Energy and the New Congress: Beyond Keystone

• The Keystone XL pipeline is likely to get another opportunity for approval once the new Congress is sworn in next January.
• However, it will not be the most important part of a new Congressional energy agenda, and it might not even be the most urgent.

Voters in the US mid-term election earlier this month might be forgiven for assuming that its result assures quick approval of the Keystone XL pipeline (KXL), notwithstanding the drama over a Keystone bill in the "lame duck "session last week. The pipeline has been under review by the Executive Branch for six years, yet despite its symbolic importance to both sides of the debate, and an apparent majority in both houses of the newly elected Congress favoring its construction, its future remains uncertain. Nor is KXL necessarily the most urgent or important energy issue that the new Congress is expected to take up.

It's worth recalling that the Senators who just lost their seats  were elected in the aftermath of the oil-price shock of 2007-8, amid great concern about increasing US dependence on imported oil and natural gas. They took office in 2009 with a President whose main energy policies focused on addressing global warming, with energy security inescapably linked to climate change. Largely as a result of the shale revolution, the new class of Senators will begin their jobs in an entirely different energy environment. That will have a bearing on both the priorities and approach of the new Congressional leadership.

The energy agenda for the two years of the 114th Congress will most likely include not just the status of KXL, but also restrictions on US crude oil exports, reform or repeal of the Renewable Fuel Standard (RFS), the extension of renewable energy tax credits for solar power (expiring at the end of 2016) and wind power (already expired),  regulation of greenhouse gases by the Environmental Protection Agency under the Clean Air Act of 1990, expanded oil and gas drilling on federal lands and waters, and a stalled piece of energy efficiency legislation that might be the least controversial energy bill, on its merits, that either chamber has considered in years. Support for nuclear power and the disposition of nuclear waste could get another look, too.

Tax incentives for both renewable and conventional energy may also be swept up in efforts to reform the US corporate and individual tax systems, a high priority for some incoming committee chairmen. The least likely measures to be considered, however, are comprehensive energy legislation along the lines of the Energy Independence and Security Act of 2007 or climate legislation similar to the Waxman-Markey bill of 2009 that subsequently died in the Senate.

It is also possible that the 113th Congress could clear some of its backlog of energy measures before handing off to the new Congress in January. The dynamics of the lame duck session will be different from the pre-election period, and the outgoing leadership could be motivated to strike deals on measures such as the restoration of the wind power tax credit (PTC) within a larger package of expiring tax measures called the "extenders bill."

Aside from KXL, perhaps the most pressing energy matter for the new Congress is to address is the question of US oil exports, which are restricted under 1970s-era laws and regulations. The urgency of debating oil exports is twofold: One company has already indicated its intention to export condensate, which is treated as crude oil under current regulations, without government approval. And with oil prices having fallen by 20-25% since summer, oil exports and related shipping regulations could provide a crucial relief valve as US producers of light tight oil (LTO) from shale deposits seek to reduce their costs and find higher-priced markets.  Senator Lisa Murkowski (R-AK) is slated to chair the Senate Energy & Natural Resources Committee, and this is one of her big issues.

However, the cooperation Sen. Murkowski will receive from the other party in getting export legislation to the Senate floor could depend on the result of December's runoff in Louisiana.  If Mary Landrieu, current chair of Energy & Natural Resources, falls to Representative Bill Cassidy (R-LA), her replacement as ranking member for the minority on that committee is expected to be Maria Cantwell (D-WA). Senator Cantwell appears to be more skeptical about oil exports, as well as on other issues the oil and gas industry might hope would advance next year. 

For that matter, while gaining approval of KXL and reining in the EPA are clearly part of the incoming Republican agenda for energy, other issues cut across party lines in ways that make their outcomes less easily predictable. For example, proponents of reforming or repealing the RFS may have as much difficulty getting traction in the 114th Congress as in the 113th. Geography, rather than party affiliation, seems like a better predictor of whether new Senators like Joni Ernst (R-IA) or Mike Rounds (R-SD) would support or oppose changing the rules for biofuels. That could apply to the wind tax credit, too.  Even an oil export bill might similarly split both parties.

