Peak Watch

The Radical Hypothesis

Plus ca change, plus c'est le meme chose
   — an old saying

And what rough beast, its hour come round at last,
Slouches towards Bethlehem to be born?
   — from The Second Coming, a poem by W. B. Yeats

It is hardly an exaggeration to say that humanity has reached a fork in the road, and future generations await our decision. Our energy & economic prospects are at stake, and these two necessities are inextricably linked. At such turning points, it is natural for apprehension to cloud our judgment. We want to hang on to what we have, or improve upon it, but our uncertainty is greater than our ability to discern the long-term future. The only things that seem clear are that the future will not resemble the past, and must not resemble it.

Today I make some elementary but crucial observations about the relationship between fossil fuel energy and economies. I go on to question normal assumptions about future economic growth.

A revolutionary idea about energy and economies which is meant to banish our uncertainty and apprehension has taken hold among our decision-makers and elites. I call it the Radical Hypothesis (Figure 1).

Figure 1 — A conceptual depiction of the Radical Hypothesis. Economic growth (dotted line) has always been accompanied by growth in CO₂ emissions (black line). Emissions are a proxy for fossil fuels consumption. Now, at the Turning Point, economic growth diverges from emissions growth. A third alternative, a reduction in the carbon intensity of economic growth, is also shown (dashed line). Carbon intensity is "a measure of how much carbon equivalents (CO₂e) are emitted per capita of GDP."

The decoupling of economic and emissions growth after the Turning Point is not usually seen as a radical departure from the norm because it is (now) the consensus view. I have intentionally turned this generally accepted view on its head to put it in clear perspective.

Given the historical trend shown in Figure 2, we might plausibly expect an outcome like that shown Figure 3. I call this the Conservative Hypothesis.

Figure 2 — Taken from How Can We Reconcile Growth, Emissions and Resources? by Simon Roberts. The slides from his presentation can be found here. Emissions shrink during recessions. No doubt a similar decrease is happening now during the Great Recession (2007-?).

Figure 3 — A conceptual depiction of the Conservative Hypothesis. At the Turning Point, shrinking emissions (black line) are accompanied by shrinking economies (dotted line). Economic abatement does not necessarily follow emission reductions due to technological progress (see below). Thus, the economic growth curve might be flatter or steeper, but the global economy (GDP per capita) must diminish in the conservative view as available fossil fuel energy declines.

At issue is the true nature of modern civilization's relationship to fossil energy. What we know historically is expressed in proposition (1).

(1) If the global economy grows, then CO₂ emissions grow

It follows that—

(2) if CO₂ emissions are not growing, the global economy is in recession (like now).

It is not the case that—

if CO₂ emissions grow, then the global economy grows

because emissions could rise for all sorts of reasons unrelated to economic growth

The consensus, politically-correct opinion, represented (for example) by Al Gore or Obama's science adviser John Holdren, says that a past tight correlation between economic and emissions growth does not necessarily imply that modern economies have depended on burning fossil energy to fuel growth. The Radical Hypothesis says you can have your cake (grow the economy) and eat it too (reduce emissions).

Logically speaking, the radical position contradicts proposition (1). It thus goes against our historical experience. The Conservative Hypothesis takes our previous experience (Figure 2) at face value—reducing emissions will reduce economic growth. You can not have your cake and it eat too. This is very much a minority view.

The Radical Hypothesis rests upon the complex assumption (3).

(3) Technological progress marches on and improvements are always sufficient to meet our needs (including our need for energy)

At the Turning Point, and "forever" after, technological improvements permit the decoupling of economic growth from fossil fuels consumption. For example, wind or solar replace coal, biofuels replace oil, etc. Net energy calculations (EROEI) don't matter because they are based on present science & technology. Technological improvements will enhance energy extraction efficiency in all areas (e.g. in biomass to liquids conversions, or even in exploitation of oil shales, should it come to that).

Some taking the conservative view reject assumption (3) outright—we have run out of technological solutions to our energy predicament. Others grant that some technological progress will take place, but reject the notion that such progress will be sufficient to break our dependency on fossil fuels to achieve economic growth (proposition 1). The latter expresses my own view.

Our expectation of reduced CO₂ emissions over time is due to two factors:

• resource constraints (e.g. the peak of oil production rates, or peak natural gas and coal some decades hence)
• pro-active measures taken to reduce emissions to mitigate climate change in 21st century (e.g. policies that encourage switching to renewable "clean" energy sources, a moratorium on new coal-fired plants and a phase-out of old ones, and so forth)

Those adapting the Radical Hypothesis either deny that limits on exploitable fossil energy exist, or adopt the fall back position that fossil fuel resources don't matter due to the inevitable dominance of "clean" energy made possible by technological progress. If resource limits do not exist and or pro-active measures are not taken—or don't work because technological progress comes up short—we get a business-as-usual (BAU) scenario as shown in Figure 4. In this case, future economic growth would be taken for granted because nothing has changed.

Figure 4 — A business-as-usual (BAU) scenario. In this case, the best science available assures us that humanity faces a climate catastrophe in this and coming centuries. The BAU scenario is impossible if 1) prompt (between now and 2040) resource limits exist or 2) technological improvements do indeed come to the rescue. Assuming CO₂ emissions rise at a rate of 2 ppmv/yr, we will reach 450 ppmv (parts per million by volume) in the atmosphere in 2041 (from ~386 ppmv now). Alternatively, the world might follow a reduced carbon intensity path (as shown in Figure 1) whereby carbon emissions grow at a slower rate. The science says that such a reduction will help, but not enough to avoid dangerous anthropogenic interference with the climate (e.g. we will get catastrophic sea level rise).

I've only scratched the surface of interlinked economic & energy problems in this brief introduction. Let's explore another facet of the Radical Hypothesis.

Discounting the Future

Human beings discount the future, whereby "society places a lower value on a future gain or loss than on the same gain or loss occurring now. And so do economists because—

If people’s preferences count and if people prefer now to the future, those preferences must be integrated into social policy formulation. Time-discounting is thus universal in economic analysis, but it remains, as it always has, controversial.

In 2005 the British Government asked Sir Nicholas Stern to review the economics of climate change. The end result of Brown's request was the Stern Review on the Economics of Climate Change published in late 2006.

To my knowledge, no comparable review has ever been carried out to work out the economics of resource depletion. The so-called Hirsch report comes closest, but has neither the scope (in terms of economic analysis among other things—Stern's report is more than 576 pages long) nor the weight of a report specifically requested by (then) British Chancellor Gordon Brown. This is not an accident. Rather, it follows from the general acceptance of the Radical Hypothesis (Figure 1), in which our reliance on fossil energy is devalued, and the presumed continuation of technological progress as stated above.

Stern's conclusions were (and still are) controversial because he used a very low discount rate, as explained in Frank Ackerman's The Stern Review vs. its Critics: Which Side is Less Wrong? Ackerman's review, along with Figure 5, provide a simple but good-enough introduction to discounting in general and how it relates to climate change in particular. I thus quote Ackerman at length—

... In Stern's view, inaction on climate change would lead to damages worth at least 5% of world output per year, and, depending on how the damages are calculated, perhaps as much as 20%. Most of these damages could be prevented, according to Stern, by spending 1% of world output annually on mitigation...

The discount rate is central to the economics of climate change. When costs are incurred to reduce emissions today, the benefits of reduced climate change will occur decades or centuries later. How much less valuable are those benefits, because they will happen in the future? At a discount rate near zero, future benefits are almost as valuable as if they occurred today, implying that it is “worth it” to take action now to secure those future benefits. At a high discount rate, future values fade rapidly into insignificance, implying that very little climate mitigation is “justified” by its (heavily discounted) benefits in generations to come.

Economic theory distinguishes between two components of the discount rate: the “rate of pure time preference” that would apply if all generations had equal incomes; and a growth-related rate, assuming that if the future will be richer than the present, then there is less need to make investments on their behalf today.

Stern endorses the philosophical argument that present and future generations are of equal ethical standing, implying that pure time preference should be zero. Your granddaughter is no less important than your daughter simply because she will be born a generation later. Other economists frequently object that people display impatience and short time horizons at a level incompatible with zero pure time preference. Moreover, a rate of precisely zero causes technical problems in some economic theories. Perhaps to avoid this technical issue, Stern introduces a miniscule rate of pure time preference, 0.1% per year, based on an arbitrary estimate of the annual probability that the human race will not survive.

Like other economists, Stern includes a second part of the discount rate, tied to economic growth. His discount rate thus becomes the rate of growth of per capita consumption, plus 0.1%. Since economic growth averages 1.3% in his model, his discount rate averages 1.4%. Other economists assume both a more substantial rate of pure time preference, and a larger growth-related component, yielding discount rates as high as 6%. The difference this makes is enormous: $100 of benefits 100 years from now would be worth $25 today at a discount rate of 1.4%, versus $0.25 at 6%. In short, economic analysis can “see” much more of the future at a discount rate as low as Stern’s, but becomes myopic at a rate as high as 6%.

[My note: so, the discount rate = the rate of pure time preference (0.1%) + the economic growth rate (1.3%) = 1.4%/year.]

[My note: I emphasize the "arbitrary estimate of the annual probability that the human race will not survive."]

Figure 5 — From The Ethics of Climate Change by John Broome, Scientific American, June, 2008. William Nordhaus of Yale is one of Stern's severest critics. As the image text states, his "6 percent discount rate places far less value than Stern's rate of the well-being of future generations."

Before examining Stern's low discount rate, let's make sure we understand the answer to a key question: why discount future goods & services at all?  Ackerman alludes to a "future ... richer than the present." John Broome, cited in Figure 5, fills in some of the details—

The Richer Future
Why discount future goods at all? The goods in question are the material goods and services that people consume—bicycles, food, banking services and so on. In most of the scenarios predicted for climate change, the world economy will continue to grow. Hence, future people will on average possess more goods than present people do. The more goods you already have, the less valuable are further goods, and so it is sound economic logic to discount them. To have one bathroom in your house is a huge improvement to your life; a second bathroom is nice but not so life-changing. Goods have “diminishing marginal value,” as economists put it.

I am more interested right now in Stern's calculation of future economic growth at 1.3%/year than the laudable ethical stance implicit in his choice of a near-zero rate of pure time preference (see my remarks at the end). How did Stern arrive at this growth rate?

Beyond the human preference for the here & now, the stipulation of continuing economic growth is just what it appears to be—it's an a posteriori (experience-based) assumption based on past growth in the 20th century. As Ackerman notes in a longer treatment of the Stern Review, the 1.3% average growth rate is a "plausible" choice among others—

This is not to say that Stern’s specific discount rate is precisely correct; it is hard to be confident of Stern’s 0.1% annual risk of global catastrophe, an admittedly arbitrary estimate. The 1.3% average growth rate of per capita consumption is plausible but far from proven to be correct. A balanced conclusion might be that Stern demonstrates that 1.4% is among the plausible discount rates – and that such low rates have profoundly different implications from rates like 5-6%, used in many other analyses.

Simon Roberts, who is referenced in Figure 3, tells us more about Stern's average growth rate and provides some perspective on the unassailable presumption of continuing economic growth. Here are his informal remarks—

Economic growth. Actually, it’s quite a recent concept, because up until about a hundred years ago, the way that you get more money is by having more people or raising taxes, or invading other countries. It was only about a hundred years ago which is to say, you can actually produce greater value than you need merely for subsistence.

So, the idea of economic growth is comparatively recent. The last century is the economic growth century, really. What it means is that government policy is about encouraging economic growth, without encouraging a rise in prices, which means inflation. That’s the language of what we want governments to do, and the other point about it, it must continue. You can’t question the need for growth. Also, to leave the markets to sort out the appropriate mix between the factors of production, but the market is a way to achieve it and also technology will deliver....

So, let’s just see what the Stern Review, a year old, to see what Stern said about growth. How much should it be? Here’s an extract I found at about page 200, global GDP is around 2.9% on average for the last century. Therefore, projections for growth “to continue at that rate does not seem unreasonable”, and that’s it! That’s the only basis for picking that number 2.9%, but that’s what it says there. I can’t find anymore details about it within the Stern review.

[My note: The actual quote is on page 182 (chapter 7) and reads as follows: "But given that the growth rate of global GDP was around 2.9% per year on average between 1900 and 2000, and 3.9% between 1950 and 2000, projecting world growth to continue at between 2 and 3% per year (as in the IPCC SRES scenarios, for example) does not seem unreasonable." Stern believes we should devote 1%/year of global GDP to mitigating climate, so we get the plausible but arbitrary value of 1.3%/year.]

[My note: My own view is that for almost all people throughout prehistory and human history before the 20th century, a standard assumption was that—outside the occasional disaster—future generations would be no worse off than the present generation.]

Let's sum up.

1. Mitigating climate change or overcoming limits on available fossil energy will require or force massive decreases in CO₂ emissions over the 21st century.
2. Economists assume future generations will be richer than the current one. Stern's estimates economic growth in the 21st century to be 2-3%/year based on an average growth rate of 2.9% in the 20th century. Less the 1% devoted to climate mitigation, he comes up with a "plausible" value of 1.3%.
3. The conservative idea that 2.9% annual growth in the 20th century depended on a steady rise in CO₂ emissions is rejected—this is The Radical Hypothesis. The belief that economic growth is a necessity and will continue is not debatable.
4. The assumption that economic growth in the 21st century growth will take place without an accompanying rise in emissions is justified by the stipulation that technological progress solves all problems as stated in (3) above.

There's a whole lot of assuming going on here. The apparent contradiction is the use of a posteriori reasoning to justify future economic growth (#2), while rejecting such reasoning when evaluating the need for a concomitant rise in CO₂ emissions (#3).

The $64,000 Question

It is far easier to envision shrinking economies in 2009 than it was in 2006 when William Nordhaus was criticizing Stern's choice of a low discount rate in evaluating how much we must invest to fight climate change. Shrinking economies are driving lower emissions now, but it is not hard to imagine that lower emissions might constrain growth in the future. The Conservative Hypothesis (Figure 3) simply extrapolates past trends, and thus does not require a big leap of faith like the Radical Hypothesis (Figure 1) does.

Stern's choice of a near-zero time preference in which future generations are valued as highly as the present one expresses an idealistic ethical stance. In reality, the present generation will always take care of its own needs before seeing to those of future generations. The climate science tells us we must invest heavily now to preserve a high quality of life in the future, but current actions (e.g. the pending Cap & Trade legislation) suggest that preserving something close to the status quo is the path we will pursue. For example, we may follow the less carbon intensive path shown in Figure 1. See my essay The Reign of Error for some discussion.

Will we have economic growth in the 21st century? That's the $64,000 question. I've described the Radical Hypothesis and the assumptions that underpin it. Whether you believe those assumptions will hold up is another matter. The relationship between energy and economy is complex, and I should probably do some kind of follow-up.

But that's enough to chew on today. As newsman Ed Morrow used to say, good night & good luck.

Contact the author at dave.aspo@gmail.com

It's Not Black Or White

2009:H2: [We have] a cyclical bull market as the economy stabilizes and OPEC maintains cuts to draw inventories to 10-year average levels. We are raising our end of 2009 WTI [West Texas Intermediate crude oil] price forecast to $85/bbl from $65/bbl.
   —Goldman Sachs, June 3, 2009

I admit the human element seems to have failed us here.
   —General "Buck" Turgidson, from Dr. Strangelove

Layer upon layer of confusion pervades the discussion of why oil prices have been so volatile over the last 3 years. People often yearn for simple explanations. Some want somebody to blame, while others hold on to cherished theories. In these cases observers demand a Black Or White view of events which caricatures more complex realities.

I was reminded of these tendencies when a friend told me about Matt Taibbi's Rolling Stone article The Great American Bubble Machine. Taibbi trashes Goldman Sachs, accusing them of blowing or taking advantage of one bubble after another—the run-up to the the Crash of 1929, the Tech Stocks (dogfood.com) fiasco, and the Housing Craze. It's a great read and chock full of damning information, at least for those of us who can still concentrate long enough to get through something longer than a 140-character Tweet. 

In the interest of full disclosure, I must admit to a tinge of jealousy here because Taibbi despises Goldman Sachs even more than I do and expresses his contempt so well ^{see note 1}. And of course he writes for Rolling Stone and I don't! But seriously...

My problem with Taibbi's account is his Bubble #4, called $4 A Gallon. I need to quote this at some length.

With the public reluctant to put money in anything that felt like a paper investment, the Street quietly moved the casino to the physical-commodities market—stuff you could touch: corn, coffee, cocoa, wheat and, above all, energy commodities, especially oil. In conjunction with a decline in the dollar. the credit crunch and the housing crash caused a "flight to commodities." Oil futures in particular skyrocketed, as the price of a single barrel went from around $60 in the middle of 2007 to a high of $147 in the summer of 2008...

That summer. as the presidential campaign heated up, the accepted explanation for why gasoline had hit $4.11 a gallon was that there was a problem with the world oil supply.... But it was all a lie. While the global supply of oil will eventually dry up. the short-term flow has actually been increasing. In the six months before prices spiked, according to the U.S. Energy Information Administration [EIA], the world oil supply rose from 85.24 million barrels a day to 85.72 million. Over the same period, world oil demand dropped from 86.82 million barrels a day to 86.07 million. Not only was the short-term supply of oil rising, the demand for it was falling - which, in classic economic terms, should have brought prices at the pump down.

So what caused the huge spike in oil prices? Take a wild guess. Obviously Goldman had help – there were other players in the physical-commodities market – but the root cause had almost everything to do with the behavior of a few powerful actors determined to turn the once-solid market into a speculative casino. Goldman did it by persuading pension funds and other large institutional investors to invest in oil futures – agreeing to buy oil at a certain price on a fixed date. The push transformed oil from a physical commodity, rigidly subject to supply and demand, into something to bet on, like a stock. Between 2003 and 2008, the amount of speculative money in commodities grew from $13 billion to $317 billion, an increase of 2,300 percent. By 2008, a barrel of oil was traded 27 times, on average, before it was actually delivered and consumed.

Hold your horses, Matt! Did you happen to notice that the demand number you cite (86.07 million barrels-per-day) is higher than your supply number (85.72)? I give you Figure 1.

Figure 1 — All liquids data for supply and demand from the EIA from 2007:Q1 (quarter 1 above) to 2008:Q4 (quarter 8). Taibbi quotes the 2008:Q2 numbers (quarter 6).

Demand easily outstripped supply as 2007 wore on, and as oil prices rose, demand started easing as supply strained mightily to rise enough to bring the market into equilibrium in the summer of 2008. There is no reason to think, as Taibbi claims, that oil prices should have been falling while demand still exceeded supply, even if the former was falling and the latter was rising—July, 2008 was the historical peak supply month at 86.653 million barrels-per-day. Finally, after 6 straight quarters in which supply fell short of demand, the market achieved a very temporary balance in 2008:Q3.

Figure 1 illustrates the early stages of the peak oil problem. Production was unable to rise in a timely fashion to meet burgeoning new consumption in the emerging economies (China, India, etc.). July, 2008 was the only time that all-liquids supply ever surpassed 86 million barrels-per-day, and there is a good chance that it will never exceed that level ever again (or 87, or 88, or something in the 86-88 range).

But what about the oil price? Taibbi believes speculators drove prices in 2008:H1 far beyond where they should have been. And he's right! But multiple factors were pushing up the price. What caused gasoline prices to shoot up over $4/galllon is not a Black Or White issue. It was not exclusively EITHER bloodsucking speculation OR supply & demand fundamentals (OR hedging against a constantly falling dollar since 2003). All these problems combined to create a record high of $147 for a barrel of oil on July 12, 2008, and there is a subtle relationship among these factors.

The mature, calm observer see shades of gray and multiple causation. Black Or White thinking is called "primitive" by psychologists. Adults under stress can easily backslide (regress) into mutually exclusive dualities typical of childhood.

When small children are learning to use words and organize their thoughts, it is normal and expected for them to see and express their world in very black and white terms. When a young child feels they are not loved, they feel they must be hated. When a child feels his or her parents don't pay enough attention to them, that child will say, "You never pay attention to me." Developmental psychologists call this primitive thinking.

Unfortunately, under duress, adults often regress to primitive thinking. Adults are most prone to regressing to primitive thinking when they are having a hard time and feel overwhelmed by their own emotions. A regression, in psychoanalytic parlance, is a backsliding from mature functioning and thinking to immature ways of functioning and thinking. For that one moment, when the adult starts relying on the words "always" or "never," and seeing the world in black and white terms, they are slipping back to the way they saw the world as a child.

It is perfectly understandable why we might feel freaked out in 21st century America. Everything is really screwed up—our cliff-diving economy, our unrepentant, bailed-out financial oligarchy, our overwhelming debt, our paralyzed political system, our impoverished state governments, you name it. Writing a diatribe blaming all the world's ills on Goldman Sachs is better than a headlong flight from reality, which is the preferred solution of most Americans. I largely agree with Taibbi: if America is now circling the drain, Goldman Sachs has found a way to be that drain. But Goldman Sachs is not our only problem, not by a long shot.

If we are to have any chance^{note 2} of working our way out of this mess, we must avoid regressive thinking, stay calm, appreciate complexity, and think clearly about the right course of action. I'm going to take a proper look at speculation in the oil market to see what the problems are and what we might actually do about them. It's one big problem among many, I know, but you've got to start somewhere.

Not Everything That Can Be Traded Should Be Traded

Let's start with a mature approach to price distortions in the oil markets. The quote and Figure 2 are from Jeffrey Korzenik's Crude Oil Trading Regulation: A Terrible Idea Whose Time Has Come. He's talking about index speculation made possible by the swaps loophole.^{note 3}

If we’re going to trade crude oil like a currency, we should regulate it like a currency, too.

I hold an apparently quaint and obsolete belief: Not everything that can be traded should be traded. Specifically, there’s great danger in using long-term, long-only commodity futures positions as an investment asset class. The same is true of the derivative baskets of commodities that replicate such futures positions. Please note that I’m not talking about futures funds (which trade both sides of the market and are generally in positions only for the short term), but rather the way that commodities are increasingly being used by pensions, endowments and hedge funds as investments rather than short term speculations; this has sometimes been called index speculation, to distinguish it from the traditional variety.

