United States Energy Policy

By Caleb SmithMay 6, 2015

Executive Summary: The United States is at a pivotal crossroads in energy usage. Currently importing

approximately 7 million barrels a day of oil from foreign nations, the United States has become dependent on foreign oil. Such dependency on other nations is concerning, particularly given the global market for commodities, and the risk and volatility associated with oil. This paper outlines a history of United States energy policy, covers changes in technology enabling America to drill resources previously thought unrecoverable, explains the risks associated with oil markets, and the impact they could have on the United States, and covers several possible policy changes the United States government, particularly the executive branch, could make to reduce America’s dependency on foreign oil.

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Table of Contents:Cover Page.………………………………………………………………………………..1Executive Summary……………………………………………………………………….2Table of Contents………………………………………………………………………….3Introduction………………………………………………………………………………..4History of United States Petroleum Policy………………………………………………..5United States Shale Revolution………………………………………………………….10Current State of United States Energy…………………………………………………...12Geopolitical Risks………………………………………………………………………..13Supply and Demand Shocks……………………………………………………………..14United States Government Policy………………………………………………………..15Conclusion……………………………………………………………………………….16Figures……………………………………………………………………………………17

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Introduction:What is a commodity? Oxford Advanced Learner’s Dictionary defines

commodity as, “a raw material or primary agricultural product that can be bought or sold.”1Examples include corn, coffee, cattle, copper, gold, silver, platinum and oil. Commodities differ in their importance to the world, as some are more practical, like plants and livestock. Others are less useful, like gold and silver, and are revered for their beauty. However, of all commodities, oil is perhaps the most important. It serves as a lynchpin of the global economy, powering, directly or indirectly, almost everything in our lives. Oil is used in transportation fuels, including gas, diesel and jet fuel. It is used in fertilizer, feedstock, plastics, petrochemicals and heating. It also provides the energy to power virtually every military and defense vehicle, making it of paramount importance to national security. Given the prominence of oil in so many areas, nations have long sought to control oil reserves, either publically or privately. Countries that are historically powerful on the world oil stage are Saudi Arabia, Iraq, Libya, Russia and Venezuela because they have significant pricing power over nations dependent on oil, like the United States. Currently, the United States is a net importer of about 7 million barrels of oil a day, the largest importer of petroleum globally. 2

In order to understand global oil markets, it is important to know how oil is traded. There are three primary benchmarks for oil; West Texas Intermediate, used for most oil from North America, Organization of Petroleum Exporting Countries (OPEC) OPEC reference basket, for countries who are a part of OPEC, and Brent Crude, used to classify oil from The North Sea. These three benchmarks make up virtually all oil traded globally and give good reference for how oil is trading. If oil prices are low, in the range of $40 to $60, it is challenging for private oil companies and nations who rely on oil exports, as they struggle to break even for every barrel of oil they sell. Countries reliant on oil imports thrive during periods of low oil prices, as people and corporations have greater amounts of discretionary money to spend, stimulating the economy. On the opposite side of the spectrum, countries reliant on petroleum exports suffer during periods of low oil prices, as National Oil Companies (NOCs) aren’t able to generate enough revenue to fund the country budget. Countries clearly rely on oil and need it to function.

Given the United States’ dependency on oil, its’ importance to our economy and its’ status as the largest net importer of oil in the world, steps need to be taken to reduce America’s dependency on foreign oil and focus on continuing to increase domestic production. Though true energy independence is impossible to achieve, the United States can achieve much better energy security. In an article on The Oil Change Project, a part of the Medill National Security Journalism Initiative, Elizabeth Bunn talks about how every president since Harry Truman has touted energy independence for the United States. But according to a 2012 United States Congressional Budget Office report on energy security, “The worldwide market for oil makes it almost impossible for a large country like the United States to gain independence, or separation, from that market”. 3 In a global commodity market, it will be impossible for the United States to be completely 1 "Commodity." Def. 1. Oxford Dictionaries. Oxford Advanced Learner's Dictionary, n.d. Web. 3 May 2015.2 "Top World Oil Net Importers, 2013." U.S. Energy Information Administration. United States Government, 18 Dec. 2014. Web. 06 May 2015.

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immune to price shocks, but decreasing our dependence on foreign oil, particularly the Middle East, will help isolate the United States economy and national security from geopolitical risk, price shocks caused by OPEC and can enable us to build stronger partnerships with other friendly North American nations like Canada. The United States government, particularly the executive branch, needs to focus on raising United States oil and natural gas production and refining and decreasing petroleum imports, which is now increasingly possible because of access to previously unrecoverable hydrocarbons due to horizontal drilling and hydraulic fracturing. This will mitigate geopolitical and supply and demand shock risk, putting the United States in a much more stable energy position.

History of United States Petroleum Policy:The oil industry in the United States truly began when John Rockefeller founded

Standard Oil in 1860, as oil was used to produce kerosene, which was used as a lighting fuel. During the next century, oil gradually supplanted coal as the United States’ preeminent fuel source and became a key commodity globally. As the 1870’s came to a close, the United States produced 85% of the world’s crude oil, and kerosene was the country’s fourth largest export.4 Between 1880 and 1900, United States oil production continued to ramp up, more than doubling from 26 million barrels a year to 64 million barrels a year as a result of increased uses for oil, most notably the internal combustion engine.5 However, during this period, the rest of the world began finding oil, as countries like Russia, Britain and the Netherlands made large discoveries globally. At the turn of the century, huge finds in California and Oklahoma, as well as a gigantic oil boom in Texas enabled the United States to continue dominating the oil markets. Over the next 30 years, oil became crucial in the United States because of its importance in fueling cars. The world recognized the necessity of oil for the future with the onset of World War I, as it was vital in fueling ships, planes and land vehicles.6 Aligned with Britain and France, the United States sought to supply them with oil during the war, but attacks from Germany often disrupted supply. As a result, the United States wasn’t able to produce enough oil to meet needs domestically and for the war, so they began importing oil from Mexico.

