Graphical Extrapolation of Gasoline Prices: Six or Seven Dollars a Gallon in Ten Years
The 1973-1986 Peak
The Current Leap
The Likely Future: Graphical Extrapolation
Conclusion: Can “Fracked” Gas or Tar Sands Save Us?
[For an explanation how fossil fuel companies’ PR hacks delude consumers about the comparative cost of solar power, click here. I don’t mean to upstage my new essay on wind and solar power, which are equally vital subjects in the longer term. But this essay is ready, and gasoline prices are a hot political issue right now.]
IntroductionThere is theory, and there are facts. If you fudge your facts to match your theory, you are an ideologue or religious fundamentalist. If you match your theory to the facts, you are a scientist or engineer.
Over the last 400 years (since Galileo), most of the world has downplayed ideology and religious fundamentalism in favor of science, engineering and technology. That trend has led us from a life that was once “nasty, brutish and short” to our present, relatively happy state.
So let’s apply some theory to the facts of gasoline prices since 1949. Fortunately, we don’t have to dig very hard to find the facts. Our own Energy Information Administration (EIA) has posted exhaustive records of the retail prices of gasoline for the last 63 years.
The graph at the head of this post derives mostly from the EIA’s historical data from 1949 through 2010. Data for last year (2011) appear here and for the first six weeks of 2012 here.
The prices shown in the graph above are averages, in cents per gallon, over all grades of gasoline and all parts of the US. Except for the last two data points (2011 and early 2012), they are “real” prices, adjusted for inflation. Hence the numbers are lower than the prices you would have seen at the pump (and those I remember from the sixties), because the dollar’s purchasing power was stronger the further back in time you go. And there’s a slight nuance for 1976 and 1977, explained here.
Now let’s make two important assumptions. First, lets assume we are scientists or engineers, not ideologues or true believers. So we will fit our theories to the facts, i.e., the graph shown. We will try to explain the graph with history.
Second, let’s assume we want to explain the facts with mainstream theory, not exotic ideas. If you’re a medical doctor, have one in your family, or know one well, you may have heard a rule for diagnosis that most doctors learn in medical school: “If you hear hoofbeats, think horses, not zebras.”
What this rule means is that you should, when possible, make diagnoses or explain things in the simplest, most straightforward way, not the most exotic. Another common metaphor for this common-sense thinking is Occam’s Razor.
So let’s try that approach with our graph. Let’s try to explain its major features not with demons (aka speculators), and not with angels (anomalous results of “Drill, baby, drill” in a nation with less than 3% of known oil reserves, while OPEC has 75%). Let’s think horses, not zebras.
In economics, that means applying the most basic, uncontroversial, and well-accepted law: the law of supply and demand. When the supply of oil gets shorter or demand increases, prices go up. When supply increases or demand drops, prices go down. No economist or business person doubts these well-tested theories.
As you look closely at the graph, you can see three major features. (You might want to open another instance of this post in an adjacent tab or window, so you can look at the graph and read this analysis at the same time.)
First, the graph starts to rise steadily in 2002. It seems to be heading off the scale in 2011. But it drops back considerably n 2009 and 2010, and again a bit in the first few weeks of this year.
Second, the graph’s central feature is a big peak from 1973 to 1986. It jumps up in 1974, reaches a small plateau from 1974-1978, then leaps much further in 1979 through 1981, only to drop down back to near the long-term trend in 1986.
The graph’s third main feature is remarkable price stability over nearly half a century, if we exclude the 1973-1986 peak. Without that peak, from 1949 until 1997 the retail price of gasoline stayed roughly even. Over the period from 1949 until 1972, the inflation-adjusted pump price of a gallon of gas actually dropped 27%, from 185 to 135 cents.
Can we explain these major features with simple, basic economics? I think so. We’ll look for historical events that relate to the global supply of and demand for oil, the commodity from which all gasoline is made.
The 1973-1986 PeakThe 1973-1986 peak is by far the graph’s most dramatic feature before the year 2000. Several historical facts explain it nicely. The first was the Arab Oil Embargo of 1973-1974.
