Fossil Fuels | Council on Foreign Relations

Fossil Fuels

Americans Don’t Seem to Want Lower Gas Prices

It’s difficult to open a newspaper or turn on the TV without hearing that Americans are apoplectic about skyrocketing gas prices. If ever there was a moment to channel public anger toward policy progress, this would seem to be it. So I was intrigued to see a new poll from Hart Research Associates, commissioned by the Center for American Progress Action Fund, which tests a series of messages about gas prices and policy responses to see which ones would work best. The poll’s sponsors seem to be excited by the results, writing that “the strongest policy solutions are the ones being advocated by progressives”. But here’s what they find: The four policies that voters most believe can help a lot with addressing gas prices are: American Oil for American Soil. Require oil companies to use the oil that is produced in the United States from public lands and offshore to meet energy needs here at home, and stop oil companies from exporting oil from our public lands and waters to overseas markets. (60 percent [support]) End Oil Subsidies. Repeal the four billion dollars per year in federal subsidies that currently are given to the oil companies, and use that money instead to fund investmentsthat will make us less dependent on oil. (55 percent [support]) Crack Down On Excessive Speculation. Tighter oversight and regulation of Wall Street speculators to prevent them from artificially driving up the price of gasoline. (54 percent [support]) More Fuel Efficient Cars and Trucks. Increase fuel-efficiency standards for cars and trucks, so they get more miles per gallon and consumers will save on their gasoline costs. (49 percent [support]) Let’s take these one at a time. The United States exports a minuscule amount of crude oil (no more than sixty thousand barrels a day at any time in the last decade), most of which doesn’t come from public lands, and all of which is traded for logistical reasons that save Americans money at the pump. That makes “American Oil for American Soil” at best a solution to a non-existent problem. Ending unwise oil subsidies would be great. There is also zero chance that it would reduce gas prices, let alone “help a lot with addressing” them. There’s a better case to be made when it comes to excessive speculation, which at least might be a real problem – it’s tough to argue that there isn’t some dumb money distorting prices on short time scales. But there’s no evidence that “excessive” speculation is a big part of what’s driving up the price of gas, particularly over the longer run. Economic fundamentals, along with fear of conflict over Iran , are the big culprits today. “Cracking down” on “excessive speculation” would do little to the price of gas. The only genuinely powerful proposal among the four that the poll flags is the fourth: increasing fuel efficiency standards for cars and trucks. Yet even with a nudge (the poll question points out that the standards would help consumers “save on their gasoline costs”), fewer that half of Americans seem to be on board. This is all deeply dismaying. People say that they want lower gas prices, and of course, I don’t doubt that that’s true. But they don’t seem all that interested in pursuing policies that might deliver them – instead, they seem more interested in gimmicks and distractions. Perhaps Americans don’t really want lower gas prices after all.

Blog Post by Michael Levi March 27, 2012 Energy, Security, and Climate
Fossil Fuels

Perception, Reality, and the Consequences of the U.S. Oil & Gas Boom

Cliff Krauss and Eric Lipton have an epic, must-read piece in today’s New York Times on the boom in U.S. oil and gas. It includes a quote from me that I ought to briefly expand on: “There is no question that many national security policy makers will believe they have much more flexibility and will think about the world differently if the United States is importing a lot less oil.” It’s not the snappiest line, but it’s convoluted for a reason. In particular, the words “believe” and “think” are essential. Analysts have an awful habit of confusing the ways that they think policymakers should behave with the ways that policymakers do behave. If basic economics tells analysts that eliminating imports from OPEC would do nothing to shield the United States from the vagaries of Middle East conflict, they conclude that policymakers will not alter their approach to the region in the face of tectonic oil market shifts. If the literature tells them that consumption, not production, is what matters most to the fate of the U.S. economy in the face of volatile oil prices, they’ll conclude that leaders will not fundamentally alter their overseas strategies simply because production has surged. This is a terribly blinkered way of looking at the world of international politics. Leaders act upon their beliefs, not upon what economic theory says – and, to judge, from the volume of writing by analysts attacking politicians for misunderstanding basic energy economics, it’s pretty clear that those beliefs don’t always line up with reality. That’s a big part of why the changing U.S. position in the energy world will likely have big consequences – leaders think it’s important, and they’re going to act on that. To be certain, there are also real economic consequences that follow from the changes underway in the energy scene, and real geopolitical implications that follow regardless of how leaders react. But that may be the smaller part of the puzzle. Those who ignore the role of leaders’ perceptions may be mighty surprised with how the future unfolds.

