Fossil Fuels

People looking for a way that natural gas could break oil’s stranglehold on the U.S. transport system typically run into forbidding limits. Gas could be used to run power plants that would charge electric cars, but those cars are currently too expensive for most drivers. Gas could be compressed and used directly in automobiles, but limited range and fueling infrastructure are big barriers. Natural gas could also be converted into gasoline or diesel, but the costs and risks of building plants can scare investors. A dedicated band of analysts, advocates, and former policymakers has been pushing another solution: methanol. Methanol is a liquid fuel can be produced from natural gas using technology that is already widely utilized in the chemicals industry. Its advocates claim that it costs a mere $100 to alter a car so that it can use the fuel. And, using current cost estimates, advocates argue that methanol could be produced at a price that would make it a highly cost-effective competitor for gasoline and diesel. Advocates acknowledge, though, that methanol isn’t going anywhere with the current transport system. They argue that legislators should require that all cars be built to take methanol as a fuel – a so-called tri-fuel mandate. That, they claim, would allow methanol to compete on a level playing field, and potentially help replace oil. It’s an intriguing idea, but it needs more flesh on the bones. Introducing a tri-fuel mandate would be politically challenging. Current fuel economy regulations give automakers special credit against their fuel economy obligations when they sell flex-fuel vehicles. If a new tri-fuel mandate replaced this approach, automakers would be forced to take other steps to boost fuel economy instead, possibly threatening margins, and prompting political opposition. At the same time, creating a new market for methanol (the transport sector) would raise the price of methanol and hurt chemicals producers who already use it as a feedstock. They would be reliable opponents of any tri-fuel mandate. Policymakers faced with these sorts of obstacles aren’t going to be swayed by the simple claim that a tri-fuel mandate would “increase competition” and possibly help displace oil. They’re going to want some stronger analysis that persuades them that the energy payoff would be worth the political price. Doing that requires three pieces of analysis that I haven’t seen: What would the all-in cost of marginal methanol supplies be in a world that featured rapidly growing U.S. methanol production for transportation? That cost estimate would need to include not only production costs for new facilities, but also new distribution and storage infrastructure. Simply pointing to the current market price of methanol doesn’t answer that question – that price does not necessarily reflect the cost of new capital investments. How much risk would investors in methanol production face – and what would that mean for likely investment and production? It’s all well and good to claim that, at current natural gas and oil prices, methanol production looks like a good bet. A real-world investor will need to consider the potential risks of lower oil prices and higher natural gas prices. Is it reasonable to expect large investments once one considers how real investors will behave? If not, a tri-fuel standard would probably do little, and policymakers are unlikely to want to pursue one. What would the national benefits of an oil-to-methanol shift be? Or, put a different way, is a shift to methanol similar to increasing oil production, or to cutting oil use? Increasing U.S. production lowers world prices by increasing supply relative to demand, but doesn’t protect the country from volatile oil prices (or reduce greenhouse gas emissions). Reducing U.S. oil demand generally does all of these. My instinct is that, at least for modest volumes, methanol prices are likely to follow gasoline and diesel prices, failing to insulate the U.S. economy from oil price volatility. For larger volumes, I’m less certain. Moreover, different fuel options can have different consequences for vulnerability to short- and long-run price increases. My sense is that methanol would do more to address long-run price increases, but those happens to be a smaller economic vulnerability in the first place. The answers to these questions are particularly important if there’s a chance that a focus on boosting methanol production might substitute for other measures to reduce oil dependence. With advocacy for methanol on the rise, it’s all the more important that these questions be answered. If methanol really is as promising as its supporters claim, then solid answers here might prompt some policy progress. Absent that, I’m skeptical that we’ll see much action on this front.

