New swaps definition provides needed exemptions for energy industry

By Dorothy Davis

In 2010 Congress passed the Dodd-Frank Wall Street Reform and Consumer Protection Act with the primary goal of re-regulating the financial system with stronger consumer protections and greater transparency. But the act's broadly written rules also inadvertently folded in an array of day-to-day transactions carried out by the U.S. energy industry, which frequently uses derivative contracts that are not easily standardized.

Of major concern to energy companies was the possible inclusion of physically deliverable forward contracts as swaps and being designated as swaps dealers if the notional value of their transactions fell into ranges as low as $100 million annually.

Energy companies often enter into long- and short-term physical transactions to buy and sell electricity, natural gas and other fuels to serve customer needs, and sometimes use financial hedges to manage volatile prices, outlines Reuters.

After two years of deliberation, federal regulators have at last approved a definition for swaps under the Dodd-Frank Wall Street Reform and Consumer Protection Agency, which includes crucial exemptions for many energy companies.

The two agencies overseeing the implementation of the new rules - the Commodity Futures Trading Commission and the Securities Exchange Commission - approved the rule on Wednesday, setting in motion more than 20 separate regulations that were waiting only on a definition for swaps.

The financial instruments are intended to help control the risks facing companies by exchanging two distinct streams of revenue. However, there were some worries that certain contracts allowing energy companies to purchase fuel in response to changing consumer demand could fall under the definition, potentially raising costs around the country.

Risk magazine notes that the CFTC ultimately proved receptive to concerns from the energy industry about unnecessarily raising costs in a sector that relied on swaps contracts for legitimate hedging, both with the definition of swaps and the inclusion of an end-user exemption to clearing requirements.

Businesses meeting the newly revised definition of a swap dealers will have 60 days to register after the final rule is published.

Dumping Oil Speculation (and Other Bad Habits)

New Eyes on an Old Industry
By Hilton Price

This year, I finally managed to do something I’d wanted to do for years; quit smoking. Before I worked for the greatest website in the oil & gas sector, I was in television news. If you’re unfamiliar with the behind-the-scenes goings-on of a TV news station, allow to me to impart one important fact: Quitting smoking is next to impossible when you work in TV news. I always promised myself once I left the industry I’d finally quit, and a few short weeks after beginning my tenure with PennEnergy, I made good on my promise.

I remember being a smoker very well. I remember the anticipation of my next cigarette break, especially if it meant getting away from my daily workload for a few minutes. I remember the soothing feeling nicotine had on me, truly a sign of my (at the time) serious addiction. Most of all, I remember how I always knew how bad those little sticks were for my health, and how I smoked them (sometimes eagerly and happily) despite this knowledge.

I bring all this up because in learning about the oil & gas industry, I have been reminded my former tenure with cigarettes. Smoking cigarettes is a lot like oil price speculation. If my new eyes on an old industry understand this right, neither makes any logical sense and seems to only cause harm, yet the practice continues largely unabated every single day.

The process of speculation is headache-inducing due to its complete lack of regard for supply and demand. Oil pricing revolves around futures, essentially a pre-set price for a delivery sometime down the road, making the classic supply/demand model no longer applicable. Now, oil sellers need only offer a price that they believe the buyer will agree to, no matter how the price is determined. The final price could be determined by a gust of wind, conjured from animal bones, or simply pulled from the ether by the imagination of an inebriated hobo. As long as the buyer agrees, congratulations! You just set the price for oil!

It’s a wonder every business across the globe hasn’t adopted this approach to pricing. If they could, I’m sure every store at my local mall would love to implement this. Instead of paying $120 for a pair of jeans today, shoppers would now agree to buy a $500 pair of jeans in 5 years. Denim futures would create a whole new generation of millionaires. Personally, I think having to sign promissory notes would make the whole shopping mall experience a lot more interesting. And don’t get me started on the food court. Panda Express would be the new high-water mark in upscale dining, with reservations made 3 years in advance.

Smoking (and exaggeration) wasn’t my only pointless habit. I’ve also always been a bit of a collector (trading cards, comics, games,) so I understand that sometimes things are priced excessively high. Every comic book store has a few books hanging behind the counter because they are “collectible.” The demand may not be obvious and immediate, but since the book is rare, it can demand a higher price than others.

