Thursday, December 01, 2016

Some Thoughts on the OPEC Deal

From one perspective, the agreement struck by OPEC's members in Vienna yesterday marks the cartel's return to the business of managing the oil market, after a two-year experiment with the free market. Viewed another way, however, it represents what Bloomberg's Liam Denning termed a "capitulation of sorts"--an admission of defeat in the price war that OPEC effectively declared in late 2014. Yet while more than a few bottles of champagne were likely consumed around the US oil patch last night, this doesn't necessarily mean a return to the way things were just a few years ago, when oil prices seemed to cycle between high and higher.

We should look carefully to assess the real results of OPEC's attempt to squeeze higher-cost producers out of the market. On that criterion it was successful: hundreds of billions of dollars in oil exploration and production projects have been canceled or deferred, mainly by Western oil companies and other non-OPEC producers. If this was the 1990s, and oil still lacked viable competition, especially in transportation, and if demand could be relied on to continue growing steadily, the strategy OPEC has just ended would have set up many years of strong and rising prices for its members.

Yet OPEC miscalculated in at least two ways. First, as many experts have noted, it correctly identified US shale producers as the new marginal suppliers to the market but failed to anticipate how quickly these companies could respond to a dramatic price cut. Having squeezed their vendors and spread best drilling practices at warp speed, shale producers are now positioned to resume growing both output and profits as oil prices trend north of $50 per barrel--undermining the effect of OPEC's cuts as they go.

Its other miscalculation was in the capacity of the cartel's members--even some of the strongest--to endure the austerity that protracted low prices would bring. Although many of these countries have among the world's lowest-cost oil reserves to find and produce, it turned out that their effective cost structures, including transfers to their national budgets, were really no lower than those of the Western oil majors that have also struggled for the last two years.

A great deal of attention will now be focused on how OPEC implements its output cuts, and whether its non-OPEC partners like Russia live up to their end of the bargain. The history of OPEC deals suggests that is only prudent. However, a new factor is at work here that adds extra uncertainty to the outcome, even if OPEC miraculously achieved 100% compliance.

OPEC's formula for sustaining comfortably high (for them) oil prices has always relied on an economic paradox: They restrain their own, low-cost production and shift the marginal source of supply--the last barrel that sets the price--to make room for non-OPEC producers with much higher costs. That allows OPEC's members to collect outsize returns on their own production, what economists call "rent".

This time, though, at least until the looming gap in supply created by all that foregone investment in deepwater platforms and oil sands facilities starts to bite, the cost of the marginal barrel from shale won't be that much higher than OPEC's marginal cost. And all of this will be playing out in the context of historically high inventories. If that's not a recipe for volatility, I don't know what is.

Thursday, November 03, 2016

Energy and the 2016 Presidential Election

In less than a week, the most controversial and acrimonious presidential election in living memory will be over. Energy has largely been a second-tier issue in this contest, although the divergence in the candidates' views on this vital subject is stark. Fortunately, the energy consequences--planned and unintended--of the last two US presidential elections hold some useful lessons for considering the proposed energy policies of this year's two front-runners.

As we look back, please recall that for most of the 2008 campaign the average US price for unleaded regular gasoline was over $3.00 per gallon. Much of that summer it was at or above $4.00. Four years later, from Labor Day to Election Day of 2012, regular gasoline averaged $3.76 per gallon. The comparable figure for the last two months of the 2016 campaign is just under $2.25.

In 2008 energy independence was a hot issue. Then-Senator Obama ran on a platform that targeted reducing US oil imports by over 3 million barrels per day, mainly through improved fuel efficiency. In his view US oil resources were effectively tapped out--remember "3% of reserves and 25% of consumption"? The main role he envisioned for the US oil and gas industry was as a source of increased tax revenue. His primary focus was on reducing greenhouse gas emissions through large federal investments in green energy technology. He would soon deliver on that promise with the $31 billion renewable energy package included in the federal stimulus of 2009.

When he was running for reelection in 2012, President Obama had kinder words for conventional energy, particularly the large expansion of US natural gas supply due to shale gas. He even took credit for "boosting US domestic production of oil". That point provoked an extended argument in the second presidential debate that year. Importantly, when the President emphasized renewable energy, energy efficiency and emissions, it was within a broader framework of "all of the above" energy.

At the same time, following the failure of comprehensive energy and climate legislation in his first term, his administration has pursued major new regulations aimed at achieving its energy and environmental goals. However, some of the most sweeping of these, including the Clean Power Plan, have gotten hung up in the courts, while others have yet to be fully implemented.

In retrospect President Obama was lucky. The shale energy revolution wasn't on his radar in 2008 and received little or no help from his administration, but it has increased US energy production by more than 17%, net of coal's losses, since he took office. It has made a major dent in US oil imports and CO2 emissions.  In the process, it saved consumers hundreds of billions of dollars on their energy bills, reduced the US trade imbalance, generated large numbers of new jobs when it mattered most, and provided the primary means for reducing US greenhouse gas emissions to their lowest level since before Bill Clinton ran for President.

Meanwhile, the renewable energy revolution on which his 2008 campaign pinned most of its hopes is still a work in progress. The cost of non-hydro renewables, mainly wind and solar power, has fallen dramatically and their deployment has grown impressively, expanding by a combined 135% from 2008 to 2014, or 15% per year. Wind and solar power are reshaping US electricity markets and changing the economics of baseload power plants, including nuclear plants. However, these sources still generate just 8% of US electricity and accounted for less than 3% of total US energy production in 2015.

What can we learn from the experience of the last two presidential terms? We are certainly in the midst of a long-term transition from a high-carbon energy economy to one using lower-carbon fuels and low- or effectively zero-carbon electricity. However, the numbers tell us that with regard to implementation, if not technology, we are closer to the beginning of that transition than to its end. The next President can double renewables, and that would still leave us reliant on conventional energy and nuclear power for three-quarters of our electricity and 90% of our total energy needs.

Going from 3% of energy from new renewables to the levels needed to meet the emissions targets that the US took on at Paris last year represents an enormous technical and financial challenge. It won't happen without a healthy economy, supported by a diverse and flexible energy mix anchored by domestic oil and natural gas from public and private lands and waters.

Although the Obama administration has added numerous regulations affecting energy, it stopped short of derailing the shale revolution. As a result, it has benefited greatly from the increased flexibility and energy security shale is providing. President Obama adapted his approach to energy and came around to recognizing the need for an energy mix that balances new, green energy with the best conventional energy sources. That's the lens through which we should view the energy proposals of this year's candidates.

There's no question that Secretary Clinton would promote the continued growth of renewable energy and the wider application of energy efficiency. If anything, she seems to be even more focused on climate change and clean energy than Barrack Obama was in 2008. However, her campaign website portrays oil and gas mainly in negative terms, with a focus on cutting their consumption, along with the industry's tax benefits. While explicitly recognizing the role that increased US natural gas production has played in reducing emissions, her policies would directly target the primary source of that growth.

Shale gas now accounts for half of all US natural gas production, but Secretary Clinton is on record supporting much stricter regulations on "fracking", the common shorthand for the technological processes involved in producing oil and gas from shale: "By the time we get through all of my conditions, I do not think there will be many places in America where fracking will continue to take place,” she said in a March debate with Senator Sanders.  

Reversing the recent growth of natural gas production from shale would lead to higher emissions during the next four to eight years. With less gas available, natural gas prices would rise, and the remaining coal-fired power plants would ramp back up to fill the gap, even as renewables continued to expand. That is happening in Germany today as that country turns away from nuclear power. In the US, without the contribution from natural gas and nuclear power plants, another of which just shut down permanently, our climate goals would be out of reach.

