Dear President Trump – What Are You Doing About Energy?

By Terry Hallmark, Instructional Assistant Professor, Honors College

Dear President Trump,

I thought I’d drop you a line. They had a symposium at the University of Houston recently on “The Future of Energy Policy.” It was good. Even tempered. A Democrat and Republican – Republican U.S. Rep. Pete Olson and Democrat Rep. Gene Green – even got along, and no one had a bad word to say about you.

That was refreshing, because lately everywhere I go on campus someone is cracking a joke every time your name is mentioned. Guess it’s because it’s a university campus – you know, where lots of left-leaning college professors hang out. A fellow who ran a bar in Brooklyn laughingly used to call professors “the Intelligenski,” because they think they’re smarter than everybody else. They can’t believe anybody would be foolish enough to pick you over Hillary. Well, I think they’re the fools. Plenty of folks voted for you – after all, you won – they’re just afraid to admit it. Maybe there needs to be something like Alcoholic Anonymous, you know, like Trump Supporters Anonymous –TSA – although it might get confused with the gang that makes you take your shoes off at the airport.

Seriously, the numbskulls who don’t like you say you’re dumb as a shovel, but you don’t get as rich as you are by being dumb – and besides, shovels are useful, especially when you’re digging holes. Plus, you’ve got the support of some smart, conservative academic types. A few weeks ago, the Chronicle of Higher Education published an article about a bunch of political scientists at the Claremont Colleges in California you’re apparently leaning on for advice. That’s where I got my Ph.D., so I know nearly all of them. Charles Kessler, who got most of the coverage in the article, was the chairman of my dissertation committee. He’s an expert on American Political Thought (back when Americans were thinking) and on the U.S. Constitution and the Federalist Papers (the “go to” handbook on how the Constitution is supposed to work). He and his buddies will be handy.

And what about your cabinet appointees, especially those who know something about energy? Rex Tillerson was a bold pick as Secretary of State. I used to work in the oil industry for this outfit called IHS, and the firm has a week-long shindig every spring called CERAWeek, where all the energy execs hang out, network and give talks. It’s run by a member of your Strategic and Policy Forum, Dan Yergin. I spoke there once. Tillerson spoke there in 2015. He has a presence, as they say. He is an Eagle Scout, and he’s from Texas. That means he’s solid and will probably do a good job.

And since he used to run ExxonMobil, he knows energy and has experience with Vladimir Putin and other heavy-handed types. He also knows about oil exploration in garden spots like Chad and Equatorial Guinea – where the people don’t give a flip about their Size 3 carbon footprint and the leaders have names that are impossible to pronounce. (Try saying Teodoro Obiang Nguema Mbasogo three times fast.) I’m a little bit worried, though, because you’re both big time wheelers and dealers at the highest levels of Big Oil and Big Buildings. Hope you guys don’t have to have your egos shoehorned into the Oval Office just to have a chat.

I’m not quite as gung-ho about your pick for Secretary of Energy, Texas’ ex-Governor, Rick Perry (now a member of your National Security Council). Sure, he’s smarter than folks think, he’s won more races for governor than anybody in the state’s history, and Texas is a big energy state – but I still wonder why you picked him. I’m not sure he’s got what President George H.W. Bush used to call “the vision thing.” He’s run for your job twice, and you’ll remember he wanted to shut down the Energy Department. Now I guess he doesn’t. Kinky Friedman, this musician/comedian/writer from Austin, ran against Perry for governor a few years back and called him “Governor Good Hair.” Maybe that’s why you picked him. You clearly know a good ’do when you see one.

As far as the issues go, I think you’ve got some things right, including support for the Dakota Access and Keystone XL oil pipelines. You’re going to take some heat from environmentalists, but don’t let that bother you. Those pipelines mean jobs for Americans, and don’t worry about all those reports casting doubt on that. If the Canadian oil intended for the Keystone XL pipeline doesn’t come here, it’ll go someplace else – like China. That’s no good.

Kudos to you, too, for being bullish on fracking. The country’s awash with shale oil and gas, and oil exports are back for the first time in years. Just when it looked like oil prices might put the kibosh on several fracking projects, low oil prices have allowed them to move forward. Voila, “Permania”! The giant shale play in the Permian Basin could have 20 billion barrels of oil and 16 trillion cubic feet of natural gas. That means more oil on the market and lower crude oil prices, which give our friends in OPEC and the Russians a bad case of nerves. Good.

