Communication problems are as old as human history. Bridging gaps is a continual challenge, and industry leaders need to know how to capitalize on overcoming those gaps.

Within the oil and gas industry (as well as in other industries), there are four generations of talent: Traditionalists (birth years 1925-1945), Baby Boomers (1946-1965), Generation X (1966-1980) and Generation Y (1981-2000). Since the 1990s, professional journals have alerted oil and gas leaders that the Baby Boomers, now the largest percentage of the workforce, are exiting the workforce at an alarming rate. The potential consequences include:

–Increased competition for talent. Due to the decrease in skilled talent following the retirement of the Traditionalists and Baby Boomers, competition for workers with required professional degrees and experience will increase.

–Shifting geography. Technology enables talent to work from anywhere and teleworking is becoming more commonplace; therefore, organizations will be able to source talent globally. This shift will affect organizational communication, strategy and business processes.

–Shifting generation. The corporate leaders of tomorrow will most likely be talent from Generations X and Y. Currently, organizations are balancing the activities of retiring two groups and preparing the organization for two others, while not neglecting any.

–Aging workforce. A majority of Baby Boomers are predicted to exit the workforce by 2015 and are followed by a much smaller group of talent, Generation X. In addition, the next generations of talent have different learning styles, communication preferences and work/life balance requirements than their predecessors. To recruit, retain and develop the next generation of talent, organizations must recognize and adapt to these styles.

–Lost information and tacit knowledge. As Traditionalists and Baby Boomers exit organizations, some for the last time, so will their communal know-how—their tacit knowledge—especially if it has not been adequately identified, captured, codified and stored in corporate knowledge repositories.

–Preparing and training talent. The fact that Traditionalists and Baby Boomers are retiring does not mean that they will not re-enter the workforce in some capacity, such as starting a new career, or working as a consultant or part-time employee. In some cases, organizations will be able to leverage veteran expertise in this way. As a result, organizations will need to update the skills of these workers, or train them along with other new hires. Thus, learning/training departments may simultaneously have to train several generations, each having distinctly different learning styles. This can perplex learning organizations that do not understand the needs of each generation.

–Sebastian Francis

About the Author: Sebastian Francis is senior consultant, commercial business services, for SAIC Corp. and specializes in knowledge management and organization learning within SAIC’s oil and gas practice. He can be reached at Sebastian.L.Francis@saic.com.

Click for Francis’ full report, “Better Knowledge-Sharing: Fill The Dry Knowledge Well With These Practices:” knowledgewellsebastianfrancissaic2010

Oil and gas markets have experienced significant changes during the past two years. Between crude oil moving from $146 to $33 in less than five months and gas going from nearly $14 to $3 over the course of a year, the past 18 months have been incredibly volatile to say the least. Adding insult to injury, the state of the capital markets has left many producers without access to much needed capital.

In these times of significant change and uncertainty, it is essential that oil and gas producers employ solid hedging and marketing strategies. These strategies will not only allow producers to survive the most challenging times, but will also allow them to excel in the best of times as well.

Houston-based EnRisk Partners, an energy hedging, trading and risk-management advisory firm, recently surveyed 38 U.S.-, Canada- and Australia-based small and midsize independent oil and gas producers about hedging activity in 2009.

The primary focus of energy risk management as it relates to oil and gas producers is hedging.

Consequently, this subject forms the basis of this study, which strives to analyze the current hedging practices and strategies of producers. Some of the key survey findings are:

–41% of study participants regularly hedge their production, while 29% never hedge.

–Only 13% are required to hedge by their lenders and/or investors.

–The majority of the participants that hedge on a regular basis stated that, on average, they hedge between 51% and 71% of their current PDP (proved, developed, producing) volumes.

–36% of the participants stated that their CEO or CFO makes the company’s hedging decisions.

–Swaps and collars are the most popular hedging instruments among the study participants.

