Does the U.S. Really Need An Energy Policy?

Financial Executive Magazine...January/February 2012

     Sen. Joe Mancini (D-W. Va.) was frustrated. Mid-way through a two-hour hearing in the Senate Energy and Natural Resources Committee on November 8, Mancini was taking out his ire on Chris Smith, Deputy Assistant Secretary for Oil and Gas in the DOE Office of Fossil Energy. The hearing was held to discuss whether the Department of Energy should approve applications for U.S. companies to export liquid natural gas (LNG). Just half a decade ago, LNG import terminals were popping up like dandelions in American coastal ports amidst spreading industrial user panic over sky-high domestic prices and disappearing supplies.

     But toward the end of this century's first decade, that gas gloom lifted without warning and  with nary an assist from the U.S. government. Because of an innovative technology called horizontal drilling or fracking, natural gas started flowing from the Marcellus and Barnett shale plays like Champaign from bottles uncorked at the Ritz on New Year's Eve. Gas prices dropped precipitously. The Energy Information Administration (EIA) now estimates the U.S. produces 5 billion cubic feet a day of natural gas more than what consumers can use, with the result that prices have dropped from a high of $12.69 per million BTUs in June 2008 (the average for that year was $8.94) to $3.60 m/BTUs in October 2011.

     Mancini had just asked Smith a question about whether foreign ownership of wells in the Marcellus formation lapping across Pennsylvania and New York could impact the domestic price of natural gas if those foreign owners decided to sell "their" gas overseas. Smith tried to answer. But an impatient Mancini interrupted. "It is shame this country doesn't have an energy policy, that is all I am saying," sputtered Mancini.

    Just half an hour earlier, though, at the very same hearing, from the very same dais, Sen. Lisa Murkowski (R-AK), the top Republican on the panel, had made the opposite point. Naming   Marcellus, Utica, Barnett and other shale plays, she emphasized, "I don't think we should fool ourselves. The government didn't make this happen. The natural gas resource is proving out without any mandate, without any tariff or moratorium, without so much as a tweak in any law or regulation."

     Ever since the Arab oil embargo of 1973, U.S. president after U.S. president has paid at least rhetorical attention to the need for the federal government to develop an energy independence policy. Last March 30, in a speech at Georgetown University, President Obama announced his Blueprint for a Secure Energy Future. He said: "We’ve known about the dangers of our oil dependence for decades.  Richard Nixon talked about freeing ourselves from dependence on foreign oil.  And every President since that time has talked about freeing ourselves from dependence on foreign oil.  Politicians of every stripe have promised energy independence, but that promise has so far gone unmet."

     But it is highly unlikely that Obama's Blueprint will lead to a firmer footing for U.S. energy security than past Blueprints from other presidents, or, perhaps more importantly, whether a Blueprint is even necessary. Obama's Blueprint policy is a loosely knit set of policies which focus on producing more oil at home and reducing dependence on foreign oil by developing cleaner alternative fuels and greater efficiency. The Blueprint is not the result of any particular deep thinking or strategy. The President's Council of Advisors on Science and Technology (PCAST) called for the development of such a strategy in its November 2010 Report to the President on Accelerating the Pace of Change in Energy Technologies Through an Integrated Federal Energy Policy. The PCAST called for a Quadrennial Technology Review (QTR) as the first step in preparing a Quadrennial Energy Review. The DOE completed the QTR in November 2011, six months after Obama published his Blueprint.

     Steven E. Koonin, Under Secretary for Science, DOE, says the QTR is limited in scope and all the DOE felt it could get done given budget and time. "Technology development absent an understanding and shaping of policy and market context in which it gets deployed is not a  productive exercise," he states. At this point there is no indication that the DOE will even undertake the much more important QER, much less complete it any time soon.

      The larger reality is that any energy independence plan proposed by any U.S. President--whether based on a QER or not--has as much a chance of coming to fruition as Washington's hapless Redskins have of getting into the Super Bowl. In any case, the rhetoric of President after President aside, maybe the U.S. doesn't even need an energy independence or energy security policy.

     The biggest energy input for industrial and commercial business users is natural gas. Natural gas prices are incredibly important, both because the fuel is used directly to run industrial processes, heat facilities and commercial buildings, and make products such as fertilizers, pharmaceuticals, plastics and other advanced materials. Thanks to the Shale Revolution, the Energy Information Administration (EIA) forecasts natural gas prices will stay low for the foreseeable future, rising to $4.66 m/BTU in 2015 and $5.05 m/BTU in 2020. That is good news for the owners of 15,000 to 17,000 industrial boilers in this country, most of which use natural gas (and many of those who still use coal are switching to natural gas). In addition, companies such as Dow Chemical are restarting operations at facilities idled during the recession, Bayer is  in talks with companies interested in building new ethane crackers at its two industrial parks in West Virginia, and Chevron Phillips Chemical and LyondellBasell, are considering expanding operations in the U.S.

