The State of the U.S. and Natural Gas Industry 2006
10th Annual Ohio Energy Management & Restructuring Conference
API President and CEO Red Cavaney
Columbus, Ohio
March 1, 2006
I am both honored and delighted to be your lead-off speaker at this 10th Annual Ohio Energy Management & Restructuring Conference. Having appeared in front of you before, I doubly appreciate your inviting me back for a return visit. Clearly, much has happened in the field of energy in the intervening years.
It wasn’t all that long ago that Americans took energy for granted. Following the oil embargo of 1973-74 and the oil supply disruption caused by the Iranian revolution in 1979, the federal government eased its control over portions of the energy business, during a time when our nation possessed sufficient supply and surplus capacity in most energy sources, including oil and natural gas. However, during the late 1980s and 90s, circumstances changed. Our industry was preoccupied with economic survival in the face of heavy government intervention and a dramatically changing international geopolitical landscape. Accordingly, it spent a minimum of time educating key audiences about the industry’s critical needs in providing consumers, both retail and industrial, with a reliable supply of affordable energy into the future. Consequently, we are all paying the price now with government policies that do not reflect their full understanding of the energy world in which we must operate.
During several years of accelerated economic growth in the late 1990s, especially in the “dot.com world,” few considered the energy consequences of this unprecedented growth spurt. In fact, a number of respected political and business leaders claimed that energy demand and economic growth had been decoupled by technology’s ascendancy. Not surprisingly, demand surged; and we entered the 21st Century with very modest amounts of energy flexibility and spare production capacity – a fact little appreciated by the general public and their political leadership.
As energy demand grew and surplus production capacity shrank, we, as a nation, were focused elsewhere – principally on implementing new regimes of government environmental regulations. And while those environmental improvements have served society well, investment dollars were being diverted away, somewhat starving refinery capacity expansion and increased infrastructure flexibility within the energy industry.
The attendant problems being created first became evident in the winter of 2000, when we experienced fuel price spikes and tight home heating oil supplies in the Northeast and upper Midwest. Similar experiences in transportation fuels have become all too commonplace since then.
While improved economic efficiency has reduced reliance on energy for economic growth in recent years, it has not decoupled the two. There is no question today as to the vital relationship between energy and economic growth. Certainly, we can see that relationship in the surging economies of the developing world, especially in China, where the massive new demand for energy has impacted world energy markets, putting significant upward pressure on the availability and price of crude oil.
To appreciate where we are today regarding energy and where our nation needs to go, two fundamental tenets must be understood. First, the energy industry is a long-lead-time, capital-intensive industry. It cannot add capacity or flexibility overnight. And, second, the energy industry cannot function effectively without a constructive partnership with government, at both the federal and state levels.
Unfortunately, today’s view of far too many policy leaders is rooted in a past that no longer exists or inaccurately characterizes the world energy dynamic of today and tomorrow. For the past several decades, following the oil embargo and other supply disruptions of the 1970s and the years that followed, a great number of foreign governments nationalized their oil industries, including their reserves.
Forty years ago, world oil reserves were largely owned by public, investor-owned oil and natural gas companies, most based in the United States. Reserves are a critical measure of a company’s ability to serve its future customers. Today, world oil reserves are 77 percent owned by national oil companies formed during the past 30+ years, while only 6 percent of world-wide reserves are now held by investor-owned oil and natural gas companies.
Consequently, investor-owned oil and natural gas companies elected to scale up to compete within this new world by creating large-scale efficiencies, greater technological and project management prowess, and substantially broader competitive access to capital markets in order to meet the competition from these national oil companies, such as those of Saudi Arabia, Russia, Venezuela, China and others. The value of this scaling up of investor-owned oil and gas companies was largely missed by most observers -- both in and out of government. Some observers, still in the dark on this necessary evolution, now view the industry in exaggerated, negative terms; as too large, too powerful, and not deserving of its earnings.
Obviously, reality is quite different. Would these critics have the investor-owned companies be small and sub-optimal in one of the world’s truly global, commodity markets? Were such the case, would national oil companies then rush to gain share our domestic market? Would that enhance our national and energy security be enhanced by such a development?