–Only 34% of the participants indicated that establishing stable and predictable cash flow is the most important goal of their hedging activities.

–67% said they would characterize the success of their company’s current and past hedging initiatives as good or excellent.

—Mike Corley

Click for Corley’s full report, “2009 Crude Oil & Natural Gas Hedging Study:” enriskpartners2009hedgingstudyresults.

For more on current hedging trends in E&P, look for the upcoming article, “Hedging Horizon,” in Oil and Gas Investor’s April 2010 edition at OilandGasInvestor.com.

Booking proved undeveloped petroleum reserves has become a give-and-take exercise under new U.S. SEC regulations. Oil and gas companies are reporting both upward and downward year-end PUD revisions in the same properties.

– Based on a new “reasonable certainty” standard, companies are reporting PUD locations at distances greater than one legal offset from economically producing wells in their year-end 2009 results. That has boosted PUD reserves, especially from shale-gas locations.

– Reporting companies took PUD wells off the books if they were scheduled to be drilled more than five years from initial PUD assignment. Few exceptions were made, but more were expected in 10-Ks to be filed on or before March 15.

Cabot Oil & Gas Co. reports it made an exception for 16 Bcfe of PUD reserves delayed by “external factors.” However, it removed 120 Bcfe of PUDs that fell outside of the five-year development window by reclassifying them to probable. That was consistent with a reallocation of its capital program to develop assets in Pennsylvania and East Texas.

Across the industry, proved reserves, including PUDs, also dropped because average commodity prices for the year were lower than year-end prices. The SEC changed the rules from a one-day year-end price to an annual average to lessen the effects of volatility.

Some companies detailed the extent to which the five-year limitation decreased PUDs and multiple offsets increased them. For Bill Barrett Corp., the net effect was to boost PUDs. The company said it included additional offsetting locations, where warranted, in the Williams Fork formation in Gibson Gulch, a basin-centered, “continuous” accumulation of gas. That increased PUDs for the field by 64 Bcfe. The five-year limitation “had a nominal impact of reducing reserves by 7 Bcfe,” the company reported.

For The Williams Cos. Inc., the net effect was a “wash.” Williams reclassified 496 Bcfe of reserves from PUD to probable because of the five-year limit, while adding 454 Bcfe of PUD reserves through additional offsets.

Companies also assigned PUD locations more than one direct offset from a producer not only in shale, but also in conventional accumulations. Barrett’s Williams Fork produces from sandstone reservoirs.

–Mike Wysatta

About the Author: Mike Wysatta is business-development manager for Ryder Scott Petroleum Consultants based in Houston. He can be reached at 713-651-9191 and mike_wysatta@ryderscott.com.

Click for the PDF of Wysatta’s full report on this, including how the new SEC reserve rules were incorporated in year-end results for Newfield Exploration Co., Pioneer Natural Resources Co., EQT Corp., Petrohawk Energy Corp., Noble Energy Inc., Range Resources Corp., Bill Barrett Corp., Ultra Petroleum Corp., OAO Novatek, Rosneft, Petrobras and Chesapeake Energy Corp. and other reserve-analysis articles in the March-May 2010 issue of Ryder Scott’s Reservoir Solutions newsletter: reservoirsolutionsryderscottmarch2010.

When discussing natural gas prices, people may think of Henry Hub or another gas-trading hub. However, when discussing natural gas costs, there is no accepted measure to turn to. A simple analogy to consider is to examine the cost of a backyard do-it-yourself BBQ hamburger that you cook at home with the family. The layers are fairly simple: a bun, green lettuce, red tomato, meat, pickle, and cheese to top it off. The cost to buy these ingredients might come to $1.25.

Similarly, the cost of the natural gas hamburger includes royalties/taxes, operating costs, finding and development expenses, overhead, some profit (the return to investors) and the cost of transportation to get the gas to market. The total of these increments added to more than $7 an Mcf in 2008, far more than the price realized at the trading hubs.

