ENERGY SECURITY

By Jeffrey Kupfer

A decade ago, the U.S. energy situation looked bleak. The gap between domestic energy production and consumption was widening, and that trend seemed likely to continue indefinitely. In 2005, the United States imported 30 percent of its total energy consumption (up from roughly 20 percent during the 1990s), and in that year’s Annual Energy Report, the U.S. Energy Information Administration (EIA) projected that net imports would rise to 38 percent in 2025. Today, ten years later, the situation is dramatically different. Net U.S. imports of total energy consumption fell to 13 percent in 2013, and analysts now project that domestic supply will continue to outpace domestic consumption. In the reference case for its 2015 report, the EIA foresees imports and exports coming into balance in 2028 (and, in some alternative scenarios, that crossover happens as early as 2019).

Moreover, energy has been one of the few bright spots in an otherwise tepid economic recovery. The consulting firm IHS CERA has estimated that the country’s new oil and gas production—generally referred to as “unconventional production”—was responsible for very nearly 40 percent of overall GDP growth from 2008 to 2013. Last year, the White House Council of Economic Advisors reported that increased oil and natural gas production alone contributed more than 0.2 percent to real GDP growth in both 2012 and 2013, a substantial component of the overall economic growth rate of 2.3 percent during those years. Furthermore, a recent study from the Harvard Business School and the Boston Consulting Group concluded that in 2014 this unconventional production supported about 2.7 million jobs. Even more noteworthy is that those jobs paid, on average, nearly twice the average national salary.

Yet while the country’s fortunes have changed for the better, the U.S. government still seems stuck in the past. Rather than embracing, encouraging, and employing our newfound bounty, policymakers seem, at best, conflicted and ineffective, and, at worst, hostile to developing and using our resources. We should be celebrating these achievements, developing and implementing policies that reflect this new reality and encouraging more of the same. The next Administration should approach energy policy with a mind to leading the United States into a new era in which we deploy America’s energy resources to strengthen both our economy and our national security.

Energy policy contains many elements, including maintaining a stable and predictable regulatory system, supporting basic research and development of new energy technologies, accounting for the environmental and climate implications of energy production and use, and recognizing the ultimate market-driven realities at work. What is truly new and deserves the next Administration’s focus, however, is the growing capacity to translate the revolution of U.S. energy production into significant domestic and foreign policy benefits.

The changes in the U.S. energy landscape have been truly remarkable. The first shot in the arm came in the natural gas sector. As of 2005, the prevailing view was that U.S. supply could not keep up with domestic consumption, and thus the country would need to rely more on imported liquefied natural gas (LNG). In 2003, Federal Reserve Chairman Alan Greenspan testified that in order to deal with higher and more volatile natural gas prices the United States would need a “major expansion of LNG terminal import capacity.”[80] In 2005, the EIA projected that LNG imports would grow from 0.4 trillion cubic feet in 2003 to 6.4 trillion cubic feet in 2025.

But the combination of horizontal drilling and hydraulic fracturing—and the resulting “shale gale”—turned all these predictions upside-down. Since 2005, U.S. natural gas production has risen every year, from 18.05 trillion cubic feet in 2005 to 25.7 trillion cubic feet in 2014, more than a 40 percent increase. Natural gas from shale, which was not even measured in 2005, accounted for 11.4 trillion cubic feet in 2013. By 2010, discussion had shifted to the viability of LNG exports from the United States; most analysts now expect the United States to become a net natural gas exporter within the next few years.

Meanwhile, entrepreneurs began applying the same techniques that had been used for natural gas development to domestic oil fields. In 2005, the United States produced an average of about 5.2 million barrels per day of crude oil, an amount that had hovered near that level for years. But starting in 2008, production rose steadily, reaching an average of 8.7 million barrels for 2014. During the first six months of 2015, crude oil production averaged 9.5 million barrels per day.

