Why Striving to be Energy-Independent is Not a Healthy Attitude

 

Energy Policies

Marty Thurston

 

1)     Strategic

 

The recent position of Canadian energy policy has been a movement towards market liberalization intended to reconcile energy, environmental, and economic growth.  There has been significant discussion on centralization and for the purposes of this paper; centralization will reflect the conjoined influence of diversification and commercialization of state enterprises.

     In 2003, North America’s per capita energy consumption was about four times greater than the world average. (North America: The Energy Picture II, 9) Energy use in North America, which represents about 30% of global consumption, has generally focussed primarily on coal, oil, and natural gas.  Europe has followed roughly similar trends but relies relatively less on coal and more on nuclear plants.

     Canada is the world’s second largest natural gas exporter after Russia but faces serious challenges in the near future.  Canada needs to focus on diversifying energy markets without significantly diverging from American policy.  U.S. crude oil reserves are located primarily in Texas, federal offshore, Alaska, and California.  It would be interesting to see how American policy objectives might have evolved if Alberta’s oil-sands had stretched partially into the U.S.  Since this obviously is not the scenario, the point is that most U.S. infrastructure is developed around these hubs, and these are the points of immediate focus for U.S. policy-makers. (North America: The Energy Picture II, 27)

     We are not running out of energy, the biggest concern we face is keeping our alternative sources of energy in an adequate state of production.  The challenges faced by carbon-based fossil fuel processors, includes increasing costs of production and upgrading facilities.

     The United States will likely expand and diversify production of alternative energy sources and this will prove beneficial for Canada; as these kinds of processing facilities gain popularity in the United States, it may ease the investment flow into Canada to create our own backward linkages.

     The report notes that most developing countries are just reaching the point where individual wealth becomes accelerated.  This accelerated pace, in conjunction with increasingly large populations, is a clear indication of where global energy consumption will be focused in the future.  This may or may not be beneficial to Canada as an energy exporter depending on the particular country’s regulatory structure.  As environmental and quality control measures become more pronounced in OECD trade relationships, these developing nations will present a significant opportunity for North American business.  “Oil and gas now provide nearly 60 percent of world primary energy.” (Hard Truths, 8)

     Another important consideration is the extent to which federalism plays a role in determining energy policies.  To be brief, Canadian provinces are relatively strong and American states are relatively weak.  Two areas in which the American states are very powerful however, is in land-use regulations and environmental regulations.  Since provinces and states have different stakes in energy trade, strong communication is essential to overcoming the regulatory discrepancies each nation will face.  The beauty of the federalist nature of North America is that it represents an excellent forum for trial-and-error negotiations.

     Now, I will briefly discuss some implications of North American interdependence, however, I will touch on this subject further in my operational analysis.  Interdependence can be witnessed in different forms on multiple levels.  Cross-border pipe/power lines, electronic marketing, tri-national regulatory meetings, regional councils, and interplay of investments and technological developments are all examples that Dukert claims are growing more important within the North American energy system.  The effects of multinational energy trade act like a ratcheting device.  “Many, small incremental moves toward furthering continental energy interdependence might be slowed or even stopped in the future (possibly by policy conflicts in some non-energy area); but most of the progress to date has been too valuable to be dismissed.” (Dukert, 136)

     The unrelenting thirst for energy by the United States is both a reliable and profitable opportunity for Canada.  Oil-sands technology in Alberta and hydrocarbon fields across the Canadian shield might not have been realized if not for the proximity and intense demand from our American neighbours.  Dukert’s three lessons of interdependence are:

 

1)     Energy interdependence makes all three partner nations more sensitive to perturbations originating within any one. 

2)     We cannot – certainly at the current stage of agreement – expect the three national governments to choose near-identical responses, especially in situations that are perceived to be temporary

3)     The reality of energy interdependence within a generally free market makes each of the three countries less vulnerable to serious and extended damage that might otherwise accompany energy-related disruptions.” (Dukert, 141)
 

     The strategic planning section of this memorandum has outlined a number of concerns with North American energy markets.  Federalism in Canada and the United States has proven to be a mixed blessing.  On one hand federalism can function as a laboratory of sorts, which formulates trial-and-error results and has a ratchet-like effect on policy coordination.  On the other hand, multiple levels of jurisdiction only make regulatory coordination that much more difficult.  In matters of environmental and land-use legislation, there is an asymmetrical relationship between Canadian provinces and American states.  The reality of the current situation is that it is modeled as a temporary agreement and, as such, we can not expect different national governments to come up with the same responses.  Overall, the North American energy system makes each member nation more sensitive to the continental regime, but at the same time, each member is also less vulnerable to serious or extended damages.

