Obama's Energy

As the election day draws closer, U.S. President Barack Obama’s record on energy is increasingly under scrutiny with mixed conclusions. The left praiseshis record to date, as the right remains highly criticalof it. The point of contention is not just the yoyoing oil prices and the delayed Keystone XL pipeline. It is also about debate over domestic oil and gas production and Obama’s support of renewable energy. Although unconventional oil and gas production saw a major increase in recent years, leading to a creation of many jobs in the shale gas and oil sector, as well as reduction of oil imports for the first time in a long time, the American Petroleum Institute (API) insistedthat the “White House is lying to the American public when it says its policies are responsible for increased oil production.” According to API’s PresidentJack Gerard, “Obama is taking credit for policies enacted under the previous administration.”

Politics and politicization of energy aside, while the Obama administration made mistakes on some key matters, e.g. shelving Keystone XL or blowing money on Solyndra and other less than economically sensible solar projects, it did not interfere with the production of shale gas and oil that transformed the energy landscape of the U.S. It is important to remember that as much as any U.S. President would be keen to have an exclusive access to a magic red button to bring up or down oil prices, they are not – and will never be – under his or her control. It is a deliberate misrepresentation to put globally-driven high oil prices on a president of a country, unless that president is a cause of a major world event, such as war, natural disaster or depletion of oil.

At this point, nothing major in the energy sector is likely to happen before the November elections. So, the focus should be on the outlook of the U.S. energy policy that goes beyond bumper stickers of the extreme left or right. As the unconventional energy business matures, the level of regulation at the state and federal jurisdictions is likely to remain a source of contention both sides of the aisle. If Obama is re-elected, his record on energy will be further put to test, depending on how his administration regulates the shale gas and oil industry, how many drilling leases on federal lands will be issued, when onshore drilling permits will come to life, what happens with clean energy, and how the right and left will react to them. Obama’s challenge will be living up to the “all of the above” plan and providing leadership to develop an unpoliticized comprehensive energy policy for the country.

The Vision Thing

As U.S. oil and gas production is back in the game, there is growing faith that achievement of full energy independence is just over the horizon. According to the U.S. Energy Information Administration’s (EIA) Annual Energy Outlook 2012, net imports of energy have been declining in the U.S., which is largely attributed to an increase in domestic oil and natural gas production. EIA anticipates an increase in U.S. crude oil output from 5.5 million barrels per day (mbpd) in 2010 to 6.7 mbpd by 2020. Echoing this positive scenario, a recent conference of the International Association of Drilling Contractors was upbeat that U.S. unconventional oil and gas production would bring net imports to zero in the next 6-7 years, the only wildcards being a possible geopolitical problem, such as war with Iran, and stricter limitations on drilling imposed by the Environmental Protection Agency (EPA).

The confluence of the Great Recession and affordability of drilling techniques and technologies such as hydraulic fracturing and horizontal drilling was a silver lining in a cloud of declining oil production in the U.S. over the past 40 years. While reliance on more domestic energy sources and less on foreign ones is good news, it is unclear whether the U.S. will learn to be a prudent energy user or continue taking energy sources for granted and expect gasoline prices to be permanently below $3 a gallon. There is still a danger that a potential accident from the production of unconventional energy sources may have a backlash on the industry and slow it down with regulations that would carry huge ramifications on the economy.

More importantly, it is uncertain whether the newfound energy bonanza will hamper development of a sorely missing comprehensive energy policy in this country that would not rely on short-term gains and low energy prices or politicization of one resource over another at election times. There is no guarantee that the abundance of unconventional energy will not taper off in coming decades with the level of energy use in the U.S. up to now.

Happiness is Multiple Pipelines

North Dakota appears to be becoming a modern day Titusville. Topping Alaska in oil production, North Dakota is now a number two oil producer in the nation, just behind Texas and ahead of California thanks to the boom in shale oil. With 152.9 million barrels of crude oil output in 2011, this Midwestern state is enjoying the lowest unemployment rate in the U.S. at 3.3 percent, drawing a massive inflow of migrant workers from all over the country, and increasing in per-capita income by 78 percent, which is twice the national average. The only complaint of North Dakotans these days has to do with crowded roads and restaurants and shortage of hotel rooms due to boom in oil workers.

While U.S. is witnessing highest levels of oil production in years, with no signs of abating in the foreseeable future, distribution of oil abundance is likely to remain a challenge in the near term. The pipeline system in the country is inadequate to carry oil freely across the states since most of it traditionally was set up to bring refined oil and gasoline from the coasts to inland. Now the problem is moving massive amounts of oil from shale production in Texas and North Dakota, leading to a bottleneck in the U.S. major crude oil storage in Cushing, Oklahoma. As a result, the price differential between Midwestern and East Coast oil prices has been substantial.

