Peak Oil Review
Vol. 5 No. 8
February 22, 2010

Tom Whipple, Editor

Steve Andrews, Publisher

1. Prices and Production
Oil prices have moved up steadily for two weeks, rising by almost $10 a barrel, and now are back in the vicinity of $80. A potpourri of developments is behind the move, including a fluctuating dollar, a small increase in US discount rates and lower inflation, the Iranian situation, a refinery strike in France, the European financial crisis, and the persistent hope that the US economy is about to start growing. The future of China’s economy—rapid growth or bursting bubble—is still on everyone’s mind.

The API reported that total US oil consumption is now at the lowest level, 18.4 million b/d, in 12 years despite the fact that gasoline rose steadily in January. US gasoline consumption is now about 8.7 million b/d as opposed to a high of 9.6 million reached in July 2007. Consumption of low sulfur diesel fuel, used in heavy trucks is down by 11.5 percent, a bad sign for the US economy.

Natural gas prices fell to their lowest level in 10 weeks, $5.04, on anticipation that the weather in the US is turning milder.

The net of all the forces at play seems to be that while US and OECD demand will remain weak for the foreseeable future, it will not fall that much further and that increasing demand from Asia and oil-producing nations will gradually overcome the drop in OECD demand.

For the coming week, the refinery workers’ strike against the French oil company Total could dominate the market. The union is protesting the closing of a refinery in northern France and says that spot shortages will start developing in 2-3 days. Total supplies about 50 percent of French oil consumption, but the union is also threatening to shut refineries run by other companies. France has enough fuel in stockpiles to last for 10-20 days before shortages become widespread. If the strike continues, exports of gasoline to the US could be threatened.

 

2. The Iranian Standoff
New leadership at the IAEA is taking a much stronger stance against Iranian claims that they are not developing nuclear weapons. In a forthcoming report, the Agency says it has credible evidence that Tehran continued efforts to develop a nuclear warhead past 2004. This report has led to a spate of dramatic headlines that strengthens the case for stronger sanctions against Iran.

The Iranians, including the supreme leader, Ayatollah Ali Khamenei, continue to deny that they intend to build nuclear weapons and continue to issue a stream of invective against the Western powers. This includes threats of what Iran will do to the world, by restricting oil exports and fomenting trouble, if harsh sanctions are imposed.

Now that the Russians seem to have joined the “something-must-be-done” camp, only Beijing, which has a lot invested in its relationship with Tehran, stands out as the major power still pushing for diplomacy rather than sanctions. During the past week, there were indications that even the Chinese are starting to appreciate the danger posed by the situation and may be moderating their policy. Suggestions continue that the Saudis may be willing to make up for any restrictions on Iranian oil exports that could arise from the confrontation.

 

3. Nuclear Power for the US
Last week President Obama announced an $8.3 billion loan guarantee to help build a nuclear power plant in Georgia. Although the US has 104 nuclear power plants, none have been built in the country for 30 years. Leaving aside the environmental fears, the plants have become very expensive (on the order of $8 billion plus) take many years to build and start earning returns, and banks are unwilling to make construction loans without federal guarantees.

The loan guarantee announcement was met with mixed reactions. While the New York Times hailed the move, Time Magazine pointed out that the exorbitant costs of approving and building nuclear reactors will eventually kill the chances that many will ever be economically viable.

Despite many problems, nuclear power plants are very popular with the Congress and more loan guarantees seem likely.

In a related development, a freight-car–sized nuclear reactor, which will cost and produce only one tenth that of the conventional nuclear plant, is emerging as a possibility. The idea is that smaller 125-140 megawatt plants based on ship reactors could be built quickly and installed in large numbers to replace aging fossil fuel generating stations.

The future of all this is still up in the air. While increased efficiency and conservation in the use of electrical energy is still by far the best path, a rapid decline in the availability of cheap liquid fuels and even coal over coming decades, coupled with widespread use of electric, cars could make nuclear power more attractive no matter what the price.

