ENERGIZING POLICYamerica and the Middle East

in an era of plent iful o il

PATRICK CLAWSONSIMON HENDERSON

THE WASHINGTON INSTITUTE FOR NEAR EAST POLICY www.washingtoninstitute.org

ENERGIZING POLICYamerica and the Middle East

in an era of plent iful o il

PATRICK CLAWSONSIMON HENDERSON

The opinions expressed in this Policy Focus are those of the authors and not necessarily those of The Washington Institute, its Board of Trustees, or its Board of Advisors.

Policy Focus 146, July 2016

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Contents

List of Figures • iv

Acknowledgments • v

Executive Summary • vii

Introduction • x

U.S. Opportunities Offered by Shale Oil • 1

Disadvantages of the New Oil Situation • 12

Maximizing Opportunities, Minimizing Disadvantages • 24

Analysis: World and U.S. Oil and Gas Outlook • 27

Notes • 52

About the Authors • 56

iv

Figures

1. U.S. Shale/Tight Oil Production • 2

2. U.S. Petroleum Production, Imports, and Exports • 3

3. Cost of Producing a Barrel of Oil and Gas • 20

4. Brent Crude Oil • 28

5. Indicative Supply Response of U.S. Light Oil 2014–20 • 32

6. Natural Gas Prices Quoted as Barrel-of-Oil Equivalent • 35

7. Energy Intensity 1970–2040 • 40

8. U.S. Tight Oil Production in Four Cases, 2005–40 • 41

9. U.S. Oil Production and Consumption • 43

10. Combined Oil/Gas Production as Barrel-of-Oil-per-Day Equivalent • 50

11. Combined Oil/Gas Consumption as Barrel-of-Oil-per-Day Equivalent • 51

v

THE AUTHORS would first like to extend their thanks to Peter Lowy, whose generosity made the project possible.

This original impetus for this project was the emerging impact on supplies of the spread of fracking techniques. At the time, oil prices were high. When prices crashed in late 2014, we suspended work on this issue for more than a year to assess the new circumstances. Trying to make sense of all these events has been challenging, and we are grateful for the intellectual exchanges we have had with many experts in Washington DC, New York City, London, Brussels and Paris, as well as Riyadh and Abu Dhabi, during the course of our work. This study benefits enormously from their insights.

Thanks are due also to Patrick Schmidt and Hatim Bukhari for providing invaluable assistance in analyzing the data, to the senior research staff at the Washington Institute for reviewing the manu-script in its various stages, to Jason Warshof for his careful editing, and, finally, to Mary Kalbach Horan for pulling it all together.

Acknowledgments

vii

Executive Summary

oil price fluctuations and technical innovation, as well as increasing sensitivity to environmental policy options, are chang-ing the debate about the fuels of the future, not only in the United States but also across the globe. For the United States, the key new factor is the increase in oil production resulting from improvements in fracking technology. There have also been significant improve-ments in energy efficiency. The United States is producing more of its own oil and using relatively less. The world is likewise consider-ing a post-oil future. But at least in the next ten to twenty years, oil will likely remain dominant, and the Middle East will be a major source of the world’s oil.

How energy markets evolve within these circumstances is hard to predict, so this report considers a range of possible energy outcomes, each of which would have a direct impact on U.S. Middle East policy options under any administration. This study is aimed at informing such a geopolitical discussion.

The continued role of oil in the world economy is only one reason the United States cannot walk away from the Middle East, as some may want. The region includes longtime friends and allies that look to the United States for support—diplomatic, military, and eco-nomic. And, at least as important as any other factor compelling U.S. presence, the region is the source of instability that has repeatedly affected the United States, such as in the 9/11 attacks. The Middle East is home to adversaries who would shame and even destroy us.

viii

Energizing Policy

While the United States calibrates how to exploit new opportu-nities and manage risks in the changing Middle East, the grave dan-ger is that perceived U.S. indifference to regional events, trends, and developments reverberates against U.S. interests and the stability and security of U.S. friends and allies.

But the radically changed nature of oil markets grants Washington new freedom to maneuver. The easing of U.S. demand for imported oil means the United States can ignore the prospect of an “oil weapon” such as that used by Arab states to embarrass the United States in 1973. A major purpose of U.S. military operations in the Middle East has been to ensure shipping lanes remain open, a role that could over time be shared with Asian countries. A United States more confident about its energy supplies can more vigorously press sanctions and other measures on Middle East states with weapons of mass destruction programs. Lower oil prices and hence less revenue would reduce the ability of Middle East actors—government or private—to pay off troublesome constituencies, thereby potentially facilitating more effective regional counterterrorism cooperation with the United States. The perception of lesser U.S. dependence on Middle East oil will thus reduce arguably the most significant obstacle to a policy of U.S. pressure for political change in nondemocratic Middle East countries. Finally, increased U.S. energy independence means the United States can be less concerned about the Middle East and shift more attention to other parts of the world, including the so-called pivot to Asia. In short, greater U.S. energy production is a power multiplier for Washington, opening up avenues for more vigorous promotion of U.S. interests on a variety of fronts.

Like any positive development, lower energy imports could have downsides. If the United States relies less on imported oil and gas, it will be harder to explain to the American people why the United States is actively engaged in the Middle East. Reduced U.S. reliance on Middle East oil may create the impression that the United States is retreating from an active stance in the Middle East, which could undermine U.S. influence with friendly states. If the region’s aggressive actors feel Washington is less committed to Middle East security, they may decide they can intensify their destabilizing

ix

activities. Higher oil and gas production in the United States could likewise constrict the opportunity for Middle East producers to expand their own output, a trend that could challenge the certainty of oil-fed prosperity and spur domestic instability.

To maximize opportunities and minimize disadvantages, Washington should actively shape expectations at home, in the region, and around the world regarding U.S. policy in the Middle East. Americans need to hear more often and more clearly the non-energy reasons for an active U.S. role in the region. Middle Easterners need to be frequently reminded by U.S. officials from the highest level down how substantial the U.S. commitment is to the region—how extensive are the U.S. military assets deployed there, how much time and effort top U.S. officials devote to the region, and how central the region is to U.S. concerns. As a whole, the world needs clear and frequent explanations that the United States remains willing and able to play an active role in several regions at the same time. Washington needs to consider how its words sound to U.S. friends who stake their national security on the reliability of U.S. commitments.

Executive Summary

x

Introduction

the energy world is in flux. Oil price fluctuations and technical innovation, as well as increasing sensitivity to environmental policy options, are changing the debate about the fuels of the future, not only in the United States but also across the globe. For the United States, the key new factor is the increase in oil production result-ing from improvements in fracking technology. There have also been significant improvements in energy efficiency. The United States is producing more of its own oil and using relatively less. The world is likewise considering a post-oil future. But, at least in the next ten to twenty years, oil will likely remain dominant, and the Middle East will be a major source of the world’s oil.

How energy markets evolve within these circumstances is hard to predict, so this report considers a range of possible energy outcomes, each of which would have a direct impact on U.S. Middle East policy options under any administration. The purpose of this study is to inform such a geopolitical discussion.

A key component of U.S. global security policy, dating back to the late 1940s, has been a guarantee to friends and allies, and to the world economy more generally, to ensure the continued flow of oil from the Middle East to meet world demand, not just U.S. needs. And since at least the 1980s, the United States has been dedicated to ensuring that no one power dominates the Middle East’s energy resources, which could give that power a chokehold on the world economy as well as tremendous resources with which to pursue an aggressive agenda.

xi

Introduction

But this background raises the question of how much these commitments could change if the United States becomes less dependent on imported oil and if the relative role of Middle East oil declines.

The global character of the oil market means that the United States will continue to be affected by oil price fluctuations, particularly if a crisis in the Persian Gulf affects either production or exports. But the impact could be more a matter of domestic variability, with higher oil prices meaning North Dakota gains and New York loses, than foreign policy concern.

The answer to the question requires looking at several interrelated issues, the impacts of which on U.S. Middle East policy are by no means clear.

The premise of the project to which this report is contributing is that the more the U.S. oil picture changes, the more the U.S. president will be able to realistically accomplish in the Middle East. In other words, the greater U.S. energy independence is a power enabler, not a reason to withdraw from the region. While the United States calibrates how to exploit new opportunities and manage risks in the changing region, it is clear that heightened indifference to regional events, trends, and developments is almost certain to reverberate against U.S. interests and the stability and security of U.S. friends and allies.

The first section of this paper accordingly looks at the opportunities offered to U.S. Middle East policy by the advent of shale oil. The following section looks at the possible disadvantages associated with this development, first in terms of U.S. Middle East policy, and then in terms of climate change and other factors. The next section discusses what can be done to maximize opportunities and minimize disadvantages. The study concludes with a technical analysis that provides notes about the world and U.S. oil and gas outlook.

1

U.S. Opportunities Offered by Shale Oil

american shale oil, known as tight oil, reduces U.S. dependence on imported oil and in 2014 and 2015 also contributed to the decline in world oil prices, as demonstrated in Figure 1. Indeed, the growth in U.S. oil production caused by shale oil is likely to offset any pres-sure pushing world oil prices higher.

In 2015, U.S. domestic oil production remarkably came to 13.3 million barrels per day (mbd), twice the 2008 figure.1 The 2008 tally marked the lowest production since 1951, whereas the 2015 amount exceeded the previous record, 11.3 mbd, achieved in 1970 (see Figure 2).

Total 2015 U.S. oil consumption, almost exclusively in the form of refined petroleum products like gasoline, diesel, heating oil, and jet fuel, was 19.4 mbd. The consumption figure has declined from a peak of 20.8 mbd in 2005, reflecting a greater use of alternative fuels and increased efficiencies.

When the United States, Canada, and Mexico are considered as one North American grouping, and when energy from all sources is included, energy produced in 2015 was equal to 98 percent of that consumed. By itself, the United States in 2015 produced energy equal to 90 percent of what it consumed. The United States is pre-dicted to be a net energy exporter within a few years.

Given these circumstances, the prospect of U.S. vulnerabil-ity to another Arab oil embargo as in 1973–1974 seems completely unlikely. Instead of being responsive to energy pressures from the

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Energizing Policy

4

Middle East, whether by Arab states or Iran—which, ruled by the shah, did not take part in the 1973 action—the United States can, in supply terms, ignore such a prospect. Any embargo would likely cause a price surge, prompted by nervous markets, yet on what scale and for how long is difficult to predict. However, unlike in the past, any action that pushes up prices would incentivize a boost in U.S. shale oil production, which can come onstream rapidly.

