Tuesday, October 31, 2006

If we build it, will they come?

The "we" refers to North America. The "it" refers to liquified natural gas (LNG) ports. And, the "they" refers to LNG tankers from exporting countries. Unfortunately, the answer to the question is "probably not," at least not in the numbers we would like them to come, according the energy investment banker Matt Simmons and resource economist Douglas Reynolds, both of whom attended the recent Association for the Study of Peak Oil & Gas - USA conference in Boston.

Surprisingly, governments, industry and the public continue to behave as if they were members of a cargo cult confident that enough LNG ships will arrive to avert a disaster. Unfortunately, the facts don't support their optimism. Exactly one new LNG port has been completed in North America since the 1970s. That makes only five total. Some 17 are in the planning and approval stages; but perhaps more telling is the fact that at least 11 others have been cancelled. The completion dates for those that survive cancellation are in many cases years away. Given the rising demand for natural gas and the obvious plateauing of supply in North America, how can it be that more ports aren't being built (not just planned) and quickly?

Matt Simmons thinks he has part of the answer. Simmons, who has freed himself from the day-to-day chores of running his eponymous investment bank, said he spends most of his time poring over energy data and news. During an impromptu question and answer session between presentations at the Boston conference, he laid out the problem with LNG imports.

He explained that the exploration arms of oil and gas companies are not spending money on the needed appraisal wells in countries with large natural gas reserves such as Qatar. This is in part because such wells have become very costly as prices for everything related to drilling and exploration have gone through the roof. The result is that financing--which can reach into the hundreds of millions for a single LNG port--has been hard to line up. Investors want to know that there will be a reliable supply for decades for their LNG port. Simmons believes there simply isn't enough information to assure many potential investors.

In a separate conversation, Douglas Reynolds said that part of the problem is that national oil and gas companies which control huge gas reserves in places such as Iran, Qatar, and Saudi Arabia are really arms of their respective governments. These companies are risk-averse and tend to spend minimally on exploration while transferring much of their current profits to their governments for social and military spending. Unlike investor-owned oil and gas companies which want to get resources out of the ground as quickly as possible in order to maximize profits, national companies have little incentive to produce more than they need to in order to generate the profits required to fund government spending.

Add to that the fact that most of the natural gas available for export via LNG tanker is found in the Middle East, an area not particularly known for its stability. And, even though the world's largest gas reserves are found in Russia, this should provide little comfort to those living in North America. The Russians recently decided to scrap a project that would have sent LNG to the United States in favor of sending the gas through pipelines to Europe.

The increasing competition for natural gas worldwide may leave North Americans without reliable LNG supplies. Indonesia announced earlier this year that as of 2010, it would keep more of its own gas for domestic use and decrease the amount going to Japan. That means that Japan will be bidding on the remaining available export supplies of LNG after that date. This development also highlights the possibility that projections of what will be available for export in the next decade may not meet expectations since countries which currently export will use more of their own gas.

Beyond this there are questions about the adequacy of world supplies. The conventional wisdom among those who see a peak in oil production within the next decade or so is that a world peak in natural gas production could come sometime around 2030. The data is so elusive that no one is making very precise predictions.

Two worrisome developments, however, imply an earlier peak, perhaps much earlier. First, 80 percent of Russia's production comes from three giant fields, all of which are in decline, Simmons explained. Second, according to Reynolds, a peak in natural gas worldwide may be caused as much by political factors as geological ones. The low exploration budgets of the national oil and gas companies and their reluctance to produce all out will inevitably shift any peak forward. This path, however, would mean a smoother production arc for world natural gas and slower declines on the downside as gas production which had been held back by the national companies is finally brought to market.

Meanwhile, in North America Simmons said that a single cold winter could create an immediate crisis not only for home heating and industrial feedstocks, but also for electricity which is increasingly generated by natural gas fired plants.

