Sunday, December 29, 2013

7 things everyone knows about energy that just ain't so (2013 Edition)

Mark Twain once said, "It ain't what you don't know that gets you into trouble. It's what you know for sure that just ain't so." And, there are many, many things that the public and policymakers know for sure about energy that just ain't so.

That list is very long indeed and getting longer as the fossil fuel industry (which has little interest in intellectual honesty) continues its skillful manipulation of a gullible and sometimes careless media.

Below I've listed seven whoppers that it would be charitable to call misleading. Longtime readers will recognize that I've addressed them before in various pieces. But I thought that it would be useful to review the worst of the worst of 2013 as the year ends.

Here are seven things everyone knows about energy that just ain't so:

1. Worldwide oil production has been growing by leaps and bounds in the last several years. Oil companies (with governments following suit) have cleverly redefined oil to include something called natural gas plant liquids (NGPLs) that you might surmise actually come from natural gas wells. These include propane, butane, ethane, and pentanes. The new definition also includes biofuels such as ethanol and biodiesel.

This mishmash is sometimes referred to as "total liquids," but more often "total oil supply." This redefinition, however, depends on something that just ain't so, namely, that NGPLs and biofuels are 100 percent interchangeable with oil. There is some interchangeability, but the volume is relatively small. NGPLs make up just 10 percent of total liquids. I've seen investment research that asserts that probably less than one-fifth of that (equivalent to about 2 percent of total liquids) can be directly substituted for oil, primarily in petrochemical refineries. That portion could grow, but only with extensive and costly retooling of the refinery industry, a move that seems risky with U.S. natural gas production stalled (see below).

Now, the central problem with including NGPLs as part of the oil supply remains that they have only a very limited ability to be used as transportation fuel which is the main driver for oil consumption.

Moreover, the energy content of NGPLs is around 65 percent of oil per unit of volume. Ethanol has about 66 percent of oil's energy, and biodiesel has slightly more than crude oil, but somewhat less than the diesel it is meant to replace. We must also consider all the energy including oil that goes into growing, harvesting, transporting and processing the crops that are feedstocks for biofuel refineries. Some studies show that more energy goes into making ethanol than ethanol produces when burned in an engine.

Despite these well-known facts, the industry and government continue to count NGPLs and biofuels in barrels right alongside oil as if they were all equivalent.

Ethanol and biodiesel do directly substitute for some motor fuels. But there are upper limits on what we can produce and use. We are near those limits with ethanol unless engines change to tolerate higher concentrations of ethanol. Moreover, neither ethanol nor biodiesel can be used for the wide variety of purposes that crude oil can.

It turns out that 2005 was an inflection point after which supply growth for both total liquids and oil proper slowed considerably. With all this in mind, let's look at the actual numbers which come from the U.S. Energy Information Administration (EIA).


Total Liquids:
Growth from 1998 to 2005: 11.7 percent
Growth from 2005 to 2012: 5.7 percent

Oil Proper (Crude Oil Plus Lease Condensate):
Growth from 1998 to 2005: 9.9 percent
Growth from 2005 to 2012: 2.7 percent

You can see that the real oil supply (crude oil plus lease condensate) has been growing at just over one-quarter the pace it did in the previous seven years--even with record prices, record investment and the wide deployment of new extraction technologies. Slowing growth coupled with skyrocketing demand in places such as China and India has put a lot of upward pressure on oil prices. It's one reason oil prices remain near record highs based on the average daily price of Brent Crude, the world benchmark.

In 2011 the average daily Brent Crude price was a record $111.26—which was followed by another record in 2012 of $111.63. The price in 2013 through December 26 has averaged $108.52.


2. U.S. natural gas production continues to grow by leaps and bounds. This claim is even more misleading than the first one. It's true that natural gas production has grown in the United States in recent years due to the exploitation of gas trapped in deep shale deposits, deposits that new technology called hydraulic fracturing is now making accessible.

But, it turns out that the rate of production of these wells declines rapidly, and the numbers suggest that raising the overall U.S. rate of production is going to be very difficult and expensive from here on out. In fact, since January 2012, monthly U.S. marketed natural gas volumes have been nearly flat despite a more than doubling of natural gas prices from their April 2012 lows. The average monthly volume in 2012 was 2.11 trillion cubic feet (tcf). For 2013 the data are only available through September, but the average through that month was 2.12 tcf. It's doubtful that the average will change that much when the final three months of the year are included.

The easy shale gas has been extracted. Now comes the hard stuff. We may already be on the shale gas treadmill.


3. There is enough natural gas under the United States to last the country for 100 years. This claim requires that you first do bad math on the numbers even the perpetrators of this falsehood provide. The number turns out to be 90 years using their figures and 2010 U.S. natural gas consumption (while assuming, improbably so, no growth in U.S. natural gas use for the next 90 years).

But even that number vastly overstates what we are likely to get out of the ground for it includes estimates of probable, possible and speculative technically recoverable resources. Now, just because something is judged to be technically recoverable does not mean it will be economically recoverable. And, if it is further labelled possible or speculative, it seems foolish to base our public policy on such resources as if they were proven to exist and were ready to extract.

