Oil and Gas:

Former Defense officials warn of tight world energy markets, potential oil price spike

Could a series of small oil supply disruptions send oil prices into the stratosphere? Former Defense Department and CIA officials say that might be the case, according to their predictions about tight world energy markets. What kind of events would cause oil prices to hit $100 per barrel? Does the energy bill address this problem at all? And how will a proposed Chinese takeover of Unocal affect the United States? Jason Grumet, executive director of the National Commission on Energy Policy, discusses how security experts are answering these questions.


Mary O'Driscoll: Welcome to OnPoint. I'm Mary O'Driscoll. Today's topic is oil, it's nearing $60 a barrel and supplies remain tight and our guest today is Jason Grumet of the National Commission on Energy Policy. Jason thanks for joining us today.

Jason Grumet: Thank you Mary.

Mary O'Driscoll: Your organization just went through an exercise where you had current and former Cabinet level members who were in a mock scenario of oil supply disruptions and what would happen to the American economy in the event of oil supply disruptions. Can you kind of explain what happened?

Jason Grumet: Certainly and Mary I should say that the National Commission on Energy Policy partnered with Securing America's Future Energy, a new group called SAFE, slick new operation in town.

Mary O'Driscoll: There you go.

Jason Grumet: And I'll say more about that in a moment. The goal of this exercise was to try to dramatize in a very real way the risks that we face as a nation from disruptions in oil supply. I think most people know with oil at $60 a barrel the system is stretched pretty tight and what we learned yesterday was that even very small disruptions in oil supply, anywhere in the world, can have very dramatic and very negative impacts in the United States and everywhere in the world.

Mary O'Driscoll: Yeah, I was going to say that your scenario only pulled 3.5 million barrels out of an 80 plus billion barrel market, which is not exactly a worst-case scenario.

Jason Grumet: We were intent, Mary, on not having kind of a Robert Ludlow dirty bomb, you know, airplanes into cooling towers. I mean what we looked at was a number of very, unfortunate, but very realistic events. Some civil unrest in Nigeria, unfortunately life is imitating art. I mean we're seeing that now reported in newspapers, coupled with some low-tech terrorism. We looked at al Qaeda hijacking a tanker and crashing it into the Port of Valdez and at a major explosion at a natural gas facility in Saudi Arabia, which would have taken natural gas off the market requiring them to use crude oil to replace their own domestic energy. And then some terrorism that just caused a real anxiety among the oil producers in Saudi Arabia. You put all that together, you take 3-and-a-half million barrels off the market and let me read to you from my cheat sheet of doom; gasoline prices at $5.74 a gallon, global oil price at $161 a barrel, a recession, two consecutive quarters of a drop in GDP, a drop in consumer confidence by 30 percent, inflation 12.6 percent, a 28 percent decline in the S&P 500, as well as I think some very realistic foreign policy concerns. As we worked through the game yesterday and started to appeal to the Saudis for example to increase their oil supply, their response was, we'd be happy to. A couple of things, re-engage in Mideast peace process, stop talking about money laundering to terrorists, stop talking about reforms of our society and we'll do our best for you. So it was a real eye-opening experience and I really think we owe a lot to the people who participated in the event because what we were able to do was put people into a situation, and we had Bob Gates and Jim Woolsey and Linda Stuntz and General PX Kelly and Senator Nickels and others who have been in that situation and we kind of through information at them that they really weren't prepared for and we watched the discussion unfold.

Mary O'Driscoll: That's really interesting, especially how energy policy, which we always think of as domestic policy, has really turned into kind of a foreign policy and a national security issue as well. I mean it just has, it's really kind of evolved into that especially since the September 11 attacks.

Jason Grumet: You know, I think that's right.

Mary O'Driscoll: Yeah and so I'm kind of curious, what kinds of lessons did we learn? I mean all of these horrible things happened in this scenario so what did we take away from it?

