Fossil Fuels | Council on Foreign Relations

Russia

The Impact of Oil Exports Is Being Greatly Exaggerated

What would allowing U.S. crude oil exports do to the global price of oil? Tom Friedman, in a column Sunday, reflects popular conventional wisdom when he says they’d do a lot: “The necessary impactful thing that America should do at home now is for the president and Congress to lift our self-imposed ban on U.S. oil exports, which would significantly dent the global high price of crude oil…. If the price of oil plummets to just $75 to $85 a barrel from $100 by lifting the ban… we inevitably weaken Putin and ISIS….” He’s wrong. Here’s why. The chart at the top of this page shows market expectations for Brent and Light Louisiana Sweet (LLS) oil prices. You should think of Brent as a “world” oil price and LLS as a “U.S.” oil price. The market expects Brent prices to be in the neighborhood of a hundred dollars a barrel for quite some time. It also expects LLS prices to be below Brent prices indefinitely. (The discount varies between about six and nine dollars over time.) Part of this – perhaps around three dollars – reflects the cost of transporting oil from the U.S. Gulf Coast (where LLS is priced) to northern Europe (where Brent is priced). A bit reflects the fact that LLS is higher quality than Brent. The rest of it reflects logistical and legal constraints on the ability to export oil from the United States. Now imagine that those constraints were removed. Friedman says that oil prices could plummet by $15 to $25 dollars. Suppose for a moment that he’s correct. The Brent price would drop to $75 to $85 a barrel. The LLS price would remain a few dollars below that (mostly reflecting transportation costs) at, say, $72 to $82. Now take another look at the chart above: This would mean that U.S. oil prices would drop by between $7 and $22. The most obvious result of this would be to depress U.S. oil production relative to what it otherwise would have been. But now stop for a moment: We are predicting a world in which oil production is lower and oil prices have also dropped. This makes zero sense: less oil production results in higher prices – not lower ones. Friedman’s claim about oil exports and oil prices quickly leads to a logical impossibility. The only possible conclusion is that Friedman is wrong. That this is the correct conclusion can be seen by looking at what allowing oil exports would actually do to the global price of oil. As a basic rule, when you connect two markets where a commodity is selling at different prices, the common price that results is somewhere between the two. So further liberalization of oil exports should reduce Brent prices by at most a few dollars a barrel; anything more and Brent (plus transportation costs) would suddenly become cheaper than LLS. In actual practice the impact is likely to be considerably smaller, with most of the adjustment coming from higher U.S. oil prices rather than lower world ones. There is an important caveat worth throwing in here: forward curves often are bad predictors of the future. It may well be that traders are underestimating how much constraints on U.S. oil exports will drive down LLS prices. But no one has identified plausible ways that the export ban could sustain a whopping $15 to $25 wedge between U.S. and world oil prices. Besides, even if it could, the impact of the ban would need to be entirely on U.S. prices (keeping them depressed), while the impact of lifting it would need to be entirely on world prices (reducing them to U.S. levels). That’s implausible. Indeed if you look at estimates in a couple recent studies sponsored by the oil industry – which presumably would want to talk up the great benefits of removing the ban – you’ll see smaller numbers than Friedman’s. An ICF study sponsored by the American Petroleum Institute (API) pegs the impact on Brent oil prices at $0.05 to $1.05. An IHS report sponsored by a group of oil companies claims a larger wedge – but even that stays below about $5 (see page IV-17 of the report for the relevant chart). (The IHS study also finds world oil prices never dropping below $95 even with free trade.) Indeed one prominent study (from a team at Resources for the Future) envisions an increase in world oil prices if oil exports are liberalized, as a more efficient refining complex boosts demand for crude oil. I don’t know which of these figures is correct. But the one figure we can be confident is incorrect is the one that Friedman puts forward in his op-ed. Liberalizing U.S. oil exports would be a good thing to do for both economic and geopolitical reasons. But it is not a massive weapon that could fundamentally change U.S. prospects in the world – not by a longshot.

Blog Post by Michael Levi September 8, 2014 Energy, Security, and Climate
Monetary Policy

Bullard Has Fed History on His Side in Rate-Hike Debate with Yellen

St. Louis Fed President James Bullard has moved decisively and vocally from the dove to hawk camp over the past year, and is now predicting a rate hike in the first quarter of next year – in contrast to Fed Chair Janet Yellen, who still does not appear to see one coming before the middle of the year. The economy, Bullard said, was “way ahead of schedule for labor-market improvement.” But it’s not just the unemployment picture that’s changed dramatically over the past half-year; the inflation picture has as well. Today’s Geo-Graphic updates one we did in March, comparing the level of unemployment and inflation today with the levels they were at at the start of previous rate-hiking cycles going back to 1994. In March, unemployment was at the top of this range, but inflation was well below where it was in ’94, ’97, ’99, and ’04. The picture is very different today, with the Fed’s preferred measure of inflation, PCE, having risen to 1.6% from 1% back in February. All other major measures are also well up. Moreover, three of these measures are now above where they were when the Fed started tightening in ’99. The Fed funds rate, however, is way below where it was at the beginning of previous rate-tightening cycles. This suggests that Bullard is right to be asking whether the Fed is at risk of “get[ting] behind the curve” if it doesn’t adjust its tightening timetable. Federal Reserve: Economic Projections of Fed Board Members and Fed Bank Presidents FiveThirtyEight: Inflation Isn’t Rising Yet, But The Fed is Watching Closely Economist: A Tight Spot for America's Recovery Financial Times: US Recovery Rouses Inflation Concerns Follow Benn on Twitter: @BennSteil Follow Geo-Graphics on Twitter: @CFR_GeoGraphics Read about Benn’s latest award-winning book, The Battle of Bretton Woods: John Maynard Keynes, Harry Dexter White, and the Making of a New World Order, which the Financial Times has called “a triumph of economic and diplomatic history.”

