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Friday, December 18, 2009

Wall Street Backs Industry Icon Karl W. Miller on Bi-Partisan U.S. Energy Policy Initiatives Report

Wall Street Backs Industry Icon Karl W. Miller on Bi-Partisan U.S. Energy Policy Initiatives Report

December 18, 2009 On December 17, 2009, Energy Industry Icon Karl W. Miller issued a report: The United States: A Global Power without an Energy Plan and without a CEO / Leader

Mr. Miller and other leading energy industry executives have been continuing to counsel Washington that its proposed energy policies will have disastrous consequences for the industry and the United States.

Today, December 18, 2009, Deutsche Bank issued a non-partisan similar report substantiating Mr. Miller's energy analysis and conclusions.

A summary of Deutsche Bank's report is as follows:

DEUTSCHE BANK-Washington DC trip-The consequences of unintended law Paul Sankey David T. Clark, CFA Research Analyst Research Analyst (+1) 212 250-6137 (+1) 212 250-8163

A fascinating major political shift in process in Washington oil & gas politics

DC oil politics are shifting, less on totally failed CO2 legislation or abandoned windfall taxes, but related to, though much bigger than, the issue du jour on this trip: hydro-fracking. In the 1980s and 1990s the US oil industry consolidated, shrank, and concentrated into Republican strongholds. The industry became a DC whipping boy. But unconventional gas is a game-changer; expanding, fragmenting, and diversifying the political base of the US oil industry. As a result, 2009 was a good year for oil in DC . For 2010, the risk is tax, not hydro-fracking or CO2.

Unintended consequences of the law

Returning a year later to Washington DC, we re-visited the aggressive anti-energy agenda that was described to us in late 2008 for the first year of the Obama administration - major CO2 legislation in time for Copenhagen, price gouging and derivatives trading legislation; oil and gas taxes to pay for stimulus, and if cap and trade didn't get the oil companies, then EPA regulation of CO2 would. In reality, none of it happened. Even close. And the current zeitgeist is that healthcare is occupying everyone's time, which is running short into mid-term elections.

The unintended law of consequences The energy agenda is drifting badly; with environmental legislation in disarray. The "EPA bluff has been called," which unleashes a nightmarish regulatory position regarding CO2 being considered a pollutant under the massively complex Clean Air Act; but this legislation was never designed for backwards-looking regulation of CO2 emission. The major starting problem is that the threshold for EPA action under the Clean Air Act is 250 tonnes of emissions - a limit set with more aggressive gases in mind than CO2. The example given is that limit, it applies to 13 cows, or Jay Leno's garage, with its collection of cars, alongside thousands of hospitals, schools, and other commercial and public buildings. Changing the rules is simply not that easy, and even if the rules are changed, the resulting blizzard of legal action will take years to unwind.

The law of unintended consequences

Senior Democratic support for domestic natural gas has surely been part-responsible for a massive rotation back into US gas by ExxonMobil. XOM saw its US gas volumes fall -60% in the past decade post-Mobil acquisition, as it pursued global LNG that the Mobil deal bought in Qatar. Now it is assuredly back in size, and the Markey call for a hearing on the subject is part victory lap on this vote of confidenc e in US gas, part re-raising of the issue of hydro-fracking. In this note we examine the pros and cons, and conclude that risk of federal regulation is rising, but on balance unlikely, given the EPA will take a couple of years to find on its environmental damage, and that jobs are the priority, with natgas

The resurgence of oil and gas power in DC politics

A fascinating major political shift is in process in Washington oil & gas politics. The major shift is less about totally failed CO2 legislation or abandoned windfall taxes and is related to, but much bigger than, the issue du jour on this trip: hydro-fracking.

In the 1980s and 1990s the US domestic oil industry consolidated, shrank, and concentrated into ossified political strongholds (e.g., Republicans in Texas, conservative pro-oil Democrats in Louisiana). As a result, the industry became a DC whipping boy.

But unconventional gas is a game-changer; expanding, fragmenting, and diversifying the political base of the US oil industry, the fuel is supported by senior Democrats. The hydro-fracking issue has been relatively quiet in DC, and legislation was sidelined on the subject by Democratic opposition from the rising number of "gas states." One unverified line we heard on the hill to make the point: there are more gas workers than coal workers now in West Virginia; this is the theme (although we have been unable to confirm that particular "fact"). Regardless, there is no doubt that natgas has been growing jobs meaningfully in a couple dozen states.

