A hot lobbying battle is shaping up over government permits for natural gas exports. The energy industry, oil- and shale-patch congressmen from both parties, and most economists are pressing for a policy of unrestricted exports. Now, a group of large industrial companies, led by Dow Chemical and Nucor, are attempting to stem this legislative momentum, and for good reason. If we put aside the environmental pros and cons of shale and focus strictly on the economics, progressives have a real stake in seeing that the industry doesn’t get its way. To understand why, here is some background.
The Promise of Unconventional Energy
Within the past decade and a half, the United States has developed cost-effective methods of extracting the very large reserves of gas and oil locked in shale formations, by means of controversial technologies such as hydraulic fracturing. Broadly speaking, shale production tends to be either in the form of liquids, much like standard petroleum, which are usually priced off the standard oil price indexes; or natural gas, which comprises the lightest hydrocarbons, which are useful for industrial heating, power generation, and chemical manufacturing feedstocks. Some major shale formations, like the Marcellus shale, which underlies western New York, much of Pennsylvania, and eastern Ohio into Virginia and beyond, produce far more natural gas than liquids.
Shale gas is often very pure, requiring only simple washing and filtering processes before it is pipeline-ready. Production costs are low, and the gas is now historically cheap. The U.S. power-generating industry is steadily converting from coal to gas, and the gas bonanza has triggered a recovery of American energy-intensive manufacturing, such as chemicals, plastics, and steel. Dow Chemical recently has listed 108 major industrial projects planned, announced, or already under way by energy-intensive manufacturers, 33 of them with 2012 or 2013 start dates and 62 with start dates by 2015. The total planned investment is estimated at $95 billion. An extra bonus is that a renaissance in industrial production may finally force a serious program to rectify our collapsing infrastructure.
Energy-intensive industries tend to have high employment multiplier effects, as much as three to one, or even more; unlike the banking or software industries, they have long production chains, involving raw material extraction, transportation, multi-stage processing, and shipping—virtually all of them generating traditional blue-collar jobs that pay quite decent wages to capable high school graduates. The new energy sector itself is a star employer. Shale exploitation is generating thousands of frequently strenuous new jobs for thousands of young people, many of them grossing $100,000 or more a year with overtime. Citigroup, the Boston Consulting Group, economists at the American Chemistry Council, and others have estimated the growth in manufacturing employment, taking into account its multiplier effects, may be on the order of 3–5 million jobs within the next decade or so. A number of the plants already under construction are owned by foreign manufacturers. Siemens is building a plant to export turbines to Saudi Arabia, and Rolls Royce has opened one to supply parts for its global airplane engine customers.
Consider the implications: between the drop in energy imports and the rise in manufacturing exports, the American current account deficit will shrink, even as the blue collar recovery will fuel a recovery in middle-class incomes. The global financial imbalances will become much more manageable. Altogether, the country will be in a much better place—again, leaving aside potential environmental issues.
The Export Drive
Gas investors have had a tough couple of years. Production boomed faster than the pipeline capacity to handle it, so the gas regions have built up a huge overhang of gas. Many gas wells simply have been shut down—they’re relatively easy to restart—and gas company balance sheets have suffered, since their gas holdings are valued by reference to current prices. But prices are steadily improving. Gas is traded on spot markets in units of a thousand cubic feet; prices have moved from less than $2 a unit last spring to an average of about $3.50 at the end of the year. Most analysts agree that, at prices between $4 and $6, the industry can make decent profits, and U.S. customers will still have a sufficient price advantage to sustain a large-scale industrial revival.
But in the meantime, gas users in Europe, Japan, and Korea are paying extortionate prices for their gas, irrespective of production costs. In much of the world, gas prices are indexed to oil prices for comparable units of energy, and are about three or four times higher than prices in the United States. Overseas gas demand has intensified in the wake of the Fukushima disaster and the German declaration that they would start decommissioning their nuclear plants. Not surprisingly, the industry is clamoring to export to reap the big foreign windfalls.
With some exceptions, exporting natural gas requires a Department of Energy (DOE) permit, after a finding that it would not be contrary to the public interest. Twenty-three companies have filed gas export permit requests, only one of which has been approved, for a facility that will go into operation in 2015 on the Gulf Coast of Louisiana.
Exporting natural gas is difficult and expensive. The gas must be highly purified and then liquefied at cryogenic temperatures, shipped in specially constructed Liquefied Natural Gas (LNG) tankers, and re-gasified at the receiving port. LNG and re-gasification plants cost billions and take years to build. In the late 1990s, as American natural gas sources dwindled, there was a rush to build re-gasification plants to import LNGs. Dozens were built, at a cost estimated at a $100 billion, and all were mothballed by the shale gas boom. The sole approved LNG export plant will be a converted re-gasification facility, so it can take advantage of much of the infrastructure already in place—pipelines, harbor work, storage facilities, and the like. But it will still cost $5.6 billion and will not be operative until 2015. In short, these are all high-risk projects.
The policy questions are: If American companies can export their gas for European and Asian prices, which may be much more profitable than selling it at home, might that force up American prices to parity with foreigners, saving only the export costs? And if that were the case, might that stifle the prospective American energy-based manufacturing boom? There is quite a large risk that the answer to both of these questions is, “Yes.” The Japanese are currently paying about $17 a unit for their gas; corrected for export costs, that would imply $12 gas in the United States, considerably higher than it was during the collapse of manufacturing employment in the first years of the 2000s. So, quite possibly, it would mean goodbye to the boom.
