Musings from the Oil Patch – September 27, 2011

• Marcellus Shale Resources: “Just one more thing…”
• Is Capital Discipline Re-emerging In The Natural Gas Market?
• Who To Believe About Global Warming – Gore Or Polls?
• Rhode Island Wind May Be Establishing A New Record
• Cold Regions Could Suffer Environmentally From Bulb Ban
• The Farce Of Green Jobs Depends On How You Define Them
• Driving Down And Now Cars Being Sold To Raise Money
• Wind Energy – Just Make Sure No One Can See It

Musings From the Oil Patch
September 27, 2011

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

Peter Falk, the actor who created the television character Police Lieutenant Columbo, employed many disarming tricks to keep his co-actors off-stride.  Their surprise to his actions helped make them more irritated in their responses to Columbo’s questions.  His most famous trick was the “false exit” when he would turn and say, “Just one more thing…”  The TV mystery ‘who-done-it’ was actually a ‘how-did-he-catch-them’ since the show began by showing the murder and the perpetrator so that was no longer the mystery, only how he will get caught.  Maybe solving the Marcellus Shale missing resources is similar to a Columbo show.  That shale has an estimated 410 trillion cubic feet (Tcf) of possible reserves according to the Energy Information Administration (EIA).  So was the recent Marcellus Shale assessment by the U.S. Geological Survey (USGS) of only 84 Tcf of undiscovered potentially technically recoverable resources merely a Columbo distraction? 

The European Energy Review reported on the discrepancy between the two U.S. government agencies and the ensuing debate about the significance.  In its article, it “quoted J. David Hughes, a geoscientist connected with the Post Carbon Institute, who noted that ‘the new estimates represent a considerable downgrade from the widely used study by Engelder (2009) of Penn State which estimated 489 Tcf of technically recoverable P50 gas from the Marcellus and the estimate of 410 Tcf published by the EIA in July, 2011, based on work done by its consultant INTEK.  The new USGS resource estimates for the Marcellus are likely to be much more rigorous than the Engelder and EIA estimates.  It should also be noted that the USGS estimates include gas underlying areas which are off limits for drilling but, as they are “undiscovered” resource estimates, they do not include the actual booked reserves of companies for SEC filings (which are very small by comparison).’” 

This statement appeared to capture the nature of the resource estimate debate, and the possible impact – a huge discounting of the potential for America’s largest shale deposit. 

Exhibit 1.  Marcellus Shale Deposit Is Large

Source:  USGS

The Marcellus Shale Coalition issued a release calling on the writers of articles emphasizing the nearly 80% smaller Marcellus resource estimate were wrong because the two estimates were like comparing apples and oranges.  In response to an email from a reader, the Review dug deeper into the estimates and talked to both the EIA and the USGS.  In a Columbo-like false exit, they wrote “A spokeswoman of USGS told us: ‘The USGS assessment is only of the undiscovered resources (not reserves) of the Marcellus Shale.  Because they are "undiscovered," they are resources in those areas yet to be found (or drilled), thus outside of currently producing areas.  Resources and reserves in currently producing areas are discovered or known, and we do not assess those.’”  This would suggest that the USGS undiscovered resource estimate should be added to the EIA’s estimated resources bringing the total for the deposit closer to 500 Tcf. 

Before we know whether Lt. Columbo has caught his man, we need to know whether the EIA advisors, who prepared the 410 Tcf assessment, based their estimate on the entire areal extent of the basin or only those areas being drilled.  In that regard, the EIA’s advisor’s assessment was based on data known as of January 1, 2009.  According to the USGS assessment release, “The USGS worked with the Pennsylvania Geological Survey, the West Virginia Geological and Economic Survey, the Ohio Geological Survey, and representatives from the oil and gas industry and academia to develop an improved geologic understanding of the Marcellus Shale.”  An interesting question is whether the USGS and its helpers sat down and drew maps of the Marcellus Shale and redlined those areas where wells have been and are being drilled and production is underway, putting them outside of the USGS’s recent resource assessment.  If so, then we should have been told. 

As Peter Falk’s Columbo character would have said: Just one more thing…if “the USGS is the only provider of publicly available estimates of undiscovered technically recoverable oil and gas resources of onshore lands and offshore state waters” as its press release states, why didn’t the EIA ask the USGS to provide the national shale resource assessment rather than a consulting firm?  Were they afraid of the answer they would have gotten?

