The Energy Renaissance – And What Its Price Cycles Mean to You

Ryan Lance | Chairman and Chief Executive Officer

Thank you, Joe. And good afternoon, everyone. I appreciate the opportunity to speak at one of the country’s most distinguished forums. I was also quite impressed at meeting all the outstanding young students. Detroit has a lot of good things going on.

It’s a long way between here and Houston, the energy capital – nearly 2,200 miles. But thanks to the interrelated U.S. economy, we’re practically neighbors.

ConocoPhillips supplies natural gas to your local utility company, DTE Energy. As well as to Muskegon Development, Vector Pipeline, Great Lakes Transmission and North Bay Energy. So Michigan is home to several of our valued customers.

We in turn are one of your customers. Michigan companies supply us with oil and gas field services, chemicals, synthetic lube oil, machinery seals, communications services, engineering software, engine filters, HVAC equipment, consulting services, electrical products and university-level research.

Our suppliers – I’ll only mention a few – include Atlas Oil, Chemtrade, Pro-Seal, Silversmith, Altair, Outerwears, Boll Filter, IMECO, SafetyServe and Integrated Security Corp.

We contribute to nearly a half-dozen universities here. We also lease quite a few trucks that are made in the U.S.A.

As an engineer, I feel at home here. Detroit ranks second in the nation in engineers per capita – second only to Silicon Valley. And who doesn’t love American muscle cars? I still have my Dad’s ’67 Mustang convertible, and a ’63 Corvette Sting-Ray split-window coupe. There could be a Charger in my future one day.

So we in Detroit and Houston depend on each other. We have a lot in common, and a lot to talk about. I’m here today to discuss:

• The energy renaissance and its benefits.
• The energy price downturn, and its causes.
• Prospects for the future.
• Potential threats to the renaissance.
• And how companies like ConocoPhillips withstand such market volatility.

Our products serve as raw materials in thousands of plastic goods, fertilizers to grow foods, synthetic fabrics for clothing and furniture, asphalt for roads, household cleaning products, medicine, lubricants, car tires and even cosmetics.

Oil and Gas Touch our Lives in Countless Ways

I’ll start by saying that you’d probably be surprised at how many times oil and natural gas touch our lives each day.

Most people use gasoline or diesel fuel in transportation. Natural gas heats three out of every four homes in Michigan. And just over one-tenth of your electricity comes from burning natural gas.

Our products serve as raw materials in thousands of plastic goods, fertilizers to grow foods, synthetic fabrics for clothing and furniture, asphalt for roads, household cleaning products, medicine, lubricants, car tires and even cosmetics.

In other words, oil and natural gas are vital to modern life. Nothing else can replace them in these multiple uses. As for energy, the renewable sources can’t come on fast enough to replace them for decades to come. Since transitions in energy sources typically take a half-century or more, oil and natural gas will remain part of the energy future.

The U.S. energy renaissance is not going away – despite the current downturn in oil and gas prices.

The Energy Renaissance Will Continue

Considering these realities, I have good news. The U.S. energy renaissance is not going away – despite the current downturn in oil and gas prices. In just over a decade, the U.S. has gone from energy shortage to abundance. That’s thanks to our relatively new ability to recover oil and natural gas from shale rock.

U.S. liquids production is up six million barrels a day since 2008, or 89 percent. Our liquids reserves are at record levels, with plenty of resources awaiting future development.

As for natural gas, the U.S. and Canada together now have a century of potential supply. In the Mid-Atlantic and Northeast, the Marcellus Shale is so big that pipelines are being reversed to ship gas from there to the Midwest and South.

This fundamental transformation has returned the U.S. to world leadership in oil and gas production – at least until the recent downturn. It has cut oil and gas imports dramatically from their mid-2000s peak, improving the trade balance. And even exports of oil and liquefied natural gas have begun. All these factors have strengthened U.S. influence in diplomatic circles and the global energy market.

America Has Benefitted

The renaissance brought real benefits to consumers and business. For example, factoring out inflation, Detroit’s current gasoline price of $2.25 a gallon equals 28 cents at the pump in 1962 – the year I was born.¹ So it’s the good old days all over again. This has helped U.S. auto sales reach new records.

Home heating and electricity bills are also down, even though natural gas demand is at record levels – and growing. Fortunately, U.S. gas reserves are also at record highs – and also growing. Shale has made a flood of gas available at low development costs. So natural gas is trading at prices around $2 per million Btus. That’s one-fifth of its price in 2008.
As a result, the energy-intensive industries have benefited from the renaissance – auto manufacturing, aluminum, iron and steel, cement, glass, oil refining, chemicals, paper products, foods and fertilizer. Manufacturing uses nearly a third of all the energy consumed in the U.S.² A new study for the National Association of Manufacturers found that affordable U.S. natural gas has encouraged manufacturing growth and job creation.³ And Michigan is helping lead the way. Detroit ranks first in manufacturing job growth since 2009.⁴ Our abundant, affordable energy is helping give U.S. manufacturers a competitive advantage.

The energy-intensive industries have benefited from the renaissance – auto manufacturing, aluminum, iron and steel, cement, glass, oil refining, chemicals, paper products, foods and fertilizer.

