Musings from the Oil Patch – February 2, 2010

• Wow! Even Bin Laden Blames U.S. For Climate Change
• SEC Mandates Corporations Assess Climate Change Risk
• A Scary Scenario For My Great Grandchildren?
• Ontario Deal Points Out Green Energy And Job Challenge
• Port Arthur Oil Spill Reminds Us To Review Mexico
• Stimulus Offsets Recessionary Impact On Wind Power

Musings From the Oil Patch
February 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

A tape recording of the voice of Osama bin Laden, broadcast in part on Al-Jazeera television, but not authenticated, warned of the dangers of climate change and said the way to stop it was to bring “the wheels of the American economy” to a halt.  In his comments, bin Laden blamed western industrialized nations for hunger, desertification and floods across the globe and called for “drastic solutions” to global warming.  We wonder whether by hiding in his cave, bin Laden missed Climategate and the revelations contained in emails of researchers at the Climate Research Unit at the University of East Anglia and the repudiation of the claim that the Himalayan glaciers would disappear by 2035 in the United Nations Intergovernmental Panel on Climate Change (IPCC) report in 2007.  A new study suggests that a change in the amount of water vapor in the stratosphere may help explain why global temperatures have been cooling for the past decade.

The study published in Science late last week showed there has been a 10% drop in water vapor in the stratosphere in the past decade triggered by an unexplained cooling of temperatures at certain high altitudes above the tropics.  Climate scientists have been trying to explain why global temperatures have cooled for the past ten years despite the planet being in a long-term warming trend.  The study concluded the decline in the percentage of water vapor might have slowed the rate of rising temperatures by 25%, partly negating the heat-trapping effect of increasing greenhouse gases such as CO2 and methane. 

Water vapor is formed through evaporation from the Earth’s bodies of water.  The amount of water vapor is determined by the coldest temperature that air encounters as it rises from the Earth.  Most of the upward trend in water vapor occurs in the tropics where “cold point” temperatures have declined in the past decade.  Scientists don’t know why cold point temperatures have fallen.  The author of the study suggests that water vapor changes are important, but doesn’t rule out the contribution of other factors such as changes in ocean currents and solar activity.  The primary problem is that current climate models don’t fully account for all the complexities of water vapor shifts in the stratosphere.

Exhibit 1.  Water Vapor Plays A Major Role In Our Climate

Source:  The Wall Street Journal

Increasingly climate change evidence is confirming how much the global warming supporters don’t know about the science, despite Al Gore’s claim that the debate is over.  In fact, one of his primary claims, and a featured point in his documentary An Inconvenient Truth, was that global warming was accelerating the melting of the Himalayan glaciers and that they would disappear by 2035 if something wasn’t done.  This claim was made in the 2007 IPCC report.  The significance to the world of the glaciers is that they feed seven major rivers in the populous Asian region. 

It has now been revealed that the IPCC claim came from a statement made by Dr. Sayed Hasnain in an obscure Indian magazine, Down to Earth, in April 1999, at a time when global warming was just emerging as an issue and scary environmental scenarios were deemed necessary to draw attention to the cause. 

In June 1999, Dr. Hasnain gave an interview in New Scientist where he touched on the glacier claim.  This better known source became the support for the IPCC to use Dr. Hasnain’s claim since it did not feel it could cite the Indian magazine as its source, although the IPCC actually used the language from the Indian magazine in its 2007 report.  The true travesty in this episode is that there is, and was, no scientific evidence behind the claim.  In fact, a leading Austrian glaciologist, Dr. Georg Kaser, a lead author on the 2007 IPCC report, described Dr. Hasnain’s prediction as “so wrong that it is not even worth dismissing.”  The IPCC claims that Dr. Kaser’s criticism was not relayed to the proper people who could have kept it out of the report. 

The scandal has grown in recent days.  The Telegraph in London recently reported that the head of the IPCC, Dr. Rajendra Pachauri, hired Dr. Hasnain to work as a senior employee at The Energy and Resources Institute (TERI), the Dehli-based company that he serves as director-general.   TERI then received part of a $500,000 grant to study the melting Himalayan glacier from the Carnegie Corporation and a share of a $5 million (€3 million) EU study on the same topic.  In addition, Dr. Pachauri described as “voodoo science” an official report by Dr. Vijay Raina, India’s leading glaciologist, who dismissed Dr. Hasnain’s glacier claim as baseless.  With the revelation of the lack of validity to the glacier melting prediction, there is increasing controversy surrounding Dr. Pachauri and calls are mounting for his ouster as head of the IPCC. 

These events highlight the nature of the global warming campaign.  It was evident in an event last summer that didn’t draw much attention at the time, but certainly fits with the global warming boosters’ campaign.  At mid-summer last year, there was a meeting scheduled for the Polar Bear Specialist Group, set up under the International Union for the Conservation of Nature/Species Survival Commission.  Dr. Mitchell Taylor, who has been researching the status and management of polar bears in Canada and around the Arctic Circle for 30 years and has claimed that polar bear numbers, far from decreasing, are much higher than they were 30 years ago.  Of the 19 different bear populations, almost all are increasing or at optimum levels, only two have for local reasons modestly declined.

