Tag Archives: petroleum

Is Petroleum A Barrier to U.S. Economic Growth?

We hear much discussion of U.S. oil imports.  Some of it is informative, some just scare-mongering but little of it focuses on the cold, hard economic reality.  With only a limited knowledge of a few simple macroeconomic concepts, the outlines of the oil-price noose on economic growth become plainly visible.

The basic Keynesian model divides up the aggregate flows of spending into four basic categories: Consumption — the biggest category; Investment — purchases of long-lived, real assets; Net Government Spending — spending minus taxes or the annual deficit; and Net Exports (exports minus imports).  These concepts all refer to spending for real goods and services, so set aside the financial sector for the moment.

If any category gets bigger, then there is more spending for goods and services and the economy grows.  Conversely, when any of these four categories shrinks, then the economy shrinks (recession).  Especially important are sudden changes.

Because our traded sector has historically been small, American economists tend to focus on the other three.  However, a sudden change in the value of net exports amounting to several percentage points of GDP can still have a substantial impact on the direction of the overall economy.

Net exports are the main channel through which the price of crude oil impacts the overall economy.  Depending on how households alter their driving and spending patterns, prices at the pump may or may not affect consumption spending.  However, the effect of price changes on net exports is entirely mechanical.  Let’s take a look at recent history.

On the left-hand axis, we measure the value of petroleum imports (price times quantity) as the share of GDP (data from the indispensable Economic Report of the President 2010).  Because our petroleum exports are minimal, the increase in the oil import bill has a direct, negative effect on net exports (which may be offset by other changes in the composition of foreign trade but let’s keep it simple).  An increase in oil prices, as we had during the decade of the “aughts” results in a significant decrease in net exports — rising from one percent to nearly four percent (price data from EIA).

Let’s take a closer look at the period of the recession, which began in December 2007 and ended in June 2009.

By 2006, when the economy was starting to slow, the petroleum import share had already doubled from the one percent level of the 1990s.  By the end of 2007, the import share had rise by half to three percent and during 2008, it nearly hit four percent.

Clearly, the U.S. economy cannot tolerate such a large and sudden negative hit.  Was it the chief factor in the recession?  Maybe, maybe not but it certainly didn’t help!

Of course, it’s not news that high oil prices are bad for the economy.  The critical point is to understand the transmission mechanism of net exports.  This helps us to understand the policy choices that lie ahead.

Oil imports as a share of total U.S. consumption will not change any time soon, staying close to two-thirds.  Global oil production seems to have reached a plateau.  Hence, any return to strong global growth that includes the United States (the world’s biggest oil consumer) will see oil prices move up accordingly.  Through the mechanism of net exports, this will have a negative impact on aggregate demand, in turn, slowing the U.S. economy.

We use more than a fifth of the world’s annual output but have only two percent of the world’s oil reserves.  Ignoring the BP oil spill, policy makers will press forward with weakening environmental protections to expand offshore oil drilling along all of our coasts but it won’t move the needle much as our once-great on-shore oil fields continue their steady depletion.

Even if policy makers could find a way to put their foot on the accelerator, they would be hitting the brake at the same time.

The United States is no longer the only economy that matters.  Petroleum demand in Asia has grown significantly since the 1990s.  This explains why the price of crude oil doesn’t “go all the way back down” during recessions.  There appears to be a ratchet effect in operation: two steps forward but only one step back.  You can see the ratchet working in the second chart where, even in the depths of the Great Recession, oil imports as a share of GDP did not drop back to one percent (compare with the first chart) and is already heading back towards the two percent level.

In the short to medium term, there appear to be no ready substitutes for all the petroleum we import.  Electric vehicles will take a long time to have much impact.  U.S. military operations are extremely petroleum-intensive.  And then there’s the cultural factor: We Americans strongly identify petroleum with power and prosperity — it’s what we have experienced for the past century.

Escaping petroleum addiction will be painful and protracted for our country.

