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Prepared by the
Institute for the Analysis of Global Security

July 12, 2004
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Energy Security Current Issue

China and US should set up a strategic dialogue on energy issues
Interview with Dr. Gal Luft of the Institute for the Analysis of Global Security, originally published by 21st Century Business Herald in Chinese.

A crude threat
The terrorist campaign against Iraq's pipelines demonstrates that pipeline attacks are no longer a tactic but part of a sustained, orchestrated effort that can deliver a significant strategic gain. They can also cause significant damage to the global oil market.
Next in line to emulate the insurgents in Iraq could well be Islamist terrorist groups operating in Central Asia, among them Chechen separatists and the Islamic Party of Liberation, a group that seeks to carry out a holy war against the West and is a suspect in the recent wave of deadly attacks in Uzbekistan.

Chilly response to U.S. plan to deploy forces in the Strait of Malacca
Whether something is profoundly wrong in the dialogue between the U.S. and the two Asian powers is an important question in itself, but the real issue is what is the best mechanism to secure the world's most important shipping corridor, through which one quarter of world trade and half of the world's oil and two thirds of liquefied natural gas move each day.

North Sea oil is declining
Since the 1970s North Sea oil has not only been a major source of wealth for both the British and Norwegian economies but also a way for Europe to cut its dependence on Middle East oil. Now many of the major fields in the North Sea are in decline and the North Sea is about to lose its prominent role as one of the world's leading oil domains.

Terror's Big Prize
Since September 11, pipelines, tankers, refineries and oil terminals have been attacked frequently. Except for a sharp increase in maritime insurance premiums in these regions these attacks had marginal strategic consequences. But in at least two cases oil terrorism could have rattled the world.

Libya: changing its spots?
Libyan crude oil is particularly attractive due to its very low sulphur content, which requires much less refining than higher sulphur oil. It is extremely high quality crude, whose characteristics are not easily found elsewhere. Despite its unique treasure, Libya's production capacity is relatively small, standing on 1.5 mbd of crude, or 2% of world supplies.
Since the 1988 Lockerbie bombing Libya had been under U.S. and UN sanctions which hindered its ability to generate enough investment to develop its oil sector. Libya's decision to embark on a rapprochement with the U.S came at unsurprisingly perfect timing, just as concessions for major U.S. oil companies were about to expire.

On the technology front

Fuel Cell power plant installed at NJ College
The fuel cell will provide 250 kilowatts of electric power as well as heat, to several buildings on the campus.

Biomass-to-Ethanol Progress
The enzyme costs of converting cellulosic biomass into sugars for fuel ethanol production have been reduced approximately twenty-fold with technology developed by the National Renewable Energy Laboratory (NREL) and Denmark based Novozymes, biotech-based leader in enzymes and microorganisms.

EU study: Methanol from biomass - competitive with gasoline
A study of a new patented Swedish technology concluded that the alchohol fuel methanol can be produced from biomass via black liquor gasification at a cost competitive with that of gasoline and diesel.

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Back Issues

Why the SPR should remain intact

With oil prices hovering $40 per barrel, demand rising due to unprecedented consumption in China and India and terrorists threatening oil targets in the Middle East, the oil market today is shakier than ever. Were a major supply disruption to occur, most likely as a result of a catastrophic terror attack on a major oil facility in the Persian Gulf, there would be nothing but the Strategic Petroleum Reserve (SPR) to stop the price of oil from going through the ceiling. Administered by the DOE, the energy security program designed to safeguard the U.S. economy from supply disruptions began collecting oil in 1977 and has the capacity to hold approximately 700 millions barrels. It was created as part of the International Energy Agency (IEA) decision that net oil importing countries are required to hold an emergency reserve equivalent to 90-days of usage.

As of June 2004, the SPR, which has already cost the U.S. $20 billion, held 661 million barrels of oil, about 94 percent of its full capacity. This oil, stored in limestone caves and salt domes in Texas and Louisiana, would cover in case of emergency just about 52 days of oil imports. According to the DOE, oil could be drawn from the SPR at a rate of 4.1 million barrels per day for the first three months, falling progressively after for the next seven months until reaching zero. Alternatively, it could be drawn down at a rate of 1 million barrels per day for a year and a half.

