Coal-to-Liquids Controversy

Coal-to-liquids has suddenly emerged from deep obscurity to the light of day with the New York Times devoting extensive coverage to the topic this last week and that coverage being echoed and re-echoed in various public policy and political blogs.

The coal industry, it seems, is lobbying for new legislation that would obligate the federal government to provide loan guarantees on coal-to-liquids construction projects, to support minimum pricing for the fuel, and to commit to long term governmental purchases. Outrage from the environmental community as well as from supporters of biofuels, who are not necessarily one and the same, has been intense. Predictably, Al Gore has also weighed in, condemning the coal industry's attempt to enlarge its energy footprint and urging instead an increased reliance on renewables.

So what's afoot here?

Clearly the coal guys sense a bonanza in the offing. They're betting that sometime soon the production of conventional oil is going to falter, and that various fossil fuel substitutes will be well positioned to make good the deficit, at least partially. As we've indicated elsewhere in this journal, we think they're right.

The problem is that they can't convince the investment banks to assume the risk of a coal-to-liquids build-out. Some investment bankers believe in the imminence of peak oil, but not all, and apparently not enough to commit the trillions of dollars necessary to construct coal-to-liquids facilities sufficient to take any real bite out of foreign oil consumption. And it's not something that can be done incrementally. In order to achieve good economics, coal-to-liquids plants have to be huge—multi-billion dollar huge. The capital requirements for a profitable plant are over an order of magnitude larger than is the case for an ethanol facility.

And it's a pretty risky investment to boot. If light crude oil prices drop and stay down, which is a possibility if not a probability, then investment in a coal synfuel facility is a loser. And even the largest investment banks can't easily absorb multi-billion dollar losses.

There's also the regulatory and legal uncertainty. Whatever else it is, coal is not carbon neutral, and coal-derived gasoline and diesel involve heavy emissions of CO2 both in the production and consumption phases—much more so in toto than is the case with liquid fuels refined from light crude. Suppose the Federal government utterly changes its complexion and starts really fretting about emissions levels? What are the plant operators going to do?

Sure, they talk about sequestering carbon dioxide, but the economics of that process are uncertain as is the long term effectiveness of the various sequestration techniques, none of which are proven. Sequestration could add 25% or more to the cost of production and it may not work very well. It's clearly a gamble.

You'll also be competing with the oil shale guys who may be able to make a cheaper product. If their facilities look like they're going to be more profitable, that's where the money will go

So if you were an investment banker would you invest in coal-to-liquids plants without loan guarantees? Probably not now.

How this May Play out or Performing the Political Calculus

I think this is going to be a protracted struggle, and the reason for that is the presence of several competing special interests with major stakes in the outcome and major resources which may be brought to bear to influence legislators. I also think certain physical, economic, and military realties are going to exert powerful effects of their own.

The major stakeholders include the coal industry, the oil industry, the petrochemical industry, the auto makers, the airlines, the ethanol producers, and the U.S. military.

Now coal is a wealthy industry, and one of the leading Democratic candidates happens to come from one the biggest coal states, namely Illinois. It's safe to say that Barack Obama has already taken a lot of coal money, both from the operators and the United Mine Workers. As one of my sources says, "they damned well expect him to deliver." Barack Obama, as it stands now, has a real shot at the Presidency. If he wins, one may expect that coal industry representatives will enjoy access.

Many oil companies also have coal properties so they stand to gain if coal-to-liquids happens in a big way. Certainly, they relish the current high oil prices and probably wish them a bit higher, but one doubts that the corporate leadership wants a severe crunch. They wouldn't be investing in oil shale and oil sands if that were the case. Moreover, coal-to-liquids would make use of much of the existing infrastructure for oil production and distribution and, to that extent, would benefit the oil industry generally. It would also moderate prices for the petrochemical guys.

