In other words, next year the oil companies will be required to buy 12.6 billion gallons of conventional corn ethanol, but because tax payers are giving them $5.85 billion they’ll consume 1.4 billion more than required. That works out to $4.18 per extra gallon.

As I’ve written before, having the tax credit on top of the RFS is like paying drivers to obey the speed limit. (Tip of the hat to Rapier for the analogy.) Some in the industry may be inclined to point to the additional 1.5 billion gallons as a justification for the tax credit, but the price tag should make that argument just silly. Taxpayers have been subsidizing the corn ethanol industry far too long at the expense of developing cleaner, more renewable biofuels.

Plus the FAPRI study also points out that the tax credit is leading to higher prices for corn and other grains–$0.18 per bushel of corn, $0.28 for soy, and $0.15 for wheat. And lest anyone argue that the tax credit is a good way of supporting farmer income, think about this: if we gave farmers an extra $0.15, $0.28, and $015 per bushel for every single one of the corn, soy, and wheat bushels they’ll grow next year, it would cost just $3.56 billion. And we’d still have enough of the tax credit money left over to subsidies the extra 1.4 billion gallons to the tune of $1.64.

The FAPRI study’s analysis of how the tax credit effects commodity crop prices also confirms the underlying economic truth of indirect land-use change. Higher prices for commodities mean that farmers here in the US and around the world will want to grow more. In those parts of the world where its cheaper to increase production by bringing new land into cultivation than increasing yields on existing lands, that’s going to lead to land-use change. Not surprisingly, EPA’s analysis, which uses the FAPRI model, finds that the emissions from this land-use change is one of the largest sources of emissions associated with corn ethanol.

Yesterday, Growth Energy had the audacity to argue that the tax credit lowers the price of gasoline. It’s a cynical, shell-game claim, meant to earn support from drivers who are actually subsidizing this well established industry every April 15.

The simple fact of the matter is the current corn ethanol tax credit is a huge waste of money. We don’t need an additional 1.4 billion gallons of corn ethanol, or the higher prices for grains and more deforestation that come with it. And we sure as heck don’t need to be spending $4.18 per gallon to get it. The corn ethanol tax credit (and the biodiesel tax credit too) needs to end!

We have to be smarter about how we use our tax dollars. NRDC has proposed a greener biofuel tax credit that encourage competition among the technologies and only pay for real performance. It’s time to transition from corn ethanol’s pollution and pork to a new generation of more sustainable biofuels that brings us closer to real energy independence.

The primary reason this happens is due to a seasonal switch in gasoline blends. There are two key (although not the only) specifications that refiners must meet for gasoline. The gasoline must have the proper octane, and it must have the proper Reid vapor pressure (RVP). While the octane specification of a particular grade is constant throughout the year, the RVP specification changes with the seasons. (See Refining 101: Winter Gasoline for a more detailed explanation of gasoline blends).

The RVP is based on a test that measures vapor pressure of the gasoline blend at 100 degrees F. Normal atmospheric pressure varies, but is usually around 14.7 lbs per square inch (psi). Atmospheric pressure is caused by the weight of the air over our heads. If a liquid has a vapor pressure of greater than atmospheric pressure, that liquid boils. For example, when you heat a pan of water the vapor pressure increases until it reaches atmospheric pressure. At that point the water begins to boil.

In the summer, when temperatures can exceed 100 degrees F in many locations, it is important that the RVP of gasoline is well below 14.7 psi. Otherwise, it can pressure up your gas tanks and gas cans, and it can boil in open containers. Gas that is vaporized ends up in the atmosphere, and contributes to air pollution. Therefore, the Environmental Protection Agency (EPA) has declared that summer gasoline blends may not exceed 7.8 psi in some locations, and 9.0 psi in others. The particulars vary, but key considerations are the altitude and motor vehicle density of a specific location.

The EPA publishes a schedule for the RVP transition:

Guide on Federal and State Summer RVP Standards for Conventional Gasoline Only

The schedule varies somewhat from region to region, but in general is as follows. After allowing vapor pressures as high as 15 psi in the winter, the limit drops starting on May 1st:

May: 9.0 psi
June – Sept. 15: 7/7.8 psi

More congested areas and hotter areas will tend to have a limit of 7.0 psi, while cooler climates generally opt for 7.8 psi. Some cooler climates maintain a 9.0 psi limit throughout the summer. One of the disadvantages of having different requirements for different areas is that summer gasoline is less fungible. This can cause price imbalances in different areas, and sometimes prevents product from flowing from one area into another to ease the shortage.

Refiners will start to pull down their inventory of winter gasoline well in advance of the May 1st deadline. On that date, all gasoline in the system has to meet the stricter requirements, and this “summer blend” is costlier to produce because it contains less butane.

Butane, which has an RVP of 52 psi, can be blended into gasoline in higher proportions in the winter because the vapor pressure allowance is higher. There are two advantages in doing this. First, butane is a cheaper blending component than most of the other ingredients. That makes fall and winter gasoline cheaper to produce.

