Meeting the global energy challenge: "there are no quick solutions to the energy supply and infrastructure challenge facing the U.S. specifically and the global marketplace generally." (National Affairs).

• Author: Weidenbaum, Murray L.

THE UNDERLYING world energy situation is neither benign nor inherently stable. In geographic terms, there is a fundamental mismatch between the location of energy supplies, especially in terms of the areas where oil and natural gas are produced, and the location of energy demand, in terms of where major consumers reside. The gap is particularly apparent in the case of Japan, which imports most of the energy it uses, and the Arabian peninsula, which exports most of the energy it produces.

When governments follow a policy of laissez faire, minimizing public-sector involvement in the economy, the marketplace tends to equilibrate variations in world supply and demand, regardless of the uneven geographical distribution. Changes in energy prices fundamentally determine the allocation of available supply among the users. These fluctuations signal the need for marketplace adjustments in both production and consumption.

For instance, a substantial increase in the cost of producing energy from conventional sources creates an opportunity to develop new sources and simultaneously emphasizes the need to enhance the efficiency of production from existing ones (e.g., secondary and tertiary recovery of oil). Increases in prices also make more attractive the use of less-energy-intensive forms of production and consumption. Examples include fewer glass windows, more-subdued outdoor lighting, and wearing sweaters and jackets rather than using more heat in homes and office buildings.

In the economist's famous "long run" the availability of energy is assured, especially if lower-grade production resources exist and labor and capital substitutions for energy consumption can take place. For example, "proven" reserves of oil are estimated to last 45 years at current rates of consumption; natural gas may cover 43 years of current usage; and coal could extend to 230 years.

These specific numbers, of course, albeit precise, are really just rough indicators. Cumulative production of these three fuels has perennially exceeded earlier estimates of reserves. Estimates of proven world oil reserves rose from 660,000,000,000 barrels at the end of 1980 to 1,034,000,000,000 barrels at the end of 1999. Global oil reserves are now more than 15 times greater than when the record-keeping began in 1948; gas reserves are almost four times greater than three decades ago; and projected coal reserves have risen 75% in the last two decades. Estimates of reserves are always sensitive to advances in technology and changes in the level of prices in the marketplace.

Although they come with a variety of costs, the necessary market adjustments will usually work effectively--so long as governments do not act to prevent those changes. However, time is an important factor in this process. Patterns of energy usage tend to adjust most effectively in the relatively long periods of time required for the orderly replacement of capital equipment, such as the construction of a new generation of factories and homes--which use more or less energy, depending on fundamental changes in availability and real prices.

In contrast, adjustments to rapid changes in energy supply are much more painful in the short run. Unexpected price shocks caused by wars, boycotts, disruption of energy production, and other sharp curtailments in energy supply are far more difficult to deal with. Moreover, the centrality of energy to national power--economic, political, and military--increases the effectiveness of threats to interfere with the orderly process of producing, distributing, and using energy in its various forms.

This is so especially because vital areas of the world economy import energy from some of the most unstable regions of the globe, and that dependence is likely to increase in the years ahead. A few examples from recent history underscore the strategic power accompanying the ability to disrupt the normal energy cycle in the global economy. The repercussions of the OPEC oil embargo in the 1970s and the Iran-Iraq war of the 1980s were immense in terms of increasing inflation, reducing industrial production, and causing substantial downturns in the output and employment of leading world economies.

The Gulf War in the early 1990s illustrated the many geopolitical dimensions of the energy supply-demand relationship. Iraq invaded Kuwait presumably to obtain the wealth and power accompanying that nation's abundant oil supply. The U.S. and its allies responded with great force because of the ramifications that would flow from such an addition of large oil reserves to Iraq's own...