Energy Revolution Offers Return of 20th CenturyUS Strategic Weapon: Spare Production Capacity

Introduction

The era of US energy abundance has arrived with such speed and

force that we can all be excused for feeling disoriented. Even as the

economic benefits to the United States quickly become apparent, the

strategic value created by the tens of billions of barrels discovered

through the use of hydraulic fracturing and horizontal drilling

technology is just beginning to be tested. President Barack Obama’s

decision on March 12 to sell 5 million barrels of oil from the

Strategic Petroleum Reserve (SPR) was partially a political signal to

Russia in response to its military aggression in the Crimean

Peninsula. Such a response – a release of sour crude barrels that

compete directly with Russia’s Urals benchmark for a non-supply

disruption purpose – would have been unimaginable less than a decade

ago, when the crude imports made up roughly 60% of total US

consumption and the SPR’s supplies covered only xx days of imports.

But what a different several years make. The decades-worth of

additional domestic oil and gas now accessible in the shale and other

geologic strata has the US Energy Information Administration estimates

that the US will surpass Russia in 2015 to be the world’s largest oil

producer and has already surpassed Saudi Arabia as the world largest

producer of total hydrocarbons. While it is an open debate to what

degree SPR oil can be used to influence US foreign policy since oil

released must someday be replaced, the most recent use of the SPR begs

the question. Are there other unforeseen strategic weapons that are

now worth considering related to oil supplies that could become

available in the near future? The short answer is yes, the newly

accessible tight oil has given the United States a chance to recreate

one of the greatest strategic weapons of the 20th Century: spare oil

production capacity.

Spare oil production capacity – also known as “swing capacity” –

is the Excalibur sword of economic and diplomatic weaponry, but before

going into detail, it’s worth reviewing a bit of economic history.

From the 1930s until the early 1970s, the U.S. was able to lead its

allies to victory in World War II and fight the early portions of the

Cold War thanks to an over-abundance of crude oil. In a long-forgotten

development, the state of Texas in the mid-1930s stabilized volatile

oil prices by regulating private production within its borders,

periodically releasing or constraining millions of barrels of

production at a moment’s notice. This capacity gave the US effective

control over the global price of oil as Texas regulators, with full

authority delegated by Congress, used “proration” to restrict output

when prices were soft and order more pumping when prices started to

spike, creating a strategic tool of immense influence. The existence

of spare capacity was used as a tool of statecraft to build the free-

trade and military alliances in the 1950s and 1960s which became the

foundation of US-led containment policy against Soviet and Chinese

communism.

The Geopolitical Value of Swing Capacity

The central question to be answered by this paper is whether the

US can recreate spare crude oil production capacity given current

technology and whether the strategic and geopolitical benefits accrued

to the US by such a tool are justified. I argue that the US can and

should recreate spare capacity – via America’s vastly underutilized

federally-owned offshore resources – and in order to support my

argument, I will explain the theoretical basis by which the US can

create spare capacity after an absence of nearly a half century. This

paper will explore the uses of spare production capacity as a tool of

statecraft using historical examples such as two US actions

restricting oil supplies to compel political allies to end their

military operations and Saudi Arabia’s use of spare capacity to

equalize its strategic relationship with the United States over the

course of the last four decades. Finally, it will explain how the

redevelopment and management of new spare capacity by the federal

government can be sustained both technically and politically.

