Energy & Security, by Jan H. Kalicki and David L. Goldwyn, editors. …

Energy & Security, by Jan H. Kalicki and David L. Goldwyn, editors.
(Woodrow Wilson Center Press, 2005), 604 pages + xxviii. ISBN 0-8018-8278-8.


       The nomination of Harriet Miers to the Supreme Court prompted New York Times

columnist David Brooks (2005) to comment that "I don't know if by mere quotation I can

fully convey the relentless march of vapid abstractions that mark Miers's prose." My

reaction to the opening discussions in Energy & Security is similar.

       It explores how foreign policy can best advance U.S. energy interests, and how
       energy can be used to advance broader U.S. foreign policy interests (xiv).

       For too long, energy policy has not been sufficiently connected to foreign policy,
       either conceptually or institutionally (xv).

       Just as war is too important to be left just to the generals, energy is too important
       to be left just to the engineers and geologists (xxii).

       The policy choices open to the United States and other countries are broad and
       challenging, and the results these choices will produce are not certain (48).

Far too few intelligent people appreciate the huge gulf between those who talk like this

for a living in Washington and those with economic training who study energy markets.



Are Energy Markets Different?

       The central premise of the viewpoint expressed in the forwards and introduction

to this book is that energy markets are more fragile than other markets. This fragility, in

turn, requires the attention of well paid elites in and out of government who use

prodigious amounts of jet fuel (the main ingredient of modern diplomacy) to make sure

everything works out.

       Those with economic training see things differently. Short run energy supply and

demand are very inelastic. Thus shocks (both gluts as well as disruptions) to energy

markets transfer large amounts of income because small changes in demand or supply
have large effects on price rather than consumption or production behavior. When those

short-term shocks occur, either firms or consumers find this unpleasant depending on

whether the shock is a glut or a disruption. But if low prices most of the time and high

prices some of the time are a "problem" isn't there a market solution?

       Long-term oil futures contracts, for example, are available for the sophisticated

investor. The fact that marketers have not tried to offer long-term stable prices to

consumers and firms by arbitraging between the futures and retail markets suggests that

most consumers actually benefit on net from low prices most of the time and unpleasantly

high prices some of the time. Said differently, we are "dependent" on oil exported from

unstable countries rather than domestic oil or alternative sources of energy because it is

cheaper in present value terms to do so. Similarly, the reason we don't have large

amounts of excess refining capacity in case a hurricane damages refineries (once every

30 years, for example) is because the costs would be greater than the benefits.

       Notice that the "solutions" to instability are higher prices most of the time in

return for lower prices some of the time. There is nothing wrong with such "solutions" if

they are achieved through contract. 30-year fixed rate mortgages, for example, allow

consumers to shift to others the risk of varying daily spot rates for borrowing (whose

mean is lower but accompanied by higher variance) in return for higher mean and no

variance (fixed) prices.

       But as I already have stated, we don't observe a robust market in petroleum in

which entrepreneurs use sophisticated hedging tools to link ordinary retail customers with

long-term futures contracts. Instead what we see are proposals for European-style taxes
on gasoline consumption or mandates or subsidies to use alternative energy sources or to

have excess production capacity.

       Unlike contractual solutions, governmental solutions have the dubious distinction

of being more expensive not just most of the time but all of the time. That is the

"alternatives" to fossil fuels are more expensive than conventional fossil fuels even when

the latter prices are at peak, which is, of course, why such solutions do not arise without

the use of coercion by the government. For example, Jerry Taylor and I (2005) have

recently calculated that the SPR has cost the taxpayer between $64.64-79.58 per barrel

(2004 dollars) to fill, which is more than the spot price of oil has ever been except during

1981 and August and September 2005.



The Electricity Example

       One energy industry in which governmental regulation precludes peak prices but

keeps prices higher than necessary much of the rest of the time is electricity (Van Doren

and Taylor 2004). Traditional electricity regulation socializes the cost of excess capacity

rather than imposing its costs on peak users and using scarcity rents as a means of

inducing new investment to handle peak demand efficiently. But restructured electricity

markets also have continued such policies in the form of installed capacity (ICAP)

requirements, which administratively determine excess capacity and socialize its costs.

       States that have restructured have adopted ICAP requirements because of the

events that occurred in San Diego during the California electricity crisis. Retail

electricity prices in San Diego were free of all controls from July 1999 through August

2000 (Bushnell and Mansur 2001, p. 4). But the doubling of rates that occurred during
2000 triggered a consumer rebellion and the reenactment of price controls by the

California legislature.

       The regulation of electricity certainly illustrates how to eliminate energy shocks,

but I doubt that most energy economists would argue it was a model system worthy of

imitation in other energy markets.



Is Regime Stability a Public Good?

       Another characteristic of energy markets viewed differently by economists and

most foreign policy scholars is regime instability. Leon Fuerth writes in chapter 17, "The

most serious foreseeable threat to national security related to oil and gas is not the

physical availability of these resources but the political stability of the regions of the

world where they are located" (413). The editors write in the introduction, "The danger

of an oil disruption is high and increasing, as the world grows more dependent on

unstable states both inside and outside OPEC for the security of its energy supply" (4).

"Energy security is a public good, and the U.S. government has failed to adopt

regulations or incentives to create adequate capacity, backup, or standby infrastructure.

Without compensation and requirements for action, private industry has little incentive to

fill the void" (4). "To assure its national defense, let alone to power its multi-trillion-

dollar economy, America needs to promote the stability of oil and gas producers around

the world and that requires a policy of global engagement" (11).

