Musings From the Oil Patch – May 12, 2009

• Natural Gas Prices And LNG’s Dirty Little Secret
• Chavez Seizes OFS Assets: Obama Grabs Chrysler Loans
• Mixed Economic Data: Is Crude Oil On A Bubble?
• British Efforts For Renewable Energy Proving Too Costly
• Calculators and Ridiculous Economic Scenarios
• Why does the ocean still have all that water when it has all those sponges living in it?
• Automobiles and Global Warming – Different Scenarios
• Debate Over But Global Warming Needs Madison Avenue

Musings From the Oil Patch
May 12, 2009

Allen Brooks
Managing Director

Note: Musings from the Oil Patch reflects an eclectic collection of stories and analyses dealing with issues and developments within the energy industry that I feel have potentially significant implications for executives operating oilfield service companies.  The newsletter currently anticipates a semi-monthly publishing schedule, but periodically the event and news flow may dictate a more frequent schedule. As always, I welcome your comments and observations.   Allen Brooks

Optimism about the ending of the U.S. recession and its impact on future demand for natural gas coupled with positive comments from large domestic gas suppliers about the trend in gas supplies has ignited a rally in natural gas futures prices during the past week.  Natural gas prices jumped from a low of $3.25 per thousand cubic feet (Mcf) on April 27th to a recent high of $4.31 per Mcf last Friday.  A near 33% rise in gas prices in such a short time-period reflects a severely oversold market.  The dramatic price run-up may have more to do with commodity short-sellers than people buying into the view of a sustainable and healthy recovery for the market. 

Exhibit 1.  Gas Prices Are Not Influence By US Dollar Value

Source:  EIA, PPHB

There were several very positive statements made by the CEOs of major natural gas producers about the changing supply/demand dynamics of the business on their company earnings conference calls with analysts.  Mark Papa, CEO of EOG Resources, Inc. (EOG-NYSE), said he expects the impact from the decline in gas-oriented drilling will result in natural gas production falling by 4.5 billion cubic feet per day (Bcf/d) by the end of the year.  He believes the resulting North American natural gas production declines could be reversed by early in 2010 if $7 per Mcf gas prices return or the gas-directed rig count falls below 650.  This view compares with that of the Petroleum Industry Research Association (PIRA) that believes gas production will be 3 Bcf/d lower at year end.  Equally bullish was Aubrey McClendon, CEO of Chesapeake Energy (CHK-NYSE), who sees gas storage being full by October and that gas production would be 10% lower at year-end compared to 2008.  That implies natural gas production should fall by 4 Bcf/d.  Should these estimates prove accurate, the supply drops would go most of, if not all, the way to wiping out the perceived supply/demand imbalance in the domestic gas market of about 5 Bcf/d due to the falloff in industrial and commercial consumption related to the economic recession and credit crisis. 

While the drilling rig count, and especially the gas-directed rig count, are down sharply from last year and continue to fall, the key question remains when we will get an upturn in gas demand from recovering automobile and housing industries.  Most gas industry CEOs and Wall Street analysts are confident that all that is needed for a sustained recovery in natural gas prices is an uptick in gas demand, but more importantly the fall in production due to the gas-rig count downturn.  Once gas prices recover, then drilling should resume, but due to the rapid production declines for most gas shale wells, the industry will be spending quite a bit of time trying to catch back up with falling supply in the face of rising demand thus sustaining higher natural gas prices.

The challenge for the oil service industry is to gauge the number of drilling rigs that will be needed once we enter the industry recovery phase.  We have heard comments from various CEOs that there may be only 1,200 to 1,400 gas-directed rigs needed, which if one throws in another 250 oil-directed rigs, suggests a total of 1,450 – 1,650 working rigs at the next industry peak.  Since we recently peaked out at 2,031 rigs, according to the Baker Hughes (BHI-NYSE) rig count data, then the domestic contract drilling industry will have a significant surplus of rigs going forward.  The simple math appears to be about 2,050 rigs plus about 300 rigs under construction that will enter the fleet boosting the domestic fleet to 2,350 rigs.  Since we will need considerably fewer rigs (1,450-1,650), the drilling industry will need to eliminate nearly 700-900 rigs in order to restore a relative balance between supply and demand that is needed to support reasonable pricing.  (Investors should consider the stocks of companies manufacturing acetylene torches since so much steel will need to be cut up.)

With a peak drilling rig fleet on only 1,450-1,650 rigs, it would appear there is a shake-out coming among land drilling contractors.  At this point we will not get into our views of the dynamics of the future drilling rig fleet and how the industry consolidation might shake out, but instead we want to focus on another gas industry issue that has not received much attention and that could have a significant impact on the land drilling business.

