- Natural Gas, Electricity And The Vehicle Market
- Can A National Energy Strategy Be Built On Green Jobs?
- Wind Power’s Profile Is Climbing Along With Problems
- Is OPEC Talking Its Book?
- The Achilles Heel Of Renewable Energy – The Cost
- A Cool Northeast June Is Topic Of Interest
- Recovery Prospects Drove Metals Prices In First Half
Musings From the Oil Patch
July 21, 2009
Allen Brooks
Managing Director
Note: Musings from the Oil Patch reflects an eclectic collection of stories and analyses dealing with issues and developments within the energy industry that I feel have potentially significant implications for executives operating oilfield service companies. The newsletter currently anticipates a semi-monthly publishing schedule, but periodically the event and news flow may dictate a more frequent schedule. As always, I welcome your comments and observations. Allen Brooks
Three high-profile senators have introduced a bill designed to boost the use of natural gas-fueled vehicles in this country. The bill, known as NAT GAS (New Alternative Transportation to Give Americans Solutions), is being spearheaded by Senator Robert Menendez (D-NJ), Senate Majority Leader Harry Reid (D-NV) and Senator Orrin Hatch (R-UT). The bill focuses on a series of existing tax credits to boost attractiveness for consumers and businessmen to purchase natural gas vehicles and for companies to invest in facilities to build and fuel them.
Consumers would be offered a $12,500 tax credit for the purchase of a light natural gas vehicle, which is much more than the current $7,500 tax credit for plug-in electric vehicles. The current tax credits for other weight classes of natural gas vehicles would be doubled up to a maximum of $80,000 for the largest class. There is also a $100,000 tax credit for fueling stations to invest in new natural gas fueling equipment. The bill also would provide a 50% tax credit for the increased costs assumed by companies to increase production of bi-fuel vehicles. Manufacturers would be eligible for tax credits of up to 100% of the cost to build a new plant that would build natural gas vehicles.
The principal force behind the bill is Boone Pickens. Recently, he stepped up his efforts to push for a new green-energy strategy for the United States based on natural gas and wind power, something he started last year as crude oil prices were climbing toward their all-time high of $147 a barrel. In early July, AT&T (T-NYSE) announced plans to invest $565 million over the next decade to buy 15,000 alternative fuel vehicles. At least $350 million of the investment will go toward purchasing 8,000 CNG (compressed natural gas) vehicles. An editorial in The Dallas Morning News praised the action by AT&T and praised Mr. Pickens for his efforts. It also suggested this investment validates Mr. Pickens’ energy plan for the country. Just to be balanced, the domestic automobile industry, while severely depressed, is still selling cars at a 9.6 million unit annual rate. Automakers believe U.S. sales will average more like 10-12 million units annually over the next several years. The AT&T order, while significant for the hybrid and CNG vehicle market segments, is but a mere drop in the bucket.
We have been examining the debate about the ultimate success of hybrid, CNG and electric vehicles and the resulting impact on the future natural gas market. A friend who is competing to build an all electric vehicle that can meet certain standards in a global competition pointed us to an article about the potential for plug-in electric vehicles and their impact on the power market. The article reported on a study prepared for the New York Independent System Operator, the regulator of power transmission and electric reliability in the state. The study showed that fully electric vehicles and plug-ins are expected to increase power demand in New York State by 2% by 2030.
The report assumes 1.5 million plug-in hybrid sales by 2016 and 50 million by 2030, including 2.5 million vehicles in New York. People may question these market assumptions. Based on two studies, however, one done by the electric industry group Electric Power Research Institute and the environmental group Natural Resources Defense Council, and the other by the U.S. Energy Department’s Oak Ridge National Laboratory, plug-in hybrids are expected to account for 25% of all U.S. automobile sales by 2020. These two studies seem to fit the pattern for hybrid vehicle sales suggested in a Frost & Sullivan market study of the global hybrid vehicle market.
Exhibit 1. Hybrid Demand Looks Bright For Next Six Years
Source: Frost & Sullivan, Seeking Alpha
The New York report supports a long-held belief of the wind power industry that recharging plug-in hybrids is ideally suited for electricity output. Winds in most areas are stronger at night meaning that they could provide a greater percentage of the electricity consumed when it becomes dark. Since this would be when most plug-in hybrids would be recharged, the task could be accomplished with little increase in carbon emissions since fossil fuel-generated electricity would barely be used or possibly not used at all.
So will the winner be natural gas or plug-in electric vehicles? If one does some calculations about the attractiveness of natural gas, gasoline and electricity for powering vehicles some interesting data points and conclusions emerge. A cubic foot of natural gas contains 1,038 British thermal units (Btus) of energy, but if used in an internal combustion engine, the energy value declines to 950 Btus. On the other hand, a gallon of gasoline contains 125,000 Btus.
