The Beginning of the End for Coal?

I saw in Tuesday's Washington Post that the EPA was ready to issue its proposed rules for CO2 emissions from new power plants. When finalized, these rules would apply to facilities larger than 25 MW that begin construction more than a year hence. As the Post notes, the chosen CO2 emissions limit of 1,000 lb. per gross Megawatt-hour (MWh) generated would make it virtually impossible for a new conventional coal-fired generating plant to comply with this requirement. That looks like another positive for natural gas, which is coal's nearest competitor today. It might also help baseload renewables such as geothermal, since wind and solar power don't ordinarily compete directly with coal. However, anyone reading this as the epitaph for coal in the US shouldn't be too hasty, because the EPA has left room for technology and other strategies to keep coal in the future mix.

I'm completely swamped with work and other commitments at the moment, so this posting will be more like an extended Tweet. However, I thought this news was too important not to comment on it, however briefly. Lacking the time to research these data myself, I'll rely on Ms. Eilperin's thoroughness and use her figures of 1,768 lb. CO2/MWh for the average US coal plant and 800-850 lb./MWh for gas. The latter is certainly a long way from state of the art, and I'm sure that a modern ultra supercritical coal plant would come in considerably below the 1,768 lb. mark, as well, yet still above the magic half ton. What intrigues me about the EPA's chosen performance standard is that meeting it would require much less than 100% capture and sequestration of a facility's CO2 emissions. Perhaps as little as 25-30% would be sufficient, particularly, if the plant were also designed to be co-fired with biomass, as some existing coal plants are. That combination, or some other similar strategy, could significantly reduce the cost of compliance and keep coal in the game.

I know that outcome wouldn't please those who see coal as not only the logical place to seek large-scale greenhouse emissions reductions, but also a major contributor to various local environmental impacts. Yet it's also an enormous domestic energy source, the global demand for which continues to grow. Moreover, as coal is increasingly displaced from power generation by cheap natural gas, its price is likely to drop, making it more competitive for export. So perhaps this isn't the beginning of the end for coal in the US, but just the start of a new phase.

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Is North America the New Middle East for Oil?

With the President of the United States currently playing the role of pessimist-in-chief with regard to US energy independence, it's refreshing to see that goal raised as a serious possibility by someone whose experience and position give him deeper insights on the subject. A few years ago Ed Morse was running the oil trading operation for Hess, and now he's at Citigroup. His op-ed in today's Wall St. Journal offers an upbeat analysis of the ongoing resurgence in US and Canadian production and the potential for North America to move within striking distance of true oil independence. He doesn't appear to be predicting $2.50 per gallon gasoline any time soon, but he does remind us that permanently higher oil prices needn't be inevitable, although he is also very clear about the obstacles that could impede these developments.

How often have politicians and pundits reminded us that we can't drill our way to energy independence? I've said that myself numerous times in the eight years I've been blogging here. So before exploring the implications of producing significantly more oil than we do today, it's worth asking why some experts are starting to question what has been a bedrock assumption about the US energy situation since our conventional oil production peaked in 1970--not coincidentally just before the first oil crisis in 1973-74.

If the tired talking point about the US having just 2% of the world's oil reserves were truly reflective of reality, rather than a technicality based on the way the SEC requires oil companies to account for their chief assets, people like Ed Morse wouldn't give energy independence a moment's thought. The number to focus on is not the 21 billion barrels of proved reserves on companies' books, but the nearly 200 billion barrels of discovered and undiscovered "technically recoverable oil resources" onshore and offshore, in the lower-48 and Alaska. That figure represents more than 95 years of production at current rates.

That estimate is also mostly based on assessments from the 1980s done with technology that bears the same relationship to current exploration techniques as an old Ma Bell rotary phone does to an iPhone. It's technology that is shifting expectations about what is actually possible. Consider the Bakken shale formation in the Dakotas. The conventional Williston Basin oil fields were discovered in the early 1950s and mostly played out by the late 1980s. The billions of barrels of resources in the adjacent Bakken shale, which might produce a million barrels per day by the end of this decade, simply couldn't have been produced at commercially useful rates with the technology that was available until the last decade. The hot question now is where the next Bakkens will be found.

