What will you pay?

I am developing a price calculator that will help answer the question “what will you pay for gasoline?” It will be on this web site in the next few weeks; until then, here are some preliminary results…

When people take into account the time they save by driving versus taking transit or bicycling, and the monetary value they put on their time, the numbers for typical trips are somewhat alarming. The calculations suggest that people would pay at times $4 to $8 per litre of gasoline (or $12 to $24 per gallon.)

To me this suggests that shortages, not prices, may end up providing the supply limit for gasoline. Check back and check it out for yourself.

Is “peak oil” a contaminated brand?

This was triggered by an article I read today regarding oil price influences and the death of Al-Zarqawi. The author describes "peak oil" as a "contaminated brand name." I wrote this response in agreement:

The problem as I see it is that people nowadays (as did Hubbert himself) try to use the peak oil "theory" to predict future supply and demand to the nth degree. Kenneth Deffeyes goes on for pages and pages (in an otherwise enlightening book) trying to demonstrate that the true curve is Gaussian or Lorentzian or Logistic. I have two degrees in physics, and even if one of those curves were a perfect fit to past data, it proves nothing about the future. Hence the "theory" (which is an inacurate and unfortunate description as well, because decline of oil fields is a historical fact) is very easy to dismiss. Not only that, it is dismissed by offering examples of where it didn't work, lending credence to the "it never happened before, so it won't happen" argument – which also says nothing about the future.

The ultimate irony to me is that one of the counter arguments to what I call the Energy Predicament (or energy decline if you prefer) is that "the market will take care of it by raising prices." That is exactly one of the warnings that we who are concerned about energy are making. If evidence such as demand elasticity for gasoline is examined, it suggests liquid fuel prices will have to more than double for any significant decrease in use. And the production and consumption statistics speak for themselves.

As a professional speaker, I am giving more and more speeches on "the Energy Predicament." I have labelled it such in part because in North America it is more than just oil – it is also the interrelationship between oil, natural gas, and electricity. And a predicament is "an unpleasantly difficult or complicated situation" – one that few people want to deal with. The Energy Predicament is not good news, and it is a problem which will affect everyone in North America and many around the world. Hence the public does not want to hear it. Presenting the situation as a theory which can easily be shot down is not going to get the message across.

When I ask people "are oil and gas finite?" they answer "Yes." When I follow up with "So when will they run out?" they almost invariably answer "I don't know," which leads to a conversation about how while oil and gas won't run out soon, we are facing the situation where supply will not be able to keep up with demand. And people can understand that.

So rather than trying to evoke a shaky theory from a dead guy, ask people to use their own logic. That's why I agree that "peak oil" is a contaminated brand name.

Natural Gas Supply and LNG

The big question – will it be here in time? Today's Globe and Mail newspaper has a story about Kitimat LNG Inc. winning a provincial environmental assessment certificate for its proposed Liquified Natural Gas terminal on British Columbia's coast.

The terminal will be capable of handling 600 million cubic feet per day of natural gas. Wow! That's a big number. Or is it?

Let's put that number in context. Alberta currently produces 17 billion cubic feet per day, so this terminal could import the equivalent of 3.5% of Alberta's production. The market for natural gas is a continental one, so to put in another context, this terminal's capacity is equivalent to 0.8% of North American consumption of 73 billion cubic feet per day.

North American natural gas production is getting tougher – more and more wells just to produce the same amount of gas: 15,000 new gas wells in Alberta alone in 2004. Old wells are declining. But LNG terminals meet with a lot of opposition from locals. Will LNG be enough, in time?

I never thought I’d see the day…

…when an automotive columnist would call for higher gas taxes. But this past weekend Jim Kenzie, the Toronto Star's senior automotive writer and tester, called for just that.
We subscribe to the Saturday Star, a mammoth paper that has not one but two sections devoted to "Wheels" – cars, trucks, motorcycles. I am far from a car fanatic; in fact, I usually scan Wheels mainly to see the latest silliness in transportation. This weekend I was truly surprised, in a pleasant way.
Jim Kenzie started his column pointing out how the Ontario government's sales tax rebates are both ineffective and unfair. Ineffective because "hybrids make up only an infinitesimal percentage of total auto sales in this province (about 1,000 per year out of 600,000, according to auto industry guru Dennis DesRosiers)" and unfair because there are other high mileage vehicles that don't get the tax break. And because people who drive for economy (slower and more gentle acceleration) don't get any tax break.
He then continued on to point out that the only effective way to get people to use less gas is to raise gas taxes. That way, any solution that saves fuel is rewarded. As Kenzie puts it: "Raising fuel prices shortens your payback time and rewards your purchase. But it doesn't simultaneously penalize the Smart owner, the car pooler or the slow guy."
Kudos to Jim Kenzie for speaking the necessary truth. One thing I would add: take the extra tax revenue and devote it to transit. Lower the price of transit, more people will take it, and even the drivers will benefit from less traffic.
One last point – remember the hue and cry a couple of years ago, when there was talk of adding a couple of cents a litre tax in Toronto to help pay for transit? That was back when gas was around 60 cents per litre. Now we're over a dollar a litre – people are still buying…

What is the new normal for energy?