Sixty percent of the cost of gasoline is attributable to crude oil. U.S. oil and natural gas companies are crude oil “price-takers,” not “price-makers.” They cannot set the world price of crude oil – the world market does. Roughly half of the oil consumed in the world crosses international borders. The world market is comprised of thousands of buyers and sellers of crude oil from around the world who operate through transparent exchanges in New York, London, Singapore and elsewhere. This world crude price is the single most important factor in determining the U.S. price of gasoline, diesel fuel, heating oil, aviation fuel, and other crude products.
There has also been considerable misunderstanding and misinformation about the earnings of U.S. oil and natural gas companies. The oil and natural gas industry is among the world's largest industries. Its revenues are large, but so too are its investments and operating costs in providing consumers with the energy they need. Included are the costs of finding and producing oil and natural gas, as well as the costs of refining, distributing and retailing oil and oil products.
The energy Americans consume today is brought to us by massive investments and reinvestments planned and made many years, or even decades, ago. Between 1992 and 2005, for example, the investor-owned oil and gas industry invested more than $1 trillion, on six continents, in a range of long-term energy projects. This trillion-dollar investment exceeded the total net income of all those companies over the same period. To succeed in reliably delivering affordable supplies of fuel to customers, the U.S. oil and natural gas industry must invest large sums, in both good and bad economic times. In this industry, to under-invest over time is to die a slow death.
Contrary to a widely held perception, the industry's earnings are very much in line with those of other industries -- often they are lower. Over the last five years, the oil and natural gas industry's earnings averaged 5.8 cents per dollar of sales compared to an average for all U.S. industry of 5.5 cents for every dollar of sales. Importantly, and for industry-sector comparison over the same five years: banks earned 17.3 cents for every dollar of sales, pharmaceuticals 16.2 cents, and real estate 10.6 cents, to name a few.
For the third quarter of 2005, the oil and natural gas industry earned 8.2 cents for every dollar of sales compared to an average of 6.8 cents for all of U.S. industry. These figures are the latest available for comparative purposes, since not all companies’ earnings reports from the fourth quarter have been filed.
It is also important to understand that those benefiting from these oil and natural gas industry earnings include numerous private and government pension plans, including 401K plans, as well as the direct investment accounts of many hundreds of thousands of individual American investors. While many shares are owned by individual investors, firms, and mutual funds; pension plans, alone, own 41 percent of oil and natural gas company stock.
Unfortunately, just when our nation should be encouraging oil and natural gas exploration, production and refining; punitive tax proposals originating in the U.S. Senate would clearly make it much more difficult for the industry to meet the energy needs of American consumers. A Senate provision to selectively increase the tax on the foreign source income of our nation’s five largest oil and gas companies would make these companies pay taxes twice on foreign income and become less competitive in international markets – at a time when they have been excluded from developing oil and gas resources in vast onshore and offshore areas within our own country. If these companies are marginalized from gaining new exploration rights, do you think this is a “win” for U.S. industrial and retail consumers? I think not.
Also pending is a tax proposal that would impose a financial penalty on these same five companies by forcing them to retroactively change the way they value their inventories for tax purposes. This Senate modification of LIFO (last-in/first-out) accounting procedures is nothing more than a thinly-veiled “windfall profits tax,” which would reduce the capital available for refinery investment – at the very time when public policy leaders of all persuasions are calling for greater investment in U.S. refining capacity.
These harmful tax proposals point up the fact that the most significant obstacle today in meeting U.S. energy challenges is government policies that do not reflect an understanding of the energy world in which we must operate. You can help keep America’s and your own energy costs competitive by urging your senators and representatives in Congress to remove these insidious, punitive energy taxes from the tax reconciliation bill under consideration.
As you will hear later this morning from U.S. Energy Information Administrator Guy Caruso, world energy markets are being radically reshaped by the mushrooming energy demand of China, India, and others. And, these increased world energy demand pressures could well be with us for the better part of the decade – or until worldwide investment provides sufficient capacity to limit, if not eliminate, the price volatility and tight supply/demand situation faced today.
