Alan Greenspan: Energy Analyst

Abstract: Fourteen interest rate cuts in two years may have done little to help the economy, but Alan Greenspan has produced the best assessment yet of the current natural gas picture.

Analysis: Thus spake Alan Greenspan.

In several appearances before various House and Senate committees over the last 45 days, the Federal Reserve board chairman has delivered a remarkable synthesis of the nation's natural gas situation.

And like quotations of Zarathustra, the sage who formed the central character for one of Friedrich Nietzsche's philosophical treatises, Mr. Greenspan's remarks had the distinct characteristic of being all things to all people.

The Federal Reserve chairman was coy in his testimony before congressional committees. To paraphrase his statements, there was no problem yet in natural gas other than a long-term change in price. But problems could occur in the industrial sector that might become permanent, driving jobs overseas. In the meantime, consumers would be prudent in preparing for higher costs for home heating this winter.

When Alan Greenspan speaks, people listen.

As for the response, choose your interest group.

The Western Business Roundtable promptly labeled Mr. Greenspan's call for more domestic gas production as "the right message at the right time." But the Interstate Oil and Gas Compact Commission charged Mr. Greenspan with "ignoring history. Relying on importation of natural gas would lead to even greater dependence on foreign energy sources and further exacerbate the threat to our national security inherent in that situation."

In some summaries, natural gas was on the verge of impending crisis; in others, Mr. Greenspan was deemed unpatriotic for suggesting that LNG and imported gas could even be considered as solutions to tight natural gas markets.

Most of the general media focused on the impact for consumers. Essentially, their take on his remarks was that no relief was in sight short term from high natural gas prices.

But what makes the Federal Reserve chairman's statements of interest to oil and gas is the fact that, despite previously typically addressing energy only in passing, this time Mr. Greenspan's talk on Capitol Hill zeroed in on the issue. With the plethora of variables that impact the U.S. economy, the Federal Reserve board has previously downplayed energy costs as having a much smaller impact on the economy than was the case back in the 1970s when the nation faced the first of the modern energy crises.

Those who dispute this argue that energy has a much greater impact than the nominal dollar value would suggest. Gasoline dollars and home heating dollars come directly out of the consumer's pocket, garnering money that would otherwise be allocated towards nondiscretionary spending. Considering that consumer spending is credited with two-thirds of the national economy, energy price spikes have greater impact than that indicated by the nominal value of increased energy costs, the argument goes.

Thus, a noticeable contributor to the recession that began in March 2001 was a hangover from high energy prices during late 2000 and early 2001.

Still, the value of Mr. Greenspan's remarks resides in the fact that someone who deals almost exclusively with macroeconomics was able to encapsulate the current natural gas situation in just a few brief paragraphs.

The text of his testimony can be found at The Federal Reserve Website.

Here is the gist of Mr. Greenspan's remarks:

Natural gas supplies have tightened. Despite higher investment and greater drilling activity, there has been no production response to date.

Natural gas faces long-term structural problems. North America is a captive regional market facing supply constraints. Globalization of natural gas would eliminate the barriers creating market tightness.

Demand destruction is focused almost entirely on the industrial sector of the economy, particularly fertilizers, chemical, and petrochemical subsectors. Although the impact on jobs has been small so far, demand destruction could be permanent, driving jobs overseas.

Although the oil and gas industry is more efficient than was the case a few years back, natural gas prices continue to rise.

Most technological innovation is directed toward difficult environments such as deepwater rather than in finding ways to obtain more volume from existing plays.

Depletion is increasing.

The futures market acts as if supply is short.

The nation is entering a period of higher base-level pricing.

Mr. Greenspan's solutions include globalization of natural gas. There are abundant supplies internationally and in more diverse regions than is the case with oil reserves, which are confined primarily to the Middle East.

Finally, the Federal Reserve chairman argued that LNG will play a big role in our future, a remark that represented one of the strongest endorsements yet for this fuel, which is enjoying a sudden surge in popularity as a potential solution to tightness in the North American natural gas industry a half-decade or more into the future.

Parsing Mr. Geenspan's remarks reveals a straightforward presentation of the natural gas situation. He drew upon recent energy industry research on demand destruction and LNG that is otherwise fairly obscure to many economists and the public in general.

He was also forthright in his assessment of the current scenario. While gas markets are tight, they had not yet impacted the manufacturing economy significantly other than to squeeze profit margins. Sectors of the economy most affected included chemical companies such as ammonia and fertilizer manufacturers.

For consumers, the impact was less visible at the moment, though households will experience "significantly higher bills" this winter, which could have broad economic implications.

Furthermore, Mr. Greenspan noted the natural gas situation took a long time evolving to its present status. Evolving away from it will also take awhile.

"Today's tight natural gas markets have been a long time in coming and distant futures prices suggest that we are not apt to return to earlier periods of relative abundance and low prices anytime soon," he told the Senate Energy and Natural Resources Committee last week.

One of the challenges in oil and gas is defining the consensus. It is a process made difficult by the fact that so many entities with specific interests often clamor to be heard, creating background noise that makes it difficult to define the critical elements. Complicating the process further is the dynamic nature of oil and gas, a resilient business that seems to bounce between surplus capacity and tight supply within short time frames.

The chief contribution of Alan Greenspan to the public dialog has been in synthesizing the industry's current status. This is not an easy job. Like him or not, Mr. Greenspan deserves a tip of the hat considering he has done so as a banker rather than an energy analyst.