All the shale oil and natural gas showing up to the Energy Prom brings me to my last point. A decade ago everyone was babbling about “peak oil” and the evils of those God-forsaken, gas-guzzling Hummers. Now the issue is “peak demand,” and GM doesn’t even make Hummers anymore (they were ugly). In 2006, the US ranked 11^th in the world in proven oil reserves. Now, thanks to the fracking boom and shale oil, the U.S. is Numero Uno. Check it out. America is great again.

A speaker at the UH symposium said oil and natural gas are cheap, reliable and plentiful sources of energy. He’s right, but that’s just for now. A decade’s nothing – just two years past the end of your next term in office. If nothing else, the last 10 years have shown us just how quickly things can change, and change is certainly in the air when it comes to energy. So, go long – take the blinders off and think about energy out 30 or 40 years. Don’t be afraid to cozy up to new sources of energy, including renewables like solar and wind. Not many people know it, but Texas produces more energy from wind than any other state (plenty of hot air). I’m afraid you’re going to have to finalize a split with coal, though. That miner’s daughter’s not coming back.

Well, that’s it for now. I’ve got to go fill up my car and then wade through as much of Alexis de Tocqueville’s Democracy in America as I can manage before noon (it’s a beast – be glad you don’t need to read it). Maybe I’ll write again sometime. Until then, I remain,

Yours in oil (crude, that is – with associated gas),

Politicus Maximus Texanus

---

Terry Hallmark is an Instructional Assistant Professor in the Honors College. He teaches the Human Situation sequence, along with courses in ancient, medieval and early modern political philosophy, American political thought, American foreign policy and energy studies. His current research is focused on the political rhetoric and writings of Will Rogers. Prior to his appointment in the Honors College, Dr. Hallmark worked in the international oil and gas industry, where he had a 30-year career as a political risk analyst. He has been an advisor to international oil exploration and service companies, financial institutions and governmental agencies, including the World Bank, U.S. Department of Defense and members of the intelligence community. He is the Honors College coordinator for the minor in Energy and Sustainability Studies.

Saudi Oil Minister Sounds Trouble For Russia At Houston Conference

By Paul Gregory, Professor, Department of Economics

Energy producers and OPEC ministers, meeting at CERAWeek in Houston, grappled with a global glut of oil that was not supposed to be. Back in November, OPEC and non-OPEC oil producers agreed to their first production cut in eight years. Thus ended a Saudi-led experiment with free markets that had driven down crude prices to historic lows. The Saudi gamble was that low prices would dry up U.S. shale investment, rig counts, and hence crude production, that competes with OPEC and Russian output.

The experiment apparently failed.

Meeting in Houston with $50 plus crude, the OPEC team, represented by the Saudi oil minister, Khalid Al-Falih, and Russia’s energy minister, Alexander Novak, grudgingly acknowledged being caught off guard by a second wave of U.S. shale production at prices they had thought would throttle the shale industry. The production quotas orchestrated by OPEC and Russia were supposed to stabilize prices below production costs of shale producers and drive them from the market. To everyone’s surprise, shale producers had used technological advances and short start-up times to push down break-even costs, below $50 in the Permian Basin.

Even the shale oil producers themselves were surprised by the speed of recovery. U.S. crude output rose to nine million barrels a day, and the global glut as expressed by rising crude inventories refused to go away, despite OPEC actions.

The OPEC-Russia coalition apparently did not anticipate that they were facing a new type of competition, one that could respond quickly and innovate to plumb the depths of cost economies.

The OPEC-Russia production cuts had been scheduled to last a half year, and they appear to have been implemented. With crude prices falling and inventories rising, OPEC – mainly Saudi Arabia – must decide whether to extend the cuts, even though the first set of cuts did not work out as planned.

The Saudi minister’s comments in Houston must have sent a chill down the spine of his Russian counterpart, as he announced that Saudi Arabia will not “bear the burden of free riders.” He also warned U.S. producers that it would be “wishful thinking” to expect Saudi Arabia and OPEC to “underwrite the investments of others [US shale producers] at our expense” through production cuts. Don’t expect us to keep prices so high that your investments are safe and you are freed from the pressure to push down costs to stay in business.

