Oil experts are deeply divided in their views on the future of what is still the world's key commodity. This divergence was on display at last week's CERA Conference in Houston, which brought together industry executives, consultants, media, and government officials from around the world. Although I didn't attend in person, the organizers provided extensive streaming coverage of keynote talks and interviews with thought leaders.
From OPEC oil ministers and the head of the International Energy Agency, we heard that the world could be headed for another supply crunch within a few years, due to low investment following 2014's oil-price collapse. I've mentioned this concern before.
By contrast, the major oil companies seemed more cautious. Low oil prices caught many of them with big, expensive projects underway--too far along to stop but undermined by prices now far below the assumptions on which they were justified. Cash flow seems to be a higher priority than growth. "Peak demand", when global oil consumption stops growing and might begin shrinking, could also arrive within ten years or so, at least according to Shell's CEO, further disrupting markets.
Renewables were discussed frequently, but shale was arguably the star of the segments I watched. Big companies touted their shift toward shale assets that can be brought into production quickly, while independent E&P (exploration and production) companies highlighted both the upside and limitations of focusing on the core, or most productive, cost-effective portions of various shale regions.
With these large, and to some extent mutually contradictory trends in play, any kind of straight-line extrapolation from current or past conditions of price, supply, or demand seems sure to be swamped by uncertainties. Rather than putting my thumb on the scales for one view or another, my best service just now is improving our understanding of these risks and why they look so uncertain.
On the supply side, the relationship between short-cycle and long-cycle investments is especially interesting and a source of great uncertainty. Short-cycle supply, mainly from shale or "tight oil" wells that can be drilled and brought on-stream quickly and for only a few million dollars each--but that also tail off quickly--was the main factor in the drop from over $100 per barrel to less than $40 just a couple of years ago. It now provides many of the lowest-risk, most attractive opportunities available to the oil and gas industry. Yet the more short-cycle oil is developed, the longer the recovery of long-cycle investment is likely to be delayed, because shale is effectively putting a low ceiling on oil prices and will consume ongoing cash flow to sustain it.
Long-cycle oil, which still accounts for over 90% of global supply, is an entirely different domain. It consists mainly of large conventional oil fields that were developed years ago and continue to pump oil with relatively little continuing investment. It also includes new, big-ticket projects in places like the deep waters of the Gulf of Mexico and offshore Brazil, that add to growth but importantly offset the natural decline rates--often 4%-10% annually--that eat into the output of older oil fields every year.
Hundreds of billions of dollars of planned investment in long-cycle projects was deferred or canceled since 2014. Because such projects take years--sometimes decades--to develop from discovery to production, this investment drought implies a hole in future production. That shortfall hasn't appeared yet, because projects like BP's Thunder Horse expansion that were begun when oil was still over $100 are still periodically starting up. The impact of the long-cycle gap might also shrink or vanish entirely if enough short-cycle oil is developed in the meantime.
We might never notice this impending gap, if demand growth slowed sharply from its recent rate of more than 1 million barrels per day per year, or even started to fall. Not so long ago, few could imagine oil demand falling without hitting a wall on supply--so-called "Peak Oil"--but now it's almost harder to envision oil demand continuing to expand in light of competition from renewables, substitution from electric vehicles, and constraints imposed by climate policies intended to comply with the Paris Agreement.
The big uncertainties for these changes are time and scale. The Solar Energy Industries Association (SEIA) forecasts US solar power growing from 42 Gigawatts (GW) last year to nearly 120 GW by the end of 2022. However, that would leave solar generating just 4% of US electricity, even if electricity demand didn't grow at all in the interim. Nor does solar power compete with oil, except in the few remaining places--mainly in the Middle East--where lots of oil is burned to produced electricity, or when it powers electric cars.
With regard to EVs, Tesla's goal of producing 500,000 cars per year by the end of next year is impressively big. However, even if those Teslas replaced only conventional cars of average fuel economy, all of which were then scrapped--unlikely on both counts--they would reduce US gasoline demand by less than 0.2%. It would take more than six times as many EVs to offset last year's growth in US gasoline demand of 1.3%. Only as EV sales ramp up and conventional cars are retired in large numbers would they start to make a serious dent in oil demand. How long will it take to reach that point, and how much would a big jump in oil prices within the next few years nudge it along?
Until recently, most of the speculation that the transition away from oil and other fossil fuels could happen faster came from outside the industry. Lately, though, respected voices in the industry--or at least closer to it--have begun to raise the possibility that the shift to renewables and EVs might accelerate, affecting demand sooner than expected.