If we use a commercial price for natural gas of about $10 per thousand cubic feet (Mcf) and the untaxed portion of the price of a gallon of gasoline of roughly $2.05 (obviously prices change all the time but we selected these prices based on when we were trying to figure out the analysis) to compare the fuels, then on an energy-per-dollar-cost, natural gas has 95,000 Btus/$ while gasoline has only 61,000 Btus/$, natural gas appears to be the winner. (It must be remembered that natural gas is untaxed, and if it were to displace gasoline then the government would need to levy taxes to secure the money necessary to build and maintain roads and bridges, etc.)
On this comparison, even though natural gas vehicles are more costly to build and are somewhat less efficient to operate, the economics argue they should be the preferred vehicle. Owners, however, caution that due to the fact that the tank needed to hold the natural gas fuel essentially uses up most of the available trunk space in the vehicle, they are not attractive alternatives beyond commuting.
If we translate natural gas into electricity, we have the following scenario. One cubic foot of natural gas produces 0.15 kilowatt hour (kWh) of electricity. If we put one cubic foot of natural gas into a Toyota Prius, which is rated at 50 miles per 125,000 Btus (one gallon of gasoline) then it gets 0.38 of a mile. [50/125000 = X/950; X= 0.38] On the other hand, if that same cubic foot of natural gas was converted into electricity and then used to fuel a Chevrolet Volt, which is rated for 40 miles on 8 kWh of electricity, the resulting mileage would be 0.75 miles. [40/8 = X/0.15; X = 0.75] Even if one assumes the electricity ratio is too high due to transmission losses, etc., then possibly the Volt’s output is only 0.60 miles.
This analysis suggests to us that electric-powered vehicles should be the winner over natural gas-powered vehicles. We think the analysis is correct and that we have taken most of the major variables into account. A more sophisticated analysis is probably warranted, but we started this examination of the future of the natural gas market several Musings ago with a simple goal of getting the magnitude of the general trends impacting the market correct and not looking for exact answers. As we like to say, it’s close enough for government work.
Exhibit 2. Natural Gas For Vehicles Is A Negligible Demand
Source: EIA, PPHB
When we look at the impact of natural gas powered vehicles on U.S. demand, one cannot ignore that the demand is almost negligible. Based on 2008 annual natural gas consumption data by sector, vehicle consumption was only 0.1% of total demand. The number of natural gas powered vehicles could increase exponentially with very little impact on natural gas demand. Electric vehicles fueled by power generated from natural gas are likely to have a greater positive impact on the gas industry long-term than natural gas vehicles. The challenge is to develop electric vehicles that go faster, farther between battery charges and are less expensive. We believe technology will solve these challenges, but getting customers to buy the vehicles will need some assistance from the government. Lifestyle changes where families have two vehicles – one run on electricity for short trips and commuting and another vehicle based on clean, efficient hydrocarbon fuels for longer trips and hauling more people and goods – is the likely outcome. Our work of examining the future for the natural gas industry will continue in future issues of the Musings as it has become one of the greatest energy conundrums of all time.
Speaker of the House Nancy Pelosi (D-CA), while making a final plea to the members of the House of Representatives to vote for the Waxman/Markey bill, said it was all about “jobs, jobs, jobs and jobs.” The cap-and-trade bill requires that utilities generate a greater percentage of their power in future years from renewable fuels. This mandate is assumed to stimulate the need to create more jobs in “green industries.” A new study makes the case this energy and environmental legislation will lead to the creation of a net 1.7 million new green jobs beyond the number of jobs that would have been created had the same amount of money been invested in traditional fossil fuel industries.
Another study earlier this year analyzed the impact of increased energy efficiency and other “green energy” mandates on job creation in Colorado. The results of this study, while positive about the impact on employment in the long-term, were less impressive than the more recent nationwide employment study of the House bill.
The Colorado study, Energy Efficiency and Job Creation in Colorado was authored by Howard Geller and Marshall Goldberg of the Southwest Energy Efficiency Project (SWEEP) in April of this year. The study followed on one prepared earlier by SWEEP. That study, The New Mother Lode: The Potential for More Efficient Electricity Use in the Southwest, was prepared in 2002. The study looked at the economic and environmental benefits from increasing the effectiveness of electricity use in six southwest states during 2003-2020. It found that Colorado would reduce its electricity consumption by 31% after the 18-year effort. Over that period, state employment would rise by 6,900 jobs and produce an annual increase in personal income of $280 million a year by the end of the study period.
In the new study, the impact on employment and the state’s economy was examined at three points in time: 2015, 2020 and 2025. The economic impact was measured by factoring in adherence to six energy efficiency and environmental programs, several of which are offshoots of proposed, legislated or under consideration energy and environmental programs. The six programs include:
“1. Expand Electric Utility DSM Programs – assumes that electric utilities, other than very small utilities, save the equivalent of 1 percent of their electricity sales from energy efficiency programs each year starting in 2010.