But butane also adds to the total gasoline pool, so that means that gasoline supplies increase in the winter as more butane is added to the mix. Not only that, but this takes place after summer driving season, when demand typically falls off. These factors normally combine each year to reduce gasoline prices in the fall (even in non-election years). The RVP is stepped back down to summer levels starting in the spring, and this usually causes prices to increase.

One misconception some have is that they can save money by buying cheap gasoline in the winter and storing it for the summer. Remember that winter gasoline will pressure up as the weather heats up, and the contained butane will start to vaporize out of the mix. You will end up with less gasoline than you paid for, and that would also contribute to the air pollution problem that summer gasoline was designed to avoid.

If, on the other hand, you were to buy summer gasoline and try to store it until winter, you might find yourself having problems getting the fuel to ignite, due to the lower vapor pressure. This would be like putting a little bit of diesel in your gasoline – not very good for your car.

So how high might gasoline prices climb this spring? The EIA’s gasoline inventory database can provide some guidance. In the spring of 2007 gasoline prices spiked above $3.00 a gallon for the first time. But that year gasoline inventories also dropped sharply. Rapidly falling gasoline inventories are a good predictor of sharply higher gasoline prices. In the fall of 2005, Hurricane Katrica also caused a sharp drop in gasoline stocks, leading to an atypical fall price increase.

So far in 2010, gasoline inventories have been at very healthy levels. While some inventory draw down can be expected during the transition to summer gasoline, it is a pretty safe bet that the current high level of gasoline stocks will prevent a rapid escalation of prices this spring. I would expect no more than a mild price increase between now and summer, and at the current inventory levels it would not be surprising to see prices start to decline from present levels.

However if oil prices escalate, that could trump high gasoline inventory levels. This is why gasoline is presently about $1 more than it was last year at this time; oil prices were $30-$40 lower than they are now. But that’s a topic for a future essay.

Gas prices are dropping except for California.

For California, though, they have seen an increase in the cost for gas, the report coming a day after the holiday weekend. The price for gas rose 6.2 cents to rest at $3.099 a gallon. California is used to high gas prices, but when the economy is rough, no one wants to spend forty dollars to fill their car.

The primary cause for the increase in gas price is due to the fact that Californian gas has to be much cleaner. In regards to the cleanliness, it is cleaner than any other state’s gas. Because of this, though, there are not nearly as many refineries that pump out this extra clean gas which causes a decrease in supply.

Furthermore, two refineries in Northern California are closed for maintenance, so the refineries that are there are forced to work even harder to try and get their output up. Analysts are suggesting that, because there are fewer refineries working, and the ones that are working are trimming some production to keep profits high, that gas prices in California might go up as high as $3.25.

There are people obviously concerned and frustrated about this. Complaints about the tremendously high fuel taxes (highest in the Union) make Californians even more distasteful about the prices. Finally, because it costs anywhere from 5-15 cents more a gallon to refine this extra clean gasoline, the prices fall on the consumer.

Because the state is down to only 13 refineries creating this extra clean gasoline, there is going to be a major issue of supply not meeting demand. If that happens, prices are expected to rise even more.

Jeff Rubin – the former chief economist at CIBC World Markets – has always struck me as someone who “gets it.” I have seen him do a number of interviews, both on television and in print – and he consistently sounds the alarm on peak oil. He understands very well that cheap oil is the lifeblood of the global economy, yet this is an era that will soon come to an end. His new book – Why Your World Is About to Get a Whole Lot Smaller: Oil and the End of Globalization – goes through the peak oil story in a way that I initially thought of as “Kunstleresque“, but I changed my mind as I got deeper into the book.

Some will certainly describe Rubin as a ‘doomer.’ However, by the end of the book I had concluded that there are some significant distinctions between the overall message that Rubin is trying to convey and the message Jim Kunstler conveys in The Long Emergency. Maybe it’s because The Long Emergency really slapped me out of complacency, but I recall being mildly shocked after reading Kunstler. I did not experience that same sense of shock while reading Rubin – but those who are only mildly familiar with peak oil may be.

Rubin covers many familiar themes, such as the domestic cannibalization of exports by energy producers, the need to produce and consume more goods locally, corn ethanol (which he describes as a ‘head fake’), and the overall impact of high oil prices on the global economy. For regular readers, you will find that much of the book is familiar territory, and for a while I was thinking “There is nothing here that I haven’t seen before.” But the book ultimately grew on me, partly because there are two themes that distinguish it from other books I have read about peak oil.

The first involves a discussion of carbon dioxide emissions. In a chapter called “The Other Problem with Fossil Fuels”, Rubin started to make a argument that I have often made: Ultimately it is futile to attempt to regulate carbon emissions, because China is literally bringing several coal-fired power plants online every week. Rubin wrote that between now and 2012, over 500 new coal-fired plants are scheduled to come online – just in China. This was the theme of my essay Why We Will Never Address Global Warming. My belief has been that there really isn’t much that will convince China and other developing countries to cut back on their emissions. While I still think carbon dioxide emissions will continue to rise until we simply run out of fossil fuels, Rubin provided an interesting argument that caused me to think that a different approach might work.