That brings us back to Keystone XL. The election result put both chambers of Congress on the same page on this issue for the first time and has apparently increased support for KXL to the crucial 60-vote threshold. That would be sufficient to obtain "cloture" and prevent a filibuster, though not to overturn a presidential veto.

Before Senator Landrieu's bill came up short last week, the President's real position on KXL began to emerge from the opacity he maintained through two elections. Nor does the fallout from his recent actions on other issues bode well for striking a deal with the new Congress on Keystone, short of it being attached to some essential piece of legislation like the budget or defense authorizations. Other parts of the likely Congressional energy agenda could fall into the same gap, and I'm less optimistic than I was after November 4th about opportunities for cooperation on energy between the White House and a unified Congress. 

A different version of this posting was previously published on the website of Pacific Energy Development Corporation.

Keystone XL Loses Another Round

The image that will stick with me from yesterday's failed attempt by Senator Mary Landrieu of Louisiana to avoid a filibuster on her bill to approve the Keystone XL pipeline is that of her Senate colleague, Barbara Boxer (D-CA) standing next to a blown-up photo of choking smog, presumably in China. Inconveniently, the greenhouse gases at the heart of this debate are invisible and global in effect, rather than local like the pollution from unscrubbed coal plants half a world away. Senator Boxer's smog ploy epitomizes the confusion and misinformation surrounding this project.

That extends to the White House, where the President's recent arguments against the pipeline reflect beliefs, rather than facts, and stand in contrast to the findings of his own administration on the economic and environmental impact of the pipeline, or of oil exports, should some of Keystone's oil be sold into the global market from the Gulf Coast.

Yesterday's defeat is likely to be more final for Senator Landrieu than for the pipeline. She goes into next month's runoff election as a distinct underdog, based on recent polling. The pipeline, however, will likely get another opportunity in the new Congress early next year, when supporters are expected to have an easier time coming up with the 60 votes necessary to bring a bill to the Senate floor for an up-or-down vote. The project may even benefit from having avoided a Presidential veto now, since the fig-leaf of letting the review process run its course would have been more transparent this time than when the President rejected the pipeline in 2012.

How Good Is The New Emissions Deal with China?

• President Obama's emissions deal with China sets an ambitious target for US CO2 cuts while leaving substantial headroom for emissions growth in China. 
• It will likely compound his problems, domestically, but could have significant influence on upcoming international climate negotiations.

Only an event like Tuesday's agreement between President Obama and his Chinese counterpart to limit greenhouse gas emissions (GHG) from the two countries could top the unexpected scramble in the US Senate to pass a Keystone XL pipeline bill as the big energy story of the week. The significance of the climate deal is open to interpretation, from both international and US political perspectives. Before exploring those, we should examine its consequences.

The White House announced that in exchange for the US agreeing to reduce "net greenhouse gas emissions 26-28 percent below 2005 levels by 2025", China would undertake to cap its GHG emissions by "around 2030." It also announced plans to step up a number of cooperative efforts with China in this area, including joint R&D and a jointly funded public/private carbon capture and sequestration (CCS) project in China. What does all this mean in terms of US emissions?

We need to start with the 2012 baseline in which net US emissions were already nearly 11% below 2005 levels. The current Annual Energy Outlook of the US Energy Information Administration (EIA), assuming the laws and regulations in force at the time it was produced, projects that US energy-related CO2 emissions will increase by 236 million metric tons (MT) by 2025, compared to 2012, leaving us at roughly 7% under 2005. Emissions from transportation would shrink, while those from industry would rise as the US economy grows by an expected 2.4% per year.

As I understand it that EIA forecast doesn't include the emissions that the EPA's "Clean Power Plan" for existing power plants would be expected to save if fully implemented. EPA targets reducing CO2 emissions from the US electricity sector--accounting for 39% of net emissions in 2005--by 25% by 2020 and 30% by 2030, compared to 2005. That would shave around 460 million MT from the EIA figure for 2025, getting us to nearly 15% below 2005. The additional savings to reach 26% below 2005 are thus in the neighborhood of 700 million MT per year by 2025. To put that in perspective, it's equivalent to the 2012 CO2 emissions from combustion in the entire US industrial sector, and exceeds total emissions of methane from all sectors, including agriculture, oil & gas, and landfills.

