Greenie gave a speech yesterday about oil to the US Chamber of Commerce - and the identical speech to the James Baker Institute for Public Policy at Rice on Tuesday. I'm not sure exactly what he said, but I think he said that our dependence on Saudi oil is over-stated.
>>Remarks by Chairman Alan Greenspan
Energy supply
At the James A. Baker III Institute for Public Policy, Rice University, Houston, Texas
November 13, 2001
Chairman Greenspan presented identical remarks at the meeting of the U.S. Chamber of
Commerce board of directors, Washington, D.C., November 14, 2001
Thank you, Jim, for that kind introduction. As I understand it, the goal of the Baker Institute here
at Rice is to expand the bridge between the world of ideas and the world of action. There are few
who have over the years joined those worlds as successfully as you have.
As economic policymakers understandably focus on the impact of the tragedy of September 11
and the further weakening of the economy that followed those events, it is essential that we do not
lose sight of the policies needed to ensure long-term economic growth. One of the most important
objectives of those policies should be an assured availability of energy. That imperative has, if
anything, been elevated by the heightened tensions in the Middle East--an area that harbors
two-thirds of the world's proven oil reserves. It is one you doubtless know well, since I am told
the Baker Institute is engaged in a series of major research projects on energy supply and security
issues.
This evening I would like first to review our recent experiences with prospective imbalances in
energy supply and demand and the importance of market prices in resolving those imbalances.
Then I plan to focus on the extraordinary role played by technology in augmenting potential energy
supplies, particularly of oil and gas.
Technology alone is unlikely to restore the United States to the position of price leader, which
characterized our role in world oil markets for most of the industry's first century. We,
presumably, will never return as the overwhelmingly dominant world producer.
The position of the United States in price leadership and in the exercise of pricing power in oil
markets dates back to John D. Rockefeller and Standard Oil. Reportedly appalled by the volatility
of crude oil prices in the petroleum industry's early years, he endeavored with some success to
control them. After the breakup of Standard Oil in 1911, pricing power remained with the
American oil companies and later with the Texas Railroad Commission, which raised allowable
output to suppress price spikes and cut output to prevent sharp declines. Indeed, U.S. crude oil
production still accounted for more than half of the world total as late as 1952. However, that
historic role came to an end in 1971, when excess capacity in the United States was finally
absorbed by rising demand.
At that point, the marginal pricing of oil, which for so long had been resident on the Gulf Coast of
Texas, moved to the Persian Gulf. To capitalize on their newly acquired pricing power, many
producing nations in the Middle East nationalized their oil companies. But the full magnitude of
their pricing power became evident only in the aftermath of the oil embargo of 1973. During that
period, posted crude oil prices at Ras Tanura in the Persian Gulf rose to more than $11 per barrel,
significantly above the $1.80 per barrel that prevailed unchanged from 1961 to 1970.
The sharp price rise of the early 1970s engendered an abrupt end to the extraordinary period of
growth in U.S. oil consumption and the increased intensity of its use that was so evident in the
decades immediately following World War II. Between 1945 and 1973, consumption of oil
products rose at a startling 4-1/2 percent average annual rate, well in excess of growth of real
GDP. Subsequent to 1973, however, oil consumption grew, on average, only 1/2 percent per
year, far short of the rise in real GDP, an issue to which I shall return.
But despite OPEC's persistent endeavors to control oil prices, the story since 1973 has been
more one of the power of markets than one of market power. The signals provided by market
prices have eventually resolved even the most seemingly insurmountable difficulties of inadequate
domestic supply. The gap projected between supply and demand in the immediate post-1973
period was feared by many to be so large that rationing would be the only practical solution.
But it did not quite happen that way. To be sure, mandated fuel-efficiency standards for cars and
light trucks accompanied slower growth of gasoline demand. However, some observers argue
that, even without government-enforced standards, market forces would have driven increased
fuel efficiency. Indeed, the number of small, fuel-efficient Japanese cars that were imported into
the United States markets increased significantly in the late 1970s after the Iranian Revolution
drove up crude oil prices eventually to $40 per barrel.
Moreover, at that time, prices were expected to go still higher. Projections of $50 per barrel or
more were widely prevalent. The Department of Energy had baseline projections showing prices
reaching $60 per barrel--the equivalent of more than twice that in today's prices.
The failure of oil prices to rise as projected in the late 1970s is a testament to the power of
markets and the technologies they foster. Today, in real terms the price of crude oil is three-fifths
less than in December 1979.
It is encouraging that, in market economies, well-publicized forecasts of crises more often than not
fail to develop, or at least not with the frequency and intensity proclaimed by headline writers. This
was certainly the case for the concerns about potential surges in the price of gasoline this past
summer. The reason, of course, is that producers and consumers alike react to price signals in
ways that help to fend off the predicted disasters.
