Oil and Gas in the Capitals

	Vol. 230 No. 2
DR. ROGER BEZDEK, CONTRIBUTING EDITOR, WASHINGTON

Outlook 2009

Energy change coming

It has been a momentous several months in the US: A sea change election in which an African-American was elected president for the first time, the Democrats significantly increased their majorities in the House and Senate, the energy market cratered, and the country faces the worst economic and financial crisis since the Great Depression of the 1930s. In November and December alone, the US economy lost over 1 million jobs, and things will likely get a lot worse before they get better.

Superimposed over all of this is the prospect for radical change in US energy and environmental policies that will emphasize climate change issues and renewables, efficiency and “green” energy initiatives at the expense of fossil energy. President Obama has committed to the largest public works construction program in a half-century to resuscitate the economy, including a large-scale federal effort to create new-era “green collar” and clean energy jobs. As the recession deepens, the size of the stimulus program and its jobs creation goals keep expanding; an original goal of creating 2 million jobs has now grown to 3 - 4 million jobs. The energy agenda of the Obama administration is increasingly about “jobs, jobs, jobs.”

Personnel is policy. President Obama has appointed what has been described as the environmentalists’ “green dream” team (or maybe the “nightmare” team to the oil, gas and coal industries) to implement his energy and environmental policies, including:

• Secretary of Energy: Dr. Steven Chu is a Nobel Prize-winning scientist who is head of DOE’s Lawrence Berkeley Lab and who is on record calling coal a “nightmare” and advocating an increase of US gasoline taxes to European levels. However, contrary to common perception, Dr. Chu’s impact may be limited: Nearly 70% of the DOE budget relates to nuclear weapons and cleanup, and most of the rest is earmarked and balkanized.
• EPA Administrator: Lisa Jackson, as head of New Jersey’s EPA, favored reducing GreenHouse Gas (GHG) emissions and supported renewable energy. She increased the state’s Renewable Portfolio Standard (RPS) to 30% by 2020 and tried to enact a moratorium on new coal plants.
• Secretary of the Interior: Ken Salazar, previously the junior US senator from Colorado, will influence energy use, mineral and natural resources, and oil and gas exploration, including fossil fuels on public lands. Salazar is a renewable energy advocate, has called for a nationwide RPS of 20% by 2020, and supports biofuels. He favors expanded domestic oil and gas production and increased refining capacity, but opposes oil shale development.
• Secretary of State: Hillary Clinton, the former first lady and presidential contender, will oversee US participation in December negotiations in Copenhagen on a successor to the Kyoto treaty.
• Secretary of Agriculture: Tom Vilsack is a strong biofuels supporter. While governor of Iowa-America’s largest corn- and ethanol-producing state-he promoted corn and cellulosic ethanol and advocated US production of 60 billion gallons of ethanol per year by 2030, a sixfold increase.
• Presidential Assistant for Energy and Climate Change: Carol Browner served as President Clinton’s EPA head and has worked for Al Gore. She opposes offshore drilling, advocates using the Clean Air Act to limit CO2 emissions, and favors imposing carbon caps that would limit oil and coal use. As “energy czar,” Browner will likely focus on climate change and renewable energy.
• White House Science Advisor: Dr. John Holdren, professor of environmental policy at Harvard, advised Al Gore on An Inconvenient Truth. He has stated that either a cap on carbon emissions or a carbon tax is desperately needed, has called climate change skeptics “dangerous,” and will likely advocate rapid, aggressive action on these issues.
• White House Council on Environmental Quality Chair: Nancy Sutley, as deputy mayor of Los Angeles for Energy and Environment, worked to retrofit city buildings to be more energy-efficient, imposed strict environmental standards on new buildings, and tried to require that LA produce 20% of its power from renewable sources. The extent of her role in energy policy will depend on Browner’s role as energy czar.
• National Oceanic and Atmospheric Administration Administrator: Dr. Jane Lubchenco, a marine ecologist at Oregon State University, is an expert on the impact of climate change on sea life, and will help manage offshore oil and gas drilling.

We can thus expect a radical shift away from the Bush administration’s energy and environmental policies. Renewable energy, energy efficiency, green energy, GHG control and Kyoto will be promoted, and fossil energy will not be treated kindly.

Offshore drilling. “Drill, baby, drill” was a slogan that emerged during the presidential campaign, leading to the end of a twofold ban on Outer Continental Shelf drilling three months ago. As gasoline prices exceeded $4 a gallon this summer, US drilling became a hot political issue, and President Bush responded by repealing a presidential offshore drilling ban put in place by his father. In October, a gridlocked Congress let a separate drilling moratorium expire after 26 years. Nevertheless, even under ideal conditions, actual leasing could not begin until 2011, and plummeting gasoline prices have sapped the offshore drilling debate of its urgency.

Nevertheless, the Bush Interior Department began implementing “drill, baby, drill” before leaving office, closing a public comment period on a proposal to lease 2.9 million acres of ocean off the Virginia coast to oil and gas companies, Fig. 1. This means that President Obama and Interior Secretary Salazar will immediately have to confront the decades-old debate over offshore oil drilling-and it is an issue where the two have disagreed.

