Energy Price Inflation

There was a funny article in the WSJ this morning talking about energy pricing in the context of bio-fuel. Anybody who has been following the alternative fuel or tertiary oil recovery industry for years knows that these alternatives to "regular" oil always come with a "cost effective" break even point, in terms of the cost of a barrel of oil. The WSJ article lamented the fact that palm oil, once thought to be a cost effective oil replacement at $50 a barrel, is now estimated to be cost effective at $130 per barrel. Somehow, the economies of scale for alternative energy keep getting pushed back.

Around 20 years ago, I worked on a Department of Energy SBIR contract for tertiary oil recovery. The idea was using RF transmitted by bore hole antennas to heat heavy oil underground. lower the viscosity and recover it. Ignoring equipment cost, the main cost (assuming we did all the science right:-) was the electricity to generate the RF field. That electricity could be purchased from the grid in some locations, and would have to be produced by diesel generators in other locations. It took a lot of hand waving based on a small scale model, but I think I put the break-even point at between $50 and $80 per barrel, or well beyond what made economic sense in the late 80's.

Fast forward to 2007 and oil is well over $80 a barrel, so is the RF assisted heavy oil recovery now cost effective? Unfortunately, both electricity and diesel fuel cost more than twice as much as they did in the late 80's not to mention the cost of equipment, environmental compliance, etc. In other words, that $50 to $80 break even cost would now be $100 to $160, all other things being equal. And that's the trick with energy inflation, it's the great equalizer. While there are some arbitrage opportunities in BTU's, such as playing locally (to North America) produced gas against imported oil, energy costs from all sources tend to move in the same direction at the same time. Inflation hits solar voltaic panel manufacturers just like it hits windmill generator manufacturers. Nothing stands still.

Well, I take that back. The only thing that stands still is the Fed's outlook on inflation, ex-food, ex-energy. By ignoring the cost increases of the two commodities most necessary to human beings, the Fed can keep inflation numbers in check. Inflation numbers, not inflation itself.