Left unresolved, this is a guaranteed train-wreck.

Under the circumstances, it's natural for the ethanol industry to ask its patron for help, in the form of a request for a waiver to blend more than 10% ethanol into each gallon of gas. Last winter, the Environmental Protection Agency told Growth Energy that it was studying their request and would respond by mid-2010. That deadline is nearly upon us, and with more oil spilling into the Gulf of Mexico every day, the pressure on EPA to agree must be mounting. This can't be an easy call to make, especially with the auto makers citing test results indicating that ethanol blends above 10% could harm some car engines. Saying no would call into question the nation's entire long-term renewable fuels strategy, at a time when green jobs and green energy are being widely promoted as the key to a new, more competitive economy. Yet granting that request, either as a favor to the ethanol industry or as a hasty response to the Gulf Coast oil spill would be a mistake that could have serious repercussions, both for consumers and for the administration making such a call. Stay tuned.

Update as of 6/18/10: EPA delays its decision on E15 until the fall.

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Not-So-Grand Compromise

This week Senators John Kerry (D-MA) and Joe Lieberman (I-CT) finally released the draft energy and climate bill they had been working on with Senator Lindsey Graham (R-SC.) From all accounts, it was intended to serve as a response to the various criticisms of the climate bill the House of Representatives passed last summer, but in particular as a means for attracting support from Senators whose primary concerns about energy are focused on US energy security and competitiveness. Unfortunately, events have a way of disrupting even the sagest strategies. A cursory review of the new bill--all I've had time for thus far--reveals the degree to which it has been altered in response to the ongoing Gulf Coast oil spill. In the process, unless I've misread its revised provisions on offshore drilling, the expected "grand compromise" has turned into a poisoned chalice, at least for oil.

Like its climate-legislation predecessors and most major bills from the last several Congresses, Kerry-Lieberman (originally Kerry-Graham-Lieberman) starts out at 987 pages and is likely to grow much larger, as it accumulates support one vote--and thus typically one new provision or modification--at a time. I simply haven't had a chance to read the whole thing in detail, yet. Once I've done so, I'll comment on its other key provisions, including the cap & trade mechanism at its heart, which seems to have been influenced by the "cap & dividend" proposal of Senators Cantwell (D-WA) and Collins (R-ME). With so much attention currently directed at offshore drilling, that's where I focused my brief review.

While the bill was being prepared, there was much speculation about the incentives it would include for expanded offshore drilling, which, along with expanded support for new nuclear power, was regarded as one of the principal carrots to be offered to those in Congress who wouldn't otherwise be inclined to support a standalone cap & trade bill. Whatever form those incentives were expected to take, the bill's skimpy offshore drilling "subtitle" looks disappointing, if not downright negative.

On the positive side, it would extend the same royalty-sharing benefits to states pursuing new drilling that the four main Gulf Coast producer states of Texas, Louisiana, Mississippi, and Alabama currently receive from oil & gas exploration and production in the federal waters off their coastlines: 37.5% of lease premiums collected and the same percentage of production royalties. This is something that states such as mine, with an official state policy supporting drilling, have been calling for. But while it will be favorably received in Virginia, other states, particularly in the West and Midwest, regard this as an unreasonable diversion of federal revenue. Even if the Deepwater Horizon hadn't blown up, this provision would have been a tough sell.

The rest of the offshore oil subtitle appears to have been hastily modified in response to the spill. Among other things, it offers states a veto over new drilling within 75 miles of their shores. A glance at the map for the planned Lease Sale 220 offshore Virginia shows that at least a portion of it falls within 75 miles of the Delaware and Maryland coasts. Nor do I think this is an unreasonable provision; as we've seen in the Gulf, a spill off Louisiana clearly affects the shorelines and marine activities of neighboring states. By itself, this provision, which I believe was altered from an original 50 mile exclusion, would not rule out a resumption of new offshore leasing and drilling, once the causes of the current spill have been identified and new measures and regulations put into effect to reduce the risk of another occurrence to an acceptable level--however the Congress and administration might specify "acceptable".

The problem lies in Section 1205, which defines the impact studies that must be done prior to opening up an area for drilling. As drafted, paragraph (h)(2) effectively extends the 75 mile limit on the veto rights of non-drilling states, if the government's assessment "indicates that a State would be significantly impacted by an oil spill resulting from drilling activities within an area identified in a 5-year (leasing) plan". Under this paragraph, Florida or Alabama could potentially veto any new drilling off Texas or Louisiana. I'm not a lawyer, but that's what the text appears to say.

