Washington portends a mixed bag for oil and gas

The major U.S. political and legislative story of 2014 is the mid-term elections: They will be held on Nov. 4, 2014, with 33 of 100 seats in the Senate and all 435 seats in the House of Representatives contested. The Senate is controlled by Democrats and the House by Republicans. The chances that the Democrats regain control of the House are remote—less than 5%. However, there is a real possibility that the Republicans could regain control of the Senate, and this would be welcome news for the oil and gas industry.

SENATE SHOWDOWN

There are 53 Democratic, 45 Republican and 2 independent senators (who caucus with the Democrats). Republicans will have to gain at least six seats, since any Senate tie votes will be decided by Democrat Vice President Joe Biden. Several things work in the Republicans’ favor:

• First is math: Among the seats up for election, 21 are held by Democrats and 14 by Republicans—12 of which are being defended by incumbents. Thus, the Democrats have seven more seats to defend.
• Second, several seats up for election are in swing states, where Republicans are competitive, and where Democrat incumbents are retiring.
• Third, is history: Off-year elections in a President’s second term usually tend to favor the opposition party.
• Fourth, President Obama’s popularity is low, and Republicans hope to capitalize on the problems with the rollout of the Affordable Care Act (ACA), aka “Obamacare.”
• Finally, voter turnout in off-year elections tends to be low, and the Democrats’ relative demographic advantage may be largely nullified.

However, there is one factor working to offset the Republicans’ advantage: The Republicans themselves, who may (yet again) manage to snatch defeat from the jaws of victory. Republicans seem to have a knack for losing Senatorial races that they should win, by ousting popular incumbents in primaries or nominating candidates who, while appealing to the party’s conservative base, do not win in the general election. This was the problem in past election cycles, and it may reoccur in November.

After losing ground in the 2012 elections, an internal fight broke out between the Republican leadership and the more conservative “Tea Party” faction over strategy and tactics for the 2014 Senate races. By December 2013, eight of the 12 incumbent Republicans, running for re-election, including Senate Minority Leader Mitch McConnell (Rep.-Ky.), faced Tea Party primary challenges.

One relevant example is West Virginia. Incumbent Democrat Sen. Jay Rockefeller is retiring; President Obama is unpopular there; and Republican Shelley Moore Capito, who has served in the House since 2001and is a strong supporter of the energy industries, would ordinarily be expected to win easily. However, various conservative groups, such as the Club for Growth and the Republican Liberty Caucus, are opposing her because, among other things, she is pro-choice and has voted to raise the debt ceiling—thus preventing the U.S. from defaulting and destroying the world financial system. They have initiated a “Too Liberal for West Virginia” campaign against her, and are supporting a more conservative Republican, who has already lost two state Senate elections. 

Another example may be Alaska. Incumbent Democrat Sen. Mark Begich narrowly won in 2008, in the heavily Republican state, largely because his opponent had just been convicted on federal corruption charges. President Obama lost the state by 14 points in 2012; the oil and gas industry is critical to the state’s economy; and Begich should be viewed as highly vulnerable.  However, the Republican “civil war” may save Begich. The state Republican Party has run through three chairmen in a year, and a three-way primary is being held, which will not be resolved until Aug. 19. 

The battle to oppose Begich has two establishment-friendly candidates—former Natural Resources Commissioner Dan Sullivan and current Lt. Gov. Mead Treadwell—running against Tea Party favorite Joe Miller. Miller won the 2010 Republican nomination in the primary by defeating incumbent Senator Lisa Murkowski—the ranking member of the powerful Senate Energy and Natural Resources (E&NR) Committee—but Murkowski then accomplished the near-impossible by winning the general election as a write-in candidate.  

Yet another example is Kentucky, where Republican Senate Minority Leader Mitch McConnell faces re-election. If re-elected, and if the Republicans win control of the Senate, McConnell will become Senate majority leader and the second or third most powerful person in the U.S. Normally this would endear him to Kentuckians and make him a shoo-in for re-election. However, he faces a strong, well-funded conservative Tea Party Republican primary challenge from businessman Matt Bevin.

