Tag: Energy

Climate and Energy Policy: What do Americans Want?

Consider, for example, the fact that President Barak Obama’s Administration has been reviewing Transcanda’s Keystone XL Pipeline project for more than six years. And, Amy Harder of The Wall Street Journal recently reported that this delay has emboldened resistance to at least 10 other oil and natural gas pipeline projects across North America representing $40 billion of investment. (See “Protests Slow Pipeline Projects Across U.S., Canada – Anti-Keystone XL Fight Emboldens Resistance to At Least 10 Other Projects.” The Wall Street Journal 9 Dec. 2014)

In addition, opposition to the Yucca Mountain Nuclear Waste Repository in Nevada and to the proposed Cape Wind generation facility off the coast Massachusetts illustrate how very long and costly delays to energy infrastructure projects can be. Some refer to this process of building public support for energy infrastructure projects as gaining “social license.” (Read more about social license and energy infrastructure here: Energy Investing: US-Canada Energy Summit).

In this environment, it’s essential for energy producers, developers, utilities, regulators and legislators to have a clear understanding of how consumers, and voters, actually think about difficult energy choices.

Fortunately, new research by Dr. Stephen Ansolabehere, Professor of Government at Harvard University, and Dr. David M. Konisky, Associate Professor of Public Policy at Georgetown University, provides rich insights into how—and how not—to develop energy, environmental and climate policy in their book Cheap and Clean: How Americans think about Energy in the Age of Global Warming.

Hats off to EPIC

Before we begin, I’d like to thank Dr. Michael Greenstone, Director – Energy Policy Institute at Chicago (EPIC), Milton Friedman Professor of Economics at the University of Chicago, for bringing Dr. Ansolabehere to Chicago recently for an engaging presentation on his research—rife with audience participation and discussion. I’d also like to thank Dr. Ansolabehere for the use of several slides and exhibits below.

EPIC is a collaborative energy institute of the University of Chicago’s Social Sciences Division, Harris School of Public Policy and Booth School of Business. I’ve found the EPIC Seminar Series of lectures and Symposia to be remarkable opportunities to gain direct access to some of the world’s leading thinkers on energy, economics and the environment.

About the Research

Ansolabehere and Konisky explain that, for decades, public opinion research on energy has been highly fragmented and episodic. The prior research often focused on the latest crisis—highlighting short-term events like oil spills, nuclear accidents and gas price spikes. As a result, “the emphasis on such episodes has made public opinion about energy seem fleeting, fractured and lacking in any rationale” (363). Furthermore, prior research typically asked about only one form of energy in isolation from other choices. The authors explain that pollsters and analysts must instead think systematically to really understand public opinion about energy in a meaningful way. Systematic thinking about energy asks questions like:

“What are the main sources of energy, and what are the public’s attitudes toward each one? What are the key attributes of each energy source, how do people view each energy source according to those attributes, and how important are each of the attributes in explaining what people want?” (578).

In my opinion, the really exciting thing about Ansolabehere and Konisky’s new research is that it has tracked these types of questions for more than a decade to see what the public wants the energy sector to look like and how public preferences have changed (578).

Their methodology utilized the MIT/Harvard Energy Surveys to gather information from 2002 to 2013 and then, based on the data, identified, quantified and explained the factors that really drive public opinion for various fuels such as coal, natural gas, nuclear, oil, hydro, solar and wind by developing a variety of multiple regression models. In addition, they also evaluated public opinion on different climate policies including regulatory caps, cap and trade and carbon taxes.

The regression models are fully described in the book and the appendix contains the summary statistics of the models including the coefficients, standard errors, significance levels and correlations.

Energy Choices

The first thing to understand is that we consume electricity, transportation, and heat, not coal, nuclear or solar power. In short, the authors explain that people value the qualities or attributes of the power they use and not the fuel itself. This means that people really want energy that is inexpensive, dependable, and safe—and it’s these attributes that really drive public opinion (62).

Having said that, the authors paint a picture of US public opinion about the energy sources used to generate electricity. As shown in the graph below, Americans want less reliance on coal and oil as illustrated by the large portions of pink (reduce use of fuel) and red (not use at all) throughout the time series (2002 to 2013). Second, Americans want to keep natural gas and nuclear power as they are, or increase them somewhat—with natural gas having the edge between the two.Third, Americans want to substantially increase the use of “alternative fuels” such as solar and wind as illustrated by the large portions of green (increase use) across the series (171).

In addition, Ansolabehere and Konisky report that very few American’s are pure conservationists who want to use less of every energy source (582). And very few want an “all of the above” energy strategy as often cited by the Obama administration (173).

So what’s the big idea?

“People have clear, stable opinions about the energy future that they would like to see in the United States. They know what sort of power plants they would like to see developed, and they know why. There is a simple, unifying structure to public opinion about energy, and that is the desire to have an energy system that simultaneously reduces environmental harms and economic costs” (363).

Economic Costs and Environmental Harms

Well, we’ve just seen what people want. But why do they want what they want? And are their perceptions about energy supported by accurate information? Ansolabehere and Konisky conclude that a “Consumer Model” best describes what people want from energy and energy policy. In short, people think about energy like they would any other consumer good.

