Three deformations of the apocalypse

In response to my 2012 outlook last week, a reader requested a five-year outlook that’s long on opinion and short on data. As SmartPlanet’s resident energy futurist, how could I decline? As that reader suggested, I will offer three scenarios: the bad, the good, and the likely.

The bad: Evil drift

Tough times call for tough men. But at this crucial turning point in history, they are nowhere to be found. The entitled class of pantywaist leeches who command our political and economic institutions spend their time slap-fighting over picayune issues and debating points of style like 18th Century French courtesans, accomplishing nothing, utterly tone-deaf to the cries of the people. (Overheard in the Bastille in the spring of 1789: “These protestors are so disorganized and filthy. What do they want? Can’t somebody just clear them from the square?”) As it always has in the past, this toxic brew spawns revolution.

The Fed remains committed to pushing printed dollars onto a world already awash liquidity, in hopes that growth will return. But it doesn’t. The captains of the financial industry refuse to mark their hallucinated assets to hard assets, because the former exceed the latter, and the people are unable to force a reckoning that would put the economy back on terra firma. The great tide of the global currency wars sucks the sand out from under our feet as it recedes, and we gradually sink deeper into the mire of debt and deflation. Slowly, bit by bit, the Great Contraction tightens around the world.

Rick Santorum is elected president in 2012 on the back of a massive evangelical campaign. The Tea Party retains its hold on the House, and the Democrats retain control of the Senate, ensuring four more years of legislative gridlock. Grover Norquist is appointed to Santorum’s cabinet, and embarks on a relentless campaign to shrink the federal government, browbeating the House leadership into radical cuts to social services. These new austerity measures squeeze the economy dry.

Spot shortages of gasoline and food begin to appear, along with ever more frequent failures of infrastructure. Transformers blow up and water mains break once a week in major metropolitan areas. Road transportation becomes increasingly difficult as roads and bridges fall into disrepair, but mass transportation systems are unable to compensate due to power outages and fuel shortages. The veneer of civilization wears thinner, and finally crumbles as complex delivery systems begin to fail.

In the aftermath of the 2012 election, Americans lose their last vestiges of faith in the corrupt, immobile knot of their so-called democratic institutions. Realizing that there are only passengers on this ship, and that no strong hand will take the till to keep us from drifting into the teeth of disaster, they live up to their self-image as anti-government, rugged individualists and take matters into their own hands.

There simply aren’t enough National Guard and police to keep the peace, and our military troops remain committed to securing our globalized corporate interests on the far-flung reaches of the American empire. Tax revolts deprive state and local governments of enough revenue to maintain, let alone increase, their police and fire services. Civil order begins to break down.

By 2013, protestors are occupying public spaces permanently. Retail shopping becomes next to impossible, sucking the remaining wind out of economy. Inner-city neighborhoods in poor areas fall under the control of local gangs. Wealthy areas hire private security and throw up fences. Street gun battles become commonplace as local thugs vie for turf. Vigorous black markets in food and fuel bloom like toxic red mushrooms in an early winter rain.

Armed mobs take over Wall Street, and go hunting in the Hamptons. The national banks collapse as it becomes impossible for them to function, leaving only small regional banks. Lloyd Blankfein meets a gory end, hanging by his thumbs from the Brooklyn Bridge. The dollar becomes worthless and gold and silver become the only accepted currencies.

Global oil supply begins to decline in 2014 as the depletion of non-OPEC producers entwines with the collapse of governments across OPEC, keeping prices high even as the global economy contracts and demand falls. Consumers in the West are continually outbid for rapidly falling available net exports by the five billion people of the East. New geopolitical alliances are formed along the shortest energy supply routes, binding Asia to Russia, and India and Pakistan to the Middle East.

By the general election of 2016, the remaining vestiges of American civil society, now desperate for order and stability, elect a hardcore right-wing fascist who promises to “kick ass on those ragheads and make ‘em give us their oil.” He launches military strikes against Iran and Syria, and re-occupies Iraq. He imposes a harsh domestic police state in an attempt to restore domestic order, imprisoning all dissidents without due process under the legal framework that Barack Obama signed into law on the last day of 2011. Millions of destitute citizens are conscripted to serve in a massively expanded military- prison complex. The governments of Canada, Mexico, and all of Central and Latin America fall under the new authoritarian government of the U.S. in all but name, as it installs friendly puppet regimes.

Global resource wars break out in 2017. The people revolt against the increasing taxes needed to fund the wars and the domestic police state, and Texas secedes from the union, followed by the states of the Pacific Northwest. (Think it can’t happen? It already did, in 1941.)

Five years from now revolution, and the dissolution of the American republic, are under way.

The good: Seizing the future

President Obama, having been reelected in 2012, abandons his previous ineffectual tactics of appeasement and finally finds his sac. At the head of a new Democratic majority in both houses of Congress, in which labor threw out the stultified party leadership and brought in a new crop of reformers, he leads the country on a breathtakingly ambitious infrastructure rebuilding program, riding roughshod over all opposition. Over $1 trillion dollars per year are committed via public-private partnerships to transition transportation to rail, rebuild our water and sewage systems, and transition grid power to renewables. Only essential local roads are maintained, and lanes of interstate highway are converted to rail corridors. The power grid is nationalized and upgraded with smart-grid technology. A high-voltage long distance DC transmission grid is built to redistribute wind power from the Plains, solar power from the South and Southwest, geothermal power from the Rockies, and marine power from the coasts. Solar PV becomes the cheapest form of power generation by 2016.

The program reunites the country politically, restoring full employment and national pride. The principled opposition to federal spending is swept away by a new fervor to retake the high ground of the global economy. The American Restoration Act of 2012 imposes harsh penalties on profits made from foreign operations, while rewarding the repatriation of profits and manufacturing with generous tax breaks. “Made in America” becomes a national slogan again, and is proudly stamped into every nut and bolt.

The surge of domestic rebuilding tilts the global balance of power back toward America, as companies scramble to rebuild manufacturing capacity at home and withdraw from their outposts in Asia. The dollar becomes stronger, and the return of growth allows the Fed to begin withdrawing the trillions of dollars it injected after the crisis of 2008.

Sweeping financial reform legislation is forced through Congress, including a massive transfer of private sector assets to the federal balance sheet. Bondholders are forced to take a 50 percent haircut. New incentives allow all Americans to refinance their homes and personal debt under federal programs at 2 percent interest for 30 years, with the stipulation that they can no longer use credit cards. Banks are once again relegated to the boring historical norm of making loans earning no more than 2 to 3 percent interest, and are forbidden to use leverage or take positions in equities or commodities. The finance sector is forced to shrink from over 8 percent of GDP today to just 2 percent, as it was in the 19th Century, and millions of its workers are forced to find something useful to do.

The “Victory Garden” initiatives of WWII are revived, and everyone plants vegetables in their yards. Those without yards are given plots to farm in public parks. Overbuilt and disused suburbs are demolished, and the land converted to agriculture. Tariffs are imposed on imported food in proportion to how far it traveled to get to the U.S., and agriculture is slowly relocalized across the country, resulting in a two-million-barrel-per-day cut in domestic oil consumption by 2017.

Five years from now, America is on course to be a new economic powerhouse with domestic demand replacing the falling consumption of Asia. The decline of global oil supply pinches the economy, but does not break the skin, as demand is shifted from liquid fuels to domestic renewables. Realizing that she can get by on North American oil supply once the transportation and power transitions are complete, America begins to withdraw its military forces across the globe, ending the drains of military adventures and foreign oil expenditures simultaneously. By the time the global resource wars ensue in 2017, she will stand once again as a prosperous, peaceful, more insular, “shining city on a hill.”

The likely: Decline by default

Barack Obama is reelected by default in 2012, since none of the GOP’s insane clown posse are deemed both electable, and acceptable to the Tea Party. A broad anti-incumbent electoral revolt completely transforms the leadership of both parties and creates a balance of power in both houses of Congress, creating a brief window of opportunity for real change.

Unfortunately, that opportunity is squandered for a lack of effective vision and leadership. As in all other scenarios, oil still declines starting in 2014, squeezing the economy and stifling growth. The Fed keep printing, but in vain. America is sucked into the deflationary vortex by default.

Oil prices remain just above the pain threshold of ordinary Americans. In response they move to small apartments in converted downtown office buildings. Empty suburbs are abandoned and James Howard Kunstler does a victory dance in the dust of the geography of nowhere, to the applause of no one. Roads and bridges fall into disrepair, forcing the working class to crowd into slow, meandering buses and decrepit light rail systems when they aren’t traveling on foot or bicycle. Things work until they don’t, and then they are abandoned.

America is drawn by default into the global resource wars starting in 2017, but fails to secure any significant new supply of foreign oil. Available imports from the Middle East begin to fall, prompting a massive drilling and mining campaign across every last inch of America where hydrocarbons may be found, with attendant soaring environmental damage. But solar PV still becomes cheaper than regular grid power, and millions of small rooftop solar systems with battery backup are installed by individuals in self-defense, creating little islands of light in a country plagued by sporadic blackouts.

