Energy Geopolitics in 2017A U.S. Posture Emerging from VulnerabilityG R E A T D E C I S I O N S

F E B R U A R Y 2 8 , 2 0 1 7

S T E P H E N V . A R B O G A S T , D I R E C T O R

K E N A N - F L A G L E R E N E R G Y C E N T E R

Discussion TopicsEnergy Geopolitics – What are the Issues?

Where are We Today?

What Dynamics will Shape these Issues Going Forward?

The Position of the United States Today

The Geopolitical Environmental Agenda & Climate Change

Where to Go From Here – Action Plans

Energy GeopoliticsDefinition & IssuesEnergy Geopolitics: The policies and interaction of nation states focused on their development, sale & acquisition of essential Energy supplies.

◦ Focused on behavior of nation states

◦ Concerned with vital role of energy in national economic life & security

This becomes clearer when we list the issues:◦ Physical shortage, due to supply interruption or boycott

◦ Political blackmail, under the threat of interrupted supply

◦ Price spikes, due to tight market conditions or supply curtailment

◦ Economic development, fostering wealth creation & jobs

◦ Environmental consequences, including Climate change

For decades, economic development was THE issue; after 1973 OPEC revolution, 1st three emerged, followed shortly by environment/climate

Today’s Questions

How should we understand the relative importance of these varied issues now and their interconnectedness?

What kind of Geopolitical policy agenda emerges for the U.S. from this understanding?

Where are We Today?

Threat of Physical shortage has receded, though not gone

Political intimidation a threat in Europe; longer term a threat for Asia

Price spikes a recent experience, but hope for moderation going forward

Economic development agenda has major issues, including conflict with environmental/climate policies and Natural Resource curse

Options for addressing these issues the best in Decades

Some History Required to Make Sense of these Outlooks

How did We Get Here?

◦ The Key is ‘Spare Capacity’ in the Global Oil Supply

◦ Prior to 1970, the U.S. provided spare capacity, and oil boycotts failed

◦ Starting 1970, U.S. spare capacity disappeared, setting stage for October 1973 OPEC boycott and price spike◦ Also set the stage for nationalization & politicization of oil supply from Persian Gulf, Venezuela

◦ Creating an energy price world driven by oil prices, looking like this:

Oil Price Cycles – A HistorySource: Prof. Chris Ross PG Oil supply disruptions

Leading to These Rules of Thumb:◦ When global oil supply spare capacity becomes:

1. All concentrated in the Persian Gulf, and

2. Falls to 2 MBD or less

Persian Gulf producers acquire acute pricing power and boycott potential◦ This includes Iran and Iraq

◦ Even if U.S. supply not physically curtailed, its economy is hostage via price

◦ The U.S. has both global responsibility and a supreme national interest in protecting security of supply from Persian Gulf ◦ This means protecting stability of Saudi Arabia

◦ Hence wars in 1991, 2001-TODAY!

How We Got to $145/B Oil in 2008Saudi Spare Capacity & Oil Prices: 2000 - 2007

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2000 2001 2002 2003 2004 2005 2006 2007Production Spare Capacity Total Capacity Price

U.S. Foreign Policy has Quietly been Hostage to Saudi Arabia

◦ Despite periodic Saudi economic aggression vs. U.S. interests and quiet support of terrorism, U.S. has steadfastly supported House of Saud

◦ Fear as much fragility of Kingdom as what Saudis might do intentionally◦ The Nightmares: civil war/insurrection destroys oil fields and/or

◦ Kingdom falls to Radical or Shia Islam

◦ U.S. responses: (so far, enough w/Saud adroitness)◦ Military alliance, proven in response to Iraqi invasion, U.S. Fleet in PG

◦ Constant arms sales and training of Saudi defense forces

◦ ‘Look the other Way’ on House of Saud ‘deal’ with Wahhabi radicals

◦ ‘Two State’ solution and financial support for Palestinians

Summarizing U.S. Foreign Policy and Energy Vulnerability: The Status Quo

◦ Still exposed to physical supply disruption/boycott, though less so

◦ Hostage via alliances to Europe/Japan on supply security

◦ Economically exposed to supply curtailments global price effects

◦ Committed to security of Persian Gulf supply routes, stability of Saudi Kingdom due to U.S. exposures & inability/unwillingness of others to act◦ Europe, Japan, China, India have greater exposure but act as ‘Free Riders’

