Wednesday, May 23, 2007

Short Memories

One of my ongoing themes here is that, despite high energy prices that now rival those of the last energy crisis, we are not experiencing the second coming of the 1970s. Unfortunately, we do seem fated to revisit every bad energy idea from that period, and today we have two on display. First, a columnist in the Washington Post proposes establishing a national oil company (NOC) to promote expanded supply, new refineries, and "hyper-competitive" pricing. Then later this morning the Joint Economic Committee of the Congress is holding a hearing on whether to pursue breaking up the largest US oil companies. At this rate, I'd better make room in my closet for the paisley shirts and leisure suits that must surely be on their way.

In his column Steven Pearlstein anticipates all sorts of oil industry opposition to the idea of a chartered national oil company set up to compete with them, and given all sorts of breaks on refinery siting and permitting and production from federal lands. Never mind that if the existing oil companies had been given those breaks when energy prices were low, we might not be in the present pickle. While I'm sure Mr. Pearlstein's plan would provoke the expected response from energy companies and trade associations, the biggest complaints ought to come from taxpayers and watchdog groups. This approach was tried all over the developed world in the 1970s, and with very few exceptions, it was given up as a bad idea. The successful NOCs are all in big net-producing countries, not net consumers. The history of Petro-Canada, founded in 1975 and 80% privatized in the early 1990s, illustrates this cycle. Mr. Pearlstein probably isn't serious, of course. His contrasting portrayal of a hypothetical NOC seems mainly intended to shame the publicly-traded oil firms for being profitable and rewarding their shareholders. But in today's climate, I wouldn't be surprised to see some legislator take up this mock cause.

Turning to today's Congressional hearing, it has become an article of faith in some quarters that the country's energy woes are the result of the industry consolidation that took place in the late nineties and early oughts. Smaller, more aggressive competitors would have apparently increased oil production and expanded their refineries at a faster pace, so that while global oil prices might now be high, at least refining margins would be lower, with consumers paying more like $2.40/gallon, instead of $3.22. But while you're unlikely to find an industry insider less enamored of merger mania than I am, this scenario flies in the face of the economic facts that drove those mergers in the first place.

From 1997-2001 I worked in Texaco's Corporate Planning & Economics Department. During that period, we experienced the disdain of investors for "old economy" industrial firms that needed capital to compete with the growing power of the NOCs in producing countries, which held more than 80% of the world's oil reserves. We just weren't New Economy enough. Then, to add insult to injury, the price of oil collapsed from the $20s to single digits, before recovering. The mergers triggered by these events weren't focused on market domination and pricing power: they were about ensuring the survival of an industry that had just come through a near-death experience.

One of the other concerns that occupied much of my time in that period was refineries. Simply put, they were dogs. Not only were US refineries consistently earning less than the cost of capital, but they were a constant drain on capital, because of wave after wave of environmental investments in reformulated gasoline and ever-lower sulfur diesel fuel, for which consumers didn't want to pay an extra penny. All that management wanted to do was to find ways to reduce our exposure to this awful sector, and that's exactly what we and the other majors did, through joint ventures and outright sales. Is it any wonder that, on the back end of such a cycle--when demand growth has outstripped domestic capacity and our reliance on gasoline imports from Europe and elsewhere has grown steadily--refining margins are finally enjoying a bonanza? If oil companies invested as much in new refining capacity as their critics would like--even if new greenfield facilities could get permits--the result would likely be another protracted cyclical bust. In the face of a 35 billion gallon/year alternative fuels mandate, that may just happen anyway.

I persist in my hope that enough of us actually learned something from the experience of the 1970s and the energy price cycles that followed that first energy crisis. If we want to ensure that the US has access to the oil and gas it will need during a lengthy transition away from fossil fuels, then what we need is not a national oil company, and certainly not a gaggle of smaller oil companies. Instead, we need a strong, dynamic energy sector, led by companies big enough to deal with the NOCs as equals and to take expensive risks on the frontiers of technology, whether in ultra-deepwater drilling or cellulosic ethanol. The times demand something much better than merely recycling the ill-considered notions of the past.

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