Rubin argues that if we put a price on carbon emissions in the U.S., Canada, Europe, and other developed countries – we can apply a carbon tariff on imports to level the playing field. Rubin states that energy usage per GDP in China is four times that of the U.S. economy. By putting a carbon tariff on Chinese steel, for instance, two things are accomplished. First, the Chinese then have a much greater incentive to become more efficient. Second, domestic energy intensive industries (like steel production) suddenly become much more competitive. The flip-side of course is that it makes energy-intensive products more expensive.

The second theme that distinguishes Rubin’s book is that it is ultimately a hopeful book. About half way through the book, you won’t have that impression. Sometimes when I read books on peak oil, the message is essentially “Abandon all hope; all exits are closed.” I was 116 pages into the book and still thinking that this was standard peak oil fare. But then it started to become apparent that although Rubin sees and understands that this is a very serious and unprecedented challenge, he sees a world emerging with some distinct advantages. He also expects that there will be some technical breakthroughs that we simply can’t anticipate that will likely make our landing into this unfamiliar territory bumpy, but survivable.

Make no mistake, Rubin’s overall message will be sobering to the uninformed. The world Rubin foresees will contain less convenience than today’s world. Gone are fresh fruits and vegetables out of season, cheap Brazilian coffee, and New Zealand mutton. Replacing them will be more expensive, but more locally produced goods. There will be new opportunities and benefits in this changing world. Because of that, I think this book will be important for scaring people into action without causing them to simply abandon hope.

Conclusion

A couple of years ago, I took a road trip from Montana to Texas (described in My Last Long-Distance Car Trip). In that essay – described by some readers as gloomy – I mused about a world in transition. In the concluding chapter of his book, Rubin does the same. He is on a fishing trip in Canada, and he discusses what higher oil prices will mean for 1). The ability of people to fly to remote locations for holidays; 2). The impact on those who depend on those tourist dollars; 3). The future of entire populations in remote areas (much like I did when I drove through Wyoming). While fishing trips to Canada aren’t something most of us can relate to, we can certainly all relate to the idea that expensive energy is going to fundamentally change our lives – and that is the message he conveys.

The last chapter is a melancholy chapter in which Rubin sees an era coming to an end – with huge global implications. He admits that he doesn’t know how this is going to play out, but he thinks that our world is once again going to become a whole lot smaller. And that’s not all bad.

Chemistry is a different matter, which is why I favor gasification processes over fermentation processes. But even beyond gasification, I have wondered about chemically processing cellulose in a refinery. I used to have a guy who e-mailed me all the time and told me he had invented a chemical process for reacting cellulose to hexane, which can then be turned into gasoline. If you look at cellulose (there is a graphic of a segment of cellulose at the previous link), you can envision that it could be done. (Whether he had actually done it is a different story).

But the chemistry pathway isn’t limited to fuels. With that preface, I want to thank a reader for bringing this story to my attention. In a recently published story in Applied Catalysis A: General (available online at Science Direct), scientists at Pacific Northwest National Laboratory have reported on a new process for converting cellulose directly into an important chemical building block (e.g., for plastics and fuel):

Single-step conversion of cellulose to 5-hydroxymethylfurfural (HMF), a versatile platform chemical

Now we all know that you can do lots of neat things in the lab that can’t really be done on a larger scale. But this particular process does not appear to be overly complicated. The abstract from the paper explains what they are doing:

Abstract

The ability to use cellulosic biomass as feedstock for the large-scale production of liquid fuels and chemicals depends critically on the development of effective low temperature processes. One promising biomass-derived platform chemical is 5-hydroxymethylfurfural (HMF), which is suitable for alternative polymers or for liquid biofuels. While HMF can currently be made from fructose and glucose, the ability to synthesize HMF directly from raw natural cellulose would remove a major barrier to the development of a sustainable HMF platform. Here we report a single-step catalytic process where cellulose as the feed is rapidly depolymerized and the resulting glucose is converted to HMF under mild conditions. A pair of metal chlorides (CuCl2 and CrCl2) dissolved in 1-ethyl-3-methylimidazolium chloride ([EMIM]Cl) at temperatures of 80–120 °C collectively catalyze the single-step process of converting cellulose to HMF with an unrefined 96% purity among recoverable products (at 55.4 ± 4.0% HMF yield). After extractive separation of HMF from the solvent, the catalytic performance of recovered [EMIM]Cl and the catalysts was maintained in repeated uses. Cellulose depolymerization occurs at a rate that is about one order of magnitude faster than conventional acid-catalyzed hydrolysis. In contrast, single metal chlorides at the same total loading showed considerably less activity under similar conditions.

So they take cellulose and react it with two metal chlorides at 80–120°C for a direct conversion of cellulose into HMF – which can be easily converted to fuel or plastics. I would think then the important considerations would be 1). What happens to the lignin and hemicellulose in the biomass?; and 2). How much energy does it take? The second item is particularly important if fuel is the objective.

While it is too early to tell whether there is a fatal flaw, this one certainly bears watching. It also strengthens my conviction that in the long-run, the right way to process cellulose is chemically.

