Energy security and climate policy: two sides of the same coin? Peter R. Hartley Kenneth B. Medlock III Rice University

“We must treat energy security and climate security as two sides of the same coin.” Tony Blair, October 20, 2006

A basis for the claim  Dependence on imported sources of energy can have negative macroeconomic and strategic consequences  Most of these imported sources are fossil fuels, the combustion of which increases CO2 emissions thereby contributing to global climate change  The US can reduce both of these undesirable consequences by reducing fossil fuel use  We shall claim that, while this argument has merit, it also has flaws  We will focus on the US, but some of our remarks will also be relevant especially for Japan and the EU

Possible meanings of energy security  Related to national security as usually interpreted:  Reduce the need to maintain influence in areas, such as the Middle East, that are rich in natural energy resources but politically unstable or hostile to the US  Reduce dependence on foreign energy suppliers, such as Venezuela and West Africa, which may be unreliable  Modern military forces require a substantial amount of oil products (in the case of the US, million barrels of oil a year)  Energy security also is related to economic security, with energy price shocks having been implicated in macroeconomic disturbances  Large oil price shocks also produce large financial flows between importers and exporters that can disrupt financial markets  Price uncertainty further reduces investment in safer sources of supply, tending to exacerbate initial instability

Policies to promote energy security  Emergency stocks (such as the SPR) can accommodate short-term shocks  Many foreign supplies have sovereign risks that are not very predictable  In a worldwide energy market, however, any change in supply or demand will affect prices everywhere  The distinction between reliable and unreliable partners is dubious  Nevertheless, security is enhanced when there are more suppliers and when developed economies supply a higher proportion of world energy  Transparent rules, good information, and absence of trade barriers produce integrated energy markets with many suppliers and demanders  In the long term, national energy security is also enhanced by a greater variety of energy supply sources and by greater substitutability between energy sources

Energy efficiency  Increased energy efficiency also reduces vulnerability to energy price shocks  Higher efficiency often requires new equipment, which can be expensive when old equipment has a reasonable remaining operating life  Similarly, new buildings are often more energy efficient than older ones, but insulation, double glazing and so on can also yield considerable savings  Altered business practices can also often yield substantial energy savings  Since energy efficiency can be increased in many ways, the most effective way of achieving it is to raise the price of energy and provide incentives for firms and consumers to respond  The alternative of direct quantitative controls typically will cost more to produce the same efficiency gains

What is good climate policy?  Take it as given that anthropogenic CO2 emissions will change climate, possibly in ways that could be significantly harmful on net  Nevertheless, it need not follow that limiting CO2 emissions is the best policy response or even part of the optimal policy response  Actions regarding climate change can be classified into four categories  Reducing the emissions of greenhouse gases, particularly CO2  Increased sequestration of greenhouse gases, particularly CO2  Limiting the chance of harmful consequences from climate change of a given magnitude  Improved remediation of damages resulting from climate change

Reducing emissions of CO2  For emission cuts to make sense as part of climate policy, they would need to be more cost effective than sequestration, which is likely to be the case  US measures need to take account of “carbon leakage”, which could increase world-wide CO2 emissions on net  If emission cuts reduce the variety of fuels or the range of suppliers to the US market, they will reduce energy security  For the remainder of this discussion, we assume that the US emission cuts are part of an effective policy response to climate change  If they are not, energy security and climate change policy would not be “two sides of the same coin”

Mitigation and remediation of damages  Measures to reduce the likelihood of large damages could include  building dykes to protect vulnerable coastlines,  improving evacuation plans and procedures,  changing building codes to increase structural integrity,  developing crops more resilient to altered climate,  removing subsidies to activities that increase the harm, such as encouraging people to live nearer the coast  Examples of improved remediation of damages could include:  better disaster relief preparation,  improved cooperation between disaster relief teams,  developing a better civil reconstruction capability  These also are alternatives to reducing CO2 emissions that do not impinge on energy security

Other issues to consider  How much climate change is natural, how much is attributable to anthropogenic non-CO2 sources, and how much results from the accumulation of CO2?  The larger the non-CO2 components of climate change, the stronger the case for mitigation or remediation of damages  Mitigation or remediation help protect against non-CO2 as well as CO2 sources of climate change, while limiting CO2 addresses only one source  Controlling emissions in the future is a substitute for controlling them today  If much uncertainty about the extent and timing of potential damages may be resolved in the near future, the case for delay is strengthened  The possibility that uncertainty about future technologies for controlling emissions, sequestering CO2, reducing consequences etc. will be resolved also increases the option value of delay