Oil has been a central factor in a series of conflicts from the

beginning of the 20th Century as the world economy industrialized and

gasoline and diesel-powered tanks and airplanes began to dominate

European battlefields. One reason the Allies won the Second World War

was the ability by the United States to expand oil production to

almost any desired level, while historians point to oil shortages as a

major reason for both Germany and Japan’s failure to permanently

secure their early military gains.1 Oil was one of the primary causes

of the conflict between the US and the Empire of Japan as the

Roosevelt administration banned oil exports to Japan in an effort to

discourage Japanese militarism. During the Seven Days War of 1967

between Israel and Arab nations, the reserve petroleum capacity of the

US prevented Arab states from using the threat of an oil embargo to

apply political pressure on Western Europe.2

1 Daniel Yergin, The Prize: The Epic Quest For Oil, Money & Power, Simon & Schuster, New York 1991 p.1372 Ibid.

Without such a reserve, the US could have forfeited some of their

foreign policy objectives at critical junctures during the Cold War to

whichever governments controlled allied oil supply. And in an example

of strategic compellence underappreciated by energy and geopolitical

analysts today, the US during the 1956 Suez crisis threatened to

withhold emergency oil supplies from Britain and France until they

removed their occupying troops from the Suez Canal zone.3 A

combination of strong oil demand growth and a decline in oil

discoveries in the 1960s led to the loss of America’s position as the

world’s swing petroleum producer. This disappearance in spare capacity

surprised American policy-makers, causing the US to enter a decade of

failed attempts in the 1970s to protect the US economy from high and

volatile oil prices through protectionist measure. Spare production

capacity was retained in Saudi Arabia, and it has been zealously

guarded ever since. The Saudi Kingdom has used it to fill-in missing

supplies disrupted during the 1990-1991 Gulf War, the 2003 invasion of

Iraq and more recently, the output shortfall caused by the 2011 Libyan

civil war and UN-sponsored sanctions regime against Iran’s oil

industry since 2012. Spare capacity gives the market stability, since

traders can count on additional supplies being available in times of

emergency. In return for periodically using this spare capacity, Saudi

Arabia has maintained its strategic relationship with the US, even in

the face of major policy and political disagreements. On one occasion,

its existence may have created deterrence against a US military attack

on Saudi oil installations (xx).

The Role of Compellence and Deterrence in Energy and National Security

3 Ibid., p. 491

US spare oil capacity can become such a tool of statecraft if the

United States wishes it so. The use of compellence has been linked

with deterrence theory and nuclear weapons use doctrine. Nuclear

weapons theorists such as Thomas Schelling have defined compellence as

using the threat of punishment to get a nation to do something and as

a result, change the status quo.4 In this way, compellence is the

reverse side of deterrence, which signals to opponents that actions to

change the status quo will backfire. Second-strike nuclear capability

is the most popular example of nuclear deterrence, although many types

of deterrence below the nuclear threshold exist. Compellence is

considered harder to maintain than deterrence, and must be accompanied

with credibility, capacity and rationality. Compellence usually

involves initiating an action on the part of a state to change an

opposing state’s behavior, and can be done through a variety of means

– harassment, blockade, travel bans, electronic disturbance, the use

of violent air power, covert activity, and prisoner-taking to name a

few.5

All of these examples, however, are a type of “hostile” pressure,

and can provoke a military response. A less common compellence method

of involves “non-hostile” pressures. Schelling uses the example of the

French Army’s occupation of a province in Northern Italy in June 1945,

just after the end of World War II, with the intention of annexing the

area as a “minor frontier adjustment.”6 Despite the action being

contrary to Allied plans and American policy, the French announced

that any effort of their allies to dislodge them would be treated as a

hostile act. After arguments with the de Gaulle government went

4 Thomas Schelling, Arms and Influence, Yale University, 2008, Chapter 25 Ibid., p. 776 Ibid., p. 69

nowhere, President Harry S. Truman informed the French that no more

supplies would be issued to the French army until it had withdrawn to

pre-existing national boundaries.7 Because the French were entirely

dependent on American logistics and supply, this non-hostile pressure,

which did not reach the threshold of provoking a militant response,

was viewed as an unusually safe and effective coercive act, causing

French forces to withdraw quickly. As we will see in more detail later

in this paper, US “non-hostile” political pressure in the form of a

refusal to use spare oil production, initially promised for use by

European allies in case of an emergency, will be used again against

the French and British military during the 1956 Suez Crisis.

In addition to the strategic value of spare capacity to coerce

opponents, its loss over the past 40 years has led to an “addiction”

to imported oil that has taken a toll on America’s finances, politics

and its strategic doctrine. The point has been made many times that

dependence on crude oil imports has become one of the most serious

strategic challenges faced by the United States going forward. Between

1965 and 2005, the amount of oil importing by the US increased from

around 10 percent of its daily consumption to nearly 60 percent,

accounting for trillions of dollars of lost wealth and an enlarged

trade deficit. Over the decades, this dependency transformed the US

from a creditor to a debtor nation, threatened to weaken its currency

to a point where its reserve currency status was threatened, and

created strategic doctrine leading to limited wars of occupation in

oil-exporting regions, costing both blood and treasure to American

society.

