Mixed Signals From US Government On Oil Policy

This past Monday's Wall Street Journal contained a 'green' section, in which an article entitled, "One Step Forward, One Step Back,' focusing on US governmental policies with respect to oil, was featured.

The crux of the article was to describe the back-and-forth nature of our government's attitude toward the development of onshore oil and oil refining projects. In part, the piece stated,

"In its efforts to set the U.S. on the road toward energy independence, Congress may be constructing a detour.

The House and Senate have passed separate energy bills and are now working on combining the two into final legislation that could come up for a vote by the end of the year.

Both bills are designed to lessen American reliance on foreign oil, in part by mandating far greater use of corn-based ethanol and so-called cellulosic ethanol, which is made from biomass like grasses and wood chips. The Senate bill also calls for higher fuel-economy standards.

Here's the catch: Anything that creates uncertainty about demand for gasoline over the long term means less incentive for refiners in the U.S. to expand their capacity. And that means greater reliance on gasoline imports in the near term, at least until ethanol becomes a mainstream fuel. And that, of course, is the opposite of energy independence."

This is no small matter. Remember when, in the wake of hurricane Katrina, just a little over two years ago, the great hue and cry from Congress was,

'Why hasn't the oil industry built (us) a new refinery in over 30 years?'

The Journal piece continues,

Critics also question whether the country can supply the 15 billion gallons a year of corn-based ethanol that the Senate bill mandates by 2015 without substantially raising the cost of food -- or whether the supply can be relied on in drought years.

Not long ago, at hearings and press conferences, lawmakers called on refining companies to increase capacity in the U.S., after the devastating hurricanes of 2005 hobbled a number of Gulf Coast refineries and sent pump prices soaring. And there remains some support in Congress for such an expansion.

"We're going to become dependent on foreign refineries," Sen. Orrin Hatch, a Utah Republican, warned at a Finance Committee hearing earlier this year. "If we can't refine oil, others will do it for us, and it's foolish if we don't wean ourselves off imports."

But refiners see the political winds shifting. "If you want to add refining capacity here, how can you have the president advocating reduced consumption?" says Greg King, president of Valero Energy Corp., the largest independent refiner in the U.S. "It's a mixed message."

Mr. King says he is concerned that incentives to encourage expansion are in jeopardy. The House version of the energy bill doesn't extend beyond 2008 a provision from the Energy Policy Act of 2005 that grants refiners tax savings on 50% of the costs of investments that increase capacity by at least 5% at any one refinery. The bill also would take away from refiners a tax deduction granted to other U.S. manufacturers.

Meanwhile, refiners in other countries are forging ahead. Saudi Arabia is gearing up to start four refineries, each able to process 400,000 barrels of crude oil a day. Kuwait has approved plans for a 615,000-barrel-a-day plant, and a 580,000-barrel-a-day facility will soon be processing in India.

"It will be difficult to build a new refinery in the United States," says Lehman's Mr. Robinson. "There are significant investments coming on line in the world that will, in addition to this whole ethanol craze, continue to de-incentivize building new refineries in the U.S."

This, I think, is the key point. Only two years after suffering gasoline supply disruptions and rising prices due to inadequate onshore oil refining capacity, Congress is behaving in a manner which injects uncertainty into decisions to expand US refining capacity, even as foreign projects near completion, making the onshore investments look less profitable with each passing month.

Recently, US presidential candidate and Democratic Senator Hillary Clinton has called for the ending of tax breaks for oil companies, saying,

'They don't need them anymore.'

Great, Hillary. Just when oil companies require more certainty to underpin the requests/pleas they have received from the US government to add more refining capacity, Clinton threatens to remove incentives for them to do so. And supporting ethanol just adds to the confusion.

Despite their current, temporary profit increases from the global oil demand and supply situation, US oil majors aren't guaranteed a continued flow of those profits, as the sovereignization of oil deposits has changed the world in which they must compete.

Then we have this passage from the Journal article,

"Bill Wicker is a spokesman for Sen. Jeff Bingaman, the New Mexico Democrat who chairs the Senate Energy and Natural Resources Committee and is one of the chief proponents of the proposed biofuels mandate. Mr. Wicker concedes that the energy policies in the Senate bill might increase gasoline imports if cellulosic-ethanol technology doesn't produce on schedule the billions of gallons the mandate requires. But he urges the energy industry to join the effort to steer the country away from oil-based fuels.

"There are big oil companies that are also looking at investing in ethanol refineries," Mr. Wicker notes. "They are energy companies, not oil companies, and if the market is trending towards domestic grown or produced energy, I certainly hope that the industry sees that and acts accordingly." "

Thanks, Bill. Here, we have a rather faceless spokesman for yet another Senator of dubious expertise in the field telling us that oil companies are, in fact, energy companies now.

I hope Bill Wicker called ExxonMobil CEO Rex Tillerson to break the news to him. Lee Raymond, the firm's just-retired CEO, famous for refocusing Exxon on oil, to the exclusion of alternative energy forms, must have lost his breakfast when he read that quote.

I recently wrote this post comparing BP to the ill-fated, defunct Penn Central Railroad. In my opinion, Penn Central's experience illustrates what can happen when a company unwisely broadens its focus and wrongly loses sight of its narrower expertise.

Both that example, and financial theory with respect to diversification, suggest that capital markets and venture capital are more than up to the task of funding promising startups in alternative energy sectors, such as ethanol, wind, solar, etc. None of which seem to share much with oil in terms of business models.

Who do you think will most rapidly and successfully exploit a new energy source: a startup devoted to that energy, or some new division of a large oil company, whose fate is still largely invested in petroleum-based energy provision?

If government truly wants other energy forms, it should provide a stable, certain regulatory environment, within which all competitors may function. Arbitrarily recasting ExxonMobil, Chevron, et.al., as energy companies, when they are, in fact, merely very large oil companies, is a recipe for weakening the largest producers of energy, in the form of refined oil products, for our country's transportation needs.