A good handle on the relative cost to explore, develop, produce and market natural gas across the various gas basins in North America is important to an investor who wants to determine where to direct funding for the best return. For years, getting accurate cost data for gas from various producing basins was very challenging, if at all possible.

Based on ground-breaking research, in early 2008, Ziff Energy published the first complete, full-cycle gas analysis of 85 plays from two dozen gas basins. The next cost study of North America gas basins is currently being finalized using cost data as of late 2009 (the current low gas price/low cost environment). Economic ranking of the gas basins across North America will determine which regions producers are funding and which basins will see continued slowdown.

For mergers, acquisitions and divestitures, is it better to buy gas reserves, or is it better to explore, develop, produce and market?

The answer depends on the specific gas basin. This age-old question is being asked by boards of directors and by executive managements conducting due diligence on pending deals. Even service companies, such as drillers, pipelines and suppliers, would benefit by knowing the economic ranking of the major gas basins so they can focus their services and equipment to where producers need it most.

State and provincial governments will be better stewards of their producing communities if they understand the relative economics of basins. They will be better able to assess the impact of tax/royalty options and development issues which will impact (positively or negatively) incremental investment by operators, and therefore increase regional gas production.

Exploding growth among various shale-gas basins leads to a similar question. Which shale-gas basin is most attractive to invest in from a total cost perspective? Cost assessments of Barnett (Fort Worth), Arkoma, Haynesville, Marcellus, Appalachian and Canadian shales will be included in the upcoming study.

Graphically impressive, the new edition of the North American gas-basins study will help to explain the cost structure of all the significant conventional and unconventional gas basins.

–Bill Gwozd

About the Author: Bill Gwozd, P. Eng., is vice president, gas services, for energy-research and -consulting firm Ziff Energy Group. He can be reached at 403-234-4299 or bill.gwozd@ziffenergy.com.

What can we say about the T indices for the petroleum complex? For the Nymex heating-oil and gasoline futures markets, the T indices are within range of what had not been considered excessive for the agricultural futures markets.

For the very brief time period that we have ICE Futures Europe data, the conclusion for the ICE WTI contract is the same as that for the Nymex heating-oil and gasoline contracts.

As long as one includes options positions, the T indices for the Nymex oil futures markets are not excessive, again, provided that it is acceptable to use the historical agricultural futures markets as a guide to the adequacy (or excess) of speculation. It is also noteworthy that from the summer of 2007 to the summer of 2008 the Nymex WTI oil futures market did become more speculative (relative to hedging), even if the data for futures and options combined showed that the peak T index would not be regarded as excessive using our historical benchmarks.

Now, to be circumspect in our conclusions, we must note that if we exclude the option positions in the Nymex oil data, the futures-only data would potentially indicate excessive speculation in the U.S. oil futures markets.

We must clearly be careful about how strongly we word our conclusions. Within the closed system of the US oil futures and options markets, we find no evidence of excessive speculation, at least not when we use traditional metrics and when we include options positions with outright futures positions.

Also, if excessive speculation can be defined differently than as in our paper, then obviously we cannot say for certain that there has not been excessive speculation in the oil derivatives markets. Nor are our conclusions necessarily incontrovertible, if it is inappropriate to use the historical balance of agricultural speculation versus hedging activity to categorize this balance in the oil markets.

In addition, we have not examined whether futures-spreading activity over the past three years could have constituted excessive speculation. Finally, we cannot say there has not been excessive speculation in the oil markets through other venues.

But we can say that, based on traditional speculative metrics, the balance of outright speculators in the U.S. oil futures and options markets was not excessive relative to hedging activity in those same markets from June 13, 2006, to October 20, 2009.

