Chris Nelder - Angel Publishing

What Peak Oil Can Do for Climate Change

With all eyes focused on the Copenhagen climate summit in less than three weeks, perhaps its time for the peakists to find a new purpose.

The reason is simple. Money isn't interested in problems; it's only interested in solutions. And wherever capital goes is where the changes will be made.

The public also has little appetite for unpleasant stories, even true ones. The message is: Don't tell us what we can't consume — tell us what we can consume. Tell us our grid power costs are going to go up because of climate change and we'll fight it. But help us buy efficiency improvements and renewables that will pay for themselves in fuel savings, and we'll support it all the way.

A new Pew study on "apocalypse fatigue" highlights the problem nicely. The public's confidence in the global warming problem has fallen sharply this year, even as momentum built toward Copenhagen.

Guilt and deprivation simply don't sell like opportunity does.

That's why trillions of dollars are pouring into cleantech annually, while the peak oil community continues to go begging for a few dollars to staff a small office and keep a web server running, all while battling a constant onslaught of misinformation placed in the top mainstream media by very deep-pocketed vested interests.

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That's why I said last week that the IEA was shrewd to turn its annual World Energy Outlook into a stalking horse, masquerading its alarm about peak oil as an earnest appeal to address climate change.

It's also why I applaud Chevron's new commitment to offer mentoring, resources, and financial support to the Cleantech Open through its $240 million venture capital arm. Chevron has long held the lead among its peers, I think, for engaging with the public on the energy challenges ahead with their "Will You Join Us?" campaign.

Oil industry, take note: That's how you bridge the great divide between the Greens and the Browns — by putting some oil industry profits into the solutions for a world after cheap and easy oil.

Here are a few key concepts from the peak oil study that should inform climate policy.

All of the Above

First, solving the energy crisis isn't an either Green or Brown proposition, but all of the above. There is a dangerous paradox here that the peakists can help the world avoid.

Climate activists need to realize that the renewable energy revolution can only be built on the back of fossil fuels. It will take vast amounts of oil, gas, and coal to mine raw ores, crush them, transport them, smelt them down and turn them into stock, transport them again, and turn them into end-products. . . then transport them again. We have no idea how to do all that without petroleum fuels, gas, and coking coal.

Therefore, in order to build a vast new infrastructure of solar and wind generation, ubiquitous rail transport, plug-in and natural gas vehicles, the next-generation grid, and so on, and do it at a reasonable price, we'll have to ensure that fossil fuels receive vigorous and sustained investment.

Here's a rough, rule-of-thumb way of expressing the supply dilemma: We have to fill a 25% gap in 25 years, a 50% gap in 50 years, and we need to be off fossil fuels completely by the end of the century.

Here's another rule of thumb: Starting two to four years from now, the world will need to build the equivalent of all the world's existing renewable energy capacity every year just to compensate for the decline of oil.

Meeting that challenge with renewables and efficiency would solve the emissions problem as a side effect, only it would do so by harnessing the profit motive — not by penalizing production. That's how capitalism works best.

If we allow climate policy to pour cold water on the fire of fossil fuels, we would extinguish the growth in renewables too. Failing to maintain a steady supply of fossil fuels, even as they peak and decline, their prices rise, and their availability shrinks, would subject the cleantech industry to devastating boom and bust cycles.

Count on Less Fuel. . . and Less CO2

It's fairly astonishing, but none of the climate change models take the peaking of any fossil fuels into account. They all project — over a period of 30 years or more! — fairly simple growth curves for population and the global economy, assuming that sufficient oil, gas and coal will be available to satisfy demand at historically normal prices.

As the peakists know, nothing could be further from the truth.

If my current understanding of the situation is even close to correct — peak oil circa 2005-2012; peak gas 2015-2020 and peak coal 2025-2030 — then the climate models are not accurately modeling 78% of the global energy supply over the next 30 years.

Accordingly, the CO2 projections must be wrong. Ultimately, the population-based forecasts must also be wrong. The peak oil study can help correct these glaring flaws by offering better data to the CO2 emissions models.

Easier to Switch than Fight

Resisting the policy focus on climate change, and resisting the truth about peak oil, the fossil fuel industry has become its own worst enemy.

By perceiving these issues as threats, the Browns have created a vicious cycle. Fighting the renewable energy revolution sows public opposition, adds cost, and delays the deployment of renewables, which makes the CO2 problem worse. The worse the CO2 problem gets, the more it costs them.

If instead the Browns acknowledged that the future of fossil fuels will be increasingly difficult and expensive, and that CO2 is a problem they need to own, it would feed a virtuous cycle.

Peak-adjusted fuel models would lower the projected CO2 emissions, reducing the cost of mitigation and buying a bit more time for the transition to renewables. It would give the energy industry a clear mandate to invest more in renewables, and do so in a measured, less disruptive way. In turn, the accelerated adoption of renewables would reduce CO2 projections and feed further investment, reducing CO2 even more.

Hopefully, the peakists can help the fossil fuel industry come to terms with a decarbonized future, and in so doing, ensure its long term survival.

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Incentivize, Don't Penalize

Perhaps the most important way that the peakists can help the climate change cause is by changing the focus to what goes into the engine, instead of what comes out of the tailpipe.

As I have argued, incentivizing renewable energy solutions would be far more effective than penalizing fossil fuel producers. As an example, consider carbon capture and sequestration (CCS).

CCS remains an infant technology. As a recent article in Scientific American pointed out, there is currently only one project in the world that does CCS (the 1,300 megawatt coal-fired Mountaineer Power Plant in West Virginia), and it captures a lousy 1.5% percent of its emissions.

Before CCS can be scaled up, there are also significant issues to be solved in finding sufficient storage capacity, transporting the CO2 to the storage sinks, and doing it all at an acceptable price.

Worse, if CCS is ever deployed at scale, the cap-and-trade approach to CO2 emissions would push the technology toward cement factories and natural gas-fired power plants before coal-fired plants, because of the additional cost and complexity of filtering out CO2 from coal plant effluent.

The CCS process alone will consume an estimated 30% of the energy a "clean coal" plant produces, and add up to 78% to the cost of the produced power. Should the technology catch on, its added costs and reduction in output would likely arrive at the worst time: just as oil goes into its long decline.

Emphasizing CO2 emissions in policy, therefore, has several undesirable outcomes: It doesn't address coal plants satisfactorily; it raises costs substantially; it reduces overall power output; and it engenders resistance from the energy industry.

By contrast, focusing on the renewable generation side — what goes into the engine — results in increasing amounts of power that was clean to begin with, at ever-declining costs, and could create a long-term growth opportunity for the energy industry.

Follow The Yellow Brick Road

One needs to look no further than the backpedaling in anticipation of the Copenhagen summit to see the fundamental problem. The meeting is now essentially pre-programmed for failure, thanks to a continuing deadlock between developed and developing nations over who will shoulder the responsibility for future emissions.

It doesn't help that President Obama has refused to commit to binding emissions targets internationally before Congress passes domestic emissions legislation, and that the U.S. Senate has now decided not act on its bills until the spring.

Commenting on the climate bill, Sen. Claire McCaskill (D., MO) said, "It's really big, really, really hard, and is going to make a lot of people mad."

I think that's true, and it should tell us something: It's a whole lot easier to find the financing and business support to roll out millions of little solar systems and insulation upgrades and more efficient vehicles, and so on, than it is to get a world full of politicians to agree on anything. Even after you get that agreement, you still have to build the solar systems and cars and install the insulation.

At best, the summit will probably result in non-binding political agreements. But I prefer to take a longer view of the climate change movement.

It doesn't really matter if Copenhagen is deemed a failure or a success. And it doesn't really matter if we take a backwards approach to the renewable energy revolution.

The only thing that matters is that the world continues to make progress in the right direction. Here, the peakists have an important role to play.

Somewhere over the rainbow, down a long and winding Yellow Brick Road, is energy's Emerald City, and we'll need the pragmatic peakists to lead us there. With their help, the Greens can get their heads out of the clouds, the Browns can move their rusting limbs again and learn some compassion for the earth, and the policymakers can find some courage.

Until next time,

Chris

China The Vampire Squid of Commodities

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For my final report on the 2009 ASPO peak oil conference, I must address the world's new prime mover of commodity demand: China.

With flat-to-declining economic growth rates in most of the rest of the world, the Red Dragon has emerged as the dominant force driving global demand for natural resources.

Adam Robinson, a Vice President at RBS Sempra Commodities who gave an excellent talk on the oil trade and its relationship with the recession, noted that China's willing to buy oil in size at $55 a barrel for its strategic stocks, providing a natural floor for global prices.

Steven Kopits, the managing director of Douglas-Westwood LLC, said China will overtake the U.S. as the world's top consumer of oil by 2018. In fact if supply is available, he thinks it could double U.S. consumption by 2025.

Tom Petrie, Vice Chairman of Bank of America Merrill Lynch, essentially agreed. In his model, all of the growth in oil demand through 2030 comes from non-OECD countries, with China accounting for fully 43%. The IEA anticipates that absolute oil consumption in the OECD will fall over next 20 years by about 3 mbpd, while China's increases by 9 mbpd.

Investors are looking at the convergence between falling OECD oil demand and rising demand in non-OECD, Robinson explained, and after taking monetary policy into account, the see commodities winning either way.

His reasoning is astute: Even if the Fed's fiscal stimulus turns to drag, and we don't get the recovery, then where does the dollar go? Down - which will be bullish for commodities. And if we have a V-shaped recovery, demand and prices will rise - again, bullish for commodities.

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Voracious Demand

In his presentation on China's oil and gas balance, Michael Rodgers of PFC Energy made one thing abundantly clear: China's domestic oil production has nearly peaked, while its demand for oil is only going up.

China currently accounts for about half the total oil production of South Asia, Southeast Asia, and Australia combined:

Source: PFC Energy

The crude oil reserve balance for Asia went negative in the early 1980s, when the region began producing more oil than it was discovering. Like the rest of the world, most of its current production is from large reserves discovered in the 1960s and 1970s, supplemented by smaller discoveries since. The region's current deficit is about 1.5-2 billion barrels per year.

Source: PFC Energy

After years of continuous increase, China's oil production base is now in decline with overall depletion levels of 60%. Fields producing prior to 2000 are generally declining at rates of 5-7% per year, but mature fields are declining by as much as 16-20%. China expects enhanced oil recovery (EOR) technology to bring the overall decline rate to 6.7%.

New fields should allow it to maintain a production plateau around 3.6-4 mbpd for another 8-10 years in the PFC forecast. But then China will see a "catastrophic" drop in production as mature fields, accounting for 3 mbpd of production now, fall to about 1 mbpd by 2020.

Against a GDP growth rate of 8-8.5%, the stagnant supply picture means that China's demand for oil imports will grow from 4 mbpd today to over 10 mbpd by 2020. China now constitutes 7.5% of global GDP and 9% of global oil demand, which will soon grow into the teens.

An appetite like that, Rodgers said, means China must do exactly as it has been doing: aggressively compete with the rest of the world to secure reserves, and export workers.

The picture for natural gas is slightly better, but also points to sharply increasing imports. China's gas consumption is expected to rise from 7.6 billion cubic feet per day (Bcfd) in 2008 to over 30 Bcfd by 2030. Domestic production should keep up with demand until around 2014 — at which point imports will have to pick up the slack - and peak around 2020.

China is already building pipelines from every possible direction to import gas. I'm sure I'm not the only one who, looking at the following map, thinks "vampire squid."

Source: PFC Energy

China's demand for coal is just as astonishing: In just the last four years, Kopits observed, its increase in demand for coal was equivalent to the total U.S. coal demand.

Vince Matthews, director of the Colorado Geological Survey, rounded out the picture with some stunning facts on the demand for minerals and other commodities. China is:

The #1, #2 or #3 producer in the world for 15 of the most important commodities;
The #1 importer of copper, accounting for more than 40% of world demand;
Both the #1 producer in the world of iron ore and the top importer;
The #1 car manufacturer in the world, and the #1 car market. (Petrie later made a similar point: China is now second only to the U.S. in first-class interstate highways.)

Consider this little factoid: China built 70,000 new supermarkets in 2005 alone. For a little perspective on that number, the 2002 census counted about 150,000 "food and beverage stores" in the United States.

That voracious demand drove up prices across the board. Matthews ran down a list of price increases from various months in 2003 to the present:

Copper up 307%
Scrap iron up 559%
Molybdenum up 997%. Exports from the U.S. doubled, most of which went to China.
The average price increase of major metals was 379%, and the average price increase was 746% for 15 other industrial metals.

Although prices for many of the metals fell sharply in the commodity crash last year, they're now staging a comeback, driven by Chinese demand.

Worse, most of these metals are bought via long term contracts, not on the spot market. When those contracts expire, Matthews expects spot prices to spike again.

Even cement demand was disrupted when China when began importing it in 2003, resulting quickly in price spikes and shortages in the U.S. China now consumes half of all the cement in the world.

The resources causing the most consternation, though, are the rare earth elements. As I discussed a few weeks ago, China has a virtual corner on the world supply of these crucial elements, which are used in wind turbines, solar equipment, parts for hybrid cars, and many of the other solutions for a post-peak oil future.

The U.S. now imports between half and all of its supply of the rare earths, putting it at China's mercy for some of the raw materials that would be needed for a "Made in the U.S.A." renewable energy revolution.

Indeed, Matthews believes that China intends to take advantage of its position by clamping down on its exports of rare earths, to bring world manufacturing to them.

But perhaps this should not unduly alarm us.

If China is clear-headed and deep-pocketed enough to invest in the energy solutions of the future while we are not, and they can build them faster and more cheaply than us, then maybe it's time to stop worrying and learn to love our new Chinese overlords.

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Outmaneuvering America

Rodgers has no doubt that China understands peak oil and expects future supply disruptions, which is why it's accumulating foreign assets and diversifying its import options.

Peter Dea, the president of oil and gas exploration and production company Cirque Resources LP, made the same point a bit more obliquely, rhetorically asking if China had no doubts about the future of oil, why would they have recently outbid Exxon Mobil for new drilling in Ghana?

Putting a finer point the difference between the strategies of the U.S. and China, Dea wryly observed that the U.S. has potential for offshore drilling for natural gas, but "it won't be developed until the U.S. takes energy resource planning as seriously as China does."

That doesn't appear to be in the offing any time soon. Washington doesn't seem to understand the commodity markets at all, Matthews said, nor the shrewd moves that China is making. While Japan already has a strategic mineral stockpile, and China is quickly amassing one, the U.S. is selling off its key minerals: "The lack of knowledge and concern over it in Washington is horrifying, and I can't explain it," he moaned.

Well, I have explained it: America has no energy plan, and we won't have one until we give up our fantasies about energy independence or drilling our way out, admit that oil is peaking, and get serious about planning accordingly.

While America was busy with its hallucinated wealth meltdown and trying to raise some cash by selling assets at garage sale prices, just one of China's three major oil companies, CNPC, secured 75 resource projects in 29 countries.

Another of the three, energy giant China National Offshore Oil Corporation (CNOOC), just bought oil assets in the US for the first time. The size of the deal for four deepwater exploration licenses in the Gulf of Mexico was undisclosed, but Norway's Statoil, the seller, characterized it as "small."

Still, the purchase is bound to make it more difficult for China to maintain a low profile as it snaps up resources.

Perhaps that's why it has begun trying to cover its tracks: China OGP, an oil industry newsletter issued by Xinhua news agency, recently announced that it would no longer publish data on China's stockpiles of crude oil, gasoline, and diesel. (As if that data weren't hard enough to get already! Killin' me.)

The lesson on China for retail investors should be clear: Buy domestic reserves while they're cheap, and hold ‘em, hold ‘em, hold ‘em.

Until next time,

Chris

Editor's Note: This article is the final part of Chris's six reports from the 2009 ASPO Peak Oil Conference. See also Part 1, Part 2, Part 3, Part 4, and Part 5.

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No Plan for Oil Shortages in North America

On Halloween day this year, I killed part of a beautiful afternoon at a local shooting range with a buddy. It had been quite a while since I did that, and I needed the practice.

[I know some of my gentle readers might find it a little shocking that a peace lovin' hippie like me would do target practice, but I was raised with it. My parents put us boys through the NRA's gun safety program at a fairly early age, before agreeing to take us hunting. Later I was certified to carry a weapon in the line of duty as a security officer. I've always had a healthy respect, if not real love, for guns.]

I was taken aback when I walked in the door at the nondescript, low industrial building. The place was packed. I could hardly find a place to stand and I waited about 15 minutes just to speak to a clerk. The registers were ringing constantly, taking in $100-$300 totals at a whack. Where I come from, we call that a gonga business.

The gun business has been strong this year, without a doubt. Guns have been flying off the shelves and ammo shortages have been common (and surrounded by conspiracy theories).

Unfortunately, most gun makers are small private companies that make high specification steel, leaving Smith & Wesson (NASDAQ: SWHC) as one of the few good tradeable stocks in the sector. And it has done nicely: up 62% YTD after declining from a huge rally in the spring.

Clearly, the general public has had an increased appetite for guns. And let's not kid ourselves — they're not planning to go deer hunting. It's about fear in an increasingly chaotic world and demand for better personal defense.

From an energy standpoint, that fear is certainly justified.

No Plan for Oil Shortages

At the 2009 ASPO Peak Oil Conference, the security outlook for North America was given a surprising twist by Rick Munroe, a Canadian farmer who learned about peak oil some years ago and decided to find out if the military or the government was doing any planning to address the problem.

His efforts turned up three good studies: Alan Smart (ACIL Tasman, 2004); Kathy Leotta (PB, 2004); and Helen Peck (Defence Academy, 2006). But within the actual gears of government, he found naught but denial.

One government official assured him that because Canada is a member of the IEA and has 200 years of oil supply in the tar sands, people should relax. (If you don't immediately realize what a cretinous statement that is, see "The IEA'S Come-to-Jesus Moment" and "Tar Sands: The Oil Junkie's Last Fix," Part 1 and Part 2.)

Munroe found numerous studies about peak oil by the GAO (U.S. Government Accountability Office), which were apparently dropped from any further consideration. As early as 1981 the GAO wrote: "It is questionable whether an adequate organizational structure exists which could effectively manage a crisis."

The IEA's messaging has been clearer. In 2005 it warned that pre-planning is critical, and that the public must be primed and well informed in advance. Yet their strategies for dealing with the impending oil crisis are laughable, boiling down to a short term "surge" in production, and drawing down emergency reserves-at most, a 90-day solution.

Munroe offered a quote by Dr. Helen Peck, a lecturer at Cranfield University in the UK and an expert in complex systems, energy security, and national emergency planning, that highlighted the relationship between food and energy I wrote about in my last article: "The fundamental problem is that it is the very efficiency of the nation's food and drink supply chains, under normal circumstances, that make them so vulnerable under abnormal ones."

Those who try to plan for such emergencies know that in the absence of a plan, the public usually responds to shortages with panic buying and hoarding. Preventing such an outcome requires top-to-bottom pre-planning.

Yet those who have tried it found that mandatory measures are hard to implement. Energy expert and veteran government researcher Roger Bezdek explained at the 2007 peak oil conference that he worked on an oil rationing program in the 1970s, and it was "a nightmare." The team found that they could not improve upon the market, and indeed, he now believes that many of the problems we had in the 70s were due to government interference in the markets.

In his research, Munroe found a confidential report by the IEA explicitly stating that in the event of a crisis, the market should be left alone and allow price spikes to pass through to all consumers. And as recently as 1996, he says, the GAO expressed its faith in the principle by writing "physical shortages. . . are virtually impossible in a market economy."

We know something about what the market does when supplies run short. It caused oil prices to triple up through last July. In fact that outcome was actually anticipated by a 2005 intelligence exercise called "Oil Shockwave," in which nine former White House cabinet officials convened to simulate what would happen if 4 mbpd of global oil supply were suddenly lost. The predicted result was a near-tripling of the world oil price.

U.S. Secretary of Defense Robert Gates was one of the participants in the exercise, and commented afterward, "The threat is real and urgent, requiring immediate and sustained attention at the highest levels of government."

Yet, four years later, not one city, state, or federal government in North America has a plan to deal with the effects of an oil shortage. The official plan is to have no plan.

We can rest assured that the government won't be on our backs the next time there is a supply interruption. As long as we can pay — even if gas is $7 a gallon — there simply cannot be physical shortages! Hurrah!