The European financial turmoil is roiling global debt, equity and currency markets.  These markets in turn are impacting commodity markets and creating significant near-term volatility.  There doesn’t appear to be much direction evident in commodity markets other than their reaction to global events.  Weekly changes in crude oil inventories and natural gas injection volumes keep prices bouncing around.  West Texas Intermediate crude oil seems to be bouncing between $80 and $90 per barrel, although a leading oil trader says the price action has established a pattern of lower highs and lower lows leading him to sell crude oil futures every time they rise and buy them when they fall until that trade doesn’t work. 

The picture for natural gas prices appears less clear.  A larger than expected injection of natural gas into storage was reported the week before last while a smaller than anticipated injection last week has kept prices unsettled.  Natural gas in storage remains below year-ago levels and about in the middle of the five-year range.  The weekly volatility reflects changes in weather and perceptions of industrial demand trends.  Increased concerns about future economic growth, as highlighted by the International Monetary Fund’s reduced forecasts for U.S. and global economic growth in 2011 and 2012.  These reduced economic growth estimates suggest the key to any recovery in natural gas prices in the near term will depend on falling supply growth rather than a demand increase.

Exhibit 2.  Gas Storage Within Historical Range

Source:  EIA

We are approaching the end of the third quarter when E&P company managements will report their operational and financial results to the outside world and the start of the budgeting season when companies set their spending plans and operational expectations for 2012.  Wall Street has begun to try to get a fix on the view of management toward the key issues that will drive capital spending next year.  These issues relate to the outlook for commodity prices and production growth, and importantly their operating costs and capital spending requirements.  As managements sort through these issues, some may be questioning their ability to continue playing the game as they have for the past few years. 

If you remember, U.S. E&P companies have been obsessed with capturing as much land as possible in the gas shale plays.  With this land grab came drilling and production obligations that are driving capital spending.  For many companies, the ability to finance this game in the face of weak gas prices and rising drilling and completion costs outran cash flow generation forcing them to hedge future gas production, enter joint ventures and tap capital markets.  Hedging often forced companies to be aggressive whenever futures prices rose.  According to traders we have talked with, this phenomenon continues.  The greater challenge comes from companies’ ability to find new joint venture partners and tap capital markets.  Until this summer it appeared investors had an insatiable appetite to fund companies involved in shale plays.  The love affair may be changing, and with it may come pressure to cut spending.

Encana Energy (ECA-NYSE), a Canadian-based E&P company, has indicated it plans to cut back its spending directed toward dry natural gas development and that it will sell assets such as its production and acreage in the Barnett Shale in order to fund its future spending needs.  With the prospect of lower crude oil prices, and in turn natural gas liquids prices, even those E&P companies that pivoted toward liquids-rich shale plays and away from dry gas plays as gas prices remained weak are facing a possible squeeze on their cash flows.  Rising drilling and completion costs are further straining budget projections.  If a management has been properly focusing its drilling efforts for the past few years on the sweet spots in its shale acreage, the risk of losing acreage because of failure to drill leases shouldn’t carry as much of a penalty now as it might have in the past.

A report from broker Bernstein Research focused on the costs, capital spending and financing condition for a large group of E&P companies.  We have borrowed several of their charts, not as a comment on individual companies but rather to point out the challenges this industry faces and their possible implications.  Costs for E&P companies are starting to rise, which signals a profit margin squeeze.  While some managers might say that their DD&A expense is less meaningful because it is not a cash expense, we believe that if one only focuses on the production cost segment of this chart he will see a relatively steady upward trend commencing in 1Q2009.  The climb in this cost component in the past three quarters has been at a much sharper rate, which is a concern.

Exhibit 3.  Production Costs Are On The Rise

Source:  Bernstein Research

There is a difference in the cash costs of large versus small E&P companies, not a surprising trend, but the important thing to observe is the increase in the trend over the past few quarters for both groups.  Larger E&P companies are better positioned to push back on the oilfield service industry’s price increases, and we fully expect that to occur.

Exhibit 4.  All E&Ps Are Facing Higher Costs

Source:  Bernstein Research

With rising operating costs E&Ps are faced with having to cut back their spending somewhere unless they believe they can fund higher spending through tapping capital markets or finding new partners.  Based on the data Bernstein analyzed, the large E&Ps have done a better job of controlling their capital spending versus their operating cash flows.  Smaller companies have been less disciplined, but that probably reflects optimistic managements grasping for the brass ring of rapid asset and production growth.  In certain environments, a strategy of relying on Wall Street to fund spending, while risky, may prove to be the ticket to building a small company into a large one.  On the other hand, a risky expansion strategy can lead to a corporate disaster.  We believe that if capital discipline isn’t returned to this industry, there will be disasters, the important question is how many?