Dr. Taylor believes that the Arctic has been warming, but he attributes it to currents bringing warm water into the Arctic from the Pacific Ocean and the effect of winds blowing in from the Bering Sea and not due to rising CO2 levels.  As a result of this position, Dr. Taylor was denied the right to attend the meeting.  In fact, even after securing funding to attend the meeting, Dr. Taylor was told his denial had nothing to do with his expertise on polar bears, but rather “it was the position you’ve taken on global warming that brought opposition.” 

Likewise, the global warming movement was shocked by the acknowledgement a while ago by photographer Amanda Byrd that her photo of the two polar bears on an ice flow just off the coast of Alaska were in no danger.  She also said her picture had nothing to do with global warming but rather because she thought the wind-sculpted ice the bears were standing on made such a striking image. 

Exhibit 2.  These Polar Bears Were Not In Danger

Source:  AP

As this battle continues, we find that comments by Bjorn Lomborg, the director of the Copenhagen Consensus Center at Copenhagen Business School, reflect the true issue the world needs to be evaluating.  Writing in The Wall Street Journal last week, Mr. Lomborg stated, “There is a superficial logic to the conventional wisdom that the only serious way to stop global warming is to get governments to either force or bribe their citizens into slashing their reliance on fuels that emit carbon-dioxide.  After all, if carbon emissions cause global warming, shouldn’t eliminating them cure it?”  He then went on to explain, “Yes it would.  The question is at what cost?  The fact is that whatever prosperity we currently have or are likely to achieve in the near future depends heavily on our ability to acquire and burn carbon-emitting fuels such as coal, oil and gas.’  Mr. Lomborg has been a leading supporter of global warming, but believes the money needed to mitigate the possible temperature rise would be better spent for mankind in other ways such as fighting disease and famine, for example.

Maybe that is why a poll last week conducted by the Yale Project on Climate Change showed that only 50% of American now say they are “somewhat” or “very worried” about global warming, a 13-point decrease from a similar poll taken in October 2008.  The new poll showed that only 57% of Americans believe global warming is happening, a decline of 14 points.  And the percentage of Americans who think global warming is caused mostly by human activities dropped by 10 points to 47%.  While, in our opinion, the global warming/climate change issue has peaked in importance, it is rapidly becoming institutionalized.  That means climate change will be a force that shapes our views and actions on virtually everything we do going forward. 

Last week in a straight party-line vote, the Securities and Exchange Commission (SEC) ruled that corporations must assess the risk of climate change to their business.  That risk might arise from lawsuits or legislation, or merely from the impact climate change might have on the corporation’s assets or investments.  For example, if a bank were to loan money on homes built on the coast that could be destroyed by storms or rising water due to climate change, it would have to disclose to investors that its assets were subject to this risk meaning they might not be worth what the corporation says. 

Mary Schapiro, the chairwoman of the SEC who was appointed by President Barack Obama, said in her opening statement, “Similarly, a company must disclose the significant risks that it faces, whether those risks are due to increased competition or severe weather.  These principles of materiality form the bedrock of our disclosure framework.”  At the same time, Commissioner Kathleen Casey, appointed by former President George W. Bush, countered that the mandate was unnecessary because the SEC already requires extensive disclosure of risks associated with environmental issues.  She went on to say, “I can only conclude that the purpose of this release is to place the imprimatur of the commission on the agenda of the social and environmental policy lobby, an agenda that falls outside of our expertise and beyond our fundamental mission of investor protection.” 

Ms. Schapiro emphasized in characterizing the SEC’s position that “we are not opining on whether the world’s climate is changing; at what pace it might be changing; or due to what causes.  Nothing that the commission does today should be construed as weighing in on those topics.”  Given the breakdown in the Copenhagen climate change legislation conference, this action, following on the actions of the Environmental Protection Agency (EPA) to regulate CO2 emissions, suggests that the present administration is determined to enact climate legislation through the government’s regulatory agencies. 

So how are CEO’s going to respond?  After talking to two oilfield service CEO’s the day after the ruling, neither was aware of it.  After having it explained, they both said they would look to see what the first company wrote and probably adopt that language.  The challenge is that not only are there risks, but there might be benefits from how the company’s customers may have to deal with climate change risks.  As one of the CEO’s pointed out, his company has been collecting all the data necessary to report on its carbon footprint to shareholders.  In the end, one CEO commented that given all this increased regulation being heaped on corporations was it any wonder why companies are seeking to move out of the country?