Without dismissing the legitimate concerns of neighboring states, this raises all sorts of practical problems. An exchange I had earlier this week with a Maryland-based blogger highlights one of them. He was blogging in support of Senator Ben Cardin's (D-MD) stance against any offshore drilling on the Atlantic coast. However, as I noted in my comment on his posting, Maryland consumed 272,000 barrels per day of oil in 2008, not one barrel of which was either produced or refined in that state. Just how far should offshore drilling be removed in order to satisfy the concerns of a state that is entirely reliant on energy produced by other states and foreign sources, which must bear whatever risks it entails? Is Louisiana far enough away? Is Saudi Arabia?

As compromises go, this one doesn't look very tempting. Unless I've misread the bill's offshore drilling provisions, it appears that their effective result would be to end all offshore drilling, not just in areas that were recently released from long-standing drilling moratoria, but in the long-established zones of the Gulf Coast that are becoming America's energy breadbasket. That would surely qualify as the kind of overreaction to the Gulf Coast spill of which the International Energy Agency has just warned, emphasizing the unintended consequences that we would risk. Perhaps those looking for something in exchange for supporting limits on greenhouse gas emissions will regard the bill's significant support for nuclear power as sufficient, though I'm skeptical. They could probably get the same thing in an energy-only bill, perhaps in exchange for a national renewable electricity standard. As for the crucial source of domestic transportation energy we would forgo if we turned our back on offshore drilling, there is currently no substitute available soon enough, or in sufficient quantities, to make up for its loss.

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Finding Facts or Fault

I devoted several hours yesterday to watching Senate hearings on the Gulf Coast oil spill. The Energy and Natural Resources Committee hosted two panels, one a technical panel featuring a former official of the Minerals Management Service--the agency that Interior Secretary Salazar has announced he intends to split in two--and a Professor of Petroleum Engineering from Texas A&M. The second, juicier panel was composed of senior executives from the three main companies involved in the spill, BP, Transocean and Halliburton. Despite the importance of these hearings in putting a face on this disaster and giving our elected representatives an opportunity to demonstrate their concern, I thought the panels served a useful educational purpose. And somewhat to my surprise, they also turned up at least one apparently new fact that might prove crucial in understanding what went wrong 5,000 feet below the Gulf of Mexico on April 20th.

I can't claim to be a great connoisseur of Congressional hearings. They offer some of the same morbid fascination as a car wreck: you know you shouldn't be watching, but you can't take your eyes off it. True to form, a few of the Senators treated the session as an opportunity to show their outrage and alignment with their constituents' concerns. Most, however, followed the tone set by the Chairman, Senator Bingaman (D-NM), in asking thoughtful, probing questions--though I couldn't help chuckling when one Senator seemed to imply that she had participated in the 1986 Space Shuttle Challenger hearings in that same room--alluding to their famous "O-ring" revelation--even though she would have just been elected to her state's legislature that year. Despite the obvious frustration of the committee members when the three executives deflected their efforts to pin the blame for the accident on each of them in turn, the discussion remained civil and the comments and questions mostly substantive.

I found two lines of questioning especially intriguing. The first related to the cause of the accident itself--as distinct from the subsequent leak--and whether it might have had something to do with the well having been cleared of drilling mud prior to setting the final concrete plug in the well. As I understand it, drilling mud is used to balance the pressure in the well between the higher reservoir pressures deep underground and the much lower pressure at the surface. Once the heavy mud was removed and replaced with lighter seawater, the barriers installed in the well (steel casing, cement, the first plug, and ultimately the blowout preventer, or BOP) would have had to withstand the full pressure in the reservoir, which Dr. F.E. Beck from the first panel estimated at 14,000 psi. Since this was apparently the last action performed by the drilling crew prior to the explosion, the sequence and timing of this step makes it an obvious candidate for one of the root causes leading to the explosion on the topsides of the Deepwater Horizon rig. Senator Sessions (R-AL), in particular, tried in vain to get any of the three witnesses to concur that it was contrary to normal practice for the mud to be displaced prior to the setting of the final cap.

