Musings From the Oil Patch – August 19, 2008

• Will Americans Drive Less With Lower Gas Prices?
• Arctic Energy Resources Struggle Coming To Forefront
• Stonger US Dollar Sends Crude Oil And Stock Prices Lower
• Allegheny Energy Transmission Line A Sign of The Future?

Note: Musings from the Oil Patch reflects an eclectic collection of stories and analyses dealing with issues and developments within the energy industry that I feel have potentially significant implications for executives operating oilfield service companies.  The newsletter currently anticipates a semi-monthly publishing schedule, but periodically the event and news flow may dictate a more frequent schedule. As always, I welcome your comments and observations. Allen Brooks

Will Americans Drive Less With Lower Gas Prices?

 

June marked another month in which Americans left their cars in their driveways.  According to the latest monthly data from the U.S. Department of Transportation (DOT), total vehicle miles (VMT) driven in the United States (including both urban and rural mileage) was down 3.7% from the same month in 2007.  This was the eighth consecutive monthly decline in vehicle miles driven.  Based on a 12-month rolling total of VMT, drivers are driving about the same number of miles they did in the fall of 2004 despite an increased population and more vehicles in the U.S. fleet.  June, however, was also the highest point in gasoline prices, which clearly has been the primary factor causing the decline in driving.  Today, as we prepare to close out August, gasoline pump prices have fallen to a three month low following the decline in crude oil prices that began in mid July.  Will Americans continue to observe their new patterns of reduced mobility in the face of lower gasoline prices?

 

It has become clear from the various transportation statistics compiled over the first six months of 2008 that Americans have altered how they use their vehicles.  For example, the American Public Transportation Association reports that in 2007, U.S. commuters took 10.3 billion trips, up 2.1% over 2006, on some form of public transportation.  That is the highest proportion of public transit use since 1957, some fifty years ago.  That increased ridership trend continued in the first quarter of this year with riders taking 2.6 billion trips, some 88 million more trips than in the same quarter of last year.  At the same time transit use increased 3.4%, the DOT reports that VMT volume declined 2.3% in the quarter. 

 

 

 

Exhibit 1.  Vehicle Miles Driven Continues To Fall

Source: Dept. of Transportation, PPHB

 

In 2008’s first quarter, light rail systems experienced the greatest growth in transit usage, up 10.3%, while commuter rail increased 5.7%, heavy rail (subways and elevated lines) use grew 4.4% and bus ridership increased the least, rising only 2.2%.  What is most impressive about the growth of public transit use is that since 1995, it has increased by 32% while our population increased only 15%.  VMT only increased 24% in the same period suggesting that public transit is gaining in its share of the population’s travel. 

 

The ridership of Amtrak, the nation’s passenger railroad system, shows that American’s are climbing aboard trains in greater numbers than at any time in recent history.  Train ridership in July increased 13.9% over last year in response to high gasoline prices.  In the month, only one of Amtrak’s services saw fewer riders than the year before.  The use of Amtrak trains in the heavily traveled Northeast corridor climbed by 8% over last year.  The pace of Amtrak’s ridership growth has put the railroad on a pace for transporting 28 million passengers, up from 25.8 million passengers in its previous fiscal year.  This comes at the same time Amtrak has been wrestling with higher fuel bills for its trains and the need to increase investment in its system to deal with the increased usage and the aging of its infrastructure.  Recently, the rail line had to suspend some of its trains between New York City and Boston while it reconstructed a railroad bridge over the Connecticut River.  The interruption was only about four or five days, but it did create problems for travelers and did cost the railroad financially with fewer passengers on the route.  According to Amtrak, it needs to spend

 

nearly $5 billion to bring the service in the Northeast Corridor to a state of good repair.

 

Exhibit 2.  Amtrak Ridership Growing With High Gasoline Prices

Source: Amtrak, The Wall Street Journal

 

An interesting measure of the change in driving habits is the growing use of motorcycles.  As a result of high gasoline prices, motorcycle riders are traveling more miles per year and there are more new purchases of motorcycles.  The flip side to this increase is that motorcycle deaths are up nearly 7% between 2006 and 2007 according to data from the National Highway Transportation Administration.  This marks the 10th consecutive year of rising motorcycle deaths while car-related deaths have been steadily declining.  Since 1997, motorcycle deaths have increased by 128%.  Today, motorcycles are involved in 13% of all fatal vehicle accidents.

