Wednesday, December 17, 2008

Higher Energy Prices, Dr. Chu?

As I've indicated in previous posts, energy prices may well drop further in the short term. The drop of almost 8% in oil prices after the announcement of substantial OPEC production cuts is testament to the downward bias of the market, worries about the economy and the ineffectiveness of the cartel. Even so, as I've also noted previously, I believe prices in the longer term will be somewhat higher, in the $50-75 range.

None of the several developments over the past few days in the energy world change that. However, one event stands out as far and away the most influential in driving the future of energy...the nomination of Dr. Steven Chu as the Energy Secretary. This development will change the energy future in significant ways, of which you should be aware.

Dr. Chu marks a departure from the old ways. Previous appointments have been from the more traditional hydrocarbon side of the energy world. Dr. Chu is from the alternative energy side, and he has made clear very strong beliefs which could redirect and clarify the direction of energy in the US for the next several years. Further, it is pretty clear his agenda is supported by Obama and the Congress. I believe his new direction will have support from the general public as well, at least until the bills come due. As a result, I believe he will be successful in implementing many of his concepts. So, let's take a look at some of his beliefs, and then explore the likely results:
  • He has stated repeatedly that coal is his biggest nightmare.
  • He has voiced support for a cap and trade system.
  • He has advocated promoting conservation by imposing motor fuel taxes similar to those in Europe, raising gasoline prices to levels similar to Europe (and most other developed countries).
  • His career has focused on alternative fuel sources, particularly cellulosic ethanol.
  • He believes strongly in improved efficiency and conservation as the way forward.

Given the assumption that many of these concepts will be implemented, what are the impacts? Let's start with coal. Coal is used to produce about half of the electricity in the US. Under a cap and trade system, coal will be under a signficant disadvantage. While in time other alternatives will replace coal, this process will take several years. As a result, the only way to utilize coal would be with carbon sequestration. My analysis (explained in a previous post) is that sequestration would approximately double the cost of power generation using coal. So, it is reasonable to assume a 50% increase in electricity cost over the next few years based on this factor alone.

The story for motor fuels is similar. Raising motor fuel taxes to levels similar to the rest of the world would increase gasoline cost to about $5 per gallon. Again, in this scenario, alternatives would begin to replace gasoline, but this process would take several years to replace a significant portion of the gasoline and diesel now being used. In the mean time, transportation cost increases would be on the order of 100-200%. Biofuels obviously are one alternative, but for the foreseeable future, they will be substantially more costly than current prices. Electricity is an alternative, but battery technology is still a problem, and increased electricity use would exacerbate the electricity issue mentioned above. Hydrogen? For the foreseeable future, it is generated only by using electricity or hydrocarbons.

On the positive side, these measures, if maintained over the long term, are likely to result in improvements in alternatives that most Americans would say they want. power, wind power, biofuels.

On the down side, it will result in several years of higher personal, as well as, business costs. The economy will be weakened relative to the rest of the world. More jobs will leave for lower cost locations.

The worst, and most likely result, is that a lot of money gets wasted before everyone realizes this will be more onerous than they thought and the whole thing comes down like a house of cards.

For the record, I too believe efficiency and conservation are a key to our energy future. But I believe this process will happen most effectively automatically, as a result of normal supply and demand. Imposing artificial factors such as cap and trade and significant new taxes to speed up the process just make it more inefficient and ultimately results in wasted resources and a reduced standard of living.

So, there you have my projection of the future. Debate. Resist. Promote. But, whatever you do, be ready. See previous posts for ideas.