Energy Policy Is Fundamental to U.S. Competitiveness

Harvard Business Review

The United States desperately needs an energy policy. It is fundamental to our economic growth, environmental sustainability and national security. With five percent of the world's population and 20 percent of its energy use, the U.S. has an obligation to lead globally. We need to set the right example at home.

When President Obama took office three years ago, he put climate change at the top of the agenda. However, to have climate change policy you need an energy policy. People confuse the two — you need both for sustainable development.

In this year's State of the Union address, President Obama tempered his message, saying the country needs an "all of the above" energy policy to provide supplies that are cleaner and cheaper. That is nice political rhetoric — but a gross oversimplification of the challenges ahead.

At the same time, the energy industry must do a much better job informing the public and educating political leaders about the pragmatic realities we face and the difficult choices we must make. Sound energy policy can only emerge if the government, energy industry and the public have a shared understanding of the challenge. To achieve this, the energy industry needs to regain the public trust. In a Gallup poll last year of public opinion of 25 business sectors and government, oil and gas ranked next to last. Only the federal government had worse ratings.

These are the energy realities that we face:

1. Eighty-five percent of the world's energy comes from hydrocarbons: 35 percent oil, 30 percent coal and 20 percent natural gas.

2. It is estimated that the world population will grow from seven billion today to nine billion by 2050, with much of that growth in developing countries. With a corresponding increase in living standards, hydrocarbon energy is essential for economic development.

3. World demand for oil is expected to grow on an annual basis by at least one million barrels per day, driven by the developing economies of the world and growth in transportation, which is forecast to increase from one billion cars today to two billion in 2050.

4. We are not running out of oil. We have already produced one trillion barrels and globally there are approximately two trillion barrels remaining of conventional oil. While we currently have world surplus oil production capacity of two to three million barrels per day, as demand grows in the next decade we will not have enough oil production capacity to keep up. Without greater investment in new capacity, tight supply will ration demand and prices will skyrocket — which could bring the world economy to its knees. The per barrel oil price of $140 four years ago was not an aberration, but a warning.

5. While renewable energy is needed and development should be encouraged to meet future energy demand and reduce our carbon footprint, hydrocarbons will fuel the world's economy for many decades to come. Renewables do not have the scale, development timeframe or economics to materially change this outcome as much as we would hope.

The energy industry has to stand up to provide strategic vision. Here are some thoughts for a United States energy policy.

Oil: U.S. energy policy for oil should aim at moderating demand through efficiency and increasing supply by focusing on drilling. In terms of demand, we need to raise the mileage performance standard to 50 miles per gallon as quickly as possible. This can be achieved first and foremost through hybrid electric cars, as well as a combination of vehicle mix, engine downsizing and advanced combustion technology. Replacing the nation's fleet of 230 million cars and light duty trucks with more fuel-efficient vehicles over 15 years could save three million barrels of oil equivalent per day. At today's price of $100 per barrel, this change would save over $100 billion a year in energy costs — a worthy prize.

Electric battery powered cars are viewed by some as the ultimate solution for moderating oil demand. Unfortunately, there are significant obstacles to the widespread implementation of electric cars. The challenge is that range is generally limited to 40 miles on an eight-hour charge and batteries cost more than $10,000 per car. The laws of physics explain the range challenge. The energy density of today's best battery is 200 watt-hours per kilogram versus the energy density of gasoline — 13,000 watt-hours per kilogram.

To increase oil supply, we must maintain tax provisions that incentivize drilling and strengthen energy security. In 2010, the oil and gas industry spent approximately $135 billion in intangible drilling costs (IDCs), which are current cash operating costs of drilling that tax law allows companies to expense in the year incurred. President Obama recently said in his State of the Union Address that we have subsidized oil companies for a century and that is long enough. Taking this position might be good politics — but it's not good policy. It serves nobody's purpose for our political leadership to vilify oil producers. These costs are neither tax breaks nor subsidies for oil companies; they are an investment in America's energy future. Eliminating expensing of IDCs would decrease domestic supply, increase foreign imports, hurt our balance of trade, decrease jobs and reduce energy security.

We also must do all we can to increase the world's oil supply. With non-OPEC production nearing a plateau, the supply burden in the future will increase on OPEC, specifically Saudi Arabia and Iraq. The global oil and gas industry is expected to spend $600 billion this year on exploration and production, or 10 percent more than a year ago. With the long lead times in our business, the world is not investing enough globally to ensure surplus capacity in the next five to ten years.

