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6 Energy Myths Debunked

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On the tails of the oil crash, Michael A. Levi addressed a number of myths he’s found to be widely believed.

Levi — director of the Council on Foreign Relations program on energy and security and director of the Maurice R Greenberg Center for Geoeconomic Studies — recently spoke at the New York for the IMCA 2015 New York Consultants Conference.

Myth No. 1: Cheap energy will drive U.S. manufacturing.

“The first myth I want to talk about is this idea that cheap energy is bringing industry back home in a big way, and it’s a pretty popular view,” Levi said.

There are a lot of industries that use energy — steel, cement, aluminum and any kind of manufacturing. And because the U.S. had a crash in natural gas prices while Europe and Asia face far higher prices, to some it may seem that the United States has grabbed a decisive advantage in manufacturing.

“The reality is that for most industries,” Levi said, “even for most of these energy-intensive industries, the energy cost is rarely what’s pivotal.”

According to Levi, only a small percentage of U.S. manufacturing has more than 2% of its costs come from energy. Large parts of the manufacturing industry are not particularly energy intensive, he said.

“Even if you take energy costs to zero, there’s only so much of an advantage you can get,” Levi said. “Particularly when you think about the other inputs that matter: capital costs, land costs, in some cases labor costs and then the transportation costs if you’re going to try and compete in overseas markets.”

Myth No. 2: No one saw the oil crash coming.

“If you believed that it wasn’t coming, it probably had something to do with this guy,” Levi said showing the crowd a photo of Saudi oil minister Ali al-Naimi. “If you asked people a year ago, what will happen if there is a lot more production than there is consumption? If U.S. supply is doomed? They would say, ‘This guy will stop the price from falling. Saudi Arabia will cut its production and that will balance [it]. That’s what Saudi Arabia is there to do.’”

Or, Levi said, maybe those people would point to OPEC, thinking the oil producers’ group would cut production to keep prices high.

“The reality is that OPEC and Saudi Arabia haven’t fine-tuned the oil market for a long time,” Levi explained.

As an example, Levi said, look back to 2008.

“As the economy collapsed and oil prices fell to $100, $90, $80, $70, $60 a barrel, OPEC decided they weren’t going to do anything,” Levi said. “It fell to $50, they tried and they did not stop the price from falling.”

Levi said that only when prices got to $30 or $40 a barrel did Saudi Arabia and others in OPEC cut production so decisively that, combined with the response from the rest of the world, the price of oil reacted.

“So if you looked at how these countries made decisions and what they did in the past, you wouldn’t be too shocked,” Levi said. Myth No. 3: OPEC is dead.

Levi described OPEC’s meetings as “they deliberate on what their quotas will be — their quotas usually track their past production rather than predicting it — and after these meetings not much actually happens in their production.”

“The market does what it will do, and so some reasonably conclude now that OPEC is dead,” he said.

Levi, though, made the case that OPEC is still thriving.

“This is essential to remember: Just because OPEC does not control or influence short-term price fluctuations does not mean that Saudi Arabia and other OPEC members do not have a lot of influence over longer-run developments and prices in the global economy,” Levi said.

Levi said there was a lot of oil that could be produced very cheaply in parts of the world that aren’t producing nearly as much as they could.

“There is a basic sense that if Saudi Arabia wanted to produce twice as much oil — it couldn’t do it tomorrow; it’d need an investment program — but it could produce a lot more oil than it does right now,” he said. “The [United Arab Emirates] could produce a lot more oil than it does right now. Kuwait could produce a lot more oil than it does right now. The fact that those countries don’t produce a lot more oil means that they are influencing the market through their decisions.”

So, it’s not necessarily the OPEC meetings that matter but the individual decisions from OPEC members that “still do influence the world market enormously.”

Myth No. 4: We’ll never see $100-a-barrel oil again.

Some commentators argue that, thanks to technology, cheap oil is here to stay.

The reality, according to Levi, is that the rise of oil price volatility means $100-a-barrel oil is entirely possible.

“My reason for thinking that we will see $100 barrel oil in the next five years, maybe three years, possibly sooner, is that … the oil market and the oil price respond very sharply to relatively small mismatches between supply and demand,” he said. “We’re seeing now what happens when that mismatch runs in one direction, but it can run in the other direction relatively easily.”

There are many possible surprises that could overwhelm the capacity of the system quickly. Levi pointed to geopolitical events in Venezuela, Nigeria and the Middle East, and surprises in U.S. production — saying, “we’re still awful at predicting U.S. production.”

“There are a lot of ways that we could be surprised in the next several years,” he said. “And the system is just as bad at reacting when prices go up and when pressure is in that direction as it is when responding quickly to the sort of thing we’re seeing right now.” Myth No. 5: Cheap gas will kill coal.

While the coal industry is doing awfully — the share prices of the four largest coal-producing companies, which make up roughly half of the U.S. coal production market, are less than half that of PetSmart — coal is still the largest source of U.S. electricity generation, Levi said.

“The reality is that the coal industry can be doing awfully even with coal itself remaining a major and even dominant contributor to US electricity generation,” he said.

Coal is still the largest source of us electricity. And, unless there is substantial new regulation that drives substitution of gas for coal, Levi predicts coal will remain the dominant source of U.S. electricity for the next decade.

“And that’s because most of the cost of coal electricity generation is not the coal, it’s the power plant,” Levi said. “If the power plant is already built, it’s very difficult to dislodge.”

Myth No. 6: The oil and gas boom will kill renewable energy.

 “There is a belief out there that this boom will kill renewable energy,” Levi said. “I think a lot of the conventional wisdom [behind this myth] has to do with the dominant source of renewable energy over the last decade, and that is corn ethanol or ethanol in general.”

Ethanol is, Levi said, a direct competitor for oil. And, abundant oil — particularly if it pushes prices down — will really hurt ethanol and biofuels more in general.

“The reality is, though, that there is a lot more to renewable energy than ethanol,” Levi added. “Pretty much for everything else, the connection is far more attenuated.”

The reality of the boom in U.S. renewables production in the last year or so has not been ethanol, Levi said. It has been, largely, solar power.

“Now, of course, solar power does not compete directly with oil,” he said. “We don’t use oil in any meaningful way in electricity generation. A lot of the solar power that’s been coming on doesn’t even compete directly with natural gas. A lot of the boom in recent solar power has been distributed solar generation, the stuff people put on their roofs, the stuff companies put on their facilities.”

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