Musings From the Oil Patch – February 5, 2008

• Oil Demand Risk: Weak Consumer and Global Economy?
• Oilfield Service Stocks: Either Stars or Dogs
• Punxsutawney Phil: Six Weeks Of Winter – Does it Matter?
• Energy Savings: Light Bubls, Wal-Mart and Consumers
• Global Warming Solutions And Costs
• Views of Alternative Energy Puzzle Energy Executives

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

Oil Demand Risk: Weak Consumer and Global Economy?

 

Last Friday, the Labor Department’s employment report shattered many economists’ views of the health of the U.S. economy and its ability to avoid entering a recession in 2008.  The report showed a loss of 17,000 jobs and marked the first monthly employment report to show a loss of jobs in the last 52 months.  The last economic report of the week capped off a period of volatile economic news including a half a point cut in the Federal Reserve’s federal funds target rate.  The rate cut, following a three-quarter of a point reduction merely a handful of days before the latest cut, has brought the discount rate to a level not seen since 2004.  The rate cut coupled with a report of an increase in new durable goods orders and news that a broad economic stimulus program urged by the President was approved by the House of Representatives caused many investors to believe that the U.S. economy’s slowdown was being cushioned and the pace of economic activity would soon accelerate.  A growing rather than declining economy means a boost for energy consumption and that suggests stable or higher oil prices.

 

With the bullish case for the economy’s near-term outlook undercut by the employment report, economists, analysts and investors shifted back to examining long term trends in economic statistics and for energy demand.  The analysis suggests that energy demand is fading and, as global economic growth forecasts are being marked down by the International Monetary Fund (IMF), it is difficult to expect crude oil prices to remain close to the $100 per barrel threshold.  Recently, we have examined several economic and investment studies of the economy and energy demand that would lead readers to conclude that global oil prices are heading down with the only questions being how far down and when?

 

In the United States, the latest economic data suggests that consumer budgets have been negatively impacted by rising energy and food prices.  The recently released data for the 2007 fourth quarter national income accounts showed that consumer spending for food and fuel was consuming a greater share of budgets while expenditures for clothing and shoes and other non-durable goods was lower compared to consumer spending in the same quarter of 2006.  The year-over-year expenditure increases in these four categories reflected what happened last year in the energy and agricultural market places.  Gasoline and energy expenditures increased by 27.9% year over year while food was up 6.0%.  Clothing and shoe expenditures were higher by 2.4% while other expenditures increased 3.6%. 

 

Exhibit 1.  Consumer Budgets Are Being Squeezed By Gas

Source: BEA, PPHB

 

Within the national income accounts, the relative importance of durable and non-durable expenditures should also be noted.  In 2006’s quarter, durable goods spending accounted for 11.3% of total personal consumption expenditures while non-durable goods spending represented 28.9%.  In contrast, last quarter, spending on durables had slipped to 11.0% of the total, but non-durable spending rose to 29.2%, which largely reflects the impact of higher prices for energy and food.  So with non-essential consumer spending being negatively impacted by rapidly rising energy and food costs, it is likely that consumer spending will remain under pressure until, and unless, the costs of these goods decline or consumer incomes rise.  The latter outcome is questionable given the current turmoil in the housing and commercial construction and credit markets.  So as Clément Gignoc, Chief Economist at the National Bank of Canada, points out in a presentation, the U.S. may be heading into a recession driven by a decline in consumer spending.

 

 

 

 

 

Exhibit 2.  A Consumer Driven Recession?

Source: NBC

 

The Department of Energy’s latest weekly gasoline stock data showed that gasoline inventories rose by 3.6 million gallons and inventories are now at their highest level in a year.  This product rise comes as refinery utilization continues to decline, falling to 85% of industry capacity last week.  For the week of January 25, gasoline demand, as measured by fuel supplied by refineries, declined to the lowest level in two years.  This data came at the same time MasterCard’s SpendingPulse report showed that gasoline purchases, measured by purchases at the pump, fell 1.7% from the prior week to the lowest level since April 20, 2007. 

 

The gasoline data is significant as other Department of Energy data showed that U.S. oil demand for the first 11 months of 2007 rose by 10,400 barrels per day (b/d).  This increase is the smallest year over year gain in the January-November period since 1995.  Moreover, the prior year’s gain was just 50,000 b/d.  The 2007 figures call into question the Energy Information Administration’s (EIA) forecast for 2007 U.S. oil demand growth of a 40,000 b/d increase.  

