Oil curse, gas blessing? The Case for a Transatlantic Charter on Energy Trade

Oil Pumpjacks

WASHINGTON — The price of oil is too high! This seems to be the unanimous refrain of policymakers all over the world who fear that oil prices, currently over $120 a barrel, could stifle economic recovery. But the price of natural gas, at least in the United States, is too low. At least that is the claim of some policymakers and also U.S. natural gas producers Chesapeake and Encana, which have announced cutbacks in their gas production.

So where exactly do we want energy prices to be? If high enough, they stimulate investment in new and previously unviable ventures, such as deep-water operations or the extraction of oil from tar sands; if low enough, they boost the economy by bringing down manufacturing and transportation costs. Each commodity has its own market because they are not easily substituted for each other. Oil is paramount for transportation and marginal in other sectors of the economy, while natural gas is the exact opposite, being mostly used in industry, home heating, and electricity generation and hardly at all in transportation.

But quietly hidden behind these market dynamics is a huge opportunity for Europe and the United States to dramatically influence the way global markets for energy commodities develop. Even if markets cannot force much substitution in the short term, they can do wonders in the medium-to-long term: if natural gas stays so low and oil so high — as seems likely — then the United States will surely start to switch to cheaper natural gas in the transportation sector. Whether it happens through a shift to public transport and railway freight or through the introduction of gas-to-liquids technology, or even automobiles that run on natural gas, this is where the gap in the relative prices of oil and natural gas will lead the U.S. economy.

It is important to keep in mind that the economic driver here is the low natural gas price, not the high oil price. It is unconvincing (bordering on reckless) to claim that the high oil prices themselves will have beneficial effects on Western economies. In fact, they can only depress them while stimulating investments in complex, environmentally dubious, and sometimes dangerous ventures, many of which are in politically unstable regions where this new money will only worsen the “oil curse” of countries blessed with oil becoming more autocratic.  A high oil price on its own can only depress demand; a low natural gas price, sustained by domestic production, will induce substitution instead.

Freed from the chains of oil dependency, the United States will be able to execute a substantially different foreign policy in certain non-democratic regions of the world. And if European industry and policy leaders allow the start of a shale gas revolution there, too, or if Europe manages at least to reap some of the benefits from the low natural gas prices on the other side of the Atlantic, then Europe and the United States could find themselves reunited around a common energy market based on transatlantic values.

Indeed, the reason why natural gas prices are low in the regional U.S. market is that the gas market there is surrounded by a stable political framework, so prices are allowed to respond to market fundamentals. This should become the model for all other energy commodities. In contrast, the high oil price is a function of a complex combination of factors including fears of a war in Iran, expectations about rising demand in Asia, a long-term trend of dollar inflation, speculative trading in futures and long-term indexing to futures prices, and production still controlled by a cartel, OPEC, that is mostly made up of imperfectly democratic countries.

In order to allow a switch to market fundamentals, the transatlantic community should use its increasing freedom from OPEC to promote a new Charter on Energy Trade. This would revolve around two commercial principles: guaranteeing the rule of law on the fulfillment of existing supply agreements and refraining from strategically withholding production, unless it is deemed to be in the common interest of the entire Charter community, both producers and consumers. The Charter should be accompanied by a code of conduct extending some core transatlantic values to other parties, most importantly requiring them to improve their efforts toward democracy and human rights. Some big producers will still not find it appealing to participate, but many others will, in what would become a textbook example of leadership by initiative.

History shows that the oil curse has wrecked many societies and slowed down economic development in producing regions all over the world. Instead, the emerging shale gas revolution has the opportunity to become a “gas blessing” for the entire transatlantic community and beyond.

Paolo Natali is a fellow with the Transatlantic Academy in Washington, DC.