IEA Expects Global Energy Focus to Shift Eastward

Last month the International Energy Agency (IEA) released its annual long-term forecast, the World Energy Outlook (WEO). Its projection that US oil output would exceed that of Saudi Arabia within five years was featured in numerous headlines, although some of the report's other findings look equally consequential. That includes the continued strong growth of energy demand in China, India and other Asian countries, and the linkages between that growth and a dramatic expansion of Iraqi oil production. The agency also set a cautionary tone concerning the increase in global greenhouse gas emissions accompanying all this growth.

In the IEA's primary "New Policies" scenario, the US overtakes Saudi Arabia in oil production by 2017, adding 4 million barrels per day (MBD) of unconventional output, mainly from shale (tight oil) deposits such as the Bakken in North Dakota. US oil imports decline significantly, due in roughly equal measure to higher production and the implementation of strict vehicle fuel economy regulations. As a consequence, the need for imports from the Middle East approaches zero within 10 years. When this change is combined with the growth in oil demand in Asia, where China alone accounts for half the forecasted global growth in oil consumption in this period, the IEA envisions Asia becoming the recipient of 90% of Middle East oil exports by 2035.

The detailed assumptions behind the IEA's conclusions weren't provided in the public release. These include crucial questions such as the assumed status of US rules barring most crude oil exports. As noted in a Reuters op-ed at the time, maximizing the potential of US unconventional resources may depend on allowing higher quality unconventional oil to seek global markets, while continuing to import oil from Latin America and the Middle East into Gulf Coast refineries geared to these heavier, higher-sulfur feedstocks. The op-ed's author also reminded us that the natural gas liquids included in the headline comparison with Saudi production are useful but quite different from crude oil, yielding little gasoline and diesel fuel.

The expected growth of energy demand in China remains extraordinary, even with the country's economic growth slowing from the levels seen a few years ago. To put this in context, when Dr. Fatih Birol, Chief Economist of the IEA, presented the new WEO to the media in London on November 12th, he suggested that China's electricity demand would grow by the equivalent of "one US and one Japan of today" by 2035. Much of that additional electricity generation is projected to come from renewables, nuclear power and domestic gas. Nevertheless, and in spite of significant increases in China's unconventional gas production, the IEA forecasts that import dependence will grow from about 15% for gas and 50% for oil today, to 40% for gas and over 80% for oil by 2035. That increase in imports would equate to additional hundreds of millions of dollars per year of outflows for energy.

In the view of the IEA, much of the extra oil demanded in Asia will be supplied by Iraq, which they project will increase its output from around 3 MBD today to 6.1 MBD in 2020 and 8.3 MBD in 2035, in the process becoming the world's second-largest oil exporter, after Russia. Since the reserves to support that growth have already been identified, with much lower production costs than many other basins, the uncertainties involved are mainly political and structural. Resolution of the current standoff with Iran over its nuclear program would provide even more Middle East oil for Asian markets.

As in its earlier "Golden Age of Gas" scenario, the IEA expects large increases in global natural gas consumption. Unconventional sources, mainly in the US, China and Australia, would contribute around half the additional production required to meet expanded demand. However, at the launch presentation in London Dr. Birol also stressed that unconventional oil and gas are still at an early stage, with significant uncertainties about the eventual magnitude of their resources. This seemed to be a particular issue for the agency's post-2020 forecast of oil production in the US and gas production in China.

Despite the rigorous analysis and level of detail involved in producing the IEA's World Energy Outlook, long-term energy forecasting should always be taken with a grain of salt. Yet whether or not the highlighted trends mature precisely in line with these projections, the shifts that the IEA identified are significant and already becoming evident in current data for energy production, consumption and trade. Even if North America failed to become a net oil exporter--which many equate with energy independence--by 2030, the movement of the center of gravity of global energy trade towards Asia is essentially pre-determined: baked in by differences in economic growth rates and resource opportunities. The economic, geopolitical and environmental consequences of that shift are just starting to take shape.

A slightly different version of this posting was previously published on the website of Pacific Energy Development Corporation.

Read More

Does the Gas Tax Belong in the Fiscal Cliff Fix?

