Nuclear Power

Nuclear is one of those industries that sounds vastly different on TV, by people, and in mainstream than what it really is. Many reading this section are going to immediately have different pictures pop into their heads relating nuclear. I will classify them into 3 camps:

1. The anti-nuclear crowd has images of Chernobyl, Three Mile Island, and WMDs. They will recite stories of mutations, babies born deformed and other horrific images. Nuclear will be painted as a demonic technology that cannot ever be properly utilised and as a consequence will inevitably cause great harm. Vast caverns filled to capacity with spent fuel will ooze poison taking its toll on Mother Earth. We will call these [insert insult here], Greenpeace, WWF, David Suzuki Foundations, and hordes of other groups that say the same dribble.



2. This is a group of people who really don’t give a darn. They will have images of Homer Simpson, Superheroes, Godzilla, or other creatures that are born of radiation. They will have heard of nuclear accidents and think that nuclear is or is not dangerous, but does give lots of electricity. Feelings either pro or con will be minimal and thus little actual knowledgeable reading or educating will be done. Thus, a "gut feel" type conclusion will be made, yeah or nay.



3. The pro-nuclear crowd will mainly be composed of people who are actually in the industry (engineers, physicists, scientists), have lived near a nuclear power plant, or people who understand the experts. They will look at incidents like Chernobyl and Three Mile Island and learn from the mistakes and further improve the industry. Stories of mutations, superheroes, and Homer Simpson will also be considered humorous while recognizing that such stories are removed from truth and science.

Now, like any good brainwashing of the masses, the only way to de-program the victims is to hit them with some knowledge (and please question me as much as you want, because I can prove you wrong). Please remember I am also simplifying the information into a digestible manner, so no snarky remarks about exact wording. Let us start with Chernobyl.

Chernobyl

What is considered to be the worst commercial nuclear reactor accident has been studied extensively by many organizations, reported on by hundreds of media outlets, and is a great source of horrific stories of mutations and the dangers of nuclear power. What was not provided to the masses in 1986 was the truth, being that:

• The Chernobyl accident in 1986 was the result of a flawed reactor design that was operated with inadequately trained personnel and without proper regard for safety.


• The resulting steam explosion and fire released at least five percent of the radioactive reactor core into the atmosphere and downwind.



• 28 people died within four months from radiation or thermal burns, 19 have subsequently died, and there have been around nine deaths from thyroid cancer apparently due to the accident: total 56 fatalities as of 2004.



• An authoritative UN report in 2000 concluded that there is no scientific evidence of any significant radiation-related health effects to most people exposed. This was confirmed in a very thorough 2005-06 study.

Pages upon pages could be written on this incident, and they have been, so rather than repeat and bore you, I will provide you with the following link, and 2 images of the reactor before and after. Note that Chernobyl had no containment building, which all CANDU reactors have had since the first one ever built.

Now you may be sitting there wondering how can the big bad Chernobyl, the accident which brought fear and despair to the world and especially the nuclear industry and assisted in the fall of the Iron Curtain, have had only 54 deaths. Well it did; the media forgot to mention this fact FOR THE LAST 30 YEARS!! The same UN study mentioned in bullet 4, and provided in the following link, stated that more loss of human life and human suffering was caused by poor diets, poor lifestyle factors (smoking, etc.), poverty, and lack of access to health care than Chernobyl ever will.

Thus, the moral of the story is; the worst nuclear incident in the entire history of mankind, caused by poor reactor design, bad training, without regard for proper safety, killed 54 people. This incident brought the nuclear industry to its knees, and caused countries to abandon nuclear power and resort heavily on Coal. On a side note, in May 2005 a train derailment near Amagasaki, Japan caused at least 100 deaths, but there were no cries from Greenpeace to ban trains and shutdown existing train stations.

Now let us discuss Three Mile Island and what happened, or more importantly did not happen.