For any state like Maryland that imports 100 percent of its petroleum consumption, the economic choking effect of oil prices is even greater.  Maryland’s leaders should put themselves in the shoes of a small nation like Denmark that produces no oil and no cars.  Because oil and cars must all be imported, they constitute a burden to the Danish economy and are heavily taxed.

Automobile use should be strongly discouraged in Maryland in order to reduce the economic risks of oil price increases.  This can be done through taxes on fuel, parking and automobile ownership, an end to wasteful new highway construction and changes in land-use policy to promote denser, transit-oriented development.

“Impossible!” politicians and voters will say, but offer no alternative other than keeping our collective head in the oil-price noose.

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BP’s High Wire Act Continues — Why Marylanders Should Worry

While the jockeying was under way in June over the proposed BP victims’ compensation fund, Maryland Energy Report identified President Obama’s dilemma:

Here is President Obama’s balancing act.  On the one hand, BP may fall into crisis if its liability for damages is not somehow limited and made predictable — the swift and cruel judgement of the financial markets.  On the other hand, if BP’s liability cap is set too low, then we taxpayers will be on the hook for ballooning damage costs in the future.  President Obama does not want to let the company collapse nor does he want to let BP off too easily and face the wrath of the voters.

The balancing act continues.  The New York Times’ headline says it all: BP Says Limits on Drilling Imperil Oil Spill Payouts.  BP is alarmed at the prospect that it could be excluded from the Gulf of Mexico which is currently the source of 11 percent of the company’s total output.  Congress is attempting to do just that:

BP is particularly concerned about a drilling overhaul bill passed by the House on July 30. The bill includes an amendment that would bar any company from receiving permits to drill on the Outer Continental Shelf if more than 10 fatalities had occurred at its offshore or onshore facilities. It would also bar permits if the company had been penalized with fines of $10 million or more under the Clean Air or Clean Water Acts within a seven-year period.

Only one company fits that description — BP (formerly known as British Petroleum).

BP is pushing back by suggesting that its exclusion from the Gulf would threaten funding for the $20 billion victims’ compensation fund.

“If we are unable to keep those fields going, that is going to have a substantial impact on our cash flow,” said David Nagle, BP’s executive vice president for BP America, in an interview. That, he added, “makes it harder for us to fund things, fund these programs.”

According to an analysis by Tyson Slocum at Public Citizen, the linkage between the two things — the $20 billion fund and BP’s continued access to the Gulf — is actually quite direct and tight.

The Deepwater Horizon Oil Spill Trust Agreement is between “BP Exploration & Production Inc.” (“BPEP”) and Citicorp acting as corporate trustees (along with two individual trustees).  Executed on August 6, the Trust exists to supply funds for the “Gulf Coast Claims Facility” (GCCF) that is administered by Kenneth Feinberg.  These are the operational guts of the $20 billion deal announced by President Obama after his June 16 meeting with BP executives.

If the House legislation cited by the NY Times becomes law, then “BPEP” would lose its legal right to operate in the Gulf.  It’s not clear what would happen to BPEP’s licenses (could they sell or transfer them?) but clearly the operating revenues intended to fund the Trust and the GCCF would go away.  There would be no money for the GCCF other than the $3 billion deposited with Citicorp in early August.

Many Americans suffered real economic losses as a result of the Deepwater Horizon disaster that killed eleven workers.  These include losses from lost business, lost jobs and lost tax revenue.  They will never simply vanish but will be “compensated” by some combination of the following: (1) Uncompensated individuals might simply absorb the losses, some portion of which will come back to the rest of society in the form of indirect costs like food stamps, lower economic activity, Medicaid costs and so on; (2) Individuals can get compensation from BP and other responsible parties, either via the victim fund or through the courts; (3) Finally, the federal government could, in theory, compensate victims and spread the costs over all taxpayers.

It makes sense to put as much of the burden as possible on BP shareholders — without putting the corporation out of business.  However, if BP is allowed to limit its liability too much for past as well as future disasters, then the rest of us are at risk for the burden of BP’s mistakes.  It’s a high-wire balancing act in an increasingly windy political environment.

