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S. HRG. 108–98

OVERVIEW OF GLOBAL ENERGY SECURITY ISSUES

HEARING

BEFORE THE

SUBCOMMITTEE ON INTERNATIONAL ECONOMIC

POLICY, EXPORT AND TRADE PROMOTION

OF THE

COMMITTEE ON FOREIGN RELATIONS

UNITED STATES SENATE

ONE HUNDRED EIGHTH CONGRESS

FIRST SESSION

APRIL 8, 2003

Printed for the use of the Committee on Foreign Relations

(

Available via the World Wide Web: http://www.access.gpo.gov/congress/senate

COMMITTEE ON FOREIGN RELATIONS

RICHARD G. LUGAR, Indiana, Chairman

CHUCK HAGEL, Nebraska

LINCOLN CHAFEE, Rhode Island

GEORGE ALLEN, Virginia

SAM BROWNBACK, Kansas

MICHAEL B. ENZI, Wyoming

GEORGE V. VOINOVICH, Ohio

LAMAR ALEXANDER, Tennessee

NORM COLEMAN, Minnesota

JOHN E. SUNUNU, New Hampshire

JOSEPH R. BIDEN, JR., Delaware

PAUL S. SARBANES, Maryland

CHRISTOPHER J. DODD, Connecticut

JOHN F. KERRY, Massachusetts

RUSSELL D. FEINGOLD, Wisconsin

BARBARA BOXER, California

BILL NELSON, Florida

JOHN D. ROCKEFELLER IV, West Virginia

JON S. CORZINE, New Jersey

KENNETH A. MYERS, JR., Staff Director

ANTONY J. BLINKEN, Democratic Staff Director

SUBCOMMITTEE ON INTERNATIONAL ECONOMIC

POLICY, EXPORT AND TRADE PROMOTION

CHUCK HAGEL, Nebraska, Chairman

LINCOLN CHAFEE, Rhode Island

MICHAEL B. ENZI, Wyoming

LAMAR ALEXANDER, Tennessee

NORM COLEMAN, Minnesota

PAUL S. SARBANES, Maryland

JOHN D. ROCKEFELLER IV, West Virginia

JON S. CORZINE, New Jersey

CHRISTOPHER J. DODD, Connecticut

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CONTENTS

Page

Hagel, Hon. Chuck, U.S. Senator from Nebraska ................................................. 1

Larson, Hon. Alan P., Under Secretary for Economic, Business and Agricultural Affairs, Department of State ..................................................................... 11

Prepared statement .......................................................................................... 13

McSlarrow, Hon. Kyle E., Deputy Secretary of Energy, Department of Energy 3

Prepared statement .......................................................................................... 5

Olcott, Dr. Martha Brill, Senior Associate, Carnegie Endowment for International Peace ...................................................................................................... 48

Prepared statement .......................................................................................... 52

Yergin, Dr. Daniel, chairman, Cambridge Energy Research Associates ............. 27

Prepared statement .......................................................................................... 30

Zanoyan, Vahan, president and CEO of PFC Energy, Washington, D.C. ........... 37

Prepared statement .......................................................................................... 40

ADDITIONAL MATERIAL SUBMITTED FOR THE RECORD

Statement Submitted by The American Petroleum Institute, ‘‘On Global Energy Security Issues’’ ........................................................................................... 69

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(1)

OVERVIEW OF GLOBAL ENERGY

SECURITY ISSUES

Tuesday, April 8, 2003

U.S. SENATE,

COMMITTEE ON FOREIGN RELATIONS,

SUBCOMMITTEE ON INTERNATIONAL ECONOMIC POLICY,

EXPORT AND TRADE PROMOTION,

Washington, D.C.

The subcommittee met, pursuant to notice, at 2:33 p.m., in Room

SD–419, Dirksen Senate Office Building, the Hon. Chuck Hagel,

chairman of the subcommittee, presiding.

Present: Senators Hagel and Sarbanes.

OPENING STATEMENT OF HON. CHUCK HAGEL, U.S. SENATOR

FROM NEBRASKA

Senator HAGEL. Good afternoon. Today we have brought together

two distinguished panels of senior Administration officials and

leading private sector experts to examine global energy security.

Energy security is a critical component of America’s national security. Reliable energy supplies, particularly oil and natural gas,

are crucial to our economic development and growth. Our national

energy and national security interests cannot be separated from

world developments and global stability. Our dependence on imported crude oil creates potential vulnerabilities to our economy

and national security.

During this hearing, we will examine where global energy resources are concentrated and how much potential remains untapped globally. We will explore the impact of war and political instability on global energy supply and possibilities for mitigating

that impact.

America’s economy is almost 60 percent dependent on imported

oil. This situation will not change for the foreseeable future. America is the world’s leading consumer of crude oil. We use 19 million

barrels per day, or almost 26 percent of the world total. We are the

world’s leading importer of crude oil, bringing in more than 9.6 million barrels per day.

And as Deputy Secretary of Energy, McSlarrow points out in his

prepared testimony for today’s hearing, and I quote, unless the Secretary has changed his testimony,

The United States is increasingly dependent on foreign

oil and may not be far from the point at which we no

longer can assume a domestic or even a North American

supply of natural gas that fully meets demand.

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America needs a comprehensive energy policy that recognizes the

realities of our inter-connected world. We cannot develop our energy policies under the false assumption that energy independence

is achievable in the short-term. Our dependence on OPEC oil, including and especially Middle Eastern Gulf crude oil, is more likely

to increase than decrease in the foreseeable future.

America’s demand for natural gas will continue to exceed its supply. This imbalance will continue to grow.

The interdependence of global energy markets requires that

America and her allies must work with Persian Gulf and Middle

Eastern energy suppliers regardless of the political risks associated

with the region. The United States presently depends on Middle

East Gulf oil for 25 percent of its crude oil imports. Middle Eastern

Gulf oil provides 26 percent of Europe’s crude oil imports and 67

percent of Asia’s imports.

Russia and oil-producing countries in the Caspian, Latin America

and West Africa will all continue to play important roles as global

supplies of crude oil. But the Persian Gulf will remain the choke

point of the global economy. For example, Middle Eastern Gulf oil

is responsible for over 20 million barrels per day, or almost 30 percent of the world’s total oil production, 57 percent of global oil exports, and 65 percent of oil reserves.

The two primary oil producers in the Caspian, Kazakhstan and

Azerbaijan, at times touted as a possible alternative strategy supply source in the Caspian region, today produce 1 million and

300,000 barrels of oil per day respectively. And even under the

best-case scenarios, production would only double to 3 million barrels per day by 2010.

America’s energy security depends in part on the reliability and

the volatility of oil producing regions. Our energy security interests

must, therefore, promote stability and economic grown in these energy-producing regions of the world.

Long-term energy security will depend on the success of our efforts to support political and economic reform and regional security

in oil producing countries and regions such as the Middle East,

West Africa, the Caspian and Latin America.

Political instability in Venezuela and Nigeria show that the correlation between political instability and oil supply is not limited

only to the Middle East. The absence of responsible governance and

democratic institutions over time will undermine security and stability, with dangerous implications for the global economy.

Energy security is not limited to just assuring an adequate supply of crude oil. The American economy is also captive to dependable and reliable supplies of natural gas, as well as other resources

like nuclear energy. Conservation and renewable fuels need to play

more and more of a role in America’s energy future.

I welcome our distinguished witnesses today and look forward to

their testimonies. We will begin with Kyle McSlarrow, the Deputy

Secretary of Energy and Alan Larson, Under Secretary of State for

Economic, Business and Agricultural Affairs.

The second panel will include expert private sector witnesses, including Dr. Daniel Yergin, Chairman of Cambridge Energy Research Associates and author of ‘‘The Prize,’’ which received a Pulitzer prize and ‘‘Commanding Heights, The Battle for the World

3

Economy,’’ which will be broadcast on PBS as a six-part television

series starting next month; Mr. Vahan Zanoyan, CEO and President of PFC Energy, an internationally recognized leader and expert on the commercial, political and strategic aspects of the global

oil and gas business; and Dr. Martha Brill Olcott, Senior Associate

to Carnegie Endowment for International Peace and one of the

leading American experts on the politics of Central Asia and the

republics of the former Soviet Union.

Ladies and gentlemen, thank you for making yourselves available today. We are grateful for your time and your expertise and

what you have to say. We all look forward to it. We will begin with

the Deputy Secretary of Energy who, I understand, has been consumed today with negotiations with our Russian friends.

So thank you, Mr. Secretary, for taking time to work us into the

schedule. And with that, please proceed.

STATEMENT OF HON. KYLE E. McSLARROW, DEPUTY

SECRETARY OF ENERGY, DEPARTMENT OF ENERGY

Mr. MCSLARROW. Thank you, Mr. Chairman. I am pleased to appear before you today and I look forward to discussing the important role that energy plays in the global economy and the Administration’s efforts to enhance our energy security. And I am pleased

to be here with Secretary Larson with whom I work very closely

on a daily basis on a lot of these issues, and it is really a reflection

of the coordination, the close working relationship that the Department of State, Department of Energy and the Department of Commerce enjoy.

Over the past century, we have witnessed the power of energy

to drive economic development and sustain progress. On the other

hand, since the 1970s we have also learned firsthand how energy

shortages and the high prices that result can compromise economic

growth and the quality of life to which Americans have grown accustomed.

The U.S. is far and away the largest single energy market in the

world. And as a result, U.S. energy policy plays a critical role in

maintaining global energy security. From our first days of the Bush

Administration, we knew that the United States faced an energy

crisis long in the making. In addition to the California crisis, which

you will recall, Mr. Chairman, consumers faced unparalleled increases in natural gas and gasoline prices.

And what was true in the beginning of 2001 is still true in 2003.

We have a series of long-term energy challenges that require action

now. And these are challenges that are present along the entire energy continuum, and affect the environment and economy, the

transmission of electricity, and commodities ranging from crude oil

and its associated products to natural gas.

As you noted, Mr. Chairman, we long ago ceased to fully provide

for our petroleum needs domestically, and though most of our natural gas can be supplied currently by North American production,

the trend here is also toward a greater share for gas imported from

outside our hemisphere. We are often at the mercy of events and

decisions over which we have limited, sometimes no, control. When

winters and summers are mild; when all refineries or pipelines are

online; when supply from abroad is abundant and reliable, we do

4

not feel this dependency. However, when almost any one of these

factors breaks down, markets react instantly, and we face the higher prices and volatility that have become by now an almost certain

cyclical phenomenon. President Bush recognized that to prevent

these problems, we needed a national energy plan, and he presented this plan to the American people almost two years ago.

Under President Bush and Secretary Abraham’s leadership, our

approach to energy security—indeed, to global energy security—is

contained in the following principles. First, we must balance increased production with a renewed focus on the clean and efficient

use of energy. Second, we must expand international engagement

with consumer and producer Nations. Third, we must expand and

diversify our sources of supply. And, finally, in everything we do,

we must champion free markets and free trade.

Thus our initiatives are not limited to domestic activities. In fact,

we are aggressively pursuing a variety of international cooperative

efforts to strengthen energy security, in most cases working very

closely with the State Department. Those efforts basically fall into

two types of initiatives. The first type is to leverage our leadership

in high technology. The second type is to pursue a set of policies

that strengthen our security.

I will just take a moment and summarize what I have submitted

in the written testimony, but I would like to just highlight a couple

of initiatives where we are partnering with key energy countries to

help create new technologies and develop new energy sources that

will enhance U.S. and global energy security. One example is the

Generation Four International Forum, so called GEN–4, in which

we work with about nine other countries on joint nuclear energy

research and development. Through this process, we are cooperatively exploring six new reactor designs that are more advanced,

safer, more efficient, and more proliferation-resistant.

Another example is the recently launched Carbon Sequestration

Leadership Forum in which we will work with countries around the

world to develop cutting edge pollution-control and carbon-sequestration technologies that can make tomorrow’s coal or natural gas

plant truly emissions free.

Earlier this year as you know, Mr. Chairman, President Bush

also announced that the United States would join with the international community to develop the International Thermonuclear

Experimental Reactor, the so-called ITER.

But the second prong of our international energy strategy is

more than just technology cooperation, and it is based on a principle of diversification. Put simply, to meet our long-range energy

needs, we must expand and diversify our sources and types of energy. We need to maintain a diversity of fuels from a multiplicity

of sources. We are working to diversify energy supplies and promote the development of new resources around the globe. And I

look forward to talking with you further about that today.

We are working to enhance our dialogue with key producing and

consuming countries. And we are working to expand global capabilities to protect against energy supply disruptions.

I will stop there, Mr. Chairman. I appreciate the opportunity to

answer any questions you may have.

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Senator HAGEL. Mr. Secretary, thank you, and your full statement will be included in the record.

Mr. MCSLARROW. Thank you.

[The prepared statement of Mr. McSlarrow follows:]

PREPARED STATEMENT OF HON. KYLE MCSLARROW

Thank you, Mr. Chairman. I am pleased to appear before you today to discuss the

important role that energy plays in the global economy and the Administration’s efforts to enhance our energy security.

I. Introduction

Over the past century, we have witnessed the power of energy to drive economic

development and sustain progress. On the other hand, since the 1970s we have

learned firsthand how energy shortages and the high prices that result can compromise economic growth and the quality of life to which Americans have grown accustomed.

As energy markets become more integrated, U.S. energy security has become integrally linked to developments around the world. The U.S. is the largest single energy market in the world. As a result, U.S. energy policy plays an important role

in maintaining global energy security.

From our first days of the Bush Administration, we knew that the United States

faced an energy crisis long in the making. In addition to the California electricity

crisis, you will recall that consumers faced unparalleled increases in natural gas

and gasoline prices.

That is why President Bush so quickly directed the completion of a comprehensive

and balanced national energy policy.

II. Energy Outlook

What was true in the beginning of 2001 is still true: we have a series of longterm energy challenges that require action now. These challenges are present along

the entire energy continuum, and affect the environment and economy, the generation and transmission of electricity, and commodities ranging from crude oil and its

associated products to natural gas.

These challenges can be summarized by one phrase: energy security. To be more

specific, the United States is increasingly dependent on foreign oil and may not be

far from the point at which we no longer can assume a domestic—or even a North

American—supply of natural gas that fully meets demand.

Thus, before I address some of the policy issues before this committee and Congress, it is worth analyzing the premise of growing dependence on foreign energy.

I will use the analysis presented by the Department of Energy’s independent analytical arm, the Energy Information Administration, in its Annual Energy Outlook

2003 (AEO 2003), and will confine this brief review to petroleum specifically and

total energy supply and demand.

A. Petroleum Trends

The historical record shows substantial variability in world oil prices, and there

is similar uncertainty about future prices. Three AEO 2003 cases with different

price paths allow an assessment of alternative views on the course of future oil

prices. The three price cases are based on alternative assumptions about OPEC oil

production levels, primarily from the Persian Gulf: lower output in the high price

case and higher output in the low price case. However, with its vast store of readily

accessible oil reserves, OPEC is expected to be the principal source of marginal supply to meet demand increases in all scenarios.

By 2025, OPEC production is projected to be 61 million barrels per day (more

than twice its 2001 level) for the ‘‘Reference’’ case. Based on growth in world oil demand of about 2.0 percent annually, projected prices in real 2001 dollars reach

about $27 per barrel in 2025. In nominal dollars, the reference case price is expected

to exceed $48 per barrel in 2025.

In the high world oil price case, OPEC production is assumed to only increase to

46 million barrels per day by 2025 (about 25 percent less than the reference case)

and prices rise by about 3 percent per year from 2001 to 2015. Prices remain at

about $33 per barrel (in real 2001 dollars) after 2015 as market penetration of alternative energy supplies become economically viable at the higher price and cap oil

prices.

In the ‘‘low world oil price’’ case, with assumed greater expansion of OPEC production to 71 million barrels per day by 2025 (about 15 percent greater than the

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reference case), prices are projected to decline from their high in 2003, reaching $19

a barrel by 2010 (in real 2001 dollars), and remain at that level to 2025.

U.S. petroleum consumption varies, not only with oil prices, but the level of economic growth. While projected U.S. petroleum consumption varies with the projected price of crude oil, from 28.2 million barrels per day in the high world oil price

case to 30.2 million barrels per day in the low world oil price case in 2025, the largest variation is with different assumptions about the rate of economic growth. Total

petroleum consumption in 2025 ranges from 26.9 million to 31.8 million barrels per

day in the low and high economic growth cases, respectively.

In the reference case, gross domestic product is expected to increase by 3.0 percent per year between 2001 and 2025. In the high economic growth case, GDP grows

at a faster 3.5 percent per year and in the low economic growth case at a slower

2.5 percent per year. However, while petroleum consumption varies with each scenario, it increases in all cases from today’s level.

In 2001, net imports of petroleum accounted for 55 percent of domestic petroleum

consumption. Dependence on petroleum imports is projected to grow in the reference

case, reaching 68 percent in 2025. The corresponding import shares of total consumption in 2025 are expected to be 65 percent in the high world oil price case and

70 percent in the low world oil price case.

The growth in the share of petroleum accounted for by imports has received little

notice in recent years. Expenditures on petroleum as a share of GDP have fallen

from a peak of 9 percent in 1980 to only 3 percent today. The OPEC share of U.S.

petroleum imports has fallen from a peak of 70 percent in 1977 to 40 percent in

2002. More importantly, the share of U.S. petroleum imports originating from the

Persian Gulf is about 20 percent today versus a peak of 28 percent in the late 1970s.

However, as the marginal source of supply, OPEC and, ultimately, the Persian

Gulf producers are expected to become increasingly important for future supplies to

the United States and the world. By 2025, 53 percent of U.S. petroleum supply is

expected to come from OPEC, including 26 percent from the Persian Gulf.

Although crude oil is expected to continue as the major component of petroleum

imports, refined products are projected to represent a growing share. Growth in domestic U.S. refinery capacity is expected to remain constrained by regulations and

economics. While total capacity is projected to grow by 3 million barrels per day between 2001 and 2025, all of the growth is at existing refineries. No new facilities

are expected to be built over the forecast period.

Growth in total U.S. petroleum demand in the reference case, from 20 million barrels per day in 2001 to over 29 million barrels per day by 2025, is projected to outstrip U.S. refinery capacity. As a result, refined petroleum products are projected

to account for a growing portion of total net petroleum imports, reaching 34 percent

of total net imports by 2025 (6.7 million barrels per day) in the reference case, up

from a 15 percent share of total imports in 2001 (1.6 million barrels per day).

This means that the U.S. will increasingly rely on foreign refinery investors to

provide not just the volume of petroleum product needed by U.S. markets but products that meet the required characteristics (e.g., sulfur content, octane levels, etc.)

of the U.S. supply slate. This decreases the flexibility and direct control that U.S.

policymakers have in dealing with petroleum supply issues.

B. Total Energy Trends

Another way to analyze our energy picture is to look at our total energy consumption and balance it against our total energy production.

Total U.S. primary energy consumption is projected to increase from 97 quadrillion Btu in 2001 to 139 quadrillion Btu by 2025 in the reference case, 1.5 percent

per year. It is important to note that the reference case already assumes continued

improvement in energy consuming and producing technologies, consistent with historic trends. Without these improvements, total primary energy consumption would

otherwise grow to about 200 quadrillion Btu by 2025.

The difference between reference case consumption and domestic energy production is the level of net imports (all energy types) required to meet projected U.S.

energy consumption levels. Because of slow growth in domestic energy production,

total net imports are projected to grow from about 26 quadrillion Btu in 2001 to

almost 50 quadrillion Btu in 2025.

As I mentioned earlier, this already assumes that future gains in energy efficiency

take place at the same impressive rate as in recent years. Nonetheless, the EIA also

analyzed what it termed a ‘‘high demand side technology’’ case, with an even more

aggressive decline in energy intensity.

With more rapid decline in energy intensity, total energy consumption could be

reduced to levels below that shown in the reference case. In the high demand side

technology case, it is assumed that increased spending on research and development

7

will result in earlier introduction, lower costs, and higher efficiencies for end-use

and electric generation technologies than assumed in the reference case. Due to a

faster decline in energy intensity in the high demand side technology case, total primary energy consumption is projected to be 6 percent lower in the high demand side

technology case by 2025, at 130 quadrillion Btu.

With lower levels of total consumption, net imports are also reduced. However,

the reduction in imports is partially offset by lower levels of domestic energy production resulting from a decline in the energy prices that producers see with lower consumption levels. Net energy imports decline to 45 quadrillion Btu by 2025 in the

high demand side technology case from nearly 50 quadrillion Btu by 2025 in the

reference case. The result is that even in a case with an accelerated decline in energy intensity, the U.S. will still be highly dependent on energy imports to meet future consumption needs.

III. President Bush’s National Energy Policy.

These trends are a concern. We long ago ceased to fully provide for our petroleum

needs domestically, and though most of our natural gas can be supplied currently

by North American production, the trend here is also toward a greater share for gas

imported from outside our hemisphere.

Quite simply, we are at the mercy of events and decisions over which we have

often limited—sometimes no—control. When winters and summers are mild; when

all refineries or pipelines are online; when supply from abroad is abundant and reliable, we do not feel this dependency. However, when almost any one of these factors

breaks down, markets react instantly, and we face the higher prices and volatility

that have become by now an almost certain cyclical phenomenon.

President Bush recognized that to prevent these problems from becoming a permanent, recurring feature of American life, we needed a long-term plan for energy

security that would promote reliable, affordable and environmentally sound energy

for the future.

Almost two years ago, President Bush presented his solution, a national energy

policy, to the American people.

Our approach to our energy security—indeed, to global energy security—is contained in the following principles.

First, we must balance increased production with a renewed focus on the clean

and efficient use of energy. Second, we must expand international engagement with

consumer and producer nations. Third, we must expand and diversify our sources

of supply. And, finally, in everything we do, we must champion free markets and

free trade.

IV. Energy Security: Closing the Gap Between Supply and Demand

The Administration believes that a balanced, comprehensive energy plan is imperative to the long-term strength of our economic and national security. This balance

should include a recognition that we must also increase domestic production in

order to reduce our rising dependence on imported oil and gas; and key to achieving

this balance is the President’s proposal to open a small portion of the Arctic National Wildlife Refuge (ANWR) to environmentally responsible oil and gas exploration and development.

But we also understand that we need to leapfrog the status quo and fundamentally change our reliance on imported energy. That is one important underpinning

of the President’s Hydrogen Initiative, which the President announced earlier this

year during the State of the Union Address.

Hydrogen can be produced from diverse domestic sources and has the potential

to free us from reliance on foreign imports for the energy we use at home. When

hydrogen is used to power fuel cell vehicles, it will do so with more than twice the

efficiency of today’s engines.

And hydrogen-powered vehicles would have a tremendous positive impact on the

environment, as they would produce none of the harmful emissions that we see with

today’s gasoline-powered fleet. In fact, the only byproduct of the fuel cell is pure

water.

The Hydrogen Fuel Initiative complements the Freedom-CAR initiative, a partnership with the U.S. auto industry that Secretary Abraham announced at the Detroit Auto Show in January 2002. The Freedom-Car partnership is designed to

greatly accelerate the pace of development of fuel cell vehicles powered by hydrogen.

The President’s Hydrogen Fuel Initiative represents a commitment to the future

hydrogen economy, and it has already generated tremendous enthusiasm among the

energy and auto industries—partners that will be integral to transforming our nation’s energy future from one dependent on foreign petroleum, to one that utilizes

the most abundant element in the universe.

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As the President has said, his goal is to see to it that the first car driven by a

child born today could be powered by hydrogen and pollution free. To support the

Hydrogen Fuel Initiative and the Freedom-CAR partnership, we propose to focus

$1.7 billion over the next five years on overcoming several significant technical and

economic barriers to the development and expanded use of hydrogen, fuel cell, and

advanced automotive technologies.

If we are successful in this endeavor, we estimate that industry could make a

commercialization decision on fuel cell vehicles, hydrogen production, and refueling

infrastructure by 2015. A positive decision would lead to hydrogen fuel cell vehicles

in the showroom by 2020, and by 2040, this could reduce oil use in light duty vehicles by over 11 million barrels per day—an amount of oil that approximates that

which America imports today.

V. Energy Security: Strengthening International Cooperation

But our initiatives are not limited to domestic activities. We are partnering with

key energy countries to help create new technologies and develop new energy

sources that will enhance U.S. and global energy security. These international partnerships allow us to share costs, increase our knowledge base, and eventually expand markets for advanced energy technology.

One example is the Generation Four International Forum (GIF) in which we work

with Argentina, Brazil, Canada, France, Japan, South Africa, South Korea, Switzerland and the United Kingdom on joint nuclear energy research and development.

Through this process, we are cooperatively exploring six new reactor designs that

are more advanced, safer, more efficient, and more proliferation-resistant.

Another example is the recently launched Carbon Sequestration Leadership

Forum in which we will work with countries around the world to develop cutting

edge pollution-control and carbon-sequestration technologies that can make tomorrow’s coal or natural gas plant truly emission free. This June, the U.S. Government

will host a ministerial level conference to discuss international collaboration on carbon sequestration, including the FutureGen Project. With international and private

sector partners, the U.S. will sponsor this $1 billion initiative to design, build and

operate the first coal-fired, nearly emissions-free power plant.

Earlier this year, President Bush announced that the United States would join

with the international community to develop the International Thermonuclear Experimental Reactor (ITER). When built, ITER is expected to achieve the first sustained burning plasma, an essential next step on the long technical, regulatory, and

economic road toward demonstrating the feasibility of commercial fusion energy systems. If ITER and significant future scientific and engineering efforts prove to be

successful, fusion energy plants would produce no harmful emissions, no long-term

radioactive waste, and—because no fissile materials are required in the fusion process—virtually no proliferation threat.

VI. Energy Security: Increasing Diversity of Supply

To meet our long-range energy needs, we must expand and diversify our sources

and types of energy. To assure energy security, we need to maintain a diversity of

fuels from a multiplicity of sources. Opportunities for increased investment, trade,

exploration and development are increasing every year, far beyond the traditional

markets of the last 50 years.

We are working to diversify energy supplies and promote the development of new

resources in the Western Hemisphere, Russia, the Caspian Region and Africa. We

are working to enhance our dialogue with key producing and consuming countries

to better predict and monitor oil market developments and offset energy crises. And

we are working to expand global capabilities to protect against energy supply disruptions.

A. North American Energy Working Group

Shortly after taking office, the Administration prioritized our energy relationship

with Mexico and Canada, the top two energy suppliers to the United States. In April

2001, President Bush Canada’s Prime Minister Chretien and Mexico’s President Fox

launched the North American Energy Working Group to further integrate the North

American energy market and make it stronger and more efficient.

Our experts meet regularly to develop and implement strategies that enhance

North American energy trade and interconnections, and most of all energy security.