The authors explain that in the Consumer Model, “an individual’s opinion about the use of various fuels and the direction of public policy depends on two key factors or attributes of energy—the economic cost (the private good) and the environmental cost (the public good)” (580). In fact, they found that between 75 and 80 percent of the variation in support for different fuels was explained by these two factors and while there can be other factors—they are of secondary importance (362). Survey respondents were then asked how expensive they thought electricity from each of these different fuels sources is and how harmful each method of generating electricity is to the environment.

In terms of costs (above), people generally got the cost of coal and natural gas as less expensive than nuclear and oil correct. However, the public incorrectly believes that solar and wind power are much less expensive than coal, natural gas, nuclear power and oil (246).

When informed of the true costs of electricity from solar and wind power, they found significant decreases in support for these fuels and increases in support for fossil fuels (411). Americans still wanted to significantly expand use of these fuels but their support was more tempered. So, Ansolabehere and Konisky remind us that public support for a fuel source does not mean that people ignore economic costs of the fuel in judging a public policy to increase the use of that fuel (389).

In terms of environmental harm, Ansolabehere and Konisky note that people have the relative harms about right. They correctly see coal and oil as having the most adverse environmental effects. Natural gas is seen as less harmful than these fuels but more harmful than hydro. Solar and wind power are correctly perceived to pose few environmental harms (259).

Importantly, people gave greater weight to environmental harm than to economic considerations in evaluating energy choices and policies. In fact, environmental harms were more than twice as important than economic costs as evidenced by larger coefficients in the regression models (290). So environmental harm is a strong predictor of energy preference. The policy implication of this finding suggests that the government should put, for example, $2 into clean coal for every $1 into research on cheap solar to be in line with the public’s relative preferences (361).

The public’s reaction to nuclear power appears strong and perhaps exaggerated (258). The authors conducted further research into nuclear power and found that two-thirds of the sample indicated they would support significant expansion of nuclear power “if there were a safe and effective way to deal with nuclear waste” (264).

Providing more information on environmental harms decreased support for coal, natural gas and oil and increased support for nuclear power (422). In addition, there was a substantial decrease in support for coal and an increase in support for alternative fuels, especially wind (432).

Interestingly, the research dispels conjecture that public perceptions about energy are explained by political or demographic differences among people. The authors found that it’s not political party or ideology, education, age or religion that really matters. Those factors are secondary. Rather, people think about energy through a common lens of cost and harms and then fit particular fuels into that framework. Then, the particular fuel defines the terms of the political debate (276).

Finally, economic cost and environmental harm were also found to be the most important factors that explain why people oppose the location of some sorts of power plants near their homes but not others—the not in my backyard (NIMBY) attitude (354).

Understanding the Trade-Offs

In order to effectively move climate and energy policy forward, we must recognize that there are real trade-offs between the economic costs and environmental harms of energy production. Today, no fuel exists that is both cheap and clean (593).

Based on data from Dr. Michael Greenstone and Dr. Adam Looney, the authors illustrate a “technology frontier” for new electric generation sources by plotting the “levelized” cost of generation against the social cost (environmental harm) for each fuel. The levelized cost is the present value, in real dollars, of the total costs of building and operating an electric generation plant over its financial life and duty cycle—presented in cents/Kwh (125).

Social costs are the hidden costs that consumers do not see on their electric bills. They arise from pollution caused by energy production that causes increased health care costs. For example, burning coal produces sulfur oxides, nitrogen oxides and particulates that contribute to the formation of smog (ground level ozone), acid rain and other pollution (lead, mercury, etc.). High levels of smog increase risk of cardiovascular disease, lung cancer, bronchitis, and asthma (110). Greenstone and Looney also estimate that the true social costs of fossil fuels (ignoring global warming) is about 75% more than we currently pay for energy (609).

As illustrated below, Ansolabehere and Konisky use existing coal-fired generation plants as the reference point since they are the least expensive (about 3 cents/kWh) but have the highest social costs from pollution and carbon emissions. New pulverized coal plants provide only a marginal reduction in social costs and are more expensive than new natural gas plants that provide significantly greater reductions in social costs. Solar, wind and nuclear power have significantly lower social costs. However, solar power costs about 17 cents/kWh more than coal while wind and nuclear are about 5 cents/kWh to 7 cents/kWh more respectively.

Bottom line, cleaner energy will cost more.

Global Warming

Today, the risks associated with global climate change (flooding in major cities, expansion of deserts, droughts, disruption of food supplies, etc.) are widely discussed by almost every national government in the world. The authors explain, “energy is back on the national agenda not because we have an energy crisis but because there is a risk of a looming global environmental disaster” (450).

The conundrum for public policy makers who realize the long-term implications of today’s energy choices is that although most Americans are concerned about global warming they don’t see it as the most important problem (“MIP”) facing the nation and have a low willingness to pay (“WTP”) to solve the problem. In short, the authors did not find climate concern to be a major driver of public opinion about energy (443).