The issue of climate change and its impact on the business world cannot be underestimated based on existing lawsuits and their similarity to tobacco and asbestos cases.  Three cases were highlighted in a recent Wall Street Journal article.  One case, recently dismissed, involved the Alaskan Inupiat Eskimo village on the barrier island of Kivalina that sued two dozen energy and utility companies for having helped cause climate change that is accelerating the erosion of the island.  Another case was in Mississippi where Gulf Coast property owners claimed that industry-produced emissions contributed to climate change that increased the intensity of Hurricane Katrina.  The final case is in Connecticut where attorneys general of eight Eastern states, the City of New York and environmental lawyers have teamed up to sue Midwest utilities for their emissions that have contributed to climate change damages.  All of these cases are based on the nuisance common-law principle that allows people to sue their neighbors over social and environmental issues. 

The important point about climate change regulation and disclosure is that regardless of whether the Congress enacts legislation to deal with this issue it will be a force impacting corporate actions.  This conclusion is based on the history of other industry-wide problems such as the cancer concerns associated with tobacco and asbestos.  Each of these issues led to legal battles, increased government regulation and corporate bankruptcies with substantial shareholder wealth destroyed.  Managers of energy and utility companies will be fearful of acting in a way that climate change regulations or lawsuits could contribute to their companies being forced into bankruptcy.  As the international insurance company Swiss Re reportedly concluded in a study of the issue last year, “climate change-related liability will develop more quickly than asbestos-related claims.”   This suggests the pressure for companies to acquiesce for regulation rather than litigation will intensify.  Climate change, whether the science is correct or not, has changed the landscape for business, and probably forever. 

A new study done by climate modelers at the National Oceanic and Atmospheric Administration’s (NOAA) Geophysical Fluid Dynamics Laboratory (GFDL) in Princeton, New Jersey, suggests that the U.S. may experience more intense hurricanes in the future as a result of global warming.  Of course it is also possible that the study is totally wrong.  The new study was reported in an article in Science magazine on January 22, 2010.  Its results have been reported extensively by the media keen to help climate change researchers regain their momentum following the Climategate email and glacier melting revelations that have led to serious questioning of the science and the validity of conclusions contained in the UN’s Intergovernmental Panel on Climate Change (IPCC) study about the impact of global warming on the world’s climate.

The attempts to tie together global warming and increased hurricane activity and intensity mushroomed after the four Southeast landfalling hurricanes of 2004 (Charley, Frances, Ivan and Jeanne) and the major 2005 hurricanes of Dennis, Katrina, Rita and Wilma.  The addition of three Category 2 hurricanes (Dolly, Gustav and Ike) that devastated the Gulf Coast has furthered the interest in linking global warming to storm damage.  Between the mid 1970s and late 1990s there was a warming of sea surface temperatures.  In addition, there has been a general warming of the globe during the past century. Despite those warming trends, the global numbers of hurricanes and their intensity has not shown increases in recent years except for the Atlantic basin since 1995. 

The problem is trying to research the linkage of global warming to hurricanes is that in low-resolution models, such as global climate models, the atmosphere is very fuzzy such that hurricanes cannot be generated.  High-resolution models, such as those used by the National Weather Service to forecast hurricanes, produce a realistic mix of both weak and strong storms, but cannot simulate global warming.  To try to get past these model short-comings, the GFDL researchers applied a technique called “double-downscaling” to try to project both the number of future hurricanes and their intensity. 

The process involved starting with the average of atmospheric and oceanic conditions forecast for the end of the century taken from 18 climate models.  These averaged conditions were then transferred into a North Atlantic regional model with sufficient detail to generate a realistic number of hurricanes.   Finally, the researchers transferred the regional model’s storms into an even higher-resolution hurricane forecasting model capable of simulating which ones would develop into Category 3, 4 and 5 storms.  The results of the study showed an 18% decline in the total number of hurricanes.  The decline in the number of storms was focused in the moderate-strength storms.  The combined Category 4 and 5 storms about doubled in frequency, with the Category 5 storms nearly tripling. 

As a part of the research, the study produced a computer simulation of the most intense hurricanes in the future period that is marked by a warmer world compared to the present climate.  What is interesting is to note the number of storms that landfall on the U.S. Gulf Coast.  Our initial reaction when examining the chart of these storms is that the oil and gas industry will be in for a very rough time if the simulation proves accurate.  But then we were relieved to remember that by the time these storms arrive, the world will be well past Peak Oil so they won’t have nearly the same impact on U.S. energy supplies as storms would have today.  We may be facetious in our view, though.

The primary conclusion to come from the study is that while the overall number of hurricanes will be down, those that occur will cause greater damage.  That view is based on the fact that Category 3 to 5 hurricanes have accounted for 86% of all U.S. damage despite representing only 24% of all the U.S. landfalls.  The research team suggests this is a function of the increasing intensity of the

Exhibit 3.  More Severe Storms Forecast By New Study

Source:  Science

storms because as they move up from one category to the next, the potential damage roughly doubles.  Since the study shows that the Category 5 storms will increase the most, it concludes that the net impact on potential damages is a roughly 30% increase. 

