Styles 2010 energy round-up

Geoff Styles, as preeminent an energy blogger as there is, has a little round-up of 2010 in energy, which is worth reading in full (including links), so I won't paraphrase it exhaustively here. He comments that the two truly unforeseen and shaping events of the year were Deepwater Horizon and "the less spectacular but no less profound awakening to the possibilities of the shale gas revolution." His comment on shale gas is particularly insightful:

That might help explain why the developers of renewable electricity sources such as wind have struggled so much this year, despite receiving $3.9 billion in direct cash grants from the US Treasury. They're not competing with $90 oil; the US generated less than 1% of its electricity from petroleum this year, through September. Instead, they're competing with gas at an effective price of $25/bbl or less.

Here's the killer graph:
Shale gas really is a game-changer, but its continued rapid growth is not a foregone conclusion. The two massive unknowns that I will be watching closely in 2011 are the environmental impact (already much debated and increasingly feared), and how it evolves outside of North America - in previously gas-vulnerable Europe, and even more so in China, where the reserves are likely enormous and the government has the power to develop them rapidly, if desired.

With that, Merry Christmas to you and your loved ones, and I will get back to mine.

74% of BP spill eliminated

The good news - an impressive 74% of the oil from the Deepwater Horizon spill is estimated to have "already evaporated, dispersed, been captured or otherwise eliminated":

A government report finds that about 26 percent of the oil released from BP’s runaway well is still in the water or onshore in a form that could, in principle, cause new problems. But most is light sheen at the ocean surface or in a dispersed form below the surface, and federal scientists believe that it is breaking down rapidly in both places.

That bad news is that 5 billion barrels of oil was a lot to start with.

Strange disaster math

Alex Tabarrok at Marginal Revolution:

Number of birds killed by the BP oil spill: at least 2,188 and counting.

Number of birds killed by wind farms: 10,000-40,000 annually.

Number of birds killed by cars: 80 million annually.

Number of birds killed by cats: Hundreds of millions to 1 billion annually.

Don't worry there is some good news.

Number of birds killed by fisheries: tens to hundreds of thousands annually (fortunately for the birds, some of these fisheries are now shut down).

BP foresaw its doom

This would be hilarious if it weren't so sad:

Offshore Oil Strike is a genuine BP-endorsed board game from the 1970s, in which players manage an offshore drilling operation. Hazard cards hinder gamers with clean-up costs and rig explosions.

The fact that the current scenario could be roughly foreseen decades ago in a board game, let alone the type of sophisticated scenario-planning exercises oil companies (Shell in particular) are known for, leads me to agree with Michael Roberts that

... BP was in fact irrational when it came to prevention efforts. The risks and potential damages to their bottom line profits were, objectively I suspect, way larger than BP's CEOs thought, despite warnings from their engineers.

A few BP links

Just got back from two weeks of vacation, including some time in South Africa for the World Cup (which was fantastic, by the way, except for the elimination of a promising U.S. side by Ghana, and the subsequent elimination of Ghana - the last African team - by the hand of God Luis Suarez).

Anyway, back to the real world... I've spent the morning reading through my RSS feeds and here are a few BP-related links that I don't feel the mental energy to write full posts on.

1. "And if we aren’t careful, we will encourage companies that have enough money for collection to leave the drilling to those that don’t." (Richard Thaler, via Tyler Cowen)


2. Don't forget, BP also gave the world Ayatollah Khomeini (via Chris Blattman)


3. Container cap no longer on?


4. BP now more evil than Goldman Sachs


5. BP spills coffee

Addendum: Here's the Economist (subscription required) on the Obama deepwater drilling ban:

The people it presumably intends to protect—the residents of south Louisiana, whose fisheries and shorelines are being fouled by BP’s still-gushing Macondo well, and the oilfield workers who could be at risk from another disaster—are probably its loudest critics. Nearly two out of three Americans support the ban, according to one recent poll, but gulf coast residents are split down the middle.

