Apr

25

It is true Enron's management was engaged in a series of bad decisions. It is also true Enron offered major contributions to the energy industry. Their biggest contribution was to introduce power markets to the electric utility industry.

Because of Enron, control of the nation's transmission lines was wrestled away from utility engineers and put into the hands of traders and bankers. Physical transactions were replaced with financial transactions. Free options to use assets were monetized and priced in open markets.

One example is firm transmission rights (FTRs). Before Enron, owners gave away rights to use transmission lines to a trusted few. Now, FTRs are auctioned in open markets, where users bid for the right to use utility assets.

Because of Enron, Regional Transmission Organizations (RTO's) gained significance. RTOs are what many believe is the "nation's grid." The truth is North America has many unconnected grids, ten of which are open markets in the form of RTOs (most of the nation's population centers are located in one of those RTOs). Every day, RTOs conduct a series of open auctions for energy. They also conduct other auctions for capacity, FTRs and related products and services.

Enron helped transform a highly regulated government-controlled industry into a loosely regulated market-based industry. Enron went bankrupt before the transformation was complete. Initially, only the Northeastern states and California jumped into market-based power. Later Midwestern states, Texas and some Southwestern states joined in. But to this day, many Southern states shun power markets, preferring instead a government-controlled regulatory scheme.

It is true that Enron tried to corner the very market they created. It is also true that the financial techniques they introduced were new in the energy industry, they were borrowed from Wall Street, they were transformative, they were sometimes unfair and most were legal at the time.

Today, RTO's operate under Federal Energy Regulatory Commission rules. Those rules include valuable lessons learned from Enron and other actors. They continue to evolve.

On balance, Enron was a positive force for free markets. They were also a negative force for fair markets.

Russ Sears writes: 

Enron is a good example of what can happen when a company/species goes from a survival of the first strategy into a survival of the fittest as their niche draws competition and does not survive the process. Normally, growth and high profit margins are a sign of strength, but the temptation as the niche gets crowded is to eat the young to support the current generation of leaders so they can grow and have the high profits they were brought up to believe was their birthright. A similar thing happened in the mortgage backed markets.

These are the times that test collaboration and integrity. It is easy to be honest in passing out the pot when it keeps growing fast and furious. I believe Apple may be a case where it survives through a good collaborative environment within. Time will tell. Given Jobs' reputation of being a dictator and his temper, would this have been the case if he was still running things once continued growth became limited? 

David Lillienfeld comments: 

The issue with Jobs isn't what he would have done. It's whether the management team he left leads the company to continued prosperity. It isn't yet clear that they are so doing, but I'll give them another year to show one way or another.

Managements have two responsibilities–place the right people in their jobs and to provide for an orderly succession that allows the company to continue and hopefully better its lot. (Bettering its lot means ultimately bettering the lot of its shareholders.)

The book on Jobs as CEO isn't yet concluded. Many suggest that he was the greatest CEO of all time. I'm not ready to subscribe to that notion–not until his successors provide some demonstration that the company is not adversely impacted by his departure–no man being indispensable (that great Churchill comment about the cemeteries of Europe being filled with supposedly indispensable men). From my limited perspective, I think the title of the greatest CEO remains a tie between Alfred P. Sloan and John D. Rockefeller. One can argue about what they did, but its hard to argue with the results–both during their tenure and afterwards. J. P. Morgan, too. I suppose one could put George Washington in that league too, but I'll defer to others on this list who can speak to that idea–pro or con–better than I can.

Jobs was an SOB, but the man performed. So was Bob "get rid of the olives" Crandall. And Henry Frick. They all performed, they were all considered magnificent CEOs. The latter two hardly qualify as among the greatest CEOs, and the book is still out on the former.

Mar

14

I believe the Prime Minister backed off his statement about restarting Japan's nuclear plants. In all likelihood, some of their nuclear units may return to service, but now seems too soon.

Japan's commercial nuclear power plants can produce bulk power for approximately $12 per megawatt-hour. Importing Liquefied Natural Gas (LNG) to fuel gas turbines produces power at approximately $144 per megawatt-hour (assuming ~ $18/MMBtu for delivered natural gas and an average heat rate of ~ 8,000 Btu/kWh).

With 48,000 megawatts of undamaged nuclear capacity in Japan's fleet, the difference between $12 and $144 is significant. Assuming a 85 percent capacity factor, the simple difference adds up to approximately $50 billion per year.

In fact, the cost difference is greater than $50 billion. First, utilities must continue paying operations, maintenance, capital and fuel management costs even if their nuclear plants are idled. Idled plants produce no revenue to offset costs.

Second, the power market is punishing. The $144 would be a base bid in any power auction. Market-clearing prices would start at $144 and shoot up to higher heat rates, depending on hourly demand. (Higher heat rates suggests higher production costs)

The economic pain associated with high energy costs should cause Japan's policymakers to think hard about practical options. In all likelihood, Japan will restart some of their newer units, but not right away. Any restart will likely be slow, deliberate and sequential.

In the meantime, Japan will invest heavily in renewable energy. Production costs for wind, solar and demand-response are near $0 per megawatt-hour. More importantly, power from renewable power displaces the market's costliest fossil-fueled plants watt for watt.

The world seems to be betting Japan will continue to shun nuclear power production. Australia, Qatar, Indonesia and the US are eyening Japan as their prime customer for new LNG production. It appears their collective bet may not fully consider Japan's options of renewable energy and nuclear restarts. But that is another topic for another thread.

As an aside, Japan's power grid has an unusual design. Half of the nation is 60 Hz (because it was designed by Americans). The other half is 50 Hz (because it was developed by Europeans). Japan cannot easily move bulk power between 50 Hz and 60 Hz systems. The fact the grid is not homogeneous means the energy flowing within the grid is not fungible. It also means Japan's power markets are not efficient.

Carter Dimitroff writes: 

From a market perspective, the near zero production costs of wind and solar are reached without government subsidies. Government subsidies drive production costs into negative numbers or they reduce capital costs. Some nations use feed-in tariffs, which subsidies capital expenditures, production costs and margins.

Many in the utility industry are befuddled by production costs. For decades, utilities in the US have been regulated. Regulated assets need not respond to market forces, because there appears to be no market in regulated regions.

The fact is that where there are no formal markets, utilities create virtual markets. Responsible utilities dispatch regulated power assets using market principles. First, they dispatch low production cost assets, then they dispatch progressively expensive assets. The virtual market becomes distorted when there is limited liquidity. Small utility regions with few assets will often dispatch "must run" assets even if they are uneconomic.

Production costs are not levelized costs, nor are they operating costs. They are market-based costs. From an energy production perspective, production costs are the incremental costs incurred when a facility changes its state from offline to production. Those incremental costs are mostly made up of fuel and fuel handling costs. They also include additional costs for manpower, operating based maintenance and, in the case of US nuclear, waste disposal costs. But for the most part, fuel is the big driver in production costs (after all, a power plant is just an energy conversion device that wastes two thirds of its fuel in the conversion process).

Wind and solar facilities are largely passive machines. They need no costly fuel as feedstock and no incremental manpower to operate. They just sit passively and wait for sun or wind to manufacture energy.

Carder Dimitroff adds: 

First, the US has no feed-in tariffs for solar or for wind. There are negotiated power purchase agreements scattered about, but no formal feed-in tariffs exist like we see in Europe.

Second, no grid has an over abundance of solar power needed to spark the imagination suggested. At best, solar acts as a peaker. It is difficult to imagine a case where solar could supplant base loaded production. It is also difficult to magically arrive at a point where there is no cash flow. Investors would have throttled back before reaching this point.

Third, the case you cite for solar is extreme and hypothetical. But it has happened for wind. The locational marginal price has blown past zero on several occasions. But that was a signal there was a problem with transportation, not production. It was also a signal that higher cost producers refused to respond to market signals and as such, they refused to exit.

What does "h" mean?

Anonymous comments: 

Japan's fossil-fueled generation remains high because of continuing nuclear plant outages. Because Japan's thermal energy is imported, solar is beginning to look cheap.

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Feb

13

Beware the Ides of March. They come to demonstrate, not to legislate.

As damages are tallied, cash becomes king.

Opportunities abound as rubble is cleared. Swept away will be demonstrators, who rue the day they forced a great nation to the edge of the abyss.

Feb

11

Pilgrim Nuclear Power Plant, near Plymouth, Massachusetts was forced into a cold shutdown, due to a loss of offsite power (LOOP). This is not a big deal, but I'm sure some of the FUD folks will make hay out of Pilgrim's situation.

First, the need for power in New England is diminished. Current load is off by the equivalent of three nuclear plants right now. Projected load at New England's hub was supposed to be 16,980 megawatts and the actual load is 14,240 megawatts. So the temporary loss of the nuclear plant affects price, but not supply.

Second, when a nuclear plant loses offsite power, it is supposed to shut down. Usually, it shuts down without operator assistance.

