A bipartisan group of former U.S. ambassadors joined forces today to officially launch the Diplomatic Council on Energy Security (DCES)—a project of Securing America’s Future Energy (SAFE).  The members of the DCES aim to call attention to the diplomatic and foreign policy constraints posed by America’s dependence on oil.  Led by co-chairs Ambassador Alfred Hoffman Jr. and Ambassador Elizabeth Frawley Bagley, members of the group participated in a press conference and moderated roundtable discussion, and took questions from a public audience in Washington, DC.

The DCES also released its inaugural report, Oil and the Trade Deficit.  This report highlights petroleum as a crucial component in the growth of the U.S. trade deficit over the past decade to a potentially unsustainable and damaging level.  It provides yet another important argument for taking critical steps to end American dependence on oil.

Report Summary

Oil is traded globally, and its price is affected by events in oil-producing and oil-consuming nations around the world, in addition to international waterways and events in nations that host important shipping channels or infrastructure.  Much of the world’s oil is produced in unstable regions and nations hostile to the United States, and its price is increasingly high and volatile.  At approximately 19 million barrels per day (mbd), the United States is responsible for more than one-fifth of total global oil consumption, and is thus both greatly exposed and vulnerable to global market volatility.  This poses a serious threat to U.S. national and economic security.

Although the United States is also a major oil producer and prospects for continued growth in domestic production are positive, the nation remains reliant on imports for a large portion of its total oil use.  At an annual cost below $100 billion as recently as 2002, the nation has run an aggregate trade deficit in petroleum of more than $1.5 trillion since 2007—an average yearly deficit in excess of $300 billion.  In fact, progressively higher oil prices have increased the total cost of the U.S. oil import burden in recent years, even as imported volumes have declined.  For example, net petroleum imports declined by approximately 1 mbd between 2010 and 2011 and yet the petroleum-related deficit increased by more than $60 billion.  Despite even lower anticipated import volumes this year, further elevated prices are forecast to increase this deficit further in 2012.

The nation has sustained a trade deficit with the rest of the world for more than a quarter of a century.  However, over the past decade, the size of this deficit has grown significantly. The current size of the trade deficit, totaling more than half a trillion dollars in 2011, cannot be sustained indefinitely.  It creates significant risks and vulnerabilities for the U.S. economy, including an increased dependence on consistent capital inflows from foreigners.  This compounds America’s international debt burden while lowering the prospects for long-term U.S. economic health.  A readjustment of the U.S. trade balance is almost certain to be necessary.  Whether gradual or more sudden, this process is likely to involve higher levels of saving and lower levels of consumption, higher interest rates and prices for imports, and lower prices for exports.  These factors will moderate the trade deficit, but also reduce living standards below what they would be if borrowing continued unabated.  A sudden adjustment would occur if increasing import demands are not matched by foreign willingness to purchase U.S. assets, thereby causing abrupt pressure to lower spending.  If the nation could not reduce its reliance on foreign oil, imports of other goods and services would have to decline, and if capital inflows fell low enough, it is possible that the nation would be unable to afford its oil imports.  This kind of adjustment could be orders of magnitude worse than a more gradual process.

By taking action to decrease its trade deficit sooner rather than later, the United States can reduce the painfulness of an adjustment.  Petroleum represents a crucial component of the U.S. trade deficit on which changes in policy can have a clear, direct, and significant impact.  Any approach must focus on increasing domestic oil production and decreasing oil consumption.  New investments to aid the return of strong and sustained economic growth must also address structural limitations of the economy with respect to oil, most notably in the transportation sector.

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The WSJ puts it this way:

North Dakota has passed Alaska to become the No. 2 oil-producing state in the country, reflecting how the embrace of new drilling technology is redrawing the U.S. energy map.

North Dakota’s daily production of oil rose 3.1% to 575,490 barrels in March, according to preliminary state data, 1.4% more than Alaska’s daily production of 567,480 barrels for the month.

Texas, which pumped 1.7 million barrels a day in February, holds a firm grip on first place.

This is of course good news, especially for North Dakota.  It’s also good news for US energy security.  While it’s true that domestic production in a globally-linked market doesn’t shield us from price increases and even from volatility caused by sudden market disruptions, more domestic production does help our balance of payments and trade deficit.  Dollars flow to American workers and American shareholders rather than hostile petro-states.

What’s surprising is how sudden this North Dakota boom is:

The leap past Alaska came “substantially earlier than we thought. We had graphed this out [to happen] early next year,” said Ron Ness, president of the North Dakota Petroleum Council, which represents more than 350 companies in the state’s oil fields. “I don’t foresee us giving Texas a run right now, but certainly we’ve moved up in the batting lineup.”