Ideas matter. Or at least Council on Foreign Relations fellows like to believe that: otherwise, we’d be wasting a lot of our time. With that in mind, I canvassed some of the smartest observers of the energy and climate worlds – scholars, advocates, journalists, businesspeople, and policymakers – for their picks for the most influential studies, reports, in-depth articles, or books of the year in the field. Then I threw my own judgement into the mix. Without further ado, here are my picks for the five most influential energy or climate publications of 2012. This isn’t a list of “the best” analyses of the year – it’s a collection of those that have had the most impact. Read them if you haven’t yet. You’re already feeling their consequences in any case. Ed Morse et al., “Energy 2020: North America, the New Middle East?”. There’s little doubt in my mind that this study, released by Citigroup in March, was the most influential item published on energy or climate this year. Sure, there had been diffuse buzz about “energy independence” earlier, but this report was the first to put hard numbers to the discussion, not just for oil production, but for macroeconomic consequences too, helping vault the discussion onto a new plane. It should go without saying that changes on the ground are the fundamental root of renewed enthusiasm for U.S. oil production. But whether you’re thrilled or appalled by all the energy independence talk, give this paper a lot of credit for bringing it to the fore. Energy Information Administration (EIA), “The Availability and Price of Petroleum and Petroleum Products Produced in Countries Other Than Iran”. Part of me wanted to list this dry report as the most influential energy publication of the year. When Congress passed a tough set of new Iran sanctions in late 2011, it gave the president a way out: the EIA was to issue a report on the price and availability of oil from outside Iran; the president could then decide that the oil market was too tight for sanctions to go ahead. The EIA report, published in late February, could have teed up such a judgment, but instead helped pave the way for Iran sanctions to go ahead. Those sanctions have had more bite than many initially expected. Yes, the report primarily described existing market conditions, but it had considerable leeway in interpreting them. Its real-world impact may have been large. Bill McKibben, “Global Warming’s Terrifying New Math”. How often does an article about climate change get 121,000 likes on Facebook and merit 13,600 tweets? Those are the stats that this Rolling Stone piece, published in July, has racked up. The article, which juxtaposed numbers for fossil fuel reserves (large) with estimates of how much carbon can safely be released into the atmosphere (smaller), has spawned a speaking tour that reportedly has drawn as many as two thousand people to individual events, and a fossil fuel divestment movement on college campuses across the nation that is attracting considerable attention. It has also helped crystallize thinking in some important quarters that U.S. oil and gas gains are incompatible with climate safety. This one is a lot like “Energy 2020” in one important way: love or hate its analysis, it’s getting a lot of traction, in this case particularly among students who will become political leaders some day. This one is a toss up between “Effect of Increased Natural Gas Exports on Domestic Energy Markets” (EIA) and “Macroeconomic Impacts of LNG Exports from the United States” (NERA Economic Consulting for DOE). The first, published in January, forecasted large potential price spikes if natural gas exports went ahead; the second, published this month, concluded that price impacts would be limited and that macroeconomic gains would be had. These are basically the two poles in the ongoing debate over whether to allow liquefied natural gas (LNG) exports. They currently rate a tie. The Obama administration will probably announce its LNG export policy early next year. Then we’ll know which study was really the most influential. Alvarez, Pacala, Winebrake, Chameides, and Hamburg, “Greater focus needed on methane leakage from natural gas infrastructure,” Proceedings of the National Academy of Sciences. Bob Howarth and two of his colleagues threw much of the climate world into intense confusion when they published a paper in early 2011 claiming that natural gas was worse for climate change than coal. The February 2012 paper from Alvarez et al., which looked at how the impact of a shift from coal to gas would affect temperatures over time, seems to have helped people put methane in perspective, and has moved the debate onto considerably firmer ground. There’s still much to contest in the PNAS paper – and much more data to be collected – but it appears to have shifted policy-related discussion from “is gas worse than coal?” to “how do we make gas better for the climate?” That’s a change that can have big real-world consequences. Honorable mentions include Richard Muller’s “BEST” study that confirmed global warming trends, which made a big splash but seems to have since faded; the IHS study that estimated a gain of 600,000 jobs from shale gas (technically ineligible because it was published in December 2011) – its estimates made it into the president’s State of the Union address this year, and seem to have influenced White House thinking on natural gas more broadly; the Breakthrough Institute’s work establishing the federal government’s historical role in promoting shale gas technology, which also made it into the State of the Union, and has helped remind many that federal support remains vital to energy innovation; and the “Darkest Before Dawn” study from three McKinsey consultants that projected widespread grid-parity for solar power within five years, influencing opinion among an important segment of people who think about where clean energy is heading. And finally an invitation to chime in in the comments section: What did this list miss?

Policymakers, analysts, and pundits regularly argue over whether countries should care about who they buy their oil from. Economist usually insist that, because markets are flexible, the precise patterns of oil trade don’t matter. Security strategists often insist that they must. It’s long bothered me that despite voluminous writings that explore whether oil trade patterns should affect international relationships, there’s basically nothing out there on whether they actually do affect international relationships in practice. To address that gap, Blake and I brought together a great group of scholars, practitioners, and businesspeople earlier this year. The group prepared case studies of a dozen pairs of countries in advance. Then the collected participants discussed their implications. Blake and I have now published an article in Survival that draws lessons from the studies. (An ungated pre-publication version is available here.) We’ve also collected most of the case studies at a special CFR website here. We learned a lot in the course of researching and writing it, and hope that the case studies and the final article help others do the same. I won’t step through the whole thing, but I do want to highlight one lesson that stood out for me: the details of oil trade often influence political relationships because leaders think that they do. If, for example, U.S. leaders believe that they should afford special treatment to the countries that supply their oil, that will have consequences for international relations, no matter what their economic advisers tell them about fungible commodities and liquid markets. This lesson, along with the others in the paper, is worth keeping in mind as analysts and policymakers try to sort through the upheavals currently underway in the world of oil.