Offsite power is used to power the plant's internal lights and equipment. Station service power comes from the grid, into the local switchyard, to the station service transformers and into the plant's power distribution systems. I'm guessing the LOOP problem is in the nearby switchyard, which is a huge substation and the origin of major transmission line(s). If there is a problem in the switchyard or in the transmission lines, then there is no transportation available for plant's produced power.

When there is a LOOP, diesel generators automatically activate. In US nuclear plants, there are three diesel generators, any one of which can handle the station's full load. One generator feeds the "Train A Circuit," which serves all critical loads, including battery chargers. Another generator feeds the "Train B Circuit" which feeds the redundant system of vital loads. The third generator is the swing - it can switch between Train A and Train B circuits. The Train A and B circuits are color coded, physically isolated, electrically isolated and the swing generator is a "break-before-make" swing (to maintain integrity of electrical separation).

Generators are frequently tested and test results are reported to the NRC. There is adequate amount of fuel available on site to power the generators for days (I forgot how many days are required under 10 CFR).

Currently, Pilgrim's diesel generators are operating as planned. As the nuclear plant finalizes its cold shutdown procedures, the load on the diesel generators becomes less critical. Depending on the design, vital systems needed to cool the primary system and to assure cold shutdown.

In the unlikely case where all three diesel generators fail, there are at least two banks of redundant batteries. These are massive lead acid batteries, which are hard wired into the redundant systems. Diesel generator failure will cause the batteries to supply energy without even a second of delay. Batteries are downstream and they feed four redundant vital circuits. Vital circuits are designed for instrumentation and control and they are color coded, physically isolated and electrically isolated.

Now the FUD folks (Fear, Uncertainty and Doubt) will argue that Pilgrim is a lot like Fukushima. There is enough truth to the statement to make the comparison seem valid. But the comparison is completely bogus and fear is unwarranted.

Like Fukushima, Pilgrim:

   1. Was designed by General Electric
   2. Is a Boiling Water Reactor (BWR) Mark I design.
   3. Is 40+ years old
   4. Has an ocean-facing site.
   5. Had a LOOP incident

Unlike Fukusima, Pilgrim:

   1. Has an upgraded BWR design
   2. Is designed to manage LOOPs
   3. Has access to unlimited amounts of fuel oil
   4. Didn't experience an historic earthquake
   5. Didn't experience a historic tsunami
   6. Didn't experience a historic earthquake, THEN a subsequent tsunami,
   AND a LOOP, THEN a loss of fuel oil
   7. Didn't incur any physical damage to any part of the facility

If you can keep objective distance from the Fukushima incident, you might appreciate that their plant's design. Their 1960-era design withstood an historic earthquake and it kept on tickin'. It withstood a subsequent tsunami of historic proportions and it kept on tickin'. It withstood a subsequent LOOP, and it kept on tickin'. Later, and only after the subsequent loss of fuel oil, did some units at Fukushima fail. It took four simultaneous failures before some units became crippled.

Keep in mind; some other units at Fukushima remain largely undamaged. Those undamaged reactors could technically return to service and provide electric power to the region. For policy and practical reasons, it isn't going to happen, but from an engineering perspective, it is technically possible.

Before memories fade and fear media takes over, it should remain clear that Fukushima did not cause the original earthquake, or the tsunami or the LOOP. There was a massive earthquake and massive tsunami, which damaged an entire coastal region, including local nuclear, coal and gas power plants.

Don't let the FUD folks make you go loopy over Pilgrim. While the station experienced a LOOP, a far more serious incident happened nearby. There was a 17-car pileup on one of Boston's highways. Pilgrim's LOOP will be reported nationally. The pileup will be relegated to page four of the local paper.

Feb

8

On Thursday, February 6th, at the Junto, Ivan Eland delivered a talk about the misplaced fears about oil shortages and how it has led to bad economic and political positions and interventions. He talked about 11 myths taken from his book "no war for oil".

1. no viable market exists for oil
2. Big oil colludes with OPEC to stick consumers with high prices.
3. Global oil production has peaked and the world is running out of oil
4. Oil is a special product of great strategic importance.
5. A strategic petroleum reserve is needed in case of emergency.
6. The us should become independent of oil, foreign oil or overseas energy
7. Oil price spikes cause economic catastrophes.
8. Us policy is to maintain the flow of oil at the lowest possible price.
9. Possession of oil means economic and political power.
10. The US must defend autocratic Saudi Arabia because of oil
11. Dependence of Europe on Russian energy is a threat to us security.

The gist of the argument was that high prices lead to increased supply and substitution of cheaper fuels and more drilling activity. And that oil producers were often the beneficiary of us policies which were designed to help them rather than the consumer. I believed that the talk was sadly needy of some scholars who knew something about oil that could have presented counter arguments or facts to the debunking of the myths that Eland presented. It was the kind of talk that needed some energy experts in the audience to present the opposite case if there was any. And I felt that the arguments made would not have persuaded anyone, except the vast majority that believed in the myths already. I wonder if any of the people knowledgeable about energy on this site could comment on the veracity and verisimilitude of these myths.

David Lillienfeld writes: 

Was any reference made to the West African oil fields or the Eastern Med fields (they may be as big as the Qatari natural gas fields) or even the new North Sea fields? (I won't get into the Brazilian or Mexican oil activities (Pemex is supposedly shedding some of the featherbedded/political spoils jobs it has), though they may be significant in the future.) Few analyses seem to factor these sources into the discussion, and while there are lots of geopolitical issues in play (Israel-Turkey-Cypress is but one potential flashpoint), the economic ones haven't been pushed to the side (witness some of the political stability emerging in West Africa (relatively speaking, of course)).

I don't know the book, but from these 11 points, it sounds remarkably US-centric. I gather no mention was made that the agreement between FDR and the Saudis was as much about the US-UK rivalry as it was about access to oil (which the US didn't need at that point–and didn't think it would need for some time to come. If I recall correctly, much if not most of the Allied effort in WW2 ran off of US oil. (One of Churchill's major accomplishments as First Lord of the Admiralty was moving the HRH Navy off of coal. The result was faster, more maneuverable ships able to stay at sea longer. But to do that change, the British needed a secure source of oil, which it had in the Persian Gulf. That's one of the reasons that Britain's 1970 decision to withdraw its troops from bases in Kuwait was significant.)

Stefan Jovanovich writes:

In 1904 - 7 and a half years before Churchill was appointed First Lord of the Admiralty - the Journal of the American Society of Naval Engineers was publishing the Report of the Liquid Fuel Board of the U.S. Navy. (You can find the Journal as an eBook in Google Books - search Journal of the American Society of Naval Engineers, Inc, Volume 16.) The conversion from coal to oil was already taken for granted. What people were struggling with were the very real technical challenges that had to be met in dealing with a liquid fuel that burned much hotter than coal - the shapes of the boilers themselves, the design and metallurgy of the boiler tubes, the advantages and problems of the super-heated steam that oil could produce, etc. What the same volume of the Naval Engineers journal also has a is a brief note detailing how many problems the British were having in their fleet exercises with the conversion and how many of those problems could be attributed to the inferiority of their metallurgical skills. The business about Churchill would be a bad joke if it were not representative of how much "history" has now become the endless copying of self-promoting gossip and rewritten press releases from the newspapers of the period. (It does, however, remind one of why it was around this time that Mencken decided he had had enough with newspapers and looked for somewhere else to write the truth.) .

This is not a rip on David. It is, however, another of Stefan's rants about the corruption of historical scholarship in modern academia. When a profession becomes nothing but an endless retelling of secondary sources, it develops the idiocy that medicine had when it was only practiced by reference to what Aristotle and Galen wrote. Churchill's taking and receiving credit for converting the British Navy from coal to oil is absolute nonsense. It is nonsense that is dutifully repeated in all the current discussions on the topic of oil, and it is a pure example of the peer-reviewed lie.

David Lilienfeld responds: 

Since the Royal Navy didn't function off of its subs and destroyers, I don't think one could use the use of oil in those ships as a proxy for the navy overall.

The problems the British were having with their metallurgy around 1920 (+/- 5 years or so) had impact beyond the Royal Navy. Wasn't there the suggestion that the brittleness of the rivets in the Titanic's hull when the Titanic struck the iceberg rather than a long gash in the hull that was responsible for its sinking?

Stefan Jovanovich replies: 

No Navy in the world had finished abandoning coal for oil before WW I because they had not worked out the problems. What I questioned was the assertion that Churchill or Fisher, for that matter, had somehow shaken the Admiralty out of its lethargy; that is part of the Churchill myth, and it is complete and utter crap.

The British submarines were not oil-fired; they ran on what the Brits called petrol (our name for it would be diesel). It was the same technology in basic design now used on every modern railroad locomotive -diesel to electricity to motive power.

It was not beyond the metallurgical skills of Harland and Wolff to have used different rivets. The alternatives were well-understood by them and by the Board of Trade. Tim Foecke's analysis is that "the builders used stronger steel rivets where they expected the greatest stress and weaker iron rivets for the stern and the bow, where they thought there would be less pressure, he said. But it was the ship's bow that struck the iceberg."

The questions about the rivets have nothing at all to do with the metallurgical problems everyone faced with the conversion from coal to oil.