During the 1920’s, oil prices actually peaked sparking fears of oil reserves running out in the near future. To combat this, Congress gave oil producers generous tax allowances, increasing capital expenditures and enabling massive, new oil reserves to be discovered.7 Called the Oil Depletion Allowance, it enabled corporations to deduct a specific percentage of oil reserves they had depleted during the year from gross profit,

3 Bunn, Elizabeth. "The U.S. Can Become Energy Independent." Oil Change Project. National Security Zone, 2015. Web. 06 May 2015. <http://oilchangeproject.nationalsecurityzone.org/the-u-s-can-become-energy-independent/>.4 Johnson, Toni. "Timeline: Oil Dependence and U.S. Foreign Policy." CFR.org. Council on Foreign Relations, 8 Mar. 2011. Web. 6 May 2015. 5 Johnson, Toni. "Timeline: Oil Dependence and U.S. Foreign Policy." CFR.org. Council on Foreign Relations, 8 Mar. 2011. Web. 6 May 2015. 6 Johnson, Toni. "Timeline: Oil Dependence and U.S. Foreign Policy." CFR.org. Council on Foreign Relations, 8 Mar. 2011. Web. 6 May 2015.

7 "American Dependency on Foreign Oil." Intellectual Takeout. Intellectual Takeout, 13 Feb. 2013. Web. 06 May 2015.

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effectively decreasing their tax expense.8 The Government also passed the Mineral Leasing Act of 1920, which was designed to “promote the mining of coal, phosphate, oil, oil shale, gas and sodium on the public domain.”9 Essentially, this allowed private companies to competitively bid and drill public land for natural resources, with both the State and Federal Government taking a portion of the profits. All of these domestic concessions, along with a boom in Middle East oil production led to an extreme oversupply of oil, as prices dropped to pennies per barrel in 1931.10 Again, the United States government intervened, with Franklin Roosevelt creating the Code of Fair Competition for the Petroleum Industry, which gave the Secretary of the Interior power to fix prices, limit production and control oil imports through a duty tax.11

While these problems were going on with oil production domestically, there was a widespread trend of oil nationalization. Starting in 1932, Iran cancelled concessions to Anglo-Persia, a British Oil company, but allowed them back into the country after being granted generous royalties. Mexico followed with nationalization of their oil industry in 1938, kicking United States oil companies out. The global importance of oil, already prominent, became undeniably obvious as World War II began. With the United States responsible for 60% of world oil production in 1940, Japan was heavily reliant on America for oil imports.12 Following Japan’s invasion of Indochina, the United States stopped exporting oil to Japan, a partial cause of their attack on Pearl Harbor. During this period, the United States and Saudi Arabia began developing a friendly relationship with President Roosevelt even declaring Saudi oil crucial to the United States. After World War II, the United States was a military and economic superpower, and among other things, supplied oil to Europe to help the rebuilding. As a part of the forty-five month Marshall Program, the United States gave more than $11 billion of oil aid, weaning Europe of a dependency on coal.13

Between 1945 and 1950, the United States flipped from a net oil exporter to net oil importer. By 1950, approximately one million barrels a day were being imported, with this figure only increasing over time. Partially in order to quench America’s increasing thirst for oil, British and American intelligence agencies help the Iranian military overthrow the Prime Minister in 1953.14 Following the coup, the United States Government and American oil companies worked with the new Shah-led Iranian government to allow mostly American oil companies to manage Iran’s oil. The dramatic increase in production, primarily from the Middle East, again leads to oversupply, causing President Dwight Eisenhower to impose the Mandatory Oil Import Program in 1959; a quota system that prevented oil imports from exceeding 9% of domestic

8 "Oil Depletion Allowance Law & Legal Definition." U.S. Legal Definitions. N.p., n.d. Web. 06 May 2015.9 "Mineral Leasing Act of 1920." CFR.org. Council on Foreign Relations, 14 Feb. 2011. Web. 6 May 2015.10 Johnson, Toni. "Timeline: Oil Dependence and U.S. Foreign Policy." CFR.org. Council on Foreign Relations, 8 Mar. 2011. Web. 6 May 2015.11 "American Dependency on Foreign Oil." Intellectual Takeout. Intellectual Takeout, 13 Feb. 2013. Web. 06 May 2015.12 Johnson, Toni. "Timeline: Oil Dependence and U.S. Foreign Policy." CFR.org. Council on Foreign Relations, 8 Mar. 2011. Web. 6 May 2015.13 Johnson, Toni. "Timeline: Oil Dependence and U.S. Foreign Policy." CFR.org. Council on Foreign Relations, 8 Mar. 2011. Web. 6 May 2015.14 Johnson, Toni. "Timeline: Oil Dependence and U.S. Foreign Policy." CFR.org. Council on Foreign Relations, 8 Mar. 2011. Web. 6 May 2015.

