Seven Questions: America’s Energy Predicament

In the United States, high gas prices and mammoth oil company profits have set off a new round of hand wringing in Washington. In this week’s interview, energy analyst Amy Myers Jaffe of Rice University's Baker Institute of Public Policy explains America’s energy predicament, why more offshore drilling should be permitted, and why the oil majors are at risk of being beaten in the race toward the future.

Foreign Policy: What should be the top policy priority on energy?

Foreign Policy: What should be the top policy priority on energy?

Amy Myers Jaffe: We have to reduce the annual rate of increase in U.S. gasoline consumption. I like to remind people that if you take just the U.S. increase in oil imports over the past 15 years, it is equal to Chinas entire current oil use. We need to get a grip on that. And there are several ways to do that, such as taxes on gasoline and increases in fuel efficiency standards. One proposal that Congress refuses to consider because it doesnt please the special interests is to impose taxes on cars based on their social cost to us as a nation.

China has already done this: If a car has higher emissions and poor gasoline mileage, theres a higher tax. So in China youd pay something like a 20 percent tax on a Hummer. People correctly mocked the minuscule amount President Bush allocated to the energy science initiative. Well, a great way to raise that revenue is to tax the people using the most resources. If you can afford to buy a big car that gets 3 miles to the gallon, you should be taxed for the environmental and security burden that places on the rest of us. We tax people for having yachts. We tax people who smoke cigarettes. So we can tax people who want to drive around in giant, inefficient cars.

Second, in the long term, the goal should be to improve automobile technology. A lot of people are taking the Brazilian experience and saying Oh, jeez, look at that, why cant we be more like Brazil? We need to remember two things. One, Brazil has been working on that for over 30 years. Second, Brazil was able to do that using American-manufactured cars that are flexfuel vehicles, which means they can use either regular gasoline or ethanol fuel. As an American who had to evacuate from Houston in the lead up to hurricane Rita when there was a gasoline shortage, I would like the choice to have a car that runs on more than one fuel. I would like to be able to choose between plugging in my car to my home or running it on liquid fuel. We have the capability to manufacture fuel-cell cars, or some variation on them, that works on a combined system of battery and liquid fuels so that if liquid fuel were scarce or too expensive, I could plug my car into my house or office. It would be good to have diversity and flexibility in the system, so that if there were a crisis in the Middle East or if a hurricane knocked out major oil refineries, the many Americans who drive less than 10 miles to work every day could just run off of their batteries.

FP: With domestic production of natural gas in decline, it looks like the United States is going to be more dependent on imports. Whats the larger significance of that?

AMJ: Thats significant for two reasons. At the Baker Institute Energy Forum, weve projected that the United States will have to import 25 percent of its natural gas supply from the Middle East and other distant producers by 2025 to 2030. If we know that thats the direction we are going in, then we know we have to change something. We are already uncomfortable with the security implications of rising level of oil imports from the Middle East. Do we want to add the problem of security of our natural gas supply?

FP: What about the prospect of drilling on the Outer Continental Shelf off the Atlantic coast?

AMJ: For the short term, we must consider those huge deposits of natural gas off the coasts of Florida, the Carolinas, Maine, etc. Im not sure that the public has really thought it through. Politicians and the media are all pointing to Brazil as a success story. But Brazil is going to be energy independent not because they have a small but successful ethanol program. They are going to be energy independent because they had a massive offshore drilling program which has more than doubled their oil production from 650,000 barrels a day in 1990 to 1.6 million barrels a day now. So when we consider drilling in the United States, we have to ask ourselves; What are people afraid of? Why don’t they want this drilling? Brazil has a tourist industry that is focused on beaches too. U.S. reserves we are talking about are so far away from the beach that you wouldnt be able to see the offshore platforms. You have to take a four-hour helicopter ride to reach them. Its a reasonable fear that wed have a terrible hurricane that knocks down the platforms and ends up spilling oil. But weve recently had three of the worst hurricanes in the last 100 yearsIvan, Katrina, and Ritaand the industry practices are so good at this point that there was no damage to Texas and Louisiana beaches. Its time for the public to consider that we could drill for our own natural gas and boost our domestic supply.

FP: With elections coming up in 2006 and 2008, it appears that political leaders in Washington would rather not risk alienating Florida voters on the drilling issue for fear of being punished at the polls in that very important state.

