JHU/APL Rethinking Seminar Series
Rethinking Global Security Constructs,
Threats and Potential Responses
www.jhuapl.edu/rethinking
17 December, 2014
Mr. Edward Chow
Senior Fellow, Energy and National Security Program, CSIS
The Shaking Energy Landscape
Notes:
1. Below are informal notes taken by a JHU/APL staff member at the Seminar.
2. In his presentation Mr. Chow used an extensive series of graphs and charts, which
are available with the video and audio on the Video Archives page of the website.
3. Links to the video, audio, bulletized notes and presentation files for past seminars
can be found on www.jhuapl.edu/rethinking and the JHU/APL YouTube Playlist.
Introduction
Mr. Chow noted his interest in the overall theme for this year’s Rethinking Seminar Series –
enduring American strengths – and believed that energy certainly fits in. He also noted that
there must have been some greater understanding five weeks before when he was
contacted to speak. At the time the price of oil was about $20 a barrel more, so energy
would become that much more of a topic. Mr. Chow was not sure he could explain exactly
what had gone on in energy in the intervening time, but would propose some topics for
further discussion.
The Price of Oil Today
 May be the most volatile price variation in Chow’s 40 years of experience – and
maybe even in the154 years of modern oil production
 This current situation has been seen before but the changes have come faster and
are more compressed now.
o The 1970s price spikes were followed with relatively low fuel prices (when
adjusted for inflation) from mid1980s until 1999
o High gas prices do lead to trends in the long lead-time industry
 Many people believe that demand is not responsive – not true
 High prices do lead to conservation, efficiency gains, fuel substitution,
and ultimately to new investment in energy production and
innovation
 May take a long time
o Low gas prices over a long time do lead to low levels of investment and high
levels of waste
 Timing always seems to be surprising
o Chow as been saying for 3 and a half years that $100/barrel oil was not
sustainable
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o Chow recognizes that he has been wrong for 3 and a half years
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Last spike was 2008 (see chart above)
o From summer 2007 to 2008 the price of oil more than doubled
 Then dropped by $100
o First it was too high at $147/bbl and then too low at $40/bbl
 Right price was somewhere in the middle
o Had a rather rapid recovery driven primarily by political uncertainty
 Arab Spring, Libya, Iraq,
 Under performance by Venezuela and Liberia
 Not really a supply and demand issue – more market psychology
o Big surprise was in North America – American innovation responded to the
very high oil prices
 Based on R&D, national labs, university research grants
 Done because Americans like to do science
 Also because of American entrepreneurship
 George Mitchell (the “father of fracking”) insisted that oil could
be obtained from shale – just didn’t know how
 Advances caused by high prices did not come from oil fields of
the North Sea or Russia – why?
 Counter-intuitive that advances made in the US since the lower 48
states are the most drilled areas of the world
 Would have thought that everything had been found by now
 But western Pennsylvania, home of the original oil production
industry, now producing more gas than ever before
 How was American able to do this?
