India Power Outage: The Shape of Things to Come?

July 31: Indian national television reports on power outage (to a limited audience?!)”So far as I am able to judge, nothing has been left undone, either by man or nature, to make India the most extraordinary country that the sun visits on his rounds. Nothing seems to have been forgotten, nothing overlooked.”
Mark Twain, Following the Equator.

The enormous power cut recently seen in India, which affected perhaps 700 million people, serves to highlight the degree of the structural dependency we have built into our lives in the era of cheap energy.

Electricity is one of the most complex manifestations of our complex system and has come to be widely seen as a basic necessity. It enables many of our modern life support systems. Expectations have been raised, even in many of the slums of the world, that electricity will be available, at least some of the time. The lack of it, especially if that lack is sudden and unexpected, or prolonged, increasingly leads to social unrest.

It is instructive to contrast the extent of the dependency on electricity, and the expectations that surround it, in developing and developed economies. The way a blackout plays out in a place like India is quite different than a similar outage would be in a place where power supplies are far more reliable. The primary difference is one of resilience.

Power Generation and Infrastructure

The Indian blackout has been described as “an accident waiting to happen” by Suresh Prabhu, who ran India’s power ministry in the early 2000s. India’s electricity sector faces many chronic challenges thanks to the rapid development of the country. It is highly dependent on coal for 70% of generation, and commonly experiences coal shortages:

The fuel shortage is acute when it comes to coal, which accounts for two-thirds of the country’s power generation.

India has about 10 percent of the world’s coal reserves but output by the near-monopoly Coal India has stagnated, importing coal is far more costly and a lack of rail capacity from ports has held up supplies. Many power plants have less than seven days’ of coal stocks, a level seen as critical to continuous operation.

“Coal India has enough reserves. But evacuation (transportation) is the main problem,” said a senior coal ministry official. He said Coal India had set aside $900 million to lay train tracks in the next five years but the railway ministry had not responded to the plan.

Generation is water dependent, and the delayed monsoon this year has exacerbated existing water scarcity, meaning less water for hydro power and for cooling other forms of generating capacity. Lack of cooling water could cause generation, notably nuclear plants, to be shut down. Temperatures have stayed higher than normal, increasing demand for space cooling at the same time.

The lack of rain has also increased the need for irrigation water for farming, meaning increased demand for the power to access and use groundwater. Power use by farmers is subsidized, hence there is little incentive for them to conserve. The effect on demand at times of low rainfall can therefore be considerable. Climate change is likely to accentuate the water problems in the future, as monsoons may be increasingly affected, the melting of glaciers in the Hindu Kush would also reduce surface water availability and heatwaves would increase evaporation.

The economic impact on state electric boards expected to supply subsidised demand to farmers and many others is considerable.

Perhaps the biggest challenge, though, is the health of decrepit distribution companies that depend on subsidies and face huge losses from low tariffs and rampant power theft. Together, they are now saddled with debt worth some $35 billion and are increasingly unable to pay for new supplies.

“Generation capacity will only get financed if the financiers feel that the generators are selling power to distributors who are financially capable of paying for it,” Planning Commission deputy chairman Montek Singh Ahluwalia said recently in defense of a government plan to bail out the mostly state-owned distribution companies.

Populist-inclined state governments have made it difficult for distributors to set cost-reflective tariffs. However, with bank loans drying up, many distributors have been forced to raise tariffs sharply over the past six months.

Many of the state run electricity companies, which collectively lose $4.5 billion per year, are essentially bankrupt.

Supply, Demand and Unofficial Connections

Power infrastructure in India is not capable of providing the sufficient and reliable power supply that westerners take for granted. Some 300 million people have no access to electricity since the grid does not reach their areas.

While India ranks sixth in the world in terms of overall electricity production and consumption, its population of 1.2 billion means that per capita levels of electricity consumption remain low at just over 500 kWh per person per year, compared to more than 2,600 kWh in China and nearly 12,000 kWh in the United States.

Unlike in richer countries neither supply nor power quality can be reliably maintained:

Reliable operation of the large interconnected grids of North America and Europe is founded on established practices of tight frequency control and all control areas sticking to their respective interchange schedules. The grid frequency normally remains within +/- 0.03 Hz of the rated frequency, and any excursion beyond that is considered alarming. Utilities deviations from their schedules are minimal, and have to be made up in kind the next day. They are therefore not priced. Adequacy of generating capacity enables maintenance of requisite spinning and cold reserves at all times, for overcoming contingencies. In a regime with such discipline, all power plants must generate power according to the schedules decided by the concerned load dispatch centres, and pit-head and nuclear power plants can steadily operate at a substantially constant MW as per their respective schedule.

The situation, on each of the above counts, is very different in India. The peak-hour consumer demand far exceeds the available generating capacity. Capacity shortage is officially stated as around 15%. Load-shedding is a daily routine except in metropolitan cities and State capitals. Rural supplies are regularly rostered commonly and restricted to 8-12 hours a day in most States. State utilities, in their anxiety or compulsion to minimise load-shedding in their area, tend to overdraw power from the larger grid. Interchange schedules go for a toss, and frequency often plunges below the stipulated lower limits. As per a recent report, the frequency was below 49.2 Hz for about 25 % of the time during August 2009. On the other hand, industries and commercial establishments need back-up diesel generators for continued operation when power supply from the grid is cut-off or is curtailed (for a few hours every day), and domestic consumers have to bank on their own battery-backed “inverters” to get the basic amenities of light and fan round the clock.

Since deviation from drawal schedules of State utilities are inevitable and substantial, and cannot be returned in kind, they are priced. Utilities pay for overdrawal, and get paid for under-drawal at a frequency-linked rate, which goes up as frequency declines and goes down as frequency rises…

…Frequency is the most crucial parameter in the operation of an A.C. system. The rated frequency in India is 50.0 Hz. While the frequency should ideally be close to the rated frequency all the time, it has been a serious problem in India. There was a time it varied from below 48.0 Hz to above 52.0 Hz, even beyond its legally permissible limit of +/- 3%, i.e. from 48.5 Hz to 51.5 Hz as per Indian Electricity Rules, 1956…Frequency fluctuations are caused by load-generation imbalances in the system, and keep happening because consumer load keeps changing.

Poor power quality control has knock-on effects on equipment operation, including large-scale generation capacity. Equipment damage can, of course, further compromise supply and aggravate the effects of chronic fuel shortages. Crucially, nuclear plants do not function well in such an environment:

Nuclear power plants are particularly susceptible to frequency fluctuations. As frequency changes, the speed of the coolant pumps changes proportionately, and the coolant flow and consequently the temperature differential across the reactor also vary. The above temperature differential is a primary signal for reactor power control, and its variation gives a command for change of reactor power even when the reactor has been operating at the optimum level. This is turn causes unnecessary fluctuations of reactor power and undesirable wear of fuel rods, etc.

Demand often exceeds supply by 10%, hence rolling blackouts are a constant feature. Losses in the transmission and distribution systems are huge – 40-50% – thanks to decrepit infrastructure and extensive power theft. The power system (as with much of society) is plagued by corruption. This leads to great popular frustration:

Citizens could take to the streets if the blackouts continue, warned Harry Dhaul, director general of the Independent Power Producers Association of India, a non-governmental organisation that campaigns for improvement of the Indian power sector: “There will obviously be some agitation in urban areas, which have become very reliant on electricity … There could be riots; there could be protests.”

At the beginning of July, repeated power cuts during a spell of 40C-plus heat prompted hundreds of residents to vandalise electricity substations in the new city of Gurgaon just outside Delhi. Rioters beat up energy company officials, holding some of them hostage and blocking roads in several parts of the city.

A large minority of those in the blackout zone have never been connected to any grid – just 16.4% of the 100 million people who live in the central-eastern state of Bihar have access to electricity, compared with 96.6% in Punjab in the west.

In order to help balance supply and demand, consumers are required to inform the power distributor of the proposed load. They are supposed to apply for, and pay for, permission to connect the new device, but since this can take a long time and be relatively expensive, the rule is often not observed:

Central Electricity Supply Utility of Orissa (CESU) officers said most of the disruptions are due to damages in the electrical circuits because of undisclosed load. For adding new electrical devices, one can apply to the area junior engineer of the power distributor by paying the security deposits. If one adds an AC using 1 kilo watt power, he would have to make a security deposit of Rs 432 and so on, Sinha explained…

…CESU sources estimated that the undeclared load has gone up by around 20 per cent in the past few days. “This is because hundreds of air-conditioners and air coolers were installed by people to get respite from the scorching heat. However, very few people had actually announced these additions,” said CESU spokesman Golak Bihari Sahoo.