But we’re not talking about some niche collector market. This isn’t baseball rookie cards or obscure comic books from the 50s. This is the one commodity, besides food, that nearly everyone in every industrialized nation is using. So, we’re essentially ignoring the demand on one of the few items that will always have demand. The growing interest and shrinking cost of renewables means demand for oil will one day be replaced by demand for something else. So, not only are we ignoring the massive demand for oil, we’re failing to take advantage of that demand while it exists! Save the futures and speculator nonsense for 100 years from now, when every home has solar panels and our cars are powered by canola oil. That will be the time to charge prices pulled from thin air. That will be the time to sucker buyers with talk of future pricing. Today is not the time for imagination in pricing. Today is the time to sell the oil to the people that want it for a reasonable price.

But, instead, the success of our speculator market has other countries interested in their own game of financial make-believe. Much like younger friends I had who once considered smoking because they saw me do it, now other countries are considering picking up our bad financial habit. Although, the U.S. is younger than China, so the metaphor is getting a little shaky. Point is, speculation has been successful for some, and now others want in. Meanwhile, there may be a chance that rational thinking could one day return to our own markets.

President Obama, always a favorite topic around the office, announced plans to crack down on speculation. At least, I think I saw that somewhere. As the 24-hour news cycle does, it was soon replaced with other stories. But I swear he said that, and whether it’s a political ploy or a real concern for the man, it’s very much needed. People are getting rich making stuff up, and not in a cool way like Stephen King or DEVO or those guys behind LOST. Their making up pricing, and we’re playing along because we think there’s no other way.

I remember another time I felt like I did something because there was no other way. I smoked cigarettes. Why? Because I had smoked for years, and I was addicted, and it was just part of who I was. Well, then I quit. Now, I don’t smoke. It’s dumb and dangerous and I don’t want any part of that. Speculation is the same. Together, as a planet, we need to quit, and keep our friends, the other countries, from starting. It’s dumb and dangerous and trust me, we don’t want any part of it.

The Path More Regulated: EPA rules generate debate, but little else clear

By Dorothy Davis

One of America's most critical resources is the nation’s electrical grid, an engine of commerce across essentially all industries. The less popular side of the electric generation industry is its role as one of the country's biggest sources of emissions.

While everyone wants to keep the lights on, consumers now more than ever are demanding cleaner energy. In response, the U.S. Environmental Protection Agency (EPA) took decisive action last year to reduce emissions. The new regulations are spread across several major new proposals covering both the energy industry and several other related sectors.

Perhaps the most widely-reported rule has been the Mercury and Air Toxics Standards (MATS), which the EPA hails as the first overarching regulation of emissions of toxic substances ranging from mercury to arsenic. Technically the EPA implemented rules governing mercury emissions under the Bush administration, but these regulations were challenged by local and environmental groups for failing to meet standards set out by the Clean Air Act.

On top of these new emissions limitations, the EPA also imposed restrictions on emissions that travel across state boundaries. The Cross-State Air Pollution Rule (CSAPR) would replace the Clean Air Interstate Rule (CAIR) from 2005 and requires more than two dozen states to reduce their emissions of sulfur dioxide, nitrogen dioxide and ozone. CSAPR has been challenged in court and the industry is currently operating under CAIR while the case is reviewed.

Lastly, a more specifically targeted rule would require that all businesses using boilers and large incinerators to meet specific emissions standards for chemicals such as mercury and other substances like soot, known as the Maximum Achievable Control Technology or MACT standards. Most boilers already meet these standards, but some 1 percent would need maintenance, modification or replacement.
Each of these new rules would be implemented under the timeline laid out in the Clean Air Act, requiring full compliance with the law within three years, with the possibility of a one-year extension at the discretion of the EPA.

The debate over these new rules has involved vehement arguments on either side, with the EPA touting huge potential health savings and many energy companies insisting the costs of implementing these new regulations could prove economically catastrophic.