Three Mile Island

Three Mile Island is one of the funnier incidents in my mind. While the entire US media and public were demonizing the nuclear industry in 1979, the people that worked in the nuclear industry were giving each other high fives and saying “we partially melted the core, and caused no harm to the public. This proves that our safety systems and designs work”. Of course the media, Greenpeace, and other organizations jumped on this like crack addicts and painted a horrific picture. So instead of boring you again, I will provide you with the following bullets of fact and a link to read more about it:

• In 1979 a cooling malfunction caused part of the core to melt in the # 2 reactor at Three Mile Island in USA. The reactor was destroyed.



• Some radioactive gas was released a couple of days after the accident, but not enough to cause any dose above background levels to local residents.



• There were no injuries or adverse health effects from the accident.

Thus, the moral of the second story is; the second worst nuclear incident in the entire history of mankind, caused by a relief valve failing to close, and operators diagnosing the incident to late due to deficient instrumentation and inadequate emergency response, did nothing but scrap a companies equipment. This incident, due to a movie, "China Syndrome", being released brought the nuclear industry to a halt around the world, especially in the US. What makes it really funny is that actual truth and fiction from the movie began to blur, with more and more fiction entering news coverage. As a result, what all these countries did was turned to coal. I should add that over this past Victoria long weekend, 16 people died in car accidents while no cries for banning long weekends were heard from Greenpeace or other organizations.

Nuclear Bad Reputation or Bad Representation?

So far we have learned that the 2 most severe nuclear accidents in commercial nuclear reactors in the world have killed a total of 54 people over 20+ years. Yet somehow the masses have it engraved in their minds that nuclear is dangerous. So, let us apply this logic to other common things that should be banned:

• Trains, planes, cars, ships, and virtually all modes of transportation,


• Guns, knives, forks, spoons, swords, poles, pitchforks, about anything you can hold in your hand,


• Camp fires, swimming, smoking, drugs (the good kind), and virtually anything that can be inhaled or eaten...

Instead of figuring out everything that should be banned that killed more than 54 people, someone tell me something that was invented by man that has killed less than 54 people, that list will be easier to compile.

Nuclear Moneys

So is it all rose pellets, and singing….no. The single largest barrier to nuclear is Capital Cost. Current estimated from all the major nuclear companies put the cost of reactors at $1000 - $2000 per KW, which translates into $1.5 to $2.0 billion dollars. It should be noted that life cycle costs of nuclear power is the lowest, with coal in second place. Furthermore, the price to generate electricity is the lowest for nuclear. This is why France and Sweden have some of the lowest energy costs in Europe (France 80% nuclear, Sweden 50%). The table below includes in the prices, construction, operations & maintenance, fuel and decommissioning.

Source: International Energy Agency, "Projected Costs of Generating Electricity ", 2005.

As for return on investment, well I’m not privy to that kind of info, but the number that floats around the industry to keep a single reactor down for a day is $1 million. Using that number, a single reactor would make $350 million a year (remove some days for maintenance), and thus payback the initial capital in 5.7 years (assuming no interest). This can be done in various ways, public money, private money or a combination. But ask any investor and that turnaround is not fast enough, especially with something as tricky as nuclear power. In the past it has been public money, but governments are trying to create market environment to allow the private sector to take on this tricky deal. Why is it tricky you ask?

Long Time to Build?

Well of course silly, it is tricky because it takes 10 years to build a nuclear power plant... WRONG. It takes 54 months, at least for AECL on Qinshan Unit 1 in China on December 31, 2002. That is first-concrete to full power. So where does this 10 year number come from? Well it actually takes 10 years due to environmental assessments, town hall meetings, filing paperwork with the government, go to court against Greenpeace or WWF, having to redo the environmental assessment (come to same conclusion), redo town hall meetings, re-file paperwork, have a change in government so NDP or Liberal party who cancels/restarts project, have a union strike, go to court again against Greenpeace because on form 456578903 you forgot to cross the "t", re-file paperwork, have laws changed, etc...

I hope you have gotten the picture by now. Long schedule and high budget for nuclear does not come from the technology, but rather the cumbersome overburdening process that is continually forced by various special interest groups, who then argue that nuclear costs too much and takes too long. So what do countries do? They turn to coal.

How Much Nuclear Can the Grid Handle?