Exhibit 5.  Large E&Ps Managing Capex Better

Source:  Bernstein Research

When Bernstein did its analysis of second quarter 2011 company capital spending versus cash flow, it found only 10 of 43 companies or 23%, had adhered to conservative principles.  Last spring those companies might have been faulted by Wall Street for being too risk-adverse, but given the current economic and financial environment they are probably being touted as heroes.  If financial conditions deteriorate further, they may be singled out as survivors.

Exhibit 6.  Small Segment Of Industry Conservative

Source:  Bernstein Research

While it is not evident yet that Wall Street is abandoning the E&P industry, as demonstrated by the annualized pace of capital-raising activity this year, the prospect of stagnant gas prices and squeezed profit margins is not conducive for an industry to be welcomed with open arms by investors.  Companies that have demonstrated capital discipline are financially strong with less need to tap Wall Street and are positioned to capitalize on any turmoil in the E&P industry. 

Exhibit 7.  Capital Still Flowing Into Shale E&Ps

Source:  Bernstein Research

A recent presentation by the director of research of BENTEK Energy predicted that with a normal winter, his firm expects we will end this winter with a continued imbalance in natural gas supply and demand of 0.7 billion cubic feet per day (Bcf/d).  Since it expects close to the same volume of gas to be in storage as last winter, BENTEK believes current futures prices for the first months of the upcoming winter season are lower than what will be generated in the spot market by supply and demand trends, but they also believe that futures prices are too high for the ending winter months.  The volume of gas shale production growth continues to confound market analysts seeking a stop to production growth. 

An interesting point about the future gas market came in response to a question during the BENTEK presentation about the impact of hurricanes on Gulf of Mexico production and the growing importance of gas shales on supply.  BENTEK has concluded that the impact of the 2005 hurricanes (Katrina and Rita) pushed Henry Hub natural gas prices up by $4-$6 per thousand cubic feet (Mcf) to $13.  Today, BENTEK estimates a similar hurricane event would only move gas prices up by $1-$1.50/Mcf.  This dramatic difference is due to the fact that since 2005 Gulf of Mexico production has fallen by 42% while onshore production has climbed by 38%.  This development may signal that in the future, while Gulf of Mexico hurricanes will continue to be news and human safety events, they will have less of an impact on commodity prices.  This is another unintended benefit from the gas shale revolution.

Exhibit 8.  Land Gas Production Continues Growing

Source:  EIA, PPHB

Exhibit 9.  GoM Production Continues Falling

Source:  EIA, PPHB

While investors are awaiting E&P company executive pronouncements about flattening or reductions in 2012 capital spending, analysts are focused on trends in the drilling business as an indicator of when production growth may slow and even begin falling. 

The U.S. drilling rig count was in a steady uptrend from the early 2000s until the start of the financial crisis and resulting recession.  Crude oil prices bottomed in early 2009 and began recovering.  The pace of recovery was sharply faster than the pre-crisis rig count growth rate.  That growth seemed to slow at the end of 2009, and even flattened in the last half of 2010, but then accelerated in 2011.  That acceleration was largely driven by the shift to crude oil and liquids-rich shale plays as crude oil prices soared in response to the civil unrest in the Middle East and North Africa. 

The shift between drilling for natural gas and crude oil is best shown by the chart below.  It shows how non-Gulf of Mexico gas-oriented drilling actually declined in late 2010 and early 2011.  The shift hasn’t helped the gas supply picture because there are significant volumes of associated gas produced in liquids-rich plays and even with crude oil wells. 

Exhibit 10.  Rig Count Show Rapid Recovery

Source:  Baker Hughes, PPHB

In our attempts to forecast how natural gas supply might grow, we have used the mix in the rig count (gas- and oil-oriented) to apply to the count of rigs drilling horizontal, directional and vertical wells.  Presumably rigs targeting natural gas should be more productive than those targeting liquids-rich plays.  The chart in Exhibit 12 shows non-Gulf of Mexico rigs drilling for natural gas by category of rig type.  What the chart shows is that since the end of 2004 there has been a steady narrowing of the count of non-vertical gas rigs and horizontal gas rigs.  In and of itself, this is not a revolutionary point, but it can help explain gas production trend changes based on shifts in drilling rigs.