McConnell, despite being Senate Republican leader, is openly criticizing right-of-center groups like the Senate Conservatives Fund, which are backing Bevin. This may be the purest Republican establishment vs. Tea Party contest, and is thus worth watching. The U.S. Chamber of Commerce is supporting McConnell. However, his problems will not end, if he survives the primary. His general election opponent will be Kentucky Secretary of State Alison Lundergan Grimes (Dem.), who is mounting a strong campaign, and polls indicate that McConnell is vulnerable. While it is more likely than not that McConnell will retain his seat and may become the new Senate majority leader, the stakes here are huge. 

Irrespective of which party wins control of the upper house, the Senate race in Louisiana is worth watching. Third-term Democratic incumbent Sen. Mary Landrieu, this year, as always, a top Republican target, has never won with more than 52% of the vote, and Louisiana is a Republican state. However, because there is no primary in Louisiana, her Republican challenger Bill Cassidy must also deal with two conservative challengers through November. A retired Air Force colonel and a state representative are also both running for the Senate seat, and thus there will be four candidates—one Democrat and three Republicans—on the November ballot. If Cassidy can keep Landrieu’s vote to less than 50%, then there will be a December runoff, and he may have a better chance for an outright victory.   

TAXATION

In its FY 2014 budget proposal, the Obama Administration proposed to eliminate a set of tax expenditures (subsidies) that benefit the oil and gas industry.  The proposals included: Repeal of the enhanced oil recovery and marginal well tax credits, of the current expensing of intangible drilling costs provision, of the deduction for tertiary injectants, of the percentage depletion allowance for independent producers, and of the passive loss exception for working interests in oil and natural gas properties; elimination of the manufacturing tax deduction for oil and gas companies; and increasing the amortization period for certain exploration expenses.  The administration estimated that the changes would have yielded $24 billion in additional revenues between FY2014 and FY2018.  

The White House appears to be digging in for a prolonged fight with the oil and gas industry on several environmental and tax issues. Photo credit: Matt H. Wade.

However, these tax provisions are not targeted “subsidies;” rather they are comparable to similar provisions affecting other industries.  The good news is Congress agreed, and in December passed bipartisan budget legislation that retained these tax provisions.  Obama signed the two-year U.S. budget agreement, which had only minor impacts on the oil and gas industry.

Industry representatives welcomed the legislation, and the Independent Petroleum Association of America stated that it was “encouraged that the budget deal doesn’t jeopardize the industry’s tax provisions.”  However, the industry should realize that this is only one battle won, in what will be a long war.

RETURN OF THE CONSIGLIERE

In December, John Podesta, CEO of liberal think tank Center for American Progress (CAP), who served as President Clinton’s chief-of-staff, was appointed by President Obama to be a senior White House counselor to “advise on a range of issues, with a particular focus on issues of energy and climate change.” Global warming advocates and environmentalists are “thrilled” at Podesta’s appointment and view it as “an early Christmas present for everyone who cares about the environment.” 

John Podesta, former CEO of the Center for American Progress (CAP), has been appointed senior White House counselor by President Obama.

Podesta will likely advise the White House to pursue aggressive action on climate change, since CAP placed a heavy focus on climate policy, and he has been recommending that the White House be more active on climate change. He will almost certainly side with environmentalists over energy companies on matters that count. 

Podesta's return to the White House is the latest evidence of Obama’s organizational strategy—develop an exclusive inner circle to help him make the most difficult policy decisions, and coordinate their rollout among federal agencies and departments. This coordination used to occur through the White House Council on Environmental Quality (CEQ). But under Obama, CEQ has functioned largely as a liaison with environmentalists, rather than a policymaking entity. Podesta may ensure that CEQ remains largely on the sidelines, or he may give it a larger role in coordinating issues in Obama’s climate agenda.

The climate issue is dispersed across several White House offices and Cabinet agencies. Thus, implementing the President’s climate agenda requires a strong hand in the White House, and Podesta will fill that role. He strongly advocates marshalling all the forces in the administration. He agreed to the job on the condition that he be allowed to oversee an aggressive climate change agenda via executive action.

Podesta favors aggressive polices that bypass Congress, including:

• Even more stringent U.S. Environmental Protection Agency (EPA) regulations on fossil fuel power plants
• A fee on oil imports—the authority for which, he has noted, the White House already possesses
• Reducing methane emissions from natural gas production and fracing, and controls on fracing on public lands
• Facilitating international climate-change talks, and establishing the U.S. negotiating strategy for the 2015 UN climate meeting in Paris
• Issuing an EO requiring a doubling, by 2015, of the percentage of federal vehicles that use non-oil-based fuel and requiring federal vehicles to have 15% higher-than-average fuel economy 
• Requiring bus fleets to have vehicles powered by “low-polluting fuel” 
• Increased requirements for clean energy in the military
• Enhanced efficiency standards for appliances and buildings.

