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Four new anticipated novels about the decline of oil and gas prices

Harlequin novel cover“We are drowning in information but starved for knowledge,” said John Naisbitt, American author and public speaker. Because of this fact, intuition and instinct, rather than rational thinking, often guides leadership behavior. Guess right, based on what your intuitive self or instinct tells you concerning your iterative policy decisions — particularly the big ones — and the payoff for you and the nation may well be significant. Guess wrong, and the nation could be hurt in various ways and you might not be around for a long time, or get buried in an office close to a windowless washroom. Charles Lindblom, noted political scientist, probably said it correctly when he noted that in complex environments we often make policy by “muddling through.”

Confusion reigns and analyses are opaque and subject to quick amendment concerning the current, relatively rapid decline in oil and gasoline prices. Indeed, key government institutions such as the EIA (Energy Information Administration) and the IEA (International Energy Agency) appear to change their predictions of prices of both, almost on a daily basis. Oil and gas production, as well as price evaluations and predictions resulting from today’s imprecise methodologies and our inability to track cause-and-effect relationships, convert into intriguing fodder for novels. They do not often lend themselves to strategic policy direction on the part of both public and private sector. Sometimes, they do seem like the stuff of future novels, part fiction, and, perhaps, part facts.

Ah … the best potential novels on the decline of oil and gas, particularly ones based on foreign intrigue, will likely provide wonderful bedtime reading, even without the imputed sex and content of the old Harlequin book covers and story lines. Sometimes their plots will differ, allowing many hours of inspirational reading.

Here are some proposed titles and briefs on the general theme lines for four future novels:

An Unholy Alliance: The Saudis and Qatar have joined together in a new alliance of the willing, after secret conversations (likely in a room under a sand dune with air conditioning built by Halliburton, in an excavated shale play in the U.S., a secret U.S. spaceship, or Prince Bandar’s new jet). They have agreed to resist pressure from their colleagues in OPEC and keep both oil production and prices low. By doing so, they and their OPEC friends would negatively affect the Russian and Iranian economy and limit ISIS’s ability to convert oil into dollars. Why not? The Russians and the Shiite-dominated Iranians have supported Syria’s Assad and threated the stability of Iraq. Qatar and the Saudis support the moderate Syrian rebels (if we can find them) but not ISIS, and are afraid that Iran wants to develop hegemony over Iraq and the region, if they end up with the bomb. Further, ISIS, even though it’s against Assad, is not composed of the good kind of Sunnis, and has learned a bit from the Saudis about evil doings. If ISIS succeeds in enlarging the caliphate, it will threaten their kingdoms and the Middle East. According to a mole in the conversations, Russia was really thrown into the mix because, sometimes, it doesn’t hurt to show that you might be helping the West while paying attention to market share.

OPEC in Fantasy Land: Most OPEC members see U.S. oil under their bed at night and have recurring nightmares. “Why,” they asked, “can’t we go back to the future; the good old days when OPEC controlled or significantly influenced oil production and prices in the world?” Several members argued for a counter intuitive agreement.

Let’s surprise the world and go against our historical behavior. Let’s keep prices low, even drive them lower. It will be tough on some of us, whose budgets and economy depend on high oil prices per barrel, but perhaps our “partner” nations who have significant cash reserves, like my brothers (the hero of this novel started to say sisters, but just couldn’t do it) in the Kingdom, can help out.

Driving prices lower, agreed the Saudis, will increase our collective market share (really referring to Saudi Arabia), and may permanently mute any significant competition from countries such as Russia, Mexico, Iraq, Venezuela, and others. But, most importantly, it will probably undercut U.S. producers and lead to a cutback in U.S. production. After all, U.S. production costs are generally higher than ours. Although some delegates questioned comparative production cost numbers and the assumption that the U.S. and its consumer-driven politics will fold, the passion of the Saudis will win the day. OPEC will decide to continue at present production levels and become the Johnny Manziels of oil. Money, money, money? Conspiracy, conspiracy, conspiracy!

Blame it on the Big Guys: The U.S. will not escape from being labeled as the prime culprit in some upcoming novels on oil. The intuitive judgments will go something like this: Don’t believe what you hear! U.S. producers, particularly the big guys, while worried about the fall in oil and gas prices, on balance, believe both will have intermediate and long-term benefits. They have had it their way for a long time and intuitively see a rainbow around every tax subsidy corner.

Why? Are they mad? No? Their gut, again, tells them that what goes down must come up, and they are betting for a slow upward trend next on the following year. Meanwhile, technology has constrained drilling costs. Most feel they can weather the reduced prices per barrel and per gallon. But unlike the Saudis and other OPEC members, they are not under the literal gun to meet national budget estimates concerning revenue. Like the Saudis, however, with export flexibility in sight from Congress, many producers see future market share as a major benefit.

Split Dr. Jekyll and Mr. Hyde personalities exist among the U.S. producers. Jekyll, reflecting the dominant, intuitive feeling, supports low prices. The Saudis and OPEC can be beaten at their own game. We have more staying power and can, once and for all time, reduce the historic power of both concerning oil. While we are at it, big oil can help the government put economic and political pressure on Russia, Iran and ISIS, simultaneously. Wow, we may be able to get a grant, change our image, a Medal of Freedom and be included in sermons on weekends!