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consumption. This drove United States oil prices up and frustrated Middle Easter Countries, who banded together in August of 1960 to form the Organization of Petroleum Exporting Nations (OPEC). Made up of Saudi Arabia, Venezuela, Kuwait, Qatar, Iran and Iraq, they represented 80% of the world’s crude oil exports.15 However, OPEC largely unsuccessful over their first decade, marked by their embargo to the United States and Great Britain following the Six Day War, which only led to a supply glut as the United States increased production.

As the 1970’s started, OPEC began to gain power, most notably when they forced foreign oil companies to deal with OPEC nations in two separate sections; one for Persian Gulf producers and one for Mediterranean producers. This directly led to higher prices and happened at a time when international oil company’s reserves were dropping and United States production was peaking.16 In 1973, OPEC really flexed their pricing muscles, as they reduced their crude oil output. This caused prices to spike and raised the profits of every OPEC nation. Coupled with the attack by Syria and Egypt on Israel in October of 1973, and subsequent United States aid to Israel, Arab countries like Iraq, Iran and Saudi Arabia, stopped supplying oil to America. Incredibly long lines at gas stations, gas rationing and price controls resulted as gas prices spiked 40% in two months, causing widespread panic. This led President Richard Nixon to end the Mandatory Oil Import Program implemented 14 years earlier by President Eisenhower. Immediately, oil imports, which were 30% of United States consumption in 1973, began to rise, becoming over 50% of consumption within four years.17 This energy crisis caused President Nixon to unleash Project Independence. Nixon said “What I have called Project Independence 1980 is a series of plans and goals set to insure that by the end of this decade, Americans will not have to rely on any source of energy beyond our own.”18 Another effect of the supply crisis of the early 1970’s was the creation of the Energy Policy and Conservation Act of 1975, which created the Strategic Petroleum Reserve.

During the latter part of the 1970’s, domestic price restraints kept production in the United States low, further increasing America’s dependency on foreign oil. Consumption of oil imports doubles between 1974 and 1978 and demand domestically increases 2.1 million barrels a day.19 (See Figure 1) Geopolitical risk became a very real threat to oil supply and prices towards the end of the decade, highlighted by Iran’s overthrow of the Shah. In the fall of 1978, Iran experienced massive civil unrest, leading to elimination of all oil production, dropping global production by 5%.20 In January of 1979, The Shah was forced to leave and a Shiite cleric took over Iran. President Jimmy Carter ended all relations with Iran, including oil imports, which resulted in oil prices doubling globally during 1979. Conflict in the Middle East continued through much of 15 Johnson, Toni. "Timeline: Oil Dependence and U.S. Foreign Policy." CFR.org. Council on Foreign Relations, 8 Mar. 2011. Web. 6 May 2015.16 Johnson, Toni. "Timeline: Oil Dependence and U.S. Foreign Policy." CFR.org. Council on Foreign Relations, 8 Mar. 2011. Web. 6 May 2015.17 "American Dependency on Foreign Oil." Intellectual Takeout. Intellectual Takeout, 13 Feb. 2013. Web. 06 May 2015.18 Nixon, Richard M. "Nixon's Speech on Energy Policy and Project Independence." The White House, Washington, D.C. 25 Nov. 1973. Council on Foreign Relations. Web. 5 May 2015.19 "U.S. Imports of Crude Oil (Thousand Barrels)." U.S. Energy Information Administration. United States Government, 29 Apr. 2015. Web. 06 May 2015.20 Johnson, Toni. "Timeline: Oil Dependence and U.S. Foreign Policy." CFR.org. Council on Foreign Relations, 8 Mar. 2011. Web. 6 May 2015.

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the 1980’s, most notably the war between Iraq and Iran. The United States remained neutral, but President Ronald Reagan dramatically increased American military presence, particularly the Navy, in the Persian Gulf in 1983 to help keep oil fields and facilities on line.21

Domestically, a shift was occurring where American companies explored for and produced oil, as offshore drilling increased in popularity and prominence. Despite significant public backlash, and a moratorium on offshore drilling in 1981 on drilling off all United States coastal waters except the Gulf of Mexico and off of Alaska, offshore drilling grew exponentially. In 1981, only 8% of American crude oil production was from offshore drilling, but by the end of the 2000’s, represented over 30% of American oil output.22 The United States Government, under President Reagan, completely deregulated crude oil prices, which enabled American oil producers to raise prices to market levels and helped cut into OPEC’s market share and limited their ability to control prices. This helped with American oil imports, as they dropped to 28% of total consumption in 1982, down from 45% in 1977.23 However, this quickly changed as global demand dropped and price cratered with it, from over $35 a barrel in 1981 to under $15 a barrel by 1986.24 This change caused American oil companies to explore foreign countries for reserves, once again causing imports to the United States to increase.