Then there's deepwater drilling, which suffered a big setback with the Deepwater Horizon accident and spill but is still contributing 1.2 million barrels per day and could reach 1.9 million next year. What moves Mr. Morse's speculation from wishfulness into the realm of practical possibility is the potential of applying technologies like those to exploit conventional and unconventional reservoirs to which industry has not had access since their development, if ever.

Another talking point that we've heard like a drumbeat over the last several months is that even if the US could produce more oil, it would make little difference to oil prices in a global market of 90 million barrels per day. We simply don't control the price of oil; OPEC does. That has been true for essentially the entire time I've worked in energy. But here's where it's handy to have the background in oil trading that I share with Mr. Morse. Traders have to think about how prices are really set, and they understand that it's the interaction of the last few million barrels per day of supply, demand and spare capacity that really count, along with inventories. An extra million or two barrels per day--a quantity of which North America is certainly capable--can make a huge difference in oil prices. We saw that in 2009, when a drop of about 3 million barrels per day of demand sent prices from $140 to $40 within a few months, and we saw something similar involving both supply and demand during the Asian Economic Crisis of 1997-98. (See chart below.)


Nor is OPEC monolithic; it's made up of a group of producers with very different levels of reserves and production, and differing domestic requirements for the revenue they earn from selling their oil. That means that, contrary to yet another talking point, OPEC does not have unlimited capacity to back down production, in order to keep prices high when others increase output. And even when it can maintain enough cohesion to tighten quotas and restrict its own output, the production in question merely shifts to "spare capacity", the expansion of which reduces oil market volatility. Imagine how different the market's response to the current confrontation over Iran's nuclear program might look if other producers had a multiple of Iran's exports in reserve.

Just because something is possible with a decade or so of determined effort doesn't make it inevitable. While I share Mr. Morse's optimism about the benefits of boosting North American oil production on a scale that would dwarf the modest recent upturn, which has received so much attention from politicians who had nothing to do with it, I'm also skeptical that it could proceed to quite that extent in today's climate. Aside from people who are genuinely concerned about the possible environmental impact of more oil development, there are also those who would regard such a turn of events as contrary to their own interests and their perception of the nation's. How would we convince consumers to pay the premium for new cars achieving an average of 54.5 mpg in 2025 if gasoline remained between $3 and $4 per gallon, instead of trending toward $6--let alone shifting them into electric vehicles that the government and carmakers have invested billions in developing? And how would we stimulate production of advanced biofuels if the future price of crude oil were seen as being capped at or below $100 per barrel, except during geopolitical crises?

I believe all such questions have answers that don't depend on us constraining access to our resources at the cost of remaining more vulnerable to overseas suppliers and weakening both our trade deficit and our currency. I'd rather have the extra domestic oil and then worry about how to spend some of the resulting windfall of federal and state taxes, bid bonuses and royalties on achieving our other policy objectives, such as promoting efficiency and reducing emissions. Nor is relying on OPEC to keep prices high the best or most effective way to encourage us to use oil more frugally.

I don't know if North America is the next Middle East, although it's worth recalling that we were the world's biggest oil supplier before the first well was drilled in Saudi Arabia, and DOE estimates suggest we have as much oil left as we've produced to date since 1859. However, I do know that I would much rather give OPEC's leaders sleepless nights worrying how they'll keep oil prices high in the face of a wave of new production from the US, Canada and possibly Mexico, in preference to giving US consumers sleepless nights about how they'll pay for the gasoline they need for their commutes and the fuel to heat their homes, if prices stay this high or higher from here on out.

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A Cleantech Trade War with China?