What doesn’t seem to be commented on with regards to the study’s conclusion is that given inflation and the continuing development along the United States’ Atlantic and Gulf Coasts, why shouldn’t we expect an increase in the total amount of damages regardless of any increase in the number of major hurricanes?  Having recently competed a total renovation and expansion of our vacation home on the Rhode Island shore and knowing what construction techniques and materials are mandated, we can see where damage should be reduced in the future.  On the other hand only a small number of structures are undergoing this type of construction in the area.  Despite the real estate market collapse, homes along the coasts continue to claim premium prices, although lower than before.  But since this is the population of structures likely to be damaged by landfalling hurricanes, we fully expect financial exposure to increase in the future.

So should we be concerned about the results of this study?  Various climate-change researchers were quarried about the study and all praised its value in advancing the study of hurricanes and global warming.  We contacted Dr. William Gray of the Department of Atmospheric Studies at Colorado State University (CSU) and the former head of its hurricane forecasting team.  In an email response to our question, Dr. Gray said, “Never believe a numerical model that goes out 50-100 years – when the model developers are long dead.”  Dr. Gray, who still co-authors the forecasting reports, relinquished his role as head of the forecasting team to devote more time to trying to improve their ability to do long-range forecasting of storm landfall probabilities and to investigate the role of global warming in the creation and intensity of hurricanes. 

While Dr. Gray acknowledges there has been a marked increase in the number of major hurricanes during the 15-year period of 1995-2009 in comparison to the prior 25-year period of 1970-1994.  But he believes this increase is primarily the result of the multi-decadal increase in the Atlantic Ocean thermohaline circulation that is not directly linked to global sea surface temperatures or CO2 increases.  The increase is believed to be driven by changes in ocean salinity.  The multi-decadal changes are also referred to as the Atlantic Multidecadal Oscillation (AMO).  As Dr. Gray points out, we have experienced other active periods similar to 1995-2009 such as the 1945-1969 period.  That earlier period experienced a high level of major storm activity such as now, but activity in the earlier period may have been underestimated due to the lack of satellite data prior to the mid 1960s.  Between the two active periods the major difference was in named storms and hurricanes.  The number of major hurricanes and the measures of accumulated cyclone energy (ACE) and net tropical cyclone (NTC) activity were much closer between the two active periods. 

Exhibit 4.  Major Hurricanes Similar In Active Weather Periods

Source:  Dr. Gray, CSU; PPHB

The CSU forecasting team has also recently created an index of the AMO utilizing North Atlantic sea surface temperatures and tropical and sub-tropical Atlantic sea level pressures.  The levels of tropical storm activity closely match the positive and negative values of this index.

Exhibit 5.  AMO Index Values Closely Match Storm Activity

Source:  Dr. Gray, CSU
The CSU team has prepared charts showing that for the 25-year period from 1945-1969 when there was a general global cooling trend there were 80 Category 3, 4 and 5 storms and 201 major hurricane days.  By contrast, in the 25-year period 1970-1994 when there was a general global warming trend there were 38 major hurricanes and 63 major hurricane days. 

Exhibit 6.  More Major Storms In Cooling Period

Source:  Dr. Gray, CSU

Another analysis Dr. Gray has done is to examine the hurricane records for U.S. landfalling storms since 1900. He divided the time span into two 55-year periods.  While the global mean ocean and Atlantic sea surface temperatures have increased by about 0.4°C between the two periods, the frequency of U.S. landfall has actually shown a slight downward trend for the later period. 

Exhibit 7.  Fewer Major Hurricanes Landfall In Later Period

Source:  Dr. Gray, CSU; PPHB

The trend is particularly noticeable for the U.S. East Coast and Florida Peninsula where the difference in landfall of major hurricanes between the 44-year period of 1922-1965 (24 landfall events) and the 44-year period of 1966-2009 (7 landfall events) is especially large.  For the entire U.S. coastline, 38 major hurricanes made landfall in the earlier 44-year period compared with only 26 for the latter 44-year period.  This decline came despite the fact the CO2 concentration rose in the latter period to an average of 365 parts per million (ppm) compared to 310 ppm during the earlier period. 

Exhibit 8.  Fewer Major Hurricane Landfalls In Warm Period

Source:  Dr. Gray, CSU

After considering the conclusions of the new hurricane study for more strong storms and greater damages at the end of the century and the work of Dr. Gray, we are swayed more by the latter than the former.  We are also left thinking about the post script to Dr. Gray’s email, which said, “Oh the crimes committed in the name of global warming.”

On January 21, Ontario Premier Dalton McGuinty signed a deal with the construction division of the Samsung Group and its partner, Korea Electric Power Corporation (KEPCO) (KEP-NYSE), 54%-owned by the South Korean government, to build a C$7-billion ($6.6 billion) wind and solar power project to supply 2,500 megawatts (MW) of electricity to 580,000 homes in the province.  As part of the deal, Ontario is promised some 16,000 green jobs.  But like all mega-projects, the devil is in the details that have slowly been discovered and reported on by the Canadian media. 