We work to identify and overcome the regulatory, technical and policy obstacles to

increased production and delivery of energy within North America in an environmentally friendly manner.

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B. Western Hemisphere

The North American effort is just part of the process. Half of all U.S. petroleum

imports come from Western Hemisphere countries, and Trinidad and Tobago is the

United States’ largest supplier of liquefied natural gas. We have been working with

our partners in the Hemisphere to promote increased development of oil and natural

gas resources and advance energy integration on a regional scale. We have met with

our counterparts from Mexico, Canada, Bolivia, Brazil, Ecuador, Colombia, Peru and

Venezuela—all of whom are determined to develop and expand their vast energy resources. The Hemispheric Energy Initiative is a product of the Summit of the Americas and provides an arena for hemispheric cooperation on energy issues.

C. Russia

Outside of the Western Hemisphere, we continue to strengthen our energy relationship with Russia, now the second largest crude oil producer and exporter in the

world. Last year, Presidents Bush and Putin launched a new era in our bilateral

cooperation by creating a new strategic energy initiative between our two countries.

As the American co-chair of the Energy Working Group, I am pleased to report the

continued success of this initiative.

Under the Working Group, our experts meet regularly to exchange information

and technical expertise. The objective is to help create the regulatory and investment conditions required for increased energy development in Russia as well the infrastructure necessary to deliver the energy to the outside world. Our cooperation

takes into account the environmental risks associated with oil production and transportation. Earlier this month, Secretary Abraham and his Russian counterpart established a bilateral dialogue on oil spill prevention and response.

The private sector plays an important role in this effort. Last year, the U.S. and

Russia co-hosted a Commercial Energy Summit in Houston to incorporate companies into the dialogue and leverage our technical cooperation with investment opportunities. In our view, rising Russian production significantly increases the supply

diversity in the world oil market.

D. Caspian Region

In addition, the United States has a strong interest in resource and infrastructure

development in the Caspian Sea region. The United States has been a strong supporter of oil and gas development in the region, urging governments to establish the

necessary legal, fiscal, and regulatory environments to safeguard the large investments required to develop these new resources. The Caspian Basin has proven reserves in the 17–33 billion barrel range (to put this in perspective, Persian Gulf

proven reserves amount to approximately 679 billion barrels), with possible oil reserves of about 233 billion barrels. With sufficient investment, the Caspian region

could produce 3.5 to 4.0 million bpd by 2010.

The Administration has been a strong advocate of new pipeline capacity to transport oil—and gas—in an east-west corridor to reach world markets. Secretary Abraham attended the inauguration ceremony for the Caspian Pipeline Consortium

(CPC) that opened its pipeline from Kazakhstan to the Black Sea, providing direct

access from Kazakhstan to export markets. Secretary Abraham also participated in

the ground-breaking ceremony in Baku for the Baku-Tbilisi-Ceyhan pipeline that

will be able to carry 1 million bpd from the landlocked Caspian to world markets.

E. Africa

Energy from Africa plays an increasingly important role in our energy security,

accounting for more than 10 percent of America’s oil imports, and is a key engine

for economic development in Africa. We are pleased with the resolve of African nations to facilitate private sector investment in the development of energy resources.

At a meeting of U.S. and African Energy Ministers last year in Morocco, the U.S

and African countries reaffirmed a commitment to good governance and stable regulatory structures and discussed additional steps to encourage private investment in

the energy sector. At that meeting, we met with government and industry to discuss

ways to improve energy trade and facilitate energy sector development to better

serve U.S. and African economic growth and development.

F. Producer–Consumer Dialogue

In addition to these efforts, we have been strengthening our dialogue with key

producing and consuming countries to better monitor energy market developments

and respond to supply disruptions.

We continue to participate in the International Energy Forum (IEF), a multilateral effort to enhance relationships between oil producing and consuming nations.

A key focus of the IEF is a joint effort to improve the transparency, timeliness, and

10

accuracy of the data that guides global oil markets. This initiative, begun by the

United States, has garnered broad support from both producers and consumers.

G. G–8 Energy Cooperation

We are also working closely with our other friends in major consuming countries

to address our common energy challenges. Last year, as recommended by the National Energy Policy, Secretary Abraham co-chaired with his Canadian counterpart

a meeting of energy ministers from the G–8 countries in Detroit. We reaffirmed the

importance of emergency oil reserves and our commitment to coordinate their use.

We agreed to work together to meet growing energy demand by encouraging the investment that will be needed in energy development, production and infrastructure,

as well as in improved energy efficiency.

H. Asia Pacific Economic Cooperation (APEC)

We also participate in the Energy Working Group of the Asia Pacific Economic

Cooperation (APEC), most notably in the APEC Energy Security Initiative, which

the United States originally proposed in 2000 and which was endorsed by APEC

Leaders in at the 2001 Shanghai Leaders Meeting. Shorter-term actions under the

initiative include enhancing the transparency of the global oil market and sharing

ideas on energy emergency preparedness. Longer-term actions include cooperation

on energy efficiency, renewable energy, and alternative fuels.

I. U.S.–U.K. Energy Dialogue

Last year, President Bush and Prime Minister Blair agreed to establish the US–

UK Energy Dialogue. The dialogue involves discussion on both domestic and international energy policies. The collaboration focuses on deepening cooperation on environmental, economic, and developmental issues, and incorporates the private sector

in implementing these objectives. We are in the process of developing a comprehensive report for our leaders, which will highlight our common position on various energy issues and outline joint activities to be undertaken.

J. Cooperation on Natural Gas

Although most of these initiatives encompass a wide variety of topics, with a particular emphasis on petroleum, we also have stepped up our cooperation on natural

gas issues.

We have, for example, undertaken a joint study on natural gas with Canada and

Mexico to assess future supply and demand projections. And, last November, the Department of Energy hosted a liquefied natural gas (LNG) Summit with Algeria to

discuss the investment and infrastructure required to expand LNG trade between

our two countries. And we look forward to continuing our work with other key natural gas producers such as Trinidad & Tobago, Angola, and Nigeria.

In addition, the Department of Energy participates in the World Bank’s Gas Flaring Reduction Initiative and is a member of its steering committee. We undertake

research and development activities and partner with other organizations to assist

in gas flaring reduction. Bilaterally and multilaterally, we are working with various

countries and organizations to promote the development and utilization of natural

gas resources, which, in turn, will directly contribute to the reduction of gas flaring

and venting.

VII. Emergency Strategies: Response to Supply Disruptions

All of these activities are directed at ensuring a reliable and affordable supply of

energy to the American people today and in the future. But we also recognize the

importance of protecting against the possibility of a severe supply disruption. The

Administration early on reaffirmed the importance of maintaining a strong Strategic

Petroleum Reserve (SPR). In November 1991, the President directed that we begin

to fill the SPR to its 700 million barrel capacity. Today the SPR contains a record

599 million barrels of oil—the highest amount in its history. This oil can be released

at a maximum rate of 4.2 million bpd, and we can begin delivering oil to the market

within 13 days of the President’s order.

We continue to play a leadership role in the International Energy Agency (IEA).

Created following the 1973 oil crisis, the IEA includes 26 member countries that are

committed to holding emergency oil reserves and to taking common effective measures to meet oil supply emergencies. Together, IEA members’ oil stocks total nearly

4 billion barrels, 1.2 billion barrels of which are under direct control of member governments, with the remaining 2.6 billion barrels from commercial stocks. IEA members have the ability to draw down these stocks at a rate of over 8 million bpd (including the SPR).

At the G–8 Energy Ministerial last May, we agreed on the importance for net oil

importing countries to maintain emergency stocks and to use them when necessary

11

to respond to major physical supply disruptions. We also recognized the value to

global energy security when other countries, including those in Asia (whose import

dependence is projected to increase sharply), build similar stocks.

Mr. Chairman, at this point, I thank you for the opportunity to testify before you

today, and I welcome any questions the Committee might have.

Senator HAGEL. Secretary Larson, welcome.

Mr. LARSON. Thank you. Senator Hagel: Please proceed.

STATEMENT OF HON. ALAN P. LARSON, UNDER SECRETARY

FOR ECONOMIC, BUSINESS AND AGRICULTURAL AFFAIRS,

DEPARTMENT OF STATE

Mr. LARSON. Thank you very much, Mr. Chairman. I too have a

longer statement for the record, but I would like to summarize that

at this point.

I really welcome the opportunity to testify on this important and

timely subject and to do so with Deputy Secretary McSlarrow because, as he said, we really do have a strong working relationship.

And many of the issues that we have to deal with span traditional

energy policy and foreign policy considerations.

We need to begin by recognizing some hard facts. For example,

the United States and our key allies and trading partners must import half or more of our oil needs. This reliance on imports is likely

to grow since oil demand is rising and domestic production capabilities are limited. Moreover, some two-thirds of the world’s proven

oil reserves are found in the Middle East.

Energy security does not and cannot mean self-sufficiency. Energy security does mean ensuring that there are sufficient and diversified supplies of oil and other forms of energy, and that these

supplies are available on terms that support the growth of the

American economy. Energy security also means being sure that actual or threatened interruptions in energy supplies can never seriously disrupt our own economy, nor impair the ability of the President to conduct foreign policy.

My testimony highlights three important dimensions of our international energy security policy. First, we work to make imported

energy more reliable, by increasing its supply, by improving the climate for private energy investment, and by diversifying our sources

of energy.

Second, we maintain an active dialogue and strong partnership

with established oil producers in order to ensure that they maintain responsible production policies that support the needs of a

growing world economy.

And third, through our cooperation both with responsible producers and with our partners in the International Energy Agency,

we make sure that we have flexible and effective responses to any

actual or threatened physical disruption in the supply of oil.

The starting point for our diversification strategy is North America. Canada is our leading supplier of oil, natural gas and electricity. And Mexico is one of our top four suppliers of oil.

We are making progress in developing a North American energy

market that would bring substantial benefits for all three countries. We also have made significant headway in the Caspian, a region with the potential of increasing oil production from 1.6 million

barrels a day to 5 million barrels a day in 2010, a somewhat higher

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number than your estimate, and we will find out, but in any event

there is substantial capacity there.

Senator HAGEL. I used just two countries.

Mr. LARSON. Right. The United States has offered strong support

for the Baku-Tbilisi-Ceyhan oil pipeline. Construction is just beginning now, and the pipeline will begin transporting oil in 2005. The

Shah Deniz pipeline will provide a similar outlet for Caspian gas.

Russia is an energy superpower. There is significant potential for

expanded production and exports of Russian oil and gas. To achieve

this potential, it will be necessary for Russia to attract private investment, including foreign direct investment into exploration, production and transportation projects.

In West Africa, the development of oil and gas reserves could

contribute to global energy security and be a source of revenue to

finance badly needed economic development. Achieving this potential will require a much stronger institution supporting the rule of

law, transparent systems for receiving and expending budget resources, and a stronger commitment on the part of leaders to using

energy revenues for the benefit of their own people.

Historically, Venezuela has been one of our most reliable suppliers. Under President Chavez, however, Venezuela has pursued a

foreign policy that sometimes is hostile to some of our key objectives. At home, he has contributed to a polarization that resulted

in untimely interruptions of Venezuela’s oil supplies to the United

States. We are working very hard to encourage Venezuelans across

the spectrum to work with the OAS Secretary General, Gaviria, to

find a peaceful, constitutional, democratic and electoral solution to

their domestic crisis.

The traditional Gulf producers, and especially Saudi Arabia, play

an important role in energy security. Their interest in maintaining

a long-run demand for oil has moderated OPEC production policies.

Their willingness to maintain and to use excess production capacity

has helped offset supply interruptions, such as the recent interruptions from Venezuela and Iraq.

Cooperation in the International Energy Agency is the centerpiece of our energy security policy. In the IEA, we work with key

partners on policies to diversify energy supplies and to respond to

energy supply disruptions. IEA countries hold more than 1.2 billion

barrels of emergency oil reserves of which 600 million barrels are

represented by the U.S. strategic petroleum reserve. IEA countries

stand ready to use these stocks if necessary to help offset oil supply

disruptions.

Let me end with a word on Iraq. The Administration has

stressed many times that the oil reserves of Iraq are for the Iraqi

people. Our post-war strategy will fully reflect this principle.

Mr. Chairman, there is no quick fix or panacea that will produce

energy independence. Rather, we must preserve our energy security by sustained, patient and determined efforts to diversify supplies, to increase the scope for market forces, and to maintain our

ability to respond to oil supply interruptions.

Thank you.

Senator HAGEL. Mr. Secretary, thank you. Thank you, Mr. Secretary. And your full statement will also be included in the record.

[The prepared statement of Mr. Larson follows:]

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PREPARED STATEMENT OF HON. ALAN LARSON

Mr. Chairman, distinguished Committee members, I am pleased to be here today

with Deputy Secretary of Energy McSlarrow to discuss the international aspects of

U.S. energy security.

Hard Facts About Energy

We approach international energy policy aware of a number of hard facts that

must be factored into the formulation of the nexus of an effective energy security

and foreign policy. These hard facts include:

• Imports supply roughly half of our oil needs, and an even greater share of the

needs of some of our most important allies and economic partners.

• We are no longer self-sufficient in natural gas. We now import 15 percent of

our natural gas, almost entirely from Canada, but in growing volumes from

Trinidad and other LNG suppliers.

• Two-thirds of proven world oil reserves are in the Middle East. In contrast, the

United States has 2 percent of proven world oil reserves.

• OPEC nations provide roughly one third of the total oil exports, but also control

two-thirds of world reserves.

• Oil supply shocks in any region of the world have an impact on our economy

through the instantaneous operation of international oil markets, as we saw recently in Venezuela. Taken together, these facts mean that an effective international energy security policy must, as outlined in the President’s National Energy Policy:

• Promote increased and diversified production of energy from a range of foreign

suppliers in many regions.

• Coordinate effective international measures to respond to physical oil supply

disruptions, through investment in strategic oil stocks, and through cooperative

mechanisms to draw on them in case of a severe physical oil supply disruption.

• Encourage major oil producing countries to maintain responsible production

policies to support a growing world economy and reduce oil market price volatility.

American energy security policy must complement and support America’s eco- nomic and foreign policy goals. We must ensure that our economy has access to energy on terms and conditions that support economic growth and prosperity. And we

must ensure that the United States can pursue its foreign policy and national security interests without being constrained by energy concerns.

The international oil market can be both volatile and unpredictable, as its recent

reactions to recent events in Venezuela and Iraq have demonstrated. We have intensified our already close contacts with major oil producing and consuming countries,

making clear that we look first to producers to follow through on their offers to offset market disruptions. If needed to reinforce their efforts, consuming countries

stand ready to use strategic stocks. We are pleased that major producers, especially

Saudi Arabia, have stepped up production, which has helped to stabilize and reassure global oil markets. This approach—looking to cooperation with the major producers and consumers—to handle challenges of the global energy market underscores the role of foreign policy in promoting energy security.

Domestic Energy Supplies

Energy policies that rely on market forces have made our economy more flexible

and responsive. We use energy more efficiently; since 1970, America’s energy intensity (the amount of energy it takes to produce one dollar of GDP) has declined by

40 percent. New technologies, such as deep-water drilling and enhanced oil recovery,

are reducing the environmental effects and the economic costs of accessing technically challenging oil and gas reserves in the United States. In fact, the U.S. Gulf

of Mexico remains one of the world’s most promising regions. Alaska also holds vast

reserves that can bolster our energy security.

The U.S. is a leading energy producer. The United States produced 72 of the 98

quadrillion BTUs of energy that we consumed in 1999. The United States is the

world’s second largest natural gas producer and its third largest oil producer.

We are virtually self-sufficient in all energy resources except oil, of which we import just over half of our needs. EIA forecasts suggest that over the next 20 years,

U.S. oil consumption could increase by 33 percent or more than 6 million barrels

a day. Depending on many factors, including the domestic and international energy

policies we adopt, the Energy Information Administration estimates that imported

oil could grow to as much as 62 percent of our total oil consumption by 2020.

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Other developed regions are also dependent on foreign oil. Europe currently imports 52 percent of its oil needs. Japan imports 98 percent of its oil needs.

These high levels of imports by friends and allies, as well as by the United States,

means that energy security cannot be defined as self-sufficiency, as much as we

would like that to be the case. With 2 percent of the world’s proven oil reserves,

the United States is unlikely to ever again be self-sufficient in oil.

Reliability Through Diversification

Energy investments are costly, risky and require long-term commitments. For

that reason, neither companies nor countries can have all of their eggs in one basket. Recognizing this reality, American energy security policy has sought to encourage like-minded free market policies toward energy, emphasizing the expansion and

diversification of energy supplies. In the immediate future, however, oil and natural

gas will likely continueto play a central role in the world economy and international

energy markets. So we must find more oil and gas supplies, and these supplies must

be reliable and made available on terms that permit sustained economic growth.

Let me provide you with just a few concrete examples that demonstrate what we

are doing to achieve these energy goals.

North America: Energy Integration

We have made strengthening our energy cooperation with Canada and Mexico a

top priority of energy security policy. We established a North American Energy

Working Group in 2001 to serve as a forum for exchanging information and pursuing joint strategies. Senior energy experts from the three North American governments recently released a North American ‘‘Energy Picture’’ report that, for the first

time, jointly measures the energy stocks, trading balances, and energy flows in the

continent. This marks the first time we have truly looked at the North American

market as a unified one. It is an important first step towards greater integration,

and mutual economic benefit, and greater energy security. And our work on the

Working Group continues.

Canada is our leading supplier of imported natural gas, electricity and oil. All

three flow across the border in both directions. The Canadian energy sector is developing its heavy oil reserves, with production expected to reach one million barrels

per day by year-end. These heavy oil reserves are anchoring Canada as a pillar of

North American energy security. World-scale oil and natural gas projects are also

underway in Atlantic Canada, which is now the fastest growing source of natural

gas for New England.

New England is the region of our country that is most dependent on home heating

oil. New England homes tend to be a the end of our nation’s natural gas grid—or

are not even connected to the grid at all. Canadian gas is helping reduce significantly that dependence.

Several Canadian provinces are also enthusiastic about major new hydroelectric

projects, with potential for large-scale new supply the United States.

Last but not least, Canada is a leader and a key partner in a range of renewable

and alternative energy sources, from fuel cells to bio-mass.

Canada’s vast resources, market based energy policies, and our interconnected energy infrastructures, contribute significantly to U.S. energy security and to the

shared economic health of our two nations. These are all reasons why the State Department hosts an inter-agency bilateral ‘‘Energy Consultative Mechanism’’ between

the two governments, allowing each side to work towards common ends and to address issues of concern.

Mexico is one of our leading energy and trading partners, and has, with other

major producers, surged production in recent months to reduce market volatility.

The U.S. is also the leading market for Mexican manufactured exports, which are

now about 10 times the value of Mexico’s oil exports. Energy trade with Mexico is

not a one-way street. We import crude oil and electricity from Mexico, and are a

net exporter of refined petroleum products and natural gas to Mexico.

Mexico will make its own decisions on whether or how it wants to liberalize its

energy sector to attract investment, and whether that investment will be domestic

or foreign. Mexico has already liberalized transportation, distribution, and storage

of natural gas, and has successfully attracted domestic and foreign investment to

that sector. In the last few years, Mexico has also begun to allow independent power

producers (IPPs) to sell power to the public grid.

The reliability of North American energy trade is also enhanced, of course, by geographic proximity. But more important than geography alone is the rule of law and

predictable investment conditions created by NAFTA, integrated pipeline networks,

closer cooperation between our governments and energy companies and long-term

reliable supply relationships. Our policy is to deepen further this framework of rule

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of law and predictable investment conditions in North America and to use it as an

example as we seek to build similar frameworks in other regions. For example, the

North American Energy Working Group has five expert sub-groups that have harmonized certain appliance standards to facilitate trade and established a mechanism for scientific and technical cooperation.

Venezuela: Traditional, But Strained, Supplier

Venezuela and the United States have also enjoyed strong historical energy ties.

Traditionally, Venezuela has been one of our most reliable oil partners. Venezuelan

oil policy, until recently, has been built upon a reputation of reliability to international markets, which was of great mutual benefit. Through World Wars, politically inspired embargoes, and global dislocations, Venezuela found that its national

interest was best advanced through maintaining a reputation of reliability.

Venezuela’s turmoil came at a difficult period for the world economy, but production, and to a lesser extent refinery operations, are now recovering. Venezuela led

the way in opening aspects of its energy sector to U.S. firms. These firms remain

hard at work there, just as Venezuelan owned CITGO continues to operate in the

U.S. as a commercial entity. These reciprocal energy investments bring benefits to

both parties. We maintain a robust, if more difficult, energy dialogue with Venezuela, and will continue to do so.

And the United States will continue to work to help Venezuelans resolve their political differences. The key to reverse the severe economic and political decline in

Venezuela is a renewed dedication to find a constitutional, democratic, peaceful and

electoral solution to the crisis as called for in Organization of American States

(OAS) Permanent Council Resolution 833. Democracy and the rule of law are essential elements of a sound investment climate. The dialogue facilitated by the OAS

Secretary General remains the best forum in which the Government and the opposition can secure such an agreement, and we urge both sides to avail themselves of

this opportunity. The Friends of the OAS Secretary General’s Mission for Venezuela,

of which the U.S. is a member, was formed in January to support this dialogue.

Caspian Coming On-Line

The Caspian basin has tremendous potential, offering the possibility of production

increases from 1.6 million b/d in 2001 to 5.0 million b/d in 2010. This will represent

the largest non-OPEC production growth in the world. Transporting this oil from

this land-locked region to world markets through the development of multiple pipelines has been a major U.S. foreign policy priority since the mid-1990s. In addition

to enhanced energy security, this policy will strengthen the sovereignty and economic viability of new nation states in the region.

The Department of State maintains a Senior Advisor on Caspian Basin Energy

Diplomacy. The incumbent, Ambassador Steve Mann, serves as a catalyst between

governments, industry and in some cases NGOs, to achieve specific milestones to

forward the goal of creating an East-West energy corridor from the Caspian to the

Mediterranean.

Construction of the Baku-Tbilisi-Ceyhan (BTC) pipeline begins this month, April

2003. BTC will start shipping oil in 2005. The pipeline will transport up to 1 million

barrels/day when it reaches full capacity (in 2010) . The U.S. is also working with

the governments of Kazakhstan and Azerbaijan to bring Kazakhstani oil into the

BTC pipeline system.

The South Caucasus gas line, running from the off-shore Shah Deniz gas field in

Azerbaijan to central Turkey, is also moving ahead and will begin operations in

2006. We are also working to improve the investment climate throughout the region

by stressing the need for governments to respect contract sanctity and fight against

corruption.

Russia: Energy Super Power

Russia already is an energy super-power. Expanded oil and gas production in Russia can make a major contribution to its own economy and to a well-balanced global

supply mix. Russia is developing new oil and gas fields, including multi-billion dollar projects, with U.S. and other foreign investors. They are also successfully expanding production from existing fields as they work more closely with, and learn

from, Western service companies. We welcome strengthened energy ties with Russia, and their new energy production in the coming years will enhance U.S. and

global energy security. Through the programs of Eximbank and OPIC, we are providing financing and insurance to reduce the political risk of energy investments.

We look forward to working with Russia as it strengthens its ties with the International Energy Agency.

We join the Department of Energy and the Department of Commerce in the U.S.-

Russia Energy Working Group. The working group has met several times in the last

16

year, and has formed five sub-groups to focus on cooperation in the areas of: (1) Stability of oil supply, prices and forecasts;(2) Investments into the Russian Energy

Sector; (3) Energy Efficient Technologies; (4) Information Exchange; and (5) Small

and Medium Energy Enterprises. The third meeting of the high-level group will be

in Washington April 7–9, but the working level sub-groups have launched several

concrete initiatives.

We also joined with the Department of Commerce and the Department of Energy

to establish the U.S.-Russia Commercial Energy Dialogue. Our Commercial Energy

Dialogue with Russia focuses on facilitating commercial cooperation both within and

outside Russia and addressing bottlenecks that limit the amount of Russian energy

that can reach world markets. The U.S. hosted the first U.S. Russia Commercial Energy Summit in Houston in October, 2002, with participation by a large number of

American and Russian energy firms and senior officials. The next official dialogue

meeting was held in Moscow in December, and successfully organized follow-up to

be driven by the private sector. Five sub-committees are preparing recommendations for both governments on possible steps to enhance the potential for commercial

cooperation. These groups meet regularly in Moscow, and focus on the investment

framework, the regulatory framework, markets and transportation, services and

equipment, and small-medium sized enterprises.

West Africa: Great Potential

The Administration recognizes Africa’s emerging role as a major energy supplier.

For example, Nigeria is normally the fifth largest supplier of crude oil to the U.S.,

with exports to the U.S. averaging nearly 600,000 bpd in 2002. We are in close contact with the Nigerian government and the firms operating in the Niger Delta region in these days of unrest.

Oil reserves generate a large share of government revenue in countries such as

Nigeria, Angola, Gabon, Equatorial Guinea, Republic of Congo and Cameroon.

Emerging potential producers, such as Sao Tome, Chad and Mauritania also will

begin producing significant new oil supplies in coming years. U.S. energy firms are

key in Africa’s on-going emergence as an energy-supplying region. From the large

firms, such as Exxon-Mobil and Chevron-Texaco, to the smaller oil firms such as

Amerada Hess, Marathon, Ocean Energy, Kerr-McGee and others, U.S. companies

bring the most advanced technologies and resources to assist African countries in

developing their energy resources.

We have a strong policy interest in assisting oil-producing countries to channel

their energy resources into solid and sustainable economic development that will

benefit their populations. Democratization and the development of responsible governing institutions are particularly important in reducing oil related conflicts and

promoting African supply stability. Substantial foreign direct investment is needed

to develop African energy resources both onshore and offshore deepwater. We support this process by encouraging the reforms needed to improve the investment climate. Accountability and transparency are necessary to ensure that oil revenues

benefit the population and support development. We have an interest in helping

West African nations solve these problems, not just out of altruism, but also selfinterest.

We are prepared to explore new partnerships to help West African countries make

good on their commitment to good governance, transparent business practices,

sound economic policies and market-based regulation. We have negotiated a bilateral energy cooperation framework agreement with Nigeria. We favor the World

Bank’s involvement in independent monitoring arrangements in the Chad-Cameroon

pipeline project. Another sign of our commitment is the opening of our new embassy

in Equatorial Guinea. This new mission will support our ongoing work in the areas

of energy security, human rights, and good governance in Equatorial Guinea.