     One of the realities we face is that virtually all forms of current energy extraction are going to have to be expanded to meet the projected future demand.  We do not have to look into the crystal ball to assess the importance of shifting regulatory climates within the developing world, specifically India, China, and Brazil.

 

2)     Sectoral Analysis

     To better understand Canada’s position in energy markets, it is helpful to understand the American and North American perspectives.  The United States is a major, and growing, net importer of energy. In 2004, the United States net imports of energy exceeded 29 quadrillion Btu (quads), up from around 12 quads in 1980 and 14 quads in 1990. (North America: The Energy Picture II, 16)

     In 2004, about 33 percent of total U.S. net energy imports came from Canada

(24.2 percent) and Mexico (8.4 percent). (North America: The Energy Picture II, 17) Given Canada’s relative size and power, a 25 percent share of American energy imports represents a great deal of marketable potential to Canadian producers.

     Canada provided more than 94 percent of U.S. net imports of natural gas in 2004.

These imports accounted for about 14 percent of U.S. natural gas consumption in

2004. (North America: The Energy Picture II, 17)

 

North America consumed about 27.5 trillion cubic feet (Tcf) of natural gas in

2004. Canada consumed 3.3 Tcf, Mexico consumed 1.8 Tcf, and the United

States consumed 22.4 Tcf. (North America: The Energy Picture II, 18)

     At present, the gas pipeline infrastructure is more developed between Canada and the United States than between Mexico and the United States. Canada’s gas flows to the United States through several major pipelines feeding U.S. markets in the Midwest, Northeast, the Pacific Northwest, and California. Some key examples are the Alliance Pipeline, the Northern Border Pipeline, the Maritimes & Northeast Pipeline, the Iroquois Pipeline, TransCanada Pipeline System (including Foothills and the Gas Transmission Northwest System, the Duke Energy Gas Transmission (formerly Westcoast Energy) pipelines, and the Northwest Pipelines. (North America: The Energy Picture II, 28)

     A large portion of natural gas pipeline capacity in the United States is directed from the major product areas of Texas and Louisiana to markets in the North-Western and Midwestern regions of the country. In the past ten years, increasing levels of gas from Canada have targeted these markets as well. (North America: The Energy Picture II, 36) This is another example of diversification on Canada’s part by using existing technology to accommodate infrastructure expansion.

     “Ideally, a multiple pipeline strategy would include, simultaneously, expanding capacity along the Russian route, expanding shipments to China, and dramatically increasing shipments across the Caspian Sea to Western markets – either by a shuttle-fleet of more efficient oil tankers or, more ambitiously and controversially, by seabed pipelines for oil and natural gas.” (Hard Truths, 225)  If this could materialize, oil and natural gas products could be delivered to the highest demand markets without the political red tape.  This strategy would face huge financial and political barriers as well that at this time, can not realistically be overcome.

     I think that like the United States and Canada should “actively engage energy suppliers, encouraging open trade and investment to expand international energy production and infrastructure. (Hard Truths, 11)  In international negotiations we should regularly revisit energy issues to enhance transparency and mutual recognition between North American trading partners.

Geopolitics

     Oil and gas have been experiencing increasingly high demand and will continue to in the future. It is foreseeable that the United States will conduct more cautious bilateral trade agreements, with recognition of their declining global market status.  One example of the kind of energy expansion that will be required in the future is the case of world oil demand.  “It took world oil demand 18 years (1977-1995) to grow from 60 to 70 million barrels per day, but only eight years (1995-2003) to increase from 70 to 80 million barrels per day.  If present projections prove accurate, demand could exceed 90 million barrels per day by 2010 and 115 million barrels per day by 2030.” (Hard Truths, 214)

     The rapidly growing developing world will continue to play a significant role in energy policies.  Transportation technology going to be important to meeting the increased consumption by developing nations in the future.  There will be important concerns over “geographical choke points, both for oil shipments and, increasingly, for natural gas – whether delivered by pipeline or in the form of liquefied natural gas. (Hard Truths, 215)

     International oil companies rely on a list of risk factors that ultimately influence the desirability of investment.  By examining the investment trends of large companies, we can get a better understanding of why these trends are so common.  There are six main risk-factors.

 

1)     Geological risk – are the hydrocarbons present

2)     Technological risk – can resources be accessed with existing/available technology

3)     Commercial Risk – at what price, and under what terms? Are these adequate to ensure a favorable return on investment relative to shareholder and portfolio risk?

