Energy Policy and Conservation Act of 1975

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The Energy Policy and Conservation Act (EPCA), enacted in 1975 in the aftermath of the 1973 oil crisis, sought to clarify US energy policy and promote energy security. Nearly 40 years later, the US has met many of the conditions for energy security, and, as an unintended consequence, the provisions of the Act have come to serve the interests of narrow groups within society rather than contribute, in any real sense, to American energy security. The EPCA, formulated to treat the energy market of the 1970s, restricts market efficiency in exchange for security by making energy more autarkic; it is these market inefficiencies that enable and give rise to rent-seeking. This rent-seeking compromises energy security by attempting to keep domestic energy prices low, thereby encouraging consumption and discouraging production. Thus, the EPCA presents a case of risk of unintended distributional conflict that undermines the original objectives of the legislation. The EPCA offers a study of the need for periodic review and revision of long-standing laws and definite objectives for legislations to better determine when interest groups are violating the intent of the law.

Theoretical and Analytical Framework

            This analysis seeks examine the dynamics and political economy of the American energy market and interest groups therein. The analysis will use Meadows’s systems theories to provide structure and address the effects of the Act on the individual oil and gas markets, thereby clarifying the beneficiaries and losers from the present conditions in the market. The distributional conflict will be examined through the lens of Thurow’s The Zero-Sum Society and Mancur Olson’s The Rise and Decline of Nations, supplemented by his earlier work, The Logic of Collective Action.

The EPCA sacrificed market efficiency for the sake of security in 1975, primarily by limiting the exports of oil and gas; it thereby enabled distributional conflict by granting undue economic benefits to those that benefit from export restrictions. The market changes and export restrictions in the 1970s create excess domestic supply and lower energy prices in the present. Applying the aforementioned theories of special interests, the benefactors of the present situation, those benefiting from low domestic energy prices, seek to perpetuate the market inefficiencies, while opposition groups, those wanting to sell energy at world prices, seek to overturn them. The small number of players in the distributional conflict ensured that interest groups organized quickly and held enough power to shape the distributional conflict and at a minimum delay, if not prevent, changes to the lucrative niches created as a result of the EPCA. It is this rigidity that undermines security by discouraging new production and adoption of new technologies, both of which depend on high prices. As such, the Act creates the conditions for the existence of interest groups, which then undermine the aims of US energy security.

Letter of the Law

            Following the 1973 oil crisis, the EPCA sought to improve energy security in a US economy configured to rely on inexpensive and readily available oil. The EPCA sensibly tried to improve US energy security by adding resilience to the energy market, primarily by addressing supply and demand and the inelasticities therein. The Act sought to encourage diversification away from the use of oil by supporting alternatives such as additional coal usage. The Act also created the Strategic Petroleum Reserve, consisting of up to one billion barrels of oil, with a minimum set at 150 million barrels to serve a buffer in the event of a supply disruption, though the minimum would have only constituted 23 days’ worth of imported oil in 1975.[1] The Act further gave the president the ability to implement contingency plans in the case of an energy emergency, with the added ability to impose conservation and rationing on ordinary consumers and industry in times of extraordinary distress.

The EPCA grants the President special control over the export of fossil fuels. Section 103 of the Act allows the President to “promulgate a rule prohibiting the export of crude oil and natural gas produced in the United States”[2] and “exempt from such prohibition…exports which he determines to be consistent with the national interest and the purposes of [the] Act.” As such, the executive enjoys a mandate to impose and remove export restrictions when it suits the national interest, defined nebulously. However, the Act provides a special caveat that the restrictions “shall not apply to any covered product if such covered product is manufactured, sold, or held for sale for export from the United States.” As a result, the Act effectively prohibits the export of crude oil and natural gas, but specifically exempts products derived from crude oil and natural gas – the exact products that most consumers and industries use, such as gasoline and diesel. In the 1970s this caveat was irrelevant as few such products were exported. However, the export ban and the caveat have created substantial market inefficiencies that encourage rent-seeking by beneficiaries.

The Spirit of the Law

After the 1973 oil embargo, President Nixon introduced his Project Independence initiative, maintaining that by 1980, “Americans will not have to rely on any source of energy beyond [their] own.”[3] He urged Americans to “adopt certain energy conservation measures to help meet the challenge of reduced energy supplies,” and used executive power to introduce limited energy efficiency improvements and lift restrictions on Alaskan oil production. With Nixon’s resignation, Ford carried on the initiative, making energy the main issue in his first state of the union address. In a speech given upon signing the EPCA, Ford made it a priority to give “industry an incentive to explore, develop, and produce new fields” and “expedite the decontrol of crude oil [prices] in order to increase domestic production.”[4] He raised import duties on oil to encourage domestic production and discourage consumption. The Act focuses on bolstering energy security, achieved through increased resilience by diversification of energy sources, promotion of domestic production and conservation, and diversified import partners.

The overarching US goal was to ensure that it would not be held hostage to foreign producers, sacrifice growth or suffer a debilitating transfer of wealth from the US to oil producers. Energy prices were relegated to a secondary standing, given that measures taken at the time increased prices directly and indirectly, coupled with a recognition that a sustained level of higher prices leads to increased supply in the future. With these aims, the low domestic energy prices in the present are not an original aim of the legislation.

The Oil Market

            In order to fully understand the manner in which the EPCA creates the opportunities for rent-seeking, establishing a systemic framework of the oil industry is necessary. In this system, two stocks exist: crude oil and refined oil products. Domestic and foreign producers both contribute to the stock of crude oil. Under the EPCA and presidential discretion, most crude exports are illegal and, because oil is usually not useful in its crude form, this stock can only be converted into refined products. The refineries and petrochemical companies form the intermediary and control both the outflow from the oil stocks and the inflow into the oil product stocks. Finally, the oil product stock outflows in two directions; it can flow to domestic or foreign consumers due to the lack of export restrictions on oil products. As a result, the US is a net exporter of oil products as these exports usually receive a higher price on the world market.

Adding further complexity, it is important to recognize that crude oil differs widely in quality, with the highest quality oil being low in both sulfur content and viscosity. Most US refining capacity, 52%,[5] is configured to accept low quality crude from Canada, Mexico, and Venezuela. With the US tight oil boom, the market has experienced an influx of high quality crude to the domestic US market that has no choice but to be sold to US refiners.[6] Ordinarily, high quality crudes command a premium on world markets as they can be converted into a larger quantity of high value refined products.

The EPCA artificially limits crude exports and thus gives rise to an anomalous situation in which high quality crudes cannot command their due premium. This is the result of inelastic supply as independent producers of shale oil continue producing so long as prices are above average variable costs. This has created a large and inelastic supply of domestic oil. As US refineries control nearly the entire demand for this oil, in addition to maintaining access to foreign supply, they receive inordinate market power. Furthermore, environmental regulations prevent an expansion of refining capacity, with the most recent US refinery coming online in 1976.[7] As a result, the refineries are able to receive high quality oil feedstocks at low prices and then sell the refined products on the international markets at a substantial markup. This market inefficiency has resulted in a record spread for refinery operating margins between the US and Europe.[8] With the prospect of liberalizing crude exports, refiners have formed an interest group to maintain the system that awards them undue economic profit. This mismatch risks curtailing the energy boom by disincentivizing additional production.

The Natural Gas Market

While similar to the oil industry, the natural gas market has its own nuances, though it remains similarly impacted by export restrictions. Natural gas is not a globalized commodity; it is confined to regional markets due to transportation costs. As such, the primary supply of natural gas in the US comes from domestic producers with a limited imports. Natural gas does not need to be processed to be useful, thus there is no intermediary. It is bound to pipelines, creating several gas stocks that flow from producers to consumers in regional markets. The primary consumers of gas are private end consumers for heating, power plants for electricity generation, industrial consumers, and chemical companies that use natural gas as feedstock. All four of these consumers benefit from cheap natural gas resulting from export restrictions.

Similar to independent oil producers, independent natural gas producers must continue producing to recover initial investment costs, creating the large inelastic supply of gas that brought prices down from a high of $12.69 in 2008 to $4.12 in November 2014.[9] This regional market structure has resulted in vast differences in regional prices and substantial arbitrage opportunities. As a result of restricted exports, the spread between US natural gas prices and those in Japan, the most expensive developed market, remains at $10.25 per million BTU of energy.[10] Given this lucrative opportunity for arbitrage, US natural gas producers, naturally, want to lift the export ban to take advantage of the wide regional price disparities. Although the Executive branch has granted a few export licenses, demand for such licenses far outstrips the pace at which they are granted. US natural gas consumption has increased dramatically in recent years, as low prices discourage conservation and encourage profligate usage. Gas consumption has outpaced real GDP growth by 1.6%[11] on average since 2007, when the US reversed its historic decline in gas production. Thus, export restrictions directly benefit the end consumers of gas.

The New Realities of American Energy

            Differentiating between the US in 1975 and 2014 serves to highlight the great strides taken to improving American energy security, both as a result of the EPCA and exogenous factors. The shock of the 1973 crisis and subsequent legislation did serve to diversify the US economy away from oil. In 1975, the US used about 11 times more petroleum for power generation, which presently accounts for less than 1% of oil consumption. [12] This difference has been filled with increased usage of coal and natural gas. Presently, nearly 70% of oil consumed in the US is used in the transportation sector where demand is most inelastic, up from 55% in 1975.