While we wait to see whether the next big move in oil prices--and hence gasoline prices--is up or down from today's level of around $125 per barrel, two stories in today's Wall St. Journal highlight some of the challenges facing manufacturers of equipment used to produce renewable energy. One concerns the intention of the US administration to seek the World Trade Organization's assistance in easing China's restrictions on its exports of rare earth materials used in a wide range of devices, including wind turbines, hybrid and electric vehicles, and some solar panels. The other is an op-ed offering a solution to the looming trade war over solar panel and wind turbine tower exports from China, modeled on the 1996 Information Technology Agreement that lowered trade barriers in that industry. The two stories are related, reflecting major unintended consequences of the ways we have approached our transition away from fossil fuels and toward lower-emission sources of energy.

Trade wars are risky things, because you never know where they will lead. The classic example of this is the Smoot-Hawley tariff of 1930. It and the responses to it by other countries helped deepen and extend the Great Depression, and I have never seen any analysis of them that concluded they were a good idea. A major trade dispute now over renewable energy hardware and the ingredients needed to produce it looks doubly unwelcome, because none of the parties comes to it with clean hands. Much of China's output of rare earths is being consumed by China-based manufacturers producing permanent magnet wind generators, electric vehicle motors, compact fluorescent lights, and solar equipment, much of which is exported to global markets that owe their very existence to government interference in the form of manufacturing, deployment and consumer tax credits; government loans and loan guarantees; feed-in tariffs; and fuel economy and lighting efficiency standards. There's hardly a single aspect of the global cleantech industry that is the result of unaided market forces.

The US complaint about solar imports is a good example. I wouldn't be surprised if the US government can make a strong case that the Chinese solar firms in question benefited from government assistance in ways that constitute unfair competition under established rules of international trade. Yet the same US government has provided substantial assistance to US solar manufacturers in the form of direct R&D support and federal loans and loan guarantees, as well as indirect help in the form of solar investment tax credits, cash grants, and project loans and loan guarantees that helped create and sustain a domestic market for them. All of these were necessary, because despite the significant cost reductions these incentives facilitated, the output of solar panels is still substantially more expensive than electricity from conventional generation. If we win this round with China, do we open the door to a whole series of WTO complaints against us by others who could claim harm from our own renewable energy policies?

From my perspective, these trade issues are a symptom of the larger problem of global overcapacity in wind and solar equipment manufacturing that has been created by the complex interaction of a mare's nest of national and local incentives and support for the production and deployment of these technologies, amplified by the disruption caused by the global financial crisis and recession of a couple of years ago and the ongoing financial crisis in Europe. A vast industry was created out of nothing and handed a market through a set of policies that could not sufficiently fine-tune development to prevent the emergence of a boom-bust cycle, and that now appears to be unsustainable itself in light of developed-country deficits and debts.

Trade disputes are one possible mechanism for attempting to rationalize this overcapacity, but in my view they constitute a much less productive approach than the one suggested by Professor Slaughter, who if I understand his proposal correctly is urging the rationalization of the government subsidies that have caused this situation in the first place. My biggest concern about his advice is his choice of the UN climate negotiating process as the best body to pursue such an initiative. That might be an appropriate venue, but its recent history doesn't inspire much confidence that it is up to the task.

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Is There A Better Way to Use Strategic Petroleum Reserve Oil Now?

With US gas prices rising rapidly to record levels for this time of year, it was inevitable that some politicians would start calling for a portion of the oil in the Strategic Petroleum Reserve (SPR) to be released in hopes of moderating high oil prices, which are mainly responsible for the current gas price spike. A narrow majority of Americans apparently agrees. This is a profoundly bad idea, for reasons of both actual US energy security and the uneven effectiveness of past releases. However, rather than railing against this proposal, it occurred to me that there might just be a better way, an alternative that could send the signals that those concerned about commodity speculation wish to send, but without draining oil that we would miss in an actual supply crisis. What if instead of instructing the Secretary of Energy to sell a certain quantity of oil from the SPR, the President told him to sell an equivalent volume of call options on SPR oil, on the condition that they that could only be executed in an actual emergency?