Persian Gulf: Key Global Suppliers

The Middle East holds two-thirds of proven world oil reserves and has the lowest

production costs in the world. Saudi Arabia, the world’s largest oil producer, has

pursued a policy of investing in spare oil production capacity and storage, and diversifying its export routes to both the Persian Gulf and the Red Sea. These enormous

investments allow Saudi Arabia to credibly assure markets that it has the spare

production capacity, and the export outlets, to mitigate supply disruptions in the

Gulf or elsewhere. Saudi Arabia and other major Gulf producers, such as the UAE,

Kuwait, and Qatar, repeatedly emphasize their commitment to be reliable suppliers

of oil and natural gas to world markets. And they have demonstrated their leadership by offsetting the recent fluctuations in Venezuelan and Iraqi exports.

Despite frequently expressed concerns about ‘‘dependence’’ on the Middle East, the

world and U.S. economies clearly benefit from access to these low-cost supplies. In

17

fact, this region is a core supplier not to the U.S., but to our key economic partners,

primarily in Asia. Without abundant, low-cost Gulf supplies, we would expend

scarce economic resources to secure the energy we need at higher cost to the world

economy, and our citizens.

Gulf producers will continue to have an indispensable role in the world market.

In fact, we will encourage them to increase foreign investment to steadily expand

supplies, and increase their own economic potential. But, just as the disruption in

Venezuela has shown, the world needs a highly flexible, resilient oil market that

will allow for some regions to compensate for ebbs and flows in others. And the

greater diversity and growth in world oil production we seek should also allow the

market to work better.

Emergency Preparedness and the International Energy Agency

Continued close cooperation with energy producers and consumers enhances our

collective emergency preparedness. In the event of disruptions, we have looked to

producers to make a maximum effort to use spare capacity to replace lost supply.

Producers are acting, but we are also ready if needed. We sustain intense consultations with our partners in the International Energy Agency (IEA) and, if necessary,

we are ready, willing and able to make an appropriate emergency response, primarily based on coordinated drawdown of strategic stocks. The 26 IEA members collectively hold over 1.3 billion barrels of government-controlled stocks, representing

114 days import coverage.

The critical role of the International Energy Agency (IEA) is worth underscoring

here. Founded in 1974 in response to the oil shocks, the Agency Secretariat and 26

member countries have developed a coordinated approach to emergency preparedness and potential use of strategic petroleum reserves. In addition, the IEA’s small,

expert staff provides information and analysis on the quick-changing energy scene.

The IEA tracks all five energy sources—oil, gas, renewables, coal, and nuclear—and

provides a global framework to support short-term readiness to respond to energy

disruptions and long-term diversification and technology development. The agency

also provides expert guidance to important non-member countries, such as Russia

and China, on investment policies, strategic stocks, and how to work better within

energy markets. This dovetails with work the U.S. and others are doing in the Asia

Pacific Economic Cooperation (APEC) forum and contributes to enhanced energy security.

Energy Infrastructure Security

Given potential terrorist threats to energy infrastructure, the State Department’s

Counter-Terrorism Coordinator and Political-Military Bureau’s Office of Critical Infrastructure Protection work closely with the Departments of Homeland Security

and Energy and U.S. Ambassadors overseas to increase awareness of these threats

and facilitate cooperation to handle them.

Problem Countries Needing Special Treatment

While our general energy security approach is to actively support the global opening of trade and investment opportunities, there is a set of problem countries whose

policies and actions are of such concern that we bar or restrict American firms from

most commercial activities with these states, including exploring for or developing

energy resources, and, in most cases, buying or importing their oil. These countries

include major oil producers such as Libya and Iran, and more limited producers

such as Sudan, Cuba and Burma. Libya, Iran, Sudan and Cuba are designated State

Sponsors of Terrorism.

In dealing with these nations, we balance our desire to diversify our energy

sources with our very real concerns about the security threats that these nations

pose to the international community. With the Iran and Libya Sanctions Act (ILSA),

Congress set out a policy to discourage investment in the development of petroleum

resources in Iran and Libya because of concern about those countries’ support for

international terrorism and pursuit of Weapons of Mass Destruction (WMD).

Iraq: Country in Transition

The Administration has been clear that our actions in Iraq are not ‘‘about oil.’’

As the President has assured the world, Iraqi oil belongs to the Iraqi people. Coalition forces are working to ensure that Iraq’s oil sector is protected from acts of sabotage. When Iraqi oil flows again, we will do everything we can to ensure that the

proceeds are applied for the benefit of the Iraqi people. Iraq’s oil and other natural

resources belong to all the Iraqi people—and the United States is and will respect

this fact.

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Conclusion

Energy security is a leading Administration priority, and our National Energy

Policy spells out the road map to achieve it. In the long run we need new technologies such as hydrogen that can fuel our economy without posing threats to the

environment or our national security. In the interim, our international energy policy

must address the familiar challenges posed by a hydrocarbon-based economy where

oil reserves are concentrated in various challenging regions of the world.

Energy security is advanced by sustained improvements in the investment climates in Russia, the Caspian, Africa, and in our own hemisphere, as well as by improved investment opportunities in traditional venues such as the Gulf and Venezuela. We are placing special emphasis on making the integrated North American

market work better. To counter short-term, physical disruptions, we stand ready,

with our IEA allies, to deploy a collective response if needed.

We intend to engage intensively with energy partners all over the world to diversify supplies, improve investment opportunities and assure that market forces work

as transparently and efficiently as possible. Like the war on terrorism, achieving energy security will not be achieved by one dramatic breakthrough but rather by sustained, patient and determined efforts. The State Department here and overseas is

actively engaged on this entire effort to enhance our energy security.

Senator HAGEL. Let me begin with Secretary McSlarrow. You

both referenced Russia. And of course, Secretary McSlarrow has

been engaged with the Russians today. But you both made some

significant comments about that relationship which, for purposes of

our hearing today, is somewhat isolated on energy capacity and relationships, but I am going to get to you on that point as well, Secretary Larson, to maybe embroider a bit beyond just the energy dynamic.

But to you, Secretary McSlarrow, what are the challenges that

we face, most significant challenges in developing our relationship

with Russia and their emerging energy industry, so that we not

only are working out and structuring a short-term relationship but,

probably more importantly, a long-term relationship with them?

Mr. MCSLARROW. Well, Mr. Chairman, I think it is important to

think about this relationship, at least in terms of energy, in two

ways. As you know, Presidents Bush and Putin last year established the U.S.-Russian energy dialogue. I am the U.S. co-chair

and, as you noted, we have had two days of meetings, the third

such meetings since it was established.

But one aspect of the relationship is the Administration’s belief

that our partnership and relationship with Russia will be strengthened by increased U.S. investment and participation in the energy

sector within Russia itself. And the second aspect to it is, given the

resources, predominantly oil and gas and very much so on the gas

side, that Russia has, how Russia might play a role in the future

global energy markets, and it already is a significant exporter, but

it is clear that it could export oil even more than it does now. And

so when you look at the challenges for both of those aspects, one

challenge is to ensure the kind of transparency, certainty of the

rule of law, tax treatment of U.S. corporations that are investing

in pipelines or in exploration and production projects. And there

are a number of challenges there, although it is also clear that the

situation has improved very much over the last few years.

And then on the other side, it really comes down to transportation. And so, for example, the U.S. and Russia both at the Governmental levels, but even more importantly in some ways, within

the private sector, are exploring additional routes to allow the additional export of oil, for example, the proposed Murmansk pipeline

19

and Murmansk terminal that would allow potentially up to 1 million barrels a day of Russian oil to hit the global energy markets

and actually, in some ways, is closer to the coast of the United

States than the Persian Gulf would be. In both of those, you are

dealing not just with logistical and transportation challenges, but

you are also dealing with the fact that you right now have a pipeline monopoly, Transneft and Russia—the Russia Federation is

going to have to sort through some of those issues—as well as, once

again, the kinds of issues that relate to U.S. or, more broadly

speaking, Western investment.

Senator HAGEL. Thank you.

Secretary Larson, would you like to take any piece of what Secretary McSlarrow has said especially in the areas of transparency

and rule of law, the things that the State Department obviously

has been focused on as well, but even a wider portfolio that you

work on?

Mr. LARSON. Very much so, sir. I would comment on two domestic energy policy issues. One is the overall investment climate and

rule of law issues. And this has been a very big problem that, over

time, has prevented some foreign investment that otherwise might

have occurred.

There has been this interesting development recently where BPAmoco has proceeded with a major investment that is in a way the

first of its kind.

As we look forward, I think there are two issues that are very

much on our minds right now. One is whether the Russian Government will move forward with some type of arrangement on production-sharing agreements that would at least address very expensive

and risky offshore developments, because it is important for there

to be the sort of investment that would make sure that Russia is

adding to its reserve base even as it is increasing its output.

The second issue, Secretary McSlarrow mentioned, and I think it

is worth underscoring again. And that is the tension between a policy of having state-controlled pipeline systems, Transneft and

Gazprom, versus allowing enough private investment and competition to create more outlets for the production and export, and more

competitive outlets for production and export of energy.

The other point that I think is worth introducing here is the

broader—a broader range of economic initiatives that can promote

the rule of law. Here I think the WTO accession of Russia is a very

important issue. We are supporting that very strongly. We think it

is important to move forward, but to do so on commercial terms.

We also think that it is important to move forward with the

graduation of Russia from the Jackson-Vanick rule, which I think

is something that could significantly improve the tone of the economic relationship.

Senator HAGEL. Thank you. Develop that a little bit if you would,

Secretary Larson, for the Caspian, the same issues, transparency,

the investment challenge, rule of law. Obviously, we have a pipeline, the Baku-Ceyhan pipeline that soon will be underway, the

construction of it, if not already. So the private sector dynamic

seems to, in some cases, be at least in the transportation area developing a strong foothold. Production is another matter. But that

area, the Caspian, if you would reflect on that, as well as West AfVerDate 11-MAY-2000 15:01 Sep 11, 2003 Jkt 000000 PO 00000 Frm 00023 Fmt 6633 Sfmt 6602 88999.TXT SFRELA2 PsN: SFRELA2
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rica, using the same parameters that you and Secretary McSlarrow

have just spoken of.

Mr. LARSON. I think a good starting point is that in the long run,

our energy security is enhanced if the countries in which we are

investing and from which we are buying energy are countries

where the benefits of that oil and gas production are flowing into

the society and helping develop the society and helping to improve

the lives of ordinary people because I think that is part of making

sure that there is a stable political base over a period of ten to

twenty years, during which an energy investment project reaches

its fruition.

In West Africa, just to start there, we have been working harder

to support countries like Nigeria that have a significant amount of

oil and gas, but where there have been both security problems recently that forced temporary closure of some of the production facilities in the Niger Delta, and more generally over a period of time

where there has not been sufficient success in turning oil and gas

wealth in the ground into human capacity and education and

health and things of that sort. We want to be working with countries to help them in that regard.

In Kazakhstan or in the Caspian more generally, first of all,

there is tremendous potential. And there has been tremendous

progress from where we were just a very few years ago when the

idea of a Baku-Tbilisi-Ceyhan pipeline seemed to many like a fairly

farfetched possibility. And now ground is being broken and construction is underway.

There have been some significant investments made in countries

like Kazakhstan. When I was visiting there recently, there was unfortunately a fairly serious disagreement between the major Western countries and the Government. Now, this seems to be working

itself out, but it is part of a set of factors that color the investment

climate and make it a climate that is a little bit difficult even

though the size of the energy resources there is so great that companies really want to be involved there.

Here to, I think both for the production but also for the pipeline

project, it is important to work with these countries to help them

make sure that some of the benefits of these resources are flowing

to the people. That pipeline flows, crosses some very, very poor

areas. And you can look after the security of that through military

forces to some extent, but I think you also have to attend to the

security of the pipeline by making sure that the people who live in

its path see economic benefits coming from it.

Senator HAGEL. Thank you.

Secretary McSlarrow, would you develop a little bit what you referenced in your testimony—and as I looked through your prepared

testimony, you develop it in some detail—some of the projects that

the Energy Department is looking at now and particularly the

President’s hydrogen fuel initiative? Could you talk a little bit

about that, how that fits into the overall energy independence picture here for our country and the future?

Mr. MCSLARROW. I would be glad to, Mr. Chairman. As we just

discussed, the basic premise of our approach has been diversification. That is diversification of sources, diversification of fuels. And

we are a country that is endowed with enormous natural resources

21

in some ways, but it is also very clear that to pursue this strategy,

we need to do so bilaterally, multilaterally through different

means, and I guess our philosophy could best be summarized as

‘‘Let a thousand flowers bloom.’’ Almost anything, if it is economical, is the right policy when it comes to energy policy, whether it

is here or abroad. The situation you do not want to be in is one

where all of the eggs are in one basket.

And so, for example, I mentioned a couple already in the oral

statement earlier, but we have pursued the North American Working Group because, as Secretary Larson pointed out and you did as

well, the significance of North America to our energy needs is

great. I mean, North America or this hemisphere supplies 50 percent of our oil. That is not inconsequential. And there are a lot of

trading opportunities with Canada and with Mexico, in addition to

a lot of opportunity with our neighbors in South America.

We also hosted the first Africa, U.S.-Africa energy ministerial.

Secretary Abraham hosted that, co-hosted that. And there are a lot

of opportunities in working, again, on a bilateral and sometimes

multilateral basis for opportunities, whether or not it is for investment or for ensuring that supplies, needed supplies get onto the

world market.

I think the interesting thing about what we are doing at the Department is, in addition to all of the sort of traditional investment

opportunities which we are aggressively seeking, to go back to my

oral testimony, is the technology opportunities that we have. You

mentioned the President’s initiative on hydrogen. Right now in this

country, the vast majority of coal is used for electricity generation.

The vast majority of nuclear energy is used for electricity generation. About 23 percent of natural gas is used for electricity generation, but that is forecasted over the next 25 years to increase as

a percentage.

And then when you look on the transportation side of the ledger,

three-quarters of petroleum in this country goes for transportation.

And so what we are trying to accomplish with the hydrogen initiative, in addition to all of the environmental benefits that come with

it, is to essentially take advantage of the domestic resources that

we have in abundance, principally coal, and others, and shift the

balance so that we are in one category and transportation not completely dependent on one type of supply of energy, let alone one

type of supply from one region of the globe that has the ability to

affect prices and, thus, our economy.

And as Secretary Larson said, it is very clear: We are not going

to achieve energy independence in the sense that we are going to

produce all of the energy at home. But on the margin, what we are

trying to do with diversification is to lower the ability of others to

control our destiny. And so the more we diversify, the more we control our own destiny.

Senator HAGEL. Secretary Larson, would you like to add anything to that? I am going to ask a question of each of you which

follows along with what Secretary McSlarrow was just referencing,

and that question is: How do the two departments that you represent coordinate in working through these objectives, the national

energy policy group that was set up to, in fact, coordinate these efforts and harness the resources that your departments and others

22

bring to the focus that we are putting on this overall effort of national energy independence with all of the other pieces that factor

into it? Maybe you could begin, Secretary Larson, explaining how

that works. Thank you.

Mr. LARSON. Much of the process works in the way that I think

the most efficient processes in business and Government work, and

that is in a very informal, personal and intensive way. As Secretary McSlarrow said, I think at the beginning of his remarks, we

have made it a point to coordinate very, very closely and directly

on all of the key issues that arise. And I will give you just one very

recent example in the area.

In preparing for the eventualities that might arise out of military

operations in Iraq, we have a strong policy of working with key

partners in the International Energy Agency, and that is something that the Department of Energy and the Department of State

do jointly, to represent our interests in this international organization that we created after the first oil embargo.

We sat down and developed a strategy months in advance for

preparing the way in the International Energy Agency to make

sure that the consultative machine ran and the other machinery

was very well prepared. And then when it became clear that there

was a real prospect of action, we began together to consult some

of our key partners around the world on what the appropriate responses should be.

At the same time, the two Departments really over the last two

years have been very closely orchestrating our contacts with the

key energy producing countries so that we had a very constructive

relationship with them, one based on trust. Obviously, the Secretary of Energy is the point person in this because most of the

people with whom we do business are the Secretary’s counterparts.

But when I have been traveling or others in the State Department have been traveling to parts of the world where there is energy business to do, we have always discussed in advance what the

points to make were and shared. The briefing materials, and made

sure that we were presenting to these Governments a very consistent and coordinated approach on what the United States’ position was. As a result of that type of preparation over the course of

the Administration, we think that there has been a very constructive response. We think, for example, that the major oil suppliers

that had unused capacity did respond effectively, first to the Venezuelan disruption and later to the commencement of military operations, that the comments that they made to the press and that the

International Energy Agency made to the press and that we and

our partners made to the press, were very consistent, factual, credible and, therefore, reassuring to the marketplace.

And the way that happened was primarily because of the working relationships that have been established between the two Departments and in cooperation, of course, with The White House and

the National Economic Council and the National Security Council.

Senator HAGEL. Thank you.

Secretary McSlarrow.

Mr. MCSLARROW. Well, I do not have a whole lot to add to that.

I think Al covered most of it. But I would just add only that, at

least internationally one thing we discovered is that there a variety

23

of international fora that crop up frequently. In fact, the problem

is too many.

So the ability of the Energy minister and his counterparts to talk

on a frequent basis is there, and one that we take full advantage

of. And as Al said, we coordinate very closely.

Domestically, again as he referenced, we work very closely with

the National Economic Council, first under the leadership of Dr.

Lindsey and now under the leadership of Steve Friedman. Energy

is obviously a vital part of our economic future, and The White

House takes it as such. And so at least domestically in terms of

how we interact, in addition just to our informal cooperation, I

would say that that is the most formal process that we work

through.

Senator HAGEL. What additional thoughts would you have, Mr.

Secretary, as to what we here on Capitol Hill could be doing in the

way of giving more support or focus or attention or emphasis to

your efforts over at Energy? We have a number of, as you know,

energy initiatives up here in various committees in the House and

the Senate for a number of fuels, a number. But beyond that,

there, I am sure, are other areas where we could be doing things.

I am not surprised, but I note that nuclear has not been touched

upon here, not much, in the first 45 minutes of this hearing. Coal

has been referenced a couple of times. But those would be two

areas that you might want to include in whatever thoughts you

have, because I would be interested in getting both of your sense

of nuclear and coal for our future energy portfolio.

Mr. MCSLARROW. Well, there is no doubt that our view is that

nuclear and coal have an important part of the energy mix, and

have to play an important role in our energy future.

As I said before, nuclear provides about 20 percent of our electricity generation today. Nuclear energy has a couple of challenges

which we recognize in the national energy plan. One was: What do

you do about nuclear waste? Well, the Administration recommended and Congress approved moving forward on Yucca Mountain. Now, we are still a ways yet. We are hoping to have—to take

receipt of nuclear waste starting in 2010. But that was a big answer to a big question.

Another issue has to do with proliferation. I mentioned earlier,

the GEN-4 international consortium. One of the goals is to work on

advanced fuel cycles and advanced reactor designs that address, up

front, proliferation and safety issues.

I think in today’s market, the biggest problem that nuclear energy faces, frankly, is not the mechanics of nuclear energy. The industry has come a long way from 20 or 30 years ago. It is regularly

operating at 90 percent capacity. It is one of the most efficient, lowest cost providers of electricity in the country. It is really the political dimension, and there—that is a dimension that affects investment decisions. And I think until there is a greater comfort level,

it is going to be hard to convince people to make that kind of upfront investment decision.

And so there would be a place I would say it would be very important for the Senate and Congress in general to make clear that

nuclear energy has that kind of vital role in the future and in the

energy bill that is presently before the Energy Committee.

24

On coal, again, coal provides 50 percent of our electricity generation. We have a 250-year supply. It is abundant. It is cheap. But

it also has challenges, particularly in the environmental arena.

So what we are working on and what the Administration has

proposed and President Bush has announced, is a number of initiatives that take on those challenges and that try to figure out how

you use coal, whether or not you use it in a gasified form so you

can sequester carbon and reduce emissions, or some other technological advances. But it is clear we cannot walk away form coal.

But it is also clear that just based on the R&D that has been done

in the last few years, we have real opportunities to turn that into

a low emissions source of energy. But it is not without challenges,

and it is not without cost.

And finally, Mr. Chairman, at the risk of beating a dead horse,

I should mention ANWR because—I realize we had a vote here in

the Senate recently on this, but I do think it is important to think

about ANWR in this way. And that is, and particularly in this environment where I think people are—where this will resonate a little more. If you look over the last five years at the spare capacity

on the world market, it averages about 4 million barrels a day,

with production today of about 77 million barrels. And if you look

at the forecast from the Energy Information Administration, which

is an independent arm of our Department, over the next 25 years,

it is not much different. It is about between 4 million and 5 million

projected of spare capacity.

If ANWR had been—when it was first eligible to be voted on, had

come online, we could be producing 1 million barrels a day now.

The way to look at this is that is 25 percent, potentially, of spare

capacity. And at a time when only a few million barrels off the

market has put us, in terms of markets and everybody watching

what OPEC is doing and what we are doing with the petroleum reserve, it ought to be a reminder that when people say ‘‘1 million

barrels a day,’’ that is still on the margin a very significant increase in our energy security potentially. And as I said, I know I

am risking beating a dead horse, but I think that is an important

thing to continue to consider.

Senator HAGEL. Well, I did ask what you thought we should be

doing up here. And so you are looking for two more votes.

Mr. MCSLARROW. That is about right.

Senator HAGEL. Secretary Larson.

Mr. LARSON. I agree that both nuclear and coal are indispensable

parts of an energy balance. I would focus just quickly on the international dimension of that. We find in groups like the G–8, for example, that there is a vast range of views on this subject. Countries

like the United States, France and Canada have maintained nuclear as an important option. Countries like Germany are moving—

and Italy are moving strongly away from it. And some like the

United Kingdom are a little bit on the fence. I actually should include Japan in the camp of countries that are maintaining nuclear

as an option.

We would like to try to work with countries to improve the ability to use nuclear power in a safe and efficient way, and that gets

to a point that I want to make more generally that, to the extent

that we are able through the research and development initiatives

25

that you have referred to and that Kyle McSlarrow has been talking about, that we can have these open to participation by countries that are prepared to ante up and share in the costs and,

therefore, also share in the benefits. I think it is a very important

way to proceed. It lessens the budget costs for the United States

to explore these options, and it adds to our energy security if other

countries can also find ways of diversifying their energy mix.

On coal, I do not have too much specific to add to what Kyle said

except to say that I think that some of these technologies that minimize the environmental impact of coal, clean coal technologies,

carbon sequestration, can be very important in increasing the acceptability of coal outside of the United States.

The last point I would make comes back to the North American

energy market. I think that we will have potential to further integrate the energy market is this hemisphere. That will require,

among many other things, making sure that we treat energy production throughout North America in an even-handed way. Occasionally, there are proposals that move in a different direction.

They do not all come in the United States. Sometimes they come

from our neighbors as well.

But I think each country, as I have had the opportunity to have

more intensive discussions with them on this subject, sees that

there is a North American energy future that is a better future

than the future we build if we build them separately. And that is

going to require, I think, that we are very conscious to make sure

that we are not erecting small barriers or small impediments to the

free flow of energy across national borders in North America.

Senator HAGEL. Thank you. I appreciated also, in your written

testimony, one of your last points about Iraq and making a very

clear statement on Iraqi oil which the President and Secretary of

State have recently made the same points, that Iraqi oil belongs to

the Iraqi people. I think there is still some question, maybe significant question in the world, as to what all of America’s motivations

are in Iraq, and certainly oil is right at the top of that list of questions. So the more we can make that point very clear, as you know

so well, I think the better off we are.

I would say to Secretary McSlarrow that you know that we are

doing our part up here for renewable fuels, in particular bio-diesel

and ethanol, not that we have any parochial interest in that, but

in the overall interests of a wider, deeper energy portfolio for our

country, that is, we think that is probably good.

Maybe I could ask one last wraparound question of the two of

you. You have been up here for an hour and I appreciate very

much your time. And you both have made this case well in your

written testimony and some of the specific points you have made

in answer to the questions.

The importance of integrating policy, I do not think can be understated at a time when so much is at risk in this world. This

piece that we are focusing on today, energy, is but one of those. But

I think it has been pretty clear in what each of you have said, representing the two important Departments here for the Government

in this area, that without that integration of understanding our national security interests, our diplomatic interests, our economic interests, energy interests, that we will not accomplish any of our inVerDate 11-MAY-2000 15:01 Sep 11, 2003 Jkt 000000 PO 00000 Frm 00029 Fmt 6633 Sfmt 6602 88999.TXT SFRELA2 PsN: SFRELA2
26

terests unless we come at it from the wider-lens view that they are

all inter-connected and all inter-related, and investment and relationships are critical.

And because we have had a good deal of emotion and passion as

to how we got into a war in Iraq, I think we face some significant

challenges within our own country, within our own pockets of people who talk, some up here on Capitol Hill, responsible members

of Congress, ‘‘Well, let us sanction some of our allies. Let us hurt

some of our allies,’’ because they did not agree with us on Iraq,

that in my view is a very dangerous and short-sighted reaction.

And I think just viewing this from the narrow focus of energy, we

come to clearly understand how dangerous that kind of reaction is.

The President said it again yesterday and he has been saying it,

as well as Secretary of State and Secretary of Energy, that these

great challenges that lay before us are world challenges and not

just U.S. challenges.

I would give you each an opportunity to respond to that, or expand on that, or say anything you would like before I ask the second panel to come up.

Secretary McSlarrow.

Mr. MCSLARROW. Well, Mr. Chairman, first, thank you for the

opportunity to be here today.

I guess I would just close by using the example we discussed before, which is Russia. I mean obviously, there were—these are difficult times. But nonetheless, I believe my charge from President

Bush and Secretary Abraham is to continue driving forward on the

energy dialogue. It is good for the partnership. It is good for U.S.

energy security. It is good for U.S. investors. It is good for U.S.

companies. And so I am just going to properly stay in my lane and

just focus on that. But I think it is one of the—as in many other

cases, we can differ and still work together at the same time.

Senator HAGEL. Yes. Thank you. Well, please convey to the Secretary and all of your colleagues our appreciation for what you are

doing, and we are mindful of it. And we will help in every way we

can. So thank you.

Secretary Larson.

Mr. LARSON. Thank you. I would like to make two comments, Mr.

Chairman. The first I think arises out of my capacity as one of

President Bush’s Presidential appointees who, at the same time, is

someone who served in different administrations. And that is that

energy security cannot be a partisan issue. There are no panaceas.

Most of the things that people talk about are things that we need

to do, but we cannot just do one or two of them. We need to do all

of them.

We have to pursue energy conservation and renewables. We have

to pursue initiatives like ANWR. We have to pursue the development of a diversified energy mix by looking into all of these different parts of the world that we have discussed today, and others,

to create a resilient energy market.