Grid Security

The U.S. electrical grid has its own peculiar security issues, as Scott Pugh testified in his presentation at the conference. Pugh is a former captain of the U.S. Navy and now serves with the Department of Homeland Security (DHS).

Few people know this (I certainly didn't), but our national grid has three parts: East, West, and Texas. A major grid fault can take down the entire western or eastern halves of the country without affecting Texas, so, Pugh quipped, "Texas can secede from the union any time they think they should."

It's a good option to have. U.S. grid power is generated by over 1,400 power plants and passes through some 25,000 substations in a network of transmission and distribution lines, all of it privately owned by hundreds of transmission utilities & generating companies. A shutdown at any one of those points can take down large segments of the grid.

In an effort to assess the grid's vulnerability, DHS and DOE staged a cyber attack test in 2007 to see if they could shut down a substation by damaging it with a cyber attack. They succeeded. Subsequent war game scenarios produced frightful results.

Yet, as it now stands, the agencies are primarily working on alternative ways to respond to an attack, and praying for a rapid smart grid transformation which should make more fine-tuned grid control possible. In any case, their hands are somewhat tied, said Pugh, because the government doesn't see fit to interfere too much with the privately owned grid infrastructure.

Laissez Faire or a Dereliction of Duty?

It may be the most heinous dereliction of duty ever witnessed in the history of democracy, but that's where we stand in North America. While the UK, Australia, and New Zealand continue to work hard on contingency plans for an oil emergency, we remain in widespread institutional denial, complacent that our fuel supply will be assured by the wise hand of Mr. Market.

We don't need no stinking plans. Panic buying and hoarding — pshaw! We're going to do the job the free market way, through voluntary demand reduction and switching fuels! Remember how the financial markets worked so much better after the Phil Gramm era of deregulation?

If a supply interruption event should happen, and farmers can't get fuel to plant their crops when the seasons dictate. . . well, the resulting food shortages and price spikes will simply have to be the cost of doing business in a free market system. And if oil and gas companies, airlines, trucking companies, farmers (and, well, just about everybody), can't swing with increasingly frequent fuel price spikes and crashes — then I guess we don't need them.

Our government's blithe laissez faire attitude toward the threats of fuel shortages and grid attacks may be intellectually comforting to free market champions, but I'm willing to bet that should such events seriously compromise national security, they'd turn authoritarian in a heartbeat. . . and that includes me.

After seeing these presentations my first thought was: This is utter insanity. We need to nationalize the grid and prepare for deliberate fuel rationing ASAP.

It's not that the government doesn't know about peak oil. Some of the most important studies on the subject and on its likely effects have been produced there. Indeed, Pugh asserted that the military definitely gets peak oil because "they're paying for fuel in money and blood daily." Their primary focus is on using it more efficiently, he said, but they don't worry about shortages because "there's always going to be enough oil for the military."

I'm sure that's true. But I'm not at all sure it's something we want to test.

Failing to plan is planning to fail. The government's weak, bumbling federal response to Katrina is still relatively fresh in the national psyche. And there is a growing awareness among the rank and file that the free market's ability to govern itself failed miserably in the financial meltdown of 2008, and laid a heavy burden of debt on the next several generations of citizens.

Is it any wonder that people are starting to think about personal defense? About being able to generate and store their own electrical power? About growing their own food and putting up some extra canned goods, water, and batteries in the basement, "just in case?"

Until next time,

Chris

The 2009 IEA Oil Report & World Energy Outlook

The International Energy Agency (IEA) released its annual World Energy Outlook (WEO) this week — a report I always anticipate eagerly. Hey, it's like Christmas for energy geeks.

The IEA found coal in its stocking though, after a report the previous evening in the UK's Guardian newspaper cited unnamed whistleblowers alleging the agency had been distorting its true view on peak oil in order to prevent public panic.

The internal sources claimed its analysts did not really believe that global oil supply could rise to the level in the official forecast, but that the agency had bowed to U.S. pressure to paint a rosier picture.

The quotes were unquestionably damning:

The 120m figure always was nonsense but even today's number is much higher than can be justified and the IEA knows this. . .

Many inside the organisation believe that maintaining oil supplies at even 90m to 95m barrels a day would be impossible but there are fears that panic could spread on the financial markets if the figures were brought down further. And the Americans fear the end of oil supremacy because it would threaten their power over access to oil resources. . .

We have [already] entered the 'peak oil' zone. I think that the situation is really bad. . .

. . . imperative not to anger the Americans. . .

Peak oil analysts nodded their heads in agreement. It was hardly a revelation.

John Hemming, the MP for Britain's all-party parliamentary group on peak oil and gas (yes, they actually have one — jealous?) was gruff: "Reliance on IEA reports has been used to justify claims that oil and gas supplies will not peak before 2030. It is clear now that this will not be the case and the IEA figures cannot be relied on."

I've critiqued the reports of the Energy Information Administration (EIA) and the IEA many times over the years (here, here and here), and concluded that both agencies understood the reality of peak oil well enough, but somehow had been pressured to spin the story in the most optimistic way possible. Either that or they had some seriously schizophrenic people.

I have no doubt that a cohort of government and industry representatives from the U.S. and other OECD countries (at whose pleasure the IEA serves), have made their preferences known to the IEA leadership, and possibly reminded them who's their daddy. After all, the agency was created after the 1974 oil crisis for a fundamentally political purpose: to safeguard the West's energy supplies.

To be clear, my analysis of the agency's data supports the allegations. Uncertainty has always been used to put an optimistic spin on the reports.

Several years back, it was the uncertainty around enhanced oil recovery and new discoveries, and the potential for higher prices to increase recoverable reserves

When conventional crude flatlined at 74 mbpd in 2005, despite a tripling of prices afterward, the emphasis shifted to the unrealized potential for non-OPEC supply.

When that didn't pan out, the potential for unconventional sources such as natural gas liquids, tar sands production, extra heavy oil, coal-to-liquids, and biofuels defined the optimistic gray zone.

There were also a few disturbing discontinuities along the way in which report summaries didn't quite match up with the details in the later chapters. Various kinds of unconventional fuels began creeping into the "conventional crude" category.

The spin was absolutely detectable to a sharp eye.

Wind Grows Faster than Coal, Nuclear

Over the past year, energy production from wind has grown faster than coal, nuclear, and even natural gas.

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Concealed Clues

At the same time, another transformation was taking place.

The edges between the solid data and the gray zone gradually became sharper. Over the last few years, the agency's estimates for peak oil production fell from 120 mpbd to 105 mbpd. . . but oddly, their forecast for the date of the peak remained stubbornly around 2030. Curves were gradually flattened, but reached the same point. Simple head-scratchers like that.

The language of the reports also grew in clarity and intensity, alarming critics. By last year, it had become downright shrill: "The world's energy system is at a crossroads" . . . "global trends. . . are patently unsustainable". . . "the era of cheap oil is over". . . "Time is running out and the time to act is now."

This year, they admitted what many of us had already figured out: non-OPEC supply has basically peaked, yet forecasted that global oil supply would still rise from 84.6 mbpd in 2008 to 105.2 mbpd in 2030.

They then devoted fully half the report to a "450 Scenario" in which a vigorous global investment in efficiency, renewables, carbon capture, and nuclear power averts global disaster by keeping atmospheric CO2 concentration below 450 ppm, with a price tag of $26.5 trillion (in 2008 dollars).

The good news now is the situation isn't quite as dire as we thought it was last year. Their cost forecast has come down from $35 trillion, and they now think the world will only need to come up with 45 mbpd in additional crude capacity (another four Saudi Arabias) not 64 mbpd (another six).

Indeed, the divisions between reality and fantasy in this report grew sharper still.

They worry at length about the effect of the global financial crisis on investment in new energy supply, yet still imagine the world will spend about $1.5 trillion a year on new supply infrastructure.

While envisioning a massive investment in efficiency and renewables in the 450 Scenario, they observed that low oil prices, receding investment in cleantech in 2009, and general economic malaise could mean slower growth rates for the solutions.

They forecast that OPEC alone would come up with 17.5 mbpd in new supply — 85% of the global increase — but expect the Middle East to spend only $1.9 trillion out of a global total of $25.5 trillion.

In an extremely dubious scenario, they see global natural gas supply growing faster than demand, eventually resulting in a massive glut. At the same time, they published for the first time a detailed, field-by-field analysis of nearly 600 major gas fields, accounting for 55% of global production. It showed an average 5.3% post-peak decline rate for the world's largest gas fields, and a global production-weighted decline rate of 7.5% for all post-peak fields — very similar to the decline rates they published (again, for the first time) last year on oil fields.

While noting that nearly all of the growth in global energy demand will come from the developing world, and that much of the investment capital needed to obtain their 450 scenario will need to be invested there, they also expressed significant uncertainty about those prospects.

Most telling, however, were the comments made in the press conference at the report's unveiling.

When a reporter asked why they're still sending a signal that the world will come up with another four Saudi Arabias of supply in their reference scenario, when no one believes that is possible, IEA chief economist Fatih Birol tipped his hand:

This is not the scenario we think is — first of all — likely; this is not the scenario that we want to happen. . . This is the scenario that, if it happens, we are going to have an accident in terms of climate, in terms of energy security, and other things, and it is the reason why we are pushing the 450. . . We push the 450 not only for the climate change reasons. . . it is also for the energy security reasons. And it is the reason why our ministers in October have endorsed our work in general. . . We think this [report] is a driver for [policies developing around climate change].

Essentially, he admitted that they deliberately tilted the report toward climate change with an expressly political purpose: to motivate capital and policy in the direction of a decarbonized energy supply. And they did that because it was politically expedient, with all eyes now on the upcoming Copenhagen summit on climate change.

Finally, the agency's highly-nuanced, limp denial of the whistleblower allegations was well salted with impassioned pleas to reckon with their 450 Scenario, reiterating that "the era of cheap oil is over." Birol even emphasized that the IEA had decided to make their data on oil depletion available on its web site for the world's free and transparent examination — a clue that was not concealed, but painted in fluorescent orange.

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The Climate Change Stalking Horse

I have considerable sympathy for the IEA. It's not easy to follow your heart and tell the truth for the benefit of humanity while the boss man is glaring at you and pulling a finger across his throat. Of course their report is politically distorted.

Yet, as I highlighted the key points in the report's executive summary and mentally ticked off the articles I've written on each one over the last few years, I realized how far the IEA has really come. They may have no choice but to walk a tightrope in an intense global spotlight, but they're backing into the truth as quickly as they think they can. For that fact alone, despite its flaws, this report gets my thumbs-up.

Regarding the IEA's Reference Scenario, my view remains basically unchanged from what I said this time last year: "Here's my prediction: their 2010 report will state that the new peak is only 95 mbpd, at a cost of over $30 trillion. And by 2012, they'll admit that the peak was in fact in June of this year, at 87 mbpd. By 2030, fully 20 years past the peak, world oil production will likely be under 70 mbpd."

As for the 450 Scenario, I continue to believe that climate change is a backwards approach to the problem. I have seen no serious rebuttals to the studies by Kjell Aleklett and David Rutledge calling into question whether the world can even get to 450 ppm when peak oil, and then peak gas and peak coal, are properly considered. (Currently, no climate change scenarios have any cognizance of fossil fuel peaking whatsoever.) In e-mail correspondence this week, Aleklett told me that he will soon have two new newspaper articles published in his native Sweden (which will be translated to English) that demonstrate on scientific bases that all of the IPCC scenarios are wrong.

But even that is not important.

Climate change is merely a stalking horse for the IEA. Whether we focus on energy or on climate, the ends are largely the same. And the IEA has astutely recognized that there's a whole lot more public momentum and investment money to be focused on climate change than there is on dour old peak oil.

What the 2009 WEO Really Means

I could go on for pages and pages, as I have in the past, pointing out the discrepancies and critiquing the scenarios. But that's not really what this report is about.

Never mind the outlandishly optimistic oil and gas production scenarios. We can throw out the 450 Scenario, as well. They're wrong, and we all know it — wink wink, nudge nudge.

The IEA doesn't believe either one of its scenarios any more than they believe humans roamed the earth with dinosaurs. Some stories are meant to be read as parables.

The internal message of the 2009 WEO is clear: The world is facing an energy crisis of epic proportions. The path we're on is precarious and unsustainable. (The word "sustainable" occurs 18 times in the report, which I'm sure is a record, and Birol repeatedly emphasized the phrase "energy revolution" in his comments.)

There is a way to avert disaster, but it's going to require the world to commit an incredible amount of capital to the energy sector for many decades to come. And if we fail to rise to the challenge, we'll be dead in the ever-rising water.

That, of course, is our entire raison d'être here. To motivate capital, rise to that challenge — and make some cheese in the process.

And making cheese is exactly what people who see the forest for the trees have been able to do — not just by questioning what is fed to them via sugarcoated goverment reports. . . but also by following the guidance of experts.

My work gives me the pleasure of working with people who know how to surpass the cold feet many investors have these days and invest with success. My colleague Ian Cooper is one such person. Members of his Pure Asset Trader have been having nothing but success, in spite of the market's volatility. In fact, they're trading with a 94.2% success rate. You can read more about Ian's service here.

Until next time,

Chris

The Most Profitable Energy Transition The World Has Ever Seen!

On November 12, 2008, the International Energy Agency (IEA) officially confirmed that every fossil fuel resource we rely on today will simply not be able to keep pace with demand.

As a result, the IEA stated in very clear terms that renewable energy will soon become the second largest source of energy.

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How To Invest in the New Energy Paradigm

One of the more interesting themes that emerged from this year's ASPO peak oil conference was the problems of maintaining complex systems, and the role that energy plays in them.

Dr. Jason Bradford, the biology brains behind Farmland LP (more on that here), ticked off a few of the key vulnerabilities of the U.S. food system in his presentation on sustainable agriculture:

Commercial agriculture consumes 10.3 quads (quadrillion BTUs) of primary energy in order to produce 1.4 quads of food energy. The inputs are mainly fossil fuels used in running tractors, producing artificial fertilizers, producing seeds, trucking, refrigeration, processing, freezing and cooking.
Commercial agriculture not only depletes non-renewable resources and degrades soil, air, and water, but it also releases 5 billion pounds of harmful chemicals and massive amounts of greenhouse gas emissions into the environment per year.
Animal waste provides critically important fertilizer to small distributed farms, but in the modern massive feedlots of concentrated animal populations it becomes an environmental hazard. All the feed transported to the feedlots uses petroleum fuels, and the hay is grown using ancient "fossil water" pumped from deep, essentially non-renewable aquifers.
Over the last four decades or so, runoff from commercial agriculture has resulted in massive "dead zones" near our shorelines caused by algae blooms that suck the oxygen out of the water and create anoxic environments where nothing can live. (The dead zone in the Gulf of Mexico has grown to an estimated 8,500 square miles.)
Just three crops comprise 71% of U.S. crop acres: corn, soybean, and wheat.
Monsanto, Pioneer, and Syngenta —all basically chemical companies — dominate the seed industry with patented GMO seeds. Those seeds are finely tuned to the temperature, rainfall, and so on of the recent past, making climate change a major threat to the whole food regime (more on that here).
Likewise, a handful of giant companies now control the vast majority of the food supply system — a stark contrast to the millions of small family farmers who dominated it prior to the 1960s.
Nearly all of the food delivery system uses just-in-time inventory methods, so there is only one to three days' supply at any point in the distribution chain.

In short, Bradford explained, we have built a complex food supply system with very low diversity and strong connectivity. Yet in nature, those characteristics lead to instability. Stable systems are highly diverse with weak connectivity. The very complexity and interconnectedness of our food web is, in itself, a dangerous vulnerability.

Bradford aptly compared our blithe faith in the food supply system to "the hubris of Wile E. Coyote" just before he realizes he's about to plunge into the canyon.

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The Energy-Water Nexus

A presentation by Michael Webber of the University of Texas at Austin emphasized another important interrelationship: We use water for energy, and energy for water.

Nearly all power plants are thermoelectric heat engines — they use heat to produce electricity (the notable exceptions to this are hydro power and solar photovoltaics). Although there are many variations of the process, here's a simple explanation: A source of heat is applied to one side of the engine, which causes the expansion of a gas. The expansion of the gas makes a turbine spin, generating electrical power. The heat is then dumped by the cold side of the engine, which causes the gas to condense again.

Water is typically used to remove the heat on the cold side. Air-cooled plants are also possible, but they are less efficient because they're less cold, and so water-cooled plants are far more common.

It should come as no surprise, then, that the largest user of water in the U.S. is the thermoelectric power sector, accounting for 48% of the total water withdrawal and 39% of freshwater withdrawals.

The first vulnerability of the energy-water relationship is what happens when insufficient (or insufficiently cold) water is available: It forces power plants to scale back, or shut down altogether, which has happened at numerous coal- and nuclear-fired plants around the world over the last few years.

Webber believes that droughts could even close nuclear power plants in the Southeast permanently due to limited water.

On the flip side, Webber noted that roughly 10% of electricity in the U.S. is used for waste and wastewater, including end uses. But in denser, larger states the energy load can be much higher. According to a 2005 study by the California Energy Commission, fully 19% of the state's energy use is related to pumping, treating, transporting, heating, cooling, and recycling water.

The energy-water nexus includes liquid fuels as well as electricity. Net energy researcher David Murphy noted at the conference that the EROWI (energy returned on water invested) is 228 for petroleum diesel, but only 0.024 for corn ethanol, because making it requires massive amounts of water.

Producing liquid fuels from low-grade resources like tar sands and oil shale also requires enormous amounts of water to produce steam and fracture shale. Vince Matthews, the director of the Colorado Geological Survey, expressed his doubts at the conference that his state's shale resources would be developed because of the water dependency. The "head" of the state's water supply is dropping by about 30 feet per year, he said, and has been falling for 20 years. He expects it to hit the aquifer around 2011.

Finally, we must not forget that most of the Middle East is investing heavily in the desalination of seawater to provide adequate fresh water for its burgeoning population (and of course, its indoor ski slopes). Desalination requires over 9,800 kWh per million gallons, according to Webber. I can easily imagine desalination becoming a major factor in the declining oil exports from the Middle East.

On the energy-water nexus, Webber made two important conclusions: first, we need to rethink transportation; and second, water conservation and energy conservation are synonymous.

Peak Credit = Peak Oil

Gail Tverberg, energy analyst and editor of The Oil Drum, discussed the financial side of complexity in her presentation, describing the economy as a highly-networked system of great interdependence: manufacturing depends on international trade; businesses depend on credit, manufactured goods, and electricity; electric utilities depend on credit and on replacements parts, and so on.

There is a systemic risk in highly-networked, interdependent systems she said, like a computer crash: one thing stops working, and everything else stops working. International trade and finance and credit, for example, are closely linked with oil extraction. It's not coincidental that consumer credit peaked in July 2008, just as oil production peaked. . .

Credit enables oil production, and also enables demand for oil, by allowing consumers to buy things made with and from oil. Conversely, shrinking oil supplies limit economic growth, leading to the kind of defaults we saw this past year. When banks cut back on lending, it leads to less supply and less demand.

The net impact of credit on oil is that it provides positive reinforcement for oil extraction when it's growing, and negative reinforcement on the way down. Peak oil equals peak credit, and peak credit equals peak oil.

Therefore, Tverberg concluded, our complex systems' vulnerabilities to peak oil extend far beyond mere fuel supply. Our current model of food production may cease to work. Our current model of transportation may cease to work. Globalization will fail without ample cheap liquid fuels, making re-localization a necessity. And ultimately, without all complex systems we take for granted today, we will likely be forced to accept a much lower standard of living.

Simplify, Simplify

Simon Ratcliffe, an energy advisor for the UK government and an expert on energy and security in Africa and South Africa, offered this graphical depiction of some of the interconnected risks he has studied in those nations:

Source

Just reading a chart like that makes you want to turn away and latch onto a simpler view, doesn't it? Well, keep that in mind and we'll return to it in a moment.

The problem with complex systems of course is that they're. . . well, complex.

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No one can model demand accurately, and no one predicted that oil would hit $147 and $33 in a span of six months last year.

No one has a good model for the feedback loop from GDP to oil demand, oil demand to price, price to supply, and supply to GDP — let alone the influence of new Frankenstein financial instruments and monetary policy.

No one has a good model for how much fossil fuel we'll need to build the renewably-powered infrastructure of the future, let alone how we'll procure it in a scenario of shrinking global supply. (In fact, hardly any models even contemplate the reality of depletion.)

