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By Geoffrey Styles on Oct 21, 2013 with 3 responses

Energy Security Four Decades After the Arab Oil Embargo

Forty Years After

In October 1973 the United States and other Western countries experienced a new phenomenon: an embargo on oil deliveries from a group of the world’s largest oil exporters, imposed in response to our military support for Israel during the Yom Kippur War then underway. Last week I attended a session in Washington hosted by the US Energy Security Council commemorating these events. It included a fascinating conversation between Ted Koppel and Dr. James Schlesinger, US Secretary of Defense at the time of the embargo and later the first US Energy Secretary.

The other, related purpose of the meeting was a presentation and discussion proposing that fuel competition provides a surer means of achieving energy security than our pursuit of energy independence for the next four decades following the Arab Oil Embargo. This idea warrants serious consideration, since energy independence, at least in the sense of no net imports from outside North America, is beginning to appear achievable.

A Shaken Foundation

The 1973-74 embargo was the first oil shock of a tumultuous decade, and it triggered a true crisis. The US had relied on oil costing around $3 per barrel (bbl), not just to fuel our transportation system, but also for 17% of our electricity generation and numerous other uses. The US was one of the world’s largest oil producers, but required imports comprising about one-third of supply to balance our growing demand. With the sudden loss of over a million barrels per day of oil imports from the Middle East, and lacking the sort of strategic petroleum reserve that was established a few years later as one of many responses to the oil crisis, an economy already battling inflation was tipped into recession.

The embargo rattled more than the US economy; it challenged basic assumptions of American life, including our sense of entitlement to cheap and plentiful gasoline. Before the oil crisis, gasoline prices hovered around the mid-30-cent mark, with occasional local “gas wars” taking the price down to the high-20s, the inflation-adjusted equivalent of $1.60 per gallon now. Of course with average fuel economy around 13 miles per gallon, the effective real cost per mile wasn’t necessarily lower than today’s. Within a year gas was over 50¢ at the pump, and by the end of the decade it passed $1.00/gal. for the first time. The gas lines that resulted from the unexpected supply shortfall and the federal government’s efforts to limit the ensuing increase in prices were an affront to drivers, a category that encompassed most of the over-16 population.

That first oil crisis and the subsequent crisis surrounding the Iranian Revolution in 1979 set in motion a number of important changes, including a sharply increased focus on energy efficiency, a deliberate effort to diversify our sources of imported oil, a pronounced shift away from oil in power generation — to the point that it now makes up less than 1% of US power plant fuel — and the beginnings of our search for affordable, renewable alternatives to oil.

What Is Energy Security?

The US Energy Security Council is an impressive group that includes many former government officials and captains of industry. They’ve clearly spent a lot of time studying this issue, and their report is worth reading. As I understand their conclusions and recommendations, they regard high oil prices as a bigger risk to the US economy than oil imports, per se, because of their impact on consumer spending and the balance of trade.

They have concluded that the most effective way to apply downward pressure on oil prices is not simply to reduce US imports, but to introduce meaningful fuel competition into transportation markets, where oil remains dominant with a share of around 93%. They don’t dismiss the benefits of increasing US oil production from sources such as the Bakken, Eagle Ford and other shale formations, but because these are relatively high-cost supplies, they have concluded that their leverage on global oil prices is limited. That means that higher US oil output couldn’t provide a path back to the price levels that prevailed before the Iraq War, when West Texas Intermediate crude averaged $26/bbl in 2002 and gasoline retailed for $1.35/gal.

This is a reasonable argument, though it’s worth considering that a return to $75/bbl might be feasible, if US production kept rising. That could yield US retail gasoline prices around $2.75/gal., equating to $2.15 in 2002 dollars. This isn’t as far-fetched as it might seem, because the global oil price is determined not by the entire 90 million bbl/day of world supply and demand, but by the last few million bbl/day of incremental supply, demand, and inventory changes.