A story on NPR yesterday morning, “The Downsides of Living in an Oil Boomtown,” had an interesting portrait of the economic effects of high oil prices and booming oil production on Williston, North Dakota. The frenzied pace of job creation has led to high wages but also high turnover. A leap in demand for local goods like housing has caused massive inflation in housing prices and day care services. A similar story could be told of many other rural communities in states like Pennsylvania and Texas where the ramp up in oil and gas drilling activity has been a sudden shock on an otherwise rather static business scene. The underlying message of the NPR piece is straightforward: Every economic change has its tradeoffs. Taking into account the massive joblessness problem in the United States right now—what Fed Chairman Ben Bernanke recently called “an enormous waste of human and economic potential”—there’s some irony in a news story focused on the downside of too much hiring happening too fast and too much money flowing into the hands of a local workforce. But the report is right to get people thinking about the economic tradeoffs involved anytime local economic growth is tied closely to the extractive sector. I was interested to see that Carmen Reinhart and Kenneth Rogoff’s This Time is Different singles out commodity price fluctuations as having played “major role in precipitating sovereign debt crises” over the last two centuries. Analyzing the co-movement between defaults and real global commodity prices, they write: Peaks and troughs in commodity price cycles appear to be leading indicators of peaks and troughs in the capital flow cycle, with troughs typically resulting in multiple defaults… Emerging market borrowing tends to be extremely procyclical. Favorable trends in countries’ terms of trade (meaning high prices for primary commodities) typically lead to a ramping up of borrowing. When commodity prices drop, borrowing collapses and defaults step up. So what’s the link to the NPR story? The extractive industry is a cyclical business; and so, too, will be the economic fortunes of the those local, or even state, economies that depend heavily on it. Unforeseen fluctuations in commodity prices can carry local consequences  entirely different from, and at times much stronger than, what a country as a whole experiences, if a particular local economy is insufficiently diversified and unhedged. Typically, discussion of what the American energy boom could mean for the U.S. economy has focused on aggregate outcomes in areas like domestic output or employment. But what about for smaller slices of the country, which may be more exposed? Yes, the good times can be pretty heady—but the bad times can be especially tough. Texas, for instance, went into recession when oil prices collapsed in 1986, though lower prices were a net economic benefit to the rest of the country, which breathed a sigh of relief after the oil crises of the 1970s. The state’s economy is more diversified now, making it less sensitive to oil prices. But the link’s still there, as it is in other producing regions. Energy economists in major hydrocarbon-producing states like Texas have known this for a long time, so they’ve devoted lots of attention to understanding how a change in prices affects their part of the country. Mine Yücel at the Dallas Fed is among those who have done years of excellent research on these localized oil-related macroeconomic dynamics. Policymakers in states less accustomed to these levels of hydrocarbon-driven economic activity will now need to follow suit, and those in the oil patch may need to re-learn old lessons.

OPEC ministers met in Vienna on Wednesday to discuss the current oil market outlook and make a decision about future production levels, as well as to select a new secretary general. After deliberating, the group opted not to alter the current production ceiling of 30 million barrels per day (though they are currently pumping more than that). Nor could they agree on a replacement for the current secretary general, Abdalla Salem el-Badr, a Libyan national, choosing instead to extend his tenure an additional year starting next month. As with any OPEC meeting, what was not decided—and at times not even mentioned, at least publicly—can be as revealing as what was. So what did this week’s events tell us? Here are three quick takeaways: The question of how to accommodate soaring output from Iraq is becoming more and more pressing for the rest of OPEC. Currently outside the collective output target, Iraq’s 3+ million barrels per day of crude production is becoming an increasingly significant force in the global market. Iraqi production is widely expected to increase by several thousand barrels a day next year. Its ascent may force its OPEC peers to give way—but that won’t happen without a fight. Some member countries, including Saudi Arabia, think it’s time to give the country a firm target; others, notably Iran and Venezuela, disagree. The ultimately unresolved debate over who should be the new secretary general bodes poorly for OPEC’s ability to tackle bigger strategic problems in the months and years to come, such as a declining call on OPEC oil next year and booming North American crude.  Several countries put forward names for consideration, including Saudi Arabia, Iran, Iraq, and Ecuador, but none garnered enough support. Riyadh and Tehran both vetoed each other’s nominees. This lack of consensus underlines the depth of the political rivalries within the producer group. Should global market fundamentals become less rosy for OPEC, these divisions raise the likelihood of trouble in an organization where unity is central to the effectiveness of the whole venture. Despite the longer-term challenges, OPEC can pat itself on the back for a solid 2012, all things considered. There could be trouble ahead, but as for the here and now, OPEC’s doing just fine, thank you very much. According to calculations by brokerage PVM, OPEC saw an average sales price that was $2.32 higher than last year’s $109.70 per barrel, boosting the group’s turnover by $1.14 billion. Not bad for a year where demand-side uncertainty and broader financial market volatility has been pronounced. Now if only Washington and Brussels could manage their markets these days with that much aplomb…

