Energy Economics in the 21st Century

Bill Pike

21 April 2010

Points to Remember as We Discuss Energy Economics

• The global oil and gas industry is the world’s largest private sector enterprise, generating approximately $4.5 - $5 trillion in gross revenue yearly.

• Oil and gas are commodities. Oil is a global commodity but gas remains, mostly, a regional commodity subject to local economic factors.

• Simple supply and demand economics should explain supply, demand and pricing of oil and gas, but most often do not.

• Despite the rising level of political rhetoric, carbon-based energy sources (oil, gas and coal) will remain our primary energy sources through 2035, at the very least.

The Basics

Bill Pike

21 April 2010

Supply and Demand Economics

(Groan)

• Demand – The Law of Demand holds that, other things being equal, as the price of a good rises, demand for that good will fall, and vice versa.

The Demand Curve

Equilibrium Point

Quantity in the Market

Un

it P

rice

Supply and Demand Economics

Few of us have experience with the supply side of the market. Supply is derived from producer’s desire to maximize profits.

• Supply – The Law of Supply holds that, other things being equal, as the price of a good rises, its quantity supplied will rise, and vice versa.

The Supply Curve

Supply CurveDemand Curve

Equilibrium Point

Un

it P

rice

Quantity in the Market

The Supply/Demand Model

Equilibrium Point

Quantity in the Market

Un

it P

rice

Price and Supply at Equilibrium

World Demand for Energy Will Continue to Grow

0

100

200

300

400

500

600

700

En

erg

y C

on

sum

ptio

n Q

uad

. BT

U

Oil Natural Gas Coal Nuclear Renewables

Source: EIA, International Energy Outlook

Primary Energy Demand (1015 btu)

2010 2015 2020 2025

• Petroleum 185 204 224 245

• Natural Gas 108 122 139 156

• Coal 108 117 127 140

• Nuclear 30 31 32 30

• Other 39 43 47 50

Source: Energy Information Administration, U.S. Department of Energy

By The Numbers

Petroleum Consumption in Developing Nations Will Exceed Developed Countries by 2025

0

20

40

60

80

100

120

140M

illio

n B

arr

els

of

Oil/

Da

y

1970

1975

1980

1985

1990

1995

2000

2003

2010

2015

2020

2025

Developed Countries Rest of World

Global Energy Demand

by sector, billions barrels of oil equivalent

Energy Demand and GDP (1980 – 2002)Primary energy demand per capita (Gigajoules)

United Nations Human Development Index versus per Capita Electricity Consumption

0

0.1

0.2

0.3

0.4

0.5

0.6

0.7

0.8

0.9

1

0 5,000 10,000 15,000 20,000 25,000 30,000

Electricity, kWh (2002 data)

HD

I (20

03 d

ata)

IcelandNorway

Canada

United States Qatar

Energy and Well Being

But What About Supply?

• We Know Where There is Enough Oil– Mature Fields– Unconventional Assets– Ultra-Deepwater– Arctic Regions

But What About Supply?

• We Know Where There is Enough Gas– Shale Gas– Tight Gas– CBM– Methane Hydrates

to Fuel the World’s Economy and Society for Many Decades.

So, We Should Be Set to Let Supply and Demand Economics End This Global Price Roller Coaster Ride?

If You Believe This, See Me Later for a Really Good Deal on a Bridge.

Factors Skewing Supply and Demand Fundamentals

• Political and/or economic instability in major producing areas

War – The Ultimate Instability

Factors Skewing Supply and Demand Fundamentals

• Political and/or economic instability in major producing areas

• Speculation in the market place

Instability and Worldwide Oil & Gas Reserves

NOC

Non-NOC

OPERATED BY:

Oil & Gas Reserves combinedSource: BP Statistical Review

of World Energy 2004

Unstable

Unstable

Unstable

Nationalizing

Unstable

Unstable

Speculation in the Market Place

• Hedging: The spot and futures markets• Fear that wars, political maneuvering and/or

nationalizations will disrupt oil and gas supplies leads market traders to buy and hedge upwards to guarantee supply

• This probably accounts for as much as $15 of the price of a barrel of oil today

• Most producers would be happy with an oil price of $75 to $85 per barrel

Factors Skewing Supply and Demand Fundamentals

• Political and/or economic instability in major producing areas

• Speculation in the market place• Artificial pricing through subsidies and taxes

Artificial Pricing Through Subsidies

2007 U.S. Energy Subsidies: $ millions

• Coal 932• Refined Coal 2,370• Natural Gas/Petroleum Liquids 2,149• Nuclear 1,267• Renewables 4,875

• Total 11,593

Types of Subsidies/Market Intervention

• Direct Subsidies• Royalty Relief• Tax Credits• Investment Credits• Depletion Allowance• Research and Development Funding• Grants• Accelerated Depreciation• Import/Export Restrictions• Price Controls

Linkage – Subsidies and Prices

In the aggregate, subsidies throughout the world to any particular form of energy will tend to depress prices and encourage consumption, and overconsumption, of the resource.