The conventional wisdom about the contract drilling business is that sometime later this year or early in 2010 the rig count will begin rising from the roughly 800 rigs that will be working at the industry trough to maybe 1,200 rigs.  But that conventional wisdom is predicated on the domestic natural gas supply/demand balance being restored and crude oil prices remaining in the $50 a barrel range.  Our question is what happens if the gas market doesn’t recover its balance?  How might that happen? We suggest there is a “dirty little secret” about liquefied natural gas (LNG) that could disrupt the North American gas supply/demand balance and contribute to low gas prices for several more years.  Can anyone spell “gas bubble?”

Exhibit 2.  Growing Gas Surplus Pressuring Gas Drilling

Source:  Baker Hughes, PPHB

We recently spoke at a conference where another of the speakers was an old acquaintance, Jim Jensen, a leading U.S. consultant on LNG.  Mr. Jensen and I had time to talk about the LNG market.  We were looking forward to getting educated on LNG market trends given this fuel’s growing importance on the outlook for the domestic natural gas industry.  We will not go through his talk’s conclusions, but he also shared with us another, more detailed LNG talk he made earlier this year.  His bottom line is that the LNG market is going through another upheaval that is likely to impact the North American natural gas market.  This upheaval could last through 2011, but the future for the North American natural gas market after that date remains uncertain because the future will depend on decisions LNG players make about new investments in the current period. 

Since there are so many new LNG facilities coming on stream, many after delays, there is a surge in LNG supply coming.  Its arrival coincides with the decline in gas demand, and the question mark about when gas demand will resume its traditional growth.  To understand the magnitude of the LNG supply issue, Mr., Jensen calculated that for the 14 year span of 1997-2011 including the completion of the LNG facilities currently under construction, LNG supply will have grown at an 8.4% annual growth rate.  For the prior 14-year period, the supply growth was only 4.7%.  Today, Qatar has replaced Indonesia as the world’s largest supplier of LNG, which is where the “dirty little secret” comes in. 

Exhibit 3.  Surging LNG Supplies To Impact Natural Gas Prices

Source:  Jim Jensen, MIT presentation, March 2009

Conventional wisdom suggests that LNG cargos come to the United States because it has the largest available storage capacity, which is true.  However, people believe that when gas prices get very low, below $3 per Mcf, LNG sellers will look for other international markets with better prices.  Many of these foreign markets have linked their LNG pricing to crude oil prices, which was partially the reason why we heard of LNG cargos going for $18-$20 per million Btus (roughly per Mcf).  Why would LNG sellers want to dump their gas into the U.S. if gas prices are so low?  Well, what if you make so much money from the sale of the natural gas liquids (NGLs) contained in the gas streams utilized to produce the LNG that the gas actually has a negative value?

According to Mr. Jensen’s data, Qatar gas contains 48 barrels of NGLs per Mcf.  Qatar can realize enough income from selling those NGLs to cover the cost of liquefaction, transportation and re-gasification of the LNG, and still have profit left over.  In that case, Qatar would find no natural gas price too low to stop sending LNG cargos to the United States.  In Mr. Jensen’s March speech at MIT, at a time when the domestic natural gas price was around $4.50 per Mcf, he posed the question of who would blink first between shale gas producers and LNG exporters.  But the question becomes, who blinks at $3, or $2 or $1 per Mcf gas prices?  If Qatar could actually pay someone to take their LNG, then shale gas producers, no matter how low a finding and development cost they have, will be have a hard time convincing Wall Street analysts on the value of their production and reserves.  The dirty little secret becomes more significant when one realizes that most of the LNG gas streams have even higher NGL content than Qatar’s gas distorting the economic decision about exporting LNG volumes.

Assuming the shale gas producers are the ones that blink, what happens to drilling and oilfield service activity in the United States?  Our guess is that there would be little recovery in the drilling rig count until this imbalance with LNG is resolved.  So could the domestic oil service industry be looking at a rig count averaging in the 800s for several years?  That would certainly change the outlook for oil service company earnings and the attractiveness of their stocks.  That would also magnify the challenges of restructuring the domestic oilfield service industry.  We will be revisiting this scenario in future Musings.

While we always talk about the natural gas business being primarily a regional industry, the globalization of the LNG business may radically alter the U.S. natural gas industry.  We could, however, be entering a period much like the domestic gas business was forced to deal with in the late 1980s and early 1990s when $1/Mcf gas was a reality.  We are not forecasting such a dire outlook since there are many factors at work in this scenario.  However, we are certainly going to be monitoring these factors to attempt to assess their possible impact on future natural gas prices and the outlook for U.S. oilfield service industry activity.  But not considering the impact of an extended “L-shaped” pattern for the domestic rig count could be a mistake, whether one agrees with our LNG concerns or not. 

We were dismayed to see that the small group of Chrysler secured debt holders have given up their battle to gain a better deal from the bankruptcy court in the Chrysler restructuring due to pressure from Pres. Obama and his administration.  This news came at the same time President Hugo Chavez of Venezuela acted under a newly-enacted law giving him the ability to seize the assets of oilfield service companies working in Venezuela for PdVSA, the state-owned oil company, who were determined to have taken unfair advantage of the state-owned company during the industry boom of 2007 and 2008.  These are many of the same companies that PdVSA has not been paying because it doesn’t have the money for the invoices. 

