November 2007
The following is a summation of a presentation I gave to the Calgary CFA Society in Canada last April.
The concept of ‘the future’ is a dangerous fantasy because it implies simplicity, and this is particularly true of the future of energy. Energy is at the very center of our society, and is tied up in everything we do. As a result, it is enormously complex, involving so many different aspects of the economy, and of supply and demand, that it’s almost impossible to talk about in its entirety. As a result, what I’m planning to do in the time I have today is to focus on selected aspects of energy, and then make some broad generalizations. And since all generalizations are false – including this one – I’m under no illusion that I will deal with all aspects of this enormously complex subject.
There’s been a lot of talk about ‘peak oil’, with forecasts about the coming shortage of petroleum. There’s also been a lot of talk about the greening of the economy, and how alternatives are going to displace petroleum as a source of energy. To paraphrase Mark Twain, I believe that reports of both oil’s demise and its replacement have been greatly exaggerated. What I want to do is talk about some of the forces at work that are driving change in the energy industries, and how the Green Economy may develop. I plan to look out several decades into the future – but I don’t expect my projections to be right. I should also point out that no one knows what’s going to happen, and I am certainly going to be wrong on any number of points. That’s not truly important. What are important, though, are the rough outlines of the future, and that we learn to ask the right questions. More important than whether I’m right or not is whether I can expand our understanding of the future of energy, and thereby help you to prepare and invest profitably.
The future of oil
Petroleum will continue to be the centerpiece of energy for decades to come, which implies that oil will neither go into rapid decline, nor be replaced. First, let’s deal with peak oil. I have one statistic that, I believe, refutes the entire peak oil argument: three-quarters of the world’s surface is covered by water. Virtually all of the oil discovered and exploited so far has either been on land, or very close to it. Accordingly, I feel quite confident in saying that there are massive fields not yet discovered, and that we are in no danger of running short. We are, however, probably running out of cheap oil. All in all, then, I doubt if oil is going to go into drastic decline. It is, however, likely to get more expensive.
Next, petroleum will not soon be replaced by more environmentally-friendly energy sources for two reasons. The first is its energy density, which relates to the amount of power you can get from a given mass or volume. Petroleum has a very high energy density, which means it’s easier and more efficient to transport and use as an energy source than most alternatives. And secondly, and in some ways more importantly, we have organized our economy around petroleum: all of our power, transportation, distribution, and manufacturing systems are geared to, or biased towards, its use. This means that any move away from petroleum will require substantial investments to replace infrastructure, which will slow the rate of substitution. However, the longer the price of oil remains high, the more likely such investments are to be made, and the faster substitutes will appear. The greatest tragedy to befall Big Oil is the apparent high price of oil – even though I don’t consider oil prices to be high at $60 a barrel.
According to the U.S. Federal Reserve Bank of St. Louis, if you adjust for inflation, then the price of oil today is roughly where it was in 1986. The historic peak price of oil, also adjusted, topped out at just under $100 dollars per barrel in today’s terms. But if you adjust for increases in wealth or standard of living, then oil prices are lower now than at any time since the Yom Kippur war of 1973. All of this argues that oil will continue to be the centerpiece of energy use for a long time. Having said that, though, let me also point out that oil is fungible, which means it’s freely exchangeable for or replaceable by a similar commodity. As the price of oil rises, it creates room for other energy substitutes to make their way into the marketplace. So let’s look at how alternatives and replacements might work their way into the market, because that will largely determine the emergence of a green economy.
Gasoline alternatives and replacements
Since the Argonne National Laboratory, an arm of the U.S. government, says that about 75% of America’s petroleum use is devoted to transportation, and most of that by road vehicles, I’m going to focus on gasoline as a specific example of the future of energy.
There are several gasoline substitutes emerging, such as biobutanol, (butanol made from biomass), biodiesel, and so on, but I’m going to focus on ethanol. In some ways, butanol may be a better substitute than ethanol because you can run a B85 mix (that is, 85% butanol and 15% gasoline) in today’s automobiles without the modifications that ethanol requires. You can likewise run today’s diesel engines entirely on diesel made from biomass, such as leftover oil vegetable oil used for cooking french fries, filtered, but without modification. Yet, I’m going to focus on ethanol for purposes of illustration because it has the highest profile of gasoline substitutes, largely because of politics.
