Folks,

Here’s my take on what 2007 will hold, especially for the energy investor. This was originally published at Energy and Capital in two parts: Part 1 and Part 2.

2007: Renewable Energy Gets Real

By Chris Nelder

Thursday, January 11th, 2007

In my earlier article, “2006: A Time of Transition,” I looked back at some of the major changes and trends of the last year. The most obvious to me were 1) a major change in public consciousness about global warming and our vulnerability in oil and gas supply, 2) confirmation of peak oil theory in the data from last year’s supply and demand, and 3) some very weighty changes in the geopolitical balances of power, as influenced by oil and gas. Now let’s take a look at how those trends will develop in 2007.

RE Explodes

First and foremost, I think it’s clear that 2007 is the year when renewable energy finally gets real. That is, it will make sense as an investment just on the return alone, no matter what your politics or your view on climate change may be. This tipping point for RE has been awaited for so long that the veterans in the wind and solar businesses (especially) have grown gray and wrinkled, waiting at the altar with a handful of long-dried brown flowers while their beards grew to the floor. But no more. This is it, baby!

Let’s take a look at just a small selection of the positive indicators.

The Energy Information Administration’s (EIA) Annual Energy Outlook 2007 projects major growth in all forms of RE: more biofuels, more CTL capacity, more alternative forms of transportation, more nuclear generation, more coal use, and an acceleration in the adoption of energy efficiency measures. In fact, the biggest growth sector in their projections through 2030, at 6.8% annually, is “Other,” a category that “includes liquid hydrogen, methanol, and some domestic inputs to refineries.” Their projected annual growth rate for ethanol? A stunning 11.8%!

Bellying Up to Ethanol

In the ethanol sector, 2006 saw a few darlings turned demons and some IPOs that went south so fast you’d think it was a migration of falcons. So should ethanol still be unloved? Not at all.

As any observer who is up-to-date on peak oil knows, the most pressing problem right now isn’t a need for greener electricity, but for liquid fuels. Solar and wind and other forms of RE are great, and clean, and we continue to love them, but they make electricity. What we need most urgently is a replacement for liquid fuels, particularly diesel and gasoline. As I will explain next week, there are some inherent limits to biodiesel production, primarily that it’s mostly made from corn in the U.S. and therefore quickly cuts into food supply. While ethanol is also mostly made from corn today, it can be made from a variety of waste products as well.

Ethanol production in the U.S. is set to double over the next 18 months and increase as much as 15-fold by 2030. Now that’s a growth story! So much so that Thomas Weisel Partners analyst Kevin Monroe wrote in his January 5 note to clients that the latter part of 2007 may see an oversupply of ethanol—although he primarily blames the demand side, calling for greater discretionary spending and higher Renewable Portfolio Standards (RPS) for ethanol.

Other Liquid Fuel Alternatives

Other than ethanol, the only liquid fuel alternatives are biodiesel, methanol, and various technologies for converting coal, natural gas, wood and other less energy-dense (and therefore less desirable) energy feedstocks into liquid fuels—at high production costs, both in dollars and energy. Let’s run down the numbers:

• Like ethanol, biodiesel production is also set to explode in a 16-fold increase from 25 million gallons in 2005 to 400 million gallons in 2030.
• Methanol has some good potential in specific applications, but as an industry it’s still very much in its infancy and has negligible production.
• Coal-to-liquids, or CTL, which uses the Fischer-Tropsch process originally developed by the Nazis to synthesize liquid fuels from coal, is a promising direction. We have relatively large supplies of coal (never mind the “200 years’ worth” estimate, by the time it gets used for everybody’s Plan B, it will be closer to 80 years’ worth), and if some of the new “in-situ” recovery techniques prove economical and practical, such that you can get the hydrocarbons out without destroying entire landscapes, it might not be all that horrible as a substitute. But the EIA anticipates only 5.7 billion gallons of CTL production by 2030, equivalent to about 8% of the production we anticipate from biodiesel and ethanol by then. And other methods for converting less preferential feedstocks, such as gasifying oil shale and wood and then turning that gas into a liquid, are not yet production-scale technologies.
• Demonstrating their serious intent in Congress, Sen. Barack Obama and other Midwest senators have already offered the Biofuels Security Act, which would require the United States to use 60 billion gallons of ethanol and biodiesel a year by 2030. Along with Sen. Jim Bunning (R-KY), he also introduced the Coal-to-Liquid Fuel Promotion Act of 2007, a package of loan guarantees and tax credits that would promote large-scale production of CTL fuels. Other Congressmen are offering their own energy solutions, such as Rep. Roscoe Bartlett’s Energy Farm Bill, which would offer federal R&D support to make farms “net positive” in both food and energy.

