The Political Implications of America's Oil & Gas Boom - James Kwak Interview

As we begin a new year we wanted to take a look at the current energy landscape and see what the future holds for the global economy, America’s oil and gas boom, whether renewables will continue to be a favourite amongst investors and whether we should be focusing more attention on conservation and energy efficiency rather than our continuous effort to increase supply.

To help us look at these issues and more we managed to speak with the well known economist James Kwak. James is an associate professor at the University of Connecticut School of Law. He blogs at The Baseline Scenario, which he co-founded with Simon Johnson. Simon and James have also written two books: 13 Bankers and, more recently, White House Burning: The Founding Fathers, Our National Debt, and Why It Matters To You. In a previous career, James worked as a management consultant and co-founded a successful software company. You can follow him at @JamesYKwak.

In the interview James talks about:

•    The political implications of America’s oil & gas boom
•    How the shale boom will impact climate change
•    Why China may be forced to change its political system
•    An easy way to solve the debt crisis
•    Why we should expect a comeback from coal in the future
•    Why we must invest in renewable energy
•    Why cheap energy isn’t vital to economic growth
•    How Obama’s second term will alter the energy landscape
•    Why we need to focus on conservation
•    Why we shouldn’t take note of the doom and gloom predictions

Interview by James Stafford of Oilprice.com

Oilprice.com: What changes do you see happening to the domestic energy landscape in Obama’s second term?

James Kwak: The biggest trend is obviously the domestic boom in shale gas and oil, and hence the biggest question is what will happen to it. Frankly, I don't see anything happening to change the current trend. Plentiful fossil fuels do have obvious short-term economic benefits that the Obama administration is not blind to. Insofar as the administration wants to reduce fossil fuel consumption—and it's not clear that they do want to—there is enough opposition, both in Congress and in the courts, to justify a policy of doing nothing.

Oilprice.com: What are your thoughts on America’s oil and gas boom?

James Kwak: There are some obvious benefits. Lower dependence on politically unstable parts of the world is clearly good. Shifting electricity production from coal to natural gas is also good. One can also come up with a plausible scenario in which plentiful natural gas buys us the time necessary to shift toward greater usage of renewable energy sources.

On the downside, I worry about the political implications of the boom. Increased domestic production will encourage politicians to declare victory on the energy front without doing anything about the big, long-term problem: climate change. Before, fears of rising energy prices and dependence on the Middle East were encouraging political investment in renewables and conservation. Now the message from ExxonMobil and its allies will be that we don't need to do anything because we are a (net) energy exporter and energy is cheap. That will further reduce the chances that we do anything meaningful about climate change. 

Oilprice.com: What do you see happening to the US and global economies in 2013?

James Kwak: I'm modestly positive about the U.S., but that's not because of any particular insight. It's because I read Calculated Risk, and because the housing market is turning around.

Oilprice.com: Obama has made clear his desires to cut the $4 billion a year tax breaks given to oil companies. What affect do you believe this would have on the US economy and the US oil industry?

James Kwak: I find it hard to imagine this would have a big impact on anything. $4 billion is simply not a lot of money for the energy industry (something like a few weeks' operating profit for ExxonMobil), and even assuming they pass it on to businesses and consumers, that's not a lot of money for the U.S. economy. At the same time, it won't do much to cut the deficit. But it's still a good idea simply to get rid of economic distortions.

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Oilprice.com: What is the relationship between energy and the economy? Is cheap energy vital for economic growth?

James Kwak: I don't see why, as a logical matter, you need cheap energy to have economic growth. My background is in software, for example, and energy inputs were just not an important part of our cost structure. We sold software to insurance companies, and their ability to pay for our software was not constrained by higher energy prices, since they weren't a big part of their cost structure, either. Cheap energy can certainly change the type of economic growth you have, and maybe it can increase growth, all other things being equal, but I don't think it's a prerequisite.

Oilprice.com: At this moment in time natural gas extraction is cheap – which is leading people to say coal is finished. Is it too soon to predict this – as natural gas prices can’t stay depressed forever?

James Kwak: I think it's always too soon to make this kind of prediction. People thought wood was finished in England sometime in the eighteenth century, and now other people are talking about biomass (which hopefully won't make a comeback, but does have its supporters). Coal may not be economically viable now, but as energy prices rise in the future it could become viable again, and maybe someone will figure out a way to use it "cleanly."

