Windfall

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Windfall Page 11

by Meghan L. O'Sullivan


  In the first type, an autarkic America would realize many of the benefits of those who have dreamed about energy independence for decades. Completely set apart from any international trade (except perhaps to export excess energy), the United States could be inoculated from potential global supply disruptions, threatened embargoes, or the price spikes that have so often precipitated economic calamity or at least frustrated sound economic planning.

  Alas, America is not yet close to reaching this level of self-sufficiency. It is true that virtually all the coal, nuclear, and renewable energy consumed in the United States is produced or generated indigenously. It is also true that, with relatively little effort, this could be the case for natural gas as well. But oil self-sufficiency is far from inevitable. While U.S. oil imports have diminished dramatically, the United States remains a considerable distance from producing all the oil it needs on its own. Positioning America so it could sever its dependence on any form of petroleum or oil imports in the near term would take dramatic government interventions to staunch imports, increase production, reduce consumption, and transport oil long distances domestically from producing areas to consuming ones.

  Two historical episodes give us a good sense of what efforts to achieve oil self-sufficiency might look like—and how costly they might be. The first dates back to when Dwight Eisenhower was president of the United States. Like his successors of recent years, Ike was concerned about the national security implications of America’s growing dependence on foreign oil. In the face of cheap oil from the Middle East, Venezuela, and North Africa, imports had nearly doubled during the 1950s, reaching close to one-fifth of U.S. consumption by 1957. Ultimately, Eisenhower was swayed by the arguments of small American oil companies—and legislators from oil-producing states, such as Senator Lyndon Johnson and House Speaker Sam Rayburn, both of Texas—that cheap foreign oil was undercutting the domestic U.S. oil industry, which could have not only economic, but also national security, implications. After failed attempts to induce voluntary reductions in the use of oil, on March 10, 1959, Eisenhower issued a presidential proclamation limiting the imports of foreign oil to roughly 10 percent of domestic consumption in order to preserve “a vigorous, healthy petroleum industry.”

  Clarence B. Randall, a well-known conservative economist and then Eisenhower’s chairman of the Commission on Foreign Economic Policy, argued against the new policy. He stressed that it would push up domestic consumer prices while simultaneously accelerating the depletion of domestic resources. Subsequent years validated his predictions that this policy would be costly. A task force initiated by President Nixon before he lifted the import quota in 1973 calculated the costs of Eisenhower’s policy in 1969 to have run to the tune of $5 billion ($33 billion in 2017 dollars).

  To be sure, the quota and its accompaniments did also contribute to the more rapid development of American resources; crude oil production increased by a third over the span of this policy, before peaking and then beginning its descent in 1971. Yet these gains contributed to a geopolitical calamity that was already brewing. Predictably, limitations on the import of oil by the United States created a glut in international oil markets, driving down global prices. Feeling the pain, one of the Seven Sisters—the handful of international oil companies that effectively controlled the global market at the time—made the unilateral decision to cut the price it would pay Middle Eastern producers for every barrel they produced. This action, in turn, led Iran, Iraq, Saudi Arabia, and Venezuela to gather in Baghdad in September 1960 and establish the Organization of the Petroleum Exporting Countries or OPEC. While their stated objective at the time was to restore the price of oil to the level it had been before the cut, their goals morphed over time and their collective power grew until it culminated in the 1973 embargo.

  That sounds like ancient history today, but we do not need to go back so far in time to see the high costs of government interventions aimed at isolating American energy from international markets. We have an excellent case study from recent years: the ban on the export of crude oil from the lower forty-eight states of the United States that was in place until December 2015. This ban was a relic of times past, when real and perceived supply shortages in the 1970s threatened America’s sense of well-being. In 1975, when Congress instituted the ban, the notion of sending precious and limited American crude abroad seemed antithetical to U.S. interests. There seemed to be no practical reason for any U.S. administration to lift the ban over the next forty years; as imports doubled, then tripled, after Eisenhower’s restriction on imports was removed, exporting U.S. crude seemed inconceivable. So the export ban persisted, virtually forgotten, from its inception in 1975 until the 2010s.

  Burgeoning U.S. tight oil production led to a reexamination of this policy, and Congress agreed to remove it in 2015. However, the extensive public debate that occurred before Congress made its move generated a thorough examination of the significant costs associated with separating the United States from global oil markets. These costs brought together bedfellows as unlikely as Republican senator and Tea Party stalwart Ted Cruz and President Obama’s former economic advisor Larry Summers. They—and many analysts and institutions in between—stressed the costs to the U.S. economy of continuing the ban. If left to the market, they anticipated that some of the crude oil produced from U.S. tight oil fields would more naturally be shipped abroad than be refined at home, given differences in the quality of crude and refining capacities. Instead, because there were no alternative markets for their oil, the delta between the price U.S. producers could get for their crude and a common global price was as much as $15 per barrel. Producers, therefore, had less incentive to invest. American consumers ended up paying more at the pump because gasoline prices correspond to global prices, which would have been lower if U.S. crude were flowing to international markets and thereby increasing global supply. John Hess, CEO of Hess Corporation, and others fervently made the case that the export ban—by threatening jobs and investment in the oil industry—created risks for the larger U.S. economy. Scholars and institutes from across the political spectrum—from the liberal-leaning Brookings Institution to the conservative Heritage Foundation—advocated lifting the ban, citing the significant gains to be reaped by American consumers in the form of lower energy prices, more jobs, higher wages, and increased economic growth.

