US Faces Hard Energy Choices, Says Independent Task Force
The US faces hard choices in order to cope with an extensive period of projected energy supply shortages and price hikes, according to an independent task force report co-sponsored by the James A Baker III Institute for Public Policy of Rice University, Houston, and the New York-based Council on Foreign Relations. The report, entitled “Strategic Energy Policy Changes For The 21st Century,” says that unless the US adopts a long-term, comprehensive energy policy without delay there could be more crises of the kind experienced recently in the electricity supply industry in California. “Given the capital-intensive nature of the energy industry,” the report says, “such energy woes could worsen before they get better. Americans should therefore brace themselves for more California-style electricity problems and seasonal shortfalls of natural gas and heating fuels, as well as occasional spikes in regional gasoline prices.” These developments, the task force says, are not a sign that the world is running out of energy sources, but are the results of “chronic under-investment and soaring energy use.”
The energy supply challenges faced by the US were addressed last month by Energy Secretary Spencer Abraham in a speech to the US Chamber of Commerce (MEES, 26 March). Still awaited is the report of an official energy task force headed by Vice President Dick Cheney. This latest joint report from two leading think tanks in the US, drawn up by a task force chaired by Edward L Morse of Hess Energy and directed by Amy Myers Jaffe of the Baker Institute, will contribute to the public debate on US energy policies.
The 107-page report published on 12 April opens with an assessment that “the energy sector is in a critical condition. A crisis could erupt at any time from any number of factors, from an accident on the Alaskan pipeline to a revolution in a major oil producing country…Oil is still readily available on international markets, but prices have doubled from levels that helped spur rapid economic growth through much of the 1990s. And with spare capacity scarce and Middle East tensions high, the chances are greater than at any point in two decades of an oil supply disruption that would even more severely test US security and prosperity. Worse still, the precarious oil market situation comes against the backdrop of severe energy infrastructure constraints across the US, from the wellhead to the burner tip. These constraints are raising domestic energy costs and prompting a public outcry, highlighting the fact that an energy crisis need not arise abruptly, but can emerge through slower contagions.”
How the US and the rest of the world got into the current difficulties, the report says, “is a long and complicated story. But one of the fundamental reasons is unambiguous – the US has not had a comprehensive integrated strategic energy policy for decades. As a result, today’s situation arose by stealth, as years of rapid growth crashed into the physical supply barricades that were erected by decades of under-investment in energy infrastructure.” This was the result, in part, of low industry profits through much of the 1990s, exacerbated by tightened environmental restrictions and an uneven regulatory process. “No new oil refineries are likely to be built in the US due to the high costs of environmental compliance and historically low returns on investment. Nuclear power faces other obstacles, ones related less to environment and more to safety and, to a certain extent, non-proliferation.”
In the short term, the task force concludes, the “energy situation may well improve due to seasonal downturns in demand as well as economic slowdown in the US. But from a longer-term perspective, the difficult situation in energy markets may get worse before it gets better.” In the developing world, material needs of an expanding middle class are growing, while in the US, “years of prosperity are testing the country’s ability to deliver secure, clean and reliable energy.” The world, the report continues, appears to have entered “a new energy era, one that is no longer concerned with working off and managing surplus capacities. The new era, instead, is focused on marshaling capital to develop adequate resources and infrastructure to meet rising demand for energy, in a manner that is consistent with environmental goals. In order to satisfy that demand, reliance on volatile Middle East oil resources could increase dramatically over the next two decades unless policies are put in place to promote oil development in other regions, to shift to alternative sources, or to rein in unbridled or wasteful consumption. In practice, a hands-off US policy towards energy markets has increasingly led to a dangerous complacency about energy supplies that has flagrantly ignored the importance of conservation and demand management.”