Hyde, who rarely shows up at the oil company table until duty calls, now joins the group. He offers what he believes is sage, intuitive advice. He is the oldest among the group and plays the “you’re too young to know card” a bit, much to the chagrin of his younger colleagues. He expresses some rosy instincts about the oil market but acknowledges the likelihood that the future is uncertain and, no matter what, price cycles will continue. He acknowledges that there might be a temporary reduction of the political pressure to open up the fuel markets and to develop alternative fuels because of present relatively low prices. However, based on talking to his muses — both liberals and free market conservatives — and reading the New York Times, he suggests that it might not be a bad idea to explore joining with the alternative fuel folks. Indeed, Hyde indicates that he favors adding alternative fuel production to the production menu of many oil companies. If this occurred, oil companies could hedge bets against future price gyrations and maybe even win back some public support in the process. The industry also might be able to articulate their overblown claim that the “drill, baby, drill” mantra will make the U.S. oil independent. (At this point, the background music in the room becomes quite romantic, and angelic figures appear!) Hyde doubt that going after global market share would bring significant or major early rewards because of current regulations concerning exports and may interfere with the health of the industry in the future as well as get in the way of the country’s still-evolving foreign policy objectives.

Tough sell, however! Contrary to Hyde’s desires, Jekyll carries the day and “kill the bastards” (assumedly the Saudis) becomes the marching orders or mantra. Let’s go get ‘em. Market share belongs to America. Let’s go see our favorite congressperson. We helped him or her get elected; now is the time for him or her to help us eliminate export barriers. A U.S. flag emerges in the future novel. Everyone stands. The oil groupies are in tears. Everybody is emotional. Even Hyde breaks down and, unabashedly, cries.

David and Goliath: Israel has also become a lead or almost lead character in many potential novels on oil. According to its story line, because of Israel’s need for certainty concerning U.S. defense commitments, it has convinced the “best in the west” to avoid a significant reduction in drilling for and the production of oil. Israel advises the U.S. to extend its security-related oil reserves! Glut and surplus are undefined terms. Compete with the Saudis. Drive the price of oil lower and weaken your and our enemies, particularly Iran and Russia. The U.S. should play a new and more intense oil market role. For some, an alliance among U.S.-Israel and other western nations to keep oil and gas prices low is not unimaginable and, indeed, seems quite possible. What better way to anesthetize Iran and Russia? Better than war! An Iran and a Russia unable to unload their oil at what it believes are prices sufficient to support their national budgets would be weakened nations, unable to sustain themselves and meet assumed dual objectives: defense and butter. Finally, what more “peaceful” way to deal with Hezbollah and Hamas, to some extent, than to cut off Iran’s ability to lend them support?

Each of the future novels summarized above clearly suggests some reality driven by what we know. But overall, each one has a multitude of equally intuitive critics with different facts, hypotheses, intuition and instincts. As indicated earlier, it is too bad we cannot generate better more stable analyses and predictions. For now, however, just realize how complex it is to rest policy as well as behavior on, many times, faulty projections and intuition or instinct. Borrowing a quote by the noted comic and philosopher, George Carlin, “tell people there’s an invisible man in the sky who created the universe, and the vast majority will believe you. Tell them the paint is wet, and they have to touch it to be sure.” Similarly, restating but changing and adding words, a quote from the Leonard Bernstein of science, Carl Sagan, that the nuclear arms race (if it does occurs in the Middle East) will be like many “sworn enemies waist-deep in gasoline,” the majority with many matches and one or two with only a few matches.

Novels and Alternative Fuels:

Where does this all leave us with respect to alternative fuels and open fuel markets? Too many producers and their think tank friends believe that low oil and gas prices will reduce the likelihood that alternative fuels will become a real challenge to them in the near future. They, instinctively, opine that investors, without patient money, will not risk funding the development of alternative fuels because prices of oil and gas are so low. Further, their “house” economists argue that consumers will be less prone to switch from gasoline to alternative replacement fuels in light of small or non-existent price differentials between the two.

The truth is that we just don’t know yet how the market for alternative fuels and its potential investors will respond in the short term to the oil and gas price crash. Similarly, we don’t know how long relatively low prices at the pump will last. We do know that necessity has been and, indeed, is now the mother (or father) of some very important U.S. innovations and investor cash. In this context, it is conceivable that some among the oil industry may well add alternative fuels to their portfolio to mute boom, almost boom and almost bust or bust periods that have affected the industry from time immemorial. Put another way, protecting the bottom line and sustaining predictable growth may well, in the future, mean investing in alternative fuels.

Low gas prices presently will likely be followed by higher prices. This is not a projection. History tells us this: importantly, lower gas prices now may well build a passionate coalition of consumers ready to, figuratively, march, if gas prices begin to significantly trend upward. The extra money available to consumers because “filling ‘er up” costs much less now, could well become part of household, political DNA. Keeping fuel prices in line for most consumers, long term, will require competition from alternative fuels — electricity, natural gas, natural gas-based ethanol, methanol, bio fuels, etc. Finally, while our better community-based selves may be dulled now by lower gas prices, most Americans will probably accept a better fuel mousetrap than gasoline because of their commitment to the long-term health and welfare of the nation. But the costs must be competitive with gasoline, and the benefits must be real concerning GHG reduction, an enhanced environment and less oil imports. My intuition and instincts (combined with numerous studies) tell me they will be! Happy Holidays!

CNG-pump

Will falling gas prices hurt alternative vehicles?

Everyone is saying that falling gas prices will ruin the market for alternative fuels and vehicles. But it isn’t time to give up on them now.
Ethanol and methanol are still two liquid fuels that will easily substitute for gasoline in our current infrastructure. Ethanol is making headway, particularly in the Midwest, where it is still cheaper than gasoline and has a lot of support in the farm economy. The big decision will come when the EPA finally sets the quota for ethanol consumption for 2015 – if the agency ever gets around to making a decision. (The decision has been postponed since last spring.) A high number should guarantee the sale of ethanol no matter what the price of gasoline.