Combined with greater efficiency in domestic oil use (another positive trend), U.S. production increases have also reversed the oil import story. In December 2005, the United States had net imports of about 12.5 million barrels per day of crude oil and petroleum products, which was 60 percent of our overall consumption of almost 21 million barrels per day. By June 2015, net imports dropped to 5.1 million barrels per day, a little more than 25 percent of consumption.

The next Administration should approach energy policy with a mind to leading the United States into a new era in which we deploy America’s energy resources to strengthen both our economy and our national security.

While most developed countries are slowing their consumption of petroleum liquids, the EIA sees continued growth (at about 2 percent per year) for developing countries, with roughly two-thirds coming from China, India, and other Asian countries. Energy needs around the world will grow, and the United States stands in an excellent position to capitalize on that situation.

But the speed of the private sector in developing domestic resources has not been matched by the U.S. government, which has seemed alternatively indifferent or unwelcoming to the new reality and the resulting opportunities. We have seen this approach manifest itself in regulatory policy impacting production, infrastructure, and export markets.

Federal regulations for fossil fuel production in the United States have been inconsistent and slow developing, and thus have caused much uncertainty for market participants. Regulations and permitting for infrastructure have suffered from the same problem. Regardless of what one thinks of the merits of the Keystone XL Pipeline, the project’s seven-year odyssey has been a lesson in how not to handle an important decision—and at the time of this writing, the issue still remains unresolved. The entire process has created doubt, damaged our relationship with Canada, and crowded out more substantive energy discussions. During that same period, U.S. imports of crude oil from Canadian oil sands have increased by nearly as much as the projected capacity of the pipeline, but this oil has been transported by rail, which is both less efficient and less safe.

As for export policy, Federal law requires government approval for gas exports from the United States. If the U.S. government has a free trade agreement in place with the recipient country, the Department of Energy (DOE) will automatically deem the application to be consistent with the public interest. However, when lacking a free trade agreement—as is the case with Japan (the world’s largest LNG market), China, and the European Union—DOE will hold a hearing and study whether the application is in the public interest.

The first LNG export applications were filed in 2010. It took more than two years for the first non-FTA application to be fully approved, and even now, only six have received DOE’s final approval. During this period, billion-dollar investment decisions remained in limbo, and U.S. allies around the world wondered whether the U.S. government would let its companies provide a needed resource. Even now, while the pace of approvals has picked up, questions remain about the timing and criteria to be used to decide on applications.

Meanwhile, there has been even more tentativeness infecting policymaking regarding crude oil exports. Forty years ago, reacting to the Arab oil embargo and domestic price controls, Congress enacted a ban on U.S. crude oil exports. The law provided the President with discretion to lift the ban for certain countries, sellers, or classifications judged to be in the “national interest.” President Reagan first used this waiver authority to allow unlimited crude exports for internal use within Canada, and then Presidents George H.W. Bush and Clinton used it for more narrowly tailored purposes.

With skyrocketing domestic oil production, there is an increasing mismatch between the lighter types of oil produced in the United States and the heavier crude that U.S. refineries are configured to process. As such, the price for domestic oil has been consistently lower than the worldwide price, and, without a worldwide outlet, analysts expect a reduction in the growth of domestic production, with a corresponding impact on jobs and economic growth.

Regardless of what one thinks of the merits of the Keystone Pipeline, the project’s seven-year odyssey has been a lesson in how not to handle an important decision.

Nevertheless, there has been little movement within the Executive Branch to allow crude oil exports, despite some recent pressure from Congress. After a lengthy wait, the Commerce Department recently allowed some crude oil swaps with Mexico. The Department has also issued a few discrete rulings that allow exports of processed condensate (a very light hydrocarbon liquid), but there is still uncertainty about how much processing is necessary to get into the refined product category (which is exempt from the ban). The Obama Administration has promised to study the overall issue, but no concrete activity is in evidence, and one cannot detect the slightest indication that the President is considering using his authority to provide any broad-based exemptions.

