The Consequences of U.S. Oil Dependency

The Council on Foreign Relations established an Independent Task Force to examine the consequences of dependence on imported energy for U.S. foreign policy. Since the United States both consumes and imports more oil than any other country, the Task Force has concentrated its deliberations on matters of petroleum. In so doing, it reaches a sobering but inescapable judgment: The lack of sustained attention to energy issues is undercutting U.S. foreign policy and national security. What follows is an excerpt from the full report published in October 2006 currently posted at the Council on Foreign Relations website.

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Foreword

Through most of the 1990s energy supplies were plentiful and prices were low. The Economist speculated about the political consequences of a world in which oil declined to $5 per barrel. U.S. foreign policy generally accorded little attention to energy, except in special circumstances such as the location of strategic pipelines in Central Asia.

In recent years, energy prices have surged. President George W. Bush, in this year’s State of the Union address, warned of an addiction to imported oil and its perils. Yet there is no consensus on what should be done to shake the addiction. Virtually everything concerning energy has changed—except U.S. policy.

The Council on Foreign Relations established an Independent Task Force to examine the consequences of dependence on imported energy for U.S. foreign policy. Since the United States both consumes and imports more oil than any other country, the Task Force has concentrated its deliberations on matters of petroleum. In so doing, it reaches a sobering but inescapable judgment: the lack of sustained attention to energy issues is undercutting U.S. foreign policy and national security.

The Task Force goes on to argue that U.S. energy policy has been plagued by myths, such as the feasibility of achieving ‘‘energy independence” through increased drilling or anything else. For the next few decades, the challenge facing the United States is to become better equipped to manage its dependencies rather than pursue the chimera of independence.

The issues at stake intimately affect U.S. foreign policy, as well as the strength of the American economy and the state of the global environment. But most of the leverage potentially available to the United States is through domestic policy. Thus, the Independent Task Force devotes considerable attention to how oil consumption (or at least the growth in consumption) can be reduced and why and how energy issues must become better integrated with other aspects of U.S. foreign policy. …

Overview and Introduction

The lack of sustained attention to energy issues is undercutting U.S. foreign policy and U.S. national security. Major energy suppliers—from Russia to Iran to Venezuela—have been increasingly able and willing to use their energy resources to pursue their strategic and political objectives. Major energy consumers—notably the United States, but other countries as well—are finding that their growing dependence on imported energy increases their strategic vulnerability and constrains their ability to pursue a broad range of foreign policy and national security objectives. Dependence also puts the United States into increasing competition with other importing countries, notably with today’s rapidly growing emerging economies of China and India. At best, these trends will challenge U.S. foreign policy; at worst, they will seriously strain relations between the United States and these countries.

This report focuses on the foreign policy issues that arise from dependence on energy traded in world markets and outlines a strategy for response. And because U.S. reliance on the global market for oil, much of which comes from politically unstable parts of the world, is greater than for any other primary energy source, this report is mainly about oil. To a lesser degree it also addresses natural gas.

Put simply, the reliable and affordable supply of energy—‘‘energy security”—is an increasingly prominent feature of the international political landscape and bears on the effectiveness of U.S. foreign policy. At the same time, however, the United States has largely continued to treat ‘‘energy policy” as something that is separate and distinct—substantively and organizationally—from ‘‘foreign policy.” This must change. The United States needs not merely to coordinate but to integrate energy issues with its foreign policy.

The challenge over the next several decades is to manage the consequences of unavoidable dependence on oil and gas that is traded in world markets and to begin the transition to an economy that relies less on petroleum. The longer the delay, the greater will be the subsequent trauma. For the United States, with 4.6 percent of the world’s population using 25 percent of the world’s oil, the transition could be especially disruptive.

This report concentrates on the next twenty years, a period long enough to put necessary policy measures into place but not so distant as to encounter a wider range of future geopolitical or technological uncertainties. During this next twenty years (and quite probably beyond), it is infeasible to eliminate the nation’s dependence on foreign energy sources. The voices that espouse ‘‘energy independence” are doing the nation a disservice by focusing on a goal that is unachievable over the foreseeable future and that encourages the adoption of inefficient and counterproductive policies. Indeed, during the next two decades, it is unlikely that the United States will be able to make a sharp reduction in its dependence on imports, which currently stand at 60 percent of consumption. The central task for the next two decades must be to manage the consequences of dependence on oil, not to pretend the United States can eliminate it.

