OF POWER SHIFTS AND SPARE CAPACITY

August 2, 2013 § 1 Comment

A recent article by Bordoff (Columbia University) and Levi (Brookings Institution) makes some interesting observations with regard to a possible shift in the balance of oil power from the Middle East to the Western Hemisphere.  Of particular note is their discussion of the concept of spare capacity.  For a net exporting nation this would be defined as the ability to shut in or produce more at will.  They report that the Saudis have spare capacity of 3.5 million barrels per day (MMbpd) against total exports of 8.7 MMbpd.
saudi prince
This immense spare capacity allows the Saudis to be the moderating influence on oil prices. If prices rise steeply, with the risk of causing demand destruction, the Saudis can open the spigots. They could also respond to pressure from influential importing nations. No small wonder, therefore, that the US continues to have a comfortable relationship with the Kingdom despite major differences of opinion on issues such as women’s rights and the war on terrorism.

For net importing nations the concept of spare capacity scarcely applies. For the US, increased domestic production, which is proceeding in leaps and bounds, merely means decreased reliance on foreign oil. But here is the kicker. Our new found oil is all from tight formations and virtually all of it is sweet, light oil. It commands a higher price than the heavy oil from Canada, Mexico and Venezuela. Many of our refineries have invested heavily in coking equipment to deal with the heavy stuff. Their margins are less for the light crude. So, the displaced crude will be the light oil from Nigeria and some from the Middle East, which is increasingly turning heavier, despite the benchmark name Arabian Light.

All of this complication underlines a truism: oil is not just oil and refineries are very picky about what crude suits them.  The smartest move may be for us to export the light crude at high prices and continue to import the heavy crude at low prices (that differential can be as much as $30 per barrel).  That requires Presidential approval, I do believe.  For reasons best known to someone other than I, refined products can be exported at will but the raw oil or gas export requires approval, except to NAFTA countries.  Permitting oil exports at high prices has no downside to it especially if the resulting import is from friendlies such as Canada.  The question of Canadian oil being dirty can be debated elsewhere.  Suffice to say there are solutions if folks are prepared to be a wee bit innovative.  Unconstrained export of LNG will have a significantly net negative impact on the economy.  When you go to this link, go further to the report linked therein.
The authors of the cited article opine that the Saudis will continue to be the controlling factor on oil prices even if our dependence drops dramatically. This seems right because even if the US drops to zero oil from the Middle East, it will have an interest in keeping oil price moderated. In part this would be to keep our own imported oil price in check, and in part it could be to protect our allies. But this probably means that the dreams of a few of us, of ceasing the policing of the Strait of Hormuz, may well need to be relegated to the wishful thinking pile.

One important point missed by the authors is the potential impact of gas and gas derivatives reducing domestic demand for oil.  They recognize the oil/gas price spread and the arbitrage opportunity it brings in the chemicals industry.  But they don’t sufficiently recognize the significant movement in displacing diesel with compressed natural gas (CNG), liquefied natural gas (LNG), gas derived synthetic diesel and dimethyl ether (DME).  Technology is increasingly enabling this direction and it could have a material impact upon the demand for oil.  When added to the oil derived chemicals, such as nitrogen fertilizer, ethylene and propylene, as already noted by them, significant demand destruction of oil can be anticipated in the US.  This was noted recently be a Saudi prince (pictured above) in a warning to the Saudis to diversify.
One final argument relates to the previous point regarding the role of abundant and cheap natural gas in the US. To the extent that this affects demand destruction of oil, natural gas could be the spare capacity nobody is thinking about. It can be turned on in under a month when needed. Shutting in natural gas is more feasible than shutting in oil. In an odd twist the oil substitute natural gas could be our spare oil capacity.
Vikram Rao

“Just In Place” Manufacturing

July 22, 2013 § 6 Comments

Many are aware of Just In Time (JIT) manufacturing.  It was originally invented by Toyota Motor Company and then copied elsewhere.  This is one of the principal tenets of lean manufacturing, the technique of manufacturing with a minimum of waste.  The most powerful piece of JIT is inventory control.  Inventory is kept slim at each juncture of the manufacturing cycle and made available only just in time as needed.  Similarly products are made only as needed, thus minimizing finished goods inventory.