However, that does not always apply. Many subsidies to domestic producers, and many import restrictions, for example, keep these producers competitive with less expensive imports and/or options.

Removal of subsidies will save taxpayers billion of dollars.

Factors Skewing Supply and Demand Fundamentals

• Political and/or economic instability in major producing areas

• Speculation in the market place• Artificial pricing through subsidies• Cost variations – reserve types and recovery

costs

Cost Variations: Price Sensitivity for Development

Source: Martin Wolf, “Coal and open markets are the best hope for energy security,” The Financial Times, 5 July 2006, p 13.

Cost Variations: Processing Costs

• Cost to process a barrel of oil for the refinery gate– 160 various types of crude produced worldwide– a price differential of $15 barrel, or higher– depending on the composition of the oil,

processing cost can vary widely

Company profit on a $3 per

gallon gasoline at the pump is

about 10 cents a

gallon.

The Role of Taxes

Factors Skewing Supply and Demand Fundamentals

• Political and/or economic instability in major producing areas

• Speculation in the market place• Artificial pricing through subsidies• Cost variations – reserve types and recovery

costs• Regulatory restrictions - Macondo

Regulation and Prices

• Macondo– Delays due to moratoria and complex permitting

and development regulations will result in the loss of 82,000 barrels of oil per day in the Gulf of Mexico next year

– Moratoria in other areas, such as the Arctic, will forestall or prevent development of incremental production

What is the story for the U.S.?

• We have significant amounts of mature and unconventional resources to moderate declines in domestic oil production.

• However, they won’t be enough to end our dependency on imported oil.

U.S. Primary Energy Consumption by Fuel, 1980-2035(quadrillion Btu)

Annual Energy Outlook 2011

“Let us set as our national goal, in the spirit of Apollo, with the determination of the Manhattan Project, that by the end of this decade we will have developed the potential to meet our own energy needs without depending on any foreign energy source.”- President Richard Nixon (November 7, 1973)

“I am recommending a plan to make us invulnerable to cutoffs of foreign oil. … [a] new stand-by emergency programs to achieve the independence we want…”- President Gerald Ford (January 15, 1975)

“This intolerable dependence on foreign oil threatens our economic independence and the very security of our nation.”- President Jimmy Carter (July 15, 1979)

“We will continue supportive research leading to development of new technologies and more independence from foreign oil.”- President Ronald Reagan (February 18, 1981)

“There is no security for the United States in further dependence on foreign oil.”- President George H. Bush (August 18, 1988)

“We need a long-term energy strategy to maximize conservation and maximize the development of alternative sources of energy.”- President Bill Clinton (June 28, 2000)

“This country can dramatically improve our environment, move beyond a petroleum-based economy, and make our dependence on Middle Eastern oil a thing of the past.”- President George W. Bush (January 31, 2006)

“For decades, we have known the days of cheap and accessible oil were numbered…. Now is the moment for this generation to embark on a national mission to unleash America’s innovation and seize control of our own destiny.”- President Barack Obama (June 15, 2010)

Annual Energy Outlook

0

5

10

15

20

25

30

1960 1970 1980 1990 2000 2010 2020 2030

U.S. Petroleum Supply, Consumption, and Net Imports,1960-2030 (million barrels per day)

Consumption

Domestic Supply

Net Imports

58%

62%

Annual Energy Outlook

History Projections

Instability and Worldwide Oil & Gas Reserves

NOC

Non-NOC

OPERATED BY:

Oil & Gas Reserves combinedSource: BP Statistical Review

of World Energy 2004

Unstable

Unstable

Unstable

Nationalizing

Unstable

Unstable

What is the story for the U.S.?

• We have more gas than we know what to do with.

• We are set to become a net exporter of natural gas at current resource development rates.

• However, basic economics may hinder development of these resources in the near and mid term.

