Peak Fossil Energy Archives


January 23, 2016

What the L.A. Methane Leak Tells Us About Investing

by Garvin Jabusch

Sempra Energy’s leaking gas field in Porter Ranch, CA, near Los Angeles, has been making national headlines recently, as it now enters its third month of being the largest methane leak in U.S. history. How big is that? The LA Times says that, “by early January, state air quality regulators estimate, the leak had released more than 77 million kilograms of methane, the environmental equivalent of putting 1.9 million metric tons of carbon dioxide in the air.”

1.9 million metric tons of carbon dioxide and counting. In addition, methane isn’t only a powerful greenhouse gas, it can have health consequences for those exposed. In reporting that California Governor Jerry Brown has formally declared the leak an emergency, the New York Times on January 6 wrote that, “already, more than 2,000 families have left this affluent suburb because of the terrible smell and its side effects, which include nosebleeds, headaches, dizziness and vomiting.”

What does it all have to do with investing? It tells us more than you might think, and it speaks volumes about how many investment managers think about the idea of a sustainable economy, and also about the limited tools they have to construct a portfolio that reflects actual long-term viability of the global economic system. As economist and sustainability expert Ken Coulsen tweeted recently, “I thought the idea in #trading was to ask ALL the [questions] - most investment groups refuse to go deep on the intersection of #science [and] #economics.”

Coulsen’s right. Investment managers are supposed to be assimilating all the risks, so why do some have a blind spot when it comes to natural gas and other fossil fuels? Part of it is inertia, a sense that doing things the way they’ve always been done must be “right.” Part of it is ideological and a tribal affiliation among some institutions and investors who resist the idea of an economic switch to renewables as simply contrary to the way they view the world.

The fact that Ted Cruz, a  leading  GOP candidate for the U.S. presidency,  recently described  signatories to the COP12 agreement as, “ideologues, they don’t focus on the facts, they won’t address the facts, and what they’re interested [in] instead is more and more government power" tells us all we need to know about both the  politics involved and the power of Orwellian rhetoric in claiming truth in the opposite of reality. 

Finally, the standard tool kit used by most portfolio managers, collectively called modern portfolio theory, doesn’t particularly allow one to attempt to look forward in assessing risk, basing almost all such calculations on the way stocks and groups of stocks have performed historically.

In any event, Sempra’s utility SoCalGas didn’t think too much about the risks, and neither did a lot of energy investors. SoCalGas/Sempra, as reported by Newsweek, had not installed a “subsurface safety valve that was found faulty and removed in 1979—but never replaced, because the well was not close enough to residential areas to necessitate such a valve. [Rodger] Schwecke, the SoCalGas vice president, says he does not know why the valve was removed and never replaced, but he downplays the ability of a subsurface valve to stop a powerful leak like this one. “It wasn’t a requirement,” he says without much contrition.”

Zero Hedge reports that, “The Company Behind LA's Methane Disaster Knew Its Well Was Leaking 24 Years Ago,” and yet the firm was still considered an upright corporate citizen, among the finest and safest of our fossil fuels firms. Many money managers did not perceive a risk. According to, on October 30th eight days after the leak was detected, “Standard & Poor's Ratings Services affirmed its 'BBB+' issuer credit rating (ICR) on Sempra Energy (NYSE: SRE) and our 'A' ICRs on subsidiaries San Diego Gas & Electric Co. (SDG&E) and Southern California Gas Co. (SoCal Gas). The outlook remains stable.”

Then, on November 16, seven weeks after the world became aware that the leak had begun, the company itself announced that, “Sempra Energy (NYSE: SRE) has been selected for the S&P 500 Climate Disclosure Leadership Index in 2015. The S&P 500 Climate Disclosure Leadership Index lists the top 10 percent of companies within the S&P 500 Index for the depth and quality of climate change data disclosed to investors and the global marketplace.”

Obviously, there is a disconnect between real world, scientifically verifiable risks and traditionally contemplated investment risks, at least in the case of SoCalGas at Sempra. Which is a danger when you get into the business of looking for standouts in an inherently destructive business: even the very best are still destructive. It’s like trying to decide which cancer you would like to get. Maybe you’d select skin cancer because it’s eminently curable if caught early, but the real answer is you don’t want cancer at all.

The risks are real. The Los Angeles Daily News says that “Since Oct. 23, Southern California Gas Co. has spent $50 million to try to stem the flow from the nation’s fifth largest natural gas field, while relocating two schools and some 12,000 residents, many of them sickened by gas detection fumes. A fix may not be in the works until March.”

That means SoCalGas may still be in for more expenses than they thought. Maybe a lot more. Again, from the Los Angeles Daily News, “the researchers recorded elevated levels of the main ingredient in natural gas—10 miles away from the nation’s largest gas leak.” A recent essay from the Union of Concerned Scientists adds, “while this is just the most recent in a long history of oil and gas industry disasters, the particulars of this circumstance are unprecedented (sadly not unheard of). Legal experts predict that SoCal Gas will be on the hook for billions over a long period of time,” and “3,000 more [families] are waiting to be relocated…As these houses sit empty, they become vulnerable to crime and decline in value. And beyond paying to fix the leak, cover medical costs, and relocate families, SoCal Gas is already fielding 25 lawsuits with more expected in the coming weeks, months and perhaps years.”

The traditional way of thinking about investment risks excludes hugely important ones that should have been incorporated into the fiduciary standard a long time ago, begging the question: what is the fiduciary standard for if not to assess these risks? We allow extremely risky activities from a regulatory point of view and then ignore these risks in investment management. But if you don’t include these risks, you’re exposing yourself and your clients to them, and the minute these risks are recognized for what they really are, you could see your value in certain companies, such as SoCal Gas, evaporate before you can get your next statement.  So why build a portfolio with only the ‘good cancers’ in it? Why not build one with no disease at all?

As Newsweek points out, “The methane leak in Porter Ranch, though, is an apt demonstration of our complex affair with carbon fuels. The natural gas stored in Aliso Canyon flows to the homes of about 20 million customers in the greater Los Angeles area. So while we contemplate wind farms and solar arrays, we remain married to an antiquated infrastructure that lets us do what we have done for centuries: extracting energy by burning carbon.” And so, sometimes ignoring all seemingly non-financial risks, do fund managers.

But, increasingly, someone has to answer for those risks. Fossil fuels companies don’t think it will be them. says it all when they report that, “none of the 65 oil and gas companies reviewed in a just-released study by Environmental Defense Fund disclose targets to reduce methane emissions, the main ingredient in natural gas.”

You don’t manage a risk you don’t think you’re going to have to pay for, and therefore most oil and gas companies don’t manage them adequately. For portfolio managers it’s different though, we can and should be thinking about risks even when companies themselves don’t. Our clients’ financial well-being is at stake.

Yet portfolio management, populated with professionals who try to leave no stone unturned in rooting out risks and dangers associated with every stock, has a blind spot when it comes to fossil fuels. In a time when it is clear that the beginning of the end of the fossil fuels era has begun, when we know fossil fuels contribute massive risks to the global economy from all the outcomes of warming to failing health to destruction of land and biodiversity, when we can say with certainty that for many purposes renewable energies are now more economically competitive, most investment professionals still continue to hold coal, oil and gas stocks. They have their stated reasons: diversification, historical performance, modern portfolio theory and fiduciary standard requirements. But backward-looking diversification methodology (again, the standard in present day investment management) has allowed construction of portfolios fraught with systemic risks.

What the LA methane leak tells us about investing today is as much about inertia as it is about research and new ideas. This is probably inevitable and to be expected, but it’s a shame, because where capital is invested in this world is where change happens, and it’s time professional investors realized they need to stop investing in the world’s greatest systemic risk.

Given the tools provided by modern portfolio theory, mainstream investment management only seems to be able to think as far as: "we need to be sustainable, so which fossil fuels firms are greenest?" This is shortsighted. The world economic forum at Davos now sees climate as the world's number one economic risk; why don't most portfolio managers and other fiduciaries?

Garvin Jabusch is cofounder and chief investment officer of Green Alpha® Advisors, LLC. He is co-manager of the Shelton Green Alpha Fund (NEXTX), of the Green Alpha Next Economy Index, the Green Alpha Growth & Income Portfolio, and of the Sierra Club Green Alpha Portfolio. He also authors the Sierra Club's green economics blog, "Green Alpha's Next Economy."

September 10, 2014

Divesting: Last One Out Loses

Tom Konrad CFA

Anew report written by Nathaniel Bullard at Bloomberg New Energy Finance highlights the difficulties large institutional investors would have divesting from fossil fuels. What it does not specifically discuss is that these difficulties could lead to large financial losses for investors who see the difficulty of divesting as a reason to delay.

Just as we can't easily fill up our cars with solar power instead of gasoline, the report points out that there is no asset class that can directly substitute for oil and gas in large institutional portfolios.

A person with a short commute can simply ditch gasoline for renewable fuel by riding a bike, and small investors can easily divest from fossil fuels without sacrificing growth or yield by using small capitalization stocks and yield cos.

The relatively high yield of oil and gas stocks is the most difficult to replicate, even at its level of 2.41%, which the report describes as “not enormous.” According to the report, the only sector with a higher average yield is REITs (at 4.55%). REITs have a total market capitalization of less than a third of oil and gas stocks, so it would be impossible for more than a fraction of large investors to replace their oil and gas holdings with REITs.

The Instructive Case of Coal

In contrast to oil and gas, the report makes the point that because the market capitalization of coal companies is much smaller, divesting from coal alone is much easier than divesting from oil and gas. The report states that “Coal equities are less than 5% the total value of oil and gas equities, and have already trended down nearly 50% in the past five years... as a result, divesting from coal would be much easier then divesting from oil and gas.”

The report's author Nathaniel Bullard, told me in an interview that divesting from coal would have been more difficult just three years ago. He says, “US coal has had clear indicators of future change in place for a while. … Some coal equities have lost 90% of their value since 2011... This much diminished size means that... the same number of shares will represent a much smaller portion of an investor's overall portfolio relative to 2011.”

Hold High, Sell Low?

To put it more bluntly, investors who have already lost their shirts in coal stocks will have a much easier time selling their much-diminished holdings today than they would have when coal stocks were at their peak. Ironically, it's easier to sell low and buy high than vice-versa, especially for investors who manage large pools of money.

It does not take a multi-million dollar salary to know that waiting until your stocks have fallen by half before you sell is a suboptimal investment strategy. Despite past “clear indicators of future change” and lower estimates of future coal demand due to air pollution regulations in the coal industry, institutions like Stanford are only now beginning to divest from the sector. Most have not yet budged.

Are Oil and Gas Next?

The report begins with a quote from an executive who describes the divestment movement as “one of the fastest-moving debates I think I've seen in my 30 years in the markets”. If this fast-moving debate leads to fast-moving divestment, the sheer size of institutional oil and gas holdings would lead to a scale of the selling that could easily drive down prices of oil and gas stocks as fast as coal stocks have fallen over the past few years.

The divestment movement was only in its infancy when coal stocks peaked in 2011, so divestment has been only a minor contributor to their decline. Bullard attributes most of the decline to fundamental factors, such as low gas prices and (to a limited extent) wind power in the US, and concerns about air pollution in China.

That said, the long term fundamentals of oil and gas are not favorable. Industry costs are rising as producers shift towards unconventional sources such as tar sands and tight oil and gas which are extracted with relatively expensive techniques such as hydraulic fracturing (“fracking”). Meanwhile, high fuel prices are beginning to reduce average driving distances in mature markets such as the US and Europe while the declining costs of efficiency technologies such as hybrid and electric vehicles further lower demand. In the fastest growing vehicle fuel market, China, air pollution concerns have led the government to aggressively promote “new energy” vehicles, particularly hybrids and EVs.

Natural gas faces increasingly inexpensive competition in electricity markets from wind and solar generation. That, combined with technologies such as storage, smart grid, demand response, and better transmission which make it easier and cheaper for these variable sources to supply a larger portion of electricity demand with less reliance on dispatchable generation such as natural gas, hydropower, and biomass-fired electricity.

The fundamentals of all fossil fuels will be further undermined if the world ever makes a concerted effort to rein in carbon emissions. At the moment, the prospects for large scale regulatory moves seem dim, but at some point the increasing costs in terms of falling crop yields, widespread and severe heat waves and droughts, ocean acidification and the like will lead to political action. At this point it will almost certainly be too late to avoid significant economic and human costs from climate change, but that does not mean that it will not help us avoid even greater damage. And the longer we delay taking substantive actions to curb greenhouse gas emissions, the more draconian those actions will have to be. Drastic moves to curb carbon emissions will have even more drastic effects on the fundamentals of fossil fuel industries.


In part because it is so hard for large investors to exit fossil fuels, it is unlikely that a majority of such investors will move to divest before they have lost a large portion of their current holdings to price declines driven by the fundamental factors outlined above and selling from more motivated investors.

Some of the factors listed above, such as concerted political action to curb carbon emissions, may take a long time to be felt. Other factors, such as the declining cost of renewable energy and efficiency technologies and the increasing costs of fossil fuels are moving energy markets today.

When these factors will begin to hurt oil and gas stocks is unclear, but the coal industry shows that, although divesting is hard, it does not pay to wait too long.

This is where the analogy to replacing fossil fuels in your commute by buying an electric car breaks down. With electric cars, the more people own them, the easier and cheaper they will be to use: growth in charging infrastructure will rise with the adoption of plug-in vehicles, while higher volumes should help bring down their initial cost.

In contrast, it pays to be first rather than last when divesting from fossil fuels. While it is possible to be too early, at some point the worsening fundamentals of fossil fuel industries and/or a large scale divestment movement will undermine the value of all fossil fuel stocks. Those who divest sooner will have much more money to invest elsewhere than those who delay because divesting is just too hard.

Fortunately, small investors have it easy. Divesting, for once, is a place where the small investor has the advantage on Wall Street.

This article was first published on Renewable Energy World, and is republished with permission.

May 16, 2013

Ten Economic Risks of Fossil Fuels

Garvin Jabusch


A train, loaded with coal, crashed into the back of a passenger train in Czechloslovakia in 1868.

Securities of fossil fuels firms, as an economic sector, may soon be on the decline. Predictions as to when oil, gas and coal will become a smaller part of the investment society makes into its total energy mix in favor of renewables (such as solar, wind and ocean energies) vary, ranging from 2060 on the long side (this prediction from oil industry powerhouse Shell) to 2030 or even sooner on the shorter side (as reported by Bloomberg). But so far, markets appear to be mispricing the risk this presents to fossil fuels companies, and their share prices for now remain stable. In our opinion, it’s not too soon to consider divesting from fossil fuels while one might still recover significant value.

Coal, oil, and natural gas, though, are the main sources of energy that have gotten civilization this far (at least since the late 1700s, or the entire industrial revolution), so why are many expecting them to so quickly diminish in importance? 

Mostly because of recent innovation and renewable energies’ efficiency and cost gains. Our ‘next economy’ thesis asserts that the energy and material resources we need to host an indefinitely thriving economy exist in more than sufficient quantities (particularly energy), if we would only collect and use them in smart and efficient ways. The innovations required to put world economies on a long term sustainable path largely exist today. For example, the various forms of solar energy collection have become so efficient over the last 20 years that all of civilization’s energy requirements could presently be met by covering 0.3% of the earth’s land surface with solar panels and concentrated solar thermal systems. Our models insist that through promoting true sustainability solutions in materials and energy, we can indeed maintain a healthy, thriving biosphere, all while growing our economies and improving standards of living potentially everywhere, for everyone.

This in mind, we put together 10 primary reasons why fossil fuels investments, in next economy terms and indeed in general economic terms, no longer appear to be the attractive source of risk-adjusted returns they have historically been.

Fossil fuels are economically becoming subprime because:

1. Fossil fuels have the capacity to threaten basic systems.

Warming and its sequelae such as severe weather, droughts, floods, more frequent and intense storms and attendant uncertainties all undermine our basic economic foundations. A recent World Bank report conceded that “There is … no certainty that adaptation to a 4° C world is possible,” referring to a global average temperature increase of 7.2 degrees Fahrenheit from pre-industrial times that is considered likely by scientists over the next few decades if fossil fuels’ use is not soon severely limited. To rephrase what this means, the traditionally conservative World Bank believes that human economies may not be able to adapt to a world that has on average warmed four degrees Celsius or more. Note that the global temperature has risen nearly one degree Fahrenheit since 1975.

Millions of pages have been written on the underlying reason for the unsustainability of fossil fuels. Their power to disrupt basic climate and therefore world societies is vast, complicated and is a topic best left to our best specialists. I suggest to the interested reader the works of more qualified practitioners including Dr. James Hansen, Lester Brown and Bill McKibben.

2. Fossil fuel assets present abandonment risk.

Fossil fuels companies are now confronted by the risk that many of the still-in-the-ground assets they count on their balance sheets and/or in their future revenue projections may never be recovered or realized. As this becomes the apparent, their asset valuations and revenue guidance may be revealed as currently far too high, and the values of their companies and stocks overvalued. Citing abandonment risk, Bloomberg recently reported that “Investors in carbon-intensive business could see $6 trillion wasted as policies limiting global warming stop them from exploiting their coal, oil and gas reserves.”  Carbon Tracker reports that “Between 60-80% of coal, oil and gas reserves of publicly listed companies are ‘unburnable’ if the world is to have a chance of not exceeding global warming of 2°C.”

The press down under is reporting that “Australian based analysts at Citigroup say fossil fuel reserves in Australia face significant value destruction in a carbon constrained world, with the value of thermal coal reserves likely to be slashed dramatically if governments get serious about climate action…Fossil fuel asset owners could be best advised to dig the resource up as quickly as they can.”

Over at HSBC they recently pushed up a similar report, encompassing a global scale, essentially saying we can’t count all the fossil fuel reserves on firms’ balance sheets because we cannot burn them all and therefore “Oil and gas majors, including, BP, Shell and Statoil, could face a loss in market value of up to 60 percent should the international community stick to its agreed emission reduction targets.” (As reported by (I don’t believe most policymakers in governments around the world currently have the wherewithal to honor their various carbon reduction treaties, but I also don’t believe that matters. Peak oil demand is upon us because the alternatives are simply becoming far more competitive and because awareness of fossil fuels’ dangers is rapidly advancing.)

What Bloomberg, Citi and HSBC are saying, in sum, is that infinite growth of a known harmful asset – in this case an asset with the ability to disrupt climate and civilization – must come to an end, and soon.  And shares of the firms exploiting this asset are at risk.

3. Renewables are becoming too competitive for fossil fuels.

Forbes has quoted Rick Needham, director of energy and sustainability at Google saying, “While fossil-based prices are on a cost curve that goes up, renewable prices are on this march downward.” That pretty much sums it up. In just the last five years, solar photovoltaic module prices have fallen 80 percent and wind turbines have become 29 percent less expensive. Moreover, after the initial investment, renewables such as wind and solar, having no cost of fuel, will prove far too competitive for fossil fuels no matter how cheap those may appear to be. Cheap fuel is still more than free fuel.

One of the first major investors to recognize this was Warren Buffett. Via his MidAmerican Energy subsidiary, he has quietly made Berkshire-Hathaway America’s single largest owner of both solar and wind electrical power generation capacity. Patrick Goodman, Buffett’s CFO of MidAmerican said simply “we believe renewables is the better investment right now.” Warren Buffet, who believes that once a good investment has been identified it’s time to “back up the truck,” is showing no signs of giving up his leader status on solar, having just begun construction on the “largest solar plant in the world.”

All this is happening now, today, with today’s technologies and today’s economics. That the smart money already sees renewable energies as more competitive long term than fossil fuels is obvious. The ‘smart money,’ by the way means individuals as well as institutions. Solar crowdfunding pioneer Mosaic in April of this year sold out the first tranche of $100 million in solar project investments to Californians in just hours.

Further technological advances aren’t required to make renewables competitive, but advances are occurring. Fossil fuels will represent only a small percentage of all energy investments in just a few years for a simple reason: few will want to invest in the less profitable technologies of the past.

4. Fossil fuels firms are beginning to have to pay for their externalities.

Fossil fuels companies have never had to pay for their economic externalities such as pollution, warming, health effects and contaminated water and farmland. There are signs that this is beginning to change, and firms will increasingly be liable for damages in the tens if not hundreds of billions. The highest profile example is BP’s Deepwater Horizon spill, the worst oil spill in U.S. history. BP has already been required to set up a US$20 billion fund to cover cleanup and damage costs, and perhaps far more significantly, is facing potentially “tens of billions” in additional damage payments pending the outcome of what the Financial Times is (in a dedicated section) calling the “trial of the century,” now underway in Louisiana. The FT is also reporting that BP is facing an additional 2,200 lawsuits related to the spill. Even if BP should prevail in most or even all of these suits, the massive costs of these litigations will start to become a drag on the firms’ traditionally easy profitability. Newsweek has a longform piece covering many details including additional BP liabilities such as: “that BP lied about the amount of oil it discharged into the gulf is already established. Lying to Congress about that was one of 14 felonies to which BP pleaded guilty last year in a legal settlement with the Justice Department that included a $4.5 billion fine, the largest fine ever levied against a corporation in the U.S.” BP’s continuing potential liabilities from this one incident, including “uncapped class-action settlements with private plaintiffs” and “civil charges brought by the Justice Department” and “a gross negligence finding [that] could nearly quadruple the civil damages owed by BP under the Clean Water Act to $21 billion,” show the danger to shareholders. Any representative of an asset class carrying this kind of risk can justifiably be labeled a subprime investment.

Other firms facing liability issues surrounding the dangerous nature of their products include Chevron, which has had to abandon Ecuador altogether to avoid paying a $US19 billion settlement there in a “nightmare case” that threatens to drag on around the world as Ecuador seeks payment via Chevron’s assets in other nations.

5. Fossil fuels are likely to have to face carbon taxes.

There will be carbon taxes in many if not most countries that will directly impact the profit margins of fossil fuels firms. The New York Times Op-Ed framed the argument like this:

“Substituting a carbon tax for some of our current taxes — on payroll, on investment, on businesses and on workers — is a no-brainer. Why tax good things when you can tax bad things, like emissions? The idea has support from economists across the political spectrum, from Arthur B. Laffer and N. Gregory Mankiw on the right to Peter Orszag and Joseph E. Stiglitz on the left. That’s because economists know that a carbon tax swap can reduce the economic drag created by our current tax system and increase long-run growth by nudging the economy away from consumption and borrowing and toward saving and investment.”

A carbon tax is good for everyone but fossil fuels companies, who will see their profits reduced (or attempt to pass the costs on to consumers, reducing demand for their products further). So far, several nations, provinces and individual municipalities have implemented a carbon tax, and many others have carbon trading schemes (the Carbon Tax Center is a good resource for keeping up with these). Carbon taxes can raise revenues, shrink deficits, and move tax burden away from citizens, all while slowing the worst effects of warming. Look for their implementations to continue to spread.

6. Fossil fuels will soon face diminishing governmental subsidies and benefits.

Fossil fuels have received as much as half a trillion dollars per year in subsidies from the U.S. alone. To the extent that austerity or desires to balance budgets, combined with legislation to limit greenhouse gas emissions, reduce the scale of this windfall, the seemingly easy profitability of these companies will be undermined. This point, as well as point five above, is more fully developed in point seven.

7. There is growing global institutional belief that transition to renewables solves climate AND economy.

We’ve already seen the dire warnings about warming coming from the World Bank, and discussed the positions of Bloomberg, Citi and HSBC. These institutions are far from alone. The International Monetary Fund, in calling for “Energy Subsidy Reform,” recently calculated that between directly lowered prices, tax breaks, and the failure to properly price carbon, the world subsidized fossil fuel use by over $1.9 trillion in 2011 — or eight percent of global government revenues, representing a huge drag on economies. The United States taxpayer is fossil fuels’ largest benefactor at $502 billion in 2011. China came in second at $279 billion, and Russia was third at $116 billion. For perspective, that $502 billion is just over 3% of the US economy, currently being given away to big fossil fuels companies.

The IMF concluded that the “link between subsidies, consumption of energy, and climate change has added a new dimension to the debate on energy subsidies.”  The IMF’s solution to both economic and climate risk (as reported by The Hill) is in two simple parts: “end fossil fuel subsidies and tax carbon.”  The solution to both climate and economy is worldwide conversion from fossil fuels to renewables.

8. Fossil fuels are the ultimate non-circular: they’re completely consumed upon first use, so more primary source extraction is required.

As I mentioned above, to get global economies on an indefinitely sustainable foundation, we need to make far more efficient use not only of energies but also of raw materials. Fossil fuels represent both raw resources and energy sources, and they represent the worst of both. Smart, efficient use of materials means reusing nearly everything at the end of its lifecycle to repurpose into something else we need. For a thriving, sustainable long-term economy, we need to get close to perfect recycling of resources of all kinds so we can minimize our depletist impacts on earth and avoid the basic environmental degradations that go along with those.

