What Will the U.S. Energy Industry Look Like Over the Next Five Years?

WSJ – Low fuel prices and new climate policies are rapidly transforming the American energy sector, while escalating wars in the Middle East and a nuclear deal with Iran are clouding the global oil picture.

To get a sense of what the energy future may hold, The Wall Street Journal reached out to three experts in energy and geopolitics: Amy Myers Jaffe, executive director of energy and sustainability at the University of California, Davis; Sarah Emerson, principal at ESAI Energy and president of Energy Security Analysis Inc.; and Meghan O’Sullivan, the Jeane Kirkpatrick professor of the practice of international affairs and director of the Geopolitics of Energy Project at Harvard University’s Kennedy School of Government. Here are edited excerpts.

One-year outlook

WSJ: What will the U.S. energy industry look like a year from now if low oil and gas prices persist?

MS. O’SULLIVAN: If prices stay low, it is safe to assume overall U.S. production will continue to drop. But you might remember that in past years nearly everyone underestimated how much oil the U.S. would produce and overestimated how fast American output would decline when the price collapsed. This should make us humble about our ability to predict oil production a year from now, even if prices stay low.

But investment in new exploration and production will be lower. That delayed spending will bring the oil market back into balance, but has serious implications for the structure of the industry. The oil-field service companies will be forced to make even more severe job cuts, and that is a cause for concern. We know from past downturns that when the price of oil does rise, we have labor shortages and it is tough to find skilled people who can perform those jobs.

MS. JAFFE: The American energy industry has always been surprisingly resilient, so chances are 2016 will be no exception. There are three notable differences at work today, though.

First, shale production is more flexible and can revive quicker should oil prices recover. Second, the rapid growth of solar and wind, combined with energy-efficiency gains for automobiles, means low oil prices may not trigger a big oil demand rebound like we’ve seen in the past. And third, oil execs see funding fleeing the coal sector as new climate policies kick in and we get less rosy economic outlooks for China and emerging markets. That is prompting some large energy companies to reconsider the viability of their expensive megaprojects that take a long time to build before they produce oil and gas, including drilling in the Arctic, Caspian and some deep-water locations.

MS. EMERSON: Next year is looking like a pivot year. Low oil prices have slashed the profitability of the shale industry. Companies with strong balance sheets are managing better than those that borrowed heavily from banks or that rely on private equity and hedge funds. Stronger companies will consolidate, accumulating better-producing assets, while weaker companies downsize or disappear.

As shale properties become part of stronger, perhaps larger, oil companies, the biggest impact could be a shift away from the mentality of “produce as fast as possible right now.” Companies with lots of oil and gas assets in diverse portfolios might think about timing and markets differently.

ENLARGE

Pressure points

WSJ: Some say oil prices will be lower for longer because of the resilience of American shale. Do you agree?

MS. JAFFE: Given the sustained surplus of shale gas in the U.S., some executives now worry that the oil surplus may push a rally in prices farther down the road. But American shale oil is only a small percentage of global crude supply. Wars raging across the Middle East mean the kind of cumulative oil-production losses we’ve already seen from Libya, Syria, Yemen and parts of Iraq—now totaling nearly two million barrels a day—could grow as conflicts widen.

MS. EMERSON: I would add that lower for longer may not look exactly like a flat line. The market could yield a pretty wide trading range, from $40 to $70 a barrel over the next few years, all other things being equal. But there is the rub. I don’t believe all other things can be held equal. Oil prices will respond to signals from OPEC, namely the return of Iranian oil exports.

How conflict in the Mideast unfolds could have significant repercussions, but it isn’t the only place with problems. The possibility of a humanitarian crisis in Venezuela is real and may affect that country’s stability and its oil production. Low oil revenues in Nigeria and Angola threaten their stability. It is hard to imagine that political instability or military conflict won’t overflow to affect oil flows and prices at some point in the next five years.

MS. O’SULLIVAN: We can’t forget the anticipated anemic global growth that is forecast for the next several years. I’d also like to posit that an agreement among producers to cut oil production isn’t out of the question. OPEC’s obituary has been written prematurely far too many times for me to conclude the cartel is dead.

Saudi Arabia may not be ready to shift its strategy away from its current pursuit of market share by pumping more oil, but if the price stays low, Riyadh’s calculations could change. The Saudis could have difficulty sustaining the expensive social programs which underpin the political stability of the regime.

While the Saudis have said they don’t intend to cut production unilaterally, they’ve signaled that a joint production cut could be acceptable. A few more years of low oil prices might soften objections inside and outside OPEC—particularly from Russia—to joining Saudi Arabia in curtailing output.

Growth prospects

WSJ: Given how low oil and gas prices are today, how much can U.S. wind and solar grow over the next five years? What happens to coal and nukes?