The Deepwater Horizon disaster raises several major issues that we as a society are grappling with: (a) How much should the responsible parties pay and to whom?; (b) Should BP be allowed to continue deepwater drilling in view of its safety record, if yes, under what conditions?; (c) What are the real risks of deepwater drilling, under what conditions should any company be doing it, if at all?

One would like to be able to discuss these issues calmly, rationally and separately.  Executing the Trust agreement with BPEP means that questions (a) and (b) are mixed up together.  While this was clever on BP’s part, it puts the Obama administration in an uncomfortable position — a very risky move.  BP not only needs to face down restrictions emanating from Congress but also from the Executive Branch.

BP’s gambit will more likely succeed if the Obama administration is crippled by the loss of Democratic Party control in one or both houses of Congresses in the November elections.

What does all this have to do with Maryland? It can’t happen here, right?  Immediately after the Gulf spill, Senators Cardin and Mikulski joined other East Coast Senators in a letter to the president opposing drilling near their states.  Governor O’Malley has repeated his opposition.

Marylanders need to take the long view and not be complacent about risks to the Chesapeake Bay from offshore drilling.  Governors change and federal laws also change, including the one that currently gives states a veto over drilling off their coasts.  The global oil situation is such that pressure to produce more oil from U.S. territory will grow more and more intense in the not-too-distant future.

Here is a link to a 2009 Department of Energy presentation that shows in stark detail the tightening global oil outlook.

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Maryland Without Oil?

Solving our energy and climate challenges will require us to find new ways of tapping into the creativity of our fellow humans. We need solutions — not just new hardware but also new behaviors, new attitudes and new ways of interacting that lead to sustainability.

World Without Oil is the name of an experiment with online gaming that aimed to do just that.  Developed by Jane McGonigal of the Institute for the Future, WWO went live in 2007, asking participants to re-imagine their own lives during an oil shock through blog posts and video submissions.  Participants joined in from all over the world.

WWO demonstrated that large numbers of people could be drawn into playing a serious, alternate-reality game and generate “crowd-sourced” solutions to real-world problems.  WWO also showed the potential for stimulating behavior change in players.

Maybe Maryland needs an alternate reality game to help us imagine a different energy scenario for The Old Line state?

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What President Obama’s Deepwater Quandary Might Mean for Maryland

Petroleum supply has been a central anxiety of U.S. leaders since World War Two.  In the context of the BP Gulf oil spill disaster, we are starting another national debate over energy and the environment — one that has important implications for Maryland.  Let’s pause to consider the “official projections” that inform this debate by taking at look at the Annual Energy Outlook 2010 (AEO 2010) from the Energy Information Administration.

The AEO 2010 projections are not a “crystal ball” prediction of the future but rather reveal the present-day state of conventional wisdom concerning energy trends.  The exercise of projecting out to 2035 simply clarifies what the EIA experts think is happening within the industry today.

With this caveat in mind, what we discover is that the “reference case” for petroleum is surprisingly optimistic.  EIA projects that the decades-long decline of domestic oil production will reverse.  Domestic production will rise — although not to anywhere near U.S. historic highs.

As the chart suggests, the heavy bet here is on increased output from deepwater wells:

In the short term, a vast majority of the increase comes from deepwater offshore fields. Fields that started producing in 2009 or are expected to start in the next few years include Great White, Norman, Tahiti, Gomez, Cascade, and Chinook. All are in water deeper than 800 meters, and most are in the Central Gulf of Mexico [aka “Hurricane Alley”]. Production from those fields, combined with increased production from fields that started producing in 2007 and 2008, contributes to the near-term growth in offshore production. (See page 75.)

If anything were to put a crimp in that deepwater production, then the projections for domestic crude supply would slip from modest growth back into decline.  Although the difference between those two projected states might be small in percentage terms, shifting from growth back to decline has outsized strategic implications for the United States.

The EIA analysts are also banking on CO2 enhanced oil recovery (EOR):

Lower 48 onshore production of crude oil continues to increase through 2035, primarily as a result of wider application of CO2 EOR techniques. EOR makes up 37 percent of total onshore production in 2035, up from 12 percent in 2008. (See page 75.)