The province of Ontario has been in the lead in Canada in promoting green energy.  At the same time, it has been struggling to offset the loss of its manufacturing base that was part of or dependent upon the automobile industry.  In fact, a number of years ago, Ontario established a $500 million program designed to subsidize the establishment of manufacturing plants for autos and auto parts as a key component of its industrialization policy.  The collapse of the American auto industry in the recession and the fallout among Canadian plants building cars for the U.S. and parts for both Canadian and U.S. vehicles has hurt the province’s economic health and employment situation.  Ontario’s Green Energy Act was designed to help overcome this economic weakness.

Exhibit 9.  Ontario Is Closely Aligned With U.S.

Source:  Worldatlas.com

The Samsung deal is a 25-year contract that will entail the construction of wind farms in the province with 1,000 turbines and solar plants that will produce the 2,500 MW of power, equal to 4% of the province’s electric power consumption and more power than the entire electricity-generating output of Nova Scotia.  The economics of this deal assure Samsung premium tariffs and assured access to power transmission facilities.  In return, Samsung has promised to construct four plants for building wind and solar power components.  And they get an additional electric power rate subsidy.

The deal was done without the usual tender process.  As has been pointed out, for more than 100 years the consensus on power in Ontario was that the purpose of the system was to make it as cheap as possible.  In other words, the power philosophy was a “consumer-oriented” policy.  That policy is being thrown out for the promises of a “dream team” of some green jobs and some wind turbines and solar panels.  This transaction highlights the challenges green energy projects face unless politicians engage in actions that override the concerns of the citizens. 

As Terence Corcoran wrote in a column in The National Post, “green economics is a wonderful thing, except for consumers.”  He went on to outline the financial costs of this deal for consumers.  Over the life of the contract, he estimates Ontario electricity users will pay 50% more for the wind and solar electricity produced under the deal than for electricity produced from conventional sources.  Because Premier McGuinty can order the power authorities, electricity distribution companies and power regulators to set rates and construct power lines to accommodate this new power, he can agree to its terms. 

Samsung gets Ontario’s Feed-in Tariffs for its power that guarantee above-market power rates of 13.5¢ per kilowatt-hour (kWh) for wind and 44.3¢/kWh for solar power.  Samsung also gets an additional 1¢/kWh for each power source to offset the cost of building the four alternative energy equipment manufacturing plants.  Two of the plants are anticipated to manufacture turbine towers and blades, while the other two plants will build inverters and modules for solar facilities.  Over the life of this deal, the incremental subsidy will cost electricity consumersC$1 billion ($0.94 billion) or, as the Ontario government put it, C$437 million ($ 411 million) in net present value.  That works out to C$1.60 ($1.50) per year to the average Ontario electric customer. 

Mr. Corcoran estimates that over the life of this power contract, KEPCO will deliver 110-million MW at guaranteed prices, which is the equivalent of 110-billion kWh.  That means KEPCO is guaranteed about C$25 billion ($23.5 billion) from customers are an average price of about C23¢/kWh (21.6¢).  The current price for new gas-fired power, with all costs accounted for, is roughly C12¢/kWh (11.3¢), or about C$13 billion ($12.2 billion).  As a result of the higher guaranteed Feed-in Tariff rates, Ontario electricity consumers will be paying about C10 billion ($9.4 billion) as a subsidy to KEPCO, or about C$4 billion ($3.8 billion) in net present value.

One of the problems of these sweetheart alternative energy deals is their cost compared to power generated from conventional fuels.  We have been writing about this issue as it relates to the consumers in Rhode Island in light of the recently negotiated rate between the state’s electric utility and Deepwater Wind who is building a demonstration wind farm offshore Block Island.  The negotiated wind power rate in Rhode Island is about three-times the wholesale rate from gas-fired power sources.  A similar negotiation has begun in Massachusetts for the surplus power that may come from the Cape Wind offshore wind farm targeted to be built in Nantucket Sound.  Massachusetts utility officials hope that the negotiated rate will only be twice the wholesale rate for power from gas-fired power plants.

To understand the magnitude of the cost disparity in Ontario, we went to the web site for Ontario’s Independent Electricity System Operator (IESO).  It showed that for January 22, 2010, the wholesale price for electricity on its systems was C4.74¢/kWh (4.5¢).  There was also an estimated average for the entire month of January of C3.87¢/kWh (3.6¢).  In an early January press release from the IESO, it said the average wholesale price for electricity in 2009 was slightly over C6¢/kWh (5.6¢).  That suggests that the Ontario Feed-in Tariff for wind is about twice the 2009 average wholesale price and about three-times the January average.  The Feed-in Tariff for solar power is more like seven times 2009’s and 11-times January’s rate. 

An additional and possibly greater issue for consumers and other alternative energy project developers from this contract is the “assurance of transmission” terms.  This means that KEPCO will get unlimited access at the expense of other power sources – both conventional and from other alternative energy projects.  Based on the latest electric power supply sources in Ontario, the Samsung project will deliver 10-times the current amount of wind and other alternative power sources.  But there is already another wind power project that has been eight years in design and regulatory approval that would about double the current amount of wind power in Ontario. 