  If becoming energy self-sufficient or autarkic is too costly and inefficient, then perhaps it is preferable to strive for the second form of energy independence often discussed: a situation in which the United States simply produces more energy than it consumes. The United States may well still import and export some oil, but the key in this scenario is that the country would be a “net exporter” of energy. Certainly, becoming a net energy exporter is a more feasible and achievable goal. If one standardizes all energy sources and counts them simply in terms of their energy content (in British thermal units, or btus), America could become a net energy exporter in less than a decade according to the U.S. EIA, depending on the assumptions one makes about prices, economic growth, and resource development. Demand for nuclear power, coal, and renewable energy would continue to be met largely by domestic sources, as they are today. The United States would likely export significant volumes of natural gas, which would cancel out the continued import of crude oil.

  In addition to being a net energy exporter, the United States could also be a “net oil exporter.” To claim this status, the United States would need to export more oil than it imports. But unlike in the autarkic scenario, the United States would be both an importer and exporter of oil, with the market and existing infrastructure and refineries to a large extent determining volumes and directions. Various companies and agencies differ as to whether the United States is likely to become a net exporter of oil, depending on their views about the resource base, coming efficiency measures, and other factors. The more “optimistic” scenarios do not see the United States reaching this milestone until the 2030s. Others see America as coming
close, but not clinching the net exporter status.

  If markets alone cannot deliver net oil exporter status, the U.S. government could certainly help. Allowing the market to determine what is exported and imported would reduce the inefficiencies associated with the autarkic option, so the policies needed to achieve this net exporter status most likely would not entail the potentially large costs and inefficiencies associated with the pursuit of self-sufficiency.

  A reasonable debate might ensue about whether such policies are worth their costs—if in fact net exporter status were a meaningful measure of energy security. However, despite the raw appeal of exporting more than one imports, net exporter status would not protect the United States from either the supply shocks or the price spikes that make energy independence attractive in the first place. The United States, as both an exporter and importer, would still be tied to the global market and to the global price set for oil. As a result, any disturbance to that market would still reverberate throughout the U.S. economy. If Iranian production, say, were drastically curtailed for any reason, the global price would rise, boosting the price Americans pay to fill their cars with gasoline—even though the United States does not import a drop of Iranian oil. Although there may be other reasons to pursue the government policies mentioned above, the goal of becoming a net exporter of energy is not one of them.

  Alas, the appeal of energy independence does not survive scrutiny in the harsh light of day. While the benefits of energy self-sufficiency may be considerable, the prescriptions for getting there are more toxic than the affliction of energy dependence itself. In contrast, being a net energy or oil exporter may be less costly to achieve, but its value is much more limited than it might at first seem. In the words of a March 14, 1909, New York Times editorial on a totally different subject, “Cheapness without usefulness is not a bargain.”

  Fortunately for those fixated on energy independence, there is a third variety that comes in the continental form. Heralding “North American energy independence” has become more fashionable as the downsides and limited benefits of a more narrow U.S. energy independence have been exposed. This broader concept envisions the United States, Canada, and Mexico collectively meeting all their energy needs from resources on their shared continent. It would still require the United States to be dependent on other countries, but most Americans would be comfortable that neither Canada nor Mexico is likely to undergo change so revolutionary that it could disrupt production. Nor is either country likely to use energy to blackmail the United States. Moreover, the three economies are already so closely integrated that for any one country to use energy to extort or inflict costs on another would be in some measure an act of suicide. Unlike some other forms of U.S. energy independence, North American energy independence could well be within reach. Its prospects depend not only on U.S. energy fortunes, but also those in Mexico and Canada—two countries that have also seen many changes in recent years.

  A Historic Set of Reforms

  Enrique Peña Nieto, a young politician with movie star charisma and a record as governor of Mexico’s most populous and politically important state, became Mexico’s fifty-seventh president in 2012. At the time, he faced multiple challenges, any number of which could easily tank his otherwise promising six years in office. High on his agenda was reforming Mexico’s energy sector. In its heyday as recently as 2004, Mexico was the fifth largest oil producer in the world, producing nearly 3.5 million barrels of oil per day—roughly the same amount Iran was producing before intensive international sanctions were put in place against it in 2012. Cantarell, a shallow offshore field named for the fisherman who in 1976 reported an oil slick off the Yucatán Peninsula that led to the field’s discovery, was once the second largest producing oil field in the world after Ghawar in Saudi Arabia.