Unemployment continues to rise until Americans are willing to work for less than the Chinese. Farming is the hot sector for young people entering the workforce, as the finance, insurance and real estate sectors shrink. Millions of Americans move to Canada in search of a better life and a stronger currency. The dollar survives, but it doesn’t buy much.

Five years from now, America is crumbling, mumbling and bumbling its way to a smaller, leaner, and more agrarian economy. Its superpower days are fading into history. The republic holds together in name only. The inability of the economy to generate excess revenue starves the federal government of receipts and a gradual, decades-long shift to more regional governance and culture begins.

Postcript

I have offered these fanciful, extreme, and hopefully mildly humorous scenarios to provoke thought, not to draw a map. And if I seem hard on the GOP, it’s because of their staunch opposition to energy and transportation transition, which I believe are absolutely necessary to avoid collapse. In reality, the next five years will be replete with surprises—including natural disasters, unprecedented political upheaval, and unimaginable financial hijinks—that may incorporate elements of all these scenarios.

So. . . What’s your scenario?

Illustration: “Enchantment’s End” (gideon_wright/Flickr)

That was originally part of my recent post, The questionable economics of shale gas

I’d also point your attention to a new piece by Reuters, who did some good investigative journalism on top shale gas operator Chesapeake Energy, and accused them of conducting a stealth “land grab” operation by using a series of shell companies: Energy giant hid behind shells in “land grab”

This kind of work is vitally important, because the majority of press about shale gas still consists of wild-eyed optimism and verbatim repetition of industry propaganda. For example, this new piece in the Wall Street Journal.

There is still plenty of energy-illiterate press going around, such as the recent rash of articles that misinterpreted the US becoming a net exporter of refined products as being a net exporter of oil, when we are still the world’s top importer of oil. It’s pathetic. The data are freely and publicly available, so why are these egregious errors still being propagated in high-profile publications? I hope my recent pieces help to clear things up just a little.

Postscript: Al Gore blogged on my story January 8, 2012

Corrections: Most regrettably, I discovered two typos in the story some weeks after it was published:

1) “At the 2010 rate of American consumption—about 24 tcf per year—that would be a 95-year supply of gas, which apparently has been rounded up to 100 years.” should have been “At the 2009 rate of American consumption—about 22.8 tcf per year—that would be a 95-year supply of gas, which apparently has been rounded up to 100 years.” At the 2010 consumption rate of 24.089 tcf/yr, the 2,170,000 bcf estimate would last 90.082 years. (Therefore, one could say that one year’s increase in US gas consumption shaved five years off the claimed supply.)

2) “It offered a range of estimates, from 43 tcf at 95 percent probability, to 84 tcf at 50 percent probability, to 114 tcf at 5 percent probability.” The high end USGS estimate was 144.1 tcf, not 114.

Read it here: 2012: Terra incognita

Predicting the future is never easy, but as I contemplate what 2012 might bring, I confess that it’s never been harder.

In 2005, it was fairly easy to see that commodity prices would rise in the coming years, and that the purveyors of petro-Prozac who dominated the press were wrong. It was evident in the data, particularly on oil. My outlook was generously validated up through the first half of 2008. While I expected a significant correction in housing prices and equities, I underestimated the magnitude of the late-2008 crash in the financial markets. Only a few observers who paid close attention to arcane derivatives markets got that one right.

In the fall of 2009, I made some outlier calls for 2010 on oil, equities, the US dollar, and China, all of which proved correct. I attribute that in part to luck, but mostly it was the result of having done my homework and developing a fine-tuned contrarian view.

Then it got more difficult.

In the fall of 2010, I was having a long email discussion with some fellow peak oil analysts about our outlooks for oil supply, trying to identify when the next big oil price spike might occur. After working over several detailed models of OPEC and non-OPEC supply, I snipped irritably that oil prices would likely be affected far more by above-ground factors in the next few years than below-ground factors. Geopolitics would soon trump geology, I ventured, and we would do well to pay attention to the news overseas. One well-placed bomb, another big hurricane in the Gulf of Mexico, a civil war in the Middle East, or any number of other events could blow our carefully constructed mathematical models out of the water.

But even I did not anticipate how radical the upsets of 2011 would be. No one could have predicted the earthquake and devastating tsunami that struck Japan on March 11, or foreseen how wide-ranging its effects would be: from shutting down automobile manufacturing plants, to record grid power prices in Hawaii, to several of the world’s most advanced economies turning their backs on nuclear power. We had plenty of advanced warning that weather would become more erratic due to climate change, but a record 12 natural disasters in the U.S. costing $1 billion or more, each, was an eye-opener. And I don’t think anyone expected the Arab Spring. It was a tough year for dictators.

Geopolitical challenges for fossil fuels

Above all, what jumps out of my crystal ball about 2012 is geopolitical instability. The popular unrest we saw worldwide this year feels like a mere prelude to a very chaotic period.

As an example, consider the slew of threats that currently imperil the global oil market:

• On December 16, a months-long peaceful protest by striking oil workers in Kazakhstan exploded into violence. Somewhere between 14 and 64 people were killed by police over the following weekend (depending on whether you believe the official count or a report from the morgue) in a harsh government clampdown which included shutting off all Internet and telephone access, and cordoning off the city. (Steve LeVine has been doing some terrific coverage of the events there for Foreign Policy.) The echoes of the Arab Spring are unmistakable. With about 1.6 million barrels per day (mbpd) of oil production, Kazakhstan is the world’s 18th-largest oil producer, on par with Libya’s output before the uprising there added about $10 to the global price of oil.
• Fresh waves of unrest in Syria could lead to civil war and seriously destabilize the already-tenuous oil trade in the Middle East. Oil production there has fallen from over 400,000 barrels per day in 2010 to 260,000 bpd now, in part due to EU sanctions. And Egypt is still very much in play in the region.
• Sanctions are likewise behind heightened tensions with Iran, as the US and EU forbid domestic and foreign partners from doing any business with the country in continuing efforts to stymie its nuclear ambitions. Iran conducted naval war game exercises near the Straits of Hormuz last week in retaliation, an implicit warning that it would attempt to shut down the critical Persian Gulf oil trade chokepoint if hostilities increase. And yesterday, they made that warning explicit, as Vice-President Rahimi said, “If Iran oil is banned not a single drop of oil will pass through Hormuz Strait.” Iran’s primary oil buyers, including China, Japan, Korea, and India appear to be seeking alternate supplies, but that will support oil prices globally as competition increases for oil from OPEC producers, notably Saudi Arabia.
• The situation in Iraq deteriorated almost immediately upon the exit of US military forces, with fighting between Sunni and Shiite leaders within the fledgling central government threatening its dissolution. A barrage of attacks in Baghdad over the last week portend continuing violence and instability, and do not bode well for the future of oil supply in the region.
• Tens of thousands of protestors jammed the streets of Moscow on Christmas Eve, jeering the Kremlin over widely alleged fraud in the recent election which retained Prime Minister Vladimir Putin’s grip on power. Russia was the largest oil producer in the world at the beginning of 2010, and now stands just below Saudi Arabia with 10.3 mbpd of production. Were it not for Russia, non-OPEC oil production would have been in steep decline for the last several years, and as such it remains a critical pillar of stability for world oil markets. . . a pillar which may now be eroding.

Though little reported in the American press, popular protests are on the rise in China as well. With a major turnover in leadership scheduled for 2012, there is at least the potential for significant reforms favorable to the country’s burgeoning middle class, who are growing increasingly restive under the suppression of its central government. But there is also the potential for renewed attempts to reinforce authoritarian rule. In the province of Guangdong in the south of China last week, tens of thousands of residents participated in two separate protests against the local governments over land policy and a planned expansion of a coal-fired power plant in the smog-choked town of Haimen. With the largest GDP of any province in China due to its heavy manufacturing base, Guangdong may be considered a leading indicator of China’s direction, more oriented to its trading partners to the west than to Beijing. Local authorities capitulated to the demands of the Haimen protestors, but only after police used tear gas to quell the demonstration. In short, China looks like an interesting wild card in 2012 where popular unrest could explode, particularly if its economic growth slows significantly, as some observers expect, and/or if the protests in Russia become more strident.

Another interesting wrinkle with potentially far-reaching implications emerged on Christmas Day, as China and Japan announced that they would begin direct bilateral trading of their currencies. About 60 percent of the trade between the two nations is currently settled in US dollars, according to Japan’s Finance Ministry. Coming from the two largest holders of foreign-currency reserves in the world, the accord constitutes a potentially serious threat to the hegemony of the US dollar, which has conferred an enormous economic advantage to America for many decades. The pact is considered largely symbolic for now, but could signal the ascendancy of the renminbi, and will likely lead to continued weakening of the dollar against it. More broadly, the move could presage an entirely new era of geopolitical alliances.

Economic outlook

The economic front looks perilous indeed. It is certainly possible that 2012 will be another year of aimless bouncing around in a narrow channel while the world’s central banks keep trying to extend and pretend. With just three trading sessions left in a brutally difficult year that ruined many a seasoned hedge fund manager, the S&P 500 stands up a lousy 0.6 percent on the year. That could happen again. But I would put greater odds on a real reckoning. The long series of attempts to save the Eurozone in the final months of 2011 staved off collapse, but they fixed nothing. The enormous overhang of leveraged debt and the impossibility of restoring economic growth in the West are still with us, and every month that passes without an honest strategy to bring obligations in line with hard asset values only increases the threat. Faith in the markets, the dollar, and the euro has all but evaporated, and our economies now hang by a string dangling from the hand of Ben Bernanke. If that string doesn’t break in 2012, it will in 2013, or 2014 at the latest. The key question is how long the world’s central bankers can skate on the thin rim of the deflationary vortex.

