Rethinking Energy Policy

In the aftermath of the fuel shortages and soaring prices caused by Hurricane Katrina, senior U.S. lawmakers say they plan a new legislative push to expand offshore production of oil and natural gas and to encourage the construction of new refineries in areas outside of the Gulf Coast. "If there is a silver lining in this tragic situation, it may be that our country understands how fragile our energy sector is and how easy it is to disrupt it," House Energy & Commerce Committee Chairman Joe L. Barton (R-Tex.) remarked at a hearing last month. "This hurricane is a reminder of what needs to be done."

Barton noted that U.S. refineries have been operating at maximum capacity for the past two to three years. "It's time to not only rebuild what we have, but in my opinion, it's time to build additional resources so we're not as stressed as we have been," he said. "We have not built a refinery in the U.S. in more than 30 years, and Katrina has shown us that our refining capacity is inadequate."

The hurricane put a significant crimp in the nation's energy supply because 29% of U.S. oil and 21% of domestic natural gas come from the Gulf of Mexico. Nine major refineries located in the coastal regions hardest hit by Katrina were shut down as the catastrophic storm approached, putting 12% of the nation's total refining capacity out of commission. Four of those facilities--three in the New Orleans vicinity and another in Pascagoula, Miss.--suffered extensive damage and may not be back in operation for months, according to industry officials.

"Hurricane Katrina exposed the harsh reality that we have been skating on thin ice when it comes to the concentration of energy infrastructure and production on the Gulf Coast," said Senate Energy & Natural Resources Committee Chairman Pete V. Domenici (R-N.M.) at a recent committee meeting.

Damage from Hurricane Rita, which is still being assessed, further exposed the vulnerability of the nation's energy supply system.

NEARLY HALF of America's refining capacity spans the coastline from Texas to Alabama, and more than 60% of the nation's imported oil comes through Houston and other ports in the region. "The Gulf Coast is the heartland of the U.S. oil and natural gas industry," said Red Cavaney, president of the American Petroleum Institute, in testimony before the House energy panel. The reason for this geographic concentration in a high-risk hurricane area, he noted, is that government policies have largely limited offshore exploration and production to the central and western Gulf. "Our onshore facilities, including refineries, have been welcomed in communities in the region as well," Cavaney added.

Oil and gas development has been banned for more than two decades in federal waters off the East, West, and Florida Coasts. Congress enacted the first moratorium in 1981 when U.S. natural gas supplies were plentiful and cheap, and later expanded its reach. Drilling is now banned in 85% of the 1.76 billion-acre outer continental shelf (OCS), which in most cases begins three miles offshore and extends 200 miles to the international boundary. "It would make a difference today if we were not as restrictive as we've been the last 20 years in where we drill," Barton said. "We can't just get our oil and gas from Texas, Louisiana, Mississippi, and the Gulf of Mexico. We could be drilling off the coasts of several other states."

However, any suggestion that the restrictions on energy exploration and production should be eased has been met with fierce resistance by environmental activists and many coastal state lawmakers. During debate on the comprehensive energy bill that Congress passed this summer, Sens. Lamar Alexander (R-Tenn.) and John W. Warner Jr. (R-Va.) proposed giving states the right to opt out of the federal moratorium. In addition to boosting energy supplies and providing diversity to domestic resources, opening more coastal areas to offshore drilling would raise billions of dollars for state and federal treasuries through lease sales and royalty payments, they argued. The amendment was withdrawn when Sens. Bill Nelson (D-Fla.) and Jon S. Corzine (D-N.J.) threatened to derail the bill by engaging in procedural delaying tactics. Alexander has claimed that 51 senators were prepared to vote in favor of his "states' rights" proposal, nine short of the number needed to overcome a filibuster.

Domenici said the political landscape on energy policy has now changed. "The things that were not possible two months ago are still before us and require an answer," he remarked. "Political obstacles cannot stop us from addressing the hard issues that will secure our energy infrastructure." Offshore drilling in areas that are not subject to hurricanes "clearly has to be put on the table," he said. That is possible, Domenici observed, if efforts are also made to reduce energy use.

Repeated attempts to require automakers to make their vehicles more fuel-efficient have failed because of bipartisan opposition in Congress. But the hurricane was "a serious wake-up call that we have to do something both on the supply side and the conservation side," Domenici said. "Any time you see $3.00 gasoline and the highest natural gas prices in the world, the first thing you can do is conserve and the second thing you can do is drill," Alexander added. "We need to do both."