Some of you who saw my piece last month for the Globalist, “The Middle East’s Voracious  Hunger for Energy,” wondered if I could post some charts showing the data underlying the argument.  Here are three. The piece argues that the Middle East’s rising oil consumption, driven by access to cheap government-subsidized oil, is becoming more central to global oil market fundamentals. These countries are facing a growing appetite for their own oil, which limits the amount they can export. Unless government leaders in the region chart a new course by addressing subsidies, the implications for their fiscal positions, as well as for world oil supply, are problematic. As I explain in the piece: “Unlike the BRIC countries, the Middle East’s strong growth in demand for oil has mostly stayed under the radar. In the first decade of the 21st century, it rose by 56%, more than twice the increase seen across Latin American and Asian Pacific nations, and four times the global average. Although it was no match for China’s 90% growth, in absolute terms the region gulps close to as much oil (8.1 million barrels a day in 2011) as the Middle Kingdom does (9.7 million barrels a day), according to 2012 data in the BP Statistical Review of World Energy.” So why the surging demand growth in the region? Population growth is part of the story. So is oil-driven electricity demand, notably in Saudi Arabia, where two thirds of power generated comes from direct crude burn. Add to that list consumers who enjoy ultra low fuel prices. All in all, energy demand per capita in the region has risen remarkably over the last few decades, and the size of the consumer base has expanded. Take a look at the energy intensity of these economies, or the amount of energy they use to produce a unit of GDP. As the chart below illustrates, the energy intensity of Middle Eastern economies is head and shoulders above most anywhere else—including China. While the energy intensity of the world as a whole has been trending downward in recent decades, not so the Middle East. The energy intensity of its economies surpassed the global average in the mid-1980s and has kept rising. The Middle East’s growth in GDP per capita since 1971 has been more or less on par with several other parts of the developing world. So the story appears in large part to be one of a region whose economy and energy mix has become more and more structurally dependant on cheap oil, thanks to public subsidies, and rising population growth.  Of the $192 billion of oil subsidies doled out around in the world in 2010, $121 billion of them were in OPEC, according to IEA figures. It’s astounding to consider that Saudi Arabia, for example, has an economy one-sixth the size of Germany and yet consumes as much oil. It never hurts oil demand growth when a gallon of gas costs less than a dollar, as it does in places like Kuwait and Saudi Arabia. But it can become a costly habit.

With the Middle East unrest ongoing and the global economy recovering, gasoline prices are rising considerably. But policies to ease U.S. consumer impact take time and policymakers are divided over the course of action.

