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A question of balance: US energy independence or security

Mitt Romney’s energy strategy promises to reach for the stars. Barack Obama’s may be more realistic. Shaun Polczer reports on the US election

Barack Obama and Mitt Romney are offering the American people two categorically different visions of their country’s energy future: security versus independence. The distinction may sound subtle, but the details – when they can be found – reveal a fundamental divergence in the candidates’ approach to global markets and North America’s energy boom.

Romney, the Republican party’s challenger, has vowed to accomplish what every presidential candidate since Richard Nixon has promised, but failed to deliver, freedom from imports. It would be driven by higher production of fossil fuels like oil, natural gas and coal. He believes energy autonomy could be America’s by 2020, or the end of a second term.

President Obama’s strategy is to achieve enhanced energy security – a balance of higher oil and natural gas production that also includes measures to sharply increase fuel efficiency and ramp up the US’ negligible renewable energy capacity.

Key to Romney’s strategy is empowering states to control onshore energy development, alongside a wider energy partnership with Canada and Mexico, the US’ two North American Free Trade Agreement (Nafta) partners. Streamlining regulation and promoting private-sector development of new energy technologies, both mainstay policies that tap the Republican view of a shrunken federal state, would create 3 million new jobs, he believes, including 1m in the manufacturing sector – and “trillions” of dollars of new government revenues.

The promise of energy independence by 2020, however, is either naive or deliberately misleading. The numbers and the economics don’t add up.

US oil demand may be stagnant, but last year it amounted to 18.8m barrels a day (b/d), making it by far the world’s greediest oil consumer. Despite the much-vaunted surge in domestic production, however, US output of 10.1m b/d was still 8.7m b/d shy of self-sufficiency.

Indeed, without steep falls in consumption during a hypothetical Romney term, the US would have to increase production by more than 1 million b/d each year during his tenure to meet his target. Eliminating imports to become self-sufficient, in other words, is a tall order even for the world’s third-largest producer.

As for demand, Romney does not have much to say. Politically, Obama seems to have trumped him. On 28 August, the White House raised fuel efficiency standards for cars, mandating them to reach average mileage of 54.5 miles per gallon by 2025 – a near doubling of present fuel-economy standards. This will will reduce oil consumption by 12 billion barrels over the course of the programme, or 1.5m b/d by 2030. That is equivalent to all imports from Saudi Arabia and Iraq in 2010.

Romney called the new standards “extreme”, leaving Obama to shoot back: “It doesn’t seem extreme to me to want to build more fuel-efficient cars. Maybe the steam engine is more his speed.”

In any event, Romney’s supply-side plan is not really about energy independence so much as co-dependence on Canadian bitumen and a revival in Mexican production. This makes it a Nafta energy plan, based on the willing co-operation of the neighbours. Romney’s US would provide the market and the energy would stream across the border.

Figuring out the wider economic benefit of this strategy is complicated by the nature of the oil on offer. North American supplies remain relatively high cost. At some point – perhaps at around $70 a barrel – developing every marginal field is a money-losing proposition that would undermine domestic oil and gas output.

According to Goldman Sachs, most new oil projects need $115/b to break-even. Although the numbers are lower in North America, US producers are relying on $90/b to cover costs and generate modest returns. New oil-sands projects, for example, tend to carry a price tag of $75/b to bring on stream. Gulf of Mexico output can be just as pricey, at $80/b. Mexican deep water, still undeveloped, would likely require even higher prices.

Basic supply and demand economics complicate this, too. Rising US production has come in a period of strong international oil prices that have encouraged unconventional development. But the kind of output surge envisaged in Romney’s plan could swamp the market and drive prices down. Unless North American production costs fell precipitously, too, high-cost North American production would be uneconomic.

Much depends on timing. If Middle East tension and other global forces kept prices high for long enough, the production gains could be made while economies of scale drove down prices. Therein lies another paradox. According to a study by Harvard researcher Leonardo Maugeri, such a surge of capacity – in the absence of a geopolitical crisis – would have the effect of driving down the long-term prices needed to sustain a drill-at-all-costs energy policy after 2015.

It is hard to know whether these wider economic considerations have been factored in Romney’s plans, because his 21-page document makes no mention of them. It may, for example, be sensible for the US to allow crude-oil exports, so that if US prices fell amid a glut in supply the producers could tap demand elsewhere. But that would require presidential approval for crude-oil exports. Would Romney allow this? And how would he square that with his energy independence plan?

Oil independence

He can take some encouragement from the upstream. Things are moving in the right direction for the US. Last year, it became a next exporter of petroleum products for the first time since 1949, according to the Energy Information Administration (EIA). Without such exports (of products, which are allowed), some refineries in the Gulf would likely be shutting down, a peculiar factor driven by the disconnect between West Texas and global Brent.

Outright independence may be a pipe dream, but Obama’s premise of greater energy security is plausible, given the trajectory of the unconventional energy renaissance.