That leaves methanol, the fuel that has the most potential to replace gasoline and would it fit right into our present infrastructure but must still run the gamut of EPA approval and would require a change in habits among motorists. Methanol is still relatively unknown among car owners and is hindered by people’s reluctance to try new things. But the six methanol plants that the Chinese are building in the Texas and Louisiana region could break the ice on methanol. The Chinese have 100,000 methanol cars on the road now and are shooting for 500,000 by 2015. Some of that methanol might end up in American engines as well.

Another alternative that is still in play is the electric car. In theory, electric cars should not be affected much by gas prices because that is an entirely different infrastructure. The appeal is not based on price so such as the idea of freeing yourself from the oil companies completely and relying on a source of energy.

The Nissan Leaf has not been badly hit by oil prices. Tesla’s cars, of course, have not gone mass market yet, but the company is relying on a new breed of consumer who does not worry too much about the price and will appreciate the car for its style and performance. Elon Musk has shown no indication of backing down on his great Gigafactory, and Tesla is still aiming to have the Model III (its third-generation vehicle, which will come at a much lower expected price point of $35,000) ready by 2017.

This leaves natural-gas-powered vehicles as the only group that might be hurt by falling gas prices, and here the news is not too good. Sales of vehicles that have compressed natural gas as their fuel declined 7.2 percent in November. As David Whiston, an analyst at Morningstar, told the Houston Chronicle’s Ryan Holeywell: “I hear all the time from dealers: As soon as gas starts to go down, people look at light trucks.”

CNG’s appeal has always been that it will be cheaper than regular gasoline, so plunging gas prices make it lose much of its appeal. It costs $5,000 to install a tank for CNG fuel, and that is not likely to attract a lot of takers with oil prices low. For a gas-electric hybrid, there is similar math. For the Toyota Corolla, the electric portion adds another $7,000 to the price. That’s why the CNG-based solutions never caught up with the light-duty vehicle. They are still attractive for high-mileage vehicles like buses and garbage trucks. “For the consumers doing the math, if gas goes below $3 per gallon, the payback period goes out a number of years,” Whiston told Holeywell. “And the break-even point makes sense for fewer people.”

The collapse in gas prices is not the end of the road for alternative fuels. In a couple of months, the price may be up again, and all those people who have rushed out to buy light trucks will be stuck with them. The changeover to alternative fuels is a slow process, fraught with false starts and misleading signals. But in the end, it will be well worth it to reduce our dependence on imported oil and achieve some kind of energy independence. Car buyers have very short memories and an inability to look very far into the future. Remember, it’s always a passing parade. Consequently, their reaction has been only short-term. But once people buy those trucks, they’re stuck with them for the next 5 to 10 years. If the price of gas goes up again, they may live to regret it.

Abbott and Costello, war, sectarianism and Middle Eastern oil — a trifecta

Abbott & CostelloI bet only those on Medicare, like me, remember the old Abbott and Costello joke, “Who’s on first, What’s on second, I Don’t Know is on third”… or something like that.

The dialogue was funny at the time. But the joke, in some respects, tracks the current, very serious situation in the Middle East: Who’s on first, a very militant Sunni group called ISIS; What’s on second, well maybe Iraq (if it can get its act together, which is increasingly unlikely); and, I Don’t Know exactly who’s on third, maybe the Peshmerga from among the Kurdish Regional State in Iraq and, perhaps soon, a surprise addition from the Kurdish PKK military group living among Kurds in Turkey. Who are the umpires? Perhaps Israel. Maybe OPEC. How about the world’s respected ethicists — if they can ever agree.

Isn’t this fun? Let’s try it again, for there are several possible lineups. Let’s try this one: Who’s on first, how about the Assad-related Shiites in Syria. What’s on second, the new caliphate in Iraq and Syria. I Don’t Know exactly who’s on third, maybe, but unlikely, in light of its numerous conflicting interests (e.g., NATO, Islam, etc.), Turkey. Who’s the hapless lonely umpire or umpires at home plate? Perhaps, the U.N. — the so-called moderate rebels. Perhaps the USA, England or France, or perhaps all three. After all, each Western country has had, at best, a difficult, morally ambiguous historical record in the area, and faces a tough, complex future. Justice and fairness have not always guided their respective objectives and actions. If you believe they have, step up to the plate and you can buy the Brooklyn Bridge for a dollar.

It’s a crazy baseball game! I know the Israelis are in the stands but they have found it tough to get emotional. In their view, at least, both of the team’s captains are Iranian. Since it’s not in the official lineup, the game has little meaning to the Israelis.

We are not sure that all the batters, base runners and umpires are on the same team or in the same game. At times, some players appear to run right and some left. Some run into each other. Others don’t run at all. Most appear to be playing by Middle Eastern norms, which mean they frequently change uniforms, roles, rules and alliances. The umpires seem to be confused and frustrated. They may be ready soon to go for a higher legal or spiritual reviewer but they cannot agree on which one (e.g., the International Court of Justice, God or his or her surrogate).

I yearn for the simplicity of just a year or two ago — before ISIS. Many of our leaders and media types referred to America’s role then in terms of seeking stability in the Middle East. Some even suggested, often knowing better, that it was based on a commitment to establishing western-style democracy. Very few played Don Quixote, or even a good forensic economist searching for the truth. U.S. and Western involvement in the Middle East for a long time has been, to a large degree, premised on dependency on oil. As dependency on oil imports was recently reduced significantly to about 30-35 percent of total oil use because of tight oil development, increased fuel standards, and a slow growth economy, the U.S. has agreed to defend our allies’ right to unfettered international oil transportation from wellhead to refinery.