Jason Grumet: A couple of key takeaways. One is that we, the greatest nation in the world, are basically impotent to address, in the short term, oil disruptions. I mean the options would before the group were like real life. You know, a choice of three real bad options. When there was a problem with Nigerian oil, there was no real military option to go into Nigeria and take over the oil fields. We had a lot of discussions, as we have in the real world about what to do with strategic petroleum reserve. There were some who said, let's release it and calm the markets. There were others who said, no, no, no, that doesn't work that way. When the U.S. releases oil from the SPRO people think, oh no, we have a big problem and actually the markets get heated up. The military folks say, whoa, whoa, whoa, this is a little blip. This is civil unrest in Nigeria. If we release the SPRO now we shoot our bullet. What's left to do? People said, well, wait a minute. If we release our strategic petroleum reserve and the rest of the world doesn't, here we are subsidizing oil internationally. So people realize that that's not a pure solution. When it came to the long-term answers, which, you know, the energy bill does grapple with some of them, they're lovely answers if you have seven or eight years to wait around.

Mary O'Driscoll: Right.

Jason Grumet: So the idea of significantly diversifying our fuel, domestic production increases in the U.S., I mean these are controversial issues, but none of them are going to solve a 12-month oil spike.

Mary O'Driscoll: Well then what do we do in the short term? I mean as you said, the energy bill, and we'll talk about that in just a second, I would like to touch on that in a moment, but I mean in the short term, what do we do?

Jason Grumet: We eat it. I mean this is the reality that I think we were hoping to reveal. You know when the national commission put out its report last December the number one priority issue that we addressed was the need to deal with domestic oil security. I think that we have -- the SPRO is a significant buffer. It's very good news that our economy uses about half as much oil to produce the same GDP now as we did before the first oil embargo. So we are in a better position in some regards than we were before, but we use 25 percent of the world's oil. We possess 3 percent of the world's reserves and we are fundamentally now in a system that is stretched so thin ... now if it wasn't civil unrest in Nigeria it could've been a labor strike in Venezuela. I mean these are very real risks and the answer is prices go up.

Mary O'Driscoll: Right.

Jason Grumet: And we probably wind up using our SUVs a little bit less and saying to ourselves, why hadn't government done something to protect us from this?

Mary O'Driscoll: But I mean you're talking about a recession kind of situation, so I mean will we even be able to drive our SUVs at that time? I mean it's a little unnerving I must say.

Jason Grumet: I did see, I saw the Mad Max movie over the weekend and it kind of prepared me for the realities of $160 a barrel oil.

Mary O'Driscoll: Oh boy!

Jason Grumet: These are career-ending prices for many people in this town and I think that, our hope is that collectively the Congress and the administration will start to see that not only do we have to work on these issues as matters of national energy policy, that these are issues of national security, economic strength and our foreign policy prerogative.

Mary O'Driscoll: Right. I wanted to touch on that in a minute, but let's talk about the energy bill. That the Senate just completed its work on the energy bill and now they're going to a conference with the House. Is there anything that you see specifically in the House and/or the Senate energy bills that would address something like this and what's the soonest? I mean it looks like we're kind of on a timeframe here that, you know you have a very, pretty nasty looking window of opportunity here.

Jason Grumet: Well things are very tight right now and, I guess, if there's good news, much of the oil market works through supply and demand. With oil at $60 a barrel we're starting to see a lot of projects come on line that had previously been not economic. So I'm optimistic that the prices are going to calm down over the next six to 12 months to an extent, but we are facing a demand shock more than a supply shock right now. It's really the incredible move of the 2.4 billion Chinese and Indians to join us in the gas lines that's going to keep the pressure here. So the energy bill does a lot of really very good things, in particular, I would say the Senate, the Senate bill. I think the effort to move towards a greater reliance on domestically produced biofuels is a step in the right direction and 8 billion gallons of ethanol is basically, would be about 5 percent of the fuel supply over that relevant time period and that's important. There are some pretty important production subsidies in the bill, especially in the House bills, that will increase domestic supply. I think the very hard fought debate about what do we do about the resources in this country is going to be a continuing issue for the Congress. You know we have a tremendous amount of oil off the coast of California and Connecticut. I mean these are really large reserves, but there are obviously and understandably very strong resistance to going and exploiting those reserves. So I think that issue is not going to go away. There are strong incentives for hybrid vehicles, but I think where the House bill and the Senate bill fall short, and I think it's really the one place where there's really a glaring weakness in the Senate bill, is the failure to address in a mandatory way the need to make our vehicle transportation system more fuel efficient.