The SPR was established in the 1970s, and as I've noted on several occasions it's overdue for a major redesign to reflect the ways in which both the world and US energy consumption patterns and infrastructure have changed in the interim. However, this is clearly not the appropriate time for such an undertaking, with the very real prospect of a major disruption in the Middle East that might require the largest-ever SPR release to address.

The past history of SPR releases is well-documented. The two releases most relevant to the current situation include last year's release of 30 million barrels in coordination with other member countries of the International Energy Agency, to compensate for reduced exports from Libya resulting from the revolution that overturned Col. Gaddafi's regime. Although one could argue about the appropriateness of that response in the absence of a meaningful disruption in oil deliveries to the US, its outcome is now clear. The market impact of the release was small and quickly dissipated in the noise of market volatility. That stands in marked contrast to the SPR release announced at the start of hostilities in the Gulf War in 1991. Following the announcement of a 34 million barrel SPR sale, only half of which was ultimately delivered, oil prices fell by 33% literally overnight. I will never forget that, because I was trading petroleum products in London for Texaco at the time and the sudden shift in prices was stressful, to say the least. The lesson I take from these and other examples is that SPR releases are much more effective in an actual emergency than when they are perceived as merely attempts to manipulate the market.

But let's give those calling for a release now the benefit of the doubt that $125 oil and the resulting near-$4 gas prices might be at least partly the result of speculation--all the while recognizing that for every speculative buyer there must be a seller taking the opposite view of prices. If the Department of Energy were to sell options on SPR oil, instead of the oil itself, it could accomplish several useful things in this scenario. First, it would send a stronger signal to the market than the will-he-or-won't-he cloud that customarily hangs over such releases, conveying that the US is serious about covering a shortfall that might result from the manifestation of the various risks that have driven up oil prices by about 13% since the beginning of the year, notably focused on tensions with Iran. It would also generate a bit of revenue for the Treasury, in the amount of the option premiums collected. More importantly, it could significantly shorten the normal delay between the decision to hold an SPR sale and its actual execution, by identifying, pre-qualifying and contracting with specific buyers ahead of actual need. Hastening the flow of SPR oil in a crisis by a week or two could be very helpful. And the best feature from my perspective is that the whole time the oil would stay right where it should remain until it's really needed, in the SPR caverns on the Gulf Coast.

A number of crucial details would have to be worked out, including the careful specification of the precise circumstances under which the options could be triggered, how long they would remain active before expiring, who would be eligible to purchase them, and for what purposes. In order to be of value to buyers, the triggering event(s) would have to be objectively observable and not under the seller's control. Perhaps a specified reduction in exports through the Strait of Hormuz, or the outbreak of hostilities between Iran and Israel or the US would be the most suitable choices, since it is presumably such risks that have taken oil prices to their current level.

I don't know whether selling SPR options would be permissible under current statutes. If not, it might be hard to get a change like this through a deadlocked Congress, even though the idea of selling options rather than physical oil ahead of an actual emergency straddles the concerns of both parties. I'm also sure there would be unintended consequences, as well as a lot of finger-pointing after the fact if some trader or refiner made a fortune on one of these transactions. Still, it seems worth exploring as an alternative that might be useful, not just when we're facing high prices and a potential crisis but under more routine circumstances.

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Shale Gas Likely to Alter China's Energy Mix

Two recent news stories highlight the significant shifts underway in China's energy sector, along with the global impact that is already apparent from these changes. Last week the Chinese government announced a new estimate for the country's potential resources of shale gas that is nearly double the Department of Energy's latest estimate for US shale gas. However, having the resource and developing both it and the infrastructure and market to take advantage of it are distinctly different things, as I pointed out in a brief interview on the subject on public radio's Marketplace program. The key to that may be found in a front-page story in today's Wall St. Journal describing the recent pace of Chinese investment in the North American energy sector.