Blog Post by Michael Levi March 23, 2012 Energy, Security, and Climate
Fossil Fuels

Natural Gas and Climate Change: It’s Policy that Matters

Study after study seems to be reaching the same conclusion: abundant natural gas is no solution for climate change. Indeed some scientists, having looked at the numbers, have come to an even harsher conclusion: there is so much unconventional gas in the ground that our only hope for dealing with climate change is to leave it untouched. The chart below, which is frequently invoked by skeptics of unconventional resource development, seems to reinforce the point. The amount of carbon contained in conventional oil and gas makes their extraction look tolerable, but the amount contained in unconventional gas (and in coal) is literally off the charts. Chart courtesy of James Hansen Alas this picture is hugely misleading. Here’s another series of charts that shows why. The first chart shows four different estimates. The top two both show projected carbon dioxide emissions from the U.S. power sector; each has a different assumption about U.S. gas reserves. One assumes that natural gas is roughly as abundant as we thought it was in 2010, while the other assumes that reserves are substantially larger. You’ll notice that projected emissions are barely affected by the choice. EIA Projections of Power Sector Emissions Under the American Power Act Now look at the bottom two lines. They’re both projections of what would have happened to power sector emissions had the Kerry-Lieberman cap-and-trade bill passed; one assumes moderate gas resources while the other assumes much larger ones. Those two lines are both radically lower than the ones without policy – but they’re both similar to each other. The lesson is simple: it’s the policy, not the gas resource, that matters most. Indeed if you look closely, emissions fall more if gas resources are larger, because gas with CCS becomes an economically attractive emissions-cutting option. Perhaps this is an artifact of the particular policy? Nope. Here’s a similar chart, this time with a Clean Energy Standard rather than cap-and-trade. The pattern is the same. EIA Projections of Power Sector Emissions Under Clean Energy Standard None of this should surprise you. Absent demand-side policy, abundant natural gas displaces coal and renewable power, and increases electricity consumption. With demand-side policy, abundant natural gas displaces renewable and nuclear power, unless CCS isn’t available, in which case, by the 2030s, gas gets phased out. But cheap natural gas does have one big bonus from a climate perspective: it makes cutting emissions less expensive. The lesson for people who care about climate change should be simple. Focus on constraining gas supplies, and even if you win, you’re unlikely to effect much change. Concentrate on demand side policy and your odds of victory may be longer, but a win will be far more worthwhile.

Blog Post by Michael Levi March 19, 2012 Energy, Security, and Climate

United States

How to Handle Oil Price Volatility

Prices at the pump are emerging as a significant U.S. election issue. Five experts offer a range of policy options, from lowering regulations to encouraging less consumption.

Expert Roundup by Toni Johnson, Michael Levi, Daniel P. Ahn, Nicolas Loris, Daniel J. Weiss and Robert McNally March 16, 2012
Iran

Using the Strategic Petroleum Reserve: In for an Inch, In for a Mile

Oil prices are on the rise, and with them so are rumors of a possible release from the Strategic Petroleum Reserve. I’m ambivalent about the wisdom of a release later this year, on both economic and political grounds. In this post, though, I want to drill down on a separate point: the United States should only release oil from the SPR if it’s fully committed to further releases as the year goes on. An SPR release would probably do two things. By adding oil to the market, it would lower prices from where they otherwise would be. That would hurt anyone who had been betting on higher prices, either through financial markets or by stockpiling oil themselves. As a result, a release would also deter private stockpiling and financial speculation on high prices. That’s all well and good if you believe that private hoarding and financial speculation are bad things. But they’re only bad if they’re based on irrational beliefs. If, subsequent to an SPR use, sanctions on Iran or even military conflict took additional oil off the market, the economy would be more exposed that it would have been without a prior SPR release. Private stockpiles would be less adequate to buffer the resulting shock. Oil prices, previously depressed by the release, would jump by more than they otherwise would have, creating greater pain for consumers. The government would thus need to step in once again with a further SPR release to counteract these dynamics. This is fundamentally different from the situation that surrounded the SPR release last year. Then, the government was responding to previous disruption in Libya; it had good reason to think that a bigger shock wasn’t on the way. But this year is different. Speculators are responding to the prospect of escalating conflict with Iran, and it’s not clear that they’re wrong to do that. There’s one caveat to all this: an SPR release could backfire. One good reason to release oil from the SPR is to help prime the market for an attack on Iran. If market participants concluded from an SPR release that the U.S. government had decided that an imminent attack was far more likely than they’d previously believed, they might react by bidding up prices and driving oil into stockpiles. That would be the opposite pattern from the one I’ve just described. Of course, if the U.S. government expected such an outcome, it would probably be unwise to release oil in the first place. In any case, the bottom line is straightforward. An SPR release would send a simple message to private players: the government is going to handle rising oil prices; you can step back. Once government decides to make handling price volatility a public, rather than private, job, it needs to be fully committed to sticking with that program, wherever that leads.