Natural Gas: U.S. energy policy for natural gas should focus on shale gas, which is a real game changer. Five years ago, shale gas accounted for approximately five percent of U.S. natural gas production; today it makes up almost 30 percent. Natural gas provides a significant competitive cost advantage for the United States in terms of cost per unit, which is several times lower than it is in other countries. It also has environmental advantages, with half the carbon footprint of coal, and helps our nation's energy security as supplies are forecast to last for the next 100 years.

We should grow gas demand as a fuel in heating, electricity, petrochemical manufacturing and transportation. However, the biggest opportunity is electricity generation, where natural gas has lower costs and higher efficiency than in transportation. An electric plant is 50 percent efficient, whereas natural gas used in transportation is 15 percent efficient.

We must use hydraulic fracturing to develop our abundant natural gas resources. This has been a common practice since 1949 and over one million wells have been hydraulically fractured in the U.S. Eighty percent of the 44,000 wells drilled in our country each year require hydraulic fracturing, using a closed system with water, sand and a small percentage of additives to fracture rock and release hydrocarbons. Most states do a very good job regulating this activity. Adding duplicative federal regulation would be counterproductive.

Coal: U.S. energy policy for coal should reduce its use until research breakthroughs make clean coal technically feasible and commercially viable. While almost 50 percent of our electricity comes from coal, Al Gore's words ring true: "Clean coal," he said, "is like healthy cigarettes." At present, it does not exist. We have more than 600 coal plants in the U.S., one third of which are over 50 years old; many need significant investments to meet anticipated environmental regulations. With the superior economics of natural gas, older plant capacity should be replaced with gas-fired plants.

Nuclear: Even before the disaster in Japan, nuclear power had problems due to the high cost of new plants, the long lead time needed to build them and the challenges of secure nuclear waste disposal. While we need to maintain our technical capability and portfolio options by building a few new plants a year, the high cost of nuclear plants means they cannot compete economically against natural gas and they will have a limited role going forward.

Climate change: U.S. energy policy must also deal with climate change in a way that sets targets that sustain economic growth and protect the environment. Proposals to reduce the world's carbon emissions by 80 percent by 2050 are not achievable. A study done by Princeton University's Carbon Mitigation Initiative sets forth strategies needed to mitigate emissions globally such as setting 60 miles per gallon for fuel efficiency, doubling the number of nuclear plants, capturing and storing carbon from 800 coal plants and increasing wind power by 10 times today's capacity. Executing eight of these herculean initiatives would hold CO2 emissions flat by 2060. We should be realistic about targets we set and make sure we do not put the economy into reverse.

The United States and Europe cannot meet the challenge of climate change alone. The role of China, which now accounts for 10 percent of the world GDP, is critical. China recently surpassed the U.S. in CO2 emissions and will probably triple its CO2 emissions in the next 30 years. China's energy policy is integral to its national security and foreign policy. In the last three years, China spent over $45 billion to acquire oil and gas reserves worldwide.

The United States needs to get serious about climate change once our economy recovers and people get back to work. Some say we should then consider energy taxes, such as a $1 per gallon gasoline tax for transportation and a $10 per ton carbon tax for electric generation. While it would take political courage, these taxes should be given full examination. They should be introduced over a five-year period and only when other major industrial powers in the G-20 take similar measures.

Carbon price signals would ensure that we use hydrocarbon energy more efficiently and make meaningful reductions in CO2 emissions. When fully implemented, such taxes would generate over $200 billion per year. Ninety percent of the revenue could be directed at reducing our nation's financial deficit — provided it is coupled with spending cuts. The remaining ten percent could be dedicated to research in alternative energy technologies such as batteries, biofuels and carbon capture and storage, as well as infrastructure projects such as smart grids and the hydrogen economy. We need to develop these technologies so that one day they can reach their promise and competitively position the U.S. economy for the future.

Three C's: Energy and climate change have been called the greatest challenge of the 21st Century. Energy industry leaders should help offer a solution by following three principles I call the "Three C's": Communication, Courage and Collaboration.

First, we must communicate the pragmatic realities we face and the fact that hydrocarbons are critical to our future.

Second, we must have the courage to provide the strategic vision for a secure energy future that underpins economic growth and protects the environment.

Third, we must collaborate — Democrats and Republicans, government and industry and the United States with the rest of the world — in the spirit of compromise for the common good. We need to put energy policy at the top of the U.S. political agenda and that of the G-20 as well. Together, we can create an energy policy to make our country more competitive and secure economic prosperity for future generations.

John B. Hess is the Chairman and CEO of the Hess Corporation.

Visit www.bloomberg.com/sustainability for the latest from Bloomberg News about energy, natural resources and global business.

Press spacebar to pause and continue. Press esc to stop.

Bloomberg reserves the right to remove comments but is under no obligation to do so, or to explain individual moderation decisions.

Please enable JavaScript to view the comments powered by Disqus.