The other fascinating exchange occurred later in the hearing, at about 1:24 into C-SPAN's archive video, when the ranking member, Senator Murkowski (R-AK), questioned Transocean's CEO, Mr. Newman, about reports that Deepwater Horizon's BOP had been modified. According to Mr. Newman, one of the five "ram" preventers on the BOP stack was converted "from a conventional well-bore-sealing ram preventer to a BOP test-ram", to "allow for more efficient testing of the BOP." He went on to explain the economic benefits of such a modification, which apparently has been done on other rigs, in reducing the cost and delays associated with testing the BOP. Unfortunately, although Senator Murkowski followed up with a question about whether any modified BOPs had experienced incidents, she didn't ask whether that modification had reduced the capability of the BOP to respond to a catastrophic failure of well control.

Perhaps I've misunderstood Mr. Newman's remarks, and the modification would have had no impact at all on the operation of the BOP. Or it's possible that one extra ram might have made no difference at all, in conjunction with the cascade of other failures necessary to produce a blowout of this magnitude. However, this certainly seems like a topic that should be examined in much greater depth during the full incident investigation that must follow.

I didn't have time to catch the afternoon hearings, in which the same executives were grilled by the Senate Environment and Public Works Committee, or the House hearings this morning. I'll be interested to see if any other new insights emerge, though a couple of things seem clear. First, and with due respect to the Senators and their staffs who clearly worked hard to get up the steep learning curve on this subject, they are simply not equipped to conduct an engineering investigation into an accident of the technical complexity involved in deepwater drilling. Moreover, the format and adversarial approach aren't well-suited to eliciting the necessary level of candor and cooperation from witnesses who've essentially been told they are auditioning for the role of chief villain in the piece. If anything, that understandable tendency to prioritize blame-apportionment over impartial fact-finding seems to have been amplified by the financial crisis and recession. But while it's easy to write such hearings off as political theater, they can still serve a useful purpose, because that same lack of technical knowledge on the part of these committees constrains the dialog to a level that the average American actually has a chance of understanding. That makes it all the more essential that the Congress should refrain from leaping to premature conclusions that could turn out to be wrong, but very hard to correct later with the public.

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How Fast a Transition from Oil?

The Gulf Coast oil spill remains the top energy story this week, eclipsing a $10 drop in oil prices that should soon ripple through to gas pumps near you. With BP's latest effort to contain the spill having run afoul of a slush buildup composed of methane hydrate crystals, the deepwater well continues to leak at an undetermined rate. The longer the spill continues, the greater the chances for severe environmental consequences, and the likelier that it will become a perception-altering milestone event as some environmentalists have already suggested. However, even if the spill were to galvanize public opinion in a manner similar to the 1969 Santa Barbara oil spill, what options do we have that could realistically reduce our reliance on oil produced from offshore platforms?

Last week I focused on the energy contribution of the oil we produce offshore in US waters, particularly in the deep water of the Outer Continental Shelf (OCS) of the Gulf of Mexico. It constitutes 30% of domestic crude oil production, or about 10% of our total oil consumption, and contrary to the wildly-inaccurate assertion on a widely-read environmental blog last week, essentially none of it is exported. (Anyone who doesn't know the difference between crude oil and petroleum products has no business commenting on that aspect of energy policy.) Today I'd like to go into a little more detail on the alternatives to offshore drilling that I alluded to last Wednesday.

Gasoline, jet fuel and diesel accounted for 75% of the petroleum we consumed last year. Other than the heating oil included in the diesel tally, these are the fuels that power most transportation of people and goods. Many initiatives are under way to develop non-petroleum fuels for cars, trucks and even jet aircraft, though at this point they are all in relatively early stages of development or deployment. On paper, at least, electricity looks like the best option for replacing gasoline, by means of plug-in electric vehicles like the Chevrolet Volt and Nissan Leaf. Since less than 1% of US oil consumption is used to generate electricity, switching cars from gasoline to electric power represents a nearly total displacement of oil. It would also facilitate the direct use of renewable electricity sources to eliminate greenhouse gas emissions. This prospect has many people excited, and I've heard it mentioned frequently in reactions to the Gulf spill. Yet this is hardly a slam-dunk, for numerous reasons, topped by scale and the unproven consumer acceptance of mass-market EVs.

