Energy Security and the Leadership Challenge

David J. O'Reilly

By David J. O'Reilly, Chairman and CEO
Chevron Corporation

San Francisco, California, June 6, 2007

It's a privilege to be speaking again at the Commonwealth Club. This club has a distinguished history of engaging in the critical issues facing our state and our nation - and there are few issues that are more critical today than energy.

So I appreciate the opportunity to offer some thoughts on ways we can build a secure energy future for Californians, and for Americans - because reliable, affordable and responsible energy is one of the fundamental building blocks of our economy and our quality of life.

When I last spoke here seven years ago, I was optimistic about the future of global energy markets and California's energy future. At that time, a barrel of oil sold for about $30 and gasoline sold for about $1.50 a gallon. There was enough spare capacity in global oil markets to absorb minor supply disruptions. We were at the top of the technology bubble, a time when some people believed in the emergence of a so-called "new economy" in which the business cycle was a relic of the past.

Today, we face a different equation. Rising demand, constrained supplies, and very little spare capacity are creating volatility in energy prices. Oil reached a high of $78 a barrel in 2006 and today is selling for about $65 a barrel. Gasoline sells for just under $3.40 a gallon in California. Spare capacity in global oil markets is at historic lows, meaning that small supply disruptions - or even the threat of disruptions - can cause a sharp jump in prices.

The business cycle that some had thought was a relic is still a reality and is still very much a function of supply and demand, which is evident in everything from energy to housing markets.

America is at a crossroads when it comes to energy - a critical intersection created by growing demand and constrained supplies. To quote Wallace Stegner, "California is like America, only more so." The state's demand for energy, driven by a growing economy, is challenging our ability to deliver reliable, affordable supplies.

It wasn't always this way. California's energy profile has changed dramatically over the last several decades. California, in fact, played a pioneering role in the modern oil industry.

In 1876, one of Chevron's predecessor companies, California Star Oil Works, discovered the state's first commercial oil field with a legendary well called Pico No. 4 in San Joaquin County's rugged Pico Canyon.

By 1910, California supplied almost 25 percent of the world's oil production. In 1985, California was still producing more than 60 percent of the crude oil that was consumed in the state, and most of the remainder was shipped from Alaska. Foreign producers only supplied five percent.

By 2005, however, California produced less than 40 percent of the crude oil it needed. Alaska supplied about 20 percent and foreign imports had grown to 40 percent. Production of natural gas, which supplies about a third of California's electricity, has also shifted dramatically. In 1985, California produced about one third of its natural gas demand, with the remainder coming from the Southwest and Canada.

Today, California imports almost 90 percent of its natural gas requirements through pipelines from Canada and other states in the United States. Those sources are expected to decline in the future, and yet California is not allowing liquefied natural gas as an alternative to make up the shortfall.

The trend is clear. There has been a steady decrease in energy production in the state and a corresponding rise in imports. California, increasingly, is at the end of the pipeline when it comes to energy supplies. And at the same time, demand for energy in California is going in one direction - up.

Today, California has 36 million people. By 2025, the population is projected to increase to more than 45 million. Our state's economy - which is among the top 10 in the world - will continue growing. More people and a larger economy will mean more demand for energy.

Over the next 10 years, California's use of natural gas will increase nearly 25 percent. Demand for electricity will increase nearly 20 percent and gasoline consumption by 10 percent.

The challenge is clear. To sustain economic growth, we'll need energy - and we'll need a lot of it. The best way to do that is to increase and diversify our energy resources and to use these resources more efficiently. We need to think of energy as a broad portfolio and make policy and investment decisions accordingly.

Thinking of energy as a portfolio begins to shift the frame of reference in the energy debate. Just as there are fundamentals to managing an investment portfolio, there are fundamentals to managing an energy portfolio.

To start with, we need a savings plan. Energy efficiency is the cheapest and most plentiful form of new energy that we have. Energy saved is quite literally energy found.

Energy efficiency is a priority for our company. Chevron has reduced our own energy consumption by 27 percent since 1992. We also market energy efficiency to other businesses and institutions through a subsidiary called Chevron Energy Solutions (CES).

For example, CES installed solar panels and a hydrogen fuel cell system at the Alameda County Jail, lowering electricity use by more than 80 percent. Solar power systems we installed at post office facilities in the Bay Area have cut their electricity use by as much as 50 percent.

California is a proven leader in energy efficiency. We were the first state to adopt efficiency standards for household appliances in 1976. Other states followed our lead and a national standard for appliance efficiency was signed into law in 1987. But there is still more that we can do, especially from a global perspective.

