What Can Be Done to Mitigate the Problems

There is no “silver bullet” that can save us from the coming turmoil. Rather we need aggressive work on all fronts. Key actions to be taken include:

• Dramatically increase conservation/efficiency improvement efforts – which is the most crucial and most promising option.

  - This is the only response to supply shortages and/or price spikes that can have a significant effect in the near-term.

  - Most buildings and production facilities can reduce energy consumption by at least 10 – 20% through simple low-cost/no-cost measures.

   

• Basic maintenance of HVAC equipment and better training of operations & maintenance staff are critical needs.

   

• Improving O&M practices is a prerequisite for achieving the savings that investments in new, more-efficient HVAC, lighting, and building equipment can provide.

   

• These actions typically have very high ROIs.

  - Technologies that are more efficient than current standard practice are readily available today, but we still need to develop and promote even more efficient technologies.

   

• Building owners and developers need to push for more efficient designs and be willing to invest the resources needed to create improved designs and then install the efficient equipment that is specified. “Value engineering” should be value engineering, not simply a mask for blatant cost cutting during construction.

   

• Buildings constructed and HVAC equipment purchased today represents a 15 – 30 year energy commitment. Intelligent buyers will incorporate life cycle costing in the planning processing.

  - There is no reasonably possible scenario for the future in which improving energy efficiency is not highly beneficial to everyone.

   

• Develop alternative fuels production technologies and build facilities to produce liquid and gaseous fuels to supplement/replace crude oil and natural gas.

  - Coal and biomass gasification and liquefaction are the leading options for the near-term and long-term.

  - The energy density (Btu/pound) of liquid hydrocarbon fuels is far greater than energy density of any of the promising hydrogen storage options.

  - Liquid fuels are the only feasible power source for aircraft and they are the preferred option for long-distance truck transport or automobile travel.

   

• Develop renewable energy resources – biomass, waste heat/fuel recovery, hydropower, wind, solar, geothermal, ocean waves, ocean thermal energy conversion.

   

• Improve emissions controls for dirty fuels so that it is more acceptable to use them closer to load centers – e.g., coal-fired combined heat and power (cogeneration) or district energy systems.

   

• Increase electrification of end-uses and strengthen the electric grid.

  - This will enable us to more easily utilize renewable, coal, and nuclear resources

  - Strengthening the grid and improving energy storage technologies also will increase energy supply reliability and flexibility.

   

• Educate the general population to increase awareness of energy problems, understanding of how energy is produced and consumed, and knowledge of how to reduce consumption.

Barriers to Overcome

The main barriers to improving energy efficiency in this country are institutional and economic in nature, not technological. We need to change attitudes toward energy and remove institutional barriers to energy efficiency. Rising energy prices will help break down economic barriers, but volatility will be high and the periodic price drops that occur will inhibit action.

The two main institutional or behavioral barriers to improving energy efficiency are:

• First cost dominates operating cost/efficiency in equipment buying decisions.

  - In commercial real estate, the person who pays for HVAC equipment often does not pay the resulting energy bills. Developers and owners are unlikely to change their current practices until tenants start demanding more efficient buildings.

  - In residential appliance, vehicle and housing markets, first cost and features/appearance are highly emphasized while operating cost typically is ignored of downplayed.

   

• Neglect of operations and maintenance – while reducing operating costs is a high priority of facility managers, few seem to recognize that neglecting HVAC O&M can greatly increase operating cost and cause air quality problems. Staff salaries and maintenance contracts are highly visible on operating statements, hence O&M personnel and maintenance contracts often are cut in misguided attempts to reduce operating costs.

The high cost of upgrading our existing infrastructure (e.g., buildings, utility power plants) and change commuting/living patterns is another major barrier. It will take a lot of energy to keep inefficient buildings constructed in the days of cheap energy habitable and it will take several decades to upgrade or replace them. In most of the country, it is virtually impossible to live without a car. We must find ways to shrink the energy consumption of cars and reduce the need for them which will require major lifestyle and social changes.

Past experience clearly indicates that education alone will not be sufficient to achieve lasting improvements. Consequently government action probably will be needed to ensure sustained action. To borrow a phrase from the 1970s, we are facing “the moral equivalent of war.” Defending a country from attack is a key function of the government. A reliable energy supply is absolutely essential for the health, safety, and well being of the population and the impact of protracted shortages could be just as devastating as a foreign attack. Government action to reduce the potential for severe problems and mitigate their impact is appropriate and may be necessary. However, this is an extremely complex situation and misguided government action could easily do more harm than good.

A good example of the challenge is efficiency standards. Energy efficiency requirements for buildings, appliances, and vehicles should be raised, but the structure of new standards can greatly affect their impact. In most cases, higher standards will increase the cost of the new equipment which gives consumers a reason to postpone upgrades. The new standards should include provisions to preclude indefinite delays in equipment replacing equipment.

