The Weekly Wrap: June 18, 2011

For electric cars, a long battle: A misunderstanding about the international electric-car race — the rivalry for domination of a possibly gargantuan market for electric cars and advanced batteries — is that the winner will be known soon. It’s clear why people would so conclude — so much hoopla has surrounded the launch of the Volt, the Tesla, the Leaf and other models that the international contest looks a bit like the U.S. Open. We only wish we knew now which one is Rory McIlroy (pictured above). But does this perception conform with other recent examples of big technological adaptations? Not really. Even in our super-charged, accelerated world, laptops took 15 years of scaling up and pricing down before embedding themselves popularly, and cellular phones have been the same. By that measure, it will be the second half of the 2020s before electric cars are a significant part of the highway traffic.

In an upcoming study, the Boston Consulting Group, a management consulting firm, forecasts that electric cars will make their biggest splash from 2035 to 2050 (autonews.com helpfully posted a draft copy of the study). While no one can reliably forecast consumer taste one way or the other, this outlook seems a reasonable dart-throw. Of course, we are talking pure electric vehicles — when you add in hybrids, penetration will be much faster. The reason is that both manufacturers and consumers are going to be thinking flexibility — it will be prudent to have hybrid capability. Yet one reason the climb will be long is not just the height of the bar — making models that travel far enough before requiring a recharge — but the requirement to beat out gasoline-driven rivals, which for competitive reasons are bound to become far more efficient, as Jeff Bennett writes at the Wall Street Journal.

Read on for more of the Wrap.

Japan’s pain Russia’s gain: Italy, which hasn’t relied on nuclear power since the 1987 Chernobyl nuclear accident in Ukraine, convincingly overturned an effort by Prime Minister Silvio Berlusconi to build new nuclear reactors. In doing so, Italy follows Germany, which already decided to eliminate nuclear reactors that provide a quarter of the country’s electricity. Switzerland, too, is phasing out nuclear power, and Great Britain may as well. All of these steps are in response to Japan’s Fukushima nuclear crisis, which dramatized yet again that — as rare as they are — nuclear meltdowns can happen. Large parts of Europe no longer want to take the risk. The big winner? As discussed previously, it is Russia, which had been losing its natural gas market to lower demand and the encroachment of lower-priced Qatari liquefied natural gas. Now, gas demand is sure to surge, putting Russia’s Gazprom back in the driver’s seat. Gazprom already supplies a quarter of Europe’s natural gas.

Does this new reality change the ground in Europe’s pipeline war — the years-long contest to build new natural gas pipelines into Europe? I don’t think so. The U.S. and Europe want to build a $15 billion line called Nabucco, and limit Russia’s influence on the continent. Russia wants to reinforce its place by building a $23 billion line called South Stream. The promoters of both lines are indefatigable talkers, but I don’t see how either benefits. Nabucco still doesn’t have enough gas.  As for South Stream, it has always reeked of hucksterism, a point raised in less blunt language by James Kanter in the New York Times. At the volumes required for Italy, Germany and the others, sufficient gas can pass into Europe through existing lines and Nord Stream, a new pipeline being built from Russia into Germany.

… and what about a chain reaction to Macondo?  The Fukushima crisis is knocking the wind out of the nuclear power industry. Not so much last year’s Gulf of Mexico oil spill, though — apart from a longer waiting period for Gulf drilling permits, it is difficult to see any setback to the oil industry from the five-million-barrel spill. One reason is that, unlike as she did with nuclear power, Angela Merkel, for instance, cannot simply declare that Germany will use no more oil by a date certain — the German economy would grind to a halt, and the geopolitics of the continent, Russia and further afield would be altered instantly. No country one can. But the industry itself is also hedging its bets. It knows that another such spill wouldn’t be treated lightly anywhere in the world despite oil’s centrality. ExxonMobil has led the development of a rapid-response system that is meant to contain a Macondo-size spill. We have wondered whether the industry will offer such equipment elsewhere in the world, and the answer turns out to be yes. A subscription-based Aberdeen, Scotland-based company called Wild Well Control says it’s prepared to fly a similar system anywhere, and already has clients in Brazil, the Mediterranean and west Africa, writes Simone Sebastian at fuelfix.com. In case you are interested, Wild Well charges $3.3 million for a five-year subscription.

