API

Blogger Conference Call

Moderator: Mark Green, API Speaker:

John Felmy, Chief Economist, API

March 26, 2012

Transcript by Federal News Service Washington, D.C.

Bloggers on the call included Bear from The Absurd Report, Bruce McQuain from Questions and Observations, Geoff Styles from Energy Outlook, Joy McCann from Little Miss Attila, Mark Perry from Carpe Diem, Marlo Lewis from Competitive Enterprise Institute, and Norm Leahy from Bearing Drift MARK GREEN: Good afternoon, everybody. This is Mark Green from the American Petroleum Institute. Thanks for joining us today. We just heard who was on the line. Has anybody else joined in, in just the last 30 seconds? OK. Maybe we should just go through again with you guys identifying yourselves with your blog. (Pause.) Hello? BRUCE MCQUAIN: Bruce McQuain, QandO. MARK PERRY: Mark Perry, Carpe Diem. MARLO LEWIS: Marlo Lewis, Competitive Enterprise. JOY MCCANN: Its Joy McCann, Little Miss Attila. MR. GREEN: Marlo? MR. LEWIS: Thats right, Im here. MR. GREEN: Great. And Joy. GEOFFREY STYLES: Geoff Styles, Energy Outlook. MR. GREEN: OK, thanks. Lets just go ahead and get started. Ive got my iPad with me today, so if youre having trouble getting through or hearing or anything like that, please dont hesitate to email me a question or let me know that youre listening in and well take care of things as best we can. Theres just a few ground rules for todays call. To improve audio quality, please mute your line thats star six when youre not speaking. Please be open and transparent, respect the other participants on the call and introduce yourself each time you speak. Well post a transcript of todays call on the Energy Tomorrow Blog on Wednesday at the latest. Were here today to discuss rising gasoline prices. Certainly theres been a lot of misinformation about some of the key factors figuring into the prices Americans pay at the pump, starting with the presidents regularly repeated line that the U.S. has only 2 percent of the worlds oil reserves, which is simply misleading in terms of the countrys actual resource reserves. Well talk about that and other related topics today with John Felmy, APIs chief economist, who has an opening statement before we get to your questions. John?

JOHN FELMY: Thanks very much, Mark. Hello, everybody. Thanks for joining our call. With gasoline topping $4 a gallon in many parts of the country, according to the AAA, Americans are understandably frustrated because too many talk as though were powerless to do anything but watch global events and market conditions drive the cost of crude oil higher, which can translate into higher fuel costs, because crude accounts for 76 percent of the price Americans pay at the pump. Americas oil and natural gas companies believe a preemptive surrender to the global marketplace and world events is absolutely the wrong policy because, in fact, were energy rich and have lots of options. Although the president repeatedly talks of very limited U.S. resources, its just not so. Although his rhetoric suggests that he only sees the effect of global markets resulting from decreasing demand through efficiency and conservation strategies, we think theres a greater effect that producing more oil could have. When President Bush lifted the moratorium on oil and gas exploration on the east and west Outer Continental Shelf in 2008, the 45 day price average for crude oil dropped 12 percent or $16 per barrel. Markets are driven by expectations, and its time the United States began sending the markets the message that Americas serious about developing its ample resources to help exert downward pressure on fuel price. This will take bold leadership bolder than the administration has shown so far. We need strategies that, while acknowledging that renewable energy sources have an important role to play in our countrys energy future, our economy is and will continue to be for the foreseeable future, driven by oil and natural gas and that we need to get serious about developing resources that currently are off-limits. Despite what many Americans hear, we are the worlds third-largest producer of oil and we have vast resources that we havent begun to explore. Safely and responsibly developing them will let markets know that America will control its energy future. What are those resources? Currently, the U.S. oil and natural gas industry is only allowed to explore, develop and produce on less than 15 percent of federal off-shore areas. The Arctic National Wildlife Refuge in Alaska, now off limits, is estimated to hold 1 million barrels of oil per day that could be developed on a parcel of land the size of a good sized airport. We could and should approve the full Keystone XL Pipeline to bring up 830,000 barrels of oil per day from our neighbor and ally Canada. A committed strategy that brings these and other sources on line would say that America plans to shape its energy future instead of letting the future happen to us. The compelling argument is resonating in the country. Poll after poll shows significant majorities support approval of the full Keystone XL project. The number of Americans who believe we should produce more of our own oil and natural gas resources is growing. Finally, let me say that our companies are ready to meet the challenge of producing more energy. We will strengthen our economy, create hundreds of thousands of jobs and increase