       A different and more economically informed perspective comes from J. Robinson

West in chapter 8, "Today, oil exporters have much more reason to worry about the

security of their markets than importers have reason to worry about the security of their
supplies" (205). Those with the most to lose from disruptions regardless of their cause

are the state owned oil companies because their revenue sources are not diversified (to

borrow a term from finance).

        This understanding undermines the claim that regime stability is a public good.

The Saudi Arabian government has tremendous incentive to eliminate natural and man-

made disruptions to its oil output because it has no other source of revenue. Saudi Arabia

and no one else gets the revenues from its production. Until the point of diminishing

returns, its efforts to increase the security of its supply are an efficiently supplied private

good.



The Problem of "Rents to Bad Guys"

        Geo-strategic thinking about oil markets is not entirely without merit. The

owners of natural resource rents can become rich, and if the nation-state owners more

resemble characters from Goodfellas than traditional nation states, they can certainly

cause trouble for their neighbors. Everything else being equal we would rather that the

nation-state sellers of oil resemble Norway. Iraq, of course, is not like Norway. But

when it tried to rearrange the ownership of natural resources through force (invading

Kuwait), Iraq's neighbors paid the U.S. to restore the status quo in Gulf War I.1

        But oil rents are neither necessary nor sufficient for Middle East violence. Wars

happened before the increase in oil prices (1973-1982) and Sadam's aggression in Kuwait

occurred well after the collapse of prices in 1985. Was he aggressive toward his

neighbors because of insufficient rather than excess revenue?
Rents to Good Guys Cause Struggle Too

         Even if the role of oil rents in creating violence is overemphasized, the

distribution and appropriate uses of oil rents certainly create political struggle. Much

elite jockeying occurs over the ownership of natural resources or transportation pipelines

that generate rents because if one can obtain ownership of either of them politically rather

than having to pay market prices, then one can get rich and those riches can be used to

alter political competition. For example, the struggle between Russian President Putin

and Yukos CEO Mikhail Khodorkovsky is, in part, a struggle over the ownership of

natural resource and pipeline rents, but, more importantly, a struggle over whether those

rents could be used to create political rivalry, with Putin's answer being a definitive no.

         While many may think that such struggles are limited to the developing world,

our own petroleum history has analogous struggles. For example, The Governor of

Texas used the National Guard to enforce orders of the Texas Railroad Commission over

proper production levels during the early days (1931-33) of the East Texas oilfield.

         The net effect of the political struggle over rents on the timing of oil production is

unclear. The Russian and Texas cases certainly suggest that is reduces production, but

M. A. Adelman (1995, p. 33) famously argues that the net effect of state ownership is to

reduce time horizons relative to private owners and thus increase production rates.




1
 Saudi Arabia and Kuwait paid approximately $33 billion (55 percent) toward the total cost of Desert Storm
and Desert Shield, which was $60 billion. The U.S. share was only $6 billion (10 percent). Defense
Department Press release 125-M May 5, 1992.
Many Chapters Reflect Economics

       Many of the chapters in the book are more neutral in tone, have an economic

rather than political mode of analysis, and provide much factual information to the

reader. I discuss three examples. Chapter 1, "World Energy Futures," by Adam E.

Sieminiski provides a useful EIA-Energy-Outlook-like survey of likely future aggregate

fuel use trends.

       Chapter 3, "OPEC in Confrontation with Globalization," by Edward L. Morse and

Amy Myers Jaffe remind the reader about the origins of OPEC. In 1959 the U.S.

imposed mandatory restrictions on imports. The restrictions reduced the demand for

OPEC oil, which, in turn, lowered its price and the royalty income of the producing

countries. They responded by forming OPEC. If the U.S. had not restricted trade

unwisely against the low-cost imports petroleum political economic history might have

been different. Morse and Myers also point out that OPEC is a counterexample to the

general trends in the world economy of less state involvement in the economy.

       Chapter 22, "Can a `Global' Natural Gas Market Be Achieved?," by Donald A.

Juckett and Michelle Michot Foss describes the contradiction in U.S. policy between the

drastically increased use of natural gas in electricity production and the constraints on

U.S. production outside the Gulf of Mexico and LNG imports. Section 311 of The

Energy Policy Act of 2005 gives FERC siting and permit-approval authority for LNG

terminals and reduces the ability of local governments to resist their construction and

expansion. As long as court suits do not challenge the FERC approval process, LNG

imports will increase rapidly, and the current discrepancy between the U.S. and world

natural gas prices will narrow.
Conclusion

       Energy & Security consists of two entirely different books. The first is

unfortunately representative of an entire foreign policy cottage industry that obsesses

about the need for nations and their diplomats to worry about and attempt to manage

petroleum markets. Economists play little role in this scholarship and it shows. The

second, consisting of many of the substantive chapters within the book, is informed by

economics and contains information and arguments that undermine the premises of the

other parts of the book. If economists played a larger role in informing foreign policy

discussion there would be less obsession with and better operation of energy markets,

many foreign policy analysts out of work, and much less jet fuel used.



References

Adelman, M. A. (1995). The Genie out of the Bottle: World Oil since 1970. Cambridge
MA: The MIT Press.

Brooks, David. (2005). "In Her Own Words." New York Times October 13, 2005.

Bushnell, James and Erin Mansur. (2001). "The Impact of Retail Rate Deregulation on
Electricity Consumption in San Diego." Program on Workable Energy Regulation
Working Paper no. PWP-082. www.ucei.berkeley.edu/PDF/pwp082.pdf. April 2001.

Taylor, Jerry and Peter Van Doren. "The Case Against the Strategic Petroleum Reserve."
Cato Institute Policy Analysis 555. November 21, 2005.

Van Doren, Peter and Jerry Taylor. "Rethinking Electricity Restructuring." Cato
Institute Policy Analysis 530. November 30, 2004.