Insight

Powering Up

Regulation, consumption trends, global population growth, and the pandemic’s many earth-shaking effects make this moment highly uncertain for the upstream-energy industry—and the only way forward is to change with the times.

Power plant in skyline at sunset
GL

George H. Lugrin IV

October 14, 2020 08:00 AM

In late February, I was on a Boeing 787 burning jet fuel, returning to Texas from London because of the novel coronavirus. I had no idea that after I got back the virus would virtually shut down air travel, personal vehicle use, and the burning of hydrocarbons in general worldwide.

Depending on where you get your data, the environmental impact of the shutdown has been anything from slight to significant. But there’s strong evidence from NASA and the European Space Agency that there have been sizable reductions in pollution—particularly in Wuhan, China, the source of the outbreak, where the government implemented and strictly enforced stay-home orders.

Readers of a certain age will remember the ozone crisis of the 1980s. Earth’s atmospheric ozone layer blocks most harmful wavelengths of UV sunlight, those that cause cancer and assorted maladies in humans and other animals. In the ’70s, some smart scientists noticed a marked reduction in the size of the ozone layer. By the 1980s the primary cause had been traced to the use of refrigerants (remember CFCs?). Given the fraught politics of the issue—yes, even then—it wasn’t until 1989 that countries banned ozone-depleting chemicals. In 2019, NASA reported that the ozone hole was the smallest it has been since it was first observed.

What should we make of this for the future of oil and gas exploration and production companies (also known as upstream companies—those who find and produce hydrocarbons), particularly given that stocks are now often rated on their “social sentiment” and the fact that many more people than in the past will likely work from home in the years ahead? I think the prognosis is good for integrated large companies (those that are upstream, midstream, and downstream, in other words), but not for non-integrated upstream companies unless something is done now to help them.

We should also note a few other important factors unrelated to the virus itself. Prior to the pandemic, virtually all “Big Oil” (e.g. Exxon Mobile, Chevron, Shell, BP, Total) had published net-carbon-neutral or carbon-reduction plans involving a combination of efficiency improvements, carbon-capture technology, and increased production of green energy—primarily solar and wind but also geothermal and my forgotten favorite, the fuel cell. (More on this in a moment.)

Critics charge that these prominent companies are engaged in nothing more than public relations, but I disagree. These businesses are realistic. They’re run by very smart people (some of whom I know), all of whom have families and an interest in protecting the environment for future generations. They’re not evil, as they’re often depicted.

Likewise, the sky is not falling. Continually improving energy efficiency—think of variable-speed air conditioners, for example—and better upstream exploration and extraction techniques have proven wrong all the “we’ll soon run out of fossil fuels” naysayers from the 1980s. It amazes me that people never fail to underestimate the speed of innovation.

Natural gas is plentiful, cheap, and burns cleaner than oil or coal. It’s the natural choice for a transition fuel to green energy. It’s expensive and risky to extract, though; the overwhelming upstream supply is locked within shale—tight rock—which requires horizontal drilling and hydraulic fracturing for efficient production. This requires money, something the large integrated businesses have and that capital providers have quit doling out to non-integrated upstream companies.

Recall that before the pandemic, capital providers had already moved away from non-integrated companies due to their poor returns and constant need for cash to sustain production. There are many views about how elevated prices have to be to make extraction profitable, but to me, the fact that the money flow has largely dried up is proof that current prices aren’t high enough.

Once extracted, gas must be moved to downstream facilities. Non-integrated companies therefore must make deals with midstream businesses to get their gas into the system to be sold. This increases expenses, lowering profits and necessitating, again, higher prices to make money. Integrated companies, by contrast, have their own midstream facilities—or, failing that, they possess greater leverage to make better deals. Either way, their midstream costs are lower, which translates to higher profits on upstream assets.

This makes for a bleak outlook for non-integrated companies should they fail to adapt to the changing landscape. For example, oil and gas leases can be modified to permit wind or solar farms in suitable locations. Or companies can partner to add natural-gas-fired electricity-generation plants where appropriate, then place the resulting power on the grid, skipping the midstream component entirely—something anyone with solar panels on their home already does. This has the added benefit of reducing the risk of transporting gas through the U.S.’s aging pipeline infrastructure. Companies can also team up with a carbon-capture business at the electricity-generation site to further reduce emissions (and, ideally, generate a tax benefit). The possibilities are limited only by human ingenuity.

I propose four important steps: First, we need to continue to reduce our reliance on coal in an orderly way, as it’s just too inefficient and dirty for a modern energy source. Reducing oil consumption is second, but with a caveat: Oil is different. We use it as feedstock to make a variety of products necessary to nearly everything we do. Absent some quantum technological leap, it’s not going away anytime soon.

Third, we must foster the acceleration of the move to electric vehicles and artificial-intelligence-based self-driving technologies. The most dangerous thing most of us do, after all, is drive a car. Self-driving tech will eventually significantly reduce needless death and suffering. It will also cut local carbon-monoxide and noise pollution.

Finally, we need to move away from the electric-grid system in most areas, relying instead on local fuel cells—the “forgotten favorite” I mentioned earlier—to power homes and buildings. Fuel cells are electrochemical devices that convert hydrogen (the most abundant element in the universe) and air to electrical energy. The byproducts of this chemical conversion, which involves no combustion, are heat and water—water you can drink right away. Fuel cells produce electricity on demand and, as long as there’s a steady hydrogen supply, continuously. The wind doesn’t have to blow; the sun need not shine. Hydrogen can be separated from water using energy generated by natural gas, at centralized locations that use carbon-capture technology.

The naysayers of the 1980s were right about one thing, though: population growth. The number of people on the planet has increased as expected, and the global population is now projected to be 10 billion by 2050—an additional 3 billion energy consumers in just 30 years. Nor does this even address the increased energy needs of today’s emerging markets as their middle classes grow.

You don’t have to be a genius to take two key points from all this: One, we’ll need more energy in the future, and two, more of it will be green. Regarding the latter, we can take a lesson from Mother Earth herself, who seemed to have settled on solar and geothermal energy before humans came along and discovered things to burn. (Thinking on an even larger scale, nature runs on hydrogen, otherwise known as the sun. But I digress.)

I’m passionate about fuel-cell technology not just because it’s green and will reduce pollution but because it has the potential to eliminate those large, ugly, view-blighting sticks known as telephone poles. I also like the idea of capturing heat and using it much like a mini-cogeneration facility. The technology has a way to go, however. Hydrogen is more flammable than gasoline, and transportation and storage present risks. But I’m confident all these problems can be solved by innovators who have the incentive to succeed.

Hydrocarbons, like it or not, are not going away, and we should think creatively about how to use them as a transition fuel. That includes saving our non-integrated upstream companies from our current upstream troubles. After all, they were the innovators who gave us the shale revolution and the plentiful, cheap, and cleanest hydrocarbon transition fuel. We’ll soon need to satisfy the energy needs of emerging markets and a growing world population while simultaneously being mindful of the health of the planet. For that, we need our non-integrated upstream companies to innovate as they always have.

George H Lugrin IV is the shareholder, director, and president of Houston-based litigation law firm Hall Maines Lugrin, P.C. A successful and prolific trial lawyer with several high value “wins” under his belt, Mr. Lugrin routinely tries complex commercial and insurance cases for both plaintiffs and defendants, including coverage, subrogation, architectural and engineering professional malpractice cases, take or pay contract disputes, and upstream and pipeline transportation issues.

Headline Image: UNSPLASH.COM / THIJS STOOP, JAAKO KEMPPAINEN, NASA

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