revenue to the government. Additionally developing more domestic energy sources could help put downward pressure on prices. Thanks, and with that, Im happy to take your questions. MR. GREEN. Thanks, John. OK, so who would like to lead off? MR. MCQUAIN: I would. Bruce McQuain, QandO. Hey, John, how are you? MR. FELMY: Good, good. MR. MCQUAIN: Listen, AP came out with something last week in which they supposedly fact-checked this claim about drilling more dropping the price of gasoline. And they concluded and Im quoting them a statistical analysis of 36 years of monthly inflationadjusted gasoline prices and U.S. domestic oil production by the Associated Press shows no statistical correlation between how much oil comes out of the U.S. wells and the price at the pump. Now, I had a friend of mine whos been in the business for years and years and years write to me after he saw that. And he thought it was kind of weird that 36 years was picked instead of 40 or 50 years. And he claims that 36 years ago, 76 by picking that, they ignore that there were about the same number of active rigs in the U.S. as there are today, and that that rig count swelled to 4,000 by the late 70s and reached an all-time high in 81. And he said that level of exploration dropped the price per barrel to under $10 a barrel and forced OPEC to regulate after that. And he also mentioned what you mentioned, that when George W. Bush announced that he was opening up the Outer Continental Shelf, he said 16 bucks dropped off of price per barrel before the first lease was sold. So my question to you is, wheres AP going with this, and have they got any basis in fact for the claim? MR. FELMY: Well, you know, first, a couple quick comments. First of all, Ive actually tried to find a study, other than just what appears to be selective endpoints to kind of compare before and after. So the first thing is I need to see exactly if theres any sound statistical analysis in that, because thats what youve got to do because anybody knows that, you know, correlation doesnt mean causation, and you need to be careful about what your endpoints are and so on. But a couple other things. They said, well, you know, it seems as though lets see, they said that when prices went up the same time as drilling activity went up. Well, thats not surprising. You know, youve got a more profitable product to try to develop your resources on, so its not at all surprising to see those kind of relationships. But I think one of the things that you need to step back on and look is that what kind of a price experience have we had over the last, oh, far too many years that Ive been in the business? I mean, if you go back into the you know, the unfortunate energy policies of the Carter administration, where you had active discouragement of producing, for example, gas because of different things; you had windfall profits tax that raised taxes on the industry, reduced

production, increased imports; and then they poured the money down the drain on things that didnt work yeah, that can have a counter a negative effect on whats going on. And then you move into the Reagan years with decontrol, which was very important in terms of not having the continuation of gas lines and things that were just unfortunate energy policy. And then youre absolutely right; you saw a collapse and with oil prices into the middle 80s and then moving forward. The one thing the report also said is that they didnt see much of a difference between Republican or Democratic administrations. And I think one of the things thats helpful to also remember is that if you look at the Clinton years, you had the lowest energy prices I think on record. Ive traced it way back in previous administrations, and the Clinton administration had really low energy prices. Now one of the reasons why they had low energy prices is good energy policy. One of the most successful pieces of energy policy that we had was passed in 1995, the Deep Water Royalty Relief Act. And that really sent both message to the industry that, you know, well help out a fledging development of very high-cost deep water operations. And it was a resounding success when you see how much of our oil were getting out of the deep water and so on. And so I think theres clearly good cases that can be made that there were some good policies there, and you had, you know, improvements. And were bearing the fruit of those improvements from that administration even today. And so, you know, Im very wary about picking endpoints and so on. Id have to see, you know, more in terms of the study, in terms of what types of analysis, statistical approach and so on theyd have beyond just beyond just that. So before I see the study I would reserve any more comment. But I think if you look back over history, youll see things that were good for energy policy; youll see things that were bad for energy policy; and that reflected in energy markets. You know, the policies of the Carter administration were a big failure in terms of taxes, reducing production, increasing imports and then frittering the money away. And so lets not repeat that. MR. LEWIS: May I interject a comment? This is Marlo. MR. FELMY: Sure. MR. LEWIS: You know, you can see the same correlation in the amount of ethanol produced and also the height of or the stringency of fuel economy standards. I mean, both of those things have gone up (chuckles) and gasoline prices have gone up. So inferring some kind of causality here is just not does not seem to be possible from any of these numbers. MR. FELMY: I would agree with that. And as I said, Id have to see the analytical work that went into it other than just kind of the endpoint comparisons. MR. STYLES: Hey John, this is Geoff Styles. Ive seen the same analysis out there. And one of the things that immediately struck me, and Id appreciate your thoughts on that the