The task force says that the US has frequently stated its desire to see new acreage around the world opened to oil and gas exploration, but has failed to match its words with actions. “On the contrary, it has frequently used energy sanctions as an instrument of foreign policy, blocking targeted countries from trade and investment, while making energy goals secondary to other foreign policy objectives…US unilateral sanctions as well as multilateral sanctions against oil-producing countries have discouraged oil resource investment in a number of key oil provinces, including Iraq, Iran, and Libya. US sanctions policy has constrained capacity expansion to some extent in Iran and Libya, although the unilateral aspect of the US action limited its impact. In the case of Iraq, the UN sanctions imposed as a result of the Iraqi invasion of Kuwait have had a severe effect on potential Iraqi production. Sanctions’ role in constraining investment in several key OPEC countries has aggravated the global problem of spare production capacity, which is now less diversified among a number of large producers than was the case 20 years ago. The consequent lack of competition has contributed to high prices. Most of today’s spare productive capacity is located in Saudi Arabia. And Saudi Arabia’s high, and growing, level of production and the lack of significant spare unutilized capacity outside the kingdom have spotlighted that country’s critical role in determining the state of current and future oil markets, in turn creating unique political pressures. Iran and Iraq accuse Saudi Arabia of seeking higher production rates to accommodate the economic interests of the United States, Japan, and Europe at the expense of the needs of local populations, creating internal pressures in the Arabian Gulf region against a moderate price stance. Bitter perceptions in the Arab world that the United States has not been evenhanded in brokering peace negotiations between Israel and the Palestinians have exacerbated these pressures on Saudi Arabia and other GCC countries and given political leverage to Iraq’s Saddam Husain to lobby for support among the Arab world’s populations. Several key producing countries in these important areas remain closed to investment. Encouragement of open investment policies in these countries would greatly promote renewed competition among the largest oil producers and the advancement of oil supplies in the coming years. A reopening of these areas to foreign investment could make a critical difference in providing surplus supplies to markets in the coming decade.”
The
Hard Choices Facing The US
To cope with the challenge of what the report calls “an extensive period of supply shortages and price hikes in the US and in other parts of the world…the US faces three policy paths.” The first option is to muddle through, with marginal management of the Strategic Petroleum Reserve (SPR) and free market solutions. The second is to take a near-term narrow approach by expanding supply to ensure cheap energy. The third option – favored by the task force – is to “develop a comprehensive and balanced energy security policy with near-term actions and long-term initiatives addressing supply-side and demand-side policy instruments and diversification of energy supply resources that enable the US to escape from a pattern of recurring energy crises.” The report warns that “any comprehensive plan is likely to require confrontation with other policy objectives that have deep constituencies. In some measure, concessions will have to be made that impinge on certain local environmental goals, states’ rights, Middle East policy, economic sanctions policy, policy towards Russia and hemispheric and international trade policy. Making compromises could be politically painful and will require sustained leadership from the highest levels of government. But the benefits will be quite real. The comprehensive approach could minimize the negative consequences of a disruption in any particular fuel and help shield the American consumer from the painful effects of the cyclicality of the energy business.”
The task force warns, too, that “this invigorated energy policy will take time. Quick fixes can alleviate supply bottlenecks or conserve energy use,” but solutions will take five years or longer to be implemented. Energy issues of this kind also need to be brought before the public to counter widespread misconceptions and to start building a broad base of popular support for the hard policy choices ahead. “There are no easy, immediate and politically attractive solutions to the country’s or the world’s infrastructure and supply problems.”
The task force outlines four recommendations for building a new US energy strategy:
1.
Deter
and Manage International Supply Shortfalls.
“Recent
oil market-price volatility has been driven by a number of complex factors.
However, three key drivers continue to fuel upward pressure on prices: OPEC
policy and the organization’s lack of spare productive capacity; the policies
of Iraq and concerns about the reliability of its UN-monitored oil exports; and
fears of a possible flare-up in the Arab-Israeli conflict. These factors have
created uncertainty in markets that has at various times outweighed
considerations of immediate market supply availability, fueling speculation and
pushing prices above $30-35/B at various times in recent months. Although these
situations cannot be solved overnight, certain steps could be considered to
ameliorate their negative impact on oil market stability:
·
Develop a diplomatic
program ensuring GCC allies remain prepared and willing to maintain stable
prices to promote global economic growth and also to fill any unexpected supply
shortfalls in times of turmoil in the oil markets, whether created by accident
or by the adverse political actions by any producing nation. The vast majority
of all unused, spare oil productive capacity is located in Saudi Arabia and the
UAE. It appears that Kuwait might soon be added to that list. Saudi Arabia has
over 1mn b/d of spare sustainable capacity and considerably more surge capacity
that could be brought online for several weeks in a crisis. The UAE has some
limited spare capacity of several hundred thousand b/d. Kuwait might soon have a
similar amount. These are all very important countries for the US, with a
fundamentally positive attitude toward cooperation and support, and with the
only meaningful spare production capacity in the world. They all deserve being
cultivated as special priorities of US policy.
