Thursday, November 07, 2013

Energy Security Four Decades After the Arab Oil Embargo

  • The Arab Oil Embargo of 1973-74 focused our attention on energy security and set in motion drastic changes in the way we produce, trade and consume energy.
  • With US energy output approaching or exceeding 1970s levels, some experts now advocate prioritizing competition from non-petroleum fuels over reducing oil imports.
Forty years ago this month the United States and other Western countries experienced a new phenomenon as an embargo on oil deliveries from a group of the world’s largest oil exporters took effect. The embargo was a response to the military support that the US and some of its allies were providing to Israel during the Yom Kippur War then underway in the Middle East. A recent session hosted by the US Energy Security Council commemorating these events included a fascinating conversation between Ted Koppel and Dr. James Schlesinger, US Secretary of Defense at the time of the embargo and later the first US Energy Secretary.

The other, related purpose of the meeting was a presentation and discussion on the proposition that fuel competition provides a surer means of achieving energy security than our pursuit of energy independence for the next four decades following the Arab Oil Embargo. This idea warrants serious consideration, since energy independence, at least in the sense of no net imports from outside North America, is finally beginning to appear achievable.

The 1973-74 embargo was the first oil shock of a tumultuous decade, and it triggered a true crisis. The US had relied on oil costing around $3 per barrel (bbl), not just to fuel our transportation system, but also for 17% of our electricity generation and numerous other uses. The US was then one of the world’s largest oil producers but required imports comprising about one-third of supply to balance our growing demand. With the sudden loss of over a million barrels per day of oil imports from the Middle East, and lacking the sort of strategic petroleum reserve that was established a few years later, an economy already battling inflation was tipped into recession.

The embargo rattled more than the US economy; it challenged basic assumptions of American life, including our sense of entitlement to cheap and plentiful gasoline. Before the oil crisis, gasoline prices hovered around the mid-30-cent mark, with occasional local “gas wars” taking the price down to the high-20s--the inflation-adjusted equivalent of $1.60 per gallon now. Of course with average fuel economy around 13 miles per gallon, the effective real cost per mile wasn’t necessarily lower than today’s.

Within a year gas was over 50¢ at the pump, and by the end of the decade it passed $1.00/gal. for the first time. The gas lines that resulted from the unexpected supply shortfall and the federal government’s efforts to limit the ensuing increase in prices were an affront to drivers, a category that encompassed most of the over-16 population.

That first oil crisis and the subsequent energy crisis resulting from the Iranian Revolution in 1979 set in motion a number of important changes, including a sharply increased focus on energy efficiency, a deliberate effort to diversify our sources of imported oil, a pronounced shift away from oil in power generation — to the point that it now makes up less than 1% of US power plant fuel — and the beginnings of our search for affordable, renewable alternatives to oil.

The US Energy Security Council is an impressive group that includes many former government officials and captains of industry. They’ve clearly spent a lot of time studying this issue, and their report is worth reading. As I understand their conclusions and recommendations, they regard high oil prices as a bigger risk to the US economy than oil imports, per se, because of the impact of oil prices on consumer spending and the balance of trade. They have concluded that the most effective way to apply downward pressure on prices is not simply to reduce US oil imports, but to introduce meaningful fuel competition into transportation markets, where oil remains dominant with a share of around 93%.

The group doesn’t dismiss the benefits of increasing US oil production from sources such as the Bakken, Eagle Ford and other shale formations, but because these are relatively high-cost supplies, they have concluded that their leverage on global oil prices is limited. That means that higher US oil output couldn’t provide a path back to the price levels that prevailed before the Iraq War, when West Texas Intermediate crude averaged $26/bbl in 2002 and gasoline retailed for $1.35/gal.

This is a reasonable argument, though it’s worth considering that a return to $75/bbl might be feasible, if US production kept rising. That could yield US retail gasoline prices around $2.75/gal., equating to $2.15 in 2002 dollars. This isn’t as far-fetched as it might seem, because the global oil price is determined not by the entire 90 million bbl/day of world supply and demand, but by the last few million bbl/day of incremental supply, demand, and inventory changes.