For example, in Gallup’s January 2012 poll, “two-thirds of Americans identified the economy as the nation’s most important problem, followed in order by dissatisfaction with government (15 percent), healthcare (6 percent), immigration (3 percent), education (3 percent)”. Typically, energy and environment do not rank highly compared to the economy and other problems (467).

Ansolabehere and Konisky found that the median amount people were willing to pay to “solve” global warming was only $5 per month ($60 per year) or about 5% of the typical monthly electric bill. And two dozen other studies, assessed by Johnson and Nemet, found the median amount to be $135 per year. In short, “most Americans don’t appear willing to make the trade off that many policy experts feel is required: substantially higher energy prices in order to substantially reduce carbon emissions” (483). The authors sense that Americans don’t want to pay more now to solve a future problem with no immediate health or environmental benefits for people living today (e.g. pay more, get nothing) (445).

Although nuclear power is widely recognized by climate scientists, economists, and others as a potentially important way to significantly reduce carbon emissions to address global warming the public doesn’t yet make that connection (334). Despite the fact that nuclear power has virtually no carbon emissions and offers the capacity to offset significant amounts of greenhouse gas. In addition, nuclear power provides more reliable electricity at a far lower price than solar or wind (286).

Ansolabehere and Konisky explain, “Nuclear power is the one non–fossil fuel that can be deployed quickly at an industrial scale to bend the carbon curve in our energy sector. Unlike wind and solar power, nuclear power does not suffer from either the intermittency or the transmissions problems that currently limit these sources, making it a useful way to generate baseload capacity” (335).

Surprisingly, Ansoblahere and Konisky found that people who were concerned about global warming were less, not more, likely to support nuclear power than those who were not concerned. And nuclear power was not alone. Except for solar power, they found no relationship between concern about climate change and support or opposition to the fuel (312). However, providing information about global warming seems to increase support for nuclear power (373). And what’s really interesting is that public attitudes for every fuel were local rather than global.

“Americans are more concerned about local pollution issues, including pollution of rivers, lakes, and reservoirs, air pollution, pollution of drinking water, and toxic waste contamination of soil and water. Even other global issues, such as ozone depletion and loss of tropical rain forests, weigh more heavily on the minds of most Americans than global warming” (470).

In other words, people mentally connect with perceived local environmental harms from air and water pollution and economic cost more than they do to global warming. Given these findings, how can climate and energy policy move forward?

Climate Policy

Ansolabehere and Konisky explain that the problem with our highly competitive electricity market is that it exerts strong downward pressure on prices but that the social costs associated with different fuels are not reflected in prices. As a result, the market fails to deliver cleaner energy.

“The electricity market fails, then, to allow people to “buy” cleaner water or cleaner air. There is pent-up demand for these attributes for fuels, and, hence, people give even greater weight to those attributes in public opinion polls, because that is the unmet demand in the market” (508).

Certain government policies, like environmental regulations and fuel taxes, are designed to force firms to “internalize” the social costs that would otherwise not be seen on the consumers monthly electric or gas bill (17). Ansolabehere and Konisky reviewed numerous public opinion polls, from 2007 to 2012, on three commonly discussed policies designed to address climate change. These three polices are:

  1. Regulate carbon emissions (Regulatory Cap) – Either directly through a cap or limit on carbon emissions from manufacturing, industry and consumers or indirectly through renewable fuel standards that require a minimum amount of electricity come from noncarbon emitting sources. Notably, 30 state legislatures and electorates have adopted renewable portfolio standards (576).
  2. Create a market for emissions (Cap and Trade) – A system of tradable carbon emission permits issued by the government up to a total limit on all emissions (a cap). Generally thought to be more economically efficient than a “one-size fits all” regulatory cap because firms with a low marginal cost of reducing carbon emissions would have an incentive to further reduce emissions and trade them while firms with a high marginal cost to reduce emissions could efficiently buy permits instead of facing costly restrictions. (See Regional Greenhouse Gas Initiative (RGGI) of 9 Northeast and Mid-Atlantic states)
  3. Tax emissions (Carbon Tax) – A direct tax on the production or consumption of coal, natural gas and oil in order to discourage use of fuels that emit carbon into the atmoshpere and to encourage use of fuels that do not. A simple and direct method of adjusting the price of each energy source to reflect its social costs (524).

These polls found dramatically more public support for a regulatory approach to limit emissions than for the other policies. First, there was about 75% to 80% support for a regulatory cap on carbon. Notably, the public wants a regulatory approach to limit emissions even though many economists believe that cap and trade would be a more efficient policy. Second, cap and trade received between 45% to 55% support. Third, carbon taxes were supported by only 25% to 45% of respondents depending on the level of the tax. Although taxes are efficient they can be politically unpleasant (528). However, public support rose to 40% for “revenue-neutral” carbon taxes which are tied to an equivalent reduction in federal income and payroll taxes (564).

Seeking to further explain this phenomenon, Ansolabehere and Konisky identified the correlations between the three regulatory policies, concern for global warming and the environmental and economic attributes of energy as shown below.

Global Warming Concern (Green) – The green portion of each bar explains the amount of predicted support for each climate policy that’s associated with a concern for global warming. Notice that the baseline support associated with a concern for global warming is relatively high–about 30% for Regulatory Caps and Cap and Trade and about 22% for a Carbon Tax.