The impact on electric generation capacity alone could reach a substantial level. The North American Electric Reliability Corporation estimates that, between derated power plants and retirements, the MACT standards alone could lead to the loss of anywhere from 2.9 gigawatts (GW) to 17.6 GW of generation capacity. The CSAPR regulations, meanwhile, could lead to the loss of between 2.8 GW and 7.2 GW.

Combined with all other new regulations the report predicts anywhere from 40 GW to 76 GW of lost capacity. According to the EIA, the highest figure represented more than 7 percent of the country's electricity generation capacity in 2010.

In particular, a report from Credit Suisse projects that around 60 GW of coal-fired power plants are likely to shutter. Given that NERC projected lower-than-usual capacity reserves in some of the affected areas, particularly Texas, in its 2011 Long-Term Reliability Assessment, those losses could prove costly.
Certain sectors expect to be hit particularly hard by the new regulations. The American Forest and Paper Association notes an internal report estimating as many as 36 paper mills might be forced to close without the ability to pay to upgrade outdated boilers. Those closures would cost more than 20,000 jobs. The Council of Industrial Boiler Owners projects even more substantial cuts of 230,000 jobs, suggesting that the vast majority of current boilers are entirely incapable of meeting the proposed standards at all. Replacement and improvement costs are estimated at $14.3 billion.

All told, a report commissioned by the American Coalition for Clean Coal Electricity and composed by National Economic Research Associates found that the net effect through the rest of the decade would be a loss of 1.4 million job-years. That amounts to a net loss of around 175,000 jobs. It also projects electricity rates to rise around 12 percent, imposing its own economic costs.

But not all analyses project economic losses because of the rules. Credit Suisse portrays the new regulations as an opportunity to realize larger profits on existing generating capacity that already does or can meet emissions standards, which represents the majority of all generating capacity. This will necessarily mean higher electricity rates for the affected areas, and potential economic costs as a result, but also means greater stability for natural gas-fired power plants and other electricity generators, as well as the potential for greater investment in new capacity that meets emissions standards.

A Bloomberg Government study goes so far as to suggest that the new EPA regulations will have limited impact on the energy sector and similarly minimal effect on actual emissions.

But other analyses project a more substantially positive impact. The EPA estimates the MATS regulations alone will produce 46,000 temporary construction positions and another 8,000 long-term jobs.
A report put together by environmental advocacy group Ceres and the Institute of Clean Air Companies suggest that the total economic impact of the new rules could mean as many as 1.5 million new jobs over the next five years. Many of these would be shorter-term construction positions, while others would come from long-term jobs with power plants or at environmental control mechanism manufacturers. The remainder would represent the broader impact of these new jobs.

The Economic Policy Institute takes a more inclusive approach, accounting for lost positions in the energy sector and their impact, but still finds a net gain of between 28,000 and 158,000 jobs in the same time frame. The energy industry could stand to lose as many as 17,000 positions, while anywhere from 31,000 to 46,000 jobs could be lost because of higher electricity rates.

However, the energy sector could also gain as many as 35,000 positions as resources shift in other directions, while the pollution control industry would add at least 81,000 jobs. With the net-positive impact on industry jobs, the impact on secondary economies is expected to be substantially positive as well.

So where do all these numbers leave the electric power industry and consumers in terms of the far reaching impact of these new regulations? Nowhere near a clear answer unfortunately. What lies ahead is as always determined by what roads are taken now and that road is still being paved by electric power regulators, providers and consumers.

Spare the rod, spoil the oil-producing nation…

New Eyes on an Old Industry

By Hilton Price

Growing up an only child, I missed out on some of the unique elements of living in a sibling-filled household. Luckily, thanks to Iran, I still get to experience the petty and often meaningless tirades of a selfish child on a regular basis. The country has long been home for random acts of foolishness broadcast to the world, but in recent weeks the petulance, selfishness, and downright silliness have gotten out of hand. For these new eyes on an old industry, it’s clear. The naughty children need to spend more time in time-out.

Iran’s decision to halt oil exports to EU nations in lieu of the upcoming EU oil embargo is as classically juvenile as a tactic can get. It’s the world stage equivalent of “You don’t want it? Well, I wasn’t going to give it to you, anyway!” Does the line sound familiar? It should, you probably said it yourself… when you were 9.