Exhibit 11.  Oil Drilling Surpasses Gas Drilling

Source:  Baker Hughes, PPHB

If we look at what has happened to these two rig counts under this methodology since the beginning of 2011 we find an interesting pattern.  Until recently, the peak in both rig counts was in late February.  Since then, the two counts declined until mid August for horizontal rigs and the week before last for non-vertical rigs.  For the last five weeks (through 9/16/11) horizontal gas-oriented rigs were at

Exhibit 12.  Horizontal Rigs Gaining Market Share

Source:  Baker Hughes, PPHB

or above their February peak, despite the shift toward more liquids plays.  Only in the very last week did the number of rigs drilling non-vertical gas wells go above their late February peak.  Given this rig count performance, one would conclude that gas production will continue to grow.  It is possible that the production growth rate may slow as older shale well productivity falls, but that is not assured.  Also, gas supply will be impacted by the completion of previously drilled-but-uncompleted wells, which appears to be happening as the service industry adds hydraulic fracturing horsepower to their fleets.  We also hear that the number of fracture stages in newly drilled wells is not increasing, or at least at their historical pace. 

Exhibit 13.  Horizontal Gas Rigs On The Rise

Source:  Baker Hughes, PPHB

This fall may be a tougher time for the energy business than anyone anticipated merely 30-60 days ago.  The economic growth outlook remains cloudy.  The unity of the European Economic Community and the solvency of certain members remain unclear.  The political struggle in the U.S. will be ramping up creating greater uncertainty about future economic and tax policies.  Unsettled capital markets will increasingly become risk adverse and thus less willing to provide funds to companies with less than rock-solid outlooks.  Producers of commodities will fall into the risky category, although commodities themselves may retain some of their safe-haven qualities, albeit at lower prices.  That safety support should hold oil and gas prices sufficiently high that instead of a 2008-2009 energy market, it may look more like the May–September 2002 period when the rig count was essentially unchanged but the Philadelphia Oil Service Stock Index (OSX) fell by about 35%.  Living through that period was trying, but that environment offered many attractively-priced energy stocks, assuming one had a long-term horizon. 

On September 14th and 15th, former Vice-President Al Gore and his Climate Reality Project conducted a global live-streaming show hammering on climate deniers and the Armageddon facing the planet from rising temperatures.  The show, 24 Hours of Reality, featured presentations in 13 languages and from 13 different time zones and concluded with Mr. Gore’s hour-long PowerPoint slide show.  Mr. Gore’s presentation was a slightly updated version of his Oscar-winning movie, “An Inconvenient Truth.”  His updated presentation put deniers into the same category of people who denied the link between cancer and smoking.  Yet, Mr. Gore and his family benefitted for 20 years from selling tobacco following the 1963 release of the first study linking cancer and the plant.  Part of that benefit came even after Mr. Gore’s sister had died from cancer, an emotional point he often used in speeches.

The presentation was criticized by climate change supporters for its attempt to link global warming and severe weather events despite the fact that there has been no scientific linkage.  In fact, there has been refutation of a potential link by climate scientists and experts in severe weather as it relates to the Texas drought.  National Oceanic and Atmospheric Administration (NOAA) research meteorologist Dr. Robert Hoerling, who was the lead author of the “U.S. Climate Change Science Plan Synthesis and Assessment Report.”  Dr. Hoerling stated, "This is not the new normal in terms of drought.  Texas knows drought.  Texas has been toughened on the anvil of droughts that have come and gone.  This is not a climate change drought.  What we do anticipate from climate change is a situation where temperatures progressively increase."  While experts and even supporters are challenging Mr. Gore, a key question is whether his movement is gaining or losing traction with the American public.

Two polls on the question make for interesting reading and interpretation.  One poll was conducted by Ipsos for Reuters during the period of September 8-12.  That poll concluded that 83% of Americans believe the planet has been warming, up from 75% who believed it in 2010.  The Reuters poll results story attributed the increase to the topic becoming a focal point in the Republican presidential candidate debates raising the issue’s profile among Americans.  The poll said that 72% of Republicans and 92% of Democrats believed the warming statement.  But what was interesting was the response to a question posed about the cause of global warming.  According to the summary, “A large majority (71%) believe that if warming has been happening, it has been caused either partly (45%) or mostly (27%) by things people have been doing.  27% believe warming to be the result of natural causes.”  It was interesting that the same percentage of respondents is adamant about the primary cause of global warming. 

The Ipsos poll also made the point that there has been a hardening of attitudes about global warming.  The percentage of adults certain that warming is happening has increased to 53% from 45% in last year’s poll.  For those who do not believe in global warming the percentage is also at 53%, which was significantly higher than the 35% in 2010.  Based on this poll, one would conclude that Mr. Gore has a lot of supporters for his cataclysmic view of our future on a warming planet. 