But, perhaps even more disturbing, Reynolds believes that natural gas production declines in North America which have been gentle so far will ramp up to perhaps 5 percent annually starting in 2007 or 2008 and create a natural gas cliff. That in itself could cause a crisis even without a cold winter. But a combination of the two would be truly devastating.

Unfortunately for residents of North America, LNG imports will have little cushioning effect if a natural gas cliff arrives this coming winter or within the next several years. For that reason it is truly puzzling that no one in government is talking about the one option left: a massive conservation effort to buy us some time. The only thing that can explain such obliviousness is that cargo cult thinking continues to overpower all the warnings that are now in plain view.

Sunday, October 22, 2006

Mr. Market, manic-depressive: Is there a cure?

Benjamin Graham, the father of value investing, loved to relate the story of Mr. Market, a partner in a going concern. On some days he would arrive jubilant, ready to take the entire business off the hands of his fellow partners at a rather exorbitant price. Other days he would arrive depressed beyond belief, ready to sell them his portion of the company for a pittance. Graham advised his clients to pay little heed to Mr. Market and form their own opinions based on the facts. Only then should they decide whether Mr. Market's offer was worth taking.

Of course, Graham was concerned with the way stock market investors behave, and he observed that most of them behave very much like Mr. Market. For Graham Mr. Market's roller-coaster mood swings were an opportunity, not a problem.

For society as a whole, however, the manic-depressive nature of markets can have serious and even potentially dangerous consequences. Wild price swings make it difficult for people, companies and governments to plan. It is just such behavior which has characterized the energy markets in recent years. And, there are reasons to believe that we should expect more of the same.

First, queuing theory (essentially, the theory of how lines form) tells us that when a system approaches 100 percent of its capacity, the length of the line to access that system can become highly chaotic, changing from very short to very long in rapid succession. In our case the line is filled by those trying to buy energy, particularly natural gas, oil and coal. (I am indebted to Kenneth Deffeyes for pointing out the relationship between queuing theory and energy prices in his book, Beyond Oil.)

In North America the natural gas system has been operating near capacity for several years. Only warm weather has prevented a serious crisis. For all intents and purposes, North American natural gas supplies have peaked and have been on a long plateau. When Hurricane Katrina hit in 2005, the line of those eager to nail down natural gas deliveries for the coming winter became very long, very quickly. But that line dissipated just as quickly when the winter turned out to be one of the warmest in history. As a result the price of natural gas first rose to almost $15 per thousand cubic feet and then dropped below $5 before rebounding.

Meanwhile, in the oil markets turmoil in the Middle East and fears of hurricanes in the Gulf of Mexico took prices to near $80 a barrel last summer. The price hikes were not merely the result of fear, but also the result of very little spare capacity for producing oil around the world. When those fears subsided, the number of people in line to buy oil suddenly dropped as did the price. This is exactly what queuing theory would predict in an oil market running near capacity. Whether the capacity problem is permanent because we've hit world peak oil production or merely temporary is unknown. But the result for now is wildly swinging oil prices.

Coal has not been immune, either. The coal infrastructure has been operating near capacity. This is despite the fact that everyone acknowledges that coal reserves remain immense. The current infrastructure appeared to be stretched to its limits until recently when coal prices for several major coal grades dove 20 to 50 percent inside of 18 months. In one case a 23 percent decline occurred in a mere two weeks. But, these declines come after the doubling and tripling of prices in the last three years.

A second and widely trumpeted cause of volatility in energy markets is speculation. There is some truth to this as the spectacular losses of one hedge fund in the natural gas market recently illustrated. The fund's accumulation of an enormous position in natural gas undoubtedly helped push prices up. When the market turned down, the fund manager was forced to liquidate that position at fire sale prices. This pushed natural gas prices to extreme lows.

Oil and to a lesser extent coal are subject to the same pressures from large speculators. But, the huge effect of these speculators is only made possible by tight markets. Large speculators can suddenly add considerable length to an already long line of regular energy buyers crowding the market, and those speculators can disappear just as quickly when the market turns down.