Upon reading these two stories in the Saturday morning edition of the Calgary Herald, we immediately thought about the picture of the two presidents shaking hands and smiling at the summit meeting of the leaders of the hemisphere’s democratic leaders last month.  There was substantial outrage voiced in many quarters about the significance of the handshake and the willingness of Pres. Obama to engage Pres. Chavez.  Maybe there was a greater kinship between the leader of the Free World and the socialist leader of Venezuela than any of us thought at that time. 

Exhibit 4.  Was There More To The Smiles Than We Knew?

Source:  AP, Miraflores Press Office

We were extremely disappointed that Pres. Obama used his “bully pulpit” to attack the secured debt holders in Chrysler who were exercising their fiduciary duty to seek the maximum return for their investment through the well-established legal workings of the bankruptcy court structure.  We now must consider that the United States has started down the slippery –slope in which the “ends justify the means,” which violates the rule of law foundation of our country.  As a result of this development, we anticipate that next year in the various business and credit risk assessments of countries, the United States will rank much lower than at any time in the past. 

Energy industry executives seriously must consider the proposition unveiled in the Obama budget that the energy industry is to be a “piggy bank” to help fund the President’s grand social vision.  Higher taxes, greater restrictions on access to federal lands for oil and gas exploration and political attacks on the morality of “dirty fuel” executives will color the next three and half years.  I guess a religious person might describe the new environment as the “lean years” that are supposed to follow the “fat years.”  It is one thing to lose some fat, but when an industry loses muscle and bone, the risks are magnified immensely.

Crude oil prices had been bouncing around within the broad range of $45 to $55 a barrel, until the past several days when they jumped to over $58 a barrel.  The movement of oil prices has depended on a number of factors including the direction of the stock market, the strength or weakness of the value of the U.S. dollar against foreign currencies, weekly oil inventory data and the positive or negative view of overall global economic data.  The most recent upward move in the value of oil appears to be most closely correlated with the soaring optimism about the impending end to the recession and the serious weakness in the value of the U.S. dollar against a basket of other currencies. 

The popular economic phrase du jour is “green shoots.”  These are economic data points that are being seized upon by optimists to be accurate and early reflections of en economic turnaround.  They are generating optimism whenever the figures reflect actual increases or show that the rate of decline of economic statistics is slowly turning negative economic news into positive.  It makes one think that the investing world is living in an Alice and Wonderland world where things are as we want them to be rather than as they actually are.  That is not a complete indictment of the current world view since we must acknowledge that the stock market is an early forecaster of future events, but as such it has been credited with forecasting many more recessions and recoveries, too, than actually occur.

Crude oil prices have jumped in recent days aided largely by positive news about the health of the United States economy and the weakness in the value of the U.S. dollar.  One can see that over the past six months, crude oil prices completed their $100 a barrel correction that had begun in July 2008, and then rallied higher as we entered 2009.  Since then they had been trading in this wide range, until last week when they jumped again to record highs for the year.  But as shown in the subsequent chart, the recent strength in crude oil prices is clearly associated with the weakness in the U.S. dollar as reflected in the course of the U.S. dollar index. 

The question on the minds of most managers and investors is: Are we living in a world where the stock market is accurately forecasting the end of the current recession, or is it merely projecting a view of the current world through “rose-colored glasses?”  The following set of charts depicts various recent global economic data from multiple sources showing both positive and negative outcomes.  Stock market bulls have seized on the positive data as signs that the recession is winding down, but the bears see continued deterioration in economic data as reason for continued concern.  The coloring of the outlook must be viewed in the context of a recent 35% rally in

Exhibit 5.  Oil Price Reflects Optimism and Weak U.S. Dollar

Source:  EIA, PPHB

Exhibit 6.  The U.S. Dollar Index Has Been Weakening Recently

Source:  Commoditycharts.com

the overall stock market.  The market upturn has contributed to a significantly enhanced optimistic view of the world ahead.  In fact, a week ago, when the economic data released for the United States was not particularly negative, reporters on Wall Street investing shows were beginning to speculate on when the government would release data showing that the downturn had ended and the official chronicler of recessions would declare this one over. 

Since it took the Bureau of Economic data almost nine months to determine that the United States had actually fallen into a recession beginning in the fourth quarter of 2007, we are not surprised there is considerable doubt about whether the current recession has actually ended.  The length of the average post-World War II recession has been fairly short – lasting roughly 16 months.  At the moment, the current recession is 17 months in duration.  As a result, we have only recently passed the average duration of post-World War II recessions.  So expecting economic data to begin to show positive traits should not be surprising.  Whether the improvement in economic data signals that this bad economic period is behind us is impossible to forecast.  Take for example the following data – some of which we would clearly call positive, but other that reflects ongoing negative economic trends.

