COMMENT: West should consider ramifications of its off-oil rhetoric

Environmental and political enthusiasm in the West for getting rid of oil as an energy source may have major unintended consequences through its impact on decisions by a handful of key oil exporters. Such consequences could paradoxically include increased Western dependence on oil and higher energy prices.

An energy crisis is imminent if oil-exporting countries believe Western rhetoric and decide to reduce their investment in capacity expansions at a time when the West is failing to find a suitable substitute. In this case, consumers will pay a dear price for the ill-considered statements of their leaders.

If, by contrast, oil producers attempt to counter a policy-induced decline in demand and kill oil substitutes by raising production to lower crude oil prices, or if demand actually declines, a different set of problems might emerge. Either scenario could wreak havoc on the economies in the Middle East, supposedly one of the least stable areas in the world. The cost of such political instability in terms of lives, money, and pollution will render all the positive results from weaning consuming countries off oil negligible.

If oil-consuming countries wish to lead the world safely to a future without fossil fuels, they will have to consider energy-market realities and how to meet the revenue needs of current oil exporters, as well as how to ensure adequate oil supplies during the transition and investment sufficient to develop new energy-supply technologies. The new energy vision must adhere to market realities. Otherwise, market forces will soon defeat these efforts.

Market realities

The main threat to sustainability of energy supplies is not a terrorist attack on energy facilities or the imposition of an oil embargo by an oil producing country. These threats are short-term events that can be dealt with quickly and effectively through various measures that include the use of the Strategic Petroleum Reserve, increased production, and diversion of oil shipments.

The main threat to sustainability of energy supplies in the medium term is the mismatch between investment in production capacity and energy infrastructure, on one hand, and growth in demand for energy, on the other. One of the most plausible scenarios is a relative decline in investment supporting additional production capacity in the oil-producing countries in response to calls around the world to reduce or even eliminate dependence on oil.

An energy crisis in this case is imminent if those who are calling for eliminating dependence on oil fail to provide the ultimate replacement in a timely manner. Most likely, these efforts will fail to replace oil within a reasonable time. Most of the efforts to replace oil are not market-driven and are heavily subsidized. They cannot sustain the pressure of markets in the long run.

Oil is still abundant. But much remaining conventional oil is in the hands of a very small number of governments, primarily in the Middle East. Will all the talk about reducing dependence on oil have an impact on the behavior of those governments?

Major oil exporters have tended to view their remaining oil in the ground as an appreciating asset, one which should be exploited at a measured pace so that some is left for future generations. To them, the call for security of demand becomes very attractive when the other side is exerting pressure on the producing countries to insure security of supply.

Talk about moving away from oil through coercive policies seriously challenges the sustainability of oil producers’ societies. To add insult to injury (or injury to insult), much of this kind of talk comes from European governments that take a high share of the economic rent on the exporters’ oil through extremely high taxes on end-consumers. Those consumer-country governments are thus claiming much of the current revenue stream from the oil producers’ major asset while simultaneously planning to eliminate the demand for it.

Even hopes for a peaceful, democratic Iraq cannot come to fruition without oil revenues. Major oil exporters treat talk of eliminating dependence on fossil fuels as an existential threat to their societies, especially when the talk is based on hostile ideological agendas rather than market principles.

Possible responses

To these apparently hostile statements from across the political spectrum in oil-consuming countries, oil producers might react in a number of ways:

• Their simplest response would be to ignore escalating Western claims about weaning themselves off oil as some bizarre form of liar’s poker among Western political classes. Oil exporters might look at the actual continuing growth in oil demand and conclude that oil consumers do not intend to follow through with the necessary hard choices. Additionally, oil exporters could sit and watch Western developments, comfortable in the knowledge that currently popular carbon capture and storage is very energy-intensive and, if implemented, will substantially increase the demand for fossil fuels, thus rendering their oil resources even more valuable.
• Oil exporters could take Western commentators seriously and assume that oil importers will indeed reduce their demand for oil, leaving them with then-unmarketable oil in the ground. Their logical response to this threat would be to accelerate production of oil while their resources still have value. This would of course drive down the price of oil and undermine the economic feasibility of alternative energies. A collapse in the price of oil would kill several new energy technologies and ultimately increase demand for oil. In fact, the oil-producing countries might view increasing oil production and lowering prices as a logical policy to counter the antioil policies of the governments of consuming countries. Historical data from periods of oil price collapses support this point: Low oil prices increase oil demand, decrease efficiency improvements, choke alternative energy resources, and increase waste.
• Alternatively, expecting a decline in demand for their oil, oil-producing countries might decide to reduce their planned investments in production capacity expansion and maintenance and mothball some planned projects, which would shortly lead to declining oil supplies. If new technologies do not come on line by the time oil production starts declining, the world will face a serious energy crisis, probably unparalleled in history. Reversing such a trend of declining investments would take years, despite massive increases in oil prices. This alternative is not a mere possibility: Several major projects have been mothballed in the past when the oil-producing governments deemed these projects not needed.
• If oil-consuming countries do begin to reduce their dependence on oil, major oil exporters could seek to use their now less-valuable oil within their own borders as cheap fuel with which to expand heavy industries. Instead of exporting oil directly, they could export the energy from that oil embedded in metals, chemicals, and manufactured products at prices that far undercut Western products, constrained as Western manufacturers would be by having to use higher-cost alternative energy sources. The net result would be a loss of jobs and economic strength by the West without having any impact on the overall global consumption of fossil fuels.

Even if Western countries successfully replaced imported oil with indigenous alternative energy sources, they would still have to live on the same planet as oil-exporting countries, whose fragile societies would then face the loss of their main source of revenue. Energy independence for current oil importers, if somehow achieved, would aggravate political instability in oil-exporting countries.

In addition, it is unclear what will happen to the world monetary system without trade in oil and the associated recycling of petrodollars. A change to a world where most industrial countries depend on their own domestic energy resources would require a major change in the global financial system. Such a change would create its own difficulties, impacting even the industrial countries.

Possible responses

Major oil producers have several long-term, market-oriented, economically viable, and sustainable options to ensure their economic growth, prevent a worldwide energy crisis, and reduce emissions.

They might, for example, invest heavily in CO2 sequestration and various emissions-reduction technologies. This investment might include CO2 for enhanced oil recovery. This is a transitional option that guarantees the availability of energy supplies and a steady stream of oil revenues while it reduces emissions from fossil fuels. Oil exporters might reasonably expect importers to pay a higher price for this “greener” oil.

Oil-producing countries also might seek to become leaders in nonfossil fuels through direct investment in projects or by research funding. Oil-producing countries in North Africa and the Middle East, for example, have the large areas of vacant land and consistent sunshine required by two of the alternative energy sources most amenable to technological breakthrough: photovoltaics and biofuels. An interesting question is whether Western politicians now intolerant of oil from those regions might respond in the same manner to alternative energy from the same places.

In the shorter term, oil exporters might lobby consuming-nation governments for loopholes in antioil laws, invest in the downstream businesses of consuming countries to help meet oil demand and gain local political influence, or fund unconstrained scientific research into global climate processes. Some such activities obviously might strain ethics and, from the perspective of oil exporters, backfire.

Goals of cooperation

Politicians, environmentalists, and the public in oil-consuming countries should not ignore the valid interests of the oil exporters on which they currently depend. Oil consumers and producers will have to find ways to cooperate.

For oil-consuming countries wishing to reduce the global use of fossil fuels without provoking an economic depression, the objectives of cooperation should be ensuring adequate supplies of oil during the transition away from oil and keeping the oil price stable at a level high enough to encourage investments in alternative energy sources. For major oil-exporting countries, the objectives of cooperation should be maintaining national revenues as demand for oil is progressively reduced and replacing the asset underlying their economies as oil in the ground loses value.

Balancing these objectives will be challenging. It might require politically difficult sacrifices by oil-consuming countries, such as compensating exporting countries for their declining sales volumes or mothballing their own oil-production capacity.

The willingness to make such sacrifices and acceptance of such risks will be a test of how serious oil consumers are about weaning themselves off fossil fuels. If industrial countries are reluctant to incur the costs of mothballing their own sizable oil-production capacity or are unable to agree on an equitable sharing of the costs of this policy between themselves, they will have demonstrated that they are not serious about reducing global oil consumption. And OPEC countries can comfortably invest accordingly.

The authors