So unless I've done my sums wrong, or misinterpreted the government's data, the US/China deal commits to reducing US emissions by as much again as we've cut since 2005--largely as a result of a weaker economy and the shale gas revolution--after banking the expected savings from the 2011 fuel economy regulations, energy efficiency programs and renewable energy incentives, and an EPA plan for the power sector that is certain to run into strong opposition in the new Congress. That seems pretty ambitious to me, although it falls short of the 40% reduction recently agreed by the EU for 2030.

It's harder to assess what China's side of the deal means in practical terms. Its 2012 emissions were estimated at nearly 10 billion MT/yr, having grown by 8%/yr since 2004 and by 6%/yr since 2009. At that rate, even if its emissions peaked in 2030, they could double before starting to decline. If China's emissions growth declined to just 2% per year, consistent with the lower rates of growth in coal consumption observed recently, by 2030 it could still add nearly 4 billion MT/yr--equivalent to the current emissions of the entire EU, and 5 times the incremental US cuts to which President Obama just agreed. The most recent projection of China's emissions from the EIA had them growing by 5 billion MT by 2030 but essentially plateauing thereafter.

This falls substantially short of what would be required to keep global emissions within the range that climate models predict would limit average global temperature increases to 2°C, compared to pre-industrial levels. However, it goes well beyond China's previous commitment on emissions intensity at Copenhagen in 2009.

Now consider how this deal looks from the standpoint of US politics. Voters just resoundingly handed undivided control of the legislative branch of government to the President's opposition. Republican office-holders and those who just voted for them are likely to regard it as an unwelcome commitment of the US by a lame-duck President to a promise that only his successors could fulfill. In the process, it hands China and other countries a point with which to prod future US administrations should they fall short of its goals. In exchange, he got President Xi Jinping to admit that China can't emit CO2 limitlessly, but can still do more or less what it may have been planning, anyway. It's hard to see this making things easier in Congress for the President's existing environmental agenda.

The deal looks better from the perspective of international environmental and climate policy circles in the lead-up to the Paris climate conference, "COP21", at the end of 2015. One lesson from the Kyoto Protocol is that to be meaningful a global climate agreement must have a strong commitment from the world's largest emitters of CO2 and other GHGs. China and the US are the two biggest emitters, and the EU at #3 is effectively pre-committed. Together these three blocs account for over half of all emissions today. Having them on-side at the start raises the chances of reaching a  big agreement.

As others have observed, this deal makes it harder to argue against a global CO2 agreement based on China's relative inaction, while increasing pressure on other developing countries to agree to limit their own emissions. It also signals that despite political weakness at home, the White House will likely push for aggressive targets at COP21, setting up further conflict with Congress in the next election year. Finally, its timing is early enough to influence the negotiations but not so early as to permit close scrutiny of Chinese or US follow-through on its goals before the Paris talks begin.

Will Falling Prices Shift Oil Industry's Focus to Cost Reduction?

• Lower oil prices may have less impact on US oil production from shale than competitors in Saudi Arabia and elsewhere appear to assume.
• The cost of  producing tight oil is not static, and US producers have various options for cost reduction, including optimizing their logistics. The newly elected Congress can help.

Oil prices have dropped by more than 20% since July, based on futures contracts for UK Brent crude. Some expect prices to rebound relatively quickly, apparently including at least one large oil services company. However, indications that the official policy of Saudi Arabia may have shifted away from its customary role of "swing producer" raise the possibility of an extended period of lower prices. This is new territory for the relatively young US shale industry.

From the end of 2010 to the first half of this year, as the rapid development of light tight oil (LTO) from shale deposits was adding more than 2.9 million barrels per day (bpd) to US output, the benchmark price of West Texas Intermediate crude oil (WTI) averaged $96/bbl. The global oil price, represented by UK Brent, averaged $110/bbl for the same period. Having now fallen to the $80s, if prices were to stay here or lower for long, we should expect to learn a great deal about the actual cost structure of new and existing LTO production in the Bakken, Eagle Ford, Permian Basin and other shale plays.

