Experts urge US policymakers to address long-term challenges

Energy policymakers should not waste the opportunity that lower oil prices provide to address US supply concerns, two experts told the congressional Joint Economic Committee on May 20.

Nick Snow
OGJ Washington Editor

WASHINGTON, DC, May 21 -- Energy policymakers should not waste the opportunity that lower oil prices provide to address US supply concerns, two experts told the congressional Joint Economic Committee on May 20.

"The recent rise in oil prices again underscores the present reality of long-term challenges. Even if we see significant short-term gains in global oil production capabilities, if demand from China and elsewhere returns to its previous rate of growth, it will not be too long before the same calculus that produced the oil price spike of 2007-08 will be back to haunt us again," warned James D. Hamilton, an economics professor at the University of California at San Diego.

"Once global economic growth resumes, so will growth in oil demand. That will once again put energy security, and the relation of energy to economic well-being, back at the top of the agenda. Given the lead times to develop new supplies, policy decisions made today should take into account the likelihood of future cycles, and what they mean to the American economy and to American consumers," added Daniel Yergin, chairman of IHS Cambridge Energy Research Associates.

The two experts returned to testify amid dramatically different conditions from their last appearance, observed Rep. Carolyn B. Maloney (D-NY) who chairs the joint House-Senate committee. "The most recent estimate from the Energy Information Administration is that regular gasoline prices will average $2.21/gal over this summer's driving season and that diesel fuel prices will be $2.23/gal. That's a far cry from the $4 or more a gallon for gasoline and diesel that drivers faced last summer," she said in her opening statement.

Price 'break point'
"When I had the opportunity to testify to the committee almost a year ago, oil prices were on a sharp upward trajectory. Sixteen days after that very timely hearing, they reached an all-time peak of $147.27/bbl. Although some people then were talking about $200, $250 or $500/bbl oil, it seemed clear to use at IHS CERA that a 'break point' was nearing on prices that would market the beginning of a reversal, which we have seen," said Yergin.

When oil's price hit its peak on July 11, it was more than two months before Lehman Bros. Holdings collapsed on Sept. 15, taking the US economy from "moral hazard" to the much more frightening world of "systemic risk," with the threats of credit freezes, economic free fall, and overall breakdown, Yergin said.

"It is well-recognized that the main drive of the deepest recession since the Great Depression was the failure of the US and global debt and credit systems. But the surge in commodity prices, notably oil, was a very significant contributing factor," Yergin said.

High oil prices hit consumers hard, notably those with lower incomes, making them reduce spending, he said. They also put an unexpectedly heavy burden on many businesses, both large and small. Most notably, they helped knock the US auto industry "flat on its back," reducing consumers' ability to buy cars and leaving Detroit stranded with a product mix that it could not change quickly enough as motorists quickly moved away from what if offered.

"The automobile industry was knocked flat on its back not by the collapse of Lehman Bros. but by the price at the gasoline pump," Yergin said.

'An important factor'
Oil prices doubled between June 2007 and June 2008, Hamilton observed. "In my mind, there is no question that this latest surge in oil prices was an important factor that began in the US in 2007's fourth quarter," he said.

He disputed assertions that financial speculators pushed crude oil prices higher, saying that several other factors contributed to the run-up. "World oil production decreased slightly between 2005 and 2007. Declining production from mature oil fields in the North Sea and Mexico played a role, as did political instability in Nigeria. Saudi Arabian production, which many analysts had expected to increase to meet rising demand, fell by 850,000 bbl a day between 2005 and 2007. These declines were enough to offset production gains in places such as Angola and Central Asia, with the result that total global oil production dropped slightly," he said.

Meanwhile, demand continued to grow, according to Hamilton. "World petroleum consumption increase by 5 million b/d during 2004 and 2005, driven largely by a 9.4% increase in global [gross domestic product]. Over the next two years, 2006 and 2007, world GDP grew an additional 10.1% which, in the absence of an increase in the price of oil, would have produced further big increases in quantities consumed," he said.