 

We also found the IMF’s recently revised lower 2008 economic growth forecasts for all countries and regions of the world could possibly mark the high point for crude oil prices for the immediate future.  The prior IMF 2008 economic forecasts had already signaled a slowing in growth from the rate experienced during the past two years, but now that reduced growth has been marked down more.  Significant in the revisions is the IMF’s reduction of the growth rates for both advanced economies and emerging market and developing economies.  When put in the context of world economic growth and its correlation to oil demand and oil prices, we noted from Mr. Gignac’s presentation that whenever we experience periods of

Exhibit 3.  IMF Has Cut Its 2008 Growth Projections

 Source: IMF, PPHB

 

Exhibit 4.  Growth Depends on Various Country Contributions

Source: IMF

 

above average economic growth, crude oil prices have moved higher.  When the growth rate has been below trend, oil prices have retreated or remained stable at lower levels.  It looks like we may be entering another period of weak global economic growth that will only be reversed when oil prices ease.

 

 

 

 

 

 

 

Exhibit 5.  High Growth Associated With High Oil Prices

Source: NBC

 

It is important to note two other aspects of the current economic environment.  First, sentiment about the economic health of Japan and European countries have been declining suggesting that those regions are facing weakening business conditions.  That should mean less energy consumption. 

 

Exhibit 6.  A Worldwide Recession Brewing?

Source: NBC

 

Second, many forecasters are projecting that there is a de-coupling of the economies of the United States and China.  Part of the explanation for the de-coupling theory is the rapid industrialization of China and the potential for rapid growth of domestic consumption that would offset any decline in exports due to an economic slowdown in the advanced economies of the world.  Therefore, these forecasters believe that China’s economy can continue to grow at rates similar to its recent performance of 10% to 11% per year and that energy demand, especially demand for petroleum products, can grow at a continued high rate in order to sustain the country’s economic growth. 

 

Exhibit 7.  Can China Grow In A Global Recession?

Source: NBC

 

Not all forecasters embrace this de-coupling theory.  Some believe that a U.S. recession or slowdown will impact China and cost the country between two and three percentage points of its projected economic growth rate.  Clearly that demand cut would impact China’s energy and oil demand growth.  The economists who question the de-coupling theory suggest it is not just the United States that investors should watch, but other regions such as Europe and Japan, and most importantly Asia.  They point out that a lot of raw materials and partially assembled products are shipped from other Asian countries to China before being sent to the developed economies of the world.  So it will be important to watch what goes on in these other economies to have a better understanding of the possible impact on global oil demand of an economic recession in the industrialized world.

 

In looking at all the economic data and forecasts, one would conclude that if there is to be a weakening of energy demand, it will develop during the first half of 2008.  That would support the rationale for OPEC’s decision not to change the organization’s output at last week’s meeting, but rather to defer their decision until their March 5th meeting.  At that time, OPEC will be facing the seasonal demand fall of the second quarter as winter ends, along with the fear of repeating the organization’s 1997 action in boosting output just as economic activity was collapsing due to the Asian currency situation.  These fears will cement a decision to cut its output rather than maintain or boost production to try to lower global oil prices.  Depending on how much and how fast OPEC cuts its output will likely determine the amount that oil prices retrace their 2007 rise.  However, an oil price fall, coupled with the financial and fiscal stimulus being injected into the U.S. economy will probably jump-start its growth and produce a late 2008 economic recovery.  Important for investors is that the stock market will be climbing well before that recovery becomes obvious, but energy stocks may struggle during the early part of that market recovery.

 

Oilfield Service Stocks: Either Stars Or Dogs

 

Looking at the performance of the oilfield service stocks as the companies report fourth quarter and full-year 2007 earnings results reminded us of the growth matrix made famous by Bruce Henderson and his associates at the Boston Consulting Group (BCG).  Mr. Henderson, a Harvard Business School alumnus, was lured away in 1963 from his position at Arthur D. Little by a challenge from the CEO of the Boston Safe Deposit and Trust Company to start a consulting arm for the bank.  In order to differentiate his firm from other consultants, Mr. Henderson focused BCG on business strategy, which evolved into the “growth-share matrix” to help corporations determine the proper allocation of cash among its various business units.  This matrix became a popular management tool for operating companies with a portfolio of businesses.  The matrix was popular for at least two decades and is still used by managers.