A popular response to the steep rise in energy prices in recent years is the false expectation that policies to lower imports will automatically lead to a decline in prices. The public’s continuing expectation of the availability of cheap energy alternatives will almost surely be disappointed. While oil prices may retreat from their current high levels, one should not expect the price of oil to return, on a sustained basis, to the low levels seen in the late 1990s. In fact, if more costly domestic supply is used to substitute for imported oil, then prices will notmoderate. Yet the public’s elected representatives have allowed this myth to survive, as they advocate policies that futilely attempt to reduce import dependence quickly while simultaneously lowering prices. Leaders of both political parties, especiallywhen seeking public office, seem unable to resist announcing unrealistic goals that are transparent efforts to gain popularity rather than inform the public of the challenges the United States must overcome. Moreover, the political system of the United States has so far proved unable to sustain the policies that would be needed to manage dependence on imported fuels. As history since 1973 shows, the call for policy action recedes as prices abate.

These problems rooted in the dependence on oil are neither new nor unique to the United States. Other major world economies that rely on imported oil—fromWestern Europe to Japan, and now China and India—face similar concerns. All are having difficulties in meeting the challenges of managing demand for oil. But these countries do not share the foreign policy responsibilities of the United States. And the United States, insufficiently aware of its vulnerability, has not been as attentive as the other large industrialized countries in implementing policies to slow the rising demand for oil. Yet even if the United States were self-sufficient in oil (a condition the Task Force considers wholly infeasible in the foreseeable future), U.S. foreign policy would remain constrained as long as U.S. allies and partners remained dependent on imports because of their mutual interdependence.Thus, while reducing U.S. oil imports is desirable, the underlying problem is the high and growing demand for oil worldwide.

The growing worldwide demand for oil in the coming decades will magnify the problems that are already evident in the functioning of the world oil market. During that period, the availability of low cost oil resources is expected to decline; production and transportation costs are likely to rise. As more hydrocarbon resources in more remote areas are tapped, the world economy will become even more dependent on elaborate and vulnerable infrastructures to bring oil and gas to the markets where they are used.

For the last three decades, the United States has correctly followed a policy strategy that, in large measure, has stressed the importance of markets. Energy markets, however, do not operate in an economically perfect and transparent manner. For example, the Organization of Petroleum Exporting Countries (OPEC), quite notably, seeks to act as a cartel. Most oil and gas resources are controlled by state-run companies, some of which enter into supply contracts with consumer countries that are accompanied by political arrangements that distort the proper functioning of the market. These agreements, such as those spearheaded by the Chinese government in oil-rich countries across Africa and elsewhere, reflect many intentions, including the desire to ‘‘lock up” particular supplies for the Chinese market. Some of the state companies that control these resources are inefficient, which imposes further costs on the world market. And some governments use the revenues from hydrocarbon sales for political purposes that harm U.S. interests. Because of these realities, an active public policy is needed to correct these market failures that harm U.S. economic and national security. The market will not automatically deliver the best outcome.

Recommendations

The Task Force recommends a policy strategy based on five types of actions.

First, while the United States has limited leverage to achieve its energy security objectives through foreign policy actions, it has considerable ability to manage its energy future through the adoption of domestic policies that complement both a short- and long-term international strategy.

The Task Force is unanimous in recommending the adoption of incentives to slow and eventually reverse the growth in consumption of petroleum products, especially transportation fuels such as motor gasoline. However, the Task Force did not agree about the particular options that would best achieve this objective. The Task Force considered three measures:

Used singly or in combination, these measures would not only encourage higher-efficiency vehicles (although these will take time to find their way into the fleet), but also encourage the introduction of alternative fuels, as well as promote changes in behavior such as the greater use of public transportation. While there are other domestic policies that could be adopted to limit demand for fuels, no strategy will be effective without higher prices for transportation fuels or regulatory incentives to use more efficient vehicles.

The Task Force does not believe there is a corresponding need to adopt additional measures to limit demand for natural gas. While there are reasons to be concerned about the adequacy of the near-term supply of natural gas to the North American market, at present natural gas markets work relatively well. To date, there is little dependence on natural gas from outside of North America, thus avoiding the political repercussions accompanying oil imports.

There are large amounts of ‘‘stranded” gas available around the world that can be transported to markets using technologies that are increasingly economic. Most attention is focused on the technologies of liquefied natural gas (LNG), through which gas is cooled and compressed to a liquid, shipped on tankers, and then warmed and re-gasified to its original form. Realizing the potential for LNG will require additional facilities to receive and re-gasify imported LNG in the United States.