Wind power has increased in Ontario by more than 60% in the past year.  But the increase in power comes at a time when the province’s electric power consumption is in decline.  Demand fell by 2.3% in 2008, 4% in 2009 and is estimated to decline by 0.4% this year.  The demand decline is reflective of a long-term structural change in the province’s economy away from energy-intensive activities, the success of conservation programs and the economic downturn.  After years of ever escalating electric power demand, the province saw its consumption growth rate slow dramatically from 1989 until 2005.  After that consumption began falling and is projected to fall further in the future according to recent forecasts from the Ontario Power Authority and IESO.  As power prices rise and appliances and housing become more energy efficient, consumption growth becomes questionable.  Once the cost of the Samsung power is considered in future forecasts, one has question what will happen to Ontario’s electricity consumption? 

Exhibit 10.  Ontario’s Electricity Demand Is Projected To Fall

Source:  Pembina Institute

Ontario was a leader in Canada in building nuclear power plants to produce both cheap energy, but also clean energy.  Even though the province stopped building in the 1990s, nuclear power still supplies over 55% of total electricity consumption.  The push for green power came as the province debated the cost of building another nuclear power plant, and it was decided that green power sources could meet the output of the nuclear plant at a cheaper cost.

When we examine the data for Ontario’s electricity power sources in 2009 versus the data for January 22nd, we find similar trends but some notable differences.  The January data showed that nuclear and hydro continued to dominate the electric power supply, although the nuclear share was lower than in 2009.  Hydro’s share was marginally higher but coal’s share was nearly 40% higher.  Wind power was lower by one-third, which continues to highlight the problem of wind-generated power when the wind doesn’t blow, which happens often during winter time.

Exhibit 11.  Ontario’s Power Supply Is Heavily Eco-friendly

Source:  Ontario Independent Electricity System Operator; PPHB

Clean energy supplies dominate the Ontario power market.  Between nuclear and hydro-electric power, over 80% of the electric power market is supplied by clean energy sources.  Under the Samsung deal, Ontario is planning to hold back its coal power plants as backup for the intermittent power sources of wind and solar. 

Another aspect of the green energy push is to get green jobs – whatever those are.  The Samsung deal promises to create 16,000 jobs in return for the additional income.  We have seen, however, that Samsung is saying employment in each of the four manufacturing plants promised will be about 1,100 jobs.  That suggests that if all four plants are actually built, and we have no understanding of the potential penalties if they are not, then there will be about 4,400 permanent jobs created.  Clearly there will be permanent jobs created to manage the installed wind turbines and solar panel installations, but we doubt they will equal 12,000 jobs.  But part of the plan for these plants is for them to be supplying neighboring markets.  As Premier McGuinty put it, “The reason Samsung and Korea Electric Power are making this investment in Ontario – and not in New York or Michigan or Texas or California – is because of Ontario’s Green Energy Act.”  But will American markets be off-limits to Samsung in Canada under “Buy American” policies of local U.S. governments and utilities?  Michigan with its huge force of unemployed, highly skilled automobile manufacturing employees has already tried the green jobs approach with little success.  Increasingly, with Washington funding and Buy American policies, the green energy industry is becoming a local, cottage industry, negating the potential for world-scale manufacturing operations.  It will be interesting to see if the Koreans conclude they would be better served to build wind and solar equipment at home and ship it to Ontario. 

On the surface, green energy sounds good, but its success depends on the carbon emissions policies of governments and the role they play in our environment.  Given the growing revelations about unsound climate research, this dependency could be undercut.  Green jobs also sound nice, but hereto they will be dependent upon continued environmental policy tightening.  Increasingly we are finding that green jobs will not have anywhere close to the positive impact suggested by the claims.  While we will hear lots of positives trumpeted about the Ontario/Samsung deal, we will wait and see. 

On Saturday, January 23, 2010, a chemical barge being pushed in the Sabine-Neches Waterway on Port Arthur, Texas’ riverfront crashed into the 805-foot, double-hulled tanker Eagle Otome ripping a gash in one of the vessel’s compartments and spilling 11,000 barrels, or 462,000 gallons, of heavy sulfur-laden Mexican crude oil.  The Port Arthur-spill follows another spill some four months earlier in the Houston Ship Channel.  In late September last year, a tanker was turning around when it was hit by a barge spilling 10,500 gallons of heavy fuel oil.  It was classified as a medium spill and closed a two-mile stretch of the 52-mile long channel for two days.

Exhibit 12.  Port Arthur Barge/Tanker Collision

Source:  Houston Chronicle
The oil spilled from the recent accident was heading to ExxonMobil’s (XOM-NYSE) refinery near Port Arthur.  This accident shut down that busy channel for five days, a major route for imported crude oil moving to the large refineries located nearby.  The accident highlights the increased risks associated with importing oil, but it has no relationship to the risks associated with offshore drilling that we were pleased to hear President Obama speak favorably about in his State of the Union address. 

