Musings from the Oil Patch -March 2, 2010

• Green Jobs: Real Or A Figment Of Proponents’ Imaginations?
• Gas Shales May Change More Than U.S. Energy Markets
• More Wind Energy Potential In U.S. – Should We Relax?
• TVA Looks To Cut Customer Electric Consumption
• Global Warmers Believe All Weather Supports Their Case
• Cost Remains Critical Ingredient In Wind Power Development
• Energy Costs And The Cruising Industry

Musings From the Oil Patch
March 2, 2010

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

In the push for increased government support of more funding for renewable energy sources, an emphasis has been put on the number of “green jobs” that will be added.  This focus is even greater in light of the ongoing recession and the high unemployment it has created.  The problem with green jobs is they are illusive to count, and despite all the studies proclaiming how many will come from the renewable spending, there are serious doubts whether they actually exist.

We recently read a 97-page study published by the University of Illinois’s College of Law (UI) prepared by four professors representing the economic, business and law disciplines about green jobs.  The study is entitled “Green Jobs Myths” and its thrust is just as the title suggests.  The study takes an interesting approach because it is essentially a detailed examination of four major reports by global institutions and the problems they have in their determination of the impact on green jobs that will come from governmental efforts to push renewable energy projects and restricted carbon emissions.

The report begins by making the following point: “The assertion that ‘green jobs’ can be created to improve environmental quality while reducing unemployment is behind an aggressive push for a ‘green economy’ in the United States and elsewhere.”  The report goes on to point out that all the studies focus on the significant job growth that can come from investment in a green economy.  The report quotes a 2008 U.S. Conference of Mayors (Mayors) report dealing with current and potential green jobs saying they can provide “up to 10% of new job growth over the next 30 years.”  In an economy that appears to be challenged to create new jobs, this forecast has to be welcomed.  Another study, by the American Solar Energy Society (ASES) in December 2008, projects 40 million green jobs by 2030 assuming an “aggressive deployment forecast scenario.”  As the UI study initially concluded, with the prospect that every dollar of investment in green energy projects will be repaid many times over, it is hard not to see the prospect as a fantastic opportunity.

The UI study examined four reports that attempt comprehensive analyses of the green jobs situation as opposed to accepting anecdotal claims made by many other reports.  The four reports the UI study looked at were all published in 2008 and they include: the United Nations Environmental Programme [sic] report (UNEP); the Mayors report; the ASES report; and the Center for American Progress report (CAP).  The UI study says that before accepting the green job claims, one must examine “the underlying arguments made in favor of them, not just assertions or the hyperbole of political discourse.”  One part of that examination is to understand the objectives of the organizations, and in some cases their partners, that prepared the reports.

The UNEP report was prepared by the United Nations’ staff that focuses on environmental issues and the Worldwatch Institute, an environmental advocacy group noted for promoting population reduction, and with the assistance of the Cornell University Global Labor Institute, a pro-union organization.  That report begins with the acceptance of the conclusions of the Intergovernmental Panel on Climate Change (IPPC) report that global warming poses a significant threat to the quality of life on the planet.  The Mayors report, on the other hand, was prepared in an effort to forge a consensus among a diverse group of American local politicians and is making the case for green jobs as an urban economic redevelopment strategy.  This report recommends specific benefits for each American community that would be paid for by the federal government.  The ASES report is published by a trade group for an alternative energy industry – solar power – that certainly is advocating this technology, its benefits along with justifying the federal government subsidies.  The CAP report was prepared by a “left-leaning” think tank in Washington, D.C., founded by John Podesta, the former Clinton administration staffer, along with the Political Economy Research Institute (PERI) at the University of Massachusetts that describes itself as “progressive” but does note its links to organizations such as ACORN.

The problem with these reports, and many other efforts at determining the impact of renewable energy investments on green jobs, is to understand what constitutes a green job.  Virtually every report has a different definition making comparisons between them almost meaningless and further raising issues with their forecasts.  Additionally, because there are no solid numbers on existing green jobs the growth projections are substantial.  The explanation for these high growth rates is the assumption of the acceptance of specific technologies that may or may not prove economic. 

