Monday, October 11, 2010

After the Drilling Moratorium Is Lifted

As I was thinking about the offshore drilling moratoria--both the official one that's scheduled to end in a few weeks and the unofficial one that might drag on for months or years--it occurred to me that the Deepwater Horizon accident couldn't have happened at a worse time, in terms of our grasping its impact on our energy economy. There's never a good time for a tragedy on that scale, but the fact that it occurred during a period in which slack global oil demand and temporarily abundant OPEC spare production capacity have insulated oil markets from its effects has created a misleading impression of its inconsequentiality to our oil supplies. If you doubt that, imagine how the oil market--and the stock market--might have reacted if the accident and our response to it had begun on April 20, 2008, when oil futures traded at $117 per barrel, on their way to $145 a couple months later. Unless drilling resumes fairly soon on something close to the previous scale, or unless expectations of an uptick in global oil demand next year prove premature, we could all be in for a taste of those masked consequences within a year or two.

No one expects drilling to resume as though Deepwater Horizon had never occurred, and the industry has its work cut out for it to restore trust in its capacity to develop this energy in a safe and environmentally acceptable manner. New regulations, more consistent enforcement, and initiatives such as the new Marine Well Containment System, to which several of the major oil companies have committed, should help. But until the government and public are satisfied that all of the key lessons from the Deepwater Horizon disaster have been identified and put into practice, the industry will remain on probation. It's somewhat ironic that while we are still grappling with all this, the Parliament of the European Union--widely regarded as being more environmentally sensitive than the US--just voted against a proposed drilling ban. In the meantime, the effects of delayed development will begin to compound, in the absence of any near-term alternative that can fill the gap at the scale required, other than increased oil imports.

In a posting in May I described the potential impact of a protracted halt in US offshore drilling, particularly from the deeper waters of the Gulf of Mexico, and explained why neither expanded biofuels production nor the deployment of electric vehicles (EVs) or highly fuel-efficient hybrids can substitute for domestic oil production. We require these alternatives in any case, but it will be quite a few years before they could plug the resulting gap in our energy supplies. Replacing the equivalent of each 50,000 barrel-per-day oil field that's not developed in the next year or two would require 20 additional ethanol plants, 1.6 million EVs, or a like quantity of foreign crude oil or imported gasoline, diesel, jet fuel, lubricants and other products. And as I noted at the time, delay amplifies the effects of the decline of existing fields, so that the hole out of which we must dig ourselves grows larger with every month that new exploration and production are deferred.

What makes this particularly worrying now is that it has become evident in the last few months that the scheduled lapse of Interior Secretary Salazar's deepwater moratorium at the end of November will almost certainly not restore drilling even in the Gulf of Mexico to anything close to its former level for some time. The impact on technically non-moratorium shallow water drilling from the reorganization of the former Minerals Management Service into the new Bureau of Ocean Energy Management, Regulation and Enforcement, under new management and with a new, stricter set of regulations to enforce, makes that clear. It's also evident that offshore drilling in the Arctic, which is needed to backfill declining output from the Alaskan North Slope, could be delayed even longer.

For the moment, this might not seem like a big deal, when weighed against the universally-shared objective of reducing the risk of another major oil spill as much as humanly possible. With US petroleum demand still depressed by the aftermath of the recession and financial crisis, and with domestic oil production having recovered to levels not seen since before Hurricane Katrina--thanks in large part to the success of deepwater drilling--our net petroleum imports are actually 2 million barrels per day (bpd) lower than they were in 2007. That has helped set up a global oil market in which OPEC has had to keep a tight lid on its output to prevent prices from falling. However, if the analysis in this week's Economist is correct concerning the significant growth of demand from the developing world this year and next, along with an impending peak in non-OPEC oil production, then OPEC's problem will become much easier to manage and prices will begin to head back upward.

The resulting scenario isn't very appealing, unless you're convinced that higher oil prices are a good thing and perhaps the only thing that will get us to address our energy security and emissions challenges head on--though that ignores the lessons from a couple of years ago concerning how the competitive breakeven price of many alternative energy technologies tends to recede as oil prices rise. The deepwater drilling moratorium has nothing to do with the upward trend of oil prices in the last few weeks, and it probably won't be the actual trigger for higher prices next year. However, if oil prices do resume their pre-recession trajectory, the accumulating lagged effects of the moratorium and its aftermath could reinforce the impact on our wobbly recovery and gaping deficits in very unpleasant ways. By the time we wake up to this, it will be too late for second-guessing whether the US government has moved swiftly enough to get this key industry back to work.

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