Earlier today, the Department of Energy released a long-awaited (and long-delayed) study on the macroeconomic impacts of liquefied natural gas (LNG) exports. The study, prepared by the consultants NERA, is the most in depth look at the economics of LNG exports published to date. That means it’s long, and will take a while to digest. Here are a few quick observations and context. I’ll write another post later on differences between the NERA results and what I reported in my own LNG exports study earlier this year. The study reaffirms that allowing exports would be good for U.S. economic growth. No matter how NERA sets up its model – different assumptions about U.S. gas resources, domestic demand, or international markets – the U.S. economy as a whole benefits from allowing exports. This shouldn’t be a surprise: the fact that economies gain from allowing trade is pretty robust. The negative headline from the report is that allowing exports would lower average real wage income. This happens despite little or no impact on nominal wages; it is due to higher natural gas prices, which imply slightly lower average real wage income. As an isolated matter, this is fairly uncontroversial (though the impact on income after taxes and transfers like LIHEAP is unclear), but I have concerns, which I’ll explain below. Either way, all of the macro numbers are pretty small. U.S. economic welfare rises by between roughly 0.005 and 0.015 percent in most scenarios. Impacts on GDP can be a factor of ten higher – still relatively small. No sector loses more than 1 percent of output (aside from electricity generation in an extreme case); manufacturing, for example, loses between 0.05 and 0.25 percent. Real wage income typically declines by about 0.1 to 0.2 percent. The study also supports those who are skeptical that large-scale LNG exports will materialize, but suggests that there are ways for that to happen. When NERA assumes the DOE reference cases for U.S. and international natural gas demand, no exports result, because they are uneconomic. If U.S. gas resources are scarcer than mainstream estimates suggest, exports only materialize given extreme international demand, and only at low levels. Almost all cases come in at or below the 5-6 bcf/d that analysts often assume. Only when NERA combines assumptions of surprisingly high availability of U.S. natural gas and a complete shutdown of the Japanese nuclear industry does it see exports approach 10 bcf/d by 2020. When it adds on an end to the Korean nuclear program, and supply shortfalls elsewhere in the world, it projects as much as 12 bcf/d in exports by 2015 and 15 bcf/d by 2020. It is difficult to imagine the path to that much investment, particularly by 2015. Despite these often-massive export volumes, NERA projects consistently limited natural gas price impacts. In only one scenario – higher than expected U.S. shale resources and massive international demand leading to very large exports – do prices rise by more than a dollar for a thousand cubic feet in the next decade. (They rise by $1.11 in that case.) Most results see an increase closer to fifty cents. One can turn this around: substantial exports only exist because price rises are limited; if prices rose quickly, the economics of exports would collapse, limiting volumes. A corollary is that U.S. prices always remain well below overseas ones despite exports. The study, like any, has some non-trivial limitations. It assumes full employment, which makes it impossible for natural gas exports boost U.S. employment (through a positive demand shock) in the short run. This is a particularly important limitation for the scenarios with large LNG exports by 2015, since the economy will presumably remain substantially away from full employment by then. It is unclear from the text, but as best I can tell, blocking U.S. exports in the model does not lead to higher exports from Canada, even when the economic incentive for Canada to export is very strong. This is misleading, and important, since exports from Canada would have the same negative consequences for the United States as U.S. exports, but would have fewer of the positive ones. (In particular, Canadian exports would also depress real U.S. wage income.) I would also be interested to drill down on the manufacturing output and employment estimates. The study lumps together all natural gas production in determining the demand that gas production creates for manufactured inputs. To the extent that shale gas is more manufacturing intensive than other gas production, this will underestimate manufacturing employment. Perhaps the most important limitation is that it assumes no misfires by investors. The macroeconomic impacts of natural gas exports could be quite different if there was significant over- or under-investment in export facilities.  That is not a crazy possibility, particularly given the massive uncertainties present here. (It’s also a possibility that I neglected in my own study.) It’s also important for policymakers to put the results in context. Whatever the direct impact of U.S. LNG exports on the economy, the bigger policy stakes may lie in what a U.S. decision would mean for the global trading system more broadly. That could have larger impacts on GDP and real wage income than gas exports themselves.

The annual United Nations climate talks got underway in Doha, Qatar on Monday. In a piece for the CFR website, I walk through the issues on the table, and offer some thoughts on U.S. strategy. The title of the piece – “A Transitional Climate Summit in Doha” – is a pretty good summary.  After three years of high tension and high stakes summits, Doha will almost certainly be more mellow, though no climate conference would be complete without a few fireworks toward the end. Read the whole piece for more. In an op-ed in the Financial Times, I observe that Qarar is an unusual place to host a climate summit, but a great setting to debate an increasingly prominent part of the climate conversation: what role should natural gas play in global climate strategy? The strangely fitting setting for the talks dawned on me when I visited the tiny Gulf state a couple weeks ago. I argue in the piece that natural gas has an important role to play, but that strategists should not lose sight of the medium and longer terms, where a strong shift to zero-carbon energy will become essential. I also say a bit about policy (though I appreciate that connecting the policy decisions I discuss to the UN talks is a stretch). Read the whole thing for more, at the FT website or on CFR.org. Now is also probably as good a time as any to link back to a post I wrote a year ago that tells the story of what I often think is the biggest Clean Development Mechanism (CDM) boondoggle ever. If you guessed that it’s in Qatar, you’re right.