“2. Expand Gas Utility DSM Programs – assumes that gas utilities save the equivalent of 1 percent of gas sales to their full service gas customers each year by 2011.
“3. Update and Enforce Building Energy Codes – assumes that energy codes result in 5 percent electricity savings and 10 percent natural gas savings in all new buildings starting in 2007, with 5 percent additional savings realized every three years starting in 2010.
“4. Implement Lamp Efficiency Standards – accounts for the lamp standards in the Energy Independence and Security Act of 2007 which will eventually eliminate ordinary incandescent lamps.
“5. Undertake an Industrial Energy Efficiency Program – assumes that industries increase their investment in energy efficiency measures and practices with electricity and natural gas savings reaching 6.5 percent by 2015, 11.5 percent by 2020, and 16.5 percent by 2025.
“6. Adopt the Clean Car Standards – assumes that Colorado joins other states in adopting and enforcing these standards, or that the Administration harmonizes the federal CAFE standards and the Clean Car Standards. In addition, we consider the impact of the strengthened federal CAFE fuel efficiency standards included in the 2007 Energy Independence and Security Act. “
By using these policies SWEEP’s analysis concluded that in 2015 there were would be a net 4,660 green jobs created but that gross state product (GSP) would be reduced by $43 million. Since Colorado had about 2.6 million workers and 134,000 unemployed workers, the net gain in new jobs is equal to 0.2%. By 2020, the employment impact of these policies would create 11,600 new green jobs and increase GSP by $44 million. The employment impact translates into a possible 0.45% increase in Colorado employment.
Earlier this summer we were involved in a letter to the editors writing duel in The Westerly (R.I.) Sun with a local resident over the potential of green jobs. One of the studies we unearthed to challenge the other writer’s claims of huge employment increases from green jobs involved the growth of Colorado’s wind energy business and its employment impact. As we wrote at that time, “The May 23rd issue of The Economist reports that Colorado has quadrupled wind-energy production and is building the nation’s third largest solar power plant. The Colorado renewable energy sector is growing 30% a year, but ‘apart from temporary work for builders, the industry directly employs only 1,500-3,000 people, according to the University of Colorado.’ Colorado’s labor force has 2.7 million workers.”
A study of the potential impact of the American Clean Energy and Security Act (ACESA) on employment and energy consumption was conducted by three people affiliated with the Department of Economics and Political Economy Research Institute (PERI) at the University of Massachusetts at Amherst and published in June. The study, entitled The Economic Benefits of Investing in Clean Energy, concluded that the prospect of investing $150 billion annually in clean energy projects over the next decade would add 2.5 million green jobs to the nation’s employment rolls. The study also shows that there would be 800,000 jobs lost if the same amount of annual investment in traditional fossil fuels industries was lost. The net result of the green energy investment would be a net 1.7 million new jobs created.
We found certain aspects of this analysis interesting. One interesting fact was the employment multiplier of the two types of jobs – clean energy and traditional fossil fuel. According to the U.S. Commerce Department’s Input-Output tables, based on $1 million of investment spending, clean-energy jobs grow at about three times the number of jobs added by the same spending in traditional fossil fuel businesses. We would like to see more data behind these figures. Our explanation for the difference in the employer multiplier rate is that so many of the traditional energy businesses have all their key employment positions filled so there is less need to hire additional people to do what is needed. It is also possible that the location of green jobs is in areas where there are few existing jobs.
Exhibit 3. Clean Jobs Grow 3-times Faster Than Fossil Fuel
Source: Commerce Dept., PERI
An interesting question is what are these clean-energy jobs? The PERI report listed a number of clean-energy jobs in each of the clean-energy fuel categories. What we found interesting was that there was no table showing the type of traditional fossil fuel jobs that would be lost if capital investment was reduced by $150 billion a year.
Exhibit 4. Clean-energy Jobs Created By Investment
Source: PERI
An equally important issue is the impact of these potential 2.5 million new clean-energy jobs on employment in the states. As shown in the accompanying table, every state of the union will benefit from this surge in new jobs. We are quite sure that will happen, but only if the investment is made. Equally important is that the amount of the annual investment assumed in the analysis proves correct.
Exhibit 5. Every State Will Gain Clean-energy Jobs
Source: PERI
The $150 billion annual investment program envisioned by the ACESA act is spelled out in the exhibit below. The bulk of the annual investment is targeted for retrofitting buildings to make them more energy efficient. This is a very labor intensive effort, but we question the economic impact from these jobs. In the end, we will have to wait to see how the investment dollars are spent.
Exhibit 6. Retrofitting Buildings Is Focus of Energy Investment
Source: PERI
Another interesting aspect of this study was the analysis of the investment required to meet the targeted amount of renewable energy targeted by the legislation. The PERI study was prepared prior to passage of the ACESA act, so the analysis involved targets of 15% and 20%, respectively, of electricity being generated by renewable fuels by 2020. According to the PERI analysis, the nation will need to invest either $148 billion in new power facilities or $292 billion to meet the 15% and 20% targets. It was in examining this part of the analysis, admittedly in an appendix and not the main part of the study, we found questionable assumptions.