The US has also become much less energy intensive per dollar of GDP. Structural changes shifting the economy to services and increases in energy efficiency and conservation resulting from high prices in the 1970s and 2000s have been largely responsible. With the boom in unconventional oil and gas since 2009, which has come at a time of lower per capita demand, the US is well-positioned for energy security. Additionally, booming Canadian oil production and exports remain captive and oriented for the US market. As a result, the International Energy Agency predicts that “collectively, the United States and Canada become self-sufficient in oil before 2030.”[13] The goals set out in the initial impetus for the EPCA, decline in imports, decline in dependence on foreign producers, increased diversification and alternatives, and increased conservation, without sacrificing economic growth to achieve it, have all been achieved. The US has attained energy security as a synthesis of market and legislative forces.

Rent Seeking in the Oil and Gas Sector 

            The rent-seeking that the act has enabled is most apparent in the organization of separate interest groups seeking to influence policy decisions on the liberalization of oil and gas exports. Given that the recent US production boom and decrease in overall demand has moved the prospect of exporting substantial quantities of oil closer to reality, this has increased the impetus for organization among the various benefactors and losers of the present system. The EPCA gives rise to this particular situation as an unintended consequence, which encourages distributional conflict that works against energy security.

The benefactors from the oil export ban remain the refiners which benefit from low US oil prices and high world prices, while the oil producers do not receive a higher price for their oil. The oil industry’s longstanding interest group, the American Petroleum Institute, (API) has already begun the lobbying effort to lift the ban. A more specialized group, Producers for American Crude Oil Exports, (PACE) quickly came into existence in 2014 and represents only a few members in their support for lifting the ban.[14] Together, API and PACE represent all major integrated oil companies and many of the independent producers, all of which forgo revenues from the aforementioned anomalous oil pricing scheme. Consumers and Refiners United for Domestic Energy, (CRUDE) is comprised of independent refiners and opposes lifting the export ban.

Both sides are comprised of a relatively limited number of companies; API, by far the largest, only has about 600 members, of which only a handful represent a substantial portion of the market. API’s established organizational capacity has supplied a quick lobbying response. CRUDE and PACE have fewer members and thus have been able to lead an accelerated lobbying effort convince the administration and the public that their position is correct due to faster cost negotiations. As expected in Olson’s theoretical background, the consumer lobby is unorganized because an individual’s benefits from lobbying are diluted while costs are constant and cannot overcome mass freeriding. Insofar as the public is concerned, lower energy prices, most visibly in cheaper gasoline prices, are the major concern. The complexity of energy markets and the uncertainty over the effects of lifting the export ban has prevented a strong public response in favor of either side.

Within the natural gas sector, America’s Energy Advantage (AEA) and the American Public Gas Association (APGA) constitute the primary groups opposing gas exports. Both groups assembled shortly after the price crash in 2009 that enabled the prospect of exports. The APGA represents utilities accustomed to receiving cheap gas to sell to end users while the AEA represents the united interests of the largest chemical, fertilizer, aluminum, and steel companies in the US, which either rely on cheap energy derived from natural gas or cheap natural gas feedstocks to manufacture their end products. The AEA and APGA display all the traditional characteristics of an interest group: small size, organizational capacity, seeking to delay or prevent harm to their accustomed business. Once again, the API represents the gas producers seeking to liberalize gas exports from the US, and the individual consumer lobby remains unorganized.

Unintended Consequences

The EPCA was enacted during a time of unprecedented national duress; its main objective was the implementation of immediate measures to improve resilience and address slow-moving variables such as general oil demand, efficiency, and conservation. Despite imposing measures and tariffs to raise prices and spur domestic energy production, it was not intended to be redistributional legislation. This is most evidenced in the strict price controls imposed on oil and gasoline in the 1970s and the supplemental Crude Oil Windfall Profit Tax Act passed in 1980 after prices were deregulated to prevent extraordinary oil profits due to legislative action.

While the provisions of the Act did work to improve security in the 1970s, the changing market realities have enabled rent-seeking. Interested parties seek to preserve their own economic security by promoting the autarkic measures that keep domestic prices low as expected in Thurow’s formulation of interest groups. The exceptions for refined product exports, which were negligible in the 1970s and 1980s, have currently reached record levels[15] and can hardly be described as promoting energy security. These new realities of American energy of low domestic prices, unforeseen in 1975, encourage profligacy and discourage new oil and gas exploration and production, both of which retard technological progress by disincentivizing new production and efficiency solutions when energy is so cheap. The lobbying of CRUDE, AEA and APGA that focus on preserving market inefficiencies are particularly damaging to energy security and self-serving. The lobbying to remove export restrictions, while also self-serving, increases society’s income and government revenues and promotes conservation and production that feeds into energy security. The lobbying for market inefficiencies serves to make the US less resilient to future shocks and thus undermines the EPCA’s original aim of energy security. The EPCA addresses the energy market of the 1970s and presently provides the circumstances through its export bans that undermine the original aim.

Conclusion

            The EPCA functioned well in the 1970s energy market to bring about increased US energy security. However, the same inefficiencies that helped bring about energy security in the 1970s function to benefit consumer groups in the present with booming oil and gas production held captive due to EPCA export restrictions. This has led to a distributional conflict as the beneficiaries lobby to preserve their economic security, inadvertently undermining the very aims of the EPCA by attempting to keep energy prices low and decreasing US resilience to future energy shocks.

[1] Data derived from British Petroleum. BP Statistical Review of World Energy June 2014. (London: BP, 2014).

[2] US Congress. House of Representatives. Energy Policy and Conservation Act of 1975. H.R. 2. 94th Congress, 1975.

[3] Richard Nixon, “Address to the Nation About Energy Policy.” 25 November 1973

[4] Gerald Ford, “Statement on the Energy Policy and Conservation Act” 22 December 1975.

[5] Calculated by the author EIA, “Refinery Utilization and Capacity.” 20 December 2014

[6] EIA, “Attributes of Crude Oil at US Refineries Vary by Region.” 26 September, 2012

[7] Ben Lefebvre, “Shale-Oil Boom Spurs Refining Binge.” The Wall Street Journal. 2 March 2014.

[8] EIA. “Lower Crude Feedstock Costs Contribute to North American Refinery Profitability.” 5 June 2014.

[9] EIA. “Henry Hub Natural Gas Spot Prices.” 20 December 2014.

[10] This data derived from US Henry Hub spot prices as of December 10, 2014, and Japan LNG Import prices for November 2014

[11] Derived from BP and IMF figures by the author

[12] Data compiled by author from EIA Data – EIA, “Monthly Energy Review – November 2014.” 20 December 2014.

[13] International Energy Agency, World Energy Outlook 2013. (Paris, France: IEA, 2013) p 76-77.

[14] Jim Snyder and Brian Wingfield. “Oil Producers Form New Group to Lobby to Lift Crude Export Ban.” Bloomberg. 24 October 2014.

[15] Brad Plumer. “U.S. oil exports have been banned for 40 years. Is it time for that to change?” The Washington Post. 8 January 2014.

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1973 Oil Crisis in Context

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Gas Shortage

Introduction

On October 17th, 1973, the industrialized world woke up to a sudden and unprecedented threat to its own growth and prosperity; never before had it faced such a constraint to its growth nor had it ever been so dependent on a resource it no longer had unlimited dominion over, overturning a system in place since 1860. Price shocks and crises of supply were nothing new within the oil market. However, it was the utter helplessness to alleviate the crisis given the dependence on and inelasticity of oil consumption. The US invited the 1973 oil shock through its complacency and revealed the rigidity of the oil supply-demand system. Although elements within the policymaking establishment sounded the alarm in the years prior to 1973, there was no action to prevent or mitigate the blow of a supply crisis. The direct event leading to the embargo was clear – US support for Israel during the 1973 war. The systemic issues were longstanding and pushed the oil supply-demand system in that direction for years. Despite the confluence of events that suggested a high probability of an effective and sustained oil embargo against the West, the US failed to understand the oil supply-demand system and its elements, misreading both the quantitative risk and immeasurable uncertainty, allowing itself to blunder into the crisis and forgo preventative measures.

1973 Crisis in Context

The oil crisis of 1973 presented the industrialized world with a radical departure from its collective experience in the previous oil crises of 1956 and 1967. An easy escape from consequences in the previous crises altered the calculus in the US, forming biases in the evaluation of risk and uncertainty. The outcome of these crises prevented an evaluation of the systemic changes had accrued between 1956 and 1973. Thus, a brief description of the 1956 and 1967 crises is necessary for understanding biases against action before October 1973.