There are several reasons why the U.S. government should be embracing the development of domestic resources, and actively facilitating their entrée into world markets. First, it is good for our economy. The EIA estimates that expanded LNG exports could increase GDP by 0.05 to 0.2 percent over the 2015-40 period. While some studies predict a slight rise in domestic natural gas prices as a result of opening up the export market, any increase would be more than offset by higher employment and investment in the sector.

As for crude oil, IHS estimates that lifting the ban would add $86 billion to $170 billion annually to U.S. GDP between 2016 and 2030. Higher U.S. production would put more oil on the world markets, thereby lowering worldwide prices for both crude oil and refined products such as gasoline. It may sound counterintuitive to non-experts—and this has been one of the political problems with moving forward to void or adjust the 1975 export ban—but virtually every study shows that lifting the ban would lower consumer prices at the pump by at least a few cents per gallon.

Second, the freer flow of oil and natural gas is consistent with a commitment to free trade, which has been a cornerstone of U.S. international economic policy for decades. During the past few years, the reduction in net crude imports has already improved our trade balance, and expanding exports of LNG and especially crude oil would bolster this trend. As we push for additional free trade agreements, such as the Trans-Pacific Partnership in Asia and the Transatlantic Trade and Investment Partnership in Europe—or when we complain about other governments restricting imports or exports—obsolete U.S. export policies undermine our own arguments.

Third, U.S. energy exports could greatly benefit U.S. allies, strengthening existing relationships and building new ones. Over the next few decades, much of the worldwide energy growth will take place in Asia, and those countries are hungry for access to U.S. energy supplies. Japan and South Korea are almost completely dependent on imports of liquefied natural gas. As for oil, the top importing countries (besides the United States) are China, Japan, South Korea, and India. Besides the prospect of lower global energy prices, global markets will benefit from an increase in supply from a more stable part of the world, and a diversity of transport routes that will help to alleviate risk from current maritime bottlenecks. For European countries, which receive about 30 percent of their oil and natural gas from Russia, the availability of more U.S. energy supplies would allow them to diversify their sources of supply and reduce Russian leverage on them.

Fourth, energy exports would help build U.S. diplomatic leverage (whether we use that leverage effectively is a separate question). It is well understood that lower worldwide oil prices have harmed the economies, and arguably limited the influence, of countries such as Iran, Venezuela, and Russia. Less well understood is that increased U.S. production has helped to facilitate the imposition and severity of energy-related sanctions. It clearly would have been much more difficult to convince oil-consuming countries to boycott Iranian oil—and potentially deal with higher oil prices as a result—if the United States was not adding millions of barrels per day to the global market. The same dynamic occurred as the U.S. and its European allies debated whether to impose sanctions on Russia’s energy sector. Looking forward, the growth of U.S. energy production and its availability on the world market should help the U.S. government to build international support for new or broader energy sanctions, should they become necessary.

U.S. energy exports could greatly benefit U.S. allies, strengthening existing relationships and building new ones.

At the same time that we extoll the benefits of increased energy production for our economic and national security, we must keep it all in context.

First, we need be realistic about the volumes and timing. While increased U.S. production and exports of oil and gas are having tangible impacts, they cannot transform the energy situation overnight. The global gas market is about 328 billion cubic feet (bcf) per day, with LNG accounting for about 31 bcf per day. As a point of comparison, the EIA predicts less than six bcf per day of U.S. LNG exports by 2020. Meanwhile, the global oil market is currently over 93 million barrels per day, and increased U.S. production will range up to a few million barrels per day.

Second, while there is available regasification capacity (mainly in Europe), maximizing the impact of these new supplies requires massive, global infrastructure investment that will take years, if not decades, to construct and operationalize. For instance, many European countries that are most dependent on Russia for energy supplies cannot shift easily and quickly to other sources, even if they become available on the open market.

