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Let's Not Play The Oil Game

Author: Richard N. Haass, President, Council on Foreign Relations
May 15, 2006
Newsweek International

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No doubt it’s a sign of the times. Today’s war games have more to do with the falling supplies and rising price of oil than with tanks and armored personnel carriers rolling across borders. Consider just such an exercise, conducted several months ago at the World Economic Forum in Davos. The setting was late December 2006. In a simultaneous three-front strike, terrorists sank a tanker in the Bosporus, blocking the Turkish straits linking the oilfields of the Caspian Sea with the Mediterranean. They also successfully attacked the oil port of Valdez in Alaska. An assault on the critical Ras Tanura complex in Saudi Arabia was rebuffed, but several million barrels a day (roughly 5 percent of world supply) were taken off the oil market for at least four months.

Overnight, prices jumped to $120. U.S. gasoline prices shot to $5 a gallon. Participants in the game included the CEO of a major global oil company, a head of the national oil company of an important Middle East producer, senior officials from the International Energy Agency and the U.S. government, the president of a large insurance company and various counterterrorism and energy experts. I played the U.S. Secretary of State. The wargamers recommended specific steps, including parallel drawdowns of national strategic oil reserves, a temporary relaxing of environmental regulations to make it easier to refine crude oil into gasoline, lower speed limits and requirements for a minimum number of passengers in private vehicles. These relatively modest moves ensured adequate supplies but did not eliminate upward pressure on prices, which stayed high until the integrity of the global oil network could be re-established. Longer-term recommendations focused on preventive measures to guard global oil installations and transit routes so that a bad situation did not grow worse.

What surprised me is how sanguine the participants seemed about the political and economic consequences of far more costly oil. But it is highly unlikely that this muted reaction would be mirrored in the real world, especially if U.S. gasoline prices were to reach $5 or $6 per gallon. Nor did the players consider other eventualities, such as a meltdown of the global financial system.

What can we learn from this exercise? First: with global demand and supply balanced so closely, and with so little excess production capacity, it doesn’t take much for oil prices to skyrocket. In the scenario, a slender loss of supply caused prices to more than double. In the real world, similar results could be caused by any number of events: terror, conflict with Iran over its nuclear program, political instability in Nigeria or irresponsibility in Venezuela, even a hurricane or earthquake. And as opposed to the Davos scenario, there’s no guarantee that such a disruption would be short-lived.

A second lesson: waiting to develop a serious energy policy until catastrophe hits only increases the pain. It takes years to increase supply or introduce meaningful energy efficiencies that will not prove overly disruptive or costly. The good news is that we know what needs doing. The bad news is that we remain largely unwilling to act. And by not acting, the United States and other oil-consuming nations leave themselves at the mercy of the market, or to individual producers who would manipulate it.

America’s reaction to the recent energy crunch is not reassuring. Proposals for $100 gasoline rebates. Threats to investigate oil companies. Calls to suspend the already low federal gas tax. None would make an appreciable difference. Energy politics is one thing. Energy policy is fundamentally different. We have too much of the former and not enough of the latter.

Current high prices largely reflect the fact that demand is rising faster than supply. India and China are growing rapidly, as is their consumption of oil and natural gas. The world cannot drill its way out of this conundrum. The answer mostly lies in using less oil—something that will result from increasing efficiency and accelerating alternatives. In the United States, the best way to cut back on demand is through much higher gas taxes. Fuel-efficiency standards for new cars, SUVs and light trucks should be raised. There must be new incentives for companies to produce and people to purchase fuel-efficient hybrids and advanced diesel cars. The emergence of substitutes can best be hastened not by government-directed R&D but by guarantees that gas taxes will be kept high enough to discourage wanton consumption and to ensure a decent return on investment in alternatives.

Today’s situation may lack drama in the sense that there has been no successful terrorist attack on some tanker or refinery. But current energy policy (or the lack of one) empowers some of the most repressive and reckless regimes in the world, further impoverishes hundreds of millions of the world’s poor and contributes to global climate change. If this isn’t a crisis, what is?

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