Furthermore, there is little examination of the impact on existing jobs in industries that would be lost by the adoption of these new technologies, something we will look at later in this article.  Lastly, there is the potential for green jobs to represent inefficient use of labor within the production process meaning they are marginal jobs.  This is especially important if the government decides to provide subsidies for industries that provide green jobs leading to increased profits from merely having jobs declared “green.”

Before we can determine how many more green jobs will be created by government spending and private industry investment, we need to figure out how many green jobs currently exist.  The ASES report claims that in 2006 there were 8.5 million direct and indirect jobs in renewable energy and energy efficiency.  They go on to say that without any further change in government policies, by 2030, there will be 16.3 million green jobs.  On the other hand, the Mayors report finds only 751,051 green jobs compared to the ASES’s estimate of 8.5 million.  The CAP report projects that with a $100 billion in new federal spending for solar and wind power, biofuels, smart electric grid, mass transit and building retrofitting, the national unemployment rate will be reduced by one percentage point, or creating two million new jobs.  The UNEP report doesn’t estimate how many green jobs there are in the United States, but rather focuses on world totals.

While these hoped-for new green jobs are the focus of the reports, little work has been done to estimate the number of jobs that might be lost due to the embrace of renewable energies and technologies.  An interesting, and detailed, analysis of this problem has been done relating to the Obama administration’s spending for smart electric meters under the American Recovery and Reinvestment Act.  The government allocated about $4 billion in spending on creating the smart grid with much of the money dedicated to installing close to 20 million smart meters over the next five years. 

Exhibit 1.  Conventional Electric Meter

Source:  maine.gov

Smart meters are digital versions of the spinning electric meters that record the amount of electricity used by homes that are ubiquitous in America.  Spinning meter technology has not changed much in more than a century and must be read by workers.  Smart meters automatically transmit the electricity consumption data to the utility virtually eliminating the need for human intervention.  Smart meters promise more accurate electricity measurement along with the ability to eventually provide efficient energy management. 

Exhibit 2.  A Smart Meter – Coming To A Home Nearby

Source:  FreeFoto.com

The analysis points out that about 40 million smart meters have been deployed worldwide, mostly in Europe.  Smart meters currently are being installed in Dallas and Houston in a process that will take several years to complete.  The jobs created by smart meters can be classified into four categories: manufacturing; installation; research and development; and information technology (IT) services. 

It generally takes two certified electricians half an hour to replace the old meter with a new digital smart meter.  That means that these two electricians could install about 15 meters per day, or roughly 4,000 in a year.  If we were installing one million meters in a year, there would be about 500 new installation jobs created.  If the 20 million meter government target is realized in five years that means about four million meters per year, or about 2,000 new installation jobs created for the next five years.

According to GE (GE-NYSE), the manufacturing of smart meters is highly automated and mostly done in Europe so there are very few domestic manufacturing jobs to be generated by this investment program.  There would be some high-paying research and IT jobs, but most likely in the hundreds or low thousands of new positions at best.

But what about potential job losses from smart meters?  If it takes one meter reader roughly 15 minutes to read a single meter, in a full day he can read about 30 meters, or 700 per month.  Since meters are read each month, this becomes the base period for calculating the number of meter-reading jobs.  If there are one million meters to be read each month, that requires about 1,400 meter-readers.  In five years, under this investment program, 20 million manually-read meters will disappear, or four million meters per year.  That means each year there will be a loss of 5,600 meter-reading jobs, or a total of 28,000 positions over five years.  Therefore, while smart meter investments are touted as a way to add green jobs, besides the energy savings that will come from the use of the meters, the effort actually will destroy jobs. 

As Dallas and Houston residents are finding out with their monthly electric bills, they are paying extra for the upgraded meters, while ensuring that their utility provider will save money by reducing its headcount from eliminating meter-reading positions.  After going through this analysis, we were reminded of the controversial 2008 study of the Spanish wind energy industry.  The study concluded that for every wind energy job created, two jobs were lost.  The study’s conclusions were roundly rejected because the institute that performed the study supposedly received some funding from the oil industry. 

What the smart meter analysis and the UI study reinforces is that critical analyses using solid numbers about green jobs may prove that the claims by groups using fuzzy definitions and math about how many green jobs will be created by renewable energy investments are wrong.  The level of analysis required to challenge the green job claims will be similar to the current effort examining the science behind global warming. 