Democracy and oil proved to be an uneasy mix. Secular animosity and intense internal as well as external competition for oil revenue and market share seemed much more difficult than the naive assertion made after 9/11 that the Iraq citizenry would welcome U.S. military with cheering crowds — shades of WWII after U.S. troupes retook Paris. If only it could have been!

What has occurred in the past year or so has once again shifted the game players, the rules and roles (the ecology of Middle Eastern games). The rise of ISIS and its quick absorption of land in both Syria and Iraq combined with its brutality toward the vanquished in captured territories as well as detained westerners has shifted U.S. and its new coalition’s (e.g., England, France, Saudi Arabia, Qatar, Iraq, Kurds, etc.) attention away from getting rid of Assad to stopping establishment of the caliphate. No longer is democracy a major goal. How could it be with such tested democratic states as Saudi Arabia and Qatar front and center? I shouldn’t be cynical…or should I? Now the focus is on stability — translated: salvage what can salvaged from what is left of Iraq and assumedly prevention of what appears to be an increasing sectarianism from disintegrating into wars fought over God and Mammon or maybe my God and your Mammon or vice versa. The new coalition led by the U.S., apart from the British and French includes:

  • Implicitly, Iran, despite Iran’s enmity and its support of groups like Hamas and Hezbollah.
  • Syria, despite its vicious regime, a regime that has killed or terrorized large sectors of its population, far more than ISIS has to date and probably will far into the future.
  • Qatar, whose chameleon foreign policy reminds one constantly of Ronald Reagan’s quote about the Russians, “Trust but verify.”
  • Saudi Arabia, a Sunni-dominated kingdom, that, until the Arab Spring, seemed reasonably secure in its religious, non-democratically based, very conservative legal framework, as well as a caste and class system based on discrimination and corruption.
  • Iraq, a country that, despite U.S. support, is a nation in name only. It is divided by sectarianism into at least three potential would-be nations — each one dominated by dominant religious and ethnic groups. Its central government is unable or unwilling to secure consensus as to governance and military approaches. Its army, despite years of U.S.-supported training and U.S.-supplied weaponry has been, up to now, no match for ISIS. Its sectarian-controlled militias are not committed to consensus building and may end up as a threat to further nation building.

The new coalition has shaken up the Middle East and suggests the old adage that, “The enemy of my enemy is my friend.” Endorsement of the present nation states in the Middle East, as well as opposition to territorial aggrandizement and religious extremism, provides the rationale for U.S. and Western involvement in the current war.

But, irrespective of the coalition’s normative marching orders about stopping extremism and a big land grasp, I suspect that oil or trafficking in oil remains a key factor, indirectly or directly, in back-room decisions to push back ISIS boundaries. Let’s see: the Saudis must soon consider increasing the price of a barrel of oil if it is to avoid the need to cut back on services to its citizens and risk tension. It also must soon consider an increase in oil prices if it is to sustain its defense budget in terms of the present conflict with ISIS. While the U.S. has surpassed the Saudis in oil production, Saudi oil is needed by the West and Asia to avoid significant future price rises premised on future growth. As a result, the U.S. will remain a protector of oil transit. Apart from fearing the collapse of Iraq for political, economic and moral reasons, the U.S. is still committed to safeguarding Iraq’s oil and the oil from one of its regions, the Kurdish Regional Government, for its allies and also for the revenue needed by both. Qatar is a conundrum. Today, it’s a western ally against ISIS; yesterday, reports indicated it supported militants in the Gaza. Which twin has the Tony? Where will it be tomorrow? Finally, remember ISIS needs oil for revenues to function as a government.

If only! If only we could find home-grown, market-acceptable substitutes for oil and its derivative gasoline that would relieve any hint or suspicion that oil or gasoline would be even an indirect consideration in a U.S. or Western nation decisions to go to war. We are not there yet, in terms of the majority of the vehicle owners. But we are getting close with alcohol-based fuels, biofuels, and hydrogen and electric cars.

coin flip

Are Americans risk-averse?

The name of the game is “the St. Petersburg Paradox,” and it proved that people are risk-averse, even when they have nothing to lose and a chance to win big from playing a game. It has become a well-established principle in economics and helps explain why people are so reluctant to switch to alternative fuels, even when they stand to gain from the exchange.

The architect of this theory is Daniel Bernoulli, the 18th century Swiss mathematician who is also responsible for Bernoulli’s law, which states that pressure becomes less intense as a fluid travels over one side of a surface at greater speed. It is the basis of airplane flight.

Bernoulli lived in St. Petersburg for a period and became involved in the gambling scene, which was very intense. Like any good mathematician, however, he became more interested in why people bet, rather than the outcome of the game.

He became particularly intrigued by something called the “St. Petersburg Game.” The rules were fairly simple: It involved the simple flip of a coin. If the coin came up tails, the player would receive a dollar (ruble). If the coin came up tails a second time, the player would receive $2, third time $4 and double for each round thereafter. In other words, as long as the coin kept coming up heads, you kept winning. Theoretically, a player could make $500 and on up. The question is, how much would you pay to play this game?

Bernoulli found that even though the average payout was $2, players were very reluctant to buy into the game for more than $2. Their thinking was very short-term and logical. The possibility of a huge payout was of little appeal to them. They were risk-averse.

From this observation, Bernoulli deduced another principle he called the “marginal utility of wealth.” Bernoulli differentiated between “wealth” and “utility.” The utility curve, he said, was concave, and people tended to put more value on the money they lost rather than what they gained. Therefore, they were much less inclined toward risk. Even the possibility of a large payout in an uncertain future is not enough to entice them into the game for a higher price.