By 1990, the United States was importing close half of its oil, a large portion of which came from the Middle East. When Iraq invaded Kuwait in 1990, President George H.W. Bush came to the defense of Kuwait, with the first Gulf War, partially to protect United States’ oil interest in the Middle East. In a famous speech delivered August 8, 1990, Bush said, “The stakes are high. Iraq is already a rich and powerful country that possesses the world’s second largest reserves of oil…. Our country now imports nearly half the oil it consumes and could face a major threat to its economic independence. Much of the world is even more dependent upon imported oil and is even more vulnerable to Iraqi threats.”25 Later in the speech, he also spoke about Iraq bordering Saudi Arabia, the home of the world’s largest oil reserves, largest producer and one of the most important exporters of oil to the United States. President Bush continued saying, “Let me be clear: The sovereign independence of Saudi Arabia is of vital interest to the United States.”26 He continued saying, “I will ask oil-producing nations to do what they can to increase production in order to minimize any impact that oil flow reductions will have on the world economy. And I will explore whether we and our allies should draw down our strategic petroleum reserves.”27 In January of 1991, a United States-led military

21 Johnson, Toni. "Timeline: Oil Dependence and U.S. Foreign Policy." CFR.org. Council on Foreign Relations, 8 Mar. 2011. Web. 6 May 2015.22 Johnson, Toni. "Timeline: Oil Dependence and U.S. Foreign Policy." CFR.org. Council on Foreign Relations, 8 Mar. 2011. Web. 6 May 2015.23 Johnson, Toni. "Timeline: Oil Dependence and U.S. Foreign Policy." CFR.org. Council on Foreign Relations, 8 Mar. 2011. Web. 6 May 2015.24 Johnson, Toni. "Timeline: Oil Dependence and U.S. Foreign Policy." CFR.org. Council on Foreign Relations, 8 Mar. 2011. Web. 6 May 2015.25 Bush, George H.W. "President George H.W. Bush's Address on Iraq's Invasion of Kuwait, 1990." The White House, Washington, D.C. 8 Aug. 1990. Speech.26 Bush, George H.W. "President George H.W. Bush's Address on Iraq's Invasion of Kuwait, 1990." The White House, Washington, D.C. 8 Aug. 1990. Speech.27 Bush, George H.W. "President George H.W. Bush's Address on Iraq's Invasion of Kuwait, 1990." The White House, Washington, D.C. 8 Aug. 1990. Speech.

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coalition liberated Kuwait and President Bush released 34 million barrels of oil from the United States Strategic Petroleum reserve in order to prevent an oil shock. Prices actually dropped from $30 a barrel in September of 1990 to below $20 a barrel in January 1991, as the Strategic Reserve served its purpose.28

The 1990’s saw the United States become increasingly dependent on oil, particularly as sports utility vehicles rose in popularity. Also a cause in United States oil demand increasing by 3.6 million barrels a day between 1993 and 2005.29 Oil prices once again plummeted in the late 1990’s, down 50% from the end of 1997 to the end of 1998, due to an economic crisis in Asia causing demand to contract. This led to many enormous oil companies merging, including BP and Amoco, Exxon and Mobil, and Texaco with Chevron. A study by the United States Government Accountability Office (GAO) in 2007 found among other factors, the 2,600 mergers in the oil and natural gas industry were a probable reason for higher gas prices. “Finally, consolidation in the petroleum industry plays a role in determining gasoline prices. For Example, mergers raise concerns about potential anticompetitive effects because mergers could result in greater market power for the merged companies, potentially allowing them to increase and sustain prices above competitive levels; on the other hand, these mergers could lead to efficiency effects enabling the merged companies to lower prices.”30 As the 1990’s came to a close, Hugo Chavez came to power in Venezuela and Vladimir Putin assumed office in Russia. Both of these leaders nationalized most of their country’s oil resources, which restricted access by international oil companies.31

Between 1970 and 2005, the United States dependency on foreign oil increased. Though the 2000’s didn’t see this trend change, they reduced their exposure to Middle Eastern oil considerably. In 2004, Canada surpassed Saudi Arabia as the largest exporter of oil to the United States, providing 1.6 million barrels a day, more than Saudi Arabia’s 1.5 million barrels a day.32 Canada was able to increase their production because of the development of their oil sands, a costly and unconventional way to extract and refine oil. In 1999, oil sands were only 15% of Canadian crude production, but by 2010, oil sands represented close to half of Canada’s oil production and had boosted Canada’s oil reserves to second behind only Saudi Arabia, globally.33 In 2005, President George W. Bush passed the Energy Policy Act, which gave oil companies extensive incentives to explore and drill the Gulf of Mexico, and an additional $2.8 billion in tax reductions for fossil fuel production. Oil prices peaked in 2008 as they hit records of $147 a barrel because of economic expansion in China and India and simple lack of supply.34 During

28 Johnson, Toni. "Timeline: Oil Dependence and U.S. Foreign Policy." CFR.org. Council on Foreign Relations, 8 Mar. 2011. Web. 6 May 2015. 29 Johnson, Toni. "Timeline: Oil Dependence and U.S. Foreign Policy." CFR.org. Council on Foreign Relations, 8 Mar. 2011. Web. 6 May 2015. 30 Energy Markets: Mergers and Other Factors That Influence Gasoline Prices, United States Government Accountability Office: Testimony Before the Joint Economic Committee (United States Congress) Cong. (2007) (testimony of Thomas McCool). Print.31 Johnson, Toni. "Timeline: Oil Dependence and U.S. Foreign Policy." CFR.org. Council on Foreign Relations, 8 Mar. 2011. Web. 6 May 2015.32 Johnson, Toni. "Timeline: Oil Dependence and U.S. Foreign Policy." CFR.org. Council on Foreign Relations, 8 Mar. 2011. Web. 6 May 2015.33 Johnson, Toni. "Timeline: Oil Dependence and U.S. Foreign Policy." CFR.org. Council on Foreign Relations, 8 Mar. 2011. Web. 6 May 2015.