 

Exhibit 8.  BCG’s Growth-Share Matrix

Source: BCG, Wikipedia.com

 

The growth-share matrix (Exhibit 8) forces management to characterize each of its business units based on the unit’s relative market share, either high or low, and whether that market’s growth is high or low.  Each of the four boxes in the matrix has a designation based on the high and low dynamics of growth and market share.  Each business unit is characterized as either: Star; Question Mark; Cash Cow; or Dog.  From the perspective of allocating cash flow, according to the BCG matrix, a manager should take cash flow from his mature, low-growth businesses (Cash Cows) and reinvest it in established high-growth units (Stars) and potentially high-growth units (Question Marks).  Cash should also come from disposing of the low-growth and low-market-share businesses, affectionately known as Dogs.

 

Wall Street analysts and investors often follow these guidelines, but maybe without recognizing them.  Some of us call their strategy “momentum investing.”  While the recent broad stock market correction and the violent energy stock drop would have suggested that momentum investors had abandoned the oilfield service sector, the price performance of the stocks of reporting companies following their earnings reports would support the view that momentum investing is alive and well! 

 

We tracked the oilfield service companies that have reported their earnings results through last Friday.  For those companies that met or exceeded Wall Street’s expectations, with the exception of Cameron International (CAM-NYSE), the price action of the stocks on their reporting day was quite positive in a period characterized by extreme stock market volatility.  On the other hand, Heaven help you if you came up a little short of the analysts’ expectations, and it was really true if management issued any kind of qualified guidance or reduced expectations for the future, the likely explanation for Cameron’s stock price performance. 

 

Exhibit 9.  Positive Results Make Companies Stars

Source: Yahoo.com, PPHB

 

Wall Street’s willingness to trash under-performing companies without consideration for its longer term business outlook suggests that the desire for instant gratification by investors still reigns supreme.  This short-term stock price performance focus is reinforced by a chart of the length of time investors held the average stock on the New York Stock Exchange.  If investors actually now have investment time horizons of only nine months, it is impossible for managers to take business steps with long-run implications since the current shareholders will largely not be around.  This short-term focus reinforces the view that management should emphasize corporate actions that boost near term financial results, or immediately reward shareholders such as stock buybacks. 

 

Exhibit 10.  Average Holding Period Now at Nine Months

Source: SG Equities

 

But the real question is whether the Dogs will eventually become Stars, or the Stars turn into Dogs?  A greater effort by analysts to divine the answer to that question for each company would be a welcome change to Wall Street’s research focus.

 

Punxsutawney Phil: Six Weeks of Winter – Does It Matter?

 

Exhibit 11.  Phil Unceremoniously Hoisted Up

 

 

Source: Keith Srakocic, AP

 

On Saturday, in western Pennsylvania at Gobbler’s Knob, the famous marmot, Punxsutawney Phil emerged from his winter hibernation to check the weather.  Once again he saw his shadow and tried to head back to bed, but he was unceremoniously hoisted into the air by his handlers for the horde of photographers and TV cameras to see.  The groundhog’s supporters issued Phil’s official forecast.

 

Here Ye!  Here Ye!  Here Ye!

 

On Gobbler’s Knob on this fabulous Groundhog Day, February 2nd, 2008,

Punxsutawney Phil, the Seer of Seers, Prognosticator of all Prognosticators,

Rose to the call of President Bill Cooper and greeted his handlers, Ben Hughes and John Griffiths.

 

After casting a weathered eye toward thousands of his faithful followers,

Phil consulted with President Cooper and directed him to the appropriate scroll, which proclaimed:

 

“As I look around me, a bright sky I see, and a shadow beside me.

Six more weeks of winter it will be!”

 

This groundhog has become a legend because of his presumed accuracy in predicting the timing of the end of winter.  Phil, or at least one of his ancestors since marmots only live about ten years, has been at this forecasting gig for 122 years now.  During that time Phil has seen his shadow 98 times while only 15 times has he called for an early end to winter.  There were nine years when Phil’s call was not recorded, probably because he hadn’t achieved his current level of stardom.  Maybe someday, just like the recent discovery of a missing Beatles tape, we will be treated to the discovery of Phil’s lost forecasts. 