Recently I've seen several articles along the lines of this one from CNN, suggesting that an increase in the federal gasoline tax might be included in negotiations to avert the impending US "fiscal cliff".  While the gap between the gas tax, which was last raised in 1993, and highway repair costs grows each year, that's not just because past Congresses and administrations have been reluctant to hike it again.  As I've discussed in previous posts, gas tax revenue is declining for structural reasons related to curtailed driving, rising fuel economy and alternative fuel vehicles.  Simply adding another 10-15 ¢ per gallon to the current 18.4 ¢ tax wouldn't solve the long-term problem, although it would raise enough revenue to allow us to continue to ignore these growing challenges for a few years.  For that and other reasons, changing the gas tax deserves closer scrutiny than the waning hours of a preoccupied lame-duck Congress can provide.

Yesterday I attended another excellent event held by Resources for the Future in Washington, DC.  This one was devoted to "The Future of Fuel."  The panel discussion began with a presentation of the current energy forecast of the Energy Information Agency (EIA) highlighting the shifting energy mix the agency expects between now and 2035.  Although the slide deck didn't include the chart below, taken from EIA's 2012 Annual Energy Outlook, I couldn't help thinking of it in the context of both yesterday's meeting and the question of future fuel tax revenues. 

The EIA forecasts US gasoline demand to decline by about 8% from current levels by 2035 as cars meeting the new federal fuel economy standard enter the fleet, along with small but growing numbers of vehicles running on electricity and other non-petroleum fuels. An 8% drop in gasoline sales--and thus gas tax revenues--doesn't sound large until you realize that the current gas tax system was predicated on consistently rising gasoline sales as a means of expanding revenues. That's crucial, because highway construction and maintenance costs rise each year, too.  If gasoline sales were still growing at the 1% annual rate typical when the gas tax was last increased, gas tax revenues would be at least 37% higher by 2035 than the level the EIA would now project.

Stepping back from the details, the government faces a fundamental disconnect between its need to raise sufficient funds from the gas tax to cover the cost of maintaining the nation's road network and explicit federal policies aimed at reducing our consumption of the fuels being taxed.  Another one-time bump in the gas tax, whether of 5¢, 10¢ or 15¢ per gallon, will again be overtaken by the combined forces of inflation and declining volumes.  Fortunately, this problem is well-understood and a number of solutions are under consideration.  Inconveniently, many of them involve basic and controversial changes in how the road tax would be collected, such as shifting to a mileage-based tax assessed via annual inspections or real-time GPS monitoring. 

No one should expect or desire the 112th Congress to resolve these issues between now and the end of its term in January, particularly when the money at stake represents such a tiny fraction of either the fiscal cliff's package of tax increases and spending cuts or of the entire federal deficit.  I'm also not sure that reforming the gas tax belongs within the larger federal tax reform effort that should be undertaken next year, because the issues involved are so different from those associated with revamping the business, income, and payroll taxes.  Even a temporary fuel surtax would likely encounter strong opposition, due to its regressive nature and coincidence with gasoline prices that, despite recent declines, remain at or near seasonal record highs.  Unlike the rest of the fiscal cliff, this might just be one can that would benefit from being kicked down the road, at least past the current crisis.

Read More

EPA Unwavering in Support for Ethanol, Despite Drought

Last Friday the US Environmental Protection Agency (EPA) rejected the petitions of a bi-partisan group of state governors for a waiver of the federal ethanol mandate, resolving one of several energy-related issues that had been deferred beyond the presidential election.  The waiver requests filed in August cited the harm that the Renewable Fuel Standard (RFS) is causing to the poultry, dairy and livestock sectors and related businesses--and by extension to consumers--by increasing competition for corn during a severe drought that has sharply constrained supply.  The EPA's detailed response made frequent references to the "high statutory threshold of severe harm to the economy" required for a waiver of the RFS, and to the output of a model simulating the market for corn and ethanol. It also included the extraordinary assertion that, "the RFS volume requirements will have no impact on ethanol production volumes in the relevant time frame, and therefore will have no impact on corn, food, or fuel prices."  If that were true, then it's not obvious why the mandate should exist at all.