Over
the past year, Iraq has effectively become a swing producer, turning its taps on
and off when it has felt such action was in its strategic interest to do so.
Saudi Arabia has proven willing to provide replacement supplies to the market
when Iraqi exports have been reduced. This role has been extremely important in
avoiding greater market volatility and in countering Iraq’s efforts to take
advantage of the oil market’s structure. Saudi Arabia’s role in this needs
to be preserved, and should not be taken for granted. There is domestic pressure
on the GCC leaders to reject cooperation to cool oil markets during times of a
shortfall in Iraqi oil production. These populations are dissatisfied with the
‘no-fly zone’ bombing and the sanctions regime against Iraq, perceived US
bias in the Arab-Israeli peace process, and lack of domestic economic pressures.
A diplomatic dialogue that emphasizes common US-GCC goals and programs should be
pursued at the highest levels to minimize the potential for tension over these
other issues. Goodwill efforts such as a US offer to buy oil from spare capacity
for the SPR when market circumstances warrant and a willingness to discuss
coordinated response to supply emergencies can be used to offset anti-American
sentiment among elite groups in these countries. There are, however, some
trade-off issues. Working together with the GCC could restrict some of the US’
freedom of movement on security and foreign policy actions that might be
desirable with regard to Iraq or the Arab-Israeli conflict from a US point of
view.”
Under
the first recommendation, the task force says the US should also:
·
Prepare for contingencies
and gain agreement on coordination in the IEA in efforts to deal with any
removal of oil by adversary nations from international markets;
·
Minimize public conflicts
with OPEC and other independent oil exporting countries, but emphasize the
importance of market factors in setting prices;
·
While moving to diffuse
tensions in the Arab-Israeli conflict through conflict resolution and
negotiations, maintain energy and political issues in US-Middle East relations
on separate tracks;
·
Review Iraq policies to
lower anti-Americanism in the Middle East and elsewhere; set the groundwork to
eventually ease Iraqi oilfield investment restrictions.
2.
Remove
Bottlenecks and Other Obstacles to Energy Supply, Both Domestically and
Internationally.
This
measure recommends investigating “whether any changes in US policy would
rapidly facilitate high Caspian Basin oil exports.”
3.
Take
a Fresh Approach to Building and Maintaining National Strategic and Commercial
Crude Oil and Petroleum Product Inventories.
4.
Develop
Mechanisms for a New National Approach to Energy Policy.
Long-Term
Energy Policy Initiatives
As
for long-term energy policy initiatives, the report outlines nine
recommendations:
·
Review international
approaches to build, maintain and use strategic and commercial crude oil and
petroleum product inventories;
·
Accelerate demand
management efforts at home and internationally;
·
Maximize efforts to
develop every clean source of domestic fuel supply;
·
Augment diplomatic
initiatives to spur non-OPEC production increases – including encouraging
reforms in Russia’s energy sector;
·
Initiate diplomatic
efforts to encourage the re-opening of countries that have nationalized and
monopolized their upstream sectors;
·
Review sanctions
policies, to identify ways to reduce the negative impact on energy supplies
while accomplishing the objectives for which the sanctions were imposed;
·
Develop a credible
international stance on global warming and other environmental issues –
including conducting a thorough review of the Kyoto accords and recommending
ways for the US to revive international discussions on climate change;
·
Support efforts to
develop and disseminate accurate and timely information about the fundamentals
of energy market supply and demand; and
·
Lay the foundation for
new global energy institutions, including building on “overlapping interests
and relations between the world’s largest oil exporter – Saudi Arabia –
and the largest consuming country – the US.”