Third, the energy industry in the United States is composed of hundreds of players, all of whom study the market and make their own business decisions. This is a good thing; the innovation and dynamism we have witnessed would have been impossible without it. But the role of the private sector means that the government cannot set the agenda based solely on national security implications. Private companies will determine, for instance, how much to produce and where to sell their products. They will not render OPEC or Saudi Arabia irrelevant. While increased U.S. shale production certainly adds flexibility to the global system, it is not the same as having a few state-owned companies that can make a decision and influence the market almost immediately.

Fourth, increased domestic production does bring a set of environmental issues, including ones related to climate change, that should not be ignored or brushed aside. The next Administration can justifiably argue, however, that the most effective way to deal with these issues is not to bottle up domestic energy production or to impose limitations on the export of these resources. To the extent that these issues are localized, they can be (and generally have been) handled by risk-based and cost-effective regulation. To the extent that they are global, they can be addressed by realistic, equitable, and cost-effective actions. Besides, environmental considerations cut both ways. In part because of increased natural gas usage displacing mainly coal, U.S. carbon dioxide emissions are now about 10 percent lower than they were in 2005, and in April 2015, monthly power sector carbon dioxide emissions hit a 27-year low.

Finally, we cannot let our success in the oil and gas sector blind us to the continued challenges in the energy space. In the first place, no one knows how long the “shale gale” will last. We would be foolish to allow our new optimism to become as untethered from reality as was our former pessimism. Therefore, among other things, we need to continue supporting research that could lead to technological breakthroughs and enable us to further diversify and sustain our energy sources. We need to let innovation flourish, let markets work, and eliminate special interest programs that are not sustainable. We need to revitalize our domestic nuclear industry, as we are becoming increasingly irrelevant while other countries look to develop and build civilian nuclear power. And we need to modernize and protect our country’s electricity system, making sure that we can deal with new sources of supply as well as a stressed and vulnerable grid.

The goal—and the accompanying rhetoric in the next Administration—should be about energy security, not energy independence. Regardless of whether and when the United States achieves energy self-sufficiency, it is unrealistic and counterproductive to think of ourselves as an energy island that is immune to events in the rest of the world. Gasoline prices in the United States will continue to be determined in large part by the global price of crude oil. That is already evident in Canada and Norway, for instance, both of which are "energy independent" or self-sufficient in oil, but their pump prices ride the global roller coaster just like everyone else’s (markets for natural gas are different).

But at the same time, there are clearly benefits to having a larger percentage of U.S. energy consumption come from domestic sources. According to a recent CEA analysis, the less money that the U.S. economy has to dole out on net petroleum imports, the smaller the impact a supply disruption would have on it. Moreover, a stable and reliable resource base, with a short and consistent transportation system, certainly enhances our energy security. This is why we should be focusing even more attention on greater cooperation with Canada and Mexico to form a North American energy powerhouse. Canada is among the world’s top producers of oil and natural gas, and Mexico recently enacted a series of energy sector reforms that are designed to reverse the country’s production declines. While there is already significant cross-border infrastructure and trade, especially between the United States and Canada, opportunities for more collaboration and heightened benefits for all abound.

No one knows how long the “shale gale” will last. We would be foolish to allow our new optimism to become as untethered from reality as was our former pessimism.

Yet even with the focus on North American resources, the United States will continue to have a vital interest in the stability of global energy supplies and infrastructure. This principle applies to many areas around the world, but especially to the Middle East. During the past few years, the Middle East has produced about 30 percent of the world’s crude oil supply, but its share is projected to rise to 35 percent by 2040. And so the idea that the U.S. government can disengage from that region without any ill effects is misguided.

The past decade has transformed the U.S. energy situation from one of relative scarcity to one of abundance. Policymakers have been slow to adjust, failing to embrace and exploit these resources to improve our economic and national security interests. Starting in January 2017, the next President, working with Congress and the private sector, can change all that. The benefits of doing so are much too great to waste.

(80) Testimony to the U.S. House Energy and Commerce Committee, June 2003.


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