In addition to the historical events, understanding the complex system that brought oil from well to consumer is crucial. In an economics system framework of Meadows, the stock of the system is the available supply of oil. The inflow into this stock comes from the producers, the supply-side, and the internal mechanisms that allowed this production. Up until 1973, the major producers of the world were the US and the countries of the Persian Gulf, North Africa, Indonesia, and Venezuela. The Eastern Bloc was generally autarkic and remained outside of this inflow. Within that, it was the Western oil companies that had the expertise and technology to extract oil effectively. Through this power, the companies were able to negotiate the terms of royalties agreements and dictate prices to the world markets through posted, rather than floating, prices. The entrance of smaller independent companies into the market gave host governments leverage to negotiate with them by the late 1960s. Within each producer, there was a different mixture of domestic politics that influenced production – regulatory bodies and environmental legislation in the US and authoritarian and popular politics that influenced production in the remainder. Of the US regulatory bodies, the Railroad Commission of Texas (RRC) was the most powerful, stewarding oil production to encourage conservation and maintain prices in a “situation of chronic potential oversupply,”[1] creating the easily employable spare production capacity in the US. Indeed, it controlled more oil production than all other major producers. The RRC served as both a buffer for the system and a regulatory feedback loop that regulated prices around a band to avoid the volatility that characterized the oil market in its early years. The main objective of the supply side of the oil market system was to provide abundant oil at relatively cheap prices; it was produced these exact results, much to its own detriment.

The demand side of the system, to which the stock outflowed, consisted of the major industrial economies, the US, Western Europe, and Japan and the subsystems that defined their level of oil consumption. Fueled by both economic expansion and preference against polluting coal, these economies expanded their use of oil for power generation, spurred on by seemingly endless cheap oil prices. As these countries became ever more reliant on oil for transportation and electricity, their demand increased and became more inelastic, making the system more rigid and precariously balanced on an oversupply of oil. This created an unsustainable reinforcing feedback loop that oversupply of oil kept prices low, which encouraged profligate oil use, which further tightened supply. Eventually, prices had to increase in accordance with supply and demand, or the rigid system would suffer a shock.

1956 – The American Oil Weapon

By the time Gamal Nasser finished excoriating erstwhile European colonial powers in his speech in Alexandria on July 26, 1956, the Egyptian army had already moved forward and seized the Suez Canal. The Canal was the crucial supply line to Middle East oil, and the British and French governments decided to bring it back under Western control. British Prime Minister Anthony Eden complained to Eisenhower that “Nasser can deny oil to Western Europe and we shall be at his mercy.”[2] Ironically, Eisenhower would be the one denying oil to Western Europe in short order.

US contingency plans for an oil shortage among the European allies centered on the Middle East Emergency Committee, which was tasked with coordinating the resources to draw on American spare oil capacity and reroute the tanker lines to supply the Europeans. The French and British, assuming they would have American support, coordinated with the Israelis to launch a joint intervention and seize the Suez Canal on October 24th, 1956. Eisenhower, fearing that military action could generate instability in the Middle East and open an opportunity for Soviet gains in the region, was furious with the Europeans. Nasser scuttled several ships in the Canal as a result of the war, shutting it down and forcing the oil supply lines to go around Africa and thus constricting supply to Europe.

With Britain and France in the middle of an oil supply crisis, Eisenhower refused to activate the emergency resupply committee and actually imposed oil sanctions on them until they accepted his demands for withdrawal. Meanwhile, Saudi Arabia also embargoed Britain and France to little effect. Under political and economic pressure, Britain and France fully withdrew from Egypt, at which point the US finally activated its emergency committee to make up the oil shortfall. The lesson was clear; the US was able to impose its will through its abundant oil resources. Although a European crisis, the 1956 oil shock confirmed US energy security.

1967 – The US Rescues Europe

By 1967, the global oil market was changing but was not a radical departure from 1956.  OPEC had come into existence in 1960, but it was still an ineffective coordinating body. The industrialized world consumed ever greater quantities of oil, averaging 35.5 million barrels each day in 1967, accounting for 45.7% of all domestic energy consumption.[3] On the eve of the Six-Day War, Europe imported 75% of its oil from the Arab exporters, leaving it vulnerable in the short term.

On June 5, 1967, Israel preempted an attack by the Arab states of Egypt, Syria, and Jordan, quickly overrunning their positions. For their support of Israel, the Arab exporters imposed an oil embargo against the US, UK, and West Germany on June 8, reducing production by 60% and precipitating an immediate oil crisis in Europe.[4] The US set into action, with the RRC allocating an additional million barrels of production to make up the shortfall, resupplying Europe and saving it from the crisis. By July, the oil weapon and the embargo had failed; the Arab exporters gave up revenues while continuously subsidizing the Arab belligerents. The Arab producers had to increase production to maintain their market share, thus Arab production was 8% higher after in August than just before the war.[5]  Once again, the US, as described by the National Security Council in 1960, was “Europe’s principal safety factor in the event of denial of Middle East oil.”[6] However, it took a mere six years for this margin of safety to erode.

The US Invites the Wolf

By 1973, the confluence of several factors eroded the energy security of the industrialized world, even if the perceptions of security remained. The US passed a significant milestone in March, 1971, when the RRC  allowed full production for the first time under normal circumstances; the spare capacity of 4 million barrels a day during the period of 1957 to 1963 had been whittled down to 500,000 barrels in 1973, only 1% of industrial world consumption.[7] As a result, the US was importing 36% of daily consumption by 1973. As early as 1968, the US State Department had informed the OECD countries, much to their surprise, that the US would soon be left with no spare capacity and unable to provide emergency relief. Contemporaneously, the industrialized nations were undergoing an economic boom, with 1973 GNP growing at 10.4% in Japan, 5.9% in the US, and 5.4% in Western Europe.[8] The oil glut of the previous 20 years kept prices low, incentivizing the switch from coal to oil electricity generation for economic and environmental reasons. Compounding the issue, the ordinary consumers became accustomed to boundless cheap energy; efficiency and conservation became an afterthought. Oil thus constituted 46% of all energy consumption in 1972, up from 28.9% in 1950.[9] These changes added not only demand but short-run inelasticity to the system of demand. On the supply-side, low oil prices made more expensive production uneconomical, an issue further compounded by increased environmental regulation. A victim of its own success, the cheapness of oil encouraged profligate use, which fed back into the system, making it even more rigid and vulnerable.

Just as the demand was becoming more inelastic, the major oil companies came under pressure from independent producers, which were offering host countries better royalties agreements. Nascent revolutionary regimes in Libya, Algeria, and Iraq seized upon the opportunity, isolating the companies and gaining concessions. Once Qaddafi wrested a 55% share of the profit from oil sales in 1970, the event changed the entire supply-side dynamic; 55% became the minimum acceptable to host governments. With profit sharing altered, the issue of price became the main negotiating point. The abandonment of the Bretton Woods System and relaxation of the gold standard devalued the US dollar in the early 1970s, bringing down the real posted price of oil. Suddenly, the oil companies came under further pressure to raise posted prices, which had remained nominally the same since 1961.[10] The US government was unconcerned with this development at the time, as the pressure to increase prices “did not immediately seem threating to a range of interests broader than those of the corporations immediately involved.”[11] These events significantly increased quantifiable risk in the system as a function of import dependence, tight supplies, and inelastic demand, suggesting a higher probability of a shock.

As the US ignored the risk, it also misread the uncertainty of the situation and gauge the probability of an impending disaster. Warnings did come from within the government. A 1970 State Department report recognized the changes in the oil market, warning that producing countries will be able to collude in raising prices and determining production, yet “no one in Washington paid any serious attention to the message.”[12] Contrarily in the same year, the president’s Task Force on Oil Imports predicted “only five million barrels per day would need to be imported, and most of this could come from the Western Hemisphere” by 1980.[13] The projection was already exceeded by 1971. Another alarming State Department report by James Akins, a senior Foreign Service Officer, encouraging “the development of alternative energy sources, and controlling [American] consumption”[14] to reduce dependence. Akins published his concerns publicly in his article “The Oil Crisis: This Time the Wolf is Here” in Foreign Affairs in 1973. Akins was able to separate the signal from the noise, recognizing the changing dynamics of US spare capacity, demand inelasticity, and changes in the Middle East that put OPEC in “[control of] a product which is irreplaceable in the short run, and is vitally necessary.”[15] The view of Akins and the State Department were controversial, particularly the projections of price increases seen as impossible, while opposing viewpoints, those of an impending oil glut, proliferated in Washington. In a sense, the “warning flags were up, but there was no particular response, nor…was there the requisite consensus either in the United States or among the industrial countries as a group that would have been needed for more concerted prophylactic action.”[16] Indeed, “before 1973, there was no policy at all envisaging a serious confrontation with OPEC.”[17] Understandably, in the 1960s, it was assumed that spare capacity of two million barrels would still prevail in 1975[18] and the US even rejected an offer from the Shah of Iran in 1969 to deliver “1,000,000 daily barrels of oil for ten years at $1.00 per barrel in order to establish a stockpile”[19] as a buffer in the system. The risk was in place; the uncertainty was made difficult by the multitude of opinions and misunderstanding of the supply and demand system.

