Energy Policy! What's that?

This commentary is an excerpt about energy policy from my 2015 book, Principled Policy. As Saudi Arabia announces a cut-back in production and Russia the shut-off of the Nord-Stream pipeline, some of the events described in my book may seem a bit dated but the underlying concept is still relevant today. Perhaps even more relevant as oil prices fluctuate and natural gas prices soar, portending a winter of super high prices and power outages here and in Europe.

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When I first started writing this book [back in 2014], oil was over $100 per barrel. As I revise this chapter[in 2015], oil is $45 per barrel and headed south [side note: oil in 2022 is now almost $90 a barrel]. What is going on? In order to understand what is happening and its implications we need to look at how energy has affected the United States, economically, strategically and politically.

Why do we need an energy policy? The free market economic system gives us access to copious amounts of energy from a wide variety of sources. This is true. But these sources of energy all have their limitations.

All our energy comes from basically four sources, each of which has its own unique problems. The sources of energy are hydrocarbons (which includes oil, gas, coal and wood), nuclear power, hydropower, and a wide variety of alternative energy sources. Hydrocarbons create carbon dioxide pollution along with a number of other pollutants (although some hydrocarbons produce more pollution than others). Nuclear energy has a problem with the disposal of waste products, which can remain radioactive for many centuries. Also, the fear of meltdowns and accidents is real, both Fukushima and Chernobyl spread radiation thousands of miles from the site of the reactor. Hydroelectricity generated from dams is limited by topography and some say also disrupts the migratory habits of fish, which are a necessary element in their reproductive cycle. The widespread use of alternative energy sources (solar, wind, geothermal) requires new technological advances to be economically viable.

The critical factor about energy is that energy is fundamental to all other industry and economic activity in the world; the sources of energy are often not located in places where it is needed (it requires transportation on a massive scale); delivering it requires massive investment in capital; some energies are not very transportable (geothermal) while others are not very storable (wind, electricity); much of the energy business is trans-national in nature,; and it carries drastic implications for the environment in which we and other creatures must live. So it is no easy thing to meet our energy needs.

More importantly, for the last fifty years we have been dependent on foreign countries for much of our energy needs (primarily oil and its derivatives). This dependence on foreign oil gave monopoly power to a small handful of countries that could control the price of oil. This pricing power was an political and economic weapon in the hands of countries not in line (and often opposed) to US foreign policy. Our foreign policy was constrained by our dependence on oil and forced in directions we would otherwise not have taken. Would we be up to our eyeballs in the Mideast quagmire if we were not dependent on that oil? What policy choices did we forego in order to keep the oil flowing?

And what has our government in Washington done about this situation? Well, like most other difficult problems facing our government, Washington has done - nothing.

Rather it has been our private sector entrepreneurs that have made the most progress in solving our problems (hint: why don’t we let them take a crack at some of our other vexing dilemmas?).

Since the Arab Oil Embargo in 1973, the Organization of Petroleum Exporting Countries (OPEC) has been able to control the international price of oil by adjusting the levels of oil production of its members. The price of oil declined in absolute and real terms in the eighties and nineties due to new non-OPEC producers coming online but remained significantly above previous levels. Throughout this period, the US was always a price-taker because, although we are a large producer of oil, we consumed far more than we produced.

Because oil-consuming nations can purchase oil from anywhere in the world on the international oil market, disruptions in supplies of oil in a single country can impact the international price of oil. Being a price-taker meant that we were dependent on the oil production of others and that the necessity of keeping oil flowing was a huge constraint on our foreign policy. Our addiction to foreign oil meant that we had to put aside our democratic principles in order to maintain that flow, much like a drug addict abandons all his ethical instincts in order to get the next fix. The US struck a kind of “grand bargain” under which the US would buy oil from the middle east and guarantee the security of certain countries (Saudi Arabia), and in exchange OPEC oil would flow and prices would be denominated in US Dollars, giving the US and its dollar enormous clout in the world as the reserve currency.

Since the 911 attack the United States has been deeply involved in the Middle East, partly to avenge the attack but also to protect the precious supply lines that guarantee the flow of oil. The Mideast turmoil drove oil prices to over $100 a barrel and we were advised to become accustomed to the new normal.

