A New Dawn for Oil?

By Ben Thompson, Senior Editor

The Obama administration promises to mark a new chapter in America’s leadership on climate change, strengthen energy security and create millions of new jobs in the process. But given his vow to free the world from what he calls “the tyranny of oil”, exactly what does the new president have in the pipeline?

“Although more exploration and production is good news for the industry, recent economic factors are causing the sector some serious headaches”

It's March 2008, and the Democratic Party's brightest hope for the White House is standing in a gas station speaking directly to camera. Intercut with archive footage of cars lining up for gas at an Exxon station back in the 1970s, he explains how energy independence is a policy issue that has been consistently fudged through four decades of mismanagement on the part of both political parties. Nothing's changed, he points out, other than that oil companies have gotten richer and customers are paying more at the pump. Calm and self-assured, his message is clear and concise. "I'm Barack Obama," he intones. "I don't take money from oil companies or Washington lobbyists. And I won't let them block change anymore."

For many in the oil sector, that 30-second TV spot - launched during this year's primary campaign - told them all they needed to know about what an Obama administration might look like for their industry. Riding into Washington in the wake of $4-a-gallon gas prices, the Obama campaign focused on the area of most concern for potential voters: their pocketbooks. America was in thrall to oil, he implied, an industry guilty of decades of self-interest rather than one focused on finding common solutions to the nation's energy problems. Obama's vision was one of a greener and more efficient America. It would create jobs, and cut US reliance on rogue, oil-producing states in the Middle East and elsewhere. And the implication was that he would get there with or without the cooperation of the international oil majors.

As a statement of intent, it certainly set industry pulses racing. Obama's administration is widely expected to pursue policies that could hurt oil companies' profits, with most headline objectives aimed at weaning the US off its dependence on the black stuff. He promised windfall taxes on oil profits over $80 per barrel; was guarded in his support of further domestic drilling; and, both during the campaign and since his election victory, made it clear that his presidency finally intends to change the way America powers and propels itself. "We go from shock to trance," he explained in an interview with 60 Minutes on November 16. "Oil prices go up. Gas prices at the pump go up. Everybody goes into a flurry of activity. Then the prices go back down and suddenly we act like it's not important and we start filling up our SUVs again. As a consequence, we never make any progress. It's part of the addiction that has to be broken. Now is the time to break it."

The challenge facing Obama
It won't be an easy task. In order to support its vision, the new administration favors a carbon cap-and-trade scheme, supports greenhouse gas reduction in line with Kyoto Protocol targets and has called for 25% of US electricity to come from renewable sources by 2025. Biofuels are in, crude is out. Obama has also vowed to increase government support for both public and private sector research and development to meet US (and global) energy demand through new technologies. By channeling funds and committing government departments (including the military) to greening and incorporating the use of these new technologies, the new administration hopes to create a sort of 'moon-shot' economy in the US, with a commonality of purpose in tackling oil dependence.

But while there is no doubt that a concentrated effort to drive the US economy in this direction will eventually start to bear fruit (even if it is subsidized in the near term), the realities of the current economic situation mean that potential is not enough.

The recession has propelled a stimulus package to the top of his agenda, after the government announced that the US economy lost 533,000 jobs in November and the unemployment rate had climbed to 6.7%, its highest level for 15 years; as Obama knows, energy and the economy are inextricably intertwined. America needs energy now if it is to stimulate a recovery.

"Energy is everything and without energy – particularly low-cost energy, which we've become accustomed to in this country – all the great things we're able to accomplish that have made us the envy of the world would not be possible," points out Jack Gerard, CEO of the American Petroleum Institute. "Oil and gas is the backbone of the American economy. It has been for many years; it will continue to be for many more years. We could quadruple what we're talking about in the area of alternatives and renewables, and what would that give us? About 3% of our energy production."

As such, oil and natural gas must remain an important part of the energy mix, he insists, and indeed the president-elect is already facing pressure from both sides to clarify his plans for offshore drilling. Oil and gas companies appeared to score an all-out victory over the summer when President Bush lifted an executive ban on offshore drilling and congressional Democrats let a moratorium expire soon after. It's good news for a domestic industry that has long called for increased access to America's huge untapped reserves, but even so it's only a first step. Obama has not yet stated whether he will challenge the Bush administration's move, and even if the moratorium is not re-instated those who think nothing stands between oilrigs and the outer continental shelf are misguided.

"A lot of people think that once the moratoria are lifted, oil companies can go out and do whatever they want," says Lisa Flavin, Senior Policy Adviser at the American Petroleum Institute. "That's just not the case. There are tons of permits and regulations. It's a very lengthy process."