Conclusions

The energy outlook is not encouraging. Conclusions that can be drawn with a high degree of confidence include:

• Natural gas and oil production will decline significantly in coming years. The timing and rate of decline is uncertain, but there is no doubt that the decline will begin before most people are ready to deal with it.

   

• NG and oil prices will be very volatile in coming years.

  - We will see significant price increases and possibly shortages during periods when demand exceeds supply. Price spikes could be extremely high by historical standards because much of the demand is highly inelastic.

  - Price spikes will be separated by periods of lower prices resulting from economic weakness and/or mild weather. However, it is quite possible that these “lows” will be high by historical standards.

   

• There is no indication that recent price increases have led to a significant improvement in the average efficiency of buildings, appliances, or vehicles in the US. The nominal life of these systems varies from around 10 yrs (vehicles) to over 30 years (buildings) and supply problems are certain to occur before the end of their useful life.

   

• There is no “Plan B” if the supply optimists are wrong. We need to increase awareness of potential the severity of the problem and promote actions to rapidly increase energy efficiency and flexibility and accelerate action on developing alternatives to oil and gas.

   

• The U.S. infrastructure – housing, commercial buildings, transportation, utility network – has been built based on plentiful, relatively inexpensive energy. The country must make the transition to a world where energy is expensive and supplies of certain sources may be limited and/or periodically interrupted. Doing so will be expensive and time consuming. Delaying serious action further will make the transition even more difficult.

   

• The most promising near-term option is dramatically increasing conservation and energy efficiency improvement programs. These efforts will provide major economic benefits (new jobs, operating cost savings, smaller increases in energy prices) and environmental benefits (reduced air and water emissions, improved indoor air quality).

Reliability/Believability of This Forecast

At the current time (mid-2005), the opinions of energy prognosticators vary over a wide spectrum. At one end are those who believe “the sky is falling – head for the hills.” Those at the other end generally agree that we have some near-term problems, but they are optimistic that market forces will prevail, which will lead to supply and demand rebalancing at reasonable prices. There is not doubt that market forces ultimately can bring supply and demand into balance. However, current trends indicate that the prices at which supply and demand will balance – and the turmoil during the transition – could reach levels that are devastating to the US economy. Furthermore, these extreme prices may appear much sooner than most people anticipate.

So why should you believe the assessment presented here rather than the optimists’ more reassuring projections? The main reason is the difference in approach. Many (if not most) forecasts are based primarily on either econometric analyses or resource availability assessments, and they downplay or ignore concerns raised by the other approach. The assessment presented here attempts to merge these two approaches and incorporate other critical concerns. Two key concerns addressed here are 1) the typical behavior of consumers and corporate decision makers in response to changes in energy prices/supply and 2) the limited availability of trained personnel and capital funds needed to implement solutions. Adding all of the relevant factors to the mix leads an objective observer to question the validity of many of the assumptions upon which the optimistic forecasts are based.

For example, econometric evaluations often do not seem to adequately address some crucial drivers. These models normally incorporate factors that can be quantified, but many of the key factors are qualitative in nature or they are unpredictable. The two factors that generally have the greatest effect on projections – weather and level of economic activity – fall into the “unpredictable” category. Crucial factors that cannot be quantified readily include:

• Political – potential for terrorist attacks of key export facilities, government instability in some major producing countries, potential for further misguided deregulation/re-regulation efforts, or new government interventions in U.S. markets

   

• Market behavior in the US – institutional barriers to energy efficiency and the low priority of energy systems lead to a high degree of “economically irrational” behavior (e.g., lack of preventive maintenance, refusal to use high-efficiency/high-ROI technologies)

   

• Resource availability constraints:

  -Most models assume that as prices rise, supply also will rise due to increased exploration and technological advances. They assume there depletion of current resources can be overcome even though this rate has been increasing steadily in recent years (“the treadmill is steadily speeding up”).

  -The reliability of the data being used to estimate the size of known reserves and probable resources is questionable.

  -It is assumed that technological advances will solve many of the problems, but few major improvements are in the pipeline and it takes a long time to bring major changes into the mainstream.

  -Optimistic projections generally assume outcome on the favorable end of the resource and technological advances spectra.

   

• Environmental – when will exploration moratoriums and intense resistance to coal and nuclear power plants, transmission lines, pipelines, LNG terminals, etc., remain in effect.

   

• Financial constraints – limitations on the capital available to build massive new infrastructures for LNG liquefaction & transport, renewable energy capture and conversion, electric grid improvement, coal & nuclear power plants, alternative fuels production facilities, etc.

   

• International competition for energy supplies – developing countries will need huge quantities of oil or some alternatives to if their economies are to grow.

The assessment presented here has attempted to summarize information that, when analyzed as a whole, indicates that the world is facing major energy problems soon. No attempt was made to develop and run a quantitative model estimate the timing and magnitude of the problem. A modeling exercise such as this would provide little useful information because of: 1) the high degree of uncertainty in all of the major drivers, 2) difficulties of trying to quantify qualitative factors, 3) the inability to portray the volatility inherent in these markets, and 4) the uncertain reliability of the assumptions that developers have incorporated in the models.

