CONNECTING THE DOTS: UNDERSTANDING U. S. FOREIGN OIL DEPENDENCE

Environmentalists, politicians and journalists warn of the dire consequences of US dependence on foreign oil.  The United States is accused of running a foreign policy based entirely on petro-centric interests and of fighting wars solely for the purpose of ensuring the free flow of oil at market prices.  The US is criticized for its dependence on foreign oil, especially Mideast oil and for tolerating tyrants and despots in the quest for cheap affordable oil.  So, what is the truth about the US and its nasty little oil habit?


UNDERSTANDING NATIONAL SECURITY POLICY

1. Oil is the most critical natural resource of the global capitalist system and the stability of oil exporting regions is a critical US national security interest.  This is why France and other industrial nations normally critical of the US are unusually silent with regard to global oil politics. These nations are content to let the United States bear the weight of acting to preserve stability in the far-flung oil regions of the world.

2. US national security policy is based on the concept of stability, not the free flow of oil at market prices.  However –

• Oil prices are very sensitive to instability. 
  
  
• Capitalism thrives on stability.  Stability encourages investment, creates markets and enhances trade.
  
  
• Stability normalizes the availability of essential raw materials so companies and investors will risk capital to build, create, sell, profit and eventually pay taxes.
  

UNDERSTANDING THE WORLD OIL MARKET

1. Oil is a commodity of varying qualities; therefore, the source that supplies the highest quality (a characteristic that makes it easier to crack and turn into high quality distillates) will command the highest prices (we capitalists love that).  Oil supplies of equal quality are priced based on several simple concepts - first, supply and demand (over production lowers prices); second, OPEC; and third risk (i.e. stability). 

FACTOID:  Today we hear of a fourth possible source of effect on the price of oil – SPECULATION!  In fact, the US government conducted research to determine if terrorist groups such as Al Qaeda use their financial resources to affect speculation in the oil markets. Speculators have existed in the oil business since day one, they have normally functioned as a moderating influence in the markets.  Since oil is a commodity, the markets try to set prices for oil that has yet to come to market – they do this with an investment vehicle called oil futures.  These futures bear risk for the investors and so the market makers must be very agile in setting futures prices when supply instability, caused either by war or by natural disaster, threatens to interrupt the free flow of crude oil.  As communication and weather forecasting technology enabled more immediate knowledge of world events, the oil futures markets became more volatile trying to respond to events without really knowing if they would actually cause supply instability.  It is interesting to note that as soon as Congress and the press started calling for the regulation of speculators in the oil markets – bam – the speculators ran from the market and oil prices began to moderate almost instantly, despite continuing threats to the stability of oil supplies.

2. Today, oil continues to be in huge supply, however; high quality crude oil that is easy to extract and deliver is not.  Middle East oil is very high quality (sweet), they have lots of it and it is easy to extract and deliver.  In fact, many wells in Iraq, Saudi Arabia and Kuwait do not require pumps – the oil shoots out at high pressure.  Wells in Texas and the North Sea often require expensive methods (water injection) or extensive infrastructure (oil well platforms floating in rough seas) to get at the “sweet” crude.  Oil fields in the former Soviet Republics lie on the wrong side of major mountain ranges, complicating delivery.

3. The US still produces huge amounts of oil and could produce more except for three interesting facts. 

• First, for decades now it has been cheaper to buy oil outside the US than to exploit all of our more difficult to extract domestic sources.  With prices at current levels, this reasoning is not longer relevant.

• Second, oil exploration relies on educated guesses and brilliant luck to find the massive reserves that still exist in the US.  A test well can miss a reserve with millions of barrels of oil by as little as four feet and never know it.  However, technology today is enabling modern oil researchers like Permian Energy to accurately find previously unknown reserves and drill them with great precision – vastly reducing the risk of failure.

• Third, the U.S. Congress and many states have enacted laws prohibiting oil exploration and drilling in some of our most promising geological areas.   However, with the massive run up in oil prices during 2008, there is renewed pressure on politicians to open vast promising areas of the US to oil exploration.