Environmental and Economic Attributes – The purple, red, blue and yellow components illustrate how the predicted support for each policy is influenced by those who also see the connection with the environmental harms (purple) and economic costs (red) of traditional fuels as well as the environmental benefits (blue) and economic costs (yellow) of alternative fuels. Notice that these attributes of energy production dramatically added 50% of support for Regulatory Caps (now at 80%) but only about 20% to Cap and Trade.

The political implications of these findings are huge. In short, concern for global warming alone is not enough to drive climate legislation. Furthermore, a simple regulatory approach appears to be the politically expedient solution. The authors go on to illustrate the nexus between their research and two key pieces of legislation.

First, The American Clean Energy and Security Act (Waxman-Markey bill), which passed the House in 2009 but failed to pass the Senate, proposed a national system of tradable carbon allowances (cap and trade). It was almost entirely viewed as about global warming and this may have been the political error. The sponsors failed to make a connection between reductions in local environmental harms and climate policy. However, their opponents successfully emphasized the economic cost of the legislation (603). Case in point, concern for global warming alone was not enough to carry the day.

Second, California passed the Global Warming Solutions Act in 2006, also known as AB (Assembly Bill) 32, which created a cap and trade system. Subsequently, Proposition 23 was put forth to postpone implementation of AB 32. However, opponents of Proposition 23 successfully emphasized the environmental and health damages of coal and oil, which the voters understood, and it was defeated. They rarely even mentioned global warming (606). Today, AB 32 is regarded as the most aggressive piece of climate legislation ever adopted by an American legislature (494). Here, climate legislation was driven by local environmental concerns.

“It takes more than just concern about global warming to win support of a majority of the public for climate policy. The political fate of various climate policies depends primarily on the other half of the equation—how the public thinks about energy” (567).

Environmental Policy + Energy Policy = Climate Policy

Ansolabehere and Konisky conclude that we should stop thinking narrowly about climate policy as just climate policy. Instead, they suggest that climate issues should be viewed more broadly from the perspective of energy and the environment.This strategy would seek to develop policies that simultaneously achieve immediate environmental and energy goals and long-term climate goals (573).

For example, the authors suggest aggressively targeting the co-pollutants of carbon such as particulates, sulfur and mercury that present immediate and localized health risks. By reducing the use of fuels with the highest concentrations of these pollutants progress can be made on immediate health risks (573). In this way, progress is made on the local pollution issues as well as on the long-term climate issue. Dr. Ansolabehere goes on to suggest, “mercury and soot regulations might do more to help the US meet its climate goals than a 25 cent gas tax and would be politically easier to sustain.”

This appears to be a very logical strategy based on the research findings. Ansolabehere and Konisky have found considerable public support for regulatory policies like U.S. EPA caps on carbon emissions and renewable portfolio standards. And they’ve found that on questions of immediate environmental regulation public opinion approaches a consensus (or at least a majority) large enough for the government to act (575).

Pragmatism and Policy

I highly recommend Cheap and Clean: How Americans Think about Energy in the Age of Global Warming by Dr. Stephen Ansolabehere and Dr. David M. Konisky for their holistic and systematic analysis of how Americans really think about energy, environmental and climate policy.

It’s amazing to know that there is a basic consumer model that aptly describes public opinion on energy. It’s rational and apolitical. It weighs the trade-offs between economic costs and environmental harm and is primarily concerned about local issues.

After that, climate policy can be highly partisan. But this research should help policymakers in both government and industry develop the pragmatic solutions Americans want while simultaneously addressing long-term climate issues.

Ansolabehere and Konisky summarize their findings best by saying:

“Americans need to hear pragmatic solutions that fit with our approach to energy generally. We think about energy as consumers. We are motivated by the economic costs and local environmental harms, things we can see and feel and name. We need to think and act locally” (493).

Energy Investing: Made in America

CFA Society Chicago hosted approximately 140 people at the University Club of Chicago overlooking Millennium Park on Sept. 23, 2014, to discuss energy investment opportunities at a thought-provoking conference entitled “A Seismic Shift: The Changing Dynamics of the Global Energy Scene.” I served on the planning committee for this event and can tell you that we were thrilled to have two panels of experts who provided insights ranging from global, macroeconomic and geopolitical energy issues all the way down to sector-specific investment ideas across the energy value chain. The dramatic increase in U.S. proved oil and gas reserves due to fracking is expected to drive a reindustrialization of North America. It should be noted that the panelists did not provide specific recommendations to buy or sell particular securities or provide investment advice.

Douglas Brown, Senior Vice President and Chief Investment Officer of Exelon Corporation (EXC) and CFA Chicago Board Member, gave a warm welcome to the attendees and emphasized that this is an important time of energy transformation for North America. Tim Greening, formerly Managing Director at Fitch Ratings, moderated our first panel discussion with Olga Bitel,Portfolio Strategist at William Blair, Rachel Bronson, Senior Fellow for Global Energy at The Chicago Council on Global
 Affairs and Jan Kalicki, Public Policy Scholar at the Woodrow Wilson International Center. Read more about all of our panelists here.