 

Exhibit 12.  NOAA Questions Punxsutawney Phil’s Forecasts

Source: NOAA

 

So is Phil’s forecasting ability any better than those of the national weather service or the highly priced private weather services?  Several years ago, the National Ocean and Atmospheric Administration (NOAA) issued a special Punxsutawney Phil’s forecast report.  It covered the groundhog’s record of winter calls for 1988-2005 compared to the average temperature for the following two months.  It appears that Phil’s ability to call the end of winter is about as successful as your local TV weatherman. 

 

So far this winter according to NOAA, November’s average temperature was 44.1o F and was 1.6o F above normal.  The Southwest experienced the 7th warmest November on record, and no region of the country was below normal or cooler.  The month was officially the 13th driest on record.  Things changed in December, however, as the nation’s average temperature was near the 20th century mean at 33.6o F versus 33.4o F.  Temperatures related to energy demand were 1.9% below the average forecast.  NOAA’s Residential Energy Demand Temperature Index forecast that energy consumption for homeowners was 2.5% below average.  December also was wetter than normal; in fact, it was the 18th wettest December since 1895. 

 

The January data for heating degree days, weighted by population, show that the country was 34 days below normal, but had 48 heating degree days more than last year, which was a very warm winter.  When we look at the states that primarily rely on heating oil for their homes, the figures were almost exactly the same as the national totals at -36 days and +49 days, respectively.  The states where citizens use electricity to heat their homes, the figures were much lower versus the norm (-107 days), but only slightly higher than last year at 51 days.

 

Exhibit 13.  Normal Temperatures For Rest of Winter

Source: NOAA

 

The recent national temperature forecast for the next three months by NOAA shows almost all of the country experiencing about an equal chance of temperatures being above or below normal.  Two specific regions are forecast to have normal temperatures and only one small area in south Texas is projected to have above average temperatures.  But when we looked at early winter forecasts, we found two contrasts – Accuweather.com and the Farmer’s Almanac.  If this winter turns out as predicted: warmer than normal but cooler than last year, energy demand will probably be slightly more than last year.  That trend is not good news for oil price bulls as the warmer than normal winter will not offset reduce energy demand from higher oil prices.

 

Exhibit 14.  A Warmer Winter Forecast

Source: Accuweather.com

 

Exhibit 15.  A Colder Winter Forecast

Source: farmersalmanac.com

 

 

Energy Savings: Light Bulbs, Wal-Mart and Consumers

 

Just over a week ago, Wal-Mart (WMT-NYSE) CEO and President Lee Scott spoke to the more than 1.3 million associates (as Wal-Mart employees are called) about the company of the future that he envisions.  His talk touched on a number of major global topics, but the primary thrust of his presentation was the role Wal-Mart and its associates can play in helping its customers meet environmental challenges and overcome the pressures of higher energy costs.  While Mr. Scott highlighted the range of issues the world is confronting: international trade; climate change; water shortages; social and economic inequities; infrastructure and foreign oil, he suggested that Wal-Mart, a company known as a problem solver, could offer solutions if its associates focused on new ideas that address these challenges. 

 

We found the discussion of energy initiatives that formed an important part of Mr. Scott’s talk to be quite interesting within the broad scope of shifting domestic energy consumption patterns and increasing further this country’s, and eventually the globe’s, energy intensity.  Mr. Scott focused on what Wal-Mart and its associates could do to help their customers stretch their budgets to accommodate the impact that rising energy costs are having on consumer budgets.  As Mr. Scott pointed out, for working families, Wal-Mart’s target customers, about 17% of their monthly income is spent on energy.  Since out of pocket costs for energy for this group of families have doubled over the past decade, Mr. Scott says someone needs to help them and Wal-Mart is that someone. 

 

Wal-Mart’s mission is helping people save money.  Is it possible that Wal-Mart can help its customers use less energy and spend less on energy?  Mr. Scott believes so.  To accomplish this goal, Wal-Mart will target the products it sells to use less energy.  This is not a small task as many of our modern appliances and electronics gadgets continuously draw standby power even when not in use.  Wal-Mart’s goal is to work with those suppliers who make the most energy intensive products to make them 25% more energy efficient within three years.  As Mr. Scott knows, and openly admits, he is not sure exactly how this will be accomplished and even whether it can be done.  Is it actually possible to make items such as hair dryers, portable phones and televisions 25% more energy efficient?  What he does know, however, is that Wal-Mart’s approach to working with its suppliers to accomplish specific goals works.