So now that budget and scheduling of nuclear has some truth put to it, I guess the anti-nuke crowd needs a new argument--they may try to argue that you cannot have too much nuclear on the grid because it cannot load follow. This argument is hogwash. France has 80% of its electricity generated from nuclear and it load follows quite well, why pray tell? Well nuclear power can actually generate power in the range of 60% to 100% of capacity, but of course the bean counters want to run at full tilt. Theoretically then, nuclear can economically provide 100% of a country’s power. Nuclear is meant to run full tilt all the time, base load, thus it would be advisable to have supplemental generating sources, like coal or natural gas, for peak demand (on a hot summer day for example). Load levelling can help with this issue, by pushing energy consumption from the day into the night, and thus have a more level energy demand.

This is where things like hydrogen or electrical cars could fit in nicely. Use the excess energy from nuclear at night to produce hydrogen or re-charge electric cars. I will not get too futuristic on you, but I will mention that CANDUs are not only good at producing electricity, but they can also be used for desalination plants (making fresh water from salt water), hydrogen generation, utilising spent fuel from US or French reactor designs, utilising actinides and greenhouse heating (done at Bruce in past) just to name a few.

So now with the anti-nukes are biting their nails, and wondering 'boy what is left to scare people about?', this leads us to nuclear waste, or as the industry likes to call it, "spent fuel" .


Spent Fuel?

Spent fuel is exactly what its name implies. For CANDU reactors the fuel stays in the core for about 1 year, it is the removed through online fuelling, and deposited into the storage bay (large pool), after 10 years they move it to dry storage. To date, in Canada all spent fuel from all CANDUs are kept on site and are continuously monitored. Now that may sound scary, but let me give you 2 images:

1. 40 years of spent fuel generated in all of Canada from 22 CANDU reactors is equivalent in volume as a soccer field pile 6 feet high.


2. The city of Toronto generates an equivalent amount of garbage to Canadian spent fuel is a single day.

Now you might all be thinking of that episode of the Simpsons when Mr. Burns pushed a barrel of radioactive waste into a tree trunk (don’t forget the squirrel with laser eyes). Now that is incredibly inaccurate, because not only does spent fuel not go in barrels, it is also not a liquid. Spent fuel looks exactly the same as fresh fuel, see figure. Every bundle is numbered, tagged, and it's location is known, and continuously monitored.

For some reason this is thought of as being scary, so let me make a comparison between spent nuclear fuel and municipal waste:

• Spent fuel comes in solid metallic bundles, which is eventually stored in concrete leak tight multi-layered containers, and are monitored regularly. Containers don’t corrode or react with the environment, and if they did they would be replaced (remember they are monitored), or


• Municipal garbage is anything and everything you throw into your trash (paint cans, used chemical bottles, batteries, food, metal, etc.) that is brought to a landfill and just dumped. It sits there for a prolonged period of time decomposing and reacting with whatever is around. Heavy metals leech into the ground, along with other chemicals.

One of these we regard as dangerous, the other is perfectly safe common practice. So which one is safe? I’ll leave that up to you to figure out, but I will say this; I would rather live near a spent fuel storage facility then a garbage dump.

I should also mention, that the reason spent nuclear fuel should not called waste is because the it can be reprocessed to produce additional fissionable material which can be extracted and re-used.

Summary

We have all been lead to believe that nuclear power is a big bad scary demonic technology that can only do harm. Thanks to the likes of Greenpeace, WWF, David Suzuki Foundation, and many other special interest groups, and due to their tireless efforts, and war on nuclear for 30 years now, they have accomplished a great feat. This is causing the construction of many dirty coal power plants around the planet that emit large quantities of air pollution. They have systematically blocked, cancelled, and prevented the expansion of nuclear power. They have subsequently caused the industry to superfluously increase safety standards (to a point that some may call ridiculous); blocked, prolonged, and took companies to court over environmental assessments, town hall meetings, and general paperwork; all which of unnecessarily add to capital costs.

Nuclear power is safe, clean, and generates cheap constant electricity. It is essentially the exact opposite of what the current mainstream public thinks about it. There are many other added benefits, and of course the above could be expanded upon greatly, which I will leave to next time, otherwise I won't have an excuse to come back and write in Kent’s Blog.