     Fracking has also had a much less remarked-upon effect on petroleum prices, which are important to businesses with transportation fleets. New oil sources are spurting from the   Bakken and Eagles Ford shale plays.  U.S. oil prices have fallen from $133.88 a barrel of Texas intermediate crude in June 2008 to $86.07 today. The EIA predicts oil prices will rise to $94.58/bbl in 2015 and $108.10/bbl in 2020.

    Beyond the flood of natural gas washing over them, U.S. companies are also benefitting from three decades of investments--most of which made without federal subsidies or support--into facility energy efficiency. Ralph Cavanagh, Co-Director, Energy Program, Natural Resources Defense Council, member of Electricity Advisory Board at the DOE, says the most important single solution for U.S. businesses worried about energy prices and energy access is aggressive energy efficiency. "Energy independence is the wrong issue," he says. "It is reducing the cost of energy services and improving energy security. "U.S. business has done a tremendous job in energy efficiency over the past three decades," he states. "It takes less than one-half of a unit of energy to create $1 of economic value than it did in 1973. Industry has done that by upgrading the efficiency of process equipment and upgrading lighting."

     Others may well argue that the U.S. needs, and has always needed, an energy policy, but one narrowly targeted. Kenneth B Medlock III, PhD, Deputy Director, Energy Forum, James A Baker III Institute for Public Policy at Rice University, notes that the DOE and the Gas Research Institute  helped develop, with federal funding,  the horizontal drilling (i.e. fracking)  technology that Mitchell Energy (now a part of Devon Energy) pioneered.  "Government ought to be focused on research & development," he states. He also is a supporter of loan guarantees to promote investment activity in frontier technologies, and argues that as long as there are more good bets than bad bets in that kind of portfolio, the funds committed in total are a good investment.

     But spectacular failures like Solyndra and other less publicized busts such as Beacon Power's Chapter 11 filing kill the prospect of any additional congressional funding for energy loan guarantees of any kind. That is true even when legislation has bi-partisan support, which is the case for the Energy Savings and Industrial Competitiveness Act of 2011 (S. 1000) which would, among other things, provide grants for a revolving loan program designed to develop energy-saving technologies for industrial and commercial use. The bill passed the Senate Energy Committee by a vote of 18-3 in July. However, the Congressional Budget Office has pegged the cost of the bill's provisions at $1.2 billion over five years. That is a serious barrier to passage. And in any case, even if it did pass, the bill would simply authorize funding. Congressional appropriations committees would have to approve the money as part of the DOE's budget, which would be highly unlikely, Solyndra aside, since similar programs authorized by the 2005 and 2007 energy bills are still begging for appropriations.

        Besides impact on the federal deficit, politics, too, often impede progress on otherwise sensible policies. Politics clogged up the Keystone XL oil pipeline extension from Canada. Environmentalists, a Democratic constituency, oppose the project, arguing it would created more greenhouse gas emissions than necessary and pose a potential drinking water danger for Nebraska residents because it passed over the Ogallala Aquifer, a view held, too, by Nebraska's Republican Governor Dave Heineman, who took the opposite position from all Republican presidential candidates, who supported U.S. approval of Keystone XL.  Labor unions, another key Democratic constituency, support the project which TransCandada, the project sponsor, says will bring more than 118,000 person-years of employment to workers in the states of Montana, South Dakota and Nebraska.

      If the Keystone debate features Democrats v. Democrats and Republicans v. Republicans, efforts to substitute domestic natural gas for foreign petroleum features business v. business. Obama in his Blueprint speech at Georgetown mentioned legislation supported by both Republicans and Democrats called the New Alternative Transportation to Give Americans Solutions Act of 2011 (H.R. 1380), called the NAT GAS Act.  The bill has 180 co-sponsors ranging from Rep. Joe Barton (R-Texas) on the right and Rep. Barbara Lee (D-Calif.) on the left. The bill seeks to provide federal support for a natural gas fueling structure for autos thereby reducing gasoline demand. However, 65 manufacturing and agricultural organizations sent a letter to the House Ways & Means Committee in September opposing the bill, fearing a diversion of natural gas to transportation--even give the 5 b/cu/ft/day overage in supply at the moment--would increase domestic costs of natural gas. Calvin M. Dooley, President & CEO, American Chemistry Council, calls the NAT GAS Act, an "ineffective, inefficient proposal." Supporters of the bill include local and interstate natural gas companies, bus and taxi companies, food companies and the National Beer Wholesalers Association.

