NATURAL GAS:

Exxon-XTO deal forces Congress to reconsider resource

With a $31 billion swipe of its virtual debit card, Exxon Mobil Corp. has started changing decades-old conventional wisdom in Congress that accessing the ocean of natural gas trapped under U.S. soil is merely a pipe dream.

Natural gas is the cleanest of the fossil fuels, and electric utilities that burn it to generate electricity belch out half the amount of carbon dioxide emissions they produce when when they burn coal. Exxon's decision in December to purchase Fort Worth, Texas-based XTO Energy, one of the nation's largest gas producers, could mark a dramatic shift in the way Washington understands domestic energy supply. It also underscores the role that gas is likely to play in cutting industrial emissions, in the United States and in fast-growing developing countries such as China and India.

"The industry is about a year, or maybe two years, ahead of Washington in understanding that this ability to almost manufacture gas from shale underneath a huge part of the United States and Canada is a revolutionary development in energy," Deutsche Bank's chief energy economist, Adam Sieminski, told the National Economists Club in Washington last month.

Congress has long been undecided about where natural gas should fit into the energy-supply pie. Coal has dominated as a fuel source for electricity generators. More than 100 nuclear plants supply about 20 percent of U.S. power, and natural gas supplies about 20 percent.

Industry estimates and policymakers' assumptions about gas supply and its role in cleaning the air shift decade to decade. At the end of the 1970s and into the 1980s, gas was considered a precious commodity with a short, 10-year domestic supply. But starting in the late 1990s and through much of the past decade, utilities built gas-burning power plants to the exclusion of coal-fired plants to help them comply with clean-air mandates.

North American gas supply and demand changes depending on the weather, gas storage, U.S. industrial demand and the impact of hurricanes on Gulf Coast drilling rigs. Gas prices skyrocketed after Hurricane Katrina hit in 2005, and since then prices have been a roller coaster for producers and consumers. In the past year, the economic recession slashed consumption and kept household gas and electric bills relatively low.

In Congress, the long memory of those price swings has kept the skeptics skeptical and the industry largely on the sidelines during the ongoing climate debate.

At a Senate hearing in August, Sen. George Voinovich (R-Ohio) tore into the chairman of the Federal Energy Regulatory Commission, Jon Wellinghoff, for suggesting that gas, in combination with renewable resources and energy efficiency, could be a near-term bridge until zero-carbon technology is widely deployed.

"We encouraged our electricity to go to natural gas; our gas prices went up to the top," Voinovich said, leaning into the microphone to get his point across. "We lost millions of jobs in this country because of high natural gas costs. When we did that policy, we didn't pay attention to the impact it would have on our economy."

Deal could give Exxon new clout on climate policy

The $31 billion Exxon-XTO all-stock deal still has to jump some regulatory hurdles. If the merger becomes real, Exxon will be the largest natural gas producer in the country, controlling large chunks of acreage in the most promising onshore gas fields in the United States. Texas, Louisiana, Oklahoma, Arkansas and the Appalachian regions of Pennsylvania and New York are the epicenter of shale gas, coalbed methane and tight-sand gas formations.

Because natural gas, not oil, is so critical to power generation, Exxon's voice will carry weight it perhaps never did before in the battle over climate policy. Exxon has openly opposed proposals to adopt a cap-and-trade program that would reduce greenhouse gas emissions below 2005 levels by making it expensive for industrial plants and utilities to use high-carbon fossil fuels.

"It gives them a lot more reason to be involved in the U.S. policy discussion," said Andrew Logan, director of the oil program at Ceres, a Boston-based coalition of institutional investors and environmental groups. "It doesn't necessarily represent a strategic shift in its approach to environmental issues or climate change."

Ceres has pressed Exxon to reveal more to shareholders about the long-term financial risks it faces due to climate change and government policies aimed at targeting oil consumption. Logan said investor activists have filed those resolutions again, hoping Exxon's board will heed their concerns and open up the dialogue.

Exxon has a fraught relationship with Congress. In 2008, when world oil prices climbed to $147 a barrel and its earnings soared, Exxon became a punching bag for populist Democrats and Republicans. For much of the past decade, perceptions that the company is run by climate skeptics who are hostile to any policy prescription aimed at reducing industrial emissions put Exxon on the enemies lists of some on Capitol Hill. For others, Exxon is the corporate name behind "foreign oil" because of its headstrong push, with U.S. backing, into hostile areas of the world in search of oil.

Exxon has been more outspoken about climate change under CEO Rex Tillerson, who has been less willing than his predecessor, Lee Raymond, to completely dismiss it as a policy challenge. Still, the company's precise views on the issue are hazy to both lawmakers and investor activists who have pressed Exxon for more clarity.

Consider this exchange from a House Energy and Commerce Committee hearing last week, where Tillerson testified about the Exxon-XTO merger and answered questions about Exxon's position on climate and energy use: Exxon scientists believe the climate is changing, Tillerson said, and one contributing factor is industrial greenhouse gases. But, he continued, "It is a scientific challenge. We view it as a risk-management problem."

"Our view for some time has been, first and foremost, let's continue to support the scientific investigation of what is one of the most complicated areas of science that people are studying today, and that is climate," Tillerson said. "We support the scientific advancement of understanding this issue."

Climate models, he asserted during the hearing, are inconclusive.

Rep. Jay Inslee (D-Wash.) replied, "I still get letters from constituents saying humans are not involved in changing the climate. I'm going to report back to them that the leader of the largest energy company in the United States believes that we are one contributing factor to climate change. I hope they'll listen to that."

Energy's new '800-pound gorilla'

"Exxon has minimal investments in non-fossil fuel energy, and it has played a negative role historically in the climate debate," said Ceres' Logan. "There's real concern about the company's strategy."