This approach of course excludes fossil fuels and other resources that are consumed entirely on their first use. Raw materials can keep economies growing for a long time if we preferentially mine our huge stockpiles of already extracted resources and minimize extraction from primary, geological sources. But fossil fuels, unlike materials used to make solar panels and wind turbines, don’t work like that. Since they are consumed entirely on their first use, reuse is impossible and we have to literally go back to the well for more. This means ever more greenhouse gasses in the atmosphere, ever more degrading of the local environments where extraction takes place, ever more risk of accidents, and the possibility of eventually exhausting the resource completely (although on this last point I personally believe we will – for the reasons presented here – reach peak demand far before we fully exhaust fossil fuel reserves).

9. Distributed renewable energy grid is more secure than traditional hub and spoke systems, even those powered by domestic fossil fuels.

FERC Chairman Jon Wellinghoff has recently said, “It wouldn’t take that much to take the bulk of the power system down. If you took down the transformers and the substations so they’re out permanently, we could be out for a long, long time,” and “A more distributed system is much more resilient…Millions of distributed generators can’t be taken down at once.”

This is common sense. And short of equipping every home and business with its own diesel or natural gas generator – which of course would be disastrous for local areas’ air quality – fossil fuels can never offer anything like the kind of security and resilience that distributed renewables like rooftop solar can.

10. Renewables will counter fossil fuels’ endless ‘boom and bust’ economic cycles.

As I’ve posted before, the price of oil and other fossil fuels has, at least since World War II, been the main control knob permitting expansion and causing contraction of world economies. It’s widely known that 10 of the last 11 major recessions were preceded by peaks in oil prices. Rising oil prices are inflationary, adding to the costs of almost everything from transportation to fertilizers to plastics, and they therefore cause demand for all these affected items to become depressed, slowing economic production.  Renewables, relying as they do on free fuels like sunlight, present no such economic pressures, and as they become an ever larger percentage of our energy mix, fossil fuels’ huge GDP drag will begin to disappear.


What then is the future for fossil fuels versus renewables? Fossil fuels have already begun to rapidly lose market share. In 2012, most new electricity generating capacity brought online in the United States was from renewables, and in January and now March 2013, all new U.S. electrical generating capacity was provided by renewables. So where is this headed?

Clean Energy Investment Projection
Image courtesy BNEF

Bloomberg New energy Finance (BNEF) has calculated that “70% of new power generation capacity added between 2012 and 2030 will be from renewable technologies (including large hydro). Only 25% will be in the form of coal, gas or oil.” BNEF CEO Michael Liebreich has said "I believe we're in a phase of change where renewables are going to take the sting out of growth in energy demand," which goes to our thesis that we can both lighten our ecological footprint and increase our standards of living.

So add Bloomberg to the growing group of financial analysts warning that fossil fuel investments are poised to become a bad bet. 

Citi bank, in its note about the Australian coal industry, went as far as to warn investors that it will be difficult to extract value from their still-in-the-ground resources as action on climate change advances, stating, "If the unburnable carbon scenario does occur, it is difficult to see how the value of fossil fuel reserves can be maintained, so we see few options for risk mitigation." (Italics added; Source.)

Well, with all due respect to Citi, I can think of one option: we, like Buffett and Google, can instead invest in civilization’s non-carbon sources of power. As the IMF pointed out, the solution to both climate and economy is worldwide conversion from fossil fuels to renewables. This massive conversion program will lead to powerful economic growth, less economic drag from energy costs, higher revenue for treasuries, and strong employment drivers.

If we fear for the future, it is paradoxical to attempt to mitigate risks by remaining invested in fossil fuels. What we do now will bring about the future for better or worse. If we’re to emerge from our 19th century energy system, it must be us, now, today, who set that emergence in motion. Leave fossil fuels for those who prefer to look backwards.

Garvin Jabusch is cofounder and chief investment officer of Green Alpha ® Advisors, LLC. He is co-manager of the Shelton Green Alpha Fund (NEXTX), of the Green Alpha ® Next Economy Index, and of the Sierra Club Green Alpha Portfolio. He also authors the Sierra Club’s green economics blog, "Green Alpha's Next Economy."

July 15, 2012

Natural Gas Liquids are Following Natural Gas Off a Fracking Cliff

Tom Konrad CFA

The unprecedented boom in natural gas supplies over the last few years as been one of the few tail-winds for the US economy over the last few years, as plummeting natural gas prices have lowered costs for both industry and consumers.  Few outside the natural gas industry even understood the shear scale of the shale gas resource, although industry insiders did.

The Shale Gas Glut

In 2008, I recall a natural gas executive complaining about how he could not get policymakers to understand the sheer scale of the shale gas resource.   To be honest, I did not take his comments seriously, either.  That was a mistake.  Shale gas has transformed our economy in many ways, and changed the economics of competing fuels, from coal and nuclear to renewables like solar, wind, and geothermal.  Cheap natural gas is even doing what Pickens failed to do: get a major oil company to invest in natural gas filling stations.

While shale gas transformed our economy, it also transformed the stock market, which is why I should have paid more attention.  Low natural gas prices have not only hurt renewable energy stocks, they have also helped chemical and fertilizer companies that use natural gas as a feedstock.  I first came across LSB Industries (NYSE:LXU), a geothermal heat pump (GHP) and chemical company that uses a lot of natural gas a couple month’s after I heard the natural gas executive’s rant.   I bought both LXU and its pure-play GHP rival Waterfurnace (TSX:WFI,OTC:WFIFF) at the time, but I sold LXU a few months later, congratulating myself on a quick double at $16, while holding Waterfurnace.  Waterfurnace is down a little since I bought it (although it has been paying a nice dividend along the way, while LSB doubled again, in large part because of the tail winds from low natural gas prices.

I don’t plan to make the same mistake again, so I pay more attention to what’s going on with fossil fuels.  To that end, I attended the 2012 Symposium on Oil Supply and Demand: Studying the Wildcards, where industry experts tried to predict the next fossil fuel “surprise” that should not be a surprise, if we’d only been paying attention.  (The presentations and video proceedings are available at

NGLs: The Next Shale Gas?

If there is going to be another fossil fuel glut to follow natural gas, it will probably be Natural Gas Liquids (NGLs, not to be confused with Liquefied Natural Gas, or LNG).  Natural gas liquids are the slightly larger carbon compounds such as ethane, pentane, and propane, which are co-produced with natural gas, but are usually counted with oil production in industry statistics.  But, as I learned at the symposium, NGLs should not really be counted with oil or gas, or even separately.  Each NGL has its own uses, and its own market, and they need to be considered separately if we are to understand the price dynamics.

Perhaps most importantly for those of us worried about the ability of oil production to keep up with demand, NGLs are not used as transportation fuel (with a tiny exception for propane in forklifts and the like.)  Hence, even though NGLs are often counted as part of the oil supply, they do not ease the constraints on the supply of gas or diesel.

rig count rich vs lean

The reason NGLs are interesting now is because recent low natural gas prices have led natural gas producers to dramatically shift drilling away from “lean” prospects (which produce natural gas but few NGLs) to “rich” ones (which produce significant NGLs along with the natural gas.)  This trend was highlighted at the Symposium by Adam Bedard, Senior Director at BENTEK Energy, an energy markets analytics company (see graph above).  So far, relatively high prices for NGLs have kept many wet gas wells profitable despite low gas prices.  In a sense, gas companies are drilling for NGLs, and producing natural gas a a byproduct.

The problem is that the rapid shift towards NGL-rich plays is liable to produce more NGLs than the market can handle.    According to George Little, a partner at Groppe, Long & Littell, an oil and gas analysis and forecast provider speaking at the Symposium, the leading indicators of periods of NGL oversupply are the relative prices of olefins ethylene and propylene, which are made from NGLs.

US Olefin Prices

When propylene prices are above ethylene prices, it is a leading indicator for ethane being sold for its heat value into the natural gas market, rather than being sold into the chemicals market.  That indicator, according to Little,  is currently “flashing red” (see graph above.)  The problem with selling ethane into the natural gas markets is that, with current low natural gas prices, it will only fetch $0.10 to $0.16 per gallon, a fraction of the current price.

Competition with natural gas for industrial uses and heating has also been eroding the propane market.  The butane market is similarly stagnant.

Stocks to Avoid

With stagnant demand in most NGL markets, it’s no surprise that new supply has been dramatically reducing NGL prices.  The coming flood of new supply will only push NGL prices down further.  Natural gas producers that are counting on high NGL prices to maintain profitability are likely to find it as hard to profit from NGLs over the next few years as it recently has been to make a profit from natural gas.

Which natural gas producers are most reliant on NGLs, and hence vulnerable to a price collapse?  Devon Energy (NYSE: DVN), recently announced a sixth consecutive quarter of increasing NGL production and an 80% year over year increase in NGLs from the Cana Woodford shale.  On the other hand, Chesapeake Energy (NYSE:CHK) may be less vulnerable, since that company recently trimmed its projections for NGL production.

On the green side of the coin, biochemical companies which have turned to these higher-margin businesses in order to escape commodity squeezes in biofuels may see the same story repeating itself in chemicals.  Investors should not count on high-margin biochemicals to remain high-margin if they replace petrochemicals made from NGLs.

Likely Winners

On the other hand, midstream NGL companies should be able to produce increasing profits from NGL bottlenecks.  Pipeline operator ONEOK Partners (NYSE:OKS) and Enterprise Products Partners (NYSE:EPD) have both been seeing increasing margins from their NGL operations.  Those trends are likely to continue as the growing NGL glut increases demand for NGL transportation and processing infrastructure.

Disclosure: Long LXU, WFIFF

This article was first published on the author's blog, Green Stocks.

DISCLAIMER: Past performance is not a guarantee or a reliable indicator of future results.  This article contains the current opinions of the author and such opinions are subject to change without notice.  This article has been distributed for informational purposes only. Forecasts, estimates, and certain information contained herein should not be considered as investment advice or a recommendation of any particular security, strategy or investment product.  Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.

March 22, 2012

LNG Exports Would Help the Environment

Tom Konrad CFA

to LNG Terminal
Photo: Robin Lucas, via Wikimedia Commo

With friends like these, who needs enemies?

The Sierra Club is fighting new Liquified Natural Gas (LNG) export terminals, because they believe LNG exports would reward and encourage producers of shale gas.

Fighting shale gas has blinded them to the bigger picture.

If LNG exports were to reward shale gas producers, they would have to be significant enough to raise the price of domestic natural gas. Such large exports would also lower the world price of LNG.

Effects on Domestic Markets

Higher domestic natural gas prices would help shale gas producers, but they would also help other producers of domestic energy which compete with natural gas. Domestic consumers of natural gas would also have stronger incentives to use gas more efficiently, or switch to other options. Solar, wind, geothermal and energy efficiency industries (of which the Sierra Club is a vociferous supporter) are all hurt by low natural gas prices because it lowers the price they are able to get for the power they sell.

The Case of the Bi-Fuel Truck

The case for electric and hybrid vehicles is hurt as well when low gas prices make the economics of natural gas vehicles look better. GM and Chevrolet both recently announced bi-fuel pickups able to run on natural gas. The selling point for such vehicles is the lower running cost when using cheap natural gas, despite the initial up-front cost. The companies are oddly silent on the additional cost of such vehicles, but the trade-off between higher up-front costs and lower operating costs sounds eerily similar to that for hybrids and EVs.

The Hybrid Chevrolet Silverado costs an additional $2500 up-front, but will also save fuel costs with an EPA fuel economy of 20 mpg for city driving, and 23 highway, compared to 14 mpg city/ 19 highway for the base model, and also comes with four 20 amp A/C outlets allowing it to function as a work-site generator. If we assume 10,000 miles each of city and highway driving annually, the hybrid Silverado will save an annual savings of 306 gallons or $1224, at $4 gas, which will pay for the additional cost in 2 years. Perhaps the bi-fuel pickups will have quicker paybacks (although I doubt it, given the manufacturers' unwillingness to quote prices), but any payback for a bi-fuel truck will depend on natural gas prices staying low.

In other words, the Sierra Club is promoting natural gas vehicles over hybrids, and natural gas power generation over renewables and efficiency by fighting LNG exports.

Effects on World Markets

LNG exports would also lower world LNG prices, hurting LNG exporters in other countries, something the Sierra Club should support, since making LNG has such a high carbon footprint.

Meanwhile, the world's largest LNG importer has long been Japan, and Japan's LNG imports have skyrocketed to make up for electricity from shut-down nuclear reactors. Cheaper LNG imports could help Japan afford the aggressive move to renewable energy and efficiency the country is embarking on.


Hydrofracking for shale gas can be harmful to the environment, especially when it is poorly regulated as it is in much of the United States, and cash-strapped drillers take shortcuts with safety and environmental protection. But if drillers are not going to take shortcuts, they need to be able to afford proper precautions, and funds need to be made available for proper oversight of their operations. All of this cannot happen at today's low extremely low gas prices.

If the Sierra Club wants to stop dangerous fracking, they should not be fighting export terminals, they should be working to force the industry to fund proper oversight. Perhaps a levy on natural gas produced by fracking to fund safety and environmental inspections could be passed as part of a deal to allow LNG export terminals.

Such a deal would be a win for the environment, for renewable energy developers, for energy efficiency, and for the Japanese, who are bravely trying to find their way to a nuclear-free future.

This article was first published on

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February 07, 2012

The End of Elastic Oil

Tom Konrad CFA

The last ten years have brought a structural change to the world oil market, with changes in demand increasingly playing a role in maintaining the supply/demand balance.  These changes will come at an increasingly onerous cost to our economy unless we take steps to make our demand for oil more flexible.

We're not running out of oil.  There's still plenty of oil still in the ground.  Oil which was previously too expensive to exploit becomes economic with a rising oil price.  To the uncritical observer, it might seem as if there is nothing to worry about in the oil market.

Unfortunately, there is something to worry about, at least if we want a healthy economy.  The new oil reserves we're now exploiting are not only more expensive to develop, but they also take much longer between the time the first well is drilled and the when the first oil is produced.  That means it takes longer for oil supply to respond to changes in price. 

In economic terms, the oil supply is becoming less elastic as new oil supplies come increasingly from unconventional oil.  Elasticity is the term economists use to describe how much supply or demand responds to changes in price.  If a small change in price produces a large change in demand, demand is said to be elastic.  If a large change in price produces a small change in supply, then supply is said to be inelastic.

Elasticity of Demand

On the demand side, the elasticity of our demand for oil reflects the options we have to using oil for our daily needs. At a personal level, we can quickly cut our demand for oil a little bit by combining car trips, keeping our tires properly inflated, etc.  But the ability to make such reductions is often limited, and even such simple measures come at a cost of time or convenience, which is why we're not doing them already.  If we live in an area without good public transport (as most of us do) we can't stop driving to work without losing our job, so we keep driving to work, and paying more for the gas to get there.

Over the longer term, our personal options to cut oil consumption increase.  We can move closer to work, or to somewhere where we can walk or use public transport to get to our job. This is why the most fuel-efficient vehicle is a moving van. 

Replacing a car with a more fuel efficient vehicle is an option for those who have money or credit, but the people who are under the most pressure from high fuel prices are unlikely to be able to afford such options.  If they can't resort to ride sharing or public transport, they may simply lose their jobs because they can't afford to get there. 

The reduction in fuel use that comes from people losing their jobs and no longer commuting to work also contributes to the elasticity of demand, and I mention it to highlight the point that while reductions in fuel use can be benign (properly inflated tires, for instance), they can also be harmful to the economy.  Reductions in demand due to high prices are often called demand destruction, and it's just as unpleasant as it sounds.

Elasticity of Supply

Since our options for reducing oil demand in response to rising prices range from inconvenient to expensive, to downright painful, it's clear why the media and politicians focus so much attention on the other half of the equation: When supply adapts to changes in demand, voters don't have to make uncomfortable choices. 

But there are also limits to the ability of oil supply to adjust.  Most OPEC nations, including Saudi Arabia, need at least a $100/bbl for oil to keep their budgets in balance, so why would they increase production to reduce the price below that?  In fact, as (subsidized and hence inelastic) OPEC domestic consumption continues to increase faster than supply, OPEC net exports will continue to fall, further raising the price needed to balance exporters' budgets. 

While fiscal issues constrain OPEC's elasticity of supply, geology and politics constrain oil supply elsewhere.  Brazil's giant pre-salt fields, like deep water discoveries in the Gulf of Mexico and elsewhere, are much more expensive and slow to develop than were past discoveries.  Canada's tar sands are large mining operations, and are similarly slow and expensive to develop.

Put simply, if the oil were quick and easy to get at, we'd have gotten it already.  All these factors mean that the elasticity of oil supply is falling, so oil demand has to adjust more in response to changes in price than in the past.


Since there is little reason to assume that the elasticity of oil demand has changed significantly (do we have more options for doing without oil than we did ten or twenty years ago?) while the elasticity of oil supply has fallen, we have to expect that overall oil price elasticity has fallen as well, and these changes should show up in oil market data.

Using oil annual supply, price and consumption data from the EIA and IEA, and making some back-of the envelope adjustments to account for the difference between their different definitions of what constitutes oil, I made some estimates of the price elasticity of oil supply and demand.

Since neither demand nor supply can respond instantly to changes in price, I first had to estimate the average reaction time.  To do this, I looked at the correlation between changes in the oil price and changes in supply and demand with various lags.  I used price and volume changes over a period of three years because three year changes gave me the strongest results, although one and two year changes were similar. 

Below you can see the correlations between three year changes US and worldwide supply and demand with three year changes in US oil prices (WTI) and world oil prices (Brent), after various lags:

Oil correlation of price and volume.png

Note that we're looking for negative correlation between price and demand (we use less oil when we have to pay more for it), and positive correlation between price and supply (companies produce more oil if they can get more money for it.) 

From the chart, we can see that world oil supply has historically taken about one year to respond to changes in world prices (the blue line peaks at 40% correlation with a one year lag), while domestic US oil production (supply) has typically taken about four years to respond to changes in the oil price, but that response is much stronger than the response of world supply.

The difference between the response between US and world oil supply makes sense because domestic oil production operates in a much freer market than world oil supply, where changes are mostly dominated by political decisions in a few OPEC nations.  Political decisions are quicker than drilling new wells (one year as opposed to four), but they are only about half as responsive to changes in price.

On the demand side, we see very little response to changes in price at all.  The correlation between demand and price is always positive, showing that changes in supply have accounted for virtually all of the market response to oil price changes over the period. 

Changes Over Time

To test my hypothesis that supply is becoming less elastic, I split my data set into two periods, one from 1987 to 2000, and one from 2001 to 2010.  If the hypothesis is correct, we will see less supply and more demand price response in the later period than in the earlier one.

The graphs which follow show significant changes in how both supply and demand respond to changes in price.  Perhaps the most significant change is that we now see a response in the demand for oil to the oil price.

In the early period, only US demand for oil shows a small response to price, with a slight negative correlation (-30%) between three year changes in US demand and changes in price.  World oil demand still shows no measurable price response.   I take this to indicate that at the end of the last century, Americans responded to changes in the oil price by using the relatively easy options such as eliminating discretionary trips when oil prices rose, but price was not an important factor for determining world oil consumption.

Oil correlation of price and volume Early.png
In the later period, the US demand no longer shows a short-term response to rises in the oil price, perhaps because the easy reductions in oil use have already been made, but we now see a relatively strong response to higher oil prices (with a -90% correlation) over a period of four years for both US and world oil demand.  This probably corresponds to such changes as purchasing more efficient vehicles, and minimizing commutes by moving closer to work or working more from home.

Oil correlation of price and volume Late.png

World oil demand's very significant response to changes in the oil price implies that demand is now playing a much bigger role in the adjustments the oil market makes to changes in price than it has in the past. 

Because oil supply has become less elastic and less responsive to changes in price, oil prices have become much more volatile in order to force market adjustments. 

The chart below shows that while the magnitude (either up or down) of annual changes in supply and consumption have been in the 3% to 7% range for the last quarter of a century, the magnitude of oil price changes has been rising relentlessly.  In the 1990s, oil prices usually changed by an average of 25% or less per year, while they now typically change by three or four times that amount in any given year.

Average Magnitude of Changes.png

If the price elasticity of the oil market had not been falling over time, the increasing magnitude of changes in oil prices would have produced a similar increase in the magnitude changes in oil supply and demand.

As the Market For Oil Becomes Less Flexible, We Should Make the Market for Transportation Services More Flexible to Compensate

If what we care about are the effects on the economy, it does not matter how much oil is in the ground.  Over the last ten years, we have see a structural change in the oil market which will continue to have far-reaching effects on the economy even if we manage to increase the amount of oil produced. 

Before 2000, oil supply did the heavy lifting when it came to balancing supply and demand in the oil market.  That is no longer the case, and the oil price signal has grown significantly stronger in order to elicit a response in demand.

With 2% of the world's oil reserves, changes in the US supply of oil will remain insignificant in the world oil supply demand picture, developments in the Bakken shale and cheer leading from political leaders notwithstanding.  On the other hand, as the consumer of a quarter of the world's oil supply, we can have a significant effect on the world oil market by making sure that our economy can adjust quickly and easily to changes in the oil price.

What measures can we take to increase the elasticity of oil demand, and reduce the pain of demand destruction?  Measures which increase our citizen's options for reducing oil use. 

  • Increased investment in alternative modes of transport, such as mass transit (both buses and rail), bike lanes, bike and car sharing, and walking improvements to allow many more workers the option of getting to their jobs without the use of a personal car.
  • Improvements in our nation's rail system to allow more freight to be shifted from truck to rail.
  • Increasing gas taxes slowly and predictably over time to both fund the above improvements, and to signal to consumers that they need to prepare for long term higher prices by purchasing more efficient vehicles and changing where they live so that they have the ability to reduce their driving.
  • The use of road congestion pricing, pay as you drive insurance, and other price signals that give people the right market signals and enhance the most efficient use of our nation's roadways.
  • Encouraging the electrification of transport (including the alternative transport options mentioned above) to provide transport options which are not dependent on oil.

In short, we need to make the market for transportation services more efficient by encouraging new entrants (mass transit, bikes, trains) and competition with the incumbent car/internal combustion engine infrastructure.  Competition within the car infrastructure should also be encouraged by sending price signals such as the slowly and predictably increasing gas tax mentioned above to better reflect the dangers to our economy posed by the new oil market regime.

Thanks to Jim Hansen of Ravenna Capital Management for his help.  This article was first published on

May 24, 2011

The Clean Fossil Fuel? Natural Gas Under Fire

By Christopher Mims

According to some of the most complete calculations available, when we use natural gas to generate electricity in an average power plant, it results in 40 percent less warming than if we generate the same electricity with coal. If we fully utilized the natural gas-fired power plants that already exist in this country, we could significantly reduce the amount of coal we’re burning practically overnight. What’s more, primarily because of access to new natural gas reserves, proved reserves of natural gas recently shot up to 284 trillion cubic feet – more than we’ve had on hand at any time since 1971.

It’s for these reasons, among others, that many experts and policymakers have proposed switching to natural gas as a “bridge fuel” to immediately reduce greenhouse gas emissions while we undertake the much larger and long-term project of ramping up the percentage of our energy generated from renewables, which is currently about 7 percent. (Most of the that renewable energy is hydroelectric and biomass, to boot.)

Still, there’s another side to the story: recent research on the lifecycle of natural gas, from the moment we remove it from the ground to the moment it’s burned, has challenged assumptions about its climate-friendliness. At base, economic and policy assumptions about whether we can use natural gas to reduce emissions in the short-term depend on what we know about the effects of its extraction and use on the atmosphere.

A controversial paper

Methane, the primary constituent of natural gas, is up to 100 times more powerful a greenhouse gas than carbon dioxide over a 20 year time horizon (though other studies have found it is 72 times more powerful). As many climate scientists have pointed out, it’s precisely these near-term warming effects that we want to avoid if we wish to avoid pushing the climate toward disaster.

Robert Howarth

Robert Howarth: The Cornell professor's paper shook the natural gas establishment.

This discussion was heightened last month when Robert Howarth, a professor of ecology and environmental biology at Cornell University, published a controversial paper arguing that natural gas from fracking has a greater net warming effect on the climate than burning coal.

Howarth and his co-authors argue that one of the main problems with methane is that, as a gas, it tends to leak into the atmosphere both when it’s drilled and when it’s transported. Hydraulic fracturing, or fracking, is the process by which wells are drilled into shale rock, then water and a mix of chemicals are injected at high pressure, to crack or “frack” the deposit, allowing natural gas to escape.

“If you look at the inventory of emissions of human-controlled methane from the U.S., 25-50 percent of it is from [the use of] natural gas,” says Howarth.