Electricity connections are financially out of reach of many, notably the many residents of India’s teeming slums.

Sprawling industries and emerging urban lifestyles in Ahmedabad enfolds in itself a dark and morbid life of scarcity, filth and deprivation. Nearly 41 per cent of people in the city live in slums.

There are 792 slums spread all across the city. Migrants from Rajasthan, Maharashtra and Madhya Pradesh who come in search of a livelihood also live here. But the majority comprises scheduled castes and scheduled tribes. A good percentage of migrants from Bengal and Bangladesh is also seen…

…”We have to pay Rs 750 for the connection and an additional Rs 250 to fix the metre box. Every month we get a bill of Rs 150-200. We cannot afford to pay more than Rs 1,000 for a connection,” said Gita Rabari, a slum-dweller of Baba Ramdev Nagar of Chandloda slums in Isanpur.

This does not necessarily mean that slum dwellers do not have electricity, but that ‘unofficial’ power connections are incredibly common.

A one-room slum hut next to the nahalla, the foetid, drainage canal which runs past the cremation pyres near Nizamuddin, costs about 500 rupees rent a month, usually paid to the local gangsters.

The slums around my place usually have electricity, illegal of course. Every electricity post is rigged with hundreds of wires leading down into the slum dwellings, and because of this illegal tapping (local garment shops and factories also do it) Delhi is cursed with power black-outs. Twice a day, for up to six hours at a time, in 111 degree [Fahrenheit] heat, my electricity goes. The poor suffer, while the rich in New Delhi crank up their noisy generators to charge their ceiling fans and fridges.

Power theft is not just an individual matter. It is also a means for small slum businesses to supplement their meagre income:

With nearly 25 per cent of the slums not having electricity, slum-dwellers have resorted to stealing it from those who have installed metres. There are also ‘dealers’ who illegally supply electricity to houses.

“My paan shop hardly provides me with any money. Therefore, I supply electricity to houses. I get the wire connections from an electricity metre in the neighborhood. Five to six houses can get electricity from one wire in just Rs 150,” claimed Raju.

Power theft has become a way of life. It is simple, low cost, and makes an enormous difference to the quality of life of those at the base of the economic pyramid:

Electricity theft is also part of the problem, but simply identifying the problem as “theft”—as many do—rather than recognizing that people deserve access to electricity, minimizes the social and economic reasons that drive people to frustration to the point where they feel they have a right to steal power from the grid.

Despite massive loans, debt, and the poorest paying for the power with their land or their lives, one-third of India’s households do not have enough electricity to power a light bulb, according to last year’s census. And so they steal it. And in stealing it, they increase energy inefficiency, by often grounding the wire they have hooked up illegally to the grid in the soil, thereby losing more power.

In this June 13 file photo, an electrical linesman repairs cables in the middle of a spider web of illegal subsidiary wires around the main cables in Allahabad, India. Stealing of power is a frequent phenomenon in Indian towns. AP Photo by Rajesh Kumar Singh

With such strong incentives, it is no surprise that the practice is endemic:

How can you live on a few dollars a day? Well, it helps a little if your electricity is free. For slum dwellers in Rohini, a residential district in North West Delhi, power theft is almost a way of life. There’s little or no effort to hide it, and the method is simplicity itself: just find the nearest overhead power cable, sling a metal hook over it, then run a wire from the hook to the home. The result: an illegal supply of free electricity that lasts until inspectors from the local power utility stage one of their periodic raids. And when that happens, people simply all wait for a few hours until the inspectors have gone before reconnecting.

The evidence for this is there for all to see. Across a main road from the slum is a line of pylons carrying mains electricity cables. As well as the thick wires they are supposed to be supporting, most of the pylons have dense tangles of other much smaller wires sprouting off in different directions. The proliferation of connections makes the pylons look a little like over-decorated Christmas trees.

These little wires run across the road siphoning off power from the transmission lines to homes and businesses located in the slum, which is a maze of little alleyways with children and animals running around. Most households here seem to have an illegal connection to the grid. In many instances there are several unauthorized connections – and on occasion a legal one as well…

…Although Delhi has been dubbed the power theft capital of the world, the situation in other parts of India is little better. There are no hard figures, but the best estimate is that somewhere between a third and half of the country’s electricity supply is unpaid for. No other country suffers revenue losses on this scale.

It is not just the very poor who do not pay. Power theft is far more extensive than that. The inability, or unwillingness, to pay for supply means that improvements to the system are very difficult to finance.

Slum dwellers’ unofficial hook-ups are the most visible sign of India’s power theft crisis, but there are yet bigger problems dogging the country’s energy sector. Meter tampering by middle class households seeking to pay less than they should costs still more, says Sangeta Robinson, an official with local utility North Delhi Power Limited, a subsidiary of energy giant Tata Power. And yet another huge loss – albeit one which no-one can quantify – is electricity theft by industrial enterprises.

Giresh Sant, who works for an NGO called Prayas campaigning for more efficient and accountable government, says the problem is one of corruption – and a vested electoral interest in turning a blind eye. No-one likes paying their utility bills, he says, so often politicians regard laxness about revenue collection as a vote-winner. And opportunities for personal enrichment through corruption related to industrial power theft have given them, as well as civil servants and utility officials, further incentives not to rock the boat.

The political aspect is most acute in rural areas, where the larger-scale farming operations are collectively influential:

At least 20% of India’s power is consumed by farmers’ irrigation systems. Frequently they either get free power or pay low set charges that bear no relation to the amount of electricity used. The powerful farmers’ lobby is hard for politicians to ignore in country where a majority of the population still makes its living from agriculture.

The task of removing illegal connections often seems insurmountable:

A tired man with a thin mustache, Seth is one of the many people fighting block-by-block to clean up the system. It’s an unenviable task. If Sisyphus had been Indian, his sentence might have been to unsnarl the boulder-sized knots of wire that hang from every electric pole.

Many Indians have a long-standing reluctance to pay for power, dating back to the era when the state controlled nearly the entire economy, including the energy sector, and securing a legal power connection could take a lifetime.

Pervasive corruption acts as a barrier to change at every level of power system operation:

Corruption certainly has played a role in India’s power failures for decades. At every step in the supply chain, money is siphoned off, resulting in a shoddy system– from backup systems to warning systems to good cables. Currently, good cables intended for transmission get sold and shoddy materials put in their place.

It would be a herculean task to reform the power sector into anything remotely resembling what the developed world is used to.

Blackouts – Planned and Unplanned

The July 30th blackout appears to have begun in Agra, Uttar Pradesh. The transmission lines were apparently carrying twice the permitted load. When the Agra-Gwalior line went down, the effect was a cascade, with lines tripping one after the other.

The current prevailing theory is that the outage started with an internal failure in a power line in Agra, removing significant generating capacity from the grid. This event should have triggered an immediate order to all states on the grid to shed load, or intentionally reduce power delivery to their consumers. By the time this order was given, however, most other generators on the grid had already dropped frequency due to the load demand being greater than what they could generate. This happened as no regions shed load and the rest of the generators were struggling to cover for the lost power on the failed Agra line. Before anyone could react, the whole northern grid had collapsed.

The impact was considerable. People were trapped in the metro or stranded at stations, with electric trains unable to move and blocking the movement of diesel trains. Massive traffic jams formed in New Delhi as traffic lights went out. Electric crematoria ceased to function. Hundreds of miners were trapped underground. Water supply was heavily impacted. Some hospitals faced major difficulties in the following days:

Generators require fuel, which can be scarce during a blackout. The Wall Street Journal reported on Tuesday that at a major hospital in Gurgaon, the backup generators failed after prolonged use. This forced nurses to manually operate life-saving equipment such as ventilators for about 15 patients. “We were lucky that no lives were lost,” a senior doctor said. “The generators came back up in about 20 minutes.”

Out-patients also struggled:

Among those affected by the outage was 62-year-old Pramitha Devi, who was bidding to take the metro toward Ram Manohar Lohia hospital in New Delhi after her home dialysis machine was damaged by electricity fluctuations. A doctor who identified himself as R.C. Bhargava said the hospital’s generators had not been fully refueled since the July 30 grid collapse, leaving them with about two hours of electricity for the intensive care unit. “We have to make plans to shift critical patients to other hospitals,” said Bhargava.

