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.

CONGRESS IS BATTLING over whether to approve the Keystone XL oil pipeline, proposed for the heart of the country.  The project has clear value to the United States. Yet, with all the amped-up rhetoric, it is important to remember what the project would not do. It would not endow the United States with “energy security” in the sense that most Americans understand the phrase and that many pipeline advocates wield it. It would not significantly lower oil prices. In fact, when it comes to oil, America will be affected by global events for decades, and that’s assuming the right policies are in place.

All true, and well put.  The pipeline does have clear value for the US:  more access to a secure product, continued good relations with our stable ally to the north, good jobs, etc.  And yes, the pipeline will not lead to 100% energy security — nor is it the threat to the environment that opponents fear (or fear-monger about).

The Post has some good prescriptions for reducing our dependence on foreign oil — and thus our exposure to world-wide economy-constraining high prices and economically damaging price volatility:

There are sensible policies to promote this long-range goal. An economy-wide, anti-carbon policy, such as a carbon tax, would fit the bill. Short of that, the best policy would be a higher gasoline tax, which could also fund transportation needs. President Obama’s auto efficiency standards will also help. In contrast, direct subsidies for electric cars are extremely expensive for meager benefits.

Unfortunately, after making those mostly solid points, the WaPo takes a gratuitous shot at incentives for electric vehicle and infrastructure deployment.  They are wrong on that.  Vehicle electrification has long been viewed as the logical next step in reducing our economy’s oil intensity.  As key executives at Shell (hardly an entity one would expect to be pro-electrification) said nearly a decade ago:  use electrons for transportation and reserve molecules (of petroleum) for higher-valued applications.  That’s still the right answer for our economy and our energy security.

The mix of fuels used to generate electricity in the United States is experiencing a seismic shift that is unlike anything that has happened in decades.  Looking across all sectors, U.S. coal-fired generation in 2011 fell to its lowest level since at least 1949, which is the earliest data available from EIA.  Moreover, according to EIA’s latest estimates, this trend will accelerate sharply in 2012, with coal-fired generation falling to just 36.2 percent of the U.S. total—far removed from its decades-long position as the source of more than half of U.S. power generation.

What’s driving this shift?  One look at the graph above tells the story pretty clearly.  The use of natural gas in power generation—which has steadily increased since about 2003—is set to soar in 2012.  While total U.S. power generation will increase by less than 1 percent between 2011 and 2013, gas-fired generation will increase by 23 percent.

In the past, natural gas was viewed as a risky option for baseload power generation, because fuel prices tended to be both high and volatile, making them unable to compete with coal. This fuel price volatility has historically outweighed the distinct advantage held by natural gas generators when it comes to capital cost. The revolution in domestic shale gas production, which has depressed natural gas prices to levels that are highly competitive with coal in numerous U.S. markets, has fundamentally changed the calculus for power generation economics.  Moreover, some recent analysis suggests that the capital cost equation has been moving even farther in favor of natural gas as air quality regulations and the complex construction requirements drive the cost of coal plants higher.

Changes in the fuels used to generate electricity could have important implications for everything from electricity prices to greenhouse gas emissions and air quality.  One area of particular interest to us is the impact a cleaner grid will have on the upstream CO2 emissions associated with plug-in electric vehicles (PEVs).  We sometimes point out that PEVs are the only vehicles that will get “cleaner” as they get older as the grid moves toward lower-carbon forms of electricity.  The experience of the past several years and expectations about the very near term demonstrate this quite well.

As the figure below shows, the amount of upstream CO2 emitted by a PEV in charge-depleting mode has been declining substantially in recent years—even when it is powered by the average U.S. grid mix.  A driver who purchased a PEV in 2005 would have seen his or her upstream emissions fall by 16 percent by 2012.  In other words, the driver’s vehicle would have continuously improved its advantage over the average light-duty vehicle for that year, which achieved an adjusted fuel-economy rating of 19.9 miles per gallon.  In fact, even when taking into account line losses, a PEV purchased in 2005 would just about be on par with the best hybrids on the road today, which tend to register fuel-economy ratings of about 50 miles per gallon. Going forward, as more U.S. electricity is generated by natural gas, nuclear power, and renewables, electric vehicles will only continue to get cleaner.

A final note: Of course, no EV is likely to be powered by the ‘average mix.’  Instead, it will be powered by the marginal power plant serving its load.  To the extent that this is a natural gas turbine, nuclear power plant, or renewable source, EVs are already the cleanest available transportation option.  Analyses like this one from Oak Ridge National Labs suggest that gas turbines are likely to play a key role in powering EVs.

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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Back in the old “aughts” when natural gas prices bounced wildly from single to double-digits per million British thermal units (Btus) and back again, Congress and the Bush Administration pulled out all the stops to encourage the construction of import facilities for liquified natural gas (LNG).  That was then, of course, and now we have gas hovering around $2/mmBtu and nobody in their right mind wants to try to import LNG.

