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infinite energy

Issue 83
January/February 2009
Infinite Energy Magazine

New Energy and the World Economy
Bill Zebuhr

These are confusing times for many people, but it is particularly difficult for anyone in the alternative or new energy field. Gasoline was $4 per gallon and many people were expecting it to keep rising; now it is under $2 per gallon and people expect it to go lower. Many energy projects, including some in the oil industry, have been put on hold until there is some clarity about future prices. Many alternative and new energy projects cannot compete until the equivalent cost of energy is well over $4 and perhaps more like $10 per gallon. The current uncertainty will jeopardize projects that are already risky but, in combination with many others, will be necessary to supply energy at a reasonable price in the future when demand once again outstrips supply or the other factors that determine the price and supply of oil make it scarce and expensive.

Is it the supply and demand of oil that determines the price or is it the “other” factors? And, what are those “other” factors? This is an important question to answer if we are to have an energy cost environment that is conducive to a smooth transition to alternatives. There are many industries—including those that supply most goods and services to most people—that experience fluctuations in supply and demand, but a factor of two in cost to the consumer is not necessary to create a balance. The price of cars, computers, houses, toys, and industrial equipment does not vary by a factor of two in a matter of months. Oil is different from these in that the actual cost of extraction for all but the marginal oil is much lower than the selling price when the price is high. That is why the Middle East has so much cash when prices are high.

From a supply point of view, the price is set by the cost of extracting the last gallons, not the majority of the gallons. The demand side is willing to pay much more than the cost of extraction to get the oil when economic times are good. This tends to keep the supply capability at a peak level that is not sustainable when the economy shrinks and demand falls. Part of the problem is that the oil industry is a mix of corporate and government organizations and this leads to a lack of control and discipline that causes some entities to act against the good of the industry and even their own long-term benefit. Governments get committed to make payments to keep citizens in line and they are willing to pump oil at low prices for short-term cash even though their interest is much better served by letting the price rise and preserving their supply of oil for future higher prices.

The cost of extracting oil varies widely. A well can cost as little as $1 million where oil is close to the surface on land, to over $100 million for a deep well in the ocean. The price paid must support the expensive well and therefore gives the owner of the low cost well an unreasonable profit. The whole situation is further complicated by inappropriate ways of accounting for the depletion of the oil. Tax credits are given, but the accounting should consider that the land is now devalued due to the reduced quantity of oil. Oil is treated as a mineral and land owners are protected (and sometimes harmed) by laws that govern the ownership of minerals. There is a further complication in that oil can flow from one area to another underground and so if one area is heavily drilled and extracted, oil can flow from a nearby area that is not being exploited even though it may be being held in reserve for a later time. There may also be long-range planetary effects from the depletion of so much oil that are not taken into account in the price.

The oil business can be chaotic and unjust, as well as harmful to the environment and poorly accounted for. It is also a huge business with huge potential profits. This leaves a lot of room for manipulation of the price and a lot of power to do so. Speculation and hedging influence the market. Hedging is an effort to protect against large swings in the price to be able to control fuel costs; speculation takes advantage of these swings simply to make a profit on the changes in price but with no intent on actually using the oil. Both of these mechanisms serve a purpose but can cause price swings to become more extreme if they form a destructive resonance with the market forces.

The price of oil makes headlines, but the cost of energy from coal is also a major driver of overall energy cost. Coal is generally used by large consistent consumers and sold via contracts so the price is much more stable. Also, the quantity of coal available is huge, which keeps the price from rising too much and the cost of extraction and transportation is substantial, which prevents large reductions in price.

Energy conserving technologies involving transportation generally compete with the cost of oil, whereas the technologies that compete with electricity are influenced by the price of coal. The cost of electricity has been quite stable and has not been much of a public concern, so most of the perception of the cost of energy is influenced by the price of oil.

Preventing a further reduction in the price of oil is important to all the efforts that are now planned or in the development stage that would be seriously threatened by a sustained low oil price that would make their end products uncompetitive. Since the first oil price shock in 1973, we have had a fundamentally flawed policy toward oil which has resulted in hundreds of billions of dollars leaving the country with much of it funding our enemies. The government does not have to fund energy alternatives; it simply has to quit creating an artificially low price for oil by giving favors to the industry which include tax credits, political maneuvering and wars to protect sources. Mineral right law and regulation should be reconsidered to reflect long-term effects and the fact that oil can migrate underground. It has been shown repeatedly that people will conserve in response to cost and not because of the principle of conservation.