No one seems to recognize that although the population growth curve led the energy curve on the way up, energy will lead population on the way down.

Even the historical data is all from an era of constantly growing energy supply, making it a poor guide to the future.

A quick aside: In a presentation to the World Future Society annual conference this year, David Pearce Snyder, an editor of The Futurist magazine, argued that schools are not equipping students with the necessary skills to deal with complexity, and that new curricula are essential to surviving the modern world. I agree completely.

So how can retail investors navigate this increasingly complex and chaotic world?

My guiding lights here include the likes of E. F. Schumacher, Paul Erlich, Paul Hawken, and Thomas Malthus — they were right, if a little (or a lot) early. And of course Henry David Thoreau, who exhorted us to simplify.

They would tell us to focus on simplicity in our investing strategies: Think locally, not globally. Small and distributed is more resilient (and more beautiful) than big and centralized. Using less energy to accomplish the same thing will succeed over trying to produce more energy. Imitating nature's low-energy, low-impact, non-toxic methods in our industrial activities — a study now known as biomimicry — will succeed over inventing wacky new chemicals that nature has never seen before.

From now on, we should let the K.I.S.S. principle be our guide: Keep It Simple, Stupid.

Until next time,

Chris

P.S. As you may know, Green Chip's Nick Hodge has been making a killing by following a simple investment strategy. By focusing only on cleantech stocks, he's been able to close a winner for his readers every single week this year. In fact, he's even taken several double-digit gains from the very sectors I discussed today: water and energy efficiency. And he thinks his next pick — a tiny Chinese lithium-ion battery play — could be one of his biggest yet!

Editor's Note: This article is Part 4 of a series of Chris's reports from the 2009 ASPO Peak Oil Conference. See also Part 1, Part 2, and Part 3.

Energy Sector Outlook

With peak oil already upon us, sustaining oil supply is akin to running up the down escalator.

Or, as Nate Hagens put it at the ASPO peak oil conference earlier this month, "Technology is in a race with depletion and is losing (so far)."

The urgent question then is: Can renewables fill the gap of oil depletion?

Mind the Gap

The most recent global data summarized by fuel available from the EIA is, unfortunately, for 2006 and only preliminary (I know they're trying to improve their reporting, but seriously — they need to do better than that). But we'll use what we've got. . .

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In 2006, the total amount of energy the world consumed was 469 quadrillion BTUs, or quads.* Charted in percentage terms, the global fuel mix looks like this:

World Primary Fuel Mix, 2008. Chart by Chris Nelder. Data source: EIA Annual Energy Review 2008 (released June 2009)

If the latest information I gathered at the ASPO peak oil conference is correct (and I think it is, or at least as close to, correct as anybody is going to come at this point), then we should expect oil to begin declining at about 5% per year, starting around 2012-2014.

Of the 157 quads provided by oil, a 5% decline rate will give way to 7.85 quads lost per year, or 1.7% of the world's primary energy supply.

The "Geothermal and Other" category — supplying 1.6% of the world's primary energy — represents all the renewable sources combined: geothermal, solar, wind, biomass, and so on.

Since 1.7% is very close to 1.6%, we can put the challenge of substituting renewables for oil this way: Starting around 2012-2014, we will need to build the equivalent of the entire world's existing renewable energy capacity every year just to replace the lost BTUs from oil.

Fortunately, renewable energy of all kinds is enjoying a massive growth spurt, attracting trillions of dollars in investment capital. On average, the sector seems to be growing at about 30% per year, which is phenomenal. . . but it's not 100%.

In terms of BTU substitution, then, it seems unlikely that renewables can grow at the necessary rate.

Not Just BTUs

However, the challenge is more complex than mere BTU substitution.

Replacing the infrastructure, particularly transportation, that's based on oil with one based on renewably generated electricity will in itself require energy — and lots of it. As Vail pointed out, between 80% and 90% of the energy inputs for renewables must be made up front, before they start to pay any energy out.

Even if renewables were able to make up all of the lost energy from oil, still more would be needed to afford any economic growth.

In all, it seems a fair bet that it will take at least a decade for renewables to merely catch up with the annual toll of oil depletion. The gap will likely manifest as fuel shortages in the OECD, when the developing world outbids it for oil, and a long economic recession or depression. . . unless efficiency comes to the rescue.

To that point, Jeff Vail, an associate with Davis Graham & Stubbs LLP, said at the conference that population increase alone could offset as much as 30% of the improvement in conservation and efficiency. He noted that despite the recession, car sales are up 29% in India as people buy their very first cars.

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Falling Net Energy

Another driver of the down escalator is that the net energy (EROI, or energy returned on energy invested), of nearly all fossil fuel production is falling.

Dr. Cutler Cleveland at Boston University has observed that the net energy of oil and gas extraction in the U.S. has decreased from 100:1 in the 1930s; to 30:1 in the 1970s; to roughly 11:1 as of 2000.

Simply put: As the quality of the remaining fossil fuels declines, and they become more difficult to extract, it takes more energy to continue producing energy.

This begs the question: What EROI must the replacements have to compensate for oil depletion?

Vail presented several models attempting to answer it. In his optimistic scenario, assuming a 5% rate of net energy decline and an EROI of 20 for the renewables, the "renewables gap" was filled in year 3. In his pessimistic scenario, assuming a 10% rate of net energy decline and an EROI of 4 for the renewables, the gap wasn't filled until year 7.

For a sense of how reasonable those assumptions are, we must turn to the academic literature — since no business or government agency has yet shown any particular interest in EROI studies (much to my dismay).

Studies assembled by David Murphy put the average EROI of wind at 18 (Kubiszewski, Cleveland, and Endres, 2009); solar at 6.8 (Battisti and Corrado, 2005), and nuclear at 5 to 15 (Lenzen, 2008; Hall, 2008). No data is available for geothermal or marine energy. All the biofuels are under 2, making them non-solutions if the minimum EROI for a society is indeed 3 (Hall, Balogh and Murphy, 2009).

[A quick aside: The huge range of the nuclear estimate is one indication of how difficult it is to accurately assess the costs of nuclear, which is part of the reason I still haven't written the article I know many of you are hoping to see some day. I'm working on it, and still looking for current research with appropriately inclusive boundaries and updated numbers. Nearly everyone is still using cost estimates that predate the commodities bull run, not even realizing how it distorts their analysis. So far, I have found nothing to change my outlook that the nuclear share of global supply will stay roughly the same for several decades.]

I am not aware of any studies on the EROI of biomass not made into liquid fuels. For example, methane digesters using waste, landfill gas, and so on. . . but its sources and uses are so varied that if the numbers were available, they probably wouldn't be very useful. While such applications are generally good, they're not very scalable: They work where they work, and don't where they don't.

Theorem of Renewables Substitution

Where EROI analysis leaves us is unclear; it needs more research and a great deal more data. There are some useful clues in it, though.

First, we know that biofuels — at least the ones we have today — won't help much, other than providing an alternate source of liquid fuels while we're making the transition to electric.

Second, we know that solar tends toward Vail's pessimistic scenario, and wind fits the bill for his optimistic scenario.

But here's the rub: The lowest EROI source, biofuels, is the easiest to do, with the vigorous support of a huge lobby and Energy Secretary Chu himself. Rooftop solar is the next-easiest to do. . . but making up the lost BTUs takes longer, due to its moderate EROI. And the source with the highest EROI, wind, is the hardest. (I explained why solar is easier here.)

Therefore I propose the following, slightly snarky Theorem of Renewables Substitution: The easier it is to produce a source of renewable energy, the less it helps.

The Winner: Efficiency

All of these factors — the declining supply, the pressures of the developing world on demand, the renewables gap, and the theorem of renewables substitution — underscore how crucial efficiency is to addressing the energy crisis.

They also underscore how profitable the entire energy sector will be for many years to come.

With supply maxed out, and demand at the mercy of a developing world, the name of the game now is doing more with less. More efficient vehicles and appliances, building insulation, co-generation. . . and all the other ways to eliminate waste.

I know it doesn't have the sex appeal of oh, say, space based solar power. . . but it's where the real gains will be made.

Until next time,

Chris

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Editor's Note: This article is Part 3 of a series of Chris's reports from the 2009 ASPO Peak Oil Conference. See also Part 1 and Part 2.

* The thermal values (heat content) of various fossil fuels are typically measured in BTUs. One BTU is roughly equivalent to the heat produced by burning a wooden kitchen match. One cubic foot of dry natural gas contains approximately 1,031 BTUs. For those who prefer their data measured in joules, 1 quad = 1.055 exajoules (EJ, or 10¹⁸ joules). Renewable energy, however, is typically measured in kilowatt-hours (kWh), or the amount of energy delivered by a one-kilowatt source over the course of an hour. 1 kWh = 3412 BTUs.

Our First Peak Oil Recession

One of the most bedeviling problems for oil producers (and oil investors) is knowing when it's too cheap to keep producing, and when it's too expensive to sell.

Last year gave us new boundaries: $147 a barrel was too expensive, and $33 was too cheap. But those aren't terribly useful numbers in the real world.

We now know that $147 was extra-inflated by too much money sloshing into the sector, and $33 was extra-deflated by the fear and confusion that dominated all markets in December of last year. It's likely that tighter regulation of the oil futures market will tamp down the former, and the latter will not be seen again. . . so long as the world banking system continues to beg, borrow, and steal its way to stability and "full faith and credit."

Largest Gas Find in U.S. History Sparks "Louisiana Land Rush"

If you're a Chevron trying to decide if you should plunk down another $5 billion for a big new deepwater platform, or a marginal producer of oil from unconventional sources where the production cost is high, you'll find it hard to commit to new projects with price volatility like that.

One way to get a handle on the question is to look at the supply side costs. As I wrote in March, the current cost of new production in the few places in the world where oil production can still be increased ranges from $60-$75 a barrel, and the average minimum is around $65. The more extreme and marginal projects we'll be eyeing in ten years' time will need closer to $100 a barrel to pay off.

But prices on the demand side of the equation are harder to gauge.

Our First Peak Oil Recession

Several presenters at the Association for the Study of Peak Oil (ASPO) conference two weeks ago used measures of GDP to express the economy's tolerance limit for high oil prices.

David Murphy, a pioneer in net energy (EROI) research at SUNY, noted that major recessions are always associated with petroleum and offered this chart, suggesting that that oil expenditures over 5.5% of GDP lead to major recessions:

Source

Murphy changed the time scale from years to months at the end of the chart to demonstrate how the portion of GDP paying for oil last year spiked and crashed as much in 12 months as it did in 4-5 years during the most recent recessions.

Steven Kopits, Managing Director of Douglas-Westwood LLC, came to similar conclusions in his presentation. He noted how oil stopped responding to price signals in 2004, with production remaining basically flat even as prices tripled. The global oil supply only expanded by 2% while global GDP grew 17%, causing prices to increase by about 25% per year from 2003 on.

By 2008, when crude expenditures reached 4% of GDP, the U.S. fell into recession. In fact, said Kopits, oil over $80 would have been enough on its own to cause what he called "our first peak oil recession."

Former head of exploration and production for Saudi Aramco Sadad al-Husseini opined similarly in his interview with ASPO, saying that the spending ceiling is between 5% and 6% of global GPD. Accordingly, he thinks alternatives to petroleum like Arctic oil, coal- and gas-to-liquids, and so on may not be economical to develop because their costs are too high.

In essence, OECD countries are simply getting squeezed out of the market as the global drivers of demand shift to the developing world. When the cost of filling the tank on an SUV goes from $60 to $100, it really takes a bite out of consumption in America. But your average resident of, say, India or the Philippines can shrug off a 50-cent increase in the cost of filling the tank on his scooter, because he gets so much more economic value from the transportation.

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Kopits believes that $70 oil is enough to effectively lock out the EU from the oil market, and $75 locks out the U.S. This begins to explain how, as independent oil producer Jeffrey Brown observed in his presentation, the U.S. was outbid by Kenya for oil last year.

On a related note, ASPO analyst Dave Cohen made a convincing argument that economic fundamentals will not support increased oil demand — even from China — for years to come, ensuring that global GDP growth remains weak.

In counterpoint, Matthew Simmons asserted that we don't yet know the economy's tolerance point, and thought it could be as high as $500-$700 a barrel.

This is where I must make my departure from Simmons' camp. The data presented on GDP and price at the conference have forced me to reconsider my longstanding belief that peak oil will bring much higher prices. Although prices 5 to 10 years from now, when we're well past the peak and into decline, remain an open question. . . I now doubt that we'll see oil over $150 anytime soon.

A Narrow Ledge

If these analyses are correct, then we are on what Kopits called "a narrow ledge": Houston needs $75 oil to keep drilling, but the economy goes into recession with oil at $80.

Two editors of "The Oil Drum" generally concurred. Nate Hagens put the boundaries a bit wider at $60 to keep drilling and $80-$100 as the economic pain tolerance point, and Gail Tverberg observed that oil at $75-$80 seems to kick off a recession.

If the stability of oil production relies on oil spending staying within roughly 4% and 5% of GDP, it's going to be dicey. But if the oil price ledge is only $5 wide, then it's not clear to me whether the global GDP can manage to stay on it.

In short, the world may not be able to continue executing the expensive oil projects of the future at all. The tension between the price of new production and the pain tolerance of the global economy may be resolved not by stable prices, but by a failure to bring new supply online.

This is indeed a crisis — but it's also a hint that it's time to focus on how we're going to replace oil.

Take it from Sadad al-Husseini: "The hidden opportunity may be efficiency and conservation."

The investment community has already heard that message. At the ASPO conference this year, I estimate that not one of the roughly 400 attendees represented development capital, while at a typical Cleantech Forum in San Francisco, at least half of the 1,500 or so attendees are with banks, VCs, and big hedge funds. Granted, the ASPO conferences are about information, not deal-making. . . Still, investors seem to prefer theses based on abundance to those based on scarcity.

It only makes sense. If you had a large chunk of capital to deploy in the energy space, would you rather try to balance on a narrow ledge, or jump into a sector that's growing at 30% per year — with no ceiling in sight — and the wind of oil depletion at its back?

Efficiency and conservation may not be as sexy as solar and wind, but for the next several decades they will be the only real way to survive a future of volatile oil and gas prices and declining supply. It takes a long time to rebuild an infrastructure. . . and in the meantime, we're going to have to make do with what we've got.

In the pursuit of investment capital, cleantech clearly has the edge over oil now.

Until next time,

Chris

P.S. Chris continues this article as Part 2 of a series of reports from the 2009 ASPO Peak Oil Conference. See also Part 1.

P.P.S. It's no surprise that the bulk of new efficiency dollars is going to the smart grid. Indeed, CEOs of both GE and Cisco have each said its development will rival the Internet in size, scope. . . and profit. As economic pressures weigh on the development of new oil. . . there's no limit to how high conservation stocks could climb. In fact, this report has all the details on three that could easily double.

High Speed Railroad

Chris Nelder recently wrote a fantastic piece about high speed rail in our sister publication Energy and Capital. I found the article to be on point and completely relevant for Green Chip readers, so I've decided to send it to you today.

I think you'll really enjoy it.

Jeff

_ _ _

"'Boondoggle‘, 'Loss-making whim‘, ‘Monument to bad territorial planning'. . .

Such are the arguments of high speed rail critics, as the United States finally gets on board the passenger rail revolution that is sweeping the world.

But that quote wasn't about the U.S., and it wasn't about today's debate.

It came from an essay by José Blanco López, Spain's minister of transport and public works, which was published in a new pamphlet from SERA, a sustainability activist organization within the government Labour party. He was talking about the two decades of opposition that conservatives had mounted against the country's progress in building a high speed rail system.

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Starting with a line from Madrid to Seville in 1989, Spain pursued an aggressive and determined commitment to high speed rail that, by 2012, will produce the longest system in Europe. This year alone, most of the country's €19 billion development budget will be invested in high speed rail. By 2020, López says, more than 90% of the country's total population will be within 31 miles of a high speed train station.

Here he put his country's achievement in perspective:

Shielded behind overly simple, short sighted cost-benefit analysis, critics complained with those arguments against high speed projects over years, until the success of each one of the new corridors proved them wrong and showed that in troubled economic times, the best investments for a society are the ones which improve equality.

History has proved rail's critics wrong in Spain, as economic development and rider enthusiasm followed it everywhere it went.

Cretinous Shortsightedness

Even so, ever unwilling to learn from the successes of the rest of the world, the U.S. is now starting the same effort at about the same place as Spain was 20 years ago.

The president of the U.S. High Speed Rail Association, Andy Kunz, appeared on Fox Business last Friday to make his pitch. And what argument did the show's overcoiffed co-host raise? "Amtrak has been in the red for years and years and years, and nobody in charge over there seems to be able to turn a profit, despite the fact that everybody I know takes the train from New York to Washington D.C., the Acela. It's just not working though financially," she whined.

After Kunz explained that that the Acela leg (with a maximum speed of only about 100 mph) was in fact profitable, and that the rest of the system needed to be upgraded so that it was equally attractive and profitable and capable of speeds over 200 mph, the host pressed on: "How do you get people to ride it?" Kunz patiently explained his point again, and pointed out that when Europe opened its new high speed lines, they filled up with riders immediately. The hosts then tossed off a quick wisecrack about the Chunnel and muttered about the need for profitability, but assured the audience that "Nobody more than Fox Business wants to see new ventures succeed."

Be that as it may, one wonders why Europe's success would not convince them that high speed rail would be a good thing for this country. A projection from rail proponents FourBillion.com indicates that building the 9,000 miles of high speed corridors identified by the U.S. Department of Transportation would create 4.5 million permanent jobs and 1.6 million construction jobs, save 125 million barrels of oil, eliminate 20 million pounds of CO2 per mile per year, reinvigorate U.S. manufacturing, and generate $23 billion in economic benefits in the Midwest alone — all alongside a long list of intangible side benefits.

Putting aside the cretinous shortsightedness and obstinacy of conservative media, let's take a look at what the rest of the world is doing.

A Global High Speed Rail Explosion

The UK's Labour party is also pursuing an expansion of high speed rail, having commissioned a study on building a new line from London to the West Midlands and extensions to the north. Currently, Britain has only one high speed line, the 69-mile-long "High Speed 1" link from London to the aforementioned Channel Tunnel ("Chunnel") to France. The Tories have offered their own £15.6 billion plan, so it seems likely that Britain will soon have a new high speed project.

France, as I mentioned last year, already has the wonderful 200 mph high speed TGV network, with 1,100 miles of track, more than 400 trains, and the third-highest ranking of rail passengers per year, behind Switzerland and Japan. Personally, I found it to be the most enjoyable travel experience I have ever had.

Bombardier's ZEFIRO 380

This week, the Chinese government awarded a $4 billion contract to build 80 high speed (236 mph maximum) electric train sets for the new 3,700-mile-long high speed train network it is building. Half of the contract went to Bombardier Sifang, a Chinese joint venture with Berlin-based rail giant Bombardier Transportation (TSE: BBD.A). The company will begin delivering the trains in 2012 and finish by 2014— boom, done.

Bombardier is already building 20 sleeper trains for China and another 20 passenger trains, in addition to the 500 high-power electric freight locomotives that it contracted to build for China in 2007.

Russia is taking the plunge into high speed rail as well, spending nearly $1.5 billion to upgrade 401 miles of track between Moscow and downtown St. Petersburg, and buy eight electric Sapsan trains made by German conglomerate Siemens (ETR: SIE) with a top operating speed of 217 mph. Four runs a day will make the trip in less than four hours, compared with an average five hours to make the trip by airplane, including the time wasted getting to and from the airport and running the check-in and security gauntlets.

Meanwhile, Back in the States. . .

Calling the U.S. "a developing country in terms of rail," a Siemens representative told the New York Times last week that his company was a candidate for a proposed high speed link between San Francisco and Los Angeles, along with Bombardier and Japanese bullet train manufacturer Hitachi.

The California line is on the short list of high speed rail priorities prepared by the America 2050 group, ranking it fifth nationally in terms of ridership demand behind four other lines for the Northeast.

High Speed Rail Phasing Map by America 2050. Source.

SCNF, the French company that runs the TGV network, has submitted its own plan to the U.S. Federal Railroad Administration (FRA) for four 220 mph corridors in California, Florida, Texas, and the Chicago-Midwest area. The company believes it could open the first line from Milwaukee to Detroit by 2018 and be in full operation by 2023. The costs would be recouped quickly, according to SNCF, returning triple the $69 billion cost of the Midwest corridor within 15 years in environmental and other benefits.