Fig. 1. One of Obama’s first major energy decisions will be whether to allow leasing for oil and gas exploration to proceed on 2.9 million acres of federal waters offshore Virginia. President Bush began the leasing process, the first since federal drilling bans expired last year, shortly before leaving office. Courtesy of MMS.

Virginia is an unlikely ground zero for the drilling debate because of possible reserves off the coast and a relatively friendly state government and influential governor; Democratic Gov. Tim Kaine was an early Obama supporter, was vetted as a possible running mate, and is the new Democratic National Committee chairman.

Environmentalists oppose the drilling, the US Navy is concerned about rigs in the area where its Norfolk fleet trains, and NASA objects because it launches satellites and low-altitude rockets from Wallops Island, Virginia. President Obama could stop the leasing cold either by directing the Interior Department to freeze the offshore process or by issuing another presidential ban on offshore drilling, or he could let the process proceed. In early 2008, Salazar was part of a bipartisan group of lawmakers that wanted to open up OCS drilling. At the time, presidential candidate Obama strongly opposed offshore drilling, but that changed during the campaign, when gas prices were high and politically explosive. Candidate Obama said that he rethought his position, concluding that “responsible” offshore exploration should be part of the total energy picture.

What eventually happens off the coast of Virginia should be closely monitored as indicative of the prospects for drilling off other US states and as a bellwether of future energy policy direction in the Obama administration.

The threat of low prices. President Obama and his advisors face the most daunting climate in decades for remaking US energy policies. As noted, his energy and environmental team indicates that Obama plans to put a heavy emphasis on GHG control, promoting renewable energy and conservation, and reducing US dependence on imported oil. He is trying to package these policies as a way to increase employment and resuscitate the economy by stimulus spending on green energy projects.

However, he faces enormous problems, including declining oil prices, a tanking economy and disagreements among his advisors. For example, Browner opposes offshore oil and gas drilling, whereas this policy is favored by Interior Secretary Salazar and by Obama’s national security adviser, retired Marine Corps Gen. James Jones. Similarly, Energy Secretary Chu advocates increasing gasoline taxes to encourage fuel efficiency, whereas Obama has already rejected the proposal, stating it would be a “mistake” that would put “additional burdens on American families right now.”

Few members of Congress support increasing the federal gasoline tax, and the last effort to impose a new energy tax-under President Clinton in 1993-failed in Congress and was a major reason the Democrats lost both the Senate and the House in 1994. Since the energy crises of the 1970s put energy prices and energy security on Washington’s agenda, Congress and presidents from both parties have worked toward one common goal: Keeping US energy prices low.

No US president has made significant headway changing US energy policies during a period of declining oil prices, and oil prices will likely remain low until the world economy revives. Falling prices and tight credit are already cancelling hundreds of green energy projects across the country, from wind farms and solar projects to biofuel refineries. Reviving those projects, even with significant government incentives, will not be easy.

Further, if Washington’s debate over whether to bail out GM and Chrysler appeared acrimonious, wait until the debates over energy and climate change policy rev up. The auto bailout debate has become a proxy for coming clashes over energy strategy, and some Democrats argued that Detroit’s carmakers should be compelled to use federal subsidies to improve vehicle mileage. Others from both parties questioned how companies that have mostly lost money on small cars and hybrids will suddenly find ways to make them profitable. The underlying argument about Washington’s role in guiding industry’s behavior on energy issues is just getting started.

There are few areas of American economic life that are not affected by energy costs, and this brutal fact will likely prevent any action in Congress on GHG control legislation this year, and maybe next year. Most Democrats, and some Republicans-including 2008 presidential candidate John McCain-favor a cap-and-trade system. Aside from being a bureaucratic nightmare, such a system is little more than a large stealth tax on fossil fuels, and in the current economy no one is advocating tax increases. Furthermore, while cap-and-trade is favored by environmentalists and some politicians, it has elements that are unpalatable to powerful Democratic and Republican constituencies. While Republicans are likely to oppose it based on the party’s anti-tax, anti-regulation philosophy, Democrats may oppose it because energy taxes are among the most regressive, disproportionately impacting low-income and minority families.

Nevertheless, in the longer term a cap-and-trade system may be imposed, for its greatest fault is also its most important advantage: It is a stealth tax increase that could generate hundreds of billions of dollar annually in federal government revenues. Facing trillion-dollar deficits, the US government will eventually have to find a way to increase taxes significantly, and cap-and-trade may be the least objectionable (i.e., most opaque) way to do so.

Sleepers. On Dec. 17, 2008, the Energy Information Administration (EIA) published the draft of its 2009 Annual Energy Outlook. This didn’t receive very much publicity, but it should have, for it represents a major departure from EIA forecasts of the past several decades. Incredibly, EIA is now forecasting-in its reference or “most likely” case-that, over the next two decades, US oil consumption will not increase, domestic liquid fuels production will increase, oil imports will fall dramatically (Fig. 2), US gas production will increase significantly, and by 2030 the US will be a net exporter of pipeline gas. This represents an almost complete reversal of energy trends that date back four decades.