Mr. Gore’s supporters, however, should be cautioned to not place too much faith in the Ipsos polling data as The New York Times/CBS poll taken during September 10-15, concluded that global warming doesn’t even register with the American public as a concern.  On the question of the cause or existence of global warming 12% of the public doesn’t believe it exists, 42% believe it is man-made, 33% said it was caused by natural causes, 7% said it was a mixture of the two and 6% either didn’t know or didn’t answer the question.  But maybe more important for the global warming/climate change debate was that in response to the question about what is the most important problem facing this country today, it wasn’t even on the list of top 25 responses categorized.  In all likelihood it may have been buried in the 14% who said “Other.”  The top issue at 32% was jobs followed by the economy at 27%.  In prior polls the environment had been at 1% in some polls and below that threshold in others such as the latest poll. 

The data suggests that global warming/climate change is a burning issue for a very small segment of the public.  Economic and political issues are more important to the public than the environment as long as it does not boost their cost of living.  This was the conclusion of The New York Times, but its poll may signal more about the future direction of government policy toward the environment and climate change.  Rather than going to the people seeking support, we will probably see more attempts to impact the issue through administrative action and regulation such as we are witnessing with the Environmental Protection Administration.  The polls’ results also signal that any steps to control climate change will provoke a political response.  Despite Mr. Gore’s claim, the debate is far from over!

Rhode Island has been working hard to be the first state in the nation to construct an offshore wind farm with its approval of the Deepwater Wind five-turbine demonstration project off the coast of Block Island.  Already sprinkled throughout the state are a handful of onshore wind turbines producing power for specific buildings, but there has yet to be any real commercial wind farms developed.  The town of Charlestown, where our second home is located, has had in place a moratorium on building wind turbines for nearly a year.  That moratorium was the direct result of the Town Council’s inability over the prior two years to draft an ordinance acceptable to the citizens in response to a proposal to construct a two-turbine commercial wind farm.  At the Town Council meeting held three weeks ago, the members, at the urging of the Town Counsel, voted to ban all wind turbines, both commercial and residential.  This action was in conflict with the recently enacted state legislation dealing with renewable energy project siting, construction and power-purchase rules. 

In May, the state legislature enacted legislation establishing a Renewable Energy Coordinating Board.  One aspect of that legislation was a section instructing the Board about facility siting guidelines.  Section 42-140.3-9. Renewable energy facility siting guidelines of the law states, “The board shall: (1) As a component of the strategic plan, adopt and amend as necessary the renewable energy facility siting standards and guidelines promulgated by the division of planning under section 42-11-10.  (2) Monitor the adoption of renewable energy siting ordinances by cities and towns.  (3) Communicate with towns and cities to encourage and facilitate the adoption of recommended renewable energy siting ordinances.”  The Charlestown action challenges the board’s mandate, 

According to ecoRI News, Charlestown’s act is a first-in-the-nation, although from all the renewable news we read we’re not sure that is a fact.  However, in Rhode Island and New England, it is definitely true.  The Charlestown ban was urged by the Town Counsel because he understands that the state frowns on moratoria extending beyond brief time periods.  As the Charlestown one was approaching a year’s duration, he felt it would be better for the Town Council to ban all wind turbines until the Planning Commission could draft ordinances for residential and commercial projects.  As a result, the actual action undertaken was to pass a wind turbine ordinance that effectively banned their existence. 

The ban drew sharp criticism from people in attendance at the meeting who were reacting to the negative impact the ban would have on residential wind turbines, which are growing in popularity among farmers, homeowners and others wanting to get off the grid and generate their own power.  It was suggested by one town council member that a residential wind turbine ordinance could be completed in three months and that it would take about a year to draft one for commercial turbines.  Critical issues yet to be resolved involve the height of wind turbines, the flicker effect, noise pollution and the distance they can be placed from neighboring structures.  Each of these issues is highly contentious in a town that prides itself on preserving its rural character. 

Exhibit 14.  Rhode Island Has Reasonable Wind

Source:  U.S. Dept. of Energy

A map of Rhode Island’s wind resources, measured at a height of 80 meters (250 feet), shows much of the state has moderate wind speeds.  Charlestown lies to the right of Westerly and extends from the coast to the area surrounding the blue ponds.  Our home is directly below the “y” of Westerly and on the edge of the saltwater pond.  According to this map, we experience an average annual wind speed of 6.5 m/s.  The wind measurements on the map need to be converted to a more familiar speed measurement.  The Beaufort scale for wind measurements was developed by Sir Francis Beaufort, an Irish-born officer in the British Navy in the 1830s.  It was based on the work of Daniel Defoe nearly 100 years earlier and the system was first used on Charles Darwin’s voyage of the Beagle.  The Beaufort scale ranges from zero to 12 with top category representing hurricane force winds.  In the case of Charlestown, the wind speeds of 6-6.5 m/s translate to 13-14 miles per hour.  The speed range of 6-8 m/s (13-17 miles per hour) is Beaufort scale 4, which is characterized as having small waves with breaking crests, some whitecaps, raising dust and loose paper and moving small branches. 

