achieving progress in energy’s next era through informed policymaking

Remarks by Stuart R. McGill
Senior Vice President, Exxon Mobil Corporation
CERAWeek 2006, Houston, Texas
February 7, 2006

 

I congratulate CERAWeek on its silver anniversary. For a quarter century, this forum has brought industry and government leaders together in an informative – and formative – dialogue about our energy future. 

That tradition continues with this year’s conference and its focus on the next era of energy. According to the International Energy Agency, the world will need 50 percent more energy by 2030 – energy to fuel vehicles, electrify homes, prepare food, power factories and perform countless other functions that lift living standards in developed and developing countries alike. 

The future challenge is as much geopolitical as it is scientific. There is little question that abundant energy resources exist – according to the U.S. Geological Survey, the Earth was endowed with more than 3 trillion barrels of conventional recoverable oil resources. Conservative estimates of heavy oil and shale oil push the total resource to over four trillion barrels. To put those quantities in perspective, since the dawn of human history, we have consumed just one trillion barrels of oil. 

What remains in question is the political leadership to develop this energy -- effectively, efficiently and economically. 

Public policy decisions made by government leaders about how to access, tax and regulate these resources will play a pivotal role in shaping the world’s energy and economic future. It is therefore crucial that these decisions benefit from the most reliable and most realistic information. 

Unfortunately, the current information environment in which many policymakers operate is often not conducive to effective government action. That is a failing, in part, of those of us in industry. 

We in industry have a duty to share information about the fundamental workings of our business and the realities we face, and to do so in a way that is coherent and not confusing. Those in government have a duty to act on this information responsibly.

To build a richer information environment, we must start by developing a better understanding of the essential nature and enormous scale of energy markets. To us, this understanding is intuitive. To many policymakers it is not. 

By its nature, oil – like corn or copper – is a commodity. It is a primary good that is fungible and freely traded in markets around the globe. While prices for specific crudes reflect quality and location differentials, the price of oil in general reflects the market's overall perception of the relative balance between the world’s supply and demand at any given moment.  Like all commodity markets, the global market for oil is fluid and sensitive to supply disruptions, demand surges, inventory levels, and countless other economic, environmental and political factors. 

What differentiates oil from other commodities, however, is its scale. 

As the primary source of transportation fuel and, in some regions, a leading feedstock for heating and power generation, oil is ubiquitous in the world economy. As a result, the scale of our industry is enormous.

Currently, the world’s consumers use over 80 million barrels of oil a day, or 40,000 gallons per second. In dollar terms, the bill for the world’s petroleum consumption is more than $2.5 trillion a year at current market prices. . . about the size of the U.S. federal government’s entire annual budget. 

The reality, therefore, is that the economics of oil is similar to that of other commodities in many respects, but different in terms of the enormous scale in which these economics play out.  Public perceptions of oil’s economics often diverge from these realities, however. And the resulting reality-perception gap can lead to counterproductive policymaking. Allow me to highlight a few examples.

First, prices. Many in this country and beyond perceive petroleum prices as being disproportionately high. 

Prices for gasoline and heating oil are indeed higher this winter than last, putting a real strain on many household budgets – and, consequently, putting pressure on policymakers to respond.

Overlooked, however, is the fact that fuel prices are lower than prices for many other liquid commodities. Bottled water, for example, can cost over $10 a gallon, as compared to an average of about $2.34 for a gallon of regular unleaded gasoline. Not only would filling your tank with bottled water not get you far, it would cost you more.

And from an historic perspective, the real price of West Texas Intermediate crude has increased 11 percent since 1985. This is far less than the increase in price over this period for other commodities. Over the last 20 years, the price of nickel has increased 66 percent, the price of copper 43 percent, and the price of sugar 33 percent. 

Public perception of fuel prices, however, is tied more to price volatility than to absolute increases. Price fluctuations are a fact of life for all commodities, including oil. 

Since 1985, the average fluctuation in price from month to month for West Texas Intermediate crude was about 6.3 percent. This is similar to other commodities, such as sugar at 7 percent, nickel at 6.2 percent, and copper at 4.3 percent. 

However, unlike other commodities, consumers see and feel fluctuations in the price of oil quickly and directly. Prices change frequently, and are displayed on service station signboards at street corners everywhere, day and night. And, because the cost of the underlying commodity – crude oil – is the primary factor in the final product price, consumers are impacted directly. 

A second misperception is the belief that oil and gas industry earnings are disproportionately high.

Undeniably, many energy companies posted high earnings last year. In 2005, ExxonMobil set a record, which is good news for our two to three million American shareholders and the millions more who own a part of our company through their pension, insurance and mutual funds.

Our profit margins, however, remain in step with the national average for major U.S. industries. For every dollar of sales during the third quarter of 2005, the oil and gas industry on average earned about 8.2 cents. That compares to a national average of about 6.8 cents per dollar of sales for all major industries. Many industries had higher margins – some as high as 18 percent.

The disconnect arises from the difference in the volumes and costs involved in the petroleum business. Producing and delivering energy is an expensive enterprise. In the first 9 months of 2005, ExxonMobil spent $229 billion to cover production and delivery costs – more than the U.S. federal government paid in Medicare costs nationwide during the same period.

Also overlooked is the reality that energy companies use today’s earnings to make the investments needed for future energy needs. The International Energy Agency estimates that industry needs to invest an average of over $200 billion each year between now and 2030 to produce and deliver the oil and natural gas required to meet the world's needs. 