Blog Post by Benn Steil and Dinah Walker August 18, 2014 Geo-Graphics
Fossil Fuels

A New Keystone XL Paper is Probably Wrong

I’ve been trying to avoid two things lately: Keystone XL and picking on shaky scientific papers. But a new paper on Keystone XL in Nature Climate Change has been generating a lot of buzz and requests for comment, so a post on it seems worthwhile. The paper claims to show that the State Department has underestimated the emissions impact of the pipeline by as much as 83 million tons of carbon dioxide equivalent annually. The authors say that the State Department “did not account for global oil market effects” that would lead to greater world oil consumption – and therefore emissions – as a result of higher Canadian oil sands production. They claim that, by now including those effects, they have produced the correct emissions number. The authors are on reasonable grounds to argue that State should have been less confident in assuming no impact of higher oil sands production on world oil consumption – an issue that scores of analysts (myself included – see, for example, this 3+ year old blog post or my 2013 book) have long understood is real. But their estimate of that impact is thoroughly unpersuasive and almost certainly too high. Let me explain why in three pieces. The authors assume that, climate change aside, the world oil market is a perfect market. No manipulation, no politics, nothing. Just textbook economics. If you’re skeptical of this, you’re right. The authors’ basic methodology is straightforward. Assume that Keystone would add to world oil supplies. This would push world oil prices down. The result of that would be to encourage increased oil consumption and deter some now-uneconomic oil production. The system would come to equilibrium at a lower oil price and a higher level of oil consumption. That new price and consumption level can be estimated using observed or calculated elasticities of oil supply and demand. Here is the central problem: It is hugely controversial to claim that that price changes affect oil production only through altered project economics. That’s how a normal market works. (If, say, I’m selling milk, and the price of milk drops so far that I can’t profitably do my business, I’ll cut back or shut down.) But there are oodles of serious people (including big environmental groups and analysts that produce the regulatory impact assessments that justify things like fuel economy rules) who reasonably think that that’s not all that’s going on when it comes to oil. Instead they believe that one or more big players in the world oil market – think Saudi Arabia or OPEC – manipulate their production to maximize revenue or target a particular oil price. What that means in practice is they believe that a production increase in, say, the United States or Canada would be met by production restraint in, say, Saudi Arabia. The net result is to blunt the impact of Keystone XL and its ilk on supply, prices, and consumption. Indeed it is precisely this phenomenon that environmental advocates rely on when they claim that increased U.S. oil production would do almost nothing to benefit U.S. consumers at the pump. I don’t know how Saudi Arabia and other low cost producers might react to increased Canadian oil production. The State Department analysis implicitly assumes that their reaction would fully offset any Canadian increase; I find that implausible. But the new paper assumes without any serious attempt at an argument that they don’t change anything at all; I find that even more difficult to believe. In essence, both the State Department and the Nature Climate Change paper probably have the politics wrong. Assuming that each of them otherwise have the economics correct, the State Department number becomes a lower bound on the impact of Keystone XL, and the Nature Climate Change paper gives an upper bound. Which brings us to the second and third problems with the Nature Climate Change paper. The authors’ numbers for oil supply elasticity are shaky. A low elasticity of oil supply means that lower prices caused by a rise in Canadian oil production will do relatively little to prompt other suppliers to cut back on their own production. The lower an oil supply elasticity one uses, the greater the impact of Keystone XL appears to be. The headline number that the Nature Climate Change paper reports (a net addition of 0.6 barrels to world oil production for each extra barrel of Canadian crude) assumes a supply elasticity of 0.13. The paper reports a sensitivity test where the supply elasticity is 0.6; that cuts its estimated impact by more than a factor of two. So where does the 0.13 figure come from? It’s read off the following chart from Rystad, a consultancy. The steeper the supply curve, the lower the supply elasticity – and the authors have read their supply elasticity off the almost-steepest part of the curve (at 96.62 million barrels a day, an EIA projection for 2020 oil consumption, to be precise). That might be fine if this particular supply curve were gospel, but it’s not – there’s enormous uncertainty around the cost of future supplies. (Incidentally, if anyone can explain to me why the right hand side of the supply curve is a mile above the estimates shown for cost of each source of supply, I’d really appreciate it.) The authors also have no reason to be confident that, excluding Keystone XL, world oil consumption will be 96.62 million barrels a day in 2020 – yet a quick glance at the curve shows that even if you accept the Rystad supply estimates, the point on the curve at which you estimate supply elasticity can have a very large impact on the result. The basic implication of all this is that a lot of pieces need to line up in order for the paper’s central conclusion to hold up (again, we’re setting aside the political assumptions for now), but there’s no compelling reason given for believing that they actually do. Indeed I’ve left one more out so far. The authors’ assumptions are in far deeper conflict with the State Department analysis than they acknowledge. The authors understand that State Department analysis already concluded that only if oil prices were somewhere around $65-$75 would a lack of pipeline capacity tilt the balance against oil sands, since otherwise, rail would be able to pick up the slack. They write: “The overall GHG emissions impact of Keystone XL is determined… by the extent to which Keystone XL leads to an increase in oil sands production. Here, the State Department concludes that owing to availability of other pipelines... or rail for transporting oil sands crude, the rate of Canadian oil sands extraction would most likely be the same with or without Keystone XL.... The State Department also suggests a case in which the oil sands production could increase by Keystone’s full capacity. If future oil prices are lower than expected, specifically $65–$75 per barrel, ‘higher transportation costs (due to pipeline constraints) could have a substantial impact on oil sands production levels, possibly in excess of the capacity of the proposed Project’.” The authors then go on to elaborate reasons that oil prices might indeed end up in that range as a way to motivate the possibility that blocking Keystone would actually constrain oil sands production. But take another look at the supply curve. If you really believe that curve (which the authors say you should), and you’re now looking at a case where oil prices are $65-$75, that means you ought not be looking at the point on the curve where production is 96.62 million barrels a day – instead, you should be looking well to the left, at a part of the supply curve that’s far flatter and hence less supportive of the paper’s conclusions. A quick read of the supply curve suggests an elasticity of about 1 in the $65-$75 price range – well above the number they use, and even outside the range of their sensitivity analysis. Despite all this, I wouldn’t go so far as to say with 100 percent confidence that the authors’ emissions estimate is too high. Odds are that the numbers in the Nature Climate Change paper are too high and that those in the State Department report are too low. (That doesn’t necessarily mean that State has overestimated the likely emissions impact -- given that, in the case it considers most likely, Keystone has no impact on Canadian oil production, and hence no impact on emissions. What’s too low is State’s upper bound.) If you forced me to bet, I’d put the real number a lot closer to the State Department one than to the Nature Climate Change result. But there are all sorts of uncertainties involved in analyzing world oil markets beyond the ones I’ve just discussed. There are undoubtedly more uncertainties than the new Nature Climate Change paper acknowledges. One nice thing for policy analysis is that many of those uncertainties (such as in the elasticity of oil supply) affect not only the environmental costs of Keystone XL but also the economic benefits – so that, in a proper cost-benefit analysis, they often cancel out. One last thought: Cross-over papers that take climate change and fossil fuel markets both seriously are important and too rare. It’s good to see people trying to bridge that gap. (Even the Bob Howarth paper on methane leaks, for all its extraordinary flaws, was commendable for trying to grapple with both worlds). But you’re rarely going to find two peer reviewers who can credibly tell an editor whether such a paper is fit for publication – the range of expertise required is almost inevitably too large. Either journal editors need to solicit a larger numbers of reviews (covering a wide range of expertise) than typical for such papers, or journalists need to lay off treating them as much more than preliminary ideas until they’ve withstood sustained public scrutiny. I doubt the latter will happen, but one can hope that journal editors take new steps to get these sorts of papers right.

