How Shale Reduced US Energy Risks from Hurricanes

• The Gulf of Mexico will be a key region for energy supplies for years to come, but shale development has boosted output elsewhere to such an extent that the US is much less vulnerable than a decade ago to shortages resulting from hurricanes.

Just in time for the 10-year anniversary of Hurricane Katrina last month, the US Energy Information Administration (EIA) reported on the reduced vulnerability of US energy supplies to Atlantic hurricanes, as a result of the energy shifts of the last decade. As the Houston Chronicle noted, this illustrates another benefit of the revolution in shale oil and gas. However, with oil still below $50 per barrel, it is also worth considering how durable these particular effects might be if low oil prices were to persist much longer.

Following hurricanes Katrina and Rita, which made landfall on the Gulf Coast within a few weeks of each other in 2005, I recall some lively  discussions concerning the concentration of US energy assets in the region, and what that meant for US energy security. There was talk of new inland refineries, and even proposed legislation to promote them. With the exception of one small refinery in North Dakota, which came online earlier this year, most of that talk led nowhere. The synergies of the Gulf Coast refining and petrochemical complex were and still are overwhelming.

From the perspective of diversifying US crude oil and natural gas supplies, the situation looked equally daunting in 2005, excluding higher imports of both--an outcome that already seemed unavoidable. The country's main onshore oil fields, including the Alaska North Slope, were in decline. In 2004 their combined output averaged less than 4 million barrels per day for the first time since the 1940s. The deep waters of the Gulf of Mexico were where the majority of accessible, unexploited US oil and gas was expected to be found.

With hindsight it now seems clear that in 2005 the first large-scale application of hydraulic fracturing ("fracking") and horizontal drilling to shale in the Barnett gas field near Dallas, TX was pointing to an entirely different set of possibilities.  The Barnett had just passed a major milestone: one billion cubic feet per day of production. However, other than visionary entrepreneurs like George Mitchell, few energy experts then foresaw how rapidly shale could scale up elsewhere.

Fast-forward to 2015, and the country has experienced a profound geographical diversification of its energy sources. As the following key chart from the EIA's analysis shows, since 2003 the offshore Gulf of Mexico's share of US production has fallen by 40% for crude oil and by nearly 80% for natural gas.

The divergence in those figures may seem surprising. "Tight" oil from deposits North Dakota, onshore Texas and the mountain West supplemented deepwater production that post-Deepwater Horizon has recovered to roughly the level of 2004, bringing total US oil output close to an all-time record earlier this year.  Meanwhile, rising shale gas output in Arkansas, Louisiana, Ohio and Pennsylvania  more than compensated for  the steady, long-term decline of Gulf of Mexico gas production. The extent of the shift in US gas sources has even raised questions about the viability of the benchmark Henry Hub (Louisiana) trading point for the main gas-futures contract. 

In fact, when we look beyond oil and gas to factor in the growth of renewable energy and the recent decline in coal consumption in the power sector, since 2004 the equivalent energy dependence of the US on the Gulf of Mexico--including imports--has fallen from 7% to roughly 4%, in terms of total energy consumption.

If oil prices had remained where they were a year ago, above $90 per barrel, there would be little doubt that this trend would continue. However, the latest short-term forecast from the EIA suggests that US onshore oil production will fall by about 6%, due to reduced shale drilling, while Gulf of Mexico production ticks up about the same percentage, as more projects that were begun under higher oil prices come onstream. This is generally consistent with the outlook of the International Energy Agency. By itself that could cause a small increase in Gulf of Mexico dependence.

As for gas, EIA projects that US onshore natural gas production will continue to grow, though at a slower rate than recently, while offshore gas continues its decline, reinforcing the shift away from the Gulf. The technology and techniques for developing onshore shale gas continue to improve, even with low natural gas prices, while the identified gas resources of the eastern Gulf of Mexico remain off-limits.

The relative importance of the large refining centers on the Gulf Coast may be evolving, too, for different reasons. US refined product exports have grown substantially since the financial crisis, with most of them sourced from the Gulf Coast. To the extent such shipments could be delayed in an emergency or swapped for product sourced abroad to be delivered to their original destinations, that effectively creates a buffer against storm-related disruptions in domestic deliveries.

The abundance of natural resources and the legacy of decades of infrastructure investment guarantee that the US Gulf Coast will remain a key region for US energy supplies. However, the technology for tapping resources elsewhere has greatly reduced the chances for a repeat of the events of 2005, when a pair of hurricanes set the stage for the highest natural gas prices in US history. Low oil prices might slow down further reductions in the relative energy contribution of the Gulf, but a significant reversal of this trend looks unlikely under either low or high oil prices.

 

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

What Do Futures Markets Tell Us About Long-term Oil Prices?

• The tendency to believe that the prices of oil futures contracts are predicting the future price of oil is understandable but not supported by the track record of such bets.
• The prices of long-dated oil futures merely reflect where buyers and sellers are willing to strike a deal today, for their own, diverse reasons.

A recent article in the Wall Street Journal reminded me of numerous debates about the significance of energy futures prices, when I was a trader and later a trading manager for the former Texaco, Inc.  Do changes in futures contract prices actually predict future oil prices as the Journal's reporter suggests? If so, then it might be reasonable to conclude that today's low oil prices could persist for years. However, from my perspective that over-interprets the market data and ignores some important oil fundamentals.

As tempting as it might be to think so, the futures market for West Texas Intermediate (WTI) crude oil isn't a crystal ball, and neither is the market for UK Brent crude. A futures price is simply the price someone is willing to pay or receive now for oil to be delivered (or settled without delivery) later. It is typically based on business needs, rather than deep analysis.  A concrete example might be helpful.

The parties who on August 11th bought or sold oil for $56 or $57 in December 2017 likely did so, not because they were certain what the price would be then, but because they couldn't be sure and either needed to hedge another transaction or activity, or thought it constituted a reasonable bet. Aggregating a modest number of such transactions--long-dated futures trade much less frequently than those for the near months--doesn't improve the accuracy of these bets on an inherently unpredictable commodity over long intervals. Anyone who thinks it does should examine the track record of oil futures as predictions; it is a sobering exercise, especially for those who have traded this market.

Consider that while the September 2015 WTI contract closed at a little over $43 per barrel that afternoon, traders were buying and selling the same contract for more than twice as much during long stretches of 2012--about as far removed from us as the late-2017 contract prices cited in the Journal article as evidence of a persistent oil-price slump. Prices for the September 2015 contract were even higher in the middle of last year, when traders knew nearly as much about the growth of US tight oil production and its rising productivity as we do today, but crucially didn't know that OPEC would choose not to cut output to alleviate an over-supplied market as they had done in the early 1980s and late 1990s. Similar examples abound.

So how else might one explain the fact that long-dated oil contracts are trading for less today than they were this spring, if not as a prediction of a longer period of low prices ahead? Behavior and learning play key roles. With the  first anniversary of this historic price collapse just a few months off, expectations of a quick rebound in prices have faded. The possibility that the US could produce as much tight oil, for now, with fewer than half as many drilling rigs in operation as a year ago has sunk in. So has the reality that as painful as $50 oil is for some of OPEC's members, cartel leaders like Saudi Arabia show little inclination to blink first.

