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Posts Tagged ‘Energy’

The Congressional Budget Office is out with another fine infographic, this time on energy security.

The entire infographic is too big to post here, but here’s how Andrew Stocking and Maureen Costantino portray America’s energy sources and uses:

One of the most notable features is the absence of any link from natural gas to transportation (some natural gas is used in transportation, of course, but not enough to make the cut for this image). Given the ever-growing divergence between oil and natural gas prices, I wonder whether that will still be true a decade from now? Or will someone finally crack the natural gas to transportation fuel market in a big way?

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Over at Bloomberg, Julie Johnsson and Mark Chediak document how low natural gas prices are reshaping electricity markets. Wind, nuclear, and coal all look expensive compared to natural gas generation:

 With abundant new supplies of gas making it the cheapest option for new power generation, the largest U.S. wind-energy producer, NextEra Energy Inc. (NEE), has shelved plans for new U.S. wind projects next year and Exelon Corp. (EXC) called off plans to expand two nuclear plants. Michigan utility CMS Energy Corp. (CMS) canceled a $2 billion coal plant after deciding it wasn’t financially viable in a time of “low natural-gas prices linked to expanded shale-gas supplies,” according to a company statement.

Mirroring the gas market, wholesale electricity prices have dropped more than 50 percent on average since 2008, and about 10 percent during the fourth quarter of 2011, according to a Jan. 11 research report by Aneesh Prabhu, a New York-based credit analyst with Standard & Poor’s Financial Services LLC. Prices in the west hub of PJM Interconnection LLC, the largest wholesale market in the U.S., declined to about $39 per megawatt hour by December 2011 from $87 in the first quarter of 2008.

Power producers’ profits are deflated by cheap gas because electricity pricing historically has been linked to the gas market. As profit margins shrink from falling prices, more generators are expected to postpone or abandon coal, nuclear and wind projects, decisions that may slow the shift to cleaner forms of energy and shape the industry for decades to come, Mark Pruitt, a Chicago-based independent industry consultant, said in a telephone interview.

The hard question, of course, is whether low natural gas prices will persist, particularly if everyone decides to rush into gas-fired generation:

“The way to make $4 gas $8 gas is for everyone to go out and build combined-cycle natural-gas plants,” Michael Morris, non-executive chairman of American Electric Power (AEP) Inc., said at an industry conference in November. “We need to be cautious about how we go about this.”

The whole article is worth a read if you follow these issues. (ht: Jack B.)

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In 2010, I wrote a series of posts documenting how oil and natural prices had decoupled from each other (see here and here). For many years, oil prices (as measured in $ per barrel) were typically 6 to 12 times natural gas prices (as measured in $ per MMBtu). That ratio blew out to around 20 in 2009 and again in 2010, a severe break with historical trends.

At the time, that seemed like an enormous disparity between the two prices. In retrospect, we hadn’t seem anything yet. As of yesterday, the ratio stood at more than 33:

A barrel of oil has roughly 6 times the energy content of a MMBtu of natural gas. If the fuels were perfect substitutes, oil prices would thus tend to be about 6 times natural gas prices. In practice, however, the ease of using oil for making gasoline means that oil is more valuable. So oil has usually traded higher.

But the current ratio is unprecedented. Each Btu of oil is now worth about five times as much as each Btu of natural gas. Thanks to a torrent of new supply, natural gas prices are down at $3.00 per MMBtu even as oil (as measured by the WTI price) has risen back above the $100 per barrel mark.

Perhaps natural gas vehicles will be the wave of the future?

Note: Energy price aficionados will note that I’ve used the WTI price in these calculations. That used to be straightforward and unobjectionable. Now, however, we have to worry about another pricing discrepancy: WTI is very cheap relative to similar grades of oil on the world market (for background, see this post). For example, Brent crude closed Monday around $112 per barrel, well above the $101 WTI price. Brent prices are relevant to many U.S. oil consumers. There’s a good argument, therefore, that my chart understates how much the price ratio has moved. 

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Auto companies have made great strides in improving engine efficiency in recent decades. But those improvements haven’t done much to improve the fuel economy of America’s passenger car fleet. Instead, consumers have “spent” most of those efficiency improvements on bigger, faster cars.