Blog Post by Michael Levi August 13, 2014 Energy, Security, and Climate

Sub-Saharan Africa

Is the IMF Going to Save Ghana’s Troubled Economy?

This is a guest post by Cheryl Strauss Einhorn, a journalist and adjunct professor at the Columbia University Graduate School of Journalism Long hailed as evidence of Africa’s growing political and economic stability, Ghana is suffering a reversal of fortune. One week ago as President John Mahama arrived in Washington for the U.S.-Africa Summit, his government finally admitted it needed urgent help to fix its faltering economy and contacted the International Monetary Fund for financial assistance. "The ultimate objective is to stabilize the cedi (Ghanaian currency) in order that domestic prices will be brought under control," Finance Minister Seth Terkper told a local radio station Joy FM. Indeed, despite being rich in natural resources with plentiful oil, gold, and cocoa, West Africa’s second largest economy has been in disarray, its problems laying bare many of the challenges facing the continent as a whole. Ghana’s oil production levels remain stagnant and gold prices are languishing, yet the government has drastically increased its spending. Critics charge that it has overspent on pricey offices and golf courses, as well as public sector wages and subsidies for utilities and fuel. The result: investors have lost faith in Ghana’s ability to pay its debts. Ghana’s cedi is the worst performing currency in the world this year. Its value has been nearly cut in half against the U.S. dollar, sparking a significant rise in the cost of living. Inflation, at 15 percent, is at a four year high and economic growth is slowing just as the nation faces a double digit budget deficit as a percent of GDP. The economic crisis has led to a series of labor protests. News reports recount five separate demonstrations organized against Ghana’s government in July alone with the largest gathering thousands in the streets of all ten regional capitals. More protests are reportedly planned. Yet an IMF bailout may not provide any immediate relief. Instead, it is likely to inflict marginal pain on Ghanaians as the IMF demands faster spending curbs that will impact public wages, subsidies, and taxes. Moreover, Finance Minister Terkper told reporters that Ghana will continue to extend its borrowings, despite expensive terms. Bond yields are near 10 percent. Yet he said Ghana plans to seek over one billion dollars from international investors to fund new infrastructure projects and pay down debts. Terkper predicts an IMF package would increase the bond offer’s appeal, signaling that the IMF believes Ghana will improve its macroeconomic management. But is that assumption correct? President Mahama has been a poor economic steward and stubbornly refused to go to the IMF amid claims that Ghana could fix its own problems, which it did not, or could not. And Ghana has been here before, having tapped the IMF multiple times. Ghana had a golden opportunity in 2005, when as part of a global relief plan for poor nations, most of its debt was cleared. Yet today its economy is in shambles. The question remains: Is Ghana a stable and favorable investment destination, or is it a cyclical economy, beholden to a few volatile commodity markets with a government unable, or unwilling to exercise fiscal and economic restraint?

Blog Post by Guest Blogger for John Campbell August 13, 2014 Africa in Transition
Fossil Fuels