As a result, 2009 was a good year for oil in DC. We last ran this field trip a year ago, when what seemed to be an aggressive anti-energy agenda was described to us for the first year of the Obama administration - major CO2 legislation in time for Copenhagen, price gouging and derivatives trading legislation; oil and gas taxes to pay for stimulus, and if cap and trade didn't get the oil companies, then EPA regulation of CO2 would.

In reality, none of it happened. In fact, none of this legislation ever even came close to passing in the Senate, which was always going to be the battleground. And the current zeitgeist is that healthcare is occupying everyone's time, which is running short into mid-term elections that are likely to be extremely tough in many key areas.

The feeling in Washington is that the Obama administration must pass healthcare to retain credibility regarding their ambitious and aggressive agenda of change on tough issues. By the time they have got through their current priority list; health care by year end, financial/banking regulation reform early next year, and then, as a function of marginal seats and a suffering economy, legislation on jobs, jobs and jobs, we will be in a position of facing the election directly; arguably by Memorial Day that is the focus. Marginal seats are threatening a super-slim and legislation-supporting 60-seat majority in the Senate - that may well weaken in the mid-term 2010 election; additionally the comfortable side of the Democratic legislative agenda, the house, may shift sufficiently at the margin to make legislation there more difficult to pass.

Clearly, the Republicans we met are pleased with their success in obstructing major progress on the Obama Democrats' signature legislation. For example, it was stated plainly to us, across the political spectrum, that cap and trade legislation in its current form is dead. A year ago, it was seen as imperative to get that legislation in place in time for Copenhagen. Word in Washington was that the summit was in danger of turning into a farce, and there were even questions as to whether the President would attend. However one influential Democrat did point out that many major summits have risen phoenix-like from the ashes of a mid-summit farce; but that was a lone view. The fact that a blizzard dumped four feet of snow on what apparently has been an over-crowded and somewhat chaotic event only adds to the f eeling that, alongside "Climategate" the CO2 agenda has struggling momentum.

If no cap and trade, what is the risk on EPA regulating on CO2?

Indeed, overall the energy agenda is drifting. A comment was made that "The EPA bluff has been called," which is a reference to the fact that a year ago, it was said that if legislation on CO2 failed, then the EPA could regulate it as a pollutant. That regulation threat was seen as "a stick to beat Congress with." A Senate staffer dryly commented that "Congress doesn't take threats."

And it is indeed clear that the EPA regulation route unleashes a nightmarish regulatory position regarding CO2, now considered a pollutant (Supreme Court ruled as such in 2007) and an endangerment to public health (early December EPA finding) under the Clean Air Act (CAA). The CAA is a massively complex law, with Federal and State-level regulatory frameworks intertwined, and by virtue of the difference between the pollutants it was intended to control, such as sulphur dioxide, and their dangerous quantities, compared to CO2, it is arguably CO2 in-appropriate - at least taken totally at face value, which laws must be.

That quantity issue is a major starting problem. The threshold for EPA action under the Clean Air Act is 250 tonnes of annual emissions - that is obviously a limit set with more aggressively polluting by quantity gases in mind than CO2. The example given is that with the CAA enumerated threshold, Jay Leno's garage, with its collection of cars, is now subject to regulation, alongside thousands of hospitals, schools, bakeries and other commercial and public buildings. Another example given is that 250 tonnes of annual emissions is produced by around 13 cows.

Under the Act, when the EPA initiates regulation (along with the Department of Transportation) of the US light duty vehicle fleet, it will trigger permitting requirements under the Prevention of Significant Deterioration (PSD) and Title V operating permit programs contained in the CAA; in other words, broad regulation of CO2 emissions.

Additionally the legislation is designed around new source control, rather than retrospective control of emissions.

EPA has proposed to get around the absurd results dictated by the 250 tonnes threshold by implementing a "tailoring rule" to re-set the greenhouse gas emissions regulation threshold at 25,000 annual tons, though the "tailoring rule" rests on administrative law doctrines rather than legislative language, and is therefore sure to produce litigation from aggrieved businesses who will claim the EPA lacked proper legislative authority to change the threshold.

A typical refinery produces 1-5 million tonnes/year of greenhouse gases, and so the threshold for regulation is not the major issue for them, however other areas within the oil and gas ecosystem could be impacted, such as production units, depending on how the "industrial facilities" is defined by the EPA.