In four years, oil output has quadrupled in North Dakota. In March 2008, the state was the No. 8 oil-producing state at 144,000 barrels a day.

 And of course it’s all about hydraulic fracturing and horizontal drilling.  Most of the controversy about fracking has come from the new natural gas plays, where production is happening in areas where it hadn’t before.  For tight oil, however, production is resuming in areas thought to be tapped out.  The fact that there’s no controversy over fracking in ND is a clear indication that it’s not the process but the critics that cause the criticism.  Policy-makers should keep that in mind as they weigh the benefits of our domestic oil and natural gas boom.

Between 2009 and 2011, the United States experienced three consecutive years of crude oil production increases for the first time since the early 1980s, as well as the largest surge in output within a three year period since the late 1960s. This marks a sharp reversal from conventional wisdom of only a few years ago, suggesting U.S. crude oil production was in a decades-long state of decline. This shift has far-reaching implications for the United States, with positive benefits including substantive reduction of the trade deficit, and potential employment gains driven by petroleum industry growth. The role of policymakers is to ensure these benefits are maximized by making promising tracts of federal land available for development in environmentally responsible ways.

However, while encouraging pursuit of these advantages, the report emphasizes the importance of long-term strategies to reduce our petroleum dependence and the heavy costs associated with it. While current projections show that extractable resources could drive net liquid imports down by 21 percent by 2020, this boon to our energy supply must not be conflated with energy independence. Notably, even oil exporting nations which produce more than they consume (such as Canada and Norway) are part of the global oil market, and remain subject to the same high and volatile oil prices. Rising domestic production will not achieve a long-term domestic price advantage in oil, and a nation’s level of oil production does not necessarily improve its energy security—a goal which can be achieved through significant cuts in consumption. Furthermore, even with rising domestic production, U.S. oil dependence constrains foreign policy and military options due to our commitment to stability in oil-producing regions of the world.

Consequently, policy prescriptions must also focus on long-term abatement of our petroleum consumption. Towards this end, SAFE recommends aggressive pursuit of fuel economy standards to reduce the oil intensity of the economy, and transitions towards alternative fuel sources, such as natural gas for heavy-duty trucks, and electrification of light-duty vehicles. Only by diversifying the transportation sector can real energy security be achieved.

Click here to access The New American Oil Boom.

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Naim notes that “during a period in which oil prices are booming” and private sector multinationals are setting profitability records, “these three companies are declining.”

 ”Their production, reserves and potential are lower than they used to be and their performance is far poorer than it could be, given the rich geology of the areas over which they enjoy a virtual monopoly.”

Why is this?  Naim points to underinvestment, ”mismanagement, limited access to new technologies and the mistreatment of foreign partners” as factors common to all three.  And those factors are generally derivative of politicization, as well as “cronyism and patronage.”

Naim contrasts the three in decline with ”the rapid ascent of Brazil and Colombia as oil-producing countries.”

 ”Brazil’s Petrobras, while state-controlled, has a governance structure designed to protect its management from political interference. The company has become a global player in the same period that its less fortunate Latin competitors were falling. Petrobras’ discovery of large Brazilian offshore reserves may well propel it to the top of the industry leagues once production there starts. Colombia, a nation that until recently had no significant presence in the oil industry, is also growing very rapidly.”

Naim then gives some context to the announcement that the Kirchner government in Argentina will be taking over YPF, which was privatized a few years ago and acquired by Repsol, a Spanish company.  He cites cronyism, “rifts between rival oligarchs, political expediency, populism and the wish to please a public resentful of the privatisations of the 1990s” as elements in the take over.  Yet another lesson, as if we needed one, in the lack of freedom in the global oil market.

The clear answer is yes, unless leakage rates from natural gas production are significantly higher than current estimates.  The WaPo gets a few things right:

America’s abundant supplies of unconventional gas have the potential to be a rich economic and environmental blessing. New extraction techniques — hydraulic fracturing, or “fracking” — make the country’s vast reserves accessible at low cost. The fact that burning natural gas produces about half the carbon emissions as coal means the fuel could be an attractive, affordable alternative, giving lower-carbon energy options more time to become less expensive.

And it then raises the current issue in the radical enviro community:

“Oil and foreign policy wonks should be celebrating their success in cutting oil exports. Instead, I hear consternation. The goal in Washington and Brussels was always to cut Iran oil exports to the minimum, “but”, as a senior US diplomat told a recent gathering, “not too fast” to avoid unsettling the market. So far, the cut is too fast and too wide.

