Book review: The Quest

Authored by Daniel Yergin in 2011 (ISBN 978-1-59420-283-4).

I was attracted to this book because I so enjoyed Mr. Yergin's previous work, The Prize, which was awarded the 1992 Pulitzer Prize for Non-fiction. I did not enjoy this work as much as I did the previous one, probably because of my bias for history. So many people have lived on this earth, doing so many different things, that when an author bothers to pick out the more interesting bits those bits cannot help but fascinate me. This book is firmly grounded in the present, with the first few chapters providing some historical background.

The world is running out of oil. Except, it is not. People have been predicting the end of oil since shortly after its discovery in Western Pennsylvania. There are two sets of risks, below-ground and above-ground. The above-ground risks often control: what are the economic, political and military impediments to extracting the oil below the ground. Under what terms is the controlling government likely to grant access? How can the enterprise physically protect its plant and people? The "peak oil" theory has been proven wrong, at least to date, because the original theory failed to account for changes in price and technology. Higher oil prices make formerly unpromising finds lucrative and advances in technology reduce the cost of acquiring oil that was previously expensive.

In the last few years we have seen the emergence of new sources of oil, what Yergin refers to as tight oil. Large amounts of oil exist in North and South Dakota and Northern Canada, in what is commonly referred to as shale oil and oil sands, respectively. The Dakota oil, in the Bakken field, the same fraccing (his spelling) technique used to release natural gas is used to release oil. In Canada, excavators burn natural gas to heat tar sands sufficiently to cause them to flow to the surface. It is an expensive method of extracting oil, but it takes place in a politically and militarily stable environment with a very, very long time before depletion.

But what about the price spike of a few years ago, is not that a result of diminished supply? Oil prices rose steadily from the $22-$28 per barrel band established by OPEC in 2004. Attendees to an OPEC meeting in February of that year fretted about a supply glut and announced a substantial production cut. Prices rose, not unexpectedly, but continued to rise, which was unexpected. China's economy was growing (and is still growing) at approximately 10% per year, and China has few domestic supplies. Political upheaval in Irag, Nigeria and Venezuela disrupted supplies.

Large oil companies such as Exxon (as Yergin calls them, the "majors") remembered well the price collapse (to $10 per barrel) during the mid 1990s and were hesitant to invest in new capacity. Exploring a new field can cost upwards of $10 billion, especially with increased demand for raw materials occasioned by China's growth. Exploration also requires substantial lead times. Months and years would elapse between the time the majors recognized the demand and their ability to meet it.

At the same time interest in oil futures, which were first traded on Nymex in 1983, increased. Participants in these markets fall into roughly two categories: hedgers and speculators. Airlines would be hedgers: their business model relies on predictable costs for fuel, and they benefit by buying the right to purchase fuel at a particular price on a particular future date. In short, a market participant with an actual need for oil would be a hedger. All the other participants are speculators, those hoping to make money by buying low and selling high, or by borrowing now and buying when the price goes down. Essentially, speculators trade risk. Risk has a cost; for example, an airline may not be able to fly profitably if the price of fuel is too high. Airlines call out to the market: "is there anyone around here willing to take this risk off my hands?" The speculators step up and say: "sure, for money." The speculators manage their risk by buying and selling many different contracts at many different prices and execution dates, not unlike a life insurer that insures the lives of many people of varying age, health, lifestyle and location.

The price of oil to be delivered in the future, like the price of any financial instrument, should reflect the average, rational expectations of market participants. Rational expectations are based on projections from past experience, and when the current conditions are unlike anything seen in the past, those expectations may be (very) incorrect. Look at the recent price for gold as an example. As a speculator observing a rise from $90 per barrel to $100 over a period of weeks it was be natural to bet on a price of $110 a few weeks later. There was no historical precedent. Humans tend to confirmation biases; sure there have been bubbles in the past, but "this time is different".

