Strategy

How a Broken Energy Policy Hurts Business

The CFO of Union Pacific wants the next U.S. President to adopt a national energy policy that promotes business investment.
Vincent RyanSeptember 13, 2012

As John B. Hess, the chairman and chief executive officer of Hess Corp., said in a Harvard Business Review blog early this year, the United States needs a “strategic vision for a secure energy future that underpins economic growth and protects the environment.”

But according to some experts and at least one CFOthat’s not what the Obama Administration is providing: or at least it’s providing one they don’t like. The problem is that it’s focusing on clean energy and climate change instead of the future of business investment in fossil fuels.

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While many politicians agree the goal of U.S. energy policy should be energy “security”  avoiding having foreign and military policy driven by the need to buy energy from overseas  the United States hasn’t had a clear energy policy for decades, experts say. That has a huge impact on companies in many industries, whether they are a supplier, part of the value chain, or an end-user. Rob Knight, CFO of railroad operator Union Pacific, says, for instance, that the lack of a policy currently is inhibiting investment.

“Our utility customers are sitting around worrying about the next regulatory issue. There’s no clarity right now,” Knight says. “They are rightfully moving slowly, and are cautious about making major long-term capital investments, and that has a direct impact on employment.”

“I spend a lot of time talking to power executives, and there is general uncertainty about the long-run arc of investment in the United States,” echoes Robert Stoddard, leader in the energy and environment practice at Charles River Associates. “Should they be retiring their older fleet and building new gas units, and if that’s happening, where are the gas pipelines going to come from and who is going to pay for them? Or should they be embracing renewables? But if they do that, are state utility commissions going to allow them to recover the costs?”

The Obama Administration has tilted toward renewables and a desire to lower dependence on fossil fuels. Through loan guarantees, the Department of Energy has supported about 40 clean-energy projects that will generate enough clean electricity to power 3 million homes and displace nearly 300 million gallons of gasoline annually, says the White House’s March progress report on the President’s “Blueprint for a Secure Energy Future.”

A focus on renewables policy was reinforced by the BP Macondo oil disaster in the Gulf of Mexico, says Chris Ross, a senior consultant to Charles River Associates. But many production tax credits for corporate investors in wind, solar, geothermal, and bioenergy products  designed to stimulate the renewable industries  are set to expire by 2016, beginning with wind energy at the end of 2012.

“It’s a sort of hit-or-miss approach that’s been going on, picking winners or losers in a way that companies can’t manage strategically,” Stoddard says. “They can’t know whether they should be in wind, for example, because the investment tax credits come and go.”

And the Obama Administration’s policy has “been forced to confront reality,” says Ross, because of the technology advance of “fracking.” Fracking, or hydraulic fracturing, allows energy producers to get abundant oil and gas from shale rocks. Natural-gas prices have been driven downward by the technology. Shale “really gives us an opportunity to reduce emissions from the power sector while retaining inexpensive power, and this has thrown into relief the fact that renewables are relatively expensive,” says Ross.

“The [United States] has achieved greater carbon-emission reductions over the last five years than any other industrialized country,” Stoddard notes, “and it’s not because of any comprehensive policy decisions, but a huge abundance of very cheap gas.”

Union Pacific is benefiting from this current energy-market dynamic, says CFO Knight. The low price of natural gas, which is a raw material in chemical manufacture, is causing Union Pacific’s chemical customers to expand their capacity in the Gulf Coast, a prime corridor for the 150-year-old, $21 billion railroad company. 

The development of oil and gas from shale is also driving higher volumes in the business of hauling the sand used for drilling and the equipment for rigs, as well as the transport of oil out of shale formations. “The manufacturers and producers in the shale play are the ones making investments in rail cars to handle and haul oil,” Knight says. “And they’re investing in storage facilities.”

But the shale play has its risks. First, there are concerns about the process of fracking, in particular its effect on water safety and its link to microearthquakes. Regulators and industry “need to have a comprehensive, thoughtful look at exactly what is safe fracking, what are the safe fracking fluids, how they should be recovered and handled, and how retired wells should be sealed off,” Stoddard says.

In the area of shale gas production, President Obama’s blueprint for secure energy notes that a committee is exploring measures to reduce the environmental impact and improve the safety of shale gas production. The Department of Interior is also developing new standards to ensure public disclosure of chemicals used in hydraulic fracturing operations on public lands, the document says, and the Environmental Protection Agency is “taking steps to address concerns about potential impacts to water and air resources.”

