The JASON scientific advisory panel cautiously endorsed further research into what is known as Magneto-Inertial Fusion (MIF) as a step towards achieving fusion-generated electricity.

“Magneto-Inertial Fusion (MIF) is a physically plausible approach to studying controlled thermonuclear fusion in a region of parameter space that is less explored than Inertial Confinement Fusion (ICF) or Magnetic Confinement Fusion (MCF).”

“Despite having received ~1% the funding of MCF and ICF, MIF experiments have made rapid progress in recent years toward break-even conditions,” the JASONs said in a report to the Advanced Research Projects Agency-Energy (ARPA-E) late last year.

Even so, “Given the immaturity of the technologies, the future ability of fusion-generated electricity to meet commercial constraints cannot be usefully assessed. Rapidly developing infrastructures for natural gas and renewable energy sources and storage will compete with any future commercial fusion efforts.”

See Prospects for Low Cost Fusion Development, JASON Report JSR-18-011, November 2018.

The fusion report is one of two unclassified reports prepared by the JASONs in 2018. (Release of the second is pending.) The other twelve reports from last year are classified.

The New York Times recently provided an overview of fusion research in Clean, Abundant Energy: Fusion Dreams Never End by C. Claiborne Ray, January 11, 2019.

Meanwhile, the Federation of American Scientists warned that the current shutdown of federal agencies threatens many aspects of U.S. science and technology.

“The partial government shutdown is compromising the very research that is important to the health and security of our nation. Important scientific breakthroughs could be compromised or lost with each and every day that the shutdown continues,” FAS said in a January 16 letter to the White House and Congress.

“We therefore urge you to open the federal government, send researchers back to work at their agencies, and allow science to flourish throughout the United States.”

The Trump Administration budget request for FY 2018 would “severely reduce” Energy Department funding for development of carbon capture and sequestration technologies intended to combat the climate change effects of burning fossil fuels.

The United States has “more than 250 years’ worth of clean, beautiful coal,” President Trump said last month, implying that remedial measures to diminish the environmental impact of coal power generation are unnecessary.

Research on the carbon capture technology that could make coal use cleaner by removing carbon dioxide from power plant exhaust would be cut by 73% if the Trump Administration has its way.

“The Trump Administration’s approach would be a reversal of Obama Administration and George W. Bush Administration DOE policies, which supported large carbon-capture demonstration projects and large injection and sequestration demonstration projects,” the Congressional Research Service said this week in a new report.

“We have finally ended the war on coal,” President Trump declared.

However, congressional approval of the Administration’s proposal to slash carbon capture and sequestration (CCS) development is not a foregone conclusion.

“The House Appropriations Committee’s FY2018 bill funding DOE disagrees with the Administration budget request and would fund CCS activities at roughly FY2017 levels,” the CRS report said.

“This report provides a summary and analysis of the current state of CCS in the United States.” It also includes a primer on how CCS could work, and a profile of previous funding in this area. See Carbon Capture and Sequestration (CCS) in the United States, July 24, 2017.

Other new and updated reports from the Congressional Research Service include the following.

Methane and Other Air Pollution Issues in Natural Gas Systems, updated July 27, 2017

The U.S. Export Control System and the Export Control Reform Initiative, updated July 24, 2017

Base Erosion and Profit Shifting (BEPS): OECD Tax Proposals, July 24, 2017

Oman: Reform, Security, and U.S. Policy, updated July 25, 2017

Lebanon, updated July 25, 2017

Aviation Bills Take Flight, but Legislative Path Remains Unclear, CRS Insight, July 25, 2017

Military Officers, CRS In Focus, July 3, 2017

Military Enlisted Personnel, CRS In Focus, July 3, 2017

Transgender Servicemembers: Policy Shifts and Considerations for Congress, CRS Insight, July 26, 2017

Systematic, authorized publication of CRS reports on a government website came a step closer to reality yesterday when the Senate Appropriations Committee voted to approve “a provision that will make non-confidential CRS reports available to the public via the Government Publishing Office’s website.”

As I write this president’s message, the U.S. election has just resulted in a resounding victory for the Republican Party, which will have control of both the Senate and House of Representatives when the new Congress convenes in January. While some may despair that these results portend an even more divided federal government with a Democratic president and a Republican Congress, I choose to view this event as an opportunity in disguise in regards to the important and urgent issue of U.S. energy policy.

President Barack Obama has staked a major part of his presidential legacy on combating climate change. He has felt stymied by the inability to convince Congress to pass comprehensive legislation to mandate substantial reductions in greenhouse gas emissions. Instead, his administration has leveraged the power of the Environmental Protection Agency (EPA) to craft rules that will, in effect, force the closure of many of the biggest emitters: coal power plants. These new rules will likely face challenges in courts and Congress. To withstand the legal challenge, EPA lawyers are working overtime to make the rules as ironclad as possible.

The Republicans who oppose the EPA rules will have difficulty in overturning the rules with legislation because they do not have the veto-proof supermajority of two-thirds of Congress. Rather, the incoming Senate majority leader Mitch McConnell (R-Kentucky) said before the election that he would try to block appropriations that would be needed to implement the new rules. But this is a risky move because it could result in a budget battle with the White House. The United States cannot afford another grinding halt to the federal budget.

Several environmental organizations have charged many Republican politicians with being climate change deniers. Huge amounts of money were funneled to the political races on both sides of the climate change divide. On the skeptical side, political action groups affiliated with the billionaire brothers Charles and David Koch received tens of millions of dollars; they have cast doubt on the scientific studies of climate change.  And on the side of wanting to combat climate change, about $100 million was committed by NextGen Climate, a political action group backed substantially by billionaire Tom Steyer. Could this money have been better spent on investments in shoring up the crumbling U.S. energy infrastructure? Instead of demonizing each side and just focusing on climate change, can the nation try a different approach that can win support from a core group of Democrats and Republicans?

Both Democratic and Republican leaders believe that the United States must have strong national security. Could this form the basis of a bipartisan plan for better energy policy? But this begs another question that would have to be addressed first: What energy policy would strengthen national security? Some politicians, including several former presidents, have called for the United States to be energy independent. Due to the recent energy revolution in technologies to extract so-called unconventional oil and gas from shale and sand geological deposits, the United States is on the verge of becoming a major exporter of natural gas and has dramatically reduced its dependence on outside oil imports (except from the friendly Canadians who are experiencing a bonanza in oil extracted from tar sands). However, these windfall developments do not mean that the United States is energy independent, even including the natural resources in all of North America.

Oil is a globally traded commodity and natural gas (especially in the form of liquefied natural gas) is tending to become this type of commodity. This implies that the United States cannot decouple its oil and gas production and consumption from other countries. For example, a disruption in the Strait of Hormuz leading to the Persian Gulf will affect about 40 percent of the globe’s oil deliveries because of shipments from Iran, Iraq, Kuwait, Qatar, Saudi Arabia, and the United Arab Emirate. Such a disruption might occur in an armed conflict with Iran, which has been at loggerheads with the United States over its nuclear program. Moreover, while the United States has not been importing significant amounts of oil from the Middle East recently, U.S. allies Japan and South Korea rely heavily on oil from that region. Thus, a major principle for U.S. national security is to work cooperatively with these allies to develop a plan to move away from overreliance on oil and gas from this region and an even longer term plan to transition away from fossil fuels.

