Do we still need alternative fuels?

As the Obama administration struggles to come up with a solution to the dysfunctional renewables fuel standard (RFS), many in the industry are asking the question: do we actually need alternative fuels? In this blog, I tackle that question from the standpoint of a person who believes that the shale oil and gas revolution is real and can deliver sustained supplies for the next decade and beyond.

This week in Iraq saw a further escalation in hostilities where conflicts centered on the grab for oil and gas assets. On July 11, Kurdish military forces secured a set of oil fields near Kirkuk and thereby prevented the Iraqi Central government from disrupting the Kurdistan Regional Government’s new independent oil pipeline export spur to Turkey. The move followed news reports of a struggle for control of the Baiji refinery in Northern Iraq following attacks by the militant group, the Islamic State of Iraq and Syria (ISIS) and ISIS’ capture of much of Syria’s oil production capacity. Even though the escalation of conflicts in the region has not spread to Southern Iraq where the majority of oil output is located, the exit of technical personnel from Western, Russian and Chinese oil companies active in the restoration of production, there is likely to impact negatively Iraq’s progress in restoring and maintaining any rising oil export flows. It is also a good assumption that the sectarian violence erupting across the Middle East will spread beyond Iraq and Syria and could impact oil assets elsewhere as localized sectarian populations demand a larger financial cut of the resource deposited under their feet as is already apparent in Libya and Nigeria.

If a major oil disruption did take place in the Middle East, US tight oil will provide some relief but the United States is still importing 40 percent of its oil supplies. If a major disruption takes place, even the small marginal supplies coming from biofuels won’t seem as inconsequential as it might in normal times. Biofuels are expected to be 10% of the U.S. fuel supply chain by 2030, up from 5% currently, according to research by the University of California Davis Institute of Transportation Studies (ITS). The possibility of natural gas trucks, which Citi estimates could remove as much as 9 million b/d of diesel fuel demand, may also become instantly compelling, were exportable oil harder to come by. In a situation where oil was temporarily in short supply, these alternative fuels will be a critical marginal supply substituting for oil, even if tight oil supply might be increased over time.

Environmental factors also play a role in what is likely to be a bigger push over time for alternative fuels. Air pollution is a major concern both in major US metropolitan areas and in major developing markets like China and India.  Even European drivers are starting to question the advantages of the shift to diesel fuel on the basis of urban air quality concerns.

Last week’s Supreme Court decision to decline an appeal on the constitutionality of California’s Low Carbon Fuel Standard (LCFS) is further evidence efforts to block policies to bring alternative fuels to market  are missing the big picture.  Geopolitical unrest and severe weather will continue to disrupt fuel supply chains, perhaps more dramatically in the future, and the public will demand a response. To date, some of California’s largest refiners have said they will buy alternative fuels as they become available but don’t think returns are sufficient to make their own investments in their development. Consumers may take a more substantial changes next time gasoline prices spike following a prolonged, 1973-style outage, leaving the US refining industry with a more permanent loss in demand for gasoline and diesel fuel over time.

Already, Millenials are more inclined to favor alternatives such as ride sharing and living densely. These new patterns could gain more momentum if war or other disasters or simply congestion reduce the utility of individual oil-based car ownership in U.S. urban areas. Instead of buying cars and fuels, we could see a major transformation in how transportation services are delivered and priced in the next several decades. We discuss these transformations on a new blog page at University of California Davis.

There is strong evidence that other fuels could pick up the slack for the LCFS where cellulosic ethanol might be failing, including renewable diesel, electricity, natural gas in trucking, and other biogas/biofuels alternatives. The intention of the LCFS is to promote investment in these alternatives without picking winners, and hopefully, in its wake ultimately lower prices for fuels, and create alternatives for consumers. To date, the LCFS is driving fuel shuffling with sugar and sorghum biofuels and cleaner biodiesel being shipped to California to gain LCFS credits and higher carbon U.S. based corn ethanol and more carbon intensive biodiesel being used elsewhere in the United States, and not in California. However, besides encouraging bio-digester and waste-based biofuel start-ups, the LCFS requirement has succeeded in incentivizing major players to venture into alternative fuels, including: Waste Management, Clean Energy, and Southern California Gas Company. These companies, among others, are actively investing in new natural gas or biogas fuels and fueling infrastructure in the state.

Just as the oil industry benefitted from complying with the clean air rule in the 1980s, by increasing its productivity and profitability, so a broadening of alternative fuels investment will best position companies for a more resilient future that will include a large number of unpredictable uncertainties involving reliability of feedstock supplies, infrastructure security, a growing future appetite for environmental regulation on air quality worldwide (if not carbon), and changes in consumer lifestyles and preferences.

Computing power and innovation have been driving dramatic change across other industries. The refining industry is not likely to be an exception. Changing consumer preferences and government policies aimed to reduce pollution and enhance energy security are gaining momentum. This will spell dramatic adjustments also to gasoline and diesel markets, giving the oil industry impetus for innovation and new strategies. In those circumstances, companies that have alternative fuel portfolios might outperform those sticking with traditional refined products.