There is a third reason as well for the current tightness and volatility of the energy markets. Energy users typically have no quick and easy substitutes for the fuels they need to perform such activities as the extraction of resources; the manufacture and transport of goods; the production of electricity; or the heating of homes. Economists use the term inelastic demand to describe this situation.

All of this might not matter if no harm resulted. But high price volatility in the natural gas, oil and coal markets makes it difficult for alternatives to gain a foothold. First, those seeking to bring alternative energy to market may find buyers for those alternatives reluctant to commit. One month it may seem as if the price of fossil-fuel energy will only escalate for the foreseeable future. The next month severe price declines can make buyers think twice about those alternatives. (Wise planners sometimes regard volatility itself as a risk. But they must believe that the volatility will persist.)

Second, consistently high prices for energy can induce conservation as businesses and consumers perceive that investments in efficiency will be returned quickly in the form of energy savings. But, volatile prices make it difficult to count on quick paybacks for such investments. Consequently, these investments may be put on hold until the picture becomes clearer.

Third, volatility confuses policymakers. High energy prices can summon the necessary public support for needed conservation and efficiency measures and for investments in alternative fuels and public transportation, for example. But politicians can end up looking like fools (even when they've been wise) if prices dip precipitously before election day.

Given the serious questions about our energy future, now may be a good time to address the manic depressive moods of Mr. Market. A floor on natural gas, oil and coal prices would create the kind of stability in the energy markets that would encourage conservation, efficiency and alternative energy development. The floor could be accomplished through sliding taxes that rise as the price of the energy resource falls below an agreed floor. Conversely, those taxes would fall and then disappear as the price rises and eventually breaches the floor price.

The floor could be set well below current prices and still be effective. This is because many alternative energy sources would remain competitive even if the price of oil were $40 a barrel or the price of natural gas were pegged at $5.50 or $6 per thousand cubic feet. With floor prices in place, those working on conservation and efficiency measures; alternative energy; or the expansion of public transportation could be assured that they won't be severely penalized or wiped out during energy's next big swoon.

A floor price offers a clear signal to the market that could help us make steady progress toward a more secure and sustainable energy future. Failing to do something like it will only leave Mr. Market untreated. And, as with real people who go untreated, ignoring the effects of Mr. Market's manic-depression will have serious consequences for our energy future--not only for those in his immediate vicinity such as speculators, utilities, and oil and gas companies, but also for society as a whole.

Sunday, October 15, 2006

Confessions of a Tourist in an Energy-Challenged Age

Tourism is perhaps best described as a theatrical production in which the tourists become the audience, the destination becomes the set, and the natives become the actors. In general, the tourist goes to a destination to witness the enactment of another culture, either domestic or foreign.

The performance can take place under different conditions. When only a few tourists (i.e., audience members) are present, the natives may find those tourists to be an oddity and generally go about their business as if there were no audience. At most, the locals attend to the visitors as they would any visitor.

When the number of tourists increases, certain natives find it profitable to cater to the desires of tourists. These natives, in effect, become the ushers of the theater and become aligned with the tourists. When the number of tourists overwhelms a particular locale, the performance suffers. This happens when, for instance, those sitting next to the tourists in restaurants are other tourists. The other restaurant guests are no longer part of the performance, but part of the audience. In such cases, the actual performers are reduced in number to those working in restaurants, shops and hotels, i.e., places where tourists spend most of their time.

Two developments result from this last scenario. First, the natives still living in the tourist destination begin to shape themselves to satisfy the fantasies of the tourists and neglect their own culture. What tourists want and expect becomes paramount (and highly profitable). Second, this process can breed both conscious and unconscious resentment that occasionally comes to the surface as rudeness or remains hidden as offstage contempt for the tourist audience. The natives resent being reduced to a servant class whose job is to provide a caricature of their culture consistent with the fantasies of the tourists.