AMJ: And that is why were in this mess. There is no form of energy supply that one can discuss that doesnt affect some constituency. It has to be about leadership. Theres enough blame to go around. The president and the governor of Florida yielded to public protests and they cancelled bid rounds for Florida offshore blocks. On the other side, you have Robert Kennedy Jr. on the cover of Vanity Fair magazine as a leading environmentalist. But his family doesnt want windmills to block their view from Marthas Vineyard. Kayakers dont like hydro-electric dams. Birdwatchers dont want wind farms. Nothing is clean enough for people, and yet nobody is willing to turn their lights off. If Sen. John McCain were successful on campaign finance reform then our energy problems would have probably been solved too.

FP: It seems incoherent to argue that the oil majors should be investing in cleaner fuels but that gasoline should remain cheap at the pump.

AMJ: Yes, theres a huge disconnect. But in fairness to the public, its not just that people arent willing to look in the mirror and consider their own habits. Its also because they feel vulnerable, because they woke up in the morning after these hurricanes and were suddenly afraid that they werent going to be able to get to work. When the oil companies say oil is cheaper than Starbucks coffee, it doesnt matter. I can go to the store and get Folgers or not drink coffee. But if I need to drive to work, I dont have any choice but to use gasoline. And thats why I think the solution has to come in the form of individuals having choicescars should be able to run on more than one thing. The energy companies are missing an opportunity to provide leadership in providing choices. There can be a market for alternative fuels. The demand is there. The oil companies could take a leadership role or they will lose the opportunity to someone else such as General Electric or Iogen.

Part of the price swings can be attributed to the fact that in the United States, we dont require refineries to carry a minimum inventory. Thats why we had such a big problem during Rita and Katrina. We had to stop manufacturing and there was limited oil in storage. The Europeans sent us their gasoline from inventory, because they mandate minimum inventories for refineries in Europe. Today in Congress, there is no proposal to have a minimum inventory requirement. But its a no-brainer. I dont see the Congress debating any of the proposals that would actually do something.

FP: The International Energy Agency estimates that to produce the amount of oil we will need by 2030, $4 trillion dollars of investment into oil and gas production will be needed. But oil companies still assume prices are coming down, so theyre not investing as much. Should we be concerned about that?

AMJ: The oil majors are not increasing their spending on drilling because either they think prices will come down or theyd rather just take the cash so they can please Wall Street this quarter. They dont have to make investments based on $80. That would be bad management. But today you can buy oil in the futures market for $70, or at least $50. Then why dont they secure oil derivatives sales contracts at high prices and lock in their profits? I’ve asked some executives in natural gas about this and the logic is remarkable. They say If I hedge and the market goes higher, Ill lose my job for making a mistake. But if I dont hedge and the price drops no one will blame me because then it would have happened to everyone. That’s the mindset.

FP: Private oil companies control only about 10 percent of oil reserves and state-owned companies control the rest. Will they be able to deliver future supplies?

AMJ: Im not concerned about the size of the reserves being overstated. The Saudis probably have more than they say they have. But the larger question is whether the state-run oil firmssuch as Russias Rosneft, Venezuelas PDVSA, or Saudis Aramcoare going to have the political climate to allow them to spend billions of dollars expanding production. Its politically easier to just take the higher prices in the short term.

Think about Saudi Arabia. They are already going to spend $50 billion on new production, but that doesnt get them very far because of declines in existing fields. But to produce the amount of oil the world needs from them in the futurearound 20 million barrels per daythey would have to spend up to $100 billion dollars at a time when the country has a rising population, tremendous social pressure, and a lot of competition for that capital. I wrote a historically wrong article in Foreign Affairs in 2000 that assumed that many OPEC countries were eventually going to let foreign oil companies in. But we have the opposite trend now.

The question is: Does it make sense to hang our future on the assumption that the governments of Iraq, Iran, Russia, Saudi Arabia, and Venezuela are going to be really well organized and deploy hundreds of billions of dollars of capital to develop the kinds of oil resources we’re going to need? To bet that thats going to happen defies the current instability in all those systems. It also goes against the grain of history, which is that OPEC capacity to produce oil has fallen over the last 30 years.

Amy Myers Jaffe is the Wallace S. Wilson Fellow in Energy Studies at the Baker Institute Energy Forum at Rice University.

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