The worldwide impact of U.S. shale oil is already evident. Low oil prices arguably contributed as much as sanctions to Iran’s decision to agree to constraints on its nuclear program, an early indication of the sort of diplomatic opportunity presented by U.S. shale oil pro-duction. Another concern is the way countries like Saudi Arabia are thought to have used their oil revenues either to pay off, by way of protection money, or to fund hardline Islamists, including al-Qaeda in the late 1990s, as well as groups fighting in Syria, for which, more recently, Qatar has been blamed. Low oil prices mean low oil rev-enues and so arguably limit such behavior. This reasoning, though, has always been suspect—terrorism is comparatively cheap and therefore affordable whether the oil price is high or low. Also, sup-port for what the United States regards as terrorist organizations is often considered in the Middle East as merely aid for good Muslims via charitable contributions and rich individuals rather than govern-ments. It is therefore independent of the price of oil.

Although many news stories have covered how the Islamic State (IS) exploits oil-production facilities in the parts of Syria and Iraq where it operates, the volumes concerned are very small in world terms. The jihadist group’s oil has implications for the local econ-omy, and some transfers may occur by truck across the border into Turkey. Even as such oil therefore helps sustain IS, it is a peripheral rather than central factor.

In overall economic terms, increased U.S. energy independence means the United States can be less concerned about the Middle East and shift its attentions to other parts of the world, including the so-called Asia pivot espoused by then secretary of state Hillary Clin-ton in October 2011. That said, the United States still has important interests in the Middle East, in particular the continued production and export of large amounts of oil and natural gas. Any disruption

5

U.S. Opportunities Offered by Shale Oil

to that supply will have a quick impact on the world economy, in terms of either supply or price or both. The line in Jeffrey Goldberg’s April 2015 Atlantic profile attributing to President Obama the view that “the Middle East is a region to be avoided—one that thanks to America’s energy revolution will soon be of negligible relevance to the U.S. economy” is just plain wrong.2

The economic argument also cannot be considered in isolation. Politically and diplomatically, the United States has friends and allies in the Middle East that look to Washington for support and security. These links are the bedrock for cooperation over a range of issues. To be sure, the nature of such links changes over time, according to circumstances and personalities, but to downgrade or discard them completely would be counterproductive.

President Obama encapsulated U.S. policy toward the Middle East and North Africa in his September 2013 speech to the United Nations General Assembly, saying this vision would guide the remainder of his presidency. He identified four core principles—protecting allies and partners, ensuring the free flow of energy, dis-mantling terrorist networks that threaten the United States, and acting against the development or use of WMD:

The United States of America is prepared to use all elements of our power, including military force, to secure our core inter-ests in the region.

We will confront external aggression against our allies and partners, as we did in the Gulf War.

We will ensure the free flow of energy from the region to the world. Although America is steadily reducing our own depen-dence on imported oil, the world still depends on the region’s energy supply, and a severe disruption could destabilize the entire global economy.

We will dismantle terrorist networks that threaten our people. Wherever possible, we will build the capacity of our partners, respect the sovereignty of nations, and work to address the root causes of terror. But when it’s necessary to defend the United States against terrorist attack, we will take direct action.

Energizing Policy

6

And finally, we will not tolerate the development or use of weapons of mass destruction. Just as we consider the use of chemical weapons in Syria to be a threat to our own national security, we reject the development of nuclear weapons that could trigger a nuclear arms race in the region, and undermine the global nonproliferation regime.

He continued:

Now, to say that these are America’s core interests is not to say that they are our only interests. We deeply believe it is in our interests to see a Middle East and North Africa that is peaceful and prosperous, and will continue to promote democ-racy and human rights and open markets, because we believe these practices achieve peace and prosperity. But I also believe that we can rarely achieve these objectives through unilateral American action, particularly through military action. Iraq shows us that democracy cannot simply be imposed by force. Rather, these objectives are best achieved when we partner with the international community and with the countries and peoples of the region.

While opponents and critics of President Obama could take issue with the way he has enacted these policies, a broad public consensus likely exists on the merit of his core principles.

With this in mind, the opportunities for U.S. Middle East policy prompted by the advent of U.S. shale oil can be grouped as discussed in the following sections.

Military

Less dependence on oil imports from the Middle East does not mean the United States can absent itself from the region militarily. In the areas of the Middle East where governments struggle to function or do not control their own territory (Libya, Somalia, Syria, Yemen), the United States will perhaps need to deploy military forces to tackle the problem, depending on the degree to which U.S. security, or the security of its allies, is threatened.

Additionally, the United States must be able to counter a resur-

7

gent Iran, which, despite the nuclear agreement, behaves as a malev-olent force toward Washington and its allies. The particular allies that feel threatened by Iran include the Gulf Cooperation Council states (Saudi Arabia, Kuwait, Bahrain, Qatar, the United Arab Emir-ates, and Oman) as well as Israel. This spectrum of U.S. allies facing a common threat has perhaps been the single most important factor in moving the Middle East geopolitical narrative away from tension between the Arab states and Israel over Palestine, despite the lack of official, public acknowledgment of this change. However, the prin-cipal form of U.S. military operations is likely to be its traditional role of keeping the shipping lanes open to allow for the unrestricted passage of oil to markets worldwide.

All these roles could be shared with new partners, from not only the region itself but also major importers of Gulf oil such as China, India, and Japan. Cooperation has improved in countering piracy, leading to the prospect of close relationships over a wider geographical area. Such cooperation and therefore savings in U.S. defense spending may seem unlikely in the short term but should not be ruled out as possible or even likely within a few years.

Energy

As already stated, with the easing of U.S. demand for Middle East oil, the threat of another Arab oil embargo fades, creating the opportunity for U.S. policies that need not account for a potential Arab “oil weapon” aimed at embarrassing the United States, as in 1973.

Perhaps perversely, one of the easiest accomplishments for U.S. policy in a low-oil-price Middle East is the development of a sub-regional market for Eastern Mediterranean natural gas. Obvious destinations for gas from fields offshore Israel, Cyprus, and the Gaza Strip are power plants in those countries as well as simi-lar facilities in Jordan. Surplus gas can be exported to Egypt for local use or for export via Egypt’s underutilized liquefied natural gas (LNG) installations. Plans also exist for either a seabed elec-tric-power-transmission cable linking Israel, Cyprus, and Greece

U.S. Opportunities Offered by Shale Oil

Energizing Policy

8

or a pipeline to carry natural gas from the Eastern Mediterranean to Greece.

Such developments, particularly in relation to Jordan, are cur-rently being inhibited by Gulf oil exporters offering funding for supply routes from the Gulf, though this funding could be prob-lematic if the oil price is low. Although superficially attractive, the routes, especially a proposed project from Iraq, come with too many implied political conditions, of which the main one is to stop economic integration between Jordan and Israel. A further problem is that fighters of the Islamic State currently control or can threaten some of the territory on the pipeline route. Turkey’s own problems with Russia, a consequence of differing views on the Syria crisis, have endangered energy supplies from its north-ern neighbor and caused it to look to Israel as an alternative natu-ral gas supplier. This opportunity to reconcile two U.S. allies that have been at diplomatic odds could facilitate this trade as well as opening up additional benefits.

Low oil prices could also impinge on fuel supplies for the Gaza Strip, currently provided for free as aid from Qatar. The need to maximize oil revenues could pressure Doha to cut these supplies, potentially diminishing Qatar’s involvement in Palestinian politics as well as pressuring the Palestinians to make some logical choices about their energy options. One possibility would be the develop-ment of the Gaza Marine offshore field, currently controlled by the Ramallah-based Palestinian Authority. The PA, in its owner-ship role via the Palestine Investment Fund, would have to help in meeting the costs of development—between $800 million and $1 billion. The gas could be used to generate electricity in Gaza and, more contentiously, be sold to Israel. But the revenues from the sales could ease the PA’s continual budgetary problems as well as incentivize a rapprochement with the Hamas authorities con-trolling the Gaza Strip.

All in all, developing Mediterranean offshore gas fields makes economic sense and could have political benefits. Continued low oil prices will result in fewer funds for countries that are against developing those fields, undermining their opposition and creating an opportunity for U.S. policy.

9

Counterterrorism

Middle East oil producers have both actively funded terrorism (e.g., Iran) and paid off terrorists to avoid being attacked (e.g., Saudi Ara-bia from 1996 to 2003). Additionally, private individuals in countries like Saudi Arabia, Kuwait, and Qatar have funded groups actively involved in terrorism for a variety of motives, including even charita-ble ones, with insufficient attention to how funds are spent. Lower oil prices and hence less revenue, along with more active measures like the threat of U.S. and other financial sanctions or military response, may have changed the parameters of these behavior pat-terns, official and private.

The United States will remain concerned with the activities of the Islamic State as well as al-Qaeda remnants. The basis of U.S. concern will be that these groups threaten Americans and U.S. interests in the Middle East and elsewhere, as indicated by the 2015 Paris, Brussels, and San Bernardino attacks and the June 2016 attack in Orlando. Washington will therefore need to bolster counterterrorism efforts wherever Middle East governments are coping with IS and al-Qaeda.

With less money, Middle East countries will have reduced ability to deflect the threat of terrorism by paying off troublesome constituencies. This could open up opportunities for even more effective counterterrorism cooperation with the United States.

Countering WMD

U.S.-led efforts to counter the development of weapons of mass destruction and long-range missiles capable of carrying WMD war-heads have been central to Washington’s involvement in the Middle East for more than thirty years, with notable successes. Iraq after the liberation of Kuwait in 1991 marked one such accomplishment, although suspicion over a clandestine program prompted the much-criticized U.S.-led invasion of Iraq in 2003. The overthrow of Sad-dam Hussein is considered a crucial factor in the subsequent deci-sion by Colonel Muammar Qadhafi of Libya to surrender his nascent

U.S. Opportunities Offered by Shale Oil

Energizing Policy

10

nuclear program and chemical weapons infrastructure. The 2015 nuclear agreement with Iran also fits this category, although much less disarmament occurred than in the Iraqi or Libyan case and the success of the agreement can only be properly judged with the pas-sage of time. Nevertheless, sanctions on Iran’s oil exports contrib-uted to the diplomatic pressure that forced Tehran to the negoti-ating table, as did eventually the growing supply of U.S. shale oil, which depressed prices and drastically reduced Iran’s oil revenues.

Democracy, Human Rights, and Open Markets

The Middle East region, variously defined, is made up of twenty or so nations, each of which has a vote at the UN and other interna-tional forums. The vast majority of these nations are the Arab states, which usually vote as a bloc and are seldom supportive of U.S. posi-tions. This voting pattern is facilitated by Arab aid money and other transfers from oil-rich to less rich states. The attraction of voting against U.S. positions may well be lessened if the persuasive powers of the richer, oil-producing states are hampered by low oil revenues. The benefits of a good relationship with the United States should outweigh the conditional and more forced alliances lubricated by oil revenues. This could also have a knock-on effect with the Arab League, even though it is now a comparatively weak forum, under-mining its decisions, which are always reached by consensus and often antagonistic toward U.S. policy.

The 2003 invasion of Iraq and the absence, beginning in 2011, of U.S. direct involvement in the chaos that has engulfed Syria represent two ends of a spectrum of Washington’s attempts to shape the domestic political futures of Middle East countries. Both have been unhappy failures. But there remains broad bipartisan support in the United States for encouraging greater freedoms and wider political participation in U.S. allies across the world, especially the Middle East.

