Energy Policies are Complex Energy Solutions Are Even More So -- The Pickens Plan --

Energy Policies are Complex Energy Solutions Are Even More So -- The Pickens Plan --

3.27.09

Andrew C. Givens, President, Cardinal Energy Service, Inc.

The energy market is extremely complex and crosses international boundaries. On the supply side there are many participants including sovereign nations that own and develop reserves; multinational integrated producers; regional and local fossil fuel developers, drillers, miners and producers; refiners and processors; transporters; local dealers and utilities. With regard to nuclear fuels there are issues about politics, the environment, and security as much as there is about fuel supply. Politics, weather, and public perceptions all impact the energy supply and price from each of these components.

On the demand side, there are individual residential and commercial utility consumers; heavy industry that may have some flexibility in the energy sources; industries such as transportation that lack fuel flexibility ; utilities as purchasers of fuels; governments and the military forces; and drivers just like you and me. The energy market structure is also very diverse with utilities that have been heavily regulated for the last 70 years, and some segments that are very free market, as with the spot market for oil that we hear about on the evening news.

The complexity of the energy market has always been accompanied by supply and demand conflicts and there is no single silver bullet that will eliminate all perceived ills in the market. On the other hand, there are refinements in the market that will make a more efficient energy market in this country, and hopefully around the world. Because the "Pickens Plan" put forth by T. Boone Pickens has been put forward as a solution to the energy problems in this country, this paper will address aspects of the Pickens Plan and complications with the implementation in this complex market. The Pickens Plan is available at www.pickensplan.com .

The Pickens Plan:

First, I commend T. Boone Pickens for bringing this plan to the American people because it is important to have this national discussion. I also commend Mr. Pickens call for strong leadership to craft a coordinated approach to our energy markets. However, I believe in a market approach to energy development that reflects the complexities or the market and offer these comments that should be considered in forming an opinion and public policy around the Pickens Plan.

1. Mr. Pickens is correct that the billions we are spending on foreign oil is shifting our national wealth to foreign countries. Of course so is the billions of dollars which we have spent on toys, trinkets, electronics, extra t-shirts, drive through give-a-ways, and other casual and frivolous consumption of products from China and the third world. The scale and impact of this foreign spending for the sake of consumption amounts to consuming our seed corn and we will pay the price in the future.

But with regard to energy, and particularly oil, the changes which Mr. Pickens refers to since 1970 is made up of three things;

a. The US oil consumption rose about 5 million barrels per day, from about 16 million barrels to about 21 million barrels per day.

b. Our domestic oil production dropped about 4 million barrels per day, from 9.5 million barrels to about 5.5 million barrels per day

c. The price of oil rose from about $20 (2006 $) to over $140 per barrel in 2008. It currently is in the range of $50.

Viewing the change in this way, we can see three approaches that may effectively address the enormous flow of dollars to foreign producers that Mr. Pickens does not mention. First, we can address the increase in consumption by taking steps to reduce total energy consumption, not just replace oil with natural gas. We have shown that we can reduce our consumption in response to the gas price last Fall. We should use this as an awakening experience to make permanent improvements to the auto and truck mileage standards and, our driving habits.

Second, we can increase production at home with offshore oil production and production of new resources in the mid-west and Rockies. Even as oil prices come off the spike above $140 per barrel, the production in these new domestic sites should be feasible and they are domestic. Of course this takes time to be developed and will speed up the ultimate depletion of these resources but it can be part of an intermediate plan to transform our energy market.

Third, we can add market stabilization structures that can reduce the short and intermediate term uncertainty that has battered the oil market in recent years. We have seen that as a leader of an oil nation shakes his fist, or a storm shakes the windows in the gulf, the price of gasoline can go up 10 or 15 cents over night. While things have settled down over the past few months, the American drivers have paid billions of dollars to share that risk. Measures such as long term contracting, which should decrease the impact of the short-term spot market, and use of a market stabilization petroleum reserve and a possible companion market hedge mechanism. Just as it has now become evident that the critical financial markets need regulation and structuring to provide stability and reduce the speculation and fear, the energy markets need to reflect true economic market factors rather than hysteria, fear, and panic.

The bottom line of this comment is that there are real solutions that may not involve the investment of billions of dollars in new generation, transmission, transportation fleets, and vehicle fueling facilities.