o Worth investigating
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Shale Gas Revolution
 Comes from a combination of technological advances including
o Advances in computer imagery and electronic interpretation
o Horizontal drilling and hydraulic fracturing at a larger scale than could be
done before
 But there were non-technical reasons, too
 US production of natural gas and oil have gone up dramatically despite the market
prices so it is important to investigate why
o Oil production is the most exciting – now producing the same amount as in
the mid-1980s
 Americans assume that the US is special and there are reasons to back up the claim
for shale development
o Known geology and data availability – not true around the world
o Pricing liberalization – decontrolled natural gas prices in 1978 – if still had
controls, the shale gas revolution would not have happened
o Mineral rights ownership
 Developers pay land owners for the opportunity to look for oil and
then will pay them if some is found
 Elsewhere in the world, governments generally own mineral rights so
there is no incentive for land owners
 Large number of independent producers – innovation not done by the
big companies since they wouldn’t experiment
 Not found elsewhere in the world
 Can raise private capital and investment funds like not done
elsewhere
 Stable tax regime and regulatory environment
 Even the British Exchequer makes adjustments every year
where the US doesn’t
 Competitive oilfield equipment and services sector
 US firms have outsourced services so that they can drive down
costs when prices go down
 Does not normally happen elsewhere
 Creates economic efficiency
 Existing infrastructure, (inadequate now with boom) with pipelines
being about 8x longer that those in Russia, a bigger country
 Shale gas seems to be everywhere
o No one would have expected that North Dakota would be the second largest
oil producer – bigger than Alaska, California, or Louisiana
o Data comes from the authoritative Energy Information Administration (EIA)
or other international organizations so the predictions are conservative
o One-third of the shale gas will make up more than 50% of the gas predictions
for the future
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o The Marcellus production region alone running from West Virgina to New
York will be the largest LNG production area in the world – more natural gas
than Australia will produce
 It is transformational and it is just beginning

US will shortly (2018-2019) become a net exporter of gas
o US has previously imported a lot of LNG from Canada but Louisiana
production increasing
US net import of oil has been dropping dramatically and will continue to do so (see chart
below)
 US is the largest user of oil and natural gas in the world
 Now (and for the last 4-5 years) producing more oil and gas in BTU-equivalents than
Saudi Arabia
 Cannot exaggerate the advances of the last few years
 Expect that trends will continue to be favorable for the US
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What would have happened to oil prices if US production had not ramped up in the last few
years?
 US production growth has more than compensated for disruptions that might have
spiked prices in just the last few years
 Prices did not go up because the market had factored in US shale gas production
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China became the largest oil importer this year
 China’s energy requirements will increase
 China had been a huge driver for price increases for years
 Its demands will exceed those of the European Union’s shortly
 Problem: Where will China get all the energy it needs?
o Want to increase gas imports to cut down on the use of coal
 Not clear that will be accomplished despite agreements
o Expect that China will have as large an impact on the gas market as it did
with the oil market up until 2008
Oil versus Gas Imports
 When comparing oil and gas imports worldwide, Japan is always the outlier as the
country is almost completely dependent on both
 For the rest of the world the relationships have shifted over time
o Most countries are moving closer toward Japan’s position
o Only the US is moving away with less of both oil and natural gas imports
 Implications for foreign policy
o Middle East still needed but there is a shift in the direction of energy exports
coming from the Middle east
o Most exports now moving eastward toward the Asia Pacific (see chart
below)
o Stagnant demand in Europe, lesser need in Americas, greater need in the East
o Raises the importance of the Strait of Malacca and South China Sea especially
for China
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o Middle East remains important to the rest of the world
 Has most of the proven reserves and where it is cheapest to produce
oil and natural gas
 US will still be linked to the global market despite its lack of
dependency on Middle East oil
Latest IEA Predictions
 In the short-term oil production growth will occur in the US with major drop-offs in
the Middle East
 In the long-term out to 2030 through 2040 the Middle East will regain the lead
while growth will be slowing in the US, with Brazil and Canada taking larger roles
 But predictions are highly speculative
 Using hydraulic fracturing of the source rock increases the resource base by two or
three fold
o If you can then improve the recovery rate from 6% to 8% that is another
huge addition to the supply
o Technological advances will allow these improvements
o Cost efficiencies may also improve
 What you can’t do today at $50 you may be able to do for well less
than $30 in 5 years