Recently, Secretary Clinton was also cited as wanting to expand the current administration's moratorium on coal development from public lands to encompass oil and gas. As shown in the chart below, based on data from the US Energy Information Administration, this production is already trending downward, overall. Imposing a moratorium on oil and gas development on public lands would accelerate that contraction, without new wells to offset the decline from mature fields.

If implemented as described, Secretary Clinton's policy toward shale energy would have an even more pronounced effect on US energy supplies than restricting development on federal land. With oil prices low, shale oil production has already fallen by 1.2 million barrels per day since output peaked in May 2015. The drop would have been much steeper had US producers not been able to focus their greatly reduced drilling activity on their most productive prospects.

US oil imports are increasing in tandem with falling shale oil production and rising demand. We still have 260 million cars, trucks and buses that require mainly petroleum-based fuels, while electric vehicles make up a tiny fraction of the US vehicle fleet. If shale oil drilling were further curtailed by new regulations, the shortfall would be made up from non-US sources and imports would grow even faster. The party that stands to gain the most from that is OPEC.

From what I have seen and read, Secretary Clinton's proposed energy policy would undermine the all-of-the-above energy mix necessary to maintain US economic growth and energy security as we transition to cleaner energy sources. It is disconnected from the lessons of the last eight years and should not be implemented in its present form.

There is no doubt that Donald Trump views the shale revolution and the resources it has unlocked very differently from Secretary Clinton. It has been harder to gauge where he stands on other aspects of energy. During the primaries, Mr. Trump's energy policy lacked much detail, as I noted at the time. He has since largely remedied that, though many of the points raised on the energy page of his campaign's website seem mainly intended to counter Secretary Clinton's positions.

Mr. Trump's energy vision and goals are posted on his website, and he has made several speeches on the subject, focused mainly on expanding US oil and gas production and making the US a dominant global player in the markets for these commodities. His main theme is sweeping deregulation and reform, including revoking the current administration's executive orders and regulations affecting infrastructure projects, resource development, and the role of coal in power generation.

He endorses an all-of-the-above approach, but there's still little mention of renewables, efficiency or nuclear power. In any case his support for renewables is not linked to man-made climate change, which he disputes. He is also on record opposing US adherence to the Paris Climate Agreement.

How do Mr. Trump's ideas on energy square with the lessons of the last eight years? It seems clear he would rather swim with, rather than against the tide of the shale revolution. It's less clear how much additional activity that would stimulate in the near term if oil and gas prices remain low, even if regulations could be cut as he proposes. As for renewable energy, there doesn't seem to be enough information to assess where it fits into his version of "all of the above".

It's important to keep in mind that energy is not an end in itself. Stepping back from the details, and at the risk of grossly oversimplifying some complex and thorny issues, the key difference I see between the two candidates in this area is that Mrs. Clinton's energy policies seem designed mainly to serve environmental goals, while Mr. Trump's energy policies seem aimed at mainly economic goals.

In that sense, the choice here looks as binary as on many other issues this year. Just don't interpret that conclusion or my analysis above as an endorsement of either candidate.

Tuesday, October 11, 2016

Is the US Really Energy Independent?

Toward the end of Sunday night's presidential debate I was startled to hear Secretary Clinton reply to an audience question by stating, "We are now for the first time ever energy-independent." If the price of oil were $100, rather than $50, that might have constituted a "Free Poland" moment, recalling President Ford's famous gaffe in a 1976 debate.

This point is likely to get lost in the dueling fact-checking of both candidates' numerous claims, but while the overall US energy deficit has fallen from about a quarter of total consumption (net of exports) in 2008 to just 11% in 2015, we still import 8 million barrels per day of oil from other countries. That includes over 3 million barrels per day from OPEC, a figure that has been growing again as US oil and gas drilling slowed following the collapse of oil prices in late 2104.

Oil has always been at the heart of our notions of energy security and energy independence, because it is our most geopolitically sensitive energy source and the one for which it is hardest to devise large-scale substitutes. So although the US is certainly in a better overall position than it has been in decades, with progress on multiple aspects of energy, it is not yet energy independent, especially where it counts the most.

Moreover, the policies that Mrs. Clinton has proposed would, at least initially, be likely to expand that gap by imposing additional restrictions on hydraulic fracturing, or "fracking." Mr. Trump, for his part, seemed to devote much of his response to Mr. Bone's debate question  talking about coal, which while still a significant player in electricity production has become largely irrelevant to the topic of energy independence, because its use is being displaced by other domestic energy sources, mainly natural gas and renewables like wind and solar power.

In fact, of the various contributors to the energy independence gains the US has made from 2008-15 (shown in blue in the above chart) the largest depend on fracking. Oil still makes up most of our remaining energy deficit, after help from a million barrels per day of ethanol--50% of the energy content of which comes from domestic natural gas. Electric vehicles also help, but the roughly 400,000 on the road in the US today displace the equivalent of only about 12,000 barrels per day of oil products, too small to be visible on the scale of this graph. As a result, continued fracking of shale and tight oil resources must be the linchpin of any realistic strategy to close the remaining US energy deficit within the next decade or so.

I understand that Secretary Clinton's proposed energy policies put a higher priority on addressing climate change. However, she raised the issue of energy independence in the second debate, even though her proposals are unlikely to deliver it in the foreseeable future--or preserve our present, hard-won reduced dependence on foreign energy sources. Anyone who doubts that this is a pocketbook issue should recall where oil and gasoline prices were just three years ago, before US shale added over 4 million barrels per day to global oil supplies.

Thursday, September 29, 2016

OPEC Agrees to Agree

  • Yesterday's reported OPEC deal left many details unresolved, so oil prices remain under $50, at least for now.
  • Time has given OPEC greater leverage to make effective production cuts, and ample incentive to do so. Will that be enough to close the deal come November?
Yesterday's news that OPEC's members have agreed on the outlines of a deal to reduce output is a fine reason to end my long, unplanned hiatus between blog posts. This morning's news commentary seems focused mainly on the difficulties OPEC faces in sorting out the details by its next official meeting at the end of November. Fair enough, but we shouldn't miss the fact that what came out of the informal meeting in Algiers is qualitatively different from anything OPEC has announced since their meeting in October 2014, which pushed the oil price collapse into high gear.

It's worth taking a moment to review how we got to this point. After oil prices recovered from their last big dive during the financial crisis of 2008-9, the global oil market--best represented during this period by the price of UK Brent crude--settled into a range of roughly $70-90 per barrel. The events of the "Arab Spring" in 2011, including the revolution in Libya, pushed prices well over $100, where they remained until fall 2014.

By early 2010 US shale, or more accurately "tight oil", production was beginning to ramp up. Total US crude oil output (excluding gas liquids) had fallen steadily from 9 million barrels per day (MBD) in 1985 to a plateau around 5 MBD in the mid-to-late 2000s. Most experts thought we would be lucky if it stayed that high in the long term. So the 4 MBD of production from tight oil that came onstream by late 2014, pushing total US production back to 9 MBD, was largely unexpected.

The market impact of the first couple of million barrels per day from US shale was muted by events in the Middle East. In addition to the ongoing instability from the Arab Spring, tighter sanctions on Iran had taken another million-plus barrels per day out of exports. Prices remained high, providing a strong incentive for more tight oil drilling, which from 2013 to 2015 yielded the biggest increase in the history of US oil production.