So the reversal of U.S. production decline also hinges on the wider application of this new technology.

How does the rosy scenario for domestic production translate into projected imports?  Not surprisingly, AEO 2010 sees the import share of liquid fuels declining (“liquid fuels” means that they include domestic production of alternative fuels in their projections though it’s a relatively minor factor).

In the EIA model, higher oil prices accelerate domestic output and so cause the import share to drop faster; however, even the “reference case” shows decline.

If President Obama takes a tougher line on risky deepwater drilling, then he risks changing both of these charts from modest growth in domestic production and a declining import share back to the “bad ole days” of declining output and growing import dependence.

The EIA’s conventional wisdom could be overly optimistic to begin with and perhaps their rosy scenarios are improbable.  Nevertheless, when viewed through the lens of the AEO 2010, President Obama appears to have been backed into a political corner.  Does he want to face the voters in 2012 surfing on a gusher of deepwater oil or as a Jimmy-Carter-like prophet of energy doom and gloom?

While it may not be the actual choice he faces, one can rest assured that this version of conventional wisdom is echoing loudly and clearly within the walls of the White House.  Remember “Drill, Baby, Drill!”

What the AEO 2010 does not include in its projections is the growing burden of the U.S. oil import bill under any scenario.  (The import bill is the quantity of oil imported times the price.)  The AEO 2010 shows the world price of oil bouncing back sharply under both the “reference case” and the “high oil price case.”  This suggests that even if the percentage share of oil imports stabilizes or declines slightly, the total cost of imported oil will rise dramatically as the world economy recovers.

Will the U.S. be able to afford to import the oil it needs?  It is this challenge of the financial burden of oil imports —  and not simply the quantity of imports — that may be decisive in coming years and force us to grapple with cutting petroleum use.

How does all this affect Maryland?

1.  Maryland imports 100 percent of its petroleum. Every gallon saved translates into more dollars staying within Maryland.  Our state has a strong economic interest in national policies that cut the need for petroleum.

2. Maryland’s economy depends on its maritime resources. Our beloved and still-bountiful Chesapeake Bay must be protected from a Deepwater Horizon-type disaster which could be easily envisioned if irresponsible drilling is permitted off the Virginia coast.

3. Offshore drilling remains a threat to Maryland and other Atlantic states. It is noteworthy that the AEO 2010 forecast includes the output from expanded offshore drilling:

Removal of the Congressional moratorium on drilling in the Eastern Gulf of Mexico, Atlantic, and Pacific regions of the Outer Continental Shelf also allows for more crude oil production from offshore areas in the Pacific after 2016, in the Atlantic after 2021, and in the Eastern Gulf of Mexico after 2025. In 2035, U.S. crude oil production includes 0.4 million barrels per day from the Pacific offshore, 0.2 million from the Atlantic offshore, and 0.1 million from the Eastern Gulf of Mexico. (See page 75.)

The push to drill off the Atlantic coast will not go away.  This would be a nightmare scenario for Marylanders.  Will it be an issue in the 2010 governors’ race?

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A Look at BP’s Cash Flow and President Obama’s Dilemma

While the public and the media are understandably focused on what’s happening now in the Gulf, BP’s executives are keeping one eye on their swelling river of cash.

Several conclusions follow from this chart (data from the Financial Times.)

The first is that BP is simply a gigantic cash machine, like the other “oil majors.”  It can fund its massive capital expenditures from its own cash flow without recourse to the bond market even while paying huge dividends to shareholders.  No hint of economic crisis here.

BP’s financial position will improve significantly next year. Presumably, oil fields recently developed are ready to come on line as global oil prices remain firm or rise on Asian demand.

BP can handle even large payments into a federal damage fund so long as future liability is capped.

Shares in BP tumbled more than 9 per cent on Monday as US Democratic senators called on the multinational oil company to inject $20bn immediately into a ring-fenced fund to clean up the Gulf of Mexico spill.

This would equal two years of dividend payments and still leave all of the lovely “free cash flow after dividends” in 2011 and 2012.

