Fossil Fuels

Had you asked most analysts a year ago what it would take to decarbonize the transportation system without aggressive new policy you’d have got an answer something like this: You need low-carbon technologies that can beat $100 oil on its own terms. And if you ask the same question today about electric power, you’ll usually hear that zero-carbon technologies need to come in at costs under the ever-rising cost of grid-distributed, fossil fuel generated electricity, a rather fat (and growing) target. Both answers are wrong. The fundamental problem is that substantial initial success in displacing fossil fuels with zero-carbon energy will drive down the price of the remaining fossil fuel energy. (The supply-driven fall in oil prices hasn’t helped either.)  This means that, absent policy, clean energy will face an ever-tougher economic challenge as it increasingly succeeds. Consider transportation fuels. A surge in oil production has driven prices well below where people previously expected them to be. But the same thing would have happened to prices had there been a surge in deployment of ultra-efficient cars or low-carbon biofuels that had the same impact on the supply-demand balance. And – this is the critical thing – effecting such a surge is exactly what people who want a clean energy revolution envision. If the world shaved, say, ten million barrels a day off its oil consumption over the next decade, oil prices would be far lower that if that didn’t happen. That would make the next ten million barrel a day reduction considerably more difficult. Something similar applies to electricity. If you’re only expecting a little distributed solar penetration, then it’s reasonable to assume (as a widely circulated recent Rocky Mountain Institute report does) that it’s competing with grid-generated electricity that needs to charge ever-more over time in order to pay for investment in transmission, distribution, and new generation capacity. But if you’ve got massive penetration of distributed solar in mind – say, the kind of stuff that might trigger “death spirals” and utility bankruptcies – then you’re not going to see those same price increases. (Bankrupt utilities don’t invest in new anything, and they certainly don’t generate revenues that recover all their costs.) You’ve already seen a variation on this with coal to gas switching: cheap gas displaced some coal-fired generation, but once it had done that, the remaining marginal unit of coal-fired power was a lot cheaper; as a result, gas stopped making such radical inroads. Once again, for a new technology to take a massive share of the market rather than just nip at its fringes, that new technology will either need to have steadily (and often sharply) declining costs, or will need a helping hand from policy. Some models, of course, capture these equilibrium dynamics. But too much thinking about what it takes to effect large-scale change implicitly assumes that large-scale change won’t actually happen. That’s a recipe for understating what a big transition would require.

On Monday, the Obama administration gave Shell conditional permission to move forward with Arctic oil drilling. The New York Times captures a common sentiment well in identifying this as a “tricky intersection of Obama’s energy and climate legacies”. The reality, though, is that this intersection isn’t nearly a fraught as many assume: decisions about offshore drilling in Alaska are indeed difficult, given the local economic and environmental stakes involved, but climate isn’t a central factor. I’m ambivalent when it comes to federal decisions on offshore Arctic drilling. The Arctic is a special place. I saw that first hand when I visited with the Coast Guard in 2008 – a trip on which I also learned how challenging oil spill response there can be. (I also learned that a buoy tender isn’t the ideal place to spend your first night ever at sea.) Opposing offshore Arctic oil development is a reasonable position. At the same time, with the right precautions, spill risks can be substantially reduced, though inevitably not eliminated. And there’s a federalism issue (perhaps not in the legal sense but in a more basic one): it’s easy to be strident in taking positions from Washington, DC, but this is a much more intimate economic and environmental issue for Alaskans – so presumably their preferences should have some special say. Navigating these tradeoffs is difficult. But throwing climate change into the mix as a central consideration lacks empirical foundation. (Perhaps that’s why that Times article doesn’t follow through on its headline’s promise.) Yes, at a global level, more oil production means more oil consumption, and hence greater carbon dioxide emissions and worse climate change. But more oil production in one place generally means less oil production elsewhere – that’s how markets and prices work – which substantially blunts the effect. Bill McKibben drills home the conventional wisdom in a Times op-ed, blaming Obama for “climate denial” by claiming that “you can’t deal with climate on the demand side alone”, backing that up by citing a study that was unable to identify any “climate-friendly scenario in which any oil or gas could be drilled in the