A New National Standard for Automotive Fuel

DID YOU SEE THE HEADLINE? It would have been easy to miss, I suppose. The news hit the presses on Friday, Nov. 24, 2006, the day after the U.S. Thanksgiving holiday. So perhaps you were up and about early, driving over to the mall to catch one or more of those bargains at the “Black Friday” sales. It’s OK, really. Despite Peak Oil, you are allowed to go shopping on the day after Thanksgiving. We don’t issue judgments about what people do with their time and money, particularly when they are our friends and subscribers. Besides, who reads Page 5 of the Financial Times? And who cares what the Chinese put into their gas tanks, anyhow? Oh, wait a minute. Maybe we do care what the Chinese put into their gas tanks. Hold that thought.

Synthetic Fuels

In the past year or so, we have received a lot of e-mail from readers asking why we do not write more about alternative fuels like methanol and ethanol. It is not that we don’t follow these developments. Our colleagues at Strategic Investment,Outstanding Investments, and Capital & Crisis have covered these subjects quite a bit. And if you want to get into the commodities end of these things, Resource Trader Alert’s Kevin Kerr is on a hitting streak that would land him in the Hall of Fame at Cooperstown if he were playing baseball instead of helping his subscribers manage their portfolios. But yes, we are watching the synthetic fuels business with our 20/20-corrected vision. And on the day after Thanksgiving, something grabbed our editorial attention.

Beijing Sets National Standard

“Beijing Sets National Standard for Methanol as Automotive Fuel,” stated the well- regarded, if salmon-tinted newspaper. Methanol? Yes, good old “wood alcohol.” This is the stuff that if you drink it, will make you blind. But this particular label of Chinese methanol is not and will not be somebody’s moonshine. Instead, this Chinese methanol will be derived from coal in the so-called “Fischer-Tropsch” chemical process, which leads to an industrial method described as “coal-to-liquid” (CTL). Added to gasoline, coal-derived methanol creates a cleaner-burning type of fuel. And at oil prices above about $35 per barrel, methanol is very much a cost-competitive option for automotive fuel. Very clever, those Chinese. Here are a few of the key paragraphs from the Financial Times report:

“Beijing has settled on a national standard for methanol as an automotive fuel, a decision which will legitimize and bolster a market that has been growing rapidly without central government approval. The standard, which has yet to be officially announced, was reported in a trade magazine and confirmed yesterday by an official attached to the National Development and Reform Commission (NDRC), the economic planning body responsible for the standards.

“Local companies have under construction, or are awaiting approval to build, plants to produce methanol equivalent to about 20% of China’s present oil consumption…By the time the plants, which convert coal to liquids, start producing in 2011-2013, China’s oil demand will have doubled, allowing methanol to supply about 10% of the market.”

A New Kind of Energy for China

Methanol will become, for China, “a major alternative fuel which does not exist in any other country in the world,” said James Brock, a Beijing-based energy consultant. Another commentator, a senior Chinese regional official who is deeply involved in China’s methanol industry, has stated that China’s coal industry “is doing the best job in China in promoting the use of methanol as fuel.” The Chinese official added, “Our aim is to solve the problem of China’s oil shortage. We are creating a new kind of energy.”

The man must mean “a new kind of energy for China.” The technology to turn coal into gas and oil was invented in the 1910s and 1920s in Germany. CTL processes were used extensively to manufacture motor fuel for the German armed forces during the Second World War. Of more recent vintage, CTL technology was greatly advanced by the South African company Sasol over the past three decades. Initially, the Sasol technology was used as a means for South Africa to avoid apartheid-era sanctions, and more recently, Sasol’s technology has been highly competitive in world markets on its own merits.

Large Foreign Investment, Advanced U.S. Technology

Within the past few years, China has been experiencing an investment surge into CTL plants. One recent announcement, for example, stated that Royal Dutch/Shell and a Chinese partner have committed to a three-year study of a CTL plant, which, if it proceeds, will cost between $5-6 billion and be one of China’s largest single foreign investments. The proposed Shell project, to be located in the western province of Ningxia, would produce the equivalent of about 70,000 barrels of oil a day, equal to about 1% of Chinese oil demand, now just over 7 million barrels per day (mpd).