Hard Times for Hydrocarbons

Not only is the Democratic majority leading the way in Congress to push for alternative fuels, but they’re also gunning for Big Oil. It looks likely that they will repeal some of the 2004 tax cuts for oil and gas companies, to the tune of $5 billion. Not only that, they are making a concerted effort to collect royalties on drilling leases, which went unpaid under the Bush administration due to a clerical error. Add another $9 to $11 billion for that. And where will that money go? Into a new fund to promote conservation and help develop renewable energy. Compared to the dearth of investment in renewables under the last six years of leadership by Big Oil cronies, that’s a HUGE shot in the arm for renewables.

Further, the oil industry can expect a new attempt at passing a federal law against price gouging by oil companies and the elimination of another set of tax breaks that weren’t intended for them, but that have benefited them anyway—“a break they didn’t earn, deserve or need” says Rep. Jim McDermott, D-WA.

But the biggest potential new cost—untold billions more—may come from another proposal that would raise taxes on oil inventories. “That would significantly raise the cost of holding inventory” and “prices will go through the roof,” causing oil companies to reduce their stores, according to Red Cavaney, president of the American Petroleum Institute. This is very bad news indeed for a country increasingly dependent on imports.

The Peak Comes Into View

The oil industry isn’t going to like 2007 for another reason: the peak of global production. As I mentioned in my 2006 wrap-up, it appears that we may have reached the global peak of crude oil production in 2006, including the unconventional types that were expected to increase overall production for another few years. We already hit the conventional oil peak in 2005.

The outlook for oil production in 2007 isn’t promising. Exploration for oil fields is coming up with gas more often than oil, reflecting the reality that we’ve already plucked the low-hanging fruit and we’re now getting into the iffy prospects. Oil companies are reducing their exploration budgets, preferring to prospect on Wall Street for M&A targets than to risk drilling yet another dry hole. Dry holes are now outnumbering wet ones by about four to one.

It also appears that previous forecasts were overly optimistic, both for growth in reserves and growth in new oil and gas fields. “An Evaluation of the USGS World Petroleum Assessment 2000,” a 2005 paper from the American Association of Petroleum Geologists, compared a 30-year forecast by the USGS (US Geological Survey) from 1995 with the actual additions that materialized in the world through 2003. They discovered that in the intervening eight years, or 27% of the forecast span, “only about 11% of the estimated undiscovered oil and about 10% of the estimated undiscovered gas resources were discovered.” This is not an encouraging revelation given how often these USGS surveys are cited as if they were biblical truth. The only “growth” that was more or less on target was the growth in reserves estimates, which are, as any peak oil student knows, notoriously unreliable and politically skewed.

Unfortunately, the “Invisible Hand” isn’t showing itself yet to correct the supply issue via higher prices. For a multiplicity of reasons, not the least of which is futures speculation, crude and gas prices remain low relative to the recent past, with light sweet crude now at an 18-month low. Consequently, expansion plans are being tabled, particularly for some of the more exotic (though eagerly anticipated) sources like the tar sands of Alberta.

In some cases, ironically, the price of oil itself is stifling oil projects. For example, at Shell’s Alberta oil sands project, the cost of producing a barrel of oil after a planned 100,000 b/d expansion will be six times higher than the cost of a barrel when the project first started!

Let’s take another example: offshore oil production. Just Saudi Arabia’s efforts alone to offset the depletion of their major fields and increase their “spare” production capacity have drawn some 58 offshore drilling rigs away from the Gulf of Mexico. That’s over a third of the 148 rigs that we had in the Gulf in 2001. This competition from the Saudis has caused the cost of renting the rigs to skyrocket from about $190,000 per day last year, to $520,000 per day this year. That pushes them out of the feasibility zone for some of the mature, marginal wells in the Gulf. All of which adds up to less domestic production of oil and a greater reliance on imports.

In dollar terms, it adds up to about $20 trillion in new investment over the next 25 years just to keep supplies up with demand, according to a recent IEA estimate. But as frightening as that number is, following the lessons of the examples we just discussed, we should expect that number to be even higher when the day arrives. Much higher!

Higher Prices, More Attacks Ahead

All of this has prompted some observers to note that we seem to be setting ourselves up for another crisis and a serious price spike, when (not if) the next major shortage event occurs (another bad hurricane season, a successful terrorist attack on a Saudi oil facility, Iran blocking the Strait of Hormuz, Russia playing hardball . . . pick your poison).