Geopolitical and Macroeconomic Issues (Panel 1)

The energy environment is in a state of revolution.

Jan Kalicki, Public Policy Scholar at the Woodrow Wilson International Center, started the program out at a sweltering pace by announcing that the “energy environment is in a state of revolution” as world energy production is shifting from the Middle East to North America. Drawing from his published expertise on “Energy and Security: Strategies for a World in Transition,” he quickly pointed out that the newfound oil and gas supplies in the United States has made the country more energy secure but not necessarily “energy independent.” Rather, it’s better to use the term “energy interdependence” to describe today’s situation because energy is a global commodity and the idea of energy isolationism is an illusion. Kalicki pointed out that the U.S. still needs to develop a national and global energy strategy that should include “free trade in energy” like LNG exports to Japan while noting that Japan does not have a Free Trade Agreement (FTA) with the United States. Furthermore, 85% of the Outer Continental Shelf still remains off limits for development. He stated that the Keystone XL Pipeline Project by TransCanada (TRP) is a good idea for the U.S., safer and more effective than attempting to ship oil by railcar and a better alternative than allowing it to go to other markets abroad. The shale plays in the U.S. have been successfully developed by private, rather than governmental, investment and the U.S. is now at a competitive advantage to other nations with less favorable land use/access policies for energy development. Finally, Kalicki noted that Russia is facing a major threat of economic recession and huge flights of human and financial capital. GazProm is the largest energy monopoly in the world and only recently has the European Union begun to move against it. Also, Eastern Europe remains far more susceptible to gas shortages from Russia than Western Europe.

A global disruptive energy boom will drive economic growth where resources are exploited.

As an economist, Olga Bitel, Portfolio Strategist at William Blair, quickly pointed out that economic growth is always subject to resource constraints. A decade ago horizontal drilling and fracking in North America was just getting started but through a favorable regulatory regime and “lucky” geology the U.S. is experiencing an unprecedented energy boom which will eventually be a global phenomenon that will affect every country in the world. Secondly, there have been continuous changes in renewable energy technology that will be just as disruptive to energy markets as we’ve seen with fracking. Thirdly, people are actually starting to talk about decarbonization of the global economy. On environmental issues, Bitel emphasized that they are far too important to ignore – especially as it relates to coal usage and the health issues associated with air pollution. She explained that the market will eventually find a way for the energy to flow – even if it’s not along an optimal path. Therefore, it’s important to get the regulation right on things like the Keystone XL Pipeline project where a pipeline through relatively unpopulated areas would be a safer alternative than railcar transportation. Bitel believes the environmental issues associated with fracking (water pollution, etc.) can be properly resolved with the right regulation and protections when properly considering the economic costs and benefits. Finally, Bitel made a variety of points regarding energy markets, prices and trade including:

LNG: The U.S. has gone from contemplating more LNG import facilities to approving LNG export terminals. This wasn’t in anybody’s playbook a decade ago. The approval of U.S. LNG exports was so significant that it was felt in foreign exchange markets!

Natural Gas: Geology and water access issues may delay development across the globe but China and other parts of the world will develop new gas resources this decade. BASF has announced plans to invest in a specialties chemicals plant in Louisiana which demonstrates the market’s view that natural gas prices will be cheaper in the U.S. for a considerable period of time. And that the U.S. is the best place to make significant energy investments. Yet, gas prices will eventually start to move closer to a more central world market price as time goes on … in the 3, 5 or 10-year time frame.

Renewables: Wind and solar power are commercially available and costs on par with fossil fuel energy. It’s not just being developed in the desert anymore. Germany is producing 20% of their electricity from wind today and Denmark has been exporting energy for a decade. During the first six months of 2014 the U.S. has seen tremendous growth in new utility-scale solar ad renewable power development.

Source: U.S. Energy Information Administration, Electric Power Monthly, August 2014 edition with June 2014 data

Note: Data include facilities with a net summer capacity of 1 MW and above only.

Oil: About 80% of net new oil production compensates for the decline in field production alone while only 20% provides for new demand. Therefore, each new oil well costs more to develop. Globally, risks in Argentina and Venezuela continue to be significant where assets could be confiscated on a dime. Oil prices are expected to be broadly stable and declining in real terms.

Utilities: The utility industry has been about as stable and staid as you can get for the last 100 years with a regulatory environment that is still stuck in first part of 20th century. There is no forward-thinking regulatory policy in Germany and Japan at this time. We need a new electricity market to properly compensate for different and changing sources of electricity. If we get this right, then the required investment will come forward.

U.S. Dollar: The U.S. dollar is the global reserve currency and the source of global liquidity. We’ve seen lower levels of U.S. dollars flowing abroad, and a lower current account deficit, because energy imports are shrinking quite rapidly and over the next three years the U.S. will begin exporting LNG. In light of fewer dollars flowing out of the country there will be a higher premium for U.S. dollars that will lead to a rising value of the dollar. The energy boom will create more stable oil and commodity prices globally. As monetary conditions tighten, the Federal Reserve may not have to move as fast on increasing interest rates due to the reduced impact of energy on inflation.