When we think about energy in China, we tend to focus on the vast scale of its coal use, which affects local, regional and, at times, trans-Pacific air quality, to say nothing of its huge greenhouse gas impact. Coal made up 70% of China's total energy mix in 2010. Or we might think of the explosive pace of renewable energy deployment, although China's solar industry, and to a lesser extent its wind power industry, are still mainly export-oriented. Non-hydropower renewables, which were identified as a strategic industry within the 12th Five-Year Plan, account for just 0.5% of China's energy, but the government has recently indicated it would rein in the "blind expansion" of such sources. Together with hydro and nuclear, low-emission energy sources account for just 8% of the total, less than half the 18% share of oil, which is likely to continue expanding as the transport sector grows and encompasses more personal cars. That leaves natural gas with just 4% and a much lower profile than in the US, where it supplies roughly one-fourth of total energy.

If the resource figures that were just released are any indication, the potential growth of gas in China may exceed that of all other energy sources over the next several decades. Nor is that growth dependent on shale gas development, which is in its infancy there, with only a few wells having been drilled. China has some conventional gas production and a small but growing coal-bed methane industry, and it is already one of the world's largest purchasers of liquefied natural gas (LNG). Although the shale gas figures might seem like bad news for companies planning LNG exports from the US, or for the enormous new LNG projects in Australia and elsewhere in the region, they could prove complementary in two ways.

First, the current availability of large and growing quantities of LNG in Asia-Pacific provides the basis for developing both the enormous potential gas market in China's coastal industrial centers and the infrastructure for serving it, including the crucial "reticulation system"--what other industries call the last mile. You simply don't build this unless you have a large, reliable supply on hand, and you also don't develop huge new domestic supplies unless they have an assured market. LNG could thus be the key to avoiding a classic chicken-and-egg dilemma that might otherwise retard the growth of gas in China for years.

At the same time, the recently identified shale gas resources solve a major problem for LNG vendors, by reassuring Chinese buyers that they will have access to ample gas to satisfy industrial, commercial and residential demand long after the 20-year or longer LNG contracts expire and the reservoirs feeding the region's LNG plants are depleted. But that's only true if China acquires the expertise for developing its own gas, and that's where its North American energy deals come into play.

The Journal article provides a good overview of how Chinese companies changed their approach to North American oil & gas mergers and acquisitions in the aftermath of CNOOC's failed bid for Unocal in 2005. Chinese investors have learned not to raise the hackles that that deal did, and they have focused on minority shares in oil & gas companies or in specific field developments, mainly in unconventional plays such as the Eagle Ford shale in Texas with Chesapeake Energy. Even if no intellectual capital flows back to the investing companies, the mindset required for selecting and managing such projects surely will, and that will have a direct bearing on China's enormous new shale resources, which if proved up would equate to 230 years of current consumption.

No one can know at this point how durable last week's estimate of 25.1 trillion cubic meters (886 trillion cubic feet--TCF) of undiscovered, technically recoverable shale gas will be. The Energy Information Agency recently cut its previous US shale gas estimate of 827 TCF by 42%, based on updated information on per-well recovery rates and other factors, particularly in the Marcellus formation underlying New York, Pennsylvania and other northeastern states. (Despite being widely publicized by critics of shale development, this adjustment won't have any bearing on actual shale gas output for many years, during which the resource estimate is likely to be further refined many times.) China will gain similar experience as it develops its shale resource and should have a much better handle on its probable size within a few years. As with nearly everything else related to the country's economic development, the number is still likely to be very big.

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What Would It Take for Gas to Hit $5 per Gallon?