–Hillary Till

About the Author: Hilary Till is a research associate for EDHEC-Risk Institute (Nice, France), a principal of Chicago-based, proprietary trading firm Premia Capital Management LLC and co-editor of the best-selling book Intelligent Commodity Investing (RiskBooks.com/IntelligentCommodity). Before co-founding Premia Capital, Till was the chief of derivatives strategies at Putnam Investments and a quantitative analyst at Harvard Management Co. She has a B.A. with General Honors in Statistics from the University of Chicago and an M.Sc. in Statistics from the London School of Economics, where she studied under a private fellowship administered by the Fulbright Commission.

Click for Till’s full report: Has There Been Excessive Speculation in the US Oil Futures Markets? What Can We (Carefully) Conclude from New CFTC Data?

December 3, 2009

President Barack Obama

The White House

1600 Pennsylvania Avenue, N.W.

Washington, D.C.  20500

Dear Mr. President:

Today at the White House, you had the chance to hear firsthand from several interested and informed parties—lawmakers, business owners, labor and academics—about the seriousness of the economic challenges facing our nation. The timing was critical, with the official number of unemployed Americans nearing 16 million, with some estimates reportedly in excess of 25 million.

As president of an independent natural gas and oil company (Swift Energy) and chairman of the Independent Petroleum Association of America, I’ve learned an important lesson: Never in human history has the safe and responsible development of available domestic energy resources failed to create value—not only for those who produce them, but for those who consume them as well. In a modern context, that value can be realized in the form of new, high-wage jobs for the American people, billions in revenue for state, local and federal governments, and a genuine means of reducing our dependence on foreign, unstable energy suppliers.

The American natural gas and oil industry continues to be one of the most powerful and dynamic forces of job creation in the nation—by some estimates, responsible for more than 9 million direct and indirect jobs in this country, and more than 7%  of total GDP. That spirit of growth and innovation is especially prevalent among our nation’s small and independent producers—men and women who, on average, employ just 12 workers apiece but still find a way to develop nine out of every 10 wells in service across the country today.

Maybe we’re just lucky with our “wildcatter” fortitude. Or maybe it has something to do with the fact that 150% of what we make (and haven’t quite made yet) is re-invested back into the work of finding and producing energy for the American people. We take this work seriously. And we stand ready and willing to put that work to use, in service of the goals and objectives identified by your jobs panel this afternoon.

Some of the most exciting work in this sector is taking place in areas across the country known as “shale plays.” Through technological advancements and industry ingenuity, massive amounts of clean-burning natural gas resources—once thought to be out of reach—are now being realized. And to your credit, Mr. President, you’ve started to take notice—releasing a position statement during your recent trip to China that hailed the United States as “a leader in shale-gas technology and developing shale-gas resources in a way that mitigates environmental risks.”

May we add “creating new jobs” to that list as well? Only a couple years back, analysts predicted that shale-gas production in Texas’ Barnett Shale would create $6.5 billion in economic output and 70,000 jobs. Nice try. In 2008, the Barnett generated more than 111,000 permanent jobs and $11 billion in economic activity—and the expectation is for those numbers to climb dramatically in the years to come.

Penn State University has conducted similar research on the enormous potential of the Marcellus Shale formation in the mid-Atlantic. Last year alone, according to Penn State, 29,000 jobs were created—and more than 50,000 jobs are expected to be created by the end of this year. The production also was responsible for $2.3 billion in economic development. And along New York’s Southern Tier, experts have predicted that natural gas production in Broome County could produce as many as 16,000 jobs and generate more than $790 million in wages, salaries and benefits.

As you can see, Mr. President, we have plenty of good news to report. We also have our share of disappointing news. For example, your budget calls for massive, job-killing tax hikes on small, independent oil and gas producers, potentially stripping $36 billion from many of these small businesses. The result would be a 20% drop in oil production and a decline in natural gas production of 12%. Countless jobs would also be lost.