missing piece here one of the many missing pieces is the time lag, because you know, if youre looking at prices today and production today, well, production today is the result of decisions that were made five to 10 years ago. If youre looking at prices today and drilling rigs today, those rigs are not going to produce oil at least for a couple of years potentially. So could you talk about how any of these correlations would have to adjust for the relative time lags of the different decisions in order to have any relevance at all? MR. FELMY: Absolutely. And I made a too curt too short of a point on that when I said you know, talking about how, you know, you can have prices go up at the same time you have a lot of drilling going up. And there is clearly a lag. It takes a while between actually having rigs running to where youre producing product. You have to have the infrastructure thats put in place. You need all those things before you actually have production, which really does, you know, have an impact on markets. And in that vein, of course, one of the things that we do have to remember is that this is a world market. The U.S. is only part of that market. And so weve got to understand that role. But nevertheless increased production, as any economist will argue, all other things equal, helps consumers. And so yeah, theres a lot of things that go into that. You know, you saw huge amounts of rigs running back in the late 70s and early 80s, because everybody who could possibly get in the business did. And then it was only after those successes came online that you saw production. And that reinforces I think a couple other things, Geoff, that you know, we hear this argument so often that, well, you know, you cant do anything because it takes too long and you know, and so on. And I find that argument to be really unfortunate, because were going to need to make decisions now that are going to affect us in the future. We should have made some of those decisions many years ago. And so lets move forward and look to the future and so on. But people who say, you know, well, its not going to have an impact so we shouldnt do it you know, as Ive quoted very often some of you heard me say well, Confucius said the best time to plant a tree was 10 years ago. The best time to have done expanding energy was 10 years ago too, but at least lets start today. THE BEAR : John?

MR. FELMY: Yes. THE BEAR: The Bear here. Ive been reading about the refinery closings in the northeast, I think at Sunoco? MR. FELMY: Yes. THE BEAR: What about the impacts MR. FEMLY: Well, we go ahead. We have had several refineries weve had the Sunoco and ConocoPhillips Trainer Refinery close. There may be another Sunoco refinery to close. Youve got the Hovensa SA refinery thats closed, and then just recently a Valero Aruba