Small (deepwater drilling) world

The now-infamous Deepwater Horizon was the same drilling rig that shattered the record for deepest well and discovered the massive Tiber field for BP back in September.

Connection made with the help of this post by John Whitehead of Environmental Economics.

The other oil spill

The Deepwater Horizon spill has continued to worsen - the latest estimates of leak volume have doubled (again), BP's reputation is plummeting (as is its market value), the Obama administration appears largely powerless and increasingly blamed, and U.S. consumers and taxpayers appear to be the major losers in the long term. But as the Guardian pointed out, Nigeria's agony dwarfs the Gulf oil spill - and it has been going on for decades.

One report, compiled by WWF UK, the World Conservation Union and representatives from the Nigerian federal government and the Nigerian Conservation Foundation, calculated in 2006 that up to 1.5m tons of oil – 50 times the pollution unleashed in the Exxon Valdez tanker disaster in Alaska – has been spilled in the delta over the past half century. Last year Amnesty calculated that the equivalent of at least 9m barrels of oil was spilled and accused the oil companies of a human rights outrage.

That is a wide range of estimates - at 7 barrels per ton, Amnesty's estimate for last year is almost equivalent to the other estimate for the past century. But even if we take the former estimate, it would take the Deepwater Horizon well almost a year flowing at the new estimated 30,000 bbl/day rate to equal the amount of oil leaked into the Niger Delta over time - and look at the horrific environmental and economic consequences after only a month.

The problem with Nigeria, of course, is the security challenges atop the technical ones.

Last month Shell admitted to spilling 14,000 tonnes of oil in 2009. The majority, said the company, was lost through two incidents – one in which the company claims that thieves damaged a wellhead at its Odidi field and another where militants bombed the Trans Escravos pipeline.

I don't have any answers - it is such a complicated situation that it is hard to know the best way to intervene, even if the political will could be summoned. But maybe one tiny silver lining of the Gulf disaster is that Americans will now appreciate more vividly the consequences that Nigeria has faced for so long - I know I do.

Regulation vs. torts

Responding to libertarian commenters, Paul Krugman argues that torts are not nearly as effective as environmental regulations in practice.

Commenters say, but isn’t that an equally strong reason to believe that regulation won’t work either?

Well, here’s the thing: regulation demonstrably does work where tort law doesn’t. Consider the environmental issue: in reality, the perpetrators of oil spills never pay most of the cost; but in reality, environmental regulation has led to much cleaner air and water. (Look up the history of Los Angeles smog or the fate of Lake Erie if you don’t believe me.)

Tyler Cowen dissects Krugman's argument in his typical incisive and dispassionate style, scoring points (except I don't think he's keeping score) like:

There is in fact an agency regulating off-shore drilling and in the case under question it totally failed. How can Lake Erie, an orthogonally related success, be cited but this very directly relevant failure not be mentioned?

As usual, Cowen comes across as eminently sensible and I find it hard to disagree with much that he says. Am I just too rushed, and/or not trying hard enough?

Dead zones vs. oil spills

While ethanol producers have been quick to spin the Deepwater Horizon tragedy toward their own advantage, NRDC's Nathanael Greene has a quick rebuttal:

The nitrogen runoff from corn grown all along the Mississippi causes a huge dead zone in the Gulf every summer. As this map shows, the dead zone at least as large as the oil spill and it takes a huge toll on the marine life and region's economy every summer. With about a third of the corn crop going to make corn ethanol, it should be clear that more corn ethanol is not a real solution.

He's referring to this image from the NYT, which makes a side-by-side visual comparison easy; in fact, the hypoxic zone looks considerably larger than the oil spill to date.

A hypoxic zone is in some ways not as destructive as an oil spill - it will not cripple fragile marshland ecosystems, for example - but the impact on marine life alone is no doubt harmful for the coastal fishing industry that could be (and once was?).