The Charlestown wind turbine ban was enacted barely four days after a Rhode Island Foundation-sponsored community forum entitled “The Future of Offshore Wind Energy in Rhode Island.”  This was actually a taping of a show for Rhode Island Public Radio and involved seven participants involved in various aspects of the offshore wind effort including former Governor Donald Carcieri, the chief development officer for the wind farm developer, the head of the Coastal Resource Management Council, the head of the Save the Bay environmental group, a University of Rhode Island economist, an environmental researcher and an official from the local power company.  While the program was designed to better explain the rationale for offshore wind, the scope and timing of the Block Island project, what has been done to protect the environment and why it is a good idea for Rhode Island, there was little in the way of new information presented.  It was nice, however, to hear all the (positive) details at one time. 

The high cost of offshore wind power, especially given the alternative of much cheaper onshore wind power being available, was brushed off with a statement that costs are coming down and we have no idea what will happen to fossil fuel prices in the future.  The average cost of electricity in Rhode Island has risen from 9.15 cents per kilowatt-hour (¢/kWh) in 1990 to 14.23¢/kWh in 2009, the last year data is available.  Under the power purchase agreement between Deepwater Wind, the developer of the Block Island wind farm, and the local utility, the first year price for the electricity generated offshore will be capped at 24.5¢/kWh, which is programmed to increase at a mandated 3.5% per year for the 20 years of the contract. 

The green jobs potential was argued extensively by the former governor, who characterized the state’s offshore potential as the “Saudi Arabia of wind” and that Rhode Island was ideally positioned to become the staging area for all future offshore wind developments extending from New Jersey to Maine.  The economist said that this industry is a high-tech business and will employ thousands of workers.  He also believes that within 20 years Rhode Island can generate all its electricity from renewable sources.  That will be a tall order!  Since 2009, only 1.3% of the state’s total electricity was generated from renewables, down from 1.6% in 1990, even though the state’s power use has nearly tripled. 

The Forum was a “feel-good” session with lots of “feel-good platitudes” directed at a very sympathetic audience.  There seemed to be many people in the packed auditorium who desire distributed renewable power.  If they have their way, the state can look forward

Exhibit 15.  Project To Have Five Larger Turbines

Source:  ecoRI News

to neighborhoods of wind turbines and solar roof panels.  Maybe this movement will create green-jobs, but based on the permanent employment figures for the offshore wind projects, we doubt it will become a major employer for the state. 

As the U.S. ban on the manufacture and/or distribution of “inefficient” incandescent light bulbs (ILB) draws near, we recently discovered that our neighbor to the north, Canada, has actually delayed its ban by two years to 2014.  Does that mean Americans may want to schedule trips across the border to stock-up on ILBs to avoid having to buy and use compact fluorescent light bulbs (CFLB)?  We have no idea how U.S. customs officials will deal with carloads of ILBs since the law does not ban their possession or use. 

In April, Canada amended its legislation banning ILBs because they are “inefficient.”  The delay implemented by the amendment was "required in order to strengthen communication activities, to allow for technology innovations and to consider the concerns expressed about the availability of compliant technologies and perceived health and mercury issues, including safe disposal for CFLs."  As one newspaper columnist wrote, this delay is actually an admission that the original legislation was rushed without sufficient investigation, research and preparation. 

When the prospect of mandating this bulb switch emerged several years ago, a study of its impact on Canada’s greenhouse gas (GHG) emissions was conducted.  The study pointed out the problem of lost heat from ILBs compared to CFLBs and how it could impact additional space heating needs during winter months.  Depending upon the source of fuel to generate electricity, which also provides space heating, it is entirely possible the light bulb switch could boost GHG emissions in regions of cold countries such as Canada.  The study showed that if Canada’s electricity was generated totally from coal, a switch from ILBs to CFLB by every household in Canada would save five times the volume of GHG emissions than the current situation.  The study calculated that under the coal-powered scenario, the bulb switch would eliminate 14 million tons of CO2 annually.  Because Canada’s power is largely green, the model suggested that the complete bulb switch would only avoid 2.7 million tons of CO2 annually.  According to Canada Statistics, the nation generates over three-fourths of its electricity from clean fuels – hydroelectric, nuclear and renewable fuels.  Of the remaining quarter of its electricity, about 20% is generated by natural gas, which is the cleanest of the fossil fuels. 