The U.S. natural gas industry has been focused on the effect the commerciality of gas shale formations is having on the domestic industry.  One result is that after years of declining gas production, the U.S. has experienced a rise in domestic supplies.  Secondly, the Potential Gas Committee has suggested, based on its study, the country has huge gas resources that can be developed with today’s drilling and completion technologies.  They did not, however, suggest that all the potential natural gas resources identified are commercial at current gas prices, and especially at the sub-$5 per thousand cubic feet (Mcf) prices being experienced now.  One of the key new basins that will supply this growth in natural gas production is the Marcellus Shale that extends from West Virginia through Pennsylvania and Ohio and into New York.  Reportedly this is the largest basin in areal extent (95,000 square miles vs. 5,000 square miles for the Barnett Shale) and possibly in the amount of gas potential with an estimated 500 trillion cubic feet (Tcf) of reserves. 

While Marcellus Shale gas has been targeted for the Northeast energy market, not only due to its close proximity to the major consuming markets in Pennsylvania, New Jersey, New York and New England, Canadian gas pipeline companies are thinking that

Exhibit 3.  Marcellus Is Largest U.S. Shale Basin

Source:  Geology.com

some of this supply could move north of the border to satisfy Ontario’s market.  TransCanada Corp. (TRP-NYSE) along with Ontario-based Union Gas Ltd. (UGSLF.PK) and New York-based Empire Pipeline are seeking input from Marcellus Shale producers about their willingness to ship gas across the border to the Ontario market.  The gas pipeline companies are holding “open season” calls to determine about how much supply Marcellus Shale producers might be willing to commit. 

The significance of opening up the neighboring Canadian market for Marcellus Shale production is that it could help boost the basin’s demand and consequently the price for natural gas in the region.  Importantly, natural gas prices in the region tend to be higher than in either the Southeast or Southwest geographic regions because of the closer proximity to final consuming markets.  This price differential reflects the shorter distance the gas must be moved.  If gas demand from the basin rises pushing up local prices, it could have a positive impact on national gas prices. 

Marcellus Shale gas, however, could also face growing competition from increased liquefied natural gas (LNG) imports from the Canaport LNG terminal located near Saint John, New Brunswick, that will ship gas into northern New England.  Additionally, there is growing excitement about the potential for the Utica Shale gas play unfolding in Quebec that could provide gas volumes for Ontario or New England and New York, putting downward pressure on Marcellus Shale gas markets and prices.

One aspect of the “open season” call is to determine if there are sufficient gas volumes that might move across the border justifying the reversal of the flow of existing pipelines.  Those lines that terminate at the Niagara River currently bring gas from Western Canada into the Northeast region of the United States.  In this case, Marcellus Shale gas would flow into Ontario on a TransCanada pipeline and then westward to its Dawn hub near Sarnia, where Union has major natural gas storage facilities.  This shift in gas flow would reduce the need for as much gas from Western Canada.  The shift will also create other challenges for Canadian pipeline companies and Canadian E&P companies.

Exhibit 4.  Gas Shales May Upend Canadian Gas Flows

Source:  Globe and Mail

Ontario’s natural gas consumption is roughly 2.5 billion cubic feet per day (Bcf/d), or slightly more than 10% of U.S. gas consumption.  Marcellus Shale production is projected to range from a minimum of 2.5 Bcf/d to as much as 10 Bcf/d by 2020.  The problem for pipeline companies facing the loss of this Ontario gas demand is its impact on their shipping economics.  Declining volumes would drive up pipeline tolls that are dependent on the volume of gas flowing through the line, which would further encourage consumers to switch to Marcellus Shale gas.

Besides the pipeline companies, Canadian gas producers would need to look to other markets for their output.  That could increase the competition for markets in the western United States or for export in the form of liquefied natural gas (LNG).  Recently Apache Corp. (APA-NYSE) took an ownership position in a proposed LNG terminal off the coast of British Columbia near Kitimat.  The LNG would be exported to the northern Pacific countries such as Japan and South Korea, two of the world’s largest consumers of LNG.  Apache’s investment was designed to provide the company an outlet for natural gas production the company anticipates developing from the Horn River and Montney Shale formations of Western Canada.  To the extent that surplus Western Canadian gas competes for western U.S. markets, there could be downward pressure on natural gas prices in the future.