How to Make Fuel Subsidy Reform Succeed

Fossil fuel subsidies are a global scourge. They distort markets, strain government budgets, encourage overconsumption, foster corruption, and harm the environment while doing little to remedy inequality or stimulate development. Yet despite compelling arguments for reform, fossil fuel subsidies remain deeply entrenched. Citizens have yet to be convinced that fuel subsidies can and should be replaced with more efficient poverty alleviation programs. As a result, governments refrain from phasing out fuel subsidies for fear of triggering a public backlash, and even civil unrest. To bolster the prospects for subsidy reform, the United States should support the creation of a new public-private partnership within the World Bank, the Global Subsidy Elimination Campaign (GSEC), to work with governments to execute country-specific communication programs that would build the case for fossil fuel subsidy reform among citizens. The GSEC would start with pilot programs in select countries, and on the basis of these efforts, expand its work to other countries interested in fuel subsidy reform. If the GSEC helps generate just a 5 percent reduction in the more than half a trillion dollars that governments now spend on fossil fuel subsidies, it would free up billions of dollars for more effective anti-poverty initiatives. Subsidies Undermine Development Fuel subsidies impose a particularly significant fiscal toll on developing countries. Uzbekistan, the world's heaviest fuel subsidizer, spends 25 percent of its gross domestic production (GDP) on fossil fuel subsidies, seven times more than on health and education combined. Fuel subsidies are particularly burdensome in the Middle East and North Africa (MENA) region, which accounts for half of all fuel subsidy spending. Yemen, for example, spends 6 percent of its GDP on fuel subsidies, more than its budget for much-needed infrastructure and social spending. Egypt spends over 10 percent of its GDP on fossil fuel subsidies, contributing significantly to the country's budget problems. Subsidies stretch limited state budgets in developing countries, inhibiting governments' abilities to invest in development and growth. Fuel subsidies also inadequately address inequality. Touted as poverty-alleviation mechanisms, fuel subsidies primarily benefit middle- and upper-income groups. The richest 20 percent of households in low- and middle-income countries use six times more subsidized fuel than the poorest 20 percent. Why Technical Expertise Is Not Enough Some governments and international organizations have made fuel subsidy reform a priority. Yet, cases of failed attempts continue to outweigh success stories. One of the main barriers to reform is lack of public awareness about the costs of fuel subsidies. A 2012 World Bank study found that 70 percent of the population in Morocco did not know their fuel was subsidized. Without understanding how much their government spends to subsidize fuel, citizens are unlikely to agree to replace them with better alternatives such as cash transfers, which are widely recognized as far more efficient and effective at poverty alleviation. Instead, they will only see the elimination of a tangible good (lower-cost energy). The public needs to be convinced of the near-term benefit of more targeted income support for the poor and the longer-term benefit for all of additional government resources for productive investments. In Indonesia, Yemen, Egypt, and Nigeria, public resistance and mass protests at the prospect of subsidy removal have alarmed leaders and encouraged policymakers to abandon reform efforts. Without public support, leaders cannot implement the subsidy reforms they know are critical. International organizations—the World Bank and International Monetary Fund (IMF) in particular—have impressive expertise on subsidy reform and have helped countries to evaluate existing subsidies and craft policies to shift to better alternatives. As the few success stories demonstrate, subsidy reform hinges on an effective communications strategy that builds domestic support by clearly articulating the goals and benefits of reform. Iran, which reformed its subsidy program in 2010, conducted a broad public relations campaign before the reforms took effect to explain their purpose, how people would be compensated for higher energy prices, and the benefits to the country. Ghana's efforts to phase out fuel subsidies were helped by commissioning and publicizing an independent assessment that showed poor people would benefit from the elimination of fuel subsidies. Going Directly to the People Although such success stories are heartening, too few governments recognize the value of laying the groundwork for reform by communicating with citizens about the costs of existing programs and the benefits of alternatives. And there is no place for them to turn for a full-service solution that combines technical expertise with marketing capabilities. The GSEC would fill that gap by developing the following initiatives: Public awareness campaigns targeted to specific markets in conjunction with local media, marketing experts, and government officials. Such campaigns would communicate information about the negative consequences of fuel subsidies including: exacerbating income inequality, consuming a large portion of the national budget, contributing to corruption, and undermining the environment and public health. The campaign would also underscore how subsidies constrain a government's ability to make important investments in human capital and social safety nets. It would leverage research conducted by local governments, nongovernmental organizations (NGOs), the World Bank, and the IMF on who benefits and who loses from fuel subsidies. If credible research does not exist, it would commission it from an independent third party. A communications campaign that informs citizens of the advantages of replacing subsidies with more effective alternatives such as cash transfers to the poor and a targeted social welfare mechanism that reaches societies' neediest with far greater efficiency and lower corruption. Informing citizens of alternatives creates the conditions for a viable bargain: citizens will support subsidy reform if governments commit to replacing them with tangible alternative benefits. In Iran, this was a cash transfer; in Ghana, the government raised the daily minimum wage and eliminated school fees. The campaign would disseminate information through radio, television, print, text messages, and social networks. Technical solutions for implementing alternatives to subsides such as cash transfers. The World Bank is already implementing mobile money and smart card payment systems, but the GSEC could help tailor such applications as specific end-to-end replacements for fuel subsidies. The Global Subsidy Elimination Campaign would be beneficial for several reasons. Working in cooperation with local and international marketing agencies, it would leverage best practices from different country cases to devise innovative public-awareness campaigns. Being housed at the World Bank with its own board and budget (following a model similar to that of the Consultative Group to Assist the Poor), the GSEC would have access to the Bank's considerable research capabilities while being able to act nimbly and independently. For example, the partnership could take an active role on subsidy reform, in countries where the issue has not been a focus of the World Bank. The GSEC would also push the World Bank itself to prioritize subsidy reform. Over time, its marketing campaigns could be instigated by the World Bank in consultation with client governments or commissioned on a fee-for-service basis by wealthy countries. The GSEC should be seeded with an initial budget of $100 million over three years: 10 percent allocated to finance internal operations and 90 percent to develop messaging and purchase media in three countries that agree to work with the GSEC as demonstration cases. Countries should be selected based on the relative magnitude of their subsidy problem and their willingness to implement a sound reform program. Yemen and Egypt are possible candidates. Yemen has begun to chip away at fuel subsidies that currently account for about 20 percent of government spending. Prospects for reform there will be enhanced by a well-communicated program that commits the government to reallocate savings to productive infrastructure investments and poverty alleviation programs; subsidy reform is also critical to relieving Egypt's fiscal crisis and freeing up funds for health and education spending. Nigeria, which abandoned a fuel price hike in January 2012 that it implemented with almost no prior communication and only vague promises of investing more in infrastructure, is another candidate. Subsidy reform will not succeed there unless the government is able to build trust that consumers will be compensated for higher energy prices. Spending $30 million in each of these markets on sophisticated, targeted media—including billboards, community radio, text messaging, and social media—would raise awareness that can be measured and evaluated through public opinion polls. Based on results, GSEC's work could expand to countries undergoing reform, which stand to benefit from a campaign that galvanizes support and decreases public hostility, and to those with an interest in undertaking reform, which would benefit from a campaign that lays the foundation for future policy. The United States should jump-start the establishment of the GSEC by providing half its initial funding, with a challenge to raise the remaining half from others interested in the enormous potential of fuel subsidy reform. Such donors—including other countries, NGOs, the World Bank itself, and private foundations—should be motivated by an interest in poverty reduction and economic development, environmental concerns, and strategic considerations. Host countries should be required to contribute at least 10 percent of their specific marketing campaigns as buy-in to the process. Conclusion The success of efforts to curtail fuel subsidies is strategically important to the United States: geopolitically critical countries such as Yemen and Egypt will not see robust economic growth and political stability in the absence of successful fuel subsidy reform. The GSEC could play a pivotal role in communicating the harms of fuel subsidies and building support for shifting to more equitable and productive alternatives. Of course, public awareness campaigns will work only if matched by credible government action to replace subsidies with other, more effective investments, such as targeted cash transfers and productive health and education spending. But the potential upside of fossil fuel subsidy reform is so significant that it demands the funding of the GSEC concept.

Policy Innovation Memorandum by Isobel Coleman August 11, 2014
Iran

Will the U.S. Oil Boom Make Energy Sanctions Easier?