In Japan, preliminary industrial production data for April showed a 1.5% increase after nine consecutive months of declines.  While suggesting a positive view, one must bear in mind that the index is still down by over 35%, suggesting there is a long way for the Japanese economy to go before it reflects significant strength. 

Exhibit 7.  Japan’s Production In April Showed An Uptick

Source:  News N Economics

The following chart shows the change in export volumes for Switzerland and Thailand through March and the Philippines through February.  The chart shows that the annual decline in exports for Switzerland and the Philippines has slowed.  This provides some comfort about an improving global trade outlook since these two countries were previously reporting double digit decline rates.  But again, these economies have shown huge declines signaling that it might be tough to expect a rapid turnaround. 

Exhibit 8.  Switzerland And Philippines Export Declines Slow

Source:  News N Economics

Recent survey data offers a more encouraging view of the future for the global economy.  The German Ifo business confidence index rose to the highest level it has attained in five months.  The index’s improvement came as a result of inventory liquidations that suggest a recovery in industrial production should be starting.  Many other industry sources, however, are suggesting that final demand is not growing so the inventory liquidation is less a sign of an impending manufacturing recovery and more a step adjustment for companies to reduce their working capital stresses. 

In the United States, the consumer confidence index surged, which was supported by a 2.2% annualized increase in consumer spending several days later.  The problem with this data is that the improvement in confidence is coming from a very low base, so there is skepticism about the significance of any meaningful recovery in consumer spending.

Exhibit 9. Outlook Sentiment Reflects A Degree of Optimism

Source:  News N Economics

The last data shows the first quarter gross domestic product (GDP) for the United States, the United Kingdom and South Korea.  What the data shows is that the decline in economic activity is continuing.  Moreover, the rate of decline is about the weakest it has been since the early 1980s recession, or possible worse. 

Exhibit 10.  Global GDP Reflects Economic Weakness

Source:  News N Economics

A new measure of economic hope has been the recent data on the U.S. employment market.  The most recent data for the change in nonfarm payrolls showed a slowing in the rate of decline, which in today’s world is positive data.  As shown by history, when the rate of job losses slows, economic recessions soon end.  That is not a surprising indicator since an expanding economy will require additional workers to meet demand.

Exhibit 11.  Nonfarm Payroll Decline Slowing; Recovery Here?

Source:  The New York Times

Another indicator of when the recession has ended and a recovery begun is the trend in part-time employment.  The latest data shows that there has been a 2-million person jump in temporary employment, consistent with other recessions.  However, as shown in the accompanying chart, when the part-time employment number starts to drop, it signals that part-time employees are being hired for full-time positions and manufacturers and service enterprises are re-staffing in response to increased demand.

Exhibit 12.  Part-time Worker Drop Will Signal Recession End

Source:  CaseyResearch.com

It seems clear that the global economic picture is a mixed bag.  At the present time, the optimists looking for an economic recovery are winning the psychological war over the pessimists who see increased economic challenges ahead.  How the financial industry will deal with a further deterioration in the commercial real estate market or how the overall economy will deal with prolonged bankruptcies of our automobile companies and some of their suppliers remain serious questions amidst this rosy view of a recovering U.S. economy.  Time, and more global economic data, will tell which school of thought is correct. 

For the energy business, the economic uncertainty is an impediment to further sustained improvement in company share prices.  If crude oil prices are being supported by optimism about the pace of the global economic recovery, than any weakness in that scenario should cause investors to shift their focus from green shoots to the building inventories and flagging demand for crude oil.  If oil prices cannot sustain the $50 a barrel level, then we are left most likely with the price falling somewhere into the lower $40 a barrel range.  Dashed economic hopes will translate into sharply correcting energy company stock prices.

The recently introduced British government budget proposed incentives designed to bolster investment in huge offshore wind farms and ensure that the country hits its target for raising the share of electricity produced from renewable sources to 35% to 40% by 2020.  The big question is will these incentives work in today’s low oil and gas environment?  According to a new study by the UK Energy Research Center (ERC), none of the scenarios for how Britain can slash its carbon emissions by 80% by 2050 finds renewable fuel uptakes fast enough to meet the 2020 targets. 

Britain, like many other industrialized countries, faces the challenge of both renewing its older electricity plants and meeting future power demand while at the same time trying to reduce carbon emissions.  About 40% of the UK’s power stations were built before 1975 and are desperately in need of replacement.  But the combined impact of the credit crunch, falling oil and coal prices and the weaker British currency are threatening to hold up wind projects just at the point when the government has raised its commitment to green electricity. 