In one of their periodic special sections on energy, today's Wall St. Journal included an article on the development of EV recharging networks in the US. It cited a study by Pike Research forecasting 610,000 EVs by 2015. That would be a great start, though it would fall short of President Obama's goal to put a million plug-in vehicles on the road by then. Even assuming that the million-EV mark were reached that soon, and that they were driven as much as other cars and replaced vehicles averaging 25 mpg, the quantity of gasoline they would displace amounts to just 31,000 bbl/day--less than the quantity of oil the leaking Macondo field would have been producing in a couple of years, had Deepwater Horizon's exploration well been completed uneventfully. Substituting for all of the oil currently produced from offshore drilling--or for the decline in US oil production that would occur by 2020 if we stopped drilling offshore--would require up to 50 million EVs, making up roughly 40% of all the cars likely to be sold in the US this decade. I suppose that might barely be possible on a crash basis, with a World War II-style mobilization of the resources required to achieve it, but it doesn't look very likely to me. I would be impressed if the US had 10 million EVs by 2020, implying annual production of well over a million units within just a couple of years, though that would reduce our current oil demand by under 2%.

So if EVs can only take us a small part of the way to replacing our oil consumption in the near future, what about advanced biofuels? There are many promising avenues, including biofuels produced from agricultural or forestry waste or dedicated energy crops, biofuels from algae, and bio-hydrocarbons from plant sugars. All are in their infancy. The EPA recently had to reduce its mandate for advanced biofuels delivered in 2010 from 100 million gallons to just 6.5 million gallons--424 barrels per day--because no truly commercial-scale facilities will come on-stream this year. We might get a few billion gallons per year from these sources by 2020, if numerous technical and economic hurdles can be overcome, but that would displace at most a couple of hundred thousand bbl/day of oil.

Natural gas looks like another good alternative transportation fuel. T. Boone Pickens has put forward his plan to shift long-distance trucking onto compressed or liquefied gas. There's no shortage of gas available for this purpose, thanks to the much larger supplies made possible by shale gas drilling. It starts from a very low level, however, with current natural gas used in transportation equivalent to less than 1,500 bbl/day of diesel fuel. It also competes with other uses of gas, such as generating more electricity to reduce our consumption of coal. Or, looking at it another way, there might be plenty of gas to do both, but not at today's price.

That leaves what looks like the best option for reducing our oil consumption, other than simply deciding to drive less, as some folks have apparently already done. Because the US car fleet is so large and is driven so far, increasing its fuel efficiency by just 3 miles per gallon could save nearly a million bbls/day of gasoline. That's more than the entire contribution of corn ethanol, our most significant alternative transportation fuel. In fact, the latest demand forecasts of the Energy Information Agency are already based on that kind of improvement, reflecting new regulations requiring new-car fuel economy to increase to 35 mpg before 2020. Still, only a small fraction of our fleet of 240 million cars turns over every year, so it will take a long time before average fleet fuel economy even begins to approach these levels.

Whether your preferred alternative to offshore drilling requires replacing millions of vehicles with hybrids, EVs, natural gas-powered vehicles, or highly-efficient small conventional cars like the new Ford Fiesta, or depends on a vast new infrastructure of alternative fuel production and distribution, none of these solutions can work overnight. In the meantime, every barrel of oil we consume but don't produce here must be imported, some of it from countries that don't like us very much--as we're frequently reminded--and all of it with serious implications for our national financial and trade balances. (And don't forget the inevitable oil spills from all those extra tankers.) If we don't want OPEC to be the biggest beneficiary of a new environmental mindset after the Gulf Coast spill, then we face some very tough choices, including whether we'd prefer to open up major new areas for onshore drilling, instead of some of the offshore prospects that were slated to be leased in the next few years, or to continue drilling offshore under updated procedures and with strengthened environmental protections, at the same time we pursue all of our options for reducing our overall reliance on oil.

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Green Energy Competitiveness

As I was catching up on recent op-eds in the New York Times, I was intrigued by one with the snappy title, "Red China, Green China." As the author, an "executive in residence at Columbia Business School," built his case for why the US is falling behind China in clean energy technology, I was hopeful that he'd offer some sensible recommendations for resolving the problems that have made it harder for the US to compete across a whole range of industries, not just cleantech. Unfortunately, two of his three suggestions were focused on measures to ensure a market for clean technology, and the third on R&D for carbon capture and storage. These are worthy goals, but there wasn't a word about making our manufacturing sector more competitive. That blind spot seems to be shared by the Department of Energy, which according to an article in MIT's Technology Review ran out of money for clean energy manufacturing tax credits, but spent more than $3 billion funding renewable energy projects, many of which are being built with imported hardware. If we're serious about competing in a global clean technology race, we've got our priorities backwards.