One issue that has not received much attention is the availability of uranium to power the hundreds of new reactors people are talking about. Some observers are saying that in the not to distant future the availability of uranium will be a major impediment to more nuclear power.

 

Quote of the Week
• "Sanctions [against Iran] are a long-term solution. They may work, we can't judge. But we see the issue in the shorter term maybe because we are closer to the threat... So we need an immediate resolution rather than a gradual resolution."
-- Prince Saud al-Faisal, Foreign Minister of Saudi Arabia

 

The Briefs (clips from recent Peak Oil News dailies are indicated by date and item #)
• Saudi Arabia is gradually reducing crude oil exports to the US as it is pushing deeper into China and other fast-growing Asian markets. Exports to the US fell to 837,000 b/d in November, the lowest level in 21 years. Last year, Mexico was ahead of Saudi Arabia as a crude exporter to the US, supplying about 951,000 b/d despite a plunge in those exports. Nigeria also overtook Saudi Arabia, with its exports to the US climbing to a 15-month high of around 984,000 b/d in November. (2/19, #9)

• Iraqi oil Minister Hussein al-Shahristani assured foreign companies contracted to develop its major oilfields that security is not a problem anymore. But as parliamentary elections scheduled for March 7 approach, al-Qaida and other militants are keeping up their attacks. In 2003-05, there were 200 attacks on oil and gas pipelines. By 2007, there had been more than 600, with exports reduced to a trickle. (2/20, #9)

• Iraq: In the history of the modern oil industry, no country has increased output with the speed the Iraqis envisage. Over the next seven years Iraq intends to go from producing 2.5 million b/d to 12 million, a target that exceeds Saudi Arabia’s current output by more than 30%. But progress will be slower than oil minister Hussein al-Shahristani has led voters to believe. The industry does not have enough qualified specialists. And there is growing opposition to Iraq’s oil surge from its neighbors (2/19, #10)

• Pemex is mulling a $377 million upgrade of crude oil treatment facilities to fix quality problems in its main export blend. People familiar with the plan said they think the problems are linked to natural field decline. As the amount of water produced at Cantarell exceeds Pemex's processing capacity, wells must be shut down, speeding up the decline of the field.(2/19, #12)

• The North Sea oil rig Ocean Guardian arrived in Falklands waters on Friday in defiance of the warnings from the Argentine authorities. HSBC and Barclays are thought to be on a list of companies that could be hit in revenge for the exploration, which Buenos Aires claims is a “violation of sovereignty”. (2/20, #14)

• US Energy Secretary Chu will travel next week to the Middle East "to strengthen and expand" relationships in the region. The trip comes as the Obama administration continues its efforts to wean the US off oil imports and targets the petroleum industry for tax hikes and greenhouse gas emission reductions. (2/19, #14)

• Because of overbuilding in the late '90s sparked by deregulation of energy markets, there are so many US gas-fired power plants that on average, they are used only about 25 percent of the time. A few gas companies have begun to offer long-term contracts to utilities at a price that comes close to making it competitive for base-load generation. (2/19, #15)

• State regulators are doing a good job overseeing a key natural gas production technique called hydrofracking and there's no evidence the process causes water contamination, a senior official with the US Environmental Protection Agency said Monday. (2/16, #16)

• Nearly all the major oil companies are looking across Europe for shale gas, an unconventional energy source that has transformed the US energy market. Unlike in the US, Europe does not have as many as land rigs available to search for shale gas—an estimated 20 land rigs in Europe vs. well over 1,500 in the U.S. (2/19, #18b)

• Russia is poised to seize control of Kovytka, one of the world's largest gas fields, from TNK-BP, a joint venture between BP and four Russian oligarchs. A $20 billion development project is under way, but after 10 years there has been no production. TNK-BP was originally asked to sell its stake in Kovytka to Gazprom, the Russian state energy monopoly, in 2007 but talks stalled after years of wrangling on price. (2/19, #20)

