The Energy Economy

John S. Watson

By John S. Watson, Chairman and CEO
Chevron Corporation

University of Chicago

Chicago, Illinois, October 13, 2010

Good afternoon everyone. I appreciate your kind invitation and this chance to revisit a familiar place. When I think of Chicago, it brings to mind two of the best years — and longest winters — of my life. As I was nearing graduation, I also recall wondering just how much of what is taught here would have any relevance to the business world. And I've come back with the answer: a great deal.

The way I approach issues, analyze problems and think about business is deeply connected to the University of Chicago and the education I received here. In fact, it was here, in 1980, that I began to think about a career in the energy industry.

Back then, energy was on the front page every day. The Shah of Iran had been deposed. The Ayatollah Khomeini had taken control of the country. Political disruption in the Mideast led to the second oil shock in 10 years. The average price of oil shot up to about $39 a barrel — when converted to today's dollars, the highest price in history until 2008. Supply shortages — largely the result of price controls — led to long lines at gas stations. Americans used 150,000 barrels of oil per day just while idling their engines.

And in 1980, in an attempt to effectively create a new energy economy, the U.S. government started the Synthetic Fuels Corporation to produce an alternative to petroleum. Shortly thereafter, prices were decontrolled and stabilized, and supplies became plentiful again. The Synthetic Fuels Corporation became overwhelmed by economic and technical challenges. It was later disbanded — at an estimated cost of $8 billion to the American taxpayer.

I watched all of this and realized how critical the energy business is to America — not just to our energy security, but to our basic economic security. I decided then I wanted to be part of it.

Now, 30 years later, it seems that in my business, everything has changed — and then again, nothing has changed. The technology leaps we've made are breathtaking. The level of skills that people in the energy business have today couldn't have been imagined 30 years ago. And some of the areas where we are producing energy today weren't even mapped back then.

On the other hand, some things haven't changed. Iran remains on the front page, the energy debate is still politically charged, and a lack of understanding about market fundamentals continues to generate some ill-informed policy. And now, as then, Americans want reliable, affordable energy. They want it to be produced responsibly. They want the things that energy can provide — light, heat, mobility and, in some cases, 24-hour texting and tweeting.

With those expectations in mind, I want to offer my thoughts about energy today — about the scale of the global energy system, its vital importance to economic growth and dynamics that impede affordability.

This is important to understand, because affordable, reliable energy is vital to the life we lead today and to any progress we hope to make — for ourselves and the world.

Many of you apparently think so too. The Chicago Energy Initiative recognizes energy as "essential to the . . . spread of prosperity worldwide." And it calls the development and distribution of abundant energy the most important social challenge of our time.

We agree with that.

In fact, we are working with the University of Chicago, among others, on a study addressing the long-term future of fuels. This wide-ranging study is being conducted through the National Petroleum Council at the request of Energy Secretary Stephen Chu. It is engaging a diverse group of representatives from vehicle manufacturers, NGOs, industry and academia.

I truly appreciate the help that the Chicago Energy Initiative and Bob Topel are providing on this important work. By examining these complex issues through the lenses of economic competitiveness, energy security and environmental stewardship, we hope to make a significant contribution to the energy dialogue.

I think any discussion about energy should start by looking at the facts. So let's begin there.

It's taken more than 100 years to build the energy system that powers the global economy today. It is a vast, interdependent network centered largely around fossil fuels — oil, natural gas and coal — which comprise more than 80 percent of the world's energy portfolio.

It's sometimes difficult to grasp the magnitude of this system, but let's try.

Chevron is a Fortune 3 company, and in the first half of this year we earned nearly $10 billion. Our market cap is currently about $170 billion. That may sound big, but let's put it into perspective. Chevron is responsible for just 2 percent of the world's oil and gas production.

The world's energy system is huge. And its foundation — fossil fuels — is ubiquitous in our economy. Oil, as you know, is our primary transportation fuel. But oil also is an essential component in products that range from toothbrushes and medical equipment to iPads and Flip cameras.

So what do we get from this energy? Simply put, we get our way of life.

Reliable and affordable energy was a catalyst in the Western world's evolution from an agricultural economy to an industrial economy. And it will help the evolution of the digital economy as well. Just consider this. Americans make about 13 billion Google searches a month. Those searches take energy — roughly the same amount used by 4,200 homes a month.

