Article12 Sep 2012

Are the Politicians Getting it Wrong on US Energy?

Citi GPS Opinion Article
It’s no wonder that energy policy has become a front and center issue in this year’s Presidential election campaign – the US has become the fastest growing producer of oil and gas in the world and looks likely to remain so for years to come. What was once thought inconceivable is now being widely accepted and consequently has become a political hot button in this year’s Presidential election campaign. Republican candidate Mitt Romney is in the position of asking for close to unrestricted drilling of oil and nearly unfettered use of the country’s abundant coal resources in order to achieve “energy independence". President Obama, on the other hand, mindful of his anti-oil, gas and coal environmentalist supporters is reluctant to advertise that companies will likely end up drilling twice as many wells or more during his first term than either of his two highly pro-oil Republican predecessors.

Candidate Romney is seeking a new policy of energy independence without talking about what this independence might mean. President Obama is reluctant to articulate a policy or understand that the supply boom that is taking place has virtually nothing to do with policy. Romney is pushing for a devolution of policy-making from the federal to state governments, without taking into account the importance of lease bonuses and royalties on federal lands in the federal budget, the need for standards of best practices across the country, or that left to themselves many states retard rather than accelerate supply growth. Most ironic, perhaps, is that if the state of Nebraska had its say in licensing, the Republican touted Keystone XL pipeline, bringing Canadian oil to the US Gulf coast, would almost certainly not be built.

Current policy in the United States has not yet impacted the production renaissance, which has been based, in part, on private lands already under state jurisdiction. But the production boom will inevitably impact not just the position of the United States in the global energy sphere, but has a fundamental role to play in global energy prices in the future, in the geopolitics of energy internationally, and in the future of the United States as a global power. As such it should be seminal to a more comprehensive discussion of energy policy, what it means for the US and the rest of the world.

Let’s take one step back for a moment. The energy boom in the United States is part of an extraordinary expansion of exploration activities that was triggered by higher prices starting a decade ago. Companies are spending six times what they were then to find and develop oil and gas, and even if cost inflation is taken into account, real spending has more than doubled and is continuing to grow. High prices have enabled firms to tap into resources previously too costly to delineate let alone produce. Canada is blessed with oil sands, whose production is adding over 2-million barrels a day this decade. The US, like Brazil, the countries of West and East Africa, and perhaps even China, is well endowed in deep-water resources. And the US has especially robust shale gas and shale oil.

Production of all of these unconventional resources can grow significantly at prices above $75 per barrel. Over the next decade, producing these resources is likely to convert what looks at present to be a floor price for oil at $90 per barrel into a new ceiling price, with impacts across the global economy. Concerns will grow with producers that prices will fall steeply at times, mirroring current concerns for global growth, and at others the prices will break out above an acceptable range.

The United States stands out as a global winner in this new world. A significant part of this gain comes from what Governor Romney calls “energy independence.” By the end of this decade, with oil consumption falling, natural gas and electricity prices that look cheap by world standards, and imports plunging to two to three million barrels a day at most (virtually all of it from Canada) the US has multiple advantages.

Critics of “energy independence,” are quick to point out that even if the US became a net oil exporter, American consumers would still be vulnerable to price spikes in the case of a severe disruption globally. We don’t disagree about this being the case, but there are clear global advantages as well.

For starters, US foreign policy will be freed from the shackles involved in sacrificing a value-driven policy focusing on human rights and democratic institutions in order to secure cooperation from resource-rich despotic regimes.

Well beyond this, the two huge vulnerabilities to US superpower status have been dependence on oil imports and a weakened US dollar. Unique among major powers, the supply miracle in North America is eliminating both of these longer-term policy handcuffs. Neither China nor the European Union can look to such a future. Additionally, Russia’s future global position looks challenged, with other commodity prices likely to follow energy prices significantly lower and with commodities lingering as the main source of wealth generation, domestic power and international influence.

A serious debate about appropriate policies has major domestic elements as well. Five years from now the fruits of a major surge in investment following on the heels of the oil and gas boom will begin to bear fruit. And by that time resurgent production from the deep waters of the Gulf of Mexico will add to the surge in onshore production.

US natural gas prices look likely to remain significantly lower than global prices for decades to come. Indeed the US, Canada and potentially Mexico look to be the lowest natural gas cost countries in the world, with the possible exception of Qatar. That spells investment opportunities in energy intensive industries, from petrochemical and fertilizers to cement and metal fabrication, including steel and aluminum. An industrial renaissance built on the energy renaissance could add a significant amount of jobs to the US economy. It could also mean lower import requirements and in all likelihood produce a surge in exports. It means significantly cleaner oil and gas-based energy replacing dirtier coal power. It means an accelerated move to natural gas-driven cars and trucks.

Are there downside risks as well? Of course there are. It’s now clear that so long as oil prices remain above $75 per barrel global supply will continue to outpace global consumption on a sustained basis for the first time in over 20 years. If the global energy boom that follows the North American boom succeeds, prices could fall much lower and production would also fall. To some extent the high price environment leading to this boom is the result of OPEC’s subsidizing of investments by guaranteeing a floor price. The oil industry has for a century and a half been a boom or bust business. But now’s not the time to debate and worry about the bust years ahead.

There’s plenty to debate about the US’s energy future. The debate might focus on revenue and environmental enhancements through an appropriate land-use policy. It could focus on ways to stimulate investment – from home and from abroad – in industries that can take advantage of the newfound energy wealth. It might focus on job creation via private and public partnerships. And of course, it should focus on global energy issues and foreign policy. What’s at stake goes well beyond a debate over whether to drill. So far, it looks as if neither candidate is willing to address the deeper implications associated with domestic energy policies and instead are content to keep the conversation at a superficial level.

GPS Opinion
New Energy

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