Investment flows into the futures market can distort the pricing that should instead be determined by producers and users of commodities. Price distortions of this type cause enormous economic inefficiencies, are deeply injurious to the world’s poorest, and create significant structural risk in the markets. The chart below is a good illustration of just how “financialized” energy prices have become... [Figure 2, and I've included a recent snapshot taken June 17th of oil prices in 2009. Click on the image to see a larger version.]

[My note: Long traders are betting on a longer term price rise, whereas those "going short" are betting the price will fall.]

Figure 2 — The trade-weighted U.S. Dollar index (the dashed line) versus the DJ-UBSCI Energy Spot index^{note 4} (the solid line) since the beginning of the year. Korzenik says "as emphasized by the arbitrarily drawn horizontal line, these plots are virtually mirror images of each other (running a regression results in a correlation of -0.88). This corresponds to the type of linked price action we saw during the buildup to the commodity frenzy last year. It’s interesting to note that commodities like gold show nowhere near the correlation (-0.177) with the dollar over this same period. Clearly, the pricing of crude oil and energy products have become dominated by financial, not commercial interests."

Taibbi fixated on price speculation in the run-up to $147/barrel in 2007-2008. Better he should have focused his attention on—he does mention it—the recent rise from an average monthly price of $39.16 for crude oil in February to about $68.00 now during the worst economic downturn since the Great Depression. While some of the price rise might be due to OPEC cuts and stockpiling in China, no data I'm aware of show an increase in demand, or even a definite stabilization of the recent downward trajectory in global oil consumption.

Therefore we must conclude, and it's no secret, that the recent price rise has been due to long-term, long-only community futures positions taken by index traders (e.g. pensions, endowments, hedge funds) using the avenues available to them. Conveniently, the means are furnished by Goldman Sachs, among others. Here is economist James Hamilton writing about how the speculation works on May 17, 2008.

An important recent trend in management of pension and hedge funds is the increasing allocation of investment dollars to commodity speculation. There are lots of ways you can do this. Perhaps the simplest is to purchase, say, the July NYMEX oil futures contract. If you'd bought that contract Friday, it would enable you to take delivery of oil in Cushing, Oklahoma some time in July for $126/barrel. As a pension fund, you don't actually want to receive that oil, so in early June you'd plan on selling that contract to someone else and using the proceeds to buy the August contract. If oil prices go up and you can sell the contract for more than $126/barrel next month, you will have made a profit. By rolling over near-term futures contracts in this way, your "investment" will earn a return that follows the path of oil prices.

The Goldman Sachs Commodity Index is essentially a mechanical calculation of how much money you'd have each day if you followed a strategy like this for each of the major commodity contracts, with energy prices comprising about 70% of that index. There are a number of firms [like Goldman Sachs] that offer products that could implement such strategies on your behalf, such that the dollar value of your investment will essentially follow the GSCI (or similar index) less trading costs and management fees.

Long-only index traders are now said to be hedging against expectations of future inflation, which manifests as a hedge against a falling dollar as shown in Figure 2. Wall Street bankers, who know that short-term inflation expectations are nonsense, are no doubt driving & riding the long wave, as I described in Mr. Market Gets It Wrong Again. Thus Goldman Sachs issues bogus oil price forecasts to keep the ball rolling (like the one in our opening quote at the top).

Taibbi approvingly quotes hedge-fund operator Michael Masters, who believes the influx of index speculators into the oil market has been the sole factor driving up prices since 2003, and was the biggest factor in the price rise from end-2007 until July, 2008 (Figure 3).

Figure 3 — The open-interest (contracts) in oil rose steadily until the end of 2008. The rise was largely due to the influx of index (pensions, endowments, hedge fund) traders. This graph is taken from the Air Transport Association's Energy Matters presentation dated June, 2009. The airline industry is understandably upset about index speculators. Some airlines took a bath when they tried to hedge their risk by locking in forward (6-month) prices at $120/barrel or more. At the time, few foresaw the crash in September. Some airlines were thus stuck with exorbitant oil prices long after the price had fallen below $50.

Masters' position is a caricature of reality. If it's Black Or White, let's call his view the "Black" alternative. He can explain Figure 2 (recent speculation) but he can not explain Figure 1 (the supply & demand imbalance). Nevertheless, the recent price rise strongly suggests that there was speculative froth over and above what the "fundamentals" price should have been in 2008:H1. This premium might have been somewhere in the $25-35 range, as it is today. That would suggest that the "real" price at the top should have been somewhere between $100 and $110/barrel, as I argued in Mr. Market.

The "White" position ascribes the entire upward price movement in 2007-2008 to supply & demand fundamentals. From the June 17, 2009 CNN Money story Obama vs. the Oil Bubble—

Scott Irwin, an agricultural economist at the University of Illinois, says there is little evidence to support the notion that index fund buying is playing a substantial role in the level of commodity prices. "The academic work to date finds no evidence that the massive run-up of commodity prices can be traced to the index funds," he said.

Irwin said a recent study of dynamics in the corn market, where prices spiked last year as well, shows that the rise in futures buying by index funds and other long hedgers was met with increased selling by large commercial interests—the entities that these markets were created to serve.

Back on September, 2008, Hamilton published Scott Irwin takes down Michael Masters at Econbrowser.

My purpose in writing this post is to show that Mr. Masters' bubble argument does not withstand close scrutiny. He first makes the non-controversial observation that a very large pool of speculative money [Figure 3] has been invested in different types of commodity derivatives over the last several years. The controversial part is that Mr. Masters concludes that money flows of this size must have resulted in significant upward pressure on commodity prices, which in turn drove up energy and food prices to consumers throughout the world. This argument is conceptually flawed and reflects a fundamental and basic misunderstanding of how commodity futures and related derivatives markets actually work. It is important to refute Mr. Masters' argument since a number of bills have been introduced in the U.S. Congress with the purpose of prohibiting or limiting index fund speculation in commodity futures and OTC derivative markets.

The first and most fundamental error Mr. Masters makes is to equate money inflows into futures and derivatives markets with demand, at least as economists define the term. Investment dollars flowing into either the long or short side of futures or derivative markets is not the same thing as demand for physical commodities. My esteemed predecessor at the University of Illinois, Tom Hieronymus , put it this way, "for every long there is a short, for everyone who thinks the price is going up there is someone who thinks it is going down, and for everyone who trades with the flow of the market, there is someone trading against it." These are zero-sum markets where all money flows must by definition net to zero. It makes as much logical sense to call the long positions of index funds new "demand" as it does to call the positions of the short side of the same contracts new "supply." 

[My note: Irwin presents other economic fundamentalist arguments in this vein.]

I wonder how Irwin explains away the recent rise in oil prices, an increase which apparently reflects a "financialized" market that does not serve the interests of oil end-users and is almost entirely divorced from supply & demand fundamentals. Given his recent remarks to CNN Money quoted above, I guess he thinks everything is OK and there is nothing to explain. Worse still, his argument that the commodities markets are always in (or only temporarily out of) equilibrium—this is his "zero sum" game—seems to imply that bubbles are impossible in principle!

The key word here is "temporarily." In the longer run, the tail (speculation) does not wag the dog (fundamentals). Bubbles are temporary by definition—they must all collapse sooner or later. But while they are going on—they go on for months at a time—a lot of damage is done to the commercial interests the market is supposed to serve. Why should buyers & sellers of commodities be put at such risk? If you doubt this, just ask Delta Airlines.

The upshot of Irwin's argument is that the skyrocketing price in 2008:H1, the precipitous fall in 2008:H2, and the recent rise in 2009:H1 were all due entirely to supply & demand fundamentals. Like Masters' view, Irwin's position is a caricature which ignores the human—you know, crazy—element in economics, now properly modified to be behavioral economics. See Scientific American's recent article The Science of Bubbles and Busts (July 9, 2009).

It's not Black Or White. But let's go to the heart of the matter. Why speculate in energy (oil)? Why is oil being treated like a currency?

If you've been paying any attention to events in the oil markets over the last 5 or 6 years, you probably "know" four things: 1) economic growth always seems to be accompanied by growing oil consumption; 2) thus, growing emerging economies like China and India are using more and more of the stuff; 3) the price got really high in 2008 and rose for 5 years before that; and 4) there's a persistent rumor about something called "peak oil"—even if you're not quite sure what that actually means. (Does it mean oil production starts declining when half the reserves are gone? or are we Running Out Of Oil?, or some other nonsense?)

If you are a pension fund or an endowment armed with this "knowledge" that oil is really precious stuff, betting that oil prices will rise in the future looks like a sure thing. So we see that Figure 1 and Figure 2 really do fit together, despite what Taibbi, Masters and Irwin say, and despite the mistake index traders are making by going long on oil far too early.

You've got it wrong if you believe that only speculation pushed oil prices up from 2003 to 2008 or only fundamentals drove all the price increase—an existing market disequilibrium between available supply & potential demand gave and still gives legs to speculation in oil. Both factors played a role in inflated oil prices, with supply & demand being the underlying cause—that's what the word "fundamentals" means. It's Black And White. Goldman Sachs is merely a morally-challenged facilitator of short-term price bubbles, i.e. they are the drain we're going down.

There's No School Like the Old School

Speculation causing temporary bubbles in the commodity markets is a bad thing. Unwarranted price distortions & volatility cause needless pain for producers and consumers. I don't know enough about the gory details of how the NYMEX currently works to recommend specific solutions, but I do know this: the "swaps loophole" must closed and "bona fide hedging" exemptions should be repealed. The market should probably work as it was set up in 1936. I agree in principle with Taibbi when he writes—

In 1936, however, Congress recognized that there should never be more speculators in the market than real producers and consumers. If that happened, prices would be affected by something other than supply and demand, and price manipulations would ensue. A new law empowered the Commodity Futures Trading Commission – the very same body that would later try and fail to regulate credit swaps – to place limits on speculative trades in commodities. As a result of the CFTC's oversight, peace and harmony reigned in the commodities markets for more than 50 years.

Depression-era regulation has been repealed over and over again in the last 20 years. You can clearly see where that got us. There's no school like the old school. The derivatives industry is against proposed CFTC changes. That's bona facie evidence that something good might be in the works.

Taibbi describes how Goldman Sachs is preparing to blow or take advantage of a new bubble in the Cap & Trade carbon trading market (Bubble #6, Global Warming). Inflated "asset" values (carbon?) are a likely outcome if the legislation passes. A society that can not define and police its markets properly has no chance of fixing the longer term problems (the oil supply, the climate) that underlie them.

Contact the author at dave.aspo@gmail.com

Notes

1 This is a slide from the American Transport Association (see Figure 3).

Investment banks must issue bullish reports to drive the index investor herd (the Goldman Sachs theme song...)

Rollin', Rollin', Rollin'...

Keep Movin', Movin' Movin'
Though they're disaprovin'
Keep them doggies moving,
Rawhide!

Don't try to understand 'em,
Just rope and throw and grab 'em,
Soon we'll be living high and wide.
My heart's calculatin'
My true love will be waitin',
be waiting at the end of my ride...

Rawhide!

2  A few protests in the streets à la Iran might be helpful too. Americans can't afford to hit the snooze button on the alarm clock anymore. Even if the protests wouldn't accomplish anything, they could still demonstrate that we're awake and watching something other than TV.

3  From the Senate testimony of Michael Masters last summer:

When Congress passed the Commodity Exchange Act in 1936, they did so with the understanding that speculators should not be allowed to dominate the commodities futures markets. Unfortunately, the CFTC has taken deliberate steps to allow certain speculators virtually unlimited access to the commodities futures markets. The CFTC has granted Wall Street banks [like Goldman Sachs] an exemption from speculative position limits when these banks hedge over-the-counter swaps transactions. This has effectively opened a loophole for unlimited speculation. When Index Speculators enter into commodity index swaps, which 85-90% of them do, they face no speculative position limits.

The really shocking thing about the Swaps Loophole is that Speculators of all stripes can use it to access the futures markets. So if a hedge fund wants a $500 million position in Wheat, which is way beyond position limits, they can enter into swap with a Wall Street bank and then the bank buys $500 million worth of Wheat futures.

In the CFTC’s classification scheme all Speculators accessing the futures markets through the Swaps Loophole are categorized as “Commercial” rather than “Non-Commercial.” The result is a gross distortion in data that effectively hides the full impact of Index Speculation.

4  About the Dow Jones-UBS Commodity Index: "UBS Securities LLC has acquired AIG Financial Product Corp's commodity business has of May 6, 2009. As such, the Dow Jones-AIG Commodities Indexes have been rebranded as the DJ-UBSCI effective May 7, 2009." I'm not going to make a big deal out of this; I just thought you ought to know.

A Shale Gas Boom?

But I think you also have to be impressed by the credulity of the people who invested and the desperation and almost the laziness—the lack of due diligence of the people who pumped their money in. I mean, when it comes right down to it, people really don’t know much about this world, and they’re looking for some kind of Virgil to give them a tour through it. And they don’t really do much investigating, and they just—they defer far more to someone like [Madoff] than they would in circumstances where the stakes are much lower
    —David Margolick, a writer for Vanity Fair, speaking on NPR about Bernie Madoff's victims

With the release of the Potential Gas Committee's 2008 year end assessment last week, there was a fresh wave of enthusiasm for replacing oil or coal with natural gas. The PGC, led by Dr. John B. Curtis of the Colorado School of Mines, found a lot of new resources in their reevaluation of potential shale plays.

The Potential Gas Committee (PGC) today released the results of its latest biennial assessment of the nation’s natural gas resources, which indicates that the United States possesses a total resource base of 1,836 trillion cubic feet (Tcf). This is the highest resource evaluation in the Committee’s 44-year history. Most of the increase from the previous assessment arose from reevaluation of shale-gas plays in the Appalachian basin and in the Mid-Continent, Gulf Coast and Rocky Mountain areas...

The Potential Gas Committee reports its gas resource assessments biennially in three categories of decreasing certainty—Probable, Possible and Speculative. For each category, a minimum, most likely and maximum volume is assessed for each of 89 geological provinces in the Lower 48 States and Alaska. The mean values shown in Table 1 below were calculated by statistical aggregation of the minimum, most likely and maximum traditional values for each resource category...

[My note: see the link above to view Table 1. Figure 1 shows the major U.S. shale basins.]

Figure 1 — The major shale plays in the United States, from a report by Navigant Consulting, Inc. for the Clean Skies Foundation sponsored by Chesapeake Energy Corp. (CHK). Some of the biggies in or starting development include the Antrim (#1), Barnett (#3), the Haynesville (#10), the Marcellus (#13) and the Bakken (#2).

If you add up the mean values for Traditional Gas Resources, which includes shale gas, and Coal Bed Methane, you get the 1,836 Tcf of potential resources. If you throw in the EIA's proved reserves, the total resources are 2,074 Tcf in the Lower 48 and Alaska. Curtis explained that his tally represents the ‘technically recoverable’ gas resource potential of the United States. At current consumption rates, the new total represents about 100 years of supply. If speculative resources (500 Tcf) are excluded, we would still have about 75 years of supply.

Suffice it to say that there is little reason to doubt that the potential natural gas resource base in the United States is very large. The hidden problem with such estimates relates to whether the gas is economic to produce, an issue which is outside the PGC's purview.

Let us assume for now that all the gas (2,074 Tcf) that might be there is actually there. Let's further assume that it is indeed technically recoverable and economic to produce at a "reasonable" price, which I will leave undefined. What would we do with the gas?

We have two energy problems in the medium to long term, climate change and peak oil. (In the very long term, all bets are off.) Consequently, shale gas has been proposed as a temporary (a few decades) solution to both. We can—

• use natural gas to replace liquid fuels in transportation, especially as a replacement for diesel in long-haul trucking. This is the (T. Boone) Pickens Plan, which is currently dead in the water. Pickens expressed his excitement about the PGC reports, saying that "the 2,074 trillion cubic feet of domestic natural gas reserves cited in the study is the equivalent of nearly 350 billion barrels of oil, about the same as Saudi Arabia’s oil reserves." Pickens is selling his plan—he knows better than to spout nonsense like this. ASPO-USA commentator Tom Standing did an excellent job of analyzing the energy density issues and practicalities (e.g. compressed natural gas versus liquefied natural gas) of replacing diesel with gas. It would take decades build out the supply chain (e.g. swap petroleum gas stations for natural gas stations). Robert Rapier also wrote an analysis worth reading on this subject.

• use natural gas to replace coal in electricity generation to reduce CO₂ emissions. Dr. Joseph Romm of the influential Center for American Progress is already calling the potential shale gas play a game-changer. The imminently practical idea is to ramp up under-utilized natural gas power generation capacity to replace base-load coal. Geoffrey Styles' analysis Shale Gas and Climate Change provides an excellent overview, so I won't repeat the details here. Even if you don't believe we are going to make an 80% reduction in our emissions by 2050—I don't believe it—official policy is to act as though we are going to do so. We now have the makings of a de facto moratorium on coal (and here). We seem to be unwilling to build new nuclear capacity. It is theoretically possible for wind to provide 20% of our electricity by 2030, but there are many practical, economic & political barriers to success. Thus it would behoove us to switch to natural gas at large-scales if we want to maintain a functioning electricity grid 10-15 years from now. This is my current view, but the political winds could change quickly as the Great Recession grinds on.

If we are at the beginning of a long term shale gas boom, it is clear we can put the gas to good use. But that's a big IF. Before we make a policy commitment to a natural gas future, we must be certain the gas will be there.

Let's return to the real world, a messy place where some potential gas resources may not exist, or may not be economic to produce. Things get complicated here, but don't they always?

Shale Gas Economics

At first glance, increased shale gas production (Figure 2) looks like a textbook case of resource economics. A "new" technology (horizontal drilling & hydraulic fracturing) combined with rising price (Figure 1) boosts recoverable reserves over time.

Figure 1 — The history of natural gas wellhead prices since the 1970s, from the EIA. Volatile prices have increased since about 2002, but have fallen lately during the downturn.

Figure 2 — Increased shale gas production with a risked estimate out to 2018, from a Tristone Capital study (October, 2008)  described in the Oil & Gas Journal's Study analyzes nine US, Canada shale gas plays. These are risked production additions — "the study expects companies ultimately to recover from these resources 261 Tcf of gas, based on various risk factors applied and a long-term average gas price of $8.50/MMbtu. Without the risk factors, Tristone Capital says these shales have a 743-Tcf recovery potential." The Horn River and Montney shales are in Canada, so they don't appear in Figure 1.

Tristone Capital's future production estimate depends on a long-term average price of $8.50/Mcf (per thousand cubic feet abbreviated as Mcf, equivalent to million British Thermal Units, abbreviated as MMbtu). The required price is well over the 15-year average of ~$5.50/Mcf.

What average natural gas wellhead price allows the shale boom to continue? Shale gas economics is a contentious issue. One camp believes that shale gas is economic at—and will keep future prices in—the $5-6/Mcf range. I'll call these analysts the optimists.

The other camp believes the marginal cost of shale gas production is $7-8/Mcf, and perhaps much higher depending on the shale play. These are the pessimists. Let's break down the arguments.

Barclays Capital stock analyst Tom Driscoll is an optimist. On May 27, 2009, Platts quoted Driscoll as saying—

"Conventional gas is being displaced by unconventional gas," Driscoll said and it may take "20 years for natural gas prices to recover."

"The emergence of low-cost unconventional, and especially shale gas, resources may lead to lower than expected natural gas prices for the next five to 10 years," Driscoll said. "Shale -- along with other low-cost unconventional gas -- could provide 75% to 90% of new gas supply over the next several years and set the marginal cost of new supply."

Despite the nearly 50% cut in rig counts since their peak in the fall of 2008, Driscoll estimates that fourth-quarter 2009 gas production numbers will show no decline from fourth-quarter 2008 numbers...

He said he estimated the market will average 4 Bcf/d worth of oversupply this year and 3 Bcf/d worth of excess gas in 2010.

Driscoll said the more productive horizontal rigs are profitable at prices "materially below" $6/Mcf, which just keeps gas flooding into the market even as cash prices plummet.

[My note: Driscoll and others also project that shale gas may provide up to 40% of U.S. supply by 2013.]

This is a very bullish forecast. Despite reduced rig counts, and despite the likelihood that we will have low or average gas prices over the next few years due to the recession and oversupply, the market share of shale gas grows and grows. This forecast looks like a high-wire act that defies not only gravity, but also the laws of supply & demand. One wonders what the minimum price is that makes shale gas unprofitable. $4.50/Mcf? $3.50/Mcf?

Another optimist, Ziff Energy, tells us how much gas is produced from shale now.

Ziff Energy Group forecasts unconventional gas production will supply 53% of US gas needs by 2020, up from 30% in 2000.

Ziff Energy's Shale Gas Outlook to 2020 says shale gas production in 2008 was more than 5 Bcfd (8% of North American gas production), with 70% coming from the Barnett shale in the Fort Worth basin of Texas.

In the future, the report sees increased gas coming from the Barnett, Fayetteville, and Woodford shales as well as many other plays such as the Haynesville, Marcellus, Horn River, Utica, and Gothic. The report expects in 2020 that North America will produce 87 Bcfd compared with 70 Bcfd in 2000.

[My note: "Bcf" stands for billion cubic feet and "Bdfd" is the daily rate. U.S. dry gas production was 20.56 Tcf in 2008. The production rate was 56.33 Bcfd. The U.S. consumes more gas than it produces, getting the rest from Canadian and liquefied natural gas (LNG) imports. Conventional gas production peaked in the 1970's in the United States. New supply from unconventional tight gas (and some coal-bed methane), along with imports, filled the supply/demand gap. As Figure 2 shows, shale gas is a johnny-come-lately on the gas scene.]

The biggest booster is the man who is selling shale gas—Chesapeake CEO Aubrey McClendon.