With Oil Prices Poised to Jump as Much as 70%, Every Investor Needs an Energy Strategy

By Keith Fitz-Gerald
Investment Director
Money Morning/The Money Map Report

The U.S. news media has convinced many investors that oil consumption is falling because of the global recession. While that may be true, it’s a disservice to millions of investors because production is declining at a pace that’s actually three times faster.

And that suggests higher oil and gasoline prices in coming months – perhaps as much as 50% – 70% higher, or more – particularly if a U.S. economic recovery is truly in the offing.

To really see what I’m talking about, let’s start with a close look at consumption. I’m asked about this frequently in my global wanderings, most recently at the Las Vegas Money Show last week.

For months we’ve been hearing about a drop in global demand. It’s a popular story and one that sounds credible: After all, it seems logical to assume that during economic chaos, consumers and businesses alike will rethink their budgets and ratchet back their spending.

For consumers, the continued economic malaise will mean fewer trips to the store, less-ambitious vacations, and car-pooling to school or work . For businesses, the cutbacks by consumers will clearly translate into canceling trips where conference calls will suffice and using lower-cost shipping alternatives for the decreased sales volumes most U.S. companies will experience.

According to the U.S. Energy Information Administration, oil consumption fell by nearly 50,000 barrels a day throughout 2008. According to the latest figures, the EIA suggests that global oil demand may slump to 83.4 million barrels a day in 2009 – nearly 2.4 million barrels below 2008 consumption levels. On a percentage basis, that’s almost a 3% drop. I have my doubts that we’ll actually see a decline of this magnitude, but if it does occur, it will be the first time ever that consumption has declined for two straight years. That alone is pretty noteworthy in this era of cohesive and powerful global growth.

The reason I have my doubts about such a steep decline in demand is this: While overall consumption is dropping in such developed economies as the United States, Europe and Australia, it’s being at least partially offset by continued growth in China, the Middle East and Latin America. Because the data produced there is less than transparent, I can’t help but think that analysts are underestimating the growth we’ll be seeing in those markets, where consumption is accelerating strongly. And it’s entirely possible that growth in those markets will outstrip any fall here in the developed world.

Even if the growth in the emerging markets doesn’t quite offset the decline in their developed brethren, analysts seem to be forgetting that oil prices are a function of two variables – consumption and production. And it’s the change in production that’s going to catch a lot of people by surprise.

After a run of record high oil prices punctuated by frantic resources development, we’re now seeing the opposite scenario. The long period of lower than anticipated oil prices following oil’s meteoric rise last year means that the entire industry is no longer making the investments needed to sustain production capacity or actual production.

And not many folks recognize this fact.

For instance, direct project investment in drilling may be down as much as 20%, while the number of drill rigs in operation in America alone has dropped by more than 40%. Various estimates from the EIA and private sources suggest that actual U.S. production may fall by as much as 320,000 barrels a day. While the amount is a matter of debate, the fact that production is declining is not.

More than 20% of total U.S. oil production comes from tiny wells located in remote areas that were marginally profitable producers when crude oil was trading at $100 a barrel. With oil currently at about $61 a barrel, those producers are practically worthless now. So the “mom-and-pop” shops that own them are actually abandoning entire fields and equipment without a moment’s thought.

To be fair, at least part of the drop in demand can be attributed to increased reliance on methanol, ethanol and other types of biofuel, but that’s hard to quantify at the moment because the long period of low oil prices has eroded the economic viability of alternative fuels – at least for now.

The story is much the same with new exploration projects being cancelled left, right and center. The trend is particularly apparent in the Canadian oil sands that were everybody’s fancy only 24 months ago. Now we’re seeing Royal Dutch Shell PLC (NYSE ADR: RDS.A, RDS.B), StatoilHydro ASA (NYSE ADR: STO) and Petro-Canada USA (NYSE: PCZ) each backing away from multi-million dollar investments that were to bring online an estimated 500,000 barrels a day.

Russian, Saudi and Mexican producers are reporting the biggest production drops seen in 50 years. Even Venezuelan leader President Hugo Chavez – the perennial motor mouth and longtime U.S. critic – is eating crow. He’s begrudgingly invited (read that to mean “is begging”) the oil companies whose assets he nationalized only a year ago to “come back” into the market.

He has no choice. Venezuela’s oil production is already below its 1997 levels, and many analysts say that output could fall even more since Chavez has done such a thorough job of alienating the big foreign oil companies that actually possess the technology needed to extract crude oil from that country’s hard-to-reach reserves.

Chavez’s Chavez’s government seized the assets of 60 foreign and domestic oil service companies after conflict erupted over nearly $14 billion in debt owed by the country’s state-owned energy company, Petroleos de Venezuela (PDVSA). PDVSA accumulated the debt as oil prices took a dramatic slide from over $147 a barrel last July to less than $35 a barrel in February.

Then there’s simple shrinkage. This is an oil industry term for declining output. The EIA recently released data suggesting that production at more than 800 oil fields around the world is going to decline by about 9.1%. It doesn’t matter whether the decline is prompted by depletion, war, or simple neglect. The fact is that this shrinkage will take an estimated 7.6 million barrels per day out of the system.