In India, the issue is not whether or not there will be blackouts. People know that there will be, often for several hours every day. They prepare for outages and take them in stride:

When I was growing up in Delhi, we were well accustomed to daily summer power outages, euphemistically called “load shedding.” These blackouts were regularly scheduled every evening and often created an atmosphere of genial neighborly fun — people out on terraces enjoying cold drinks, talking with neighbors over walls, taking walks, kids playing in the street — and they didn’t seem particularly inconvenient. But all that was another time and a far cry from the catastrophic two-day power crisis that India experienced earlier this week.

The distinction that matters is between planned and unplanned outages. Planned outages are called rolling blackouts:

A rolling blackout, also referred to as load shedding, is an intentionally engineered electrical power shutdown where electricity delivery is stopped for non-overlapping periods of time over geographical regions. Rolling blackouts are a last-resort measure used by an electric utility company to avoid a total blackout of the power system. They are usually in response to a situation where the demand for electricity exceeds the power supply capability of the network. Rolling blackouts may be localised to a specific part of the electricity network or may be more widespread and affect entire countries and continents. Rolling blackouts generally result from two causes: insufficient generation capacity or inadequate transmission infrastructure to deliver sufficient power to the area where it is needed.

Rolling blackouts are a common or even a normal daily event in many developing countries where electricity generation capacity is underfunded or infrastructure is poorly managed. Rolling blackouts in developed countries are rare because demand is accurately forecasted, adequate infrastructure investment is scheduled and networks are well managed; such events are considered an unacceptable failure of planning and can cause significant political damage to responsible governments. In well managed under-capacity systems blackouts are scheduled in advance and advertised to allow people to work around them but in most cases they happen without warning, typically whenever the transmission frequency falls below the ‘safe’ limit.

Where outages are scheduled, people adjust their activities accordingly. However, unscheduled blackouts, or outages much longer than scheduled, cause public resentment. Disruption is tolerated, so long as it is organized disruption.

Unscheduled power outages are back to haunt citizens of Greater Hyderabad…

…”Central Power Distribution Company Limited (CPDCL) officials have suddenly started implementing three-hour power shutdowns without giving any schedule. We will be prepared for power cuts if the schedule is announced,” A Chandrasekhar, an IT consultant and resident of Habsiguda, told TOI.

Several residents complain power cuts were beginning as early as 6 am. Office goers and students are being put to inconvenience, affecting their daily chores in the morning due to the outages.

“There was no power in my area for more than an hour in the morning. We were not prepared as the power cut starts at 9 am. With this, we could not fill our water tank and got delayed to office,” ASR Murthy, an IT employee and resident of Srinagar Colony, said.

Potential solutions exist to the organizational problem, if not to the mismatch between electricity supply and demand.

“CPDCL has data of mobile phones of about 12 lakh [1.2 million] consumers in the city. They should at least inform citizens about power interruptions through SMSs on a day-to-day basis so that people can plan their chores accordingly,” M Uday Kumar, a resident of Kushaiguda, said.

Indian businesses and household compensate for the inevitable power cuts with generators, fuel supplies, renewable generation and inverters, and battery banks for power storage. The elements of redundancy – alternative means to achieve the same essential function – have endowed the system with flexibility and resilience. It comes at a cost however, for the equipment and for expensive generator fuel. This provides business opportunities for those who facilitate independent generation:

Microtek, an Indian company that specializes in selling power backup inverters, claims to have 100 million “satisfied customers.”

“Every year in the summer months demand peaks and there are power failures, so most middle-class families purchase an inverter. That’s why we’re in business,” said Manoj Jain, vice president at Microtek.

To be able to afford this, one must be relatively wealthy. Otherwise, inconveniences and the discomfort of sweltering temperatures without cooling must be endured.

Ironically, the super-rich generally do not bother, as their power supplies are far more secure. They are therefore more exposed to large scale unplanned disruptions than the middle class.

In the centre of Delhi, one of the world’s biggest, dirtiest, noisiest cities, is an island of calm. Here, government ministers live in vast, state-owned villas; judges, generals and senior bureaucrats walk their dogs across well-watered lawns as servants scrub their government cars; top politicians confer in compounds and the wives of unimaginably wealthy industrialists hold lunch parties catered by top chefs. You live here and visit India.

Last week, India visited this island in the shape of a giant power cut.

Such outages are a daily occurrence for the rest of the population – or at least the two-thirds of India’s 1.2bn inhabitants who actually have any electricity supply. But they are not for India’s elite. For the latter, power guarantees power. The bureaucrats in charge of Delhi’s grids switch off the supply to hospitals before they plunge the homes of top politicians into darkness. But this time the lights did go off. And so the residents of the most upmarket parts of the city – so confident of their power supplies that they do not have generators – had to sit in the fetid monsoon temperatures of 35 degrees [Celsius] like everyone else.

Impact on Development and Obstacles to Improvement

The unreliability of electricity supply has a significant impact on economic development, as it decreases productivity and increases cost substantially. In addition to supplying back up power, companies may have to arrange alternate water supplies or alternate employee transportation.

There are often equipment compromises that have to be made, and this has knock-on effects on operations. Businesses are often equipped to cope with intermittent power, but are worried about competitiveness and investment.

Work making potato chip display racks at Jayraj Kumar’s factory barely paused when much of India’s power grid collapsed. The backup generators kicked in automatically and the electric saws, presses and welding machines kept running, just like they do during the five-hour power cuts the factory in suburban Delhi suffers nearly every day.

India’s unreliable power system has forced businesses to create a workaround electricity system of noisy, dirty diesel generators that prepared them well when the world’s worst blackout hit the country Tuesday. But the trouble has also vastly increased businesses’s expenses, dragged down their productivity and hampered economic growth in the country. “Running a factory is very tough here,” Kumar said…

…Kumar, 56, started his business turning metal wire into display racks 23 years ago with just three employees. Now his company, The Rhino, runs a factory of 200 workers that churns out 1,500 red racks a day for clients from PepsiCo to Nestle that are ubiquitous in markets across India.

When the company opened its new factory in this Delhi suburb three years ago, “we knew that power would be a problem,” he said. “From the very first day, whenever we start an office or factory we immediately think of having a decent power backup,” he said.

Behind the cavernous whitewashed factory, lined with workers operating spot welding machines and kicking up sparks as they saw through metal, stands a large, green 80 megawatt generator on a brick foundation. In a corner on the ground floor is another generator rigged with a truck ignition that starts with a belch of gray smoke. Nearby, two more generators are hooked up, and, taking no chances, Kumar bought a fifth one Wednesday.

The factory runs 16 hours a day, at least five of them on generator power, he said. This backup system comes at a huge price for Kumar’s business. “Generators are meant for emergencies, they aren’t meant for production purposes,” he said.

Each generator costs 1 million rupees ($18,000) and has to be replaced every three years. The four full-time generator operators cost him another 1.2 million rupees ($21,600) in salaries. He pays 4 million rupees ($72,000) in diesel bills. In all, he estimates the generator power costs him 10 times as much per unit as the grid power and adds 20 percent to his overall costs.

And the fluctuating voltage from the generators wreaks havoc with his equipment. The welding and grinding machines work unpredictably on generator power, vastly slowing down production and reducing the quality of his racks. He is forced to pay an extra 6 million rupees ($108,000) to repair equipment the unstable voltage damages every year. “You cannot plan your production, your commitments are gone,” Kumar said.

He must use the most basic, labor intensive machines, because generator power would destroy computerized equipment. When he tempted fate by importing two 5 million rupee ($90,000) machines that printed large format ads to adorn the racks, they both stopped working within a week, he said. He can’t export his products because their quality is too low, but he can’t get the machines that would make them better either, he said. With reliable power, he would instantly increase his output by 30 to 40 percent, he said.

His work in China has left him jealous of the infrastructure there. Smaller countries such as Vietnam and the Philippines have surpassed India and he laughed about a one-minute power outage he once experienced in Singapore that turned into a major news story.

The massive blackout has brought India’s power supply problems to far greater attention:

While India created dubious history on Tuesday with the world’s largest blackout, its $100-billion software and services sector managed to keep its lights and links with clients on by drawing power from diesel gensets. But not before India’s image as a premier investment destination for technology was called into question by jittery clients worried about the ability of companies to provide uninterrupted services.

“The blackout has impacted the perception of India at a country level. India’s image has taken a beating,” said Som Mittal, president of IT trade body Nasscom.