Solar companies, especially solar thermal, were thriving and beginning to become stable and self-sufficient in the early 1980s due to the high price of fuel and, to some extent, tax credits. However, in 1985 the price of oil dropped by more than half and the tax credits were discontinued; this double blow wiped out virtually the entire industry. The price of oil was high and had it stayed there the solar thermal industry would have grown at a reasonable pace. It had started in the late 1970s as a response to high prices. Tax credits were later introduced and that increased the growth rate but also attracted businesses that were, in effect, selling tax credits and not solar systems. At that point the industry was losing integrity and unrealistic claims were being made. The government also funded research and development efforts in the industry, which was counter-productive. I founded a solar company which sold state of the art systems for water and space heating, but at one point I was horrified to see that the government was funding a competitor to develop a similar system. The government should help maintain a good business environment and then stay out of the way.

The economy is going to make some painful adjustments in the next few years. The problems were caused by a lot of poor management, poor judgment and a serious lack of vision by the government, financial industry and individuals. They were all ignoring the fundamental principles of economics. Under the apparent effects of blatant mismanagement there is a serious fundamental shift taking place that few seem to be aware of—we are being forced to shift to a more mature, sustainable and balanced economy. We are going from a situation where many people were buying things just because they could, and for appearances, based on an artificial increase in home prices to one where people will be buying things because they need them or at least will use them. Much of what has been bought in recent years is simply wasted—starting with huge houses and vehicles that are overly expensive and waste fuel to boats that cost thousands and are used twice a year in a harbor where dozens or even hundreds of boats are resting unused. Landfills and junk yards are full of under-utilized things that were bought for no good reason. This can not continue and we are now paying for the adjustment. Japan paid for this adjustment years ago so is in better shape now, but the U.S. government is advising people to spend to get the economy going. This is exactly the philosophy that has caused the problem. Einstein may not have been right about everything, but he was right when he said you can’t solve a problem with the same mentality that caused it. The laws of economics are now forcing the adjustment and there is not much that can be done about it.

The new and renewable energy industry will gain attention as a “green” industry in spite of the recent collapse of fuel prices. The recent high prices and talk of “peak oil,” climate change and the environment have kept interest high. The resources to do much about it, however, will be scarce. Much of the research is funded by donors who expect no financial return or have a very long view, but these people have been affected by the current financial meltdown and are not in the same condition to donate. Other potential investment capital will go to buying cheap stock or real estate, expecting a substantial return in the next year or less. The real crime is that so much money is being spent to bail out the results of incompetence and outright fraud, and it would be much better spent on long-term positive issues like new science and technology.

In relative terms, the amount of capital needed for most of the new energy projects being considered is very small. Colleges and universities are logical places to do the early investigation of frontier science, but today a large fraction of their research budgets is funded by the federal government—which does not see the merit in the technology. Gene Mallove pointed out the huge conflicts of interest within the universities regarding cold fusion and these conflicts and vested interests are still mostly in force.

The new federal administration is going to be very restricted in the kind of action it can take because of so many conflicting demands resulting from the current economic condition which will exist for at least the next year. But there are some things that can be done to correct the underlying poor management of the oil industry. The current low cost of oil presents an opportunity to impose a fuel tax, with a corresponding reduction elsewhere, which is rationally based of the government’s cost associated with the industry. This includes defense, environmental issues and regulation. A $1 per gallon tax now would bring the price to $3, which is still lower than the recent $4 price so it would be easy to accept. People lived with the $4 price and in fact started to conserve in a meaningful way. The price will probably not go back to the $4 range until the economy has recovered, at which time the then $5 price would be accepted and there would be time to adjust fuel consumption habits.

There are many entrepreneurs that would benefit from even this simple policy change. They would have a reasonable energy cost minimum that would support the cost of getting the new technology into the market and there would be the awareness that the government was finally serious about reducing the dependency on oil. Not all new developments that help reduce oil dependency are radically new or technically risky, but they are still risky as businesses because any start-up company has to deal with so many unknowns. Having a reasonably stable price point to aim at can make the difference between success and failure or the difference between starting a new venture or not. It is necessary to encourage many new ventures in order to have the required number of successful ones.

The current economic crisis has exposed a lot of weaknesses in the behavior of government, business and private individuals. A lot of lessons are being learned the hard way, but if they are learned and remembered for a reasonable time the future will be better for it—especially for those that will help in the new, more sustainable economy.

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