At Chesapeake Energy's recent shareholder's meeting, Chairman and CEO Aubrey McClendon suggested that the increased use of natural gas would be a way to help the U.S. stop indirectly funding nations that are "declared enemies" and would benefit the environment as well. McClendon said the lack of availability of natural-gas-powered cars in the U.S. is "the most frustrating part of my existence today" and pointed out that General Motors manufactures 12 car models throughout the world that come off of the assembly line ready to run on natural gas, yet there are no such models in the U.S.

McClendon knows how to sing the right notes, but I thought his "most frustrating part of my existence" statement is a bit overdone. What do the pessimists—they would prefer to be called realists—say about all this? And how would optimists respond?

Art Berman, a Houston geologist and columnist at World Oil Magazine, does not believe most shale gas wells are economic unless operator costs go down, gas prices rise sharply, and high average prices are sustained. Talking about the Haynesville in A Long Recovery for Natural Gas Prices, Berman says—

Drilling and completion costs [in the Haynesville] vary from $7.5 to $10.5 million per well. The marginal cost for operators to find and develop natural gas reserves is $7 to 8/Mcf, and current netback prices in the play are less than $3/Mcf. The threshold netback gas price for a better-than-average 5.5 Bcf well to break even is $7/Mcf at NPV10 (Bodell and Pittinger, in press). For companies that have favorable hedge positions, realized gas prices for 2009 will be as high as $6.50/Mcf and $6.00/Mcf for 2010. This means that the play is marginally commercial today for operators with favorable hedge positions, but not commercial based on cost and price fundamentals.

Berman's argument is based on current (and likely future) gas prices, a minimum ultimately recoverable per well, and "all-in" costs of about $7.50/Mcf, not on the impressive initial well flow rates often reported in Rigzone. At current prices, the netback of $3.25/Mcf barely covers operating costs, so no Haynesville well is economic and rates and reserves simply do not matter. Berman's analysis of the Barnett is just as bad—

Shale gas is not commercial at any "reasonable" price because the costs are too high—I once calculated that at ~$12/Mcf only slightly more than 50% of Barnett Shale wells would break even or more money. I am now working on a re-evaluation of the Barnett Shale 11,500 wells later. The average per-well EUR is about 0.6 Bcf—pathetic! The cost is staggering—more than $30 billion and most of it hopelessly non-commercial...

[My note: quoted from an e-mail from Berman. 0.6 Bcf includes vertical wells, about 1/3 of the total drilling in the Barnett play. The average estimated ultimately recoverable (EUR, reserves) for horizontal wells is ~0.75 Bcf.]

But what about our classic case of resource economics? Prices rose (Figure 1) and shale gas production increased (Figure 2). That would seem to belie Berman's pessimism—the proof is in the pudding. What's the problem?

The wrench in the works is that operators appear to have lost money producing shale gas. McClendon recently stated that "we believe that Chesapeake's strong financial condition and extensive hedges provide us with ... [the] flexibility to make prudent natural gas revenue maximization choices." No doubt Chesapeake will try to maximize their revenue, but do they have a strong financial condition? Berman says No—

I have worked through the 10-Ks of most of the major shale players (Chesapeake, Petrohawk, Range Resources, etc.)—they’re all taking a bath financially but put on a brave face, and have huge debt. As long as their stock price is good, the executives get rich so why do they care? The analyst community is so naive about true costs that they believe the propaganda.

[My note: Chesapeake has 14.4 billion in senior debt and their stock price is faring badly. "CEO Aubrey McClendon has come under some well-deserved fire for his high compensation in the face of poor results and a declining stock price. He was paid a one-time $75 million bonus at the end of 2008—suspicious timing given that the stock had lost most of its value in recent months and Mr. McClendon had lost his entire stake in the company to margin calls."]

Most shale operators work on borrowed capital—who is going to lend that kind of money [~$150 billion for the ~30,000 wells required to quadruple shale gas production] to companies like HK [Petrohawk] and CHK [Chesapeake] that are already in debt up to their eyeballs?

[My note: The 10k is a document filed with the SEC that contains ... the same financial statements the annual report does in a more detailed form.]

I entirely agree with Berman's take on things here. There's no dearth of clueless analysts—I've read or listened to more than a few. Berman's deeper point about propaganda is also right on the mark. In the Age of Hype, the Ponzi Scheme and the Swindle, why wouldn't some natural gas companies want to get in on the deal?

Other analysts like Ben Dell, a senior energy analyst at Bernstein Research in New York, are suspicious about corporate reporting of returns on shale wells.

In a March 27 research note, [Dell] notes “a growing discrepancy between the internal rates of return (IRR) presented in corporate presentations and company reported ROACE (return on average capital employed)... For example, in many plays companies claim to generate IRR’s above 100% at $7.50/mcf gas or claim that their production is economical even at $2-3/mcf gas prices, but at the same time report 6-7% ROACE at a corporate level over the last 3 years, when the average gas price was $7.50/mcf.”

Titled “Why the Haynesville Won’t Work…at $4, $5, or $6/mcf gas”, Dell posits that companies are overstating production, understating costs, or there is a terminology gap at work. For example, a producer could say the IP rate of a well (Initial Production) is 8 mmcf/d (million cubic feet per day). But was that a 30 day average, as is normal, or was it a 12 hour average just after coming online. These HD wells can decline in production so rapidly sometimes that for stock promotion purposes, companies issue figures that may have been correct for a short time, but have no context and are not really “best practices” type numbers.

Dell also questions if the all in costs of a well are being amortized properly into the economics that appear in a company’s press release. If the cash operating cost of a well is $3/mcf, which is the number that appears in a release that does not include the $4-7 million it cost to buy the land and drill the hole - costs that Dell suggests basically doubles the breakeven level of the well to $6/mcf. And to get an acceptable return - even to generate enough cash to drill the next well - would be $8/mcf.

Dell's analysis and Berman's are the same in all the essentials. Let's sum up the situation so far—

• Shale gas operators are up to their eyeballs in debt. They would need to borrow vast sums of money—Berman suggests it would take ~30,000 wells and ~$150 billion—to get shale gas up to 40% of total U.S. dry gas production by 2013.
• Shale gas operators can't possibly make money at current natural gas prices, or medium-term future prices if these are close to the 15-year average (~$5.50/Mcf).

The situation is actually worse than our summary indicates. Shale gas wells have very steep decline rates. Consider the Griffith #1 well in the Haynesville as reported at Rigzone.

The Griffith #1 well located in Desoto Parish, Louisiana was completed and brought online in January 2009. The exact reading for total gas produced from the Haynesville shale [Griffith #1] and shipped to market through March 10, 2009 is reported at 568,856 Mcf or .568 Bcf...

The Haynesville Shale play is a new play less than one year old and there is limited data to work with to determine the decline rate for Haynesville Shale wells. [Mainland Resources, Inc.] believes that the recoverable reserves for the Griffith well may ultimately be from 7.5 Bcf to 15.81 Bcf. The 15.81 Bcf rate was determined by a reserve report for the Griffith #1 done by T.W. McQuire & Associates, Inc., prepared pursuant to U.S. Securities legislation. The ultimate recovery was determined by using a type curve that uses 80% decline for the first year, followed by 30% decline for the second year, 15% decline for the third year, and then a 10% decline over the remaining expected life of the well. This decline was derived from the Deutsche Bank report issued in 7/08 based on a study of various shale plays.

[My note: The quoted .568 Bcf is over the first 40 days of operation. Using a type curve to figure declines in the Haynesville may be misleading. Berman's observed decline rates for the Barnett Shale are as follows:

Year 1:  65%;
Year 2:  53%;
Year 3:  23%;
Year 4:  21%;
Year 5:  20%;
Year 6:  17%;
Year 7:  21%

Berman notes that "there is no empirical justification to lower terminal decline rates to 10%/year, and there is no factual  evidence for the declines used in Years 2 & 3 by Deutsche Bank. This is what happens when bankers try to  do petroleum engineering and geology. They have used a model to get these declines but have not bothered to calibrate it against the only shale play in the world with enough production history to it compare to."]

The Griffith #1 well may or may not turn out to be a winner, but the reserves (7.5-15.8 Bcf) seem inordinately large for a shale gas well. Steep declines several years into production, even when there is a high initial flow rate, largely determine what the well reserves will be, which Berman calculated as only 0.6 Bcf on average for the 11,500 wells drilled in the Barnett Shale.

And we only hear about the successful wells, the creme de la creme. It would be unusual to find a story at Rigzone that reads like this—

Desoto Parish, Louisiana -- March 13, 2010

Mainland Resources, Inc. announced today that their Bogus #2 well in the Haynesville showed weak flows in the first few weeks after production began ... Spokesman John Q. Smith said "we probably won't get 0.3 Bcf out of the damn thing... We'll never get our money back." He called the results "very disappointing." ... Smith concluded that "drilling this well was a complete waste of time and money."

When we consider disappointing wells and high decline rates in successful wells, it is clear that getting shale gas up to 40% of U.S. production by 2013 is not only very expensive—$7.5-10.5 million for drilling & completion according to Berman—but also requires poking a lot of very expensive holes in the ground.

One problem with analysts like Tom Driscoll, who is a stock analyst working for Barclays, which is a bank, is that they remember how to add but they've "forgotten" how to subtract. This applies straightforwardly to the shale gas play. The usual human bias, as evidenced in Rigzone stories, is to play up the successes and ignore the failures, as Nassim Taleb pointed out in his book Fooled By Randomness. We see the single entrepreneur who succeeded on TV, but we never hear about the 10,000 who failed. This introduces a significant skew into the data being examined.

I do not mean to make a sweeping generalization. Paul Horsnell, who is an oil market analyst at Barclays, knows what he's talking about.

The optimists' response to all this bad news is summed up by Keith Shaefer's Natural Gas: Costs go down as learning curve goes up. To give the opposition equal time, I will quote it at length.

Operating costs are still coming down in North American natural gas and oil plays. This isn’t showing up as reduced all-in costs on the financial statements of these energy producers just yet, but it will.

Costs are lowering for two reasons. One is demand destruction, which has cut in half the number of rigs drilling for oil and gas in North America. This has meant that rig rates have also dropped—energy executives are saying they see 20%-35% cost reductions year over year. Lower drilling costs have an obvious impact on profitability.

The second is that companies in both the US and Canada are figuring out how to properly frac these new unconventional gas plays—both tight gas and shale gas...

Calgary based securities firm Tristone Capital says wells in the Montney gas play on the BC-Alberta border are now 8-10 mmcf/d [million cubic feet], about twice what they were when the play first started.

... the energy producers are learning how to frac these plays much better, using special mixes of chemicals and water to get the most oil or gas out of these new, very tight reservoirs. It can sometimes take some expensive trial and error on how to get that frac formula right.

Tristone estimates the average break even level of these new shale plays is now hovering around $5/mcf, with the best plays already at $4, and as the learning curve goes up, the cost curve will continue to go down, taking the break even price for natural gas production down with it.

What will likely mask these costs on the financial statements of these companies is the huge land acquisition costs these companies had to pay for these unconventional plays. As an example, British Columbia in Canada has sold their land rights at an average $680/hectare (1 hectare = 2.5 acres) compared to $3511 per hectare over the same time frame in 2008 -- and B.C. has the new Horn River Basin in the north and part of the Montney gas play along the Alberta border. Both 2007 and 2008 saw huge land cost increases across North America as companies rushed in to buy up acreage...

Until some of these high land costs are amortized out, don’t expect to see the “accounting” cost of finding a barrel of oil [gas] -- usually shown as DD&A - Depletion, Depreciation and Amortization—on the balance sheet, to go down much, even though “real” costs are dropping a lot.

So when people ask “Where is all the cheap gas?”, it’s here, and it’s getting cheaper by the month, but it might not show up in the companies’ financial statements for awhile.

It appears Tritone has changed its tune, revising its $/Mcf from $8.50 (Figure 2) to $5. This story says that 1) previous "all-in" costs of $7.50 or more were due to expensive land acquisition; 2) oilfield expenses are declining as rig rates go down; and 3) operators are ascending the learning curve for shale drilling, which lowers costs and boosts reserves & flows. These factors imply that fewer wells will produce more gas due to "more productive horizontal rigs," as Driscoll maintains.

Berman's response?

If shale operators cannot substantially reduce their costs, I doubt that most of them can survive a year or so more of low prices (Barclay's "low camp" $5-6/Mcf) because their marginal cost of production is $7-8/Mcf, much less find $150 billion or so for more unprofitable drilling.  I believe that the cost of services will escalate at a higher rate than cost, and will never drop to meet low price (except for possibly too brief a period for most operators to take advantage of).

Actually the frac costs keep increasing because operators are now commonly using 10-12-stage fracs that cost millions.  Rates are higher but at what cost and for how long?  The key here is that the extra cost may only accomplish a rate acceleration and not an increase in reserves.  In the Barnett Shale, the average horizontally drilled and fractured wells only have ~25% more reserves than vertical wells but 3x the cost!  This talk about lowering operating cost and increasing reserves is more propaganda, and most cost benefit is more than negatively compensated by more interest expense on debt.

Let's sum up.

A Shale Gas Boom?

Will we have a shale gas boom? I've described the contentious argument among those who follow the natural gas industry. Generally, my sympathy lies with skeptics like Art Berman. As someone who has written extensively about peak oil, I've encountered the human proclivity to hype a situation far beyond any semblance to reality time and time again—the Jack #2 discovery in the Gulf of Mexico comes to mind.

Nevertheless, I'm going to say the jury is still out on this one. That's not a cop-out, because the verdict will be in very soon, certainly within the next few years. Art Berman is making specific predictions, just as Driscoll, Shaefer, and Ziff Energy do. Berman surmises that natural gas prices may stay below or in their average range (~$5.50) for a few years based on a host of new factors that include greater availability of tight gas from the Rockies and increased LNG imports. If Berman is right, we will not see large increases in shale gas production through 2011, or some companies will go belly up, or both.

Promoters like T. Boone Pickens and Aubrey McClendon have offered us a Golden Vision of a future powered by natural gas. Their forecasts assume a shale boom that will last for decades. But we shouldn't count our chickens before they're hatched. It costs us very little to take a wait & see attitude on the shale gas boom—we'll know soon enough if it's for real.

Contact the author at dave.aspo@gmail.com

Bad Signs, New Bubbles

Starting with the tulip bulb mania in the 1630s, bubble after speculative bubble has been erased from the popular memory: the South Sea bubble in the early 1700s; the Mississippi bubble, which caused a stock market crash in 18th-century France; the Florida real-estate bubble in the 1920s; the stock market crash of 1929; the stock market crash of 1987; the Nikkei bubble, which began in 1991; and the Nasdaq bubble of 2000 [and now the Housing Bubble of 2006]
    —from Saving Capitalism and Ending Poverty

The speculative bubble always comes to an end--and never in a pleasant or peaceful way
   —John Kenneth Galbraith, quoted in 1999

The rise in oil prices (and commodities generally) driven by speculation that I described in Mr. Market Gets It Wrong Again is now the conventional wisdom among observers who aren't directly vested in blowing a new bubble. The economy is on its knees, but Americans must cope with daily increases in the price of gasoline.

Higher oil prices drive up fuel costs, which dampens consumer spending on other goods.

"People say it doesn't matter until gas gets to $3 or $4 a gallon," said Peter Beutel, an oil analyst at Cameron Hanover. "But every time it goes higher it takes that much more money out of consumers pockets."

Beutel can even tell you how much. For every 10 cent rise in gas price, people can spend $40 million less a day on other things...

"Crude oil prices appear to have been divorced from the underlying fundamentals of weak demand, ample supply, and high inventories," Adam Sieminski, chief energy economist at Deutsche Bank, wrote in a recent note.

So far, so good, but then this CNN Money story takes an odd turn.

The rise in [oil] prices is instead being driven by a falling dollar and investor interest.

A falling dollar is causing oil to rise as investors buy crude as an inflation hedge. Money is also coming out of bonds and other safe haven investments and back into oil, stocks and riskier assets as early signs suggest the economy may be improving.

[My note: The falling dollar/inflation hedge angle is correct.]

While motorists may be miffed to learn that Wall Street is the main driver for the recent run-up in fuel prices, it's probably not such a bad thing that investors are expressing confidence in the economy. Renewed lending and job creation will likely outweigh any pain people may feel from paying higher gas prices.

Whoa, Nelly! Job creation? Renewed lending? This is hogwash. Here's another example from Reuters' James Pethokoukis, who is blogging on money & politics.

"There is a debate going on whether the spare capacity opening up will allow inflation to stay low for a prolonged period of time, but markets don't seem to be buying this view," said Sarah Hewin, senior economist at Standard Chartered.

Markets' inflation fears appear to stem from the potential impact of quantitative easing, as well as the recent slew of positive economic data, Hewin said.

But she added: "We don't buy the view that the extent of QE we have seen will bring a resurgence of inflation -- at least until the end of 2010 and we think U.S. Treasury yields may have backed up too far."

Hewin is probably right to say that a new resurgence of inflation will be delayed until sometime in 2010, but a recent slew of positive economic data? Give me a break!

Although brilliant self-deception allows most of us to get through life, I don't think now is the time to rely on that often helpful quality.

A plausible, albeit unpleasant, view of the future is emerging which explains heightened inflation expectations contributing to bubbly speculation in commodities. Baseline Scenario's Simon Johnson and Peter Boone outline this trend in The Bubble Next Time. I will return to this article, but here is their conclusion.

The balance of global power is shifting. Japan was perceived as a great powerhouse until 1990 — deflation, the lost decade, and demographic decline have ended that. America and Europe both have years ahead of low interest rates, balance-sheet problems, and sluggish growth. Brazil, China, South Korea, Russia and the like used to be called emerging markets; now they’ll be known simply as the New Rich.

This view, if correct, has profound implications for economic conditions in the OECD (developed) nations and future global energy consumption. Let's start with the prognosis for the United States.

Dim Prospects for Consumption

The credit & debt bubble in the United States is unwinding. Many Americans are down for the count, and will likely lie prone on the canvas for some time to come. The economic fundamentals are absolutely clear on this point as shown in the first three graphs.

Figure 1 — The net worth of American households from Calculated Risk, based on data in the latest Flow of Funds Report from the Fed. You can see the bubbles. Net worth has fallen back to a value typical of the period 1987-1995. Will we see household net worth fall to levels last seen in the 1970s?

Figure 2 — Taken from Jobless Recovery Redux? from the San Francisco Fed. Calculated Risk provides data on previous jobless recoveries. Unemployment rose for 15 months after the 1990 recession officially ended. Unemployment rose for 19 months after the 2001 recession officially ended. The official U3 unemployment number is 9.4%, well below recent Blue Chip (and Fed) forecasts. The U6 number, which includes people whose hours have been cut back and those who have given up looking for work, is 16.4%. The current "Great Recession" is far worse than 1990 or 2001. The "jobless recovery" shown is probably too optimistic, but still shows U3 unemployment above 9% in 2012. The San Francisco Fed reports that there are additional reasons for pessimism, for example "[the data] suggests that, more than in previous recessions, when the economy rebounds, employers will tap into their existing workforces rather than hire new workers. This could substantially slow the recovery of the outflow rate and put upward pressure on future unemployment rates."

Figure 3 — Mortgage debt (blue lines) versus equity (red line) from 1945 to the present, taken from T2 Partners' More Mortgage Meltdown. They estimate that house prices must fall another 5-10% before reaching the longer term (Case-Shiller, Lawler) trend line, but typically in a post-bubble period prices fall below the trend line before bouncing up again.

This data represents a small but significant subset of all the trends showing the deterioration of conditions on Main Street. It is easy to reach the following conclusions—

• Growing mortgage debt driving lower household net worth will depress consumer spending in coming years. It will take at least two more years for house prices bottom-out.
• Growing unemployment through mid-2010 combined with high jobless rates thereafter will also depress consumer spending in coming years. Remember, the U6 (all the unemployed and unwillingly underemployed) is now at 16.4% and will likely surpass 20% before the worst is over. Is the Employment Picture Really Better Now Than in 1933? gives an interesting perspective on this problem.

Personal Consumption Expenditures (PCE) made up 72% of 2009:Q1 Gross Domestic Product (GDP, output) according to the preliminary numbers provided by the Bureau of Economic Analysis. It appears that no significant turnaround in consumption is possible before 2012 in the best case. Even if the NBER were to call (in retrospect) an end to the Great Recession in the 2nd half of this year or the 1st half of 2010, GDP growth will be sluggish at best for quite some time thereafter.

What is obvious to me and untainted economists will also be obvious to analysts getting paid to advise Wall Street banks, hedge funds and private equity.

Future Investments In the United States?

It is hardly an exaggeration to say that when the dust settles, Too-Big-To-Fail Finance will be in better shape than any other segment of our economy. The Treasury (with Congressional approval) and the Fed have paid off (socialized) the bank losses and guaranteed bailouts on future losses. Quantitative easing makes their product—money—dirt cheap. If you can obtain money at little or no expense to yourself and then lend it out at higher rates of interest, the future looks very bright indeed.

There is no compelling reason to believe the trends shown in Figure 4 will not continue after the Great Recession ends.

Figure 4 — Financial profits share of GDP versus debt as a percentage of GDP. T2 Partners made this graph based on Federal Reserve and BEA data as of 2007:Q2. The debt line (red line) may flatten out a bit but is unlikely to decrease. The recent disruption of financial profits (black line) is temporary. Bank losses were covered by the Treasury and the Fed. The remaining banks will be stronger than ever.

When the downturn bottoms out, the banks will be flush with money made available by the Federal Reserve. Quantitative easing and deficit spending will continue because tightening interest rates or cutting government spending would put us back into the Great Recession, Phase II. Our debt will continue to be backed by the Chinese, Japan, oil exporters and many others for the time being. Paul Krugman is urging policymakers to stay the course, and I believe they will.

