Message-ID: <24871860.1075846349825.JavaMail.evans@thyme> Date: Fri, 22 Sep 2000 04:00:00 -0700 (PDT) From: rob.bradley@enron.com To: steven.kean@enron.com Subject: Energy Situation and Policy Mime-Version: 1.0 Content-Type: text/plain; charset=us-ascii Content-Transfer-Encoding: 7bit X-From: Rob Bradley X-To: Steven J Kean X-cc: X-bcc: X-Folder: \Steven_Kean_Dec2000_1\Notes Folders\Heat wave X-Origin: KEAN-S X-FileName: skean.nsf Steve: Your angle is much better for the corporation, and a lot of the below might be "mastering the obvious," but here it is. - Rob ----------------------------------------------------- The petroleum, natural gas, and electricity price situations have a different set of facts but a common demoninator--very tight infrastructure relative to energy demand. Here is a general set of conclusions with a few "sound bites." * The current energy price situation is "all about economics." It is economics 101--supply and demand. Demand has been rising faster than supply with a predictable response. This is the bad news for consumers. The good news is that there is reason to believe that prices for oil and natural gas are at the top of their commodity price cycle. The NYMEX futures market shows a "backwardation curve" for both--look in the daily Wall Street Journal in Section C under "Futures Prices" that usually is around page 14. Look at the settle price for the different energy commodities and the prices after the prompt month (October) fall over the next months and years except for this winter's natural gas price. * Big oil did not suddenly get big or greedy with petroleum prices any more than "big gas" has with natural gas. Many of the same players were profit-maximizing during the previous price slump. * The constraint on energy markets is not the resource base but the infrastructure to produce, refine, and transport supplies. Infrastructure constraints have had a cumulative effect of slowing the great engine of market supply, reflected siting issues and also low profitability (partly the result of rapid implementation of new environmental requirements). * The solution is to stop taking supply for granted and build more flexibility and incentives in the system to profitably meet ever-rising demand. Energy investment must compete against many New Economy investment opportunities that have potentially high rates of return. Oil This is a global market so declining U.S. production is a very small part of the world supply, but the real constraint is domestic refining capacity. Since 1990, operable U.S. refineries have declined from 205 to 159 when 50 refineries closed and only 4 new refineries entered the market. [National Petroleum Council, "U.S. Petroleum Refining," June 2000, p. 23. Other refineries have been able to expand to increase overall capacity, but capacity utilization has risen rapidly in recent years and is above 95%--a tight situation. EPA permits to allow further expansion is a major issue to making sure that domestic infrastructure keeps up with demand (p. 27). A number of proposed requirements to further improve the environmental quality of gasoline has raised profitability questions as well (pp. 27-30). The two actions the U.S. can take in the short run to increase crude supplies are to lift the embargo on Iraq and withdraw oil from the Strategic Petroleum Reserve (up to 3 mmbd). Liquidating the reserve could be part of a privatization program to get support from the free market community, and the proceeds could be used to help low income energy users this winter. The days don't get much more "rainy" than now given that without price controls price and not supply is in question in an "emergency." A longer run approach must be to encourage domestic and international drilling to make the supply response as elastic as possible to higher prices. Alaska activity such as drilling at the Arctic National Wildlife Reserve (ANWR) would be a major contribution to world supplies. On the gasoline side, much has been written about "boutique fuels" where certain environmental requirements are required for certain regions that makes the supply/demand balance very sensitive to interruptions (such as refinery downtime or a pipeline closure). The key to prevent price spikes for consumers is to not let new environmental requirements outrace technology or infrastructure constraints. This discontinuity happened earlier this summer in Chicago, for example, where gasoline prices rose well above $2 per gallon. Electricity This is an infrastructure problem that could be alleviated by a more efficient use of the transmission grid to get power to its highest valued uses. California in particular has followed a "soft" energy path where conservation was substituted for permitting urgency for new power plants. The digital age is driving demand growth although many traditional appliances (such as refrigerators) are using less power. General economic growth also means many new appliances, traditional and new, are being produced and used, adding to power demand. Natural Gas Natural gas supplies (and infrastructure to some degree) must catch up to high demand after many years of slumping gas prices and reduced incentive. Over 200 Tcf of potential gas reserves is in areas that are off limits to drilling--something that should be corrected given the advances in drilling technology that make exploration and production much less invasive to surface area than ever before. Other public policy drivers should be a continued emphasis on expedited certification for new pipelines and avoiding new short run regulatory "fixes." Past this winter, however, gas prices are expected to decline, so consumers can lock in long term prices that are below current prices. Conclusion Energy supply and infrastructure have been taken for granted for too long. It was assumed that low prices would continue despite increasing disincentives to increase supply and infrastructure to meet demand. Demand has also increased faster than thought due to economic prosperity and the "wealth effect." Market forces can correct the imbalance over time without regulatory quick fixes and with reasonable incentives for industry performance. Robert L. Bradley Jr. Director, Public Policy Analysis Enron Corp. P.O Box 1188, Room 4724a [1400 Smith Street 77002] Houston, Texas 77251-1188 (P) 713-853-3062 (F) 713-646-4702 Assistant: Joan Stransky 713-853-4702 jstrans@enron.com