Understanding the market: energy reforms have ignored resilience of the oil industry.

• Author: Manoyan, John M.
• Position: Analysis

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Alternative energy efforts that ignore or work against energy market economics usually fail in the long run, while attempts to shift demand toward new energy solutions that respect market economics are more likely to survive and succeed.

Previous energy reforms have failed for a number of reasons, but mostly because they focused on new technologies and energy sources unable to compete without sustained and substantial direct funding, tax subsidies, legislation, or because they could not meet the scale and delivery of current sources.

Many alternative energy efforts also ignored the resilience and robustness of traditional energy sources, especially fossil fuels. They underestimated the ability of the oil industry to maintain its market share by aggressively competing on price and reliability. They also underestimated how long it would take for reforms to take root. Bottom line, they failed because any real and permanent change needs to be soundly grounded in energy market economics. This does not mean the nation can't reduce its dependence on foreign oil, just that it needs to be done in a way that leverages the oil market, and does not take it head on, ignore it, attempt to will it away or prematurely announce its imminent demise.

Dependence is a two-way street, and there are many forms of dependence. Perhaps interdependence would be a more accurate term. Oil-exporting countries such as Russia, Saudi Arabia and Venezuela depend on oil-importing countries to generate critically needed hard currency. Saudi Arabia consumes some 2 million barrels per day for its own domestic needs, while the rest of its more than 8 million barrels per day production is sold in international markets.

Members of the Organization of Petroleum Exporting Countries today still supply about 50 percent of U.S. imported oil. But no single country supplies more than 15 percent of the nation's imported oil. In contrast to the shortages and long gasoline lines that consumers suffered during the first and second oil shocks of 1973-74 and 1979, due to a much higher dependence on OPEC, there are no such lines today, even when oil hit $145 a barrel and gas went above $4 a gallon.

The global oil industry is perhaps one of the most carefully balanced and efficient markets in the world. It closely matches total demand and supply, while coping with the pressures of a market growing a couple of percentage points per year. It is hard to find any other global commodity market of this magnitude that is so finely tuned. It is precisely this tight match of supply and demand that makes for such spikes in market prices when supply drops a bit or demand rises a bit.

Weather, geopolitical uncertainty, infrastructure accidents and other factors threatening the amount of oil available and deliverable are immediately processed, magnified and expressed in spot prices, while longer term futures prices remain far less volatile. The global oil industry is constantly scouting out new reserves, and has a planning window of 20 years. Futures contracts for purchasing and delivering oil go out far enough that contracts for oil in 2028 can be had today.

The easily...