Pitt T. Maner III writes: 

Taking on one of the myths.

On #3. Global oil production has peaked and the world is running out of oil

1)  from (a nice overview report) the BP Energy Outlook 2030 (January 2013)

"The world has ample proved reserves of oil and natural gas to meet expected future demand growth. At the end of 2011, global proved reserves of oil were sufficient to meet 54 years of current (2011) production; for natural gas that figure is 64 years."

2) The USGS has a good page on the latest publications related to ever changing assessments.

3) A slide presentation with interesting graphs showing how predictions were made and have varied over time. Basic idea:

"The conventional (or static) approach to exploration is rapidly changing to the dynamic (petroleum system) approach, and this transformation is the most profound shift in the petroleum business in a century. "

Henry Gifford writes:

I do know a little about oil and boilers. Some of what I've been hearing makes little sense, which could be one clue to how much to believe other things someone says on a topic.

I have never heard of a metallurgical challenge to burning oil vs. coal in a boiler. When heated they both (and natural gas and gasoline and wood) pyrolyse into a soup of Hydrogen and Carbon molecules, which then combine with Oxygen in the air. Same as any hydrocarbon. They also contain a little Sulfur, which produces Sulfuric acid which eats the boiler if it is cooled below the dewpoint temperature, which is about 400F. Same problem with modern fuels and modern boilers or furnaces or water heaters, as found in most basements today.

The story that oil burns hotter than coal is nonsense. All Hydrocarbons produce a soup of Hydrogen and Carbon which produce a fixed quantity of heat when burned. The temperature is a function of how quickly that process takes place in how small an area. You can today pay $15 at Home Depot for a propane torch or $60 for a propane torch. The $60 torch makes a hotter flame from the same fuel by mixing it with air better. Same fuel, very different temperature, same amount of heat of course from a given quantity of fuel. Ships burning oil make less smoke, and because the machinery and fuel and handling equipment take up less space, can go further and faster.

The story that oil is necessary to produce superheated steam is also not accurate. "Superheated" means heated to a temperature higher than the boiling temperature at that pressure. The Freon returning from the cold side of your air conditioner is "superheated," despite being very cold at that point. The old steam locomotives superheated the steam, as do steam engines powering turbines, this to prevent liquid steam impinging on the turbine blades.

As for oil being strategic, I think access to Middle Eastern oil had a lot to do with WW1. The German navy adopted oil sooner than the British did, both on the eve of WW1, both gradually with many dual-fueled ships built. The British had to import oil by tanker, the Germans started building a pipeline. A straight line on a map from Berlin to Baghdad goes through all the countries that fought on the German side, except one in the Balkans, where one day a prince was shot, soon there was an unbroken chain of allied or occupied countries stretching from Baghdad to Berlin.

As for WW2, Roosevelt was quoted on the cover of the NY Times as saying the US embargo of oil to Japan "was tantamount to a declaration of war" 6 months before the surprise at Pearl Harbor. The fighting in Burma was not over access to coconuts. The German invasion of Russia had a Southern thrust aimed at oilfields, and there were very heavy allied attacks on the German controlled oil fields in Romania. In the middle of the war US and German fighter pilots both went into battle with about 300 hours of training (except the Tuskegee Airmen, who were black, therefore considered mentally inferior, thus returned for additional training, twice, or maybe nobody wanted them to fight, and so they ended up the best trained pilots around, which helped very much with survival rates and proficiency), soon the German hours were dropping because of fuel shortages, and ended up well under 100
hours with the classroom ratio constantly increasing, while the US training
hours increased for the rest of the war. The Germans fought with the ME-262, a very real and very practical jet fighter, and reportedly towed it to the runway with horses to save fuel. But, I think the horse story is not true. I heard the air force used cows because the army had all the horses. The Japanese built the largest battleships in history, and sent them out without enough fuel for a return trip (but with thousands of young men on board).

Or parents' and grandparents' generation came to control the world through, in significant part, access to oil.

Do I think oil is a strategic material?

I don't think the US military is in the middle east for a shortage of falafels or for women's rights.

The reports that there is 50something or 60something years of supply so we don't have to worry sound to me like good reason to worry, if true. Toward the end, or even near the end, things will get very expensive, and probably scarce - those numbers are for today's production, with a constantly increasing population and with more and more people buying cars and air conditioners.

The US military runs on one fuel: diesel. Also called jet fuel or #2 fuel oil. The difference between diesel and #2 fuel oil is taxes, and a dye -thus the clear plastic fuel tube on every diesel car. The same stuff, or virtually the same stuff, drives all tanks, planes, jeeps, ships (other than large nuclear ships and subs), subs, trucks, etc. There are reasons for this.

Oil of one sort or another (gasoline or diesel) has a Watt-Density far in excess of anything else by either weight or volume. Compressed Hydrogen has only 1/5 the Watt-Density of diesel by volume even after being compressed to 300 atmospheres (4,400 PSI), which of course requires a spherical tank, which won't conveniently fit into an airplane wing or between the muffler and tailpipe of a car. Far in excess of batteries or anything else. Batteries can power a car for a while, but that volume and weight of gasoline or diesel would power a vehicle much, much further. And forget planes with batteries. And the military is not giving up planes. Nor tanks or other vehicles, and they want them to travel far and fast - they will burn diesel until or unless something with more power is discovered.

Is oil scarce? How much is left? I have no idea, but I don't think BP was drilling 5 miles deep in the gulf of mexico because it was easy.

The President of the Old Speculator's Club writes:

This thread reminded me of a book I read years and years ago and which became a classic of sorts. The book is "Delilah" and the author, Marcus Goodrich. It's a huge book, a lengthy and, at times, a difficult read as it goes into minute detail on the men and operations of a pre-WWI destroyer…coal devouring monsters that make some of Aubrey's accommodations look luxurious.

The book was published in 1941 and was the first of two that were to complete the story. Over the next 50 years (until his death in '91) Goodrich labored over the second book - sometimes spending an entire day "perfecting" a single sentence. The second manuscript, reportedly incomplete has never been made available to the public.

How big a deal was it back in '41. Goodrich became a minor celebrity, and good enough and popular enough to write the original "treatment" for "It's a Wonderful Life." He later married Olivia DeHavilland. Little was heard from him after that - he once stated that if he couldn't finish the second book he'd "probably burn it."

Carder Dimitroff writes: 

I'll give it a shot. You can write a book on any one of these statements

*1 no viable market exists for oil*

This is a partially true statement. There are several markets for oil. There are two major markets (WTI and Brent) and several dozen regional markets. Most are not pure markets. Some are manipulated markets.

Complicating the issue is the fact that crude oil is not a physically fungible commodity. There are attempts to address physical inconsistencies using normalizing techniques to achieve a financially fungible commodity.

The challenge is refineries. Refineries are designed to process specific types of crude oil. For example, many refineries cannot accept some of the heavier oils. As such, the refineries often set their own bid for a specific type of oil delivered to their facilities, but they will not bid other oils. This complicates markets' handling of basis differentials.

Under these circumstances, the so-called market price is only a broad indicator.

*2. Big oil colludes with OPEC to stick consumers with high prices.*

This is an inflammatory comment that misdirects issue. The comment assumes there is only one market for oil. It assumes producers are only interested in the public good. It also assumes OPEC producers have a lot of flexibility in setting prices. These are all incorrect assumptions

Of course, producers want higher prices. It's a business. But if OPEC and the majors collude (with other producers) and force significantly higher prices, demand will decline and revenues could be compromised.

*3. Global oil production has peaked and the world is running out of oil*

This is a tricky question. First, there has to be consensus on the definition of oil. It may surprise consumers to learn oil production figures often slip in production for ethanol and natural gas liquids. It's not a dirty trick. Petroleum is used primarily for transportation fuels. Ethanol is also used for transportation fuel. Some, but not all natural gas liquids are used for transportation (and that is why their price is often indexed to oil, not natural has).

It's a tricky because the question links two unrelated issues. The question suggests production has peaked because the world is running out of oil.

It's also a tricky question because it assumes production is currently limited by drilling constraints.

It is true new production can take time to respond to market signals. It is not true that the world is close to running out of oil.

*4. Oil is a special product of great strategic importance.*

In general, this statement appears to be true. But adding context would be helpful.

*5. A strategic petroleum reserve is needed in case of emergency.*

In general, this statement appears to be true.

*6. The US should become independent of oil, foreign oil or overseas energy*

Again, this statement is packed with three, mutually exclusive ideas. It is true, the US and all other nations should become independent of oil. So far, no practical substitute has been found.

It is true that the US should become independent of foreign [crude] oil. Assuming this independence includes Canada and Mexico, there is no practical option for the US to go it alone.

With respect to other primary fuels, the US is already energy independent, or almost energy independent. We are completely independent when it comes to renewable energy (hydroelectric, ethanol, biomass, wind, solar and others). We are energy independent when it comes to energy efficiency. We are net exporter of coal. We are virtually energy independent with respect to natural gas.