Adam Bruce, chairman of the British Wind Energy Association, is convinced that a European super grid that could eventually eliminate fossil fuel powered electricity plants, is only a matter of time.  He said, “We are only limited by our own ambition.  The capacity is there.  There is the potential for wind alone to supply 50% or more of our energy needs.”  This dream of renewable energy captures the imagination, but for Britain, which generates just 1% of its electricity from renewable sources at the present time – the least amount among European Union nations after Malta and Luxembourg – the gap between ambition and reality seems particularly wide.  The problem is that wind power, arguably the most economically attractive form of renewable energy in the UK, remains hugely expensive when compared with natural gas and coal.

A recently approved natural gas-fired power plant in Pembroke, England is estimated to cost £1 billion ($1.5 billion) and will be the largest in the UK, producing 2,000 megawatts.  Estimates are that it would cost six times as much to build a wind farm of similar capacity.  Jim Skea, research director for the ERC, said, “Renewables can make a significant contribution, but if you look at the scale of what is required, I think that is very, very challenging and 2020 is almost tomorrow when you look at what needs to be achieved.”

Mr. Skea believes that Britain urgently needs to set a much higher carbon price to push the pace of adoption of low carbon technologies and to boost investment in energy research.  Energy research, surprisingly, has collapsed in recent years, having fallen from roughly £700 million ($1.06 billion) a year in the 1970s and 1980s to just £100 million ($151 million) in recent times.  The ERC is recommending that the carbon price be raised to £200 ($302) per ton from the current £13 ($19.60) charged now.  Mr. Skea said this increase would equate to an increase in the price of gasoline to about £5 per liter, or $28.40 per gallon based on 3.875 liters per gallon if levied in the United States.  Mr. Skea stated with regards to the ERC’s research of the issue, “In almost every scenario we looked at, oil is driven out of the system.  It would be cheaper for people to shift to biofuels or electric vehicles.”

The goal of cutting emissions by 80% was achievable according to the ERC, but only with big changes in funding and in people’s lifestyles, including a shift toward teleworking and phasing out of gasoline-powered vehicles.  The ERC claims that the cost of meeting these goals would be £17 billion ($25.6 billion) a year, or £670 ($1,010) for every one of the 25 million UK households, which would be achieved through higher utility bills, extra transportation costs and higher prices for goods and services.  As Mr. Skea put it, “Meeting them [the carbon emission targets] will require efforts well beyond the bounds of historical experience.”  At the present time, the UK spends about £100 billion ($151 billion) a year on energy, including domestic power, transportation and industrial use.

The challenge for Britain is to figure out how to increase its green electricity in order to meet its ambitious carbon emissions target while not bankrupting the citizens.  There is a strong notion that Britain has the engineering capability to build 30 gigawatts of wind power within the 2020 deadline.  The more relevant question, however, may be the seldom-asked one of whether the public wants the British power industry to undertake this challenge when the costs are fully understood. 

At the present time, British power companies selling electricity generated from nuclear, coal or natural gas bid their capacity into the grid, but they must now buy a certain amount of wind power – the renewable option.  Such a massive increase in wind power is creating headaches for National Grid (NG-LSE) as it seeks to ensure that all the offshore wind turbines have equal access to the system as the power stations sitting close to the economic centers in southeastern England.  Because wind is an intermittent supply source, the investment in expanding the grid is hugely inefficient.  Wind turbines with roughly 20% operating efficiency will still require power backup from coal and gas power plants.

A proposed solution for this problem is to develop a clever system that can prioritize wind.  When it blows hard, the proposed 30 GW of wind-generated power would become the base load for the system.  Every electron produced by wind turbines would be used with nuclear, coal and oil picking up the slack.  This would be the best use of the resource and it would cut out the maximum amount of carbon emissions, but it would turn the power market on its head.  Instead of a system that rewards the most efficient and cheapest source of power, we would have a command to buy the most expensive and unreliable.  By government fiat, the electricity that powered your home appliances would be the most dear energy feedstocks while the cheapest would be held off the market.

As the authors of these various studies and proposals for using more expensive electricity sources admit, the systems can be made to work and work efficiently.  However, Britain would not just be building wind turbines, it would be shifting away from a market economy for electric power and to a planned economy.  Once any country goes down that path it is virtually impossible to reverse course.

In the last issue of the Musings, we wrote about Secretary of the Interior Ken Salazar’s comments about the amount of potential wind energy lying off the East Coast of the United States and how it could ultimately replace the entire amount of electricity generated by coal in this country.  As a reader suggested, our analysis demonstrated the power of the pocket calculator to destroy profound (or maybe idle) statements about energy matters.  In looking at Sec. Salazar’s statement, we showed that to produce one million gigawatts of power offshore with wind turbines would require anywhere from 277,777 to 909,000 wind turbines, depending upon the accuracy of the variables used in the analysis.  Just how efficient wind turbines are and how large they would be all figure into the analysis.  At the same time, we looked at how these turbines would be arrayed along the 2400-mile long coastline.  It seems that we are looking the possibility of a ribbon of wind turbines up to as many as 35 rows deep extending the entire length of the U.S. East Coast.

