Wednesday, November 08, 2006

The Next Two Years

The Democrats have won the House of Representatives by a solid margin. Control of the Senate may come down to recounts in Montana and Virginia, but even if their lead in both these races evaporates, they end up with a one-vote deficit. Although energy wasn't as large an election issue as it might have been had fuel prices remained where they were in August, it was still one of the main topics on which the Democrats campaigned, and it features in Speaker-presumptive Pelosi's plan for the "first 100 hours" of the new Congress. It's hard to gauge the degree to which energy policy in this country will change without knowing who will run the Senate, but there were clear signals in the Democratic effort to take the House. Superficially, the result looks negative for US oil and gas interests and good for alternative energy.

For the oil industry, and for the Supermajors and large integrated firms in particular, scrutiny on prices and profits will increase, and tax breaks will vanish. During the campaign, Nancy Pelosi talked about rolling back $12 billion worth of tax benefits for the industry as one of her priorities for the first few days of the 110th Congress. If the House can accomplish that without running afoul of a reluctant Senate or a Presidential veto, then it will deprive the industry of incentives that certainly appeared to be frosting on the cake over the last couple of years, but that could prove significant if oil prices continued to drop. It's easy to forget that when some of these measures were granted, including the royalty relief that has become so controversial, oil prices were well under $20 per barrel. Many of the projects that are coming on-stream now were planned during that period.

As disappointing as this outcome might be for many oil and gas companies, the industry is adaptable and will soon figure out how to work with a Democratic Congress, as it has many times before. For the time being, however, the 109th Congress appears to have been the high-water mark for greater access to drilling opportunities in the US. There are still Senate and House versions of drilling bills that must be reconciled in the lame duck session, and whatever comes out of that conference will be as good as it gets for drilling in the next two years. It is noteworthy that a major sponsor of the House offshore drilling bill, Representative Pombo (R-CA) appears to have lost his seat. It hardly seems necessary to add that the chances of drilling in the Arctic National Wildlife Refuge have moved from barely possible to extremely remote.

The picture for alternative energy firms looks brighter. Although I'm not sure that last night's shift improves prospects for wind or solar power, which already benefit from a wide variety of state-level initiatives, including widespread Renewable Portfolio Standards for electricity generation, biofuels look like the big winner. While efforts to add to domestic oil production are likely to stall, aggressive promotion of ethanol and biodiesel will enjoy strong bi-partisan support and seems unlikely to attract a veto. Look for more generous incentives for ethanol, including tax breaks for E85 infrastructure. Still, the defeat of Proposition 87 in California, the largest "blue state", sends some kind of signal about how alternative energy should be funded.

On the environmental front, we should expect the new Congress to push for aggressive enforcement of existing regulations, and no one should be surprised to see legislation for a stronger national response to climate change emerge between now and the Presidential election in 2008.

On balance, the implications of last night's electoral shift may be less significant for energy investment policies, than for demand-side initiatives that have languished for years. Changes to Corporate Average Fuel Economy standards and gas taxes could be back in play, soon. The government's response to a future energy crisis, whether in the form of a cutoff of exports from Iran or Iraq, or another devastating Gulf Coast Hurricane, may also alter. The outgoing Congress was solidly committed to letting the market manage disruptions, and as uncomfortable as fuel prices got for many Americans, we didn't see a repeat of the gas lines of the 1970s. Even though the incoming Democrats reflect a broad mix of populists and fiscal conservatives, a Democratic Congress would be tempted to intervene in a future crisis--or must at least explain to their base why they wouldn't do so.

The next two years should be very interesting for the entire energy industry. I'll be posting much more on this in the next few weeks.

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