Iran oil exports dropped last month by around 300,000 barrels per day, with production falling to a 10-year low. The country’s oil production falls seasonally in the spring as refiners undertake maintenance, but the drop in 2012 is much larger than usual. JPMorgan believes that by the summer Tehran’s oil exports will have fallen another 700,000 barrels per day. Oil traders and Gulf-based oil officials talk in private about similar export losses.”

The poor execution of sanctions, combined with Iran spitefully cutting off supplies to many EU nations in January, has helped drive up the price of crude in recent months, to the detriment of our economic recovery.

The Islamic Republic’s President, Mahmoud Ahmadinejad, has remained defiant against sanctions, stating “We have as much hard currency as we need and the country will manage well, even if we don’t sell a single barrel of oil for two or three years.” Iran’s recent actions don’t reflect this reality. Blas reported on Wednesday that the nation is attempting to tempt its customers to continue buying oil by offering “discounts” through easy credit. Numerous EU nations as well as Turkey, Japan, South Korea, and China, have all announced sharp cutbacks in their purchases of Iranian crude, (with the exception of Greece, whose sovereign debt crisis has left it suffering a shortage of willing oil suppliers, and has dramatically increased its purchases—the topic of which was the subject of a recent SAFE intelligence report). The fact that Iran is now offering discounts on its oil through relaxed credit terms is a testament to its current desperation. NPR reports that Iran will officially enter into talks about its nuclear program with member nations of the U.N. Security Council in Istanbul this weekend.

It is unclear how productive these talks will be. It is possible that, as has been observed in the past, Iran will simply complain about how the West is treating it. Needless to say, although the sanctions are clearly having the desired effect, there’s virtually no way to cut off a major oil supplier without threatening the global economy. This is not a matter of enacting sanctions in the perfect way (probably an impossible task) but a matter of taking real steps to sever our oil dependence once and for all.

This is a close question, but the idea of preparing to release strategic petroleum reserves — and communicating that preparation — is probably a good one.  It can send a signal to the Iranians that OECD nations will not suffer from sanctions imposed on Iranian exports — and can combat to some degree moves they might make in the Straits of Hormuz that the Iranians hope would be economically damaging. 

Actually releasing those reserves now, simply to combat current prices, on the other hand, would be a transparently political move designed to reduce gasoline price increases (and thereby enhance reelection prospects) as we near the summer drive season.  The US reserve is called a Strategic Petroleum Reserve, after all, and many believe it is fundamentally designed to ensure military supplies in the event of war.  Others view the SPR as an insurance against sudden and unforseen supply shocks caused by either natural disasters or armed conflict.  The idea of using the SPR simply to reduce consumer prices or calm jittery markets, especially in a presidential election year, is highly controversial.

Yet it is indeed an election year on both sides of the Atlantic (though not in the UK).  And that’s probably why Faucon was able to find an analyst who’s fairly confident that a release will occur:

“A [U.S.] strategic stock release, either unilaterally or via the International Energy Agency, appears inevitable during the next two quarters,” London bank Barclays said in a note last week.

Inevitable is a strong word — and the IEA member nations will need to weigh that move against the likelihood that it will irritate our mutual patrons in Saudia Arabia.  Note the perspective provided by the Saudis, as reported by Faucon:

“You saw what happened in the last release? Nothing,” Saudi Oil Minister Ali al-Naimi said last week, referring to last year’s release of stockpiles to make up for a Libyan export shutdown. U.S. oil futures fell 5% at the time, but bounced higher within a week.

As long as we’re as dependent on OPEC and the Saudis as an allowance-receiving child, our ability to manage our own economic affairs is severely constrained.  Former Senator Byron Dorgan emphatically made the point on Morning Joe today: “There’s no free market in oil!!”

The kingdom’s oil minister insisted this week that oil markets are amply supplied and that it stands ready to boost output. Its council of ministers asserted that excessively high petroleum prices threaten the global economy and that a downturn would lead to an abrupt pullback in prices, hurting the interests of oil exporters and consumers.

 Last week, the transport arm of state-owned Saudi Aramco booked at least nine supertankers — far more than usual — for shipments to the United States, according to traders and Lloyd’s List. Each tanker can carry 2 million barrels of oil.

 And the Saudi oil minister, Ali al-Naimi,told reporters in Doha, Qatar, on Tuesday that the kingdom was producing 9.9 million barrels a day, about three-quarters of which is exported.