According to the most recent EIA numbers, US oil production was up about 10% year-on-year in August, helping to drive down imports, which now amount to less than 45% of total demand, compared with 57% in 2008.

Since 2011, the US has been the fastest growing contributor to non-Opec supply. According to EIA numbers, US oil production was up 1m b/d in the first half of 2012 and is expected to add 1.3 million b/d by 2013 – an impressive performance from a country once thought to be in permanent decline.

Indeed, oil production has risen every year since Obama was elected in 2008 and the US’s proved reserves are the highest since the EIA began keeping track 35 years ago. In 2010 proved natural gas reserves topped 300 trillion cubic feet, their highest estimate ever.

This is a growth trend that will continue past November, regardless of who wins the White House. The question is how best to manage this boom.

Though he is quick to take credit for higher oil and gas output, Obama’s policies have often been a hodgepodge of regulatory overlap and jurisdictional turf wars between government departments like the Environmental Protection Agency (EPA), the Bureau of Land Management (BLM) and even the State Department when it comes to approving new pipelines from countries such as Canada.

Obama’s dithering on the Keystone XL pipeline, designed to carry oil-sands crude from northern Canada to refineries on the US Gulf coast, has created gridlock in the North American transportation network, opening huge differentials in the price of domestic oil to the global benchmark Brent. These differentials cost US producers some $200m a day.

It’s a huge opportunity cost of about $73 billion a year for local producers. Democrats argue that the savings have been borne by consumers. But this isn’t really the case: US gasoline prices are largely driven by the price of Brent, not WTI.

Obama provides some soft targets for Romney, too. The White House continues to give disproportionate support to renewable energy sources that make little difference to supply. During his acceptance speech to the Democratic convention, Obama himself suggested transferring $4bn of “corporate welfare” from oil companies to help promote wind, solar and biofuels.

But wind and solar power account for just 3% of the market, says the EIA, and even the heftiest of subsidies is unlikely to push it above 10%. The bankruptcy of Solyndra, a Californian clean-tech firm that received preferential loans from the US government, has tainted the very notion of federal support among some voters.

While renewables struggle, though, natural gas has made genuine inroads into US emissions, by displacing base-load coal in power generation. That should be a winner for both sides in the presidential contest, given that US emissions, at a two-decade low, have been slashed without much federal intervention or the enactment of carbon rules. Under pressure from coal states, however, Romney is less keen to promote natural gas as an alternative fuel.

War on coal

Indeed, the former Massachusetts governor has accused Obama of “waging a war on coal” with rules to curb emissions of carbon, mercury and other pollutants. To be sure, coal is under the cosh: natural gas’s share of power generation is up 24% in the past year, according to Bentek Energy, a Denver-based analytics firm. But natural gas’s rise is a victory for exactly the kind of drillers Romney wants to encourage. If producers aren’t to find a market in the US power-generation sector – which would inevitably cut coal’s role – where will their gas go?

That seems to be a difficult issue for both candidates. Neither has offered a clear position on whether US liquefied natural gas (LNG) exports will be allowed – even though the industry is preparing to begin exports after 2015. A policy that endorsed foreign sales would reward gas drillers by giving them a more lucrative overseas market. But it would also disappoint US petrochemicals producers and other industries, which see a long-term supply of cheap fuel on their doorstep. If Romney endorses the gas industry’s hopes, however, LNG exports would help lift US Henry Hub prices, undermining that cheap-fuel advantage.

As for climate change or carbon taxes – material business risks to which businessman Romney, more than Obama, is surely attuned – the issue has scarcely troubled either camp. For now, legislation to curb emissions – whether once-mooted cap-and-trade laws or a levy on carbon – is off the table. It won’t stay that way forever, so the election is hardly doing a service to the American people in avoiding the debate.

There are some sound proposals in Romney’s programme, though they are hardly earth-shattering. Allowing states to administer federal land isn’t a radical shift – but it is sensible, provided it’s not a case of one cash-strapped level of government dumping responsibility on another. The same can be said for opening federal lands offshore Virginia and South Carolina. If states can enforce federal standards, let them.

However, to suggest, as Romney does, that opening the Atlantic offshore is going to have an immediate impact on domestic oil prices is false. Offshore projects in frontier regions such as these would take a minimum of 10 years to get under way – two years longer than a two-term Romney presidency.

So, in energy, American voters have a distinct choice – perhaps, as Obama said, the clearest one in a generation. Romney offers a jingoistic call to drill at all costs that will appeal to the isolationist instincts of the US right wing and many oil companies. Obama offers a moderate approach to balance higher domestic oil and gas production with small but practical steps to reduce reliance on fossil fuels.

The test for whichever candidate wins, however, will be to make a difference. Rhetoric aside, the great surge in US domestic output and the stagnation of demand have been driven by the market, not by Washington. What happens in US energy after 6 November may depend more on the oil price than on Romney or Obama.

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