The rationale of Paulson, Summers, Geithner & Company for saving the banks—we will foster a recovery by getting credit flowing again to over-leveraged consumers—looks like a cruel hoax when viewed in light of fundamental data shown in Figures 1-4. And continuing the spending spree, wherein we borrow from the future to provide artificial lift to the present, is ultimately a Disaster of Biblical Proportions—one can easily imagine a day when 50% of government expenditures go toward interest on the debt, but that's not my main focus today.

Getting back to Big Finance, the only remaining question for them is: where will they invest all that cash? It won't be in the United States.

Many parts of the American landscape resemble a burnt out husk. Take commercial real estate (New York Times, June 8, 2009)—

Talk of American infrastructure tends to focus on inadequacies: roads that need to be repaired or widened, bridges fortified, electrical grids updated. All the more striking, then, that America’s retail infrastructure — its malls, supercenters, big boxes and other styles of store-clumping — has come to be characterized by rampant abundance. This has been a decades-long trend. But it has taken the economic downturn, with chain stores liquidating, mall tenancy slipping and car dealerships scheduled for closure, to focus popular attention on the problem with our retail infrastructure: there is too much of it.

A recent book, Retrofitting Suburbia, by Ellen Dunham-Jones and June Williamson, notes that in 1986, the United States had about 15 square feet of retail space per person in shopping centers. That was already a world-leading figure, but by 2003 it had increased by a third, to 20 square feet. The next countries on the list are Canada (13 square feet per person) and Australia (6.5 square feet); the highest figure in Europe is in Sweden, with 3 square feet per person.

Allow me to repeat Figure 5 from my article Let It Burn.

Figure 5 — FIRING UP the economy. From Calculated Risk’s early report on government stress testing for banks. Note the relative size of residential mortgage + home equity + commercial real estate + credit cards (taken together) as opposed to commercial/industrial loans. The numbers cited are for potential losses, but the absolute sizes can be calculated by using the loss numbers and the percentages.

As with overbuilt commercial real estate, making large future investments in residential mortgages, home equity, and credit cards amounts to throwing good money after bad. Let's return to Simon Johnson and Peter Boone's thesis of a great economic shift in from West to East and South.

The Bubble Next Time

The new credit & debt bubble will take place in Asia, South America and "even Africa."

The next global bubble is already under way. What happens when the most powerful nation in the world, with a reserve currency everyone trusts and holds, decides to push a big credit expansion — again, at the instigation of our financial sector? The creditworthy borrowers this time are not in the United States — they are in Asia, Latin America, and even Africa. They have little debt and great prospects; for a mere 1 percent per year they can borrow American dollars, spend the funds at home, and turn paper money into real assets. Every great bubble begins with a truly convincing shift in fundamentals.

In the 1990s this was called the “carry trade.” You borrowed from the Japanese at 1 percent and bought anything outside Japan that yielded a bit more (including United States subprime mortgages). The coming American carry trade is the same thing: it weakens the dollar, lifts the economy out of recession through exports, and creates inflation that reduces the real value of our debts. This can last quite a while — both the Treasury and the Fed are sure that early attempts to tighten policy prevented serious recoveries in Japan in the mid-1990s and in the United States toward the end of the 1930s.

I could quarrel with the idea that the American "carry trade" will "lift [our] economy out of recession through exports" but the rest—a weakened dollar, inflating away the debt—looks right.

I keep wondering what it is we will export. Software? No, we export software jobs. Cars and auto parts? That part of our shrinking manufacturing sector just took a huge hit. Caterpillar excavators and pipe layers? Probably, yes. Semiconductors, pharmaceutical preparations, and telecommunications equipment? Yes. Farm (food) exports? Yes, again.

But is all of this enough to turn sluggish growth into prosperity? A weakened dollar makes imports more expensive, which reduces them. The same inflated dollar encourages exports. But without a massive infusion of new investment in America's manufacturing base, there are limits on how much our exports can grow. Will these investments get made? (I discussed the importance of exports/imports for the U.S. economy in Real GDP and the Oil Shock of 2007-08).

Mostly, the United States will export credit.

The new bubble remains in its formative stages because the global economy is still in terrible shape, as detailed in Martin Wolf's The recession tracks the Great Depression (Financial Times, June 16, 2009). As the emerging economies crawl out of the muck created by the collapse of the Housing Bubble and the Oil Shock, banks on Wall Street, in London, Switzerland, and Paris, in Tokyo, in Dubai or Singapore, and offshore in the Caymans will be able & eager to provide inexpensive dollars to emerging economies to get them back on a rapid growth track.

Johnson and Boone conclude—

Perhaps this is the greatest foreign-aid package of all time. But are we [in the United States] re-establishing our global leadership, albeit in a strange way, or just throwing all pretense to strategic leadership out the window? And are we laying the foundation for a truly massive international debt crisis?

We're not re-establishing our global leadership, that's for sure.

A Dress Rehearsal

From Main Street's point of view, the current "rally" in oil prices and the S&P 500 is a lot of hot air. The alleged "green shoots" benefit monied interests in New York.

Fed officials take comfort in other developments in financial markets. Though mortgage rates have risen, many other private-sector borrowing rates are coming down. For example, the London interbank offered rate [LIBOR] -- the rate at which banks make short-term loans to one another -- has declined. Rising stock prices are also helping improve financial conditions and bolster household wealth.

"Conditions in a number of financial markets have improved since earlier this year," Mr. Bernanke said last week in testimony to Congress.

I'm sure families who are losing their house—they can't refinance now because of the rise in mortgage interest rates—will be overjoyed to hear that the LIBOR interbank lending rate has declined. Reporters at CNN Money and other fish swimming in the Wall Street water pick up the "green shoots" theme and mindlessly repeat it. I heard one CNBC commentator say he wished consumers would join the rally and spend more money! 

Life is pain, and anyone who tells you different is selling something.

Simon Johnson recently posted a Five Point Summary of where we stand. Items #4 and #5 are of interest here.

4. The consensus from conventional macroeconomics is that there can’t be significant inflation with unemployment so high, and the Fed will not tighten before late 2010.  The financial markets beg to differ – presumably worrying, in part, about easy credit leading to dollar depreciation, higher import prices, and potential commodity price inflation worldwide.  In all recent showdowns with standard macro models recently, the markets’ view of reality has prevailed.  My advice: pay close attention to oil prices. 

5. Emerging markets are increasingly viewed as having “decoupled” from the US/European malaise.  This idea was wrong in early 2008, when it gained consensus status; this time around, it is probably setting us up for a new bubble – based on a “carry trade” that now runs out of the US.  The ”appetite for risk” among investors is up sharply.  The G7/G8/G20 is back to being irrelevant or merely cheerleaders for the financial sector.

I do pay close attention to oil prices, and being somewhat knowledgeable about them, I believe a purely speculative play must collapse. To be successful, a bubble must be grounded in reality. You can't have a Housing Bubble if nobody wants houses. You can't have an oil price shock if demand for the stuff is about 4 million barrels-per-day below capacity.

The price may not crash all the way down to $25/barrel as I said in Mr. Market, but come August and September, the blue skies of Spring will give way to the storm clouds of Fall.

Along with Simon Johnson, I believe easy credit (aka. quantative easing) will eventually lead to "dollar depreciation, higher import prices, and potential commodity price inflation worldwide." But not yet. It's illuminating to observe the religious war that has broken out among economists.

Something akin to a religious war has erupted among economists on the next move for the Fed. One camp worries that higher long-term interest rates could choke off the recovery. As a result, they argue the Fed should ramp up its purchases of Treasuries to push rates lower. Others think rising rates are a clear signal that the market is worried about inflation. They want the central bank to check out of the Zero Interest Rate hotel as soon as possible.

To counter the financial crisis, the Fed has raised new reserves for the banking system to almost $900 billion by purchasing all sorts of assets, including toxic mortgages, from the banks. Some economists think these reserves are inflation-rocket-fuel.

Others argue that the reserves are not really money because they are not being used. They think the reserves could be drained before spilling over into the market.

"The Fed is not printing money and passing it out on the street corner so it jingles in everyone's pocket," said Jim Glassman, senior economist at JP Morgan Chase.

[My note: No kidding, Jim. Note to Helicopter Ben: send some of that money our way!]

"There is almost a semi-religious view that money, in-and-of-itself, causes inflation," said Bill Cheney, chief economist at John Hancock Financial Services, in Boston. "Money, sitting it a bank as excess reserves, won't do anything. Half of the problem with the economy now is that consumers aren't doing anything with it," Cheney added.

[My note: Why do you think consumers aren't doing anything with it, Jim? And also, the last time I checked earlier in this article, consumer spending was 72% of GDP.]

The markets don't believe "excess reserves" ($900 billion) parked at the Federal Reserve will be "drained" without being loaned out. I can't take this outcome seriously either. Americans trying to repair balance their sheets don't need more credit, but perhaps would-be consumers in Morocco, Malaysia, Chile, Egypt, Brazil and India might be able to put it to good use.

Nevertheless, commodity traders pricing in their expectations about inflation are doing so too early. Indeed, such trading is self-fulfilling because bidding up oil contributes to inflation. The state of the global economy does not justify bidding up oil.

We are now witnessing a dress rehearsal for The Bubble Next Time. The current commodity inflation foreshadows the real thing, which I expect to begin in earnest next year or the next. Finance types are chomping at the bit to blow a new bubble—Simon Johnson called this a heightened "appetite for risk." Our outsized banking sector, which has been the beneficiary of so much government largess and lack of regulation, will have free rein in this matter.

Johnson notes that "emerging markets are increasingly viewed as having decoupled from the US/European malaise." He believes this is an illusion that will foster the carry trade bubble. It is an illusion, but here's the bottom line for the longer term—

The pain for Asian economies, means they have to rethink the old model of "Asians make it, Americans buy it," and start boosting domestic consumption, Masahiro Kawai of the Asian Development Bank (ADB) Institute said last week.

"This pattern (of US consumption propping up Asian growth) is rapidly changing and I believe that this change is not simply a temporary phenomenon. It is going to be more permanent, or at least semi-permanent," Kawai told a seminar held by the Association of Southeast Asian Nations (Asean).

"Asia should remain the factory of the world, but Asians have to start consuming more. Asians have to start spending more," he said.

The historical convergence is nearly perfect. Finance must find new places to invest, but the United States, Europe and Japan are tapped out. The Asians and others must kick old habits and boost domestic consumption. It's a marriage made in Heaven. On a normal development path, it would take decades for emerging economy markets to reach the size of those in the developed world. The Big Banks can step in to "speed up" the process if they can persuade emerging economies to drink some of the bubbly. I don't think it will be a hard sell.

Assuming the Bubble Next Time thesis is correct, where does that leave us? We will eventually get inflation rates over and above the 1-2% currently priced in. Burgeoning consumption in emerging economies will cause commodity prices to soar again as they did in the period 2003-2008:H1. The sky will be the limit for a barrel of oil. The United States economy will remain in the doldrums for many years. This is a worst of both worlds scenario. We hope for the best, but in 2009, why shouldn't we expect the worst?

Oh, by the way, did I forget to mention that we are now living in the peak oil era? That is definitely going to make all this a lot more "interesting" than it already promises to be.

Contact the author at dave.aspo@gmail.com

Peak Oil = Peak Demand?

I think it would be a good idea
   — Mahatma Gandhi, when asked what he thought of Western Civilization

Captain Renault: I'm shocked, shocked to find that gambling is going on in here!
Croupier: [hands Renault a pile of money] Your winnings, sir.
Captain Renault: [sotto voce] Oh, thank you very much.
   — Casablanca

Yesterday a news item appeared on the front page of this website with the headline "CERA Official Acknowledges “Peak Oil is Here”. Unfortunately, this report was a little premature.

Speaking at the Center for Strategic & International Studies (CSIS) in Washington DC on 8 June, CERA Global Oil Group Managing Director Jim Burkhard began and ended his talk by stating that “CERA acknowledges that peak oil is here, you heard it from a CERA person.”

[My note: Burkhard spoke at CSIS's  Transforming The Transportation Sector: Energy Security, Climate Change And Transportation meeting.]

What could this be about? I looked further, downloading the audio for the meeting (mp3, large file, Burkhard is introduced at 1:14:20). The CERA official began his presentation like this—

[There are] two things I'm going to talk about. One, peak oil and how peak oil has arrived. And two, share an idea about how the low cost electric car, especially in Asia, could be a long-term game changer.

First, peak oil. Peak oil has arrived. We at CERA do believe peak oil has arrived. Some of you who are familiar with CERA's work may find that surprising. Ah, but not at all. Let me clear up some confusion. You may think I'm talking about peak oil on the supply side, the thought that we've reached a geological point where we've produced more than half the world's oil. And we could have a day-long debate on that particular perspective on peak oil, but the peak oil I'm talking about is peak oil in transport fuel demand for light-duty vehicles ... peak oil demand in the United States and Europe. We've reached it...

Thanks for clearing up my confusion, Jim. For a minute there things got a little topsy-turvy for me.

What about this "peak demand" view? Like Gandhi's view of Western Civilization, I think it would be a good idea. If only life were that simple. Here is Burkhard's sole presentation slide.

Figure 1 — The CERA view of long-term U.S. gasoline demand. "Slower Growth in Fleet Miles and Greater Fleet Efficiency." This forecast pertains to "light-duty vehicles" only (no long-haul trucks, backhoes, tractors, et.al.).

Burkhard speaks to why CERA expects peak demand for petroleum gasoline in the United States.

One, the biofuels mandates. Two, the lower growth in VMT (vehicle miles traveled). Since 2005 it's been flat... [VMT declined in 2008 and is declining so far this year] ... This is a trend that we haven't seen in many, many years, and it happened before the depths of the recession...

Another factor is  the fuel economy legislation. That's having a real impact, again it takes time for this to filter through... we don't change the transportation paradigm overnight. We certainly don't expect that, but the fuel economy legislation will have a big impact in the long-term.

And lastly the Great Recession is intensifying these trends. We hope that this is a temporary influence... [then he shows Figure 1].

[My note: Burkhard then goes on to say that U.S. gasoline demand (in barrels-per-day) is still larger than China's entire consumption. He also says Europe has reached peak demand. I didn't—couldn't—listen to the whole thing. Mea Culpa.]

These remarks are based on CERA's report Drivers Turn the Corner in the United States released on June 19, 2008. Oil prices were soaring at the time. Such prices were seen as triggering a long-term shift toward fuel efficiency.

Though the current U.S. economic slowdown explains some of the decline in gasoline demand, long-term shifts in consumer behavior that began as much as two years ago in response to high prices are the key drivers to lower demand, the report says.

[My note: I can't read the report without paying for it. It costs the usual 1000 bucks, I suppose.]

After the economic meltdown in 2008:Q3, oil (and gasoline) demand and prices in the United States fell dramatically. Thus in early 2009 a spate of stories appeared proclaiming that peak demand had arrived.

CERA is whistling past the graveyard because it is very likely that we really are in the post-peak oil era (my column, February 19, 2009). The view that non-OPEC production has peaked is now going mainstream (Wall Street Journal, May 4, 2009).

Raymond James notes that non-OPEC oil production apparently peaked in the first quarter of 2007, and given precipitous falls in oil output from Russia to Mexico, there’s not much hope for a recovery. OPEC production—and thus global output—peaked a little later, in the first quarter of 2008, Raymond James says.

Analysts at Barclays and Deutsche Bank, among others, see falling non-OPEC output in future years, but CERA is still holding out, saying they "saw no immediate non-OPEC fall." (Reuters, April 1, 2009). On March 27, 2009 Reuters reported—

Lower oil prices, which have fallen around 65 percent from record highs last July, have put at risk around 7.6 million barrels per day of new planned oil capacity by 2014, [CERA] said.

Lower investment prospects prompted CERA to revise its global oil production capacity outlook to 101.4 million barrels-per-day for 2014, versus a "pre-collapse" forecast last year that capacity would grow to 109 million barrels-per-day by 2014.

Current EIA data puts world oil (all liquids) supply at 83.86 barrels-per-day in May, 2009. OPEC's crude oil spare capacity is set at 4.34 million barrels-per-day, which yields a total of 88.2 million for world liquids capacity. CERA's downward revision would thus require the world to add 13.2 million barrels-per-day of capacity between now and 2014.

This outlook might fly in Disney World, but it is clearly impossible in the Real World. This leaves CERA with a public relations problem. Not only must they disavow their fantasy forecasts, but they must also explain away the fact that the oil production will probably never exceed its July, 2008 peak.

CERA must have been thinking really hard in the first half of 2008 about how to spin the fact that global demand was growing but supply could barely rise to meet it. And then it must have come to them like a bolt from the blue—peak demand! This is an ingenious solution. The oil supply doesn't have to grow anymore because we don't need it to. World oil production capacity doesn't matter anyway. We can acknowledge peak oil without acknowledging peak oil.

And so in June, 2008 when things looked bleak for the oil supply, CERA issued its report Drivers Turn the Corner in the United States. CERA knew, as many of us did, that demand would surely collapse with prices over $140/barrel and stay down for a long, long time.

Jim Burkhard's talk describes the latest version of CERA's peak demand story. This narrative should hold up over the next few years as actual global demand remains below capacity. Eventually increased oil demand in the emerging BRIC economies (Brazil, Russia, India, China) and the Persian Gulf will overwhelm any efficiency gains achieved in the OECD. Gasoline demand in Japan, the United States and Europe will rise again, but may not reach previous levels. Unemployment (and under-employment) will be very high in the United States for some time to come. Japan and Europe are still reeling. And so on.

When CERA's peak demand story eventually fails, they will need to change their tune again. For now they've got some breathing room. Sometime after 2011, when 2007-08 global oil demand levels reappear, CERA will go back to saying that geopolitical "above ground" factors (Chavez’s Bolivarian socialism, chaos in Iraq, unrest in the Niger Delta, under-investment in the Persian Gulf) are holding down the oil supply. They’ve got to blame somebody—what else can they do?

A VERY Brief Rebuttal

You will find a summary of current American oil policies in my Obama Tackles the Liquid Fuels Problem (with many additional links, ASPO-USA, May 28, 2009). This article includes almost all the information  you need to evaluate Burkhard's peak demand remarks and Figure 1, including an analysis of new CAFE standards and our prospects for oodles of ethanol by 2030. Figure 2 is the only thing I have to add.

Figure 2 — Taken from the Union of Concerned Scientists' Running Out of Gas. You can see that the rate of growth of gasoline consumption slowed for a while when CAFE standards were first introduced. Consumption then started rising again because 1) greater efficiency makes driving cheaper and 2) standards were not toughened after the mid-1980s. The former is related to Jevons Paradox (i.e. the rebound effect).

Future gasoline consumption in the United States depends on the design & implementation of specific policies affecting it and general economic conditions. There is considerable uncertainty about both. It is not enough to present Figure 1 and tell a simple peak demand story as Burkhard did, but CERA's real mission is not to make accurate assessments.

Marketing Is Everything

The triumph of sales over substance is nearly complete in the United States. CERA, which is a subsidiary of IHS Energy, is selling reports at $1000 a pop, consulting services, whatever. Let's not kid ourselves. To that end let's listen in on the IHS, Inc. F408 (Qtr End 11/30/2008) Earnings Call.

Moving now to our consulting business [including IHS CERA], it continues to be soft yet profitable. It accounted for 8% of our fourth quarter revenue and was down 24% organically compared to last year. A slight uptick in the percentage of total revenue represented by our consulting business is reflective of the addition of Global Insight. If you look at just the legacy IHS business and exclude IHS Global Insight, consulting represented 6% of total revenue for Q4...

To be clear we remain committed to our consulting business and we have seen modest improvements in our pipeline at IHS CERA and continue to focus on larger individual consulting opportunities. Lastly as we get into the back half of 2009 we also will have the benefit of more favorable year-over-year comparisons. Finally the remaining product offerings are grouped into the other category.

This category includes events and conferences like CERA Week coming up in February...

Success in sales depends on telling a happy story and walking the corridors of power. CERA, with its highly visible chairman Daniel Yergin, is adept at both. The peak demand story is a winner. Talking a good game makes all the difference Inside The Beltway.

People concerned with the economic problems attending peak oil—myself included—have labored under the mistaken assumption that winning an argument with CERA about the world's upstream exploration & production prospects matters. I don't think it matters at all, at least not as far as CERA and the Powers That Be are concerned. If CERA is making money and telling a good story, and they are, they are winning as far as IHS is concerned. The peak demand story maintains the status quo, so everybody in our Nation's Capital is happy too. Win-win.

Putting down a loosely organized group of peak oil activists—the phrase "loosely organized" overstates the case—was worth the risk for CERA back in 2006. Peak oil is not good for business.

CERA's win-win story promotes complacency in the face of an upcoming & ongoing catastrophe, but in 21st century America such obvious truths seem beside the point. The United States is now structured like the CBS television show Survivor—it's every man for himself in this game. The current economic crisis didn't pull us together. We've seen that Wall Street will do just about anything to aggrandize itself at Main Street's expense, and Washington helps them do it.

Having voted myself off the island—or did I get voted off?—some time ago, I can speak freely about what's happening. But CERA successfully plays the insider game. CERA may whistling past the graveyard, but I doubt they care as long as sales are brisk.

I am genuinely sorry that things have come to such a pretty pass in the United States. But that's just the way it is as far I can see.

Contact the author at dave.aspo@gmail.com

The Decline of the American Empire

[T]he decline of Rome was the natural and inevitable effect of immoderate greatness. Prosperity ripened the principle of decay; the causes of destruction multiplied with the extent of conquest; and, as soon as time or accident had removed the artificial supports, the stupendous fabric yielded to the pressure of its own weight. The story of its ruin is simple and obvious; and, instead of inquiring why the Roman empire was destroyed, we should rather be surprised that it had subsisted so long.
    —Edward Gibbon, from the Decline and Fall

Perhaps you have noticed a common theme in my recent columns. Each policy proposed to solve our economic, oil or climate problems I have examined has a fatal flaw, and often more than one. New initiatives always seem dead on arrival.