All Costs Considered

Building America's high speed rail network will be expensive — about that, there is no disagreement. The $8 billion appropriated for high speed rail in the stimulus plan was dwarfed by the $103 billion in applications the FRA received for the funds, and is a small fraction of what the total network will cost. The California run alone will probably cost over $40 billion to construct, and that's after the state's existing commitments to building support networks and light rail links.

On the other hand, as the director of the BART light rail system pointed out this week in his testimony to San Francisco city supervisors with the city's Peak Oil Preparedness Task Force, the U.S. currently spends as much on parking as it does on national defense. I haven't run the numbers, but it seems within reason that if that is the case, spending that money instead on high speed and light rail would cover a very large part of the total cost.

Indeed, all of the cost arguments I have heard against rail are incomplete and wrong.

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The true costs of remaining committed to our current road and air infrastructure are never taken into full account. . . like the health care costs of polluted air; the cost of continuously maintaining roads, bridges and tunnels; the availability of materials (remember, several cities in America literally could not buy asphalt during the oil frenzy of last year, because refiners were cracking every last lighter molecule they could from the crude); the trillions of dollars we are spending on oil imports and defense operations in oil producing regions of the world; the billions' worth of damage that our current ways do to the environment; the insurance costs of keeping up 240 million cars and light trucks; the damage and death that those millions of drivers cause; and so on, ad infinitum.

Rail is cheaper, safer, and better on every single count.

When the boundaries are properly defined, the entire transformation of transportation from liquid fuels to renewable electricity would create millions of permanent jobs, and could probably pay for itself.

But the cost isn't really the point anyway.

The Future: A No-Fly Zone

America still has no energy plan, let alone a plan to address the looming threat of peak oil. With the decline of global oil production starting around 2012 already "baked in," due to a lack of sufficient oil megaprojects, we desperately need to start making tracks toward a high speed rail infrastructure. . . or face a painful future of fuel shortages and economic dislocation (at best).

No part of our transportation system is as vulnerable to volatile fuel prices as the airline industry. It was built on the expectation that oil would rarely cost more than $40 a barrel, and it is completely dead if oil stays over $100 a barrel. Last year's oil price spikes put many smaller carriers out of business and cost the major carriers billions. Then the operators who had the largest hedges against rising prices last year got whacked again as prices plummeted.

For my money, the airline industry may as well be dead. Not just because of the damage that oil price volatility has done and will continue to do — and not just because the experience of air travel has become a painful routine of delays and personal insults — but because it's so inferior in every way to high speed rail travel for distances under 500 miles. The TGV line from Paris and Lyons virtually eliminated air travel between those cities, and the high speed line from Madrid to Barcelona cut air travel in half in the first year of its operation.

Forward-looking investors would be wise to accumulate long positions in some of the major players in high speed rail, which have enjoyed a very nice rally over the last three months, as the next wave of investments in it began to hit the press:

I continue to believe that rail — particularly high speed rail — is the longest safe bet one can possibly make. As I have explained in this column over the last several years, we simply cannot replace enough gasoline- and diesel-burning cars with ones that run on electricity to address the peak oil challenge in the time we have left.

Like compressed natural gas vehicles, PHEVs and EVs are "silver BBs" that will help cushion the blow, but in the long term and for the majority of miles traveled, rail is truly the only answer. Rail is by far the cheapest and most fuel-efficient form of transport, requiring about a third less fuel than air for personal travel, and as little as 3% of the energy for freight.

The serious pursuit of high speed rail would also make a real and significant dent in CO2 emissions, and enable part of the urgent transformation we must accomplish from liquid fuels to renewably generated electricity. As Lord Andrew Adonis, Britain's transport secretary, put it in the SERA publication: "High speed rail is now pretty well a ‘no-brainer' transport strategy for the 21st century."

The rest of the world is already kicking our butts in deploying renewable energy. China is running circles around us in long term resource planning and buying up every hard asset under the sun. And compared with the rest of the developed (and developing) world, we're bringing up the rear in rail.

But it doesn't have to be that way.

It's Go Time

If you've watched any of the new Ken Burns series on America's national parks, you know that protecting the common good has always been a struggle against vested interests and conservatives resistant to change. It took strong-willed men of vision like Teddy Roosevelt, John Muir, and Stephen Mather to override the opposition and do the right thing for the future. We need that kind of leadership now.

If I were President Obama, I would direct the Department of Transportation to immediately begin transforming America's infrastructure to one based on electric rail, regardless of the long-term cost, starting with the highest potential traffic and fuel savings and working our way down the list from there. I would do as the French did when they created the TGV: Declare eminent domain and lay in the high speed rails where they make the most sense. I would restrict federal funding for roads and bridges to critical maintenance projects where rail can't take over the load in time — with not a penny more spent on new car-based infrastructure. I would forbid any subsidies for cars and trucks with a fuel economy of less than 30 mpg. I would move all subsidies for fossil fuels into renewable energy — then double or triple them — to ensure that we can run that new electric infrastructure cleanly. I would bind Congress to my purpose and ride roughshod over the objectors, making it my number-one priority.

I know it may seem hard to believe, with oil holding steady around $70 and gasoline around $3. . . but if you haven't studied the data, then take the word of a guy who has: We're in serious trouble, folks. The Armageddon of transportation is dead ahead and we need to move aggressively and determinedly to head off the peak oil challenge. Rail is hands-down our best and biggest shot.

Until next time,

Chris

Oil and Gas Outlook

I have just returned from the annual conference sponsored by the U.S. contingent of the Association for the Study of Peak Oil (ASPO-USA) with a wealth of new information and perspective to share, so this will be the first of a series of reports.

I look forward to the ASPO-USA conferences all year, because they consistently deliver good, solid data on the state of energy and afford an opportunity for vigorous and stimulating discussion with some of smartest and up-to-date experts in the world-particularly over dinner and drinks late into the night. This year was typically outstanding.

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As usual I took detailed notes, which will be uploaded in the weeks to come. But I'll begin with some high-level updates on the key aspects of the peak oil study.

Past the Peak?

Perhaps the thing that struck me most was how much the outlook on peak oil has changed since the first conference in 2005.

Those who thought conventional oil had probably peaked back then were considered extremely pessimistic, where the consensus view saw the peak another 5-10 years off, and the optimists put it 20 years away or more. Some thought the peak rate of "all liquids" would be around 100 million barrels per day (mbpd), up from 85 mbpd at the time. Most thought non-OPEC production would increase up through 2010. Biofuel boosters were sunny about their future.

Four years later, the view on oil and biofuel has grown considerably worse.

We now know that conventional crude did in fact hit its peak-plateau in 2005, having remained around the 74 mbpd level ever since. The expected growth from non-OPEC mostly failed to materialize, as depletion of mature fields took its toll and the cost of new projects soared—especially for deepwater and production from marginal sources. More pessimistic observers now think the 87 mbpd all liquids peak recorded at the height of the 2008 boom was the peak, and the more optimistic ones have cut their expectations to under 100 mbpd, with 90 mbpd looking more likely.

Biofuels now have a black eye from the corn ethanol frenzy of 2007-2008, which has all but collapsed. Ethanol from algae and cellulose still looks about as far in the distance as it did in 2005, as no one has figured out how to produce either one at commercial scale or with an acceptable net energy return. And biodiesel has remained a minor player, with little expectation for it to scale up any time soon.

But the most surprising change has been the outlook for North American natural gas. In 2005, the majority of observers seemed to think it had peaked for good, and saw gas prices remaining in a high range of $11-15/Mcf. I don't think any of them expected the recent boom in North American shale gas, and there was certainly no suggestion that gas prices would crash to nearly $2 this year.

In fact the main worry about gas now seems to be that the shale gas boom will prove to be short-lived, and sucker us into building more vehicles and infrastructure to use it just as it sputters out. We only have a couple of years of data to work with on shale gas wells, and the only good data is from the Barnett Shale.

Running down the depletion numbers on shale gas, analyst Arthur Berman found that in the first year of production decline rates have been in excess of 50% for Barnett wells, and 90-95% for Haynesville Shale wells. The average well in the Fayetteville Shale is "profoundly non-commercial" he said, and predicted that most shale gas wells will be abandoned in less than five years after their first production because the output will be so low.

There is also a fear, which I have articulated previously, that with an average production cost of $7-8/Mcf for shale gas and prices through most of 2009 staying around $4 or less, new wells simply haven't been getting drilled. The effects of that lapse should show up next year and cause our "glut" to disappear quickly, taking prices much higher.

Supply Decline Rates

With the end of growth in the rate of global oil production now either in the past or looming in the next few years, attention is progressively focused on the depletion rates of mature oil fields and the rate and date of overall decline.

Most observers believe the globally averaged depletion rate has risen from 4.5% per year in 2007 to about 5 - 5.5% now, which will accelerate to around 6.5% per year by 2014. This is more or less in line with the average rates from IEA's report last year. Petroleum geologist Chris Skrebowski pointed out that a 5% per year decline rate means a loss of 4 mbpd per year, equivalent to all the volume of biofuels, tar sands and heavy oil combined, or losing the entire North Sea in about 14 months, and that it would be a huge challenge to replace those lost volumes.

Analysts using the Megaprojects database (of large oil projects started up after 2005) generally agree that production will peak in the 2009 - 2010 time frame. Net new supply each year is expect to begin declining around 2014 - 2015 as depletion overwhelms new projects. Supply may reach as high as 92 mbpd in 2010, then plateau to around 89 mbpd in 2014, then decline to 84 mbpd in 2020 and 78 mbpd in 2030.

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That view was generally in line with comments from oil consultant and former head of exploration and production for Saudi Aramco, Sadad al-Husseini, in a video interview clip. Seeing insufficient large new projects in the next 5 - 6 years to compensate for decline rates of 6.5% in non-OPEC and 3 - 4.5% for OPEC, he expects a shortage of capacity in the next 2 - 3 years.

The poster child for decline rates is, of course, Mexico with its crashing Cantarell field. Matthew Simmons projected that its decline would end Mexico's long era as an oil exporter in 18 - 36 months. David Shields, an author and expert on Mexican oil production, delivered a devastating indictment of the country's political leaders and its oil company Pemex, asserting that Pemex officials knew exactly what Cantarell was going to do as far back as 2002, but said exactly the opposite in public. A chart that Pemex shared with the Mexican Senate showed that production from its largest fields would fall to 1 mbpd by 2017, a full 1.8 mbpd lower than the official forecast of about 3 mbpd. If political manipulation is distorting the public impression of Mexico's near-term oil potential (and I believe Shields on this point) then it could be very bad news for the U.S., for which Mexico is the #3 source of oil imports.

Demand Growth Rates

On the whole, I would say there is now a strong consensus (at least among analysts who prefer data to faith) that global oil production will begin to decline in the 2012 - 2015 time frame. The later-dated estimate is based on the notion that the global recession of the last two years has probably given us that much longer before terminal decline sets in.

Peak oil deniers who have projected continued growth for many decades hence and ultimate peak rates of 120 mbpd or more have obliquely capitulated in the face of the recent evidence and switched to a "peak demand" argument: It's not that supply couldn't keep up for geological reasons, it's that demand wasn't strong enough to support high enough prices to raise supply further.

It's a classic tactic to try to change the game if you can't win it, but the peakers aren't buying it. As Skrebowski pointed out, the peak demand argument only really holds for the OECD, where demand is off a few percent from the peak.

The real demand story is shifting quickly to the developing world, particularly China. Analyst Steven Koptis projected that China would overtake the U.S. as the top consumer of oil by 2018, and if supply is available, would double U.S. consumption by 2025.

Indeed, as petroleum geologist Jeffrey Brown pointed out in his presentation of the Export Land Model, the U.S. has already been outbid by Kenya for oil. According to the model he developed with Dr. Samuel Foucher, the top five oil exporters in 2005 will in aggregate reach zero net exports by 2032, and most of that will be shipped early on. In just three years, they shipped 1/5 of their total expected net exports after 2005.

Petrobras' Promise

As a counterpoint to the generally gloomy data on global oil supply and demand, a razzle-dazzle keynote was given by Dr. Marcio Rocha Mello, president of HRT Petroleum and a 24-year veteran of Brazil's oil company Petrobras (NYSE: PBR). He asserted that the recent pre-salt finds in very deep formations off the shore of Brazil, like the much-hyped Tupi field, indicated that there was a great deal more oil in the pre-salt layers—we just need to drill deeper.

In an extremely animated presentation that at times seemed more like a carnival sideshow than a serious analysis, Dr. Mello served up combination of stratigraphic charts and contrarian theory to make the case that between the pre-salt of Brazil, West Africa, the Congo basin and the Gulf of Mexico, there are another 500 billion barrels yet to find.

While entertaining and humorous, I don't think Dr. Mello made too many converts in the room. As former BP oil exploration chief Jeremy Gilbert pointed out the following morning, none of the alleged pre-salt oil is yet proved, and in fact he'd be surprised if there were 5 billion barrels of proved oil there. "Don't confuse passion with precision" he warned, and noted that it would take 20 - 30 years to prove the resource. In short, it doesn't change the peak oil story at all. By the time pre-salt barrels come online, we'll be well down the back side of the production curve. Rising resource nationalism in Brazil also bodes poorly for very many of those new barrels to make it to foreign markets.

I'll conclude this report with a brief comment on oil prices. As I mentioned in my update three weeks ago, the outlook for oil prices has been murky for months as they traded in a $60 to $75 range. I was long oil but cautiously bearish, and watching for signs of a new signal. This week, that signal came as oil breached the $75 level and touched $78 this morning. It's a decidedly bullish move and I think it portends higher prices to come, at least in the near term.

I took the opportunity to beef up my oil exposure with positions in EOG Resources (NYSE: EOG) and, naturally, Petrobras. Even if Dr. Mello is wrong about the pre-salt, Petrobras is one of the most sophisticated and aggressive oil companies in the developing world, and they are positioned better than most to mint money for years to come. And if he's right...well, it will be a great position to hold long term.

Stay tuned to this space for much, much more from the cutting edge of peak oil analysis in the coming weeks.

Until next time,

Chris

Energy and Capital

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Update on Solar, Electric Cars & Energy Policy

After all that I have written in this column about the enormous challenges that the future of energy holds, it's good to focus once in a while on the progress that is being made.

So this week I have brewed up a batch of good news soup.

I begin with an update on feed-in tariffs (FiTs). (A feed-in tariff, for those of you who don't know, is an incentive structure to encourage the adoption of renewable energy via government legislation.)

Two weeks ago, I wrote about the superiority of FiTs over our existing incentives for renewable energy and criticized California for its failed approaches. This week, I discovered that in fact California already has a FiT, which the California Public Utility Commission (CPUC) introduced on January 31, 2008.

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The reason nobody talks about it is that it is an ineffective incentive based on the avoided wholesale cost of natural-gas fired generation, plus a greenhouse gas premium — far too low a price to attract much interest. Only 14 megawatts (MW) have been installed under this 500 MW program, according to a study by E3 Analytics.

But a new bill passed by the California legislature in September might improve the FiT. SB 32 would require the CPUC to include "environmental and distributed attributes (values)" in the tariffs, increase the cap on the existing program to 750 MW, raise the maximum project size to 3 MW, and make a number of other changes that should benefit rooftop solar PV projects on commercial buildings like schools, government buildings, and warehouses.

SB 32 is now sitting on Ahhnold's desk — along with about 700 others — with a deadline for him to sign by this Sunday at midnight. Unfortunately, he has threatened a mass veto of the whole lot in his showdown with the Legislature over an overhaul of the state's water system. I certainly hope SB 32 manages to escape that fate. It's not a perfect bill by any means — and it still pays far too little per kilowatt-hour — but it might finally create a successful FiT in the nation's largest power market that can be improved over time.

Three other new FiTs hit the news this week:

The Hawaii PUC decided to offer a 20-year FiT for solar projects up to 5 MW in size for Oahu and 2.72 MW for Maui and Hawaii Island (how they came up with those numbers, I have no idea). The tariff rates are not yet set, but it seems likely that with the most expensive electricity in the nation at 21.3¢/ kWh (EIA 2007 data) and a power generation system that mostly runs on fuel oil, they will be attractive. Hawaii is arguably the most vulnerable state in the nation to the threat of peak oil.

Ontario, Canada, also launched a 20-year FiT that will pay anywhere from C44.3¢/kWh for large ground-mounted PV systems (up to 10 MW) to a whopping C80.2¢/kWh for residential-sized systems (10 kW or less), when the going rate for grid power is typically C5.7 - 7.9¢/kWh. A pricing structure like that could quickly make Ontario the hottest solar PV market in North America. The province is leading the charge to a renewable energy future in Canada, with a commitment to phase out all coal-fired generation by 2014, several gigawatts of solar and wind generation built or in the pipeline, and a deal with Better Place to deploy electric cars.

Last month, India apparently introduced a FiT that embraces a comprehensive list of renewable energy sources and establishes a calculation framework for setting the rates. Depending on how the numbers turn out, India could become the next nation to deploy PV in a big way.

Electric Cars

The future of electric cars got a nice boost last week when the French government announced that it would spend about $2.2 billion to create a network of battery charging stations for electric cars. One million charging stations will be built under the plan by 2015, with 90% of them in private homes and the rest in parking lots and other sites. Additionally, all apartment buildings with parking lots will be required to install the charging stations after 2012, and all office parking lots must install them by 2015. This should result in a total of four million charging points by 2020.

The new charging network will support France's goal of putting two million electric and hybrid cars on the road by 2020. Currently, the country has only a few thousand such vehicles. To jump-start their deployment, the government will give carmaker Renault €125 million to develop of a new battery manufacturing plant and a €150 million loan to build an electric car factory. Another €100 million will be made available for other electric carmakers. Fleet orders for electric vehicles are expected to reach 100,000 units by 2015.

An Urgent National Priority

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It's a far more ambitious plan than Cash for Clunkers, and will deliver a lot more bang for French buck.

In partnership with Nissan, Renault is planning to invest €4 billion in electric vehicle technology. Renault also has an agreement with Better Place to build at least 100,000 electric cars for Israel and Denmark by 2016, using the latter's battery switching technology.

The plan comes on the heels of a new commitment by the French government to spend $10 billion on freight transport by rail. If you saw my article last week, you'll know that I believe investing in rail is the smartest strategy governments can pursue to address the peak oil threat.

Though it pales in comparison, the best recent news on electric vehicle deployment in the U.S. was that Nissan will deploy 5,000 of its Leaf EV cars and 12,750 charging stations in Oregon, Arizona, California, Tennessee, and Washington by 2012 under a program sponsored by the Department of Energy. Hopefully, the results will speak for themselves and lead to a much larger rollout of EVs in America.

Energy Monitoring

There was an exciting bit of news on the energy management front this week as well, with an announcement that Google had partnered with Energy Inc. to deliver an energy management solution that doesn't need a smart meter. Homeowners and businesses will be able to use Energy Inc.'s $200 "TED 5000" device, along with Google's PowerMeter software to monitor the energy usage of individual circuits in the building. They will be able to see how much it's costing them at the moment and in aggregate over the month. The data then is made available over the Net using any browser without charge.

Google has been working to integrate PowerMeter into smart meters, including those made by one of our favorite smart grid companies, Itron, Inc. (NASDAQ: ITRI). But its market penetration has been somewhat slowed by competing proprietary monitoring packages and the long, measured roll-out of smart meters across the country's utility networks. Until the majority of consumers have smart meters, the deal with Energy Inc. should help make real-time energy management an everyday reality and help utilities reduce the peak demand loads they have to supply. On the whole, it's a great step forward for the smart grid. (For more on smart grid plays for investors, see "Smart Profits on the Smart Grid.")

Policy Progress

Finally, there is the progress on President Obama's clean energy agenda. Secretary of the Interior Ken Salazar recently reviewed his agency's progress at an energy summit in September:

A groundbreaking framework for offshore renewable energy development has been crafted which eliminated red tape between FERC and Interior. The latter also issued the first-ever leases for wind development offshore from New Jersey and Delaware.
$41 million has been devoted to fast-tracking utility-scale solar and other renewable projects on public lands. New Renewable Energy Coordination Offices are being set up in western states to streamline the review and approval process and identify the projects that are ready to go. (For more on that, see "Utility Scale Solar Heating Up.")
Interior has identified 24 "Solar Energy Study Areas" that could host nearly 100,000 MW of utility-scale solar projects. More than 4,500 MW of new capacity from those projects would be in western states, plus another 800 MW of new wind capacity should be ready for construction by the end of 2010.
Over 55 million acres of new offshore leases for oil and gas development have been sold or auctioned since January.
Interior has also worked to set a good example by installing a green roof on its headquarters, quantifying its carbon footprint, and installing energy saving devices and solar panels on its facilities in parks and public lands.