A number of factors have rendered increasing supply problematic. Apart from the endemic corruption that complicates every transaction and adds cost at every turn, there has also been political infighting, with the power system used as a political football:

Lack of political will coupled with successive governments’ short sightedness has cost the country dearly in terms of implementing several projects. For example, in 2008, the energy infrastructure company Reliance had proposed to build an 8 gigawatt (GW) natural gas power plant. The political party in power at the time allowed the company to acquire the land in Dadri, Uttar Pradesh, for power plant construction after compensation was given to land owners and farmers. When the opposition party came into power in the next session, political rivalry triggered biases and this land was declared disputed. Reliance lost the case in Supreme Court and construction of the plant has now been shutdown. This plant could have been instrumental in reducing the daily power cuts utilities make in and around Uttar Pradesh.

In addition, higher costs are being imposed for access to land for the construction of new generation:

The interest rate on government land loans has increased from 9 percent in 2010 to 14.5 percent in 2011. This increase in land loan interest rates has made it less feasible for private firms to invest in power plants. Higher land costs increase the amount of initial capital needed, and the impact can be seen in the form of increased electricity costs and lower returns for utilities.

Troubled international relations also aggravate attempts to broaden fuel supply options and reduce fuel constraints:

India’s relations with certain neighboring countries have hindered the development of its power sector, as seen in the case of the Iran-Pakistan-India Pipeline. India has considered various proposals for international pipeline connections with other countries. One such scheme is the Iran-Pakistan-India (IPI) Pipeline, which has been under discussion since 1994. The plan calls for a roughly 1,700-mile, 5.4-Bcf/d (billion cubic feet per day) pipeline to run from the South Pars fields in Iran to the Indian state of Gujarat. While Iran is keen to export its abundant natural gas resources and India is in search of ways to meet its growing energy demand, a variety of economic and political issues have delayed the project agreement. Indian officials have made it clear that any import pipeline crossing Pakistan would need to be accompanied by a security guarantee from officials in Islamabad.

India’s rapid growth rate – 8% per year in recent years – leads to projections that $300 billion will need to be spent on new generating capacity and new transmission and distribution infrastructure over the next 25 years in order to meet demand. Of course, given the impact of the global financial bubble bursting, those growth projections are highly unrealistic. However, capital scarcity in a period of economic depression is likely to mean investment drying up and problems becoming far worse before there may be any chance of improvement.

Attempting to Regularise Power System Operations

One area where some tentative progress is being made towards getting supply and demand more closely aligned, at least in places, is in addressing power theft. Despite the seemingly overwhelming scope of the problem, programmes of sticks and (at least a few) carrots are showing some signs of beginning to regularise operations. The 2003 Electricity Act specifically criminalized power theft for the first time, and established enforcement mechanisms including special courts and specialist police stations dedicated to tackling the issue. Monitoring systems are beginning to be built in order to provide for auditing and accounting of supply and demand, so that the scale of the problem can be quantified.

State authorities are increasingly attempting to target the impact of load shedding on the perpetrators of power theft, rather than using the blunt instrument of citywide rolling blackouts:

The state government will rationalize load-shedding by cutting power supply to those who do not pay their bills on time. At present, an entire city has to put up with power cuts because of a few defaulters. In the new system, consumers who pay their bills regularly will get power while those who default on payments will face cuts.

In the new system, consumers will be segregated feeder-wise. Normally, each feeder supplies power to 100 to 600 consumers. Those drawing power from a feeder with a distribution and commercial loss of 33% and above will face power cuts in cities. In case of rural areas, distribution and commercial losses of 37% and above will attract power cuts. This means that only a certain set of consumers within a city or a town will face power cuts while those in neighbouring areas will be spared.

Currently load-shedding is carried out on the basis of the group (A, B,C,D,E and F) a city or a town has been placed in depending on its distribution and commercial losses. The new system, by factoring in losses at the feeder-level, will see power cuts being affected at the micro level.

Villages where power theft is rampant are also being threatened with outages, despite the power of the rural lobby.

The Maharashtra State Electricity Board (MSEB) has decided to implement around 11 hours of load shedding in the villages of Sathpati, Umrole and Manor, which has reported a loss of over 50 per cent of power generated…

…Sathpati village is likely to be affected the most due to the load shedding as it is from here that fishermen export their catch. The fishing jetty has around 550 boats which depend on ice for storage of fish. Fishermen fear that lack of electricity will affect the manufacture of ice and storage of fish. The daily requirement of ice for the fishermen of the village is around 350 tonnes. With the fishing activity discontinued during monsoon, a large quantity of fish caught during the past week has been kept in cold storage for export. Fishermen are worried as load shedding may lead to rotting of the fish.

MSEB officials say that there are over 5,000 consumers in the three villages but most of them enjoy zero billing. Stolen power is used by the villagers to organize night cricket matches and other sports. Festivals and marriages also largely function on stolen electricity. The electricity board has already fined seven customers for power theft and recovered Rs 57,000 from them. The load shedding, say officials, will continue till the power theft is minimised.

The idea of privatisation is gaining traction, on the grounds that this may improve management and lead to greater cash flow, which could fund improvements to the system. The two largest private power companies (Tata Power and Reliance Energy) have been given control of electricity supply in the Delhi area, and claim to have limited losses through a combination of pursuing legal action, ‘educating people about the merits of paying for power’, and offering small financial incentives.

Through dozens of power raids every week, among other strategies, they have managed to dramatically reduce theft in Delhi. BSES, the Reliance subsidiary that handles two-thirds of Delhi’s power, has sent more than 650 people to prison and booked more than 114,000 cases in special courts that handle only electricity cases. By the end of last year, BSES…..had cut theft from around 52 percent in 2002 to 28 percent. They want to bring that down to 10 percent.

Tata Power is offering slum-dwellers enough electricity for lights and a fan for a fixed price of 179 rupees ($4; £2.30) a month. This does not sound like much, but considering that it amounts to probably almost half the monthly rent for a person living in such an area, the cost is still very high relative to ability to pay.

International aid programmes are bringing some funding to bear on slum connections, but the scope of such projects could hardly be described as ambitious in comparison with the scale of the problem:

Reliance Infrastructure, the Global Partnership on Output-Based Aid (GPOBA), and other partners have launched a project to provide improved access to safe electricity supply to around 104,000 Indian slum dwellers. The GPOBA Improved Electricity Access to Indian Slum Dwellers project aims to provide up to 26,250 new and upgraded electricity connections for residents of the Shivajinagar slum in Mumbai. About 8,000-12,000 new connections and 5,000 upgraded connections are planned in a first phase expected to be completed by 2011.

Currently, many slum households in Mumbai do not have access to safe and reliable electricity. The challenge is that there is no support beyond the regulated point of supply (the metering point). Arrangements are informal and the lack of an institutional framework to support the financing of connections for the poorest leads to bottlenecks in connection investment. The relatively high upfront costs of the connection, which are estimated to be in the region of US$105 per connection, also act as a significant constraint.

Under the GPOBA scheme, households will pay less than half the connection cost, with GPOBA providing a one-off subsidy to make up the difference. Payment of 90 percent of this subsidy will be conditional upon independent verification of working connections and of six months’ supply and billing. The connection work (wiring from the meter to the house and internal wiring) will be carried out by licensed electricity contractors chosen directly by the customers. The scheme offers a framework not just for performance-based subsidies, but also for community awareness building, training of electricity contractors, and a check on quality of service to the hutment.

“The Mumbai slum electrification scheme presents an opportunity to understand how output-based aid can be used to supply basic services in areas beyond the regulated utilities’ responsibility,” explains Mustafa Zakir Hussain, GPOBA and World Bank task manager for the project. The GPOBA project, financed through a US$1.65 million grant, forms a financing window in a larger Slum Electrification and Loss Reduction program, led by the US Agency for International Development (USAID) in cooperation with the International Copper Promotion Council (India) or ICPCI.

The project targets approximately 100,000 slum dwellers of the six million in Mumbai alone – over 50% of the population. At this rate, progress will not be rapid, and it will remain difficult to combat unofficial connections when legal ones are still expensive and can take months to arrange.

While government officials are trying to convince the illegal electricity suppliers to get metres provided by the municipal corporation, the slow process of getting electricity after filling up the application form puts off many.

“I had applied for electricity months back. I own a shop. They are asking us to pay Rs 3,600 to get a connection for commercial usage,” said Bharat Thakore, a paan shop owner in Chandlodia slum.

“We are planning to appoint an individual from the slum itself who can take our applications in bulk and give them to the municipal corporation. This will fasten [hasten] the long awaited process of getting electricity. When we are ready for legal connections, we are being asked for more money,” said Thakore.

Residents are typically not optimistic about the prospects for improvement:

Citizens of Gurgaon, often dubbed the millennium city, told NDTV that the power shortage and lack of water have been a major hit to the city.