In thinking about what OPEC might achieve with the modest cuts they are apparently discussing, it's crucial to understand that while US tight oil at its peak in 2015 was no more than 5% of the global oil market, it had a massive effect on prices, because the price of oil is set by the last barrels in or out of the market. Inventories matter, too, but less from the standpoint of their absolute levels, than how fast they are growing or shrinking.

Simply put, the unanticipated growth of US shale swamped the market but is now an established part of supply. In late 2014 OPEC's members likely concluded that, given the upward path shale was then on, they couldn't cut their output by enough to keep prices high without simply making more room for shale, so they were better off keeping things uncomfortable for the competition by standing pat. In fact, they doubled down on that by increasing output after October 2014, mainly from Saudi Arabia and other Persian Gulf producers.

Two years of low oil prices have changed the landscape in ways that I doubt OPEC's members expected. US shale contracted but didn't die. If anything, the efficiencies that shale producers found have made many of them competitive at current prices and big beneficiaries of any future price increase. The latest rig counts from Baker Hughes show a small but steady increase in drilling activity over the last several months. However, what has collapsed with little indication of revival is investment in large-scale, non-shale oil projects from non-OPEC countries.

According to analysis from Wood Mackenzie, global oil investment--actual and planned--is down by over $1 trillion for the period 2015-20. Because of the development time lag for big oil projects, that means that a potentially serious supply gap is being created a few years down the road. Remember that non-OPEC, non-shale production makes up over half of global oil output. French oil company Total has estimated the potential shortfall at 5-10 MBD by 2020, or 5-10% of global supply.

This outcome is a mixed bag for OPEC. To whatever extent its decision to increase, rather than cut output in late 2014 was a "war on shale", that has failed at the cost of many hundreds of billions of dollars of foregone revenue. The collateral damage to the global industry, particularly in places like the North Sea, has been dramatic, even if it won't become obvious until the pipeline of projects started in the $100 years dries up sometime soon. OPEC will surely be blamed for any future price spike, but the likelihood that any cut they make now would be back-filled by non-OPEC production is much less than it was in 2014 or '15.

OPEC faces a conundrum. The market remains over-supplied in the near term, and inventories are at historic levels. Failing to reach agreement in November would not greatly hamper US shale. However, it would prolong their own pain and continue to enlarge the potential supply gap and price spike that is being stored up for an uncertain future that now also includes electric vehicles and possible carbon taxes, the incentive for both of which will expand significantly if oil prices spike again.

What's a cartel to do? We will see much speculation about that during the next two months. My guess is that the need to shore up the national budgets of OPEC's member countries, which are going deeper into debt by the day, along with a desire to avoid a price spike that would merely hasten the transition to non-hyrocarbon energy, will lead to an agreement in November to make at least cosmetic cuts in production. Stay tuned.

Thursday, July 28, 2016

Don't Book Your Solar-Powered Flight Yet

  • An around-the-world flight by a solar-powered airplane is a remarkable achievement, but it does not signal that solar passenger planes are the next big thing.
  • Compared to other options, solar's low energy density makes it an especially challenging pathway for pursuing large cuts in the emissions from aircraft.
Earlier this week the pioneering solar-powered airplane, Solar Impulse 2, completed its record-setting circumnavigation of the Earth, returning to Abu Dhabi. Just a few hours earlier, the US Environmental Protection Agency announced its intention to regulate greenhouse gas emissions from aircraft engines under the Clean Air Act. Over the last dozen years I have written numerous posts linking stories like these together, but this is one case in which I sincerely hope these events were entirely unrelated. That requires a bit of explanation.

Let's start by acknowledging the engineering talent and sheer courage involved in the flight of the Solar Impulse 2 (Si2). The aircrew and designers deserve all the kudos they will receive; they have earned a place in aviation history. However, notwithstanding the prediction of pilot Bertrand Piccard that, "within 10 years, electric aircraft could be carrying up to 50 passengers on short to medium-haul flights," I am skeptical that this project will be the forerunner of solar-powered commercial flight in the way that Charles Lindbergh's transatlantic flight in 1927 led to the first non-stop commercial flight across the Atlantic in 1938.

There's no anti-solar bias involved in that statement, just an appreciation of the constraints that physics and geometry (e.g., the "square-cube law") impose on the amount of solar energy an aircraft can harvest during flight with anything like current technology. Energy density is an essential factor in the economics of commercial air travel.

According to the website for the Si2, the aircraft is approximately "the size of a 747 with the weight of a car." That should be our first hint that scaling up to the performance and capacity of today's jets would be an even bigger challenge than the one these folks have just completed. During the course of its journey, which entailed over 500 hours of flight spread across 17 months, the Si2 collected and consumed electrical energy equivalent to a little over 300 gallons of kerosene-based jet fuel. By comparison, a Boeing 777, which is capable of carrying up to 400 people, burns an average of around 2,000 gallons of jet fuel per hour.

If you covered a 777's wings with the same 22%-efficient SunPower solar cells used by the Si2, they would generate the fuel-equivalent of less than 3 gallons per hour at noon on a cloudless day. Even allowing for the higher efficiency of electric motors compared to gas turbines, that is still orders of magnitude less than the energy necessary to push a fully-loaded jetliner through the sky at 550 miles per hour. (The Si2 averaged 47 mph.)

As the Financial Times reported, the near-term applications of solar-powered flight are likely limited to surveillance drones and other specialized platforms for which long-range fuel-free flight confers a big advantage. I could also envision lightweight, high-efficiency solar cells being used on next-generation commercial aircraft to provide auxiliary (non-motive) power, saving both fuel and emissions.

That brings me back to the EPA. The agency's stated rationale for targeting aircraft engines now is that they expect these emissions to increase in the future, and that reductions would lead to climate and health benefits. There's no mention of solar-powered aircraft, and I must trust that had nothing to do with their announcement.

The EPA's latest greenhouse gas inventory reported that in 2014 commercial and other aircraft accounted for 8% of US transportation-related emissions, and about 2% of all US emissions of CO2 and other greenhouse gases. It also showed that aviation emissions have fallen 22% since 2005.

Perhaps the growth they are worried about is proportional, rather than absolute, as emissions from electricity generation and other sources decline faster. However, compared to cars and light trucks that account for over 60% of emissions from transportation, and for which many emission-reduction options are available, aviation is a small and rather challenging focus for further reductions.  Those will likely rely on advanced biofuels, along with additional gains in turbine efficiency and airframe weight reduction. 

The website for Solar Impulse 2 acknowledges that its flight was intended to highlight the earth-bound applications of renewable energy: "Behind Solar Impulse’s achievements, there is always the same goal: show that if an airplane can fly several days and nights in a row with no fuel, then clean technologies can be used on the ground to reduce our energy consumption, and create profit and jobs." Solar-powered air travel for the masses seems pretty far off, and certainly not something we can count on for cutting our emissions

Friday, July 01, 2016

EVs and The Service Station of the Future

Tesla Motors is apparently in talks with Sheetz, Inc. to install electric vehicle (EV) Superchargers in the latter's chain of gas stations. This caught my eye, because I was involved in a much earlier effort to install EV recharging facilities in service stations in the late 1990s. It wasn't just ahead of its time; it was stymied by some of the same economic challenges noted in the Washington Post article, as well as physical and regulatory issues that weren't mentioned.

