Tis the season for energy plans. Coming up on the elections, everyone has to have a plan – and I was just e-mailed a copy of Montana Senator John Tester’s plan. There are some good components, but it is also rich with irony.

A common-sense energy plan for Montana and America

As Sharla and I buckle down for another harvest near Big Sandy, we’re feeling what all Montanans are feeling at home — the pinch of out-of-control energy prices.

It’s an issue that I deal with every day as a U.S. Senator and as a family farmer. Our energy problems are the result of poor presidential leadership and a weak dollar. And with $12 billion in borrowed money going to Iraq every month, our dollar isn’t going to get stronger any time soon.

For 30 years we’ve known that depending on imported oil was dangerous foreign policy and bad economic policy. But we haven’t done what it takes to get ourselves off it. That needs to change. And that’s why I support a three-part plan for the short term and the long term:

First, we ought to drill more in places that make sense, like eastern Montana. The Bakken Formation holds an estimated four billion barrels of recoverable oil. I don’t have a problem with responsible drilling offshore or in parts of Alaska set aside for drilling. But I want to be darn sure that oil stays in America, not shipped off to Asia so the big oil companies can make more record profits.

Second, I believe that oil speculation and hedging has gotten way out of hand. Some folks on Wall Street are trading oil they never intend to actually use in order to make a quick buck. That creates artificial supply and demand, resulting in artificially high gas prices. That’s why I support smart legislation cracking down on out-of-control manipulation of the oil market.

And of course, conservation and renewable energy have to play a big role in our energy future. It’s time to make a serious investment in renewable energy like biofuels, wind, solar power, and geothermal energy.

Unfortunately, a few White House allies in Congress shot down important legislation like extending tax credits for renewable energy, cracking down on speculators and hedgers, and getting tough on OPEC. They pay lip service to the need for renewable energy, then insist on voting only for legislation that gives big oil bigger profits.

Drilling for more oil can’t be the only solution. Drilling is a bridge, but without a long-term solution it will be a bridge to nowhere. As a country that uses 25 percent of the world’s oil, yet has only three percent of it, drilling alone won’t solve the problem. Some on the other side of the aisle are not shooting straight with Montanans.

You would think from listening to some politicians that the big oil companies’ agenda is the solution to record high gas prices. That defies common sense when the U.S. is exporting 1.4 million barrels every day to other countries. It’s another example of the failed leadership that has taken the price of a gallon of gas from $1.50 in 2001 to more than $4 today.

With our national and economic security at stake, it’s time for all of Congress to work together. It’s a shame partisan politics gets in the way of common sense. Montana families and main street businesses deserve better than that.

I’m always interested in hearing your thoughts on the issues. Please visit http://tester.senate.gov/contact to drop me a note.

Jon Tester
United States Senator

Funny story about Tester. Montana has a significant oil refining industry. Yet when he was campaigning, gasoline had just cracked $3/gal, so he campaigned on the party line: “Big Oil is evil and is ripping everyone off.” So, one day I was at home in Billings, and the doorbell rang. It was someone from the Tester campaign, asking if they could count on my vote.

I looked at him for a few seconds, and I said “I work downtown at the ConocoPhillips refinery. You have said some pretty nasty things about my industry, and insulted a lot of hard-working people in the process. So tell me why I should vote for Tester.” The guy looked very uncomfortable, and said “Look, buddy. It’s not personal. It’s just politics.” So I responded with “And it won’t be personal if I don’t vote for him.”

That is Jon Tester. A man with some good idea, but also very quick to fall in line and resort to the ad hominem attacks in order to win votes. In his proposal above, he calls for responsible drilling, conservation, and investments in renewable energy. I am with him on those. And then he makes some completely asinine statements that make me wonder “Is this guy serious?” Here are some examples:

But I want to be darn sure that oil stays in America, not shipped off to Asia so the big oil companies can make more record profits.

That’s stupid on several fronts. First, oil removed from federal lands must already stay in America. Second is the implication that oil companies are engaged in the shady business of sending oil to Asia when we have shortfalls at home. (More on that below). Finally, he wants to be sure that America’s oil stays in America. How about Canada’s oil? As Canada is our largest supplier of oil, where would we be if Canada adopted Tester’s plan – that Canada’s oil stays in Canada? What if all of our suppliers adopted that position?

You would think from listening to some politicians that the big oil companies’ agenda is the solution to record high gas prices. That defies common sense when the U.S. is exporting 1.4 million barrels every day to other countries.

That’s just rubbish. He needs someone on his staff to do a bit of investigating before he makes uninformed statements like this. First off, here are the numbers from the EIA on exports from the U.S. of petroleum and petroleum products. What is the #1 destination for these exports? Mexico, one of our largest suppliers of crude oil. #2? Canada, our largest supplier of oil. And what are we sending them? Here, again, is the breakdown. The #1 product that we are supplying? Petroleum coke. #2? Residual fuel oil.

