STRATEGIC ENERGY POLICY CHALLENGES FOR THE 21ST CENTURY

Many industry representatives and specialists believe that market forces can eventually initiate many of these changes without government interference. They even argue that consumers can foster cleaner fuel preferences through the marketplace and market mechanisms. There is merit in these arguments in favor of market solutions. But energy sector deregulation and reliance on market solutions and consumer preferences can only go so far because they do not take into account critical "public goods" aspects of energy supply and environmental protection.

In the 1970s, virtually all governments in the industrial and developing worlds directly administered the prices of key energy components, both at the primary level (crude oil, natural gas) and at the consumer level (petroleum product prices, residential natural gas, and electric power). Governments were also involved in major purchase contracts for internationally traded energy commodities (oil and natural gas primarily), and often tied these contracts to other trade and national security issues (barter of oil for construction projects, soft loans, arms).

Today governments have largely retreated from the energy sector. There is a widespread global consensus that administered policies and regulations that fly in the face of market fundamentals are inefficient, impede smooth adjustment to rapidly changing times, and infuse energy issues with other political issues (in short, politicizing energy issues unnecessarily). Markets have been deregulated and liberalized; and government companies have been privatized. Wherever governments still own significant energy assets, the state-owned enterprises are generally run on commercial terms. Moreover, governmental monopolies in the energy area have been broken, and national preferential considerations have been reduced.

Generally speaking, liberalization has facilitated efficiency and smooth allocation of resources to users who most require these resources. But rapid deregulation of the oil, natural gas, and power sectors have also reduced the incentives for specific businesses to invest in large inventories or excess capacity that can help smooth markets during times of disruption or unexpected volatility in demand growth. Tightening environmental regulation for construction of new energy facilities has also discouraged investment in some locations. These changes have placed more pressure on how to achieve the public benefits of inventory and spare production and generation capacity without discouraging investment in energy resources. It has also changed the nature of the debate on strategic stockpiles and government-controlled assets.

The IEA has provided an important institutional mechanism for coordinating international preparations for such a disruption, and its members have instituted strategic stockpiles that have, in turn, served as a major deterrent against producer countries individually or collectively using their "oil weapon" to pressure or "blackmail" individual oil-importing countries. However, deregulation has brought some unintended consequences about strategic stockpiles. By and large, deregulation of energy markets has meant that the establishment of inventories and the determination of their size have been left by governments to the market to decide, except in the case of government-held emergency stores. But markets do not always send fully accurate signals. That is in part a result of lack of market transparency and the realities that with imperfect information market participants tend to take the short view.

More recently, the lagged interplay between supply and demand in several energy commodities this year has caused market disruptions. It is possible that for some of these commodities, the market may, over time, provide its own solution, through increased refinery runs, increased gas drilling/production, and greater stimulus for investment to increase capacity. But interventions may occur that hasten this process or ease constraints more quickly.

Inventories serve as a premier tool in preventing market failures and in managing supply dislocations. Spare petroleum or natural gas production and deliverability capacity or redundancy in power generation capacity are ultimately inventory and inventory management issues. Spare capacities reflect an inventory of available supply in case of market dislocation or unexpected disruption. Similarly, more conventional references to stores of natural gas or of petroleum products or of crude oil are also inventories. Energy markets are constantly challenged by unexpected events—from severe weather to sudden technological changes that undermine forecasts of supply and demand. Without inventory or spare capacity, such events can create extreme price volatility, sometimes for short periods of time but also sometimes for extended periods of time. Moreover, severe price volatility can become self-generating by discouraging investment by industry players who cannot properly assess future market potential.

The unanticipated consequence of deregulation, industry consolidation and restructuring, and of environmental policies on inventories is now raising new challenges for policymakers. It is also redefining the debate on the appropriate role of government intervention in energy markets. That’s because of the political impact from supply shortfalls and price volatility on classes of consumers and on the general economy, when supplies are effectively auctioned to the highest bidder in times of shortage.

The Task Force’s action program for implementing a coherent U.S. energy policy is framed in the context of the fundamentally changed circumstances in today’s energy sector. For the two decades following the energy price spikes of the 1970s, the main opportunities and challenges for governments and consumers were based on the sometimes extraordinarily large surplus capacities that defined the energy system. These surplus capacities have now disappeared, or have been reduced to such low levels that there is only a limited cushion available to meet growth in demand or to buffer economies against disruptions. As demand moves against and away from capacity limits, the result is price volatility.

Over the past three years, the prices of most core energy sources—electricity, natural gas, and oil—have been more volatile than at any time in recent history. At a global level, crude oil prices hit their highest and lowest levels since the price collapse of the mid-1980s between 1998 and 2000, with the exception of a brief price spike after Iraq invaded Kuwait in 1990. In North America, natural gas prices this winter set all-time record highs, and may well do so again a year from now, while electricity prices have reached unprecedented peaks in California and other pockets of the United States. Other regions of the country are likely to suffer the same fate this summer.

Under these circumstances, history demonstrates that the main tasks of energy policy are the following:

• To assure that markets operate efficiently so as to develop the infrastructure necessary to meet growing requirements of demand;
• To facilitate orderly growth in demand;
   
• To ensure the well-being of the human habitat and ecosystem; and
   
• To guarantee that mechanisms are in place for warding off and, if necessary, for managing disruptions to energy supply.

FINDINGS

This report is motivated by the belief—shared by many energy specialists—that pervasive shortages in the energy sector will not go away of their own accord, other than through a sharp economic downturn. Market solutions are fundamental to providing the kind of stable and predictable energy prices that are needed to sustain the economy and safeguard security over the long term, and they should be embraced. But market solutions go only so far, especially at a time when inventories of all sorts are so low as to result in price surges that harm consumers and cause political backlash. A more comprehensive strategic approach is needed.

Implementing this reinvigorated energy policy will take time. Quick fixes can alleviate supply bottlenecks or conserve energy use, but the energy sector is capital intensive and, with few noteworthy exceptions, involves projects that can unfold only within a three- to five-year horizon, or even one that is even longer.

Energy issues need to be brought before the public to counter some widespread misconceptions. There are no easy, overnight, and politically attractive solutions to the country’s or the world’s infrastructure and supply problems. There is no existing technology that can quickly replace oil in the crucial transportation sector. There is no place at home or abroad where enough oil or gas can be developed fast enough to moderate prices in the next six to twelve months. There is no cost-free way to allow unrestricted energy use and simultaneously safeguard the environment. But neither is the world running out of energy resources.