What’s more, the residents said that this isn’t at all unusual for them. One male resident said on average they have 10 – 11 hour power cuts when they have to rely on generators and tankers to supply them with water. One resident said its was “hell to live” there, while another said “If you want a millennium city go to Hong Kong.”

India’s Power Future

India’s power system problems are part of a much larger crisis of decrepit infrastructure, unable to be repaired thanks to lack of funds and lack of political will to tackle endemic corruption. Moving forward will be difficult, and, even without a looming global financial emergency, it would take decades to construct a power system recognizable in the developed world. By the time it could hypothetically have been accomplished, fuel shortages would have become far more acute than they are today, as the world would be well past the peak of the hydrocarbon age.

It seems that a modern grid serving the whole population reliably and seamlessly will remain a pipe-dream. The future of power in India is far more likely to involve something much less ambitious, but also arguably far more appropriate for an energy and capital constrained era rife with uncertainty and unrest. Given its complexity, the ‘ideal’ central station power grid will be difficult to maintain anywhere under such circumstances, very much including the developed world. Rather than aspiring to reach an unattainable goal, it may well be better to design a simpler and more decentralised system based on micro-grids, and designed to deliver basic needs, rather than wants. Decentralised systems may be less efficient, in that one sacrifices economies of scale, but they are also more resilient, and that will be critical.

Private power alternatives are likely to flourish to an even greater extent than they already do, at least where liquidity remains available, as power system problems become even more acute in the future. The industry is being unbundled, with generation, transmission and distribution being separated, as they have been in many places that have pursued liberalization of the industry. Generation in particular has seen increasing private investment, to the point where it accounts for about a quarter of capacity.

India has set its sights on renewables, with an ambitious target of 15% of energy requirements from renewable sources by 2020:

India’s Solar Mission aims to generate 20,000 MW of solar power and deploy 20 million solar lighting systems for rural areas by 2022. This tremendous scale-up is expected to drive down costs rapidly so as to achieve grid parity in that time frame. A key enabling policy for this is a Renewable Purchase Obligation (RPO) requiring state energy providers to buy a certain percentage of their energy from renewable sources, including a carve-out for solar specifically. There are also significant opportunities for improved energy efficiency.

One interesting application of solar photovoltaics is to use solar panels to cover irrigation channels for agriculture. This not only generates a significant quantity of electricity, but also reduces evaporation from the open channel, thereby easing water shortages. The potential benefits are considerable, although this remains a large-scale, top-down, expensive and technologically complex approach, which is unlikely to be the best means for India to proceed over the longer term. (See for instance this TED talk on the ancient art of water harvesting in India for an example of more appropriate traditional technology that is far more sustainable.)

This solar panel laid on the vast stretches of agricultural channels in Gujarat generates 1 MW of electricity per KM & prevents evaporation of 1 crore [10,000,000] litres of water every year

Many argue for a system of feed-in tariffs – premium payments for renewable power fed into the grid – which have been successful in delivering so much renewable generation in various European countries, notably Germany:

Ironically, one region that did well during the power crisis in India was Jodhpur, where, after a brief interruption, the windmills kept hospitals and households powered up while the rest of the country went black. Were the World Bank to have pushed a model, such as that successfully employed in Germany and other countries, where a “feed-in tariff”—a guaranteed rate of payment for energy fed into the national grid– for renewable energy had been put in place, small farmers and others in rural areas would be able to both provide power to the grid and earn money in doing so.

But instead, they foisted on the largest democracy a neoliberal model—where unions were busted, power was privatised, people were treated like pawns on a giant chess board, while they targeted the affluent and heavy industries first for energy delivery using some of the most environmentally destructive energy resources on the planet. The assumption: energy services would eventually trickle down to the poor. Nearly two decades later, after billions in investment, one-tenth of the world sits in the dark, the planet is rapidly heating up, and the only thing trickling down to the poor is contaminated water or, if they’re lucky, enough water to keep their parched crops alive.

While wind power can be very useful, it is not a panacea. While it may have helped in the recent blackout, and clearly helps at other times, dependency on intermittent power can also contribute to the problem of unscheduled load shedding when the energy source is not available:

K. Kathirmathiyon, secretary of Coimbatore Consumer Cause, says the problem of unscheduled power cut has arisen because the State is heavily dependent on wind power during the windy season. TANGEDCO officials say that on most of the days the load shedding in an area is according to a schedule, though it is not yet announced. There is no load shedding or it is for a shorter duration when the wind energy generation goes up.

Unfortunately, India is not Germany. The existing power hierarchy and the pervasive corruption would make implementing such a system very difficult. But more significantly, feed-in tariffs around the world are very likely to be cut back or abandoned in a global financial crisis, even in the locations where they have been very successful. In fact this is already occurring, as we discussed here at TAE in The Receding Horizons of Renewable Energy. This will leave people who have borrowed money in order to build large projects without the income stream needed to service the debt incurred to do it. Trusting government promises to pay for 20 years are risky at the best of times and in the least corrupt of places.

The other objection to this approach to utilising renewable power is that the requirement to feed into expensive and complex infrastructure greatly reduces the energy returned on energy invested (EROEI) of what is already a low EROEI energy source. As with all such sources, the energy profit ratio is too low to sustain a society complex enough to produce them in the longer term. Renewable power is a misnomer, since the materials required to harvest it are not themselves renewable, and the ability to build and maintain the infrastructure depends heavily on the continued availability of high EROEI energy sources. However, it can be used to make a huge difference to people’s lives, and it will make a larger difference for a longer time at much lower cost if it is implemented in such as way as to maximise the EROEI by minimising the requirement for extraneous infrastructure.

Embracing a simpler future before being forced to do so by circumstance could allow a country like India to avoid a great deal of expense, keep to a human scale where much of the impact of corruption could perhaps be avoided and provide basic services for far more people. Unfortunately, this approach is highly unlikely. It feeds neither the demands of the wealthy for developed-world level electricity services, nor the appetite of the corruption machine for large-scale projects where funds can be spun off in the direction of the well connected. India is therefore likely to see greater attempts to improve service for those who can pay, and to remove service to those who cannot.

Some experts are more hopeful than in the past because a number of Indian officials have made politically difficult decisions in recent months to raise electricity prices. State governments in Tamil Nadu, West Bengal, Rajasthan and Punjab have moved to stem losses at public utilities that had been selling power for far less than it costs them to buy it. Besides providing more money to invest in additional supply, the higher prices for consumers and businesses should also help lower demand for power.

“I think everybody has realized that there are no free lunches,” said Chandan Roy, a former director at India’s largest state-owned power producer, the National Thermal Power Corporation.

India Versus Developed Country Power Systems

Power systems in developed countries do not face the obstacles of fuel shortages, supply /demand imbalance and corruption faced in India. Despite aging infrastructure, and underinvestment that will store up problems in the future, the systems presently have sufficient integrity to allow for good control over power quality parameters. Equipment is not damaged by power surges or brownouts. Electricity supply is reliable and stable. This has been the case for so long, that it is taken utterly for granted. An indicator of just how reliable power supply has become was provided when a 1994 earthquake temporarily knocked out power in Los Angeles:

Now we have so much artificial light that after a 1994 earthquake knocked out power, some concerned residents of Los Angeles called the police to report a “giant, silvery cloud” in the sky above them. It was the Milky Way. They had never seen it before.

Very few provide for back ups, as these would almost always be seen as an unnecessary expense. Private safety margins are few, hence resilience of the larger system is much reduced. Rare interruptions to supply therefore cause difficulties, and can rapidly lead to public anger. Access to however much electricity one could want, whenever one might happen to want it, and at an affordable price is seen as an entitlement, or even as a basic human right. The structural dependency on electricity supply has increased to the point where it has become a life support system in many ways. Without it, the technology traps will close very quickly. Witness the effects of a 2011 incident in California:

“Electricity was primarily a luxury when the majority of our grid was built 50, 60 years ago. Most people didn’t require computers to do their jobs every day. They didn’t need the Internet access. IPhones didn’t need to be charged, and communication was all hard-wired, so you could still make a phone call when the electricity was out.”…

…Schools closed, planes were grounded for hours, traffic lights went dark and gridlock followed. People were trapped on rides and in elevators at SeaWorld and Legoland. Pumps failed at water-treatment plants, flooding San Diego Bay with more than 2.5 million gallons of raw sewage and forcing beaches along the coast to close.

What an investigating commission later called a “cascading and uncontrolled” shutdown became the most extensive power outage in California history.