The Arab Oil Embargo was the first successful attempt to play global politics with oil. Upset with the West’s military support for Israel in the Yom Kippur War, Arab oil suppliers boycotted Israel’s major supporters, including the US and the UK. As a result, the price of oil jumped about four times. (See graph here.) This jump became known as the “oil shock” of the 1970s.
The Arab Oil Embargo was very short. It lasted only about five months, from October 1973 to March 1974, until the last Israeli troops pulled out of Egypt. You can see its effects above in the leap in gasoline prices in 1974, leading to the low plateau from 1974 to 1978. The downward slope in that plateau is probably due to relatively radical (for the time) conservation efforts in the US, couple with drastic efforts to increase production from remaining US mainland reserves.
But the much bigger part of the 1973-86 peak came after the Arab Oil Embargo. What was going on then?
What happened then was economics, not politics. The Arab Oil Embargo’s dramatic effect on prices taught the Arabs—especially the Saudis—the economic power of their virtual monopoly of global oil reserves.
OPEC had formed in late 1960, in response to global domination of oil production and prices by the major Western multinational oil companies, which were then known as the “seven sisters.” At first OPEC was weak and disorganized. Its members were few and squabbled among themselves. (They were, after all, mostly in the Middle East.) But the Oil Embargo sent the Arabs to economics school. It showed them forcefully what their control over global oil supplies could do.
They had ample motivation. Oil was (and still is) priced in dollars. But the Arabs had to pay for food and manufactures, most of which they imported, in their own currencies. While the “seven sisters” controlled oil prices in dollars and kept them low, prices for food and manufactures imported into the Arab world rose dramatically, threatening political unrest.
The Arabs’ obvious solution was to control (and raise) the price of oil, the vast majority of reserves of which were on their land. So, during the next few years, OPEC members: (1) strengthened and disciplined OPEC, (2) taught themselves economics, and (3) nationalized oil reserves and production facilities within their national boundaries, including those belonging to the “seven sisters.” The result was today’s state of affairs, in which OPEC controls 75% of all global oil reserves and—if its members stick together—has near-absolute control over global oil pricing.
These events were the cause of the biggest part of the 1973-86 peak in US gasoline prices, from 1978 to 1981. You can see the same effect on oil prices in this graph on Wikipedia.
What caused the decline from 1981 to 1986 was also economics. The West didn’t have to go to school; it already knew economics. So it could use the law of supply and demand, too. It made drastic efforts to reduce demand for oil and increase non-OPEC supply. Like the Arabs, it also had ample motivation: the rising price of oil, which affected the prices of almost everything else, caused massive inflation in the eighties, with interest rates in the double digits.
The three major efforts to fight back economically were well-known cultural artifacts of the eighties. First, Congress established the Corporate Average Fuel Efficiency (CAFE) standards for cars in 1975. It mandated roughly doubling cars’ average miles per gallon by model year 1985.
Second, the Japanese helped by choosing fuel efficiency as their major competitive advantage in penetrating the American automobile market. Many American consumers cooperated. They bought Japan’s small, fuel efficient cars to save money and because (after a brief trial period) they found those cars more maneuverable and of better quality than competing American gas-guzzlers. The Japanese car makers were so successful that many pundits then predicted eventual Japanese domination of the global auto market, a feat they have come near to achieving today.
Third was a simple rule of economics and capitalism. When prices of a commodity go up, people not only use less. They also find substitutes and new sources of supply. The late seventies and early eighties was when new deep-sea oil-drilling technology first took off. A Yankee entrepreneur brought the first North Sea oil to Britain in 1975. By the early 1980s Britain was a net exporter of oil, for the first time in its history.
Together, these three trends reduced US demand for oil and gasoline and increased the global supply outside of OPEC’s control. The result was the dramatic fall in gasoline prices from 1981 to 1986, back to the earlier trend line and a level that remained stable until the turn of the century.
So basic economics explains the graph’s most dramatic feature in the whole twentieth century. No zebras. No speculators or other demons. Just good ol’ supply and demand.