Translated, the Saudi minister warned his fellow OPEC members and Russia that Saudi Arabia is not prepared to cut its own production, which it can pump at low breakeven costs, to keep prices up for high-cost “free riders,” such as Russia. Russia, with its depleting reserves, antiquated technology, isolation from Western capital and technology, and Petrostate dependence on oil revenues must learn to live with $50 (or below) oil.

Energy producers from the Middle East. Latin American, Africa and North America must come to the realization that the energy market has reconstituted itself, with the U.S. as the swing producer. U.S. breakeven costs on unconventional oil will henceforth determine the long-run price of crude.  Over the next decade, there will be fluctuations in crude prices as world demand fluctuates and political disruptions interrupt supplies, but the price should tend towards the equilibrium set by marginal costs in the U.S.

Two further factors could push the price even lower. The United States has elected a pro-energy president, who will lessen environmental and other regulations on energy production. These steps will drive break even cost even lower. If Europe and other countries follow the United States’ political changes, restrictions on unconventional oil would begin to disappear worldwide. If so, the world economy can look forward to cheap energy for decades to come.

In the meantime, Russia’s Putin will be on the outside looking in. The Russian economy and state have survived two plus years by tapping foreign reserves and depressing living standards. It is unclear how it could survive decades of energy prices below what Russia needs to stabilize its economy and provide the government with the funds it needs to maintain political harmony while fighting its hybrid wars abroad.

Paul Gregory is a professor of economics at the University of Houston. He currently teaches a course on comparative economic systems.

Gregory has published several articles in scholarly journals, in both Russian and English, and is an expert in Soviet economics and transition economics. His current research, funded by the National Science Foundation, is on the topic “High-Level Decision Making in the Soviet Administrative Planned Economy: Evidence from Soviet State and Party Archives.”

In the past, Gregory was involved in several funded economics research projects, and has earned multiple awards and honors, including the Fulbright Fellowship.

Gregory earned his bachelor’s in economics and master’s in Russian in economics from Oklahoma University, and his PhD in economics from Harvard University.

The Future Of Oil And Gas? Look To The Past

By Chris Ross, Executive Professor, C.T. Bauer College of Business

In the early days of 2017, it behooves oil and gas companies to reflect on the past, while making plans robust to an uncertain future outlook. There are several questions that should be asked:

• Where are we in the oil and gas price cycles?
• How will politics and policies affect the business outlook?
• What are the appropriate strategies?

Learning from the Past

It will not surprise any investor in oil and gas and related businesses that theirs is a cyclical business. Prices run up when supplies fall short of demand, hover on the summit for a few years, then tumble as new supply sources are developed and demand growth slows down (Figure 1).

After the collapse of 1986, oil prices remained volatile through 1990, then declined further through 1998 as production from the Middle East, Norway, Iran and Venezuela increased to meet demand growth and replace declines in Russia and North America. One consequence of the price decline in 1998 was major oil company mega-mergers. These resulted in high-grading of projects, reduction in aggregate capital spending and slowdown in production increases, setting the stage for the run-up in prices after 2002.

The period from 1986 through 2002 can be seen in retrospect to have been a “long grind,” as oil prices were set by the long-term marginal costs of incremental production sources needed to satisfy demand growth and replace declining production from mature oil fields and political turmoil.

Tightly controlled wellhead natural gas prices in the 1970s led to supply shortages. The 1978 Natural Gas Policy Act (NGPA) started a process of decontrol and broadened the responsibility the Federal Energy Regulatory Commission held over the industry.

In 1985, FERC issued Order No. 436, which changed how interstate pipelines were regulated. This established a voluntary framework under which interstate pipelines could act solely as transporters of natural gas, rather than filling the role of a natural gas merchant. However, it wasn’t until Congress passed the Natural Gas Wellhead Decontrol Act (NGWDA) in 1989 that complete deregulation of wellhead prices was enabled. Issued in 1992, FERC Order No. 636 completed the final steps towards a competitive market by making pipeline unbundling obligatory.

Natural gas became a traded commodity subject to its own cycles (Figure 2).

The decontrolled market opened new sources of supply, enabled by new seismic technologies that uncovered large resources of natural gas under the Gulf of Mexico (GoM) continental shelf. A gas bubble was inflated, holding spot prices below $3/million British Thermal Units from 1989-1999. New markets, notably independently owned cogeneration plants empowered to sell electricity to industrial plants and the grid at prices representing the “avoided cost” that new utility projects would have incurred, caused rapid demand growth.   The bubble burst as gas production in the Gulf of Mexico peaked, natural gas prices increased and LNG import terminals were built.