Not a bad list of achievements for only nine months!

America may be pulling up the rear in its efforts to steer the country away from dying liquid fuels and toward the bright green future of an all-electric renewable energy infrastructure. . . but the wheels do seem to be in motion and I remain cautiously optimistic about our prospects. If we can only get our heads on straight about where we are and where we're going, I think we'll make great strides. Hopefully, we will position ourselves a whole lot better to face the decline of oil just three short years from now.

Until next time,

Chris

P.S. My colleague, Nick Hodge, has been profiting from bullish cleantech news at every turn. His new "R-Track" system weighs policy information and news like I've just shared with you. It seeks out the companies involved, and identifies the best publicly-traded ones to invest in. He's closed 41 winners this year, including two yesterday for 40% apiece. If you want to invest in cleantech with a near-certain accuracy and consistency, I suggest you read this report about the system. . . and how you can start using it today.

High Speed Rail: A No-Brainer

"'Boondoggle‘, 'Loss-making whim‘, ‘Monument to bad territorial planning'. . .

Such are the arguments of high speed rail critics, as the United States finally gets on board the passenger rail revolution that is sweeping the world.

But that quote wasn't about the U.S., and it wasn't about today's debate.

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Here he put his country's achievement in perspective:

History has proved rail's critics wrong in Spain, as economic development and rider enthusiasm followed it everywhere it went.

Cretinous Shortsightedness

Even so, ever unwilling to learn from the successes of the rest of the world, the U.S. is now starting the same effort at about the same place as Spain was 20 years ago.

Putting aside the cretinous shortsightedness and obstinacy of conservative media, let's take a look at what the rest of the world is doing.

A Global High Speed Rail Explosion

France, as I mentioned last year, already has the wonderful 200 mph high speed TGV network, with 1,100 miles of track, more than 400 trains and the third-highest ranking of rail passengers per year, behind Switzerland and Japan. Personally, I found it to be the most enjoyable travel experience I have ever had.

Bombardier's ZEFIRO 380

Meanwhile, Back in the States. . .

High Speed Rail Phasing Map by America 2050. Source.

All Costs Considered

Indeed, all of the cost arguments I have heard against rail are incomplete and wrong.

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Rail is cheaper, safer, and better on every single count.

But the cost isn't really the point anyway.

The Future: A No-Fly Zone

But it doesn't have to be that way.

It's Go Time

Until next time,

Chris

Investor's Note: Have you heard of the 'R-Track System' before today? My colleague, Nick Hodge, has been utilizing this investment strategy — and he's delivered 45 winning trades within the last 12 months. But please don't take my words for it. . . I want you to see this one for yourself. He lays it all out here.

The Renewable Energy Challenge

With the Copenhagen summit on climate change less than three months away, and governments the world over engaged in intensive discussions and preparations, it feels like we are finally standing at a true crossroads.

One direction leads to a vision of a sustainable future, with adequate energy, food, and water for all without compromising the welfare of future generations.

The other direction is a continuation of the path we're currently on, which the vast preponderance of empirical evidence says is not sustainable, but which continues to be vigorously defended by vested interests.

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Climate change is the headline purpose that brought us to this point, but choosing the sustainable path has far greater implications. As sustainable business proponent and founder of the carpet company Interface, Ray Anderson, put it in the introduction to his new book, Confessions of a Radical Industrialist:

By survive, I mean business must be steered through a transition from an old and dangerously dysfunctional model to a far better one that will operate in balance and harmony with nature—thrive in a carbon-constrained world, and put down the threats of global climate disruption, species extinction, resource depletion, and environmental degradation. In a word, develop a business model that is sustainable.

The sustainability cause is championed by an unlikely alliance of climate scientists, government agencies, military analysts, environmentalists, and forward-thinking business leaders like Anderson — the Greens — all of whom realize that we are heading for Big Trouble if we keep on going the way we have been.

On the other end of the struggle are the Browns: businesses who would rather fight than switch. The oil and gas industry dominates this faction, but they are by no means alone. All those whose livelihoods depend on our continued use of fossil fuels have found common cause in opposing efforts to curb climate change.

In the past several weeks, two utility companies — Duke Energy, which provides power to five states; and Alstom, a French manufacturer of power plant components —and aluminum giant Alcoa resigned their memberships in the American Coalition for Clean Coal Energy after revelations surfaced of forgeries the group perpetrated as part of its lobbying against climate change legislation.

This week, California utility PG&E made a similar move by leaving the U.S. Chamber of Commerce over the organization's extreme stance on climate change. Three weeks ago, the Chamber called for a "Scopes monkey trial of the 21st century" to put climate change science on trial — a silly idea, since science is intrinsically a process of examination and proof; and strange choice of metaphors, considering that science won the Scopes argument.

Then again, it's not called the U.S. Chamber of Sustainability. Would that we had one!

A House Divided

While those who stand to lose something waste their energy impeding our progress on the march to sustainability, those who stand to gain from it are going gangbusters.

As I discussed two weeks ago in my article "Welcoming China's Energy Revolution, China has made aggressive and well-timed moves in the solar race. In only five years it has gone from being a negligible player to the world's top producer of solar PV cells, according to a new report from the European Commission Joint Research Centre Institute for Energy. Worldwide solar module production increased by 80% in 2008 alone, with Asia and Europe taking the largest share while the U.S. share barely budged.

Source: JRC PV Status Report 2009. "In 2008, China became the global leading producer of solar cells with an annual production of about 2.4 GW, followed by Europe with 1.9 GW, Japan with 1.2 GW and Taiwan with 0.8 GW. It this trend continues, China might have about 32% of the world-wide production capacity by 2012."

It must greatly amuse the Chinese to watch the Greens and Browns in the U.S. waste their energy squabbling over who's going to pay for the transition to a sustainable climate, starving the country of investment in the clean energy solutions of the future while China is busy taking over the global PV market and implementing policies that will soon take it far beyond the U.S. in meeting climate change and renewable energy goals.

Indeed, the U.S. is fighting itself at every turn, offering more incentives that will increase CO2 output than those that would curb it.

Last week, just days before President Obama would warn at the United Nations that the "irreversible catastrophe" of climate change must be avoided, the Environmental Law Institute issued a new report finding that U.S. subsidies to fossil fuels ($72 billion) were over two-and-a-half times as great as those it invests in renewables ($29 billion). Of the latter portion, traditional renewables received only $12 billion, while corn ethanol — a net energy loser — got $17 billion.

The OECD also issued a report last week estimating that eliminating fossil fuel subsidies alone would cut emissions by more than 10% by 2050. I suspect the two reports had something to do with Obama's call on Wednesday of this week to "work with my colleagues at the G-20 to phase out fossil fuel subsidies."

As of this time, however, the madness continues. Pending House legislation sports tens of billions of dollars of incentives for so-called "clean coal" technology, which does not exist commercially, but has no hint of a feed-in tariff (FiT) — the primary impetus behind Europe's stunning renewable energy growth.

As I have written previously, FiTs have been responsible for an explosion of renewable energy in over 37 countries and put them on track to meet their carbon emission reduction goals. But instead of following those examples, the U.S. is fixated on a backward approach to the climate problem: a highly corruptible and ineffectual cap-and-trade mechanism that puts the focus on what comes out of the tailpipe instead of what goes into the engine. (Notable exceptions to this are Gainesville, which has adopted a FiT, and San Antonio, Los Angeles, and Sacramento, which are considering one.)

A new research note from Deutsche Bank points out that under Germany's FiT the share of electricity supplied from renewables grew from 6.3% to 14% and created 300,000 new jobs, but the program's cost only contributed between 3% and 4% to the increase in electricity prices from 2004 to 2006.

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Over the same time period, the fraction of renewable energy in the U.S. actually fell from 10.1% to 9.4% while the Browns fought it tooth and nail. Job creation was anemic, electricity prices still rose, and oil imports continued to increase.

A Case Study in Failure: California

As usual, California offers a useful example of how backward the U.S. approach is to formulating energy policy.

A recent showdown occurred over a bill that would raise California's renewable portfolio standard (RPS) from 20% by 2010 to 33% by 2020. Governor Schwarzenegger threatened to veto the bill because of a provision that would require the power to be generated by plants connected to the California grid — an attempt to keep the projects in-state and limit imports — calling it "protectionist." Then he proceeded to issue an executive order to the California Air Resources Board establishing the new 33% RPS by mandate.

The RPS approach, which favors utility-scale projects, has already failed to yield the desired results. California's three big utilities will almost certainly fall short of meeting the existing 2010 goal, with laggard San Diego Gas and Electric currently getting only 10% of its electricity from renewables. (I can also tell you firsthand that the one residential solar project I did in SDG&E territory was a slow-moving absolute nightmare of confusion and paperwork compared to the projects I did in PG&E territory.)

At the same time, an approach that actually works continues to meet resistance.

California's net metering law, which requires utilities to give credits to customers who feed renewable power back to the grid, is currently capped at 2.5% of the total load. A new bill would have raised the cap to 5%, but was stalled when the International Brotherhood of Electrical Workers (IEBW) successfully inserted an amendment that would have permitted only contractors with a general C-10 electrician license to install projects larger than 250 kilowatts, excluding numerous non-union contractors with the solar-specific C-46 license. (The IEBW has attempted the same strategy several times in recent years, impeding the progress of pro-solar policy while gaining nothing for itself.) If the net metering cap is not raised, there is a distinct possibility that PG&E will hit the existing cap and trigger another slump in the long boom-and-bust history of solar.

Time to Choose

If the U.S. were serious about making progress on climate change and renewable energy, it would put aside the jockeying of narrow-minded interest groups and implement long-term policies with proven records of success.

As I see it, the effective policy approaches are stable, transparent, long-term, and simple:

Forget about cap-and-trade and RPS, and incentivize clean energy with a generous and long-lived national FiT modeled on successful programs elsewhere.
Shift all subsidies for brown fuels to green fuels, with priority given to those with the highest net energy (geothermal, solar, and wind), instead of those with the best lobbies (corn ethanol).
Level the playing field between rooftop and utility scale solar by removing net metering caps, allowing utility customers to put as much excess renewable energy onto the grid as they can generate.
Tear down the barriers between states and utilities, and create a national market for renewable energy.

Above all, we should stop framing our decision-making around short-term cost arguments, and accept the fact that all of the energy solutions of the future will cost more than those of the past. The cost of fossil fuels will continue to rise because the best resources have already gone up in smoke, and what remains is progressively more expensive to produce. The cost of renewables will cost more in the short term, but fall as the technologies mature.

Besides, ample research has shown that in the long run — once the true costs of all fuels are recognized, with nothing externalized, and cost-benefit analyses are extended into multi-decade time frames — renewable energy wins hands-down over fossil fuels.

With which would you rather align yourself: a dirty, mature industry going into decline that still claims to need billions in public support. . . or a clean, new industry that's growing at 40% per year, with no limit in sight, and a reasonable expectation of being able to get along without subsidies in 20 years or so?

Beyond renewable energy's long-term benefits — a more resilient economy, jobs created indirectly, better public health, a reduced burden on the national coffers for imported oil (on the order of $400 billion for this year in the U.S.), and other indirect and intangible benefits — there is the straightforward imperative that we begin the urgent transformation toward true sustainability.

The short-term cost argument is tired, and we have already delayed too long. It is time we evaluated our choices in terms of the wealth and welfare of future generations, not just the personal net worth and power of today's kings of industry.

At this crossroads in history, the United States can either seize the opportunity to reinvent itself and secure a prosperous future, or allow an unproductive process of selfish bickering to lead us further down a dead-end street. We can apply our vaunted ingenuity and innovation to the renewable energy challenge, or watch our fortunes continue to slide while the rest of the world kicks our butts.

We do have a choice.

Until next time,

Chris

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Peak Oil Update

Everyone who follows the peak oil story has by now seen some of the editorials that blanketed the press over the last few weeks, attempting to debunk it and disparage its adherents. I responded to the worst of them three weeks ago.

Michael Lynch fired back quickly, saying that my article "tops them all" and alleged that I had predicted $500 oil with a global depression.

I'm flattered, but as my longtime readers know, that was quite a mischaracterization.

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Lynch was referring to my July 28, 2008 appearance on Yahoo! Finance's Tech Ticker show with Aaron Task, wherein I explained the important concepts of the peak oil study, alongside some of the key data.

Here's what I actually said (emphasis mine):

Task: "Where do you see oil prices in 10 years?"

Nelder: "That's impossible to say. If demand holds up, which is going to be primarily due to continued growth in Asia and the Middle East, then the sky's the limit—it could be $500 a barrel, for all I know. If we have a major episode of global depression that sets in and demand really—[Task: which may be a possibility]—it's a likelihood!—then I think oil will come back down when that happens, but at what point does that happen? When oil's $200, when oil's $300 a barrel, and then it goes back to $250? You know—it's going to be something like that."

We all know what happened after that: Demand fell, a major episode of global depression did indeed set in, and oil did come back down.

Now I'll admit that I was dead wrong about the floor for prices being around $120, nor did I know that when $147 a barrel had printed two weeks earlier, it would turn out to be the all-time price peak. Such are the perils of price forecasting, which I have tried to avoid ever since.

On the other hand, nobody expected crude prices to run the gamut from $147 to $33 and almost halfway back again over the course of a year. Thus did the market make fools of us all. I quite rightfully expected prices to keep on going up, had oil demand continued to rise after last July in keeping with its long history. And nobody knew that $147 was the peak price until it had faded into the rear-view mirror.

In the same way, we can't know for sure when the supply of "all liquids" has peaked until that date is also well behind us. Not coincidentally, the current record flow rate for all liquids production is a rounded 87 million barrels per day (mbpd), which occurred along with the price peak in July 2008. ("All liquids" includes conventional crude plus unconventional hydrocarbons such as natural gas liquids, "extra heavy" oil, synthetic oil made from tar sands, refinery gains, liquids produced from the conversion of coal and natural gas, and biofuels. Regular conventional crude production topped out in 2005 at just over 74 mbpd, and has remained at roughly that level ever since.)

Honest analysts know that one of the keys to oil pricing is the amount of spare production capacity, because oil is priced at the margins. When that spare capacity fell to around 1% of total supply last year, it created a tradeable opportunity that attracted speculators, driving prices still higher.

When global demand recovers, prices will spike again, because new drilling into progressively marginal fields will be unable to keep up with the decline of mature oil fields. This is one of the key concepts of the peak oil study.

We now know that the global economy's maximum pain tolerance point is around $150 a barrel. However, it may not have to rise that high next time to destroy demand and cause prices to fall because the global economy and the overall credit environment are now substantially weaker. At the same time, it's not unthinkable that gasoline prices could again reach the $4 range; refiners are operating now at substantially lower levels due to the compressed crack spread.

Therefore, oil prices will continue to have a volatile stair-step pattern for a long time, as we keep bumping our heads against the supply ceiling.

So the next time you hear a peak oil denier who has spent the last several years blithely asserting that oil will soon be back to a nice comfy $30, or that technology is increasing reserves all the time without addressing the question of flow rates, ask yourself how credible he is.

Reviewing My Track Record

Now take a look at my track record. I have written an exhaustive book on peak oil (which geologist and peak oil expert Colin Campbell called "the best job I have seen in describing the Peak Oil issue in a sound and very understandable way"), and over 150 articles since 2003, in which I have explained the theory behind peak oil; showed the actual supply and demand data; put new discoveries into perspective; discussed the relationships between oil and the economy; and tried to peer into the future as accurately as possible.

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So far, I have seen no serious factual rebuttals to my arguments. The counter-arguments, like the most recent ones from the peak oil deniers, are generally simple expressions of faith: Faith in technology, faith in the markets, and faith in humanity. They aren't supported by the data. Unfortunately, cars and power plants don't run on faith. Faith can't cook your food or keep your house at a reasonable temperature. And economies don't keep growing without a continually increasing supply of cheap energy.

Other than that Tech Ticker appearance, my price guidance has actually been pretty good for the last three years. (Perhaps that's why Lynch cited—and mischaracterized—that one call.) I knew when prices were too low, and put out contrarian bullish calls at almost exactly the right time for oil and natural gas. And when oil prices bounced back up to $60 in May, I said it would be prudent for investors sitting on double-digit gains to take some off the table. I also said that when prices neared $70, they would likely cool off. So far, so good. (Oil generally has been bouncing around the $70 level since May.)

The near-term future of oil prices is, in some ways, even murkier now. . . with upward pressure applied by a dollar that has been falling since March, and downward pressure applied by high inventories and falling crack spreads. My gut feeling is that they are currently in a kind of equilibrium, but it's hard to support that quantitatively. For the last few months, my guess has been that oil would be range-bound somewhere between $60 and $75, and I think that could remain the case for a while yet.

However, I also see an increasing risk that we could have an episode of dollar strength and a selloff in equities and commodities before the end of the year. That's a discussion for another day, but at this point the downside risk for oil feels like it's strengthening, and the rally in equities is starting to feel silly. A strong correction seems due - but try telling that to this ever-irrational market. I am still long commodity stocks because the getting has been very good, but my stops are tight and I'm prepared to get short at the first sign of trouble.

Again, contrast those calls with the repeated assertions of Lynch and Yergin that oil will soon return to a hallucinated "mean" in the $30-$40 range.

Warning Signs of Peak Oil Increasing

Putting the troublesome questions of price aside, though; let's get back to the increasing indications that peak oil is indeed upon us.

For the last year, I have warned in this column that volatile oil prices and a weak credit environment were putting the hurt on investment in new oil production, leading to a lack of expected supply from new drilling in a few years. This week, French oil giant Total echoed that warning, saying that it had slashed 4 mbpd from its estimate for oil production in 2015 and that the world would face a supply crunch by the middle of the next decade.

I give Total credit for owning up to a future supply crunch where few of the other oil majors have and I agree with their assessment. The data suggests it's now all but a foregone conclusion that the world's oil supply will begin its inevitable decline around 2012. By 2015, the world will realize that the good ol' days of cheap oil and continual economic growth aren't ever coming back.

Ian Reid, a senior executive at the Australian investment bank Macquarie who had 16 years of experience in the oil industry, apparently agrees, telling Reuters this week: "This is our view - capacity has pretty much peaked in the sense that declines equal new resources."

He believes that the lack of investment this year, in addition to rising resource nationalism (e.g., Brazil) and the declining prospects for discovery, will wipe out the current spare production capacity of 5.2 mbpd by 2012, causing global oil production capacity to fall from 89.6 mbpd this year to 87.3 mbpd by 2015, while demand rises to 90.9 mbpd.

If you're now thinking that BP's recent Tiber field discovery in deepwater Gulf of Mexico and the other "giant" finds of the last few years give the lie to peak oil, allow me to put them in perspective. As I wrote last week, the amount of actually recoverable oil from Tiber is probably less than 1 billion barrels, and this oil might take as long as 10 years to come to market, at a development cost in the low billions of dollars. We have no way of knowing what the all-important flow rate might be at this point, but using other nearby fields as a benchmark, let's assume it might achieve a maximum rate of 200,000 - 300,000 barrels per day in 10 to 15 years' time. Meanwhile, the world stands to lose about 4 mbpd of supply capacity each year, starting somewhere around 2012.

In other words, we would need to make a discovery like Tiber roughly once a month in order to significantly change the global supply curve, whereas we're actually making such discoveries more like once a year.

Don't be fooled. Peak oil is here, and the low prices of the last year are only setting us up for less supply just a few years down the road. Understanding the complex reality of global oil production is a recipe for investing success, but thinking that the next 20 years will be anything like the last 20 will lead to certain failure.

Play your cards accordingly.

Until next time,

Chris

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Nanosolar's New Solar Technology

There was a very exciting announcement in the world of energy this week, and I've been taking a hard look at it.

No, it wasn't the Tiber field find by BP. Although peak oil deniers seized on the discovery as validation of their argument that technology will continue to make vast new reserves of oil accessible and solve the peak oil problem, the hype was typically overblown. It reminded me of the initial excitement over the Jack field in 2006, which is east of the Tiber field and part of the same Lower Tertiary trend in deepwater Gulf of Mexico.