I wrote on Wednesday that the big headlines predicting a massive U.S. oil boom rested in substantial part on an underlying assumption that OPEC countries would restrain production in order to keep crude prices from crashing. It turns out that I was beaten to the punch. The culprit? OPEC itself. Its annual World Oil Outlook (PDF), published late last week, registers the North American supply boom clearly. (Thanks to Robin Mills for pointing that out to me.) The authors also write that “OPEC crude oil spare capacity is expected to rise to beyond 5 mb/d as early as 2013/2014”. That threshold was exceeded for a couple years following the financial crisis, but otherwise, you need to go back to 2002 to find spare capacity levels this high. One can also infer projections for spare capacity through 2016 from the OPEC report. OPEC estimated its spare capacity at a smidge less than 4 mb/d during 2011. (This number is slightly misleading for some purposes, since a good part of it couldn’t have been brought online quickly, but it’s the right number for the issue we’re looking at.) OPEC estimates a gain of 1.2 mb/d in its production from 2011-16 but an increase in its liquids capacity of 5 mb/d over the same span. That means an increase in spare capacity of 3.8 mb/d, taking it to a whopping 7.8 mb/d. You need to go back to April 2002 to find OPEC as restrained as it would need to be to keep 7.8 mb/d of capacity offline. Yet that restraint lasted for precisely one month, and was in part the product of motives other than a desire by OPEC countries to prop up prices. Iraq slashed its oil exports that month, claiming it was in support of the Palestinian cause, with other OPEC members objecting. Venezuela produced 700,000 barrels a day short of its potential due to domestic turmoil. The amount of oil held off the market due to deliberate attempts to stiffen prices, which had weakened following the September 11 attacks, was considerably less than the 7.8 mb/d figure that I estimated above. If you want to look further back, there’s a very brief period in the late 1990s where OPEC holds that much off the market; beyond that, you need to go back to the 1980s to find similar restraint. The IEA’s estimates of likely OPEC spare capacity, which I discussed in Wednesday’s post, are a bit more modest – perhaps around 6-7 or so mb/d. Even that, though, has limited recent precedent. OPEC held around that level for around a year after the onset of the financial crisis, through a combination of deliberate restraint in several countries and conflict in Nigeria, which took large amounts of oil production offline. Otherwise, you need to go back a decade to find similar behavior. It should not be surprising, then, that the OPEC report, after forecasting the large gain in production capacity, warns that “investment decisions and plans will obviously be influenced by various factors, such as the global economic situation, policies and the price of oil” (emphasis added). Ultimately, the odds that OPEC will actually hold close to 8 mb/d of spare capacity are small. If the OPEC and IEA reports are right about trends in North America and elsewhere, we’re likely to either see some restraint in OPEC investment, or to find ourselves faced with oil prices that fall considerably, at least for a while, until the market comes back into balance.

The International Energy Agency (IEA) made headlines around the world earlier this week when it published a major report predicting that the United States would pass Saudi Arabia to become the world’s largest oil producer by 2017. It is a striking conclusion that reinforces much of what industry analysts have been writing for the past several months. But buried in the report is a major assumption that underpins its conclusions: the IEA analysts assume that OPEC producers will hold a substantial amount of oil off the market in order to prop up prices. A similar assumption, often implicit rather than explicitly stated, underlies many other optimistic analyses too. The IEA report tips its hand in an aside on page 124. Here’s what it says: “In the New Policies Scenario, demand rises by 5.7 mb/d by 2017, implying a substantial increase in the amount of effective spare capacity, all of which is in OPEC countries, from 2.6 mb/d in 2011 to 5.9 mb/d in 2017.” The New Policies Scenario assumes some modest moves toward new policy on energy efficiency and alternatives; the “Current Policies Scenario” sees roughly a million or so more barrels a day of demand by 2017. It’s reasonable to say that the IEA assumes that OPEC will hold an extra four million barrels a day or so of spare capacity beyond what it has in recent years by 2017. This is a big assumption. As Bob McNally and I wrote in Foreign Affairs last year, a host of forces are conspiring against OPEC members choosing to hold much more spare capacity than they have carried in recent years. Indeed when I visited Kuwait earlier this week, I consistently heard that the country was likely to essentially get out of the spare capacity game, leaving only the UAE, and primarily Saudi Arabia, balancing the market. It doesn’t strike me as reasonable to assume that Saudi Arabia to more than double its spare capacity over the next five years (though anything can happen). That leaves two other possibilities. The first is that OPEC members could cut back on their planned investments. That would leave them with less oil to sell – certainly a financial sacrifice, but far less of one than building new infrastructure and then not using it to produce oil. Indeed the head of OPEC warned of just this possibility in London conference yesterday. If that doesn’t happen then there is a third possibility: oil prices will fall in order to balance the market. Part of their function would be to incentivize greater oil demand. But plunging prices would also serve to deter investment and production outside of OPEC. New Canadian oil sands projects would probably be the most vulnerable – but depending on how far prices fell U.S. tight oil could be next. The IEA report acknowledges the possibility of a price decline. It says in response that it “assume[s] (as apparently does the oil futures curve) that geopolitical risks will counterbalance the better supplied market to sustain oil prices in this period.” I’m skeptical of this claim. “Geopolitical risks” are often trotted out to explain temporarily elevated prices. But it’s very difficult to see how they’d be sufficient to sustainably bridge a gap as big as the one that the IEA identifies. (More on that, perhaps, in another post.) The agreement of the futures curve with the IEA projections is at least as likely to be coincidental. That leaves us with three possibilities: U.S. oil booms and OPEC producers massively raise the amount of spare capacity they hold (unlikely); U.S. oil booms and OPEC producers cut back on investment (more likely); and an oversupplied market pushes prices down far enough to stall the U.S. oil boom, at least temporarily, within the next five or so years (not unreasonable either). Only time will tell which one of these comes to pass.

