ENERGY SECURITY:LIBERALIZATION, ENVIRONMENTAL POLICY AND FOREIGN POLICY

ISTITUTO BRUNO LEONIMICHAEL C. LYNCH

TRADITIONAL VIEW

PETROLEUM IS A SCARCE RESOURCEPOSSESSION OF OIL = POLITICAL AND ECONOMIC POWERRELIANCE ON IMPORTED OIL = VULNERABILITYTHE WORLD IS VULNERABLE TO MIDDLE EASTERN POSSESSION OF OIL

WHICH WILL INCREASE SHORTLY (SEE ABOVE)

THEREFORE:

REDUCE MIDDLE EASTERN OIL USECOAL, LNG, NUCLEAR, RUSSIAN GAS

AGGRESSIVE FOREIGN POLICYMAINTAIN GOOD RELATIONS WITH PRODUCERSCOOPERATION WITH CONSUMERS?

GOVERNMENT REGULATIONSURGE CAPACITYVOLUNTARY CONSERVATIONNATIONAL/DOMESTIC OIL COMPANIES

BUT RESOURCE SCARCITY NOT A REAL ISSUE

FEARS BEGAN 2500 YEARS AGOSTILL WAITING

PEAK OIL IS BAD SCIENCEWARNINGS HAVE BEEN REPEATEDLY EXAGGERATED

MALTHUSIAN BIAS

PRODUCERS VULNERABLE TOODEMAND SECURITY

OPEC MARKET SHARE FORECASTS (1996)

30%

35%

40%

45%

50%

55%

60%

1970 1980 1990 2000 2010

ACTUAL DOE IEA/CC IEA/ES WORLD BANK (1995) OPEC LYNCH/GRI

THE “OPTIMISTIC” IEA’S FORECASTS FOR OECD OIL PRODUCTION

10

11

12

13

14

15

16

17

18

19

1967 1972 1977 1982 1987 1992 1997 2002 2007 2012 2017

MB

/D

ACTUAL 1978 1982 LOW 1982 HIGH 1994 1998 2000

PEAK OIL/SCARCE RESOURCESPEAK OIL IS IMMINENT

(OR ALREADY PAST)

DUE TO GEOLOGICAL SCARCITYCAN’T BE ALTERED BY TECHNOLOGY OR INVESTMENTPRICES/RECESSION MUST CUT DEMAND IN RESPONSE

IMPACT IS SEVEREGLOBAL RECESSIONENERGY PRODUCERS’ POWER GROWS

LAHERRERE FORECAST FOR UK

Curve seems to fit perfectly, but estimate of currentproduction is about 60% too low.

CAMPBELL DISCOVERED (2005) VS URR (1997)

0.0%

50.0%

100.0%

150.0%

200.0%

250.0%

300.0%

350.0%

-50.0 -40.0 -30.0 -20.0 -10.0 0.0 10.0 20.0

BLN BBLSCampbell has found that more than half of all countries studiedhave, by 2005, found more oil than he thought they ever wouldin his 1997 analysis.

CAN GOVERNMENTS HELP?

FIGHTING THE LAST WARPOOR ANALYSISSPECIAL INTERESTS

COAL, ETHANOL, ETC.

PERCEPTIONS SET POLICY, NOT REALITY

YOU’RE IN GOOD HANDS…

…OUR HERO!

FIGHTING THE LAST WAR

1951: BUILD REFINERIES1956: BUILD SUPER TANKERS1967: EMBARGO WON’T WORK1973: FIGHT EMBARGO WITH SHARING1979: BUILD SPR1990: DON’T USE SPR2003/2007: MORE GOVERNMENT INTERVERTION IN MARKETS!

FOREIGN POLICY TO THE RESCUE!

