There is almost no question that natural gas will play an important role in the U.S. energy future. With the almost continual upward revision of reserves from shale gas, there is sufficient supply to replace some coal burning power plants with cleaner burning natural gas power plants, and perhaps, use natural gas as a transportation fuel, either directly or indirectly with electric vehicles.

Professor David Spence, the UT McCombs expert on energy policy, provides his insights on the future of shale gas in a recent energy brief. I followed up on his findings with a few brief questions:

We have seen how BP’s Deepwater Horizon disaster has affected the business of every offshore oil producer in the United States. Is there a comparable scenario for shale gas, one in which a single bad actor may poison the well (no pun intended) for other producers?

David responds:
Certainly this is a politically delicate time for hydraulic fracturing, particularly in the Marcellus Shale, where there is a great deal of popular trepidation about fracking and its risks. The movie “Gasland,” a documentary being broadcast on HBO right now, portrays fracking as an inherently dangerous activity. There has already been an apparent spill near the towns of Dimock and Damascus, in Pennsylvania, one that is reputed to have affected drinking water wells. Presumably, whatever contamination occurred there was the product of surface activities (spilled f Continue Reading »

In February, 2010, Nick Olds of ConocoPhillips visited The University of Texas at Austin to talk to us about the oil that is being extracted from the oil sands in Alberta, Canada. Nick is the Senior Vice President, Oil Sands, for ConocoPhillips Canada.

In addition to providing us with access to his slides from the talk, he has graciously agreed to answer some of my questions:

How much oil is currently being produced from oil sands in Alberta? Can you give me a sense of the total available reserves from oil sands in Canada? Are there other areas in the world that have significant unexploited oil sands?

Nick responds:
The oil sands are an enormous resource. Most of the oil sands of Canada are located in three major deposits in northern Alberta. These are the Athabasca-Wabiskaw oil sands, the Cold Lake deposits and the Peace River deposits of Alberta. Between these three resources, there is approximately 1.75 trillion barrels of bitumen in place. The Alberta oil sand deposits contain at least 85% of the world’s reserves of natural bitumen (representing 40% of the combined crude bitumen and extra-heavy crude oil reserves in the world). That’s a lot of oil, and probably the largest hydrocarbon deposit we know about.
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BP has been criticized for offering to pay all “legitimate” claims. However, a recent suggestion of the Obama administration has provided an example of the type of claim that is not legitimate, by suggesting that BP compensate oil industry workers laid off because of the federal moratorium on deepwater drilling.

The claims of beach resort owners and fishermen are legitimate, since BP’s actions have clearly caused financial harm to these individuals. It is also true that BP’s action led to the deepwater drilling moratorium, which harmed many oil industry workers in the Gulf. However, the moratorium did not arise because of the spill per se, but because the spill revealed that deepwater drilling may not be as safe as we may have originally thought. In a sense, this is the one good thing that we can say about the spill – that it may have lead to actions that will prevent future spills.

To understand this a little bit more clearly consider a hypothetical situation where an explosion in deepwater resulted in a spill that was immediately capped, with very little damage to the environment. Seeing the near disaster, the administration puts a halt on all new deepwater drilling, leading to changes that prevent future disasters. In this case, it is clear that the near disaster had social benefits that outweigh the social costs.

The moratorium following an actual disaster is no different. The moratorium certainly has its costs; however, it was imposed because we learned something from the disaster that suggests, at least to some people in the administration, that the moratorium has benefits that exceed those costs.

With the recent passage of the Lieberman-Kerry energy bill earlier this month, energy policy is again a hot topic in Washington, D.C. The Deloitte Center for Energy Services will be having a conference to discuss these issues in early June, but to get a head start thinking about key trends and topics, I had a conversation with Branko Terzic, who is the Regulatory and Policy Leader in Deloitte’s Energy & Resources group.

We’ve heard very good things about you, Branko–that you’re the expert to talk to about what’s going on in terms of regulation and legislation. Let’s start by talking about the Lieberman-Kerry bill. It looks like Congress is converging on what has been described as a “cap and trade” system, rather than a tax. What do you see as the advantage of a cap and trade system?

Branko responds:
The Senate bill has cap and trade because the House bill that it’s supposed to reconcile with (the Waxman-Markey bill) has cap and trade. This way when they go into conference, they are easier to reconcile. In terms of the benefit of cap and trade, versus a tax, the electric power industry is familiar with cap and trade with respect to NOx and SOx and other pollutants and so they already understand how the markets work–it’s something that they can mechanically handle well and conceptually handle well.

As you know, politicians have an aversion to raising taxes, at least directly. Consequently, since the additional cost of CO2 in the form of emissions permits to electricity is an indirect tax instead of an explicit tax — you don’t have Congress directly raising taxes. Having said that, opponents of cap and trade call it cap and tax.

For this legislation to have any teeth – for it to appreciably change carbon output — it has to raise prices enough to curtail consumption; is that correct?

Branko responds:
Yes, in order to curtail consumption on the basis of consumer pass-through, it would have to have some significant cost increases. As you know, people don’t use energy–their devices do. After the 1970s and ’80s, it took about five to six years for the capital equipment to be changed out and to reflect the higher energy cost. Continue Reading »

An Interview with David Spence

With the introduction of the Lieberman-Kerry energy bill earlier this month, energy legislation is again on the Senate agenda. My colleague David Spence has been doing research on energy policy and the legislative process and is the McCombs expert on this topic.

