Energy & Entrepreneurs #29                                                                               

Energy Economics, Drilling and Development

by Raymond J. Keating

Prices and profits serve as signals in the free market.  As they rise, for example, incentives to boost production are enhanced. 

This certainly holds for energy markets.  Consider what's happened with higher oil and gas prices. On October 22, the American Petroleum Institute (API) released its estimates for drilling activity in the third quarter of 2007.  It was noted:

• "U.S. drilling estimates for the third quarter of 2007 are at twice the level of third quarter drilling activity recorded during the 1990s and the first nine months of U.S. drilling estimates haven't been this high since 1985."

• "An estimated 13,543 oil wells, natural gas wells and dry holes were completed in the third quarter of 2007, a 22-year record for the quarter and up four percent from third quarter 2006."

• Regarding natural gas, "an estimated 7,628 natural gas wells were completed in the third quarter of 2007, the highest third quarter natural gas estimated drilling activity ever."

• "An estimated 4,544 oil wells were completed in the third quarter of 2007, the highest third quarter oil well estimated drilling activity since 1985."

Energy markets do, in fact, work.  A key problem remains governmental obstacles and costs - both in effect and under consideration - relating to energy exploration and development.  Such government intervention sends the wrong signals to the marketplace.

And this must all be pondered within the context of energy reality today and tomorrow. 

The U.S. Energy Information Administration provides estimates for future energy needs.  While all such projections must be understood given the uncertainties about the future, they do provide some kind of best guess on direction.  The EIA "Annual Energy Outlook 2007" points to the following:

Total primary energy consumption, including energy for electricity generation, grows by 1.1 percent per year from 2005 to 2030 in the reference case... Fossil fuels account for 87 percent of the growth. The increase in coal use occurs mostly in the electric power sector, where strong growth in electricity demand and favorable economics under current environmental policies prompt coal-fired capacity additions. About 61 percent of the projected increase in coal consumption occurs after 2020, when higher natural gas prices make coal the fuel of choice for most new power plants. Over the longer term, growth in natural gas consumption for power generation is restrained by its high price relative to coal, although natural gas use increases in the near term. Industry and buildings account for about 90 percent of the increase in natural gas consumption from 2005 to 2030. 

Transportation accounts for 94 percent of the projected increase in liquids consumption, dominated by growth in fuel use for light-duty vehicles. Fuel use by freight trucks, second in energy use among travel modes, grows by 1.8 percent per year on average, the fastest annual rate among the major forms of transport. The remainder of the liquids growth in the AEO2007 reference case occurs in the industrial sector, primarily in refineries. The projected trend in liquid fuels use in the buildings sectors is relatively flat in the reference case. 

AEO2007 projects rapid percentage growth in renewable energy production, partly as a result of State mandates for renewable electricity generation. Additions of new nuclear power plants are also projected...

So, even with an assumed big percentage increase in renewable energy production, the projected increase in energy demand in the U.S. will still be overwhelmingly met by fossil fuels.

That means it's time to stop the wishful thinking and government mandates favored by some elected officials and many environmental activists, and time to get serious about removing barriers to market-led energy exploration and development.

So, rather than focusing on regulatory and tax schemes that will inevitably raise energy costs, the policy focus should be on removing tax and regulatory obstacles to energy exploration, development and production, including opening up domestic lands and waters to development that are currently off limits.

It's quite simple: basic economics instructs that investors and businesses will not invest when government regulations, taxes, mandates and restrictions reduce potential profits. Such mistaken government actions send clear signals to send resources elsewhere.

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Raymond J. Keating is chief economist for the Small Business & Entrepreneurship Council.