 

Now that gasoline prices have backed off along with crude oil prices from their highs of earlier this summer, the speculation is that Americans will breathe a huge sigh of relief, look at the extra $10 to $20 per month they are saving and return to their old driving habits.  We are not convinced that will happen.  Why?  Because we believe American attitudes have shifted toward the energy situation that haunts this country.  High gasoline prices are only one measure.  The public is also confronting high and rising electricity costs as a result of their consumption, the lack of new electric power plant generating capacity and the high cost of fueling the power plants.  The rapid shift in the public’s attitudes toward energy development in this country has surprised virtually everyone.  Little would we have

 

thought merely six months, or even a year ago, that this November’s presidential election would turn on the public’s perception of what the two candidates may do about our energy challenge? 

 

Conservation is going to have to play a larger role in solving our nations’ energy problem and the first battles over how to restructure electric power rates are already underway.  Duke Energy (DUK-NYSE) has proposals for rate relief before the regulators in two states – North Carolina and Ohio.  The problem is determining how much conservation is actually achieved and how much the company should be able to earn from avoiding the cost of building new power plants.  Under the traditional business model the earnings calculation was quite easy.  The company invested in new power plants to produce and sell more energy and was allowed to earn a fixed return on that increased investment.  

 

Duke has proposed earning 90% of the value from avoiding building new plants or having to buy power elsewhere.  In earlier hearings in South Carolina and Indiana, Duke was forced to reduce its share of avoided costs to 85%.  Reportedly, the staff of the North Carolina Public Utilities Commission will present a case for retaining traditional financial regulatory measures that would reward Duke a return of 5.5% on the investment it makes in actually generating conservation and load shifting.  This will prove to be a difficult issue to resolve, but at least the various parties are trying.  In order to find the proper balance between a radical new way of compensating a company for convincing its customers to use less of its product and merely rewarding it with a nominal return on the money it invests in conservation technology and hardware some new thinking by utility regulators is in order.  Rewarding conservation turns the business model upside down and the regulators need to rethink the regulatory reward policy. 

 

On the rest of the energy supply question, the national debate is well underway and the range of solutions is wide.  Should the U.S. undertake a large nuclear power plant construction effort to help address our growing electricity needs and to replace old, inefficient and highly polluting existing power plants, or should we go with traditional power plants, or even power plants fueled by renewable sources?  The debate brings in the environmental movement adding another degree of difficulty in reaching a consensus.  With respect to the nuclear power plant debate, what may have been lost is the fact that the United States has to import 92% of our enriched uranium fuel.  At the moment we are benefitting from the dismantling of the Soviet Union’s nuclear warhead inventory.  Today, the United States gets 43% of its enriched uranium from this source, but that will change when the 20-year Russian program known as Megatons to Megawatts ends in 2013.  When that happens, in order to fuel our existing and planned nuclear plants with enriched uranium, we may find ourselves potentially a hostage of foreign nations, just as we are for our crude oil today.

 

Another national debate has surfaced that involves both our electric

 

power business and our transportation industry.  The debate has been launched by the introduction of the Pickens’ Energy Plan to build huge wind farms throughout the central portion of the United States in the region extending from the Gulf Coast to the Canadian border and use the electricity generated from these turbines to free up natural gas supplies currently powering electricity generation boilers.  T. Boone Pickens, a billionaire oil man, has proposed this plan as the only way for the United States to get out from under what he calls the “greatest wealth transfer ever” as we ship $700 billion a year to foreign governments for imported crude oil. 

 

Mr. Pickens’ plan rests on the assumption that the United States has sufficient natural gas resources and the technology to shift this resource into the transportation fuel market.  He believes that we can develop a natural gas powered transportation industry with nationwide filling stations dispensing compressed natural gas.  The industry would also employ vehicle filling outlets installed in homeowner garages.  Not only is natural gas recognized as a clean fuel, it is abundant in the United States and cheap compared to crude oil, but the switch will be technologically challenging.  Equally difficult is getting the public to embrace wind- and solar-powered electricity plants as their reliability is not yet assured. 

 

The Pickens’ plan assumes that the government will embrace the concept of switching natural gas from fueling electricity generation to powering our automobile fleet.  At the moment, natural gas’ share of the electric power generating industry is about 20% (in 2006, the latest EIA statistics available) or virtually the same share as nuclear.  Each of these fuels accounts for less than half the amount of electricity generated from coal (49%).  Whether the electric power industry is prepared to let its gas supplies be moved remains a huge question never addressed by Mr. Pickens. 