And it is very important to maintain the sense that we do not

have the option of achieving energy self-sufficiency, but we can

achieve energy security if we approach it in a bipartisan way and

if we look at all of the things we have to do, not just a small subset.

27

The second point I wanted to make picked up on your very apt

remarks about the importance of international cooperation and of

not holding grudges, if you will, and I will just give you one example. After the 1973 oil embargo, the United States did make a policy of forming the International Energy Agency. At the time, one

important country chose to stay out of the IEA, and that was

France. They felt that they wanted to pursue an independent Middle East policy, that they wanted to go their own way, and that

was a subject of considerable tension at the time.

Today France is a member of the International Energy Agency.

And when Mr. McSlarrow and I and others held our consultations

earlier this year on how we should respond effectively and in a coordinated and concerted way to any developments in Iraq, it was

with the new French leader of the International Energy Agency.

They now hold the executive director position in the agency that

they once made a political choice to stay out of. And I think that

is an illustration of the point that you made, which is that over

time, you know, countries come back to the fold. And on this issue

of energy security, France is a country that has worked very closely

with us in recent years through the IEA.

Senator HAGEL. Thank you, gentlemen. We are grateful. And

again, I would say to you, Secretary Larson, as I did to Secretary

McSlarrow, please pass on to your colleagues how much we appreciate what they are doing at a very difficult time. Thank you very

much.

Mr. LARSON. Yes, sir. Thank you.

Senator HAGEL. As our first panel packs up, the second panel is

welcome to step forward. [Pause.]

Senator HAGEL. Welcome again. We appreciate the three of you

being here today because you represent so much expertise and experience in the area that we are talking about today. So thank you.

We will begin with one of our first private sector witnesses. And

as you know, I have introduced the three of you. So, Dr. Daniel

Yergin, welcome. Proceed.

STATEMENT OF DR. DANIEL YERGIN, CHAIRMAN, CAMBRIDGE

ENERGY RESEARCH ASSOCIATES

Dr. YERGIN. Thank you, Senator Hagel. It is an honor to be addressing your subcommittee this afternoon.

Events over the last several months have, of course, made energy

security front and center, and have demonstrated anew the importance. We have seen disruptions not only in the Persian Gulf but

also non-Gulf countries, Venezuela and now Nigeria.

But this issue of energy security is very much of continuing importance. And it has been for over a century. It probably began

when Winston Churchill converted the British Navy from coal to oil

on the eve of the First World War, meaning that the Royal Navy

was now dependent on oil from Persia, Iran. And at that time, he

laid out one of the most important principles of energy security. He

said, ‘‘Safety and certainty in oil lie in variety and variety alone.’’

And that is still the case today.

What I would like to do in my testimony is to provide the subcommittee with a framework for understanding the national energy

position, to identify some key axioms for thinking about energy seVerDate 11-MAY-2000 15:01 Sep 11, 2003 Jkt 000000 PO 00000 Frm 00031 Fmt 6633 Sfmt 6602 88999.TXT SFRELA2 PsN: SFRELA2
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curity, and then to relate them to some of the areas that you have

already raised as being of particular importance.

Why are these issues so salient now? Some are obvious: what is

happening in the Middle East; the rise in U.S. oil imports. To that

add the market pressures, energy price spikes in 2000 and 2001,

and then in 2002–2003, have reminded us in this post-new-economy world of the importance of energy and its importance to our

economy.

Finally, of course, there is a new sense of post-9/11 vulnerability.

To the traditional concerns about energy security, add those about

the security of energy infrastructure.

Now, as Senator Hagel pointed out, our $10.5 trillion economy

rests, first, on oil. And then altogether oil, natural gas, coal and

nuclear provide 93 percent of our energy. Oil is almost 40 percent.

Wind, though growing, and solar provide a little over one-tenth of

1 percent, about 75,000 barrels a day, compared to almost 20 million barrels a day of oil.

As you pointed out, Senator Hagel, most of these issues are debated in the context of what is unfolding in the Middle East, and

I think people lose sight of the fact that the United States gets 90

percent of its oil either from within the U.S., from the Western

Hemisphere, or from West Africa and the North Sea.

But still our imports continue to rise. As Secretary Larson said,

there is no single formula of what to do. To the list he had, I would

certainly add technology. One of our focuses at Cambridge Energy

Research Associates is on what we call the digital oil field of the

future, which we think over five to ten years could add the equivalent of 125 billion barrels of economically recoverable reserves—

which are more than those from Iraq.

I have in my testimony, eight principles of energy security. I will

not mention all of them, but one of them, Senator Hagel, is a point

that you have made about the importance of cooperative relationships with allies, and that these are not issues that we can go

alone with.

What about tomorrow? When we look at the shares of world oil

production and world oil reserves, we see that something very dramatic has happened that people have not much focused on. There

has been the first major increase in world oil reserves since the

mid-1980s, when all of the Persian Gulf countries together increased almost overnight their proven reserves by what amounted

to 50 percent. That is, we have now seen 175 billion barrels increase in proven reserves. They are not, however, in the Middle

East. They are in our neighbor Canada. And those new reserves

that have been added, oil sands, are 50 percent more than Iraq’s

proven reserves.

Obviously, the reserves of the Persian Gulf—now not 66 percent,

but 56 percent—are still not only among the cheapest to produce

but are of absolute central importance to the health of the world

economy. And their security and stability is of critical importance.

Yet, at the same time, these resources exist in a larger and more

diverse network of global oil production and supply.

Again, as you suggested, things need to be seen in perspective.

Iraq’s recent production is less than 3 percent of total supply.

29

What about the future of Iraqi oil? Our estimate is that it would

take two to three years and several billion dollars simply for Iraq

to get back to where it was in 1990, and perhaps $30 billion in

seven to ten years to add another 2 million to 2-and-a-half million

barrels a day.

Altogether when we look out over this entire decade, we see an

increase of about 20 to 25 percent increase in world production capacity. The leaders in new sources will be the Middle East on one

hand and Russia and the Caspian on the other, pretty much even,

and then West Africa.

So let me say a word about Russia and the Caspian. The numbers are quite striking, from—together—from 7.8 million barrels a

day to 14.2 million barrels a day over this decade. The U.S. Government has played a very important role in encouraging the development of Caspian reserves and production.

The striking growth has been in Russia, what some have started

to call the miracle in the Russian oil fields, a 25 percent increase

over the last three years, and more than anything else, it is technology, and the application of economic principles to the operation

of those fields.

As Secretary McSlarrow discussed, transportation is the key bottleneck, and certainly there’s an area for the U.S. and Russia to cooperate as we look to the development of these new pipelines that

would make Russia a significant exporter potentially to this United

States. I think we all welcome the words that have been said in

the last few days by President Putin and our President’s National

Security Assistant, trying to look beyond the major disagreement

on Iraq to cooperative relations, including energy.

Let me say a word about West Africa, which is the other area

of significant growth. By 2006–2007 West Africa could overtake the

North Sea as a source of oil. But we also see the risks there as exemplified in this almost 40 percent shutdown of Nigerian capacity

over the last few weeks because of political instability.

There are major obstacles that need to be focused on in order to

encourage this development of production in West Africa which

would be so important to the economic health of those countries

and to their economic growth. One need is to market the natural

gas that comes with oil. Another is to address the instability in the

political environment.

How can the U.S. help? We can help in terms of strengthening

state institutions, improving political relations with West African

countries and developing domestic and regional gas markets.

That is an overall picture. I would like to say something further

about the principles of energy security. I began by quoting Winston

Churchill, one British Prime Minister, on energy security. I would

like to conclude by quoting another, a discussion I had with Margaret Thatcher in the course of working on Commanding Heights.

At the end of our talk, she said, ‘‘Remember Thatcher’s Law.’’

Not being familiar with what it is, I asked her, ‘‘What is Thatcher’s

Law?’’ ‘‘The unexpected happens,’’ she replied. ‘‘You had better prepare for it.’’

At times like this, we are very mindful of the surprises, whether

in the Middle East, Venezuela or Nigeria. But Thatcher’s Law

seems to me a very good principle, indeed an essential principle,

30

1Daniel Yergin, The Prize: The Epic Quest for Oil, Money, and Power (Touchstone, 1993).

to keep in mind, both now and in the future when it comes to energy security.

Thank you.

Senator HAGEL. Dr. Yergin, thank you.

[The prepared statement of Dr. Yergin follows:]

PREPARED STATEMENT OF DR. DANIEL YERGIN

I. Introduction

I am very pleased and honored to be invited by the Subcommittee to discuss Global Energy Security. Energy security is a subject that has much engaged me for over

25 years. It constitutes one of the major themes of The Prize: The Epic Quest for

Oil, Money, and Power.1

A year ago this hearing might have been more theoretical, about ‘‘what-ifs.’’

Events over the last several months have, of course, made it front and center, and

demonstrated anew the importance of oil to our security and our economy. The issue

of oil in the Persian Gulf is foremost now. But we have also seen the significant

disruptions in non-Gulf countries, Venezuela and Nigeria. The disruptions in Venezuela removed more oil from the world market than the cessation of Iraqi exports

and did much to push up oil prices and deplete U.S. inventories. Barring further

disruptions, we should see oil prices continue to ease as demand decreases with the

end of the winter in the northern hemisphere and as large volumes of stepped-up

production from other countries reaches our shores.

But the issue of energy security will remain one of continuing importance. Energy

security is not a new concern. It has recurrently been an issue since the rise of industrial society more than a century ago. The beginnings may well have been when

Winston Churchill, as First Lord of the Admiralty, converted the Royal Navy from

coal to oil on the eve of the First World War. As a result, the Royal Navy moved

from Welsh coal as the source of its propulsion to Persian (Iranian) oil. Confronted

by this new risk, Churchill articulated a principle of energy security that is no less

apt in the first decade of the twenty-first century: ‘‘Safety and certainty in oil lie

in variety and variety alone.’’

Over the century since Churchill’s decision, energy security has persistently come

to the fore. It was a very critical dimension in World War II. In the decades after

World War II, there were five Middle East crises that either disrupted or threatened

to disrupt the world oil supply system. We are now in the sixth.

The previous crisis was a little more than a decade ago, with the Gulf Crisis of

1990–91. At that time, the imminent threat was that the breadbasket of world oil

production—the Persian Gulf—would fall under the sway of Saddam Hussein, enabling his regime to translate oil into political, economic, and military power—and

into weapons of mass destruction.

A decade later, Iraqi oil is no longer entering the world market. In looking back,

it is clear that, with the end of the Cold War and the resolution of the Gulf Crisis,

we passed into a decade of exaggerated confidence about security. That includes energy security.

My objectives in today’s hearing, in response to the subcommittee’s specific questions, are threefold:

• First, to provide the subcommittee with a clear framework for understanding

the national energy position.

• Second, to identify key axioms for thinking about energy security.

• Third, to relate international relations in various regions—including Russia and

West Africa—to the future of oil supply and to try to answer the question, ‘‘How

important is Persian Gulf oil in a global context?’’

The reasons energy security is so salient—and why these hearings are taking

place—is clear:

• War in Iraq—turmoil and crisis in the Middle East. This extends beyond Iraq

to terrorism, al Qaeda, demographic pressures, the Israeli-Palestinian conflict,

and generational change.

• Rise in U.S. oil imports. A quarter century ago, at the time of the 1973 oil crisis, the United States imported 36 percent of its oil. Today it is over 50 percent.

31

2 Commanding Heights: The Battle for the World Economy, PBS, beginning May 15, 2003 at

10pm.

• Market pressures. Energy price spikes in 2000–01 and 2002–03 have in this

post-‘‘new economy’’ world reminded people of the importance of energy, which

slipped away during the now-defunct era of the ‘‘new economy.’’

• Vulnerability. To all this, add a new concern in addition to the traditional concerns about the flow of oil: the security of energy infrastructure, part of the

overall focus in the United States on ‘‘homeland security.’’

II. The U.S. Energy Position

America’s $10.5 trillion economy rests on an energy foundation. Some 93 percent

of that foundation is provided by oil, natural gas, coal and nuclear power. (Oil, at

about 20 million barrels per day (mbd), alone provides 40 percent of the total. Natural gas is 22 percent). Another 2.6 percent is hydropower; and biomass also provides 3.5 percent. Wind, though growing, and solar provide a little over one tenth

of 1 percent—the equivalent of about 75,000 barrels per day (bd). It is noteworthy

that the United States consumes about a quarter of the world’s oil, while its GDP

is about a third of total world GDP.

Imported oil meets over 50 percent of U.S. total oil consumption (see Table 1).

Seventy percent of America’s oil either is produced in the United States or comes

from our neighbors in the Western Hemisphere. Another 20 percent comes from

West Africa and the North Sea.

Table I.—The Top Five: U.S. Oil Imports, November 2002

(million barrels per day)

Country Amount

Canada ................................................................................................. 2.07

Venezuela ............................................................................................. 1.60

Nigeria .................................................................................................. 1.59

Mexico ................................................................................................... 1.53

Saudi Arabia ........................................................................................ 1.50

Source: USDOE, Monthly Energy Review.

The simple reason that U.S. oil imports are going up is that U.S. demand has for

many years been increasing more rapidly than production, which is increasing only

modestly.

The prospect of rising oil imports has caused concern in the United States ever

since the United States became a net importer in the late 1940s. After all, the

United States provided six out of seven of all barrels of oil used by the Allies in

the Second World War. For 30 years, ‘‘energy independence’’ has been a recurrent

cry. Yet, during these years, the United States has become more integrated into the

world economy in many ways that have contributed to higher standards of living

and higher employment. This integration emerged as one of the major themes of our

new PBS series, Commanding Heights: The Battle for the World Economy. 2 Some

of the indicators are: U.S. foreign trade doubled during the 1990s and is now equivalent to 25 percent of GDP, compared to 10 percent a couple of decades ago. Americans made 200 million overseas phone calls in 1980. By the end of the 1990s, that

number was over 5 billion. One out of seven U.S. manufacturing workers is employed by a non-U.S. owned firm.

Oil, however, is a strategic economy. The issue is not whether the United States

should import oil, but, rather, how to avoid being in a position that makes it vulnerable to disruption. Unless one is able to imagine some draconian regulations or a

series of technological breakthroughs that are not now apparent, the practical question does not revolve around substantial reductions in imports, but rather about stabilizing them.

But how to do that? There is no single answer or formula.

Conservation has a significant role. The United States already has made a good

deal of progress. Today, the amount of oil used per unit of GDP is only half of what

it was in the 1970s.

32

3Digital Oil Field of the Future, CERA Multiclient study, 2003. 4The Hydrogen Economy, How Far and How Fast?, CERA Private Report.

Stabilizing or increasing oil production is also important. Technology has meant

extraordinary strides in the capabilities and efficiency of oil production within a

strong environmental framework. The deepwater Gulf of Mexico is the major reason

that the U.S. production is increasing—slightly offsetting the strong declines elsewhere. But the ability to continue to increase production will depend, more than

anything else, on policy decisions made on access to resources.

A major technological revolution is unfolding today—what we at Cambridge Energy call ‘‘DOFF’’—the ‘‘digital oil field of the future.’’ This brings together a panoply

of information and control technologies, remote sensing mechanisms; ‘‘intelligent

drilling,’’ and highly-accurate measurement tools to make exploration and production far more exact and targeted. The consequence will be to substantially lower

costs. As a result, physical supplies that were previously too expensive or too difficult to reach will now become economically feasible. The impact of DOFF will be

enormous. For example, in our recent major multiclient study on the subject, we

show that in the next five to ten years the digital oil field could expand world oil

reserves by 125 billion barrels—more than the entire currently-proved reserves of

Iraq.3

New technologies, particularly in the transportation sector, will be important, although this will only unfold over time, as the U.S. vehicle fleet cannot quickly turn

over. While there is much discussion about the fuel cell, it does not seem imminent

as a competitive technology in transportation. It appears that the biggest mediumterm impact will come from hybrid vehicles—part internal combustion, part batterydriven.4

III. Principles of Energy Security

Being that the United States will be a large oil importer—the world’s largest— for some years to come, what are key principles for thinking about energy security?

Based upon the experience of the United States over the last 30 years, I would offer

the following common-sense observations:

1. Recognize that there is really only one oil market. The United States

is part of a global oil market, an extraordinarily huge logistical system that

moves 77 million barrels of oil around the world every day. U.S. security

resides in the stability of the overall market.

2. Churchill’s maxim of 90 years ago still holds true: diversification of

supplies is one of the key guarantors of security and this has been an important element of United States policy since the 1970s. The recent sudden

losses of production from Venezuela, Iraq, and, partially, from Nigeria underscore this point.

3. Emergency stocks, such as the U.S. Strategic Petroleum Reserve, are

a front-line defense against disruption. But their value should not be devalued and undercut by turning them into market-management schemes

that confuse temporary hikes—seasonally induced or the result of regulatory-induced balkanization of the gasoline market—with a serious disruption. At the same time, spare capacity maintained by key producing countries is a major defense against disruption, as was demonstrated in 1990.

4. The oil market is far more flexible than it was in earlier decades.

Intervention and controls can be highly counterproductive, hindering the

system from readjusting. As tough as it is, resisting the temptation to

micromanage markets can be one of the most significant contributions of

public policy. After all, the famous gas lines of the 1970s were largely

homemade—the result of controls that prevented moving gasoline to where

it was needed from places where it was not needed.

5. Pursue cooperative energy relations with other importing nations,

whether they be the other industrial nations, the new ‘‘globalizers’’ like

China and India that will be the most rapidly growing importers of oil, or

the poor nations. These can be pursued on a multilateral basis, as with the

International Energy Agency, or bilaterally.

6. Government can allay the panic that creates self-fulfilling prophecy

through quality information and by facilitating the exchange of information

within the industry that makes possible more rapid adjustment.

7. Most oil exporting nations recognize the mutuality of interest and are

deeply interested in ‘‘security of demand’’—stable commercial relations with

their customers, whose purchases often provide a significant part of their

33

national revenues. Thus, the United States needs to maintain strong dialogues and a spirit of cooperation on a consistent basis with the exporting

nations.

8. A healthy, technologically driven, domestic energy industry is part of

energy security. So is a commitment to research and development and innovation across a broad spectrum that takes into account current and future

environmental considerations.

IV. Today’s Oil Supply—and Tomorrow’s

Table 2 provides the basic outline of share of world oil production and world oil

reserves. As is evident, the Middle East is the largest regional source of oil. But

one of the most noteworthy features since the 1970s is the significant growth in

non-OPEC production. As a result, the Persian Gulf’s share of production has declined from 40 percent to under 30 percent. Most noteworthy is the 35 percent decline in output in Iran over the last 25 years and the 20 percent decline in capacity

in Iraq between 1990 and 2002.

Reserves are a different story. A far larger share of world oil reserves is concentrated in the Persian Gulf region. The percentage share is typically given as 66

percent. But that is no longer up-to-date. It is now 56 percent.

Table 2.—World Oil: Regional Shares

(percent of total)

Percent of

World

Liquids

Production

Percent of

Reserves

North America ............................................................................ 18.5 17.7

United States ........................................................................ 10.4 1.8

Canada .................................................................................. 3.3 14.8

Mexico ................................................................................... 4.9 1.0

Middle East ............................................................................... 29.2 56.5

Saudi Arabia ......................................................................... 11.6 21.5

Iran ........................................................................................ 4.8 7.4

Iraq ........................................................................................ 2.9 9.3

Kuwait ................................................................................... 2.7 8.0

United Arab Emirates ........................................................... 3.2 8.0

Africa ......................................................................................... 11.1 7.6

Asia Pacific ............................................................................... 10.6 3.2

Latin America ............................................................................ 8.8 8.1

Europe ........................................................................................ 9.1 1.6

Eurasia ...................................................................................... 12.5 6.4

Russia ................................................................................... 6.8

Other .......................................................................................... 4.0

Source: Cambridge Energy Research Associates, Accenture, and Sun Microsystems, ‘‘Global Oil Trends

2003.’’

Although almost completely overlooked, something very important has just happened to supply. This past year saw—after several years of discussion—the first

major increase in world oil reserves since the mid-1980s, when all the major Persian

Gulf countries announced that they were increasing their proven reserves by what

proved, in aggregate, to be more than 50 percent.

The new increase is some 175 billion barrels. This is a great deal of oil—50 percent more than Iraq’s proven reserves and two thirds those of Saudi Arabia’s. These

new reserves, however, are not in the Middle East, but in Canada. Advances in the

technology for handling the oil sand deposits in the province of Alberta have, by cutting costs almost in half, moved this enormous volume of potential supply into the

economically-recoverable ‘‘proven reserves’’ column. For the first time since the famous geologist Everette DeGolyer reported to President Roosevelt in 1943 that the

34

‘‘center of gravity of world oil production’’ was shifting to the Persian Gulf, there

has been a significant decline in the Persian Gulf’s share of total world oil reserves,

from 66 to 56 percent.

The point here is that world oil supplies are not some finite constant sum. Rather,

the picture is dynamic and changing. The reserve picture will continue to shift. It

is altogether possible that if and when a ‘‘new’’ Iraq sorts out its arrangements and

reintegrates into the world economy, new exploration will substantially increase its

reserves, pushing up once again the Persian Gulfs share of the total.

That the Gulf’s reserves, among the cheapest to produce in the world, are of central importance to the health of the world economy can hardly be doubted. They are

critical both to the developed and the developing world. Altogether, the region provides more than a quarter of the rest of the world’s total oil.

Yet, at the same time, these resources also exist in a much larger and more diverse network of global oil production and supply. Losing sight of that is to lose

sight of the context. Some of today’s rhetoric would have one believe that Iraq is

uniquely important to world oil supply. That simply is not true. It amounts to less

than 3 percent of total world supply, and technology is making available new supplies in ways that most people do not realize.

One other observation: it is continually said that Iraq has the second largest proven reserves in the world (although there is some question about the word ‘‘proven’’ in the case of Iraq, given how relatively under-explored it is). But Iraq is no longer

the second largest; it has the third, after Canada. Also, it is helpful to note that

Iraq’s reserves are more or less in the same range as neighboring countries—Kuwait, Iran, and the United Arab Emirates.

CERA sees significant growth in world oil supplies over this decade—measured

in terms of additions to capacity, on the order of a 20–25 percent—plus increase.

(See Graphic ‘‘World Liquid Productive Capacity’’). Some of the most noteworthy

growth will occur in Eurasia (Russia and the Caspian), West Africa, and Latin

America—as well as Canada. The deepwater U.S. Gulf of Mexico is also very important.

The largest growth, at least at this point, looks to be in the Middle East. On

present estimates, Middle East capacity is expected to increase by about 7 million

barrels per day—more growth than in any other region. But Russia and the Caspian

will be very close.

The overall growth in world productive capacity will be required to meet rising

demand from developing countries, led by China and India. (China’s oil consumption

has doubled since 1990, and today China is the world’s third largest oil consumer

and is rapidly moving up on Japan.)

But the prospects for future oil supplies are not fixed. They will be determined

by economics, politics, public policy, and technology. Whatever the part of the world

one is talking about, one critical factor will be the stability and reasonableness of

the investment framework and its openness to foreign investment. The second thing

that needs to be taken into account is time frame. There is no fast-forward button

to push. An ineluctable ‘‘law of long lead times’’ seems to govern when it comes to

major oil and gas development. Projects unfold over five or ten or fifteen years. At

every stage, the investors are managing risks. This reinforces the need to shape investment environments that meet the needs of both host governments and international companies over time.

These observations should be kept in mind when discussing the speed with which

the Iraqi oil industry will be restored and expanded.

What might be expected from some of the major regions? To begin with, Canada

will become a much more significant producer—moving from 3 mbd in 2003 to 4.5

mbd in 2010—led by the oil sands from Albert and, to a lesser extent, from eastern

Canada’s offshore.

V. Russia and the Caspian

Russia and the Caspian have taken on new significance for the world oil market

over the last year. Waves of optimism and pessimism about the potential contribution of the Former Soviet Union have swept over the world oil market in the last

decade. At one point, there was expectation that the Caspian region might be a new

‘‘el dorado,’’ a new Persian Gulf. At other points, there was focus on the decline of

output from the Russian Federation.

There has been a striking shift in the picture of Caspian oil and gas reserves in

the last decade. Ten years ago, Caspian hydrocarbon reserves were visualized as

consisting very largely of oil, concentrated mainly in the southern third of the basin.

Now, after a decade of intense exploration, it has emerged that most of the oil is

located in the northern third of the basin, while the hydrocarbons located in the

southern third appear to consist mainly of gas.

35

5Miracle in the Oil Fields? The New Growth in Russian Oil Production: Drivers and Implications, CERA Private Report. 6 Changing Course? Iraq and the New U.S.-Russian Relationship, CERA Global Alert

That has put a very different face on the commercial challenges of developing the

Caspian Basin, and on the geopolitical implications. The proximity of the oil of the

northern Caspian to the Russia transportation system makes Russia a prime candidate as an export route. As for the gas of the southern Caspian, it is still unclear

whether the primary market will turn out to be Russia or Turkey—or indeed to

what degree a substantial share of the Caspian gas will remain stranded.

In our work, we have identified several factors that have come together to

strengthen the confidence about potential sizable growth from this area.5

• The Russian oil industry is going through considerable modernization, as it

shifts from an industry that was the remnant of old Soviet ministries toward

that of independent oil companies seeking to operate at world standards. New

technology, new organization, and new attitudes are turning around the production outlook. Observers are noting a shift in the outlook of the industry toward

an emphasis on efficiency and cost reduction. Transportation bottlenecks are in

the process of being reduced, although they are still significant. The results can

be seen in the sharp increase in production last year and this year, as well as

an increasing appreciation in the scale of reserves.

• However, it is worth noting that most of the increase in Russian oil production

in the last four-and-a-half years is due to the Russian oil companies themselves.

With the significant exception of the offshore development of Sakhalin, most of

the Russian production increase comes from West Siberia, long the traditional

core of the Soviet oil industry. So far the only significant Western players have

been the leading service companies.

• The August 1998 financial crash in Russia was a great shock to Western investors. Russia has had several years of solid economic growth since, however, combined with continuing market reform. This strengthens the confidence of Western investors and creates a more solid basis for economic and political cooperation. After years of frustration and disappointment, Russia is now a higher priority for significant investment on the part of Western companies that want to

diversify their resources. As time goes on, world capital markets may well attribute higher value to Russian oil reserves than they do today.