Another problem with econometric models is that they covey an incorrect image of future prices. Figure A-1 illustrates this problem. Historical data in both examples clearly shows the volatility of prices while the Projections show relatively stable future prices. Furthermore, the “high price” scenario doesn’t come close to high prices that were experienced recently.

Price fluctuations are caused primarily by factors that are beyond our control and their magnitude and timing cannot be accurately predicted. We know that the future prices will exhibit strong volatility, but forecasting models can only address this volatility through sensitivity or scenario analyses. Hence, they generally give a false image of stability and predictability.

As noted above, the questionable nature of the assumptions built into forecasting models is another reason for challenging their projections. Figures A-2 and A-3 illustrate this problem. In Figure A-2, the heavy solid line shows actual prices and the dotted lines show EIA’s forecasts in 1981, 1983, 1986, 1989, 1992, 1995, and 1996. EIA’s model assumed that we were running out of gas hence the price had to rise. The near term projections were adjusted each year based on recent market trends, but the model retained a bias toward increasing prices over the long-term.

Figure A-3 shows a recent EIA forecast that disagrees with the outlook presented in this paper and illustrates the challenges in interpreting and extrapolating data. In April 2000 the US Geological Survey (USGS) published results from an in depth assessment of potential worldwide oil resources that was conducted by 40 geoscientists from a variety of backgrounds. EIA then conducted an in-depth analysis of the long-term oil supply outlook based largely on the USGS results. Figure A-3 is a compilation of forecasts for 12 scenarios that were evaluated. EIA assumes that production of conventional crude oil will expand to meet the 2% consumption growth rate that has been experienced in recent years until peak production occurs and then output will abruptly go into sharp decline. Depending on scenario, they forecast that peak production will occur somewhere between 2021 and 2112.

This analysis illustrates the danger of relying on mathematical models and failing to consider the feasibility of the forecasts they produce. The USGS study estimated that ultimate worldwide recoverable resource would be between 2248 and 3896 billion barrels with a mean value of 3003 (which compares to an estimate of 600 in the 1940s). The 3003 estimate is composed of 600 already produced, 1000 in current proven reserves, and 1400 to come from new finds or growth of current reserves. EIA’s base case assumes that the 1400 billion barrel addition would occur between 1996 to 2025 which means an average find of 46 billion bbl/yr, which is more than 4 times the find rate experienced in the 1990s. However, reserve additions since 1996 have been running at less than 30% of this rate. Figure 14 showed that finds of the giant fields that account for 60% of total finds to date stopped in the mid-1990s, hence most or all of the new supply would have to come from relatively small fields. Furthermore, production from areas of the world that already have passed their peak show a gradual rise and decline, not the sharp peak in the EIA forecasts.

What is even more troubling is that the analysts who conducted this study seem to believe that continued rapid growth in consumption followed by an overnight, massive collapse in production is a feasible scenario. This indicates to me that we have some analysts who are seriously out of touch with economic reality.

One of the main goals of the assessment presented here is to raise awareness of the severity of the energy problems we are facing. We know beyond a reasonable doubt that we will experience severe oil and gas availability and price problems in the near future unless some even worse catastrophe (e.g., severe worldwide economic depression or another world war) occurs and postpones the onset of energy supply problems. The timing and magnitude of these problems will be greatly affected by factors beyond our control and difficult or impossible to predict – e.g., weather, level of economic activity, political problems. However, the onset of severe problems is likely to occur within the next several years, not several decades from now.

Bibliography

References for information presented in this paper and good sources for additional background information are:

1. Energy Challenge 2004 – a series of 11 articles on different fuels and other aspects of the energy industry by Murray Duffin which also have been published in EnergyPulse; located at http://www.energypulse.net/centers/author.cfm?at_id=575

2. Numerous presentations by Matthew Simmons of Simmons & Company International which are available at: http://www.simmonsco-intl.com/research.aspx?Type=msspeeches.

3. Raymond James Financial, Inc. – Energy Stat of the Week, Natural Gas Update (weekly) and Energy Monthly available at http://www.rjcapitalmarkets.com/industry_1300_main.asp?indid=71

4. U.S. Department of Energy, Energy Information Administration – Extensive database of energy price and supply information, forecasts, and analyses, available at http://www.eia.doe.gov.

• Long-Term World Oil Supply Scenarios, John H. Woods, Gary R. Long, David F. Morehouse, August 18, 2004, available at (http://www.eia.doe.gov/pub/oil_gas/petroleum/feature_articles/2004/ worldoilsupply/oilsupply04.html)

5. Peak Oil Scenarios – description of 5 basic scenarios with backup articles describing rationale for each, available at http://www.oilscenarios.info/index.htm

6. Peak Oil News and Message Boards - http://www.peakoil.com/

7. Hostage to Oil: World Supply Is So Precious That More Price Spikes Are Inevitable, U.S. News and World Report, January 19, 2005