 

Replacing the gas-fired power plants with wind, solar and other renewable fuel sources also is problematical.  Neither wind nor solar have figured out yet how to economically store their power for use when electric demand is high and their power generation capability is low.  As a result, all wind and solar power projects have to have some backup fuel supply or the buyer must have access to alternative electricity sources to meet this contingency.  Until these issues are addressed, it is highly unlikely that state utility regulators will want to risk experiencing power blackouts such as that which hit Texas earlier this year when electricity generated by wind turbines fell dramatically at the wrong time of the day for electric power demand and the switch over to alternative supplies was fumbled.  While Mr. Pickens’ plan has appeal, it lacks solid analysis of exactly how the transition will occur and at what cost.  Unfortunately, the plan looks more like a way to insure the success of the $8 billion wind project proposed by Mr. Pickens in West Texas.

 

 

 

 

 

Exhibit 3.  Natural Gas Is Less Than Half of Coal’s Share

Source: EIA, PPHB

 

The American Clean Skies Foundation (ACSF) recently completed a survey along with Navigant Consulting Inc. to estimate the amount of natural gas reserves in the United States.  According to their work, the country has 2,247 trillion cubic feet (tcf) of natural gas reserves, enough for 118 years of supply at the consumption rate of 2007.   Most of the growth in proved reserves is due to the commercialization of “unconventional” sources.  This is the result of the success the E&P industry has had in unlocking the reserves in the numerous shale basins that underlie large portions of the United States.  For example, proved coal bed methane (CBM) reserves today are estimated at nearly 20 tcf, up from 11.5 tcf in 1998.  Proved gas shale reserves have increased to 15 tcf from 3.5 tcf in 1998 while tight gas reserves have grown to 80 tcf from approximately 36.6 tcf over the same period. 

 

Exhibit 4.  Natural Gas Production Growth Due to Unconventional Reserves

Source: EIA

The impact of new well fracturing technology coupled with greater success in drilling horizontal wells has allowed substantially larger gas production volumes from new wells.  In fact, the growth of natural gas production is accelerating and is becoming a concern for some industry analysts who foresee the United States developing surplus productive capacity that will undercut currently high natural gas prices, which, in turn, could make some of these unconventional gas resource plays uneconomic.  The challenge facing the natural gas business is similar to that faced by many of the new renewable fuel businesses – the cost to develop this energy is high and without sufficient demand that keeps prices high, they will become uneconomic and not developed.  This is another example of the old ‘chicken and egg’ problem.

 

The impact of the gas shales is demonstrated by the growth in domestic natural gas production.  Over the nine year period from 1986 and 2006 gas production in the U.S. was flat.  From the first quarter of 2006 to the first quarter of 2007, gas production grew by 3%.  But from the first quarter of 2007 to the first quarter of 2008, production has increased by almost 9%.  In fact, Aubrey McClendon, the head of ACSF and Chesapeake Energy Corp. (CHK-NYSE), has suggested that with the growing natural gas production, the United States should begin building natural gas liquefaction facilities to enable the country to compete in the global liquefied natural gas (LNG) business.  What is overlooked is that the United States still imports about 13% of our gas supply from Canada and a small percent of our gas supply comes here in the form of LNG.  Also, to continue to grow our shale gas production will require a growing number of drilling rigs and additional frac equipment as we must continue to drill new wells at a very high rate to help offset the rapid decline experienced by these new gas wells.

 

Exhibit 5.  Current Natural Gas Production Growing Rapidly

Source: EIA

 

 

There is little doubt that the technology to exploit gas shales has improved and high gas prices has made many of these plays economic.  However, they are still highly sensitive to the economics of securing the acreage, drilling and completing the wells and being able to sustain high well production flows.  The last time we had government mandates directing how natural gas would be used in this country, the result was a huge distortion of the market that ultimately did more damage than if it had been left alone.  From the mid 1950s to the early 1980s, this country had federal price controls over natural gas used in interstate commerce.  Because the price was set too low in the early years, E&P companies focused on finding and developing gas to be sold within producing states operating markets with decontrolled prices.  So while federal controls limited interstate prices to $0.50 and then $0.75 per thousand cubic feet (mcf) of gas, customers operating in the Texas and Louisiana intrastate gas markets at the same time were willing to pay upwards of $8 to $12 per mcf.  Guess where all the gas went?