After returning from a business trip to California, I don't find media speculation concerning the possibility of $5 gasoline later this year quite as far-fetched as I might have last week. Perhaps seeing $4.299 per gallon posted for unleaded regular on many street corners there, compared to $3.699 or so here, gave me a touch of "availability bias" even if I also understand that gasoline taxes in the Golden State are a full 29¢ per gallon higher than in Virginia, and that environmental regulations there make it very much more difficult for refineries to produce fuel that meets California's specifications. Without dwelling on regional differences that could make $5 gas likelier in some places than others, I thought it might be worth spending a moment considering what it would take to reach that level on a national average.

In a situation such as the current one, as I described a few weeks ago, it comes down to crude oil prices. Calculating the oil price implied by $5 gasoline requires backing out the other key components of the pump prices we observe. Start with federal and state taxes, which according to API averaged 48.8¢/gal. in January. (That's only a snapshot, because many states include sales taxes that change in proportion to the overall price level.) You also have to subtract the retailer/distributor margin, which is typically around 15¢/gal. That leaves $4.36/gal., or roughly $183 per bbl, for pre-tax wholesale gasoline. But we still have to account for refining margin, or more accurately the spread between wholesale gasoline and crude oil, since a true refining margin would include the influence of a range of other products and byproducts like diesel, jet fuel, lubricants and petroleum coke. In 2010, before the Cushing crude bottleneck depressed West Texas Intermediate prices to the extraordinary degree we've seen in the last year, the average difference between gasoline and light crude futures on the New York Mercantile Exchange was $9.67/bbl. Knock that off the above calculated wholesale price and we get an implied price for light sweet crude of just under $175/bbl.

As of today, Louisiana Light Sweet and UK Brent, the best current indicators for this kind of crude, stood at $127 and $126, respectively, while poor old WTI languished at $109. So based on the above calculation, $5 gasoline would require world oil prices to rise by about $50/bbl--or more if you back-calculate from last week's average US gas price of $3.72/gal. Short of the saber-rattling in the Persian Gulf turning into a shooting war, it's hard to see that happening without the kind of economic conditions that took oil close to $150/bbl in 2008. That experience also suggests that if we reached $5/gal., the event might be short-lived as the shock waves it would cause undermined the economy and thus the fundamentals of oil prices.

Unlike Tom Kloza of Oil Price Information Service, I will not don a clown suit if the average US price of gasoline reaches $5 this year. However, I would be very surprised, barring the outbreak of hostilities between Iran and the US or Iran and Israel, a global or self-imposed boycott of Iranian oil exports, or a sudden, unexpected problem in another major producing country. Whether that makes predictions of $5 gas "hyperbole", as Mr. Kloza apparently suggested, or merely the result of failures to do the math, I leave for you to decide.

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How Helpless Are We in the Face of Rising Oil Prices?

Oil is rarely not political, and with gasoline prices hitting record levels early in a presidential election year, we shouldn't be surprised that both the President and his challengers have focused on energy policy. President Obama gave what was billed as a major speech on energy at the University of Miami in Florida yesterday. After urging more students to study engineering--a sentiment I would strongly second--he laid out his view of the situation and its solutions. He got a lot right, including the long-term nature of the problem and the value of improving the efficiency of our vehicle fleet. But unfortunately, he also missed the mark in many ways and generally reflected the exaggerated fatalism that his administration has consistently exhibited towards oil prices. Boosting domestic supply is not the only answer, but it could be far more effective in moderating high oil prices and their impact on the economy than the President admitted.

To see why requires a sense of how the oil market works, as well as the uses to which we put oil today, rather than a generation ago. For starters, although the President has worked hard to improve conditions for renewable energy sources like wind and solar power--sources that certainly have an important role to play in our long-term energy mix--these technologies, along with nuclear power, are out of place in a conversation about oil prices in 2012. That's because they produce electricity rather than liquid fuels, and less than 1% of US electricity is generated from oil today, compared to more than 10% in 1980. Electricity from renewable and nuclear power doesn't compete with imported oil or any other kind of oil; it competes with domestic energy sources like coal and natural gas, most of which now comes from conventional and unconventional gas fields, rather than as a byproduct of producing oil. So by all means lets have a conversation about renewables in the context of reducing greenhouse gas emissions today and displacing oil from transportation when there are tens of millions of electric vehicles on the road in the future, but in terms of oil prices now and in the near future, they are a rhetorical diversion.

