The New Administration’s Energy Puzzle

On February 28th, US President Donald Trump delivered his first address to Congress, driving home twin themes of economic opportunity and efforts to protect the American people. The Trump Doctrine, as best as it can be discerned at this inchoate stage, is a mix of economic nationalism coupled with an insular definition of national security. It paints a vision of a world that is more often than not a zero-sum game, and makes explicit the intention to put America first in such a world. While all states can be expected to pursue their strategic interests in a variety of ways, the United States under President Trump is one that proposes to do so by charting as direct a path as possible between objectives and actions.

The “America First” doctrine is, even in its simplicity, a natural rebuke to the elevation of complexities and interdependencies in the current global order. It seeks to capitalize on a fraying consensus in the US and elsewhere over globalization, and to exploit anxieties over the so-called “4th industrial revolution” that Klaus Schwab once warned would foster faster, more disruptive waves of change via technology, even as it brings about tremendous strides in human prosperity, empowerment and poverty alleviation.

President Trump’s speech was one of broad strokes, and while he managed to lay out at least an impressionistic vision for priorities such as tax, healthcare and immigration reform, energy policy was notably absent. Nowhere in the speech was “energy” mentioned, nor its component priorities such as “oil”, “climate”, “natural gas”, “solar” or “nuclear”. It leaves many wondering what the President’s priorities are for the American energy system, and in particular what role the United States will play in global energy markets. Many diplomats, including those from regions such as Europe with acute energy security concerns, are eagerly awaiting answers to these questions.

However, not everything is a mystery when it comes to energy. The direction of travel for the Trump administration’s energy policy has been articulated with a tripartite emphasis on reducing regulatory burden, increasing energy exports and achieving energy independence. For the administration, it is a cohesive effort aimed at creating jobs, stimulating economic activity, and increasing US national security.

However, this three-legged stool rests on shaky foundations. When considered in combination with what we know about the administration’s trade policy priorities, the President’s energy and trade agenda seems to encompass several inherent contradictions, and it would behoove any observer to consider them carefully.

First, the administration will soon have to come to terms with the debate over whether it should allow for more liberalized exports of primary energy commodities such as oil and natural gas, or whether it instead should seek measures to encourage these commodities to remain within US borders as inputs to industries such as manufacturing and petrochemicals that may ultimately produce higher value-added products for export. The debate is not a new one; it was in many ways at the heart of the debate over crude oil export restrictions before they were lifted by the US government in late 2015.

While trade in oil has seen greater liberalization, many countries – including potential bilateral trade agreement partners such as Japan and the United Kingdom – would like to see the United States enshrine into law more liberalized exports of liquefied natural gas (LNG). Currently, in accordance with the Natural Gas Act, all LNG export projects are required to apply for approval from the US government, with a de facto automatic approval for exports to countries with which the United States has a free trade agreement. Even this exception was deemed insufficient by the European Union in its negotiations with the United States over the Transatlantic Trade and Investment Partnership (TTIP), where it sought binding, irrevocable assurances of free and unimpeded LNG trade in a proposed “energy and raw materials” chapter.

So, would one expect the administration to further deepen and codify liberalization of US energy exports? One the one hand, this fits well with stated priorities of maximizing US exports and further strengthening the domestic energy industry. On the other hand, the energy industry is not a homogenous entity, and while upstream oil and natural gas drillers might support such an action, operators of refineries and petrochemical complexes would instead prefer to see impediments to primary commodity exports, so as to depress the price of inputs in manufacturing processes at home. The Trump administration has also made clear its concern for the health of American manufacturing, and so may ultimately be willing to forego a laissez-faire attitude traditionally advocated by Republicans in favor of a more industrial policy-style approach to managing the economy. And where all of this fits with the promise of “energy independence”, including whether it is meant to mean complete autarky or simply large domestic production, is anyone’s guess.

The debate here is not merely academic; it will have material repercussions both for the political economy “winners” and “losers” at home, as well as for allies in Europe, the Asia-Pacific, and elsewhere that do not enjoy the same domestic energy endowments as the United States and are in turn far more dependent on participation in the global market to meet their demand.

The second contradiction is a related one. The administration will eventually have to reconcile with the empirical fallacy that it is free trade agreements, rather than automation and productivity gains, that has led to a decline in the American manufacturing employment. It is not so much that the US has lost its industry; but instead that industry has slowly shorn its employees in the pursuit of competitiveness. Indeed, the manufacturing sector of the US produces as much as it ever has in history, even as manufacturing employment has seen a steady decline since the turn of the current millennium.

This can be clearly seen in the oil and gas industry as well. A look at US oil and gas economic output versus employment shows an increasing de-linkage between the two as the domestic shale sector has matured and increased its efficiency. Much of this has been done through automation and the introduction of IT technology to shale operations; despite the fact that the US has only one-third of the rigs operating as was the case in 2014, it is down only 10% from its previous record levels of oil production. Oil production may indeed see new record highs in the years to come, but employment in the sector will almost surely not. It is, then, an odd strategy to pin hopes of a resurgent labor market on a sector that continues to survive by doing more with less.

This, in turn, raises a final point regarding the allocation of benefits, costs and risks in society. The pursuit of a robust supply of domestic energy, and even maximization of that output, may be a desirable priority in its own right. But it is sub-optimal to inter-mix a labor market strategy with energy strategy, particularly in a sector with such cyclical, boom-and-bust employment as the shale hydrocarbon sector in the United States. And it would be even less wise to predicate a stimulus for that sector upon the unilateral roll-back of policies meant to ensure that clean air and water is safeguarded even as we enjoy affordable energy supplies.

Scrutiny of existing regulations is understandable, and reform surely merited, in cases where regulations are not based on sound science, impose total costs greater than their total benefits, or can have their objectives achieved in a more efficient manner. Reform is one thing, while mass repeal is another. When a government haphazardly tears up pollution reporting requirements, clean water legislation and other such safeguards, it does not do away with the risks that they are meant to protect against. It simply does away with the cost of the current “insurance premium” (in the form of the targeted regulation) to hedge against these risks, while raising the potential for damaging events that incur higher, perhaps privately-borne, costs in the years ahead. It shifts, not reduces, societal costs.

Similarly, one of the less-noticed side effects of the Administration’s proposed border tax adjustment (BAT) in the trade policy sphere would be to raise the costs for American insurance companies to utilize foreign reinsurance services. It is a seemingly banal detail, but not without consequences. At the moment, approximately half of US insurance relies on reinsurance to further diversify risk. This is a particularly important function when it comes to catastrophic coverage, such as that implicated by many climate change-driven weather events. Simple economics suggest that as the costs of foreign reinsurance rise, the costs of domestic insurance provision would be expected to rise as well. Domestic reinsurers may stand to temporarily benefit from this protectionism, but at the expense of either increasing future risk exposure or increasing the costs of society to insure against that risk exposure.

It would be unfair to pass final judgement on an energy policy constellation that is still in formation. Nevertheless, there are already clear indications of many elements of internal contradiction that has regularly beleaguered energy policy and the pursuit of affordable, reliable and sustainable energy supplies. These incongruences may be all the more pronounced in a White House that has vowed to overturn the longstanding consensus in a number of proximate policy areas, from foreign policy to trade. It will be up to the pragmatists in the administration, particularly those who come from a world of commerce governed by numbers rather than a world of politics governed by rhetoric, to smooth out these contradictions and file down some of their sharper, unrefined edges.