Actually, this long term plan is not really that far into the future. According to optimistic estimates (for example, from Cambridge Energy Research Associates) for when global oil production will reach its peak, the world only has until at least 2030 before the peak is reached, and then there will be a gradual decline in production over the next few decades after the peak.¹ (Pessimistic views such as from oil expert Colin Campbell predict the peak occurring around 2012 to 2015.² We thus may already be at the peak.) Once the global decline starts to take effect, price shocks could devastate the world’s economy. Moreover, as the world’s population is projected to increase from seven billion people today to about nine billion by mid-century, the demand for oil will also significantly increase given business as usual practices.

For the broader scope national security reason of having a stable economy, it is imperative to develop a nonpartisan plan for transitioning from the “addiction” to oil that President George W. Bush called attention to in his State of the Union Address in January 2006. While skepticism about the science of climate change will prevail, this should not hold back the United States working together with other nations to craft a comprehensive energy plan that saves money, creates more jobs, and overall strengthens international security.

FAS is developing a new project titled Sustainable Energy and International Security. FAS staff will be contacting experts in our network to form a diverse group with expertise in energy technologies, the social factors that affect energy use, military perspectives, economic assessments, and security alliances. I welcome readers’ advice and donations to start this project; please contact me at cferguson@fas.org. FAS relies on donors like you to help support our projects; I urge you to consider supporting this and other FAS projects.

Legal and illegal power connections in Lahore, Pakistan

A stable and thriving Pakistan is the key to preserving harmony and facilitating progress in the broader South Asia region. Afghanistan, which is to the west of Pakistan, has a long border that divides the Pakhtun people between the countries. As a result of this border, Pakistan not only has a significant role in the Afghan economy, but instability in the loosely governed Pakistani frontier region spills across the border into Afghanistan. Because of this relationship, Pakistan has a direct impact on the outcome on the 13 year U.S. led war in Afghanistan.  On the other hand, an unstable Pakistan would not only shatter budding trade relations with India, but could also spark conflict between the two nuclear armed rivals.

From frequent attacks by Islamic militants across the country to a slowing economy, it is clear that there are many issues that threaten Pakistan’s stability. However, the most pressing issue that Pakistan faces today is its deteriorating economy. In particular, a crushing energy shortage across the country significantly constrains economic growth. This fiscal year, Pakistan’s Gross Domestic Product (GDP) is forecasted to grow by measly 3.4 percent. At the same time, the country’s population is expected to grow by 1.8 percent adding to the 189 million people living there today. If there aren’t jobs available for the millions of young Pakistanis entering the work force, not only will poverty increase, but there is a strong possibly that some of these youth could vent their frustrations by joining the countless Islamic militant groups active in the country.

To build a more prosperous economy, Pakistan needs to address its energy problems. Without a reliable source of electricity or natural gas, how can Pakistani businesses compete on the global market? Large parts of the country today face blackouts lasting an average of 10 hours each day because of the electricity shortage. The current gap between electricity generation and demand is roughly 2500 MW, a shortage large enough to keep a population of 20 million or the city of Karachi in the dark.

These power shortages are only expected to become worse in the coming summer months. This is because demand for electricity peaks in the sizzling heat, while hydroelectric generation decreases as the water flow in the rivers drops due to seasonal fluctuation. This article will focus on the causes of the country’s energy problems involving the electricity sector and explore possible directions Pakistan can take to improve its energy situation, building its economy in the process.

How Does Pakistan Generate its Electricity?

Figure 1: Pakistan’s Electricity Generation by Source

Figure 1 breaks down Pakistan’s electricity generation by source. Thermal power, which includes natural gas, oil, and coal generated electricity, accounts for 70 percent of Pakistan’s total electricity generation, while hydroelectric generation is roughly responsible for the remaining 30 percent.

Electricity generated from furnace oil accounts for slightly over a third of Pakistan electricity. In the early 1990s, the country faced a power shortage of about 2000 MW when there was a peak load on the electricity grid. To resolve the growing crisis, the Pakistani government implemented a new policy in 1994, which was designed to attract foreign investment in the power sector and as a result there was construction of oil based power plants. These power plants were cheaper and faster to construct compared to other electricity generation plants such as hydroelectric dams. At the same time, the relatively low prices (below $17 a barrel) of crude oil meant that these plants generated electricity fairly cheaply. Fast forward to present times, the price of crude oil has risen to hover roughly around $100 a barrel. Unlike nearby Saudi Arabia, Pakistan is naturally not well endowed in crude oil reserves. This means that Pakistan must ship increasing amount of valuable currency abroad to secure the oil it needs to keeps these power plants running.

Along with furnace oil power plants, natural gas is used to generate about another third of electricity; it is provided by domestic reserves, thereby helping Pakistan’s economy and energy security. According to the U.S. Energy Information Administration, Pakistan has proven natural gas reserves of 24 trillion cubic feet (Tcf) in 2012. These reserves will last Pakistan an estimated 17 years based on the country’s annual consumption rate of 1.382 Tcf in 2012. At the same time, consumption rates are estimated to increase four fold to nearly 8 Tcf per year by the year 2020, further reducing the size of the domestic reserves.

The Pakistani government in 2005 under President Pervez Musharraf promoted the conversion of cars to run on compressed natural gas (CNG) instead of gasoline. The rationale was that this conversion would reduce the amount of money spent on purchasing and importing oil abroad. At the same time, CNG is cleaner for the environment than burning gasoline. As a result of this policy, more than 80 percent of Pakistan’s cars today run on CNG.But because of this surging demand for its limited natural gas, there is a critical shortage of it which has adversely impacted the country’s ability to use this fuel source to generate electricity. Essentially Pakistanis are forced to decide whether to use natural gas to fuel their cars, cook their food, or generate electricity.

Power Theft and the Circular Debt Issue

The reliance on oil and natural gas to generate electricity is incredibly inefficient, but these inefficiencies alone are not responsible for the crippling power shortages. The other source of tension involves the accumulation of circular debt in the electricity sector over the past few years. Circular debt is a situation where consumers, electricity producers and the government all owe each other money and are unable to pay. By June 2013 when the new government led by Prime Minister Nawaz Sharif took control, this circular debt had ballooned to $5 billion.

There are several reasons for the accumulation of this debt; the largest problem stems from power theft. Many Pakistani elites and even parts of the government do not pay their electricity bills. The law and order situation also prevent power companies from collecting bills in certain parts of the country. As a result, Pakistani electricity companies currently recover only 76 percent of the money that electricity consumers owe them. In fact, the Pakistani Minister for Water and Power, Mr. Khwaja Muhammad Asif, has acknowledged that the Pakistani government is one of the country’s largest defaulters of electricity bills. As part of recent crackdown, the power ministry cut supplies to the Prime Minister’s home and the Parliament House (among many government offices) because they were delinquent on their electricity bills. While many Pakistanis don’t pay their electricity bills, others steal power by illegally hooking into the power grid. This theft coupled with an inefficient electricity grid and the associated transmission loss means that Pakistan’s electricity generators are left with huge financial losses.

All these losses accumulate to form the circular debt and it places power producers in a position where they are unable to purchase enough fuel from abroad to operate power plants at full capacity. With an installed generation capacity of 22500 MW, Pakistan currently has more than enough installed capacity to meet peak demand levels today. The power producers are in reality only able to generate between 12000MW and 15000MW because of both inefficient energy infrastructure and circular debt. This actual amount of electricity generated is far less than the 17000 MW of demand nationwide during peak hours of electricity usage.