Up and Atom,
Laszlo Zsidai

The Alternatives

In recent days we've seen oil prices top $135/barrel. The market has begun to show a negative response to such high prices. Major airlines announced major cutbacks in staff, flights and effectively hiked prices. The Ford Motor company (NYSE:F) has announced that its bid to become a profitable company again won't happen until 2009 and that it would change its 'focus'. According to its annual reports, Ford's Automotive division has not turned a profit since before 2002. General Motors (NYSE:GM) shares hit a 34-year low (that's without adjusting for inflation).

Consumption data has yet to show an actual reduction in demand but with projected reductions associated with these types of announcements, it appears as though oil prices may come down at the expense of the U.S. economy. America needs to close the gap on its energy deficit. And soon.


Why hasn't the United States opted for Energy Independence earlier?
It pretty much comes down to cost. The financial cost of oil in the last century was so low that exploiting this allowed the economy to grow at a rate much higher than it would if more expensive renewable energy sources were used. For example, running a car on corn-based ethanol is much more expensive than running it on gasoline when you look at the overall costs. It also costs money to improve fuel efficiencies--few people will pay the extra cost of a hybrid because it simply doesn't pay out (this may change in the near future). American policymakers obviously didn't anticipate how quickly oil prices would rise otherwise they would have done more. Some did have this foresight, but for the rest of us, 'hindsight is 20/20' sums it up.


How do we measure energy cost?
There are several ways to do this. One very good indicator is Energy Returned on Energy Invested (EROI or EROEI). It's basically a ratio of the energy produced by a particular energy source to the energy required to produce it. Think of it as a rough indicator of how much it will cost to produce one gigajoule of energy (higher number=cheaper cost). For example, in order to get gasoline, an oil well needs to be drilled, produced and the products refined. All of this takes energy, but for the case of oil, the energy output is about thirty times the energy required to get it out of the ground and produce it. High-quality (high EROI) oil reservoirs like the supergiants are the first to be exploited. As these become depleted, oil prices go up, which leads to lower quality (lower EROI) reserves like the oil sands being exploited. The key to this is that for non-renewable energy sources, EROIs always trend downwards and energy prices trend up. The following table lists rough estimates of the EROI for different energy sources.

Why is hydrogen negative?
Hydrogen is not a potential energy source. It is a potential energy carrier like electricity. It can potentially be used as a transport fuel but because of thermodynamic energy losses (nature's inefficiencies), some energy is lost in the process. I have heard some claims that cars can run on water. There are only two ways that a car will be able to 'operate' on water:

1. The car has some sort of very advanced 'charger' device. You fill it with water and plug it in overnight and it splits water molecules into its elemental hydrogen and oxygen via electrolysis, and stores it in a tank for use by a fuel cell device while driving. The technology to do this isn't competitively priced yet and associated electricity costs are high.


2. The laws of thermodynamics are wrong.

More than 90% of industrial grade hydrogen is currently produced by ripping the molecule from natural gas. This method is much more economic than using electricity to split water, but it obviously doesn't reduce the need for fossil fuels.

What about plant-based ethanol fuels?
It's currently debated whether or not corn-based ethanol can net more energy than it requires to produce it. Even if it does, it's unlikely to make America energy-independent given such a low rate of energy return. It took Brazil 30 years to get to the point of using subsidy-free cane-based ethanol, which has a much better rate of return than corn does. Technology improvements will help improve the EROI but this will take years to do. And as we've seen, the huge farming areas required to produce transportation-grade ethanol can also lead to food shortages.


So what is the solution?
Most experts agree the future of energy will need to include some sort of balance between 'all of the above'. Wind and solar are still developing technologies and they have constraints that won't allow them to meet more than 20-30% of America's energy needs. For example, if the sun isn't shining, you won't produce any electricity with solar--this may be okay in some instances, but not if you're using it to heat your home. The other problem is that energy sources that generate electricity can't be used as transport fuels yet because electric and hydrogen fuel cell vehicles are still 15+ years from being competitive on the market. The Chevy Volt looks promising, but they had to go back and redesign the lithium-ion battery (they had some issues with fires, explosions and such). It appears the only solution for Americans right now is to improve fuel economy standards and eliminate unnecessary driving.