Perhaps I'll write on Tiber when there is more hard information about it, but on the basis of the very scant data currently available, I would speculate that first oil from it might be produced in 10 years, at a cost in the low billions of dollars, and that it might achieve a maximum flow rate of 200,000 - 300,000 barrels per day (bpd) some years later.

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In other words, in the context of the peak oil problem, where we're worried losing 4 mbpd of oil production capacity each year starting somewhere around 2012, a discovery like Tiber is a good thing. . . but it's hardly a solution. We'd need to continually make similar discoveries roughly once a month in order to significantly change the global supply curve, and that simply isn't happening.

Rather, what had me excited was an announcement from Nanosolar that it was finally ending its "quiet period" after seven years of development, and had completed a new solar panel assembly plant near Berlin. The plant is fully automated using state-of-the-art equipment, and can reportedly sustain a production rate of one panel every 10 seconds, or 640 MW (megawatts) a year if operated 24/7.

The company claims to be churning out 1 million solar cells (about 1 MW) per month now, including production from its San Jose, California, plant which opened earlier this year and is expected to eventually reach 430-MW capacity. When both plants are operating at capacity, Nanosolar would be getting close to thin-film king First Solar's (NASDAQ: FSLR) manufacturing capacity, which is expected to reach 1,189 MW by the end of the year.

Nanosolar has taken a few hits in the press for keeping the wraps on its technology for so long. Founded in 2002, it gained early notoriety for raising a $150 million startup war chest — which rose to $500 million last year — before publicly divulging any real details about its technology, its strategy, or its anticipated production capability. The company is still privately held (much to the dismay of your editors here at Green Chip Stocks!).

Now we have an idea why the company was so careful to play close to the chest. . . and why their unveiling is truly a big deal.

Groundbreaking Technology

I first became aware of Nanosolar in late 2005, when a couple of their engineers gave a dog-and-pony show of their technology to the solar company where I was working at the time. I was immediately impressed by their visionary approach of "printing" solar material using a printing-press technology, which had the potential to achieve enormous savings in manufacturing cost.

But there were some problems to be solved first, like how to deposit a nice even coat only one-micron thick of their CIGS (Copper-Indium-Gallium-Selenium) "solar ink" on the substrate, and to do so at high speed, while still producing cells that were electrically matched so they could be wired together into high-efficiency panels.

There were also uncertainties about whether they should try to produce something revolutionary — like giant solar wrappers that could cover a bus or a building — or more evolutionary, like traditional rectangular modules that could be mounted using the same hardware as standard silicon modules.

Now, it appears they have solved those problems, tested their modules thoroughly, and gotten everything approved by UL, the International Electrotechnical Commission, and other regulatory agencies.

Here are a few of the advantages that Nanosolar's technology has over other types of photovoltaics.

"COP-15"

Instead of using glass as a substrate, like First Solar and other thin film manufacturers do, Nanosolar uses aluminum foil. This has three advantages: One, foil is much cheaper (one or two cents per square foot and mil thickness). Two, it enables them to make the cells in a "roll-to-roll" process, turning a roll of foil into a roll of 50,000 cells in one continuous loop. (Check out their video to see their process in action.) Three, the end result is very lightweight and adaptable to many applications.
Nanosolar may be able to produce its modules more cheaply than any other manufacturer.

Until now, First Solar's module manufacturing cost has been the lowest in the industry, at about 87 cents per watt. Nanosolar has not yet announced its manufacturing cost or module pricing because it is only targeting utility-scale projects where the price is customarily undisclosed. (At this time, the company does not have a product for the retail market, but reports that one is in development.) But in an e-mail response to my inquiry, Nanosolar CEO Martin Roscheisen stated that his company is "planning to demonstrate that our capital efficiency is three times as good as First Solar's."

"Capital efficiency" is a broader metric than cost per watt, including the cost of building a fabrication plant and other costs. As recently as last year, Nanosolar believed it could potentially deliver product to the market at 1/10th the cost of traditional silicon, and build physical plants with roughly 1/10th the capital. I did not receive a direct answer on whether this is still their claimed. But it does seem plausible that Nanosolar will be the cheapest manufacturer in the industry.

The efficiency of Nanosolar's cells is now the highest in the thin-film industry. The National Renewable Energy Laboratory has independently verified that Nanosolar's cells can convert a maximum of 16.4% of the solar energy hitting them into electricity. When the cells are sorted and matched and turned into modules, Nanosolar's median efficiency is higher than 11%, just edging out First Solar's average efficiency of 10.9%. By comparison, traditional silicon modules are about 16% efficient, and hybrid modules like those from SunPower (NASDAQ: SPWRA), are 19.3% efficient — but both types cost more than twice as much as thin-film modules.
Nanosolar has incorporated several important innovations in the design of their Nanosolar Utility Panel^TM modules.

With their solar foil hermetically sealed between two sheets of tempered glass, their modules are mechanically stronger, more durable, and more lightweight than other thin-film modules, so they can be made in larger sizes and eliminate the need for bulky aluminum frames. They claim their modules are able to span 1.7 times the distance between rails that First Solar's modules can, reducing the need for mounting rails by 41% and significantly reducing the installation labor. Their thin profile also allows the company to ship more than three times as many kilowatts-worth in a shipping container as First Solar can, reducing shipping costs.

Nanosolar's panels can carry six to seven Amps of current, compared with one Amp for First Solar's panels, which minimizes resistive losses and puts them on par with silicon modules. Consequently, the panels can be strung together in much longer strings before hitting the inverter's voltage input limit. This can reduce the need for cables running back to the inverter — a significant part of the balance-of-system costs — by as much as 73%, and allows arrays as long as 64 meters (versus a 12-meter maximum for First Solar), further reducing installation and cabling costs. The panels are also designed and certified to handle a system voltage of 1500V — 50% higher than the industry standard.

Finally, the modules have an electrical connector on the edge of the module, rather than inside the back of the module, so only a short cable between modules is needed to make the electrical strings. This reduces the labor cost of interconnection by 85%, according to independent third-party testing. Having personally spent many an hour crawling around under arrays fiddling with the wires (and occasionally making costly mistakes in the process), I can tell you this is a terrific innovation.

In total, Nansolar believes the advantages of its module design will bring the balance-of-system costs for their installations in line with that of traditional high-efficiency silicon modules.

A Very Promising Future

Now, you might be wondering why I'd spend this week's column talking about a company that isn't publicly traded. The answer is simple: Nanosolar's technology could be a game-changer for solar PV, pushing the industry ever closer to the point where watt-hours generated from solar are as cheap — or cheaper — than those from coal. Its production process also offers the tantalizing possibility of churning out solar cells almost as easily as we print newspapers.

As the company matures and increases the consistency and rate of its output, and its product cost becomes more fully-known, the rest of the world will get a glimpse of just how effective solar power can be in addressing our energy challenge. With a reported $4.1 billion backlog of orders to fulfill (outside the U.S.), a strong balance sheet, and a bright future ahead, Nanosolar is emerging as a serious player. . . and they haven't even started on the retail market, let alone groundbreaking applications beyond rectangular rail-mounted modules.

In time, maybe we'll even get a chance to jump in on an IPO, and ride the next big wave of technological evolution in solar.

Until next time,

Chris

P.S. While you can't invest in Nanosolar just yet, there are plenty of available solar plays turning profits for investors. In fact, Nick's readers at the Alternative Energy Speculator are finding ample opportunity for profit. Of the nearly 40 winners they've closed so far this year, 17 of them have been from solar companies. And that doesn't include the open winners in his portfolio! Click here to see how Nick is closing more than a winner per week and what his next move will be.

China's Energy Revolution

———

If we want an example of good long-term resource planning, we might want to look to China.

While the First World spent the last decade taking on debt and levering up dubious assets like dot-com startups and subprime mortgages, then suffering the inevitable fallout, China kept its debt relatively modest and its currency depressed while it accumulated a vast war chest of foreign-exchange reserves — some $2.1 trillion worth as of the end of June, according to the Wall Street Journal.

Now, with a significant risk of the U.S. dollar and other currencies not backed by hard resources imploding after the greatest spree of worldwide money-printing in history, China is prepared (if not anxious), to exchange its potentially worthless forex holdings for hard assets like oil, metals, and fertilizer.

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Their timing was perfect. The prices of all key commodities fell sharply in the financial crisis of 2008, leaving undercapitalized developers and those with more marginal resources on the ropes, gasping for funding to continue operations.

China Investment Corp. (CIC), the country's sovereign-wealth fund, had a $300 billion portfolio at the end of 2008, which is mostly held in Chinese banks. The fund wisely decided to sit on the sidelines during the carnage of last year, spending only $4.8 billion on global markets.

But 2009 has been a different story, as China swooped in to buy up natural resources at distressed prices. Chairman Lou Jiwei told the Journal last weekend that CIC invested as much in one month this year as it did in all of 2008.

Since December, China has spent $17 billion on foreign energy assets alone.

The point was driven home this week with the announcement that PetroChina had agreed to make its largest oil sand investment to date — a $1.7 billion, 60% stake in the Athabasca Oil Sands Corp.'s MacKay River and Dover projects. China already owns part of several other Canadian oil and gas developers.

Other small oil sands developers, including UTS Energy Corp. (TSE: UTS), Connacher Oil and Gas Ltd. (TSE: CLL), Oilsands Quest Inc. (AMEX: BQI) and Opti Canada Inc. (TSE: OPC), rose on the news in speculation that they could be the Red Dragon's next targets.

At the Reuters China Investment Summit this week, Vice-General Manager of Beijing Sinodrill Yang Junmin said he expected foreign projects to rise from 20% of the company's income to 50% within two years, and that the company is in talks with miners in Australia, Indonesia, and the Philippines for long-term joint venture agreements.

Oil is but one of China's resource ambitions, however. . .

Metals

China launched a spate of both friendly and hostile overtures for mining properties this year, particularly in Australia and Canada.

Australian mining giant Rio Tinto (NYSE: RTP) made headlines when it rebuffed a $19.5 billion offer to buy stakes in its largest iron ore mines by Aluminum Corp. of China Ltd. (Chinalco) in June, but the latter is now making another run at Rio Tinto for its bauxite and alumina resources.

Zhang Yansheng, director of China's Institute of Foreign Trade of the National Development and Reform Commission, was sanguine after the first deal fell apart, telling news agency Xinhua that other opportunities await. "With demand and money in hand, why do we worry about lack of iron ore resources?" he sniffed.

This spring, mining companies owned by the Chinese government bought large interests in Australian mines operated by Lynas Corp. and Arafura Resources, both of which lost their financing in last year's crisis.

Copper has been another high-priority target, with China's imports of unwrought copper and products up 118% year-over-year. BNP Paribas Fortis estimates the nation now holds more than 800,000 tons of the metal off-market, although imports appear to have cooled off with prices on the London Metals Exchange having risen to a 10-month high. Scotiabank Economist Patricia Mohr estimates that Chinese consumption of refined copper will be up 20% on the year.

Imports of nickel, zinc, and other base metals have surged this year as well, as China seized the opportunity to stockpile them on the cheap.

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What really got the world's attention this week, however, was a report by the New York Times that China had virtually cornered the world market for rare earth elements. Half the world's production of rare earths comes from a single mine in Inner Mongolia, according to the Times. China produces 93% of the world's output of rare earth elements like terbium, dysprosium, and neodymium, which are used in key parts — like lasers, magnets, and other special materials — of everything from nuclear reactors to missiles, to wind turbines and hybrid car motors.

China has cut back on exports of rare earths over the last three years, preferring to husband its resources for the long term. In doing so, it also secures its place as a top manufacturer of crucial components for the green energy revolution.

Solar PV

On a related note, China has come under considerable criticism for "dumping" solar photovoltaic (PV) panels and components on the world market, cutting panel prices nearly in half over the last year. In an interview with the Times last week, the chief executive of Chinese solar manufacturer Suntech Power (NYSE: STP) admitted his company was selling solar panels on the American market below its manufacturing and shipping cost. Suntech, which makes nearly all of its product for an overseas market, is expected to become the world's number-two supplier of PV cells this year, second only to First Solar (NYSE: FSLR).

PV competitors in Germany and the United States cried foul over the allegations and launched investigations to see if there are any prosecutable charges, while analysts and lawmakers fretted about whether China would overtake the West in PV manufacturing.

The fuss seems a bit misbegotten to me. Of course China will overtake us in PV — all the advantage is on their side — and that may be a good thing.

The U.S. is moving at a snail's pace in supporting renewable energy; our manufacturers are undercapitalized; our political leadership is a hydra without a long-term energy strategy; and we make our renewable energy businesses live and die on their own, instead of subsidizing them directly — the minimal federal stimulus spending on research and development notwithstanding.

By comparison, China turns out more engineers every day; their manufacturing and labor costs are super cheap; they capitalize on technological advancements very quickly; and the government gives its solar manufacturers generous direct support.

Besides, China is not just exporting finished PV product to the West. They're also exporting solar components and assembling modules in the U.S. to minimize shipping costs. For example, Centron Solar (which represents a consortium of 30 Chinese solar companies), has established a sales hub in Eugene, Oregon, and plans to set up assembly shops in multiple American cities. Their strategy offers a triple benefit by creating new jobs, enabling us to deploy more PV at a lower cost, and reducing worldwide petroleum consumption.

Crisis and Opportunity

Resource-rich nations may resent and fear China's resource acquisition spree, but would be wise to take a broader view of the situation.

After all, oil is but the first of the world's critical resources to peak and go into decline. A century of cheap and easy resource extraction is behind us, and all fossil fuels and most industrial minerals will reach an intolerable point of diminishing returns over the next century.

By adopting a protectionist stance, commodity producers can retain ownership of their resources and keep more of the revenue at home. But as strapped for investment capital as they are, and with commodity prices still too depressed to paint a picture of profitability in the short-to-medium- term — the strategy could stifle new development and ultimately shortchange their own futures.

Opening arms to China might be the rest of the world's best hope for surviving a volatile future of commodity prices even while the costs of resource extraction continue to rise.

Simply put, taking a decades-long approach to strategic resource planning and investment is much easier for a centralized authoritarian government than it is for a democracy that turns over its leadership and changes tack every few years. China has displayed both the will and the ability to control its resource future for the long term, while Western free enterprise concerns itself with beefing up next quarter's balance sheet.

I'm not suggesting that investors should pile into Chinese resource plays at this point. The best part of the shopping spree is probably done, and there are fresh indications that Chinese banks are now looking to rein in lending and spending. Should resource prices gain materially from here, China could even decide to unload some of its stockpile at a nice profit.

But we should forget about "energy independence." For the world to accomplish a speedy transition to a renewably-powered electric infrastructure as we face the end of oil, we may need China much more desperately than anyone now imagines.

Until next time,

Chris

Energy and Capital

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Reading Peak Oil Deniers Is a Waste of Time

Editor's Note:

Today's Green Chip Review comes from contributing editor Chris Nelder, who you may know from previous Green Chip reports, his Energy & Capital letter, and from the book that we co-authored, Investing in Renewable Energy. Enjoy.

— Jeff

We are all sufferers from history, but the paranoid is a double sufferer, since he is afflicted not only by the real world, with the rest of us, but by his fantasies as well.

— Richard Hofstadter

Three bombs were dropped on the peak oil community this week, in what smells like a coordinated attack timed to incite public uncertainty about the validity of the peak oil argument, and question the importance of mitigating climate change and transitioning to renewables.

The peakers are mobilizing a response, an onerous task made necessary only because their critics' bombs received prominent placement in major publications with large readerships, not because their critiques had any serious validity.

I will leave it to the capable hands of authentic petroleum geology experts to debunk the latest critiques. It is in order, however, to give the public a brief look at who these critics are, and their abysmal track records, which I have tracked and debunked since 1996.

Michael Lynch

Michael Lynch made the biggest splash this week with an op-ed that was featured on the front page of the New York Times web site, titled "'Peak Oil" Is a Waste of Energy." Lynch is the former director for Asian energy and security at the Center for International Studies at MIT, and is currently an energy consultant. With a background in political science, Lynch puts his rhetorical skills to work as an avid peak oil denier, despite seeming to live in an alternate universe when it comes to the actual data.

I first came across Lynch on the Energy Resources forum at Yahoo around 2002, which pre-dated the current crop of blogs and web sites devoted to discussion on peak oil. He has carried on a vigorous disinformation campaign against peak oil theory for nearly two decades, sticking to his guns despite all factual evidence to the contrary. At the time I attempted to engage him in rational discussion, but quickly abandoned the effort when I realized that I was dealing with the equivalent of a religious zealot who avoided any argument he might lose, and who clearly enjoyed all the attention he received for his contrarian views (he often referred to his critics' responses as "fan mail").

Lynch's 1283-word screed in the Times was a virtually fact-free, high-handed indictment of the peak oil study that cleverly wove a mix of random historical references (including Stalin and King Canute) with carefully cherry-picked incidents to make the argument that "we can't let the false threat of disappearing oil lead the government to throw money away on harebrained renewable energy schemes or impose unnecessary and expensive conservation measures."

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It was a politically astute effort, and I'm sure that whoever pays him for his work appreciated it as they fight for their survival against a turning tide of public opinion. Perhaps a few gullible readers even bought it (however, if the reader comments are any indication, few were). Unfortunately, it was as wrong as Lynch has always been.

Consider just a few examples of Lynch's "expert" opinion.

In 1999, Lynch crowed that when IHS Energy's estimate of ultimately recoverable reserves increased 10% over a previous estimate to 1800 billion, it "put a nail in the coffin" of the peak oil debate. He continued to thump the reserve growth issue as the number rose to 2100 billion — where it has stayed, at least for reliable petroleum geologists like Campbell and Laherrère. But that hasn't slowed down Lynch, who apparently now believes that remaining recoverable reserves are not 1200 billion, but 2500 billion, an absurd number based on his belief that the world will somehow achieve a recovery rate of 35%, without venturing to guess how it might be done.

In April 2004, when WTI spot was trading around $37 a barrel, Lynch confidently predicted that oil would fall to $25 by summer. By mid-August, it was trading at $47.

Undaunted, Lynch wrote in September 2004 that one year later, oil would be under $30. In September 2005, it hit $67.

In March 2006, when oil was hanging around $62, Lynch again forecasted that oil would drop back to $40 before the year was out, possibly even $30, and then remain flat for at least the next two decades Instead, oil climbed as high as $76 a barrel before finishing the year at $61.

In April 2007, Lynch predicted that oil would gradually drop from the current $65 a barrel to the mid-to-low $40s in 2008. In reality, it climbed steadily to $147.

I could go on for days pointing out the errors in Lynch's long history of peak oil denial, but at this point I think his record speaks for itself, and it seems unsporting to continue.

As far as I am aware, Lynch has not offered a detailed model of his own for oil reserves or production. I don't know if that's because he lacks the data and skills to do so, or simply because it would expose him to fact-based criticism. Instead he simply argues that the future will be like the past, relying on rhetorical devices and a sharp eye for weakness to gleefully poke holes in other analysts' arguments. His faith in a continually increasing supply of cheap oil on a finite planet is unflagging, and firmly rooted in the gospel of perfect markets and technological progress. I have never seen him print a single mea culpa for his long, wrong, predictive track record.

I don't know why the Times would choose to print such insouciant invective as Lynch's op-ed, but apparently that's what passes for coverage of the peak oil story today. It has been a painful experience to watch the "Gray Lady" botch and distort the issue for the last six years or so, descending from "All the news that's fit to print" to all the news that's print to fit its world view.

Of course the problem is not that naysayers like Lynch spout nonsense, but that members of the media take him seriously. If we let outlier critics like Lynch lull us into a false sense of security about future oil supply, we won't begin soon enough on the decades-long effort to leave oil before it leaves us — and we will pay for it dearly.

Daniel Yergin and CERA

The other prominent peak oil denier is Daniel Yergin, a writer with a Ph.D. in international relations who co-founded an energy research consultancy called Cambridge Energy Research Associates (CERA). Yergin earned respect for his Pulitzer-winning 1991 book on the history of oil, The Prize, but his credibility has been crumbling since he took up the peak oil debate. Still, Yergin's consultancy has made a pretty living peddling happy talk to the oil industry despite a horrendously bad track record, and he continues to be the first call for media looking for upbeat oil commentary (and they're always looking for that).

