Chamber of Commerce reponse by Steven Eule

Many thanks to the Energy Bulletin for posting a Rick Munroe’s review the Index of U.S. Energy Security Risk and giving the Energy Institute the opportunity to respond. We appreciate the spirit in which the criticisms were offered—we want to improve the Index where we can—and I’ll respond in the same spirit.

Instead of addressing each of your comments point-by-point, I think it might be more useful to provide your readers with an explanation of how we approached oil-related issues in the Index.

The Index incorporates 37 different metrics of energy security that when weighted and combined are used to convey U.S. energy security risks in a single number. To get at aspects of oil supply and demand (directly or indirectly), we use a number of different metrics. These include crude oil price, price volatility, import expenditures, import expenditure as a share of GDP, stocks, refinery utilization, petroleum intensity, share of non-petroleum transportation fuels, vehicle miles traveled, and average vehicle miles per gallon.

Although the review ignored several of these oil-related metrics, they are extremely important to the Index and address some of the criticisms in the review. For example, to the extent that oil production peaks, net energy declines, export capacity shrinks, or domestic demand in oil producing countries eats into exports—or that these things are forecast to happen—that should be reflected in higher oil prices. On the demand side, greater efficiency and an increasing share of non-petroleum fuels in the transportation sector—the rate we’re “leaving oil” in IEA parlance—will act to moderate other oil-related risks.

Our metrics assessing the security of international oil supplies, both production and reserves, incorporate two primary concepts—freedom in oil producing countries and diversity of supply among countries—that when combined provide a reasonable measure of supply risks.

We begin with the proposition that countries exhibiting the greatest degree of political and civil liberties are more likely to be politically stable and reliable trading partners and are less likely to join cartels or use oil supplies to achieve geopolitical aims. To measure this we use Freedom House’s rankings of political freedom to weight the average barrel of crude oil reserves or production worldwide. The turmoil in Algeria, Bahrain, Egypt, Libya, and other Middle Eastern countries with limited freedoms, many of them oil-producing, provides timely confirmation of the inverse relationship between the degree freedom and political stability.

The second proposition is that greater diversity of supply leads to enhanced competition and reduced volatility, both of which help lessen security risks. Even if a set of oil producing countries fares poorly on a measure of freedom, our energy security still is enhanced when supplies are spread more evenly among them. (And yes, oil consuming countries are better off from an energy security standpoint if the there are a large number oil producers. Supply concentration, even in the United States, increases risks, especially in a global market. Let’s say a hurricane shuts in U.S. offshore production. Clearly, we’re in a better position to weather the storm, so to speak, with a diverse source of suppliers rather than just a few. And don’t forget that the diversity metric is combined with a freedom metric, where the U.S. scores at the best level.)

Together, these metrics provide a good picture of the international supply risks, and past movements in these metrics comport well with general impressions of supply risks since 1970. Looking forward, the review mentions that risks in our crude oil reserve and production measures (and import measures, as well) don’t move that much and posits some explanations. The primary reason is that we don’t have any forecasts of political changes or reserves estimates in oil producing countries. So instead of making our own prediction out of thin air, we chose to adopt a neutral stance and assume that political conditions in each producing country remain unchanged going forward (we do use EIA production forecasts, however). But part of the beauty of the Index is we can test “what-ifs” and can see how energy security risks might change if, for example, the Arab Spring produces true democratic reform.

(For more detail on these and other metrics, we encourage readers to go to our “Metric of the Month” series of papers, two of which examine the crude oil supply metrics. February’s crude oil production paper, for example, notes that “looking ahead, production is expected to decline in Mexico, Norway, and the United Kingdom, and possibly the United States, which could lead to greater concentration of supplies,” a point made in the review.)

Overall, our concern with the international oil supply metrics is less about the amount of oil available (or natural gas and coal) and more about the risks attached to that supply. Peak oil is an interesting concept, but it can arise from different phenomena. If oil peaks as demand is declining, is that a problem? (The Stone Age didn’t end because we ran out of stones.) These supply risks need to be considered in conjunction with prices, both past and projected. And our Index does that: EIA’s projections of rising oil prices affect several of our metrics on prices and expenditures.

I’d also like to note that data limitations constrain what we can do. We are reliant on the availability of accurate, annual, unbiased data going back to 1970 and forecast data going forward 25 years or so. We rely almost exclusively on government data and forecasts, primarily from the Energy Information Administration. Over such a long time-frame, there are many things we can think of that affect some aspect of energy security but simply cannot be tracked consistently and over time. The Index necessarily reflects a balance between what is theoretically ideal and what is reasonably practicable.