U.S. Natural Gas Production, Consumption, and Net Imports,1960-2030 (trillion cubic feet)

0

5

10

15

20

25

30

1960 1970 1980 1990 2000 2010 2020 2030

15%

21%Net ImportsConsumption

Production

Natural Gas Net Imports, 2004, 2025, and 2030 (trillion cubic feet)

2.8

0.6

2.3

1.2 1.2

4.4

6.4

4.1

0

1

2

3

4

5

6

7

Pipeline Liquefied Natural Gas

2004AEO2005AEO2006 - 2025AEO2006 - 2030

Annual Energy Outlook 2005 and 2006

History Projections

Cancelled

Unconventional Gas to the Rescue

Energy Economics in the 21st Century

Renewable Energies

Renewable Energy Consumption in the Nation’s Energy Supply, 2008

Source: http://www.eia.doe.gov/cneaf/alternate/page/renew_energy_consump/rea_prereport.html

The British thermal unit (BTU or Btu) is a traditional unit of energy. It is approximately the amount of energy needed to heat one pound of water one degree Fahrenheit.

Richard Newell, SAIS, December 14, 2009

Renewables Gain Electricity Market Share; Coal Share Declines

0

1,000

2,000

3,000

4,000

5,000

6,000

1990 1995 2000 2005 2010 2015 2020 2025 2030 2035

billion kilowatt-hours and percent shares

Natural gas

Renewable

ProjectionsHistory

Nuclear

Oil and other

Coal48.5 43.8

21.4

20.8

19.6 17.1

9.1

17.0

1.41.5

Source: Annual Energy Outlook 2010

Comparative Electrical Generation Costs

Cents per kwh (2008)Resource:

Wind 5.7 – 11.3Geothermal 5.8 – 9.3Biomass (direct) 6.5 – 11.3Natural Gas (combined cycle) 7.4 – 10.2Coal 11.0 – 14.1Fuel Cell 12.7 -- 15.0Solar (thermal) 12.9 – 20.6Solar (photo voltaic 16.0 – 19.6

Source: www.sourcewatch.org

Comparative Electrical Generation CostsWith Federal Tax Subsidies Removed

Cents per kwh (2008)Resource:

Natural Gas (combined cycle) 7.4 – 10.2Biomass (direct) 7.8 – 13.6Wind 8.2 – 16.1Geothermal 8.3 – 13.3 Coal 11.0 – 14.1Fuel Cell 15.2 – 18.0Solar (thermal) 20.6 – 33.0Solar (photo voltaic) 25.6 – 31.4

Source: Lazard, Levelized Cost of Energy Analysis – Version 3.0, 2009

And, That Is Just With Federal Tax Subsidies Removed • It does not take into account state, regional and local

tax breaks• Direct subsidies• Land donations• And myriad other concessions that can and are made

An Additional Cost: Infrastructure Retooling

• How many of you think that all Americans will be driving totally electric cars in 10 years?

• How many of you think that all your goods will be moved in totally electric vehicles?

• How many of you think you will have a photovoltaic array in your backyard?

• Or a geothermal well in your neighborhood?• How many of you think we have resources or the

intent to totally replace our energy provision and transportation systems – at today’s usage levels – in the next 10 years?

Conclusions

• The economics of oil and gas are subject to external forces and respond to altered supply and demand models.

• Despite assurances to the contrary, we will not end our dependency on foreign oil nor our vulnerability to fluctuating oil prices.

• We have massive reserves of clean, inexpensive natural gas.• The sheer volume of increased gas production may suppress gas

prices and slow future reserves development.• Wide spread adoption of renewable energy is, at present, a pipe

dream.• Alternative energy is too expensive, especially in today’s strained

economy, and can currently only be made competitive with generous subsidies. And the economic limitations are only part of the reason that renewable energy is not now viable.

• Renewable energy must be developed and made economic. We must, however, be realistic about how and when this will happen.

Macondo – The 800 lb. gorilla in the roomWhat we know:• The accident occurred

because of a combination of mistakes

• The U.S. offshore oil and gas industry will never be the same

• The resultant impact on the Gulf Coast economy is severe

Macondo Fallout – Direct Loss of Revenue• EIA estimates a daily production shortfall in the Gulf of

Mexico of 200,000 bbl in 2011, primarily as a result of moratoria and new regulations arising from Macondo.

• The estimated development and production cost of a deepwater GOM project is $65/bbl.

• The multiplier for local and regional economies contacted by deepwater development is calculated at 2.7.

Using these figures, the revenue shortfall for the Gulf Coast economies affected by the Macondo incident in 2011 alone will be:

$35,100,000/day$12,812,100,000/year

1 2 3 4 5 6 7 80

2

4

6

8

10

12

U.S. ProductionImports

U.S. Oil Supply Projections – Production VS Imports

Mill

ions

Bar

rels

2011 2012

But There May Be Wider Consequences

EIA Short Term Energy Outlook 2011

Will Economic Recovery Be Killed By Higher Oil Prices?

Thanks for Your Attention.

Questions?