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February 11, 2009

The Global Energy Market: Changing Geopolitical and Financial Risks

Amy Myers Jaffe

By kind invitation of Austin Mitchell MP, the Henry Jackson Society hosted a discussion with Amy Myers Jaffe, Wallace S. Wilson Fellow in Energy Studies, James A. Baker III Institute for Public Policy, Rice University, where she discussed the changing geopolitics of the energy market. 


We should reflect on the reality that we had $147 per barrel oil and $36 per barrel in a very short space of time.  We need to try to understand why that happened.  I’ll turn back the clock a little bit.  Between 2004 and 2006, the market started to acquire what was called ‘the terror premium’.  It was connected to a series of events that started to scare the market into thinking that there could be a major disruption in the supply of oil. 

The first one went unnoticed initially; Osama bin Laden began to call on the faithful to attack oil facilities and these Fatwas were issued about why that was legitimate in the jihad of the West and the enemies of Islam.  Very soon thereafter, there was a Saudi cell in Al Qaeda that attacked a facility there called Abqaiq.  That was a major crude processing area.  It is way too large to blow up; there are miles and miles of facility, but the fact that they had tried spooked the market.  There were attacks on facilities in Iraq.  That began the thought that there would be a terror premium on oil.

In addition, there was the three way tension between Israel, Iran, and Hezbollah.  In 2006, we saw the Israelis respond to Hezbollah missiles.  That unnerved the oil market; it might have seemed irrational, but back when the Israelis had made statements about Iran obtaining nuclear weapons, they had threatened to blow up Iran’s main oil export island as a countermeasure to defend their national security.  As that conflict escalated, it created the risk of an extended war in the Middle East.

Then we started to see a different problem.  The price of oil went up and the US economy came under pressure because of the higher trade deficit we have owing to a high percentage of oil imports.  The dollar then started to weaken.  And then, in my opinion, we had an asset play.  You had all this extra ‘hot money’ from the Gulf made off of the terror premiums.  Their economies could not absorb all the money since there wasn’t enough projects in which to invest in such a short period of time.  So, money had to go out into the investment community.  The London and New York communities all start chasing the same assets with the same dollars and we had a bubble.  This was the oil futures bubble.  This race took the price of oil from $100-147.

The reason this was a problem is because you had the general tenor of the US economy slowing from the sinking dollar.  You also had the sub-prime mortgage crisis.  Once you had the financial crisis, financial institutions had to start exiting their investment and trade positions and they had to start bringing their capital home.  Once that happened, all the money in oil futures had to be liquidated.  Once you had liquidation, the market started to go down.  In the reality of the bubble, those political problems had eased.

But then, Ahmadinejad’s party had lost its big majority.  You saw more votes for the centrist party and the conservative party.  There was the possibility of Iran’s government changing its position on dialogue with the West.  At the same time, the Israelis were in dialogue with Syria which seemed to reduce the potential for conflict there.  And you had announcements from US leadership and intelligence that the global infrastructure of Al-Qaeda had been crippled.  People started to think the likelihood of that kind of attack was reduced.  The geopolitics seemed to be calming down.  The market made a reassessment based on the fundamental outlook for the US economy and that was down, down, down.

The interesting thing is now we’re at $40 a barrel.  How do we move forward?  There are a lot of variables.  In the Middle East, there is a lien of thought that says, perhaps, the market getting overheated was a bad thing.  You have different attitudes towards it.  All these financial surpluses coming in didn’t help anybody.  There was a sense that we don’t need the price to be as high, combined with a realisation that they were holding dollar-assets and didn’t therefore want to see the destruction of that system.  There’s debate about what the ideal price should be.  I’m a big believer in seeing, not saying.  My feeling is that since the market is hovering about $40-45, that’s the proper price.

 $40-45 a barrel, however, must seem very low to Russia.  We had an OPEC meeting in September last year.  It’s held in a meeting room this size.  There are 12 ministers who sit around a table and each minister, if he wants to appear very powerful, has his staff stand behind him during the meeting.  In years past, the delegations would bring more people to stand behind the minister.  In the September meeting, the Russian minister came as an observer and he brought 20 people to stand behind him. 

