Musings From the Oil Patch, August 28, 2012

• BSEE Actions On Drilling Catches OFS Industry In Net
• Will They Or Won’t They Extend The Renewable Tax Credit?
• Notes From A Different Part Of The Country
• AWEA CEO Argues Critics Of PTC Missing The Boat
• Are U.S. LNG Exports Now A Go With Exxon Onboard?
• Chevy Volt And Honesty In Advertising In UK
•  

Musings From the Oil Patch
August 28, 2012

Allen Brooks
Managing Director

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

August 15, 2012, may mark a new day for the offshore oilfield service industry as the Bureau of Safety and Environmental Enforcement (BSEE) issued two actions that are reshaping the regulation of oil and gas operations in U.S. waters.  One action was an Interim Policy Statement that expressly announced new policy to hold oilfield service companies jointly and severally liable with the lessee/operator when performing any activity that is subject to regulation.  The second action was issuing the Final Rule for Offshore Drilling Safety, which follows on the Interim Final Rule issued last October and that had been subject to public comment.  The Final Drilling Safety Rule reiterated BSEE’s claim for extending its jurisdiction to oilfield service companies. 

We have been covering the evolution of this regulatory expansionary effort by BSEE and its previous iteration, the Minerals Management Service (MMS).  BSEE is extending federal regulation of offshore operations beyond the contractual relationship between the lessee/operator and the federal government to all the oilfield service companies who work offshore.  You can read our coverage of this issue in our March 27, 2012, and April 10, 2012 issues of the Musings.  In the past, or pre-Macondo era, federal offshore regulation involved the lessee/operator who was responsible for all operations and any resulting problems involving the activities of the oilfield service companies. 

The rationale for this extension of regulation came as a result of the Deepwater Horizon disaster and the resulting Macondo well blowout and oil spill.  One response was the government’s reorganization of the MMS, creating the Bureau of Ocean Energy Management, Regulation and Enforcement (BOEMRE), which was later split into two organizations, one focusing on managing offshore assets and the other on offshore operations and safety.  Michael Bromwich, former Inspector General of the U.S. Department of Justice and a partner in a global law firm, was named to head the new organization.  In a speech at the 2011 Offshore Technology Conference, Secretary Bromwich set out two policies – one for regulation of offshore permitting and the other expanding offshore regulation to oilfield service contractors.  His prepared comments contained the following statement about the second objective: “We have completed our review of the issue and have concluded that in fact we have broad legal authority over all activities relating to offshore leases, whether engaged in by lessees, operators, or contractors. We can exercise such authority as we deem appropriate.”  (Emphasis added)  He cited the fact that all prior regulation that had been limited to lessees/operators was designed to keep a clear line of regulation, but now the agency believed it could also pursue contractors for violations of regulations, too.  The foundation for this regulation expansion was the belief, expressed by Secretary Bromwich at the 2010 fall conference of the National Ocean Industries Association that the long offshore safety record of the oilfield service industry was really due to luck.  Philosophically, regulation becomes the only way to ensure that the industry’s safety record will be maintained rather than just counting on luck.  After the Deepwater Horizon disaster, the service industry required tighter regulation because the country could no longer rely on the industry’s operational luck.

The BSEE Interim Policy Statement claims to be an internal document and lists the standards and procedures the agency will attempt to follow when issuing citations for oilfield service company violations.  The problem is that the standards and procedures are based on discretionary decisions made by the agency’s personnel.  Their decision is supposed to be based on “serious violations of BSEE regulations,” but what does that mean?  To consider a violation, BSEE employees are to consider four factors: the type of the violation; the harm (or threat of harm) resulting from the violation; foreseeability of harm (or threat of harm); and the extent of the contractor’s involvement in the violation(s).  Under each of the four factors are a series of other considerations.  But the key point is that offshore oilfield service companies are now subject to regulation in which they have not had any input into the establishment of the rules the companies must now live with.  By avoiding the usual rule setting process, the service companies have been deprived of the opportunity to state their case about what should be regulated and how the regulations should operate.  Now the companies are subject to ex post facto decisions and actions by government inspectors.  Possibly a more troubling consideration is that the Final Drilling Safety Rule reiterated BSEE’s claim for extending its jurisdiction to the offshore oilfield service companies.  By being included in the final rule, BSEE’s jurisdiction may supersede the Interim Policy Statement and its claim to be only an internal document.

Offshore oilfield service company managements need to understand that they are now regulated in a different way than ever before.  This regulation carries obligations that impact company operations, including securities filings if it is publicly-owned, insurance coverage, regulatory compliance plans, financing covenants and customer contracts.  Welcome to the new world of offshore regulation! 