 Learning this lesson about advancing technologies
 Need more experience with tight oil to provide better predictions
o Have more confidence with predictions about gas because have had
experience from Canada and Brazil
 Bottom line: Increased US production from new sources doesn’t change importance
of the Middle East in the medium-longer term as much as the US would like
o Almost all Middle East oil already going to Asia
o By 2040 Asia will need to attract supplies from elsewhere, too
Shale opportunities for gas and oil are all over the world
 Department of Energy looked at which countries had technically (not financially)
recoverable oil or gas
 China actually has lots of shale gas opportunities while Russia has a lot of shale oil
opportunities, but it is not clear that either could make use of those opportunities
 Not all the work that the US is doing to exploit opportunities is actually being done
in the US
 Mexico is an interesting case – opportunities in the Eagle Ford region don’t stop at
the US-Mexican border
 China would have problems since they might not want to liberalize politically and
commercially enough to encourage production
 Bottom line: although US tight oil production will eventually not grow and might
even decline there will be opportunities elsewhere in the world
o Argentina has the necessary geological structure but whether it can get its
act together to produce is questionable
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Russia and the Breakeven Point
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This chart is somewhat controversial but relevant to current discussions
Shows the price of oil a country needs to avoid having a budget in deficit
Russia needs a relatively high price for oil to support its budget
o Russia as an Energy Super Power was discussed for years
o Russia is much more of a petro-state than was the USSR
 USSR’s production was largely traded within its own sphere – not tied
to the global market
 Russia is tied to the global market now and feels a greater impact on
the ruble with shifts in the price of oil as seen in last few days
 Yo-yo effect on the ruble
 Despite the Russian Central Bank raising interest rates to 17%
the ruble has crumbled
o Inflation going up in Russia because so many of the
goods in the Russian market now come from the global
market and are priced in $$
o Imported foods ban tried to help but didn’t
 Russian government estimates that its GDP growth based on oil at
$80/bbl is nearly zero; but since oil prices are much lower now,
Russian GDP will decline
 Had estimated about 1% growth in 2014 but now looks like it
may be more like -1%
 A predicted decline of 4% by the government probably means
the decline will be even greater
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o During the last major oil price decline in 2009, the Russian economy dropped
by 8% – only Ukraine did worse
 Ruble is doing worse today so things don’t look good
 Is China the answer when Putin is so desperate?
 He signed agreements that the Chinese did not really want and
probably not a good project
Bottom line: Russia is desperate for markets and alternative sources of financing
o Putin went to India to talk possible deals but it would be very difficult to
move gas to India from Russia economically
o Russia also concerned about China’s efforts in the Shanghai Cooperative
Organization where Putin was not front and center in the official pictures
 Big change in the relative relationships of China and Russia in this
own-backyard organization
 China’s Xi proclaiming the new “Economic Belt for the Silk Road”
 Sounds better in Chinese
 Involves doing deals throughout Central Asia – largely based
on oil and gas but not exclusively so
Lots of talk about Europe moving away from reliance on Russia for oil and gas
 Many in Washington think the US should do something to support the idea
 Chow is skeptical
 The geography makes too much economic sense to change
 Same situation between the US and Venezuela
o Venezuela would like to sell oil to China but the US has the production
facilities designed to accommodate its type of heavy oil
o China is just too far away
 Bottom line: In both cases the cost of diversification is not free
o Europe’s problem with Russia is accepting the monopoly of an exporter and
accepting the market rules that support a monopoly supplier
 Doesn’t matter whether it is Gazprom or some other country’s
monopoly
o Europe skeptical that Russia would sell all of its oil to China and would not
supply Europe
Africa
 International Energy Agency studies show that Africa has great potential for many
energy sources
o Including wind and solar
 More than one billion people do not have access to energy in the world – most are in
South Asia and Sub-Saharan Africa
o Big variations in distribution of the resources through out the region
 Big political problems need to be overcome to produce energy
 Hard to combat Ebola in hospitals without electricity
 There is oil in Africa but the risks involved in exploring for it are great
o Recent high prices have allowed for more exploration recently
o A lot of activity has recently occurred in East Africa but with high risks
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Mozambique, Madagascar
Bottom line: Africa does have the opportunity to be a future energy producer for the
global market
o May suffer from the resource curse
 Really a problem of governance as in Nigeria
 US is the prime example of the opposite end
 What is the difference between Texas and East Africa?
o Where do you invest the funds developed from production?
 In human development and a market-based economy?