It is not news that corn ethanol is hardly an environmental angel, but it is worth keeping in the public conscience as the Deepwater Horizon leak continues unabated and the inevitable public backlash builds in strength.

Chances of history: Deepwater Horizon and Texas City

With the Deepwater Horizon spill worsening further, and "ultimate relief" likely three months away, it's not surprising that people have started to throw bricks at the involved parties with articles like "BP Fought Safety Measures at Deepwater Oil Rigs." This will no doubt continue (Halliburton and Transocean have also already been called for a Congressional pillorying), and wherever the lion's share of the blame is ultimately laid, no one will come out looking good.

I find the parallel to the Texas City refinery blast fascinating. There also, BP was accused of prioritizing cost savings over safety, and the tragic accident ultimately derailed the aspirations of John Manzoni, then head of BP downstream, to succeed John Browne as CEO of BP. Until then the heir apparent. Manzoni fell from grace with the Texas City incident and the lesser-known head of BP's upstream business, Tony Hayward, assumed the spotlight, and ultimately Browne's job.

Imagine the parallel universe in which Deepwater Horizon blew up in 2005, and Texas City not until 2010. Does Manzoni become CEO? Does BP not back away from "Beyond Petroleum" as much as it has during Hayward's tenure? Does this have knock-on effects beyond the super-major and throughout the entire global energy business?

I don't have any answers, but the questions fascinate me, as does the idea that such a complex and enormous beast like global energy markets can turn simply on chance and personality.

On a distantly related tack, Michael Roberts takes this opportunity to look at what might be called the political economy of small-probability catastrophic events.

Energy back-of-the-envelope of the day

Geoff Styles calculates that the newly-approved Cape Wind will generate only slightly more energy than is leaking from the single well drilled by Deepwater Horizon:

Cape Wind and the Macondo prospect that the Deepwater Horizon rig was drilling into represent opposite poles of the energy spectrum, and not just because the latter is now leaking oil into the marine environment at a rate that the latest estimate puts at 5,000 barrels per day, much higher than initially thought. Cape Wind would tap into the clean and renewable, but extremely diffuse energy sources that surround us. After taking into account the restrictions imposed by DOI, its 130 turbines would on average generate as much electricity as a gas turbine power plant consuming a quantity of natural gas equivalent to 6,000 bbls/day of oil. In other words, it takes a very large array of offshore wind turbines to match the energy in the oil currently leaking from a single well. Platforms similar to what BP might have been planning to install after successfully completing the exploration of Macondo routinely produce up to 20 times that much oil.

Louisiana spill quickly worsening

Lots of things look very bad about the Deepwater Horizon explosion and oil spill, starting with the fact that it can now be seen from space:

It is also five times larger than originally thought (and they have discovered a previously undetected third leak), only 16 miles off the Louisiana coast and expected to come ashore on Friday, the military has been called, state of emergency declared, and platform owner BP has already started finger-pointing at operator Transocean.

Meanwhile, Geoff Styles is, while still dignified, about as defensive as I have ever read him. For example, while it may be true that much more oil leaks naturally than from man-made spills, natural leakage simply does not cause the magnitude of environmental impact that I fear we will see shortly on the Louisiana coastline, so its relevance is negligible. His conclusions are more robust, but still optimistic - first, that

However we assess the cost of such spills when they happen, the benefits of offshore drilling are still compelling

... which is probably true, but could turn into political kryptonite depending on how badly this environmental disaster plays out. His second main conclusion is that

It is only right and fair for states like mine that are adjacent to the federal waters in which drilling would occur to share in the royalties this will generate. Politicians in inland states might see those royalties as belonging to the whole country, but their states won't bear any of the risk, no matter how small it might be before the fact.

This is very reasonable, but may not be very relevant for his home state of Virginia, among others, if this very visible accident swings the political tide against "Drill, baby, drill!" for the foreseeable future.

Greenland's oil, cont.