Consider Yergin's price predictions for oil. In a column for Forbes on Nov 1, 2004, on a day when oil was trading at $49 a barrel, Yergin gave his usual sunny projection and predicted that one year hence, oil would trade at $38. On Nov. 1, 2005, WTI spot closed at $59.85.

This was no surprise to the peakers over at the Oil Drum, where a lively and generally well-informed discussion on peak oil and energy has tracked the fallacies and poor predictions of CERA, Lynch and other deniers closely since March 2005. In a May 1, 2006 post, Dallas-based independent petroleum geologist Jeffrey Brown proposed that when oil closed above $76, or double Yergin's $38 prediction, that the day be named Daniel Yergin Day in his honor. From that point on, $38 became known as a "Yergin."

We didn't have to wait long. Daniel Yergin Day was reached just 10 weeks later, on July 13, 2006, as oil crossed $76 — two Yergins.

Oil breached three Yergins on April 15, 2008, and four Yergins on July 3, 2008.

A June 21, 2005 CERA gushed "We expect supply to outpace demand growth in the next few years, which would take the pressure off prices around 2007-08 or thereafter and even lead to a period of price weakness," predicting that oil prices would fall to an average of $40.

In fact, oil left $38 a barrel in the dust in mid-June 2004 and never looked back, revisiting the $30s for only the 10 weeks beginning in late Dec 2008 when the global markets for absolutely everything had crashed. We haven't seen $38 oil since February, and oil is now once again pushing two Yergins.

Far from repentant, Yergin's editorial for Foreign Policy this week ("It's Still the One") which was subsequently lauded in the Wall Street Journal blog, actually blamed the peakers for a "belief system" that was "stoking fears of a permanent shortage" for helping to push oil to $147, then mischaracterized the peak oil position as one that we had "'run out' of oil," which it isn't. As Yergin well knows, the peak oil study is one of flow rates.

But price has always been the most difficult part of oil forecasting (I've gotten a few calls wrong myself, but not nearly as badly as CERA has), so we'll put that aside for the moment. Let us turn now to CERA's projections on oil flow rates, where they have taken pains to debunk any notion of a proximate peak in oil production.

In a 2005 report, CERA first said that worldwide liquids capacity would rise from 85.1 mbpd in 2004 to 101.5 mbpd by 2010 (a 16 mbpd increase), then later in the report claimed 17.7 mbpd of gross capacity would be added by 2010. Apparently the authors weren't even sure exactly how optimistic they were.

In fact, just a few months shy of 2010, global capacity probably* (I'll explain that in a moment) remains just below where it topped out last year, around 88 mbpd. The increase since 2004 has been 3 mbpd, not 17.7.

By emphasizing capacity (a theoretical number that is hard to know, given the opacity of information provided by OPEC producers) over actual production volumes (which is regularly reported by EIA, IEA and other agencies) CERA gives itself some wiggle room to claim that prices simply weren't high enough to max out capacity.

This is why most honest analysts of the oil markets look at actual supply, which ranged from 81.6 to 84.6 mbpd in 2004, and from 84.0 to 85.3 mbpd in 2005. In 2006, the maximum monthly production recorded was 85.4 mbpd. The highest production ever recorded was last July at 86.9 mbpd, the same month that oil prices hit their all-time peak at $147 a barrel.

Today, the world consumes about 84 mbpd, of which about 74 mbpd is conventional crude, and the remainder is other liquids such as natural gas liquids, heavy oil, oil synthesized from Canadian tar sands, refinery gains, liquids produced from the conversion of coal and natural gas, and biofuels.

In 2006, CERA projected that capacity could rise from 88.74 mbpd at the time to 110 mbpd by 2015. In 2007 and 2008, CERA continued to assert that capacity would rise steadily into 2015 and beyond, even as global spare capacity shrank to a small margin and kicked off a spectacular run in oil prices. High prices have failed to bring enough supply to market to keep pace with demand since 2004, falsifying the cornucopian claim that they would.

Yet Yergin remains unbowed today, confident that his vision of a 20% increase global oil capacity by next year has only been sidetracked by "aboveground" factors, and that future investment and magical technology will yet bring it to pass...even as the world economy wobbles in a deflationary environment with credit still tight and consumers struggling to cope with rising prices for gasoline and other necessities.

I'll admit that I envy that kind of optimism a bit. Oh, to have such faith, to be so free of reality that I could simultaneously believe that even though the cost of a cutting-edge oil megaproject went from $1 billion in the ‘90s to $10 billion today, and even though capital remains reluctant to commit to long-term projects after oil's recent volatility, and even though the world economy shuddered and fell to its knees when oil hit $147 as supply-induced scarcity set in, and even though global oil discoveries have been in a declining trend for over 40 years now, that somehow the gods of the Almighty Market will provide, and we'll have no sign of a peak for another good 40 or 50 years. Hallelujah!

CERA has decried the combative tone of the peak oil debate, and pretended to a gentle stance while trumpeting its high-priced privileged information, but in fact the group has issued a drumbeat of anti-peak oil invective, repeatedly declined to debate knowledgeable peak oil adherents or attend their conferences, and ignored a $100,000 bet offered last year by friends of the Association for the Study of Peak Oil USA to back up its ridiculous supply prediction with real money. It also routinely ignores any published criticism.

In the debate about the future of oil, CERA has been consistently cowardly. I can understand that, since the unfolding of reality has not been at all to their advantage.

Raymond Learsy

Raymond J. Learsy is another prominent peak oil denier with a high profile column at the Huffington Post, but he doesn't really merit mention alongside the previous two. A Wharton graduate with a previous career in commodities trading and the author of Over A Barrel, Learsy has written a series of anti-peak oil rants which are consistently free of facts but offer just enough in the way of conspiracy allegations and wild speculation to earn him a following of left-wing sycophants who want to believe that the Saudis, or the oil companies, or the speculators, or some other evil-doers are responsible for our energy predicament.

Learsy was quick to capitalize on the stir created by Lynch's screed this week, calling it "a day of deep gloom for the McPeaksters" and celebrating Lynch's "revelations" about the "hierarchy" of peak oil "disinformation" while patting himself on the back for his own brave work in hurling completely unfounded accusations at peakers.

Learsy has long been a font of vituperation, making wild claims unburdened by empirical data about potential oil production, and heaping scorn upon anyone with a different view. Earlier this month, he went so far as to call the International Energy Agency (IEA) "shills for OPEC, the oil speculators and the peak oil pranksters." Apparently Learsy doesn't really care if such allegations are patently silly (peakers are generally opposed to deniers in the oil industry and OPEC, not in the same bed with them, and the IEA serves at the pleasure of the OECD, not OPEC) — as long as they sound good enough to make his credulous readers think that this whole peak oil thing is just a nasty hoax, his job is done.

If you're not yet convinced that Learsy is likely a nut-job, he is also a big fan of the theory that oil may have an abiotic origin, in opposition to all standard petroleum geology theory. The scant Russian "evidence" for the theory has never, so far as I know, been replicated or taken seriously by any Western petroleum geologist. Its main proponent was Thomas Gold, an astrophysicist with several discredited theories to his name who loved to challenge conventional science with his intuitive but unempirical views. It wouldn't surprise me if Learsy has also been taken in by the Gull(ible) Island yarn floating around the net.

I have attempted, along with many others, to straighten Learsy out about some of his blatantly false assertions, but he apparently prefers spewing conjecture to engaging in reasoned and factual debate with anyone. I suppose there will always be an audience for somebody like Learsy, but those who prefer facts over rhetoric will find he's just another waste of time.

The Truth Will Out

In a world where fact-checked information were valued over mere argumentation, where intelligent inquiry and dialogue were preferred to invective-laden diatribes and declarations of fact-free faith, the voices of Lynch, Yergin and Learsy would never be heard, let alone paid large sums of money for "proprietary" information about their foolish dreams.

But we don't live in that world. We live in a world where they are given one-sided top billing in the media at the very same time the oil industry is busing its workers to rallies to protest the climate change bill.

In the real world, those who have made the most careful effort to figure out what the future of energy really looks like, and alert the public to the most serious challenge the world has ever faced, are simply spited, ignored, and marginalized while the media carries on with its game of pretending to offer a "balanced" debate. I should also note that peak adherents are almost universally unpaid for their difficult work, and forced to do it in their spare time. Their only vested interest is in the future of humanity.

There is a bright side to all this, however.

Those who have the good sense to seek out the analysts with a rigorous grasp of the data and a proven track record of successful prediction — like the petroleum geologists who present their findings through the ASPO, the editors and contributors at The Oil Drum, the folks at the Post Carbon Institute and a few others (including, if I may be so bold, me) — have an incredible window of opportunity to place the right bets on the future of energy while the majority of the uncomprehending public remain in a swoon of denialist soma. The risk of peak oil, as I recently wrote, remains badly mispriced.

We who have been fighting to bring the best information about oil to the public against a never-ending tide of misinformation can take heart. Our best days are yet ahead. As Mahatma Gandhi said, "First they ignore you, then they laugh at you, then they fight you, then you win." We've been ignored (1956-1970), laughed at (1971-1995), fought (1991 to the present), and by 2012, we will win this debate when oil begins its inevitable decline. At that point, the media may find the courage to run out and shoot the wounded.

Independent analysts who are not beholden to vested interests in oil and politics can now snatch a fat piece of the consulting services pie from the likes of CERA and Lynch, and help businesses avoid the costly, even deadly mistake of remaining in blithe ignorance and dependent on cheap oil. Among the peaker community are dozens of bona fide independent petroleum experts who are ready, willing, and able to prove their excellent track records and offer solid analysis and tradable insights to those have ears to hear them.

But don't listen to the peak oil deniers. Their arguments are specious and their projections are worthless.

We're past the point where academic quibbles about the timing of the peak and its precise level matter. All of our efforts now should be directed toward preparing ourselves for the decline of oil, minimizing the pain it will bring, and investing heavily in alternatives.

Until next time,

Chris

Energy Sustainability Issues

The more I probe the hardest questions about the future of energy and our best shot at sustainability, the more I am convinced that the real questions are not about technology, but about human nature.

We have all the technology we need to make homes that produce their own energy. We know how to build high-efficiency rail and sailing ships. We know how to grow food organically and sustainably. We have the science to create economic systems that internalize all effects and operate in a beneficial manner. We've had the quantitative knowledge for decades that we would eventually go into resource and environmental overshoot.

We certainly have the technology to build an all-electric infrastructure entirely powered by renewables. We will crack the storage problem and all the other technical problems. I have no doubt that the technology also exists to build an all-nuclear solution, or even an all-hydrogen solution.

We have the technology to recycle all our water and reclaim all our waste. We could even control our population. . . if we had the will.

We also know what real sustainability means. I don't think I have ever seen it better put than by my friend Paul Hawken in his book, The Ecology of Commerce:

Sustainability is an economic state where the demands placed upon the environment by people and commerce can be met without reducing the capacity of the environment to provide for future generations. It can also be expressed in the simple terms of an economic golden rule for the restorative economy: Leave the world better than you found it, take no more than you need, try not to harm life or the environment, make amends if you do.

The real problem is we don't want to act that way. Virtually no business in existence meets that standard.

Technology and knowledge simply aren't the issue.

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We don't want to think about having to put CO2 back in the ground after we burn fuels. We don't want to worry about the waste from our consumption. We don't like to hear about limits to anything we want to do. We don't want to rearrange our stuff, our lifestyles, so that they are truly sustainable. And we certainly don't like anybody telling us we can't have more kids.

In fact we don't even like to think about it. . . so when the subject comes up, we dismiss it with a flip comment like, "So I suppose you want us all to be living in caves and working by candlelight?"

The upwelling of emotions that this topic inspires — especially fear — usually makes a neutral and scientific discussion out of the question.

And from fear, most people leap to faith: faith in the perfect wisdom of free markets, faith in technology, faith in human ingenuity. No rational discussion needed.

Nor is this aspect of human nature a news flash. ‘Twas ever so. At the suggestion of a smart hedge fund manager buddy, I recently put Thucydides' history of the Peloponnesian War in my reading queue for clues on how humanity actually performs when presented with serious fiscal and resource challenges.

I know some very smart people who are fully armed with the data on resource depletion and peak oil, and who still choose to believe in a cornucopian future where humanity acts wisely, humanely, justly, and in concert with a view toward long-term planning, solving all of our problems without any serious hardship.

This time, they contend, it will be different. After all, aren't we entering the Age of Aquarius, when humanity finally embraces unity and understanding?

Well, forgive me for being skeptical. The degree of cooperation they envisage has no precedent whatsoever in human history, and there are thousands of examples to the contrary.

In fact I was a bit shocked today when I looked back on my first opus on sustainability ("Envisioning a Sustainable Future"), published in my online magazine Better World 13 years ago, and realized that all of the problems are the same now as they were then, only worse: population, energy, water, extinction, environmental destruction, flawed economic theory, global warming, and humanity's problem with long-term planning.

It gave me pause. A long pause. Are all my efforts, and those of my fellow agitators for sustainability, simply battling human nature? And if so, what good is it?

Tantalizing Technologies and Hard Questions

At this point, 13 years later, the questions are even less tangible: How will people respond to the coming changes? Can the political support for truly sustainable solutions be marshaled? Will the economy hold out long enough to accomplish the transformation? And how will declining energy supply impede our efforts?

Certainly, in theory, we could replace 220 million light ICE cars and trucks with electric models, and heavy transport trucks with a combination of biofuels, natural gas, and hydraulic storage technologies. The technology exists. But will we have the investment and primary energy supply to build them, if we simply let the market and politics guide us?

Consider "Cash for Clunkers." Using data and estimates from the New York Times, I calculate that the program pays off in nine years at $70 oil, and in five years at $120 oil. In terms of effective investment in the future, that's really not too bad. (The photovoltaic systems I designed and sold in my previous career typically paid off in more like 20 years, before incentives.)

Even so, Cash for Clunkers was reviled for swapping out over a quarter-million cars for more efficient ones at a mere cost of $1 billion. What are the chances we'll have the political support to do 220 million vehicles that way? Especially if oil gets more expensive and we start having shortages and more heavy industry failures when oil goes into decline a mere two years from now?

Sure, we can run airplanes on "renewable" synthetic diesel fuel made from green waste such as yard clippings, and early investors in such technologies will make a bundle. Rentech's (AMEX: RTK) recent announcement that it had signed a deal to provide as much as 1.5 million gallons per year of the stuff to eight major airlines sent the stock soaring over 360% in two weeks.

But 1.5 million gallons per year is nothing, and thanks to the transport and handling cost of green waste, it doesn't scale. If it requires transporting massive amounts of the feedstock with diesel-powered trucks, it isn't sustainable either. Need we even discuss recycled fryer oil?

Similar problems bedevil the alcohol fuels and biofuels, including algae. There are many interesting approaches to both in the lab, but for a long list of reasons (including water availability and the net energy of the processes), they don't scale well. I don't see any of the biofuels making more than a 50% gain from their current paltry levels for a good many years yet — and then we'll be having so many other problems with energy, water, food, and the economy, that the long-term outlook gets very murky.

Sure, we can try to turn to Canada's tar sands and deepwater heavy oil as the good cheap stuff runs out, but a cursory look at their net energy tells us that doing so is an attempt to play the oil game into overtime, not an attempt to do something sustainable. Thinking otherwise is simply denial.

A straightforward analysis of the data suggest that once we take peak oil, peak gas, and peak coal into account, there may not be enough time left to use cheap fossil fuels for the decades it would take to accomplish a transformation to true sustainability, let alone the human will to do it. And the experience of the last year gives me no confidence at all that the world can smoothly transit this inflection point in economics.

Yet I want to foster inspiration, not desperation. For most people, hope is as essential to survival as food, water, and air. And there is hope — not for business as usual, but for a much better kind of business. Not for endless growth, but for a more sustainable future.

But I am not one for false hope. I have endeavored to bring a dose of realism to this column for three years now, and I will soldier on. The opportunities to create sustainable solutions and profit from them are probably greater now than they have ever been. It's our task to find them, promote them, invest in them. . . and beyond that, hope for the best.

Until next time,

Chris
Energy and Capital

P.S. My colleague, Nick Hodge, is finding, promoting, and recommending winning sustainable solutions to his community of green investors. Thousands of readers of the Alternative Energy Speculator have closed more than one winning position per week so far in 2009. That's profiting in the right direction! Click here to learn how Nick's readers will cash in on their next sustainable winner.

The Chevy Volt's 230 MPG

Cleantech and hybrid car enthusiasts were all a-Twitter this week over General Motors's claim that the new Chevy Volt will get a fuel economy of 230 miles per gallon (mpg). It was widely circulated and many breathless column-inches were printed, yet I was unable to find a single article that actually made any sense of this number.

As usual, I was forced to sort it out for myself. Follow me as I walk through the numbers. . . such as they are.

First, the very concept of miles per gallon doesn't make sense if it doesn't take the initial charge of a plug-in hybrid into account. That's like saying the electricity that runs the Volt for the first 40 miles is free.

Instead, we should be using a new metric, like miles per kilowatt hour (I will use m/kWh for this). By converting the gasoline used into its kWh equivalent, then adding it to the kWh for the initial charge, we could come up with a simple number.

The reality, however, is much more complex.

Calculating Miles per Kilowatt Hour

In a serial hybrid like the Volt, there are losses incurred (on the order of 15%) for using an on-board generator that burns gasoline to charge up the battery pack which drives the powertrain motor. There are also transmission losses, and losses from the self-discharge of the battery pack when it's unplugged, both of which are difficult to quantify.

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So simply converting the BTU content of the gasoline to kWh (33.7 kWh equivalent per gallon) isn't quite right. Nor do we know the actual efficiency of the Volt's generating and charging systems.

Even if we had accurate numbers to work with, it would be somewhat misleading to use m/kWh as a basis for comparison. As most consumers know, there is a big difference between city and highway driving, because straight gasoline engines typically operate at very low efficiency below 25 mph, and are most efficient between 25 and 55 mph.

Electric motors operate with a fairly constant efficiency at various speeds, but if the battery pack on a serial hybrid is deeply discharged and the gasoline generator used heavily, the overall fuel economy plummets. In the case of the Volt, it would fall from the alleged 230 mpg to 50 mpg or less. And both straight gasoline engines and hybrids consume more energy over 65 mph as wind resistance increases.

In order to address the issue, the Environmental Protection Agency (EPA) is working on a new draft methodology for testing mileage and establishing fuel economy ratings, but it is not yet public and EPA has declined to confirm GM's claim for the Volt.

In the absence of good comparative standards, car companies can get away with wild claims like 230 mpg; not to be outdone, the Nissan boasts 367 mpg for its new Leaf car. But we can take a stab at some reasonable calculations.

GM claims that the new EPA methodology will be stated in terms of kWh per 100 miles traveled, and that by this metric, the Volt will go 100 miles on 25 kWh of battery charge. This seems a less than perfect way of rating the fuel economy, since the Volt will only run 40 miles on a charge before the gasoline generator kicks in. To arrive at the 230 mpg number, GM assumes a 51-mile driving cycle with drivers charging up their Volts once a day, so the battery powers 4/5 of the distance.

Taking GM's claim at face value though, we can calculate that the Volt gets about 4 m/kWh. This can be compared to approximately 0.8 m/kWh for a typical European diesel car getting an average 40 mpg, or about 0.4 m/kWh for a typical American gasoline car getting an average of 20 mpg. (Newer models have a range of higher fuel economies, but those are the averages of the current fleets.)

Professor David MacKay of the University of Cambridge notes that even this metric can range wildly from 0.24 m/kWh for the BMW Hydrogen 7 car, to 3-10 m/kWh for some all-electric vehicles.

A blog post by former Tesla chief marketing officer Darryl Siry claims that the Tesla Roadster will do 244 miles on a 62.3 kWh charge, for a 3.9 m/kWh economy. That's close to the Volt's alleged 4 m/kWh, so let's use the latter as an example.

Now we can try to evaluate the actual cost of driving a Volt. If you thought the above numbers were squishy, try these on for size.

What Does It Cost To Drive?

First there is the price of residential electricity. This varies widely from state to state, depending on a number of factors including the fuels used in power stations, the utility rate structures, and the time of use. At the low end is Idaho with an average $0.07/kWh, and at the high end is Hawaii with $0.22 /kWh. In my home state of California, the average cost is $0.14/kWh (EIA Apr 2009 data).

