Hearings and Business Meetings

SD-366 Energy Committee Hearing Room 09:30 AM

Mr. Frank Verrastro

Director and Senior Fellow, Energy and National Security Program, Center for Strategic and International Studies

Testimony before the
Committee on Energy and Natural Resources
United States Senate
“Comments and Observations on the Topic
of U.S. Energy Independence”
March 7, 2006
A Statement by
FRANK VERRASTRO
Director and Senior Fellow, Energy Program
CENTER FOR STRATEGIC AND INTERNATIONAL STUDIES, 1800 K STREET, NW,WASHINGTON, DC 20006
TELEPHONE: (202) 887-0200; FACSIMILE: (202) 775-3199
WWW.CSIS.ORG

Mr. Chairman, Members of the Committee, I appreciate the opportunity to appear before you
today to discuss the broad ranging topic of America’s energy independence. I currently serve as
Energy Program Director and Senior Fellow at the Center for Strategic and International Studies
(CSIS), but my professional background also includes a variety of energy policy positions in the
White House, and the Departments of Interior and Energy, as well as senior executive positions
dealing with both upstream and downstream issues in the energy sector, first as Director of
Refinery Policy and Crude Oil Planning for TOSCO Corporation, and more recently as a Senior
Vice President at Pennzoil Company.
Given the composition of this morning’s panel, the bulk of my remarks will be directed at the
issue of oil import dependence and prospects for replacing and reducing petroleum demand for
transportation fuels, but more generally I will also touch on the U.S. energy balance and proffer
the view that we would be well advised to pursue a broader array of options for ensuring that our
energy needs are met. These options should include:
stimulating additional supplies of conventional and traditionally non-conventional fuel
sources, including renewables and alternatives;
improving energy efficiency and conservation efforts;
promoting research and technology development, and where applicable, accelerating the
deployment of useful technologies;
addressing infrastructure needs to facilitate the delivery of fuel choices;
pursuing the development of a more comprehensive energy strategy that recognizes the
potential for simultaneously introducing transformational policies while managing the
realities of our existing energy interdependence in a global energy market, and
performing the above activities consistent with current investment and market practices.
I would also add that focusing on Energy Independence, while politically attractive, may in fact
be a misguided quest and that we would be better served by mapping out a strategy for managing
the transition to a different energy future as our current path is clearly unsustainable.
Our Evolving EnergyWorld
Mr. Chairman, the events of the past few years have served to refocus attention on the critical
role which energy plays in our national and global economies. Rising global oil demand,
concern over the adequacy, reliability, and pricing of energy supplies, the environmental
implications of increased use of fossil fuels, the cost of those supplies for developed and
developing economies alike, trade and capital flows, and global geopolitics are issues that
preoccupy business and governments around the globe.
Faced with these evident realities, concern over the continued ability of this nation to secure
energy supplies from an increasing list of inaccessible, high risk or less than reliable parts of the
world has prompted policymakers to once again raise the issues of both the desirability and
achievability of energy independence.
U.S. consumers have come to both enjoy and expect a healthy domestic economy, which is
underpinned by an energy supply that is at once available, affordable, secure, and environmentally benign. In this new world are those criteria able to be satisfied or are they just
beyond the reach of current energy paradigms and policies?
Global energy demand is projected to increase by 50 percent over the next 25 years, yet the
relative shares of the five major fuel groups – oil, natural gas, coal, nuclear and renewables – are
expected to remain remarkably constant, with fossil fuel consumption still accounting for over 85
percent of total energy demand in 2025. In the developing world, that figure exceeds 90 percent
(see figure below), carrying obvious consequences for consumer competition and the
environment.
As we consider our energy options, I would strongly urge that we not forget the substantial
contributions that conservation and improved efficiency can make to achieving our future energy
goals. In the power generation sector, it currently takes three to four units of primary energy to
produce one unit of delivered electricity. Conservation, efficiency and infrastructure delivery
improvements coupled with additional contributions from renewable energy sources can obviate
the need for additional, incremental production of fossil fuels for power generation purposes.
Similarly, improving auto efficiency and accelerating the deployment of proven technologies
into the auto fleet can, over time, make a substantial contribution to reducing transportation fuel
demand.
Analyzing this forecasted future leads to two seemingly inescapable conclusions. The first is
that absent major technological breakthroughs, significant changes in consumption patterns and
policies, or massive dislocations that alter the course of events, the consumptions trends depicted
by this chart are simply unsustainable for the long term. Secondly, even assuming a significant
contribution from a wide range of alternative fuels, conventional energy sources will continue to
dominate the landscape for at least the next several decades.