The PERI report relied on the U.S. Energy Information Administration’s Annual Energy Outlook 2009 and the Assumptions for the Annual Energy Outlook 2009 for the data necessary to perform their analysis. According to AEO 2009, the U.S. will need 4,618 billion kilowatt hours (kWhs) of electricity power capacity in 2020. If the 15% renewable power target is to be met, then the U.S. will need to have 692 billion kWhs of renewable capacity. Based on the relationship of 0.2 gigawatts (GWs) in capacity being associated with every one billion kWhs of generation, the country would need 153.8 GWs of renewable capacity to generate 692 billion kWhs. As of 2007, the nation had 100.8 GWs of renewable energy generating capacity in place meaning we only need to build 53 GWs of new renewable generating capacity.
To determine how much investment would be necessary, the authors used the estimates of the weighted average cost of capital to build renewable generating capacity from the Assumptions report. The PERI analysis says that the cost would be $2,750 per kWhs of capacity, which they round up to $2,800. Based on that figure, PERI estimates the country must invest $148 billion to meet the 15% renewable target. The same analysis yields a $292 billion investment requirement to meet the 20% renewable target. We were troubled by this relationship. Why does is cost 90% more to increase the renewable percentage from 15% to 20%? Could it be that we would be investing in progressively more expensive alternative fuels?
When we went through the data, we are not sure how the authors weighted their cost figure since the average of all the renewable fuels was $3,387 per kWhs, fully 21% higher than the figure PERI used. If we look only at those renewable fuels being mandated by the Obama administration as the preferred renewable fuels, then the average cost rises to $4,208 per kWhs, or slightly over 50% more than the study’s rounded estimate. Two of the cheaper renewable fuels are geothermal ($1,711 per kWhs) and hydroelectric power ($2,242 per kWhs). Geothermal energy has limited applications and we know the country will not be building any more dams as the proper environmental policy today is to dismantle existing dams.
If we use our estimates of the cost to build these renewable power plants, then to meet the 15% target we will need either to invest $179 billion or $222 billion, rather than the estimated $148 billion. To meet the 20% target, the spending requirements rises to $353 billion or $438 billion rather than $292 billion. Given the country’s current and projected future financial condition, it is highly suspect that we are going to be investing these sums of money in new renewable energy generating facilities. This is part of what comes from a strategy of making the most costly energy sources our base electricity supply.
Another recent study of the employment benefits from green energy investments was prepared for the European Commission’s energy department this past spring. As reported in a Reuter’s news report, the study states that if the 27-member states in the European Union achieve their goal of getting 20% of their energy from renewables by 2020, there will be 2.8 million jobs created. But because of the impact on power plant jobs and industry from the resulting high energy prices, 2.4 million jobs will be lost, leaving a net gain of 410,000 jobs. That represents two-tenths of one percent of the 227 million E.U. workers. These results are similar to those of the PERI study, but the E.U. only gets about a quarter of the number of clean-energy jobs forecast for the U.S. Is there that much structurally different about the labor markets of the U.S. and the E.U.?
The important conclusion of all these economic studies is that green energy investments should provide new jobs for our economy. The question is how many? The risk is that as we become too enamored by the possible number of new clean-energy jobs that we sacrifice many more traditional jobs by enacting extreme measures that have unintended consequences in our economy.
The British Government’s strategic environmental assessment (Sea) recently confirmed projections that an extra 25 gigawatts (GWs) of electricity generation capacity from wind could be accommodated in UK waters. Coupled with the 8 GWs of offshore power already built or planned, the country’s total offshore wind-generated electricity capacity could reach 33 GWs, enough to light every household in the UK at full output. The report pointed out that offshore wind has the potential to meet more than a quarter of the UK’s electricity needs while providing 70,000 jobs and generating £8 billion ($12.8 billion) a year in revenue.
The report’s conclusions have given the government the impetus to move forward with round three of its offshore wind farm leasing program. But the report’s findings are also pointing up challenges facing offshore wind generation, and wind in general that are becoming sticking points for wind’s growth in other countries around the world. As part of the round three offshore leasing programs, the UK Department of Energy and Climate Change and the energy regulator Ofgem are moving forward with the tendering process for companies to provide the £15 billion ($24 billion) of new cabling needed to connect all the new wind farms.
A report by the British Wind Energy Association (BEWA) says that 9 GWs of wind power capacity will be built by 2015 allowing wind to overtake nuclear in terms of installed capacity in the next four to five years. As we have previously written, one of the proposed new nuclear power plant locations on the northwestern coastal of Great Britain would require the possible removal of some or all of one of the earliest wind farms built in the country. The BEWA said the government needs to create a framework for wind to facilitate grid connections and ease supply chain pressures. This hurdle is becoming a highly contentious issue in the United States as the wind industry battles over where their farms should be placed in order to tap the most efficient wind locations. At the heart of this battle is the expansion and upgrading of the power grid.
