Thursday, March 23, 2006

Since the State of Union address, President Bush has continued to echo his message of reducing our dependence on oil through technology and alternative sources. Since the speech, events across the globe have only confirmed that the U.S. faces some serious energy supply challenges.

The programs the president outlined were significant in their new direction, though very modest in size. With goals of 6 to 16 years, however, they do nothing to solve the very serious problems we confront today.

The challenge is energy security-reliable supplies at reasonable cost. At more than $60 per barrel, the markets are already nervous — jumpy at the potential of an Iranian embargo that could send prices through the roof.

Even before Iran, crude oil markets were already tight, with very little spare capacity to meet growing demand in the U.S. and Asia. This is driven by a radical change in industry structure that bodes ill for the future of supply.

More than 80 percent of oil reserves are controlled by National Oil Companies (NOCs), state enterprises that hold and operate petroleum sector for a country. International Oil Companies (IOCs) control only 8 percent but offer technical, financial and operating strength. The problem for the petroleum industry and the world economy is that some critical NOCs that control huge reserves are in a state of flux, if not chaos.

In Russia, President Vladimir Putin is consolidating his control over the oil sector, squeezing out the oligarchs (many of whom were deeply corrupt) and replacing them with two massive state-run enterprises — Gazprom and Rosneft. Mr. Putin is within his rights to do so. However, the operation of this sector must be efficient. Unfortunately, given high oil prices, there is rampant corruption with little management accountability.

As a result Russia’s production lags earlier projections. Furthermore, Russia straddles the Eurasian land mass, thus controlling pipeline routes. Russia seems to be expanding its power, not providing more energy. For example, Russia is blocking expansion of the Caspian Pipeline Consortium, which would bring another 800,000 barrels per day to the market from Kazakhstan.

Energy security will be at the top of the agenda for upcoming G-8 Summit, which Mr. Putin will host in St. Petersburg in July. Given this opportunity, Russia must demonstrate it is part of the solution, providing reliable supply at reasonable cost to the world economy. Unless this can be done persuasively, Russia runs the risk of deep embarrassment on the world stage.

Excoriated by Washington as a stooge of Fidel Castro, Venezuela, with more oil reserves than Russia, offers another challenge. Petroleos de Venezuela (PdVSA), Venezuela’s NOC, is changing its contracts with the IOCs to collect a larger share and have greater control. It wants to expand its own production and diversify away from its reliance on U.S. markets. Furthermore, policy often is driven by well-meaning but inexperienced ideologues, and corruption is rampant. The result is instability. Venezuela has tried to be a reliable energy partner to the U.S., while also a political rival. For example, PdVSA increased its exports to the U.S. after Hurricane Katrina but the U.S. energy secretary has been barred from meeting with his Venezuelan counterpart.

Washington should seek to work with PdVSA where we have mutual interests, while challenging President Chavez where we disagree on his political program.

Iraq is another nation with huge reserves but falling production. Iraqi fields are in worse condition than when Saddam fell. The petroleum sector is divided by politics, corruption and security issues. Though it has some excellent professionals, it lacks a clear national mandate as well as the financial and technical resources to restore production and open new fields.

The greatest danger for the Iraqi oil sector is fragmentation along regional lines, complicating development and possibly leading to civil war. This cannot be permitted.

Once the fundamental structure is in place, two steps should be taken quickly:

(1) All international companies should agree not to retain agents or pay bribes, and to publish all payments to the government. The petroleum sector must be transparent, since the potential for corruption of Iraq is enormous, particularly from aggressive Russian, Indian and Chinese companies.

(2) It may take years to write a new petroleum law, but the IOCs should be brought in soon on terms acceptable to the Iraqis. It is Iraqi oil, and sovereignty must be respected. A solution is short-term service contracts guaranteed by export credit agencies, quickly established so IOCs could undertake specific projects for a limited period, perhaps three years. This approach would stimulate production while a new, long term petroleum law is drafted.

Energy insecurity — unreliable supply at an unreasonable cost — took years to create. Solutions will take years as well.

In the meantime, working with the international community, Washington must develop better knowledge, more tools and greater will to effectively address international petroleum supply issues in foreign and economic policy.

Focused activities, skillfully executed, in producing countries could bring millions of barrels more to world markets. We would then have less to fear from Iran or other threats.

The U.S. must certainly move to alternative fuels and greater efficiency in the future, but for now, we must learn to deal competently with unpleasant realities such as Iran.

J. Robinson West is chairman and founder of PFC Energy. He was assistant interior secretary in the Reagan administration with responsibility for offshore oil policy.

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