7 Ibid.

The tight oil revolution, combined with improved fuel efficiency

standards, has cut the percentage of imports for daily consumption in

half since 2005, and additional tight oil supply growth is expected in

the next five to seven years. The creation of a spare capacity would,

over time, change the US strategic relationship with oil exporters

even more than the changes currently underway. The United States, as a

result of its military and political primacy developed during the Cold

War, has taken responsibility as prime defender of the “global

commons.” As a result, the US military has become the “global sheriff”

in charge of security of supply for Middle East oil resources shipped

to its European and Asian allies. This Cold War-era responsibility has

not been re-adjusted in the past two decades, allowing strategic

competitors like China, India and Iran to benefit from essentially

free economic security.

New Hydrocarbon Supply

Up until 2008 or 2009, the conventional wisdom held that US crude

production was in inexorable decline. Production of conventional crude

oil peaked in the US in 1970 at roughly 9.6 million barrels a day and

fell to less 5 million b/d in 2008, the lowest level since the 1940s.8

But the twin developments of hydraulic fracturing and horizontal

drilling have come together to dramatically increases the amount of

accessible hydrocarbon reserves. By drilling horizontally, oil

explorers are able to access far greater amounts of oil or natural

gas-bearing formations from a single drilling pad compared to a

vertical well, while hydraulic fracturing uses a slurry of high-

pressure water, silica sand particles and chemical additives to create

large rock fractures from which hydrocarbons can drain into the well

8 http://www.eia.gov/dnav/pet/hist/LeafHandler.ashx?n=PET&s=MCRFPUS2&f=A

pipe.9 This allows large amounts of "tight oil" to escape from the rock

that otherwise would have been trapped and irretrievable. Spurred by

oil prices over $100 a barrel, the US over the past five years has

reversed the long-term domestic production decline and in March 2014

was produced 8.2 million barrels of crude a day, the most since May

1988.10 When adding the additional production of natural gas liquids,

which can also be refined into motor fuels, the US produced more than

11.5 million b/d of liquid hydrocarbons at the end of 2013.11 These

developments caused the federal government’s Energy Information

Administration (EIA) to estimate that tight oil will make up half of

the 9.6 million barrels a day (b/d) of crude to be produced in the US

in 2020.12 Roughly 2 million b/d of additional crude has been produced

in the US in the last two years, and some experts believe another 2.5

million b/d or more will be added by 202013

Along with hydraulic fracturing success, advances in computer

power have allowed geologists to increase dramatically the rate of

discovery of conventional hydrocarbons. Four decades ago, the

discovery rate per conventional exploratory well drilled was between

20-30 percent. Now, explorers are able to drill at 70-80 percent

9 Congressional Research Service, Unconventional Gas Shales: Development, Technology, and Policy Issue, Oct. 30, 2009 p. 22 http://www.fas.org/sgp/crs/misc/R40894.pdf

10 http://www.businessweek.com/news/2014-03-19/u-dot-s-dot-crude-oil-production-rises-to-highest-in-almost-26-years11 https://www.energyaspects.com/publications/view/us-oil-and-shale-output-dec-201312 Energy Information Administration, 2014 Early Release Outlook http://www.eia.gov/forecasts/aeo/er/executive_summary.cfm13RBC Report, Conversation with Brookings’ Charles Ebinger, March 21, 2014 https://research.rbccm.com/sellside/EmailDocViewer?encrypt=bf5d65ae-6ddf-4fd9-9ce3-8d65ecec58b4&mime=pdf&co=rbcnew&id=cshafer@energyintel.com&source=mail

discovery rate, which lowers the risk to investors and increases the

amount of capital available for exploration companies. As a direct

consequence of these technical advances, a study for the National

Association of Regulatory Utility Commissioners published in 2010

found the resulting increase in estimated oil and gas resources from

1970 to 2009 in the Gulf of Mexico to be between 4-6 times larger than

initially thought as a result of evolutionary technology.14 The US

Department of Interior in 2006 estimated a mean of 86 billion barrels

of oil and 420 trillion cubic feet of natural gas could be discovered

in offshore Continental Shelf areas of the Atlantic, Pacific and

Eastern Gulf of Mexico by incorporating advances in petroleum

exploration and development technologies.15 This is roughly four times

the amount of proved reserves currently believed to be available in

the entire United States, but for several decades, presidential and

congressional moratoria had blocked development of the Atlantic,

Pacific, Alaska and Eastern Gulf of Mexico. Record high oil prices in

July 2008 caused President George W. Bush to end a presidential

moratorium on off-shore drilling in those areas, followed by a lapse

in a congressional moratorium in September 2008.