It is worth noting that this price volatility is not limited to the United States, rather it is a worldwide phenomenon. For example, even though European countries tax motor fuels heavily, they too have experienced price increases, though of a lesser percentage change.
How can we meet these challenges here in the United States? For one thing, we cannot any longer afford to revisit energy policy only once every 10 years or so. Energy has become an every-year issue – as changes continue, as markets evolve, and as new technologies come online. We must continue to address our energy policy until we get it right.
As I mentioned earlier and importantly, in meeting U.S. energy challenges, industry cannot do it alone. We cannot meet the energy needs of U.S. consumers without an effective, comprehensive approach by government to energy policy. We can no longer rely on knee-jerk responses, quick-fixes, or wishful thinking alone. The energy legislation signed by the President last year was a good first step, but much remains to be done. Make no mistake about it, government policies do have a huge impact on energy outcomes.
Following Hurricanes Katrina and Rita, some people asked why our industry concentrated its facilities and operations along the hurricane-prone Gulf coast. There is a reason for this geographic concentration in a high-risk storm area. Government policies have largely limited offshore exploration and production to the Central and Western Gulf of Mexico – and our onshore facilities, including refineries, have been welcomed in communities in the region. Unfortunately, oil and natural gas development has been barred elsewhere – including the eastern half of the Gulf, the entire Atlantic and Pacific Coasts, and large parts of the offshore and onshore areas of Alaska. Undiscovered technically recoverable offshore resources could provide enough natural gas to heat 52 million homes for 120 years and enough oil to fuel 48 million cars for 60 years and heat 10 million homes for 120 years. Onshore construction in the lower 48 has been held back by government restrictions, permitting delays, and not-in-my-backyard (NIMBY) sentiments.
Recent history provides overwhelming evidence that the U.S. industry can find and develop oil and natural gas resources safely and with full protection of the environment, both on land and offshore. For example, according to the U.S. Coast Guard, from 1980 to 1999, 7.4 billion barrels of oil were produced in federal offshore waters, with less than 0.001 percent spilled, less than the volumes of natural seeps that occur on the sea floor of the Gulf of Mexico. The industry’s leak prevention performance in offshore production during three major hurricanes (Ivan, Katrina and Rita) – including two of them back-to-back featuring 200 miles-per-hour winds and seas of up to 100 feet and all within 12 months - continues this remarkable environmental protection record.
If history has taught us anything, it is that markets work. And free markets - including the free flow of oil, products and technology - work best. However, when government has interfered with markets, the result has been price volatility, supply shortages, and other disruptions. In the early 1970s, many U.S. energy policymakers were “sure” that the reserves of oil and natural gas would soon be exhausted, and government policy was explicitly aimed at “guiding” the market in a smooth transition away from these fuels to new, more sustainable alternatives. Price controls, allocation schemes, limitations on natural gas, massive subsidies to synthetic fuels, and other measures were funded heavily and implemented. And not a one proved sustainable.
We need to learn from that sad and unfortunate experience. Given the current and projected worldwide demand, we need all sources of energy, and we need a greater commitment to energy efficiency and energy conservation. We do not have the luxury of limiting ourselves to a few sources of energy supply at the exclusion of others. Nor can we afford to write off our leading source of energy – oil and natural gas -- before we have found cost-competitive and readily available alternatives.
We also need to keep energy sources in the proper perspective. Yes, alternative sources have great potential – but, while the U.S. EIA forecasts a 50 percent increase in renewable energy consumption between 2004 and 2025, it also forecasts that the renewable energy share of total U.S. energy consumption will rise from 6 percent to only 7 percent during that period.
There is a misperception by some about the time and costs involved in any transition to the next generation of fuels. Consider what would be involved in replacing the dominant role of oil with a substitute like hydrogen or solar power. Most experts agree that such a transition would require dramatic advances in technology and massive capital investments – and take several decades to accomplish, if at all.
The United States – and the world - cannot afford to leave the Age of Oil before realistic alternatives are fully in place. It is important to remember that man left the Stone Age not because he ran out of stones. And, we will someday leave the Age of Oil, but not because we will have run out of oil. Yes, someday oil will be replaced, but clearly not until alternatives are found and tested -- alternatives that are proven more reliable, more versatile, and more cost-competitive than oil.