The Current LeapThe graph’s current leap—since 2000—is much more dramatic still. The price levels greatly beat, and the slope of the increase matches, anything in the twentieth century, including the dramatic peak of 1973-86. Can supply and demand explain them, too?
I think so. Whether or not you use the loaded term “Peak Oil,” the supply of non-OPEC oil is tapped out. It took a few years for Exxon Mobil, the world’s biggest and most competent oil company, to admit the point. But in 2010 it did. It did so not just in words, but by deeds.
In 2010, Exxon bought XTO, a natural-gas company with enormous natural gas reserves. Exxon’s managers explained the purchase to the business press. Good oil was getting harder and harder to find and more and more expensive to extract. Untapped deep-sea resources were getting deeper and deeper, requiring more expensive and more dangerous technology to exploit them. One result (later) was the Great BP Oil Spill.
While Exxon once had a climate-change denier for a CEO, the folks who run it now are mostly good energy engineers. They understand energy; they understand drilling; and they understand economics. When they bought XTO, they understood that natural gas was much cheaper than oil on an energy-equivalent basis.
That’s even true today, in the midst of the gas “fracking” craze and controversy over possible water table pollution. Last week’s market price for natural gas was around $2.6 per million BTU, and a barrel of oil provides 5.8 million BTU. So natural gas with energy equivalent to a barrel of oil would cost 5.8 x $2.6 = $15.08. In comparison, last week’s price for an actual barrel of oil on the West Texas Intermediate market was about $105. Exxon Mobil’s energy engineers are not stupid, are they?
The problem, of course, is that most cars and trucks don’t yet run on natural gas. To take advantage of natural gas’ more-than-six-fold price advantage, we’d have to convert our fleet of vehicles, or a significant part of it, from gasoline (petrol) to natural gas. So we continue to pay over six times more for fuel than we could. And we’ll pay even more as gasoline prices continue to rise. (More on this point later.)
If you insist on looking for demons, you can blame OPEC, which absolutely controls global prices for oil. But OPEC has every incentive to keep prices down. Now that Exxon Mobil has made its move, OPEC knows that there are alternative fuels out there. Not only is there natural gas—over six times cheaper than oil right now. There is also electricity made from wind or sun, nuclear power, and coal. The first real electric cars—the Chevy Volt and Nissan Leaf—are in showrooms right now.
OPEC’s members have learned a lot about economics in the last half-century. The lessons of the great drop in oil and gasoline prices from 1981 to 1986 are not lost on them. They know that keeping prices for oil too high for too long will only cause customers to look for substitutes and alternative sources of supply. For the last two decades, they have been very skillful in keeping oil prices “just right”—for them.
For a long time OPEC’s members have skimmed the cream of the global economy while keeping prices low enough to avoid stalling it. That’s their game, and they are getting quite good at it. What they can’t do is produce more oil than they have, or extract it too quickly for their own, internal economic good.
The Likely Future: Graphical ExtrapolationNow look closely at the part of our graph after year 2000, where the current great leap begins. Except for 2009, 2010, and early 2012, the graph goes straight up.
The dip for 2009-2010 has obvious causes. The Crash of [late] 2008 and the Great Recession that followed it killed the global economy and, with it, demand for oil. The data point for 2011 corroborates this point. As global recovery from the Great Recession began, it fell roughly on the same dramatically upward trajectory as the data points for 2002-2008.
The dip in early 2012 has a similarly obvious cause: the slowdown in Europe and now even China resulting from the Greek debt crisis. But suppose the EU solves that crisis, as it is even now promising to do? What will happen then?
Well, the graph will likely continue on its trajectory from 2002-2008. So you can get a good idea of what gasoline prices will be like in the next few years (if, as everyone hopes, we get by the Greek debt crisis) simply by extrapolating. Just extend the trajectory of the data points for 2002-2008 and 2011 forward, while ignoring the Crash-caused drop back in 2009 and 2010, as well as the short Greek-crisis-caused drop back in the first weeks of this year.
You can extrapolate mathematically, using a least-squares technique to fit the best straight line to the data points for 2002-2008 and 2011. Or you can extrapolate graphically, eyeballing a straight line on an extended graph.