Capturing “fugitive” gas

Industry has a monetary incentive to eliminate these losses, at least during the drilling and initial distribution stages, but thus far it has been slow to do so. Granted, there are barriers to eliminating leaks. For example, when a new well is being drilled, gas storage infrastructure must also be built in advance in order to capture the gas that leaks during the drilling phase. The EPA has studied Reduced Emission Completions technologies, and concluded that on the average well, these technologies mean a higher up-front investment, but they pay for themselves after 3-5 months by capturing gas that would otherwise be lost. Still, at present they are rarely built.

Howarth came to the conclusion that when we use frack-produced natural gas to generate electricity, the net effect on the climate is worse than coal when looked at from the perspective of the next 20 years. (When looked at over the course of the next 100 years, natural gas comes out ahead of coal, because methane is removed from the atmosphere more quickly than carbon dioxide.) This distinction is crucial: as conventional natural gas wells in the U.S. decline as a proportion of our gas production, more and more of our gas will come from fracked wells.

Conclusions questioned

Howarth’s conclusions have come under fire from both scientists and industry.

Science is an iterative process, and Howarth himself admits that the data he used to determine the natural gas lost during the drilling process were sparse. Unfortunately, they’re the only data available.

The conclusion of scientists like Bill Chameides, Dean of Duke’s Nicholas School of the Environment, is that we simply don’t yet have enough information to determine the climatic effect of natural gas from fracking. That won’t change until academics and industry obtain better measurements of losses of methane during drilling.

Natural gas key to more renewables

What’s more, because natural gas power plants can be fired up so quickly, they play a unique role in the world’s electricity production system — they are activated when supply, as from renewables, is outstripped by demand.

“I would say that without natural gas, the grid will not be able to manage the variability and intermittency in power output from wind and solar plants,” says Paulina Jaramillo, a professor of engineering at Carnegie Mellon.

As executive director or the RenewElec project, which aims to increase the proportion of intermittent sources of renewable energy in the world grid, Jaramillo specializes in thinking about the transition off fossil fuels. She doesn’t believe we’ll be able to get more solar and wind on the grid without natural gas, precisely because the only alternative — storage mechanisms like batteries and demand-side management — aren’t far enough along.

Howarth believes that in the future, the major drivers of these human emissions of methane will prove to be use of natural gas, especially if we come to rely on it for an ever larger portion of our energy.

The good news is that it seems the effects of methane gas can be limited through action by industry. But the economics of drilling, mediated by the actions of regulators, will determine just how “clean” natural gas ultimately proves to be.

Christopher Mims is a contributor to Good, Technology Review and The Huffington Post, and is a former editor at Scientific American and He tweets @mims.

This article first appeared in the Txchnologist and is reprinted with permission.

April 04, 2011

Some Realism on Shale Gas

shale gas Eamon Keane

shale gas shale gas Shale gas is back in the news recently after Obama hearted the shale gale in his energy speech ("Recent innovations have given us the opportunity to tap large reserves, perhaps a century's worth of the shale under our feet,"), and Daniel Yergin (full disclosure: he wrote The Prize) has a lengthy piece in the WSJ along with an interview in which he says a bunch of stuff.

It turns out that the US and Canada also had a 100 year supply of natural gas in 2001: "Natural gas is also plentiful. An estimated 2,449 trillion cubic feet of reserves in the United States and Canada is enough to meet today's demand for 100 years."

In the interim there was a panic in 2005:

We need to declare a national crisis," Andrew N. Liveris, the chief executive of the  Dow Chemical Company, said in recent testimony before the Senate. Dow, the nation's largest chemical maker, has shut 23 plants in the United States in the last three years in places like Somerset, N.J.; South Charleston, W.Va.; and Elizabethtown, Ky., as it shifted production to Kuwait, Argentina, Malaysia and Germany, where natural gas is cheaper.

"Call it demand destruction," Mr. Liveris said. "Dozens of plants around the country have closed their doors and gone away, and are never coming back."
"There's still a shortage of drilling rigs. We skipped a generation-and-a-half of rigs in the United States."

Now we're back to 100 years of supply, and have returned to the feast stage of the feast-or-famine natural gas cycle. Unless this time is different, then the NG scene will not always be this rosy. This 100 year statistic which was derived from the Potential Gas Committee's (PGC) 2009 report. Nowhere in the PGC's press release was a 100 year figure mentioned, but the intense need for journalists to find a soundbite gave birth to the centennial stat. These articles gave none of the caveats that the PGC's director gave in the release:

"Dr. Curtis cautioned, however, that the current assessment assumes neither a time schedule nor a specific market price for the discovery and production of future gas supply. “Estimates of the Potential Gas Committee are ‘base-line estimates’ in that they attempt to provide a reasonable appraisal of what we consider to be the ‘technically recoverable’ gas resource potential of the United States,” he explained."

I thought I had clarified the situation in an article a year ago, although apparently not, and a frequent rejoinder to any talk about renewables or [insert x] remains to point to the "abundant" shale. More discerning types will know that when it comes to energy, it is the flow that is much more important than the stock. To that end, it will be noted that the flow of the other NG components is decreasing, and hence if shale lives up to expectations, the outcome will merely be a very gradual increase in total gas production.

aeo 2011 natural gas supply

There's a reasonably large if. The chief critic is Art Berman, much maligned for his skepticism. The main disputed variable is the decline rate of wells, which is dictated by the "b-exponent". It has a major influence on the economics of shale as shown by a slide from one of Art's recent presentations:

art berman graph

If the levelised cost of shale is closer to $8/MMBtu, this will have a large bearing on the competitiveness of renewable generation, since the natural gas price accounts for approximately 75% of the levelised cost of nat gas fired generation. As the recently released World Economic Forum's Green Investing 2011 shows, onshore wind in some cases is competitive with nat gas, and a significant increase in gas costs would mean that many more locations would be:


The Green Investing report introduces an interesting new term "Policy Premium" to indicate "the amount governments overpay for renewable energy generation above the rates required for investors to earn a standard return". This premium is very high in the US relative to other countries, which if reformed and coupled with a higher gas price would be doubly positive for onshore wind.


I'd suggest that there is still energy policy after shale gas, and rather than going full retard about it solving the world's energy problems for the next 100 years, hopefully bets will be hedged.

March 20, 2011

Peak Oil Risk in Muni Bonds

Tom Konrad CFA

Bargain hunters looking for opportunities in muni bonds should be mindful of peak oil.

Meredith Whitney predicts a wave of defaults in municipal (muni) bonds, followed by indiscriminate selling and potential buying opportunities for some.  She's been widely criticized for the prediction of defaults, but I'm a lot more interested in the prediction of the market's reaction. 

With tax-free, AAA-rated munis currently yielding more than comparable taxable Treasury bonds, they seem at least a relative bargain already.  I would not call it outright panic, but I'd expect there are be some bargains to be had.  Yet muni bonds' relative illiquidity and high brokerage commissions make short term trading in munis inappropriate for most investors.  If you are in a high tax bracket, and want long term income, they often make sense when held to maturity.  Yet if you intend to hold a muni bond for five to twenty years, it's all the more important that the interest on offer fully compensate for the risk of default.

Types of Muni Bonds

I spend most of my time analyzing stocks, so I'm not going to claim I can find those muni bond bargains that are probably out there, but I'm pretty confident I know a couple places not to look. 

If you want to understand the risks of a muni bond, you need to know what revenues back up the bond you're interested in.  If those revenues are safe, then so is the bond.  General Obligation (GO) bonds are backed by tax rolls, which may be able to be raised if a municipality gets into trouble... provided the citizens would not rather have their municipality default and take the consequences.  Revenue bonds, on the other hand, are backed by the revenue of the project they were issued to finance (The Obligator.)  Obligators can be water and waste water utilities, toll roads and bridges, hospitals, airports, transit authorities, or universities:  The obligator can be any enterprise that a municipal borrower undertakes that has its own identifiable revenues.

Risks to Obligator Revenues

There are any number of risks to these revenues.  For instance, CERES recently released a report (PDF) highlighting the risks of diminishing water supplies to muni bonds, discussed in this recent Renewable Energy World podcast.  It's not only water utilities that face risks of diminishing water supplies, but even GO bonds could be affected if there is not enough water in the future to support a population large and vibrant enough to repay the bonds.

Climate risks may also play a role.  In addition to water scarcity exacerbated by climate change, increasingly powerful hurricanes do not improve the credit worthiness of cities in the hurricane belt.  Rising seal levels will also add costs for flood protection in coastal cities, and larger floods will do the same for cities on major rivers.  That could affect GO bonds, or the bonds of city water and sewer systems.

Probably the largest near-term resource risk for muni bonds is peak oil.  Rising oil prices will do most of their damage to car-dependent communities, and so exurban and rural GO munis may be much riskier than they appear.  Diminishing car traffic could easily undermine the economics of toll roads and bridges at the same time as it increases maintenance costs by increasing the cost of asphalt.  Municipal parking garages also seem risky.

Airports are also at risk, particularly small ones.  A recent New York Times article looked at how small airports are increasingly feeling the pinch as higher fuel costs drive up airfares at small airports (which are served by smaller planes using more fuel per passenger) faster than at large ones, and travelers increasingly choose to drive to larger hubs for fares.  As regional airports close, larger airports may gain somewhat, but will it be enough to offset overall air traffic declines?  And as smaller regional airports close, will that begin to undermine the appeal of air travel altogether, leading many people to take fewer trips or travel by bus or train?

Winners as Well as Losers?

Some munis might be helped.  As noted above, large airports might gain revenue at the expense of small ones, although that seems a risky bet if peak oil leads to a long term overall decline in air travel.

Transit authority muni bonds seem more attractive. Transit powered by electricity, such as subways, much rail transit, and trolley buses have the added advantage of fuel costs that are largely uncorrelated to the price of oil.  If such transit authorities benefit from increased ridership as commuters look for alternatives to increasingly expensive cars, their bonds should be much safer than many investors expect.  I've long been an advocate of investing in mass transit stocks as a hedge against peak oil.  Muni investors have an advantage over stock investors: they can get exposure to transit authority revenues through municipal bonds.


The muni bond market is large and varied, and there are many other factors to consider in addition to resource constraints.   With many investors already selling, there are probably bargains to be had.  Yet today's municipal bargains may still become tomorrow's screaming deals, especially with more downgrades coming.   I think there's more room for the indiscriminate selling Whitney talks about.  When I see that, I'll be looking for munis backed by municipal transit authorities of large cities outside the hurricane belt. 


DISCLAIMER: The information and trades provided here are for informational purposes only and are not a solicitation to buy or sell any of these securities. Investing involves substantial risk and you should evaluate your own risk levels before you make any investment. Past results are not an indication of future performance. Please take the time to read the full disclaimer here.

March 11, 2011

Shale Gas: If this is such a good deal why are you selling it to me?

Jim Hansen

That is the question many buyers of shale gas assets should have been asking themselves over the last few months. This week’s news that shale gas high roller Range Resource was selling its Barnett shale properties reinforced our view that there is major trouble brewing in the shale gas business. Upstreamonline reported that “…Range Resources Corporation said it will sell almost all of its Barnett shale properties to a private company for $900 million…”

Then of course there is the number one shale gas play cheerleader of them all, Chesapeake Energy. Just last week they announced the sale of gas properties in the Fayetteville shale to BHP Billiton. BHP Billiton is sitting on a pile of cash after its failed attempt to takeover Potash Corp. of Saskatchewan last year so they just couldn’t resist the siren call of shale gas’s either. In Chesapeake’s case they managed to get BHP Billiton to hand over $4.72 billion in cash.

shale Gas Plays

For Chesapeake the BHP Billiton deal follows on the heels of other deals done over the last year to either sell property or joint venture the risk to someone else. The reason given for the Chesapeake sales was to focus on the higher margin oil business. They didn’t mention that it might also be a move to get out of debt laden land speculation based on a questionable shale gas model.

Here is an example of Chesapeake’s confidence in shale gas; “CHK will fund shift to liquids-rich plays by decreasing gas drilling…” (Chesapeake investor presentation, Feb. 2011) Remember to look at how companies spend their money and not at what is cranked out from the public relations office. An example is this industry sponsored web page expounding on how compressed natural gas (CNG) would give the U.S. “Freedom from Foreign Oil”. If that is true why is Chesapeake shifting to liquids?

So if shale gas was going to make the U.S. energy independent why would companies like Chesapeake and Range Resources be making these moves? Is it possible the game was never about the gas to start with…?

Most important though is that there will be opportunities in natural gas; just not until more money is drilled away.

There are still other troubles ahead for shale gas production.

The New York Times: “Over the past nine months, The Times reviewed more than 30,000 pages of documents obtained through open records requests of state and federal agencies and by visiting various regional offices that oversee drilling in Pennsylvania. Some of the documents were leaked by state or federal officials. Here, the most significant documents are made available with annotations from The Times.”    The NYT has an animation of hydraulic fracturing that helps understand the process available here.

Is this a game changer for shale gas? Maybe not but then maybe shale gas isn’t the game changer it is hyped as either.

Jim Hansen is an investment advisor at Ravenna Capital Management based in Seattle, Washington. He has spoken at the ASPO-USA national conference as well given other public and academic presentations. His weekly report The Master Resource Report is available online.

DISCLOSURE: Clients and Advisors of Ravenna Capital Management do not currently hold positions in CHK or RRC

October 03, 2010

The Four Best Peak Oil Investments

Tom Konrad CFA

The best four stocks I've found in my six month quest to find the best peak oil investments.

I apologize for being a tease. 

Since March, I've been writing this series I've called "The Best Peak Oil Investments," but in many cases what I've actually done is to warn readers to stay away from particular sectors.  This bait-and-switch was compounded for my syndicated readers at Seeking Alpha when their editors decided to re-title the early articles in this series "Peak Oil Investments I'm Putting My Money On." 

If you've stuck with the series for the last seven months and twenty-five articles despite the sometimes misleading titles, I'm going to (finally) try to make it up to you.  After mentioning over fifty stocks in the course of this series, and dismissing entire sectors, I'll narrow my stock picks down to the four I like best at current prices.

My Criteria

These stocks are chosen to do well in what I called "The Methadone Economy" in part nine.  If oil prices continue to rise, I expect it to take a toll on economic growth and the availability of funding will probably remain tight.  I'm looking for companies that have solid balance sheets and can fund investment from internal cash flow.  I'll be looking for positive free cash flow, low debt, and high current ratios. 

I'm also looking for companies that typically reduce the use of the personal car, rather than simply making the car more efficient to drive.  More efficient vehicles do reduce fuel use per mile, but because of their lower operating costs may encourage driving, and fail to reduce overall fuel use as much as the efficiency number might lead us to believe.  I also see problems with most alternative fuels, mainly because there are limits to supply, which should lead to the prices of any widely adopted alternative fuel to track the price of oil.

The stocks I do like are Alternative Transportation stocks such as rail and bus companies, bicycle and e-bike companies, and Smart Transportation companies that combine information technology and pricing schemes to reduce waste in the transportation system by making the markets for travel services more efficient.  Unfortunately, I was not able to find any pure-play or nearly pure-play smart transport stocks that meet my financial strength and liquidity criteria.  Portable Navigation Device (PND) maker Garmin (GRMN) has the financial strength I'm looking for, but the increasing competition from GPS-enabled smartphones kept the company out of this list, even though I'm personally an avid user of the company's PNDs.

Top Four Peak Oil Stocks

#1 Advanced Battery Technologies (ABAT) is a Chinese company whose core business in making polymer Lithium-ion batteries.  The company recently bought an e-bike manufacturer which uses ABAT's batteries in its bikes.  I consider batteries in general the best way to invest in vehicle electrification, and ABAT's focus on e-bikes rather than cars also appeals to me.  At the recent stock price of $3.47, ABAT trades at a trailing price earnings multiple of 6.7, has an off-the charts current ratio of over 32.  Free cash flow has been negative over the last year, but turned positive in the last two quarters, and the company has enough cash on the balance sheet to internally fund operations for many years at current rates.  I discuss ABAT in more detail in this article on six electric vehicle and hybrid electric vehicle stocks.

#2 Stagecoach Group (SGC.L) is an operator of rail and bus services in the UK and North America, and it was my favorite of the three mass transit operators I've found because of low debt, relatively strong liquidity, and low price/earnings multiple.

#3 Accell Group (ACCEL.AS) is my top pick among bicycle company stocks.  Accell has a large stable of brands controlling leading positions in many European bike markets and segments.  High gas taxes and dense cities have helped Europe establish a lead in adoption of bikes for commuting and short trips, meaning that Accell has more experience meeting the needs of such riders, who grow in number with oil price rises.  Although I also like the business of bike component manufacturer Shimano (SHMDF.PK), Accell currently trades at a much better valuation.

#4 Vossloh AG (VOS.DE) German commuter and high-speed rail supplier Vossloh trades at an inexpensive price/earnings ratio of 11, with decent growth and dividends that are well covered by income and cash flow.  You can read more about Vossloh in my recent article on mass transit supplier stocks.

Honorable Mentions

In a recent article, I implied I'd pick my five favorite peak oil investments, not four.  When it came to actually picking, I found myself eliminating potential candidates on one criterion or another until I had just four. 

However, I do have two honorable mentions.  The first is the Powershares Progressive Transport Portfolio (PTRP), which I said "The Powershares Progressive Transport Portfolio (PTRP) is a good option for investors looking for a one-stop shop of non-oil related stocks that are better prepared to cope with rising oil prices." One caveat: as some commenters on the original article pointed out, PTRP trades at very low volume, so PTRP is only appropriate for a long term investor and should always be traded using limit orders to minimize price impact.

A second honorable mention is Kandi Technologies (KNDI), which was profiled in a series of guest posts here.  Kandi is a profitable but little known Chinese company making electric mini-cars.  I bought a small position on the speculation that it might become better known, but I did not want to include it in this list because I consider it much riskier than the somewhat similar ABAT, which is already in the list.


For US based investors like myself, it's unfortunate (if not surprising) that only one of these companies is listed on a domestic exchange, and that one is a Chinese company.  To trade the three European companies, North American investors will need to go through the world trading desk of their broker, and this will involve paying much higher transaction costs.  The high transaction costs mean that these stocks should only be purchased as long-term investments to be held for several years.  However, that should not be a problem for peak-oil motivated investors, since we already can only be certain that oil prices will rise over the long term; short term price changes are anyone's guess.

I personally do not yet have a position in any of these stocks because I expect the stock market to continue to decline in the near term.  I'm waiting to make my purchases (of a possibly slightly different set of peak oil stocks) at even more attractive valuations.


Even though I'm not buying these stocks today, I find it useful to look back on my stock picks and see how they have performed over time.  As I write on September 11th, a $10,000, equally weighted portfolio of these four stocks would contain 720 shares of ABAT, 878 shares of SGC.L, 61 shares of ACCEL.AS, and 24 shares of VOS.DE.   Since I've come out saying that investing in oil exploration and production companies is not the best way to invest in peak oil, I plan to test my theory by comparing this portfolio in the future to 183 shares of the Energy Select Sector SPDR (XLE), which is composed of oil E&P companies. 

[Late note: This article was not published until October 3, at which point the portfolio had risen 5.8%, while XLE was up by 4.0% between writing and publication.  While this makes the relative valuation of the companies less attractive, the reasons for choosing them over oil and gas companies are unchanged.  I have not yet bought any of them because I'm still expecting a significant market correction, and am waiting for even more attractive prices.]


These are my top oil related picks, but I have to admit I'm as curious as you are as to how they work out.  Can you do better?  Leave your picks in the comments, and I will track them along with my own when I check back to see how these stocks and XLE are doing.

DISCLAIMER: The information and trades provided here are for informational purposes only and are not a solicitation to buy or sell any of these securities. Investing involves substantial risk and you should evaluate your own risk levels before you make any investment. Past results are not an indication of future performance. Please take the time to read the full disclaimer here.

August 24, 2010

The Best Peak Oil Investments: Why Invest for Peak Oil?

...and Why Not Invest in Oil Companies?

Tom Konrad CFA

The purpose of this series on peak oil investments has been to highlight companies outside the oil sector that are likely to benefit from increasing oil prices.  This article explains why we should expect oil prices to rise.

What is Peak Oil?

There are many definitions for peak oil.  In its most basic form, Peak Oil is the moment of highest production.  World oil supplies are finite, and so we cannot continue to produce oil in increasing quantities forever.  It's a mathematical certainty that at some point the supply (the annual total production) of oil will stop increasing and begin declining.  Theoretically, peak production could be the result of declining oil demand, or it could arise from declining oil supply.  With rising economic activity and car ownership in much of the third world, there is little prospect of declining demand, so nearly all observers focus on supply. 

If demand continues to follow its current rising trend, even stable oil supplies will lead to rising oil prices.  How quickly oil prices rise in response to increasing demand will depend on how responsive oil supply is to changes in the oil price.

Oil Price Volatility

Historically, increases in volatility in the price of oil has been associated with disruption of supply. Consider this price chart from (click for full size image.)  Before 1973, the oil price was remarkably stable.  In 1973, 1979, and 1990, we see sharp jumps in the price of oil caused by the Arab oil embargoes and the first Gulf War.  But in addition to the immediate increase in the price of oil, we also see that each of these price spikes is also associated with more volatility in the price of oil (the graph becomes more jagged.

Histoical inflation-adusted oil price

After 2002, the recent rising trend in the oil price has been accompanied by a further increase in oil price volatility.  Economics says that the price adjusts to bring supply and demand into balance.  We know that demand for oil has been increasing for most of this period, and supply has been increasing to keep up.  This can account for the observed increases in the oil price.  But what accounts for the increasing oil price volatility?

Is it Speculation?

Many have been quick to point the finger at speculation as the cause of increasing volatility in the oil price.  Multiple studies have looked for but have not found any link between oil speculation and oil price volatility [pdf].

In addition to the lack of evidence that speculation increases price volatility, blaming speculation for increased volatility demonstrates a naivete about how speculators make money.  As anyone who has ever traded anything from baseball cards to exotic derivatives knows that, in order to make money, a speculator needs to buy low and sell high. When speculators buy oil, they are acting to increase demand (the aggregate desire to buy), and so are increasing the oil price.  When speculators sell oil, they are acting to increase supply (the aggregate desire to sell), and so are decreasing the oil price.

In order to increase price volatility, a trader would need to buy when prices are high (raising prices further) and sell when prices are low (causing them to drop further.)  Any speculator who consistently buys high and sells low will also consistently lose money, and will soon stop speculating because of lack of funds. In contrast, a speculator who buys low and sells high will not only make money, but will reduce overall volatility.  Selling when prices are high will moderate price spikes, while buying when prices are low will moderate price falls: both have the effect of reducing price volatility. 

In other words, speculators who increase volatility will soon run out of money and stop speculating, while speculators who reduce volatility will make money and likely continue speculating unless laws are changed to prevent them from doing so.  Attempts to ban or limit oil speculation are likely to have the perverse effect of increasing, rather than reducing future oil price volatility.

The End of Easy Oil

If increased volatility is not the result of speculation, it probably has to do with other changes in the structure of the oil market.

Except for geopolitical events such as the wars and oil embargoes mentioned above, the supply of oil tends not to be volatile.  Demand fluctuates with changes in economic activity, and so the demand for oil will be more volatile when economic activity is more volatile.  Hence, the price volatility associated with the large spike in oil prices leading up to 2008, along with the subsequent rapid decline and recovery may be attributable to changes in oil demand.  However, the years from 2002 to 2007 were characterized by remarkably steady economic growth.  Hernce the high oil price volatility during 2002-07 must indicate that the ability of the oil supply to respond to changing demand had decreased compared to earlier periods.

I conclude that the most likely source for increased oil price volatility is a reduction in the ability of oil supply to adjust to changes in price.  This agrees with another formulation of the Peak Oil thesis:  Peak Oil is not the end of oil, but the end of "easy" oil.  We still have an oil supply, and it may or may not be declining, but extracting enough oil to meet demand is becoming increasingly difficult and expensive.  We pay the increased cost of extracting the more difficult oil reserves in higher and more volatile prices at the pump, and in environmental disasters such as the blow-out of BP's Macando well.

Implications of the End of Easy Oil

As world oil demand continues to rise, and extracting oil becomes increasingly expensive and more dangerous, several trends are likely to continue.
  1. Oil prices will rise in order to compensate oil companies for the increased costs and risks of finding oil.
  2. Oil companies will become less able to quickly adjust supplies to changes in the oil price, further increasing price volatility.
  3. Increased drilling risks will cause more frequent oil spills.  Increased political risks as oil firms increasingly search for oil in places controlled by less stable political regimes will lead to more frequent expropriation of oil firms' assets by those same unsavory regimes, as we have seen in Venezuela.
  4. Increased oil prices will lead to adjustments in our oil use that decrease demand.
Why not Just Invest in Oil Companies?