 

As Mr. Scott says, if the company’s 25% energy reduction goal is achieved just in the United States, Wal-Mart would save enough electricity to power three million homes for a year, or the equivalent of 10 million barrels of oil.  During his speech, Mr. Scott announced several initial steps that he hopes to achieve by 2010.  Those included having every air conditioner sold in the U.S. Wal-Mart stores to be Energy Star-rated (a government rating standard) and all flat-panel television 30% more energy efficient.  The energy savings on televisions alone would save enough electricity to power over 53,000 single family homes for an entire year.

 

Mr. Scott also announced that Wal-Mart was rolling back the price for 3M Allergen Air Filters by $2 – from $12.88 to $10.88.  Clean filters save energy because heating and cooling systems do not have to work as hard to heat and cool a home.  He pledged to work with suppliers to lower costs of as many energy efficient products as possible.  Wal-Mart’s goal is to double the sales of products that make homes more energy efficient.  He further illustrated the impact that Wal-Mart can have by following this strategy.  For example, by reducing the cost of weather stripping and doubling the volume sold, Wal-Mart estimates it can save its customers $285 million in heating costs and save the energy equivalent of over 4,000 tanker truckloads of gasoline.

 

According to Mr. Scott, Wal-Mart has held discussions with the heads of the leading automobile manufacturers about what role the company could play in the sale of hybrid electric or plug-in electric cars.  That would help the company’s customers reduce the amount of money they would have to pay to fuel their automobiles.  But it appears there is no room for Wal-Mart in this market, at least at the present time.  So Mr. Scott has shifted his focus to other steps Wal-Mart could take to help their customers with alternative fuels. 

 

Wal-Mart has been working to bring E85 ethanol fuel to its gasoline pumps to help customers who are buying flex-fuel vehicles.  It is also testing wind turbines and solar panels for generating power at the new generation of super energy-efficient stores.  These alternative energy devices could be used not only to power the stores and their exterior lighting, but also to generate electricity for plug-in electric vehicles of customers while they shop.  It would even be possible that Wal-Mart stores could generate enough power to sell some back to the electric grid, significantly lowering the stores’ energy bills.

 

In that regard, Wal-Mart just announced the opening of its second generation energy efficient (H.E.-2) prototype store in Romeoville, Illinois.  In 2005, the company built the first generation of experimental energy-efficient (H.E.-1) stores in McKinney, Texas and Aurora, Colorado to measure the potential benefits of implementing new energy efficiency technologies and practices into Wal-Mart stores across the nation.  Those experimental stores were designed to reduce energy use by 20% from the amount consumed at conventional Super Wal-Mart stores.  Over the course of the past two years, daily energy consumption has been measured and certain of the experimental technologies were judged to be quite successful, while others were less so and remain in the experimental stage.

 

The H.E.-1 stores employed new technologies such as light-emitting diode (LED) lights used for exterior signs as well as internal grocery, freezer and jewelry cases.  The stores used T5HO florescent bulbs to improve interior lighting quality at significantly (12%) lower energy consumption, and placed the lights at lower heights to improve the light quality while reducing power consumption.  Wal-Mart installed sophisticated daylighting technology that employs skylights and clerestories to direct natural light inside the stores and is tied to controls that dim the interior lights.  The controls monitor the natural light and adjust the store lights accordingly to maintain a constant illumination level. 

 

Exhibit 16.  Daylighting Controls Power Consumption

Source: Wal-Mart

 

New heating and cooling technologies were developed that used water sprayed into the air stream to cool the air as it evaporates.  By mounting the air distribution ducts 11 feet off the ground enabled distribution of the air closer to the floor.  This water spray system enables Wal-Mart to maintain a temperature about two degrees F higher than other stores, significantly reducing the cost of cooling while keeping customers comfortable.  A portion of the heating for the experimental stores is produced from recovered cooking oil and motor oil burned in a bio-boiler to heat water used in radiant heating systems. 

 

These stores use new refrigeration cases that have doors and employ LED lights.  The doors reduce air infiltration in the case, reducing electricity and heating demand.  The use of doors, LED lights and an evaporative condenser has resulted in energy reduction.  A test is still underway to determine whether doors on refrigeration cases results in fewer impulse purchases.  This is one of those interesting issues because Wal-Mart will have to balance reduced energy costs versus lost business.