Supply Stays Tight

According to the IEA, in 2007 the supply growth outside of OPEC should roughly balance out the demand growth, which it will have to do, because OPEC production remains flat at 28.8 mbpd. Many peakers have observed that OPEC’s announced production cuts, particularly Saudi Arabia’s, may be simply a way to hide the fact that they’re in terminal decline and can’t do much about it.

As for the price, one analyst I respect, Tim Guinness of Guinness Atkinson Funds, puts the 2007 probabilities for the price of WTI (West Texas Intermediate crude) as follows: 10% for under $50, 40% $50–60, 40% $60–80, and 10% over 80. Based in his predictive track record, I think these estimates are a bit on the conservative side, and we should see $80 oil this year, no problem. One factor that I don’t think he, or most other analysts, has taken into account is the price increases that will likely be the result of all the pressures I’ve described on the oil business as a whole.

As for natural gas, our number-one source of imports, Canada, may have 10% less to sell us in 2007, due to reduced drilling (in turn due to higher costs) and the increased consumption of gas by the tar sands boom. Since North America is past the peak of gas production and the hope of increasing imports in the form of LNG from places like Qatar is still several years off, this means that a suddenly cold winter could leave poorer customers in the cold, or that a hot summer could cause more major grid failures.

But supply and demand issues aside, the oil and gas picture is considerably worse once you factor in the geopolitics. With Russia, Venezuela and Bolivia all making bold moves to renationalize their oil and gas assets in 2006, kicking out the Western oil majors, there is no reason to think that they’re going to be any nicer this year—or that other countries that have enough military might to defend themselves might not try to follow suit. Russia really has Europe by the short hairs, especially in the icy grip of winter, and Venezuela has become a stone in the shoe for the U.S., because we can’t live without its imports—not with Canada and Mexico both on the downslope. The biggest sticks on the block, the U.S. and the U.K., are increasingly vulnerable to geopolitical disturbances to their supplies of fossil fuels. I think it’s safe to expect that terrorist attacks on facilities in Nigeria and Angola will continue in 2007, because they were remarkably successful in 2006. And let’s not forget that Africa is one of the two places in the world that has any hope of seriously increasing its exports of oil and gas right now, since the world’s major producers are all past the peak (or likely so).

States Step into the Breach

Hydrocarbon fuels are increasingly under attack for their greenhouse gas emissions. While President Bush buries his head in the sand, still refusing to admit that global warming is man-made and breaking his campaign pledge to regulate C02, the states and cities have stepped into the leadership void and taken action:

By the end of the year, we should have at least a dozen states with laws intended to reduce greenhouse gas emissions.

Twenty states already have portfolio standards that require their utilities to produce some percentage of their power from renewable sources.

In his State of the State address last week, California Gov. Arnold Schwarzenegger announced that he will order, by executive decree, a 10% cut in motor vehicle emissions of greenhouse gases. (Under state law, the governor has the authority to regulate fuel content.) A 10% cut in emissions will translate to a 20% drop in gasoline consumption and more than triple the size of the state’s renewable-fuels market, because burning biofuels produces less carbon than oil. This will offer some much-needed confidence for biofuel manufacturers, particularly Pacific Ethanol, the largest independent marketer of ethanol in the West. “The opportunity is there, not just for us but for others to see a critical path to additional production of renewable fuels for the California market,” said Bill Jones, chairman. “That’s very important for financing additional plants and the long-term viability of an emerging industry.”

From a global warming perspective, the latest statistics show that 2006 was the hottest year yet, and 2007 is “set to be the hottest on record worldwide due to global warming and the El Nino weather phenomenon,” according to the British Meteorological Office. “This new information represents another warning that climate change is happening around the world,” the office said.

In terms of public opinion on global warming, Big Oil just took another big hit with the publication of a report last week by the Union of Concerned Scientists showing that Exxon has “funneled nearly $16 million between 1998 and 2005 to a network of 43 advocacy organizations that seek to confuse the public on global warming science.” The campaign has deliberately distorted global warming research and attacked state and local actions to regulate carbon dioxide emissions. And that $16 million is just from Exxon; we don’t yet know how much has been spent on disinformation by the oil industry as a whole. So that cat’s out of the bag. Now that the public has proof that Big Oil is trying to confuse them and stymie the debate, it won’t be quite as easy to mislead the public about global warming anymore.