• Bank of America and Barclays Capital have told clients to brace for crude above $100 a barrel by next year, before it pushes relentlessly higher over the decade. B of A analyst blames oil demand growth from China and India by 2015 (5.3 million b/d) combined with non-OPEC production declines of 4.9 percent per year. (2/19, #21)

• What constitutes an acute oil crisis? At a 5% decrease in the oil volumes that are accessible to the Western world, the U.S. President may give permission to release oil from the strategic oil reserve. A decrease of 7% would trigger an "international crisis under emergency treaties", and a decrease of 10% would be a disaster which, according to an energy expert, would be "so off the chart that we cannot even model it". The United States does not have a plan to handle such a never-occurred-before situation. (2/19, #25)

• Two of the world’s leading companies in the enzyme business, Novozymes and Danisco of Denmark, announced this week that they had found a way to produce enzymes that could reliably and affordably convert agricultural waste into cellulosic ethanol. According to Novozymes, advances in the enzyme development have reduced costs by 80 percent over the past couple of years, bringing the cost of a gallon of cellulosic ethanol within striking distance of $2 a gallon. (2/19, #27)

• Middle Eastern oil producers are scrambling to protect their market share in Asia amid rising competition from a new Russian pipeline to the Far East. The new pipeline’s current capacity, about 600,000 barrels/day, will rise to 1 million barrels (2/18, #9)

• In Saudi Arabia, one lesson thoroughly learned is that very high oil prices — even for short periods — have nonlinear effects on people’s behavior in a way that is probably irreversible… Delhi is a case in point. A recent high court judgment required a changeover from petrol to compressed natural gas overnight. It generated protests but it was done and now all public transport is gas powered. (2/18, #10)

• Solar PV: Using arrays of long, thin silicon wires embedded in a polymer substrate, a team of scientists from the California Institute of Technology has created a new type of flexible solar cell that enhances the absorption of sunlight and efficiently converts its photons into electrons. The solar cell does all this using only a fraction (as little as 1/50th) of the expensive semiconductor materials required by conventional solar cells. (2/18, #13)

• Offshore Mexico, a new oil field was identified in the southern Gulf that could help rescue Mexico's lagging industry. The field is located off the coast of the Mexican state of Campeche, and contains an estimated 900 million barrels. The discovery is one of the largest in the past decade. Production could begin in about two years, when up to 150,000 barrels a day could be pumped out, offsetting one-third of recent declines. (2/17, #6)

• The U.S. economy could lose $2.4 trillion over the next two decades if the federal government does not allow oil and natural gas drilling in restricted onshore lands and in offshore areas previously closed to energy companies, according to a new study prepared for the National Assoc. of Regulatory Utility Commissioners released on Monday. (2/17, #9)

• Exxon Mobil added 2 billion barrels of oil equivalent to its proved reserves last year, replacing 133% of 2009's production, including additions from its liquified natural gas projects in Papua New Guinea and Australia. That helped put the reserve addition at the highest level of the decade for the oil giant. (2/17, #11)

• To supply a plug-in hybrid fleet with lithium batteries, Mitsubishi estimates that the world will need 500,000 tons of lithium per year. The Salar di Uyuni deposit in Bolivia holds at least 9 million tons, although the country has, in total, perhaps as much as 73 million tons. But for a variety of reasons, the production of much lithium from Bolivia might be a bit further in the future than they currently expect. (2/20, #25)

• Canada, faced with growing political pressure in the US over the extraction of oil from its highly polluting tar sands, has begun courting China and other Asian countries to exploit the resource. (2/16, #19)

• In Utah the state regulators oblige Questar, the natural gas provider, to sell half their gas to retail natural natural gas vehicle owners at the cost of production. This is an excellent example of government market distortion and is a recipe for sweated assets. (2/16, #24)

• Last November Nigeria’s president, Yar'Adua, a chain smoker who has been ill for years, went to Saudi Arabia for treatment and has yet to return, and the peace process — and all Nigeria — were left in limbo. Recently the parliament decided that the president is too sick to rule, and promoted Goodluck Jonathan to acting President; he will need more than luck to fix Nigeria. (2/15, #10)

• Troubled talks on a global climate change treaty suffered a further setback on Thursday with the resignation of the United Nations official heading the process. (2/19, #4)

 

Commentary: The Redundant Subsidy
By Robert Rapier

(Note: Commentaries do not necessarily represent the Peak Oil Review’s position; they are personal statements and observations by informed commentators.)