Like many of the impromptu and heated words of children, reality often steps in with other plans. Sure enough, after Iran refused to sell some of its oil, the country was left with unsold oil. That seems a poor choice of endgame for an oil-exporting country. Last I read, some of that unsold oil had been sold, but the clock remains ticking to unload the bulk of it or risk it sitting idle on tankers in the open sea. That possibility, and the resulting unpredictability in the oil-trading markets, has led my new eyes to realize something else about this old industry. Supply and demand is useless here, and that is the cornerstone of Iran’s power in this struggle.

When there’s a potential oil shortage, the price at the pump goes up. When there’s uncertainty in reserves, the price at the pump goes up. When there’s potential that a bunch of unsold oil will be sitting around in tankers on the open sea…, the price goes up? Wait…what? I’ve come to realize the markets don’t seem to reflect the actions of the world in any way similar to business basics. It’s all because of “speculation,” a word that seems to give far too much power to analysts. However, I’m new here and still learning how it works. I’ll try to reign in the urge to go running down the street screaming, “The whole thing is fixed! The game is rigged! We’ll never win!” without at least a little more time in the trenches.

It’s this negative effect on the markets that Iran clearly hopes will drive EU countries back to its oil. The problem is, outside of the markets, Iran has almost no power. The country traditionally exports 2.2 million barrels each day. That seems like a lot, until you consider the typical world consumption of 89 million barrels each day. Then, it quickly becomes a drop in a pretty big bucket. Who’s providing the other 86.8 million? Are any of those countries causing trouble? Norway produces almost as much oil as Iran. When was the last time Norway threatened to close any shipping straits? How much “not for weapons (we swear)” yellow cake are the Norwegians going after? I’m pretty sure the country hasn’t done either of those things. Okay, maybe the yellow cake, but it’s probably just moist, delicious, yellow cake. And who doesn’t love cake?

I can’t answer that, but I can tell you who doesn’t “get” any cake; Naughty children. Even as I bring this blog to a close, I’m reading how Iran is refusing to allow nuclear inspectors onto its military bases, even though it’s believed that is where the country is storing nuclear-related items, possibly even potential weapons. This half-assed approach to openness is another childish maneuver. It’s the world-stage equivalent of “I’ll show you how I cleaned my room, but you’re not allowed to look in my closet.”

Enough is enough. I don’t allow this nonsense in my home, and it shouldn’t be allowed in the interactions between nations. It’s time to put the naughty children in time-out. They clearly need to spend some more time thinking about what they did.

Oh, for frac’s sake…

New Eyes on an Old Industry
By Hilton Price

In the upcoming edition of PennEnergy Workforce Magazine, I’ve contributed an article on why I believe public outcry and government legislation have been good for the fracking industry. It’s pretty compelling stuff. You should read it.

During the week I spent researching the piece, I learned a lot about fracking, far more than I had in the preceding 3 months I’ve been working in the industry. Amid that intense study, I realized two things. First, the theme of my submissions in this recurring blog will be my own ongoing education in the oil and gas industry. Second, no one outside the industry is ever going to be entirely comfortable with fracking. The process is too weird for normal human consumption, and the very nature of how it is performed means someone, and most likely many someones, will always oppose it.

The list of fracking chemicals is shrinking. With each unsuccessful frac (or successful legislation), the number of reliable and permissible chemicals is reduced. That’s a good thing. That means less dangerous junk is pumped underground. For instance, the first frac involved Napalm. I don’t have the list of acceptable chemicals in front of me, but I’m pretty sure that’s not on it anymore. You’d be hard pressed to find someone who would say napalm should be used in anything, expect possibly for blowing stuff up.

Even with napalm and some of the other obviously problematic chemicals removed, the permitted frac fluid list is still littered with a bevy of chemicals not familiar to most people. Unfamiliarity breeds fear. Until the bulk of mankind starts taking a personal interest in high school chemistry, almost every chemical on that list is going to be a source of fear.