JIT image

JIT is powerful and the principles go beyond the fairly obvious efficiencies in sequential assembly line type of manufacture.  Goldratt broadened it into his Theory of Constraints as first detailed in his extremely readable book The Goal.  In all of the discussions in the past manufacturing has been defined by large plants that make and then distribute products.  We will discuss here a relatively new concept: make it when you need it (just as in JIT), but also right where you need it.  I call it Just In Place (JIP) manufacturing.

Almost by definition JIP entails smaller plants.  This flies firmly in the face of the engineering principle known as Economies of Scale.  Larger plants are simply more efficient per unit of production.  Consequently, we are presented with the engineering challenge to ameliorate this effect.  Certain endeavors, such as production of vehicles, will simply not meet the criteria.  Electricity production using solar panels fits like a glove.  In fact, one could argue that solar power ought to be distributed to take advantage of the inherently valuable feature, and not be force-fed into large solar farms.

JIP plants will enjoy the economic advantage of reduced distribution infrastructure.  In the limit, as for example of transport fuel produced directly at a truck stop, the infrastructure is essentially zero.  This brings us to the question: which products may inherently be better suited to JIP? Rather than taking a crack at a generic argument, we will discuss two examples, both in the transportation sector.

Cheap natural gas in North America has emboldened the displacement of gasoline and diesel with natural gas.  To the extent that methane is used directly in the engine, the production of the fuel simply entails tapping into the natural gas infrastructure, which is extensive.  If compressed natural gas (CNG) is the fuel carrier in the vehicle, it can be filled at a service station.  But if the more energy dense Liquefied Natural Gas (LNG) is required, as it would be for long haul trucks, distribution infrastructure for LNG becomes an issue.  LNG is conventionally made in massive plants and refrigerated transport over great distances could be prohibitive. Each normal LNG plant produces at least 9 million gallons per day.  That is about 5.2 million gallons diesel equivalent per day (LNG has about 58% of the energy content of diesel).  That is a lot of truck fill ups at 180 gallons a pop, so distribution will be needed to a lot truck stops.

Mini LNG plants are slated for about 50,000 gallons per day.  This is about 160 fill ups.  Also the natural gas requirement is only 4 million cubic feet per day a manageable rate for most gas supply lines.  A number of big players are after this segment, including Linde, Shell and GE.  An ongoing study at RTI appears to indicate that if the newer nitrogen expansion cycle method of refrigeration is used, small scale plants could deliver LNG quite economically.  Keep also in mind that preparing on or near the site for essentially same day use is a good deal cheaper on refrigeration than shipping over distances.  This stuff is stored at -162 degrees Fahrenheit.

Volvo recently announced a truck engine running on dimethyl ether (DME).  DME is derived from natural gas and produces zero particulates when combusted.  At current natural gas prices on a diesel equivalence basis it can be manufactured for far less than the cost of diesel.  Volvo is teaming up with Oberon Fuels, a California company, who have designed plants to make DME economically on a scale over 100 times smaller than conventional plants.  Although Oberon is the current leader, others are heading in the same direction.  Some of these others are targeting the production of diesel from natural gas, a somewhat more difficult target than DME.

One other tidbit. Smaller plants are easier to finance, are quicker to build and distribute jobs all over the country rather than in concentrations such as the Houston Ship Channel.

Just In Place manufacture is on its way.  Watch that space.

Vikram Rao

Putin Preaches Energy Security

July 1, 2013 § 1 Comment

In a recent news report President Putin of Russia defends current pricing of natural gas.  One expects self-interest to play roles in the voicing of opinion by country leaders.  But really, invoking buyer energy security to support the Russian position is rather specious.  Russia dominates gas supply to most of Europe, especially southern Europe.  Countries such as Greece are completely dependent.  Their energy security would be enhanced by alternative sources not increased reliance on Russia.