So, is ethanol a perfect substitute for gasoline? No. To start, it has a lower energy density. If you were to fill your tank with ethanol, you could only go about 73-82% as far as you could with a tank of gasoline, depending on the car and the commentator. You would also need to modify your car to run on ethanol because it is more corrosive than gasoline. This modification consists mostly of substituting Teflon-coated hoses, and lining the gas tank to prevent corrosion, but these are really trivial changes. The ‘flex-fuel’ option that allows cars to run on 85% ethanol costs all of about $250 on a new car – or about 1% on a $25,000 car. However, you also need to upgrade the fuel distribution system if you’re going to start distributing ethanol on a large scale. As I understand it, for instance, you couldn’t use existing oil pipelines to transport ethanol because it’s too corrosive. You could, however, use existing natural gas pipelines, so there are changes and investments that would need to be made to switch to ethanol from gasoline. They are, though, manageable, and nowhere near the massive changes that would need to be made to switch to hydrogen, for example.
Then there’s the source of ethanol – can we produce enough of it? With the ethanol gold rush currently underway, we can already see significant distortions in food prices around the world – what happens if we go further? According to the Ethanol Development Council of Saskatchewan, to produce enough grain ethanol to produce E10, or a 10% ethanol, 90% gasoline blend, for all the vehicles currently powered by pure gasoline in Canada, it would take just over 20% of all the acreage under cultivation. We couldn’t even go to a 50% blend of ethanol from grain – there’s not enough farmland in cultivation in all of Canada!
However, ethanol from corn or barley is not a long-term solution, merely a starting point. In fact, there’s a technical name for ethanol from corn. Where I come from, it’s called ‘bourbon’ and you don’t pour it into gas tanks. Grain ethanol will eventually be replaced by cellulosic ethanol, which is closer than most people realize. This is ethanol made from wheat chaff, straw, switchgrass, sawdust, or waste wood – all of which have almost zero economic value today. We could also import ethanol from Brazil, which leads the world in the production of ethanol, and in the technologies to use it. They produce ethanol from sugar cane, which is far more efficient than producing it from corn or barley, and all new cars in Brazil can run on anything from 100% gasoline to 85% ethanol, 15% gasoline – or anything in between. However, even though this may make environmental and economic sense, it is a hard sell politically, and so is a desirable, but unlikely near-term solution. The welfare of Brazilian cane farmers doesn’t rate very high in Ottawa or Washington.
So, the big question is: Is it worth switching to ethanol? This depends on the four key determinants of the future of energy: economics, carbon emissions, technology, and politics. But before I explore them, you should know that there are all sorts of cat fights going on about the pros and cons of ethanol vs. gasoline, and each side has its own statistics that prove conclusively that the other side are liars, fools, and charlatans. This is a perfect example of Churchill’s contention that there are ‘lies, damned lies, and statistics.’
Economics – I’m going to sidestep that entire economic battle over ethanol by appealing to the market for judgment. The cost of ethanol as of May 4th, 2007, according to the State of California, was about US$1.52/gal, including a 51¢ federal subsidy (therefore, US$2.03 without the subsidy). The lowest cost of regular gasoline at about the same time in California was US$3.14/gal. Hence, adjusting to get an equivalent number of miles (rather than equivalent number of gallons), gives a price of US$2.78 per gasoline-gallon equivalent for ethanol (assuming 73% of gasoline’s distance/gallon), compared to $3.14 for gasoline itself to travel the same distance. In Canada, this would translate into market prices of 80¢ Canadian per liter for ethanol, compared to 91¢ per liter for gasoline – and there are a lot of people who will drive across town for an 11¢ difference in fuel prices. This ignores the taxes on gasoline, which are a big factor, but then again, there’s no depletion allowance for ethanol. Moreover, the price of oil and ethanol do not move in lockstep, so these figures change daily. My point is that ethanol is already close to becoming a market substitute for gasoline, even though it’s not a perfect substitute.
Carbon emissions – There’s no comparison here: ethanol wins hands-down as it adds almost zero net carbon to the atmosphere when it is burned. It’s not non-polluting – nothing is – but it is far less polluting than gasoline, especially in all-important carbon emissions.
Technology – Ethanol wins again, hands down, because the technology of ethanol is just getting ramped up, and the price will keep dropping for at least the next decade. And, by the way, this is going to lead to the first ethanol glut, and the first ethanol production bust, probably before the next recession hits, as there is too much production capacity coming on stream, and not enough demand in the system (unless governments mandate E10). Wall Street and Bay Street are buying into ethanol like it was Nortel and this was 1999, and with predictable results.