Okay, I found the list. There are, admittedly, a few that don’t sound so scary. Take Isopropyl Alcohol, for example. Practically every family has at least one bottle of Isopropyl Alcohol under a bathroom counter in their home. So, seeing that name on the list might not concern everyone. Of course, the chemicals on this list aren’t just sitting on a list or hiding under a bathroom counter, they are being forced into the ground at high pressure and speeds. This brings up the other reason most people won’t ever be “okay” with fracking. It involves pumping stuff into the Earth, a concept that in itself is unsettling to the uninformed.

It’s easy to make assumptions on how people will act, and that’s largely what I’m doing here. So, allow me to add some context. I’m in Tulsa, Oklahoma as I write this. It’s where I live; I didn’t just stop here to write. Over the last few years I’ve grown accustomed to Tulsa’s unique weather anomalies. Severe thunderstorms, epic snowfall, and tornado warnings are just part of the Oklahoma life. Then last year, something else popped up with increasing frequency: earthquakes. I felt two of them, and they were pretty scary. So, I understand why people began trying to find a cause almost immediately. We’re not used to them and we want answers.

Of course, someone from Tulsa posted a story about fracking’s possible link to earthquakes on their social network page. Within minutes, everyone had strong opinions on the topic. It was very cute. Thoroughly uninformed, but very cute. It also exemplified the way people view fracking. The effect of the process isn’t fully understood by people, so the idea of some frac fluid setting off “the big one” makes a weird kind of sense. Geologists have found a connection between fracking and earthquakes, but not in the point-A-leads-to-point-B way the public has embraced. It’s more complex than that, and that complexity, a recurring theme here, is why the public just doesn’t get it.

Lucky for us, the public doesn’t understand a lot of things it discusses, and that’s why in the end we don’t really have to pay too much attention to what they say. From Federal finances to relationships in Hollywood, public discourse is common. Politicians don’t worry about my thoughts during budget debates, and celebrities have never asked for my input on their trysts. As long as the people behind the fracking industry can accept that the process will be discussed by those who aren’t fully informed, it can persevere past the hurdles mass discourse will occasionally toss in its way.

Natural gas prices and shale estimates plummet

While many in the power industry and certainly consumers are grateful for the plummeting prices of natural gas, the news has proven far worse for gas exploration and production companies.

The drop has been attributed to the massive surge in natural gas production from the proliferation of hydraulic fracturing and the recent lull in demand created by an unusually mild winter.

Natural gas prices have slumped from above $4 per million British thermal (Btu) units to below $3 per million Btu; a game changing drop that has prompted many of the nation’s gas producers to begin scaling back operations to focus on higher value resources. All told, the country has 780 natural gas rigs in operation, a 14 percent decline from the same time last year.

Now in an interesting turn of events, the latest estimates of shale natural gas reserves in the U.S. have taken a shocking step backward.Projections released by the U.S. Department of Energy estimate that the country holds around 482 trillion cubic feet of recoverable natural gas from shale basins. That represents a 42 percent decline from the year before when estimates of shale gas reserves were placed at around 827 trillion cubic feet.

Probably the most substantial impact of the updated estimates, however, was the 66 percent reduction in recoverable reserves in the Marcellus shale formation in Pennsylvania, New York, Ohio and West Virginia.

Ironically, it’s the surge in natural gas exploration in shale deposits over the last year that has provided these revised estimates. Last year that basin was estimated to hold 410 trillion cubic feet of gas, enough to fill U.S. gas demand for 17 years at 2010 level. Now, that number has been reduced to 141 trillion cubic feet, or around 6 years.

Nevertheless, the DOE estimates natural gas production will rise even higher than previously predicted despite the smaller resource base.

Powering America: The Critical Need for Transmission Investment to Spur Growth

Economic investment has been a common theme in Washington, D.C., over the past few years as the country struggles to recover from the blow it took in the recent financial downturn. Politicians are pushing for expanded research and development, while physical capital investments have largely centered on base infrastructure such as bridges and outdated rail systems. But surprisingly little attention has been paid, at times, to the critical issue of electricity transmission and distribution.