The long-term ramifications of this potential change in natural gas flows in Canada could be quite significant.  It could reverse a 50+-year history of the Canadian natural gas pipeline industry and the way Canada’s E&P companies have targeted the development of the Western Canadian Sedimentary Basin.  In 1958, then Canadian Prime Minister John Diefenbaker supported the construction of the 3,500-kilometer (2,175-mile) TransCanada pipeline from Alberta to Central Canada in order to support the development of western gas resources while providing secure energy supplies for the central and eastern regions of the country.  That history of mutual dependency and support could be turned on its head with other knock-on events we haven’t even imagined at this point.  It is safe to say that the impact of the North American gas shale developments potentially will cause very dramatic changes to the natural gas industry.  Hopefully these changes will be positive. 

The Department of Energy’s National Renewable Energy Laboratory (NREL) has recently released a study, done in conjunction with AWS Truewind, suggesting that the U.S. has substantially more wind energy potential than previously thought.  The study concludes the U.S. has sufficient wind resources to be able to generate nearly 37,000,000 gigawatt-hours (GWh) per year of electricity, or more than nine times the nation’s current consumption rate.  AWS Truewind is an international leader in renewable energy technology applications, advanced atmospheric modeling and measurement, and engineering services.

This study updates an earlier one done in 1993 by Pacific Northwest Laboratory that estimated the potential for electricity from wind power in the U.S. at 10,777,000 GWhs.  The new study suggests the wind energy potential of the United States is three times greater than the earlier estimate.  The results from the latest study certainly have significant implications in the national debate about the potential for a clean-energy future, however, like all high-level studies, the details of the study often suggest a less rosy outlook. 

The results of the study were applauded by Denise Bode, CEO of the American Wind Energy Association (AWEA).  She issued a statement saying, “This new analysis confirms that America is blessed with vast wind resources that can energize our economy, create jobs, and avoid carbon for years to come – if we give ourselves the policy tools to do so, including a strong national Renewable Electricity Standard with aggressive, binding near- and long-term targets.  A national Renewable Electricity Standard would not only ensure that we tap our nation’s vast wind resources, but create thousands of new American jobs today, manufacturing the 8,000 component parts that go into a modern wind turbine.”  She went on to say, “The wind resource is there, vast and inexhaustible, waiting for us. Meanwhile, the economy can’t wait, job creation can’t wait, and America can’t wait. We need Congress to act now and pass a comprehensive climate and energy bill that includes a strong national Renewable Electricity Standard.” 

Obviously companies involved in wind energy are claiming the results of this study demonstrate the huge potential for their business.  If the prospects for wind energy are so attractive, what’s holding it up?  Could it be that some of the beauty of wind power is only in the eyes of its supporters, as demonstrated by the strong opposition to the Cape Wind offshore wind project in Nantucket Sound?  If wind is free, why does its delivery cost so much that it needs significant federal, state and local subsidies?  Moreover, how do we deal with the costs and challenges of moving the power generated by the wind resources to where it will be consumed?  Building long distance, high voltage electricity transmission lines has become a challenge due to permitting problems.  These transmission lines also are proving both a technology challenge due to the amount of power lost during its movement and an economic cost due to this lost power on the electricity provider. 

The report involved a joint effort of the NREL and AWS Truewind using the latter’s dataset that estimated the gross wind capacity factor, not adjusted for losses, at a spacial resolution of 200 meters (656 feet) and a height of 80 meters (262 feet).  The special measurement reflects the areal extent required for each wind turbine.  The height measurement reflects the better understanding that stronger and more consistent winds are found at this greater height than the height employed in prior studies.  Based on these parameters, the study was able to determine the area of land experiencing sufficient wind strength to power a turbine a minimum of 30% of the time within each of the 48 contiguous states.  The amount of potential land meeting this requirement is then reduced by eliminating any land that is not capable of being developed such as wilderness areas, forests, national parks, urban areas and wetlands.  The reduced land area is then multiplied by the nameplate capacity representing newer, larger wind turbines that represent five megawatts per square kilometer to estimate the potential electricity that can be generated. 