I could go on but I think you get the picture.

Now imagine what could happen to oil-and-gasoline prices when normalized demand resumes. Not only will there be less oil in storage, but virtually the entire industry – exploration, production, refining and sales – is going to be caught sitting on its heels when the world needs it to be zooming along in high gear. And that means the companies that make up this industry will have to ramp up again to meet the newly increased consumption demands.

This whole process could take two years – or even longer – to play out.

As for prices, history is replete with examples of what happens when there are major shortages of key commodities.

In the Energy Crisis of 1973-74, for example, I can still remember the numbingly long gas lines and waiting in the car for hours to get a fill-up. My father and grandfather vividly remember that prices quadrupled in a matter of months. I’m sure you do, too.

Only a few years later, in 1979, we got another oil shock when prices quadrupled again. Because it was coupled with stagnant economic growth and virulent inflation (stagflation), this period was an economic disaster for the United States.

For those who had learned from the earlier crisis, however, it was a mondo- profit opportunity.

The same can be said for 2007-2008, when the huge spike in oil prices that I predicted contributed to the bear market in stocks, tight credit and recessionary conditions that led to the current malaise that continues to grip the U.S. economy. As much as anything else, high oil prices contributed to the carnage we’ve seen in the auto-making and airline industries, and to the financial crisis that started here before spanning the globe.
Which brings us full circle.

Many investors will refuse to believe we’ve arrived at this new energy nexus, especially given all the hype we’ve seen surrounding alternative fuels, hybrid vehicles and the new “green” mentality that’s taken hold here in this country. If you listen to some of the real believers, they’ll tell you that we could be living in a petroleum-free Nirvana – as early as tomorrow.

While I personally would like that, too, it’s a misleading argument if for no other reason than there are millions of consumer items we use – from plastic bags to makeup – still created using petroleum. And there are still more than 60,000 manufacturing processes that depend on petroleum, and even the most aggressive estimates suggest that it will take the world decades to shift away from them.

We’re in much the same situation when it comes to hybrid vehicles. There isn’t a mass-produced electric vehicle available today that could offset the coming rise in recovery-driven demand for oil and gasoline. There’s a strong effort underway, but I’m not aware of a single company ready to field the solution in cost-affordable quantities by 2010 – which is when most analysts say a recovering economy will stoke demand for oil.

Of course, U.S. President Barack Obama’s much-lauded efficiency and greenhouse-gas-standards mandate will help significantly, but that’s like bolting the barn door after the horses have run for the fields. The irony of watching auto executives “applaud” his press conference was almost too much to watch with a straight face. But that’s a story for another time.

The bottom line is this: Our society will be highly dependent on oil for many years to come and investors should plan accordingly.

If governments around the world really want to get serious, they could collectively work to eliminate the fuel subsidies that are part of the price paid for gasoline in Asia or sugarcane ethanol in Brazil. We could also stop our own energy pork barreling. But given the complete lack of transparency that surrounds this issue – not to mention the influence wielded by vested industry interests, and the scores of well-paid lobbyists that patrol the halls of power in our nation’s capital – I don’t think we’ll see any big changes anytime soon.

So I’m left with one inescapable conclusion, at least in the intermediate term. Every investor needs to have at least some sort of energy strategy – preferably one that includes a range of drillers, producers and suppliers to cover the spectrum from wellhead to consumer.

That way, we can profit from an increase in energy prices that we can only hope rise fast enough to jump-start the oil industry’s production arm but not so fast that it snuffs out the badly needed economic recovery.

[Editor's Note: Money Morning Investment Director Keith Fitz-Gerald is the editor of the new Geiger Index trading service. As the whipsaw trading patterns investors have endured this year have shown, the ongoing global financial crisis has changed the investment game forever. Uncertainty is now the norm and that new reality alone has created a whole set of new rules that will help determine who profits and who loses. Investors who ignore this "New Reality" will struggle, and will find their financial forays to be frustrating and unrewarding. But investors who embrace this change will not only survive - they will thrive. With the Geiger Index, Fitz-Gerald has already isolated these new rules and has unlocked the key to what he refers to as "Golden Age of Wealth Creation" The Geiger Index system allows Fitz-Gerald to predict the price movements of broad indexes, or of individual stocks, with a high degree of certainty. And it's particularly well suited to the kind of market we're all facing right now. Check out our latest report on these new rules, and on this new market environment.]

Stricter mpg rules may be boon for automakers

By issuing rules aimed at sharply boosting vehicle gasoline mileage and slashing greenhouse gas emissions, experts say the Obama plan is just what carmakers need given the prospect of higher gas prices and worries about global warming.

Automakers, in fact, reversed decades of opposition to stricter mileage standards by supporting the administration’s new rules — likely spurred in part by the industry’s heavy reliance on bailout money from U.S. taxpayers. Auto executives, for their part, said they like the plan’s unified approach to rulemaking.

The plan’s 30 percent boost in fuel economy would translate into a 35.5 mile per gallon average for cars and light trucks in 2016, four years earlier than the existing law called for. New passenger cars sold here would need to average 39 mpg, up from the current 27.5 mpg. Light trucks, which include pickups and sport-utility vehicles, would need to average 30 mpg, up from 23.