Now, reduced U.S. energy dependence on the Middle East means that the need for oil supplies no longer constitutes arguably

11

the single most significant obstacle to a policy of U.S. pressure for political change. The effectiveness of such pressure, though, varies and the challenge is multidimensional. Just in terms of oil exports, Saudi Arabia could be an ideal test case but probably will not. Bahrain, with no oil exports of any consequence, remains resistant to U.S. pressure partly because it hosts the U.S. Fifth Fleet and possibly because of the protective shadow of its neighbor, Saudi Arabia. Egypt, a medium-ranking oil and gas producer, seems impervious to U.S. pressure, since the United States depends on preferential use of the Suez Canal as well as transit rights through Egyptian airspace.

A further opportunity involves encouraging economic reforms. U.S. shale oil production, as noted, contributes to extra supply, thus exerting downward pressure on oil price. The high prices of oil in recent years have distorted many economies, particularly those in the Middle East. Regional oil producers have created extensive subsidy regimes, further extending the social contract whereby lack of political rights is counterbalanced by cheap utilities and food subsidies. In non-oil-producing countries or those, like Egypt, with large populations, such subsidies have prompted near political crises as subsidies have eaten up increasing amounts of the national budget—energy and food subsidies along with government wages account for 75 percent of spending. But the fall in energy prices has reduced the need for subsidies, in some cases allowing them to be completely removed. This development has eased the strain on national budgets, but problems could reemerge when energy prices rise again.

A benefit of such reforms is that they make countries more attractive to foreign direct investment, which could otherwise be deterred by the distortions in the economy compared with investment opportunities in other countries. Since the U.S. economy is the world’s largest, a significant portion of increased FDI would likely be American, which could create further policy opportunities for Washington.

U.S. Opportunities Offered by Shale Oil

12

Disadvantages of the New Oil Situation

achieving greater energy independence has been a goal proclaimed by successive U.S. presidents for more than forty years. Presumably, therefore, a reduced reliance on energy imports will be good for U.S. interests globally. That said, like any positive outcome, lower energy imports could have downsides. This section thus outlines some potential problems regarding U.S. Middle East policy, as well as suggesting ways to forestall or mitigate them. The issues fall into several categories: explaining U.S. Middle East policy to domestic audiences, deterring aggression, reassuring friends, and reducing the risk of instability in friendly oil-producing countries.

Justifying U.S. Middle East Policy at Home

If the United States relies less on imported oil and gas, it will be harder to justify to the American people continued U.S. engagement in the Middle East. With many countries in the region, Americans do not necessarily have the sense of common values that binds them to Europe. Not only is the Middle East geographically far from the United States, but for most Americans it is also culturally far, with the partial exception of Israel. Furthermore, Americans may not be convinced that the United States can accomplish its proclaimed objectives in the Middle East, at least not at a price Americans wish to pay. U.S. recent involvement in the Middle East is widely seen by

13

Disadvantages of the New Oil Situation

Americans to have ranged from ineffective to disastrous, leaving nei-ther the United States nor the region more secure: the Iraq war did not go well, and the Arab-Israeli peace process has not achieved much for all the effort top U.S. officials have devoted to it. There is a wide-spread sentiment among Americans, from general public opinion to the policy elite, that the United States should prioritize problems at home over engagement abroad, particularly the sort of heavy involve-ment the United States has had in the Middle East in recent decades. In that context, reduced reliance on imported oil and gas becomes yet another reason to reduce the U.S. commitment to the region.

Much as that sentiment is understandable, it overlooks the com-plexity of U.S.-Middle East ties. For one thing, U.S. involvement in the Middle East has had real advantages for Americans and for the people of the region. The Middle East has been an important mar-ket for U.S. products, and the investment flows in both directions have been significant. People-to-people contacts, such as the many Middle Eastern students studying in the United States, enrich the lives of Americans and Middle Easterners alike. And Americans have a strong attraction to Israel and its people.

However one regards the positive factors linking the United States and the Middle East, another dynamic supports continued U.S. involvement in the area: the Middle East, when left to its own devices, exports instability. When U.S. forces left Iraq in 2011, the country was more peaceful than it had been in decades—admittedly a low bar—with a shaky democracy and a functioning military. That calm soon fell apart, as sectarian-minded politicians felt no checks on their campaign to weaken national institutions and empower their sectarian allies. The result was to feed discontent and enfeeble the state, leading to the spectacular 2014 advances of the Islamic State, which eventually overran significant areas in Syria, estab-lished “provinces” from Libya to Afghanistan and Yemen, and car-ried out vicious terrorist attacks in the West, as in Paris and Brus-sels. U.S. forces had to return to Iraq, with the nearly five thousand there in mid-2016 not far short of the figure proposed in 2010. The Iraq situation eerily echoed how U.S. inattention to Afghanistan following the Soviet withdrawal in 1989 led the country to spiral downward, becoming the base for the 9/11 attacks.

Energizing Policy

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Similarly, by some reckonings, U.S. failure to take a clear stance against Iraqi threats emboldened Saddam Hussein to invade Kuwait in 1990, requiring a massive U.S.-led effort to reverse the Iraqi occu-pation. The decision in 1991 to stop the fighting with Saddam still in power seems less wise in retrospect because Saddam remained in power for many years, creating quite a problem for U.S. interests. In other words, failure to stay involved in the Middle East runs the serious risk of allowing major crises to develop that require a larger-scale U.S. return.

While it is easy to deplore the prospect of a decades-long quag-mire, in fact, those parts of the world where U.S. forces have stayed for decades postconflict have been notably stable, not requiring periodic U.S. large-scale intervention. South Korea is a success in no small part because the United States has maintained 30,000 troops there for more than sixty years.

Explaining that the United States is involved in the region because of the threats it poses—the instability that emanates from it—rather than because the Middle East is important or its peoples are U.S. friends is a difficult task, requiring a more sophisticated argument than simple statements about U.S. reliance on imported energy. “It’s all about oil” is an easy way to explain the U.S. commit-ment of significant military assets to the Middle East, even though that has never been the full story and has often not been particu-larly central to the story. A more accurate formulation would be “It’s all about how hostile leaders can use oil revenues to launch attacks on their neighbors and on Western interests while oppressing their people.” Or, deferring to the bumper sticker version, “You may wish to ignore the Middle East, but the Middle East will not ignore you.” Indeed, leaving the Middle East to its own devices is a recipe for more mass terrorist attacks in the West and genocide in the region.

Appearance of Reduced Ability to Deter Aggression

As noted, U.S. involvement in the Middle East has often come in response to threats to global peace and security from aggressive actors, such as Saddam Hussein and the Islamic Republic of Iran.

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Sensing reduced U.S. involvement, those seeking to increase their power in the region may decide they can intensify destabilizing activities. In particular, hardliners in Iran may successfully push for the Islamic Republic to be more aggressive—to more actively fund militias and terrorists or to more openly threaten naked force (e.g., in Gulf waters). The challenge for U.S. policy will be to find ways to effectively deter such steps.

Although the threat posed by states willing to destabilize the region has been magnified by their oil income, carrying out their troubling plans is not necessarily very expensive compared to the amounts they earn. Therefore, a reduction in oil earnings—as implied by some possible scenarios in which U.S. oil production rises sharply—will do little to reduce the risk of aggression in the Middle East. In fact, the threat of external aggression has been as high or higher during periods of low oil prices as during periods of high oil prices. While low oil prices may crimp such states’ resources, those prices may redouble their determination to assert themselves aggres-sively. Certainly, Saddam Hussein explained his invasion of Kuwait as a response to what he saw as unacceptably low Iraqi oil income. He complained that the Gulf states were not being forthcoming: Kuwait was stealing oil from fields on the border with Iraq, the Gulf states overall were not reducing their output in a way that prompted higher prices and accommodated greater Iraqi production, and these states were not helping Iraq recover from the Iran-Iraq War, which Saddam felt served to defend them as well as Iraq.

While the prospect now seems distant, U.S. policymakers should make clear that any aggression in pursuit of larger oil income would be met with the same vigorous, determined U.S. response that coun-tered Saddam’s invasion of Kuwait. In addition, Washington should assess how key players may seek to limit damage to their interests, given a changed world energy situation. For example, if a glut of global oil production leads to a sharp drop in prices, in what way might Russia, Iran, or Saudi Arabia “export instability” as a way to prop up prices artificially? Such a scenario seems more likely than open aggression. To the extent that the U.S. worry is about instabil-ity, such a concern may well not diminish if the world moves toward less reliance on Middle East oil, and it may grow.

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Much the same is true regarding WMD proliferation. While WMD programs are expensive, the sums required are well within reach for determined proliferators. No conceivable reduction in oil income will change that calculus for any of the region’s many potential proliferators. Decisions about proliferation will be based on strategic calculations. The risk is that if the United States—and arguably Europe, traditionally its principal partner in pressing for nonproliferation—is seen as less involved in the Middle East, a potential proliferator may conclude that the Great Powers will care less, at least about borderline activities that do not cross the prolif-eration threshold. If the United States is seen as a less reliable guar-antor of security, some countries in Iran’s neighborhood may feel they need to match the extensive Iranian nuclear capabilities the 2015 agreement authorizes after about a decade’s delay.

The United States draws great advantage from its role as global guarantor of freedom of navigation, including in the Middle East, but this role effectively provides a security guarantee that benefits others as well as the United States. As the U.S.-guaranteed free flow of oil from the Middle East becomes of less direct benefit to the U.S. economy and of increasing importance to Asia, Americans will ask tough questions about sharing the defense burden. Among the chief beneficiaries of that free flow of Gulf oil is China, which creates a quandary for the United States because China may become even more of a strategic competitor with the United States than it is at present. The obvious temptation is to ask why China cannot bear more of the Middle East defense burden. And the correspond-ing challenge for U.S. policymakers will be to make the case that the United States would be ill-advised to encourage China to develop a global power-projection capability, which China might well use for narrow self-interest rather than to protect the global commons and global stability. It is not in the U.S. interest for China to become a global competitor militarily as well as economically, with a mili-tary able to contest U.S. power and influence far from home, in part because China may not be a responsible defender of access to the sea-lanes of communication for all rather than just for itself. Simi-larly, it is not in the U.S. interest for Russia to project its military power across the Middle East, because that would encourage those

17

in Russia who dream of returning to the days of U.S.-Soviet rivalry, with all the attendant risks of global thermonuclear war. On pro-tecting the free flow of oil, the quick summary case for the United States to continue bearing this burden is “If we don’t do it, someone else will develop the capabilities to do so—and we may regret what they do with that power.”

Need to Reassure Friends

Those concluding, based on reduced U.S. reliance on Middle East oil, that the United States is retreating from an active regional stance may include not only those actors contemplating aggressive moves but also U.S. friends. Such a development could undermine U.S. influence in the Middle East, making it harder for Washington to accomplish any objectives at all.

