Thursday, February 16, 2017

Is the US Ready for a Carbon Tax?

  • While the Trump administration seeks to undo CO2 regulations, a group of former Republican officials has proposed a new, market-based emissions plan.
  • This "carbon tax" looks simpler than EPA's Clean Power Plan or previous cap-and-trade legislation, but not simpler than the pre-Obama status quo.
The idea of taxing the carbon content of energy--and presumably the goods and services produced with it--is back in the news. A group of Republican "wise men" has floated it as an alternative to the regulation-based approach to emissions that the Obama administration pursued after its preferred "cap & trade" legislation died in the Congress.

Reduced to its basics, a carbon tax is a focused version of a consumption tax, based on usage rather than income or valuation. The level of the tax would be set by law, either as a fixed amount per ton of emissions or at an initial rate with preset future increases. What can't be known with certainty in advance is just how much a given level of carbon tax would reduce actual emissions.

This contrasts with the method of setting a price on carbon preferred by many other economists and environmental groups, called "cap & trade." In this approach, the government sets a cap, or maximum level, on emissions for a designated sector or the economy as a whole, while parties subject to the cap are allowed to trade emission allowances and credits with each other under that cap. Thus policy makers set the level of emission reductions, and allow the market to find the resulting price on carbon. In principal, that ought to be more efficient than the simpler carbon tax, because market forces should drive participants with low costs of cutting emissions to make the deepest reductions and then sell their excess cuts to others, for less than it would cost the latter to reduce by that amount.

From the late 1990s until 2009 or '10 I was convinced that cap & trade was the better approach to pricing emissions. However, the experience of watching the US Congress attempt to design a cap-and-trade system for the US economy cured my certainty. As I have described at length, the inclination of legislators to help favored companies, industries and sectors, combined with the extraordinary temptations created by the sheer scale of the revenue such a system would channel through the government's hands, revealed practical problems that look insurmountable in the real world, at least under our political system.

In fairness, cap-and-trade is currently used to promote emissions reductions in various jurisdictions, including California, the mainly northeastern states participating in the Regional Greenhouse Gas Initiative, and the European Union. From what I have observed, all of them have experienced technical difficulties involving the allocation of free allowances, inadequate liquidity, and other issues. The biggest practical problem is that the carbon prices these systems have tended to deliver might be characterized as the opposite of a Goldilocks price; i.e., they are typically high enough to generate substantial revenue, creating strong constituencies for their continuation, but too low to influence behavior very much.

For example, California's emissions credits currently trade at around $13 per metric ton of CO2, equivalent to $0.10 per gallon of gasoline containing ethanol. Would an extra $1 per fill-up make much of a difference in how much you drive, which car to buy when you replace your current car, or whether to sell your car (or forgo buying one) and take public transportation?

Moreover, California's emissions have been essentially flat since the state implemented cap-and-trade in 2012. However, since 2002 the state's electric utilities--historically the highest emitting sector--have operated and invested under a Renewable Portfolio Standard requiring them to increase the share of renewable energy in their generation mix to 20% by 2010, 33% by 2020, and now 50% by 2030. I suspect that accounts for most of the 7% drop in emissions since 2002, while the impact of a carbon price equivalent to 0.6 cents per kilowatt-hour (kWh) is likely lost in the noise. Of course a carbon tax would create its own political and practical complications.

First, consider how a carbon tax would affect different energy sources. As with cap & trade, a carbon tax should have its biggest impact on the highest-emitting forms of energy. In practice that would compound the current disadvantages for coal compared to abundant, low-priced natural gas and rapidly growing, essentially zero-emitting renewables like wind and solar power. At least on the surface, that seems at odds with the stated goal of the Trump administration to attempt to rescue the US coal industry and the communities that depend on it.

Like cap & trade, a carbon tax would also require a significant amount of new bookkeeping to track the path of "embedded emissions"--the CO2 and other greenhouse gases emitted at each step of a product or service's supply chain--through the economy. Some of this is already done voluntarily by companies participating in various sustainability reporting efforts, but it would be new for many others. The EPA, Department of Energy, and numerous non-governmental agencies have done much work to quantify such emissions, but a carbon tax would require a level of rigor and audit trail consistent with the creation of what amounts to a shadow currency within the economy.