 

The list of new technologies and the number of applications of existing technologies never used in retail store settings is long.  But importantly, the combination of them has enabled Wal-Mart to reach its goal of lowering the experimental stores’ energy consumption by 20%.  The more successful technologies are being slowly phased into existing stores and all newly constructed stores.  With the opening of the new H.E.-2 store, the goal is to use these energy saving technologies, along with other new experimental technologies, to drive energy savings by an additional five percentage points.  The Illinois store is the first of four new H.E.-2 stores planned to be opened this year.

 

New technology employed in the H.E.-2 store includes a fully integrated water-source format heating, cooling and refrigeration system where water is used to heat and cool the building.  The store has added a state-of-the-art secondary refrigeration loop that reduces refrigerant consumption by 90%.  They have taken the glass doors on refrigerated cases one step further and are now using them on deli and dairy cases along with employing motion-activated LEDs in refrigerated and freezer cases.

 

Exhibit 17.  White Roofs Are Wal-Mart Trademark

Source: Wal-Mart

 

The store also has employed an optimized pump package that is 50% smaller than in the H.E.-1 stores and uses less copper piping.  The daylight harvesting system has been improved as well as the reflective white membrane roof.  The building is built using recycled construction materials such as fly-ash, slag, integrally colored concrete floors and baseboards and chair rails made from recycled plastic.  The store has also installed sensor-activated, low-flow bathroom faucets and waterless urinals. 

 

Wal-Mart has been very active in working with its suppliers to improve the energy intensity of products and reduce the waste associated with packaging them as a means of further improving the company’s social and environmental measures.  An example would be the 2006 introduction by Unilever (UN-NYSE) of All Small-and-Mighty, a product that is three-times concentrated and contains enough detergent for the same 32 loads of laundry as a 100-ounce bottle.  Less water means less packaging.  Smaller packages means Wal-Mart can ship more of the product for less.  And it means less shelf space needed.  All of these benefits can be passed on to customers in the form of reduced prices. 

 

Another product that Wal-Mart targeted for its energy savings impact on customers was the compact fluorescent light (CFL) bulb.  The company committed to sell 100 million bulbs at its Wal-Mart and Sam’s Club stores in 2007.  By changing its marketing approach, educating its customers and in some cases lowering prices, that goal was met three months early and Wal-Mart ultimately sold 137 million CFL bulbs in 2007.  Those bulbs will, over their life, save an estimated $4 billion in electricity costs along with preventing more than 20 metric tons of greenhouse gases from entering the atmosphere. 

 

We found the company’s success with CFL bulbs interesting in light of some market research conducted by two Harvard University researchers.  In 2005, the upscale New York store, ABC Home Furnishings, allowed these researchers to test the issue of the significance of labels, and especially socially conscious labels.  The researchers conducted an experiment on two sets of towels; one carried a label with the logo “Fair and Square” and the following message:

 

These towels have been made under fair labor condition, in a safe and healthy working environment which is free of discrimination, and where management has committed to respecting the rights and dignity of workers.

 

The other set of towels had no such label.  Over five months, the researchers observed the impact of making various changes such as switching the label to the other set of towels and raising prices.  Not only did the sales of towels increase when they carried the Fair and Square label, but they continued to increase each time the price was raised.  This suggests that there is a segment of the population that will buy products made with strict labor standards or green credentials.  The challenge is to find out how large this ethically-minded consumer group is.  It has been suggested by Joel Makower, the executive editor of GreenBiz.com, that given a choice, most consumers will be happy to choose the greener product – provided it does not cost any more, comes from a trusted maker, requires no special effort to buy or use and is at least as good as the alternative. 

 

Meeting all of the above conditions is a huge hurdle and may help explain why CFL bulbs haven’t gained a greater market share and require a federal mandate.  The fact that Wal-Mart had to lower CFL bulb prices at times to boost their sales speaks to this hurdle.  CFL bulbs do come from trusted makers and require no special effort to buy, but they cost more and are often more difficult to use because of their inability to meet certain customer needs.  The other day, a reporter for The New York Times interviewed Dr. Robert Pai, the head of CFL bulb research for the Osram Sylvania division of Siemens (SI-NYSE) upon his retirement.  The interview delved into the problems of CFL bulbs that would suggest it will be some time before these bulbs can significantly gain market share, which we equate with their need to meet more consumer demands.

