Oil, biomass, carbon – the value story and a look through the lens of price

May 29, 2019 |

History shows that where ethics and economics come in conflict, victory is always with economics. Vested interests have never been known to have willingly divested themselves unless there was sufficient force to compel them. B. R. Ambedkar

Scarcity is the basic human problem — we have limited resources to expend on the unlimited desires of our civilization and imagination, and price is the mechanism by which we allocate the resources we have. But price is an onion with many layers — the value of the good, the affluence of the forces that are competing for resources, the skill we have in production and design, the limited time we have on earth, the presence of alternatives to realize our wants. And so, price is one of the most interesting realms of study, and a taxi or a tsunami standing between us and our dreams. Today, let’s look at the bioeconomy through the lens of price.

Oil prices

Oil prices have four components, more or less. The energy value, the utility value, the cartel component, and the currency value. The first is the price we would pay just to have the energy in a free market where oil could be used for anything and so could anything else.

Then there’s utility, because you can’t use oil to power a solar array and you can’t run Hawaii or combustion engines on wind farms — the infrastructure we have built based on the applications we have developed — that’s utility. If you’ve been chasing the production of succinic acid because you think it would make a bioprivileged molecule — a fantastic platform — and then are shocked by the low demand — that is the problem of insufficient applications, and that’s the utility value at work. If there’s a battle over expanding ethanol tolerance in modern engines from 10 percent to 15 percent, that’s utility at work, too. Volatility in prices at the pump — much of that stems from imbalances in energy stocks…too much of this on hand for the expected demand for that, and so on. All of this is utility.

The cartel component takes into account that there are multiple sources of oil at variable costs, and those actors would usually be competing against each other to maximize return rates on capital — turning the world into a giant, over-producing, price-collapsing Titusville.

So, producers band together to limit production and raise prices in the short term and oil-field value in the long-term. Cartels generally do a much better job of limiting production than the free market does. The free market· generally raises production until it meets the cost of production plus the cost of capital — or, seeks to add supply from alternative sources, such as renewables. In a world where Saudi Arabia can produce from its established fields at $3 per barrel and the risk-free capital cost is less than 4 percent, cartel value looms large as a driver of oil prices, for now.

Then there’s the currency value, because oil prices are expressed in dollars, which means that there’s no currency effect for Americans or those with currencies pegged to the dollar, but for 96 percent of the world’s population. the local price of oil changes every time the currency moves.

Oil’s been sliding lately, after West Texas Intermediate reached a high of $76 in October, it’s down to $51 today. Brent Crude peaked at $86 in early October and has slid to $60 today. Averaged out over the year, Brent’s been around $70 and WTI at around $61.

The first thing of course you notice is something endlessly annoying to consumers, and that’s the price volatility. WTI went as high as 25% over its January 1 starting point and now sits 14% below it. Yikes, that’s tough on planning.

Part of the problem lies in fears of global recession, or at least a slowing of growth rates and particularly in China where the country’s finances may be impacted by the US-China tariff wars.

But consider the impact of US currency strength. If one week the Euro is worth $1.24, and later shifts to $1.13, as has happened recently a European has to pay about 10 percent more for oil, just because of currency impact and having to buy dollars with weaker Euros to obtain oil. Now, the US represents around 20 percent of the world economy, currency swings are either pushing up or tamping down oil demand. And the Euro has swung from a low of $0.90 around the time of 9/11 to a high of $1.48 just before the Great Recession.

Carbon prices

Carbon prices are a nascent market, not exactly as mysterious as bitcoin, but certainly the price of carbon is swinging wildly depending on where you live because some regimes have no carbon prices and others have formidable ones. Some are hidden inside mandates, too. A 10 percent requirement for fuels that have, say, a 25 percent reduction in carbon-related emissions creates a market for carbon, albeit small.

There’s an argument that carbon markets should be sharply limited at first — rising geometrically rather than arithmetically over time to meet the world’s carbon goals.

Here’s why.

Take for example the EU. They set a 10 percent biofuels target during a time when there were 20-40 percent carbon reducing fuels and feedstocks available. The first-gen feedstocks became wildly controversial, and the 2-4 percent carbon impact was generally pretty small. Consequently, the EU has retreated to a 7 percent mandate based around double-counting advanced technologies that can provide a 50-110% reduction in net carbon emissions. Averaging the technologies, that’s about a 2-4 percent reduction in carbon. Which is to say, better technologies but the same petroleum displacement and no change in overall carbon progress. And hardly anyone is fast-tracking alt-fuels projects at commercial-scale in Western Europe right now, though a few pioneers have been bravely tacking Scandinavian and Eastern European potential.