In rejecting pleas for relaxation of the ethanol standard, the EPA appears to be relying on two key facts.  First, wholesale ethanol prices remain lower than wholesale gasoline prices, despite corn prices that are high enough to force many ethanol producers to cut back output.  I'd attribute that mainly to weak US gasoline demand and the much-discussed impact of the "blend wall" in limiting ethanol to 10% of the gasoline pool, rather than as a sign of an unaffected market.  The agency is also relying on the availability of "paper ethanol" in the form of Renewable Identification Number (RIN) credits from past over-blending of ethanol by refiners and other gasoline blenders.  The EPA's estimate puts the number of available RINs at the equivalent of 2-3 billion gallons, or around 20% of this year's 13.2 billion gallon conventional ethanol requirement. As a result of these factors, EPA can claim with some justification that ethanol prices are not harming motorists at the gas pump at this time.  That's small consolation to the petitioners.

EPA's assurances to those in the poultry, dairy and livestock value chains are based on much thinner evidence--in fact, on none at all, unless you count as evidence a model that predicts corn prices would only fall by $0.58 per bushel if the ethanol mandate were eliminated entirely.  Simulations are useful but still aren't reality. The output of a model is only as good as its assumptions and algorithms, and when that output defies logic, it calls for the application of good judgment, particularly when the result happens to align so neatly with the internal concerns about the long-term implications of a waiver that are evident in the agency's response.  I can't help concluding that an agency whose management possessed greater depth and breadth of experience outside of government--especially in the business sector--would have given more weight to the struggles of the dairies, ranchers, meat-packers and others who are being squeezed by a mandate that is projected to consume 42% of this year's corn crop and is very likely inflating the cost of the Thanksgiving meal that many of my US readers will eat on Thursday.   This administration's lack of outside experience has been a glaring shortcoming that the President could easily remedy as turnover creates openings at the start of his second term. 

I can't say that I'm surprised by the EPA's ruling on the waiver requests.  I also can't help wondering whether it provides any indication of how the administration is likely to deal with the other issues that were deferred until after the election.  Yet even if we can't read anything else into this decision, it's clear that the Renewable Fuel Standard enacted in 2007--before the financial crisis and recession--is in serious need of reform.  If its language doesn't require the EPA to adjust the ethanol mandate in light of a drought that will result in the smallest corn crop since 2006, when US ethanol production was 65% lower than last year, then the law simply didn't incorporate sufficient foresight about possible future events.  Together with its unrealistically ambitious cellulosic biofuel standard, the provisions of the RFS increasingly seem to relate to some other, parallel universe, rather than the one in which we live.  

Read More

Is Gas Rationing Superior to Raising Prices for Consumers?

With New Jersey about to end the odd-even gasoline rationing  imposed in the aftermath of Hurricane Sandy, we have an opportunity to consider whether this kind of response actually produces better outcomes than the price increases by which the market would normally balance supply and demand.  Most of the defenses of "price gouging" that I've seen, including Matthew Yglesias's recent posting in Slate, tend to focus mainly on its supply-side aspects. Yet such arguments, however well-reasoned, are unlikely to sway Americans from their innate sense of fairness, on which most anti-gouging regulations are premised.  That's inherent in the judgmental term itself.  However, having spent my share of time in gas lines during the energy crises of the 1970s, I believe that supporters of these rules are ignoring some even more pragmatic, consumer-based arguments for allowing prices to rise after a disaster.

In addition to the tragic loss of life and property inflicted by Sandy, the storm left the petroleum products infrastructure on which New Jersey depends paralyzed for days.  Refineries were shut down, distribution terminals full of gasoline were unable to deliver product, and gas stations without power had no way to sell the fuel stored in the tanks under their forecourts.  This combination represented a huge supply shock to the region, and it wasn't long before gas lines formed at those stations that had both product and electricity.  New Jersey has strict and specific anti-gouging rules and is already charging merchants with violations following Sandy.  Within a few days, in an effort to alleviate the queuing that resulted from the supply shortfall and the inability of retailers to raise prices, Governor Christie resorted to rationing by license plate number.