The logic of an alliance between Tesla and gasoline retailers like Sheetz seems sound. Tesla embarked on its strategy to build a network of quick-rechargers in order to sell more cars. Its Superchargers are likely to be more effective in that role if they're installed in places that are both convenient to highways and offer a variety of other amenities for drivers, while they wait 15 minutes or more to top up their car's range. High-volume fuel retailers like Sheetz have already optimized their sites for convenience of location, and they have a wider range of food and beverage choices than the average gas station.

They also provide another essential feature: space. When Texaco was evaluating adding rechargers for GM's ground-breaking EV1 electric car to its Southern California retail network nearly 20 years ago, the fire marshals with whom we met insisted that high-voltage electricity and pumps dispensing volatile fuels like gasoline could not share the same pump island. They had to be widely separated for safety, and few of our L.A. locations had large enough footprints for that. Sheetz, by contrast, typically has large stations--many in rural or suburban locations--that could accommodate EV charging without endangering customers filling up with gas or diesel.

Another obstacle I encountered at Texaco was that EV rechargers are expensive, while electricity is cheap. Even if you're allowed to charge customers for it--we weren't, for regulatory reasons--it takes a lot of usage to pay back the substantial investment in equipment and installation. With EV sales still occupying a small niche in the market, that calculation hasn't changed much in the intervening decades. However, Tesla's primary motivation isn't to make money selling electricity, but to generate profits and support its stock price by selling more premium EVs. I would hate to see the standalone P&L for Tesla's growing Supercharger network, but that's beside the point.

This resolves a major hurdle for Sheetz and other fuel retailers that might want to add EV recharging to expand their customer base, or "green up" their image to enhance the loyalty of current customers, especially among Millennials. The profitability of such an investment would still be questionable, even if they sold EV owners lots of premium coffee and snacks while they wait. But if someone else is footing most of the bill for the added hardware, the extra revenue in the convenience store is all upside.

The service station of the future has been slower arriving than my colleagues and I envisioned when we developed Texaco's first global scenarios for the future of energy nearly twenty years ago. Sales of EVs and cars running on hydrogen have not grown as fast as we expected, while the improving performance of gasoline cars has raised the bar for alternative vehicles. However, current trends suggest that our vision of facilities offering a diverse mix of transportation energy was more premature than wrong. I will be very interested to see how Tesla and Sheetz or others move ahead with this idea.

Tuesday, June 21, 2016

Another Step Backward for Nuclear and the Environment

I don't normally do breaking news, but today's announcement by PG&E and a coalition of environmental groups on retiring the Diablo Canyon nuclear power plant in California within 8-9 years merits immediate comment.

Given the enormous social and political challenges PG&E faced in undertaking the re-licensing of the facility when its current operating licenses expire in 2024 and 2025, this action is understandable, though regrettable. I lived in California when Diablo Canyon was planned and built. It was sufficiently controversial in the 1970s, and the environment has only become more contentious. Extending the operating licenses of nuclear power plants to 60 years has become typical elsewhere, but the utility's board must have concluded that it was a non-starter in today's California.

However, we should not be misled by press-release language about replacing "power produced by two nuclear reactors...with a cost-effective, greenhouse gas free portfolio of energy efficiency, renewables and energy storage." Under California's extremely aggressive renewable energy and storage targets, the alternative energy mentioned here was coming, anyway, but it was intended to replace higher-emitting sources like out-of-state coal and in-state natural gas generation. Until there is an overall surplus of zero-emission energy--when?--the energy mix is a zero sum game.

This agreement--perhaps the best deal possible under the circumstances--thus represents the net loss of 18 billion kilowatt-hours (kWh) per year of zero-emission electricity. That's equivalent to 9% of all utility-scale electricity generated in California last year. The state went through a similar event in 2013 with the permanent shutdown of the San Onofre Nuclear Generation Station between L.A. and San Diego. As I noted at the time:

How much emissions will increase following the shutdown depends on the type of generation that replaces these units. If it all came from renewable sources like wind and solar, emissions wouldn’t go up at all, but that’s impractical for several reasons. Start with the inherent intermittency of these renewables, and then compound the challenge by its scale. Even in sunny California, replacing the annual energy contribution of the SONGS units would require around 7,200 MW of solar generating capacity, equivalent to nearly 2 million 4-kilowatt rooftop photovoltaic (PV) arrays. That’s over and above the state’s ambitious “Million Solar Roofs” target, which was already factored into the state’s emission-reduction plans.

Grid managers from the state’s Independent System Operator indicated that in the near term much of the replacement power for SONGS will be generated from natural gas. Even if it matched the mix of 71% gas and 29% renewables added from June 2012 to April 2013, based on “net qualifying capacity”, each megawatt-hour (MWh) of replacement power would emit at least 560 lb. more CO2 than from SONGS. That’s an extra 4 million metric tons of CO2 per year, or 8% of California’s 2010 emissions from its electric power sector and almost 1% of total state emissions. If gas filled the entire gap, or if the natural gas capacity used was not all high-efficiency combined cycle plants, the figure would be closer to 6 million metric tons, equivalent to the annual emissions from about 1.5 million cars.

So far, the state's environmental data supports this conclusion. Although offset by larger imports of low-emission power from out-of-state, there was a noticeable uptick in greenhouse gas emissions from in-state generation from 2013 to 2014. (See Figure 8 in the 2016 California GHG Inventory.) 

California will get more renewables either way, but shutting down Diablo Canyon when it still has decades of useful life left represents a net loss to California consumers, PG&E shareholders, and to the global environment. 

Thursday, June 16, 2016

Could the Hydrogen Economy Run on Ethanol?

  • Plans for a fuel cell car running on ethanol look like a clever way to circumvent the obstacles faced by other fuel cell vehicles.
  • However, it is not clear that ethanol's perceived logistical benefits or emissions profile would give Nissan an edge in the competitive market for green cars.

Japan's Nissan Motor Co., Ltd. made headlines this week when it announced plans to produce a fuel-cell car that would run on ethanol, instead of hard-to-find hydrogen. As reported by Scientific American, the company expects to commercialize this approach by 2020, even though competitors like Toyota already have fuel cell cars in their showrooms. It's an interesting choice. Ethanol seems to offer logistical advantages over hydrogen, but the technical challenges involved aren't trivial, nor is ethanol without drawbacks from an energy or environmental perspective.

Fuel cells have long promised a different and potentially superior path to electrifying automobiles, compared to battery-electric vehicles (EVs) with their limited range and relatively long recharging times. One of the biggest obstacles has always been the lack of infrastructure and supply--hydrogen must first be liberated from water, methane or other compounds--and the problems of storing sufficient quantities of it on board. I've driven prototype fuel-cell vehicles (FCVs) and found the experience pretty similar to driving a regular car, as long as you have a hydrogen filling station handy.

Nissan makes the case that ethanol (chemical formula C2H6O) is much easier to source and distribute than gaseous hydrogen, and the process for making it give up its hydrogen is routine, at least under laboratory conditions. However, as the alternative energy research subsidiary of my former employer, Texaco Inc., found in pursuing a similar concept with gasoline, it's one thing to do this in a bench-scale device and quite another to do it in a size and shape that will fit easily and safely in a car and run as reliably as an internal combustion engine. I suspect Nissan's engineers have their work cut out for them for the next four years.

The bigger questions about this approach are more basic: Does it make sense from an economic, energy and environmental perspective, and can it find a large enough market? Consumers already have a wide range of green alternatives from which to choose, ranging from Prius-type hybrids (gasoline only), plug-in hybrids (gasoline + electricity) and battery EVs, not to mention the continuous improvement of non-electric cars. 