What else can be done?
The policymakers need to look at the 'big picture'. If fossil fuels are conserved for applications in which there currently no feasible alternatives (primarily transportation), then the price of crude will come down. For example, heating oil and natural gas is used to heat many homes in America. This is the most efficient way of heating a home, but the simple alternative is electricity. The cheapest way to get electricity without the use of hydrocarbons is nuclear (in terms of EROI, hydroelectric is better but it is effectively maxed out). Nuclear is also the only proven technology that is 'market ready'. Nuclear may have some legitimate concerns, but for some reason it is no longer considered 'green' despite the fact that it has essentially zero emmissions. Plans are currently in the works to build a nuclear plant to power energy-intensive Canadian oil sands projects. The oil sands require steam for oil extraction, and hydrogen to upgrade heavy oil to lighter 'synthetic' crude, both of which are well suited for nuclear power plants. Currently, we are using natural gas for this. I think I'd rather save natural gas for the barbecue.

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Next up: guest writer Laszlo Zsidai will give us some of his perspectives on nuclear from his experience in the industry.


Additional reading:

1. Indiana Senator Lugar's answer to $100 oil


2. Wake Up, America...


3. "It's the flows, stupid!"

The American Half-Trillion Dollar Problem

As I primer to this section, I must note two things.

• I'm not an economist nor do I have much academic training in economics.
• I'm not an alarmist--I did not buy any candles, canned foods or bottled water in the days before Y2K; I took the Spadina streetcar (unmasked) during the SARS outbreak in Toronto; and I didn't think that World War III was imminent on September 11^th, 2001.

That said, I do think the U.S. crude oil trade deficit numbers are quite alarming. In this post I'll try to explain why.


What's so Alarming?
The U.S. is the third biggest producer of oil in the World. Most people don't know this because it's overshadowed by the fact that they are also the World's largest consumer of oil (they use 23% of global production). The difference is a 15.5 million barrel a day trade deficit. The worst part about this is is that with declining domestic oil production, rising prices, and relatively stagnant demand, the problem seems poised to get considerably worse in future years and there's no end to the problem in sight. Below is a chart of domestic (United States) crude oil production.

As you can see, production peaked in 1970 and spiked again in 1985 due to heavy investment initiatives following the 'oil crisis' of the early seventies. With the subsequent decline, despite record prices, is a clear that as a whole, oil production in the United States is in the late stages of Secondary recovery and in many areas Enhanced Oil Recovery (EOR). This means higher production costs for lower recovery rates. Few areas on American soil remain unexplored (Alaska for example still has some potential). This declining trend is not going to miraculously reverse itself, and the crude oil trade deficit will likely only widen.


Why didn't Government do anything?
What's clear is that the Bush administration realized not only that the US was "addicted to oil", but also that this could present a serious problem for the future. In their defense, I'm not sure anyone anticipated such high prices at this time (NYMEX CL:$127/bbl on May 19, 2008). One thing Bush's administration did was to push the development of "clean coal" technology knowing the abundance of domestic coal supplies. Secondly, they banked on the idea that Enhanced Oil Recovery projects could somehow stop the declines of domestic oil supply by subsidizing these projects. Recall in my last post (How High Will They Go?) I used the analogy of drying clothes to illustrate how much more difficult and expensive it is to remove the last bit of fluids from mature reservoirs. I now see advertisements on US television networks noting that the United States has plenty of domestic oil reserves to meet demand. While there is still plenty of domestic oil, it won't be coming out of the ground quickly or cheaply. I'm not sure who paid for these ads but it could have been the Independent Petroleum Association of America (IPAA) who are looking to get more government subsidies. Bush has repeatedly begged OPEC to raise quotas to no avail, but Saudi Arabia has recently agreed to raise production by 300,000 barrels a day. This could help bring down prices a bit in the coming days.


