Energy Security: New Dimensions and Key Principles

1. NS4054 Fall Term 2015Daniel Yergin – Energy Security II

2. Overview • Daniel Yergin, Energy Security and Markets, in Jan Kalicki and David Goldwyn, Energy and Security, 2013. • Extends earlier piece – showing how dynamic the idea of energy security can be – need to keep revising our idea of energy security as conditions and technologies change • Argues the dependence on energy systems and growing complexity underline need to understand the risks and requirements of energy security • Addresses two questions: • What are the new dimensions of energy security? • What are the key principles of energy security

3. Broader Approach I • At time of first essay many thought that “peak oil” was the main threat to energy security • Feels major risk to energy supplies over next decade or two is not geology but geopolitics • Arab Spring added a fear premium to price of oil • Rising tensions over Iran nuclear program – sanctions and Iranian threat to close Straits of Hormuz • Iraq could be major world producer, but great uncertainty about its future • Jihadism and global terrorism threaten the entire supply system • Conflicts and political instability in Nigeria and Venezuela • Resource potential in South China Sea, though unproven will remain undeveloped due to tension

4. Broader Approach II • Standard definition of energy security centers on availability of sufficient supplies at affordable prices. • First, leads to physical security – protecting assets, infrastructure, supply chains, and trade routes • Like Strait of Hormuz, pipelines and transmission lines also chokepoints • Planning requires not only strategic petroleum reserves, but also generators that can be quickly deployed when power system crippled • Second, access to energy is critical • Access to energy means ability to develop and acquire energy supplies physically, contractually and commercially • Barriers and restrictions to energy trade not only impede energy flows – also make adjustment to disruptions more difficult • Good example might be ban on U.S. crude oil exports

5. Broader Approach III • Third, energy is a system • Involves national policies, and international institutions designed to respond in a coordinated way to disruptions, dislocations and emergencies. • For this reason International Energy Agency (IEA) set up after first oil crisis in 1973-74. Do we need to expand the IEA to deal with complexity that has happened since then? • Fourth energy security requires favorable investment climate • Energy development can take a long time and thus requires a consistent flow of investment as well as fiscal and regulatory regimes that allow those funds to flow. • Same can be said on long-term funding of research and development required for future investment

6. Broader Approach IV • “Energy Security” means different things for different countries: • Developed world – availability of sufficient supplies at affordable prices • Energy exporting countries – security of demand for exports • For Russia, aim is to reassert state control over strategic resources and gain primacy over main pipelines to international markets • For China and India – their ability to rapidly adjust to their new dependence on global markets after long standing commitments to self sufficiency • For Japan – how to manage dependence on imported natural gas -- • For many countries – whether to build new nuclear plants and perhaps return to clean coal • For Canada -- access to U.S. and Chinese markets

7. Principles of Energy Security I • Develops 10 principles of energy security: • Principle 1: The importance of Diversification • Diversification of supply starting point for energy security • Widening the sources of supply lessons impact of any particular disruption and provides alternative supplies • Principle of diversification extends to energy transportation and infrastructure • Also serves interests of suppliers by creating a more stabile market for their exports. Stable prices reduce investment risk. • Principle 2: The Position of the United States in the Global Oil Market • Policymakers need to recognize that there is only oil market • U.S. security resides in the stability of this global market • Being “independent” of global market makes little sense

8. Principles of Energy Security II • Principle 3: The Need for a Security Margin • Security margin is the availability of the extra supply that can replace supplies that have been displaced • This margin takes two forms: • One is spare capacity—extra capacity above normal output levels that can be put into production quickly • A critical component of spare capacity is the 1.5 million to 2 million barrels per day Saudi Arabia traditionally maintained at some cost. • Has been used when Iraq’s output disrupted during 2003, Libyan production disrupted in 2012, and when sanctions reduced Iranian exports.

9. Principles of Energy Security III • The other is emergency stocks such as the US Strategic Petroleum Reserve (SPR) of around 700 million barrels and similar ones in other countries • Has been political temptation to use SPR as a market management scheme to deal with price fluctuations • Bad idea. Prices give signals and convey information needed for investment • Principle 4: The Role of Well Functioning Energy Markets • Large, flexible and well-functioning energy markets contribute to security by absorbing shocks and allowing supply and demand to respond more quickly than a controlled system • Markets can often more efficiency and effectively – and far more quickly – resolve shortfalls and disruptions than more centralized direction

10. Principles of Energy Security IV • Oil market today much more flexible than it was in earlier decades • Intervention and controls can be highly counter productive – can make situation much worse • Hindering the system from swiftly shifting supplies around to adjust to changes in market or disruption in supply • Resisting temptation to micromanagement markets in face of political pressures essential • Gas lines in 1973 and 1970 largely result of price controls and cumbersome allocation system that prevented suppliers from moving gasoline from places where it was not needed to where it was

