Wednesday, October 15, 2008

Drill Baby, Drill!: Unrealistic, Reality, or a Bit of Both?

Attempts to keep politics out of any issue in today’s ultra sensitive pre-election atmosphere, be it the economy, religion, social values, foreign policy, the environment, and a host of others is difficult. However what stirred my interest in the subject of drilling for oil was the “Drill Baby, Drill” mantra voiced so effusively at the Republican Party Nominating Convention. Of course, controversy existed both before and after the convention.

Perhaps the most troubling aspect of the controversy is, basically, whether drilling in currently protected coastal areas, and Alaska is advisable. More specifically, is it worth the potential environmental harm?; will it produce meaningful enough oil to minimize our reliance on foreign (unfriendly) sources?; if so, over what period?; and the most current question: will it reduce the escalating price of gasoline quickly? To insure objectivity, more than one source has been consulted. And, as Sergeant Joe Friday used to say in the TV program, Dragnet, “Just the facts, Ma’am.” But first, some background.

To some degree the controversy is subsiding since the Congress seems to be moving toward a bi-partisan agreement that will allow at least some off shore drilling. A recent CNN poll indicates that about 69 percent of voters favor more drilling in currently protected areas and 51 percent say that the ban on offshore drilling is a “major cause” of higher gasoline prices. The point is not whether the poll participants are right or wrong, the question is whether they are well enough informed to make an educated judgment.

First some background as described in Scientific American. “World demand for oil, if it has not already done so, will unquestionably outstrip world supply. Crude oil production in the Persian Gulf has been nearly flat at just over 20 million barrels a day (mbd) since the early 1970’s. Whatever growth has occurred since then has come from oil fields outside the mid-East. However many of these fields (the North Sea for example) have not only reached production limits, but are in actual decline.” [There are some who believe––executives at Exxon Mobil for example––that new technology and new finds will solve the problem].

The China Card

However, a major factor is that the acceleration in global automobile usage is likely to be relentless. China alone, with today’s count of some 50 million vehicles (about 40 per 1,000 people) does not compare with some 240 million vehicles in the United States (roughly 800 per 1,000 people). With China’s booming economy, it already is the world’s second largest market for vehicles sales. We must assume that China’s economy will continue to prosper at a remarkable rate, enabling hundreds of millions of households within financial reach of car ownership.

Remember that China has a current population of 1.3 billion. Let’s assume that at some point it attains just half of the U.S. per capita ownership of passenger vehicles. That would account for some 500 million vehicles, about twice as many as in the U.S. Currently there are 650 million cars, trucks, and buses worldwide. A conservative estimate of an additional 500 million vehicles between China and India within the next 30 years raises the question of whether this magnitude of increased oil demand could be met. Placing this in perspective clarifies an issue that many Americans seem to ignore––oil is a global commodity, and oil prices are set in the world market.

The Scientific American article, published in late September, points out that “The 15 billion barrels or so of oil that is supposedly economically accessible in protected U.S. off shore sites would slake around six months of global demand in 2008, and of course a much smaller share by the time they reached the market in 15 years.”

Drill? With What?

However even if there were significantly greater supplies, a very major hindrance exists.A recent article in The New York Times explains: “…a shortage of ships used for offshore drilling promises to impede any rapid turnaround in oil exploration and supply. In recent years this global shortage of ships has created a bottleneck, frustrating energy executives and constraining their ability to exploit known reserves or find new ones.”

The article points out that the world’s existing drill-ships are booked solid for the next five years. It further states, “Demand is so high that ship builders, the biggest of whom are in Asia, have raised prices since last year by as much as $100 million a vessel to about half a billion dollars.” Some of the newest ships now lease for about $600,000 a day compared with $150,000 a day in 2002. (If you think ship building and leasing might interest you as an investment, research the companies Transocean (RIG), and National Oil Varco (NOV)––Disclosure: I own both). An article in U.S. News & World Report agrees that “...tight supplies of equipment and labor will severely constrain exploration in the next decade.” It puts the price of new drill-ships at $700 million, with many going to Brazil, West Africa, and South Asia. It also estimates that it would take seven to ten years “for the oil to start flowing.”

Questions have also been raised as to why energy companies have not fully utilized their existing permits on federal lands. Existing federal leases contain an estimated 82 percent of all the natural gas and 79 percent of oil available. The negative arguments against drilling is probably best expressed by our own U.S. Energy Information Administration (EIA) that did a detailed study of the likely outcome of offshore drilling for its “Annual Energy Outlook 2007.” The conclusions were “The projections in the OCS [Outer Continental Shelf] access case indicate that access to the Pacific, Atlantic, and Gulf regions would not have a significant impact on crude oil and natural gas production or prices before 2030.” It reiterated “,,,any impact on average well head prices is expected to be insignificant.”

The most compelling and frankly, most sensible article promoting drilling in currently protected areas was written as an editorial piece in U.S. World & News Report. The author Morton Zuckerman is the publisher and editor-in-chief. He also happens to be one of my favorite editorial writers, second only to Tom Friedman of The New York Times. In the two page article titled “Stop the Energy Insanity” published in mid-July, Mr. Zuckerman covered a broad range of subjects with visible anger stating, “WE ARE IN A HOLE––AND STILL DIGGING. We have oil at a catastrophic $140 a barrel yet no sign of a bipartisan energy policy assured of passage––let alone the forceful execution needed to expand domestic supplies and restrict domestic consumption. Instead, we have the blame game about greedy speculators, careless consumers, and cowardly politicians, inevitable maybe in an election year but a betrayal of the promise of America.”

His intent is to make the case that “It’s clear that the age-old standoff on whether domestic drilling or conservation is the solution is now irrelevant. We must have both.” On the subject of the potential negative impact on the environment, he writes, “We can get past the lame repetition of the decades-old argument over the virtues of offshore drilling. Simply put: To refuse to exploit our vast oil reserves is insane. The United Sates is one of the few countries in the world that choose to lock up their natural resources by dramatically restricting production and exploration. At least until now.

He is also an advocate for drilling in the Arctic National Wildlife Refuge (ANWR), maintaining that, “…we’re talking about a tiny corner of 2.200 acres (an area the size of a small airport) out of 19 million acres. The proposed drilling promises to yield an estimated 10.4 billion barrels, representing well over 20 years of imports from Saudi Arabia. Drilling would take place on the coastal plain, a mosquito plagued tundra and bog in the summer, not in the snowcapped mountains of ANWR that television pictures would have you believe are at stake.”

He then writes that the outer continental shelf could be tapped with minimal environmental disturbance based on the fact that there were virtually no spills when Hurricane Katrina and Rita hit in the Gulf area. In addition, “The stellar environmental records of eco-sensitive regions such as Scandinavia, the Netherlands, and Great Britain have shown that the greatest oil spills would be avoided because they typically come from tankers importing oil, not from drilling or other off shore locations.” He also claims that since prices for crude and gasoline are set by future expectations, “Any policy that pushes the future supply to increase or leads future demand to drop can cause today’s prices to fall or to rise less than they otherwise would.”

So, what’s your opinion? Don’t be swayed by the preponderance of negative information above. Perhaps that’s just an indication of a more liberal media as some complain.


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