What does this have to do with alternative fuels and alternative vehicles? Well, the early adopters are taking big risks. They risk that the new technology may not work out, and they will be stuck with a white elephant. They risk that the fuel savings may not be as great as they are led to believe. The risk that the price of fuels may change drastically – such as the current free fall in oil prices – and any advantage they might have had with the alternative fuel may quickly evaporate. The natural gas tank on a utility truck costs about $5,000, on top of the cost of the normal gas tank. Anyone who as one installed is taking a big risk. Is it worth the extra investment?

The concave marginal utility curve also explains why wealthier people are more inclined to try the alternative vehicles than the average person. They have more room to experiment and are less concerned about losses. Tesla has been deliberately targeting the $75,000 and up market. The first Tesla driven in the United States was bought by Leonardo DiCaprio. Elon Musk is taking a tremendous risk himself by trying to manufacture a $45,000 Tesla that will appeal to a much larger audience.

But risk aversion for the average person is very hard to overcome. Look at another version of the St. Petersburg game: You are allowed to buy into a game where you flip a coin for money. If you win that one flip, you will be awarded $1,000 each year for the rest of your life. Alternately, you may flip the coin every year for $1,000 for that year. Which would you choose?

Experience proves overwhelming that the majority of people prefer to flip every year rather than stake it all on one flip. This proves that people are not risk-takers but would rather have incremental increases rather than an all-or-nothing opportunity. People do not expect extraordinary events to occur to them, but base their decisions on the more normal rate of chance.

Peter Drucker said that in order to replace an existing technology you had to have something that is 10 times as good as what you are trying to do. There are so many impediments – inertia, trying to get known, trying to overcome people’s aversion to risk –that it’s a very difficult task.

That’s why many believe that we need the intervention of the states and the federal government to prime the pump for alternative fuels and vehicles. There are just very few people willing to take the risk. California’s program to put 15,000 cars on the road running on methanol in the 1990s was a good example. Should it be duplicated? There is no downside to running on ethanol or methanol, and there are probably some environmental advantages, as well as money to be saved. But the societal benefits – energy independence and freedom from imported oil – are spread out, while the risks remain on one person – the individual who buys the vehicle.

Individuals are risk-averse – there’s no getting around it. It may take some initiative from the government to mitigate those risks and spread them out over a wider range of people. That way they become more tolerable.

By health check or economic necessity: A tale of two oil industries and their response to illness

By John Hofmeister and Marshall Kaplan

shutterstock_118647259A bad cold starts with a tickle in the throat and a languid day. It grows to painful swallows, stuffed sinuses and likely a fever. Does the patient treat the symptoms? Does he or she transform to avoid illness in the future?

Few oil company players will admit to it yet, but the future threatens a very bad cold for the current industry, or worse. Very few feel it coming because current business plans are robust and the workload is on overload. When they are recognized, the threats to the current business model are going to take more than treating the symptoms; there are transformative requirements to avoid getting permanently sick, including, for many, a difficult transition to alternative fuels. The industry’s investors are not likely to remain committed to oil. Neither are the politicians, the Wall Street analysts and the public who, for different reasons, some economic and some with concerns for the environment, are already shaky with respect to the future of oil. Unenthused investors actions, however, will speak much louder than concerned words.

Everyone agrees that conventional oil has peaked. Unconventional oil may be abundant, but it’s expensive. It’s so expensive that industry valuation is already being impacted by worried investors who don’t like companies borrowing cash to pay dividends. Shale formation decline rates demand evermore drilling. Drilling costs increase as more wells per amount of production are completed, raising per barrel costs. Sweet spots are finite as the majors have learned the hard way. They bought into many plays too late. The Middle East is, well, the Middle East. Don’t look for reduced tension in the near future. Do look for OPEC nations to increasingly shift oil for export into oil for local consumption — a residual of the Arab Spring. Business as usual is history. Brazilian, East African, Russian and Arctic production opportunities abound, except that the degrees of difficulty are unclear and uncertain, but are sure to be costly. The high costs and regulatory uncertainties of oil limit global growth and nourish alternative fuel prospects. Oil investors don’t like sore throats emerging from hard to swallow realities. They will want to create a new reality to protect their financial wellbeing.

The costs of carbon have yet to be added onto oil and we know they’re coming. There’s debate over the form of payment, not the reality. Take a look not only at the number of governments backing carbon constraints coming out of this year’s climate meeting at the UN, but, more importantly, count the companies! Count the crowd recently claiming the high ground from Central Park to Midtown in New York and other cities around the world. The oil industry’s low favorability gives it limited public influence. While special-interest money may run out the clock on near-term legislation in the next Congress, for the industry, it not a long term solution. Civil society and political trends are inevitably contrary to the industry’s status quo interests. The rhetoric alone will tax the bronchial capacity of oil and gas leaders; investors will cease shaking hands with infected stocks.

Cash is to oil what gasoline is to the internal combustion engine. Higher upstream costs and more expensive fuels reduce consumer demand and, inevitably, cash flow. Downstream cash can’t make up the difference for higher upstream capital (cash) outlays when consumers drive less or take advantage of increasing availability of lower-cost alternative fuels, despite the BTU and/or mileage disadvantages of alcohol fuels versus oil products.