An upcoming reversal of the Seaway pipeline from Oklahoma to Texas will provide cheap domestic oil to the refineries there, which would help reduce oil imports. While the reversal of Seaway may help balance the price of West Texas Intermediate (WTI), a North American benchmark in oil pricing, the situation is calling not only to be careful in assuming that it will bring down oil prices and keep them stable, which are still affected by international developments, but also to get serious with building more pipelines to move rising domestic crude across the country.

Iraq’s Critical Juncture

Iraq is torn by its own contradictions again. For the first time since 1989 it is enjoying the highest level of oil production and exports, which averaged 2.51 million barrels per day (mbpd) in April 2012 with $8.8 billion in revenue, according to the Iraqi State Oil Marketing Organization. It anticipates oil exports to go up to 2.75 mbpd by the end of 2012.  Relying on oil exports for 95 percent of its income, petrodollars are important for this war ravaged country’s reconstruction efforts.  Iraq’s oil boom also helped make up the loss of the Iranian oil, as the West began tightening its sanctions on the latter. In fact, the major boost in OPEC oil supplies were from Iraq in April 2012.  As the country prepares for its fourth energy licensing auction to be held May 30-21 in Baghdad, it is bullish about becoming “the world’s biggest source of new oil supplies over the next few years,” particularly when one of its largest oil fields, West Qurna-2, comes online.

But there is a good chance that Iraq’s internal problems may hijack its growing role in the oil market.  Recent tensions between the country’s central government and the Kurdish regional administration exhibit signs of a brewing conflict that necessitate a comprehensive solution to the management of Iraq’s oil wealth and binding legal measures before it is too late.  Efforts of the Kurds to sign contracts with foreign oil companies and to sell oil and gas without Baghdad’s authorization have led to the central government’s hard line to foreign firms operating in Kurdistan, including denial of a bidding opportunity to ExxonMobil in the next round of licensing auctions.  Exchange of accusations of corruption, greed, fraud and illegal oil smuggling between the Kurds and the central government signals a potential conflict, which may activate secessionist attitudes of the Kurds as well as drive a wedge between delicate sectarian and ethnic relations. 

In this context, the influence of neighboring Iran, which is suffering from sanctions over its reported nuclear ambitions, on Iraq’s mostly Shi’a population is likely to grow given its vested interests in weak Iraq.  Adding public discontent to the mix due to the lack of security and dire living conditions in view of growing oil revenues may be another source of tensions.  Iraq appears to be at a crucial point in its petroleum production when it should heed the advice of one of its oilman who has been behind Norway’s oil success – exploit energy sources slowly to avoid resource curse and build institutions, transparency, and legislation to insure against it. 

U.S.: Avoid Oil Speculation Overkill?

President Barack Obama’s latest policy initiative to take a more aggressive stance against manipulation of oil markets received mixed reactions. The proponents of the measure, including Chairman of the Commodity Futures Trading Commission (CFTC), Gary Gensler, welcomed Obama’s proposal, noting that it “build[s] on progress the CFTC has made in making the unregulated swaps market more transparent and implementing new anti-fraud and anti-manipulation reforms.”  Other federal agencies, including the Energy Information Agency, pointed out the role of oil supply disruptions from unstable parts of the Arab world as well as temporary interruptions from Canada, China and Brazil due to technical problems were key factors in elevated crude and gasoline prices. 

A bigger argument against Obama’s policy initiative appears to be that high oil and gasoline prices are not because of the presence of financial investors in the oil futures markets and “there is no evidence that the bulk of the financial investors taking positions in oil futures markets since 2003 have engaged in such activities.” According to the Chicago Mercantile Exchange (CME) Group, which sets margins for the benchmark U.S. crude oil contract, “speculation should not be confused with manipulation.”  Still, it is interesting that “speculators tend to buy crude when there is a strong underlying reason to do so such as the loss of Libyan crude last year or sanctions and possible military action against Iran” this year.  In fact, higher oil price bets by speculators at times of an anticipated supply crunch from Libya and Iran increased prices by $15-$20 a barrel. 

At this point, a prudent approach for the Obama administration to understand the oil futures market may be to monitoring it better, particularly since it plans to increase access to CFTC’s data, before setting trading margins on the market.  The latter may carry unintended consequences, such as making prices more susceptible to swings by squeezing out smaller investors out of the market and giving more influence to bigger hedge funds and banks.

New Federal Emission Caps on Fracking: To Be or Not to Be?