As big as the global energy system is today, it will become even bigger as the world's industrial base grows, new technologies are invented and populations expand. Today, there are more than 300 million people in the United States. By 2050, there will be 90 million more people here, and 2 billion more people in the world.

And all of them will need energy to maintain and improve their standard of living.

Those of us in the United States, as well as those in other developed nations, have a standard of living that most of humanity is still trying to achieve. In many parts of the world, particularly in China, India and Africa, billions are waiting for the same essentials of progress, and a better life. That will take energy — a lot of it. According to most estimates, the world's demand for energy will increase 30 percent to 40 percent by the year 2030.

The sheer scale of our energy needs is far beyond the capacity of any one source or technology. And under any scenario, oil and natural gas will be the largest part of that portfolio for decades to come. So more exploration and drilling are crucial, but they are not enough. Coal and nuclear will play a role, but they are not enough. Expanding our use of renewables is good and necessary, but they are not enough.

In short, we must do all of these things and do all of them at once.

Thirty years of experience in the industry leaves no doubt in my mind that the free market will find ways to meet demand as fast as it grows. But the record of public policy doesn't always inspire great confidence. Over 40 years and eight presidencies, Americans have heard about the goal of becoming energy independent. Yet over these 40 years, we have moved in the opposite direction. In 1974, we imported one-third of our petroleum. Today, we import more than 60 percent.

Clearly there is a gap between our aspirations and our reality. It's time to rethink our policies. Perhaps energy independence should not be our goal. Energy and economic security should be.

A first and fundamental step to create reliable, affordable energy is to enable the U.S. oil and gas industry to aggressively — and responsibly — develop our country's natural resources.

We have a strong base to build on. The United States is the world's No. 1 producer of natural gas and the third-largest producer of oil. We also have significant endowments of natural resources yet to be developed. We have enough undeveloped gas resources, for example, to heat 60 million homes for 160 years.

Around the world, virtually every resource-rich country is creating a pathway to develop its resources and its energy industry, including those with the strongest environmental policies — Australia, Canada, Norway, Denmark, and the UK, to name some. They are not just focused on resource production — although that is a primary benefit of a strong energy industry. They also are focused on the economic benefits that robust energy production provides.

Right now, for instance, the U.S. oil and gas industry supports more than 9 million jobs and accounts for about 7.5 percent of America's GDP. That is a powerful engine of economic growth. Any sound strategy should rush to leverage a strength like that — particularly in light of the generational challenge we face to revive the U.S. economy.

Don't misunderstand me — I am not advocating that our industry rush in wherever we want and start drilling. We recognize that we must operate safely, with a strong commitment to environmental stewardship. The incident in the Gulf of Mexico this spring was a tragic event that took 11 lives. It also took a toll on the economy and ecology of the Gulf Coast. But based on everything we know, and how we operate at our company, we believe it was an utterly preventable incident.

I can tell you that our company has the technology, the processes and the people to prevent incidents like we witnessed in the Gulf. There is no goal more important at our company than operating safely and responsibly.

We also did everything we could to learn from this incident. Chevron led an industry task force to review operating standards in the Gulf. And it became clear that the minimum industry standards needed to be raised, and they have been.

We're now working closely with the U.S. government to develop additional regulatory reform for operations in the Gulf. Lifting the moratorium was a good first step. Issuing drilling permits is now what's required.

We also expect fair and reasonable policies that allow us to compete and invest to the best of our ability. But some of our policies seem to be working against us, potentially erecting barriers to the growth of the U.S. oil and gas industry. For example, let's look at tax policy.

The oil and gas industry is a huge source of revenue to governments worldwide. Between 2003 and 2008, major oil companies in the United States paid nearly a half-trillion dollars ($450B) in income taxes around the globe. Our industry's average income tax rate in 2009 was more than 48 percent. That's 20 percentage points higher than the rate for the average U.S. manufacturer. And that doesn't count royalties, excise taxes, severance taxes or lease bonuses.

Yet we're facing demands for more. The current U.S. budget proposal calls for an aggregate tax increase on the industry of roughly $80 billion over 10 years. And some proposals in Congress call for discriminatory taxes against the U.S. oil and gas industry that would put foreign companies at an even greater advantage.

In short, the federal government is considering policies that would effectively diminish the development of our energy resources, reduce U.S. competitiveness — and add to energy costs. I don't think that is a path our country should take.