Finally, when divestment trends start to impact the industry, perhaps initially not directly through actual shifting of resources, but because of the growing perceptions of the risk of stranded assets, opportunity costing equations will begin to hit hard. The value associated with increasing capital costs for oil development will be muted. With ever higher costs, more difficult unconventional production, more challenging resource basins and tighter regulatory scrutiny, along with environmental constraints, existing assets may never get produced. The probable reserve that never makes it to proven becomes ever less valuable with time, perhaps even worthless. Investors don’t like that. Oil price to support such production is unsustainable; the price rises until it crashes; production cannot recover from the collapse because sustainable alternative fuels will have taken increasing market share. To remain competitive, oil may not be able to climb above the $55 – 75 range. This prospect will cause full blown pneumonia for oil companies. Most still do not see it coming. For OPEC countries who are under inconsistent pressures — first to increase exports for needed revenues at home to fund services for an often restive population; second, to reduce exports to provide energy and gasoline products to larger population numbers, it could present real challenges affecting political stability.

Some companies that sense it coming will not wait for the cold symptoms to lodge in their respiratory systems. They will get out in front with natural gas, using an entirely different cost/price structure to displace high cost oil by producing natural gas for fuels, including ethanol, methanol, CNG and LNG. They’ll also embrace biofuels as a sustainable and carbon-reducing alternative to oil products only. In both cases, their cash flows and capital outlays will fund reasonable and rational alternative investments in downstream and midstream infrastructure to produce, distribute and sell alternative fuels, extending their business models and capabilities rather than risking everything on their past model. They’ll choose investor and their own health and economic necessity as the basis of a new business model transforming the mobility industry with fuels competition.

A handful of smart companies will astutely come to grips with their industry’s endemic inability to change their historic focus on oil as their base business. They’ll see diversity as an opportunity to run the race with competitive fuels, and they’ll recognize that oil and gasoline will only be able to sustain their monopoly status at the pump for a relatively short period of time. They will trade one form of steel in the ground for another, bringing the competencies of size, scale and execution to an ever-growing, oil-displacing, alternative fuels industry. In the process, they will simultaneously reduce the size of the oil upstream capital, cash, environmental and stranded asset problems that alienated investors, and, at times, the public, particularly related to emissions and other pollutants.

With a proper health check, after scanning the industry’s economic and environmental horizons, they acknowledge the inevitability of the changing critical role of investors. Their own financial health and economic necessity will redefine the role of oil and change the competitive landscape.

 

John Hofmeister, Former President Shell Oil Company (retired), Founder and CEO Citizens for Affordable Energy, Author of Why We Hate the Oil Companies: Straight Talk from an Energy Insider (Palgrave Macmillan 2010)

Marshall Kaplan, Advisor Fuel Freedom and Merage Foundations, Senior Official in Kennedy and Carter Administrations, Author

Religion, structural changes in the oil Industry and the price of oil and gasoline

Oil barrelAmericans — in light of the decline in oil and gas prices — don’t take happy selfies just yet! Clearly, the recent movement of oil prices per barrel below $80 and the cost of gasoline at the pump below $3 a gallon lend cause for, at least strategically, repressed joy among particularly low-income consumers, many of whose budgets for holiday shopping have been expanded near 10 percent. Retail stores are expressing their commitment to the holiday by beginning Christmas sales pre-Thanksgiving. Sure, sales profits were involved in their decisions, once it appeared to them that lower gas prices were here to stay, at least for a while. But don’t be cynical; I am sure the spirit moved them to play carols as background music and to see if in-store decorations made it easier for shoppers to get by headlines of war, climate change and other negative stuff and into, well yes, a buying mood. If retail sales exceed last year’s and GNP is positively affected, it will provide testimony and reaffirm belief that God is on America and the free market’s side, or at least the side of shopping malls and maybe even downtowns. Religious conversions might be up this year…all because of lower costs of gasoline at the pump. The power of the pump!

But, holy Moses (I am ecumenical), we really haven’t been taken across the newly replenished figurative Red Sea yet. There are road signs suggesting we won’t get there, partly because of the historical and current behavior of the oil industry. Why do I say this?

If history is prologue, EIA’s recent projections related to the continued decline of oil and gasoline prices will undergo revisions relatively soon, maybe in 6 months to a year or so. I suspect they will reflect the agency’s long-held view that prices will escalate higher during this and the next decade. Tension in the Middle East, a Saudi/OPEC change of heart on keeping oil prices low, a healthier U.S. economy, continued demand from Asia (particularly China), slower U.S. oil shale well development as well as higher drilling costs and the relatively short productive life span of tight oil wells, and more rigorous state environmental as well as fracking policies, will likely generate a hike in oil and gasoline prices. Owners, who were recently motivated to buy gas-guzzling vehicles because of low gas prices, once again, may soon find it increasingly expensive to travel on highways built by earthlings.

Forget the alternative; that is, like Moses, going to the Promised Land on a highway created by a power greater than your friendly contractor and with access to cheap gas to boot. Moses was lucky he got through in time and his costs were marginal. He was probably pushed by favorable tides and friendly winds. The wonderful Godly thing! He and his colleagues secured low costs and quick trips through the parting waters.

Added to the by-now conventional litany concerning variables affecting the short- and long-term cost and price of gasoline and oil (described in the preceding paragraph), will likely be the possible structural changes that might take place in the oil industry. If they occur, it will lead to higher costs and prices. Indeed, some are already occurring. Halliburton, one of the sinners in Iraq concerning overpricing services and other borderline practices (motivated by the fear of lower gas prices), has succeeded in taking over Baker Hughes for near $35 billion. If approved by U.S. regulators, the combined company will control approximately 30 percent of the oil and gas services market. According to experts, the new entity could capture near 40 percent relatively quickly. Sounds like a perfect case for anti-trust folks or, if not, higher oil and gas costs for consumers.

Several experts believe that if low gas prices continue, oil companies will examine other profit-making, competition-limiting and price-raising activities, including further mergers and acquisitions. Some bright iconoclasts among them even suggest that companies may try to develop and produce alternative fuels.

