Energy under the spotlight

While oil is essential to fuel economic growth, its supply is volatile, subject to short- term interruptions as well as longer-term lapses in the rate of supply development.

As a consequence, any lapses carry with them substantial economic costs and give rise to concern over oil security. And there has been much to be concerned about over the past couple of years. Unrest in the Middle East, the devastation caused by hurricane’s Katrina and Rita, the oil spill at Prudhoe Bay, and a resurgence in calls for greater energy independence are just some of the issues that have been tipping the balance.

According to the American Petroleum Insitute, one of the biggest challenges that lie ahead is the sheer magnitude of the prospective growth in demand likely to be required to sustain modest global economic growth. It highlights a variety of recent forecasts by the International Energy Agency, the US Department of Energy, and the OPEC Secretariat estimating that sustaining a three percent rate of annual growth in the global economy over the period to 2020 will require an expansion of between 24 and 28mmbd in global oil supplies. The reaction has been mixed as to whether or not this will actually be achievable.

In an exclusive interview, O&G caught up with Red Cavaney, President and CEO of the American Petroleum Institute (API), to press him on the biggest issues affecting the US oil industry today.

O&G. Oil production and prices are being affected by troubles in the Middle East, deteriorating violence in Iraq, the lingering security problems in Nigeria and tensions in Iran, to name a few. Is instability in oil-rich regions the biggest challenges that the producers are facing today?

RC. One of the biggest challenges we have is getting opinion leaders, policy makers and elected officials to understand the industry and its needs in obtaining or delivering oil products and natural gas to retail and industrial consumers. For several decades, the American public and their elected officials have not really had to worry about energy, or government or industry spent little effort educating people about energy. Understandably, we have arrived at this period of volatility with a lot of people clamouring for instant relief or action that will mitigate energy challenges overnight. Obviously, in our industry there is little that can be done to increase supplies or reduce volatility in the short term. We people need to begin to realistically look at the world as it exists, not only today but likely tomorrow, and to do so with an increased appreciation and understanding for what it takes to solve problems related to oil and natural gas. Stakeholders, producers and consumer must work together to craft policies, regulations and approaches that will help reduce some of the volatility and some of the uncertainty and gain the political consensus necessary to enact those policies.

A decrease in the gap between worldwide crude oil production and worldwide demand would reduce anxieties over energy. The larger a cushion, the more stability and less volatility there will be in the overall crude oil market. Historically the Middle East has been a region where there have been a lot of geopolitical swings, and there’s little reason to think this behaviour is going to change overnight. Developing more global supply sources or increasing domestic supplies, or better energy efficiency, are good ways to help create that bigger cushion between worldwide supply and demand.

O&G. Obviously the price of oil is a contentious issue at the moment, especially with a barrel of crude hovering around US$75. With summer demand up on last year and pump prices high, do you foresee oil prices rising even further? How long before we see US$100 barrel?

RC. Our industry has been through a number of cycles throughout its history. Inside those cycles are smaller cycles created by smaller swings in volatility. The next swing is likely to never be too far away, so it will continue to be very hard to forecast exactly when prices are going to rise and fall. Such movements rely on the overall economic growth level throughout the globe, and increasingly more and more of this manifests itself with increased demand in China and India. These levels of increased demand are clearly at the higher end of recent past experiences. To meet this demand, we have to rely more and more on technology. It’s becoming increasingly more expensive to extract oil and natural gas but to predict when it’s going to reach US$100 a barrel is a fanciful thing at best.

O&G. Oil producers seem to be continually posting record profits, yet the price of gas for motorists continues to rise in the US and Europe. Can you appreciate the public’s dismay?