However, others are blinking, and that's why I'm skeptical that oil prices can remain this low indefinitely. The cuts in staff and investment budgets by major oil companies and their national oil company peers have been breathtaking, totaling $180 billion this year according to one analysis. The cuts suggest that the projects in question require significantly higher oil prices to be profitable, even after recent cost reductions, or have become too risky at current prices.

Few of these companies are big players in shale. Their bread and butter is large, conventional onshore oil fields and enormously expensive deepwater oil projects, the collective output of which is inherently subject to annual declines in output. Decline is the "silent killer" of output, to the tune of 5% or so every year. The only way to offset this trend within the portfolios of these producers is to spend large sums every year on new wells and new projects--projects that according to Rystad Energy, as cited by Bloomberg, have been cut more than at any time since 1986.

We must also put the US shale revolution in its proper context. When added to a global market that was balanced between supply and demand at around $100 per barrel, it was a game-changer, not least because no other producer or group of producers was willing to reduce output enough to accommodate this new source. However, even at today's 5.4 million barrels per day US tight oil represents only about 6% of global supply. The combination of shale plus OPEC covers less than half the world's oil demand.

The remainder must come from onshore and offshore oil fields in non-OPEC countries like Brazil, Canada, Mexico, Norway, and Russia. This non-OPEC supply has grown thanks to  a wave of completions of  large projects begun 5-10 years ago, when prices were rising rapidly. However, reduced investment now surely means lower non-OPEC production within a year or two.

The key question for future oil prices is therefore when demand, which according to the International Energy Agency is growing rapidly under low prices, and supply, for which new investment has suddenly shifted from the accelerator to the brake pedal, will cross over, erasing today's glut. It's hard to infer the answer from the thinly traded market for long-dated oil futures contracts.

Is North America the New Middle East for Oil?

With the President of the United States currently playing the role of pessimist-in-chief with regard to US energy independence, it's refreshing to see that goal raised as a serious possibility by someone whose experience and position give him deeper insights on the subject. A few years ago Ed Morse was running the oil trading operation for Hess, and now he's at Citigroup. His op-ed in today's Wall St. Journal offers an upbeat analysis of the ongoing resurgence in US and Canadian production and the potential for North America to move within striking distance of true oil independence. He doesn't appear to be predicting $2.50 per gallon gasoline any time soon, but he does remind us that permanently higher oil prices needn't be inevitable, although he is also very clear about the obstacles that could impede these developments.

How often have politicians and pundits reminded us that we can't drill our way to energy independence? I've said that myself numerous times in the eight years I've been blogging here. So before exploring the implications of producing significantly more oil than we do today, it's worth asking why some experts are starting to question what has been a bedrock assumption about the US energy situation since our conventional oil production peaked in 1970--not coincidentally just before the first oil crisis in 1973-74.

If the tired talking point about the US having just 2% of the world's oil reserves were truly reflective of reality, rather than a technicality based on the way the SEC requires oil companies to account for their chief assets, people like Ed Morse wouldn't give energy independence a moment's thought. The number to focus on is not the 21 billion barrels of proved reserves on companies' books, but the nearly 200 billion barrels of discovered and undiscovered "technically recoverable oil resources" onshore and offshore, in the lower-48 and Alaska. That figure represents more than 95 years of production at current rates.

That estimate is also mostly based on assessments from the 1980s done with technology that bears the same relationship to current exploration techniques as an old Ma Bell rotary phone does to an iPhone. It's technology that is shifting expectations about what is actually possible. Consider the Bakken shale formation in the Dakotas. The conventional Williston Basin oil fields were discovered in the early 1950s and mostly played out by the late 1980s. The billions of barrels of resources in the adjacent Bakken shale, which might produce a million barrels per day by the end of this decade, simply couldn't have been produced at commercially useful rates with the technology that was available until the last decade. The hot question now is where the next Bakkens will be found.

Then there's deepwater drilling, which suffered a big setback with the Deepwater Horizon accident and spill but is still contributing 1.2 million barrels per day and could reach 1.9 million next year. What moves Mr. Morse's speculation from wishfulness into the realm of practical possibility is the potential of applying technologies like those to exploit conventional and unconventional reservoirs to which industry has not had access since their development, if ever.

Another talking point that we've heard like a drumbeat over the last several months is that even if the US could produce more oil, it would make little difference to oil prices in a global market of 90 million barrels per day. We simply don't control the price of oil; OPEC does. That has been true for essentially the entire time I've worked in energy. But here's where it's handy to have the background in oil trading that I share with Mr. Morse. Traders have to think about how prices are really set, and they understand that it's the interaction of the last few million barrels per day of supply, demand and spare capacity that really count, along with inventories. An extra million or two barrels per day--a quantity of which North America is certainly capable--can make a huge difference in oil prices. We saw that in 2009, when a drop of about 3 million barrels per day of demand sent prices from $140 to $40 within a few months, and we saw something similar involving both supply and demand during the Asian Economic Crisis of 1997-98. (See chart below.)


Nor is OPEC monolithic; it's made up of a group of producers with very different levels of reserves and production, and differing domestic requirements for the revenue they earn from selling their oil. That means that, contrary to yet another talking point, OPEC does not have unlimited capacity to back down production, in order to keep prices high when others increase output. And even when it can maintain enough cohesion to tighten quotas and restrict its own output, the production in question merely shifts to "spare capacity", the expansion of which reduces oil market volatility. Imagine how different the market's response to the current confrontation over Iran's nuclear program might look if other producers had a multiple of Iran's exports in reserve.

Just because something is possible with a decade or so of determined effort doesn't make it inevitable. While I share Mr. Morse's optimism about the benefits of boosting North American oil production on a scale that would dwarf the modest recent upturn, which has received so much attention from politicians who had nothing to do with it, I'm also skeptical that it could proceed to quite that extent in today's climate. Aside from people who are genuinely concerned about the possible environmental impact of more oil development, there are also those who would regard such a turn of events as contrary to their own interests and their perception of the nation's. How would we convince consumers to pay the premium for new cars achieving an average of 54.5 mpg in 2025 if gasoline remained between $3 and $4 per gallon, instead of trending toward $6--let alone shifting them into electric vehicles that the government and carmakers have invested billions in developing? And how would we stimulate production of advanced biofuels if the future price of crude oil were seen as being capped at or below $100 per barrel, except during geopolitical crises?

I believe all such questions have answers that don't depend on us constraining access to our resources at the cost of remaining more vulnerable to overseas suppliers and weakening both our trade deficit and our currency. I'd rather have the extra domestic oil and then worry about how to spend some of the resulting windfall of federal and state taxes, bid bonuses and royalties on achieving our other policy objectives, such as promoting efficiency and reducing emissions. Nor is relying on OPEC to keep prices high the best or most effective way to encourage us to use oil more frugally.

I don't know if North America is the next Middle East, although it's worth recalling that we were the world's biggest oil supplier before the first well was drilled in Saudi Arabia, and DOE estimates suggest we have as much oil left as we've produced to date since 1859. However, I do know that I would much rather give OPEC's leaders sleepless nights worrying how they'll keep oil prices high in the face of a wave of new production from the US, Canada and possibly Mexico, in preference to giving US consumers sleepless nights about how they'll pay for the gasoline they need for their commutes and the fuel to heat their homes, if prices stay this high or higher from here on out.