When you do so, you will get a real gasoline pump price for 2022, ten years ahead, somewhere between $5.00 and $5.75 per gallon.
But that’s not the price you’ll see at the pump. Remember, our graph shows “real,” i.e., inflation-adjusted prices. They’re all expressed in terms of the dollar’s current purchasing power. So to find the numbers you’ll actually see posted outside gas stations in 2022, you’ll have to increase the “real” prices to adjust for future inflation.
Let’s say that Ben Bernanke (or his successor) is entirely successful, for the next ten years, in limiting inflation to the Fed’s nominal target of 2%. That in itself would be quite a feat, but let’s assume he can do it. Then prices would increase by a factor of (1.02)**10 = 1.22 (Google or your scientific or business calculator will do the math for you). That works out to an average posted pump price between $6 and $7 per gallon in ten years.
Conclusion: Can “Fracked” Gas or Tar Sands Save Us?It doesn’t much matter whether you believe that we’ve long passed Peak Oil or that OPEC is slowly and cleverly twisting the screws to squeeze the rest of the world dry. In either case, that graph will likely continue on its 2002-2008, 2011 trajectory. It will regardless of how much we “drill, baby, drill” in the US for oil, because we have less than 3% of global oil reserves, while OPEC has 75%.
Only a few things could stop the current, rapidly rising trend in gasoline prices. Another great recession could, just as the Great Recession of 2008-2009 did and the slowdown caused by the Greek debt crisis is starting to do right now. In the long run, a surprise breakthrough in energy technology might, but there’s no such surprise on the horizon. Even the sudden discovery of nuclear fusion in a bottle, which scientists have been chasing hard for half a century, would take a decade or two to roll out.
A few things might make the extrapolation even worse. In the short term, Iran could block the Straits of Hormuz, or there could be yet another war in the oil-rich Middle East. Or OPEC could decide to abandon the path of economic rationalism and use oil to play politics again. More likely, OPEC’s projections of the extractability and extraction rates of its oil could prove optimistic, supply could fail to match rapidly increasing global demand, and the graph’s slope could turn even further up. This latter risk is the most likely one.
Only two things might put a cap on US gasoline prices in the short or medium term (ten years or less). The first is converting our vehicle fleet to natural gas, and later electricity. A serious effort toward these ends would contain national demand for oil and increase the supply of alternative power for transportation. Electrified high-speed intercity rail would also reduce the demand for jet fuel, which also comes from oil. Let’s call this the “demand-side solution.”
A second possible solution would work on the supply side. If Exxon Mobil and other big oil companies could exploit Canada’s tar sands cheaply enough and quickly enough, the resulting supply increase so close to our borders might contain price rises for a time.
There are four problems with the tar-sands solution. First, we just don’t know yet how expensive large-scale extraction and refinement of tar sands will be. Making oil from tar sands requires heating them up, extracting something resembling oil by mechanical and chemical processes not yet fully developed at commercial scale, and (in the process) wasting a huge amount of energy. It stands to reason that these additional steps—making an oil simulacrum before refining it into gasoline—are likely to make gasoline more expensive, not less, at least in the short run.
Second, converting tar sands into something resembling oil produces tremendous pollution, including carbon compounds that cause smog and will accelerate climate change. Although Canadians want the jobs, the process is likely to lay waste large areas of pristine wilderness in Alberta. Then transporting the resulting faux oil into the US, probably by pipeline, would create oil-spill threats to additional Canadian wilderness and all the US wilderness en route. (That, in a nutshell, is the reason for the Keystone Pipeline controversy.)
Third, once you have extracted something resembling oil, you still have to refine it into gasoline, with all the energy loss, pollution and expense that that process usually entails. And when you’re done, what you have is another gallon of gasoline, competing on a global market with flat or dwindling supplies and rapidly increasing demand. Tar-sands exploitation is unlikely to offer much, if any, price relief to consumers.
Finally—and most important—reconstructing the industrial infrastructure of Alberta and building a new continental-scale pipeline would take time. The necessary environmental reviews alone might take several years. Tar sands are hardly a short-term solution.