 

As the interstate gas markets faced serious supply shortages, the federal government determined that natural gas was too valuable a fuel to be burned under boilers.  It was to be saved for use in high value-added uses such as the petrochemical business and for producing drugs, etc.  At the same time, the government was dismantling its regulations and freeing up all natural gas prices, which ultimately stimulated gas drilling that resulted in the development of a surplus of gas production.  We started with a ‘gas bubble’ that then morphed into the infamous ‘gas sausage’ as the surplus production grew and consumption growth was limited.  The net result of the gas sausage was that natural gas prices fell to $1 a mcf, an uneconomic condition except for the largest gas fields.  The Gulf of Mexico market was devastated, resulting in a huge drop in drilling activity leading to the basin being referred to as the Dead Sea.

 

The point of this discussion is to highlight how much price plays in the supply and demand of energy fuels in this country.  Will Americans resume their profligate ways with gasoline and other energy fuels as and when their prices decline?  History would argue that they will.  That assumption could become a Black Swan for forecasters.

 

 

Arctic Energy Resource Struggle Coming To Forefront

 

Two weeks ago the U.S. State Department announced a joint US-Canada scientific expedition to map the Arctic seabed in an effort to claim ownership of the underlying natural resources.  There will actually be two intra-agency expeditions during the August through October period.  These expeditions will collect scientific data about the continental shelf and the oceanic basins of the region and will help to define the natural resource and commercial potential of the region.  This data will certainly further boost the claims of the United

 

States and Canada to their share of the region when the United Nations re-examines the area’s ownership question.

 

The struggle over who owns what portion of this region was highlighted last year when a Russian scientific expedition sent a mini-sub to the floor of the Arctic Ocean to plant a Russian flag and claim the territory as under its jurisdiction.  The Russian expedition was collecting scientific data to help bolster its claim to substantial areas of the Arctic region.  Its earlier claim to the area had been denied by the UN agency responsible for determining ownership of the outer continental shelf off each of the bordering country’s land mass. 

 

In the United States, the struggle for Arctic ownership and its potential natural resource bonanza has increased the pressure on Congress to ratify the UN Convention on the Law of the Sea.  This international treaty establishes the mechanism for the nations of the world to determine subsea boundaries.  Under the treaty, any coastal nation can claim territory extending 200 nautical miles from its shore and exploit the natural resources within that area.  The importance of the Arctic region was highlighted by a recent report by the United States Geological Survey (USGS) on the potential oil and gas resources in the Arctic region.

 

The USGS has estimated that in the area north of the Arctic Circle, there are potentially 90 billion barrels of undiscovered, technically recoverable crude oil and 1,670 trillion cubic feet of undiscovered, technically recoverable natural gas and 44 billion barrels of undiscovered, technically recoverable natural gas liquids (NGLs) contained in 25 geologically defined basins.  The significance of this estimate is that it suggests the Arctic region contains 22% of the world’s undiscovered, technically recoverable oil and gas resources – 13% of the oil, 30% of the natural gas and 20% of the NGLs.  Moreover, the amount of oil equals the known reserves of Venezuela and the gas supplies almost match those of the world’s largest holder of gas reserves – Russia.  Some 84% of these undiscovered resources in the Arctic are located offshore.

 

More than half of the undiscovered oil is estimated to occur in three geologic provinces: Arctic Alaska with approximately 30 billion barrels of oil; the Amerasia Basin with approximately 9.7 billion barrels; and the East Greenland Rift Basins with approximately 8.9 billion barrels.  Two additional provinces – the East Barents Basins (7.4 billion barrels) and West Greenland/East Canada (7.2 billion barrels) bring the total of the five provinces to over 70% of the undiscovered oil resources.  Natural gas resources are more concentrated.  More than 70% of the undiscovered gas resources lie within three provinces – the West Siberian Basin (approximately 650 TCF); the East Barents Basins (318 TCF); and Arctic Alaska (221 TCF). 