The Council’s view also appears to emphasize the direct impact of oil prices on consumer spending without recognizing that rising production and falling imports shield the economy as a whole from the worst effects of high oil prices. With oil’s contribution to the trade deficit shrinking steadily, the main impact of higher oil prices is to divert money from consumers to shareholders of oil companies — of which I should disclose I am one. While exacerbating income inequality, that should at least result in a smaller impact on GDP and employment than the combination of rising oil prices and rising imports.

Which Path to Open Fuel Competition

If last Tuesday’s discussion had stopped at that point, it would have been just another interesting Washington gabfest. However, the group’s analysis forms the basis for the actions it has identified as necessary for achieving their desired outcome: US energy security extending beyond the current US oil boom, underpinned by an expanding unconventional gas revolution that is widely expected to last for decades. The group’s report includes a long list of recommendations, including giving fuels like methanol derived mainly from natural gas the chance to compete with gasoline made from oil, and with biofuels.

They would start with revisions to the current US Corporate Average Fuel Economy standards to give carmakers incentives — not cash subsidies or mandates — to make at least half their vehicles fully fuel-flexible, capable of tolerating a wide range of blends of methanol, ethanol and gasoline. That seems like a no-regrets approach that could be achieved at a very low incremental cost for new cars. Even if you never bought a gallon of E85, M85, or M15, it could pay for itself by protecting your car from the damage that might result if you inadvertently filled up with gasoline containing well over the 10% ethanol that carmakers believe is safe for non-flex-fuel cars. Other recommendations include easing regulations for retrofitting existing cars for flex-fuel and forming an alcohol-fuels alliance with China and Brazil.

Yet while I repeatedly heard that the group wasn’t promoting any single fuel, talk of methanol dominated the conversation. The moderator, Ann Korin, even joked that the session sounded like an “alcohol party.” As I later pointed out to her, there wasn’t a single mention of drop-in fuels — gasoline and diesel lookalikes derived from natural gas or biomass. I regard that as a crucial omission, because such fuels would be fully compatible with the billion cars already on the road, rather than just the 60 million or so new cars produced each year. They could provide greater leverage on oil prices by producing pipeline-ready products with which consumers are already familiar, from sources other than crude oil.

Part of the appeal of methanol seemed to be the potential for producing it from shale gas at a cost well below the cost of gasoline, even on an energy-equivalent basis — an important caveat, because a gallon of methanol contains half the energy of a gallon of gasoline. I hear the same argument in support of various pathways for producing jet fuel from non-oil sources, and it subscribes to the same fallacy: that market prices are set by manufacturing costs rather than supply and demand.

Fuel is a volume game. For a non-oil gasoline substitute to drive down oil prices –and thus motor fuel prices– as far as the Council apparently envisions, it would take at least several million barrels per day, on an oil-equivalent basis. Producing six million bbl/day of methanol from natural gas would consume 20 billion cubic feet per day of it. That’s 30% of last year’s US dry natural gas production, requiring 100% of the Energy Information Administration’s forecasted growth of US natural gas production through 2034. A number of other entities have their eyes on that same gas.

Conclusions – Rethinking the Lessons of the Oil Embargo

As many of the speakers at the Energy Security Council event reminded us, the world is a very different place than it was in 1973. Among other changes, US energy trends are headed in the right direction, with oil demand flat or declining, production rising and imports falling. That alone makes us more energy secure than we were, either five years ago or in 1972. Future oil supply disruptions are also unlikely to look much like the Arab Oil Embargo.

The Council is certainly correct that our unexpected shale gas bonanza, producing large quantities of new energy at a price equivalent to oil at $25 or less per barrel, provides a unique opportunity to weaken OPEC’s influence on oil prices. In pursuing that goal, however, it’s essential to remain flexible concerning the best pathways for gas to compete in transportation fuel markets, whether as CNG or LNG, or through conversion to electricity, methanol, or petroleum-product lookalikes. Consumer acceptance could prove to be the biggest uncertainty governing the ultimate outcome.