Should the global financial regime fail, there will be blood in the markets. Bank runs are not out of the question. Commodity and equity prices could fall to the tune of 40 percent or more, but without destroying enough demand in Asia to restore a comfortable cushion of supply in oil and agricultural commodities. Here, it is useful to reflect on 2008. From 2005 on, the data suggested that 2012 would be the turning point when oil supply began its long, inevitable, terminal decline. But the crash of 2008 bought us a few more years of adequate oil supply at a moderately uncomfortable price, and pushed that point off, at least theoretically, to around 2014. If there is a similar crash in 2012, the turning point could be delayed another year or two, but only if supply from all of the highly unstable sources mentioned above remains firm. I would put 50-50 odds that it does not, in which case prices will remain uncomfortably high even as deflation takes a firmer grip on Western economies. The world will be hard-pressed to increase liquid fuel supply from current levels.

Certain uncertainty

The one thing I can say with certainty about 2012 is that it will be fraught with uncertainty. 2011 could look tame by comparison.

More natural disasters are almost certainly on the menu, which will disrupt supply chains and exact a painful toll of blood and treasure the world over.

Regional skirmishes over resources, particularly in developing oil-rich areas like the Caspian and Africa, are likely.

Authoritarian governments, along with their corporate sponsors, will continue to be challenged by the people, and will resort to heavy-handed crackdowns in response. The Arab Spring and the Occupy movement are merely the beginning of popular revolts that will ultimately transform the political and economic order of the world. Unrest in previously pacific areas should be expected.

Intelligence agencies will find it difficult to keep up with multiplying threats. Attacks by the hacker group Anonymous on powerful vested interests, like the Christmas weekend attack on the US-based security think-tank Stratfor, will become more commonplace and focused on high-value targets like government and military organizations. The potential disruptions to business as usual are hard to overestimate. Banks, public services, utility grid operators, and communications systems could suffer extended outages. Electronic systems of exchange could be compromised. Faith in our large, complex systems will wane.

In the face of all this uncertainty, then, what is one to do?

The answer is simple: Do what you can.

Minimize your expenses, and pay down debt as rapidly as possible.

Grow some of your own food, whether you have a big backyard or just a little balcony with room for a couple of small pots. Millions of people have begun doing so since the crash of 2008, and they have found it a universally rewarding and fun experience. It helps to ground one in reality, and brings a little peace of mind. Before you know it, you’ll be expanding your garden and maybe keeping a few chickens.

Reduce your consumption of fossil fuels any way you can, by focusing on efficiency. Then (and only then), if you can, think about installing some solar hot water, solar PV, and battery backup on your house or business. I expect the distributed solar market to be a rare and surprising bright spot in 2012.

Keep a little “rainy day” cash on hand. To really hedge your exposure to financial collapse, physical gold and silver bars and coins are your best insurance.

Renew your relationships with friends, family and neighbors. Nothing is worse than feeling alone when the world is going crazy around you, and they will help you keep your head on straight.

Most importantly: Try to keep your mind in the present. Don’t let the uncertain future frighten you into immobility, and don’t let the past keep you from doing the best you can today. It’s surprisingly hard to do, but it gets easier with practice. The Buddhist approach is to simply be mindful of what you’re doing, seeing, hearing, and feeling right now, be it walking down the street or cleaning the cat box. Or, in the Biblical verse of Matthew 6:34, “So do not worry about tomorrow; for tomorrow will care for itself. Each day has enough trouble of its own.”

I wish all of us luck, wisdom, fortitude, and peace of mind in what will undoubtedly be a very challenging year. We will soldier on, somehow.

Photo: marcobellucci/Flickr

Shale gas is being sold to the American public as a miracle, arriving just in time to save us from peak oil. It’s an abundant new fuel supply that will be a “game-changer,” we’re told. We’ll soon be a major exporter of gas to the rest of the world. The economics of fossil fuels have been changed forever, along with our balance of trade.

But what if the business isn’t actually profitable? What if it’s really based on accounting trickery and overstated claims?

“Fracking” — extracting natural gas by drilling horizontally through dense shale, then fracturing it with high-pressure fluids — has indeed given the U.S. a nice bump in gas production. Production of dry shale gas soared ten-fold from under 0.4 trillion cubic feet (tcf) in 2003, to 4.8 tcf in 2010. Total gas withdrawals, including conventional gas, are up 16 percent since the end of 2005. Shale gas now accounts for about one-quarter of total U.S. dry natural gas production, and about 4 percent of our total primary energy supply.

Our shale gas resources, however, while much ballyhooed in the press, are far less certain. We may now have a 100-year supply of gas in America, as suggested by recent reports. . . or we may not. The U.S. consumes 24 tcf of gas per year. Currently, we only have an 11-year supply on the books: 273 tcf classified as “proved reserves,” meaning gas that is commercially producible at a 10 percent discount rate. Beyond that, there are only “probable,” “possible,” and “speculative” resources, where the gas has not yet actually been discovered, or proved to be economically recoverable. Even where we are sure that the resources exist, we do not know how much of is technically recoverable until we produce it. And as I noted two weeks ago, in the EIA’s Low Case shale gas estimate, the U.S. could become a net gas importer by 2035.

There is no doubt that we are producing a lot of gas, for the moment. But it may have come at the cost of profitability.

EBITDA: Earnings Before I Tricked the Dumb Auditor

Houston-based petroleum geologist and energy sector consultant Arthur Berman, along with petroleum engineer Lynn Pittinger, has independently studied the economics of thousands of wells in the three shale gas formations with the longest production histories — the Barnett Shale in Texas, the Fayetteville Shale in Arkansas, and the Haynesville Shale in Louisiana — and found numerous irregularities.

When the true structural costs of shale gas are fully incorporated, he says, including the costs of leasing, restimulating wells where production was flagging, and general operation and administrative overhead, operators need $8 to $9 per thousand cubic feet (mcf) to break even, assuming an 8 percent discount rate. For new development on existing leases, considering just the costs of drilling, completion and operation, operators need $5 to $6/mcf to break even. But the spot price (for immediate delivery) of gas is only $3.11/mcf today, and except for two brief moments in 2010, it has remained below $5 since February 2010. On an averaged annual basis, shale gas has been unprofitable since 2008.

If shale gas production is unprofitable, then why is there still so much drilling activity, and how are producers able to claim otherwise?

One answer to this conundrum is that operators need to keep drilling in order to hold onto their leases. If they don’t actively work the land that they spent the last several years acquiring in a buying frenzy, they lose it. The early operators in these gas formations, or “plays,” aren’t sufficiently well-funded to continue drilling at a loss; they’re simply trying to hold onto their leases long enough to flip them to larger companies at a profit. Hence the recent rash of joint ventures with deeper-pocketed players, which give the original leaseholders a way to pay off the leasing and initial drilling costs, but ultimately reduces their net asset values.

A detailed examination of the financial data bears this out. If shale gas is so profitable, then one might expect operators to pay for leasing and drilling costs out of cash flow, and pay down their debt. But quite the opposite appears to be the case. According to analysis by Bernstein Research, capital expenditures on land acquisition and new drilling exceeds cashflow (by as much as 511 percent in the worst example, Carrizo Oil & Gas) for 18 of the top shale gas producers, and they’re still heavily laden with debt.

A more direct explanation is that producers are willing to take a big gamble on shale gas in order to support their market valuations. Before the shale boom, reserves of both oil and gas had been in a decades-long trend of decline. Producers were nervous. Cash tomorrow, as represented by reserves, is almost as valuable as cash today from earnings. When production and reserves fall, the stocks of producers fall too and can trigger defaults on loans. Maintaining reserves, even while draining them, is an imperative.

In order to show profitability, shale gas operators have employed complex creative accounting. Instead of the usual “netback” calculations that clearly state the net profit per barrel of oil equivalent (or per mcf of gas) produced, in the 10-K reports filed with the SEC, one finds an intricate set of statements which would only be comprehensible to an expert accountant, not an average investor. Hedging strategies employed after 2008 have counterbalanced some of the losses on production, and major capital costs have been excluded through off-book accounting. Worse, Berman found that some operators have used variable production payment schemes to recognize borrowed cash up front, then failed to account for it as debt and actually claimed it as an asset.

The production of associated natural gas liquids, which generally command about half the price of oil, further complicates the economics. (At the 2011 average of $95 a barrel for oil in the U.S., gas sells at an enormous discount to oil, at $3.29 per million BTU, versus $16.39 for oil.) Natural gas liquids produced along with the “dry” gas have certainly helped generate revenues, but to what degree, we don’t know, since they are not separately reported to regulators. Berman estimates they might add $1/mcf after processing. Operators commingle the revenues from “dry” gas with those from associated natural gas liquids, masking the true profitability of the gas production.

