Wednesday, November 30, 2005

Oil: Shortages, Technology and Economics

Throughout the history of the petroleum industry, there have been alarmists crying that the world was running out of oil. In 1920, experts predicted that only 7 billion barrels of oil remained in the United States. By 1943 four times that amount had been consumed, and there were 20 billion barrels of proven reserves. Meanwhile, vast oil deposits were discovered in Saudi Arabia and, within few short years, elsewhere in the Middle East.

The trend continued: we continued to use more oil—and reserves continued to expand faster than consumption. Major oil deposits were discovered in Venezuela, Nigeria, Norway, Indonesia, Mexico, the Gulf of Mexico, and Alaska.

The temporary shortages in the 1970s brought on by the OPEC oil embargo renewed fears of shortages. Dismal scenarios were put forth of the “inevitable” exhaustion of the world's oil resources. Yet the trend continued: in the decade of the 1980s the world consumed 200 billion barrels of oil, but at the end of the decade world reserves were 50 percent greater than at the beginning. Since 1980, despite growing worldwide consumption, proven oil reserves have more than doubled and estimated reserves have more than tripled. And the end is nowhere in sight.

Where will the new oil come from? There will probably be some sources we can't envision any better than previous generations could envision our current sources of supply. But there are others that we can already see developing. It wasn't so long ago that the idea of obtaining oil from beneath the sea was regarded as an impractical fantasy. It was only in 1947 that the first oil well out of sight of land was drilled. As recently as the late 1970s, the “frontier” for drilling was 600 feet of water. Today it is 10,000 feet. This means a billion-dollar-plus platform where workers can guide a steerable drilling apparatus through 10,000 feet of water—almost two miles—and then through 20,000 feet of rock below. With three-fourths of the earth's surface covered by water, there is a lot of unexplored territory beneath the oceans.

Then there's the potential on land. Canada's Athabascan tar sands contain huge potential. These deposits have been known for many decades, but the cost of refining usable petroleum products from them has long delayed their development. Now, however, economics and technology have come together to make it profitable to exploit them. The 180 billion barrel petroleum reserve here is second only to Saudi Arabia's.

An even larger future resource is shale oil, which is abundant all over the world. This oil is in the pores of rocks and difficult and expensive to extract. At present there is no demand for developing it while so much other oil is available so cheaply, but it is a resource that is available when economics and technology come together. The marketplace will tell us when that time arrives. And, as I point out in my book MAKERS AND TAKERS, this is a resource which, at the world's current rate of petroleum consumption, would last for 40,000 years.

My book also points out that there are huge deposits of natural gas in gas shale. What may be the largest reserves of gas in the world are found not in the Middle East but in eastern United States. The deposit may contain as much as 460 quadrillion cubic feet of natural gas, of which 285 trillion cubic feet are already recoverable. (Annual U.S. consumption is about 22 trillion cubic feet.)

A source of natural gas with far greater economic potential is the “geopressurized” zones underlying the Gulf coast regions, both on and offshore. These may contain 60,000 to 80,000 trillion cubic feet of natural gas dissolved in water and as free gas above the water zone. “This is an almost incomprehensibly large number,” said Dr. V. E. McKelvey, former director of the U.S. Geological Survey. He noted that even the lower figure “represents about ten times the energy value of all the oil, gas, and coal reserves in the United States combined.”

The discovery of oil at great depths leads to the question of whether the traditional “fossil fuel” explanation is adequate to explain the world oil deposits. Oil has been found at depths and places in the world where the geological record indicates there never were any living forms or organic matter to be transformed into oil deposits. And some depleted oil wells are known to be refilling from below. This raises the prospect that oil is being produced by a combination of chemical reactions from heat deep within the earth and the biological actions of bacteria that produce the same effect as organic matter that is transformed into crude oil. If that is the case, the supply of oil is virtually inexhaustible.

In the same way that the alarmists fail to see the historical trend of continuous success in increasing oil supplies, they are blind to the trend of continuous failure of government actions they favor to remedy “shortages.” Ten years ago, John A. Hill, former deputy administrator for the Federal Energy Agency (predecessor of the U.S. Dept. of Energy) stated that over the previous 35 years the federal government had spent more than $100,000,000,000 on synthetic fuels, solar energy and other alternative fuels without adding one viable technology to the commercial marketplace.

The government's experience with synthetic fuels is instructive—but one which the proponents of government interventionism would like to forget. Following the Arab oil embargo, the federal government set up Synfuels Corporation to show that government could provide a synthetic fuel where the private sector could not. After losing billions upon billions of dollars, the government gave up on Synfuels, sold its assets at a fraction of what they had cost the taxpayers, and went out of the business. But some people never learn. Now the government claims to have the answer to future shortages and high gasoline prices: hydrogen cars and ethanol. (For my views on ethanol, see my posting August 10, 2005 "Ethanol and Biodiesel Fuels.")

According to Business Week, January 24, 2005, a fuel cell system powerful enough for a car would add $100,000 to the sticker price of today's automobiles. The most efficient prototype fuel cells generate electricity at a cost of $800 to $1,000 per kilowatt hour. To be affordable, the cost needs to be closer to $12.