To be clear, I am still convinced that constraints on how fast capital stock turns over--vehicle fleets, HVAC, factory equipment, etc.--impose a speed limit on any large-scale transition like this. However, careful examination of the last 20 years of oil prices provides ample proof that smaller-scale shifts can have large impacts. From the Asian Economic Crisis of the late 1990s, to the massive price spike of 2006-8, followed by the financial crisis, the Arab Spring, and the shale boom, we can see that supply/demand imbalances of no more than about 2-3 million barrels per day--say 3-4% of production or consumption--were sufficient to drive oil prices as low as $10 and as high as $145 per barrel.
When we combine the big, new trends outlined above with normal uncertainties about the economy and then factor in the extreme sensitivity of oil markets to relatively modest surpluses and shortfalls, predicting the likely path for oil looks very daunting. The factors driving it may be changing, but accurate oil forecasting remains as challenging as ever. That same realization stimulated interest in scenario planning more than 40 years ago, focused on the insights available from considering multiple possible futures, rather than just one.
Friday, March 17, 2017
Thursday, February 16, 2017
- While the Trump administration seeks to undo CO2 regulations, a group of former Republican officials has proposed a new, market-based emissions plan.
- This "carbon tax" looks simpler than EPA's Clean Power Plan or previous cap-and-trade legislation, but not simpler than the pre-Obama status quo.
Reduced to its basics, a carbon tax is a focused version of a consumption tax, based on usage rather than income or valuation. The level of the tax would be set by law, either as a fixed amount per ton of emissions or at an initial rate with preset future increases. What can't be known with certainty in advance is just how much a given level of carbon tax would reduce actual emissions.
This contrasts with the method of setting a price on carbon preferred by many other economists and environmental groups, called "cap & trade." In this approach, the government sets a cap, or maximum level, on emissions for a designated sector or the economy as a whole, while parties subject to the cap are allowed to trade emission allowances and credits with each other under that cap. Thus policy makers set the level of emission reductions, and allow the market to find the resulting price on carbon. In principal, that ought to be more efficient than the simpler carbon tax, because market forces should drive participants with low costs of cutting emissions to make the deepest reductions and then sell their excess cuts to others, for less than it would cost the latter to reduce by that amount.
From the late 1990s until 2009 or '10 I was convinced that cap & trade was the better approach to pricing emissions. However, the experience of watching the US Congress attempt to design a cap-and-trade system for the US economy cured my certainty. As I have described at length, the inclination of legislators to help favored companies, industries and sectors, combined with the extraordinary temptations created by the sheer scale of the revenue such a system would channel through the government's hands, revealed practical problems that look insurmountable in the real world, at least under our political system.
In fairness, cap-and-trade is currently used to promote emissions reductions in various jurisdictions, including California, the mainly northeastern states participating in the Regional Greenhouse Gas Initiative, and the European Union. From what I have observed, all of them have experienced technical difficulties involving the allocation of free allowances, inadequate liquidity, and other issues. The biggest practical problem is that the carbon prices these systems have tended to deliver might be characterized as the opposite of a Goldilocks price; i.e., they are typically high enough to generate substantial revenue, creating strong constituencies for their continuation, but too low to influence behavior very much.
For example, California's emissions credits currently trade at around $13 per metric ton of CO2, equivalent to $0.10 per gallon of gasoline containing ethanol. Would an extra $1 per fill-up make much of a difference in how much you drive, which car to buy when you replace your current car, or whether to sell your car (or forgo buying one) and take public transportation?
Moreover, California's emissions have been essentially flat since the state implemented cap-and-trade in 2012. However, since 2002 the state's electric utilities--historically the highest emitting sector--have operated and invested under a Renewable Portfolio Standard requiring them to increase the share of renewable energy in their generation mix to 20% by 2010, 33% by 2020, and now 50% by 2030. I suspect that accounts for most of the 7% drop in emissions since 2002, while the impact of a carbon price equivalent to 0.6 cents per kilowatt-hour (kWh) is likely lost in the noise. Of course a carbon tax would create its own political and practical complications.
First, consider how a carbon tax would affect different energy sources. As with cap & trade, a carbon tax should have its biggest impact on the highest-emitting forms of energy. In practice that would compound the current disadvantages for coal compared to abundant, low-priced natural gas and rapidly growing, essentially zero-emitting renewables like wind and solar power. At least on the surface, that seems at odds with the stated goal of the Trump administration to attempt to rescue the US coal industry and the communities that depend on it.