Fuel efficiency and plain old conservation can play an important role in reducing both our exposure to higher oil prices and in contributing to lower prices, because both attack demand directly, and demand is a big factor in oil prices. The President is right to emphasize this. Americans have cut back on oil consumption to the tune of 1.8 million barrels per day since 2007, and this was a significant factor in the oil price collapse in late 2008 and the generally lower prices we've enjoyed since then. Unfortunately, that happened largely as a result of the recession and financial crisis, rather than a sudden spike in fuel efficiency. If Americans buy the new, more efficient cars that Detroit must make under the administration's stricter Corporate Average Fuel Economy standards, then over the next decades the efficiency of the US car fleet will improve significantly, and even after rebound effects our oil demand and need for imported oil should fall. But let's not delude ourselves that this can happen overnight. There are roughly 250 million cars, SUVs and light trucks on the road in the US today, and even at pre-recession sales levels it will take more than a decade to turn over enough of them to make a serious dent in oil consumption.

President Obama made only a passing reference to biofuels in his speech, and for good reason. At current production levels ethanol displaces up to 600,000 bbl/day of petroleum gasoline, after adjusting for its lower energy content. That's good, but we've essentially played that card already and can't play it again. Almost all the gasoline sold in the US today contains 10% ethanol, the maximum level that most cars can tolerate without damaging their fuel systems or voiding their warranties. There's little appetite among consumers for the 85% ethanol E85 blend that flexible fuel vehicles can use, and there's even less appetite among fuel distributors for the 15% ethanol blend that the EPA blessed in 2010. With ethanol maxed out for now, our focus must shift to biofuels that are much more compatible with gasoline and diesel fuel, and that rely on technologies that haven't yet been demonstrated at commercial scale or competitive cost.

And that brings us back to the potential for reducing our dependence on oil imports and moderating oil prices by producing more domestic oil. Now, it's certainly true that US oil production and consumption are only part of a much larger global oil market, where prices are actually set. The US couldn't control the global price of oil, as it once did, even if we imported virtually no oil from outside North America. However, it's simply not correct to gauge the potential impact of an extra million bbl/day of US production--a figure that is well within the range of what a more aggressive domestic drilling program could deliver--by comparing it to the entire global output of nearly 90 million bbl/day. As with other commodities like grain and coffee, the price of oil is determined by relatively small changes in supply, demand, inventories, and in the case of oil, spare capacity. What really counts is the last few million barrels per day that are traded, whether inventories are rising or falling, and how large global spare capacity is and who owns it. The last three times that oil prices collapsed, in the mid-1980s, late-1990s, and 2008, it happened as a result of net changes in these parameters amounting to less than about 3 million bbl/day.

Yesterday the President cited statistics indicating that US oil production has returned to levels we hadn't seen for several years. That's true, and it's equally true that this modest surge of about 14% is the result of factors over which his administration had no control: oil prices and federal policies in the previous administration and the application of improved drilling technologies in the deepwater Gulf of Mexico and onshore locations like North Dakota's Bakken formation and the Eagle Ford shale of Texas. Moreover, it's only technically accurate to state that he has "opened millions of acres for oil and gas exploration", when the lease sales in question were originally scheduled to have taken place earlier, and were to have encompassed much more acreage, including offshore acreage that has been off limits for decades, such as offshore Virginia. The Deepwater Horizon accident certainly changed the context for the President's previous drilling plans, but his administration's responsibility for the subsequent decline in offshore production, the slower pace of development and tighter geographic constraints on where the industry can look for oil since then must be acknowledged in this discussion.