announcement and so on. Its a huge amount of capacity that I certainly am paying attention to. Its because the refinery margins for the East Coast refineries have been terrible. Theyve been largely tied to Brent crude markets. And so the crack spreads that they got off of the returns were just so low that they couldnt continue to operate and lose money. You know, when you have a situation with refiners when you dont control your price of your crude and so, you know, youve got to thats your cost; you dont control the price of your gasoline, and thats going to be a lot influenced by some world competition and so on, and you get whats left in between in November and December that was negative for the whole industry. Its improved a little bit, but it still looks as though refiners on average are losing money. And so youve seen these closures that have happened. It is of course, you know, a sizeable component of the East Coast supply right now. Going forward, you know, I cant speculate about what the outcome will be. You know, markets tend to work in terms of supplying customers and moving products and so on. But there will be challenges. So the Department of Energy I think did a good job, EIA, laying out the issues and their concerns and so on. And so Id direct everybody to those comment that study that they had. THE BEAR: Well, the point I was driving at is that reduced supply its got to drive up prices. Thats the way I see it. MR. FELMY: Well, right now we have a situation where fortunately weve had record production of gasoline nationwide. Were producing far more gasoline than were consuming. And so the issue is what will happen in terms of the product, where itll come from? There is of course gasoline on world markets because most of the world is moving toward more toward diesel. You know, well have to see. There may of course be higher costs. But one of the things that I think Ive observed is that you do have all those refineries in place with storage facilities, with intake facilities, and so theres a possibility that some of them, if theyre converted to terminals, it would just mean a slightly different kind of supply that youd have. So Id say its kind of too early to say anything. If there was one area I had more concern about than about the situation, it would be the heating oil market, versus gasoline, because of course they are important suppliers of heating oil, and heating oil is primarily used in the Northeast. And when you marry that with the decisions by at least a couple states, most notably New York, where they have mandated ultra-low sulfur heating oil, less than 15 parts per million, that adds a further complication to the situation. And it actually was probably one of the circumstances that, you know, kind of added to the decision on the part of those refiners to shut down. Because if you cant sell your existing product and you have to make additional investments and youre losing money on operation already, thats kind of a final push, if you will. MR. GREEN: Do you have a follow-up, Bear? Is that it?

NORM LEAHY: Yeah. Hi, this is Norm Leahy. Im with Bearing Drift. Tim Kaine is running for the Senate here in Virginia. He issued a press release I think it was today calling for the support of the Repeal Big Oil Tax Subsidies Act huh, I love those titles. So he and the administration are both harping on the idea, again, that we need to end oil subsidies, people are paying twice at the pump once for gas and then once for their tax, their federal taxes. And then of course Kaine wants to put all of this money toward clean energy. Its a wedge issue here in Virginia. How do we how do we get around this kind of thing? Talk me through the subsidies. I know weve done this before, but alternative energy these exotics they get far more in subsidies than oil and gas. Is that correct? MR. FELMY: Well, thats absolutely right. They get far more they get subsidies, we dont. Thats just political spin. Thats just recognizing that the American people do not support tax increases and so theyre politically spinning it as subsidies. We get provisions to duck costs. Now, you know, were in a system where you dont pay taxes on costs, and so were not paying taxes on costs like every other industry. And in some cases were disadvantaged such as Section 199, were disadvantaged compared to other industries. So theyve already targeted us. No, this is just political rhetoric run amok. We are we are a very large supplier of money to the federal government. If anybodys getting subsidies, its were subsidizing the federal government to the tune of, you know, over $85 million a day. And so you know, this is just the political strategy to try to divert attention from what is, you know, basically bad policy. I mean, what youre effectively doing is raising taxes on the industry. We tried that before. We tried it under the Carter administration. It resulted in reduced production, increased imports, lost jobs and then pouring the money down the drain. You know, I find it very disappointing. You know, theres no question theres a future for some other types of energy and so on, but right now were going to need oil and gas for the foreseeable future. The other thing that amazes me is I have never understood arithmetic that tells you, you raise an industrys cost of producing the fuel and its going to lower prices. I just simply have never understood that third-grade arithmetic. And finally, its as though, well, were just going to attack the big oil companies as though theyre owned, as I like to say, by space aliens when in fact the industry is owned by millions of Americans that have their retirement savings, their pension plans, their 401(k)s and other investments in oil companies. And so it is utterly unfair to, you know, basically impose and rip them off in terms of these types of an activity. You know, I hope that theres going to be a vote today and I hope senators with good purposes will take a careful thought about this, get the politics out of it and realize that this is a bad idea. And so I honestly cannot understand anything other than just this is politics in Washington. MR. LEAHY: Great, thanks. MR. GREEN: Has somebody else got a question?

