Synfuels industry still banking on a future oil crunch

When the giant Exxon Corporation pulled out of the Colony oil shale project last year, many observers interpreted the highly publicized event as the beginning of the end of the nation's efforts to convert its abundant supplies of coal and oil shale into liquid fuel.

But Joseph Schell, manager of the synfuels program at the investment firm Kidder Peabody, attacks this prediction as a fundamental misreading of current events in the energy industry.

''The industry is smaller, but it is not dead,'' Mr. Schell maintains. In fact, he asserts, it is stronger today than it was a few years ago. ''Then there were 75 to 100 projects, many conceived of in a three- to four-week period. Most of those pretenders have disappeared.''

Two projects - an oil shale plant in western Colorado and a coal-to-natural-gas plant in North Dakota - are now nearing completion.

It is true that the big, multinational energy companies like Exxon have temporarily lost interest, says Edward Miller, vice-president for finance of the US Synthetic Fuels Corporation (SFC), an organization set up by the federal government to assist in the development of a domestic synfuels industry.

But the middle-tier companies, like Union Oil which is completing the Colorado oil shale project, continue to maintain an active interest, he reports.

Companies have continued to search for ways to convert coal and oil shale into liquid and gaseous fuels to replace oil and natural gas - banking on the belief that the current ''oil glut'' with its drop in petroleum prices is temporary. Sooner or later, many energy analysts say, energy prices must begin rising again.

In fact, ''a third oil shock could happen much sooner than most people expect ,'' warns Ragaei El Mallakh, director of the University of Colorado's International Research Center for Energy and Economic Development. He predicts that economic recovery will bring increased oil demand by industrialized countries. And he observes that many Middle East countries are convinced that their oil is worth more in the ground than when produced.

For this reason ''the United States cannot afford to abandon synthetic fuel development,'' the energy economist argues.

The SFC has been authorized to commit $20 billion in the form of loan guarantees and price supports to encourage the development of synthetic fuels. Those funds can be justified solely as a lever which moderate members of the Organization of Petroleum Exporting Countries (OPEC) can use to keep oil prices lower than they would be otherwise, says Mr. Miller. ''If the existence of a synthetic fuels industry keeps down the price of oil by $1 per barrel, it more than pays for itself,'' he explains.

Still, recent events have shattered the assumption upon which many synfuels projects were based - that energy costs can only rise. This twist has injected a considerable element of uncertainty in the prospects of synthetic fuel plants with their long lead times.

''There is an awful lot of skepticism about 20-year energy projects these days,'' Schell acknowledges. In addition, some of the most rewarding tax breaks for synthetic fuel developers either expired or were discontinued last year, creating added uncertainty about federal support for such projects.

Economic troubles have forced the SFC to escalate its levels of support substantially. It is now offering price and loan guarantees up to 75 percent of the total cost of a project. It will buy a project's syncrude for as much as $67 a barrel, more than 50 percent higher than previous levels. It has also come up with a device it calls a convertible guarantee.

''We lend the money to you and then, as you pay it back, we use it to pay you for your oil,'' Mr. Miller summarizes.

According to Mr. Schell, these guarantees make synthetic fuel projects economically attractive despite current conditions. He calculates a 25 percent return on investment for a typical 10,000 barrel-a-day plant, growing to 40 percent as the plant is expanded - even if the price of oil remains at current low levels.

Both Miller and Schell agree that the cost of fuel produced by small, new synfuels plants will be considerably higher than the cost of competing oil. But as plants expand, the cost of their operations will drop steadily.

''I look at this as an energy Headstart Program, assistance which lets industry get started earlier than they could otherwise,'' says SFC's Miller.

To do this more effectively, the quasi-government corporation has started to issue what it calls ''targeted solicitations,'' in which companies bid for SFC support on specific types of projects.

''Essentially, we are auctioning off our aid to those who can use it most efficiently,'' Miller explains.

The first such solicitation is an offer of up to $1.6 billion in support for an oil shale plant capable of producing 10,000 barrels a day. In the next few months, a similar proposal will be issued for a Gulf Coast lignite conversion plant.

These solicitations will aid in the necessary consolidation of the industry, Schell maintains.

''Right now there are a number of companies still promoting their own projects by themselves, even though they can only raise a small portion of the necessary capital. They would be better off putting their own projects on the back burner and participating in one of the more advanced projects,'' he advises.

So far the industry has not followed this suggestion. For instance, there are eight shale oil projects still under active consideration, while the industry only has the financial wherewithal to support two more. The industry analyst argues that SFC solicitations will encourage a healthy consolidation.

If this approach does not work, then the SFC will try to form joint ventures with selected partners. And, if that doesn't work, it may set up government corporations to produce synthetic fuels.

Thus, the nation will have some capability to produce synthetic fuels within the decade, unless the SFC's congressional opponents have their way. A number of conservatives oppose the corporation as a form of government interference in the free market.