On December 31, 2012, the Production Tax Credit (PTC) for renewable energy is due to expire unless extended by Congress.  This legislation is showing signs of gaining increased bipartisan political support as both “red” and “blue” state politicians with potentially large wind and solar resources see a positive impact on their local economies from federal financial support of new renewable energy projects.  On the national level President Barack Obama is supporting the extension as it fits with his administration’s push for more green electricity as part of his “all-of-the-above” energy strategy.  The presumptive Republican presidential nominee, Mitt Romney, is opposed to extending the PTC as he believes all renewable energy projects should be forced to stand on their own economics.  After 30-plus years of renewable energy subsidies, most of them still cannot compete against fossil fuels, although their sponsors continue to cite projections of reduced costs that will make them competitive in the future.  This is a variation of the “over the horizon” forecasting technique in which current trends always change to the positive once we get beyond the horizon.

As the battle in Congress over the extension of these green energy subsidies is on hold until after the upcoming election, the philosophical debate about energy tax subsidies remains unresolved.  A new study from the World Watch Institute contends that on a global basis fossil fuel subsidies dwarf those offered to the renewable energy industry.  We have not read the study, but don’t doubt its accuracy on a global basis.  Most of the oil and gas subsidies, however, come from the decisions of foreign governments to provide gasoline, diesel and kerosene for cooking and heating to their citizens at below market prices.  These are conscious social policy decisions.  Attempts in many countries to reduce energy subsidies by raising prices have been met with riots and boycotts making governments reluctant to act.  The World Watch study suggests this year’s global energy subsidies will reach $1 trillion, with at least $650 million represented by consumption subsidies. 

Domestically, some green energy proponents claim that fossil fuels still receive “massive” subsidies at the expense of renewable energy, but the studies prepared over the past few years by the government’s own energy department refute the claims.  The latest study prepared by the Department of Energy’s Energy Information Administration (EIA) in response to a late 2010 request from Congress clearly shows that renewables receive the bulk (77%) of the government’s energy subsidies but only contribute 13% to the nation’s energy supplies.  The inverse relationship exists for fossil fuels, which receive 23% of subsidies for providing 87% of our energy.  Moreover, if we look at what has happened to energy subsidies over the past few years, we see fossil fuel support dropping or only increasing modestly in dollar terms while renewable energy subsidies have soared.

Exhibit 1.  Fossil Fuel And Renewable Subsidies And Power

Source:  EIA; PPHB

In the latest energy subsidy report, the EIA did not calculate the amount provided to each fuel based on a standard measure of energy output.  The omission occurred despite the specific request for that analysis, which was contained in the Congressional request letter sent to the EIA asking for the study.  Those figures had been prepared in an earlier EIA study.  We have provided the charts from that study.

Exhibit 2.  2007 Renewables At Top Of Subsidies List

Source:  EIA

In the electricity market, refined coal, which refers to “clean coal” technology, receives the largest government subsidy per megawatt-hour (MW).  Solar is the next most heavily subsidized energy source with wind close behind.  Conventional fossil fuels such as coal, oil and natural gas receive a fraction of the subsidy awarded to clean energy sources.  At about $24/MW for wind and solar, their subsidy is nearly 100 times that provided to natural gas and petroleum liquids and close to 50 times the amount for conventional coal.  Outside of electricity, green energy subsidies easily dwarf those for coal, natural gas and petroleum liquids.  Ethanol for the transportation market receives the largest subsidy per million British thermal units, a common energy measure. 

Exhibit 3.  Ethanol Big Winner Outside Power

Source:  EIA

The Wall Street Journal wrote an editorial about energy subsidies.  They were the only ones who pointed out that the EIA didn’t calculate the subsidy cost on a common energy unit of measurement as requested by Congress.  So the WSJ used data calculated by the Institute for Energy Research that did convert the 2010 fuel subsidy data into a measurement of dollars per unit of energy.  Their calculation merely demonstrated the same skewed subsidies for renewables versus conventional fossil fuels that were contained in the 2007 study. 

Exhibit 4.  Renewables The Big Subsidy Winner

Source:  The Wall Street Journal

A Congressional Research Service (CRS) study on energy subsidies prepared in 2010 shows that in 2009, renewable fuels provided 10% of the nation’s primary energy supply, yet received 77% of the federal government’s fuel subsidies.

Exhibit 5.  2009 Energy Production By Fuel Type

Source:  EIA

Exhibit 6.  Subsidy Allocation By Fuel Type, 2009

Source:  Congressional Research Service

When we look at all the subsidies and tax credits that the federal government spends money on or loses revenues from, the dramatic shift in balance between fossil fuels and renewables in recent years becomes clear. 