Didn't the U.S. invade Iraq to secure supply?
Haha. Well, many people certainly believe this, but I will try to avoid the controversy of this claim and just state the facts. The stated reasons for the Iraq War were weapons of mass destruction (before) and humanitarian causes (after). It could just be a coincidence that Iraq also has the second largest volume of proven conventional oil reserves in the world at 112 billion barrels. Still, I can't think of a good explanation why former Secretary of Defense Donald Rumsfeld had a change of heart after cordial meetings with Saddam Hussein in this 1983 video from the National Security Archives. Regardless of the reasons, even if oil security were the true goal of the war in Iraq, then it undoubtedly failed in this regard. Iraqi oil production is down about 400,000 barrels a day since the start of the war. Prices have gone up steadily since news of the war broke, and instability in the region is now much higher than it was under Saddam Hussein. An very recent op-ed in the Boston Herald has some more perspectives on this (link).


How big is the problem?
At the oil prices of the last century, the deficit wouldn't present too much of a problem other than during the oil embargo years. Now, it adds more than half a trillion dollars to the trade deficit each year (assuming a very conservative oil price of $90/bbl). Perspective: US$500 billion is about the same as total annual U.S. military spending! And it means indirect funding of countries like Iran and Sudan, who sell their oil to other countries at near-market prices. The chart below shows the monetary deficit in inflation-adjusted 2007 US dollars (with consumption and production rates plotted on the right axis as areas). It is only plotted up until the end of 2007. If oil prices average $120 a barrel in 2008, Americans will be paying US$1.8 billion a day in exchange for foreign oil imports. Thankfully Canada will get to add nearly 20% of this to its GDP.


Consequences?
I would liken it to a huge battleship going full speed and then having a giant anchor thrown overboard. Initially, it may have enough momentum to keep going for awhile, but unless action is taken quickly, it will slow and come to a dead stop. Some of the more pessimistic economists I have heard claim the American economy is in worse shape for the future than it was at the start of the great depression. I personally don't see this level of severity because with 25% of the world's oil consumption, a recession alone should reduce demand enough to bring down oil prices. Another saving grace is that many of the international oil and gas corporations are American, which means they will bring some of this deficit back into the country in the form of profits.


What next?
Well, certainly dwelling on the past won't do anything. But solutions need to be found, and quickly. Next up is a look at America's energy options for the future. Keep it locked..

How High Will They Go?

Crude oil prices, like many other commodities, are traded on world markets. This of course means that the prices are set by a balance between supply and demand. Markets fluctuate, and at any given time oil can be overvalued or undervalued, but over time the market will correct and average itself out. This is one of the the basic macroeconomic principles for ideal conditions, and historically, it has worked relatively well.¹

In order to predict oil prices, one has to comprehend the supply/demand balance.


Demand
In general, economists can assume that world demand is mostly independent of price. This is normally a good assumption because people will always need to heat their homes, transport goods, move people, and so on. Given this assumption, it's just a matter of forecasting global economic growth and the corresponding crude oil requirement for that growth. The assumption can fall apart under excessive prices, in which case we can do a price forecast and estimate demand accordingly. Either way, predicting demand for oil is a walk in the park compared to predicting the supply of oil.


Supply
I would say there are three major factors when it comes to oil supply: Reserves, Recovery rates and Geopolitics.

1. Reserves
   Estimating how much oil there is thousands of meters below ground is at best pseudo-science. Especially when those reserves are beneath a seabed hundreds of metres offshore. Seismic technologies can give us a decent initial guess of the volumes in place. Once an exploratory well is drilled, a considerably improved estimate can be obtained using established logging, coring and testing techniques. Many areas in the world have not even been explored yet, but even if exploration in these areas began today, its oil would take over 5 years to hit the market and have no impact on short-term supply.
   
   
   
2. Rates and Recovery
   Even if we did know exactly how much oil there is in the ground, this tells us nothing about how quickly we can get it out and at what cost. Virgin reservoirs are typically produced in three stages:
   
   
1. Primary recovery. Virgin reservoirs are at high pressures and produce at high oil-water ratios (lots of valuable oil, not much invaluable salt water). Some wells are termed 'gushers' because they initially flow without even being pumped. Eventually though, external energy is needed by pumps to continue the recovery process.
   
   
2. Secondary recovery. As pressure decreases over time, pumping alone may not be sufficient to keep the well flowing economically. Fluids are injected into the reservoir to maintain pressure support (most commonly produced water). Most of the recoverable reserves are recovered at this point and at a relatively low operating cost.
   