Strong U.S.-Saudi ties are based in part on America’s status as the world’s largest oil consumer and Saudi Arabia’s as one of the top three global producers. If that strategic rationale fades, ties may wither between two very different countries with very different val-ues, possibly endangering their cooperation on important strategic issues such as opposition to radicalism and Iranian aggression.

If they perceive the United States as less of a player, the Saudis and other regional states may act in ways to which Washington objects. The greatest and most obvious challenge posed by a U.S. retreat, as discussed, is how to deter hostile powers from increasing their destabilizing activities. Yet the image of a withdrawing United States may also cause friends to pay less attention to U.S. concerns. Washington has had only indifferent success at urging Middle East states to act in their own long-term interest, be it to reform their economies, open up their societies and politics, or settle the Arab-Israeli conflict. U.S. leverage to promote such causes will diminish further, however, if these countries think the United States is less committed to protecting their security.

If regional states feel the United States does not have their back, they may decide to act on their own to address security concerns, possibly in ways Washington finds dubious or even counterpro-

Disadvantages of the New Oil Situation

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ductive. The current Yemen war may presage what is to come: Gulf states deciding on their own that they must assemble a coalition to act vigorously and then exploring what the United States may or may not be prepared to do to help them—with the subtext that if U.S. support is not forthcoming, the Gulf states will proceed on their own. Washington has made clear its lack of enthusiasm for the Yemen war—indeed, its unhappiness with some of the ways the war has been fought—but such objections have barely, if at all, affected the Gulf states’ actions. The result is that the United States has been relegated to the sidelines of the war.

Much as an increasingly aloof U.S. attitude may lead the Gulf states to act more independently, the impact of the new oil realities on the U.S.-Israel relationship could be profound. If, in the popular imagination, energy is removed from the rationales for U.S. engage-ment in the Middle East, some Americans may regard U.S. sup-port for Israel as the main reason the United States is stuck in the muck of Middle East war and conflict. Furthermore, Israelis could worry that the United States is less committed to Israel as well as to the region as a whole, which might reinforce a stiff Israeli ethos of self-reliance in matters of defense. Recall that the very concept of a Zionist state is rooted in the idea that Jews must defend them-selves. Both the U.S. and Israeli sides could wonder if the special relationship of the last forty-five years is fading. This does not imply that the United States would abandon Israel but that the two sides could be less close than they have been. Israel and the United States have always had differences—not infrequently leading to crises—but these could become more enduring if not reinforced by the same glue provided by active U.S. leadership in the broader region.

Increased Risk of Instability in Oil Producers

Higher oil and gas production in the United States could mean less opportunity for Middle East producers to expand their own output, although, as explained in the technical analysis section, the extra U.S. production is more likely to displace output from high-cost areas such as deepwater sites off the North Sea, Brazil and Africa

19

(see figure 3). But in at least some scenarios, the combination of increasing U.S. output and constrained demand to address global climate change could mean Middle East oil production grows very modestly while populations grow more rapidly. Such a situation could reduce the ability of Gulf Arab producers to continue provid-ing generous services and ample subsidies to their peoples.

If oil-fed prosperity is perceived to be uncertain, Middle East oil-producing countries could experience instability—both Iran and the countries friendly to the United States. As discussed, the social compact in all the Gulf states—encompassing the GCC members, Iraq, and Iran—is based on the regime delivering a considerable degree of prosperity in return for popular acceptance, or at least tol-eration, of a political system many see as unfair or, at the least, unre-sponsive to the people. That social compact could come under strain if Gulf oil revenues are as limited as implied by some oil-outlook scenarios, in no small part because those scenarios forecast much higher U.S. oil and gas production.

Despite the current strain on Gulf government budgets, some oil producers may delay reforms in the expectation that within a few years, a tighter oil market will generate higher prices and demand. That approach has worked in the past: modest adjust-ment has allowed muddling through periods of slack oil markets until low prices were reversed. Certainly, many in the Gulf believe in the old industry adage “Nothing cures low oil prices more effec-tively than low oil prices,” with such prices stimulating demand and depressing investment. However, if prices remain depressed for decades due to the same technological forces that are stimu-lating U.S. oil and gas production—combined with structurally lower demand due to concerns over global climate change—those Gulf states that have delayed profound reforms will be vulnerable and may be forced into rapid and fundamental economic restruc-turing that could deeply stress their society and politics.

Such socioeconomic shocks could put at risk governments friendly to the United States while also stimulating radical forces, including violent Islamist extremists hostile to both the local gov-ernments and the West. At the very least, the governments faced with such shocks would be preoccupied with their domestic

Disadvantages of the New Oil Situation

20

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21

problems, potentially putting them in a poor position to confront external pressures. A state might thus contemplate using external aggression as its way of diverting a discontented populace. A dan-gerous combination could thus emerge of weak and preoccupied status quo governments and domestic troublemakers out to turn attention away from problems at home.

The obvious antidote is for Gulf oil producers to accelerate structural socioeconomic reforms. But such changes are pain-ful, and so the counterargument is to cushion the blow of hard times now and wait until the situation improves before under-taking needed reforms—advice that is tempting to those who wish to postpone taking difficult steps. However, in Gulf debates about what approach to take, Washington’s advice is not likely to be sought out or listened to. The U.S. government has few policy levers with which to influence how Gulf countries deal with their domestic problems, especially when Gulf governments are uncertain of how committed Washington is to protecting their security.

Other Potential Problems

Outside the impact of the new oil situation on U.S. Middle East policy, higher oil and gas production offers the United States many positive features, not least of which are higher incomes and more jobs. That said, it is worth briefly noting two other potential prob-lems for U.S. interests from the new oil environment: instability in the global oil business and complications for countering global climate change.

On the first count, the sharp drop in prices could spark an equally steep climb within a few years. Claudio Descalzi, chief executive of ENI, warned in December 2015, “A big gap is forming in oil industry investment. That will lead in two to three years to an imbalance between supply and demand that will push prices higher.”3 This theme was developed at length by Prince Abdulaziz bin Salman, the Saudi vice minister of energy, industry, and min-eral resources:

Disadvantages of the New Oil Situation

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Just as the assertions heard a few years ago that the oil price would reach $200 a barrel were proved wrong, so the recent assertion that oil prices have shifted to a new low structural equilibrium will also turn out to have been wrong...Rather than being a commodity in decline, as some would like to portray, supply and demand patterns indicate that the long-term fundamentals of the oil complex remain robust...Previous cycles have shown that the impact of low oil prices is long-lasting...During sharp downturns, the industry tends to lose talent, technical expertise, financial resilience, and the confi-dence to embark on new investments...Around $200 billion of investments in energy have been canceled this year...This is the first time since the mid-1980s that the oil and gas industry will have cut investments in two consecutive years...Nearly 5 mb/d of projects have been deferred or canceled.4

Yo-yoing oil prices create a burden for producers, consumers, and financers. While the price drop in recent years has benefited consumers, it has caused severe dislocations. The loss of oil industry jobs—250,000 worldwide, according to a widely cited study5—has not been trivial. Banks and investors have lost much, both directly in the oil and gas business and in related infrastructure, such as housing for oil field workers. By some estimates, a trillion dollars has been invested in U.S. shale, much of it now of dubious profitability.6 Were prices to shoot up, the economic dislocation would also be severe as consumers turned away from energy-intense products like gas-guzzling vehicles. U.S. and Middle East economies will be ill served if the new oil situation turns out at least as unstable as in the 1970s and 1980s, when OPEC so strongly influenced world oil prices.

The second complication of the new oil situation is the impact on combating climate change, in line with U.S. commitments to that end. If U.S. oil and gas production is growing rapidly, it will be hard to explain both at home and abroad how that development meshes with U.S. pledges to reduce carbon emissions. Furthermore, to the extent that the United States has a larger domestic oil business that could view climate-control measures unfavorably, it may be more challenging to forge a broad political consensus to act on the

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matter. Some parts of the energy industry accept—and in some cases embrace—tighter regulations. For instance, some larger firms have been open to changing fracking practices to reduce methane gas release and small earthquakes. Other parts of the energy industry bitterly resist what they see as burdensome regulations, as illustrated by the complaints about the “war on coal.”

Given the various potential problems that arise from the new oil situation, the challenge for U.S. policymakers is to find measures that limit the negative impacts and take full advantage of the opportunities created by lesser U.S. reliance on imported energy.

Disadvantages of the New Oil Situation

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Maximizing Opportunities, Minimizing Disadvantages

to put in context the impact of energy on U.S. policy in the region, Washington should actively shape expectations at home, in the region, and around the world regarding U.S. policy in the Middle East. It is not enough to let actions speak for themselves. In particular:

� Americans need to hear more often and more clearly the non-energy reasons for an active U.S. role in the Middle East. It may seem peculiar that a mere fifteen years after the 9/11 attacks, Americans need to be reminded that Middle East instability can threaten the U.S. homeland, but the American people do not have long memories.

� Middle Easterners need to be frequently reminded by U.S. officials from the highest level on down how substantial the U.S. commitment is to the region—how extensive are the U.S. military assets deployed there, how much time and effort top U.S. officials devote to the region, and how central the region is to U.S. concerns. Washington needs to explain that smaller military deployments do not reflect a lack of commitment but rather skepticism over whether larger deployments would serve a better purpose. While a massive U.S. military pres-ence may address immediate problems, creating political solu-tions and viable local security forces represents a better long- term approach.

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Maximizing Opportunities, Minimizing Disadvantages

� The world as a whole needs clear and frequent explanations that the United States remains willing and able to play an active role in several regions at the same time—that a greater U.S. diplomatic and military presence in East Asia or East-ern Europe is a complement to an active role in the Middle East, not a replacement. Especially as the United States faces greater challenges from a resurgent Russia and an ambitious China, steps demonstrating U.S. resolve in any region will redound to deter aggression in other regions as well.

� U.S. friends, both in the region and around the world, need to be frequently consulted—which means “listened to”—not just seen. Washington needs to consider how its words sound to U.S. friends that stake their national security on the reliability of U.S. commitments. If U.S. friends are wor-ried about the durability and depth of the U.S. commitment to their security, Washington must take such worries seri-ously and work together with those U.S. friends to address their concerns.

