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Reviving the Petroleum Administration for War: A Case for Government-Industry Partnership

The Russo-Ukrainian War is exposing deep fissures in global energy networks and finally forcing Western capitals to address their energy security. The prices for crude oil and natural gas in the United States have risen approximately 50 percent and 100 percent respectively since December 2021, with even higher prices for U.S. allies in Europe. Combined, these increases are pushing inflation to 40-year highs and threatening to tip many developed economies into recession. The economic pain is causing instability in the developing world and weakening NATO cohesion on Ukraine.

To confront this profound challenge, policy should consider creating a partnership between government and industry for managing energy resources. We believe the Biden administration should look to the World War II-era Petroleum Administration for War as a model. A 21st-century Petroleum Administration for War would focus on supply chain resiliency and price shock mitigation measures to rapidly increase oil and natural gas volumes when needed, with the ultimate goal of delivering lasting energy security to the United States and its allies.

 

 

The Petroleum Administration for War, first known as the Office of Petroleum Coordinator for National Defense, was created in 1941 to marshal America’s diverse production, refining, and transportation assets for the war effort. The administration relied on deep industry buy-in, leveraging the technical and commercial know-how of the private sector for its remarkable success. An updated version of this approach — call it the Energy Security Agency — could again facilitate government-industry cooperation, enabling the U.S. government to partner with domestic producers to address key energy security challenges.

The Rise and Fall of Shale

Today’s crisis marks a dramatic reversal of the halcyon days of the “shale revolution,” the period from 2007 to 2014 when U.S. domestic oil production nearly doubled and energy security seemed assured through the independent actions of private firms responding to price signals. This breathtaking expansion was driven by the new technology of hydraulic fracturing and massive influxes of capital investment chasing yields in an environment with low interest rates and rising commodity prices. In 2014, Goldman Sachs proclaimed that the United States would replace the Organization of the Petroleum Exporting Countries as the primary “swing producer,” effectively putting a ceiling on global prices for oil. Once captive to autocratic regimes, U.S. energy security, defined by steady supplies at affordable prices, would be assured by domestic production delivered solely by a nimble, innovative private sector.

However, when the dust settled on the 2010s, oil and gas companies were the worst performing sector of the S&P 500. As a whole, the oil and gas segment delivered dismal returns of 6 percent versus the benchmark’s 190 percent over the course of the decade. Despite bringing down drilling and completion costs by 40 percent between 2014 and 2021, the shale model was not working due to rapid initial decline rates of new wells and lower commodity prices. Investors, in seeking to recoup their losses, now demand disciplined spending and low debt levels. As a result, since January 2021 annualized U.S. domestic production growth has not responded to higher prices, remaining at an anemic 3 percent compared to growth rates of 13 percent and 19 percent following similar price increases in 2011 and 2018 respectively.

The industry’s newfound financial prudence compounded steadily with emerging structural changes in climate investing. Beginning in 2004, the Environment, Social, and Corporate Governance framework grew out a U.N. report calling for ethical reforms to capitalism following the Enron and WorldCom scandals. This framework led to a steady reduction in investment dollars available to oil and gas firms. Private equity, university trusts, sovereign wealth funds, and public pensions are actively divesting from fossil fuels. These investors are motivated by ethical concerns, but perhaps more importantly, growing financial risks. With the U.N. Intergovernmental Panel on Climate Change setting the goal of net zero greenhouse gas emissions by 2050, investors are increasingly worried that existing oil and gas reserves will be stranded in an environment where it is no longer profitable to produce them.

In short, capital markets have grown increasingly reluctant to fund fossil fuel investments following a decade of poor returns, price volatility, and growing concern over climate change. As such, domestic producers, subject to these market forces, can no longer supply the volumes needed to moderate price increases. This shortfall is particularly acute following decades of chronic underinvestment in oil and gas infrastructure outside the United States, a post-pandemic surge in demand, and Western sanctions of Russian energy. These overlapping changes in the capital markets strip U.S. domestic oil and gas producers of the money and incentive needed to be the world’s swing producer — thus endangering the affordability part of the energy security equation.

A Model for Government Leadership

Recognizing that U.S. producers are unlikely to ride to the rescue, the Biden administration is pursuing a kitchen sink strategy toward lowering prices for consumers. On the domestic front, this involves tapping the Strategic Petroleum Reserve, allowing higher biofuel blends for gasoline, admonishing U.S producers and refiners for obscene profits, and offering up a potential federal gas tax holiday. Abroad, the administration is seeking more production from autocratic states within the Organization of the Petroleum Exporting Countries Plus, specifically Venezuela, Iran, and Saudi Arabia. With Saudi Arabia in particular, this strategy is resulting in a major reversal of administration policy. But this has done little to ease global energy prices. Thus, Russian sanctions are weaker and the unified NATO support for Ukraine is in peril.