The Task Force acknowledges that energy policy starts at home. But any attempt to reframe U.S. energy policy must take into account the fact that the energy sector has become extremely interdependent internationally. The United States cannot achieve energy independence without the emergence of new technologies that are not yet on the horizon. Increasing domestic supplies will therefore not necessarily reduce U.S. vulnerability to disruptions to any substantial extent, and artificial ceilings or targets for imports will contribute little to security and could create unwanted distortions. An oil shortfall anywhere in the world will produce an equal price rise in every country, irrespective of the level of national import dependence, as long as markets are allowed to clear without government interference.

The United States must face up to this energy interdependence squarely and pursue new paths to assure that neither its economy nor policies are excessively vulnerable to foreign influence. For the foreseeable future, the Gulf will remain the world’s base-load supplier and least expensive source of oil to meet growing demand. The global nature of oil trade and pricing means that it matters little if Gulf oil flows to Asia or to the United States. Middle East Gulf pricing and supply trends will affect energy costs around the globe regardless. If the United States wishes to change this reality, it must start now to deploy new energy technologies that will lessen this dependence in the long run.

The Task Force determined ten broad findings:

1. The U.S. government has not for a long time adequately integrated the security, energy, technological, financial, and environmental policies that make up a comprehensive energy policy. It has relied on overlapping commercial and political interests with key oil-producing countries to meet the needs of its own economy and those of the international economy. A surplus in energy supplies during the past two decades convinced policymakers that other objectives could take precedence over energy security and that the costs of neglect would remain low. That period has ended. In today’s tighter energy markets, the costs of leaving energy security unattended could become extremely high. These costs, and the means of reducing them, need to be evaluated in a more purposeful, strategic fashion.
    
2. There are no overnight solutions to the energy supply and infrastructure bottlenecks facing the nation and the world. Success will require long-term investments. It will also require the revocation of failed, outmoded, or simply less important policies, which interfere with the pursuit of energy security. Economic sanctions that limit energy investment and environmental policies that increase the costs or availability of energy sources require a fair-minded review. A few concrete short-term actions are available; but many of these clash with other policy objectives, which may need to be compromised or even scrapped.
    
3. Continuous governmental review is needed of the tradeoffs between energy security and other national goals. The articulation of a coherent energy policy requires the integration of foreign, national security, and trade policy with numerous domestic environmental, tax, and investment programs. Energy policy should play a significant role in diplomatic discourse, especially where bilateral relations with major powers are concerned. (See Appendix B.)
    
4. Environmental issues affecting energy policy require new approaches at home and abroad. The American public cares as much as the citizens of other countries about such issues as greenhouse gases and other atmospheric emissions, underground leakage of noxious substances, and other environmental dangers. Sensible energy policy must take this into account. But it is important that the public understands that enhanced environmental standards come at a price to the availability and cost of fuels. It is equally important that the public understand the environmental and public-health consequences of unfettered energy consumption. The government should take a leadership role in fostering such understanding. Also, better coordination of fuels standards is needed, both inside the United States and with U.S. trading partners.
5. Energy infrastructure can be rebuilt and expanded rapidly only if the government actively facilitates private-sector decision-making and investment. The government should pave the way by removing unnecessary jurisdictional and other obstacles to construction and enlargement of pipelines, power plants, the electricity grid, and other infrastructure. It also needs to weigh the desirability of incentives to accelerate the development of spare infrastructure and the accumulation of inventory to alleviate supply disruptions.
    
6. U.S. energy independence is not attainable. Policy must therefore focus on increasing the number of energy suppliers, the kinds of energy consumed, and the efficiency with which energy is used. The effort should include renewable and non-conventional forms of energy, as well as conventional fuels, while recognizing that even a doubling of renewable fuel supplies by 2020 could result in renewables having a lower share of the market than today. Oil supply-side policy should take into account the danger of relying on Middle East producers for all of the world’s spare capacity without also bolstering strategic stockpiles and reviewing rules for their use.
    
7. Persistently tight crude oil markets highlight the concentration of resources in the Middle East Gulf region and the vulnerability of the global economy to domestic conditions in the key producer countries. The Gulf nations have one major asset—their oil and gas reserves. They, like Russia, Mexico, Indonesia, Nigeria, Venezuela, and some other oil-producing nations, depend heavily on hydrocarbons to support their citizens. If the current regimes in the Gulf cannot deliver a better standard of living for rapidly increasing populations, social upheaval could result, and anti-Western elements could gain power. Similar concerns exist with respect to some other oil-producing countries outside the Gulf.
    
8. Energy policy has underplayed energy efficiency and demand-management measures for two decades. It is clear that vigorous demand management could significantly lower the volume of energy required for economic growth. Demand curbs could apply to residential, commercial, and industrial uses, but they are likely to bring the greatest and fastest benefits in the core transportation sector.
    
9. The instruments available to deal with energy-supply disruptions are increasingly inadequate to the tasks they need to manage. To date, the keystone to managing emergency supply disruptions has been the Strategic Petroleum Reserve. The International Energy Agency and its policies, including building of strategic reserves of crude oil and petroleum products and mechanisms to share available supplies in times of disruption, play an important role, as well. But this program addresses yesterday’s needs. IEA members’ oil consumption has stagnated, while demand has grown rapidly outside, causing the agency to lose the critical mass necessary for managing a future shortfall. The size and effectiveness of the ninety-day cushion mandated by the IEA also needs to be reexamined, as does management of the SPR, particularly by bringing in modern financial tools to help build the reserve with minimal impact on government budgets. Finally, what constitutes an energy supply shortfall needs to be redefined in light of changes in the structure of the global oil market.
    
10. The United States needs to articulate a new vision of how best to manage international energy interdependence, one that promotes market transparency and fair distribution of gains from increased trade and investment. Fundamental information about market trends is often unavailable. Energy producers and consumers need to find ways to build common institutions. Unless the U.S. government provides leadership in modernizing market and investment structures, there is a clear danger that others will take the reins and develop institutions that run counter to U.S. interests.

