USOGA Editorial Piece

On behalf of the association, I appreciate the opportunity to share our perspective on our nation’s energy circumstances and to provide some information on our challenges, as well our opportunities. This is a pivotal and highly challenging time for those of us involved in the industry and for energy consumers. Clearly, supplies of energy in all forms are not keeping pace with economic demand. High demand and a tight supply environment lead to high energy prices. I recognize that it is certainly a difficult time for residential, commercial, and industrial consumers.

I recall last year hearing an energy expert quoted as saying that we are close in this country to having a “realistic” discussion about energy. I think this comment reflects a growing realization that part of our energy solution is more energy supplies from new areas of production. Alternative and renewable of energy, conservation and energy efficiency all will play a part in our short-term and long-term future, but coal, oil and natural gas will continue to provide the lion’s share of our energy needs. The purpose of this article is to highlight opportunities for Mississippi, discuss the impact of Katrina and Rita on the energy markets, analyze our refining circumstances, provide a perspective on 3 rd quarter energy company profits, and review the broader policy questions that face policymakers.

Mississippi is an important energy state. Our energy assets and infrastructure include 12 major natural gas pipelines, a major refinery and several smaller refineries, oil and natural gas production, petroleum and petroleum products pipelines, abundant electricity generation, and lignite resources. This industry has existed in Mississippi for over 60 years and contributed significantly to the economic growth in the state. We work everyday to help provide energy and energy solutions for consumers in the state, the region and the nation in a safe and environmentally sensitive manner. We have opportunities for growth because the potential exists for continued onshore exploration for deep and shallow natural gas in both traditional and newer areas of the state, lignite coal development, offshore natural gas development, continued expansion of the existing pipeline network, natural storage and refining facilities. Further, we currently have the prospect of having facilities in Jackson County, Mississippi to receive imported natural gas from abroad.

The impact of Hurricanes Katrina and Rita on our industry is difficult to exaggerate. Because of the infrastructure in the Gulf Coast region, virtually all of the offshore oil production and 80% of the natural gas production was knocked out due to the storms. The Gulf Coast region includes some 4,000 offshore platforms in federal waters, dozens of refineries and natural gas processing plants, and hundreds of transportation and marketing facilities. The offshore production contributes nearly 30 percent of the nation’s crude oil production and approximately 20 percent of the natural gas production. Today, we have restored about 70% of the oil production and 82% of the gas production. The damage brought by these unprecedented storms exacerbated an already tight market in terms of supplies of energy and demand. The circumstances caused gasoline prices to jump and we are still feeling the impact on natural gas and oil prices. Crude oil is the single largest component of the price of gasoline. Even before the hurricanes, world oil prices were high and remain today at about $60 a barrel. It is important to note that oil and natural gas prices are set in international markets with the price subject to many variables, including worldwide demand. World demand actually reached unprecedented levels in 2004 and continues to put pressure on prices because the ability of producers around the world to increase their capacity in the short term is at its lowest level in years. Similarly, in the natural gas markets, we produce domestically about 85% of what we use everyday in the U.S. We currently use about 22 trillion cubic feet a year and demand continues to grow. Natural gas is used for heating and cooling, electric generation and to make a wide array of products such as fertilizer, paper, glass, steel, chemicals and plastics. Again, strong domestic demand for gas taxes the ability of domestic producers to meet this demand. Liquefied natural gas or imported natural gas, though critically important, will simply augment our current supply capability.

More efficient use of energy in this time of tight supply is crucial as is the development of alternative and renewable fuels. However, efforts to bolster new onshore and offshore supplies of domestic oil and natural gas are also crucial to our economy and energy consumers. The Department of Energy (DOE) forecasts that by 2030 U.S. consumption of energy will grow by 41% with petroleum demand up by 34%, and natural gas, 20%. Today, these energy sources, along with coal, contribute more than 80% of our total needs and will continue to do so in 2030 according to the DOE. Dependency of foreign oil will increase to 62% of our need according to the government agency.

Higher natural gas prices have taken their toll as more than 2.8 million U.S. manufacturing jobs have been lost since 2000, and chemical companies closed 70 facilities in the year 2004 alone and have tagged at least 40 more for shutdown. Today’s price takes it toll on residential consumers and household budgets. Quite frankly, in our pursuit of an effective energy policy, consumers are not always heard in the debate. That’s changing as more and more consumer related organizations, such the American Gas Association, representing gas utilities, the Edison Electric Institute, representing electric utilities, and others are an important part of the debate to address our supply/demand circumstances on behalf of their customers.