The Role of the United States in a Global Energy Marketplace
For the past thirty years, U.S. oil policy initiatives have centered around 4 major themes:
increasing and diversifying sources of conventional and unconventional energy supplies both at
home and abroad; encouraging, wherever practicable and politically achievable, the adoption of
improvements in conservation and fuel efficiency; the expansion of the strategic petroleum
reserve; and reliance on Saudi Arabia to balance oil markets and moderate prices.
For the most part, in an era of surplus supply, this strategy has largely worked. Times and
market conditions, however, may well be changing. Global demand for all energy forms is
accelerating, and resources are increasingly controlled by national players, whose primary
national objectives may not conform to traditional market practices or concerns.
It took the world 18 years (from 1977-1995) to grow global oil demand from 60 to 70 million
barrels per day (mmb/d); eight years to grow from 70 to 80 mmb/d; and if current projections are
correct, global oil demand will exceed 90 mmb/d by 2010. Forecasts for oil consumption in
2030 approximate 115-120 mmb/d – roughly half again as much as we currently consume.
Setting aside the debate about resource availability or so called “peak oil,” market growth of that
magnitude will require huge investments, place enormous strains on transportation and
infrastructure needs, and carry significant implications for security, global geopolitics and the
environment.
In addition, the entry of new market players, like China and India, with growing energy appetites
and expanding economies may pose competitive threats to America’s market dominance. Added
to that are heightened security concerns about threats to infrastructure and facilities posed by
terrorist groups and insurgents. Taken together, these changing circumstances have the potential
to re-order the marketplace and fundamentally alter the geopolitical balance that has governed
the past half century. Such changes may also warrant a thoughtful recalibration of our economic,
security, environmental, energy and foreign policy calculations and policy choices.
The United States is currently the world’s largest producer, consumer, and net importer of
energy. We are home to roughly 5 percent of the world’s population and produce 17 percent of
the total energy supplied. Yet in the process of generating some 30 percent of global GDP,
America consumes nearly a quarter of the world’s energy.
In terms of energy self-sufficiency, the United States in 2004 produced (domestically) roughly
71 percent of the total energy it consumed. Today, the United States remains self-sufficient in
meeting virtually all of its energy needs with the exception of two key energy forms – petroleum,
and increasingly, natural gas – both of which are critical commodities.

In its recently released 2006 Annual Energy Outlook, the U.S. Energy Information
Administration (EIA) forecasts that overall energy usage in the United States will continue to
increase at an annual growth rate of 1.2 percent for the next 25 years. U.S. energy demand for
all fuels is projected to increase from roughly 100 quadrillion Btus (Quads) to over 127 quads by
2030 with oil, gas and coal leading the way. Projected incremental growth for non-hydro
renewables will also be substantial, but starting from such a small base, is expected to account
for about 7 percent of total domestic energy demand by 2025, with 60 percent of that amount
devoted to grid-related electricity generation.
In contrast, total U.S. demand for petroleum products, largely driven by increases in
transportation fuel needs, is projected to increase by over 30 percent from current levels (slightly
below 21 mmb/d in 2005) to just over 27.5 mmb/d in 2030. Demand for all forms of petroleum
fuels except for the bottom of the barrel increase, and total gasoline demand increases to about
12.5 mmb/d. Petroleum fuels currently supply 97 percent of all domestic transportation needs.
After a brief period of increased output (from 2006-2015, largely as a result of additional
production from the deep water of the Gulf of Mexico) domestic crude oil production is expected
to resume its gradual decline. And with U.S. refineries running at or near capacity, absent
substantial new investment, increased domestic demand means expanding reliance on imported
petroleum, both for crude oil and, increasingly, refined petroleum products.
In 2025, net petroleum imports are expected to account for 60 percent of demand (up from 58
percent in 2004), although that figure could increase to almost 70 percent depending on
assumptions about price and economic activity. Net imports of refined petroleum products
increase from 17 to 22 percent of total oil imports by 2030.
The rise in oil import levels, both in absolute and relative terms, carries important infrastructure,
logistical, environmental, financial, trade, security, and foreign policy implications. Assuming
investment continues to lag in the creation of additional domestic refining capacity, the projected
rise in imports of refined petroleum product increases U.S. vulnerability to supply disruptions
and potentially undermines the value of the Strategic Petroleum Reserve (SPR).