The interpretation of how the Russians behaved in the meeting was fairly negative from the perspective of the Arab States.  They saw a Russia trying to behave as a superpower.  This was a Russia that was above coming to this meeting, but that they were not happy about the high oil price and the Arab States needed to do something about it. 

The question is, though: what leverage did the Russians have short of cutting off Ukraine for a few weeks?  The leverage they have is dangerous.  They have the possibility of a relationship with the Iranians.  By helping the Iranians with their nuclear program, they send a message to the other Arab states: if I don’t like the way you’re behaving, I might support the Iranians’ adventurous activities since we both want the price of oil to be higher.

In the context of that, the Russians held a meeting in Moscow about whether there could be a national gas OPEC.  Then they said there should be a troika: Russians, the Iranians and the Qataris.  It’s a threatening scenario.  The interesting thing about that is that the Russian strategy is to sell the Iranians nuclear development materials so that we, the Americans will have to place sanctions upon Iran.  Then, Iran will be unable to sell their supplies to Europe and so the Russians will have no competition.  But maybe the Iranians won’t be happy with the position they’ve gotten themselves into.  Recently the Iranians said they wanted part of the European market.  The Russians had Gazprom announce that it was interested in investing in Iran to sell Iran’s gas to India.  Meaning ‘we’ll give you a market but not ours.’

A Change in American Energy Policy

The interesting thing about the dynamic is that the status quo is over because the US president is different.  We all have this knee-jerk reaction, myself included, that we know how the US is going to respond.  For the last 8 years we have had the neo-conservative broken record.  Now, with the new administration, things are going to be less predictable and the orientation is very different.

For example, if you think about the inner circle of Cheney and Wolfowitz, there is a similar circle of people that are going to impact the Obama administration, but they’re not in the foreign policy apparatus.  They are very committed activists on the climate issue.  That’s going to bring a big shift in US policy.  You may or may not have noticed it.  Sometimes when you read the paper, you notice things you already know rather than what you’re not expecting.

So, for example, if you look at the stimulus package and you look at Obama’s record, you’ll hear a lot of rhetoric about green jobs.  You might think that’s all nonsense, but a lot of people in Obama’s circle have put that in Obama’s stimulus package.  It extends credits for renewable energy.  They’re talking about giving federal money for states’ infrastructure, but part of that will make public buildings more energy efficient.  So, there are lots of things that Obama the Candidate said he was going to do that are actually in the stimulus package.

If you watched Obama’s press conference, he said what was in the stimulus package.  The Republicans said it was wasteful.  How can building a new building for a little school in Georgia help stimulate the economy?  I thought the President was very convincing.  He said that there is this school where the building goes back to the 1800s and there’s no heat or library, etc.  By funding this school to have a new science lab, here’s what we’re accomplishing.  People in construction have jobs.  That’s the immediate stimulus.  The children who are in that school will be more encouraged to study science because there’s a science lab.  Think about places like Doha and Riyadh and what they’re trying to do with their petrol dollars.  They’re building these places of higher learning.  They’re not doing K-12 and without K-12, you’re nowhere.  The Obama Administration admits that this is going to be a priority. 

He took a couple of first actions as president that I think people need to understand.  Those are the bona fides.  A lot of people talk about Obama’s centrist positions.  But, he authorised research for stem cells.  That’s very left wing politics for the US.  He gave California the waiver they sought that would put more fuel efficient cars onto roads in the state of California.  It is such a big market that if every car in the state of California could get 60miles to the gallon, every car in the US will have to get 60 miles to the gallon.  The bottom line is, in the big markets, where people would sell cars, the fuel economy standards are going to be even higher. 

Detroit is now going to have to come to him for money and a bail-out.  He might be a centrist, but there’s a core group of people who have key posts in the government that are very, religiously concerned about climate change.  They’re going be more concerned about climate change than they are about the unions in Detroit.  It will be very interesting to see how those politics play out in the US Congress. I’m not saying it’s a given, but it’s definitely going to change the politics.  In the Bush administration, none of those things were priorities.

The American solution is to reduce our exposure—our need for oil.  Those policies can be resold out to the American public as solving more than one problem at a time.  Can the Obama Administration sell to the public that a Green Policy as retooling our economy to create Green Jobs which will provide us with export productivity and a greener future.