The increased geological and political risks of oil exploration and production are why investing in oil companies is probably not the best way to benefit from increases in the oil price.  BP's price decline in the wake of the Deepwater Horizon disaster is a graphic reminder of the risks of investing in oil companies in the hope of profiting from rising oil prices.

BP Stock Price Chart after Deepwater Horizon disaster

Investing In Reducing Oil Demand

Not wanting to take on the increased risks inherent in oil companies, I have focused this series on the companies and technologies that help reduce demand for oil.  These include substitutes for oil, such as Biofuels, Hydrogen, Electricity, Natural Gas, Synthetic Fuels, and Algae.  I also probed the barriers that limit adoption of alternative fuels, and the constraints that limit alternative fuel deployment and profitability, which I brought together in a comparison of the short and long-term viability of all these alternative fuels.

Shifting gears a little, I took a look at what reducing oil demand will mean for the economy going forward, and concluded that technologies and strategies for reducing oil use in transportation have better prospects than most options for replacing oil.  I looked at increasing vehicle efficiency, and ways to use IT to reduce congestion and driving, including GPS navigation, and Mass Transit stocks.  Delving into AltEnergyStocks' Peak Oil Stock lists, I brought you Ten EV and HEV stocks, and then Six More HEV and EV stocks from reader suggestions.  I also looked at four bicycle and moped stocks, as well as four individual stocks that caught my attention along the way: CVTech Goup, Telvent GIT SA, Shimano, and Great Lakes Dredge and Dock.

Coming Up

This is the twenty-second article in a series that has expanded to a breadth and depth that I never anticipated when I began it in March.  (You can find a complete index here.)  I have a few more individual stocks to write about, after which I plan to cap the series with a short list of companies best positioned to profit from a long-term rise in the price of oil.  I've learned a lot in the writing of this series, and my picks today are not the same as they would have been when I started, and that is in large part due to your comments and suggestions along the way.  I hope you all have learned at least as much as I have.


DISCLAIMER: The information and trades provided here are for informational purposes only and are not a solicitation to buy or sell any of these securities. Investing involves substantial risk and you should evaluate your own risk levels before you make any investment. Past results are not an indication of future performance. Please take the time to read the full disclaimer here.

June 10, 2010

What Will the Oil Spill Do For Oil Sands Stocks?

Bill Paul

Will shares of the oil companies that are major players in Canada’s tar sands region rise or fall?

Logically, shares should rise in the wake of the deepwater drilling moratorium ordered by President Obama following the BP (BP) oil spill, as Wall Street begins to reflect on the fact that Alberta’s tar sands region is the second biggest crude-oil deposit in the world. Even before the spill, a report from IHS CERA had concluded that Canadian tar sands would be the single biggest source of US crude imports in 2010.

Just as logically, however, shares should fall, given that the environmental disaster in the Gulf likely will focus increased political and media attention on the extensive environmental damage caused by tar-sands extraction. It would seem to be just a matter of time before some reporter asks Canadian officials how they feel about the US basically outsourcing the environmental destruction caused by the US’s insatiable thirst for oil.

One Canadian newspaper – the Prince Albert Daily Herald – has already reported that the CEO of oil-sands firm Cenovus Energy (CVE) doesn’t think such a catastrophe could occur in the tar sands region, a conclusion environmentalists no doubt will disagree with.

That BP is as big in Canadian tar sands extraction as it is in Gulf of Mexico oil drilling only adds to the likelihood of an attention-grabbing front-page story in, say, the New York Times.

In addition to Cenovus, several companies’ shares stand to be impacted, among them: EnCana (ECA), Canadian Natural Resources (CNQ), Suncor (SU) and Royal Dutch Shell (RDS.A).

Disclosure: No positions

Disclaimer: This is a news article.  Please read terms and policy.

Bill Paul is Managing Editor of

May 21, 2010

The Best Peak Oil Investments: Peak Oil Stock Lists

Tom Konrad CFA

Four new stock lists for different approaches to profit from peak oil.
As I've researched and written this series on ways to invest in companies that will profit from peak oil, I've been greatly expanding the number of stocks in our old "Clean Transportation" stock list, at the same time I've been doing a lot of thinking about how these companies will fare.  Because of this, I've decided to split Clean Transportation into four groups of similar companies, depending on how they are working to reduce our dependence on oil.

The new stock categories are:

In addition to these four new categories, we have several other stock lists that are relevant to peak oil, many of which have been expanded as I researched this ongoing series.

If you know of exchange-listed companies that aren't on these lists, but should be, please let me know in the comments.  It's a constant endeavor to keep these lists up to date. 

An index to the "Best Peak Oil Investments" series is available here.

DISCLOSURE: No positions.
DISCLAIMER: The information and trades provided here are for informational purposes only and are not a solicitation to buy or sell any of these securities. Investing involves substantial risk and you should evaluate your own risk levels before you make any investment. Past results are not an indication of future performance. Please take the time to read the full disclaimer here.

May 18, 2010

EIA Annual Energy Outlook 2010: Peak what?

Peak What? Eamon Keane

The Energy Information Administration (EIA) released its Annual Energy Outlook 2010 (AEO 2010) last week, with projections out to 2035. It makes for interesting reading. Most notable was its take on peak oil, natural gas vehicles and on converting natural gas to liquids (GTL).

An otherwise reasonable report was marred by the presumption of oil plenty. Figure 1 shows a graph presented (.pdf) by Glen Sweetnam, director of the EIA's International, Economic and Greenhouse Gas division, in April 2009. Although it mentions the source as being the AEO 2009, this data does not appear in the AEO 2009. It presumably is data from the modeling system which isn't publicly released.

Glen Sweetnam Oil Supply

The large gap of some 52 million barrels per day (mb/d) is quite stark. Fortunately we can all breath a sigh of relief, because the AEO 2010 has found this phantom oil, and then some. Figure 2 shows data from Table C6 (page 180) for the sources of oil supply the EIA forsees in its reference scenario. I added in the yellow line to illustrate oil that will have to be brought online.

AEO 2010 Oil Supply

I used the reference scenario showing 2035 oil supply of 112mb/d to save you spitting your coffee at the low oil price scenario. The low oil price scenario has 2035 oil at $50/bbl and supply at 127mb/d. Seriously. The reference scenario assumes an average price of about $120/bbl and the high oil price scenario has average oil at about $180/bbl, with 2035 supply at 91mb/d.

These numbers are artifacts of the National Energy Modeling System (NEMS) used by the EIA. It has cost curves for all the oil producers in the world, and the three oil scenarios make different assumptions about 'economic access' to these oil supplies. For instance the low oil price scenario assumes that "greater competition and international cooperation will guide the development of political and fiscal regimes in both consuming and producing nations, facilitating coordination and cooperation among them". Whatever that means. The EIA also accept the fantastic notion that OPEC has 940Gb of reserves, and that the world has 1,340Gb. You will notice that the area under the total conventional crude curve is some 900Gb, with no peak in sight. This is either geological illiteracy or assumes we'll suddenly find a few Ghawars under the couch.

The AEO goes on to spend several pages discussing the Pickens Plan. Overall, their analysis is quite cool to the potential for Heavy Duty Natural Gas Vehicles (HDNGVs). They say:

"The Department of Transportation’s Vehicle Inventory and Use Survey (VIUS), last completed in 2002, suggests a wide range for the intensity of heavy truck use. Notably, in the 2002 VIUS, trucks reporting a primary range of operation that extended more than 500 miles from their base averaged 91,000 vehicle-miles traveled (VMT), or more than 5 times the average of 17,000 VMT for trucks reporting a primary range of operation range within 100 miles of their base.

Although long-distance trucking offers a potentially faster payback of the incremental capital costs for HDNGVs, their penetration and acceptance in the long-distance freight market faces two significant barriers: limited driving range without refueling and a lack of available fueling infrastructure. A diesel truck with one 150-gallon diesel tank and a fuel economy of 6 to 7 mpg can drive approximately 1,000 miles without refueling, which can be extended readily with an auxiliary fuel tank. In contrast, a CNG-fueled truck with a frame-rail-mounted storage tank can drive only about 150 miles without refueling, while one with a back-of-cab frame-mounted storage tank can drive about 400 miles without refueling, similar to an LNG-fueled truck with frame-rail-mounted tanks. In addition, regardless of fuel type, long-distance trucks are less likely to be fueled at central bases, which makes them more dependent on fueling infrastructure that is open to the public.

In addition to concerns about driving range and refueling, the residual value of HDNGVs in the secondary market is likely to be an important consideration for buyers. Also, purchase decisions can be influenced by other factors, such as weight limits on highways and bridges, which can make the considerable additional weight of CNG or LNG tanks a significant drawback in some market segments."

Even assuming that long haul trucks adopt natgas, and assuming that incremental HDNGV purchase costs over diesel costs are neutralized with tax credits and $100k subsidy per new NGV station (Pickens Plan), they arrive at about a 40% freight market share in 2035, with approximately 0.67mb/d of oil being abated. That's about 4% of current annual US oil consumption. Figure 3 shows the cost of tax credits versus the cost of fuel saved. By the AEO's estimates, the tax subsidy is larger than the reduction in fuel costs. This does not account for the benefit in balance of payments or energy security, however. Figure 3 assumes 0.67mb/d is achieved and with subsidies until 2027, per Pickens Plan.

Pickens Plan Costs

The AEO also discusses the potential for converting natural gas to liquids. They produced break even curves based on high and low estimates for GTL plants. Figure 4 shows an adapted version of Figure 28 (page 49). Below the line is the feasible region. The AEO assumptions are a 10% hurdle rate and a 10 year operating period.

GTL Break Even

This is interesting, and based on your projections of future oil prices, you can see what natural gas price is tolerable. For instance at $150/bbl, if GTL plants turn out to be very expensive (only a couple are in operation so costs aren't really known), only $2/MMBtu would be tolerable. On the other hand at the low end of the range $11/MMbtu would still allow for a 10% return. It should be noted that 43% of the energy in natural gas is lost in the conversion process, not the best idea in an energy constrained world.

Regarding Coal to Liquids (CTL), the EIA says "although advances in coal liquefaction technology have made it commercially available in other countries, including South Africa, China, and Germany, the technical and financial risks of building what would be essentially a first-of-a-kind facility in the United States have discouraged significant investment thus far. In addition, the possibility of new legislation aimed at reducing U.S. GHG emissions creates further uncertainty for future investment in CTL." CTL involves a loss of 55% of the energy in coal (page 137 of the AEO's assumptions document).

The EIA gives a big shout out to shale gas also. In the High Shale Gas scenario, the EIA sees shale output increasing to 8 tcf by 2025 and 10tcf by 2035. This assumes a Henry Hub price of about $7/MMbtu, although the full-cycle profitability of shale gas at such levels is disputed. In all the EIA's natural gas scenarios, natural gas production never goes above 27tcf, which is 3tcf higher than 2008's 24tcf.

The AEO 2010 is a very useful document but its highly improbable forecast of oil supply means if you're looking for peak oil leadership from the EIA, you'll have to dream on.

Eamon Keane is an Energy Systems Engineering masters student at University College Dublin with an interest in electric cars, rare earth metals and energy.  He is looking for a job in the energy sector anytime after August 2010.

May 08, 2010

The Best Peak Oil Investments: Index

Tom Konrad CFA

Subject / Description
Stocks mentioned
Biofuels Overview
Hydrogen Vehicles and Vehicle Electrification
Natural Gas Vehicles WPRT, CLNE,
and one I missed: FSYS
Synthetic fuels: Gas-to-Liquids, Coal-to-Liquids, and Biomass-to-Liquids SSL, SYNM, RTK
Biofuel from Algae GSPI.PK, OOIL.OB,
Barriers to Alternative Fuels

Constraints on Alternative Fuels
Alternative Fuels Compared

What Peak Oil Means for the Economy and Stock Market: The Methadone Economy

Vehicle Efficiency
CVTech Goup
Peak Oil Stock Lists

Smart Transportation: Using IT to reduce congestion
GPS Navigation stocks
Telvent GIT SA: Smart Transport Meets Smart Grid
Great Lakes Dredge and Dock: Alternative Transport and Oil Spill Cleanup
Nine Mass Transit Stocks
Ten EV and HEV Stocks
Six More EV and HEV Stocks
Bicycle and Moped Stocks
Shimano: Bicycle Components
Why Invest For Peak Oil?

PTRP - The Powershares Global Progressive Transport Portfolio PTRP
Three Mass Transit Operators
Four Mass Transit Suppliers
Guest Post Kandi Technologies: A Profitable EV and Battery-Swap Stock KNDI
The Four Best Peak Oil Investments
A. P. Moeller-Maersk
Time to Buy One of the Best Peak Oil Investments

If you are one of the readers who have been asking for a single link to the articles in my popular "Best Peak Oil Investments" series, link to this post.

DISCLOSURE: Long NFYIF, WM, CVT.TO, GLDD, ACCEL.AS (as of 11/28/11).

DISCLAIMER: The information and trades provided here are for informational purposes only and are not a solicitation to buy or sell any of these securities. Investing involves substantial risk and you should evaluate your own risk levels before you make any investment. Past results are not an indication of future performance. Please take the time to read the full disclaimer here.

April 27, 2010

The Best Peak Oil Investments, Part IX: The Methadone Economy

Tom Konrad CFA

No alternative fuel or combination of alternative fuels will allow our transportation system to operate the way it does today on oil.  As oil becomes increasingly scarce and expensive, the way we get our transportation needs met will have to change.  Understanding what the future of transportation may look like is key to making good investments in transportation.

If the measure of success for alternative fuels is the ability to continue to live in suburbs and commute in multi-ton boxes of metal on congested freeways for hours each day, then alternative fuels will fail.  No alternative fuel has the existing infrastructure, supply potential, energy density, and low environmental impact that we would need to replace oil without changing our unsustainable lifestyle.

Peak oil may mean the end of bigger and bigger cars driven farther and farther on more and more congested roads.  Peak oil may mean the end of suburban life as we know it.  Yet life as we don't know it does need not be a vision out of Mad Max.  Peak oil will mean changes, some for the better, some for the worse. 

The surest change peak oil will bring is less driving, in fewer vehicles that are filled closer to capacity.  Those vehicles will use less oil (or alternative fuels) per person-mile.  We'll also find ways to satisfy the desires and needs that we currently satisfy with travel without traveling.

Alternative Fuels

The first eight parts of this series looked into alternative fuels.  I concluded that no alternative fuel listed could replace oil as we use it today fast enough to replace dwindling oil suppliesConventional biofuels cannot be produced in enough quantity, and making hydrogen is an inefficient use of electricity or natural gas.  Electric vehicles are too expensive or have too little range.  There is not enough natural gas and there is too little fueling infrastructure to make natural gas vehicles practical on a large scale.  Gas-to-liquids makes sense for stranded natural gas, but there are too many other high value uses for natural gas to make a large dent in declining oil supplies.  Coal to liquids does too much environmental harm, and algae needs too much more technological development to achieve its promise in time.

The biggest problem with alternative fueled vehicles, however, is not the alternative fuels, the problem is the vehicles and how we use them. 

Oil was a one-time bonanza of a readily available, easily transportable, durable, energy-dense liquid.  With oil, humanity won a natural resources lottery ticket.  Like a lottery winner who blows cash that could have lasted a lifetime in a few months, we now need to realize that we've spent most of our winnings.  It's unreasonable to expect that we're going to win another such jackpot before we have to start watching our fuel budget again.  The main question is how soon and how deliberately we will make the necessary adjustment.  Will we act like the lottery winner who uses his last hundred thousand to tide him over while he looks for a job?  Will we keep partying to the bitter end, until one day we wake up, hung over in the gutter?  Will it be something in between?

The Methadone Economy

Switching to a drug analogy, most alternative fuels are the methadone to treat our petroleum/heroin addiction.  Methadone is given to heroin addicts in treatment because it mitigates withdrawal symptoms and can block the euphoric effects of heroin, morphine, and similar drugs, reducing the urge to use.

Alternative fuels can be sufficient to allow our society to function, but we're not going to feel the highs we felt when the oil was flowing freely.  Alternative fuels cannot take us back to a "normal" pre-peak oil state because our use of petroleum over the last few decades as been far from "normal:" it has been one long, fossil-fueled high.  We will eventually kick the petroleum habit with the help of alternative fuels not because alternative fuels are better than petroleum and can bring us something that petroleum cannot, but because our supplier will be getting smaller shipments over time, while the number of fellow junkies knocking on his door will keep going up with big increases in petroleum demand from emerging economies.

There are several competing visions of a future powered by alternative fuels, ranging from wildly optimistic to gloom-and-doom, with variations depending on how effectively the prognosticator thinks we can replace fossil fuels with alternatives. 

A high-technology optimistic vision includes smoothly running efficient pods in mass transit systems powered by renewable energy.  High speed bullet trains network the land, making overland air travel unnecessary.  The low-technology optimistic vision involves a peaceful return to local economies where food is grown locally, and increasing local interdependence fosters strong local community ties, and people grow happier as they become more connected to the land and each other.  The low-technology pessimistic vision is a free-for-all scramble for dwindling resources like the vision out of Mad Max referenced above.

I'm long on optimism about technology, but short on optimism about our will to make the necessary sacrifices to implement that technology quickly or efficiently.  I'm betting on a pessimistic, high-technology future.  In this future, we manage to cobble together a hodge-podge of last-minute, jerry-rigged solutions to keep the economy functioning at a basic level, but not at all smoothly or evenly. In it, we lurch from a crisis caused by financial melt-down, to a crisis caused by peak-oil to one caused by climate change.  We'll tackle each crisis with incredible ingenuity, staving off total chaos, but at the cost of mis-allocated resources and a deteriorating standard of living.  We hold out in the belief that after just this one more fix, the world will be back to normal and we can stop worrying.  But that day will never come. 

Forward thinking planners in some municipalities and communities will work on implementing true, long-term solutions.  But they will not have enough money or resources to do more than ameliorate the next crisis.  The large-scale, system wide solutions of better mass transit, algae biofuels, and continent-wide electricity transmission of the high-technology optimistic vision will be implemented too slowly, on too small a scale to achieve the economic stability the techno-optimists hope for.  But these half-built systems will still bring considerable benefit, and keep the succession of crises from being the complete disaster that would come with a complete lack of planning.

This is the Methadone Economy.  Alternative-fuel oil replacement therapy is necessary because oil supply will not keep pace with demand; we must replace oil or do without.  But alternative fuels are not oil, and will require more effort devoted to energy production to produce the same effect.  The Methadone economy will function, but it won't give us the highs we got from the cheap, concentrated, easily accessible energy of oil.

A future characterized by thoughtful, long-range planning seems unlikely to arise from the same political class and voting public that has not meaningfully prepared for anything but good times in decades.  The first IPCC report was released in 1990, and it made clear that human activities were substantially increasing levels of greenhouse gasses which would warm the planet.  Two decades later, greenhouse gas emissions are still rising.  We had the first warnings about peak oil in the 1970s oil crises, but only now are we starting to put serious political and economic capital into searching for solutions.  When the pre-2008 global debt bubble was on, NINJA (No Income No Job no Assets) loans were welcomed by politicians praising financial innovation and its ability to bring home ownership to people who could not previously afford it.

The Methadone Economy may sound gloomy, but I see it as the most optimistic vision possible given the political reality we see around us.  More pessimistic visions abound, but if you expect them, you're probably better off investing in guns and physical gold than you are investing in the stock market.


I see three major investment themes in the Methadone Economy.

First, there is the knowledge that long-term solutions will be implemented, although not completely and at insufficient scale.  Investors in contractors who specialize in mass transit and high-speed rail should do well, as should the longer-term alternative fuel solutions discussed in earlier articles of this series.  Vehicle efficiency improvements will find rapidly growing markets as fuel becomes more expensive.

Second, band-aid solutions will thrive.  Bike lanes, electric scooters, buses, and any other transportation solution which can be implemented with only small changes to existing infrastructure.  Road pricing schemes and the software technology to help people coordinate ride sharing.  The clever use of a few resources will always win over grand schemes when there are few resources to spare.

Finally, the Methadone Economy is an economy where we cannot expect long term growth.  More likely, we will see periods of anemic (and occasionally robust) growth punctuated by periodic crisis-driven declines.  This will be mirrored in the stock market, and so investors in the above two solutions should do well to hedge their overall exposure to the market.  My Green Energy Investing for Experts series and Ten Green Energy Gambles for 2010 provide several hedging ideas.

The next few articles in this series will look at more specific investments in the long-term and band-aid solutions to peak oil mentioned above.


DISCLAIMER: The information and trades provided here are for informational purposes only and are not a solicitation to buy or sell any of these securities. Investing involves substantial risk and you should evaluate your own risk levels before you make any investment. Past results are not an indication of future performance. Please take the time to read the full disclaimer here.

April 19, 2010

The Best Peak Oil Investments, Part VIII: Alternative Fuel Report Card

Tom Konrad CFA

There are two types of solution to the liquid fuels scarcity caused by stagnating (and eventually falling) oil supplies combined with growing demand in emerging economies.  The most obvious is to find a substitute to replace oil.  Each potential substitute has barriers to its use which stand in the way of it from becoming a complete substitute for petroleum based fuel.  Understanding those barriers also leads us to the investment opportunities that arise from these substitutes. 

In the last two articles of this series, I looked at barriers to adoption for alternative fuels, and the limits and constraints that will likely prevent most of them from reaching sufficient scale to replace our current oil use. 

The first barrier was the last of existing infrastructure for many fuels: the lack of a fueling infrastructure that would allow drivers to fuel their vehicles when and where they need to at competitive prices, while the lack of a distribution infrastructure can keep the fuel from getting to the regions of the country where it is needed.  The second barrier is energy density: in order to deliver the range that people expect from their vehicles, an alternative fuel and the tank or battery that holds it works best if it is both light and compact.

The constraints were the total available supply (current and long term), alternative uses which might divert that supply to more economic purposes than fuel, and the damage producing and using the fuel does to the climate and environment.

To be a success, an alternative fuel must be able to overcome both barriers, and not have such severe constraints that there is little fuel available.  The barriers put limits on the short term profitability of the technology.  The constraints limit the short-term or long-term size of the market for the fuel, and the economics of the fuel.

Investment Opportunities

The table below summarizes the discussion in parts VI and VII.  I've rated the barriers and constraints for each fuel from A to F, with F being the least favorable to the adoption of the alternative fuel, and A being the most favorable.

Fueling Infrastructure
Distribution Infrastructure
Overall Barriers
Current Supply
Long Term Supply
Alternative Uses
Overall Constraints
H2= hydrogen; NGV = Natural Gas Vehicles; GTL=Gas to Liquids; CTL= Coal to Liquids.

Hydrogen (Barriers D / Constraints C+)
If you agree with my assessments in the previous articles and as laid out in the above chart, it seems clear that hydrogen is a non-starter as an alternative fuel: the barriers are much worse for hydrogen than any of the other alternatives, and while hydrogen does have the long term advantages of potentially unlimited supply with minimal environmental impact, electricity has these same advantages, but has fewer barriers to overcome.

Natural Gas Vehicles (Barriers C / Constraints C-)
Natural Gas Vehicles are questionable as a peak oil mitigation strategy as well.  Natural gas is usually touted as a transitional fuel as we move away from oil and towards renewables.  But with the barriers to vehicle electrification no worse than the barriers to NGVs, a direct transition to electric vehicles seems a better choice. 

Biofuels (B/C+) and Gas to Liquids (A/C-)
  Biofuels and Gas to Liquids will likely have roles to play, but these roles will be limited by supply constraints.  Companies that can solve some of the problems for these two alternatives (such as land and water use for biofuels) may be profitable investments.  Algae is one possible way to overcome the supply constraints and environmental degradation caused by biofuels, but as I discussed in Part V, the publicly traded algae companies and technology is still too early stage to make attractive investments.  Biofuel feedstocks grown in salt water also have good long term potential.

The big questions lie with Vehicle Electrification and Coal to Liquids (CTL). 

Coal to Liquids (A/D+)
CTL would have a lot of potential as a short-term peak oil mitigation strategy if either 1) we choose to ignore the associated climate impact, or 2) we find and develop an economical way to sequester the associated carbon emissions.  I personally don't think that carbon sequestration is likely to be economical except in special (and small scale) situations such as enhanced oil recovery, but if a company manages to crack this nut, it is likely to be an excellent investment opportunity.

Likewise, so long as the true costs of greenhouse gas emissions are not paid by the polluters, high oil prices may make coal to liquids plants quite profitable in the short term given the ease with which synthetic diesel can be used in the current distribution and retail infrastructure.  However, such plants would be subject to potentially bankrupting regulatory risks because of the real chance that regulators may decide to price these externalities at a later date.  These risks mean that many lenders will be unlikely to finance Coal to Liquids plants.  We have seen a similar trend with many banks deciding not to finance new coal-fired electricity generation because of regulatory risk.  This trend is not all one-way, however, as some lenders (like the World Bank) are less subject to market forces, and may continue to fund environmentally harmful projects if they feel such projects are in line with other goals, such as development.