Less than 10% of what is exported is gasoline, and less than 2% is crude oil. Is that the picture Tester painted? Of course not. He has us exporting over a million barrels of crude oil to China so big oil can get rich. This is the Tester that I found so annoying during the campaign. Is he badly misinformed, or just playing political games?

Of course one might ask why we would export any petroleum products to other countries. That’s quite easy. If you are a refiner in Montana or Texas, and your product pipelines are full – or your orders are otherwise filled – you may sell some across the border to Canada or Mexico. Or, your petroleum coke that you might not be able to find a home for (and which you are selling at a loss) ends up going out of the country. Or you have some material that doesn’t meet U.S. specs, but it does meet the specs of some other country. When I was at the refinery, I remember we got in a shipment of butane. It did not meet one of our specs, but it did meet Mexico’s, so we sent it south. It had originated in Canada, came to Montana, and ended up in Mexico. It was counted as an export.

Further, I think if we adopted the position that we won’t sell to Canada or Mexico (which may be prohibited by NAFTA anyway) then we might have trouble convincing them to provide oil to us. This would be a problem, since those two countries provide more than three times the amount of oil to us as the amount of exports Tester is complaining about.

The irony then in Tester’s e-mail is that he felt compelled to write:

Some on the other side of the aisle are not shooting straight with Montanans.

And

It’s a shame partisan politics gets in the way of common sense.

I guess we can be thankful that Senator Tester is above all of that.

So, I am running through some of my daily news searches – things like “gas prices”, “gas gouging”, “alternative energy”, etc. I ran across this gem:

Gas price gouging becomes even more obvious

It is basically just another ignorant screed from someone who apparently thinks oil companies can just raise and lower prices at a whim:

As long as no significant gasoline retailer breaks ranks and the price at the pump remains fairly constant from one street corner to the next within a region, there is no reason for any oil company not to raise prices. So they do.

An absolutely abysmal understanding of the issues. It is funny that people seem to understand that when the price of gold rises, gold mining companies make more money. And there doesn’t seem to be this widespread belief that the reason they are making more money is that they just decided to raise the price of gold. People understand that they can’t do this. But these same people seem to think that oil companies can just go out and raise prices when they want.

And then this:

Oil companies last fall did all they could to keep Republicans in the majority in Congress because no matter how high prices went during its reign, the GOP never did a thing to rein them in. No hearings questioning oil company executives about their pricing practices. No anti-gouging bills. Nothing.

Prices drop every fall, for reasons I have explained several times. Last year was no different, it just happened to be an election year so it gave the conspiracy theorists something to get worked up over.

As I worked my way through the article, I thought “Boy, this sounds just like the FTCR’s hysterics.” Then I reached the end:

“These figures show that gasoline prices are not about the price of oil, but about maximizing the already obscene profits of oil companies and their refiners,” said Judy Dugan, research director for the consumer advocate Foundation for Taxpayer and Consumer Rights.

LOL!

So, what is the connection between record gas prices and record profits? Absolutely yes, there is a connection. I expect oil companies to once again turn in huge profits (keeping in mind that the profit margins are in line with other industries) and there will be a new round of political grandstanding. Eventually congress is going to be pressured into passing some sort of legislation, but almost everything that will be politically palatable to them will make matters worse for consumers in the long run.

Right now the money is being made in the refining sector. When oil prices stay constant, and gas prices skyrocket, most of that is going to the refiner. Refining margins are certainly very healthy right now. But too many people – including most of the politicians – have their cause and effect backwards. High refining margins do not cause high gas prices. The high gas prices are not a result of the desire of the oil companies to make more profits. (They do desire to make more profits, but they can’t just raise gas prices as a result). The high profits are a result of the fact that gas prices have risen. (And of course some of those high profits are going to pay for things like compulsory ULSD and ULSG requirements, the phasing out of benzene, etc.)

Why have gas prices risen? Is it as the article above suggested – just companies raising prices with nobody breaking ranks? Anyone who takes a bit of time to watch the utilization numbers, imports, demand, and inventories will understand why price moves as it does. I know that takes a bit more effort, and that the lazy way out is to just argue – as Judy Dugan says like a broken record – that the price rise is “about maximizing the already obscene profits of oil companies and their refiners.” And it is obvious that many are ignorant of the basics and too lazy to do the research. The scary thing is that many (most?) of our political leaders fall into that same category.

A fundamental problem, which the Judy Dugans of the world never seem willing to address, is that Americans like to drive whenever and wherever they want. Now that the price of this habit is coming home to roost, they demand that politicians protect them so they don’t have to change their consumptive ways. Tell a European or an Australian about the pain of $3 gasoline and they will laugh in your face.

The best thing for all parties would be to come to terms with the fact that the days of cheap oil and gasoline are over. That era is finished. Start planning for the next one.