Arctic”. True! Also true: that claim was based on looking at a whopping two scenarios. (From the original: “none [of the oil or gas] is produced in any [Arctic] region in either of the 2C scenarios before 2050”.) And, most important, the study never asked what would happen to emissions if the Arctic oil were put off limits. Had it done so, it would have found more oil production elsewhere, and minimal net emissions impact. What the study really found – and what is entirely reasonable – is that if the world gets serious about reducing emissions, oil prices will fall, and companies won’t want to develop most Arctic oil anyhow. That points to demand-side policy, denigrated by many who are painting the Alaska decision as climate apostasy, as critical. There is one theoretical exception. The United States, Saudi Arabia, Russia, Iran, and a bunch of other oil producers could team up to jointly restrict oil production. That prospect, of course, makes U.S.-China-India-Europe cooperation to reduce emissions through demand-side policy look like a cakewalk by comparison. Navigating the local economic and environmental tradeoffs involved in Arctic oil development is difficult enough without turning every decision into a climate litmus test. And getting serious on climate change is plenty tough without pretending that playing fossil fuel whack-a-mole whenever possible will be effective in reducing emissions. We’ll have better policy, and better outcomes, if we don’t make every difficult energy and environment decision about climate change too.

The P5+1 and Iran have announced a framework for negotiating a final agreement to limit the Iranian nuclear program by the end of June. Here are five quick thoughts on the nuclear and sanctions elements: The nuclear limits – particularly those on the Iranian supply chain – are surprisingly strong and significant. The rough scale of Iranian enrichment activities and low-enriched uranium stockpiling that the United States could tolerate has long been pretty clear. (I laid out the basic logic for the sorts of limits that would allow the United States to respond effectively to Iranian breakout in a technical paper a few years ago, and many others have made similar arguments.) The announced framework tracks those understandings. What I’m struck by, though, is the extent of the monitoring provisions, particularly as they apply to the Iranian supply chain. U.S. policymakers have long feared that so long as Iran could conduct some legal nuclear commerce, it would be easier to hide illegal activities, making a secret parallel nuclear program more feasible. The framework includes some pretty strong steps to address this, including a “dedicated procurement channel” for the nuclear program. These may seem like footnotes compared to the rule for centrifuges and uranium stocks, but they’re central. The time it takes Iran to comply with the agreement will depend on its final details. Take one example: Iran is required “to reduce its current stockpile of about 10,000 kg of low-enriched uranium (LEU) to 300 kg of 3.67 percent LEU”. How will this be done? Will Iran ship the material out of country? Will it blend it down to LEU that’s enriched to less than 3.67 percent? Will it convert the LEU into fuel? (Which of these will the final deal allow?) The path it takes will determine how long compliance takes, which will affect the pace of sanctions removal. Similar questions surround many other provisions. It is unclear how sanctions relief will be phased in. If compliance occurs gradually over an extended period, sanctions relief will presumably be drawn out too. Iran faces a host of sanctions on oil sales, financial transactions, travel by senior officials, and other activities. Which sanctions will be pared back first? What milestones will they be connected to? Much of this presumably remains to be negotiated, but the details will be critical to determining the pace with which sanctions are removed – and, in particular, the speed at which full-scale Iranian oil exports come back online. Removing sanctions won’t necessarily lead to a rush back into Iran. The framework notes that sanction could be “snapped back” on Iranian noncompliance. Energy (and other) companies will presumably be slow to invest in Iran given the risk that they could easily find themselves faced with sanctions once again. Financial players may decide that the complexity and risks of dealing with Iran outweigh the limited commercial benefits. Oil traders, though, are more short term in nature, and will presumably reengage quickly. This experience is going to make U.S. policymakers even more sanctions-happy than before. An easy lesson of the Iran experience (presuming that the framework actually leads to a final deal) will be that sanctions, when combined with diplomacy, can yield meaningful results. Political scientists and policy analysts will doubtless debate this until eternity: one can’t say definitively what role sanctions played in bringing about the agreement, nor is there an objective way to know whether the framework deal is better than whatever else might have happened. The reality, though, is that many policymakers will take today’s news as a straightforward affirmation that sanctions work.

