Winners and Losers from the Gulf Spill

A comment on my recent posting on oil substitution opportunities in the aftermath of the Gulf oil spill got me thinking about potential winners and losers from the broad changes that seem likely to ensue from this disaster. Some of these outcomes would depend on new laws and regulations that could alter the basis of competition within the oil and gas industry, between it and other energy sectors, and between specific energy technologies. However, I also wouldn't discount the possibility of enduring changes in our perceptions of the oil industry and of the ways in which we use oil.

Until President Obama acted to freeze new deepwater leases and drilling permits, and even drilling that was already permitted and underway--a freeze that MMS appears to have used its own initiative to extend to all offshore drilling at any depth--natural gas seemed an obvious winner from any constraints on offshore oil drilling. Now I'm less sure, even if the President is apparently ready to allow drilling in shallow waters to resume. Superficially, gas should come out ahead, because the Gulf of Mexico accounts for a smaller fraction of US natural gas production than oil production, at 11% vs. about 30%. Yet it's also my understanding that offshore gas fields tend to decline more quickly than offshore oil fields, so that gas production in the Gulf of Mexico could drop faster than oil output under a deepwater drilling ban.

More importantly, shortfalls in Gulf Coast gas production could have a bigger impact on US natural gas prices than reduced Gulf Coast oil production would on crude prices. That's because the gas market is still mainly regional, connected by relatively small and expensive global flows of LNG, while oil is a truly global commodity with significant flexibility to work around localized production problems. Although the comparison is only approximate, you can see this effect by examining the impact of Hurricanes Katrina and Rita on the prices for Henry Hub natural gas and West Texas crude oil. Between August 25 and October 5, 2005, the gas futures price spiked by 45%, while WTI actually dropped by 7%, because of the extent of refinery shutdowns caused by the storms. (Gasoline futures shot up by 33% but quickly fell back to where they had been.) In other words, ensuring that gas remains cheap enough to be an attractive substitute for oil in transportation and other uses depends on either restoring gas drilling in the Gulf at all depths pretty quickly, or expanding onshore shale gas production even faster than recently.

The situation for renewables looks much less ambiguous. Even though, as I have pointed out frequently, renewable electricity sources such as wind, solar and geothermal power don't substitute for oil in any meaningful way, at least not without millions of electric vehicles that will take many years to roll out, perception is a good bet to trump hard-nosed realism in this situation. Extending the stimulus benefits for renewables, especially the cash grant program that substitutes for the tax equity market that stalled during the financial crisis, looks a lot likelier today than prior to April 20, despite the massive federal budget deficit. Similarly, the ethanol industry stands a better chance of getting the administration to relax the 10% blending limit on ethanol in gasoline--a limit that would otherwise stall ethanol growth until E85 takes off, if ever. The EPA is expected to rule on this soon.

Nuclear power looks like another big beneficiary of the oil spill, and again not because nuclear power would substitute for much oil in the near-term, though nuclear blogger Rod Adams properly reminded me recently that electricity from nuclear plants could be just as effective at backing out heating oil as natural gas, via efficient geothermal heat pump systems. Electrification could also displace some oil in rail transport, depending on the cost-effectiveness of electrifying long-distance freight tracks and locomotives. But in any case, nuclear stands as the likely surviving "conventional energy" pole of any grand compromise on energy and climate legislation, now that offshore drilling has become a dead weight instead of a vote-attractor in the Kerry-Lieberman climate bill. It is also the only other low-carbon energy source currently available on a scale large enough to substitute for the energy we get from oil, though not for oil's attributes as an energy carrier and storage medium.

Assessing whether the US oil & gas industry wins or loses from all this is harder than it looks. Other than BP--an obvious loser--some companies stand to gain from improved economics and increased emphasis on onshore drilling in places like the Bakken formation, from better onshore gas and LNG economics, or from picking up opportunities that BP won't be offered. Even if they're not barred from bidding on new leases around the world, BP just won't look like anyone's partner of choice, at least for a while. And don't forget OPEC, which from the first day of this disaster looked like the single biggest winner from our misfortune. Anything that makes non-OPEC oil production more difficult or costly shifts more market power to OPEC, which is sitting on top of more than three-fourths of the world's proved oil reserves, much of it still fairly cheap to develop.

With one very large caveat the US public, as both consumers and taxpayers, looks like the big loser from the likely energy outcomes of this spill--as distinct from those whose livelihoods and environment have been affected directly. We'll all pay more for energy, at least in the medium term, and we'll pay more to subsidize alternatives that still need help to become competitive, as well as those that should already have been weaned off subsidies after decades at the trough. We might turn that prospect on its head, however, if the spill drastically changed our attitude towards energy consumption. Until this event, oil was largely invisible. Every day in the US a thousand times as much oil as has been leaking into the Gulf flows through pipelines, tankers, barges, rail cars and tank trucks, and eventually through hoses into the fuel tanks of our cars, trucks, trains and planes, all unobtrusively out of sight. This undersea gusher provides a rare visual hint of the sheer scale of our oil consumption. Could seeing all that oil lead Americans to think differently about how they use energy, and from which sources? Let's check back a year after the well is plugged and the story has moved off the front pages.