I must admit that I'm generally skeptical of anything that smacks of industrial policy. Industry has a mixed record at picking technologies in which to invest to create the industries of the future, but government is often worse. For example, does it really make sense to spend taxpayer money helping companies build factories to make batteries for electric vehicles that consumers haven't yet embraced, and that may only capture a small share of the total car market, similar to today's hybrids? However, this might still prove wiser than shoveling money at the deployment of green energy technologies that either don't need much assistance, or that haven't developed sufficiently to meet the needs of the economy.

It might also help to think about our competitiveness in cleantech from the perspective of the entire economy, rather than the usual practice of looking at it in isolation. From that vantage point, the main thing the economy needs from the energy sector is cheap and reliable supplies of the kinds of energy that we use: liquid fuels for transportation, gas for heat, and electricity for nearly everything else. Reliability was licked a long time ago--except for the occasional blackout--and renewables don't bring much to the table in this regard. For several of the most popular forms, such as wind and solar power, it's their weakest suit. As for cost, the price tag on wind capacity has come down significantly over the last couple of decades, and off-peak wind power is sometimes the cheapest supply available. That's still not true for solar, however, though solar thermal and some novel forms of photovoltaic cells have the potential to get there.

It's also important to recall that while we can employ subsidies or mandates to make renewables appear more competitive locally or to require their use, whether competitive or not, that doesn't alter their impact on the global competitiveness of the US economy. If we are embedding expensive energy at the heart of our manufacturing, services, transportation and distribution networks, then that must make us less competitive--unless everyone else is doing the same thing.

We should also be asking to what extent taxpayers (or ratepayers--often the same people) should subsidize the creation of a market for renewables. After all, the market already exists, and most of it is outside the US. The world apparently added 38,343 MW of new wind generating capacity last year, and only 26% of that was installed in the US. Instead of concluding that we should pay or require companies to install more wind turbines in the US, as Mr. Usher suggests in his op-ed, wouldn't it make more sense to help US wind turbine manufacturers become more competitive in the larger global market? That seems like an obvious conclusion, especially when we consider that US manufacturers accounted for less than half of the wind turbine capacity installed here last year, according to data from the American Wind Energy Association, and that the bulk of the Treasury grants issued under the stimulus have gone to non-US firms to develop wind farms equipped mainly with non-US turbines.

Nor would shifting our focus to supporting the production, rather than installation of cleantech hardware lessen the impact of US policy on reducing global greenhouse gas emissions. A wind turbine or solar panel generates emissions-free energy in any country in which it is sited, and it might even reduce more emissions if it were installed in a location where the generation source it backs out is an inefficient coal-fired power plant with minimal pollution controls, rather than an efficient gas turbine, as is often the case here.

Effective policy requires clear thinking. If we want to promote clean energy technology for reasons of job creation and global competitiveness, then shouldn't we focus our efforts where they can have the greatest positive impact on those priorities? Manufacturing is a strong candidate for that point of maximum leverage, while deployment suffers from many drawbacks, including "leakage" and higher costs that get passed on to other sectors of the economy. Whether our best approach to bolstering cleantech manufacturing is to single it out for special treatment or to focus on corporate tax reform and other measures that would help all manufacturing is a subject for another day.

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The Context for Offshore Drilling Policy

Yesterday's posting considered possible scenarios for the oil spill emanating from the leaking well in the Gulf of Mexico and explored a few of the implications for US policy towards further offshore drilling. Debate on this topic has already begun, and I expect it to heat up in the weeks ahead as the Congress and administration decide whether to take up energy legislation this year, and as the spill and its direct consequences spread. In order for this debate to be productive, it requires a context, preferably one that encompasses more than the latest images from the Gulf Coast. The environmental consequences of this drilling accident can't be ignored, and neither should the economic and energy security consequences of overreacting to it. My main worry in this regard is that, although we've had spills like this before, we've never had a spill like this in conjunction with politics like today's.

