Both the Senate and the House passed energy bills this summer, which they hope to reconcile early this fall. All energy bills are basically shopping lists, and notwithstanding the dismal talk of disappearing supplies, the list of possible energy sources grows ever longer. The debate comes down to which hydrocarbon, carbohydrate, fissile element, photovoltaic semiconductor, or 100-foot windmill blade belongs higher on the list.
But while energy sources readily substitute for each other, they are not the same. Even the wise Alan Greenspan misframed this in a major energy speech last April. Energy, he stated, ought to have one price. While different fuels supply heat at different prices today, things will eventually flatten out. In the long run, he suggested, “the prices per unit of energy” from natural gas, oil, coal, nuclear power, and renewable sources will “tend to converge.”
Sorry, Mr. Greenspan, but they won’t—ever. Investors who bet against inherent differences will lose their shirts. Policy makers who deny price spreads will end up promoting schemes that burn mostly mountains of cash.
It’s a quaint anachronism that we still measure energy sources in heat—the lowest-grade form of energy. Burn a ton of coal, a barrel of oil, or a cubic foot of gas and you release a certain amount of heat (which we measure in British Thermal Units, or BTUs). Our energy analysts routinely use BTUs to track energy production and consumption. The Hoover Dam, a power plant that burns nothing, is rated as an energy source by taking the electricity it delivers and translating that into the amount of heat that would be needed to generate the same power in a boiler. Diligent bookkeepers in the U.S. Department of Energy thus count annual U.S. energy consumption as 100 quadrillion BTUs.
This all sounds reasonable until you check prices. Mr. Greenspan did, and was surprised. “Prices for natural gas,” he noted, are “notably less expensive than those for crude oil,” measured on a BTU-equivalent basis. If all BTUs were equal and freely traded, this shouldn’t last. As “the manner in which energy is produced and consumed evolves,” Mr. Greenspan concludes, BTU-equivalent price spreads should narrow.
They won’t. Because there’s a world of difference between AAA and junk BTUs—a difference ordained by the second law of thermodynamics, which no speculator or act of Congress can repeal. Simply put, BTUs in heavy, bulky, dispersed fuels are worth less, because you have to work harder to transform them into the high-grade energy you really want. BTUs ignore the most important attribute of energy—its internal order.
Market prices reflect the fact that in BTU-equivalent terms, a pound of oil is equal to two pounds of coal, or four pounds of wood, along with the fact that a BTU of oil can be easily hauled in a much lighter tank than natural gas. True, 10,000 BTUs from any of these sources will generate about one kilowatt-hour of power. But burning coal rather than gas, for instance, requires three times as much investment in the power plant.
This is why solar, wind, and waste biomass energy sources—though “free” and limitless in supply—are quite costly to use. Their high expense lies in the silicon panels, metal blades, acres of land, and expensive delivery systems they demand.
While BTU bookkeepers are forever using taxpayer dollars to force a shift from AAA BTUs to junk-grade fuels, the market moves relentlessly toward higher-grade alternatives. Markets abandon wood in favor of oil, refine oil to separate the gasoline from the tar, and build massive arrays of centrifuges to enrich uranium.
Happily, most everything else that Alan Greenspan said about energy in his speech was right on the money. Congress should pay attention. He reminded us that innovation will inevitably “unlock new approaches to energy production and use that we can now only scarcely envision.” He noted the untapped potentials of tight gas sands and shale gas, and “immense” longer-term prospects for natural gas hydrates and the “vast” tar-oil sands of Alberta. He advised us to let “price signals” drive any necessary adjustments in supply and demand.
If we do as he says, the market will supply more BTUs, not fewer. It will use most of them to transform low-grade heat into high-grade power. BTU prices will vary wildly, and, for the most part, the market will continue to ignore the copious supplies of free BTUs in sun, wind, and biomass. Markets hate inefficiency and waste.
Peter Huber and Mark Mills are co-authors of a new book on energy technology, The Bottomless Well.
© 2005 American Enterprise