The good news is that an LNG import terminal can be retrofitted to export LNG, as Dominion wishes to do with Cove Point.  Here’s the Post:

The opportunity here is obvious: The United States should export some of its bountiful stocks of natural gas to Japan and other countries with fewer supplies and high demand. That is why Dominion Resources wants to retrofit its Cove Point facility to service exports as well as imports. It’s no surprise that Sumitomo Corp., a Japanese energy outfit, is already in contract talks to use the retrofitted terminal, pending regulatory approval of exports to Japan.

Since no good deed goes unpunished, of course, the litigation-happy folks at the Sierra Club are trying to block this action because they are afraid of the environmental consequences of natural gas production, specifically water contamination (so far unfounded) and leakage of emissions into the air (so far insignificant).

The WaPo is strong on this front:

Though environmental groups worry about hydraulic fracturing, the process drillers use to extract unconventional gas, the right response is to push for proper oversight for all energy firms, not to punish one company for trying to provide a reasonable service that others will succeed in furnishing in  coming years.

And the Post is equally good on the benefits of natural gas exporting, while acknowledging the fears of some:

Though it’s possible that allowing exports might raise natural gas prices somewhat in America, doing so would also improve the country’s trade deficit, produce returns on domestic energy projects, increase state and federal tax revenue, support construction and maintenance jobs, reduce the leverage of gas-rich international bullies such as Russia, provide nations such as Japan a lower-emissions alternative to burning lots more coal and oil, and, as Japanese Prime Minister Yoshihiko Noda indicated at the White House last week, tighten trade ties with America’s leading Asian ally.

The fact is that a little upward pressure on prices would be a good thing.  Natural gas production in shale fields is currently uneconomic; there’s plenty of room for price growth to ensure stable supplies while maintaining affordability for consumers.  A new export path for the US sector is in the national interest on multiple levels.

Of course, as is always the case, looking at the totals is much less interesting and informative than digging into the sales components. In doing so, one learns that after 15 months of alternating at the top, neither the Nissan Leaf nor the Chevy Volt was the highest selling U.S. PEV in April. Instead, the top spot was captured by the new plug-in Toyota Prius, which debuted in the U.S. in March, selling 911 units out of the gate.  In April, plug-in Prius sales hit 1,654 units, just beating the Volt’s 1,462.

Despite spotting its competitors a year-and-a-half head start, it took Toyota just two months to have the best-selling plug-in vehicle in the United States.  Like the Chevy Volt, this Prius is a plug-in hybrid electric vehicle (PHEV), capable of operating solely on electricity until the battery is depleted or certain speeds are reached, at which point the vehicle can rely on a built-in gasoline-powered drivetrain.  Whereas the Volt’s battery supports about 40 miles of all-electric driving, the plug-in Prius gives drivers about 10 miles of all-electric range.

Why the Prius popularity?  At first blush, brand reliability has to be a major factor.  It certainly isn’t cost.  The Volt’s base MSRP is $39,145, but it qualifies for the full $7,500 federal tax credit.  Absent any state incentives, that means the effective Volt MSRP is $31,645.  The base MSRP for the plug-in Prius is $32,000.  However, due to its smaller battery size, the Prius qualifies for only $2,500 in federal tax breaks, giving it an effective MSRP of $29,500.  It seems unlikely that a difference of just $2,145 explains the surging popularity of the Prius versus the Volt.

A final note: the fact that the Volt and the Prius—both PHEVs—are dominating U.S. sales at the expense of the all-electric Nissan Leaf implies that Americans are not willing to move toward BEVs in the absence of a compelling infrastructure solution. The Leaf will be the cheapest option to purchase and own compared to the Volt or plug-in Prius.  After the $7,500 federal tax credit, the Nissan Leaf lists for $27,700.  Considering the fact that it will never run on gasoline, its fuel (and maintenance) costs will also be lower than either of the PHEVs.

We should exorcise the politically convenient notion that high oil prices result from the market maneuvers of greedy “speculators.” It’s convenient because it suggests that a solution to high pump prices — or a partial solution — is to banish the offending speculators from the marketplace. That’s fantasy.

Despite periodic debunking, it returns whenever oil prices surge. In mid-2008, with crude prices approaching $150 a barrel, the Commodities Futures Trading Commission (CFTC) created a task force to study whether speculation caused the run-up. The task force included experts from the Agriculture, Energy and Treasury departments, the Federal Reserve, the Federal Trade Commission and the Securities and Exchange Commission.

Samuelson quotes the conclusion from this task force:

“Current oil prices and the increase in oil prices between January 2003 and June 2008 are largely due to fundamental supply and demand factors. . . . The Task Force’s preliminary analysis to date does not support the proposition that speculative activity has systematically driven changes in oil prices.”

Despite this clarity, politicians hate to admit they are relatively impotent over an issue like high oil (and gasoline) prices.  So, President Obama has resurrected the idea and has once again pointed an accusing finger at “speculators”:

“We still need to work extra hard to protect consumers from factors that should not affect the price of a barrel of oil. . . . We can’t afford a situation where speculators artificially manipulate markets.”