 

The USGS estimation process assessed 33 geologic provinces and evaluated 69 assessment units.  The service provided estimates for

 

25 provinces and 48 assessment units.  The study was a geologically based analysis of yet-to-find fields and focused only on conventional oil and gas resources.  This suggests that the resource potential in the region could be even greater if unconventional resources were estimated.  The value of the USGS study is that it employed one methodology and applied it consistently across all areas north of the Arctic Circle.

 

The one thing we can safely assume is that we have not heard the last of the resource potential of the Arctic region.  With global warming contributing to a reduction in the ice coverage of the region, access to the oil and gas resources in the region may become easier in the future that could be important in a energy resource constrained world.  All the nations bordering this region are in a race to strengthen their claims.  In fact, Canada is launching an archeological expedition seeking to find two British ships lost in the 1840s while searching for the Northwest Passage in hopes it will help strengthen the country’s claim.  While last year’s Russian mini-sub, flag-planting exercise may have been seen as largely a publicity stunt, the struggle over ownership of this region with its vital oil and gas resources will become more intense over the next 12-24 months.

 

Exhibit 6.  USGS Says Region Has 22% of World’s Oil and Gas

Source: USGS

 

 

Stronger US Dollar Sends Crude Oil And Stock Prices Lower

 

We are writing this story a week ahead of our publication date and plan to add an addendum just prior to emailing the report.  Our reason for writing early is to see whether the trends we foresee now will carry through the following week.  As several analysts and energy forecasters pointed out, the previous week saw the largest one-week decline for crude oil prices in history.  Much was made of the weak oil prices with lots of stories about the bursting of the commodity bubble as almost all commodity prices dropped. 

 

The past two years saw a spectacular rise in global oil prices, which has been explained as driven by the tightening of the world oil supply and demand balance.  Geopolitical considerations have played a role in the market’s tightness as the loss of oil production from Nigeria and periodic oil supply disruptions in Iraq make assured oil supplies worth increasingly more every day.  Add to geopolitical factors and growing world demand, especially from developing economies, the impact of significant production losses due to accelerating depletion rates in Mexico and the North Sea.  But one of the more talked about causes for sharply higher crude oil prices has been the significant weakness in the value of the United States dollar versus other world currencies such as the Euro and the Canadian and Australian dollars.  The latter two currencies have been helped by the rise in global commodity prices as both countries’ economies are largely based on natural resources. 

 

As if someone threw a switch several weeks ago, financial markets began to view the U.S. dollar with greater favor sending its value up against the other world currencies.  The strengthening of the value of the dollar vis-à-vis the other currencies has coincided with a peaking in global crude oil prices.  From nearly $148 a barrel, crude oil prices have fallen to a recent low of $115, or almost a 22% drop.  As one financial firm pointed out, there has been a strong inverse relationship between the value of the U.S. dollar and the price of oil.  They commented on the recent oil price drop by showing the chart in Exhibit 7. 

 

As they pointed out, up until the left edge of the red box in the chart, crude oil prices demonstrated the strong inverse relationship with the value of the dollar.  But with oil sitting at an all-time high of $104 a barrel at that time, the value of the dollar hit an all-time low.  But then the dollar began to steady and actually rose just as world oil prices sprinted to record highs of over $140 a barrel.  The inverse relationship between oil prices and the dollar’s value seemed to have broken down, at least during the period between March and July of this year.  As oil prices soared, the focus became just how high oil prices would rise – $150 a barrel by the Fourth of July; $200 a barrel within two years; or $300 a barrel or higher in the foreseeable future.  Few people talked about oil prices dropping even while U.S. consumption data showed Americans driving less in

 

 

Exhibit 7.  Oil Prices and The U.S. Dollar Back on Track

Source: Agora.com

 

response to $4-plus gasoline prices.

 

Since the peak in oil prices in early July and the reversal in the value of the U.S. dollar, the change in investor psychology has been dramatic.  Not only has the price of oil fallen, but the ratio of the value of the U.S. dollar to that of the Euro has changed.  Remember, it was not that long ago when analysts were speculating on the desirability of OPEC members switching the pricing of their oil exports from U.S. dollars to Euros in order to offset the fall in the dollar’s value and because they purchase a substantial volume of goods and services denominated in Euros. 