In the U.S., the Obama administration has been counting on investment spending to upgrade the nation’s electrical grid to aid job growth and ending the recession. The Administration has proposed about $11 billion in funds to sponsor smart grid research and development, but the issue of locating grid expansions to tap the potential of new sources of electricity from wind farms and solar plants has become a contentious issue. The Waxman-Markey energy bill that passed the House several weeks ago included a provision that allows the U.S. Government to overrule state objections to new power lines but only in regions west of the Rockies. There is no mandate for the government to overrule Eastern States. This antagonism between the West and Midwest versus the East reflects long-standing battles among the states over building new energy infrastructure. Memorable recent battles have involved Connecticut rejecting the construction of a subsea power cable from New York State to Long Island. A transmission line between Virginia and West Virginia planned by American Electric Power (AEP-NYSE) took two years to build but 14 years to gain all the regulatory approvals. We see other political battles over the possible construction of an LNG terminal in Fall River, Massachusetts, and the Cape Wind offshore power project.
Boone Pickens who was planning to build one of the largest wind farms ever in West Texas has shelved those plans because of the inability to construct transmission lines to move the power to market. The Texas power market is largely independent of the rest of the country, which has meant that the state has adequate power at reasonable prices that has promoted its economic growth. The battle about expanding the power grid is not only an issue over tapping large new power sources but also the possible loss of economic benefits from developing power generation projects in local markets.
Exhibit 7. U.S. Transmission Divided Into Three Regions
Source: EnergyBiz.com
As we watch the pitched battles in various localities in the Northeast over siting new alternative power generation facilities, and even over locating electricity infrastructure needs such as power substations, we wonder how this region will ever secure sufficient electricity supplies to ensure its economic growth. While some regional government officials see the battle over transmission lines as one of distant energy versus local energy, it is rapidly becoming an economic development issue. The not-in-my-back-yard (NIMBY) mentality remains the overarching issue in the dispute with both sides struggling to gain supporters.
An additional issue over expanding the grid is its potential impact on utility company profitability. In the East there are many hours of the day when cheap coal-fired power plants sits idle while more expensive natural gas fueled plants are running full tilt because the traffic on the grid blocks the cheaper power alternative. A two-year effort by transmission companies in the eastern half of the country to draw up plans for a stronger grid collapsed when officials in New York and New England pulled out saying the plan favored moving Midwestern power eastward at the expense of local power.
While the United States bickers over its internal problems in distributing power across the country, China is moving ahead to become the largest wind power market passing the U.S. this year. China has instituted government policies about utility company investment in renewable energy. Much like the U.S., China gets the bulk of its electricity from coal, which will continue doing so for a long time. The government, however, in September 2007 mandated that large power companies generate at least 3% of their electricity from renewable resources by the end of 2010. This mandate excludes hydroelectric power that accounts for 21% of the nation’s power and nuclear that produces another 1.1% of China’s electricity. The government now requires Chinese power companies to generate 8% of their power from renewable sources other than hydroelectric by the end of 2020.
Exhibit 8. Onshore Wind Farms Are Part of China’s Landscape
Source: The New York Times
The impact of this Chinese renewable power mandate has been to boost the country’s wind power industry. At the start of 2008, the industry planned on constructing 5,000 megawatts (MWs) of wind power by the end of 2010. That target has climbed sharply as plans now show the electricity industry will build 30,000 MWs over the same time period. If the Chinese power industry reaches its current target, it will have met the country’s current 2020 wind power target. This aggressive expansion of wind power is highlighted by the fact that the size of wind farms being constructed in China is substantially larger than those in the United States. China now has six wind farms with a capacity of 10,000 MWs to 20,000 MWs each under construction. By comparison, Mr. Pickens had proposed to build the largest wind farm in the United States at 4,000 MWs, something he recently put on hold.
Exhibit 9. China Now Largest Wind Market
Source: The New York Times
A problem with the Chinese mandate is that the companies are required to have at least 3% of their generating capacity come from renewables but there are no requirements about the amount of electricity that must be generated. As pointed out in a recent article in The New York Times, companies have been encouraged to buy wind turbines that have a lower initial cost but higher maintenance costs, which has generally been those produced by local manufacturers. Based on United Nations data for the trading of carbon credits, Chinese turbines produce less electricity because they are out of service more often.
A major thrust of the Chinese wind industry will be to construct offshore wind farms where the wind blows steadier and is stronger than onshore, just as in the United States. According to a report prepared by the National Development and Reform Commission on the Medium and Long-term Development Plan for Renewable Energy in China, the country has the potential for over 1,000 GWs of wind power. Some 300 GWs of that total would be located onshore with the balance offshore. The offshore offers significant potential because it can be placed closer to those regions that are desperately short of power such as the economically well-developed eastern areas that have a shortage of fossil fuels.
