Energy Security: Depend, but Diversify

Gail Cohen, Fred Joutz and Prakash Loungani (ploungani@imf.org)

With oil prices back above $100 a barrel, declarations of “energy independence” are back in the news. But a more reliable path to energy security lies in continuing to depend on the benefits conferred by global energy markets, while reducing reliance on any one form of energy or on any one energy supplier. And indeed, since the oil shocks of the 1970s, the actions of millions of consumers and producers have enhanced energy security in precisely this way.

Diversify, diversify

Our recent paper documents that businesses have increased the number of sources from which they import oil, making them less vulnerable to disruptions from any one source (http://www.imf.org/external/pubs/ft/wp/2011/wp1139.pdf).

The United States, for instance, buys crude oil and gasoline from over 40 countries and jet fuel from over 25 countries.  Canada and Mexico have grown in importance as suppliers, whereas countries of the Persian Gulf supply only about 10 percent of all the oil consumed in the United States. For the OECD oil-importing countries as a whole, diversification in sources of oil supplies increased significantly over the 1990s and has remained roughly constant since then.

Countries have also increased their use of natural gas, and are also importing that from many more sources as well. Norway has continued to grow in importance as an exporter of natural gas, and several new producers have emerged—Qatar, Turkmenistan, Nigeria, Egypt and Australia. Diversification in sources of natural gas has increased steadily over the past two decades.

Chart  1. More Diversified; Oil is being supplanted by natural gas, which has many suppliers

Along with natural gas, the Canadian oil sands have also become an important part of the global energy picture. Dan Yergin notes that Canada’s estimated recoverable reserve of petroleum is second only to Saudi Arabia’s. And Canada’s placid political environment makes it a reliable and steady source of energy supply.

While the general trend is toward increasing diversification, there are significant differences across countries in their exposures to particular suppliers. For instance, countries like the U.K. and Italy get over a quarter of their oil imports from Libya, compared with under three percent for the United States.

Overall, the U.S. and the U.K. have much more diversification in their sources of energy supplies than Japan or countries in continental Europe. Within continental Europe, larger energy importers such as France and Germany are much more diversified than smaller importers such as Finland and the Slovak Republic.

Chart  2. Cross-country Differences: Some have diversified sources of energy supplies, others less so (lower value indicates greater diversification)

Reduced sensitivity

Diversification in sources of energy supplies is one of the structural changes that has given countries a bit of extra resilience to oil spikes. As IMF chief economist Olivier Blanchard has noted (http://www.voxeu.org/index.php?q=node/4341), there have been two other changes of importance.

The first is a change in how wages respond to oil spikes. In the 1970s and 1980s, workers were able to bargain for an increase in their wages to compensate them for the increase in the consumer price index (CPI) caused by oil price spikes. The increase in wages then led to even higher prices, feeding a wage-price spiral.

In turn, this placed central banks in a tough spot, as they had to choose between battling the recessionary consequences of the oil spikes and their inflationary consequences. Over the past decade, however, increases in the CPI caused by oil spikes have not fed a wage-price spiral.

The other change is the increase in central bank credibility: Over the past two decades, major central banks have become much better at establishing an anchor for inflation expectations. Hence the public in many countries is much less fearful that oil prices will have inflationary consequences than was the case in the past. This allows the central bank to be much more supportive of promoting recovery in the economy rather than having to raise interest rates to dampen inflationary expectations.

All these structural changes have reduced the sensitivity of the economy to oil spikes. In joint work with noted economist Jordi Gali, Blanchard estimates that, for the United States, the effects of an oil spike on output and inflation are only a third as large today as they were two decades ago.

Global dependence

Despite these developments, fears about the impacts of oil prices often have policymakers rushing to take unilateral steps to boost their energy independence. This is a quixotic quest. Energy is increasingly traded in global markets from which no country can secede. The U.S. exports some fossil fuels, just as Saudi Arabia and Iran import some of their needs. Robert Bryce, the author of  The Dangerous Delusions of “Energy Independence” notes that in 2005 the “Saudis imported 83,000 barrels of gasoline and other refined oil products per day” and Iran imports 40 percent of its gasoline needs.

Bryce also notes that energy discoveries are increasingly made by global teams. In September 2006, a huge oil field that could boost U.S. reserves by 50 percent was discovered in the deepwater of the Gulf of Mexico. In addition to demonstrating the technical prowess of the deepwater drilling industry—the well was drilled in 7,000 feet of water—the find shows the “accelerating globalization of the energy business.” The well was drilled by two U.S. companies along with a Norwegian firm, Statoil, which operates in 35 countries.

The globalization of energy markets is only likely to grow as natural gas grows in importance. Traditionally, natural gas has been traded in regional, intra-continental, markets. But as the costs of transporting natural gas over water have fallen, trade among continents has increased dramatically; the IEA estimates that international spot trade of gas has grown by a factor of 10 over the last decade.

Global solution

A lasting solution, therefore, lies not in unilateral attempts by one country (or by the group of energy-importing countries) to become energy independent, but in a global context where everyone tries to improve the supply-demand balance in energy markets (http://imf.org/external/np/speeches/2009/052509.htm).

The needed response has three main elements: bolstering oil supplies; making oil use more responsive to price signals; and nudging along a transition from oil to other fuels and renewable sources of energy.

  • First, on the supply side, increased investment in the oil sector is crucial in bringing greater stability to oil prices. Surges in oil prices in recent years have only brought forth very modest increases in capacity. The sluggish response appears due to rising exploration and development costs and the lack of predictable regulatory and tax regimes that would provide adequate returns for expanding supply and infrastructure. Political turmoil of course makes it all the more difficult to sustain increased investment.
  • Second, making oil demand more responsive to oil price changes is critical as well. In 2008, IMF First Deputy Managing Director John Lipsky noted (http://www.imf.org/external/np/speeches/2008/042108.htm) that “relatively low gasoline taxes in the U.S., low domestic prices in China, and heavily subsidized and controlled prices in many oil-exporting and other developing countries discourage” the demand-side response that is needed. Policies to increase energy efficiency, for instance through better fuel-efficiency standards, can also strengthen the demand response.
  • And of course, development of sustainable alternative sources of energy would lower the risk from possible oil scarcity, as emphasized in the IMF’s recent World Economic Outlook. (http://www.imf.org/external/pubs/ft/survey/so/2011/RES040711A.htm).

 

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