According to the U.S. government’s Argonne National Laboratory, the ratio of energy in a fuel to the amount of fossil fuel required to produce it is called the Fossil Energy Ratio, or FER. The FER for gasoline is 0.81 – in other words, it takes 100 BTU of fossil fuel to produce 81 BTU of gasoline. The FER for corn ethanol is 1.36 – i.e., it takes 100 BTU of fossil fuel to create 136 BTU of corn ethanol. So ethanol is already less polluting to produce than gasoline – and that’s only using today’s technology. The FER of cellulosic ethanol, tomorrow’s technology, is 10.31 – dramatically higher. Even if you dispute these figures – and there are lots of people eager to do so – cellulosic ethanol is a clear energy winner over gasoline, once it becomes available in production quantities.
However, this doesn’t speak to the cost of producing cellulosic ethanol, but that, too, is dropping fast. The cost of breaking cellulose into sugar, which is the key step in converting cellulose into ethanol, has fallen from about $15 a gallon to 50¢ a gallon, and is expected to reach 10¢ a gallon in the near future, due to advances in genetic engineering. So ethanol’s technology future wins hands down over gasoline’s.
Politics – When it comes to politics, I have no idea whether ethanol or gasoline wins. If public opinion continues to move towards accepting climate change, and the forecasts of damage caused by climate change continue to get bleaker, then it will be a foolhardy politician who argues against it – or rather, it will be a temporary politician who does so, as they will be quickly voted out of office. And yet, Big Oil has enormous clout, and won’t go without a fight. Actually, the political battle I’m interested to watch is right here on the Canadian prairies, in Alberta and Saskatchewan, where we will see the oil lobby square off against the farm lobby.
The same kinds of arguments on these four factors can be made for wind power, solar energy, tidal energy, and other energy substitutes. All of them are getting better and better, under the inducement of higher oil prices, and several of them will eventually become as cheap, or cheaper, than today’s energy sources, such as gasoline.
We don’t know for sure what will happen to oil, but what we do know is that for it to maintain it’s current dominance in the energy equation into the far future, several things would have to happen:
- First, we would have to decide that either climate change is not happening, or that it’s effects will be benign. I think that the probability of that happening is extremely low, and is therefore a bad bet.
- Second, public opinion would have to turn against alternative energy sources. This could happen, say with nuclear energy, or if people were to turn against cellulosic ethanol because of its use of genetically modified organisms. But I think this is very unlikely to happen with all of the different new forms of energy being pursued – and so is another bad bet.
- Next, politicians would have to defy public opinion. This is possible in the short run, as Mr. Harper in Canada and Mr. Bush in America have demonstrated, but not possible in the long term. Public opinion is turning decisively, and probably permanently, in favour of green initiatives – especially if they aren’t the ones who have to pay for them. Politicians had better become convincingly green, or they won’t survive future elections.
- Finally, the price of oil would have to drop substantially. This is quite possible, even likely. I would, for instance, bet that the price of oil in 2010 will be lower than it is today, based purely on the rise in supply, and the decline in demand, that comes from higher prices. However, in itself, lower oil prices won’t turn back these other factors. Change is coming, whether Big Oil likes it or not.
The Broader Future of Energy
Now, having dealt with a specific aspect of the energy equation, I’m going to move on to broad generalizations about the future. The future of energy is unpredictable, but, as I said, will be driven by four primary factors: oil prices, climate change, technological development (especially biotechnology), and politics (including public sentiment). To decide what you think is going to happen with energy, you need to make some assumptions about these four factors. Here are mine.
Climate change is real, and will continue to grow in importance to the voting public. Therefore, politics will become oriented towards mitigating carbon emissions. This may be through reducing carbon emissions, sequestering carbon, conservation, new technologies, or other initiatives but will probably be a combination of things with no ‘silver bullet’ solving all problems. And, by the way, it is not going to be an optimal combination because politics will still trump reality at times. Hence, sugar cane producers in Brazil are less likely to get support here than folks who produce ethanol from barley or corn, even though importing Brazilian ethanol makes much more economic and environmental sense.
I think the posted price of oil will move secularly upwards over the next 20 years, with cyclical ups and downs. Yet, beyond about 10 years, I think that the real price of oil will start declining once again, and will keep declining in real terms through the balance of the 21st Century. The wild card in the future of energy will be technology, so let me speculate on what we may see. I emphasize that this is speculation, not prediction.
Technology and the future of energy
Conservation is the low-hanging fruit of the energy equation, and energy efficiency will improve dramatically. America’s energy use per person is almost double Japan’s – which indicates the potential for energy savings using off-the-shelf technologies, such as smart appliances that turn off when not in use or during peak periods. By 2025, North America will be approaching Japan’s current energy efficiency – and, of course, Japan will have moved much farther along. By 2050, our energy use in North America will have fallen by at least 50%, even though real GDP will have grown by more than 130%. One example, among many: home roofing systems will be available that change color from black to white, according to the external temperature, to alternately collect or reflect heat.