The Arab Exporters

As the US entered the oil market as a major importer, market prices for oil began to exceed those of posted prices. In the tight market, some Arab leaders, particularly Sadat, were insisting that the oil weapon be used to realize political goals. King Faisal of Saudi Arabia, historically dovish, rejected this use of oil, preferring American favor as a counteracting force against instability and communist incursions into the region. However, Faisal was vulnerable to public perceptions; he had to maintain solidarity with Egypt and the Palestinians or risk suffering terrorist attacks on oil infrastructure. Faisal genuinely did not want conflict with the US, but continued support for the US would isolate Saudi Arabia from the other Arabs. In light of recent devaluations of the dollar, Faisal began to reconsider his position and warn that the Saudis would “not increase their oil production capacity to meet rising demand, and that the Arab oil weapon would be used in some fashion, unless the United States moved closer to the Arab viewpoint and away from Israel.”[20] This reality was impressed upon the oil executives at Aramco, the Western firm responsible for extracting Saudi oil, who conveyed the message to an unconcerned US government: there was “a large degree of disbelief that any drastic action as imminent or that any measures other than those already underway were needed to prevent such from happening.”[21] The Saudis continued to message that King Faisal is “one hundred percent determined to effect a change in US policy and to use oil for that purpose.”[22] Although such messaging was designed to convince the US of the seriousness of the threats, and even Nixon announced at a press conference that the use of the oil weapon to change US policy “was a subject of major concern,”[23] there was little “contingency planning relating to possible OPEC and producer country actions” or more overt messaging to assuage Arab concerns. Despite the use of the embargo in previous crises, the administration took no action.

As the Arabs prepared to launch the 1973 war against Israel, Western and Israeli intelligence indicated that the event was unlikely. As a result, the October 6 surprise attack on Israel worked as planned, with Egypt and Syria scoring several initial victories. Meanwhile, the negotiations over posted prices between exporting governments and the companies were at a standstill. The countries decided to unilaterally raise prices to those of the spot market, instantly increasing oil prices by 70% to $5.11 a barrel. This event changed the entire supply-demand radically from its structure in 1967. At this point, unaccustomed to high oil prices, the US was already facing an energy crisis.

The US only wanted to avoid involvement in the 1973 war. However, given Soviet supply shipments to Syria and Egypt, the US decided to resupply Israel and keep it in the war, thereby confirming its favor of Israel over the Arabs. Henry Kissinger tried to frame the actions as anti-Soviet rather than anti-Arab, erroneously still believing that the Arabs would not use the oil weapon. On October 17, the OPEC oil ministers agreed to cut overall production by 5% each month until their political objectives were realized and the US ended support for Israel. The cuts in absolute supply pushed prices to $11. The US then announced a $2.2 billion aid package to Israel. Thus everything was in place, a tight market, organization, a willingness to use oil for political ends and no emergency supply; the wolf was at the door and the US all but invited it into the house.  On October 20th, this final public action prompted the immediate embargo of oil exports to the US from the Arab states. Thus the US was caught almost totally by surprise by the imposition of the Arab oil embargo, which it had consistently assumed would not materialize. The effects were disastrous for the US economy, which had grown so reliant on cheap oil, and it went into recession, spending the better part of the 1970s dealing with stagflation and unemployment.

[1] Daniel Yergin, The Prize: The Epic Quest for Oil, Money, and Power. (New York: Free Press, 2008): p. 549

[2] Yergin, The Prize, p. 467.

[3] Data derived from British Petroleum. BP Statistical Review of World Energy June 2014. (London: BP, 2014).

[4] Yergin, The Prize, p. 537

[5] Ibid, p. 539.

[6] Ibid, p. 538.

[7] BP, Statistical Review.

[8] Darmstadter, Joel and Hans Landsberg. “The Economic Background.” The Oil Crisis. (New York: W.W. Norton & Company, 1976. 15-39): p. 18

[9] Ibid, 19

[10] BP, Statistical Review.

[11] Philip, George. The Political Economy of International Oil. (Edinburgh: Edinburgh University Press, 1994): p. 156.

[12] Yergin, The Prize, p. 569.

[13] Akins, James. “The Oil Crisis: This Time the Wolf is Here.” Foreign Affairs. April 1973.

[14] Akins, “The Oil Crisis.”

[15] Akins, “The Oil Crisis.”

[16] Yergin, The Prize, p. 573.

[17]  Parra, Francisco. Oil Politics: A Modern History of Petroleum. (New York: I.B. Tauris & Co., 2004): p. 168

[18] Lovejoy, Wallace and Paul Homan. Economics Aspects of Oil Conservation Regulation. (Baltimore: The Johns Hopkins University Press, 1967): p. 112.

[19] Ibid, 157.

[20] Yergin, The Prize, p. 577.

[21] Ibid, p. 578.

[22] Ibid, p. 579.

[23] Ibid, p. 580

Housekeeping – Part 2

Another update post from me on the state of Energy Security. Admittedly, I have been neglecting to post new content, leading to a four month gap in my posts. Earlier this year, I had been applying to universities for graduate school, which kept me busy and focused on other matters. I will be heading into the Johns Hopkins SAIS, with a concentration on Energy, Environment, and Resources and, hopefully, International Finance this August. I hope to post another one or two articles this summer before classes begin. I’m not sure how much time I’ll have during the schoolyear, but I hope to keep things at least somewhat active here. If nothing else, it’ll be a great experience for learning more about energy dynamics.

In other news, BP just released its 2014 Statistical Review of World Energy. Go and check it out.

Keystone XL – Canada Looks to Asia

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The Keystone XL has been a topic of much contention and frustration for several years. With the US State Department’s release of its Final Supplemental Environmental Impact Statement report on January 31st, 2014, the pipeline has become no less controversial though recent developments suggest that the project will be approved. The primary contention has been the safety and environmental impact of the pipeline, though it is important to recognize the situation from a Canadian context as well as an American. 

All figures below are derived from BP’s Statistical Review of World Energy 2013, unless otherwise noted.

Canadian Oil Reserves

About 98% of Canada’s oil is concentrated in Alberta, and 99% of that oil is in the form of unconventional oil sands. These Albertan reserves amount to 170.2 billion barrels, though this oil is heavy, with a low API gravity, and sulfurous. US refineries have been increasingly equipped to handle such oil, making it suitable for the US market.

In 2012, Canada exported 3.056 million bpd and imported about 700,000 bpd. Of these exports, 2.955 million bpd went to the US, comprising 96.6% of all Canadian exports. As such, the US holds a near monopoly on Canadian oil, which has given the refining and transportation system its present structure.

Canadian oil sands are particularly sensitive to oil prices, requiring “$40-70/bbl for new in-situ projects and $80-100/bbl for new surface mining projects” according to the Energy Information Administration. Understandably, the surge in oil prices in the 2000s has led to a boom in Canadian oil sands extraction.

Avoiding a needlessly in-depth discussion of the characteristics of Canadian bitumen here, the EIA notes that “many objections to oil sands development center upon the relatively energy-intensive and carbon-intensive extraction and processing methods required. Calculations of the climate impacts of oil sands development are complicated and often yield different results but, caveats and exceptions aside, well-to-tank greenhouse gas emissions are typically higher for oil produced from the oil sands than oil produced through conventional means. The potential to exacerbate climate change is merely one of the environmental costs that accompany the development of Canada’s oil sands.”

Effectively, producing oil from Canadian oil sands requires a much larger expenditure of capital and energy, in addition to greater carbon emissions. One might expect this of an unconventional energy source, and it remains a large point of contention for environmentalists.

Canadian Exports to the US and Integration

At present, Canada suffers from bottlenecks in pipeline and rail capacity to bring its oil to the US market, resulting in losses of “$47 million a day on average, implying $17 billion a year,” according to the Fraser Institute. Essentially, Canadian oil trades at a discount to the world price because it cannot reach world markets and remains bound to the US pipelines in the Midwest, creating a glut and forcing a $37 price discount to Brent crude prices as a result. Obviously, the Canadian government is pushing to resolve the situation and decrease the discount for Canadian oil. As such, it is pushing for the approval of the Keystone XL pipeline, which will help bring more of this oil to market at a cheaper transportation rate than rail.

The result of the large price differential, coupled with pipeline bottlenecks, has been the rise of crude by rail. Even though rail is more expensive as a method of transportation, the price differential is large enough that transporting crude by rail is still profitable. If that price differential were to narrow, it would be no longer worthwhile to transport crude by rail. However, for now, the expansion of rail networks continues. The State Department’s most recent reports notes the rise of rail infrastructure in recent years and the accompanying rise in transportation, which has increased from nearly none in 2011 to 180,000 bpd in 2013. According to the report, rail loading facilities are expected to increase by 57% to a capacity of 1.1 million bpd from the present 700,000 bpd. As more crude by rail is brought to US refiners, bypassing the pipelines, the price differential will narrow, perversely, making rail less competitive. In any case, more oil will come southward to the US.

As such, Canadian oil from Alberta will continue to come into the US, albeit at a higher price, with or without the Keystone XL pipeline.

The pipeline itself will add 830.000 bpd of capacity, of which, 100,000 bpd will be reserved for the Bakken shale. This will help alleviate some of the bottlenecks and provide Canadian producers with a narrower differential for their oil, placating some concerns.

US Domestic Politics and Pipeline Approval  

The primary point of contention has been the safety and environmental impact of the pipeline on both greenhouse emissions and aquifers in Nebraska, as well as continued dependence on oil. As the project crosses the US-Canadian border, it requires approval from the State Department and, ultimately, the president to begin construction. The State Department report takes into account revised routing and additional precautions taken on the pipeline. The report appears favorable to the project, noting that “approval or denial of any one crude oil transport project, including the proposed Project, remains unlikely to significantly impact the rate of extraction in the oil sands, or the continued demand for heavy crude oil at refineries in the United States.” It also notes the bypassing of important aquifers in Nebraska and the lowered incidence of high volume spillage through the use of pipelines. The greenhouse emissions from the project are insubstantial, though the greater fear remains the US dependence on the particularly energy and carbon intensive oil sands of Canada. The much-lauded job creation aspect of the pipeline will be minimal and only temporary construction work, for the most part. 