A conservative estimate using a NARUC methodology that accounts

for unexpected technological advances would put additional off-shore

production beyond the three-mile limit of 3-4 million barrels a day,

which when added to the expected expansion of on-shore production

14 NARUC, Analysis of the Social, Economic and Environmental Effects of Maintaining Oil and Gas Exploration and Production Moratoria on and Beneath Federal Lands, Feb. 15, 2010, Executive Summary, 3-1215 Department of Interior, Bureau of Ocean Energy Management, Regulation and Enforcement, 2006 Outer Continental Shelf Oil and Gas Assessment http://www.boem.gov/uploadedFiles/BOEM/Oil_and_Gas_Energy_Program/Resource_Evaluation/Resource_Assessment/2006NationalAssessmentBrochure%283%29.pdf

would combine to over 7 million barrels a day of additional US

production. This would give the US between over 15 million barrels a

day of oil production, nearly double what is currently being produced

and well in excess of the record for total liquid hydrocarbons of

10.975 million barrels a day set in 1973.16

American Use of Oil as Compellence during 1956 Suez Crisis

The true geopolitical potential of spare capacity can be seen

most clearly through the Eisenhower administration’s dealings with

both political allies and adversaries during the 1956 Suez Crisis. The

trio of Britain, France and Israel took military action against the

Egyptian government of Gamal Abdel Nasser in October 1956 to wrestle

back control of Suez Canal zone from Egyptian troops who had taken

over the corridor in late July. The Suez was a crucial passageway for

Middle Eastern energy supplies to Europe, and both the United Kingdom

and France had shared ownership and control of the Suez for almost 100

years.17 Both fading colonial powers were interested in regaining

control of the canal, but there was no consensus with Europe’s newly

hegemonic superpower ally, the United States18 over how to deal with

Nasser. In response to the July crisis, President Dwight Eisenhower

authorized creation of a Middle East Emergency Committee, which was

charged with organizing oil supply – derived mainly from US spare

16 Energy Information Administration, http://www.eia.gov/dnav/pet/hist/LeafHandler.ashx?n=PET&s=MTTFPUS2&f=A17 Yergin, The Prize, Simon & Schuster, New York, 1991, p. 48318 Ibid.

capacity -- for Western Europe if the canal was blocked by Nasser’s

forces.19

President Dwight D. Eisenhower in particular was adamantly

opposed to military action against Egypt, based on fears of setting

off a wider international crisis involving the Soviet Union. But the

British and French on a separate, secret track coordinated a re-

occupation of Suez with help from Israel. On Oct. 29th, Israel launched

an attack into the Sinai, and in early November, British and French

paratroopers arrived in the Canal Zone.20 This gap of several days

between deployments allowed the Egyptian government to damage the

canal, scuttling dozens of ships to block the waterway and choke off

the supply of oil, the security of which had been the immediate

justification of the Europeans’ attack.21 In one of the worst

geopolitical calculations of the era, the British assumed that the US

would step into any oil shortage with US supplies, but Eisenhower was

livid, both for the secrecy and because the Europeans had failed to

account for US elections scheduled for Nov. 6 that had Eisenhower

running for re-election on the top of the nationwide ballot. The

British failure to understand US interests also had to do with the

diminishing vision of the British Empire and the expanded vision and

responsibilities of the United States. At the same time as the Suez

Crisis, Soviet troops were entering Budapest to crush the Hungarian

rebellion. To have Western colonial powers invading a former colony at

the same time as the Hungarian uprising undermined US efforts to unite

global opposition against Soviet aggression in Eastern Europe.