Via Felix Salmon, Greenland is "poised to achieve a geopolitical importance it hasn’t had since the invention of Risk."

Some estimates, including those of the U.S. Geological Survey, suggest Greenland’s coastal waters could hold anywhere from 16 billion to 47 billion barrels of oil, or 800,000 barrels for every man, woman, and child. That would mean a staggering leap in income for Greenlanders, who until two generations ago were mostly subsistence hunters and fishermen.

As the article notes (and I've noted before), not everyone is happy with this prospect. But it seems like both the hopers and the worriers will have to be a bit more patient:

The state oil company, Nunaoil, had one of the largest booths, with an eye-catching flame flaring out of an oil-burning lamp. I asked a company rep manning the booth where the oil was from. “Italy,” he laughed. “It’s olive oil from the grocery store. We haven’t found oil here yet.”

Blackstone and Warburg win big with oil

Raw commodities are far from the ideal private equity play - heavy value exposure to volatile commodity prices and seemingly little competitive advantage in either deal flow or operations. But a brave few have tried, and in at least one case succeeded:

Warburg Pincus and Blackstone Capital Partners are set to make a four times return on their investment in West African oil company Kosmos after oil giant ExxonMobil agreed to acquire Kosmos’ stake in Ghana’s Jubilee oil field for $4bn, according to reports.

I checked the Warburg Pincus website and found that:

Warburg Pincus led the company’s initial $300 million equity financing in 2004, and also led a $500 million follow-on equity financing in 2008.

I then checked the news for when in 2008 (makes a big difference!), and it was in June, or basically when oil prices were well above $100/bbl and racing towards $150. So it's not as if Blackstone and Warburg simply bet on and nailed the commodity cycle - it seems their add-on investment came at the peak. It seems the bet was more on the management team and their track record, which is impressive. That said, I doubt we see too many more of these deals - with the recent levels of commodity volatility, most major PE firms are shying away from direct commodity price exposure and looking for more indirect ways to get exposure to the overall volume and price growth.

Oilfield technology is basically good enough

Via Green Sheet, long-time energy investment banker Matthew Simmons doesn't think oilfield technology has much room for improvement (and therefore technological progress is not a good argument against Peak Oil).

The final topic the Gang discussed was the rapid advances in oilfield technology. Sadly, this is the greatest myth of all. I spent four decades as an investment banker to the global oil-service industry, which collectively invented all of this technology. The concept that there are new innovations in this area is false.

In fact, the seeds of this so-called technological revolution -- the ability to exploit oil from deep water or drill horizontally -- were first developed 40 years ago. I personally raised a great deal of the venture capital that helped implement some of the most important technical advances in the industry. Our firm, through advising on mergers, consolidations, reorganizations, and bankruptcies, helped save the oil-service companies that created these great technological advances that help us find and commercially exploit oil and gas.

None of this technology is new -- in fact, it is now quite mature. Sadly, there are few new ideas in the oilfield pipeline to replace advances that were made decades ago.

These ideas may be old, but they are still in the process of being deployed commercially against new reserves, whether deepwater like BP's new Tiber find or onshore unconventional reserves like oil sands and shale oil. To me, the crux of the technology argument is not that a new silver bullet will magically appear on the horizon, but rather that the frontier of existing technology allows us to exploit a wide range of unconventional oil reserves, of whose production potential we have only scratched the surface (e.g. Canada and Venezuela are both estimated to have reserves in oil sands equal to the entire world's reserves of conventional crude). At higher prices, probably, which means lower demand, but not imminent and catastrophic supply shortfall.

Brazil's oil policy: cost vs. jobs

Brazil has prioritized local job creation over speed and lowest cost to develop its considerable pre-salt oil reserves.

Brazil has instated heavy local content rules for production of equipment such as oil platforms to ensure the development of the deep-sea reserves provides jobs and economic growth while fortifying domestic industry.