STRATEGIC POLICY CHOICES

For two decades, the United States has gone without a serious energy policy. In the past, such complacency about energy could be justified because world supplies appeared to be indefinitely ample. The myth of plenty was reinforced by the enormous gains that were made as market forces were allowed to work, as regulations and controls were eliminated, and as energy prices fell in real terms across the world. These gains, in turn, allowed U.S. leaders—both Republican and Democratic—to take a minimalist approach supported by the comfort of consensus politics that reflected an avoidance of strategic choices. From the perspective of this Task Force, there is no escaping the fact that we are reaching the beginning of an extensive period of sporadic supply shortages and periodic price hikes in the United States and in other parts of the world. This new situation requires a reevaluation of U.S. policy approaches. The United States faces three policy paths: first, continue the easy approach of "muddling through" with marginal Strategic Petroleum Reserve management and complete free market solutions; second, take a near-term, narrow approach by expanding supply to ensure cheap energy while enduring conflict with interest groups; or third, develop a comprehensive and balanced energy security policy with near-term actions and long-term initiatives addressing supply-side and demand-side policy instruments and diversification of energy supply resources that enables the United States to escape from a pattern of recurring energy crises.

Taking the Easy Approach

Clearly the path of maintaining the status quo of no energy policy is by far the easiest short-term option. This is obviously the path of least resistance. Under such an approach, very little initiative would be needed and could be limited to a very circumspect focus: reviewing the size and mechanisms associated with the SPR and its coordinated use with other countries in the International Energy Agency. This limited policy would dictate that the United States simply muddle through any portending crisis that might occur by reducing the pain of such an actual event through the use of emergency measures at the time of the event.

It is a path that could readily be chosen for two reasons. First, there is the ever-present hope that the market, left to its own devices, will eventually correct itself and overcome current supply problems. Secondly, history seems to justify this approach. Major oil disruptions with serious consequences seem to occur only every decade or so, it can be argued, seemingly limiting the costs of doing nothing. Electric power shortages will eventually get sorted out, and in any case states rather than the federal government bear the brunt of citizens’ claims. This approach obviates the need to tackle the difficult political issues that would have to be resolved to forge an energy policy consensus in Congress. No comprehensive policy means Congress does not have to make the compromises required to enact the legislation to backstop a more effective, comprehensive approach.

One clear benefit of this approach is that the short-term costs to the consumer would be limited and that no hard sacrifices would have to be made. The costs to U.S. taxpayers seem minimal and indirect and in any event they can be postponed. Consumers have the prospect of the market assisting them yet again in achieving low energy costs. Some of the real costs, such as the high-cost U.S. military presence in the Middle East, are already accepted and forgotten by the public.

But the problem is that there is overwhelming evidence that there will be no "free lunch" for taxpayers. A disruption might well occur at a time when the mechanisms for dealing with it have become outmoded, too narrowly confined to too narrow a segment of the world community to make a difference. And meanwhile, the market volatility of the past few years may be a precursor of much worse to come—a roller coaster of prices confusing the investment climate and impeding the marshaling of capital required to overcome supply obstacles whose emergence triggered the new critical state to begin with.

Under this scenario, the United States remains a prisoner of its energy dilemma, suffering on a recurring basis from the negative consequences of sporadic energy shortages. These consequences can include recession, social dislocation of the poorest Americans, and at the extremes, a need for military intervention. Moreover, this approach leaves festering the conflict between rising energy demand and its potentially devastating impact on the global environment.

Taking a Supply-Side Approach

Another easy-to-digest approach would be one that focuses predominantly on supply-side solutions. A supply-side perspective is attractive because it offers some eventual reprieve from the negative impacts of energy shortages but with little or no direct cost or sacrifice to the average American. A supply-side approach would aim to increase the amount of land available in the United States and around the world for resource exploration and exploitation and offer whatever tax or other incentives would be needed to stimulate greater investment in energy assets. The Task Force agrees that the supply side is an essential focal point of any workable policy solution. Indeed, the Task Force recommendations incorporate a number of supply-side options, including both convention and non-conventional fuels. But the Task Force does not endorse an exclusively supply-side approach for a number of reasons.

To begin, the costs of this policy are that it almost certainly will bring its designers into conflict with public interest groups, especially those that support environmental protection and land management. This will create an atmosphere where the American people might feel forced to make a difficult choice between a cleaner environment or ample energy supplies. Partisan politicians are already driving this perception by comments in the media or through partisan bills in Congress. But no such choice might be required over the long term if a more integrative, comprehensive approach were to be chosen. Environmental protection and energy policy do not have to be de-coupled, but they can be integrally linked through smart policy choices.

Another problem with a supply-side approach is that it creates the impression that cheap energy is an inalienable right and is available in the very near term. This creates an incentive to greater consumption that is not likely to be sustainable and will eventually net us back to shortages and price volatility once again.

Taking a Comprehensive Approach to Energy Security

Thus, it is the view of this Task Force that only by forging a comprehensive energy policy can the United States escape from a pattern of recurring energy crises. It is a tenet of the Task Force that a workable and comprehensive energy policy requires a balance of supply-side and demand-side policy instruments if it is to attract a practicable operating congressional majority in the United States. Such a policy would favor diversification of energy supply by fuel and by source.

The recommendations of this Task Force represent its best attempts to outline a more coherent and comprehensive outlook for a long-term policy initiative that also takes into account immediate steps. Thus, the recommendations contained in this report are intended to be considered as a whole. Outlined supply-side options require simultaneous pursuit of the demand-management instruments enumerated by the Task Force. Combining them provides a powerful mechanism for enhancing the energy security of American citizens.

By way of one simple example, it might well be the case that enhancing exploration and exploitation of hydrocarbon resources of the North Slope of Alaska might well uncover new resources that could substantially reduce U.S. dependence on imports. But the Arctic National Wildlife Reserve is unlikely to achieve needed support for permitting the access of companies to its exploitation in the absence of strong demand-side measures. As the report indicates, demand-side measures could, alone, have even greater and less costly an impact on America’s medium-term balance of fundamentals than a supply-side only policy. And a combination of the two, of new supplies and of lower demand, in all likelihood provides a more durable solution.

A truly comprehensive policy may well provide the kind of balance and compromise that are consistent with much of America’s political history. However, any comprehensive plan is likely to require confrontation with other policy objectives that have deep constituencies. In some measure, concessions will have to be made that will impinge on certain local environment goals, states rights, Middle East policy, economic sanctions policy, Russia policy, and hemispheric and international trade policy. Making compromises could be politically painful and will require sustained leadership from the highest levels of government.

But the benefits will be quite real. The comprehensive approach could minimize the negative consequences of a disruption in any particular fuel and help shield the American consumer from the painful effects of the cyclical nature of the energy business. It might allow us to reduce military spending down the road and to create export opportunities for American firms through the development of clean energy technologies. It might also allow us to experience sustained economic growth but without perilous environmental consequences.