There are several important points about how the study data was generated that impact its conclusions.  First, the spacial resolution measure determines how far apart wind turbines should be located or, in other words, how large wind farms need to be.  The height measurement used to judge the wind’s potential is significantly higher than the height used in the 1993 study because, as we have learned in recent years, wind is more consistent and stronger at the taller height.  That said, the turbine height utilized represents the equivalent of a 26-story building, certainly something that towers over nearby structures and can be seen from much greater distances than smaller turbines.  What role will visual pollution play in further restricting the amount of acreage that can be developed with wind farms?

The most interesting conclusion from this study is the percentage of each state’s acreage that would need to be covered with turbines in order to reach the projected power capacity.  In order to build the approximately 10,000 GW of potential wind power capacity estimated to exist, the nation needs to commit nearly 27% of its land mass to the endeavor.  That is a significant number when one appreciates that the Lower 48 states cover roughly 7.7 million square kilometers, or 2.97 million square miles of area.  When one begins to look at individual states, the estimates of the percentage of area devoted to wind farms, in our estimation, become unrealistic.  For example, 91% of Nebraska, 88% of South Dakota and 84% of North Dakota need to be devoted to wind turbines according to the study.  In the nearby table (see Exhibit 6), we have highlighted the seven states that are targeted as having 50% or more of their acreage attractive for deployment of wind farms.  There are five states that could turn between 40% and 50% of their acreage into wind farms and three in the 25% to 40% range. 

In Texas, the current leading state for installed wind power capacity, slightly over 55% of its land mass would need to be covered with wind turbines if the study’s wind energy potential is to be realized.  If one imagines the “horror” of how environmentalists view old-time photos of the oil booms in Texas and Oklahoma in the early 1900s, one wonders how they will view the landscape if wind farm boom towns suggested by the study are built. 

Exhibit 5.  Boom Wind Farms?

Source:  American Petroleum Institute

Exhibit 6.  A Few States Need To Be Covered With Turbines

Source:  NREL and AWS Truewind study

The NREL study proclaims that in a single year, assuming all the wind power capacity it forecasts is in place, the turbines could produce nearly 365 quadrillion British thermal units (Btu) of energy, equivalent to the energy from all the proven oil and gas reserves in this country as estimated by the Energy Information Administration (EIA).  Once again we have the promise of a totally clean energy future if we only devote the resources and land to constructing wind farms.  That may be an acceptable proposition if you live in Connecticut (my home state) where only 5.3 square kilometers (2.05 square miles), or four one-hundredths of one percent of the state’s land mass can even support wind turbines, as opposed to 55% of Texas’ landscape.  Making judgments on the basis of unrealistic assumptions is misleading and disingenuous.  But since the clean-energy industry adheres to the belief that if everyone just followed their lead we all would live happily ever after, fantasy often becomes reality. 

The Tennessee Valley Authority (TVA), one of the cornerstone developments of President Franklin D. Roosevelt’s New Deal, is struggling with its finances.  As a result, it has begun a reevaluation of the structure of its wholesale electric power rates charged to distributors.  Aging equipment, increased electricity demand, a push toward more renewable energy use and greater environmental accountability are behind the re-examination.  To increase its revenues and energy efficiency, TVA has proposed two new wholesale rate structures – a seasonal demand structure and a time-of-use structure. 

TVA is the nation’s largest public utility with over nine million customers in seven states – Tennessee, Alabama, Mississippi, Kentucky, Georgia, North Carolina and Virginia.  The company primarily supplies power to electricity distributors representing municipal utilities and cooperatives and accounting for 85% of TVA’s revenues.  Some 50 large industrial customers and six federal installations are directly served by TVA and represent 11% of its annual revenues.  TVA also sells power off-system through the power interchange market to 12 surrounding utilities, which accounts for four percent of the company’s total revenues.