We are also concerned that broad, sweeping financial regulation reforms that your Administration is advancing could harm domestic energy production. Derivatives play a critical role in ensuring that our member companies can minimize risk and exposure. Without these key financial tools in place and available to those who need them, less energy would be produced, and fewer high-wage jobs would be retained. It’s just that simple.

I am also concerned about your Administration’s decision to slow-walk the deployment of a common-sense, supply-oriented five-year offshore energy plan. Without action from the Interior Department, the more than 1 million jobs projected to be created through responsible, 21st-century offshore energy production will simply not be realized.

Economic recovery and long-term, sustainable growth demand access to affordable, reliable and secure energy supplies. We have the energy here at home to help meet our nation’s growing demands, and a capable workforce ready, willing and more than able to ensure these resources are produced safely and responsibly. We urge your Administration to move forward with common-sense solutions that encourage domestic energy production. American jobs and our national security are at stake.

Sincerely,

Bruce Vincent

Chairman, Independent Petroleum Association of America

At last we know…sort of. An article in the U.K. newspaper The Guardian on Nov. 9, “Key Oil Figures Were Distorted by US Pressure, Says Whistleblower,” reveals what hundreds of analysts have been trying to convey to world leaders for years: The global oil supply situation is critical and getting worse, and vested interests are playing key roles in covering up this devastatingly inconvenient truth.

Over a decade ago, when I began following the Peak Oil story, the main sources were a few highly placed petroleum geologists with experience in oil fields around the globe. At that time, these brave scientists were saying that world oil production would peak sometime around 2010, and that the global economy would be hammered as a result. Since it will take decades to develop alternative energy sources to replace petroleum (if adequate replacements are even available), the consequences for transport, trade and agriculture will be almost too awful to contemplate.

In the past few years these lone voices of warning have garnered the backing of a million-voice chorus: investment banks, oil-analytics firms and investigative journalists have joined the geologists in pointing out that oil-production limits are within sight, and in calling for more transparency in official data reporting and forecasting.

But the International Energy Agency has stubbornly refused to come clean. And this is important: while financial analysts and investors are free to draw their own conclusions about Peak Oil (and a great many of them have seen the writing on the wall—hence recent run-ups in oil-futures prices), national and local governments must rely on officially sanctioned fuel supply and price projections for all their planning. Energy policy, transport planning, agriculture policy, economic forecasting, and much more depend upon the august pronouncements of the Paris-based IEA.

There are always folks who are glad to tell us what we want to hear. Indeed, the presentation of plausible excuses for the denial of serious problems offers an attractive career track. Prominent oil optimists like Daniel Yergin and Michael C. Lynch find open doors at the New York Times and other major media outlets, and wealthy clients for their consulting services, because they reassure markets that all will be well.

Nevertheless, denial leads to complacency, not problem-solving. And the end of cheap, abundant oil is a problem that could cripple the global economy not just for another year or two, but more or less permanently.

This is not to say that the recently released IEA “World Energy Outlook 2009” is worthless: The current iteration of the agency’s annual report makes many excellent points (for example, that “Falling energy investment [resulting from the worldwide financial crisis] will have far-reaching consequences”). But, as the whistleblower quoted in the recent Guardian article notes, agency forecasts for future world oil production are still profoundly unrealistic:

Many inside the organization believe that maintaining oil supplies at even 90- to 95 million barrels a day would be impossible but there are fears that panic could spread on the financial markets if the figures were brought down further. And Americans fear the end of oil supremacy because it would threaten their power over access to oil resources.

Sooner or later, we must face reality. If we do it sooner, our chances of adapting successfully are far better than if we wait and deny just a little longer.

On one hand, careers are at stake if IEA officials step forward and tell us the truth. On the other hand, the global economy is as risk if they don’t.

There is evidently a quiet battle raging within the agency, and within the consciences of many of its officials. So far, we are all the losers in that battle.

–Richard Heinberg

About the Author: Richard Heinberg is senior fellow of the Post Carbon Institute and author of The Party’s Over: Oil, War and the Fate of Industrial Societies. He can be reached via his website: Richard Heinberg.