And, One More ThingSupply Side Despair

◦ OPEC’s power rested on reality that high prices don’t unleash new supply◦ Price hikes are immediate but has taken 5-7 years for new supplies to come forth

◦ Why: Arctic, Offshore, Tar Sands all take time, huge capital to unlock

◦ A sense of this despair, vulnerability was captured in 1979 Exxon Annual Report

◦ The balance between world energy demand and available supplies will be precarious. The risk of periodic shortfalls in supplies is likely to be greater than the prospect for surpluses

since the governments of oil exporting countries may not supply all of the oil which industrial countries want, even at ever higher prices…

◦ the nation needs to accept the fact that…a world securely based on a flow of energy from renewable sources still remains a distant prospect…the nation must aggressively develop the

indigenous sources that can be available in the meantime…◦ Unless this happens, succeeding generations face the prospect of a real decline in economic

well-being and a further loss of independence in international affairs for which they can rightly hold our generation responsible.”

This has been the ‘Energy Shadow’ over U.S. Foreign Policy for 4 decadesBut, it May be Changing!

EIA’s Outlook: OECD Continues to Live With this Vulnerability –

Will that Mean Status Quo re: M.E. & Saudi policy? Let’s See

Global Petroleum Consumption/Production: EIA’17 Outlook

MB/D 2016 2020 2040

Consumption

U.S. 19.6 20.1 19.3

Rest: OECD 26.7 26.4 27.2

Other 48.8 54.2 74.5

Total 95.1 100.8 121.0

Production

U.S. 14.6 17.0 17.5

Russia 10.7 10.6 12.2

Other 32.4 33.9 39.9

OPEC 37.3 39.2 51.4

Total* 95.0 100.7 121.0

NOTES: U.S. Consumption vs. Production & ‘Call on OPEC’

* Consumption/Production may not balance due to inventory effects & rounding

The Good News: New Supply Side Dynamics are reshaping this World

◦ Hydraulic Fracking has unlocked vast new oil & gas resources @ <$100/b◦ New Natural Gas especially important strategically

◦ LNG is creating global gas market and options to move on from coal/oil

◦ Wind & Solar costs have come down to where they can displace much coal inside power generation & help make EVs feasible clean transportation

How much will these Help?

Let’s Examine Today’s Energy Vulnerabilities

Who’s Vulnerable Today…and into the Future?◦ Supply Interruption/Physical Boycott:

◦ China & India are huge importers of PG oil…China @ ~ 9 MB/D and Growing!

◦ Europe & Japan remain dependent on PG for oil imports, Russia for oil & natural gas

◦ Fracking supply moving U.S. towards balanced, only imports from Canada/Mexico

◦ Price vulnerability remains global, key U.S. exposure

◦ However, fracking, LNG & renewables change price dynamics for better

How much Difference have they Made?

Let’s measure the vulnerabilities & Supply Side progress

Oil Import VulnerabilitySource: EIA 2017 Annual Energy Outlook

Net Importers Exposure: MB/D

2016 2025 2040

CHINA cons. – prod. 6.9 8.4 10.2

EUROPE 10.4 10.3 11.3

JAPAN 3.9 3.5 3.2

INDIA 4.0 5.0 8.0*

United States 5.3 2.4 2.2

‘Call’ on M.E. OPEC 27.8 30.8 39.0

Natural Gas from RussiaEurope’s Other Vulnerability

Individual European CountriesVulnerability to Russian Gas Supply

So, How Much Difference do Fracking, LNG & Renewables Make? Let’s See for the U.S.

Net Oil Importers Exposure: MB/D

2016 2025 2040

United States 5.3 2.4 2.2

N.A. Net Exporters: MB/D

Canada 2.9 3.0 3.5

Mexico 0.8 0.7 0.8

Net N. America Imports 1.5 (1.3) (2.1)

What is Unconventional Development’sContribution Here?

MB/D U.S. Oil & NGLs

YEAR 2016 2025 2040

TOTAL U.S. 12.3 15.2 15.1

‘TIGHT OIL’ 4.6 6.2 6.3

NGLs 3.1 4.3 4.2

% Total 63 69 70

Source: EIA 2017 AEO

What About Natural Gas & Renewables?Self-sufficiency, LNG Exports, Lower Carbon ETCF U.S. DRY GAS