MIT economist Christopher Knittel has carefully quantified these tradeoffs in a recent paper in the American Economic Review (pdf; earlier ungated version here). As noted by Peter Dizikes of MIT’s News Office: 

[B]etween 1980 and 2006, the average gas mileage of vehicles sold in the United States increased by slightly more than 15 percent — a relatively modest improvement. But during that time, Knittel has found, the average curb weight of those vehicles increased 26 percent, while their horsepower rose 107 percent. All factors being equal, fuel economy actually increased by 60 percent between 1980 and 2006, as Knittel shows in a new research paper, “Automobiles on Steroids,” just published in the American Economic Review.

Thus if Americans today were driving cars of the same size and power that were typical in 1980, the country’s fleet of autos would have jumped from an average of about 23 miles per gallon (mpg) to roughly 37 mpg, well above the current average of around 27 mpg. Instead, Knittel says, “Most of that technological progress has gone into [compensating for] weight and horsepower.”

This is a fine example of a very common phenomenon: consumers often “spend” technological improvements in ways that partially offset the direct effect of the improvement. If you make engines more efficient, consumers purchase heavier cars. If you increase fuel economy, consumers drive more. If you give hikers cell phones, they go to riskier places. If you make low-fat cookies, people eat more. And on and on. People really do respond to incentives.

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In an excellent new paper, Jim Hamilton asks whether the “phenomenal increase in global crude oil production over the last century and a half” reflects technological progress or good fortune in finding new reserves. The two aren’t completely distinct, of course. Better technology helps find more resources. But the heart of the question remains: have we been lucky or good?

Based on a careful reading of production patterns in the United States and around the world, Jim concludes that we’ve been both and worries that the luck part may be coming to an end:

My reading of the historical evidence is as follows. (1) For much of the history of the industry, oil has been priced essentially as if it were an inexhaustible resource. (2) Although technological progress and enhanced recovery techniques can temporarily boost production flows from mature fields, it is not reasonable to view these factors as the primary determinants of annual production rates from a given field. (3) The historical source of increasing global oil production is exploitation of new geographical areas, a process whose promise at the global level is obviously limited.

Most economists view the economic growth of the last century and a half as being fueled by ongoing technological progress. Without question, that progress has been most impressive. But there may also have been an important component of luck in terms of finding and exploiting a resource that was extremely valuable and useful but ultimately finite and exhaustible. It is not clear how easy it will be to adapt to the end of that era of good fortune.

These arguments should be familiar to anyone who’s followed the peak oil debate, but Jim brings a welcome rigor to the discussion.

He also includes some charts illustrating how various states and regions have passed their production peaks. Here, for example, are the United States, North Sea, and Mexico:

And he discusses how oil prices affect the economy. All in all, a great survey.

P.S. If you are interested in the details, Jim’s post over at Econbrowser sparked some thoughtful comments.

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Last week I had the opportunity to testify before two Ways and Means subcommittees–Select Revenue Measures and Oversight–about the way our tax system is used as a tool of energy policy. Here are my opening remarks. You can find my full testimony here.

As you know, our tax system is desperately in need of reform. It’s needlessly complex, economically harmful, and often unfair. Because of a plethora of temporary tax cuts, it’s also increasingly unpredictable.

We can and should do better.

The most promising path to reform is to reexamine the many tax preferences in our code. For decades, lawmakers have used the tax system not only to raise revenues to pay for government activities, but also to pursue a broad range of social and economic policies. These policies touch many aspects of life, including health insurance, home ownership, retirement saving, and the topic of today’s hearing, energy production and use.

These preferences often support important policy goals, but they have a downside. They narrow the tax base, reduce revenues, distort economic activity, complicate the tax system, force tax rates to be higher than they otherwise would be, and are often unfair. Those concerns have prompted policymakers and analysts across the political spectrum—including, most notably, the Bowles-Simpson commission—to recommend that tax preferences be cut back. The resulting revenue could then be used to lower tax rates, reduce future deficits, or some combination of the two.

In considering such proposals, lawmakers should consider how tax reform, fiscal concerns, and energy policy interact.  Six factors are particularly important.