Finally, the U.S. government should keep the big picture firmly in mind. Reducing U.S. reliance on imported energy has been a goal of every U.S. president for more than forty years. Greater production of oil and gas in the United States, along with restrained demand thanks to greater efficiency, enables the United States to accomplish more in the Middle East. Therefore, U.S. interests in the Middle East are better served if U.S. policy promotes ways to increase U.S. oil and gas production. That path requires achieving greater domestic political consensus on how to reconcile this objective with environmental concerns, such as combating climate change and reducing harmful impacts from oil production and transport. Too often, these different objectives are presented as inherently contradictory, when the more fruitful way is to ask what can be done to simultaneously achieve greater environmental protection and higher oil or gas output. Technological improvements can do much to advance both goals at the same time. Indeed, unexpected technological progress swiftly revolutionized U.S. oil and gas output in a way few, if any, expected. The public policy objective should be

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to find similar ways to revolutionize the environmental impact of oil and gas production—to sharply reduce their impact on the global climate and the harmful side effects from extraction and transport. Such a course requires not just resources invested in technological improvements but, arguably more important, a spirit of cooperation from all concerned. All too often, as exemplified by the years-long nasty debate about the Keystone XL pipeline, time and money go to opposing the other side—to “build nothing anywhere anytime” or to “no regulations of any sort”—rather than to exploring what can be done to accomplish both environmental and production objectives. Government bodies should make decisions expeditiously and not be swayed by uninformed dogmatism.

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Analysis: World and U.S. Oil and Gas Outlook

recent years have seen unexpected, dramatic developments regarding oil and gas. First came the remarkable 2010–2014 rapid growth in U.S. oil and gas production driven by technological advances. Then came the abrupt decline of oil prices in late 2014, which led to cancellations of projects outside the United States worth several hundred billion dollars but has to date had less impact on U.S. production.

The future is at least as uncertain because of prospective price volatility, continuing technological innovation, possible slowdown in the growth of global oil demand, and potential actions to com-bat climate change. A recent IMF report noted that uncertainty about the oil price is so great that the price can only be confidently estimated within a very wide range, as shown in Figure 4. Lead-ing forecasters do not at all agree; indeed, many present as entirely possible scenarios with very different projections. If the turbulent markets of recent years carry any consensus, it is that one should expect surprises. Policymakers would be well advised to hedge their bets rather than assuming any particular outcome is assured. With that in mind, this note outlines where the U.S. and world oil and gas situation may be heading, emphasizing the uncer-tainties—and therefore the need to be prepared for a wide range of possibilities.

No matter what happens to prices, for years to come the Middle East will certainly remain an important world supplier of oil and

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gas. Much less clear is what role the Middle East will play in sup-plying the U.S. market.

The prospects also suggest that oil supplies will be ample. As the International Energy Agency puts it: 7

It is becoming even more obvious that the prevailing wisdom of just a few years ago that “peak oil supply” would cause oil prices to rise relentlessly as output struggled to keep pace with ever-rising demand was wrong. Today we are seeing not just an abundance of resources in the ground but also tremendous technical innovation that enables companies to bring oil to the market. Added to this is a remorseless down-ward pressure on costs and, although we are currently see-ing major cutbacks in oil investments, there is no doubt that many projects currently on hold will be re-evaluated and will see the light of day at lower costs than were thought possible just a few years ago. The world of peak oil supply has been turned on its head, due to structural changes in the econo-mies of key developing countries and major efforts to improve energy efficiency everywhere.

0

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95% con�dence interval86% con�dence interval68% con�dence intervalBrent futures

Brent Crude Oil (U.S. dollars a barrel)

Sources: Bloomberg; IMF sta� calculations.

Figure 4

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World and U.S. Oil and Gas Outlook

For this reason, some think low prices will be a structural feature of the oil and gas business for the foreseeable future. Perhaps that view is correct and low prices will persist, reflecting the pattern of decades ago. The BP Statistical Review of World Energy (the source of all data used here unless otherwise noted) shows that, in 2015 terms, oil prices were at $13–19 per barrel almost every year from the late 1920s until 1973.8

But the authors share the IEA’s view that “it is very tempting, but also very dangerous, to declare that we are in a new era of lower oil prices.”9 The cycle of the last four decades has been one of prices rising and falling. Expanding on the earlier reference to low prices only, the mantra in the business has become “The one sure cure for high oil prices is high oil prices; the one sure cure for low oil prices is low oil prices”—the point being that low oil prices increase demand and suppress supply growth, leading to tighter markets and there-fore higher prices, with the same pattern also working in reverse. That formula, however, tells us little, because both the frequency and the amplitude of the cycles have been so variable. After 1973, the price shot up for twelve years, mostly being in the $50–70 range, though spiking to $93–106 in 1979–1981. For the eighteen years from 1986 through 2003, prices were much lower, mostly in the $30–40 range, though cratering to $18 in 1998. Then, for the eleven years from 2004 through 2014, prices rose sharply, most often occupying the $80–117 range. While no one can be sure how long present low prices will last, the cyclical pattern of recent decades could well be sustained—that is, prices are not likely to be stable over the long term. Still, the cycle could take some years to turn. It is by no means certain that within a relatively short time, oil, much less gas, prices will regain much of the ground they gave up in 2014–2015. No one should count on oil prices reaching $100 per barrel any time before the next decade, at the earliest—perhaps it will happen, but betting on it would be risky.

Along with the certainty that the Middle East will remain a global gas and oil supplier for years to come, it is certain that decisions in the Middle East about oil production will substantially affect world oil prices. Likewise, oil prices in the United States will continue to be shaped by the world market, irrespective of U.S. oil production

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Energizing Policy

or import levels. Finally, most U.S. oil imports will still come from areas others than the Middle East. While all these statements can be made with great confidence, the future Middle East role in supply-ing the U.S. oil market, as noted, is far from clear.

As this paper has reiterated, U.S. dependence on imported oil has fallen dramatically in recent years. If one adopts the broad defini-tion of oil used in this report,10 then 2015 U.S. oil production rose 70 percent from the 2008 low point before plateauing in 2015. In 2015, using the broad definition of oil rather than just looking at crude oil, U.S. oil production exceeded that of Saudi Arabia, and U.S. imports were about one-third of U.S. consumption compared to two-thirds in 2008. Furthermore, U.S. gas production rose 50 percent from the 2005 recent low to 2015, with production equaling 99 percent of U.S. con-sumption. The first question, then, is whether U.S. production will remain this high or continue to grow over the medium term, defined as the next five years. The even more difficult question involves pros-pects for the longer term—the next twenty to twenty-five years.

While the primary focus here is on oil, a secondary focus is on nat-ural gas. While natural gas does not have the same integrated world market as does oil, and while the United States has never imported more than very minor amounts of natural gas from the Middle East, the role of gas may be changing to become more of a substitute for oil. Part of the reason is price. As recently as 2005, natural gas was priced more than oil for an equivalent amount of energy, but then it became much cheaper than oil on the U.S. market, until oil prices tanked and the differential shrank. Especially if oil prices recover considerably, gas could become again less expensive than oil on the U.S. market. Were consumers convinced that this situation would persist, gas could become more widely used in place of oil for indus-try and surface transportation, theoretically having the potential to replace up to a quarter of U.S. oil consumption. At present, however, any conversion on that scale seems unlikely, because the transition would require considerable investment by consumers, who may be reluctant to grant it given an uncertain price differential between oil and gas prices.

Because of the Middle East’s small role in coal, nuclear power, and renewables, this discussion excludes those energy sources,

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however profound their implications for global warming. To be sure, enthusiasts in Europe and the United States are pressing for renewables and energy conservation to dramatically reduce demand for electricity produced by gas—little electricity is produced with oil—and such a development could change the gas business.

Medium Term: The Next Five Years

Until the dramatic halving in oil prices from July to December 2014,11 the five-year trend lines for U.S. oil production and consump-tion seemed relatively clear, with production rising briskly and con-sumption relatively flat. The consensus among forecasters should have been a warning; oil markets rarely behave as expected. It is sobering to note that few analysts predicted the dramatic increases in U.S. oil output that started in 2008, and even fewer forecast the price drop of late 2014. In November 2014, the highly respected and cautious IEA’s World Energy Outlook 2014 showed a wide range for oil prices from 2014 to 2040, but that range was from $100 to $150 per barrel; not one word suggested the price could actually drop well below that range, and soon.

Much of the recent change in the U.S. oil picture has come from soaring oil production, primarily because of new technologies for hydraulic fracturing, or fracking. (Such oil, commonly referred to as “shale oil,” is more accurately known as “light tight oil” or LTO.) Until the price drop, production seemed quite certain to continue increasing rapidly for the medium term. The IEA’s June 2013 Medium-Term Oil Market Report forecast that U.S. oil output would increase by 1.7 mbd over six years.12 A year later, that figure was revised up to 2.8 mbd—an extraordinary forecast rise for only a few years out. Despite the declining oil prices, the June 2015 edition of the same annual IEA report showed the 2013–2019 increase as an additional 0.6 mbd. In other words, over a two-year period when oil prices declined precipi-tously, the IEA increased its forecast for U.S. 2019 oil production by 3.4 mbd. Another way of looking at the impact of price on U.S. tight oil production is the IEA’s estimate of the impact if the price varies from $40 to $100, as shown in Figure 5.

World and U.S. Oil and Gas Outlook

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2

1

0

-1

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-3$40/bbl $50/bbl $60/bbl $70/bbl $80/bbl $90/bbl $100/bbl

Indicative supply response of U.S. light oil for the period 2014–20, based on costsin the New Policies Scenario, for a range of 2020 oil prices.

Note: The price level (in year 2014 dollars) is a 2020 price; the underlying assumptiion on production costs are those from the New Policies Scenario.

Source: IEA analysis based on Rystad Energy AS.

(million barrels/day)

Figure 5

Despite the price decline since mid-2014, analysts and U.S. business circles remain confident that U.S. oil output will remain robust in the medium term. To quote the IEA’s Medium-Term Oil Market Report 2016, “Anybody who believes that we have seen the last of rising LTO production in the United States should think again; by the end of our forecast in 2021, total U.S. liquids produc-tion will have increased by a net 1.3 mbd compared to 2015.”13 Con-tinuing low crude prices will, of course, depress production and even more so investment, but much of the impact may be offset by cost savings as technology improves and the industry matures. Whereas the common view in 2013 seemed to be that the break-even price for U.S. LTO was around $80 per barrel, by late 2014 analysts concluded that much U.S. LTO would be profitable at $50 per barrel and significant amounts would be profitable at $40.14

By some estimates, productivity in U.S. shale output rose 40 per-cent in 2015. A modest increase in oil prices could therefore bring onto the market significant quantities of LTO—conceivably, a sustained $60 oil price could lead to an additional 1.0 mbd in U.S.

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output. Plus, it is possible that LTO production will decline only modestly even at lower prices. Indeed, the trend toward lower costs may well continue.15 And the natural gas associated with LTO may keep projects profitable even as crude prices drop. But all this depends on how far crude prices fall. Recall the stark real-ity that oil was priced in the mid-$20s in 2002.

Besides price and technological advances, U.S. oil production will depend on general economic conditions and government pol-icy stances. Regarding the overall economic climate, the key factor may be the interest rate, since many oil producers remain highly leveraged. Regarding policy, the main factors that may slow output growth are regulatory:

� ENVIRONMENTAL LIMITS. Some circles are generally hostile toward oil production because of its role in global warming. Particular concerns have been voiced about fracking and off-shore Arctic drilling. De facto or formal bans on fracking are already in place at the state level in New York and locally in towns such as Boulder, Colorado; these bans could spread, including through referenda. Democratic presidential candi-date Hillary Clinton promises to take a tough stance on frack-ing, as did her main competitor, Bernie Sanders.