The Energy Policy and Conservation Act (EPCA), which governs the usage of the SPR, allows use of SPR oil for economic reasons. It has provided guidelines for three potential types of drawdown; Full drawdown, Limited drawdown, and Test sale. A full drawdown could be ordered by the president to counter "a severe energy supply interruption." The EPCA clarifies that this an interruption "of an emergency nature," and "of significant scope and duration." A Limited drawdown can be for other circumstances than those above, so long as the situation constitutes "a domestic or international energy supply shortage of significant scope or duration," and a drawdown would significantly assist in preventing or alleviating the impacts of a shortage. A limited drawdown, unlike a full drawdown, also holds the proviso that if there are fewer than 500 million barrels in the reserve, in no case can the drawdown be in excess of 30 million barrels, or for longer than 60 days. Finally a Test sale is just that, a test; that cannot exceed 5 million barrels.

Oil from the SPR has been used for emergency purposes only once, during the Persian Gulf War in 1991.

The IEA has made clear its position that the usage of these emergency stocks is for strategic purposes and "not intended to be deployed as a means to change the commercial terms in a market." But in the U.S, the stocks are at times treated as a tool to reduce petroleum prices when these go too high. In the late 1990s, Former President Clinton gave the order for a limited drawdown in order to alleviate some of the pressure on the economy. Fifteen million barrels were released. Now with gasoline prices in most parts of the nation well over $2 per gallon many argue that if the price of oil is not brought down, the economic recovery will come to a halt, and the U.S, if not the world, will find itself in a recession. Hence they are calling for the Bush administration to ease the market pressure by releasing oil from the SPR. Some like Jay Hakes, who headed the Energy Information Administration during the Clinton administration, think the government can offer some relief to consumers by withdrawing some oil from the SPR when prices are high and replenishing the stockpile when prices decline. Others, like presidential candidate Senator John Kerry, say the U.S should stop adding oil to the reserve while supplies are tight.

But the Bush administration has rejected the idea, saying the impact of suspending shipments to the reserve would be negligible. (The amount of oil going to the reserve has averaged 132,000 barrels a day, equivalent to about 10 minutes of the U.S.' daily appetite for crude.) Furthermore, the administration is concerned about the possibility of major terror attack against oil facilities in the Persian Gulf or even the possibility of seizure of Saudi oil fields by Islamic militants.

Following September 11, President Bush approved filling the reserve to its capacity of 700 million barrels and some members of the administration even propose to expand its capacity to 1 billion barrels. There are other reasons not to draw oil from the SPR at all in order to help the market. As the overall oil demand in China and India increases, it is unlikely that the drawdown of the SPR will bring the price down for long, if at all. In fact, if China and India decide to begin to go in the U.S.' footsteps and fill their own strategic reserves, the strain on the market would offset any benefit caused by a U.S. drawdown.

At times, the government may be forced to sell oil from the SPR at a lower rate, in order to drive the price further down. While this effect is not immediately recognized in the price at the pump, it will be recognized in the nation's deficit. Finally, releasing oil for political purposes would make matters worse by removing the incentive for private companies to carry inventories which could have major ramifications in the future.

Consequently, while the price of oil may be high, and is likely causing strain on the economy, it seems necessary in light of the situation in the Middle East to continue to fill the SPR and bring it to its full capacity. In light of OPEC's announced intent to raise the production ceiling twice over the summer it would be premature to perform a limited drawdown at this point in order to help the market.

At its current capacity, the SPR barely suffices to tide the U.S. economy over in case of a severe disruption of oil supplies. However, were the SPR expanded beyond its current capacity, and were Europe and Asia encouraged to establish similarly large oil banks, the SPR could begin to serve as a liquidity mechanism. While certainly costly in the short term, expanding the U.S., Europe, and Asia's SPR's to one billion barrels of oil each would have the long term benefit of detering OPEC from manipulating supply levels. The primary portion of each of those SPR's would serve as a blood bank to be accessed only in times of emergency, while the secondary reserves held in storage could be released at will to compensate for supply reductions on the part of OPEC. This would send a signal that the oil weapon can no longer be used to coerce oil consuming countries.

Gal Luft and Marcus Koblitz Top