A massive cyberattack this summer on Saudi Aramco, Riyadh’s energy giant, left some 30,000-plus of the company’s computers lifeless, making a rather futuristic threat to the oil and gas industry front page news. U.S. Secretary of Defenese Leon Panetta called the attack “probably the most destructive…that the business sector has seen to date.” The Saudis weren’t the only targets. RasGas, a Qatari natural gas company, was also hit. Months later, investigators are still trying to get to the bottom of what happened, and more importantly, why it did, and what can stop it from happening again. In a piece for The National Interest, I argue that cyberattacks on oil assets around the world pose a real risk to energy prices, and hence the U.S. economy. They also jeopardize the competitiveness of American firms abroad. It’s an issue where national security and economic well-being meet. And it’s a challenge that’s not going away. The risks of hackers penetrating the country’s electrical grid have been widely discussed for years. Less so what cyber means for oil and gas companies and markets. U.S. officials and the global energy industry have their hands full in coming to terms with this new virtual landscape. Check out the piece here.

In a post earlier this week, I argued that people who want serious action on climate change will need to build bipartisan coalitions, which will require accepting oil and gas development. Most of the responses were encouraging, but one type of reaction was not. It came from proponents of oil and gas development, and went something like this: “Great post. But the United States can’t do anything about climate change because [it’s too expensive][renewable energy sucks][China won’t act][etc]”. That reaction highlights something important: climate advocates aren’t the only ones who are going to need to build coalitions and accept compromise in order to get what they want. Enthusiasts for oil and gas development need to realize that they’re in a similar boat. Oil and gas developers and their allies are both fighting against opposition that is focused most prominently on fracking and on the Keystone XL pipeline but that extends to issues like access to offshore acreage and fossil fuel exports too. Just like proponents of aggressive action on climate change, they’ve tried to win the policy fight in substantial part through aggressive messaging in favor of their cause. And, just like the climate advocates, they aren’t quite getting what they want. That means that they too could benefit from making some mutually beneficial deals. Indeed the same sort of deal that I argued climate advocates should be looking for – serious action on climate change in exchange for expanded opportunities for production of oil and gas – is what advocates for oil and gas development should have on their minds. In arguing that climate advocates should favor such a deal I emphasized one central point: the tradeoff wouldn’t fundamentally undermine their core goals. That’s because U.S. oil production is unlikely to have a large impact on world oil consumption and because natural gas is currently displacing coal. Something similar ought to motivate enthusiasts for U.S. oil and gas production. Instead of asking, “Is serious U.S. action on climate change a good idea?”, they should ask this: “Is a package that expands opportunities for U.S. oil and gas production, while at the same time takes serious action on climate change, something that we prefer to the status quo?” Just as people who are concerned about climate change don’t need to become oil and gas boosters in order to see the wisdom of compromise, proponents of expanded oil and gas production don’t need to become “climate people” in order to see the merits of making sensible deals. All they need to do is accept that serious U.S. climate action, regardless of whether if it solves the climate problem, isn’t the end of the world – and that it can be done without undermining their own core goals. It turns out that oil and gas advocates have a similar pair of options to what climate advocates have. They can try to unilaterally push through their preferred options -- or they can try to build coalitions that might not seem obvious at first blush. The latter path may be trickier, but it also raises the odds of real success.