 Or steal them and waste them because production is controlled by
only a small group?
Conclusion / Takeaways
 Unconventional/shale story in the US is transformative, though still in early stages
for tight oil
 Infrastructure and delivery system still evolving
 Unclear how international developments will play out
 Refinery investments/choices depend on policy
 Challenges still considerable, including climate considerations
 Middle Eastern and North African supplies still critical to global markets
 U.S. is heading towards 90% energy self-sufficiency but still part of a global market
 Foreign and defense policy implications?
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QUESTION & ANSWER SESSION
Re: Energy Independence
 There are values for energy independence beyond national security – including
environmental issues
o The Age of Fossil Fuels should end but won’t be discussed here
 Economic efficiency issues
o The US domestic natural gas consumer will always have a huge advantage
 If the cost of LNG is $4, the cost of shipping it to Japan will be $4-$6; about $4 to
Europe
 Industry view: If you don’t allow exports, then the cost of domestic gas could come
down so low that it no longer can justify the expense to produce the gas
o Need some export to keep the price at a sweet spot without denying a
domestic consumer an advantage over a foreign buyer
 Canadian oil sands are heavy and make a good combination with the Bakken sweet
crude of Montana and N. Dakota
o Would be best would to have them move down to the Gulf refineries, which
are the most sophisticated in the world
 If we don’t, then there will be a surplus of the Bakken crude
o Currently the Gulf Coast refineries can turn heavy, sour crudes into high
value products
 Can take heavy products from Mexico, Venezuela, and even Saudi
crude and transform them
 More efficient at present to refine the imported heavy crude and
export US produced light crude but it is hard to explain to US voters
o Export rules set in place because of the resource scarcities of the 1970s
o Hard to explain to voters that remaining a net importer makes sense
 Issues to be addressed: value of trading with our nearest neighbors, the safety of the
way the products are transported, the problems of putting more carbon in the air
o However, from the economic efficiency measure, it is clear what to do
o Policy-makers must discuss the other issues
 Coal
o US is converting from coal-fired plants to gas-powered plants, which are
generally cheaper
o US is exporting coal to Germany, which is opening up new coal fired plants to
replace its nuclear plants
 As a consequence, US CO2 emissions are going down and Germany’s
are going up
o Can no longer use the phrase “carrying coals to Newcastle” (the phrase refers
to brining a product to a place that already has an abundance of it), because
that is what is actually occurring with Germany. They are importing coal
when they have large reserves.
o There could be a technological response inspired by the taxing of carbon
emissions if the incentives were adequate to burn coal more cleanly
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o The IEA: Even in 2040 coal will still make up 25% of the world’s energy
supply
 There needs to be a way to help India and China produce energy in a
cleaner way
 Could involve carbon capture or sequestration or some other
technology
o Problem: with over a billion people around the world without access to
electricity, coal is unlikely to go away
Re: Saudi Arabia
 It has been a rational, but overdue, decision to keep pumping oil even at the current
low prices
o $100/bbl oil was not in the interest of Saudi Arabia
o They can produce 80 years of oil, but at that price by year 50 no one would
be interested in oil at that price level
 High prices have led to substitutions
 As an American, Chow is a technological optimist – always expecting
to find a better way
 At some point there will be a cleaner, cheaper alternative to oil and
gas
 Saudi Arabia did not need $100/bbl oil but they were propping up the price to help
Russia, Venezuela, and others which have been squandering their oil income
 Saudis remember 1985 when their production went from 8 million bbl/day to 2.5
million bbl/day
o If that rate kept up, they would have to buy oil to remain the swing producer
o This time they decided to avoid that situation and not cut production
 “Conspiracy theory” holds that Obama talked to the Saudi King to destroy the
Russian economy by dropping the price of oil
 Not believable
 Question: Has the price gone down enough for the Saudis to get the adjustment that
the Saudis wanted?