Ask someone to identify a big geopolitical consequence of the ongoing U.S. oil production boom and odds are high that they’ll invoke Iran. (Every one of the links in that last sentence is an example.) Without surging U.S. oil production, they’ll argue, sanctions on Iranian oil exports would have led to a massive oil price spike. Here is a concrete case of the oil boom yielding greater U.S. freedom of action in the world, and a harbinger, it would seem, of things to come. The historical account seems right, but it’s tough to see how the Iran experience might be repeated. The upshot is that the lessons for future U.S. freedom of action – and for geopolitics more generally – are being badly over-read. To understand how the U.S. oil supply boom helped make room for Iran sanctions, think about the impact of the supply boom first, and the sanctions second. How would the oil boom have affected the market around 2012 – the year that the oil export sanctions started to really hit Iran – had there been no curtailment of Iranian exports? In principle, rising U.S. output might have deterred others’ investment in oil production. But the gap between the emergence of the U.S. oil boom and the imposition of Iran sanctions was too short to allow any such shifts to meaningfully affect actual production. (Remember this for later.) Only two responses to accommodating rising U.S. supplies would have existed. First, prices could have fallen, encouraging greater oil demand and (at some point) shutting in some other supplies. Second, some oil producers (notably Saudi Arabia) could have voluntarily curtailed their production, bolstering prices but increasing spare capacity in the market. The actual outcome would certainly have been a mix. Now bring the Iran sanctions back in. To the extent that higher U.S. production would have otherwise encouraged greater spare capacity, this spare capacity could in turn have been used to blunt the impact of lower Iranian exports. To the extent that U.S. production would have otherwise encouraged lower prices, any actual price impact of the Iran sanctions (due to inability to fully offset lower exports through others’ spare capacity) would have happen against a lower base price, yielding a lower absolute price. And, to the extent that other commercial projects had been shut in, some would have come back online in the face of falling Iranian exports, partly offsetting the reduced supplies. Indeed this is basically what happened – except instead of occurring in a 1-2 sequence, so that analysts could easily disentangle the two dynamics, everything happened at the same time. New spare capacity didn’t emerge because it was being used up to cover Iranian shortfalls just as it was, in effect, being created. Lower prices didn’t emerge because, just as U.S. production was pushing prices down, lower Iranian exports were offsetting that impact. This is why, when people say that the U.S. oil boom created room for Iran sanctions, they’re basically correct. This same logic, though, can help us understand why this experience doesn’t tell us much about the future. Recall from a few paragraphs back: “In principle, rising U.S. output might have deterred others’ investment in oil production. But the gap between the emergence of the U.S. oil boom and the imposition of Iran sanctions was too short to allow any such shifts to meaningfully affect actual production.” The upshot was that adjustments had to occur through spare capacity or large price shifts instead. But this constraint vanishes when you look out over the longer term. At this point, higher U.S. production ought to be affecting investment decisions around the world, and more important, before long that in turn ought to be affecting actual production. Much of the impact of higher U.S. production on world prices might be neutralized by reduced oil supply investment, and hence production, elsewhere. This means that net downward pressure on prices should be greatly reduced. To be certain, there should be some net addition to supplies, and hence somewhat lower prices, which would help accommodate future sanctions. But, over the medium to long run, the effect on prices should much more muted than it is in the short term. Even more important, the boom shouldn’t boost spare capacity in the system over the long haul. Imagine, for example, that Saudi Arabia expects U.S. production to be so high that it anticipates having to curtail its own production in order to maintain high prices. In the short run, the only way it can do that is by boosting spare capacity. In the longer run, though, it can reduce investment in production. Doing that would yield the same oil revenues at lower cost and with the same amount of spare capacity that Saudi Arabia originally desired. (Since spare capacity is ultimately a political tool, the amount of it Saudi Arabia actually wants shouldn’t change with rising U.S. oil production.) The one thing that doesn’t leave the world with, though, is an increased ability to deal with new shocks – and, as a corollary, it doesn’t leave the United States with new freedom of action. The only way around this is if U.S. supply growth continues to surprise to the upside. In that case, the world will generally be oversupplied, resulting in lower prices, higher spare capacity, and greater U.S. freedom of action to do things like Iran sanctions. It’s essential to be clear, though, that this requires more than merely high and rising U.S. production – it requires high and rising U.S. production well beyond what market participants currently anticipate. Given the frenzy over U.S. oil production, that’s a high bar to meet. Indeed it seems at least as plausible, given all the current excitement, that surprises will be on the downside. In that case, we should expect the opposite of what happened around the Iran sanctions – higher prices, less spare capacity, and reduced U.S. freedom of action. You won’t see me betting either way – including on the idea that a new world of easier-to-use energy sanctions is upon us.

Blog Post by Michael Levi July 23, 2014 Energy, Security, and Climate

Monetary Policy

Yellen vs. Bullard on Wages and Inflation: Who Is Right?

Wage growth is “not a threat to inflation,” Fed Chair Janet Yellen said on June 18. “[With] our 2 percent inflation objective, we could see wages growing at a more rapid rate” before having to worry. “When unemployment goes into the five range, that is going to below the natural rate,” St. Louis Fed President James Bullard said on July 9. “I think we are going to overshoot here on inflation.” Who is right? In today’s Geo-Graphic, we look at the relationship between wage growth and inflation over the last twenty years. Perhaps surprisingly, we find virtually none (an R-Squared of 0.03). Wage growth has routinely exceeded so-called core inflation (consumer goods inflation excluding energy and food) by large amounts without the latter picking up. One explanation for this phenomenon may be the growth of imports as a percentage of GDP, from 9% in 1994 to 16% today, which acts to keep tradeables prices down. This supports Yellen’s position. This does not mean, however, that wage growth should not concern the Fed. On the contrary, as we can see from the figure on the left, unusually high wage growth—above 4%—preceded the last two recessions, in 2001 and 2007. The explanation may lie in the fact that high wage growth induces people to assume more debt that they would otherwise. Rapid wage growth was associated with rising debt service burdens during both periods, as shown in the figure on the right. Increasing debt service payments tend to crowd out other forms of consumer spending, and make households more vulnerable if expected wage increases fail to materialize. Annualized wage growth at present is still moderate, running at about 2.3%. But it is clearly on the rise. The household debt service ratio, however, is at its lowest level since the series began in 1980, and household debt is less than it was in Q1 2008—though it has started moving up again. In short, the monetary history of the past twenty years suggests that wage growth at current or moderately higher levels is unlikely to cause a significant rise in consumer price inflation. Yet a continued trending up in wage growth would likely presage a rise in household leverage, which is a credible indicator of economic instability ahead. But at the current low leverage levels, far ahead. The Economist: Waiting for Inflation Wall Street Journal: America Inc. Wakes Up to Wage Inflation VoxEU: The Impact of Low-Income Economies on U.S. Inflation Financial Times: Fed Bond Buying Set to End in October Follow Benn on Twitter: @BennSteil Follow Geo-Graphics on Twitter: @CFR_GeoGraphics Read about Benn’s latest award-winning book, The Battle of Bretton Woods: John Maynard Keynes, Harry Dexter White, and the Making of a New World Order, which the Financial Times has called “a triumph of economic and diplomatic history.”