   
3. Tertiary recovery or Enhanced Oil Recovery (EOR). Eventually, the produced fluids are virtually 100% water with very little oil. The properties of the reservoir itself must be altered in order to unlock the residual oil trapped in the pores of the rocks. Any combination of steam and/or surfactants and/or other chemicals are injected into the reservoir to achieve this favourable alteration. Operational costs are high and recovery rates are low compared to primary and secondary recovery.
   
   A useful analogy to the recovery stages is that of of drying clothes while doing laundry. No analogy is perfect of course but I think this one illustrates the important points quite well. I'll be coming back to this in my next post so I want to make sure it's clear. Click here to see the analogy.
   
   


3. Geopolitical Stability
   There are many regions of the world that have plenty of reserves with very favourable recovery conditions that have yet to be tapped. Many of the untapped reserves are also in places with high geopolitical instability. Not only can this interrupt supply, it deters investment and also creates a 'fear premium' on the price. Even in politically stable areas, oil exploration can be restricted for both social and environmental reasons.

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Do the fundamentals support the current prices or not?!?
This is still the subject of much debate. Here are the three basic perspectives:

1. Oil is overpriced. This group of people think the market is well-supplied and high prices are mostly due to a very large geopolitical risk premium added to the price by speculative traders. Given the rapid rise, the price escalation is a bubble that will ultimately burst in the form of a market correction. They believe new discoveries and technology will help supply meet world demand for the next 40 years or more.
   
   
   

   Support: An article last month inferred that oil prices rose after news that pirates attacked a Japanese oil tanker resulting in "hundreds of litres of oil" being spilt. To put that into perspective, 1000 litres of oil is less than one hundred thousandth of a percent (0.00001%) of daily world crude production. There's absolutely no reason something that small should effect prices. Also, check out Wall Street's crude ways by David Weidner of MarketWatch.





2. Oil is relatively well-priced. These people are what I would call the moderate "peak oil" theorists. They believe that while reserves are plentiful, geopolitical risk and depletion of high-quality reserves will keep the prices high indefinitely. Soaring demand from China is believed to be the single largest reason for the increase under this schema.
   
   
   

   Support: Demand from China has increased and average of 7% each year since 1991 despite higher prices. If the existing trend continues, China's consumption will surpass that of the United States by the year 2024. Click here to see a supporting chart using data from the U.S. Department of Energy.

   
   
   
   
3. Oil is undervalued. Hard line "peak oil" theorists fall into this category. Most people in this group believe tat world oil production has essentially already peaked and increasing demand will only increase price. Many believe reserves and recovery rates have been largely overstated by the industry (in order to encourage investment). Publicly traded companies are regulated by agencies such as the Securities Exchange Commission, which has rules to minimize this overstatement risk. National oil companies are generally regulated by the fact that foreign investors usually require confirmation of good reserve estimating practices by external auditors. Saudi Arabia, the world's biggest oil producer, is an exception because Saudi Aramco doesn't trade on any public markets nor does it require any foreign investment to operate.
   
   
   

   Support: Royal Dutch Shell overstated its reserves by about 23% in 2002, and were subsequently fined $150 million by the SEC and it's British counterpart.^* Although this was the highest-profile case, there are other examples of proven reserve overstatments. Dr. Jim Buckee, former CEO of Talisman Energy Inc. has said that peak oil is 'here or hereabouts'* and thinks oil will get to the $150 to $200 a barrel range before it will have any impact on demand.

What's my personal position on oil price?
Personally, I'm undecided. I think the days of $40 oil are certainly over, but I'm not yet convinced the excessive rate of increase is warranted. Given the rapid rise in prices, I don't think the market has had enough time to respond yet if a reduction in demand is imminent. The other factor that is rarely mentioned is the recent trend of oil nationalisations. Russia and Venezuela are two of the world's biggest oil producers that have nationalized their oil so far this century. The bigger piece of the pie being taken by these governments is ultimately being passed on to consumers in the form of higher prices. Less imperative but worth noting in this regard is Alberta's recent royalty rate increase.