At the same time that the United States promotes measures to reduce oil demand, it should also be prepared to open some new areas for exploration and production of oil and gas, for example, in Alaska, along the East and West coasts, and in the Gulf of Mexico. In addition to modestly increasing supply, encouraging domestic production is a valuable, if not essential, element for increasing the credibility of U.S. efforts to persuade other nations to expand their exploration and production activities.

Ultimately, technology will be vital to reducing the dependence on oil and gas, and to making a transition away from petroleum fuels. These benefits of improved technology will come in the future only if investments are made today in research, development, and demonstration (RD&D).

The Task Force notes that higher energy prices are unleashing remarkable forces for innovation in this country. Entrepreneurs are seeking new ideas for products and services, such as batteries, fuel cells, and biofuels. Private equity capital is seeking opportunities to invest in new energy technologies. Large corporations are investing in RD&D in all aspects of energy production and use. These activities will undoubtedly result in a steady improvement in the ability of the U.S. economy to meet energy needs.

The U.S. government has an important role in supporting this innovation in the private sector, especially for technologies that require significant development efforts to demonstrate commercial potential. The Task Force recommends that the federal government offer greatly expanded incentives and investments aimed at both short- and long term results to address a wide range of technologies that includes higher efficiency vehicles, substitutes for oil in transportation (such as biomass and electricity), techniques to enhance production from existing oil wells, and technologies that increase the energy efficiency of industrial processes that use oil and gas. Government spending is appropriate in this context because the market alone does not make as much effort as is warranted by national security and environmental considerations.

Second, we recommend that the United States take several initiatives to encourage the efficient, transparent, and fair operation of world oil and gas markets. The United States must not act alone in this endeavor, as all consumer nations have a common interest in well-functioning international markets for oil and gas.

The United States should continue to urge governments in all countries to reduce subsidies and deregulate the prices of oil and gas where they have been held below world market levels. While progress has been made over the last three decades, many countries—notably large developing countries, such as China, and large energy producers, such as Saudi Arabia and Venezuela—still regulate and subsidize their consumption of fuel. Russia, among many other gas-rich countries, still subsidizes its internal consumption of natural gas. These arrangements result in a world market that is not properly responsive to underlying supply and demand.

The United States should also take the lead in revising cooperative agreements originally reached in the International Energy Agency (IEA) in the early 1970s. These agreements require their members to maintain adequate national oil stockpiles and to follow procedures for coping with shortages in case of a disruption in supply. The most important revision would find a mechanism to include the large, rapidly growing economies, notably China and India, so that they can build adequate strategic reserves and coordinate the use of those reserves with other major oil importers. The best approach would involve expanding the IEA. However, an alternative institution, such as a greatly strengthened International Energy Forum (IEF), could also serve this purpose.¹

The United States should remove the protectionist tariff on imported ethanol, as that makes it much harder for U.S. refineries to take advantage of efficient ethanol producers outside our borders, such as in Brazil.

The executive branch and Congress should also reexamine the management of the United States’ strategic stockpiles and consider whether the procedures for using these stockpiles should be updated so that they are more consistent with today’s realities, such as the presence of large private stockpiles and strong oil and gas futures markets.

Third, producing and consuming countries have a common interest in reducing infrastructure vulnerability, whether to terrorist attacks or natural disasters. In the last year alone, there has been one attempted major attack on the Saudi oil processing facility at Abqaiq, and hurricanes Katrina and Rita caused substantial damage to oil and gas processing and transport infrastructure in the United States. The United States must work more closely with major oil suppliers, notably Saudi Arabia, to detect and deter attacks on their infrastructure. Greater efforts are needed to harden the energy infrastructure against both attacks and natural disasters. Over the coming decades the importance of these infrastructures is likely to grow as low-cost oil resources close at hand are depleted and hydrocarbon resources in more remote areas are tapped.

Fourth, there are too many examples of countries that exploit their oil and natural gas resources while failing to manage the revenues in a way that improves the social and economic prospects of their people. While there are limits to what can be accomplished, the Task Force believes the United States must play a stronger role in promoting better management of hydrocarbon revenues. Too often, these revenues accrue to a small minority that is unaccountable to any representative political authority, which not only undermines governance, but also risks the political stability that is essential to reliable production of oil and gas. Such actions are in the U.S. interest, both because stably governed countries are better able to attract the investment needed to maintain and increase hydrocarbon production, and because it supports the long-standing American goal of encouraging progress toward democracy and good governance.