This is a dangerous situation. The dependency is so much greater in western societies, that cascading system failure is a significant possibility if the grid were to experience a major disruption. Underinvestment is chronic, and this is storing up many challenges for a future when the money needed may not be available. As in India, no one wants to pay for the means to preserve the grid current capacities:

No one is taking care of the grid — the network of transmission lines, inter-connectors and transformers that is essential to life as we know it; two, supply cannot keep up with demand; and three, rate-setting is a political rather than an economic process. It should not come as a shock, so to speak, that neglect, failure to prepare and playing politics with essentials should lead to disaster…

…No less than the American Society of Civil Engineers said in a report released in April that the grid could break down by 2020 unless investment in it is increased immediately by about one billion dollars a year. Why so much? Because, according to the report, more than two-thirds of the system’s transmission lines and power transformers are at least 25 years old, and 60 percent of the circuit breakers have been in use for more than 30 years.

Investment of the massive size required would require increased rates for electricity, and that simply is not going to happen in a political climate where people are not expected to have to pay for anything; not their government (no new taxes) not their wars (Iraq was “off the books”) and certainly not their electricity. Despite being deregulated like many other aspects of economic life pursuant to the Reagan Revolution, electric utilities who raise their rates soon find that deregulation does not extend that far. In Maryland, when it was revealed that moving to market rates would cause Baltimore Gas and Electric to increase rates by 72 per cent, that was the end of deregulation.

In this, as in so many other areas of public life, we are like the ass starving to death because he is equidistant from two bales of hay and can’t decide which way to go. We either have to spend tons of money propping up the old system, or expend tons of effort and thought coming up with a new one. By refusing to do either, we drift faster and faster toward the precipice over which India has just tipped.

The estimated cost of grid renewal is huge:

The American Society of Civil Engineers (ASCE) calculated that an additional investment of $107,5 billion was needed by 2020 to keep the electrical infrastructure whole…

…The utilities walk a fine line between satisfying their customers and keeping their investors happy, with costly expenditures in infrastructure bound to hurt profitability unless public utility commissions allow rates to keep pace with investment…

…”By 2020, the cost of service interruptions will be $71,5 billion, or, if you break that down to households, $565 over that period,” Andrew W. Herrmann, president of ASCE, said.

As we move further into financial crisis with the bursting of the global credit bubble, it will become more and more difficult to fund infrastructure investment, and we are living on borrowed time as it is. We have already been coasting on past infrastructure investments for a long time. As India demonstrates, even truly decrepit infrastructure can function much of the time, so we are not yet at all close to risking any kind of permanent blackout scenario. However, India also demonstrates that compromised infrastructure does not deliver reliable power, and western economies have a much stronger dependency on constant power availability.

The central station model of electricity supply, with large power plants distant from demand feeding into a transmission grid, is under threat worldwide. In a capital and energy constrained environment, it will not be able to deliver what we have become accustomed to. The greater the extent of dependency, the greater we can expect the impact to be. We in the developed world, as in India, should consider looking to simpler, cheaper, more decentralised models. And we should be getting our expectations in line with what reality can hope to deliver. We are going to have to live within our means, and that will involve a much larger adjustment than most of us can currently imagine.

Bubbles and the Titanic Betrayal of Public Trust


Robert Shiller, co-creator of the Case-Shiller index for US housing and author of Irrational Exuberance, has an interesting perspective on markets. Unlike the vast majority of economists, he recognises both the role of speculative fervour in driving prices to over-reach themselves as a bubble develops and the fact that bubbles and their aftermath are swings of positive feedback inherently grounded in ponzi dynamics. As such, his position has considerable overlap with ours at The Automatic Earth:

Markets and the Lemming Factor (2008)

Some trends are persistent enough that they eventually attract a very wide pool of participants, as apparent gains amongst one’s peers eventually overcome the caution even of many inherently skeptical people. When they last long enough to overcome the caution of bankers, the result is easy credit to fuel the fire, and a blatant disregard for systemic risk. This is how the largest speculative bandwagons are formed – the ones that become manias and eventually lead to ruin for a large percentage of the population.

Prices are continually pushed up, irrespective of any reasonable objective measure of value, by those who think that it does not matter how much they pay for something if there will always be a Greater Fool who will pay even more. The evidence of pyramid dynamics where insiders and early movers benefit at the expense of later generations destined to become empty-bag holders – should be abundantly clear. The pool of Greater Fools is not limitless.

Continue reading “Bubbles and the Titanic Betrayal of Public Trust”

Jeff Rubin and Oil Prices Revisited

Jeff Rubin, former chief economist with Canadian bank CIBC, is very well known for his predictions of exponentially increasing oil prices (see for instance this 2009 lecture). Mr Rubin’s position was that prices would continue their rise due to a confluence of circumstances – that conventional supplies have peaked, that unconventional sources are expensive to produce and that demand would continue to grow with the energy requirement inherent in expanding global trade.

According to Mr Rubin, the assumption that transport costs would remain marginal led to the 2008 oil price spike, causing a global recession. In his opinion, high oil prices, not the sub-prime mortgage crisis, were the primary driver of financial crisis. This opinion is shared by many commentators. The simplistic approach of prediction by trend extrapolation is similarly common. In contrast, anticipation of trend changes is rare. Continue reading “Jeff Rubin and Oil Prices Revisited”

Peak Oil: A Dialogue with George Monbiot

George Monbiot recently made a major about-face on his peak oil stance, on the grounds that unconventional oil represents a new reality. The basis of his u-turn is a recent report on unconventional oil by Leonardo Maugeri, (former) oil executive at Italy’s Eni, published at Harvard University, where Maugeri’s a Senior Fellow at the John Kennedy School, Belfer Center, which we discussed here at TAE in Unconventional Oil is NOT a Game Changer. Continue reading “Peak Oil: A Dialogue with George Monbiot”

Unconventional Oil is NOT a Game Changer


National Photo Co. Fossil Fuel 1920
Washington, D.C. “Penn Oil and truck.”
Oil prices have been falling.


This is no surprise to us here at The Automatic Earth, as our position is that the 2008 price peak will stand for a very long time, and that the rise from the 2009 low has been a counter-trend rally. Prices of many assets have been moving with the ebb and flow of confidence, and therefore of liquidity, in this era of extreme financialisation, and commodities are no exception.

As we have pointed out many times, prices do not reflect the fundamentals of supply and demand in any particular industry. If they did so, equities and different commodities would not move in relative sychrony, yet they have often done so.


Instead, prices reflect a combination of general confidence (or lack thereof) and the perception of future scarcity or glut, whether or not that perception is, in fact, accurate. Commodities top on fear of shortages. When there is a perception of scarcity, speculators bid up the price in advance of what the fundamentals would justify at that time, as they did in the run up to the 2008 price peak.

When the speculative bubble bursts, the sector is dumped and the price collapses as speculation goes into reverse. In 2008, commodities in general fell 58%, and oil prices plunged 78% in five months as the financial crisis sucked liquidity out of the system and the perception of imminent scarcity disappeared.


With the temporary resurgence of confidence from the 2009 bottom, liquidity returned, and, increasingly, so did the perception of scarcity for commodities in general and for oil specifically. Prices were bid up again, although not to the previous high, even though analysts extrapolating the trend forward were calling for a much larger commodity price spike than 2008.


Commodity prices in general peaked in May 2011 and continue their retreat.


Confidence is ebbing as the scope of the financial crisis centred in Europe becomes increasingly evident, and vulnerabilities in other regions and sectors of the economy emerge. Even the Chinese juggernaut (the primary driver of commodity demand) is visibly faltering.

Retreating liquidity and persistent economic weakness act to undermine commodity prices further. This process is far closer to its beginning than its end. As the global credit bubble of the last thirty years implodes, we will be heading right in to the teeth of liquidity crunch, economic seizure and another deflationary Great Depression. Under such circumstances, we can expect demand to be weak for many years, and with falling demand will come falling price support.

At the same time, in the case of oil, we are seeing a sharp reversal of perception – from one of scarcity to one of glut – as pundits discuss how technological innovations, including horizontal drilling and hydraulic fracturing, will increase global supply dramatically. De-conventionalisation of oil supply is touted as the solution to peak oil for the foreseeable future.

Euphoria particularly surrounds the projections for US production, with talk of the country becoming both energy independent and an exporting powerhouse – a New Middle East.

Leonardo Maugeri:

Oil: The Next Revolution – the Unprecedented Upsurge of Oil Production Capacity and What it Means for the World

Thanks to the technological revolution brought about by the combined use of horizontal drilling and hydraulic fracturing, the U.S. is now exploiting its huge and virtually untouched shale and tight oil fields, whose production although still in its infancy is already skyrocketing in North Dakota and Texas.