� PIPELINES AND RAIL REGULATION. Opposition to the Key-stone XL pipeline has reflected and fed a general concern about the environmental impact of pipelines. This concern may slow the approval process for other pipelines, as may dis-putes about land taken by eminent domain. Meanwhile, rail transport of oil could face significant regulatory barriers if more disasters occur like the July 2013 incident at Lac-Megan-tic, Quebec, when exploding derailed containers killed forty-seven people.

Perhaps despite the partisan atmosphere in U.S. politics, these regulatory issues will be resolved. That happened in December 2015 regarding the law lifting the de facto U.S. ban on crude exports, a change that will facilitate exporting fracked oil—which as its for-

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mal name suggests is quite light—while importing heavy crude for the multibillion-dollar Gulf of Mexico refineries designed to use that type of crude. But this experience is by no means certain to be repeated for other regulatory issues. Lifting the crude export ban took a great deal of political effort, even though relative to other regulatory disputes, the benefits were quite large and the downside much smaller. Future political disputes may instead follow the Key-stone XL pattern: years of inaction before a decision that, as the final U.S. government statement frankly noted, was based on political symbolism rather than technical arguments.

Even if low prices persist, U.S. natural gas production is sure to rise for the medium term, as already noted. In early 2016, exports from the contiguous United States began, as the Sabine Pass LNG facility in Louisiana came online.16 By the end of the decade, the United States may well become the third largest exporter of LNG after Qatar and Australia, the result of investment decisions made when gas prices were much higher than they are today. The price of LNG delivered in Japan and South Korea, two of the largest mar-kets, has dropped from $19 per million British thermal units (Btu) in 2014 to $6.65 in January 2016, while the benchmark British price has dropped in half since 2013 to about $5.20 per million Btu. Figure 6 makes the same point with gas prices restated as the equivalent of barrels of oil. At such prices, U.S. exports are not competitive, requiring $5 just for liquefaction and transport. However, the deci-sion to build LNG export facilities made when prices were higher means those facilities will be available, and because their variable costs are rather low, they will be used even if prices are insufficient to cover all capital costs.

While medium-term U.S. oil production seems likely to stay high, consumption is unlikely to grow much, if at all. The Energy Department’s Energy Information Administration, in its International Energy Outlook 2016, published in May, forecasts that despite lower prices, U.S. oil demand in 2020 will be only 6 percent higher than in 2012.17 In particular, it estimates that the energy demand for ground transportation will change little, primarily because higher fuel-effi-ciency standards offset much of the growth that can be expected from lower prices.

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Outside the United States, anything but small growth in oil pro-duction through the medium term is hard to foresee. The picture is particularly gloomy for producers outside OPEC. If investors expect crude prices to remain low for some years, the most vulnerable pro-duction will be high-cost oil outside the United States in complex large-scale projects and in Canada’s tar sands.18 In 2015, projects prospectively funded with hundreds of billions of dollars were post-poned or canceled. Even if prices are expected to recover, produc-tion growth could be slowed by continuing or intensified sanctions on Russia, and by technical or organizational delays hitting major projects such as those in the deep waters off Brazil, the Kashagan project in the Kazakh portion of the Caspian Sea, or the Australian-shale-fed LNG plants.

In contrast to this falloff in non-OPEC output, OPEC oil output may grow modestly. The IEA’s Medium-Term Oil Market Report 2016 predicted that OPEC will sell 2 mbd more in 2021 compared to in 2015.19 That outcome, the IEA forecasts, would leave OPEC coun-tries in 2020 with more than 4 mbd in spare capacity even in the unlikely event Iran’s capacity remains flat over the period and mak-ing modest assumptions about capacity increases in Iraq. Given that, in fact, Iran’s capacity will likely grow by up to 1 mbd and that several major OPEC producers are discussing freezing output for a while, OPEC spare capacity may well continue to grow for some years. In such a case, any increase in the world market oil price would be driven in no small part by the political decision of major producers to withhold output from the market, rather than from a tightening in the underlying supply-demand balance. An irony of any such producer-driven price increase is that a major beneficiary of higher prices would be U.S. shale oil producers. As noted earlier, a price increase to $60 could lead to a 1 mbd increase in U.S. output, which would pose a considerable challenge to any producer effort to raise prices.

Matching the uncertainty about production is an unclear pic-ture about demand, in part because of the distinct possibility that economic growth could slow more than anticipated in key markets, whether in China, other emerging markets, the European Union, or all of the above. And the IEA’s Medium-Term Oil Market Report 2015

37

explains why demand growth may stay low even if the overall economy grows: “The global economy, reshaped by the informa-tion technology revolution, has generally become less fuel intensive. Concerns over climate change are recasting energy policies. And the globalization of the natural gas market, coupled with steep reduc-tions in the cost and availability of renewable energy, are causing oil to face a level of inter-fuel competition that would have seemed unfathomable a few years ago.”20

In sum, while the 2014–2015 crude price declines highlight the unpredictability of the oil business, a likely medium-term scenario is continuing high U.S. oil and gas production and modest U.S. demand growth, such that the oil import share remains no more than one-third and the United States becomes fully self-sufficient in gas, if not a modest gas exporter. As for the world market balance, the most likely prospect is that markets will remain amply supplied for some years and, barring a Middle East political crisis, oil prices will not return soon to the 2011–2013 levels exceeding $100 per bar-rel. But while these prospects appear most likely, the oil industry has repeatedly produced surprises.

Longer Term: Beyond Five Years

The aim of this paper is to inform a discussion about geopolitics, not to predict how energy markets will evolve. So rather than pre-senting a forecast, what follows are two scenarios designed to show the range of oil possibilities as they affect global geopolitics—to set the maximum and minimum extent to which the oil picture may change. The scenarios, as far apart as plausible in their geopolitical impact, are

� “great change,” meaning the United States exports oil and the Middle East’s role in world energy markets declines; and

� “little change,” meaning the U.S. oil and gas balance does not change much and the Middle East’s role in world energy mar-kets is reinforced.

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To understand better what may make one scenario or the other more likely, this section examines two sets of issues: first, the key drivers affecting one outcome or the other; second, the likely inflection points over the next five to twenty-five years when these drivers will make their influence felt. The key drivers are of several types:

� Price volatility and price levels

� Technologies, especially in ground transportation, energy production, and electricity storage

� Policies, such as resource nationalism in important producer countries, which inhibits investment; carbon-limitation policies for climate change reasons; and environmental concerns that reduce production expansion (e.g., restrictions on fracking)

� External shocks that affect oil and natural gas balances, such as secular stagnation of the world economy or war in the Mid-dle East or East Asia

On many subjects, Washington analysts are inclined to assume that policies and external shocks are the wild cards that can upend forecasts. And, indeed, the world oil scene has seen many external shocks and profound policy shifts. The main driver in the 2014–2015 price decline seems to have been a policy shift by OPEC countries, particularly Saudi Arabia. Yet interestingly, almost all the oil ana-lysts consulted for this project contended that the great unknown for the long-term oil picture is technology as much as policies or external shocks. The authors are in no position to judge how much technology may change or where prices will go; all that can be noted are the sorts of possibilities being taken seriously by oil industry watchers. To a considerable extent, the gap between the two sce-narios sketched out below rests on different pictures of where tech-nology and prices will go.

As for the inflection points, energy experts broadly agreed that the factors causing divergence between the two scenarios would

39

likely kick in a decade or more from now, and their full impact could take something like two decades to materialize. After all, price changes affect investment decisions most and therefore have an impact on production capacity years later. Many of the technologi-cal changes that could drive the “great change” scenario will likely be felt more fully in thirty years than in ten years. So the inflection points for the technological drivers are some decades away. By con-trast, external shocks could result in a sharp discontinuity much sooner, although even a profound shock like the 1973 oil crisis argu-ably took more than a decade to work its way through the world economy and the oil industry. The impact of changing policies would probably fall somewhere in between: possibly having influ-ence within a few years, but more likely making itself felt more fully after several more years.

Looking out on the five- to twenty-five-year horizon, one fact is clear: barring radical political change, the Middle East is likely to remain the world’s largest supplier of oil. The simple reason is that its reserves are big and its production costs lower than anywhere else in the world.

Beyond the region’s continued dominance, the picture becomes less clear. What will happen to production in twenty or twenty-five years is highly speculative, depending on geology, technologi-cal advances, business conditions, and political shifts. Much 2035 oil will come from yet-to-be-developed and yet-to-be-found fields.21

Uncertainties on the demand side are possibly as great as those on the supply side (see Figure 7). Oil demand will probably fall in the advanced industrial countries that belong to the Organisation for Economic Co-operation and Development (OECD), depending on efficiency, fuel substitution, and demographic changes. Demand will certainly rise in non-OECD countries, due in particular to the great number of cars and trucks in China and India. How much demand grows in these countries depends on how rapidly the econ-omies grow and how much energy efficiency increases. For instance, oil use in cars depends on how far countries go in replacing fuel subsidies with fuel taxes, how intensely owners use their cars, how fuel-efficient the vehicles are, and to what extent oil is replaced by other fuels.

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Energy Intensity 1970–2040boe/$1,000 (2011 PPP)

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Figure 7

Some of the most widely consulted forecasts are by the Paris-based IEA, the U.S. Energy Information Administration, and the international oil company BP:22

� The IEA’s annual World Energy Outlook has usually presented three forecasts, depending on what policies are implemented to address global warming, although the 2015 report added a low-price scenario. The central scenario is the “new policies scenario,” which involves modest steps, many of them now under way. In this scenario in the World Energy Outlook 2015, U.S. oil demand in 2040 would be 13.1 mbd, 4.4 mbd less than in 2014, while U.S. production (including biofuels) would be 11.6 mbd, 0.7 mbd lower than in 2014, with the result that net imports would be 1.5 mbd. Two other scenarios are the “cur-rent policies scenario” and a far-reaching climate-change-avoiding scenario. The report strongly suggests that under current policies, the United States would in 2040 import a modest amount of oil; under climate-change-avoiding poli-cies, it would import somewhat more.23 In the low-oil-price scenario, in which prices remain below $90 per barrel through

41

2040 (in 2014 dollars) rather than rebounding to $125, U.S. oil demand is 0.9 mbd higher in 2040.24

� The EIA’s Annual Energy Outlook 2015 presents quite a number of cases, with the range of differences among the forecasts being much larger than in the forecasts made in previous years, as shown in Figure 8. For instance, the “high oil and gas resource” scenario shows U.S. oil output at 26 mbd, 10 mbd higher than the reference case.25 The difference is hardly trivial: 10 mbd is just over half of projected U.S. consumption, which is about 19 mbd in both cases. In that high oil and gas resource sce-nario, the United States would export rather more than 6 mbd of oil on a net base. By contrast, in the low-oil-price case, the United States would in 2040 import 8 mbd of oil on a net basis. These estimates reflect an extraordinary range—from 6 mbd of exports to 8 mbd of imports. Adding in natural gas only expands the range of forecasts, because the 2040 gas exports in the high oil and gas resource case are predicted to be the energy equivalent of 6 mbd, while in the low-price case the exports

20 History 2013 Projections

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U.S. Tight Oil Production in Four Cases, 2005-40(millions of barrels/day)

Source: U.S. EIA Annual Energy Outlook 2015

Figure 8

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would be the energy equivalent of 2 mbd. The high oil and gas resource case would mark a dramatic shift in world energy power relations; at 12 mbd of oil equivalent, U.S. oil and gas exports would make the United States by far the world’s larg-est energy exporter. By contrast, the low-oil-price case would leave the United States as a major oil importer; indeed, imports would be a higher proportion of consumption than at present. The EIA’s International Energy Outlook 2016 presents updated esti-mates of the impact of oil prices being low or high, but it does not include a high oil and gas resource case (see Figure 9).