Most proposals for better management of hydrocarbon revenues rely on encouraging investors and governments to disclose payments and improve accounting, on the theory that greater transparency will make it easier to detect corruption, encourage better spending of revenues, and generally lead to better governance. Most notable of these is an initiative by the British government, working through international institutions, to implement the Extractive Industries Transparency Initiative (EITI). Making such schemes work is very difficult because, while voluntary, they can be seen as intrusions on a nation’s sovereign prerogative to manage its own revenues. Yet there are encouraging signs—such as efforts in Azerbaijan, Kazakhstan, and Nigeria to apply the EITI’s accounting standards—that these systems have a significant and positive effect. The United States should play a more active role in promoting the use of these mechanisms through its own actions and by working to convince others, such as the governments in China and India, of the importance of these measures.

Fifth, the U.S. government is not well organized to address the threats to national security created by energy dependence. There is a need to mobilize the resources of the government in a manner that better ensures continuity of attention and integration of the political, economic, technical,and security perspectives needed for energy policymaking. Closer attention to organization is needed mainly in the executive branch, but complementary actions by Congress, through legislation and hearings, will also be needed.

The success of any prescription to integrate energy issues into the foreign policy process is made difficult by the enormous range of other issues that demand the attention of high-level policymakers. The Task Force recommends that a small energy security directorate be established within the National Security Staff to coordinate interagency policymaking on energy security issues. It also recommends that the secretary of energy be engaged in any foreign policy deliberations that involve energy issues. In addition, the Task Force suggests that the terms of reference of all planning studies at the National Security Council(NSC), Department of Defense, Department of State, and the intelligence community include energy security considerations. The Task Force cautions that it would be neither practical nor wise to insist that energy security be the central foreign policy priority of the United States.

Scope of the Task Force’s Inquiry

The Task Force has restricted its inquiry to the challenges of managing U.S. and global dependence on imported oil and gas. This focus necessarily means that it has not addressed other important energy security subjects.

One example is nuclear proliferation. The Task Force believes for many reasons that the world will need more nuclear power in the future. However, a significant increase in the number of nuclear power plants and their associated fuel cycle could also pose risks to the proliferation of nuclear weapons. Iran is a vivid example today. It is important to work toward an international system that prevents the spread of potentially dangerous fuel cycle facilities while, at the same time, assuring a reliable supply of nuclear fuel for countries that build commercial power reactors.

We also have not addressed the important and complex foreign policy issues surrounding global warming, an issue that will be prominent on the foreign policy agenda in coming years, and which the Council has addressed in an earlier publication.² A sober judgment on the best policy for the United States to pursue requires examining a number of factors, including the state of scientific knowledge about global warming, the costs and benefits of different carbon emission control mechanisms, and the timing of adoption of possible policies by other countries, including the rapidly growing developing economies. The Task Force did not address these issues in depth nor did it make specific recommendations, but it has considered global warming in its deliberations. In particular, policies intended to reduce demand for fossil fuels—such as those advocated here—can also slow the accumulation of gases that contribute to global warming.

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1 The IEF was established in 2003 as a ministerial-level dialogue between major energy producers and consumers.
2 David G. Victor, Climate Change: Debating America’s Policy Options (New York: Council on Foreign Relations Press, 2004).

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Members of the Independent Task Force on Energy and U.S. Foreign Policy

Graham T. Allison, Belfer Center for Science and International Affairs
Norman R. Augustine, Lockheed Martin Corporation
Robert A. Belfer, Belfer Management
Steven W. Bosworth, The Fletcher School
Helima L. Croft, Lehman Brothers
Charles J. DiBona, Sentient Council
Jessica P. Einhorn, Paul H. Nitze School of Advanced International Studies
Martin S. Feldstein, National Bureau of Economic Research
David L. Goldwyn, Goldwyn International Strategies
Michael D. Granoff, Pomona Capital
Bennett Johnston, Johnston & Associates, LLP
Arnold Kanter, The Scowcroft Group
Karin M. Lissakers, Soros Fund Management LLC
Walter E. Massey, Morehouse College
Ernest J. Moniz, Massachusetts Institute of Technology
William K. Reilly, Aqua International Partners
Peter Schwartz, Global Business Network
Philip R. Sharp, Resources for the Future
James B. Steinberg, LBJ School of Public Affairs
Linda G. Stuntz, Stuntz, Davis & Staffier, P.C.
James L. Sweeney, Stanford University
Frank Verrastro, Center for Strategic & International Studies

Read the Independent Task Force’s full report here.