We import over 90 percent of our nuclear fuels. We can and should produce our own. But market forces favor international sourcing.

*7. Oil price spikes cause economic catastrophes.*

This may or may not be true. By definition, a spike is a short term event. As such, it may have greater political consequences than economic impact.

*8. US policy is to maintain the flow of oil at the lowest possible price.*

This is both true and false. US domestic policy is generally indifferent towards flow or price. Military policy is to assure unimpeded flow in vital areas (Middle East and Indonesia). Federal energy policy seems generally indifferent towards world crude oil prices.

From time to time, administrations do respond to political pressure to reduce prices. The fact is their options are limited.

*9. Possession of oil means economic and political power.*

Untrue

*10. The US must defend autocratic Saudi Arabia because of oil*

True. But it does not matter if they are autocratic or not.

*11. Dependence of Europe on Russian energy is a threat to US security.*
*
*

True

Finally, there is a fundamental element of the crude oil business that many cannot seem understand. Sometimes I think they don't want to understand.

The simple concept is that oil wells deplete. This idea seems elusive to many. Further, in order to replace depleting wells, market forces will motivate producers to (or should) seek the next marginal well. The next marginal well usually has higher production costs than the production costs associated with exiting wells. But decisions from sovereign producers are not always economic.

Production costs mean levelized costs, not lifting costs. It includes transportation costs to get product to market. It also includes market adjustments needed to financially normalize oil quality.

When you put it all together, the world is not running out of oil. The world is running out of cheap oil.

These are two important points:

Point 1: U.S. MILITARY PRESENCE IN THE PERSIAN GULF OR SAUDI ARABIA MERELY CONTRIBUTES TO ISLAMIST ANGER AT THE SAUDI GOVERNMENT FOR COLLUSION WITH THE U.S. AND ENDANGERS THE OIL.

Point 2: ALSO, ANY THREAT TO ANY OIL IN ANY ONE COUNTRY WILL MERELY RAISE THE WORLD OIL PRICE. INDUSTRIAL ECONOMIES, CONTRARY TO POPULAR BELIEF ARE RESILIENT TO OIL PRICE SPIKES (EVIDENCE IS PROVIDED IN THE BOOK).

With respect to Point 1, there has been significant volumes of credible work by intelligence analysts to confirm this statement. Yet politically, our leaders don't seem to believe the fact-based evidence. Most intelligence analysts will argue that that the Islamists don't hate us for who we are, they hate us for what we do. Yet you hear the opposite story on capital Hill.
 

Feb

6

Have any of you been to Argentina lately. What is the situation on the street. I am thinking of going there on the way to Antarctica later this year. Is it safe?

Vince Fulco writes:

One thing to seriously consider even though it sounds like you are going thru mostly modern areas, Amex has an extremely affordable medical expense insurance while traveling. For a few hundred bucks, as I recall < $250 for my wife and I when we traveled to South Africa, they'll airlift you out of spots and take care of many extraordinary medical expenses. Considering you'll probably never use it but if you do, fees can run tens of thousands of $ depending on what your normal health insurance covers, brought us piece of mind. Everything can be done online.

Larry Williams writes:

Careful on med-evac policies

I just lost my best buddy here; heart issues. We tried med-evac but the reality is 1) you need a local doctor to agree to release, which they will not do unless stable and 2) before the plane/jet wheels up they must have admitting dr and hospital at the other end.

That takes a long time to arrange

Best is to charter. Don't tell anyone of medical issues-get aboard and then go to closest emergency room to airport.

Carder Dimitroff writes: 

I'm sorry for your loss.

I would like to add to your thoughts. Once in the air and within US control, request the pilot use the LIFEGUARD call sign. This will notify the FAA to give the plane priority handling, direct routing and airport priority.

In addition, here may be a helpful link.

A commenter adds: 

First: LIFEGUARD has recently been changed to MEDEVAC to conform with ICAO international standards.

Second, and most important: If you are in ANY WAY fearful that your medical situation may be life threatening, communicate this CLEARLY to the crew and they will declare an EMERGENCY.

MEDEVAC flights get priority handling when they request it. But EMERGENCIES — well, let's just say that controllers will move heaven and earth and every airplane in the way to get that aircraft on the ground at the airport of the pilots choosing.

Most domestic airlines subcontract to a company that has professional medical staff on call 24/7 that assists them in determining the best course of action for the patient. They will get a doctor on the radio directly with the flight crew to assess each situation. 

Feb

5

Country                       Oil Production               Rigs

Saudi Arabia              10 million barrels/day         50
United States              6 million barrels/day          1,400

Source: Georgia Tech Strategic Energy Institute

Jan

28

This week, New England ran out of natural gas. Supply cannot meet demand because New England didn't invest in appropriate infrastructure. Mid you, there's plenty of natural gas nearby. It just can't get to any of the New England states. As a result, Boston City Gate blew past $30/MMBtu. Today, thanks to LNG from Yemen, it fell to around $15.00.

At the same time, bulk power prices skyrocketed to the stratosphere. This morning bulk power at New England's hub traded in the $400 to $500 range (400 to 500 cents per kilowatt-hour) on normal volumes. Nearby in New Jersey and Pennsylvania, it was in the $20 to $35 range (2 to 3.5 cents).

New Englanders have been protesting coal plants. New Englanders have been protesting nuclear plants. New Englanders have been protesting hydroelectric plants. New Englanders have been protesting transmission lines. So,in response, companies are withdrawing investment and retiring perfectly good energy assets.

If you are wealthy and living in New England, you're paying through the nose for state taxes, local taxes, fuel oil, natural gas and electricity. If you are not wealthy, you're freezing in the dark.

Today, Massachusetts wants to increase taxes on her citizens while they are distracted protesting yet another critical fuel. It turns out New Englanders don't want cheap Canadian oil shipped to Philadelphia through Maine's ports, so they spent the day "rallying against a proposed pipeline from Montreal" (http://tinyurl.com/adn7atf).

Mind you, these protests are not really about a new pipeline. Since World War II, New Englanders didn't fret about shipping foreign oil from Maine's ports through northern New England's pipelines and on to Montreal's refineries. Now, when operators want to reverse the flow on existing facilities, New Englanders suddenly have a conscious.

Nevertheless, when you add it all up, it looks like a collision course in the making. With escalating taxes and skyrocketing energy costs, New England's economy will not be able to attract the jobs it once owned. It will only be able hire teachers for their universities, medical professionals for their insured, busboys for their country clubs and tax accountants to keep everybody straight.

The combination of growing taxes and escalating energy costs is not sustainable. At some point, lunacy has to give way to sanity.

It would seem a movement would develop to address New England's thirst for energy. Once, New England was the nation's capital for commercial nuclear power. The Yankee System included early nuclear plants in Vermont, Maine, Massachusetts and Connecticut. They were supplemented with newer plants in New Hampshire, Massachusetts and Connecticut. Today, only one of the Yankee plants survives. The remaining non-Yankee plants struggle.

From a national energy perspective, New England is an Island. Their only borders are New York and Canada. New York is not an exporter of energy. Eastern Canada is energy challenged with their natural gas wells depleting and their surplus power limited.

New England must move beyond provincial thinking and some seek creative options. Nuclear may no longer be the answer. But solutions are needed and they are needed urgently. It will take leadership at the regional level to bridge provincial interests. Failure to address these issues across all New England states will most certainly cause their economies to deteriorate.

In the interim, the region doth protest too much, methinks.

Nov

19

This morning I used Amtrak's auto train for the first time. I went from Orlando to DC and I expected the train to be half empty. I was wrong. They kept adding cars until the entire unit was over a quarter of a mile long.

I have to say, I'll never make that drive again. While the auto train does not save time, it does save wear and tear on the car. Also, for the driver it's a lot safer to sleep on the train than sleeping on I-95. As far as cost, car and passenger cost $420. That included two meals, all the fresh fruit you can eat and no sleeper.

I saved 900 miles worth of gasoline and tolls [and speeding tickets]. I also saved one night at a hotel, meals and a lot of I-95 related stress. Amtrak's service was family-friendly and courteous. I also like big trains, so I'm biased.

Because everyone has different needs, I'm not necessarily recommending this option. But I am recommending travelers consider this option. The drive from DC to Orlando is BORING and long. Also, some of those southern boys love to ticket those damnyankees (yes it's one word)!

Oct

13

Market prices for bulk power are dropping across most regional transmission organizations (RTOs or regional grids). The introduction of wind power, solar power and new demand-side technologies are three key reasons for lower prices.

Lower market-clearing prices mean lower margins for all market participants, including wind, solar, energy efficiency and nuclear power. Commercial nuclear power is particularly threatened because they lost their long-held position as the market's cost leader.

Five conclusions can be drawn from observing the power markets:

1) Because they have zero production costs, wind and solar power affect the market and lower average market prices for wholesale power.

2) Small amounts of renewable energy production can cause significant changes in market prices.

3) Trading energy efficiency products lowers average market prices even further.

4) Power markets are agnostic towards power generation; the market doesn't care how the energy is sourced.