A carbon tax also raises similar questions of how to spend the resulting revenue that have bedeviled cap & trade. At the current US emissions and assuming few sources were exempted, the proposed $40 per metric ton initial carbon tax would raise around $275 billion per year. That's 8% of this year's federal budget. It doesn't take a cynic to guess that the first inclination of any Congress enacting such a tax would be to hang onto this money to fund new programs, reduce the federal deficit, or some combination, rather than returning it to taxpayers as former Secretaries Baker and Schultz and the economists who back them suggest.

Their proposal would require that the proceeds of the carbon tax be rebated to essentially the same people who would be paying it at the gas pump or in their gas and electric bills. This sounds similar to the "Cap and Dividend" approach to cap & trade proposed by Senators Cantwell (D) and Collins (R) a few years ago. Their bill had the great advantage of simplicity, requiring just a fraction of the 1,427 pages of the 2009 Waxman-Markey cap & trade bill, the main purpose of which seemed to be to redistribute vast sums of money outside the tax code. But like W-M, it went absolutely nowhere.

Like it or not, that's my best guess of the fate of the current carbon tax idea, too. The biggest challenge facing a carbon tax today is that it would not be running as a simpler, more market-oriented alternative to prescriptive legislation or complex EPA regulations. After all, the administration's intention appears to be to eliminate the EPA's main emissions-reduction regulation, the Clean Power Plan, not to replace it.

And although the new US Secretary of State, Mr. Tillerson, is on record numerous times in support of a carbon tax, that position seems to have been put forward mainly in preference to cap & trade, rather than on its own merits in the absence of any other strict climate policy.

A carbon tax would raise the effective price of energy commodities in which we appear to have a global competitive advantage, at least for now. The current proposal may rebate the carbon tax on exports, but most economic activity starts and ends within this country. And as noted in the NY Times op-ed by Dr. Feldstein and the other economists backing this measure, the revenue recycling to consumers would be on an equal basis, rather than proportional to usage, so there would be winners and losers as with any redistributive taxation. Lower-income Americans driving older cars seem likelier to come out on the short end of that than wealthier consumers driving new cars that meet rising fuel economy standards.

Ultimately, we must ask why President Trump or his team would want to impose a new tax on US consumers and businesses to address a problem that has probably just become an even lower priority for them than it was. Notwithstanding Mr. Trump's demonstrated unpredictability, the simplest answer seems to be that he wouldn't.

Thursday, January 12, 2017

US Energy Under Trump

  • President-Elect Trump and his appointees plan a major policy and regulatory shift for energy, focusing more on economic benefits and less on environmental impacts.
  • Obama-era regulations most at risk of roll-back are those justified mainly on climate concerns not shared by Mr. Trump and his team.
  • Emissions are still likely to fall in the next four years as shale and renewable energy output grow. 
Next week's presidential inauguration will trigger the biggest policy and regulatory shift for the US energy industry in at least ten years. That's how long it has been since energy policy was set by a Republican president and Congress. Donald Trump is a different kind of Republican, though, and his goal does not seem to be a return to scarcity and high energy prices. What should we expect, instead?

To gauge how sharply the energy polices of the incoming Trump administration will diverge from those of the last eight years, we need to understand what motivates both leaders. The Obama administration's approach was driven by a deep, shared conviction that climate change is the most important challenge the US--and world--faces. The cost of energy and its impact on the economy became secondary concerns, subordinated by the belief that the added cost of climate policies would be offset in whole or part by the benefits of the green investment they unleashed--remember "green jobs"?

We saw this in President Obama's first year in office. Amid a deep recession he worked with Congress to attempt to limit greenhouse gas emissions by means of an economy-wide cap-and-trade system, on which he had campaigned. The House of Representatives passed the Waxman-Markey bill (HR.2454), a veritable dog's breakfast of economic distortions. Yet despite a filibuster-proof majority in the Senate in 2009, Waxman-Markey and every subsequent cap-and-trade bill died there.

That failure set in motion the agenda that the Obama administration has pursued ever since, to achieve via regulations the emissions reductions it could not deliver through comprehensive climate legislation. Last year's publication of the EPA's final Clean Power Plan was a key component of an effort that seems set to continue until just before Inauguration Day.

The transformation of energy regulations under President Obama was dramatic enough that a transition to any Republican administration would be a big change. The transition now in prospect will be even more jarring. Mr. Trump's rhetoric and his choices for key administration positions point to a concerted effort to unravel as many of the Obama-era regulations affecting energy as possible. That isn't just based on philosophical differences over regulation and markets. For President-Elect Trump the economy and jobs are paramount, so the Obama energy regulations must look like an unjustifiable threat to the fossil fuel supplies that still meet 81% of the nation's energy needs.