Most vehicles will continue to be powered by gasoline through the next decade, but by 2025, the pure Otto-cycle engine, powered by gasoline, will comprise less than 20% of new vehicles sold, and most of those will be used for specialized purposes. By that time, the best production cars will get the equivalent of 100 miles to the (US) gallon (or about 2.6 liters/100 km in Canada), and will be hybrids powered by ethanol produced partly from genetically engineered sugar cane, and partly from cellulose produced with genetically engineered enzymes. Switchgrass and similar scrub plants will be the major source of ethanol, as will grain chaff and waste wood. Ethanol and other biofuels, such as biodiesel or biobutanol, will be as widely available as gasoline is today – and pumps for pure gasoline will be getting harder to find, about like diesel is in North America today.
By 2025 nuclear power will be finishing its big come-back, and will once again be on the wane. There will be lots of nuclear power stations under construction and on the drawing boards, but alternative sources of energy will be cheaper and preferable. Questions remain about the long-term cost-effectiveness of nuclear power because it looks as if they don’t stay in commission as long as expected, and the costs of decommissioning are higher than expected. I expect that these two factors, coupled with improvements in alternative energy sources, will make nuclear uneconomic before 2025.
Moves away from conventional electricity generation won’t be due to any one thing, but rather a grab-bag of new power sources. More local power generation will mean lower line losses compared to centrally generated power, increasing power efficiency. For example, fuel cells using natural gas or even (possibly) hydrogen will power some individual office buildings. Solar power may still be more expensive than the wholesale cost of other forms of power generation, but that’s not relevant – solar power is used locally, so the proper comparison is with the retail cost of electricity – and locally produced solar will be cheaper than centrally produced nuclear power long before 2025 for great chunks of North America. Solar cells will be produced by genetically engineered organisms, such as diatoms in sea water, cheaply, and with about the efficiency levels of the best solar cells of today. Moreover, solar cell efficiency will still be rising, and the cost per kilowatt falling. Wind power will be big business, with GE the biggest player. The efficiency will be perhaps 50% better than today – mostly through evolution rather than revolution. However, wind turbines will be designed to work with both higher and lower speed winds, extending the range of their usefulness and the locations where they can be used. They will also be combined with new forms of battery technology, such as flow batteries and high temperature superconductors, which will store the energy when it’s produced against the times when it’s needed. It’s improved battery technology that will finally make wind power commercially useful on a large scale.
Other applications, such as geothermal and tidal energy, may be useful at some times and in some places, but won’t be widespread – with, perhaps, a few exceptions. Many new homes will be cooled in the summer and heated in winter by inserting heat pumps into the ground beneath them, making use of the constant temperature of the Earth just a few meters below the surface, which remains at a fairly constant 10 degrees Celsius all year round. And the tar sands of the Canadian prairies may use geothermal energy instead of natural gas to extract oil – unless federal or provincial governments force nuclear power on the industry instead.
Beyond the next 20-30 years, the outlook gets very blurry, because not only is the rate of technological advance accelerating, but the rate of acceleration is increasing. It may be that we use biotechnology to adapt photosynthesis to our energy needs. We will almost certainly find ways to produce energy from currently unsuspected sources, such as quantum dots. Indeed, the most astonishing statement that I’ve heard about the 21st Century is also one I can’t quite bring myself to dismiss: ‘Anything that we can conceive that is physically possible will be accomplished by the end of the 21st Century.’
But at the end of the day, the real driving force behind new and better forms of energy use will be economic, not technological or political. The best incentive to ‘go green’ will be that it’s cheaper, and therefore more profitable to do so. For example, factories in Japan produce one ton of steel using 20 percent less fuel than American steelmakers – and 50 percent less than those in China. That being true, who has the price advantage? Japan has already proven that leaner, cheaper production is better quality production – and that applies as certainly to energy use as it does to car manufacturing.
The final word
Another word for ‘pollution’ is ‘waste’, and waste is the enemy of profit. Although the initial motivations for energy efficiency will be guilt, politics, and climate change, the eventual driver will be cost advantage. The only sustainable model for a green economy is one where eliminating waste offers a competitive advantage over the carbon economy. That should be our goal, because if we can achieve that, then the green economy will not only be self-enforcing, it will be inevitable.
by futurist Richard Worzel, C.F.A.
© Copyright, IF Research, November 2007