Mary O'Driscoll: Right. I mean it was pretty much a given that if you tried to raise CAFE standards, either in the House or the Senate, it wasn't going to work. They did a small kind of a CAFE amendment that just says you have to look at all of the safety issues and that kind of thing before you do any rise in the CAFE standards, but they pretty much do that anyway. So it looks like it's pretty much the status quo.

Jason Grumet: I mean the good news is that the administration under the status quo has the authority to increase fuel economy. There's a rulemaking on CAFE going on now at NHTSA. They're considering some ideas, some consistent with what the energy commission proposed, thinking that there are ways that we can significantly inform and improve the way CAFE works by bringing more market incentives into it, more flexibility. We even proposed a safety valve, a cost cap in the CAFE system not dissimilar to what we had proposed for climate change. But I think what we realized in our energy commission is that incentives are really nice words in this town, but what they mean is using the tax base to have good bureaucrats at the Department of Energy pick technology winners. While incentives are a nice thing if they're in the service of a market solution, I think we believe that what we really need to have is, for transportation, a real performance standard. We have to challenge the world's auto industries to do in the U.S. what they're doing in other countries and make cars more efficient.

Mary O'Driscoll: OK. Going back to the offshore drilling issue. I mean that was a pretty long debate on the Senate floor, although it was pretty much a given that it wasn't going to go anywhere because there is such strong opposition to offshore oil and gas drilling. But Senator Mary Landrieu of Louisiana said, you know, we'll be back next year. You know, we're not addressing it now, but we'll be back. I mean do you agree with that?

Jason Grumet: Absolutely. I think, and this is probably bad news for everybody but the good people here at E&E, I don't think we're on a decade-long march to the next consideration of energy policy in this country. And I give a lot of credit Senator Landrieu for the way she framed the domestic oil and gas issue. I think she's made some very important points which say, look, I like to drive cars. I like my station wagons and SUVs, but we have to become accountable for the energy that we use and the idea that we can have all of the benefits of the energy economy and kind of offshore to other countries all of the production burdens is not a viable long-term solution. So I think we are going to come back to these issues. Now I think our commission did not -- we supported actually a look at an inventory. I think our view was that as a nation we have to have the confidence to know how many cookies are in the jar. It doesn't mean we have to go on a Mrs. Fields binge. I think we have to know where all of our energy resources are so we can make intelligent decisions. I tend to believe that before we start drilling for oil in a serious way off the coast of Connecticut maybe we should try to get vehicle fuel the economy to move off the 10-year stagnant point it's been since the mid-1980s. So I would think that if we were really serious about addressing oil dependence and thinking about it not just as an energy issue, but as a security and an economic issue, and we had a serious approach to fuel economy, I think that would move the debate quite a bit on domestic production as well. You know we can't drill our way out of this problem. We can't conserve our way out of this problem. If we increase supply and reduce demand then we can get our arms around it.

Mary O'Driscoll: That would help quite a bit.

Jason Grumet: So I think we'll see a new debate and, as you were implying, I'm not sure it's going to be focused only in the energy committee.

Mary O'Driscoll: Well that's what I wanted to ask you next, is that energy has really turned into a national security policy question, as evidenced by all the national security officials, the former national security officials who participated in your exercise. Is this something we're going to see reflected in Congress as well? I mean are we going to start seeing Homeland Security and armed services getting more involved in the energy debate?