Meanwhile, the domestic oil and gas industry was becoming a key to U.S. prosperity. Over the past decade, the industry invested $100-to-$200 billion a year in North American exploration and production.⁵ Even earnings from overseas came back here for reinvestment – a reversal of past practice.

This added hundreds of thousands of new jobs in the industry. Each in turn created three jobs in the supply chain – such as here in Michigan. And another six jobs in the broader economy. In total, the industry supported 9.8 million domestic jobs at peak a few years ago.

Domestic energy development stimulated the economy and helped lead us out of the 2008 recession. One study found that the energy renaissance’s shale gas increased the average American family’s disposable income by nearly $1,400 last year⁶, for example, through both economic stimulation and energy cost savings.

Impacts of the Energy Downturn

It was long assumed that falling oil prices would benefit the economy. But a Goldman Sachs study says they have been a net negative so far.

But now, besides low prices for our natural gas, the industry is facing a sharp downturn in oil prices that began in mid-2014. But while consumers are gaining further savings, there are unanticipated consequences. It was long assumed that falling oil prices would benefit the economy. But a Goldman Sachs study says they have been a net negative so far. That’s because of tens of thousands of job losses in the industry, and its support industries. As well as reduced investment and activity levels.

The same is true worldwide. Capital investments in commodities – which include oil and gas – made up nearly one-third of all global capital investment in recent years. When these expenditures rise or fall, there’s economic gain or loss. The consulting firm Wood Mackenzie says that $550 billion of oil and gas investments are deferred or at risk because of low prices. In fact, $220 billion in budget cuts have already been announced for this year and next. That’s impacting all producing nations, including the U.S. So the downturn is contributing to sluggishness in the world economy.

The oil industry is hurting. Oil prices were $100 a barrel two years ago. They fell below $30 in less than a year. Not many industries lose 70 percent of their revenue in such a short span. Prices have rebounded to the mid-40s now. But this is still too low to enable increased investment.

Factors Driving the Downturn

The factors behind the downturn are global in nature. World economic growth has slowed down – particularly in emerging markets. For example, China’s moving from an economy based on major public works construction and exports to one led by local consumption. This has reduced their oil demand growth.

Meanwhile, much of the world has been slow to recover from the 2008 financial crisis – including the U.S. In addition, cars and trucks are becoming more fuel efficient.

The result has been the current downturn. We are seeing today’s low prices stimulate both U.S. and world demand. But not enough. Production has remained one to two million barrels a day above demand during the last few years. This despite production losses of 3.5 million barrels a day due to geopolitical events in other countries. Our U.S. production growth offset it.

Currently, with more oil coming on the market, global inventories are very high. And OPEC is not cutting production to balance the market. They’ve talked about it, but not agreed on action. This inaction is itself a new market dynamic. There is disagreement within the cartel, but the Saudis are standing firm in maintaining high production.

So that’s the downturn in a nutshell. The questions now are – how long will it last? What comes next? And will we see the extreme price volatility we experienced in the past?

U.S. production has already proven very resilient – even despite a 75 percent drop in onshore drilling in two years.

The Current Market

Here’s what some of the industry experts say. The downturn has already lasted longer than many of them first expected. But annual demand is growing by more than a million barrels per day. Meanwhile, non-OPEC production is now falling due to the low oil prices. So given time, demand and production will rebalance. Most experts expect that later this year.

But there’s another factor in play – record oil inventories. So it could then take another 18 months for the market to absorb the excess. After that, oil prices should rise, but we don’t know to what level. The experts say it takes between $50 and $80 per barrel to encourage new investment. And new supplies will in fact be needed to offset natural production decline and meet rising demand.

This new “equilibrium price” should be influenced by the fact that a lot of new supply now comes from lower-cost U.S. tight oil production – from shale. As a result, the world doesn’t need new high-cost supplies.

U.S. production has already proven very resilient – even despite a 75 percent drop in onshore drilling in two years. Not all the U.S. shale trends are still economic, but the best are. Once prices improve, activity will pick up and drive new production growth. Meanwhile, we likely won’t see any new expensive mega-projects in deepwater or Canada’s oil sands in the near term. These and other higher-cost resources will remain available for later – and they will eventually be needed.

The Future Outlook

The domestic oil production and price outlooks are important to you as well as us. We’d both like to know what gasoline and diesel fuel will likely cost. $2 a gallon, or $3 or $4? For the auto industry, that signals whether consumers will want economy cars, or pickups and SUVs.

But in reality, we live in a world of uncertain geopolitics, economics and weather. Unforeseen events in producing areas could take oil off the market. Such as in hot spots like the Middle East, Africa and Latin America. Meanwhile the world economy is uncertain. It could keep growing slowly – or take off upward – or decline. And there is always the possibility of storms in producing areas. Or as we’ve seen in Western Canada, even wildfires can affect the market.

The industry’s hundreds of separate independent producers don’t move in lockstep. It will take clear price signals to incentivize all of them to ramp up. Fortunately, we know the oil is there. And we can drill and complete new wells quickly once we get going. Then U.S. production could start growing again.