Note the euphemistic use of the word "rhythm" by Petrobras CEO Jose Sergio Gabrielli:

"The rhythm (of bidding) for those new areas will be heavily determined by the capacity of domestic industry to provide goods and services for the gigantic investment program," Petrobras Chief Executive Jose Sergio Gabrielli said in a conference call. "That is for me the driving force for the rhythm of bids in those areas."

This may seem like a poor decision from the traditional Western capitalist mindset - it will both delay the onset of production and result in higher costs than internationally open bidding would. But the Brazilian government - particularly Lula's, which has deep left-leaning roots despite its generally careful and centrist stewardship of Brazil's economy - is trying to optimize a different objective function. Local oilfield equipment manufacturing will need to spring up to supply the demand, creating jobs and potentially companies that can then compete internationally as other countries make ultra-deepwater discoveries. Viewed through that lens, the local content rules make more sense.

And while Petrobras would object if they were an independent private company, I suspect they are actually largely aligned with the government. After all, the chairwoman of their board, Dilma Rousseff, is Lula's heir apparent. And more broadly speaking, the culture of Petrobras is of a proud organ of the state. A friend who works there once described it to me as a bizarre combination of world-class technical expertise and massively inefficient and overstaffed management bureaucracy.

BP makes "giant" discovery in Gulf of Mexico

BP's "giant" oil discovery in the Gulf of Mexico is all over the news this morning.

“It will be bigger than the 3 billion barrels” of oil equivalent discovered at the nearby Kaskida field, said Robert Wine, a London-based spokesman at BP. “This is a whole new geological play we’ve got here.”

In the FT, a few analysts give their interpretations of the size and significance of the find. The FT also has this nifty chart showing the impressive technical strides deepwater drilling has made (the new "Tiber" find is over 10,000 meters deep, a depth considerably greater than Mount Everest's altitude of 8,848 meters).


Update: Tim Haab at Environmental Economics calls it "Economic theory of depletable resources 1, Peak oil predictions 0."

Again: higher oil prices create at least three types of incentives 1) Incentives to invest in alternative fuel technologies, 2) Incentives to conserve, and 3) Incentives to explore for new sources of oil.

Shoddy energy journalism

Like I said, the media doesn't really get what's going on in Brazil - take for example the latest headline from Green Sheet, "Brazil Opts For Nationalized Oil Production".

No, Brazil is not "nationalizing" oil production in the sense the term is commonly used - expropriating private assets or unilaterally abrogating contracts with foreign companies. That's what Bolivia did in 2006, and what Venezuela did in 2007, which is why foreign oil companies are reluctant to invest in the Orinoco Basin despite its relative technical simplicity (increasingly scarce in new oil reserves).

The shared-production contracts that Brazil is moving to are common practice all over the world. And while Petrosal will be the legal owner of the pre-salt oil reserves (the surrogate state, if you will), foreign oil companies will be allowed to own up to 70% stakes in some fields.

It's a complicated situation, hard for anyone to understand. It doesn't need to be further complicated by imprecise language on the part of the media.

PetroSal's raison d'être

The concept has been much-discussed, but it looks like now the government of Brazil is moving forward with plans to create a separate state oil company called Petrosal to control its heralded potential oil reserves in the pre-salt geological layer of the ocean off the Brazilian coast.

I haven't seen much understanding in the English-speaking media of the purpose of PetroSal. It will not be an operating company (Petrobras is already among the best in the world at deepwater exploration and production, private oil majors included). Rather, it will be a separate legal and financial entity that will "own" the reserves and interface - legally speaking - with foreign oil majors interested in the pre-salt area.

Why is this necessary? For one, Petrobras is publically traded, and while the government controls voting through golden shares, any profits to Petrobras would be distributed widely to international investors, rather than kept entirely within Brazil.

