Posted by: bmeverett | February 13, 2014

US Energy Independence


As US oil and natural gas production have increased, we see more talk about the potential benefits of US energy independence. This idea has been around since Richard Nixon’s “Project Independence” in 1974 and it has no more meaning now than it did then. A February 2 interview by Fox News’ Eric Shawn with Pennsylvania Congressman Tim Murphy is an excellent run-down of all the fallacies associated with energy independence. (You can find the video athttp://video.foxnews.com/v/3141843881001/saying-goodbye-to-mid-east-oil/#sp=show-clips) Let’s run down the specifics.

The piece starts with Mr. Shawn’s observation that the US is now the largest oil and gas producer in the world, with output of 22.2 million barrels a day of oil equivalent (MBDOE) compared to Russia in the number two spot 21.8 MBDOE. Please don’t do this. Oil and natural gas are both sources of energy, but they serve very different markets and should never by simply added together. Oil is a transportation fuel. It powers out cars and trucks. Natural gas is mainly a power generation fuel. There are a few points of competition, such as home heating, but they are not really significant. The implication here is that increased natural gas production helps to reduce our oil imports. That may be true someday, but it’s not true today.

The Congressman, who by the way is a Republican, says that we really need a “portfolio of oil, natural gas, clean coal, wind, solar and other renewables. You have to put them all together.” This statement is purely political. As has been discussed often in this space, renewable energy is simply not economically competitive and presents substantial technical problems as part of an electricity grid. The US economy is not helped by forcing relatively small amounts of very expensive energy into the market. This statement is analogous to saying that we need to have a portfolio of roads made from asphalt, concrete and gold nuggets.

The Congressman’s next statement is that we have spent $4 trillion in Iraq and Afghanistan protecting the oil fields there. Seriously? The last time I looked, Afghanistan had no significant oil resources at all. We went to war in Afghanistan because the Taliban had used the country as a staging ground for the 9/11 attacks on the World Trade Center and the Pentagon. Iraq, of course, does have oil reserves, but the Congressman is suggesting that we went to war there because we needed their oil for the American market. The oil market is global and integrated with a single international price structure. It does not matter where the United States purchases its oil. When the US invaded Iraq in 2003, we were in the middle of a severe sanctions regime against Saddam Hussein that had restricted his oil output to half the level produced in 2001. If the US were interested primarily in getting Iraq’s oil, why were we forcing him to reduce oil supply? We could have easily cut a deal with Saddam to allow increased US investment in oil development and a preferential right to buy Iraqi oil in return for an elimination of the sanctions regime. Saddam would have taken that deal in a heartbeat.

In reality, the US has defended the major oil producing countries of the Middle East because the world economy needs the oil, not because the US imports that oil. This is a part of the post-war US mission of protecting the “global commons.” The idea that the US would lose interest in the international oil market if we stopped importing Middle Eastern oil is rather naïve. The US economy is deeply imbedded in the global trading system which needs oil to survive. Japan is still 100% dependent on imported oil and looks to the US to protect its supply routes. Europe, China and the emerging markets in Southeast Asia also rely on the US to protect supplies not just of oil but of all major resources moving in international trade. The collapse of the world trading system would be catastrophic to the US economy.

This fallacy has been with us since the early days of the Republic. In 1807, President Jefferson faced a crisis when the British and the French, locked in the Napoleonic wars, plundered US shipping for goods and sailors. President Jefferson’s response was the Embargo Act of 1807, prohibiting Americans from engaging in trade with other countries. The result was an immediate economic disaster. The Embargo lasted all of 15 months, and the experience convinced Jefferson that the US needed to develop the means to protect its international commerce. In April, 1917, Woodrow Wilson declared war on Germany barely a month after his second inauguration, even though he had won the election based on his slogan “He kept us out of war.” Why the sudden change? Because the Germans refused to respect American neutrality and attempted to stop us from trading with Great Britain. Wilson understood that the US economy could not survive losing access to global markets.

Congressman Murphy then claims that energy independence would mean that “We no longer have to be at the mercy of OPEC, dangling threats in front of us.” OPEC, the Organization of Petroleum Exporting Countries, is nothing more than an ineffective commercial cartel. OPEC’s twelve member states include some of our true adversaries, like Iran and Venezuela, but also some US allies, like Qatar, the United Arab Emirates, Nigeria and Angola. OPEC’s sole purpose is to try to pump up oil prices by coordinating production restrictions among its members. They have been singularly unsuccessful over the last 30 years. Like most attempted cartels, the benefits of coordinated production are never realized because each member can maximize its revenue by producing as much oil as it can each day. Right now, only Saudi Arabia maintains any spare production capacity, amounting to maybe 2-3% of world oil output.
When we talk about the supposed benefits of “energy independence”, we should remember that the US has an open economy, and Americans pay the world price for oil. We are major exporters of corn, but US consumers still pay the world corn price. Increases in US oil production (not natural gas production!) will have to influence prices on a global scale, not a national scale. Today, world liquid fuel production is about 85 MBD. The US contributes about 9½ MBD and the rest of the world the remaining 75½ MBD. According to the latest projections from the Energy Information Administration (EIA), global oil production in 2040 will be about 115 MBD. The US contribution will increase by 2 MBD to about 11½ MBD, requiring 103½ MBD from the rest of the world. According to the EIA analysis, therefore, even if the US increases its liquid fuel output by 20%, the rest of the world would still need to increase output by over 35% to meet expected demand. If the US were to triple the expected increase from 2 MBD to 6 MBD, the rest of the world would still need to grow production by over 30%. The impact of increasing US production would therefore be significant but is unlikely by itself to result in a decline in the world price of oil.