HAVE GOOD RELATIONS WITH PRODUCING COUNTRIES

GAIN ACCESS TO SUPPLY

DIPLOMATS OFFER SPECIAL DEALSSOLVE ARAB-ISRAELI CONFLICTPREVENT GLOBAL WARMINGPROTECT ITALIAN CHEESES

US IMPORTS OF SAUDI OIL

0

500

1000

1500

2000

2500

Jan-73 Jan-75 Jan-77 Jan-79 Jan-81 Jan-83 Jan-85 Jan-87 Jan-89 Jan-91 Jan-93 Jan-95

TB

/D

MARKET SHARE BY COMPANY

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

1 6 11 16 21 26 31 36 41 46

NUMBER OF COMPANIES

GL

OB

AL

CR

UD

E M

AR

KE

T

1953 1972 1990 1998 2001

ENERGY SECURITY DEBATE:POLI SCI VS ECONOMICS

GEOPOLITICAL VIEWVOLUME=VULNERABILITYDANGER IS PHYSICAL SHORTAGE

ECONOMISTS’ VIEWMARKETS RESOLVE DISRUPTIONS• FUNGIBILITY

BOTH PARTLY RIGHTBUT BOTH SEE NO CRISIS IN 1973/79

REAL PROBLEMSDISRUPTION PRICE ASSUMED LONG-TERM EQUILIBRIUM

OPEC LISTENS TO THE ECONOMISTS

MARKET NOT COMPLETELY FUNGIBLEMARKET CLEARS THROUGH PRICE MECHANISM

HOARDING CAN WORSEN PROBLEM

CATASTROPHIC FAILUREHIGHER PRICES YIELD ECONOMIC DAMAGE

PRICE CHANGE DURING CRISES

0

2

4

6

8

10

12

14

0 12 24 36 48 60 72 84

MONTH OF/AFTER CRISIS

PR

E-C

RIS

IS P

RIC

E=

1

PRE-CRISIS PRICE 1956 1973 1978 1980 1990

GROSS LOSS OF SUPPLY

-6000

-5000

-4000

-3000

-2000

-1000

0

1000

2000

0 1 2 3 4 5 6 7 8 9 10

MONTH OF CRISIS

TB

/D

1956 1967 1973 1978 1980 1990

PRODUCTION INCREASES DURING CRISES

-1000

0

1000

2000

3000

4000

5000

6000

0 1 2 3 4 5 6 7 8

MONTH OF CRISIS

TB

/D

1956 1967 1973 1978 1980 1990

NET SUPPLY CHANGE

-15.0%

-10.0%

-5.0%

0.0%

5.0%

10.0%

0 1 2 3 4 5 6 7 8

MONTHS FROM BEGINNING OF CRISIS

SH

AR

E O

F N

ON

-FS

U O

IL

1956 1967 1973 1978 1980 1990

MARKET STRUCTURE

FLEXIBILITYCONTRACTSPIPELINESSPOT MARKET

OIL PRICE INDEXINGINTEGRATION

WHY NO CRISIS IN 1990?

UNCERTAINTY LOWMILITARY THREAT MINIMAL

OPEC RESPONDED QUICKLYPRIVATE STOCKS HIGHSPOT MARKET LARGESPRS AVAILABLE?FUTURES MARKET?

WHY THE CURRENT CRISIS?

2.5 MB/D OF LOST SUPPLY IN A TIGHT MARKETPOTENTIAL THREAT UNUSUALLY LARGE

RUSSIA, NIGERIA, VENEZUELA NEVER A CONCERN BEFORE

LOTS OF SPECULATIONKINDLEBERGER’S LESSON

REGULATION AND ENERGY SECURITY

COINCIDENCE OF PRESSURE FOR LIBERALIZATION AND ENERGY SECURITY AT SAME TIMEENERGY SECURITY IS A PUBLIC GOOD

INTANGIBLE

GOVERNMENTS PROVIDE PUBLIC GOODSTHEREFORE, REGULATION IS GOOD!

(BUT SEE RUSSIAN ENVIRONMENT)

REGULATION’S VALUE

INSURANCE/PUBLIC GOODSURGE CAPACITYCOST/BENEFIT TEST

FIGHT HOARDINGBUT GOVERNMENTS HOARD TOO

NOT ALLOCATIONNOT PRICE SETTING

THE ROLE OF LNG

CHEAP SUBSTITUTEBUT ONLY IF PRICED THAT WAY!CIF CRUDE EQUIVALENCE DOESN’T IMPROVE MATTERS

IMPROVES COMPETITIONUNLESS ITS ALL ALGERIAN

CONCLUSION

SUPPLY DISRUPTIONS WILL OCCURVULNERABILITY CAN’T BE ENDED• NATIONAL MAYBE, GLOBAL NO

BAD POLICY CAN CREATE LOSSESHOARDINGFOCUS ON VOLUMES INSTEAD OF PRICE

SURGE CAPACITY IS BEST INSURANCE