MS. JAFFE: In the past four years alone, U.S. solar power generation has more than quadrupled. Last year California became the first state to source 5% of its annual electric generation from utility-scale solar plants. Other states are following suit. Analysts have consistently underestimated the pace of expansion, and solar is likely to gain even stronger momentum.

A Citigroup forecast shows that weaker power demand and rising renewable energy supplies will probably offset the power lost from most coal plants that are shutting down. The solar industry is facing turbulent waters, including an uphill political battle—from entrenched power utilities—to establish fair metering for residential consumers. Still, these problems aren’t proving insurmountable.

MS. EMERSON: Wind is increasingly competitive on its own, but most renewable energy requires tax credits or regulation like President Obama’s new Clean Power Plan to grow. These supports should lead to significant renewable development.

Even with falling costs and regulatory support, renewables struggle with the same difficulties that plague all U.S. infrastructure development. The existing electric grid was built for the geography of fossil fuels. Wind farms and substantial solar arrays aren’t built in congested cities. That means adding renewable energy to the power grid requires building massive transmission lines, which trigger Nimby [not in my backyard] concerns. Five years is the blink of an eye in terms of building anything substantial.

MS. O’SULLIVAN: Coal, nuclear and renewable energies aren’t direct substitutes for oil, so cheap oil isn’t a competitor [for those resources]. But cheap natural gas is, and consistently low gas prices pose a real economic challenge to nuclear power in particular.

ENLARGE

In addition to meeting one-fifth of U.S. electricity demand, nuclear power is essential because it is the largest source of electricity that doesn’t produce carbon emissions. It is also what we call “baseload power,” which means it doesn’t get interrupted the way renewable sources do. The wind isn’t always blowing and the sun isn’t always shining. Entergy Corp. ’s recent decision to shut down its Pilgrim nuclear plant in Massachusetts in 2019 because it cannot compete in a lower gas-and-power price environment suggests it will be hard to reverse the tide against nuclear power in the U.S.

Biggest concerns

WSJ: What keeps you up at night?

MS. O’SULLIVAN: If one is going to lose sleep over potential energy disasters, focus on the growing threat of a cyberattack. Energy is one of the most, if not the most, vulnerable U.S. industries, and it is becoming more exposed as it is modernized. Smart power grids will make our electricity delivery more efficient, but also make the system more exposed to an attack. And as the targets for attack are proliferating, the capabilities of those who want to disrupt the system are also expanding.

The head of the National Security Agency [Adm. Michael Rogers] told Congress there are groups and nations with the capability to shut down our ability to operate infrastructure, including generating power across the country and moving fuel and water. He predicts the U.S. will suffer a traumatic cyberattack on energy infrastructure within a decade.

MS. JAFFE: For decades the energy sector has experienced frequent crises, and they all looked hypercritical at the time: the 1973 oil embargo, the Iranian revolution, Iraq’s invasion of Kuwait, the California electricity crisis, the Fukushima nuclear disaster. The list goes on, but markets eventually work it out. If a new oil crisis erupts in the Middle East or Russia, it will be hard to manage. But we have promising technologies that can ease fuel shortages, including rapid shale-oil development, smartphone-assisted ride-sharing, plug-in electric and natural gas-fueled vehicles and virtual office telecommunications.

What’s harder to develop is the political consensus to transition to pricing carbon emissions. Right now, climate policy is being implemented piecemeal around the world. That, combined with current low oil and gas prices, has increased the investment risk associated with future energy production. Ironically, as companies spend less on big global energy projects while we’re also seeing global oil capacity being destroyed by wars, markets could become undersupplied, which would give us extreme oil price volatility in the coming years.

MS. EMERSON: Energy discourse in the U.S. is often trumped by endless estimates of how many jobs are made (or lost) and what percentage of GDP is created (or destroyed). This simplification of our energy choices into an economic scorecard dumbs down the conversation and exacerbates the political divide.

Can we balance our cultural preference for less-regulated energy markets with enough regulation to bring about safe, long-lasting, climate-friendly prosperity? Take shale development. Our market transparency and resource ownership with access to legal protections have fueled a historic oil rush here. But along the way, methane emissions, water use, earthquakes and oil-train accidents underscore the need for similar state or coherent federal rules. So how do we move forward with climate-intelligent policies and remain internationally competitive? Can we find a way to lead on this issue, or do we hunker down and hope it turns out for the best?

The same goes for our military role. We’ve been the guarantor of global oil flows for several decades. Should we now fashion an energy future that corresponds to a smaller military and regional rivals like Russia in the Middle East and China in Asia? We used to believe energy and the U.S. role in the world went hand in hand. Now the chimera of American energy independence is encouraging isolationism.

I wonder if we can find the political coherence to make thoughtful energy choices. We need political discourse that allows for balance, because the energy choices we make have short-term and long-term implications for own well-being, and those beyond our borders.

Ms. Cook is The Wall Street Journal’s deputy Texas bureau chief, based in Houston. She can be reached at lynn.cook@wsj.com.