"Even with price increases, Chinese oil consumption increased by 870,000 b/d between 2005 and 2007. With no more oil being produced, that meant that residents of the US, Europe, and Japan had to reduce our consumption by a comparable amount. The price of oil needed to rise by whatever it took for us to do so," Hamilton said.

Consumers finally began to respond when gasoline's US average price was more than $4/gal, he said. The abrupt spending changes which resulted can seriously disrupt certain key parts of the economy and seemed to be part of the mechanism by which earlier oil price shocks contributed to previous economic recessions. "The kinds of economy responses we saw between the fourth quarter of 2007 and the third quarter of 2008 were, in fact, quite similar to those observed following previous dramatic oil price increases," Hamilton indicated.

'Hardly helpful'
The 50¢ increase of retail gasoline prices from their recent low in December has taken away about $70 billion from US consumers' annual spending power, "which is hardly helpful for the broader challenge of restoring household balance sheets to a level where spending could be expected to pick back up," Hamilton said.

"But let me emphasize that although I believe that the initial spike in oil prices was an important element of the process that produced our current difficulties, we are currently at a point at which the multipliers and spillovers associated with the recession dynamic itself have become far more important factors," Hamilton added.

Policymakers should pursue all options, the two analysts agreed. "As part of a longer-term view, we need to get beyond the 'either/or' energy debate and take a more ecumenical approach, ensuring that combination of conventional energy, renewables and energy efficiency are all developed with appropriate environmental and climate-change considerations," Yergin said.

Major initiatives in research and development, innovation, and what he called the "green stimulus" can have significant long-range impacts, he said. "Indeed, we have never seen anything like the embrace of energy efficiency that is taking place today all across the spectrum," he said.

"But there is no single answer to the energy needs of our $14 trillion economy. Today, fossil fuels (oil, natural gas, and coal) supply over 80% of our total energy. Oil by itself is about 40%. That alone makes clear the importance of oil, and the evolution of the oil market, to our economy and security in the decade ahead," Yergin said.

His recommendations
"It is in our interest to see a diverse range of energy resources developed around the world," Yergin said. "We should give clear signals to Canada to develop its oil sands and Brazil to develop its offshore oil. We should do more research on cleaner uses of coal. We should encourage more domestic natural gas production through hydraulic fracturing. And we should be prepared to use more of our offshore oil and gas deposits by encouraging their development in an environmentally intelligent manner," he said.

Unfortunately, the Obama administration seems to be doing trying to discourage domestic production growth by placing excessive limits on exploration and production, including making offshore drilling effectively impossible in many areas, asserted Rep. Kevin P. Brady (R-Tex.), the Joint Economic Committee's ranking minority member from the House.

"The administration would further penalize oil and gas production and move more energy jobs offshore by the imposition of a variety of new energy taxes. The Treasury justifies these tax increases by arguing that the lower taxation under current law 'encourages overproduction of oil and gas, and is detrimental to long-term energy security,' at least partly because it boosts 'more investment in the oil and gas industry than would occur under a neutral system,'" he said.

"With all due respect, a policy designed to suppress US oil and gas production is absurd. The Treasury notes that the lower taxation under current is 'also inconsistent with the administration's policy of reducing carbon emissions and encouraging the use of renewable energy sources through a cap-and-trade program.' In other words, when we need more development of domestic oil and gas, the administration is doing exactly the opposite," Brady said.

But Rep. Maurice D. Hinchey (D-NY), another committee member, said the country should more aggressively away from oil. "The amount being consumed on this planet is growing. We're importing about 70% of what we consume. We produce 6% of the world's total production but only have about 2% of its total reserves. That means we're depleting our own resources faster than other parts of the world," he said.

Yergin said that allowing for US product exports, its oil imports actually are closer to 56% of its total consumption. "That means that the US is producing 44% domestically of the oil it uses, which should be maintained. The investments will be made somewhere. If we make it attractive to invest here, that means the tax and royalty revenues will not flow into other countries' treasuries," he said.

Contact Nick Snow at nicks@pennwell.com.

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