The Congressman’s next statement is that OPEC uses “their money to fund terrorism and other issues around the world.” It’s certainly true that some OPEC members, particularly Iran and Saudi Arabia, channel funds to extremist Islamic groups and terrorist organizations, but most OPEC members do not. Some have been active allies in the war against terrorism. We also need to bear in mind that at the current price of $100 per barrel, global crude oil revenue is about $3 trillion annually. Experts estimate that the 9/11 attacks cost al-Qaeda somewhere in the range of $400-500,000 to plan and carry out, money that could easily have been obtained by a few well-executed bank robberies. Does anyone really believe that reducing US oil imports will cut off the funds to terrorists?

The next exchange was particularly interesting:
Eric Shawn: You mentioned something very important though, Congressman, about OPEC and about the geopolitical result of us getting off mainlining this Middle East oil. What does it mean politically in foreign affairs? The President is going to Saudi Arabia supposedly next month to meet with the rulers there. What will it mean when we’re finally off Mideast oil?
Mr. Murphy: Well, what it means is they no longer can threaten us. It also means we can help our friends and allies around the world who may also be subject to OPEC threats. The EU would love to have oil from the United States instead of being threatened by Gazprom in Russia and by OPEC. And it’s very important that Iran sells lots of oil to China. So be it. But imagine if we could do more of the same.

This exchange borders on incoherent and is based on what I call the Soup Nazi Fallacy, a reference that any Seinfeld fan will immediately recognize. On the Seinfeld show, the Soup Nazi had the best soup in New York, but refused to sell to people he doesn’t like. When Jerry and his pals complained, the Soup Nazi glared and shouted “No soup for you!” Apparently, Messrs. Shawn and Murphy think the world oil market operates this way. We need oil, and we have to kowtow to oil producers to get it. This view is wrong. Oil is a commodity; it’s interchangeable just like gold or copper. Oil has a single unified price structure, and, at any point in time, supply equals demand. No oil exporter has a unique product to sell and, apart from some relatively small quality and freight differentials, no exporter can sell his product above the world price. What precisely has OPEC threatened us with? What does the US do or not do on the world stage because we are afraid of what the oil exporters will do in retaliation?

By the way, the EU cannot replace natural gas from Russia with oil from the United States. Oil is a transportation fuel. Natural gas is not. Furthermore, any American oil exported to the EU would be sold at the world price, resulting in no net gain for the EU.

Next, let’s give Congressman Murphy some credit for a valid statement: “And when you look at what we have as well with our own oil off our coast, estimates are between 2½ and 3 trillion dollars in today’s money that is out there if we developed our own. That is a huge boom of America’s purchasing power around the world as well.” It’s certainly true that the US gains economically from the activity of producing oil and gas, just as we gain from producing cars or wheat.

Then Mr. Shawn goes back off the rails with this: “There’s a string of gas stations in your state, in Pennsylvania – Quick Fill, United Refining. It’s unbelievable. They are proud, they only sell crude from North American sources, from the US or from Canada. They boast that. They put that in their advertising. They use no Mideast oil.” First of all, let’s just straighten out the facts here. Refineries buy crude oil. Gas stations sell gasoline. United Refining operates a single, relatively small (70,000 barrels per day) refinery in the town of Warren in northwest Pennsylvania, less than 100 miles from the Canadian border. Unlike refineries near Philadelphia, which have physical access only to long-distance oil imports, United’s Warren refinery can access a pipeline bringing Canadian crude to the US. United may choose to portray this fortuitous logistical advantage as a patriotic choice, but consumers shouldn’t be fooled.

Furthermore, gas stations do not sell fuel made from specific sources of crude oil. Gasoline is shipped from multiple refineries through pipelines, ships, barges and rail cars to different distribution terminals, where it is naturally mixed together. It is virtually impossible to determine which crude oil is the source of the molecules in your gasoline.

The interview ends by summarizing all the fallacies noted above. Mr. Murphy says, “One of the nice things about pulling up to a gas station that has North American oil is that no soldier had to shed blood to protect those oilfields, and that’s really important to Americans.” Mr. Shawn finishes the love fest with the statement, “That is a fantastic testament to being energy independent.” Is it too much to ask that both public officials and journalists know at least a little economics and think about these issues critically?

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