Exhibit 7.  Tax Subsidies For Fossil Fuels/Renewables

Source:  Congressional Research Service

Exhibit 8.  Lost Revenue From Fossil Fuels/Renewables

Source:  Congressional Research Service

Another measure of fuel subsidization is the amount of research and development money the federal government spends on the respective energy types.  As shown in Exhibit 9, the federal government increased its applied R&D spending for energy from $3.01 billion in FY2007 to $4.36 billion in FY2010, a 46% increase.  R&D funding for coal and natural gas and petroleum liquids increased by a total of $108 million over this period while the amount devoted to renewable technologies increased by $692 million, or close to seven times.  If we include the $401 million increased R&D spending for end use, electricity delivery and energy reliability, most of which we believe was devoted to addressing smart grids and how best to integrate intermittent solar and wind energy into the power grid, the increased research money devoted to renewable fuels and their challenges well exceeds the total amount of R&D funding for all fossil fuels.

Exhibit 9.  R&D For Renewables Swamps Others

Source:  EIA

In the battle over extending the PTC for renewables, the wind industry has been the most vocal renewable fuel calling for the extension.  Also, wind has received the most political support from politicians on both sides of the aisle.  Wind is seen as the most competitive renewable energy source and the more popular power supply along with having demonstrated the fastest growth rate in recent years.  Wind is also the source of the largest amount of government funding in the form of loans and loan guarantees.  Exhibit 10 shows the distribution of loans extended to renewable energy suppliers and wind has received 84% of those funds.  Included in the 11% solar wedge in the pie chart is the half a billion dollars loaned to Solyndra, the failed solar panel manufacturer. 

Exhibit 10.  Percentage Section 1603 Grants

Source:  EIA; Treasury Dept.

Wind energy proponents have also been the most vocal about the negative impact on the industry’s growth and employment opportunities due to the pattern of periodic expirations and re-instatements of the PTC. 

Exhibit 11.  Impact of PTC On Wind Installations

Source:  DoE

If one goes to the American Wind Energy Association web site there are numerous news articles highlighting the loss of wind energy related jobs in 2012 due to the PTC’s extension uncertainty.  One of the latest announcements was by Vestas Wind Systems A/S (VWS.CO), the Denmark-based manufacturer of wind turbines.  As the world’s largest manufacturer of wind turbines, the company has been impacted not only by the PTC uncertainty in the United States but the economic turmoil and government energy subsidy reductions across Europe.  Vestas announced it was eliminating another 1,400 jobs on top of the 2,300 layoffs announced in January.  The company says these new layoffs will reduce annual costs by about $125 million on top of the nearly $240 million in savings from the earlier cutback.  The company also reduced its estimate of the number of wind turbines it would deliver this year to 6.3 gigawatts of power from its earlier estimate of 7 gigawatts.  Vestas also said it expects 2013 to be the worst year in many for the company. 

Exhibit 12.  Wind Job Losses To Be Large Without PTC

Source:  American Wind Energy Association

Last year was particularly tough on Vestas’ financial performance, and so far this year’s results have been even worse.  While it would appear from the chart in Exhibit 13 on the next page that the mid-2000s were the worst period for the company, current results are worse.  In 2011, Vestas generated negative earnings before interest and taxes (EBIT) of €38 million ($48 million).  Through the first six months of 2012, the company’s EBIT is a negative €164 million ($205 million), or off the bottom of the chart.  It is this poor financial performance and the slowdown in new orders that is pressuring Vestas’ management to shrink the company.

Exhibit 13.  Vestas Profit Is Falling Sharply Now


Source:  Vestas

Increasingly we are hearing that onshore wind power is now competitive with conventional energy sources in generating electricity.  The problem is that competing fuel sources have gotten cheaper in recent years and are putting pressure on the cost of wind and solar power.  A new report from the Department of Energy, and prepared by the Lawrence Berkeley National Laboratory, shows how wind energy is struggling against low wholesale power prices. 

Exhibit 14.  Wind Power Still Not Competitive

Source:  DoE

The cost of wind power is tied to the economics of building wind farms.  That means the price of wind turbines along with the maintenance and repair costs are important trends to follow and understand.  Notice in Exhibit 15 on the next page that although wind turbine prices are declining, they still remain above where there were in the early 2000s.

Exhibit 15.  2011 Wind Turbine Prices Were Down

Source:  DoE

The decline in wind turbine prices has contributed to a reduction in the cost of new wind power projects.  It is important, however, to look at the historic pattern of wind turbine prices, especially in the context of those claims that wind turbine costs are coming down, which will contribute to wind energy becoming competitive with conventionally-fueled power plants.  Wind turbine prices are down from the 1980s but up from the 2000-2006.