This phenomenon was especially evident a year ago, when markets worked to help allocate
limited supplies of fuel oil and to mitigate the problems that many had feared at the outset of the
heating season in the United States, especially in the populous northeastern states, where fuel oil is
widely used for heating. In response to low inventories of home heating oil, prices rose, demand
slowed, and we drew in large amounts of heating oil from Europe. In the event, retail prices
peaked early last winter and have declined appreciably since.
While the potential for a shortage of heating oil dominated concerns a year ago on the eastern
seaboard, sharp increases in natural gas prices were threatening to markedly escalate the heating
bills for the rest of the nation, which, in fact, they did for several months. A significant shortfall of
gas in storage, brought about by growing domestic demand and a limited ability to import, had
been a particular concern at the time. But since the start of the year, spot prices for natural gas
have fallen significantly, largely because the earlier run-up in prices induced a dramatic rise in
drilling, a boost to production, and a curtailment of demand. Of course, demand has also been
restrained by the overall weakness of the economy.
Responses to rising prices were also a major factor in stemming California's electric power crisis
of earlier this year. When higher prices for wholesale electricity were finally allowed to be passed
on to households and industry customers last spring, demand slowed dramatically. To be sure, had
California experienced average summer weather, the partial passthrough of cost increases to the
retail level arguably would have been inadequate to equilibrate demand and supply. But milder
weather, coupled with a slowing economy, brought California through the summer with an ample
buffer of excess capacity relative to peak loads. This was scarcely an exercise in free-market
dynamics, but the experience did underscore that even the demand for electric power is price
sensitive.
Although the short-term problems of the past year in the markets for gasoline, natural gas, and
electric power were resolved without significant disruption, these events and others over the past
few years have brought renewed attention to the longer-run prospects for American energy
markets.
Largely in response to past oil price increases, the energy intensity of the United States economy
has been reduced by almost half from the levels of the early 1970s. Much of the energy
displacement was accomplished by 1985, within a few years of the peak in the real price of oil.
Progress in reducing energy intensity has proceeded further since then but at a lessened pace. This
more modest pace should not be surprising, given the generally lower level of real oil prices that
has prevailed since 1985.
What has changed dramatically in recent years is the production side of the oil and gas markets,
where technological changes are taking place that are likely to make existing energy reserves
stretch further while keeping long-term energy costs lower than they otherwise would have been.
The development of seismic techniques and satellite surveillance that are facilitating the discovery
of promising new oil reservoirs worldwide have roughly doubled the drilling success rate for
new-field wildcat wells in the United States during the past decade. New techniques allow far
deeper drilling of promising pools, especially offshore. The newer recovery innovations reportedly
have raised the proportion of oil reserves eventually brought to the surface from one-third to
nearly one-half in recent decades.
One might expect that, as a consequence of what has been a dramatic shift away from the
hit-or-miss wildcat oil and gas exploration and development of the past to more advanced
technologies, the cost of developing new fields and, hence, the long-term marginal costs of new oil
and gas would have declined.
And, indeed, these costs have declined, but by less than might otherwise have been the case,
because much of the innovation in oil development outside of OPEC has been directed at
overcoming an increasingly inhospitable and costly exploratory environment. That has been the
consequence of more than a century of draining the more immediately accessible sources of crude
oil.
One measure of the decline in the marginal cost of additions to oil availability in recent years is the
downdrift in the prices of the most distant contracts for future delivery of Light Sweet crude oil.
Spot prices have soared and plunged over the past decade, but for the most distant futures
contracts--which cover a time frame long enough to seek, discover, drill, and lift oil--prices
generally have moved lower. The most distant futures prices in 2001 dollars fell from $25 per
barrel just before the Gulf War to $17 to $18 a barrel a year and a half ago.
The current six-year futures contract has risen, on net, over the past year and has been a little
more than $21 per barrel in recent days. Arguably, however, this rise is related less to technology
and the structure of underlying marginal costs and more, in all likelihood, to the future implications
of current heightened Middle East tensions.
The long-term marginal cost of extraction presumably anchors the long-term equilibrium price and,
thus, is critical to an evaluation of the magnitude and persistence of any current price disturbance.
Over time, spot prices are inexorably drawn back to the long-term equilibrium price, as the
balance between underlying supply and demand is restored. A premium over long-term marginal
costs doubtless exists for oil because so much of the world's crude oil reserves are in areas where
disruptive turmoil is always a latent threat.
The longer-term outlook for natural gas prices is less tied down by history or current practice.
Unlike oil, the natural gas consumed in the United States, as you know, is almost solely produced
in the United States and in Canada, from which last year we imported 16 percent of our 23 trillion
cubic feet of demand. The story of gas supply in the United States, in contrast to oil, is thus largely
a domestic one.
Compared with oil, the industry is relatively new. Natural gas, as you know, is more difficult to
transport in its gaseous form through pipelines and particularly challenging in its cryogenic form
when transported as a liquid. It is the latter problem that has kept imports of liquefied natural gas
at negligible levels.