The Environmental Protection Agency’s (EPA) new cap on emissions in drilling natural gas this week is the first federal ruling to tackle air pollution tied to hydraulic fracturing.  According to EPA, the new standards would reduce the release of toxic and carcinogenic chemicals such as benzene, hexane and methane.  Natural gas producers would have two years to comply with the new standards.  Although the American Petroleum Institute (API), which represents 500 oil and gas companies, argued that the new standards would slow down the production of domestic natural gas and cost hundreds of millions of dollars, some gas drillers did not think the costs would slow down the gas boom in the U.S.   Gas producers, such as Southwestern Energy Co. and Devon Energy Corporation, stressed that they already have technology in place to capture fugitive methane, an important greenhouse gas. 

Pollution related to drilling natural gas does remain a source of concern.  For example, emissions from gas wells in Wyoming attributed to the increase in ozone levels to the degree that the government may need to “declare parts of the state as an ozone non-attainment area.”  But drilling for gas has not been delayed in Wyoming or Colorado, “where technology to capture emissions has been required by state since 2009 and 2010.”  Development of shale gas in Arkansas’ Fayetteville Shale by Southwestern has been also relatively successful due to cutting costs of emission capturing from $20,000 per well to zero.

While EPA’s new environmental measure is a step towards improving environmental standards of the booming shale gas industry in the U.S., there is a potential for over-regulation of the industry or duplication of efforts already undertaken by the industry to control emissions.  Shale gas has completely transformed the U.S. energy landscape, making the country self-sufficient in natural gas.  The low cost natural gas is reviving the manufacturing and chemical industries in the U.S., shifting the heavily coal-based utility sector to gas, and bringing down the prices of heating and electricity to consumers.  Regulatory slowdown of the industry would have unintended consequences to the economy. 

At this point, addressing casing and cementing of shale gas wells as well as usage and treatment of the flowback water appear to be the most important environmental challenges facing the industry.  But before slapping a one-size fits all regulation to appease environmental groups, it is also crucial to look at functioning state regulations that already exist as well as voluntary self-regulation practiced by some gas producers to avoid major accidents.

U.S. Energy Independence: Optimism with Caution

A recent announcement by the White House that onshore drilling permit application reviews would be cut by 80 percent is good news of the month. According to the Secretary of the Interior, Ken Salazar, the measure will “make oil and gas permitting and production on public lands a reality [and] the automated permit application process, which is expected to be in place in early 2013, would be similar to a program already in place for offshore drilling permits.” The new automated processing of applications would reduce the permit review process from 298 days to about 60 days. With gasoline prices highest since 2008, Republicans criticized the Obama administration for foot dragging in issuing drilling permits and obstructing exploration and drilling in public lands. Simplification of the review procedure will further help usher the development of energy in the U.S., which has seen a renaissance over the past five years thanks to shale gas and oil supplies.

As access to federal lands for oil and gas exploration expands, some analysts optimistically predict that the U.S. is bound to significantly increase domestic oil production and reduce its dependence on foreign oil. According to Raymond James and Citigroup, U.S. oil imports will fall from 9.8 million barrels per day (mbpd) in 2011 to 4.5 mbpd by 2015 and reach zero net imports by 2020. Analysts in these companies believe that ramped up deepwater production from under the Gulf of Mexico and natural gas liquids output will account for such a dramatic change in the U.S. energy landscape.

This forecast seems to be overly optimistic. While increased domestic oil production is an important factor behind the growing U.S. energy independence, changes in the country’s hobbling economy, weak oil demand, increased physical supply, or the above average increase in crude inventories may carry implications on how the U.S. energy market would evolve. In other words, it may be too ambitious and misleading to put definitive timeframes by which the U.S. would be a zero net importer of oil. Another important factor that continues to impact oil prices is the role of energy market speculators, an interesting perspective on which is given by Forbes:

The U.S. oil production increased since 2008 from 4.95 mbpd up to 5.59 mbpd [but] is so small that U.S. supply increases have no discernible impact on the price. If oil prices were determined solely by supply and demand for oil, U.S. production might matter more to the price. But what matters most to the price of oil is the positions that speculators — who do not take delivery of oil – take. When oil hit $147 a barrel [in 2008], investigators found that those speculators accounted for 81% of the trading volume in the oil markets. There’s an easy way to take those speculators out of the oil price equation: raise the amount of capital they need to invest in their bets on the direction of the price of oil. And when the commodities exchanges require the speculators to increase the amount of their own capital — dubbed margin — into their bets, the price of oil seems to go down.

It is hard to imagine the U.S. energy market not to continue being impacted by global oil prices and by speculators in the future, given that it is already happenning at a time when the country has reduced dependence on foreign oil and boasts highest domestic oil production in eight years. Do correct if I am wrong.