The average price of $0.115/kWh for the whole U.S. is most commonly used in price calculations, but this doesn't tell the whole story. My last PG&E bill priced the first "baseline" 249 kWh at $0.12/kWh, and then continued on up a sliding scale to $0.38/kWh for the "201-300% of baseline" kilowatt-hours. Over the month, the average price was $0.22/kWh.

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So let's split the difference and use $0.15/kWh. Assuming 4 m/kWh, the electricity cost of operating a Volt comes out to about $0.04 per mile. If we compare that to a standard 20 mpg ICE vehicle burning gasoline at $3 per gallon, that's $0.15 per mile, or nearly four times the cost of the Volt's fuel.

But consider what happens when we use different assumptions. If instead we compare a new regular gasoline powered car with a fuel economy of 40 mpg, and assume a grid power cost of $0.30/kWh, the Volt would come dead even with the regular car at $0.08 per mile. And that, dear reader, is very possible — even likely.

Future Costs Are Key

Suppose you buy a new car today and drive it for a full, useful life of 15 years. Would the Volt save you money over 15 years?

Within the next two years, we should see global oil production go into terminal decline, and the price of gasoline could begin to test new highs of $5 - $6 a gallon (or more). At $5 a gallon, a 40 mpg regular car will cost $0.13 per mile to drive — if you can get the fuel at all.

At the same time, the cost of grid power will go up. Natural gas prices are dragging the absolute bottom now around $3.50/MMBtu, but they ranged as high as $13 only last year. When the economy recovers, we should see the high end of the range again. We must also assume that in the next few years, carbon emissions will come with a cost attached, so the price of electricity generated from coal and natural gas will go higher.

In 15 years, when that vehicle is ready for retirement, the world will likely be at or past the peak of oil, gas, and coal, and the prices for all of them will be significantly higher than today. Renewables will still be a small part of the grid power mix, but at that point, they should be even cheaper than the fossil fuels. So what price shall we anticipate for the year 2025 — $0.40/kWh? $0.50? More? At $0.50, the cost of driving the Volt would be the same as driving a 40 mpg car with gasoline at $6 a gallon — $0.15 a mile, or about $180 a month assuming daily trips of 40 miles.

In reality, if that's what it costs to drive a car, actual vehicle miles driven will fall as people choose to carpool and take whatever public transportation may be available at that point (assuming it costs less than $6 a day).

Even if the cost of expensive battery packs falls over the next 15 years, as it surely will, it's hard to say at this point when electric and plug-in hybrid vehicles might gain the cost advantage over higher efficiency ICE vehicles. However, when you add in the myriad other factors like CO2 caps, a gradual transition to an all-electric infrastructure powered by renewables, shortages of liquid fuels, and political sway, it does seem likely that they will win out eventually.

One thing is certain: You won't be driving 230 miles on a $3 gallon of gasoline.

Until next time,

Chris

Investor's Note: As we make that transition to an all-electric infrastructure, the last place I want my readers to be is on the sidelines. My colleague Nick Hodge and his readers are pumping out gain after gain at the Alternative Energy Speculator, fully taking advantage of this new wave of Energy profits. Perhaps it's time you joined their success.

Peak Oil and the Macroeconomic Outlook

One of the most difficult aspects of investing is pricing risk. The reward proposition is exciting and is much easier to calculate than the risk, so it tends to get much more attention from investors. But it's the risk side of the equation that can break you.

That's why at the highest levels of the finance world there are analysts who do nothing but price risk — in particular, the tail risk, or the outlier probabilities of the risk bell curve. One way to price risk is by offering derivative contracts, like the Credit Default Swaps (CDS) that contributed to the undoing of the big banks last year, as a kind of investment insurance.

Normally these risk-pricing instruments work well. But when black swan events — those that are considered extremely unlikely — occur, like all the banks suddenly becoming insolvent at once and the risk insurance fails, the damage to the economy can be massive.

In this most uncertain time for the global economic outlook, investors must be unusually alert to mispriced risk: not only because it offers incredible buying opportunities, like natural gas at under $4 and oil at $33 (from which my readers and I have profited handsomely), but because the risks are enormous. Nearly everybody in the market lost half of their wealth in the carnage of the last year.

For nearly three years in this column, I have detailed what I believe to be some of the most important risks for energy investors. Perhaps it would be helpful now to zoom out and take a long look at some of the things that hardly anybody thinks will happen, but which probably will — that is, the tail risks that remain badly mispriced.

Peak Oil

The most important risk, of course, is peak oil. It is better priced now than it was, say, four years ago; when the chief economist of the International Energy Agency (IEA) Dr. Fatih Birol issued a strongly worded warning this week that he sees peak oil occurring in 10 years, and that "we should take this issue very seriously," it actually got noticed and circulated widely in the press. That's a huge change.

Still, the risk of peak oil is not properly priced when oil itself is still selling for $70, and the investing press is full of "green shoots" talk, imagining that the economy will be off to the races again in 2012. Nothing could be further from the truth.

Birol deserves praise for his unflinching warnings, and pressing ahead with his message despite the derision of a world that remains deep in denial, uselessly searching for scapegoats and dreaming of an economic recovery that won't materialize. Unfortunately, his model betrays some wishful thinking as well.

The fact is that peak oil is already here, and has been since 2005. Within the next two years, the increment of unconventional liquids that have temporarily masked this fact will be unable to keep up with the decline of conventional crude. By 2012, just when the global economy should be resuming normal growth rates, the decline of oil will pull the rug out from under it.

Birol was clear on this point: "It will be especially important because the global economy will still be very fragile, very vulnerable. Many people think there will be a recovery in a few years' time but it will be a slow recovery and a fragile recovery and we will have the risk that the recovery will be strangled with higher oil prices," he told the UK's The Independent.

Yet nobody — and I mean nobody — is currently pricing that into their models: "I'm not very optimistic about governments being aware of the difficulties we may face in the oil supply," Birol said.

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Well, I'm sorry to say, neither am I. A substantial contingent of petroleum geologists and observers like myself have certainly made every effort to make them aware, but our words have fallen mostly on deaf ears. Consider the recurring spectacle of Rep. Roscoe Bartlett (MD) lecturing to an empty chamber on Capitol Hill about the importance and urgency of the peak oil challenge.

The implications of failing to act in a timely fashion are vast, yet whole industries are carrying on as if the threat doesn't even exist. Instead of being priced as a 99% probability, as it should be, the risk of peak oil is currently priced like a 1% probability.

If we accept that the world will wait until the terminal decline of oil sets in before taking effective action, and realize that the consequent changes will affect every industry and every part of the economy, then we can proceed to a long list of other risks that are badly mispriced.

Here then are some eventualities that I believe are highly probable, yet still priced like tail risk. The question now is not if these things will happen, but when.

Some Not-So-Crazy Predictions

Oil and natural gas prices will have a very volatile upward trajectory for decades, as we bump our heads against the supply ceiling, but oil will probably top out around $150-200, where it simply kills demand. Oil supply will decline at the rate of about 5% per year and accelerate to 10% per year. The world will be living with about half its current energy budget by 2050.

The global population will not reach nine billion people. It will probably top out around 7.5 billion circa 2025, and go into decline along with the fuel supply. Nobody programs that into their models.

Once oil decline sets in, instead of worrying about what comes out of the tailpipe we'll be worrying about finding fuel to put in the engine. Demand will be destroyed first by skyrocketing fuel prices, and then by the population decline, both of which will eliminate more CO2 emissions than our climate treaties ever contemplated. Peak CO2 will probably happen before we even reach 450 ppm.

Cap-and-trade and carbon pricing markets will have a heyday for the next five years or so, until the world figures out that we indeed have a fuel problem that isn't going to go away. Then they'll be more useful as a way to ration fuel supply than they are as a carbon reduction tool.

No CO2 will be recaptured by replanting forests. In fact, precisely the opposite will occur, as oil and gas shortages cause people to turn to wood for heat. Still, overall CO2 emissions will drop.

Coal will be unloved and shunned for its CO2 output until higher natural gas prices start to bite. Some CO2 capturing technologies for coal plants will be tried, but long term sequestration will prove problematic. Grid electricity prices will go up accordingly until renewable energy becomes cheaper than coal, at which point coal will be used primarily for things like smelting steel, not generating power.

Overpriced suburbs of McMansions will be abandoned if they remain dependent on car travel. The nouveau riche of places like Orange County will go back home and live in their parents' basement in Cleveland, or buy a $15,000 house in some small outpost of North Dakota, and try to live on a whole lot less. I call it the Dust Bowl Migration in reverse.

Home buyers may come in for a round of bargain hunting if we have a strong economic recovery and bona fide job growth circa 2011, but that will quickly fade as declining oil production begins to bite.

Some suburbs will transform themselves into small, functional, walkable and self-sustaining towns with electric light rail, electric cars, and solar panels on every roof. The suburbs that fail this test will become mega-slums, but the cool ones will be outside of L.A., with overlords who look like Kurt Russell and Ice T running lo-tech gangs straight out of a William Gibson novel, surviving and thriving amid the ruins of the San Fernando Valley.

High density residential areas near city centers with public transportation will be stuffed to the gills. After having its own brief rally circa 2011, most of the commercial real estate constructed in the last 10 years will sit dead and idle after 2013. Eventually, much of it will be converted into cheap apartments. Few people will be driving cars in the cities.

Food will become increasingly local. The current system of food distribution will eventually break down under the combined pressures of spiking costs and fuel shortages, because modern food production is essentially a process of converting fossil fuels into food. Remember, on average it takes 10 calories of input from oil and natural gas to put one calorie of food on our tables. The whole food distribution chain in the United States is on average 1500 miles long, and three days wide at the most. It's hugely vulnerable to higher fuel costs and breaks down instantly without a continued supply of fuel. This risk is currently priced at zero.

Farmland and railroads will be the best asset classes of the next several decades. Both sectors will be volatile until the real economic shakeout sets in circa 2013-2015, but then local farms will have to assume the burden of food production and distribution, and rail will have to assume the burden of most transport. You'll be eating local foods that are in season and drinking wine from your 100-mile radius, instead of from Chile or Australia.

In order to grow all this new local food supply, land will be reclaimed. Parking lots, pavement, and grass lawns will be ripped up and planted for local food supply. Large city parks, like Central Park and Golden Gate Park, will turn over some of their grounds to residents for garden allotments. Think that won't happen? It already did, in World War II. There were over 800 "Victory Gardens" in Golden Gate Park.

The much hoped-for nuclear renaissance will not happen. Even if voters get over their fears about waste and safety issues, and throw their political support behind next generation plants, the sheer up-front capital costs and long lead times will make it very difficult to do much more than rebuild the aging plants we already have. The cost of materials like cement and steel will continue to fluctuate wildly in tandem with oil and gas prices, making reliable cost projections difficult. Rounding up capital to build new plants in such an environment, especially capital that will be locked up for decades, will be very tough.

The hydrogen economy will also never come to be, for reasons I detailed here.

At the same time, renewable energy costs will continue to fall, as it rapidly grows from 2% today to over 20% of the total energy supply. Global capacity will grow much faster than anyone expects, through the multiplier effect of thousands of innovations. Utility scale solar, rooftop solar, wind, and geothermal power will become significant players. In time, so will marine energy. Europe, China, the United States, and the Middle East will all pour vast amounts of capital into all-electric infrastructure.

The intermittency problem of renewables will be fixed as new storage solutions come to market. The innovation in batteries alone over the last couple of years has been astonishing, but the whole storage area is really just getting started.

"Cash for clunkers" is only the beginning of the federal investment that will be made into more efficient and electric vehicles, as is the $2.4 billion that the Department of Energy just awarded to U.S. manufacturers to produce batteries and electric drive train technologies and vehicles that use them. Likewise, government and fleet vehicles will switch over to natural gas and regenerative hydraulic storage systems. An explosion of new electric and plug-in hybrid vehicles could solve most of the grid storage problem through vehicle-to-grid technology, but we'll only build them in large enough numbers if we start immediately.

I am particularly excited about a new type of flywheel-based energy storage device from Power Tree Corp. Unlike existing flywheel storage systems such as the ones made by Beacon Technologies, which deliver large bursts of power for seconds or microseconds and are used for applications like grid stabilization and switching station backup, the Power Tree 4th generation flywheel can store up to 30 gigawatts of electricity and discharge continuous megawatt power for hours. The company announced in July that it will complete its first unit for commercial use in December. Put enough of those in operation, and renewable energy could eventually displace nearly all of our fossil fuel demand, instead of topping out at a 20-30% share.

I have two more "outlier" theses on transportation that are absolutely going to happen. First, air travel will be only for the rich. At $100 a barrel — and we'll be there soon enough — none of the worldwide air travel industry works. The industry will shrink to a tiny fraction of its current size and airports serving less populated areas will close. On the flip side of that, coastal cities who still have working waterfront infrastructure will rebound strongly, buoyed by a resurgence in waterborne shipping and travel.

But Don't Panic!

I know these predictions may sound terrifying and apocalyptic, but after my long consideration of these questions, I think their likelihood is high. Investors who play these extremely contrarian calls correctly will become wealthy, and those who fail to hedge their exposure to these risks will experience enormous losses.

Still, while some of the changes will be truly awful, others will actually make us happier.

For example, dog manicurists and tanning salon attendants will start doing things that are actually useful and add real value to the economy. A huge barter trade will grow up and we'll stop feeding the tapeworm economy that is strangling us today. Materialistic soccer moms suffering from ennui will trade their pilates classes for work in the garden, learn to raise chickens, and go shopping on foot at the market in the downtown square (gingham dress optional). Paunchy financial district executives will turn tanned and strong from digging potatoes and wrestling their backyard pigs. Charcuteries and local bakeries will replace all the Starbucks stores. The kids will be doing a lot of work in the real world with their hands, and learn that there is more to life than prescription drugs and video games. Without cheap gas, we'll stay local and learn to entertain ourselves, maybe even learn to play an instrument. We'll get to spend more time with our families. We'll eat good, homemade food — fresh from our gardens. We might even find time for a neighborhood pick-up game of stickball.

Until next time,

Chris

Energy and Capital

P.S. This market transformation is already happening. . . and my colleague Nick Hodge has been leading investors to greener pastures the entire time. He's closed over 30 winners in the cleantech space so far this year. And his win-rate will only accelerate as the Peak Oil reality plays out. Right now, Nick's busy profiting from transition to an all-electric infrastructure—some of his plays have already doubled. I strongly urge you to heed his advice if you want to make money as oil's supply declines.

Energy Speculation Crackdown

To-morrow, and to-morrow, and to-morrow,
Creeps in this petty pace from day to day
To the last syllable of recorded time,
And all our yesterdays have lighted fools
The way to dusty death. Out, out, brief candle!
Life's but a walking shadow, a poor player
That struts and frets his hour upon the stage
And then is heard no more: it is a tale
Told by an idiot, full of sound and fury,
Signifying nothing.

— Shakespeare, Macbeth

I don't know if it's because oil is staying stubbornly above $60, or because it's just that time of year. . . but the annual spectacle over the influence of evil oil speculators is once again under way.

Only this time, it will have real consequences.

In a three-day series of hearings this week, the Commodity Futures Trading Commission (CFTC) heard arguments about the influence of speculators on the oil and gas markets, and considered new trading limits.

The CFTC issued a report last year concluding that index traders were not to blame for excessive speculation, and that prices had spiked as the result of normal supply and demand factors — a conclusion I fundamentally agreed with. But after reconsideration of new and allegedly better data, Commissioner Bart Chilton clearly means business this year. The time for debate was over, he said this week, and "whatever manner the agency proceeds, 'going slow' is not an option.''

It now seems inevitable that some sort of new technical limits will be imposed on the size of positions traders can hold, how they can be traded, and by whom. In particular, the Commission has set its sights on chasing out purely financial speculators who don't need the contracts to hedge their own business needs (let's take airlines hedging the future price of fuel for example) or who don't intend to take delivery of the commodity (for example: refiners who bid for crude oil).

A new CFTC rule was applied this week, setting position limits and accountability levels on the trade of natural gas contracts on the Intercontinental Exchange (ICE). Some traders had used the ICE to skirt stricter limits on the NYMEX exchange.

NYMEX also moved to set more conservative limits on the size and timing of its trades, presumably as a preemptive attempt to ward off further incursion by the CFTC into its activities.

In turn, the United States Natural Gas Fund (NYSE: UNG), by far the largest fund providing exposure to the natural gas futures market, announced on Wednesday that it would reduce its position in the ICE. The fund's holdings in the ICE have indeed been huge, comprising anywhere from 60% of the fund (according to broker Raymond James) to a rumor claiming closer to 80%. The fund has been bursting at the seams with incoming capital, having recently hit its limit on buying more contracts, and is currently awaiting the decision of the SEC on its request to issue up to another billion units. The fund lost 3.26% on the day in reaction.

Naturally, the commodity trading world erupted in cries of outrage, with analysts fussing over the prospect of reduced liquidity, poorer price discovery, and the possibility that the new rules would force the trade into less regulated over-the-counter markets.

Methinks the lady doth protest too much.

Take a Chill Pill, Already

For one thing, when we're talking about commodities like oil — which trades over 84 million barrels per day on a global scale — I have little patience for the liquidity argument.

As for price discovery, it seems to work just fine at lower levels of volatility.

And the CFTC is already seeking new authority to regulate the OTC markets.

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CFTC Chairman Gary Gensler holds the more regulated agricultural markets out as an example of how the energy markets should work. Let's take a look at that thesis. . .

Consider this chart of the Dow Jones-UBS Grains Subindex Total Return ETN (NYSE: JJG), which tracks the performance of soybeans, corn, and wheat, as compared to oil and gas contracts:

West Texas Intermediate, Dow Jones-UBS Grains Subindex Total Return ETN, and Henry Hub, 2008 to the present. Chart courtest StockCharts.com

In a nutshell, what the CFTC seeks to dampen is the volatility of the oil and gas indexes, so that those green and red lines run a little closer to the blue line.

I have no problem with that. In the real world, severely oscillating prices for critically important stuff like oil and gas affect the entire economy, and the extra froth that speculative traders add to the market wreaks real damage. When prices for oil and gas rise too high too quickly, they take a big bite out of everything from wages to steel production. And when they fall too low too quickly — as they did this year — it kills drilling and production. The result is less supply in the future, and an increase in the likelihood of future price spikes. A few percent difference in the range of overshoot and undershoot has outsized effects.

For such critical commodities, it makes a certain amount of intuitive sense that those who intend to actually take delivery of the stuff should dominate the trade, not financial institutions. Commodities shouldn't be treated as just another asset class when their volatility literally means life or death for people and whole sectors of the economy. Less volatility would also offer better visibility for investment in future supply, which is crucial at this time.

Furthermore, the overweening influence of big banking and hedge fund money is now roundly proven to be a real danger to the health of the economy. Let them cry and moan. . . they have no legs to stand on, and they need to be cut down to size.

On the other hand, it also seems obvious that had oil only risen to $125 a barrel last July instead of $147, it wouldn't have made consumers much happier. The damage would have been a little more limited, but not enough to stop the juggernaut of massively deleveraging markets, and not enough to win a congressman more popular kudos.

Less volatility also means higher lows. Were the oil and gas trade as moderate as the grains trade, we would not now be looking at $3.60 natural gas, but more likely something closer to $4.50. In turn, we would now have higher prices for grid power, petrochemicals, fertilizer, basic metals, and building materials.

And oil prices might be more or less exactly where they are now, having seesawed to their lowest and highest points, to find some equilibrium again in the $60s.

In all, more controlled speculation will likely offer small satisfaction to consumer cost advocates.

Even so, I applaud the CFTC's effort. Tighter regulation will hopefully put to rest the blathering of pandering lawmakers and the shrieks of uninformed consumer advocates, and let the market get on with its business of price discovery and moving capital where it is needed. There is damage done by uncertainty, too. . . just ask UNG about what it's cost them to be in limbo under a fog of CFTC rumors.

Then the next time oil and gas prices spike, perhaps we can have an intelligent discussion about the fundamental reasons for such an event, like peak-oil-induced supply limits and the role of the dollar. We might finally see that the economy is simply bumping its head against a descending ceiling of supply, instead of running off on another useless hunt for scapegoats.

Once the sound and fury over bogeymen speculators subsides and lawmakers start getting their heads around the real problems, we can have a serious dialogue about how we're going to navigate our energy future.

Until next time,

Chris

Energy and Capital

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