Blog Post by Michael Levi March 15, 2012 Energy, Security, and Climate
Sub-Saharan Africa

South Africa: An Alternative to Iran Oil?

Reuters reports that on March 13, South Africa’s minister of energy, Elizabeth Dipuo Peters, said that South Africa is looking to have in place by the end of May a plan for an alternative to Iranian crude, suggesting Venezuela as a possibility. She told Reuters the United States is not pressuring South Africa to cut Iranian imports nor has Iran offered South Africa concessionary prices. U.S. pressure would be a red flag for parts of the ruling African National Congress that are suspicious of alleged Western "neo-colonialism" in Africa. Iran supplies South Africa with up to thirty percent of its energy imports. The energy relationship between South Africa and Iran is long standing, extending back to the apartheid era. Many refineries in South Africa are specifically designed for Iranian crude. Hence, a shift away from Iranian crude is a big South African decision. Nevertheless, South Africa is a party to the UN sanctions against Iran, the most likely reason for moving away from Iranian oil, despite the likely significant costs. That South Africa is taking concrete steps to end its dependency on Iranian oil, and the explicit recognition by the minister of energy that the move was not the result of American pressure, suggests that Iran may be an area where close consultation between the Obama and Zuma administrations could be fruitful and strengthen the bilateral relationship.

Blog Post by John Campbell March 14, 2012 Africa in Transition

Fossil Fuels

Did Natural Gas Save the Pennsylvania Economy?

It’s become popular to point to record low unemployment in North Dakota in order to show how greater oil and gas production could transform the U.S. economy. I’ve argued on several occasions that the numbers simply don’t add up at the national level. Over the past couple days, Paul Krugman has gotten in on the game, hammering away at the fact that the North Dakota case simply doesn’t scale up. His most recent post takes things a step further, going beyond making claims at the national level and taking on the contention that fracking has helped shield Pennsylvania from the recession. He presents two charts: the first one shows that the scale of the North Dakota and Pennsylvania booms are almost identical; the second shows how these add up very differently in the context of two states of very difference sizes. Hence he concludes: “North Dakota has had a major employment boom, because 15,000 resource jobs are a big deal in a state with fewer than 700,000 people. Pennsylvania has not; it has done a bit better than the nation as a whole, but that probably has as much to do with the absence of a big housing bubble as with fracking.” Somewhat to my surprise, the numbers back that up. The plot below shows two numbers. The unemployment rate in Pennsylvania hasn’t climbed as much as the national rate has. The blue line is my estimate of the number of additional jobs that Pennsylvania would have lost had it followed the national unemployment trend since the recession started. I’ve used a total Pennsylvania labor force of 6.4 million people to get these numbers. The red line is my estimate of the gain in jobs due to the natural gas boom. I start with reported data for employment gains in the mining and natural resources sector. Then I take into account the fact that natural gas jobs spin off other ones: bobs are created in companies that supply the industry and in establishments that serve its employees. Including these indirect and induced jobs is normally misleading, but for an economy well away from full employment, it’s the correct approach. IHS-CERA (in, to be fair, a report commissioned by the gas industry) estimates that every job in the industry drives three jobs elsewhere. Some of these will be in other states, so let’s go with a 1:2 ratio for now. The plot tells an interesting story. Pennsylvania did better than the rest of the economy through the worst of the recession. But that was before fracking took off. And Krugman is right that Pennsylvania housing didn’t tank in the same way that it did in the rest of the country: It is indeed housing that appears to have partially spared Pennsylvania. Where natural gas development has become a force is in the last couple years – after the recession officially ended. Yet that’s a period over which the employment gap between Pennsylvania and the rest of the country has been closing. What’s going on? There’s little question that the gas boom has helped the state grow in the aftermath of the recession. That’s fortunate, because it seems that while natural gas has delivered jobs, something else has been taking others away almost as quickly.