A third misperception taking hold is the belief that this nation, or any nation, can achieve energy independence.

Realistically, it is simply not feasible in any time period relevant to our discussion today. In the United States, for example, demand for energy exceeds domestic production by approximately 10 million barrels of oil equivalent per day, according to the U.S. Department of Energy. Americans depend upon imports to fill the gap. No combination of conservation measures, alternative energy sources, and technological advances could realistically and economically provide a way to completely replace those imports in the short- or medium-term.

The potential for renewable energy to substitute for these petroleum imports illustrates the point. Today, wind and solar account for approximately 0.2 percent of total U.S. domestic energy consumption. With the help of continued mandates and subsidies, we anticipate wind and solar to see double-digit growth rates over the next 15 years. Yet, even with that extraordinary growth, they will still provide less than one percent of U.S. energy needs in 2020. 

Moreover, uneconomic attempts by governments of energy importing nations to achieve energy independence threaten domestic jobs and handicap businesses with a significant cost disadvantage vis-à-vis their foreign competitors. 

The notion of energy independence arises from a misunderstanding of the global commodity market for oil. Because we are all contributing to and drawing from the same pool of oil, all nations – exporting and importing – are inextricably bound to one another in the energy marketplace. 

In this context, the more effective means of securing supply without doing economic harm is promoting energy interdependence, not independence. If importing nations diversify their sources of energy, strengthen their partnerships with exporting nations, and develop and use their resources more efficiently, they will become less dependent on any one country or region for energy. And by removing barriers to trade, reducing taxes, and opening markets, we can all better adapt to disruptions that do occur.

These realities about the energy industry – its commodity nature, its enormous scale, its interconnectivity - are not widely understood, however. This can have profoundly negative policy implications. Misunderstandings often lead to unintended consequences.

Reacting to public pressures, governments have in the past directly intervened in energy markets through punitive taxes, price controls and other measures in an attempt to manipulate prices and/or transfer wealth. These attempts invariably fail, and are generally counterproductive.

For example, when the United States Government imposed a so-called windfall profits tax on energy companies in 1980, it drained $79 billion in industry revenues that could have been used to invest in new oil and gas production, according to the Congressional Research Service. As a result, as many as 1.6 billion fewer barrels of oil were produced domestically due to the tax, according to the CRS. 

More recently, in 2002, when the United Kingdom imposed an unexpected 10 percent supplemental corporation tax on our industry, it led to a slump in investor confidence in the North Sea. Exploration and appraisal wells dropped by 25 percent, from 60 to 45, in the first 12 months after the tax hike, and investment fell by 4 percent. The 6.5 billion pounds in wealth transfer from industry to the Exchequer over the next three years will result in 1.5 billion fewer barrels of production from the UK North Sea, according to Wood Mackenzie. 

Contrast this with the response by local, state and federal government agencies in the aftermath of Hurricanes Katrina and Rita. By collaborating with the energy industry and removing obstacles hindering our emergency response, policymakers and regulators helped mitigate the effects of these natural disasters on domestic energy supplies. By allowing markets to work, governments helped defy dire predictions about severe energy shortages.

So the most effective policies are those that help create a business environment that invites investment and stimulates competition. 

By building stable regulatory frameworks, establishing a level competitive playing field, granting access to resources, removing obstacles to development and opening markets to trade, governments enable international oil companies, NOCs, and other industry participants to fulfill their roles in making energy available and affordable.

The reason is simple. Providing private industry more opportunities and latitude to operate enables us to do what we do best – innovate.  Technological innovation and expertise are the essential elements that international oil companies, like ExxonMobil, offer to the world’s energy community. 

New advances in technology have enabled us to drill deeper, smarter and more cost effectively. Technology has enabled us to economically access resources in waters a mile deep off the coast of Angola, and on Sakhalin Island, where crude is flowing through wells with 6 miles of lateral displacement – production not possible 15 years ago. Technology has turned so-called unconventional resources into conventional ones. And technology holds the promise of helping us meet the energy challenges on the horizon.

By building a stable business environment, governments can help stimulate the competition for ideas that leads to technological innovation and ultimately the best results for society as a whole.

These best results include addressing concerns about our environment. In many countries around the globe, expectations for environmental protection, including limiting air emissions and preserving biodiversity, are increasing.  This is clear and understandable. 

Meeting these expectations requires that industry, governments and civil society as a whole engage constructively in the search for viable solutions.  This search should balance priorities, including the importance of promoting economic progress in the developing world, and should be grounded in sound science. 

Our resources – time, money, intellect – are not limitless. To effectively address environmental concerns, we must therefore seek answers that are sustainable economically. And we must seek such answers together.

In conclusion, I’d like to return to this year’s conference theme: “The New Prize: Energy’s Next Era.”

The prize we seek is progress. Progress towards providing an adequate and affordable supply of energy. Progress towards helping developing and developed economies alike grow and prosper by meeting their energy needs.  Progress towards providing all peoples the opportunity to achieve higher standards of living through greater access to energy.

Achieving such progress in a challenging new era of energy will require much.  It will require continuing dialogue between industry and governments. It will require building a richer information environment, grounded in reality-based, technically sound cost-benefit analyses. It will require continued technological innovation through the competition of ideas.

But, most importantly, it will require freely functioning markets. When energy prices and corporate earnings seem high, the temptation to tamper with markets is strong. Succumbing to this temptation could jeopardize our energy future. Resisting this temptation can enable us to master it. Thank you.