19 Ibid.20 Ibid., p. 49021 Ibid.

The secret military move by Britain and France was unforgivable

in Eisenhower’s eyes, and it motivated him to refuse to permit any of

the emergency oil supply arrangement to be put into action. Instead of

providing supplies to America’s allies, Eisenhower would impose oil

sanctions to punish and pressure his allies in Western Europe22 until

they removed their troops from the Suez Canal zone. The administration

thus refused to activate the Emergency Committee, which had the

authority to order new production from US spare capacity, and without

this American aid, the combination of a blocked Suez Canal and a Saudi

embargo would cause all of Western Europe to fall short of oil as

winter approached. With the US announcement of sanctions, the die was

cast. Harold Macmillan, the British Chancellor of the Exchequer and

future British Prime Minister, threw up his arms into the air when he

heard of the move, exclaiming “Oil sanctions? That finishes it.”23

French and British troops were out of the Canal Zone by the end of

November, only after which did Eisenhower authorize the activation of

the Middle East Emergency Committee.24

While this episode has fallen down the list of significant

political confrontations during the Cold War, the US behavior

regarding its spare oil capacity is instructive. Eisenhower understood

the power of oil capacity as a political tool. Being able to compel an

adversary – or in his view a misbehaving set of allies – so quickly

and in a non-military manner is rare, and the fact that such episodes

have so rarely occurred in history speaks to its punitive value as

such a threat. Once used as a tool, nations on the receiving of oil

embargos and sanctions rarely forget. In Britain, the Suez Crisis is

22 Ibid., p. 49123 Ibid., p. 491-49224 Ibid., p. 493

seen as one of the defining geopolitical events of the Cold War,

symbolizing a final transference of superpower status from Britain to

the United States. Prime Minister Anthony Eden resigned as a result of

the failed re-occupation of the Suez, while the French government

within the next year signed the Treaty of Rome, which laid the

foundations for the European Union by creating the Common Market. The

speed of European consolidation was likely increased by US actions.

German Chancellor Konrad Adenauer told French Premier Guy Mollet in a

Paris meeting in early November just as the US began its Suez response

that because individual European states could never again be leading

global powers on par with the United States and the Soviet Union

"there remains to them only one way of playing a decisive role in the

world; that is to unite to make Europe. . . . Europe will be your

revenge."25

Saudi-US Relations, Deterrence and Spare Capacity

We have seen strong evidence of the geopolitical power of spare

capacity over the past 40 years concerning US-Saudi relations. Most

observers identify the Feb. 14, 1945 meeting between President

Franklin Delano Roosevelt and King Abdulaziz al-Saud aboard the USS

Quincy in the Red Sea as the starting point of a deep US-Saudi

political relationship with the US promising protection of Saudi

Arabia’s oil industry in return for the Saudis’ agreement to meet

market demand and the needs of US allies. But the 1973 Saudi embargo

of the US and Europe in response to the Yom Kipper War created an oil

shock that brought the alliance into question. The embargo produced

25 Martin Feldstein, Foreign Affairs, “The Failure of the Euro: The Little CurrencyThat Couldn’t,” January/February 2012, http://www.foreignaffairs.com/articles/136752/martin-feldstein/the-failure-of-the-euro

large-scale inflation in the US, new concerns about the security of

foreign investment in oil-producing countries, and open speculation

about the feasibility of militarily seizing oil fields in Saudi Arabia

or other countries.26 Both the Nixon and Ford administrations felt such

actions were “too high a price to pay,”27 according to Secretary of

State Henry Kissinger at the time. “If you bring about an overthrow of

the existing system in Saudi Arabia and a Qaddafi takes over, you’re

going to open up political trends that could defeat your political

objectives.”

As mentioned at the beginning of this paper, Saudi Arabia has had

the only meaningful spare capacity in the world since the 1970s and

its importance to the stability of the oil markets – and equally on

the stability of the world economy – has allowed it to maintain a

close relationship with the US. The alliance has survived both

dramatic differences in each society’s views on political liberty and

women’s rights and the consequences of Salafist terrorism practiced by

al-Qaeda and its late Saudi-born founder, Osama bin Laden. Considering

the interventionist policies of a number of US administrations in the

past 20 years in Iraq and elsewhere, it’s likely the US-Saudi

relationship has operated on an equal footing only because of the

deterrent effect of Saudi Arabia’s massive oil reserves. It is

generally accepted that spare capacity must make up about 5 percent of

the total oil demand in the world to be effective, but even without

additional production from the United States and elsewhere over the

next several decades, Saudi Arabia’s great strategic asset may be on

26 Ibid., see “Congressional Research Service, “Oil Fields as Military Objectives: A Feasibility Study,” Committee Print Prepared for the House Committee on International Relations Special Subcommittee on Investigations, Aug. 21, 1975.27 Yergin, The Prize, Simon & Schuster, New York, 1991, p. 643