On Sept. 8, a coalition of chemical companies and other businesses that are heavily dependent on natural gas urged House Speaker J. Dennis Hastert (R-Ill.) and other Republican leaders to support legislation to open new U.S. offshore areas to energy production. "The nation is paying the price for concentrating so much of its energy infrastructure in a small geographic location," said the letter signed by the American Chemistry Council (ACC) and 100 other companies and organizations. "Steps must be taken now to expand and diversify our sources and supplies of energy."

According to the Interior Department's Mineral Management Service, there is an estimated 406 trillion cu ft of natural gas in offshore areas. States are unable to access much of it because of federal restrictions. "We believe it is in the national interest for Congress to immediately remove these production barriers in order to provide new sources of energy," the letter said. Drilling is now allowed only off the coasts of Alaska, Alabama, Louisiana, and Texas.

The industry coalition said the "highest priority" should be placed on opening a portion of the eastern Gulf of Mexico known as the lease sale 181 area, which is not covered by the federal drilling ban but has not been leased by the Interior Department. "Lease 181 has an abundant supply of energy resources with access to existing pipeline infrastructure that will speed delivery of natural gas to the market," the letter stated. "This is our nearest term supply addition and, among other things, could save manufacturing facilities from shutting down, while saving good jobs that would otherwise be lost."

In 2001, the Bush Administration drastically scaled back a 1997 Clinton Administration proposal to allow some new energy exploration in the 5.9 million-acre tract--a victory for Florida Gov. Jeb Bush, the President's brother.

Although natural gas prices have increased fivefold in recent years, the Energy Information Administration (EIA) is projecting even higher prices as a result of damage to energy infrastructure in the Gulf Coast region. EIA noted in its September outlook that natural gas production levels dropped by more than 40% after Hurricane Katrina, and the market is "likely to stay tight over the next couple of months, particularly in light of the supply impacts from Katrina." It predicts natural gas spot prices this winter will soar 37% to 50% above 2004 averages.

"Even before Hurricane Katrina hit, extreme supply/demand imbalances in the natural gas market had led to record high prices, resulting in higher production costs for energy-intensive industries, as well as job losses and slowed growth," said ACC President Jack N. Gerard. "Infrastructure damage in the region is making this problem worse." Although releases from the federal petroleum reserve can help the oil market regain its footing, he pointed out that there is no equivalent correcting mechanism for natural gas. "Instead, we will need changes in federal policy to provide greater and geographically diverse supply, and, in the short term, to help calm the market by signaling that these supply increases are on the way," Gerard remarked.

The industry official noted that in some countries, natural gas can be purchased for one-tenth of its U.S. price, making the U.S. manufacturing sector significantly less competitive than are some parts of the world. Chemical manufacturers use natural gas both to heat and to power their facilities and as a raw material.

"NOW MORE THAN EVER, it's clear that access to the significant natural gas assets available offshore the continental U.S. needs to be expanded," Gerard declared. "The system that supplies the nation's natural gas needs is being strained to its limits. We hope that Congress will act now to add supply measures, especially expanded access to offshore energy reserves."

Although a slight majority of lawmakers appear to favor drilling for oil and natural gas off the East and West Coasts, states such as California, Florida, and New Jersey and a host of environmental groups remain vehemently opposed, citing the possibility of spills that would damage lucrative tourism and fishery industries. "It's hard to imagine a more reckless response to a hurricane that generated major oil spills," said Lisa Speer, senior policy analyst at the Natural Resources Defense Council. "These new drilling proposals would put millions of citizens in thousands of coastal communities at risk, threatening fisheries, wetlands, and the whole coastal economy."

Carl Pope, executive director of the Sierra Club, noted that the U.S. is responsible for 25% of the world's oil consumption but holds only 3% of the world's oil reserves. "The fact is, we cannot drill our way to energy independence," he said. Sen. Melquiades R. (Mel) Martinez (R-Fla.) said the primary cause of the Katrina-related energy shortages and price spikes is the lack of U.S. refining capacity. "More drilling in the Gulf is not a solution," he said. "In this case, it would have done nothing to affect fuel prices."

Lawmakers say they will look at the possibility of building more petroleum refineries outside of the Gulf region. "Katrina reminds us of the need to protect and expand resources and infrastructure in the Gulf producing states to encourage continued operations," Barton said. "But it also reminds us of how centralized our nation's energy infrastructure is and the need to encourage investment and diversification."