• A new strategic relationship has been emerging between the United States and

Russia. This provides a context for a growing energy relationship. And, in turn,

the energy relationship is a significant dimension of the overall relation. It is

too soon to assess the significance and impact on the energy picture from the

strains between the two countries produced by the Iraq war. But the Russian

government has been careful to draw a clear line between its disapproval of

U.S. policy in Iraq and its continued strong support for economic partnership

with the United States.6

Key for future development will be the development of new pipelines that break

the transportation bottleneck. There may be a decision as early as May on which

route east for Russian oil—whether to a port in the Russian Far East or whether

to a terminus in China. There is also the possibility that a northern pipeline will

be built to the ice-free port of Murmansk—where Lend-Lease goods were shipped

during the Second World War. Such a system would enable Russia to become a significant petroleum exporter to the United States. The distances to the East Coast

would be shorter than that for a tanker from the Persian Gulf.

As it is, the transportation bottlenecks are in the process of being resolved with

new pipelines out of the Caspian region, which is facilitating the build-up of production from those countries.

What does this add up to in terms of additional oil production? Based upon what

is known today, we see strong oil growth coming out of Russia and the Caspian—

from 7.8 million barrels per day in 2000 to 14.2 million barrels per day in 2010—

almost a 60 percent increase. In addition, Russia has an enormous role as the

‘‘Saudi Arabia of natural gas,’’ supplying large volumes to Western Europe and, in

the years ahead, to growing economies of East Asia and even possibly to the United

States, in the form of liquefied natural gas (LNG).

Of course, there could be further surprises that throw either Russia or the Caspian off the new track. But it certainly has much stronger foundations than in the

past. The growth of oil supplies from Russia and the Caspian can be one of the most

important new contributions to stability in world oil markets—especially in the face

of non-OPEC declines elsewhere. The United States has many reasons to pursue

36

7West African Oil & Gas to 2020: Opportunity, Potential and Risk, CERA Multiclient Study

continued strengthening and broadening of our political and economic relations with

Russia. By developing further those relations in general, and working with the Russian government to facilitate energy development, the U.S. government can make

a significant contribution to energy security.

VI. West Africa: At the Threshold

The upstream oil and gas industry in West Africa is at a threshold. After several

years of steady but unspectacular gains in oil output, West Africa is on the cusp

of becoming a leader in global oil production growth. West Africa’s potential is manifested by large deepwater oil discoveries in recent years offshore Angola, Nigeria,

and Equatorial Guinea. Most new oilfield developments are offshore, but not exclusively. Once the Chad-Cameroon pipeline is completed, a billion barrels of hitherto

untapped oil reserves in southern Chad will begin to be exported to the global market. Many American oil companies hope to participate in West Africa’s growth.

How significant is West Africa’s potential? West African oil production capacity

could increase from 4.6 mbd in 2002 to 7.8 mbd in 2010—an increase of 70 percent.

Based on CERA’s projections, almost one out of five barrels of global capacity

growth could come from West Africa between 2002 and 2010. This growth could

strengthen the diversification of United States oil imports and thus improve U.S.

energy security. The U.S. is a natural market for West African oil.

Angola and Nigeria account for the lion’s share of regional production capacity—

roughly 80 percent in 2002—but some of the smaller producers are likely to record

significant gains to 2010. Equatorial Guinea, which produced no oil until the mid1990s, could see production more than double from 0.22 mbd in 2002 to 0.4 mbd

in 2010. Chad could see its production grow from nothing to roughly 0.25 mbd in

the next several years. Oil has been discovered in Niger, but lack of an export pipeline is one of the factors preventing its reserves from being developed. Oil has yet

to be discovered in the waters offshore Sao Tome & Principe, but it is attracting

strong interest from oil companies as it makes preparations to license acreage.

West Africa’s potential is clear, but political and market factors could lead to reality falling short of potential. We’ve seen over the past few weeks what turmoil can

mean in terms of output. Violence in the swamps of the Niger Delta—Nigeria’s main

oil producing region—led to the sudden shut-in of approximately 800,000 bd of oil

production capacity as of late March 2003. The volume of currently shut-in production is approximately 30 percent of Nigeria’s total liquid production capacity. Production disruptions occur frequently in the Delta, but the current volume of shutin capacity is exceptional and is an unfortunate highlight of Nigeria’s political situation.

One certainty is that West Africa has tremendous upstream growth prospects. If

West Africa is to realize its potential for production growth, three risks need to be

successfully managed. A new CERA study on West African oil and gas to 2020 identifies these risks.7

OPEC quota/government policy. In all West African producers, government policy—such as domestic content rules—could lead to slower-than-expected growth.

• Marketing natural gas. Could the lack of market outlets for associated gas production create indefinite delays for new oilfield developments? If the gas associated with an oil development can’t be reinjected or marketed, it could threaten

new oilfield development. Developing outlets for gas production—LNG, domestic/regional markets, gas-to-liquids—is essential for West Africa to realize its

growth potential. Gas could even spur real regional economic integration. A

much-discussed natural gas pipeline from Nigeria to Ghana would, if it is built,

represent a true milestone in regional integration.

• Political environment. Political instability—unexpected changes of government

or civil unrest or even war—could complicate exploration and development by

injecting delays and increasing uncertainty about who in government makes the

rules. Moreover, lack of political stability could result in simmering conflicts

over control of oil revenue that would preclude the use of such revenue as an

engine of economic growth and higher living standards.

The U.S. government and international financial institutions could work together

with West African governments and oil companies to diminish some of the risks that

could lead to West Africa falling short of its potential for production growth. Such

policies could be focused on:

37

8Daniel Yergin and Joseph Stanislaw, The Commanding Heights: The Battle for the World

Economy (Touchstone 2002), p. 106.

• Helping to strengthen state institutions. Weak government institutions in West

Africa often prevent oil revenue from being used as a catalyst of sustainable

economic growth and rising living standards.

• Improving political relations with West African countries. Strong ties between

U.S. and West African governments can help expand oil company investments.

Strong ties would benefit other endeavors as well, such as security cooperation.

• Developing domestic and regional gas markets. Given the large scale of natural

gas reserves in West Africa—Nigeria’s gas reserves match those for oil—gas

could serve as the foundation for expansion of the region’s modest industrial

base. Abundant gas reserves also offer the possibility of rapid expansion of

power generation capacity. Development of regional gas markets, such as the

proposed Nigeria to Ghana gas pipeline, would lead to deeper economic integration between neighboring states. A growing industrial base and rising power

supplies would create jobs and foster greater economic and social stability in

West Africa’s oil producing states.

VIII. Conclusion: One Final Axiom

I began by quoting one British prime minister on energy security. I would like

to conclude by quoting another. I remember a discussion I had with Margaret

Thatcher in the course of working on Commanding Heights. 8

‘‘Remember Thatcher’s Law,’’ she said at the end of our talk.

Not being familiar with it, I asked her what it was.

‘‘The unexpected happens,’’ she replied. ‘‘You had better prepare for it.’’

At times like this, we’re very mindful of the surprises—whether in the Middle

East, Venezuela, or Nigeria. But Thatcher’s Law seems to me a very good principle—indeed, an essential one—to keep in mind both now and in the future when

it comes to energy security.

Senator HAGEL. Now, let me ask our next witness, Mr. Vahan

Zanoyan, to please proceed. Thank you. Nice to have you with us

today. We appreciate it.

STATEMENT OF VAHAN ZANOYAN, PRESIDENT AND CEO OF

PFC ENERGY, WASHINGTON, D.C.

Mr. ZANOYAN. Thank you very much, Mr. Chairman. It is a

pleasure and an honor for me also to be here.

I would like to summarize some of the key points in my formal

testimony also without repeating the whole story. First I would like

to give a very simple definition of what I understand by ‘‘energy

security.’’ And what I understand is sustainable, reliable supplies

at reasonable price.

And immediately, I would like to go and make a major distinction here between security of supplies or crude oil, which so far I

think most of the discussion has been about, and security of supplies of natural gas which, in my view, is the bigger threat right

now in the United States. And I will argue that between these two

issues, oil which gets most of the discussion and most of the debate, actually to a large extent is not most of the problem.

Why is not oil most of the problem? I ask this even though I am

not advocating here, by any means, complacency about security of

oil supplies. I think at least in the last 30 years, if not before, we

have spent a lot of time and effort in the world to kind of adapt

to but also prepare for disruptions in oil supplies. We have built

the Strategic Petroleum Reserve (SPR) in the last 30 years, which

is a major safety net in my view, which has not even been fully

used to its full potential.

38

Not only do we have SPR, but we also have agreement on a coordinated way of deploying it should a disruption occur. We have

introduced major taxes on oil use, not so much in this country but

in other consuming countries in general. There has been a very significant diversification of supply sources, and I agree here with

what the previous speaker and Churchill have said, that diversity

does enhance security, even though I will argue that it does not

necessarily guarantee it.

We have had vast technological advances, not only in the production of energy, but also in the consumption of energy. We have

made considerable enhancements also in market transparency and

efficiency. And finally, we have done pretty good in terms of consumer/producer dialogue and coordination. Not just dialogue, but

also I think there has been an alignment of interests in the last

several years, maybe in the last couple of decades even, in what is

in the interest of major producers when it comes to oil market stability and price moderation and, at the same, what is in the interest of the major consuming—or importing nations.

Now, the results of all of this has been very impressive. We

have—if you look at the record of the last 15 years of how the global oil sector has managed to deal with major oil disruptions, it is

quite impressive. We went through a very major oil disruption in

1990, 1991 when both Iraq and Kuwait went out of commission.

The world lost almost overnight 4.5 million barrels a day. If you

look back and look at what the implications were, we had a couple

of months of price surges and tension in the market. We had a

slight recession here in the U.S. But compared to what 4.5 millionbarrel-a-day oil disruption would have meant on a 1973 scale, for

example, we did not see much of an impact at all.

And let us remember that also during that same period, when

the global oil sector was trying to adjust to this kind of disruption,

there was substantial reductions in exports from the former Soviet

Union. Production there was crashing, and net exports were falling

less, but they were falling nonetheless.

To give you a much more interesting recent example: It is not definitive because it is only weekly statistics, but according to the Department of Energy, the latest weekly statistics show that the week

of March 28th, we imported 10.4 million barrels a day of crude oil,

the highest ever weekly import rate. At the time when we are at

war with the major Persian Gulf producer, at the time when the

world has not yet recovered from the big collapse in Venezuelan

production, and at the time when Nigerian output collapsed by

750,000 barrels a day, we recorded our largest imports.

To me, this means something is working. These are not accidental events. And even though I would not base everything on just

one weekly statistics, I would take the record of the last 15 years

seriously in this, and say there have been some improvements.

And without necessarily going into a lot of complacency, I would

recognize these achievements, not just to feel good about it; but because sometimes when we try to fix what is not broken, we can do

more damage than good.

So when it comes to these oil issues, I would like to differentiate

between three specific concepts. One is diversity of supplies. As I

39

said, it does definitely enhance security of supplies, and it also creates market stability. I think the more producers, the better.

But there is one thing that diversity of supplies alone cannot do.

It cannot immediately fill a sudden disruption anywhere in the

world. If we had a lot more diversity of supplies in the world in

1991, but if we did not have at least one producer with substantial

excess capacity and the willingness and the ability to swing its production up to immediately meet the gap that was created, it would

have been a much more disastrous outcome than we had. So diversity of supplies in that case would not have helped.

The second concept that I would like to focus on is suppliers of

commercial significance; and third, suppliers of strategic or security

significance. There is a huge difference in my view between the

two. Suppliers of commercial significance are definitely Russia,

probably the largest one in the non-OPEC field. Norway is a very

significant supplier of commercial significance.

But we have right now in the world, whether we like it or not,

regardless of the politics, regardless of shared values, only one

strategic supplier; strategic meaning a supplier that is willing and

able to hold substantial amounts of idle capacity and is willing and

able to swing its own production very radically to meet market demands. And that is Saudi Arabia.

Iraq one day can become a very significant commercial supplier

along the lines of Russia and Norway. And, Mr. Chairman, I appreciated your comments here about Iraq; in order for Iraq to become

that significant supplier, I think, it is very important that the oil

is managed by them, that it is held by them. But it is also very

important that substantial amounts of transparency and accountability are introduced in the way they run it.

Finally, I would like to come to the natural gas issue. I think the

United States is far more vulnerable to supply disruptions in natural gas. U.S. demand for gas is outstripping supplies as it was

mentioned earlier by the Secretary, by—both Secretaries, I think,

mentioned that. And, frankly, Washington has not been particularly helpful in this case. It has encouraged consumption, and it

has discouraged domestic production of natural gas. And that does

not help.

Maintaining production itself, let alone increasing it to meet demand, has become extremely difficult in the United States. The

fundamental difference there between natural gas and oil is that

natural gas is not a global commodity. Global markets do not

equilibrate as fast as they do in oil, and sometimes never.

Had natural gas been a global commodity, easily transportable,

where markets equilibrated faster, and had we had the 30 years

experience in dealing with disruptions and shortages in gas that

we do in oil, this probably would not have been a problem, but we

do not have any of those things.

I will not go into the details about why domestic production is

falling, nor details about why demand has been rising. Those are

all in my written testimony, Mr. Chairman, so I will not take the

time.

But I would like to stress that right now we are at the period

of historic lows in gas storage in the United States, at the time

when production is falling by 4 to 5 percent. At these rates, we canVerDate 11-MAY-2000 15:01 Sep 11, 2003 Jkt 000000 PO 00000 Frm 00043 Fmt 6633 Sfmt 6602 88999.TXT SFRELA2 PsN: SFRELA2
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not meet both current demand and build enough stocks in preparation for the winter high demand season.

Most often what happens in a situation like this is that we cannot cut supplies from residential use. We cannot have homes dark

and not air conditioned. We cannot cut supplies from power plants.

So we end up cutting supplies from the industrial sector, which

means factories shut down and jobs are lost. It is a real cost, and

we are not adequately addressing it.

I would conclude there. Thank you.

Senator HAGEL. Thank you very much. Thank you.

[The prepared statement of Mr. Zanoyan follows:]

PREPARED STATEMENT OF VAHAN ZANOYAN

Good afternoon. Senator Hagel and distinguished members of this Subcommittee,

it is a pleasure to come before you today to address such a timely and critical issue.

My name is Vahan Zanoyan and I am the President & CEO of PFC Energy. PFC

Energy is a strategic advisory firm in global energy, based in Washington, DC. We

work with most of the companies in the global petroleum industry on various aspects of their international oil and gas investments and market strategies.

Crude Oil and Natural Gas: Different Security Challenges

This hearing is about global energy security issues, which covers both oil and natural gas. The definitions of supply security of oil and natural gas are the same: sustainable, reliable supplies at reasonable prices. However, I would like to start by

highlighting an important distinction between security of crude oil supplies and security of natural gas supplies, because these two commodities represent entirely different security challenges globally, and particularly for the United States. Oil is a

global commodity. Conditions in crude oil markets in Houston, New York, Singapore

and Rotterdam change together and in the same direction. Global oil markets equilibrate. Gas is not yet a global commodity. Vast natural gas resources in various

parts of the world remain stranded because natural gas cannot be transported as

easily as crude oil. Global gas markets do not always equilibrate—it is possible to

have a natural gas supply shortage in North America without causing a disruption

in Europe or elsewhere.

I will argue that although security of oil supplies receives most of the attention

in policy discussions and debates, oil is not the most pressing energy security problem faced by the United States. On the other hand, natural gas, which rarely gets

into the limelight of the energy security discourse, has emerged as a major supply

security problem for the United States.

Security of Oil Supplies

The world has had thirty years to adapt to and prepare for oil supply disruptions.

Both consuming nations and producing nations have participated in this process.

After the oil shock of 1973, the term ′′Energy Security′′ became synonymous with

‘‘Oil Security’’ and was firmly embedded in the mindset of policy-makers in the

West. Their response to real and perceived supply threats was massive, coordinated

and effective, leading to such results as the building of strategic petroleum reserves,

substantial new taxes on oil use, diversification of sources of supply, new efficiencies

in both energy use and production, and the establishment of more transparent and

efficient markets. The oil industry and producing countries made major contributions to these outcomes by investing substantial sums of money in developing new

resources and technologies and in increasing production capacity. Security of oil supplies may still receive lip service now and then, it may even enter into various political agendas, but it is no longer a burning concern, and justifiably so.

The record of global oil markets in dealing with major supply disruptions during

the past fifteen years is truly impressive. In 1990, in the immediate aftermath of

Iraq’s invasion and occupation of Kuwait, the world lost two important OPEC producers at once. The combined loss of production from these two countries was over

4.5 million b/d. It is not easy to imagine larger and more sudden physical supply

disruptions than this. And yet, neither the market impact of this disruption nor its

implications for the world economy was that great (although the U.S. economy slid

into a short recession). Oil prices rose for a brief period of about two months, and

then came tumbling down as soon it was known that additional supply disruptions,

41

this time from Saudi Arabia, were not likely. The lost production was made up elsewhere, mostly by Saudi Arabia, and markets calmed down.

As the world was adjusting to the loss of Iraqi and Kuwaiti production, output

from the former Soviet Union was also falling. From 1989 to 1996, crude oil output

of the FSU crashed from over 12 million b/d to 6.8 million b/d. And although domestic demand also fell considerably, FSU exports dropped by over 1.5 million b/d during a period of serious setbacks in the Persian Gulf, without causing any shortages

or sustained price spikes in the world. Again, other producers were happy to make

up for the difference.

Let’s look at a more recent example. The latest weekly statistics from the Department of Energy put U.S. crude oil imports at 10.4 million barrels/day for the week

of March 28, 2003, the highest weekly import rate ever. While our country is at war

with a major producer in the Persian Gulf, while Venezuelan production has not yet

fully recovered from a devastating collapse in output, and while Nigerian production

was down by 750,000 b/d in the past two weeks, the United States managed to

record the highest imports of crude oil ever, amid declining prices from their recent

highs. If this is not supply security, I don’t know what is.

Before I go into the reasons for this record of supply security, let me address an

important misplaced concern that such statistics often evoke, namely, the concern

with ‘‘dependence’’ on foreign oil suppliers. We will always depend on imported oil.

Interdependence among nations is not a bad thing. ‘‘Energy independence’’ for the

U.S. is a meaningless concept. U.S. production of oil is falling due to the maturity

of U.S. oil fields. U.S. reliance on imported oil has already surged by 1.2 million

barrels per day in the last five years, and is likely to continue to grow in the next

ten years, bringing U.S. net imports to 13 million barrels per day, equivalent to the

combined 2002 production of the entire North Sea and Saudi Arabia. Greater energy

efficiency can help slow down the increase in imports, but the direction is inevitable

in the medium term.

The proper way to frame concerns about ‘‘dependence on foreign oil’’ is to talk

about vulnerability to oil supply disruptions, such as the ones described earlier. In

this regard, diversity of supply clearly enhances security of supply. The more producing areas there are around the world, the better. International oil companies

have actually done a good job in diversifying oil production in a wide range of countries over the past two decades. But the role of supply diversity in providing security, though very important, can be exaggerated. Given the highly skewed distribution of oil reserves in various geographic regions, there is a limit to how much diversity can achieve in terms of security of supplies and there is an even more critical

limit to the ability of some producers to replace others as strategic suppliers of

crude oil (more on this below).

Oil Market Dynamics

The ability of the global oil sector to deal with such major supply disruptions is

not accidental. It derives from a complex set of interactions and developments in

and among producing countries, consuming countries, traders, and the industry.

Thus, the realities that have reduced the world’s vulnerability to oil supply disruptions have a permanence that will keep them relevant and effective in the foreseeable future.

One of the most basic features of this dynamic is the divergence between the degree of dependence of oil importing and oil exporting countries on oil. In the past

thirty years, while the industrialized countries successfully diversified their sources

of crude oil imports and greatly reduced their relative dependence on energy, the

major oil exporters remained dependent on oil revenues. Today, oil exporters have

much more reason to worry about security of their markets than importers have

reason to worry about security of supplies. This persistent dependence on oil revenues has meant that the major exporters—largely the member countries of OPEC—

have had to constantly balance between two conflicting interests and needs: their

short-term financial requirements and their long term market share interests. The

former calls for relatively higher prices, which jeopardize the latter. The latter requires relatively low oil prices, which jeopardize the former.

So it is not a coincidence that price moderation and stability have been the key

policy objectives of the major exporters for the past quarter of a century. They pursue this objective because it is the only way to optimize the balance between their

revenue and market share requirements. When oil prices rise too high, the industry

and the world economy strike back through both reduced demand and higher nonOPEC supplies, eroding the producers’ market share and revenue base. When oil

prices fall too low, the industry and the world economy respond with higher demand

and lower investments in exploration and production, eventually curtailing the rise

in non-OPEC output and sometimes even causing a reduction in existing flows.

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While this helps to eventually turn around the eroding market share of the exporters, it does cause considerable short-term financial pain and economic and budgetary instability in the major producing countries.

This has led to an alignment of interests between major exporters and the U.S..

The U.S. has itself opposed both very low (single digit or low teens in terms of dollars/barrel) and very high (over thirty dollars per barrel) crude oil prices. Thus, the

producers have tried to manage crude oil market supplies, mostly successfully, to

achieve a price range centered around $25 per barrel. This price is high enough to

continue encouraging substantial investment in the global upstream sector as well

as in technology, but not so high as to cause any major economic dislocations in the

industrialized economies.

I’d like to stress that I do not advocate complacency regarding security of oil supplies; just a recognition of all that has been already achieved in the past thirty years

to reduce the world’s vulnerability to supply disruptions. These are real achievements with very solid safety nets such as strategic petroleum reserves, which have

not yet been used to their full potential.

Diversity of Supplies and the Role of Various Producers

I would like to briefly comment on the oil policies and roles played by selected

exporters in the context of market dynamics and oil supply security. As mentioned

earlier, diversity of supply enhances security of supply, but it is not sufficient to

guarantee security of supply. It is important to distinguish between crude oil suppliers of commercial significance and suppliers of strategic or security significance.

Size and growth potential are important and generally sufficient determinants of

the former. They are not sufficient determinants of the latter. In order to qualify

as a strategic supplier, a producing country needs to also have the capability to

cause large swings in its production at very short notice in order to compensate for

a disruption elsewhere in the world.

Saudi Arabia

Since September 11, there has been growing skepticism towards the kingdom of

Saudi Arabia, not only as an ally which does not share our goals and values, but

also as a key supplier of crude oil. Although September 11 did not change the belowground realities of oil reserves, it did change above-ground perceptions enough to

challenge Saudi Arabia’s continued role as strategic supplier of crude oil. The central concern that has been raised in the U.S. is that if Saudi Arabia is unreliable

as an ally in the fight against terrorism, it may also be unreliable as an ally in providing energy security, regardless of the record of the past twenty-five years. To reinforce this position, some critics have maintained that we will soon not need Saudi

oil, and that the Kingdom’s role of supplier of last resort can be replaced by new

energy from the FSU—Russia and the other Caspian states. This reasoning is

flawed and could have catastrophic consequences if turned into the bedrock of a new

energy security policy. We can do a lot more harm than good by trying to ‘‘fix’’ the

current well-functioning system, especially through policies that are based on misconceived notions and wrong assumptions.

Two unique features give Saudi Arabia strategic significance as a crude oil supplier (as distinct from purely commercial importance): First, its willingness and ability to maintain substantial excess production capacity; and second, its willingness

and ability to swing production to meet changing market conditions. No other country in the world can perform these two roles to the same extent as Saudi Arabia.

In the past twelve months, Saudi Arabia increased its crude output from 7.3 million

b/d to nearly 9.4 million b/d, an increase of nearly 2.1 million b/d. This increment

is substantially larger than the entire production of Kazakhstan and Azerbaijan put

together, which was close to 1.3 million b/d last month.

The role of a swing producer in stabilizing prices is central to the orderly operation of international crude oil markets. The excess capacity that Saudi Arabia

maintains allows world oil markets not to panic at every incident, civil war or revolution. Without it, there would be cyclical booms and busts which would destabilize

economies and countries. Saudi Arabia is the supplier of last resort, the central

bank of the global oil market that provides liquidity and reassurance in difficult

times. Neither the Caspian nor Russia is likely to ever play the role of swing producer, because of the resource gap and structure of ownership of the sector.

Saudi Arabia has been a reliable supplier of oil for over a quarter century. Our

policy should not be to reject the Middle East in favor of Russian or Caspian oil.

The world will need as much Russian, West African, Caspian, Latin American and

European oil as it can get. As argued already, such diversity of supplies enhances

security. But it is a simple fact that the Middle East in general, and Saudi Arabia

in particular, will continue to be the keystone of the oil markets so long as the inVerDate 11-MAY-2000 15:01 Sep 11, 2003 Jkt 000000 PO 00000 Frm 00046 Fmt 6633 Sfmt 6621 88999.TXT SFRELA2 PsN: SFRELA2
43

dustrialized world relies on petroleum. The size of their resource endowment, the

commitment of the Saudi government to play this role, the unrelenting dependence

of the region’s governments on oil revenues and the negative consequences of their

own past experience with politically interrupting oil supplies will almost guarantee

this.

Iraq

There is no question that Iraq, with its massive proven oil reserves and vast potential, will be a major player in world oil supplies for decades to come. In the near

term, the conduct of the war and the extent of field damage will be of concern.

Longer term, the post-war oil administration structure will be crucial to setting the

foundation for Iraq’s future role in global oil markets. I commend the Administration’s calls for Iraq’s oil sector to be run for the benefit of the Iraqi people. But simply replacing President Saddam Hussein with an agreeable general is not going to

achieve this objective. Iraq should retain sovereign ownership of its principal national resource, and it should be credible and competent Iraqi professionals, not foreign nationals, who run Iraq’s oil and gas sectors. Furthermore, the participation

of foreign capital and technology in the sector should be ensured through production-sharing agreements under terms designed by the Iraqis—a strategic decision

that Iraqi technocrats made as far back ago as 1990, before the first Gulf war. However, transparency and accountability will be crucial, not only to ensure that the oil

sector is in fact being run for the benefit of the Iraqi people, but also to provide

a level playing field for the international oil and gas companies to compete in Iraq

and to successfully bring capital and technology to maintain and increase Iraq’s production. This can be achieved through scrutinizing the oil revenues, not controlling

the physical oil assets or running the sector.

However, even if such a system is put in place and Iraq’s oil production capacity

increases, Iraq cannot act as a strategic alternative to Saudi Arabia. First, the financial pressures that a new government will face over the next decade will be tremendous. Iraq may produce below capacity as part of OPEC policy, particularly in

the latter half of this present decade, but it will not be able to afford keeping spare

capacity simply to play the role of swing producer. Moreover, with significant additional production capacity increases being dependent on foreign investment, Iraq

would be forced to decide whether idled production capacity should be at the expense of international oil companies operating in the country or the Iraqi people.