The Port Arthur spill of Mexican crude oil jogged us to take a look at the current state of the Mexican oil industry.  About the same time, as we were preparing to teach a university class on energy economics, we found a chart in the latest Annual Energy Outlook for 2010 prepared by the Energy Information Administration (EIA) providing its prediction for changes in conventional oil production between 2008 and 2035 for selected non-OPEC oil producers.  On the chart, Mexico was positioned with a negative arrow showing a decline in its production from 2.5 million barrels per day (mmb/d) to somewhere in the 1.7-2.0 mmb/d range by 2035.  Will that target production, which will essentially take the country out of the oil-exporting country group and cost its economy those revenues, prove attainable? 

Exhibit 13.  Mexican Production Predicted To Fall

Source:  EIA

Mexico has been struggling in recent years due to the rapid collapse of the country’s primary offshore and major producing field – Cantarell.  The field was discovered in 1976 by a fisherman 50 miles offshore in Mexico’s Bay of Campeche.  It was recognized not only as Mexico’s largest oil field but also one of the world’s largest fields.  By 1981, the field was pumping 1.16 mmb/d but production began to stagnate and slowly decline.  In 1995, Cantarell was producing about 1 mmb/d.  The government decided to begin a nitrogen injection plan to re-pressure the field and boost its output.  The injection commenced in 2000 and boosted the field’s production steadily until it peaked at 2.1 mmb/d in 2003.  Since then production has steadily declined, falling to about 772,000 b/d in 2009 and dropping the field into second place in Mexico’s oil industry.  Late in the fall there was a modest rebound in the field’s production, but no change in the outlook for the field’s ultimate decline.

Exhibit 14.  Cantarell’s Production Fall Hurts Mexico’s Economy

Source:  Seeking Alpha

Cantarell has played a significant role in Mexico’s oil industry and has been a prime source of the country’s oil exports, and by that a generator of substantial government revenues over the past 30 years.  As shown by the graph of Mexico’s oil production, it peaked in the 2003-2005 period at about 3.4 mmb/d.  Since then the country’s production has fallen to nearly 2.5 mmb/d before the recent rebound back close to 2.6 mmb/d at the end of 2009.  The government-owned oil company, Pemex, has been working hard to boost exploration and development of new crude oil and natural gas resources to help meet the country’s growing energy needs while still being able to export oil and earn revenues for the government. 

Until Pemex was told to slow down its activity to assess the economic rewards of its drilling last fall, Mexico was probably one of the hottest oilfield markets globally.  The need for Pemex to re-assess its economic returns reflects the double challenge the organization confronts.  On the one hand, the organization is technologically-challenged as finding and developing needs become increasing more difficult and costly.  Secondly, the easy way to overcome the technology deficiency would be to allow foreign oil companies – either independent oil companies or national oil companies – to help find and develop new oil and gas resources.  Under the Mexican constitution the country’s oil and gas resources belong to the people and therefore Pemex cannot devise a plan to

Exhibit 15.  Mexico’s Oil Production In Steep Decline

Source:  Seeking Alpha

attract foreign oil companies to work in the country.  Since they could only earn a minor fee relative to the potential value they would create, foreign oil companies are reluctant to bring their technology and balance sheets to Mexico. 

The challenge Pemex faces could result in the country becoming a laboratory for new oilfield technology.  Given the difficulty in developing new oil and gas resources, Pemex may become more receptive to trying new technologies to improve its current economic returns.  In contrast to the reluctance of oil and gas companies to try new technologies because of the risks and/or fear of failure, it would appear Pemex is in the position where it has little to lose by trying new technologies.  If they work, and we fully expect some won’t produce the positive returns they predict, Pemex will be the prime beneficiary.  The history of the oil and gas industry is populated by periods of experimentation in the evolution of new oilfield technologies that have contributed to the industry finding and developing hydrocarbon resources in more remote areas while keeping finding and development costs under control.  Mexico may become the new oilfield frontier. 

The American Wind Energy Association (AWEA) announced fourth quarter results for the industry.  With the quarter’s more than 4,000 megawatts (MW) of new wind capacity added, 2009 ended as the strongest year in history for new wind power.  The industry added a total of 9,922 MW of new power, some 18% more than was added in 2008 (8,425 MW), which was the strongest prior year.  The amount of wind capacity added is sufficient to power roughly 2.4 million homes.  With this additional wind capacity, 2009 total installed wind power reached 35,159 MW, a 39% increase over the amount installed at year-end 2008, and sufficient capacity to power about 9.7 million homes. 

Exhibit 16.  Wind Power Capacity Grew Rapidly In 2009

Source:  AWEA, PPHB

Wind power today accounts for 2% of the United States’ electric generating capacity.  A recent Department of Energy study concluded that with the appropriate investment in transmission and the power grid in the eastern U.S. wind could reach 20% of the electric power generation market.  The question is whether the wind power momentum of the past two years has been derailed or slowed due to the recession.  Last year, only 38 wind turbine-component manufacturing plants were built or expanded compared to 55 in 2008.  In addition, several companies laid of workers at plants in Minnesota, Pennsylvania and Nebraska.  In actuality, the volume of new wind turbines added during 2009 was achieved only by drawing from 2008 backlog. 