Nissan didn't include many numbers in the documents accompanying its press release, but the chemistry and math involved are pretty simple. At 100% efficiency, a gallon of ethanol could produce just under 0.8 kilograms (Kg) of hydrogen (H2) using the standard steam-reforming process. The best efficiency I could find for this ethanol-to-hydrogen conversion  was around 90%, so in the real world that gallon of ethanol would yield around 0.7 Kg of H2--enough to take Toyota's Mirai FCV about 46 miles. That's pretty good, considering that same gallon in a Chrysler 200 equipped as a flexible fuel vehicle (FFV) would drive an average of just 21 miles. Fuel cells are much more efficient than internal combustion engines.

The economics of operation don't look bad, either. If we use today's average US price for E85 (85% ethanol + 15% gasoline) of $1.87/gal. as a proxy for an ethanol retail price, that equates to around 4 ¢/mile, using the Mirai's published fuel economy data. That's about 15% cheaper than a Prius on regular gasoline at this week's US average of $2.40/gal., but it's also around 10% more expensive than a Nissan Leaf using off-peak electricity in northern California.

Emissions are trickier to assess. There's a lively and growing controversy about whether biofuels produced from crops can truly be considered carbon-neutral, even in places like Brazil where the yields from sugar cane are so high. There's much less controversy that the production of most US ethanol from corn is anything but a net-zero-emission endeavor. Corn requires fertilizer sourced from natural gas, and ethanol refineries consume gas (or coal) and electricity in their production process. In any case, when Nissan characterizes their planned ethanol FCV as having "nearly no CO2 increase whatsoever", they are either oversimplifying a very complex discussion or taking a large leap of faith. 

We can count the CO2 coming out of the tailpipe of such a car, and it would need a tailpipe because the onboard ethanol converter would emit about 12.5 lb. of CO2 for every gallon of ethanol converted to pure H2, plus some CO2 from the ethanol burned to heat the unit. My back-of-the envelope calculation gives a figure of 135 grams of COper mile, or 20% lower than a Toyota Prius on gasoline. It would not be a Zero Emission Vehicle (ZEV), though of course an EV running on average grid electricity isn't really a ZEV, either, except in isolated regions or at specific times of day.

Even if there aren't any deal-killers here, I'm skeptical about Nissan's fundamental assumption that the ethanol infrastructure for their FCV would be that much easier to develop than the H2 infrastructure other FCVs require. That's because of the cost and ownership structure of the retail fuels business, which as I've argued previously helps explain why your corner gas station is unlikely to sell E15 (85% gasoline, 15% ethanol) any time soon, despite the EPA having approved it for newer cars

At least in the US, most gas stations are owned by small businesses, not by the oil companies whose brands they display. Margins are slim, and these folks don't have deep pockets, so adding a new fuel like pure ethanol or the ethanol-water mix that Nissan suggests, poses a difficult business decision: Do you take over an existing tank and stop selling diesel fuel, or premium gasoline with its high margins? Or do you rip up the forecourt to add a new tank, which entails being out of business for months--or even longer if you discover that one of your existing tanks is leaking? Either way, the investment costs and disruption to current customers are significant, in exchange for selling what at first would certainly be a low-volume product. When I was in the fuels supply & distribution business, we would have called that kind of decision a "no-brainer."

If Nissan can't encourage enough service stations to add ethanol or an ethanol/water blend--E85 would not work--to their product mix, do they start their own service station network? That seems unlikely. And if you buy one of these cars in a few years, should you carry a case of vodka in the trunk as an emergency range-extender? That's only half-facetious.  

I give Nissan credit for pursuing a novel option for making fuel cell cars more viable, as an alternative to today's range-limited EVs. Ethanol looks like a cost-competitive source of hydrogen, and it is at least easier to store than H2 gas or liquid H2. However, they face practical and marketing challenges that might well offset most of the advantages the company claims to see. The ethanol FCV could encounter the same chicken-and-egg dynamic as FCVs running on hydrogen, or indeed any new model requiring a fuel that is not distributed at scale today. It will be interesting to watch their progress.

Thursday, May 26, 2016

On Track for a Golden Age of Gas?

  • The global energy industry must overcome significant new challenges if natural gas development is to achieve the vision of a Golden Age of Gas.
  • Low energy prices and reduced investment are only half the battle as regulations complexify and organized opposition grows. 

Five years ago the International Energy Agency (IEA) issued a report entitled, "Are We Entering a Golden Age of Gas?" Gas development was booming, from both conventional resources and US shale deposits, and gas was widely seen as a vital tool for reducing greenhouse gas emissions. Much has happened since then, including a collapse in global oil prices, the signing of a new climate agreement in Paris, and a broadening of the anti-fossil-fuel focus of climate activists. If we're still on the path to a golden age of gas, the ride will be bumpy.

This is probably most evident across the pond, where Nick Butler, the Financial Times' respected energy analyst, observed this week, "Unless something changes radically, Europe has passed the point of peak gas consumption." He cited Germany's ongoing "Energiewende" (energy transition) which in order to maximize wind and solar and minimize nuclear power, ends up squeezing gas out between renewables and much higher-emitting coal.

Earlier this month France's Energy Minister announced she was pursuing a ban on imports of US shale gas--effectively any gas from the US--since France already bans domestic fracking. That strikes me as a textbook example of having to keep making bad decisions to be consistent with the first one, but it's their sovereign choice.

As the IEA defined it at the time, this Golden Age would entail faster growth in gas demand in every major sector, compared to the agency's main "New Policies" scenario in its then-current annual World Energy Outlook (WEO). They anticipated compound average growth of 1.8% per year, much faster than oil or coal, with gas consumption ending up 13% higher than the WEO's projection for 2035. That's like adding an extra Russia or Middle East to world gas demand within 20 years.

One gauge of whether that still seems realistic can be found in the US Energy Information Administration's (EIA) just-released 2016 International Energy Outlook. The EIA's long-term forecast actually has gas consumption growing slightly faster than IEA's Golden Age track in the developed countries of the OECD between now and 2035, but with a slower ramp-up to essentially the same end-point in the non-OECD countries.

Of course one forecast can't really validate another, so let's consider how some of the big uncertainties that the IEA identified in the 2011 report have shifted, starting with energy pricing. After oil's recent rebound, oil and gas have fallen by around half their 2011 US prices. That makes investments in oil and gas exploration and production considerably less attractive. Nearly $400 billion of projects have been canceled or deferred, globally, setting up slower growth in production from both gas fields and oil fields with associated gas in the near-to-medium term. This deceleration is evident in EIA's latest monthly Drilling Productivity Report for US shale.

With the contract price of liquefied natural gas (LNG) often tied to oil prices or competing with pipeline gas that has also fallen in price, large gas infrastructure projects like LNG plants look less attractive, too. We've already seen cancellations of new facilities in Australia and Canada. Fewer LNG export facilities are likely to be built in the US than previously planned. All this means less new gas reaching markets where it can be used.

Cheaper oil also reduces the attractiveness of gas as a transportation fuel. Although increasingly popular as a cleaner fuel for buses, natural gas hasn't made much headway in US passenger cars. However, this application has been growing in places like Italy and Iran, for different reasons.

Viewed in isolation, these price-related responses seem likelier to delay, rather than derail the expectations the IEA set out in 2011. The bigger challenges come from a set of issues the IEA identified a year later, in a follow-up report called "Golden Rules for a Golden Age of Gas." As Dr. Birol, now the Executive Director of IEA, indicated then, these boil down to the industry's "social license to operate."