An important part of the mix
Even so, many in the industry are heartened by the recent noises coming from the Obama camp. The decision not to pursue the profits windfall tax in the wake of a steep fall in oil prices has been welcomed, and given some insiders hope that the new president might be open to further negotiation on other key energy discussion points – most notably, the important role oil and natural gas can play in helping the US meet its energy needs.

"The goal of true energy independence is far too complex to believe that renewable sources alone will be enough," says Oklahoma Governor Brad Henry, incoming Chairman of the Interstate Oil and Gas Compact Commission. "Regulations aimed at environmental protection are important and appropriate, but they cannot come at the expense of handcuffing an industry that must enhance domestic oil and gas production. The US will need every arrow in its quiver to face the challenges of energy production in this century."

Carl Michael Smith, Executive Director of the IOGCC, agrees. "Too often we have resorted to an either-or mentality in the US on energy policy," he says. "We have viewed energy policy as a zero sum game – in other words, we can encourage either development of renewable sources of energy, or development of oil and natural gas, but not both. My message is that we can and must do both."

More drilling would certainly help in this regard, and Obama's agenda calls for "responsible domestic oil production" as part of a comprehensive energy plan – good news for domestic producers. "The role of oil and natural gas in America's energy supply, now and in the future, is critical," suggests Barry Russell, President and CEO of the Independent Petroleum Association of America. Russell's organization represents independent petroleum and natural gas producers nationwide, most of which are small businesses with fewer than 20 employees. He refutes the idea that the US oil industry is all about record profits and huge companies manipulating policies to their own advantage, arguing that the industry is actually home to a vibrant SMB community that provides a crucial economic engine.

"Our members drill 90% of American oil and natural gas wells, producing approximately 82% of American natural gas and 68% of American oil," he points out. "In addition, small business members of IPAA operate the overwhelming majority of US marginal wells that are responsible for 20% of America's oil production and 12% of the country's natural gas production. Currently, oil and natural gas account for about 65% of America's energy supply, and over the next 25 years the Energy Information Administration projects that energy demand will increase 30%. A strong and vibrant independent exploration and production industry is critical if the United States is to meet its energy needs."

Is gas the big winner?
Indeed, while oil producers wait with fingers crossed to see how their industry will be impacted by Obama's vision of a greener, less-carbon-intensive future, companies involved in natural gas could be about to witness a period of sustained growth as America looks for alternatives to petroleum. Natural gas now accounts for about 20% of the energy used to create electricity in the US, and groups like the Independent Petroleum Association of America predict that it will become even more important in the upcoming climate-change debate; in fact, over the past decade more than 90% of the new electric capacity built in the US has been natural-gas-fired generation. About 84% of America's total natural gas consumption is produced domestically, while the rest comes primarily from Canada. Only 2% of natural gas used domestically comes from other countries.

"If the Obama administration and Congress follow through on their campaign promises to rely on more renewables to make electricity, natural gas will prove extremely useful in enhancing the reliability of those fuels," says R. Skip Horvath, President and CEO of the Natural Gas Supply Association. "We are blessed as a country to have so much domestic natural gas in the ground."

At least 250 trillion cubic feet of recoverable natural gas is estimated to lie under the outer continental shelf alone, meaning that the gas industry, too, could benefit from the recent lapse in the drilling moratorium. "With calls to power cars and trucks with natural gas, opening up the far-offshore areas for natural gas exploration and development makes a lot of sense," Horvath continues. "Even in the face of hurricanes, modern recovery technologies have demonstrated our industry's ability to protect our shorelines."

What next for US energy?
It all comes back to the thorny issue of increased drilling. Specifically, Obama's campaign agenda called for oil companies to explore and produce on the 68 million acres of federal land and the 40 million offshore acres that oil companies already have under lease but are not drilling on – a 'use it or lose it' approach. The carrot for oil companies is a streamlining of the federal permitting process to encourage development in three areas: the Bakken Shale deposits in Montana and North Dakota; unconventional natural gas plays in the Barnett Shale formation in Texas and the Fayetteville Shale play in Arkansas; and the National Petroleum Reserve in Alaska. His campaign also called for enhanced recovery methods to access the 85 billion barrels that are technically recoverable from existing fields.