YEAR 2016 2025 2040

TOTAL U.S. 26.5 36.1 37.7

‘TIGHT GAS’ 4.7 4.8 5.8

SHALE PLAYS 14.1 20.8 25.3

% Total 71 71 82

Net Gas Exports QBTU (1.0) 4.7 5.8

Renewables BKWH 559 938 1139

% Total 14 23 26

Source: EIA 2017 AEO

These Developments Significantly changethe Position of the U.S. Going Forward

◦ North American oil self-sufficiency can be a reality – no need for imports from OPEC ME or even Africa

◦ North America a significant LNG exporter, with upside potential◦ Reserve supply source for Europe and/or Asia – with Alberta a ‘Reserve Gas Bank’

◦ Options to expand LNG/CNG-based transportation

◦ U.S. has best set of low-carbon, renewable options in either high carbon tax or disruptive technology world◦ Best wind/solar resources, grid, + nuclear & hydro

◦ Leading EV industry

Interestingly, this Changes the U.S. Bargaining Position with Allies & Rivals

◦ Over next 2 decades, vulnerability of Europe, Japan, China/India increases while that of U.S. should decrease

◦ THE BIG CHANGE – North American oil self-sufficiency gives U.S. the option to seal itself off from OPEC supply disruptions, INCLUDING PRICE!◦ In supply curtailment, U.S. prohibits exports outside of North America

◦ Canadian supply channeled into U.S. via pipelines

◦ USG buys Mexican production for redistribution, at world price if necessary

◦ Temporary U.S. price controls until disruption normalizes, with Mexican premium ‘socialized’ via small emergency excise tax

◦ Opening up the question, should U.S. still carry sole burden of PG security?

Injecting More Fluidity into U.S. Foreign Policy on Energy, Middle East

◦ Opportunity for Cooperative approach on burden sharing in PG◦ Initially, NATO + Japan based

◦ Eventual opportunity for China to join

◦ Backed by U.S. willingness to share ‘pain’ in supply curtailment

◦ Europe/Japan join regional military alliance with Saudis vs. ISIS◦ Intent re: Iran determined via observance of nuclear accord terms

◦ THE LEVERAGE – Alternative is U.S. ‘go it alone’ in N. America option◦ Prepared: Contingency plans for administering

Realizing this Potential involves Frac’ingso Getting Environmental Practices Right is Key

◦ U.S. Frac’ing growth is ‘Baked In’ to EIA’s Outlook – contributing 70% of oil production by 2025 and +12 TCF of Natural Gas◦ Allowing 6 QBTUs of LNG exports to Europe & Asia

◦ Such growth can only be accomplished with Acceptable Environmental practices that sustain Political & Community support

◦ After 7+ years of practice, the issues & solutions are established:1. Recycle water in dry areas and earthquake prone zones

2. Lock down fugitive methane emissions – no venting, tighten pipeline operations

3. Funding proper well abandonment & area restoration

◦ These measures are not that costly, and can be accommodated @ $70/b oil

Realizing this Potential – 5 Rules & Policies for Harvesting Benefits of Stronger U.S. Position

◦ It shall be a U.S. Foreign Policy objective to maintain > 3 MB/D of spare capacity among the Persian Gulf oil producing states

◦ Adopt Regulatory frameworks/enforcement to assure frac’ing & associated infrastructure are environmentally safe but otherwise not disrupted

◦ It shall also be U.S. Foreign policy to do the following:◦ Continue integration of North American energy production via interconnecting pipelines

◦ Encourage LNG exports to allied nations currently dependent on Russian or ME Gas

◦ Promote a ‘Burden Sharing’ approach to PG security issues, tied to continued emergency supply sharing understandings

◦ Adopt a Carbon Tax that enables nuclear power to survive/grow alongside cheap natural gas w/o ‘reenergizing’ coal in power generation

The Potential Outcome, and How it Could Be Different from Recent Decades

◦ The Potential Outcome for U.S. and Allies:◦ Moderate, Stable Oil Prices – because OPEC always has significant spare capacity

◦ Supply disruption minimized by OPEC spare, broad alliance guarding PG, consumer supply sharing arrangements, and frac’ing’s ability to ‘surge capacity’

◦ Russia’s threat to Europe diminished by absence of higher oil revenues, Europe’s access to LNG

◦ Saudi Arabia bolstered vs. external threats while incentivized to continue modernization under moderate, stable oil prices

◦ Continued transition to lower carbon economies via Natural Gas, LNG, Renewables

◦ Differences from Past:◦ U.S. no longer exposed to global oil price spikes

◦ U.S. no long hostage to Allies’ supply vulnerability

◦ U.S. no longer sole bearer of security responsibilities in PG

IT COULD BE SO

QUESTIONS?