Short-term solutions are limited, and calls for austerity have been met with little enthusiasm. But the administration has a unique opportunity to forge a new approach towards energy security built around much stronger public-private engagement. Fortunately, this type of partnership has a historical precedent: the World War II-era Petroleum Administration for War.

Franklin Delano Roosevelt formed the Petroleum Administration for War in May 1941 after declaring a national emergency in response to Nazi threats against U.S. shipping. The organization’s mission was to secure adequate supplies of petroleum products at “the proper places and at reasonable prices to meet civilian and military needs.”

The Petroleum Administration for War operated as an independent agency reporting directly to the president. It was led by Harold Ickes, the Secretary of the Interior. Ickes insisted on putting industry at its center to help address the complexity of the task in front of him and avoid the massive government staffing required for a more top-down approach. At the head of the agency was a National Office, composed of a cadre of government leaders alongside a national industry committee, which was made up of 450 private sector executives. Supporting the National Office were regional district committees comprised mostly of industry leaders and technical staff. In its daily operations, the National Office coordinated with other wartime agencies to set overarching goals and then tasked the industry-led committees to advise on the technical processes and operating plans to achieve them.

Where the United Kingdom effectively nationalized its oil champion Shell, the United States used the Petroleum Administration for War to pursue a path of cooperation and buy-in from its domestic producers. The approach was tremendously successful in supplying petroleum products to the frontlines, increasing total oil production by 30 percent between 1940 and 1945. At the war’s end, the U.S. Joint Chiefs commended the  Petroleum Administration for War, stating that “no government agency and no branch of American industry achieved a prouder war record.” In a testament to the effectiveness of this approach, the close working relationship between the U.S. government and industry continued in the post-war years. With a focus on managing supply and affordability through multiple crises in the Middle East, this partnership was vital in maintaining the country’s role as a swing producer up through the 1967 Arab oil embargo.

The key to the agency’s success was the deep level of participation and buy-in from domestic producers. This commitment grew out of an organizational structure built around industry committees staffed by thousands of executives and technical experts. These committees, which worked on a voluntary basis and were organized by functional area, performed the engineering and logistical work required to produce, refine, and transport petroleum products for military and domestic use. While the Petroleum Administration for War provided strategic direction and oversight, these committees not only executed plans, but also served as a valuable sounding board to shape more effective government policy. Assessing the results in 1946, Wharton professor William Newman concluded the agency provided “unusually effective” private-public cooperation in an era where joint action between industry and government was common, but not always value-adding.

The circumstances in which the Petroleum Administration for War succeeded aren’t that different from the circumstances today. In the 1940s, there was deep suspicion and distrust between government and domestic industry, driven by anti-trust concerns instead of today’s environmental issues. Moreover, like it is today, the mid-century oil industry was composed of many competing firms of various sizes with differing incentives, risk tolerances, and commercial capabilities.

What this current era seems to lack is the national political unity that arose from the existential threat faced by the United States during World War II. But the winds of change, at least around industrial policy, may be blowing. In addition to the obvious wake-up call provided by the Russo-Ukrainian War, there’s clear bipartisan unity around the need to counter China’s global rise. As seen by the recent passage of the Chips and Science Act to support domestic semi-conductor manufacturing, the United States is still capable of agreeing on meaningful national industrial policy. As such there may be a path forward for public-private initiatives around national security issues like energy, despite the general political divisiveness.

A New Energy Security Administration

We believe a 21st-century Petroleum Administration for War would be an asset to the security of both the United States and its allies. This partnership between government and industry should be built around the features that Newman identified as crucial for the Petroleum Administration for War’s success: clear agreement on objectives; a laser focus on well-defined problems; an emphasis on technical expertise, not politics; and mutual trust and respect.

With this spirit in mind, we propose a new Energy Security Administration, organized around addressing four main challenges: supply resiliency, refining capacity, natural gas transport, and climate change mitigation. As with the Petroleum Administration for War, the government, in close consultation with industry advisors, would provide the overarching goals and coordination for the Energy Security Administration, while industry committees would provide the technical analysis and implementation.

In terms of organization, the Department of Energy would be the most logical cabinet member to take the lead, in close coordination with the Departments of Defense, Interior, Transportation, and State. The National Petroleum Council, an underutilized advisory committee established following the success of the Petroleum Administration for War, could serve as a jumping off point for a more integrated approach with industry leaders. The initial focus for the Energy Security Administration should be contingency planning to address everything from supply disruptions due to natural disaster to the resource needs of a full-scale war.