A similar picture emerges for domestic natural gas, although demand continues to grow between
now and 2015 before leveling off as coal demand for power generation accelerates. As demand
for natural gas increases, the United States will increasingly rely on nonconventional domestic
production (e.g., tight sands and coal seam gas), gas from Alaska, on increased imports of
pipeline gas from Canada (to the extent they are available), and on LNG from sources in Latin
America, the Caribbean, Africa, the Middle East, Australia, and Russia.
Projected supplies of LNG imports assume that additional regasification capacity will be
permitted and constructed either within the United States or in areas proximate to U.S. borders –
an uncertain assumption. In addition to environmental, safety, competition, and siting issues,
opponents of additional LNG regas projects increasingly cite security and foreign policy
concerns about exposing the U.S. electric grid system to reliance on imports from countries,
many of which are oil exporters found in troubled regions of the world. (Global gas reserves
data is shown in the next figure.)
An Increasing Role for Alternative Fuels
Rising oil prices in recent years have heightened interest in a variety of alternative sources of
liquid fuels. At present, two biologically derived fuel forms, ethanol and biodiesel, are used in
the United States to supplement supplies of conventional gasoline and diesel. In principle,
biodiesel can be blended into conventional diesel or heating oil in fractions compatible with the
fuel system and/or its construction materials. On the plus side, biodiesel’s blending promotes
flexibility and reduces carbon monoxide emissions. Unfortunately, depending on the precise
chemical composition of the solvent, too high a concentration can damage certain plastics and
rubber (system) components and may contribute to increased emissions of nitrogen oxide.
Ethanol can be readily blended into gasoline. Since the late 1970s, cars and light trucks built for
the U.S. market are capable of running on a 10 percent ethanol blend. A limited number
(roughly 5 million) of the 220 million vehicles currently on the road are also capable of running
on blends of up to 85 percent ethanol. Most fuel ethanol currently produced in the United States
is distilled from corn. Since corn is also a food crop, however, there are questions related to the
volume of ethanol that can be readily produced from corn without affecting crop prices, as well
as limitations on the amount of acreage available to dedicate to fuel crop planting.
In addition, since only a portion of the plant material can be used to produce ethanol, issues have
been raised about how to handle the residual waste material – e.g., stalks, leaves and husks. A
partial answer to this dilemma has resulted in research into what is called cellulosic ethanol, but
transportation and energy content issues still remain to be resolved. For example, since a gallon
of ethanol contains less energy than a comparable gallon of gasoline, poorer mileage ratings and
more frequent fuel stops are impediments that need to be overcome. Additionally, cold weather
start problems and transport in carriers other than pipelines may complicate gasoline substitution
on a national scale.

There have also been promising breakthroughs in creating other forms of fuels from a wide
variety of sources, including biomass, agricultural, industrial and municipal waste streams, coal
to liquids (CTLs), gas to liquids (GTLs), “synfuels” made from oil sands, shale and extra heavy
crudes, and biomass to liquids (BTLs) processes that derive fuels from waste wood and other
non-food plant sources.
Biorefineries, digesters and other waste to energy process facilities are clearly in the sights of
investors, although their most significant supply impacts may be felt on a regional rather than
national basis, at least until expanded distribution and delivery infrastructure comes on line. In
this regard, better data collection would be most helpful. The National Renewable Fuels
Laboratory (NREL) and EIA have been discussing data improvements to better capture a more
complete picture of how biofuels activity is developing within the U.S., but resource limitations
affecting data collection and modeling have limited that effort.
It is worth noting, however, that based on current government data, the capital investment costs
for most, if not all, of these synthetic fuel technologies is considerably more than that required
for a traditional crude oil refinery (see page 57, of EIA’s 2006 Annual Energy Outlook).
Further, for purposes of comparison, EIA estimates that there is currently some 300,000 b/d of
installed corn ethanol capacity in the United States and an additional 12,000 b/d of biodiesel
capacity. Additionally, excluding “pilot” facilities, the latest EIA statistics indicate that there are
currently no commercial BTL, GTL or CTL plants in the United States. In contrast, U.S.
refining capacity currently exceeds 17 million barrels per day and domestic gasoline demand
averages over 9 million barrels per day.