This does not mean that our industry is narrowly focused on oil and natural gas alone. In fact, our companies have long been pioneers in developing alternative sources of energy. Permit me to cite several examples:
- BP is one of the world’s largest producers of photovoltaic solar cells;
- Chevron is the world’s largest developer of geothermal energy;
- Our industry is the largest producer and user of hydrogen;
- ExxonMobil, BP, Chevron, Shell and ConocoPhillips are key players in government/industry hydrogen fuel and vehicle partnerships, such as the DOE FreedomCar and Fuel Partnership and the California Fuel Cell Partnership;
and
- Shell is one of the top players in the worldwide wind industry.
Our companies intend to meet the energy needs of industrial and retail consumers well into the future, and they compete fiercely with one another and others for the opportunity to do so. The companies’ research and development efforts are continuing in the search for the most competitive, efficient, and economical energy technologies.
Indeed, thanks to our industry’s technology and refiner flexibility and investment, an array of alternative fuels is already included in our companies’ product slates. For example, we in the United States now consume as much ethanol as Brazil, the world’s long-time champion producer of ethanol. Very soon, we will overtake them. However, we need to keep in mind that no energy alternative is a panacea. Each has its plusses and minuses, but they can each play an important role.
For example, based on various studies, the energy savings from corn-based ethanol are moderate – 3 to 20 percent – because production from corn requires significant energy input. And, judging from this past year, ethanol is higher-priced than gasoline and, measured on a BTU basis, considerably more expensive. In addition, some have estimated that the total amount of ethanol that could be produced by converting the entire 2005 U.S. corn crop into ethanol would be about 31.1 billion gallons – an amount equal to just 22.2 percent of U.S. gasoline consumption last year.
API’s member companies feel there is a very bright future for a full range of alternatives. But, we do not want to be a party to any “over-promise and under-perform” commitment. We have to be realistic, including the need to exercise full due diligence and appropriate risk management methodologies. We need only look at the auto industry and consumer experience with diesels in the 1970s to see that wishful thinking, absent merit, can end up hurting everyone.
API and its members have recognized the need to address concerns about oil and natural gas on an industry-wide basis and have undertaken a broad-based educational outreach effort to address information gaps. This commitment encompasses the full range of activities that can help people better understand how our industry can best meet their needs. You will be seeing much more of these educational activities in a new multi-year communications effort being supported by our industry.
Through our efforts, we hope that people will better understand that, in today’s global energy marketplace, U.S. “energy independence” is impossible. We hope they come to see that, instead, “energy inter-dependence” is essential. We hope consumers will come to recognize that their interests are best served when we can source fuels from multiple providers located both in the U.S. and throughout the world. Sourcing flexibility is one of our most powerful energy security tools. We also want others to understand that we can operate only where governments permit us to do so. Just like in your businesses, if you cannot produce or sell your goods or services in an area, you go elsewhere. So, too, is the case in our business. If we are prevented from exploring for and producing oil and natural gas here at home in the United States, we must look elsewhere in the world to get you the energy you need.
If our government elects to keep us from attractive oil and natural gas production opportunities in the U.S., and burdens us from competing fairly abroad, our foreign competitors – national oil companies, heavily supported and, at times, subsidized by their governments – could move more aggressively into energy markets here in the U.S.
Clearly, we all need to work together – industrial and retail consumers, energy companies and government – to address the energy challenges we all face. In looking at these challenges, it’s easy to see the glass as half empty, when, in fact, it is half full. America’s oil and natural gas producers and suppliers have the technology, the efficiency, the infrastructure savvy, and the desire to compete anywhere on a level playing field with their competitors. We can continue to supply you with the energy you need, if you will work with us to have the government provide oil and natural gas supplies here in the U.S., especially in the Outer Continental Shelf (OCS). We must also embrace increased energy efficiency and enhanced energy conservation – both at home and at work – as well as increased domestic energy production and imports in order to maximize our energy utilization as a nation. Our nation is blessed with bountiful reserves, but their promise for the American people goes unfulfilled so long as society is unmoved about the benefits and value our products can deliver to an enhanced quality of life for all here in the U.S.