Synfuels—Back to Basics

Only dreamers or zealots expected that ten years after the oil embargo, America would "fill 'er up" with gasoline derived from coal or shale. But many thought that several synthetic fuel plants would be on their way to constituting the beginnings of a rapidly growing industry. Instead, one after the other, synfuel projects have been canceled or deferred.

At the start of 1983 only two major plants are under construction, each initiated with government assistance before the Synthetic Fuels Corporation (SFC) was formed. One, the Great Northern Plains plant in North Dakota, is designed to convert coal to gas. The other, under construction in Colorado by the Union Oil Company and slated to begin operation later this year, will convert shale to oil. When completed, the former will produce gas at the oil equivalent of 22,000 barrels per day and the latter will produce 10,000 barrels of oil per day. But these plants will not come close to meeting the objectives expressed in the Energy Security Act of 1980 that established the SFC--500,000 barrels of oil equivalent per day by 1987 and 2.2 million barrels per day by 1992.

Basic problems

At least two of the problems that have emerged in attempting to develop a program of this size have profoundly affected corporate approaches and are big enough to cause a rethinking of government strategy on synthetic fuels. Whether they will is an open question. The first problem is that the energy world of early 1983 is almost the reverse of that in which the SFC was launched. Oil is plentiful, with some 12 to 13 million barrels per day of excess capacity overhanging the market. Prices not only have stopped rising, but have been declining since the spring of 1981. Demand is down, both because energy is used more efficiently and because the economy is dragging. Budget deficits are huge and rising, and the hunt is on for projects that can be deferred or terminated. Altogether, it is not a heady environment for costly projects with untested technology to meet uncertain contingencies.

The other problem is the SFC itself. Staffed with recess appointments during the latter part of the Carter administration, the corporation lingered without leadership for many months under the Reagan administration. Not until October 1981 did the new board have a quorum. In the meantime, in the expectation that the SFC henceforth would be the place where synfuel business is done, the Department of Energy, which had solicited proposals in the past, began to back out of synthetic fuels. Then came two successive rounds of solicitations of projects from industry designed to give the SFC a broad choice in selecting worthy projects. The inevitable bureaucratic difficulties—aggravated by indecision within the SFC over whether to pursue quick and large production goals or to go for diversity of sources and technologies—delayed the program sufficiently to push it into the era of falling oil prices.

This may have been fortunate. Had the SFC moved quickly and spurred construction of several large plants, the situation today could be very bleak. The government might be making a choice between paying off on price and loan guarantees as industry failed to complete plants or coming up with more subsidies to ensure completion of projects.

Jumping ship

At any rate, with nominal oil prices at best stable and real oil prices on the decline, prior cost calculations based on a steady rise in oil prices no longer support the contemplated facilities, especially as cost estimates for the projects have risen. In the spring of 1982, Exxon withdrew its 60-percent participation from the largest planned venture, the Colony oil shale project in Colorado, that was to produce 45,000 barrels per day, announcing that estimated costs had more than doubled from an original $3.5 billion. On that recalculated basis, investment per daily barrel would have exceeded $150,000, and the oil would cost in the neighborhood of $100 per barrel. These numbers are much higher than the initial range of cost estimates and, specifically, more than twice the cost at which Union Oil expects to produce shale oil. (Union has a $42.50 per barrel price guarantee and appears to be moving on budget and on schedule.) Exxon's decision thus was hardly surprising, though it left many wondering how it had reached a position from which it had to extricate itself at considerable cost.

Rising costs and lower oil price projections also figured in Ashland's decision to abandon the Breckinridge project in eastern Kentucky, designed to produce 25,000 barrels per day from coal. In addition, the Hampshire coal liquefaction project in Wyoming (21,000 barrels per day) was delayed indefinitely after SOHIO pulled out. Both projects reappeared, however, in the third solicitation that closed in mid-January 1983. Including the new repeat entrants, there still are a few candidates for support, but their potential output is quite small. Nor are they the projects that offer the brightest hope for the future.