Clarity on price volatility: A year ago today, the price of oil was $77 a barrel. The U.S. price for regular gasoline averaged $2.70 a gallon. Yesterday, oil closed at $93.01 a barrel, and the average price of regular gasoline was $3.67 a gallon. Those, respectively, are 20 percent and 36 percent increases. But such permutations are nothing compared with 2008, when oil rocketed to $147 a barrel before plunging to $32 a barrel, and U.S. gasoline prices surpassed $4 a gallon, then whipsawed to $1.67 a gallon.

Since 2003, in fact, when spare production capacity — the availability of idle but ready-to-go oil wells — narrowed sharply, we have seen the prices of oil and gasoline jerk up and down, often changing on the tiniest bit of news. Oil prices swung by a highly unusual $10 a barrel on any given day — say from $50 to $60 a barrel — on perceived threats to oil supplies, such as hurricanes or upticks in war. Then they would go back down. The reason was that no one knew where needed new crude could be found, which created a perception of scarcity, and led traders to bid up the price. Once the crisis of the moment was over, the air would go back out of the price. Of course, the longer-term trajectory was steadily upward.

Eight years of this experience have informed us that this is no blip — we are in an age of highly unstable oil and gasoline prices. Investment banks have frequently spoken of the wild ride we will be on for some time to come, Deutsche Bank being among the most eloquent. Southwest Airlines has signaled the same with long-running, often-profitable and well-publicized hedging of fuel purchases, a strategy followed as well by JetBlue, Virgin America and many others. Mexico, too, has attracted much attention with huge, often-profitable hedging positions for its crude oil sales. Big Oil companies such as Shell have let us know to expect shocks to the system.

In a blog post this week, I cited a thoughtful article on this volatility in the new issue of Foreign Affairs by Robert McNally and Michael Levi. One of McNally and Levi’s central points is that such volatility harms economies because companies and countries have a difficulty making long-range decisions when they cannot to any reasonable degree foresee the future price of oil. Among the outcomes can be geopolitical unrest, they write. The hedging actions described above show that commercial actors are adapting — in effect, they create their own artificial closed space in which they continue to operate, make planned investments, and so on. Those who do not or cannot, however, are exposed to the elements.

I diverged with the Foreign Affairs piece on the uniformity of the volatility impact. Specifically, when there are wild price swings in what we now consider low-price ranges — let’s say the doubling of prices from $32-a-barrel in December 2008 to $66 a barrel by July of that year — it is consternating, but not necessarily a crisis. Businesses aren’t happy about such spikes — their business plans need to be flexible. But it is heaven compared with the erratic prices of 2008, when they jumped from $100 a barrel in February to $147 a barrel in July. I wonder whether many businessmen would prefer stable oil prices at $140-a-barrel to jumpy prices in the $32- to $66-a-barrel range.

Re-reading my post, however, I see that some lines may sound snarky. In their own response on Levi’s blog at cfr.org, McNally and Levi appear possibly to have perceived it as such. It was not intended to be. I do not know McNally, but Levi is one of the most careful writers on the beat. Their article is recommended reading.

I might add that an important aspect to the volatility is the excessive role of speculation, as explained in an excellent backgrounder by Toni Johnson at cfr.org. Financial players — whose purpose is not to steady a business, such as an airline, but to earn big bucks — buy and sell oil futures on the spare capacity issue. Such behavior by hedge funds, pension funds and ordinary Joes can exaggerate the normal ups and downs of prices, which they have done in the years we are discussing. The low price of admission to the trading casino encourages them to get in and stay in the game. The result can be bigger bubbles and bigger crashes. We can get into a chicken-and-egg game — that without tight supply issues, the financial players would have no reason to be in the casino. In my own view, that is twisted logic, and it is intended as a diversion. To close out, one should not outlaw the trading system; but financial players with no purpose but profit should pay more for the privilege of playing. It’s called rationing scarce goods.

In the longer term — say the end of the current decade or the beginning of the next — the oil supply situation could become much calmer because of  exceptionally high investment going on in the oil patch, and the opening up of new reserves, for example in U.S. oil shale.  Watch this video with uber-analyst Ed Morse.