The report itself appears to be a necessary piece of information for the administration to make a defensible decision on the pipeline. US domestic politics come into play as the administration, which has long-courted environmentalist constituents has to decide on the pipeline, especially when vulnerable Democrats have to win reelection and are under local pressure for and against the pipeline. 

Canada – Looking East

The more interesting effects of the Keystone pipeline are actually taking place in Canada. Canadian PM Stephen Harper has been repeatedly on the record as frustrated with American delays of the project. Even in early 2012, Harper was quoted saying “Canada will continue to work to diversify its energy exports.” With no land outlets other than through the US, Canadian energy can only by shipped by sea. As most Canadian oil is located in Alberta, shipping the crude westward to British Columbia makes the most sense. There are already pipelines to Vancouver and the Trans Canada pipeline is being reviewed for expansion. British Columbia and Alberta are already cooperating on allowing Enbridge to construct additional pipelines with a specific aim of exporting to Asian markets, pending environmental and safety concerns. Even just recently, Harper’s statements have echoed a feeling of frustration “this administration may continue to be difficult for reasons of internal politics, but I do believe that one way or another these decisions will go ahead at some point.”

The US clearly does not want Canadian oil to be exported elsewhere when it receives nearly all Canadian exports; the US National Oceanic and Atmospheric Administration released a report warning of the dangers of transporting crude to British Columbia. The timing of the report coincides with increased calls for outlets other than the US, especially when the Enbridge pipeline is expected to carry about 500,000 bpd, constituting a substantial portion of Canadian production. 

In short, the Canadian government is frustrated with the pace of developments in the US over the Keystone XL. It will begin looking for other outlets for its oil, ones that will pay the world price and minimize the discount on Canadian crude. This move would be advantageous to Canada and detrimental to the US as competition is introduced into the system. Moreover, the system of refineries and conduits depends on a constant stream of Canadian oil and would be disturbed as a result, unless US sources can make up the difference. The Keystone pipeline is about more than just environmental concerns; it underscores a systemic arrangement that is not static and unchanging; the Canadians have the option to reorient the arrangement to their benefit and to American disadvantage.

The US enjoys a monopolist’s position; political diffidence may squander this advantage for US refiners and consumers. Keystone may not lower gasoline prices in the US, but it may just prevent them from rising as it enables the current energy arrangement between the US and Canada to continue.

Iraq, Kurdistan, Oil, and Sovereignty

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Maliki

Kurdistan within Iraq has proven to be a surprising island of stability in the region and the country. Its success has cascading repercussions for Iraq and the wider region and, of course, energy developments. Although Kurdistan is unlikely to realize a significant impact on worldwide oil markets in the short term, the developments there, in both politics and oil, could produce significant changes and difficulties in the Middle East.

The Last Hurrah of Easy Oil

Kurdistani oil has been described as “the last easy oil” in the world, where one can “put a pipe in the ground and the oil starts flowing” according to the International Energy Agency’s executive director Maria van der Hoeven. Under Saddam Hussein, the region remained a target for oppression and underdevelopment. Hussein’s central government sought to divide and conquer the Kurds politically and settle traditionally Kurdish areas with Sunni Arabs. Upon the Kurdish cooperation with Iran during the Iran-Iraq War, Hussein exacted his vengeance, resulting in the infamous attacks on the Kurds in the late 1980s. Following the Gulf War, Kurdistan remained a victim in the general UN sanctions program against Iraq, although it did receive some revenues from the oil-for-food program. It also maintained a level of autonomy in the 1990s as the West imposed a no fly zone and central government troops withdrew from the region. In terms of oil, Iraq developed the oil fields near Kirkuk, yet they remained under central control despite their proximity to Kurdistan. After the 2003 invasion, Kurdistan was spared much of the chaos and managed to emerge as the most stable part of Iraq. The Kurdistan Regional Government (KRG) has focused on branding itself as different from the rest of the country and seeking foreign investors through economic liberalization and political stability.

Proven reserves in the territory under KRG administration figures at about 45 billion barrels. This accounts for about 30% of Iraq’s 150 billion barrels of proven reserves.  

It’s no surprise that major oil companies are looking to develop oil plays under the suzerainty of the KRG. Exxon, Chevron, and Total and an assortment of smaller E&P firms are trying to operate in the area. According to KRG figures,  Kurdistan itself exported 100,000 barrels a day in 2011, constituting about 3.5% of total Iraqi production. According to Ashti Hawrami, the KRG’s Minister of Natural Resources, Kurdistan presently produces 300,000 barrels daily, an increase amounting to 9.6% of total Iraqi production (BP figures). However, oil industry sources put the KRG’s total export capacity at 225,000 bpd.  Of these exports, Kurdistan has relied on trucks to transport it about 50,000 bpd into Turkey. 2014 appears to be set to see oil production increase by 33% to 400,000 bpd through the use of newly built pipelines. Hawrami, ever optimistic, predicts 1 million bpd in 2014, though previous KRG projections from 2009 wildly overestimated production figures, expecting 400,000 bpd by 2011 and 1 million bpd by 2014. Naturally, the KRG has a vested interest in being optimistic about its own prospects to attract foreign investment in an unstable region.

In terms of the deals themselves, the KRG has taken a markedly liberalized approach to E&P, offering favorable terms to oil firms. For example, DNO, a Norwegian independent, secured a production sharing agreement (PSA) with the KRG, giving it a 40% share of the first 50 million barrels produced from the Tawke oil field.  These terms are more favorable than those offered by the central government, no doubt intended to attract much-needed investment and provide a risk discount to foreign firms.

The Trials of Federal Governance

As foreign firms move into Kurdistan to build the production and export infrastructure, the central government in Baghdad is seeking to reassert its dominion over the KRG and force it to seek its approval for exporting crude oil. The Shiite Iraqi prime minister, Nouri al-Maliki, faces two restive regions, Kurdistan itself and the mainly Sunni west of the country. The primary goal of his administration, supported in this respect by both the US and Iran,  is to prevent the fragmentation of the country. The latent divisions in the country, repressed during the time of Saddam Hussein, have been a persistent issue since the 2003 invasion. 2013 has proven to be the worst year for sectarian violence since 2007, prompting a centralizing push by Maliki. 

Following the US departure in 2011, Maliki has had a free hand to secure the power of his Shiite coalition. The Washington Post has a great synopsis of the political dealings in Iraq. In a few words, the US failed to broker a political power sharing agreement in 2010 and backed Maliki’s Shiite coalition for the sake of stability. The US and Iraqi administrations also failed to establish a security agreement, contingent on prosecution immunity for US troops, similar to the current dealings with Afghanistan. Thus, following the American departure in 2011, Iraq was denied a cohesive professional American security force and the US lost additional influence in the country. Maliki took advantage of the American departure to begin persecuting his Sunni political rivals, inciting protests and sectarian violence.

Since 2011, the neighboring Syrian civil war has displaced large numbers of people and produced hardened and, often, radicalized fighters. Iraq is now feeling the secondary effects of this development. The Al Qaeda affiliate group, Islamic State of Iraq and Syria (ISIS). has begun encroaching on Iraqi sovereignty, coming into the western Al-Anbar province from Syria. The group seized Fallujah in late December 2013, forcing out the agents of the central government. However, it is uncertain if the local Sunni tribes in the province are cooperating with or confronting ISIS, with some receiving support from the Iraqi army and others remaining opposed to both ISIS and the central government. Any support for ISIS has resulted from Sunni feelings of disenfranchisement since the 2010 elections. Maliki fears losing this city, and thus his legitimacy, and has sent the army to surround Fallujah and wrest control from ISIS. As of this publication, the city remains under siege by the army.

Kurdistan in Context

Within the context of Maliki and the central government’s slipping control, comes the issue of KRG autonomy and oil exports. Understandably, losing either Kurdistan or Fallujah and the Anbar province to ISIS will deal a heavy blow to central legitimacy. Losing just one of these battles for political dominance will strengthen the resolve of political opponents in the other. As such, Maliki is put in an unenviable position of fighting a two-front political battle. Moreover, as more time passes and a section of the country remains out of his control, not only does ISIS entrench itself, but his governance appears ineffectual, giving both the KRG and local Sunni tribes in Anbar additional political maneuverability.

Maliki is making some overtures to appeal to the Sunnis, preferring to have them drive out Al Qaeda rather than risk a full assault on Fallujah. Meanwhile, he has attempted to clamp down on the KRG over the issue of oil exports. These exports fall within the purview of the central government, independent Kurdish oil exports remain an affront to Baghdad’s supremacy while denying it Kurdish oil revenues. This has resulted in Maliki threatening to reduce the share of the national budget the KRG receives under the guise of balancing the budget. The KRG is supposed to receive 17% of the budget, though, as the previously cited Economist article mentions, it frequently receives about 12%. The central government maintains that the KRG cheats the system by exporting oil independently through its own pipelines to Turkey and retaining the proceeds, thus it does not deserve its allotted budget. More than a budgetary issue, for Maliki, this is one of sovereignty. Allowing the KRG to retain oil export earnings undermines his own legitimacy while bolstering that of the KRG, which simultaneously receives funding to build up its governmental, security, and energy infrastructure.