Does it matter if some operators are able to drill profitably due to the natural gas liquids, but not the gas itself? Well yes, it does. If the wells are shut down after their liquids play out, it could leave a lot of gas effectively stranded, and a significant chunk of the anticipated reserves would never be produced.

We do know that many shale gas operators have been refocusing their operations on liquids-rich areas of the plays in the last few years, in order to capture the liquids premium. As fund manager Jim Hansen of Seattle-based Ravenna Capital Management pointed out to me, a slide in a November 2010 investor presentation by major shale gas producer Chesapeake Energy confirmed that it was “aggressively shifting capital to liquids-rich plays,” and reducing drilling to the level required to retain its leases and court joint venture partners, until natural gas prices rise above $6/mcf. This comports to Berman’s profitability analysis. Chesapeake’s stated strategy was to acquire large leaseholdings in liquids-rich plays, then sell a minority interest in them within one year, in order to recover the cost of the lease.

Hansen also observes that the rig count in shale operations is now down more than 50 percent from its 2008 high, casting further doubt on the idea that additional drilling is currently profitable.

In the oldest and most productive of the shale gas plays, the Barnett Shale in Texas, wells decline at an annualized rate of 44 percent, according to Berman’s research, with a steep decline rate of 65 percent in the first year and 53 percent in the next, falling gradually thereafter to around 20 percent per year. Shale gas wells typically pay out over half their total lifetime production in the first year. So operators must keep drilling continuously to maintain a flat rate of overall production. However, operators and the industry press tend to only report the high, initial flow rates of gas wells, giving investors a mistaken impression of how productive they really are. Indeed, Berman’s analysis suggests that the claimed lifetime productivity of the wells—and by extension, the reserves that operators are claiming in their SEC filings—may be overstated by over 100 percent.

Nobody expects the shale gas inquisition

As more data about these relatively young operations becomes available, it is tending more toward the more lower estimates of the skeptics than the initial estimates of the operators. For example, Berman’s analysis of wells in the Haynesville Shale suggested that they would produce about 3 billion cubic feet of gas on average, not the 6 to 10 bcf claimed by the operators — estimates which were based on the high initial productivity of the wells, without taking their lower, later output properly into account. Objective third-party research from Louisiana State University has just confirmed Berman’s estimate.

Berman, Pittinger, and Hansen are not alone in their skepticism about the profitability of shale gas. Writing in The New York Times back in June, Ian Urbina referenced numerous emails and internal documents from industry insiders who were skeptical about the claims made by operators. Industry defenders countered that the skeptics are outsiders, and dismissed their findings out of hand (with, I will note, some fairly specious arguments). But new scrutiny is now being applied to the claims of producers. New York Attorney General Eric Schneiderman is now investigating Marcellus Shale operators, including Range Resources, Cabot Oil & Gas Corp, and Goodrich Petroleum, specifically to see if they have overstated the productivity of their wells. And the SEC has issued dozens of EDGAR filings to shale gas companies to shale gas companies, questioning their methodology on reserves calculations, accounting of development expenses, and other formal disclosures.

If all of this is beginning to sound a bit Ponzilicious, it should, particularly if the anticipated future production and profitability don’t materialize. But that doesn’t mean it’s a fraud, and Berman is quick to point out that all of the accounting employed by shale gas producers is perfectly legal. On the other hand, so were the mortgage-backed securities, the credit default swaps leveraged on those securities, and other financial weapons of mass destruction that would have brought down the global financial system in 2008, if the Fed and the Treasury hadn’t intervened by debasing the U.S. dollar.

Now, it’s certainly possible that the story of shale gas will unfold in an orderly, totally legal manner. Some of the wildcatters could make out nicely on their debt-fueled land grab, while others go bankrupt. The bigger players who later acquire the leases could produce gas at a loss for years before gas prices rise again and put them in the black on their bets. That’s just capitalism.

But it’s also possible that early players simply took advantage of the uncertainty about a new resource and sold their operations like pigs in a poke, and that we’ll find ourselves holding a fleet of shiny new CNG trucks and gas-fired power plants just as the shale gas phenomenon flares out.

The uncomfortable truth is that, at this point, we simply don’t know how big our shale gas resources are, how much of the gas can be technically or economically produced, or how profitable producing the gas actually is. And that should give us pause. Apart from the rancorous debate over the environmental impact of shale gas fracking, we would do well to consider how much faith we’re placing in the questionable economics of shale gas, and how much of our future we’re betting on it.

Photo: “American Gasland,” artwork by River Side (marcellusprotest/Flickr)

Read it here: Occupy, Tea Party, and the Politics of Less

Beneath the complex narratives of the Occupy and Tea Party movements, and beneath the unfolding collapse of our complex global financial system, is a simpler narrative about energy. Yet this narrative continues to elude most observers, because they don’t understand the fundamental relationship between energy and the real economy. This week I’ll attempt to tell a simple version of that story, in the plainest possible terms, and explain the Occupy and Tea Party movements in that context.

Let’s begin with some economic history.

For nearly all of U.S. history up through the late 1960s, the production of energy, especially oil, had grown continuously. And economic activity, as measured by GDP, grew right along with it.

At the same time, the U.S. dollar was pinned to gold, first under a gold standard requiring the Federal Reserve to maintain 40 percent of its outstanding paper currency in gold reserves, and then under the Bretton Woods Agreement of 1944, which created the International Monetary Fund (IMF) and set exchange rates for various national currencies in terms of US dollars, which in turn were convertible to gold at the rate of $35 an ounce.

Thus the growth of the U.S. economy was pinned to oil and to gold, both hard assets. It helped to keep inflation and deficit spending under control, but it also checked economic growth.

By 1971, however, the costs of the Vietnam War and the end of the post-war infrastructure building spree had stalled economic growth, and spending began to exceed revenues. Growth was further stymied by U.S. oil production, which had peaked in the previous year and begun to decline.

Source: EIA

This was intolerable, because the U.S. had debt, which is a claim on future productivity. Without growth, debt cannot be repaid, making growth an economic imperative.

President Nixon’s solution was to abandon the virtual gold standard entirely, ending the convertibility of dollars into gold and effectively placing the world’s monetary system on a fiat basis denominated in U.S. dollars. Thus in 1971 we entered a new era, in which organic growth driven by increasing energy supply and actual productivity was replaced by artificial growth fueled by debt.

Source: Reading Nature’s Signals

At the time, the expectation of continued growth justified the departure from the gold peg, and oil supply wasn’t yet recognized as a concern. Crude from the Middle East was cheap and abundant, and the largest oil field in North America had just been discovered in 1968. Analysts of the day would have had little reason to fear that debt would run away from the real economy.

But as we can see, that’s exactly what happened. GDP continued to rise at roughly its historical rate, outpacing the faltering growth of energy supply, but it was at the expense of a burgeoning debt load, as shown in this close-up of the years 1965 to 2007:

Source: Sudden Debt

The obvious result of the debt explosion was a debasement of the dollar, in real terms, and a declining net surplus to society. Average working households experienced this as household debt exceeding real disposable income, starting around 1983. In order to thwart the resulting “stagflation,” we loosened financial regulation and borrowing restrictions, which permitted us to blow more bubbles: first the dot-com bubble, then the housing bubble, and then the debt bubble:

Source: San Francisco Fed, marked up by Dave Cohen

The ultimate result was the blow-off of the debt bubble in 2008 and subsequent economic decline as we began the long process of debt deleveraging.

The same cycle, operating over somewhat different time frames and scales, has been happening to most of the world, led first by the demands of remaining competitive in a globalized economy with a major actor becoming a major debtor and currency debaser, then by the flattening-out of world oil supply, starting in 2005. In the pithy formulation of my colleague Gregor Macdonald, “In the old oil cycle, such sovereign debt problems were merely a function of profligacy. In the new oil cycle, a debt crisis is no longer solvable with growth.”

The end of the growth acid trip

We now find ourselves with a global financial regime that is literally teetering on the brink of the abyss. The debt crisis in Europe is an echo of the banking crisis we had in the U.S. in 2008, with MF Global (leveraged 40 to 1 on European debt to equity) playing the part of Lehman Brothers (leveraged 30 to 1 on toxic mortgage debt), and Greece, Italy and Spain playing the uncreditworthy borrowers, Fannie Mae and Freddie Mac. Except in this go-round, France and Germany (playing the part of the US public) and the ECB (playing the part of the Fed) aren’t going along with the script. Rather than monetizing the European debt to infinity and beyond and socializing the losses, they are thinking about skipping out the backstage exit door for a drink and a smoke, and just letting the rest of the players sort out the rest of Act III for themselves: worst case, a global plunge into a deflationary vortex, wiping out most of the financial “wealth” in the developed world.

The fundamental problem from a theoretical standpoint, as I discussed a few weeks ago in “Economic theory and the Real Great Contraction,” is that economic theorists are, in the words of sociologist John Bradford, “unaware of the essential role that energy played in the creation and maintenance of the [economic] order.” (He has a good argument, and I encourage economics geeks to explore that link.) The apparent decoupling of energy from economic growth in the U.S. has emboldened some optimists to claim that energy intensity has increased, and that economic growth has cast off its shackles to primary energy supply. But that illusion vanishes too, after adjusting for offshoring of manufacturing over the last 30 years, and the drawdown of capital stocks. As Gail Tverberg showed this week, on a global basis, energy intensity has remained flat. Economic growth is essentially and unequivocally inseparable from energy growth.