Our (World Gas Conference) forum is taking place at a crucial point—a period in which we are searching for ways to overcome the consequences of the global financial crisis and industrial recession. In this context, the topic of gas-supply security being addressed by our session is particularly vital.

It should be noted that, in recent years, the issue of energy security, including security of gas supply, has been a focus of debate at the highest levels and has become a priority item on the agenda of international conferences, meetings of political leaders and even military alliances. Today’s forum is a good opportunity for us to discuss this subject within this assembly of top professionals and highlight strategies that gas market players are pursuing for the sake of increased energy security worldwide, without wasting our time dispelling ideological and political prejudices.

The term “investments for higher security of supply” will be construed broadly—not only as necessary capital injections, but also as a system of actions and initiatives on a global scale.

According to the United Nations, by 2030 the world population will grow by nearly one fourth—up to 8.3 billion people. Simultaneously, there will be an increase in energy consumption per capita, to be contributed primarily by the most populated countries—China, India, Brazil and Indonesia. These countries are experiencing a rapid process of industrialization, urbanization and automobile use. Energy consumption will be growing on the back of limited opportunities for boosting oil output, narrow bounds for developing the nuclear energy sector and an extremely low contribution from new, alternative non-hydrocarbon energy.

All this offers excellent prospects for the gas industry.

Most estimates are fairly consistent that in the foreseeable future mankind won’t be able to do without fossil fuels. Natural gas will be the most eco-friendly hydrocarbon that will be used on a broader basis, including for power-generation purposes and as a vehicle fuel. If the 20th century was our “oil century,” then the 21st century stands to be our “natural gas century.”

Coordination of activities among major gas exporters is not enough. Further integration of efforts made by natural gas market stakeholders is needed. Despite the obvious benefits of natural gas compared to other fuels, one should not think that the role of gas in the global energy balance is guaranteed. We believe that all of us who are interested in developing the natural gas industry, namely the International Gas Union, should be more active in shaping the world energy-development model. So far, the main goal pushed forward by some politicians amount to nothing more than just a decrease in hydrocarbons consumption.

Meanwhile, millions of our consumers will be at the mercy of a costly model of future energy consumption, a model that they will have to pay for. At the same time, calculations prove that a high demand for an environmentally friendly economy may be reached without prejudice to hydrocarbon energy, but owing to it. Thus, replacement of nearly half of the existing coal-fired power-generating facilities in Europe with up-to-date gas-fired combined-cycle power stations will cut CO2 emissions in the same amount and will cost only one third of the price of that of wind power generation.

Natural gas is the most reliable energy source in terms of energy security during peak load periods when compared to any other source of energy, including nuclear, solar, wind and hydro energy. Nobody can guarantee maintaining peak loads with energy produced from renewable sources.

When determining the balance between environmental and energy interests, it is important for us to convey to the public that it is necessary to be aware of all factors. For example, a potential reduction in CO2 emissions stipulated by vehicle conversion from oil products to natural gas is not so tangible, if compared to the power industry. Using natural gas in engines will relieve us not only from toxic gasoline and diesel-engine exhaust, but also from using fertile land for producing biodiesel fuel in lieu of food. Gas may and should be used in vehicle engines in a compressed form or as a synthetic engine fuel. Thus, natural gas will make another contribution to sustainable development.

Another essential issue we have to face together, particularly within the International Gas Union, is forming the global gas balance as a basic principle for long-term planning across the entire gas industry.