Managing American Demand

President Bush did not have an effective policy because it focused on bio fuels and you’ll read these terrible stories about how the entire bio fuels industry is now closing and we won’t meet targets set by Congress.  This is because, in the end, bio fuels require land and water.  We don’t have the technology to do it otherwise.  Even if we did, it’s going to make such a small contribution to the world energy balance that it was a ridiculous policy in the first place.

The Obama Administration isn’t talking about that at all.  People need to clear their minds.  Everyone in the world needs to take Yoga and do a 20 minute cleansing.  The way things are going to be analysed is completely different.  The United States consumes 33% of all road fuel used in the world.  China uses 5%.  There are 250m cars on the road in the US.  There are 26m on the roads in China.  I’m not saying there won’t be 100m cars in China someday because, frankly, the Baker Institute, where I work, said that before it was fashionable.  It’s a question of time.

26m cars today are not going to produce the kind of oil demand that 250m cars does.  A change in the gasoline mileage in 26m cars means nothing.  But a change in the driving habits and the gasoline mileage in 250m cars have a huge impact.  The Obama people understand that.  They used to go around with a video about plug-in electric and hybrid cars.  We calculated it out at Rice; suppose Obama implemented his plan and starting in 2015, new American cars got 50 miles to the gallon.  That means that US demand would be down by at least as much as Chinese demand would have gone up.   7m barrels a day of US oil demand would be eliminated by that one policy alone.  So the thing I tell people about resource war and all that is that if you think  about the past, 1973, 1990, even the current financial problems, no one’s ever gone to war.  Iraq invaded Kuwait—maybe it was somewhat over oil—but that is not two countries fighting because there’s not enough oil for the both of them.  In 1973, there was no war.  The Middle East countries cut off supplies.  No one attacked them.  The US and Germany didn’t go to war over the remaining oil.  All that happened is that the US, together with its European allies implemented policies of stockpiling and energy efficiency.  I don’t see why it would be any different now.

Let’s say we woke up tomorrow and someone developed some new technology that allows us to know we there was no oil left.  We would know we would have to do something else and there would be no reason to have a war.  I tell people this peak oil thing bothers me somewhat.  I understand the UK had oil and now it doesn’t.  But I mean, we have the technology to take a lump of coal and turn it into gasoline.  The best estimates as to how much that would cost is $30-40.  We can turn natural gas into $15 a barrel.  We can make coal into oil for $40 dollars a barrel.  We can turn the tar sands into oil for $70.  There’s no resource issue.  The only reason to go to war would be because we’re too stupid to use new technology.  So why wouldn’t the US and China institute a policy of making that technology together when there’s a need to?  Isn’t that the reason why we’re back down to $40?  All we need is a joint, international agreement on climate that focuses on transportation, says that every Chinese, German, Japanese, Brazilian, British car, and, indeed, all automobiles manufactured in the OECD are going to have to make a standard of 52 miles to the gallon.  We’re going to share the technology.  The demand peak will never happen.

I have been advocating a higher gasoline tax since 2000.  Every time I write it somewhere in public, I get hate mail from Americans who say I don’t understand how they’re suffering.  We did a piece in the institute.  Everyone who did policy had to write a briefing paper for the new American president and because energy is such a big topic, I decided that we would do gasoline; that’s what the public cares about.  We advocated a gasoline tax.

If you’re concerned about US credit abroad, this could rectify its fiscal issues.  You announce it in advance so the consumer could plan.  Our trading partners would see we had some fiscal responsibility.  For the first time in 9 years of advocating a higher gasoline tax, I didn’t get hate mail.  You would have thought in Houston I would have gotten hate mail for that.  I was giving a speech at a luncheon in Houston for wealthy donors to the university.  You can imagine people were a bit conservative being not only wealthy, but Texas wealthy.  People pressed me for what I thought.  They said “don’t you think the Obama Administration is going too far with all these onerous regulations that they’re planning to pass?” 

I did tell a funny story about the crazy things they’re doing in California.  There was too much to explain in 3 hours.  California is going to make it illegal in the State of California to use and sell plugs that drains energy when the appliance is off.   It’s the same thing with the car companies.  Everyone’s going to have to change then.  But I was explaining this extremely complex legislation for the Low Carbon Fuel Standard.  Say you’re Chevron and you sell petrol in California.  For all of the operations involved in making that gasoline, the well you refined, the emissions from your station and the person who used the gasoline.  You’re going to have t show the state of California your plan for reducing that.  You’re going to have these scientists and they’re going to do life cycle analysis and then Chevron’s going to have come in with lawyers and scientists and such.  It’s very complex.  If you think about how litigious the US is.  The idea of two teams of scientists on each side seems quite impossible. 

