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U.S. President Donald Trump appears before workers at Cameron LNG (Liquid Natural Gas) Export Facility in Hackberry, Louisiana, U.S., May 14, 2019. REUTERS/Leah Millis

U.S. Natural Gas: Once Full of Promise, Now in Retreat

by Guest Blogger for Energy Realpolitik July 2, 2020

This is a guest post by Gabriela Hasaj, Research Associate to the Military Fellowship Program at the Council on Foreign Relations. Tessa Schreiber, intern for Energy and U.S. Foreign Policy at the Council on Foreign Relations, contributed to this blog post. Read More

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Iran

Oil and the Iran Protests

It doesn’t take much these days to remind oil traders that Middle East geopolitical risk can raise oil prices. Unrest in Iranian cities is the latest case in point. News and video records of major protests in Iran pushed Brent prices to $67 a barrel before analysts started pointing out that the risk to oil supply from the protesters themselves was low. That analysis could be too sanguine. The protests in Iran underscore a rising risk across the Persian Gulf: disgruntled populations are willing to sabotage oil facilities to make themselves heard. Iran has been the site of such attacks of late, especially in the oil rich Khuzestan province known for its Arab separatist movement. In a sign that Iran likely takes the potential for sabotage seriously, an Arab separatist leader who was known to advocate for attacks on oil facilities in Iran was gunned down in Europe recently. Late last year, Bahrain accused Iran of being behind a terrorist attack on a pipeline that brings oil from Saudi Arabia to Bahrain. Saudi Aramco has also boosted security at its offshore oil facilities on its maritime border with Iran. Those fields, including the Marjan oil field that is shared across the border with Iran, are slated for expansion by Aramco. Iran is also increasing production on its side of the field, called Foroozan. Khuzestan province is also home to fields that are important to Iran’s ability to increase its domestic oil production utilizing Chinese investment. Saudi Arabia has accused Iran of being involved in recent missile attacks from Yemen that targeted Riyadh airport and the royal palace. The accuracy of the thesis that Iranian protests won’t spread to oil workers the way they did in late 1978 will depend in large measure on whether Iranian government repression of discontent can be successful in putting down insurgency, as it was in 2009. It is important to remember that the sequence of events that led to the fall of the Shah of Iran took months to unfold. Protests were unrelenting at the end of 1978 and oil workers were eventually motivated by the chaos to deny the military access to fuel to prevent them from killing even more Iranian citizens. As conflict escalated on the streets, oil workers walked off the job, eventually bringing Iranian oil exports to zero. The Iranian government is well aware of this risk. In 2010, in the aftermath of internal instability in 2009, it increased the presence of the revolutionary guard in the oil sector to prevent a repeat of 1979. Iran’s supreme leader Ayatollah Ali Khamenei also never seemed to embrace the notion—put forward by reformists—that Iran’s economy would benefit from integration with the global economy. Rather, Khamenei has advocated vociferously that Iran needs to stay the course on an economy of “resistance” where indigenous economic capacities are part of the battlefield and individuals sacrifice personal consumer needs in favor of the commanding heights of the state. That view seems to lend credence to commentary that Iran’s hardliners themselves started the protests initially to weaken reformers by highlighting the failure of the nuclear deal to bring about tangible economic benefits. If reports of protest slogans are correct, the population could be tiring of the hardliner view that it is a higher calling to remain cut off from the global economy to fund the security of Shiite compatriots via wars in Syria, Lebanon, Yemen, and Iraq. Rather, like citizens in many places around the world, especially countries with oil, some Iranians are asking why they should make such sacrifices for a government that lacks accountability and is excessively corrupt. Oil markets will be watching carefully to see if the Donald J. Trump administration uses Iran’s repression of its own people as a reason to refuse to issue the waiver to keep the United States from violating the terms of the nuclear deal or if the U.S. president—once again—refuses to recertify Iran’s compliance with the deal, kicking the issue back to a reluctant Congress. Markets will be looking for any signs that U.S. action will make it more difficult for Iran to sell its oil or to raise new oil and gas investments in the Iranian industry. But as tempting as that grandstanding could be, the United States should probably take no hasty actions on this one until it can give the Iranian people a chance to be fully heard. If reports are accurate, Khamenei’s long standing concept that his fellow citizens should continue to sacrifice in a resistance economy to keep the upper hand in regional conflicts could be losing ground. The United States should do nothing to hinder that momentum. Acting out in ways that reconfirm the long standing hardliner story line that the United States will always be an enemy to Iran would be a mistake at this time. Rather, the United States should take a breath and with uncharacteristic patience, do nothing regarding sanctions until it can see if the chips fall in a more favorable place.