Cap & Trade is not likely to be enacted but if it is, the law would raise energy costs while making only token CO₂ emission reductions as in Europe. President Obama put forward a proposal to think about, not build, an expanded passenger or freight rail system in the United States. A "harmonized double standard" for increased CAFE fuel efficiency mandates that cars average 39 miles-per-gallon by 2016, which probably translates to 29 miles-per-gallon in EPA bureaucratese.

On the economic front things are the same. Change we can believe in quickly morphed into a doomed attempt to return our flawed banking system to business as usual. As the Fed and the Treasury continue to bail out the banks, Arianna Huffington tells Tech Ticker's Aaron Task that

... the [Obama] administration is avoiding the big problems [in finance]...Tim Geithner and Larry Summers were creatures of Wall Street... [and they] are like people who still believe the world is flat. They see everything revolving around the Earth and in their case that's Wall Street. That's not good if you're producing maps to navigate.

Even if we require a functioning financial system to speed any "recovery" we might get, few are thinking about what those banks will invest in after our economy bottoms out. More McMansions in the exurbs? More shopping malls? Who will buy these houses miles from nowhere? And then fill up the GMC Yukon to shop at Saks and eat at the Cheesecake Factory? Some over-leveraged consumers will gas up & go, but most will not, at least not as frequently as they used to. People need to pay down their debt as they try to hang on to their low-paying jobs. Our FIRE economy (Finance, Insurance, Real Estate) will try to blow another bubble, but we're quickly running out of quality assets whose value we can inflate.

The theme that unites our flawed responses to economic and energy problems is futility, defined as

1. The quality of having no useful result; uselessness.
2. Lack of importance or purpose; frivolousness (unworthy of serious attention)

We can not seem to escape futility's vicious circle.

Figure 1 — As problems become more intractable over time, our resistance to making real changes to confront those problems, our social inertia, becomes more entrenched. Thus the solution to debt-based economic problems is more debt. The solution to liquid fuels problems is marginally more fuel efficient cars, not alternatives to driving. We study an expansion of the rail system instead of building it to provide an actual alternative to flying or driving between cities. We dream of hypothetical biofuels in the far-off future to solve an oil supply problem in the here & now.

Salon's Andrew Leonard quotes Kevin Phillips, whose book Bad Money has the subtitle "reckless finance, failed politics and the global crisis of American capitalism."

Bingeing on debt is reckless, and financialization has a long record of being a dangerous late stage in the trajectory of previous leading world economic powers. Moving money around instead of making things is always dicey, and the U.S. transformation has been the most grandiose to date...

Money is "bad," in the historical sense, when a leading world economic power passing its zenith -- before the United States, think Hapsburg Spain, the maritime Dutch Republic (when New York was New Amsterdam), and imperial Britain just before World War I -- lets itself luxuriate in finance at the expense of harvesting, manufacturing, or transporting things. Doing so has marked each nation's global decline. To institutionalize the dominance of minimally regulated finance at this stage of U.S. history is a bad idea.

[My note: Phillips wrote this before the meltdown in 2008:Q3. "finance at the expense of ... manufacturing" — look at Figure 2.]

Figure 2 — From Mark Perry at Seeking Alpha. On June 1, 2009 General Motors entered Chapter 11 bankruptcy (more below). Say goodbye to Pontiac, Saturn and Saab. GM will sell the Hummer division.

Phillips is talking about the Decline of the American Financial Empire. When our society "luxuriates in finance at the expense of harvesting, manufacturing or transporting things," we cling to the status quo instead of acting to solve the problems confronting it. We dig our heels in, our inertia grows stronger. The problems (too much debt, too little oil) do not go away. Unattended to, they get worse, as do the eventual consequences of inaction.

All my recent articles on the economy or energy describe futility.

Futility manifests itself in several ways, including—

• paralysis or indecisiveness
• frivolousness, money-seeking at the expense of others ("greed is good")
• the triumph of wishful thinking (unfounded hope or fantasy) over substance
• political in-fighting and corruption
• passivity or apathy

I'll tell a few stories to illustrate three of these ubiquitous signs of decay.

Indecisiveness

Upon assuming his duties as the Secretary of the Department of Interior (DOI), Ken Salazar extended the review period of President Bush's midnight plan to expand offshore drilling from 60 to 180 days. The Washington Post's Plan, Baby, Plan described the policy change—

Mr. Salazar's 180-day extension of the comment period is the first of four actions that he says will give him "sound information" on which to base a new offshore plan for the five years starting in 2012. He has directed the Minerals Management Service and the U.S. Geological Survey to round up all the information they have about offshore resources within 45 days. This will help the department determine where seismic tests should be conducted. Some of the data on the Atlantic are more than 30 years old.

The secretary will then conduct four regional meetings within 30 days of receiving that report to hear testimony on how best to proceed. Mr. Salazar has committed to issuing a final rule on offshore renewable energy resources "in the next few months"...

[My note: There's no final rule yet.]

Mr. Salazar's announcement was also notable for what it didn't do. Much to the chagrin of some environmental advocates, it didn't take offshore drilling off the table. Nor did it cut oil and gas interests out of the discussion. That's as it should be.

The new DOI Secretary's wish-washy attitude toward offshore drilling appears to have been among his most important qualifications for the job. He's not for offshore drilling, but he's not against it either. Salazar's announcement was notable for what it didn't do and nothing would happen before 2012 in any case. That's how it should be opined the Washington Post. Salazar then trotted off to meet the public in Atlantic City, New Orleans, Anchorage, and San Francisco to get some expert opinions.

Surfers splashed with organic chocolate "oil spills" and environmentalists dressed as jellyfish and furry polar bears gathered in San Francisco on Thursday and gave a theatrical message to Interior Secretary Ken Salazar: Don't start new drilling off California's coast.

Undoubtedly a bunch of people drove to the meeting, did their jellyfish/furry polar bear thing for Salazar's benefit, and then drove home. You can't have it both ways—either stop driving or start drilling. Make up your mind, do something, Mr Secretary. Tienes huevos!

As we further deplete our oil reserves, our lethargy on new drilling turns into paralysis. Efficiency gains lowering our fuel demand will be offset by future production losses. Our dependency on imported oil, which now stands at 64% of our consumption, will not go away. The problem will become more acute as we compete with China and other emerging markets for barrels. Yet we do nothing as we make a desperate, last ditch attempt to preserve Happy Motoring.

Frivolousness

Investors hoping for immediate hefty returns are now speculating in stocks and commodities in the midst of the biggest economic downturn since the Great Depression (Figure 3).

Figure 3 — Four Bad Bears posted by Calculated Risk from dshort.com. There has never been a stock market rally like this one in a slumping economy (bear market) that is still months away from hitting bottom.

General Motors filed chapter 11 bankruptcy on Monday this week. The move portends the further loss of tens, probably hundreds, of thousands of jobs for autoworkers, dealers and parts suppliers. What happened that day? The Dow Jones went up 221 points. The oil price jumped $1.77 per-barrel as it surged past the $68 mark. Bloomberg reported Crude Oil Rises to Highest Since November on Manufacturing Gain. Manufacturing gain?

Crude oil rose to the highest level since November as China’s manufacturing expanded and U.S. industrial output shrank less than forecast, signaling that fuel demand may increase...

[My note: Oh, I see. The manufacturing gain was in China!]

“We’re certainly on our way to $70, if not $75,” said Stephen Schork, president of Schork Group Inc. of Villanova, Pennsylvania. “That seems to be the number everyone is talking about. Given the technical momentum in this market, you cannot bet against it and step in front of this train.”

Technical traders watch for patterns on charts for clues to price direction, and may sell or buy based on those signals...

“Investors are hopeful that the economy will be buoyant during the second half of the year, which will lead to increased crude-oil demand,” said Michael Lynch, president of Strategic Energy & Economic Research, in Winchester, Massachusetts. “There are also hopes for a strong driving season.”

The peak U.S. gasoline consumption period lasts from late May’s Memorial Day holiday until Labor Day in early September, as Americans take to the highways for vacations... Gasoline for July delivery rose 2.9 cents, or 1.5 percent, to end the session at $1.9243 a gallon in New York, the highest settlement since Oct. 9.

“As we get into the $70 to $75 range, we’re going to be talking plus-$3 gasoline by the end of the summer,” Schork said. “If you’re going to tell me plus-$3 gasoline is sustainable in this economy, then kudos to you. I just don’t believe it.”

[My note: I described the current speculation in oil in Mr. Market Gets It Wrong Again. I described how traders who are all doing the same technical analysis act in concert to drive the price up or down in The Price Is Not Right.]

Bullish stock and oil moves on the day General Motors filed for bankruptcy were frivolous—these are not signs of an economic comeback.

What should be taken seriously is the orgy of escalating fuel costs that will accompany the recent spike in oil prices. Only a few traders will make money from these price movements, but everyone else will suffer. Investors are hopeful of a strong summer driving season? As they drive up gasoline prices for cash-strapped Americans amidst the worst economic downturn in 75 years? The price increase was based on a flimsiest of indicators, a slight decrease in China's Purchasing Managing Index.

Figures from the state-sanctioned China Federation of Logistics and Purchasing yesterday said that its Purchasing Managers' Index (PMI) fell slightly to 53.1 from 53.5 in April, but given that any number above 50 represents growth, it still marks an increase in output and orders.

At best speculators in oil are rationalizing sociopathic behavior by citing mediocre Chinese manufacturing numbers while U.S. industrial output shrinks less than expected. At worst they all think they're Gordon Gekko. Excessive speculation (gambling) by investment banks, regular banks, hedge funds, pension funds, and the rest got us into this economic mess. What is the answer to the problem of excessive speculation? More speculation of course!

Gambling neither reflects nor signals green shoots in our economy. The only possible outcome of running up oil prices would be to squash an incipient recovery should one appear. This behavior reveals a society that can't regulate its markets properly, a society where oil prices are not related to supply & demand and stock prices are not related to a company's earnings. If we no longer pay heed to poor fundamentals, speculation reflects futility.

Wishful Thinking

Consider the recent rise in the Conference Board's Consumer Confidence Index (and Figure 4).

The Conference Board Consumer Confidence Index™, which had improved considerably in April, posted another large gain in May. The Index now stands at 54.9 (1985=100), up from 40.8 in April. The Present Situation Index increased to 28.9 from 25.5 last month. The Expectations Index rose to 72.3 from 51.0 in April.

Figure 4 — Consumer Confidence since 1978. From Jim Puplava's Financial Sense. The "Present Situation" Index (blue) remains at a low level not seen since 1992 and 1982.

The Consumer Confidence Survey™ is based on a representative sample of 5,000 U.S. households. The monthly survey is conducted for The Conference Board by TNS. TNS is the world's largest custom research company.

Consumer expectations are getting better. That's good for spending, right?  MarketWatch took note in Consumer confidence, or consumer hope?

They call it "consumer confidence," but the numbers released Tuesday by the Conference Board might better be pegged as "consumer hope." There's a big difference, namely that confidence translates into spending, while hope is just a good feeling.

The Conference Board's measure of consumer confidence was up 35% from April, the fourth-largest jump in the 32-year history of the index. The move left consumer confidence in positive territory at 54.9, the highest it has been in eight months. The gain was far bigger than economists expected.

Consumers clearly believe the worst is behind this economy and the market, when it's not clear at all to the experts that the U.S. can avoid another leg down -- or worse -- en route to a broad-based recovery.

Consider that there was a big increase in the percentage of consumers expecting the economy to generate new jobs, despite no evidence that the current economy can actually achieve that.

Consumers expect inflation at a rate north of 5%, even though government numbers have been showing price deflation; that disconnect should undermine confidence. And while rising gas prices were cited as dampening confidence in 2008, consumers appear to be ignoring the action in gas prices now.

More consumers are now expecting the economy to start generating jobs, whereas most economists believe it will be late 2010 before the jobs numbers become positive. More consumers expect hyperinflation north of 5%, whereas the current numbers put future inflation at 1-2%. Where do these unfounded hopes or expectations come from?

Eric Janszen at Tulip took a close look at consumer confidence (aka. sentiment) after the Conference Board's latest survey. You would think confidence would correlate with job prospects, right? It does not. Consumer confidence follows the stock market! Specifically, sentiment corresponds to the Dow Jones Industrial Average (DJIA).

Figure 5 — Consumer Confidence versus the Dow Jones Industrial Average (DJIA) since 1998. Janszen's comment: "Except for a brief period in 2005 and 2006, consumer sentiment and the DJIA strongly correlate. Rising unemployment starting in early 2007 overwhelmed the DJIA as the key consumer sentiment driver; consumer sentiment peaked in early 2007 before the DJIA peaked late in the year. The DJIA and consumer sentiment declined together during the recession so far, since late 2007, until recently when the DJIA and consumer sentiment re-connected."

Janszen believes "the DJIA index is used by the FIRE Economy financial media [e.g. CNBC] to sell the current state of the economy [to consumers or investors]... The DJIA has virtually no economic significance compared to the broad stock indexes such as the S&P index and the NASDAQ that have many times the capitalization of the DOW." In a related development, bankrupt General Motors and insolvent Citigroup were dropped from the Dow index on June 1st. They were replaced by Cisco Systems and Travelers, respectively. That should improve consumer expectations considerably!

Bullish speculation in stocks bolsters consumer confidence based on ... nothing at all. Confident consumers are seen as prone to spend more money, which begets bullish speculation. Many Americans think the worst is behind us. They expect a wave a new jobs to appear any day now. This is wishful thinking.

The fundamentals of our vaporous economy are terrible. This speculative frenzy doesn't change the sorry state of Main Street. It's just a lot of hot air on Wall Street, which is trying to re-inflate stock prices. This new equities bubble (Figure 3) is like some bizarre Wheel of Fortune—round and round it goes, where it stops nobody knows.

All this behavior is utterly futile if our goal is a sound economy & recovery.

I could tell stories like this all day long, touching on political infighting, corruption or undue influence up and down the Wall Street-Washington corridor, or the docility of our passive citizenry brought about by 30 years of consumer training. I would run out of time long before I ran out of material.

Everything—I mean every single thing—is broken, including health care costs & coverage, the energy markets, the economy as a whole, public education, physical infrastructure, insurmountable deficits at the local, state and Federal levels, etc.

Can We Put Humpty Together Again?

Humpty Dumpty sat on a wall,
Humpty Dumpty had a great fall.
All the king's horses,
And all the king's men,
Couldn't put Humpty together again
   —A Nursery rhyme

Is there any hope? I'm talking about real hope, not the daily barrage of pernicious nonsense that passes for serious discourse in the United States. No radical transformation of our society will occur unless we can overcome our social inertia. We would need to get serious, escape futility, do real things again.

The first step would be to acknowledge what a sorry state we're in. Speaking with Bill Moyers back in September, Kevin Phillips didn't think soon-to-be President Barack Obama would level with the American people about how bad things are. If the President indeed understands the depths to which we've sunk, he has not come clean with us—you don't rock that boat.

History suggests that we will not be able to put Humpty Dumpty together again. Imperial greatness reaches an apogee and then follows a downhill trajectory. We had it good once, but now we cling to old dreams—like Rome, we prop them up with Edward Gibbon's artificial supports—instead of confronting unpleasant realities. The old vitality is gone. In the United States we carry out studies explaining why the cost of nuclear power is prohibitive. The Chinese build nuclear power plants. 

America is like an Obsessive-Compulsive who has lost his keys and keeps looking for them in the same drawer over and over again. We never tire of making the same mistakes, believing that "More Is Better" without acknowledging that it was this kind of flawed thinking that got us into this predicament in the first place.

Here's what Paul Krugman said about California, which is a complete mess.

California, it has long been claimed, is where the future happens first. But is that still true? If it is, God help America...

What’s really alarming about California, however, is the political system’s inability to rise to the occasion...

... and you have to wonder if California’s political paralysis foreshadows the future of the nation as a whole.

Don't worry about it, Paul. The future looks like California just as it always has. As Gibbon said of the Romans, prosperity ripened the principle of decay, the causes of destruction multiplied and eventually the stupendous fabric yielded to the pressure of its own weight.

In the near future I'll get back to writing about our futile efforts to put 1 million plug-in hybrids on the road by 2015 and similar fantasies. And if I'm alive in 20 years, I'll write another article called The Decline & Fall of the American Empire.

Contact the author at dave.aspo@gmail.com

Obama Tackles the Liquid Fuels Problem

All that is human must retrograde if it does not advance.

It is easier to deplore the fate, than to describe the actual condition, of Corsica

The principal conquests of the Romans were achieved under the republic; and the emperors, for the most part, were satisfied with preserving those dominions which had been acquired by the policy of the senate, the active emulation of the consuls, and the martial enthusiasm of the people
    — Edward Gibbon, selected quotes from The Decline And Fall of the Roman Empire

Today I'll try to explain President Obama's policy for decreasing oil consumption in the United States. Right now the administration has so many balls in the air that it is impossible to make a definite statement about what the effects of their initiatives will be, but a coherent policy is emerging if you gather all the pieces together. I compile a list Obama's policies at the end of 2nd section below.

To round out the picture we need to look at the new fuel economy standards and some special provisions in the Cap & Trade bill. Environmentalists are running this show, so all proposed changes are aimed toward fixing global warming. Aside from tailpipe (among other) emissions, oil is seen strictly as a geopolitical problem—we do not want to import increasing amounts of the stuff from unreliable evil-doers like Venezuela, Libya, Nigeria, or even our "friends" the Saudis.

In light of ongoing oil depletion and supply-side destruction following from the global economic downturn, it appears that the Democrats are simply rearranging the deck chairs on the Titanic. (I am quite sure the Republicans would do worse, given the chance.) However, we are not in a position to evaluate President Obama's policies unless we understand them. We should also remember that the President inherited these problems after decades of inaction.

A Tale of Two Standards

On May 19, 2009 President Obama announced proposed rule changes for greater fuel efficiency for cars and light trucks. The President said—

In the next five years, we're seeking to raise fuel-economy standards to an industry average of 35.5 miles per gallon in 2016, an increase of more than eight miles per gallon per vehicle. That's an unprecedented change, exceeding the demands of Congress [set by H.R. 6 in 2007] and meeting the most stringent requirements sought by many of the environmental advocates represented here today.

As a result, we will save 1.8 billion barrels of oil over the lifetime of the vehicles sold in the next five years. Just to give you a sense of magnitude, that's more oil than we imported last year from Saudi Arabia, Venezuela, Libya, and Nigeria combined. (Applause.) Here's another way of looking at it: This is the projected equivalent of taking 58 million cars off the road for an entire year.

A series of major lawsuits will be dropped in support of this new national standard. The state of California has also agreed to support this standard -- and I want to applaud California and Governor Schwarzenegger and the entire California delegation for their extraordinary leadership. They have led the way on this as they have in so many other efforts to protect our environment. In addition, because the Department of Transportation and EPA will adopt the same rule, we will avoid an inefficient and ineffective system of regulations that separately govern the fuel economy of autos and the carbon emissions they produce.

[My note: Obama's statement was often misinterpreted to mean we will save 1.8 billion barrels of oil in the next 5 or 7 years. It is over the lifetime of vehicles sold between 2011 and 2016.]

The 1.8 billion barrel savings Obama refers to comes from this Notice of Upcoming Joint Rulemaking to Establish Vehicle GHG Emissions and CAFE Standards issued by the Department of Transportation (DOT) and the Environmental Protection Agency (EPA).

Preliminary analysis indicates cumulative greenhouse gas reductions of approximately 890 million metric tons (CO2 equivalent) and fuel savings of approximately 1.8 billion barrels of oil, over the lifetime of the model years covered.

The problem with the "preliminary analysis" is that we don't have the formulas used to calculate the oil and emissions savings, so we can't see the embedded assumptions. For greenhouse gases, the U.S. emitted 7.2 gigatons CO₂e (carbon dioxide equivalent) in 2005. The purported savings are 12.3 % of the 2005 total, which is substantial and suspiciously large. For example, what is the presumed turnover rate (Figure 1) for the car fleet? In other words, how many new more fuel efficient vehicles are Americans going to buy between 2011 and 2016?

Figure 1 — The always helpful Calculated Risk graphed the turnover rate of the American vehicle fleet back in March. He said "currently this ratio is at 26.8 years, the highest ever. This is an unsustainable level (I doubt most vehicles will last 27 years!), and the ratio will probably decline over the next few years. This could happen with vehicles being removed from the fleet, but more likely because of a sales increase."

Calculating fuel savings or reduced emissions is very sensitive to the level of consumer spending on big ticket items. It looks like policymakers are assuming new car sales over the next 7 years will be very brisk indeed. But sales are very hard to project, especially with our longer term prospects for economic growth in jeopardy. If income levels are low, or unemployment looms, people will be reluctant to take on 5-year car loans. The additional cost of a new car or light truck will be $1300 on average in 2016, which also discourages purchases.

Sales are also very sensitive to gasoline prices. If gas prices are high and consumers are convinced they will stay that way, purchases of fuel efficient cars will increase. Thus calculating benefits involves making assumptions about gas prices and the longer term price elasticity of gasoline demand. White House officials expect gas to be $3.50/gallon in 2016.

The real savings from fuel efficiency is in gallons of gasoline but the quoted number is in barrels of oil. A problem arises when we do the conversion between barrels and gallons to figure out the savings. There are 42 gallons in a barrel, but a refined barrel of oil usually nets anywhere from 18 to 21 gallons. Using an energy equivalence conversion, a barrel of oil is the same as 50.4 gallons of gasoline. We don't know which (if any) of these numbers were used. The United States consumed 7.55 billion barrels of oil in 2007 and 142.35 billion gallons of gasoline.

Perhaps coincidentally, Douglas Adams' supercomputer Deep Thought said "42" was the "answer to life the universe and everything" in The Hitchhiker's Guide to the Galaxy.

In analyzing the new fuel efficiency rules, I am sorry to tell you things go rapidly down hill from here. There are actually two standards, one from the DOT and one from the EPA. When you buy a car, the window sticker displays the EPA mileage number. This is the real world number, an approximation of the miles-per-gallon you will actually get. The CAFE number is higher than the EPA number, so it does not reflect your expected mileage. This is why President Obama was careful to point out that "the Department of Transportation and EPA will adopt the same rule." If only things were that simple.