Even for staunch proponents of U.S. biofuel policy, it is hard to argue that the current subsidy on grain ethanol serves the purpose it was designed to serve. With ethanol mandates now in place in the form of the Renewable Fuel Standard (RFS), there is a mechanism – with penalties for non-compliance - to ensure that gasoline blenders use the mandated amount of ethanol. Maintaining a subsidy on top of a mandate would be like paying people to obey the speed limit. Such a program would be an inefficient usage of tax dollars, especially considering that some agency would have to administer and audit that program.

Ethanol subsidies have been firmly entrenched in U.S. farm and energy policy for over 30 years. In an effort to spur development of a domestic renewable fuel industry and wean the U.S. off of foreign oil, the government introduced tax credits for ethanol usage with the Energy Tax Act of 1978. The tax credit was an exemption to the Federal Excise Tax on gasoline, and originally amounted to $0.40 for every gallon of ethanol blended into gasoline at the 10% level.

During the 1980’s the subsidies were increased, government-backed-loans were provided to ethanol producers for plant construction, and an import fee was implemented to help protect domestic ethanol producers from cheap imports. Despite these measures, the ethanol industry struggled to make headway. The majority of the ethanol plants that were built in the early 1980’s were out of business by the mid-80’s. However, the plants that were able to stay in business increased production from under 200 million gallons per year in 1980 to 900 million gallons in 1990. Production slowly continued to grow, reaching 1.6 billion gallons by 2000 and 3.9 billion gallons by 2005.

However, there were still two glaring problems for the ethanol industry at that point. First, while ethanol production had ramped up over the years, it still amounted to a tiny fraction of U.S. gasoline demand. As ethanol production expanded by 3 billion gallons/yr from 1990 to 2005, U.S. gasoline demand grew by 30 billion gallons per year – to 140 billion gallons/yr. Petroleum imports grew by 5.7 million barrels per day (87 billion gallons per year). Clearly, if the purpose of U.S. biofuel policy was to reduce dependence on petroleum imports, ethanol was having neglible impact.

The second problem was that ethanol could not compete head-to-head with gasoline on price. The state of Nebraska has tracked gasoline and ethanol prices since 1982, and despite all the financial incentives for ethanol, the average annual price of ethanol had exceeded the price of gasoline in every single year on record through 2005. (See "http://www.neo.ne.gov/statshtml/66.html">Ethanol and Unleaded Gasoline Average Rack Prices</a>).

Not only was ethanol more expensive on a per gallon basis, it contains only 2/3rds the energy content of gasoline. So, consumers found themselves filling up more frequently when using ethanol blends. The result was that the cost per mile for consumers on the ethanol component of their fuel was often double or even triple the cost of the gasoline component. With low-percentage blends, the impact of the higher cost was diluted such that it was likely not obvious to most consumers. But for gasoline blenders, ethanol at equal to or higher than the cost per gallon of gasoline was not a price that would compel them to buy ethanol.

So the U.S. government decided to force the issue by mandating ethanol use with the Renewable Fuel Standard in the Energy Policy Act of 2005. This mandate started with 4 billion gallons of ethanol in 2006 – just about the amount that was being produced at that time - and initially increased each year to 7.5 billion gallons of ethanol by 2012.

An ethanol gold rush ensued, capacity was overbuilt, and suddenly the industry found itself in deep financial trouble as ethanol supply exceeded the mandates. Again, the government rode to the rescue by increasing the mandates in the Energy Independence and Security Act of 2007. Instead of mandating 7.5 billion gallons of ethanol in the fuel supply by 2010, the new mandate was for 12 billion gallons in 2010 and 15 billion gallons by 2015.