Blog Post by Amy M. Jaffe January 4, 2018 Energy Realpolitik

United States

Could a U.S.-Russia Oil Showdown be Coming?

About a year ago, a seasoned U.S. oil leader with deep political connections explained to me that U.S. shale would be out of the woods by 2018. His thesis was straightforward: he thought the U.S. economy would see improved growth under President Trump, pulling up global gross domestic product—and with it, oil demand. That growth would mean Saudi Arabia would be closer to maxed out on its capability to produce oil, no longer a significant threat to U.S. shale. Under this world view, American producers would be able wrest more market share in the future without fear of toppling prices, hence the Trump administration’s optimistic view of U.S. energy “dominance.” At the time, it seemed like a rosy prognostication. I pointed out how easily Russia, armed with a cheap ruble and flexible tax policy, could also increase its own oil output. But 2018 is now around the corner and that conversation now seems somewhat more prophetic. It raises the question: What would it mean for Saudi Arabia and U.S. shale producers if Russia does an about-face and makes a production push. It’s something to watch. Because, while Saudi Arabia might not be technically maxed out, global demand is on the rise and Saudi ability to flood the market to punish challengers is, at least for the moment, greatly reduced. Not only is the kingdom boxed in to supporting higher prices because of domestic economic pressures and its planned initial public offering (IPO) of state oil giant Saudi Aramco, it is also facing long term oil field problems that will not be cheap or easy to fix. Already this year, an unexpected corrosion problem at a significant pipeline at the large Manifa field reduced Saudi spare capacity. Saudi Aramco’s hefty new capital budget reportedly targets increases at three offshore fields by 2022 to replace declining capacity elsewhere but past efforts to expand sustainable production capacity have been a painstaking process, stretching over more than a decade at a cost of tens of billions of dollars. The next tranche will be even more challenging. Regardless of its handicap versus the United States and Russia at adding new producing areas in its oil fields, Saudi Arabia is not yet abdicating its leadership role. It took a pro-active stance towards recent deliberations to extend OPEC-non-OPEC production cuts into 2018. Saudi’s steadfast commitment to the deal was not initially reciprocated by Russia, which was more tentative in public statements leading up to the November OPEC meeting. The cat and mouse process led one seasoned journalist to note Russian President Vladimir Putin has “crowned himself king of OPEC.” The sequence of events prompted questioning whether Russia has finally achieved what four decades of sponsored military proxies failed to do—surreptitiously gaining sway over Saudi oil policy. For its part, Russia’s stated concern about a production cut extension was linked in part to the advantage higher oil prices are giving to U.S. shale producers. Russian oil companies complained to Moscow about their excess of 1.2 million barrels a day (b/d) of new oil field projects they’d like to green light. A Citibank report, “From Russia with Love – A Crude Romance,” suggests that not only do Russia’s largest companies have 300,000 b/d in idled current capacity, they are sitting on some 23 fields that could add substantial new production in the next five years, including 14 fields on state firm Rosneft’s books aggregating 770,000 b/d. Russia also has untapped shale potential. Any Russian increases will