The Chinese Threat

Beyond public opinion and policy, the global warming threat is bigger than ever in real terms. We have new reports that in China the emissions from increased burning of coal are suffocating and killing people. Those emissions are also killing trees in California and rendering fish stocks around the world even more unsafe to eat—due to the increased levels of mercury that bioaccumulate in fish after being expelled into the atmosphere by coal plants.

Sounds bad, but how bad is it?

Really bad.

China only recently learned that some ten new coal plants—8.5 gigawatts’ worth!—had been built in Mongolia without its knowledge or permission. They join 2,000 older, very dirty plants, and another 500 more coal-fired power stations that are on the way. China’s coal output has doubled over the last five years, and they are on course to overtake the U.S. in coal consumption within two years.

After years of resisting any caps on their greenhouse gas emissions, China now has goals to curb their emissions and reduce their energy consumption by 20% per unit of national income by 2010. But, as the world’s second largest energy consumer, with an economic growth rate of some 10%, they are a major (and opaque) factor in any global effort to get climate change under control.

Take vehicles, for example. The number of vehicles in China is expected to explode from 25 million today to 175 million by 2020. They now have one car per 280 people, but they are industrializing rapidly and they want to live like us—with one car for every two people. From an energy standpoint, as the U.S. industrialized we went from oil consumption of about one barrel per person per year in 1900 to 27 barrels in 1970. China now consumes about 1.3 barrels per person per year. To put all of that in perspective, let’s not forget that China has five times the U.S. population at about 1.5 billion.

Other Renewables & Solutions

Ethanol and biodiesel may be getting a disproportionate share of the spotlight given the urgency of the liquid fuels issue, but all other solutions and forms of renewable energy are also set for explosive growth. Senator Harry Reid, the new Senate majority leader, is coming out strongly in support of solar, wind, geothermal, biomass and nuclear power. “We can’t do it overnight but I think we have to set goals,” he says, indicating that we can expect much more along these lines.

There is even a growing coalition of bipartisan support for raising the fuel economy standards, joined by Senator Reid and Senator Ted Stevens (R-AK). As any peak observer can tell you, raising these standards is by far the lowest of the low-hanging fruit for dealing with an impending shortage in liquid fuels. It’s a no-brainer, and pays off immediately.

The outlook for solar and wind is nothing but rosy. The annual growth rate for solar photovoltaics is estimated at 11.2% in the EIA’s 2007 outlook, implying that the PV market will double in about six years. For wind, their projected growth rate is 5.2%, which seems on the low side given other available projections.

Even geothermal energy, once an all-but-forgotten part of the energy mix, is getting goosed with federal and state incentives.

It’s Hip to be Green

Everywhere I turn, I am getting media messages about reducing my energy load and my carbon footprint. By the end of 2007, I predict that a sizable number of Americans will take concrete measures to do their bit, be it simply replacing some light bulbs with LEDs or compact fluorescents, or buying carbon credits to offset their last vacation, or buying a hybrid, or putting solar thermal and solar PV panels on their roofs. It’s not quite hip to be green just yet, but by the end of the year it will be.

Plug-in hybrids may be the biggest winner of all, with their potential to displace some of our imported oil with domestically produced electricity, particularly electricity produced by clean, green sources, and at a lower cost than gasoline to boot. I read somewhere that Toyota originally made the Prius with a plug-in option for the European market, which was removed for the U.S. market. I’m not sure under what sort of rationale that dubious decision was made, but when that option is restored for cars in the U.S., hopefully in at least some models before the end of the year, I predict a boom in their sales. Again: it’s a no-brainer!

But I think the most profitable RE investments in 2007 will be the least-noticed players, tiny little off-the-radar companies that are quietly figuring out how to squeeze a little more utility out of the energy that goes into all sorts of devices, from small battery powered gadgets to passenger cars. More efficient engines, LED lights, buildings that turn off their own lights at night, more energy efficient computers and displays, smarter thermostats . . . the list is virtually endless. In a post-peak world, we will have to find ways to do more with less, all across the board. We have an entire infrastructure to replace! This is going to be a huge growth sector in 2007, despite its lack of sex appeal.

In sum, I think the time has finally arrived when it’s no longer political suicide to talk about energy conservation. And as Sen. Obama has observed, the lack of political will has been the primary reason for our lack of motivation to deal with these problems—problems that we’ve known about for decades. The CFR has given the all-clear , and now it’s safe to be green . . . and well on its way to being cool.

Chris Nelder