Second, there are little-understood tax implications. Under existing contracts, royalties for offshore accrue mainly to the states of São Paulo and Rio de Janeiro - two of the richest states in Brazil. President Lula's goal is to use the proceeds to fund massive social spending to rise the standard of living in the poorest parts of Brazil, and a new legal structure for oil royalties would channel more of the proceeds to the federal government.

This points to a third reason for Petrosal, which in my mind is a good one - separating social goals from business ones. We've seen in Venezuela how Chavez has used PdVSA as his private piggy bank for social programs, and its oil-related investments suffer as a result. This has hit Venezuela's overall oil production; Petrosal could be a step in the right direction to avoid that fate.

The creation of Petrosal and other new rules alone will not be enough to avoid the resource curse, which as Moises Naim points out in the FT can result from both macroeconomic factors (Dutch disease) and political ones (corruption and lack of government accountability). But I remain optimistic that Brazil will be able to walk the delicate line between attracting enough foreign investment in exploration and giving away too many of the proceeds. As for the efficacy of the resulting social spending, on that only time will tell.

P.S. For anyone interested in the many manifestations and implications of "the resource curse", I highly recommend Escaping the Resource Curse, a collection of essays from diverse points of view (academic, government, legal, business) on the resource curse. Oh, and both Joe Stiglitz and Jeff Sachs are editors.

P.P.S. Apparently the markets didn't like the announcement too much, shaving $7bn off of Petrobras' ~$180bn market cap. I'm not convinced the market really understands what's going on here, though. Bloomberg certainly doesn't.

The latest Peak Oil spat

A reader has asked for me to weigh in on the recent Peak Oil spat; in truth I was meaning to do so, but the commentary has piled up and I felt increasingly intimidated by the task of commenting on it. But here's an attempt at a quick synopsis:

To warm up, on Monday, Daniel Yergin (author of The Prize, the best book about oil I've ever read) wrote a piece in FP saying basically that Peak Oil fears are overblown because the combined response of technology and demand will adjust the world to declining conventional supply.

Then, main provocateur Michael Lynch published an NYT op ed calling Peak Oil "a waste of energy" and making the aggressive claim that oil is destined for $30/bbl in the long term.

The response was quick and furious; not one but two point-by-point rebuttals from The Oil Drum, as well as one by Morgan Downey (the author of the best book about oil I haven't finished reading yet, Oil 101 - I got diverted but it has received great reviews from very credible sources). And from the complete other end of the spectrum, Climate Progress took Lynch to task, going so far as to offer a bet:

Here’s my bet to Lynch. Let’s take the average price of oil from 2010 to 2015. For every $1 a barrel it is below $40, I’ll pay you $200, if you pay me a mere $100 for every $1 a barrel it is above $40.

That should be a no-brainer since I am giving him 2-to-1 and spotting him $10 a barrel off of what he says the right price is.

As I've mentioned before, I fall somewhere in the middle - I think $30/bbl is implausible, but the combination of 1), massive unconventional reserves (oil sands in Canada and Venezuela, deepwater in Brazil and who knows where else) that can be produced at a cost around $50-100/bbl, and 2), the power of high prices to destroy demand and incentivize development of alternative energy sources makes it unlikely that prices will settle much higher than $100/bbl in the next decade. Now, there may be volatility and prices spikes driven by supply shocks - we may have one coming, in fact, as the current recession has slammed exploration capex - but these will only last as long as it takes to deploy additional capital like it was deployed in 2007/2008.

(There is the chance that major geopolitical chaos could result in sustained higher prices, but that isn't the mechanism Peak Oilers are betting on.)

Peak Oil is many things - a mathematical tautology, an effective gimmick:

But regardless of the holes in Hubbert’s theory, peak oil, the gimmick, still serves to remind us that some day the oil will be gone, out of our reach, or most likely of all, extraordinarily expensive. Peak oil, as a way of understanding the real costs–political, economic, environmental–embedded in oil production regardless of the day’s market price per barrel, needs to live on.

... but I do not see it as a rigorous analytical argument that justifies energy alarmism in the short term.