Blog Post by Michael Levi March 14, 2012 Energy, Security, and Climate
Iran

From Tehran with Love

As the Iranian oil embargo begins to bite, the widespread assumption is that this should hurt Iran’s oil revenues and government budgets, hopefully inflicting enough economic pain to bring them to the bargaining table. But rather counterintuitively, some basic economics suggest Iran may have cause to thank the United States, European Union, and embargo participants for helping raise their total oil revenue! This can happen because while the embargo against Iran is reducing the overall amount of oil Iran can sell (at least for now), the drop in supply also raises the price for oil and therefore increase the revenue earned on each barrel of oil that Iran can still sell. Which factor wins out? To answer this question, I did a very simple analysis. Let’s say that Iran exports 2.2million barrels of crude oil every day (mb/d), out of global consumption of say 87mb/d. Suppose the international community manages to embargo 100kb/d of exports, so that Iran now can only sell 2.1mb/d of oil. What would that do to Iran’s total oil revenue? Well, the amount of oil that Iran can sell goes down from 2.2mb/d to 2.1mb/d but on the other hand, the price of oil goes up. How much? This depends on the short-term price elasticity of global oil demand. This elasticity determines the relationship, in particular the ratio, of changes in oil prices to oil demand quantities in equilibrium. Good estimates of the price elasticity of global oil demand are hard to get because of data and other statistical issues. But my own estimates put it at 0.02 within one year. Folks at the IMF put it at 0.01 for the non-OECD and 0.04 for the OECD. Assuming that oil prices would be at $100/bbl if there were no embargo, I calculated what would happen to Iran’s total oil revenue in the short-term over different embargo levels and different elasticities. This chart shows my results. It turns out that for low enough elasticities and low enough embargo levels, an embargo can actually raise Iran’s total oil revenue! The price effect overpowers the lower quantity effect. Now a rough guess as to the total amount of oil feasibly embargoed by the United States, European Union, and allies may be 500kb/d. Using my elasticity of 0.02, that puts the hypothetical oil revenue at $80bn annually, a hair lower than the $80.3 it would have been without embargo. So the embargo may be hurting but so little as to be almost useless. Obviously in the real world, there are a lot of other factors that this simple analysis fails to capture. One, there may be more production from elsewhere to offset lost Iranian exports, notably from Saudi Arabia. On the other hand, this rhetoric and fear around an escalation and possible military confrontation in the world’s busiest oil chokepoint has put in more risk premia into oil markets as well. And Tehran has every reason to play up that market fear. Coincidence that the (eventually unfounded) rumor of a fire in a Saudi pipeline that spooked oil markets recently originated from an Iranian media outlet? Proponents of the embargo may have to recognize this dynamic which is undermining its effectiveness, and either increase the quantities embargoed or else try to mitigate the price channel. If not, Tehran may be justified in sending a big schadenfreude-laden Thank You card to Washington and Brussels!

Blog Post by Daniel P. Ahn March 12, 2012 Energy, Security, and Climate
Cuba

Addressing the Risk of a Cuban Oil Spill

Is oil drilling in Cuban waters safe? Or might a “Cuban oil crisis” be upon us? And is the United States prepared for the possibility of a major spill just sixty miles from the Florida keys? They’re good questions, and ones that have been generating an increasing amount of buzz ever since Repsol finalized plans with the Cuban government to drill a well about thirty miles north of Havana. Drilling began the last week of January. One of my colleagues at the CFR, Captain Melissa Burt of the U.S. Coast Guard, and I just published a short piece making our case for why, and how, the the United States should address the threat of an oil spill emanating from Cuba. You can access the report here. Here’s our framing: "The imminent drilling of Cuba’s first offshore oil well raises the prospect of a large-scale oil spill in Cuban waters washing onto U.S. shores. Washington should anticipate this possibility by implementing policies that would help both countries’ governments stem and clean up an oil spill effectively. These policies should ensure that both the U.S. government and the domestic oil industry are operationally and financially ready to deal with any spill that threatens U.S. waters. These policies should be as minimally disruptive as possible to the country’s broader Cuba strategy." It’s politically tricky territory for the Obama Administration, certainly, and yet Captain Bert and I argue that there’s good reason for U.S. policymakers to take some basic precautions that need not comprise any significant revision to existing policy. These defensive measures can help lower the risk of a second Deepwater Horizon, this time coming from Cuba.

Blog Post by Blake Clayton March 8, 2012 Energy, Security, and Climate
Heads of State and Government

What Do High Gas Prices Mean for the 2012 Election?

Pundits love to talk about how gasoline prices might influence the upcoming presidential election. So it might surprise people to know that political scientists have spent precious little time investigating the relationship between oil and electoral outcomes. The first step in getting our arms around how pain at the pump might play at the ballot box is to pull together some good data. Trevor Houser has done us the favor of delivering just that. In a new research note published today, Trevor breaks down the gasoline picture state by state, and asks the gas price question three different ways. The first is the obvious one: how do current gas prices vary with political preference? Plotting pump prices against the state-level Partisan Voting Index doesn’t reveal much that’s surprising: blue states see relatively high gasoline prices, red states see lower ones, and purple states are in the middle. When I stare at the chart, though, one interesting thing jumps out. Most purple states have average prices hovering just below four dollars a gallon; if prices rise in the coming months, and the four dollar threshold caries psychological weight, that can’t be good news for the President heading into the summer. Things get more interesting when Trevor asks a different question: how much are people actually paying every month? The chart below (reprinted with permission) shows the results. It’s precisely the reverse pattern from the one you get when you look at gas prices alone, and suggests that the two biggest swing states – Pennsylvania and Florida – are doing better than one might assume at first glance. There’s a final twist in the analysis that’s particularly interesting. Several states are seeing booming oil production alongside rising pump prices. That can help offset the statewide impact of increasingly expensive crude. To very roughly estimate this dynamic, Trevor looks that the monthly per capita income change resulting from a ten dollar rise in crude prices, assuming that all revenues from production remain in state. With the exception of a handful of deep red states, and the possible (purple) exception of New Mexico, pretty much everyone else loses on net from high prices. It’s a neat analysis, with a bunch more charts and specifics than I’ve shared here. Once you’re done looking at it, come back here, and share some anecdotes: how are gas prices playing politically where you live?