5) Commercial nuclear power may fall out of favor, as they will likely lose significant margins and earnings.

Power markets are punishing generators of all flavors. Companies, such as Exelon (EXC), Entergy (ETR), Calpine (CPN), NRG Energy (NRG) and GenOn Energy (GEN), will see new pressures on their quarterlies. Summers should be good. Springs and falls should be terrible. Winders should be mediocre.

It appears commercial nuclear power in the United States is in for a rough ride. Existing fleets will become less profitable (see Exelon Generating's 10-Q). Except for TVA, new fleets of nuclear power plants will likely face postponement or cancellation.

The bright spot is transportation. Owning transmission lines will become vogue. Interstate transmission lines remain regulated assets and are a cost-plus business. The federal government is the economic regulator (FERC). New FERC rules favor independent and private ownership of transmission lines.Avoid distribution lines. While they also remain regulated, they are local assets. Their financial performance is subject to the [political] whim of state overseers.

David Lilienfeld writes: 

How much more efficient is centralized solar-based generation and then using the grid to deliver it vs decentralized (eg, homeowner/commercial buildings) generation? Are solar and/or wind competitive yet with coal/natural-gas based generation, and if not, what do the trends suggest in terms of parity (non-subsidized)? Are these trends acknowledged by the local regulators?

Carder Dimitroff replies:

Hi David:

I think you are asking about off-grid vs. grid connected. If I'm wrong, please let me know.

Off-grid will always be the most expensive option because more equipment is needed. Specifically, some form of energy storage device is required and two forms of energy conversion are needed. Not only does off-grid cost more to build, it costs more to operate. Every time energy is converted or stored, energy is lost in the process.

Grid connected is the most economic solution. In the utility world, there are two grid-connected options. One is a direct connection tot eh grid using utility-scaled solutions. The other is a net meter arrangement where the consumer pays only for the net amount of energy needed. Most state will not allow consumers to export more energy than they consume.

For most homeowners, net metering is the most practical option. If I were to add an energy storage device, I would not use batteries. If available, I would use water in a pump storage configuration. The benefit of water storage is it is simple, it can be efficient and it has a long operating life.

About economics. Energy analysis is always about point of view. From the point of view of the grid, wind and solar are far more competitive sources of energy than hydroelectric, nuclear, coal or natural gas. This is not a debatable point.

From the point of view of developers, incentives are still required. All forms of power production have incentives. The only incentive the federal government offers wind and solar are cashless tax credits.
 

Oct

1

I'm not an expert in biofuels. I am on the board of a non-profit, which focuses on renewables and the Pentagon. There, we separate renewables into two tracks– biofuels and power. Most of my renewable experience is in the power area, including wind, solar and biomass.

I do see a lot in the biofuels area. Frankly, there is a lot of fascinating technology emerging and much of it is over my head (I have a weak chemistry background). One lesson I learned was that biofuel production does not necessarily depend on traditional farms.

One technology used algae as the foundation for biofuel. They combined water, carbon dioxide and a lot of sun to produce massive amounts of algae. They processed the algae to create a bio-diesel, which was later blended with regular diesel. Algae can be produced in a sunny parking lot, a brownfield site, or a cleared lot next to a power plant. The key is capturing carbon dioxide and sunlight.

The military is taking renewable energy seriously. A number of large programs started in the Bush years and most of them rolled over to the Obama years. I can attest this issue has had the full attention of the Pentagon's top leaders; for them it's all about energy security.

If the Army can use wind and solar to reduce the number of fuel convoys, they can save lives. If the Air Force can assure energy security, they can pilot drones in the Middle East with pilots sitting at controls in South Dakota.

Incredibly, if the Air Force or Navy Air can use clean fuels, they can land at more bases. I learned from a fellow member of the non-profit that the Air Force is restricted in landing and takeoffs from several military bases because their planes emit too much carbon dioxide. That member educating me on CO2 limitations was the former assistant secretary of the Air Force under the Bush Administration.

The Navy is upset their bases in Southern California are tied to an unreliable power grid. Twice, they've lost power to naval bases in San Diego, which apparently caused all sorts of unexpected challenges.

The Navy cannot afford to rely on one source for jet fuel, diesel or bunker. They have been funding development to access equivalent fuels from alternative sources, such as biofuels.

This summer, the Navy tested their "green fleet," where all military equipment was fueled by biofuel blends. These blends included jet fuel and bunker fuel.

Several believe the military will ultimately deploy small module reactors (SMRs). They will be used in theater to fuel combat operations and reduce convoys. They will also be used domestically to provide bases with secure energy. SMR technology is already under development by four separate companies and it will likely be deployed within a decade.

The private sector is leading. I'm told several ports, including some US ports, offer priority handling for clean ships.

It's easy to diss renewable energy. I was on of those who snickered at "silly power." I've changed my mind.

Sep

28

Last night, during our breaking the fast supper, my daughter had an interesting discussion with me and my wife. My daughter is a senior in high school, and she's finalizing her applications for college–early decision application, early decision 2 applications, and regular admission applications. (When we first started talking about colleges last spring, I gave her a book on game theory–intro level; she never read it, unfortunately–too busy with classes.)

She had wanted to go to Wesleyan. It had everything she was after–small liberal arts school with lots of on campus activities, a strong record of graduate/work placements, small size, and a school where parties were not the rule of the day. Oh, and that it was on the other coast, away from my wife and me, only increased her interest in the school. She was also looking at Wellesley, Colby, Bowdoin, Carleton, Grinnell, and so on. Some public ivies too–U Wisconsin Madison, U Washington, and even some of the U of Californias, though the latter is her safety school.

The problem with the liberal arts colleges is that they now cost a fortune. Generally north of $45K a year and often north of $50K. The situation with the ivies isn't much different–they also cost a small fortune. The out-of-state tuitions for many universities (including the public ivies) are in the mid-20K range, and the chances of finishing in 4 years when attending them is diminishing by the semester. Needing to attend a U of Cal for 6 years to finish a major used to be a rarity. Not anymore. And there is no reason to think the status quo will improve any time soon. Here in California, the system developed by Pat Brown (the current governor's father) had the U of California system, the Cal State system, and then regional community college system. Not only are these systems struggling to find some way of increasing their capacity, but they are doing so at a time when the state government is cutting funding for education throughout the state, including these three post-secondary systems. This problem is not limited to California. In the SUNY system, all tuition goes to Albany, and the state legislature decides how much goes back to the individual campuses, rather than looking at each campus as a P&L center (as U of C campuses do).

Why bring all this up? My daughter is now contending with the question of what's the best value for getting a college education rather than what's the "perfect place" for her. So far, so good. This was what we discussed last night at dinner, and it got me thinking about the post-secondary education system here in the US. At the college level, that system has been in place for three centuries or so. At the graduate/professional level, the current system came into being during the mid-to-late 1800s. The problem is that with the current levels of tuition, the cost of a baccalaureate is rapidly becoming (if not already there) out of reach for much of the middle class population. Using loans is rapidly becoming untenable in the face of college grads unable to find jobs and one-in-twelve of the workforce unemployed. (I won't get into the loan fiasco as regards professional grads–the average medical student having debt north of $150K and for more than a third, it's in excess of $200K.) For many of the existing loans, it seems likely that someone other than the college grad will be left paying the bill. That's debt of about $1.2 trillion at risk. The bottom line is that the current system is rapidly becoming–if it is not already–unsustainable.

The question must be asked about what is the value of a bachelor's degree. I ask the question because it is becoming easy to have access online to some of the outstanding courses available at many of America's premiere universities. Will a degree really have much value when an employer is interested in what you have learned somewhere–online or in person? It used to be that the only way to obtain the knowledge was to attend a college or university in a degree program. The degree was a proxy for knowledge. But there are now other sources for obtaining that knowledge–does spending the money on a college degree make sense any longer?

The situation is even more daunting when you consider that during the mid-1970s, when I went to Johns Hopkins, tuition was about $3K a year. That was also the price of a Chevy Nova car at that time. A Chevy Spark now costs under $15K, and has a MSRP of $12K and change. Tuition at Johns Hopkins today? $50K.

All those contributions to one's alma mater are prolonging the day of reckoning for a system that will need to undergo extensive reform, and that reform will need to accommodate other forms of education rather than only in-person class attendance. Western Governor's University (www.wgu.edu) may be one example, but insofar as it is built around actual degrees, I'm not sure that it's the only type of solution.

An educated workforce is a major prerequisite for a competitive United States, yet the education system is in the middle of a crisis about which there is precious little discussion. That has to change.

Richard Owen writes: 

Education is becoming the quintessential branded luxury, taking a commodity input and stamping it with a brand.

Markets are made at the margins: the price driver has been (i) the rising share of wealth located abroad and (ii) the higher percentage of production available to the best paid domestic workers. The West is importing the GINI ratio of the Emerging Markets when it comes to high end property, education, etc.