This is quite timely coming on the heels of my previous essay. I talked about the press picking up and running with the comments of Oil Watchdog’s Judy Dugan as if she were actually a credible source of information. Here’s a perfect example:

Consumers boil over oil profits

For years, oil companies have been cast as villains. That perception didn’t change Friday when the two largest U.S. oil companies reported record profits — again.

Let me first say that I certainly understand why consumers are upset. I remember when I was younger and commuting a long distance, every increase in gas prices really hurt. If oil companies were reporting record profits at the same time I was paying record amounts for gasoline, I would have been angry as well.

Last year, Exxon Mobil reaped more money than any U.S. corporation has ever made, while consumers were sliding into a recession, said Judy Dugan, research director for the Foundation for Taxpayer and Consumer Rights in Santa Monica. At the same time, oil companies have lobbied against any control of the market that has pushed crude oil to $90 and up, she said.

“Their product is so important to our economy that energy costs alone are driving inflation and raising consumer debt,” Dugan said.

I am really curious as to how Dugan thinks the market can be controlled. When OPEC controls 40% of it, and the ExxonMobil’s of the world control less than 10%, it is really hard to grasp how Dugan thinks the oil companies are controlling this market. What does she think governments should do? But, it has become obvious to me that you don’t have to grasp the issues in order to be a self-proclaimed watchdog.

Dennis Clancy of Thousand Oaks has been unhappy with oil companies. “I’ve always had a problem with gas prices over $3,” he said while filling up at a Shell station in Camarillo. “It shouldn’t cost over $50 to fill up a midsize car.”

He wants to see more proof about how the oil companies’ profits are utilized, as well as less dependency on foreign oil.

Do you really want to see less dependency on foreign oil? Then embrace higher prices, which will get Americans to drive less and buy more fuel efficient cars. Downsize that midsize car. Don’t put yourself in the position where you demand a lot of gasoline, and then get made at the oil companies when the price goes up. Take matters into your own hands and reduce your own dependence, if you expect the country as a whole to reduce dependence.

Oil companies blame energy markets for high crude prices, but they profit immensely from these markets and oppose controlling them, Dugan said.

“The government has to get some control over these unregulated electronic energy trading markets,” she said.

Oil companies are spending billions of dollars buying back their own stock instead of investing in renewable energy or their own refineries, which, Dugan says, is the very definition of greed without regard for corporate responsibility.

More hysterics and fabrications from Dugan. Are oil companies buying back stock? Sure, I would be as well if I felt my stock was undervalued. But that doesn’t mean they aren’t investing back into their business. Oil companies have spent far more money expanding refineries and upgrading to meet ever tighter environmental regulations (like ultra-low sulfur product specs). Dugan’s comments are the very definition of reporting without regard for journalistic integrity.

“I’m still almost speechless at the amount of profit they made,” Dugan said. “Americans should be furious.”

We can all wish. Fortunately, there was some sanity injected near the end of the article:

The oil companies have always been “the bad guy,” but perhaps they don’t deserve the label, said Jack Kyser, chief economist of the Los Angeles County Economic Development Corp. “People don’t understand the world has changed for oil companies,” he said.

It’s becoming more expensive and difficult to find oil fields, and oil companies are trying to explore in nations where real danger or politics are involved, Kyser said. Consumers feel the pain at the pump and don’t think about the kind of infrastructure that oil companies have to build to access the oil, or the political risks.

“In a way, they’re becoming a declining industry,” Kyser said, adding that seems contrary to the companies’ financial growth. But, he said, he believes that their position as the world’s major players has changed. “It’s a whole different ball game. They don’t have the clout they used to have,” Kyser said. “They can’t go into a country and sign contracts and expect stability anymore.”

While oil companies have been accused of price gouging, Kyser said, he believes they’re simply trying to protect themselves for tough times ahead. “Everyone acts like it’s blue skies for them, but if you look over the history of the industry, they’ve had some very lean times,” he said.

This is more or less the way I see it as well. The risks have gone up dramatically for oil companies, as those operating in Venezuela found out last year. If oil prices were to unexpectedly crash, I suspect the climate would become friendlier as governments wouldn’t want to assume the risks for projects.

That’s why Venezuela invited oil companies in to start with: Prices were low, the risks were high, and the projects were expensive. So, oil companies were invited in, and contracts were signed. Then, as soon as prices shot up, Venezuela cancelled contracts and seized control. This is the world oil companies must operate in now; it’s very high risk. The Judy Dugan’s of the world would like to see oil companies take the risks, but not be rewarded when markets bid up the price of oil.

The refining sector has been in the news a few times this week, and not in a good way:

A Fine Mess For U.S. Refineries

HOUSTON — Excess capacity, weak demand for fuels and rising product inventories continue to squeeze margins for U.S. oil refiners.