In 1992, TVA instituted its current rate structure whereby residential customers pay a flat fee for each kWh of power used.  In 2008, according to the TVA, average residential electricity use in the United States per capita was 16.3 million Btus.  For the TVA, the average had increased to 22.6 million Btus.  If the TVA doesn’t increase its supply by 2028, projections show a 15,000 megawatts (MW) shortfall.  To match supply and projected demand, TVA needs more money to increase power supply or it must convince customers to consume less power, or a combination of the two.  According to Glenn Boyles, Decatur Utilities Electric Manager, “More efficient energy use is going to be a priority.”

Exhibit 7.  TVA Covers A. Large Geographic Area

Source:  TVA

TVA has determined that all 156 electric distribution companies it supplies must decide between a demand-based rate structure and a time-of-use rate structure by May and implement the plan by October.  All customers of TVA can look forward to higher electricity bills starting this fall.  By April 2012, TVA has mandated that all distributors must implement time-of-use rates, which should stimulate demand conservation as the primary way it will balance the projected supply/demand imbalance.  Increased focus on conservation as the primary way to satisfy energy demand is not good news for energy suppliers.

The U.S. Northeast was blasted again last week by a huge snowstorm.  Besides dropping snow by the foot, the energy of the storm also created strong ocean waves and currents that contributed to low-lying flooding along the New England coast.  Earlier this year when Washington was the target of weekly snowstorms, global warming advocates were claiming that the abnormal winter weather was the result of global warming.  Of course the global warming skeptics noted the cold temperatures and record snowfalls as signs that global cooling, not global warming, was in control. 

One of the global warming supporters who chastised skeptics was Robert F. Kennedy, Jr., the son of the late New York Senator and U.S. Attorney General while in his brother’s (President John F. Kennedy) administration.  Mr. Kennedy is an environmental lawyer and a professor at Pace University Law School.  In an article about his comments about global warming skeptics, it was suggested people should examine what he said about a year ago on the topic.

After a little web surfing, we found an op-ed piece written by Mr. Kennedy and published by the Los Angeles Times on September 24, 2008.  The thrust of the article was to harangue the Republican Party’s selection of Sarah Palin as the vice-presidential candidate on its national ticket.  Mr. Kennedy believed Mrs. Palin was a “Big Oil” supporter and a global warming critic and therefore not someone he was in favor of seeing achieving national political office. 

A major thrust of Mr. Kennedy’s op-ed was that the absence of winter in the Eastern U.S. in recent years was due to global warming conditions.  He talked about the current climate conditions on Cape Cod and in Virginia and contrasted them with conditions when he was growing up in the1960s.  He said that lightning storms and strikes had tripled over the past decade in Cape Cod whereas, “In the 1960s, we rarely saw lightning or heard thunder on the Massachusetts coast.”  He went on to say that he associated electrical storms with his home in Virginia outside of Washington, D.C., where he grew up.  That caused us to reflect back to our experiences in the 1960s growing up on the Connecticut coast only a little over a hundred miles south of Cape Cod.  We experienced many electrical storms when we were growing up, including some in the midst of winter storms, usually referred to as Nor’easters.  We spent one year in the 1960s in school in the Shenandoah Valley of Virginia, but don’t remember the weather being materially different from New England’s except for the severity and duration of winter. 

Mr. Kennedy went on to talk about the snowfalls in Virginia during that period, in contrast to the lack of snow that was experienced during the winter of 2007-2008.  He said people moving into Virginia would be surprised to learn that there used to be ski runs and places to go sledding in the state.  He speculated that with snow so scarce, most Virginia school children probably didn’t own a sled.  Yes, we remember those 1960s snows well – both in Connecticut and Virginia.  We also remember all the hurricanes in the late 1950s and early 1960s that tore up the Eastern Seaboard and destroyed towns in Connecticut.  No one said they were the result of global warming as the supporters claim about hurricanes Katrina, Rita and Ike. 

In his op-ed, Mr. Kennedy went on at length discussing the snowy winters of his youth and the igloo-building and sledding experiences of his father and his uncle, the late Senator Ted Kennedy of Massachusetts.  Mr. Kennedy went on to claim that the absence of winter in Virginia could be explained by global warming.  So how does he now claim that the record snowfalls this winter qualify as being caused by the same phenomenon?  We believe Mr. Kennedy is merely using his selective memory of weather events to support a position on global warming that has yet to be truly linked.  If all unusual weather events today are due to global warming, then how do we deal with them throughout history?  We remember talking with our great-grandparents about their experience living through the Blizzard of ’88 in Connecticut when snow drifts were up to the second story of homes and tunneling out was required to survive.  How significant was global warming in 1888?