From the EPA's perspective, changing and enforcing the rules will simply not be that easy, and even if the rules and enforcement policies are changed, all parties concede there will be a resulting blizzard of legal action. Keep in mind that environmentalists are in need of victories and long on funding, and that legal action is likely in both directions, pro and con.

That legal blizzard is likely to last several years at least.

Non-partisan soapbox comment from this analyst

The bottom line is that there is a simple, easily implemented, more-or-less fair solution to the issue of greenhouse gas emissions in the US, which is a direct carbon tax, or gasoline tax. This tax need do no more than take carbon intense energy prices here towards other OECD price levels. There, energy use is around half the intensity of the US. Some complexity could be added to mitigate the effects of a tax on the least able to deal with the new cost; the poor, the old, the weak. It is not clear how cap and trade will do this.

The tax could also be used to reduce the volatility of energy prices, by increasing at low prices and decreasing at high prices.

Our view is that without tax, the market will effectively tax the US consumer with high prices any way, but that the tax will go to OPEC governments and oil companies in the form of higher profits.

However there is no political will to directly and simply tax carbon in energy use, so under the guise of acting bravely, politicians of all sides hide behind complex, convoluted and ultimately potentially unfair legislation to tax air, using arbitrary judgment rather than market forces to assign costs or "blame". The net result is that legislation, particularly in a recession, struggles to pass. But as long as the simple solution is not taken, the net result is that the law of unintended consequences forces even more complex solutions to be layered on even further distorting the picture in the pursuit of the original, relatively simple, goal. And ultimately, at least so far, nothing gets done.

The biggest risk for 2010

For 2010, the biggest risk for oil companies emerging from DC for oil and gas companies is tax, not hydro-fracking or CO2. The pressure on President Obama to limit additions to the budget deficit while also advancing key job and social programs is enormous, which necessitates finding new sources of revenue without directly raising voters' taxes.

Oil and gas producers remain tremendously unpopular with the public - again, go to the polls, and find that oil and gas is consistently the most unpopular industry, even this year far outscoring banks (mid range) and are thus an easy target for increased taxation. Second least popular industry was: politicians, in the survey quoted to us.

Little happened in '09, but it appears tax will be an issue in 2010. An important energy-related Senate staffer on the Democratic side told us that "there will be a tax package in 2010 that the oil companies won't like, but it will be less than the White House wants." At the beginning of 2009, the Obama administration outlined plans to generate more than $31B in revenue over 10 years from taxes on the oil and gas industry.

The plan would slap companies with a new excise tax on production in the Gulf of Mexico, and repeal the industry's eligibility for a manufacturing tax credit worth $13.3 billion in that period. Obviously one enormous tax that seems to have been dodged was cap and trade.

The key tax threats in 2010 are, by likelihood, with a high degree of uncertainty:

1) Repeal Section 199 manufacturing tax deduction for oil and gas companies. For 2009 the deduction was frozen at 6%, could be fully eliminated for integrateds. This seems likely to go. Under the budget, that would be worth $13.3 billion between 2010 and 2019.

2) Changes to the Gulf of Mexico royalty and leasing regime. Democratic energy staffer: "Question is, are we getting a fair return on our asset leases in the Gulf of Mexico." The legal success by Anadarko in winning back tax is seen as a short term victory, a long term potential defeat, and furthermore raising GoM taxes was cited to us as a process started under the Bush administration. Under the budget, that would be worth $5.3 billion between 2010 and 2019.

3) Reinstate superfund taxes for the industry. If reinstated in 2010, it would apply to 2011 tax year.

4) Restriction of dual capacity tax creditability to instances of foreign income tax, eliminating creditability for other trade or business taxes. This is a massive threat to Integrated Oils, given their huge foreign income; the offset to this threat has been the argument that it will dis-advantage US oil companies relative to major foreign oils, European majors such as Shell and BP, but also Chinese or other majors. That argument has been sufficient to offset the risk so far.

5) Repeal of the intangible drilling costs deduction; more likely headline threat than reality because of the stronger political power of gas E&Ps, and support.

6) Repeal LIFO inventory accounting. This change now appears unlikely, but would cost the industry approximately $24bn in one fell swoop (depending on the prevailing oil price). The move is not popular with many non oil and gas industries, most notably the Kentucky whiskey industry.