Fig. 2. In a surprising reversal, the Energy Information Administration’s reference case (i.e., most likely) forecast is for US dependence on imported oil to drop precipitously, from about 60% of domestic consumption to just over 40% by 2030. Courtesy of EIA.

US oil consumption has grown steadily since the mid-1980s, and EIA forecasts issued over the past 20 years have projected a continuing trend of growing US oil use. The new EIA forecast projects a reversal in this trend, with no appreciable growth in oil
consumption between now and 2030. Thus, EIA is now forecasting that:

• US dependence on imported oil, which has increased continuously since the 1970s, will decline dramatically over the next 20 years.
• US domestic liquid fuel supply will increase nearly 50% by 2030.
• The US net import share of liquid fuels will decline from 60% to less than 40% in 2030.
• Growth in US gas production will exceed the rate of demand growth, and net imports will decline to near zero by 2030.
• The US will change from being a net importer of pipeline natural gas to a net exporter in 2030.

The significance of this new set of forecasts is hard to exaggerate, and has yet to sink in. Let us assume here that EIA is right, which is a huge assumption, given its track record in energy forecasting over the past several decades. The new forecasts imply that the US will be importing less oil every year from 2009 through 2030 and will be well on the road to “energy independence.” This development-the unfulfilled dream of politicians and energy analysts since the 1970s energy crises-would have profound domestic and international energy, economic and political ramifications. It would affect world oil prices and oil markets and could increase US foreign policy flexibility in the Middle East and elsewhere.

The possibility that within two decades the US will be a net exporter of pipeline gas is also a game-changer. Just think about it: The US will become an energy exporting nation. Does this imply that the US will then join the gas cartel that Russia, Iran and other gas-exporting nations are currently trying to establish?

Another recent report that received even less attention was the North American Reliability Corporation’s (NERC’s) 2008 Long-Term Reliability Assessment, released in late October. For years, NERC has been warning that the US faces a crisis in electrical capacity due to relentlessly increasing demand and inadequate new reliable baseload capacity. However, in its most recent report, NERC has suddenly become much more sanguine. It now forecasts that future US capacity problems will be solved by installation of wind systems and by reduction in capacity requirements due to “demand response” initiatives, a euphemism for demand destruction. The report was released through a webcast to industry experts, who were dumbfounded, and many are still trying to determine if this is an example of political correctness beginning to affect what used to be credible analysis.

NERC may have missed the boat. One thing that everyone appears to agree on is that, to dig itself out of the current economic and financial mess, the US will have to start producing more and importing less and will have to reverse the decades-long atrophy of its manufacturing sector. The US will no longer be able to shift its energy-intensive production activities abroad. The nation will thus require a lot more electrical capacity in the coming years, capacity that will not be provided by windmills or “demand response.”

Finally, in late December 2008, the Bush administration agreed to lend $13.4 billion to GM and Chrysler to keep them out of bankruptcy, and the Obama administration will likely lend them a lot more. The quid pro quo is that they produce more fuel-efficient, green vehicles-small cars, electric cars, hybrids, etc. The irony is that, once again, Detroit may end up trying to sell American consumers vehicles they do not want to buy.

Amid all the recent hype about the green economy and consumers’ new conservation ethic, few have noticed that, with gasoline now selling for about $1.65/gallon, US car buyers have gone back to preferring large, relatively fuel-inefficient vehicles. In December, trucks and SUVs outsold cars in the US market for the first time since February, while sales of hybrids declined significantly. Driven by great deals and low gasoline prices, trucks and SUVs comprised 51% of all vehicles sold in the US in December-and Prius sales declined 50%, in part due to the expiration of any tax benefits. As gasoline prices are likely to stay low through 2009 and beyond due to the worldwide recession, consumers’ memories of the record gasoline prices of summer 2008 will fade further, and their preference for small, fuel-efficient vehicles will also dissipate.

It has always been about money, and the collapse of gasoline prices from $4+ to $1.65/gallon is all we need to know to estimate consumer demand for vehicles. For example, at present, a buyer can negotiate a $10,000 discount on the price of a light truck or SUV. At $1.65/gallon, $10,000 will buy over 6,000 gallons of gasoline, which-at about 18 mpg-means the vehicle will get nearly 110,000 miles of “free” gasoline, enough to cover lifetime vehicle ownership. Of course, gasoline may increase again in the future, but consumers base their purchasing decisions on today’s prices, not forecasts. All of the lamenting of the policy analysts, talking heads and op-ed columnists about Americans’ addiction to oil and profligate energy ways will not change this basic calculation. Thus, large, inefficient vehicles may eventually be selling at a premium while small, green cars sit on the lots unsold.

Energy prices are paramount, and memories are short, So, while change in 2009 is certain, the form it ends up taking may be quite different from what its architects envisioned.

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