o Answer: not clear yet
o Will take a few months to see if the price goes down to $40/bbl
 Expectation: An OPEC meeting between the first and second quarter of 2015 before
the regularly scheduled meeting
o Will want some gesture of support from the others, including Russia
o Won’t want to be the only one cutting production to prop up the price
Re: Technology Transfer in the Oil and Gas Industry
 Can’t give someone a cookbook on how to exploit shale gas and tight oil
o Variations in geology only miles apart mean different ways are required
 US is good at adaptation and finding ways to cut drilling time
o Other countries are buying into US competencies
o That way they can watch to see how it is done
o However, not all will be able to work out how to do it just by watching
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China especially may be too tied to Communist ways to be adaptable
Example: Chinese use of state-owned in-house services will hamper
them
US companies use outsourcing to provide the cost-competitiveness needed rather
than trying to keep all people working
o Don’t expect that to work for China
If China does manage to improve, that should not be a bad thing to the US
o If they produce more domestic energy in a cleaner way
o Would keep prices more stable, with less call on the international market
US belief in free trade calls for technology transfer (but not for free)
o Apple remains ahead because it continually comes up with new phones
o If Apple kept the same phone, then the Chinese could just copy it and rebrand
it
Must think of the shale gas and tight oil not as part of the old heavy industry
o Think of it as part of the technological advances
US must maintain its technical edge with the right kind of funding, support of
institutions, etc.
o Then the US should do fine in the energy market
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Re: Europe and Shale Gas
 There is shale gas there but the conditions are very different from North America
o It is more geologically complicated so there has been more disappointment
o Chevron pulled out from a large deal with Ukraine partially because of the
less than desirable geology, which could not be supported by falling prices
 Need at least one good international success story to show investors that it can be
done
o Concept will be: “If they can do it, then we can do it”
 There are problems
o Some organized opposition, perhaps supported by Gazprom
o Population densities are different
 What you could do in N. Dakota, you would not be able to do around
Paris
 Chevron used to drill in Beverly Hills, hiding its drilling rigs in fake
Spanish bell towers, allowing the Beverly Hills High School to become
very wealthy from oil revenues
 Beverly Hills High School did not become wealthy from real
estate taxes
 Americans tend to think of what can be done especially by employing technology
o Expect that technology will make our lives better
o It explains why the US has genetically modified foods and Europe does not
 Really need that one good success story, perhaps in Romania which has 100 years of
history in exploration
o If it can be done in Romania, then why not Bulgaria and then other places
 Bottom line: The jury is still out whether it will be possible to develop shale gas in
Europe
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o Germany is actually talking about it; British are moving ahead with it
o Once the right technology appears, someone will use it
o Maybe the breakthrough will come in Mexico
Re: Nuclear Power
 Must be part of the picture
 As old plants are retired, must find ways to economically justify new plants
 Only about 20% of US energy comes from nuclear and must be sustained
o Partially because gas is so cheap
 Nuclear power plants might make good economic sense after a 50 year investment
but they do come with major economic risks
 Anywhere electrical demands are growing, nuclear power must be considered
because of its lack of greenhouse gases
o Japan and Germany are not being rational about avoiding nuclear power
while saying they also want to control greenhouse gases
o Germany is mining dirty lignite again
o Germany is also importing US coal and blaming the problems on the US
because the price of coal is so low
 Trend line is not good
o Would help to put price on carbon
Re: US Military Plans to Switch to Bio-Diesel Fuels
 Unclear why the most mechanized military in the world is trying to move away from
the cheapest possible fuel
 Military requirements need to be protected for national security
 Subsidies for new technologies are all right as long as they sunset
o They don’t help in the long run if they support technologies that are not
economically feasible
 If moving to different war-fighting modes, then fuels and fuel technologies do need
to be reconsidered
o Could choose to go with more foot soldiers, for instance, but that would bring
up many other political issues might want to address
 Rather than using technology and remote control
o Can understand these other issues
 Cannot understand why the military would consider paying twice as much for its
fuel just because it is bio-diesel
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