Vehicle Electrification (C/B+)

Where the prospects for Coal to Liquids are all short-term, the prospects for vehicle electrification are all long-term.  Energy density and the cost of batteries present serious near-term barriers to vehicle electrification.  In contrast, the long term prospects for vehicle electrification are much brighter than for any other alternative fuel.  The potential to deliver clean renewable electricity from wind and solar is sufficient to power all the worlds current electricity and transportation needs hundreds of times over.  Electric vehicles have the added advantage that they can smooth the natural variability of these most abundant renewable electricity sources by charging when the wind blows and the sun shines.

But the prospects for vehicle electrification come with a huge caveat: Plug-in Hybrid Electric Vehicles (PHEVs) and pure Electric Vehicles (EVs) are far from cost-effective ways to displace oil because of the huge cost, weight, and volume requirements of batteries.  Batteries are getting better, and many governments are pouring in the funding dollars, but for now only the mild vehicle electrification available with conventional hybrids uses batteries cost-effectively enough to make economic sense, even with a doubling or tripling of gas prices.  PHEVs and EVs can make sense as niche vehicles where performance (sports cars), silence (golf carts), or environmental sensitivity is at a premium.  They may also make sense for some fleet vehicles that follow predictable routes and can benefit from multiple battery swaps or charging sessions per day (mass transit, postal vehicles) but the cost-benefit analysis of such applications will be very sensitive to the application.  Smaller vehicles such as electric bikes and scooters also have great potential because their lower power and range requirements are easier to meet with current commercial battery technology.

Even these more limited applications for vehicle electrification are large compared to the current battery market.  As I wrote in part II, battery companies, especially those making progress with chemistries not currently the subject of intense investor interest, are compelling investment prospects.

Conclusion: The Best Peak Oil Investments

There is no perfect substitute for fossil fuels.  In the end, we are going to have to find ways to address the reality of peak oil that go farther than simply replacing one fuel with another: we are going to have to reduce our usage.  Fortunately, a number of strategies for reducing fuel use exist.  Not only is there considerable potential to increase vehicle efficiency, but there are also many ways to encourage conservation which can have net economic benefits for society.  For investors, these strategies also hold promise, although it is not always obvious how companies can turn a profit from helping consumers consume less.  

The "Best Peak Oil Investments" are not be the substitutes I have been talking about so far.  The best peak oil investments are the technologies that allow us to use less oil and still get our transportation needs met.  Future articles in this series on peak oil investment strategies will attempt to tease out the investment opportunities that arise from reducing our use of oil, not just finding substitutes for it.

Here are links to the previous articles in this series:
  1. Biofuels
  2. Hydrogen and Vehicle Electrification
  3. Natural Gas Vehicles
  4. GTL and CTL
  5. Algae
  6. Barriers to Substitution
  7. Substitution Constraints


DISCLAIMER: The information and trades provided here are for informational purposes only and are not a solicitation to buy or sell any of these securities. Investing involves substantial risk and you should evaluate your own risk levels before you make any investment. Past results are not an indication of future performance. Please take the time to read the full disclaimer here.

April 15, 2010

The Best Peak Oil Investments, Part VII: Peak Substitutes?

Tom Konrad CFA

There are two types of solutions to the liquid fuels scarcity caused by stagnating (and eventually falling) oil supplies combined with growing demand in emerging economies.  The most obvious is to find a substitute to replace oil.  Supply constraints limit the full replacement of oil by most potential substitutes.  Understanding those constraints leads us to the investment opportunities that arise from these substitutes. 

Increasing demand and constrained supply of oil is fueling the search for oil substitutes to use in its place.  Unfortunately, almost all of these potential substitutes also have limited supply.  This article looks at the factors that limit the supply of (or demand for) potential substitutes.  The next article, Part VIII will combine the insights about the barriers to adoption discussed in part VI and the constraints discussed here to highlight the investment opportunities which arise from these barriers and constraints.

Constraint 1: Conversion Efficiency / Alternatives

All alternative fuels require significant resources.  Conventional biofuels require agricultural land, fertilizer, pesticides, water, enzymes, and heat in fermentation.  Gas to liquids uses natural gas. 

To understand if a particular alternative fuel will ever be economic, it helps to consider what else might be done with these inputs.  If the alternative uses for these inputs have more economic value, then making fuel from them will never be an economic proposition.

With conventional biofuels, there is a trade off between one group of people driving, and another group eating (the food-vs.-fuel debate) and also the effects of land use change because of biofuels' tendency to increase the area used for crop land.  These trade offs are typically complex, and often difficult to calculate precisely, but in a few cases, the results are quite clear and enlightening.

Stranded Natural Gas is gas co-produced with oil far from transportation infrastructure.  Such gas is essentially a waste stream which would be burned to prevent it from venting into the atmosphere, so if the gas could be economically transported to market, either as liquefied natural gas or a Gas to liquids (GTL) product that can be shipped out with the oil, there will be a net gain, no matter how much of the gas is lost in the conversion process.  In contrast, pipeline natural gas has many alternative uses, and so its value as a transportation fuel must compete with power generation, domestic, and industrial uses.  Further, the direct use of natural gas as a transportation fuel in vehicles is in direct competition with GTL technologies.  Because much of the energy content is lost in the GTL process, it is unlikely that GTL will be viable for pipeline gas, even though it may make sense for stranded natural gas. 

A useful tool for making these sorts of comparisons is Energy Return on Energy Invested (ERoEI), which is the ratio of the energy put into a process to the energy embodied in the products.  ERoEI is useful in large part because there is a fairly extensive body of ERoEI analysis for various fuels.  In general, if two processes use the same feedstock, the one with the higher ERoEI is likely to be the most economic.  This comes with many caveats, however, since it does not take into account the different qualities of the fuels (can you really compare high-grade energy such as electricity to low grade energy such as heat?)  Further, ERoEI does not take into account the timing of the energy flows.  A process with an ERoEI of 1.1 may be better than a process with an ERoEI of 2, if the first process takes only a day and can be repeated every day, and the latter process takes a year.  I looked at a way to account for the timing of energy flows with a measure I call EIRR here and here.

Many companies are considering ways to use Municipal Solids Waste (MSW) and industrial waste streams to make various alternative fuels.  Purer waste streams with higher energy content have the most alternative uses, and the use with the highest economic value is likely to render most of the other uses uneconomic.  For instance, waste paper can be recycled, burned to produce electricity, or converted into liquid fuels by a variety of enzymatic, chemical, and thermochemical processes.  There is also economic value in reducing the amount of recycled paper at the source, by printing double-sided or moving to paperless processes.  In the case of waste paper, I do not expect it to ever be converted into fuels on a large scale, because of the potential for recycling.  If a ton of waste paper were turned into fuel, that would be a ton of paper which could not be recycled, leading to an additional ton of paper which would need to be made from virgin wood.  This is economically similar to growing the wood for biofuel, and skipping the intermediary paper step.

Another use for MSW with high energy content is to convert it into electricity via incineration.  It can also be used to make ethanol or other liquid fuels with a biomass to liquids process.  Much can also be recycled or composted.  Which one of these processes will be used for any particular waste stream will depend on the nature of the waste itself, as well as the local market for each fuel.  It also depends on the value of carbon credits, since while producing electricity tends to be the most effective way to reduce carbon emissions, electricity is difficult to store or use as a transportation fuel. 

One relatively easy comparison arises from Hydrogen.  Hydrogen currently is made by either reforming natural gas or using electricity to electrolyze water.  In both processes, some energy is lost, and the original natural gas or electricity are better fuels on several measures than the hydrogen itself.  I don't expect the hydrogen economy to progress beyond the demonstration stage unless we first find much more efficient ways of creating hydrogen and cheaper ways of storing it and using it in vehicles.

Constraint 2: Total Supply

The reason we're concerned with peak oil investments is because the total supply of oil is finite.  When total supply over time is finite, the amount pumped in any given year is also limited, and so must have a maximum, or peak.  The timing of the peak is less important than the elasticity of supply.  Elasticity of supply is a measure of how much the price of a commodity has to change in order to increase or decrease the amount supplied in response to changes in demand.  If a small change in demand requires a large change in price in order to bring supply into balance, then the supply of the commodity is inelastic.  If a large change in demand requires only a small change in price to bring supply into balance, then the supply of the commodity is elastic.  The elasticity of demand is the same, with regards to changes in price in response to changes in supply.

Sometime near the peak, oil supplies will become inelastic.  Increasing demand will produce higher prices, but the higher prices will not be able to stimulate supply to match the increased demand.  Instead, oil prices will stay high enough for reduced demand (demand destruction) to bring supply and demand back into balance.

Although we may not have reached "Peak Oil" in the sense of maximum annual production, I believe that the wild swings in the price of oil since 2007 demonstrate that we've reached peak oil in the sense of inelastic supply, as described in the preceding paragraph.  Although worldwide oil production was slightly higher in 2008 than 2005, overall production was basically flat for the whole period since 2005, despite rapidly rising prices.  The increased price volatility combined with tiny changes in market volume are strong signs of decreased elasticity or supply or demand.  I see no reason for demand to have become significantly less elastic in recent years, so I assume the observed decreased elasticity is elasticity of supply.

WTI Oil Price

Biofuels can be produced in relatively small quantities without much impact to the food supply and agricultural system.  Yet as we scale them up to replace a significant fraction of our oil use, they impact farmland and require the conversion of natural ecosystems to farmland.  Intensive biofuel production can also degrade existing farmland.

Only electricity has no real constraints on total supply, with wind and solar resources sufficient to supply all our energy needs hundreds of times over, so long as we build the wind and solar farms. 

Constraint 3: Climate/Environment

How we account for environmental externalities will also have a large influence on which alternative fuels thrive and which ones become historical footnotes.  Because of the fairly large supplies of relatively inaccessible coal, Coal-to-Liquids (CTL) technology compares favorably to all the other alternatives I've discussed until you consider the carbon emissions, disposal of the waste, and the impacts of coal mining that it entails.  All fossil fuels, even coal, are finite, and so using alternative fossil fuels at best delays the impact of peak oil.  Renewable options, in contrast, are steps towards a long-term solution.

Nevertheless, CTL stocks may turn out to be good investments despite the environmental harm.  After all, environmental harm is an externality, and so long as the local government chooses not to make the CTL producer pay the real costs of production, high oil prices could make CTL plants very profitable.  On the other hand, large unpriced externalities represent a significant risk to the companies creating them: new regulation may put a price on Greenhouse Gas emissions or take other regulatory steps which make the process unprofitable at the stroke of a pen.


Failing to take into account all constraints on a technology is a simple and common mistake.  Unfortunately, this common mistake leads investors to overly optimistic conclusions, often followed by overly optimistic investments.  Since overly optimistic investments are one of the surest ways to lose money, investors will be wise to keep these constraints on potential oil substitutes in mind when considering investments.

One reader of part VI made just this mistake.  He made the case that the supply of conventional gas (Constraint 2: Total Supply) might not limit the use of natural gas vehicles because of the potential for biomethane from cattle.  What he failed to consider is that while biomethane can be used as a fuel for natural gas vehicles, it can also be used for anything else that natural gas is currently used for (Constraint 1:Alternatives.)  Because Biomethane and natural gas are essentially interchangeable, it is more informative to consider the potential contribution of Biomethane to total natural gas supply than to calculate how many vehicles could potentially be fueled by biomethane.  I was not able to find a national resource assessment for biomethane, but I did find an assessment for California.  In California, the technically feasible biomethane resource (including biomethane from livestock) was less than 1% of California's natural gas usage.  Hence, fluctuations in natural gas supply are likely to swamp any increases in biomethane production.

If we want to understand the amount of natural gas available for natural gas vehicles, we need only consider the supply of fossil natural gas.  Biomethane is only a rounding error in the overall calculation.  Hence, while biomethane may make some investors rich by growing rapidly from a small base, it will have a negligible difference to the success of natural gas vehicles.  If you believe biomethane will take off, the best way to invest based on that belief would be to invest in dairy farms, not in natural gas vehicles.

In part VIII, I'll bring together these ideas about constraints with my thoughts about barriers from part VI, and highlight the investments that should benefit from both.

Previous articles in this series are available here:
  1. Biofuels
  2. Hydrogen and Vehicle Electrification
  3. Natural Gas Vehicles
  4. GTL and CTL
  5. Algae
  6. Barriers to Substitution

DISCLAIMER: The information and trades provided here are for informational purposes only and are not a solicitation to buy or sell any of these securities. Investing involves substantial risk and you should evaluate your own risk levels before you make any investment. Past results are not an indication of future performance. Please take the time to read the full disclaimer here

April 13, 2010

The Best Peak Oil Investments, Part VI: Barriers to Substitution

Tom Konrad CFA

There are two types of solution to the liquid fuels scarcity caused by stagnating (and eventually falling) oil supplies combined with growing demand in emerging economies.  The most obvious is to find a substitute to replace oil.  These substitute have barriers to their use as a replacment petroleum based fuel.  Understanding those barriers also leads us to the investment opportunities that arise from these substitutes. 

As I wrote the first five parts of this series, looking into potential substitutes for gasoline and diesel, it was clear that many potential substitutes would need to overcome barriers to its adoption.  This article and the next will look at these barriers, and what they say about the potential for investments in substitutes for liquid fuels from petroleum.  Part VII will look at factors which constrain the supply of these substitutes.  Part VIII will combine the resulting understanding of these barriers and constraints to highlight the investment opportunities arising from them.

Barrier: Infrastructure

One great advantage gasoline and diesel have over most of the proposed alternatives is an extensive infrastructure.  In addition to an extensive pipeline network, we also have a large number of competing fueling stations.  If a new fuel requires new fueling stations, like natural gas and hydrogen, or charging points and (potentially) battery swapping stations (electricity) it may not be enough to make sure that enough filling stations exist for would-be drivers to make long trips.  If there is only one national network of filling stations, drivers will likely become concerned that the lack of competition will mean that they overpay for fuel.

Among the possible substitutes, the synthetic fuels discussed in part IV, as well as biogasoline are the best placed in that they can use existing infrastructure. 

In terms of having a nationwide transportation network, the best placed substitutes are natural gas and electricity.  In terms of point of sale delivery, electricity has an advantage in that it's safe and relatively cheap to place charging infrastructure in parking lots, and most homes already have the capability of charging an electric vehicle, although it takes a long time from the 120V outlets in most garages.  Most homes do not have natural gas in the garage, and even when they do, a compressor is necessary. 

Conventional biodiesel and ethanol can be dispensed from the same pumps used for fossil fuels, but both present some difficulties in transport and storage.  Biodiesel cannot be allowed to get too cold, because it begins to congeal, so in colder climates, storage tanks as well as transport tankers must be insulated and even heated.  Ethanol cannot be shipped through pipelines that are also used for gasoline, because it absorbs too much water.  Hence ethanol and biodiesel are mostly shipped in tanker trucks and rail cars.  But both can be blended with conventional fuels, meaning that little new dispensing infrastructure is needed.  The importance of a competitive fueling infrastructure can be seen in in this November 2009 statement from the Trucking industry to the US Senate [pdf] about the conversion of trucking from diesel to natural gas.  They say,

It is not sufficient to have a single LNG vendor with stations built at strategic locations along key freight corridors. Absent a competitive refueling infrastructure, trucking companies could face unreasonably high prices at individual retail LNG stations that have no competition in a particular geographic area. While competition exists in the natural gas industry, the high barriers to entry for retail LNG refueling stations may slow the development of a competitive refueling infrastructure. A competitive LNG refueling model would require the presence of multiple entities selling LNG in the same geographic area.

This objection applies to any potential alternative vehicle which locks the user into one fuel, and includes Electric Vehicles (EVs) such as the Nissan Leaf and Hydrogen Fuel Cell Vehicles, but not to flex fuel vehicles (E85 ethanol) or biodiesel (which can be used in any diesel engine.)  It also does not apply to Plug-in Hybrid Electric vehicles, such as the Chevy Volt, because while charging points and battery swapping stations may be limited, the existing fueling infrastructure provides supply competition.

The fuel with the weakest infrastructure is hydrogen.  Like natural gas, it needs specialized filling stations, but hydrogen lacks a national pipeline network.

Incomplete infrastructure can be either a barrier or an opportunity.  If a potential fuel is compelling for other reasons, firms well placed to provide the necessary infrastructure should be able to profit handsomely.  If, on the other hand, a fuel lacks an existing infrastructure and also faces significant other barriers, it will be unlikely to become a significant transportation fuel, and infrastructure investors are likely to lose their shirts along with everyone else interested in the fuel.

Barriers: Energy Density

When talking about energy density, it's important to consider not only the fuel, but the tank.  Both volume and weight are important.  Few fuels are as energy-dense as gasoline and diesel, both of which can be stored in simple, unpressurized fuel tanks.  In contrast, the fuel tank for electric vehicles is the battery, and batteries are not only large and heavy for the amount of energy they store, they are also extremely expensive and degrade over time.  Although the cost of driving an electric vehicle are very low compared to gas or diesel, the large up-front investment in batteries makes the total cost of owning an eelctric vehicle higher except for drivers who use the vehicle for frequent, short trips with time to recharge in between. 

The big winners for energy density are synthetic fuels, as well as conventional biofuels such as ethanol and biodiesel.  Although ethanol has been criticized because it only contains about 2/3 of the energy of the same volume of gasoline, it's close enough that people using ethanol don't have to completely change their behavior in order to use it in a conventional vehicle.  In contrast, electric vehicle manufacturers find that the range of their vehicles is constrained not only by the cost of batteries, but also by their size and weight.  Weight is particularly important, because as a vehicle gets heavier, more of the energy is used to move the vehicle rather than the occupants, which in turn requires even more batteries.

In between energy-dense biofuels and bulky batteries lie gaseous fuels: natural gas and hydrogen, which have good energy per gram, but require heavy pressurized tanks to pack them into a space small enough to fit in a vehicle.  Hydrogen requires a pressurized tank that takes up a lot of space, even if it is not very heavy.  Natural gas can either be used as Compressed natural gas (CNG) or Liquid Natural Gas (LNG.)  CNG is similar to hydrogen, although it is a little more energy dense.  LNG has the same energy density as diesel, but requires considerable energy to compress into that form, and is not available from a home fueling station.  Hence, natural gas vehicles present a tradeoff between energy density and fueling infrastructure.


Considering just the barriers of energy density and infrastructure, it is clear why the conventional biofuels ethanol and biodiesel gained an early lead over alternatives such as electricity and hydrogen.  The big questions about biofuels arise from constraints in their total supply, and the harm that many forms of biofuel agriculture do to the environment.  Synthetic fuels made from natural gas and coal (GTL and CTL) can also have excellent energy density and can take advantage of existing infrastructure and vehicle fleets, but so far have not been adopted in a large way becasue they have had to compete with cheap oil.  As oil prices rise, we will probably also see the rise of synthetic fuels, but, like biofuels, their long term prospects will be limited by total supply and possibly by concern about the environmental harm they do. 

Such supply constraints and environmental concerns will be the subject of Part VII.  Previous articles have been:
  1. Biofuels
  2. Hydrogen and Vehicle Eletrification
  3. Natural Gas Vehicles
  4. Synthetic fuels: GTL and CTL
  5. Algae


DISCLAIMER: The information and trades provided here are for informational purposes only and are not a solicitation to buy or sell any of these securities. Investing involves substantial risk and you should evaluate your own risk levels before you make any investment. Past results are not an indication of future performance. Please take the time to read the full disclaimer here.

March 18, 2010

So Much for Peak Demand - try 134mb/d by 2030

No peak demand Eamon Keane

"So much for peak demand - try 134mb/d by 2030."  That was the startling conclusion dispatched from the ivory tower recently by Joyce Dargay, a British transport econometrics professor, and Dermot Gately, an American economics professor. I'll present their conclusions and then discuss the implications.

Their report is available here (pdf). The main conclusion is that the low hanging oil fruit has already been picked after the 1970's oil shocks. From 1978-85 OECD fuel oil consumption dropped by 7mb/d and then from 2003-2008 by another 2mb/d. The share of fuel oil in OECD consumption has fallen from 44% to 16% today, so there is not much left to cut. The authors estimate the price and income elasticities of different components of oil consumption in the OECD and other blocs.

The OECD oil demand response to higher incomes over the last 40 years is shown in Figure 1. The equi-proportional growth lines indicate the slope oil demand should have if it is proportional to income growth. It can be seen that fuel oil dramatically drops off, however per capita transport & other oil remained reasonably correlated with income growth.
equi-proportional growth
It shouldn't come as much of a surprise that transport oil consumption goes up with income. For example, Figure 2 shows a very high correlation between Irish transport energy and GDP:
Irish Transport Energy Consumption
The authors then estimated the price and income elasticities of oil in different blocks: China, Oil Exporters, Income Growers, and other countries. They combined these segments into a "rest of the world" umbrella. They then contrasted their 2030 oil demand projections with the various scenarios of the DOE, IEA & OPEC. For example, the DOE's projections are shown in Figure 3.
DOE Oil Projections
Figure 4 shows the authors' projections, in per capita daily oil consumption:
Authors' Projections
Can you spot the difference? The OECD and FSU (Former Soviet Union) projections are reasonably close. It's the rest of the world line that is much different in the DOE's projections. The DOE suggest that China, India, OPEC etc will grow at one fifth of their historic oil demand rate, despite higher income growth. Instead of the DOE's 0.56% growth rate, the authors' projections finds close agreement with the historical growth rate of 2.54%. It's not exactly unreasonable to expect the rest of the world to (attempt to) raise their consumption of oil from 1 liter per day to 2 liters per day, especially if their income is rising. The OECD slurps over 6 liters per day, after all.

The difference between the DOE's and the authors' projections is some 20mb/d, or two Saudi Arabias. So in 2030, a plausible buisness as usual scenario suggests world demand at 134mb/d. As for supply, well Figure 5 shows the IEA's flying pigs 105mb/d projection:

IEA Projection

You can add in your favourite technology if you want: biofuels (currently 1.5mb/d), Coal-to-liquids (currently 0.15mb/d), Natural gas to liquids (currently 0.08mb/d), oil shale (0 mb/d), and sundry other technologies. They might give you several mb/d by 2030. The UK Peak Oil Task Force outlined future oil production as an undulating plateau at about 90mb/d (until 2020, at least). This leaves an approximately 40mb/d shortfall (134-90). How that 90mb/d gets allocated will be interesting. The authors don't give an explicit breakdown by region, but Figure 6 shows roughly how an unconstrained scenario would look, with the dashed line indicating a possible supply cap:

Oil Demand 2010 vs. 2030

The OECD and FSU remain flat, but the rest of the world tries to get to 2 liters per capita per day. How will the 40mb/d supply-demand burden be shared? Will the new Chinese middle class buy an EV instead of a car? Perhaps. US passenger cars and light trucks consume about 9mb/d, and the fleet turns over every 20 years of so. If they were replaced with super efficient small cars (assuming folks can get credit), you might get the same number of miles with 6mb/d. We already drive small cars in Europe, but there is still some scope for higher efficiency in vehicles, and high prices should hold the Jevons Paradox at bay.

The authors show that the price elasticity of oil exporters is very low, obviously enough, since they heavily subsidise domestic consumption. In Saudi Arabia, over half of electricity generation is from oil. Courtesy of Royal Decree M/56, utilities purchase oil for $3/barrel, or 7c/gallon. Not surprisingly the grid is at break point from the demand. They plan to double installed capacity from 30GW to 60GW by 2020, although some of that will be gas-fired.

Another kicker is that in the Middle East, peak water has arrived. Saudi Arabia in 2009 cancelled their plans for agricultural self sufficiency due to lack of water. Their aquifer is depleting at 7 times the rate it recharges. Hence they are turning oil into water by desalination. Were they to replace the annual depletion (700bcf/yr) with desalinated water, that would require 0.3mb/d per year. By World Bank estimates desalination demand could rise to 1mb/d in coming years.

These anecdotes just reinforce what anyone who's followed oil knows - an export crisis is coming. Oil exporters will serve their citizens subsidised oil before exporting - it's part of the unwritten petropact.

The marginal utility of a barrel of oil is greater in India or China than in the OECD. People still dream of owning a car in Asia. Figure 7 shows Chinese car sales:
Chinese Car Sales

This suggests that the burden of adjustment will fall heavily on the OECD. Our ability to invest in solutions depends on the economy tolerating the high oil price. You can read a 70 page paper on this subject by economics professor James Hamilton here (pdf). His conclusion was:

"the evidence to me is persuasive that, had there been no oil shock, we would have described the U.S. economy in 2007:Q4-2008:Q3 as growing slowly, but not in a recession."