Understanding how offshore drilling fits into the US energy economy seems fairly daunting, but a few key insights can clarify why it has become an indispensable part of our energy supply over the last couple of decades, and why it will remain crucially important, even as we make the transition to a more energy-efficient economy, relying on lower-emitting, more-sustainable energy sources. Total primary energy supply and demand is a useful starting point. In 2008, the latest year for which the Energy Information Agency (EIA) of the US Department of Energy has compiled figures, oil covered 37% of our primary energy demand. On this basis, domestic offshore oil production accounted for about 1/10th of our total domestic and imported oil supply, or just under 4% of all the energy we used. If that doesn't sound like very much, consider that it exceeded the entire contribution of wind, solar, geothermal and hydroelectric power that year. Primary energy isn't the most useful comparison, however, because very little oil is used to generate electricity, and very little electricity is used in transportation. Petroleum and its products hold a unique position in our economy, providing most of the energy for transportation and numerous chemical building blocks for industry.

For decades US oil production and consumption were trending in opposite directions, opening a huge gap that had to be filled by increasing quantities of imported oil and, more recently, by the small but growing contribution of biofuels. Even with US oil demand reduced by 9% due mainly to the recession, net crude oil imports last year still averaged 9 million barrels per day (bpd), or 1.7 times as much oil as we produced here (excluding natural gas liquids.) One of the main reasons those imports weren't higher was that after years of decline, domestic oil production has staged a modest recovery. As the chart below depicts, those gains are entirely attributable to the expanding production of oil from the federal waters of the Outer Continental Shelf (OCS)--the result of deepwater exploration such as that which Deepwater Horizon was engaged in when it exploded and sank.


Another key factor in the context of offshore drilling policy is oilfield decline. When you stop drilling new oil wells, production begins to fall as existing wells and reservoirs deplete. As a result, calling a halt to offshore drilling wouldn't imply a standstill in production; it would guarantee a significant decline in output from year to year. My estimate of the magnitude of what's at stake comes from comparing the most recent production forecast from the EIA with the application of realistic decline rates to current offshore production. As shown below, the EIA's 2010 Annual Energy Outlook (Early Release) projected domestic oil production rising back above the 6 million bpd level by 2019, mainly on the strength of drilling success in the deepwater Gulf of Mexico. Without continued drilling offshore, US oil output could be 1.5 million bpd lower than expected by 2020--a very serious shortfall. (That's the gold wedge shown below.) And that would be the case even if onshore production remained stable over that period, which would be unprecedented since the mid-1980s.

The impact of such a shortfall would go beyond its direct economic value of around $55 billion per year at today's futures market price for 2018. We must also consider what would replace it. Now, by 2020 there could be enough electric vehicles on the road to make a noticeable dent in our oil consumption, although most EV advocates expect the electricity they would consume to back out imported oil and petroleum products, rather than standing in for missing US production. In any case, the majority of cars sold in this country between now and then will burn gasoline and other liquid fuels, so the most practical alternative to offshore oil in this timeframe would be biofuels. Unfortunately, as the chart below shows, current US ethanol output equates to just a fraction of our offshore oil production, after adjusting for ethanol's lower energy content. Corn ethanol production is approaching its mandated level of 15 billion gallons per year, equivalent to 640,000 bpd of gasoline. (It's also approaching the 10% blending limit in gasoline.) Even if the nascent technology for cellulosic ethanol and other advanced biofuels can deliver on the aggressive targets set in the national Renewable Fuel Standard, this would still contribute less energy than the 1.5 million bpd that's at stake offshore. And as with EVs, a barrel of biofuel filling in for lost offshore domestic oil can't be counted again to reduce imports.
As President Obama alluded to in his announcement in March concerning expanded offshore drilling--pre-Deepwater Horizon, to be sure--domestic oil production has an important role to play in any comprehensive energy policy aimed at reducing our oil imports and greenhouse gas emissions. As I've shown above, offshore oil is the key to stable, dependable US oil production. When you examine the data and realistic projections concerning the contribution of renewables and other alternative energy sources over the next decade, it becomes clear that turning our back on offshore oil production would hobble those efforts by diverting their impact. Although we do have many alternatives to offshore drilling, as critics are quick to point out--including increased fuel economy, vehicle electrification, expanded biofuels, and increased use of natural gas in vehicles and other places we now use oil--we can't employ these steps to both backstop failing domestic oil production and back out oil imports or displace coal-fired power generation. That's because the energy in the quantity of oil at stake is of about the same magnitude as the contribution of these options, at least for the next decade or so. Our policy towards offshore drilling in the aftermath of the Deepwater Horizon accident must take that reality into account.

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Disaster Scenario?