A new study by McKinsey & Company, for instance, estimates that by using existing technologies, the world could effectively reduce its energy use in 2020 by nearly 30 percent over projected levels. And that could be done without compromising economic growth.

There are barriers to achieving this level of efficiency, but the potential is enormous. We should work together as consumers, businesses and policy-makers to make it a reality.

A second principle in managing the energy portfolio is to enhance our core investments in the so-called "blue chips" of the portfolio - oil, natural gas, coal and nuclear. In financial terms, we need to protect our principal.

Hydrocarbons are the most plentiful and economic source of energy we have. And even with major advances in energy efficiency and the development of renewable energy, hydrocarbons will continue to be the world's leading source of energy for decades.

Fortunately, in spite of predictions that the world is running out of oil, we continue to discover new resources and to get more out of the resources we've already discovered. Let me give you two examples.

In 1899, oil was first discovered in the Kern River Field in the San Joaquin Valley. By 1965, oil production had dropped significantly. We began experimenting with a technology called steam flooding, which is a process of injecting steam to coax more oil out of the ground. Today, production is greater than 80,000 barrels a day. Eventually, we'll recover up to 80 percent of the oil in the Kern River field, compared to an average industry recovery rate of 35 percent.

While we're using technology to extend the life of a 100-year-old asset in San Joaquin Valley, we're also using technology to explore for oil in frontier areas like the deepwater Gulf of Mexico. For example, Chevron recently conducted a well test called "Jack" about 175 miles off the Louisiana coast. It's located in 7,000 feet of water and more than 20,000 feet below the seabed - the deepest well ever tested in the Gulf.

Not so long ago, the Gulf of Mexico was referred to as the "Dead Sea" regarding its potential for new oil and gas supplies. But the application of new technology has enabled us to see further and deeper into the Gulf. The results are a discovery like Jack, which leads us to believe there may be 3 billion to 15 billion barrels of oil and natural gas in that part of the Gulf of Mexico. The high end of that range would be the equivalent of 50 percent of America's current oil reserves.

All told, the Department of the Interior estimates that technically recoverable oil on the Outer Continental Shelf of the United States could run as high as 115 billion barrels. Yet the federal government has placed 85 percent of the Outer Continental Shelf off-limits to exploration, including major oil and gas resources off the Pacific coast.

It defies logic and common sense to call for energy independence in America while denying access to American resources. Any plan to enhance energy security must include an open discussion of ways to increase access to domestic supplies. We have to find a way to set aside outdated attitudes about energy and the environment. Instead, let's recognize the advances we've made in technology that enable energy production and environmental stewardship to co-exist.

When Californians think of offshore oil production, for example, an image that commonly comes to mind is the Santa Barbara oil spill in 1969. But let's look at the present. When hurricanes Rita and Katrina ripped through the Gulf of Mexico two years ago, they caused major damage to drilling platforms. But due to advanced technology, there were no major offshore oil spills in an area containing more than 1,000 wells.

The oil industry has greatly elevated our ability to recover resources without adverse environmental impacts. 21st century energy policies should reflect these capabilities. A realistic debate about energy security should also address coal and nuclear - and should consider how we can make them safer, more efficient and environmentally benign.

U.S. energy policy should focus on accelerating the development of clean-coal technology - including breakthrough solutions like carbon sequestration - so we can take advantage of a resource that exists in vast quantities in this country. This is particularly important for California, which gets more than half of its imported electricity from coal.

Nuclear power provides 13 percent of California's electricity and about 20 percent of the nation's electricity. Technology has improved the economics and safety of nuclear power. And nuclear power, of course, emits zero greenhouse gases. It's critical that we invest in a new generation of nuclear power plants as current facilities age and are taken off-line.

A third principle of managing the energy portfolio is investing in emerging energy. The successful management of California's energy portfolio over the long term will require strategic investments in the next generation of energy, including non-carbon sources.

We can't lose sight of the primary role that hydrocarbons will play for decades to come. But renewables and advanced technologies clearly have the potential to reshape the energy portfolio over the long term.

That includes ethanol, a renewable resource that is becoming an important part of the transportation fuel portfolio. Chevron supports a national goal of E-10 - or 10 percent ethanol - on average, per gallon of gasoline. This would effectively triple the volume of ethanol that was used in gasoline last year.

Here in California, state air quality regulations currently place a limit on the ethanol content in the state's gasoline blends. However, based on proposed ethanol level changes by the Air Resources Board, I think California can reach 10 percent ethanol within a few years.