Blog Post by Benn Steil and Dinah Walker July 10, 2014 Geo-Graphics
Sub-Saharan Africa

Nigeria’s Oil Industry

The Nigerian Daily Independent recently published remarks by Mutiu Sunmonu, the managing director of Shell Petroleum Development Company of Nigeria (SPDC). The remarks provide insights into Nigeria’s oil industry. Sunmonu said that Nigeria lost over three hundred thousand barrels of crude a day to oil theft, “deferment,” and illegal refining in 2013. Sunmonu confirmed that the federal government takes over 98 percent of the revenue generated by oil producing firms in Nigeria. So, the three hundred thousand barrels per day represent a loss to the Nigerian government of billions of dollars. On the highly controversial issue of oil spills, Sunmonu said that “third party interference” (involving sabotage, illicit tapping of pipes to extract oil, etc.) accounts for 75 percent of oil spillage incidents. Illegal refining of oil and the transport of illegal oil also results in the discharge of oil into the environment. Sunmonu attributed about 15 percent of the spills to “operational spill,” caused by corrosion, equipment failure, or human error. He said that incidents of oil spills resulting from sabotage and theft increased from 137 in 2012 to 157 in 2013. Whatever the cause, Sunmonu said Shell had cleaned up 85 percent of sites that had been identified in 2013 as being in need of “remediation.” Sunmonu’s remarks highlight that it is the Nigerian government that remains the overwhelming beneficiary of oil production, and that its revenue is most negatively impacted by interruption in oil production no matter the cause. This governmental dependency on the oil sector emphasizes the risks the federal government faces should the Niger Delta, where the oil is located, become unstable.

Blog Post by John Campbell July 3, 2014 Africa in Transition
China

The Other Big Energy Export News

The energy world has been abuzz this week with news that the Department of Commerce will allow exports of minimally processed condensate. This has been heralded as a “step towards a rational oil policy” and a shift that “could change the world’s energy balance”. In particular, many are speculating that this is a step toward complete elimination of the ban on crude oil exports. Meanwhile, far more quietly, BP and CNOOC announced a twenty billion dollar deal (last week) to trade liquefied natural gas (LNG). That agreement, I’d hazard, is at least as important as the U.S. move. But first the oil export news. The ban on U.S. oil exports matters: it could ultimately push down U.S. oil prices substantially and deter (otherwise) economically attractive production as a result. It’s also liable to be an irritant in U.S. trade relations with other countries, particularly because U.S. policy may be unacceptable under the WTO. This week’s news, though, says relatively little about whether the ban will be lifted. The Department of Commerce appears to have approved exports of condensate – essentially ultra-light oil – if the condensate has been processed through a distillation tower. Many politically informed market observers have long expected that the administration will ultimately allow condensate exports without any processing at all. There has never seemed to be much administration enthusiasm for the oil export ban on policy grounds; this isn’t like the gas export ban, where there are legitimate questions about impacts on consumers and on some manufacturers that stirred up internal debate. My sense is that the big question has long been political: does the administration (and potentially Congress) believe that the political price of actually lifting the oil export ban is worth paying? In that context, any low profile move that effectively relaxes the ban or confirms a loose interpretation of it – including the announcement this week – should look attractive to policymakers. Most important, this week’s move says little about the political appetite for a big move on the ban – and hence provides little insight into what its ultimate fate will be. If there’s one interesting wrinkle, it may be the timing – the administration’s willingness to do this now, rather than after the elections, implies some willingness to take political risk. On the other hand, given the amount of confusion surrounding the decision, it’s probably unwise to infer too much finely-tuned strategy behind the move. Heck, I wouldn’t be surprised if a Department of Commerce bureaucrat made this decision without any meaningful White House involvement. Meanwhile interesting things are happening in Asia with the BP/CNOOC announcement. News reports indicate that “BP will likely source much of the LNG [that it will sell to China] from its U.S. export plant at Freeport, Texas”. This follows little-noticed news last year that BG (not BP) would sell CNOOC natural gas priced according to a formula based in part on U.S. (i.e. Henry Hub) prices – an arrangement that, at a minimum, only makes sense financially for BG given its stake in U.S. LNG exports. In this case, one can’t find any public speculation about links to actual physical U.S. volumes (as opposed to U.S. prices). But when I was in China last month, I was stunned to hear an industry insider describe the deal straightforwardly as China buying U.S. natural gas. Why is this important? No Chinese company has applied directly to export U.S. LNG or has even done a direct contract with an operator of a U.S. LNG export facility. Part of this is a desire to avoid regulatory headaches. But some analysts (myself included) have suspected that Chinese companies aren’t particularly eager to depend on U.S. natural gas supplies. These two deals now make something of a pattern, and suggest that China (or at least some Chinese companies) may be more comfortable depending on the United States than might plausibly have been the case. At a time where distrust between the two countries is high, this matters. It’s important, of course, not to infer too much. If I could look at the BP and BG contracts I’d immediately focus on one thing: What are the sellers’ obligations if U.S. supplies are physically interrupted by the U.S. government? One possibility is that BP and BG would be off the hook for delivering the contracted gas, and the Chinese buyers would be sent scrambling for alternatives. If that’s the case, then the Chinese companies really are depending on the continued flow of gas from the United States to Asia, and on U.S. policymakers’ decisions. The other possibility, though, is that the contracts put the burden on BP and BG: in this case, faced with an interruption of U.S. supplies, the companies would be required to make up the shortfall using gas sourced from elsewhere. If this is the case, then CNOOC isn’t really becoming meaningfully dependent on the United States (and on U.S. policy) – they’re just getting a nice financial deal. I tend to think that these sorts of political developments in the shape of gas trade will ultimately be more important than ones in oil. Oil markets are already highly flexible; while bad U.S. decisions could erode that at the margin, it’s going to be tough to really reverse the decades-long trend in that direction. Gas markets, in contrast, remain much more rigid, balkanized, and political. Developments that change this over the next decade or so therefore have the potential to do considerably more.

Blog Post by Michael Levi June 27, 2014 Energy, Security, and Climate
China

The Dependent South Sudan

This is a guest post by Allen Grane, former intern for the Council on Foreign Relations Africa Studies program. Allen is currently an officer in the Army National Guard. His interests are in Africa, conflict, and conflict resolution. The situation in South Sudan has failed to improve despite a second peace agreement signed on May 9. As the conflict between the government and rebel forces continues, the country is also facing a collapsing economy, a massive increase in internally displaced persons and refugees, possible famine, and a cholera outbreak. So far the South Sudanese government has proven incapable of dealing with any of these issues on its own. The country’s economy has fallen drastically in recent months. This is due in large part to its reliance on oil, which accounts for nearly 98 percent of South Sudan’s revenue. Since the start of the conflict South Sudan’s oil output has dropped by a third from nearly 250,000 to 160,000 barrels of crude oil a day. In order to bolster the economy the government has looked to foreign investors and has taken over $200 million in loans from oil companies. As the conflict rages in South Sudan the United Nations and neighboring countries have been burdened with the responsibility of helping the South Sudanese people. The UN now plans to build new camps for displaced civilians in Juba, Bor, Malakal, and Bentiu states. Over 133,000 refugees from the conflict have flooded camps in western Ethiopia. In Norway, on May 20, international donors committed over $600 million to help prevent famine in South Sudan. The UN, UNICEF, and the World Health Organization have also been working to help prevent the spread of the recent cholera outbreak. Now, due to human rights violations of the conflict, such as the recruitment of over nine thousand child soldiers by both sides, the UN Security Council voted to change the UN mission in South Sudan from one of nation building to civilian protection. To this end, the UN Security Council also approved the deployment of three battalions of peacekeepers from Ethiopia, Kenya, and Rwanda. Even China has commited to sending a battalion of peacekeepers in order to help protect the people of the world’s newest nation (along with its oil assets). The South Sudanese government is failing in its responsibilities to its citizens. In fact, it seems that it is counting on international institutions, outside governments, and even businesses to provide for the well being of its people. However, despite all of the outside help, none of these pending crises will be resolved if the conflict continues. As of June 11, leaders on both sides, Salva Kiir and Riek Machar, agreed to establish a transitional government in order to bring peace to South Sudan. The nation’s future success or failure depends upon whether they are able to commit to this new government and control their respective military forces.