The circular debt also makes it more difficult for power producers to invest in upgrading existing electricity infrastructure. If power producers don’t have the money to operate oil based power plants at full capacity, they certainly do not have enough capital to build newer, more efficient power plants. Even when the lights are on, the inefficient electricity system takes an additional toll on the country’s economy. Pakistanis today pay more than double their Indian neighbors for electricity (16.95 Pakistani Rupees vs. 7.36 Pakistani Rupees per KWh respectively), putting Pakistani firms at a further disadvantage compared to regional competitors.

Fixing Pakistan’s Electricity Problems

One of Prime Minister Nawaz Sharif’s first actions after taking office was to pay off the $5 billion in circular debt that had accumulated by July 2013. Unfortunately, this step alone will not solve the power woes as it does not fix the underlying causes of the country’s power crisis. In fact, the circular debt has accumulate again, and stood at $1.8 billion by January 2014.  To sustainably address the power crisis, Pakistanis need to change their attitude towards power theft by forcing the government and those delinquent to clear outstanding bills. At the same time, Pakistan must improve the efficiency of its electricity sector as well as expand and diversify its electricity generating capacity in order to ensure that the country can handle the expected growth in demand over the coming years.

Hydroelectric Generation

Pakistan has tremendous potential to expand its electricity generating capacity by developing its renewable energy resources. At nearly 30 percent, hydroelectricity is already a major source of electricity generation, but according to the Pakistani government, this reflects only 13 percent of the total hydroelectric potential of the country. There are several drawbacks of major hydroelectric projects including that they are capital intensive and require extensive time to build. Furthermore, hydroelectric dams are harmful to the local ecosystem and can displace large populations. The U.S. government is actively investing in helping Pakistan develop its hydroelectric resources; in 2011, USAID funded the renovation of the Tarbela Dam. In the process, this added generation capacity of 128 MW, which is enough electricity for 2 million Pakistanis.

Solar Energy

Figure 2: Pakistan’s Solar Generation Potential

According to the USAID map of solar potential in Pakistan, the country has tremendous potential in harnessing the sun to generate electricity.  Pakistan has an average daily insolation rate of 5.3 kWH/m², which is similar to the average daily insolation rate in Phoenix (5.38 kWH/m²) or Las Vegas (5.3 kWH/m²), which are some of the best locations in the United States for solar generated electricity. So far, Pakistan has begun construction on a photovoltaic power plant in Punjab that will begin to produce 100 MW by the end of 2014.According to the World Bank some 40,000 villages in Pakistan are not electrified. Tapping into these solar resources could easily electrify many of these off the grid villages, while avoiding an increase in demand on the national electricity grid.

Nuclear Energy

Pakistan has three currently active nuclear power plants: two located in Punjab and one in the southern port city of Karachi. The two Chinese built nuclear power plants in Punjab each have a net generation capacity of 300 MW. The Karachi power plant, which was built with a reactor supplied by Canada in 1972, has a net generation capacity of 125 MW, enough to provide power to 2 million Pakistanis. China has been a key supplier and investor in Pakistani nuclear energy, but there are some concerns regarding the transfer of nuclear technology to Pakistan, where A.Q. Khan’s nuclear network was headquartered. Specifically, China argues that its alliance with Pakistan predates its joining of the Nuclear Suppliers Group (NSG), which has restricted nuclear sales to Pakistan, so this justifies its desire to supply Pakistan with the technology. The Chinese are helping construct four more nuclear power plants, the first of which is expected to be online starting in 2019. While these plants will add 2,200 MW of generation capacity, these nuclear power projects are expensive; the current nuclear power plants under construction are said to cost about $5 billion per plant, an investment that China is helping finance.

Coal Power

There is a large amount of coal located in the Thar Desert in the southeastern part of the country. While the quality of the coal isn’t the best, Pakistan has a lot of it, nearly 175 billion tons, which is enough to meet current electricity demands for more than 300 years. However, Pakistan currently only has one operational coal power plant.

Pakistan is taking steps to develop this resource. In January 2014, Prime Minister Nawaz Sharif and former President Zardari broke ground on a $1.6 billion coal power project in the Thar Desert. This particular project is expected to be operational by 2017.

Pakistan has taken some clear steps such as developing its renewable resources and tapping its coal reserves, which can help expand and diversify where and how it generates its electricity. Further harnessing these resources will help alleviate the electricity shortfall. However, these steps alone will not solve the energy crisis. The more difficult solution involves changing the country’s attitude toward power theft, both by private citizens and the government. Convincing people to pay their electricity bills is difficult when even the government itself doesn’t pay its fair share. At the same time, there is less incentive to pay when citizens don’t even have access to a dependable source of electricity when they need it. As long as this attitude is prevalent among Pakistanis from all walks of life as well as the government, the country cannot sustainably solve its energy woes. Circular debt will continue to accumulate and large sections of the country will face hours of darkness each day.

Tackling the energy problem is the first step to strengthening the economy; over time, a growing economy will attract greater investment in the energy sector. Pakistan’s sensitive geographic location could become a strategic asset as it would serve as a bridge linking the economies of Afghanistan and Central Asia with the broader Indian subcontinent. Not only does the population provide Pakistan with a large domestic market, but it also empowers the country with a young, entrepreneurial workforce. This gives Pakistan tremendous potential, but can only be unleashed if the country figures out a way to keep the lights on and the factories humming.

Population Projection Tables by Country: Pakistan. The World Bank. 2014.

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Ghumman, Khawar, “Increased loadshedding worries Prime Minister,” Dawn, April 24 2014. http://www.dawn.com/news/1102953

“Electricity shortfall reaches 2,500MW,” The Nation, Jan 2 2014. http://www.nation.com.pk/national/02-Jan-2014/electricity-shortfall-reaches-2-500mw

“Pakistan Energy Yearbook,” Hydrocarbon Development Institute of Pakistan, 2012. http://www.kpkep.com/documents/Pakistan%20Energy%20Yearbook%202012.pdf

“Policy Framework and Package of Incentives for Private Sector Power Generation Projects in Pakistan,” Government of Pakistan, 1994. http://www.ppib.gov.pk/Power%20Policy%201994.pdf

Beg, Fatima and Fahd Ali, “The History of Private Power in Pakistan,” Sustainable Development Policy Institute, 2007. http://www.sdpi.org/publications/files/A106-A.pdf

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Tirmizi, Farooq, “The Myth of Pakistan’s infinite gas reserves,” The Express Tribune, Mar 14 2011. http://tribune.com.pk/story/132244/the-myth-of-pakistans-infinite-gas-reserves/

“Natural Gas Allocation and Management Policy,” Government of Pakistan: Ministry of Petroleum & Natural Resources, Sept 2005. http://www.ogra.org.pk/images/data/downloads/1389160019.pdf

Boone, Jon, “Pakistan’s government deflates dream of gas-powered cars,” The Guardian, Dec 25 2013. http://www.theguardian.com/world/2013/dec/25/cars-pakistan-compressed-natural-gas-rationing

Bhutta, Zafar, “Circular debt: Power sector liabilities may cross Rs1 trillion by 2014,” The Express Tribune, May 26 2013. http://tribune.com.pk/story/554370/circular-debt-power-sector-liabilities-may-cross-rs1-trillion-by-2014/

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Jamal, Nasir. “Amount of unpaid power bills increases to Rs286bn.” Dawn. Apr 16 2014. http://www.dawn.com/news/1100237

“Govt one of the biggest electricity defaulters, says Khawaja Asif.” Dawn, May 2 2014. http://www.dawn.com/news/1103707

“Pakistan cuts prime minister’s electricity for not paying bills” Reuters. Apr 29 2014. http://in.reuters.com/article/2014/04/29/uk-pakistan-electricity-idINKBN0DF1DL20140429