come head to head with rising U.S. oil production, which the U.S. Energy Information Administration said last week could hit 10 million b/d in 2018, up 780,000 b/d. Analysts at Cornerstone Macro are similarly bullish on U.S. supply, especially should prices be above $60 a barrel. They project U.S. tight oil production could rise by 960,000 b/d next year (ex-natural gas liquids) and an additional 770,000 b/d in 2019, if prices hold around $60, bringing total U.S. crude oil production above 11 million b/d over the next two years. Increases would be even larger in a $65 oil price environment, Cornerstone Macro suggests. Longer term, the upward potential for U.S. production could be substantially higher than that, with some estimates as high as 20 million b/d. The storyline that lack of access to new funds would force capital discipline and thereby lower production gains, (e.g. focus on profits, not growth), looks increasingly questionable given that oil and gas exploration and production companies have raised more than $60 billion in bond sales so far this year, levels typical of pre-price drop conditions. Unlike past, higher risk efforts, this year’s borrowing is supported by hedging activities. Right now, production disruptions in Venezuela, the U.K., and Iraq are supporting prices in addition to a war premium fueled by raging proxy wars across the Mideast. Traders, shale investors, and even reportedly Saudi Arabia, are betting that continued problems in Caracas, among other locales, will make ample room for U.S. rising production. Longer term, there are more producers in line to increase exports, including Iran, Iraq, Brazil, and Canada, to name a few. But the real geopolitical showdown for market share will likely come down to Russia and the United States: who can bring on new oil fastest? A looming U.S.-Russia oil and gas rivalry has deep geopolitical implications. It works against improvement in bilateral relations and is a delicate security matter for trading partners of both countries. The possible conflict over market share is existential to Russian power. Washington’s energy dominance tack, which recently included an announced gas export deal for Alaska during the Trump visit to Beijing, sounds as threatening to Russian ears as NATO expansion did a decade or more ago. Not only does Russia rely heavily on its energy exports for its statist budget and as a diplomatic lever, but the commanding heights of Putin’s inner circle and his grip on power is intimately inter-linked with Russia’s oil and gas elite. Russian influence and economic health has suffered in the past from orchestrated alliances between the United States, Saudi Arabia, and Qatar that targeted Russia’s energy earnings. The threat of rising U.S. oil and gas exports could be one factor encouraging increasingly risky Russian adventurism since doing nothing about it could neutralize a major tool of Russian foreign policy. For now, Russia seems content to collaborate with Saudi Arabia on oil market stability which ironically also suits the current U.S. administration, whose America first jobs message is tied heavily to the economic engine of the shale revolution. But that delicate oil truce rests on the back of Venezuela and its woes, which is making space for everyone. At some later date, if Saudi stability seems vulnerable to continuing proxy wars in the Middle East, Putin may be tempted to see if he can tip the scales further in Russia’s favor, making additional space for his long term export surge and rendering his giant reserves all the more important. This article first appeared as a “Gray Matters” column in the Houston Chronicle.