Although restricting prices might superficially appear more equitable--particularly for lower-income consumers--than allowing them to climb to the levels necessary to clear the market without long lines, it also imposes significant costs on all consumers.  For starters, anti-gouging rules effectively confine motorists to their vehicles precisely when they have many other urgent priorities, including attending to their families and homes. They also implicitly put a very low monetary value on consumers' time.  Waiting on line for four hours to obtain 10 gallons of gas at a pre-disaster price of $3.50/gal., instead of experiencing a much shorter wait to purchase fuel for $5.00/gal., is equivalent to being paid $3.75 per hour--around half the state's official minimum wage.  This situation also increases the chances that an individual will wait for hours only to see the station run out of fuel before his or her turn comes, because demand is unchanged or temporarily higher than before the crisis.  Adding odd/even rationing might reduce gas lines by limiting demand and breaking the psychology contributing to the lines, but it also compounds the harm to consumers, some of whom are left with no legal means of acquiring fuel when they need it most.

I don't expect politicians and regulators suddenly to embrace a purely market-based approach towards post-disaster pricing of necessities like fuel.  However, we ought to expect them to look at the real-world results of their policies and apply some common sense and creativity to improve how they function.  Anti-gouging rules clearly benefit some at the expense of others. How could we simultaneously preserve the benefits for the first group, while allowing those willing to pay a premium for emergency supplies to do so, in the process sending the appropriate price signal to reduce overall demand? One solution might be to allow gas stations with multiple pump islands to raise prices as long as they have at least one set of pumps offering the pre-disaster price.   Technology should provide even more innovative and effective options.

Given the magnitude of the supply disruption post-Sandy, there was no way to avoid a serious shortage of motor fuel in the affected region.  However, the appearance of long gas lines and the resort to a 1970's expedient of odd-even rationing shouldn't satisfy anyone concerning the effectiveness of the pre-existing emergency energy policies that were called into play following the storm.  I can't imagine New Jerseyans being content with the outcome they experienced.   

Read More

Push-me/Pull-you: Post-election Energy Policies

I've seen numerous commentaries on the energy implications of President Obama's narrow, 51%/49%  victory. One of the most intriguing of these, from Reuters, concerned the prospects for exporting a portion of the growing output of natural gas produced from US shale deposits.  This issue doesn't only affect gas drillers and their residential and industrial customers, but also developers of renewable energy projects, because of the way that gas and renewables compete in electricity markets.  As much as the President's reelection, the failure of Republicans to capture control of the US Senate might turn out to be a key factor in determining the fate of potential gas exports, and by extension the environment within which renewables like wind and solar power must compete.

A variety of energy issues has been in limbo for months, pending the outcome of Tuesday's election.  That includes approval of the Keystone XL crude oil pipeline from Canada, which might have gotten a favorable nudge as a result of Senate wins by pro-pipeline Democrats in North Dakota and Montana.  Environmentalists are committed to blocking the pipeline, so the President must soon choose which part of his winning coalition he will disappoint.  By comparison, the question of natural gas exports has received much less attention in the media, although it's been discussed extensively within energy and manufacturing circles.  The likely incoming chairman of the Senate Energy and Natural Resources Committee, Ron Wyden (D-OR), appears to have strong views on the subject.   

If Senator Wyden does replace the outgoing chairman, Senator Bingaman (D-NM), as expected, this would represent a shift in constituencies from a state with significant oil and gas production to one with essentially none.  Senator Wyden thus brings mainly an end-user perspective to his Energy and Natural Resources role, and from that standpoint his concern about the potential price impact of gas exports, whether in the form of LNG or otherwise, is understandable, although I would argue it is also short-sighted and potentially detrimental to renewable energy, which he strongly supports.

On the surface, restrictions on the export of US gas should result in lower domestic natural gas prices than if large quantities of gas were shipped offshore.  After all, low US natural gas prices, compared to those in Europe and Asia, are the main driver behind the desire to build export facilities, such as the Sabine Pass project of Cheniere Energy.  Natural gas is cheaper in the US than elsewhere for several reasons, including the high and growing output from shale gas resources, as well as the epic disconnect between the natural gas price and crude oil prices, which are the basis for most international LNG contracts. US gas at the wellhead is currently trading for the oil equivalent of $21 per barrel, compared to UK Brent Crude at $107 per barrel.  The extent to which exports might increase domestic prices is a matter of much speculation and study, and I wouldn't venture a guess.  However, we can't just look at demand in gauging the impact of export restrictions.