The Task Force offers a detailed discussion of the components of a comprehensive approach with elaboration about the policy tradeoffs required for such an initiative.

STRATEGY, RECOMMENDATIONS, AND ACTION PLAN

A Strategic Vision For The Future

To ensure America’s well-being and economic prosperity in this new era of energy constraints, the United States must have a strategic energy policy predicated on a clear vision of the requirements of energy security. This vision must reflect domestic economic and environmental considerations, as well as geopolitical trends and security imperatives. It is vital for the United States to assure stable and transparent international energy markets that provide prices which foster economic growth. It is also in the strategic interest of the United States to assure that appropriate national and international mechanisms are in place to prevent disruptions in energy supplies where possible, and to manage efficiently and equitably any disruption that might occur. To this end, the United States should promote a global network of arrangements that protects against disruption, while securing equitable mechanisms for burden-sharing if required.

Given the magnitude of the potential threat represented by global climate change, it is equally in the strategic interest of the United States to identify and implement cost-effective measures at home and abroad to stabilize the atmospheric concentration of greenhouse gases at levels that will not lead to catastrophic climatic change.

Many different constituencies within the U.S. government will need to work together to develop a unified and integrated energy policy framework with well-defined and orchestrated goals—a policy that will address not only today’s energy bottlenecks, but also will seek to provide affordable, clean, and reliable energy supplies five to fifteen years into the future, in order to underpin long-term economic growth in an environmentally acceptable manner and to promote the security of the United States and its allies.

Strategy is about making choices among competing goals. In reaching the appropriate balance, U.S. energy policy must take into account the fact that the vigor with which environmental goals are pursued will affect the costs of energy supplies. Equally, the policy needs to consider that the vigorous pursuit of market-oriented solutions can diminish the level of consumer and general economic protection from the negative effects of price volatility. Finally, the goal of affordable, clean, and reliable energy supply places some constraints on and is influenced by U.S. diplomacy and strategic policy.

The Task Force developed a broad consensus on the following strategic goals for the nation’s energy policy:

1. Protecting and promoting long-term diversity of affordable energy supply for sustained global economic growth. Diversity refers both to the mix of energy sources and the geographic origin of that energy. The priorities established among fuels should take into account environmental objectives, fuel efficiency, and national security considerations.
    
2. Promoting energy end-use efficiency as a near-term approach to meeting economic, security, and environmental goals.
    
3. Providing adequate safeguards, both at home and abroad, against energy supply disruptions and against manipulation of markets by any party, state or private.
    
4. Promoting market forces wherever and whenever possible, while acting to ensure order in case of market failures or severe shortfalls or accidents. Market failures can involve interference in trade flows by private or state-owned entities and actions by adversaries. They can also involve flaws in regulatory structures, including environmental regulations.
    
5. Creating a stable, competitive, and predictable investment climate to ensure that energy resources and infrastructure expand to meet the growing needs of the world’s population in a manner that safeguards the environment, promotes consumer needs, and enables U.S. companies to operate on an even playing field.
    
6. Encouraging competition in the United States and abroad, both to the benefit of U.S. consumers and U.S. companies.
    
7. Ensuring that all citizens, and particularly less affluent Americans, have access to reliable and affordable basic heating fuels and electricity when markets fail to serve this critical function.

RECOMMENDATIONS

The recommendations of the Task Force are divided into two sections: The first comprises actions to be considered in the very short term to assure that appropriate mechanisms are in place to deal with potential supply disruptions and to buffer the economy from adverse impacts of price volatility. The second set of recommendations is longer term in nature. The first set of recommendations concerns action items designed to provide the government with "breathing space" in case of shortfalls or emergencies. The second set concerns a framework for dealing with the challenges of creating new supplies and ample capacities along various linked global energy supply chains, while also preserving and enhancing the human habitat.

Immediate Steps

1. Deter and Manage International Supply Shortfalls

Recent oil market-price volatility has been driven by a number of complex factors. However, three key drivers continue to fuel upward pressure on prices: OPEC policy and the organization’s lack of spare productive capacity; the policies of Iraq and concerns about the reliability of its U.N.-monitored oil exports; and fears of a possible flare-up in the Arab-Israeli conflict. These factors have created uncertainty in markets that has at various times outweighed considerations of immediate market supply availability, fueling speculation and pushing prices above $30––$35 a barrel at various times in recent months. Although these situations cannot be solved overnight, certain steps could be considered to ameliorate their negative impact on oil market stability.

1. Develop a diplomatic program ensuring GCC allies remain prepared and willing to maintain stable prices to promote global economic growth and also to fill any unexpected supply shortfalls in times of turmoil in the oil markets, whether created by accident or by the adverse political actions by any producing nation. The vast majority of all unused, spare oil productive capacity is located in Saudi Arabia and the United Arab Emirates. It appears that Kuwait might soon be added to that list. Saudi Arabia has over 1 million b/d of spare sustainable capacity and considerably more surge capacity that could be brought online for several weeks in a crisis. The UAE has some limited spare capacity of several hundred thousand barrels a day. Kuwait might soon have a similar amount. These are all very important countries for the United States, with a fundamentally positive attitude toward cooperation and support, and with the only meaningful spare production capacity in the world. They all deserve being cultivated as special priorities of U.S. policy.

   Over the past year, Iraq has effectively become a swing producer, turning its taps on and off when it has felt such action was in its strategic interest to do so. Saudi Arabia has proven willing to provide replacement supplies to the market when Iraqi exports have been reduced. This role has been extremely important in avoiding greater market volatility and in countering Iraq’s efforts to take advantage of the oil market’s structure. Saudi Arabia’s role in this needs to be preserved, and should not be taken for granted. There is domestic pressure on the GCC leaders to reject cooperation to cool oil markets during times of a shortfall in Iraqi oil production. These populations are dissatisfied with the "no-fly zone" bombing and the sanctions regime against Iraq, perceived U.S. bias in the Arab-Israeli peace process, and lack of domestic economic pressures. A diplomatic dialogue that emphasizes common U.S.-GCC goals and programs should be pursued at the highest levels to minimize the potential for tension over these other issues. Goodwill efforts such as a U.S. offer to buy oil from spare capacity for the Strategic Petroleum Reserve when market circumstances warrant and a willingness to discuss coordinated response to supply emergencies can be used to offset anti-American sentiment among elite groups in these countries.