Blog Post by Amy M. Jaffe December 18, 2017 Energy Realpolitik

Saudi Arabia

Oil and a More Muscular Saudi Arabia

Saudi oil policy is undergoing a significant, yet subtle shift that is likely to have broader, strategic implications. The shift comes in the wake of a perfect storm of complicated existential threats facing Riyadh that have forced its government to accommodate new realities. In effect, for the time being, Saudi Arabia appears to have lost its flexibility on oil price policy and therefore will increasingly have to respond to geopolitical challenges in ways that don’t involve actively using export policy to lower the price of oil. A significant oil price drop now would be inconvenient to Saudi Arabia’s ambitious economic reforms, as well as threaten the success of controversial social reforms. This oil revenue conundrum could drive an already muscular Saudi foreign policy while at the same time, weakening the kingdom’s interest in the inner political dealings of the Organization of Petroleum Exporting Countries (OPEC). The threat to flood the oil market with its spare oil production capacity has for decades been a critical Saudi lever to muster oil production discipline and burden sharing within OPEC. OPEC, together with Russia, for now seem willing to consider a rollover of ongoing production cuts based on current improvements in oil prices but typically OPEC output cut discipline weakens over time. It remains unclear how the kingdom would be forced to respond if oil production increases from Iraq and other members to the agreement, not to mention the United States, start to eat at lofty oil prices come next spring. In the past, escalation in regional conflicts with Iran might have been met with policies designed to hurt Tehran via lower oil prices. But the Saudi response to the intercepted missile lobbed by Yemen-based Houthi rebels targeting the airport near the Saudi capital of Riyadh has been more strategic in nature. Riyadh quickly made it clear that the response it had in mind was more direct and militarily oriented, by announcing that the coalition would close access to all land, air, and sea ports to Yemen. The official Saudi Press Agency’s frankly worded statement on the matter noted that “Iran’s role and its direct command of its Houthi proxy in this matter constitutes a clear act of aggression that targets neighboring countries, and threatens peace and security in the region. Therefore, the coalition’s command considers this a blatant act of military aggression by the Iranian regime, and could rise to be considered as an act of war against the kingdom of Saudi Arabia.” Ironically, the more robust the kingdom’s military responses over time, the more likely that oil revenues will support the Saudi economy at home. The backdrop to the new Saudi oil price stance begins at home. In a series of recent interviews in late October, Saudi Crown Prince Mohammed Bin Salman made clear Saudi Arabia’s commitment to launch an initial public offering (IPO) of 5% of state oil monopoly Saudi Aramco next year and emphasized Saudi Arabia’s continued commitment to stabilize oil markets. Analysts calculate that the kingdom needs an oil price of roughly $60 a barrel for the Aramco IPO to meet acceptable revenues from the share sale. Events inside Saudi Arabia, including the recent arrest of at least eleven senior princes, former and current ministers, and dozens of top businessmen, sent oil prices higher Monday, raising the possibility that OPEC could even set its sights on $70 a barrel. It also created the prospects that any hole in the Saudi budget can be plugged by money seized from those arrested–fortunes estimated to tally in the hundreds of billions to trillions of dollars. A new anti-corruption commission has been empowered to “returns funds to the state treasury” and “register property and assets in the name of the state property.” The Saudi news comes in the wake of oil markets that have become more sensitive to geopolitical events in recent weeks, ever since a referendum on Kurdish independence temporarily disrupted oil exports from the Kirkuk oil field. The threat of a Venezuelan financial default is also weighing on markets. But it is also assumed by analysts and traders alike that an oil price drop would be inconvenient to Saudi Arabia’s ambitious economic reforms, including the Aramco IPO, leaving some speculators to believe they can go long in the oil futures market with impunity. This backdrop is in addition to the U.S. context where the U.S. President has made his commitment to the American domestic energy industry straightforwardly clear, implying yet another compelling incentive for Saudi Arabia to keep oil prices stable. President Donald Trump recently weighed in on the Saudi IPO on Twitter, saying it was important to the United States to float the shares on the New York Stock Exchange. Still, the longer term problem of price versus volume has been a durable, longstanding challenge for Saudi oil strategists over the years. Typically, Saudi declarations that the oil rich kingdom will support oil prices with its own production cuts invites other countries to free ride with extra production of their own. Russia has been a particularly notable free rider off OPEC cuts over the years, for example, promising cuts that tend to dematerialize over time in favor of export boosts. Conversely, Saudi attempts to expand or even protect its market share most often come at the expense of global oil prices. The late Saudi King Fahd removed his famous oil minister Sheikh Zaki Ahmed Yamani when the minister faced a similar delicate dilemma of achieving both a price and volume target. In the mid-1980s, the minister was instructed by the king to change course and end an extended oil price war that had been designed to get Saudi Arabia’s market share back. On some level, today's situation is reminiscent of that historical period. The Saudi IPO could create similar problems since investors will look for assurances that a steady volume of oil sales will reap predictable revenues that are also tied to the level of oil prices. That tension is in addition to other kinds of risks related to political stability in the kingdom and uncertainty about the long term demand for oil. Higher oil prices will invite a rebound in U.S. production at a time when Iraqi and Russian industry might also be poised to expand. That ultimately might be a longer term problem for Saudi Arabia, but one that doesn’t appear to be on the geopolitical radar today.