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Abduhu, Salman. “Lack of funds real reason behind loadshedding.” The Nation, May 9 2014. http://www.nation.com.pk/lahore/09-May-2014/lack-of-funds-real-reason-behind-loadshedding

Electricity Shock: “Pakistanis Paying the Highest Tariffs in Region.” The Express Tribune, Jan 31 2014. http://tribune.com.pk/story/665548/electricity-shock-pakistanis-paying-highest-tariffs-in-region/

Chaudhry, Javed. “Circular Debt: ‘All dues will be cleared by July’.” The Express Tribune, June 14 2013. http://tribune.com.pk/story/563095/circular-debt-all-dues-will-be-cleared-by-july/

“Hydropower Resources of Pakistan.” Private Power and Infrastructure Board, Feb 2011.  http://www.ppib.gov.pk/HYDRO.pdf

USAID Issues $6.66 m for Tarbela Units. Dawn. Mar 9 2011. http://www.dawn.com/news/612058/usaid-issues-666m-for-tarbela-units

“Tarbela Dam Project.” USAID, Sept 26 2013. http://www.ppib.gov.pk/HYDRO.pdf

“Pakistan Resource Maps.” National Renewable Energy Laboratory, Aug 2006. http://www.nrel.gov/international/ra_pakistan.html

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Renewable Energy in Pakistan: Opportunities and Challenges, COMSATS-Science Vision, December 2011. http://www.sciencevision.org.pk/BackIssues/Vol16_Vol17/02_Vol16_and_17_Renewable%20Energy%20in%20Pakistan_IrfanAfzalMirza.pdf

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CHASNUPP-2. Nuclear Threat Initiative, 2014. http://www.nti.org/facilities/113/

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Shah, Saeed. “Pakistan in Talks to Acquire 3 Nuclear Plants From China.” The Wall Street Journal, Jan 20 2014. http://online.wsj.com/news/articles/SB10001424052702304757004579332460821261146

Mahr, Krista. “How Pakistan and China Are Strengthening Nuclear Ties.” Time, Dec 2 2013. http://world.time.com/2013/12/02/how-pakistan-and-china-are-strengthening-nuclear-ties/

“Pakistan’s Thar Coal Power Generation Potential.” Private Power and Infrastructure Board, July 2008.http://www.embassyofpakistanusa.org/forms/Thar%20Coal%20Power%20Generation.pdf

“Discovery Of Ignite Coal In Thar Desert.” Geological Survey of Pakistan, 2009. http://www.gsp.gov.pk/index.php?option=com_content&view=article&id=30:thar-coal&catid=1:data

“Nawaz, Zardari launch Thar coal power project.” Dawn, Jan 31 2014. http://www.dawn.com/news/1084003

Ravi Patel is a student at Stanford University where he recently completed a B.S. in Biology and is currently pursuing an M.S. in Biology. He completed an honors thesis on developing greater Indo-Pakistan trade under Sec. William Perry at the Center for International Security and Cooperation (CISAC). Patel is the president of the Stanford U.S.-Russia Forum. He also founded the U.S.-Pakistan Partnership, a collaborative research program linking American and Pakistani university students. In the summer of 2012, Patel was a security scholar at the Federation of American Scientists. He also has extensive biomedical research experience focused on growing bone using mesenchymal stem cells through previous work at UCSF’s surgical research laboratory and Lawrence Berkeley National Laboratory.

Nelson Zhao is a fourth year undergraduate at University of California, Davis pursuing degrees in economics and psychology. Nelson is the Vice-President at the Stanford U.S.-Russia Forum and the Program Director at the U.S.-Pakistan Partnership. At the U.S.-Pakistan Partnership, he aims to develop a platform to convene the brightest students in order to cultivate U.S.-Pakistan’s bilateral relations.

Whether an oil and gas company is working in the United States or is spread throughout the world, it will face geopolitical and cyber risks which could affect global energy security.

Geopolitical Risk

There are numerous geopolitical risks for any oil and gas company. Even if a company just works in the United States, it needs to know what is happening in countries all over the world, especially those countries that are large oil and gas producers. Because oil markets are so tightly connected globally, major political events in oil exporting states could seriously affect the price and even availability of oil. An attack on an oil platform in Nigeria, a terrorist event in Iraq, the closing down of port facilities in Libya and many other examples come to mind. Consider the potential effects of a major attack on the Ab Qaiq facility in Saudi Arabia. If this facility is damaged or destroyed on a large scale by rockets or bombs, the world oil market could be out 6-7 million barrels of oil a day- out of the 90-92 millions of barrels a day the world needs. World spare oil production capacity is about 2.3 million barrels a day. It could take some time to get this online. The spare production can be ramped up, but not immediately. Given that the grand majority of excess capacity in the world is located in Saudi Arabia and that this excess capacity could be significantly cut back with damage to Ab Qaiq, the situation is even riskier.

Another major risk nearby is transits through the Straits of Hormuz. About 16-17 million barrels a day goes out of the Straits. Any attempts to close the Straits (even unsuccessful ones) could have significant effects on the prices of various grades of oil. Even with the seemingly warming in relations between the U.S. and Iran, it is still possible that things could take a turn for the worse in the Gulf region. If the present negotiations with Iran break down, tensions could rise to even higher levels than before negotiations began. This could bring discussions of the military option more public. If there is a major conflict involving Gulf countries, the United States and its allies, then all bets are off on where oil prices may go. There could be many scenarios: from oil prices increasing $100 over the pre-conflict base price to well over $200 over the pre-conflict base price.

In many other parts of the world, geopolitical risks going “kinetic” can affect oil markets. Syria is a potential whirlpool of trouble for the entire Middle East. Egypt and Libya are far from stable. Algeria could be heading into some rough times. The Sudan’s will remain problematic and potentially quite violent for some time to come. The East China Sea and South China Sea disputes are not resolved. The Central Sahara could be a source and locale for troubles for some time to come.

Terrorist events can happen anywhere. Google Earth allows terrorists and others to get very close looks at major oil and gas facilities, transport choke points and more. Also, there are not that many tankers plying the vast seas and oceans of the world. Some of the most important routes are between the Gulf region and East Asia and Europe. Others travel from West Africa to Europe, and less so to the United States than before its shale oil revolution. The Mediterranean has many important tanker shipping routes. The Red Sea is a crucial route for both ships going north and south. Over 50 percent of oil trade happens on maritime routes. Many of these tankers cross through vital chokepoints like the Strait of Malacca, the Strait of Hormuz, The Bab al Mandab, The Suez Canal, The Turkish Straits, The Danish Straits, The Panama Canal, and various harbor and river routes where risks may be higher r at sea. Even whilst at sea, ships are at risk as shown by pirate attacks and hijackings off of East Africa, West Africa and previously off of Indonesia. There are about 1,996 crude oil tankers. However, only 623 of these are of the Ultra Large Crude Carrier (ULCC) or Very Large Crude Carrier (VLCC) variety that are the most important for transporting crude oil economically over long distances from the Gulf region to places like China (the biggest importer of oil), the United States, Japan, South Korea, and Europe. VLCCs can carry about 2 million barrels of oil while ULCCs can carry up to 2.3 or, rarely, 2.5 million barrels of oil. Normally these massive ships carry crude oil, but sometimes carry many different types of crude oil. Smaller petroleum tankers may carry both crude and refined products depending on their trade routes and the state of the markets at any times. There are about 493 Suez Max tankers, which can hold about 1 million barrels of oil and refined products and about 408 Afrimax vessels, which hold about 500,000 to 800,000 barrels of crude or refined products. Additionally, there are 417 Panamax vessels, which can carry 300,000 to 500,000 barrels of oil or refined products.