      Regardless of whether Americans start driving natural gas fueled vehicles, dependence on Middle Eastern oil for gasoline to fuel autos has dropped dramatically since 1973, without much U.S. government intervention, making the U.S. much more energy secure than ever before. Our number one import source is Canada, from whom we get about twice as much crude oil, according to the EIA, as Saudi Arabia, the number three source, and the only Middle Eastern source besides Iraq in the top 10. Mexico is number two.

     Given the new domestic sources of natural gas and crude oil, important strides in industrial energy efficiency and the shift away from imported Arab oil, the U.S. has made considerable progress toward energy independence or security, whatever term one wants to use, without an "energy policy." That doesn't necessarily mean we don't need a policy. But it does mean that U.S. companies do not have to panic about the absence of one.

Obama Signs New Pipeline Safety Bill

Pipeline & Gas Journal...January 2012

     The new pipeline safety bill President Obama signed in December gives PHMSA new latitude to expand integrity management requirements to new areas and require new industry safety measures such as automatic or remote-controlled shut-off valves. But the Pipeline and Hazardous Materials Safety Administration (PHMSA) will have to jump through more flaming hopes than a circus performer before it can issue final rules. The new Pipeline Safety, Regulatory Certainty, and Job Creation Act of 2011 (H.R. 2845) requires PHMSA to first do a number of studies and reports, submit them to Congress, meet congressional thresholds for enacting any new standards and in one important instance gives Congress an opportunity to forestall any new standard.

      The final bill generally pleased all industry groups, including INGAA. INGAA is already voluntarily extending integrity management procedures beyond what are called High Consequence Areas--deemed areas with high population density. The bill gives the PHMSA authority to require extension of IM processes. But first it must make an evaluation of whether extension of IM procedures is necessary and economically justified, based on criteria the bill lays out. The PHMSA has two years to make that evaluation. It must then submit its thoughts to Congress. Then Congress has one year to pass legislation based on the PHMSA report, or pass legislation prohibiting PHMSA from acting. If Congress does nothing, PHMSA is free to act on its own.

     PHMSA also has to jump through numerous hoops before requiring interstate pipelines to install automatic or remote-controlled shut-off valves. It can only do so two years after the bill's passage and after determining such a requirement is "economically, technically, and operationally feasible" and can require installation only on new pipelines.

      The bill uses identical language with regard to any PHMSA rule requiring distribution pipelines to install excess flow valves (EFVs) on lines serving apartment buildings, commercial and industrial facilities. The current PHMSA rule, enacted as a result of a provision in the last (2006) pipeline safety bill, limits installation of EFVs to new, single family homes. The National Transportation Safety Board (NTSB) has a long-standing recommendation (see item below) to require EFVs for all residential, commercial and industrial buildings.

     Among the more significant of the bill's 31 sections is the one related to maximum allowable operating pressure (MAOP). MAOP, like remote-controlled shut-off valves, was the subject of recommendations from the NTSB as a result of its investigation of the PG&E gas pipeline explosion in San Bruno, California. The NTSB recommended that Congress remove the provision in current law that exempts gas transmission pipelines constructed before 1970 from hydrostatic testing to determine the line's maximum allowable operating pressure; and require post-construction hydrostatic pressure tests of at least 1.25 the maximum allowable operating pressure in order for manufacturing- and construction-related defects to be considered stable.

      The bill does remove that exemption; it requires PHMSA to publish within 18 months rules for testing "the material strength" of previously untested pipelines within HCAs. But it goes further by saying PHMSA must require interstate and intrastate pipelines to verify that the MAOP of pipelines in class 3 and class 4 locations and class 1 and class 2 HCAs accurately reflect their physical and operational characteristics. Pipeline owners would have to submit to PHMSA within 18 months of the bill's passage documentation where their records are "insufficient" to confirm the established MAOP. Any time pressure on a pipeline exceeds MAOP the company would have to report that to PHMSA within five days.

   The bill also addresses the issue of excavation damage. It requires states to eliminate current exemptions for certain participants in one-call notification systems if that state wants to get federal excavation damage prevention grants.