Taken as a whole, we believe that our oil metrics do a good job of assessing the totality of oil-related supply and demand risks. We do not expect the Index to be the last word on the topic, and we’re always willing to entertain new data that fit our criteria. The Index was created to provide a framework and a tool for analysts and policymakers. How would peak oil affect U.S. energy security? What would lowered export capacity mean? We hope that we have provided a means to help answer these types of questions.

Stephen Eule
Vice President for Climate & Technology
Institute for 21st Century Energy

Reply to Stephen Eule’s observations

Mr. Eule’s response to my review of the Index is appreciated. He has brought forward several issues to which I offer this reply.

Mr. Eule correctly notes that my review ignored many of the 37 metrics. In an effort to keep the review concise, I selected the four metrics which were most relevant to my concerns.

In paragraph 4, Mr. Eule states, “… to the extent that oil production peaks, net energy declines, export capacity shrinks, or domestic demand in oil producing countries eats into exports [or even the threat of same] that should be reflected in higher oil prices.” The suggestion seems to be that high prices will force adjustments and innovation, thereby resolving difficulties in energy supply.

However, the Index correctly predicts not only very high oil prices, but high price volatility as well. There is well-documented evidence that oil price shocks are often precursors to recessions, which then cause the price of oil to plummet.

A cyclical inability to sustain high prices may result in a chronic subversion of investment and development of potential energy solutions.

With respect to the importance of freedom and diversity as primary concepts in assessing the security of international oil supplies, I agree with all of Mr. Eule’s points on the former (par. 6) and some of his points regarding diversity (par. 7).

I still fail to see merit in the argument that U.S. oil supply is more secure now that it produces a lower percentage of global supply. His example of a hurricane is appropriate, but the U.S. (like all IEA members) already has support in the form of the “burden-sharing” commitment of 27 other OECD nations under the IEA’s long-standing emergency response system.

What neither the USA nor the IEA has a contingency plan for is the scenario which prompted my review: the impending peak in global oil production. While Mr. Eule calls peak oil “an interesting concept,” the German military (and many others) regard it an inevitability with potentially severe consequences. Furthermore, the Bundeswehr analysts point out that we suffer from “an almost instinctive rejection of in-depth discussion of this difficult issue.”

Mr. Eule refers to “leaving oil” and the possibility of ‘peak demand’ but current evidence indicates the reverse. To date, mankind has been unable to find an energy source which is as versatile, abundant, energy-dense, convenient and affordable as petroleum, and its attendant infrastructure is thoroughly established (and is itself a barrier to alternatives). Mankind is not leaving oil: despite the deterrent of high prices and clear data about melting glaciers, current consumption is at an all-time high and is further exceeded by estimates of global demand.

Regarding the Energy Information Administration, both the Index and Mr. Eule’s reply highlight the degree to which their conclusions are based upon information from the Agency. What the Chamber regards as a strength of its Index, others may regard as a weakness: the EIA is regarded by many as having a history of over-optimistic projections.

The EIA’s annual Retrospective examines the degree to which EIA forecasts matched with what actually occurred on a number of indicators, many of which coincide with metrics in the Chamber’s Index.

The 2011 Retrospective was released last week and chronicles the inaccuracy of EIA predictions. With respect to World Oil Prices (Table 4) the EIA consistently underestimated the price by 25% to 70% throughout the past decade. Most noteworthy is its underestimation of the 2009 price by over 50% (significant because 09 was a recession year). The EIA’s 09 Outlook underestimated the price for that year by one-third. Indeed, Table 2 provides an astonishing list of Agency overestimations on twenty metrics, two-thirds of which are off by over 50%.

Mr. Eule states, “We rely almost exclusively on government data and forecasts, primarily from the Energy Information Administration.” I would respectfully encourage the Chamber to broaden its perspective and to closely examine the recent literature from military/security researchers who have incorporated the data and concerns of peak oil analysts.

Mr. Eule concludes his response by asking two very important questions: “How would peak oil affect U.S. energy security? What would lower export capacity mean?” Both issues are vital to our collective future yet they remain largely ignored by our elected officials, government agencies and mainstream media. It is hoped that both the Chamber and the EIA will address these questions in a direct and thorough manner in subsequent publications.

I thank Mr. Eule for his response, Energy Bulletin for allowing this exchange, and readers for their interest in the issue of energy security and how it may be assessed.

Rick Munroe