Putin was defending two different, albeit related, Russian stances.  One is the need for take-or-pay long term contracts.  Expensive pipelines require these to justify the investment.  Not indefinitely, though; after the amortized lifetime the argument is weak.

The second issue, pegging the contract terms to the price of oil, is indefensible.  Back in the days when oil and gas had pricing parity on the basis of energy content, this made sense.  Today, with oil anywhere from twice to five times more expensive than gas, pegging to oil gives the gas producer an advantage.  It creates absurd situations such as in India, where imported LNG, pegged to oil, is priced at over $15 per MMBTU, while domestic producers are allowed to sell gas for only $4.20.  Furthermore, all current models indicate that gas price will rise modestly compared to oil prices.  In Europe, gas contracts probably ought to be pegged to landed LNG prices, this being the only serious alternative to Russian gas.

Vikram Rao

Another Brick in the Wall

June 30, 2013 § 7 Comments

A recent announcement by Volvo is yet another salvo into the fortress of oil.  They announced the commercial launch of a truck engine that uses Dimethyl Ether (DME) without any diesel blend.  We have spoken about DME previously in this blog, but it bears repetition.  The structure of the molecule is such that when it burns no soot is produced.  The principal knock on diesel is not the carbon dioxide produced on combustion, it is the soot.  Things have improved markedly since the days of the black smoke belching from the back of school buses.  But small particulates, which the cognoscenti refer to as PM2.5, are implicated in various respiratory illnesses.  When New Delhi moved from diesel to Compressed Natural Gas (CNG) on all public vehicles, the mortality and morbidity improvements were dramatic, as reported on by the World Bank. By the way, that move was prompted by an order from the Indian Supreme Court.  And you thought the Supremes only bothered with the likes of hanging chads and rogue sheriffs in Arizona.DME truck

This underlines a favorite theme for me.  I am all for reducing carbon dioxide emissions because there appears little doubt these are harmful.  But in the short term, the health effects of diesel emissions loom larger.  In general, substituting for oil based fuel is a good idea, especially when the substitute is better for the health of the populace.  Pink Floyd aficionados will blanch at my use of their signature song in the title.  But I have always interpreted the lyrics as meaning that any individual teacher was no more than just another brick in the wall of learning.  So, in that sense, DME fueled trucks are an important step in that long road to eroding the monopoly of oil.  Sure, there will be issues.  The vast majority of the DME used in the US is imported.  Distribution of the fuel to gas stations will be daunting.  But most anything good is going to take effort.

The announcement referenced above concerned a vehicle demonstration by Volvo in Sacramento.  They were joined by a fledgling outfit named Oberon Fuels.  These folks announced the launch of small plants producing a modest 10000 gallons per day of DME.  This sort of distributed production of fuel will be a key to the infrastructure dilemma.  For perspective, typical DME plants would be sized for over 1 million gallons per day, requiring serious distribution infrastructure.  Another advantage of the small plants is the low cost and easier financing. Importantly, they can be expected to be operational in two years, as compared to four or more years for conventional plants.

I was recently making a presentation to administration officials in which one part referred to the environmental benefits of blending DME in diesel.  I noted that up to 20% could be blended with no modifications to the engine.  The secretary of the agency in question asked about the viability of pure DME.  I said they were experimenting in Sweden and Japan, but that I would check.  Weeks later came this announcement.  His interest was in part for school buses.  That is a neat concept: our children will be spared diesel fumes.  Incidentally, as far as that goes, CNG fits the bill as well.

We have discussed just the health and environmental benefits of substituting for diesel.  A compelling value is cost.  At natural gas prices today, DME can be produced at costs well below that of diesel.  Cheaper and better: one could well quaff one’s favorite beverage to that.