ACO Final Rule Acknowledges Medication Concerns

Pharmacy & Therapeutics Journal...December 2011

     The final rule published by the Centers for Medicare and Medicaid Services (CMS) at the end of October mostly simplifies and improves the financial aspects of the Accountable Care Organization (ACO) program in an effort to convince physician groups and hospitals to participate. It doesn't change the rules on who can share in any savings to Medicare produced by an ACO, a new form of integrated health care organizations, formed by physician groups and in some cases hospitals with staff physicians, aimed at providing comprehensive care to Medicare patients, and thus lowering the costs of that care, producing savings for Medicare. The Affordable Care Act (ACA) specifically states that only physicians and hospitals can share in the savings. The proposed rule followed that edict; pharmacists, chiropractors, nurses...all were deemed "out of the money." The final rule sticks to that decision.

     That said, the medication management provided by pharmacists in large physician practices and hospitals will be critical to the success of any ACO. Dave Rhew, MD, CMO of Zynx Health, a provider of evidence-based and experience-based clinical decision support (CDS) solutions to hospitals, says physicians basically prescribe medications they have traditionally prescribed, and can sometimes be behind the curve, because of time constraints, on current changes in drug profiles. It will be up to a pharmacist to update physicians and hospital formularies, for example, when a drug like Xigres (Drotrecogin Alpha), for severe sepsis, is voluntarily recalled by its manufacturer, here Eli Lilly, because of FDA concerns about the drug's effectiveness, in this case a concern that the drug does not reduce mortality.

     With regard to pharmacist interventions in ACOs, they only come into play where drugs are supplied to a Medicare fee-for-service patient by a physician in the physician's office (Part B) or in a hospital (Part A). An ACO participant's Part D drug costs will not be part of the "shared savings" calculations. This may turn out to be problematic in a number of instances, for example, in certain clinical areas such as cancer care and cardiac ablation for atrial fibrillation where ACOs may have an incentive to move patients from appropriate treatments or procedures reimbursed through Parts A or B to Part D therapies. The CMS acknowledged these are "important concerns" but the program's quality measurement and program monitoring activities "will help us to prevent and detect any avoidance of appropriately treating at-risk beneficiaries. Furthermore to the extent that these lower cost therapies are not the most appropriate and lead to subsequent visits or hospitalizations under Parts A and B, then any costs associated with not choosing the most appropriate treatment for the patient would be reflected in the ACO's per capita expenditures."

     It is impossible to know now whether this concern--medication cost shifting from A or B to D--will bear factual fruit going forward. But the CMS will apparently be looking over the shoulders of ACOs on this issue. "The financial incentives could cause physicians that are part of ACOs to increase the use of Part D medications to decrease the use of Part B medications or appropriate medical procedures," says Marissa Schlaifer, the Academy of Managed Care Pharmacy's (AMCP) Director of Pharmacy Affairs. "The Academy shares this concern." 

 

      Of course, the program integrity watchdogs at the CMS and other federal health agencies are getting fewer and fewer, federal budget cuts being the order of the day, and even in the halcyon days of federal spending with bigger staffs Health and Human Services were rather passive policemen. The office of pharmacy affairs, which administers the 340B drug program, is a good example of a department where, according to a recent Government Accounting Office report, the department detectives have had their feet up on their desks.

     We mention the 340B program here because it, too, comes into play with regard to concerns about medication cost shifting in ACOs. The 340B program allows safety net hospitals with high Medicaid populations to buy discount drugs, and it restricts whom those hospitals can give those drugs to. Recipients have to be patients of the hospital, seen by a hospital physician, and the drugs must be purchased at an out-patient (not in-patient) pharmacy. The drug manufacturers hate the 340B program, which requires them to sell drugs more cheaply than they would otherwise have to. Their concern is that safety net hospitals who join an ACO will expand their purchases of 340B drugs and provide those drugs to perhaps a medical group with whom it has partnered in an ACO. That allows the physician to substitute a cheaper drug (at 340B price) for the more expensive one he would have used, thus reducing the ACOs costs, since drug costs within Part B are calculated in the ACO equation.

        Hospital pharmacists are knee deep in the 340B program. So while they and their brethren stationed in physician offices will not be able to share in ACO savings, it looks like they will have their hands full preventing ACO headaches.

Obama Phase II CAFE Proposal and the Aftermarket

Aftermarket Business World...December 2011

     You'd have to be a college math professor to understand the formulas and factors the EPA and NHTSA propose to use in determining whether autos and trucks meet Corporate Average Fuel Economy (CAFE) standards during 2017-2025. The Obama administration released its proposed rule covering those years in mid-November, and three hearings are scheduled around the country for the month of January. Major auto manufacturers, labor unions and environmental groups already signaled their support back in July for the general concepts back in July; so the proposed rule is likely to become final with only some changes made around the edges.