The Brazil Spill

Late yesterday I saw a headline reporting that Chevron was being assessed more than $10 billion for a spill from its drilling activities offshore Brazil last month. The story was later revised to clarify that the amount in question was associated with a civil lawsuit being filed by a Brazilian prosecutor, rather than an actual fine by the government petroleum or environmental agencies. Either way, the sum involved goes beyond surprising. Given the quantity of oil that actually leaked from an appraisal well at Chevron's Frade platform, it is grossly disproportionate to any objective gauge of the scale of the spill and the effectiveness of the response, which stopped the leak within a few days and reduced the surface oil slick to around one barrel within a couple of weeks, without any oil reaching shore. For a nation that aspires to sit at the top table globally, including a permanent seat on the UN Security Council, the reaction to this event raises questions about due process and rule of law. It could also backfire badly, in light of the substantial foreign investment Brazil is seeking in order to develop the enormous "pre-salt" oil deposits off its coastline.

My purpose in writing about this incident isn't to defend Chevron. I don't have enough of the details of what happened, and my well-known conflict of interest as a former employee and Chevron shareholder would undermine my credibility on that front in any case. From my perspective the noteworthy aspects of this spill are its magnitude and the Brazilian government's hasty and exaggerated reaction to it. In terms of its energy implications, it almost doesn't matter what company was involved, except that it's highly unlikely that a similar spill by Petrobras, the partially-privatized national oil company of Brazil, would have elicited the same response.

Start with the magnitude of the leak. No oil spill is a good spill, but the estimated 2,600 barrels that leaked into open waters about 120 miles offshore was at least two orders of magnitude (100 times) smaller than the kind of worst-case tanker spill that oil companies routinely plan and train to be able to handle. Suggestions by the Brazilian government that a global oil company and its drilling contractor, Transocean, weren't prepared to handle a spill of less than 3,000 barrels--more than one year after the Deepwater Horizon accident--belong in the realm of politics, rather than serious analysis.

In fact, any comparisons to the disaster that killed eleven men and leaked 4.9 million barrels of oil into the Gulf of Mexico over 89 days, fouling beaches and harming birds and marine life in four states must pale. The total cost to BP and its partners in the Macondo well isn't yet known, but between the $20 billion escrow fund for Gulf Coast cleanup and claims, along with the federal fines they face, the bill could come to $40 billion, or 4 times what a Brazilian prosecutor is apparently seeking for a spill roughly 2000 times smaller, that never threatened Brazil's coastline. The Frade leak is also modest in comparison to spills from tankers and other ocean-going vessels. Comparable or larger spills averaged more than 3 per year in the last decade, according to the International Tanker Owners Pollution Federation.

Another interesting feature of the spill is that it didn't result from an uncontrolled well blowout, as BP's did, but from subsea oil seeps that developed during the process of drilling into the complex geology of Brazil's technically challenging pre-salt oil deposits. Although these particular seeps were apparently directly related to the well Chevron was drilling, similar seeps are a common feature of many oil-rich offshore regions. NASA has estimated that the Gulf of Mexico experiences similar, naturally occurring seeps on the order of 500,000 barrels per year.

So if the Frade spill was relatively small and contained in short order, why should anyone other than Chevron's management and shareholders care if Brazil slaps them with large fines or a multi-billion-dollar lawsuit, in an apparent attempt to make an example of them and enforce what amounts to a zero-tolerance policy toward oil spills from its offshore projects? I'd argue that we all have something at stake here, indirectly. Brazil's pre-salt reserves offshore represent some of the largest recent oil discoveries and are expected to contribute 2 million barrels per day or more to global oil supplies by 2020. With output in Latin America's two other largest producers, Venezuela and Mexico, falling due to mismanagement of their otherwise ample resources, Brazil's output could be a key factor in oil prices in this decade and beyond.

Brazil is poised to become a major oil exporter, but Petrobras can't take on the scale and risk of this opportunity on their own, without foreign partners. It's not that they lack the technology; Petrobras is a leader in deepwater development. However, if they have to go it alone because the government's response to this event scares off its potential partners, they will be forced to reduce the size of their program, and oil prices will end up higher than they would have otherwise. While I'm entirely sympathetic to the sentiment behind a "zero-tolerance" attitude towards oil spills, whether from oil platforms, tankers or pipelines, I'm afraid it belongs in the same category as a zero-tolerance toward plane crashes: a standard to aspire to, but not one on which national development policies with global consequences can realistically be based.

The Energy Glass Is More Than Half Full

A recent comment from a frequent reader got me thinking about the good news that has accumulated on the energy front, even as the rest of the economy has bogged down in pessimism. There's actually quite a lot of it, though perhaps it has been easy to miss, because most of these developments look like bad news from someone's perspective, as organizations and social-media-empowered individuals seek to outdo each other in the hunt for negative ramifications and unintended consequences. Recognizing the positive aspects of such nuggets as shale gas and its recent extension into shale oil, along with factors like the plummeting price of solar panels that contributed to the Solyndra debacle, requires stepping back to view them through the lens of the big energy problems that have plagued us for decades.

As recently as a few years ago, it was widely assumed that the US was running short of both oil and natural gas. Domestic oil production was declining steadily, as it had been since the mid-1980s, even as US oil consumption kept rising. The result was a wedge of oil and petroleum product imports that seemed likely to widen indefinitely. Moreover, US natural gas production appeared destined for the same outcome, as non-associated gas fields in the shallow waters of the Gulf of Mexico declined faster than expected, and diminishing oil production slowed associated gas output. The combination of these trends made energy security a priority concern again, after more than a decade of complacency.

The turnaround in these trends has been nothing short of astonishing. Last week the Houston Chronicle published an article with the headline, "N. American oil output could top 40-year old peak", accompanied by a graph showing a clear inflection point in 2008--not by coincidence about five years after oil prices began their climb from the $20s to a peak just shy of $150 per barrel. Motivation plus investment equals production, after an inherent time lag. But what's really changed is that those investments weren't just going into more of the same onshore conventional oil fields that had been declining; they were going into deepwater drilling, oil sands extraction, and lately into the application of shale gas drilling techniques to similar deposits of shale oil that weren't in anyone's reserves just a few years ago, because no one knew how to tap them effectively and economically.

The latter provides a fascinating example of innovation, today's hot buzzword. Drillers have been hydraulically fracturing oil wells since the late 1940s--about a million of them--and horizontal drilling has been around for more than a decade, too. Combining these techniques, along with modern seismic visualization, has unlocked what looks like a century's worth of natural gas supplies. But if this weren't enough of a game-changer, setting up gas-fired power plants as both a replacement for coal and as the on-demand backup for intermittent renewables like wind and solar, some smart folks realized that the same combination of techniques could produce oil from other shale deposits. Suddenly fields like North Dakota's Williston Basin (the Bakken formation) and the Eagle Ford shale in Texas are counted among the largest oil fields in the country, with billions of barrels of potential reserves and production in the hundreds of thousands of barrels per day.