During periods of plenty, laissez-faire economics mainly functions as a way of calling forth supply (of energy, food, and other essentials), but during periods of less, they mainly ration demand: if you can’t pay, you don’t get any. Periods of energy surplus beget positive feedback loops, in which higher demand calls forth greater supply, more debt, and more peace. But periods of energy deficit beget negative feedback loops, where declining energy return on investment (EROI) leads to declining surplus, debt deflation, less peace, less freedom, and ultimately a decline in production and trade.

Source: “Revisiting the Limits to Growth After Peak Oil,” Hall, Day, American Scientist May-June 2009

In the growing gap between real wealth and hallucinated wealth, those with the most wealth were able to game the system and capture more of the declining surplus available to society via various mechanisms: cuts in taxes on capital gains and dividends (which don’t figure in the incomes of average people), cuts in the marginal tax rates of the top income earners, shifting a greater share of the income to corporate structures, and floating individually to the top of globalized companies that continued to grow even as the center of the domestic economy was being hollowed out.

Source: Alan de Smet

The Politics of Less

This brings us to the heart of the Occupy and Tea Party movements. While I would give neither movement undue credit for having an intellectual grasp on the details of economics or energy that brought us to this point, both movements are essentially a response to the declining net surplus available to society. And this is making the banks very nervous. As a memo from the lobbying firm Clark Lytle Geduldig Cranford to the American Bankers Association, recently exposed by Chris Hayes at MSNBC, said:

“Well-known Wall Street companies stand at the nexus of where OWS protestors and the Tea Party overlap on angered populism. Both the radical left and the radical right are channeling broader frustration about the state of the economy and share a mutual anger over TARP and other perceived bailouts.”

They may not fully understand how it happened, or why, but the average Occupy or Tea Party protestor understands one thing: they are getting poorer. The rest of the debate is about the tactics of what to do about it: redistributing the remaining surplus, or shrinking the slice of that surplus consumed by government. Shall we cut the “entitlement programs” of surplus—Medicare and Social Security—or redistribute the wealth to allow them to continue? To reframe it another way, the Occupy movement is the “Help Me Party,” and the Tea Partiers are the “Help Yourself Party.”

The failure of the so-called Supercommittee to come to any agreement on how to cut a mere $1.2 trillion from the federal budget reflects how difficult it is to come to grips with the declining surplus, or as a hedge fund manager friend of mine (I’ll call him Mr. X) puts it: the Politics of Less.

The historical script for the Politics of Less is clear, as Mr. X reminds me constantly: “The period 1770-1815 was marked by bank runs, currency collapse and sovereign defaults. The politics of less led to revolution. So did the great ‘Victorian’ depression 1873-1905. Humans have had social cohesion, or non-coercion, but not both. And certainly not in times of scarcity. The Old Law will return. Cry havoc and loose the dogs of war.” Heavy-handed crackdowns on protesters, surveillance of subversive elements, mass withdrawals from banks, and sovereign debt defaults are all part of the standard story arc.

The political and economic systems that worked in the age of surplus can no longer produce social cohesion. Measured in hard assets, it becomes a fight to maintain one’s standard of living; measured in currency, it becomes a global race to the bottom (currency devaluation).

On a purely mathematical basis, absent a massive redistribution of wealth and a transition to a renewably-powered economy, we are now on a descent trajectory that will bring us to the point where the resource base times the efficiency of production equals consumption times population. That equation suggests a global population of around 1.5 billion or less by the end of this century, or a loss of about five-sixths of the world’s population from peak (circa 2020) to trough (circa 2100).

This leads us to some very fundamental, even existential, questions. Faced with the Politics of Less, can we stomach coerced wealth redistribution, or will we simply let the system collapse? Do you bet on a global expansion of consciousness such that we recognize we are all One and link arms, singing Kumbaya? Or do you get busy on your hilltop doomstead, equipped with backup energy, food, water, ammunition, and gold? Do you join your brothers and sisters in the streets, or do you withdraw to your tribe and erect a security fence on the perimeter?

There are no quick fixes to this challenge. It has evolved over roughly half a century, through Democratic and Republican regimes alike, and we have roughly half a century to respond to it, starting right now. Any response that doesn’t address the fundamental issue of declining net energy is doomed to fail. I like to think we can respond intelligently, and I would never short human ingenuity and compassion. On the other hand, it’s hard to argue against a reversion to the mean of human history.

What’s your bet?

Photo: Occupy Wall Street (david_shankbone/Flickr)

Read it here: Crowdsourcing the energy revolution

For the last six weeks I have outlined the big picture on energy, and advocated for transitions in energy and infrastructure that must really be addressed at the federal level. But if federal leadership on these big objectives fails to materialize (as it has, so far), what do we do?

If you’re a resident of Denmark, Colorado Springs, Boulder, Tucson, Orlando, Sacramento, and dozens of other communities, the answer is right in your town. You don’t even need to have an unshaded, south-facing roof and $20,000 to $30,000 to invest in a solar PV system on your house. All you need is an energy co-op.

Today I’ll survey how those strategies work. But first, I want to tell you about a dream I had about a year ago.

I had been trying to imagine how communities might develop energy self-sufficiency as the national grid infrastructure began to crumble and fail, because that is the path we’re on. Without about half a trillion dollars in upgrades between now and 2030, our existing grid is destined for decrepitude.

The technology exists to allow individual towns or regions to become largely, if not completely, self-sufficient in energy. It’s mostly off-the-shelf stuff, and much of it has been around for decades. The only missing elements are the leadership to do it, and the capital. But how do we get from here to there?

The conceptual model is straightforward.

First, the town deploys as much local generation from renewables as possible. In the Southwest, it’s solar; in the Midwest, wind; for the coastal cities, offshore wind and marine energy (comprising a whole suite of different technologies); in mountainous regions, solar and micro-hydro; and geothermal (another suite of various technologies) almost everywhere.

Second, the town develops local storage. Again, a whole range of technologies are available here, including residential- and commercial-sized battery arrays, pumped water systems, distributed flywheels, compressed air in underground caverns, molten salts, ammonia synthesis, and many others.

The final step is to deploy switches that would allow the town to disconnect from the main grid when it goes down, and fall back on their own capacity. This technology is routinely used today, to prevent one power plant failure from taking down the entire grid. But it can also be used to create a “microgrid,” allowing a region to isolate itself from the main grid. Think of a town-sized version of the switch that lets a home equipped with solar PV and battery backup disconnect from the grid when it goes down, and fall back on its battery array.

The hard part would be rounding up the capital and the leadership, and that’s what my dream was about.

A dream of self-sufficiency

It happened in Mill Valley, CA, a fairly well-heeled community of about 14,000 people where I used to live, just north of San Francisco. Frustrated with frequent grid outages, a small group of local, wealthy residents decided to take matters into their own hands. They created a small fund and set a modest target for the first year, like $1 million to buy PV and install it on the larger rooftops in town — for example, the grocery store, the rec center, the sewage treatment plant. At the same time, they added some battery arrays equivalent to the generation of each array. Because they were the town’s elites, they were able to persuade the town council to give them regulatory support for the project, clearing permitting hurdles for new solar systems, and requiring the utility to install the microgrid switches. The managers of the commercial buildings were eager to host the arrays because they were tired of the grid going down and wanted stability, and they readily agreed to buy the power the arrays generated.

When the first year proved a success, the fund was doubled, and more generation capacity was added. Each year, it doubled again. A sense of local pride began to develop around the idea, and by the fifth year, everyone wanted to be a part of it. Grandmothers dipped into their savings and contributed in $5,000 and $10,000 amounts. Schoolchildren held fundraisers and contributed $200 at a time. By the tenth year, the largest roofs and available ground space were covered in solar PV modules, and by the twentieth, nearly every spot with good solar exposure had it.

In time, the microgrid switching was installed, and larger storage projects were undertaken. A multi-million dollar system to store power for the whole town was installed, which pumped water up nearby Mt. Tamalpais and used the existing reservoirs. Old Fort Cronkhite, which is situated on the edge of the Pacific Ocean and was converted to national park in the mid-1970s, was repurposed as a tidal barrage generator like Rance Tidal Power station in France. A small wind farm was tucked back along the ocean-facing side of the mountain. Vehicle-to-grid technology allowed thousands of electric vehicles to contribute more battery backup capacity. (The Prius is ubiquitous in Mill Valley.) A free electric shuttle bus system was created that eliminated three-quarters of the local vehicle traffic, and an electric light-rail track to San Francisco was installed, all powered by town’s own generation.

Twenty years after the project began, failures of the three national grids had become commonplace, along with a great deal of social unrest. But not in Mill Valley. It had developed enough generation and storage capacity to support its essential services (like lights, heat, refrigeration, communications and emergency services) during major outages, and those occasions became celebrations of community spirit, with impromptu parties and potlucks. A culture of conservation had grown up along with the project, and everyone shared a sense of pride and ownership in what they had accomplished. Solar panels and wind turbines, once derided as scenic blights, were now considered beautiful. Hundreds of millions of dollars had been retained in the community, and it had prospered in difficult times thanks to its ability to keep the lights on.