So what could possibly be wrong with that? The problem I have with it is that it mandates that automakers build vehicles that people are not demanding. There are very fuel efficient cars available right now. In fact, that’s about all you see in Europe, and you can certainly get them in the U.S. Why is the demand high in Europe? High fuel prices. People demand fuel efficient cars when fuel prices are high, as we saw last summer when SUV sales plummeted and hybrids were flying off of the car lots. Europe doesn’t have to mandate that they are built; the demand is there. This was the thrust of my argument in 2007, and CNN has picked up on that theme as well:

Gas prices: The key to fuel economy

The Obama administration estimates these rules will add about $600 to the cost of a car. That’s on top of an estimated $700 added by changes to fuel economy rules that have already been enacted. All this may keep consumers from buying a new car, some say.

Also with fuel prices still low, consumers may want larger vehicles, but these will never be as efficient as small cars. Without soaring gas prices pushing drivers to conserve, it will be difficult for makers of larger vehicles to meet the administration’s efficiency goals.

“You could achieve the standards today with ultralight, really small cars,” said Jeremy Anwl, chief executive of the automotive Web site Edmunds.com, “but how many people are really going to buy those?”

“They’re continuing to focus on the wrong program,” said Todd Turner, an analyst with Car Concepts Automotive Research.

Bingo. The problem with this is that the end result may very well result in better fuel efficiency, but it will be an inefficient process. By making cars that aren’t in demand, you may increase the price of the larger cars (e.g. SUVs) that are in demand. This may shift demand to smaller cars. But this could be accomplished by my proposal to exchange higher fuel taxes for reduced income taxes.

I think that’s reality. But in the alternate reality where technology is magically mandated to fix problems, we get thinkers like this:

Obama’s fuel home run

America finally has a smart leader, not a good old boy from Texas and his sidekick who were in the hip pockets of the Saudis and oil interests at home and abroad. Yesterday’s announcement of dramatically enhanced fuel efficiency standards on vehicles recognizes that environmental, economic, trade and foreign policies converge and can be addressed all at once.

I think these sorts of stories are incredibly naive. I suspect everyone is for higher fuel efficiency. What these sorts of proposals suggest is that it is a painless fix. Detroit will bear the costs, while consumers can continue to drive their Lincoln Navigator, only now it will get 30 miles per gallon instead of 14. Somehow, this magic wave of the wand is going to do this, and Obama is a genius for recognizing it.

Heck, if it is that easy, I don’t understand why he didn’t mandate that all vehicles achieve 100 mpg. For that matter, I still can’t understand why we don’t mandate a cure for cancer.

Today Pacific Ethanol (PEIX), one of the companies that I have tracked the longest, declared bankruptcy for Pacific Ethanol, Inc. This is not bankruptcy for the entire company, but it is bankruptcy for the ethanol plants themselves, which apparently leaves the marketing branches (Kinergy Marketing LLC and Pacific Ag. Products LLC) intact. I state that as a matter of fact, not with any smug satisfaction.* I recognize the people who work at these plants are hard-working people with families to support, and I don’t delight at seeing anyone out of work. As I told someone recently (in fact, we were talking about Pacific Ethanol and Coskata) “This is never personal. I am just stating my opinions.” With that preface, I offer my sincere condolences to all the people impacted by this development.

It was in July 2006, in the wake of a very positive article on investing in ethanol that I wrote an article for Financial Sense that suggested that ethanol stocks were overvalued. I focused on Pacific Ethanol, stating that I would “take a look at Pacific Ethanol to show why I think the underlying fundamentals make it a very risky investment.” Here was the problem as I saw it in a nutshell:

Another factor working against Pacific Ethanol’s success is the ability to secure cheap corn supplies for their plant. According to http://www.ethanol.org/FAQs.htm [RR: This link and the next one are both now dead], an important factor to consider when building an ethanol plant is proximity to corn. Local grain supplies, preferably within 50 miles of the plant, are important for keeping costs down. Yet California produces little corn. In recent years, California’s corn crop amounted to barely over 1% of the corn crop in Iowa (http://www.corn.org/web/uscprod.htm). This makes it likely that PEIX will have to import corn from out of state, driving up production costs. It will probably be cheaper for a producer to produce ethanol in the Corn Belt, and then ship the ethanol to California than it would be to ship the corn there and produce it locally. There is a reason that California is not a hotbed of ethanol activity, despite the fact that Californians consume ethanol. It’s too far from the corn, so it is more cost effective to ship in finished ethanol.

I just never thought they were going to be able to compete with the guys in the Midwest. When you ship all that corn from Iowa, you are shipping all of the waste products and all of the water as well. You end up with byproducts in greater quantities than the local markets can absorb. It always made more sense to me to produce ethanol in Iowa, feed the byproducts to cattle in the area, and ship the finished ethanol to California. To me, that was going to be the low cost producer for ethanol in California (with the possible exception of ethanol from Brazil).

