[Senate Hearing 108-98]
[From the U.S. Government Publishing Office]



                                                         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/
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                     COMMITTEE ON FOREIGN RELATIONS

                  RICHARD G. LUGAR, Indiana, Chairman

CHUCK HAGEL, Nebraska                JOSEPH R. BIDEN, Jr., Delaware
LINCOLN CHAFEE, Rhode Island         PAUL S. SARBANES, Maryland
GEORGE ALLEN, Virginia               CHRISTOPHER J. DODD, Connecticut
SAM BROWNBACK, Kansas                JOHN F. KERRY, Massachusetts
MICHAEL B. ENZI, Wyoming             RUSSELL D. FEINGOLD, Wisconsin
GEORGE V. VOINOVICH, Ohio            BARBARA BOXER, California
LAMAR ALEXANDER, Tennessee           BILL NELSON, Florida
NORM COLEMAN, Minnesota              JOHN D. ROCKEFELLER IV, West 
JOHN E. SUNUNU, New Hampshire            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         PAUL S. SARBANES, Maryland
MICHAEL B. ENZI, Wyoming             JOHN D. ROCKEFELLER IV, West 
LAMAR ALEXANDER, Tennessee               Virginia
NORM COLEMAN, Minnesota              JON S. CORZINE, New Jersey
                                     CHRISTOPHER J. DODD, Connecticut

                                  (ii)

  


                            C O N T E N T S

                              ----------                              
                                                                   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

                                 (iii)

 
                       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.

    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 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 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.
    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 long-term 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 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 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.
    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.

            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 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 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 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:]


                 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 economic 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.
    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 
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 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 self-interest.
    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 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.

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 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 
BP-Amoco 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 Africa, 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 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 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 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 up-front 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.
    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 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 interests 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.
    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 security, 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.
    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, 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\
---------------------------------------------------------------------------
    \1\ Daniel Yergin, The Prize: The Epic Quest for Oil, Money, and 
Power (Touchstone, 1993).
---------------------------------------------------------------------------
    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.

   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.
---------------------------------------------------------------------------
    \2\ Commanding Heights: The Battle for the World Economy, PBS, 
beginning May 15, 2003 at 10pm.
---------------------------------------------------------------------------
    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.
    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\
---------------------------------------------------------------------------
    \3\ Digital Oil Field of the Future, CERA Multiclient study, 2003.
---------------------------------------------------------------------------
    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 medium-term 
impact will come from hybrid vehicles--part internal combustion, part 
battery-driven.\4\
---------------------------------------------------------------------------
    \4\ The Hydrogen Economy, How Far and How Fast?, CERA Private 
Report.
---------------------------------------------------------------------------
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 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      Percent of
                                                  Liquids      Reserves
                                                 Production
------------------------------------------------------------------------
    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 ``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.
    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\
---------------------------------------------------------------------------
    \5\ Miracle in the Oil Fields? The New Growth in Russian Oil 
Production: Drivers and Implications, CERA Private Report.

   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\
---------------------------------------------------------------------------
    \6\ Changing Course? Iraq and the New U.S.-Russian Relationship, 
CERA Global Alert

    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 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 mid-1990s, 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 shut-in 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\
---------------------------------------------------------------------------
    \7\ West African Oil & Gas to 2020: Opportunity, Potential and 
Risk, CERA Multiclient Study
---------------------------------------------------------------------------
    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:

   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\
---------------------------------------------------------------------------
    \8\ Daniel Yergin and Joseph Stanislaw, The Commanding Heights: The 
Battle for the World Economy (Touchstone 2002), p. 106.
---------------------------------------------------------------------------
    ``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.
    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 million-barrel-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 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 cannot 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, 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 non-OPEC 
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. 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 below-ground 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 industrialized 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 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 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.
    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.]

    
    
    
    

    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.
    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 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 self-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 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 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 self-administering 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 low-level 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 deteriorating 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 
full-scale 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 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 state-owned 
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 soon. While changes in Russian policy, not 
the least of which is a growing western-style 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 nation-
building 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 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 anti-American 
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.
    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 producing friends and allies of ours as a 
result of the military action 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 difference 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 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.
    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 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?
    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 
open-ended 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, 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.
    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 large-scale 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 bin-Laden-
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 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 long-term 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 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 force-marched 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 demand, 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.
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.



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.



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. 



    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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