the wane as domestic Saudi electricity demand – which is currently

produced by burning oil, not natural gas – continues to grow by 10

percent a year and threatens to eat away much of country’s current

spare capacity by 2030.28 The relative narrowing of Saudi spare

capacity is considered to be one of the key reasons for currently high

oil prices. While total OPEC spare capacity is currently between 4-6

million barrels, analysts such as London’s Chatham House estimates

Saudi Arabia will be a net importer of petroleum as early as 203829

while other estimate imply that spare capacity may end in the Kingdom

as early as 2030.30 The consequences of this dwindling spare capacity

is that high oil prices and high price volatility seen during the past

5-7 years could return rapidly, fueling inflation, promoting a rise in

interest rates and hampered economic growth over the long-term.31 If

the timing of the elimination of Saudi spare capacity is accurate,

this situation also gives the US a two-decade window of opportunity to

move away from its petroleum-based transportation while at the same

time ramping up extra production in order to potentially replace Saudi

Arabia‘s position as producer of last resort.

28 Energy Policy Information Center, Securing America’s Future Energy http://energypolicyinfo.com/2012/04/press-roundup-%E2%80%93-saudi-spare-capacity-dwindling/, April 6, 201229 Ibid., April 6, 201230 Paul Gamble and Brad Bourland, Jadwa Investment, “Saudi Arabia’s coming oiland fiscal challenge,” July 201131 Robert McNally and Michael Levi, Foreign Affairs, “A Crude Predicament: The Era of Volatile Oil Prices,” June 12, 2011

Source: EIA

A Change in Demand

New technologies and techniques to increase domestic production

highlighted above are changing the nature of supplies in the US today,

but there is no way the US can create spare capacity unless the

country undergoes a radical shift in the amount of oil used by its

thirsty transportation sector. The US is the number one user of

petroleum in the world each day, using 18.9 million b/d in 2013. While

the amount of oil imported into the US has fallen by almost four

million barrels since 2007, the US still imports about 7 million b/d.32

The only way to create enough spare production capacity – the 5 or

more million b/d need to meaningfully influence global markets – is to

dramatically shift the use of oil in the US transportation system,

which currently uses about 13.5 million b/d of crude.33 The United

32 Energy Information Administration, Mar. 14, 2014 http://www.eia.gov/oog/info/twip/twip_crude.html#production33 Energy Information Administration, AEO 2014 Early Release, Dec. 16, 2013

States is estimated to have used 8.5 percent less oil in 2013 than it

did in 2007, largely due to changes in transportation usage, with an

additional 6 percent by 2025 thanks to new fuel economy standards

passed during the Bush administration and enhanced at the start of the

Obama administration. The new rules will increase light duty-vehicle

fuel efficiency by almost 50% equaling a savings of about 800,000

b/d.34

It is not within the purview of this article to detail the

dramatic advances in automotive batteries, hybrid-automobile

technology, compressed and liquefied natural gas-driven vehicles and

full-electric vehicles made in the past five years. That said, the

current trends show a potential to impact US oil demand in similar

ways to the impact hydraulic fracturing and horizontal drilling have

had on recent US oil supplies. Rigorous studies show that the

continued gap between global oil prices and the price of US-based

natural gas and electricity could, over time, dramatically displace

internal combustion-driven transportation vehicles with non-oil-based

vehicle fleets. Such a movement toward electricity-driven light-duty

and natural gas-driven vehicle fleets over the next several decades

could dramatically cut the amount of oil being used by the US

transportation system – by as much as 6.5 million b/d by the 2040s.35

The time it takes for disruptive transportation technology to become

standard is generally measured in many decades. The adoption of

combustion-engine automobiles in the US took 25 years to take hold

from its invention around 1900, and the full expansion of the US

http://www.eia.gov/forecasts/aeo/er/early_consumption.cfm34 Ibid.35 Electricity Coalition, Electrification Roadmap: Revolutionizing Transportation and Achieving Energy Security, November 2009, p. 11

Interstate Highway System took an additional 50 years to fully

implement. A similar transition to a non-oil-powered fleet will take

decades, but will be justifiable if, as a consequence, the US could

de-link its economy from petroleum use while developing a strategic

spare production capacity that could be used to the nation’s

advantage.

Source: EIA

Policy Suggestions and Implications

The compellent and deterrent power of spare capacity has few

equals as a tool of statecraft, but even if one were to accept its

strategic value, a second large hurdle to implementation immediately

comes into view: politics.