It didn’t take more than a few multi-day outages before other communities in the Bay Area began to sit up and take notice. The town’s success made national news, and the model caught on quickly. Within a few years, every town in America wanted to be self-sufficient in times of need, and found the spine and the local capital to follow suit, using whatever local renewable resources they had.

That was my dream, but as it turns out, it isn’t just a dream. The first stage of it is already happening.

Community supported power in Denmark

Denmark has used the cooperative model very effectively to build three offshore wind parks. The first such project, a $64 million installation built in 2000 near the entrance to Copenhagen Harbor, is operated and half-owned by Denmark’s largest utility. The other half is owned by Middelgrunden Vindmøllelaug, a cooperative that sells shares in the project to the public. Nearly 9,000 shareholders, who can freely trade their shares, have received a 14 to 15 percent annual return on their $777-a-share investment over the first 10 years, 100 percent return on their capital, and residual income of seven percent per year on their remaining investments. With nearly zero risk: Those turbines, and the demand for their power, aren’t going anywhere.

Compare that to a 12 percent total return on the S&P 500 over the last decade (as of this writing – it could be flat or negative in a week or two, as the Eurozone meltdown proceeds), or a two percent yield on a 10-year Treasury bond (which is actually a negative yield, once inflation is factored in).

The economics of the Danish co-op model, as I explained last week, are supported by their aggressive feed-in tariffs (FiTs). Coincidentally, after that piece was published I learned that the Intergovernmental Panel on Climate Change (IPCC) recently issued a report with the same conclusions I had: that when properly constructed and implemented, FiTs are more effective, efficient, equitable, and low-cost than any other incentive mechanisms we use here in the U.S.

Community solar programs in the U.S.

Even without a FiT, however, communities here in the States are finding ways to make distributed solar PV work, even for residents who don’t have a suitable site or adequate funding to install solar on their own properties. By aggregating demand into a single project, the total cost can be reduced by around 30 percent.

Community solar co-ops install a central solar PV system in their local areas, using voluntary investment programs that anyone in the community can join. Some give investors proportional ownership in the project, while others sell shares in it. The solar project is connected to the local grid, where the local utility agrees to buy the power it generates while continuing to handle its customary billing and transmission duties.

The newest such program in the U.S. is in Colorado Springs, CO. A startup called SunShare is sponsoring the project and selling participation to residents with a minimum investment of $1,100, which pays for two panels. The utility will credit customers on their regular bills for the energy their panels produce, and if their share of the system generates more power than they use in a year, they’ll get a credit on future bills. The company claims investors will receive about an 8.9 percent annual return on investment, and earn back the purchase price in 10 to 12 years. The system will be installed on the nonprofit Venetucci Farm, owned by the Pikes Peak Community Foundation, and the lease will be paid for with power generated by the project. SunShare will maintain, insure and monitor the project, and maintains 14 percent of the capital in an escrow account to cover those expenses over the life of the 20-year lease customers sign. The project will be fully subscribed when it reaches 500 kilowatts, and is reportedly nearly there already, just two months after its announcement. When the Venetucci project is sold out, SunShare intends to move on and build more such “solar gardens” on local properties.

A slightly different angle, strictly focused on community investment, is taking shape in Oakland, CA. A startup called Solar Mosaic, founded by angel investors, is raising capital from the community in $100 shares, then offering it in zero-interest loans for local solar PV projects. The buildings where the systems are installed lease the equipment and enter into a power purchase agreement (PPA) to buy the power it generates at a fixed rate over 20 years or so. Solar Mosaic takes a five percent vig on funded projects, and hopes to eventually offer securities sporting a six percent annual return.

Offering securities comes with its own complex set of issues however, and falls under the jurisdiction of the SEC. Its requirements have proved too onerous and forbidding for most securitized community solar schemes to meet, because most of the programs are simply too small to spend the requisite $1 million or more in legal and filing expenses. But a new crowdfunding bill that just passed the U.S. House of Representatives could clear the way for securitized community-funded programs. It would permit social networks and crowdfunding sites like Kickstarter to raise $1 to $2 million in small amounts, under modest and reasonable reporting requirements, which would be enough to fund commercial solar PV projects in the 250 to 500 kW range (500 kW is about the size of a typical solar system on the roof of a Wal-Mart).

To avoid the headaches of securities, Sacramento, CA has taken a slightly different approach with its SolarShares program. Launched in 2008, the program allows customers to buy portions of a 1 MW PV installation in 0.5 kW increments, up to 4 kW (enough to completely power an average-sized home). The utility district SMUD buys the output of the system, which is owned by a third party, then sells the power to SolarShares customers for a fixed monthly fee. The cost to participants is an extra $4 to $50 a month, who receive a credit on their utility bills for power produced by their shares under a scheme called virtual net metering. The first 1 MW installation was fully subscribed in the first six months.

The nation’s first community solar project in Ellensburg, WA also took the virtual net metering approach, only with a central solar garden owned directly by the city. Launched in 2006, it has grown to 111 kW in size, adding new capacity with various types of modules in several phases as participation increased. Customers can join the program for a minimum $250, and buy additional shares up to the point where they offset their entire annual consumption. A Department of Energy grant matches local contributions.

Dozens of other community-based programs exist. For more information, see the Department of Energy’s solar communities guide for local governments and the National Renewable Energy Laboratory’s annual assessment of utility green power programs.

As a final example, a far more radical approach has been taken by Boulder, CO: leaving its utility completely. After years of frustration in trying to get coal-oriented utility giant Xcel Energy to deploy more renewable capacity, citizens voted two weeks ago to explore creating a municipal utility. “Boulder citizens sent a clear message that they want more renewable energy and they’re tired of waiting for it, so they took matters into their own hands,” said the executive director for the Colorado Solar Energy Industries Association. The process make take several years and is full of challenges, but if successful it would be the first city in the nation to leave its utility as an energy transition strategy. Citizens who backed the initiative hope to meet 50 percent of their needs with renewables eventually, and expect the move will add $350 million a year to the local economy instead of the current $100 million a year it pays to Xcel, based in Minneapolis, MN.

In all of these community-based strategies, the economics are about the same: Customers pay more up front, and in exchange get a fixed rate for about 20 years for locally-generated, renewable power. In 20 years, after the decline of all fossil fuels has kicked in, they will be sitting pretty, paying grid power prices far below the going rate. And shareholders in the projects will be yelling “Hallelujah!” with their 6 to 10 percent yields, while the bond and equity markets decline.

We don’t need to wait for the government to kick its fossil-fuel partners out of bed, and we don’t have to wait for a national FiT to execute energy transition. We don’t need any new technology, incentives, or laws. We don’t need to wait years for environmental reviews of huge solar parks, or for a national HVDC transmission grid to be built. We can simply assume responsibility for ourselves, voluntarily and as individuals, and take matters into our own hands.  Everything we need is off-the-shelf and ready to deploy now. And it’s not a dream — it’s already happening in dozens of communities across the nation. As cyberpunk author William Gibson famously said, “The future is here. It’s just not evenly distributed yet.”

Photo: Solar Panel Barn Raising, artwork sketch by Katherine Ball

Why America needs a feed-in tariff

The proven, most effective incentive for renewables is the feed-in tariff (FiT), yet it hasn’t caught on in the U.S. This week, I’ll attempt to explain why it hasn’t, and why we need one immediately.

FiTs have been responsible for a rapid deployment of wind and solar in over 40 countries, including most of Europe, and accounted for nearly all new solar PV systems there since 1997.

Simply, a FiT is a special fixed rate paid by utilities for renewably-generated power put onto the grid, under a contract set over a period of 15 to 25 years. FiTs are typically set at two to four times the regular grid power price, and paid for by a slightly higher standard grid power price. The strategy has met with opposition on occasion for being a regressive tax on residential customers who can’t afford to install solar PV, but the rate increases have been modest, and the programs have been very popular on the whole.

The German FIT, which began in April 2000, was the first major program of its kind in the world. It quickly captured half the world market for solar modules in five years. (When I was in the solar business in California in 2005, there were frequently periods when we simply couldn’t get modules, because everything was going to Germany. We often had to wait weeks for shipments of preferred models, and competition was fierce for locally available inventory.) Germany now has twice the solar PV capacity of the U.S., with around a quarter of our population and roughly half the insolation (available sunlight) of the Southwest. The program was so successful that it reached its target early and began accelerating the schedule to reduce it, dropping from $0.77/kWh in 2004 to $0.23/kWh for utility-scale projects in 2012.

Partially as a consequence of their FiT, Germany now has the second-highest grid power price in Europe at $0.37/kWh, a point that detractors like to emphasize. That compares to typical electricity prices in the U.S. of $0.06 to $0.13/kWh. Even so, the typical German utility bill is in the range of $100 to $275 a month, comparable to U.S. households.