The country’s first offshore wind farm began construction in March. Plans call for installing 34 turbines that will produce 267 GWs of electricity annually at a cost of $336.6 million. The electricity from this wind farm is planned to power the 2010 World Expo to be held in Shanghai. Once again, China will use a high-profile international event to showcase the country’s economic progress.
Building wind farms offshore may also ease the problem of transmitting the electricity from the western desert locations most ideal for wind farms to the more populous eastern coastal regions of China. At the present time, China is building wind farms faster than it can move the power to market. According to a local renewable energy consultant in China, only about half the country’s electricity generated by wind turbines can be transmitted. But as the photo below shows, China is capable of building massive power transmission systems if they want and need them.
Exhibit 10. Massive Transmission Grids Are In China’s Future
Source: The New York Times
It is clear that the role of wind power in the world’s energy equation is growing. The public has yet to really embrace wind power, but it is becoming more acceptable so long as the wind farms are located well away from the populous areas. What is being highlighted now is the battle brewing over constructing long-distance transmission lines to haul the power from remote areas to consuming markets. This is a political battle that will need various compromises if renewable energy is to meet the lofty goals envisioned for it in solving our energy and emissions challenges. Based on the years of political battles waged over permitting the Cape Wind offshore energy project in Nantucket Sound off Massachusetts, we are not optimistic about the willingness of powerful political interests to compromise on the transmission issue.
For those who don’t spend their lives in the stock market, talking one’s book refers to money managers, who after buying stocks, give interviews where they talk up the merits of these investments in hopes other investors will follow them and bid up the share prices bolstering the managers’ performance. OPEC last week issued its July monthly oil report and predicted that after two years of global oil demand declines, consumption would be higher in 2010.
Based on the recently released economic forecasts from the International Monetary Fund and the World Bank suggesting that global economies will grow more strongly next year than previously believed, OPEC has produced its first 2010 oil market forecast calling for an increase of 500,000 barrels per day (b/d) in demand. This increase follows an estimated demand contraction of 1.6 million b/d in 2009, unchanged in this latest OPEC forecast. Two points in the OPEC forecast stand out. First, the organization suggested that the range of possible forecasts in 2010 is from a gain of 200,000 b/d on the low side to an 800,000 b/d increase on the upside. The difference in the optimistic and pessimistic forecasts is the health of the U.S. economy and gasoline demand. OPEC also cautions about the possibility of a warm winter, which would cut demand. Based on the recent announcement by NOAA of the presence of an El Niño phenomenon that is often associated with milder winters in the northern regions of the United States, winter energy demand in 2009-2010 could be at risk.
The other data point OPEC had in its 2010 forecast is a healthy growth forecast for biofuels. OPEC is predicting growth of 150,000 b/d, which has to come out of the transportation fuels demand. Increased gasoline consumption in the United States next year would imply more ethanol use. With other alternative fuels making inroads into gasoline demand, we suspect this is an area of stealth vulnerability to the demand forecast since these fuels generally fly below the radar screen.
As expected by all forecasters, the strength in oil demand next year will come from non-OECD countries and in particular, China. OPEC sees China accounting for nearly half of the projected demand growth from non-OECD countries. OPEC does caution over the actions the Chinese government is taking to reduce its economy’s energy intensity, develop alternative energy sources and its efforts to push the use of more alternative fuel vehicles. These strategies all argue for a moderation in oil demand growth.
It is interesting to compare the oil demand forecasts of the International Energy Agency and OPEC for 2009 and 2010. For this year, the IEA is looking for a fall in global oil demand of 2.5 million b/d compared to OPEC’s forecast of a contraction of only 1.6 million b/d. In 2010, both organizations expect oil demand to increase with the IEA looking for growth of 1.4 million b/d while OPEC sees demand up only by 0.5 million b/d. I’m sure OPEC is hoping the IEA forecast comes true as there are positive implications for the call on the cartel’s oil output. Under OPEC’s forecast, the call on OPEC oil actually falls from 28.5 million b/d this year to 28.1 million b/d next. A decline in 2010 would represent a third straight year of falling OPEC output. If the IEA demand forecast is right, then the call on OPEC oil would rise in 2010. OPEC members are probably keeping their fingers crossed that better times are only a few months away.
Critics of the British Government’s energy and emissions plan point to its goal of turning the most expensive and least consistent fuel sources – wind and solar – into base load electricity sources for the country. The result, according to the critics, is that power costs will climb sharply and reliability will be at risk. In their view, the British Government is turning electricity economics on its head to the detriment of consumers.
In the U.S. the Obama administration’s energy and carbon emissions policy seems to be based on similar feel-good concepts. The Administration is favoring wind, solar and biomass over nuclear, natural gas and clean-coal. By approving regulatory and/or government mandates for using renewables, the mix of fuel sources will change as well as the trajectory of future electric power prices. The possible economic problems from these mandates are only now becoming more visible. We clearly will hear much more about this issue in the coming months and years.