  • Our tax system needs a fundamental overhaul. Every tax provision, including those related to energy, deserves close scrutiny to determine whether its benefits exceed its costs. Such a review will reveal that many tax preferences should be reduced, redesigned, or eliminated.
  • The code includes numerous energy tax preferences. The Treasury Department, for example, recently identified 25 types of energy preferences worth about $16 billion in 2011. These include incentives for renewable energy sources, traditional fossil fuel sources, and energy efficiency. In addition, energy companies are also eligible for several tax preferences that are available more broadly, such as the domestic production credit.
  • Tax subsidies are an imperfect way of pursuing energy and environmental policy goals. Such subsidies do encourage greater use of targeted energy resources. But, as I discuss in greater detail in my written testimony, they do so in an economically wasteful manner. Subsidies require, for example, that the government play a substantial role in picking winners and losers among energy technologies. The associated revenue losses also require higher taxes or larger deficits.
  • A key political challenge for reform is that energy tax subsidies are often viewed as tax cuts. It makes more sense, however, to view them as spending through the tax code. Reducing such subsidies would make the government smaller even though tax revenues, as conventionally measured, would increase.
  • Tax subsidies are not created equal. Production incentives reward businesses for producing desired energy and are agnostic about what mix of capital, labor, and materials firms use to accomplish that. Investment incentives, in contrast, reward businesses merely for making qualifying investments and encourage firms to use relatively more capital than labor. For both reasons, production incentives tend to be more efficient than investment incentives.
  • Well-designed taxes can typically address the negative effects of energy use more effectively and at lower cost than can tax subsidies. I understand that higher gasoline taxes or a new carbon tax are not popular ideas in many circles, but please bear with me. As I explain at length in my written testimony, well-designed energy taxes are a much more pro-market way of addressing energy concerns than are tax subsidies. Taxes take full advantage of market forces and, in so doing, can accomplish policy goals at least cost and with minimal government intervention. Subsidies, in contrast, make much less use of market forces and inevitably require the government to pick winners and losers. Energy taxes also generate revenue that lawmakers can use to cut other taxes or to reduce deficits.

P.S. Not surprisingly, that last point wasn’t picked up by anyone else, at least during my panel (one of three at the hearing). New energy taxes would, of course, be problematic for the macroeconomy if enacted immediately. And we’d have to make some adjustment, either in the tax code or in benefit programs, to offset the impact on low-income families. In the long-run, however, I think that would be a much better way to address many energy concerns, including carbon emissions and oil dependence. But that’s not the way our system works. Instead, as noted, it’s much more popular to use tax preferences, whose benefits are visible and whose costs are obscure, to pursue energy and environmental goals. Other participants discussed the particular incentives, existing and proposed, in greater detail; their testimony is available here.

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In a series of posts (most recent here), I’ve noted that oil and natural gas prices have become unhinged from each other. Oil (denominated in $ per barrel) used to trade at 6 to 12 times the price of natural gas (denominated in $ per MMBtu). But lately that ratio has been north of 20, thanks to a surfeit of new gas in the United States (and elsewhere) and, recently, growing global demand for oil.

The wide spread between oil and natural gas prices provides a tempting incentive for any innovators who can figure out how to use natural gas, rather than oil, to make transportation fuels.

Over at the New York Times, Matthew Wald identifies one possibility, using natural gas to produce diesel:

Diesel and jet fuel are usually made from crude oil. But with oil prices rising even as a glut of natural gas keeps prices for that fuel extraordinarily cheap, a bit of expensive alchemy is suddenly starting to look financially appealing: turning natural gas into liquid fuels.

A South African firm, Sasol, announced Monday that it would spend just over 1 billion Canadian dollars to buy a half-interest in a Canadian shale gas field, so it can explore turning natural gas into diesel and other liquids. Sasol’s proprietary conversion technology was developed decades ago to help the apartheid government of South Africa survive an international oil embargo, and it is a refinement of the ones used by the Germans to make fuel for the Wehrmacht during World War II.

The technology takes “a lot of money and a lot of effort,” said Michael E. Webber, associate director of the Center for International Energy Environmental Policy at the University of Texas, Austin. “You wouldn’t do this if you could find easy oil,” he said.

But with the huge spread between oil and gas prices, and predictions of oil topping $100 a barrel next year, the conversion technology could be a “a money-maker for whoever is a first mover in that space.”

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