Transparency, water consumption, emissions including methane leaks--all on IEA's list--are some of the key issues over which companies, regulators, NGOs and activists are sparring today. The UK is a prime example. Conventional energy production is declining rapidly and a large shale gas potential has been identified by the British Geological Survey, but every attempt to drill exploratory wells has encountered strong opposition.

A new factor the IEA did not anticipate is the emergence of political movements focused on fossil fuel divestiture and a "keep it in the ground" mantra. These may be based on unrealistic expectations of how quickly the world can transition to a zero-emission economy, but they illustrate the scale of a stakeholder engagement challenge the global oil and gas industry has so far failed to meet adequately. 

Just as social media are transforming politics, they are also altering the balance of power between organizations and their critics. The gaps that must be bridged if new gas development is to remain broadly acceptable to the public are growing in ways that will demand new approaches and new strategies to address. 

Considering the shifts in the global energy mix that will be necessary to reduce global emissions in line with the goals of last year's Paris Agreement, gas ought to have a future every bit as bright as the Golden Age the IEA described five years ago. Achieving that now likely depends less on the price of energy and the scale of available resource than on convincing regulators and the public that the trade-offs involved in obtaining its benefits are still reasonable.

Tuesday, May 10, 2016

A New Angle on Carbon Capture

In my last couple of posts I looked at the difficulty of meeting ambitious targets for cutting greenhouse gas emissions (GHG) without help from the lower-emitting portions of our current energy mix. Last week ExxonMobil announced that it is pursuing a new pathway for capturing carbon from power plant exhaust. That could help revive another important strategy for large-scale emissions reduction from our existing energy sources.

Carbon capture and sequestration (CCS) has fallen out of favor, lately, mainly due to the high cost and technical challenges of the early prototypes for large-scale implementation of the technology. Not only are the initial investment costs of today's CCS hardware still very high, but it is also inherently expensive to operate. That's because of the high energy consumption of the process, resulting in a "parasitic" load on the host power plant that reduces its net output by up to 20%, making the remaining output much more expensive. That creates a large deterrent in any market that doesn't provide either direct subsidies for carbon removal, or a high carbon tax or price for traded emissions offsets.

Another reason that CCS has received less attention recently is that the costs of renewable energy technologies like wind and solar power have kept falling. To some they now look cheap enough, especially with further cost improvements extrapolated, to enable us to reach our emissions goals mainly through wider deployment of solar modules and wind turbines.

Even if that were technically feasible, like most other energy industry experts I have met I am convinced that the deep emissions cuts desired for mid-century will require implementing or retro-fitting CCS onto the fleet of coal and gas-fired power plants that will likely still be in service decades from now. CCS underpins several of the emissions stabilization wedges pioneered by Princeton engineering professor Rob Socolow and his colleagues ten years ago.

What makes the approach that ExxonMobil and FuelCell Energy, Inc. have described so attractive is that, instead of being a drain on power generation, capturing CO2 via fuel cells would actually add significantly to a facility's reliable power output. It would increase revenue, rather than curtailing it.

The clever bit, and its potential advantage over current carbon-capture technology, is that CO2 capture in a carbonate fuel cell occurs as a byproduct of the power generation step. That means that it doesn't require a big, expensive, power-hungry process unit, the only function of which is to strip CO2 from flue gas and concentrate it for subsequent shipment and storage.

These fuel cells would still require natural gas for fuel, and they would produce CO2 emissions in the process of generating electricity, though at a lower rate than the coal or gas-fired plant with which they would be partnered. However, both their direct emissions and the CO2 extracted from the power plant exhaust would come out in a highly purified form suitable for geological sequestration and stay out of the atmosphere.

That brings up an important advantage of this approach over various schemes to capture CO2 directly from the atmosphere. Although the article on the Exxon/Fuel Cell Energy development in MIT Technology Review  described the CO2 concentration in power plant flue gas (5%-15%) as "low", that is still hundreds of times higher than its concentration in air.

400 parts per million of CO2 in the atmosphere may be worrying from a climate perspective, but it is still just 0.04% of air that remains mostly nitrogen and oxygen. And the lower the concentration, the harder--and normally more expensive--it is to extract. (Green plants can do this trick cheaply thanks to billions of years of evolution combined with cost-free sunlight.)

The press release makes it very clear that this new carbon-capture technology has so far only been demonstrated in the lab. Scaling it up will require additional work, and success is uncertain. Many other promising innovations, including a host of cellulosic biofuel technologies, have failed to scale. However, its potential applications are compelling enough to justify a lot of patience and persistence. I wish them luck.

Wednesday, April 20, 2016

Out of Reach Without Nuclear and Shale

  • US emissions reduction goals for 2025 could not be achieved without nuclear power and the fracking technology necessary to extract shale gas. 
  • Recent revisions by the EPA in its estimates of methane leaks from natural gas production and use do not negate the benefits of gas in reducing emissions.
In its lead editorial yesterday, the Washington Post took presidential candidate Bernie Sanders to task for his attacks on nuclear power and natural gas. The Post focused its critique on greenhouse gas emissions and the emissions trade-offs involved in substituting one form of energy for another. That speaks directly to one of the main reasons that Mr. Sanders' argument resonates with his supporters, but it ignores an even more basic problem. The energy contribution from shale and nuclear power is so large that if our goal is a reliable, low-emission energy mix that meets the future energy needs of the US economy, we simply cannot get there without them, at least not in any reasonable timeframe.

The pie chart below shows the current sources of US electricity in terms of the energy they generate, rather than their rated capacity. This is an important distinction, because the renewable electricity technologies that have been growing so rapidly--wind and solar--are variable and/or cyclical, generating only a fraction of their rated output over the course of any week, month, or year.

For example, replacing the output of a 2,000 megawatt (MW) nuclear power plant such as the Indian Point facility just north of New York City would require, not 2,000 MW of wind and solar power, but between 7,600 MW and 9,400 MW, based on the applicable capacity factors for such installations. Now scale that up to the whole country. With 99 nuclear reactors in operation, rated at a combined 98,700 MW, it would take at least 375,000 MW of new wind and solar power to displace them. As the Post's editorial points out, money spent replacing already zero-emission energy is money not spent replacing high-emitting sources.

At the rates at which wind and solar capacity were added last year, that build-out would require 24 years. That's in addition to the 36 years it would take to replace the current contribution of coal-fired power generation. It also ignores the fact that intermittent renewables require either expensive energy storage or fast-reacting backup generation to provide 24/7 reliability.

That brings us to natural gas, the main provider of back-up power for renewables, and the "fracking" (hydraulic fracturing) technology that accounts for half of US natural gas production. Fracking has transformed the US energy industry so dramatically that it is very hard to gauge the consequences of a national ban on it, even if such a policy could be enacted. Would natural gas production fall by a third to its level in 2005, when shale gas made up only around 5% of US supply, and would imports of LNG and pipeline gas from Canada ramp back up, correspondingly?

Or would production fall even farther? After all, one of the main factors behind the rapid growth of shale gas in the previous decade is that US conventional gas opportunities in places like the Gulf of Mexico were becoming scarcer and more expensive to develop than shale, which was higher-cost then than today. Either way, the constrained supply of affordable natural gas under a fracking ban would not support generating a third of US electricity from gas, vs. 20% in 2006. So we would either need even more renewables and storage--in addition to those displacing nuclear power--or, as Germany has found in pursuit of its phase-out of nuclear power, a substantial contribution from coal.