Shale gas expert Art Berman suggests we focus on the probable resources category and assume generously that 50 percent of those resources will actually get turned into reserves. (Keep in mind that no resource is ever exploited to 100 percent and usually only to a fraction of that. Also, resources are what are thought to be in the ground based on sketchy evidence, while reserves are what the drill bit proves are actually there and, more importantly, amenable to extraction.) Based on these assumptions, the United States has about 550 tcf feet of probable and proven reserves which means that the country has a likely supply of about 23 years (again, assuming, improbably so, no increase in the rate of consumption during the entire period).

Since Berman made those calculations, some of the probable resources have moved into the reserves category. But, the outlook has not really changed because this was expected.


4. The United States is about to become the world's largest oil producer. This claim depends on the same sleight-of-hand being used to inflate worldwide oil production numbers as noted above: the inclusion of NGPLs and biofuels in the production numbers. The United States has been furiously drilling natural gas wells in the last few years and has increased its supply of NGPLs greatly. The production of crude oil proper has also been growing for essentially the same reason natural gas production grew: the deployment of hydraulic fracturing techniques and horizontal drilling to extract previously inaccessible deposits of so-called tight oil.

The results have been impressive, lifting U.S. production of crude oil proper (crude oil plus lease condensate) from 5.2 million barrels per day (mbpd) in 2005 to 6.5 mbpd in 2012. The latest available monthly production results are for September 2013 and put U.S. crude oil production at 7.8 mbpd.

But, it seems unlikely given the very steep production declines that existing tight oil wells experience--about 40 percent per year--that production will be able to scale that of the world's number one and number two oil producers.

Russia currently produces 9.9 mbpd of crude oil proper. Saudi Arabia produces 9.8 mbpd. Both numbers come from the EIA.

Could the United States produce more crude oil proper than these countries in the near future? Since we cannot know the future, anything is possible. But, consider that the United States has gotten most of the easy tight oil. Now, it must begin to rely on extraction of the hard-to-get oil. That oil will come out at a slower rate.

Meanwhile, the tight oil wells already drilled will continue to decline at colossal rates and their output will have to be replaced before any increase in production is possible. Trying to increase oil production under these circumstances can be likened to running up a down escalator since the declining production of existing wells cancels out much of the production from newly drilled wells.

If the United States were to attain the number one spot some day, it would be hard to maintain given the high production decline rates cited above.


5. The United States is on the verge of energy independence. This canard takes advantage of the lack of public awareness about U.S. energy resources. The country has long been self-sufficient in coal. This has never been an issue. It has also been nearly self-sufficient in natural gas, importing a little over 15 percent of its needs (almost all of it from Canada) from 1991 through 2011 according to the EIA. That percentage has trended down recently as U.S. production has increased. But the U.S. supply of imported natural gas was never in danger due to political disruptions or wars in faraway unfriendly countries.

So, it turns out that energy independence really means oil independence. On this count the country is still very far away from independence despite recent gains in domestic oil production. For the week ending December 20, the United States' net crude oil imports were 7.5 mbpd. The country would have to nearly double its rate of domestic crude oil production to meet its current consumption needs. That seems very unlikely given the production dynamics discussed above for tight oil which is where nearly all the growth in production is currently taking place.


6. The United States has 250 years of coal left. This claim keeps getting recycled even though a 2007 National Academy of Sciences study concluded that there was no basis for making such a claim. It suggested that the United States might have 100 years of coal left (assuming, improbably so, there would be absolutely no increase in the rate of consumption over that period). But, the report concluded that no comprehensive study of U.S. coal resources was currently available. The truth is nobody knows how much coal is left in the United States, nor how much of that might actually be accessible.


7. Peak oil is a myth. Peak oil is the idea that oil production inevitably reaches a maximum rate and thereafter begins an irreversible decline. It does NOT mean running out, but rather that production declines over time. It turns out that peak oil is actually an empirically demonstrated reality for every oil well, every mature oil field, and now for the majority of oil producing countries in the world. Those who tell us that peak oil is a myth can only be engaged in propaganda rather than a search for the truth. Ironically, many of them cite the upturn in U.S. production as "proof" that peak oil is a myth, forgetting that U.S. production peaked more than 40 years ago.

Oil is a finite resource and so, the real debate is over the timing of peak oil production for the world as a whole. Some say the peak is nearby. Others say it is two or three decades away. But no credible expert says that there will never be a peak.

The cases for and against a near-term peak would be difficult to relate in detail here. But, it's worth noting that the optimists have been consistently wrong about prices and supplies in the last decade, and those predicting a near-term peak have been much closer to the mark.

That doesn't mean that the peak must be nearby. But it suggests that the models and assumptions of the optimists are badly flawed.


There are so many other misconceptions about energy which remain that it would take a dozen seven-item lists just to begin to address them. But, I offer these seven as a starting point for a clearer and more honest discussion of our energy future in the coming year.