Robert G. Slaughter, president of the National Petrochemical & Refiners Association, told the Senate energy committee that the nation's 148 refineries can process 17 million barrels per day of crude oil. In 1981, there were 325 refineries in the U.S. with a capacity of 18.6 million bbl/day. Meanwhile, oil consumption rose by 33% over the same 24-year period, to 20.8 million bbl/day. Imports fill the deficit.

"NO NEW REFINERY has been built in the U.S. since 1976, and it will be difficult to change this situation," Slaughter said. Economic, public policy, and political considerations--including siting costs, environmental requirements, a history of low refining industry profitability, and a pervasive "not in my backyard" public attitude--lie behind the impasse, he testified.

"Company revenues can be in the billions, but so, too, are the costs of operations," according to the industry official. And although many existing facilities have increased their capacity, Slaughter noted that expansion projects "often become controversial at the state and local level, even when necessary to produce cleaner fuels" to meet regulatory requirements.

David K. Garman, the Department of Energy's undersecretary for energy, science, and environment, told the House committee that the main obstacle to building new refineries is local opposition and an extensive permitting process, which discourages investment. "I would imagine that people would not want to put large amounts of capital at risk with so much uncertainty," he said. "History has shown us that anyone trying to put up a new energy facility of any kind faces a lot of local opposition. Investors tread lightly as a result."

Some Democrats claim that industry has closed numerous refineries over the past decade to increase profit margins for those that remain. "When 30 refineries shut down over 10 years, it appears to be an industrywide attempt to raise prices," Rep. Edward J. Markey (D-Mass.) said. "The industry doesn't want to build more refineries because it makes more money the way things are," added Rep. Lois Capps (D-Calif.). Industry officials deny any suggestion of collusion and maintain that companies have shut down the smaller, less efficient refineries while expanding others to make up the difference in capacity.

To encourage the construction of new refineries, the recently enacted Energy Policy Act of 2005 allows a state governor to petition the Environmental Protection Agency for technical and financial assistance in the permitting process. But Barton said much more needs to be done, and noted that he has been given "the green light by the [House] leadership to go out and be innovative" in crafting legislation.

Barton intends to resurrect and possibly expand an earlier proposal that would designate industrial areas with high rates of unemployment as "refinery revitalization zones."

Barton's proposal would also streamline the environmental review and permitting processes required before a new refinery project is approved. The House-passed measure was rejected by Senate Democrats during negotiations in July on the final version of the energy bill. But given the supply disruptions and price shocks that have resulted from Katrina, Barton said he believes "the country is much more receptive now to something a little stronger" than his original proposal. His revamped refinery plan is expected to include additional incentives, such as tax breaks and accelerated depreciation for investments.

Sen. Jeff Bingaman of New Mexico, the ranking Democrat on the Senate energy committee, agrees there is a need to increase and diversify the nation's refining capacity. "There might be things the federal government could do to provide incentives for construction of additional refining, closer to where the actual refined product is used," he said. "That might be the East Coast and the West Coast more than in the Gulf region, which is of course the area that is most vulnerable to hurricanes."

Although there likely isn't enough time to push another comprehensive energy package through Congress this year, lawmakers say an appropriations measure or the budget process could serve as a legislative vehicle for further policy changes. "The best approach may be to look at any of the appropriations bills in conference," said Domenici, who also chairs the Senate Energy & Water Appropriations Subcommittee. Another possibility is a $34.7 billion package of tax and spending cuts that Congress plans to take up in late October.

The budget reconciliation bill, which is expected to include language to open the Arctic National Wildlife Refuge in Alaska to oil and gas drilling, would be an attractive target for an offshore drilling amendment because the underlying measure cannot be filibustered under Senate rules. Such a provision would also generate revenue and help reduce the budget deficit.

The Bush Administration appears wary of any new legislation to address the problems brought to light by Katrina. Noting that his department already faces a heavy workload in implementing the new energy policy law, DOE's Garman said he doubts the Administration would support a refinery revitalization plan that requires government funding.

Meanwhile, the Interior Department, which is formulating its 2007-12 offshore leasing plan, has pledged not to allow drilling within 100 miles of Florida's coast. But the department is also seeking comments on whether other sections of the eastern Gulf now excluded from leasing should be opened.

"The OCS contains billions of barrels of oil and trillions of cubic feet of natural gas that can be safely produced," Interior Secretary Gale A. Norton said. "With our reliance on imports of foreign oil climbing each year, we would be irresponsible if we did not consider how we might develop these domestic resources."