The State of the Argument
To aid in its decision-making, the DOE commissioned a report from a private firm, NERA Economic Consulting, Inc., which was released in December 2012, to the hosannas of the energy industry and Wall Street. The report concluded, in neon lights, that in all scenarios:
[T]he U.S. was projected to gain net economic benefits from allowing LNG exports. Moreover, for every one of the market scenarios examined, net economic benefits increased as the level of LNG exports increased. In particular, scenarios with unlimited exports always had the higher net economic benefits. . . . Natural gas price changes attributable to LNG exports remain in a relatively narrow range across the entire range of scenarios. . . . In particular, the U.S. natural gas price does not become linked to oil prices in any of the cases examined.
Even on a first detailed reading, the report seems remarkably blindered—mechanical modeling carried out by robot economists. For example, the benefits were calculated merely by comparing the value of new export revenues against the higher gas costs imposed on the rest of the economy. Since it was assumed that companies wouldn’t export unless they received higher returns than at home, that number was necessarily positive. Not a word was said about the expected collateral gains from the rebound in manufacturing that so many economists anticipate from the drop in energy prices.
The report is remarkably tone-deaf. Although it acknowledges that, under all export scenarios, “wage income decreases in all industrial sectors except for the natural gas sector,” it happily concludes that such effects are offset by higher export revenues and additional income to “consumers who are owners of liquefaction plants.” Elsewhere, however, the authors concede that “households with income solely from wages or government transfers, in particular, might not participate in these benefits.”
Fortunately, as the drive for unrestricted gas exporting developed last year, a group of large manufacturing companies, led by Dow Chemical and Nucor, among others, formed a counter-lobby, America’s Energy Advantage, to slow it down. The economists at Dow Chemical prepared a blistering refutation of the NERA port that they submitted to the DOE on January 24. I’ll summarize some high points:
- The NERA report relies on 2009 data from the federal Energy Information Agency (EIA), but at almost the same time as the report was released, the EIA released new projections that virtually doubled the rate of growth in domestic demand, precisely because of rising domestic manufactures. The EIA is the office of the DOE that commissioned the NERA report, so it would be surprising if they had not kept the firm abreast of its changing forecasts.
- The pipeline requirements for exports do not match up well with those for domestic manufacturers. Just by authorizing the export expansion, the government will trigger an anticipatory shift in pipeline investment that will further disadvantage domestic companies. In such an environment, companies sponsoring new investment would be almost obligated to pull back from their programs.
- The report assumes virtually unlimited natural gas production capacity. But that is highly uncertain. Restrictions won by environmentalists may limit exploration. Some early wells have had disquietingly faster-than-expected depletion rates. The shale areas are vast, and only tiny portions have been thoroughly characterized, and the industry may face tougher technical challenges than it now imagines. Lower production rates combined with unlimited exports could generate violent demand-crushing domestic price spikes.
- The report assumes that, since some countries such as Russia and Qatar have lower gas production costs than the United States does, they could readily undercut the United States in global markets. That may be true, but gas contracts are usually set on a long-term reference price basis. Japan and Korea would probably be delighted to sign up for such deals, so later competition might have little price-moderating effects. A related dubious assumption is that energy prices will adjust as if they were in a completely free market. But energy markets have long been dominated by cartel pricing. Indeed, an OPEC-like organization of gas-producing nations has been organizing to do just that.
- The NERA report dismissed energy-intensive industries as “low-margin industries,” as if they produced little economic value. In fact, all heavy manufacturing firms have much lower margins than, say, software and finance. But that’s the reason they have such large employment multipliers. Their margins are lower because of their heavy supply chain and capital goods requirements, which reverberate through the entire economy. (Dow’s list of 108 commenced or announced energy-intensive capital projects referred to above are an appendix to their report.)
- The notion that export profits would returned to American “households” is absurd. In the first place, a large number of the companies participating in the shale plays are foreign—from China, France, England, Norway, the Netherlands, Australia, and some of unknown origin—and their markups will go to their own shareholders. Dow also chose not to mention that even the American companies participating in the LNG plants are global companies, who invest worldwide wherever they get the highest returns. In contrast, the extra jobs and income that would be generated by an energy-driven domestic expansion would mostly all stay here.
The Obama administration has generally been quite cordial to the energy industries. As an old-fashioned liberal, who has long lamented the loss of stable blue-collar jobs, I have been glad to see that stance. The tactic has required hewing a middle path between the demands of the environmental and energy lobbies—basically, letting the industry grow while insisting on reasonably attainable environmental standards.
Giving the industry a pass on this one, however, could completely destroy our best hope in a long time of a broad, middle-class-based economic recovery. There is no need even to turn any permits down. The NERA report is hopelessly flawed. It should either be withdrawn, or as Dow suggests, referred to peer review. The United States doesn’t have to leap in to solve the world’s energy problems. Let’s provide for the home front first, see how well production rebounds as new pipelines open markets and prices rise. If supplies turn out to be as good as the bullish projections promise, we can gradually let exports run free without damaging the markets and prices rise. If supplies turn out to be as good as the bullish projections promise, we can gradually let exports run free without damaging the markets at home.
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