Amen! Nirvana! Perhaps someday oil companies will push for an Open Fuels Law, conversion of cars to flex-fuel vehicles and competition at the pump…if they can make a buck or two. Maybe they will repent for past monopolistic practices. But don’t hold your breath! Opportunity costing for oil companies is complex and unlikely to quickly breed such public-interest related decisions. Happy Thanksgiving!

letterman4

10 reasons why falling oil prices is good for the U.S. and replacement fuels

While they might not make the Late Show with David Letterman, here are ten reasons why the fall in oil and gas prices, if it is sustained for a while, is, on balance, good for the U.S. and replacement fuels.

  1. U.S. consumers are getting a price break. While the numbers differ by researchers, most indicate that on average they have saved near $80 billion. According to The Wall Street Journal, every one cent drop in gasoline adds approximately a billion dollars to nationwide household consumption.
  2. Low- and moderate-income households will have extra money for basic goods and services, including housing, health care and transportation to work.
  3. Increased consumer spending will be good for the economy and overall job growth. Because of the slowdown in production and the loss of jobs in the oil shale areas and Alaska, the net positive impact on GNP will be relatively small, higher at first as consumers make larger purchases, and then lower as oil field economic declines are reflected in GNP.
  4. Low prices for oil and gas will impede drilling in tight oil areas and give the nation time to develop much-needed regulations to protect environmentally sensitive areas. Oil is now under $80 a barrel. The price is getting close to the cost of drilling. Comments from producers and oil experts seem to suggest that $70-75 per barrel would begin to generate negative risk analyses.
  5. Low prices for oil and gas will make it tough on Russia to avoid the impact of U.S. and EU sanctions. Russia needs to export oil and gas to secure revenue to meet budget constraints. Its drilling and distribution costs will remain higher than current low global and U.S. prices.
  6. Low prices of oil and gas will reduce U.S. need to import oil and help improve U.S. balance of payments. Imports now are about 30 percent of oil used in the nation.
  7. Low prices of oil and gas will further reduce dependence on Middle East oil and enhance U.S. security as well as reduce the need to rely on military intervention. While the Saudis and allies in OPEC may try to undercut the price of oil per barrel in the U.S., it is not likely that they can sustain a lower cost and meet domestic budget needs.
  8. Low prices of oil and gas will create tension within OPEC. Some nations desiring to improve market share may desire to keep oil prices low to sustain market share, others may want to increase prices and production to sustain, if not increase, revenue.
  9. Low prices of oil and gas will spur growth in developing economies.
  10. Low prices for oil and gas will likely secure oil company interests in alternative fuels. It may also compel coalitions of environmentalists and others concerned with emissions and other pollutants to push for open fuel markets and natural gas based ethanol, methanol and cellulosic-based fuels as well as a range of renewable fuels.

We haven’t reached fuel Nirvana. The differential between gasoline and corn-based E85 has lessened in most areas of the nation and now appears less than the 20-23 percent needed to get consumers to think about switching to alternative fuels like E85. But cheaper replacement fuels appear on the horizon (e.g., natural gas-based ethanol) and competition in the supply chain likely will reduce their prices. Significantly, in terms of alternative replacement fuels, oil and gas prices are likely to increase relatively soon, because of: continuing tensions in the Middle East, a change of heart on the part of the Saudis concerning maintaining low prices, the increased cost of drilling for tight oil and slow improvements in the U.S. economy resulting in increased demand. The recent decline in hybrid, plug-in and electric car sales in the U.S. follows historical patterns. Cheap gas or perceived cheap gas causes some Americans to switch to larger vehicles (e.g., SUVs) and, understandably, for some, to temporarily forget environmental objectives. But, paraphrasing and editing Gov. Schwarzenegger’s admonition or warning in one of his films, unfortunately high gas prices “will be back…” and early responders to the decline of gasoline prices may end up with hard-to-sell, older, gas-guzzling dinosaurs — unless, of course, they are flex-fuel vehicles.

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Methanol — the fuel in waiting

Methanol is a bit of a mystery. It is the simplest form of a hydrocarbon, one oxygen atom attached to simple methane molecule. Therefore, it burns. Methanol is one of the largest manufactured trading commodities after oil, and has about half the energy value of gasoline (but its high octane rating pushes this up to 70 percent). It is a liquid at room temperature and would therefore fit right into our current gasoline infrastructure — as opposed to compressed natural gas or electricity, which require a whole new delivery system.

Methanol made from natural gas would sell for about $1 less than gasoline. Methanol can also be made from food waste, municipal garbage and just about any other organic source.

So why aren’t we using methanol in our cars? It would be the simplest thing in the world to substitute methanol for gasoline in our current infrastructure. Car engines can burn methanol with a minor $200 adjustment that can be performed by any mechanic. You might have to fill up a little more often, but the savings on fuel would be significant — about $600 a year. So what’s stopping us?

Well, methanol seems to be caught in a time warp. It is the dreaded “wood alcohol” of the Depression Era. Methanol is poisonous, as opposed to (corn) ethyl alcohol, which only gets you drunk. (In fact, commercial products such as rubbing alcohol are “denatured” by adding methanol so people will not drink them.) But if methanol is poisonous, so is gasoline, as well as many, many other oil products. Yet methanol is somehow caught up in old EPA regulations that make it illegal to burn in car engines — even though it is hardly different from the corn ethanol that currently fills one-tenth of our gas tanks.

Methanol’s main feedstock is natural gas, and for a long time that was seen as a problem. “Methanol wasn’t practical because the price of natural gas was so high and we seemed to be running out of it,” said Yossie Hollander, whose Fuel Freedom Foundation has been promoting the use of methanol for some time. “But now that natural gas prices have come down, it makes perfect sense to use it to make methanol. We could do away with the $300 billion a year we still spend on importing oil.”