Blog Post by Michael Levi March 7, 2012 Energy, Security, and Climate
Cuba

Addressing the Risk of a Cuban Oil Spill

The imminent drilling of Cuba's first offshore oil well raises the prospect of a large-scale oil spill in Cuban waters washing onto U.S. shores. Washington should anticipate this possibility by implementing policies that would help both countries' governments stem and clean up an oil spill effectively. These policies should ensure that both the U.S. government and the domestic oil industry are operationally and financially ready to deal with any spill that threatens U.S. waters. These policies should be as minimally disruptive as possible to the country's broader Cuba strategy. The Problem A Chinese-built semisubmersible oil rig leased by Repsol, a Spanish oil company, arrived in Cuban waters in January 2012 to drill Cuba's first exploratory offshore oil well. Early estimates suggest that Cuban offshore oil and natural gas reserves are substantial—somewhere between five billion and twenty billion barrels of oil and upward of eight billion cubic feet of natural gas. Although the United States typically welcomes greater volumes of crude oil coming from countries that are not members of the Organization of Petroleum Exporting Countries (OPEC), a surge in Cuban oil production would complicate the United States' decades-old effort to economically isolate the Castro regime. Deepwater drilling off the Cuban coast also poses a threat to the United States. The exploratory well is seventy miles off the Florida coast and lies at a depth of 5,800 feet. The failed Macondo well that triggered the calamitous Deepwater Horizon oil spill in April 2010 had broadly similar features, situated forty-eight miles from shore and approximately five thousand feet below sea level. A spill off Florida's coast could ravage the state's $57 billion per year tourism industry. Washington cannot count on the technical know-how of Cuba's unseasoned oil industry to address a spill on its own. Oil industry experts doubt that it has a strong understanding of how to prevent an offshore oil spill or stem a deep-water well blowout. Moreover, the site where the first wells will be drilled is a tough one for even seasoned response teams to operate in. Unlike the calm Gulf of Mexico, the surface currents in the area where Repsol will be drilling move at a brisk three to four knots, which would bring oil from Cuba's offshore wells to the Florida coast within six to ten days. Skimming or burning the oil may not be feasible in such fast-moving water. The most, and possibly only, effective method to respond to a spill would be surface and subsurface dispersants. If dispersants are not applied close to the source within four days after a spill, uncontained oil cannot be dispersed, burnt, or skimmed, which would render standard response technologies like containment booms ineffective. Repsol has been forthcoming in disclosing its spill response plans to U.S. authorities and allowing them to inspect the drilling rig, but the Russian and Chinese companies that are already negotiating with Cuba to lease acreage might not be as cooperative. Had Repsol not volunteered to have the Cuba-bound drilling rig examined by the U.S. Coast Guard and Bureau of Safety and Environmental Enforcement to certify that it met international standards, Washington would have had little legal recourse. The complexity of U.S.-Cuba relations since the 1962 trade embargo complicates even limited efforts to put in place a spill response plan. Under U.S. law and with few exceptions, American companies cannot assist the Cuban government or provide equipment to foreign companies operating in Cuban territory. Shortfalls in U.S. federal regulations governing commercial liability for oil spills pose a further problem. The Oil Pollution Act of 1990 (OPA 90) does not protect U.S. citizens and property against damages stemming from a blown-out wellhead outside of U.S. territory. In the case of Deepwater Horizon, BP was liable despite being a foreign company because it was operating within the United States. Were any of the wells that Repsol drills to go haywire, the cost of funding a response would fall to the Oil Spill Liability Trust Fund (OSLTF), which is woefully undercapitalized. OPA 90 limits the OSLTF from paying out more than $50 million in a fiscal year on oil removal costs, subject to a few exceptions, and requires congressional appropriation to pay out more than $150 million. The Way Forward As a first step, the United States should discuss contingency planning for a Cuban oil spill at the regular multiparty talks it holds with Mexico, the Bahamas, Cuba, and others per the Cartagena Convention. The Caribbean Island Oil Pollution Response and Cooperation Plan provides an operational framework under which the United States and Cuba can jointly develop systems for identifying and reporting an oil spill, implement a means of restricting the spread of oil, and identify