| Deregulation: Plusses and Minuses 
      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: 
        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.
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.
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.)
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. 
        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.
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.
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.
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.
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.
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:
       
        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.
Promoting energy end-use efficiency as a near-term 
        approach to meeting economic, security, and environmental goals.
Providing adequate safeguards, both at home and 
        abroad, against energy supply disruptions and against manipulation of 
        markets by any party, state or private.
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.
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.
Encouraging competition in the United States and 
        abroad, both to the benefit of U.S. consumers and U.S. companies.
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.
       
        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.   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. 
         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. 
         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. 
         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).  
        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   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. 
         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.   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.   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.  
        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.   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. 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.) 
		  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.   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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