Shortly after receiving this comment, we came across the following item in a column written by Jeffry Goldberg in the May 2009 issue of The Atlantic magazine.  This is a humorous page.  The following question and answer about the impact of sponges in the planet’s oceans we found both humorous and enlightening in the vein of calculators destroying analysis.

Exhibit 13.  Why Don’t Sponges Soak Up The Oceans?

Source:  The Atlantic, May 2009

Lawrence A. Husick,
Southeastern, Pa.
Dear Lawrence,
This is an important question.  I have not paid sufficient attention to the threat posed by rampant sponge reproduction.  I asked Dave Gallo, the director of special projects at the Woods Hole Oceanographic Institution, whether the oceans are in imminent danger of sponge-related desertification.  “Let’s assume sponges hold about 10 times their weight in water,” he told me.  “Let’s also assume that there are about 16 ‘average’ sponges per pound.  The planet’s ocean water weighs 1,450,000,000,000,000,000,000,000,000,000 tons, or about 1.5 million trillion trillion tons, which is a lot.  The weight of sponges necessary to sop up all that water would be about a tenth of that or 150,000 trillion trillion tons, which is also a lot.  So, 16 sponges per pound mean 32,000 sponges in a ton.  Multiply that by 150,000 trillion trillion tons, and you come to the conclusion that you would need 4,800,000,000,000,000,000,000,000,000,000,000 sponges to soak up the Earth’s oceans.”

Based on this analysis, we assume the world is in no imminent danger of having its oceans sucked up by sponges.  That makes us feel as good as knowing that the United States is unlikely to build 250,000-900,000 windmills off the Atlantic Coast to harvest the wind, while hurting the marine environment, global ocean trade and our domestic power industry that would be asked to foot the bill for Salazar’s Folly.  Thank goodness for pocket calculators.

The bankruptcy of Chrysler Corporation and the probability that General Motors (GM-NYSE) will suffer a similar fate as part of a financial restructuring effort undertaken by the Obama administration makes one wonder how the “new” automobile industry will look in a ‘global warming’ world.  A recent article in The Wall Street Journal posed the question of whether the Obama administration knows how to sell cars?  Others, including some of the late night comedy show hosts, have wondered what exactly President Barack Obama’s guarantee to the American public that their car warranties are backed by the government truly means? 

There is little doubt that the domestic automobile industry is in dire financial shape – a combination of high costs and low sales.  But now we have the government weighing in with directives on what type of cars Detroit’s automakers should build.  They need to be “fuel-efficient” and “low-emissions” oriented, at least if you listen to the Washington cabal.  We need those kinds of vehicles if we are to address one of the two primary sources of greenhouse gas (GHG) emissions – transportation.  The other principle source of GHG is fossil fuel-powered electricity generating plants.

According to a report issued by McKinsey & Co., producing and consuming automobile fuels contributed about seven percent of the world’s GHG emissions in 2006.  While the share of total emissions is not particularly high, automobile emissions have become a highly visible target for control since its share of GHG emissions could increase dramatically in the future.  This would happen if the worldwide number of vehicle doubles by 2030 from 730 million now to more than 1.3 billion.  Under a ‘do-nothing’ scenario, where power train technologies and driving behavior continue to develop at today’s rate, automobile carbon emissions could increase by 54% by 2030, according to McKinsey.  This contrasts sharply with reductions of about 50% needed by 2030 to avert a rise in average global temperatures of 2°C according to the UN’s Intergovernmental Panel on Climate Change.

Amazingly, in the United States, the latest vehicle sales data shows that seven of the top-10 selling vehicles in April averaged 29 or more miles per gallon.  That would seem to support the notion that the American auto companies and the public are on the right track.  Unfortunately, this is not true.  Total small car sales are down 33% for the year so far.  Small cars sales of domestic brands, including the Toyota Corolla, the Chevy Cobalt and the Dodge Caliber, are down 51% for the year according to data from AutoData Corp.

The green-car movement has been led by Toyota (TM-NYSE) with its Prius model.  But Prius sales are down 49.5% for the period January 1 through April 30, 2009.  Honda (HMC-NYSE) sold only 2,096 of its hybrid Insights in April.  The hybrid Civic model’s sales are off by 26%, and at the current pace will be lucky to break the 30,000 unit sales figure for 2009 – not a huge milestone in such a weak domestic vehicle sales year. 

GM’s Chevy division hopes are riding on the success of its Volt electric vehicle model.  The problem is that the Volt is projected to have a sales price of around $40,000 per unit.  The Obama administration’s auto restructuring task force didn’t have an optimistic outlook for the vehicle in its March 30 assessment.  The task force, in its report, stated that “…while the Chevy Volt holds promise, it will likely be too expensive to be commercially successful in the short-term.”  So if you have a problem building highly fuel-efficient vehicles the public wants to buy, how else can you try to shift consumer vehicle-buying trends?