In contrast, auto makers are making natural-gas vehicles right now, and drilling companies are already in a frenzy of expanding our supplies of natural gas. The demand-side or natural-gas solution has a huge start-up advantage over tar sands.
The natural-gas approach would also be much better, much sooner, for drivers. Recall that greater-than-factor-of-six advantage of natural gas over gasoline in price per energy-equivalent.
As our head graph shows, the real cost of gasoline in the first few weeks of 2012 was $3.49 a gallon. Based on the relative prices of natural gas and oil shown above, the price of an energy-equivalent amount of natural gas is $3.49 x $15.08/$105 = $ 0.50. (This comparison ignores the additional cost of refining the oil into gasoline. Natural gas doesn’t need refining.)
That’s about fifty cents per gallon equivalent—less than half the real price of any gallon of gasoline at any time since 1949.
According to the popular radio show “Car Talk,” it costs $3,000 to $5,000 to convert a gasoline car to run on natural gas, and $3,500 to $7,000 more to buy a new natural-gas car than a gasoline car. If both cars got 30 miles per gallon (or gallon equilvaent) and ran a relatively modest 15,000 miles per year, the fuel cost savings ($2.99 a gallon equivalent) would let the natural-gas driver recover a $3,500 additional capital investment in $3,500 / ($2.99 x 500) = 2.34 years. And that’s even before auto makers climb the mass-production curve and begin to compete seriously in making natural-gas cars cheap.
Exxon Mobil and its lobbyists are pushing the supply-side “solution” because oil refining and maketing is what they do. But the demand-side solution appears simpler, cheaper, quicker and less environmentally damaging. We could work harder to convert our vehicle fleet away from oil, emphasizing natural gas in the short term and electricity in the medium and long terms. We might even provide incentives or mandates for selling natural-gas-ready vehicles and building natural gas stations in populated areas.
Exxon Mobil and other drilling energy companies can do their parts in the demand-side solution, too. They can extract the natural gas and build natural gas stations. But they can’t build cars to burn natural gas or convert existing cars to that fuel. And they will have little business incentive to build natural gas stations until there are enough natural-gas cars on the road to create reasonable demand.
As natural-gas production increases to meet demand, there is also the danger of water pollution from “fracking” wells. Not every reservoir of gas for “fracking,“ or every “fracked“” well, is close enough to drinking-water supplies to do them damage. Rather than invest millions in lawyers and PR hacks to prove there is no problem at all—when that does not appear to be the case—drilling companies should invest in taking inventory geologically, in order to estimate how much “fracked” gas could be recovered far from drinking-water aquifers, with little or no threat to drinking water. That would be an important number to know, and a crucial one for energy policy. (Our national US Geological Survey might help produce that number.)
More generally, we need a coherent national energy policy as oil prices inexorably rise globally. The decision to favor the demand side (converting vehicles to natural gas first and later electricity) or the supply side (with tar sands) will be one of the most consequential in the history of our nation’s transportation infrastructure and use of energy.
Either solution might lead to much-needed energy independence in transportation. But the two solutions’ cost, time frames, industrial and commercial consequences and impact on the environment are likely to be starkly different. As long as the drinking-water problem is manageable, the demand-side solution (natural gas) is likely to work sooner and better, with lower prices for drivers and less environmental damage.
Lacking adult supervision, our oil companies will continue to do what they do best: drilling, extracting and refining. They’ll continue to give us oil, somehow and anyhow, without much regard to long-term or even medium-term consequences. If we let private companies, in their own short-term self interest, make the critical engineering, economic, environmental and security tradoffs between natural gas and tar sands, we’ll have no assurance that they or we will get those tradeoffs right. And there’s plenty of reason to believe they’ll tilt unreasonably toward oil, because oil is what they’ve favored for a over century.