The survivors

The history of the first two solicitations reveals a striking number of casualties. None of the first-round proposals survived past December of 1982. Out of the second round of solicitations, entered by many that were unsuccessful in the first round, seven had advanced through various stages into what the SFC calls Phase II or actually were being negotiated. And in early December, SFC letters of intent were issued to three projects: a peat-to-methanol proposal (goal: 4,000 barrels of methanol per day), a heavy oil project (goal: 6,000 barrels per day of gas, naphtha, and fuel oil), and a tar sands project (goal: 4,000 barrels per day). These letters of intent are preliminary to contracting but do not commit either party. They merely say, "You seem OK." Table 1 presents a brief history of the project proposals.

The body count may differ from observer to observer, depending on how a project is classified, what is excluded, and so forth, but the broad conclusion is that few projects have survived. Moreover, the seven still in negotiation are an odd lot: only one involves coal liquefaction, one peat liquefaction, one involves coal gasification with electric power as the end product, one heavy oil, and, surprisingly, four plan tar sand conversion, surely the material that would have been voted "least likely" when the SFC was established. This is not because the tar sands technology is unknown—after all, the only operating commercial-sized synfuels plants in North America convert Canadian tar sands—but because U.S. resources are so much smaller than coal and oil shale.

Still, it is too soon to hold funeral services for the corporation. There is little question that synthetic fuels can play an important role in the long-term U.S. energy picture as reserves of conventional oil and gas decline. The SFC, or some similar entity, can be critical to this effort. But a searching review of philosophy and progress is in order, and soon. Such a review must ask and answer a number of questions.

Was the original idea of setting a production goal wrong? At the time the SFC was created, some advocated "information and insurance" as the proper objective. That would have meant a program of constructing facilities large enough to reveal potential engineering, health, safety, and other problems, but too small to make a significant contribution to supplies. Also, such a program would have been spread over a sizable number of different technologies. This approach acknowledges that there still are unresolved questions about synthetic fuel technology, especially about the costs of production. The primary objection was that such a program would "fail to send the proper signal to OPEC." As it turned out, of course, the close-to-aborted production-oriented program sent a much worse signal! The question remains, Is it time to reorient the program toward information and insurance?

Short term misleading

Industry takes its cues from anticipated market behavior. As anticipations change, based on changes in basic parameters, so do industry's evaluations—high on synfuels yesterday, when oil prices were soaring, low today, when the oil market is in the doldrums. Unfortunately, too much emphasis may be given to short-term trends. It is impossible, for instance, to predict with certainty the path that energy consumption will take if the economy returns to steady economic growth. The question then arises, Is it not wise to isolate research and development decisions from current events and short-term price and supply changes? If so, is it not advisable to place information-and-insurance synfuels development in the hands of government in a way that industry performs the hardware portion but is in no position to give go or stop signals?

Lowering sights

The SFC may now draw on the U.S. Treasury for nearly $15 billion. With budgets getting tighter by the day, hungry legislators on Capitol Hill eyeing those billions may want to sink the corporation. The Ninety-eighth Congress probably will have before it several bills to snuff out the life of the SFC. The question is, Would it not be wise to clip the SFC's wings before detractors go for its heart? Such clipping could take several forms. One would be to reduce funding, in conformity with a changed objective. Another would be to abandon altogether the 1985 claim for an additional $68 billion. In any event, since this is based on estimates of no-longer-valid windfall profit tax revenues, that figure is unlikely to have much meaning.

Joint ventures

The original act directs the SFC to enter joint ventures with industry only as a last resort, only for small-scale ventures, and only if it takes no more than 60 percent interest. But industry has shown only sporadic interest to act on its own. Government involvement may be necessary to get projects off the ground. The question is, However skeptical one might be of government's capacity to be heavily involved in industrial-type enterprises, is it not time to reconsider the limitations on joint ventures?

New approach needed

It is quite possible that matters will be allowed to drift, with no important changes in policy by Congress. After all, it would be embarrassing to basically alter a course that less than three years before was lavishly funded and heralded as fundamentally changing the U.S. energy outlook. But the risk of a hands-off policy is obvious: the SFC—anxious to do something— will be tempted to spend money on activities of questionable value. Thus, the final question, Is this not the time for the Congress or the president, or both, to undertake a profound but rapid search for new ways of tackling the matter? Such a review would be the more helpful if it gets away from considering the program as one to quickly provide significant production. Instead, government should approach synthetic fuels as a long-term continuing task with socially valuable objectives that fall outside the planning horizon and profit-oriented interest of industry.