Exhibit 16.  Are Lower Costs Sustainable?

Source:  DoE

A study conducted by the Lawrence Berkeley National Laboratory for the Department of Energy late last year identified seven drivers influencing the price of wind turbines.  Four of those drivers were factors a company could influence and three were factors it had little control over.  The study showed the impact of these factors on wind turbine costs during the rising price period of 2002-2008 and the

falling price period of 2009-2010.  As we look at these factors and current price and economic trends, it seems that many of the negatives of the 2009-2010 years when wind turbines prices were declining are now turning up, which will raise the future cost of wind energy.  The most important factors include materials prices, energy prices, currency movements and labor costs.  The recent financial results of Vestas and other wind turbine manufacturers suggest that profit margins are under severe pressure and that wind farms continue to desire larger turbines.  Warranty provisions may prove a negative as there are more old turbines in the field, which are susceptible to higher maintenance. 

Exhibit 17.  Wind Turbine Cost Trend May Be Rising

Source:  DoE

Claims of lower wind power costs are only true when the analysis ignores the cost of the transmission facilities needed to bring the wind-generated electricity to areas where is will be used plus the cost of providing backup electricity generating facilities for when the wind doesn’t blow.  Furthermore, never is it acknowledged that the useful life of wind turbines is a fraction of the life of a fossil fuel powered plant.  Therefore, when life-cycle economics of wind farms are compared against the costs of new gas-fired, or possibly coal-fired, power plants, the fact that wind turbines will need to be replaced at least once and maybe twice during the time span is ignored and significantly distorts the results. 

If wind power is competitive with conventionally fueled power plants, one has to ask why utilities must be forced to purchase wind energy at a premium to the cost of power from conventional power plants, and furthermore wind energy purchase agreements contain a mandated annual price inflation factor.  These contracts are unique compared to those signed with fossil fuel suppliers.  Wind energy, under these contracts, will never be cheaper than its first day generating power.  Therefore, consumers never benefit from the supposed cost reductions for wind energy that are projected.  Today, many utilities are actually reducing electricity rates due to the dramatic decline in the price of natural gas.  The price of electricity generated from renewables never seems to decline, yet it remains among the most heavily subsidized power source in the country.

In answer to our question, we suspect the PTC will be extended because politicians see it as a job creator, even though it ultimately costs people more (customers of higher priced electricity).

Two weeks ago today, we set out on our second trip this summer to our seasonal home in Rhode Island.  This time we decided to take a few extra days to do some sightseeing, which meant we were going to take an alternative route from our usual one.  We decided to visit the Bourbon Trail southwest of Lexington, Kentucky.  Besides seeing a different countryside, we also experienced some interesting events and were exposed to some different attitudes. 

The most direct route from Houston to Lexington is up Interstate 59, which is also marked with signs telling us this is to become Interstate 69, the mega road project from the Mexican border in South Texas through the heartland of the U.S. and eventually to the Canadian border.  The new I-69 was the vision of the NAFTA (North American Free Trade Act) legislation that opened the borders of Canada, Mexico and the United States to free trade.  Building this superhighway from Mexico to Canada is designed to facilitate that free trade, especially for our southern and northern neighbors.

As you drive along the future I-69 through East Texas and into Arkansas, you have the definite impression that this superhighway isn’t going to be built anytime soon, and when they start the construction (assuming they ever do) you want to stay as far away as possible.  We are talking about the prospect of rebuilding two- and four-lane blacktop roads into superhighways that can handle the flow of heavy trucks.  We are also talking about a highway that will have to skirt some of the towns that I-59 now goes through because there isn’t sufficient room to expand or upgrade those stretches of road.  We anticipate that the future highway will not have stop lights as it does now.  This is going to be a massive project, one that will rival the various re-buildings of the Katy Freeway over the past 30 years and the continual rebuilding of the Gulf Freeway.  It will make the construction of the Sam Houston and Hardy Toll Roads look like children’s play yard activities. 

We experienced a large number of highway rebuilding projects on our trip.  These projects forced us to drive miles on single-lane roads we shared with traffic heading in the opposite direction, because the road sections were being totally rebuilt along with various bridges the road crossed.  It didn’t matter what state we were in: Texas, Arkansas, Tennessee, Kentucky, West Virginia, Pennsylvania or New York, the roads were torn up.  Only in Connecticut was the highway construction done adjacent to the existing roadway so there is no detour.  With all the construction and asphalt and concrete, you would think the economy should be doing better than the latest statistics suggest.  Our reading on truck traffic was distorted by the road construction and our lack of knowledge of what to expect.  Our sense was that truck traffic wasn’t particularly heavy.