This may seem like a lot of ships to some. However, especially in tight markets, the pressure is immense to keep these ships at sea and to keep them on time. Moreover, there are lots of logistical complexities in trying to keep the crude moving at the right times and to the right places. If anything disturbs this complex economic and logistical ballet of behemoths, then the economic effects could be considerable. If the oil does not arrive on time then refinery production and deliveries of refined products to markets could be disturbed. Most countries have crude and product reserves to handle short term disruptions that may result from tanker losses. If the tanker losses are large or other disruptions occur in the supply chains of crude via ships, then those reserves could be worn down. It takes well over a year to build one of these tankers.

If the market for tankers is soft and some available tankers are moored in port, (such as when close to 500 hundred ships and dozens of tankers were moored off Singapore a few years ago), then the chances are better of getting the shipping logistics back to normal faster. However, problems could still arise in getting ships needed in Houston or Ras Tanura from Singapore. The travel times of these massive ships add considerable costs and disruptions.

When disruptions occur, some crude cargos can change direction and can be sold and resold, depending on the sorts of contracts that are in effect, along the way. Sometimes the disruptions are from political events, such as revolutions, insurrections, civil instability, and natural events like hurricanes and tsunamis. For example, when the tsunami hit Japan on March 11, 2011, many cargos were delayed or reconfigured. However, these sorts of events are different from terrorists blowing up a series of ships, as the psychology is different.

There is a certain amount of flexibility built into crude tanker transport markets, but a larger question is what would happen if many of them were taken out in various parts of the world. Would such a “black swan event” cause great disruptions? This is most likely. The follow on question would be how the tanker and other connected markets would react to this to help resolve the logistical attacks and how this might affect tanker insurance and lease rates.

Given that the crude and other products feed into other supply chains and markets, there could be cascades of disruptions in many parts of the world from a significant attack on even one large VLCC. Attacks on more ships would become increasingly more complex and costly in their effects.

If even one ship is sunk with a missile, the effects on oil markets and the world economy could far outweigh the mere few hundred millions of dollars in value the tanker and its cargo may represent. Ports, pipelines, refineries, tankers and other parts of the oil, transport and other infrastructures could be affected.

The destruction of an oil facility in a sensitive area that may be worth a few billion dollars could have a negative economic impact globally in the hundreds of billions, if not more. Attacks on the Houston Ship Channel, the Louisiana Offshore Oil Port, Ras Tanura in Saudi Arabia, the Jubail Complex in Saudi Arabia, Kharg or Lavan Island in Saudi Arabia could have considerable impacts economically and even militarily.

The impacts of attacks on these facilities would be stronger when oil and tanker markets are tight, and when the world or salient regional economies are growing quickly. An attack on a major tanker route out of Saudi Arabia heading to China or Japan will have a lot less effect on tanker and oil markets when there are excess tankers at anchor, and when there is excess capacity in oil production to make up in a relatively short time than when both tanker and oil markets are tight and there is little excess capacity. The less elastic the markets, the more effect any attacks will have. If a terrorist group wanted to have the most impact on the world economy it would likely attack in times of high growth in various important economies and when there is little excess oil capacity and no spare tankers. Often these three markets are tied together. When the global economy is growing quickly oil markets are under stress. When oil markets are under stress then tanker markets are stressed.

Looking to the future, some countries could be facing political turmoil such as Russia, Saudi Arabia, Iran, and Venezuela. This turmoil is not deterministic, but it is also not completely out of the bounds of probability. Depending on the type of turmoil, damage, and loss of production and export capacity, these events could have significant effects on world oil markets.

If such turmoil is going to happen, it is better for the world oil markets and the world economy that these happen during times of greater excess production and export capacity than the losses in oil production and export capacity from the turmoil. The worst of all possible combinations would be the loss of production and export capacity during very tight market times in a country where most of the excess capacity is found, which is in Saudi Arabia. If the world economy is growing quickly all around, then the effects of such turmoil will be far greater than if the world economy is in a slow growth period.

There are also regional aspects; during the 2011 Libyan Revolution, Europe’s economy was starting to dig itself out of a deep recession that had affected most European countries. Most of Libya’s oil that was cut off for a while was supposed to go to European countries, especially Italy, Spain, and France. Libyan oil production was about 1.7 million barrels a day until the civil war/ revolution began in February 2011. About 1.5 million barrels a day was exported. After the beginning of the conflict, production dropped to about 200,000 barrels a day, and did not recover until the post-civil war “recovery” that began about 8 months later. In the period between the start of the civil war/ revolution and the start of the ramp up, oil production dropped to 100,000 barrels a day and then on down to about zero barrels a day. Very little was exported during the times of the conflict. The fact that many European economies were growing slowly, or in some cases not growing at all, helped alleviate the potential effects of the cutting off of oil shipped from Libya. About 85 percent of Libya’s oil exports before the conflict went to Europe. The countries that relied considerably on Libyan were Italy, Austria, Ireland, Switzerland, Spain, Austria, and France. However, most of these were in slow-growth phases due to the ongoing recession and growing financial crises in their countries. The tanker markets were also soft and there was significant excess capacity of oil production in Saudi Arabia. The Saudis tried to backfill some orders for Libyan crude, but some of these did not work out well due to the heavier, sourer nature of the available Saudi crude compared to the usually light, sweet crude out of Libya. Switzerland is different from the other European countries as its “consumption” of Libyan oil was mostly for trading the oil in hedge funds and the big commodity firms in Geneva. The rest of these countries needed it for their overall economic needs.

Libyan crude production increased to about 1.4-1.5 million barrels a day until further problems occurred in mid-2013 with strikes at the ports and some energy facilities. Production is now down to 200,000 barrels per day. The effects on prices has been a lot less this time than during the civil war due to new, more flexible trading arrangements and better planning for such contingencies out of Libya, but also because the European economy and tanker markets remain weak.

Many Americans may think that they are relatively immune from geopolitical turmoil in oil disruptions because of the shale oil and gas revolution in the United States and Canada. However, there is potential for the increase in trade of oil with Canada which will result in greater access to oil and gas.  But, this will not buffer the United States from the vagaries of oil prices caused by geopolitical events. This is mainly due to oil being a globally traded commodity.

Unlike the oil industry, the natural gas industry is not fully globally integrated, but it looks to be heading that way. As more countries invest in both conventional and unconventional reserves production, the development of LNG (Liquefied Natural Gas) export and import facilities, and expansions of major international pipeline networks, the world natural gas market will have some great changes. Some of these may include the convergence of prices of natural gas globally. Recent prices of natural gas (FOB – Freight on Board, where the buyer pays for transport costs) in China were about $15 per MMBTU (Million British Thermal Units), a common measurement of natural gas amounts. In Japan they were in the $16-17 ranger per MMTBTU. In many parts of Western Europe LNG (FOB) prices were about $9-11 per MMBTU. Natural gas in the United States recently has sold for about $3 per MMBTU. Qatar could sell at cost for much lower, as it sells to the United States for about $3 MMBTU similar LNG that it sells to China and Japan for much higher prices. With the convergence of prices, the lower cost countries will likely be the survivors. Others may have to drop out if they have to export the LNG at a loss, unless the country subsidizes these exports, which would be problematic under the World Trade Organization (WTO) agreements.