The efficacy of holding down US prices by keeping more gas here also depends on the response of producers.  If legislators or regulators turn the US gas market into a capped bottle, why would producers be content to supply steadily increasing quantities of gas at prices that don't provide them an attractive return?  To some degree the low prices we've seen this year were the result of the combination of a weak economy and a supply glut created by contractual commitments on the part of drillers to develop gas leases at a specified pace.  My understanding is that most such commitments have lapsed, and that a significant proportion of current gas supply is coming from wells that depend on the economics of their liquids output (crude oil and gas liquids), with the associated natural gas effectively a byproduct.  It's not clear how rapidly gas production can continue to grow without natural gas prices that make gas-only wells economically attractive.  So a US gas market with no export outlets would likely produce less gas in the long run, and that would constrain opportunities to use our abundant gas resources to support new industries, displace oil from transportation, and further reduce the use of coal in power generation.

Moreover, keeping a lid on the US gas market would compound the obstacles for renewable sources of electricity.  Wind power developers and turbine manufacturers now face the expiration of the Wind Production Tax Credit (PTC).  Even if it is extended, the output of wind farms competes with the output of gas turbines, while the grid relies on gas-fired power to provide a back-up for the intermittent output of wind and solar power.  The cheaper the gas, the tougher it will be for renewables to make a profit. Market competition with gas will become an even bigger issue for renewables as they expand beyond the capacity of a cash-strapped federal government to continue to subsidize them.  The one-year extension of the PTC under consideration could cost as much as $12 billion, an annual price tag that would only grow as renewables scale up--as they must if they are going to matter.

Navigating the complexities of allowing or restricting natural gas exports, and balancing the various constituencies involved, could provide an early test of the administration's commitment to an all-of-the-above energy strategy.  That's because "all of the above"--if not merely a slogan--implies more than just producing energy from a variety of sources.  It also entails competition among all these sources within a market in which some sectors of demand are declining, others growing, and new ones--including exports--are appearing all the time.  Pushing back on one part of this market will have large consequences in other parts, and regulators could soon be overwhelmed by unintended consequences. 

Read More

US Natural Gas Prices and the Election

Every fall my natural gas utility asks if I'd like to lock in my gas price for the next 12 months.  In some respects the timing for this looks ideal.  Commodity natural gas prices haven't been lower than this year's average since 1999.  Gas is also historically cheap relative to other fuels.  Heating oil recently averaged above $4 per gallon, while the fixed price my natural gas provider is offering equates to $1.36 per gallon, including distribution charges.  However, overhanging this relatively simple choice are big uncertainties related to the economy and the potential impact of regulations on shale gas production.  To complicate matters further, both of these uncertainties are entangled with the outcome of the US presidential election, and my gas provider wants my answer by next Monday.

When I last looked at this question in detail, in 2010, I concluded that the utility's offer was attractive, after scrutinizing then-current gas futures prices and the historical relationship between the futures market and "city gate" prices for Virginia, where I live.  Using the same methodology, this year's offer of $0.62/therm ($6.20/MMBTU) looks reasonable.  Much has changed in the interim, though, in ways that undermine the rationale for locking in consumer gas prices.  The biggest benefit of a fixed price is avoiding nasty surprises during winter heating season.  More than four-fifths of my household's gas consumption occurs from November through March, a period when gas prices used to be alarmingly volatile.  

That's less of a concern, now, with US gas inventories high and supply ample. The same shale gas revolution that has increased domestic supply and backed out imports has also reduced volatility and promoted big shifts in demand. Since 2009 residential gas demand has been essentially flat, while demand from commercial and industrial users has grown by 6.5% and consumption in power generation is up by more than 10%, despite a lackluster economy.  (Gas for use in transportation grew even faster but still constitutes less than 0.2% of total gas demand.)  As a result of these shifts, peak monthly average natural gas prices since the winter of 2009-10 have occurred in summer, coinciding with air conditioning demand. With less winter price volatility, the decision to lock in prices now is mainly a bet on gas prices for the next 12 months.  The outcome of that bet hinges on future supply and demand.

On the supply side, will the surge of US shale gas production continue?  New regulations are among the biggest potential constraints on output.  The EPA has set new rules on emissions during well completion and production, with the most expensive aspect phasing in by 2015.  EPA will also issue new rules on wastewater disposal from fracking by 2014. There is growing pressure on the administration to impose federal regulation of most aspects of shale development, superseding management by the states.  Thus far, the White House has avoided a sweeping crackdown that would disrupt gas markets, and the EPA administrator is on record opposing comprehensive federal regulation of all wells.  However, it's not obvious whether such reticence stems from a basic belief in the national importance of this resource or the simple expedient of not killing the golden goose before the election.  Governor Romney has proposed streamlining regulations affecting gas production. Next Tuesday's outcome should resolve this uncertainty.

