Thursday, July 24, 2014
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The Perilous Fantasy of Energy Independence

The paradox of today’s quest for energy independence is that pursuing it actually increases energy insecurity. However much politicians who call for energy independence might prefer it otherwise, the market has chosen oil as a staple energy source. So governments should ignore neither the valid interests of oil exporters, on whom consumers in their countries depend, nor exporters’ reaction to the rhetoric of energy independence or to steps taken to achieve it. Isolationist politicians may not care about other countries, but they should think twice lest they harm their own.

The biggest threats to the world’s energy security are not terrorist attacks or embargoes by oil-producing countries – short-term events that can be dealt with quickly and effectively through various measures, including reliance on strategic petroleum reserves, increases in production, and diversion of oil shipments. Instead, the main threat to the long-term sustainability of energy supplies is the mismatch between investment in additional capacity and energy infrastructure, on one hand, and growth in demand for energy on the other.

Major oil exporters could respond in a variety of ways to political posturing on energy, most of which would exacerbate rather than ameliorate the global energy situation. One of the most plausible scenarios in response to calls by governments and politicians around the world to reduce or even eliminate dependence on oil is a relative decline in investment in additional production capacity in the oil-producing countries.

An energy crisis in this case is almost certain if those who press for energy independence fail to provide a workable alternative in a timely manner. Of course, these efforts will almost surely fail to replace oil within a reasonable time, as they are not market-driven and require heavy subsidies.

Indeed, confronted by political leaders’ hostile rhetoric, oil producers have a strong incentive to increase production in order to lower oil prices to levels that undermine the economic feasibility of alternative energy sources – a logical interventionist policy to counter the anti-oil interventionist policies of consuming countries. After all, a collapse in oil prices would be a death sentence for several new energy technologies, and, not incidentally, would increase demand for oil.

Even if the oil producing countries do not intentionally bring about an oil price collapse, they might accelerate production as much as they could in the short term, while oil still had some value. But lower oil prices, coupled with expectations of a decline in demand, would in turn put pressure on oil-producing countries to reduce planned investments in production capacity or even to mothball major projects, as they have done in the past, leading to a decline in oil supplies. Thus, if alternative energy technologies did not come on-line by the time oil production started to fall, global shortages would become inevitable, while closing the investment deficit would take years, even in the face of rising oil prices.

In spite of these possibilities, let’s assume that plans for energy independence succeed, and that several European countries, the United States, Japan, China, and India become self-sufficient. Major oil exporters could then seek to use their now less-valuable oil at home as cheap fuel for an expanded heavy industrial sector. Instead of exporting oil directly, they could export their energy embedded in metals, chemicals, and manufactured products at prices that undercut anything producers in the oil-consuming countries, especially Europe and the US, could match, given their dependence on higher-cost alternative energy sources.

Energy independence thus could destroy entire industries, especially petrochemicals, aluminum, and steel. In fact, cheap energy in oil-producing countries might make their new industries competitive with those in China, India, and Southeast Asia. The net result would be a loss of jobs and weakened economies. Countries might end up energy-independent, only to become steel-dependent or petrochemical-dependent.

So what would come next? Would politicians, with their perpetual fascination with “independence,” attempt to eliminate dependence one commodity at a time? Put another way, would the cause of “energy independence” seek to reverse globalization?

Oil is a finite resource. Only long-term, market-oriented, economically viable, and sustainable energy options can ensure economic growth in both producing and consuming countries. Isolationist policies, by contrast, always lead to shortages and discontent. No matter how energy independence is pursued, it will never amount to anything other than an unattainable – and potentially dangerous – fantasy.

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