As for the auto makers, I believe that whatever public statements they make in support of renewable fuels, they would prefer an abundant supply of liquid fuels resembling refined petroleum products. Ethanol and biodiesel are not ideal substitutes. In any case, the automotive manufacturers have studied the mid term prospects for biofuels, and they know they're not good. U.S. Department of the Interior and Department of Energy reports indicate that about a billion dry tons of biomass can be produced from various sources in the Continental U.S., maybe a little more. With the most advanced cellulosic production methods, which are not commercially proven as yet, one might get 100 billion gallons of liquid fuel, most likely ethanol. The U.S. is currently consuming over 300 billion gallons of petroleum based liquid fuels per annum, and that's got nearly fifty percent more energy content than ethanol.

Thus if the U.S. chose to shut down agricultural production for purposes other than fuel it could meet less than a third of its needs under the most optimistic scenarios. The numbers just don't work out. I'm not saying biofuels don't have a place in the energy portfolio, but they can't serve as straight replacements for petroleum products with current production techniques and at current consumption levels.

Right now American agriculture is heavily dependent on fossil fuel, so in effect the petroleum and natural gas industries are carrying the biofuels industries on their backs. They're providing fertilizer, insecticides, motive power, electricity, and process heat. Try deriving those entirely from renewable sources and the costs of production rise dramatically, at least initially.

One should bear in mind, however, that unconventional fossil fuels like coal-to-liquids and oil shale cannot completely substitute for conventional petroleum at current consumption levels either. Although in absolute terms America's coal and oil shale resources are huge, much bigger than all of the remaining light crude on the planet in terms of energy value, almost no one believes that twenty million plus barrels of oil can be gotten out of them. With both resources producing at maximum capacities and a heavy infusion of Canadian bitumen we'll probably never get much over 10 million barrels per day. Which is to say that neither synfuels or biofuels nor, in all likelihood, the two in combination will support current consumption patterns. Anyway you look at it, a future of less motor fuel seems inevitable.

So why will synfuels probably get the nod? Because the indications are that they're cheaper to produce than biofuels when all expenses are tallied. When faced with crippling oil embargoes both the Nazis and the South Africans considered biofuels as well as synfuels. Both went with synfuels. That has to tell you something. Coal and oil shale are highly energy dense while most biomass is not, and that favors the fossil sources.

The auto makers know all this, and so when it comes to influencing the vote they'll move in the direction of oil shale and synfuels from coal. In fact the industry made this decision a long, long time ago. As far back as the early seventies Detroit executives projected that conventional oil would decline in the early twentieth century and decided that the industry must adapt to lower grade fossil fuel sources.

Regarding air travel, Richard Branson, the environmentalist billionaire who founded Virgin Airways, may favor biofuels, but no one else in the airline or aircraft industry does. Ethanol is considered especially undesirable because of the low energy content. Boeing did some studies on ethanol powered jets and concluded that the vastly larger tanks required would result in much higher frictional losses in flight and that fuel efficiency would drop by almost half.

On the other hand, the ethanol industry itself is an economic powerhouse, especially the part of it comprised of large chemical and food products companies such as Archer Daniels Midland, Cargill, and Abengoa. Large segments of the venture community have attached themselves to ethanol as well. They'll certainly fight for an expanded role for biofuels, and they'll probably get it. But I doubt that they can kill synfuels and oil shale.

Why? Because of the U.S. military. Each of the Armed Services has undertaken studies on its future ability to meet its own energy needs and many of these studies are available online. They clearly indicate the attitudes of the military leadership on transport fuels.

The military may eventually use hydrogen in a future generation of hypersonic jets, but in the main they want synfuels when petroleum starts getting scarce. They're not looking at ethanol or biodiesel though they like the idea of hybrid terrestrial vehicles.

Obviously, the generals and admirals don't control a large voting block, but that’s not the point. There is, as President Eisenhower stated almost fifty years ago, a military-industrial complex, and the military radiates influence through the many corporate vendors who serve it. Major manufacturers with major military contracts will line up behind their biggest client and clamor for government support for a coal-to-liquids industry to supply all the synfuel burning vehicles they will manufacture in the years to come.

That doesn't mean the coal industry will get all of the boondoggles it wants, but my guess is they'll get some of them. Especially if the nation's first Black Presidential candidate finds a lump coal in his Christmas stocking come December.