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Wednesday marks the 40th anniversary of the Arab oil embargo, a turning point for US energy security policy.
The embargo was imposed by the Organization of Arab Petroleum Exporting Countries after the Yom Kippur war. Oapec banned oil exports to Israel’s supporters – the US and the Netherlands – tightening the oil markets to lead to a 400 per cent price rise. It used the promise of oil exports on favourable terms to separate them from Nato partners.
Three key lessons became the core of US energy policy afterwards. First, controls had to be put in place to counter the use of oil as a policy instrument by oil exporters. This led to the creation of the International Energy Agency, a self-support system of the major industrial countries.
Second, the US and its IEA partners built strategic stocks to blunt the politicisation of oil by the exporters while also decreasing the vulnerability of their economies to oil price spikes.
Finally, the IEA countries adopted market mechanisms to provide an alternative world to the beggar-thy-neighbour approach that lay at the core of the Arab boycott and which has characterised Opec politics since.
This is the world that is being eroded rapidly by the energy supply revolution unfolding in the US and that is about to start spreading globally, unless measures are taken by governments to impede its success.
Let us review the basics. The oil market is the largest in volume and value of trade and investment. It was transformed by Opec, whose members in the 1970s nationalised the companies that took entrepreneurial and capital risk to find and develop the resources.
The Opec revolution that followed the embargo set the market’s logic on its head. Before the embargo, lowest-cost production served customers first, and marginal or high-cost producers came to the fore as markets tightened. But the new Opec rules had the world’s lowest-cost producers shut in production so that the high-cost producers could set the price and so that the rents from petroleum output could be expanded.
The producers were also able to manage production levels, keeping oil underground to maintain prices, withholding oil or granting access as political favours. A zero-sum world replaced the win-win world that preceded it. For most of the last half century, the global oil and much of the global natural gas markets were characterised by “I win, you lose”, a situation that from an oil-producing country’s perspective persists today.
There are many critics of those of us who applaud the advent of North American energy independence. They point to two facts. First, energy independence does not bring with it impunity from price spikes accompanying supply disruptions. Second, it does not mean the US can turn its back on the Middle East, given its own stakes in the region, its commitments to various aligned oil-producing countries, the need to secure the openness of sea lanes for economic stability and growth, and because US security is global in an age of terrorism and interdependence.
US energy independence does not ever require that the US becomes a net oil-exporting country. But it does mean that a more secure US and global energy system needs freedom to export and import as the market warrants. That means removing barriers to exporting crude oil that have been in place for decades.
Freedom to buy and sell would lower crude and gasoline prices globally. It would reinforce today’s flood of investments into US oil and gas, as one of the only places on the planet largely secure from government intervention.
In oil and natural gas, in which the US may rival Qatar before the decade ends as a major source, market principles are defanging any power remaining in the hands of producers to use oil and gas as policy instruments. Expect the same from crude exports.
North America’s energy revolution is creating a very different and new supply hub for global markets. Governments are not intervening, but markets are likely to be working their magic. Supply surpluses are emerging and will be very big in natural gas, petroleum and petroleum products. No one is worried about the security of supply of North American-sourced hydrocarbons. No developed market government is concerned about the potential imposition of boycotts or embargoes by the US. No potential customer is concerned about the US government imposing price criteria other than market principles.
Many people argue that, with the coming of energy independence, the US should adopt strong policies to enhance oil as an instrument of policy. But the greatest “weapon” in the US policy arsenal is no weapon at all. It is to let markets work, buttressed by the growth in domestic and regional supply. That’s the ultimate way to put an end to the old oil regime.
Ed Morse is managing director and global head of commodities research at Citi
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