   There are, however, some trade-off issues. Working together with the GCC could restrict some of the U.S.’ freedom of movement on security and foreign policy actions that might be desirable with regard to Iraq or the Arab-Israeli conflict from a U.S. point of view.

    

2. Prepare for contingencies and gain agreement on coordination in the IEA in efforts to deal with any attempts by adversaries to remove oil from international markets. Some European country positions on economic sanctions against Iraq differ from the U.S. position, most notably France but also some other IEA countries including Japan. Still, the IEA must be assured of efficient joint decision-making in the event of a supply disruption under tight market conditions. This includes any possibility that Saddam Hussein may remove Iraqi oil from the market for an extended period of time and that Saudi Arabia will not or cannot replace all of the barrels. (This is a contingency that hangs over the market given the ability of Baghdad to continue to earn revenues through smuggling and other uncontrolled oil exports, even if it officially cuts off exports that are permitted through U.N. procedures.) IEA member countries should be in agreement in advance of such an event on what joint actions it will take. The IEA has been very successful in recent years in providing definitive and forceful statements of its intentions, and these statements have improved the maintenance of orderly markets. The administration needs to ensure that recent events do not derail this past success.

    

3. Minimize public conflicts with OPEC and other independent oil-exporting countries but emphasize importance of market factors in setting prices. The previous administration engaged in public exchanges with OPEC over the producer organization’s decisions to push oil prices higher. This fueled anti-American sentiment among certain sectors of the population in the Middle East, lent support to the claims of Saddam Hussein, and brought pressures on some U.S.-friendly regimes in the region. The United States needs to prevent aggravation of this situation by avoiding public discussion of the targeting of particular price goals and emphasizing common interests of promoting and protecting growth in the global economy. Such growth maintains demand for OPEC’s oil. Rather than specify a price level that is "good for the United States"—which creates an "us-against-you" mindset on oil-pricing policy—the United States should emphasize as a first line of policy its position that market forces should be left to set the price of oil. Specific discussion of price should be kept to private diplomatic discussion whenever possible. Although short-term political gains can be garnered at home in the United States for jawboning OPEC, longer term this activity is likely to stimulate more entrenched positions within that organization, leading to higher oil prices and eventually wearing down any short-term public relations benefit inside the United States.

    

4. While moving to defuse tensions in the Arab-Israeli conflict through conflict resolution and negotiations, maintain energy and political issues in U.S.–Middle East relations on separate tracks. The timing might not be appropriate for a major initiative to solve the Arab-Israeli conflict in a comprehensive manner, but it is important to reduce immediate tensions and violence in that conflict. While this is a tenet of U.S. foreign policy for other reasons, it can also be helpful to the oil situation in ensuring that the two issues do not become linked and are kept on separate tracks. Iraq has been engaged in a clever public relations campaign to intersect these two issues and stir up anti-American sentiment inside and outside the Middle East. The bombing of Iraq by the United States led coalition in February 2001 spurred anti-U.S. demonstrations in support of Iraq in traditional U.S. allies such as Egypt. Moreover, Saddam Hussein is trying to recast himself as the champion of the Palestinian cause to some success among young Palestinians. Any severe violence on the West Bank, Gaza, or Southern Lebanon will give Iraq more leverage in its efforts to discredit the United States and U.S. intentions. A focus on the anti-Israeli sympathies of some Arab oil-producing countries diverts attention from the repressive nature of the Iraqi regime. Instead it rewards Iraq in its claim to Arab leadership for "standing up to the United States for ten years." Israel will assert its right to defend itself from terrorist or other attacks, so it is important that both sides of the Arab-Israeli conflict are given a stake in avoiding conflict and violence. Creating an atmosphere where both sides are willing to show restraint can be an important goal for U.S. diplomacy on this issue.

    

5. Review policies toward Iraq with the aim to lowering anti-Americanism in the Middle East and elsewhere, and set the groundwork to eventually ease Iraqi oil-field investment restrictions. Iraq remains a destabilizing influence to U.S. allies in the Middle East, as well as to regional and global order, and to the flow of oil to international markets from the Middle East. Saddam Hussein has also demonstrated a willingness to threaten to use the oil weapon and to use his own export program to manipulate oil markets. This would display his personal power, enhance his image as a "Pan Arab" leader supporting the Palestinians against Israel, and pressure others for a lifting of economic sanctions against his regime.

   The United States should conduct an immediate policy review toward Iraq, including military, energy, economic, and political/diplomatic assessments. The United States should then develop an integrated strategy with key allies in Europe and Asia and with key countries in the Middle East to restate the goals with respect to Iraqi policy and to restore a cohesive coalition of key allies. Goals should be designed in a realistic fashion, and they should be clearly and consistently stated and defended to revive U.S. credibility on this issue. Actions and policies to promote these goals should endeavor to enhance the well-being of the Iraqi people. Sanctions that are not effective should be phased out and replaced with highly focused and enforced sanctions that target the regime’s ability to maintain and acquire weapons of mass destruction. A new plan of action should be developed to use diplomatic and other means to support U.N. Security Council efforts to build a strong arms-control regime to stem the flow of arms and controlled substances into Iraq. Policy should rebuild coalition cooperation on this issue, while emphasizing the common interest in security. This issue of arms sales to Iraq should be brought near the top of the agenda for dialogue with China and Russia.

   Once an arms-control program is in place, the United States could consider reducing restrictions on oil investments inside Iraq. Like it or not, Iraqi reserves represent a major asset that can quickly add capacity to world oil markets and inject a more competitive tenor to oil trade. However, such a policy will be quite costly as this trade-off will encourage Saddam Hussein to boast of his "victory" against the United States, fuel his ambitions, and potentially strengthen his regime. Once so encouraged and if his access to oil revenues were to be increased by adjustments in oil sanctions, Saddam Hussein could be a greater security threat to U.S. allies in the region if weapons of mass destruction (WMD) sanctions, weapons regimes, and the coalition against him are not strengthened. Still, the maintenance of continued oil sanctions is becoming increasingly difficult to implement. Moreover, Saddam Hussein has many means of gaining revenues, and the sanctions regime helps perpetuate his lock on the country’s economy.

   Another problem with easing restrictions on the Iraqi oil industry to allow greater investment is that GCC allies of the United States will not like to see Iraq gain larger market share in international oil markets. In fact, even Russia could lose from having sanctions eased on Iraq, because Russian companies now benefit from exclusive contracts and Iraqi export capacity is restrained, supporting the price of oil and raising the value of Russian oil exports. If sanctions covering Iraq’s oil sector were eased and Iraq benefited from infrastructure improvements, Russia might lose its competitive position inside Iraq, and also oil prices might fall over time, hurting the Russian economy. These issues will have to be discussed in bilateral exchanges.