The Department of Energy (DOE) reports that the U.S. electricity grid spans more than 300,000 miles of transmission lines connecting more than 1 terawatt-worth of generation capacity to hundreds of millions of homes and businesses. While the DOE suggests the system is still 99.97 percent reliable, outages still cost more than $150 billion a year and appear to be steadily impacting more and more people.

With electricity demand outpacing investments in transmission capacity by nearly 25 percent a year for the past three decades and peak demand expected to increase another 20 percent in the next 10 years, the problem only stands to worsen. It is time to stop taking our energy infrastructure for granted.

Energizing Employment

While our transmission and distribution systems serve to bring us the power we have come to rely on for almost every aspect of our daily lives, it is also a significant source of employment. Electrical grid workers are no small part of the U.S. economy. The Bureau of Labor Statistics (BLS) reports that occupations related to electric power generation, transmission and distribution accounted for over 300,000 jobs nationwide with a mean annual salary of over $65,000.

The Working Group for Investment in Reliable and Economic Electric Systems (WIRES) suggests that the country could see a major surge in employment with only a relatively modest investment in our electric infrastructure system. WIRES projects that barring regulatory and permitting issues, the transmission sector is likely to spend between $12-16 billion per year on upgraded transmission. This level of investment would lead directly to between 51,000 and 68,000 full-time jobs annually, with anywhere from 150,000 to 200,000 total full-time jobs produced a year as a result. The total economic return on these investments is estimated at around 250 percent.

In large part this is because transmission, unlike many sectors, is an eminently local industry. The group estimates domestic costs at roughly 82 percent of the total, with construction, design, permitting and most other facets entirely contained within the U.S.  Even materials, which account for 45 percent of total costs are still estimated at 61 percent domestic.

This kind of investment could prove particularly important for the struggling construction sector, which the BLS reports saw an unemployment rate of 14.2 percent in October 2011. The broad installation category saw a far lower rate of 7.2 percent, which still leaves 388,000 people in that sector out of work, though this also includes workers from multiple industries.

Vital to Green Energy

While traditional power sources face many of the strains imposed by an outdated grid, the current limitations of the U.S. transmission system pose an even greater problem for renewable power. Renewable energy sources like solar and wind power must contend with intermittency, generating electricity in inconsistent and often unpredictable patterns. With limited transmission capacity, these power sources can overload the grid at times of unusually high production.

Yet WIRES notes that current standards on how much power must come from renewable sources already require doubling the amount of renewable generation by the end of this decade. Under a stricter 20 percent national standard, this growth would be more than 350 percent by 2020 and 450 percent by 2025. Under the more modest current standards the U.S. would still need nearly $60 billion in transmission upgrades by 2025 just to accommodate growing renewables. At the stricter standard, that number would be more than $100 billion. Either way a significant investment in our energy infrastructure is going to be required to sustain reliability.

Facing the Issues

WIRES suggests that transmission companies are likely to spend billions each year on expanding and developing the grid in coming years, which might lead some believe the issue is well in hand. But these investments are only likely to come with the resolution of some serious issues in the development process. Because transmission lines cross numerous political boundaries and are often seen as unsightly, these projects can become major targets of protest, extending the approval process and dramatically raising costs. Many companies also have no realistic ways to recoup the costs of building further transmission lines, as the systems in place are designed at the state or lower levels with monolithic utilities in mind.

The Federal Energy Regulatory Commission attempted to address some of the prevailing concerns with the approval process over the summer, introducing Order No. 1,000 in June. The regulatory agency imposed new rules requiring a greater degree of regional collaboration on transmission development, though also required the costs of these projects be targeted specifically at those who directly benefit from them and that utilities consider non-transmission alternatives first. However, one crucial development for easing the approval process was ending the practice of granting local utilities the first right of refusal on transmission projects.

In addition to these more recent changes, the American Recovery and Reinvestment Act of 2009 set aside more than $1.9 billion for the distribution and reliability improvements to the grid, but many of the procedural concerns loom larger in the industry's eyes than the outright costs.

Nevertheless, a paper produced by the Federal Reserve Bank of San Francisco found the infrastructure investment of the ARRA resulted in substantial job gains in the years since, making addressing the lingering issues in the electrical distribution system an important point for encouraging economic and job growth in the country.