The Joint Rules document describes the "harmonized dual standard"—yes, I know this phrase makes no sense. The EPA's head Lisa Jackson has proposed the first-ever CO₂ emissions rule for cars and light trucks.

EPA and NHTSA [DOT] intend to propose two separate sets of standards, each under their respective statutory authorities. EPA expects to propose a national CO2 vehicle emissions standard under section 202 (a) of the Clean Air Act. EPA currently is considering proposing standards that would, if made final, achieve on average 250 grams/mile of CO2 in model year 2016... NHTSA expects to propose appropriate related CAFE standards.

Technical work conducted by each agency over the last several years indicates that there is a wide range of technologies available for manufacturers to consider in upgrading vehicles to reduce GHG emissions and improve fuel economy. These include improvements to the engines such as use of gasoline direct injection and downsized engines that use turbochargers to provide performance similar to that of larger engines, the use of advanced transmissions, increased use of start-stop technology, improvements in tire performance, reductions in vehicle weight, increased use of hybrid and other advanced technologies, and the initial commercialization of electric vehicles and plug-in hybrids. Although many of these technologies are available today, the emissions reductions and fuel economy improvements under consideration for the proposal would be expected to involve more widespread use of these technologies across the fleet...

Initial evaluations by EPA and NHTSA indicate that utilization of this suite of technologies provides a strong technical basis to proceed with consideration of a proposal containing MY [model year] 2016 GHG standards that would on average achieve 250 gram/mile CO2. If the automotive industry were to achieve this CO2 level all through fuel economy improvements, this would equate to achieving a fleet average level of 35.5 mpg.

So far, so good? Senior editor John O'Dell of edmonds.com explains the double standard.

One of the few secrets that Washington has managed to keep is that the fuel efficiency numbers politicians toss around when discussing the "corporate average fuel economy," or CAFE, standard are not the same as the EPA fuel efficiency numbers that  journalists and most everyone else use when discussing mileage and that consumers have been trained to look for when shopping for a new car...

While the new federal fuel economy program announced by President Obama this week sets 35.5 MPG as the federal fuel efficiency standard for 2016, it doesn't necessarily  mean there will be a lot of cars and trucks in the market seven years from now with window stickers that boast of 35.5-miles-per-gallon fuel economy.

In the real world - or as real as we can get - the cars and trucks on dealers' lots are still going to be wearing EPA fuel economy labels. And it [currently] only requires an EPA rating of 29 miles per gallon for a passenger car to equal the CAFE rating of 39 MPG, while 23 MPG on the EPA scale equates to the truck segment's CAFE standard of 30 miles a gallon...

Finally, there's no requirement that consumers use the CAFE numbers when shopping for new vehicles. Except for the higher fuel costs of a less-efficient vehicle - and the potential of reduced resale value - there's no penalty for buying a 15 MPG truck or 24 MPG car just because the CAFE standard for each type of vehicle is higher.

If a car can be certified for a CAFE rating of 39 MPG now with an actual (EPA) mileage of 29 MPG, will a similar disparity still exist in 2016 after the new rules are implemented? That's the $64000 question. Does 250 grams of CO₂ per mile really raise the EPA number to a fleet-wide average of 35.5 MPG? Or will the real world EPA standard be lower as it is now?

O'Dell tells us positive side of things if the new rules still reflect the double standard.

On the plus side, we're talking about a 30 percent increase in average fuel economy from today's standards, and setting it is a coup for the administration because it marks first time automakers and environmentalists have lined up with the government and agreed in advance to support a CAFE increase.

Revisiting the oil calculation, is the 1.8 billion barrels savings based on "meeting" a bogus CAFE standard (39 MPG for cars, 30 for light trucks) in 2016 or an EPA real world standard that could be (much) lower? Time and bureaucracies will tell, but I suspect the former. 

If the rules are harmonized at an actual 35.5 MPG, the automakers will not have enough time to meet the new fleet average. Here are Kevin Bullis' comments in MIT's Technology Review along with the relevant statement from the Joint Rules document—

The plan doesn't give automakers much time. Only a few cars--hybrids--meet these standards today, and it can take 5 years to develop a new car. The good news is that technology exists to achieve these standards, and automakers are already planning on rolling out much of it.... But ramping up production will take time. [from Technology Review ]

With respect to technological feasibility, during MYs 2012-2016 manufacturers are expected to go through the normal automotive business cycle of redesigning and upgrading their light-duty vehicle products (and in some cases introducing entirely new vehicles not on the market today). The proposal under consideration is expected to allow manufacturers the time needed to incorporate technology to achieve GHG reductions and improve fuel economy during the vehicle redesign process This is an important aspect of the proposal under consideration, as it would avoid the much higher costs that would occur if manufacturers needed to add or change technology at times other than these scheduled redesigns. [from the EPA & DOT Joint Rules]

We don't see automakers clamoring for more time. (Chrysler and GM are on the dole, so they can't protest anything.) Their acquiescence is prima facie evidence that EPA's real world mileage numbers will be lower than the CAFE number as O'Dell contends. There is an air-conditioning loophole affecting emissions but not fuel efficiency. (See the Joint Rules document.) There are also numerous credit loopholes.

Many current cars and trucks already have EPA fuel economy ratings that "meet" the 35.5 MPG CAFE standard. But if vehicles sold in the United States really had to achieve a fleet average of 35.5 in 2016, only a few hybrids like the Prius would be in compliance today.

Will the automakers have to achieve a real world 35.5 MGP average in 2016? Probably not. The clincher is that these rule changes are only in the early proposal stage.

Today, auto industry officials applauded the president's effort to bring together a wide range of stakeholders to hammer out what one trade group described as "broad outlines of an agreement."

"What's significant about the announcement is it launches a new beginning, an era of cooperation [between NHTSA, EPA and California]," said Dave McCurdy, president of the Alliance of Automobile Manufacturers, a trade group representing Detroit's Big Three, Toyota Motor Co. and other carmakers. "The president has succeeded in bringing three regulatory bodies, 15 states, a dozen automakers and many environmental groups to the table. We're all agreeing to work together on a national program."

We have broad outlines of an agreement between 3 regulatory bodies, 15 states, a dozen automakers, and many environmental groups. Sounds like a done deal to me!

When did everything get so complicated? Diminishing marginal returns from added complexity speeds the Decline And Fall of the American Empire.

The Hidden Gasoline Tax

The oil & gas industry is unhappy with the proposed Cap & Trade legislation. It is easy to see why.

The Waxman-Markey bill is making just about every segment of the oil and natural-gas industry unhappy. Oil refiners would be hit, because they would likely be among the largest buyers of emissions allowances. In addition to covering their own emissions, the refineries that turn crude oil into gasoline, diesel and other fuels will be responsible for the carbon emissions from transportation.

That puts the industry on the hook for some 44% of U.S. carbon emissions, according to the American Petroleum Institute, but it would receive just 2% of the emissions allowances available under the bill. Refiners would have to buy the rest at auction or on the open market.

By comparison, the electricity sector, which accounts for about 40% of U.S. CO2 emissions, would receive 35% of the allowances, with other industries such as cement, glass and paper manufacturers getting 15% of the free permits.

"The distribution of these credits is out of line with the actual distribution of emissions," said Amy Myers Jaffe, associate director of the Rice University Energy Program.

Refiners will only get 2% of the emission allowances up front, which will force them to buy many additional permits on the carbon market. These purchases will raise overall costs for refiners considerably. By contrast, the electricity sector—49% powered by coal—will get 35% of the allowances, so this sector's need for additional permits is much smaller. The Houston Chronicle's Loren Steffy knows a fuel tax when he sees one.

The government would allocate just 2 percent of the emission allowance permits to the refining industry. The cost of buying all those extra permits would get passed on to motorists, making cap-and-trade a thinly disguised gasoline tax...

It’s been portrayed as a free market solution, but with all the manipulation before the first permit has even traded, it doesn’t resemble anything close to a market.

And it darn sure won’t be free.

Technology Review, like most commentators, missed the hidden gasoline tax which is embedded in the Cap & Trade legislation.

Also, convincing consumers to buy enough of the most fuel efficient cars to make up for other people buying larger cars will be difficult. Gas taxes have helped meet a similar fuel economy standard in Europe. A proposed system of government fees and rebates could also help, and might be more palatable to consumers than raising gas prices.

Both the proposed EPA rule change for vehicle emissions and the Cap & Trade legislation must be considered together to see how the Obama administration's liquid fuels policy works. An additional piece called "Cash For Clunkers," which is also currently embedded in Cap & Trade, provides rebate incentives to trade in your gas guzzler for a more efficient model.

Under Sen. Diane Feinstein’s [D-CA] bill, S. 247, old cars that qualify for the program must be drivable, registered in the United States and have a “when-new” fuel economy rating of less than 18 miles per gallon. New vehicles must have a fuel economy rating that exceeds federal targets for that class of vehicle by at least 25 percent and a manufacturer-suggested retail price of less than $45,000 and be a model year 2004 or later.

Initial estimates set the cost of the program between $1 billion and $2 billion a year. Feinstein’s bill envisions the program lasting for four years and encouraging the retirement of up to 1 million vehicles a year, while ultimately saving between 40,000 and 80,000 barrels of motor fuel a day.

In the first year of such a proposed program, a person trading in a vehicle that is model year 2002 or later would be eligible to receive $4,500 for purchase of a new vehicle, $3,000 for purchase of a used vehicle, or $3,000 for transit fare credit. For model-year vehicles 1999 to 2001, drivers would get... [etc.]

I am now in a position to sum up the Obama administration's policies for tackling the liquid fuels problem in the United States. This summary is based on my previous research as published in this space and publicly available information.

All measures are geared toward reducing greenhouse gas emissions to mitigate climate change. Reducing or replacing oil consumption to reduce our dependency on foreign oil is presumed to follow from emission reduction policies in all cases. Oil depletion is not a motivating factor in any Obama policy. Here's the list—

• Increased vehicle fuel efficiency as Dr. Chu wants, starting with strengthening of the EPA/CAFE rules as described above. Efficiency is supposed to save 1.8 billion barrels of oil during the lifetime of the cars sold between 2011 and 2016. The Union of Concerned Scientists estimates that the U.S. will save 1.4 million barrels-per-day by 2020 based on the new timetable. I do not know how either of these calculations were done, including the assumptions used for real world mileage, car sales, etc. So considerable uncertainty exists about what the real savings will be.
• A gasoline tax imposed by severely limiting emission allowances to oil refiners in the Cap & Trade legislation combined with a short-term "Cash for Clunkers" rebate program. The latter is supposed to save between 40 and 80 thousand barrels-per-day during the program's lifetime.
• Thinking really hard about expanding the passenger/freight rail system in the United States.
• Giving some serious thought to 4th Generation biofuels which might or might not be available 20 to 80 years from now. Funded R&D is ongoing.
• Setting a goal to get 1 million plug-in hybrid vehicles on the road by 2015. Since these vehicles do not exist because the batteries aren't ready, $2 billion has been provided for battery R & D. (I haven't written about plug-ins yet.)
• 15 billion gallons of corn ethanol by 2015 as required in the Energy Independence and Security Act of 2007. We already had 9 billion gallons in 2008.
• Proposed tax changes that discourage new drilling and marginal oil production in the United States. 18% of American production comes from stripper wells.

I might add (only half facetiously) the additional "policy" spelled out below.

• Incessant prayer asking God to provide some advanced biofuels (cellulosic ethanol, algae-based liquid fuels, etc.) at price-competitive commercial scales sometime before the the heat death of the Universe or The Rapture, whichever comes first.

I believe this policy list is comprehensive and up-to-date. If you are a regular reader of this column, you know that I believe Cap & Trade will not become the Law in the United States. Regarding CAFE standards, many uncertainties must be resolved and obstacles overcome before we'll know what the actual policy and its effects are. Proposed tax changes discouraging new drilling and stripper well production have not yet been enacted. Accelerating production declines is not a wise policy, but accords with the climate change imperative.

If I'm right about Cap & Trade, that leaves us with 1) some improved fuel economy and 2) a little more corn ethanol. Everything else is hand waving. Obama's policies form a coherent whole, but taken together are inadequate to meet the coming liquid fuels crisis.

A Final Thought On Fuel Efficiency

I'm sure many of you know that Gallons Per Mile (GPM) is the right way to measure fuel efficiency (Figure 2).

Figure 2 — The actual Gallons-Per-Mile function used by the Department of Transportation for CAFE and its graph. Formula from James Kwak at Baseline Scenario, graph from the journal Science.

The GPM function demonstrates that you get far more bang for the buck if you curtail sales of gas guzzlers. Efficiency improvements have less and less effect at the high end. Despite these real world considerations, the Joint Rule document says—

Under a footprint-based [standard, each manufacturer would have a GHG and CAFE standard unique to its fleet, with a separate standard for passenger cars and light-trucks, depending on the footprints of the vehicle models produced by that manufacturer. Generally, manufacturers of larger vehicles (i.e. vehicles with larger footprints) would face less stringent standards (i.e., higher CO2 grams/mile standards and lower CAFE standards) than manufacturers of smaller vehicles. While a manufacturer’s fleet average standard could be estimated throughout the model year based on projected sales volume of its vehicle fleet, the standard of compliance would be based on the final model year sales figures. A manufacturer’s calculation of fleet average emissions at the end of the model year would be based on the sales-weighted average emissions of each model in its fleet.

[My note: the footprint is defined as "a vehicle’s wheelbase multiplied by its track width --in other words, the area enclosed by the points at which the wheels meet the ground."]

The government's matter-of-fact statement belies the important point that manufacturers of larger vehicles should face more stringent standards than they probably will in 2016 in order to maximize fuel savings (or reduce emissions). One might even go so far as to propose that SUVs or light trucks not used for business purposes be phased out over time or heavily taxed like cigarettes. We lived happily without these gas guzzlers before the 1990s, so why do we need them now? Such a policy would demonstrate that President Obama's expert team is truly serious about reducing our dependency on foreign oil. Politics precludes this sensible proposal.

I must confess that examining government fuel economy rules is not an intellectually rewarding activity. Reading my analysis and conclusions is surely tiresome as well. But our world is made up of such stuff. It is far easier to deplore the American Empire's lamentable condition than it is to describe it. Congratulations if you got this far—your painful journey is at an end.

Contact the author at dave.aspo@gmail.com

Mr. Market Gets It Wrong Again

Now do you want to hear some real bullishness? Crude has fallen so far, so fast, that we could see a snap-back rally drive it to $62 … $77 … heck, even $90 is possible!
    — Sean Brodrick, from How You Can Trade the Current Volatile Oil Market (March 25, 2009)

Once again the price of oil is in La La Land. Today the price of NYMEX light sweet crude surged past $62/barrel. My best guess based on the supply & demand fundamentals is that crude should not be trading a penny over $35/barrel right now. In a justified fit of pique last December I wrote The Price Is Not Right, which attempted to get to the bottom of why oil prices move up or down. Today's essay is Not Right, Part II.

I now believe oil has not been priced "correctly" for the last 34 months going back to about July, 2006. Occasional exceptions crop up because even a broken clock tells the right time twice a day. Why does Mr. Market get it wrong over and over again?

Green Shoots Raise the Oil Price?

GDP in the European Union shrank 2.5% in 2009:Q1. It was down 4.6% year-over-year. Recent Wall Street Journal reports included these observations.

Investors helped drive up oil prices in recent weeks, pulling their money out of cash and putting it into hard assets such as crude oil as they anticipated imminent economic recovery and a weaker dollar -- and were willing to stomach more risk. Oil futures briefly topped $60 a barrel in trading Tuesday on the New York Mercantile Exchange for the first time since November, before falling back to close at $58.85, up 35 cents. Oil prices are up 73% since bottoming out at just under $34 in February.

The [EU GDP] data followed on from fresh downward revisions to global oil demand from three agencies this week, with the latest from the International Energy Agency Thursday warning that oil demand recovery will be sluggish and remains some way off.

"I think realization is starting to hit home that everything isn't all right," a London-based crude oil trader said. "The recession is still on".

[My note: It's starting to hit home that something's Not Right? What was your first clue?]

Oil demand strength can be viewed as following from economic conditions. However, due to its tight correlation with GDP, demand also serves as an indicator of those conditions. World oil demand is way down. Japan, where GDP shrank 15.2% in 2009:Q1, consumed 3.57 million barrels-per-day in March, down 1.45 million barrels compared with previous year. For the week ending May 8th, demand in the United States was 18.194 million barrels-per-day, down 1.56 million barrels (-7.9%) compared with the same week in 2008. That's 3 million barrels-per-day right there, and I've only listed 2 countries.

According to Platts, China consumed 6.69 million barrels-per-day in the 2009:Q1, down 4.5% over the previous year. The lone "bright spot" was India, which was up 4.8% averaged over the entire year 2008-2009 ending March 31st (2.65 million barrels-per-day).

The sagging demand picture is clear enough. Although some of the quoted data is behind current conditions, key indicators say the global economy has not improved. So-called "green shoots" refer to a slowing of the rate of various declines. In a CNBC interview, economists Nouriel Roubini and Harvard economist Ken Rogoff explain why even a weak economic recovery is still months away. Roubini issued his standard warning—

"People talk about a bottom of the recession in June, but I see it more like six to nine months from now," Roubini said. "The green shoots everyone talks about are more like yellow weeds to me."

[My note: Nouriel, my friend, you're behind the times! Budget director Peter Orszag now says "the analogy is there are some glimmers of sun shining through the trees, but we're not out of the woods yet."]

Howard Davidowitz tells Yahoo's Tech Ticker why the worst is yet to come. Davidowitz provides a realistic assessment of wealth lost and debt de-leveraging that will take many years to achieve.

Given the dismal demand numbers, why has the the price of crude been going up lately? The Wall Street Journal's Liam Denning weighed in on the problem. Figure 1 shows the correlation between the oil price and movements in the S&P 500 along with the current inventory data from the EIA.

Oil prices used to pay heed to stocks -- of crude, that is. These days, they track stocks of a different kind. Over time, supply and demand set the oil price. That is why it has little, or negative, correlation with equity markets over the long term. So far this quarter, however, correlation between the moves in the S&P 500 and crude-oil prices has leapt to 70%. This week, oil markets essentially ignored both a surprise, and bullish, fall in U.S. crude inventories and a bearish report from the International Energy Agency.

Crude oil has bounced since February to almost $60 a barrel despite worsening fundamental data. Commercial inventories are overflowing, having risen in the first quarter, a period when they usually drop. Moreover, as oil prices have risen, OPEC's discipline has started cracking, with the organization raising output last month for the first time since August...

Oil is really floating on cheap money. Quantitative easing is, as intended, pushing investors toward riskier asset classes such as equities, high-yield debt -- and crude. Investors in oil funds push up futures prices, making it profitable for others to store crude and sell it forward; another reason inventories are high.

[My note: In Rotterdam, Europe's largest oil terminus, they are running out of room to store the stuff.]

Figure 1 — The correlation with the S&P 500 (left) from the WSJ. Current inventories (crude stocks, right) from the EIA. Prices have risen as inventories remain far outside their 5-year average range. Note the slight downturn lately.

Two kinds of "green" have pushed the oil price up to heights it should never have attained lately: 1) a bogus perception of green shoots in our staggering economy; and 2) an influx of money into both equities (e.g. stocks) and crude oil. These factors explain the price differential between today's $62 and my guestimate of the "correct" price (~$35 per barrel). The difference is necessarily unrelated to supply & demand fundamentals.

This kind of oil market distortion has been going on for quite some time now, but with different causes at different times.

Ignorance Is Not Bliss

Ponder the following two graphs and their captions.

Figure 2 — World liquids supply & demand annual numbers for 2001-2008. Demand exceeds supply in 2006. The gap widens in 2007. Source data from the EIA (supply and demand).

Figure 3 — Nominal WTI average monthly prices (NYMEX) 1990-present. The circled price series demonstrates unwarranted volatility (i.e. crazy price swings) after 2006:Q2. The gray line is my smoothed best guess of how the price should have moved during this period. Like a broken clock, the nominal line meets the gray line on occasion.

What set the oil price adrift after 2006:Q2? Before turning to causes, let's examine Mr. Market's erratic history between then and now.

The first outrage, which I documented in ANWR Is Not The Answer, saw the oil price fall to $54.57 in January, 2007. Based in part on the over-hyped Jack #2 discovery, oil traders decided for no good reason that oil was plentiful again despite the fact that global demand had exceeded supply during that year (Figure 2). Then traders spent almost all of 2007 playing catch-up to get the price back to where it should have been (Figure 3) as the supply & demand gap widened (Figure 2). Unsatisfied with this brief moment of accuracy at the beginning of 2008, traders on crystal meth bid up the price without restraint until June & July, 2008, when the average price hit $133 and change. When the drugs wore off in August, 2008, our manic-depressive traders took the price all the way down to $41.02 in December when I wrote Not Right, Part I. It was another case of overcompensation—the worsening fundamentals did not yet justify a price that low. The price bottomed-out at $39.16 in February of this year, but has now climbed over $62/barrel despite the fact that the fundamentals of the economy and oil markets are certainly worse now than they were 3 months ago.

All of these events followed the collapse of the Housing Bubble in 2006:Q2.

Let me take a moment to explain why oil prices reflecting actual market conditions might be important to us. Regardless of whether we are in the Peak Oil Era—we probably are—in 2009, we would like to know at all times what the relative abundance of the Elixir of Life (with respect to demand for it) for Industrial Civilizations is. Oil is important mainly because of our need to move people and stuff around. And please do not tell me about the latest biofuels & electric cars fantasy.

The price signal is the traditional Way of Knowledge for gauging oil's relative abundance measured in barrels produced daily to meet our needs. An accurate price signal helps us set priorities and plan for the future in almost all areas of life. But if Mr. Market is stoned, we do not know where we stand. Ignorance Is Bliss does not apply when it comes to oil's availability and price.