So triple digit oil prices are likely to hamper growth. This was also one scenario posited by the authors of the original study when they stated:

"Hence this imbalance [40mb/d] would have to be rectified by some combination of higher real oil prices, much more rapid and aggressive penetration of alternative technologies for producing liquids, much tighter oil-saving policies and standards adopted by multiple countries, and slower world economic growth."

It would be helpful if some governments actually recognised this reality. For now the response can be summed up as:

Head in the sand

Eamon Keane is an Energy Systems Engineering masters student at University College Dublin with an interest in electric cars, rare earth metals and energy.  He is looking for a job in the energy sector anytime after August 2010.

February 09, 2010

Cleantech Economics 101: Higher Fossil Fuel Prices; More Cleantech

David Gold

With all the complexities of cleantech policy and technologies, there is only one simple thing needed for an explosion of competitive clean technologies – increased price of fossil fuels.

The amount of R&D expenditures that will need to be invested in clean technology in order for it to hurdle the bar into competitiveness is much greater with low fossil fuel prices. And, the lower those prices, the less appetite the private sector has for making such investments. This leaves a much-increased burden on the back of government through grants and subsidies– a back that is close to being broken from debt. While clean technology development is absolutely necessary, technology development takes time and, often, a long time. And technology development is fraught with uncertainty…nobody ever knows a priori whether such efforts will be successful and how long they will take. Believe me…every venture fund in the world would love to be able to know that! But they don’t. However, virtually every venture fund and researcher will tell you that significant advances usually take much more time and more money than expected. In an environment of relatively low fossil fuel prices with high price volatility, grants and subsidies for an amount of time and at a level that will make any permanent and meaningful difference are simply unsustainable. So, for all the focus on “cleantech stimulus” the most important thing that government can do is to affect change in the cost of the fossil fuel alternatives.

If we had higher fossil fuel prices or even just clearer visibility and certainty about future increases, the free market would make dramatic increases in investment in clean technology. When the free market sees an opportunity to make a profit, it moves extremely fast. Government actions that put in motion increases in the cost of fossil fuel alternatives, even if those increases are phased in over many years, can have an enormous impact on the money invested by the private sector in alternatives (and a corresponding decrease in need for government subsidies and grants). This, in turn, will further accelerate technology advances, leading to a more rapid convergence of the time when various technologies can competitively reach the mass market.

Given the reality that fossil fuels are a finite resource, it is a fait accompli that eventually alternative energy and energy efficiency technologies will become so compelling that they will dominate the market. But the future of fossil fuel prices in the relatively near term (e.g., the next decade or two) is far from certain as both general economic conditions and new discoveries such as those in Venezuela’s Orinoco Belt play a roll. If we didn’t care about global warming, national security or economic security, there would be little need to do anything but let the market take its course. Unfortunately, irrespective of your personal policy hot button, most of us would agree that we do not have the luxury of the amount of time that this transition would likely take on its own.

The government has a role to ensure that externalities that are important to the public are accounted for in the market. But the government cannot subsidize our way there nor simply mandate that the market use a specific technology. Should it be surprising that the U.S. government “mandated” that 100 million gallons of cellulosic ethanol be produced this year and the EPA estimates that only 6.5 million will be produced? The government sank $150M into Range Fuels’ cellulosic ethanol plant expecting it to produce over 10 million gallons, but Range will only produce about 2.5 million gallons this year. How silly is it to try to “mandate” use of biofuels – did we not learn anything from the economic demise of the Soviet Union about government controlled economies? If oil had remained at over $100/barrel since 2008, I would suggest to you that biofuels production would be much higher this year without any government mandate.

The government does need to take action and do so in a way that does not crush our economy. There are important societal externalities associated with continued use of fossil fuels that are not accurately reflected in the price of the commodities in the market. Cap and trade is the right debate to be having… albeit likely the wrong solution. More on that in my next post.

David Gold is an entrepreneur and engineer with national public policy experience who heads up cleantech investments for Access Venture Partners ( This article was first published on his blog,

January 13, 2010

Plug-in Vehicles; Waist Deep In The Big Muddy

John Petersen

Generation specific cultural references can be treacherous ground for bloggers because the flashback effect is usually limited to readers with long and vivid memories. In this case, however, the lessons of history are so relevant that I'll accept the risk and offer some context for younger readers.

In my youth a war wrapped in the liberal ideology of the Kennedy and Johnson administrations and fueled by an underlying concern over who would control oil and gas resources in the Gulf of Tonkin was fought in the jungles of Vietnam, Laos and Cambodia. By current standards, the toll of 47,424 battle deaths was staggering. By the late '60s opposition to the War was widespread and a galvanizing force behind the antiwar movement was music, including an iconic folksong from Pete Seeger, Waist Deep in the Big Muddy.

While my use of an antiwar anthem to make a point about plug-in vehicles is certain to draw howls of outrage from advocates and true believers, I think the analogy is apt because the ideologically inspired road to disaster we trod during the late '60s is frighteningly similar to the path we're on today with plug-in vehicles where the prevailing attitude seems to be "damn the facts, push on."

Our fundamental energy problems are easy to identify – increasing oil prices and increasing reliance on imports. Both numbers have been climbing steadily for decades and consumers have been stubbornly reluctant to change their behavior in response to prices. The burden on the economy becomes heavier with each passing year and if you're willing to extend the current price channel out for another decade, oil price expectations in the $150 to $180 per barrel range don't seem all that far fetched.

WTI Price.png

For as long as automakers have been proposing plug-in electric vehicles, skeptics like me have been noting that fuel savings are unlikely to give consumers a cash-on-cash payback of their incremental cost over the life of the vehicle, much less the three to five year window that consumers typically expect. There are countless vague promises about  economies of scale driving down costs as the industry matures, but at least in the battery sector where raw materials and plant automation are the primary cost drivers and labor is almost a rounding error, I have a hard time banking on a fairy godmother to restrain commodity prices and equipment costs. While the following graph of long-term industrial and precious metal prices from Credit Suisse is a little dated, it certainly has the same general shape and slope as the most recent decade on the oil price chart.

Metals Prices.png

"We were knee deep in the Big Muddy, the big fool said to push on."

For several years realists like Vinod Khosla and others have noted that since the U.S. gets roughly 50% of its electricity from coal and will likely do so for decades to come, the environmental benefits of plugging an electric vehicle into a lump of coal will be few and far between. Last week, I offered a simple comparison of plug-in vehicles with conventional HEV technology (without plugs) that proves plug-ins are about one-quarter as effective at reducing oil imports as cheaper HEVs that can point to a decade of performance under real world conditions.

"We were waist deep in the Big Muddy, the big fool said to push on."

The real flies in the ointment are that plug-in vehicles don't significantly change the energy balance, they're far too resource constrained to make a dent in oil imports, and the fundamental economic premise only works if you are willing to assume that historically moderate trends in retail electricity prices will continue forever.

From an overall energy balance perspective, plug-ins don't change the amount of energy needed to move a vehicle down the road. Instead, they merely move the conversion of fuel to energy from under the hood to a local power station while increasing vehicle cost by 50% to 100%.

Likewise, the batteries that will be used in plug-ins are made from raw materials that are orders of magnitude less abundant than oil. The resource constraint issues go far beyond lithium availability and extend to every component in batteries and battery packs. Those materials all have alternative uses in high value products and from a resource availability standpoint, using batteries to conserve oil is a lot like using gold to conserve copper.

Finally, it's almost impossible to find a newspaper or magazine that doesn't have several articles on the evolution of the electric grid. We're seeing massive investments in wind and solar power installations and the estimated cost of the coming smart grid runs to trillions of dollars. Since the one certainty is that private capital will not finance alternative energy or the smart grid without expecting both a return of capital and a return on capital, it's patently absurd to believe that electricity price increases will remain as benign in the future as they have been in the past.

"We were neck deep in the Big Muddy, the big fool said to push on."

When I was but a lad one of my mother's favorite quips was "use your head for something besides a hat rack." It was her way of teaching me to look beyond my immediate circumstances, consider the factors that led me to a decision-point and reflect carefully on the likely consequences of my actions. When it comes to plug-in vehicles, investors and the general public have been little more than hat racks for too long. Instead of thinking things through and questioning assumptions, they've been placated by "wouldn't it be great if ...?" sound bites. Instead of asking whether crossing the big muddy is possible or the effort worthwhile, they've allowed themselves to be led down the garden path by politicians and activists who vainly promise gain without pain and reward without risk.

If it weren't so damned expensive, I'd describe vehicle electrification beyond the HEV stage as a zero sum game. Given the immense costs that are becoming increasingly clear with each passing day, I'd characterize it as a game where we can't reasonably hope to break even.

Disclosure: No stocks mentioned because we all know who they are.

January 04, 2010

Should Coal Company Investors Breathe Easy After Copenhagen?

Green Energy Investing For Experts, Part V

Tom Konrad, CFA

A global climate deal in Copenhagen would have been bad for coal miners, and coal companies have been rallying as the economy recovers, but it may not be clear skies for the black rock.

In the battle to reduce greenhouse gas emissions, coal is enemy number one.  The global disarray in Copenhagen can only be good for coal mining companies, and they duly rallied when the climate talks ended with little to show for it. 

Yet carbon emissions are not the only black mark on the coal industry's record, and investor relief may be premature.  

None of this is to say that coal mining stocks have to fall anytime soon.  Rather, I'm pointing out that there are large and significant risks that coal investors ignore at their peril.  The polarization of climate debate is such that many conservatives seem unable to see these risks because of their preconceived notions.  Climate deniers may crow in anticipation about their impending victory in the climate change debate, but this is a debate they cannot win because the facts simply do not support their case, no matter how many careless emails they are able to dredge up.  

Investors usually have to operate in a realm of uncertainty.  We don't know what next years earnings of any company will be, we only hope that our estimate is better than the rest of the crowd.  The climate debate, on the other hand, is a rare opportunity where we know the outcome with near certainty, and yet there is a large contingent of climate deniers willing to put their money down on the other side of the bet.

Today, with recent polls showing fewer Americans supporting action on climate change than last year, it's easy to become discouraged about the chances of real action to confront climate change.  As an investor, it is dark moments like these when courageous investors put their money down and are rewarded when the pendulum swings back, as it always does.  

Betting Against Coal: A Green Lottery Ticket

I'm not one of those courageous investors.  I prefer to take small risks that still have the potential for large rewards.  Since I don't know if the pendulum of public opinion on climate change will begin to swing back today or ten years from now, I'm not ready to start shorting coal companies.  However, I am ready to make a few small bets that change might be sudden and soon.  I've bought a couple cheap, long-dated puts on coal companies.

The Market Vectors Coal ETF (NYSE:KOL) has exchange traded options, but only with expiration dates going out six months.  In contrast, many of the large coal mining companies have exchange traded options that go out two years.  This situation is similar to the one I ran into when shorting the Mexico ETF and shorting airline stocks.  In particular, I chose to buy January 2012 $30 puts on Consol Energy (CNX) and January 2011 $25 puts on Peabody Energy (BTU.)  I chose these two because, as with airlines, they are the top two holdings of KOL.  Furthermore, both of these came near the bottom of Newsweek's Green Rankings, and BTU scores badly on quantitative valuation measures.

To be sure, these are long-shot gambles.  Coal will be with us for decades to come, and coal companies have an annoying habit of getting politicians to do their bidding.  On the other hand, these bets could pay off even if there is no real action on climate change, because of another stock market collapse (both of my puts would have been in the money at March 2009 lows,) or from some company-specific problem.

Where else are you going to buy a lottery ticket that is so environmentally sensitive?


DISCLAIMER: The information and trades provided here and in the comments are for informational purposes only and are not a solicitation to buy or sell any of these securities. Investing involves substantial risk and you should evaluate your own risk levels before you make any investment. Past results are not an indication of future performance. Please take the time to read the full disclaimer here.

December 19, 2009

Betting Against Shale Natural Gas Plays

Green Energy Investing For Experts, Part III

Tom Konrad, CFA

Controversy continues to grow about the economic viability of shale gas.  Investors who doubt the companies' claims should consider buying puts.

The Case for Gas

From the perspective of a green energy investor, natural gas is the most benign fossil fuel.  Natural gas emits less carbon than other fossil fuels (slightly more than half as much as coal, when used for electricity generation.)  Natural gas turbines also can quickly compensate for fluctuating supply and demand from other sources of electricity.  This quick response makes them a natural complement to variable electricity supply from wind and solar (along with better transmission, electricity storage, and demand response.)  Finally, natural gas will be key in making the transition away from fossil fuels, because building relatively cheap gas turbines can provide a bridge to an electric grid dominated by renewable energy, which has a high up-front cost in terms of both dollars and embedded energy.

The Case Against Shale Gas

With all this going for it, why is natural gas part of this series about sectors green investors should consider shorting? (See Part I, which made the case for shorting, and Part II, which looked at shorting Mexico country funds.)

The reasons are twofold:

  1. I think it would be unwise to short the natural gas industry as a whole... all the reasons laid out above will continue to be strong drivers for natural gas consumption.  This article is very specifically about shale gas players.
  2. There is a good chance (but not a certainty) that shale gas has been oversold.  
  3. The extensive use of fresh water in shale gas development makes shale gas development more environmentally damaging than the less-than benign conventional gas industry.

I wrote a short piece on Art Berman, the leading shale gas critic in October, outlining his views on why decline rates in shale gas wells are likely to be much faster than much of the industry says.  I'm no expert on gas, so here are some more authoritative sources for an overview of this controversy: The Financial Times, Art Berman himself, and industry defenders.


Most of this controversy is outside my area of competence.  However, that does not mean that it cannot be part of the investment decision process.  When making an investment decision, the key question to ask is: Are other investors more likely too optimistic, or too pessimistic about this company or industry?

The shale gas story, which I summarize: "New drilling techniques and discoveries have vastly expanded the available recoverable natural gas, expanding reserves so much that we no longer have to worry about running out, and we will even be able to increase sustainable production over the long term."  In other words, it sounds to good to be true.  In fact, it sounds like another version of the perennial paean, "Technology will save us," or, in another less pithy variant, "Technology will allow us to continue doing things the way we've always done them."

Technology may indeed save us from peaking fossil fuel supplies and climate change, in the sense that it may allow our society to adapt the quick loss of this massively energy intense resource that we've been completely reliant on for the last 150 years.  However, it is wishful thinking to hope that technology will allow us to keep on doing things the way we've been doing them for the last few decades.

Wishful thinking is very seductive, because it allows us to avoid confronting the present reality of our problems today.  As such, it's intensely popular, and I nearly always expect that a large number of investors, spurred on by happy-talk media, will buy it, both figuratively and literally in the form of shale gas company stock (and solar stocks for that matter.)

So, if there is a chance that shale gas companies are over hyping the potential and playing down the risks and costs of their technology, the herd of investors and analysts is most likely underestimating the probability of this chance.  I don't know what the probability is, but I do know that if I can buy insurance against the chance Art Berman is right, the premium for that insurance will probably be low enough to make the deal attractive.

Insurance for Shale Gas

In the stock market, puts are insurance against the chance that the underlying stock will fall below the strike price.  If shale gas has been over hyped, the most exposed shale gas players will see large falls in their stock prices when the truth becomes accepted wisdom.  If shale gas actually holds as much promise as the companies are saying, such puts will expire worthless, but investor losses will be limited to the price (or "premium") paid for those puts.

In Mexico, I felt a traditional short was the best way to play the country's exposure to peak oil.  Mexico is exposed to a nearly inevitable decline in oil production, which will take a continuing and growing toll on the economy.  The only real question with Mexico is how much and how quickly declining oil production will have its effect on the Mexican economy.   In contrast, shale gas companies are facing an unknown chance of a catastrophic risk to their entire business model. The question here is not "how much and how fast" but "will it happen and how soon?"  In such a case, choosing an out-of the money put is the best way to place a bet.  If the chance that shale gas companies' business models are fatally flawed and will be recognized fairly quickly is higher than is currently implied by market prices, then it makes sense to buy the put.

Which Companies are Most Exposed?

I have not decided if a bet against shale gas is for me, so I have not done an analysis of which companies are most exposed.  Here are the factors to consider if you care to do your own analysis:

  1. Which companies have the largest exposure to shale gas as a percentage of their business?
  2. Are there exchange traded puts (LEAPS) available on the company's stock that expire in 2011 or 2012?
  3. How liquid are these puts?  
  4. What is the Put/Call ratio of the stock?

We only want to buy puts on companies that have nearly 100% of their business in shale gas.  Otherwise, good news in other parts of the company's business might overwhelm the damage done by bad economics in shale gas plays, and we might not profit even if shale gas turns out to be over hyped.

We also want to make sure that we can buy long term puts, because it often takes longer than skeptics expect for bad news to be recognized in the market.

Most exchange traded options are rather illiquid, meaning that you are either going to pay a high transaction cost in the form of the spread, or you will need to use a limit order and hope that the market moves to you.  I tend to prefer the latter tactic, but it means that not all of my intended trades ever execute.  A quick measure of liquidity is the spread between the bid and the ask as a percentage of the option price.  The smaller the spread, the better.

The Put/Call ratio is a rough measure of the relative demand for downside insurance (puts) compared to upside speculative interest (calls.)  Generally, the higher the Put/Call ratio, the more demand there is for downside insurance.  Since we are contemplating an essentially contrarian downside bet, we are more likely to be find puts at reasonable prices when the put/call ratio is low, indicating that there is relatively little interest from other investors in buying protection against declines in the stock price.

Company Response

A final sign that a shale gas company may be overstating its reserves is the strength of management's response to Dr. Berman's criticism.  I feel that a company with little to lose if Dr. Berman is correct will have little incentive to dispute his findings.  A company with a lot to lose is more likely to take an active approach to refuting his claims, possibly even taking legal action in the attempt to silence him.

Berman's top detractors are Devon Energy Corp. (DVN) and Chesapeake (CHK), so those two would also be at the top of my list when considering possible puts.


DISCLAIMER: The information and trades provided here and in the comments are for informational purposes only and are not a solicitation to buy or sell any of these securities. Investing involves substantial risk and you should evaluate your own risk levels before you make any investment. Past results are not an indication of future performance. Please take the time to read the full disclaimer here.

December 13, 2009

Shorting Mexico's Peak Oil Economy

Green Energy Investing for Experts, Part II

Tom Konrad, CFA

The next Tequila Crisis will be a peak oil crisis.  Mexico's government is dependant on revenues from declining oil fields.  The prospects for replacing these revenues look slim.  Shorting Mexico Country ETFs looks like a good way to hedge market exposure.

In Green Energy Investing For Experts, Part I, I discussed why it makes sense to use companies and sectors that may be hurt by peak oil or climate change as a hedge against the market exposure in a green portfolio.  In Mexico, peak oil is already a reality.  Production has already declined , but, because most investors do not understand the irreversible nature of declines in oil output, the Mexican stock market had not yet discounted the damage that peaking oil production is likely to do to the Mexican economy.

Below is a quote from the Oil Drum about Mexican oil production:

The President just changed the head of Petroleos Mexicanos (Pemex) as the revenues that the state gets from sale of its oil (making up nearly 40% of the federal budget) dropped 30% in the first half of the year. Current Mexican Government predictions that overall Mexican production will stabilize at 2.5 mbd over next year don’t reflect the collapse of Cantarell, and also fail to recognize that the promised increases in production from other fields are not reaching the goals set. It is only a few days since the production at Chicontepec was “evaluated” after falling some 12,000 bd short of target. This field is still in development, with ultimate production targeted at 550,000 to 700,000 bd by 2017, but as it is already 16% behind the mark that does not augur well for that future.

As Euan Mearns pointed out the fields at Ku-Maloob-Zaap (KMZ) which lie adjacent to Cantarell are being produced in the same way as Cantarell, and thus production has recently risen dramatically.

That means the Mexican Federal revenues dropped 12% in the first half of 2009 because of falling oil production.  This is not a one-time hit to the budget, but part of an ongoing decline.  That means that Mexican government revenues are permanently 12% lower, and likely to decline further as oil production declines further.  

I can't think of any good way to make up for the large and growing budget gap.  Raising taxes would flatten an economy already hurting from the financial crisis.  Cutting spending would do the same.  Cutting funding to museums is painful but insufficient.  Debt  is currently at 44% of GNP, a high level, but possibly manageable if the decline in revenues were cyclical, rather than permanent and ongoing.  With declining revenues, default and/or devaluation seems almost inevitable.  No option would be good for Mexican companies.  

Shorting Mexico

If the Mexican Governments' fiscal situation is so dire, it makes sense to short Mexican companies, especially if the short is part of a hedge against exposure to world financial markets.  With a hedge, the investor only needs to be confident that things are liable to get worse in Mexico more rapidly than elsewhere, or not get better as quickly.

That seems like a very good bet to me, so I looked for Mexican Country ETFs or closed-end funds to short.  I found 

The first two are closed-end funds with limited liquidity.  The iShares ETF, however, is widely traded and liquid.  It also has a good number of exchange traded options with decent liquidity, including long term LEAPS with maturities of over a year.

In terms of the hedging strategies I discussed in Part I, I prefer buying puts when I am anticipating a not-very-likely but potentially drastic event to affect the security.  As I discussed above, in Mexico's case we are dealing with a harmful event (declining oil revenues) that is already underway, and is likely to have harmful, if not disastrous effects.  

Because the effects of declining oil production could be disastrous for Mexican stocks, I would prefer to short EWW, rather than selling an in-the-money call.  An in-the-money call will cease producing gains once EWW has declined to its strike price; a short can be used to take advantage of declines all the way to zero.  

To protect against unforeseen positive events, I usually combine such a short with a long dated out-of-the-money call, or with an in-the-money short call.  In addition to liquidity, the availability of EWW LEAPS makes the ETF particularly attractive for this sort of hedging.

Unfortunately, as with many specialty ETFs, I found that shares of EWW were not available for shorting.  Because of this lack, I chose to use a short call spread instead of a short position combined with a long call.  This means that I will only be able to take advantage of large drops in the ETF by selling new with lower strike prices when the EWW share price falls below the strike price of my short call, which increases the cost of the overall transaction.


The profitability of this short position depends on either

  1. A general world stock market decline or
  2. The decline in Mexico's oil revenues being more drastic than most investors are anticipating.

I personally expect both, but if I'm wrong about one, there's a good chance the other will work in my favor.  There's always a chance I'm wrong about both, and that's why I buy the calls.  This series will continue with more short ideas that may benefit from peak oil or climate change regulation: Diversification makes a much sense on the short side as it does on the long side.


DISCLAIMER: The information and trades provided here and in the comments are for informational purposes only and are not a solicitation to buy or sell any of these securities. Investing involves substantial risk and you should evaluate your own risk levels before you make any investment. Past results are not an indication of future performance. Please take the time to read the full disclaimer here.

October 25, 2009

Shale Gas: Promises, Promises, Promises

In a panel entitled "Natural Gas Game Changers?" at the 2009 International Peak Oil Conference, Dr. Breman presented some results from his research into the actual production from the nearly 2000 horizontal gas wells drilled in the Barnett Shale in 2007.  The Oil Drum has some interesting background and comments here.  Here are a few of my take-aways from his presentation:

  • The average well he studied will produce 0.95 Billion cubic feet (Bcf) of gas during its productive lifetime, yet he average production expected by Chesapeake (CHK), Devon Energy (DVN), and XTO Energy (XTO) is 2.65 Bcf, 2.2 Bcf, and 3.3 Bcf respectively.
  • The gas companies are assuming a hyperbolic decline curve based on a very limited data set from a few wells, while Dr. Berman found, after studying far more wells, that an exponential decline is the best model for horizontal gas wells in the Barnett Shale.
  • A $7-$8 price per million BTU is required for these companies to break even on a well that produces as much as 1.5 Bcf.
  • Shale gas companies are funding drilling with debt and asset sales.
  • There is not enough data on the later shale plays  such as the Haynesville.   Nevertheless, there is no early indication that recoveries will be higher in these new plays.
  • Operators often state that the average well life will be 40+ years, but Dr Berman has found that the average commercial life is 7.5 years, with the most common well life being only four years.
  • From a hallway conversation, Schlumberger (SLB) has a more effective fracking technology which could produce better results, but Schlumberger has not been able to find a shale gas player willing to try this technology.  The problem is that Schlumberger's technology produces lower initial flow rates, and the shale gas players are relying on high initial flow rates for their high well production projections.  They rely on these projections for their reserves estimates.  These estimates are essential to their ability to tap the financial markets for funding.
  • US Geological Survey estimates for shale gas reserves are approximately three times too high.

Too good to be True?

I don't analyze the gas market, so I have no personal expertise to evaluate Dr. Berman's analysis.  However, they have the ring of truth.  Put simply, when something sounds too good to be true, investors are usually wise to assume that it is not true.  