Kurt Cobb is an author, speaker, and columnist focusing on energy and the environment. He is a regular contributor to the Energy Voices section of The Christian Science Monitor and author of the peak-oil-themed novel Prelude. In addition, he has written columns for the Paris-based science news site Scitizen, and his work has been featured on Energy Bulletin (now Resilience.org), The Oil Drum, OilPrice.com, Econ Matters, Peak Oil Review, 321energy, Common Dreams, Le Monde Diplomatique and many other sites. He maintains a blog called Resource Insights and can be contacted at kurtcobb2001@yahoo.com.

Sunday, December 22, 2013

If Mexico is the next Brazil in oil production, brace for disappointment

Recent reforms that would open oil exploration and development in Mexico to major oil companies for the first time in decades has the media all atwitter about the prospects of a reversal in declining Mexican oil output and a possible doubling of production. The reforms have brought out comparisons with Brazil which has a similar arrangement in which the country's state-owned oil company works with major international oil giants to develop Brazil's petroleum resources. Adding to the frothy atmosphere, former Brazilian President Luiz Inacio Lula da Silva proposed a partnership between Mexico and Brazil to develop oil resources in both countries.

In a world with daily average oil prices hovering near record levels, such news might be welcome if only we could actually count on the accompanying optimistic production forecasts. But, it's instructive to look at what actually happened in Brazil since the time its potential as a major new oil producer was touted several years ago.

Brazil had discovered large oil deposits in ultradeep (30,000 feet down) reservoirs far offshore. In 2009, Petroleo Brasileiro SA (Petrobras), Brazil's state-owned oil company, announced that it would invest approxmately $175 billion in oil exploration over several years to boost Brazilian liquid fuel production from 2.4 million barrels per day (mbpd) in 2008 of oil, biofuels and other liquids to 4.6 mbpd in 2015, a move that would make the country a major oil exporter.

Let's see what kind of progress Brazil has made so far. In 2012 the country produced 2.65 mbpd of liquid fuels, making hardly any progress toward the goal announced for 2015. (The figures for oil proper, that is crude oil plus lease condensate which is the definition of oil, were 1.81 mbpd in 2008 and 2.06 mbpd in 2012.) In fact, instead of contributing to the worldwide supply of exports, Brazil remains a net importer of oil according to the U.S. Energy Information Administration (EIA), and those imports grew from 36,470 barrels per day in 2011 to 155,040 barrels per day in 2012.

The large Brazilian oil company OGX Petróleo e Gas Participações SA filed for bankruptcy recently "after disappointing output from offshore OGX wells set off a crisis of investor confidence," according to Reuters. It's no surprise that state-owned Petrobras is also finding it far more difficult to exploit its deep sea oil resources than originally anticipated. Admittedly, there are other problems at Petrobras. It has become a tool of economic policy for keeping unemployment low, saddling it with investments that it might not otherwise have made as a private company. But that doesn't change the fact that exploiting oil far offshore at extreme depths is difficult.

Mexico's state-run oil monopoly, Petroleos Mexicanos (Pemex), has seen its production drop from 3.45 mbpd of crude oil proper in 2004 to just 2.59 mbpd in 2012 according the EIA. Reforms that will give international oil companies new access to Mexican oil fields are supposed to change that trend. It's one thing to let private companies drill previously monopolized fields. It's another to raise overall nationwide production significantly as a result. Just ask the Brazilians. The easy-to-get oil has already been harvested in Mexico and Brazil. The hard-to-get oil comes next, and well...it's proving hard to get.

Will Mexico fare better than Brazil? Art Berman, a petroleum geologist and consultant who accurately forecast the bust for shale gas investors, offered this analysis in a recent email:

I have worked in Mexico since the early 1990s inside Pemex. There is a reason that no significant discoveries have been made since the 1970s--no reservoirs.
The Campeche Sound [in the Bay of Campeche] has reservoirs thanks to the biggest frack job ever, the Chicxulub meteor impact. The Golden Lane reef trend, discovered much earlier, has been fully explored with no new discoveries. Beyond that, almost nada.
The Eagle Ford Shale play [in Texas] extends into Mexico and, so far, all tests have yielded [natural] gas. There is a potential oil play in the Tampico area from the El Abra Shale that sourced the Golden Lane. The Chicontepec tight calcarenite play contains huge oil [resources] that no one has figured out how to exploit commercially as recently as in the last few years. The deep-water Gulf of Mexico has serious reservoir problems in Mexico.
Add it all up and we are left with the same sense that there should be huge remaining undiscovered reserves in Mexico that an awful lot of smart foreign companies (Amoco, BP, Chevron, Exxon, Shell, etc.) have been unable to discover working closely [through service contracts] with Pemex since the 1980s.
As far as the Citi [Citigroup Inc.] estimates go [projecting a doubling of Mexican production which is mentioned and linked above], mucho ruido, pocos nueces (much ado about nothing; literally, lots of noise, no nuts).