 

Dr. Pai is optimistic that the industry can develop CFL bulbs that will please environmentalists, energy conservationists and consumers in time to meet the 2012 government mandated date for the banning of incandescent bulbs.  He said that his company has programs underway to address the problem with dimmer switches.  They also have programs to develop bulbs with improved light quality.  But he believes that people who are extremely color-conscious will have to wait another few years before they can abandon incandescent bulbs.  This issue is receiving a higher visibility as a number of doctors are highlighting as a major problem with people who suffer from migraine headaches.

 

With respect to consumer concerns about CFL bulb quality, Dr. Pai pointed out that all the manufacturers have their bulbs made in China.  However, not every manufacturer monitors the manufacturing process quality, which is why some CFL bulbs do meet their advertised life expectancy claims.  He views this issue as a quality issue that companies will have to address, but which is easily solved.

 

Exhibit 18.  CFL Bulbs Are Gaining Acceptance

Source: HowStuffWorks.com

 

In the interview, Dr. Pai addressed the issue of mercury in CFL bulbs and the question of ballasts.  He pointed out that generating light is a function of vapor pressure and mercury is the only substance that yields just enough vapor pressure to shed light efficiently without having to heat the lamp and increase the amount of energy lost through heat.  The ballast question deals with the sensitivity of CFL bulbs to the flow of electricity.  In tests with CFL bulbs connected to power coming directly from a wall outlet, when the current or the temperature deviated even slightly, the lamp exploded.  The ballast acts as a buffer to fluctuations in the power, and it is this component that impacts the dimmer application. 

 

When asked whether any of these problems are close to being solved, Dr. Pai answered that he didn’t expect much change in the immediate future.  He went on to say, however, “But I’ll bet that anything I say now will be out of date 5 or 10 years down the road.”  Hopefully he proves right, or the American consumer, and consumers in several other countries around the world will be mighty angry with their political leaders.  Even Dr. Pai acknowledged that in his new retirement home he is using CFL bulbs where he can, but he has had to negotiate with his wife to remove some dimmers to increase the CFL bulb use.

 

The biggest question about energy savings in the near term is the issue of whether the consumer will continue to consume energy to the same degree as he has in the past.  Much has been made about the low personal savings rate in this country.  The collapse of the housing market, which has brought forward all the ills in the mortgage lending arena, has merely heightened the issue of consumers spending more than they can afford without the steady appreciation of their home bank account.  If we are in a transition from a period of extensive over-consumption relative to incomes to one of under-consuming, one has to wonder about the impact on both U.S. and global energy consumption.  We still believe there is room on the downside for crude oil prices as American energy consuming patterns shift.

 

 

Global Warming Solutions And Costs

 

As the world grapples to find solutions to the challenge of global warming due to greenhouse gas emissions, the automobile remains one of the principle targets.  In the U.S., Congress recently passed and the President signed a law mandating that automobile manufacturers boost their fleet fuel efficiency ratings.  Amidst all the teeth gnashing and hand wringing over this decision, there remains the issue of whether consumers will buy these more fuel efficient vehicles? 

 

Hybrid vehicles have been helped along in their marketing efforts by the existence of tax credits for buyers.  However, for most of these hybrid vehicles, those credits are expiring.  So the question becomes what are the economics of hybrid vehicles?  If one compares the economics of a popular hybrid, the Honda Civic, with its gasoline-powered twin, the cost differential for the “green” version appears never to be recouped by a buyer unless he allocates a substantial “feel-good” quotient to that premium. 

 

Today, the Honda Civic hybrid has a base price of $22,600 versus the gasoline version’s $15,010 ticket.  The hybrid gets 25% better mileage – 45 miles per gallon versus 36 mpg – that over 12,000 annual miles of driving yields about a $206 cost advantage with gasoline at $3.09 per gallon.  To recoup the almost $7,600 premium for the hybrid, the owner will need that fuel advantage for just under 37 years.  Of course, by that time the car will qualify as an antique!  If gasoline pump prices rise to $6 per gallon, the premium recovery needs only 19 years and at $10 per gallon it’s about 11½ years. 