I guess this would put me somewhere between perspective (a) and (b) with a bias towards the latter. I'm not investing directly in oil at these prices, although I would have in 2006 when prices were well below $70/bbl (I didn't have the capital).

My next post will be on the U.S. economy. As a consumer of 25% of the world's crude oil production I don't think we can ignore the status of the U.S. economy when it comes to predicting demand and subsequently price. As always, stay tuned..

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Notes

1. I've never taken a course in economics so please correct me if I said something that would offend the founding fathers of economic theory.
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Gas Prices

In May of 2005, I remember wondering how gas stations would display their price when it hits the century mark. A couple months later I was watching images of Hurricane Katrina on CNN. The damage to billion-dollar oil platforms in the Gulf was enough to push gas prices from 90 cents a litre to well over the century mark. At first, many gas station displays showed 00.0, but it wouldn't take long for gas stations to put in the capital and upgrade their signs to be capable of showing prices north of the 99.9 cents per litre mark. Apparently they realized these prices were the new norm.


Why are gasoline prices so high?
Crude oil prices.

The price of oil on NYMEX at the time of writing is $126 a barrel (May 9, 2008). That's about double the price a year earlier and will ultimately translate into an average gasoline price of about $1.32/L in Canada and $3.78/gallon in the U.S. (I expect prices at the pumps to be in this range entering the long weekend).

The chart below shows normalized crude oil prices compared to normalized gasoline prices in real Canadian dollars from January 1987 until May 2008.

large size

(you will need a Google account to access the source link)

As the chart shows, the price Canadians pay at the pumps has actually lagged quite a bit behind the crude oil price since 2004. The break is mostly thanks to the increased value of the Loonie compared to the Greenback (American gasoline consumers are not as fortunate in this regard).


What about price gouging right before long weekends in the spring?
This is probably due to speculative commodity traders. In anticipation of higher demand, they buy more oil and the price gets to consumers before the demand is actually there. An energy analyst I heard on CBC the other day said there is no evidence of any price gouging. I haven't seen any conclusive numbers myself that would either confirm or deny this claim.


Would boycotting gas stations help?
Yes and no. Reduced demand means improving the supply/demand balance and subsequently lower prices. But reducing demand doesn't seem to be the objective of the "boycott oil company X" initiatives I've seen on the Internet and in emails. This strategy will not work unless a significant number of people actually reduce demand and not just buy gas from somewhere else or wait until after the weekend to fill up. Toronto is the largest Canadian market and has the lowest gasoline prices in the country thanks to the so-called 'gas wars'. Torontonians pay even less on average than Calgarians who save about five cents per litre in lower provincial gas taxes. Smaller, more remote regions such as Halifax are amongst the highest in Canada. This is a pretty good indication that free-market competition forces are working as they should.


sourced from Natural Resources Canada



Can we petition government to put a cap on prices?
Sure we can. But I don't think this is a good idea. Part of the reason oil prices are so high is because of increasing demand from China, an emerging economic power that subsidizes its oil price to stimulate growth. China's economy can afford the higher price mostly because per capita consumption is only about 1/6^th of a barrel of oil per month. Here in North America, each of us use over 2 barrels per month. The approach makes sense for an emerging economy like China's but for the established economies of Canada and the United States it's an unsustainable Band-Aid approach.

In Canada, the taxes on gasoline at $1.25/L range from 25 cents to 40 cents depending on the province [detailed breakdown]. Most of these taxes are dedicated towards transportation infrastructure. Ultimately the question becomes who is going to pay to repair roads and bridges under a tax holiday or even a price cap. The most likely answer is taxpayers. Tax shifting can be good policy but I don't see why it would be in this instance.


Canada has a lot of oil and gas. Why are we selling so much of it across the boarder with such high prices?
We are essentially committed to free market prices under international free trade policies such as NAFTA. In 1980, the Trudeau government decided to regulate prices in with the National Energy Program. It was not very popular in the west and polarized the country. With tens of billions of dollars lost from the Alberta economy,^[*] I don't think we'll see a repeat of this policy anytime soon.


How high will crude oil prices go?
Stay tuned. I'll discuss this in my next post.