Blog Post by Amy M. Jaffe November 7, 2017 Energy Realpolitik

Kurds

Unraveling the Oil Geopolitics Intertwined in the Kurdish Independence Referendum

For over a decade, U.S. efforts to promote stability across the Middle East have run afoul of many complexities. The recent independence referendum in the Kurdish Regional Government (KRG) territory of Iraq is no exception. Both the sudden actualization of the referendum and some of the related geopolitical maneuvering associated with it, could provide new challenges for the United States in the region and harken back to a repeating failure of even seasoned American diplomats to head off conflicts over the final dispensation and control of important disputed oil and gas assets. The idea that Iraq’s Kurdistan region meets the prerequisites for nationhood is compelling. An independent Kurdistan was, in fact, drawn into the Treaty of Sevres almost a century ago in 1920. But the devil will be in the details of how the long-term status of the KRG gets resolved. Many complicated variables have to be navigated in the post referendum equation. Seasoned experts will weigh in on the complicated politics that has led to the KRG action and how it should be handled by the United States. This blog is aimed to underline specifically how any effort to mediate conflicts arising from the referendum will need to consider carefully the oil geopolitical aspects to the crisis. At issue is not just the possible loss to the global oil market of 500,000 to 600,000 barrels a day of Iraqi oil exports from KRG controlled territory via Turkey. In today’s oil world, this volume would eventually, if not quickly, be replaced. Rather, it is the dangerous precedent of letting subnational political and military “events” and shifting regional geopolitical alliances dictate the final dispensation of the Kirkuk oil field, which sits in historically disputed territory, before an adequate effort at a negotiated (read, internationally legally binding) resolution can be attempted. The History of Kirkuk The area surrounding the Kirkuk oil field houses many different regional peoples, including Arab, Kurdish, and Turkoman communities, the latter of which historically represented roughly 8% of Iraq’s total population according to some estimates. During the reign of Saddam Hussein, “Arabization” of the region changed its complex mix amid efforts by the Baath regime to guarantee its better access to the oil region, which in the 1980s represented close to 1 million b/d of Iraq’s total oil output of 2.0 to 2.5 million b/d. Kirkuk field holds reserves of 9 billion barrels. ISIS began to encroach on the area of the field in 2014 and when the Iraqi army’s defense of the region collapsed in June of that year, Kurdish Peshmerga forces interceded and took control of most of the oil producing region. Production at the oil fields in and around Kirkuk have been producing about 400,000 b/d of which 160,000 b/d come from three fields, Baba Dome, Jambur, and Kabbaz, which were at one point administrated by the central Iraqi government controlled North Oil Co. With Kirkuk squarely under Kurdish control, it remains unclear what the long-term status of the oil producing assets will be. The KRG has for years made its claim to Kirkuk clear in words and actions. U.S. oil companies, including ExxonMobil, have given stature to such claims by signing oil exploration deals with the KRG for oil fields in disputed territories, including blocks in and around Kirkuk. Notably, one ExxonMobil block attained from the KRG, the Bashiqa block, was taken over by ISIS militants. The firm has since relinquished several of its exploration blocks in Northern Iraq given both political and geological difficulties. Baghdad maintains all Northern region fields should be under Iraqi central government control, and especially the Kirkuk fields, and Iraqi prime minister Haider al-Abadi is forced to stake his reputation on it, with negative consequences for the unity of Iraq if he cannot prove to the KRG, and by extension, other oil and gas regions, such as Anbar and Basrah, that they cannot go their own way. Iraq’s parliament is calling upon Al-Abadi to deploy national security forces in disputed areas. Iraq’s oil ministry recently ordered North Oil Company to take immediate steps to rehabilitate the Nineveh fields set ablaze by retreating ISIS troops in a possible effort to try to reassert claims to oil resources in the region. For the past several years, Turkey has supported, financially and through transit for exports, the KRG’s oil and gas industry. But the changing domestic political landscape inside Turkey has made such positions more difficult of late for Turkey’s President Tayyip Erdogan. Last March, the leader of Turkey’s Nationalist Movement Party (MHP) stated the territorial integrity of Iraq was indispensable to Turkey’s national security and called claim to Kirkuk, “Historically, Kirkuk was Turkish. It remains Turkish even now and will become one of the most glorious Turkish cities in the future.” Erdogan has been more circumspect on the referendum saying Kurdish authorities would pay the price for the independence referendum and threatening economic sanctions. Turkey has held joint military exercises with Iraqi national troops on the border. So far, Ankara has not made good on its threat to shut down Kurdish oil exports which also are critical to Turkey’s economy. Enter the Russians Finally, ever opportunistic, Russia has recently expanded its influence into the controversy about who should control Kirkuk in the long run, via moves by state oil firm Rosneft, run by