On a recent trip to Italy I experienced all three environments. In a working class suburb of Milan, my sister and I went looking for some food to bring back to our hotel. We eventually found some shops behind a block of flats that we could see from the highway. No other tourists were in evidence and neither the proprietor nor his employees spoke any English. For the first time we were thrust into a situation that was authentic Italy. Our Berlitz Italian allowed us to buy what we needed and get directions to a nearby bakery as well. But in this small shopping district there were no special concessions to tourists. In some ways this brief encounter was the most satisfying of our trip. We were having to deal with Italians on their terms.

While in Rome we found that Romans go about their daily lives despite the million or so tourists who visit every year. Except for the occasional McDonald's, there are very few accommodations designed exclusively for foreign tourists. Still one would expect this great cosmopolitan city and seat of government to have an openness to foreigners. Accordingly, nearly every shopkeeper and concierge speaks English (and many speak French and German besides). And, yet Rome retains its essential character.

But Cinque Terra, a national park on the northwest coast containing five small cities, has become a virtual American colony. Most of our fellow hotel guests were Americans. Most of the dinner guests at the restaurants were Americans. The resentment of the locals was just under the surface. For us that resentment erupted in a spat with a waiter who piled the next course on our table only shortly after we had started eating our first one. The restaurant was exceptionally busy, and so it took considerable effort to get his attention again and make our complaint. After cutting us off, he proceeded to lecture us about our rude behavior. I couldn't help thinking that he was voicing the resentments of his fellow Italians about the tourist takeover of these five towns and the strangulation of their culture.

What could one now find in Cinque Terra other than more English-speaking tourists attempting to fulfill a fantasy about a romantic Italian vacation? The entire place was designed not to disrupt or challenge that fantasy in any way.

In fact, many American tourist destinations have perfected this kind of environment. At Disney World any actual local culture has been scrubbed away and replaced with fake, nonworking town environments and sanitized streetscapes. Perhaps the closest Italian equivalent would be the island of Capri (which was only described to me by those who took a day trip there). Capri has apparently become a free-fire zone for upscale retailers targeting cruise ship patrons. All traces of authentic Italian town life seem to have been eliminated.

People have always traveled for a variety reasons--to seek knowledge, to gain riches, to visit friends, to trade, and (lest we forget) to conquer territory. But the particular variant of travel called tourism is a more recent phenomenon. At first only the rich engaged in tours. But with the advent of cheap, fossil-fueled transportation tourism has gradually become democratized, at least for the people of wealthy nations. Nearly everyone in those nations can and does travel as a tourist. And, for many well-off retirees, tourism has become a way of life.

But, as the petroleum age wanes, there is a question not only about whether the tourism industry as we now know it can survive, but whether it can be defended as an activity worthy of the vanishing fossil fuels we expend on it. There can be little doubt that tourism has helped to break down barriers between people of different cultures. It has made it harder for world leaders to demonize foreigners, at least for people who have met those foreigners. Tourism has--even if only a little--aided a worldwide dialogue about difference, tolerance and cooperation. To paint all tourism with one brush as merely a pleasant method of dining out (and wasting resources) is too simplistic.

Perhaps one way to think about the relative merits of any tourist venture in an energy-constrained age is to ask whether a planned trip is something other than escapism. Are we open to the possibility that our current fantasies about our destination might be overturned? Are we anxious to test our ideas and preconceptions against the reality we find? Can we learn anything that may help us bring about the deep and lasting changes we require to create a sustainable society?

As our energy challenges mount, tourism is likely to become one of the first casualties, making further lectures about its wastefulness unnecessary. Around that time all of us will find ourselves cast (whether we like it or not) in a drama of transformation unlike anything the modern age has known, a drama in which the very survival of our civilization may be at stake. In that drama none of us will be playing the part of a passive audience member anymore; we will be the actors and our performance will, of necessity, be the performance of a lifetime.

Sunday, October 08, 2006

Signs, Portents and the Roman Way

Under the Tarquin kings the early Romans looked to a priestly class called augures who interpreted the flights and other habits of birds in order to foretell whether a course of action would succeed. We still have an echo of that in our current language when we say some event "augurs well" for us.