Jeffrey Brown, an independent petroleum geologist best known for his Export Land Model weighed in as well on Mexico's oil future. Brown's model, first released publicly in 2006, correctly forecast shrinking global net exports of oil in recent years. He believes that any effect of the Mexican reforms will be relatively small and delayed several years. He related his views in a recent email:

Regarding their [Mexico's] offshore potential, it's going to take a long time to work out the agreements, drill some wells and put the wells on line. I wouldn't expect to see any meaningful contributions from joint venture offshore projects until some time after 2020. Regarding onshore, [that] production could come on line sooner, but the agreements have to be made, and the per-well production rates are vastly lower than offshore. Also, I suspect that the production sharing agreements are going to be something more or less equivalent to a 50% royalty (or worse), versus much more favorable terms in Texas [which would make investment in Texas more attractive to major oil companies versus investment in Mexico].

Brown, who manages a joint venture exploration program based in Ft. Worth, also noted that "Mexico is on track to approach zero net oil exports in about six years (around 2019)." He continually reminds those making rosy predictions about oil exports for any exporting country that those countries tend to grow as oil revenues increase which means their thirst for oil also grows. That can leave less and less oil available over time for export. If the country's production is in decline, as has been the case with Mexico, exports decrease much faster than production on a percentage basis if domestic consumption grows in the face of declining production--a sort of pincer movement on oil exports.

It's possible that Mexico's production may grow somewhat as a result of the country's reforms. But, it is foolish to expect too much given what we've seen in Brazil to date. And, it is important to remember that production from currently producing Mexican wells is declining continuously making it necessary to drill a lot of wells just to maintain current production let alone increase it.

Anyone looking for oil exports or production from Mexico to reach their previous high marks would be wise to plan for a less than salutary result.

Kurt Cobb is an author, speaker, and columnist focusing on energy and the environment. He is a regular contributor to the Energy Voices section of The Christian Science Monitor and author of the peak-oil-themed novel Prelude. In addition, he has written columns for the Paris-based science news site Scitizen, and his work has been featured on Energy Bulletin (now Resilience.org), The Oil Drum, OilPrice.com, Econ Matters, Peak Oil Review, 321energy, Common Dreams, Le Monde Diplomatique and many other sites. He maintains a blog called Resource Insights and can be contacted at kurtcobb2001@yahoo.com.

Sunday, December 15, 2013

'Watch what we do, not what we say': Shell cancels U.S. gas-to-liquids plant

When civil rights advocates grew restless because of President Richard Nixon's right-wing rhetoric on the issue of desegregation, then-Attorney General John Mitchell told them, ''Watch what we do, not what we say.''

Those following the hype over America's supposed newfound abundance of oil and natural gas would do well to follow that advice when evaluating what oil and gas company executives and their surrogates say.

When Royal Dutch Shell pulled the plug on its U.S. gas-to-liquids project recently, the company offered the same explanation it used when it shut down its oil shale project earlier this year: Shell sees better opportunities elsewhere. This explanation--much like the I'm-resigning-to-spend-more-time-with-my-family explanation--tends to deflect questions about why things aren't working out.

What's not working out for Shell is a planned $20 billion plant in Louisiana designed to turn natural gas into diesel, jet fuel, lubricants and chemical feedstocks, products typically produced by oil refineries. The plug was pulled, however, while the project was still in the planning stage.

Shell did actually say a little more about why it is abandoning the project in this almost inscrutable piece of corporate prose:

Despite the ample supplies of natural gas in the area, the company has taken the decision that GTL is not a viable option for Shell in North America, at this time, due to the likely development cost of such a project, uncertainties on long-term oil and gas prices and differentials, and Shell’s strict capital discipline.

Now, here's the same paragraph translated into simple English:

The plant is going to cost a lot more to build than we thought it would. Natural gas prices are going up and could easily make it uneconomical to produce diesel and jet fuel from natural gas when compared to making them from oil. And, we don't have unlimited funds to spend on everything we think of just to see if it works.

Shell CEO Peter Voser has voiced doubts about the so-called "shale revolution" in the United States (which refers to advances in drilling technology that have opened previously inaccessible shale deposits of natural gas and oil to exploitation). In fact, Shell took a $2.1 billion write-down on its shale assets in the United States. In lay terms, the company had to reduce the value of those assets on its balance sheet to reflect reality. The company also sold small tight oil fields related to shale deposits, fields that it no longer wishes to develop.

Voser said he still believes Shell's remaining $24 billion investment in U.S. shale gas and tight oil will "be a success story for Shell." Three-quarters of that investment is devoted to natural gas from shale. But, Voser added that the potential for natural gas and oil from shale elsewhere in the world has been "a little bit overhyped" citing concerns specifically about Europe.

Now, because this rhetoric is coming from an oil industry CEO, we can assume that he is walking the line between saying things which will get him removed from the invitation lists of his fellow oil executives' cocktail parties--things otherwise known as the awful truth--and misrepresenting the facts to shareholders, which would get him into trouble in other ways.

But abandoning the gas-to-liquids plant speaks much more loudly than Voser's actual remarks. It means Voser expects that natural gas prices simply won't stay low long enough to make such a huge investment pay off. And, that means that he doesn't believe the hype about an ongoing glut of U.S. natural gas.