The Council’s view also appears to emphasize the direct impact of oil prices on consumer spending without recognizing that rising production and falling imports shield the economy as a whole from the worst effects of high oil prices. With oil’s contribution to the trade deficit shrinking steadily, the main impact of higher oil prices is to divert money from consumers to shareholders of oil companies — of which I should disclose I am one. While exacerbating income inequality, that should at least result in a smaller impact on GDP and employment than the combination of rising oil prices and rising imports.

If the discussion had stopped at that point, the meeting would have been just another interesting Washington gabfest. However, the group’s analysis includes a set of actions it has identified as necessary for achieving their desired outcome: US energy security extending beyond the current US oil boom, underpinned by an expanding unconventional gas revolution that is widely expected to last for decades.

Their recommendations include giving fuels like methanol derived mainly from natural gas the chance to compete with gasoline made from oil, and with biofuels.They would start with revisions to the current US Corporate Average Fuel Economy standards to give carmakers incentives — not cash subsidies or mandates — to make at least half of all new vehicles fully fuel-flexible, capable of tolerating a wide range of blends of methanol, ethanol and gasoline. That seems like a no-regrets approach that could be achieved at a very low incremental cost per car. Even if you never bought a gallon of E85, M85, or M15, it could pay for itself by protecting your car from the damage that might result if you inadvertently filled up with gasoline containing more than the 10% of ethanol that carmakers believe is safe for non-flex-fuel cars. Other recommendations include easing regulations for retrofitting existing cars for flex-fuel and forming an alcohol-fuels alliance with China and Brazil.

Yet while I repeatedly heard that the group wasn’t promoting any single fuel, talk of methanol dominated the conversation. The moderator, Ann Korin, even joked that the session sounded like an “alcohol party.” As I later pointed out to her, there wasn’t a single mention of drop-in fuels — gasoline and diesel lookalikes derived from natural gas or biomass. I regard that as a crucial omission, because such fuels would be fully compatible with the billion cars already on the road, rather than just the 60 million or so new cars produced each year. They could provide greater leverage on oil prices by producing pipeline-ready products with which consumers are already familiar, from sources other than crude oil.

Part of the appeal of methanol seemed to be the potential for producing it from shale gas at a cost well below the cost of gasoline, even on an energy-equivalent basis — an important caveat, because a gallon of methanol contains half the energy of a gallon of gasoline. I hear the same argument in support of various pathways for producing jet fuel from non-oil sources, and it subscribes to the same fallacy: that market prices are set by manufacturing costs rather than supply and demand.

Fuel is a volume game. For a non-oil gasoline substitute to drive down oil prices –and thus motor fuel prices– as far as the Council apparently envisions, it would take at least several million barrels per day, on an oil-equivalent basis. Producing six million bbl/day of methanol from natural gas would consume 20 billion cubic feet per day of it. That’s 30% of last year’s US dry natural gas production, requiring 100% of the Energy Information Administration’s forecasted growth of US natural gas production through 2034. A number of other entities have their eyes on that same gas for other applications.

As many of the speakers at the Energy Security Council event reminded us, the world is a very different place than it was in 1973. Among other changes, US energy trends are headed in the right direction, with oil demand flat or declining, production rising and imports falling. That alone makes us more energy secure than we were, either five years ago or in 1972. Future oil supply disruptions are also unlikely to look much like the Arab Oil Embargo.

The Council is certainly correct that our unexpected shale gas bonanza, producing large quantities of new energy at a price equivalent to oil at $25 or less per barrel, provides a unique opportunity to weaken OPEC’s influence on oil prices. In pursuing that goal, however, it’s essential to remain flexible concerning the best pathways for gas to compete in transportation fuel markets, whether as CNG or LNG, or through conversion to electricity, methanol, or petroleum-product lookalikes. Consumer acceptance could prove to be the biggest uncertainty governing the ultimate outcome.


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