The Petrobras corruption investigation, known locally as Operation Lava Jato (Carwash), entered a new phase last week, when Rodrigo Janot, Brazil’s general prosecutor, implicated 53 politicians from six different political parties. All but two come from President Dilma Rousseff’s Workers’ Party (PT) congressional coalition. The accused include two of the legislature’s most prominent politicians: Eduardo Cunha (PMDB), the president of the Chamber of Deputies, and Renan Calheiros (PMDB), the president of the Senate. Cunha is accused of taking a personal bribe; Calheiros is accused of trading political support for funds for the PMDB; both deny any wrongdoing. Dilma’s former Chief of Staff Gleisi Hoffman (PT) and former Energy Minister Edison Lobão (PMDB) were also accused of receiving illicit money for political campaigns – Hoffman for her own 2010 Senate run; Lobão to support Roseana Sarney’s gubernatorial campaign in the northeastern state of Maranhão. Sarney – the daughter of former President Jose Sarney – was previously implicated in a scandal involving Amazon development funds. Former president, now senator Fernando Collor de Mello (PTB) made the list for allegedly receiving bribes. This isn’t his first scandal; he resigned from the presidency in 1992 rather than be impeached for corruption (he was later found guilty and barred from public service until 2000). The opposition PSDB didn’t emerge unscathed either. Antonio Anastasia, an influential senator and close ally of defeated presidential candidate Aecio Neves, allegedly received R$1 million to run his own gubernatorial campaign in the state of Minas Gerais. These political revelations expand upon the already extensive investigations into Petrobras employees and numerous private sector firms, including construction firms OAS, with over one hundred thousand employees, and Andrade Gutierrez, with projects in more than 40 countries around the world, as well as the Brazilian conglomerate Camargo Correa, with operations in construction, energy, transport, and engineering. With estimates topping $4 billion in illegal kickbacks over the past decade, two high-level Petrobras executives and 24 private sector executives have been indicted so far. Twelve of the 26 have been taken into custody indefinitely, while fourteen remain under house arrest. All this is happening at a difficult time for Brazil as a nation. When the 2005 Mensalão scandal hit, Brazil was growing rapidly and the country’s president, Luiz Inácio Lula da Silva, was near his all-time highs in terms of popularity. By contrast, Dilma faces a stagnant economy, weak currency, and water shortages and electricity blackouts due to a record drought. In a recent poll, just 23 percent of people interviewed rated Dilma’s performance as “excellent or good,” down from 42 percent in December, and she is bracing for a wave of protests this Sunday. The revelations may paralyze Brazil’s government. But combined with general dissatisfaction, it also could create the incentive for real reform. Dilma’s challenge is to not waste this crisis.