The other big uncertainty surrounding gas prices concerns demand.  High shale gas output isn't the only reason gas is cheap today.  Anemic GDP growth such as the 2% rate for the third quarter reported last Friday has helped keep gas prices low.  A stronger economy with higher full-time employment would put upward pressure on prices by soaking up much of the surplus production that has depressed them.  However, the consequences of failing to mitigate January's "fiscal cliff"--federal budget "sequestration" and the expiration of many tax cuts--would likely drive natural gas back toward the lows we saw this spring.  With the economy still the number one issue for most voters, its likely future impact on gas demand is linked with our perceptions of the candidates' economic programs and promises. 

My best bet is to convince my supplier to let me wait until after the election to reply.  There's nothing like additional information to improve the value of a decision. Failing that, I'm inclined to pass on this opportunity.  The possibility of cheaper natural gas next year acts as a modest hedge against the risk of another recession, while the benefits of a stronger economy would more than outweigh any natural gas price increases I might experience on the upside.

Read More

Solyndra's Second Chapter

The details of the reorganization plan approved Monday by the judge hearing the Solyndra bankruptcy case reminded me of the admonition of one of my mentors always to beware of unintended consequences.  I'm sure the Department of Energy officials who recommended the federal loan guarantee for Solyndra in March of 2009 envisioned that the solar start-up would succeed.  As a worst-case outcome, they probably anticipated the loss of the entire $535 million direct federal loan ultimately provided by the Treasury. However, in a remarkable turn of events, the actual extent of the downside for taxpayers has now expanded to nearly $900 million, due to a quirk in the tax code and a subsequent DOE decision in 2011.

This odd sequence of events starts in early 2011 when two venture investors agreed to infuse another $75 million into the already failing Solyndra.  In order to facilitate this injection--presumably in hopes of protecting the government's substantial investment in the firm--the DOE agreed to allow the investors' loan to take precedence over the government's if Solyndra went bankrupt. Perhaps they thought that even in that case, they'd still recover most of the government's investment, because Solyndra had a sexy technology and a big new factory in Fremont, CA that could be sold to a competitor for close to full value.  They apparently didn't appreciate that Solyndra's high-cost technology had already been bypassed by falling polysilicon prices, and that the factory and its custom equipment wouldn't be of much interest to other solar producers, who were in the process of creating a huge global overhang of solar manufacturing capacity.  The Solyndra plant will now apparently be sold to a hard-drive maker for just $90 million.

In the meantime, Solyndra was piling up substantial losses running its plant and selling solar modules below cost, in order to compete with conventional solar panels that had become much cheaper. By the time Solyndra entered Chapter 11 bankruptcy, its cumulative losses apparently totaled $975 million.  To put that in perspective, the combined after tax profits of First Solar, the largest US solar producer, for the three years in which the DOE's loan to Solyndra was outstanding, were $1,265 million.

What makes Solyndra's losses relevant is that, contrary to intuition, they didn't disappear in bankruptcy.  Instead, via the investors' plan for emerging from bankruptcy, they became an asset.  And because the DOE ceded the first place in line to private investors, it is those investors who will control those "net operating losses" retained by Solyndra's reorganized parent company, 360 Degree Solar Holdings, Inc. That company apparently kept none of Solyndra's hardware, but when it acquires other companies--in any line of business--it will be able to offset future federal tax liabilities estimated by Bloomberg at $341 million.  Meanwhile, the federal government is likely to recover just 5 cents on the dollar on its "secured loan."  The Solyndra loan is a gift that keeps on giving. 

Hindsight is 20/20, but it seems pretty clear that the folks at DOE were outsmarted by private investors who had a much clearer picture of the stakes for which they were negotiating.  As we were reminded last week, Solyndra wasn't the only investment they made that went bad.  Let's hope that the others don't include similarly unpleasant surprises.  Meanwhile, I wish the IRS and Alameda County the best of luck in appealing the bankruptcy judge's ruling.

Read More