We do expect to see price cycles in the future. Although the energy renaissance can’t take the volatility out of the international oil market, it perhaps can reduce the length of future price spikes. So America’s resumption of production leadership could serve as a stabilizing factor.

With our greater resource base, we can respond to price upticks by resuming shale development. It just can’t happen overnight. There has been severe attrition in the service and supply industry. Some lag time will be required to raise capital, rehire and retrain drilling crews, and redeploy rigs to the field.

Also, the industry’s hundreds of separate independent producers don’t move in lockstep. It will take clear price signals to incentivize all of them to ramp up. Fortunately, we know the oil is there. And we can drill and complete new wells quickly once we get going. Then U.S. production could start growing again.

As we become more used to today’s prices, any price change will feel like volatility.

Emotionally, as we become more used to today’s prices, any price change will feel like volatility. But U.S. production potential should at least limit the timespan over which prices would move away from equilibrium. Certainly, all of us would prefer greater clarity and stability in our businesses. But it’s also important to understand how we can mitigate and persevere through the inevitable market cycles.

Threats to the Energy Renaissance

That said, I must point out that there are home-grown risks to the energy renaissance, related to government policy and public perception.

One of them is access to resources. The energy renaissance occurred primarily on privately owned land that we could lease from owners. There is also a great deal of potential on government-owned acreage both onshore and offshore. But gaining access can be challenging or even impossible.

That access might be needed when and if the U.S. and world economies boom again, and energy demand increases. Also, world population is growing from seven billion today toward nine billion by mid-century. That alone should increase demand.

Another threat is regulatory over-reach. There are overlaps of state and federal regulations that slow down or block development. We’re also concerned by efforts to employ regulations for unintended and ill-suited purposes, such as using the Clean Air Act to regulate carbon emissions.

Public perception can pose a risk. Every industry has its critics, and we are no exception. It’s incumbent upon us to engage with stakeholders, and respond to their concerns when possible.

We are positioning ConocoPhillips to successfully operate in a world challenged to reduce its emissions.

Legislation that imposes a cost on carbon emissions could also have an impact. The recent Paris conference reached agreement on a global greenhouse gas emissions reduction framework. This heightens the importance of managing our climate footprint. We are positioning ConocoPhillips to successfully operate in a world challenged to reduce its emissions.

And there are always threats to raise taxes – despite the already high burden. During the recent boom years, ConocoPhillips paid effective global tax rates in the mid-30s to mid-40s percent range.

Withstanding the Downturn

I’m often asked how we survive in a market with such risk and volatility. We’ve been through cycles before. Since joining the industry in 1984, I’ve experienced six downturns and five upturns. I’m waiting for the current cycle to turn. But downturns do force the industry to recalibrate its strategies, conserve capital and cut costs.

ConocoPhillips reinvested $17 billion into our company in 2014. We cut that to $10 billion last year, with only $5.7 billion planned for this year. The majority will go to projects with low cost of supply and short cycle times – like U.S. shale. We’re deferring projects that require long-term investment – while retaining optionality for the future. This flexibility is important not just today, but during any future upcycles or downcycles as well.

We’re also working hard to become more efficient.

 

And we’re striving to maintain a strong balance sheet. During the recent boom, the E&P industry reinvested 130 percent of its annual cash flow into the business. This meant it took on debt. That’s not a problem during upturns – but it is today. So everyone is watching their balance sheets closely. Once an upturn does begin, the industry will need time to repair its balance sheets before really ramping up spending.

I can say that the industry is determined to come out of the downturn stronger – more efficient – more tightly focused. And just as capable of contributing to the national economy as we have in the past.

Conclusion

Before moving to questions and answers, I’ll reiterate these key points:

The industry is determined to come out of the downturn stronger – more efficient – more tightly focused. And just as capable of contributing to the national economy as we have in the past.

• Oil and gas are essential to everyday life in far more ways than most people realize.
• We are indeed fortunate to have experienced the U.S. energy renaissance and its many benefits.
• The impacts of the oil and gas price downturn extend far beyond the energy industry.
• But this downturn will pass, like the others that came before.
• And we should remain aware that flawed governmental policies could potentially pose threats to the renaissance.

Our country’s incredible base of energy resources makes us the envy of much of the world. We have technology second to none, and extraordinarily capable people. All of us – industry, consumers and government – are in this together. If we work together, we have all we need to withstand this or any market cycle, while ensuring a sustainable energy future.

Those are my thoughts, and I look forward to your questions. Thank you.
 

 ¹ Average per gallon on www.detroitgasprices.com on 5-17, Bureau of Labor Statistics CPI Calculator
² Top 20 Facts About Manufacturing” on website of National Association of Manufacturers (NAM)
³ IHS study “Energizing Manufacturing – Natural Gas and Economic Growth,” May 2016, prepared for NAM
⁴ The Cities Leading a U.S. Manufacturing Revival,” newgeography.com; citing U.S. Bureau of Labor Statistics
⁵ Global 2016 E&P Spending Outlook,” January 13, 2016, Barclays Research
⁶ Exact number is $1,337 from the same IHS study