The Council on Foreign Relations hosted a symposium yesterday on the causes and consequences of the oil price crash. Our three panels tackled the reasons for the crash and the future of oil prices; the economic fallout from the crash in the United States and around the world; and the geopolitical consequences of the oil price crash, both to date and going forward. (These links will take you to video of each session.) I trust that everyone took distinct conclusions away from the day. Here are five things I learned or hadn’t properly appreciated before: Don’t believe what financial markets tell you about long-run oil prices. Futures markets are good at predicting near-term spot oil prices. They’re even good at telling you what smart people think oil prices will be in a few months or a year. But when it comes to their predictions for oil prices five years from now? Forget about it. Markets for long-dated futures – say, for February 2019, where Brent crude last settled at $76 a barrel – are idiosyncratic and reflect the needs of a small number of players. Better, then, to rely on fundamental analysis. Unfortunately – as Citi’s Ed Morse, CIBC’s Catherine Spector, and the EIA’s Howard Gruenspecht all confirmed on our first panel – there’s little agreement on what those are. Still, if you’re uncertain, at least you won’t be wrong. Consumer spending hasn’t yet responded to the oil price drop. The oil price drop is supposed to act like a big tax cut – with all the stimulus that entails. As Mark Zandi of Moody’s Analytics noted on our second panel, a one dollar drop in the price of a gallon of gas should translate into a thousand dollars in annual household savings, which in turn should boost consumer spending, turbocharging the economy. Yet, as both he and Harvard’s Jim Stock observed, while we’ve seen some increased saving, we haven’t seen the expected boost in consumer spending yet. Part of the explanation might be that people wait a few months for savings to pile up before going out and spending. Neither Zandi nor Stock was particularly nervous yet – but Zandi warned that if consumer spending didn’t pick up soon, he’d start to get more anxious. Falling oil prices have been a big help to emerging market economic policymakers. Emerging market oil importers obviously benefit from falling import costs. And I’ve written before that falling oil prices have allowed some emerging market policymakers to cut fuel subsidies. Charles Collyns of the Institute for International Finance (IIF) pointed out a third big dividend during our second panel: falling oil prices have eased inflation pressures and thus allowed emerging market central banks to cut rates and juice their economies. It’s easy to overlook this when you’re focused on the big developed economies; Europe and Japan are worried about deflation, not inflation, and the United States doesn’t have room to cut rates (though it can delay raising them). But when you’re more like India – with an inflation rate that hit eight percent in July of last year but now stands closer to five – this matters a lot. Watch out for geopolitical fallout in the big oil exporters’ backyards. As oil prices have plummeted, all eyes have been on the Russia-Ukraine conflict and on the Iranian nuclear negotiations, as observers have looked for signs that Moscow or Tehran might change tack. On our third panel, Georgetown’s Angela Stent and former U.S. ambassador Michael Gfoeller reported little change on either front, and warned not to expect much. But both of them – along with former State Department energy envoy David Goldwyn in his remarks on Venezuela – told people to look in the three big oil exporters’ backyards. As Russia faces budget and economic challenges, there will be economic and political spillovers in Central Asia; as Iranian revenues slide, Iran’s ability to support Hezbollah and other Shiite allies will decline; and as Venezuela tumbles, its ability to support others in the region through Petrocaribe will weaken, a dynamic that some have already argued played a role in U.S. rapprochement with Cuba. Even the good geopolitical news often comes with a downside. It might look like Egypt and Jordan – both energy importers – might benefit from falling oil prices. But, as Michael Gfoeller pointed out, both also receive support from a now-less-flush Saudi Arabia. It might also seem that climate change efforts could get a boost due to falling natural gas prices in Asia and Europe (gas and oil prices there are linked to varying degrees) – but, as David Goldwyn warned, the politics of falling oil prices could actually sap some of the sense of urgency from climate discussions. And as Angela Stent observed, economic turmoil for U.S. adversaries doesn’t necessarily lead to political change – something she noted for Russia but that applies more broadly. This only skims the surface of what I took from the panels – and I’m sure others gleaned different things. You can watch all the three panels (prices, economics, geopolitics) at CFR.org, and add your own takeaways in the comments.

In 1863, with the first American oil boom “at full tilt”, Andrew Carnegie had an epiphany: the world would soon run out of oil. He and a partner “decided to dig an enormous hole, capable of holding 100,000 barrels of oil”, where they would stockpile crude “until the worldwide oil shortage had struck”. When that happened, they’d be rich – to be precise, they’d be millionaires. As Blake Clayton recalls in his awesome new book Market Madness: A Century of Oil Panics, Crises, and Crashes, they then waited. “And waited. But the long-awaited shortage never came. The only thing that did arrive was evaporation, which kept skimming more and more oil off the top of the lake.” Carnegie, writing fifty-seven years later, “noted wryly that the shortage… still had ‘not arrived’”. I’m not an impartial observer – Blake did much of the work on this book while he was a fellow with my program at the Council on Foreign Relations, where he’s still an adjunct – but don’t let that lead you to discount my enthusiasm. This is a fascinating book: it’s simultaneously an entertaining story of four peak oil scares (and how they end) stretching back over a hundred years; an analytically serious book about behavioral finance that helps explain how markets can often be incredibly wrong; and a careful look at how policy makers manage – and mismanage – energy strategy in the face of uncertainty and fear. In any case, don’t just take my word for it. Dan Yergin calls the book “fascinating and lively”. Greg Sharenow of PIMCO calls it “a landmark study that is a must read for investors and policymakers alike”. And Charley Ebinger predicts that it “will rank with Daniel Yergin’s The Prize as an icon in the field”. Don’t bet against that. You can buy the book here. And, in a year or so, you’ll probably want to buy the paperback too – its epilogue about the latest oil crash is bound to be a must-read.