The other challenge for oil and gas producers is over “predictable” access to government lands to allow tapping shale and offshore reserves, says Ross. After the BP incident, there was a moratorium on drilling permits. But even now, “the permitting cadence is very slow and industry would like that accelerated so it can expand its reach,” he says. Still, the Obama Administration has not tried to stop the development of the shale energy industry, and indeed says it will be an important source of jobs in the years ahead.

The development of fracking has reduced the use of coal by some industries, and that is another policy complication for the next President. Union Pacific’s coal-transport business is off 12% in volume this year as of August 25. Many utilities that could switched from burning coal to burning natural gas when the price of gas was in the $2 to $2.50 range, explains Knight.

But there is a cloudy future for coal-fired energy, even though the country has an abundance of coal reserves. “What’s the life of coal?” he asks. “More [Environmental Protection Agency] pressure on the coal industry has, I would argue, made it more unclear.”

Coal-fired plants account for a little less than half of the electricity produced in the United States. But more than 600 coal plants in the United States, some from the Korean War era, will need technological updating to meet environmental regulations. Companies are beginning to shut down coal-fired plants because making them compliant would be too expensive.

There’s a good reason to be wary of coal: burning it contributes a large percentage of U.S. carbon dioxide emissions and is a significant source of mercury emissions into the air. The Obama Administration wants to focus on clean-coal technologies that produce less of a negative environmental impact, including using coal in combination with “carbon capture utilization and sequestration [CCUS],” a method of storing CO2 from the atmosphere and putting it into underground rock layers. The Department of Energy is investing $3.4 billion in developing such technologies, says Obama’s energy blueprint.

“I have seen a lot of studies on carbon capture and sequestration, and I am as yet unconvinced that this is anything more than a pipe dream,” says Stoddard. He says using the CCUS, it is extremely expensive to sequester the carbon out of the stream of a power plant’s emissions and then find a place geologically stable enough to store it. “The numbers I see don’t add up,” he says. “It’s not merely a flaw of the current technology, but fundamental limits related to physics and costs that are extremely difficult to overcome.”

Stoddard says coal has a limited life: “Just as no one heats their house in coal anymore, we’ll probably see in 40 years little or no coal used in the production of electricity.”

Republican Presidential candidate Mitt Romney wants to remove certain EPA regulatory efforts that he sees as inhibiting the future of coal. And he wants to prevent the “overregulation” of shale gas development and extraction, opening all federal lands and waters for drilling and allowing construction of pipelines to bring Canadian oil to the United States. Further, he would like to see the production tax credits for wind projects eliminated. Those statements may win him the votes of some business executives, but what Romney’s energy policy would be beyond that has not been articulated.

Despite not being addressed by Romney, renewables are part of the U.S.’s energy future. Indeed, the President’s 2013 budget includes $5 billion in tax credits for clean-energy technologies that he says would create tens of thousands of new construction and manufacturing jobs.

But businesses are worried about the expense. New technologies like solar and wind, if mandated by the government, could put U.S. companies at a competitive disadvantage, says Ross. “If renewables don’t get cheaper somehow, that raises the cost of producing power, and that cost gets passed on to businesses that operate in the United States,” he says. “Then they have a cost structure that is higher than countries like China that do not have a comprehensive move toward renewable power and are building coal plants [at the rate of] about one a week.”

The challenge for Obama or Romney in the next four years is to develop a well-articulated, well-accepted, logical, and actionable energy policy, says Stoddard. “With a policy cobbled together by a thousand little programs and initiatives, no business can predict what the thousandth-and-one program will be, so no one can think creatively about how their business can address opportunities related to the country’s energy goals,” he says.

The last President to supply a high-level vision on energy was Jimmy Carter, says Stoddard, but that Administration’s energy policies ran into political and business opposition, and didn’t get the popular support they needed.

While the energy industry and its customers want a clear direction on the future of fossil fuels, clearly they won’t get everything they want. An energy policy that gives business too much of a definite direction on investment is dangerous, given that energy markets change constantly. Five years ago, for example, much of the private sector thought there was going to be a shortage of natural gas, says Ross. “You can’t micromanage energy policy; you set the principles of it, and make them clear,” he says.