      But even a fifth-grader can understand how the aftermarket will change as a result of these standards, once they go into effect. It goes without saying that CAFE standards affect vehicle manufacturers first and foremost. The only mention of the "aftermarket" in the mammoth, eye-splitting, 700-plus page proposed rule issued in November is with regard to aftermarket conversion companies, some of whom will apply for and be granted what are called small entity and/or small business exemptions. But the aftermarket will be affected indirectly and undoubtedly heavily by the development of technologies by manufacturer suppliers, who will distribute those technologies, be they low-friction lubricants, low-resistance rolling tires, air conditioning refrigerants with a lower global warming potential (GWP), to aftermarket retailers soon after they deliver them to the OEMs.

     Of course, there are, for example, low-resistance rolling tires already available in the aftermarket. But this Phase II CAFE proposal (Phase I will cover 2012-2016, and its rule is already final) will birth, for example, a second generation of low-resistance rolling tires with a 20 percent improvement in fuel economy and GHG emission reduction over those expected to be sold in Phase I.

     Another aftermarket product line likely to see innovation is high-efficiency exterior auto lighting. It will be in the spotlight because OEMs will use new lighting technology to reduce vehicle electric loads, which will earn them GHG "credits" which lower the CAFE number they would otherwise have to meet. The EPA would extend credits for lighting that reduces the total electrical demand of the exterior lighting system by a minimum of 60 watts when compared to conventional lighting systems. To be eligible for this credit the high efficiency lighting must be installed in the following components: parking/position, front and rear turn signals, front and rear side markers, stop/brake lights (including the center-mounted location), taillights, backup/reverse lights, and license plate lighting.

      The Obama administration proposal envisions a CAFE average per fleet in 2025 of 54.5 miles per gallon, an increase from the 35.5 mpg average expected in 2016, the last year of the Obama administration's Phase 1 plan. The Obama administration's 2017-2025 proposal is based on assumptions that plug-in electric and electric vehicles will become staples of the roads over the next decade and a half. Setting aside for a moment the high cost of electric batteries and the potential consumer resistance to the technology because of its cost, EVs also suffer from recent reports of battery blow-ups and fires in the weeks following collisions.

     Despite support from a number of groups, not everyone thinks the Obama proposal is hunky dory. Jeff Breneman, Executive Director of the U.S. Coalition for Advanced Diesel Cars, says the proposal favors hybrid technology in some instances over advanced diesel internal combustion technology, whose mpg/GHG performance is about equal. Moreover, he points out, advanced diesel engines can go 300,000 miles easy, meaning the autos in which they are installed can be kept longer, sending their owners more frequently to aftermarket retailers.        

SEC Examining Financial Statement Measurements

Strategic Finance Magazine...December 2011

     Are financial statement requirements up for review? It is not clear based on the a public roundtable discussion the Securities and Exchange Commission (SEC) held on November 8. The roundtable focused on financial statement measurements and associated disclosures that incorporate judgments about future events. It was the first in a series of an indeterminate number of roundtables which will be part of the Financial Reporting Series, instituted by SEC staff to assist in the proactive identification of risks related to, and areas of potential improvements in, the reliability and usefulness of financial information provided to investors. It is not clear what precipitated this initiative. It was not the Dodd-Frank law. It contains nothing on financial reporting "reforms," either in the financial services sector or anywhere else. In fact the SEC has done very little on financial reporting issues generally during Mary Schapiro's tenure as chairman. Jeff Mahoney, General Counsel, Council of Institutional Investors, says he suspects the SEC's action is related to the issue of fair value for financial instruments.

    There is a considerable amount of enthusiasm among statement preparers for the SEC effort here. "Determining the right level of disclosure requirements for measurement uncertainty will not be an easy task, but we are encouraged that the FASB has a Disclosure Framework project on their agenda and the prospect that guidance may be provided for disclosures on estimates that require assumptions, judgments, or other internal inputs that could reasonably have been materially different," says Bob Laux,  Senior Director, Financial Accounting and Reporting, Microsoft Corp.

      While the SEC hasn't said much about "why" it is undertaking these roundtables, it has been pretty specific about the kinds of topics it wants input on. These include: 1) where the extent of

uncertainty in an accounting measurement is less (or even more) useful to investors and why a more certain measurement would be preferable; 2) where uncertain measurements are useful to

investors, how should the uncertainties be incorporated into the measure; 3) What information do investors utilize to understand uncertainty?