� BP’s Energy Outlook 2016 predicts the United States will become self-sufficient in oil by 2030 before becoming a net exporter, further predicting that through 2035, U.S. oil output will increase by the same amount as OPEC output. Meanwhile, one of the three alternative scenarios BP presents is that shale oil output will grow more rapidly, with U.S. oil exports of about 2 mbd in 2035. In explaining why it considered such a case, BP notes it has consistently underestimated U.S. shale oil prospects. In 2013, BP expected 2025 U.S. shale oil output to be 3.5 mbd; in 2015, 5 mbd; and in 2016, 7 mbd. Further-more, BP now expects U.S. shale oil output to continue rising until 2035, as far out as it forecasts, rather than peaking and declining. BP also expects the United States to export 20 per-cent of its gas output by 2030.

The “Great Change” Scenario

This scenario assumes that oil prices recover within a few years to above present levels, though presumably below the previous peak of $117 at 2014 prices. The scenario further assumes that this price rebound comes from either more robust demand growth—say, from more rapid world economic growth—or action by Middle East oil producers at least as much as from the cancellation of planned investments outside the Middle East.

U.S. OIL BALANCE: Perhaps the greatest distinction between the “great change” and “little change” scenarios involves the U.S. oil bal-ance. In the former scenario, U.S. oil production could continue to rise

43

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through the long term. LTO is the biggest potential source, but sig-nificant increases could come from tight natural gas liquids, biofuels, Gulf of Mexico deepwater fields, and, more speculatively, the offshore Arctic. The main driver for such an outcome is continuing technol-ogy improvements. An important contributing factor for increasing production would be a permissive policy environment in which con-cerns about fracking are either resolved or overridden, crude exports are permitted in one shape or another, and transportation infrastruc-ture (pipelines and rail) expands at an adequate pace and reasonable cost. Another major contributor to rapid growth would be continu-ing reductions in production costs, driven by technology and better industry practices. Additionally, a rebound in U.S. natural gas prices could add to the profitability of LTO fields with associated gas.

At the same time, U.S. oil demand could drop substantially as efficiency rises, assuming that the post-2019 Corporate Average Fuel Economy (CAFE) increases come into effect and perhaps are extended. Further savings, especially later on, could come from other fuels, such as natural gas or electricity, substituting for oil in vehicles. In addition to these technological changes, other factors constraining demand would be policies, specifically the continued rise in CAFE standards after 2020 and vigorous promotion of elec-tric passenger cars; and (2) changing demographics and consumer preferences, such as lower vehicle miles traveled per car.

Depending on what changes occur on the production and con-sumption sides, the United States could become a significant oil exporter.26 A project team from the energy consultant IHS, led by Daniel Yergin, concluded that potential production increases alone could result in U.S. net exports of more than 3 mbd by the late 2020s. Presumably, greater efficiency gains on both the consump-tion and production sides could drive that figure higher still. To take an extreme example, if 2040 production met the EIA “high oil and gas resource” case and demand were as low as in the IEA “new policies scenario,” the United States would be a net oil exporter of 13 mbd, which would make it, rather than Saudi Arabia, the world’s largest oil exporter, plus the United States would export the energy equivalent of 7 mbd of gas. While that combination seems highly unlikely, the broad consensus seems to be that the United States

45

will become at least self-sufficient in oil. Of course, the broad con-sensus forecast has repeatedly been wrong.

By some estimates, new U.S. technology is enabling the domestic oil industry to bring 2 mbd of production online within two years, although the IEA remains skeptical.27 If the United States meets such estimates, the output, combined with 700 million barrels in the Strategic Petroleum Reserve, would amount, in effect, to 2 mbd of spare capacity. That would make Saudi spare capacity less impor-tant as a factor stabilizing oil markets, and therefore reduce the geo-political importance of Saudi spare capacity.

OUTSIDE THE UNITED STATES AND MIDDLE EAST: Some of the biggest prospects for global production increases are expensive projects outside the United States and the Middle East. In this “great change” scenario, world oil prices would be sufficient to make these projects attractive, and the political and organiza-tional obstacles would be overcome. Plus, some production would come from more speculative possibilities, such as offshore Africa, the Arctic, or imitation of the U.S. shale revolution. Political fac-tors could lead some countries to emphasize expanding domestic output even where not especially remunerative; for instance, some Chinese leaders seem uncomfortable with the country’s predicted heavy dependence on imports. And the expected declines in out-put in aging fields could be reversed if technology improves or, usually more important, governments boost incentives. Combin-ing all these factors, the non-U.S., non–Middle East output would expand substantially more than the modest increase forecast by the IEA. This scenario also assumes that large-scale gas invest-ments in several parts of the world outside the Middle East and the United States—Australia, Canada, and Russia most of all—cause gas production to rise sharply.

While oil demand in the non-OECD countries will grow, demand may grow more modestly if world economic growth is slow, oil subsidies are phased out, oil taxes are raised, vehicle and building efficiency increases, or other fuels substitute for oil. Slower Chi-nese economic growth could curtail demand growth there, as could successful Chinese efforts to shift toward renewables and nuclear power in place of coal, rather than to natural gas.

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In the event this “great change” scenario occurs, the OECD coun-tries as a group might not import much petroleum. It is conceivable that U.S. production will be enough to make the OECD oil self-suf-ficient. The OECD strategic reserves would then provide consider-able safety against oil shocks.

MIDDLE EAST OIL BALANCE: Even in a world where much changes, the Middle East will continue to provide much of the world’s oil. As mentioned previously, production there is substantially cheaper than elsewhere. And arguably, the Middle East would remain best posi-tioned to move the price of oil because countries in the region—espe-cially Saudi Arabia—may continue to have the great majority of the world’s spare capacity. By bringing more production online, Middle East producers could provoke a sharp price fall, and by keeping more capacity off-line, they could support a much higher price. At present, they seem unlikely to follow either of these routes, but the region pro-duces many surprises.

If the previously discussed demand constraints and production increases all came into play, the amount of Middle East oil required to balance global demand and supply—the “call on Middle East oil”—could fall from the 2014 level of 28 mbd to perhaps 25 mbd or less. That scenario of declining production would fit poorly with the region’s announced plans. That said, continuing potential hindrances to increased production capacity and causes of perhaps reduced capacity include indecision and political infighting (as in Kuwait), a poor business environment in Iran (due to poor business terms and continuing U.S. nonnuclear sanctions), Iraqi resource nationalism (e.g., disputes between the Kurds and Baghdad, suspicions about international oil companies), and Saudi reluctance to invest.

The “Little Change” Scenario

In this scenario, increases in U.S. oil production would come to a halt while demand remained buoyant, such that the United States would continue importing about the same amount and share of its oil as at present. The Middle East would remain an extraordinarily important oil supplier to the world, one able to readily shape prices.

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U.S. OIL BALANCE: Some analysts have raised the prospect that rapidly growing U.S. production will be relatively short-lived—for instance, the IEA has long argued that this was the most likely case. In this scenario, U.S. oil production would peak as early as 2020 and then slowly decline. The tight oil revolution would turn out to have run its course, and production from each tight oil field would decline relatively rapidly. Volatile or low prices would discourage investment, including investment in improving technology. Meanwhile, demand for oil would rise, albeit slowly, fed by growing industrial demand and a slower phase-in of the currently envisaged CAFE increase. Oil would continue to dominate ground transportation; natural gas and electricity would make little headway, with volatile or low prices undercutting investment in other fuels. The overall impact would be similar to the EIA reference case: U.S. oil production, consumption, and imports would all grow modestly, and the share of U.S. oil from abroad would be about the same as today.

OUTSIDE THE UNITED STATES AND MIDDLE EAST: This scenario implies that oil demand will continue growing at a fast clip in China and India. Such an outcome would appear likely if Chinese economic growth resumes its fast pace and other emerging markets also pick up. The scenario rests on two other assumptions: that China and India see substantial increases in numbers of cars and trucks as they become more prosperous and urban; and that gasoline remains the fuel for nearly all such vehicles, given that existing infrastructure is locked in to using gasoline and price volatility discourages investment in experimental technology or technological improvements.

In this scenario, oil supplies from outside the Middle East would grow at a modest pace. This fits the forecast in the IEA’s World Energy Outlook 2015, which predicts that increased output in some countries will be offset by declines in Russia, Mexico, China, and the North Sea. That forecast could be made more likely by investor worries over potentially volatile prices and sustained periods of low prices. These concerns would affect long-term investment decisions in large projects from the Russian Arctic to deepwater Brazil and off-shore East Africa.

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MIDDLE EAST OIL BALANCE: In this scenario, Middle East oil pro-duction would rise briskly as the previously described barriers to such increases are overcome. Such a development presumably would include a very considerable increase in Iraqi oil production, imply-ing stability in the Shiite-dominated south and perhaps the Kurdish region—though not necessarily unity. Furthermore, Middle East oil demand growth may be slowed by reforms such as mandated effi-ciency increases and subsidy phaseouts.

As many forecasts suggest, in this scenario the call on Middle East oil will grow. In fact, the needed amounts from the region could be spectacularly higher, as many forecast only a few years ago, rather than the more modest increases in most of today’s predictions. The IEA’s “new policies scenario” predicts that demand for Gulf oil in 2040 will be 37 mbd (including 13 mbd from Saudi Arabia and 8 mbd from Iraq) compared to 28 mbd in 2014, while its “current poli-cies scenario” predicts 42 mbd. Its low-price scenario has as “a very important component” higher Middle East investment in expanding production capacity to preserve or increase market share.

This scenario is particularly likely if oil prices remain low. And Saudi Arabia could quite conceivably favor sustained low prices as a way of reasserting its central role in world oil markets and driving out marginal producers. While low prices would press the Saudi budget into deficit, the kingdom’s favorable macroeconomic situation posi-tions it well for riding out years of prices well below the 2016 levels.