The debate over the consequences of rising American oil production has featured a wide range of serious but conflicting views from a host of informed people. This, from well-informed industry publisher Platts, is not one of those views: “Interdependence has been a consistent theme in the world of oil for many years, the idea that even a small supply disruption in one part of the globe can have an impact thousands of miles away. Well, say goodbye to that notion, or at least part of it. The International Energy Agency has looked into the not-too-distant future and it sees a world divided between an increasingly self-contained western hemisphere and pretty much everywhere else.” The article goes on to explain how shifting patterns of production and refining are splitting the world oil market in two. Indeed there’s something to that prediction: over the next decade, oil trade is likely to become more regional, with the western hemisphere trading more with itself, and everyone else trading more among themselves. But there is nothing about this that warrants the conclusion that “even a small supply disruption in one part of the globe” will no longer “have an impact thousands of miles away”. Part of me wants to ignore claims like this because they seem so patently wrong. But they’re being peddled by smart people who know a lot about energy, so they need to be challenged. Suppose that there’s a supply disruption outside the western hemisphere (perhaps in the Middle East). In the no-impact-thousands-of-miles-away scenario, prices rise outside the western hemisphere (i.e. the usual), but they don’t rise in it (otherwise that would be an impact thousands of miles away). That raises a question: Why the heck don’t traders react by shipping oil from the western hemisphere to the higher price region or by cutting back on shipments from the higher price region to the western hemisphere? If they do, prices will rise in the western hemisphere, which means that the impact of the disruption will indeed be felt thousands of miles away. For the Platts theory to hold up, then, there needs to be some reason that traders don’t actually react this way. One can actually imagine a couple of potential reasons that traders wouldn’t react in the way that I’ve outlined. The first is if there’s a shortage of oil tanker capacity (and if we’re looking at the scenario where more western hemisphere oil gets shipped east in response to a disruption). I’ve been working on some modeling for a while now that looks at this possibility. But it almost certainly isn’t relevant here. For starters, we’re talking about small disruptions, which shouldn’t strain a global shipping system that always has at least a bit of spare capacity. Moreover, when oil supply is disrupted, that frees up the tankers that would otherwise have been moving that oil. Once again, it’s tough to engineer a supply disruption that leaves the world short of the tanker capacity needed to arbitrage across distant markets. The other possibility arises if, prior to the supply disruption, the western hemisphere is in perfect isolation, with absolutely no oil moving across the oceans in any direction. In that case, a small supply disruption abroad can move eastern hemisphere prices up so little that it remains uneconomic to ship and oil from east to west (since shipping costs money). But this is what economists call a “knife edge” condition – one can specify it in theory, but it practice, there’s an almost zero chance that it will occur. The bottom line? So long as physical oil traders are out there trying to make a buck, and so long as governments don’t constrain their ability to do that through export or import controls, the western and eastern hemispheres will not be independent of each other, even if most oil trade becomes constrained to regional routes. That has big economic and security consequences – which makes it important to get right.

Today the State Department released  the thirty-seventh volume of its history of U.S. foreign relations. It’s one that many readers of this blog will find fascinating. “Energy Crisis: 1974-1980” runs 1,004 pages, consisting mostly of previously classified meeting records and memos that give a window into a tumultuous time in U.S. energy history, and one in which many of the roots of our ongoing energy debates were first established. I obviously haven’t had time to read all the way through, but upon skimming, one thing in particular struck me. (If you want the juicy quotes, check out my colleague Micah Zenko’s post.) When we think about the relationship between oil markets and international relations today, one of the most important features we often focus on is the existence of a robust spot market, in which buyers and sellers can come together to discover the “right” price for oil. Spot markets make the geographic origin of any country’s oil far less important than it otherwise would be: If a regular oil source cuts off supplies, the consumer can turn to the spot market for relief. Spot markets therefore help depoliticize the global oil market and provide critical resilience for consumers. In the new State Department history, the words “spot market” only appear once prior to late 1978, but at that point, they start coming up a lot. Unlike today, though, the spot market isn’t seen as a savior – instead, it’s a menace. “Spot market is a small residual market that is not representative of appropriate or market clearing prices,” warns one State Department cable. In May 1979, the Treasury Secretary floats the possibility of an “agreement by the oil-importing counties to boycott the spot market”.  That June, the Secretary of State writes that “we will seek to diminish substantially the role of the spot market – and thus bring more order into the world’s oil pricing and marketing system”. Throughout the discussion a consistent theme emerges: spot markets are too vulnerable to speculators, and must thus be suppressed. There are at least two lessons worth taking away from the sharply different view of a critical element of today’s global energy system. The first concerns financial speculators. It’s tough to read the 1970s rhetoric about spot markets without hearing echos of how people talk about oil-related financial markets today, right down to the worries about speculation, lack of transparency, and price distortions, and the potential benefits of reining dangerous markets in. When it came to physical markets, though, the best cure for small and volatile spot markets turned out to be bigger and more liquid ones (along with greater transparency). The same may be true for commodities-related financial markets today: the right cure for whatever problems they currently pose may be a mix of greater scope (rather than new restrictions) along with more transparency. The second lesson is that the current market-based system of assuring energy security was never inevitable or somehow the natural order of things. Instead, it’s a political construct, and one that didn’t come into being easily. It would be unwise to assume without question that it will be around forever.