When we look at these successes and recognize that some of the most prospective US oil resources remain locked away behind actual and virtual drilling bans, the mantra that we can't drill our way to energy independence at least merits a serious reassessment. But what's even better about these recent energy revolutions is that they aren't occurring in a 1970s' context in which all this extra oil and natural gas would merely be burned in gas-guzzling cars and inefficient power plants. Instead, they coincide with impressive advances in fuel efficiency, in which muscle cars like the Camaro and Mustang can get at least 30 miles per gallon on the highway, while true economy cars get over 50 mpg today. Meanwhile, we've squeezed almost all the petroleum out of the utility sector, with just 0.9% of US power generation last year coming from oil-based fuels, while nearly 54% came from lower-emission sources such as gas, nuclear and renewables. These trends are moving in the right direction, too.

Renewables have come a long way, since solar cells were niche or novelty items and the economics of wind power only appealed to wealthy taxpayers seeking write-offs against marginal tax rates of up to 70%. Notwithstanding the struggles of individual firms like Solyndra and Evergreen Solar, global photovoltaic (PV) generating capacity grew by 74% last year to 40,000 MW, roughly where wind power was in 2003, if you ignore how much of the former has been installed in places with miserably poor solar resources. Wind power is still cheaper than solar power, but solar looks much more useful in the long run, because its output is more predictable and better aligned with demand. Both remain more expensive than conventional energy sources, though the gap is narrowing, especially for solar, and without cheap and abundant natural gas from shale resources it might not exist at all in some markets. Together with a resurgent geothermal energy sector, these renewables could soon survive with little or no subsidies by concentrating on regions with the best combinations of resources and transmission-accessible markets. (Germany would have installed its last solar panel in that scenario.) That wasn't an option just a decade ago.

The greatest contribution the energy sector can make is providing affordable and reliable inputs for the rest of the economy. Building on the developments above it should be possible to craft cost-effective energy policies to improve US energy security significantly and greatly reduce the leverage of the sources of our imported oil, including OPEC as a whole. At the same time we could move the electricity sector, which never really had an energy security problem but remains the largest source of US greenhouse gas emissions, towards much lower emissions without breaking the bank. Those outcomes seem attainable, if we can moderate our impulses to treat energy policy as a piggy bank for patronage or a laboratory for industrial policy. In that respect, energy just might be the most solvable of all our big problems.

Turning to Energy for Jobs

Yesterday's Energy Jobs Summit at the US Capitol, hosted by The Hill and API, focused on the potential of the energy sector to add large numbers of new jobs to help alleviate the national jobs crisis that President Obama will discuss in tonight's speech. The figures presented by API and others were impressive, with the oil and gas sector alone capable of creating over a million jobs if provided increased access to US resources. Panelists also discussed "green jobs", including those from energy efficiency projects. Yet I was struck by the inherent tension between today's job-creation imperative and our long-term need for an energy sector that is as productive and cost-effective as possible, in order to support economic growth and reemployment in the roughly 92% of the economy beyond energy. That makes highly productive private-sector energy jobs requiring little or no public investment especially valuable.

In a new study released at the summit, Wood Mackenzie estimates that the US oil and gas industry could increase its employment by 1.4 million by 2030, with a million of those jobs attainable by 2018--more than half in the next two years--under new policies that would lift the current bans on offshore drilling outside the established areas of the Gulf of Mexico and on shale drilling in New York, speed up permit issuance in the Gulf, open up new onshore acreage for leasing, and approve the Keystone XL pipeline. In the process, domestic production of oil and gas liquids could eventually nearly double, while natural gas output would grow by over 60%. Even better, from a deficit-and-debt reduction perspective, this effort would require no new government expenditures and stands to contribute a cumulative $800 billion in additional federal and state royalties and tax receipts.

The potential jobs impact is extraordinary, when you think about it. Oil and gas is an incredibly capital-intensive industry with very high worker productivity--one reason that salaries in the industry tend to be much higher than average. An industry like that is hardly the first place one might think to look when seeking massive job growth. The fact that such growth is even possible is both a validation of the tremendous untapped resource potential we still possess, and an indictment of decades of bipartisan energy policy mismanagement that has preferentially outsourced US energy production, rather than exploiting our own resources.

What about the contribution of "green jobs"? The growth of cleantech--renewable energy and energy efficiency--can certainly contribute to US job growth, yet we should understand clearly that such jobs won't spring forth spontaneously from the private sector without substantial continued government incentives and subsidies. Nor are those a guarantee of success. The US wind industry installed just 2,151 MW of new capacity in the first half of 2011. While that was considerably better than last year's pace of 1,250 MW, it's still 47% below installations in the first half of 2009, despite last December's against-the-odds extension of the Treasury renewable energy grants, which paid out $2.2 billion to wind projects this year. And the recent solar bankruptcies and the aggressive offshoring by solar manufacturers fighting to stay competitive with Asian suppliers also demonstrate that green jobs, other than those in installation and construction, are just as vulnerable to global competition as in any other US manufacturing industry.

Conventional energy jobs aren't immune from competition, either. I was startled to read yesterday that regional refiner Sunoco plans to exit the refining business after more than 100 years. Its two Philadelphia-area refineries will either be sold or shut down by mid-2012, with 1,500 jobs at stake. Prospects for a quick sale of these facilities look poor, because these plants are among the most exposed to global oil prices that have been running more than $20 per barrel higher than for crudes produced in Canada and the US mid-continent. Idling these plants would take a big bite out of east coast gasoline supplies and inevitably lead to both higher product imports and higher gasoline prices in the northeast and mid-Atlantic regions. As someone pointed out at yesterday's session, it's a sad commentary that Sunoco can make more money selling sodas and snacks at its retail facilities than it can refining crude oil.

That dynamic makes the production-related jobs in the Wood Mac study even more attractive: Despite being tied to a depleting resource, US oil & gas exploration and production enjoys a greater sustainable competitive advantage in the global marketplace than either refining or cleantech manufacturing, at least when it has sufficient access to domestic resources.

However, these opportunities also pose a test of our seriousness on the jobs issue. Opening up the Virginia and California coastlines, for starters, along with the coastal plain of the Arctic National Wildlife Refuge to exploration raises a host of NIMBY and environmental concerns. I don't want to trivialize them, but I would suggest that the time when we could afford such sensibilities may have passed, heralded by our continued descent in the rankings of national global competitiveness and the rapid growth of our indebtedness. Creating a number of "green jobs" comparable to Wood Mac's estimate of 1.4 million from oil and gas would require the expenditure of tens to hundreds of billions of dollars the federal government doesn't have, and that the current Congress seems unlikely to be willing to appropriate. It would also risk embedding expensive energy at the core of the US economy, hobbling our non-energy economy, where most Americans are employed.

Yesterday's energy jobs summit was held in the new Capitol Visitor Center, which I hadn't seen before. It's a gorgeous facility and a suitable addition to the paramount edifice of our democracy. However, I was also struck by the contrast it provided with the meeting's subject matter. Recall that the Visitor's Center ended up costing over $600 million, well over twice its original plan. I hope that when the President presents his jobs program tonight, it will be grounded in the crucial distinction between that kind of government-funded, "shovel-ready" project that might put some of our fellow citizens back to work for a few years and an energy-and-jobs resurgence funded entirely by companies and their investors.