So, Voser directs Shell to abandon a gas-to-liquids plant, the profitability of which would be destroyed by high prices for the natural gas which the plant must purchase. At the same time, he has Shell retain most of its shale gas wells, a move which only makes sense if he expects U.S. natural gas prices to go higher. And, those prices will only go higher if there is increased demand or reduced supply, or a combination of both.

It's not hard to figure out the meaning of what Peter Voser is doing. But it is understandably difficult to shut out the constant din of abundance stories sponsored by the industry and its well-financed public relations machine--that is, until you understand that it's not what the industry says that's important, but what it actually does.

Kurt Cobb is an author, speaker, and columnist focusing on energy and the environment. He is a regular contributor to the Energy Voices section of The Christian Science Monitor and author of the peak-oil-themed novel Prelude. In addition, he has written columns for the Paris-based science news site Scitizen, and his work has been featured on Energy Bulletin (now Resilience.org), The Oil Drum, OilPrice.com, Econ Matters, Peak Oil Review, 321energy, Common Dreams, Le Monde Diplomatique and many other sites. He maintains a blog called Resource Insights and can be contacted at kurtcobb2001@yahoo.com.

Sunday, December 08, 2013

The U.S. energy independence story: Will anyone be punished if it turns out to be wrong?

Will anyone who is currently predicting U.S. energy independence be punished if the story turns out to be wrong? I ask because the story--and that's all it is right now--appears to be driving public policy and business planning practically worldwide.

Often implied with that narrative is a corresponding abundance of oil globally. In fact, some are predicating worldwide abundance on a continuous rise in U.S. oil output. This is despite the fact that even many optimistic forecasts make such ideas seem foolish. The actual data for crude plus condensate (which is the definition of oil) show oil production in the rest of world declining almost as much as the United States has increased its production from 2005 onward. Worldwide crude volumes have barely nudged upward in the last eight years, just 2.7 percent versus 10 percent in the previous eight-year period, according to the U.S. Energy Information Administration. This is despite record oil prices and record investment!

Now, a lot of people stand to get hurt by the energy independence/abundance story--which is, in effect, a forecast--if the story turns out to be wrong. This is because governments, businesses and households will not have prepared themselves for a negative surprise--all because they were assured that the United States and even the world had nothing to worry about when it comes to oil supplies.

So, the short answer to the above question is that no one will get hurt except those who believe the story and act on it. And, herein lies what author and student of risk Nassim Nicholas Taleb calls the agency problem. His latest book, Antifragile: Things That Gain from Disorder, has much to say about the agency problem and should be mandatory reading for anyone who must manage risk--which means just about everyone.

Let's take the dodgy U.S. energy abundance story and see if the people who are propagating that story will be hurt if it turns out to be wrong. These people are essentially acting as agents for the industry even though they often appear in the media as neutral observers and thus agents for the public in its quest to understand our true energy situation. The most salient fact about these sources is not their hidden ties to the industry--which is bad enough--but rather the fact that they don't have any "skin in the game." That means that while they may have significant upside as a result of their forecasts or as a result of repeating the forecasts of others, they do not share proportionately in the downside if their predictions are wrong. This is a key point. It tells us that people can hype a development to increase their own wealth and/or stature while dumping the risk on others. The actual truth of something becomes immaterial to the prospective gains.

First, let me talk about journalists. Journalists are an obvious case of the agency problem. They are ostensibly acting on behalf of their readers to discover the truth. But, they often repeat uncritically what the oil industry, their paid consultants, and fake think-tank and university academics supported by the industry tell them.

It's difficult for those reporting on energy issues to buck the industry as it might ruffle feathers among longtime sources and shut down the information pipeline. And, that's the problem. Reporters depend on living, breathing sources for their information far more than they do on meticulous documentary research. And, this has become even more the case with the advent of the 24-hour news cycle and the corporatization of news--both which developments have resulted in fewer and fewer dollars going into genuine investigative reporting. (I can tell you from experience that such reporting is time consuming and involves sifting through a lot of tedious documents.)

Some journalists are exploiting the oil hype to sell books and thereby enhance their reputations and their pocketbooks. But, neither the book-writing journalist cited in the link above, nor his compatriots who are just doing their daily job of reporting the energy news will be forced out of their jobs or be forced to return their book profits, as the case may be, if U.S. energy independence turns out to be a mirage.

In saying this, I'm not advocating laws that would force such an outcome. I'm merely pointing out that believing someone's forecast about an important and critical public policy matter, someone who has no skin in the game, that is, who has no downside if they are wrong, is personally dangerous--and malfeasance if applied to public policy or business.

You will also notice that almost without exception such stories and books make scant or no mention of climate change, as if the supposed renewed fossil fuel abundance has no consequences for the unfolding climate nightmare. When I see this omission, I suspect either stupidity on the part of the writer or cupidity for the profits and stature that come from aligning oneself with a powerful and wealthy oil industry.

Industry consultants and fake think-tank academics are already well-paid for their fealty to the industry line. When they speak to reporters, there's no downside if they are wrong. Their consulting fees and think-tank salaries DEPEND on their repeating the industry story. And, no one will take their money back if the story is discredited.