When I look at the various proposals I get the impression that our Congress prefers complicated, rather than simple, solutions. For example, I would like to see a simple tax on oil, coal and natural gas that is proportional to their carbon content. Is there an inherent bias against simple solutions, or are these solutions “simplistic” rather than just simple? Would you say we have complicated proposals because we have complicated problems, or are the proposals complicated because we have a complicated process?

David answers:
Economists have favored emissions taxes over other regulatory instruments since the earliest days of environmental regulation in the United States, yet Congress almost never chooses that option. Companies tend to prefer taxes over marketable permits or other forms of regulation as well, because taxes provide cost certainty in pollution control. By contrast, marketable permit prices can vary wildly, as we’ve seen in the European carbon trading scheme. Environmental groups distrust environmental taxes because it is difficult to predict exactly how much pollution will occur at any given tax rate, and they fear that the rate would be set too low. They also tend to believe that the American the acid rain program, a marketable permit system for sulfur dioxide emissions from coal-fired power plants, has worked well.

However, the most likely answer to your question is a logically unsatisfying one. In American politics, “tax” is a four letter word, and has been for several decades now. Public support for regulation wanes when regulation is described as a “tax.” This may be because consumers associate taxes with higher energy prices more readily than they do other forms of regulation. Taxes may also be associated with “big government” in public mind. Members of Congress have no preference for complex policy solutions, except when complexity can be used to disguise costs. They have a strong preference for policies they think their constituents want, and an even stronger aversion to policies that they fear might be portrayed as harmful to their constituents in the future.

Hence, marketable permits have been the instrument of choice in all of the recent climate change bills. There was speculation that the bill that Senators Kerry and Lieberman unveiled recently would substitute a carbon tax for marketable permits in the regulation of the oil industry. Instead, the bill tries to provide more cost certainty for the oil industry by “setting aside” a number of emissions allowances (marketable permits) on a quarterly basis, and refiners will then purchase the allowances they need for that quarter at that the price for that quarter. Hardly a simpler solution.

If this is anything like health care, we can expect substantial division between Democrats and Republicans on this energy bill. Can you very briefly where these differences are likely to arise? Do you think these differences arise because of philosophical differences (such as different views on big government) or because of their different constituencies?

David answers:
It appears as though the partisan split in Congress, particularly the Senate, is every bit as stark on this issue as it has been with healthcare. Lindsey Graham (R-SC) who was part of the “Gang of Three” who tried to develop a bipartisan Senate bill, dropped out of the process a short time ago. While he cited displeasure over the administration’s immigration reform proposals as the reason, some commentators believe that Graham was under tremendous pressure from his party not to cooperate with Democrats on energy.

The partisan split can be traced to differences over particular issues, as well as differences over basic philosophy. The fact that these bills would impose significant regulatory costs on a wide swath of industry makes small government Republicans wary. Carbon capture and sequestration will impose very large costs on coal-fired power plants. A national renewable portfolio standard for electric utilities would impose significant costs electric utilities, particularly in parts of the country with few renewable energy resources such as the southeast, where Republican support is very strong.

In addition, the base of the Republican Party views climatologists’ consensus view — that the earth is warming, and that human activity is very likely driving that warming — with great skepticism. These claims are the very factual foundation of the effort to address climate change: that is, they are what justifies the costs these bills would impose. Naturally, one who disbelieves these claims will see no purpose to bearing those costs.

Finally, can you make a guess of the likely outcome of this process? Do you think we will have new legislation by the end of the summer? Any guess on what it will look like?

David answers:
This is very difficult to predict. Right now, the prospects for passage of a bill in the Senate look very bleak. Public support for action on climate change is actually declining. On the other hand, catalyzing events, like the oil spill in the Gulf of Mexico, can change political dynamics quickly. For now, the administration seems more focused on financial reform. If that legislation passes, with Democratic support overcoming Republican opposition (as it did with healthcare), Republicans may revisit their strategic and tactical approach to major regulatory legislation, which could also change the political dynamics of the energy bills. Add to that the midterm elections coming up in the fall and it is anybody’s guess what will happen.

If I had to guess, I would guess that’s we will get either (i) no energy legislation during this Congress, or (ii) relatively weak legislation which offers more financial incentives for conservation, efficiency and development of nuclear power, but no mandatory reductions in greenhouse gas emissions, efficiency standards for buildings, or national renewable portfolio standard.

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  • About Sheridan

    Sheridan Titman, Professor of Finance at the McCombs School of BusinessSheridan Titman is a professor of finance at The University of Texas at Austin and a research associate of the National Bureau of Economic Research. He was recently elected Vice President of the American Finance Association and is incoming President in 2012. He is also the Executive Director of the Energy Management and Innovation Center (EMIC) at The University of Texas at Austin.

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  • About this blog

    This blog’s primary focus will be on energy and this will be, more or less, a learning blog. The blog will offer some of my own views, as well as the views of some of the participants at EMIC. I will also raise questions in the hopes of receiving answers, insights and opinions from our participants. Since my own expertise is in finance, much of the initial focus will be on issues that relate to hedging, financing, derivative markets, and the financial evaluation of alternative energy sources. As my knowledge of these issues expand, I would also like to explore issues that relate more broadly to innovation and the role of public financing in this sector.