One of the primary reasons cited by Mr. Sanders and others for their opposition to shale gas, aside from overstated claims about water impacts, is the risk to the climate from associated methane leaks. Here he would seem to have some support from the US Environmental Protection Agency, which recently raised its estimates of methane leakage from natural gas systems.

Methane is a much more powerful greenhouse gas than carbon dioxide (CO2), so this is a source of serious concern. However, a detailed look at the updated EPA data does not support the contention of shale's critics that natural gas is ultimately as bad or worse for the climate than coal, a notion that has been strongly refuted by other studies.

The oil and gas industry has questioned the basis of the EPA's revisions, but for purposes of discussion let's assume that their new figures are more accurate than last year's EPA estimate, which showed US methane emissions from natural gas systems having fallen by 11% since 2005. On the new basis, the EPA estimates that in 2014 gas-related methane emissions were 20 million CO2-equivalent metric tons higher than their 2013 level on the old basis, for a year-on-year increase of more than 12%. This upward revision is nearly offset by the 15 million ton drop in methane emissions from coal mining since 2009, which was largely attributable to gas displacing coal in power generation.

In any case, the new data shows gas-related emissions essentially unchanged since 2005, despite the 44% increase in US natural gas production over that period. The key comparison is that the EPA's entire, updated estimate of methane emissions from natural gas in 2014, on a CO2-equivalent basis, is just 2.5% of total US greenhouse gas emission that year. In particular, it equates to less than half of the 360 million ton per year reduction in emissions from fossil fuel combustion in electric power generation since 2005--a reduction well over half of which the US Energy Information Administration attributed to the shift from gas to coal.

In other words, from the perspective of the greenhouse gas emissions of the entire US economy, our increased reliance on natural gas for power generation cannot be making matters worse, rather than better. That's a good thing, because as I've shown above, we simply can't install enough renewables, fast enough, to replace coal, nuclear power and shale gas at the same time.

What does all this tell us? Fundamentally, Mr. Sanders and others advocating that the US abandon both nuclear power and shale gas are mistaken or misinformed. We are many years away from being able to rely entirely on renewable energy sources and energy efficiency to run our economy. In the meantime, nuclear and shale are essential for the continuing decarbonization of US electricity, which is the linchpin of the plans behind the administration's pledge at last December's Paris Climate Conference to reduce US greenhouse gas emissions by 26-28% by 2025. That goal would be out of reach without them.

Thursday, April 14, 2016

Lessons from the Coal Bust

Yesterday's Chapter 11 filing by the largest US coal mining company is the latest in a series of coal bankruptcies. While factors such as regulations and poorly timed acquisitions have played a role, this trend reflects the parallel technology revolutions playing out across the energy sector. Here are a few key lessons from the ongoing coal bust:
  • There are many other ways to make electricity, and coal brings nothing unique to the party. In a growing number of markets it is no longer the cheapest form of generation, and it is certainly the one with the most environmental baggage, from source to combustion.
  • Coal-fired power generation is in competition with alternatives that are already producing at scale, like nuclear and natural gas generation, or growing rapidly from a smaller base, like renewables. It may not compete with all of these in every market, but few markets lack at least one of these challengers.
  • The costs of renewables and gas have fallen significantly in recent years, due to major technology gains. Coal has also benefited from some improvements in scale and end-use technology. Today's ultra supercritical coal plants are more efficient than coal plants of a generation ago, but they are more expensive to build, even without carbon capture (CCS). However, wind and solar power continue to grow cheaper and more efficient, while gas has benefited from resource-multiplying production technologies and advanced gas turbines that can exceed 60% efficiency and ramp up and down rapidly to accommodate the swings of intermittent renewables.
  • Despite all of these threats, coal is not on the verge of being forced out of power generation, even in developed countries where all the above factors are at work. Replacing its enormous contribution to primary energy supply and electricity generation will be a very heavy lift, particularly where another major energy source like nuclear power is being phased out. Germany is the prime example of that.
Consider what it would take to replace the remainder of coal in the US power sector. Last year coal generated 33% of US electricity, down from nearly 45% in 2010. Gas picked up 70% of the drop in coal's power output, but that still left coal's contribution at 1,356 Terawatt-hours (TWh) or about 6x the grid contribution of all US wind and solar power last year. (A Terawatt is a billion kilowatts.)

Displacing coal completely from US electricity would require doubling the 2015 output of US gas-fired power generation and a roughly 36% increase in US natural gas production. By comparison, the US nuclear power fleet would have to more than double. If coal were to be replaced entirely by renewables, which in practice probably means gas pushing coal out of baseload power and renewables reducing gas-fired peak generation, the hill looks steep.

Last year the US added 7.3 GW of new solar installations and 8.6 GW of new wind turbines. Assuming they were mostly sited in locations with reasonable solar or wind resources, their combined annual output should be around 35 TWh. At that pace it would take another 36 years to make up what coal now generates. It's true that net annual wind and solar additions continue to grow at double-digit rates, but keeping that up may get harder as the best sites become saturated and earlier wind turbines and PV arrays reach the end of their useful lives in the meantime.

In other words, driving coal from here to zero seems possible but very difficult, even with an all-of-the-above strategy in a market without demand growth. And if electricity demand continues to grow, as it is globally, or resumed growing in the US and other developed countries to enable a big shift to electric vehicles, the prospect of retiring coal entirely recedes into the future.

Monday, March 14, 2016

Energy and the 2016 Presidential Primaries

With another round of important primary elections taking place this week, I am sadly tardy in taking a high-level look at the energy positions of the candidates. The winnowing that has already taken place simplifies the task, even as it raises the stakes: A further contraction of the field after the voting in Florida, Illinois, North Carolina and Ohio could eliminate whole approaches to national energy policy.

The divide on energy between the Republican and Democratic fields also seems wider than in recent years. In 2008, when oil prices were approaching an all-time high, Republicans placed more emphasis on resource access--"drill baby, drill"--but both major party nominees supported cap-and-trade to address climate change. After recent remarks by Secretary Clinton and Senator Sanders, this November's election is shaping up as a binary choice between the continuation of the energy revolution that has saved the US hundreds of billions of dollars, and the elevation of environmental concerns as the main criteria for future energy decisions.

