Implications for the Oil and Gas industry of ACES 2009

If you're new here, you may want to subscribe to our or .

| Sourced From |

A July 13, 2009 article in the Wall Street Journal highlighted the fractures emerging in a coalition of major businesses and environmental groups over support (or lack thereof) for the American Clean Energy and Security Act of 2009, or ACES. The US Climate Action Partnership (USCAP), which includes such members as ConocoPhillips, General Electric, DuPont, Environmental Defense Fund and the World Resources Institute, proved instrumental in shaping the bill that was eventually passed by a narrow margin in the US House of Representatives on June 26, 2009. Once a united architect behind a law that would impose significant compliance costs, the now fractured USCAP speaks to the mercurial nature of the policy-making process, and highlights the significant impact ACES will have on energy companies, especially the oil and gas sector.

By the bill’s design, the point of regulation for the oil and gas sector generally falls “upstream” of the end-user. In other words, individual automobile and home owners will not be required to purchase allowances to cover emissions from combustion of fossil fuels (as in gasoline, natural gas, heating oil, or propane). Rather, the obligation will fall upon fuel producers and importers and local natural gas distribution companies, the entities responsible for introducing the fuels into commerce. Whereas this reduces the administrative burden of the system (imagine trying to collect allowances for owners of the country’s 250 million vehicles?!), it also imposes substantial compliance obligations on individual energy companies.

To better understand the implications of the ACES bill for a specific company (and its impact on customers) we can use the nation’s largest independent oil refiner and marketer, Valero, as an example.

Valero has a refining throughput capacity of 3.10 million barrels per day. In 2008, the company processed an average of 2.80 million bbd, or about 1.02 billion barrels for the year. Based on average refinery yields, the company produced about 460 million barrels of gasoline and 357 million barrels of diesel. Assuming 100% of this was sold and combusted, we can estimate that combustion of these products resulted in the emission of 324 million tonnes of greenhouse gases. This means that if the cap-and-trade regime were in place in 2008, Valero would have had to buy 324 million allowances. To put this in perspective, an average 500 MW coal-fired power plant emits from 3 to 5 million tonnes of CO2 per year.

Assuming Valero buys 324 million allowances, we can estimate the company’s cost of compliance in 2013 (although the cap will be phased in over a four year period, the majority of the economy would be capped beginning in 2012 and companies would have until the first quarter of the following year to demonstrate compliance with the law). The US Environmental Protection Agency, in its analysis of the ACES bill, estimates that in the initial years, allowances will cost around $12 per tonne. At this level, Valero would expect to pay about $3.9 billion. As comparison, Valero’s net income for 2008 was $5.2 billion.

In order to avoid a drastic reduction in profits, Valero will pass the costs of purchasing allowances on to their customers. At $12 allowance prices, this translates into about 11 cents per gallon of gasoline. Given the volatility of oil prices and the fact that last summer saw $4.0/gal gasoline, this may not look like a lot. Yet it introduces a new fixed cost that refiners have to wrestle into their margins. Furthermore, this only represents the cost of covering emissions that occur through combustion of a refinery’s products. Beginning in 2014, Valero would also be required to cover any direct emissions associated with refining oil. Although direct emissions will be substantially less, they still represent an additional cost to the refiner.

Behold one of reasons some members of the USCAP are not happy with the current form of ACES. The bill prescribes in great detail the mechanism by which allowances will be distributed to the market. Much to the chagrin of President Obama, the bill would not auction 100% of the allowances; rather, only 15% will be auctioned off directly, and approximately another 25% would be provided to State programs that will in turn sell the allowances in the market and use the proceeds for various initiatives to protect consumers and invest in energy efficiency and renewable energy projects. The remainder will be distributed freely to various industries to help ease the burden on consumers. Public utilities that distribute electricity to consumers, for example, would initially receive about 44% of all allowances created for the entire market; this means that individual utilities would receive a volume of allowances sufficient to cover 90 to 95% of their emissions. Utilities would be required by law, however, to pass on the savings from free allocations to electricity consumers. Similarly, beginning in 2016 (when the cap is expanded to cover local gas distribution companies) allowances would be freely distributed to LDCs and the savings will need to be used to protect natural gas customers against price hikes.

In stark contrast, refiners only receive about 2% of allowances. Although this could mean up to 45% of a refiner’s emissions, individual entities would receive allotments based on a formula relating to a refinery’s relative efficiency. Independent refineries are concerned that this allocation level creates an unfair advantage for refineries based in other countries that are not subject to carbon caps and that it would create a strong incentive to begin importing a greater proportion of refined products from abroad.

As Senators turn their attention to drafting their own version of a climate bill, they will no doubt hear from a diverse range of energy companies hoping to lessen the impact of the bill on their respective balance sheets. Nevertheless, if a bill gets through, we can most certainly expect that energy companies, whose products result in the vast majority of greenhouse gas emissions in the United States, will be tasked with finding ways of reducing our country’s significant carbon footprint.