Our sightseeing involved visiting three of the six whiskey distilleries that make up the Bourbon Trail in Kentucky.  One distillery is located in Bardstown with two more relatively close by.  We drove by the Heaven Hill distillery as we entered Bardstown, which is the largest independent family-owned distillery in the country.  We didn’t visit Jim Beam in nearby Clermont, but did make it out into the Kentucky farm country to Loretto where Maker’s Mark is distilled and bottled.  That’s the bourbon known for its hand-dipped red wax sealed bottle.  We even did our own dipping.  We also stopped at Four Roses distillery in Lawrenceburg, where in 1910 the owners, enthralled by the Spanish Mission-style architecture of California, built their distillery in that style.  It is in the National Register of Historic Places.  We also stopped at Wild Turkey in the same town, a booming distillery with lots of expansion work underway.  All of the distilleries seemed to be expanding.  We aren’t sure whether it was successful marketing creating new demand or whether the health of the economy is making more citizens imbibe. 

Exhibit 18.  An Interesting Slice Of Americana

Source:  bourbonbuzz.com

One night we ate dinner at the Old Talbott Tavern in Bardstown.  The original part of the building was constructed in 1779 and over subsequent years it expanded and the courtyard was enclosed.  In 1799, the Talbott family purchased the building and turned it into a tavern with accommodations.  For over 210 years, the Talbott Tavern continues serving food and drink along with offering five B&B rooms.  According to the history of the tavern, Bardstown was the second oldest town in Kentucky and was the jumping off point for many famous people journeying west of the Appalachians.  Figures such as Lewis and Clark, Benjamin Harrison, the 23rd president, and even Jessie James passed through the town and the tavern.  In 1808, Bardstown was designated as the seat of the Catholic diocese designed to serve the area between the Appalachians and the Mississippi River, now served by 44 dioceses and 10 states.  We also learned Bardstown was cited as one of the 100 Best Small Towns in America, 50 Best Small Towns in the South and 1,000 Places To See Before You Die.  We now have only 999 more to visit.

As we went out into the countryside to visit the distilleries, we had a GPS system that wanted to take us on some truly off-the-beaten-path routes.  We saw lots of farm land and crops.  We are not an agricultural expert but we saw some corn fields that looked totally brown from the drought, but others that looked healthy.  The tobacco crops looked in great shape.  Supposedly there was wheat grown in the Bardstown area, but either we didn’t see it or we didn’t recognize it. 

Courtesy of our GPS we went by the Adolph Rupp Arena, home of the Kentucky Wildcats basketball team, in downtown Lexington, along with the campus of the University of Kentucky.  Our only food and lodging challenge on the entire trip was when we started looking for a room in Memphis, Tennessee.  On our second call we found out that we were trying to visit the city during Elvis Presley week commemorating his death.  We had to stay further west than we wanted that evening.  In the morning we stopped at the Tennessee welcome center in Memphis, which happens to be in town, just off the interstate.  There was a large statue of Elvis playing his guitar.  We found out from the attendant when we asked for literature about the Whiskey Trail that the center doesn’t get any of those brochures because that trail was too far away.  We also found out that if you enter the state at another location, you may not find brochures about Elvis and what to do in Memphis.  We are not sure whether the state is cutting back on its publications or merely perfecting targeted marketing.  Our GPS also decided to give us a guided tour of downtown Memphis, rather than getting back on the interstate. 

Our Cracker Barrel stop for Thursday night dinner, even at 7:30 pm, didn’t disappoint as they still had the turkey dinner special, although they were out of sweet potato casserole.  None of our food stops were crowded and other than Memphis we had no problem finding hotel rooms.  Part of the explanation may be that in many of the southern states the children were back in school so summer is over.  We even confronted school buses along the back roads of Kentucky. 

One thing we didn’t count on was being hit by a deer in Kentucky.  For most people the experience is the opposite.  In our case, a young doe darted across the divided highway, avoided a car and despite my attempt to swerve, ran into the side of our car.  The deer was stunned as it hit the ground, but by the time we stopped, it struggled to its feet and ran off into the woods.  We only had a small dent by our rear wheel and a lot of saliva along the rear door.  The next day we encountered an otter crossing the road, but he had more sense than the deer and stopped half way across and waited for us to pass. 

It was evident from the many signs we saw in Tennessee, Kentucky and West Virginia that partisan positions have been staked out for the upcoming election.  The most notable sign was the billboard along I-64 in Charleston, West Virginia proclaiming a “no job zone” and attacking President Barack Obama for his Environmental Protection Agency’s (EPA) stance on coal.  The red billboard is sponsored by the Federation for American Coal, Energy, and Security (FACES of Coal), which has the backing of the coal unions. 