What can be done about high energy prices? In my opinion, the 2005 Energy Policy Act is a first step, but does not adequately address the realities we face. We have growing demand for energy, yet no real commitment to developing new supplies from domestic areas. According to estimates, about 131 billion barrels of crude oil and about 1000 trillion cubic feet of natural gas remain to be discovered in the United States. However, much of these resources are off-limits to drilling and development because of federal policy. For example, in the eastern Gulf of Mexico and the Rocky Mountains, two very key areas of potential for natural gas, restrictions preclude or seriously constrain development. In the eastern Gulf of Mexico, areas that are more than 100 miles off the coast of Mississippi, Alabama and Florida are off-limits due to the State of Florida’s opposition. We simply need a policy that is balanced and in more proportion to our needs. Florida uses 730 billion cubic of feet of natural gas annually, yet contributes virtually nothing in terms of supply. Their position is irrational and not in the nation’s best interest. We are aware that opponents of development raise issues and environmental concerns. However, our record in the Gulf of Mexico is exemplary and the overwhelming evidence is that we can find and produce oil and natural gas safely and in an environmentally sensitive manner. By using the latest, most advanced technology and operational practices, this industry has reduced the environmental impact of both onshore and offshore development. In fact, the U. S. Coast Guard reports that during 1980-1999, 7.4 billion barrels of oil were produced in federal waters, with less than 0.001 percent spilled. That is less than the volume of natural seeps that occur on the ocean floor. We need to open these offshore areas and we need to open the Arctic National Wildlife Refuge for development. Misconceptions still exist about drilling in Alaska. The ANWR total area is 19 million acres, but the development would occur on the coastal plain and on only 2000 acres of this area. It is the largest new prospect in the United States and it is estimated that approximately 10 billion barrels of oil could be produced over 30 years. That translates into about 1.5 million barrels a day to the U. S. market, a volume that would impact market prices.

It is important for me to address the third quarter profits (2005) by many oil and natural gas companies because it has received a lot of attention in the media. The third quarter net profits of the larger oil companies were a result of the dramatic increase in energy prices caused by Hurricanes Katrina and Rita and other market conditions. The industry’s average was about 8% for that period, but has averaged about 5.7% for the previous five years. The oil and natural gas industry is among the world’s largest industries in terms of capital investment and dollar sales. The revenues are, therefore, large compared to many industries, but the net profit is often lower than other industries or at least consistent with other industries. The capital costs to find, produce, refine, transport, distribute and market oil and natural gas are quite substantial. In 2005, the total reinvestment by the industry was expected to be $90 billion. A single deepwater production platform can cost in excess of $1 billion. In 2004, the oil and natural gas industry realized earnings of 7 percent, compared to an average of 7.2 percent for all U.S. industry.

In a reaction to the 3 rd quarter profits by energy companies, some in Congress want to impose a “windfall profits” tax (WPT) on the industry. Such a tax existed in the 1980’s to the detriment of our nation’s energy security. A WPT was the wrong idea in 1980 and is clearly the wrong idea now. As The Wall Street Journal editorialized last year, “A windfall profits tax only discourages increases in supply by disincentivizing further production.” History offers a lesson here: the WPT drained $79 billion in industry revenues that could have been used to invest in new oil and gas production, according to the Congressional Research Service (CRS) . Further, CRS estimates that 1.6 billion fewer barrels of oil were produced domestically due to the production tax, and thus our dependency on foreign oil increased during this period. The oil and natural gas industry uses its earnings to invest in new technology, new production, refining and product distribution infrastructure, and environmental and product quality improvements. The National Petroleum Council projects that producers will have to invest almost $1.2 trillion through 2025 to fund U.S. and Canadian natural gas exploration and production activities and $200 million for infrastructure. This kind of capital investment requires a stable business climate. I might add that crude oil prices, which are set on the world market, and natural gas prices fluctuate over time. This industry must manage its investment even in light of these fluctuations. Many of you may recall that as recently as 1999, the oil and natural gas industry had to weather oil prices of around $10 per barrel.

There has also been considerable media attention and questions about the state of refining in the United States. As background, the oil and gas industry has earned historically low rates of return in the refining sector. Attracting capital for new refinery capacity has been difficult with refining rates of return averaging well below the average for S&P Industrials. Over the 10-year 1994-2003 period, the return on investment for the refining and marketing sector was 6.2 percent or less than half as much as the 13.4 percent for S&P Industrials. We have seen the number of refineries reduced from 350 to 144 in the U. S. However, through technological advancements and enormous expenditures of capital, refineries produce more from existing facilities than they did in the past. Even though a new refinery has not been built from scratch in 30 years, existing refineries are continually being upgraded and reworked to improve efficiency. U.S. refining capacity has expanded from 14.7 million barrels per day in 1994 to 17.1 million barrels a day today, or 2.4 million barrels a day. This expansion is the equivalent of about a dozen new 200,000 a day capacity refineries. Based on publicly available data on announced refinery capacity expansion plans, more than 1.3 million barrels/day of additional refinery capacity projects are either planned or under strong consideration for the years 2006-2011.

So, where are we in terms of addressing our energy needs? Are we, as the energy expert suggested, at the point of having a serious, responsible discussion about our circumstances? Do we have the political will to do what is necessary from a policy standpoint to meet the supply challenges? It remains to be seen, but it is an important debate and one that will affect consumers and our energy security for quite some time.