11. Principles of Energy Security V • Charges of “gouging” often come up in disruptions • What may not be understood is that by focusing on gouging rather than resupplying, authorizes may be hindering recovery • Threat of punishment can act as a disincentive to people applying ingenuity to get supplies to market as fast as possible • Can lead to outcomes with much higher economic and social cost: people sitting in a gasoline line for hours

12. Principles of Energy Security VI • Principle 5: The Importance of Building Relationships with Exporting Nations • Since 1980s, most oil exporting nations – though not all – have come to recognize the mutuality of interest between themselves and the importing nations • While consumers need supplies at reasonable pries, producers need assured markets • In produces’ interest to be seen as credible suppliers on whom buyers can count • Most exporters deeply interested in security of demand – stable commercial relations with their customers • Mutual interdependence helps create framework for a continuing dialogue and cooperation between producers and consumers

13. Principles of Energy Security VII • Principle 6: Need to Ensure Cooperative Relations Among Importing Nations • IEA is critical in this regard. It helps • Promote cooperation • Coordinate energy policies • Test contingencies • Develops common frameworks and • Provides mechanisms for responding to energy emergencies • In aftermath of Gulf Crisis, 1990-91 began a dialogue with OPEC – evolved into the International Energy Forum • Members comprise 90% of world’s production and consumption of natural gas • Forum charged with greater transparency on energy production, demand and inventories • Helps markets operate on basis of better information

14. Principles of Energy Security VIII • Principle 7: The Importance of High Quality Information • Better information needed to prevent panic buying during times of perceived shortages • Conspiracy theories, gouging claims can take over and obscure the real issues • Psychology can be calmed and panic avoided with the flow of high quality information • Need to exchange information within the industry that makes possible more rapid adjustment to market disruptions • In U.S. ability to respond to energy crisis been hindered by anti-trust laws preventing producers to share market data and information • Should have automatic anti-trust waver in times of crisis

15. Principles of Energy Security IX • Principle 8: The Importance of a Robust Domestic Industry • Healthy, technologically driven domestic energy industry important element in energy security • Industry needs to operate under reasonable and predictable rules with timely decision-making by the government • Keystone pipeline example of failure in this regard • As will see trilemma complicates government decision making in this regard

16. Principles of Energy Security X • Principle 9: The Role of R&D • Commitment to R&D and innovation across a broad spectrum is fundamental to energy security • No one can be sure of the mix of energy sources over the next several decades • Commitment by federal government is critical in this regard • Need to get away from results based criteria for R&D – stifles major break-throughs

17. Principles of Energy Security XI • Principle 10: The Importance of Planning for Disruptions • Mindset should be to plan for disruptions and assume they will occur • Need to conduct drills as to how to respond • Superstorm Sandy example what can go wrong • Confusion generated and days lost simlybecaue of the lack of names and phone numbers of whom to call • Some elaborations on these principles --

18. Extensions I • Energy A Hinge of World Economy • Now energy system has become a terrorist target • Not just physical infrastructure, but must protect against cyber attacks • Attack on Aramco example • August 15, 2012 Virus launched into company’s computers • Wiped clean then burned hard drives of more than 30,000 computers • Might have disrupted 10% of world oil output • Aramco computers for production run on isolated systems • Two month later another attack against Qatar’s natural gas industry

19. Extensions II • In the 1960s and 1970s computers were deployed to manage the generation and distribution of electricity and to integrate the grid • Since then system become more sophisticated and integrated and “smarter” • Makes system much more efficient, but also more vulnerable • DoD has created a Cyber Command • Developing a new doctrine in which a major attack on critical infrastructure, including energy would constitute an actof war • Efforts need to be matched by companies • Currently industry may not be getting the intelligence information it needs • Problem: security architectures have to be introduced into systems that were designed without such security in mind

20. Extensions III • A new approach is emerging to deal with this wide range of threats to the energy sector • Called resilience • Idea is to reduce the magnitude and or duration of events. • For electric power has four elements • Robustness: the ability to absorb shocks and keep operating • Resourcefulness: the ability to skillfully manage a crisis as it unfolds • Rapid recovery: the ability to get services back as quickly as possible • Adaptability: the ability to incorporate lessons learned from past events to improve resilience

21. Extensions IV • Currently a gap exists between traditional safety costs that the private sector internalizes and • Preparation for terrorist strikes that are international and focused • Problem – security is not free • Building a higher degree of security into the energy infrastructure has a continuing cost • That cost ultimately will need to be focused both into the cost of homeland security that a nation bares and into the price of energy in the marketplace • That is a requirement for enhanced energy security that US requires in this new era.