RC. To a degree, yes. We, as an industry, have not done a very good job of educating the public and opinion leaders about our operations, our costs to produce the product, and the hurdles we must surmount to deliver the product to the consumer. Absent this understanding, it is very easy for consumers to say, “Industry benefits from record high profits because I am paying record high prices.” The Federal Trade Commission did a multi-year study about a year ago and found that 85 percent of all the price movement in gasoline is attributable to price movements in the underlying crude oil. In the US, about 55 percent of the cost of gasoline at retail is attributable to crude oil itself. So when you have such a large component of the price on crude oil, and its related volatility, the profits that the industry makes in the US are at about the all-industry average. While prices may be high, it’s for reasons that don’t directly translate to a company’s bottom line. Policy makers are beginning to understand that, but it is very hard for the general public to easily understand. They are so used to paying low prices that when prices move aggressively up, they don’t want to hear explanations; they just want it fixed. I can understand their dismay, but it’s based on a lack of background and understanding and because some politicians and others take advantage of circumstance to rail against the industry, somewhat unfairly I might add.

O&G. Demand for oil is soaring, especially among the booming economies of China and India. How much of a strain is their growth putting on supplies?

RC. It is not insignificant. Again, if you go back and look at the period of the 80s and 90s, fairly stable growth existed if you looked at it in the aggregate. There were not large, short-term swings in demand, and there was ample surplus capacity. So there wasn’t a lot of volatility. There was a great deal of reliability and generally people could get product when they needed it. Now we have entered into a new era where we have two of the largest population centres on face of the globe relying more on energy. This means that their economies are developing and their standard of living is going up, which is good for everyone, ultimately. I am not sure our global system of supply was prepared to go from that more stable period, and almost overnight, to these high growth economies with large populations relying heavily on energy in general and on crude oil in particular. There is enough evidence that this new demand is real that new capacity is being now.

O&G. George W. Bush recently said the US is too dependant upon oil for its energy needs. Do you think the US, as the world’s largest consumer of oil, will ever be able to reduce its craving for the black stuff?

RC. The industry’s role, as we see it, is to provide the energy that consumers need in order to grow the economy and improve our standard of living. In the US, about two thirds of total energy is provided by oil and natural gas. The government has forecast that even with rapid increases in other alternatives that ratio by 2030 is going to remain close to unchanged. Hydrocarbons have a high energy content and are relatively stable. The technology is there, and we see increasingly cleaner fuels in the future. So there’s a great deal of interest to accelerate into so-called “sustainable” fuels, but it is likely to prove more difficult than most anticipate. Someday there will be a replacement for crude oil but that is going to be a long, long way away. It will happen because some technology will come along – maybe something we haven’t even seen yet – that will provide more value at less cost. Crude oil and its products are going to have a strong presence for a long time. But we do see an increasing amount of bio-fuels entering into the transportation fuels market, and we also see the advancement of hybrid cars and variations of new clean burning, high-performance diesel engines as having bright futures as well. Let’s look at things realistically – we do need all the energy we can get, so let’s not prematurely select one winner over another.

O&G. Is enough being done to make the US more energy efficient?

RC. There is a lot more that can be done on the energy efficiency front than most people think. When people are calling for short-term solutions or relief, whether its changing your driving conditions or paying attention to how you use energy at work, the quickest way to create extra barrels is to essentially have people embrace energy efficiency. Hopefully, energy efficiency will attract more investment dollars as businesses become more efficient and those savings go right to the bottom line.

O&G. Do you feel that the public is fully aware about the importance of being energy efficient?

RC. If you take public opinion polls the answer you will get back is that they are. And we have seen some evidence of a change in driving conditions as the price of motor fuels have gone up, but it has not been as appreciable a change as we might have suspected. Businesses have been pretty strong on energy efficiency because they can see it move to the bottom line, but the individual consumer seem to so much see a similar impact. When we went through this in the 1970s, we found it took a long time for the consumer to change, but in fact, they did change, and once they did the savings became pretty significant. Whether we are going to see a repeat where we reach that tipping point is not certain yet.

O&G. The US gets 60 percent of its oil from foreign suppliers – many of which have unstable governments and anti-American policies. What can be done to reduce this overseas reliance?

RC. There are two tracks that one should pursue in this regard. Firstly, it is unrealistic to think that as a matter of policy our nation can become fully energy independent. We believe energy security is best achieved through increased and diversified sources of supply both domestically and globally, increased attention to energy efficiency, an increased development of emerging energy technologies and an increase in the number and quality of new entrants into our business. We strongly support diversification of supply and government polices that support the continuation of free trade and increasing trade where possible to allow a greater number of economies to grow.