An article on the green power movement in China published in The New York Times highlighted the cost issue in that country. The author reported on the issue of solar power projects being proposed and built in China and the cost of the power they will produce. The Chinese government in recent years punished three of its largest power companies by restricting them from building more coal-fired power plants because they had failed to comply with environmental regulations at existing coal-fired plants. To meet their growing power needs, the companies agreed to pay $0.59 per kilowatt hour for electricity to be generated from new solar facilities.
Since then the renewable energy frenzy has mushroomed in response to the Chinese government mandate for renewable fuel use. Since most power plants are built and operated with loans from Chinese state-owned banks, the issue of power plant economics has become increasingly important to the government. Poor project economics may mean low electricity prices but likely loan losses as the power companies don’t earn enough to pay off the cost of the plants. Thus this spring when the government solicited offers to build and operate a 10-megawatt photovoltaic solar power plant, the lowest bid was for a $0.10 a kilowatt hour price. The government rejected the bid as too low as it reasoned that the state-owned bank would lose money on the loan to finance the plant. The subsequent
winning bid was for a rate of $0.16 a kilowatt hour. This rate is well below the earlier $0.59 rate, but a two-thirds drop in raw material costs has helped to lower the breakeven price for new plants. The generating company’s general manager, however, was quoted as saying the bid price was probably too low and that $0.22 to $0.23 cents a kilowatt would have been fairer.
At the same time these power deals were being entered into the electricity grid was buying power from new coal-fired power plants at $0.04 to $0.05 a kilowatt hour. Wind turbines have been selling electricity recently at $0.07, down from $0.10, a kilowatt hour several years ago. The Chinese government is supposedly accepting these higher renewable energy prices because it is concerned about the country’s limited coal reserves – only 41 years at current consumption rates.
In the United States, many electric utilities provide an option for its customers to purchase “green electricity” at a premium price. We have yet to meet many people who elect this option except politicians such as the mayor of Houston. People understand that the utility cannot segregate the electricity it delivers to one’s home but it can buy an equivalent amount of power from a clean-energy generator and charge the higher price to those customers who want to “feel good.” The problem becomes when electricity suppliers need to commit to more green-energy then they are selling.
The cost problem is highlighted by the situation at the municipal electricity provider, Austin Energy, in Austin, Texas. In 2000, Austin Energy decided to buy clean-energy from a wind farm in West Texas so it offered it through a program, GreenChoice, which sells electricity generated only from renewable sources. When the first batch of green electricity was offered to consumers, Austin Energy provided them with a 10-year fixed price guarantee. That has worked well for some consumers as there have been periods since 2000 when traditional fossil fuel prices have spiked making conventional electricity more-expensive than the renewable energy price.
The rising cost of developing new renewable energy sources has pushed new GreenChoice batches of power up in price to where they are now three times more expensive than the standard electricity rate. That reflects the fact that renewable energy costs have climbed by fivefold since 2000. The impact is that the higher renewable energy price adds about $58 a month to the electricity bill of the average home in Austin. Since commercial enterprises buy 83% of the green energy volume, their budgets for electricity are taking large hits, especially difficult in this recession.
GreenChoice has been trying to sell its latest batch of green power for the past seven months. The power is so expensive Austin Energy has only been able to sell one percent of the volume. The economic problem for Austin Energy is growing as it now has committed to buy power from a solar plant that will cost two-times the price of the current unsold green energy. All this at a time when the Austin City Council has mandated that Austin Energy generate 30% of its electricity from renewable sources by 2020. So what’s the likely solution? Austin Energy is considering possibly spreading the higher cost of green energy across all customers as one option. They are also hopeful that new transmission facilities will be built that may reduce the current cost of bringing wind power from West Texas. Whether this later development happens or whether spreading the cost across all the customers is fair are not necessarily the right questions. The financial viability of the utility certainly is. Austin Energy was created to sell the power from coal- and natural gas-fired plants owned by the city of Austin. In an era where social issues outrank bad business judgments, just living in this country, or Austin, Texas, may mean all citizens are going to be sharing the pain of subsidizing uneconomic decisions for a few.
The media has been noting that June in the Northeast was atypical weather-wise – it was cooler than normal, wetter than normal and darker than normal. According to reports from the National Climatic Data Center of the National Oceanic and Atmospheric Administration (NOAA), temperatures in Rhode Island made it the 10th coolest June in the 115 years of recordkeeping. The month was also the 10th wettest month on record. The average temperature was 3.2 degrees below normal and the state experienced an average of five inches of rain during June. Of course, in the area where our summer home is located (southwest Rhode Island) we had more than five inches of rain in one day alone, which produced localized flooding.