resources to respond to a spill. Washington should also instruct the U.S. Coast Guard to conduct basic spill response coordination with its counterparts in Cuba. The United States already has operational agreements in place with Mexico, Canada, and several countries in the Caribbean that call for routine exercises, emergency response coordination, and communication protocols. It should strike an agreement with Cuba that is substantively similar but narrower in scope, limited to basic spill-oriented advance coordination and communication. Before that step can be taken, U.S. lawmakers may need to amend the Cuban Democracy Act of 1992 to allow for limited, spill-related coordination and communication with the Cuban government. Next, President Barack Obama should issue an export-only industry-wide general license for oil spill response in Cuban waters, effective immediately. Issuing that license does not require congressional authorization. The license should allow offshore oil companies to do vital spill response work in Cuban territory, such as capping a well or drilling a relief well. Oil service companies, such as Halliburton, should be included in the authorization. Finally, Congress should alter existing oil spill compensation policy. Lawmakers should amend OPA 90 to ensure there is a responsible party for oil spills from a foreign offshore unit that pollutes or threatens to pollute U.S. waters, like there is for vessels. Senator Robert Menendez (D-NJ) and Congressman David Rivera (R-FL) have sponsored such legislation. Lawmakers should eliminate the requirement for the Coast Guard to obtain congressional approval on expenditures above $150 million for spills of national significance (as defined by the National Response Plan). And President Obama should appoint a commission to determine the appropriate limit of liability cap under OPA 90, balancing the need to compensate victims with the desire to retain strict liability for polluters. There are two other, less essential measures U.S. lawmakers may consider that would enable the country to respond more adeptly to a spill. Installing an early-response system based on acoustic, geophysical, or other technologies in the Straits of Florida would immediately alert the U.S. Coast Guard about a well blowout or other unusual activity. The U.S. Department of Energy should find out from Repsol about the characteristics of Cuban crude oil, which would help U.S. authorities predict how the oil would spread in the case of a well blowout. Defending U.S. Interests An oil well blowout in Cuban waters would almost certainly require a U.S. response. Without changes in current U.S. law, however, that response would undoubtedly come far more slowly than is desirable. The Coast Guard would be barred from deploying highly experienced manpower, specially designed booms, skimming equipment and vessels, and dispersants. U.S. offshore gas and oil companies would also be barred from using well-capping stacks, remotely operated submersibles, and other vital technologies. Although a handful of U.S. spill responders hold licenses to work with Repsol, their licenses do not extend to well capping or relief drilling. The result of a slow response to a Cuban oil spill would be greater, perhaps catastrophic, economic and environmental damage to Florida and the Southeast. Efforts to rewrite current law and policy toward Cuba, and encouraging cooperation with its government, could antagonize groups opposed to improved relations with the Castro regime. They might protest any decision allowing U.S. federal agencies to assist Cuba or letting U.S. companies operate in Cuban territory. However, taking sensible steps to prepare for a potential accident at an oil well in Cuban waters would not break new ground or materially alter broader U.S. policy toward Cuba. For years, Washington has worked with Havana on issues of mutual concern. The United States routinely coordinates with Cuba on search and rescue operations in the Straits of Florida as well as to combat illicit drug trafficking and migrant smuggling. During the hurricane season, the National Oceanic and Atmospheric Administration (NOAA) provides Cuba with information on Caribbean storms. The recommendations proposed here are narrowly tailored to the specific challenges that a Cuban oil spill poses to the United States. They would not help the Cuban economy or military. What they would do is protect U.S. territory and property from a potential danger emanating from Cuba. Cuba will drill for oil in its territorial waters with or without the blessing of the United States. Defending against a potential oil spill requires a modicum of advance coordination and preparation with the Cuban government, which need not go beyond spill-related matters. Without taking these precautions, the United States risks a second Deepwater Horizon, this time from Cuba.

Policy Innovation Memorandum by Captain Melissa Bert, USCG and Blake Clayton March 7, 2012
Iran