Implementation of the RFS has led to a tripling of ethanol production in just four years, hence it provided ethanol producers the boost they had long desired. The RFS accomplished what decades of subsidies had not. But one thing Congress did not do was eliminate the ethanol subsidy. This begs the question, “With the mandate in place, what is the purpose of the subsidy?”

As many ethanol producers have argued – the gasoline blender and not the ethanol producer receives the subsidy anyway. The gasoline blender – ExxonMobil for instance – buys ethanol for $1.70 per gallon (currently), receives a tax credit worth $0.45 per gallon (the credit was reduced to that level in 2009, but is set to expire at the end of 2010), and then blends it into gasoline that is presently wholesaling at approximately $1.90 per gallon. With the tax credit, the current price of ethanol on an energy equivalent basis to gasoline is just about equal to the $1.90 wholesale price of gasoline. So the tax credit compensates the gasoline blender for blending in a higher cost feedstock.

But what if the tax credit was not there? It wouldn’t matter. ExxonMobil is still mandated to blend a certain amount, and if they fail to do so they are subject to fines by the Environmental Protection Agency (EPA) if they fail to comply with the mandates. Since the EPA can wield a big hammer, companies willingly violate EPA regulations at great corporate risk. Therefore, gasoline blenders will use the amount of ethanol they have been mandated to use, regardless of whether there is a subsidy in place.

So in the event that blenders did not get the tax credit, the energy equivalent price they would pay for ethanol would be about $2.50 per gallon (based on ethanol’s current spot price). The subsidy amounted to about $5 billion last year, and continues to rise with increasing ethanol production. Assuming the oil companies passed on the additional costs, that $5 billion spread over 140 billion gallons of gasoline sold in the U.S. last year would increase fuel costs by just 3.5 cents a gallon. The only difference would be that the cost would then be borne directly by drivers in proportion to the number of miles they drive.

Further, elimination of the administration of the subsidy would net two additional benefits. First, there would be some efficiency and cost savings as the government got out of the business of administering the program and processing payments for gasoline blenders for the ethanol they use. (The program currently involves assigning a serial number to every gallon of ethanol produced in the U.S., and then tracking those gallons through the system).

Second, because of the slight rise in fuel prices (which should be more than compensated for by the savings from eliminating the subsidy), a small amount of fuel conservation may result. This would have the benefit of actually having some small impact on our petroleum imports.

On what grounds might the ethanol industry oppose eliminating the VEETC? A reporter from the Midwest that I regularly correspond with summed it. He suggested that the ethanol industry is terrified that if the tax credit is not extended when it expires at the end of this year, ethanol prices will collapse, and producers will be in the same dire straits as the biodiesel industry after their tax credit expired.

If that is really the case - that the ethanol industry is only being enabled by a combination of subsidies and mandates - isn't this then just one big charade? Also, if that is what the ethanol industry believes, then that is a direct admission that ethanol prices are driving the cost of fuel up - not down as they so often claim. After all, if the tax credit is propping up the price of ethanol, blenders are paying more for it than they should be, which means higher prices at the pump.

With the RFS in place none of the usual arguments for maintaining the subsidy apply. The worn argument that “oil companies get subsidies, and therefore so should ethanol producers” is irrelevant. With the mandate, the ethanol company isn’t competing with the oil company, because the oil company has to buy the product. The ethanol company is essentially competing against other ethanol companies for the blender’s business. So let’s eliminate this redundant subsidy, put the burden of our biofuel policy where it belongs, and save a few tax dollars in the process.

Robert Rapier, with a Masters in Chemical Engineering, is presently employed as the Chief Technology Officer for Merica International, a renewable energy holding company. At various times, he has worked on cellulosic ethanol, butanol production, natural gas production, oil refining, and gas-to-liquids. His articles often appear on The Oil Drum and R-Squared Energy Blog.