So, now I've covered the broad array of writers and pundits who have been touting U.S. energy independence (and some who've been saying it will solve the world's energy problems as well). How about the industry insiders themselves? Won't they suffer if their forecasts are wrong?

The short answer is that most will suffer very little. And, that's because of the curious system of compensation which most corporate officers today enjoy. The largest part of their pay often consists of stock options--that is, the option to buy the company's stock at a predetermined price for a set period of time. It doesn't sound like it would be that bad. And, their incentive appears to be to manage the company properly to increase the stock price.

But their incentive turns out instead to be to manage the news about the company to increase the stock price as quickly as possible. Investors nowadays can be easily misled and can quickly move their money to the latest speculative craze. In fact, this has always happened wherever people traded company shares through history. But, it has been enhanced by the Internet and all forms of electronic trading.

When the stock price is safely above the option price, the insider buys the deeply discounted shares from the company directly and then dumps the shares on the market almost immediately to secure a large and risk-free profit. The insider gains from short-term hype while avoiding the downside of possible long-term disappointment. And, nobody comes to take back the stock option profits when optimistic projections and pronouncements turn out to be wrong.

Then, there is the problem of the board of directors being beholden to the company management rather than the shareholders--yet, another agency problem. And, these directors often approve outrageous bonuses for management which, of course, are not taken back when things go bad.

Perhaps the most visible recent example was the $75 million bonus awarded to Aubrey McClendon in 2008, then CEO of Chesapeake Energy Corp., as the natural gas market collapsed and the excessive borrowing by Chesapeake tanked its stock price and nearly brought the company to bankruptcy. In this case, institutional shareholders actually tried to do something by filing a lawsuit. The result: McClendon got to keep his bonus, but had to buy back a $12 million collection of antique road maps that were purchased from him by Chesapeake at the direction of board to help cushion his horrendous losses on the Chesapeake stock he owned.

To his credit, McClendon had much of his personal fortune invested in Chesapeake. But, as we can see, he did not have the downside of other investors since he was able the manipulate to board into giving him $87 million of the stockholders' money (including the $12 million for his map collection). The downside, as it turned out, would have been an almost complete wipeout of his fortune had it not been for the felicitous cash infusion by order of the board.

What might solve the agency problem in such cases is never to grant stock options. Rather, we should require whoever enters top management to invest a substantial portion of his or her savings in the company and be forced to retain any position for 10 years or more before selling. This would carefully align the management's aims with those of shareholders since management would now have a lot of skin in the game with no chance of a bailout if things go badly.

But, don't hold your breath waiting for this proposal to be adopted. The entire executive compensation system for publicly traded companies is expressly designed to prevent executives from taking a hit for their mistakes while giving them all the upside for the company's success--even if it's temporary, due to factors outside their control, or due to clever manipulation of the news media. Instead, the stockholders get hit. It's the agency problem in spades!

Now, the broader issue is not the greed of corporate insiders at the expense of shareholders though that's an important issue. The broader issue is how public policy is being affected by people who have little or no downside if their public pronouncements and projections are wrong.

Unfortunately, this issue has become endemic in society as so many of us are divorced from the consequences of our actions in a world with highly specialized jobs and worldwide networks capable of wreaking havoc far from the decision and the decision-makers.

All the extractive industries disproportionately place bad consequences on those nearest the site of extraction for the benefit of the rest of us and for their own bottom line. In the case of the fossil fuel companies, they benefit from free disposal of carbon dioxide into the atmosphere which, of course, is moving us toward a climate disaster that will affect us all--just not enough for now to destabilize the fossil fuel companies.

Certain parts of the academic world--usually economics faculties--are laced with influential voices who offer advice on public matters, but, once again, suffer no punishment if their ideas are adopted (often with vigorous assistance from the financial industry) and then result in disastrous consequences. We can see how well that has worked for financial deregulation advocated by so many academic economists. So far as I know none who advocated such changes have been ousted from their tenured seats.

In fact, Harvard academic Lawrence Summers as deputy treasury secretary during the Clinton Administration was instrumental in the repeal of the Glass-Steagall Act--a Depression-era law which had kept the commercial banking system safe for 60 years by keeping it separate from high-risk investment banking. Summers not only didn't get punished for his role in setting the stage for the banking meltdown of 2008, but actually returned to run the National Economic Council under Barak Obama.

But, of course, Summers was not alone. Many academic experts and financial executives had been pushing for financial deregulation for years. And, here is another aspect of the agency problem. When one person makes a costly error, it is much easier to pin the blame and extract consequences. When hundreds or thousands help perpetrate a social, environmental or economic disaster, the blame is diffuse. No one person feels that it was he or she that caused the problem, and the law in the United States and many countries counts bad advice and misguided advocacy as free speech.

I am not suggesting that we end free speech. That would be a solution that is worse than the problem. To use Taleb's words, I am suggesting that we not allow ourselves to be suckers. And, one of the surest signs that we are on the road to being suckers is when we take the advice of someone who has little or no personal downside if he or she is wrong.

