Will Methane Emission Reduction Requirements Affect Renewable Energy Investment?

Early this year, the White House announced its plans to impose new regulations on the oil and gas industry’s methane emissions. Controlling methane emissions from oil and gas well flaring and leaks has been identified as a critical step in slowing global warming. Domestic oil and gas production has surged over the past few years, and with it concerns have been growing over the potential global warming effect of methane emissions. Beyond the obvious direct impact on methane emissions, there are concerns that the new regulations could have a meaningful impact on the energy market at large.

The rules, if enacted, would be the first direct regulation of methane emissions from oil and gas production in the U.S., and would be a further expansion of Environmental Protection Agency (“EPA”) powers under the Clean Air Act. Proposed regulations are due this summer, with final regulations expected in 2016. Initial targets call for reduced emissions by up to 45% from 2012 levels by 2025. While the President’s announcement did not suggest how the industry would accomplish these reductions, it did specify that the EPA’s proposal would apply to new and modified oil and gas sources.

Critics of President Obama’s new requirements have argued that the cost of emission control is already excessively high; the proposed regulations don’t just further increase operating costs, but they are also redundant, particularly in an industry that operators claim is already self-regulated. However, the oil and gas industry emits more methane than any other nation-wide, suggesting that existing state laws and voluntary measures being taken are not, in themselves, sufficient.

The regulations and the oil and gas industry’s complaints come at a time when oil and gas prices are plummeting. In the short term, natural gas spot prices are currently projected to average $3.05 Million British Thermal Units (MMBtu) in 2015 ($1.34/MMBtu lower than in 2014), which could mean increased consumption of natural gas for power generation. However, U.S. oil and gas drilling companies are currently operating well below their $70/per barrel break even point, and prices are as low as $48 in 2015. As operators face cash flow problems resulting from low returns on capital expenditures, exploration and production related spending in North America is expected to decrease by 30% this year. Obama’s methane regulations could add an additional cost for new wells as exploration and drilling slows down.

Renewable Investment Operating Along Side Low Oil and Gas Prices

Notably, the long-term forecast for U.S. natural gas per MMBtu is projected to increase, which may stabilize the oil and gas industry. As natural gas sets the marginal price of wholesale electricity in many U.S. markets, this upward pressure may increase electricity prices (particularly when considered in conjunction with the newly proposed regulations). The result could be a shift in the balance of natural gas and renewable use due to renewable energy becoming more cost-competitive.

Deutsche Bank and Lazar published reports in 2014 that hold that renewables are now cost competitive in many U.S. states. With national oil and gas market price set to rise, and the regulations set to increase costs on new and modified wells, renewables may become more attractive in states that have not reached price parity. Additionally, though the Administration did not explicitly state that the EPA would develop regulations applicable to already-existing oil and gas sources, its regulation under Section 111(b) of the Clean Air Act creates a legally implied requirement to regulate facilities under Section 111(d) of the Clean Air Act.

Given the current Administration’s “all of the above” energy strategy, natural gas and renewable energy sources will likely continue to evolve as complimentary. However, the low cost of oil and gas coupled with the President’s new regulations may encourage a shift toward more renewable energy options where natural gas was previously preferred. The newly proposed regulations could foreseeably raise the floor for natural gas pricing, providing low-end pricing certainty. This, in turn, will attract more interest and investment in competitive alternatives in the wholesale power markets.