Maliki cannot be heavy handed with his treatment of either issue, especially with elections looming in April. Yet, he must act lest his consolidated power slip away. The ISIS threat is clearly more urgent, though it buys time for the KRG to continue establishing itself. The KRG issue could be addressed by sending federal assets, judiciary, military, and police, to ensure that oil is not exported without central sanction. However, this would pull assets away from fighting ISIS and further alienate the Kurds. Alternatively, the central government could attempt to buy the loyalty of the Kurds and the Sunnis by increasing federal provisions, but that would result in a large budget deficit with the parameters of the present budget.

Ultimately, a federal Iraq can only be maintained by amicable relationships between Sunni Arabs, Shiites, and Kurds working towards a single commonwealth. This model can be made to work through the largesse of oil revenues, however, that would require additional stability and a single-minded focus on increasing exports while distributing them where most needed. Political ambitions, pettiness, rivalries, and outside influence all work against this model. Alternatively, it could be preserved through repression as it was during the time of Saddam Hussein. It appears as if Maliki may continue along his path of attempting to retain consolidated Shiite control of the central government through ham-fisted efforts that not only undermine Iraqi federalism and aggravate sectarian tensions, but also reduce the attractiveness of Iraq as a destination for foreign investment into its oil.

Kurdish Independence

As Kurdistan builds its institutions, the ambition of independence edges closer to realization. Interestingly enough, the KRG exports oil through Turkey, which has historically persecuted Kurds in its territory. However, energy concerns appear to be more important as Turkey attempts to diversify away from Russian and Iranian energy. Turkey’s prime minister Erdogan recently began reconciliation efforts with the Kurds, as Syrian Kurds have begun carving out their own part of Syria. Perhaps Erdogan is trying to push the Kurds away from the radical Kurdish parties in Turkey and into their own independent state, one that does not remove present Turkish territory. Pushing the Kurds to an independent Syrian or Iraqi Kurdistan may help alleviate the issue of Kurdish actions against the Turkish state, though, alternatively, they could press for pieces of Turkey with a Kurdish majority. Turkey is simultaneously attempting to build relations with Baghdad, which could provide a major source of hydrocarbons for Turkish growth. It appears that in the long-run, it can only accomplish cordial relations with either Kurdistan or Baghdad, given the former’s separatist intentions. Furthermore, it is important to note that many other players in the region have their own restive regions clamoring for independence and a successfully independent Kurdistan would legitimize these ambitions further. Iran, Syria, Israel, Russia, and, of course, Iraq would all prefer the status quo. The second and third order effects in these countries could be far-reaching, potentially resulting in shocks to energy markets and the regional military balance.

A fully independent Kurdistan with cordial relations with Turkey, and thus secured export lanes, would not likely shift oil markets very much in the near term. Even if exports rise to 1 million bpd, a potential fracturing of Iraq would result in higher oil prices as markets react to instability and the government loses additional ability to combat ISIS and other separatist factions. This could have multiple consequences for the region as a whole, which is likely why the US continues to support a unified federal Iraq. The future of the country remains in Maliki’s hands, he will either sacrifice its future stability and prosperity on the alter of sectarian politics or begin the reconciliation process to include Sunnis and Kurds in the spoils of Iraq’s oil wealth. He has not been this magnanimous in the past, and it remains likely that violence will increase as the central government loses its grip on different provinces. Though this likely remains positive for the KRG in the near term, the instability in Iraq will prove debilitating to its recent upward trajectory in oil exports.

Reality Check: Iran

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Given the recently brokered deal between Iran and the G5+1, one may wonder about Iran’s ultimate intentions in terms of energy. Why is Iran trying to develop nuclear power at all?

A quick look at Iran’s energy sector reveals a country self-sufficient in energy:

  • 157 billion barrels of oil – Second largest conventional reserves
  • 3.680 million barrels daily production – 1.971 million barrels daily consumption – Surplus of 46.4% of production
  • 1187.3 trillion cubic feet of natural gas – Largest natural gas reserves
  • 160.5 bcm yearly production – 156.1 bcm yearly consumption –                  Surplus of 2.7% of production

These figures, however, obscure a lack of Iranian refining capacity, making it a net importer of gasoline.

Regardless, Iran remains self-sufficient in fossil fuels and brings 1.7 million barrels to world markets daily, albeit at a discount because of the sanctions. As it stands, Iran could comfortably expand both gas and oil production to meet any domestic demand, though it remains limited by sanctions when it comes to bringing in foreign expertise, constructing pipelines, moving oil shipments, or finding trade partners, among other concerns.

This begs the question, why would Iran seek nuclear power when it’s sitting atop so much natural gas and oil?

Several reasons spring to mind:

  • Iran could be trying to free up fuels destined for electricity production for export, thus giving it more hard currency reserves.
  • Iran could be trying to diversify its energy mix and wean itself off of fossil fuels.
  • Iran could be seeking the prestige associated with developing indigenous civil nuclear capacity.
  • Iran could be seeking the prestige of having the first nuclear reactor in the Middle East.
  • Iran could be trying to prove itself to the world and Middle East rivals.
  • The Iranian regime could be trying to legitimize itself by portraying a scientific and geopolitical victory to the people.
  • The regime could also be trying to legitimize itself by successfully defying the United States.
  • Iran could be trying to export nuclear technology.

Many of these reasons overlap, but the reasons for doing so remain mostly political.

One thing is for sure, economically, an Iranian nuclear reactor makes no sense. This is a list, by no means exhaustive, of the costs Iran faces, both political and economic, for developing nuclear power.

  • Iran faces the high initial capital costs, especially dire for a country recoiling from international sanctions
  • The costs of research and development
  • The costs associated with ensuring that nuclear power provides a substantial portion of electricity consumption
  • The costs of uranium imports, which will likely be compounded by additional sanctions
  • The costs associated with reconfiguring the power grid to account for base load nuclear power
  • The costs of ensuring that nuclear facilities remain intact in a region prone to earthquakes
  • The opportunity cost and opprobrium associated with defying the G5+1 for years
  • Developing small scale nuclear power would only be acceptable to the West if accompanied by rigorous inspections and dismantling of much enrichment capacity, hardly acceptable for Iranian prestige
  • The secondary costs and effects of having to contend with increasingly alarmed and militarized Middle East rivals
  • Iran could face punitive action by OPEC. OPEC could attempt to lower oil prices, as it hurts Iran relatively more than the other members of OPEC.

This is not to suggest that states act rationally in the economic sense at all times. However, Iran clearly has more to lose than gain in economic terms by developing civil nuclear capacity. The question still remains, what need is there for nuclear power when the country has such plentiful fossil fuel resources? Despite protestations to the contrary, Iranian nuclear power makes little sense except for as a means of acquiring a nuclear weapon. 

US Energy Independence

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Exactly 40 years ago, on November 25, 1973, Richard Nixon, in a speech to the nation in the wake of the OPEC oil embargo, first described the desire to maintain self-sufficiency in energy. These are Nixon’s exact words:

Let me conclude by restating our overall objective. It can be summed up in one word that best characterizes this Nation and its essential nature. That word is “independence.” From its beginning 200 years ago, throughout its history, America has made great sacrifices of blood and also of treasure to achieve and maintain its independence. In the last third of this century, our independence will depend on maintaining and achieving self-sufficiency in energy.

What I have called Project Independence 1980 is a series of plans and goals set to insure that by the end of this decade, Americans will not have to rely on any source of energy beyond our own.

1980 came and went and the United States was no closer to self-reliance in energy, though it did begin to use less oil as prices spiked to $102.62 (2012 dollars) per barrel in 1980. The oil glut of the 1980s and the consequent price tumble quieted the calls for energy independence.  With lower prices and more diversified energy sources, energy became more of an afterthought. However, the post-2003 rise in oil prices once again resulted in calls for energy independence. As horizontal drilling and hydraulic fracturing became economical in 2009, causing a surge in US oil and gas production, energy independence may finally appear within reach for the first time since 1942, when defined as a minimization of crude oil imports.

From pundits to the president, energy independence has become a hot topic of discussion. In an Orwellian bend, the term itself can only be positive. Who could possibly be opposed to having a self-reliant US that need not depend on the rest of the world? However, the feasibility of a truly self-reliant US and the benefits that it would bring are two distinguishable issues that deserve a second look.

Meeting US Energy Demand Domestically

A quick look at the figures reveals a decades long shortfall in US domestic energy  supply.