Sunoco, the second-largest refiner in the country that doesn’t produce its own oil, said late Tuesday that it will soon shutter its Eagle Point refinery in Westville, N.J., which has a capacity to handle 145,000 barrels of oil per day. During the second quarter, Philadelphia-based Sunoco lost $77 million in its refining business and told analysts Tuesday that the third quarter could be worse.

A point that I have tried to stress is that for the most part, refining is not a lucrative business. It is a risky business. You may have five poor years and then one or two really good years. And then when you have a good year, you are accused of gouging and everybody wants a bigger piece of the profits – while sharing none of the risk. You can’t find those people during the bad years; they only show up when times are good.

I couldn’t help but think of Oregon Senator Ron Wyden when I read about the shuttering of the Sunoco refinery. You see, Senator Wyden has devoted a lot of time to investigating these sorts of “shady” practices, where refiners shut down refineries just to limit capacity and boost profits. He produced a comprehensive report on this a few years ago:

The Oil Industry, Gas Supply and Refinery Capacity: More Than Meets the Eye

Two excerpts from the report:

Specifically, the documents suggest that major oil companies pursued efforts to curtail refinery capacity as a strategy for improving profit margins; that competing oil companies worked together to subvert supply; that refinery closures inhibited supply; and that oil companies are reaping record profits, yet may benefit from a proposed national energy policy that would offer financial incentives to expand refinery capacity.

The major oil companies had a financial interest in seeing the closure of independent refineries. By reducing the overall supply of oil and gas and reducing the number of companies involved in producing it, the major oil companies can have tighter reins on the supply and the price.

You see, Senator Wyden believes that when refineries shut down, it is some sort of organized attempt by “the industry” to reduce capacity and boost prices. When prices are sky high, this may seem like a plausible explanation. When a refiner is losing millions quarter after quarter, it no longer seems so plausible. It looks like someone exiting a business they no longer find profitable.

I documented some of Wyden’s silliness in Gasoline Prices Part II: Long-Term Factors. The bottom line is that refiners may eventually once again benefit as excess supply is shut down. And that’s the way it works in any business. If you are producing too much of something, the price is low and marginal producers go out of business.

A lot of refiners are in trouble right now. Sunoco won’t be the last one to shutter a refinery. Maybe two or three years from now, we will once again see a short burst of profitability as the supply/demand balance tightens back up. But maybe Sunoco’s Eagle Point refinery has lost half a billion dollars by then. This is the calculation they have certainly gone through, and their conclusion is that they will be better off to shutter the refinery.

But what would Senator Wyden do if he owned Eagle Point? I have to conclude, based on his report above, that he would continue running it so prices remained low for everyone. In fact, I wouldn’t be surprised to see him expanding capacity. He might end up losing a few hundred million dollars each year, but hopefully he has a big pile of money to draw upon. It reminds me of the joke about the farmer who won the lottery. When asked what he would do with his winnings, he replied “I’m just gonna keep farming until the money is all gone.”

Senator Wyden – and a great many others who think as he does – would apparently keep refining until the money is all gone.

Ten years ago, I did a lot of investing into individual stocks. While my investing these days is mostly limited to mutual funds, one thing that always attracted me was when a company bought back shares of their own stocks. To me, this always signaled confidence in the company, and a belief from insiders that the stock would perform well in the near future. While there are some who feel that stock buy backs are what companies do when they don’t have very good investment prospects for their cash on hand, share repurchases always made perfect sense to me. If I were the CEO of a company, and I felt like my company was undervalued, share buy backs are going to be one way of enhancing shareholder value.

Yet the stock buy backs from Big Oil are often talked about as if they were reprehensible:

Congressional panel takes Big Oil to task

“Oil companies today are enjoying record profits, and while they could use those profits to invest in more production capacity, instead they use the money to buy back shares in the markets,” complained Rep. John Conyers Jr., D-Mich., the panel’s chairman.

Oil Companies Manipulate Markets and Gouge Consumers

High energy prices are translating directly into record oil company profits. In the first six months of 2006, the five largest U.S. oil companies posted $59.4 billion in profits. These companies have spent $112 billion since 2005 to buy back their own stock and pay dividends rather than invest in infrastructure or alternative energy sources, according to analysis done by Public Citizen.

Big Oil cautious about clean-energy spending

The amounts that oil companies invest in alternative energy typically pale in comparison to some of their other expenditures.

Exxon spent $19.9 billion in 2006 on capital expenses and the hunt for more oil. It also paid $29.6 billion to buy back some of its own stock, a move meant to reward investors by increasing the value of outstanding shares. The company’s annual profit hit $39.5 billion, the most ever for an American company.

Chevron spent $16.6 billion in 2006 on exploration and capital expenses, which include maintaining refineries, pipelines and other facilities worldwide. The company spent $5 billion on buying back stock. Chevron made a $17.1 billion profit for the year.