Exhibit 16.  Light Bulb Switch Hits Provinces Differently

Source:  InTech

The key issue is that while the light bulb switch could lead to a net reduction in GHG emissions for all of Canada, when one examines the mix of power generation fuel sources by individual province there is a non-uniform impact.  A switch in light bulbs would boost GHG emissions for the provinces of British Columbia (BC), Manitoba (MN), Quebec (QC) and Newfoundland (NL) because their power is primarily green.  The increased space heating needs would require more dirty fuels.  On the other hand, Alberta (AB), Saskatchewan (SK), Ontario (ON), New Brunswick (NB), Nova Scotia (NS) and Prince Edward Island (PE) should all benefit from the switch because of the impact on space heating and lighting demands and the individual provinces’ energy fuel mix.  The report demonstrated that there are many subtleties in an analysis of the GHG emission savings from the mandated light bulb switch such as cross-border power supply arrangements depending on the fuels used to generate the power, as well as what power plants are used to meet power surge demands. 

There wasn’t much publicity of the Canadian bulb switch delay last April, possibly due to fear of a reaction by the United States.  It would be evident that Canada was no longer walking in lockstep on eco-issues with the U.S., which might have added fuel to the political fire over Canada’s expanded oil sands development efforts.  That battle continues with the highly contentious struggle over approving construction of the XL Pipeline to haul more of the oil sands bitumen south of the border.  Rather than attacking Canada’s delay, maybe it should be praised as the appropriate response to the unintended consequence that the mandated light bulb switch might actually increase GHG emissions, the opposite of the intent of the legislation.

We wrote in our last Musings about The Brookings Institute study on green jobs suggesting there are 2.7 million of them.  We listed the job categories Brookings defines as green, which include transit workers, waste treatment employees, trash gatherers and recycling experts.  The problem is these definitions stretch what most American’s consider as green jobs, resulting in the count being highly inflated and misleading.  Of course, those who live and work in Washington, D.C., otherwise known as Wonderland, can define green workers any way they want and convince themselves they are creating green jobs. 

Washington’s fantasy world was on display last Thursday when the House Oversight and Government Reform Committee held hearings about green jobs.  Officials from the departments of Energy and Labor were quizzed and according to a story from Fox News, reported on several of the exchanges dealing with green job definitions.  The Bureau of Labor Statistics (BLS) is working on a study to track green-job employment, which means it first must develop a definition of what these jobs may be. 

In one of the exchanges, Rep. Connie Mack (R-Fla.) argued that because a bus driver is driving a hybrid bus doesn’t mean it’s a green job. 

“Yes it is,” responded Labor Secretary Hilda Solis. 

Rep. Mack retorted, “It’s only a green job if it fits your sales pitch.”

The debate went on and exposed a flaw in the green-job count.

BLS Commissioner Keith Hall said that the definition of bus drivers as green jobs actually is more extensive because they are working with a definition that green jobs provide goods and services “that benefit the environment to conserve natural resources.”  The BLS plans to include jobs where workers’ duties “involve making their establishment’s production processes more environmentally friendly.” 

To further the debate about bus drivers, Commissioner Hall said, “Our green jobs include mass transit, so actually any bus service” is one.  He later said, “Mass transit is a green service.”  The reason why is because, “Every single bus may replace dozens of cars.” 

Under Commission Hall’s definition, then all air transportation employees are green employees.  Do you know that according to the BLS in 2008 there were nearly 500,000 air transportation employees or close to 20% of the Brookings Institute’s count of total green workers.  How about the drivers of the shuttle buses to rental car locations?  If you share a taxi with another passenger, which may happen when there are shortages, should we count the taxi driver as a green driver?  How about those workers who build jet planes and buses?  With a sufficiently broad definition, we suspect the number of green jobs will shock even these government officials. 

On another aspect of green jobs, deputy Energy Secretary Daniel Poneman pointed out that America has fallen to third place globally in clean-energy investment.  He expounded on the clean-energy investment race among countries, how large is the clean-energy market is and why it is important the U.S. not lose the race.  We immediately wondered if the Energy and Labor departments ever talk.  It seems obvious to us that if Labor is going to count green jobs as broadly then all the money spent on mass transit, etc. should be added to our clean-energy investment.  We bet the U.S. wouldn’t be in third place.

What we are learning from this green jobs debate is that federal government officials truly have fallen down the Rabbit Hole.  They are operating in the fantasy world similar of the Mad Hatter and the Queen of Hearts.  Don’t expect that fantasy to change anytime before the next election; 13 more months.