  For decades, oil had been the undisputed powerhouse of the Mexican economy. Yet, President Peña Nieto inherited a limping energy sector. The production of Cantarell had begun a precipitous decline in 2005. Despite Mexico’s large oil reserves and the $70 billion the country plowed into investment in exploration and production between 2008 and 2012, technical shortfalls and incompetence kept Mexico from bringing enough new production online to keep its daily production numbers afloat. Petróleos Mexicanos, or PEMEX, the country’s national oil company, was amassing major losses, and was mired in corruption and inefficiencies so dramatic that in 2012 it produced just twenty-five barrels of oil for every person it employed; by contrast Exxon produced fifty-five per person, while Norway’s oil company, Statoil, churned out nearly eighty. Over the course of just five short years, Mexico’s daily production of crude oil and lease condensates dropped by a quarter. A year before President Peña Nieto took office, a study by the Baker Institute at Rice University warned that Mexico could become a net oil importer within a decade. Galloping domestic use of oil and natural gas translated into waning oil exports and, in the case of natural gas, growing imports despite the country’s own resource wealth. Notwithstanding its significant natural gas deposits, Mexico began to import expensive LNG from Nigeria, Qatar, and Egypt in 2006.

  Efforts to reform Mexico’s energy sector had been tried before despite the enormous associated political challenges. Mexico was the first country in the world, in 1938, to nationalize its oil industry. State control over oil resources remains so central to the identity of the country that Mexico celebrates the act of nationalization each year on March 18 with a civic holiday called Aniversario de la Expropriación Petrolera. Felipe Calderón, Peña Nieto’s predecessor, struggled unsuccessfully against history and tradition to produce meaningful reform.

  Peña Nieto was dealt a different and more promising hand. He was able to bring Mexico’s largest political parties together to support wide-ranging political and economic reforms through what was known as Pacto por México. And the boom in unconventional energy sources in the United States gave the country more reasons to push hard toward reform. According to initial surveys, Mexico could also claim huge deposits of both unconventional oil and gas. Reform now made sense not only to avoid the threat of becoming a net importer of energy, but also as a way of capturing a new opportunity, one with a model ready for emulation, across the border both on land and in the Gulf of Mexico. If Mexico wanted to attract the foreign investment it needed to shift its energy fortunes and capitalize on its newly discovered unconventional wealth, it needed to offer international oil companies terms competitive with those they could find just to the north.

  Reform was essential and ambitious reform was the only kind worth doing. Peña Nieto and his historic political coalition captured this moment. They introduced reforms to the oil, gas, and electricity sectors in the form of constitutional amendments, including language allowing for foreign investment in Mexico’s resources. Instead of the vague language many skeptics anticipated, the amended constitution was now explicit in welcoming a range of contract models, including the types that international oil companies have generally found most attractive. The reforms ended the long-time state monopoly PEMEX had maintained as the sole custodian of Mexico’s oil and gas reserves as well as its related infrastructure and induced meaningful competition into the sector for the first time. The electricity sector was also reformed, making way for greater private participation there and for the easing of electricity prices, which were on average 73 percent higher in 2012 than those in the United States. In August 2014, Mexico’s Chamber of Deputies passed the necessary supporting legislation in a marathon seventy-three-hour session, the longest in the history of the body and the inspiration for any number of bizarre protests. Neither the discovery of a snake, which had been inadvertently smuggled into the chamber in a display of flowers for a “mock” funeral for PEMEX, nor the spectacle of opposition legislator Antonio García Conejo stripping down to his black underwear briefs in protest, was able to derail the proceedings. The implementing legislation that followed was passed with astonishing speed.

  The realization of North American energy
independence is to some degree dependent on the success of these reforms going forward. Their passage significantly enhanced prospects for Mexico eventually reversing its production declines and recapturing its position as a significant oil—and possibly gas—producer. Despite the misfortune of coinciding with the global collapse in oil prices, Mexico’s first bid rounds have been reasonably successful in attracting the largest and most experienced oil companies to invest in Mexico. ExxonMobil, Statoil, Chevron, BHP Billinton, and the Chinese National Offshore Oil Corporation have all committed to exploring and developing Mexico’s resources. While some of the most optimistic expectations about how quickly the reforms can transform Mexico’s energy sector have been dampened, analysts and investors still anticipate a significant turnaround in the coming years.

  Companies and agencies significantly revised their previous expectations for Mexican oil production since the reforms passed. The U.S. EIA suggested that Mexico could stabilize its oil production by the end of the decade and, in the decades that follow, increase it by a third to reach 2008 levels by 2040. Mexican natural gas production is also expected to increase significantly, although Mexico’s immediate focus has been more on importing cheaper U.S. natural gas, rather than on developing its own. As is always the case, the magnitude of these improvements depends to some extent on global prices. Yet, even with such uncertainties, Mexico is poised to stem the downward trajectory of its energy industry and recapture at least some of its earlier glories. Mexico’s success will mean American success, particularly for those who see real value in securing North American energy independence.

 

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