There’s been much discussion this week about President Bush’s State of the Union address and his comments that the US is addicted to oil and should seek alternatives. This is nothing unusual as governments the world over have been pushing alternative energy technologies in recent years as a means of reducing dependence on Middle East oil.

One of the more talked-about alternatives of late is the so-called biofuels. The term biofuel describes a number of different fuels and alcohols that can be produced from organic matter. In most cases, the organic matter used is some sort of agricultural product such as corn or sugarcane. The benefits of such a fuel appear obvious: crops are a renewable resource and burning biofuels produces less pollution that conventional fuels derives from crude oil.

Ethanol, an alcohol that can be derived from a variety of agricultural products, is probably the biofuel that's best known globally. That’s certainly true in the US where some gas stations in the Midwest dispense E-85, a fuel made from 85 percent ethanol--some car models are capable of burning the fuel.

The US is certainly not the only country pursuing ethanol--in Brazil last year more than half the cars sold are flex-fuel vehicles. Brazil has gone the furthest in promoting and popularizing ethanol; the South American country has actively promoted and subsidized ethanol production for more than 20 years as a response to the 1970s oil crises. Flex-fuel vehicles are capable of burning any mixture of ethanol and conventional fuel. Some cars in Brazil are running on pure ethanol; the fuel is widely available at petrol stations in the country. The fuel has proven tremendously popular, as it’s considerably cheaper than conventional fuel.

Better still, Brazil produces its ethanol from sugarcane. Sugarcane is a more efficient feedstock than corn for ethanol production. And Brazil’s lengthy growing seasons allow it to produce high crop yields. While US ethanol production form corn is energy intensive and expensive, Brazilian ethanol production is far more efficient.

In fact, ethanol is so popular in Brazil and demand so high, the country is encountering considerable troubles increasing its production fast enough to meet global demand. Brazil is the world’s largest exporter of sugar and an important global supplier of ethanol. Strong demand at home for sugarcane to produce ethanol has meant that Brazil has less sugar to export--check out the chart below.

Source: Bloomberg

Note that sugar futures prices are at a two-decade high. One of the key factors behind the aggressive rise in sugar prices is Brazil’s growing ethanol demand. Sugar farming operations will expand rapidly over the next few years in an attempt to keep up with this demand.

But ethanol isn't the only biofuel at use in the world today. Some crops can be distilled into vegetable oils and used to produce an organic form of diesel fuel dubbed biodiesel. Like ethanol, biodiesel is easier on the environment and is a renewable resource. Europe has been aggressively pushing a form of biodiesel derived from rapeseed (a crop used to produce canola oil) in recent years.

In the most recent issue of The Energy Strategist I took a detailed look at biofuels and their use globally. I also outlined the various government programs designed to encourage their use. It’s likely that consumption of biofuels will continue to see breakneck growth in the coming years and there are several companies already benefiting from that growth--I outlined several in The Energy Strategist.

That said biofuels, like all alternatives, are no panacea. In the December 23, 2005 TEL, No Panaceas, I took a look at wind power and why the technology is never likely to be more than a marginal contributor to the world’s electric grid. The same is true of biofuels--as the chart of sugar prices above makes clear, rising demand for biofuels is already putting severe strains on global agriculture. Strong growth in consumption will offer plenty of opportunities for investors but ethanol and biodiesel will never even come remotely close to replacing oil.

Oil Supply Suggests Services

Meanwhile, signs of strain continue to emerge for the world’s largest oilfields. In Kuwait last week, parliament voted to oust the country’s new ruler as unfit to rule--in Kuwait, parliament has the final say in succession for the monarchy.

Oil policy was clearly a major factor behind the move. Parliament is instating Sheikh Sabah as the country’s new ruler; the sheikh has been a major supporter of initiatives to allow access by foreign oil companies to Kuwaiti fields. Likely such access would involve some sort of production-sharing agreement similar to agreements popular in other regions of the world.

Any move to allow foreign oil companies greater access to Kuwaiti fields should be applauded and I suspect such a deal will emerge shortly. But there is an important subtext here: Kuwait’s own national petroleum company is having a tough time producing their key fields. Kuwait is seeking foreign help because without that help it won’t be able to maintain production from key fields much longer.

I’m speaking of the massive Burgan field that has been the crown jewel of the nation’s oil industry. The field is a prolific producer of light sweet crude oil, the sort most highly prized globally. But the field has been in production and for more than 50 years and the typical problems associated with ageing fields are all-too-obvious. Chief among the problems: Water cuts--water produced with oil--are rising in Kuwait and infrastructure is obsolete.

Kuwait is not alone in that regard. The world’s third-largest oilfield is not located in the Middle East. Mexico’s Cantarell super-giant field is responsible for the lion’s share of that nation’s oil production. Cantarell is already past peak and many engineers believe production declines will accelerate rapidly in coming years, particularly if Mexico refuses to allow foreign producers to provide technology and expertise.

Unfortunately, Mexico’s national oil company, Pemex, is prohibited from cutting such deals with foreign producers--the prohibition is written into Mexico’s constitution. This also bars Mexico from effectively exploiting several large deepwater offshore fields. The development of such fields would require investment and expertise beyond Pemex’ abilities. Mexico’s problems are also a clear sign that finding and developing oil reserves globally is becoming more difficult and expensive.

The primary beneficiaries of the end of “easy” oil are the global oil services firms. Services companies have unprecedented pricing power right now and have been aggressively raising prices in recent years. Advanced technologies such as detailed seismic mapping of deepwater reserves and the completion of advanced horizontal wells are increasingly in high demand. Better still, big international oil projects are unlikely to be delayed even if oil prices eventually pull back into the low 50s.

© 2006 Elliott H. Gue
Editorial Archive

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