Take British public schools: fees are now $45k/yr for the full school life, rather than just a terminal three years at college. For three children that's $135k/yr post-tax wage dollars. 7% of the UK is privately educated historically, yet the former figure is well into the 1% income range. Whats made up the marginal demand? Wealthy foreigners with untrammeled, untaxed, EM boom dollars. London is undergoing a reverse colonization. Hence in some bijou streets in the capital, residential is up 40% in two years, (having fallen not at all during the crisis, so that's not a bounce off the lows).

Carder Dimitroff adds: 

I have two daughters in their 20s. Both have Ivy-league degrees. Frankly, I'm not sure Ivy matters.

There are wonderful state and private colleges. Most decent universities offer inquiring minds incredible opportunities. If a student is looking to learn and grow, most "average" universities can dish out more than most students can handle.

A good example is my cousin's daughter. She attended a low profile public college in Florida. She went in with the attitude of learning and developing. She and several of her classmates became Fulbright Scholars. Now she is Ph.D. candidate at Duke.

If you look at Ph.D. candidates at the nation's leading research institutions, you may notice most of them never attended Harvard, Yale or Princeton. The same can be said for many business, political and military leaders.

Each school has its own culture. In my opinion, a key to a parent's success is matching the college with the student's personality. If the student love the place from day one, all is good.

Sep

21

"Mining it More, Burning it Less": 

We're mining more coal in the US, more efficiently than ever, but burning less of it. Domestic consumption of coal is down to its lowest point since 1988. Meanwhile US coal exports have reached their highest levels in 20 years.

Republicans accuse President Obama of waging "war on coal." Coal companies blame over-regulation from Washington. But US coal production has risen substantially over the last half century, from 560 million tons in 1950 to 1.1 billion in 2011.

Sep

19

Groups make better self interested decisions.

This is confirmed by the process used to judge Olympic and NCAA diving. Judging diving is a subjective process. Actual scores are not important; consistency is very important. So if a judge consistently judges low, it doesn't matter to the diver.

To eliminate favoritism and mathematical fairness, a diver's overall score for an individual dive is calculated in the following way:

Each of the seven judges awards a score to a diver for his or her dive. (Ex: 6-5-5-5-5-5-4) The two highest and two lowest scores are eliminated. (Ex: 6 and 4 and two of the 5s are eliminated.) The remaining scores are totaled. (Ex: 5 + 5 + 5 = 15) This total (15) is then multiplied by the predetermined degree of difficulty rating associated with the particular dive performed to calculate the overall score. These degree of difficulty ratings range between 1.2 to 4.1, in one-tenth increments. (Ex: 15 × 2.0 = 30)

So groupthink generally works if outliers are eliminated.

Aug

24

A common mistake that stock people do I think is to pay attention to the increase in sales numbers. What does this have to do with future profits? I would think there is zero correlation given the earnings change since sales are so easy to manipulate by such things as discounts, pre-orders, and incentives for early buying, and reducing inventory et al. How did this ridiculous emphasis on the sales increase become as or more important than earnings relative to expectations in affecting stocks after the earnings report? I recently met with a pairs trading outfit and gave them 100 reasons I don't think it works, but it was from the seat of my pants. The main reason was of course that it goes against the drift. It hedges against the 10,000 fold return.

Gary Rogan writes: 

If sales increase while profits are decreasing, that's a bad sign. However when profits increase while sales are decreasing, this may be very good, but it can't go on too long. Sales trends gained influence as a counterbalance to profit growth being fudged. When you have profits, sales, and cash flows all increasing in unison and indebtedness not increasing, that's as good as it gets. 

Jeff Watson comments: 

Profits increasing while sales are decreasing are usually a sign of increased productivity, better inventory management, better management of labor, and better management of capital. Although Gary says this scenario can't go on too long, it really can go on forever. 

Gary Rogan replies: 

Well clearly it's mathematically possible to decrease sales by .1% per year and increase profits by .1% per year close to forever so "too long" was perhaps a bit harsh, but at some point in the real world gross margins become so high as to make further advances impossible due to competition or substitution. My statement was prompted by not being able to recall a real scenario of sustained profit growth and sales decline resulting in a good outcome having looked at hundreds of income statements, but I've never made a study out of it nor have I looked at multi-year trends. When customers are buying less of your stuff year in and year out that usually means they are not excited about your stuff, because they don't like it but perhaps in this case because the price is too high for them to use more of it. When customers get into the habit of using less of your stuff, that's hard to fight. 

Jeff Watson adds:

The Chair is 100% correct. Going back to Sears as an example…their aggressive pricing will only squeeze their retail operation out of business(if continued long enough), as prices this low are unsustainable in the long run. If a store has a 30 percent increase in sales after implementing a big sale, but it's gross profit goes from 22% to 6% or less, is that a good business plan? Even though Sears is not increasing labor to handle the increase in sales, the model is still badly flawed. I understand that one of the most important things in retail is buying right, but I suspect that most of the things Sears is selling is a loss leader. Maybe they are subscribing to the old cliche, "We might be losing a little money on each sale, so we'll make up for that with the increase in volume."

Russ Sears writes:

Coming from the world of insurance, when things sell unexpectedly well the actuaries double check their pricing. The agents and the market will quickly spot when you are selling $1 or risk coverage for 99 cents. When I started, before rate books were online, a printing error cut-off the $1 handle of 70 year old women term life insurance rate per $1,000 (this was highest age we sold term to). The month after the book went out we had more 70 yr. old women apply for insurance than we had in the past several years combined.

In other words sales increases often indicate increase in claims volatility. Sales increases make me wonder if management really knows what they are doing. One wonders if this rule holds for the retail and stocks in general. 

Carder Dimitroff adds: 

I may be naive, but in some sectors I believe the top line could be critical for long term investments. I'm thinking of regulated and capital intensive companies like electric utilities, gas utilities, water utilities, pipeline companies, transmission line companies and MLPs. In a different way, I'm also thinking of non-regulated utilities, such as independent power producers, refineries and REITs.

In all these cases, if the top line falls, the bottom line is plagued by fixed costs, such as interest, ad volerem taxes, depreciation and amortization.

The second derivative of revenues in such cases is capacity factor. Low revenues suggest low capacity factors. Low capacity factors suggest troubled assets and long-term challenges. The assets could be partially stranded by market conditions.

An example is marginally efficient coal plants. With low market prices for natural gas, many coal plants find themselves out of merit and not dispatched (zero earnings for producing energy). When natural gas prices return, marginal coal plants are again deep in the merit order and they are dispatched frequently or continuously.

Julian Rowberry writes: 

An internet marketing equivalent of over valuing sales figures is over valuing social media subscribers. Twitter followers, facebook likes, page views, ad clicks etc are all very easily manipulated.

Leo Jia adds: 

Here is my two cents regarding growth vs non-growth.

The present value of a business without growth is much lower than that of a similar sized growing business. So one obvious question to any business owner is whether he would like to receive more money or not if the business is to be sold today. The answer is obvious. But one may counter: since he is making good profits on the business, why would he sell it today? Well, isn't that the beauty of modern finance produced through Wall Street? To sell it today, the entrepreneur can collect today all his future earnings projected based on the best periods of his business performance, and with that reward, he can move on with his life, rather than be tied up by the business which may turn sourer later and cause him to suffer.

Why would Wall Street care more about growing businesses? Those people who bought out the entrepreneur have an even higher reward outlook than his and would seek higher profit on the investment.

Art Cooper writes: 

An example of this currently in the news is Hormel Foods, described in the article "Spam Sales Boost Hormel's Profit" on p B4 of today's WSJ.

The article notes that Hormel's Q3 earnings rose 13%, led by strong growth in products such as Spam and Mexican salsas, continuing a trend of higher YoY earnings. "Even so, rising commodity costs and shoppers' resistance to higher prices are pressuring its profit margins, which could affect its results in future quarters."

HRL's price has been roughly flat for a year.

Jul

15

When thinking about the future of Facebook, I believe it could be helpful to consider some context. In particular, it might be helpful to understand FB's evolution, trajectory and emerging substitutes.

My understanding of FB comes from my children and the movie. My children are Mark Zuckerberg's age and my oldest was a classmate's Mark's sister in another college. My youngest had personal insights about the Winklevoss twins though a collegiate rowing community, also in another college.

Initially, FB was aimed at one college, Harvard. Later it expanded to the Ivy and Ivy-like colleges (not graduate schools). Initially FB was intended to network among America's future elite. As time progressed, students from other great colleges were allowed to join, but they had to possess the proper e-mail extension.

As time went on, students from good universities were allowed to join. Finally, anyone with an "edu" extension on their e-mail address could join FB.

During this period, FB was aimed at the 18 to 22 year old college student. It was a symbol of, "I've made it to college and I'm a member of an important network." Because FB was largely confidential, postings were largely about gossip, interesting parties, crazy behavior, linking up and engaging in various college-age discussions. From the perspective of college students, FB was safe because parents, teachers and non-college students were denied access and those older folks had no idea what was being shared.

Then FB took a step that almost ruined its future; it allowed high school students to join. College-age students were devastated. And while privacy settings were limited, college age students began blocking the younger set. In addition, they thought of ways to prevent younger people from viewing certain areas and began to restrain themselves from certain posts and conversations.