Neither Iraq’s finances nor its reliance on foreign investment bodes well for its

emergence as a new swing producer. It is worth recalling here that the excess capacity in Saudi Arabia was developed a long time ago not from the Saudi government

budget, but by the former American partner companies of Aramco. Saudi Arabia

compensated these companies when it nationalized Aramco through the huge oil

surpluses accumulated in the 1970s. It would be next to impossible for any government today to allocate billions of dollars from its current budget to build substantial

production capacity for the intention of keeping it idle.

Russia

Russia’s oil production and exports have grown substantially in the past few

years, and this has contributed to diversity of supplies. Russian oil companies have

made progress in transforming themselves to have the governance, management

skills and capital structure of Western companies, but are still striving for stability,

transparency and accountability. The Russian companies are producing low cost oil,

which had already been discovered in huge, but aging fields. Although their oil production is increasing, it is largely through enhanced recovery techniques, producing

more oil in place, rather than exploration. Oil companies there are not organized

or capitalized for ongoing exploration in order to sustain growth.

Currently Russia blocks Western companies from investing in exploration and development. It is difficult for foreign oil companies to operate there. It does not appear that there will be a legal framework for further production-sharing agreements

for foreign companies to invest in the upstream oil sector, outside of joint ventures,

such as the recent TNK-BP agreement—which is not likely to be repeated easily.

There are other hurdles as well, such as inadequate transportation infrastructure,

which means that most Russian oil must be sold into Europe. Oil pipelines are still

controlled by the state and there are no signs that this will change.

Although Russian production is rising rapidly to be on par with that of Saudi Arabia, there are important differences between the two producers from a supply security viewpoint Russia cannot replace the Middle East, as some have speculated.

Russian production was over seven million barrels per day in 2002 and could rise

to nine million barrels per day, or over ten percent of world production, by 2007,

with exports of about five million barrels per day, if all goes well with pipeline and

44

port additions and expansions. While these are substantial additional volumes for

world markets, Russia is not another Middle East—by any relevant measure such

as swing production potential and significant excess production capacity. It would

be a mistake to base the energy security of the industrialized world on Russian oil.

Washington can take constructive steps which could make a difference in solving

some of the constraints which limit Russia’s future oil growth. Washington should

urge the Russian government to open up to foreign investment in exploration and

production, with reasonable, stable terms and enforceable laws. Russian oil output

would grow and would reach world markets. America should not worry if the oil actually gets to U.S. shores. It is one global market and the U.S. and its consumers

are part of it.

The Caspian Region

The Caspian brings together a complex package of ‘‘above ground’’ and ‘‘below

ground’’ risks. The region held great promise for international oil companies because

of the expected large scale of opportunities that could be accessed. Since 1993, when

the first contract was signed by Chevron in the Tengiz field in Kazakhstan, there

have been a few steps forward, but also many disappointments. Government relations are difficult and corruption remains a problem.

The two main producers in the Caspian are Azerbaijan, with current output of

approximately 300,000 barrels of oil per day, and Kazakhstan with current production of approximately one million barrels per day. By 2010, these two Caspian producers could have combined production of perhaps three million barrels per day,

with exports slightly below this level from all pipelines and other routes. This is the

best case scenario. While this is an important contribution to the diversification of

world oil supplies, it does not come close to challenging the Middle East. For the

most part, the Caspian is and will remain constrained by uncertain reserves, exploration risk, technical hurdles, commercial risks, political risks and chronic transportation bottlenecks.

West Africa

Another region where oil supply is surging is West Africa, notably Angola, Equatorial Guinea and Nigeria. The industry’s capital and technology is pouring in to explore and produce in the offshore. Production will rise from 3.7 million barrels per

day in 2001 to over six million barrels per day by 2007.

West Africa is the mirror opposite of Russia when it comes to oil and gas agreements. Terms and conditions are very competitive, which, combined with its high

potential for oil, has attracted massive investment from international oil & gas companies—far more investment than Russia, the Caspian or the Middle East. As a result, production is swelling. Unlike the Caspian or Russia, West African oil can be

easily loaded and moved anywhere by ship. However, this increase in production

does not change the global supply picture in any significant way: it increases the

volume coming from West Africa at the expense of the more mature areas of the

Atlantic Basin, namely, the North Sea and North America. This shift of production

from politically stable regions to West Africa will increase overall market volatility

and will enhance the role of more stable suppliers such as Saudi Arabia and Russia.

Latin America

Despite the success of the deep water in Brazil, the restrictions on foreign investments in Mexico, and the political polarization in Venezuela may delay the realization of the considerable potential in this region. There is a huge opportunity in Mexico to increase output of oil and gas. But difficult political decisions will have to be

made to either allow the Mexican national oil company, Pemex, to increase its capital expenditures and take higher exploration risk, or to allow foreign investment

in the oil and gas sector—or both. The former is difficult because governments generally do not find it politically acceptable to take large commercial risks. The U.S.

government could play a role in helping Mexico help itself by encouraging a policy

of allowing foreign capital and technology into the Mexican oil and gas sector. While

the Mexican economy is being transformed into a world class exporter that can be

competitive against any country in its class, its energy sector remains constrained

by 1970s style resource nationalism.

In Venezuela, the government has long overcome the hurdle of political resource

nationalism, and is anxious to attract foreign investment in the oil and gas sector.

The new Hydrocarbon Law of Venezuela allows for private sector participation of

up to 49 percent in upstream oil and 100 percent in upstream natural gas developments. Most of the gas development effort in Venezuela, especially in the offshore,

is aimed at delivering natural gas to the U.S. market, making it especially relevant

for the U.S. energy security concerns. However, the perceived risks by foreign companies of investing in Venezuela are greater than the actual risks. The challenge

45

of the government is therefore to demonstrate to international oil and gas companies that the rewards of investing in Venezuela outweigh the risks, and that Venezuela offers a competitive commercial environment relative to other host countries.

Some international oil and gas majors already have come to this realization and are

actively pursuing projects in Venezuela, but more needs to be done. Thus, only by

removing the real and perceived hurdles to foreign investment in Mexico and Venezuela will there be any significant additions to production capacity from the region

during this decade.

Security of U.S. Natural Gas Supplies

The domestic pressure on natural gas supplies and prices poses a greater threat

to energy security and to the U.S. economy than the rising cost of crude oil. As discussed earlier, oil is a global commodity; natural gas is not. Because it can be easily

moved by tanker and stored, the price of oil is set by an efficient and transparent

world market. Natural gas prices are set in regional markets because it is difficult

and expensive to ship over long distances.

U.S. demand for natural gas is outstripping supply. For the second time in the

last three winters, natural gas prices spiked over $10 thousand cubic feet and there

was genuine concern that there could be spot shortages in some areas. Demand will

rise even further when the economy rebounds, aggravating the problem. Warm winters can mask the problem of inadequate growth in supplies by providing temporary

relief to markets; but this simply helps prolong our complacency about the adequacy

of natural gas supplies and exacerbates the fundamental problem.

The main problem facing the gas industry is the rapidly shrinking supply in the

lower 48. Washington has not been helpful—it has encouraged consumption of natural gas but actively discouraged production in such gas rich areas as the Mountain

west, the Eastern Gulf of Mexico and offshore the Northern East Coast. This has

become more of an issue as traditional U.S. gas production areas have passed their

peak production and will see declines in the years ahead.

The reasons behind the rapid rise in gas demand are numerous and complex, but

could be summed up as follows: (a) capital stock put in place during 1990’s to take

advantage of artificially cheap gas; (b) excellent environmental benefits of natural

gas; (c) high efficiencies—especially in the power sector.

But it is becoming extremely difficult to maintain production, let alone increase

output in line with demand, no matter how high the price. A number of factors are

at play causing the slow supply response, including the following:

First, basin exhaustion is a fact of life in a mature asset base, and the number

of drilling prospects is declining in the traditional areas of production.

Second, accelerating decline rates per well have created the so called treadmill effect: the annual decline rates are around 20 percent, which means that every year

just to keep production flat, a fifth of the production has to be replaced.

Third, regulatory hurdles act as a constraint. Large areas, over hundreds of millions of acres, were excluded from exploration and production. The U.S. is the only

producing country in the world where a resource base of such significance will be

kept off limits to development.

Fourth, Liquefied Natural Gas (LNG) can provide only modest support in the foreseeable future, because of infrastructure capacity limitations. Presently there are

four LNG receiving terminals in the U.S., all located near the consumption centers

on the East and Gulf Coasts. All of these facilities are over twenty years old, and

more will be needed to import the required volumes of gas. However, the Federal

government is gridlocked over issuing permits for new terminals and for the expansion of existing terminals, with different agencies including the EPA, Commerce, Interior, Homeland Security, and Defense Departments squabbling over muddled and

conflicting authority. The energy industry is eager to build new terminals, but without permits it cannot proceed. Some of the energy industry concerns have been

heard. Late in 2002 new rules were implemented to streamline the approvals process for onshore and offshore regasification terminals. This has allowed for at least

one new terminal in the Gulf of Mexico to be approved. But much more needs to

be done in this area.

Fifth, although there are vast natural gas reserves in both the Canadian and

Alaskan Arctic, expensive pipelines are needed to transport the gas to U.S. markets.

These pipelines would require over five years for permitting, financing and construction, so they are not a short-term solution. Recent high natural gas prices are likely

to reinvigorate development of these long-distance pipelines, just as they did two

years ago after the last price spike. To the extent possible, steps should be taken

to facilitate development efforts to bring Arctic gas to the lower 48. The Alaskan

and Mackenzie Delta pipelines are the right answers, but not for this decade.

46

Complacency about gas supplies rose with the unusually warm winter of 2001–

02. This past winter, which was only slightly colder than the norm but still brought

spikes in gas prices, should be a wake up call that gas supplies, not oil, are actually

a greater threat to the nation’s ability to provide reliable supplies to consumers at

a reasonable price. Gas stocks are at an all time low, and with production declining

by 4 percent to 5 percent this year, it is unlikely that adequate storage will be built

by the beginning of next winter to meet the high seasonal demand. Industrial demand, which has already fallen, will be suppressed further to make sure that

homes, schools and hospitals can keep their lights on. This suppression of gas supplies for industrial use means something concrete: factories will have to shut down,

production will move offshore, and jobs will be lost. This is what is happening right

now, and will continue to happen until the supply bottlenecks are cleared.

Conclusions

In conclusion, it is important to understand that energy security applies equally

to natural gas and crude oil. The global crude oil sector has established an impressive set of structures, procedures and safety nets that reduce the vulnerability of

consumers to supply disruptions. Volatility in global crude oil markets is unavoidable, but diversity of supplies can help enhance both security of supplies and stability in markets. It is critical to distinguish between commercial and strategic significance when it comes to key crude oil suppliers. Although Russia is a very significant commercial supplier and Iraq can become one in the medium-term, only Saudi

Arabia can play the role of strategic supplier to world oil markets.

The United States is much more vulnerable to shortages and disruptions in natural gas supplies than to shortages in crude oil. The economic costs of this vulnerability are substantial. The challenge is to increase domestic production and, as importantly, facilitate the transportation of new and more distant supplies of natural

gas to the U.S., because the traditional sources can no longer meet demand. Many

of the constraints handicapping progress can be cleared through legislative and regulatory measures, but this requires effective coordination and focus by the government on the gas supply issues.

[See charts on the following two pages.]

47

48

Senator HAGEL. Dr. Martha Brill Olcott, welcome again.

STATEMENT OF DR. MARTHA BRILL OLCOTT, SENIOR ASSOCIATE, CARNEGIE ENDOWMENT FOR INTERNATIONAL

PEACE

Dr. OLCOTT. Thank you so much for having me. It is an honor

to be asked to testify before you. I am going to offer some short

comments to highlight some of the points in my written testimony.

49

As has been pointed out, the U.S. campaign to liberate Iraq has

occurred without the shock to the world oil market that many had

feared might occur. There has been relatively little additional destruction to the Iraqi oil industry, and it has occurred without endangering the production or shipping of oil from other producers.

As already pointed out as well, the success of this war will soon

lead to a slow increase in Iraqi production and to long-term increases in the supply of oil and the stability of supply of oil from

Iraq. This said, I think it would be a mistake to prematurely conclude that the war in Iraq has substantially changed calculations

of U.S. energy security.

As has been pointed out by all of the speakers, the U.S. uses

more oil than we produce, and our close allies also traditionally use

more oil and gas and other forms of energy than they produce. And

so this challenge is going to stay before us.

I would also like to highlight—and that is what I am going to

spend the bulk of my testimony on—that in recent months the

greatest glitches to production have been, of course, outside the

Persian Gulf, in Venezuela and in Nigeria. And these disruptions

have in no way, shape or form been caused by or affected by the

war on terrorism.

The kinds of domestic economic problems that produce these

halts in production, in my mind as a Caspian expert, provide ominous warning of the kinds of problems we might see from other

new producing states and from the states of the Caspian region in

particular.

The Nigerian crisis in particular is a portent to what might come

in Kazakhstan. In fact, I begin my recent book on Kazakhstan with

a quote from Chinua Achebe, about Nigeria, arguing that

Kazakhstan has the risk to become Nigeria without ports.

In both Kazakhstan and Azerbaijan, the problem of corruption is

a huge one. I will talk about Turkmenistan afterwards for a few

minutes. Both Kazakhstan and Azerbaijan have introduced new

national oil funds which have the potential to distribute revenue to

the population. But I would like to point out that these oil funds

are still largely untried and we will not know how well they work

until the revenue stream is in place and we know how much money

comes in as income and how much money is siphoned off by the

national oil companies as—prior to being declared as income.

The populations in both countries feel excluded. It has been a

very difficult transition period. And the kinds of risks one faces in

the long term in both of these countries is the risk of regional tensions and not so much the kind of ethnic tensions we saw in Nigeria. Obviously, I think it is not too late to see the current negative

trends in both countries be reversed, but we should be well aware

of how few effective levers we have in both places to effect change.

Both countries face transitions in the next several years. Azerbaijan is likely to be the first to go through a transition of power.

The Kazakh regime, Nazarbayev is younger and healthier, but it

too is under considerable stress that has been increased by the recent indictments in New York that have brought attention to the

Kazakh oil industry.

The attention of most of our efforts at economic and political reform are long-term efforts, predicated on the notion that things in

50

ten, fifteen or twenty years will begin to bear fruit, that these reforms will begin to bear fruit. But the crises points in both countries will come in five to ten years, and may well come well before

we can hope that these—that the reform programs will have borne

fruit. So worrying about what is ten years down the line may well

turn out to be several years too late.

There was discussion in the last panel about the recent glitches,

as they were called, in the Kazakh oil industry with regard to U.S.

investors. I am much less sanguine than our previous speakers,

that these are short-term glitches that have been worked through.

I find through close monitoring of the Kazakh press that there is

over the past year a real increase in discussion on the need to consider re-nationalization of assets in Kazakhstan. And I am not arguing that this means the big projects will be overturned, but the

whole vocabulary of talking about assets has changed in

Kazakhstan, and the argument in favor of the Kazakhs taking

more control of their energy sector is being made by the kinds of

young reformers that the U.S. had looked hopefully toward.

So I take this trend as one that poses some long-term risk to the

security of projects in Kazakhstan. The problem of renegotiation

may constantly come before us.

I want to say something just for a minute about Turkmenistan.

We have talked about gas some today. Turkmenistan’s gas does not

come to the U.S. market, and it is unlikely to come to the U.S.

market. But the development of Turkmenistan’s gas is a critical

part of any long-term solution in Afghanistan. To the degree to

which there are problems with the regime, and the regimes in

Azerbaijan and Kazakhstan are far from ideal, but they are model

states by comparison to the conditions of investment in

Turkmenistan, where we have a regime that is at best barely functioning, and at worst really on the verge, potentially, of becoming

a client state of Russia, which I see as a fairly negative long-term

trend of the Niyazov Government.

Let me say a few things about Russia itself. If you had asked me

a year ago to talk about this, I would have said that I thought that

the improving U.S.-Russian relationship and the improving U.S.-

Russian energy partnership was a potential stabilizer for Caspian

supply more generally. A year ago it seemed that the skeleton of

that energy partnership could take on the flesh necessary to support a dramatically redefined U.S.-Russian relationship.

A year later, I think we are all more cautious about talking

about the future of U.S.-Russian cooperation outside of the energy

sector. Inside of the energy sector, there is much positive to look

toward. But I think we have seen now, unlike a year ago, that the

process of finding coincidence of national interests between the

U.S. and Russia is going to be more difficult than we might have

thought.

We in the U.S. are very aware of the political pressures of our

own election cycle, but for the first time we are becoming conscious

of what the Russian election cycle means for U.S.-Russian relations

and for Russia’s foreign policy more generally.

I would argue that much of what we see occurring in the Russian-U.S. relationship is predicated by the conditions of Putin facing reelection in 2004. He will be a much stronger and more selfVerDate 11-MAY-2000 15:01 Sep 11, 2003 Jkt 000000 PO 00000 Frm 00054 Fmt 6633 Sfmt 6602 88999.TXT SFRELA2 PsN: SFRELA2
51

confident leader after that election, but beginning one day after

2004, the 2008 election cycle will begin in Russia. And that creates

the possibility of a much greater transition in Russian politics than

we have seen today.

So I think that it will be a mistake for the U.S. to rely on Russia

to serve as a stabilizer for some of these states. I should point out

that Russia is increasingly taking this role and has been trying to

take this role since the increased U.S. military presence in Central

Asia in the aftermath of September 11. Russia actually has closer

relationships with all of these states than they did previously.

But what I would say is that there is no quick-fix on the horizon

for the problems in the political and economic and energy sectors

of all three new producers in the Caspian.

I am just about out of time, and I want to make just a couple

of comments about the Persian Gulf, and then one concluding comment.

I would like to argue quite strongly that the period of transition

in Iraq, rather than simply the war itself, is the beginning of what

will be a period of great uncertainties throughout the region; that

U.S. military occupation, which is going to be what begins this period of transition, is really going to be a shock in the greater Arab

world and in the greater Muslim world. And this is going to create

great stresses on the regimes. The attitude of the population in

these countries is going to create great stresses on a whole host of

energy producing regimes upon whom we rely.

I would strongly urge that as the U.S. tries to win the hearts and

minds in Iraq with our ambitious program of nation building, we

not lose sight of the need to reach out to the populations in the

Arab world and Muslim world more generally, and be sensitive to

the increased risks for the regimes to whom we are so closely tied

and to whom so much of our energy depends.

It is important to remember that Saddam was much more of a

hero abroad than he was at home.

Finally, in conclusion, I would like to make a comment about energy security and U.S. security from my prism as a regional expert.

When we talk about U.S. energy security, and virtually everybody

testifying today has emphasized energy security as the challenge of

ensuring that the U.S. and its allies have enough energy, but we

also must be aware of the ways in which U.S. security is put at

risk by the inability of other kinds of states to ensure that they

have sufficient access to oil and gas, and by disruptions in supply

and by rapid price increases.

This really changes the security environment for poorer countries

and for rapid industrializers who have trouble paying rapid increases and going on the spot market and paying top dollar. Let

me give you two examples from my own work, from my own area,

where uncertainties in the energy prices have real impact on security.

I would say, looking about at both Uzbekistan and Kyrgyzstan

and especially on Kyrgyzstan and Georgia, three states that are

critical to us in the war on terrorism, these are all states that have

energy security problems. Georgia’s economic situation has been

shaped from the onset by their inability to pay for their gas. But

52

in Kyrgyzstan, which is an energy importer, the high prices in energy have really made that regime much, much more fragile.

Finally, one last comment about energy security and inadvertent

impacts on U.S. policy, has to do with China. China, too, is beginning to totally reshape its foreign policy, considering totally reshaping its foreign policy as a result of trying to cope with the volatility

of supply and their need to cope with energy for their market.

At least in my part of the world, in Central Asia and in Russia,

China’s efforts to copy with its energy needs have the capacity to

create a strategic tidal wave for all of the states of the region.

Thank you for your attention.

Senator HAGEL. Dr. Olcott, thank you very much.

[The prepared statement of Dr. Olcott follows:]

PREPARED STATEMENT OF MARTHA BRILL OLCOTT

Let me thank you for the opportunity to testify.

It is always an honor to appear before this committee. But it is a particular honor

being asked to speak at the current hearings, coming as they do at so critical a time

in our nation’s history.

The U.S. led war to liberate the people of Iraq is certain to be a watershed event,

one whose full impact on the post-Cold War international security system we will

not be able to accurately describe or fully comprehend for at least several years.

Many of the reverberations of this action will not even begin to form or be felt until

the culmination of the war, and others until military occupation makes way for Iraqi

self-rule.

The events in Iraq will pose a lingering risk to U.S. energy security, irrespective

of the fact that the war is being undertaken to meet a set of broader security concerns. Although the speed with which increased amounts of Iraqi oil can be brought

to market will be difficult to calculate until a careful survey of the Iraqi oil industry

is done, the end of the war will mean the resumption and expansion of Iraqi oil production.

Increasing Iraqi oil production only addresses one small part of the energy security problem. Much more important to the long run energy security of U.S. and its

closest allies is the success with which the U.S. goes about the post-war reconstruction in Iraq. For here the U.S. is sailing in far more uncharted waters than it did

throughout the phase of military operation.

It is likely to be several years before the democracy-building experiment that the

U.S. will engage in the aftermath of this war can be judged as a success, until an

Iraqi civilian government is able to demonstrate its capacity to govern the state

with public approval. Until that time the risk of instability in other oil-producing

states in the Persian Gulf is likely to remain quite high, and if U.S. led democracy

building efforts are successful in Iraq the risk to many of these regimes may well

be intensified. No matter what, the relationship of the U.S. to other oil-producing

states has been redefined, as have the relationships of the leaders of many of the

neighboring countries to their populations.

There are other threats to the energy security of the U.S. and its allies that bear

little relationship to the War in Iraq. Two other oil-producing states have also been

frequently in the news in recent months, whose reserves figure importantly on the

U.S. market, Venezuela and Nigeria. Industries in both countries have been temporarily shut down, the first because of a national strike, and in the second case because of ethnic disturbances. In both cases American held assets have been directly

affected, and the work-stoppages have affected the supply of oil to U.S. markets.

These developments too could be a harbinger for problems that may lie ahead, for

other small producers in Africa, and more importantly, in Russia and in the new

producers of the Caspian region, whose production is set to increase dramatically

over the next 5–10 years. The kind of risks that are posed to U.S. energy security

in these states will not be minimized by U.S. success in war in Iraq, or by a smooth

process of nation-building in its aftermath.

My testimony will look at the energy security threats that could originate from

these ‘‘new’’ oil producing states that lie outside of the Persian Gulf. I will then talk

about the possible threats to energy security that could come from the Persian Gulf

region in the aftermath of the current war for the liberation of Iraq. Finally, I will

53

conclude with a discussion of the ‘‘hidden’’ security costs for the U.S. of crises in

the oil industry and energy sector more generally.

Threats to Energy Security in ‘‘New Producing’’ States

The recent crises in Nigeria and Venezuela may well be harbingers of the kind

of problems that will develop in the Caspian region, as the Soviet-era rulers make

way for a new generation of rulers.

Of the five states of the Caspian region, only Iran does not in some way qualify

as a new producer. Turkmenistan, Kazakhstan and Azerbaijan all achieved their

independence in late 1991. The situation in Russia is somewhat different, as it is

a case of statehood restored. However, the economic revolution that has accompanied the fall of communism means that Russia should be viewed as a kind of new

producer as well. Russia’s reserves are vast, larger than the other new Caspian

states, and foreigners as well as Russians have been entertaining hopes of developing these assets.

All of these states have also experienced enormous political changes, going from

constituent units of a highly centralized ideologically drive political system to selfadministering political units each with its own evolving national identity. Probably

nowhere have these changes been greater than in Russia, which has already experienced a peaceful political transition, with Boris Yeltsin’s choice of political successor

being ratified by a popular election process.

The other three new Caspian oil and gas producers have yet to undergo this same

transition. Octogenarian Heydar Aliyev who rules Azerbaijan is not nearly as sickly

as his much younger former Russian colleague was. He hopes to serve out both his

current, and one additional term of office. If Aliyev’s health holds, the outcome of

the 2003 presidential election is not in doubt, But although Aliyev has been one of

the greatest political survivors of the last fifty years, even he cannot cheat death

indefinitely, and when construction is complete and ‘‘big’’ oil begins to flow through

the much debated Baku-Tbilisi-Ceyhan pipeline, Azerbaijan could find itself going

through a difficult political transition.

Saparmurad Niyazov of Turkmenistan and Nursultan Nazarbayev are in their

early sixties. The latter seems quite fit, and the former has both had serious health

problems and is the more unhealthy and more unpopular of the two. Niyazov, has

been responsible for the development of an increasingly more despotic cult of personality, and has grown so unpopular with the Turkmen elite in recent years that

in November 2002 there was a failed political coup effort against him. In the aftermath of the failed coup, the Turkmen leader has moved even closer to Russia than

previously was the case, and negotiations awarding Russia long-term control over

the export of Turkmen gas are coming to a conclusion.

For all his much publicized praise of the special relationship between the U.S. and

Kazakhstan, in recent months Nursultan Nazarbayev has also become more closely

associated with Russia’s president Vladimir Putin on a number of key issues, including almost mirroring Russia’s position on the war in Iraq. The Kazakh president has

not required the same bailing out as his Turkmen counterpart. Nazarbayev has not

been guilty of the same political excesses as his Turkmen colleague, but he too has

been responsible for a sharp restriction of political competition in his country. Increased pressure on political opposition groups in Kazakhstan has come at a time

when stories of his personal corruption, accentuated by an ongoing grand jury investigation in New York’s southern district, are increasing. While developments in

Kazakhstan have led to periodic rebukes of the Kazakh leader by reasonably lowlevel administration officials, even as the drama in NYC has continued to unfold,

the leader of oil-rich Kazakhstan has remained a welcome visitor in Washington.

The deteriorating political situation in Kazakhstan is not wholly dissimilar to that

of Nigeria, although the level of corruption in the landlocked Caspian state is still

not as all pervasive as it was in Nigeria under military rule. It is often said, in my

opinion with great justice, that the U.S. is too generous in the treatment of dictators

of oil-rich states. In tolerating the foibles of these men policy-makers in Washington

often help create the very outcomes that their support is designed to avoid, that is

to make access to oil less rather than more dependable. As estimates of the size of

Kazakhstan’s unexploited oil reserves began to grow, so too it seemed to Washington’s degree of tolerance for Nazarbayev’s ‘‘bad’’ behavior.

We are already seeing what this kind of outcomes such a strategy can lead in Nigeria, where the damage done in the years of corrupt military dictatorship left the

economy of the country in ruins, creating hard-to-fulfill popular expectations of the

civilian rulers who took power four years ago.