As the consequences of the ongoing oil leak in the Gulf of Mexico unfold, it's still not clear what we're facing. I've seen repeated requests by those affected to know what the worst-case scenario might be. I can't blame them, though when we don't even know how much oil is leaking, and with so much uncertainty surrounding the measures that BP and the US government are pursuing to plug the well and mitigate the spill, the range of possible scenarios becomes very wide. And if these near-term effects remain unpredictable, the potential longer-term implications for US energy policy are even more divergent. Until the well is capped and the full scope of the environmental and economic damage known, we can only guess at the future shape of this component of our energy supply.

In trying to imagine the range of outcomes, we must consider the rate at which the oil is flowing, how long it will flow, and the relative success of efforts to recover or break down the oil that has leaked before it reaches the shoreline, fisheries and other sensitive environments. A high-end projection of the volume of oil spilled might involve a leak that is actually well above the current 5,000 barrel-per-day (bpd) estimate, and that continues as long as it took to cap last year's Timor Sea leak: 10 weeks. Even at 5,000 bpd, that would eclipse the total spilled from the Exxon Valdez before it ended. And if oil were leaking much faster, as some estimates suggest, the result could rival the largest oil tanker spills, such as the Amoco Cadiz in 1978, while still falling short of the 1979 blowout of Pemex's Ixtoc-1 well farther south in the Gulf. We may never know the true extent of the spill, because there's no accurate way to measure the quantity of oil currently flowing from 5,000 ft. down in the Missississipi Canyon.

If that's the far extreme, what might a less dramatic scenario look like? As described in this morning's New York Times, BP is pursuing several approaches that could either shut off the well quickly, or at least contain the leakage until the well can be sealed by means a relief well drilled into the same formation to block the flow to the current well. The critical event following the explosion on the drilling rig was the apparent failure of the blowout preventer, which BP has been attempting to activate by remotely-operated vehicles (ROVs.) The BOP was supposed to cut off the errant flow--literally. The quickest solution would be to set a new BOP in place and activate it to crimp the riser and drillpipe and shear them off. From my limited understanding of the techniques involved, doing this at depths like these, using only ROVs, and with a well that might be blowing gas and oil at much higher rates once the bent riser and drillpipe were removed would be extremely challenging. BP's plan to use "domes"--essentially underwater cofferdams--to contain and siphon off the oil as it comes out of the well could be nearly as tricky to pull off, though with less downside if it failed. If any of these techniques worked, the total volume of the spill might be limited to something under 150,000 bbls, assuming that the well has already leaked 50-60,000 bbls. That would still qualify as a very large oil spill--much larger than early estimates projected--though far short of a true worst-case.

For now the efforts of all the oil and oil-service company personnel, the Coast Guard, and other military and civilian government personnel involved--along with those whose homes and livelihoods are affected--are properly focused on addressing the leak and its direct consequences. In the interim, the rest of us have had some time to think about what all this means in a broader context. Although I would argue that any permanent changes in policy would be premature, it's not too early to think about what should happen once the leaking well is capped. None of my readers will be surprised to learn that I disagree strongly with those calling for a permanent halt to offshore drilling anywhere in the US. At the same time, I believe most observers agree that the Deepwater Horizon accident raises serious questions about the technology and practices involved in drilling at such depths. This morning's Wall St. Journal cited a 2004 study questioning the efficacy of at least some of the blowout preventers that have been used in deepwater installations, and various reports have pointed to requirements by Brazil and Norway that offshore drillers install equipment enabling the BOP to be activated remotely, should the drilling vessel lose direct communication with it. Both issues should be revisited, in light of current events.

Until the Deepwater Horizon rig and the BOP on the well are ultimately recovered from the sea bottom and analyzed, we won't know exactly what caused the accident that led to the spill. That could take a year or more. Meanwhile, drilling continues on other rigs in the Gulf of Mexico. Even with President Obama calling a temporary halt to expanded drilling beyond the Gulf, that leaves a number of other blocks on the Gulf's Outer Continental Shelf that have been leased but not yet drilled. What standard should the government apply, when it receives applications for new drilling on these? (That could even include the lease encompassing the Macondo prospect, which is demonstrating its resource potential in the least-desirable manner imaginable.) Unfortunately, at this point we have nothing beyond the event itself and the previous, uneventful completion of thousands of similar wells (and many thousands of wells in shallower water) to gauge the probability of this ever happening again. If the administration opts for a hiatus in Gulf of Mexico drilling or an outright ban, that would have far-reaching economic and energy-security consequences that I will address in a subsequent posting.

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