The Foreign Service Journal, December 2003

decades. Oil prices have experi- enced record swings, and there are severe strains at critical links in the energy supply chain, especially in the United States. An oil workers’ strike in Venezuela in late 2002 contributed to rising oil prices, and in March 2003, after the U.S. and its allies began military action in Iraq, oil prices hit $37 a barrel. Meanwhile, acute shortages are evident in the United States’ elec- tric power generation and trans- mission capacities, and natural gas production has not been adequate to meet growing domestic needs, result- ing in rising prices and a need for increased imports. American refineries are struggling to produce adequate amounts of cleaner fuels that are increasingly in demand to meet clean air requirements. And, perhaps most important, the political future of the Middle East remains highly uncertain. The U.S. energy dilemma is not a new one, nor did it emerge overnight. As a Council on Foreign Relations- Baker Institute study, “Strategic Energy Policy: Challenges for the 21st Century,” stated, the U.S. has not had a comprehensive, integrated strategic energy policy for decades. As a result, today’s situation arose by stealth, as years of rapid economic growth crashed into the phys- ical supply barricades erected by decades of under- investment in energy infrastructure. Ultimately, both for energy resources generally and petroleum supplies in particular, resource levels are not the major problem: the problem is one of developing those resources and getting them to the consumer in a timely fashion. In the shorter term, the challenge is to promote market stability. The Oil Market Has Changed At the time of the 1985 oil price collapse, OPEC was estimated to be carrying 15 million barrels per day of unutilized shut-in production capacity, the equivalent of one quarter of global demand. That meant that any supply dis- ruption — from an explosion on the Colombia oil pipeline to a strike in Nigeria — could be eas- ily mitigated with an immediate increase in production from any number of potentially consumer- friendly OPEC countries. When Iraq invaded Kuwait in 1990, OPEC still had a spare capacity of approximately 5.5 million b/d, representing 8 per- cent of world oil demand — enough to replace the oil from the two warring producers. Indeed, OPEC met hastily and agreed to raise its output to maximum levels, immediately calming oil markets. Within three months of the Persian Gulf crisis, rising oil production from Saudi Arabia, the United Arab Emirates, Nigeria and Venezuela put markets back on an even keel, obviating the need for consuming countries to tap strategic oil stockpiles in any major way. But by the year 2000, OPEC’s spare capacity was a negligible 2 percent of global demand, almost all of it in Saudi Arabia. Falling levels of spare oil production capacity and ris- ing tensions in the Middle East have left the door open for oil supply disruptions that could have a potentially larger impact on the U.S. and world economy than in past crises such as the Persian Gulf War. World oil markets remain extremely vulnerable to short-term disruptions and, as a result, oil prices are very sensitive to changes in OPEC production policies. At its Sept. 24 meeting, OPEC leaders announced plans to reduce oil output limits from 10 key producers by 900,000 barrels a day, or by about 4 percent, as of Nov. 1. The decision, intended by OPEC to prevent weakening oil prices due to emerging competition from other oil producers like Russia, Angola and Chad, caused oil prices to jump up by $1.11, to $28.24 a barrel on the New York Mercantile Exchange. Analysts predict that the cuts may stave off, at least for now, possible price declines in 2004. U.S. Demand Drives Markets The days of working off and managing surplus capacities are gone. Today’s energy era is concerned with generating capital to develop adequate resources 24 F O R E I G N S E R V I C E J O U R N A L / D E C E M B E R 2 0 0 3 F O C U S Amy Myers Jaffe is the Wallace Wilson Fellow for Energy Studies at the James A. Baker III Institute for Public Policy and the associate director of the Rice Energy Program. Jillene Connors is a research associ- ate at the Baker Institute Energy Forum. Despite talk of an expanding, energy-hungry Chinese economy, it is the incredible surge in U.S. oil imports that is the most significant factor in the oil market today.