 

An alternative solution might be to buy one of the new technology diesel powered vehicles.  The Mercedes E320 model with the BlueTech® diesel engine is base-priced at $51,550 or only $1,000 more than its gasoline counterpart.  Based on an average of the government’s estimate of city and highway fuel economies, the diesel vehicle gets 30 mpg while the gasoline version only gets 21 mpg.  We know from the signs at the various gas stations we visit that diesel costs more than gasoline, a reversal from the pattern of prior years.  So we calculated the cost of driving these vehicles for 12,000 miles based on gasoline at $3.09 per gallon and diesel at $3.30.  Based on these prices, the diesel premium will be recovered in two and a quarter years.  So is clean diesel the answer to our emissions problem?  With less than a one percent market share, it would appear diesels have a long uphill battle ahead.  Part of the problem is that the cars are known to be dirty and noisy, although with the new technology these issues have largely disappeared.  However, air-quality studies point out that diesel engines help create more ozone, i.e., smog, problems. 

 

We count ourselves lucky that we aren’t in the market for a new automobile since we honestly don’t have any idea what type of vehicle or power train we would favor.  We are hoping for greater clarity in the next several years.  But ultimately, the answer may be more dependent upon whether we are prepared to alter our life-style – by asking the question of what do we really need from our vehicle?  Maybe like people who move into smaller homes that then rent hotel rooms for their family and guests when they come to visit because it costs less in the long run, we too should be thinking about smaller vehicles and even electric plug-in models if we have access to other larger, conventional vehicles for longer trips and hauling greater payloads.  This suggests that there may be an expanded market for the rental car companies.  That sort of radical solution may be what the country is heading for but with people not yet fully appreciating the future change.

 

 

Views of Alternative Energy Puzzle Energy Executives

 

We attended a conference on alternative energy trends and issues at the Houston Technology Center last week.  There was an overview presentation by Lane Sloan, a former Shell Oil Company (RDS.A-NYSE) executive who is now the director of the University of Houston Strategic Energy Alliance.  He presented the alternative energy industry in an interesting light.  He said the earth as been around for about 13 billion years.  He shortened its life to 13 years to ease the analysis, and then pointed out that homo sapiens have been around for 5 years, and the agricultural era has existed for 50 minutes while the industrial revolution only about 5 minutes.  The advanced industrial era is about 6 seconds old with alternative energy a blink of the eye.

 

There were three panels on the program: Harnessing the Potential of Kinetic Energy, Addressing the Challenge of Human Capital, and From Fossil Carbon to Bio and Captured Carbon.  The panels were made up of academics and corporate executives.  But what was most interesting were the comments made by various panelists about the view of alternative energy expressed by environmentalists and government officials.  Wayne Krouse, Chairman and CEO of Hydro Green Energy, related the observations by energy officials that hydro power is not renewable.  This position has led to hydro power not being eligible for alternative energy fuel credits in contrast to most of the other popular technologies.  As he pointed out, as long as you have moving water, you can have hydro power and there are no emissions. 

 

Likewise, Rick Zalesky, Vice President, Hydrogen and Biofuels, Chevron Technology Ventures, discussed an energy commission meeting in California where a topic was extracting waste from a landfill to generate energy.  The environmentalists challenged the idea of removing waste from the site because, in their view, once the waste was put there it should remain there.  He went on further to discuss the power plant that was going to be fueled by the waste, but said it was viewed by the environmentalists as an incinerator and should be opposed.  According to them, the plant’s operating temperature was warmer than that of the human body and should be opposed on that basis.  As Mr. Zalesky put it, that standard would ban many of the alternative energy technologies that currently are being explored, including cellulosic ethanol. 

 

At the end of the conference, and there were a number of interesting presentations that we will touch on in future Musings, the moderator commented that he was shocked at the statements he had heard from panelists about the views of alternative energy.  The conclusion of the conference was that alternative energy is not a silver bullet for our energy and global warming challenges, but rather will be one part of the solution.  More importantly, we are at the dawn of alternative energy and knowing which alternative energy or fuel type will emerge dominant is impossible to know.  One of the critical issues will be how to get the alternative fuels into this country’s existing energy infrastructure as replacing that infrastructure is not a realistic option.  It was also driven home that Houston has a serious problem, along with the energy industry in developing the labor force needed for the future of both conventional energy and alternative energy.

(Top)

Contact PPHB:
1900 St. James Place, Suite 125
Houston, Texas 77056
Main Tel:    (713) 621-8100
Main Fax:   (713) 621-8166
www.pphb.com

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.