The mandated target of producing 7.5 billion gallons of ethanol (fuel) by 2012 translates into
roughly 490,000 b/d, representing approximately 3 percent of projected domestic transportation
fuel needs in 2012 and less than 5 percent of total gasoline demand. Analyses performed by EIA
and NREL estimate that even under optimistic assumptions, alternative transport fuels (excluding
electric hybrid plug-ins) can be expected to displace/replace a maximum of 10 percent of
conventional liquid transport fuels by 2030, leaving petroleum based fuels, conservation and
improved efficiency gains to deal with the remaining 90 percent.
A 2004 report prepared by the bi-partisan National Commission on Energy Policy came up with
similar results, projecting a 10-15 percent reduction in U.S. oil consumption in 2025 by
substituting non-petroleum transportation fuel alternatives in combination with the adoption of
more stringent CAFÉ standards for cars and light trucks and providing incentives to encourage
the production and purchase of fuel efficient vehicles. In reaction to the Commission’s report,
EIA analysis attributed a 7.3 percent reduction in petroleum fuel usage to the adoption of tougher
fuel efficiency and CAFÉ standards.
In short, while contributions from alternative fuels will be helpful as a component in meeting
increased consumer demand for transport fuels, for at least the mid-term, absent significant
policy and regulatory changes to promote increased fuel efficiency, major technological
breakthroughs, and substantial changes in consumer/driver behavior (based on environmental,
security or foreign policy considerations), petroleum based fuels will remain the overwhelming
fuel of choice for at least the next 20-30 years.
Given projections for increasing fuel demand, the inescapable conclusion is that oil imports will
also be with us for decades to come. In that context, we would do well to ratchet down the
political rhetoric surrounding the notion of achieving energy independence and instead refocus
our efforts to deal with an inter-dependent energy future and simultaneously prepare for the
(longer term) transition to a post-oil world, a transition which former Energy and Defense
Secretary James Schlesinger has characterized as “…the greatest challenge this country and the
world will face – outside of war.”
U.S. Oil Imports – Sources and Concerns
In his State of the Union address, President Bush advanced the challenge of reducing this
nation’s “addiction to oil” and reducing by 75 percent our reliance on oil imports from the
Middle East. At best, this line was a thinly veiled attempt to drum up domestic political support
for a valiant yet difficult effort to reduce petroleum consumption. At worst, it showed a decided
lack of understanding of U.S. import sources, global oil markets and reserve holders.
In 2005, the primary oil suppliers (crude oil and refined product) to the United States were, in
volumetric order, Canada, Mexico, Venezuela, Saudi Arabia and Nigeria. Imports from Iraq
ranked a distant sixth. The top 5 suppliers provide over 60 percent of total U.S. oil imports. The
entire Middle East, by contrast, accounted for roughly 17 percent of last year’s imports
(representing about 11 percent of total domestic petroleum consumption).
Looking forward, imports of Canadian and Mexican oil are expected to decline as their
respective production levels decline and/or domestic requirements increase. In contrast, imports
from the Middle East and OPEC sources generally (in part because these countries represent the
several of the largest reserve holders in the world, both for oil and gas) are expected to increase.
Managing relationships with these suppliers should be a priority under any policy the U.S
devises for dealing with future energy requirements.
Pitfalls and Warnings
As with any transformational change, issues surrounding the approach, time horizon and levers
designed to accomplish the objective remain keys to success. Dealing with an energy transition
is no less daunting. To the extent practicable, every effort should be made to pursue policies and
changes that fully take into account investment and market practices and utilize as much as
possible existing infrastructure and currently available technologies. Minimizing uncertainty,
avoiding conflicting or contradictory policy signals, and evaluating/selecting options based on
economic efficiency and merit rather than political efficacy are also are highly recommended.
A few examples:
Less than eight months ago, the Congress adopted the Energy Policy act of 2005. The Act was
notable in many respects, but when read against the oil reduction challenges laid out by the
President in the State of the Union address may unintentionally lead to uncertainty and paralysis
in terms of energy investment. The energy legislation specifically included provisions designed
to encourage additional refinery capacity construction within the United States, yet the
President’s challenge to displace petroleum usage could likely have a chilling impact on both
international upstream investments and domestic refining additions, both expensive and longlived
investments.
Similarly, after much debate and deliberation and for a wide variety of reasons, the single
MTBE-related provision (repeal of the oxygenate mandate) that survived the energy conference
has resulted in a reduction in available octane enhancing components and will likely produce
higher ethanol and gasoline prices while reducing gasoline availability.