2. Remove bottlenecks and other obstacles to energy supply, both domestically and internationally

There are few options available to United States to expand supply in the short run whether or not there are energy supply shortfalls. There are even fewer options available to reduce short-term demand. Fortunately, in the area of petroleum, the government has a fairly robust strategic reserve. But beyond petroleum, the options are severely limited. It is in this context that the Task Force recommends that the government consider all possible means of de-bottlenecking supplies and removing obstacles to delivery of supplies, both domestically and internationally. Options need to be considered that are unilateral as well as those that are bilateral, regional, and international or multinational by nature. In addition, the government needs to establish permanent machinery for integrating energy policy with economic, environmental, and foreign policy on a sustained basis.

Virtually all domestically available raw-material energy resources are being produced that can be. In fact, there are virtually no actions that can be taken in the short term to increase these home-grown supplies. However, there are significant obstacles to the production and distribution of certain petroleum products, gasoline in particular and distillates to a lesser extent, that have come about due to localized differences in regulations concerning petroleum product-quality specifications. These differences are related in some cases to the implementation of the Clean Air Act in areas with particularly troublesome pollution levels or because of regional preferences as discussed in the introduction to this report. These boutique fuels and the "Balkanization" that they create in the market hinders efficiency and promotes shortfalls in local markets even when surplus products of other specifications might be available nearby.

What can be done to deal with Market Balkanization? In general, the federal government should attempt to find ways to increase its flexibility in dealing with market anomalies that stem from product specifications and to increase product standardization so as to reduce the pernicious impacts of lack of standardization. Such actions involve steps to be taken both at home and abroad (see below).

1. Streamline procedures for waiving product specifications. A permanent interagency task force needs to be created involving, at a minimum, officials from the Department of Energy and the Environmental Protection Agency (EPA) to review the impact of boutique product specifications on regional markets within the country. It should be empowered to take action expeditiously to waive or ease mandated specifications for limited periods of time so that market dislocations can be managed.

   There are a number of tradeoffs that need to be considered. Clearly, the suspension of mandated standards could set back the achievement of national, regional, or state environmental goals. Waivers of product standards that are issued in order to enhance supply should explicit address the continued commitment to the environmental objectives in the original regulations as well as the temporary nature of the waiver. In addition, there are potential inequities to industry: waiving certain standards could "punish" companies that had invested in new equipment and technology to meet product specification requirements and who stand to benefit from any increase in prices for their rare product. Such inequities could be remedied in the longer term through tax policy favoring those who complete costly investments

    

2. Establish procedures to grant Jones Act waivers without adversely affecting U.S. ship owners or U.S. labor. As discussed in the introduction to this report, U.S.-manufactured petroleum products are transported mainly by domestic pipeline or by ship but under federal mandate only U.S.-flagged ships can be used for these deliveries. For a long time the Jones Act tanker fleet was in long-term decline, but U.S. flag owners and operators have invested significant amounts of money to build vessels in the United States to comply with the Jones Act. When the pipeline is fully utilized and when imports are inadequate as was experienced last winter in New England, there is a potential need to waive the Jones Act requirements on the U.S. product tanker fleet to enable non-U.S.-flagged vessels to carry cargoes between U.S. ports. As long as the current law exists, the government needs to send a strong signal that under no circumstances will it provide a Jones Act waiver on purely economic grounds. This is needed to give U.S. tanker owners the ability to recover costs associated with U.S.-built tankers and remove any investment uncertainty. But when the U.S. government is concerned with logistics issues, officials could signal that waivers would be granted for foreign-flagged vessels to enter the trade on an emergency, case-by-case basis when no vessels could be made available on the spot market by U.S. owners. Similar issues concern labor, which has an interest in both the manufacture and manning of the Jones Act fleet. While Jones Act waivers are available, the procedures to accomplish this are cumbersome and the waivers are rarely granted. Streamlining procedures for issuing waivers to the Jones Act would facilitate the elimination of this market anomaly and free up supply within the U.S. market during severe logistics crises.

    

3. Enact legislation for federal primacy over state regulations, especially with respect to product specifications and pipeline right of way. Ways need to be created to simplify the nation’s total petroleum product slate in order to reduce Market Balkanization and therefore ease localized product-supply shortages and related price volatility.

   There is little doubt that establishing the primacy of federal regulations would remove a significant bottleneck to future regional supply glitches in this as in other areas. For example, it would enable the federal government to override the objections of individual states to exploration and development in offshore acreage. It could also expedite procedures involved in the siting of new or expanded energy infrastructure, including new pipelines, refineries, or power plants.

   If the federal government wants to make a serious effort to foster market transparency, facilitate the development of new supplies, and expedite permitting for new energy infrastructure, legislation mandating federal primacy over state legislation and regulations in specific areas should be a very high priority. However, there are major obstacles to enacting this legislation.
    

   • Federal legislation would almost certainly be opposed by many states, whose legislatures and elected governors have enacted product specifications that are different from and at times more stringent than federally mandated specifications.
      
   • Federal legislation could be challenged as unconstitutional.
      
   • In the case of some boutique fuels, local authorities have mandated them in order to help their urban areas meet national Clean Air Act targets or targets of their own that are even more stringent. Such conflicts would have to be managed by structured cooperation among the EPA, federal agencies responsible for product standards, and local officials.
      
   • In efforts to mandate federal primacy, the administration might well feel compelled to find a middle ground for quality specifications that are significantly less stringent than what many state governments would find acceptable. Conversely, if the federal standards were to be strict enough to assist the most polluted urban areas, product quality standards and compliance costs would be unsuitably high and unnecessarily costly for regions with less severe air quality problems.

    

4. Enact legislation to facilitate regional solutions to a variety of energy challenges. Mechanisms that would be far less intrusive of the authority of state governments and regulatory bodies could be created via regional approaches. Unlike legislation mandating the primacy of federal regulations, the federal government could urge and facilitate collaborative approaches that would provide federal incentives for states that decide to work together on regional solutions. Regional approaches would be far preferable to state-only approaches in a variety of areas, including larger regional frameworks for mandating fuel specifications, emissions limits, and for establishing siting requirements for new energy infrastructure. Regional Councils should be established and mandated to work in a streamlined manner with federal agencies including the EPA, the Federal Energy Regulatory Commission, and the Departments of Energy and Commerce on a variety of permitting issues.