Vikram Rao

LNG in the News Again

May 17, 2013 § 3 Comments

The DOE announced today approval of another LNG export permit.  The story linked here points out that FERC approval is still pending.  It also expresses surprise that this announcement came a day or so after Secretary Moniz was confirmed unanimously in the Senate.  The comment suggests that they would have expected Moniz to settle in before making the decision.  The cynic in me says they waited until after the confirmation before posting the decision so as not to lose any votes.  Also, the suggestion that Moniz, while at MIT, was not completely clued into the LNG debate is laughable.

lng tanker

The usual people are predicting the beginning of the end of cheap gas.  Let’s do the arithmetic.  The Cheniere permit plus this one brings the permitted export to 3.5 billion cubic feet (bcf) per day.  Compare that to the current consumption of about 68 bcf per day.  This is around 5%.  This is material, but is not going to change the price.  For one, the country already has shut in capacity that likely exceeds that.  Certainly hardly anyone is drilling for dry gas now.  The eastern Pennsylvania and Haynesville bust towns will attest to that.  From the day you decide to do it, gas production is possible in as few as 21 days.  But, figure on it being 90 days.  Compare that to the fact that no new gas will be needed till at least 2015 (Cheniere) and 2017 for the newly permitted outfit.

Expect for sure that gas  required for these two permits, when needed, will more than adequately be supplied by existing shut in facilities, possibly augmented by new wells.  One of the features of shale gas that is so unusual is that the spigot can be switched on so quickly.  With conventional offshore gas that would have taken five years.

This aspect of shale gas, that it can be produced on demand, is what bothers the Sierra Club and other opponents. They may even be concerned that a rush to produce more may cut corners.  There is merit to this last point.  However, after some laxity, most states, including ours, are putting down stringent regulations.  Much of the problem in Pennsylvania can be attributed to inadequate regulation and the unpreparedness of the small operators, and the communities, for that matter.  Waste water was sent to municipal treatment facilities with the best of intentions.  They were simply not suited to handle it.  We know that now.

I believe that due to the lag time to actual operation of LNG plants, permitting of up to 10 bcf per day will be benign.   The suppliers will have plenty of time to fill the gap.  Also, by that time most regulations assuring sustainable production will be in and functioning.  The US EPA regulation requiring zero fugitive methane emissions at well sites by 2015 will be in place. The technologies for handling these small volumes of gas will also have time to be developed.

The protestations of chemical manufacturing entities such as Dow, as reported in the cited piece, aside, there is no question that cheap natural gas is causing a renaissance in US industry today.  Many industries in Europe and Asia will simply not be able to compete with US companies.  They will be forced to invest here.  This will be good for us.  More jobs and more economic growth.  Consequently, LNG exports permits ought to be carefully considered to not squander this incredible advantage.  Then there is the Alaska wild card of which I wrote recently.

LNG exports are a good thing if we do it smartly.

Vikram Rao

What Happened to Global Warming?

May 14, 2013 § 9 Comments

In a recent issue of the Economist is the disturbingly interesting report that in the last decade or so the carbon dioxide emitted was according to predictions but the temperature remained flat.  Between 2000 and 2010 the world added about 100 billion tonne of CO2, but the five year running average of temperature remained flat over the same period.

Global temperature rise

This needs some serious explanation.  That reduced emissions are generally good for us is not in question.  But the models quantifying this ought to be robust if we want the general public energized.  There is nothing robust about the model in the indicated period.  Continued emphasis on energy efficiency is certainly warranted.  This delivers both economic benefit and reduction in emissions.  But the more costly carbon sequestration suggestions may now come under greater scrutiny.

Vikram Rao

LNG Exports: the Alaska Wild Card

May 13, 2013 § 4 Comments

The President has another of his no-win decisions on his desk.  If he says yes to Liquefied Natural Gas (LNG) exports he will be seen as caving to ExxonMobil.  If he says no, he will be accused of pandering to the liberals.  He could pull a Solomon and split the baby, although in this case actually do it: approve limited export.  A recent AP story goes into the likely options.  But nobody mentions Alaska.  One wonders if they are unaware of the wild card that Alaska represents in this debate.  More on that below.