Oilprice.com: Advances in renewable energy technology are slow and expensive. Do you see renewables making a meaningful contribution to global energy production? And if so over what time period?

James Kwak: Renewables can and must make a meaningful contribution to global energy production, or else much of our coastline will be underwater in a century. But I think we're talking about a few decades here, not a few years. The problem is that behaviorally we find it very difficult to make choices that seem painful today and whose benefits are both uncertain in magnitude and far off in the future. Having a dysfunctional political system in the United States and not much better ones in Europe doesn't help. (I'm not saying that China has a good political system, but as an autocracy it is more able to dictate a national energy strategy, whether or not it's the right one.)

Oilprice.com: With cheap oil running out do you see Americans changing their driving and energy consumption habits?

James Kwak: Unfortunately, I think Americans' energy consumption habits will shift relatively slowly in response to increases in the price of oil. There are many factors that lock us into our current driving patterns, most notably the physical layout of our cities, suburbs, and exurbs. The stickiness of people's living and working arrangements means that we will always be slow to respond to changes in prices. In addition, there are cultural factors at work here. I imagine many people will continue driving long distances either because they take pleasure in it or because they refuse to change their habits as a matter of pride, despite the economic disincentives.

Oilprice.com: Peak oil has been finding itself in the press a great deal recently with peak oiler’s taking quite a bit of flak over the shale boom. What are your thoughts on peak oil?

James Kwak: Peak oil is inherently difficult to predict because it is an economic, not a scientific concept. The rate of oil production will always depend on at least three factors: difficulty of extracting the marginal barrel of oil, difficulty of producing the marginal unit of the alternatives, and demand for energy. The more difficult is to produce alternatives and the higher the growth of the overall world economy, the more worthwhile it is to extract the next barrel of oil. These days we should know not to bet against technological progress when there is enough of an economic incentive for it, so peak oil will depend on that incentive.

Oilprice.com: Economic growth goes hand in hand with carbon emissions. This means that China and India, whose economies are growing quickly, are also the largest polluters. In our global battle against climate change is it fair to limit the economic growth of developing countries by demanding they keep their emissions below a certain level?

James Kwak: This is a complicated question that ultimately depends on your moral philosophy. The simplest and perhaps most sensible answer is that it doesn't make sense to deprive people in developing countries of the lifestyle that we enjoy in the United States because of our high energy consumption, and therefore emissions limits should be roughly the same, per capita, worldwide.

However, you could come up with an alternative argument on utilitarian grounds. If we were to mandate equal emissions levels for everyone, the disutility that Americans would suffer in having to radically change our lifestyles is probably far greater than the utility that people in developing countries would gain, because they would presumably be able to consume more energy than they do today.

The other thing to look at is that it is the people in developing countries who are going to suffer the most from climate change (and are suffering already), whether from coastal flooding or because their agricultural systems are the most vulnerable to climate change. Arguably they have the most to benefit from global emissions limits and therefore should be willing to accept lower limits on energy consumption than in the United States. A deal like that would be "fair" when measured against the likely alternative but "unfair" in an absolute sense. 

Oilprice.com: Most publications and commentators are focused on the supply side of the energy equation. Do you think we should instead focus more attention on the demand side and conservation?

James Kwak: There should certainly be more attention on the demand side. I believe, for example, that we could reduce energy consumption significantly by improving the energy efficiency of our residential buildings, through investments with relatively short payback periods. More stringent building codes could also go a long way. There is also the benefit we could get by overhauling our car fleet with hybrid technology. There are also other obvious policies that would reduce consumption, like a higher gasoline tax (which would make sense for all sorts of reasons, including the externality costs of congestion and accidents).

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That isn't to say that this is a complete long-term solution, but it's one of the most obvious things we could be doing today while renewable technology develops.

Oilprice.com: There have been quite a few doom and gloom articles in the press recently from hedge fund managers and commentators looking at resource depletion, population growth and climate change. What are your thoughts on these types of articles?

James Kwak: When I was growing up in the 1970s and 1980s, there was a lot of the same kind of talk. That doesn't mean that it isn't true today—maybe it was true then— but you have to take this kind of thing with a helping of salt. I'm no expert, but I would be skeptical of doomsday scenarios based on resource depletion or population growth. Population growth, as I understand it, is slowing down. Being more efficient about resource usage is a technological issue, and given the incentives in place I think that that type of technological development will do well.