Based on my experience of several oil-price declines from the inside during my time at Texaco, Inc., I'm skeptical that many LTO producers would be inclined to trim output from currently producing wells, other than as a last resort. From late 1997 to the end of '98, WTI prices fell by almost half, from around $20/bbl to under $11--equivalent to roughly $15 today.  Prices for heavier grades of oil fell to single digits. After months of that, revenues from some oil fields no longer covered variable costs, and upstream management took the decision to shut in high-cost production. Once prices revived, they discovered that some of that capacity had been lost essentially permanently.

I suspect there would be even greater uncertainty and hesitation today about shutting in producing shale wells for any significant period, especially in light of the limited experience with such wells. The bigger question is whether the drilling of new wells would slow or stop, resulting in a gradual slide in output as existing wells decline.

Then and presumably now, however, the first option in a situation like this is generally to cut costs, rather than output. I saw this in the mid-1980s, when oil prices fell by nearly 60% and took more than a decade to recover fully, then again in the late '90s, and during periodic, smaller market corrections. Suppliers were squeezed, big projects deferred, and employees saw travel, raises and benefits curtailed. Similar actions now could make a difference in keeping new shale drilling going.

Even for relatively efficient operators, it can be surprising how much expense can be reduced without affecting near-term productivity, and many of those savings would persist if prices recovered. LTO producers might ultimately become more profitable after weathering a period of weak prices.

A heightened focus on costs would also likely extend beyond producing company budgets and supplier agreements. One of the biggest non-production costs for LTO is transportation, whether paid directly by the producer or deducted by the purchaser from the market price.  Because of its rapid growth and the constraints of existing infrastructure, a high proportion of LTO output must currently be shipped by rail--up to one million bpd in the second quarter of 2014.

Rail offers flexibility and can reach many destinations, but it is expensive.  For example, if it costs over $10/bbl to ship Bakken crude to the Gulf Coast by rail, that means that with WTI at $78/bbl the producer might realize less than $70/bbl at the wellhead.  Pipelines are often cheaper to use, though not in all cases. The current tariff on the existing Keystone Pipeline for taking oil from the Canadian border to Cushing, OK, the storage hub for WTI, works out to around $4/bbl. If oil prices stayed low for a while, that might increase interest in the proposed Bakken Marketlink Project. It would connect the Bakken shale operations to the Keystone XL pipeline, the prospects for which look decidedly better after the outcome of Tuesday's mid-term election.

Another aspect of transportation costs that could come under a different kind of pressure relates to federal restrictions on shipping oil and petroleum products by vessel between US ports. Under the "Jones Act", only US-flagged, -owned and -crewed ships can perform such deliveries, even though the rates for such shipments are normally significantly higher than on foreign-flag tankers in comparable service. This is a significant factor in current petroleum trade patterns, in which refined products from Gulf Coast refineries are often shipped halfway around the world, while blenders and marketers on the east and west coasts must import gasoline and other products from outside North America.

And as long as US crude oil exports are prohibited, with a few exceptions, the combination of the Jones Act and the export ban effectively keep LTO bottled up on the Gulf Coast--depressing its price--or force it onto rail. Amending the Jones Act to exempt LTO, or the issuance of a waiver to that effect from the Executive Branch, could increase producers' margins while expanding the supply options for US refineries on the other coasts. I wouldn't be surprised to see this taken up by the new Congress early next year.

 Based on the current behavior of oil markets, the global impact of the US shale oil boom has been greater than many expected and seems very much in the national interest of the US--and of US consumers--to keep it going. It remains to be seen whether measures such as new pipeline infrastructure and reform of shipping regulations, together with more traditional forms of expense reduction, could boost producers' returns on LTO sufficiently to sustain drilling at roughly current rates while oil prices are weak. 

Even if both drilling and tight oil production slowed for a while, this price correction won't spell the end of the shale boom. As the Heard on the Street column in the Wall Street Journal put it recently, "Once someone has cracked it, it can't be unlearned. Barring a prolonged period of very low prices, the US oil industry isn't about to disintegrate." Rather than an existential crisis, the current weakness in oil markets looks like a test of adaptability for this new but important energy sector.

A different version of this posting was previously published on the website of Pacific Energy Development Corporation.