The EPA actually granted California an exemption during the 1990s that allowed 15,000 methanol-powered cars on the road. The experiment was a success and customers were happy but natural gas prices reached $11 per million BTUs in 2005 and the whole thing was called off. Only a few months later, the fracking revolution started to bring down the price of natural gas. It now sells at $4 per mBTU. Yet, for some reason the EPA has not yet reconsidered its long-standing position on methanol.

At the Methanol Policy Forum last year, Anne Korin of the Institute for the Analysis of Global Security (IAGS), made a very insightful remark. “I think methanol fares poorly in Washington precisely because it doesn’t need any subsidies or government assistance in making it economical. For that reason you have no big constituency behind it and no member of Congress crusading on its behalf.”

That may be about to change, however. China has a million cars burning methanol on the road and wants to expand. In the past few weeks alone, Texas and Louisiana have been hit with what is being called “Methanol Mania.” The Chinese are planning to build six major processing plants to turn the Gulf Coast into the world’s biggest center of methanol manufacture. One project will be the largest methanol refinery in the world, two times the size of one located in Trinidad.

All this methanol is intended to be sent back to China. The Chinese want to employ it as a feedstock for their own plastics industry, plus use it in Chinese cars. They will be shipping it the expanded Panama Canal, which will be completed in 2015.

But at some point someone in this country is going to look around and say, “Hey, why don’t we use some of this methanol to power our own automobiles.” At that point the methanol industry, along with the Texas and Louisiana, may have enough political leverage to get the EPA off the dime and see a decision about using methanol in our cars as well.

(Photo credit: Stockcarracing.com)

gas-prices

The decline of oil and gas prices, replacement fuels and Nostradamus

“It’s a puzzlement,” said the King to Anna in “The King and I,” one of my favorite musicals, particularly when Yul Brynner was the King. It is reasonable to assume, in light of the lack of agreement among experts, that the Chief Economic Adviser to President Obama and the head of the Federal Reserve Bank could well copy the King’s frustrated words when asked by the president to interpret the impact that the fall in oil and gasoline prices has on “weaning the nation from oil” and on the U.S. economy. It certainly is a puzzlement!

What we believe now may not be what we know or think we know in even the near future. In this context, experts are sometimes those who opine about economic measurements the day after they happen. When they make predictions or guesses about the behavior and likely cause and effect relationships about the future economy, past experience suggests they risk significant errors and the loss or downgrading of their reputations. As Walter Cronkite used to say, “And that’s the way it is” and will be (my addition).

So here is the way it is and might be:

1. The GDP grew at a healthy rate of 3.5 percent in the third quarter, related in part to increased government spending (mostly military), the reduction of imports (including oil) and the growth of net exports and a modest increase in consumer spending.

2. Gasoline prices per gallon at the pump and per barrel oil prices have trended downward significantly. Gasoline now hovers just below $3 a gallon, the lowest price in four years. Oil prices average around $80 a barrel, decreasing by near 25 percent since June. The decline in prices of both gasoline and oil reflects the glut of oil worldwide, increased U.S. oil production, falling demand for gasoline and oil, and the likely desire of exporting nations (particularly in the Middle East) to protect global market share.

Okay, what do these numbers add up to? I don’t know precisely and neither do many so-called experts. Some have indicated that oil and gas prices at the pump will continue to fall to well under $80 per barrel, generating a decline in the production of new wells because of an increasingly unfavorable balance between costs of drilling and price of gasoline. They don’t see pressure on the demand side coming soon as EU nations and China’s economies either stagnate or slow down considerably and U.S. economic growth stays below 3 percent annually.

Other experts (do you get a diploma for being an expert?), indicate that gas and oil prices will increase soon. They assume increased tension in the Middle East, the continued friction between the West and Russia, the change of heart of the Saudis as well as OPEC concerning support of policies to limit production (from no support at the present time, to support) and a more robust U.S. economy combined with a relaxation of exports as well as improved consumer demand for gasoline,

Nothing, as the old adage suggests, is certain but death and taxes. Knowledge of economic trends and correlations combined with assumptions concerning cause and effect relationships rarely add up to much beyond clairvoyance with respect to predictions. Even Nostradamus had his problems.

If I had to place a bet I would tilt toward gas and oil prices rising again relatively soon, but it is only a tilt and I wouldn’t put a lot of money on the table. I do believe the Saudis and OPEC will move to put a cap on production and try to increase prices in the relatively near future. They plainly need the revenue. They will risk losing market share. Russia’s oil production will move downward because of lack of drilling materials and capital generated by western sanctions. The U.S. economy has shown resilience and growth…perhaps not as robust as we would like, but growth just the same. While current low gas prices may temporarily impede sales of electric cars and replacement fuels, the future for replacement fuels, such as ethanol, in general looks reasonable, if the gap between gas prices and E85 remains over 20 percent  a percentage that will lead to increased use of E85. Estimates of larger cost differentials between electric cars, natural gas and cellulosic-based ethanol based on technological innovations and gasoline suggest an extremely competitive fuel market with larger market shares allocated to gasoline alternatives. This outcome depends on the weakening or end of monopolistic oil company franchise agreements limiting the sale of replacement fuels, capital investment in blenders and infrastructure and cheaper production and distribution costs for replacement fuels. Competition, if my tilt is correct, will offer lower fuel prices to consumers, and probably lend a degree of stability to fuel markets as well as provide a cleaner environment with less greenhouse gas emissions. It will buy time until renewables provide a significant percentage of in-use automobiles and overall demand.