US Consumption and Production in 2012 in million tons of oil equivalent (mtoe)

  • Oil – Consumed – 819.9 mtoe – Produced – 394.9 – Shortfall – 51.8%
  • Gas – Consumed – 654 mtoe – Produced – 619.2 – Shortfall – 5.3%
  • Coal – Consumed – 437.8 mtoe – Produced – 519.9 – Surplus – 15.7%
  • Nuclear – Consumed – 183.2 mtoe – Produced – 183.2
  • Hydro – Consumed – 63.2 mtoe – Produced – 63.2
  • Renewables – Consumed – 50.7 mtoe – Produced – 50.7

While US oil production has grown every year since 2008 and gas production has increased every year since 2006, the US is still some way off from being able to produce enough energy domestically to meet its needs. Factoring in oil imports from Canada and Mexico, equivalent to 197.9 mtoe, the shortfall only decreases to 27.6%. The question then becomes, can the US increase its production of oil by 27.6% of consumption or decrease consumption to equal production?

In terms of oil, the United States has a reserves to production ratio of only 10 years, meaning that present oil reserves would be depleted in 10 years, given that production continues at the current rate. It should be noted that, despite increasing production, US proved reserves have only increased since 1992 from 31 billion barrels to 35 billion in 2012. This figure, however, depends on oil prices, technological advances, which impact the cost of extraction, and discovery of new reserves.

Increasing production, with its high capital costs and need for associated infrastructure, is a longer term prospect, making immediate energy independence unfeasible. It should be noted that petroleum is only used for 1% of US electricity generation, with its primary usage being transportation and industrial purposes. As a result, energy independence becomes an issue of finding alternatives for transportation rather than electricity; the US is self-sufficient when it comes to electricity production.  It is very simple to conflate the issue of electricity production and transportation and many pundits seem to ignore the difference.

Reducing use of oil for transportation can come in several forms. Vehicles can become more efficient, Americans can use less energy by driving and flying fewer miles, or another fuel source can supplant or diversify the energy used for transportation.

Partly as a result of market forces and partly because of government regulations, American vehicles have become more efficient. Between 1980 and 2012, the average fuel efficiency increased by 46.5%, from 24.3 mpg to 35.6 mpg. However, as the number of vehicles in the US has increased over the years, oil consumption only grew. Recent trends, partly as a result of higher gasoline prices, have prompted Americans to drive and fly fewer miles, decreasing consumption. In fact, US oil consumption peaked in 2005 at 20.8 mbd, even before the 2008 financial crisis hit. As such, energy independence becomes a reality as oil production increases while consumption simultaneously decreases.

Similarly, over a medium-long time horizon, the US, with its present glut of natural gas, could potentially supplement the oil used for transportation. There are several options to this end. Vehicles can be retrofitted or manufactured to run on compressed natural gas (CNG) or liquefied natural gas (LNG). CNG and LNG achieve comparable performance to gasoline or diesel at a fraction of the cost. The infrastructure is, for the most part, not present. However, T. Boone Pickens has, through Clean Energy Fuels, tried to address this by connecting both coasts with LNG refueling stations. This map from Clean Energy Fuels demonstrates the coast to coast connections. However, it should be noted, as more vehicles begin using natural gas as fuel, its price will increase, given flat production. Nascent gas-to-liquids technology could also advance to the point of being an effective replacement for gasoline, though the technology is not economical at this point.

Natural gas, coupled with improvements in battery technology in electric vehicles and improvements to efficiency and increases in conversation, could supplement oil-derived fuels and decrease US oil consumption and thus reliance on foreign oil.

Given that this natural gas infrastructure and other technologies are not ready in the short term, it appears that energy independence can only be achieved by increasing oil production and decreasing demand. Even if the United States were able to produce all of its oil domestically, it would still not be energy independent, and the costs associated with any potential autarkey would be too great to bear. 

Oil is a global fungible commodity. Oil produced domestically and in other countries is equally interchangeable on the open market, though price differences do exist because of shipping costs and the needs of refineries for certain types of oil. As such, US prices would still remain at the mercy of the markets. Does independence allow for the country to be susceptible to instability and supply shocks around the world? Closing the country to both oil imports and exports, thus providing an autarkic market, would insulate it from these shocks but also increase prices. Most of the recent increases in oil production have been from unconventional sources, making it more expensive to extract when compared to conventional oil. Note, as domestic oil prices increase in this scenario, more production would come online as more expensive to extract deposits become economically viable.  In addition, these increased prices would only hurt the economy as they shave points off of already slow GDP growth.

Moreover, it would not make sense for the US to produce all of its own oil, even if it had the capacity. It can receive cheaper oil from abroad than it can produce by itself. After all, the point of energy is to sustain economic activity; more expensive energy would only hurt economic activity. As it stands, autarkic markets with a surfeit of a good lower prices, as evident in the US natural gas market that exports very little, while autarkic markets with a scarce good will increase its price.

Fungibility of oil makes it such that energy independence is a convenient rhetorical phrase, but would remain unworkable and lacking substance. 

Feasibility Aside, What are the Benefits of Energy Independence?

As previously mentioned, energy independence does not appear feasible in the short-term without a major restructuring of the US economy. What would actually happen if the US removed itself from the global oil market?

In this scenario, where the US simultaneously increases supply and decreases demand, oil prices would decline, increasing economic activity around the world. The US current account deficit would shrink and the US would stop funding the national oil companies that fund various states. On the surface, this appears wholly beneficial, more money stays in the US, unfriendly regimes receive less funding, and economic activity increases. However, over the years, petrostates have come to rely on oil at over $100 a barrel to balance state budgets. As these states and their expensive low-tax, high-subsidy, high-entitlement ways of life begin to unravel, they become less stable. A basic principle of human psychology is that human beings hate to lose more than they like to gain, especially when it comes to losing things that they have been accustomed to receiving.

Where government largess once bought the loyalty of the governed, repression begins to become dominant as a means of controlling the people and allowing the regimes to remain in power. At this point, the US has lost the leverage and influence it once enjoyed as a buyer, and, often, protector of these countries. Thus, without US dollars flowing to these petrostates, they become more volatile, alienated, and more prone to domestic and international conflict. Although many of these states are undemocratic and violate many of the rights Americans hold dear, they provide convenient bulwarks against instability, particularly in the Persian Gulf.

Two potential scenarios emerge, one where China and other emerging economies fill the void that the US left behind and buy petroleum and natural gas from these countries, thus helping them balance their budgets. With disappointing recent growth figures, however, these countries are unlikely to equal the lost US demand. In addition, these countries certainly do not possess the power project capability and naval strength to maintain the sea lanes of communication to energy suppliers. As a result, they would feel vulnerable and begin building military capacity, which is inherently destabilizing. An arms race between the emerging countries and the US is possible. A second scenario could be the unraveling of OPEC as countries attempt to break their cartel rules and make up their budget shortfalls by increasing production, resulting in a race to the bottom. Once again, prices would plummet and these states would face unbalanced budgets and the resulting protests.

Neither of these scenarios is particularly welcome and the second and third order effects of an energy independent US, though two potential scenarios are given here, are difficult to predict due to the interrelated nature of world petroleum supply and demand and how different entities would react to it.

This is only an urging to avoid unbridled optimism; US energy independence may seem to be only beneficial, however, upon inspection of the secondary and tertiary effects, it may be just as negative as positive.

Note: All data herein derived from BP Statistical Review of World Energy 2013 or BP historical data, unless otherwise noted.

Housekeeping and Moving Forward

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I just wanted to get everyone updated on the status of Energy Security. This project is not dead, though I have been admittedly neglecting to post new analyses. I hope to fix that in the coming months. In addition, I think that everything will move in a different direction from the previous posts, with a focus on getting information out in a briefer format more frequently rather than submitting longer pieces, like those already up. The post on the Myths of Fracking may be a good example of how things will evolve.

Regardless, I’m looking forward to the months to come and bringing new content. With that said, I think the following topics will deserve a briefing:

  • Oil and Gas Developments in an Unstable Iraq
  • Effects of Iranian Sanctions on Russia and Central Asia
  • The American Shale Revolution – What It Means Domestically and Internationally
  • Canadian Bitumen – The Frozen North Heats Up
  • Fracking and Water Concerns
  • Primer on the Energy Infrastructure of the USA
  • Prospects of the Liberalization of Pemex
  • Twilight of the Supermajors and Rise of the NOCs?
  • Rosneft and the Russian Focus on East Asian LNG
  • Internal Energy Politics of Russia
  • Arctic Energy
  • Going Nuclear with Thorium
  • Systemic Effects of Draw down of Nuclear Power in Germany and Japan
  • The Viability of Algal Biofuels and Cellulosic Ethanol
  • The Latent Chinese Shale Revolution
  • PetroBras and Prospects of Brazilian Energy Independence
  • Instability in Nigeria – Boko Haram and the Nigerian Oil & Gas Bounty
  • Chinese Encroachment on Central Asia and Geopolitical Implications
  • Future of Coal
  • Energiewende
  • The Effects of US-Saudi Tension

If you have any suggestions or would like to see a particular topic covered more quickly, please go ahead and leave a comment. I can see to it that I cover it more quickly.

France, Nuclear Dependence, and West Africa

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In light of the recent attack on a Nigerien uranium mine in Arlit, Niger, it is worth taking a step away from fossil fuels to examine the nuclear side of energy.

French Nuclear Ambitions

France is known for, amongst other things, its reliance on nuclear power to deliver electricity to its citizens. Électricité de France exists as a public company with majority ownership by the French state and manages most French electricity production.