When the government of Nigeria was returned to civilian rule four years ago it

was already too late to introduce relatively easy fixes for the country’s growing economic crisis. Nor were there any ready solutions for reversing decades of deterioVerDate 11-MAY-2000 15:01 Sep 11, 2003 Jkt 000000 PO 00000 Frm 00057 Fmt 6633 Sfmt 6621 88999.TXT SFRELA2 PsN: SFRELA2
54

rating social conditions in many parts of the nation. In a country as ethnically diverse as Nigeria, the introduction of a participatory form of government with the

backdrop of social and economic crises was a recipe for ethnic conflict, much like

we have seen in recent weeks in the Nigerian Delta region, where U.S. and other

foreign producers have recently suspended oil production.

The trigger for the most recent violence is Nigeria’s current election cycle, which

culminates with presidential elections in mid-April. The real cause, though, is the

decades of neglect by Nigeria’s rulers. While the military dictators were in power

the thrust of U.S. policy was to support U.S. businesses involved in the country, and

provide only minimal assistance to the regime in power. Since the return of civilian

rule, the U.S. has made a substantial increase in assistance money available to the

Nigerian government, and non-governmental agencies working in the country. But

this assistance money is unlikely to lead to rapid solutions in Nigeria. A slow improvement in the country’s economic and social situation could develop, but this is

not guaranteed. Civilian government could be abandoned in favor of a military or

even other form of dictatorship, and the country could devolve into further chaos

or a civil war on ethnic and or regional lines. As bad as the recent level of ethnic

violence has been, and there have been over ten thousand deaths in four years,

under a dictatorship or during a civil war things could grow much worse, with fullscale genocide resulting.

Although one should not generalize too far from the situation in Nigeria, many

features of this African country’s crisis could be duplicated in Kazakhstan, albeit in

somewhat muted forms. In any political succession, elite groups from Kazakhstan’s oil-producing regions (found largely in western Kazakhstan) are certain to demand

greater representation and a greater share of the spoils (both in terms of personal

wealth and as investment in the economy of their region).

The demographic mosaic of Kazakhstan is not nearly as complex as that of Nigeria, but ethnic and sub-ethnic divisions are critical there too. Should political succession fail to meet the expectations of the prominent families of the Small Horde (from

western Kazakhstan) and solely reward those from the Great Horde (which is the

group that President Nazarbayev is from), or those of the Middle Horde (in northern

and eastern Kazakhstan, whose prominent families have generally favored close ties

with Russia) then the threat of territorial secession could become more than a hypothetical one.

One of the complaints that helped set off the current protests in Nigeria’s Delta

region has been the shortage of petrol as well as problems with energy supply more

generally. This has been a recurrent problem in Kazakhstan and Azerbaijan both,

and in both places there has been a sharp differentiation in the standards of living

between the urban rich and the rural poor, and the percentage of the population

falling into the latter category is an increasing one.

The situation in Venezuela while different from that of Nigeria, is in many ways

equally disturbing, proving the case of what scholars have called ‘‘the Dutch disease.’’ Oil is the principle source of income in Venezuela, and the state oil company

is that country’s largest employer, and economists have been warning that

Kazakhstan, Azerbaijan and Russia could all fall victim to ‘‘the Dutch disease.’’

Venezuela’s crisis was caused by the mismanagement of the oil industry, by a

sharp turnover in management as well as bad choices in how income from foreign

investments was used. Add to the mix a controversial and unpopular president, and

you get a situation that developed into a nation-wide strike in both the oil extraction and petroleum refining industries.

It is not difficult to imagine variants of the Venezuelan crises potentially developing in either Azerbaijan or in Kazakhstan, especially if the newly organized National Oil Funds do not receive or properly distribute the amount of money in oil

revenues that most of the populations of these countries are counting on. This is

especially true because the next group of presidents could be less popular and more

controversial than the current group. This is very likely to be the case in Azerbaijan, but could also be true in Kazakhstan, as in both countries the new leaders

will have to create the foundations for their political legitimacy.

Moreover, despite Washington’s long-time support for these less than popular regimes, the presidents of Kazakhstan and Turkmenistan remain likely to turn to

Moscow instead to bolster their regimes. The Kazakh oil and gas industry is becoming more intertwined with Russian interests than was previously the case. At the

same time relations between the Kazakh government and leading U.S. and other

western energy companies are becoming more strained, and the Kazakh government

seeks to redefine terms of existing contracts, and to insure that the Kazakh national

oil firm gets majority ownership stakes in all new projects that are let.

The conditions of political succession are likely to put new and more serious pressures on foreign investors in Kazakhstan, who even if they back the winning side

55

are likely to find the ground-rules of doing business increasingly more set in sand.

What makes this most unfortunate, from the U.S. point of view, is that these developments are likely to occur in the period (2005–2010) when Kazakhstan’s new large

oil fields begin to become significant producers. Russian elite groups are already

working closely with competing economic and political forces within Kazakhstan, determined to ensure that the outcome of a political succession struggle is to their

benefit. And unlike U.S. groups, that are also interested in protecting themselves

against unfavorable outcomes, the lack of transparency of the playing field works

much more to their advantage.

The relationship between Baku and Moscow is more complex, given the enmity

on the Azerbaijani side that dates from the Karabakh crisis and Moscow’s tacit support of the Armenian position. But the realist camp in Azerbaijan, of whom Heydar

Aliyev is certainly the most prominent representative, is well aware of the critical

role that Moscow can play to help secure the position of the country’s next president. Azerbaijan is the only one of these oil-producing states to have joined the current coalition in the war to liberate Iraq, but in the past few years President Aliyev

has also sought to improve relations with Russia.

Can Russia be a stabilizer in neighboring states?

In the first year of the War on Terrorism there was reason for U.S. policy-makers

to be optimistic that improved U.S.-Russian energy cooperation could advance the

cause of U.S. energy security as well as U.S. security interests more generally.

Putin had great hopes for a strong U.S.-Russian energy partnership, and had hoped

that it would stimulate foreign investment in Russia’s oil industry as well as advance the cause of Russia’s geopolitical interests more generally by creating a new

and strengthened international role for Russia.

From the onset, there has been a strong element of pressure to the Russian-American energy partnership, hype generated by the two states involved rather than by

the media. From the U.S. side, talk of enduring cooperation with Russia put Saudi

Arabia and other Gulf producers on notice, that there were new energy sources becoming available to the U.S., and that if they wanted to preserve their privileged

place in the U.S. market they had to be more forthcoming with their oil reserves.

From Russia’s point of view the partnership gave Putin’s presidency a seeming

international success, at a time when U.S. policies were marginalizing Russia in Europe and in the international community more generally. It also seemed to give the

Russians a reward for participating in the War on Terrorism, and for quietly standing aside when the U.S. opened military bases in Uzbekistan and Kyrgyzstan.

Developments in the last few months are making clear that Russia’s sense of national interest diverges in many key ways from that of the U.S. At the same time,

Russia’s energy resources are real and considerable, and their oil reserves in particular can be developed in ways that if coordinated with the development of Azerbaijani, Kazakh and Turkmen reserves can be to everyone’s advantage. Moreover,

the changing nature of Russia’s relationship to the other former Soviet republics

also makes it seem less imperative for the U.S. to take great pains to ‘‘protect’’ these

states from Russian bullying in oil, gas, and other commercial sectors. This is especially true, if being partisan in this way would restrict U.S. access to Russia’s own

reserves.

Although conditions have improved for western firms doing business in Russia

under Vladimir Putin, they are still far from problem free. In part they reflect the

unstable relationship between Russia’s oil industry and the economy more generally.

The health of the Russian budget is directly linked to the current high price of oil,

and when the price of oil drops Russia’s leaders look to other forms of income, which

include the sale of arms, weapons systems and various forms of military technology

by state monopolies. The oil industry is not the major employer in the same way

that it is in Venezuela or in the Gulf states, and there is real debate among Russian

economists as to how rapidly Russia should expand the oil and gas sectors of its

economy.

While Russia is unlikely to have a Venezuelan style economic crisis, it is still not

clear how large or how stable a force Russia will be in the international energy market. Russia’s oil industry is still evolving, and the divide between private and stateowned companies is still not a fixed one. Moreover, it is unclear whether the Russian government will ever give up full ownership of its assets, nor regularize the

terms for foreign investors’ participation in their development. Russians investing

in their own in the oil and gas sector has also faced serious road-blocks, not the

least of which is the difficulties posed by the continuing state monopoly on the transit of oil and gas.

All of these problems affect U.S. and Russian cooperation in the energy sector,

and make it unlikely that this is going to turn into a real ‘‘partnership’’ anytime

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soon. While changes in Russian policy, not the least of which is a growing westernstyle corporate culture among some of the large Russian firms, make projects in

Russia seem more desirable, very few firms seem eager to leap into the Russian

market with both feet at least until they evaluate projects in other parts of the

world that may become available to them in the near future.

BP’s acquisition of a 25 percent stake in the Russian TNK oil company is a major

development, and the first real show of western confidence in the Russian oil industry in quite a long time. But it is less clear what kind of harbinger it is, whether

western firms will want to buy large stakes in Russian oil companies, and whether

other Russian firms will sell stakes large enough to give western companies the

managerial role necessary for them to make such an investment. For all of Putin’s interest in attracting western investment, the rules of political engagement in Russia have been fixed to insure that westerner firms don’t have ‘‘unfair’’ advantage

over Russian firms, but little is being done to make the world of ‘‘insider’’ transparent to those from without.

The increased tensions between U.S. and Russia owe their origin to the different

stances of the two countries on the need for a war to liberate Iraq, but the idea of

a close U.S.-Russian energy partnership was based on a confluence of interests that

for many other reasons was not likely to develop. The fact that Russian and U.S.

national interests sometimes overlap does not mean that their core values have

much in common.

Looking Ahead in the Persian Gulf

While most of the non-Arab oil producing states outside of the Persian Gulf region

will be able to minimize the impact of the current war in Iraq on energy and other

security issues, the same is not true of those within the Gulf region. There is no

way that the states of the Persian Gulf and the nations of the Arab world more generally can insulate themselves from developments in Iraq. The fighting in Iraq also

could lead to security problems in Indonesia, another oil-producing state in which

radical Islamic groups enjoy popularity.

The fact that the U.S. enjoyed rapid military success in Iraq is a very hopeful

sign, but as the reconstruction and nation-building stages in Iraq have yet to begin

in earnest means only those analysts who enjoy second sight have much sense of

how developments are going to play out.

The period of U.S. military occupation will be a time of real stress in the Persian

Gulf and in the Muslim world more generally, where many will see the U.S. military presence as a form of thinly disguised twenty-first century-style colonialism. U.

S. policy-makers are now gearing for a massive humanitarian assistance and nationbuilding effort to ‘‘win the hearts and minds’’ of the Iraqi population. But the protection of U.S. national security, of which energy security is only one element, really

demands that the Bush administration launch a successful public relations battle

in the rest of the Arab and Muslim world.

As is so often the case with tyrannical figures, Saddam Hussein was a much

greater hero outside of his country than within it, and even Iraqi public opinion may

remain divided over just how Saddam Hussein was removed. In much of the Arab

and Muslim world the evil one knows often seems preferable to the risks of the unknown, especially if the unknown is to be delivered by as problematic a force as the

U.S. military. The discovery of weapons of mass destruction in Iraq, would go a long

way to repairing relations with U.S. allies in Europe, but this will not have the

same impact in the Islamic world, where strong leaders are expected to take strong

steps to protect their populations.

Public opinion outside of Iraq has been heavily against the U.S.-led war effort.

Protests in both the Arab and the Muslim world more generally are likely to continue throughout the period of U.S. military occupation and this kind of public reaction will make the regimes that have supported the U.S. effort more vulnerable from

their critics. When one adds up active and inactive supporters, the regimes in Kuwait, Qatar, Saudi Arabia and Jordan have all been put at greater risk, and the

last two were already quite vulnerable.

The long-term security of all of these regimes is dependent upon the success of

reform movements within each of these states. But U.S. policy in the region can

serve to further destabilize these regimes in the short-run, and could serve to undermine the political security of the states that provide so much of our energy needs.

It is also hard to imagine that the U.S. can devise successful public relations efforts in the Arab world in the absence of a comprehensive peace settlement for the

Arab-Israeli conflict. It is bad news for the Saudi regime in particular, if the U.S.

image in the Arab world becomes increasingly more tarnished in the coming weeks

and months, for they are probably the most fragile of the states upon which U.S.

energy security depends. In time, the Saudi regime could experience its own version

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of the Venezuelan oil crisis. The country faces a demographic bulge, with growing

numbers of young people being rendered virtually unemployable by the religiously

dominated education system that all but the most privileged elite children pass

through. In recent months the regime has at least making the right noises that it

recognizes the need for economic and political reforms (although the role of religion

in Saudi Arabia will at best only he tinkered with a bit). But the reform process

is certain to produce change slowly, at best, in leave the regime with serious opposition for the foreseeable future.

U.S. policy-makers should also make sure that they have drawn all the appropriate lessons from our military engagement in Iraq before challenging the regime

in Iran by military means. First there is the question of international support for

such an operation, which is certain to be even more difficult to obtain than for the

current operations in Iraq. But even if U.S. policymakers were convinced that we

could successfully overcome the international diplomatic fall-out of proceeding militarily with a small coalition of allies, there is the question of how the Iranian military and Iranian people would each respond in the face of a military incursion.

While it is certainly the case that the Iranian political and religious establishment

are in an uneasy alliance at best, Iranian nationalism is a much more formidable

and deeply rooted force than Iraqi nationalism, and there is little or no evidence

to suggest that outside forces would be welcomed by any significant sector of the

population as the source of moving the Iranian polity toward a more secular and

pro-western form of government.

U.S. energy security in the Persian Gulf will be very heavily influenced by how

the U.S. exercises its authority in Iraq, once Saddam Hussein is ousted from office.

The less the transition authority seems like an occupation force, and the less the

transitional regime can be accused of being a puppet for U.S. interests the less antiAmerican sentiment will be thither stimulated in other oil-producing states and the

Arab and Islamic world more generally.

Most outside observers will be closely watching how the Iraqi oil industry is managed, whether oil income goes to help support military occupation and administrative costs, or if it is solely directed for the purchase of food and other humanitarian

assistance for the Iraqi people. There will also be a lot of attention to how the contracts are let for rehabilitating Iraq’s oil-wells and repairing the country’s infrastructure, with the question being whether the process is a transparent one in

which non-U.S. firms are offered a level-playing field from which to tender their offers. It will be critical how decisions are made about the ownership Iraq’s still undeveloped oil reserves, as well as how the choices will be made as to how and by whom

they will be developed.

It is one thing for the Bush administration to insist that the war for the liberation

of Iraq is not about oil, but their claims will not dissuade U.S. and foreign critics

until such time that U.S. policies give evidence to the contrary. The way that the

U.S. goes about the reconstruction of the Iraqi oil industry will either dispel these

rumors, or insure that they are never able to be dispelled.

Security and Oil Dependency

The fact that the U.S. and virtually all of our principal allies consume more oil

resources than they produce insures that the question of energy security will remain

a vital one until such time that new sources of energy or new patterns of consumption emerge. That time is not imminent, although estimates of when it may occur

vary dramatically.

This means that the U.S. and its allies will continue to depend upon all of the

existing producers to meet their energy needs, no matter how problematic the stability of some of these states may be. Many new oil producers could come on line

whose domestic political stability could be even more problematic than those states

described in this testimony.

Forecasting the course of international developments is never easy, but it is never

more difficult than in a period of rapid international change. Modifications in how

the international oil market operates that began to be introduced in the aftermath

of the 1973 Yom Kippur War have done a lot to cushion the U.S. and other major

oil consumers from sudden changes in the international oil market. But all the industrialized and rapidly industrializing nations remain vulnerable both to cataclysmic changes in oil supply and to dislocation provided by several producing nations simultaneously reducing their exports.

The U.S. and its allies are also vulnerable to the subtle impact of policies that

are designed to increase energy security, but that oftentimes have a long-term effect

that is quite opposite to their intended purposes. U.S. policies that offer support of

non-democratic leaders in oil-producing states may maximize the supply of oil in the

short-run, but often have exactly the opposite effect in the long-term.

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While the U.S. and most of our closest allies have the economic means to insulate

ourselves from paying too big a price for such mistakes, as we are generally able

to absorb sharp increases in costs that are caused by the vagaries of uncertain supply and a fluctuating price structure other states have less flexibility. Uncertainties

in the oil market have great impact on less developed states, as well as those that

are in the midst of rapid industrialization. Both groups of states have difficulties

paying high spot prices for oil when oil supplies that they counted on are no longer

available at the price that they expected to pay.

For this reason, uncertainties in the international oil market can cause all sorts

of seemingly unrelated security problems for the U.S., even when steady supply to

the U.S. markets is maintained. High prices of oil, especially unexpectedly high

prices, disrupt the economic plans of less developed states, making fragile states

even more fragile, destabilizing whole sub-regions of the world.

Rapidly industrializing states with growing energy needs are also highly vulnerable to changes in the price and supply of oil in particular. One state worthy of mention in this regard is China, a country whose need for energy resources is growing

and whose economy can not easily absorb sharp jumps in price or shortages in availability. For that reason China’s leaders are looking for stable partners who in partnership with leading Chinese firms will insure that China’s long-term energy needs

are met. More than most any other country, China’s search to protect its own security interests could create unexpected security challenges for other states.

And as China is looking to Russia, Iran and the Caspian for some of these new

partnerships, U.S. interests are sure to be affected in the process. If the war in Iraq

does not produce any major dislocations in world oil supply China is apt to move

reasonably slowly to better protect its economy from future dislocations. But if the

war does at some point produce even temporary major shortages, then the Chinese

will certainly rethink their strategy and be more aggressive about asserting their

national interests in the energy field.

It is still too early to predict the impact that this war will have on the oil industry

in Iraq, not to mention the political climate in neighboring oil producing countries

and in the Middle East region more generally. The fact that there are certain to

be long-term and unpredictable outcomes of the War in Iraq on energy security

highlights the way in which oil specifically, and energy more generally, is intertwined with a host of other security factors.

Senator HAGEL. You mentioned in your book—you have a new

book.

Dr. OLCOTT. I have a book called Kazakhstan: Unfulfilled Promise, that came out last February.

Senator HAGEL. All right. Well, we should plug that as well. I

mean, Dr. Yergin gets a couple of plugs here, and so we are going

to plug your book.

And where can we get it? Is there a book signing that you and

Yergin can go to? I have to deal with people like McCain around

here, and every month he has a book signing for a new book.

So when will we get to——

Dr. OLCOTT. Actually, we are going to do an event next month.

I will make sure your staff is notified.

Senator HAGEL [continuing].——All right. There you go. That is

the way to do it. I am glad I asked, thank you.

Well, all three of you have presented insightful, lucid testimony

that is very relevant to the challenges of today and what we are

going to have to deal with down the road.

Beginning with your quote from your friend, Lady Thatcher, ‘‘The

unexpected happens. You had better prepare for it,’’ and that certainly has been a theme from the three of you this afternoon.

And I would like to pick it up at that point and ask your two

wise, learned colleagues, Dr. Olcott, to respond to your last or almost last comments regarding what you see as great uncertainty

unfolding in the Middle East that will put great stress on energy

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tion in Iraq, and I guess your point is more to the point that there

will continue to be American and allied security forces in that region for some time to come, and then you developed it, I thought,

in a very clear way.

And then your last point, if I recall, was: It is going to be important for the United States and its allies to make a significant effort

to reach out to the Muslim and Arab populations of the world. I

happen to subscribe to that theory, but I am not giving testimony

today. I am just running the hearing. So I would be very interested

in your colleagues’ response to that point.

Dr. Yergin.

Dr. YERGIN. I think we may not really full understand in this

country how deep is the breach in public opinions between how

things are seen in this country, how they are seen in the Middle

East, Europe, China, in terms of what is unfolding, and that is

going to be a lasting question to deal with. And critics and enemies

of the United States and others will put it into the framework of

new crusaders. And so I think that is going to be a very major

issue. And I think what Martha said about reaching out and being

very cognizant of how deep is the division on opinion, is going to

be a major political factor for us.

Senator HAGEL. Thank you.

Mr. Vahan? Mr. Zanoyan?

Mr. ZANOYAN. Thank you very much. I think this is a very pertinent question right now. I happen to travel a lot both to the Middle

East region almost every month, and throughout Europe. And,

frankly, right now if you look at the disconnect between the way

things are viewed from Washington and the way things are viewed

from outside in the world, it is coming to a point where it scares

me. It is not just in the Arab world.

We mentioned Arab and Muslim world. There, there is an enormous amount of confusion. There is a very schizophrenic attitude

about what is going on, because almost all of them would like to

see the final outcome of Saddam Hussein being toppled. I do not

think you will find a single critic of American foreign policy who

opposes that aspect.

But there are all kinds of other issues which are far too complicated right now to get into, that make them very wary of our

real intentions.

But you go outside the Middle East, throughout Europe and

Asia, and for those countries the big threat is not Osama bin

Laden, is not Saddam Hussein, is not al Qaeda. The big threat is

this new radical, militant United States, a country which has superior military capabilities, is not afraid to use them, and is not

afraid to use them unilaterally. So they do not trust us—it is not

just our strength that they worry about. It is our intentions, plus

the strength. And there is a lot of mistrust about this. And it is

all over Europe also.

My colleague, Dr. Yergin, mentioned critics and enemies in one

breath; well, if he meant that they are the same, I would like to

take issue with that.

Dr. YERGIN. No. No, I did not.

Mr. ZANOYAN. Okay. They are not the same. We have a lot of

critics out there who are our friends, and if we cannot tell the difVerDate 11-MAY-2000 15:01 Sep 11, 2003 Jkt 000000 PO 00000 Frm 00063 Fmt 6633 Sfmt 6602 88999.TXT SFRELA2 PsN: SFRELA2
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ference and if we keep saying, ‘‘If the people are not with us, they

must be against us,’’ I think we are missing a very important nuance in the whole international environment right now.

Senator HAGEL. Thank you. Is there anything you would like to

add, Dr. Olcott, to this?

Dr. OLCOTT. Just that I think that there is a difference—I mean,

I agree. I just came back from Europe as well. There is very

sharp—I have never seen this degree of criticism of the U.S. and

I was a student in Europe during the period of Vietnam.

But I think the difference between what we see going on in Europe and what we see or potentially see in the Muslim world is

that it is potentially regime-rocking in the Muslim world in a way

that I do not think—you know, I am not worried about revolution

in England despite the size of the protests that we saw against

Prime Minister Blair.

So I think that the threat to U.S. security by the dissatisfaction

in the Middle East, by the crowd, by the streets in the Middle East,

is much greater than the threat to U.S. security by whatever the

displeasure in Europe and Asia is, except that I would add, places

like Indonesia or the Philippines, those go on the list. I mean, that

is why I said that, the Arab and Muslim world.

I think the occupation is really—it is creating a set of circumstances in the Middle East that have not been there for over

50 years. And if one remembers, at the time of the Suez crisis what

kinds of response that was, and that was a much less destabilizing

act to the status quo.

So I agree with everything Dr. Yergin said about the street being

content to see Saddam gone. But at the same time, the whole prospect of a long-term U.S. military presence or an occupation is one

that just is fodder for radical ideologues. It is like—it is as if they

created the conditions. It so meets what they want ideologically to

attack. We have created a strawman of, you know, absolutely of

their—that is just totally in line with their vision of what they accuse us of being.

Senator HAGEL. Thank you.

We have been joined by the Ranking Democratic Member of the

Foreign Relations Committee on this subcommittee, a man who has

been on this committee I think since 1977, so he knows a little bit

about what we are talking about today, Senator Sarbanes from

Maryland.

Senator Sarbanes.

Senator SARBANES. Well, thank you.

Thank you very much, Mr. Chairman. I want to welcome this

very able panel. We are very pleased to have the benefit of your

thinking.

I would like to sort of look out into the future a little more and

broaden the context. We tend to talk about this energy security

problem, in a sense, in the current context and the U.S. demand

and so forth. But think with me for a moment about where economies are going worldwide, what their growth would imply for energy demand, and what kind of impact that would have on

geostrategic considerations.

And let me just illustrate what I am thinking of with one example: China. You know, we have this huge population. They grow

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year to year economically in very impressive terms, considering

what is being done elsewhere. And of course, as they do that, their

demand for energy increases at a very rapid rate. Where are they

going to find that energy? What is the implications of that? On how

things develop internationally, and what are the implications for

the U.S.?

And it is not only China. I mean, there are other countries one

could cite, too, where this is all taking place. So there is a dynamic

at work that I do not think we focus on sufficiently in terms of

where we may end up with energy security. If that makes any

sense to you, I would like you to take a crack at it.

Dr. Yergin.

Dr. YERGIN. Okay. Yes, you start with China and you start with

India because of their size. Chinese oil consumption has doubled in

a little more than a decade. It is now the third largest consumer

of oil in the world. It will soon overtake Japan and become the second.

And over the last several years, there has been much debate

about what is China going to do about it? A few years ago there

was this fear that there would be resource wars in Asia over that.

But at least so far, what China has decided to do, more or less, is

do what it has done with the rest of its economy, sort of go with

the world economy. It is partly privatized. It is oil industry and its

companies are around the world, seeking to be players, and I think

they will become much bigger players. And the best solution is to

see China seek to deal with these issues through the market and

through the strength of its economy, rather than, in a sense, deal

with it geopolitically.

Senator SARBANES. All right.

Mr. Zanoyan.

Mr. ZANOYAN. Yes, I agree with what Dr. Yergin said about

China. I am not going to dwell on that part too much, except for

adding one issue. I think longer term, since you wanted to have

this longer-term picture in mind, China is probably our most important, in general, strategic competitor. Not just a country that

would be an important player in energy markets, but it will go

even beyond that. This is specifically true when it comes to the

Middle East.

Senator SARBANES. When it comes to what?

Mr. ZANOYAN. To the Middle East.

Senator SARBANES. Yes.

Mr. ZANOYAN. In the Middle East, a lot of our other current

trade partners, allies, or competitors are there, basically, in the

same way, essentially for trading oil or developing oil, but not to

compete with us in a strategic way. I think China could play that

other role.

But I would like to raise another issue here, which is much closer to home to us. This was in my testimony, Mr. Chairman, but I

did not have time to raise them. And it is the issue of Mexico and

Venezuela. They are two interesting countries. Both have enormous

potential to increase their both oil and gas production, but they

face different problems.

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In Mexico, the challenge is to open up. The challenge is to overcome this 1970s-style resource nationalism that says, ‘‘No, no. Nobody else can touch our oil.’’ In Venezuela, they have long overcome that challenge. The country is open. They have a new hydrocarbon law that allows for up

to even 100 percent participation in the upstream gas sector, 49

percent participation in the upstream oil sector. Their challenge is

to convince the oil and gas companies that, in spite of some of the

political problems there and in spite of Chavez’ very populist policies, the country is not going to confiscate their investments tomorrow morning, and that this is still a viable place to invest.