ConocoPhillips spent $16.3 billion on exploration and capital expenses, and $925 million on buying back stock. The company’s 2006 profit topped $15.5 billion.

Yet if Home Depot or Best Buy announce stock buy backs, there is no public outcry. CNN’s take on it is more to my liking. In the wake of ConocoPhillips’ announcement yesterday of a $15 billion share buy back, CNN wrote the following:

Buyback Announcements Are Bullish For Market

Shareholders of two blue-chip companies, as well as investors generally, were treated Monday to a bit of good news that carries potentially bullish long-term consequences.

First, Johnson & Johnson (JNJ) announced that its board of directors had authorized the repurchase of up to $10 billion of its common stock.

Then, later in Monday’s trading session, ConocoPhillips (COP) announced that its board had approved a $15 billion share buyback program, representing an increase of $13 billion above and beyond the $2 billion that remained in a previous buyback program.

These announcements are good news because the average company that repurchases its shares outperforms the market by an annualized average of 3.1% over the four years following the announcement of its share repurchase program. That’s the finding of perhaps the most comprehensive academic study of repurchase programs, which appeared in the Journal of Financial Economics.

Why would repurchases carry such bullish potential? One theory explains it in terms of simple supply and demand: Repurchases reduce the supply of a company’s stock outstanding, which according to Economics 101 should increase the price of those shares that remain.

Another theory: Companies that repurchase their shares are so confident about their future prospects that they are willing to commit corporate resources to buying them. This is worth paying attention to, since a company’s executives and Board of Directors have access to insider information that the rest of us do not.

I am sure we will be treated to a lot of negative stories about the COP buy back, but I don’t suspect the same is true of the J&J buy back. That will be viewed as a shrewd move by their CEO.

Just wanted to provide a quick update, since it will be a few more days before I have a new essay up. I am trying to finish up an article on Peak Oil for Omninerd, and need to devote a couple of days toward working on that. I recently finished my first submission for The Oil Drum entitled Big Oil and Alternative Energy . Feel free to comment on it at The Oil Drum, or if you aren’t registered there you can comment on it in this thread. The article addresses the statements from various groups that oil companies should invest their record profits into alternative energy. I explain why this is wishful thinking.

Below is a list of subjects that I will be covering in upcoming essays (not necessarily in this order), along with a brief description. If you have a topic you would like to see addressed, let me know.

The Solar Economy – I have only mentioned solar energy on my blog in passing, but it is far and away my favorite alternative energy choice. There is nothing else that compares to the efficiency of direct solar capture. I can envision a society that is driven largely off of solar power, but electrical applications and many automotive applications would need to be operated via rechargeable batteries.

The Diesel Economy – Even if we had no oil at all left, we can produce diesel from coal, natural gas, or even biomass. The capital costs are pretty high, but the feasibility exists (and in fact, is already taking place).

Fischer-Tropsch – I plan to give a brief, layman’s overview of this very important reaction, which will enable The Diesel Economy. This is also how the Germans produced some of their liquid fuel in WW2.

GTL – Gas to liquids, or diesel production from natural gas. This option is currently well under way in Qatar.

CTL – Coal to liquids. This is Montana Governor Brian Schweitzer’s dream for Montana coal. While it is viable, capital costs will be high, and the environmental costs may be steep. I will have a detailed discussion of the issues.

BTL – Biomass to liquids. This one is the least developed, but has the most potential for producing diesel from a renewable resource. I will discuss potential hurdles to be addressed.

I am open to suggestions on other topics. As always, I will continue to comment on current events, so I expect this list of ideas to take me through the next month or so. But I am always open to suggestions.

On May 15th, the Senate Committee on Energy and Natural Resources conducted a hearing entitled Short-Term Energy Outlook Summer 2007: Oil and Gasoline. You can listen to the web cast here. I have done so, and this essay will be about my impressions of the hearing.

You can find the testimony of the various witnesses at the links below:

Mr. Guy Caruso – EIA Administrator
Paul Sankey
Geoff Sundstrom
Kevin Lindemer

Mr. Sankey is an analyst with Deutsche Bank, Mr. Sundstrom represents AAA, and Mr. Lindemer is an analyst with Global Insight. The witnesses really knew their material, although Mr. Sundstrom seemed terrified and Mr. Caruso had to make sure some of his answers were “politically correct.” On one occasion he stated that the EIA does not foresee that cellulosic ethanol is going to scale up to even a billion gallons by 2030, and one senator said “Isn’t that in direct contrast to what the president thinks?” Then some pretty nifty tap-dancing ensued.

The Q&A, in my opinion, was an embarrassing display of partisan politics, and revealed serious deficiencies in some of the senators’ understanding of energy issues. Some Republican senators took the opportunity to push for coal-to-liquids and drilling in ANWR, and some Democrats did a bit of grandstanding over windfall profits – directly ignoring the answers the witnesses were giving them.