On top of the geographical problem, the sector as a whole has been in big trouble as too many producers joined the party. While PEIX was at one time fairly well-capitalized, they were ultimately unable to withstand the problems plaguing the sector in general. My prediction is that the plants will end up being auctioned off as the Verasun assets were.

* OK, maybe a tiny bit of satisfaction toward people who suggested that since Bill Gates had invested in PEIX, I must be an idiot for criticizing it.

I watch very little TV, but one show I always make it a point to watch is The Daily Show with Jon Stewart. While I find that Bill Maher (who has similar political views to Stewart) generally gets on my nerves, Stewart always makes me laugh, and usually has very witty insights into politics, the media, etc.

Because I am not usually in a position to watch The Daily Show live, I generally record it or watch it on the Internet. Last night I finally got around to watching the May 7th episode (that’s the direct link, in case the embedded video doesn’t work for you) in which Stewart interviewed Secretary of the Interior (and Colorado rancher) Ken Salazar. The questions start out by mentioning the issues with corruption at the MMS, and then go on to oil leases and coal. Position on the clip is noted in parentheses.

Jon Stewart (2:30): Famously, there is a corruption issue in the MM..what is it? (Salazar: The Minerals Management Service.) They were accused of corruption, of being literally in bed with oil and energy executives. How did you clean that up, because obviously that’s under your office, no?

[RR: For more on that particular story, see Report Says Oil Agency Ran Amok.]

Ken Salazar (2:50): We cleaned it up, new code of ethics, and you know, a few bad apples at the very top essentially created lots of problems; but we cleaned up the mess, and they are out. We continue to clean up the mess every day.

JS: (3:03): What is the Interior responsible for; aren’t you sort of the oil company landlord? They pay you, you lease the public lands to the oil companies, and then they pay you for it?

KS: (3:18): That’s right.

JS: (3:20): Now you are looking at me like you don’t know. (Laughter). For a second there you were looking at me like “I’m not sure about that one.”

KS: (3:25): No, that’s not all that we do. We manage 20% of the land mass of the United States on behalf of the American citizens. We also manage 1.7 billion acres of the Outer Continental Shelf with the Department of America [RR: ?]; we go coast-to-coast, sea to shining sea, and way, way out into the oceans. We really are the department of America; the department of everything that happens in America.

[RR: Skip down to 4:35]

JS: (4:35): What about the oil companies? The relationship is obviously changing. I am under the impression that the oil companies are not paying the American taxpayer to lease these lands over the past 8 years to the tune of about $50 billion. Is that correct?

[RR: That's a blatantly false statement, and incredibly irresponsible for Stewart to spread misinformation like that. As far as I can tell, Stewart is talking about the contracts that were signed by the Clinton administration that supposedly amounted to an error in the calculation of royalties. I have never heard anything like what Stewart charges here about lease payments. Salazar looked at him for a moment as if he doesn't know quite what to say, but then doesn't correct him.]

KS: (4:50): Well, there needs to lots of reform, and royalties – we need to collect more royalties on behalf of the American taxpayer. The American citizen has to get a fair return and we are in the process of getting that done.

JS: (4:58): Would you call up Chevron, and be like, “What’s up man, Ken Salazar.” (laughter) (KS: Fork it over.) “Listen, where’s my money?”

JS: (5:05): What recourse do you have?

[RR: I want to know what recourse the oil industry has for Stewart spreading this sort of misinformation. With junk like this being spread around, it is no wonder people hate oil companies. The only problem is that Jon is grossly misinformed.]

KS: (5:08): We have the authority to adjust royalties, and we are working with Congress right now to take a look at them.

JS: (5:14): Can you kick them off? Can you say “If you don’t give us our royalties, that’s my derrick now brother?”

[RR: This is just awful. Stewart needs to retract this whole line of questioning and apologize.]

KS: (5:23): We probably can’t kick them out, because they have lease arrangements. But we need to make sure those lease arrangements are fair to the American taxpayer, and that’s what President Obama has charged us to do. That’s what I am trying to do in the Department of the Interior.

JS: (5:38): Coal is our oil. That’s the natural resource we have the most of. We have got to make good use that in a responsible way, because we can’t just give up on that. Coal’s good stuff.

[RR: Not something I would have expected Stuart to say.]

KS: (5:50): Coal is good stuff, (JS: That’s what I’m talking about.) but we have to make sure we use it and burn it cleanly.

JS: (5:55): What? (laughter)

KS: (5:58): We have to use it and burn it cleanly.

JS: (6:00): I like the use it; burn it cleanly doesn’t sound right to me.

KS: (6:03): You have to sequester the carbon; put it in the ground.

JS: (6:05): And you just repealed a law, making it where they can’t dump their waste in the Appalachian streams any more. Because weren’t they doing that over 8 years?

[RR: Salazar again looks confused, as if he doesn't know what Stewart is talking about.]

KS: (6:13): That’s right, we have to protect our streams. We have to protect our water.

JS: (6:16): You act like I am babbling secrets here. (laughter) You are sitting there like “Oh, you are going to tell them about the coal in the water.” Those people don’t deserve that. They should have some clean streams. And we should use their coal. And we should get that money back from the oil companies. Come on, brother! Who’s with me?