Those countries that develop their LNG export facilities the fastest will capture more of the most important markets (such as Japan, South Korea, and especially the potentially gigantic market in China), than those countries that doddle along in their decisions to export or not. The future of global gas markets is more of a very competitive and very expensive 4D chess game played by very powerful people, rather than just some engineering or economics exercise as some look at it.

As the now regional and segmented natural gas markets develop into global integrated markets, they  will become more efficient and regional prices will start to converge toward a global price, much like oil. As the global natural gas markets develop, there will be more spot markets developed and less need for long term contracts in many instances. For decades, oil and gas prices were linked. As a global natural gas market develops, and especially with the further spread of the shale gas revolution, fewer and fewer natural gas contracts will be linked to oil prices. However, this integration of the natural gas industry globally also brings the risk of terrorist or political driven turmoil at or near LNG ports, LNG ships, and even in the market trading centers in places far removed from the United States. The more globally integrated the natural gas markets are, the more likely reverberations to prices will occur globally, rather than just locally. It is sort of like dropping a large rock in a pond with many barriers compared to dropping a large rock in a pond without many barriers in it. The waves will have more extensive effects without the barriers.

At the moment, the United States has a special domestic market that is fairly immune from outside events, as one would expect that they would happen in Canada, the United States’ major natural gas trading partner. This will change over time as U.S. natural gas markets get more connected with the world. The United States have some buffers during difficult gas shocks globally due to massive shale gas reserves. However, it could take a long time for these reserves to surge into the domestic markets to make up for the price increases.

Large profits can be made in exporting natural gas to places like China, Japan, South Korea, and Western Europe where gas prices are much higher. Over time those price differentials will decline because more LNG and piped gas will be flowing to the more profitable markets, hence putting pressure on prices.  Global gas prices will tend to converge, but not entirely given different extraction, production, liquefaction and gasification prices.

With greater integration there are also new risks to consider. Some of these include potential attacks on major LNG facilities as natural gas becomes a more vital part of the world economy and some countries. There are also increased risks that as the global markets get more integrated in natural gas, events distant from the United States could affect prices in the United States much like what happens now with oil markets.

There are great profits to be made from exporting the potentially massive amounts of natural gas (mostly shale gas), from the United States into these newly developing world markets. (The greatest profits can be made in the first years of the development of these markets prior to the lowering of prices in Asia, Europe and higher priced areas as the markets get integrated.)

However, nothing is ever certain and some planning and emergency regulations may be required to help potential shocks from entering U.S. markets. Complete immunity is not possible when a market is globalized, but with proper consideration risks might be mitigated. A very large natural gas strategic reserve system might be best built and filled when the natural gas is cheap for times when it may be less accessible (likely for the short run given how quickly shale gas pads and production can be set up).

Cyber Risks

According to Europol there have been many cyber-raids in 2012 on logistics and computer networks connected to container ships by criminal gangs to obtain the illegal drugs they had hidden in the holds of the ship. The gang truck drivers were able to find the containers, get the security codes, and were able to get the drugs off the ship without being caught. This could be the start of far more serious cyber-attacks on shipping and maritime logistical networks. The oil and gas industry is information intensive and it is hard to get around that. Computer systems, the internet, and other cyber-based devices and operations are key elements to the operations of the industry. For example, Saudi Aramco and many other oil companies in the Middle East region have been cyber-attacked in recent years.

In addition, cyber-attacks have both financial and real effects, including distortions in the prices of oil and gas. Hacking into the derivatives and futures markets could wreak serious havoc on the industry. Real effects could include attacks on SCADA (Supervisory Control and Data Acquisition) systems that control oil and gas pipelines. SCADA is also used in refinery operations.  If a container ship can be hacked, how far off is it when an LNG or oil tanker is taken over or hacked? Tanker traffic is often controlled and monitored via computer systems and the internet. Clever cyber warriors and others are likely trying to crack these systems (or potentially have even cracked them at times), but the industry would rather not discuss such events. It may be entirely possible to use something like STUXNET on affected SCADA systems to send the wrong signals to those trying to monitor the complex logistics of the shipping. A ship may be seen on the company’s monitor being one place, whereas it might be somewhere else. That is anyone’s guess, but I suggest that is not impossible. The new pirates attacking tankers may be cyber-pirates sending in malicious code, not just the barefoot Somalis and others tossing hook anchors on to the stern of the tanker and climbing up.

Cyber risk can also have considerable effects on the overall supply chains for the oil and gas industry. To get an oil rig, a refinery, a series of pipelines up and running takes a massive administrative supply chain effort that could involve sometimes hundreds if not thousands of subcontractors and suppliers that have to get things done in a specific order and on time. Anyone who has built a house or even had a kitchen remodeled knows how important it is to get the carpenters, electricians, masons, and roofers to be on schedule and in the right order. Now consider the complexity of getting all the right people, equipment and information on schedule and in the right order in the build out of a complex oil rig in 10,000 feet of water 150 miles at sea with millions of dollars (and maybe lives) at risk due to any scheduling mistakes.

A cyber-attack on major refineries and pipeline systems could bring costs that may seem unthinkable at the moment. However, this could just be a matter of time if the industry does not constantly update its protective systems and understanding of the risks. The industry remains constantly vigilant as hackers and cyber-warriors like the SEA (Syrian Electronic Army) are always looking for opportunities to attack. Constant vigilance will not be enough if one of these attackers gets “lucky” and gets through. The sophistication of cyber warriors and hackers is not static, nor should the sophistication of the oil and gas industry to counter these threats be static.

Note: All opinions expressed are those of the author alone. Sources supplied upon request.

Paul Sullivan is the Adjunct Senior Fellow for Future Global Resources Threats at the Federation of American Scientists and a Professor of Economics at the Eisenhower School at the National Defense University. He is also an Adjunct Professor of Security Studies at Georgetown University and a columnist for newspapers in Turkey and Mongolia.

Dr. Sullivan is an expert on resource security issues, with a special focus on the nexus of energy, water, food and land. He is also an expert on issues related to the economics, politics, and militaries in the Middle East and North Africa. 

Introduction

Rapid growth in the developing world has changed the economic center of gravity towards Asia, especially with regard to the world’s energy economy. World-wide demand for energy, especially energy that can propel automobiles, is increasing. High energy growth is producing two problems.  The first, widely recognized, is the increased greenhouse gas concentrations that result from burning fossil fuels. Barring a substantial reduction of fossil fuel use, world-wide temperatures could increase to dangerous levels. While the huge infrastructure of the energy economy rules out quick changes, if action is taken now, the necessary world-wide reduction of greenhouse gas emissions may still be possible. However, the required uptake of clean energy technologies will require strong government policies to offset initial investment costs.¹

The second problem is less widely recognized. The share of GDP that must be spent on oil supplies may also limit economic growth. At times, the price of oil is limited only by the strain it places on the world economy. We have seen episodes where high and rising oil prices precede an economic downturn. During the downturn, oil prices can drop to levels that, along with a weak economy, discourage investment in new oil production. When strong growth returns, we can see the cycle repeated.

These events are not surprising because oil has a very low elasticity of demand and supply with respect to price. That means very large price changes are required to increase supply or decrease demand. In addition, oil has a very high elasticity of demand with respect to income. That means economic growth strongly increases oil demand. Lastly, oil expenditures can be a large enough component of GDP to adversely affect economic growth if they grow too large. Added together, these interactions can produce the following cycle:

• High GDP growth drives oil prices to high levels since high income elasticity increases oil demand while low price elasticities require high oil prices to balance demand and supply²;
• The resulting high share of GDP spent on oil reverses GDP growth;
• With lower GDP growth, high income elasticity reduces oil demand;
• With lower oil demand, low oil price elasticities sharply lower oil prices; and
• Low oil prices reduce oil production investments but encourage high GDP growth.