Whatever the motivation, Podesta's record suggests that he will leave a lasting mark on the Obama administration and will not shrink from confrontations with the energy industry, even if they are politically divisive.

INTERNATIONAL CONCERNS

In 2013, John Kerry replaced Hillary Clinton as Secretary of State, and he has made climate change one of his top priorities. This is not good news for the fossil fuel industry: Kerry was the 2004 Democratic Presidential nominee. Prior to becoming Secretary of State, he was an influential senator from Massachusetts, and has been strongly advocating climate change and related environmental policies for decades. He has worked closely with former Vice President Al Gore on climate policy in Congress; he attended the first UN Rio 1992 climate summit meeting; and in 2007 he co-authored, with his wife Teresa Heinz, the book, This Moment on Earth: Today’s New Environmentalists and Their Vision for the Future. He is a founder of the American Security Project, which defined climate change as a national security threat. 

After Obama was elected in 2008, Kerry began holding meetings with influential policymakers focused on climate policy, and in the Senate, he sponsored an ambitious (some say draconian) climate bill, which was not enacted. Kerry will now try to use his position at State to achieve a global warming legacy that has long eluded him. His goal is to become the leading broker of a global climate treaty in 2015 that will commit the U.S. and other nations to massive reductions in fossil fuels. 

After Kerry was sworn in last February, he issued a directive that all meetings between senior American and foreign diplomats include a discussion of climate change. He placed top climate policy specialists on his State Department staff, and he is pursuing climate deals in forums like the Group of 20, the countries that make up the world’s largest economies. Kerry’s desire to sign a global treaty is another sign that the Obama administration intends to pursue aggressive climate policies. Despite the administration's willingness to take unilateral actions, Kerry's global treaty faces long odds. Previous attempts have failed—including a summit in Copenhagen in 2009 that Kerry was involved in—and even if an agreement is reached, it would still have to be ratified by the U.S. Senate, which is highly unlikely.

Another important issue that Kerry is directly involved in is the never-ending Keystone XL pipeline saga. In September 2008, TransCanada Corporation requested U.S. regulatory permission, a “presidential permit,” to construct the fourth of four Keystone pipeline phases. Its proposed route runs from the border with Canada, to Steele City, Neb. This route requires approval from the State Department, and ultimately the President, because it involves cross-border construction and maintenance. While then-Secretary of State Hillary Clinton indicated that she would urge the White House to approve Keystone, the issue heated up during the 2012 Presidential election cycle. In January 2012, Obama rejected TransCanada’s initial application. TransCanada modified its application and re-submitted it to the Obama administration, initiating a new round of environmental impact studies, public comment sessions, and lobbying efforts.

A 2013 State Department draft report concluded that Keystone would not worsen climate change, because oil sands could be developed without the pipeline and moved to market by other means, including rail. The government just finished a final report—which finds no environmental harm—and which was based on input to the draft that included environmental considerations. A separate review underway, by State’s Inspector General, is assessing whether there were any contracting improprieties during the initial response to TransCanada’s request. This review will be completed by March 2014, with a decision presumably coming sometime thereafter. However, a recent scenario being circulated has Obama deferring the Keystone decision to the next administration, postponing a decision until 2017.

EPA TRUNDLES ON

EPA continues to increasingly act as if it is the fourth (unelected) branch of government. In fact, EPA Administrator Gina McCarthy has given notice that she is finished “waiting for Congress to act” on climate issues and intends to bypass the legislative branch in implementing federal policies. 

EPA Administrator Gina McCarthy seeks to expand her power to include oversight of land use for oil and gas.

McCarthy, who was confirmed in July 2013, gave a remarkable (frightening) speech at the University of Colorado at Boulder. She cited President Obama’s June 25, 2013, speech, in which he unveiled his Climate Action Plan and vowed to make combating climate change a priority of his second term. McCarthy stated that “Essentially, he said that it is time to act, and he wasn’t going to wait for Congress, but that he had administrative authorities and that it was time to start utilizing those more effectively and in a more concerted way.”