Drilling technologies for natural gas have mirrored those for oil, and through much of the industry's
history one could not tell whether a successful drilling hit would turn up valuable crude oil or
natural gas, which was often flared for lack of transport facilities.
But with many of the transportation hurdles surmounted, demand has surged over the past two
decades, reflecting the myriad new uses for natural gas in industry and as a clean-burning source
of electric power.
At times in recent years, supply has not kept pace with the growth of demand. Indeed, the
inventories of natural gas held in underground storage caverns were drawn down to record low
days' supply levels last winter. As a consequence, spot prices of gas quadrupled, engendering a
surge in domestic drilling.
But the very technologies that have improved our drilling success rates have also enabled us to
drain newly discovered gas reservoirs at an increasingly faster pace. Data for Texas, for example,
show that in recent years more than 50 percent of recoverable gas reserves were extracted from
wells in the first year of operation, compared with roughly 25 percent in the 1980s. As a
consequence, to achieve a rise in net marketed gas, gross new discoveries, and the drilling activity
associated with them, have had to accelerate.
The combination of demand for environmentally superior gas in our power plants and continued
expansion of household and industrial use will be putting significant pressure on the reserve base as
the economy recovers. Virtually all new electric power facilities now on the drawing board are
gas-fired or dual-fired. To meet the higher anticipated needs, the always-present tradeoff between
our energy requirements and our environmental concerns will doubtless be heightened in the years
ahead.
Such inevitable tradeoffs have stimulated renewed interest in a greater expansion of coal, nuclear
power, and nonconventional sources of energy. The nation, of course, has large reserves of coal,
and, in terms of thermal equivalents, we produce more of it than either natural gas or petroleum.
Moreover, rapid technological improvements in coal mining have resulted in productivity gains in
this industry that have exceeded those for the economy as a whole by a wide margin and have led
to sizable declines in the relative price of coal.
Still, the use of coal has been restrained by environmental concerns over emissions from
coal-burning power plants. Technology has already alleviated some of these concerns and, given
the realistic range of alternatives, coal is likely to remain a significant factor in our energy future.
An obvious major alternative to coal in electric power generation is nuclear power. Low prices for
competing fuels and concerns about safety have been a drag on this industry. Nevertheless, its
share of electricity production in the United States increased from less than 5 percent in 1973 to
20 percent about a decade ago and has since maintained that share. Given the steps that have
been taken over the years to make nuclear energy safer and the obvious environmental advantages
it has in terms of reducing emissions, the time may have come to consider whether we can
overcome the impediments to tapping its potential more fully. Up front, of course, are the concerns
of making plants safe from terrorist attacks. More difficult is the challenge of finding an acceptable
way to store spent fuel and radioactive waste. If this problem can be resolved and if some of the
long-deferred research and development efforts to make nuclear power more economical were to
bear fruit, the potential for this source of energy could doubtless be much enlarged.
The remainder of our domestic energy production comes from a variety of renewable energy
sources, the most prominent of which are hydroelectric power from dams and the energy
generated through the recycling of waste and byproducts from industry and agriculture. Solar and
wind power have proved economical in some small-scale and specialized uses, but together they
account for only a tiny fraction of renewable energy.
More broadly, substantial experimentation and exploration is under way in the application of
advanced technologies to alternative approaches to energy production and conservation.
Improvements in fuel cell technology, for example, hold considerable promise in a wide variety of
commercial applications, and fuel-efficient hybrid cars are approaching wider use. With rapid
scientific advances, it is not inconceivable that technological breakthroughs will allow
nonconventional energy sources to play a larger role in meeting our demand for energy than is
currently the case.
In the more distant future remains the potentials of fusion power. A significant breakthrough in this
area has been sought for years but seems discouragingly beyond reach. But success could provide
a major contribution to our nation's future power needs. The input costs of fusion power would be
minor, and it produces negligible nuclear waste or pollutants.
We cannot say with certainty how these technological possibilities will play out in the future, but
we can say with some assurance that developments in energy markets will remain central in
determining the longer-run health of our nation's economy. The experience of the past fifty
years--and indeed much longer than that--suggests the important role that can be played by
market forces in conserving scarce energy resources, directing those resources to their highest
valued uses, and ultimately ensuring adequate productive capacity for the future.
It is obvious that to successfully exploit new sources of energy and the technologies that engender
energy conservation will require considerable long-term investment in research, exploration, and
development. An updated and improved means of energy transport, especially electric power
transmission and distribution, will also be essential.
To be sure, energy issues present policymakers and citizens with difficult decisions and tradeoffs
to make outside the market process; as always, national security and environmental concerns need
to be addressed in setting policy. But those concerns should be addressed in a manner that, to the
greatest extent possible, does not distort or stifle the meaningful functioning of our markets. We
must remember that the same price signals that are so critical for balancing energy supply and
demand in the short run also signal profit opportunities for long-term supply expansion. Moreover,
they stimulate the research and development that will unlock new approaches to energy
production and use that we can now only scarcely envision. <<
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