Honey, I Shrunk the Oil Industry

I finally finished watching the archived video from last week's Senate Finance Committee hearing with the heads of the five largest major oil companies in the US, including the two that are based in the EU. The few nuggets of real information and insight that were exchanged were nearly drowned out by political posturing, but my hat is off to Chairman Baucus (D-MT) for his willingness to engage in a genuine give and take with his guests. I attribute much of the frustration that was on display to the conflict between the facts and their context: Although the companies are mostly right on the principles and consequences involved in the proposal to strip them of their tax incentives, it's nearly impossible for anyone outside the industry to get past the large profits these companies are making and the out-of-control federal deficit that the Congress must endeavor to rein in. Perhaps I can offer a bit of perspective for both sides of the argument.

First, neither this Congress nor the administration is proposing windfall profits taxes--government's traditional threat when oil profits soar--nor are there serious calls for nationalization of the industry. Having watched other countries make a hash of such moves, it appears we've learned a thing or two in the last three decades. The measures currently under consideration are much less extreme than that, and I imagine they sounded reasonable and fair to a lot of Americans who are in sticker shock every time they drive by a gas station. However, that doesn't make them good policy--energy or tax.

At the same time, despite Senator Hatch's pie chart showing the relative size of the US oil industry compared to the global industry, including OPEC, few of those grilling the CEOs seemed to grasp the scale involved--a major factor in the absolute magnitude of the profits in question--including the size of companies with which these firms must compete for opportunities around the world. For comparison I couldn't turn up an estimate of Saudi Aramco's first quarter earnings through a Google search, so I had to devise one myself. Based on an average OPEC basket price of $101/bbl and a conservative production cost of $20/bbl, Aramco's average volume of oil exports in January and February, as reported in the database of the Joint Organizations Data Initiative, implies quarterly earnings of around $50 billion--more than the total of the five companies represented at the hearing--and that's assuming that every barrel Aramco refines and sells within the Kingdom is at a breakeven. When it comes to oil profits, big is relative. Even the much smaller Petrobras, 64% owned by the Brazilian government, posted $6.7 B in first quarter earnings, beating US #2 Chevron, in which I own shares.

Several of the Senators complained that the math didn't seem to work, in terms of understanding how the withdrawal of a couple of billion a year in tax incentives could have a serious impact on the five companies and shift investment away from the US, a much more serious concern than the effect on earnings. Having participated in the project portfolio process of a major oil company in the past, I believe I know what the Senators were missing.

It seems counter-intuitive, but corporate-level accounting profits reported after the fact have virtually nothing to do with project selection decisions, other than influencing how much money is available to invest. The choice of which new projects to pursue and which to leave on the shelf hinges on detailed comparisons of expected future after-tax earnings and cash flow for each project. Tax rates, deductions and credits play an important role in those calculations. For some projects the go/no-go decision rests on a knife edge of risked net present value, and in that environment a lost tax deduction (Section 199) or tax credit could make US projects look consistently less attractive than their foreign counterparts. (Ironically, these companies' renewable energy investments in the US would also suffer the same disadvantage.) Put enough US energy projects in that position, and the result is inevitable: fewer wells drilled here, less future US production as current production declines, and eventually a smaller domestic oil industry with fewer capabilities.

Despite a few half-hearted attempts to channel the ghost of William Jennings Bryan, I doubt that any of the Senators participating in the hearing really wants such an outcome. It wouldn't help the millions of Americans who are alarmed by high gas prices, and it's hardly consistent with the President's goals of reducing oil imports by one-third and improving US energy security. Unfortunately, because of the way the question has been framed, in terms of a narrow set of tax breaks the industry enjoys, there are no good answers. Those can only be found by expanding the conversation to encompass a truly constructive US energy policy promoting both conventional and renewable energy, along with meaningful deficit reduction.

Obama on Energy: Getting the Balance Right

Another energy crisis, another presidential speech? It must seem that way to many of us who came of age in the first set of energy crises in the 1970s, and the President acknowledged that history in his talk on energy at Georgetown University on Wednesday. Yet although it contained little in the way of new ideas or initiatives, along with a target that was remarkable mainly for the relative ease with which it might be met, it at least presented a perspective that balances the continuing importance of our current energy sources with the potential of our new ones. No more talk of "yesterday's energy."

I was under the weather this week, so this is at least a day later than it should be, but if nothing else was clear from Wednesday's speech it's that our energy challenges have persisted for so long, while our preferred solutions have shifted with the mood of the moment, that a day or a week changes nothing. However, a sense of urgency matters, as gasoline prices rise to levels we haven't seen since 2008. A president can't be seen to be behind the curve on this issue. Except for a few quibbles I'll come back to, Mr. Obama got matters mostly right, reminding his audience that we will remain dependent on oil for a long time, and that increasing domestic oil production and relying on stable neighbors are both crucial strategies for managing our vulnerability to imports from less dependable sources. That puts him squarely in the mainstream of serious American energy thinking for the last four decades.

The President's goal of reducing oil imports by one-third from their level of 11 million barrels per day in 2008 seemed appropriate for several reasons. First, because the basis of that goal is the right one: net imports of crude oil and petroleum products. It would do little for our energy security to reduce crude imports by constraining US refineries and then importing more refined products from abroad. Nor should one ignore the growing US exports of refined products arising from mismatches between US fuel regulations and refinery configurations and yields. More importantly, this is one of the first energy security goals I've seen that we stand a fair chance of achieving. The DOE's preliminary forecast for 2011-35 shows a 17% reduction in oil imports by 2025 in the reference, or base case. Last year's forecast for the high oil price case showed an even steeper reduction, meeting Mr. Obama's goal as early as 2021. Reaching the President's target shouldn't require Herculean efforts, provided we stay focused on the things with the greatest potential to deliver in that timeframe: increased domestic production, efficiency, and possibly next-generation biofuels. That leaves out electric vehicles, which are a longer-term proposition, along with wind, solar and other renewable electricity sources, which only stand to displace oil via EVs. (Remember, a million EVs replace less than 0.2% of our oil consumption.)

The President was right to highlight the potential contribution from biofuels while calling for reform in biofuel subsidies, a task that is long overdue. He cited two examples of how biofuels could help to reduce our oil imports. One related to the military's goal of obtaining half its domestic jet fuel needs from alternatives to petroleum, while the other promoted four "next-generation biorefineries", referring to facilities that produce fuel from non-food biomass. Unfortunately, he didn't mention cost as one of the key trade-offs involved. It's laudable for the military to seek to reduce its vulnerability to oil-supply disruptions, and it can provide a crucial early-adopter base for new technologies. However, to the extent that bio-based jet fuel is more expensive than conventional fuel, then either Air Force operating budgets must include cuts in other areas, such as missions and training, or we will be buying fewer new-gen aircraft to pay for it. And while subsidies can help next-gen biofuels reach commercial scale--I don't consider 20 million gallons per year (1,300 bbl/day) as meeting that definition--they can't guarantee they will be commercial. That will require mastery of one or more of the numerous technology paths now being pursued, more than a few of which have already disappointed. Technological mastery doesn't appear on command.