Despite that, it is unlikely the new administration will go out of its way to target renewable energy or the tax credits that have driven its growth to date. Renewables are becoming increasingly popular with conservatives. However, because Mr. Trump sees climate change as, at best, a secondary issue that may not be amenable to human intervention, his administration's won't put renewables on a pedestal as the Obama administration has done.

The biggest challenge for renewable energy may come from tax reform intended to make US companies and factories more competitive globally and shrink the incentive for them to relocate to lower-tax countries. This appears to be a high priority for the new White House and Congress, and one on which they broadly agree. If corporate tax rates drop, the value of the tax credits renewables enjoy is likely to fall, too, making wind, solar and other such projects less attractive and less competitive.

It remains to be seen how many of the Obama energy regulations can be rolled back. The most recent regulations might be averted through legislation like the Midnight Rules Relief Act, or the REINS Act, both of which would update the Congressional Review Act, a rarely used 1990s law intended to limit what presidents could impose by last-minute executive actions. Other regulations may eventually stand or fall as the courts rule. The stakes are high, particularly for regulations affecting the production of oil and gas from shale by means of hydraulic fracturing and horizontal drilling.

Energy independence was a touchstone of Mr. Trump's candidacy. Despite his campaign's focus on coal, it is fracking, as hydraulic fracturing is more commonly known, that holds the key to achieving that goal in the foreseeable future. It has been the main driver of the growth in US energy production since 2010.

The latest long-term forecast from the US Energy Information Administration (EIA) puts energy independence within reach--in the sense of the US becoming a net exporter of energy--by 2026 or sooner. However, the recent flurry of regulations affecting such things as drilling on federal land, and putting large portions of US waters off-limits for offshore drilling would not have been part of that projection. As EIA Administrator Adam Sieminski remarked at a briefing on the forecast, "If you had policy that changed relative to hydraulic fracturing, it would make a big, big difference to everything that's in here."

That's a key point, because most past notions of energy independence assumed that energy prices would have to be very high to promote lots of efficiency and conservation and stimulate large amounts of expensive new supply. The shale revolution changed that.

However, the global context is also changing. OPEC is attempting to reassert its control over the oil market, with help from non-OPEC countries like Russia. Two years of low oil prices shrank global oil and gas investment budgets by around a trillion dollars, and the International Energy Agency has warned of coming oil price spikes as a result. Forestalling tighter US regulations on fracking and offshore drilling increases the chances that US supplies could grow by enough to balance shortfalls elsewhere and avert much higher prices at the gas pump.

Energy infrastructure is likely to be another focus of the new administration, because the economic and competitive benefits of abundant energy will be diluted if, for example, Marcellus and Utica shale gas or Bakken and Permian Basin shale oil have to be exported because domestic customers don't have access to them.

That suggests an early effort to reverse decisions by the current administration to block the construction of various pipelines, starting with the Keystone XL pipeline and more recently the Dakota Access Pipeline. That will force new confrontations with activists and environmental organizations that have raised their game to a new level in the last eight years.

Such opposition would likely intensify if the new administration sought to withdraw the US from the Paris climate agreement, which recently went into effect, or submitted it for review by the US Senate as a treaty. But it's not clear that a big change in direction would require leaving Paris.

The US commitments at Paris, like those of the other signatories, were voluntary and non-binding. For that matter, recent shifts in US energy consumption and especially electricity generation have put the US in a good position to meet its initial Paris goals with little or no additional effort, as noted by outgoing Energy Secretary Moniz. The Paris Agreement will only become a major point of contention if President Trump chooses to make it one.

In his list of the top energy stories of 2016, fellow blogger Robert Rapier rated the election of Donald Trump ahead of the OPEC deal and many other important events of the year, based on its likely impact on "every segment of the US energy industry." In retrospect that was equally true of Barack Obama's election in 2008. The shift we are about to experience on energy will be that much sharper, because President Obama and President-Elect Trump both set out to make big changes to the status quo for energy, in opposite directions. We shouldn't miss one important difference, however.

The course that Barack Obama's administration followed on energy was largely predictable from the start, because it was based on openly and deeply held beliefs about energy and the environment. Donald Trump's well-known preference for deals over dogma sets up the prospect of some big surprises, in addition to what we can already anticipate.

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