Given the controversy over the contract price negotiated between Deepwater Wind and National Grid (NGG-NYSE) for surplus electricity generated from the wind project development located offshore Block Island in Rhode Island waters; Massachusetts officials are closely watching the negotiations between Cape Wind and National Grid for the power from the project in Nantucket Sound.  To heighten the pressure on the two negotiating parties, Ian Bowles, Massachusetts Secretary of Energy and Environmental Affairs wrote a letter to them making clear the state’s position on the contract price.  Mr. Bowles wrote that “suggestions in the media that the contract negotiations could yield pricing at the level of the Rhode Island offshore wind project, which will produce power at over 30 cents (per kilowatt hour) (kWh) including transmission costs” are troubling to the state.  He went on to write, “Let me be clear.  Our expectation is that the Cape Wind project must produce electricity at a substantial discount to the Rhode Island offshore wind project.” 

We previously wrote that media speculation was that rather than the 24.4¢/kWh price, excluding transmission, negotiated between Deepwater Wind and National Grid in Rhode Island, the price would be more in the 17¢/kWh range, but that is still about twice the cost of wholesale power from other energy sources.  The Rhode Island contract price is nearly three times the wholesale power price from alternative fuels and has drawn criticism because of it.  The 24.4¢/kWh price in Rhode Island was lower than the originally discussed price that was targeted to be in the upper twenty-cent range.

A spokeswoman for National Grid said that the company had two goals in its negotiations.  “One is to help facilitate the development of renewable sources of energy, which we feel is critical to the energy future of the Commonwealth of Massachusetts and country as a whole.”  She went on to say that the second goal was “to secure the best price in terms that we can get on behalf of our customers.”  While these are admirable goals, she failed to mention the state has a renewable fuel standard forcing utilities to provide 5% of the state’s total electricity from renewable sources by 2010, a figure that escalates one percentage point per year indefinitely.  The other goal comes from the Public Utility Commission (PUC).

The Massachusetts PUC still must sign off on any contract terms negotiated between Cape Wind and National Grid.  The two parties have agreed to provide an update on their negotiations to the PUC at the end of February if they haven’t reached an agreement in the interim.  The Massachusetts Supreme Judicial Court is reviewing the “super permit” approval granted for the offshore wind project.  The Court has said it will rule on the validity of the permit within four months.  U.S. Interior Secretary Ken Salazar is scheduled to rule on the federal permit necessary for the project by April following the inability of the various parties to agree to a deal on the Indian tribe request for Nantucket Sound to be placed on the national historical register that would prevent construction of the wind farm. 

Two recent developments may impact the Interior Secretary’s decision.  First, an Interior Department investigation has determined that reviewing agencies felt rushed in their deliberations on the Cape Wind project due to pressure from the Bush administration to seek approval before the end of its term.  However, the agencies all said that being rushed did not alter their conclusions. Second, a member of one of the Indian tribes objecting to Cape Wind says the claims about the tribe’s rituals are bogus and they have no reason to object.  We are sure that Sec. Salazar would prefer for the parties to reach an agreement on Cape Wind, but our guess is the pressure to approve is growing as the deadline draws near.

The Baltic Dry Index (BDI) is considered a measure of the health of the global economy since it tracks the rate shippers pay to charter vessels to haul raw materials from their origination point to where they will be turned into products.  Lately, this index has been diving, falling by about 40% and bringing rates down to their lows of October 2009.  An article discussing this trend pointed out that the index’s decline was driven less by a fall in cargoes and more by a surge in new vessel construction.  To support this contention, the writer pointed to the capsize ships, the largest oceanic vessels and one of the workhorse class of cargo ships in the fleet.  Between 1980 and 2008, the industry took deliveries at a pace of about one new capsize vessel every two or three weeks.  This moderate growth essentially maintained the fleet’s supply/demand balance and turned the BDI into a relatively good measure of economic activity for shippers and investors.