Peter Dea, of Cirque Resources LP made the optimistic case.  He called shale gas the solution to his "three E's:" Energy Security, the Environment, and the Economy.   That sounds great to me, and he was quite convincing.  Towards the end of his talk, I was thinking about investments in natural gas pipeline companies with pipelines leading from the biggest concentrations of North American shale plays in the Rocky Mountains to areas of potential increasing demand, especially the Northeast US.  The Northeast would likely increasingly substitute natural gas for heating oil under a peak oil, abundant natural gas scenario.

I'm no longer considering gas pipeline investments.  If natural gas infrastructure is overbuilt in the expectation of abundant natural gas supplies, it is not only exploration and production companies with overly optimistic estimates that are likely to suffer.

DISCLAIMER: The information and trades provided here are for informational purposes only and are not a solicitation to buy or sell any of these securities. Investing involves substantial risk and you should evaluate your own risk levels before you make any investment. Past results are not an indication of future performance. Please take the time to read the full disclaimer here.

October 14, 2009

Oil & Alt Energy Redux

Charles Morand

Last week, I conducted an analysis showing the lack of evidence supporting claims that oil and alt energy returns are strongly correlated (claims that sometimes come from outfits as reputable as Bank of America Merrill Lynch).    

I don't want to belabor this topic but I thought I would post the results of another, similar analysis I conducted following comments I received on how to improve the first one. In a nutshell, the comments suggested I do the following:

1) Look at daily correlations or even smaller periods, as "common knowledge" market movements can often dominate over the real relationship in the short and very short run

2) Look at absolute (price) correlations as well as relative (return) correlations (my first analysis looked only at relative movements)

3) Look at directionality (i.e. what % of the time do assets X and Y move in the same direction regardless of the size of the move)

4) Extent your analysis to five years or greater

New Analysis, Same Difference

The three sets of tables below show daily return correlation coefficients, daily price correlation coefficients and daily directionality statistics (% of days that the assets close Up, Down or No Movement together) for oil, nat gas, the S&P 500 and alt energy stocks.

The time periods have been extended from three to five years or since inception. The oldest alt energy ETF available is PBW that was listed on March 03, 2005 - not quite 5 years but a decent chunk of time nonetheless. The other 3 ETFs (sector specific) were all listed in the 2nd half of 2008.

Correl Returns Oct 14-09_3.bmp

Correl Prices Oct 14-09.bmp

Correl Returns Oct 14-09_2.bmp

The first set of tables show that returns on oil are not particularly useful at explaining returns on alt energy stocks on a daily basis (let's say that we enter useful territory at 0.5 and above), although the results for PBW show the relationship strengthening somewhat in the last year (which has been anything but a normal year for the markets). These results are in line with those from my previous analysis which looked at weekly returns.

As far as absolute prices go (the second set of tables), correlation coefficients for oil and alt energy are high, but they are just as high if not higher for alt energy and the S&P 500. PBW shows the relationship strengthening over time, but it strengthened even more between oil and the S&P 500, something Tom opined might be the case a few months ago.

I don't find absolute price correlations all that useful. In the medium and long terms, returns matter far more than absolute prices. If a $1 movement in oil consistently results in a $1 movement in an alt energy ETF over the long run, the high coefficient could obscure a divergence trend between the returns on both assets as their prices rise.

Finally, the directionality tables (note that assets appear in a different order) show a fair bit of co-directionality between oil and alt energy (with the exception of PTRP [alternative transportation], something Tom and I discussed last week). But here again, the S&P 500 emerges as the stronger predictor.


I did not go any more granular than daily data: anything beyond that becomes relevant only to traders.

Once again, the general conclusion that emerges from this analysis is that oil - whether in terms of returns, prices or directionality - is not a particularly useful indicator to go by when investing in alt energy stocks, especially when compared to equity markets in general (i.e. the S&P 500).

The implication for investors is that they should not invest in alt energy as a hedge against or a play on rising oil prices. If anything, what little relationship does exist will probably tend to disappear overtime as alt energy and cleantech stocks respond more to core business fundamentals than to seemingly logical yet unproven narratives about external drivers.  


October 07, 2009

Crude Oil & Alt Energy: The Non-Relationship That Just Won't Go Away

Charles Morand

The relationship - or lack thereof - between oil prices and the performance of alt energy stocks has been a long-time interest of mine. I discussed it last in late March when I looked at correlations between the daily returns of alt energy and fossil energy ETFs. At the time, I found that only a weak relationship existed between the two and that if someone wanted to make a thematic investment play on Peak Oil, alt energy ETFs were not an ideal way to do so. 

Seeing as the popular press and countless "experts" continue to claim, whenever they get a chance, that the fortunes of alternative energy stocks are closely tied to the price of oil, I figured I would revisit the topic.

Fossil & Alternative Energy: The Relationship That Isn't There

This time around, I took a slightly different approach for my analysis: I correlated the weekly returns for US oil and US natural gas directly (as opposed to through an ETF) with returns for the S&P 500 and four alt energy ETFs. For US Oil and Nat Gas, I used price data provided by the Energy Information Administration here (Spot Price FOB Weighted by Estimated Export Volume) and here (Contract 1), respectively. I got ETF and S&P 500 price and index value data from Google Finance.

For the ETFs, I picked the Claymore/Mac Global Solar Index ETF (TAN) as the solar sector representative, because I took a position in it in March (which I liquidated last week even though I initially claimed I would hang on to it for 18 to 24 months. I have now grown more worried about downside risk than I am optimistic about upside prospects over that time horizon, so I took my money out).     

The other ETFs were: the First Trust Global Wind Energy Index (FAN) for wind, because it represents a more direct play on the sector than the alternative; the PowerShares Clean Energy (PBW) ETF for alt energy other than solar and wind, as an analysis I conducted earlier this year indicated it is the best way to access other sectors; and the Powershares Global Progressive Transport (PTRP) ETF, as it provides the only proxy I know of for returns on a basket of stocks with exposure to alternative modes of transportation.          

The graph below displays returns for all four ETFs, Oil, Nat Gas and the S&P 500 between Jan. 1, 2007 and Sep. 25, 2009 (click on the image for a large view).             

Oct 7-09 Chart 1_2.bmp

The table below shows returns and volatility for all seven assets over the same time interval but broken down into sub-periods. Seeing as 2009 and the post-Lehman collapse period have been eventful times to say the least, I thought it would make sense to create a few distinct sub-periods for analytical purposes.

What jumped out at me from this table is the relatively strong performance of the Powershares Global Progressive Transport (PTRP) ETF, even after adjusting for volatility. As the correlation analysis below demonstrates, this performance is not due to a rise in oil prices.

My going theory is that there is a Green Stimulus Effect at work given how much of global stimulus dollars have gone to transportation programs. This would be something worth exploring further but it certainly seems in line, at least on the surface, with a prediction I made nearly one year ago. 

Oct 7-09 Fig 1_2.bmp

The following three tables contain the real meat of my analysis. They are fairly self-explanatory: they show correlation coefficients between US Oil, US Nat Gas and the S&P 500 with all other assets. The correlations are for the periods outlined in the tables or since inception in the case of PTRP (Sep. 19, 2008), TAN (Apr. 18, 2008) and FAN (Jun. 20, 2008). The correlation coefficients above 0.5 are highlighted.

Oct 7-09 Fig 2.bmp

These results are, once again, in line with my expectations: there is little reason to believe that there is a strong relationship between changes in the price of oil and the performance of alt energy stocks. Even for natural gas, where one could expect a correlation with wind and solar given that all three fuels are used in power generation (or load abatement), there does not seem to be a strong relationship.

TAN and FAN have not yet been around for long enough to analyze returns going very far back into the past, but PBW has. Although the correlation between PBW's returns and oil's returns seems to have strengthened somewhat in the past year, it certainly does not qualify as strong.

I must admit that I was fairly surprised to find such a low correlation between the returns on oil and those on the PTRP ETF. My guess is that this ETF hasn't been around long enough, and that a relationship might emerge under an extreme Peak Oil scenario. That said, spending on public transportation is heavily dependent on the fiscal health of various levels of government, and we've just been moved from the emergency room to the critical care unit.    

On the other hand, I was not particularly surprised to see that returns for all four alt energy ETFs are strongly correlated with returns for the S&P 500 - that seems intuitive enough given that they all belong to the same asset class. 


It doesn't really matter how one slices and dices the data: there just does not appear to be a strong relationship between returns on oil and returns on alt energy stocks, including alternative modes of transportation.

That's not going to matter to a great many commentators who will continue to claim in newspaper and magazine articles, on blogs and on TV that the success of alt energy stocks is closely tied to the price of crude, even though that's mostly untrue.

Those who invest in alt energy should, however, pay close attention. These results suggest that there are far more important factors than oil prices, most notably returns in equity markets in general and regulatory incentives by governments.

There is a good chance that equity returns and returns on oil will diverge in the next couple of years as oil prices climb and equities stagnate or decline. If such a scenario materializes, those who have the relationship backwards could be in for unpleasant surprises.   

September 28, 2009

What Is Peak Oil?

Charles Morand

Peak Oil is a term that has become common currency in energy debates in last three years, due in large part to the spectacular rise in the price of crude between 2005 and the end of 2008. But what does Peak Oil actually mean and, more importantly, what do I mean when I use it in my articles?

In the purest and original sense of the term, Peak Oil refers to the point in time at which the rate of oil production (as measured, for instance, in barrels per day) peaks. This peak, according to the original theory, is then followed by a rapid and irreversible decline as attempts to extract more oil out of the ground run into the absolute geological limits of the resource. Wikipedia, as always, does a great job of explaining the theory of Peak Oil and provides a wealth of resources for those who would like to expand their knowledge further.

I do, on occasion, refer to Peak Oil in my articles, including one I wrote last week where I claimed that Peak Oil would be a powerful driver of gasoline prices in the next few years. Given how contentious this theory is, I wanted to clarify where I stood on it and how readers should interpret what I mean when they see those two words side-by-side in my posts.

Are we about to run into the absolute geological limits of oil in a way that won't allow us to increase production going forward? I don't know and I have nowhere near the appropriate level of knowledge to truly judge the data I see on this weekly. And frankly I don't particularly care; humanity will hit that peak at one point or another and the exact timing is of very little relevance to me.

What is far more relevant is the price point (and time) at which we hit the economic - rather than the geological - peak: let's call that Effective Peak Oil (EPO). EPO occurs where the marginal barrel of oil, which sets the price for all barrels of oil in the market, is so expensive that: (1) it triggers a process whereby governments, people and firms search for and find substitutes in a way that alters the structure of the economy and demand for oil forever and; (2) in the process, it also triggers a substantial economic shock. Does EPO look like a nice, smooth bell-shaped curve? Probably not, or at least not when plotted on a timescale relevant to most human beings (i.e. 60 to 90 years).

In the following interview he gave on CNBC last week (thanks to the Infectious Greed blog), Jeff Rubin, former Chief Economist at CIBC World Markets and author of the new book Why Your World Is About To Get A Whole Lot Smaller, sums up my thinking on this issue better than I ever could. His most memorable quote: "What we are running out of is oil we can afford to burn."


July 14, 2009

De-Carbonizing Electricity - Will King Coal Finally Be Dethroned?

Charles Morand

Last Friday, the WSJ's Environmental Capital blog noted how, according to HSBC, growing government efforts to de-carbonize the electricity supply across the developed world would hurt makers of power generation technology with high exposure to coal.

Yesterday, the EIA released its Electric Power Monthly report for April 2009. In it, the agency notes the following:

The drop in coal-fired generation was the largest absolute fuel-specific decline from April 2008 to April 2009 as it fell by 20,551 thousand megawatthours, or 13.9 percent [...] The April decline was the third consecutive month of historically large drops in coal-fired generation from the same month in the prior year  [...]

Coal's drop is larger than the national decline at 5% between April 2008 and April 2009, and that of all other fuel sources but petroleum liquid:

Generation from conventional hydroelectric sources was the largest absolute increase in April 2009 as it was up by 3,918 thousand megawatthours, or 18.4 percent from April 2008. [...] Nuclear generation was up 3.1 percent. Generation from natural gas-fired plants was down by 1.5 percent. Net generation from wind sources was 34.8 percent higher. [...] Petroleum liquid-fired generation was down by 26.5 percent compared to a year ago [...]

The main culprit for the fall overall fall in generation is the significant decline industrial production:

 For April 2009, sales in the residential and commercial sectors both decreased by 0.7 percent and 1.6 percent, respectively, while sales in the industrial sector decreased by 13.6 percent, as compared to April 2008.

Yet coal remains the single most widely-used fuel in power generation in the US, accounting for more than nuclear, gas and renewables combined:

Year-to-date, coal-fired plants contributed 46.1 percent of the Nation’s electric power. Nuclear plants contributed 21.0 percent, while 20.5 percent was generated at natural gas-fired plants. Of the 1.2 percent generated by petroleum-fired plants, petroleum liquids represented 0.9 percent, with the remainder from petroleum coke. Conventional hydroelectric power provided 7.0 percent of the total, while other renewables (biomass, geothermal, solar, and wind) and other miscellaneous energy sources generated the remaining 4.1 percent of electric power [...]

Coal is indeed public enemy number 1 in the fight to de-carbonize the electricity supply and, as noted in the HSBC report, the elusive (I think illusive is actually more appropriate here) quest for carbon capture and storage is unlikely to change that.

The next two years are going to be interesting as a number of currents converge: (1) a price will be placed on carbon across America; (2) billions of dollars in subsidy money for environmental industries are going to trigger a significant amount of activity both in alternative energy and in energy efficiency; and (3) an economic recovery will eventually get underway and industrial production will rebound, raising the demand for electricity.

Are we truly witnessing the beginning of the end or is King Coal set to rebound with a vengeance as soon as demand picks up again? If coal declines in the U.S. abd Europe, will that make any difference at all given China's love affair with the black stuff?         

Power generation, transmission, distribution and management in North America offer very attractive investment opportunities for investors, and something tells me that the age of coal will end here before the world runs out of it, much like the stone age ended with plenty of stones left.

July 05, 2009

Oil's Sesquicentennial; the Dream Becomes Nightmare

John Petersen

On August 27th, we'll celebrate the 150th anniversary of Colonel Edwin Drake's completion of the world's first successful oil well near Titusville, Pennsylvania. That discovery and the many that followed planted the seeds of an industrial, economic and cultural revolution that transformed America from an agrarian backwater into a global superpower. For the next 114 years, oil was cheap, plentiful and the solid bedrock of the American Dream. Since the early '70s, however, the dream has gradually become a nightmare as domestic and global oil production began an irreversible decline.

My first graph comes from the Energy Information Administration and shows the annual U.S. production of crude oil over the last 150 years.

My second graph comes from Wikipedia and shows both nominal and constant dollar oil prices over the last 150 years (click on the graph for an expanded view).

The most interesting feature of the two long-term graphs is the general shape of the constant dollar oil price curve. If you smooth out the price shocks of the '70s and '80s, the graph shows a pronounced albeit elongated U-shape. While there are many theories about where oil prices will stabilize when the global economy begins to recover, it seems safe to assume that the price won't be $20 or even $40 per barrel.

My third graph takes historical oil price data I downloaded from the Energy Information Administration, adds a price channel overlay on the ten-year trend and shows why I believe oil prices will stabilize around $80 per barrel later this year and continue to move upward in the price channel over time.

Barring unexpected major new discoveries, there's only one way for oil prices to go over the long term.

It doesn't take much reflection to see that oil production, consumption and pricing have become major problems that can only get worse as six billion people in emerging economies strive to attain the lifestyle that 600 million Americans and Europeans have enjoyed for decades. The harsh but undeniable reality is that oil cannot sustain global economic growth for the next 20 years, much less the next 150. This reality is the driving force behind a concerted global effort to identify and harness alternative energy resources that can offer relevant scale solutions to a looming global shortage. Unfortunately, many alternative technologies are even less sustainable than oil because they depend on a smaller natural resource base.

There are only four unlimited energy sources known to man. The first is the internal heat of the earth itself. The second is the movement of the hydrosphere. The third is the movement of the atmosphere. The fourth is the sun. Where the Ancient Greeks taught that earth, water, air and fire were the classical elements, the new science of alternative energy teaches that earth, water, wind and sun are the true classics. When it comes to harnessing that energy, however, the only thing that matters in the long run is the mineral wealth of the earth's crust and oceans.

Many alternative energy technologies including windmills, PV solar cells, fuel cells, advanced batteries, and advanced electric motors depend on exotic metals that were pretty scarce to begin with. Like oil, each of these exotic metals will have a U-shaped price curve and while they're relatively cheap and relatively available for the time being, each will eventually hit an inflection point where they'll no longer be cheap or available. According to experts like Jack Lifton, many critical natural resources will reach their price inflection points within a few years, rather than decades or centuries. So far, the only alternative energy technologies I've identified that do not face daunting mineral scarcity risks are concentrated solar power, or CSP, and geothermal power.

Historically, investors have not had to worry about how natural resource constraints might impair their portfolio companies because the required raw materials have always been available for a price. As we enter the Age of Cleantech, the sixth industrial revolution, those rules will be re-written in ways that many will find shocking. I've previously described how raw materials shortages will impact the battery and hybrid electric vehicle markets. Over the next few weeks I hope to expand my focus to consider the principal raw materials that are critical to the development of a truly sustainable alternative energy infrastructure. Unlike this article, future installments will identify companies that enjoy specific natural resource advantages or suffer from specific natural resource risks, and hopefully help investors identify the likely winners and losers.

Given the long-standing animus between environmentalists who see themselves as protectors of the planet and miners who see themselves as simple providers of essential raw materials, I'm not optimistic that humanity will be able to solve its energy problems without catastrophic conflict and horrific environmental consequences. If we are to have any chance at all, the environmentalists must come to grips with the fact that a clean energy future depends on the robust and responsible development and use of all the earth's resources.

Readers that want to develop a deeper understanding of the issues and opportunities in the energy storage sector may want to join me in San Diego for Infocast's Storage Week on July 13th through 16th. The speaker's list includes more than 80 thought leaders from the battery industry, the government, the utility and automotive industries, and the research and development sector. I'll be participating in three panel discussions and hope to return home with new investable insights that I can share with readers in future articles. If something important happens while I'm on the road I'll try to cobble a quick blog entry together. Otherwise, you can look for my next article in a couple weeks.

March 28, 2009

Do You Need To Invest In Oil To Benefit From Expensive Oil?

Two months ago, Tom told us how he'd dipped a toe into the black stuff (i.e. bought the OIL etf) on grounds that current supply destruction related to the depressed price of crude oil would eventually lead to the same kind of supply-demand crunch that led oil to spike during the 2004 to mid-2008 period.

If you need evidence that the current price of crude is wreaking havoc in the world of oil & gas exploration, look no further than Alberta and its oil sands. The oil sands contain the second largest oil reserves in the world after Saudi Arabia, but more importantly will account for the lion's share of incremental supply as conventional oil production continues to decline. The province's economy, which had been growing at a breakneck pace for the past five years, has come to a grinding halt: employment insurance claims grew by twice the Canadian average over the past year; personal bankruptcies jumped by 61%; and home foreclosures are on the rise. This is the result of significant project cancellations that will no-doubt limit Alberta's ability to ramp-up output once prices climb back again.

It is thus no surprise that Cambridge Energy Research Associates and others are warning about the economic hazards of curtailing investments into conventional and alternative energy.  

Alt Energy & Fossil Energy

Oil being the most followed of the energy commodities, it is no surprise that it is receiving most of the media attention. Arguably, natural gas and coal prices should matter more to alt energy investors than oil prices: according to REN21, of the $71 billion invested in renewable energy in 2007, 47% went into wind and 30% into solar PV. Both technologies are used for power generation (investments into transportation alternatives are comparatively small) and, in the US, coal and natural gas are the dominant fuels in power production. The relentless focus of the popular press and other pundits on the the economic case for alternative energy being closely tied to the price of crude oil is thus mostly misplaced.

Case in point, last November, a reader wrote me with a correlation analysis conducted over a 5-year period (or, where there wasn't five years' worth of data, since inception). The correlation coefficients between the returns on crude oil and those on alt energy securities were as follows: GEX, 0.19; PBW, 0.14; TAN, 0.18; and the index underlying FAN, 0.19. These are, by most measures, pretty low correlation coefficients. Given the reader's reputation, I trusted the numbers. 

Nevertheless, in alt energy investing as in life, perception is often reality. Given the many signs pointing toward a rapid escalation in crude prices - demand can and will rebound far quicker than supply - I decided to re-explore the relationship between fossil and alt energies. If a strong positive correlation can be found between alt energy investments and crude oil, natural gas and coal investments, there may not be a need to dip a toe into the black (or colorless) stuff at all - one can focus on alt energy alone and still enjoy the ride up.

In order to verify this, I ran a basic correlation analysis with the daily returns on the KOL (coal), OIL (crude) and UNG (nat gas) ETFs/ETN on the one end, and the daily returns on the alt energy ETFs on the other. I got the return data from Yahoo Finance using the Adjusted Close prices that include dividends and splits. Given the results above from our reader's analysis, I only went back six months to see if the (lack of a) relationship still held.   

OIL and UNG track the prices of futures contracts in the underlying commodities, so they are pretty decent securities to use to estimate the returns on crude and nat gas investments. KOL, on the other hand, tracks a basket of coal company stocks. It's the closest thing I could find but it's not ideal as stock returns don't necessarily track commodity returns. For instance, large mining firms will often sell a high proportion of their output through fixed-price contracts, preventing them from benefiting from sudden surges in spot prices. 

The boxes delineate general alt energy ETFs (ICLN to GEX), the solar ETFs (TAN, KWT) and the wind ETFs (FAN, PWND). There aren't any notable differences between the ETF categories, with the most significant differences being between the fossil fuel ETFs/ETN and the alt energy ETFs.   

The relationship between alt energy stocks and coal stocks appears relatively strong. However, in the absence of return data on coal, it's hard to tell whether investing in alt energy stocks (or coal stocks for that matter) is an optimal way of playing increasing coal prices. Given the structure of the coal market, with significantly less involvement by purely financial actors than in oil or natural gas markets, this is a hard one to play for retail investors, although data appears to suggest there is a play.

Though the correlation appears to have strengthened somewhat between crude oil and alt energy investments in the last six months, it remains weak enough that if someone wants to play a return to expensive oil they are still better off dipping a toe (or even an entire foot!) in the black stuff. The same holds for nat gas.

This quick and dirty analysis wouldn't withstand close methodological scrutiny. My only intent here was to see whether these relationships were worth exploring further - they are not. If you want to benefit from crude oil and nat gas price increases and have no ethical qualms about it, invest in them directly!

DISCLOSURE: Charles Morand has a long position in TAN.

DISCLAIMER: I am not a registered investment advisor. The information and trades that I provide here are for informational purposes only and are not a solicitation to buy or sell any of these securities. Investing involves substantial risk and you should evaluate your own risk levels before you make any investment. Past results are not an indication of future performance. Please take the time to read the full disclaimer here.

February 16, 2009

Life After Coal: It's Sooner Than You Think

by Tom Konrad, Ph.D.  

A couple years ago, I began to see reports that coal supplies might not last the 200+ years we've all been lead to believe, so I wrote an article about what you could do to prepare your portfolio for Peak Coal.

Now two years have passed, and Peak Coal is undeniably 2 years closer.  (Did you ever wonder why people who have been saying that we have 200 years of coal for 20 years aren't now talking about 180 years of coal?)  But more than being 2 years closer, the evidence continues to mount.  Caltech Professor David Rutledge, has been spreading the peak coal word for most of the time since.  I recommend the video of his 2007 lecture on the subject.

It's great that the NY Times is asking "Is America Ready to Quit Coal?" but the real question may be "Will we have any choice?"

On February 12th, Clean Energy Action released a report on Powder River Basin coal supplies, based in part on a 2008 USGS report.  The Powder River Basin matters because Western coal has been the only source of new coal production in the US for the last two decades.  Appalachian and Interior coal production has been declining, despite mostly increasing prices, and uniformly increasing prices since 2003.  Northern Appalachian coal production having peaked in the middle of the last century, while Interior coal production peaked at the start of this decade.  When production declines in the face of rising prices, constraints other than economics must be coming into play.  Future increases in production in these regions seems unlikely.

coal by rail.bmp

Of the top 6 coal producing states in the US, only Wyoming and Montana are still increasing production.  West Virginia, Kentucky, Pennsylvania, and Texas all peaked in the 1900s.  With existing Wyoming mines, which dominate current production, all having less than 20 years of reserves remaining, only Montana will remain... and we simply don't know much about the geology to know how much can be recovered.  Jim Hansen, author of the Master Resource Report, tells me that available rail supply lines out of Montana are likely to be another critical limiting factor on that state's production.