2. Mr. Pickens states, "In America today, 750 out of a thousand people have cars. In China 44 people out of 1000 have a car." I accept this as accurate, but ask, "Does this not say that there is going to be a rebalancing here? Are we in trouble?"

Americans, with sound leadership, can institute ways to significantly reduce their energy consumption, and I suggest that we are better off stepping up to the plate with responsible steps to reduce energy consumption rather than new ways to feed our existing energy diet. Energy reduction now, rather than after we are forced to by the next energy shock, can be smooth. I suggest that Mr. Pickens proposal just shifts investment to additional supply sources (which he is developing), and ignores the fact that our 4% of the world's population in the US consumes 25% of the world's energy.

Reducing energy consumption is not just wishful thinking. With strong action since 1975, California has maintained its annual per capita electric consumption at about 7,000 kWh while in the rest of the country the average has increased by 50% to about 12,000 kWh. Mass transit is used successfully by many US and foreign cities to reduce fuel consumption and can be implemented in many more municipalities. The initial CAFE standards in the 1970's reduced auto fuel consumption and higher CAFE standards now will lead to further reductions.

3. Mr. Pickens supports the use of natural gas as a clean and domestic resource. At this time we import 16% of our natural gas. About half of that is from Canada and Mexico. The other half, about 7% of the total US consumption, is imported as liquid natural gas or LNG. This gas comes from some of the same OPEC countries as the oil, including Libya, Nigeria, Qatar, and other oil and gas producers. The importation of LNG requires vast investments by foreign and domestic companies for new infrastructure in this country, including the existing specialized ports in Massachusetts, Maryland, and the gulf coast. Additional LNG ports are being developed. With significant increases in natural gas use, we may develop a significant dependence on foreign LNG suppliers. As we do so we also build into the system a significant investment in new LGN infrastructure and the move to a higher base supply cost for the fuel.

In addition, it must be said that Mr. Pickens has in the past, and I suspect currently has significant financial interests natural gas production. I appreciate his entrepreneurial success in the oil and gas industry, but I think that if he is proposing this as a solution to a significant national problem, he needs to make it clear what stake he has in this enterprise. If this is an ad for his companies, that is fine, but we should interpret it that way and not as a public policy piece.

4. Mr. Pickens proposes to substitute wind generation for the existing natural gas electric generation to free up the natural gas for transportation fuel. While the wind industry advocates are busy trying to meld the wind generation into the existing electric mix, there are still important differences in the characteristics of wind generation and natural gas generation. Natural gas generation, whether in simple cycle or combined cycle application, is dispatchable and provides capacity on call when it is needed. This increases the reliability to the utility grid. In addition, natural gas generation is dispersed and typically located near load centers or existing gas and electric transmission lines to reduce the need for new infrastructure.

On the other hand, the wind generation operates when the wind blows and is located only where the relatively constant winds exists. While the wind in areas such as west Texas and the plains is relative constant, when the wind subsides, there may be no resource to call on. When the load increases, there is no way to turn on the wind. An example of this problem occurred in February 2008 when the West Texas wind unexpectedly dropped approximately 1,400 MW in a short period and alternative resources were barely available to avoid a blackout in areas of central Texas. With a larger installed base and greater dependence on wind generation, backup generation may be less able to make up for the reduced wind generation, and the grid would be less reliable. The bottom line is that wind generation is not a direct substitute for natural gas or other forms of conventional generation.

5. The Pickens Plan states that the wind in the central part of the country is ideally located for serving the east and west portions of the country. Currently the electric generation is located throughout utility service areas and interconnected by the transmission network that allows power to flow from various generators to customers reliably. While many factors are considered, power plants are typically located near load centers for purposes of reliability, reduced transmission cost, and reduction of energy losses. The idea of serving the major load centers in the East and the West from the Midwest wind resources is difficult to accept.

The existing transmission grid is not suited to carry large one-way power flows from the Midwest to the load centers in the East and the West. Anyone who has watched the process of designing new transmission lines understands the difficulty in finding environmentally and politically acceptable routes. In many regions, it is nearly impossible to locate new lines. The process of building a large number of new, radial transmission lines across the Appalachians or the Rockies to serve populated eastern and western regions of the country would be particularly difficult.

As a small example of the cost of getting the wind power to the customers, we can look at Texas that is planning to spend $4.9 billion for a transmission system to bring the wind power in Texas to the major load centers in the state.