 Yet oil markets remain unimpressed. On Wednesday, the price of the West Texas Intermediate grade of crude oil for May delivery rose $1.20 to $107.27 a barrel — about where it was a week earlier. Expensive crude is driving up gasoline prices — a fact the Obama team worries will hurt the president’s reelection prospects.

 “What the Saudis are trying to do is to change the psychology of the market and demonstrate that the market is well supplied,” said Robin West, chairman of PFC Energy, a consulting firm.

In a free market, the laws of supply and demand combine with open competition to produce prices that rise and fall.  Crude prices have been steadily rising — or have been stuck on near-historic highs — because of growing demand.  In a normal market that demand would be pulling new supply into the market until the demand was met and exceeded, at which point prices would begin to fall.  Then either supply drops or demand grows, and prices rise again.  A macroeconomic circle of life, as it were.

Only not for oil:

Naimi said that Saudi Arabia could boost output to 12.5 million barrels a day to meet demand but that customers are not interested in buying more than they are now.

 “We ask the customers, ‘Do you need more?’ And invariably the answer is, ‘No, thank you,’ ” he said, according to Reuters.

 Really?  How could that be?  Here’s the answer:

One major oil trader, who requested anonymity to protect business relationships, said that if Saudi Arabia really wanted to tamp down prices it could lower its asking prices and then customers might buy more. Saudi prices are adjusted monthly, but the trader said Saudi Aramco is “extraordinarily inflexible” in the terms it offers buyers.

In a free market, other competitors would undercut the Saudi price and that would force more flexibility for Saudi Aramco.  But, as some politicians can’t seem to grasp, there is no free market in oil.  That’s why folks who are normally libertarian-leaning on economic matters advocate policy interventions when it comes to energy security.

That’s right.  Some administrations have sought to use the SPR as a price management tool,  but the clear intent behind our Strategic Petroleum Reserve is to compensate for a sudden and unforeseen supply disruption.  Prices rise, as any Econ 101 student will tell you, when demand goes up and/or supply goes down.  The reasons behind today’s high prices are primarily demand-related — and particularly demand in developing countries.  So high prices are probably here to stay and don’t justify an SPR release.

But will there be a sudden supply disruption, the type of disruption that would warrant tapping the SPR?  Herron writes that:

Mr. Cameron and Mr. Obama discussed the topic during a meeting at the White House Wednesday, but didn’t come to any conclusions . . . . The meeting came as oil prices remain very high and the International Energy Agency warned that sanctions against Iran could remove as much as 1 million barrels a day of oil production from an already tight market. . . .

The IEA estimated Wednesday in its monthly oil market report that the EU ban, combined with action from other countries and financial sanctions, could remove between 800,000 and 1 million barrels a day of Iranian oil from the market. With gasoline prices already at all-time highs in much of Europe, and becoming a hot issue in the U.S. presidential election, many industry analysts have begun to speculate that consumer nations could release oil from emergency stocks this summer to blunt the affect of sanctions.

The sudden loss of 1 million b/d is a bit over 1% of total global consumption, and 1 million b/d has historically been thought of as the “cushion” available that keeps the liquid fuels market liquid.  Does that justify a release?

Let’s be clear that the IEA isn’t advocating a release, as Herron notes:

The executive director of the IEA, Maria van der Hoeven, said Wednesday that an emergency release isn’t imminent.

“There is a tightening market, there is no doubt about that” as oil inventories are below the five-year average, she said. “At this moment there is no need to use [emergency oil stores].”

Key is the phrase “at this moment.”  Herron also points out that the “last IEA emergency stock release was in June 2011, after the Libyan civil war shut down 1.1 million barrels a day of oil exports.”

That’s why well regarded DOE Dep Sec Daniel Poneman “said Wednesday that the U.S. is constantly monitoring whether a release is necessary from its Strategic Petroleum Reserve.”

“The president has been very clear, we have every tool available at our disposal,” Mr. Poneman said on the sidelines of the International Energy Forum in Kuwait City. “We are going to keep consulting with our partners globally and the [IEA] to see what tools we need to be using.”

Fair enough.  One thing readers should keep in mind, though.  There are many who oppose energy production in the Arctic National Wildlife Refuge on grounds that we “can’t drill our way out of this” — that the incremental production from ANWR won’t make that much of a difference.  So remember that when we face the loss of 1 million barrels of day on the global stage, the world rushes to tap strategic reserves.  What’s the likely daily ANWR production, according to the US EIA?  Between 1.55 million barrels per day and 1.90 million barrels per day.  Not a sermon, just a thought.