Like many economic sectors that benefited from high prices in recent years, ship owners were incentivized to grow, thus shipyards gained a huge influx in new capsize vessel orders.  In 2009, the industry delivered 112 vessels or nearly one every three days.  This year, however, the number of new capsize vessel deliveries is scheduled to rise to 335 or almost one every day.  The result is that the BDI is dropping due to the fleet being overwhelmed with new tonnage.  To offset this weakness, the shipping industry has reverted to “slow steaming” as a way to reduce fuel consumption, a major component of a vessel’s cost structure. 

After reading about the growth of this shipping fleet, we saw an article about the growth of the cruising business.  Since we are preparing for a family cruise, the article sparked our interest.  What we found was quite interesting as it relates to the economic and energy trends of cruising.  In 1970, about a half a million North American citizens took seven-day cruises.  By 1984, that number had risen to 1.7 million travelers.  At that time analysts and industry officials grew concerned that the 52,000-berth fleet was about to be overbuilt due to the influx of new cruise liners ordered.  Surprisingly, by 1989 the number of people taking seven-day cruises had grown to three million.  The fear of overbuilding proved unfounded. 

The latest industry data suggests that in 1999 well over seven million travelers worldwide ventured forth on seven-day cruises.  The growth in cruising was supported by the industry’s continual building of progressively larger ships.  Estimates are that in 2010 the cruise industry will carry 18.4 million passengers and generate $26.8 billion in revenue.  A key to the revenue growth has been the introduction of larger ships that can support more elaborate entertainment options.  This trend was begun by Ted Arison, the founder of Carnival Cruise Lines (CCL-NYSE), in the 1970s when sharply rising fuel costs were hurting the cruise industry’s profitability.  Saving fuel by going slower began the trend that shifted the cruise ship from a transportation vehicle to a destination experience.  It is estimated today that about 25% of a cruise line’s revenues come from onboard spending. 

Interestingly, it was pointed out that the industry’s capacity growth has actually contributed to economies of scale that with the growth of onboard spending has contributed to relatively stable pricing.  The ticket price of a seven-day Caribbean cruise aboard the S.S. Norway in 1980 could be had for as little as $650.  This compares to the $631.95 cost for an inside cabin on the Carnival Dream (one of the new super-ships) for a seven-day trip beginning May 1st. 

In discussing the new super-ships, Richard Fain, Chairman and CEO of Royal Caribbean Cruises Ltd. (RCL-NYSE) stated, “The Oasis of the Seas will cost 40% less to operate per passenger than older ships.”  How is this possible?  It is largely the result of the use of new technologies for powering the ship along with other efficiencies in the ship’s design.  The Oasis has a high-tech electric propulsion system powered by diesel generators that uses nearly 30% less fuel per passenger.  Additional savings come from the installation of solar panels to generate power and the use of compact fluorescent and LED lighting throughout the ship.

Exhibit 8.  Split Hull Has Fun And Lowers Energy Cost

Source:  AP, Royal Caribbean Cruise Line

One of the more innovative energy saving applications used by the Oasis was its basic design.  In order to carry the 5,400 passengers and crew of 2,000, the Oasis was going to have to be substantially bigger – both in height and breadth – than existing ships.  The ship’s designers and engineers understood that the oversized vessel would require more energy to illuminate and air condition the vessel.  Their innovative solution was to “split the hull.”  The ship has eight decks rising on either side of an open-air courtyard.  The design allows natural light to filter in, and with a tropical garden of 12,000 plants, trees and flowering greenery acting as a natural coolant, the ship’s owner is confident it will be much more energy-efficient than older cruise ships helping to hold down fuel costs and boost profitability.

Fuel costs will continue to be a driving force impacting profitability for the shipping industry and the cruise sector in particular.  The industry will be forced to find additional ways to become more energy-efficient, especially as more coastal countries mandate low-emission fuels to be used by the vessels when they enter or traverse its local waters.  These more environmentally-friendly fuels are also more costly.  Slow steaming and higher tariffs are the answer for the cargo carriers.  Larger, more elaborate cruising experiences that generate higher spending onboard are the hope for the cruise lines.

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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.