U.S. sanctioned Putin crony, Igor Sechin. Rosneft in recent weeks accelerated its negotiations of a major energy collaboration with KRG. The mooted deal is said to include a possible stake in the Kirkuk oil field, investment in the expansion of the Kirkuk to Ceyhan oil export pipeline, and a possible investment in a natural gas pipeline from the KRG to Turkey and Europe. Last June, Rosneft took five exploration blocks in the KRG and signed a memorandum of understanding to create a 300,000 b/d oil offtake agreement. The KRG reportedly discussed the Avana, Baba, and Khurmala domes as part of the deal, which include areas previously operated by the Iraqi state’s North Oil Company. Rosneft has also stepped in as a white knight to Kurdish finances, offering a capital injection of up to $3 billion in part to refinance debt coming from $1 billion in pre-financed oil sales deals with international traders. Firms Glencore, Vitol, Trafigura, and Petraco had loaned the KRG finance based on future oil sales. The trader oil has been going to Spain, Greece, Germany, Italy, and Croatia. The KRG’s annual oil revenues are projected at roughly $8 billion. With so many parties affected by any decision to stop oil exports from the KRG, Turkey’s Erdogan finds himself boxed in by domestic and international concerns. The involvement of Rosneft in KRG oil affairs adds additional tricky dimensions to any negotiation about the future of the KRG and purposely so. The Kurdish referendum gave the Kremlin a convenient possible out to peace negotiations in Syria by disincentivizing the Syrian Kurds from voicing cooperation. It also allowed Russia to counter checkmate Turkey, which saw energy cooperation with the KRG as a means to break the vice Moscow had on its own Turkish national energy supply. For the past several years, Ankara has been offering Turkish finance and technical support to promote KRG oil and gas export pathways to Turkey. Ankara had hoped to diversify itself from Russian energy and by extension, Europe, through its own link-up to the KRG energy supply. But the cost to Kurdish leader Masoud Barzani of high dependence on Turkey must have proved too restrictive. In effect, for the Kurds, the offer to sell oil assets to Russia would potentially solidify Russian assistance at the United Nations Security Council, should Baghdad or other regional powers seek to solicit U.N. sanctions against the KRG. What’s left is a geopolitical mess that will take skill and patience to disentangle. Possible outcomes that displease Iran could propel it to back local Shia militias to try to defy Kurdish Peshmerga control of Kirkuk. Iran has its own concerns, given its own restive Kurdish population which numbers 6.7 million or a little under 10% of Iran’s population. Iran was the first to move against the KRG after its referendum, closing its air flights and borders to the KRG. In other words, through Rosneft’s activities, Russia has gained leverage over Turkey and Iran’s interests in the Kurdish question and potentially reasserted oil and gas export leverage over not only Turkey but also major economies in southern Europe. The Oil Element and U.S. Interests The geostrategic element of Kirkuk as an oil producing province nearby to Turkey, Iran, and the Syrian conflict, makes the stakes higher than just the kind of economic conflict that has spurred localized military action by warring factions in South Sudan or Libya. The fate of Kirkuk will also be closely watched by other parties from contested oil regions who will look to U.S. and U.N. responses towards the KRG for some hints to their own aspirations. The United States has long kicked the can regarding the arduous task of navigating the finer details of oil revenue sharing shuttle diplomacy in failing states. The consequences of this failure has turned out badly in several locations, including Libya. Now, in the case of the aspirations of the KRG, is the time to redouble efforts to establish sustainable precedents. The principal of revenue sharing geographically by census/population count was rejected in the early days of reconstruction in Iraq, in my opinion, to the detriment of the entire experiment of trying to re-forge a national identity. To help the KRG and Baghdad create a viable path forward, the oil resource control and revenue sharing issue should be settled once and for all, peacefully and through binding negotiation that can include a payout or ongoing revenue sharing, depending on final deliberations. The consequences of a failure to diplomatically steer this “whose-oil-is-it” struggle to a successful outcome have been devastating for the people of the region. Militias throughout the Middle East have learned that they can undermine the authority of established political leaderships by overtaking oil producing areas. So far in the process of such conflicts, the oil and gas industries of Syria, Yemen, and to a certain extent Libya, have been destroyed. The United States should consider more active diplomacy on the resolution of the future of Kirkuk in hopes that persistence this time around might show better results than past efforts. Such an investment of diplomatic time, effort, and prestige could yield long-term benefits, not only for the people of Iraq and the KRG but also in other regions around the Middle East where oil revenue sharing and border fields remain in dispute. A win for a diplomatic settlement on the future dispensation for Kirkuk would offer a productive path for many other oil producing regions. This is not to say that the task is not a gargantuan one, but just that it is one well worth pursuing.