Exxon is expanding its gas drilling, Logan said, but doubling down in the Canadian oil sands, where a significant percentage of Exxon's new oil reserves are located. Environmental groups have criticized Exxon and the parade of oil companies developing Alberta's fields for bankrolling a massively dirty, greenhouse gas-heavy and water-intensive oil project. Operators there say it will provide a large amount of oil to the United States.

Exxon has a majority stake in one of Canada's largest oil companies, Imperial Oil, which has stakes in three major oil sands projects. According to a 2008 financial statement, Imperial's Cold Lake field is the largest of its kind in the world.

Green Century Funds, a Boston-based group, has filed a stockholder resolution calling on Exxon to report on the long-term financial risks associated with the "significant environmental, social and economic challenges associated with the oil sands." It will be the first resolution addressing the oil sands if Exxon includes it as part of the corporate proxy statement put before shareholders at its general meeting this spring.

The company's new role in the North American natural gas market isn't all bad, Logan said. "The potential for applying that in innovative ways is very real," he said. "This purchase has implications in terms of global energy use."

Exxon is a disciplined operator, Logan said, and could raise the bar for environmental stewardship in shale and tight-sands gas fields where public concern about groundwater contamination has emerged as a potential liability for smaller producers.

"Their entrance also brings in a new 800-pound gorilla," Logan said. Exxon might raise the bar on a field-by-field basis, but it has lobbying heft that could stifle attempts in Congress to impose a broad set of rules on hydraulic fracturing, the process of using some combination of chemicals, water and sand to blast through rock and release trapped natural gas.

Tillerson and XTO Energy CEO Bob Simpson told the congressional panel they could support a federal requirement that producers disclose those chemicals. But they said additional U.S. EPA regulation -- or an outright ban on the process to protect drinking water -- would bring a quick and certain end to unconventional gas development in the United States. Gas producers that use the technique the industry refers to as "fracking" and use horizontal drilling to extend the reach of gas rigs maintain the process is safe and poses no threat to nearby water tables.

Questions have been raised by environmental and local groups. New York officials and communities that sit on top of the Marcellus Shale in the northern part of the state contend that any leakage of harmful chemicals out of pipes drilled into gas formations would contaminate water used by millions in the region and in New York City.

People in Appalachian regions of Pennsylvania, where much of the giant Marcellus Shale gas formation resides, have emphasized the job growth and real estate boom that has come with the land rush by energy companies and gas drilling.

Supply for natural gas exists, but what about demand?

Deutsche Bank's Sieminski has been among the more outspoken energy economists pushing for policies that promote gas as a short-term "bridge fuel" used by electric utilities to replace coal as the country develops low- or zero-carbon electricity sources.

Produce the nation's shale gas and shut down the 80 highest-polluting coal plants, he told his colleagues at the National Economists Club. What's the politics of that?

"To get the climate bill passed, they have to get the coal-state senators to go along, Pennsylvania, Ohio, Indiana, Illinois," he said. "It turns out that a lot of the shale gas formations are under the same states. If the politicians wake up and see there's at least as many jobs in natural gas as there are in mining, then you might actually have something."

Joseph Stanislaw, a senior energy adviser for Deloitte & Touche, said Exxon's decision to carve out a substantial space in the U.S. gas market should boost confidence in Congress that industry claims that there is a 100-year supply under the continental United States aren't bluster.

"How it plays out on Capitol Hill, who knows? It's a real question mark," Stanislaw said. "But one has to have the confidence that the resources can be developed."

Small, independent gas producers have expanded into unconventional gas effectively and efficiently, he said. But the Exxon-XTO combination sends a political signal about the reality of the expansion. "It gives Congress confidence it can actually happen," Stanislaw said.

"The demand side is the real challenge. Can the capacity to use gas be developed, and will it be developed?"

Exxon and the other members of Big Oil club -- the investor-owned global oil and gas giants such as BP, Chevron, ConocoPhillips and Shell -- do their best to deflect criticism from environmental and investor-advocacy groups that they haven't diversified their business portfolios enough and should pour money into alternative fuels and clean energy technology. Exxon has been vilified the most.

Stanislaw said most major oil companies are expanding investments in biofuels, natural gas and carbon capture and sequestration. There is no common approach among the majors for integrating more alternative energy into their portfolios, but he said the ability to use the billions of dollars in infrastructure in place for fossil fuel development will dictate their choices for decades. Exxon is more likely to find a way to develop technology that strips carbon dioxide emissions out of oil and gas than it is to shift to wind or solar power.

"The one thing they can do is mobilize resources," he said. "They're all trying to do it within their own corporate model in a way that doesn't jeopardize their ability to act in the future."

Still, Stanislaw talked about their financial force. "They can scale fast," he said. Big Oil isn't the only group of companies that can transform the energy landscape, "but this is a huge economic force that will have tremendous momentum."

For its part, Exxon has already shaken up the debate in gas industry circles. At the Jan. 20 House hearing, Tillerson said using gas to produce baseload electricity is "a lot more efficient use of the gas" than using compressed natural gas to replace Exxon's oil in trucks and buses. The idea that power generation is a good use of gas raises the ire of gas utilities and gas-heavy industries such as chemical makers that worry about gas prices shooting through the roof if power companies use too much of the supply.

Some analysts have suggested that the Exxon-XTO deal is a rather straightforward acknowledgment by Exxon that it has limited capacity to increase oil production in areas of Africa, Asia and the Middle East where unstable and unpredictable governments call the shots and state-run oil companies get first dibs on local resources.

Perhaps to that end, Tillerson expressed unfettered optimism about the future of gas, and he used the language of climate politics to explain the merger. "Already, policies [are] in place in much of the world, in European countries and elsewhere, that do put a price on carbon, and that does shift you toward natural gas," he said.