The 2007 report from Energy Watch Group (which triggered my earlier article), David Rutledge, and Clean Energy Action all found that what we don't know about our coal reserves far outweighs what we do know.   What we do know should be very worrying to anyone who hopes that we might be able to replace our current coal fired electricity generation with any sort of "Clean Coal."  Any attempt to sequester CO2 by pumping it underground or to the bottom of the sea would require considerably more energy than simply releasing it into the atmosphere, as we do now.  That energy would come at a cost of less net energy from what will likely prove to be very limited coal supplies.

Peak Coal Accounting

If "Clean Coal" can be made to work, and we are able to replace part of our electricity supply with this technology, it seems increasingly unlikely that we will be able to supply as much electricity from coal 30 years from now as we do today.  Coal plants are intended as 50 to 60 year investments, and part of the reason they are considered so "cheap" is that the construction costs are depreciated over more than half a century of payments.  If, in reality, those construction costs must be paid over a shorter period, the effective cost of coal fired electricity will be considerably higher... even if the accounts do not yet show it.

Transitioning away from coal now makes sense both from an economic and climactic standpoint.  If new coal plants will have shorter than expected useful lives simply because of the limited supply of coal, an honest accounting cannot spread construction costs 60 years, as has been done in the past.  A shorter useful life means significantly raising the accounting cost of coal power per kWh, even before we place any price on carbon emissions or other environmental damage.

Carbon Capture and Storage

That is not to say that improving Carbon Capture and Sequestration technology will not be useful.  Even without building new coal plants, we have a massive fleet of existing coal plants which are already spewing carbon into the atmosphere.  According to a recent Inside Renewable Energy podcast, French utility EON puts current carbon capture technology costs about $40 per ton of CO2, and they hope to get the cost down to $20.  This does not include the cost of pressurizing the gas and injecting it into some form of permanent storage.  (Even permanent storage may not be so permanent.) Capturing CO2 for industrial uses can make economic sense today, and the economics will only get better when we begin to have reasonable prices for carbon emission.  However, cleaning up the emissions of currently built fossil-fueled generation is not the same as investing new money in generation which we hope to clean up later.

We have the technologies today to begin this transition, and other promising technologies at least as near to development as "Clean Coal."  Wind power is nearly as cheap as coal with current accounting.  If we reassess the useful lives of prospective new coal plants, and put a price on carbon emissions, it will be much cheaper.

Building out the Smart Grid and additional Transmission capacity will allow us to integrate much more wind than skeptics currently think is possible.  A recent report from the researchers at the Rocky Mountain Institute and the University of Colorado Boulder found that optimized diversified portfolios in the Midwest of wind and solar generation were 55% more reliable (measured by the variability of output) than the average individual site used in the study. For large scale baseload and dispatchable generation, Concentrating Solar Power needs only continued price improvement which will come from mass deployment, and a more robust national grid.   For large-scale clean baseload power anywhere in the US, Enhanced Geothermal Systems are likely to be easier and cheaper to develop than "Clean Coal."

All of these are the right investments for the country, but they are also likely to be good moves for investors.  We may still have 30 years before coal production in the US peaks.  The stock market reaction will not wait until the actual peak... the stock market reaction will happen when sufficiently many investors realize it's coming. 

How many more reports will that take, I wonder?

DISCLAIMER: The information and trades provided here and in the comments are for informational purposes only and are not a solicitation to buy or sell any of these securities. Investing involves substantial risk and you should evaluate your own risk levels before you make any investment. Past results are not an indication of future performance. Please take the time to read the full disclaimer here.

January 25, 2009

Dipping a Toe in the Black Stuff

I was tempted by greed, and I succumbed.

Last week, I bought the iPath S&P GSCI Crude Oil Total Return Index ETN (OIL), at $19.75 a share.  oil.png

The Temptation

I made the trade as a simple speculation.  I watch oil because the oil price is one of the key drivers of investor interest in alternative energy, although oil is only a true competitor for biofuel companies, not producers of wind turbines (at least until there are a significant number of plug-in electric vehicles.)

With crude trading below $40/barrel, oil producers are cutting back on new drilling.  This is compounded by the extremely difficult financing environment.  Even oil-rich Dubai wants to sell recently acquired luxury retailer Barney's to raise cash.  Many OPEC nations cannot finance their budgets with crude at $60 a barrel, let alone below $40, so they will have to cut spending, even if they cheat on their quotas.  In Texas, the number of active oil rigs has declined 20% since August.

All of this is against a backdrop of relentless depletion and declining production from existing wells.  In 2007 and 2008, with oil prices at record levels, and drillers going all-out, total liquid fuels production increased only slightly, and all of that increase was attributable to OPEC and biofuels.  As noted above, most OPEC nations need $60 oil to fund their budgets, while many biofuels are not competitive below $50 a barrel, although plunging grain prices may help this... but only be reducing farmers' incentives to plant.  I conclude that no significant new supply will come on until crude is again in the $50-$75 range.  

I have little doubt that demand can continue to fall from current levels, but the longer the price stays below the $50 level, the faster declines at existing fields will cause overall production declines to accelerate.  Even if world oil demand falls in 2009, supply is likely to fall faster, eating into current record oil stocks.  With underlying decline rates from existing fields as high as 11% (Mexico), supply will fall faster than demand unless higher prices encourage new supplies.

Moral Qualms

My colleague Bill Paul calls me "Pure Green" because I normally will not touch fossil fuel investments.  I firmly believe that our investing should be guided by moral principles, even if it means making less money.  So why am I going against my belief that we must shift away from fossil fuels as quickly as possible by buying a proxy for that poster child of cheap, polluting energy, crude oil?


  1. I can tell myself that the money I make today will be invested in fixing the problem tomorrow.  Although this may sound like a fatal moral compromise, it is similar to the compromise made by buyers of solar panels.  The high embodied energy of solar panels almost certainly comes from fossil fuels, and the buyer believes that after a few years to pay back the fossil energy cost [pdf], the extra energy produced later justifies the initial cost.  This argument only works if I am likely to make money on my speculation.  If I lose money, then not only may I encourage the drilling for oil, but I've lost opportunities to encourage clean alternatives. 
  2. I plan to sell when oil hits $60 (which should give me about a 60% gain.  I'd be happy with 60% even if it takes 3-5 years.)  As I discussed above, I don't believe that oil prices below $60 will encourage new drilling.  Low prices are also hurting clean alternatives, while encouraging people to use more oil today.

Do these excuses justify my speculation?  I believe they do, but if you are considering doing likewise, you may find a different balance.  I think it's more important that we ask ourselves and those who manage our money about the moral aspects of our investments, not just about how much money we're likely to make (or lose.)  Many former Madoff investors will now agree.  If I lose money on this speculation, I will not only feel the loss financially, I will also have lost the opportunity to make the world an ever-so-slightly better place.  That will hurt much more, on a dollar-for-dollar basis, than what I lost on VRB Power or Electro Energy last year.

A Note On Oil Speculation

I've joined the ranks of oil speculators, who were widely blamed for the run-up in oil prices last year (although, unsurprisingly, they received no credit for the decline.)  Some of these "speculators" were mere hedgers, such as United Airlines (UAL), who have recently lost a great deal of money in the decline.  The oil market does not ask if an investor is buying to hedge an underlying risk, or just to make money.  The size of the purchase moves the market, not the motivation for the purchase.

How can an airline be hurt by both rising and falling prices?  They weren't: UAL was hurt by poor planning.  By not hedging when prices were low, and then hedging when they were high, they lost money in both directions.  Most speculators suffer the same fate: If more speculators are buying when prices are high (they must be, or they would not be "causing" the rise,) then more speculators will lose money, simply because they are buying high, and must inevitably sell low.  In other words, attempts to ban speculation are disguised attempts to ban foolishness.  Good luck on that.

I hope that my speculation is of the rarer, and volatility-decreasing "buy low, sell high" variety.  I'm quite confident that we'll see $60 oil again, although I don't know when.  But the sooner it happens, the better, because the longer it takes, the harder it will be to increase oil supplies in response, and the sharper the next price spike will be.

Tom Konrad, Ph.D.

DISCLOSURE: Tom Konrad owns OIL.

DISCLAIMER: The information and trades provided here and in the comments are for informational purposes only and are not a solicitation to buy or sell any of these securities. Investing involves substantial risk and you should evaluate your own risk levels before you make any investment. Past results are not an indication of future performance. Please take the time to read the full disclaimer here.

November 12, 2008

Oil Prices & Alternative Energy Stocks

The recent slump in the price of energy commodities that has accompanied slumps in the rest of the market has reignited an old debate: to what extent is the performance of alt energy companies (and their stock prices) linked to fossil energy prices? People who argue that the two are closely connected implicitly believe that policy-makers and other important economic actors view alt energy mainly as a hedge against high energy prices, and therefore believe that a drop in fossil energy costs will result in a fall from grace for alt energy (there is evidence that at least some firms view renewable energy as such, providing credence to this argument). Those who, like myself, believe that the fundamental performance of firms in the sector is not connected to the price of fossil energy (considerations of input costs aside), argue that the policy commitment behind the growth of much of renewable energy for the past few years has had more to do with political positioning on the increasingly-salient environment file.  

In a simpler follow-up to an article I wrote in July, I decided to put together a chart looking at the performances of a few ETFs since early July, when the commodity bubble burst. I included the following: (a) the S&P 500, as a general benchmark of performance for equity markets; (b) the USO ETF, which tracks the price of crude oil; (c) the UNG ETF, which tracks the price of natural gas; (d) the PWND ETF, which I believe provides more direct exposure to the wind sector than does the other wind ETF, FAN; and (e) the KWT ETF for solar, for no particular reason. Tom wrote a useful article on alternative energy and cleantech ETFs and mutual funds in July, for those who missed it. I apologize for the quality and look of the graph - I picked the background that made it easiest to see the lines, and BigCharts doesn't exactly allow you to produce nice, clean charts.


If we accept that current stock prices reflect expectations of future firm performance, looking at this chart certainly seems to indicate that investors believe the outlook for the wind and solar sectors is grim. Indeed, not only have wind and solar stocks fallen much further than the market as a whole (>30% for solar!), but investors have discounted them beyond the fundamental risk they see in falling fossil energy prices. This outcome is broadly in line with the efficient market hypothesis - alt energy outperformed the market as a whole over the past couple of years because alt energy investors took greater risks.   

For the solar sector, this drop can be explained by concerns over a perfect storm brewing over the industry in 2009, coupled with uncertainty over the sustainability of very generous subsidy regimes in key markets like Spain and Germany. For wind, which relies for its deployment on project finance-type of arrangements with high gearing ratios, concerns over rising debt costs have added to anxiety about declining natural gas prices, wind's main economic competitor in the US.

In light of this, what's the answer to the main question posed initially about the relations to fossil energy prices? It's not clear. It is still too early to draw conclusions about any clear relationship between the performance of solar and wind firms and the prices of oil and natural gas. It is also impossible at this stage to disentangle all of the headwinds facing solar and wind and assert that energy prices play a larger role than other factors. In my view, if policy commitments to alternative energy are strengthened rather than weakened during this crisis, which looks like it might be the case, it would represent the clearest evidence yet that policy-makers pay little to no attention to energy prices in deciding on support measures for the sector. In any event, what policy-makers believe may not matter much of the IEA is right about global oil supplies. In either case, alt energy investors win.

DISCLOSURE: Charles Morand does not have a position in any of the securities listed here.

May 27, 2008

Peak Oil & Energy Efficiency In The News

A couple of interesting items in the news yesterday on topics dear to alt energy investors' hearts.

Firstly, a new report (PDF document) by CIBC World Markets arguing that globalization could be reversed by high oil prices. The folks at CIBC WM contend that growing shipping costs driven by higher prices for transportation fuels could erase the Asian labor cost advantage, driving a renaissance in North America's manufacturing sector. What's the main culprit? Peak Oil, albeit not called directly Peak Oil. I watched an interview with Jeff Rubin, CIBC WM's Chief Economist, on Bloomberg's In Focus yesterday, and he pin-pointed supply problems as underlying what he saw as a secular upward trend in oil prices. Mr. Rubin certainly didn't appear to be of the opinion that major new supply would come on-stream in the foreseeable future, and believed that the solution to this energy crunch rested with demand-side management. He was therefore opposed to lowering taxes on fuel on grounds that that would do nothing to curtail demand.

The second thing that caught my attention yesterday was an article in the WSJ (subscription required to view the full version) discussing new research by Cambridge Energy Research Associates (CERA) showing a marked increase in the cost of building power plants. Last Thursday, I wrote an article discussing the potential for energy efficiency. As noted in the WSJ article, certain utilities are turning to efficiency measures like smart metering as a way not to have to build new generation capacity because of growing costs. See the WSJ Environmental Capital blog's summary of the article.

Taken together, these two pieces of information are in line with my belief that a significant push toward efficiency and demand-side management across energy-intensive sectors is about to get underway, as it already has in the airline industry.

December 19, 2007

Jim Rogers: What Peak Oil Will Do for Cotton

The most recent issue of Fortune has an excellent interview with Jim Rogers, of Investment Biker and Adventure Capitalist fame, as well as an excerpt from is new book, A Bull in China.  Jim saw the start of the current commodities supercycle early (peak oil is just one driving force for this cycle), but it still has a long way to run, in my opinion, as well as Jim's.   Almost everything has some dependence on energy prices, because of either the embodied energy, or because if the embodied energy of substitutes.   As Jim says in the interview,

Cotton is a good way to buy oil-- hear me out.  Much apparel has been made from synthetics.  Synthetics come from oil.  So many textile makers are converting back to natural fibers because oil is at an all-time high.  So if you want to buy oil, buy sugar [because it is easy to turn into ethanol], or buy cotton.  What I'm buying right now is agriculture.

I hadn't thought of this cotton-oil connection before, and it's drawing these connections before others do that makes a great investor.  Incidentally, cotton and oil are also connected more directly via the use of oil to make pesticides and fertilizer, and indirectly when land formerly used to grow cotton is shifted to grain production because of rising ethanol prices, but I think the substitution effect Jim talks about is likely to be strongest.

Tomorrow I'll share with you one of Jim's stock picks that I think fits well into an Alternative Energy portfolio.

April 15, 2007

The Peak Coal Portfolio

Last week, we alerted you to a report from Germany's Energy Watch Group called “Coal: Resources and Future Production,��? which predicts peak coal by 2025.  Readers of AltEnergyStocks are doubtless familiar with peak oil, the inevitable fact that as we consume a finite resource (oil reserves) at some point the rate of that consumption must peak, and taper off.  Serious arguments about peak oil center around "when" oil production (and consumption) will peak, not "if."  

The same it true for other finite natural resources, such as natural gas, uranium, and even coal.  The difference with coal is the received wisdom: that the US has two centuries of remaining coal reserves, with the (often unspoken) implication that there is no need to worry about it in our lifetimes.  Other reports have drawn attention to peaking coal supplies before this, and I have no doubt that more will follow.  

How to beat the market

As an advisor seeking superior returns for my clients, I take reports like this seriously.  Dismissing them out of hand because it disagrees with the consensus view is not only close-minded, but a massive missed opportunity.  That's because, in order to achieve superior returns, I must accomplish four things:

  1. Have hypotheses that differ from the consensus view.
  2. Act (i.e. make investment decisions based) on those hypotheses.
  3. Be correct as often as not.
  4. Have a mechanism for testing the hypotheses, to enable a change of tactic when a hypothesis is proven wrong.

The first two are easy... but without  numbers 3 and 4, I'd be just another whack-job in the blogosphere losing my own and my client's money.  Here's how my hypothesis looks for peak coal:

1. A hypothesis.  The consensus is too complacent about the supply of coal.  Note that I don't need to pin down a precise date for the peak in coal production (worldwide or in the US), I simply have to identify something I believe the majority of investors have gotten wrong and the direction of the error.  My hypotheses are normally of this form: how the consensus view is incorrect.

2. See "How to prepare your portfolio for Peak Coal" below.

3. You don't have to be right all the time.  One of the great benefits of diversification is that it allows an investor to make mistakes.  None of us is right all the time.  For example, I've been bearish on the market as a whole since 1998... which means I was wrong in 1998 and 1999, right in 2000, 2001, and 2002, and wrong since then.  However, despite the fact that I was wrong about the market for six out of the last nine years, over that time period, I put a large chunk of the money which I otherwise might have allocated to US stocks into foreign currency denominated bonds mostly through close-end funds such as the Aberdeen Global Income Fund (AMEX: FCO), because I expected a general decline in the dollar. Note that is is a vast oversimplification of one choice taken within my managed portfolios over the period, and should be considered educational, not taken as an example of past returns.  Looking at this chart comparing SPY and FCO (I'm using SPY as a simple proxy for the US stock market as a whole) for the last nine years,  you will note that SPY outperformed FCO over the period by about 25%.  However, over that time SPY has had an average yield of around 1.5%, while the yield on FCO has averaged around 7%, over 9 years, that difference amounts to a 35-50% advantage for FCO (depending on the investor's tax rate), for an advantage in total returns for FCO of between 10% and 25%, or 1 to 2% compounded annually.  

Also note that risk (measured in terms of volatility) for FCO has been much lower than that of the market over that time period.  So while I was wrong about the market 2/3 of the time over that period, I was correct about the general decline in the dollar a bit more than half of the time, and the extra income I earned with my risk adverse strategy of investing in bonds rather than stocks left me with a slight advantage over the period.   Through these slight advantages, amounting to only 1-2% per year, a successful investor can dramatically increase his returns over the long term.  Once again, these returns are only an example, showing the long term advantage of acting on the hypothesis that both the US market and the dollar would under perform over the last 9 years.  I still believe both these to be true, and as a result, I and my clients continue to be over-allocated to foreign bonds, and under-allocated to US Stocks (with the exception of alternative energy.)  Nevertheless, past returns are no guarantee of future results, which is why it's important to...

4. Quickly recongnize when you're wrong. Thinking again about my hypothesis the market is overly complacent about coal supplies, how can I know when it is incorrect, either because I was wrong to begin with, or because conditions have changed?  That could happen because coal will continue to be as easy to mine as most investors think, or because they become as worried about coal supplies as the situation warrants.  China, where the most rapid coal depletion is taking place, may indeed recognize the severity of coming shortages, but my hypothesis is primarily about investor in US markets.  Until recently, the Chinese have mostly confined themselves to buying huge chucks of our Treasury and other agency debt, but we see them rushing to secure long term coal contracts in Africa and elsewhere.  Since China is a net coal importer, it is much harder for them to be as complacent about coal reserves as we are in the US.  At the moment, I don't see any worrying at all about coal reserves in the popular press, and reporters typically accept the "200 years of coal" line without question.  When that changes, it will be time to re-evaluate.  As to my simply being wrong in my pessimism, even the normally Pollyanna-ish EIA estimates, coal production in the US will peak in 2060, which implies a peak in world production much sooner, because the US has the lion's share of remaining reserves.  I don't believe that a world peak in coal production even as late as 2050 has yet been acknowledged.  When it is, it will again be time to reevaluate this hypothesis.

What to expect from Peak Coal. 

While I usually only make investments that I expect to pay off in 5-10 years time, and even the earliest predicted peak for world coal production is still 18 years off, the precise date of the peak is not at all important for the purposes of investing.  What is important is when we will see unexpected price rises as demand adjusts to constrained supply.  As an example, the first effects of peak oil are not happening today; instead they happened in the early 70's, when United States production peaked, and Texas could no longer act as the swing producer of oil, leading to a shift of production in the Middle East.  Because of the new investment required, that shift took a number of years, during which time oil stayed at historically high levels, until new production caught up with demand.

Could something similar happen with coal?  If any country is likely to be a driving force for world demand, sending prices up for everyone, that country is likely to be China, which is by far the largest producer of coal, but has only half the reserves of the US (according to the EWG report.)  How many times have we heard that the US is the "Saudi Arabia of Coal"?  If it is, the China is the "United States of Coal."  I think a price spike in coal available for worldwide trade is the most likely investable event for peak coal in the near future.

Here are some effects I would expect from such a price spike.

  1. Coal prices in current coal importers would skyrocket.
  2. Coal prices in areas with easy access to ports would also rise dramatically.
  3. Transportation links such as rail from coal producing regions to ports, ports, and bulk shipping would also benefit.
  4. The price of electricity in regions relying on coal fired power (other than mine-mouth plants) would increase several cents per kWh.

How to prepare your portfolio for Peak Coal.

  1. Companies owning or discovering new coal reserves in coal importing regions will benefit dramatically.  (I'm far from an expert on coal companies, so I have no specific recommendations here.  I also avoid investment in coal because of the effects of mountaintop removal and global warming.)
  2. Coal mining companies with easy access to ports will also benefit dramatically. 
  3. Rail lines with connections to large port facilities would benefit, as well as the port operators.  (Again, I'm no expert.)
  4. Construction companies able to quickly build rail lines and expand port facilities will also benefit. (I don't know much, do I?)
  5. Shipping companies who own large ore/coal carriers will benefit.  Shipyards which produce these ships likewise. 
  6. Companies that use coal for purposes other than electricity generation will be hurt.  Avoid coal-to-liquids companies such as Sasol [NYSE:SSL], Rentech [NYSE:RTK] and Syntroleum [NASDAQ:SYNM].  I wouldn't advise shorting these, unless you are a lot better than I am at anticipating price changes in energy markets: they'll all profit from Peak Oil, perhaps long before they are clobbered by Peak Coal.
  7. Alternatives to coal based electricity will also benefit.  Because coal plants supply base-load power, the first beneficiaries will be Nuclear power and Geothermal, both of which are also inherently base-load power sources.  The easiest way to invest in Nuclear today is by buying uranium miners an processors.  I'm personally not a big fan of this approach, but you'll find a lot of other people's uranium picks over at Seeking Alpha.  Warning: there is a lot of talk about Peak Uranium as well.  Since I have decided to stay away from Nuclear because of the proliferation and hazardous waste effects, I have not made an attempt to figure out how serious this will be for miners.  This brings up another general point about investing: you don't have to have a hypothesis about everything... nor should you.  It is much better to have a few good ideas than a stack of half-thought out ideas.
  8. Geothermal is an under-appreciated renewable form of electricity generation.  Ormat Technologies (NYSE:ORA) is the premier geothermal company, and should be the centerpiece of a geothermal portfolio.
  9. Concentrating Solar Power CSP can be combined with thermal storage to produce base load power (or even peaking power.)  North American companies are only now starting to discover CSP, wit the exception of FPL (NYSE:FPL), which owns most of the original CSP plants built in the United States in the 1970s and '80s.  European Conergy AG (an engineering firm) and Iberdrola SA (a utility) are actively pursuing CSP.   I'm also watching an Australian company called Enviromission (EVOMY.PK), which is developing Solar Chimney projects, which can easily be a source of base load power, and are remarkably low-tech (which leads to very low running costs.)
  10. Biomass, such as wood waste and trash incineration  is a good source of small amounts of base load power.  Boralex (TSX: BLX)) and The Boralex Power Income Fund (TSX: BPT.UN) have experience with biomass.  Another option I like are forestry and paper companies, especially ones committed to sustainability such as Catalyst (TSX: CTL) and Domtar (NYSE:UFS.)  Waste Management, Inc. (NYSE: WMI) has a variety of power generation projects fueled by the trash it collects.
  11. Power storage technologies such as Compressed Air Energy Storage and Flow Batteries which can allow intermittent sources of energy such as wind to meet base load power needs. One flow battery company I like is VRB Power (Toronto Venture: VRB.)
  12. Hydropower based utilities, such as Idacorp (NYSE:IDA) will increase their cost advantage over coal, and their dispatchable nature will become even more valuable as a balance for intermittent wind.  Some may also have valuable opportunities to take advantage of pumped hydro power storage.

Given the uncertainties about the timing and effects of the early stages of peak coal, I find it fortunate that a lot of the things I'm doing to prepare my managed portfolios for carbon regulation are the precise things I should be doing to prepare for rising coal prices.  I have little doubt that serious regulation of CO2 emissions is on its way, and quite likely sooner and much more comprehensively than most investors are prepared for.  But that's a hypothesis for another day.


Energy Watch Group report

Discussion at The Oil Drum

EIA Coal data

Discussion of the EIA's most recent Energy Outlook at The Cost of Energy

DISCLOSURE: Tom Konrad and/or his clients have positions in FCO, ORA, FPL, Iberdrola, BPT.UN, CTL, UFS, WMI, VRB, and IDA.

DISCLAIMER: The information and trades provided here are for informational purposes only and are not a solicitation to buy or sell any of these securities. Investing involves substantial risk and you should evaluate your own risk levels before you make any investment. Past results are not an indication of future performance. Please take the time to read the full disclaimer here.


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