There are several benefits to adopting a national standard of 10 percent ethanol:

  • E-10 can be accommodated with the existing vehicle fleet and the existing distribution system.
  • E-10 is likely to be economically and technically achievable, while allowing enough time for the next generation of fuel technologies to be developed.
  • And E-10 could lower imports of petroleum products into the United States by more than 25 percent.

But getting beyond E-10 with corn-based ethanol will be a challenge.

Today, ethanol makes up 3 percent of every gallon of gasoline on average, and consumes one-fifth of the U.S. corn crop. This has led to a rapid run-up in corn prices, which has affected the cost of food ranging from cereal to beef and poultry. Increased production of corn ethanol will further strain the food supply - and food prices.

The real promise - and the real challenge - of biofuels is developing technology that will allow non-food sources such as wood pulp or agricultural waste to be used for ethanol. This will liberate us from the food vs. fuel debate.

Our company sees a viable future for biofuels and we're committing significant resources to make it a reality. We have research partnerships with UC Davis, Georgia Tech, Texas A&M and the federal government to develop the next generation of ethanol technology.

We also recently struck an alliance with Weyerhaeuser, the forest products company, to conduct advanced R&D into commercial-scale biofuel production using wood fiber and other cellulose-based materials.

The market today is witnessing an unprecedented flow of capital into alternatives and clean technology. Globally, it's estimated that over $70 billion was invested in renewable energy and clean technology in 2006. Chevron will spend approximately $2.5 billion on alternatives, renewables and energy efficiency between 2007 and 2009.

When resources of this scale are directed at developing new technology, breakthrough solutions can't be far behind.

There's one other element of energy policy I'd like to address today and that is the subject of climate change. There are few issues where the need for policy alignment is greater.

California is at the forefront of the climate change debate and has already set ambitious goals for reducing greenhouse gas emissions. But ultimately, we can't solve this problem at the state or local level. Meaningful advances in carbon management require a national framework that is rational, cost-effective and equitable.

Otherwise, we run the risk that state and local actions - no matter how well-intentioned - will create a patchwork of regulations that impose high societal costs with limited benefits.

In California's case, we run the risk of putting the state's economy at a competitive disadvantage, if carbon mitigation measures aren't put in the context of an equitable, national framework.

Reaching consensus on the components of a national framework should be guided by several principles.

First, we should acknowledge the critical need for global engagement. Reduction of greenhouse gas emissions should involve all the major emitting nations in the world.

Second, there should be broad and equitable treatment of all sectors of the economy to ensure that no single sector is unfairly burdened.

And third, there should be open communication about the costs, risks and trade-offs associated with climate change policies.

The world has clearly reached a point where integrated carbon management is needed. Now we need to exercise the leadership that is required to create policies that are balanced, practical and flexible.

These fundamentals of managing the energy portfolio - efficiency, protecting core investments, investing in alternatives, and environmental stewardship - are the building blocks of responsible energy policy.

But knowing the right thing to do is one matter. Finding the political will to get it done is another. For too long, energy policy in this country has defaulted into predictable positions - Republicans against Democrats, business against environmentalists, hydrocarbons versus renewables.

We need to bridge these divides. We need to shift our perspective from the special interests to the common good - from the tyranny of the "or" to the genius of the "and."

This is something California needs to understand. The strength of this state is built on the diversity of its people, its geography and its economy. We should also value the same principle of diversity when it comes to energy.

Californians seem to want the benefits of affordable and reliable energy without taking the steps necessary to secure it. I believe the steps we need to take are very clear.

We need to continue to use energy more efficiently.

We need to enhance and diversify traditional sources of energy. Today that would include liquefied natural gas infrastructure, streamlining the permit process for refinery expansions, and the responsible exploration of oil and gas resources. In the future, it will include the accelerated development of biofuels and other emerging energy sources.

California's history is one of rising to great challenges and seizing great opportunities, from projects like the Golden Gate Bridge and the California Aqueduct, to the creation of entire industries such as oil, technology and entertainment.

Energy is no less a challenge and opportunity.

If we seize that opportunity, and create the leadership necessary for a successful energy policy, I believe that several years from now we'll look back on this time as a turning point, a time when we finally approached energy issues strategically and pragmatically, a time when we realized that the solutions were right in front of us.

And a time when we acted on those solutions, when we summoned the courage to make the necessary trade-offs required for an effective energy policy, and stayed committed to that policy for the long term.

Our shared future demands nothing less.

Thank you.

Updated: June 2007