May 9, 2012
Energy use is pervasive throughout the U.S. economy. Households and businesses use energy from oil, natural gas, coal, nuclear power, and renewable sources (such as wind and the sun) to generate electricity, provide transportation, and heat and cool buildings. In 2010, energy consumption represented 8.4 percent of U.S. gross domestic product.
Disruptions in the supply of commodities used to produce energy tend to raise energy prices, imposing an increased burden on U.S. households and businesses. Disruptions can also reduce the nation’s economic output and thus people’s income. This paper examines energy security in the United States—that is, the ability of U.S. households and businesses to accommodate disruptions of supply in energy markets—and actions that the government could take to reduce the effects of such disruptions.
The vulnerability of the U.S. economy to disruptions in the supply of a particular energy source depends on the importance of that energy source to the economy. More than 80 percent of the energy consumed in the United States comes from oil, natural gas, or coal. For each source, several factors determine how vulnerable the nation is to a disruption in its supply:
- The extent to which disruptions occurring anywhere in the world affect energy costs in the United States,
- The likelihood of disruptions and the ability of energy suppliers to respond to disruptions if they occur, and
- The ability of energy consumers (including electricity producers, oil refiners, households, and businesses) to shift to other, less expensive sources of energy.
Consumers and the economy are more vulnerable to disruptions in oil markets than they are to disruptions in other energy markets, as shown by a comparison of the two largest energy-consuming sectors of the U.S. economy—transportation and electricity. In particular, transportation is almost exclusively dependent on oil supplied in a global market in which disruptions can cause large price changes. Moreover, consumers have few easy and inexpensive options for switching to other fuels or reducing consumption of transportation fuels. In contrast, electricity can be produced from several sources of energy, all of which are less prone to disruptions, and consumers have more options for reducing demand for electricity.
The Potential for Global Disruptions to Affect U.S. Energy Prices
Disruptions in the supply of any commodity tend to raise that commodity’s price; however, disruptions in the supply of oil have a much larger effect on prices than interruptions in the supply of other energy commodities. The extensive network of pipelines, shipping, and other options for transporting oil around the world means that a single world price for oil prevails, after accounting for the quality of that oil and the cost of transporting it to the marketplace. Except for countries where the price of oil is regulated or subsidized in certain ways, disruptions related to oil production that occur anywhere in the world raise the price of oil for every consumer of oil, regardless of the amount of oil imported or exported by that consumer’s country. In contrast, the high cost of moving natural gas, coal, nuclear power, and renewable energy limits their markets to geographically bounded regions, such as North America. Consequently, foreign disruptions have had little or no effect on the prices of those fuels in the United States.
Although the global nature of the market for oil makes U.S. consumers vulnerable to price fluctuations caused by events elsewhere in the world, it also benefits those consumers by lowering the price of oil relative to what it would be in a regional oil market; that benefit would be greater, however, if the global market was less prone to disruptions or if oil producers and consumers were better able to adjust to such disruptions.
The Likelihood of Disruptions and the Ability of Suppliers to Adjust to Them
A substantial amount of oil is produced in countries that are vulnerable to disruptions resulting from geopolitical, military, or civil developments, and few countries other than Saudi Arabia have much spare production capacity in the near term to offset such disruptions. In contrast, the U.S. markets for natural gas, coal, nuclear power, and renewable energy either are less prone to long-term disruptions or have significant spare production and storage capacity. For example, U.S. producers and consumers of natural gas maintain a significant reserve in storage (30 percent of annual consumption in 2010). Similarly, stocks of coal in 2010 represented 9 weeks of U.S. consumption and, over the past decade, producers of coal in the United States maintained an average spare production capacity of 17 percent. Much of the limited potential for disruptions in the supply of those fuels involves their transport across the United States (via pipeline, railcar, river barge, or truck), for which redundancy and spare transport capacity exist.
The Ability of Energy Consumers to Adjust to Disruptions
The U.S. electricity system is quite flexible and operates with significant spare capacity in most circumstances. That spare capacity means that when western coal is not available to electricity providers in the East, for example, they can shift generation to facilities that rely on coal from Illinois or Appalachia or increase generation from natural gas or renewable sources. In addition, some facilities are maintained in reserve and operated only during periods of peak electricity demand or during a disruption at another facility. Thus, when the price of one commodity used to generate electricity rises, another commodity can be substituted, keeping electricity prices relatively stable.