Almost always in such cases, there are hidden risks that only appear too late to address. By that time the touts have long absconded with their riches or remain well-protected by their benefactors.

The record of history recommends extraordinary proof in the face of extraordinary claims. Given that oil is finite, given that we are now consuming it at the highest rate in history, given that oil continues to hover at its highest average daily price ever (even after adjusting for inflation), and given that the risks of climate change are so great that they could wipe out our civilization as we know it--the burden of extraordinary proof lies with those who claim that oil abundance for the long run is an actual fact and that that fact won't somehow destroy civilization as we know it.

So far, all they've given us are disjointed, ambitious and deceptive claims about supply that are at odds with independent assessments. And, they've given us absolutely nothing about how this supposed new abundance doesn't bring a climate disaster closer.

But, the promoters of the U.S. energy independence story and the renewed oil abundance meme have managed to do one thing quite well: enrich themselves while being protected from any long-term downside of their forecasts--until, that is, world oil production becomes so constrained or the habitability of the planet so severely affected due to climate change that even their wealth and stature won't protect them from at least some of the consequences.

P.S. For my view on how we should approach the uncertainties of our energy future, see my previous piece "Dueling forecasts: Why our energy future is actually a risk management problem".

Kurt Cobb is an author, speaker, and columnist focusing on energy and the environment. He is a regular contributor to the Energy Voices section of The Christian Science Monitor and author of the peak-oil-themed novel Prelude. In addition, he has written columns for the Paris-based science news site Scitizen, and his work has been featured on Energy Bulletin (now Resilience.org), The Oil Drum, OilPrice.com, Econ Matters, Peak Oil Review, 321energy, Common Dreams, Le Monde Diplomatique and many other sites. He maintains a blog called Resource Insights and can be contacted at kurtcobb2001@yahoo.com.

Sunday, December 01, 2013

The single most important principle for sustainability

No doubt you know someone who's told you about his or her great aunt who lived to be 98 and never went to a doctor. Or maybe it was a grandparent who led a vigorous existence and never went to a hospital, not once. We think of such people as being the hardiest of the species. But, there might be an additional explanation. Has it ever occurred to you that both people were that healthy and vigorous BECAUSE they never went a doctor or a hospital?

One estimate puts deaths from medical errors at around 200,000 per year in the United States, a number which does not, of course, include those injured but not killed and saddled with disabilities--both obvious and subtle--that can affect health for a lifetime. Now, why am I telling you a medical story if my topic is principles for sustainability?

The short answer is that medicine has a term for its errors--which include outright mistakes by physicians, but also adverse reactions to drugs and other treatments. And, it attempts to count these errors which it calls iatrogenic, meaning caused by the doctor's treatment.

But, we have iatrogenic-like errors and problems caused by all sorts of modern inventions and procedures in a wide array of professions, trades, and industries--inventions and procedures which are thought to be improvements over the past. Think about how financial derivatives were supposed to be far superior instruments for mitigating and managing risk in the marketplace--until the 2008 market meltdown showed derivatives to have enormous hidden risks!

The late CBS television reporter and commentator Eric Sevaried was famous for saying, "The chief cause of problems is solutions." Perhaps we should say "presumed" solutions. The main problem with these presumed solutions is that typically, we have very little history with them, especially if they are the product of recent technological innovation. So, the risks associated with these supposed "solutions" are largely hidden from us.

The "solutions" we find in nature (and therefore in our bodies which are part of nature) are tested through the evolutionary process for a very long time. They may not be perfect solutions. But neither are many modern pseudo-solutions to our perceived problems. In fact, these pseudo-solutions often make matters worse--sometimes much worse--for reasons that cannot be detected until it is too late (and sometimes not at all if the risks are well hidden). The watchword in the medical profession used to be, "First, do no harm." Now, it's intervene so that the patient thinks you are doing something. And that, it seems, has become true in so many other professions as well. How can the fee be justified otherwise?

So here, finally, is the principle: "The non-natural needs to prove its benefits, not the natural."

I take this principle directly from a book I've mentioned previously, Antifragile: Things that Gain from Disorder by Nassim Nicholas Taleb. And, my discussion of it is largely based on his observations. This principle is the clearest expression of the precautionary principle I've ever seen, and it is even more stringent.

Now, those who shower our air, water, soil and bodies with newfangled chemicals (some of them called pharmaceuticals), tell us that it is our responsibility to provide evidence that these novel chemicals are harmful. In fact, logic dictates that those who introduce non-natural substances into the environment should be obliged to prove that those substances are safe. Nature's record is long, unassailable and open to inspection. The chemical industry has been with us for less than 200 years, and the modern chemical industry as we know it is a post-World War II phenomenon, an industry not exactly celebrated for its openness to public scrutiny.

So, here's a corollary to the principle above. A novel substance or action used to address a perceived problem for individuals or society should have far greater benefits than natural substances or than just doing nothing. Taleb suggests absolutely NO medical treatment for minor ailments such as headaches (the temporary kind), muscle spasms, and indigestion, for example. Nature suggests a change of diet, a change of routine, or even a change of jobs, strategies which have little risk associated with them compared to novel treatments.