Some people say that prices skyrocketed because of supply; others demand; others expectations of future supplies and demand; others amplification by the financial markets. Yergin says: all of the above.

When oil prices increase oil exporting countries benefit. Or do they? Yergin explains that petro-states, such a Venezuela and Saudi Arabia, whose oil exports generate a large fraction of government intake suffer widespread rent-seeking behavior. That is, the country's elites ignore entrepreneurship and invention and focus on diverting the oil revenue stream to their own special projects or own pockets. It is politically difficult in these countries to put this wealth aside for a rainy day. In good times the populace becomes accustomed to a high level of spending that is not sustainable when the market dips. Political suppression results from the need to control this disappointment.

What holds for the future? There will be a new energy mix for certain, but oil will continue to dominate because of the existing infrastructure (more than 100,000 filling stations in the United States and more than 100,000,000 gasoline vehicles) and because of oil's high energy density: oil, per unit of liquid volume, has twice the energy of its nearest competitor, natural gas.

No modern discussion of future energy supplies and policy would be complete without mentioning global warming. Yergin is convinced that carbon dioxide levels in the atmosphere are increasing and the increase will lead to warming. He grounds his conclusion on the work of the Intergovernmental Panel on Climate Change which has been issuing "cautious" and "careful" reports relying on data collected by others (such as the data Charles David Keeling collected at Mauna Loa in Hawaii from 1959 to 1970). By way of illustrating "cautious", Yergin notes that even the most recent reports do not say that global warming is a fact. Rather, it is so likely to be true, and the consequences so far-reaching, that humankind ought to act.

Energy sources that produce less CO2, therefore, will have a certain political and perhaps economic advantage. Coal produces the most CO2 per unit of energy, followed by natural gas and oil. Geothermal, wind, solar and nuclear power produce nearly none, excepting the building of the infrastructure itself. For all alternatives he examines present cost and eventual scalability. Technologies that will not scale are unlikely to succeed, and he dismisses geothermal power on this basis. Of nuclear power he sees great technical promise but middling political promise. The best hydropower sources are already being exploited.

Yergin sees wind and solar as having high potential. Wind, in some ways one of the oldest energy technologies, is having the most success now. Photo-voltaic power is limitless and clean, but efficiencies too date are low even after twenty years of research. Solar power focused to boil water and produce steam is more efficient, but requires water, which is often in short supply where the sun shines the hardest.

No alternative source today can match the price point of coal, so how will these technologies succeed? He points to arrangements in Europe, where the utilities are required to purchase a certain amount of alternative-sourced electricity and "mix" it will conventionally-derived electricity. The higher cost is then "averaged-out" and results in only moderate consumer bill increases. Operators can be promised a certain price for electricity produced in this manner, creating incentives for these operators to reduce costs and pocket the improvements. Unlike some commodities, there is no risk of a supplier delivering a substandard product.

Yergin also admire the efficiency of carbon caps and trading markets. Some object to giving utilities the right to pollute, which is a starting point for any such scheme. That may be true, but moot, in my opinion: they are already exercising that right, even if they do not possess it. By taxing the production of carbon government gets out of the way of industrial progress. But, taxes are politically difficult, where as pollution-control legislation does not appear to raise anyone's taxes, even though it effectively increases costs that are then handed to ratepayers.

Some years ago, when my local utility was offering sizable rates for the installation of a passive solar or PV (photo-voltaic) system, I hosted a couple of contractors for bids. The PV contractor did not even give a bid; the passive solar (hot water) contractor bid so that that I would never, even under the most optimistic assumptions, make my money back. (Not that saving money was a requirement, but I did not want to effectively double my utility bill.) Part of the problem was my roof: it undulates rather than presenting a flat, South-facing surface. I had never considered that issue when I purchased the house in 2004. The other problem is that installing things on a roof is expensive. Much better to require installation on new buildings, when there are already workers scrambling on one's roof.