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this period, the United States Shale Revolution was starting to come to light, which will be discussed later.

Over the past five years, oil markets have continued to fluctuate with major events such as the BP Oil Spill, uprising in Middle Eastern nations and many nations releasing oil from strategic reserves, causing significant volatility in energy prices. Prior to the BP Oil Spill, President Barack Obama was supportive of opening more U.S. offshore locations to drilling, but following the spill in the Gulf of Mexico and ensuing environmental disaster, led to tougher regulations, a temporary ban on offshore drilling and fewer offshore projects. 2011 saw significant turmoil in Arab countries, most notably Libya in 2011. The uprising caused virtually all production in Libya to stop, effectively cutting 2% of the world’s oil supply.35 Globally, oil prices spiked 10% in a day amid concerns the crisis in Libya could and would spread to other oil producing nations, causing a supply shock. President Obama responded with a speech on March 30, 2011, saying “We will keep on being a victim to shifts in the oil market until we get serious about a long-term policy for secure, affordable energy.”36 President Obama continued later in the speech saying, “Meeting this new goal of cutting our energy dependence depends largely on two things: finding and producing more oil at home, and reducing our dependence on oil with cleaner alternative fuels and greater efficiency.”37

United States Shale Revolution:As of the end of 2014, the most recent data released by the United States Energy

Information, the United States has proved reserves greater than 36 billion barrels of oil for the first time since 1975.38 This increase in oil is the fifth consecutive year of reserves rising, which coincides with the start of the United States Shale Revolution. Though the United States only has about 2.2% of the world’s 1,656 billion barrels of proven oil reserves, the increases since 2009 have been dramatic, as America’s proved reserves have nearly doubled, increasing well over 80%.39 (See Figure 2) This comes at a time when other historically dominant oil nations have struggled to increase their proved reserves, like Canada, Iraq, Iran, Kuwait, Saudi Arabia and Libya.40 (See Figure 3) This chart shows the United States has been able to successfully increase reserves every year for the past five years, while other historical oil powerhouses have languished, depleting reserves or seeing growth stagnate.

The United States has been able to increase proved reserves over the past seven or so years because of a dramatic improvement in technology. Hydrocarbons like oil and

34 Johnson, Toni. "Timeline: Oil Dependence and U.S. Foreign Policy." CFR.org. Council on Foreign Relations, 8 Mar. 2011. Web. 6 May 2015.35 Johnson, Toni. "Timeline: Oil Dependence and U.S. Foreign Policy." CFR.org. Council on Foreign Relations, 8 Mar. 2011. Web. 6 May 2015.36 Obama, Barack. "Obama's Remarks on "A Secure Energy Future", March 2011." Georgetown University, Washington, D.C. 30 Mar. 2011. Council on Foreign Relations. Web. 5 May 2015.37 Obama, Barack. "Obama's Remarks on "A Secure Energy Future", March 2011." Georgetown University, Washington, D.C. 30 Mar. 2011. Council on Foreign Relations. Web. 5 May 2015.38 Neuhauser, Alan. "U.S. Oil Reserves Hit 38-Year High." US News. U.S.News & World Report, 4 Dec. 2014. Web. 06 May 2015.39 "International Energy Statistics - Crude Oil Proved Reserves." U.S. Energy Information Administration. United States Government, 28 Apr. 2015. Web. 06 May 2015.40 "International Energy Statistics - Crude Oil Proved Reserves." U.S. Energy Information Administration. United States Government, 28 Apr. 2015. Web. 06 May 2015.

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natural gas that were previously inaccessible are now able to be drilling and utilized through hydraulic fracturing and horizontal drilling. These two techniques of hydraulic fracturing and horizontal drilling have put the United States in a much stronger energy position and have enabled us to reduce our energy imports materially. In order to understand how the United States was able to improve its proved reserves so dramatically, it is important to understand the technology behind the drilling. Geologists have known for decades there were substantial deposits of oil and natural gas trapped deep in shale formations miles below the earth’s surface. These shale reservoirs were created tens of millions of years ago, but have only become reachable for human consumption in the past decade.41 To begin any well, a hole is drilled straight down into the ground. Once the hole extends beyond the deepest fresh water aquifer, the drill pipe is removed and replaced with surface casing. Cement is pumped down the casing, and once it reaches the bottom, is pumped back up between the outside of the casing and the bore hole wall. This serves to create an impermeable barrier between the well bore and any drinking water sources.42

At this point, the process differs from a conventional well, as in shale formations, it is necessary to drill horizontally to extract the hydrocarbons. Once the maximum vertical depth is reached, called the kick-off point, horizontal drilling begins and the wellbore begins curving, until it reaches the appropriate angle, sometimes less than or greater than perfectly horizontal.43 This enables drilling to extend 360 degrees, or in all directions and maximizes the utility of one drill pad. Drilling can extend miles underground in any direction from this single drilling pad, a significant advantage. After the targeted distance is reached in the horizontal wellbores, the drill pipe is removed and steel casing is inserted for the full length and cased in place with cement, just like the vertical portion of the well.44 This is the final part of the drilling phase of a well, leading to the well completion.