When it comes to broader planetary issues, the introduction of massive amounts of carbon dioxide and other greenhouse gases into the atmosphere through the burning of fossil fuels, deforestation, and modern farming practices, is clearly non-natural. The true risks remained largely hidden even 100 years after Svante Arrhenius did the first calculations concerning global warming in 1896.

(Arrhenius vastly underestimated the pace of that warming, calculating that it would take 2,000 years to double carbon dioxide levels in the atmosphere. The current time line puts this event in the middle of this century. But, he was surprisingly close to modern estimates of the likely temperature change, about 5 degrees C. Incidentally, he did all these calculations by hand!)

Modern farming practices--the so-called Green Revolution--lulled the world into believing that farming could sustainably be transformed into just another industrial activity with cookie cutter instructions. Grain yields and food supplies bounded upward until the mid-1980s, when per-capita grain yields began to fall. They haven't fallen dramatically. But, the fact that they have fallen tells us that there are limits to what industrial farming can do. We have more grain, but less grain per person than we used to.

It turns out that these limits might result from what we are doing to the soil through such farming. The solution so far has been to pour more chemicals onto the land. But that, too, is starting to lose its effectiveness as yields level off or even drop in areas where soil has been depleted of its natural fertility.

The real solution has been to look to nature and how it preserves and enhances soil fertility. Organic farmers have known this for a long time. The problem from the modern point of view with this approach is that it would likely require many more people to be involved in growing food. Organic farming typically requires more labor inputs than the machine-driven agriculture of monocrop grain farms.

All of this is not to say that NO improvements can be made over what is naturally occurring. More precisely, it is to say that the proposed improvements ought to be so compelling and so advantageous that any unanticipated downsides can be tolerated. A patient near death is unlikely to complain much about long-term side effects if the medicine saves him or her. One who has a headache but ends up with, say, a rare, life-threatening blood disorder from the treatment, will almost certainly conclude that the cure was not worth the (hidden) cost.

Expectant mothers who took thalidomide to relieve the distressing (but temporary) symptoms of morning sickness--only to have deformed children later-- were unknowingly taking large risks for small immediate gains. And, that seems to be the problem with much of what we label "progress." It's only progress until the unanticipated side effects kick in.

Okay, so let's think for a minute about the previously announced principle for sustainability: "The non-natural needs to prove its benefits, not the natural." Think about how deeply conservative that principle is. And, here I mean conservative in what has become an almost archaic sense of the word, that is, to conserve those practices and attitudes which have proven themselves truly sustainable over the ages.

What passes for conservative today is actually a radical political and economic agenda to strip the world of its resources as quickly as possible and turn them into wealth for a small elite. There is absolutely nothing conservative about this program.

But even those who style themselves liberal are typically only a few steps behind their pseudoconservative adversaries. Many of the world's progressives essentially believe that we should strip the world of its resources as well, only at a more measured rate while sharing the spoils more equitably. Both ways of thinking, however, have modern human society racing toward destruction. And, political liberals--who congratulate themselves for being open to the newest trends--may be even more susceptible to new technologies and methods that come with large hidden costs.

This piece is not a call to reverse history. That would be futile even if that's what I were proposing. Rather, it is a call to look with considerable skepticism on so-called "solutions" to the present crises that have no antecedent in nature or no long relevant tradition in society--and to place a special burden on technological solutions to show how they are far better than what nature suggests to us.

Let me give you an example of what I mean. The emerging sharing economy is based on the relevant and longstanding tradition of sharing with neighbors. It is not really a technological innovation so much as it is a social innovation--one, that is, well, not exactly new.

What's new is that the Internet makes sharing across vast distances with people you don't know possible--sharing extra rooms, cars, and office space, for example. The founders of the sharing economy didn't invent sharing; nor did they invent the Internet. They simply took an age-old tradition and used now existing technology to take advantage of huge unused capacity available worldwide in people's homes and driveways.

By my lights, this is an innovation that has big advantages over building more cars, more offices, and more hotels, by lowering overall consumption and freeing people from ownership of things which they only need occasionally.

In this I'm admitting that the Internet--a hog for electricity--might have net benefits when these kinds of insights are applied to it.

The criteria I've suggested for evaluating innovations are not scientific, nor could they be since they touch on values. But at least they offer a way to sift through the plethora of ideas for a sustainable world and ask whether these ideas themselves are sustainable and advantageous on their face.

Kurt Cobb is an author, speaker, and columnist focusing on energy and the environment. He is a regular contributor to the Energy Voices section of The Christian Science Monitor and author of the peak-oil-themed novel Prelude. In addition, he has written columns for the Paris-based science news site Scitizen, and his work has been featured on Energy Bulletin (now Resilience.org), The Oil Drum, OilPrice.com, Econ Matters, Peak Oil Review, 321energy, Common Dreams, Le Monde Diplomatique and many other sites. He maintains a blog called Resource Insights and can be contacted at kurtcobb2001@yahoo.com.