 

Exhibit 8.  The Dollar and Euro Are Reversing Course

Source: Barchart.com

 

As the dollar/crude oil price relationship has returned to its tight inverse pattern, the impact has been most noticeable on energy securities, and in particular the oilfield service stocks.  We have put

 

two charts together – one showing the ratio of the U.S. dollar and Euro to oil futures prices and the other showing oil prices against the value of the Philadelphia Oil Service Index (OSX).  The patterns could not be more clearly defined.  As oil prices rose during the recent period of time when the inverse relationship between the value of the dollar and oil prices broke down, the OSX soared.  With the peak in oil prices and the return of the dollar/oil price inverse relationship, the OSX has come under significant pressure.  The weakness in the OSX has many in the industry perplexed as generally the service companies have been reporting strong second quarter earnings and, more importantly, signaling strong business activity suggesting that future quarterly earnings results should be strong, also, but share prices have been falling.  Not only have stock prices declined, in some situations the drops have been dramatic on specific days.

 

Exhibit 9.  The Oil Price Rise in 2008 Counter to Currency Ratio

Source: St. Louis Federal Reserve Bank Research, EIA, PPHB

 

Exhibit 10.  Oilfield Service Stocks Closely Follow Oil Prices

Source: Yahoo.com, EIA, PPHB

 

We have recently updated our chart comparing the performance of the oil service stock component within the Standard & Poor’s 500 Index during the boom period of the 1970s and early 1980s and the current boom period, a chart we initially published in our April 1st issue of the Musings.  (We have published one earlier update of the chart.)  While the pattern of the two periods seems to be slightly different – there was only one peak in energy stock prices in the earlier period while the earlier peak in recent months was followed by a drop and subsequent rise to a new peak but now another drop.  Given the recent performance of energy stocks it appears they are back on track with the 1970s pattern.

 

Exhibit 11.  Oilfield Service Stocks Tracking Correction of 1970s

Source: Global Financial, PPHB

 

The oil industry and financial community are wrestling with the future direction of oil prices.  Have we merely taken the fluff off the boom with the $30+ correction in prices?  Or does the price correction suggest a more fundamental shift in the oil supply/demand fundamentals?  We previously published a chart (reproduced in Exhibit 11) that showed from a commodity trading perspective, the real fundamental strength to support crude oil prices lies in the $95 a barrel region.  We saw an analysis by an energy research group that concludes there is a strong case for oil support at $92 a barrel.  If the U.S. dollar continues to strengthen, we believe the likelihood is that oil prices will continue to fall and with them energy stock prices.  As they say, this is bear market and nothing works.  For energy company executives, they need to continue to focus on their businesses and maximizing earnings since there is virtually nothing they can do about stock valuations given the industry’s investment environment.

 

 

 

 

 

 

Exhibit 12.  Oil Price Support in $95 Range

Source: EIA, PPHB

 

ADDENDUM

 

While we were involved in business in Canada last week, the value of the U.S. dollar continued to weaken – substantially against the Euro – and crude oil prices continued their slide.  During the week, the value of the Euro fell by 3.4 cents to $1.4673.  Crude oil prices declined about 1.2% over the week closing at $113.77 a barrel, but they hit a low Friday morning of $111.34 for a 3.4% decline from the prior Friday close.  The volatility of crude oil and currency prices contributed to a difficult week for energy stocks.  The OSX was only off 0.6% week to week, but during the week the index rose by 3.0% only to then fall by 3.5%.  The relatively small overall movement in the index’s value was in keeping with the movement of the two broad market indices – the S&P 500 that rose 0.1% for the week and the Dow Jones Index that fell 0.6%. 

 

Increasingly we are seeing new forecasts for crude oil prices that suggest we are headed below $100 a barrel.  This is in sharp contrast to the bullish forecasts of early summer.  When the momentum changes in the trading pits, you can be sure that every bit of negative news gets magnified while any bullish news or data is ignored or marginalized.  While the stocks and oil prices are in bear market territory, we continue to suggest that the best thing to focus on is how much demand destruction is underway and how permanent that destruction may be.  That factor will tell us just how long the bear market for energy might last.  In the meantime, investors will have to be resolute in owning energy shares as the long-term outlook remains attractive. 

 

 

Allegheny Energy Transmission Line A Sign of The Future?

 

The West Virginia Public Service Commission (PSC) has just handed down its recommendation that a subsidiary of Allegheny Energy (AEY-NYSE), be allowed to build a 240-mile, 500 kilovolt transmission line that will transverse the state.  The project still needs to be approved by the public service commissions of both Pennsylvania and Virginia.  The transmission line is scheduled to be finished by 2011 and will cost $1.1 -$1.2 billion to construct. 