So don’t look for zebras, demons or angels. Just apply basic economics and simple mathematical methods. If you do so, you come to an inescapable conclusion. Unless we start converting our national vehicle fleet to natural gas right away, or unless we begin the massive industrial infrastructure projects needed to convert Canadian tar sands into oil and gasoline, the price of gasoline at the pump, in then-current dollars, will be at least $6 to $7 per gallon in ten years. And you can think of a lot of quite realistic scenarios in which it might go even higher.
Isn’t it time we started working harder on the best alternative sources of energy for our cars and trucks, namely, natural gas now and electricity later?
FootnoteFor 1976 and 1977, unleaded gasoline was just getting started. It was on the market but not yet required. For those two years, the EIA’s numbers don’t provide an all-fuel average, probably because unleaded gas was just a small part of the picture. And without volume figures, I can’t calculate one. So I took the lowest prices, which were for leaded gas, probably because it was still the volume leader.
Personal Disclosure: I’ve invested substantial amounts (for a consumer) in naked long-term call options on Exxon Mobil stock (symbol XOM). No matter which way we go—natural gas and electricity or tar sands—Exxon Mobil will profit in the short or medium term. Unless the global economy tanks, I expect oil and gasoline prices to increase substantially during the next few years, raising Exxon Mobil’s revenue and profits without much additional effort on its part.
I’m afraid that, as a nation, we’re going to dither and dally in bringing them down. I fear that clueless politicians will continue to make absurd one-liner arguments and propose thoughtless “solutions,” like building the Keystone Pipeline without proper environmental review (as if it could be built overnight in any event!) and with no assurance that the rest of the tar-sands infrastructure will even exist. If that happens, we’ll miss the proper starting times either for investing in natural-gas and electric vehicles, or for the massive projects needed to exploit Canadian tar sands.
I would be delighted to earn less on my options and be proven wrong. But that’s going to require politicians and business executives to get much more serious, think longer term, and hire more engineers and scientists and fewer lawyers, marketers and PR hacks. The prospects for that happening anytime soon are not particularly encouraging.
How to Make Solar Power Seem Expensive When it Isn’tIn a recent post, I explained why coal companies’ cost comparisons with solar and wind power are meaningless at best, fraudulent at worst. But an important question still remains: why do so many people believe otherwise?
As I was redrafting my explanations again and again, trying to make them simpler and clearer, it hit me. My puzzlement grew out of my own over-education. With a Ph.D. in physics and an “Accounting for Lawyers” course at Harvard Law School under my belt, I knew (and still know) exactly how to calculate the real cost of solar energy. But most people don’t. Apparently they compare apples and oranges, and coal companies’ PR hacks encourage them to do so by the words they use and the numbers they repeat ad infinitum, ad nauseum.
From the point of view of physics, engineering and basic accounting, it’s all a gigantic fraud. From the point of view of “public relations” and political “consulting,” it’s sheer genius. But, whichever side of that line you fall on, I’m sure that, once you see it in its full glory, you’ll think it one of the most clever, thorough and diabolical deceptions in American political or business history.
Here’s how it works:
The source of the confusion is the use of seemingly similar terms with wildly different meanings for solar and conventional power. Coal companies’ PR hacks use this confusion to make solar power sound as if it’s ten times more expensive than conventional power to produce.
But as engineers do the calculation—correctly this time!—the result is just the opposite. Solar photovoltaic power is at least six times cheaper than conventional power, right now, today.
[Note: this post does not discuss the so-called cost “comparison” that confronts consumers when they install solar roof arrays in their homes. That’s a whole different kettle of fish. There the power company tells you both what you must pay per watt of output to install the solar arrays on your roof and what it’s willing to pay you (or deduct from your bill) for the power that the arrays generate. It controls, if not dictates, both sides of the equation, in a “tails I win, heads you lose” approach. This post is about what it actually costs the power company to generate solar photovoltaic electricity.]
The PR Hack’s Method
Energy-policy buffs like to quote the cost of photovoltaic solar cells in terms of dollars per watt. That’s the number of dollars it costs to manufacture a photovoltaic solar cell that, in good, strong sunlight, can produce a watt of electrical power. The solar industry reduced this production-cost parameter to about a dollar a watt in 2009. Half that value (fifty cents) is expected soon, at least in China.