–Alexey B. Miller

Click for Miller’s full presentation to the 24th World Gas Conference, Oct. 6, 2009, Buenos Aires: AlexeyMiller.Gazprom.Speech.10.6.09

When developments occur that surprise us, it is often because our assumptions about the present, not to mention the future, have turned out wrong. The consequences can be very severe for companies, governments and societies as the current economic crisis demonstrates. If one assumed the U.S. government would always step in to save large financial institutions, then the failure of Lehman Brothers in September 2008 was a big surprise—as were the events that pushed Lehman to the wall in the first place. If one believed the price of oil could not stay above $50 for a year or more—a common belief not long ago—then the price trend of 2005–08 was a shock, as were the wild gyrations that followed. Such beliefs point to a disconnect between how we assume the world works and how it actually works.

No course of action will lead to the gift of perfect clairvoyance about the future. The development of scenarios is a disciplined process, however, that forces us to question the present to understand the different ways the future could unfold and to prepare. Through the creativity, dialogue, investigation and analysis that are part of the scenario process, one can, as Daniel Yergin, IHS CERA chairman, once put it, “peer around the corners of the future and think through and plan for discontinuities before they occur.”

The scenario process helps companies to be early, flexible and adaptive, and to be prepared for abrupt changes in the business environment. It provides a methodology for “thinking the unthinkable”—especially important when the “unthinkable” has a habit of becoming a reality. For instance, several years ago IHS CERA’s “Global Fissures” scenario laid out the dynamics of a deep world recession at a time when recessions were supposedly a thing of the past.

Scenarios provide a way to get beyond the “conventional wisdom” of the moment, to test company doctrine and to put aside prestige and position to ask fundamental questions. A means for tackling real issues and questions that companies face both next year and in 10 years is what the scenario process offers.

But what exactly is the scenario process and how are scenarios developed? First, let’s be clear about what they are not. Scenarios are not simply the fantastic musings of imaginative, feet-on-the-desk free thinkers. Nor are they the exclusive domain of calculations cranked out of a computer. It is not one or the other.

Instead, scenarios, at their best, marry expansive, qualitative thinking about the future with the rigor and feedback of quantitative modeling. Each scenario—a scenario exercise typically creates two to four scenarios—tells a “story,” a logical story, about the future that includes important trends and events, describes the key players and their actions, and explains the dynamics of the system or the set of questions under study.

The aim is not to predict a precise order of events and outcomes, but rather to enable development of robust strategies that will stand up no matter what happens. Scenarios make us explicitly identify and question our assumptions about the future. Inquisitive and disciplined thinking is at the heart of the scenario process—and a key source of insight and value.

The scenario process can address very large questions, such as the future global balance of power, or it can focus on specifics, such as the demand for automobiles in a single country or region of a country. But regardless of the scope of analysis, a vital aspect of the scenario process is that it encourages exploration of linkages among different forces.

For example, how will efforts to develop a global framework to manage greenhouse gas (GHG) emissions affect trade policy, nuclear proliferation or the commercialization of a large-scale electric-vehicle fleet? On the surface, some issues may not seem to influence one another but, in reality, they often do—or will in the future. Geopolitics, markets, technology and the world of business do not evolve in isolation from one another. The scenario process recognizes this reality.

–James Burkhard

Click for Burkhard’s full report, including:

–Scenarios: Expanding Analysis-Testing Assumptions

–Brainstorming the “Big Questions” and Developing Scenario-Building Blocks

–The Next Step: Develop the Scenarios

–The Role of “Shoe Leather”—And Engaging “the Great Women and Men of the World”

–Using the Scenarios

–To Understand the Future, We Need to Question the Present

About the author: James Burkhard is managing director of IHS CERA’s global oil group. He was the project director of “Dawn of a New Age: Global Energy Scenarios for Strategic Decision Making—The Energy Future to 2030,” a comprehensive study by IHS CERA that encompassed the oil, gas and electricity sectors. He is also the co-author of IHS CERA’s World Oil Watch, which analyzes short- to medium-term developments in the oil market. He was on the U.S. National Petroleum Council committee that provided recommendations on U.S. oil and gas policy to the U.S. energy secretary. He can be contacted at 303-736-3000 and jburkhard@cera.com.