That's an important consideration, because as desirable as it is to produce large quantities of biofuel without setting up ruinous competition between food and fuel, it seems equally important not to build another industry that will be unprofitable without sustained large government subsidies for decades to come. Helping new technologies through the development stage and across the "commercialization chasm" makes sense, but the level of support now offered for cellulosic biofuel, at $1.01/gal., looks unaffordable once output finally start to take off. As it is, corn-based ethanol will collect roughly $6.3 billion this year from a subsidy less than half that generous, for its displacement of just under 7% of our gasoline consumption on an energy-equivalent basis.

That brings us to the only item in Wednesday's talk that we haven't been hearing about for years: the application of the nation's newly-tapped shale gas bonanza to address the problem of our oil imports. Aside from the jokey references to the expertise of his Secretary of Energy, whose Nobel Prize in Physics was for "development of methods to cool and trap atoms with laser light"--not so relevant to natural gas extraction--this was the speech's money line. Shale gas is the only new technology we have that can deliver huge amounts of energy to compete directly with oil in transportation using off-the-shelf-technology: no breakthroughs required. This would have sounded even more impressive and serious if the punch line had focused on knocking down the barriers to making that happen, including infrastructure requirements and vehicle conversion costs, rather than calling for a bill regulating the production of shale gas.

And unfortunately, that was symptomatic of the things that kept the President's talk from being a landmark in our decades-long battle with energy security. It's one thing to state the problem clearly and lay out the options; it's another to bring it all together in a realistic plan for action. The administration's new "Blueprint for a Secure Energy Future" merely incorporates natural gas into a grab bag of many of the same initiatives it has been pushing since Inauguration Day 2009. Nor does it help when the President repeats his old talking point about the US consuming 25% of the world's oil (it was actually 22% last year) but having only 2% of its oil reserves. Someone needs to pull him aside and explain that current US proved reserves are no more of a limitation on future US oil production than wind power's contribution of just 2% of US power generation last year caps its future potential at that level. Reserves support today's production; resources determine tomorrow's, and the US has many billions of barrels of untapped resources, many of which remain off limits under the administration's policies.

So call it two-thirds of a great speech on energy. Unfortunately, what we desperately need is that missing third that concentrates it into something that the American people--and American industry--can rally behind.

Press Conference Confusion

After listening to the energy portions of the presidential press conference last Friday, I found myself confused about the administration's approach to energy. Although I heard the President defending certain US energy policies, they weren't mainly those of his administration, nor were many of the outcomes he highlighted the result of actions he has taken. What's odd about that is that this administration has pursued as clear a set of energy policies, explicit and implicit, as any administration in recent memory; they just happen to be focused on a very different set of goals than attempting "to boost domestic production of oil and gas". And while I haven't agreed with all of them, his administration's actual policies concerning energy are certainly defensible in the context of putting the highest national priority on concerns about climate change. Before looking at this in more detail, I want to share a few thoughts on the aftermath of the quake and tsunami in Japan.

Having spent many years in earthquake country, I have deep sympathy for what the people of northeastern Japan are experiencing. The cleanup and recovery will take years, and the tectonic and emotional aftershocks will persist for a long time. The aftershocks for energy are more difficult to assess. It seems premature to draw conclusions about the impact on Japan's nuclear reactor fleet and the future of the global nuclear power industry. However, if the damage to several reactors is as bad as reports suggest, then the Japanese power grid must make up for the lost generation using either spare capacity at fossil fuel plants or with new technology. That could affect global fuel markets and the global demand for quickly-deployed generation, including both photovoltaic power and conventional small generators. At the same time, the extent of disruption the quake has caused to the global supply chains for such technologies is not yet clear. I'll be watching for discernible trends on these concerns in the weeks and months ahead.

Now back to the press conference. Two years into this administration, it has a track record on energy. The President campaigned on a platform of refocusing the government's energy efforts on renewables and energy efficiency, and he has followed through on that. The stimulus bill enacted in February 2009 included nearly $17 billion for those areas and not a penny for oil and gas. The administration's latest budget proposes slashing funding for R&D on fossil energy technology and ending tax incentives for domestic oil and gas production, using the savings to increase support for renewables and efficiency, consistent with his State of the Union remarks about investing in tomorrow's energy instead of "yesterday's". The President also supported comprehensive energy legislation, the explicit purpose of which was to make energy derived from fossil fuels--especially oil--more expensive. Although I have disagreed with many of these measures because I thought they took too little cognizance of the realities of the energy sector that supports our economy and the length of time a transition to cleaner energy entails, there was at least an admirable--and defensible--consistency to them. I would not have expected the President to tack away from defending these policies the first time oil and gasoline prices seriously spiked since his inauguration.

Then there's the matter of appearing to take credit for the recent recovery in US oil production by citing it twice in his remarks. The increase is real enough, though most experts, including the administration's own Department of Energy expect it to be short-lived, as the lagged effects of the post-Deepwater Horizon deepwater drilling moratorium work their way through the system. In fact, lags are the key to the whole question. If you have had experience with large projects, and particularly oil projects, then you realize that it typically takes a lot longer than two years for them to go through all the stages from inception to first production, including leasing, exploration, permitting, procurement and construction. The last time I looked at this in detail for oil the average time lag involved was around 7 years.

What was happening seven or eight years ago? Well, oil prices were in the early stages of the long climb that peaked in July 2008 at $144. It's no coincidence that a wave of new projects should have been coming onstream over the last couple of years, because the attractiveness of investing in them increased tremendously when prices broke out of their long-standing $20-30 per barrel price range. Yet it can be no more than a coincidence that the resulting increase in production should appear during an administration that has put in place policies restricting access to oil & gas development, delaying permits, and in some cases rescinding previously awarded leases.

The President's statement about undeveloped oil leases is a further reflection of how short his administration is on staff with industry experience. Companies don't lease these tracts with the intention of letting them sit idle. Instead, they continually prioritize their drilling prospects and pursue the best ones first, adding new leases to their inventory when they appear to have higher potential than those in their backlog. This process benefits taxpayers as well as the companies involved by helping to maximize the production on which royalties are paid and displacing more imports. And in the meantime, the Department of Interior continues to collect rental payments on any undeveloped leases, having already pocketed the bid bonuses on the basis of which they were awarded in the first place.

President Obama isn't the first politician to take credit for the results of actions taken in another administration. Considering the blame presidents often receive for events over which they likewise had little control or responsibility, it might even be understandable. Still, I can't help being surprised when the leader of an administration that has focused 90% of its energy efforts on resources and technologies that account for about 5% of our energy consumption and treated oil and gas as a legacy of a previous, less enlightened era suddenly embraces rising oil output. Whatever the reason, the change is welcome. And he has certainly learned the lesson of not being overly specific in explaining the circumstances under which the Strategic Petroleum Reserve would be tapped. All that's needed now is a shift of emphasis to recognize both the large potential of the renewable energy technologies in which we are investing and the enormous contribution of the domestic oil and gas that supply 37% of our energy needs and can do even more in the medium term, under the right policies.