In contrast, the United States has no alternatives that can be readily substituted in large quantities for oil in providing fuel for transportation. Moreover, consumers have less flexibility in the near term in how they use transportation, and changes in transportation use tend to be more expensive over the long term than changes in electricity use. For example, households and businesses can reduce electricity consumption by adjusting their thermostat settings or switching to energy-efficient light bulbs in the near term, or they can switch to natural gas heating or energy-efficient appliances over the long term. However, most decisions that would reduce transportation costs, such as what vehicle to drive or where to live, cannot easily be altered in the near term. Changes can be made over the long term, but such adjustments tend to be more expensive than those that can be made to reduce electricity use.
Policy Options to Improve Energy Security in Transportation
Addressing concerns about U.S. energy security requires considering policies related to the nation’s supply of and demand for oil, because transportation relies so heavily on that commodity. Because of the global nature of the oil market, no policy could eliminate the costs borne by consumers as a result of disruptions but some policies could reduce those costs. This report examines the ability of some commonly proposed policies to decrease those costs, but it does not evaluate the costs or benefits of implementing those policies or how well they would address other objectives.
Policies designed to address temporary disruptions could seek to increase the supply of oil (by releasing oil from the Strategic Petroleum Reserve, for instance); facilitate development of markets to provide insurance that would protect consumers against sharp increases in prices; or provide consumers with options for reducing their consumption of oil (by expanding public transportation service, for example, or promoting the use of telecommuting). A release of oil from the Strategic Petroleum Reserve or more widespread use of insurance could reduce the impact of some disruptions, although the beneficial effects of such policies could be neutralized if releases were not implemented in coordination with other oil-producing countries or the insurance did not transfer risk to those better able to bear it. Policies that enabled consumers to use their vehicles less during periods of high gasoline prices would be more likely to lower costs for households and businesses.
Policies designed to decrease the impact of increases in oil prices that persist for several years or more can also be divided into those that would increase the supply of oil or oil substitutes (such as increasing domestic oil production) and those that would encourage consumers to reduce their reliance on oil (such as increasing the gasoline tax or developing vehicles that are more fuel efficient or that use other types of fuel). Both types of policies would tend to lower the world price of oil, either by making more oil available to the world market or by reducing demand for it. However, the effect of either type of policy on the world price would probably be small. Many analysts (including the U.S. Energy Information Administration) expect that large oil-producing countries would reduce their actual or planned production of oil in the face of increased production of oil in the United States, thereby diminishing or eliminating the effect of such U.S. actions on the world price of oil. Recently, for instance, Saudi Arabia announced that it would reduce its planned expansion of oil production in light of increased production in Brazil and Iraq.
Policies that promoted greater production of oil in the United States would probably not protect U.S. consumers from sudden worldwide increases in oil prices stemming from supply disruptions elsewhere in the world, even if increased production lowered the world price of oil on an ongoing basis. In fact, such lower prices would encourage greater use of oil, thus making consumers more vulnerable to increases in oil prices. Even if the United States increased production and became a net exporter of oil, U.S. consumers would still be exposed to gasoline prices that rose and fell in response to disruptions around the world.
When a disruption occurs, those countries with spare production capacity—of which Saudi Arabia is the largest— can determine whether to partially or fully offset the disruption. In fact, Saudi Arabia has chosen to offset, to a large extent, the impact of disruptions by increasing production when oil prices rise because of a disruption. If the United States was able to develop similar spare production capacity held in reserve until disruptions occurred, that capacity could be used to limit increases in oil prices during times of disruption—but pursuing that option would probably be costly or impractical. Production capacity in the United States is owned by private firms and operated on the basis of the geologic characteristics of the oil reserves and the returns required by shareholders. Without sufficient compensation, private firms would be unlikely to hold newly developed capacity in reserve and use it only to offset disruptions in other countries. Therefore, such spare capacity would probably need to be owned by the U.S. government.
In contrast, policies that reduced the use of oil and its products would create an incentive for consumers to use less oil or make decisions that reduced their exposure to higher oil prices in the future, such as purchasing more fuel-efficient vehicles or living closer to work. Such policies would impose costs on vehicle users (in the case of fuel taxes or fuel-efficiency requirements) or taxpayers (in the case of subsidies for alternative fuels or for new vehicle technologies). But the resulting decisions would make consumers less vulnerable to increases in oil prices.