The critical issue is not the dollar figure — $10 billion? $20? $30? — but whether it caps BP’s liability for all damages arising from the spill.  After all, limiting liability is the very essence of corporate management.

The ultimate size of the spill — which is still ongoing — is unknown.  The economic and environmental damages are widespread, long term and very difficult to quantify at this time.  Without that liability cap, BP’s financial future is cloudy indeed and its stock price is unlikely to recover.  (It’s down fifty percent since the spill.)  In the words of the Washington Post:

Don’t get us wrong — BP must pay cleanup costs, compensation and damages, which are likely to be considerable. But Mr. Obama’s fund also should not become the means to accomplish the politically attractive end of forcing BP to pay in a manner that unnecessarily overstresses the company. Indeed, victims of the spill should hope that BP flourishes — so that it has the profits from which to pay them in the years ahead.

The irony here is that the victims of the current spill will have a financial interest in BP’s continued development of risky deepwater oil resources.  The same is true of the rest of us who will suffer individual losses or pay through our taxes for whatever BP does not — or cannot — cover.

Here is President Obama’s balancing act.  On the one hand, BP may fall into crisis if its liability for damages is not somehow limited and made predictable — the swift and cruel judgement of the financial markets.  On the other hand, if BP’s liability cap is set too low, then we taxpayers will be on the hook for ballooning damage costs in the future.  President Obama does not want to let the company collapse nor does he want to let BP off too easily and face the wrath of the voters.

Unfortunately, we humans have demonstrated poor decision-making skills when it comes to managing unpredictable future costs.  Behavioral economists have suggested that we are prone to hyperbolic discounting whereby costs and benefits in the medium and long term are discounted more heavily than those in the short term.  Hyperbolic discounting explains the warped thinking of addicts who focus on their immediate need for the substance in question — nicotine? heroin? petroleum? — while ignoring or downplaying the future consequences.

Hyberbolic discounting affects the decision making of investors, voters, consumers and politicians alike.  We want our gasoline, 401k growth, fresh oysters and clean beaches and we want them now.  Those who aspire to be leaders must show us a path out of this trap that does not condemn our children and grandchildren to greater burdens.

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Tell Americans the Truth About Oil, President Obama

When President Obama makes his first Oval Office address to the nation tomorrow night, the topic will be the BP oil spill disaster in the Gulf.  He cannot mobilize our people in support of a sensible energy strategy if they don’t have the crucial facts about the U.S. petroleum situation. Here are three:

1. Domestic crude oil production is in long term decline. (Data from EIA.)

Yes, that’s an uptick in 2009, the first since 1991.  Overall, the trend is one of decline since production peaked in 1970.  Our richest oil fields were developed long ago and are now mostly depleted.  Risky and expensive deepwater fields are now being developed in a desperate effort to offset depletion.  2009 production remains below the 1950 level.

2. The US has only a tiny share of the world’s remaining reserves — two percent — while we consume roughly a quarter of global production. (Data from BP.)

It has been documented that most Americans believe we have plenty of oil, as much as fifty percent of world reserves.  This delusion, which supports the “Drill, Baby, Drill” fantasy, must be cleared up quickly.

3. As we import nearly two-thirds of the oil we consume, any price increase balloons the trade deficit which acts as a brake on the economy. (Data from EIA.)

The estimate for 2009 is $189 billion, as the price dropped from historic highs in 2008.  However, data for April 2010 show that we are on pace to reach $250 billion this year because crude oil prices have stayed above $70 per barrel.  (Data from the Bureau of Economic Analysis.)

If the U.S. were to return to the strong growth that is needed to bring down our high unemployment rate, then the price of oil would rise further, swelling the oil import bill and the trade deficit while putting downward pressure on aggregate demand.

The U.S. is no longer the main driver on the demand side of the oil market.  Strong and growing demand for petroleum in Asia is having an upward ratchet effect on price.

President Obama, please inform our people that we must add to petroleum’s significant environmental and security risks a new reason to cut petroleum dependence — our oil import bill represents a major financial risk to our economic health.

Instead of being a source of prosperity, oil is now a barrier to it.