How would the US manage the asset in a way that clearly benefits

the nation-at-large, rather than a small sub-set of domestic and

international oil producers and green automobile manufacturers who

already benefit from government incentives and can already be defined

as representing special, politically-connected interests? Several

examples exist at the federal level involving regulatory institutions

that manage commodities trading and wholesale electricity markets.

These organizations grew out of Progressive and New Deal era and

continue to operate with little question of their legitimacy. Examples

include the National Labor Relations Board (NLRB), the Federal Energy

Regulatory Commission (FERC) which regulates natural gas pipelines and

manages wholesale electricity prices, the Commodity Future Trading

Commission (CFTC), and the Securities and Exchange Commission (SEC).

These boards all operate with quasi-judicial powers and do so in a way

that depoliticizes (to the degree it’s possible) the industries they

regulate. The same is true of the hundreds of state-level commissions

and boards operating throughout the country that deal with everything

from retail electricity pricing to coastal zone management and

cosmetology licenses. That said, there are several dilemmas and

challenges in the creation of a “federal spare capacity board,” not

the least of which is the simple congressional politics of creating

the “grand bargain” between those interested in more supply and those

interested in less oil demand. This paper does not deal with the raw

politics of crafting US national energy policy except to say that

issues of legitimacy have become paramount in the eyes of the US

electorate concerning all federal office holders. The fact that quasi-

judicial regulatory bodies have operated throughout the federal and

state governments for roughly a century suggests that the model works

for what it is designed to do, which is to regulate commercial

industries. In terms of commodity and specifically oil production,

there have been three government policies used by US federal and state

regulators in the 20th Century to support and control production: oil

import quotas, a percentage depletion allowance – basically a tax

deduction that acted as an incentive for oil production – and

proration.36 Of the three, proration has shown itself to be the most

flexible regulatory tool available to limit oil production because it

allowed the wells to stay in operation, rather than shutting down

wells in order to lower production. By limiting production

proportionally to a percentage of the total capacity of each producer,

spare production can be created, and in this way would likely be the

first tool utilized by a federal spare capacity system.

Unfortunately, despite the attraction of a regulatory structure

that aims to de-politicize a major energy security issue like oil

dependence and spare capacity, a federal spare capacity

board/commission would probably not have the political legitimacy

needed on simple constitutional grounds. There are obvious "separation

of power" issues to deal with, and attempts to influence the global

price of crude oil using federal resources would have foreign policy

implications with every other nation on the planet. Since the US

President is constitutionally obligated to run US foreign policy, any

President interested in protecting his or her constitutional

purgatives would not allow a regulatory body to direct influence over

foreign policy. The President already has direct control over the

Strategic Petroleum Reserve (SPR), which has been used sparingly to

fill supply disruptions in other parts of the world. These releases

are usually done in concert with other developed nations in Europe and

Asia that are members of the International Energy Agency (IEA),

although the most recent one in March 2014, we a “test” release and

not coordinated.

36 Vietor, Energy Policy in America Since 1945, Cambridge University Press, 1984 p. 224

So the problem of partisanship and political equities are a real

concern, but this criticism must be measured against spare capacity as

a unique national asset over many election cycles and political eras.

Indeed, it is arguable that swing crude oil capacity is one of the

pre-eminent tools of strategic deterrence and compellence available

short of a nuclear weapon. In terms of compellence, spare capacity

should be viewed as superior to nuclear weaponry, since there is no de

facto taboo against its use, nor has there been an entire

international movement against its existence in the way the anti-

nuclear movement has developed. This strategic argument has the

potential to overwhelm the ideologies of some partisans, even in the

current political environment. It should also be remembered also that

spare capacity was one of the tools of statecraft that knit the free-

trade alliances made with Europe and Asia during the 1950s and 1960s

that served as the foundation for US-led containment policy during the

Cold War. Given these restrictions of constitutional authority and

political legitimacy, it is preferable to pass federal legislation

that allows creation of a committee within the National Security

Council (NSC) bringing together principals from the Departments of

Interior, Energy, Treasury, Defense and State while taking direction

from the President and the National Security Advisor on how to manage

spare capacity. It also makes sense to focus the actual physical areas

of spare capacity on solely federally-owned offshore areas that have

not yet been opened up to development. The length of both the

Presidential and Congressional moratoria on Outer Continental Shelf

(OCS) exploration that expired in 2008 has allowed for huge swaths of

Atlantic, Pacific and Arctic Ocean to become available even though the

areas are largely unexplored. Taking into account estimates by the

2006 Department of Interior survey, total undiscovered reserves in

these areas are in excess of 80 billion barrels thanks to

technological developments involving computer technology and robotics,

it is quite possible to imagine 3-4 million barrels a day of

production being available on the OCS that could become part of a

spare oil capacity regime for a period of several decades. (The recent

announcement of Interior Department xxxx)