Denmark, which has long had the most aggressive renewable incentives in the world, also pays the highest rates for electricity in Europe, at $0.41/kWh. Yet by all accounts the Danes are pleased with and proud of their transition effort, with over one-quarter of their electricity now generated from wind. “A green and more sustainable world does not evolve by itself,” said newly-elected Prime Minister Helle Thorning-Schmidt at a conference in Copenhagen last month, while announcing a raised goal to generate 50 percent of the country’s power from renewables by 2020. (Oh, to have such leadership here!)

A fierce war of words has ensued in the UK over the government’s recent decision to halve the FiT for small rooftop solar projects installed after December 12 this year. The program has been a stunning success and resulted in a solar industry that grew from under 3,000 jobs to over 25,000 since its launch in April 2010. The decision to cut the FiT from $0.69/kWh to $0.34/kWh (where the average electricity price is $0.22/kWh) was made to stretch the program’s $1.4 billion budget, which is on track to be fully claimed within a few months. Industry representatives report that the new deadline is forcing thousands of projects to be cancelled, and will result in layoffs of more than half their current staff. Such boom-and-bust cycles in renewables are all too familiar to those who have observed the history of short-lived incentives in the U.S., and it’s unfortunate that the UK hasn’t learned from that history and designed a program with a much longer horizon.

Even so, the cost of FiTs have added far less to energy bills than the cost of fossil fuels. As Damian Carrington pointed out in the Guardian this week, high natural gas prices in the UK have added £170 to the average household’s annual energy expenditures, while all renewable subsidies have added only £20.

FiTs have encouraged equally rapid growth in other European countries, notably Spain, Italy, and France. Lax quality and budgetary controls in those countries have somewhat sullied the reputation of FiTs by incentivizing some poorly designed systems, but the problems have been in implementation and oversight, not the strategy itself.

When China unveiled its new unified national FiT in August, it completely changed the economics of solar and is resulting in a sudden explosion of installations. Set at a relatively low $0.18/kWh this year and dropping to $0.16/kWh in 2012, it has nevertheless made the business profitable where coal-fired generation costs about $0.05/kWh and the average industrial electricity price is $0.11/kWh. At the same time, the rapidly falling cost of China’s domestic solar module manufacturing has driven the installed system cost down to around $2.9/watt (which has to be the world’s lowest), on its way to $2/watt. The new tariff will allow systems to pay themselves off in seven years and throw off free cash for another two decades after that, according to the New York Times. The IRR over 25 years will be in the neighborhood of 10 percent, a substantially better yield than similarly low-risk assets. In the Gobi desert city of Golmud, capacity is expected to jump from 40 MW to over 300 MW in just six months. Solar market research company Solarbuzz reports that China will match US solar capacity with its installations in 2011.

The next major FiT will begin July 2012 in Japan. The initial rate for solar PV power will be a generous $0.50/kWh, which should take them a long way toward their objective of replacing their nuclear capacity. Their aim is to install 30 GW of renewable capacity within 10 years—equivalent to installing more than the entire grid-connected PV capacity of the U.S., every year for a decade.

Grid parity isn’t the objective

The rapid growth of the solar and wind industries due to FiTs has driven their costs down to the point where grid parity has already been reached in sunny and windy regions, and has put them on course to reach parity for most the world by 2018.

Trends in PV & Grid Residential Electricity Prices, U.S. Annual Averages
Source: Home Power

According to a new report from the IEA, wind has grown worldwide at an average rate of 27% per year, and solar PV at an average rate of 56%. Those growth rates are primarily the result of FiTs.

The ability of FiTs to produce rapid deployment of renewable capacity is critical for several reasons. First, as I explained last week, transitioning to renewables will require decades. Transition must begin before fossil fuels go into decline, and before market signals encourage it. Second, simply maintaining our existing power generation regime isn’t an option. Many of the existing power plants in the U.S. are aged and due for replacement, as shown in this EIA chart:

Over half of the nation’s generating capacity comes from plants that are at least 30 years old. Of the nation’s 104 nuclear power plants, contributing 20 percent of our electricity supply, half are over 30 years old, and all but two are at least 20 years old. They were initially granted operating licenses for 40 years, and 61 have already been granted 20-year extensions. Within 20 years, all but two will have reached their original expiration dates, and by 2050, all of them will reach their current expiration dates. But the life of a nuclear plant isn’t indefinite. Concrete becomes brittle, and other components wear out. Without additional extensions, all of the current U.S. nuclear capacity will need to be replaced within the next 40 years.

Nearly three-quarters of our coal-fired capacity, contributing 46 percent of our electricity supply, is at least 30 years old. Many of the plants are using outdated, inefficient technology. Some need to be retired immediately, and within 20 years nearly all of them will need to be replaced. The declining quality of domestic coal, which now has 20 percent less energy per kilogram than it did in 1949, will also exert a continuous upward pressure on its price.

The age of our power generation plants highlights why grid parity isn’t really the important metric. The cost of old legacy power generation plants has been fully recovered over decades, while the cost of new generation from renewables is fully priced in upon installation. One cannot simply compare the current cost of generation from an old coal plant ($0.04/kWh) or a nuclear plant ($0.02/kWh) to the cost of a renewable alternative. Instead, we must consider the cost of new generation. Per EIA, that cost for solar PV is now $4,755/kW, lower than coal-fired generation with carbon capture and sequestration (a fair basis for comparison to renewables, which emit no carbon) at $5,348/kW, and nuclear at $5,339/kW.

Since we must replace two-thirds of our power generation capacity within the next 40 years, why would we not choose renewables, which will have become significantly cheaper, while killing coal-plant emissions and the still-unsolved nuclear waste disposal problem at the same time?

Why FiTs are superior to other incentives

Given the obvious success of FiTs as a policy tool in Europe, one must wonder why the U.S. has not embraced them. Germany already tried all the incentives that we’re using in the U.S., such as aspirational targets like renewable portfolio standards (RPS), rebates, and low-interest loans, and eventually turned to FiTs because they proved to be far more effective, simple, low-cost, and efficient.

For example, compare a typical FiT with the main incentive program for residential rooftop PV in California, which leads the nation in solar electric generation.

If you install a solar PV system under a FiT program, you only get paid for its actual generation. If it doesn’t perform as expected, you don’t get paid, so the incentive encourages good design. Generating more than you consume becomes an advantage, which encourages consumers to reduce their consumption and install larger systems. The paperwork usually consists of a contract a few pages long. It’s simple, and generally uncorruptible.

By contrast, if you want to take advantage of the California Solar Initiative, you have to first get an energy audit of your home, which will guide you to install a smaller system. Then you have to find an installer, who will be required to vouch that a system of a certain size is needed, and supply documentation to prove what the output of the system will be, adding significant cost for the contractor. The installer then applies for the available rebates on your behalf, but the rebates can fall at any time depending on demand, and each period’s allocation can become fully subscribed before your application is approved, forcing you to accept a lower rebate for the following period. (Pennsylvania is experiencing this problem now.) Once your system is installed, it can be randomly inspected to prove that it performs as advertised. Then, after the system is approved and connected to the grid, you can claim the rebates and other incentives, requiring a load of additional paperwork. If you don’t use all the power you generate in a given year, you don’t get paid for it, which discourages conservation. In all, it’s a slow, bureaucratic nightmare compared to a FiT. (California did introduce a FiT in 2008, but at $0.096/kWh, it was too low to attract much interest.)

As a result of all that complexity and its inability to scale, Californians wound up paying incentives averaging around $0.34/kWh for solar PV last year, according to feed-in tariff expert Paul Gipe. If they had used a German FiT model instead, Gipe says, the cost would have been $0.24/kWh. (Those who are interested in the details of FiT rates are highly encouraged to explore Gipe’s work.)

The lack of a national FiT prompted states and a few cities to try creating their own equivalents. Unfortunately, they quickly ran afoul of regulation, because the Public Utility Regulatory Policies Act (PURPA) of 1978 forbids states from setting tariffs above the “avoided cost” of generation from other sources like conventional natural gas-fired plants. This led the states to adopt strategies like renewable energy credits, RPS policies, subsidies, and tax credits, which fall outside the Federal Energy Regulatory Commission’s (FERC) jurisdiction.

California then petitioned FERC to exempt systems under 20 MW from PURPA, paving the way for its state FiT. FERC issued a clarifying order which affirmed its jurisdiction over wholesale electric sales and continued to require rates to be set based on avoided costs, but opened the door to FiTs based on different ways to calculate those costs. Where that leaves FiTs today is unclear.

The absence of a FiT has spawned a renewables industry in the U.S. that’s clunky and inefficient, with incentives and standards (like equipment ratings and electrical codes) varying wildly from state to state. It has also given us a cottage industry of third-party financing strategies designed to capture the federal tax credits, which ultimately redirects a significant portion of the already-marginal profit to the financial industry instead of adding new capacity.

With the wind of Chinese and Japanese FiTs at their backs, along with the world’s lowest manufacturing costs, the stage is now set for Asia to absolutely blow the doors off the U.S. PV market, starting next year. While we have been building new manufacturing capacity in the U.S., it probably won’t be sufficient to dampen that giant sucking sound, and could result in another round of module shortages here. The U.S. grid-connected solar PV market doubled to 878 MW from 2009 to 2010, but that was dwarfed by the demand of the German and Italian FiTs. More than 17 GW of capacity was installed globally in 2010. If the U.S. were to install PV commensurate with its share of the global energy market as a whole, we’d have installed 3.87 GW; instead we installed about one quarter of that.