But although more exploration and production is good news for the industry, recent economic factors are causing the sector some serious headaches. Not only does Big Oil look likely to lose its tax breaks, Obama is also calling for oil companies to go after harder-to-get and more-expensive-to-produce oil and gas deposits – which may be technically feasible, but would be much less profitable. The collapse of oil prices is making E&P a much more difficult investment proposition for oil and gas companies; add in the prospect of tighter environmental regulations, and Obama's plan is going to be a tough sell to an industry used to making record profits.

Indeed, while Obama's energy advisors have charted an ambitious policy, it remains to be seen how practical such a plan really is. While his mandate for change is considerable, it is important to remember that presidents alone do not set US energy policy and that Obama's victory has not been comprehensive enough to give him an easy ride through the Senate, the key hurdle for enacting legislation in the US. It may be prudent for the new president to reach out not only to members of the Republican Party in setting energy policy, but also to include key executives from the international oil companies, too. Offering them a prominent role in developing future energy policy – in other words, allowing them to be part of the solution, rather than viewing them as part of the problem – could be one way of ensuring a reasonable market-based (and job-creating) energy policy that at the same time delivers some of the administration's key objectives.

Obama's lead energy advisor recently said that when the Obama administration leaves office, it expects the US to be using less oil and creating less CO2 than it does now.

Obama has the ear of the country, and of the world, and this is a message that many have been longing to hear out of Washington for many years now. We wait with interest to see whether 'change we need' is actually a change for the better.

Energy and the credit squeeze

Obama's energy goals will be closely aligned with re-invigorating the economy. Here's why.

The credit squeeze has already put some smaller players in the oil and natural gas industry out of business. Many are still operating but are experiencing a cash crunch - either because others don't want to do business with them, or because the credit that is available is very expensive.

Some are offering discounted rates for their services in the hope that they will be able to maintain cash flow. Petrobas recently ran into problems when it awarded contracts for building 20 deepwater drilling rigs to Brazilian firms with little experience in such projects. Many of these firms were not able to borrow the money they needed to finish the promised rigs; now Petrobas has the choice of advancing these contractors the additional funds they need, or finding other contractors at a much higher price.

Others are trying to use the lower prices available from contractors to their advantage. Saudi Aramco is renegotiating contracts on its $15 billion Manifa project, originally scheduled to add 900,000 barrels per day in oil production in mid-2011. The intention is to reduce costs, but will likely increase the risk of subcontractor bankruptcy and delay the start of new production.

Many oil and gas companies are finding it necessary to limit their investments to what they can finance with cash flow. In the Canadian oil sands, both Suncor and Petro-Canada have pushed back purchasing plans, at least partly because of cash flow considerations. US natural gas producer Chesapeake Energy recently cut its spending plans three times within a single month.

Other companies have found different ways to work around the capital freeze. Russian oil company Rosneft reached an agreement with Chinese energy company CNPC Sinopec to lend it funds for a pipeline in return for a guarantee of oil. Meanwhile Lukoil, another Russian oil company, has asked the Russian Development Bank for a $1.8 billion loan to refinance its foreign debt.

Without outside sources of credit, companies are under pressure to keep capital expenditures within the funds that are generated by cash flow. And since the credit squeeze keeps prices low, there is no point in extracting oil and gas if the market price is too low to provide a reasonable return on investment. The net impact is that oil production has already started to decline. Plans for future investment have been cut back, so it is likely that oil production will stay low for quite some time. Even if prices should rebound, lack of credit will limit the ability of the oil supply chain to increase production. For these reasons, world oil production is likely past its peak.

Fast Facts

Obama's energy proposals

• Help create five million new jobs by investing $150 billion over the next 10 years to boost private efforts to increase clean-energy production
• Within 10 years, save more oil than the United States currently imports from the Middle East and Venezuela combined
• Put one million plug-in hybrid cars that can get up to 150mpg on the road by 2015
• Ensure 10% of the country's electricity comes from renewable sources by 2012, and 25% by 2025
• Implement an economy-wide cap-and-trade program to reduce greenhouse gas emissions by 80% by 2050

Use it or lose it

• Independent American oil and gas businesses - not big oil - develop 90% of the nation's oil and gas wells
• There are 5000 independent oil and natural gas companies in the US with, on average, 12 employees
• These independent businesses also hold the majority of the nation's federal oil and gas leases onshore and offshore
• American oil and gas companies are developing more oil and gas wells than at any other time since 1985
• Developing leases requires both technical and procedural steps. Technically, areas must be analyzed and exploratory wells drilled. Procedurally, the federal permitting process must be navigated
• Most of the drilling on federal leases has been for natural gas, and natural gas production was way up last year, along with demand