The geopolitics of energy is changing on a daily basis.

Rachel Bronson, Senior Fellow for Global Energy at The Chicago Council on Global
 Affairs, is an expert on energy issues in the Middle East and author of “Thicker than Oil – America’s Uneasy Partnership with Saudi Arabia.” She emphasized that changing energy geopolitics are everywhere in the press today. Examples include, territorial disputes between China and Vietnam in the South China Sea, driven by potential oil and gas under the waters, and ISIS capturing oil resources in Iraq and selling it on the black market. Nations throughout the world are now aggressively seeking access to energy resources. China’s huge demand for energy and air quality problems are driving its energy resource development. Although Russia can meet a lot of Chinese demand, the Chinese are trying to make themselves as self-reliant as possible and seem to be managing it quite well. China’s demand is so large that it will be importing coal for a long time and it remains to be seen who else would be willing to finance infrastructure in China – other than the Chinese. Poorer countries, like Morocco, are developing new energy resources to make them more economically competitive by exploiting their solar resources, reducing energy imports and possibly exporting energy in the future. The energy landscape continues to change dramatically across the globe as the U.S. moves from being an energy consumer to a producer, China transitions from an energy exporter to an importer and Israel develops new resources in the Mediterranean Sea.

Bronson also emphasized that the U.S. is more energy secure but not energy independent. Although there are 3 million more barrels of oil going on the market per day from new resources the market has lost just as much from political turmoil in other parts of the world. Even if oil from the Middle East doesn’t flow to the U.S. it will flow to Asia and the Middle East will remain a strategically important place in the energy landscape. For example, Saudi Arabia has been the global “swing producer” of oil because it doesn’t produce to capacity and has been able to put more oil on the market in response to a crisis. But if, for some reason, Saudi Arabia can no longer play this role as the swing producer (i.e. due to the lack of a smooth political transition, etc.) oil prices could still shoot to $200 per barrel.

Bronson concluded with a sobering warning on the riskiness of Germany’s huge bet to transform its economic base through its tremendous shift to renewable energy sources and a more climate-sensitive economy. She indicated that we should be paying daily attention to Germany’s energy plan because if it doesn’t work then it could pull down the German economy and much of Europe as well. The problems include the fact that the energy resources are far away from the demand centers and Germany lacks the infrastructure to get the energy to where it’s needed. In addition, electric prices in Germany are currently twice the cost of the U.S. and that may push more energy intensive companies out of the country. As Germany attempts to replace its nuclear power resources with renewables it’s incurring huge costs, with no guarantee of a reliable outcome, and increasing its reliance on coal. Japan is wresting with the same issue in a country where they rely on energy imports for over 90% of their demand and finding that it’s very difficult to turn off the nuclear plants.

Investment Opportunities Across the Energy Value Chain (Panel 2)

Herve Wilczynski, Partner at A.T. Kearney in Houston with over 20 years of oil and gas experience, moderated the second panel and transitioned the discussion from the geopolitical and macroeconomic environment to sector-specific investment ideas. Wilczynski underscored the magnitude of the shift in energy to North America with the fact that Exxon/Mobil, one of the global super majors, is relocating its headquarters to a massive facility in The Woodlands near Houston, Texas. He observed that it’s hard to image that on April 5, 2005 Federal Reserve Chairman Alan Greenspan said, “North America’s limited capacity to import liquefied natural gas (LNG) has effectively restricted our access to the world’s abundant gas supplies.” And today the U.S. is playing in a global energy world with Russia and Qatar. Wilczynski introduced the members of Panel 2 which were Mr. Mark Ermano, Vice President Chemical Market Insights at IHS Chemcial, Mr. Terry Smith CFA, Executive Director, Head of Credit Research – Americas at UBS Global 
Asset Management, Mr. Anthony “Tony” Lindsay P.E.R&D Director – Advanced Energy Systems Group – Gas Technology Institute (GTI) and Mr. Ron Mullenkamp CFA, a professional investment manager and founder of Mullenkamp & Company, Inc. The panel probed the factors that could impact the sustainability of the U.S. energy revolution including regulatory, infrastructure, labor shortages, etc. and were generally bullish about the the prospect of significant demand growth in areas like chemicals, transportation, power generation and a number of other areas noted below.

Base chemicals and plastics drive a renaissance in U.S. manufacturing

Mark Ermano, Vice President Chemical Markets Insights at IHS Chemical, quickly made the connection to our day-to-day lives on the “far right hand side of the energy value chain” and explained that chemical industry is producing plastics which enable modern living through thousands of durable and non-durable goods like cars, phones, trash bags, etc. all derived from energy feedstocks on the left side of the energy value chain such as oil, natural gas, coal or biomass which are transformed into different chemicals and eventually into the retail goods we use every day.