Later Romans living under the republic and the empire embraced astrology as the key to unlocking the future, according Michael Grant in his wonderful capsule of ancient Roman life, The World of Rome. Even highly cultivated Romans such as the emperor Tiberius believed in astrology. Astrology was and is based on the notion that there is a natural "sympathy" between what happens in the heavens and on the earth. It seemed obvious to the ancients that everything was connected and that one had only to read the signs--in this case, the stars and the planets--to see which way events were heading.

Accompanying this devotion to astrology was a belief in Fate. This wasn't complete determinism, for if one could learn ahead of time what Fate had in store, there were ways of mitigating or even averting misfortune.

Besides astrology and fate, natural events such as the comet which appeared after Julius Caesar's murder or the supposed birth of a monkey to a maid of the Emperor Claudius made profound impacts on the minds of the Roman people.

Today, we know better. We no longer look to the natural world to predict our future. While some people still subscribe to a morbid determinism, most--at least in wealthy, industrialized countries--believe that our own choices are central to the trajectory of our lives. The natural world is now something which seems largely explained by science and controlled by technology.

Having tuned out natural signals, most moderns look for signs of the future in the financial news and from political pundits and pollsters. The auguries of our day are those armed with sophisticated financial models or polling results.

But, within the last three decades or so scientists have come to the public to share the results of their own models in the form of Limits to Growth, the famous study of resource depletion and pollution, and in the form of various climate models. Unfortunately, the idea that the natural world could tell us something about our future has been so thoroughly undermined that these scientists have found it difficult to get a hearing.

As a result, only now has the problem of global warming become an everyday topic of conversation in some circles. But the idea of resource depletion is still treated with scorn, even in many environmental circles. And, the proposition that human consumption and population might have limits can be discussed in polite company only at one's peril.

We do not, however, need to return to the naive mindset of the ancient Romans in order to cast nature once again in a central role. We have methods of studying nature and testing theories far beyond anything the augures or astrologers could imagine. In addition, it might behoove us to contemplate the notion of fate in our own time. Nature still does not negotiate. It lays down limits which we are obliged to obey. We may temporarily evade them by, for instance, using huge quantities of finite fossil fuels. But in the end we cannot repeal those limits.

We might do well then to listen to what our modern-day augures, the climate and resource modelers, are telling us so that we, like the ancient Romans, might mitigate or avert a disastrous fate. The portents are all around us: the deformed frogs; the rapid extinctions; the evaporating lakes; the devastating hurricanes; the severe droughts; the deadly heat waves; the spike in certain cancers; and the rapid melting of the polar ice. The list goes on and on.

The natural world and the scientific one are warning us to change course without delay. With this much evidence, I'm betting a sensible Roman would have done just that long before now.

Sunday, October 01, 2006

The Infrastructure of the Future

As I watched the Italian countryside whisk by me from my train seat, the engineer announced that we were now traveling at 300 kph (186 mph). To most Americans such high-speed passenger trains might seem like marvelous new technology when, in fact, they have long been commonplace in Europe.

But, it is the view of the countryside that ought to interest those who are thinking about the infrastructure of the future. For here in the rolling landscape of this mountainous country, small farms carpet the hills with alternating olive groves, grape vines, lemon trees, vegetable gardens, grain fields and pasture populated with pigs, cattle and sheep.

The dictates of this landscape--too hilly for large-scale row crop farming--have combined with the Italian insistence on good, pure food to produce an agriculture that seems scaled to survive our energy-challenged future. For in such a future everything including food will have to be sourced closer to home. Physics and economics will make it so. The declining availability of liquid fuels is destined to drive up dramatically the cost of shipping food. And, that means that small, family-run farms may become a common sight again in places where they have been largely extinguished such as North America.