Exhibit 19.  No Love For Obama In West Virginia

Source:  blog.wvpolicy.org

There were plenty of other anti-Obama signs and an occasional pro-Obama sign.  We recently read an article about the No Job Zone billboard and the fact that the United Mine Workers of America (UMWA) had decided to sit out this election and not endorse either presidential candidate.  In 2008, the UMWA was an early and rabid backer of Mr. Obama.  This spring, UMWA President Cecil Roberts stated on a radio show, “The Navy SEALs shot Osama bin Laden in Pakistan and Lisa Jackson [head of the EPA] shot us in Washington.”  An official from the union said it hadn’t completed its political endorsement decision process, which would be done by September.  But in 2008, they gave their endorsement in May.  Maybe we are on the cusp of an announcement from the EPA that it needs to take another look at some of its coal regulations.  Of course that will only last until after the election.

In all our travels so far this year, we remain puzzled by what we see and encounter and how reflective it is of the spotty economic statistics released weekly and monthly by the federal government.  We have a hard time squaring our impressions of the health of the economy with a soaring stock market.  We sure hope the stock market is telling us that things are going to get better. 

Last Wednesday, Denise Bode, the CEO of the American Wind Energy Association, wrote a blog for the Huff Post Green Internet Newspaper dealing with the wrangling surrounding the extension of the production tax credit (PTC), which has gained bipartisan political support in recent weeks.  Ms. Bode’s blog was aimed at the critics of the PTC extension, most particularly The Wall Street Journal that authored a highly critical editorial about tax subsidies for renewables, including wind, being too expensive for the country.  In the blog Ms. Bode wanted to show what these critics were missing, but some of the support she relied on and her rationale was questionable in our view.

Ms. Bode wrote, “Traditional energy sources have had a huge head start in government support. A recent study from the Congressional Research Service (CRS) points out that traditional energy sources enjoy an enormous advantage with regard to tax relief and other incentives: ‘For more than half a century, federal energy tax policy focused almost exclusively on increasing domestic oil and gas reserves and production … These provisions remain in the tax code in limited form today.’"  The problem with this paragraph is that the CRS study was done two years ago and the quote she uses comes from the section of the report dealing with oil and gas tax policy from 1916-1970.  Since then the taxation of oil and gas has changed dramatically, thereby reducing the amount of tax subsidies they receive.  Those subsidies primarily relate to deducting intangible drilling costs (IDC), which are the expenses for drilling a well that leave no facility behind, and the excess of the percentage over cost depletion deduction. 

What the CRS study said about the workings of the IDC is important, but was ignored by Ms. Bode and most other critics of the oil and gas subsidies.  The report pointed out that “The tax expenditure estimate for the expensing of the IDCs provision can be negative – indicating an increase in federal revenues rather than a loss – since the provision represents a tax deferral, essentially an interest free loan from the government.  Government revenue losses from the expensing of IDCs are incurred when an investment is made, as the costs are expensed in the first year.  Over the next four years, however, there is an offsetting gain for the government, as no further deductions on investments can be made.  When investments are growing, the additional amount deducted via expensing exceeds the offsetting gains from reduced cost depletions, and the government faces revenue losses.  Investments in oil and gas fell off following the collapse of oil prices in 1986.  In 1988 and 1989, the tax expenditure estimates for expensing of IDCs provision were negative, indicated an increase in federal revenues.  Throughout the 1990s and into the 2000s, the estimated revenue losses associated with this provision remained relatively small.”  The point is that the IDC is really a tax shifting mechanism rather than an outright subsidy.  It appears to be a subsidy when the oil industry is expanding activity, but the government benefits when the industry slows down.

One of Ms. Bode’s big issues is drawn from the conclusions of a report prepared by DBL Investors entitled, What Would Jefferson Do? The Historical Role of Federal Subsidies in Shaping America’s Energy Future.  The report analyzed the amount of government subsidies for each energy fuel during the first 15 years of its assistance and compared that to an inflation-adjusted federal government budget starting in 1916.  The conclusion of the report was that oil and gas subsidies relative to government spending were much greater than for renewable fuels during their respective time periods.  The study ended in 2009 and as a result, it missed the explosion in tax subsidies for renewables.  By including just the 2010 renewable subsidy expenditures, the results would have been quite different. 