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BP and the Two Percent Solution

The BP Gulf of Mexico disaster will be a transformative moment — just as the 1969 Santa Barbara oil spill was.  What we don’t know is the direction that transformation will take.

For a century, Americans have learned to identify petroleum consumption with prosperity and power.  That mythology was semi-sensible only so long as we were the dominant oil producer in the world.  We lost that status long ago.

How much oil remains?  According to BP’s recently released Statistical Review of World Energy 2010, the United States has 28.4 billion barrels of oil reserves remaining, or 2.1 percent of the world total (see page six).  Meanwhile, our share of world consumption is a whopping 22 percent.

Here’s the challenge: The only way to reduce our dependence on imported oil is by reducing our dependence on oil. Imported oil drives the U.S. trade imbalance and totaled $253 billion in 2009 — equal to half of the trade deficit.

U.S. domestic oil production will not increase because:

(1) We have only two percent of the world’s oil reserves and have used up our easy-to-produce oil fields.

(2) We are on a downward trend: U.S. domestic production peaked in 1972 at 11.2 million barrels per day and last year we produced only 7.2 million (see BP’s Statistical Review of World Energy 2010).

(3) Much of our remaining reserves can be produced only at great risk to the environment, in deepwater or the Arctic (see BP’s Gulf oil spill) and they aren’t enough to reverse the declining output from our depleted oil fields.

The only way to cut our oil imports is to cut our overall oil usage.

“Drill, baby drill” is quite simply divorced from reality.  Unfortunately, it is difficult for Americans to understand this simple truth because, while they accurately understand our import dependence, they are woefully misinformed about U.S. oil reserves. As shown in the accompanying chart, Americans believe we have about half of the world’s oil reserves — and that illusion has been rising!

To begin with, our leaders need to educate the American people about the petroleum reserves situation.  In any speech on oil and energy, every sincere national leader — starting with President Obama — should emphasize the “two percent” challenge.  We cannot expect our country to arrive at a sensible energy policy if most people have a fundamentally mistaken belief about how much oil the United States has left in the ground.

Once the average person understands that we have only two percent of the world’s oil reserves, then he or she will be very open to new ways of thinking about the problem.

How can we possibly end our addiction to oil?  Most petroleum is used for transportation so we have to look there.  Making all vehicles more fuel efficient much more rapidly is a good place to start.  Switching away from petroleum where possible is also helpful.  (Montgomery County, Maryland, is switching its garbage fleet over to compressed natural gas which will clean the air and save money.)  Research on substitutes for petroleum fuels should also continue.  Here’s a roundup of recent ideas.

However, we need to do more than just tinker with fuels and vehicles.  We must alter our low-population-density pattern of development that forces people to get in their cars simply to get to work or even just to buy milk.  It is this entrenched pattern, reinforced by decades of planning decisions, cultural attitudes and corporate promotion that needs to be changed.  The goal should be population densities high enough that public transit can sustain itself and people aren’t forced to own cars.  This won’t work everywhere for everybody but it can work for many of us.

Our energy-intensive lifestyle wasn’t chosen by individuals or decreed by Manifest Destiny.  It resulted from deliberate government decisions about zoning and road building.  We must begin to reverse those decisions now.

The good news is that the market is already trending toward higher density and more mixed use.  Governments at all levels must accelerate this trend while avoiding misguided decisions that promote energy-intensive, low-density living.  Such foolishness can be seen even in “environment friendly” Montgomery County, Maryland, where leaders pushed for years to build the Inter-County Connector and continue to encourage other projects that foster low-density, energy-intensive sprawl.

We need to make our urban spaces vibrant and desirable places to live and work.  States and localities can lead the way.  Make Baltimore a Green Metropolis.  Philadelphia already has an Office of Sustainability.  Cities across the country are expanding bike-sharing programs.  See the Smart Growth America website for more information.

Politics and culture change slowly but sometimes they change quickly, especially in the wake of national traumas like the BP Gulf oil spill.  Giving people accurate information is a good place to start.

And thanks, BP, for sharing this data with us!

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