KS: (6:35): I’m with you.

[RR: The interview wrapped up at that point. I know that it is a comedy show, but people who watch it regularly know that the underlying messages from the show are serious. Plus, the interviews are generally serious, with high-profile guests. John needs to do a much better job of explaining the issues he brought up, or he just furthers ignorance on the topic of energy. He gave everyone the impression that oil companies decided to simply stop paying on their leases, therefore ripping off American taxpayers. That just is not the case.]

Now this week he has stolen the assets of oil field services companies:

Venezuela Seen Paying Price for Chavez Expropriation of Oil Contractors

In the wake of the seizure of foreign and domestic oil service companies and assets by armed troops following the orders of Venezuelan President Hugo Chavez, experts began to count the cost to Venezuela — which holds the Western Hemisphere’s largest oil reserves — in lost oil production, lost jobs, lost foreign investment and lost foreign expertise.

This one is ironic, because he was “forced” to seize these assets based on his miscalculations on his previous thefts. Let me explain. In 2007, when oil prices were rising, the heavy oil investments of ExxonMobil and ConocoPhillips (Full disclosure: My former employer) finally began to pay off. It is very expensive to extract and process the heavy oil from the Orinoco Belt in Venezuela. It requires a lot of capital investment and significant expertise, but it also doesn’t pay off until oil prices rise. But when oil prices did rise and Chavez saw the goose start to lay golden eggs, he decided to seize the goose for himself. The problem is that Chavez doesn’t know how to care for a goose, so what has happened in the wake of these seizures should come as no surprise.

It was bad enough that oil production has fallen sharply under the Chavez regime. The reasons for that are simple enough, and have been covered here before. In a nutshell, the issue is this: It takes a lot of capital to maintain the heavy oil business, and Chavez was siphoning off profits to pay for his social programs. Now some (extreme-leftist) people might think that’s just great, but the only reason any money was there to siphon off was due to the high investments to begin with. By not reinvesting back into the business, Chavez set the stage for the plunging oil production we see now – but now the goose is on life-support so there will no longer be money for those social programs.

Much higher oil prices for a while dampened the blow of falling production, but once oil prices started to fall, plunging revenues became a real problem. You would think he would have saved some money for a rainy day, but he is just like that irresponsible person who spends their entire paycheck every week, no matter how much money they make. Although I guess you don’t have to save for a rainy day if you are willing to just rob a bank when the rainy day comes.

But first, he had the bright idea to invite Western oil companies back in to invest again. Surely they can let bygones be bygones? Apparently not, because there doesn’t seem to be a rush to come back in. After all, does anyone doubt that Chavez will steal the investments as soon as prices/production turn back up?

This all leaves Chavez in a bind. He hasn’t made the investments that he needs to make, and nobody else is doing it for him. Production and prices are falling, and he has social programs to pay for. Debt started to pile up with oil services companies, and Chavez demanded lower prices from them. Given that he simply has no money for investment, he does what he always does. Threaten and then steal when he doesn’t get what he wants:

Venezuela’s Oil Production Squeezed by Chavez’s Heavy Hand

Chavez’s government and seized the assets of 60 foreign and domestic oil service companies after conflict erupted over nearly $14 billion in debt owed by the country’s state-owned energy company, Petroleos de Venezuela (PDVSA).

Irate over a growing backlog of invoices, many of the companies threatened to halt operations – something PDVSA and Chavez can ill-afford. The company accounts for about half of Venezuela’s revenue, and is largely responsible for funding and administering the social programs that Chavez has employed to court popular support.

PDVSA brought in more than $120 billion in revenue in 2008, but this year, it will likely make just $50 billion. With its back against the wall, PDVSA is demanding that service companies accept a 40% cut in their bills. Last Friday, the government began expropriating equipment and projects from foreign oil service firms that refused to renegotiate their debt. At least 12 drilling rigs, more than 30 oil terminals, and about 300 boats were seized, the according to The Financial Times.

But the brash gesture will also bring negative consequences that could significantly jeopardize the nation’s oil production, which is already in decline.

“PDVSA has to invest in the business,” James L. Williams, heads of oil consultancy WTRG Economics told BusinessWeek. “You have to feed a cow if you expect it to give milk.”

Hey, this is about geese and golden eggs, not cows and milk. But, point taken. The fact is that Chavez continues Venezuela’s slide toward becoming Zimbabwe. One wonders if he truly lacks the ability to plan, or was just too stupid to see the consequences of this road he has chosen to go down. The only thing that can save him at this point will be for oil prices to go up. Ironically, that’s the same thing I would like to see happen, but if we are lucky Chavez will be ousted before prices get much higher. Then again, if production continues to fall it won’t matter how high prices go; they won’t be able to offset the drops in production.

Chavez is now rattling sabers with Coca-Cola, so don’t be surprised if they go down next. Seriously, I don’t know why we don’t just seize Citgo as a response, auction off the refineries, and then pay damages to those whose assets have been expropriated. Chavez has said he doesn’t want to operate in the U.S., so we should extend a helping hand. It is the least we could do.