There are different challenges. But I think in the longer-term it

may be in the United States’ interest to try and encourage both of

those countries to enhance or increase foreign participation in their

oil and gas sectors, because that definitely will make a very big impact on even short-term supplies, let alone long-term.

Senator SARBANES. Dr. Olcott.

Dr. OLCOTT. I concluded my testimony with a very brief discussion of China because I feel really strongly that China’s search to

meet and guarantee its own energy security creates security risks,

potentially, for all of the neighboring states.

I am much less sanguine than Dr. Yergin that China will use the

market and solely the market to meet and provide for its energy

needs. I have trouble believing that the Chinese firms, as you point

out, will be competitive with the Western firms on any sort of even

basis, even playing field. And if Central Asia is at all a window

into Chinese strategic thinking and other places, they have certainly used geopolitical weapons—I mean, geopolitical tools— ‘‘weapons’’ is way too strong—and not just market tools in order to

advance their interests in the energy business.

And I see the evolving Russian-Chinese relationship is going to

be increasingly having to deal with these energy issues as well. So

it is of critical importance for China’s dealings with Central Asia.

But it will, if we are going ten years down, certainly be of critical

importance in the Russian-Chinese relationship which is a very

complicated relationship in many ways.

Dr. YERGIN. But, I would say that it is a good and appropriate

thing for Russia and China to have their relationship based less on

Marx and Lenin and more on oil and gas. It is a natural course.

Dr. OLCOTT. I am not disagreeing, but it——

Senator SARBANES. Yes.

Dr. OLCOTT [continuing].——But I see the Chinese as mixing the

market and the geopolitical. They do not have two separate arsenals that they bring to the table. They try to use whatever advantage, strategic advantage they have in these deals; at least that is

how I see it.

Senator SARBANES. This may have been asked before I got here,

but I am interested in to what extent, if any, you think human

rights concerns should play into our thinking with respect to having a global energy policy, or as we address the questions of global

energy security? [Pause.]

Dr. OLCOTT. I guess I can—I think it is a really tricky question,

obviously. And I did not talk about it in my testimony. I think that

from the point of view of the states that I study most closely, the

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long-term instability of these states is predicated on the fact that

they have not had economic reform—I mean, that they have not

emphasized transparency, and not emphasized political participation. So the real difficulty is for: How can we be more effective in

trying to get the message that, ‘‘You are making yourself unstable

by virtue of not addressing these issues’’?

I think that we cannot preserve our energy security in the long

term if these regimes do not reform. But I do not see easy solutions

for us to do it.

I talked a little bit about Turkmenistan. I mean I think that

Turkmenistan is a case where we really have a disaster, where it

is a crisis situation where the human rights policy of the regime

is making the state a highly ineffective potential partner for us.

And as I mentioned in my oral testimony, in the absence of

Turkmen gas, it is very hard to see long-term rebuilding in Afghanistan. So that is the one place that I see it as a crisis at this point

in time.

And the other is—the other places in the Caspian is less than

ideal and it could undermine the stability of the regimes as we

move forward.

Mr. ZANOYAN. I would like to make a brief comment on this. If

the issue of human rights, if the issue of human rights appears as

a matter of principle, as a United States policy principle that in our

dealings with foreign countries we should always consider this,

then it should not be tied just to oil policy or just to energy security

issues. It should be tied to any bilateral relationship regarding any

kind of trade or investment and so on, in my view.

The only way it comes specifically into the oil side is what Martha was suggesting, that if there are countries whose internal stability depends on more representative governments, more human

rights, more equality of income distribution, and, frankly, less corruption is the way I would put it, more of the oil revenue being

used for the good the people rather than just being squandered by

the leaders abroad, then that becomes a much more specific energy-related issue, and I can see how that can be applied.

The problem is: How do we apply it then uniformly across all

countries? Like it was mentioned earlier, some of the new states

in the Caspian have so much corruption that some of our oil company clients tell me that they would put even Nigeria to shame.

So these are the issues that we should address, if it is for internal

stability issues.

More than human rights, I would look at how oil is used. Is it

really used properly for the country? And then, I would not know

what kind of policy to structure around that, but that is how I

would cut the issue.

Senator SARBANES. Okay. Before I hear from Mr. Yergin, let me

just put one follow-up question to you. You said that if we are

going to include human rights considerations, it should not just be

on oil countries or in the area of the oil policy but more broadly,

across the board as I understand it. Having said that, assuming

that it is across the board, are you in favor of including it in or

in favor of excluding it out?

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Mr. ZANOYAN. I am in favor of using human rights as a broad

policy and dimension, among many others, in the way in which we

form our bilateral relationships with other countries.

Senator SARBANES. Okay. Dr. Yergin.

Dr. YERGIN. Like the other speakers, I see human rights, as we

look out at the 21st century, as one of the sources of stability for

government. And the development of human rights in some of the

governments we have been talking about, that is a big consideration. I also see it in terms of the issues of transparency and corruption.

The way you phrase it, it is so broad that I am not sure what

you are looking for on human rights in terms of suggesting that we

do not buy oil from countries where we object to the human rights,

or whether it is one of the principles, one of the issues that is engaged in our dialogue with them. And so that makes it hard to be

a little more specific in the answer.

Senator SARBANES. Well, I tried very hard to give you an openended question, because I am really interested in the weight you

would place upon it rather than having you react to the weight I

might place upon in.

Dr. YERGIN. All right.

Senator SARBANES. So as an open-ended question, what weight

would you place upon it.

Dr. YERGIN. I think it is one of the critical questions. What you

see in many oil exporting and producing countries is that one of the

areas of biggest contention is between the central Government and

the region, whether you are looking at Nigeria or whether you are

looking at Indonesia. And I think that is a tough one for us to engage in because, of course, for them it is also issues of sovereignty.

So I think to go back to what Dr. Olcott said, it is a tricky question,

but it is one of the areas where we can apply our influence, and

I would say that it is one of the elements.

Senator SARBANES. Well, thank you, Mr. Chairman.

Senator HAGEL. Go on if you want to.

Senator SARBANES. No, no. I think I am done. No, that is all

right.

Senator HAGEL. Okay.

Senator SARBANES. Oh, well, let me ask—if I can ask one more

question.

Senator HAGEL. Of course.

Senator SARBANES. I apologize again; I was not here at the outset. What are your expectations as to the balance between the demand for oil as we go out into the future, and the supply of it, supply of oil, oil and gas?

Dr. YERGIN. The picture we have is that we see world oil demand, going back to the China question, growing very substantially, in fact, over the decade, but we see supply keeping up with

it. And one of the things that I think has not gotten as much attention is this huge addition to Canadian proven reserves because of

bringing down the costs of oil sands.

So we look around the world, and the viewpoint I think of oil

companies is that it is always an uphill struggle to add new reserves and discover them. But when we do our numbers we see

those supplies increasing, led by the Middle East, Russia, Caspian,

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West Africa, and that Canada will play a larger role than people

may have anticipated.

Senator SARBANES. Yes. Okay.

Mr. ZANOYAN. Yes, when it comes to crude oil, I think that over

time, no matter how fast demand grows, I think supplies will definitely be there to meet it.

And I spent some time in the beginning of my testimony saying

that the world has had 30 years to adapt to and prepare for all

kinds of disruptions in crude oil supplies and, frankly, we have a

very successful record in the last 15 to 20 years where the global

oil sector has responded very well to these kinds of disruptions.

Sometimes I get the feeling that these achievements on the part of

both oil consuming and producing Nations have not been adequately recognized. And, you know, this is very fashionable to

worry about oil supply security.

But when it comes to natural gas, I think we will have a different story. We have natural gas reserves; it is not a reserve issue.

We have as much, if not more, gas reserves in the world as we

have oil. It is a simple market reality that gas is not as global as

oil is. It is not as easily transportable. Gas markets do not equilibrate. We can have a gas shortage here in the United States and

a gas surplus somewhere in Europe, and it is not necessarily automatically obvious like it will be with oil, that the commodity will

just move to fill the gaps.

And, therefore, I can see more discontinuities, if you want, looking ahead in the way in which supplies and demand will meet each

other in the gas side in specific markets than I see in the crude

oil side.

Senator SARBANES. All right. Dr. Olcott.

Dr. OLCOTT. Well, I am going to leave that question.

Senator SARBANES. What?

Dr. OLCOTT. I am going to leave that question, I mean, to——

Senator SARBANES. Yes. Well, we got two pretty good answers, I

thought.

Dr. YERGIN. If I could respond.

Senator SARBANES. Yes.

Dr. YERGIN. From public policy perspective, we will be dealing

with the growing role of gas imports into the United States. And

will we be or end up being a significant importer of L&G into the

country? And then the question is: Where will those terminals be?

Senator SARBANES. Yes. How much room do you think there is

on the demand side in terms of more energy efficient uses? How

much of a benefit can we gain on that side if one were really committed to major policies in that regard?

Dr. YERGIN. I have always believed that energy conservation is

one of our most available and cheapest energy resources and think

of it that way. In fact, we have accomplished a lot. We only use

about half as much oil for every unit of GDP as we did in the

1970s. We are a lot more efficient than we were, but I am sure

there is a lot more—even before we switch over to other technologies decades in the future, there is obviously a lot of ground

to be more efficient between here and there.

Senator SARBANES. Yes.

Dr. OLCOTT. I want to add something from the last question.

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Senator SARBANES. Yes.

Dr. OLCOTT. One point that I talked about in my testimony,

which I think is really critical, has to do with the security risks

that are caused by other states not being able to afford their energy. And that is something that I think is going to increase. So

we may be able to—there may be enough energy out there for us

to meet our needs; but I see, in the countries that I study, a lot

of states that are really falling off the map economically because

they cannot afford the energy, that it is just being priced out of

their range. And that is creating a whole host of security crises for

us.

And I point to the case of Georgia as one where the long-term

security of that state, which is critical in part to our energy security because of the Baku-Ceyhan pipeline, is being affected in part

by ethnic problems in Georgia, but also by the inability of Georgia

to pay its gas and electric. And that is not improving.

Senator SARBANES. Yes. Thank you very much, Mr. Chairman.

And I thank the panel as well.

Senator HAGEL. Senator Sarbanes, thank you.

Let me go to one question that we have. We came as a result of

exploring from your ending comments, Dr. Olcott, and your testimony, about the uncertainty in the Middle East which you believe

will put great stress on our energy producing friends, specifically

Saudi Arabia.

As we have talked this afternoon about future sources and reserves and the unknowns that Lady Thatcher talked about,

Churchill talked about, how do you see this playing out in specific

terms with Saudi Arabia? And all three of you mentioned Saudi

Arabia in different aspects. One of you mentioned it is the one ally

we have that has always reserved the capacity that we needed, essentially, when we needed it.

So I would be interested in your thoughts on this as to how they

relate to Dr. Olcott’s last thoughts in her testimony, because I

think my understanding is you generally have, all three of you,

agreed with the general premise of that uncertainty.

Dr. Olcott, we will begin with you.

Dr. OLCOTT. All right. I see the situation in Saudi Arabia as tied

in part to what is going to happen in the Arab street more generally, so that even if you—you are not going to get large-scale

demonstrations in Saudi Arabia no matter what happens, or you

are unlikely to. If you get those demonstrations, you are in a situation of really on the edge of final crisis there. But if there are largescale demonstrations against the U.S. presence throughout the

Arab world and if it is a continuing sense of Arabs feeling aggrieved by this, what they see as this intrusion, then I think it is

going to create an increased environment for receptivity for extreme groups that are Saudi-funded, you know, that you are going

to get—even if we stamp out bin Laden, you are going to get binLaden-ism without bin Laden, or you are going to get some form

of new kind of radicalism or continued fuel because he was just

part of a whole radical cycle in that part of the world.

So it will be that the rifts within the Saudi polity will only become more pronounced and I think that there will be confusion on

the part of the regime with how to deal with it. What happens is

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there is mass demonstrations in Egypt, regular demonstrations in

Egypt? I am very concerned about the stability of Pakistan. What

you fuel is a cycle of crisis in the Muslim world, which puts

threats, puts risks on the Saudi regime.

So I am talking about—I am not so concerned with what happens

today to tomorrow, but what kind of environment we are building

for the next few years.

Senator HAGEL. And how then does that apply to further production capability or the willingness of the Saudis to continue to

produce, essentially, what they have done over the last 25 years,

less likely, more stress, more conditions, more problems?

Dr. OLCOTT. I think—and others may have very different opinions—that the Saudi regime will try to continue to accommodate us

in production, but the question is: What does this do to the longterm security of that regime if it—if the situation in the Arab

world continues, becomes more volatile?

Senator HAGEL. So if I understand this, your point is that the

uncertainty of whether we can count on that continuing, that

steady stream of resources when essentially we have needed them,

is or could well be in jeopardy if it plays out in any way the way

you have noted.

Dr. OLCOTT. The security could be in jeopardy if the regime

comes under jeopardy. But the divisions within the society, within

the ruling elite, will become more profound if there is a greater

politicization in the Muslim world and if Saudi money is going to

fund it.

Senator HAGEL. But does that still continue to produce oil for the

United States?

Dr. OLCOTT. As long as this regime is in power. But to the degree

to which those rifts within the elite make that regime more fragile,

then you increase the risks that that regime will be pushed from

power. I mean, you make the regime less stable in the long term.

Senator HAGEL. Yes. Thank you.

Mr. Zanoyan.

Mr. ZANOYAN. Mr. Chairman, I would like to separate, as I think

you were trying to do here, the issue of Saudi oil policy from the

big imponderable, whether the current structure as we know it is

sustainable or not.

The oil policy, they do not do it just for us. You mentioned the

phrase, ‘‘Will they still produce oil for us.’’ Well, they do not

produce oil for us. They produce oil for themselves, for their own

oil revenues. They need it. As I think I explained in my formal testimony, it is that they have a vested interest themselves in this

price moderation and stability of the oil market. More than $30 oil

is not good for them. It is great for them in the very short term

and for their treasury. But they have learned very well that when

prices are that high, both the world economy and the industry hits

back and they strike back with a vengeance by reducing demand

and by creating all kinds of non-OPEC supplies.

So they have come to the conclusion that it is in their best interests to keep prices within a certain moderate band and to keep the

market supplied for their own long-term strategic interests. If they

were doing it just for us, I would not trust them, by the way. The

reason I trust them is because they are not doing it just for us, and

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it is also in their best interests to continue this type of market

management.

Now, I am not as sure, though, as Dr. Olcott may be suggesting

that the oil policy alone could bring the system down because it is

so unpopular.

Dr. OLCOTT. I did not say that.

Mr. ZANOYAN. Oh, I am sorry.

The oil policy in Saudi Arabia is one of the few things which is

not politicized in terms of public debate. There is no public debate

of oil policy as such. There is a lot of public debate on whether in

general Saudi Arabia is too pro-U.S. There is a lot of debate on

whether the American troops should be there. There is a lot of debate whether, given U.S. policy towards Israel, that Saudi Arabia

should even have relations with the United States. But there is no

public debate—at least I have not seen it in all of my trips—that:

Do we have right oil policy here vis a vis United States? That is

not as politicized as one might think. Actually, it is a very interesting situation.

So I think given the fact that, number one, it is in there own interests and, number two, it is not as politicized, just the anti-Americanism alone is very unlikely to change this.

Now, what would change this is something truly much more radical than we have seen so far, more than what is happening in

Iraq. I think what would change something like this would be a

major change in the West Bank and Gaza, if Israel were to annex

them, for example, or if you had these scenes on al Jazeera television with hundreds of thousands of Palestinians being forcemarched across into Jordan, something like that, then the system

may say, ‘‘There is no way we can keep producing or trading or

doing anything,’’ given something like that.

Short of that, I do not see sufficient political pressure internally

to change the oil policy.

Senator HAGEL. Thank you. Before I go to you, Dr. Yergin, Dr.

Olcott, did you want to respond to something.

Dr. OLCOTT. I was implying that the general rise of anti-Americanism in the Middle East and in the Arab world has a capacity

to increase rifts within the Saudi ruling class. I was not implying

that it was going to be on the oil policy at all.

Senator HAGEL. Okay. My only point, and my point about producing oil for us—I am agreeing completely with what you just

said, that they produce oil for themselves.

But my point is: It is the one large capacity producing nation

that we have been able to rely on when additional capacity has

been required or whatever. They are probably keeping the prices

down, again, for their own interests, of course. Thank you.

Dr. Yergin.

Dr. YERGIN. I have a few points to follow up on what has been

said. I think, number one, this issue of anti-Americanism is not a

temporary phenomenon. This is a big deal in the world, and we

have to make a very big effort to understand it. I do not think it

is just issue specific. It is very significant.

I think, secondly, the producers and these supplies, as Vahan

Zanoyan said—and it applies to Saudi Arabia and to others—we

talk about security of supply; but they worry about security of deVerDate 11-MAY-2000 15:01 Sep 11, 2003 Jkt 000000 PO 00000 Frm 00072 Fmt 6633 Sfmt 6602 88999.TXT SFRELA2 PsN: SFRELA2
69

mand, because this is their national revenue. It is very important

to them.

The sooner a transition can be made in Iraq to an Iraqi government the better. The issue of perceptions and how the U.S. role is

seen is very important. One cannot forget that one of the things

that got al Qaeda going was the American military presence in

Saudi Arabia. That was a mobilizing issue.

In terms of threats to the supplies throughout the region, in my

testimony I mentioned war in Iraq and turmoil and crisis in the

Middle East, but we also need to consider the demographic pressures throughout the region. Generational changes are very significant. In countries where a large part of the population is made up

of young men without jobs, we become very quickly a focus of their

ire.

Senator HAGEL. Any other points on this? [No response.]

Senator HAGEL. Thank you. Well, let me mention that each of

your testimony will be placed in the record in full. I know you have

all given abbreviated statements which we appreciated. That way

we had a little more time for an exchange which, by the way, I

thought has really been very exceptional actually between the

three of you, having nothing to do with Senators.

But that is what you always hope for when you get the best in

witnesses, and I think we had that today. Your knowledge of not

only the subject matter but the area and the bigger, wider lens

scope of the world is exactly what we needed to hear and understand a little better. We will be calling upon you again as we have

called upon you many times in the past to help us sort this out.

Mr. Zanoyan, do you have a book? I forgot to ask. Recently, anything that is current.

Dr. YERGIN. Start one now.

Mr. ZANOYAN. I am too busy.

Senator HAGEL. Making money, yes, that is a noble effort.

Anything that you would like to add before we adjourn, any of

the three of you?

Dr. YERGIN. No. Thank you.

Mr. ZANOYAN. Thank you.

Dr. OLCOTT. Thank you.

Senator HAGEL. Thank you again. You have assisted immensely

in our understanding of a very complicated issue. Thank you.

The hearing is adjourned.

[Whereupon, at 4:40 p.m., the hearing was adjourned.]

ADDITIONAL MATERIAL SUBMITTED FOR THE RECORD

STATEMENT SUBMITTED BY THE AMERICAN PETROLEUM INSTITUTE

ON GLOBAL ENERGY SECURITY ISSUES

It is extremely timely that the Committee take a fresh look at the issue of global

energy security given events in the Middle East and following a winter which witnessed major oil supply disruptions in Venezuela and Nigeria, and sharp upward

spikes in natural gas prices for the second time in the last three winters. As it does

so, it is essential to recognize how significantly our understanding of the energy security issue has evolved over the past several decades.

70

Energy Security: Then and Now

Thirty years ago, faced with an embargo of oil from several key Gulf producers,

the security problem was widely characterized as an import problem, premised on

the notion that trade was inherently risky and to be avoided if at all possible.

Largely in response to this paradigm, we embarked on policies designed to insulate

ourselves from these risks with domestic price controls and allocation schemes, and

expensive subsidies to the development of alternative domestic energy sources, such

as synfuels. Today, those schemes are universally recognized as having been colossal

failures. Not only did they fail to insulate us from the risks associated with trade,

they unambiguously aggravated the very problems they set out to correct.

For more than two decades now, the US has come to rely heavily on the functioning of global energy markets, and the active protection of those markets through

the normal channels of defense and diplomacy. This increased reliance on trade, by

increasing competition and promoting diversity of global supplies, has generally increased global energy security. While disruptions of oil markets have occurred in the

past two decades, such as the disruption associated with the Gulf war of 1990/91

and the several disruptions experienced this year, both the magnitude and duration

of those disruptions have been far less serious than those associated with the disruptions in the 70s. This more recent experience has demonstrated clearly that

trade is not the cause of the energy security problem, but rather a potential remedy

to it.

As the U.S. develops an energy policy suitable for the future, it is essential to recognize the essential and productive role of expanding trade in energy. Clearly, our

current energy situation contains risks, but these risks are not confined to imports.

Domestically, our entire energyinfrastructure is strained, both from the standpoint

of the very limited domestic areas we can explore and produce U.S. oil and natural

gas and from the standpoint of refinery capacity and delivery of the energy required

by a growing U.S. economy. The risks associated with neglect of these domestic constraints are no less serious than those associated with growing imports. Internationally, the U.S. will continue to rely on global markets to supply the bulk of both our

own growing oil demand and that of our major allies and trading partners.

The U.S. faces three energy challenges in this emerging environment. First, a

massive volume of new global production capacity must be developed within the

next two decades to sustain the world economy. Second, this capacity must be developed without recourse to the large volumes of readily available surplus capacity typical of global markets in the past two decades. Third, this development must occur

in a setting where the market share of the OPEC cartel is expected to be rising.

Despite a number of key uncertainties in this outlook, failure to develop such new

supplies will have major long term costs to both the U.S. and global economy. While

the U.S. has influence over meeting these three international challenges, it has little

direct control over any of them. Its greatest channel of influence is promoting free

trade and investment in energy worldwide, and encouraging U.S. firms to participate in that trade and investment to the fullest extent possible.

A Growing World Economy Will Require Growing Volumes of Oil and Gas

The sustained growth in the world economy over the past two decades has been

fueled by a steady growth in the use of oil and gas. In 2000, the world used 77 million barrels of oil per day (mmb/d). As seen in Figure 1, energy growth is required

to sustain economic growth in virtually any country examined. Moreover, because

of the key role of transportation to such growth, and the key role of oil in fueling

transport demand, there is a similarly close relation between economic growth and

oil consumption. Global demand for oil grew by 13.1 million barrels per day (mmb/

d) between 1985 and 2000. This was not an aberration. As the center of economic

growth continues to shift from industrial to the developing countries, this growth

is expected to accelerate, even with continued progress in conservation and aggressive development of alternative fuels. In the reference case scenario examined in the

2002 DOE International Energy Outlook, for example, nearly 42 mmb/d of new global oil supply is expected to be required by 2020.

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Massive New Oil and Gas Investments Will Be Required To Satisfy Economic

Growth

Supplying this worldwide growth will be especially difficult. Many of the traditional areas of expansion over the past several decades are already in decline or expected to be so. In Figure 2, demand growth between 2000 and 2010 is likely to be

in the neighborhood of 20 mbd. But at the same time, production from existing reservoirs is in decline. Some of the major companies report decline rates as high as

10 percent per year. But even a decline at half this rate, shown here, would require

replacement of 40 mbd of oil production capacity over ten years. This is double the

amount required to satisfy demand growth, so that between satisfying demand

growth and replacing lost supply, a conservative measure is that 60 mbd of capacity

needs to be installed over the course of this decade. This increment is nearly eight

times the current output of the world’s largest producer, Saudi Arabia. The investment required to finance this oil and gas growth is estimated to exceed one trillion

dollars over the decade.

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Meeting This Challenge Will Require Global Expansion on Old and New Frontiers

The world’s oil and gas resources, unfortunately, are not always conveniently located. First, there is no escaping the fact that the bulk of remaining world oil resources is clearly concentrated in the Middle East, especially the Persian Gulf The

required growth in global supplies will not occur without a major expansion of supply from the Gulf In the Department of Energy reference case scenario, supply from

the Gulf nearly doubles over the next two decades. But this alone is not enough.

In fact, the anticipated growth will require major expansion into new frontier areas

as well. While half of the world’s increased energy production from 1980 to 2000

came from OECD countries, over the next two decades the International Energy

Agency estimates that over 95 percent of the increase will originate in non-OECD

countries, with the Middle East and the transition economies (Russia and the Caspian region, primarily) accounting for half of this.

The Cost of Failure to Develop These New Supplies

There are major challenges to be overcome in each of the geographic areas where

new supply is projected. There is no inevitability that such supplies will be forthcoming. However, what is inevitable is that failure to develop the new supplies will

have costs. If the estimated supply growth falls short of the levels suggested above,

prices will be higher, and economic growth lower, than in the DOE’s reference case.

In a hypothetical scenario constructed by DOE, in which supply by 2020 falls 5 mbd

short of that estimated in the reference case, world oil price is over $6 per barrel

higher, causing an increase of over $200 billion annually in the global cost of oil.

Beyond direct effects on oil markets, the role of oil in the world economy is sufficiently significant that such impacts may have consequences for broader economic

growth. While there is a range of opinion as to the magnitude of these effects, there

is broad consensus that higher oil prices damage economic growth. The reasons for

this are clear.

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Oil, like capital and labor, is a productive input into a broad range of economic

goods and services. If higher oil prices reduce oil use, economic growth will be reduced unless the lost contribution of oil can be offset by increased supplies of labor,

capital, other energy, or by technical change. It is not easy to augment such factors,

especially in the short run. The extent of the economic damage will depend on the

magnitude and the duration of the increase. A recent paper by the International

Monetary Fund (IMF) estimates that a $5 per barrel permanent increase in oil price

would reduce world GDP by as much as 0.3 percent during the first several years

following the increase, entailing a loss to the world economy of about $100 billion

annually.

The Role of U.S. Energy Policy

Since the early 80s, the U.S. has generally pursued a domestic and foreign policy

that has relied on markets, combined with the active promotion of free trade and

investment, to ensure development of the necessary worldwide oil and gas supply

capacity. The supply diversification that has resulted has proven to be a very effective tool for managing the risks associated with import dependence. Sustaining this

diversity in a growing global market will be challenging, and will require continuous

diligence to encourage both the development of competitive world class domestic resources, and freedom of trade and investment to allow U.S. oil and gas firms to be

competitive both at home and abroad. Relaxing restrictions on federal land access,

decreasing reliance on economic sanctions for foreign policy, and preserving the competitiveness of U.S firms operating abroad via tax policy are all essential elements

of a strategy designed to meet this challenge.

For the future, continued success in managing the problem of global energy security will rely on continued expansion of global trade and the full participation of US

firms in that expansion.

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