What to Do About Oil - US Dependencies on Middle East and Russia

Here's how the U.S. can reduce its dependence on Mideastern crude

Business Week: October 29, 2001

Department: News: Analysis & Commentary

Byline: By Laura Cohn and Stan Crock in Washington, with Peter Coy in New York, Stephanie Anderson Forest in Dallas, David Welch in Detroit, and Christopher Palmeri in Los Angeles

For months, America's energy debate seemed like little more than a sparring match pitting conservatives against liberals. Republicans rallied around President Bush's call for a dramatic boost in production. Democrats asserted with equal fervor that White House plans to drill in wilderness areas would pillage the environment and provide a windfall for oil companies. The answer, they insisted, is conservation.

Now the dialogue is being transformed by the September 11 attacks on the U.S. and by Bush's declaration of a long and unrelenting war against global terror networks. The country still relies on OPEC for 51% of its imported crude. But Saudi Arabia and other Middle East oil- producing nations may be destabilized as a byproduct of U.S. military intervention and the backlash it sows in the form of Islamic fundamentalism.

"A VERY TALL ORDER." Indeed, what to do about U.S. reliance on Saudi oil is suddenly an issue that's front and center in Congress and at the White House. "Our country needs greater energy independence," said Bush, pushing his stalled energy plan in an Oct. 17 speech to Sacramento business leaders. "This issue is a matter of national security and I hope the Senate acts quickly."

But with the energy conundrum now tougher then ever, the Administration--along with the country at large--may need to rethink long-held positions. If the events of September 11 suddenly infused the energy debate with a new importance, they also deepened the economic slowdown against which that debate is occurring. Reeling from 12 straight months of declining industrial production and the psychological blow of the September 11 terrorist attacks and the anthrax scare, the ailing economy can't tolerate short-run solutions that would dramatically raise energy costs or further weaken consumers. An energy policy that takes economic weakness into account "is a very tall order," says David M. Nemtzow, president of the Alliance to Save Energy, a broad-based Washington group that promotes energy efficiency. "If it was free and good for the economy, it would have happened already."

Even amid the slowdown, energy markets are fragile. While the global economic downturn has depressed demand and kept oil prices at a modest $22 a barrel, the U.S. is more vulnerable to an oil-shock than it was during the 1990 Gulf War, when prices soared to $40 a barrel. Back then, there were 5 million barrels a day of excess capacity worldwide. Now, that figure is about 50% lower due to U.S. curbs on energy investments in Libya and Iran and tight national budgets in oil-producing nations. "If something were to happen today, it would be more serious," warns Amy Myers Jaffe, senior energy advisor at the James A. Baker III Institute for Public Policy in Houston.

The high-wire balancing act of weighing long-run energy policy against the current needs of the economy is putting pressure on policymakers to tone down the rhetoric. Moreover, it's shifting the focus. While an overall rethinking of energy policy that goes beyond oil to encompass a re-evaluation of nuclear energy, coal, natural gas, and alternative energy sources--along with broader conservation moves--remains important, the critical emphasis now is on oil. In part, that's because the aftermath of the terrorist attacks has made clear that the risks of destabilization in the Middle East will remain sharply higher for the foreseeable future. And U.S. vulnerability to an oil shock is increased by the fact that oil accounts for 40% of the nation's energy needs, is critical to transportation, and, for most uses, can't be substituted for with other types of energy.

What should Washington do? A simple energy-use tax would raise the price of oil, penalize inefficiency, and work to drive down demand. But a new energy levy that would sock already-strapped consumers is a political non-starter with the economy heading downhill.

That doesn't mean lawmakers are powerless to address the problem. Among the ideas to consider: dramatically expanding the Strategic Petroleum Reserve as a hedge against future supply disruptions, moving aggressively to diversify sources of oil imports, boosting domestic production, and promoting new technologies. While these steps may be incremental, "small changes can be important in terms of affecting the pricing power of OPEC," notes Ronald B. Gold, vice- president of the Petroleum Industry Research Foundation. Indeed, a wide range of options are now under consideration:

*Up The Strategic Reserve The reserve now holds about 544 million barrels of oil--a 60-day supply. That's well shy of its 700- million-barrel maximum, and some lawmakers, such as Representative Joe Barton (R-Tex.), want to expand it to one billion barrels. Although it could cost up to $6 billion to reach that level, with oil prices relatively low, now would be a good time to fork over the cash. "The more oil you have access to, the more leverage you have in a global market," says Red Cavaney, president of the American Petroleum Institute.

*Diversifying Imports Although it could be expensive, the U.S. needs to move rapidly to forge closer ties with oil producers outside the Middle East to diminish dependence on the unstable region. And in truth, America already has made substantial progress. Today, the U.S. imports 51.6% of its oil needs and relies on OPEC for about half of that--roughly 26% of total consumption. That's down from 33.6% in 1977, but more than double what it was in the mid- 1980s. Today, Canada, Mexico, and Venezuela each supply the U.S. with roughly as much crude as Saudi Arabia, the world's top producer. And over the long term even Russia could help. There are also vast pools of as-yet-untapped oil in Angola, Nigeria, and Chad, says H.J. Longwell, executive vice-president of Exxon Mobil Corp. However, "bringing these projects to fruition will require huge new investments," he says.