Consider supply resiliency. In March 2022, the Biden administration committed to withdrawing one million barrels per day from the Strategic Petroleum Reserve over a six-month period. Although it had a muted impact on prices due to the much larger loss of Russian volumes from global markets, it was notable as only the second time the reserve has been used as a mechanism to impact affordability.

Better government-industry coordination could build on the Strategic Petroleum Reserve’s ability to rapidly add supply. Consider the benefits of creating a strategic reserve of drilled but uncompleted wells. These are wells that have been constructed but not yet hydraulically fractured. A “Strategic Drilled but Uncompleted Well Reserve” would be built over time on federal leases. It could be modeled after the Naval Petroleum Reserves — a series of proven oil fields that served as an emergency fuel source for much of the 20th century. Although a variety of contractual structures are possible, the basic goal would be to create an incentive for companies to drill additional inventory beyond what market forces would dictate. Drilling these strategic reserve wells alongside other wells ensures that technical efficiencies and lower costs are realized. Building an inventory over several years sufficient to produce 2 to 3 million barrels per day for a few months would be an ideal complement to the Strategic Petroleum Reserve and would help restore America’s historic ability to moderate global prices.

An Energy Security Administration could also improve the supply and transportation of natural gas. Natural gas is important both in liberating U.S. allies from dependence on Russia and indispensable as a transition fuel source for reducing greenhouse gas emissions. Although ongoing investment in liquid natural gas terminals and pipeline transport will be core to the European Union’s ability to wean itself off Russian gas, aggressively increasing gas production on the continent could also contribute significantly. An Energy Security Administration, relying on industry committees, could provide vital technical, commercial, and policy guidance on developing Europe’s shale reserves. While early assessments of viability of European gas production were pessimistic,  dramatic advances in well construction techniques forged in the crucible of a hyper-competitive U.S. shale business over the last five years have altered the economic calculus. Moreover, justified concerns over methane emissions can now be effectively addressed. In a significant reversal, U.S. utilities and gas producers dropped lifecycle emissions 17 percent from 2005 to 2015 and have consistently demonstrated that natural gas is a cleaner fuel source than coal.

Although much of the focus of a nascent Energy Security Agency would be on the ability to rapidly increase oil and gas supplies in times of crisis, climate change mitigation and decarbonization should also be incorporated into the organization’s DNA. The oil and gas industry is increasingly comfortable with renewable technologies, leading investment in carbon capture and storage, geothermal energy, and hydrogen production. Furthermore, any large-scale transition to renewables will require the implementation of long-duration energy storage to resolve the intermittency challenge associated with solar and wind. This in turn will require repurposing oil and gas reservoirs to store energy as compressed air or water on a massive scale. By building a closer working partnership between government and industry, an Energy Security Administration could forge the flexible, integrated relationship between regulatory agencies, utilities, and local communities that would make this possible.

The advantages offered by an engaged partnership between government and domestic energy providers are immense. They include building emergency oil and gas supplies to lessen price shocks, maximizing global natural gas production as a transition fuel, and creating a shared strategy based on decarbonization

As members of the oil and gas industry, we and our colleagues are eager to be part of the solution to ensure the United States and its allies can access sustainable and affordable energy without interruption. The Russo-Ukrainian War has given Washington and other NATO capitals a newfound focus on energy security, creating the opportunity to forge a new path forward. Prior to meeting with industry executives on June 23, Energy Secretary Jennifer Granholm remarked, “this is an honest conversation… how we can be partners in providing relief to people.” We believe this spirit of partnership is the right one to build on delivering long-term energy security to the United States and its allies.

 

 

Ryan P. Kellogg is an investor and manager in the oil and gas industry with 18 years of experience. His work with Occidental Petroleum in Long Beach, California, and Shell in Groningen, the Netherlands, featured uniquely close government-industry interaction. Kellogg earned a B.S. in chemical engineering and international relations from North Carolina State University and an M.B.A. from the University of California-Los Angeles. His work has appeared in the Society of Petroleum Engineering journals, and he currently co-hosts a biweekly podcast featuring energy policy and its impact on U.S. foreign policy, Kellogg’s Global Politics.  

David Brunnert is an investor and executive in the oil and gas industry with over 25 years of experience. His previous employers have included Key Energy Services, where he served as COO, and Weatherford International. A graduate of Ranger School, Brunnert started his career as an officer in the 82nd Airborne Division, where he served as platoon leader during Desert Shield/Storm. Brunnert earned a B.S. in mechanical engineering from the United States Military Academy and a Master of mechanical engineering from the University of Houston. His work has appeared in the Society of Petroleum Engineering journals and he is a named inventor on over 40 patents.

Image: Government Accountability Office

https://warontherocks.com/2022/08/reviving-the-petroleum-administration-for-war-a-case-for-government-industry-partnership/ Reviving the Petroleum Administration for War: A Case for Government-Industry Partnership

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