Cutting the Federal Budget Wisely

This week the administration issued its third budget since taking office in January 2009. In a year otherwise focused on belt-tightening, the proposal includes a 12% increase for the Department of Energy, focused on additional R&D for renewables and nuclear power. The increase would be offset by cuts in fossil energy programs and the elimination elsewhere in the budget of various tax deductions and tax credits--"tax expenditures" in Beltway parlance--that benefit the US oil and gas industry. Also new for this year are proposed additional fees on the industry to cover the increased cost of issuing drilling permits in the aftermath of the Deepwater Horizon accident, along with another provision to raise the cost of holding inactive oil and gas leases. Aside from the politics involved, this exercise reminds me of the periodic waves of cost-cutting I experienced at Texaco, Inc. in the 1980s and '90s. Unfortunately, the government hasn't yet learned the vital lesson that my former company and many in other industries finally figured out after years of experience: Reducing expenses only helps your bottom line when the items you are cutting contribute less in revenue than they cost.

Start with the oil and gas subsidies, which I've discussed previously. The newly submitted budget estimates these at approximately $4 billion per year. As we heard the President say in his latest State of the Union address, "I'm asking Congress to eliminate the billions in taxpayer dollars we currently give to the oil companies. (Applause.) I don't know if--I don't know if you've noticed, but they're doing just fine on their own. (Laughter.) So instead of subsidizing yesterday's energy, let's invest in tomorrow's." It's a guaranteed applause line, as the White House's own text indicates, despite including potentially serious errors of fact.

Now, one could argue in the abstract whether a tax credit or deduction constitutes a gift of "taxpayer money" (i.e., the government's) or an opportunity for the taxpayer in question to remit less of his own money to the government. I know how I feel about that when it comes to filing my form 1040. One might even arrive at different answers in different situations. As a practical matter, however, what counts in the current context is not whose money this is in the first place, but whether taking more of it leaves either the federal government or the US economy better off. Even from the perspective of tax revenue, a recent study found that after an initial increase, the long-term impact of higher taxes on the oil & gas industry resulted in reduced government revenue. Higher taxes on US oil & gas production will translate into less of both--and so less to tax--while also yielding more future imports and higher trade deficits, along with reduced energy security.

The President's remarks also suggested incorrectly that oil and gas are yesterday's energy, and not also today's and tomorrow's. In 2009 oil and gas accounted for 62% of our energy consumption, and the US Department of Energy expects them to continue to supply as much as 57% of our needs in 2035, after subtracting the contribution of liquid biofuels. Treating these key energy sources as undesirable could have serious consequences for our energy and economic security in the years ahead. Nor would it assist our efforts to reduce greenhouse gas emissions. Natural gas can contribute significantly to reducing the emissions from the power sector, which accounts for 40% of US CO2 emissions, and the main opportunities for reducing emissions from transportation, where most of our oil use takes place, are on the user side--conservation and more efficient cars, trucks and planes--and not on the extraction, refining and distribution side of the industry.

If the administration couldn't get these tax changes enacted in the previous Congress, they stand even less chance this term. However, that might not be the case for the additional "user fees" and lease fees, since they are new this year. The former are related to the redesign of the oversight agency for offshore drilling and were recommended by the Presidential commission investigating the accident. As I noted when their report came out, we already have a mechanism for recouping the expenses that the Bureau of Ocean Energy, Management, Regulation and Enforcement (formerly the Minerals Management Service) incurs in the course of reviewing leases and drilling permits and monitoring offshore activity. That mechanism is the lease bids and royalties that brought in $8 billion from onshore and offshore oil and gas in fiscal 2010. In a good year these sums could cover the entire Interior Dept. budget, let alone that of BOEMRE. Adding new fees on top of the existing royalties further reduces the attractiveness of drilling in US waters, on top of the "moratorium/permitorium" --now in its tenth month--for which critics finally received a belated explanation earlier this month. The net result of new fees would be less drilling here and more drilling in places like offshore Brazil.

Then there's the notion of "establishing fees for new non-producing oil and gas leases (both onshore and offshore) to encourage more timely production." This is clearly an outgrowth of the "idle leases" canard that was making the rounds in 2008. However, in light of protracted delays in issuing new permits and the likelihood that fewer permits will be issued in the future than in the past, it seems almost Kafkaesque to penalize companies for not drilling sooner on more of their leases. In truth, companies already pay twice for non-producing leases: once when they pay a bid bonus to acquire the lease, and then every year in the form of a lease rent that is due as long as the lease remains undeveloped. Companies factor this into the bonuses they bid, along with their assessment of the likelihood that a lease contains commercial quantities of oil or gas. Additional fees on non-producing leases seem likely to result in one or more of the following outcomes: lower bonus bids, fewer bids, and an increased focus outside the US. None of that would help either the deficit or energy security.

I'm entirely supportive of the government cutting expenses, including unwarranted subsidies, in order to begin the difficult task of bringing the federal budget closer to balance within the next few years. This seems essential if we're to avoid serious consequences for our credit rating, interest rates, and exchange rate. However, along the lines of what I saw when the oil industry reduced expenses in the aftermath of the big oil price drops of the mid-1980s and 1998-9, it would be counterproductive to do so in a manner that would actually result in lower overall tax receipts, while reducing domestic energy production in the bargain. Ultimately, it makes a lot more sense to target repealing the tax expenditures in question as part of the broader tax reform that seems inevitable if we want to get the deficit under control. That would eliminate specific tax breaks but simultaneously reduce overall corporate tax rates to make US industry more competitive globally, not less. A budget that proposes to double corporate income tax receipts by 2013--to a level higher than their 2007 asset bubble peak--is out of step with the competitiveness agenda that the administration has espoused, aside from its shortcomings in narrowing the long-term deficit.

Sputnik State of the Union

Energy didn't feature as prominently in last night's State of the Union Address as it has in some years, including last year's speech. Rather than making it a primary focus area, the President seemed to mention it more as an example of his broader innovation and competitiveness agenda. That's probably a good thing, because the administration's persistence in pitting conventional energy against renewables reflects the muddle in which US energy policy remains. We're desperately worried that China is getting ahead of us in renewable energy, yet we don't seem to notice that China is hardly treating oil and gas as yesterday's energy. I suspect that from China's perspective, their focus is not especially on renewable energy or clean energy but on cheap energy, which is what their economy needs to grow. I wouldn't think we're so different in that regard.

I won't waste time dissecting the President's suggestion to strip the oil & gas industry of its tax benefits in order to fund a new or expanded clean energy innovation effort. If the administration couldn't make that happen when its party dominated both houses of Congress by large majorities, then this idea is simply dead on arrival in an era of divided government. The best way to address those subsidies, along with the much larger per-barrel subsidy for ethanol, is through the kind of tax reform that would make all US industries more competitive globally. So I was pleased to hear the President suggest simplifying the tax code and reducing the corporate income tax.