Moreover, drumming up new sources of oil is made vastly more complicated by the sometimes-conflicting goals of the U.S. government and U.S. oil companies. The government wants stable sources above all else. Oil companies want to go wherever crude can be gotten relatively cheaply, despite political risk. The energy plan Bush and Vice-President Dick Cheney unfurled this spring, for instance, calls for reinvigorating multilateral U.S.-African panels to promote investment in the region's energy resources. But the major oil companies prefer places with low extraction costs, such as Iran, Libya, and Saudi Arabia. That clashes with any drive to reduce reliance on the region.

*Boost Domestic Drilling The U.S. is the most reliable oil source of all, of course. But as energy demand surged 17% during the 1990s, domestic oil production rose by just 2%, forcing America to rely more heavily on imports. Oil experts believe there are 6 billion to 16 billion barrels of untapped oil in the Arctic National Wildlife Refuge of Alaska, and another 4 billion in the lower 48 states. And with advanced technology, 59 billion barrels of oil may be available off U.S shores. But environmental restrictions and local opposition have barred such development. Says Robert J. Allison Jr., chairman of Houston-based Anadarko Petroleum: "We are shooting ourselves in the foot."

The tensions unleashed by September 11 and the ensuing Afghanistan war are giving new urgency to decades-old domestic squabbles. "No amount of domestic production will keep us free of foreign sources of oil," insists Tyson Slocum, energy research director for Public Citizen, a consumer group founded by activist Ralph Nader. Even Bush's brother Jeb, the conservative governor of Florida, has fought offshore drilling, though he may soften that position.

One way around the environmental debate could be the advent of new drilling technology that's far less invasive. "We're not talking about raping the environment," says Allison. The public may be receptive to such moves. According to a poll conducted Sept. 15-17 by Wirthlin Worldwide, a GOP polling firm, 38% of Americans say "protecting our national security" is the most important reason for a comprehensive energy plan, up from 19% in July.

*Improve Auto Fuel Efficiency It's a lot easier to get consumers to curtail energy consumption when they're faced with high energy prices, as in the 1970s and in California during its recent electricity crisis. With energy prices relatively low, consumers have little incentive to change their habits. Still, the new environment appears to have increased the willingness of the Administration and Congress to support a phasing in of tougher fuel-efficiency standards for passenger vehicles, which account for nearly half of oil consumption. And by spreading out any increases over a number years, Washington could minimize the negative impact on the economy.

Such a move would reverse a serious erosion in fuel-efficiency wrought by the huge popularity of SUVs. A new Environmental Protection Agency report shows that cars and SUVs last year had the lowest average gas mileage since 1980. The average mileage in 2000 was just 24.2 mpg for cars and 17.3 mpg for trucks. That's far below the standards vehicles are currently supposed to meet: 27.5 mpg for cars and 20.7 mpg for light trucks. If light trucks, which include SUVs, had to meet the required level for cars, that would save a million barrels of oil a day, according to the Alliance to Save Energy.

Federal intervention may be needed if there is little market incentive to make or buy less-thirsty vehicles. The Feds could help kickstart a market by encouraging use of hybrid cars, which combine gas engines and electric motors and can cut fuel consumption by as much as 40%. Indeed, the House-passed energy bill includes tax credits for buying hybrid autos. Such incentives would give a much- needed boost to the nascent hybrid market. Toyota Motor Corp. and Honda Motor Co. already sell hybrids that get 48 mpg and 56 mpg, respectively. General Motors Corp. and Ford Motors Co. plan to launch their models in 2004, but they are expected to be less efficient.

One day, many experts believe, the auto industry could virtually wean itself completely from fossil fuels with so-called fuel cells that use hydrogen. But that day is at least 20 years away. To speed the process, some would like Washington to embark on a crash R&D program on alternative energy technologies. Says David Orr, chief economist for Wachovia Corp. in Charlotte, N.C.: "So far, fuel cells and other technologies haven't gotten the emergency allocation that a war might bring about."

 Will any of this come to pass? Much depends on whether politicians can lay aside ideological differences and forge a consensus to bolster security by reducing dependence on foreign oil. It will be a test for both the White House and Congress to see whether the current collegiality extends to something as contentious as a national energy policy. But as the bombing campaign rages on in Afghanistan and the specter of instability in the Middle East grows, Washington has little choice but to try.

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 Business Week: October 29, 2001

Department: News: Analysis & Commentary

Russia: How Much of a Reserve Tank?

Byline: By Anna Raff in Moscow and Patricia Kranz in New York, with Christopher Palmeri in Los Angeles

 Four months ago, when President George W. Bush met Vladimir V. Putin for the first time, he looked into the squinty blue eyes of the spymaster- turned-Russian president and said he "was able to get a sense of his soul." Now, in the wake of the terrorist attacks on America, the love fest between Russia and the U.S. is heating up. Putin immediately denounced the terrorists, said he would allow the U.S. to conduct humanitarian flights from Russia, and gave a nod to the stationing of U.S. troops in neighboring Uzbekistan, a former Soviet republic. And in a speech to German industrialists in Essen on Sept. 26, he made a surprising offer. "In case of regional conflicts breaking out, Russia is prepared to supply more oil," Putin said. "And I say this loud and clear."