The layoffs at wind turbine-component manufacturing plants cost the industry 1,500-2,000 workers.  The industry offset these lost jobs with an equal number of new construction and maintenance jobs, helping to keep industry employment steady at 85,000.  According to AWEA CEO Denise Bode, the Recovery Act of 2009 saved 40,000 industry jobs.  As a result of the State of the Union address by President Obama, Ms. Bode is optimistic that the wind industry will benefit from the new emphasis on clean energy jobs.

A year ago, the wind industry had just completed a record year in new capacity added and had created 13,000 jobs.  But due to the recession, the industry was anticipating a 50% decline in business in 2009.  The stimulus bill provided $2.2 billion in funding for dozens of wind farm projects and wind turbine-component manufacturing plants.  This stimulus is what helped the industry build the nearly 10,000 MW of new wind power capacity and hold industry employment flat.  Now, the prospect of another stimulus plan focused on preserving and creating new jobs may help 2010 turn out better for the wind power industry than presently expected.

The AWEA data showed several interesting trends for wind power.  Of the nearly 10,000 MW of capacity added last year, Texas accounted for 2,292 MW, nearly one-quarter of the industry total.  Not only did Texas add 2.5 times the megawatts of wind power added by the number two state, Indiana, a relative newcomer to the wind power market, it remains the leader in the industry.  Iowa added the third largest amount of new wind power capacity, but with 2009’s addition, the state moved into second place among all states with 3,670 MW of installed capacity.  That is interesting because Iowa has now surpassed California, the first state to install wind power and the state that kept the industry alive for nearly 20 years.  Last year, California added 277 MW of wind power, ranking it 12th among the 28 states that built new wind power capacity.  California’s new wind power capacity increased its installed base by 11% last year, while Texas grew by 32% and Iowa by 31.5%. 

As the wind power industry is maturing as a significant alternative energy market, we are noticing that the concentration of wind farms is now in the wind corridor of the United States.  The adjacent map of the country shows the areas with the strongest winds.  This corridor is located in the plains states stretching from the Canadian to the Mexican border.

Exhibit 17.  Wind Farms Focused On Corridor And Offshore

Source:  National Renewable Energy Laboratory

When we compare the AWEA map showing the amount of wind power capacity installed by state, the growth in new wind power capacity in these corridor states becomes evident.  The two states showing the fasted growth last year were Arizona and Utah.  Arizona’s wind project was the first for the state.  Utah added 204 MW of new capacity to an installed base of 19 MW.  Relative to installed bases, other states with strong years in 2009 included Texas, Montana, South Dakota, Colorado and Nebraska. 

Exhibit 18.  Wind Corridor Focus of Wind Farm Development

Source:  AWEA

While the economics for wind power still appear to pale with conventional fossil fuels, this clean, alternative power seems to have been embraced by the administration for environmental reasons and its jobs potential.  Several recent studies have been issued about wind power, all designed to help boost the case for this power supply source.  One study examined the records of home sales near wind farms showing that their values had not been harmed by the proximity to the turbines.  Another study conducted by the Electric Reliability Council of Texas (ERCOT) showed that even if the wind slowed or ceased at one place, over an area as large as Texas, wind power is relatively constant.  Moreover, wind power can be forecast one day in advance enabling utilities and transmission companies to plan to adjust and/or bring on back-up power sources.  This means less back-up generating capacity is needed for wind farms.  The need will be to upgrade the grid and utility power supply management systems.

On another front, a panel of medical experts reported that wind turbine sounds are not harmful to humans.  This study was done to confront claims in a self-published book by country doctor, Nina Pierpont, describing the “Wind Turbine Syndrome.”  The medical condition has not been recognized by any medical authority, but Dr. Pierpont describes “sleep disturbance and deprivation, headache, ringing in ears, ear pressure, dizziness, vertigo, nausea, visual blurring, fast heart rate” and a host of other conditions caused by living too close to turbines.  The medical panel’s effort “was to provide an authoritative, scientific reference document for those making legislative and regulatory decision about wind turbine developments,” according to Ms. Bode of AWEA. 

The problem with the medical panel’s work is that if Dr. Pierpont’s work is fresh, than the industry’s review of earlier published work, much of it not specific to wind turbines, is not convincing.  While the panel pointed to no adverse medical effects for the people living for many years near the 50,000 turbines in Europe and the 30,000 in North America, most of those turbines are much smaller and further from residences than those now being built in the U.S. and Europe.  Dutch and Swedish studies have found remarkable levels of annoyance and sleep disturbances that they described as having an adverse health effect.  Finally, lease and neighbor easement contracts have gag orders against making public any health problems associated with wind turbines.  Also, many properties near wind turbine facilities are bought by the owners of the wind farms because of health complaints, such as in Dufferin County, Ontario, with new gag orders.  The medical concerns about living near wind turbines could become a new challenge for siting of wind farms, much like the problems nuclear power plants experienced in the 1970s.

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.