ALLOWABLES NEEDED TO FIX U.S. GAS INDUSTRY CRISIS

James G. Floyd
President, Chief Executive Officer
Brooklyn Union Exploration Co.
Houston

Troops were dispatched quickly to solve the last gulf crisis. But there's another gulf-related problem closer to home that demands expedient action.

It involves the Gulf of Mexico, the basin that holds our nation's largest reserves of natural gas.

This domestic crisis merits an equally swift response either from the energy industry or from government. It is no coincidence the Texas Railroad Commission is now considering rules to set allowable limits for gas production.

Many E&P companies strongly support the proposition, recognizing allowables will ensure supply meets demand, waste is eliminated, and the energy industry is responsibly monitored by government. These companies understand that unless we implement and enforce some limits on natural gas production, we risk significant damage to the nation's economic and energy infrastructure.

Gas prices have plunged to the point that, for many producers, prices are actually below cost of replacing reserves. While low prices have worked to the short term benefit of consumers, the lack of economic incentives leaves many companies unable to justify further exploration. This situation threatens the future supply of gas and could result in prices beyond the public's imagination.

Critics who have assailed allowables as a means of simply driving up gas prices are misinformed. The proposed allowables are designed to promote the long term supply of natural gas and eliminate waste.

THE PROBLEM

U.S. E&P vital signs are bad, but domestic production has increased the fifth year in a row. Why?

First, demand has increased among industrial and residential consumers because of the fuel's attractive price and environmental advantages. Second, a number of companies are opening their gas valves year-round to either fund international operations or generate cash flow to service debt.

Unfortunately, this creates gas-on-gas competition, where cash-strapped companies must produce and sell larger volumes at cheaper prices. The lower the price, the more producers have to sell to break even. The more they sell, the lower the price.

This situation is not free market enterprise; it is folly. Industry observers estimate half of all independent producers have ceased operations in the past 5 years, and the bloodletting is far from over.

Forget the adage that ours is a cyclical industry, with price increases waiting in the wings to prompt renewed exploration. Prices may indeed rise, but the "relief" will come far too late to help the thousands of communities affected by industry's decline. Our research shows that only a 10-15% shut-in during "soft" months would balance supply/demand. During periods of peak use, production would increase to ensure consumers' needs are met.

THE RESISTANCE

Opponents argue Texas cannot singularly affect the industry. On the contrary, Texas supplies 25% of the nation's gas market. Oklahoma supplies 12% of the market and signed allowables into law.

Opponents argue allowables are ill conceived because the industry suffers from an image problem related to artificial gas shortages in the mid-1970s. Indeed! This provides all the more reason to ensure a long term supply by responsibly monitoring production. Opponents also argue Texas gas will increase in price and Canadian gas will quickly flood the market if allowables are enforced.

Both are falsehoods.

If so-called Texas gas increases in price it will only reflect the market.

Canadian gas supplies only about 8% of the U.S. market, and pipelines do not now exist to support increased imports.

Finally, opponents argue increased prices will destroy incentive to use an environmentally preferred resource. But even if prices did increase somewhat, gas still would be preferentially priced to coal, oil, and nuclear energy.

FAVORING ALLOWABLES

Why should TRC vote in favor of allowables? I submit these reasons:

Allowables will help stabilize the industry. Volatile prices, whether too high or too low, result in unreliable budget forecasts and poor operational planning. Long term investment in exploration must be encouraged to ensure we meet future demand. Allowables will likely prompt higher prices, which in turn will provide companies necessary profit incentives to hunt new prospects.
Allowables will help conserve energy. Waste is the inevitable result of low prices and can occur when financial managers strapped for cash injure reservoirs by depleting them faster than norma
Allowables will help the economy by helping save jobs in the energy industry. But spillover effects will be equally dramatic for other employers that benefit from a healthy gas industry.
Allowables will increase local, state, and federal revenue. Oil and gas production accounts for billions of dollars in direct sales, ad valorem, and employment taxes.

Reality has presented a crisis of grand proportions, and allowables offer the most logical solution to avoid even more painful junctures and decisions in the future.

If we do nothing, we will slowly deplete current reserves, drill fewer exploratory, wells, rely on ever larger foreign supplies of energy, and see consumers faced with massive price increases. I believe these reasons strongly position allowables as a prudent plan of action.