  1. By ben on October 23, 2013 at 3:13 pm

    Geoff

    While I appreciate the general thrust of your views concerning the handiwork reflected in the ESLC’s report, I’m left with a bit of “not again” since it was only a year ago we got a tidy little report out of Gen. P..X. Kelley and Frederick Smith and colleagues at the US Energy Security Council. In visiting with PX–a fine Marine and Irishman–I got a chuckle from his remarks about these policy councils serving as little more than opportunities to pretend we’re smarter than the average guy while enjoying some really nice lunches and dinners! :)
    So here we go again with some incredible chest-thumping and precious little traction.
    Let’s face it IAGS is another group with the best of intentions and prospects of shaping real-world outcomes about slim-to-none. Don’t get me wrong, Bud McFarland is a decent man and patriotic Marine. The same kind of compliments are in order for Jim Woolsey who is an bipartisan a public officials as we’ve had serve in Washington for the past generation. Regrettably, both of these gentlemen have spent nearly all of their time inside the Beltway and reading from their own press releases. That is a waste of energy and by reasonable measure some talents. Alas, so long as the holy grail for many professionals is to be “relevant by remaining in the loop,” they remain captives to the group-think that dominates policy-making in and around our federal seat of government.

    The foundational point with which I take exception in the ESLC’s recent report is the presumption that pre-Iraq War pricing is preferable or even advisable. The market’s pricing mechanism tends to have salutary effects over time notwithstanding the discomfort that often accompanies the ebb and flow of global price-setting.
    If we think that “affordable” energy supplies is the same as “cheap” energy, well,
    we may find ourselves barking up the wrong tree. This is particularly true if we are
    to consider the waterfall implications for balance of payment and petrodollar dynamics let along the potential impact on global climate change policies.
    I suspect we need to step away from the traditional, top-down (read: power-centric) views of those who, however well-intentioned, have long rode the old horse that has brought us to the edge of the canyon. We would do well to look elsewhere for the solutions that matter most and, as ever, they will be found in the most unsuspecting places thanks to the enterprising minds of tomorrow’s economic future.
    Thanks for your efforts in seeking to be part of the solution without remaining
    a part of the problem. Something that tends to be much easier said than done.
    Ben

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    • By Geoffrey Styles on October 24, 2013 at 9:07 am

      Ben,
      Thanks for your insightful comment. There’s something about being in a room filled with smart people you have admired or at least seen in the news frequently. Like you, I don’t hold out much hope for groups like this to drive big-picture change. However, I wouldn’t discount their ability to get smaller measures inserted into legislation and regulations, through their links to lobbyists and the federal bureaucracy.
      Some examples of useful recommendations from the report that could find their way into policy by that route include fuel tax fairness–taxing fuel based on energy content, rather than gallons–and moving away from miles per gallon to a recognition that what really counts is miles per dollar. EPA and DOT are already using miles-per-gallon-equivalent (MPGe), though I take issue with their basis of calculation that ignores the actual BTU cost of a typical kWh.
      A reversion to pump prices equivalent to $25 oil could undo much of the good work that’s been done on efficiency in the last decade. However, as I noted, shale gas provides the US economy with the equivalent of $25 oil, if we recognize the opportunity.

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      • By ben on October 24, 2013 at 3:29 pm

        I think it fair to suggest that the room gets a little smarter with you in it:) Your analysis is consistently rigorous and objective–two qualities that are too often absent from discourse on Capitol Hill and within the administration.
        An old USMC associate used to handle Congressional Affairs for Gen. (“don’t forget the second e!”) Kelley. They had a mutual friend who actually help put Fred Smith & company into business after he came back from Vietnam and left the Corps. The USMC fingerprints are on a good deal of the energy security stuff, to include the longstanding interest of Gen. James L. Jones.

        I fully expect the combination of the central bank’s policy of financial repression and fiscal drag resulting from an indefinite slowdown in public sector expenditures will help ease energy prices despite growing demand in Asia. Natural gas may well prove an exception given the that cheap US supplies will increasingly gravitate toward export markets and a number of higher-better uses domestically. Such cost-push influences will nudge prices higher. I’m not sure we are about to fully embrace the Methanol Economy of Dr. Olah, but it does seem we are starting to swing a leg over the horse.
        Thanks for your thoughtful analysis and civic spirit. We need a lot more of both!
        Ben

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