Index Fund Traders Bet On Oil

The Wall Street Journal's Liam Denning believes the "oil [price] is really floating on cheap money" as investors in oil funds push up futures prices. This is a only reasonable interpretation of what's going on. Reuters' John Kemp supports Denning's view.

Retail investors betting on a price rise in oil via exchange-traded funds and institutions using commodity indices are paying a steep price for going long too early. The cost of rolling positions forward in a contango market is wiping out any gains they are likely to make if prices eventually rally later this year or early 2010.

Contango is the term used to describe the situation in a futures market where prices for immediate or nearer delivery trade at a discount to those for future delivery.

Figure 4 — A recent snapshot of the current market contango. Today's front-month contract price just surpassed the futures prices out to October, 2009. If oil is more expensive in July than it is in June, rolling your contracts over to the next month costs you money.

In the meantime, the main beneficiaries are investment banks taking the opposite side of the trade to their customers, and physical traders able to store increasing amounts of crude and finance it by running a short position in the futures markets.

In effect, retail investors and pension funds are paying the bills for the record quantity of crude oil being stored in tank farms around the world and in vessels offshore, via the losses they make when they roll their positions forward every month.

I want to frame these observations in terms of supply & demand. Speculators betting on a long-term price rise by purchasing near-term contracts and rolling them forward, or physical traders buying oil now and storing it in tankers, are creating artificial demand for oil. This has everything to do with futures prices (the contango) and little to do with end-user demand (refiners). It has still less to do with inventory levels, which have actually gone down lately (Figure 1) because oil stored on tankers does not go into crude stocks.

Thus the oil price goes up as the glut on the world market grows. Mr. Market is said to be behaving "correctly."

The contango is waning as the market "self-corrects"—the once steep differential between future and front month prices flattens out as current spot prices catch up with futures prices (Bloomberg, May 5, 2009). After the correction it is no longer advantageous to buy oil now and store it on tankers. Already Bloomberg reports that Shell failed to sell a load of North Forties crude.

“Oil should soon start to return to the market as contango structures appear to be narrowing, especially in the U.S.,” Vienna-based JBC said in an e-mailed research note today. JBC estimates that as of end-April, 40 million barrels were being stored in the U.S. Gulf Coast while as many as 24 million barrels were anchored off the U.K. and West Africa.

Shell, Europe’s largest oil company, sought to sell a cargo of North Sea Forties oil on May 1 which it has been storing in a supertanker off the coast of the U.K. since November. Shell said it failed to attract a buyer for the crude which is on board the 2-million-barrel Leander.

Traders are storing 100 million barrels of oil at sea, enough to supply Europe for five days, Frontline Ltd., the world’s largest supertanker operator, said April 23. Provided they can secure storage and financing for less than the difference between near-term and future prices, they can lock in a profit by buying prompt oil and selling it forward.

Physical traders storing oil will start dumping it back on the market. They will need to dump it all or pile up losses leasing supertankers. The ensuing snowball will cause the oil price to crash. Oil may fall below its February low as today's distorted $62 price becomes tomorrow's distorted $25 price. I could be wrong of course. Mr. Market may experience another drug-induced mood swing which reflates the oil price. Naturally it is hard to predict Mr. Market's future emotional state.

How would you like to be an small independent oil exploration & production company trying to plan new drilling projects under these circumstances?

There's also the bandwagon problem I discussed in Not Right, Part I. We have all these "retail" investors who have no idea what they're doing making the same mistakes together. I believe they're about to lose their shirts, which will only make the price outlook worse when they head for the hills. Inexpert investors move in herds. Jump on in! The water's fine! (said the sharks...)

Why has the oil market become the playground of index fund traders? Why does the oil market follow the S & P 500? When my friends ask me ("the expert") why the price of gas is going up during a recession, what I am supposed to tell them? I should tell them the allure of easy money broke the oil market and it has not been repaired. Perhaps the market is FUBAR and can't be repaired.

And Then There's Stupidity

A bunch of smart people got together at the EIA's 2009  annual conference to figure out what pushed prices upward in the first half of 2008. The cause of 2008's crude price surge remains elusive according to conference participants (Oil & Gas Journal, April 9, 2009, subscription required).

Nine months after crude oil prices reached record levels, experts agreed at the US Energy Information Administration's 2009 annual conference on Apr. 7 that speculators shouldn't be blamed. They also could not say definitively what pushed prices upward during 2008's first half...

"The answers haven't been palatable to politicians or to us. We haven't been able to point at one particular type of trader and hold them responsible for running oil prices up to $140/bbl last summer. We have not been able to find the smoking gun," Jeffrey Harris, the CFTC's chief economist, said...

[CFTC = Commodity Futures Trading Commission]

The CFTC is the single government agency which identifies hedge funds in commodity markets, but it has found that index fund traders could not be found as easily, he said. "Index funds can come to the market through commodity pools or banks. Many come through swap dealers," he said.

Well, Jeffrey, if you think the market is functioning normally now, as you probably do, then I guess you won't find any smoking guns. Generally speaking, if a person can't see a hand being waved in front of his face, he's going to miss a lot of things. All defenders of Mr. Market—they are legion—have the same eyesight problem.

Robert F. McCullough Jr., managing partner at McCullough Research in Portland, Oregon, argued that the CFTC data is incomplete and uses "outmoded classifications that do not reflect the current make-up of the commodities market." Harris responded that "the commission actually has begun to receive fairly good data from over-the-counter markets, especially about index funds, to supplement its own findings." (Good to know!) Everybody agreed that supply & demand fundamentals were not to blame (see Figure 3). Everybody agreed the 2008:H1 price spike was inexplicable.

Conference participants occasionally wandered into territory which (perhaps accidentally) overlaps reality.

Finally, said Adam E. Sieminski, Deutsche Bank's chief energy economist, "stupidity can drive decisions. That's the best explanation for somebody buying a crude oil contract at $147/bbl and expect the price to go up. Governments can't regulate against this"...

Robert J. Weiner, an international business professor at George Washington University, said traders adopting a herd mentality, where they made decisions by copying other market participants instead of examining fundamental influences, is a likelier force [promoting volatility]. "If lots of people try to get into or out of a position at the same time, volatility can result," he said.

[My note: you can't fix stupid ...volatility can result. We've all learned something today!]

I can already hear the protests. I have defamed the sacred market. The market does what the market does. The price of oil is the price of oil. The market can't make mistakes by definition.

My answer is Figure 3. Stare at this graphs. Think really hard about it. Do those price movements since 2006:Q2 look right to you?  The oil market is broken. Today's $62 price makes no fundamental sense. As a friend told me, there's trillions of dollars floating around out there and it's got to go somewhere. Some of this moolah distorts the oil price. The explanatory burden falls on people who think Mr. Market is OK. Or the ones who think he's a little woozy but can't figure out why. Unless we get Mr. Market into rehab pretty damn quick, we are all going to pay the consequences.

Contact the author at dave.aspo@gmail.com

The Reign Of Error

We had to burn the village in order to save it
    —Vietnam War quote

To be is to do
    —Socrates
To do is to be
    —Jean-Paul Sartre
Do be do be do...
    —Frank Sinatra

The fur is flying on the climate front. The proposed carbon Cap & Trade legislation sponsored by Henry Waxman and Ed Markey can't seem to make it out of the Energy and Commerce Committee. If you read my last column, you know why I think it highly unlikely that something like this bill will become The Law in the United States this year or ever. The bogus debate about Cap & Trade and the realities of the existing carbon trading system teach us valuable lessons about contentious but ineffective schemes to combat global warming. National Public Radio's Living On Earth describes the current Cap & Trade carbon credits trading system.

The carbon credit system was created by the Kyoto Protocol. It's called the CDM, or Clean Development Mechanism. Here's how it works: an industrialized country or company producing greenhouse gases can offset its pollution and get credit by bankrolling clean carbon projects in developing nations.

Today I talk about the confused (and confusing) Cap & Trade debate and future CO₂  levels in the Earth's atmosphere. I believe we live in a Reign of Error. It's not quite as bad as "we must smother the internal and external enemies of the Republic or perish with it" as Maximilien Robespierre's said during his Reign of Terror when lethal idealism resulted in the death of many innocent people. In 2009 we face another kind of dangerous idealism in the climate debate. I will attempt to clear up what I regard as misconceptions about policies to mitigate global warming, fossil fuels resources, how people actually behave, and what we can expect in the future.

Please do not contact me if you think anthropogenic climate change is not happening. Which word do you not understand? Greenhouse? Or Gas?

Cap & Trade = Smoke & Mirrors

Two debates are taking place as the House of Representatives thinks really hard about carbon Cap & Trade. The first pits the environmentalists against political "conservatives" and those in fossil fuels business. Chevron's Oreilly Says Carbon Targets Unrealistic typifies this debate (Bloomberg, May 7, 2009).

“Seeking those reductions without any realistic plan to replace that energy is a straight path back to a pre-industrial economy and a standard of living to match it,” O’Reilly said today in a speech in Boston.

Without referring to specific bills or members of Congress, O’Reilly said that talk of cutting emissions 20 percent by 2020 or 80 percent by 2050 “sounds good” but is unrealistic. For example, the 62-year-old Dublin native said, replacing all of the global transportation system with zero-carbon alternatives would cut greenhouse-gas emissions by only 15 percent.

[My note: I don't know where O'Reilly got that 15 percent. I suspect he pulled that number out of his ... posterior.]

“Trading in false hopes and inflated numbers will get us nowhere,” O’Reilly said. “We need to set goals that are both high and realistic.”

[My note: O'Reilly's "high and realistic" is an oxymoron.]

I have little doubt that an 80% emissions reduction would throw us back (in some respects) to an economy resembling that of the 18th century, but our hardscrabble existence in 2050 is neither here nor there for legislators in 2009. The second more entertaining debate is the internecine squabble among environmentalists (Huffington Post, May 8, 2009). Grist's Dave Roberts has been there, done that—

I find it really hard to believe, but the perennial "carbon tax vs. cap-and-trade" debate is still going on. It goes on and on and on and it never changes. It's like everyone's following a script now. I've been over this territory so many times that I hardly know what to say any more. So here's what some other people are saying:

Joe Romm started this off by asking James Hansen to drop his quixotic and politically toxic campaign against the Waxman-Markey climate/energy bill. Kevin Drum chimed in, supporting Romm.

Michael O'Hare responded with a heated defense of carbon taxes (or as he calls them, carbon charges), premised mainly on a basic misunderstanding of Romm's post...

Ryan Avent says taxes and caps are not that different in effect and only one has a chance of passing, so carbon taxers should STFU. Andrew Sullivan responds that he thinks the tax will work better, and so no, he won't STFU. Kevin and Ryan both respond to Sullivan, pointing out that he seems to be suffering from some serious misunderstandings about cap-and-trade systems. (In this he has, to put it mildly, plenty of company).

[My note: "Serious misunderstandings" are perfectly understandable. STFU is an acronym used as a verb that means exactly what you think it means.]

Meanwhile, Yale 360 has rounded up a group of "experts" to weigh in on the issue, though several of the purported experts seem to understand very little about the policies and/or the politics at hand. The submissions from Jeffrey Sachs and Roger Pielke Jr., in particular, are so poorly argued as to defy explanation...

I would be crazy to get involved in this dispute, so I won't, and besides 1) I'm not up on these issues; and 2) I don't think Cap & Trade as opposed to a Carbon Tax matters one bit, which is why I'm not up on these issues. However, the Romm versus Hansen dispute does deserve comment because it directly addresses the question of how much CO₂ in the atmosphere constitutes dangerous human interference with the Earth's benign Holocene climate. But first I need to explain why Cap & Trade doesn't matter.

My eyes glazed over as I read the complicated arguments about Cap & Trade permits—will they be auctioned off? or given away?—and potential revenues from a 648 page proposal that likely won't ever come to a vote in the House. But what about the $20 billion carbon market (from the Kyoto Protocol CDM) that exists now? Is it working? Are Europe's greenhouse gas emissions going down? I would think this question would be of interest to American policymakers who are—as they always do—arguing about money instead.

In the misleadingly titled EU Carbon Trading System Shows Signs of Working, the New York Times tells us what we need to know (April 1, 2009—April Fools Day!). Also look at Figure 1.

Europe’s controversial trading system to cut carbon emissions is showing faint signs of working, according to analysis of preliminary figures released Wednesday by the European Commission.

Emissions among industries covered by the E.U. system fell between 4 percent and 6 percent during 2008 [from 2.24 billion tons in 2007 to 2.11 billion in 2008] compared with increases of roughly 1 percent in the two previous years, according to analysts who reviewed the figures.

Most of the decline was from falling industrial and electricity production linked to the economic slump. Even so, the size of the decline compared with the increases in previous years showed that some businesses were becoming marginally cleaner as a result of the system, these analysts said.

Figure 1 — EU-27 emissions up to 2006. The black line shows the total emissions. The Times quotes officials as saying that emissions rose 1% in 2006 and 2007 but then dropped dramatically in 2008 due to the economic downturn. Transportation emissions have been rising steadily over the entire period, which completely offsets reductions in other areas. The graph is from the European Commission's Directorate-General for Energy and Transport. Their data does not show a 1% increase in 2006 as the Times reported.

It makes sense that the world's economic near-death experience is cutting into European greenhouse gas emissions. Figure 1 shows at least that emissions have not grown since the year 2000, so this data might be construed as one of those famous green shoots supporting Cap & Trade like the ones said to be sprouting in our economic Gardener's Paradise. Does this interpretation of the data hold up?

The answer is No because a lot of Europe's carbon offsets are phony.

My first inkling that something was amiss came from the Green, Inc. blog at the New York Times. This is from Do Carbon Offsets Cause Emissions to Rise?

Michael Wara, a law professor and energy expert at Stanford’s Program on Energy and Sustainable Development, has cast new doubts on the efficacy of the European Union’s Emissions Trading System, which is the model for a carbon-capping system foreseen in the United States.

Mr. Wara wrote in an e-mail message to Green Inc. that European-based polluters were likely to have bought so many permits from carbon-reduction projects based outside the trade bloc that industries emitted roughly 1 percent more in 2008 than they did in 1990...

Offsets allow companies and governments in the wealthy world to pay developing nations to make their carbon reductions for them.

Living On Earth's Bruce Gellerman interviewed Mr. Wara, who patiently explained how the scam works. The live radio argument is disjointed, so I have recreated the dialogue for clarity in the quote below. You can always listen to the original interview if you like.

GELLERMAN: Let's say I have a small electricity power plant in China. I'm using coal, and we're producing a lot of greenhouse emissions. Someone from Germany has a factory and wants to pay us money to convert to a wind farm. They get the credits, and we stop polluting. Win-win.

WARA: Win-win, in theory. Now, here's the question, though. What other incentives did you, the power plant owner, have to switch to wind? Very often, it turns out, there are multiple incentives to make that switch. China is becoming one of the largest producers of wind energy in the world. Part of the reason for that ... is the subsidy provided by the CDM. But we think a much bigger part of the reason is the incentives and subsidies provided by the Chinese. So without the credits I would have made the switch anyhow.

Someone has to say, this wouldn't have happened without the credits, or, it would have. And that's important for a key reason: these credits go to Europe or other countries that have signed and ratified the Kyoto Protocol, and they're used in lieu of emission reductions within those countries. So the reduction happens in China, but it doesn't happen in Germany. If the reduction in China would have happened anyway, then you're not entitled to the reduction in Germany.

GELLERMAN: Who makes the decision to grant offset credits?

WARA: Most of the actual evaluation of projects happens – is done by - private third parties that act sort of like a credit-rating agency.The companies being certified as emission credit-worthy, like the one in China converting from coal to wind, pay these third parties. So there's a conflict of interest.

Wara looked at about 3000 green projects and found that in half of them, it was dubious or ambiguous whether greenhouse gas offsets should have been granted. All this is detailed in his Stanford Working Paper A Realistic Policy on International Carbon Offsets.

Have European emissions gone down since 1990? Wara says No. Do you say corporations would find a way (through strategically placed loopholes) to game the system if a Cap & Trade program were implemented in the United States? No way! Surely you jest! I'll move on to more serious matters now.

350 Or Bust?

Prominent climate scientist James Hansen recently compared the Cap & Trade proposal to the Temple of Doom made famous by Steven Spielberg's Indiana Jones movie. His open letter spells out why he feels this way—

My frustration arises from the huge gap between words of governments, worldwide, and their actions or planned actions.  It is easy to speak of a planet in peril.  It is quite another to level with the public about what is needed, even if the actions are in everybody’s long-term interest.

Instead governments are retreating to feckless “cap-and-trade”, a minor tweak to business-as-usual...

Cap-and-trade is the temple of doom. It would lock in disasters for our children and grandchildren.  Why do people continue to worship a disastrous approach? Its fecklessness was proven by the Kyoto Protocol. It took a decade to implement the treaty, as countries extracted concessions that weakened even mild goals. Most countries that claim to have met their obligations actually increased their emissions. Others found that even modest reductions of emissions were inconvenient, and thus they simply ignored their goals.

There is little doubt that a Cap & Trade program would be feckless, as Michael Wara has demonstrated. The whole point of Cap & Trade is to create the appearance of acting responsibly while actually doing next to nothing. In this sense, and only in this sense, Hansen, who supports a stringent carbon tax, has no illusions about what is going on. Hansen's objection, however, is based on his view that avoiding dangerous interference with the climate requires a target CO₂ level in the atmosphere of 350 ppm (parts-per-million). Unfortunately, that level is now 386 ppm and it's still rising.

Hansen's reading of the paleoclimate record in Target Atmospheric CO2: Where Should Humanity Aim? indicates to him and his colleagues that 350 ppm, not the consensus target of 450 ppm, is required to avoid losing the big ice sheets.

Humanity today, collectively, must face the uncomfortable fact that industrial civilization itself has become the principal driver of global climate. If we stay our present course, using fossil fuels to feed a growing appetite for energy-intensive life styles, we will soon leave the climate of the Holocene, the world of prior human history. The eventual response to doubling pre-industrial atmospheric CO2 likely would be a nearly ice-free planet.

[My note: For anatomically modern humans, history began about 195,000 years ago during the Pleistocene, not in the last 10,000 years during the Holocene. Behaviorally modern humans show up about 50,000 years in ago in Africa.]

Paleoclimate evidence and ongoing global changes imply that today’s CO2, about 385 ppm, is already too high to maintain the climate to which humanity, wildlife, and the rest of the biosphere are adapted. Realization that we must reduce the current CO2 amount has a bright side: effects that had begun to seem inevitable, including impacts of ocean acidification, loss of fresh water supplies, and shifting of climatic zones, may be averted by the necessity of finding an energy course beyond fossil fuels sooner than would otherwise have occurred.

We suggest an initial objective of reducing atmospheric CO2 to 350 ppm, with the target to
be adjusted as scientific understanding and empirical evidence of climate effects accumulate. Limited opportunities for reduction of non-CO2 human-caused forcings are important to pursue but do not alter the initial 350 ppm CO2 target. This target must be pursued on a timescale of decades, as paleoclimate and ongoing changes, and the ocean response time, suggest that it would be foolhardy to allow CO2 to stay in the dangerous zone for centuries.

The Where Should Humanity Aim result is not universally accepted among working climate scientists—this is putting it mildly. Nevertheless, climate "progressives" like Bill McKibben (350.org) have unquestioningly accepted it. Does the activist rule of thumb say the more doom the better?

Hansen's argument concerns the very-long-term sensitivity of the Earth's climate to a doubling of pre-industrial CO₂ levels (= ~550 ppm). The normal "Charney" sensitivity derived from climate models is around 3ºC. Hansen's "Earth" sensitivity over centuries or millennia is 6ºC. The greater sensitivity implies a lower CO₂ target if we hope to preserve a glaciated Greenland and Antarctica (among other calamities). Gavin Schmidt of NASA GISS discussed Hansen's result at length at Real Climate. I can not possibly review the main points in a short essay, so I recommend you read that discussion if you are conversant with the climate science or you're willing to learn. Look particularly at posting #38 from Andy Revkin of the New York Times and the responses of the climate scientists—this goes to the heart of the matter.

I have the greatest respect for Hansen the scientist, but perhaps he has not thought through the full implications of what he is advocating.

Achieving the 350 ppm target in the 22nd century through very aggressive actions we will pursue on "a timescale of decades" lies entirely outside the realm of what is politically (i.e. humanly) possible as I explained last week. Hansen speaks of the "bright side" of a very aggressive approach to replacing fossil fuels, but his "uncomfortable" observation that "industrial civilization itself has become the principal driver of global climate" is the main driver of his policy views. He seems to believe that very-long-term global climate stability (on human time-scales) supersedes all other considerations, including the manner in which all the people alive now will live out their remaining time on Earth.

Thus Hansen appears to be saying that we must voluntarily dismantle our Industrial Civilization in order to save it. I can assure you that humankind will not willingly go down that road. He recently called upon us to phase out coal, plant more trees, and burn wood instead. All the energy humans derived from burning coal amounted to 121 quadrillion (1.21 x 10¹⁷) British Thermal Units (BTU) in 2005. Measured in cords, that's a lot of trees.

It is telling that Joe Romm, in refuting Hansen's position, unknowingly calls into question whether the standard technological or policy solutions to achieving the consensus 450 ppm target will ever actually work. He is hoisted by his own petard! These solutions are called "wedges" and I've included a few of the ones Romm lists.

Wedges are strategies that reduce emissions steadily until they achieve a 1 GtC/year saving — in 50 years in Princeton’s original framework, but for those in a hurry like all of us now are, it must be less.

The bad news about 350 ppm is that you need some 18 standard (50-year) wedges from 2010 to 2060, if I’m reading your paper right — plus a whole lot more after that — just to be on a path to get back to 350 ppm in 2150. The really bad news is that, to achieve your frontloaded reductions from shutting down all traditional coal plants in the next two decades, you need eight of those wedges by 2030.

