Green Energy and Cheap Oil Don't Mix
by Andrew McKillop
Strategic Analyst and Advisor
April 30, 2010

CHEAP OIL AND GROWTH

Cheap oil is still held to be a passport for economic growth, as witnessed by Ben Bernanke identifying the 100-dollar barrel, at the August 2009 Jackson Hole meeting of leading finance ministers and central bank chiefs, as the red line in the sand. Beyond this, he threatened, interest rates might have to be smartly moved upward to head off rising inflation and slowing economic growth that economic folklore says are due to high energy prices.

The problem for green energy is break even values for green energy output mostly rack up in lockstep with the oil price - and especially for the only one that directly saves oil: the biofuels. Equity performance for biofuel companies moves up, and moves down as the oil price moves up and down. Common to all equity plays, green tech and cleantech need hope that the economy can grow and will grow: raising interest rates is unlikely to do that!

Bernanke's "classic stance" on high oil prices and the economy, with a classic threat of slugging interest hikes to swipe down rising oil prices if oil prices edge past his red line, refers to a fantasy wish list economy, when there was no debt constraint. This was fine 20 years ago but most OECD governments, today, are struggling with massive debt.

Cutting a traditional deficit - the trade deficit swollen by oil imports - lacks the zeroes that national budget deficits and accumulated debt generate. The fiscal and current account deficits in central banker language have democratized and shifted to the tabloids and Internet news sites just because they are so massive - meaning economic growth is the only way out.

Today's OECD economies are struggling to service national debts suddenly and massively swollen by bail outs to banks, insurance companies and financial players through 2008-2009. They are struggling to service accumulated debt racked up over more than 20 years of classic remedies for unclassic problems.

ENERGY PROBLEMS AREN'T CLASSIC

Bernanke's repeat of classic liberal ideas about oil prices, that he has himself nuanced many times (before becoming US Fed chief) also flies in the face of politically correct reality. President Obama and his small band of Old World G7 leaders believing in climate change catastrophe - shrinking to only Merkel and Sarkozy as Gordon Brown crashes off the radar - announce history's biggest transition. By about 2040 they say, current fossil energy will be 80% or 90% replaced by soft and clean energy. In that context, given the costs of transiting to an unknown but exciting New World, worrying about $99 or $100 oil is small change.

Being great leaders they don’t have to spell the who and how of paying and funding their great plan, if it survives the rest of 2010. Given the size of their FY 2010 national budget deficits, probably around $ 2.5 trillion for the 4 countries, they would likely be unfazed by talk of energy transition costing anywhere from $ 15 to 30 trillion over 25 years. To them, just a few more zeroes.

But energy problems are real, making this an unclassic challenge among the paper crises. As the BP Gulf of Mexico blowout demonstrates, deep offshore oil can be dangerous for corporate finances as well as the environment. Getting more conventional fossil energy while also paying for a high priced transition to green energy; is going to be costly.

Hiking interest rates in this context would spell hara kiri for maintaining the 'green shoots' of recovery in the US and other OECD economies, and trigger further bloodletting for government tax takes and revenues. Worst case scenarios could see a wave of currency devaluation or sovereign debt defaults - not by Third World debt strapped nations - but by OECD countries. Since Bernanke knows this better than most persons, his threat of hiking interest rates the moment oil trades above $99.99 a barrel can likely be taken as nice sentiments and simple grandstanding

Direct oil substitute green energy is only produced by bioethanol and biodiesel - from food grains, tubers and oils - until and unless "second generation" biofuels emerge. Current generation biofuels output can seem impressive at around 80 billion litres a year in 2009. But this ignores the petroleum needed to produce, process, transport, store and distribute them. Net oil saving by global biofuels likely only runs at a fraction of the high ground figure of 80 bn litres a year (compared with 13.75 bn litres a day for world oil). Actual and real oil savings from world biofuels are perhaps 0.5 million barrels/day, on a total of 86 Mbd, when we take out the oil needed to produce them.

Understanding this, after more than 5 years of intense and ineffective market play in the biofuels could help Obama and other oil import dependent leaderships get a handle on the transition goals they spell out at the microphone. The transition will be long and will be costly. Current numbers for real and effective oil substitution by green energy are unimpressive and can only have a marginal impact on oil prices. As we found in 2008-2009, the only magic silver bullet for oil prices is outright slump into recession. In the US for example, oil demand fell about 7.5% in 2008-2009: oil prices slumped by 75% from July 2008 to Jan 2009.

GREEN ENERGY AND GROWTH

These are both obligatory. Running a high price transition to green energy on the back of long-term economic recession and debt strangled austerity has even less future potential than Gordon Brown getting back to power in the UK. To be sure, green energy goals are going to be pared, as the higher priced vanity projects are weeded out, but the long-term program will have to be outlined some day. After that, it has to operate year in and year out.

Delivering the capex needed both for green energy transition and keeping conventional fossil fuels supply high enough to avoid price panics can only mean one thing: higher energy prices. Energy spending at the likely and probable needed rates, and cheap oil, do not make sense. If cheap oil was possible it would only raise the subsidies, state-backed loans, and state intervention featuring carbon taxes or other revenue raising needed to give a price advantage to green energy. Cheap oil does not mix with the real world need for producing and paying for ever deeper offshore oil, tarsand oil, global LNG and coal infrastructures, and uranium mining expansion. In the real world and in fact, the fossil fuels are getting more expensive due to rising demand, increasing exploration and production costs, rising environmental risk, and depletion impacts on remaining reserves and exploration costs.

Under almost any non-austerity scenario, energy prices will rise. Making the challenge even more special, transition will happen in a context of radical dislocation, change and restructuring of energy systems, energy markets and energy economics. The vast range of doubt and incertitude on green energy transition will intensify these emerging realities, already feeding back, in early 2010, as rising scepticism on present public goal for energy transition having realistic chances of success.

One clear example concerns the Bernanke response from central banks and finance ministries to "high oil prices" which we can define at around $ 100 a barrel, while average European motorists at the filling station pump pay above $ 325 a barrel at the filling station pump in several countries, in April 2010 with oil prices around $ 85 a barrel. This response, if it is Bernanke and classic, could include "fiscal rectitude", that is interest rate hikes. If so, transition and growth are both dead.

© 2010 Andrew McKillop
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