For example, Paul Sankey had explained that oil companies lost a lot of money in the 80’s and 90’s, and therefore investments fell off. A couple of different senators kept asking the same question again and again: “Yeah, but why aren’t they investing today, with record profits?” And Sankey kept telling them that they were.

Sankey didn’t mince words at all, and at one point told the committee to keep in mind that these record high prices are less than half the level of the prices in Europe.

Anyway, here were some of the more interesting exchanges which I transcribed myself. Senator Craig Thomas was the first to demonstrate that he didn’t understand the answer to a question:

Senator Craig Thomas: Most any time that you have great markets and so on, you also have investment, like in the refineries. When the market is there, and the price is high, I don’t understand the lack of incentive to invest.

Paul Sankey: The incentive is there, and the companies are now investing, it’s just not an issue that you can expect that 4 years after companies are making losses, that suddenly there is an exponential increase in investments in refining capacity. It’s just not that simple. It’s a very tough market out there for any kind of infrastructure investment, as I mentioned you have competition from the Canadian heavy oil sands, you have competition from Asia, in Europe; but these companies are increasing their investments. The fact is that the companies are deploying capital to the best of their ability. One disincentive for investment is brought about by uncertainties in regulation and government interference. One concern they have is that regulations will cause them to lose money if they invest now. In my opinion it’s in your interest to maintain a stable regulatory environment to encourage investment.

Senator Craig Thomas: I agree with that. But if lack of infrastructure is causing the price to go up, and the companies are not investing in infrastructure then it seems to be a bit of a contradiction.

So, right after Sankey says they are investing, Senator Thomas can’t understand why they aren’t investing. I lost count of how many times Sankey went through the investments that are taking place now.

Immediately after the above exchange, Senator Ron Wyden from Oregon apparently awoke from a slumber, because he asked the same question:

Senator Wyden: Mr. Sankey, quick question. You stated that in the 80’s and 90’s, there were poor returns for the companies, and that contributed to their problems. But now we also have the problem of starving investment in refineries, but we have record profits. Certainly that’s been the case for the last 5 or 6 years. Why wouldn’t the companies have invested in refineries and in the infrastructure – the things that were missing in the 80’s and 90’s – in the last 5 or 6 years?

Paul Sankey: This goes to the same point. You had losses as recently as 2002, and there have been changes in regulations – potential threats to gasoline as the fuel you want to make in this country. If you are talking about an investment of 2 or 3 billion dollars, it’s immensely expensive now to add refineries, and there are huge amounts of uncertainties over how much it will ultimately cost you because of all the other challenges that there are out there with global energy infrastructure competing away the staff and materials to do the job. But even amongst all that, we have some fairly significant investment going on right now. One of the subtleties here is that we may not be adding a tremendous amount of capacity, but in terms or our ability to upgrade more complex heavy, sour crude there is very definitely a surge of investment going on.

Senator Wyden: I can see the argument, and you make it eloquently in your paper for not going forward with investments in the 80’s and 90’s; it just doesn’t make sense given these record profits.

You have to wonder whether he heard a word that Sankey said. Is he just posturing? Or is he not paying attention? Or does he not understand that investments are actually being made (as I show in later)? Yes, these are the people formulating our energy policy.

The other exchange that I watched in disbelief happened between Senator Robert Menendez and Sankey:

Senator Menendez: Over the past few years, it seems that bracing for the onslaught of record high prices at the gas pump has become as common as planning for the summer vacation. And we see prices rise and fall, we understand the concept of a changing supply and demand chain, that’s not foreign to us, but when we see no singular event, no visible cause for the increase in prices, consumers scratch their heads and try to figure out what’s happening. This is the 3rd year in a row in which consumers are facing gasoline prices above the $3/gallon mark. Yet there’s no devastating hurricane this year; there’s no single event at a refinery or in an OPEC country that explains why, in the first half of May, consumers are already experiencing sticker shock. Mr. Sankey, when you say there is no price manipulation through the whole supply chain, then why do prices seem to spike during times of greatest motorist activities such as the summer, and Memorial Day weekend? Now, I am sure that demand is part of the answer, but it seems that we find that it is in these time periods that the prices spike. Is that just convenience, that it just conveniently happens that way? Is it just a pure coincidence?

Now remember, Senator Menendez just said that he understands all about supply and demand, and now is asking if it’s a coincidence that prices increase at the times of highest demand. If I had been a witness, it would have been hard for me to hide my disbelief at this question from another member of the Senate who happens to be formulating energy policy.