The McKinsey study says there are multiple ways to achieve reduced carbon emissions from vehicles.  Among their suggested actions are: 1) dramatically improving fuel-efficiency; 2) broadening the use of biofuels; 3) improving road and traffic infrastructure; and 4) changing consumer behavior by emphasizing eco-friendly driving habits and promoting the wider use of mass transit.  The report found that by 2030, the automobile sector could reduce its total carbon emissions by 18% below today’s rate despite the projected growth in the global fleet by taking actions across three main priority areas.

Increasing the fuel-efficiency of new vehicles could contribute 72% of the potential emissions reductions.  By increasing the proportion of bio-ethanol blended with gasoline, an additional 17% of potential emission reductions could be achieved.  Lastly, by improving driving behavior and traffic flow and reducing the distances driven, we could save an additional 11% of potential emissions.  Clearly, improving fuel-efficiency has the greatest impact on reducing carbon emissions.  The problem is that the average car remains in use for about 15 years, meaning that the impact of selling cleaner-burning vehicles will take a long time to impact the entire vehicle population. 

Actions that impact the entire automobile fleet would have a quicker benefit and might be able to be done with minimal cost.  A solution would be to raise the average biofuel mix in gasoline to 25%.  This change could be instituted and achieved quickly.  Of course the recent decision by the Environmental Protection Administration (EPA) to require that all the carbon emissions associated with the production and sale of biofuels needed to be considered in the scheme of determining exactly how emissions-friendly biofuels truly are might delay that shift.

McKinsey also looked at technologies to improve fuel efficiency, but there would be a cost to the consumer.  Technology currently exists to improve the fuel-efficiency of gasoline-powered internal combustion engines by around 40% relative to current engines, but at an estimated additional cost of $3,700 per vehicle.  Hybrid vehicles could be improved by 44%, but at a $5,000 per vehicle added cost.  Plug-in hybrids could see 65%-80% reductions in carbon emissions, but at an estimated $18,000 per vehicle cost.  McKinsey believes that particular cost increase could be reduced to $4,800 per vehicle by 2030. 

Governments appear to be reacting to this challenge in vastly different ways.  In China, now the world’s largest new auto sales market, the government is spurring a shift toward more fuel-efficient vehicles by lowering the tax nearly in half on vehicles powered by 1- and 1.5-liter displacement engines.  On the other hand, it has doubled the tax rate on cars with engines with displacements of 2-liters or more.

In Europe, the traditional way of shaping consumer auto buying and using habits has been to maintain high gasoline prices.  But even that approach looks like it might be about to change.  Norway’s finance minister Kristin Halvorsen has introduced a proposal to ban the sale of new gasoline- and diesel-powered cars in the country beginning in 2015.  The idea is that after that date, carmakers would only be able to sell new cars that run fully or partly on fuels such as electricity, biofuels or hydrogen.  Hybrids that use fossil fuels and electricity would still be permitted to be sold.  Media reports are that this proposal is opposed by prime minister Jens Stoltenberg so it is given little chance of passage.  However, Ms. Halvorsen said, “We [the socialist left] are often a party that puts forward new proposals first.”  She also said that many people in Norway misunderstood her proposal thinking it was banning the use of existing cars, when it only targets the sale of new vehicles after 2025.

In the U.S. the Obama administration has ignored the pleas of automakers to raise the gasoline pump price via taxes as the primary way to alter consumer vehicle buying habits.  Instead, the Administration plans to leave gasoline pump prices alone but rather offer tax breaks of up to $7,500 per vehicle for the purchase of hybrids, mandate higher fuel-efficiency standards for new cars forcing manufacturers to use new fuel-saving technologies and investing in new battery technology. 

As Pres. Obama becomes more entangled in the actual running of the domestic automobile industry, we will not be surprised to see proposals more along the lines of China and Norway.  This is a president who firmly believes in the three C’s that have been the by-word of the military – command, control and communication.  While Pres. Obama says he doesn’t want to run the auto companies, to meet all his other global objectives, especially those dealing with global warming, and to sustain the adulation of foreigners, he will need to become more dictatorial about consumer choices of vehicles.  So maybe we will return to early days of Henry Ford when you could buy a Model T in any color as long as it was black.

The perils of sending email have exposed the need for global warming supporters to resort to Madison Avenue tactics to try to prevail in the debate.  An email containing a summary of the research findings and recommendations of ecoAmerica, a nonprofit environmental marketing and messaging firm in Washington, D.C., was accidently sent to a number of news organizations a week ago.  The president of ecoAmerica, Robert M. Perkowitz, requested that the summary findings not be made public until the group’s report was formally released later in May, but this was rejected by the news organizations since the distribution had been so wide. 