   While regional solutions would be less efficient than national solutions in eliminating bottlenecks to supply, they may in the end be more readily acceptable, since they would lend the appearance of greater local control.

    

5. Investigate whether any changes to U.S. policy would quickly facilitate higher exports of oil from the Caspian Basin region. Generally speaking, all oil-producing countries outside of OPEC are producing at maximum rates. There are a few exceptions where political problems block immediate shipments, such as pipeline problems in Colombia, where guerrilla warfare against the government extends to attacks on oil installations. Also included in this category are labor unrest and investment disputes that slow the progress of developing and producing oil in Nigeria—or Norway, for that matter. The U.S. government should assist with resolution of these problems, but a quick resolution is unlikely.

   However, the exports from some oil discoveries in the Caspian Basin could be hastened if a secure, economical export route could be identified swiftly. It is unclear how much oil could be thereby released: estimates range from a relatively insignificant 10,000 b/d to well over 100,000 b/d. To this end, the administration should review policies toward this region. The option exists to downplay diplomatic activities that dictate certain geopolitical goals for specific transportation routes for Caspian oil in favor of immediate commercial solutions that may be sought by individual oil companies for short-term exports of "early" oil, including exports through Iran. These geopolitical goals can later be articulated for longer-term pipeline routing questions into the next decade.

   The administration, of course, needs to take into account the tradeoffs of this policy shift. Some European companies might choose to send more oil via Iran. U.S. companies may seek case-by-case waivers to send oil through Iran that would otherwise not be produced, thus effectively forcing the United States to consider signaling a change in its policy toward Iran. In any event, the United States might find other reasons to improve relations with Iran. For example, Iran could serve as a regional counterweight to Iraq. A shift in pipeline strategy to favor commerciality might also encourage some regional Caspian players to seek a closer relationship with Russia in order to facilitate the movement of oil through Russian routes. Russia may interpret this policy as one showing weakness of resolve and a green light to press Georgia and other neighboring states to compromise their sovereignty in favor of Moscow’s interests. Still, it remains unclear whether these potentially adverse developments might occur regardless of U.S. policy toward pipeline routes. In general, for strategic reasons related to U.S.-Russian relations, the United States might want to move the Caspian region into a zone of cooperation with Russia, instead of a zone of competition or confrontation. (It might seek this, for example, in order to jointly counter the rise of radical, Islamic militant elements in the region). This arena of discussion could thus start with energy issues and later move on to other issues. Finally, U.S. insistence on the longer and costly Baku-Ceyhan pipeline route could jeopardize a more comprehensive approach toward the export of the Caspian Basin’s resources and would put at risk a more commercial approach.

3. Take a Fresh Approach to Building and Maintaining National Strategic and Commercial Crude Oil and Petroleum Product Inventories

There is no doubt that the most important mechanisms for dealing with supply shortfalls are inventories of crude oil and petroleum product held both by the government and by commercial enterprises. Inventories, especially strategic stores, provide the nation’s first line of defense against a supply shortfall and therefore warrant immediate attention. Nor is there any doubt that the level of crude oil and seasonal product inventories has become a significant domestic political issue. For example, there was a strikingly widespread consensus nationwide when the Northeast Heating Oil Reserve was created last year, although there were questions raised about whether this should be managed by government or by industry (with the latter through tax incentives). With respect to inventories, the Task Force has a series of recommendations.

1. Review the size and financing of the Strategic Petroleum Reserve. The SPR represents the best means of replacing lost barrels of crude oil. Its ideal size relative to the size of imports has not been officially reviewed in two decades. Meanwhile, the SPR has declined both as a share of imports and in absolute size since the mid-1990s. At its peak, the SPR covered more than eighty days of imports; today it covers under fifty days. The administration should, as a high priority, review what the ideal size of the reserve should be, given the fundamental changes in the nature of disruptions that the country confronts. The review should take place both as a national, stand-alone issue and in conjunction with an international review. (See the section on longer-term issues, below.) For example, the administration may choose to make its decision about the ideal size of the SPR in consultation not only with other IEA members, but also in consultation with key OPEC producer countries. The administration should also review how it should finance reserve additions. Ideally this might be accomplished through direct budgetary allocations. At a minimum the government should aim to fill all of the nearly 700 million barrels of capacity it currently has available.

   It should be recognized that one problem with trying to refill the reserve at this time when markets are strong is that any purchases made by the U.S. government (or other consuming countries) would add to the current tight supply of international oil markets. Also, critics of the reserve may argue that it hasn’t been necessary to tap a full draw-down since its creation, arguing against the need for a full ninety-day supply. Thus, other, more creative measures might be advised for filling the reserve during times of temporary market weakness. One option would be to make such purchases through a bilateral arrangement with a key oil supplier of the United States, again at a time when markets soften. The purchases could be designed to help an oil-producing ally maintain oil sales during a time of market weakness. Another would entail buying oil that an OPEC country might otherwise have held back from the market as part of its market-maintenance, production-quota agreement. Such arrangements would have the benefit of demonstrating U.S. support for positive consumer-producer relations. Such a signal might improve relations between the United States and important foreign oil suppliers.

   Efforts have been made in the past to "lease" unused production from Saudi Arabia at prices below the fair market value for the oil to be put in cheaper storage in the United States. These initiatives were rejected by Saudi Arabian officials who did not want to produce the resources and "lease" them for nominal amounts such as $2 a barrel. A plan that provided funds for the United States to pay "fair" market value to acquire unused Saudi or other producer-country oil for the SPR in times of market weakness would highlight the commitment of the United States to reciprocal relations, potentially easing tensions regarding conflicting oil price goals.