Paul Sankey: I would highlight once again, that BP has 2 of the 5 largest refineries in the U.S. effectively running at half capacity right now because of the safety issues. What happens in times of such tight capacity is that you have an extremely seasonal market. What happens is that at times of demand run-up, you begin to exceed available supply and prices rise exponentially, attempting to price out demand or encourage more supply. What you will find in such a tight market is that in winter you will suddenly get tightness in natural gas and heating oil, because there isn’t that available spare capacity to address the sudden seasonal rise in demand, and when you get to driving season – because everyone loves to go to the beach on Memorial Day – what you find is that you exceed available supply and then prices rise exponentially.

Then Senator Menendez gets his facts completely wrong:

Senator Menendez: Isn’t there a reality that we are paying for some industry decisions that actually reduced refining capacity in this country? I mean there was a time that we had greater refining capacity, and the industry reduced that refining capacity, and as a result of making that decision, consumers today find themselves with exactly the consequences that you have described in your testimony before.

Sankey then tried to explain something about the cycle, but did not correct Senator Menendez on the key point: Refining capacity has not been reduced; it is at an all time high. Some refineries have been closed down, but the expansion of the existing ones far surpasses the lost capacity from those that were shut down. See my essay addressing this.

But Senator Menendez continued:

Senator Menendez: My point is that the reduction in refining capacity helped drive up the cost.

Your point is incorrect, and you misinformed a lot of people when you made it. Perhaps this kind of misinformation explains some of your anger at the oil industry?

But don’t take my word for it. Visit the EIA and see the numbers for yourself. Refining capacity has increased by 2 million barrels per day in the past 10 years. And in the past 5 years? The years that Senator Wyden complained that no investments were being made? Refining capacity has increased since 2002 by 700,000 barrels a day – 250 million barrels a year. To put this in perspective, that amount is equal to 10.7 billion gallons, or about double the entire ethanol production in the U.S. That’s the amount of refinery expansion that a number of senators on the committee pretended never happened because they believe no investments have been made (and this on top of the investments to upgrade heavy, sour crudes and to produce ULSD and ULSG).

Final Thoughts

I don’t know if the committee members are really so uninformed, or whether they were just playing politics. You got the impression watching the web cast that they were making some statements just to make sure those were picked up by the media, regardless of whether they were accurate. Senator’s Wyden’s comments are a perfect example. It was clearly explained to him that investments are being made, and then he turned around and asked why they weren’t investing.

The comments from Senator Menendez may be another matter. He may actually believe that refining capacity has been reduced. But he is on the energy committee. He should understand the overall picture. This is important stuff, and we can’t have energy policy being formulated by people who are either proceeding with half-baked ideas, or are just interested in scoring political points.

There is also one thing that all politicians must come to grips with. Let me make it crystal clear that I firmly support tough environmental regulations. I support the move to ultra-low sulfur diesel (ULSD) and gasoline. I support phasing out benzene in gasoline. I would also point out that Senator Wyden has been actively involved in this issue. But the politicians have to understand that these regulations do have consequences. If you tell refiners they must install equipment to produce ULSD, there are four things to keep in mind.

First, this necessarily redirects capital that might have gone into expanding refining facilities. Second, it increases the costs of producing the fuel. Third, this additional level of processing reduces the overall product yield. Fourth, and perhaps of greatest importance, it increases the complexity of the refinery. Those are the consequences. The more complex the refineries are, the more unreliable they are going to be. So, when you formulate these sorts of rules, don’t sit around and scratch your heads and ask “Gosh, I wonder why gasoline prices are going up?” A big part of the reason gasoline prices are going up is because of the policies you have enacted. Many of which – as in the case of the aforementioned environmental regulations – I agreed with. Nonetheless, these are issues that helped crimp supplies and add to costs.

But I have to tell you that I am sick of this crap. I want you guys to put your heads together and formulate a coherent energy policy. Stop playing politics with this. It is far too serious a matter. Also, the committee members need to get up to speed ASAP on energy issues. We don’t need members on the energy committee who have a tenuous grasp of these issues. Finally, listen to what your experts are telling you. If you are going to call expert witnesses to testify, don’t completely ignore their testimony just so you can spew your canned sound bites. START SOLVING SOME FLIPPING PROBLEMS!

I have a few essays in the queue (including a nifty biodiesel story), but I thought I would comment on an article in today’s Deseret News out of Salt Lake City. The article was entitled “Will U.S. Slap Tax on Big Oil Profits?”. (1) A few excerpts from the article, followed by my comments:

Republican Sen. Arlen Specter said Sunday that the U.S. Congress should consider taxing the “windfall profits” reaped by oil companies as a result of surging crude oil prices.

I understand the frustration with high gas prices even as oil companies rake in record profits. But what is Specter trying to accomplish? Does the good senator believe this will magically bring the price of oil down? Will it cause OPEC to open the taps, flooding more oil into the market? Or is the real purpose to punish oil companies for making money, so he can boast about it during his reelection bid? Would he stipulate that the money be allocated to somehow reducing our demand for oil, which is the real issue?

