Challenging the myths of energy security

Financial Times, 11 January, 2008

On both sides of the Atlantic, foreign policy analysts have convinced politicians that the west faces a severe energy security challenge. The 1970s myth of energy independence is back. We hear the same “moral equivalent of war” speeches and see the same subsidies to well-connected industries to save the west from “energy superpowers” and oil-funded “Islamofascists”.

Those who do not advocate energy independence promote a strategic approach to energy security. The west, they say, should stop being naive about markets. Exporters are renationalising the energy industries and placing their energy assets at the heart of their foreign policy. Large new importers secure supply through government-to-government deals. Energy policy has become high politics and energy security is hard security. The appropriate institution to deal with these concerns is no longer the International Energy Agency (IEA) but Nato.

It is time to challenge this vision. The global oil market is not falling apart. Despite the move towards greater government control, oil is still traded in a globally integrated, highly liquid market. Accessing this market requires no diplomatic or military capacity. The world economy does face a mid-term risk of liquid fuel scarcity and a short-term risk of oil supply disruption, but there is nothing we are ill-equipped to deal with. The answer to the first is higher taxes on oil, tougher fuel-economy standards and increased spending on alternative technologies. As for the higher risk of supply disruption, a new wave of investment is needed in emergency storage, a move the US has already embarked on.

When the risks go up it makes sense to buy more insurance. It is also important to go from a regime based on the Organisation of Economic Co-operation and Development to one that includes the fast-growing energy economies of China and India. Whether that means bringing these countries into the OECD or taking the IEA out of the Paris-based organisation is for governments to decide, but the goal is clear.

Above all, both risks require that we let the markets work. One of the key lessons of the 1970s is that free markets are the consumers’ first line of defence. Freedom to import and the absence of price regulation protected the US from physical disruption during the Venezuelan strike of 2002 and after the 2005 hurricanes. Import and price regulations are the only cause of the chronic oil shortages in China. As Beijing is learning, oil supply security is too serious not to be left to the market.

Similarly, higher prices are not an energy security problem but a solution. Since the first oil shock, the energy intensity of the US gross domestic product (the amount of oil used per a unit of wealth created) has declined by almost 60 per cent. The rate of decline had sharply slowed down when prices collapsed but since 2005 it bounced back to twice the 10-year average. US oil imports have not increased in almost three years.

The case for strategic energy security policies is not much stronger for natural gas. True, reserves are concentrated and gas exporters might organise themselves to extract monopoly rents. This is no threat to security of supply, which is determined by the ability of the gas economy to cope with supply disruptions. There is a good case that the structural dynamics of natural gas markets provide consumers with an increasing degree of supply security. Contracts become more flexible, gas-to-gas competition increases, once isolated regional markets are linked through arbitrage opportunities exploited by traders. Accordingly, bilateral relations become less relevant and the potential for spontaneous reallocation of flows across markets increases.

The single biggest contribution to international gas supply security would be for the European Union to create a competitive, integrated gas market. It would also diminish Russia’s ability to leverage the bilateral gas relationships, increasing the chance for Europe to speak with one voice to Moscow.

The dreams about energy independence lead to expensive policies with no real energy security benefits. The nightmares about “energy wars” reinforce prejudices in China and India about the need for aggressive foreign energy policies – a process that looks like a vicious circle. Energy security risks have probably gone up but have not changed in nature. More money is needed to buy collective insurance. But energy independence is nonsense and a Nato for energy is dangerous nonsense.