To serve future demand we need competitive and stable tax policy that promotes expansion of all energy sources and progresses America's energy leadership. Instead, our policy in some respects seems to be drifting toward a European model of subsidies and mandates for renewable energy, regardless of efficiency or economics — at the expense of proven, affordable, conventional energy.

Generally, subsidies are bad. They can play a role to nurture new technologies when there are no market signals to do so. But when subsidies become prolonged, they distort markets and create an investment framework that is not sustainable.

Consider the case of Spain, where subsidies for renewables between 2000 and 2008 totaled $36 billion, or about 2 percent of the country's GDP. In those years, however, Spanish solar power reached only about 1 percent of the country's total power production. Even worse, it is estimated that 2.2 jobs were destroyed for every new job created in the renewables sector.

They did the math in Madrid and realized that even with massive subsidies, current renewables technologies can't scale up to anywhere near the volume provided by fossil fuels. In August, Spain announced that it was cutting subsidies for renewables in half because the government cannot afford them in light of crushing public debt. The result? A spike in power prices — and stranded investment.

I don't believe prolonged subsidies are a path we want to replicate in the United States — particularly with the rate of deficit spending our nation and states are accumulating. Let me be clear about this. In the long-run, renewables are going to play an important role in meeting global demand, and my company will contribute.

Today, Chevron is the world's largest producer of geothermal energy. In fact, we produce nearly twice as much power from geothermal in Indonesia and the Philippines than all of the solar electricity generated in the United States. We're also a significant investor in the development of second-generation biofuels, and we're leading our industry in energy efficiency.

Chevron is committed to renewables. But, I've charged my company with developing a renewables business that is profitable and can operate at industrial scale without subsidies. We won't chase arbitrary mandates. It only seems reasonable that U.S. energy policy should have the same objectives.

Closely linked to the development of renewables is the concern about the growth of greenhouse gas emissions. We share the concern of governments and the public on this issue.

The challenge of reducing greenhouse gases is rooted in economics. It is no coincidence that the strongest environmental standards exist where we have strong and developed economies. There is a reason for that. Economic growth generates capital that can be invested in new technology to protect the environment. It also is understandable that in developing economies, and in times of economic weakness at home, the fundamentals of jobs, livelihoods and economic growth clearly take priority.

The fact is, there are multiple pathways to a low-carbon future. We have choices.

At Chevron, we think that a low-carbon future is, first and foremost, an energy-efficient future. America is energy efficient now, but still far short of our potential. Excluding the transportation sector, McKinsey estimates that energy efficiency in the United States has the potential to reduce energy demand 23 percent by the year 2020 — and yield energy savings of more than $1 trillion.

My point is this: There is simply too much opportunity to reduce carbon emissions through efficiency — at a relatively low cost — to ignore.

And upon reflection, instead of pursuing complex regulatory schemes that can be very costly and lead to unintended consequences — from land use to trade flows — the world may be better served to turn our attention to basic R&D. Focused research and investment, over time, may lead to low-carbon energy technologies that can compete economically and can work at scale.

One technology that is getting a lot of attention is carbon capture and storage. Chevron is pioneering carbon storage at our Gorgon natural gas project in Australia — in fact, it will be the largest carbon storage project in the world when it comes on line.

But it will take extensive investment and research — and time — before we can determine if it is economic for broader application.

I've touched on a lot of issues today, but I hope I've seeded a few thoughts. I hope I've left you with a better understanding of the scale of the world's energy system and the time — and investment — it takes to make changes to the system.

I hope you agree with me that access to reliable, affordable and responsibly produced energy is a cornerstone of economic expansion and U.S. competitiveness. And it almost goes without saying, but I am confident you realize that everything you've learned here — the power of free markets, the strength of data-driven analysis, the wisdom of the rational consumer and the value of pragmatic solutions — should be the foundation of the 21st century energy economy.

Finally, I want to leave you all with a challenge.

Keeping energy abundant, affordable and environmentally acceptable will be the work of generations — but its success depends on decisions we make right now. Don't let our energy future be something that you stand by and watch.

Be informed. Remember what you've learned here. Help build that future. Energy is important to everyone in this room, whether you're in the energy business or not. Every business and every consumer depends on affordable and reliable energy.

The world is changing fast, and the challenges we face are growing larger. I wish you the best in representing the University of Chicago as you rise to face those challenges — which I know you will do.

And now I look forward to your questions. Thank you very much.

Published: October 2010