EcoAmerica has been conducting research for the last several years to find new ways to frame the discussion about environmental issues and to build public support for global warming legislation.  This research and investigation into linguistics makes us wonder whether the global warming debate truly is over.  It seems to us that the American public is both smart enough and wise enough to understand the questions posed by global warming and its impact on the planet and could be persuaded if the evidence was presented in a truthful manner and supported by convincing scientific facts. 

In a Pew Research Center poll released last January, it found global warming ranked last among 20 significant voter concerns.  That study did not receive much attention at the time from the media since it suggests there is something wrong with the global warming issue – either the facts or the message.  Since there are more facts emerging about the planet slipping into a global cooling period, and more scientific data showing that the effects of global warming may not be as severe as presented by the movement’s supporters, the problem must be centered in the message. 

For those younger readers of the Musings, Madison Avenue in New York City was the home for many of the leading advertising firms that emerged in the post war era of the 1950s.  These firms became the driving force behind the sophisticated advertising campaigns that drove American consumption habits.  Their efforts led to the development of new techniques for measuring consumer attitudes and shaping their tastes.  The efforts emerged from new tools such as focus groups, marketing surveys and subliminal advertising messages.  They capitalized on the emergence of the new medium of television and the public’s fascination with movie spectaculars and Broadway musicals, etc.  Many of these trends were exposed in a book written by an ex-advertising executive, Vance Packard, called The Hidden Persuaders.  (Mr. Packard’s wife was my seventh grade art teacher and a participant in a number of lively classroom discussions about the book.)

The global warming movement has struggled with the grim warnings associated with the term according to ecoAmerica.  Because the last few years have not produced the continuation in the trend of rising global temperatures, the movement latched on to the term “climate change” since it covers all sorts of weather variations – unusual snowfalls, heavy rain storms, draughts, increased hurricane and tornado activity, etc.  The ecoAmerica group advocates that instead of global warming, people should talk about “our deteriorating atmosphere.”  They also suggest that global warming supporters should move away from talking about “carbon dioxide” and instead focus on “moving away from the dirty fuels of the past.”  They suggest not confusing people with “cap and trade” talk, but rather to talk about it as “cap and cash back” or “pollution reduction refund.”  Don’t you feel better already?

When questioned by The New York Times about the organization’s recommendations Mr. Perkowitz said, “When someone thinks of ‘global warming,’ they think of a politicized, polarized argument.  When you say ‘global warming,’ a certain group of Americans think that’s a code word for progressive liberals, gay marriage and other such issues.”  The first sentence of Mr. Perkowitz’s statement is factual.  The second sentence is a gratuitous throwaway line designed to obscure the truth.  The politicization and polarization of global warming has come from the movement’s supporters when reacting to questions about the validity of the science behind it and the sanctity of the computer generated forecasts. 

As we have learned in recent years, computer-generated assessments of the value of credit default swaps or the soundness of subprime mortgages or the accuracy of super-levered stock and bond trading strategies have all been ridiculed for their failings, yet we are told to accept as gospel the predictions of computer models of the Earth’s climate 40, 50 or 100 years in the future.  What is scary is that these climate models have failed to explain the past with any degree of accuracy without the fudging of the data.

Mr. Perkowitz was also quoted as saying that the term “energy efficiency” makes people think of shivering in the dark.  Therefore, he advocates changing the emphasis to “saving money for a more prosperous future.”  We thought “energy efficiency” means saving money because you are using less of it.  Maybe in Mr. Perkowitz world, “energy efficiency” actually means “rationing” that does signify “freezing in the dark,” an expression citizens of energy-rich states use to direct to their fellow-citizens living in the Northeast who wielded political power during the 1970s. 

Mr. Perkowitz also believes that global warming supporters should drop any reference to “the environment” and instead talk about “the air we breathe, the water our children drink.”  The shift probably fits with the “don’t squeeze the Charmin” advertising campaign featuring Mr. Whipple.  We wonder how Mr. Perkowitz would modify that famous advertising slogan, “Where’s the beef?” since it was pretty clear that the hamburger buyer was being taken advantage of by the fast food establishment. 

As we are firmly ensconced in the age of sound bites, campaign slogans and 30-second ad spots, the message has become the issue rather than the facts.  We find it fascinating that whenever Al Gore is challenged to a debate about global warming by knowledgeable skeptics, he ducks the offer, but always with a smile.  We also remain amused how many people on the left and in the center of the political spectrum who helped elect Barack Obama president based on his campaign slogans of “Yes we can” and “Change you can believe in” are now upset with his governing policies and actions, and he has barely touched the energy and environmental issues yet.  Obama administration spokesmen merely say, the President is doing what he said he would do during the campaign.  All those upset people must never have listened to what candidate Obama actually said last year. 

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Parks Paton Hoepfl & Brown is an independent investment banking firm providing financial advisory services, including merger and acquisition and capital raising assistance, exclusively to clients in the energy service industry.