But the free market works in funny ways, at least in the minds of politicians and economic planners. High oil prices have generated a wave of innovation in oil production. Wildcat oil producers came up with a technique called hydraulic fracturing (fracking) as well as horizontal drilling to get at previously hard to get at oil and gas. US production of oil and gas has risen rapidly and the US is approaching energy independence, a goal always promised, but never delivered by the politicians in Washington. (Note: we still import oil but can export other forms of energy as well as petroleum derivatives like gas).

US oil production has completely changed the equation of the oil market that has existed since the seventies. It is clear that US energy production is now the driving force in the world oil market. Oil prices have gone down dramatically and there is no end in sight. The Organization of Petroleum Exporting Countries (OPEC) under the leadership of Saudi Arabia has adopted a strategy of continuing high levels of production in order to drive down prices in an attempt to bankrupt the new sources of supply from America. As a low cost producer, this strategy makes a lot of sense for Saudi Arabia but it has a very different impact on other producers. Higher cost producers like Venezuela and Ecuador are facing significant losses that will impact their economic strategies and financing capabilities. Other producers facing sanctions, such as Russia and Iran, will find those sanctions biting much harder.

The falling oil prices also are pinching oil companies from Texas to North Dakota. New production has ground to halt and many of these companies face bankruptcy (fracking is a high cost production method, needing a market price of $50 per barrel or more). Saudi Arabia and other low cost producers are hoping that they can drive these new interlopers out from what they consider their proprietary market.

The lower oil price provides a strategic benefit to the United States. Previous oil price declines were temporary because the United States consumed far more energy than it produced, contributing to a very large trade deficit. But more than deficits, the lack of US production made us dependent on foreign oil and this affected (or rather infected) our formulation of foreign policy. Dependency on foreign oil has kept us kowtowing to oppressive regimes, medieval monarchies and tin-pot dictators for far too long. It is time for the United States to take hold of its energy future and resist the attempt to bankrupt our energy independence.

The US Strategic Petroleum Reserve (SPR) was designed to protect us from temporary supply disruptions, usually caused by political events such as the Arab Oil Embargo of the seventies. But with a reserve of only around 40 days’ supply, the SPR is hardly strategic. It is more a tactical reserve that was designed to assuage the concerns of US consumers than as a strategic ability to control our own energy future. As noted above, OPEC is trying to drive US shale oil producers bankrupt and with it our energy independence. As such, OPEC under Saudi leadership is acting in direct contravention to US strategic interests. We cannot allow this to happen.

But the US does not need to produce energy in order to be energy independent. We need only the ability to produce the energy. Even if all the shale oil producers go bankrupt, the oil and gas is still locked up within those shale formations. The US should acquire the shares of these failing companies in order to protect our production capabilities. The price should offer a reasonable return to the owners as they have provided the United States a vital strategic capability and deserve reasonable compensation for their service.

This would appear to go against our free market principles; however, oil is being used as a weapon against US strategic interests by other countries while we have floundered for years without an energy policy to protect ourselves. The government should not allow OPEC (which is run by other governments) to attack the interests of our private sector, especially when that private sector is providing so much strategic value. War is no longer a matter of planes, ships and tanks; it is also cyber-attacks, non-state militants and economics.

The ability to turn the shale oil spigot on or off would make the United State the price leader for the international oil market. We would replace the Organization of Petroleum Exporting Countries (OPEC) with the Controlling Petroleum Exporting Country (CPEC). This would liberate us from the shackles of the Middle East. We would be free from having to ingratiate ourselves to kings and sheiks that use the money from oil exports to fund the export of fundamentalist Wahhabi Islam and the financing of terrorism. Without oil money these petty princes might have to join the twenty-first century, offering their citizens productive employment instead of oil entitlements. It would also limit the ability of countries opposed to our foreign policy that use oil windfall profits to threaten our allies and undermine the spread of democratic institutions around the world. We would be able to base our foreign policy on American democratic principles rather than economic necessity.

It will take bold action to seize this opportunity that has fallen into the lap of the current administration, an administration not known for taking decisive action on the foreign stage. If the current administration does not move to take advantage of this opportunity, Republicans should pass the enabling legislation to move forward on this matter. I would like to see how President Obama could justify vetoing such legislation.

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That’s what I wrote back in 2015. The energy policy of the Biden Administration is even more disastrous that that of President Obama. Energy prices have gone up ten times in Europe because of their dependence on green energy and President Biden is taking us down the same road. It is time for an energy policy that works.