LNG in the US has had an incredible five years.  Around 2008 we fully expected to import large quantities of LNG and eleven re-gas terminals were permitted and in various stages of construction.  Today we are debating being allowed to export the stuff.  All this is, of course, due to shale gas driven abundance.  This causal connection is what prompts environmentalist push back.  Curiously, their bedfellows in this one are folks like Dow Chemical who currently enjoy an enduring competitive advantage against most of the world in chemicals derived from gas.

Unfettered LNG exports would certainly raise domestic gas prices.  The permit to Cheniere Energy, already granted, is for 2 billion cubic feet (bcf) per day.  This translates to about 700 bcf per year, against our current consumption of 25,000 bcf per year.  So it is unlikely to have an impact on the price of gas.  In fact up to about 10 bcf per day should prove pretty benign, particularly because production could pick up.  This is precisely what bothers the folks who believe shale gas cannot be produced safely.  However, a lot of the initial pick up will be in the dry gas wells that have already been drilled and shut in.  Less new drilling.  But none of this will happen for a while.  LNG plants take up to 6 years to build, so there will be no quick relief to the beleaguered dry gas owners.  Owners of import terminals do have an advantage on timing.  The deep water berthing of the massive vessels, the containment tanks and piping, all these can be used.  In fact such sites will have significantly lower new investment and the build time could be shortened by a couple of years.

LNG exporters, by definition, rely on the raw gas being cheap.  This is why so much of it comes from Iran and Qatar.  The liquefaction and re-gas adds up to about $3.50 per MMBTU and can be a bit more.  Transport adds between $0.50 to 1.50 depending on distance.  So, from the Gulf of Mexico the landed price in Asia would be the domestic price, say $4 plus about $5, maybe a bit more because of the long voyage around South America.  If the Panama Canal widening does happen, the voyage would be shorter but there would be fees.  Still, after all that, one could expect a landed cost of around $10 against a price of $17 or so.  Hence the excitement, even if the US prices went up some.

There is also a political dimension.  Relations with Japan would be strengthened if we guaranteed supply.  Since the Fukushima Daiichi disaster they are incredibly reliant on LNG.

alaska map

Alaska the Wild Card:  Unnoticed in this debate is the role Alaska can play in all of this.  Alaska has vast reserves of natural gas that are well and truly stranded from the Lower 48.  The contemplated pipeline is on life support and ought to be allowed to die.  They are forced to re-inject gas associated with oil production, to the tune of 8 bcf per day.  If they were allowed to export this as LNG, there would be no material impact on US pricing because it never was on the market.  Note that this would be four plants of the size of Cheniere. In fact an even higher rate would have no effect on our pricing absent a pipeline.  All of this gas is produced from conventional reservoirs.  The Sierra Club, the most vociferous opponent of exporting LNG, should have no beef with this because it would not increase shale gas activity.  The US chemical industry ought to have no concern because they would continue to enjoy cheap gas.

This would be highly competitive with exports from the Gulf of Mexico or the east coast.  The shipping distance ought to be nearly half even with Panama Canal passage.  The raw gas ought to be priced extremely low because it has no market value and in fact a small cost is incurred to re-inject it.  This would work especially well if the gas producer were to be a partner and the gas would have internal transfer pricing.  This is certainly the case with the only current LNG exporter, which is ConocoPhillips/Marathon out of Alaska today.  In case you are wondering, the source for that gas would not be sufficient for expanded export.  The stranded gas referred to above is up at the North Slope.  A pipeline would have to be built, although much of it could likely come down alongside the existing TAPS oil pipeline.

The US should be a net exporter of LNG, but the bulk of it ought to be from Alaska.

Vikram Rao

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