Revisiting High Oil Prices and the U.S. Economy

Given how oil is back in the media spotlight and as oil markets brace for the implementation of the Iranian oil embargo, it seems as good a time as any to revisit the question of high oil prices and their impact on the U.S. economy (as well as revitalize my hitherto moribund blog output), discussed at length in this post. According to the U.S. CPI, the average U.S. (urban) consumer currently spends about 9% of his or her income on energy. About 5.2% is on gasoline alone. With the surge in Brent prices again to $125/bbl or near 100 euros, gasoline prices (even in cheap New Jersey) are getting close to the psychologically significant $4/gallon threshold. Some media still discuss WTI crude oil prices which are still trading at a significant discount to Brent but most refined product prices, especially in the U.S. Gulf and East Coast, are tracking more closely the Brent market, which is waterborne and a better recent indicator of global tightness. So how high do Brent prices need to go for the economy to slow down or even go into a recession? One way to answer this question is to look at it historically. Back in the late 1970s, we spent a whopping 8% of GDP on oil. In 2008, we spent 4.8% of GDP on oil, with a peak of 6.6% in the month of June. Currently, we are spending about 4.5-5% on GDP. So are we uncomfortably close to reaching stall speed again? The problem with this historical analysis is that our economy is a lot different of that in the 1970s or even 2007-08. Notably, as everyone knows, the economy is now a lot more energy efficient than the 1970s. Even compared to 2008, U.S. domestic oil consumption has trailed previous consumption levels despite regaining our previous level of output and despite fairly strong output and labor numbers recently, as my colleague emphasized recently in this post. I believe we are seeing the delayed impact of the previous price spike on consumption behavior and improved conservation/efficiency. Also, we are enjoying a domestic production boom, particularly in natural gas, which may moderate the impact. So where is the new pain threshold? 7% of GDP? 8%? 9%? Another way to tackle this is to explicitly simulate an oil price shock using a U.S. macroeconomic model. There are certain advantages to doing this. For one, we can take into account feedback loops and second round effects. For example, as consumers fork over more for gasoline, that also means less savings that will be put to use for investment. That also slows economic growth. Or higher oil prices may stimulate inflation, forcing the Fed to raise rates earlier, with consequences for growth. The main disadvantage is the sheer hubris of trying to model something so complicated as the U.S. economy. Even with the most sophisticated and complex model, there is always something missing. Still, as an intellectual exercise, I simulated what would happen to the current economy if real oil prices went any higher. I considered two types of shocks: a 10% price increase that either happens gradually over 5-6 quarters or that happens quickly within two quarters, and the same shock only with a 50% magnitude price increase. They would roughly correspond to Brent prices increasing to $135/bbl and $180/bbl respectively. (By the way, these are meant to be oil supply shocks, not a price increase that happens from stronger domestic demand.) What I find is that it matters a lot whether the price increase is gradual, giving the economy time to adjust to it, or whether it happens quickly. It is also nonlinear, so a 50% price increase hurts more than five times as much as a 10% price increase. Most economists are saying that the U.S. economy would otherwise be growing at somewhere between 2% and 3% this year. Hence, at least the model is saying that a 50% additional price increase or Brent oil prices at $180 (WTI at $150) for a sustained period may be enough to push the economy into an actual recession. That in turn would probably cause oil prices to slingshot back as the United States and global demand contracts. So it looks like we still have some breathing room at least in terms of price. On the other hand, it may not take much for oil prices to rocket to these levels. Observe how jittery the markets were in reaction to rumors of a fire in Saudi Arabia recently. There is a lot of military hardware floating out near the Strait of Hormuz. Or take Russia or Nigeria. The oil supply side has plenty of hotspots to choose from. The supply-side revolution from shale oil/gas may be promising better energy security soon but it’s not quite yet. There may be room for discussion of another stockpile release, something I plan to tackle in subsequent posts.

Blog Post by Daniel P. Ahn March 4, 2012 Energy, Security, and Climate
Climate Change

Missing the Point on Natural Gas as a Bridge Fuel

Hardly a month seems to go by without another study that’s touted as showing that natural gas is a dead end when it comes to climate change. First there was the International Energy Agency’s “Golden Age of Gas”, which foresaw global temperatures rising by as much as five degrees centigrade. Then there was a paper by Tom Wigley in Climatic Change Letters that was released under the banner “Switching From Coal To Gas Would Do Little For Global Climate”. The latest entry in the genre is a paper out a couple weeks ago in Environmental Research Letters, whose abstract concludes: “Conservation, wind, solar, nuclear power, and possibly carbon capture and storage appear to be able to achieve substantial climate beneﬁts in the second half of this century; however, natural gas cannot.” One prominent climate blogger interpreted that bluntly: “Natural gas is a bridge fuel to nowhere”. So I’ll forgive you if what I’m about to say comes as a surprise: None of these studies look at natural gas as a bridge fuel. That’s right: Zero. Not a single one. Every one of them boosts natural gas relative to business as usual. That’s the first part of a bridge. But none of them ever phase it out – an element that’s equally integral to the bridge idea. It turns out that if you continue to use natural gas forever, things don’t turn out very well. But that isn’t news, or at least it shouldn’t be to the intelligent folks who keep hyping the new studies. To really understand the potential impact of natural gas as a bridge fuel, you need to look at scenarios where – this will shock you – it’s a bridge fuel. I have a paper in the works that does just that. I can’t share the results right now, but I will say that some of them surprised me. More on that to come. P.S. I have an article out today in Foreign Policy, “The Driller In Chief”, which defends President Obama against baseless claims that he’s out to destroy oil and gas. Take a look.