Then FB became attractive to cool people in their late 20's and early 30's, primarily college educated. However, FB's culture was changing; it was no longer elitist, unique nor confidential. Online behavior, particularly among the undergraduate age, became formalized and restrained.

Then the worst happened. Mom and Dad signed up. Mom and Dad started posting baby pictures of their college-aged students. They posted obscure discussions about their good 'ol college days (sans the bad stuff they didn't want their kids to know about).

With Mom and Dad watching, a whole new culture evolved, particularly among the college age and recent graduates. They avoided discussions about religion, politics, sex and money. They rarely talked about another person unless it's good news. They tried to blend into the background.

Even though some thought the worst had already happened, the absolute worst hit when Granny got her account. Granny didn't understand the culture and protocols and ranted about this and that, publicly mused about the future of the nation's youth and reminisced about the good 'ol days.

For some, FB's value had been completely diminished. For people in their 20's, online conversations became limited. Posting of pictures had to be Granny-safe. FB, once a private network, had become a family album.

Young people finishing college or recently out of college began to focus on LinkedIn. There they can create a variety of networks, including alumni groups, and focus on professional development. While Granny is unlikely to connect in LI, they don't care. On LI, the language is already sanitized and professional; Granny would be proud if she only understood.

FB's trajectory suggests the site is becoming less relevant for certain age groups. FB started with undergraduates who are now in their late 20's. It appears FB is now losing that age group. In addition, it seems FB's loss is spreading to nearby age groups.

Accelerating FB's downward trajectory are gaffs that violate users' sense of privacy, cultural mistakes that make assumptions about user preferences and reporting profiles to marketers and government policing agencies. FB is becoming more like Microsoft and less like Apple.

In the end, I believe FB will become family oriented, at least for users in the West. LI is becoming more relevant, particularly the 20 to 40 age group.

I don't know what will replace FB, but it certainly isn't twitter. Right now, for the 20 to 30 age group, it seems smart phone texting is de rigueur; it's private, focused, discrete and direct.

It seems to me there's a void developing. It's in the very market Zuckerberg originally identified; a live yearbook.

More directly, FB seems to be losing relevance among its core users at an accelerating pace. I think FB peaked, at least in the West.

Looking forward, I wouldn't be surprised if FB bought Ancestry.com (ACOM).

Jul

12

Australia is also setting themselves up to displace Qatar and become the world's largest exporter of natural gas. Australia's oil and gas producers are planning massive investments in LNG trains, export facilities and floating LNG platforms. In addition, Shell (RDS.A) is building the world's largest ship that can drill, produce and transform deep-water natural gas into LNG. Shell's mother ship, larger than several aircraft carriers, will be parked off Australia's shores and it will feed Asia's LNG fleet. By 2015, Asia should begin to see lower LNG prices.

For Australia, United States and other coal producing nations, thermal coal production has to endure a difficult transformation. Worldwide consumption is adjusting to a long-term decline in demand as natural gas displaces coal in the power sector. It's not just environmental regulation driving the decision, it's economics. A combined cycle gas turbine is a more efficient consumer of fuel than any coal boiler. Add lower natural gas prices into the mix, and coal becomes relatively uncompetitive.

Nevertheless, coal markets will ultimately reach a baseline level of consumption. As Harvard's Michael Porter argued decades ago, the coal industry's cost leaders will own that baseline.

One key metric for achieving a competitive advantage will likely be dollars per million British thermal units ($/MMBtu), not dollars per ton. Owners of high-ranked coal reserves will likely survive the transformation.

Jun

26

Last night (very late) I put down my reading and turned to Book TV. The weekend interviews and presentations are usually fairly interesting and highly partisan - generally speaking, both sides are given significant representation. I just happened to catch the middle and end portions of a presentation given by one Dambisa Moyo. She was talking about her latest book, Winner Take All.

It's an overview of China's methods and actions in acquiring the resources it feels will be necessary in the near and very distant future. Its investment rationale, unlike those we're familiar with, have nothing to do with discounted cash flow models, but with perceived need. As a result it will purchase whatever it wants at prices that may seem outrageously high. The government's only concern is remaining in power and that it will do anything to do so. This includes cooking the books, manipulating the currency, and over-building just to keep the labor force content.

Her views are remarkably different from this I hear from either the China bulls or bears. Simply put, the Chinese leadership cares nothing about Western investment models or practices — it does whatever is necessary to secure its future access to vital resources - and, unlike many of our policies, to do so in the least intrusive way, with many carrots and few sticks.

This is a very bright, literate woman who gives a great presentation and, I believe, some fresh insights into the world's most interesting country.

Her website is dambisamoyo.com

You can check your cable listings for her current interview which, as I recall, was recorded on 6/24

While these types of allegations have certainly been made in the past, does anyone close to China have any thoughts on this? Leo?

From the NYT :

As the Chinese economy continues to sputter, prominent corporate executives in China and Western economists say there is evidence that local and provincial officials are falsifying economic statistics to disguise the true depth of the troubles. Record-setting mountains of excess coal have accumulated at the country's biggest storage areas because power plants are burning less coal in the face of tumbling electricity demand. But local and provincial government officials have forced plant managers not to report to Beijing the full extent of the slowdown, power sector executives said. Electricity production and consumption have been considered a telltale sign of a wide variety of economic activity. They are widely viewed by foreign investors and even some Chinese officials as the gold standard for measuring what is really happening in the country's economy, because the gathering and reporting of data in China is not considered as reliable as it is in many countries.

Indeed, officials in some cities and provinces are also overstating economic output, corporate revenue, corporate profits and tax receipts, the corporate executives and economists said. The officials do so by urging businesses to keep separate sets of books, showing improving business results and tax payments that do not exist.

The executives and economists roughly estimated that the effect of the inaccurate statistics was to falsely inflate a variety of economic indicators by 1 or 2 percentage points. That may be enough to make very bad economic news look merely bad. The executives and economists requested anonymity for fear of jeopardizing their relationship with the Chinese authorities, on whom they depend for data and business deals.

The National Bureau of Statistics, the government agency in Beijing that compiles most of the country's economic statistics, denied that economic data had been overstated."This is not rooted in evidence," an agency spokeswoman said.

Carder Dimitroff comments:

I would not focus on one commodity. Coal in China is a complex issue. I believe many coal-fired power plants are running on the margin, and many are privately owned (AES, for one). When a power plant is on the margin, there is no gross margin. No private owner will operate in the face of negative gross margins, so units with high production costs (fuel cost and heat rate) sit idle until prices return.

Coal is on one leg of the dark spread, the consumer is on the other. My understanding is the government placed a cap on electricity prices. I understand they want to curb inflation and keep electricity prices low. That cap keeps the dark spread compressed. Leo may be able to provide insight in this area.

However, I think the overall conclusions might be correct. While I'm an amateur in Chinese economics, I did research publicly traded utilities and found implausible balance sheets. If you believe their quick ratios, the should have been out of business years ago. Colleagues warned that the numbers were meaningless.

I've worked with a number of project developers that were either working on projects in China or were using Chinese money for foreign investments. They warned that Chinese investors don't always care about pro formas and they will buy into projects that others might shun.

One example is their huge investment in new nuclear power plants. It's impressive, it's aggressive and it makes no economic sense if anyone looks at the levelized costs. However, if only production costs are analyzed, nuclear makes a lot of sense. This is confirmation the Chinese are in fact ignoring capital costs to achieve an altered goal.

Others may be in a better position to comment, but overall China's economy seems to be struggling. Combining the coal situation with oil, iron ore, copper, it seems like a slowdown.

Jun

23

I happened to catch a History Channel re-run about the Bermuda Triangle. They offer some interesting commentary, some farfetched. One person they interviewed observed that "water is water" and the water in the triangle is no different.

Actually, the water in the triangle is very different in two ways. The most obvious is the Gulf Stream; it goes right through the Triangle.

The most interesting is the recent discovery of methane hydrates. The U.S. Geological Survey reports, "A pair of relatively small areas, each about the size of the State of Rhode Island, shows intense concentrations of gas hydrates. USGS scientists estimate that these areas contain more than 1,300 trillion cubic feet of methane gas, an amount representing more than 70 times the 1989 gas consumption of the United States."

It turns out there're methane hydrates more all over the coastal U.S., with huge amounts deposited in the Gulf of Mexico and Alaska. But for the moment let's stick to the Triangle.

Natural gas bubbles in the water will cause some boats to lose buoyancy. The same is true with natural gas and airplane buoyancy.

I'm wondering if there is a connection between the methane hydrate field and the Gulf Stream. Specifically, I'm wondering if the Gulf Stream warms, it "melts" the methane hydrate crystals and releases natural gas. With gas occasionally appearing in the water and air, boats and planes begin to have challenges.

If this is true, then the Bermuda Triangle is more than folk lore.

In any event, it's becoming apparent that the U.S. has a lot more natural gas than has been recently reported. Apparently, there are companies working with the Department of Energy looking for safe ways to harvest and convert methane hydrates.