 

Exhibit 13.  Allegheny Transmission Line Key For East Power

Source: Allegheny Energy

 

While the transmission line has been blessed by the principal state in the project, the environmental opposition to its construction has not ceased.  A number of local environmental groups plan to appeal the ruling, and West Virginia Sierra Club officials have called the plan for this new transmission line nothing more than an oversized extension cord that will devastate the state so that some wealthier areas of the country can have power.  Despite this opposition, the way Allegheny Energy was able to rework the project in order to win the approval of the West Virginia PSC is a sign of the likely outcome in Pennsylvania and Virginia.  Even with the various state approvals, the transmission line will require several years before it will be in service providing electricity to the Washington, D.C. and surrounding areas on the East Coast.

 

Exhibit 14.  Infrastructure Projects Have Lengthy Time Lines

Source: Allegheny Energy

When we consider what it will take to improve the United States’ energy situation, the objections of environmentalists may become a key consideration.  Some of their historic power has been usurped by the enactment of the Energy Act of 2005, however.  That act empowered the U.S. Secretary of Energy to designate national interest electric corridors in those areas that have electric capacity constraints or congestion.  The states where a project will be located will have first crack at the approval process, but there is a provision in the law that allows the Federal Energy Regulatory Commission (FERC) to step in if state law precludes the regulators from considering the interstate benefits of the project and the state takes longer than one year to act after the application has been filed. 

 

FERC has not been granted a blank check in this effort, however.  FERC may act on any proposal to build a new transmission project or expand one if certain conditions are met.  Those conditions include: the transmission line must be used to develop or support interstate commerce; its construction must be consistent with the public interest; it must significantly reduce existing transmission capacity congestion; and the project must maximize the use of existing towers or structures.  There is significant litigation underway challenging the scope of this FERC backup approval authority under the 2005 Act with an appeal with the U.S. 4th Circuit Court of Appeals.  There are 15 states involved in the litigation.

 

The PJM Interconnection organization, responsible for the transmission grid for the 13-state area, warned that without the Allegheny Energy project stability of the grid and the reliability of the flow of electricity cannot reasonably be assured.  This could result in blackouts, voltage disruptions and brownouts.  These conditions could severely impact the economic health of the region.  This outlook had been foreshadowed by the National Transmission Grid Study completed several years ago that estimated the PJM system’s demand would grow by 20% in the coming decade, but the capacity to carry electrons would grow by only 6%.  Without more capacity, the economies of the regions serviced by the PJM system would be at jeopardy.

 

As one would expect in public hearings over the construction of a major power facility, there was substantial local opposition.  After listening to the opposition in open hearings before the West Virginia Public Service Commission, Allegheny Energy agreed to re-route the line in certain areas to appease landowners.  It also agreed to provide free power to those residents whose property was invaded by the line; it promised some rate reductions and additional low-income financial assistance.  In ruling in favor of the revised Allegheny Energy plan, the West Virginia PSC said it believes the line benefits the state by enabling local coal companies to sell additional volumes and that it benefits the region by improving the reliability of electricity supply.

 

The text of the West Virginia PSC’s decision characterized the challenge facing all regulators in ruling on new power infrastructure projects.  “The siting of electric transmission lines is invariably controversial.  Regardless of the route selected, there will be opposition from the affected property owners.”  But the PSC went on to point out that the project “will have substantial and positive economic impacts on West Virginia.”  It would be a welcomed development if opponents of energy infrastructure projects would observe the reality the West Virginia PSC described.  But as we have seen with siting of LNG re-gasification terminals off the East Coast and West Coast of the U.S. and the battle over the approval of the Cape Wind wind-farm project in Nantucket Sound off Cape Cod, the legal battle seems never ending and very provincial in its opposition.  It is time, as mandated by the 2005 Energy Act, that regional benefits and costs be weighed against the parochial interests of the local residents.

 

Just as we are witnessing a tipping point for energy consumption in the United States, maybe the Allegheny Energy ruling is signaling a tipping point for infrastructure investment.  Maybe all those objections: NIMBY (Not In My Back Yard); NIABY (Not In Anyone’s Back Yard); NOTE (Not Over There, Either); NOPE (Not On Planet Earth); and BANANA (Build Absolutely Nothing Anywhere Near Anything) – will become a thing of the past.

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