The energy revolution has created a North American manufacturing renaissance in the United States. Chemical plants require three basic things to beat the competition. First, access to a low cost Btu feedstock for a long period of time that allows the plant to earn its return on and of capital. Importantly, the cost of new refining or derivative complexes can range from $20 million to $50 million per plant. Second, locating new plants where demand is growing the fastest reduces logistics costs and provides a competitive advantage. Third, use of the right chemical manufacturing technology provides a competitive advantage. BASF’s announcement that they will not use steam cracking but go directly from natural gas to propylene in a world-scale methane-to-propylene complex in the U.S., which requires three times the conventional investment, clearly demonstrates their favorable long-term market view of U.S. natural gas supplies and pricing.

Today, due to the abundant new supplies of low cost natural gas in the United States, we are seeing a massive wave of new investment in the U.S. petrochemical industry to bring new capacity on line in the 2015-2020 timeframe. Previously, the petrochemical industry was building abroad and the U.S. had not added a new cracker since 2000. However, we now expect to see an ethylene-based cracker built in the United States by the end of 2015. These investments will require huge amounts of basic infrastructure, labor, iron, ironworkers, welders, electricians, etc. Furthermore, since demand in the U.S. market is forecasted to be relatively stable most of the new products derived from these chemicals will be exported and new infrastructure companies will be needed to support that function. China’s emerging middle class is expected to reach the purchasing power of the U.S. consumer in the next 5, 10 or 15 years and other emerging economies will drive demand. Finally, watch for new foreign flows of investment capital into the U.S. chemical market.

Potential Winners: Midstream companies. Feedstock companies. North American fundamental gas, ethane and chemical derivatives manufacturers – now seeing the highest levels of profits ever experienced as higher-cost producers abroad set the price and low-cost U.S. producers extract high levels of margin in that chain. Winners may include base chemicals and plastics manufacturers like BASF and SABIC. Also, infrastructure providers, pipe, valves, iron, welders, electricians, etc.

U.S. energy infrastructure expands in many directions…

Terry Smith CFA, Executive Director, Head of Credit Research – Americas at UBS Global
 Asset Management, believes that North America will have an economic advantage from shale gas for at least the next two decades. Furthermore, the U.S. will be in a position to export its shale gas/oil intellectual property, engineers, patents and designs to the rest of the world. He sees more natural gas liquids (NGL) fractionation plants being built and noted that there are 14 new LNG facilities currently being planned.

This reindustrialization of North America drives demand for everything from infrastructure and labor to chemicals, coatings, and technology start-ups unrelated to IT. And many of those workers buy new pickup trucks, which boosts the auto industry, as well. Solar and wind farms also benefit from low cost natural gas prices because these facilities need a reliable source of backup power from a combined cycle gas turbine. The transportation sector will see more long-haul trucking converted to LNG while ethanol producers may transition to isobutenol as an oxygenator. Smith suggests that water handling will be an area of enormous opportunity due to the amount of water necessary for fracking and the difficulty to transport this amount of water by truck which could lead to new long-haul fresh water pipelines. And more water will also be needed to clean the solar panels and wind turbines. That revolution in water technology will also provide a boost to agriculture, and to potable water for cities and industry. Finally, Smith observes that most of the new solutions will not eliminate the others so investment analysts should focus their research on the cost/benefit of the opportunity, the market size and the competition.

Potential Winners: Wind and solar farms. Combined-cycle gas turbines. Natural gas liquids (propane, butane, ethane, etc.). U.S infrastructure and labor providers. LNG tank manufacturers for long-haul transportation (tanks, valves, hoses, etc.), LNG for locomotive engines, tugs, barges and ferries. Increasing demand for carbon fiber. Water handling and transportation.

The third time’s a charm … natural gas as a transportation fuel.

Anthony “Tony” Lindsay P.E.R&D Director – Advanced Energy Systems Group – Gas Technology Institute (GTI), explained that the U.S. is currently in its third major “wave” of developing natural gas as a transportation fuel. The first wave occurred as a result of the perceived oil shortages in the mid 1970s and some new natural gas vehicle products were developed at that time. However, when gasoline prices dropped, the wind was taken out of the sails of the first wave. The second wave was driven by two key pieces of U.S. legislation: the Clean Air Act Amendment (CAA) of 1990 and the Energy Policy Act of 1992 (EPACT-92). The tighter vehicle emissions standards of the CAA led the big three automakers to produce a number of new natural gas vehicle offerings including the Ford Crown Victoria, F-150 pickup trucks, cargo and passenger vans, Chevy Cavalier, pick-ups and full-size vans, and Chrysler also introduced its B-series vans for compressed natural gas (CNG). In addition, the EPACT-92 mandated certain fleets of vehicles to switch from gasoline or diesel to alternative non-petroleum energy sources like natural gas. However, the legislation lacked significant penalties, there was not much “pull” from fleet owners because the economics were only marginal, and the second wave also crashed to the shore. Today, we’re in the third wave and Lindsay believes it’s a “perfect storm” for natural gas vehicles (NGVs) because the economics are favorable, environmental concern is high and the U.S. has an abundant, low-cost supply of natural gas from the shale revolution that can finally provide the U.S. with the energy security that was previously lacking.