6. Mr. Pickens discussed his plans for the construction of 4,000 MW of wind generation near Pampas Texas. Many in the wind industry speak of these developments as being economically viable and competitive with existing generation. In fact, the feasibility of many wind projects is dependent on the direct federal production tax credit (PTC) of approximately 2.0¢ per kWh generated. Further, many wind farms have been able to sell renewable energy certificates in the voluntary or compliance markets. This is in addition to the revenue the operator gets from the sale of the electricity to the utility.

For the Pampas plant, with a capacity of 4,000 MW and a capacity factor of 40%, the annual generation would be 14 million MWH, and the tax credits each year would be $266,000,000 to Mr. Pickens' enterprise. It is a good thing to produce the power at a price where the customer can choose to buy or not buy based on the price. However, the tax credits and other support subverts the market forces by reducing the electricity prices but not the resource cost. This encourages additional consumption, and gets the country locked into a higher cost generation mix for years into the future, at a significant cost to the government. If the people of Texas or other states believe that it is a good investment, they should pay for it with their electric rates not with federal tax credits. Avoiding carbon and bringing the energy production to our shores will cost money, and those who consume the energy must see the price signals of that shift.

7. Mr. Pickens calculation of $700 Billion per year for imported oil appears to reflect the spot market $140 per barrel price of some months ago. This is truly a large amount and has a significant impact on the US economy. However, with the reduction of the price to about $50 recently, the value of imports is down to approximately $250 Billion. While it is not at all clear where the price will be tomorrow, next month, or next year, it is not wise to base major investments in energy infrastructure on unstable peak prices.

As an aside, in the 12 months ending June 2008 our total US imports were over $2,040 billion dollars. Much of this was on casual or frivolous consumption that has permeated our consumer economy in the last 10 years. A sincere interest in the economy would also apply to reducing this casual consumption. After all, the high cost of oil imports discussed by Mr. Pickens is based on a price spike, while the consumption of foreign consumer goods shows little sign of abating unless our economy stops growing.

8. In the 1950's nuclear power "...was going to be too cheap to meter." In the 1960's fusion power was going to provide unlimited power and was only 40 years away. In the 1970's solar power would be cost competitive in 10 years and would help carry us until fusion power came in. I am as optimistic as the next guy, but after the oil shocks of the 1970s we resumed our increase in per capita consumption as though some new technology would save us. We should not place our hopes in supply side solutions.

New supplies will be part of our future, but they will not save us from our own addictive consumption. The only short-term or long-term answer is to significantly reduce per-capita energy consumption. Some of this may come from life style changes, and some can come from technological changes. Therefore, the primary aim of our energy policy should be to reduce energy consumption, and extend the life of our energy resources, rather than finding ways to extract and consume the limited energy resource we have. This will have a double benefit of extending the life of our limited resources, and will tend to reduce the market price of what we do use by reducing the demand. A stabilized market environment, where the price reflects the full resource cost is necessary to achieve a long-term energy supply balance.

This is not to say that wind, solar, and other renewable generation should not have a major role in our energy mix, but it is critical that the energy consumers pay the full resource cost of the energy so that the consumption reflects the natural and financial resources which are consumed to provide the energy. To subsidize the energy development with the Production Tax Credit or similar tax incentives artificially under prices the energy, encourages additional consumption, and stimulates the need for even more production. In addition, considering the fact that tax incentives further increase our national debt, much of which is financed by foreign investors, this is not a wise policy.

With regard to carbon, which is not a focus of the Pickens Plan, the federal government must establish a regulating mechanism which allows utilities, industries, fuel suppliers, and the average consumer a way to value carbon emissions, and take steps to control it. Without such a structure, the threat of future restrictions leads to uncertainty and inconsistent plans. With a structure for valuing the carbon, utilities, industries, researchers, investors, and consumers will have a price tag that reflects the carbon impact and directs their rational market response.

Many states have Renewable Portfolio Standards that require electric utilities to include renewable energy in their generation mix, and the cost is passed on directly to the consumers. This uses the market forces to fund the generation and as the levels of renewable generation increase, the prices will increase, and the customer will make the buying decisions facing the resource cost. These states have been able to determine the renewable resources available and the proper generation mix in their region. Such mechanisms at the state level should replace the tax credits that are a critical component of funding some of the new energy technologies.