A third example relates to the permitting of additional LNG regasification facilities in the United
States to handle increased volumes of imported natural gas. As indicated earlier, as we strive to
reduce reliance on imported oil, we appear to be simultaneously encouraging increased import
dependence of natural gas – the bulk of which may come from similar import sources.
And finally, at a time when policymakers are intent upon encouraging specific types of large
scale energy investments, does it really make sense to hamstring major industry players by
proposing tax changes that ultimately reduce their ability to pursue those investments?
Altering the trajectory of future demand for petroleum based fuels is prudent policy for a wide
variety of reasons. But in doing so, we should not confuse displacing oil with the larger
objective of tempering overall consumption and improving efficiency as the main priorities.
Crop growing also requires energy. Plug in vehicles that run on electricity require energy
sources to generate that power – the bulk of which currently comes from coal, although nuclear,
natural gas and renewables also play significant roles.
The oil market is a truly global market. Reducing America’s oil consumption can potentially
have a dampening effect on prices, but it will not completely insulate us from supply or price
volatility. We frequently speak about “politically unstable” sources of oil supplies around the
globe, but the largest protracted losses of global oil and gas output in both 2004 and 2005 were
the result of hurricanes in the U.S. Gulf of Mexico.
The Stone Age did not end because we ran out of rocks – something better came along. The Oil
Age will similarly be overtaken when a better solution or a series of component solutions
emerge. We can and should accelerate that process, but need to do so carefully and prudently –
by introducing cost effective substitutes, while employing (insofar as possible) existing
infrastructure and delivery systems, minimizing uncertainty, using available market mechanisms
and educating the public on the need for change.
Conclusion
Over the past 50 years, U.S. energy policy has been faithfully diverse, often internally
inconsistent, amazingly flexible in adjusting to public, market and commercial pressures, and
incomprehensible to most observers. It is likely to retain many of these unique elements.
The 1970s provided the last clear articulation of an attempted national energy strategy – and this
was largely in response to global energy events. The 1973 Arab Oil Embargo prompted the
development of the SPR, the adoption of CAFÉ (Corporate Average Fuel Efficiency) standards,
and the formation of the International Energy Agency (IEA). Domestic natural gas shortages and
the prospects for declining oil supplies prompted President Carter’s decision to lift oil price
regulation and pursue energy sector transformation, ushering in a new era in U.S. policy driven
by the market.
In short, economics has prevailed over the past 25 years. Until recently, oil prices have remained
relatively low and U.S. energy efficiency has increased. However, changing market and political
conditions may complicate America’s policy agenda going forward, and these include:
Energy security, broadly defined in terms of attacks on infrastructure, and greater
vulnerability to imported energy supply threats, either physical or financial, due to growing
production concentration;
Market developments, particularly in alternative fuels and with respect to climate change. In
the future, markets may drive policy more than policy drives markets;
Less multilateral cooperation in the international oil trading and investment market places as
governments pursue specific narrow interests;
Increased vulnerability to supply disruptions due to growing natural gas import dependence
in the power sector; and
Political hostility to U.S. policy in specific regions as allies and friends abandon the United
States to ensure their own political survival.
The role of the United States as an energy producer, consumer, and importer has already been
noted in some detail. The energy future of the country seems at once very clear but very
worrisome: declining domestic production and rising domestic demand, with the gap to be
covered by imports from suppliers whose national interests may not and historically have not
coincided with our own.
This almost inevitable growth in reliance on foreign supplies would, to the casual observer, seem
to be a call to action, to define and implement policies that would concomitantly expand
domestic supplies while setting demand management efforts in motion. To do so, however,
requires a certain political will on the part of both the U.S. consumer and the government. And,
to date, despite higher energy prices, real and threatened interruptions in supply, environmental
damage, hurricanes and blackouts, that critical ingredient remains lacking.
All energy producer/exporters and consumer/importers are bound together by a mutual
interdependency. All are vulnerable to any event, anywhere, at any time, which impacts on
supply or demand. This means that the U.S. energy future likely will be shaped, at least in part,
by events outside of our control and beyond our influence. Calls for energy independence,
absent major technological breakthroughs and a national commitment, ring hollow, and in the
near term are both unrealistic and unachievable. In the absence of decisive political will to
undertake those steps necessary to improve efficiency, promote conservation, encourage the
development of domestic energy resources and renewable energy forms, learning to manage the
risks accompanying import dependency may be the only reasonable course of action.
It is against this backdrop that future U.S. environmental, economic, foreign, energy and security
policies must be fashioned.
Thank you.