Oil prices are only one factor affecting the world economy. Nonetheless, world GDP growth and oil prices are periodically engaged in the cycle described above. Oil prices can also stabilize at levels that are not high enough to cause a downturn in GDP growth, while GDP growth is not high enough to push oil prices past the level where the share of GDP spent on oil reverses GDP growth.³

The Clean Energy Challenge

High economic growth encourages more fossil fuel use and increased greenhouse gas concentrations.  High oil prices also provide an opportunity for clean alternatives to be more competitive. However, if high oil prices periodically blunt economic growth, it is more difficult to make clean-energy policies a government priority. Economies that are struggling with low growth and high unemployment are less likely to maintain strong clean-energy policies. Without these policies, we cannot hope to limit the increase of world-wide temperatures to 2^oC above pre-industrial levels, the level deemed likely to avoid the more serious consequences of climate change and accepted by the G8 countries as a target to be achieved by international climate policies.⁴

A recent IEA study⁵ estimated the increase in clean power-sector technologies that would be needed to prevent a world-wide temperature increase of over 2^oC (Figure 1). They estimate that the future annual growth of nuclear power must be between 23 and 31 gigawatts (GW). To put this into perspective, the historic high in building nuclear power plants was 27 gigawatts per year (GW/yr).  Photovoltaic power must, after 2020, reach 50 GW/yr and, after 2030, exceed 100 GW/yr. Onshore wind investments must exceed 60 GW/yr from now through 2050. Offshore wind must exceed 20 GW/yr after 2020. After 2020, coal with carbon capture and storage would need to grow by more than 20 GW/yr.

The challenges to achieving the 2^oC scenario in the transport sector are no less daunting, requiring that the world sales of electric vehicles double each year between 2012 and 2020. Advanced biofuel production must grow from ~ zero to 22 billion gallons by 2020. IEA estimates that the incremental energy-sector investment that would be needed to keep world-wide temperatures from increasing over 2^oC is $37 trillion (cumulative investment between now and 2050).⁶ The bulk of this investment would have to be made in the developing world.  It is not likely that these additional investments, over and above what is necessary to provide required energy supplies, will be made without strong government policies, even though they would produce offsetting savings in the long term. Without strong world-wide economic growth, it will be difficult, if not impossible, to implement the policies necessary to achieve the 2^oC scenario.

Figure 1

Average Annual Electricity Capacity Additions to 2050

2012 IEA Energy Technology Perspectives 2^oC Scenario

Source: IEA, Energy Technology Perspectives 2012

Oil and Economic Growth

World oil prices have, from time to time, reached levels that have impaired world economic growth such as the aftermath of the 1973 oil embargo. This first “energy crisis” accompanied a major change in the way petroleum was controlled and priced. Prior to 1970, world oil prices were managed by a relatively small number of large oil companies. These companies enjoyed liberal access to most countries’ oil resources. They could develop large oil fields in host countries with terms that allowed ample world supply at non-competitive but reasonable prices. These companies pursued a strategy to maintain affordable and stable oil prices that supported economic growth in the industrialized world and encouraged increased demand for oil. These arrangements were undone by reforms in the member-countries of the Organization of Petroleum Exporting Countries (OPEC). The reforms moved the control of the world’s largest oil resources from the international oil companies to OPEC and, given sufficient OPEC cohesion, the ability to control of world oil prices. OPEC’s control of oil prices was short-lived. The rapid price hikes associated with the 1973 embargo and the 1979 Iranian revolution stimulated new supplies, especially from the North Sea and Alaska. High oil prices also stymied demand as consumers turned to more efficient automobiles.

By 1981, oil prices began a steady decline. Saudi Arabia tried to maintain higher prices by cutting production until by 1985, its output had fallen to 3 million barrels per day (mmb/d), 70 percent lower than it had been in 1980.  In 1986, Saudi Arabia adopted netback pricing⁷ to regain market share. Oil prices collapsed to $10 per barrel (/b)⁸. By 1988, the OPEC pricing regime was replaced by commodity market pricing, a system that remains in place today and for the foreseeable future. The London InterContinental Exchange (ICE) established a contract for Brent, a mixture of high quality North Sea crudes[ref]The selection of Brent and WTI as marker crudes reflected several factors: 1) the desirability of Brent and WTI to most refiners; 2) the sources of Brent (UK and Norway) and WTI (United States) relative to the world’s financial capitals, London and New York; 3) the supply of Brent and WTI would not be controlled by national governments or OPEC; and 4) Brent and WTI were produced in sufficient volume to be an important component of world oil supply.[/ref].  Additionally, the New York Merchantville Exchange (NYMEX) established a contract for West Texas Intermediate (WTI), high-quality crude similar to Brent.

Only a small percentage of the world’s crude petroleum is WTI, Brent or other traded crudes.  Nonetheless, these marker crudes affect the contract price of other types of crude oil since most crude oil contracts are indexed to one or more marker crudes. Spot oil prices also respond to whether the oil commodity markets are in backwardation or contango⁹

This new pricing regime did not entirely eliminate OPEC’s price setting role. A few OPEC countries maintain spare production capacity. Saudi Arabia, by far, keeps the largest production capacity in reserve. Saudi Arabia can increase or decrease its oil production in response to world market conditions. If Saudi Arabia believes that prices are too high, they can put spare capacity into production, putting downward pressure on market prices. Likewise, if Saudi Arabia believes that prices are too low, they can reduce production (increasing spare capacity) putting upward pressure on market prices.  Most other oil producing countries and all private oil companies are price takers. They only respond to higher or lower oil prices by increasing or decreasing planned investments in new production capacity. Whether or not these investments are made has little impact on current oil supplies or prices, but has a large impact on future oil supplies and prices.

Figure 2

The new pricing regime produced relatively stable oil prices until 1999 (except for a sharp increase in 1990 due to the Gulf War). In 1999, oil prices began a sharp upward trend culminating in an extremely sharp $40/b rise from January 2007 to June 2008. With record high oil prices, U.S. demand finally slackened and, soon after, failing financial institutions launched a world-wide banking crisis.  Oil prices plummeted reversing in one year the gains made since 2005.

Since 2008 there have been two rapid increases in oil prices. In early 2011, the Libyan civil war removed 1.5 mmb/d of light-sweet crude from the market. Oil prices spiked again in 2012 due to increased supply outages from Iran, Nigeria, Sudan and Yemen. The 2012 run-up was followed by a significant price slide due to a deteriorating economic outlook in the Eurozone and uncertainty whether the EU and the European Central Bank would take the necessary actions to prevent an unraveling of the euro.

Figure 3

Source: IEA, World Energy Outlook 2011

Figure 3 shows oil prices and annual changes in world-GDP. Each spike in oil prices was followed by a sharp drop in world GDP growth. The price rise from the 1973 oil embargo preceded a 4% drop in world GPD growth. Within two years, world growth slid from over 6% to 1%. The oil-supply outage resulting from the 1979 Iranian revolution doubled oil prices. Growth slid from 4% to 2% and, later, to below 1%.