Well completion begins with the creation of a connection between the final casing and reservoir rock. A special tool, called a perforating gun, filled with explosive charges, is pushed down the wellbore. Once it reaches the end of the wellbore, the explosives are detonated, blowing small holes in the casing, cement and shale. These holes connect the wellbore to the reservoir, which is in the shale.45 The perforating gun is removed and a mixture of water, sand and chemicals is pumped down the wellbore, into the reservoir formations. This stimulates the shale through the perforations, creating fractures in the rock. The water and sand stay in the fractures in the rock once the pressure from pumping drops, keeping them open. Now, the trapped oil and natural gas flow to the wellbore through the fractures created by the sand and water from fracking.46 This initial segment is isolated with a special plug and a perforating gun is reinserted, and the process of detonation and pumping of fracking fluid continues with this next section, concluded 41 Animation of Hydraulic Fracturing (Fracking). Marathon Oil - Hydraulic Fracturing. Marathon Oil, 2014. Web. 5 May 2015.42 Animation of Hydraulic Fracturing (Fracking). Marathon Oil - Hydraulic Fracturing. Marathon Oil, 2014. Web. 5 May 2015.43 "How Does Directional Drilling Work?" Rigzone. N.p., n.d. Web. 06 May 2015.44 "How Does Directional Drilling Work?" Rigzone. N.p., n.d. Web. 06 May 2015.45 Animation of Hydraulic Fracturing (Fracking). Marathon Oil - Hydraulic Fracturing. Marathon Oil, 2014. Web. 5 May 2015.46 Animation of Hydraulic Fracturing (Fracking). Marathon Oil - Hydraulic Fracturing. Marathon Oil, 2014. Web. 5 May 2015.

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with capping the region with the special plug. Once this process has been completed for the entire horizontal portion of the well, the plugs are drilled out. Water begins to flow into the horizontal casings, then oil or natural gas, right up the wellbore. The construction and completion process of the well takes three to five months, but the well can provide oil and natural gas for 20 to 40 years, or even longer.47 With these new well-drilling techniques of horizontal drilling and hydraulic fracturing, the United States can continue increasing proved reserves at rates similar to the past five years.

Current State of United States Energy:This increased access to oil in the United States because of the shale revolution

presents significant opportunity for the United States to change oil policy. The United States currently is a net importer of 7 billion barrels of oil a day, the largest importer of oil in the world. Though our imports are at a 17-year low, and our production levels are at a 24-year high, we are still highly dependent on other nations to meet our energy needs.48 (See Figure 4) As discussed earlier, energy independence isn’t something truly achievable given the global nature of a commodity like oil, but reducing American dependence on foreign oil would help decrease the United States exposure to geopolitical risk, especially from the Middle East and supply and demand shocks, helping improve our economic stability and national security.

In 2014, the United States imported approximately 9 million barrels a day of petroleum products. This includes crude oil, natural gas liquids, liquefied refinery gases, gasoline, diesel, ethanol and biodiesel. About 80% of this figure was crude oil.49 America actually gets a significant portion of our oil from Canada, at 37%, with another 13% coming from Saudi Arabia, 9% from Mexico, 9% from Venezuela and 4% from Russia. Digging a little deeper into these figures, 35% of United States imports comes from OPEC countries, with 20% of them in the Persian Gulf.50 (See Figure 5) But the United States actually winds up exporting a significant amount of oil they receive from Canada and Mexico because the refineries are primarily located in America, while refining virtually none of the oil they receive from Persian Gulf countries and almost none of the oil they import from OPEC countries. This leaves America vulnerable to geopolitical issues from the Middle East and unprotected from supply and demand shocks. Given America’s increased oil production capabilities, the government should leverage this opportunity to decrease the United States’ dependence on foreign oil.

Geopolitical Risks:A large portion of the world’s oil production comes from areas with high levels of

political uncertainty, citizen unrest and general risk to oil production. These regions include the Middle East, Northern Africa, Russia and parts of South America, like Venezuela. With the geopolitical uncertainty in these areas, and a globally connected oil

47 Animation of Hydraulic Fracturing (Fracking). Marathon Oil - Hydraulic Fracturing. Marathon Oil, 2014. Web. 5 May 2015.48 "Two Very Important Lines Crossed Last Month, and It Means Big Things for Our Energy Security:." The White House. The White House, 13 Nov. 2014. Web. 06 May 2015.49 "How Much Petroleum Does the United States Import and From Where?" U.S. Energy Information Administration. United States Government, 11 Mar. 2015. Web. 06 May 2015.50 "How Much Petroleum Does the United States Import and From Where?" U.S. Energy Information Administration. United States Government, 11 Mar. 2015. Web. 06 May 2015.

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market, any instability or changes this market has worldwide ramifications. As the United States is the largest net importer of oil in the world, these instabilities and changes to oil markets can potentially have a drastic effect on America’s economy.51

In a report explaining the geopolitics of the oil and gas industry produced by Ernst & Young, geopolitics is defined as “a broad range of frequently interconnected issues, including diplomacy and security, global economics, financial and supplier market uncertainty, commodity constraints and pricing, exchange rate fluctuations, and civil and workforce distribution.”52 (See Figure 6) Over the past twenty five years, there have been serious geopolitical issues that have affected oil markets. Some major examples from this period include Iraq’s invasion of Kuwait in 1990, to Hugo Chavez and Vladimir Putin nationalizing virtually all of Venezuela and Russia’s fossil fuels, respectively, and Libya ceasing oil production in 2011, dropping world daily oil production by 2%, resulting in a 10% spike in oil prices in one day. This pattern of destabilization and rising political uncertainty has risen in recent years, leading to greater competition for natural resources and has placed a greater emphasis on geopolitics for the oil and gas industry. A major trend the energy space is the shift from International Oil Companies (IOCs) to National Oil Companies (NOCs).53 Nations are becoming increasingly concerned with energy security and this shift doesn’t look to change any time soon. These NOCs have become increasingly powerful and give significant power to sovereign nations with oil resources, like Saudi Arabia, Brazil, Libya, Russia and Iraq, while taking power away from countries like the United States and China, who are major importers of oil. IOCs have become increasingly dependent on NOCs and must partner, often under uneasy circumstances to develop oil in international countries beyond where they are headquartered.