Blog Post by Amy M. Jaffe October 4, 2017 Energy Realpolitik

United States

Harvey Lessons for U.S. Export Role: Public-Private Stockpiles

Inventories play a crucial role in oil and gas commodity markets by smoothing out short term dislocations and sudden changes in demand. The historically high inventory levels lingering from the after effects of a global market share war that has been raging since 2014 helped mute potential shortages from emerging in the wake of Hurricane Harvey. The hurricane initially knocked out roughly four million barrels a day (b/d) of U.S. refining capacity, pipelines, and over a million b/d in U.S. domestic oil production, including offshore output as well as 300,000 to 500,000 b/d from south Texas onshore fields inhibited by flooding for several days. Oil and gas infrastructure requires electricity, workforce availability and safety conditions to operate. While some of the shuttered oil and gas facilities are now coming back on line, the broad physical toll of Harvey’s severe weather event warrants revisiting of the policies surrounding both commercial and strategic inventory management. Just over half of all U.S. refining capacity is located on the U.S. Gulf coast, which is seasonally prone to hurricanes. A reevaluation of inventory policy is particularly important given the United States’ newfound role as a major exporter of oil and gas. In preparation for the storm, close to fourteen refineries fully shut down production around the Houston area. The geographic range of the shutdowns ranged from Corpus Christi, where five refineries were shut down, to Beaumont and Port Arthur, where three refineries went offline. This included Motiva’s 603,000 b/d Port Arthur facility, which is the nation’s largest refinery. As of September 7, the U.S. Department of Energy [PDF] reported that six refineries in the Gulf coast were still shut down and five were just in the process of restarting. At least two ExxonMobil refineries suffered structural damage during the hurricane. U.S. national security can be enhanced by embracing the country’s emerging export role. The Donald J. Trump administration is looking to leverage the opportunity created by U.S. oil and gas exports to assert global energy “dominance.” But for U.S. industry and the United States to benefit to the fullest from its status as a major global oil power, it needs to shore up its bonafides as a secure and reliable supplier. That means forging a stronger link between private and public management of inventories needed to keep oil and gas flowing even in the face of natural disasters and other kinds of supply emergencies. My research with co-authors Colin Carter and Daniel Scheitrum shows that there has been a significant substitution effect between private commercial crude oil inventories and public inventories over the past two decades in the United States. We also found that inventory patterns are changing rapidly as the shale revolution and related export flows have altered oil, gas, and refined products pipeline flows around the United States in ways that are changing the calculus between public and private oil stockpiling activities. For example, reversed pipelines to bring U.S. domestic production down to Gulf coast refiners have meant that access to the Strategic Petroleum Reserve (SPR) for mid-continent refineries is now limited, propelling local refineries to carry higher working inventory. California’s pipeline access to SPR releases is similarly inhibited and has been under study at the federal level. California’s refiners have not increased inventory holdings to sufficiently cover for occasional accidental supply outages, leading to billions of dollars in burdensome fuel premiums being paid by the public. The brief Harvey-related cut off of the Colonial Pipeline, a main artery to bring gasoline to the northern United States from the Gulf coast, turned out to be less severe than similar problems during Hurricane Rita and Katrina partly due to its brevity and availability of local buffer commercial inventories but also given changing trade flows. Earlier this summer, Colonial Pipeline was experiencing lower than usual shipments to the U.S. Northeast as rising oil demand from Mexico and Latin America pulled more U.S. Gulf coast gasoline and diesel exports southward. In other words, a significant portion of the