Coal advocates love this measure of cost because ignorant consumers often confuse it with the cost of generating electrical power itself. But it’s not the same. It’s the cost of making the generator—a single tiny solar cell. There are thousands or tens of thousands of those cells in a rooftop array, and millions in a serious commercial photovoltaic power plant.
In contrast, your power company charges you for the electricity it produces, not for the cost of building the power plant. And the unit it uses to bill you is kilowatt-hours, not watts.
Today, the national average cost of a kilowatt-hour of electrical power is about eleven cents. So the average rube, comparing the two numbers and ignoring what they represent, might say, “See, the power we get from coal now is five to ten times cheaper!”
Allowing and encouraging consumers to make this completely bogus comparison has been an enormously effective propaganda strategy.
The Error! The Error!
To an engineer or scientist, as distinguished from a PR hack, this comparison is absolutely absurd in several respects. First of all, it compares apples and oranges. The solar-cell cost is the cost of manufacturing the cell, which later generates electricity. The cost of power on your electricity bill is the cost of using an already-built plant to produce electricity. They are completely different numbers in concept, meaning, units and common sense.
Second, there’s basic high-school physics. The watt is a measure of power. The kilowatt-hour is a measure of energy, i.e., the ability of power, over time, to do useful work. To an engineer or scientist, comparing them is like comparing feet and pounds, or pounds and fluid-ounces. The comparison is utterly meaningless.
Third, there’s accounting. The cost of producing the solar cell is a capital cost, not even amortized. The cost of electricity on your bill is the operating cost of a conventional power plant, with perhaps a small fraction derived from amortized capital cost. (My earlier post explains how plant cost is amortized, or averaged, of a plant’s useful productive lifespan to derive a meaningful adder to the cost of power. It also explains why, for renewable energy, but not for conventional power, amortized capital cost is the dominant term in power cost.) Any accountant or economist who seriously compared the two would be fired.
Coal companies’ PR hacks never make this comparison in so many words. They could be sued. Instead, they encourage ignorant consumers and Fox commentators, who are dumb as boards and protected by the First Amendment, to do so. They just assert—over and over again!—that coal is so much cheaper and let ignorant consumers draw their own conclusions from numbers they read in the popular press.
How an Engineer or Accountant would Make the Comparison
The two numbers—plant cost and electricity cost—are completely different in theory, practice, economics and accounting. But it’s possible, with some arithmetic and common sense, to compare them. Here’s how an engineer or physicist with some knowledge of accounting would do it.
Suppose a photovoltaic solar cell that can produce a watt of electrical power continuously in sunlight costs one dollar to make. How can we calculate the cost of the power it produces?
As discussed in my previous essay, that dollar is the capital cost of building the solar cell. In order to calculate the cost of the power it produces, you have to amortize (i.e., average) that capital cost over the entire lifetime of the plant—all the power it produces during its useful life, until you have to invest in a new plant.
Let’s be very generous to solar power’s detractors. Let’s suppose that the cost of building the rest of the plant—apart from the cell itself—doubles the cost of the solar cell, to two dollars per watt output. (The “installed” cost of rooftop solar arrays for homes may be higher—as much as three times the cell’s cost by itself—because home installations lack the economies of scale of large power plants.)
Remember there are millions of such cells in a commercial solar plant. There are also wires and equipment to transmit the power out, instruments to monitor and control the plant’s operation, and machines to keep the cells facing the sun. So let’s assume that the cost of this other equipment doubles the cost (per watt) of each of the millions of cells in the plant.
With this assumption, the cost of building the solar power plant as a whole becomes two dollars per solar-cell per watt of power output.
But how much does the plant cost per unit of energy produced, namely, a kilowatt-hour?
As its name suggests, a kilowatt is a thousand watts. So a kilowatt-hour is a thousand watts running for an hour. Every year has 24 x 365 = 8,760 hours, but the sun only shines (in sunny climes) for about eight hours per day. So let’s take a third of that, i.e., 2,920 hours. During every year in which that little solar cell (of which a whole power plant has millions) chugs along producing its tiny watt of power, it ends up generating 2.92 kilowatt-hours of power, all for two dollars total capital cost.