Like cap & trade, a carbon tax would also require a significant amount of new bookkeeping to track the path of "embedded emissions"--the CO2 and other greenhouse gases emitted at each step of a product or service's supply chain--through the economy. Some of this is already done voluntarily by companies participating in various sustainability reporting efforts, but it would be new for many others. The EPA, Department of Energy, and numerous non-governmental agencies have done much work to quantify such emissions, but a carbon tax would require a level of rigor and audit trail consistent with the creation of what amounts to a shadow currency within the economy.
A carbon tax also raises similar questions of how to spend the resulting revenue that have bedeviled cap & trade. At the current US emissions and assuming few sources were exempted, the proposed $40 per metric ton initial carbon tax would raise around $275 billion per year. That's 8% of this year's federal budget. It doesn't take a cynic to guess that the first inclination of any Congress enacting such a tax would be to hang onto this money to fund new programs, reduce the federal deficit, or some combination, rather than returning it to taxpayers as former Secretaries Baker and Schultz and the economists who back them suggest.
Their proposal would require that the proceeds of the carbon tax be rebated to essentially the same people who would be paying it at the gas pump or in their gas and electric bills. This sounds similar to the "Cap and Dividend" approach to cap & trade proposed by Senators Cantwell (D) and Collins (R) a few years ago. Their bill had the great advantage of simplicity, requiring just a fraction of the 1,427 pages of the 2009 Waxman-Markey cap & trade bill, the main purpose of which seemed to be to redistribute vast sums of money outside the tax code. But like W-M, it went absolutely nowhere.
Like it or not, that's my best guess of the fate of the current carbon tax idea, too. The biggest challenge facing a carbon tax today is that it would not be running as a simpler, more market-oriented alternative to prescriptive legislation or complex EPA regulations. After all, the administration's intention appears to be to eliminate the EPA's main emissions-reduction regulation, the Clean Power Plan, not to replace it.
And although the new US Secretary of State, Mr. Tillerson, is on record numerous times in support of a carbon tax, that position seems to have been put forward mainly in preference to cap & trade, rather than on its own merits in the absence of any other strict climate policy.
A carbon tax would raise the effective price of energy commodities in which we appear to have a global competitive advantage, at least for now. The current proposal may rebate the carbon tax on exports, but most economic activity starts and ends within this country. And as noted in the NY Times op-ed by Dr. Feldstein and the other economists backing this measure, the revenue recycling to consumers would be on an equal basis, rather than proportional to usage, so there would be winners and losers as with any redistributive taxation. Lower-income Americans driving older cars seem likelier to come out on the short end of that than wealthier consumers driving new cars that meet rising fuel economy standards.
Ultimately, we must ask why President Trump or his team would want to impose a new tax on US consumers and businesses to address a problem that has probably just become an even lower priority for them than it was. Notwithstanding Mr. Trump's demonstrated unpredictability, the simplest answer seems to be that he wouldn't.
Thursday, January 12, 2017
- President-Elect Trump and his appointees plan a major policy and regulatory shift for energy, focusing more on economic benefits and less on environmental impacts.
- Obama-era regulations most at risk of roll-back are those justified mainly on climate concerns not shared by Mr. Trump and his team.
- Emissions are still likely to fall in the next four years as shale and renewable energy output grow.
To gauge how sharply the energy polices of the incoming Trump administration will diverge from those of the last eight years, we need to understand what motivates both leaders. The Obama administration's approach was driven by a deep, shared conviction that climate change is the most important challenge the US--and world--faces. The cost of energy and its impact on the economy became secondary concerns, subordinated by the belief that the added cost of climate policies would be offset in whole or part by the benefits of the green investment they unleashed--remember "green jobs"?
We saw this in President Obama's first year in office. Amid a deep recession he worked with Congress to attempt to limit greenhouse gas emissions by means of an economy-wide cap-and-trade system, on which he had campaigned. The House of Representatives passed the Waxman-Markey bill (HR.2454), a veritable dog's breakfast of economic distortions. Yet despite a filibuster-proof majority in the Senate in 2009, Waxman-Markey and every subsequent cap-and-trade bill died there.
That failure set in motion the agenda that the Obama administration has pursued ever since, to achieve via regulations the emissions reductions it could not deliver through comprehensive climate legislation. Last year's publication of the EPA's final Clean Power Plan was a key component of an effort that seems set to continue until just before Inauguration Day.