Innovation and tax reform will indeed be crucial if the US wants to be a leader in clean energy technology, not just as the favored beneficiary of today's version of our periodic debate over industrial policy--picking winners--but as one part of a more robust and competitive US manufacturing sector. However, it's myopic to compare ourselves to China on infrastructure and clean energy innovation while ignoring China's full-court press to meet its rapidly growing demand for oil and gas. China doesn't have an offshore drilling moratorium or "permitorium"; instead it has focused on offshore drilling as a primary means for expanding its domestic production and limiting its oil imports, which a few years ago eclipsed those of Japan as the world's second largest, behind our own. Chinese companies are investing in oil & gas projects, joint ventures and acquisitions all over the world, because China recognizes that oil wasn't just the dominant fuel of the 20th century; it remains a key energy source in the 21st. And for those worried about China's lead in renewable energy, exemplified by the news that its wind power capacity surpassed that of the US last year, I recommend Michael Levi's article in Foreign Policy.

On a more positive note, President Obama seemed to signal his support for moving the debate on a national renewable energy standard toward encompassing all clean energy. His remarks suggested that this would include not just nuclear power--by far our largest source of low-emission energy today--but also natural gas and clean coal. With those inclusions, the goal he suggested of generating 80% of our electricity from "clean energy sources" by 2035 could be the most achievable energy goal his administration has put forward since taking office. With coal's share of electricity generation currently at 45%, it would require increasing the contribution from nuclear, renewables and natural gas by just under half--or less with some help from efficiency and conservation. Not easy, but not impossible, either, as long as we build enough new nuclear power plants to more than replace the ones that will likely have been retired by then.

Whether or not this is truly "our generation's Sputnik moment", the speech's recurring theme exhorting us to "win the future" was perhaps a bit too reminiscent of another presidential speech centered on a different kind of "WIN". Ensuring that this initiative doesn't share the fate of that earlier one in the Ford Administration might just depend on making sure that in an environment of tightening purse strings, the government's investments in new energy are focused on making clean energy cheap enough to compete without unsustainable subsidies. In the meantime, while we're waiting for that effort to bear fruit, it's worth recalling that America's conventional energy industry is still one sector in which we don't have to catch up with anyone else, unless we deliberately set out to hamstring it.

The Commission Finds...

I've been skimming through the report of the presidential commission on the Deepwater Horizon accident. Lacking time to read every word, I'm finding it on the whole a moderate document. By that I mean that it will not satisfy either those who expected the commission to repudiate deepwater drilling entirely or those that harbored faint hopes that it might issue a blueprint for a rapid return to drilling incorporating the key learnings of the disaster. Instead, as a number of observers have pointed out, its findings point to a complex web of contributing factors--in the process implicating the entire industry--and its recommendations suggest a thicket of new regulations and added fees for oil & gas exploration in US waters.

Anyone awaiting gleaming insights and Ah-ha! moments such as those that exemplified the Rogers Commission's investigation of the space shuttle Challenger accident was bound to be disappointed. With no commissioner having direct knowledge of the theory and practice of offshore drilling in the way that the Rogers Commission included some of the leading lights of the US aerospace community at the time, there was no one to lead it to such results, only paid technical staff to carry out the guidance of a team led by professional politicians. That's not as bad as it sounds. Given the breakdown of what little trust existed for the oil & gas industry, a commission made up largely of experienced oil executives, petroleum engineers and geologists would have lacked credibility with governmental decision makers and the public. However, the composition of the commission surely presaged the outcome of its work.

In the foreword to the document, which is probably all that many will ever read, I was reassured to see a broad recognition of the importance of petroleum to the US economy, the challenges involved in moving away from it, and the necessity of exploiting the resources of the Gulf of Mexico. The commission also pointed out that our conscious decision to focus offshore drilling in the Gulf and not elsewhere carries risks--a surprising admission considering that one of the commission chairs played a significant role in the establishment of that policy. However, I was disappointed at the sweeping indictment of the practices of the entire industry.

The commission was neither tasked nor staffed to investigate the entire US offshore drilling community. Such an undertaking would have required either years or a much larger effort. The parallel to the implication that because most of the industry uses the same contractors, then most of the industry must operate in a similarly risky manner would be as if the Rogers Commission had found that because most rockets and many aircraft were built with components from the same suppliers, most rockets and aircraft must be as risky as the shuttle proved to be. That logic is shaky, at best.

My own experience in the industry doesn't qualify me to pass judgment on the overall quality of the commission's investigation or the full implications of its technical and procedural recommendations. However, in my quick perusal of the document several points jumped out at me that seemed to reflect a limited perspective. I'll highlight two examples.

First, with regard to the risk of fatalities on offshore facilities, the report concludes that "From 2004 to 2009, fatalities in the offshore oil and gas industry were more than four times higher per person-hours worked in US waters than in European waters, even though many of the same companies work in both venues." This was backed up by a chart on page 228 comparing these statistics from several sources. Yet while every fatality is one too many, and no one should be complacent about them, I was astonished that it didn't seem to have occurred to the commission's staff to compare these accident statistics to the US industrial safety statistics, either overall or in similar industrial settings. In a brief Google search I turned up the "Census of Fatal Occupational Injuries Summary, 2009" from the Bureau of Labor Statistics of the US Dept. of Labor. Converting the average US fatal work injury rate of 3.3 per 100,000 full-time equivalent workers for 2009 (the year before Deepwater Horizon) to a comparable rate of 1.6 per 100 million manhours, it appears that offshore work is roughly three times as hazardous as the average of all work. When you consider that the latter reflects the contribution of tens of millions of service and government workers in categories for which highway accidents and homicides account for the largest share of risk, I'm not sure how much lower I'd expect the fatality rate to be for a group of people working long hours aboard facilities jammed with rotating equipment and heavy objects. The subject at least deserves a more thorough look than it was given here.

Then there's recommendation G2, which is the catch-all funding mechanism for all the extra regulatory work required to carry out the commission's other recommendations. I don't disagree that the agencies that monitor and issue permits for offshore drilling should be staffed with enough professionals of suitable experience and training to provide effective oversight and to minimize bottlenecks and delays in the permitting and oversight process. However, the idea that the industry should pay for this with added fees--based on a half-baked analogy to the telecommunications industry--ignores the enormous funding mechanism that's already in place in the form of the lease bonuses, rents and royalties collected by the government from these companies. In the previous fiscal year the agency formerly known as the MMS reported $2.3 billion in revenue from activity on the Outer Continental Shelf, after collecting $9.1 billion the year before. If the federal government has been spending these funds for other purposes, rather than allocating a sufficient portion to protect its investment, there's no guarantee that additional monies collected from the industry would be spent more wisely.

Ultimately, the questions of what happened on the Deepwater Horizon and who bears the blame are likely to be resolved in a court of law. It may be just as well that the commission didn't wait for all the evidence to be in to issue its findings. But they also can't be viewed in isolation. We live in a world in which OPEC seems to be quite content to sit on its ample spare production capacity and watch oil prices ratchet back up towards $100 per barrel and potentially higher, as the global economy recovers. The oil buried under the Gulf represents one our best hedges against OPEC's understandable satisfaction with the status quo. Yes, we need better response capabilities for future spills--some of which is already in the works--and yes, the industry must increase its focus on offshore safety and accident prevention. At the same time, we also need the industry to resume drilling absolutely as quickly as feasible under the new guidelines. The apparent lack of urgency on the part of the commission and administration to make that happen seems divorced from the broader context.