No question, Russia can pump up production. In the past three years, oil companies have spent billions modernizing their facilities. This year Russia will produce 7 million barrels a day, 13% above 1999, and second only to Saudi Arabia, whose daily output is 8.4 million barrels. Russia could hike output by 4% next year, estimates United Financial Group, a Moscow brokerage. Some are even more optimistic. "Russian oil is a standby reserve," says Mikhail B. Khodorkovsky, CEO of Yukos Oil Co., Russia's second-biggest producer. "Russia could increase production by 10% to 15% a year easily."

That could substantially reduce the risk to the U.S. and Western Europe of a disruption in supplies from the Middle East--provided the oil can reach their markets. Russian exports are running at 2.8 million barrels per day this year, a 22% increase over 1998. But that remains nowhere near the 7.1 million barrels a day exported by Saudi Arabia. Though Russia could hike exports by 500,000 barrels a day by December, it would hit the limit of its pipeline system. That's too little to help the U.S. greatly in a sudden emergency. New pipelines on the drawings boards could up Russia's export capacity by 2.5 million barrels a day, but they won't be ready until 2004 or 2005. "There is a long way to go," admits Simon G. Kukes, president of Tyumen Oil Co.

Russia's size is the root of the problem. Most of the country's oil is produced in Western Siberia, thousands of miles away from ice- free ports that have oil-export capability. Oil must go by pipeline to Western Europe, or to tankers that can carry it to the U.S. or other markets. Transneft, the state pipeline monopoly, can export 3.3 million barrels a day, but it's carrying all it can. Many oil companies don't produce at full capacity since they can't get more pipeline space.

PIPELINE RACE. Even so, Russian producers are racing to boost drilling. Oil companies have tripled capital spending, to $6.5 billion since 1999. The Russian government is also doing its bit, by cutting rates on corporate profits from 35% to 24%.

More critical is the race to build new pipelines to ports in both Russia and its neighbors near the oil-rich Caspian Sea. Kazakhstan is expected to become one of the world's major oil producers in the next decade, and has received $10 billion in foreign investment since independence in late 1991. Azerbaijan, Uzbekistan, and Turkmenistan also have large reserves. "Central Asia will become a much more important region," says Daniel Yergin, chairman of Cambridge Energy Research Associates. "Certainly this new relationship between Russia and the U.S. will facilitate development of resources."

The first pipeline to transport Caspian oil overseas began operating on Oct. 15. The Caspian Pipeline Consortium, whose shareholders include ChevronTexaco, spent $2.5 billion on the pipeline, which stretches about 1,000 miles from western Kazakhstan across southern Russia to the Black Sea port of Novorossisk. Also in the works is one that would run from Azerbaijan across Georgia to the Mediterranean port of Ceyhan in Turkey.

Thousands of miles north, the first stage of the new Baltic Pipeline System will be done by yearend. Stretching from Russia's Timan-Pechora region to Primorsk on the Baltic Sea, it will add 240,000 export barrels a day. A number of oil majors, including Exxon Mobil Corp. (XOM), are exploring deposits off Russia's Sakhalin Island near Japan, where crude reserves estimates run more than 8 billion barrels. Japan is a natural market, but it's also a straight shot for tankers to the U.S. West Coast.

Still, it will be three to five years before major new amounts of Russian oil hit foreign markets. "I see Russia's oil production increasing, and as it does, I'm sure some of it will make its way to the U.S.," says Commerce Secretary Donald Evans, who was on an official trip to Russia last week. "It won't necessarily happen because of Afghanistan. It will happen because that's the way the market will work." But if Middle East oil is disrupted, Bush's new buddy Putin could make sure Russia sends as much oil as it can to the West--now.

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Business Week: October 29, 2001

Department: News: Analysis & Commentary

Boosting the Barrels for Russia and Other Oil Production

 BALTIC SEA

 A new pipeline stretching from Russia's Timan-Pechora region in north Siberia to the port of Primorsk on the Baltic Sea will be completed by the end of the year.

 CASPIAN SEA

 The first pipeline dedicated to crude from the oil-rich Caspian basin, 15% owned by ChevronTexaco (CVX) and stretching about 1,000 miles from the Tengiz field in Kazakhstan to the Black Sea port of Novorossisk, started operations on Oct. 15. On the drawing board is a pipeline that would run from Azerbaijan across Georgia and Turkey to the Mediterranean port of Ceyhan.

 WESTERN SIBERIA

 Producers in Russia's traditional oil patch are ramping up production and exports.

 SAKHALIN ISLAND 

Royal Dutch/Shell already pumps 35,000 barrels of oil per day. ExxonMobil (XOM) and others are also exploring reserves estimated at 8 billion barrels.