I said that when I see things like that, I thought it would be just simpler if we would just tax energy and then give the money to the national sciences foundation and take the money and use scientific peer review to set clear bars about what energy efficiency technology we needed to produce and that, if we did that, we would get there in 10 years.  In Texas, advocating an energy tax where the money went to science, I got a standing ovation.  That’s a change in US attitudes.

Energy and Democracy

The Bush Administration believed that if you could democratise the Middle East, you would break the back of al-Qaeda.  The theory was that we would pick a weak place like Iraq and then once all the other countries saw how successful Iraq was they would follow its lead.  You could say you shouldn’t’ve done it by force, but they’re all authoritarian and armed—how would you do it another way?

Part of the feature of oil and democracy is not that oil stops democracy; it’s that you have what’s called “resource rent”.  In other words, I can get money almost by doing nothing.  If I have so much oil that I don’t have to tax my citizens to govern and spend, it creates a lack of civil involvement.  I’m voting for you, but you are not spending my tax dollars.  It does give you a slightly different dynamic.  I’m spending our collective resource dollars.  There’s a lot to fight about because we have this free rent and if I get into power, I can take this rent for myself.  I do think this is a major barrier to peace in Iraq but not democracy, mind you.  Indeed, it’s not like you cease to be democratic just because you have resource rent.  With the proper desire, they could go democratic.  The fundamental problem though, is that if you have other strains in society, but the people who win also get more money, that makes it harder. 

Towards Sustainable Energy Production

Scaling up is a difficult thing.  Some of what the ’renewables people’ talk about are impossible.  I’m not so knowledgeable about the hybrid cars.  To make the batteries, those materials could become a problem if everyone buys them.  A lot of the research needs to go into material science—for solar, for batteries.  A professor that I worked with had this conceptual idea which was the soundest thing I’ve heard.  His idea was that we need to move to distributive energy.  We keep having problems because we’re trying to have centralised system like a giant nuclear plant and a giant wind farm. 

If I have to come up with a way to turn all the woodchips in Washington State and turn it into fuel, that’s pretty daunting.  But if you want me to design an efficient solar panel that I could put onto someone’s home that would feed into a box the size of a washing machine in someone’s home that would store electricity for 24 hours, then it becomes a much more manageable problem.  You could see how I could deliver that, but if I had countries in Africa where building a power station and wiring out to villages is not possible, if I got the costs down, the people who need it most could get energy.

The oil industry likes to say we have the magic fuel, it’s cheap and efficient.  I say, you have never been around the world.  One third of the people on this planet have no access to modern energy at all; they are burning sticks.  How miraculous is a fuel if it is leaving one third of the world’s population in abject poverty?  No heat, no cooking fuel, no lighting.  How is that a good energy system?  That is a very poor energy system.  You’re seeing a movement in the United States where young people are understand that.  Young people are concerned about global poverty and so we had to start a program at Rice, just to be competitive, where we would have students designing these technologies and trying to help villages in Africa, working on micro-hydro, or to make solar panels or to do something where you could raise people’s living standards by providing innovative technology.  This has to be the path: small scale, not large scale. 

Even in the nuclear industry, people say the tar sands burn too much carbon dioxide.  But the Japanese have the technology of micro-nuclear power.  Imagine a little box that is a nuclear power station.  You can plunk it down anywhere and then when you’re finished with it, the company that owns the box will take it back and handle it and they’ll bring you a new box.  This is an innovative technology that people are talking about using in Canada in a serious way.

I would say that it becomes one whether you believe the US government can lead by ideology.  The people in charge have a green mandate; will they push it anyway?  I think it’s too early to say.  What Americans are looking for is to have that technology be just as cheap.  That is the fantasy.  Those technologies are a problem because whatever technology you’re talking about, you cannot store electricity.  It’s not even that they’re more expensive, but I can’t solve the intermittency problem with just a tax.  I hope we have a scientist ahead of the deal, that people will understand that the critical research piece is electricity storage.  Without that, it’s not realistic.