The U.S. shale/tight oil could be a paradigm-shifter for the oil world, because it could alter its features by allowing not only for the development of the worlds still virgin shale/tight oil formations, but also for recovering more oil from conventional, established oilfields whose average recovery rate is currently no higher than 35 percent.

The natural endowment of the initial American shale play, Bakken/Three Forks (a tight oil formation) in North Dakota and Montana, could become a big Persian Gulf producing country within the United States. But the country has more than twenty big shale oil formations, especially the Eagle Ford Shale, where the recent boom is revealing a hydrocarbon endowment comparable to that of the Bakken Shale. Most of U.S. shale and tight oil are profitable at a price of oil (WTI) ranging from $50 to $65 per barrel, thus making them sufficiently resilient to a significant downturn of oil prices.


World oil production capacity to 2020 (Crude oil and NGLs, excluding biofuels)

From: Maugeri, Leonardo. “Oil: The Next Revolution” Discussion Paper 2012-10, Belfer Center for Science and International Affairs, Harvard Kennedy School, June 2012.

The difficulty is that an analogous scenario has unfolded before, in the natural gas industry. Out of sync with other commodities, the boom and bust in natural gas is giving us a glimpse of the future for unconventional oil. The extraction techniques are the same ones that have generated tremendous hype, while simultaneously setting up a ponzi scheme in flipping land leases, creating the perception of supply glut, crashing the price of natural gas in North America to far below break-even, amplifying financial risk for increasingly indebted producers, and threatening to put those same producers out of business.

This is the dynamic that is set to lead North America into a natural gas supply crunch over the next few years, as we discussed recently in Shale Gas Reality Begins to Dawn.Those involved in unconventional oil would do well to take note.

The drilling costs are high, as are the decline rates (“While some have been able to yield as much as 1,000 barrels a day, the rate then falls off to 65 percent the first year, 35 percent the second, and 15 percent the third”), and the EROEI is very low in comparison with conventional oil. As with unconventional gas, which suffers from the same obstacles, the industry is set on an accelerating drilling treadmill in an attempt to grow equity by expanding the reserve base with the cash flow generated.

Continued expansion is necessary to maintain the perception of company value. In other words, the industry is based on ponzi dynamics. So long as prices hold up, we can expect it to continue, but if we look at the broader economic context in conjunction with the lessons derived from unconventional gas, there is every reason to expect that the production boom is temporary, precisely because these circumstances will generate a price collapse.

Estimates of the price required for the new supplies to be economic vary. The consensus appears to be that there is a sufficient price cushion to withstand a fall, but producers are not anticipating a major one. Unfortunately for them, we can expect the perception of glut, combined with deepening economic depression, to force prices down to the cost of the lowest price producer, and quite possibly lower, at least temporarily. Companies on the unforgiving drilling treadmill will be facing increasing financial risk, and over the next few years, as over-extended and over-indebted companies go out of business, we can expect a supply crunch to develop.

The timescale is difficult to predict, as there are many factors with different timeframes to consider. Large scale deleveraging, which is set to unfold over the next few years, will have a tremendous impact on project capital availability, on demand, and on the affordability of operating and maintaining existing infrastructure. It will also be very difficult to build out new oil transport infrastructure to cope with changing energy supply patterns. The infrastructure mismatch will put continued downward price pressure on North American oil in comparison with international supplies, reducing the fungibility of oil.

Marin Katusa:

Oil Price Differentials: Caught Between Sands And Pipelines

North America has a long history of oil production and processing. Decades of producing oil and consuming lots of petroleum products have left the continent with a pretty good system of pipelines and refineries but pipelines are annoyingly stagnant things that tend to stay where you build them. And it turns out that the pipelines of yesterday are in the wrong places to serve the oil fields and refineries of today.

America’s oil infrastructure was built around two inputs some domestic production and large volumes of imports. You see, while the Middle East may be the biggest producer of crude oil in the world, most of the refining occurs in the United States, Europe, and Asia. There are two reasons for this. The first is that it’s easier to ship massive volumes of one product (crude oil) than smaller volumes of multiple products (gasoline, diesel, jet fuel, and so on). The second reason is that refineries are generally built within the regions they serve, so that each facility can be tailored to produce the right kinds and amounts of petroleum products for its customers…

…Remember how the US’s oil pipelines were designed primarily to move refined products from the Gulf region and the coastal refineries to inland customers? Well, those pipelines of yesterday now run the wrong way.

The production boom in shale oil has momentum, and that is likely to carry on for some time, even in the face of sharply falling prices, as has been the case for natural gas. The rig count in shale oil production is skyrocketing, even as the rig count for natural gas falls, and production lags rig count.

The quantity of recoverable oil has been considerably hyped, and this resource is not going to represent a game-changer. In fact it would not even if we were not facing economic circumstances set to crash production.

Robert Rapier:

Does the U.S. Really Have More Oil than Saudi Arabia?

The estimated amount of oil in place (the resource) varies widely, with some suggesting that there could be 400 billion barrels of oil in the Bakken. Because of advances in fracking technology, some of the resource has now been classified as reserves (the amount that can be technically and economically produced). However, the reserve is a very low fraction of the resource at 2 to 4 billion barrels (although some industry estimates put the recoverable amount as high as 20 billion barrels or so). For reference, the U.S. consumes a billion barrels of oil in about 52 days, and the world consumes a billion barrels in about 11 days.

In addition, the enormous number of expensive wells required would takes decades to drill with the rigs available, even if considerable efforts were made to increase their number, meaning that the oil that is there would be produced very slowly.

Beyond the shale oil of the Bakken in North Dakota or the Eagle Ford in Texas, there are other forms of unconventional oil that form part of the North American production boom hype.

Robert Rapier again:

When some people speak of hundreds of billions or trillions of barrels of U.S. oil, they are most likely talking about the oil shale in the Green River Formation in Colorado, Utah, and Wyoming. Since the shale in North Dakota and Texas is producing oil, some have assumed that the Green River Formation and its roughly 2 trillion barrels of oil resources will be developed next because they think it is a similar type of resource. But it is not.

The prospects for some of these are significantly worse than for shale oil, especially where the EROEI is even lower. Colorados oil shale in particular is unlikely ever to amount to much. While shale oil is a liquid hydrocarbon trapped in low permeability source rock, which can be liberated through fracking, oil shale is not a liquid at all, but solid kerogen that requires tremendous energy inputs to be separated from the source rock. Those required energy inputs mean a rock-bottom EROEI. Costs in monetary terms are sky-high as well.

Elliott Gue:

The Difference Between Oil Shale and Shale Oil

To generate liquid oil synthetically from oil shale, the kerogen-rich rock is heated to as high as 950 degrees Fahrenheit (500 degrees Celsius) in the absence of oxygen, a process known as retorting.

There are several competing technologies for producing oil shale. Exxon Mobil has developed a process for creating underground fractures in oil shale, filling these cracks with a material that conducts electricity, and then passing currents through the shale to gradually convert the kerogen into producible oil. Royal Dutch Shell Plc buries electric heaters underground to heat the oil shale.

Although estimates of the cost to produce oil shale vary widely, the process is more expensive and energy-intensive than extracting crude from Canada’s oil sands. Producers would require oil prices of roughly $100 a barrel before this capital-intensive process would be feasible on a commercial scale.

Shale oil may have an EROEI of approximately 4, while tar sands would come in at 3 and oil shale would be 2 or less.


Cutler J. Cleveland and Peter O’Connor – A comparison of estimates of the energy return on investment (EROI) at the wellhead for conventional crude oil, or for crude product prior to refining for oil shale

Humans are prone to grasp at straws and believe in fantasies rather than face unpleasant realities. Believing that unconventional fossil fuels can maintain business as usual is a fantasy. We cannot run our current complex society on low EROEI energy sources.

We are still facing peak oil, and, on the downslope of Hubberts Curve, we will be running faster and faster on our accelerating treadmill just to slow the decline in supply. Unconventional supplies with lower and lower EROEI are not going to change that picture, and the crash of prices that will happen thanks to economic depression will aggravate the situation considerably in the short term. We can expect prices to fall faster than the cost of production, and many corporate casualties to emerge as boom turns to bust, as it always does.

The next few years will be remembered for financial crisis, where it will be money in short supply rather than energy. As economic contraction proceeds, and purchasing power falls substantially due to the collapse of the money supply, demand for energy will – temporarily – fall a long way. Beyond that, as the deleverging comes to an end and the economy begins to stabilize somewhat (probably between five and ten years down the line), we are likely to see a supply crunch develop.