Higher prices induced innovation on the supply side as George Mitchell figured out how to extract natural gas from tight shale rock, and the technologies were deployed in other gas and then oil shale plays. Natural gas prices collapsed in 2009: demand accelerated as natural gas displaced coal in the power sector, somewhat constrained by limitations on pipeline transportation. New pipeline connections were built despite opposition; LNG import facilities were converted to export facilities.

Mark Twain wrote “History doesn’t repeat itself, but it does rhyme.”  If history were to repeat itself, oil prices would remain low for another “long grind”, mirroring 1986-2002 by declining further over the next 15 years; natural gas prices would start strengthening in 2019.

Politics and Policies

For oil markets, turmoil in the Middle East and Africa withdrew about 3 million barrels per day from world markets between 2005 and 2015. Ideological conflicts, coupled with the demographic realities of a growing number of young men with few employment opportunities, suggest continued instability.

OPEC’s agreement to reduce production with apparent support from Russia will be tested by inducing expansion of U.S. shale production. But the need for cash to meet social commitments is likely to reduce funding available for capital spending by the national oil companies and will lead to lower production, regardless of the OPEC quotas. The “long grind” seems likely to be shorter this time around, more likely five rather than 15 years.

The past eight years have seen a series of rules designed to suppress coal use, to the benefit of natural gas as well as renewables. Several of these rules are still being litigated, and the new administration may choose not to defend constitutional challenges by various individual states. There may also be a reduction in subsidies and mandates favoring renewables, but natural gas will likely find it difficult to displace coal at the pace seen in recent years. LNG exports will allow further production growth, but the resource available in shale plays in 2017 is significantly larger than the GoM shelf resource available in 1989. Expect natural gas volumes to grow but prices to remain capped by coal through the mid-2020s.

Strategies

For upstream companies, the not-so-long grind through the early 2020s calls for a conservative approach to strengthen balance sheets, sustain dividend payments and drill within cash flows. Prices will be volatile and excessive exuberance will be punished by periods of low prices. However, it will be important to see around corners and monitor closely the factors that could shift the outlook to a new run-up in prices, requiring an expansionary emphasis on capturing new resources and a greater tolerance for debt.

The oilfield services sector has been hammered by the downturn and will likely consolidate further. It remains to be seen whether the consolidation will be lateral or vertical. Halliburton failed in its attempt to strengthen its verticals by merging with Baker Hughes; Schlumberger and Technip have taken a French solution of lateral extension by acquiring Cameron and FMC Technologies, respectively, and the forthcoming merger between GE Oil & Gas with Baker Hughes is also mainly lateral extension of business lines. Historically, oil companies have preferred to purchase equipment and services from best-in-class providers, and the new conglomerates will need to work hard to overcome past preferences and create a persuasive value proposition for bundling purchases of equipment and services from a single vendor.

Midstream companies should be able to resume organic growth as companies “replumb” energy infrastructure, aided by a supportive rather than hostile federal government and underwritten by producers seeking access to liquid markets.

Refiners and petrochemicals companies should benefit from an increasing gap between natural gas (used as feedstock and energy) prices and crude oil (setting international petroleum and petrochemicals products prices) as the oil price cycle will be out of phase with the gas price cycle. Nevertheless, these sectors will see limited volume growth and should continue to focus on limited capital improvements, operations excellence and accretive, synergistic acquisitions.

Well managed companies created value for shareholders through the 1990s by leveraging new technologies, simplifying their organizations to improve productivity, partnering creatively with providers of equipment and services and making acquisitions when prices were low. That playbook should be dusted off and updated for the next five years.

---

 As a consultant, Professor and Energy Fellow Chris Ross works with senior oil and gas executives to develop and implement value creating strategies. His work has covered all stages in the oil and gas value chain.

UH Energy is the University of Houston’s hub for energy education, research and technology incubation, working to shape the energy future and forge new business approaches in the energy industry.

U.S. Crude Oil Policy – The Case for an Export Ban and an Import Quota

By Ed Hirs, College of Liberal Arts and Social Sciences

Congress is considering lifting the crude oil export ban that prevents American oil from being sold overseas. The ban was enacted in the midst of oil market turmoil in 1975. Domestic producers of crude oil want the ban lifted; refiners want the ban