The rising trend of National Oil Companies coupled with threats to oil producing nations like Islamic State of Iraq and Syria (ISIS) make it clear there are issues that could quickly arise in oil markets, creating significant problems for a country like the United States, the largest importer of oil. An organization like ISIS, with clearly established anti-American position could take over a country like Iraq; completely stop all oil exports to nations they don’t politically agree with, which would introduce extreme turmoil, volatility and uncertainty into the oil markets. Also, given their current geographic location, they could easily spread across more of the Middle East, even into a more politically stable country like Saudi Arabia and disrupt oil production and distribution across the region. As was the case with Libya, only a 2% drop in production creates major shockwaves throughout the world. Due to the inherent volatility and uncertainty regarding geopolitics in the world right now, the best way to be prepared to deal with them is avoid them as much as possible. The United States has a lot of exposure to foreign oil, and should work to mitigate this risk.

Supply and Demand Shocks:

51 "Top World Oil Net Importers, 2013." U.S. Energy Information Administration. United States Government, 18 Dec. 2014. Web. 06 May 2015.52 Ernst & Young. "Navigating Geopolitics in Oil and Gas." Ernst & Young (2014): n. pag. 2014. Web. 30 Apr. 2015.53 Ernst & Young. "Navigating Geopolitics in Oil and Gas." Ernst & Young (2014): n. pag. 2014. Web. 30 Apr. 2015.

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Along with the substantial geopolitical risk inherent in current oil markets, the United States is vulnerable and susceptible to supply and demand shocks. As the world’s largest net importer of oil, any sudden drops in oil production or oil demand will affect America significantly.54 In a study by Oak Ridge National Laboratory, they discovered supply and demand responds slowly to shocks, with long-run oil market demand elastics ten times greater than short-run demand elastics.55 In the short run, oil supply is also very inelastic, meaning a cartel like OPEC has significant control over oil prices and can essentially set them where they want, given they control such a large portion of the world’s oil supply, approximately one-third.56 OPEC typically doesn’t expand production even though their costs for developing a barrel of oil are dramatically below selling price, meaning they don’t behave competitively. For example, it costs Saudi Arabia about $2 to extract a barrel of oil from the ground.57 If they were to behave competitively, they increase production levels, flood the market with cheap crude and see oil prices drop to around the cost of development, refining and transportation with smaller profit margins built in. But this would dramatically depress crude prices, and their profit margin would decrease, as is the case with virtually all OPEC producers.

This monopoly behavior by OPEC has had a dramatic impact on the U.S. economy. During the 1970’s, the U.S. Department of Energy estimated the lost economic growth from the two oil shocks to be $2.376 trillion (when estimated in 1988 dollars). There are three main causes a sudden increase on oil prices would create for the U.S. economy. First, there would be loss of the potential to produce because the economy can produce fewer goods for the same input, essentially lowering output. Second, there would be macroeconomic adjustment losses as wages and prices don’t adjust quickly enough to the change in oil prices. Lastly, there is a flow of wealth from US oil consumers to countries exporting oil.58 This report concluded by summarizing the problem with US oil dependence isn’t eventually running out of oil, but is the short-run inelasticity of supply and demand with oil, OPEC acting with monopoly power to control prices because they have a majority of the oil reserves and the US being too dependent on foreign sources of oil.59

United States Government Policy:Given the problems presented by potential supply and demand shocks,

particularly in the short-run, and volatility and uncertainty generated from geopolitical risk, plus the United States’ significant increase in proved reserves and ability to access 54 "Top World Oil Net Importers, 2013." U.S. Energy Information Administration. United States Government, 18 Dec. 2014. Web. 06 May 2015.55 Jones, Donald W., and Paul N. Leiby. "The Outlook for US Oil Dependence."Energy Policy 26.1 (1998): 55-69. Web. 14 Apr. 2015.56 "International Energy Statistics - Crude Oil Proved Reserves." U.S. Energy Information Administration. United States Government, 28 Apr. 2015. Web. 06 May 2015.57 Mullaney, Tim. "OPEC Is Wrong to Think It Can Outlast U.S. on Oil Prices." MarketWatch. Wall Street Journal, 2 Dec. 2014. Web. 06 May 2015.58 Jones, Donald W., and Paul N. Leiby. "The Outlook for US Oil Dependence."Energy Policy 26.1 (1998): 55-69. Web. 14 Apr. 2015.

59 Jones, Donald W., and Paul N. Leiby. "The Outlook for US Oil Dependence."Energy Policy 26.1 (1998): 55-69. Web. 14 Apr. 2015.