The government's propensity for throwing money at the problem—thus showing it has learned nothing from its own Synfuels experience—is matched only by its propensity for throwing regulations at the problem. That doesn't work either. Recently Rep. Gil Gutknecht introduced a bill requiring 10 percent ethanol in all gasoline sold in the U.S., thus misdirecting human efforts and investments to less beneficial, less profitable enterprise than would result from marketplace actions. Politicians can no more rewrite the laws of economics than they can rewrite the laws of physics or mathematics. But they keep trying. If ethanol or hydrogen were economic, they wouldn't require regulations forcing their use or government money (i.e., subsidies) to produce them. As the Nobel Prize-winning economist Friedrich Hayek points out, society is always worse off when government tries to substitute its economic choices for those of the marketplace. When it diverts money to hydrogen cars, ethanol, or anything else, it is always necessarily displacing economic choices that are more beneficial to society. Spending money on hydrogen cars may, for example, divert money that could be used to make today's cars burn cleaner or more efficiently or to develop the oil and gas resources mentioned above. Or it may divert money from cancer research, education, retirement, clothing or other consumer needs, or many other worthwhile causes. Society is always worse off. Hayek called it “the fatal conceit” that political leaders can make economic decisions more beneficial to society than the choices people voluntarily make in the marketplace.

If the government really wanted to be helpful, it would REDUCE its regulations. It would remove the moratorium on oil drilling on the 85 percent of our Outer Continental Shelves, with 400 trillion cubic feet of natural gas, which would make gas more abundant and cheaper—instead of blaming the industry for higher gas prices and “windfall profits.” It would permit drilling in the ANWAR reserve in Alaska—at least in areas where scenic and wildlife assets are not threatened. It would repeal the laws that have prevented construction of even a single oil refinery in this country for 29 years. See my October 7 posting “E=HGP (Environmentalism=higher gas prices).” And it would eliminate the regulations that for a quarter of a century have prevented building a single new generating plant for world's safest form of energy. This is the only energy industry that has never had a fatalities in the U.S., emits no greenhouse gases, and for which fuel is inexhaustible. It is the nuclear power industry.

Tuesday, November 15, 2005

Why Vaccine Shortages?—a Political “Virus”

Concerns are being voiced that vaccines may not be available if there is an epidemic of avian influenza, transmitted from birds to humans. This latest chapter about vaccine shortages is yet to be written, but there have already been eight major shortages of vaccines just since the year 2000. These include shortages of vaccines for diphtheria, tetanus, whooping cough, chicken pox, measles, and three years of shortages of flu vaccine. The Wall Street Journal has noted that the supply disruptions “result from government policies that treat vaccine makers as a branch of socialized medicine—to the point that many have stopped making vaccines.” For 30 years the politicians have been driving the industry out of business with regulations, price controls, litigation—including opportunities for frivolous lawsuits—and intellectual-property abuse.

In 1967 there were 37 vaccine manufacturers in the U.S. By 2001 there were only ten. Today there are only three large vaccine makers in the U.S. In 2004 there were only two makers of flu vaccine. After one of these shut down, there was a severe shortage of flu vaccine. The remaining one was a Swiss company (Roche)—and it is the only one the U.S. is counting on for a vaccine that would potentially protect against bird flu.

Under a new crackdown by the FDA on vaccine manufacturers, the FDA in October 2000 fined Wyeth-Ayerst $30 million for manufacturing problems even though the agency admitted it never found any contaminated products. A few months later, Wyeth got out of the market for tetanus, leaving just one manufacturer. Wyeth and Baxter both got out of the vaccine market for diphtheria and pertussis. These exits created major shortages.

The FDA’s crackdown also escalated the costs of vaccine approval. The manufacturers used to be allowed to perform their test on hundred of patients. Now they need tens of thousands, and approval normally takes six to seven years. Vaccine makers also contend that the FDA has an unscientific approach to risk, which derails production and exposes companies to lawsuits. The industry also has revolutionary technologies (reverse genetics and mammalian cell culture) that would dramatically cut time and development costs. Europe is moving forward on these, but the FDA has refused to do so.

The manufacturers cannot recover the escalating costs by raising prices, because the government buys more than half of all the vaccines in the country—thanks to Hillary Clinton’s Vaccines for Children’s Program—and uses its clout to keep prices low. The program offers free vaccines to uninsured children under 18 or to those who are eligible for Medicaid or care from federally qualified health centers. The Centers for Disease Control in many cases pays less than half of what the private sector pays. So, if it is no longer profitable to manufacture vaccines, the companies quit making them. There is no point in investing huge amounts of money in extensive research when that investment cannot be recovered in the sale of products. When Wyeth spent more than a decade on a revolutionary new childhood vaccine against pneumonia and meningitis, it asked for $58 per dose. So-called public health advocates went ballistic, and the CDC paid only $46.

In 2003 a report by the Institute of Medicine, an arm of the National Academy of Sciences, noted that the price squeeze and a heavy regulatory burden have driven companies out of the vaccine business. It also noted, “reimbursements [to health-care providers such as doctors and clinics] for vaccines and administrative fees barely cover the costs of vaccine purchase. In many cases, providers lose money on immunization.”

Politicians want companies to take the risk of developing vaccines, but they don’t want them to make any money from taking those risks. This includes not only the pricing of the products but protection of the companies’ intellectual property—their patents. Private companies developed the AIDS drugs that have extended millions of lives, but countries like Brazil and South Africa--and "do-gooders" everywhere--want the drugs given away at cost. And UN Secretary General Kofi Annan said he hoped concern for “intellectual property” would not “get into the way” of distributing avian flu vaccine.

When politicians try to manipulate the market (for vaccines or anything else) in their efforts to benefit some some people at the expense of industry or taxpayers—the socialism model—consumers should expect disastrous consequences. Childhood vaccines that cost $10 in 1975 by 2001 cost $385. And we have shortages.