Specter, of Pennsylvania, earlier this month introduced legislation to strengthen antitrust enforcement of the oil and natural gas industry to counter the consolidation of production and refining operations. Sen. Byron Dorgan, D-N.D., is proposing a 50 percent excise tax on profits from oil sold at more than $40 a barrel.

Let’s think about that for a moment. A lot of oil is expensive to extract, and only becomes economically viable as oil prices climb higher and higher. As oil prices climb, the incentive to pump more oil increases. If more oil can actually be pumped, it should eventually result in an oversupply situation, and prices will come back down. (This is why the oil industry is cyclical). If more oil can’t be pumped, then prices won’t come down.

However, neither situation is helped by slapping a tax on oil over $40 a barrel. In fact, such moves decrease the reward for marginal producers, which may lead them to shut in production. Since foreign producers won’t be paying that tax, what do you think is going to happen? U.S. production will decrease further, imports will increase, and oil prices will remain high. If high oil prices are the objective, then this is a way to accomplish that objective.

“Windfall profits, eliminating the antitrust exemption, considering the excessive concentration of power are all items we ought to be addressing,” Specter said Sunday on CNN’s “Late Edition” program. “Anybody up for election this year ought to be working very hard, taking it very seriously.”

Oh, I bet they are. That’s why they ignore the real reasons for rising oil prices, and aren’t doing anything to address those issues. They are posturing and pandering, trying to make sure they get themselves reelected. The founding fathers would be rolling over in their graves if they saw the level of mediocrity that permeates our government today. Nobody has the guts to stand up and tell the truth.

Sen. Carl Levin, D-Mich., said President Bush should call oil company executives to the White House and tell them he’ll support a new tax on their profits unless they lower prices.

“I’ll bet that the price of gasoline would come down within a matter of days,” Levin said on the CNN program. “We need a windfall profits tax because these profits have been absolutely obscene.”

Wow! Is Levin this uninformed? Does he think oil company executives set the price of oil? Does he not understand that oil is a global commodity, and if China or India are willing to pay more for oil than we are, then that is going to drive the prices up? That’s sort of like asking a company to lower the value of their stock, because you want to buy some, but think it’s too expensive. It’s the price it is because that’s what buyers and sellers in the open market have agreed upon for a value. Oil company executives do not set the price of oil. This only happens in politician’s dreams.

Bush, in California over the weekend to promote his initiative on alternative fuels, said a lack of refining capacity in the United States and the thirst for oil in emerging economies such as China and India are contributing to increased energy costs. He said he recognized the price of gasoline is hurting consumers and warned that the price is likely to go higher.

Like him or hate him, Bush is correct about this. I bet even the good senators would agree with this. So, let’s pose a question. A lack of refining capacity is a problem that is putting a lot of pressure on gasoline prices. Expanding refineries takes lots of capital. If we extract more money from the oil companies in the form of punitive taxes, are they likely to spend more money or less money on capital projects? Now, is this likely to make the refining bottleneck better, or worse? Again, if your goal is to have gas shortages and drive the prices even higher, then they are on the right track. Like I have said before, we tried this already and it didn’t work. (2) From a 1990 Congressional Research Service report:

“The windfall profits tax reduced domestic oil production between 3 and 6 percent, and increased oil imports from between 8 and 16 percent. This made the U.S. more dependent upon imported oil.”

This report should be required reading for legislators who think a windfall profits tax is a good idea.

Specter has focused his attention on oil industry consolidation and competition. “We have allowed too many companies to get together to reduce competition,” he said.

There were more than 2,600 mergers in the oil industry in the 1990s, according to James Wells, director of natural resources and the environment for the Government Accountability Office. A study by the GAO, Congress’ research arm, found that concentration of market power may have added as much as 7 cents to the price of fuel, he said.

As much as 7 cents? I think Senator Specter has identified the culprit. Gasoline prices are “as much as” 7 cents higher than they would be had they stopped those mergers. This is clearly the source of spiraling gas prices. If it was “as much as” 7 cents, I wonder what the lower estimate was. It really sounds like Specter is on a wild goose chase.

While politicians pander, I am still waiting for someone in government to have the guts to suggest that a potential solution to this problem is to encourage Americans, somehow, to conserve. I am waiting for someone to explain that cheap oil is not an American birthright, and as long as China and India compete for the same oil, there will be no more “cheap” oil. Of course more expensive oil will enforce conservation eventually. Maybe the politicians are much smarter than I think, and this is part of the plan. If we adopt the policies they are advocating, oil prices will spiral out of control, gas will no longer be affordable, and we will finally start conserving. Maybe there is a method to their apparent madness.

References

1. “Will U.S. Slap Tax on Big Oil Profits?”, Deseret News, April 24, 2006.

2. Glassman, James K., “Windfall Profits” Tax on Oil Companies, Capitalism Magazine, September 26, 2005.