Are policies toward energy security and climate change complementary?  Increases in energy efficiency serve both policy goals  Increasing the use of non-fossil sources of energy also serves both goals  In the long term, new energy technologies are essential for energy security, but more basic research is needed to make them competitive suppliers of bulk energy  It is doubtful whether limiting diversity of fossil fuel sources can actually reduce global CO2 emissions given the likelihood of “carbon leakage”  Coal and unconventional oil in particular provide potential energy security benefits for the US and Canada, but these are relatively CO2-intensive fuels

Coal and unconventional oil in the US

US electricity generation Generation by source 2006Generating capacity 2005 Average annual net capacity growth in the EIA Annual Energy Outlook, 2008 reference case

Modeling North American natural gas imports  We used the Rice World Gas Trade Model (RWGTM) based on MarketBuilder software from Altos Management Partners  The RWGTM is a dynamic spatial equilibrium model linked through time by Hotelling-type optimization of resource extraction  Capacity expansion, both greenfield and brownfield, is based on capital, operating and maintenance costs, and anticipated revenues  The model is non-stochastic, but allows analysis of different scenarios  The model predicts:  Regional (country and sub-country level) prices, supplies and demands, inter- regional flows and associated capital investments  For detail see:  Hartley, Peter and Kenneth B Medlock III, “The Baker Institute World Gas Trade Model” in Natural Gas and Geopolitics From 1970 to 2040, ed. Jaffe, Amy, David Victor and Mark Hayes, Cambridge University Press (2006), available online at

Modeling North American natural gas imports  The demand for natural gas as an input into electricity generation in the US is modeled conditional on the available capacities of the different types of plants  We first examined the likely evolution of LNG imports into the US, Canada and Mexico with capacity additions as specified in the EIA reference case  The imports into all three countries are examined because we allow LNG to imported indirectly into the US via Canada and Mexico  We then assumed that all the coal-fired capacity additions in the US were required to be natural gas instead  CO2 constraints will favor natural gas a fuel, while the reference case already assumes substantial development of nuclear and renewables capacity  Our analysis likely understates the effect since replacing coal plants by natural gas plants would require the latter to be operated as base load  Arguably, the energy security implications of heavy dependence on Middle Eastern suppliers of LNG are greater than heavy dependence on Middle Eastern suppliers of oil

Reference case US LNG imports

Reference case LNG trade

Changes in sources of US supply

Instruments and targets  Some policies can further both goals:  Increasing energy efficiency  Increasing non-fossil fuel sources  Some policies have conflicting effects:  Directly limiting the use of coal and unconventional oil  CO2 emissions constraints, which can artificially increase demand for natural gas  Climate change policies with no effect on energy security:  Increased sequestration  Climate damage mitigation and remediation

Two policies compared  Constraints on CO2 emissions would tend to:  Encourage energy efficiency by raising the overall price of energy  Encourage investments in non-fossil energy sources by disadvantaging fossil fuels  A similar effect could be achieved by directly taxing all energy and using the proceeds in part to subsidize investments in non-fossil energy technologies  There are three major differences between these two options:  The tax plus subsidy option would not disadvantage CO2-intensive fossil fuels in the short term, thus assisting with energy security but at the expense of more CO2  The energy tax policy could provide revenue for climate change mitigation and remediation strategies and subsidizing research into alternative energy technologies  Constraints on CO2 emissions will favor non-fossil alternatives that are currently the most competitive whereas subsidies could be directed toward non-fossil sources that have the greatest long term prospects

Conclusion  Policies to address climate change and energy security are not necessarily “two sides of the same coin”  For the US at least, the goals are as likely to conflict as coincide, while some measures could further one goal with little effect on the remaining goal  Perhaps the conflict in goals is less significant for Europe and Japan, where coal and unconventional oil is less prevalent  Mitigation, remediation and sequestration also address climate change without affecting energy security  The goals are more complementary when it comes to encouraging energy efficiency and non-fossil energy sources  Taxing energy use encourages energy efficiency, while the revenue could be used to  mitigate and remediate harmful effects of climate change; and  subsidize basic R&D into alternative energy technologies  If energy security is a concern, this could make more sense than constraining the use of coal and unconventional oil