Exhibit 20.  Renewables Have Been Poor Sister

Source:  DBL Investors

The authors of the study produced the chart in Exhibit 20 showing the annual average energy subsidy for each fuel type over the past 90 years.  Renewables, which, according to the authors, only began to benefit from subsidies after 1992, averaged $370 million per year.  Over the 15 year period 1994-2009, that means renewables received a total of $5.55 billion in subsidies.  In 2010, renewables – comprising wind, solar and hydropower – received subsidies of $6.34 billion alone according to a study from the Congressional Research Service and the Energy Information Administration.  The subsidies for renewables in that one year exceeded the subsidies received over the entire prior 15 year period.  And the pace of wind and solar subsidies has continued at that rate in 2011 and 2012.  When we examine the modern history of fuel subsidies, it becomes quite clear how the pendulum has swung in favor of renewables and against fossil fuels.

Exhibit 21.  Tax Subsidy Trend For Energy/Renewables

Source:  CRS

Our final problem with Ms. Bode’s analysis is her characterization of the PTC.  According to her, “Wind energy’s incentive is tax relief. Wind’s incentive is in the form of a federal tax credit. To call tax relief a subsidy is to assume that all money belongs to the government. Rather, a tax credit simply leaves more money in private hands.”  Hmm, both the CRS and the DBL Investor reports Ms. Bode relies on in her analysis call all energy tax credits subsidies.  In the case of the PTC, a wind farm developer can take his credit to the government and receive a cash payment based on the discounted present value of the 2.2-cent per kilowatt-hour credit for the estimated production over the first ten years of the project’s life.  Not only does the developer receive his funds before he ever pays a penny of taxes, he receives it before he generates the power for which the credit is paid.  In addition, there is no guarantee that the wind farm will ever generate the amount of power for which the credit is paid.  So is that a subsidy or tax relief?  If you haven’t ever paid taxes, we don’t know how you can call the government’s help tax relief except maybe in the world of Alice, the Mad Hatter and the Queen of Hearts. 

A significant policy debate is underway about whether the United States should allow domestic natural gas production to be exported.  This debate originated after the highly successful marriage of horizontal drilling and hydraulic fracturing turned America from a gas-short country into a gas- surplus one.  The result of the marriage of these oilfield technologies has been significant growth in natural gas production that has depressed gas prices.  The natural gas industry has been aggressively seeking market opportunities to use this abundant resource in hopes that the incremental demand will boost gas prices higher and provide better returns and cash flows for gas producers that would induce them to continue their successful drilling and gas well completion undertakings. 

A factor impacting the debate over the nation’s gas supply is whether the oversupply condition is temporary, or if the country has entered an extended period to be marked by abundant gas supplies and lower than anticipated prices, is the life of gas reserves.  There is a belief that the technology to tap our gas shale and liquids-rich wet gas plays has unlocked significant resources that will supply the country for upwards of 100 years at current consumption rates.  This is the optimistic scenario from which most energy policy is emanating.  An alternative view based on geological considerations suggests that the gas shale resource volumes that can be extracted at reasonable cost is considerably less than the optimists believe and, as a result, means America needs to be very careful about which new gas consumption markets it promotes.  That also means we need to be conservative about exporting domestic gas as liquefied natural gas (LNG).

While this debate about the future direction of our natural gas industry has been underway for the past several years, politicians have begun to weigh in with proposals to restrict the exporting of U.S. shale gas resources.  Their objective is to keep the domestic gas mark in a temporarily oversupplied state that will depress gas prices and reward American manufacturing and chemical companies with lower raw material costs, helping their businesses expand and the companies to hire additional workers.  The politicians are touting that low gas prices are making America’s manufacturing sector more competitive globally.  They see the manufacturing sector improvement continuing to boost the pace of the U.S. economic recovery. 

Exhibit 22.  Future LNG Export Terminal?

Source:  Golden Pass

The current gas oversupply situation has upended the long-term thinking about energy policy that was based on a continuing decline in gas supply that would necessitate America importing an increasing amount of its supply to meet demand.  From a country focused on building more LNG importing terminals, we have now shifted to figuring out how to build gas exporting facilities and how many to build.  Last week, Exxon Mobil Corp. (XOM-NYSE) weighed in with a proposal to construct gas export facilities at its huge LNG importing terminal located at Sabine Pass, Texas.  The terminal, Golden Pass, is a joint venture between ExxonMobil and the Emirate of Qatar in the Middle East.  ExxonMobil has been a partner with Qatar Gas in the development of the emirate’s North Field gas resources.  The joint venture constructed Golden Pass to handle up to two billion cubic feet per day of gas imports.  As part of the LNG receiving infrastructure at Golden Pass, the partnership constructed 69 miles of pipeline from the terminal to major interstate natural gas pipelines further onshore in order to move the gas to market.  The partnership also built 14 dedicated LNG tankers to transport the LNG from Qatar to Texas.  Initially, as the domestic gas oversupply condition emerged, Golden Pass asked permission from the federal government to be able to re-export LNG that had been brought to the terminal and stored there.  Now the partners are asking for permission to construct liquefaction facilities in order to export domestic gas. 