With that we are likely to see a major price spike, and the potential for resource wars will grow dramatically. Oil is liquid hegemonic power, and conflict can be expected to develop when it is perceived to be scarce. Thats not where we find ourselves today, but it is where the future is taking us.

Shale Gas Reality Begins to Dawn

It has long been our position at The Automatic Earth that North America is collectively dreaming with regard to unconventional natural gas. While gas is undeniably there, the Energy Returned On Energy Invested (EROEI) is dramatically lower than for conventional supplies. The critical nature of EROEI has been widely ignored, but will ultimately determine what is and is not an energy source, and shale gas is going to fail the test.

As we pointed out in Get Ready for the North American Gas Shock in July 2011, the natural gas situation is not what it seems at all:

The shale gas bubble is a perfect example of the irrationality of markets, the power of perverse short-term incentives, the driving force of momentum-chasing, the dominance of perception over reality in determining prices, and the determination for a herd to stampede over a cliff all at once.

The perception of a gas glut has driven prices so low that none of the participants are making money (at least not by producing gas) or creating value. We see a familiar story of excessive debt, and the hollowing out of productive companies dead set on pursuing a mirage.

Many industry insiders know perfectly well that the prospects for recovering substantial amounts of gas are poor, and that the industry is structured as a ponzi scheme. Still, there has been money to be made in the short term by flipping land leases and building infrastructure to handle gas.

The hype is so extreme that those who fall for it contemplate, in all seriousness, North America becoming a natural gas exporting powerhouse, and a threat to Australian LNG producers, or to Russia’s Gazprom.

This concept, constructed from a mixture of greed and desperation (at the lack of conventional gas prospects), is entirely divorced from reality. (See here for Dimitri Orlov’s excellent piece on why Gazprom has nothing to worry about.)

Nevertheless, euphoric hype is extremely catching. Given that prices are driven by perception, not by reality, hype has the power to change the dynamics of an industry, exaggerating boom and bust cycles in practice. The hype has resulted in the perception of glut – that North America is drowning in natural gas. The inconvenient fact that this perception is completely wrong does not alter its power in relation to prices.

Natural gas companies gambling on shale gas have been facing prices so low – far below the cost of production – that all of them have been producing gas unprofitably. The financial risk has been increasing dramatically as the companies have been drowning in debt trying to ride out the rock bottom prices that have been the result of people believing the fantasy. Finally, casualties of the financial shenanigans involved are emerging. It is very likely that there will be many more, as companies that have tried to ride out the low prices go under.

Wolf Richter:

Natural Gas: Where Endless Money Went To Die

Alas, thanks to the Feds zero-interest-rate policy and the trillions it has handed over to its cronies since late 2008, the sweeps of creative destruction have broken down. Instead, boundless sums of money have been searching for a place to go, and they’re chasing yield when there is none, and so they’re taking risks, any kind of risks, in their vain battle to come out ahead.

The result is a stunning misallocation of capital to the tune of tens of billions of dollars to an economic activity drilling for dry natural gas that has been highly unprofitable for years. It’s where money has gone to die. What’s left is debt, and wells that will never produce enough to make their investors whole.

But the money has dried up. And drilling for natural gas is collapsing. Last week, there were only 562 rigs drilling for dry natural gas, the lowest number since September 1999…

…At $2.53 per million Btu at the Henry Hub, the price of natural gas is up 33% from the April low of $1.90 per million Btu, a number not seen in a decade.

.But even if it doubled, it would still be below the cost of production. And if it tripled, it might still be below the cost of production for most producers. That’s how mis-priced the commodity has become.

More from Wolf Richter:

Dirt Cheap Natural Gas Is Tearing Up The Very Industry That’s Producing It

The economics of fracking are horrid. All wells have decline rates where production drops over time. But instead of decades for traditional wells, decline rates in horizontal fracking are measured in weeks and months: production falls off a cliff from day one and continues for a year or so until it levels out at about 10% of initial production. To be in the black over its life under these circumstances, a well in the Barnett Shale would have to sell its production for about $8 per million Btu, pricing models have shown.

…Drilling is destroying capital at an astonishing rate, and drillers are left with a mountain of debt just when decline rates are starting to wreak their havoc. To keep the decline rates from mucking up income statements, companies had to drill more and more, with new wells making up for the declining production of old wells. Alas, the scheme hit a wall, namely reality…

…The natural gas business is brutal. The peak in drilling occurred in September 2008 with 1,606 rigs. Then the financial crisis threw it into a vertigo-inducing plunge. After last years mini-peak, the plunge continued…

…Production lags behind rig count, and while rig count for gas wells has been setting new decade lows, production has been rising month after month to new record highs. But lagging doesn’t mean decoupled. And someday…. Oops, it already happened. It has started. Production has turned the corner, and not just in one field, but across the US.

Its still just a little notch in the curve. But its a sign that the collapse in rig count is translating into lower production numbers. And when the steep decline rates are beginning to overlap the drop in rig count, production will head south in a dizzying trajectory.

Money has been thrown at the industry, but the notion is dawning that the game is up and that returns will never materialise. The ponzi scheme has reached its natural limit, and investors are waking up to the realisation that they have been chasing a fantasy.

Ironically, just as the washout begins, natural gas prices may have bottomed. Conventional natural gas in North America peaked in 2001. Coal bed methane and now shale gas have been revealed to be massively overblown as an energy source. Producers are reaping the consequences of mal-investment and will be going out of business. Demand has been building with the transition from coal to natural gas for power generation. This is an ideal set up for a supply collapse and subsequent price spike.

North America is poised for a huge natural gas shock. Far from being an exporter, North America is going to experience a natural gas supply crunch. Prices will be rising at the same time as peoples purchasing power falls precipitously, thanks to deflation. The structural dependency on natural gas that has been cemented in recent years is going to guarantee maximum pain as prices reconnect with reality.

Capital Flight, Capital Controls, Capital Fear

The ending of extend-and-pretend is ushering in a new era of fear and uncertainty which is rapidly evolving into the next phase of the on-going credit crunch.

It is becoming clearer to many that the problems run much deeper than they had perceived, and more people all the time are realising the systemic nature of the risks we are facing. Fear leads to knee-jerk reactions. In financial markets, it leads to volatility and self-fulfilling prophecies to the downside. It leads to capital flight, and then to capital controls. Continue reading “Capital Flight, Capital Controls, Capital Fear”

Then and Now: Sunshine and Eclipse

The video Sunshine and Eclipse is a must see for anyone interested in economic history, and in the psychology of economics in the real world (as opposed to the ivory tower of modern neo-classical economics). The documentary is describing Canada in the period between 1927 and 1934, in other words, in the euphoric phase of the Roaring Twenties bubble and the credit implosion of the 1930s.

It is of far broader interest than Canada, however. It is fascinating to look at the insatiable optimism of the Twenties, the commodity boom, the expansion of trade and the sense that human beings had overcome adversity and created ever-lasting prosperity. In fact, the Roaring Twenties were simply a rediscovery of leverage, as are all credit bubbles. Continue reading “Then and Now: Sunshine and Eclipse”

How to Build a Lifeboat



National Photo Co. Mack Sennett Girl 1919. Actress Marvel Rea, one of film producer Mack Sennett’s well-rounded “bathing girls”


Yesterday we talked about why we are facing deflation and today I wanted to review and explain the suggestions we have made previously for dealing with a deflationary scenario. In short, this is the list we have run periodically since we started TAE (with one addition at the end):

1) Hold no debt (for most people this means renting)

2) Hold cash and cash equivalents (short term treasuries) under your own control

3) Don’t trust the banking system, deposit insurance or no deposit insurance

4) Sell equities, real estate, most bonds, commodities, collectibles (or short if you can afford to gamble)

5) Gain some control over the necessities of your own existence if you can afford it

6) Be prepared to work with others as that will give you far greater scope for resilience and security

7) If you have done all that and still have spare resources, consider precious metals as an insurance policy

8) Be worth more to your employer than he is paying you

9) Look after your health! Continue reading “How to Build a Lifeboat”

40 ways to lose your future

People have been asking how we see the future unfold. In case you wonder what we stand for, much of our view of what’s to come can be found in the primers on the right-hand side bar. Here is an additional brief summary (in no particular order and not meant to be exhaustive) of the ground we have consistently covered here at TAE over the last year and a half, and before that elsewhere. Continue reading “40 ways to lose your future”