Shell, which is a leader in liquefaction technology, has already licensed its technology to 15 projects in China. Shell has one plant with Sinopec, one of China’s leading petrochemical companies, under construction. According to Lim Haw Kuang, executive chairman of Shell in China, “We have proven technology that converts coal to gas and then gas to liquids. We believe this technology is important to China.”

The Shell process uses oxygenated gasification, a technology pioneered in the U.S., under the sponsorship of quite a bit of U.S. government funding over the years. Oxygenated gasification permits isolating carbon dioxide (CO2) during the manufacturing process, and thus is more compatible with carbon sequestration than other leading fossil fuel technologies. If the Chinese actually sequester the CO2, or use it for purposes such as enhancing oil production from older oil fields, this will be a big step forward for China’s environmental protection, as well as for controlling emissions of greenhouse gases.

30 Plants Under Construction

According to a report by Credit Suisse, there are at least 30 large-scale CTL projects in the detailed planning, permitting, or feasibility stage. The Credit Suisse report notes that the expensive, capital-intensive CTL plants are generally considered financially viable when oil prices are above $35-40 a barrel, which is a safe bet in a world that is catching on to the concept of Peak Oil. Coal is China’s “real strategic (energy) reserve,” states the Credit Suisse report, because it can be obtained locally, although China is also a major coal importer.

China possesses, of course, vast coal reserves. China also possesses one of the world’s most extensive coal mining industries, although working the coal pits of China happens to be one of the most dangerous and lethal occupations in that ancient land. According to the Los Angeles Times, well over 5,000 people per year perish in Chinese coal mines, a mortality of over 100 deaths per week. But despite the lethality of the effort involved, the Chinese coal industry is experiencing skyrocketing demand amid generally rising oil and energy prices.

Raw Strategic Calculus

In the raw strategic calculus of planning and developing its future energy infrastructure, CTL makes great economic and political sense for China. China has abundant coal resources, but rapidly declining domestic oil reserves. With anticipated future growth in its energy demand, China will become ever more reliant on oil imports, which now account for about 40% of Chinese oil consumption. The Chinese economy currently consumes about 7 mbd of oil, which means that China is the world’s second largest user of oil after the U.S., which uses about 21 mbd of oil (over 60% of it imported).

One major oil supplier to China is Angola, which is now China’s largest single source of petroleum. (And by the process of elimination, Angola is thus a problematic future supplier of oil to the U.S.) Other oil suppliers to China include Saudi Arabia and Iran, which are, of course, places with attendant political risk, even to the Chinese. On the other hand, much of China’s imported coal comes from Australia and Canada, places well known for long-term political stability.

In addition to the operations and logistics of assuring their own energy supplies for the future, the Chinese are apparently well aware of the concept and implications of Peak Oil. For example, a number of computer servers located in and around Beijing are among the busiest sites on the planet when it comes to accessing Western Peak Oil sites on the Internet. The Chinese are downloading Peak Oil-related information as fast as it is published. (Hi, guys.) So both in terms of gathering knowledge and securing future energy sources, the Chinese are, characteristically, thinking long term.

World’s Largest Synthetic Fuels Program

Despite meriting only an article on Page 5 of the Financial Times (below the fold, as well), the Chinese adoption of a policy that supports methanol production via CTL is one of the most important stories in the energy-using world.

It is now official. China is embarking on the world’s largest synthetic fuels program. This has immediate implications for energy planners everywhere, for worldwide finance and capital expenditure, for the global coal markets, for the ecological footprint of Chinese development, for emissions of greenhouse gases, and so much more.

No, you did not read about China’s new national standard on the front page of The New York Times, or listen to Katie Couric breathlessly describe the details on the CBS Evening News. These journalistic worthies had other priorities, apparently. And things like future energy trends in China, let alone the future energy trends of mankind, are just not on their collective radar screen. But really, dear readers, this methanol gig is serious stuff.

What Do the Chinese Know?

The reports out of China present a national goal for that country’s economy to obtain 10% of its liquid fuel by 2011-2013 using methanol produced from its own coal resources. And China’s 10% of liquid fuel from CTL is just the beginning. Within a decade, that number could approach 20%. Moreover, China is also embarking on major, national-scale programs to generate electricity from wind power, as well as from solar photovoltaic systems. It is almost as if the Chinese know something.