Now, take as a different approach the Low California Fuel Standard and the US Renewable Fuel Standard, in tandem. Pioneer projects aimed at the California market right now can capture up to $7 per gallon in fuel price, because of carbon prices that add more than $4 to the energy value.

The important point is that, especially in the case of California, what is driving up the carbon price are the scarcity of alternative fuels, because carbon prices rise when supply is low. When there are 10 times as many gallons available of low-carbon fuels, the carbon price will be 10 times lower, in theory. So, pioneers have huge incentives equal to around $400 carbon prices, that subside in deployment down to prices more in line with that $30-$40 carbon prices that are at the high end of most political regimes to tolerate carbon prices.

The tricky part is having a variable carbon price. There’s no point in offering a pioneer low-carbon project the benefits of a $40 carbon price, or political regimes that expect to consider carbon prices as a tax that flows into general revenues and can be used to support other social projects. There will be little or no project construction where incumbents have simply to pay a $40 carbon penalty which is likely just passed on to the consumer — the incentive to invest in project construction is just not there for investors.

But $400 carbon prices for pioneer developers is moving the needle, there are more than one dozen low-carbon projects in development for the California market right now. That’s a refinery construction pace not seen in that part of the world since the California oil boom of a century ago. While none of these projects are as large as major oil refineries, some of them approach the scale of small oil refineries. The Dickinson ND refinery is being converted to renewables, and the old Paramount refinery in Los Angeles, too.

The trick of course is to find a way to continue to bring forward projects as deployment spreads and the carbon price (expressed on a per project basis) comes down. You want to have a situation where there’s more construction at $100 carbon than there was at $400, and still more at $40 — rather than simply installing a set of pioneer-stage first-of-kind biorefineries and then not building any more. That would be a set of privileged refineries whose owners would reap a huge benefit from pioneering, but no one else comes along. It would be like giving the whole of Oregon country to the first half-dozen Conestoga wagons that made it across the path. You might get pioneers, but you won’t build a region.

It’s tricky because the enduring challenge is not conversion rate and construction cost — which is the problem of, say, solar technology. With solar, the feedstock costs nothing, so conquering the refining costs is everything.

Now, there are low-cost biofuels feedstocks — that’s waste, and there we essentially have the solar problem of making the refinery work at high conversion rates — building in efficiency and reducing the cost of materials through, say, modular construction and assembly. That’s the Enerkem plan, in a nutshell, and why that company isn’t valued on the basis that solar technologies are is a failure of equity analysis. It’s a solar technology in disguise.

But when it comes to large-scale deployment there will be variable feedstock costs, and they will loom large in the cost per barrel — and keeping those going down as deployment occurs, rather than rising, that’s the trick. You want economies of scale, not the economics of scarcity. It doesn’t mean more land, but it does mean maximizing the use of land.

One factor to watch — and that’s the convergence between cattle and sugar markets. It’s more efficient to convert sugar to meat via a fermenter (a la Impossible Foods) than via the pasture and the corn bin. The more Impossible burgers we eat and the more Perfect Day gallons we consume, the more land is released for other uses, such as energy. It is indirect land use change, in reverse,

Biofuels prices

Somewhere in between the petroleum price and the carbon price is the biofuels price. It is an energy form with advantages in carbon, so it is not exactly one or the other. Biofuels are an alternative or supplement to carbon pricing, and an alternative or supplement to petroleum, both at the same time.

Accordingly, the biofuels price tells us much of how we compare the value of carbon and the value of energy. A high biofuels price relative to energy tells us that carbon’s component is rising in importance in the marketplace, while a low biofuels price relative to energy tells us that carbon is fading in market power.

Carbon value and energy value are wrapped in a 21st century braid. The presence of carbon value bothers some people — often, those disadvantaged by it — but it doesn’t bother markets, really. There must be more than 100 molecules in an average gallon of gasoline — each has its own economics and value attributes and no one generally bothers to think about them much in the world that critiques or analyzes carbon as an attribute. It is just one more attribute, and the argument that a society can’t afford carbon is generally the same argument advanced by those preaching retrenchment in military preparedness — that we cannot afford the safety margin. Anti-militarists are endlessly pooh-poohing the threats that military power holds in check, and anti-carbonistas are endlessly pooh-poohing the threats posed by climate change.

But, economists? Generally, carbon is just one more attribute in the mixture to analyze, one with variations in utility according to the variation in market price, just like any other molecule in the gallon. Carbon rises, carbon falls. The budget for safety is, like anything else, limited, and our appetite to run risks varies with our fortunes and the rewards in front of us. Ask any insurance salesperson — no matter how hard they try, they never sell enough coverage for all the risks that life presents. And it’s amazing how many policies they sell after a major disaster.

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