Blog Post by Michael Levi March 2, 2012 Energy, Security, and Climate
China

How Bad Could High Gas Prices Be?

Gas prices continue to climb, and, as I predicted last week, so does the volume of gas price punditry. That post sparked a sequence of smart thoughts from Matt Yglesias, Ryan Avent, Tim Duy, and Karl Smith. They collectively raise two big points that are worth talking about. (There’s also a lot of discussion of Federal Reserve policy – see here for my thoughts on that.) Yglesias begs for some elaboration. Why, he asks, shouldn’t we expect the market to blunt most of any shock? (Side note: I never said that it wouldn’t; I just said that this looked more like a supply shock that one might first imagine.) If, say, Chinese growth is driving up oil prices, won’t we see increased demand for U.S. exports, like “airplanes and soybean oil and Friends reruns”? (There’s a lot of talk of Friends reruns in that post; perhaps his SEO experts know something I don’t.) Alternatively, if they (and oil exporters) don’t consume more, that means they’re putting more money away; that should drive down U.S. interest rates and help prop up the economy. Matt speculates that the latter link might be broken: with nominal interest rates stuck at the zero bound, it’s impossible to drive them down. I think that’s wrong. The short term Fed funds rate is indeed stuck near zero, but there are a lot of other rates that aren’t. So long as money can be pumped back into longer term public debt, agencies, and private debt, this particular channel can still help blunt any oil shock. Where I think there may be a bigger problem is in the assumption that increased demand for U.S. exports will balance things out. Shifting trade patterns takes time – perhaps not years, but certainly months, and perhaps more. Dreamliner orders take time to shape up, even if Friends reruns (I’m learning!) can be ordered on demand. In the meantime, the U.S. economy can experience a big net drop in demand. I’m not trying to imply that we’re about to be crushed; I do think, though, that traditional demand shock thinking may be insufficient to the present task. This story is all about demand. Ryan Avent, though, makes an important point: “We also need to note that rising oil prices represent both demand shocks and supply shocks to the American economy. Dear oil can impact demand directly, by reducing real household income, and indirectly, by influencing consumer confidence. If rising oil prices were purely a problem of demand, then the only thing to fear would indeed be fear itself—by households or by overactive central banks. They are not, however. Soaring oil prices can also dent an economy’s productive capacity.” It seems to me that there are two problems with this. The first is on demand: the problem isn’t only fear; it’s cash flow. Absent irrational fear, neither Avent nor I are going to cut back on purchases because we’re spending a bit more on gas. But there are a lot of people of more meager means, who also don’t have access to credit, who can’t just smooth their consumption. They’ll cut back on non-oil spending as a simple matter of necessity. The second problem is on the supply side: the numbers just aren’t very big. Standard economic theory tells you that the impact of rising oil prices on productive capacity should be proportional to the reduction in commercial oil use that the price hike prompts. But yhose reductions tend to be very small; indeed if there’s one thing about oil that most economists agree on, it’s that supply side factors can’t come close to explaining the impact of oil shocks. None of this is either alarming or comforting. The links between oil and the macroeconomy remain pretty murky. That suggests that policy should be more about risk management than anything else.

Blog Post by Michael Levi February 28, 2012 Energy, Security, and Climate
Fossil Fuels

Real U.S. Gas Prices? Still Real Bad

Some readers of my post on Friday about record-high seasonal gasoline prices asked a good question: Were those data adjusted for inflation? Answer: No, they weren’t. They were nominal prices. So what do the inflation-adjusted data show? The bottom line: accounting for inflation doesn’t make the picture any prettier. In fact, it puts today’s seasonal U.S. gas prices in even starker terms historically (1979 anyone?). Figure 1 depicts U.S. retail average gasoline prices adjusted for inflation, during the month of January only, from 1976 through 2012. Last month’s $3.38 a gallon was essentially even with January 1981 ($3.39) as the highest January prices ever recorded by the U.S. Energy Information Administration (EIA). The next highest was January 1980 ($3.30), with 2008 and 2011 close behind. Figure 1. U.S. Retail Price of Gasoline in January only between 1976 and 2012, Adjusted for Inflation (Monthly, EIA) You can find the EIA’s official numbers here. Note that EIA data on retail gasoline prices only extend back to 1976 unless you’re talking annual figures, but those don’t tell us anything about seasonal variation during the year. Weekly data only go back to 1993. Today’s gas prices are in rarified territory, even after adjusting for inflation.

Blog Post by Blake Clayton February 27, 2012 Energy, Security, and Climate