Ethanol E15 This week the EPA delayed a decision on raising the allowable percentage of ethanol blending into at-the-pump gasoline from 10% to 15% until 2010, but also signaled that it would be supportive of a change towards a higher level. The need for this is the ethanol "blendwall," whereby owing to ethanol being mandated by volume, not share, and the massive decline in gasoline demand, the share of ethanol in the gasoline pool is moving beyond 10% to meet volume requirements.

The major issues slowing down E15 are 1) concerns about the potential effect of ethanol on engines; 2) warranties for car engines (as well as other combustion motors, such as for boats and lawnmowers) are currently written for E10, and will be voided if E15 is used unless a waiver is given; 3) wider issues beyond engine warranties, such as different emergency response for ethanol due to different combustion characteristics than gasoline.

The first issue appears to be the driver of E15 timing, as technical testing being conducted by the Department of Energy will be finished sometime between April and June 2010. Two of the eight scheduled tests have been completed, and a Democratic staffer told us that they went well, and that her expectation was that the DOE would conclude that E15 won't harm car engines. It was pointed out to us that Brazil adopted E20 (minimum) to E25 (maximum) in 2003, and has had no widespread issues with engines. More recently, Brazil moved to E25 as a minimum.

Much as with ExxonMobil's entry to US gas, it was noted that refiners are buying bankrupt ethanol players, although this was not seen negatively.

Think domestically, because internati onal is a nightmare

On foreign policy, a former top-ranking covert intelligence official - a former spy chief - told us that in 30 years of experience, this is the scariest global environment he has ever seen.

In particular he was concerned about

1) the deteriorating situation in Pakistan, and the growing possibility of a Pakistani nuclear device falling into the hands of radical Islamists; there are 100+ nuclear devices in a country that is drifting into anarchy with an army reluctant to take power in the way they have in the past to restore order, and rising Islamic radicalism. The threat is that a renegade gets hold of one or two nuclear devices and then. what? Attack India? The Straits of Hormuz? It is a terrifying prospect.

2) the "unwinnable" war in Afghanistan, where the US seems to have intentionally tied its own hands by trying to limit civilian casualties (i.e., much less air support for ground troops in difficult terrain will be offered now as a guerilla war is fought and a "hearts and minds" war is simultaneously fought);

3) escalation in the Iran-Israel-US tension, with the linchpin in the calculus tilted towards the degree of existential threat perceived by Israel; the fact that Israel would potentially attack unilaterally if they perceived that Iran's nuclear capability had become a genuine threat to Israel; that is, that Iran could destroy all of Israel with nuclear strikes. The view is that moment is coming faster and faster, and might be under-taken unilaterally. and

4) a terrorist strike in the US, possibly on a greater scale than 9/11.

On this last point he highlighted intel (intercepted communications) that have indicated that jihadists have opted to delay or cancel operations in the US, not due to an inability to carry out the plan, but because they decided the resulting mayhem wouldn't be dramatic enough to produce an economic and social breakdown. Without specifically predicting a calamity, the official sug gested that President Obama, though challenged by myriad issues both domestic and foreign, will likely be tested further by some kind of terrorist action on US soil before he leaves the White House. A recent example he highlighted was the Najibullah Zazi led plot to detonate multiple bombs off in lower Manhattan that was busted up by the FBI in September. Not if but when, was his chilling prognosis.

We have consistently been terrified by security risk analysis in Washington over the past five years and thankfully, little of what was promised has come to pass. But there remains a horrible sense that, the very fact that we have escaped lightly thus far, is increasing the likelihood that we do not in the future. Our best hope, is democracy, and for all its faults, there is no greater centre of democracy than Washington DC. We are thankful for the openness of the staffers, politicians and lobbyists who offer their time to us selflessly despite what are clearly very tough and busy schedules, and for their work on behalf of global democracy.

"Democracy is the worst form of government except all the others that have been tried." Winston Churchill.

To solve positively: democracy is the best form of government.

Disclosure: long Themes: natural gas, clean fuels, oil, energy policy Stocks: CHK, DVN, APA, APC, XOM, CVX, MRO, EOG Source: VBCC

* News submitted to Investor Ideas green newswire by Karl Miller

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1 comment:

Low Cost Energy said...

From what I've noticed, the US have put together an energy tax credit program, through which they are trying to boost lowering the costs on energy use, for companies, householders, or other categories of population.