4)     Political Risk – what threats do political conditions pose to the project and investments? What if the political situation changes? Can these risks be managed?

5)     Environmental risk – can the resources be developed in environmental acceptable ways?

6)     Human-resource risk – are there enough suitably trained and qualified people available to develop the resources?

 

     If we apply this checklist to petro-chemical and bio-fuel development, including but not limited to, ethylene, ammonia, and propylene, we might observe that the technological risks are rapidly dissolving and the only real barriers to full-scale development are the commercial and environmental risks.  As far as political risk is concerned, it would be considered risky if Canada did not pursue alternative energy production.  As the technological risks dissipate, the environmental ones will be the next to fall.  From that point, business should stabilize until new barriers are encountered.

     It should also be noted that in energy policies, the logical solution is not always the most practical.  “Countries outside the Middle East that once welcomed foreign investment, such as Venezuela and Russia, have turned increasingly hostile.  Thus, investment capital, as well as the best industry technology and manpower, cannot be applied in the most economically effective manner to increase supplies of oil and natural gas for the world market, even at a time of historically high energy prices.” (Hard Truths, 219)

     The US should also boldly offer credible proposals for reforming international institutions, such as the United Nations and the International Monetary Fund.  Multilateral institutions should be strengthened in order to enforce international rules that support not only US interests but those of the rest of the world. (Hard Truths, 229)

     Not dissimilar to the NPC policy suggestion for the United States, I would suggest Canada follow the same route of expanding and diversifying Canadian energy markets.  Following with our goal to pursue forward linkages of investment, Canada should “conduct national and regional basin-oriented resource and market assessments to identify opportunities for increasing oil and natural gas supply. (Second, 242) The potential results of such action could take the form of increased production within the decade, to the tune of approximately 40 billion barrels of oil and 250 trillion cubic feet of natural gas.  Also, Canada should accelerate all research and development programs in the fields of non-conventional oil and gas recovery.  Making this technology more economically feasible, (ie. Meeting clean air and water standards) will help alleviate some of the pressures of the declining trends of conventional natural gas by offering an increased production and/or viability.

     In a parallel action, Canada should also accelerate development of biomass energy sources as they offer processing and manufacturing potential.  By accommodating (and controlling) more of the stages of production, Canada would be more attractive to foreign investors and would see more of the profits from our resources.  Canada should “support research into second-generation bio-fuel crops that have lower input requirements or are suited to more marginal lands.” (Second, 242)  While doing this it will be important to balance the pre-existing agricultural policies in an effort to balance the demand for food and biomass.  Finally, Canada should “support policies that promote the development of the infrastructure for harvesting, storing, and transporting energy crops, and facilitate the integration of bio-fuels into the national transportation fuel supply.” (Hard Truths, 243)

     In sum, 24% of net American energy imports come from Canada.  Natural gas is probably Canada’s biggest export to the U.S., accounting for around 94% of total American imports.  Accounting for this large amount, Canada has started to focus on American infrastructure hubs connected to Canadian gas pipelines in Texas and Louisiana.  Ideally, we would aim to increase the capacity of gas flow to Russia and focus on larger shipments to China.  Transportation technology, as well as political uncertainties are the most significant restraints to this development.  Canada will have to take stock of risk-management principles to determine the timing of these policy objectives.  We should aim to expand and diversify Canadian energy markets while accelerating the development of bio-fuels that may provide forward economically linkages.

3)     Operational Analysis

     One significant managerial component of emerging energy policies has been interdependence between Canada and the United States.  Interdependence is a result of the two-way business and investment relationship on both sides of the border.  Energy policies usually rely on a significant degree of mutual recognition between trading partners.  This can take the form infrastructure and technical standards coordination. 

     Inter-vulnerability was illustrated to be a very real phenomenon after Hurricanes Katrina and Rita in 2005: storm damage to oil rigs and refineries in the Gulf of Mexico affected markets worldwide, and US demand could only be met with the help of petroleum supplies from around the world.” (Hard Truths, 226)  This is an example of why energy independence can never really be thought of as a sustainable condition, nor would it be a desirable one.  This is one of the biggest geopolitical challenges.  “The opening up of new resources in any particular region adds to overall global supplies and thus benefits all consumers, wherever they may be.  Therefore, managing “energy interdependence” is a worldwide geopolitical challenge, one in which the United States must play a constructive leadership role.” (Hard Truths, 226)

     One of my main arguments is that Canada focus on developing forward linkages to resource infrastructure.  By this process we aim to regionalize processing and production facilities to strengthen our regional market-share.  Likewise, where possible, we should focus on scientific and engineering facilities to accommodate research and development expansion.