I'll take a closer look at the energy positions of the remaining Democratic candidates in a future post. For now I want to focus on the Republican field, because the first round of winner-take-all primaries looks like a make-or-break moment for the two candidates with the most detailed published positions on energy:
  • Kasich - On his campaign website the Ohio governor argues for increasing US energy supplies from all sources, including efficiency and conservation.  He endorses North American energy independence, but also sees the need for innovation in clean energy technology. He would rein in regulation, including the Clean Power Plan, to "balance environmental stewardship with job creation." And while he has supported the development of Ohio's Utica shale, putting the state in the top rank of natural gas producers for the first time in decades, he has also led an effort to increase state taxes on oil and gas production. The appeal of Governor Kasich's positions to moderates is understandable, although no one would mistake them for a 2016 Democrat's energy platform.
  • Rubio - The Florida senator's energy proposals are even more detailed, with more of a legislative focus than Governor Kasich's. Their tone is simultaneously positive and adversarial: Senator Rubio has an upbeat vision for the role energy can play for the US, and much of it is presented on his website in counterpoint to the actions and priorities of an administration he clearly believes has largely been mistaken on energy. There's a "wonkish" flavor to much of the content, such as his argument for education reform to fill the jobs energy development can help create. Although a reference to support for the Transatlantic Trade & Investment Partnership might be a red flag in a year dominated by populist sentiment, most of the ideas here fall solidly within the mainstream of recent conservative thought on energy.
Each of the other two remaining Republicans represents a more significant departure from their party's recent approach to energy, at least at the presidential level:
  • Cruz - Senator Cruz appears to take a more overtly libertarian stance on energy and what he calls the Great American Energy Renaissance. He wouldn't just lighten federal regulation of energy, as his rivals advocate; he would take on the government's ability to regulate. For example, in addition to opposing the Clean Power Plan, he co-sponsored legislation that would make it much harder for the EPA and administration to use the federal Clean Air Act to devise other ways to regulate greenhouse gas emissions from power plants. Consistent with his plan to abolish the IRS, he would also eliminate the Department of Energy. He supports an all-of-the-above energy strategy, but on a level playing field. Ethanol, for example, after his phase-out of the Renewable Portfolio Standard, would have to find its way into the energy mix without a federal mandate or subsidies.  
  • Trump - From my quick perusal of it, the Trump website lacks the kind of specifics on energy that are found on the other candidates' sites. We are left to piece together Mr. Trump's positions on energy based on his answers to specific questions or issues, elsewhere. You can find a number of quotes from those on Google. If there's a unifying principle to his views on energy, he seems to be as deal-focused as on other topics, and less allergic to using the power of government than his opponents.  For example, he supported the Keystone XL pipeline but apparently thought we could get a better deal from Canada and the project developer. If Dilbert creator Scott Adams is correct in his analysis of Donald Trump as a Master Persuader, the details of his views on any issue like this matter less in an election than how he frames them.  
The energy context of the 2016 election could not be more different than that of four or eight years ago. A global oil glut and natural gas priced low enough to edge out coal for the top spot in US power generation are giving candidates a rare luxury. They can address energy without the pressure of angry consumers demanding immediate answers. However, even if the election will not be decided based on energy, it remains a major pillar of the economy. How candidates view energy can shed important light on the consistency of their other positions. I expect to return to this point in the weeks ahead.

Thursday, February 25, 2016

OPEC's War on US Producers

The comments of Saudi Arabia's oil minister at the annual CERAWeek conference in Houston this week provided some sobering insights into the strategy that the Kingdom, along with other members of OPEC, has been pursuing for the last year and a half. Perhaps the ongoing oil price collapse is not just the result of market forces, but of a conscious decision to attempt to force certain non-OPEC producers out of the market.

Notwithstanding Mr. Al-Naimi's assertion that, "We have not declared war on shale or on production from any given country or company," the actions taken by Saudi Arabia and OPEC in late 2014 and subsequently have had that effect. When he talks about expensive oil, the producers of which must "find a way to lower their costs, borrow cash or liquidate," it's fairly obvious what he is referring to: non-OPEC oil, especially US shale production, as well as conventional production in places like the North Sea, which now faces extinction. If these statements and the actions that go with them had been made in another industry, such as steel, semiconductors or cars, they would likely be labeled as anti-competitive and predatory.

We tend to think of the OPEC cartel as a group of producers that periodically cuts back output to push up the price of oil. As I've explained previously, that reputation was largely established in a few episodes in which OPEC was able to create consensus among its diverse member countries to reduce output quotas and have them adhere to the cuts, more or less.

However, cartels and monopolies have another mode of operation: flooding the market with cheap product to drive out competitors. It may be only coincidental, but shortly after OPEC concluded in November 2014 that it was abandoning its long-established strategy of cutting production to support prices, Saudi Arabia appears to have increased its output by roughly 1 million barrels per day, as shown in a recent chart in the Financial Times. This added to a glut that has rendered a large fraction of non-OPEC oil production uneconomic, as evidenced by the fourth-quarter losses reported by many publicly traded oil companies.

That matters not just to the shareholders--of which I am one--and employees of these companies, but to the global economy and anyone who uses energy, anywhere. OPEC cannot produce more than around 37% of the oil the world uses every day. The proportion that non-OPEC producers can supply will start shrinking within a few years, as natural decline rates take hold and the effects of the $380 billion in cuts to future exploration and production projects that these companies have been forced to make propagate through the system.

Cutting through the jargon, that means that because oil companies can't invest enough today, future oil production will be less than required, and prices cannot be sustained at today's low level indefinitely without a corresponding collapse in demand. Nor could biofuels and electric vehicles, which made up 0.7% of US new-car sales last year, ramp up quickly enough to fill the looming gap.

Consider what's at stake, in terms of the financial, employment and energy security gains the US has made since 2007, when shale energy was just emerging. That year, the US trade deficit in goods and services stood at over $700 billion. Energy accounted for 40% of it (see chart below), the result of relentless growth in US oil imports since the mid-1980s. Rising US petroleum consumption and falling production added to the pressure on oil markets in the early 2000s as China's growth surged. By the time oil prices spiked to nearly $150 per barrel in 2008, oil and imported petroleum products made up almost two-thirds of the US trade deficit.

Today, oil's share of a somewhat smaller trade imbalance is just over 10%. Since 2008 the US bill for net oil imports--after subtracting exports of refined products and, more recently, crude oil--has been cut by $300 billion per year. That measures only the direct displacement of millions of barrels per day of imported oil by US shale, or "tight oil" and the downward pressure on global petroleum prices exerted by that displacement. It misses the trade benefit from improved US competitiveness due to cheaper energy inputs, especially natural gas.

Compared with 2007, higher US natural gas production, a portion of which is linked to oil production, is saving American businesses and consumers around $100 billion per year, despite consumption increasing by about 20%--in the process replacing  more than a fifth of coal-fired power generation and reducing CO2 emissions. $25 billion of those savings come from lower natural gas imports, which were also on an upward trend before shale hit its stride.
The employment impact of the shale revolution has also been significant, particularly in the crucial period following the financial crisis and recession. From 2007 to the end of 2012, US oil and gas employment grew by 162,000 jobs, ignoring the "multiplier effect." The latter impact is evident at the state level, where US states with active shale development appear to have lost fewer jobs and added more than a million new jobs from 2008-14, while "non-shale" states struggled to get back to pre-recession employment. That effect was also visible at the county level in states like Pennsylvania, where counties with drilling gained more jobs than those without, and Ohio, where "shale counties" reduced unemployment at a faster pace than the average for the state, or the US as a whole.
If the shale revolution had never gotten off the ground, US oil production would be almost 5 million barrels per day lower today, and these improvements in our trade deficit and unemployment would not have happened. The price of oil would assuredly not be in the low $30s, but much likelier at $100 or more, extending the situation that prevailed from 2011's "Arab Spring" until late 2014. If OPEC succeeds in bankrupting a large part of the US shale industry, we might not revert to the energy situation of the mid-2000s overnight, but some of the most positive trends of the last few years would turn sharply negative.
Now, in fairness, I'm not suggesting that this situation can be explained as simply as the kind of old-fashioned price war that used to crop up periodically between gas stations on opposite corners of an intersection. The motivations of the key players are too opaque, and cause-and-effect certainly includes geopolitical considerations in the Middle East, along with the ripple effects of the shale technology revolution. It might even be possible, as some suggest, that OPEC has simply lost control of the oil market amidst increased complexity.  
However, to the extent that the "decimation" of the US oil and gas exploration and production sector now underway is the result of a deliberate strategy by OPEC or some of its members, that is not something that the US should treat with indifference.

This is an issue that should be receiving much more attention at the highest levels of government. The reasons it hasn't may include consumers' understandable enjoyment of the lowest gasoline prices in a decade, along with the belief in some quarters that oil is "yesterday's energy." We will eventually learn whether these views were shortsighted or premature.