Then there's that other shibboleth of oil prices, speculation, which was also mentioned yesterday. As I've discussed previously, there are times when speculation can increase some oil prices, at least for a brief period. However, it's worth recalling that for every trader buying futures contracts or options in hopes they will go even higher, some seller must take the position that current prices are high enough and likely to be lower, later. This adds a froth of sentiment to the market, but it can't sustain prices for long if fundamentals aren't supportive and if the physical market doesn't follow. So while politicians see a $10/bbl rise this month in the price of West Texas Intermediate on the futures market as a symptom of speculation, they tend to ignore data like the much larger recent increase in the spot price for Louisiana Light Sweet crude, for which someone must take physical delivery at St. James, Louisiana, rather than just offsetting against another "paper barrel". When you look at physical oil inventories, there's no evidence that speculators are taking delivery of large quantities of oil and storing it so refiners can't buy it.

The key factors driving the recent increase in oil prices are tensions with Iran and the fact that, with production off-line in places like Sudan and still not back to pre-revolution levels in Libya, OPEC's effective spare capacity is below 3 million bbl/day, not much above the level that contributed greatly to oil's near-$150 peak in mid-2008. So despite relatively weak demand growth, the market looks tight now, with the prospect of Iran cutting off sales--or being embargoed via sanctions from buyers--by a volume that would erode that cushion of spare capacity in Saudi Arabia and a few other Persian Gulf producers even further--capacity that mostly sits inside the Strait of Hormuz.

So what levers does this President--or any President--really have with which to try to moderate oil prices over the next few years? It's clearly not renewable energy policy at this point. It could include foreign policy, particularly if you agree with the view of Washington Post columnist David Ignatius that Iran has displayed a clear pattern of backing down in the face of "overwhelming force". Resolving the Iranian threat to Gulf shipping and setting the outlines of a solution to Iran's nuclear program could take $20/bbl off the price of oil in fairly short order, though I wouldn't suggest that looks easy. Yet even though a decision to expand access to US oil resources significantly, along the lines of the President's pre-Deepwater Horizon plan, would not deliver new production quickly, it's wrong to be dismissive about the impact of more drilling on prices or in mitigating the impact of those prices on the economy. And in the case of onshore opportunities for which infrastructure is already in place or in the works--and here I would include the Keystone XL pipeline--it need not take 10 years for the first barrels to reach market. Together with a strong, technology-neutral effort on fuel economy, a new, more expansive approach to exploiting domestic resources would affect the back end of the futures price curve, and that could start to nudge down nearer-term prices, as well. Even if I'm wrong about that, it's still the case that at current prices every additional 1,000 bbl/day we produce here would reduce our trade deficit and the drag on our economy by about $40 million--and there are a lot more thousands of barrels per day we could be producing.

At least one of the President's potential challengers has described a plan for getting gas prices back to $2.50 per gallon. Perhaps this had something to do with President Obama's choice of topic yesterday. I will devote a lot more time to analyzing such proposals once the Republicans have chosen their nominee. However, it's worth noting that as outlandish as $2.50/gal. sounds when the average price of unleaded regular has jumped to $3.59/gal. this week, it works out to an effective crude price of around $70/bbl, after subtracting state and federal taxes and refiner and dealer margins. That's roughly what oil cost in 2006 and 2007 and more than in 2009. It's also a higher price than most oil industry experts even imagined would be possible just a few years earlier.

I don't know if Mr. Gingrich's plan would work, and I suspect that the economics of at least some of the new production necessary to force OPEC to compete on price again, rather than managing the price to suit their own needs, might be challenging at $70/bbl. Yet I'd be much more inclined for us to work towards such a goal than to dismiss it as impossible or irrelevant and fatalistically accept the consequences of $100+ oil for another decade or more. The President should at least be as open to these possibilities as he is to the possibilities of renewable energy for reducing emissions.

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