Any law passed by Congress creating spare capacity would focus

solely on the unexplored sections of federal off-shore and exclude all

onshore areas, both privately and publically held. The US could also

enhance its energy security relationship with the bordering nations of

Canada and Mexico, which already sends roughly 1 million and 500,000

barrels a day of oil respectively and have a special trading

relationship with the United States through the North American Free

Trade Agreement (NAFTA). This relationship would involve strengthening

current special trading rights and monetary compensation in return for

having some Canadian and Mexican capacity taken off-line at times of

the US’s choosing. This type of special relationship between the US

and its closest neighbors concerning energy security is not

unprecedented. The Eisenhower administration exempted “overland”

imports from its Mandatory Quota Program created in 1959, allowing

Canadian and Mexico imports special access to US markets.37

Building and holding spare capacity is extraordinarily expensive.

The most recent large field constructed in Saudi Arabia, the 900,000

barrel a day Manifa field, cost $16 billion to build38 while the costs

of deep-water offshore construction is considerably higher. Given that

37 Vietor, Energy Policy in America Since 1945, Cambridge University Press, 1984 p. 12838 McNally and Levi, , Foreign Affairs, “A Crude Predicament, The Era of Volatile Oil Prices,” June 12, 2011

the OCS areas in the Atlantic, Pacific and Arctic are essentially

frontier provinces with no production infrastructure, costs could run

into the hundreds of billions. It is therefore worth remembering that

the estimated value of the OCS oil at current prices – if taking the

technologically enhanced estimates -- is roughly $8 trillion. These

areas could be open to private investment and production in the many

years before US oil demand fell to levels that the US would start

ordering a proration regime. It would be possible to motivate

investment through the tax code, allowing increased deductions or a

low or zero-tax regime during the first decade or more of production

in return for the understanding that in response to a Presidential

order, production could be prorated to achieve a strategic or foreign

policy goal. The Congress could also include state revenue-sharing

with coastal states that currently are not part of the federal royalty

and bidding schemes but would bear the brunt of any environmental

degradation caused by accidents or spills.

Conclusion

In order to create US spare capacity on the scale of several

millions of barrels a day needed to impact world markets, this paper

has explained the policy decisions needed to increase US production by

more than 6 million barrels a day to at least 14-15 million barrels a

day while cutting US demand by 6.5 million barrels to 12-12.5 million

barrels a day. By expanding US energy production to include off-shore

spare capacity, a radical shift would take place in the relationship

between the US with oil exporters in the Middle East, Russia and

elsewhere, especially if the spare production is built while the US

economy starts to transition away from an oil-based transportation

system.

If this was done, high oil prices would not threaten the US

consumer economy in the same way as it would other oil-importing

economies, giving the US the potential to make new alliances. The US

could send excess oil onto the market at times of global shortage or

threaten to withhold production at times of surplus. In global energy

markets, the threat of decisive action is as potent a tool as the

action itself, and this tactic would accrue political power to the

United States if it lowered energy price volatility for consuming

countries in Europe, Asia and the Americas. Conversely, by rationing

off-shore production, the US could increase prices in a way that would

slow the economies of importing countries with whom the US disagrees,

as happened with Britain and France during the Suez Crisis. For

strategic competitors such as Russia, Venezuela and Iran, this new

political weapon would be of serious consequence, with the potential

to undermine their primary earning power as petro-states.

Now is the time to initiate a debate unimaginable only five years

ago, namely, should the US as a matter of national security build

spare oil production capacity? Perhaps, but only if the American

electorate has confidence that the resource development is taking

place with the explicit goal of first creating spare capacity used to

further America’s strategic interests, followed closely by maintaining

the levels of environmental stewardship modern society has come to

demand. Because the US government never overtly controlled spare

production capacity and because more than a generation has passed

since such a tool existed, Americans can be excused for doubting

elements of a spare production capacity strategy. But given how

dramatically the energy landscape has shifted in America’s favor in

the past five years, it makes sense to consider the possibility of

creating a major strategic tool for the US that could last until the

end of the Oil Age.