Jason Grumet: I believe we absolutely are, and I think the jurisdiction is understandably jealously guarded territory, but I expect that we are going to see Homeland Security and armed services and foreign relations and finance start to grapple with these questions. I mean these are -- three-and-a-half million barrels of oil through a series of unfortunate events that are by no means hard to imagine, and we plunge into a recession. I don't think that the Finance Committee can sit by and say, well, we like the energy bill very much, but since they failed to fully grapple with this issue, I guess we don't care about the risks of recession. I don't think we're going to see armed services -- I mean this recent revelation that the Chinese are trying to purchase Unocal has cast this issue, now fairly or unfairly, and I think the concern is not a private company in China buying a private company in the U.S., it's the idea of the Chinese government --

Mary O'Driscoll: The Chinese national oil company.

Jason Grumet: -- purchasing U.S. resources. I think that reframes this issue.

Mary O'Driscoll: That has really caused quite a bit debate on the Hill and it's interesting that it came up during the latter parts of the energy bill debate. I mean do you see that kind of converging again and I mean is this good or bad in the national security sense?

Jason Grumet: I think it's real. I think that there is a strong view which says that the world is more secure the more integrated China is into the global economy, the more invested they are in sustaining the status quo. You know some would argue that that's actually in our long term interests. They are desperate for energy in China. You know about half of the people in the United States own a car, 2 percent of the Chinese population own vehicles. Now if that goes up to the point where only 20 percent own vehicles, we are still going to have incredible upward pressure on oil supply. They don't have a lot of oil in China and I think the strategic alliances that we're starting to see form, I mean they're doing exactly what they should be doing. They are trying to figure out where are they going to get their oil? They have every right to get oil in the United States. I mean most of the Unocal reserves are in Asia, right? I mean so we have had a happy somewhat colonial posture on oil for the last hundred years. We've had American flag tankers going overseas and extracting reserves and bringing them home, with not a lot of competition and I think this is the future. Our ability to address it will depend on whether we get ahead of these disruptions and once something like this happens it's just too late.

Mary O'Driscoll: OK. So, just back to the exercise that your group did. I mean something like this, this kind of a supply disruption, could it happen tomorrow? Are we looking at another year from now? I mean is this something that could happen right away? I mean is it that real?

Jason Grumet: Yeah and one of the things I think we want to be careful about is whenever you're doing these kind of war games, I mean these are imaginary scenarios.

Mary O'Driscoll: Oh sure.

Jason Grumet: You have to be very careful to avoid, as we I hope did effectively, that kind of anxiety. This is an eminently real scenario. You know Bob Gates, ex-CIA director, now president of Texas A&M, who ran the exercise said that he thought that these were entirely realistic scenarios. We developed these scenarios working with experts, David Froud, who used to run upstream production at Royal Dutch Shell. We had comments from the U.S. military. Dan Yergin with Cambridge Energy was very involved. We basically talked to the people out there on the front lines trying to protect the oil supply and said what are you afraid of? And we created those scenarios based on those concerns. We then went to Wall Street. We worked with Sanford Bernstein and the investment banks and we used the very models that they use to predict oil prices so that the, you know, we say oil will go to $160 a barrel. What if it's only $140? OK, we only lose 1.8 million jobs instead of 2 million jobs. I mean these numbers are directionally correct. It could be a little worse. It could be a little better, but you know I think that yes, this is a very real possibility. I think that everyone around the table agrees it's not a question of whether something like this will happen if the question of when and crises don't usually happen from one event. Crises happen from an unfortunate confluence of a couple of little events and that's what we saw here.

Mary O'Driscoll: Right. OK, well that's going to have to be it for today. Thank you so much for coming. I'm sure we have not had the end of this debate.

Jason Grumet: Thank you Mary.

Mary O'Driscoll: I like to thank Jason Grumet from the National Commission on Energy Policy. I'm Mary O'Driscoll. We'll see you next time on another edition of OnPoint.

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