I think climate change is more worth being gloomy for the obvious reasons. First, it's already baked into the cake; I believe we're hoping we can limit average global temperature rise to two degrees Celcius, or 3.6 Fahrenheit. Second, because actions today don't have effects until decades into the future, the incentive structures necessary to solve the problem don't work properly. 

Oilprice.com: Chris Martenson has said that the economy, energy, and the environment are all coming to a head. Which do you think will give, and how will this affect the other two, and also the entire world?

James Kwak: I think the environment will be the first to give for the simple reason that it has no real political constituency. Sure, there are plenty of liberals in rich countries who care about the environment, and there are hundreds of millions of people in less rich countries whose lives will be seriously disrupted by environmental change, but in the short term, economic growth will always win over environmental protection. The politics are so one-sided that in the United States—supposedly a well educated, scientifically based society—a blocking minority of the political system denies that anthropogenic climate change is taking place.

Oilprice.com: China’s economic growth is slowing slightly, but has been expanding for several years at an alarming rate. How do you think China’s actions over the next decade or two will shape the whole world?

James Kwak: The big question about China is not its economic development, but its political development. China has obviously been a huge economic success story, but there are plenty of reasons to doubt it can continue in the long term in the current political system. Besides the Tocquevillian J-curve (political turmoil comes when people have rising expectations), there is evidence of both corruption among the political leadership and mismanagement of capital by the state-controlled financial system. I believe, along with Daron Acemoglu and James Robinson, that at some point China's economic development will require more open political institutions, and it doesn't appear that the country's current leaders are interested in making this transition.

Oilprice.com: US debt levels are at their highest ever, a level that is actually impossible to pay off. Yet the US is not trying to drastically cut back its spending, so what does this tell us? Does the US effectively have a bottomless bank account? Will it eventually catch up with them, and in what way?

James Kwak: The most obvious way to deal with the debt crisis is the one that is rarely mentioned, except by people like Bruce Bartlett: If we taxed ourselves like an average OECD country, we would run large surpluses and pay down the debt relatively quickly. For decades, however, self-appointed deficit hawks have simply asserted that it is impossible to solve the debt problem through higher taxes and that therefore we have to cut entitlement spending.

That said, the higher-tax solution is politically infeasible. The fact that we are not drastically cutting back spending simply tells us that there is no political percentage in cutting Medicare, since Medicare is one of the most popular government programs in American history. The interesting question is why the debt markets don't seem to care. This is a complicated question, but probably the biggest factor is that the aforementioned "debt markets" (which are really investors) don't have any other safe place to put their money. In the long term, I think they will find another safe place, which might be Germany, or a reformed China, or something else. So in the long term, I think we will need to do something about the debt problem, or we will start facing rising interest rates and a downward fiscal spiral that will end in severe austerity.

Oilprice.com: The public expects economic growth anything less is treated as a recession, but is constant economic growth a realistic goal? Is it achievable?

James Kwak: Constant economic growth (meaning, say, three years out of four, given the business cycle) is realistic under normal circumstances. Long-term economic growth, the way we usually measure it, is just population growth plus productivity growth, with changes in capacity utilization (meaning not just factories, but productive assets and people more generally) causing the ups and downs. Even if you focus on per capita economic growth, that should still be positive because of productivity growth, which is based on technology. We could have severe shocks, and energy is one possible cause of such shocks, that could cause contraction for a sustained period, but growth should be the norm.

That said, there's a question of whether we're measuring it the right way. As some people have written on this website, all the costs of energy extraction count toward economic growth. As others have written, things like environmental remediation and lawyers' fees for court cases also count toward economic growth. All health care spending counts toward economic growth, which means that health care inflation is contributing toward economic growth. Even without getting to the happiness question, it's not clear that our definition of economic growth is all that accurate a measure even of people's material well-being.
 
Oilprice.com: What opportunities and pitfalls do you see on the horizon?

James Kwak: The biggest issue here in the United States is our long-term national debt problem. I'm sympathetic to the view that right now we need to worry about growth and jobs, but I see that as a short-term problem, and one that will largely take care of itself as long as we don't do anything too stupid.

The opportunity we have is to take a huge wedge out of the long-term national debt by letting the Bush tax cuts expire, by which I mean all of them. To the extent that we need economic stimulus, we should do something like a payroll tax cut, which not only is more stimulative than, say, preferential rates for capital gains, but also has exactly zero chance of being made permanent.

Unfortunately, this isn't going to happen.

Interview by James Stafford of Oilprice.com – the No.1 source for Oil Prices