In Massachusetts, June average temperatures were the 9th coolest on record. The Providence Journal reported that at the Blue Hill Observatory in Milton, Massachusetts, June 2009 was the second dimmest month on record going back to 1885, the longest continuous record in North America. The observatory uses a pyroheliometer to record sunshine, which burns a line on a card when the sun is shining. June had less sun in the Northeast than any June since 1903, when the sun was out less than 25% of daylight hours. In addition, the month was one of the five dimmest months of all, out un-shining almost all the Novembers, Decembers and Januaries. This is an amazing development when one considers that June is the time of the summer solstice when the month has the most daylight.
As the paper pointed out, the cool temperatures and dim light were associated with increased clouds. Cloudiness is called albedo by weather experts and is thought by some to be the way the planet regulates temperatures. NOAA pointed out that their data showed June temperatures nationwide to be near the long-term average as well as for the amount of participation. The Providence paper also pointed out that the barometer has been stuck below 30 inches, a persistent low pressure for most of this summer. As the hurricane season develops, a low pressure area helps to attract storms.
This phenomenon of hurricanes moving up the East Coast has been talked about for the past few years by storm forecasters who point to the 1950s as the appropriate analog period. Having grown up during those years in Southern New England, we lived through a number of hurricanes that tracked the coast from Miami to Maine. With a summer home in Rhode Island we watch this pattern closely, but then again by living in Houston it would appear we have a “storm wish.”
Offsetting positive news comes from NOAA, which states that an El Niño has developed in the Pacific Ocean that usually suppresses Atlantic Basin tropical storm formation. NOAA will be updating its seasonal hurricane forecast on August 6th, as well as most other hurricane forecasting groups. Among other weather trends that arise from El Niño are greater participation in the Southwest during the winter, more winter coastal storms along the West Coast and less wintry weather in the North. These trends should be of concern for energy watchers who continue to be treated to lower than expected energy demand due to the recession and cool weather in the populous North. This appears to be one of those times when the energy industry can’t catch a break – demand down due to the recession and no help from weather.
The first half of 2009 was all about the “green shoots” associated with a global economic recovery. An old Wall Street boss of mine referred to the phenomenon of looking for or counting on good news or positive data points among the dung of reality as “wishing and hoping.” Today, investors would tell you that to be successful in the professional investment performance derby managers must be ahead of the crowd in recognizing and seizing investment trends. Of course that means grasping at straws that appear to be early signs of economic trend changes while being fully cognizant that what they are grabbing may prove to be nothing but straw – the dried out green grass from prior growing seasons.
This spring investors seized on improvements in highly economically sensitive activity measures such as the Baltic Dry Index that measures the daily rate charged for cargo ships hauling bulk materials such as iron ore. That index, after falling nearly 95% in the second half of 2008 from its all-time peak, began to rise this spring as China waded into commodities markets to restock the country’s depleted inventories of raw materials while taking advantage of depressed prices. From the low of last year, the BDI has risen nearly 550%.
Purchasing raw materials was further encouraged by Chinese businessmen’s expectations of a demand rebound in response to
Exhibit 11. BDI Was Early Green Shoot But Fading Now
Source: Baltic Index, PPHB
China’s financial stimulus efforts. That occurred in the early months of 2009, but then seemed to ease off in April and May before resuming its recovery recently. The government’s economic stimulus came with a significant step-up in bank lending designed to bolster domestic consumption growth.
Exhibit 12. China’s Stimulus Plan Is Bold
Source: US Global Investors
Manufacturing output in many countries around the world has begun to show signs of recovery suggesting that the coordinated government stimulus efforts are making a difference in the course of economic activity. The problem is that stimulus efforts are making a positive impact on economic activity; however the pace of the recovery is quite slow. If activity accelerates then we could see a sustained pattern of industrial commodity prices rising further during the rest of 2009.
Exhibit 13. China Lending Like Crazy
Source: WSJ.com
As shown in Exhibit 14, the top eight categories of industrial commodities we have been tracking experienced increases of greater than 20% during the first six months of the year. The top eight categories included crude oil and silver, which often are not immediately thought of as industrial materials.
Among the poorest performing commodities so far this year are coal and natural gas, but both these fuels have suffered from reduced energy demand. Additionally, both fuels have been targeted by the U.S. government to reduce their consumption as a part of efforts to reduce carbon emissions. The recently passed cap-and-trade legislation by the U.S. House of Representatives will make coal and all other fossil fuels more expensive to use as power plants, refineries and petrochemical plants must pay for carbon emissions associated with using them. If either economic activity turns up more sharply than currently expected and/or the cap-and-trade legislation is revised or rejected, coal and natural gas might turn in better than expected price performance during the second half of 2009.
Exhibit 14. Industrial Metals Prices Respond To Green Shoots
Source: The Wall Street Journal, London Metals Exchange, PPHB
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Parks Paton Hoepfl & Brown is an independent investment banking firm providing financial advisory services, including merger and acquisition and capital raising assistance, exclusively to clients in the energy service industry.