But that’s not all. No engineer in his or her right mind builds any power plant, let alone a solar plant, to last just one year. Let’s suppose that the solar power plant lasts only as long as most nuclear power plants in business today, which are still running after about forty years. Then, over the lifetime of that solar plant, the little chugging solar cell will produce 2.92 x 40 = 116.8 kilowatt-hours of power, all for a manufactured price of two dollars.
So what’s the total cost of power, per kilowatt-hour, generated by that little solar cell over the forty-year lifetime of the plant? It’s $ 2 divided by 116.8, or $ 0.017; it’s 1.7 cents. At this cost, the little solar cell beats conventional power plants by a factor of 11/1.7 = 6.4.
Yes, you read that right: not only is the little solar cell not five to tens times more expensive per kilowatt-hour of power; it’s actually 6.4 times cheaper. And that’s right now, today, when solar power is confined largely to China and Germany, and we still have a long learning curve to climb. Maybe those Chinese and Germans know something the dolts on Fox don’t.
And recall we have made a very generous assumption for the cost of the rest of the solar plant, besides the solar cell itself, which has the most exotic technology and is the most critical part.
For comparing solar power with conventional power plants, we needn’t add anything to this amortized capital cost. Solar power has no fuel costs at all. It’s plant-maintenance costs are much lower than those for coal or even natural gas. And because it produces no effluent it has no external costs either.
If we made the comparison more realistic, coal would come off even worse, for two reasons. First, we have every reason to believe that solar-power plants will last much longer than nuclear-power plants, which suffer massive radiation of operating components, have many more moving parts, operate at incomparably higher temperatures, and are infinitely more complicated, sensitive and delicate. Second, this calculation entirely neglects coal’s humongous external costs, for things like smog, acid rain, mercury pollution of lakes, seas and fish, particulate induced asthma, and climate change. Our little solar cell produces none of those costly effects.
So right now, today, with our generous allowance for building the rest of the plant, our little solar cell produces electricity 6.4 times more cheaply than conventional power plants. Do you begin to ken why coal and even natural-gas companies hire lawyers and public relations hacks, rather than engineers, to “explain” their cost calculations?
P.S. Some readers may object that this calculation ignores the time value of money. There are two responses to that objection. The short answer is that energy companies are rolling in money and needn’t borrow to build new solar plants. The longer answer is that, at current interest rates, borrowing the money to build the plant would about double the cost of solar power, still leaving it more than three times cheaper than conventional power.
You can verify that result using a standard mortgage calculator, such as this one. If the plant has one million solar cells, and so (according to our hypothesis) costs $2 million, the power company can borrow that money at 4% interest for forty years for a monthly level payment of $8,359, or $100,308 annually. On a per-cell basis, that’s 10 cents per year. Since the solar cell produces 2.92 kilowatt hours per year, the cost of that power is 10 cents/2.92 or 3.42 cents per killowatt-hour. No conventional power plant can match that low cost today.
Even this calculation is overly generous to solar power’s detractors. The reason? Nothing requires a power company to borrow money for the entire actual working life of the plant. The two variables—loan payoff period and actual plant lifetime—are completely unrelated. By paying off the loan more quickly, the power company can reduce its effective cost of capital, just as you can reduce your mortgage payments by taking out a fifteen-year mortgage rather than a thirty-year one.
The same result applies if you worry about inflation. The dollars a power company receives in payment for its power become less valuable as time goes on. But the calculation above expresses that difference, if you consider the 4% an annual inflation rate, rather than an interest rate. That rate is quite conservative—twice the Fed’s maximum target rate 2%.
So, any way you look at it, the cost of solar photovoltaic power is at least three times cheaper than its conventional counterparts. And that’s right now, today, without us Yanks having climbed the learning curve (like the Chinese and Germans) and gotten experience in using solar power and building plants cheaply. It also assumes a very conservative lifetime for solar photovoltaic plants: the same forty years that incomparably more complex nuclear power plants have already enjoyed.