According to the EIA, France generated 530 billion kWh in 2011. Of this, the majority came from nuclear, and the rest from a mixture of fossil fuels and renewables. This is the breakdown:

  • 420 billion kWh from nuclear – 79.24%
  • 45 billion kWh from all fossil fuel sources – 8%
  • 44 billion kWh from hydroelectric – 8%
  • 22 billion kWh from renewables – 4%

French installed capacity for electricity generation, meaning total capacity of currently installed generators, expressed in kilowatts (kW), totaled 124 million kW in 2010. If the entirety of French capacity operated 24/7 for a full year, it would be capable of generating 1.086 trillion kWh. For comparison, the world consumed 18 trillion kWh in 2010.

The following list shows the breakdown of French installed capacity in 2010:

  • 63 million kW of nuclear – 50.8%
  • 27.4 million kW of fossil fuels – 22.09%
  • 18 million kW of hydroelectric – 14.51%
  • 8.5 million kW of renewables – 6.8%
  • 6.9 million kW of pumped storage hydro – 5.5%

If all French nuclear plants operated at 100% capacity for a full year, they would be able to generate 551,880 million kWh, which is more than French consumption in 2011. In this sense, France is very secure in electricity production as long as it can continue operating its nuclear reactors and retain the other sources of energy

Compiling data from the International Atomic Energy Agency, French nuclear reactors operated at a capacity factor of 73.73% in 2012. For comparison, US reactors operated at a capacity factor of 91%.

Giving some attention to the systemic issues with French energy, it is important to note that France achieves its high level of nuclear power generation because it is able to export to neighboring countries. According to the French General Commission on Sustainable Development, France exported 56.4 billion kWh in 2011.

The following list shows French net electricity exports by country in 2011:

  • Germany – 20.2 billion kWh
  • Italy – 13.3 billion kWh
  • Switzerland – 10.7 billion kWh
  • UK – 5.8 billion kWh
  • Belgium and Luxembourg – 4.9 billion kWh
  • Spain – 1.7 billion kWh

According to the World Nuclear Association, France will require 9254 tons of uranium in 2013 or roughly 13% of world demand. The uranium markets operate on a contractual basis of 3-15 years, and as a spot market, which constitutes less than 20% of supply.  According to Reuters, France received about 18% of its uranium from Niger in 2008.

Uranium mining provides the primary supply, but the secondary supply, resulting from “commercial stockpiles, nuclear weapons stockpiles, recycled plutonium and uranium from reprocessing used fuel, and some from re-enrichment of depleted uranium tails” provides additional energy security. These stockpiles are difficult to quantify due to commercial confidentiality, but they are estimated to be near 154,000 tons of uranium.

Uranium Mine Attacks in Niger

Although the event was not covered very well in the US, extremists attacked two towns in Niger on May 23, 2013.  One attack occurred at a military base in Agadez and another at a uranium mine in Arlit. The attacks were coordinated, occurring simultaneously. According to NPR, Moktar Belmoktar, the extremist behind the Algerian attacks in January, claimed responsibility for the attack on Arlit, while the Movement for Oneness and Jihad in West Africa (MUJAO), an affiliate of Al Qaeda, claimed responsibility for both attacks. The attacks on Algeria already had potential effects, which have been described here before. 

Africa Map.

Legend:

  • Red represents areas in Mali outside of government control. 
  • Green represents Niger
  • Black dots represent recent terrorist attacks. 

Effectively, large swathes of the Sahara lays ungoverned and provide a base of operations for extremists in the area. French intervention in Mali has halted further gains, but the French presence in Niger, limited to special forces allowed to secure mining operations, is hardly a full commitment, allowing the extremists to become bolder in their attacks.

Implications of Uranium Production Disruption

Although France depends on nuclear power for its electricity at the present, supply shocks from Niger will not definitively endanger France. France is diversified enough to withstand such a shock, being capable of generating as much power from non-nuclear sources as from nuclear. The country focuses on energy security, and its stockpiles of uranium, though the numbers are confidential, are likely to be ample enough to withstand a disruption in Nigerien uranium production. One must note that Germany and Japan are decreasing their use of nuclear, driving down prices and making more uranium available. Simultaneously, Chinese growth in nuclear pushes up demand and prices. Furthermore, France could tap into other countries’ secondary supplies if necessary and possibility import electricity if absolutely necessary. As a result, the threat to France is only minimal at this point.

However, the main threat rests with increased energy and commodity prices as a result of diminished supply and shift to other fuels for power generation. The market tends to react to such events;  the attack on Arlit on May 23 caused a small spike in uranium prices. However, spot prices are somewhat difficult to gauge because of the limited market. Electricity prices in Europe will likely rise in the case of a Nigerien supply shock because the French electricity export market affects  neighboring countries, especially Germany as it decreases its own capacity for nuclear power. This carries both political and economic risk as several governments face uncertainty and unpopularity at home while economies are teetering on the brink of recession. As a result of these woes, the effect of additional pressures in the form of a uranium supply shock is multiplied. Furthermore, Russia becomes relatively more powerful as it has the potential to supply natural gas to mitigate the effects of such a shock. Given Gazprom’s history of monopolistic pricing, it would likely take advantage of the situation for both political and economic gain. Gazprom is slowly succumbing to the pressure of mismanagement and seeks to reverse its decline; a disruption in the normal energy order within France would provide a lucrative opportunity.

Political and Military Security Risks of Expanding Extremist Influence

If the extremists in West Africa are able to continue carrying out such attacks and gain unmolested safe havens in the vast lawless areas of the region, then both Europe and West Africa will suffer. Successful attacks are inherently legitimizing to a group such as MUJAO, even if they fail to cause catastrophic damage; they are used as a tool of recruitment for the decentralized networks of fighters. Furthermore, the countries in the region are hardly developed and are lacking in capacity to withstand such incursions. Even oil-rich Nigeria can scarcely contain the fomenting insurgency within its own borders. In a positive feedback loop, successful attacks beget additional followers and cells, which culminate in additional attacks and further reach, especially into Chad and down into the energy rich coastal region. These safe havens also allow for the opportunity to plan attacks against Europe for further legitimization. However, the West African desert is not like Afghanistan in that it is much more inhospitable. If the terrorist threat is not addressed, the risk of collapse, coups, and political instability is heightened while Europe becomes exposed to low-level terrorist attacks if the extremists gain a foothold there.

Future of Energy Panel

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I’ve got an interesting update rather than full post on a particular issue. I attended a discussion panel on the Future of Energy at Georgetown University which included several figures from both academia and local think tanks. It was an interesting discussion followed by a Q&A session. I have summarized the main points of the discussion below:

Oil is still the primary commodity in energy and remains the world’s most traded commodity, in both value and volume. However, the US is probably past peak demand for crude oil, while energy demand is shifting to other sources, such as cheap natural gas. The energy infrastructure, to include electricity, transportation, industry, and supply lines, is slowly changing to accommodate these changes. The large capital costs prevent a rapid shift.

The United States will likely become energy independent, possibly by 2020, as technology improves. Hydrocarbons will still dominate the energy solution, in the US as well as around the world. Renewables and alternatives to hydrocarbons are not viable at the moment and will remain more expensive than hydrocarbons for the foreseeable future. The technology that has made the exploitation of shale gas and oil and other unconventional resources has driven down their costs and has made alternatives uncompetitive economically. Currently, renewable cannot compete with such cheap sources of oil and gas.

The technological advances in the US and the vastly expanded supply of hydrocarbons in the country will alter the dynamic behind the worldwide energy trade on both the supply and demand side. This will change the system upon which the Middle East and Russia rely for export earnings and maintaining their systems of governance.

Middle East wealth distributions are too skewed towards the top causing resentment and instability with the majority of citizens in these countries. The rulers, to whom the oil and gas wealth flows, have no incentive to change as they enrich themselves and would be unable to do so if the government were to adopt stronger and fairer rule of law or any further changes. As a result, there will be more turmoil in the region, especially as the US increases its own oil and gas production and disrupts supply and demand in the markets. It is possible that Iran and Iraq descend into chaos or suffer upheavals that present opportunities for the countries to attack smaller, but rich countries, such as Kuwait and Qatar, to bolster incomes and provide a common enemy for the people.

Nuclear power will likely continue to grow as countries, especially those in the Middle East seeking to sell rather than burn oil and operate water desalination plants, try to meet their electricity demands. However, the infrastructure and regulatory bodies for these industries are difficult and time-consuming to implement at the level of desired competence and authority. The capital costs behind these projects, barring small modular nuclear plants, are prohibitive for most countries. Moreover, stakeholders in nuclear, such as students studying the science behind it and regulators, would need assurances and guarantees of completion of these projects to commit themselves to the nuclear path. Such guarantees are, however, only viable in specific cases in countries with adequate capital at hand. Many of the countries considering this route, such as those in the Middle East, are notorious for wasteful public budgets and many are indebted and retain budget deficits despite their enormous hydrocarbon wealth. This effectively prevents a simple transition to nuclear power.

These are the basic ideas I gathered from the panel. Overall, it was bullish on hydrocarbons and pessimistic about the viability of alternatives in the face of cheaper oil and gas. Turmoil in the Middle East also appeared to be a given in the near to medium term. I will likely expand upon these issues in future posts, but I wanted this to serve as a quick update rather than a protracted explanation.