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Executive Summary #2216 on Energy and Environment

December 18, 2008

December 18, 2008 | Executive Summary on Energy and Environment

Executive Summary: The Oil-Price Roller Coaster: Global Challengesfor the Obama Administration

The global financial and economic crisis has caused an abrupt slide in energy prices, down to $40-$50 a barrel of NYMEX light sweet crude from the July 2008 highs of $147. While oil prices, along with other commodities, are expected to continue to fall in the short term, over the medium to long term, economic recovery is likely to generate growth in demand, and oil prices are expected to recover as energy markets tighten. Moreover, lower oil prices may also impede the massive investment needed to meet rising demand by 2030, delay intro­duction of energy-saving technologies, and make alternative fuels less competitive. The tight credit environment will also make it more difficult for energy firms to obtain the necessary funding for financing the capital-intensive capacity growth, especially for expensive and difficult offshore explo­ration and development, and heavy oil, oil sands or oil shale production.

As the recent steep fall in oil prices has illus­trated,predicting the price of oil is a risky business. Goldman Sachs and Russia's Gazprom, which pre­dicted oil at $200 to $250 a barrel, respectively, in 2008, were proven wrong. Yet, a number of trends are firmly in place that point to higher oil prices be­yond the current recession, and are, indeed, trans­forming the global energy market: a massive rise in oil demand from emerging markets; a lack of OPEC and non-OPEC spare capacity to meet peak demand; a shift of influence over oil reserves and production from international oil companies (IOCs) to national oil companies (NOCs); an insufficient level of investment in production capacity; a de­crease in discovery of oil fields; and a rising rate of oil field depletion. Making matters worse, there contin­ues to be an increase in energy nationalism and the proclivity to use energy as a geopolitical tool.

The increase in demand for oil in China, India, the Persian Gulf states, and other developing nations remains the most significant phenomenon transforming global oil markets today. Rising inter­nal consumption in key oil-producing states is also leaving less oil for export and is a significant constraint on future supply.

Overall, the projected rise in global demand between now and 2030 is staggering. Even correct­ing for the financial crisis, the likelihood that plans to increase crude oil production by 25 to 30 mil­lion barrels per day (mbd) by 2030, as the Interna­tional Energy Agency forecasts, will be successful is not encouraging. With non-OPEC supply growth expected to increase slowly and contribute little in meeting demand by 2030, the burden will increas­ingly fall on OPEC. OPEC claims that its member countries already have the plans and investments to expand production capacity to meet demand in place. However, it has already failed to meet its 2006 capacity expansion targets and its members aresuffering from project completion delays.

In order to meet growing oil demand beyond the current crisis, the world will need much greater investment in the oil and gas sector. Non-OPEC and OPEC suppliers are not taking the necessary steps to facilitate this investment and are failing to meet production forecasts.

Moreover, the depletion rates of oil fields world­wide are rising, and new oil fields are not being dis­covered or coming online quickly enough to replace the existing production capacity. Depletion rates of the world's top oil fields range from 4.5 percent to 9 percent, roughly the equivalent of Iranian and Saudi annual production, respectively. (Even 4.5 percent is an enormous percentage and has major implica­tions to future supply.)

With diminishing global spare capacity and the growing geopolitical potential for supply disrup­tions, it is time to confront anti-competitive policies by the OPEC and non-OPEC oil producers which block investment and foreign ownership of reserves. To increase and diversify automotive fuel supply, boost investment, open access to the remaining oil and gas reserves, and diversify the basket of trans­portation fuels, the Obama Administration and Con­gress, in coordination with international oil companies and other consumer countries should:

  • Increase pressure on OPEC and non-OPEC countries to increase exploration and develop­ment of petroleum reserves, expanding access for the more efficient international oil compa­nies. The next Administration should work with other energy-consuming governments and inter­national organizations to enhance the rule of law and promote property rights among oil-export­ing countries. Consumer nations should make opening energy-producing economies to energy investment a part of their bilateral agendas with producers.
  • Authorize oil exploration and production in the Arctic National Wildlife Refuge (ANWR), other promising Arctic areas, and the lower 48 states in order to expand domestic energy supply. Congress should also streamline regula­tions for areas in the Arctic thatit has already opened but heavily regulated.
  • Encourage market-based energy-saving tech­nologies and competitive unconventional sources of transportation fuels worldwide to expand global supply of transportation fuels and facilitate transition to electricity-based urban automotive transportation.
  • Facilitate transformation of the automotive fuels and propulsion without distorting the market or subsidizing automakers.

Conclusion

A tight transportation-fuel (petroleum) market is likely to return in the years ahead due to global demand, heightened political risks, and increasing resource nationalism by oil-producing governments. This perfect storm of supply and demand turbulence may have temporarily subsided, but two significant implications remain. First, oil-producing states will return to accruing more influence in the years to come, wielding the energy weapon, pressuring con­sumer nations, and placing constraints on the foreign policy options for the U.S. and its allies. Second, the world could face a major supply crunch by 2015. These trends are far-reaching and have major implications for national security and energy policies, and must be anticipated by the incoming Obama Administration.

Ariel Cohen, Ph.D., is Senior Research Fellow in Russian and Eurasian Studies and International Energy Security in the Douglas and Sarah Allison Center for Foreign Policy Studies, a division of the Kathryn and Shelby Cullom Davis Institute for International Stud­ies, at The Heritage Foundation. Owen Graham is a Research Assistant in the Allison Center.

About the Author

Ariel Cohen, Ph.D. Visiting Fellow in Russian and Eurasian Studies and International Energy Policy in the Douglas and Sarah Allison Center for Foreign and National Security Policy, a division of the Kathryn and Shelby Cullom Davis Institute for International Studies, at The Heritage Foundation
Douglas and Sarah Allison Center for Foreign and National Security Policy

Owen Graham Research and Operations Coordinator
Douglas and Sarah Allison Center for Foreign and National Security Policy