Lindsay explained that approximately 26% of the energy consumed in the United States each year is from natural gas. And the U.S. uses approximately 95 quads (quadrillion BTUs) of energy per year. Yet, the transportation sector uses less than 1% in vehicles (which is only about 140,000 natural gas powered vehicles) while the top five nations using natural gas vehicles are Iran, Pakistan, Argentina, Brazil and India, each with over 1 million NGVs on their roads! After evaluating the U.S. NGV market, Mr. Lindsay believes that high-usage, heavy-duty vehicles represent the best opportunity for near-term growth because these vehicles consume from 5,000 to 30,000 gallons of fuel per year and that produces enough savings to justify the incremental vehicle and fueling investment cost thereby creating a 1.3 Tcf/yr growing market for gas as a transportation fuel. Notably, Waste Management’s (WM) fleet of about 1,700 CNG and LNG vehicles is the largest in the waste industry. Although the light-duty car and truck market is as large as 16 Tcf/year those vehicles typically consume only about 1,000 gallons per year and the U.S. currently lacks a robust compressed natural gas refueling infrastructure to conveniently support them. However, if a low-cost natural gas home refueling device could be developed then it may be a significant game changer in the light-duty market.

Potential Winners: Refuse haulers, cement mixers, regional fleets with the ability to refuel at a central location, fleets of taxis serving airports, CNG/LNG storage tank manufacturers and those that make the materials that go into the tanks, lighter weight higher strength composite cylinders with carbon fiber wrap, high pressure gas components, hoses, fittings, meters and valves. Manufacturers of heat exchangers used in the LNG industry as well as engine manufacturers serving medium and heavy-duty truck applications.

Natural Gas: An Energy Game Changer

Ron Muhlenkamp CFA, a professional investment manager, founder of Muhlenkamp & Company, Inc. and author of “Ron’s Road to Wealth: Insights for the Curious Investor,” provided an astounding range of perspectives from his experience as a farmer, investor, engineer (M.I.T) and Harvard M.B.A. Mr. Muhlenkamp’s farm sits directly on top of the Marcellus Shale in Butler County, Pennsylvania and he began by providing the audience a real education on natural gas from his booklet entitled “Natural Gas: An Energy Game Changer” 

First, in Figure 1 below, he points out that natural gas has been priced significantly below crude oil on an equivalent price per MMBtu basis since 2009. This dramatic divergence in price is huge since the two have been fairly close on a $/MMBtu basis since 1995. While many in the Northeast still heat their homes with oil those who have converted to natural gas are now realizing significant savings due to the availability of low cost natural gas.

Figure 1 Natural Gas and Crude Oil Prices, 1995-2013

Source: Bloomberg; Oil; Generic 1 ‘CO’ Future, Natural Gas; Generic 1 ‘NG” Future delivery to Henry Hub

Second, in Figure 4 below, he shows the steadily increasing use of natural gas for U.S. electric generation since 1996 and the corresponding decline in the use of coal-fired generation. Utilities switch from coal to gas-fired generation at about $3.00 per Mcf so more access to lower-cost gas supplies reduces both home heating costs and electric bills.

Figure 4 Percent of Total U.S. Electricity Net Generation: Electric Power Sector by Energy Source, 1960–2012

Source: U.S. Energy Information Administration; Electric Power Monthly. Table 7.2b and 8.2b

Third, Figure 5 shows that Barnett Shale fracturing began in 1997, Marcellus shale in 2005 and Bakken Shale in 2008. Importantly, U.S. oil and dry natural gas proved reserves began increasing dramatically after these events reaching 29 Tcf of gas and almost 27 (bnb) billion new barrels by 2011. Muhlenkamp notes that the U.S will be drilling the Marcellus Shale for a long time and in fact has more supply than available pipeline takeaway capacity to deliver it to New England. Bottom line, the last five years have been an energy game changer!

Figure 5 U.S. Oil and Dry Natural Gas Proved Reserves, 1979-2011

From an environmental standpoint, Mr. Muhlenkamp points out that by switching from coal to natural gas the carbon content of the fuel source is cut by more than 50%. From a land use perspective, if we consider the fact that 80 windmills are equivalent to about 10 gas wells then wind farms are not be as “clean” as we might think. In addition, although fracking requires significant amounts of water most people don’t know that burning 1 Mcf of natural gas produces 11 gallons of fresh water in vapor form. Mullenkamp turns the equation on its head by stating that by burning natural gas you produce fresh water at 8 cents/gallon and you get the energy for free. Going further, if you use salt water for fracking (subject to salinity limits in the wells) the well effectively becomes a desalinization plant. Agreeing with many of the other speakers, Mr. Muhlenkamp also believes we are taking a step “backward” when we produce fuel (ethanol) from food (corn) since historically farmers increased food production only after moving from horses (which required acreage to feed them) to tractors.

Potential Winners: Natural gas pipelines. Labor markets where skills to work in the oil and gas industry can be acquired in 12 to 18 months at junior colleges. Natural gas consumers – benefiting from prices at $3.00 to $5.00 Mcf but putting pressure on producers where break even is at about $3.00 per Mcf. Producers benefiting by drilling horizontally 5 to 8 times, in different directions, from the same gas pad saving approximately $500,000 per well. Also see p. 52 of “Natural Gas: An Energy Game Changer.