• 1.5 wedges of concentrated solar thermal — ~2500 gigawatts (GW) peak. (1 wedge = 1667 GW.)
• 1 wedge of vehicle efficiency — all cars 60 mpg, with no increase in miles traveled per vehicle.
• 1 of forestry — End all tropical deforestation.

Here are the impediments Romm lists for achieving eight wedges by 2030.

• An individual wedge is a staggering amount of carbon-free energy
• There isn’t political support to do even a single 20-year wedge today.
• Doing eight such accelerated wedges simultaneously is far beyond the capability of the market on its own no matter how high a carbon tax you impose.

Apparently it has not occurred to Dr. Romm that these steep obstacles to climate progress will exist in 2030 just as they do now in 2009. Are we supposed to believe that what is politically impossible or technologically iffy now will become achievable as time goes on? Why is a 50-year window for ending tropical deforestation more realistic than a 20-year window? If we acknowledge that 20 years is not nearly enough time to get the required concentrated solar thermal, how can we be sure that we will achieve 1667 gigawatts in 50 years, the equivalent of 1667 1 GW coal-fired power plants? We would need to build a 1 GW thermal solar plant each week for the next 32 years.

Romm's view requires a big leap of faith. Read the Kenneth Boulding quote in my essay The Secretary of Synthetic Biology. Here is part of it, and remember that Boulding said this in 1982.

There is an underlying assumption throughout ... that we will solve the problem of the development of large quantities of usable energy from constantly renewable sources, say, by 2010. Suppose, however, that in the next 50, 100, or 200 years we do not solve this problem; what then? It can hardly be doubted that there will be a deeply traumatic experience for the human race, which could well result in a catastrophe for which there is no historical parallel.

If you substitute 2060 or some other far-flung date for Boulding's 2010, you get Romm's working assumption. It is now 2009 and we've made very little progress in getting those large quantities of renewable energy Boulding spoke of nearly 3 decades ago. What renewable energy we have gotten pales in comparison with the increase in fossil fuels we have burnt since 1982 and continue to burn everyday.

Politics always preserves the status quo as we see with Cap & Trade. We also consistently overrate our technological prowess. We've made excellent progress in nifty cell phones, but in energy we're banging up against the laws of physics and biology, natural resource limits on clean energy, and mathematical chaos (clouds & wind). Those are the scientific and political realities, and such realities do not change over time. I believe we will continue do what works until we can't do it anymore.

The Fossil Fuels Depletion View

Some of us think humankind will be running low on exploitable fossil fuels in the first half of the 21st century. Resource depletion can change climate change scenarios significantly. I'll briefly present my version of that story here, my confidence buoyed by the knowledge that such a narrative can not possibly be less reasonable than positions staked out in the global warming debate. Figure 2 and Figure 3 give hint at what I'm talking about.

Figure 2 — Taken from The millennial atmospheric lifetime of anthropogenic CO₂ by David Archer and Victor Brovkin. Response of the CLIMBER-2 model to Moderate (1,000 Gton C) and Large (5,000 Gton C) fossil fuel inputs (called slugs). The equilibrium climate sensitivity of the model is 2.6°C.  Panel a is Emissions scenarios and reference IPCC SRES scenarios (B1 and A2). Panel b is simulated atmospheric CO₂ (ppmv). Panel c is simulated changes in global annual mean air surface temperature (°C).

Figure 3 — Oil production in the B1 Image and A2 ASF SRES marker scenarios. Black shows the actual with a projection to 2010. The gray line shows one plausible scenario for future oil production. If you don't believe that oil production might follow the path shown in this figure, read my Are We In the Peak Oil Era? for an explanation of why non-OPEC oil has almost certainly peaked. Also bear in mind that OPEC (Persian Gulf) oil reserves never go down, i.e. produced oil and reserves growth magically coincide every year. Of course the accounting is rigged.

Taking the two graphs together, notice that 1) our excursion above 425 ppm is relatively short-lived in the B1 scenario as shown in Figure 2, panel b; and 2) the B1 Image scenario probably overestimates (by a wide margin) how much oil the world will produce between now and 2050. I'm not claiming this is the whole story, but if the Figure 3 scenario is reasonable, some B1 pathway (as opposed to A2) looks plausible even if there is more recoverable natural gas & coal than a few pessimists believe. Coal energy peaks in 2040 in this scenario, and energy from natural gas peaks in 2050.

Let's look at a bigger picture. Here are the reasons why I think 450 ppm is a plausible upper bound on how much CO₂ will end up in the atmosphere.

1. A slowdown in the global economy will reduce emissions in the medium term (2008-2013)
2. The world's oil supply will be flat or declining by 2013-2015, which will further impede economic growth thereafter—this is the "peak oil" constraint. (Figure 3 includes tar sands and extra-heavy Orinoco oil.)
3. Fuel switching (e.g. from coal to natural gas or renewables) will be ongoing but will not follow an exponential growth curve as it has done in its very early stages (e.g. for wind).
4. If Cal Tech professor Dave Rutledge is correct or in the ballpark, recoverable coal reserves are far lower than the optimistic B1 Image scenario suggests. Rutledge's analysis is bolstered by 2 data points: 1) coal production on a country-by-country basis (e.g. the UK) has followed a Gaussian distribution; and 2) world coal reserves are actually falling in recent evaluations. Also, the Chinese coal reserves accounting follows OPEC practices for oil (see the note in Figure 3).
5. Various constraints (environmental, fresh water access, net energy returns/costs, etc.) prohibit the development of most unconventional hydrocarbons (e.g. most shale gas, oil shales, methane hydrates)

Is this story complete? Certainly not, no story could be. As Yogi Berra said, it is hard to make predictions, especially about the future. But some version of this story could come true. 

The Reign of Error

The problem for the depletion story is not that it's crazy. The real problem is that taking resource limits seriously necessarily lies outside the consensus view. The depletion story is politically incorrect. It is easy to see why. Joe Romm's consensus view promises a transition without significant disruptions. James Hansen wants us to voluntarily disrupt our lives to cut emissions. The depletion story says an involuntary disruption is coming and there's not much we can do about it outside of adjusting to a lower-energy lifestyle. Taking depletion seriously will never be a popular stance regardless of its validity.

It is fair to say that the usual climate narrative which now holds sway with policymakers does not ever consider limits on producing hydrocarbons. This is a grievous error. The consensus never questions the views of the "authorities" on resources (the WEC, the EIA, the USGS, OPEC). Ironically, but in typical human fashion, these authorities never tire of quoting each other, so we are left with a perpetual, self-reinforcing set of erroneous assumptions that are never challenged in the climate debate. Robespierre aside, this is the real Reign of Error.

The depletion story does not make impossible demands on Human Nature—no 1677 gigawatts of concentrated solar thermal, no burning of billions of trees required. The depletion story takes a realistic view of technology—no dependence on non-existent but essential breakthroughs. The depletion story takes exponential curves seriously—no unlimited growth on a finite planet. So you've got to wonder sometimes: who is delusional and who is not?

I do not pretend that the consensus view will change any time soon. I expect the bizarre climate debate to continue in its present form for some time to come. When Cap & Trade is not enacted, we will hear a lot of moaning and groaning. Then it will be back to business as usual in the climate world, which like the funeral business with Baby Boomers retiring, promises to be a growth industry.

I think Frank said it all: Do be do be do.

Contact the author at dave.aspo@gmail.com

Never put off until tomorrow...

...what you can do the day after tomorrow
    — Mark Twain

Oh Lord, make me carbon-neutral, but not yet
    — Carl Mortished in the Times Online

Normally staid energy analysts became unglued when Jon Wellinghoff, our new Chairman of the Federal Energy Regulatory Commission (aka. FERC, or "the FERC"), opined that "we may not need any [new nuclear or coal-fired plants], ever" (New York Times, April 22, 2009). The Chairman went further, stating—

"I think baseload capacity is going to become an anachronism," he said. "Baseload capacity really used to only mean in an economic dispatch, which you dispatch first, what would be the cheapest thing to do. Well, ultimately wind's going to be the cheapest thing to do, so you'll dispatch that first."

Since coal and nuclear supply almost all of America's baseload electricity generating capacity, and about 70% of overall capacity, this did not sit well with people who are happy with the current arrangement, which has been over 99% reliable for decades. (If you're wondering, natural gas is usually used in follow-up or peak demand generators.) Geoffrey Styles posted Dangerous Delusions at his blog Energy Outlook after learning of Wellinghoff's remarks.

If you've read this blog for any length of time, you know that it's not my practice to single out individual officials or politicians for particular praise or criticism, preferring an even-handed and scrupulously non-partisan approach. So it is with some reluctance that I feel compelled to share my considerable alarm about the views expressed by the new Chairman of the Federal Energy Regulatory Commission (FERC), Mr. Wellinghoff. His suggestion that "baseload capacity is going to become an anachronism" and that renewable energy can meet all our future energy needs represents a dangerous delusion, at least for the next several decades. I am not dismissing the vital contribution of renewables in addressing climate change, or the potential of a smarter electricity grid to accommodate a greater share of generation from renewable sources than would be feasible today. However, while I appreciate the benefits of visionary leadership in moving the country towards those goals, that vision must be grounded in reality, and not skewed by wishful thinking or the ingrained habits of a long career spent in advocacy for renewable energy.

My own reaction was far more muted, even amused. I don't worry too much about visions unless the Evangelical gun owner next door is having one in which I'm the Anti-Christ. We don't know what the grid will look like in 2040 because we haven't carried out the necessary experiments with distributed renewables to find out.

I hunted for the text in Wellinghoff's remarks I knew would be there and found it on page 2 in the Times and at Platts.

But planning for modifying the grid to integrate renewables must take place in the next three to five years, he said. "If we don't do that, then we miss the boat,"Wellinghoff said. "That planning has to take place so you don't strand a lot of assets, a lot of supply assets."

Unlike coal and nuclear, natural gas will continue to play a role in generating electricity, he said "Natural gas is going to be there for awhile, because it's going to be there to get us through this transition that's going to take 30 or more years."

[Wellinghoff noted] that [natural gas] production companies in recent years have discovered that "we have twice as much" gas in the US "than we previously thought." That, in combination with other factors, figures to keep natural gas relatively inexpensive "for a while," competing "on the margin with coal" for new generation load

[Note: The last paragraph is from Platts.]

I'll talk about our unconventional natural gas recoverable reserves another day, but my research says that some gas production companies are not reliable sources. For example, Chesapeake's mouthpiece Navigant Consulting (via CleanSkies.org) appears to have overstated the recoverable gas in the Marcellus Shale by a factor of 7.

Those in the nuclear industry found Wellinghoff's remarks worrisome. It is easy to see why, but he doesn't run nuclear policy—that task falls to Energy Secretary Steven Chu. Those charged with maintaining the grid were miffed at the chairman's casual dismissal of the importance of baseload capacity.

I'll talk about the baseload issue, but once again we must confront the difference between talking the talk and walking the walk. Actions speak louder than words. Why do we require 3 to 5 years of planning to modify the grid to integrate renewables? Haven't the Danes already done this?  What's the hold-up?

The Energy Reality Challenge

Wellinghoff believes that we can replace baseload power with wind eventually, but the FERC chairman also claims that years of planning are required so we "don't strand a lot of supply assets," where I assume a supply asset is a wind farm (or some other distributed energy source). Right now there appear to be a number of major impediments to actually doing something, including a welter of red tape, wind farm siting issues and a lack of long-distance high-voltage (765kV) power lines to connect that wind power to the grid. These transmission lines require the permitting approval and coordination of each state they cross.

There is a project on the boards now that could solve many of these problems. The ITC's Green Power Express has a plan and they're raring to go (Figure 1).

Figure 1 — High voltage transmission lines planned by the ITC's Green Power Express. So-called wind supply assets need not be "stranded" in the Upper Midwest. Power can be moved east and south to where it's needed.

Wellinghoff supports the project.

ITC Holdings Corp.'s "Green Power Express" would cost $10 billion to $12 billion and carry 12,000 megawatts aimed at reducing congestion, improving transmission reliability and strengthening aging electricity infrastructure. But the project has faced regulatory snags (ClimateWire, Feb. 12, 2009)...

The Federal Energy Regulatory Commission approved the transmission-investment incentives for [the Green Power Express], saying it would provide benefits such as improved transfer capability and access to wind power generation...

In granting the approval, FERC Chairman Jon Wellinghoff noted the importance of investing in new transmission infrastructure to meet renewable energy goals, and he said building such projects will require planning beyond the needs of a single utility, state or region.

I don't know what a "transmission-investment incentive" is and I don't want to know. Why let red tape stand in the way of progress?  At an estimated $10-12 billion, the Green Power Express is a bargain. That's nothing considering we're saving the Earth here—we gave Citigroup $52 billion last year! And they're still insolvent!

What about those troublesome state approvals? Already taken care of. A letter from the Upper Midwest Transmission Development Initiative advocating such a project has been signed by top utility regulators from Minnesota, Wisconsin, South Dakota, North Dakota and Iowa. A private-public partnership could be put in place almost immediately. If we step on a few toes, construction could start next year.

Talk is cheap, so today I issue the Energy Reality Challenge—take the "F" out of FERC, rhymes wit irk, meaning to "to be irritating, wearisome, or vexing"—to Mr. Wellinghoff.

I believe there are reasons deeper than red tape, the need for coordination, or "stranded assets" that explain our foot dragging in implementing wind power on large scales to achieve some cost savings from efficiency (maybe) and reduce our carbon footprint. Perhaps we're afraid of what we're going to find out if we actually build the Green Power Express. And in the last section, I'll touch on some even deeper reasons why I think procrastination has been our strategy of choice.

Usually critics of wind talk about its intermittent nature and the resulting 30% capacity factor—sometimes the wind doesn't blow. Wind advocates respond that if you distribute enough wind farms over a wide enough area, you will get the power you need—the wind is always blowing somewhere. I will take a different tack today. Let's look at some lessons learned about transforming the grid from those industrious Danes.

Lessons From Denmark

This section presents a lot of data and analysis, so I apologize if it is hard to follow. I'll begin with data from the Danish Energy Agency's 2007 statistical summary.

Figure 2 — Danish wind power capacity (left scale) and share of domestic electricity supply (right scale) in the period 1980-2007.

Figure 3 — Total Danish CO₂ emissions 1990-2007, with emissions by fuel type (right).

Denmark got 19.7% of its domestic electricity from wind in 2007 as shown in Figure 2. Looking at the decrease in overall carbon dioxide emissions since 1990 shown in Figure 3, and particularly those from coal, one could easily jump to the conclusion that wind is fulfilling the promise of carbon-free power generation. That's partly true, but now look at Figure 4.

Figure 4 — Danish electricity production by fuel-type from 1994-2007 (left), with the overall share coming from Combined Heat & Power generation (CHP, right).

Former Clinton energy official and climate activist Joe Romm explains what CHP is at his blog Climate Progress.

Probably the least understood major climate solution is the simultaneous generation of electricity and heat, called cogeneration, combined heat and power (CHP) or recyled energy. You can read the basics here.

I have proposed one “stabilization wedge” [for mitigating climate] of CHP (here). Some people, like my friend Tom Casten of Recycled Energy, think it could be multiple wedges. He is probably right — when you consider that the energy now lost as waste heat just from U.S. power generation exceeds the energy used by Japan for all purposes.


Figure 5 — Greater efficiency achieved through CHP (cogeneration). Almost all CHP uses natural gas or coal as the input fuel, but it is also possible to use biomass or waste on smaller scales. Natural gas is the fuel of choice for smaller, distributed cogeneration. Denmark converted existing coal plants to CHP and built a large number of smaller natural gas or biomass cogeneration facilities.

In the period 1997-2007 when coal consumption declined dramatically as shown in Figure 4 (left panel), the Danes were also ramping up cogeneration of heat and power (right panel). Denmark was able to reduce their coal consumption partly through the efficiency gained from combining heat and power generation. Cogeneration in smaller natural gas generators and 3 of Denmark's 8 baseload coal-fired plants, not the wholesale replacement of coal combustion by wind power, helped Denmark make a large reduction in their CO₂ emissions after 1995.

Another factor contributing to Denmark's reduced CO2 emissions came from burning biomass in cogeneration plants, not coal, to generate electricity (Other in Figure 4, left panel) and for district heating (Figure 6). As with CHP, 3 of Denmark's 8 baseload central power plants have biomass combustion units.

Figure 6 — Replacement of baseload coal by renewable energy for district heating in Denmark. About 95% of this energy resulted from burning straw, wood and waste.

A fact sheet from the Danish energy authority sums up why their CO2 emissions have been falling.

• Strong increase in end-use energy efficiency. There has been a strong improvement of energy efficiency of buildings and the energy efficiency of appliances and industrial processes has increased.
• A more efficient production of electricity and heat, mainly due to a huge expansion of combined heat and power production (CHP — –Cogeneration).
• A shift in use of fuels — introduction of natural gas and more renewables [wind & biomass], less oil and coal

Even with all their energy busyness, the Danes are still well short of their required 2012 Kyoto Protocol CO₂ emissions level.

The deficit between expected Danish emissions of CO2 and the target Denmark is committed to achieving is 13 million tonnes for the period 2008-12. The allocation plan documents how this deficit will be reduced to zero: The EU Commission: Denmark's allocation plan

[Note: See Figure 3, which shows that 2007 emissions were about 53 million tons of carbon dioxide in 2007. Don't follow this link unless you read Danish.]

To put this in perspective, the Chinese probably replace all of Denmark's emissions reductions since 1995 each month, but let's get back to Mr. Wellinghoff.

The key result of this quick & dirty analysis is that there is no question of baseload capacity from coal  becoming obsolete in Denmark even with wind supplying 20% of their electricity as Wellinghoff implied. Perhaps wind would have to supply 30-40% of Denmark's electricity to replace baseload coal. The FERC Chairman said that "ultimately wind's going to be the cheapest thing to do, so you'll dispatch that [as baseload] first." Maybe so, but that's not what the lesson from Denmark teaches us so far.

Greater efficiency from cogeneration using coal, natural gas and biomass seems to have been the largest contributing factor to reduced carbon dioxide emissions in Denmark over the last decade. Wind power also played a role in the reduction, as did greater end-use efficiency in electricity consumption. Cost savings from greater energy efficiency are a good thing until Jevons Paradox kicks in. So if wind eventually turns out to be cheaper than coal, so much the better. Otherwise, there is no compelling reason to implement renewables unless your primary goal is reduced CO₂, assuming we'll never run out of exploitable hydrocarbons to burn as the IPCC claims.

Wind supplies only 1.25% of America's electricity currently, but President Obama wants to boost that share to 20% by 2030. Even if we are successful, how much baseload capacity would that wind actually replace? The Danish example suggests that reductions in our coal consumption and emissions would be relatively small from wind alone without a significant contribution from CHP. Many baseload coal plants in the United States are miles from nowhere, which makes combined heat & power impractical. We would need to build lots of smaller gas- or biomass-fired cogeneration plants close to areas where people actually live.

Wellinghoff no doubt had cogeneration and biomass in mind when he talked about distributed versus centralized power generation, but his enthusiasm for wind power seems misguided. This mistake is understandable when your policy position is identical to Greenpeace's. The wind power mania in the United States will no doubt persist until we actually implement it on very large scales. Then we will find out the truth about wind like the Danes have before us.

True Confessions

I believe we in the United States are going to talk global warming to death without ever doing much about it. I also suspect many other thoughtful people feel the same way but are reluctant to come out and say it. Passionate statements by Jon Wellinghoff and others on renewables are a lot of "sound and fury signifying nothing" in my view, although these are not necessarily idiots telling the tales.

Humans are comfort-seeking animals—a redundant statement because we are animals after all, although we don't like to admit it, and all animals maximize their comfort. We like it when the lights come on when you flip a switch or the heat comes on when you turn up the thermostat. Once you've tasted the good life fossil fuels offer, there's no going back until the party ends after the beer runs out.

Global warming is a gradual phenomenon (on human time scales) that will make few dramatic, sustained demands on our attention in the next few decades like the economy does now or the oil shock did last year—and assuming the meltdown in the Arctic doesn't cause a rapid climate shift. That's one reason we procrastinate on reducing our carbon emissions by talking about planning for wind instead of actually moving forward quickly to implement it on very-large scales. And once it sinks in that climate change is a Tragedy of the Commons, and thus every large nation on Earth must be equally committed to fixing it, we will have to acknowledge the impossibility of such unprecedented cooperation on a planetary scale. This isn't Star Trek and the United Federation of Planets, folks.

Some people rationalize inaction by denying that anthropogenic climate change is happening, despite ample warning signs to the contrary, or distorting the climate science while ignoring the generally accepted physics of the greenhouse effect. Lay people who deny we are changing the climate don't know anything at all about the science. The important thing in all these cases is to continue doing nothing by claiming there is nothing to do.

There is also a problem relating to Joseph Tainter's diminishing returns on investment in "advanced" societies like ours. Solving problems becomes harder and harder as time goes on. We want to build those wind farms, we really do, but somehow we just can't get it together. It takes years and years to get around to doing Big Projects—if we ever do. In the 1950s, when we built the interstate highway system, anything seemed possible. In 2009, nothing does. We know how to print money but we no longer know its value or how to spend it.

Therefore I don't think the Big Earthly Powers (the US, the EU-27, the BRIC countries) which have achieved or desire comfort will ever have the political will to make an 80% carbon dioxide emissions cut by 2050. Of course, the date 2050 is meaningless in 2009, which is the whole point. If such a reduction does occur, it is far more likely to happen because humankind ran short of fossil fuels to burn, not because of voluntary efforts to reduce our carbon footprint.

So I don't get too bent out of shape about Jon Wellinghoff's vision of Things To Come, a time when baseload capacity will be an "anachronism." And I can certainly understand the conservatism and discomfiture of those like Mark Styles who worry that such visions are not "grounded in reality" and "skewed by wishful thinking."

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Contact the author at dave.aspo@gmail.com