The Treasury Department has released its draft OTC derivatives regulation bill, “The Improvements to Regulation of Over-the-Counter Derivatives Act.” The actual language of the 115-page proposal follows quite closely what Geithner has been floating for several months—a clearing mandate for standardized derivatives, attempts to force OTC derivatives trading onto execution facilities, differential margin and capital requirements for cleared and non-cleared products.

My initial reactions:

First, there’s a whole lot of delegatin’ goin’ on. A good part of the bill sets out the haziest general objectives, and then directs the CFTC, SEC and “the Prudential Regulator” (either the Fed, the Office of the Comptroller of the Currency or the FDIC, depending on a bank’s charter status) to come up with specific rules on what constitutes a standardized derivative, capital and margin requirements, position limits and so on.

There is an aggressive timeline for most of these rules: 180 days. Given the depth and breadth of the issues, and their contentious nature, and the needs to coordinate among disparate agencies, this will be very difficult to do at all, and extremely difficult to do well.

Second, the Treasury has finessed the jurisdictional issues by giving multiple regulators authority over OTC derivatives markets, with the injunction that everybody share and play well together. Many of the provisions require that the CFTC and SEC issue rules jointly with the proviso that, if they cannot, the Treasury will prescribe them.

Given the delegation-heavy aspect of the proposal, there are few specifics to analyze. But there are some aspects of the proposed bill that are spelled out with sufficient detail that deserve comment.

I’ve beaten the clearing mandate horse repeatedly before, so I won’t do more than repeat my previous conclusion that the mandate approach is wrong-headed, and ignores crucial economic issues. The proposal does not require clearing when “one of the counterparties to the swap— (1) is not a swap dealer or major swap participant and (2) does not meet the eligibility requirements of any derivatives-clearing organization that clears the swap.” This would seem to permit an end user (e.g., a gas producer) to enter into a swap with a dealer without triggering the clearing mandate.

This is a desirable feature and would permit end-users to enter swaps without having to clear them; this could be especially important for end users concerned about the cash flow and liquidity risks associated with daily mark-to-market. However, there are some peculiarities as to what constitutes a swap dealer or major swap participant that confuses and creates ambiguity in the application of this exemption from the clearing requirement.

It is a travesty to call this the “Improvements to Regulation” act. All of the substantive element—the clearing mandate, the trading mandate, the setting of capital and margin requirements by relatively uninformed regulators subject to influence and pressure, the position limits—have no solid economic justification.

Indeed, the stronger justifications cut the other way in virtually every case. Moreover, the ambiguities in the definition of key terms that determine the reach of the mandates are a recipe for trouble later on. The delegation of virtually all implementation details to regulators, the rapid timeframe for the formulation of specific rules, the need for coordination across regulators and the lack of anything more than the haziest guidance will create immense implementation problems and lead to enormous influence activities.

All in all, therefore, this would be better titled “The (Further) Bollixing of the Regulation of Over-the-Counter Derivatives Act.”

–Craig Pirrong

About the author: A recognized energy-markets expert, Craig Pirrong is director of the University of Houston’s Global Energy Management Institute and a professor of the university’s carbon-trading course—the first of its kind in the U.S. The institute is part of the university’s C.T. Bauer College of Business. Pirrong joined the university in 2003. He previously was the Watson Family professor of commodity and financial-risk management and an associate professor of finance at Oklahoma State University, and was on the faculty of the University of Michigan Business School, the graduate school of business of the University of Chicago and the Olin School of Business of Washington University in St. Louis. He holds a Ph.D. in business economics from the University of Chicago. The full version of Pirrong’s commentary on OTC derivatives—including details on the peculiarities as to what constitutes a swap dealer or major swap participant that confuses and creates ambiguity in the application of this exemption from the clearing requirement—and on more energy subjects is available at his blog www.streetwiseprofessor.com. He can be reached at cpirrong@gmail.com.