The spike in oil prices resulting from the 1990 Gulf War led to a drop in world GDP growth from over 3% in 1990 to 1% in 1991. GDP growth did not reach 3% until 1994. The price spike from 1999-2000 was followed by a drop in world GDP growth from over 4% in 2000 to 2% in 2001. The world economy appeared to survive the long price rise from 2002 to 2007 until 2008, when the world suffered the worst financial crisis since the 1930s. World GDP growth dropped from over 4% in 2007, declined to less than 2% in 2008 and plummeted to -2% in 2009. While these high oil prices did not cause the world-wide recession, they were a contributing factor. High oil prices directly affected automobile sales and travel-related industries. High oil prices also reduced a household’s disposable income for other goods and services that remained after paying unavoidable fuel expenses.¹⁰

While each oil spike has been followed by a sharp drop in world economic growth, since 1987¹¹, there has been only one sharp reduction in world economic growth that was not preceded by an oil price spike.¹² GDP growth has remained above 3%, apart from the 2^nd or 3^rd years following an oil price spike.

The world oil market has been subject to unplanned supply outages for quite some time. However, since 2011, supply outages have increased considerably from most prior years. They also reflect causes are likely to be chronic conditions as opposed to one-off events. During 2010, oil supply outages averaged less than 1 mmb/d; since 2011, they have averaged ~ 3 mmb/d and remain high today. Reports of insurgent attacks on oil-producing and distribution infrastructure, ethnic or sectarian conflict and civil war in the oil-producing states of the Middle East and North Africa (MENA) are too common to enumerate. The security situation has caused private industry to withdraw personnel from regions that are not deemed to be safe. In addition to loss of trained personnel, insurgent attacks on infrastructure, political disputes concerning sovereignty, disagreements about the validity of oil-related contracts and other problems are not likely to be passing problems that we can assume will be resolved. While these may be necessary side effects as countries replace autocratic rule with democratic governments, they nonetheless pose a great risk for future oil supplies. The International Energy Agency recently warned that relatively stable oil prices should not conceal “an abundance of risk” as “much of the Middle East and North Africa remains in turmoil.” “The current stalemate between the West and Iran” is “unsustainable” and “sooner or later, something has to give.”  The political situation in the MENA region reflects a “precarious balance” that does not bode well for “clear, stable and predictable oil policies, let alone supplies.”¹³

OPEC production capacity has been essentially flat for the last 30 years. Over that time, growing oil demand has been met by additions to non-OPEC capacity. A number of disappointing non-OPEC supply developments helped drive the sharp rise in oil prices from 2002 and 2008. During that period, the cost of oil and gas drilling equipment and support activities increased by 260%.¹⁴ More recently, the growth of Canadian oil sands and U.S. tight oil production has kept the world oil market in balance. Without increased oil production in the United States and Canada, non-OPEC production would have been in decline in recent years.

Sufficiently high oil prices are needed to sustain the growth on non-OPEC oil. The IEA estimates that the cost of oil sands and tight oil production ranges from $45/b to over $100/b. ¹⁵ As production moves from the most productive plays to less promising plays, costs will tend to move to the upper end of the IEA range. For example, Global Energy Securities estimates that the price of oil needed to generate an attractive internal rate of return increases from $67/b in Eagle Ford (Texas) to $84/b in Monterey/Santos (California).¹⁶ While current oil prices are higher than they need to be to justify increased investment, they are not that much higher than what’s needed to motivate the large investments needed to grow non-OPEC oil production.¹⁷

As long as world oil demand grows, so will the cost of oil. The only long-term pathway to lower oil prices is to reduce and reverse the growth of world oil demand.

World Economic Growth, Unemployment and Poverty

In OECD ¹⁸ economies, unemployment is the most serious consequence of limited GDP growth. Okun’s law describes a statistical relationship between an economy’s potential rate of growth, its actual rate of growth and changes in unemployment. According to this rough relationship, a 2% difference between a country’s actual GDP and its potential is associated with 1% more unemployment. Applied over time, unemployment will grow by 1% if economic growth is 2% below an economy’s potential.¹⁹ The picture in developing countries is more complicated because of movements of labor between the agricultural and industrialized economies. Growth below a developing country’s economic potential limits or reverses the movement from the agricultural sector to the industrial sector causing underemployment.²⁰

While increasing productivity within the agricultural sector is a development priority, it also leads to underemployment in the agricultural sector.

The relationship between economic growth and the movement of the population out of the agricultural sector is vividly illustrated in the recent history of China. By the late 1970s China possessed an inefficient agricultural economy with a rudimentary industrial sector. China possessed a population exceeding 1 billion people, of which the vast majority lived in poverty. Economic reforms produced a sustained GDP growth that has averaged 10.2 percent per year.²¹As a result, China has moved 400 million people out of poverty into the modern economy. Currently, ~ 650 million people still live in the agricultural sector, 450 million more people than are needed.

High Chinese economic growth would permit more people to move out of the underemployed agricultural economy to productive labor in the modern economy, as there are 450 million people living in poverty.²² Within one generation, emigration out of the agricultural sector can be the first step to careers in commerce, business, education, medicine, engineering, science and management.

Reducing Petroleum Demand

By 2014, more oil will be consumed outside the OECD than within.²³ Increased personal income and increased auto ownership appear to be as inextricably linked in rapidly developing economies as it had been in the OECD after the Second World War. With economic growth, automobiles (especially luxurious automobiles), are likely to be purchased in increasing numbers. Domestic automobile consumption will also help developing economies move from export reliance to supplying domestic markets.

With a rapidly increasing consumption of energy for personal mobility, it is imperative to satisfy this growth with non-petroleum energy. If the world continues to rely on petroleum fuels for personal mobility, high oil prices are likely to cause periodic episodes of low growth causing significant hardships for hundreds of millions of people.

Energy Security Trust

The Energy Security Trust, proposed by President Obama,²⁴ aims to make current electric vehicle technologies cheaper and better with $2 billion for research. In addition to advances in batteries, electric vehicles and ubiquitous electric refueling, it will also fund sustainable biofuels.²⁵ As stated by the White House; “In each of the last four years, domestic production of oil and gas has gone up and our use of foreign oil has gone down. And while America uses less foreign oil now than we’ve used in almost two decades, there’s more work to do. That’s why we need to keep reaching for greater energy security. And that’s why we must keep developing new energy supplies and new technologies that use less oil. The Secure Energy Trust will ensure American scientists and research labs have the support they need to keep our country competitive and create the jobs of the future.” The success of initiatives like the Energy Trust Fund would produce world-wide benefits as the uptake of competitive advanced clean energy technologies would be global. Competitive alternatives to petroleum-fueled personal transportation, combined with strong clean-energy policies, would go a long way to achieving the G8’s 2^oC climate goal. They would also remedy an important impediment to world GDP growth.

Carmine Difiglio is the Deputy Assistant Secretary for Policy Analysis, U.S. Department of Energy and may be reached at carmine.difiglio@hq.doe.gov.  His work and publications include the first engineering-economic transportation-energy model, several other modeling projects including the International Energy Agency’s Energy Technology Perspectives project, studies of international oil and natural gas markets, and policies to promote energy security, energy efficiency, motor-vehicle efficiency and alternative transportation fuels.  Difiglio also serves as Co-Chair of the World Federation of Scientists’ Permanent Monitoring Panel on Energy and Vice-Chair of the IEA Standing Group on the Oil Market.  He was Vice-Chair of the IEA Committee on Energy Research and Technology, Chairman of the IEA Energy Efficiency Working Party and Chairman of the Transportation Research Board Committee on Energy and Transportation. Difiglio’s Ph.D. is from the University of Pennsylvania. The data and views expressed in this paper are those of the author and are not endorsed by the U.S. Department of Energy or the United States government.