Blog Post by Guest Blogger for John Campbell June 17, 2014 Africa in Transition
Sub-Saharan Africa

South Sudan Conflict: Personalities, Resources, and Threats

This is a guest post by Allen Grane, intern for the Council on Foreign Relations Africa Studies program. Allen is currently an officer in the Army National Guard. His interests are in Africa, conflict, and conflict resolution. In March, the Intergovernmental Authority on Development (IGAD), the international organization that represents east African nations, announced plans to deploy a stabilization and protection force to South Sudan by mid-April. As of April 1, IGAD also announced that peace talks between the warring factions in South Sudan were suspended for a month. There is no update on the development of the stabilization force. This is not a good sign. Despite a peace agreement the conflict in South Sudan continues and IGAD has not only been unable to call up troops to deploy they have also failed to develop a mission mandate. This must be done in conjunction with the AU and the UN, who already have a force in South Sudan. The question now is, when does IGAD plan to deploy troops? The current delay may have something to do with threats from Riek Machar, the former vice-president of South Sudan and leader of the rebel forces. Machar is strongly opposed to any international deployment including an IGAD force. He has stated that, “if [IGAD] wants to colonize us we will fight them.” Machar appears to have plans of his own. Despite the peace agreement between his forces and the government he announced plans to seize the Paloch oil fields in the north of the country. Since the beginning of the conflict oil production in South Sudan has fallen from 240,000 to 150,000 barrels a day. These oil fields are in danger despite the UN forces in the region as they are preoccupied with displaced peoples, and their mandate does not specifically cover the protection of facilities. The South Sudanese government understands how important oil production is to their success. Just last week an article in Businessweek discussed the South Sudanese government’s plans to raise oil output and develop diesel refineries in Unity state. However, after heavy fighting over the last two days the rebel forces claim to have seized oil fields near Bentiu, Unity state. It is still unclear who instigated the fighting in the region. If Machar is able to seize the oil fields in Paloch the country’s oil production will fall even more drastically. As oil accounts for approximately 98 percent of South Sudan’s revenue, Machar would essentially have a strangle hold on the country and its resources. Machar would be left holding all the chips in the negotiation process. The government, led by President Salva Kiir would either be forced to capitulate to Machar’s demands or respond with military force. I believe the government would choose the latter option. As such the mission and goals of IGAD’s stabilization and protection force could change drastically if it takes too long to respond. Currently, IGAD would be able to move to protect many of the country’s oil fields and prevent conflict over control of South Sudan’s greatest resource. However, if Machar is able to take control of the Paloch oil fields before this happens, IGAD may have to decide whether they are willing to send their forces into what could possibly be an active war zone.

Blog Post by Guest Blogger for John Campbell April 16, 2014 Africa in Transition
Sub-Saharan Africa

American "Quality" Press and Nigeria

On April 15, arguably the most influential of the American print press carried the story of the horrific April 14 bombings in Abuja. The New York Times, the Wall Street Journal, and the Washington Post among others all had stories or photographs on their front pages. Nevertheless, the biggest story in all three continued to be Ukraine. Yet, as African hands know, Nigeria’s population–at an estimated 177 million–is far larger than that of the Russian Federation. In addition to Abuja, the Nigerian press is credibly reporting that some 200 people in the far northeast were killed last week, including students on their way to take their high school exams. From what I have seen, that story has received no American coverage. Neither has the report that suspected Boko Haram members stormed a secondary school and abducted over 100 female students studying for their exams earlier this week. It takes horrific violence in the capital city, Abuja, to generate U.S. coverage on Nigeria. In the U.S. as in southern Nigeria, the carnage receives little to no attention–no matter how great it is–so long as it is far away in the northeast. The “Giant of Africa” and until recently Washington’s most important strategic partner in Africa and a major source of imported oil and gas, Nigeria is largely ignored by the U.S. media, beyond occasionally boosterish articles on the business pages that focus on the Lagos-Ibadan corridor and the country’s oil patch. While the New York Times and the Wall Street Journal are honorable exceptions and have previously broken stories of gross human rights violations by the government security forces U.S. media inattention to Nigeria seems short-sighted and unwise.

Blog Post by John Campbell April 15, 2014 Africa in Transition
Sub-Saharan Africa