I received a call today from a reporter in New Brunswick. The NB Premier, Bernard Lord, announced today a full rebate of the provincial portion of sales tax on electricity and other heating sources. He also committed to bringing regulation to the gasoline and home heating markets.

While the Premier also talked about energy efficiency and increasing renewable sources of electricity to 30% by 2016, it was his comment about why he was doing this that caught my eye.

"I'm not suggesting today that regulating gasoline will provide lower prices," Lord said. "It will provide more stable prices and what we have seen because of the world market situation we face now, it's an unusual situation that requires regulation."

Premier Lord talked about the uncertainty worldwide in energy markets and a need for certainty in New Brunswick.

Sorry, Premier Lord, but uncertainty is the new normal. With conventional oil production reaching its peak worldwide, and mammoth drilling efforts in North America just to keep natural gas production the same as last year, volatility and uncertainty are going to be around for a while.

Of course, just like here in Ontario, the provincial government has a lot more power over electricity than other energy sources. And like here in Ontario, the government is keeping electricity rates artificially low, subsidizing those who use lots of electricity by taxing everyone. Premier Lord has vowed that regardless of the outcome of a Public Utilities Board hearing on electricity rates, he will cap the rate increase at 8%. When combined with the 8% sales tax cut, prices will not change.

I recognize the realities of politics, especially for a minority government. But both economics and common sense says that if you want people to use less of something, it has to go up in price. (Besides, they are paying for it one way or another.) Explain the situation to people. Provide relief for those who need it. Increase the price gradually. But don't imply that this is a temporary situation we need to get through.

Expensive, uncertain energy is the new normal.

CNN on the bandwagon

CNN will air a special on Saturday night at 8:00 pm (and I believe other times as well) titled “We Were Warned: Tomorrow’s Energy Crisis.” It is a fictional glimpse into the future where hurricanes and terrorists conspire to create oil and gasoline shortages. I guess it is still too scary to say this is a real scenario; however, any publicity of the issue is good publicity. More information on the program is available here: www.gazette.gmu.edu/articles/7978/

Some not so good news

Henry Groppe founded Groppe, Long & Littell in 1955. The Houston, Texas based energy consulting firm serves corporate, government and private clients and is noted for its long range forecasts of oil and gas supply, demand and prices. Yesterday on Report on Business Television, Mr. Groppe stated that world wide conventional oil extraction has peaked, with some interesting corrollaries. One, all countries will be producing at maximum capacity from now on. Two, as a result, OPEC essentially has no influence on oil prices any more. Three, because of oil sands production, Canada will be the number one oil exporter to the U.S. in the future.

Mr. Groppe described three eras of oil:

1870 to 1970 – the U.S. dominated oil production, and oil prices (in 2004 dollars) averaged around $13 per barrel

1970 to 2004 – OPEC dominated, and oil prices averaged around $36 per barrel

Now and Forwards – the new era, where scarcity and price rationing (and volatility) will dominate.

ROB TV archives are here – look for March 10, 2006, 12:30 p.m.

Some Good News

Galleon Energy Inc. announced on Thursday a major find of light, sweet crude oil along with natural gas in Alberta. (Not surprisingly, Galleon shares have jumped about 36% in the past two days on the news.) Since Galleon is a junior oil and gas company, the expected production of 4,000 to 8,000 boepd in 2007 is very large for them. Of course, to keep this in perspective, this would represent about 0.007% of current world daily consumption. Still, new discoveries of light sweet crude oil are rare these days. For more information, go to the Galleon Energy web site.

Hello from Oil country

I haven’t written for a couple of days – I’m out in Alberta right now. Interesting experience – this week, the Alberta government announced a budget surplus of 7 billion dollars (10 billion if you really add everything in) on a 27 billion dollar budget. It is greater than the government of Canada’s surplus.

They are planning to sock some away, about a billion. By some measures, sounds like a lot, but once natural gas (the principle source of royalty revenue as I understand it) starts to decline, it may go fast…

But for now at least, things are booming!

Prices and demand

Oil prices jumped $1.44 per barrel in early trading today after militants in Nigeria attacked oil facilities, causing Royal Dutch Shell to reduce output by 455,000 barrels per day.  This is despite a glut of oil as consuming nations have been stockpiling, leading to lower prices in past weeks.

Analysts say this is a reminder that much of world oil supply comes from high-risk countries.  I think it is interesting to look at the numbers involved.  With current global consumption at 84 million barrels of oil per day, 455,000 barrels represents 0.5% of daily consumption.  Yet the price rise was 2.4%.

This situation reflects traders’ awareness that demand for oil to tends to be inelastic – that is, demand drops a small amount when prices increase, at least in the short term. Consequently, a small drop in supply results in a large increase in price.

Of course there is much debate about the price elasticity of oil, gasoline, and natural gas.  The real problem is that if we are truly reaching the maximum daily extraction rate of oil, price elasticity theory may not work very well.  The theory is based on the principle that if prices rise demand will drop, or if prices fall supply will rise.  But what happens if we hit a hard, physical limit to the amount of oil that can be produced?  What if production starts to decrease?  What effect will that have on the theory and practice of the economics of elasticity?  And what will be the effect on the economy?