This is a guest post by Nathaniel Glidden, intern for the Council on Foreign Relations Africa Studies program. He is currently pursuing a Master’s in International Affairs with concentrations in Development and Cities & Social Justice at The New School. The African Union (AU) Summit concluded January 31 in Addis Ababa, Ethiopia. As had been predicted, Zimbabwean president, Robert Mugabe, was named chairman of the AU for 2015. The largely ceremonial position of AU chairman has a one year term and is generally awarded to the leader of the country hosting the following summit. Notwithstanding its ceremonial nature, the position of AU chairman should represent the AU’s mission of increasing citizens’ quality of life, promoting democratic principles, and protecting human rights. Yet Mugabe’s record stands in stark contrast to this mission. The ninety-year-old autocratic leader has been Zimbabwe’s president since the country’s independence in 1980. Described as a “reign of terror,” his rule has drawn widespread criticism, and he has been condemned for committing alleged human rights abuses in 2002; for rigging elections; and for enacting policies that led to the collapse of the Zimbabwean economy in 2000. The response to his appointment has been mixed. While Mugabe enjoys support from AU member states, who ultimately confirmed his chairmanship, the international response has been lukewarm. Globally, Mugabe has long been perceived as a controversial figure. In fact, the European Union (EU) and United States imposed sanctions against him in 2002 and 2003, respectively. In light of his appointment, the EU offered to make some exceptions to his travel ban, so he can attend intergovernmental meetings abroad and fulfill his duties as AU chairman. Given his track record as Zimbabwe’s president, Mugabe’s chairmanship could blemish the AU’s integrity. A negative perception of the AU’s leadership is problematic given the organization’s ties outside of the continent. Considering its close alignment with the United Nations and its dependence on funding from international donors, which accounted for more than 50 percent of the AU’s 2014 budget, the credibility of the AU is critical. Under questionable leadership, donors to the AU might reconsider their contributions. The AU currently faces several challenges across the continent: Boko Haram’s insurgencies in Nigeria, falling global oil prices, and civil and ethnic wars across central Africa. A potential loss in funding or credibility could hinder the AU’s ability to act on these issues.  

Where will oil prices ultimately shake out? I argue in an FT op-ed today that political dynamics sparked by falling prices will be as important as purely economic forces in determining the answer: “The assumption that politics, whether Saudi manipulation or collusion in the OPEC oil producers’ cartel, would keep prices eternally above $100 a barrel was proved wrong [by the oil price crash]. Now people are flipping to an opposite view, where market forces are king and politics no longer matters. Instead of reading the tea leaves in Riyadh and Vienna, they are focusing narrowly on how commodities and capital markets will adjust to low prices — which in isolation is just as wrong and just as dangerous.” The piece works through potential supply-side policy shifts by both low- and high-costs producers and possible demand-side changes too. Each is worth an extensive analysis in its own right, and none have been getting serious treatment by analysts so far. This is a largely understandable short-term reflex – it is right to believe that markets, not energy policy, are now central to shaping oil prices in the short-run. But it is the wrong way to look at long-run responses to lower oil prices. The piece doesn’t talk about “geopolitics” in the traditional market-analyst sense –upheaval in Nigeria or Venezuela, macroeconomic policy in Europe, and such. There’s no debate that such things will always influence prices. What’s essential to remember is that, OPEC or no OPEC, policies that might shift directly in response to lower oil prices still matter. You can read the whole piece here.