Big Men: Ghana, Nigeria, and the United States

This is a guest post by Emily Mellgard, research associate for the Council on Foreign Relations Africa Studies program. A great discovery often brings together strange bedfellows. Such is the case when the Jubilee Oil Field is discovered within Ghana’s national waters in the Gulf of Guinea. The heights and depths of the relationships between the people and groups pulled together around this oil field is the subject of the new Rachel Boyton (director) and Brad Pitt (producer) documentary Big Men. The documentary was filmed over five years from first discovery of the oil field to nearing “first oil” -when actual production begins. The cast includes the original owner of the oil exploration license, George Owusu, a Ghanaian; the leadership of Dallas-based Kosmos Energy, which buys out and hires Owusu; the Blackstone Group, which funds the exploration and initial production phases of the project; two administrations of the Ghanaian presidency; and “The Deadly Underdogs,” a Niger Delta oil bunkering group in Nigeria, which is primarily portrayed as a cautionary tale of everything that could go wrong should Ghana’s new “national resource” be misused. The documentary continually juxtaposes the conflicting motivations, goals, and intentions for the oil and its revenue between the different “big men.” Ghanaian presidents John Kufuor and his opposition successor John Atta Mills are interested in having the oil reserves extracted, but only -and this is particularly apparent in Mills’ rhetoric- on Ghana’s terms. The investors are looking to see a return on their investment, and the Ghanaians are adamant about benefitting more from these newly discovered oil reserves than they feel they have from over one hundred years of gold mining and export in Ghana. No single perspective is elevated above the others by the filmmakers, instead, each is given equal space to state their case. The effect is to provide a glimpse into the hugely complex sector of oil (and other extractive resources) production, and into corporate/government relations. Possibly the most interesting contrast in the documentary is that between the fortunes of Ghana and Nigeria. The filmmakers made multiple trips to the Niger Delta throughout the nearly five year process of filming. They record specifically the changing fortunes of one militant group in the Delta creeks that is destroying pipelines and bunkering (stealing) the oil. In interviews with the militant group “the Deadly Underdogs,” and with other individuals engaged in bunkering, the consensus is that Nigeria’s oil belongs, not only to Nigerians, but specifically to the communities in which the oil is found. Yet the benefits of oil extraction are not felt in the communities, nor is a path open to them to oppose their perceived marginalization. This disaffection is where the bunkering rises from. One militant with the “Deadly Underdogs” stated that “we are in the creeks so that our children can have something better.” Two other interviewees, who admitted to being engaged in sabotage of the pipelines in a bid to be hired as a repairman for those same pipelines had diverging sentiments on their actions. One felt that Nigerians were shooting themselves in the foot by attacking their resources, but could find no alternative action available to gain access to them. His companion however said -and I’m paraphrasing- “I don’t feel that this is wrong. If someone pays me to shoot myself in the foot, I will do it. If I survive I will have the money.” It’s a stark image of desperation and destitution amongst riches. I would highly recommend the documentary. It is showing in the West Village in New York City and opened this week in Washington DC and Los Angeles. It is a revealing window into the complex world of oil exploitation and production, the dreams such resources conjure, and (in some cases) the utter destruction of those dreams.

Blog Post by Guest Blogger for John Campbell April 4, 2014 Africa in Transition
Sub-Saharan Africa

Really, Really Rich People in Africa

According to Forbes, the first African ever has entered into the “top 25” of the world’s billionaires. He is Aliko Dangote, number 23. Forbes says that his net worth is now U.S. $25 billion up from $3.3 billion in 2007. His wealth is based on cement, but he is also investing in agriculture. Forbes identifies twenty-nine African billionaires, fifteen if the fourteen from North Africa are excluded. Of those fifteen, seven are South African and four (including Dangote) are Nigerian. The other four are one each from Angola, Swaziland, Uganda, and Tanzania. For the first time, there is also an African woman on Forbes’ list, Folorunsho Alakija, from Nigeria. Forbes estimates that her net worth is U.S. $2.5 billion. She is self-made; her fortune is based on fashion and oil. The wealth of the South African billionaires comes from real estate, retail, diamonds, media, pharmaceuticals, “investments,” and mining. Only one, Patrice Motsepe, appears to be a black African. The Nigerians’ wealth is heavily based on oil, telecommunications, and cement. It is no surprise that South Africa and Nigeria dominate the list. They are the first and second largest economies in sub-Saharan Africa. Most, but not all, of these billionaires are self-made. Nevertheless, sub-Saharan Africa still produces a tiny percentage of the world’s billionaires, whom Forbes estimates at 1,645 world-wide.

Blog Post by John Campbell March 27, 2014 Africa in Transition
Fossil Fuels

FiveThirtyEight’s Data Problem

Nate Silver’s new FiveThirtyEight has been catching a lot of flak since it launched last week. Perhaps the harshest has been directed at the site’s retention of the often-contrarian climate analyst Roger Pielke Jr., with everyone from Paul Krugman to the Center for American Progresspiling on. The onslaught is disturbing. I’ve disagreed with Roger often, but he is genuinely well intentioned. People who care about getting good policy should want more thoughtful voices, not fewer, proposing options – and organized campaigns to run heterodox thinkers out of town are awfully ugly. But that doesn’t mean I’m impressed with the new FiveThirtyEight. Indeed it’s another energy post – “U.S. and Chinese Current Accounts Converging” – that’s troubling. The post starts out with an arresting chart (reprinted at the top of this post) that shows an impressive improvement in the U.S. current account balance. The author then explains what’s happened: “In the U.S., a natural gas boom is cooling demand for imported petroleum, and oil represents a huge share of American imports. The dollar, meanwhile, has depreciated, boosting American exports.” This is certainly the conventional wisdom. But what one expects from FiveThirtyEight is a data-driven interrogation of that conventional wisdom. Alas that would have produced a different result. Here’s another chart that combines the data presented by FiveThirtyEight (the blue line – it looks different because I’m showing absolute numbers rather than percentage of GDP) with three other series. Start by comparing the blue and red lines. These seem to move together beginning in 2009. In particular, what you’ll see is that the big shift in the current account comes in 2008-9. Indeed the decline in the oil trade balance (the red line) accounts for a little more than half the decline in the current account balance. So far so good: changes in oil trade seem to explain a lot of what’s happening with the current account. But now look at the dashed lines. The green dashed line shows that net petroleum and product imports have been declining steadily since about 2007. This raises a first problem with FiveThirtyEight’s analysis: if falling oil imports explain so much of the lower current account deficit, why hasn’t the current account deficit continued to plunge alongside oil imports? The answer is pretty straightforward: oil prices have gone up. The United States imported 64 percent as much oil in 2013 as in 2009, but the average cost of an imported barrel was 66 percent higher. It’s the purple dashed line, though, that’s the most damning. What that line shows is that in the span that the U.S. current account balance really shifted – 2008-9 – U.S. oil production had barely begun to pick up. It was only later, beginning in 2011-12, that output really took off. But that’s not the period when the big change in the current account balance appeared. (Had I added in natural gas liquids, which started rising earlier, the comparison would look a little better, but the basic problems would remain.) Had FiveThirtyEight actually juxtaposed the current account balance with oil trade data, it wouldn’t have ratified the conventional wisdom. Indeed one shouldn’t be surprised with this result. As Robert Lawrence showed in a paper that my program published in January, there are strong theoretical reasons to be skeptical of claims that falling U.S. oil imports and rising U.S. oil production will substantially reduce the U.S. current account deficit. Which gets to the heart of FiveThirtyEight’s challenge. They want to do theory-free data analysis. But without at least some sort of theory, you at best need to investigate a much larger volume of data in order to get useful results. (That’s what Nate Silver did so well with election predictions and baseball statistics.) At worst, if your data isn’t good enough, theory-free analysis leaves you with nothing. Here’s hoping that FiveThirtyEight will be disciplined enough to stick to analyses where its unusual approach works.

Blog Post by Michael Levi March 24, 2014 Energy, Security, and Climate