For your evaluation, here are some references:

USGS map of the methane fields

Museum of Unnatural History's map of the Bermuda Triangle

University of Miami's map of the Gulf Stream

Department of Energy's discussion about methane hydrates (notice the reference to thermogenic sources)

Jun

15

These numbers seem to change all the time, but this is what Bloomberg is reporting today:

$42 - Qatar
$44 - Kuwait
$71 - Saudi Arabia
$84 - UAE

$105 - Algeria
$112 - Iraq
$117 - Libya
$117 - Iran

May

30

I'm involved in some utility-grade solar projects in the US. The ideal size is 4 to 5 MW, which will require approximately 20 acres. With all government incentives combined, solar projects are currently not bankable.

If homeowners are going to take on solar, most shouldn't use their roofs as their platform. Most homes are oriented incorrectly and will their roofs will not produce the optimum amount of power. A better approach is to mount panels on the ground. Ground-mounted panels are cheaper to build, cheaper to operate and will always produce the optimum amount of power.

In most states, net-metered panels cannot produce more power than the customer normally consumes. This is normally not a problem for homeowners because panels only produce power a third of the time and peak consumption tends to occur slightly after the panels are dark.

For U.S. consumers, it is not worth the investment to go off the grid. Energy storage equipment are costly and inefficient; they will consume approximately 20 to 30 percent of all energy produced.

When judging the efficacy of solar, consider the various points of view. If you are a consumer in a deregulated state, you want your neighbor to build a lot of solar. Solar has production costs approaching zero. The market-clearing price of wholesale power is largely based on production costs. If your neighbor's solar facility is producing power, it displaced the marginal generator or most expensive power producer. In deregulated states, solar reduces the cost of wholesale power.

If you are a utility in a deregulated state, you are indifferent about solar. Electric utilities in these states are not regulated power producers.

If you are a policymaker, solar is a winner. It is an ideal peaking generators as it produces power during the peak of the day. It will displace the the most costly generator and, in all likelihood, the dirtiest generator. You have an economic win and an environmental win. Score!

If you are a utility in a regulated state, you are also indifferent about solar. Electric utilities in these states will get a return no matter what assets are deployed.

If you are a consumer in a regulated state, you might have some concerns about solar. The levelized cost of solar is high and you will have to pay that price plus a margin. High prices are offset by lower fuel adjustments, but not a full offset.

If you are an independent power producer such as Calpine, GenOn Energy, Dynegy, Exelon and Entergy you might not like solar. Solar is hitting your gross margins. When solar power facilities are producing, market clearing prices fall and so do your gross margins.

Keep in mind, most power production policies are set at the state level, not the federal level. This might explain why northern states (deregulated states) endorse solar power and why southern states (regulated states) do not.

Bruno comments:

This is what you said. The little guy is making sacrifices for the future.

If you look at the problem only from an energy standpoint, the German look stupid. They are building renewable capacity which is more expensive than nuclear.

But if you look at the whole picture, this is brilliant. They pay more today to have an even more competitive economy in the future.

It is like building autobahns and panzer divisions. Out of the box thinking, a bit of daring going against conventional wisdom, sacrifice for the population, flawless execution (> 26 GW solar installed in less than 3 years, that is no small feat, and they are doing the same with windpower), incredible discipline (they are doing exactly what they said they would do a few years ago).

If you were the little guy, what would you prefer? Consume a bit less today and still have a job in 10 years, or consume more today and have no job in 10 years?

Does it mean that each household is forced to pay for the "their" piece of the renewables infrastructure? If so, is this the new advanced German "invention": let's make the little guy pay for our competitive industry and that's how we'll finance our future competitiveness? Sounds surprisingly old school, if that's the case.

Stefan Jovanovich comments:

A few minor quibbles. The Germans did invest in panzer divisions; what they did not invest in were maintenance and supply corps. The basic logistics of the German Army in the field in WW II were handled as they had been in WW I - by horse-drawn wagons off-loading from rail depots.

When the German General Staff ran the military exercises for Barbarossa, they found that they had to stop in front of Moscow, even if the Russian Army completely disappeared; the forage loads for the horse transport were consuming 100% of the supply chain capacity.

The autobahns were almost entirely a show-piece; the national transport network was rail. The U.S. alone produced nearly 2.4 million trucks in WW II; the Germans made fewer than 350,000. The British built 100,000 more lorries. Using WW II as an example of Teutonic foresight is not - perhaps - the best example.

The local market for power is, as you say, deregulated; but the market for capital has the Federal government's thumb on the scale, along with many of the state's that have deregulated the buying and selling of power itself. It is, as you say, what it is. I may be expressing my bitterness at California's capacity to do everything so badly - slaughter raptors in the name of wind power, adopt the one kind of deregulation that could allow the clowns at Enron to think they were the smartest guys in the room since the ones from Baldwin-United. Happlly, after tomorrow, that is no longer my concern.

Apr

17

I offer the following question only because I would appreciate some constructive criticism.

Free markets work well for short term investments, such as publicly traded commodities and equities. The free market falls down in long term investments because they lack liquidity and price discovery for investments lasting 5, 10, 15, 20, 30, 40 or 50 years.

How is a utility to finance capital improvement projects under such circumstances? I'm finding every investment organization I've talked to is unwilling to participate in a US deregulated power market asset because they cannot hedge their investment.

Today, few are financing power plants in deregulated regions because there is no bankable offtaker. The result is few power plants are being built in these areas.

What is the Austrian School's take on this challenge?

Henry Gifford responds:

As for deregulated electricity markets, I think what is currently called "deregulated" is different from what I think of as free market. I will use the California deregulation as an example.

When California deregulated the electricity markets, they formed three new state government agencies, one with monopoly power to sell electricity at the wholesale level. I have no idea what the other two did. The agency signed long term sale contracts with local utilities, and bought electricity from both in-state and out of state (California is a net importer) suppliers on the spot market or on short-term contracts. I repeat - they signed short term purchase contracts, and signed long term sale contracts for set prices. The agency made a few billion dollars of profit in a few years, as buyers were barred by law from buying from anyone else (remember, I am describing deregulation), and the state bought for a lower price than they sold for.

The inevitable happened - short term prices rose above the prices they had contracted to sell for. The state government did the inevitable: they passed price control laws, barring their suppliers from selling at a price that would be unprofitable for the state government (remember, I am describing deregulation). Out of state suppliers refused to sell at the lower prices, so the California governor asked the president to pass price controls for suppliers outside of California. The president did not do this. Meanwhile, suppliers went unpaid. I repeat - the state agency did not pay for what they had bought. Instead of paying, the state demanded to first investigate their allegations of "unfair profits" while the bills went unpaid. As out of state suppliers who were owed money were getting investigated, they refused to sell power to the state, and the lights went out. (repeat: I am describing deregulation). This gave deregulation a bad name for a generation, spawned the usual anti-freedom documentaries, and because the arrangement was called deregulation, free markets were also given a bad name. But, I don't think a government monopoly is a free market, and have never met anyone else who does. Instead, people just keep calling it deregulation and saying deregulation doesn't work, and the free market doesn't work, including many people who know the deregulation involved formation of monopolies, price controls, etc.

Now if you reread the description above, and think of the position you would be in if you were a producer of electricity in California, or were considering becoming a producer, or financing a new power plant, your lack of enthusiasm would be understandable, but have nothing to do with failure of what I think of as free markets, long term or short.

The statement that free markets fall down in long term investments is I think inaccurate. Lack of liquidity is priced into investments that are difficult to sell.

 I don't know what "price discovery" is. Real Estate is rather illiquid, but prices for most transactions are a matter of public record, and advertised prices for comparable properties are always available.

I would invest in an electricity producing plant in California if I thought the price was right. With some looking I would tell you what that price would be, which I think indicates there is no lack of price discovery for long-term investments.

Gary Rogan writes:

 It seems in retrospect that combining regulated rate utilities with unregulated power assets is asking for trouble. It's the same kind of trouble as defined benefits pension obligation funders eventually always have to face: when you promise something definite far into the future but the source of funds for your promise is indefinite, this has to blow up sooner or later for many participants. Nothing is ever really guaranteed and some percentage of attempts to make such promises will either run out of money or will have to ask the government for help. Some bonds in the "real world" become worthless, and some insurance companies promising life-time annuities go belly up.

There must be a long and complicated history of how natural regulated monopolies came into existence, but I bet they were accepted too easily. The real cost of energy cannot be projected too far into the future, and in what I would consider a "fair" world nobody would be guaranteed any particular rate of return, and anybody would be allowed to compete for the end customer's business, with property access rights of course being in private hands is so historically determined. Investments in new sources of power would only be made when the benefits were outrageously obvious or the investors were unwise. Even the wise investors would of course sometimes striker out. That's free market, and that's what delivers an ever increasing standard living. That said I will always look for monopolies to invest in where I can find them at reasonable prices. You have to somehow deal with the unfair world.

Tyler Cowen adds:

Maybe political risk is the worry.

If the market is pricing a Monet painting, or a forest, it seems quite well to account for the services yielded decades into the future…
 

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