MR. STYLES: John, its Geoff Styles again. Ive got a question. When I was reading the summary of the monthly statistical report for February, I was intrigued by something in the first paragraph. It says this increase in gasoline demand is not enough to offset the secular changes due to the increase in fuel-efficient cars on the road. Id be interested in hearing, you know, to what degree youve quantified that, how big that effect is and, you know, to what degree you can actually distinguish between the effect of new, more efficient cars that are being bought as opposed to people shifting their driving habits away from the less efficient cars in their familys fleet towards the more efficient cars. Because certainly we see vehicle-miles traveled (VMT) has dropped, but the change in demand is larger than that. The drop in demand cant be explained just by VMT alone. MR. FELMY: Thats right. And youve got a lot of a lot of very complicated things going on. I was trying to state that and I probably could have said it a little better that, you know, you do have this trend of declining consumption. Weve seen that since, you know, several years ago. Theres both a price impact, theres an income impact and then theres the trends that are things like driving age, population, efficiency and so on. And its really hard to separate those out. In fact, analytically I havent even attempted because of all those. What I was trying to say was probably a little simpler in the sense that weve seen a long a number of years where youve seen declines in gasoline consumption that are a function of a lot of things. And then this changed last month, where you saw for the first time in a year the increase in gasoline demand. And, you know, thats a positive sign because gasoline demand is very closely related to important economic activity like employment and retail sales and so on. And so its good to see that type of that type of a turnaround. You did, however, also see a slowing of or a lower increase in diesel demand, which is more closely tied to manufacturing, production and so on. And yet was still positive. So it kind of gives some mixed signals. And I was just trying to point out that there are a lot of longer-term things going on, but this was good to see an increase in demand because it may be reflective of an improving economy. But all those youre absolutely right, Geoff, all of those things are very hard to tease out. And putting them in a regression equation and trying to get confidence in terms of whats happening is very difficult. And also youve got since many of since many of the things have the same directional impact, you get potential multicollinearity issues and other statistical challenges and so on. So I was trying to be a little less precise than that, just to say that theres long-term changes going, but it is good to see an increase from what we had. And thats that was an improvement over January, of course, because it was down, and there that was kind of an interesting circumstance because you had you had a positive employment report in January of, you know, an increase of 243,000 jobs, but that was driven solely by seasonal adjustment because of the weather issues. And in fact, not-seasonally adjusted employment declined by 2.7 million. But it was good to see an improvement in February and a reflection of some of that in gasoline.

MR. STYLES: Yeah, thanks. I wasnt really trying to put you on the spot there. Its just I see an awful lot of people making claims about the impact of more fuel-efficient cars. And its you know, its very difficult to figure out because at this point the actual fleet CAFEs have not changed dramatically. And even with new car sales almost back to pre-recession levels, its still a very small fraction of the total fleet. So it seems like it is very much a long-term trend. MR. FELMY: Absolutely. And you have the added complication when you talk about fuel economy in that when you do improve fuel economy, you make it cheaper to drive and people tend to drive more. So theres that snap-back effect that also has an impact. And then you have the other added complications of improved fuel economy, where if you make the vehicles significantly more expensive, people dont buy those newer vehicles and so they end up driving a lesser fuel-efficient car than they otherwise would have. They may, you know instead of buying that slightly more fuel-efficient car, they just drive the older car longer. So its a real complicated discussion. MR. STYLES: Its a shame none of this fits on a bumper sticker. MR. FELMY: (Laughs.) MR. STYLES: Thank you, John. MR. FELMY: Thank you. MR. GREEN: Were pretty close to 1:00 here. Weve got time for maybe one more question. Has somebody got a question? OK. Are you there? I heard something click. MR. FELMY: OK. Well, thank you all for joining the call. This is John to close out. And if you have any further messages, please give us a call. The media line, I believe, is 202682-8114, or send us an email and, you know, see what we can do to help out. MR. GREEN: Thanks, John. MR. GREEN: Yeah, and as he said, if you have any other questions that may come up, send them to me by email. Ill get them Ill get them over to the right people. Well have a transcript on the blog by Wednesday. So thanks again for everybody for joining us. Have a great week. (END)