 
4. OPEC  (The Organization of Petroleum Exporting Countries) is a consortium of twelve nations, only six of which are located in the Middle East.  Those six are:  Iran, Iraq, Kuwait, Qatar, Saudi Arabia and United Arab Emirates.  The remaining six OPEC nations are:  Algeria, Angola, Ecuador, Libya, Nigeria and Venezuela.

5. Who started OPEC?  Venezuela! (I didn’t know that!)  They did it as a way to calm the volatile market price fluctuations of oil while simultaneously ensuring a profit for its members.  Ultimately, the market sets oil prices and prices move because of fluctuations in supply, demand and perceptions of risk. 

6. OPEC tries to leverage supply to control the market price of oil by setting production quotas for its members.  However, many times OPEC members do not follow these quotas. 

FACTOID:  As of 2008 Venezuela is only producing 73% of its OPEC quota.  They say they are doing this to keep prices high, but the reality is that Venezuelan President Hugo Chavez has used the massive oil revenues of Venezuela to fund social projects and political projects in the region at the expense of maintaining and modernizing Venezuela’s oil infrastructure.  This combined with President Chavez’ policy of nationalizing the assets of foreign oil companies and placing politically friendly but inexperienced executives in charge of oil production means that Venezuela cannot reach their OPEC quota even if they wanted to.

 
UNDERSTANDING US FOREIGN OIL DEPENDENCE

Popular Mythology - The United States imports the lion’s share of its oil from the Arab Middle East or Persian Gulf


Reality - In 2002, the US imported a grand total of 3.32 billion barrels of crude oil, or roughly half of US oil consumption.

• 1.5 billion barrels (45%) came from OPEC nations and 1.9 billion barrels (55%) came from non-OPEC nations like Canada, Mexico, UK, Norway, Angola, Colombia, Gabon and Ecuador.
  
  
• Only 803 million barrels or 24% of our foreign oil came from the Persian Gulf
  
  
• US exposure to Mideast and/or Persian Gulf oil supply risk is actually only 12% of US oil consumption.   
  

In calendar year 2001 the top four foreign sources of crude oil were:

1. Saudi Arabia –           OPEC                  (694 million barrels)
2. Canada –                   Non OPEC          (548 million barrels) Tie
3. Mexico –                   Non OPEC          (548 million barrels) Tie
4. Venezuela –               OPEC                  (475 million barrels) 

In 2002 the top four foreign sources of crude oil were:

1. Saudi Arabia –           OPEC                  (548 million barrels) Tie
2. Mexico -                   Non OPEC          (548 million barrels) Tie  
3. Canada -                   Non OPEC          (527 million barrels)
4. Venezuela –               OPEC                  (438 million barrels)

In 2007 the top four foreign sources of crude oil were:

1. Canada -                   Non OPEC          (896 million barrels)
2. Mexico -                   Non OPEC          (559 million barrels)
3. Saudi Arabia –           OPEC                  (542 million barrels)

ANALYSIS:    

1. The United States effectively hedges its oil supply risk.

• More than 84% of US oil imports come from geographic areas outside the Persian Gulf.
  
  
• More than 56% of US imported oil comes from non-OPEC sources.

2. The US is more dependent on Western Hemisphere oil sources than Middle East sources.  

3. Instability in the Middle East creates fear of oil supply interruptions.

• Fear causes increases in spot oil prices. 

4.US national security policy focuses on creating and preserving regional stability.

• Stability fuels trade and capital markets and mitigates oil supply risk. 

5. US oil risk hedging continues to focus on oil sources less at risk for political disruption and supply interdiction.

6. Oil speculation over time has served to create stability in the market and enable large consumers of oil to hedge their oil costs against possible supply risks.

7. Just as oil prices were ready to go through the roof, the world economy followed fundamental economic theory and corrected for abuses in the markets, over production and runaway economic growth.

Note:  All data derived from US Department of Energy, Energy Information Administration,
Petroleum Supply Annual 2001, 2002, 2007.