Even as the so-called "local food" movement gains momentum in the United States, the word "local" in front of "food" would, for most Italians, seem redundant. (The global food network is making some inroads, of course; but Italians are fighting back, for example, with "Italian Meat Only" signs in corner groceries and delicatessens.) Small farms are the backbone of this highly diversified agricultural system. One guide explained that in the United States there are perhaps a dozen varieties of wine grapes grown. In France, he claimed, there are about 45. In Italy, almost 300. The hills and valleys along the winding coast create a large number of microclimates making Italy friendly to many varieties not just of grapes, but of other fruits and vegetables as well.

Some will complain that the European agricultural subsidy system has allowed these "uneconomic" farms to remain. But in the years to come, these farms will probably return to being economically profitable as well as absolutely necessary. Europeans will be glad that they suffered through so many good meals and paid taxes to support the farms where the food was raised. For at that point others around the world may be scrambling to reorganize their agriculture along similar lines.

There are also many other aspects of Italian life that make the country seem better prepared than most for an energy-constrained future. Besides the high-speed trains which run on electricity, there are electric trams in the major cities; an extensive and heavily used bus system; a limited but useful subway in Rome; and, of course, a plethora of tiny automobiles, the most faddish of which is now the Smart Car. Then, there are the myriad motor scooters which swerve constantly through traffic, scooters which every Italian under age 45 knows how to ride. And, of course, there is that most underrated form of transportation which is in broad use in Italy, namely, walking.

No wonder then that the Italians are some of the most parsimonious users of energy in the world. Of course, their overall heating bills are much smaller than those who live in Denmark or Iceland. On the other hand, few Italians bother with air conditioning even in the hottest months of the year. Nor do they think that automatic clothes dryers are a necessity as any casual survey of city balconies will tell you.

As one awakens in Italy's smaller towns, it's not unusual to hear something which seems to have nearly disappeared from the American outdoors: the sound of sweeping. Surely some Italians, especially commercial establishments, could afford the petroleum-powered blowers which so dominate the American urban landscape. But, perhaps Italians just value their quiet. (I found Italy, even Rome, to be surprisingly quiet, much to my delight.)

The news on the energy front is not all good, of course. One might think that with all those mountains, Italy would be flush with hydroelectric power. Alas, much of its electricity, some 82 percent, is generated using fossil fuels including about 25 percent from oil. That's changing with a move away from oil and toward natural gas. Natural gas will, of course, eventually prove to have limits as well. But, Italy has a huge potential for solar and geothermal which the government is now trying to tap.

Perhaps more worrisome is the large workforce serving tourists, especially in the southern half of the country. Italy today receives the fifth largest number of tourists of any country and is considered by some to be the world's top tourism "brand". Unfortunately, declining energy availability and the resulting high energy prices will likely translate into less tourism, severely curtailing over time an industry that currently represents about 5 percent of the Italian economy.

Still, it should be no surprise that the Italian government continues to plan for perpetual growth. The most visible recent sign is the concern about a long-term labor shortage which the new center-left government wishes to address by encouraging immigration. In fact, one of our Italian guides remarked that there are now many jobs "which Italians won't do." But perhaps the real problem--if it can be called that--is the famously low Italian birthrate of about 1.3 children per woman--far below the replacement rate of about 2.1. If that rate remains unchanged, the number of ethnic Italians in Italy will decline greatly over the next century.

All this presupposes, of course, that the ever-expanding supplies of energy needed for continual growth will remain available not only to Italy, but to the world into which Italy sells its fashionable clothes, cars, wine and leather goods. In the short run, the Italian government will likely be right about the need for more labor. In the long run, however, the odds appear to be against them.

But Italians are exceedingly adaptable as their millennia-long habitation of the Italian peninsula demonstrates. And, two minor, but surprising developments make it clear that they remain as adaptable as ever. Not long ago the government passed a ban on smoking in public places including restaurants and bars as well as a helmet law for riders of motor scooters. To everyone's surprise, the Italians obeyed.

One Italian journalist noted that while his countrymen don't like rules, they do know what's in their own best interests. There's hope in that and in the fact that the Italian infrastructure may just be one of the best adapted for the energy-constrained future into which we are now heading.