    

2. Establish professional criteria for managing the SPR. A significant amount of controversy arose last year concerning President Bill Clinton’s use of his discretionary authority to lease oil to the market on a time-swap or exchange basis in order to address winter heating-oil inventory concerns. The criticism was threefold: (1) The exchanges reduced the size of the SPR, making less prompt oil available to manage a future disruption. (2) The SPR should not be used as a buffer stock but rather to manage severe accidents or supply emergencies; and (3) The time-swap was badly managed, thus earning the government far less in interest than it should have. Unfortunately, perhaps, the government’s use of its swap authority in the autumn of 2000 became associated with a policy that appeared to advocate that the SPR should be used as a market buffer stock to damp prices and price volatility. In reality, proactive use of the swap or exchange authority actually provides the government with an ability to build the SPR over time and to improve its quality through prudent use of market structures. It also enables the government to monetize its crude oil reserves, which otherwise sit idly and unproductively. The government should look into ways to improve management of the SPR through the following types of actions:

    

   • Take advantage of the market’s forward price structure to make sure the strategic reserve is strengthened efficiently over time. Thus, if the market structure were backwardated, with future prices lower than current prices, the government would be able to replenish the reserve with more oil than it had leased on an auction basis. If the market structure were in contango, with future prices higher than prompt prices, the government could lease its cheaper spare storage capacity to industry, thereby also providing revenue to build government-owned reserves at a later time. (Leasing spare tankage should also be considered separately by the Department of Defense.) If a government agency did this on a regular basis, as a standard operating procedure, it would earn far more than it did in its initial efforts in the fall of 2000 and would have a means to finance a larger reserve.
      
   • There are two objections that can be raised to this, however. First, there are potential physical limits to using underground natural salt caverns (salt domes) for storage in this manner without the need to leach them anew. Second, there are objections—as there were in 2000—on the ground that using the SPR oil in this manner reduces theoretically the amount of oil available in an emergency should one occur. That is a clear trade-off to be taken into account in policymaking.
      
   • Seek legislative authorization to expand the government’s latitude in implementing SPR exchanges. Professional management of the SPR would require an expansion of the current limits on the authority of the government to undertake time-swaps of SPR crude. Current authority limits such swaps to 30 million barrels within a specified time frame, but the reserve isn’t permitted to drop below 500 million barrels. The authority for time swaps could be increased by several-fold.

      

3. Establish Clear Policy for Use of the SPR. The administration should as an early priority define publicly its general policy for using SPR crude. It is especially important during times of lost supply and uncertainty about future supply for the government to damp speculation that breeds price volatility. For example, in August 1990, when Iraq invaded Kuwait, the government delayed an announcement about use of the SPR until January 1991. Had the SPR been used by September of 1990, if for no other reason than to calm markets until supplies could be fully made up from other sources, the price spike of that autumn could have been reduced and the likelihood of a recession in 1991 also reduced. The administration should therefore define its position on the SPR soon. It should provide general criteria for determining when strategic stocks might be tapped under the President’s authority, defining more generally what will be considered an emergency and what conditions might prompt the President to authorize a time-swap. The administration should also determine what conditions might prompt the Department of Energy to either accelerate purchases for the SPR or to lease out storage space to industry when future and forward oil price curves encourage this. Finally, the administration should improve the operability of the SPR. Unlike commercial stocks, the recent release of the SPR (mostly sweet) crude showed that the industry isn’t fully educated about logistical issues involved in getting SPR oil into the domestic refining system efficiently. Therefore it would be prudent to review and highlight the negative experiences of those who participated in last year’s exchange program.

   It should be noted that clarification of the use of the SPR would have a couple of additional benefits. It would eliminate debate or trial balloons to media in the event of an interruption that meets the clear criteria set by policy. Trial balloons or public debate often cloud market transparency to the detriment of predictable price formation and orderly markets. Public articulation of policy would also eliminate the risk of holding hostage a release of strategic stocks to the production policy of key OPEC countries.

   Coordinate use of the SPR with other IEA countries. It goes without saying that the United States should coordinate release of the SPR in cooperation with other IEA countries. This would be especially important either in the case of a market in which one or more producer countries intentionally reduces or bans exports in order to increase prices, or in case of market disruption. Nonetheless, it should also be recognized that unilateral use of the SPR by the United States might be criticized for giving other countries that do not cooperate a "free ride" on the benefits of the SPR release. The free rider problem may well be an unavoidable consequence of having and using the SPR—otherwise the United States would have to consult and share decisions about its use, which would also be risky and questionable.

   Coordinate use of the SPR with actions by key producer countries. One of the unnoticed and less criticized aspects of the use of the SPR exchange by the United States in 2000 was that it was performed in a "cooperation" rather than a "confrontation" mode with producer countries in both OPEC and elsewhere. Only after the OPEC secretariat and key OPEC members repeatedly stated that "we have done our part" in easing the market and that "it is up to the industrialized countries to do their part," was the SPR exchange actually triggered. Its timing demonstrated that in a cooperative mode, use of the SPR could work hand-in-hand with diplomacy vis-à-vis producing nations. (See next section, number 4, below.)

    

4. Review tax, accounting, and other factors affecting industry’s incentives to hold petroleum product and natural gas inventories, with the intent of enhancing inventories before seasonal demand and neutralizing any adverse impact of current rules.

   There has been significant bipartisan support in oil "consuming" areas of the United States for government-controlled stockpiles of products and even of critical product components (e.g., ethanol). There has also been support for state governments’ mandating minimum stocks for fuel-switching purposes of certain categories of consumers, including power plants. The federal government last year also established the Northeast Heating Oil Reserve. Given the critical role played by inventories in smoothing out supply shortfalls, the government should undertake a wholesale review of product inventories and consider incentives to industry to hold higher levels of inventory than has recently been the case.

   Industry inventories would be an alternative to the federal Northeast Heating Oil Reserve. Industry generally fails to build inventory when futures markets are in backwardation; that is, when futures prices are lower than prompt prices. Industry builds stocks when markets are in contango and industry expects that future prices will be higher than prompt prices. Since industry is now managing inventories on a just-in-time basis, there is a danger that market structure will not go sufficiently into contango when product builds are required. Therefore, industry will not have an incentive to build gasoline stocks in advance of the traditional summer driving season or heating oil and natural gas stocks in advance of the traditional winter heating seasons. An alternative incentive could come from fiscal measures that reward firms that carry seasonal inventory or penalize firms that do not.

   Accounting rules, especially "last-in, first-out" (LIFO) rules, create year-end changes in inventory in order for companies to reduce their tax liabilities. The federal government should review national and state government rules and their impacts on corporate inventory management positions, with the intent of neutralizing any incentive on the part of companies to reduce stocks at year-end when markets do not require rapid de-stocking.

    

5. Encourage states to review minimum inventory for fuel switching where feasible and also fiscal incentives to industry to build inventories in advance of seasonal demand increases. Such an effort could be incorporated into incentive programs for state governments cooperating with one another on a regional basis. (See recommendations for immediate actions, above.) States have traditionally made the issue of backup supplies part of their regulatory frameworks. These requirements have generally faded in the age of deregulation and should be reexamined.

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