So, according to McCarthy, “We’re going to do this, this year, next year, the following year, until people understand these are not scary things to do, these are actions we can all do.” Never mind that in 2009, Congress rejected a bill to establish a cap-and-trade system designed to discourage GHG emissions. That legislation passed the House but was defeated in the Senate—at a time when Democrats controlled both houses. The Democrats were further chastised in 2010, as they were trounced by voters in the off-year elections. 

EPA is also seeking a massive expansion of its regulatory power over land use, including energy development. As recently noted by the House Committee on Science, Space and Technology, “EPA intends to expand federal regulatory authority, under the Clean Water Act (CWA), to include even the most isolated wetlands, seasonal drainages and prairie depressions. A sweeping reinterpretation of EPA jurisdiction would give the agency unprecedented control over private property across the nation.” Thus, McCarthy and EPA bureaucrats will be able to tell people (and energy companies) what they can and cannot do with their private property.

THE 800-POUND GORILLA

The most serious threat to energy companies may not reside in any particular Senate election, the composition of the White House staff, international climate negotiations, or EPA machinations. Rather, it may stem from the Obama Administration’s use (or misuse) of the social cost of carbon (SCC), which is an estimate of the monetized damages associated with an incremental increase in carbon emissions in a given year, and is meant to be a comprehensive estimate of climate change damages. In February 2010, a Federal Interagency Working Group (IWG), consisting of 12 agencies, developed SCC estimates of about $22/ton, and in May 2013 the IWG revised upward its SCC estimates to about $36/ton.

The purpose of the estimates is to allow agencies to incorporate the social benefits of reducing CO2 emissions into benefit-cost (B-C) analyses of regulatory actions, and EPA and other federal agencies use the SCC to estimate the climate benefits of rulemakings. The new, higher SCC estimates were used for the first time in a June 2013 rule on efficiency standards for microwave ovens. Quite simply, arbitrarily high SCC values will force oil and gas out of many markets and sectors and, via regulation, make fossil fuels ineligible for many uses. Given the Obama administration’s history, it is highly likely that in forthcoming updates, the SCC values will increase, with trillions of oil and gas dollars at stake.  

The first deficiency in the use of SCC in B-C analysis is that the IWG methodology used in developing SCC estimates is not rigorous, and is flexible enough to produce almost any estimates desired. The IWG used three integrated assessment models to estimate the SCC: FUND, DICE and PAGE. These models are supposed to combine climate processes, economic growth, and feedbacks between the climate and the global economy into a single modeling framework. However, there is a limited amount of research linking climate impacts to economic damages. Further, each model uses a different approach to translate global warming into damages, and transforming the stream of economic damages over time into a single value requires “judgments” about how to discount them. As objective analysts have concluded, the SCC estimates developed by the IWG have little or no validity and are “close to useless.”

Second, the differences in the 2010 and 2013 SCC estimates are so large, and of such immense potential significance, as to raise serious questions as to their validity—especially since, prior to February 2010, the “official” Federal government SCC estimate was zero. If any valid governmental economic estimates, such as GDP or unemployment, were revised by 30–50% within a 3-year period, it would represent a scandal and a farce. 

Third, as noted, the SCC estimates will be updated over time. Thus, it is likely that current SCC estimates will be repeatedly and substantially revised in the future—perhaps in both directions, but more likely only upward. How useful or relevant can the SCC estimates be, if they continually change over time? Will regulatory decisions based on one set of SCC estimates be revisited, as the estimates change?

Finally, no attempt is made to estimate carbon benefits or positive carbon externalities. Since the development of B-C analysis in the 1950s, such analysis has sought to assess both the costs and the benefits of a proposed initiative, to determine if the benefits exceed the costs. It is thus a self-evident truism (an inconvenient truth?) that a valid B-C analysis must include both costs and benefits and, indeed, as noted, under EO 12866, agencies are required “to assess both the costs and the benefits of the intended regulation.” So, it is thus incredible that the IWG process hypothesizes almost every conceivable carbon “cost,” including costs to agriculture, forestry, water resources, forced migration, human health and disease, coastal cities, ecosystems, wetlands, etc., but it fails to estimate carbon benefits. 

We must not kid ourselves: This is extremely serious business and high, arbitrary SCC estimates will cause immense problems for the oil and gas industry. The Obama administration has declared war on fossil fuels, and ignoring or minimizing the magnitude of the problem is not a solution.