U.S. Gulf coast refining disruption affected U.S. refined product export volumes, which had been averaging 532,000 b/d for gasoline and 1.1 million b/d for diesel in July. The U.S. Department of Energy (DOE) and the General Accounting Office (GAO) have been studying how best to upgrade current SPR infrastructure given changes in the U.S. oil industry and the fact that some of the SPR’s current surface equipment is approaching its technical end of life, raising the chances of equipment failures. Among the questions being asked are: what is the appropriate size for the SPR over time as U.S. oil import levels shrink and also what kinds of upgrades are needed to maintain the system’s broader regional effectiveness. What will help the Trump administration in its current efforts to rethink SPR policy will be the fact that industry now has a greater incentive to ensure that its global image as a secure and reliable supplier is not damaged by poor logistics planning. In other words, policy makers may now have a unique opportunity to reshape the public-private partnership role in inventory management, taking into account the rising importance of the United States’ new role as a global energy exporter. A 2014 National Petroleum Council study entitled Enhancing Emergency Preparedness for Natural Disasters highlighted the importance of coordination between government and private sector leadership in emergency fuel preparedness and implementation. An important lesson from Hurricane Harvey may be that the U.S. emergency preparedness system, including the SPR, needs more flexibility, regional diversity, and enhanced private sector participation. As the Trump administration looks to consider how privatization could best be applied to emergency fuel management, it can look to Europe’s paradigm of combining coordinated mandated requirements for minimum private sector holdings of refined product stocks with more limited public holdings of crude oil for insights on how the SPR system could be reformed to meet the changing U.S. energy outlook. The European system allows for a more interactive coordination between private industry holdings and public policy. There is no question that a more flexible system that combines refiner products stocks and federal government crude oil stores would be beneficial, especially if U.S. import levels decline as expected. The Trump administration could also investigate whether any shale producers around the country could serve as flexible suppliers during a long term national emergency, perhaps through a public tender pre-payment system to purchase incremental local production for emergency release through a funding system for incremental drilling and well completions. Flexibility and public private partnership should be important elements to improving the SPR system. The current Congressional authorization targets up to one billion barrels to be held in the SPR, a level which may now seem arbitrary in light of changing market dynamics. The Trump administration has proposed selling off 270 million barrels of the reserve's current 687.7 million barrels over the next decade as part of a budget plan. The ultimate size of emergency stocks must represent enough to replace U.S. oil imports for 90 days in order to meet its obligations—together with U.S. allies such as Europe, Canada, Japan, and South Korea—under the International Energy Agency’s (IEA) coordinated emergency response measures for the Organization for Economic Cooperation and Development (OECD) membership. There is currently much uncertainty about what level U.S. imports will average in ten years. In light of recent experiences from natural disasters, which can range from hurricanes to flooding events to wildfires, geographic distribution of national emergency stockpiles needs to be given higher consideration in any revamp of the future U.S. preparedness system. Upgrades to the existing public-private emergency preparedness partnership should also consider how to protect the United States’ oil and gas export role to avoid losses in market share during outages. By thoughtfully rejiggering the existing system, the Trump administration might be able to save the tax-payer money, protect U.S. export market share, and wind up with a better, more reliable emergency response.

Blog Post by Amy M. Jaffe September 13, 2017 Energy Realpolitik