The transformation of energy regulations under President Obama was dramatic enough that a transition to any Republican administration would be a big change. The transition now in prospect will be even more jarring. Mr. Trump's rhetoric and his choices for key administration positions point to a concerted effort to unravel as many of the Obama-era regulations affecting energy as possible. That isn't just based on philosophical differences over regulation and markets. For President-Elect Trump the economy and jobs are paramount, so the Obama energy regulations must look like an unjustifiable threat to the fossil fuel supplies that still meet 81% of the nation's energy needs.
Despite that, it is unlikely the new administration will go out of its way to target renewable energy or the tax credits that have driven its growth to date. Renewables are becoming increasingly popular with conservatives. However, because Mr. Trump sees climate change as, at best, a secondary issue that may not be amenable to human intervention, his administration's won't put renewables on a pedestal as the Obama administration has done.
The biggest challenge for renewable energy may come from tax reform intended to make US companies and factories more competitive globally and shrink the incentive for them to relocate to lower-tax countries. This appears to be a high priority for the new White House and Congress, and one on which they broadly agree. If corporate tax rates drop, the value of the tax credits renewables enjoy is likely to fall, too, making wind, solar and other such projects less attractive and less competitive.
It remains to be seen how many of the Obama energy regulations can be rolled back. The most recent regulations might be averted through legislation like the Midnight Rules Relief Act, or the REINS Act, both of which would update the Congressional Review Act, a rarely used 1990s law intended to limit what presidents could impose by last-minute executive actions. Other regulations may eventually stand or fall as the courts rule. The stakes are high, particularly for regulations affecting the production of oil and gas from shale by means of hydraulic fracturing and horizontal drilling.
Energy independence was a touchstone of Mr. Trump's candidacy. Despite his campaign's focus on coal, it is fracking, as hydraulic fracturing is more commonly known, that holds the key to achieving that goal in the foreseeable future. It has been the main driver of the growth in US energy production since 2010.
The latest long-term forecast from the US Energy Information Administration (EIA) puts energy independence within reach--in the sense of the US becoming a net exporter of energy--by 2026 or sooner. However, the recent flurry of regulations affecting such things as drilling on federal land, and putting large portions of US waters off-limits for offshore drilling would not have been part of that projection. As EIA Administrator Adam Sieminski remarked at a briefing on the forecast, "If you had policy that changed relative to hydraulic fracturing, it would make a big, big difference to everything that's in here."
That's a key point, because most past notions of energy independence assumed that energy prices would have to be very high to promote lots of efficiency and conservation and stimulate large amounts of expensive new supply. The shale revolution changed that.
However, the global context is also changing. OPEC is attempting to reassert its control over the oil market, with help from non-OPEC countries like Russia. Two years of low oil prices shrank global oil and gas investment budgets by around a trillion dollars, and the International Energy Agency has warned of coming oil price spikes as a result. Forestalling tighter US regulations on fracking and offshore drilling increases the chances that US supplies could grow by enough to balance shortfalls elsewhere and avert much higher prices at the gas pump.
Energy infrastructure is likely to be another focus of the new administration, because the economic and competitive benefits of abundant energy will be diluted if, for example, Marcellus and Utica shale gas or Bakken and Permian Basin shale oil have to be exported because domestic customers don't have access to them.
That suggests an early effort to reverse decisions by the current administration to block the construction of various pipelines, starting with the Keystone XL pipeline and more recently the Dakota Access Pipeline. That will force new confrontations with activists and environmental organizations that have raised their game to a new level in the last eight years.
Such opposition would likely intensify if the new administration sought to withdraw the US from the Paris climate agreement, which recently went into effect, or submitted it for review by the US Senate as a treaty. But it's not clear that a big change in direction would require leaving Paris.
The US commitments at Paris, like those of the other signatories, were voluntary and non-binding. For that matter, recent shifts in US energy consumption and especially electricity generation have put the US in a good position to meet its initial Paris goals with little or no additional effort, as noted by outgoing Energy Secretary Moniz. The Paris Agreement will only become a major point of contention if President Trump chooses to make it one.
In his list of the top energy stories of 2016, fellow blogger Robert Rapier rated the election of Donald Trump ahead of the OPEC deal and many other important events of the year, based on its likely impact on "every segment of the US energy industry." In retrospect that was equally true of Barack Obama's election in 2008. The shift we are about to experience on energy will be that much sharper, because President Obama and President-Elect Trump both set out to make big changes to the status quo for energy, in opposite directions. We shouldn't miss one important difference, however.
The course that Barack Obama's administration followed on energy was largely predictable from the start, because it was based on openly and deeply held beliefs about energy and the environment. Donald Trump's well-known preference for deals over dogma sets up the prospect of some big surprises, in addition to what we can already anticipate.