A comment by the Tom Folliard, CEO of CarMax (KMX-NYSE), during an earnings results call with analysts pointing up the changing U.S. automobile market.  The company reported a 2% decline in same-store sales, which Mr. Folliard attributed to weakening consumer confidence.  He also commented, "My belief is I think a lot of people are just getting out of an extra car to turn them into cash."  The number of U.S. automobiles peaked at 250 million in 2009 and declined to 246 million in 2010.  Since new car sales are falling below the pace of recent history, an aging fleet suggests junking cars will lead to a continuing shrinkage of the fleet.  Besides falling consumer confidence, we also have the smallest population of potential new drivers than at any time in the post World War II era. 

The economy and driver demography have combined to reduce miles driven.  The rolling 12-month cumulative miles driven chart below shows mileage peaked in 2007 immediately prior to the financial crisis.  After declining during the recession, mileage recovered only to start declining again in 2010. 

Exhibit 17.  Driving Mileage On Decline

Source:  FHTSA

The decline is highlighted in the charts below showing monthly mileage driven for 2009, 2010 and 2011 year to date.  It appears that miles driven are falling in every month compared to the prior year’s month and the year before that. 

Exhibit 18.  Monthly Mileage Driven In Decline

Source:  FHTSA

When we look at gasoline supplied, it is evident that following years of rising consumption, the volume consumed peaked during 2007.  Since then volume used has been steadily declining.  That decline is tied to the fall in the number of vehicles, their use and improving vehicle fuel efficiency.

Exhibit 19.  Gasoline Market In Permanent Decline?

Source:  EIA, PPHB

That decline in the amount of gasoline supplied has been clear over the past three years.  As gasoline pump prices spiked higher this spring due to the civil unrest in the Middle East and North Africa, and the economy struggled with high unemployment and rising food prices, Americans were forced to cut back their driving and thus the amount of gasoline consumed. 

Exhibit 20.  Monthly Gas Use Sharply Lower

Source:  EIA, PPHB

It appears the gasoline industry is destined to follow the road of slow decline as all the factors cited above weigh on demand.  In fact, the American Petroleum Institute reported Friday that August gasoline fell to a nine-year low.  Fewer drivers, more efficient vehicles, a weak economy and shifting life- and work-styles will drive our petroleum economy in the future.  None of these are positive.  America is changing.  The energy business is changing.  How the nation and the energy industry will look five and ten years from now is unknown, but it is safe to say it won’t be as it has been.  Our mission is to investigate and envision those changes and help our readers understand how the future may develop.  

There is an interesting development with wind power in New York State.  According to an interview given to the Buffalo (NY) News by State Senator George Maziarz (R-Newfane), the New York Power Authority is switching its support from an upstate wind project in Lake Ontario in favor of a larger, but more expensive, downstate offshore wind project.  The power authority has been reviewing the merits of the upstate project for over a year, but is now less supportive of it.  The Galloo Island Wind Farm project for a 246-megawatt (MW) wind farm on an uninhabited island in state waters six miles offshore in Lake Ontario and connected to shore by an underwater transmission line would have a cost of an estimated $1 billion, or slightly under $4.1 million per MW. 

The authority is now favoring a proposed wind project targeted for 13-17 miles off the coast of Rockaway Peninsula and Long Island. The project calls for building 350 MW of generating capacity at an estimated cost of $2.34-$4.67 billion, or $6.7-$13.3 million per MW.  One has to wonder why an offshore wind project costing 50% to three times as much as the upstate project would be more attractive.  The offshore one will have to go through federal permitting and licensing steps, which will certainly add several years to the process.  The upstate project was ready to move forward.  The explanation is that downstate power demands and pricing are the drivers causing the switch. 

The offshore wind project is being driven by a group of 40 Democratic politicians who believe the state needs to move forward aggressively in order to prevent other states from drawing away developers.  Since New York State is considerably behind its neighboring East Coast states in developing offshore wind, the politicians are urging the governor to approve the plan.  On September 15th, the New York Power Authority, along with two state utilities, filed to obtain an offshore lease to develop a wind farm.  When any federal offshore wind leases will be awarded remains uncertain, but probably not soon.  Media stories suggest the wind farm could be as large as 700 MW at the cost figures cited above.  A major attraction is that the project would create 2,300 to 4,700 construction jobs and 35-70 permanent jobs, based on a 2010 study.  It was admitted, however, that utility rates in the area would rise due to this “new” technology, but green jobs, clean energy and locking in power costs were thought to be more important.  After following Cape Wind and the Block Island wind projects for years, we wish offshore wind proponents could develop new rationales for proposing them or at least present some real world statistics to demonstrate positive economics from this effort. 

Contact PPHB:
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Main Tel:    (713) 621-8100
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www.pphb.com

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.