Well, the good news is we don’t have to worry about speculators artificially manipulating markets, as Samuelson reminds us with a lesson in Economics 101:

It’s true that outside investors (a.k.a. “speculators”) have dramatically shifted money into commodities — raw materials. “Commodity index funds,” which invest in a basket of commodities (oil, wheat, corn), have attracted hundreds of billions of dollars. It’s easy to imagine all this money chasing prices up in futures markets, just as speculative stock market frenzies push share prices to unrealistic levels. It’s also wrong.

The stock and futures markets operate differently. In the stock market, herd psychology can lead to speculative bubbles or panics. In a bubble, almost everyone seems to win (until the bubble bursts); in a panic, everyone seems to lose (until the panic subsides).

By contrast, futures markets are “zero-sum games.” One investor’s gain is matched by another’s equal loss. Here’s why. Under the standard futures contract, one investor agrees to buy the commodity (say, 1,000 barrels of oil) at a future date for a given price, and another investor agrees to sell for the same price. If the actual price on the settlement date has gone up, the buyer reaps the gain; if it’s gone down, the seller wins. The loser pays the winner; actual commodities are rarely transferred.

There are measures that policy-makers can adopt to help lessen the impact of high oil prices — and ultimately lower prices themselves.  Chief among those would be assisting in the deployment of vehicle electrification infrastructure and advanced biofuels.  Bashing the bogeyman of speculation doesn’t help a bit.

Ever since wind energy came on the scene, questions have been raised about their impacts on local weather.  It stands to reason that diverting wind from its old pattern of whistling down the plain to make electricity would have SOME type of impact on weather patterns.  Now comes this study, that ”showed for the first time that wind farms of a certain scale, while producing clean, renewable energy, do have some long-term effect on the immediate environment.”

This is a first, at least for your writer.  And the methodology seems sound:

“Using sensors aboard a NASA satellite, researchers at the University at Albany-State University of New York, and the University of Illinois systematically tracked a cluster of wind farms in central Texas as the installations grew from a few dozen turbines in 2003 to more than 2,350 by 2011.

On average, the nighttime air around the wind farms became about 0.72 degree Celsius warmer over that time, compared with the surrounding area, the scientists reported Sunday in the peer-reviewed journal Nature Climate Change.”

Far from earth-shattering — and clearly offering no reason to shy away from wind energy — today’s report once again demonstrates two things:  1) The law of unintended consequences is real; and, 2) there is no impact-free technology we can use to harness energy.  The net effect of wind farms is of course still overwhelmingly positive, but let’s not pretend that it is uniformly so.

On the demand side, little has changed in recent months.  IEA still expects global demand to reach record highs in Q3 and Q4, hitting 91 million barrels per day (mbd) in the final quarter of 2012.  This would represent an increase of 1.2 mbd over the same period last year.  The entire increase comes from emerging market economies.

On the supply side of the market, IEA has upped its estimate of unplanned non-OPEC outages for Q1 2012.  Between Syria, Yemen, Sudan, Columbia, the North Sea, and Canada, total outages were 1.1 mbd for the January-March period.  In Q2, IEA expects these outages to rise further to 1.3 mbd.  The level of unplanned outages has been a major factor behind rising oil prices this year.

The other primary factor driving oil prices has been geopolitical risk associated with the standoff over Iran’s nuclear program.  The EU is moving closer to full implementation of its import ban and continues to crack down on financial dealings with the Iranian oil sector.  At the same time, a number of key developments in Asia suggest that it will be difficult for Iran to find buyers for displaced European barrels.  The result: IEA now suggests that Iranian oil production could fall by as much as 900,000 b/d by mid-summer 2012 compared to end-2011 levels.  Saudi Arabia and other Gulf Arab states are already pumping at levels that could help compensate for lost Iranian barrels, but the consequence has been a steady erosion of spare capacity, which fell to just 2.5 mbd in March 2012. At that low level, any further unexpected supply-side disruption(s) could be a significant problem.

The IEA report also contained a useful graphic that illustrates just how tight oil markets have been for the past several years.  We have recreated the chart using data from the Department of Energy’s custom table builder, which is somewhat different but very close—and also free.  The chart is below.

The two lines are quarterly global supply and demand of liquid fuels.  As you can see, demand has routinely exceeded supply in recent years, which implies a drawdown in commercial inventories.  The tightest periods occurred between late 2007 and mid-2008 and then again from late 2010 through late 2011.  Both periods were characterized by exceptional increases in global oil prices.  However, in the first quarter of 2012—a period during which Saudi Arabia pumped oil at a 30 year high—the global market appears to have experienced a much needed implied build in inventories.  IEA reports that developed-country stocks may have built by 500,000 b/d, while stockpiling in China and Saudi Arabia could equal as much as 700,000 b/d during the first quarter.  Saudi Arabia now reports that stocks within the Kingdom and elsewhere are now full.  Chinese government stocks may have built at a rate of several hundred thousand barrels per day. And U.S. commercial crude stocks were at the very top of the 5-year range as of Wednesday’s weekly DOE report.

What does it all mean?  As the market enters what promises to be an eventful summer, the tightness that drove the most recent wave of oil price volatility could be abating—a hopeful sign.  A less optimistic view would be that we are seeing the equivalent of a gigantic deep breath by the market—preparation for the plunge into a summer and fall of rising emerging market demand and confrontation with Iran.