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significantly more oil and natural gas resources previously thought unrecoverable through horizontal drilling and hydraulic fracturing, it is time for the United States to take a different approach to energy. America has done an outstanding job decreasing imports and increasing production, but this hasn’t been because of any government intervention. With the significant economic repercussions and potential national security implications, it is time for the United States government, particularly the President, to recognize the importance of oil and take steps to reduce America’s dependence on foreign oil.

Though tax bills originate in the legislative branch, it would be challenging in our current partisan government to have a bill passed right now if the President disagreed with the ideas. The President needs to come out with tax reforms to support both the upstream, exploration and production, and downstream, refining, portions of the oil and natural gas industry. For the upstream portion, companies should receive a tax credit for 20% of their annual capital expenditures in the United States. This would encourage companies to explore for more natural resources, increase production and ultimately lead to the United States being less energy dependent on foreign countries. To deal with this increase in production generated by the change in tax code for upstream companies, a similar tax break would be needed for downstream firms. As upstream firms increase their capacity, downstream firms will have to increase their capacity, in turn. Downstream firms should also receive a tax credit for 20% of their capital expenditures, which will encourage them to expand refining capabilities. In addition to these two permanent changes to the tax code for oil and natural gas related companies, there should be a five-year reduction on their corporate tax rate. Currently, the corporate tax rate is 35%, one of the highest in the world. Between 2016 and 2020, every corporation operating in the upstream or downstream oil and gas industry should have their corporate tax rate dropped to 25%. This tax decrease, coupled with the tax credits for increased capital expenditure spending, should give all oil companies sufficient financial flexibility and free cash flows to reinvest in their businesses, leading to a rapid increase in proved reserves in America, production and refining, decreasing the United States dependency on foreign oil.

In addition to amending the tax code for oil and natural gas companies, the government needs to change restrictions on where companies can drill for oil. Proved reserves refer to oil resources that have been discovered and can be recovered with certainty. However, the United States has access to exponentially more than the 36 billion barrels of proved reserves. A 2012 article by the Institute for Energy Research predicts the United States has 1,442 billion barrels of technically recoverable oil, which would go a long way towards reducing America’s dependency on foreign oil.60 A large portion of these 1.5 trillion barrels of oil isn’t a part of the United States’ proved reserves is because the government restricts drilling. Right now, drilling is forbidden in the Alaskan Wildlife Refuge, the Naval Petroleum Reserve in Alaska, at least 45% of the Gulf of Mexico, the Chukchi and Beaufort Seas off the Coast of Alaska, and oil shale on federally controlled land in Colorado, Utah and Wyoming.61 If opening drilling on select areas of these 60 "Exposing the 2 Percent Oil Reserves Myth - IER." Institute for Energy Research. Institute for Energy Research, 13 Mar. 2012. Web. 06 May 2015. <http://instituteforenergyresearch.org/analysis/exposing-the-2-percent-oil-reserves-myth/>.61 "Exposing the 2 Percent Oil Reserves Myth - IER." Institute for Energy Research. Institute for Energy Research, 13 Mar. 2012. Web. 06 May 2015. <http://instituteforenergyresearch.org/analysis/exposing-the-2-percent-oil-reserves-myth/>.

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federally controlled lands were able to unlock even 5% of the technically recoverable oil, it would increase the United States’ prove reserved base to over 105 billion barrels, effectively tripling the proved reserves base. Though there are environmental concerns to be considered when determining what areas to drill, the economic stability and national security of the United States could be strengthened and America’s dependency on foreign oil could be nearly eliminated if these lands are opened by executive order to drilling.

Conclusion:The United States is facing a pivotal moment in its energy history. With markets

for oil globally interconnected, it is impossible to achieve true energy independence. However, this doesn’t mean a country can’t be energy dependent on others. The United States imports nearly 7 million barrels of oil a day from foreign nations, making them incredibly reliant on foreign support and leaving them vulnerable to uncertainty and volatility for a geopolitical standpoint and at constant risk to supply and demand shocks, which can have dramatically negative effects on the domestic economy. With improvements in technology enabling oil and natural gas companies to recover shale reserves previously thought unreachable because of horizontal drilling and hydraulic fracturing, the United States now has access to significantly more oil domestically. The United States government, specifically the President, needs to take action, through tax cuts and credits and opening areas for drilling where it is currently restricted. If these actions take place, the United States will be able to increase its proved reserves base, increase production, and increase refining capacity, thus reducing our dependence on foreign oil and mitigating risks like geopolitics and supply and demand shocks.

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Figure 1:

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62 "U.S. Imports of Crude Oil (Thousand Barrels)." U.S. Energy Information Administration. United States Government, 29 Apr. 2015. Web. 06 May 2015.63 "International Energy Statistics - Crude Oil Proved Reserves." U.S. Energy Information Administration. United States Government, 28 Apr. 2015. Web. 06 May 2015.

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Figure 3:

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Figure 5:

64 "International Energy Statistics - Crude Oil Proved Reserves." U.S. Energy Information Administration. United States Government, 28 Apr. 2015. Web. 06 May 2015.65 "Two Very Important Lines Crossed Last Month, and It Means Big Things for Our Energy Security:." The White House. The White House, 13 Nov. 2014. Web. 06 May 2015.

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Figure 6:

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66 "How Much Petroleum Does the United States Import and From Where?" U.S. Energy Information Administration. United States Government, 11 Mar. 2015. Web. 06 May 2015.67 Ernst & Young. "Navigating Geopolitics in Oil and Gas." Ernst & Young (2014): n. pag. 2014. Web. 30 Apr. 2015.

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