     Government and industry will play an important role in developing these technologies, and these types of petrochemical facilities will continue to grow successfully as long as most of the following four conditions are met:

1. The technologies mature and costs decrease
2. Fuel costs increase and remain high
3. The technologies are valued by the consumer
4. Policies encourage adoption of improved technologies

(Hard Truths, 209)

 

     Technological limitation, infrastructure investments, and additional costs are some of the main difficulties that will have to be overcome for this sector to really flourish over the next two decades.  “In the future, emissions from emerging economies and the developing world are expected to increase dramatically, accounting for over 60 percent of new growth in global greenhouse gas emissions.” (Hard Truths, 221)

     This is contrasted with the notion of global warming that has very real implications on Canadian policies.  “Policy responses to climate change, such as carbon taxes, cap-and-trade systems, and tougher efficiency and fuel standards, will affect both the supply and demand for oil and natural gas. (Hard Truths, 222)  “Differing national responses could damage the international trading regime by distorting competition and provoking retaliation by other countries. (Hard Truths, 222) 

     Another barrier to increased energy production, especially in electricity, are the rising costs of energy storage.  This means that more and more, the system must be maintained in a position of flow demand/supply balance.” (Plourde, 75)  Furthermore, the interconnected nature of energy policies is illustrated in electricity markets.  “There are complex externalities associated with the flow of power across constrained transmission systems – in other words, changing power flows to meet demand conditions in one part of an interconnected system will affect the flow of power available in other parts of the system.  Because of these factors, there has to be a central coordinating function in electricity that is absent from crude oil and natural gas. (Plourde, 75)

     Since 9/11, security protocol has been of utmost concern of American policy-makers. 

The perceived threat of terrorism also has significant influence over the viability of policy options.  “If a radical group were to come to power in any Middle Eastern producing country, it might cease shipping oil to the United States or selling it to US oil companies.  Such restrictions would result in at least short-term supply disruptions that could put a small premium on oil destined for US markets as other suppliers diverted their product in the global market.” (Hard Truths, 224)

     If technological barriers, global warming, and terrorism are not enough China and India are both rapidly expanding nations with enormous populations, and will definitely take center stage in future energy debacles.  In order to meet their projected energy demands (and avoid social unrest) they will face significant challenges at home.  “Domestic coal is the most abundant and economic resource in both countries.  It is often, however, used inefficiently and is subject to infrastructure bottle-necks such as those in rail transportation.  Expanded use of coal would increase greenhouse gas emissions even more rapidly.” (Hard Truths, 223)

 

     Through two devastating hurricanes, Mother Nature paints a striking example of the inter-vulnerability of energy policies.  The last decade has shown, more than anything else, that there is no such thing as energy independence.  Self-reliance should not be considered a favourable condition when it comes to energy.  Fuel prices have no where to go but up, and policies are increasingly geared toward environmental concerns.  Furthermore, security-related issues have trumped trade-related issues in the United States since 9/11, and there is little indication that things will chance.  Through diversification and expansion, Canada will have to utilize all of its energy capacities.  This will also be true for North America as a continent; world demand is about to enter a new level of urgency as developing countries start to flourish and the major Asian players grow larger.  It will be a task on its own to meet these projected demands, and it will be an even greater task to establish manufacturing and R & D facilities to keep Canadian products in Canada as long as possible.  However, if the latter task can be established, Canada will have carved itself a strategic position for domestic energy markets and this will strengthen Canadian interests while reducing reliance on the United States.

 

 

 

 

 

 

References

 

 

Canada. North American Energy Working Group (2006), “North America: The Energy

     Picture II” (Ottawa, Washington, DC, Mexico City: January); online at:

     http://www.pi.energy.gov/documents/NorthAmericaEnergyPictureII.pdf

 

United States. National Petroleum Council (2007), “Hard Truths: Facing the Hard Truths

     about Energy” (Washington, DC: Department of Energy, July), 1-33; online at:

     http://downloadcenter.connectlive.com/events/npc071807/pdf

     downloads/NPC_Facing_Hard_Truths.pdf

 

Plourde, Andre (2005), “The Changing Nature of National and Continental Energy

     Markets”, in G. Bruce Doern, ed., Canadian Energy Policy and the Struggle for

     Sustainable Development. (Toronto: University of Toronto Press), 51-82

 

Dukert, Joseph (2007), “North America”, in Sidney Weintraub, ed., Energy Cooperation

     in the Western Hemisphere (Washington, DC: Center for Strategic and International

     Studies), 132-57