MANAGEMENT & ECONOMICS: US needs expansion of 30% at all levels of energy chain

California signaling future problems

William Furlow
Senior Editor

Ongoing power shortages in California hint at a larger problem for the US that is not likely to go away soon. Experts now realize that there is not enough capacity at any level in the entire energy chain.

If similar problems are to be avoided in other US regions, dramatic steps must be taken, according to economist and investment banker Matthew Simmons, President of Simmons & Company. Simmons believes the so-called new economy was mistakenly thought to not require additional power. He said all of the computer equipment central to this growth consumes electricity faster than the US, and the world, can produce and distribute it. Offsetting this shortage and keeping the economy of the US and other industrialized nations on track will require a coordinated expansion effort. Simmons estimates an expansion in the area of 30% will be required at all levels of the energy chain. This is a financial and managerial challenge the world has not seen since the Marshall Plan was proposed to rebuild Europe after World War II.

Simmons and Marshall

There are a number of similarities between Gen. George Marshall's plan to rebuild Europe and what Simmons sees as the necessary expansion of the world's energy infrastructure. He believes capacity must be added to every stage of the energy industry, from the wellhead to the pipeline, and to the refinery, power plant, and electrical grid.

Simmons said such an expansion will be a tremendously expensive project, just as the Marshall plan was. But, the similarities go deeper. Gen. Marshall's point, when he introduced the plan during a commencement address at Harvard University in 1947, was that if Europe was not rebuilt, the chaos and poverty that resulted would present a threat to the security of the US.

In the same sense, it is equally important for the US to help expand the energy infrastructure globally to protect energy sources. Simmons said one of the most impressive accomplishments of the Marshall Plan was that it induced a dozen countries, who were war allies but did not necessarily get along, to cooperate and put aside their differences in favor of a common goal. This is a critical necessity of the energy expansion as well.

Government's role

Simmons said government will play a key role in this effort because the free market does not have the unified vision necessary to expand all sectors of the energy business at the same time. The private sector does not operate in an orderly and rapid manner.

The free market will lurch from one perceived market opportunity, where the prices become unbelievably high, to another, Simmons said, overbuilding each as it goes. Government needs to provide very careful guidance, sprinkle money in areas where there is little private sector incentive, then get out of the way.

Getting out of the way is an important step. Once the governments of the world provide industry with the vision and incentive to begin the process, they must let the private sector take charge and build up capacity.

This cannot be an isolated, US effort. Acting alone, Simmons said, the US cannot solve this problem. Shortages and bottlenecks in other countries will affect the supply in the US. This is a global market, which means the solutions have to be global. "This needs to be carefully coordinated on a global basis," he said.

Simmons said he was encouraged to hear more discussion about the energy crisis lately, which means that there is recognition of the problem. Simmons has testified before the US House of Representative committee meeting on natural resources. He said several committee members were receptive, while others were concerned about conservation, convinced that rather than expanding production, conservation should be encouraged. "Conservation is something we have to take seriously, but it will never solve our energy problems," he said.

Conservation

While conservation does not solve the problem, Simmons said, it does slow down the energy deficit, while capacity is being expanded. Still, he said, it is foolish to believe cutting down on energy use can solve these problems.

Simmons gave as his example the common household refrigerator. He said this is recognized as the one household appliance that consumes the greatest amount of power. As an example, he pointed to the hypothetical introduction of a new generation of refrigerator that was 20% more energy efficient than those now in use. Assume further, he stated, that there was growth in the refrigerator market, and this new product was so popular it replaced 10% of the existing refrigerators each year, with the effect that in 10 years, this new appliance made up 100% of the market. Now, everyone in the US has a refrigerator that is 20% more efficient; however, at the end of 10 years, this new device would have saved only 1% of the US's energy consumption.

Larger advances

Conservation is a baby step, Simmons said. The real advances will be opening up new areas to drilling and increasing the capacity to handle this additional production. Simmons said it is encouraging to see the US government take a greater interest in the energy crisis. He is confident that by the end of his first year in office, US President George W. Bush will have given more speeches about energy than any other issue.

Another factor in increasing awareness is the higher energy bills people are seeing across the US. Not only is this a symptom of a shortage, but it is a necessary part of the cure. Simmons said energy prices are now at a level that should be considered low.

Sustainable prices have to remain at or above the current level to offer the industry the necessary incentive to drill new wells and build new power plants, refineries, and pipelines. "This idea that $30/bbl oil destroys the economy is just a myth," he said.

Fixed oil price

Simmons said he has created a formula for setting the global price of oil based on the economy of Saudi Arabia. His point is that it is in the security interests of the US that this country have enough revenue to produce a middle class. That means the 22 million people living there today and the 35 million who will live there by 2010 must have a target per-capita wealth equal to Spain, one of the countries at the lower end of the OECD (Organization for Economic Cooperation and Development).

This should be a realistic minimum goal. If the country is exporting 15 million BOE/d by 2010, up from 8 million BOE/d today, then it would need a price per barrel of $35. Of course, as the country's population expands, it will consume more oil domestically, which would jump this number to $55/bbl. While Simmons admits this is just a mental exercise, it does point out that the natural price of oil is most likely not in the teens of dollars.

In the end, it is difficult to see how this problem could be fixed in an orderly fashion. Simmons said the increased awareness and the higher prices for oil and gas are a good first step, but it will take added spending across the industry.

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