* * *As a final note about the data, it is worth pointing out how the

“hydrocarbon” world—combining oil and gas—looks quite differ-ent than the oil world. As explained earlier, oil and gas are becom-ing increasingly interlinked, though that process is by no means complete. Considered together as in Figure 10, the role of the Mid-dle East in world production is large but not overwhelming while the U.S. share rises: U.S. combined oil and gas production is two-thirds that of the Middle East, compared to 40% for oil alone. And on the consumption side, as shown in Figure 11, the share of Rus-sian consumption rises sharply, though still modest at just under seven percent of the global total.

Turning to the forecast, the two scenarios outlined in this

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report differ substantially. Even if price volatility abates, the pace and substance of technological change represent major unknowns that impede accurate forecast ing on oil markets globally and in the United States. The full scope of possible long-term technological improvements will probably not become apparent until a number of years from now, and there may be few early indicators of the direction in which energy mar kets will evolve.

The two scenarios outlined in this report differ substantially. Even if price volatility abates, the pace and substance of technolog-ical change represent major unknowns that impede accurate fore-casting on oil markets globally and in the United States. The full scope of possible long-term technological improvements will prob-ably not become apparent until a number of years from now, and there may be few early indicators of the direction in which energy markets will evolve.

While the most likely outcome may be somewhere in between the two outlined scenarios, each of the two extremes appears plausible. Through 2012, the “little change” scenario probably reflected conventional wisdom, but the balance shifted by 2014 toward the “great change” scenario, with many executives and analysts privately predicting more change than their published papers let on. As the 2014 price decline persisted, the consensus view has reverted toward “little change.” The shifting winds should serve as a cautionary note against placing too much stock in the consensus forecast.

Whichever scenario comes to pass, U.S. policy in the Middle East will always have an energy dimension because of the international nature of the energy market and the region’s huge oil and gas deposits. That said, the weight of energy factors in U.S. Middle East policy could well decline, just as the Middle East could remain as central as today to the world and U.S. energy picture. Not only in energy policy but in foreign policy as a whole, Washington must be prepared for a wide range of energy possibilities. Geostrategists must consider which long-term policies make sense in the one case but not in the other, as well as how the United States can best preserve the flexibility needed to take advantage of new opportunities if oil markets do undergo great change, while remaining mindful of the distinct possibility those markets could change little.

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Notes

1. Including natural gas liquids (NGLs) and biofuels as well as the “refinery gain” needed to balance data on production and consump-tion. Data from the BP Statistical Review of World Energy 2016, http://www.bp.com/content/dam/bp/pdf/energy-economics/statisti-cal-review-2016/bp-statistical-review-of-world-energy-2016-full -report.pdf.

2. Jeffrey Goldberg, “The Obama Doctrine,” Atlantic, April 2015, http://www.theatlantic.com/magazine/archive/2016/04/the-obama-doc-trine/471525/.

3. Georgi Kantchev and Bill Spindle, “Oil Glut? Some See a Shortage,” Wall Street Journal, December 31, 2015, p. C1, available at http://www.wsj.com/articles/from-oil-glut-to-shortage-some-say-it-could-hap-pen-1451499384.

4. Prince Abdulaziz bin Salman al-Saud, opening remarks at the Sixth Asian Ministerial Energy Roundtable, December 8, 2015, https://www.ief.org/_resources/files/events/6th-asian-ministerial-energy-roundtable/amer6_hrh_abdulaziz.pdf.

5. Mark Mills, “After the Carnage, Shale Will Rise Again,” Wall Street Jour-nal, January 19, 2016, http://www.wsj.com/articles/after-the-carnage-shale-will-rise-again-1453162664. The piece cites estimates of U.S. job losses at 100,000. Another study cited 65,000 jobs lost in the North Sea alone; see Christopher Adams, “Relentless Fall in Crude Has Oil Com-panies over a Barrel,” Financial Times, January 14, 2016, http://www.ft.com/cms/s/0/ed7cbf66-b9e7-11e5-bf7e-8a339b6f2164.html.

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Notes

6. Cited in Mills, “After the Carnage,” http://www.wsj.com/articles/after-the-carnage-shale-will-rise-again-1453162664. This figure, how-ever, seems inflated—e.g., by including human capital investment.

7. International Energy Agency, Medium-Term Oil Market Report 2016 (OECD/IEA, 2016) https://www.iea.org/Textbase/npsum/MTOMR 2016sum.pdf.

8. BP Statistical Review of World Energy (London, June 2015), https://www.bp.com/content/dam/bp/pdf/energy-economics/statistical-review-2015/bp-statistical-review-of-world-energy-2015-full- report.pdf.

9. Ibid.

10. Including natural gas liquids and biofuels as well as the “refinery gain” needed to balance data on production and consumption.

11. The U.S. Energy Information Administration website lists the spot price of West Texas Intermediate (WTI) crude in Cushing, Okla-homa, as $104 on July 30, 2014, and $53 on December 31, 2014. The price drifted lower until end-March 2015. Since then, the price has at times drifted down, usually recovering somewhat but remaining in the $30–40 range. Brent crude in Europe followed a similar path.

12. International Energy Agency, Medium-Term Oil Market Report 2013 (Par-is: OECD/IEA: 2013), http://www.iea.org/publications/freepublica-tions/publication/MTOMR2013_free.pdf.

13. International Energy Agency, Medium-Term Oil Market Report 2016 (OECD/IEA, 2016), https://www.iea.org/Textbase/npsum/MTOMR 2016sum.pdf.

14. An RBN Energy study cited in Mills, “After the Carnage,” http://www.wsj.com/articles/after-the-carnage-shale-will-rise-again-1453162664. Mills is also the source for the 40 percent productivity increase cited.

15. According to the IEA’s November 14, 2014, Oil Market Report, “While falling prices may well trim investment in U.S. light tight oil, such potential cuts should not be misconstrued as a production drop, and indeed would likely pale in comparison with recent gains in LTO productivity. Cost reductions and efficiency gains in LTO produc-tion have been constant, and price pressures would only provide more impetus for producers to cut costs further.” See https://www.iea.org/media/omrreports/fullissues/2014-11-14.pdf, p. 5.

16. This paragraph relies heavily on Ed Crooks, “U.S. Will Be a Gas Sup-

Energizing Policy

54

plier to the World by Tomorrow,” Financial Times, January 11, 2016, p 17. Available at http://www.dynamiccontrols.co.uk/pdfs/LNG-NEWS-DCL.pdf, pp. 15-16.

17. As of this writing in mid-June, the EIA had not issued the full version of Annual Energy Outlook 2016 (which is about the United States) or In-ternational Energy Outlook 2016, although some tables and text from each were available at http://www.eia.gov/forecasts/ieo/. A table available from the former report showed that transportation energy demand, which is overwhelmingly for oil and accounts for most oil demand, would peak in 2017 and decline 8 percent by 2040.

18. This will be one of the earliest predictors of that trend, accord-ing to Daniel Yergin, who wrote in late 2014: “The biggest impact of lower oil prices on future output may well be not in North America, where many people are looking for it, but in the rest of the world.” See Yergin, “The Global Shakeout from Plunging Oil,” Wall Street Journal, November 30, 2014, http://www.wsj.com/articles/daniel-yergin-the-global-shakeout-from-plunging-oil-1417386897. After examining 400 fields around the world other than U.S. shale, Goldman Sachs concluded that fields representing 2.3 mbd by 2020 (and 7.5 mbd by 2025) are uneconomic at $70 per barrel. See “Oil Producers to Lose $1tn if Price below $60—Goldman Sachs,” Fi-nancial Times, December 16, 2014. Published online by Financial Times on December 15, 2014, as “Oil Price Fall Threatens $1tn of Proj-ects, http://www.ft.com/cms/s/0/b3d67518-845f-11e4-bae9-00144f eabdc0.html.

19. See Medium-Term Oil Market Report 2016, which includes OPEC pro-duction of NGLs, https://www.iea.org/Textbase/npsum/MTOMR 2016sum.pdf.

20. International Energy Agency, Medium-Term Oil Market Report 2015 (OECD/IEA), https://www.iea.org/Textbase/npsum/MTOMR2015sum.pdf.

21. The IEA’s World Energy Outlook 2015 estimates that in 2035, 22 mbd will come from yet-to-be-developed fields and 13 mbd from yet-to-be-found fields. See http://www.worldenergyoutlook.org/weo2015/.

22. OPEC also produces an annual World Oil Outlook, which offers pro-jections within the range of those described here.

23. The report shows only U.S. consumption and OECD Americas out-put, including robust Canadian and Mexican, and does not forecast biofuel output. Thus, no definitive statement about the implication of such scenarios for net U.S. imports.

55

24. In describing the low-price scenario, the IEA warns, “views will dif-fer on the feasibility of the individual assumptions adopted here, al-though, in our judgement, each of them is reasonable and plausible; the chances of them all being realised simultaneously and sustained for the long term [are], though, not high.”

25. The total U.S. “petroleum and other liquids production” is 16 mbd in the reference case (9 crude, 5 NGLs, 1 refinery gain, and 1 biofuel) and 26 mbd in the high-oil case (17 crude, 7 NGLs, 1 refinery gain, and 1 biofuel).

26. No matter the situation, in 2040 the United States would still im-port oil for the Gulf of Mexico refineries designed to work with heavy crudes, but those imports would be offset by exports of refined prod-ucts and lighter crude.

27. The IEA argues that the tight oil response to a price increase may be “stickier” than expected: banks may be reluctant to lend, and it may take time to remobilize staff or equipment.

Notes

56

About the Authors

PATRICK CLAWSON is the Morningstar senior fellow and director of research at the Washington Institute, where he also heads the Iran Security Initiative. Widely consulted as an analyst and media commentator, he has authored more than 150 articles about the Middle East and international economics and written or edited eigh-teen books on Iran. He publishes widely in the New York Times, Wall Street Journal, and Washington Post, among other publications; he has also testified before congressional

committees and served as an expert witness in federal cases against Iran. Prior to joining the Institute, Clawson was a senior research professor at the National Defense University’s Institute for National Strategic Studies, a senior economist at both the International Monetary Fund and the World Bank, and a research scholar at the Foreign Policy Research Institute.

SIMON HENDERSON is the Institute’s Baker fellow and director of the Gulf and Energy Policy Program, where he specializes in energy matters and the conservative Arab states of the Persian Gulf. A former journalist with the BBC and Financial Times, Henderson has also worked as a consultant advising corporations and governments on the Persian Gulf. He served as a foreign correspon-dent in Pakistan in 1977–78 and reported from Iran dur-ing the 1979 Islamic revolution and seizure of the U.S. embassy. Henderson writes and speaks frequently on the internal political dynamics of the House of Saud, energy developments, events in the Gulf, and Pakistan’s nuclear program, including the work of Pakistani nuclear scientist A. Q. Khan.

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Not only in energy policy but in foreign policy

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for a wide range of energy possibilities.

Geostrategists must consider which long-

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