The economics are now clearly in favor of renewables, especially over a 20 year horizon. Retrospective studies have shown that over time  FiTs reduced the fully-considered costs of delivering power, and were the most cost-effective incentive strategy.

The only reason we wouldn’t follow the example of the rest of the world with an aggressive renewable FiT is because we, like the UK, are deeply beholden to the incumbent industries. Utilities, coal and natural gas producers, railroads, and pipeline companies make a great deal of money under the fossil fuel regime by shipping natural gas and coal to power stations, then shipping the electricity to consumers, then marking up that power for retail sale. Solar PV on sunny rooftops cuts all of that out of their businesses. It benefits them to bend federal regulations to their favor, drag their feet on installations, disperse a cloud of squid ink around climate change science, and throw up as many bureaucratic hurdles as possible.

This is, admittedly, a simplified analysis. There are actually twelve different FiTs in Germany alone. Different FiTs have different degrees of complexity, and grid power rate schedules can have many different tiers of pricing. I passed over other important factors, like grid capacity and interconnection issues, and focused on residential solar PV when utility-scale projects and other renewables like wind are equally affected by FiTs.

But what should be clear is that the hodgepodge of regional, state, and federal incentives in the U.S. has resulted in a far lower rate of deployment, at a higher cost, than what FiTs have produced. With a national FiT, the cost would be spread across all consumers and create sustained demand, instead of allowing it to collapse once or twice a year whenever state rebate funds run dry. If America wants to remain competitive in energy, we should try what has worked so well for Europe. FERC should do whatever is necessary to clear the way for a national FiT of around $0.30/kWh for at least 20 years and be done with it. We can’t afford to dink around with our regulations for several more years, kowtowing to vested fossil fuel interests, while the rest of the world pulls rapidly ahead in the race to energy transition.

Photo: (solarpanels-chinacom/Flickr)

The Race for Arctic Oil Is On

By Chris Nelder
Wednesday, August 31, 2011

Yesterday Rosneft, the 75% state-owned Russian oil giant, kicked BP to the curb in favor of ExxonMobil as its joint venture partner to explore Russia’s portion of the Arctic for oil and gas.

The French television station France 24 asked me to weigh in on the deal (my thanks to @willedwards and producer @jenfrance24 for having me on). Here’s the clip:

Where BP Went Wrong

Rosneft needed a Western oil company partner with the deepwater drilling expertise to tap one of the most challenging and untried oil provinces on earth, the Arctic.

BP thought it had secured the partnership back in January, and had touted it as part of its future growth strategy to recover from the Macondo well disaster in the Gulf of Mexico. That strategy is now thrown into question.

BP had offered Rosneft a 5% stake in BP in exchange for a 9.4% share of Rosneft, in a $16 billion share swap deal. BP’s investors hated it, partly because it would dilute their shares, and partly due to a longstanding aversion to having Russian owners in the company. But that’s not what killed the deal.

BP had some Russian billionaire partners known as AAR—Alfa, Access and Renova—in a separate joint venture called TNK-BP, which BP was supposed to represent as its exclusive partner for investments in Russia. AAR viewed the overture to Rosneft as a breach of that agreement, and they opposed the deal, which was later voided in arbitration. BP attempted to buy them out for $32 billion in May, but failed. That left the door open for Exxon.

Exxon offered a simpler exchange of assets, which would not dilute its shareholders. Exxon will gain access to three oil deposits Russia’s East Prinovozemelsky blocks in the Kara Sea, and one in the Tuapse license block in the Black Sea. In exchange, it will give Rosneft a joint venture role in at least six of its exploration projects in the Gulf of Mexico and “tight oil” formations inTexas. Rosneft liked Exxon not only for its  expertise and deep pockets; they also salivated over the prospect of getting more exposure to oil and shale gas fields in the US. Further, Exxon was already a trusted Rosneft partner, working with it on an offshore project near Russia’s Sakhalin island.

Exxon will put up $3.2 billion in initial funding for the joint venture. Drilling is expected to commence in 2015. Rosneft will have a two-thirds stake, and Exxon one-third, but Exxon will bear the lion’s share of the exploration costs.

Some $200 billion to $300 billion dollars in direct expenditures are anticipated to develop the Russian resources, but the total project cost might be as high as $500 billion including related infrastructure investments, according to Vladimir Putin.

In short, Exxon got a better deal with fewer concessions than BP had offered, and BP’s CEO Bob Dudley came off looking like an inferior negotiator to Exxon’s Rex Tillerson. More to the point, BP showed that it couldn’t play Russian oil hardball. They weren’t prepared for it legally, nor did they have the political savvy to survive internal Russian business politics. During earlier negotiations in July 2008, as readers may recall, Dudley fled Moscow and went to a secret, high-security location in a hurry, to escape intimidation by Russian authorities (likely at the behest of AAR) who intended to summon him for questioning over alleged violations of labor laws. I don’t blame him for wanting to escape the same fate as Mikhail Khodorkovsky, but I do think he was a bit out of his league in negotiating with the Russians. Tillerson, in contrast, is a tried-and-true American oil company warrior.

As further evidence that BP might be having “a spot of trouble” with the Russian oligarchs, their offices in Moscow were raided today by Russian court officials, in pursuit of a lawsuit filed by AAR. Non-executive employees were sent home and the offices were sealed, Reuters reported. But political analyst Nikolai Petrov of the Moscow Carnegie Center downplayed the raid, calling it “a coincidence in timings,” not evidence that BP will see further pressure from Russian authorities.

BP is now working to convey the image that it still has other meaningful opportunities, including Brazil, the Caspian Sea, Australia and elsewhere. However BP is still unable to resume drilling in the Gulf of Mexico after the Macondo well disaster. BP has lost 22% of its market capitalization this year.

How Big Is The Prize?

The Arctic is thought to hold one-fifth of the world’s undiscovered, recoverable oil and natural gas, according to the most recent (2009) assessment by the United States Geological Survey (USGS). Sixty percent of the oil is concentrated in just six small areas (“assessment units,” or AUs, in USGS parlance), predominately in Alaska, and two-thirds of the undiscovered gas is in just four AUs, predominately in Russia. Of the 61 significant Arctic oil and gas fields, 43 are thought to be in Russia. The Russian Arctic is thought to be gas-prone, while the North American Arctic is likely richer in oil.

Rosneft claims there are an estimated 36 billion barrels of recoverable oil in the Kara Sea, out of a 110 billion barrel resource base. The Black Sea block is thought to have 9 billion barrels of reserves. However those numbers are probably on the high side.

As I detailed in my June 2009 article, “Arctic Oil and Gas Potential,” USGS gave a 95% probability for there being 44 billion barrels of oil, and 770 trillion cubic feet of gas, waiting to be discovered in the Arctic. Allow me to underline that these are undiscovered resources. At 50% probability, they said there might be 83 billion barrels and 1547 trillion cubic feet of gas. In my experience, the P95 numbers should be used, especially in an area we know so little about. So I am skeptical of the claim offered with the news of this deal that there are 60 billion barrels recoverable in the Arctic. Assuming a generous 25-35% recovery factor, the Arctic may in fact have only a 4-month world supply of recoverable oil, and around a 2-year supply of gas.

Even so, I think it’s safe to say that Exxon got a pretty good deal in the Rosneft joint venture, even assuming the high estimate of $500 billion for the total project cost. If the 110 billion barrel number is credible for the Kara Sea resource, and they are only able to achieve the low end 25% recovery factor, they’ll get around 27 billion barrels out of it for a production cost of $18.18 per barrel. And if the high 60 billion barrel recoverable figure is correct, the cost would be a mere $8.33 a barrel. With Brent crude trading at $115 today, the payoff for the joint venture could be huge either way.

But we must never forget that oil exploration in the briny depths is always a highly risky endeavor. It’s not unusual in today’s oil business, while trying to plumb the most remote resources on the planet, to drill a $200 million dry hole. It’s not unusual to run into unforeseen technical challenges, or have equipment failures, as we all saw last year. It’s very likely indeed that the $500 billion figure will turn out to be on the low side, as the original project timeline gets stretched out, and prices for key structural commodities like steel rise to heretofore unseen levels…especially if my guess is right, and the world enters the age of terminal oil decline starting around next year. And if that happens, prices could spike like they did in 2008, crushing demand, and forcing oil prices back down to very low levels. So the Arctic prize may or may not turn out to be as golden as this quick math might suggest.

Indeed, altogether new technology will have to be developed to produce oil from the Arctic. Exxon and Rosneft will create an Arctic research and design center in St. Petersburg to invent it, as part of the joint venture. For example, the oil business currently does not know how to clean up a spill in the months-long night of Arctic winter. Technology to manage ice will be needed, and higher specification components will have to be developed that can endure the freezing conditions. Even simply housing and feeding the workers and attending to their medical needs so far from civilization will be a major challenge. All of this will extend the usual timelines for deepwater projects significantly.

Until next time,

Chris

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