Two considerations emerge from this move.  First, ExxonMobil is wading in on the significance of the gas shale revolution and its impact on the long-term supply of U.S. natural gas.  The timeline for the shipping of domestic LNG from Golden Pass is likely upwards of five years from now, or 2017-2018.  The cost, as we have seen with a competing Louisiana terminal upgrade, will be in the billions of dollars.  So this move is a significant strategic move by ExxonMobil.  It follows on the purchase in 2009 by ExxonMobil of XTO, a leading U.S. natural gas producer.  At the time, ExxonMobil Chairman and CEO Rex Tillerson said he was willing to pay a substantial premium for XTO in order to gain their technical expertise in drilling gas shale wells that his company was lacking.  Recently, Mr. Tillerson acknowledged that at the currently depressed natural gas prices everyone in the gas producing business was losing their shirt.  Finding a solution to the gas oversupply situation without stopping drilling requires that ExxonMobil find new markets for its gas output.  The second point about this move is what it says about Qatar’s long-term LNG strategy.  The emirate has to be looking at the competitive price advantage U.S. LNG would have in the huge European and Asian LNG consuming regions, the focus of Qatar’s LNG marketing strategy.  By having access to cheaper LNG in its portfolio, Qatar can help balance its LNG supplies and possibly mitigate some of the price erosion that U.S. LNG exports will have on Qatar’s customers.  This move by ExxonMobil and Qatar merits paying close attention to for understanding its full impact on the global natural gas industry.

General Motors (GM-NYSE) is working hard to brand its Chevy Volt extended range electric vehicle (EV) as the ultimate green machine.  Their efforts are struggling as exemplified by the company’s recent experience in the United Kingdom due to concerns about the truth in its advertising.  GM introduced an ad in the UK for its Ampera model of the Volt, which is sold by the company’s Vauxhall subsidiary.  The ad clams the Ampera has a 360-mile range, but the ad’s content was dismissed as misleading by the UK Advertising Standards Authority (ASA), the equivalent of the U.S.’s Federal Communications Commission.  As a result, the ad has been banned in the UK.

The television ad was created by GM’s agency, McCann Erickson, and came with the usual but hard-to-read disclaimer stating: “Comparison based on electric vehicles and extended range electric vehicles driven electrically at all times, even when an additional power source is generating electricity.”  The ASA views advertisements through the eyes of an ad’s target audience, the average auto buyer.  From that perspective, the ASA was quoted as saying, "We considered that throughout the ad the emphasis was on the fact that the car was being driven electrically, and that most viewers would not understand that the car was in some circumstances being powered by electricity generated with a petrol [gasoline] engine. The ad promoted an innovative product which many viewers would not immediately understand and we therefore considered that it would need to explicitly state that the car had a petrol [gasoline] engine.”  They went on to say, "Because it did not clearly explain how the vehicle worked in extended-range mode, we concluded that the ad was misleading." 

This rejection of GM’s ad is making its way around the auto industry web sites and blogs.  While there is some discussion among readers about the veracity of this ad compared to earlier ads for Toyota’s (TM-NYSE) Prius and the mileage claims of many high miles-per-gallon vehicles, the thrust of the focus of reader comments was on other misleading ads that have been produced by GM.  The two ads most readers mentioned were those where former GM Chairman and CEO Ed Whitacre declared that the company had repaid its government bailout “loan, in full, with interest, years ahead of schedule” and the Bloomberg interview with Tony Posawatz, the line director of the Volt, in which he claimed the Volt’s cost of ownership matches the average car when the $7,500 federal tax credit and fuel savings are factored in. 

The ad with Mr. Whitacre brought intense scrutiny including from the Detroit News that said the ad “glosses over the reality” and from the Competitive Enterprise Institute (CEI) that filed a deceptive advertising complaint with the Federal Trade Commission.  The CEI also filed a Freedom of Information request with the Treasury Department that took a year, and not the required 20 days, to fulfill, and showed that the company had not repaid all its government loans.  Likewise, Mr. Posawatz’s comments clashed with GM’s advertising claims.  Is GM pushing the edge of the envelope in its ads or just engaging in sound marketing practices?  Either way, the auto companies and the consuming public are wrestling with issues of range anxiety and lack of battery charging infrastructure for EVs, something that continues to hold back broad-based acceptance of EVs. 

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Parks Paton Hoepfl & Brown is an independent investment banking firm providing financial advisory services, including merger and acquisition and capital raising assistance, exclusively to clients in the energy service industry.