A Nation on the Mediterranean Diet

This immediate Chinese goal of obtaining 10% of that nation’s liquid fuels from methanol within five years, and more thereafter, far outpaces U.S. targets for producing ethanol from corn and other agricultural products. According to recent studies from numerous scholars, such as David Pimentel of Cornell University, the U.S. energy infrastructure may have problems ever getting much beyond 10% or so of its needs from synthetic fuels derived from agricultural products. In a recent discussion, professor Pimental noted his calculation that if the entire U.S. corn crop of 2005 were transformed into ethanol, and not a single ear of corn diverted to other uses, the resulting quantities of fuel would substitute for less than 15% of total U.S. liquid fuel demand.

In addition to what the scientific community is saying about the problems of using corn to manufacture ethanol on a vast scale in the U.S., no less an authority than the chief executive of Tyson Foods Inc. recently warned that ethanol-driven corn prices are already increasing the cost of beef and chicken, among other foodstuffs, for U.S. consumers. So the U.S. approach to substituting agricultural-based alternative fuels for imported oil is going to create direct competition in the corn pits between its food supply and its transportation fuel requirements. By default, the population of the U.S. will begin to find itself on the Mediterranean Diet.

Policy Drives Investment

By way of comparison, for the U.S. to have a program equivalent to what is already on track and official policy in China, U.S. production of synthetic fuels would have to exceed 2 mbd of oil equivalent within about five years. But even a casual glance at current trends in U.S. energy investment reveals that nothing comparable to the Chinese goal is going to happen in the world’s most prolific oil-burning nation.

There is, of course, much investment going on in the U.S. grain belt. According to a recent report in The Wall Street Journal, something over 125 ethanol facilities have been completed or are under construction in the U.S. And as no less a Peak Oil scholar than Rep. Roscoe Bartlett, member of Congress from Maryland, has noted, “We already pay farmers in this country not to grow food, so if we are going to have a lot of ethanol, we may as well put those farmers to work.” But, notes Rep. Bartlett, “It takes a lot of fossil fuel and energy just to grow the grain. Most fertilizer is derived from natural gas, and most agricultural chemicals come from oil. Add in the energy required for transport and processing, and ethanol is barely a break-even substance, from an energy standpoint. I worry about eventual depletion of soil fertility.”

Production of ethanol is soaring in China as well, partly driven by the high prices available for ethanol exports on the world market. So China both imports oil and exports ethanol. But Chinese critics of ethanol appear to be gaining an upper hand. There is a powerful strain of recognition within Chinese governing circles, based on that nation’s long history, that pays great respect to what the Chinese refer to as “food security” for the country. Many Chinese commentators argue that it is inappropriate to use corn and other agricultural products to convert to liquid fuel at a time when China is struggling to keep its precious agricultural land in production.

The U.S. Approach

There are numerous proposals within the U.S. for developing a CTL industry. There has been some discussion of CTL at the federal level, but much of the impetus for CTL efforts has originated at the state level. Among others, Gov. Brian Schweitzer of Montana has advocated a program of coal gasification, and Gov. Ed Rendell of Pennsylvania has also supported efforts for CTL.

At the level of private industry, Sasol of South Africa, of course, remains among the world leaders in CTL technology. But in North America, Sasol focuses on the production and marketing of chemicals at its advanced plants in Baltimore, Md., and Lake Charles, La., that produce olefins and surfactants, as well as solvents. Sasol has no plant in the U.S. comparable to its South African facility that produces gasoline, diesel fuel, and jet fuel.

There are also smaller, publicly traded companies, such as Rentech, in partnership with Peabody Energy (BTU:NYSE), that are constructing CTL facilities on a modest basis. And there are numerous private equity efforts in the CTL arena. But even if this article were to be utterly exhaustive on the U.S. effort in the realm of CTL, it is clear that there is no large-scale CTL effort going on in the U.S. comparable to what is occurring in China.

For the foreseeable future, and for lack of a comprehensive policy that focuses on exploiting domestic energy resources with available technology, the U.S. will just have to keep on trading U.S. dollars for oil from our friends in places like Saudi Arabia and Venezuela. The U.S. is simply living in, and making policy based upon, the fading memories of its storied past. Meanwhile, the world advances and at least some nations, like China, are inventing their own futures. On that happy note, I bid you all farewell.

Until we meet again…
Byron W. King
November 27, 2006