Buenos Aires, 2000

XI REPSOL YPF-HARVARD SEMINAR

HARVARD UNIVERSITY

JOHN F. KENNEDY SCHOOL OF GOVERNMENT

BUENOS AIRES, ARGENTINA DECEMBER 2000

ENERGY POLICIES AND MARKETS: NEW TRENDS OR OLD CYCLES?

WILLIAM W. HOGAN BIJAN MOSSAVAR-RAHMANI EDITORS THE REPSOL YPF-HARVARD SEMINAR SERIES

JOHN F. KENNEDY SCHOOL OF GOVERNMENT HARVARD UNIVERSITY 79 JFK Street Cambridge, MA 02138 USA

REPSOL YPF Paseo de la Castellana 278 28046 Madrid, Spain

FUNDACIÓN REPSOL Juan Bravo 3B 28006 Madrid, Spain

ISBN: [TO BE ADDED] Depósito legal: [to be added]

Copyright 2001© FUNDACIÓN REPSOL Servicio de Publicaciones CONTENTS

FOREWORD ...... v

EDITORS’ NOTE ...... ix

OPENING SESSION

WELCOME MR. ALFONSO CORTINA ...... 3 «ARGENTINA’S ECONOMY IN THE NEW CENTURY» THE HONORABLE JOSÉ LUIS MACHINEA ...... 11

KEYNOTE ADDRESS

«LIBERALIZATION AND THE ECONOMY IN LATIN AMERICA» THE HONORABLE DOMINGO F. C AVALLO ...... 17

SESSION I OIL

INTRODUCTORY REMARKS MR. BIJAN MOSSAVAR-RAHMANI ...... 29 «PERSPECTIVES ON THE INTERNATIONAL OIL MARKET» MR. ADRIÁN LAJOUS ...... 33 «POLITICS AND OIL» MR. RICHARD PERLE...... 43 «FURTHER CONSIDERATIONS ON THE PRICE OF OIL» THE HONORABLE HUMBERTO CALDERÓN BERTI ...... 49 «PETROLEUM INVENTORIES: ECONOMICS AND LOGISTICS» MR. JAMES RAGLAND...... 57

iii iv

SESSION II ENVIRONMENT: WHERE IS GLOBAL CLIMATE POLICY TAKING US?

INTRODUCTORY REMARKS PROFESSOR ROBERT N. STAVINS...... 71 «COP6: OBSERVATONS OF AN INTERESTED BYSTANDER» PROFESSOR CHARLES KOLSTAD ...... 75 «OBSTACLES TO EFFECTIVE CLIMATE CHANGE POLICY» DR. ALAIN HEILBRUNN ...... 83 «BEYOND KYOTO: A BETTER, LONG-TERM APPROACH TO CLIMATE CHANGE» DR. BRIAN P. F LANNERY ...... 91

SESSION III LATIN AMERICAN ENERGY MARKETS

INTRODUCTORY REMARKS MR. JOSÉ LUIS DÍAZ FERNÁNDEZ ...... 103 «ENERGY MARKET INTEGRATION IN LATIN AMERICA» MR. PHILIPPE REICHSTUL ...... 107 «LATIN AMERICA’S CHINESE WALLS IN ENERGY MARKETS» MR. ROBERTO MONTI...... 115 «THE QUIET REVOLUTION IN LATIN AMERICA: ELECTRICITY AND NATURAL GAS MARKET INTEGRATION» DR. EVANAN ROMERO ...... 123

CLOSING SESSION

SUMMARY AND COMMENT PROFESSOR WILLIAM W. HOGAN...... 133 «A REPSOL YPF-HARVARD SEMINAR RETROSPECTIVE» MR. JOSÉ LUIS DÍAZ FERNÁNDEZ ...... 143

BIOGRAPHIES OF SPEAKERS...... 151

LIST OF PARTICIPANTS...... 159

REPSOL YPF PUBLICATIONS ...... 167 FOREWORD

In December 2000, the XI Repsol YPF-Harvard Seminar on Energy Policy convened in Buenos Aires, after meeting in Spanish cities for the previous ten conferences. We are proud of our new corporate identity as a Hispano-Argentine energy company and were delighted to join with our Latin American colleagues in presenting the Seminar in Argentina.

Buenos Aires was, of course, an ideal site for our meeting. It is a cos- mopolitan city where Europeans, North Americans, and South Americans can enjoy a sense of shared culture, and one where all participants, no matter what their origin, can feel welcomed and enriched. To add to our enjoyment, we were able to sample the rich artistic heritage of Latin America. We were particularly pleased to draw from our cultural project, the Repsol YPF Program for the Music of Latin America, sponsored by UNESCO, by including an evening of Hispanic-American music performed by the Exaudi Chamber Choir.

v vi Foreword

We also were honored to share in Argentina’s intellectual culture. Our speakers included two Argentine economists and public figures of international stature: Dr. José Luis Machinea, Minister of the Economy of Argentina (1999–2001), and Dr. Domingo Cavallo, Minister of the Economy of Argentina (1992–1996; 2001 to present). Both spoke elo- quently on liberalization and the economies of Argentina and Latin America, focusing on the need to reform market structures and gov- ernment oversight in order to build consumer confidence, promote competition and cross-border trade, and encourage investment.

In the 18 months since our last Seminar, the energy world has seen a disturbing increase in oil price volatility and a greater emphasis on controlling petroleum inventories. We also have become more aware of the complexity of the environmental challenges we face. In response to these developments, we structured our XI Seminar— titled “Energy Policies and Markets: New Trends or Old Cycles?”—to offer participants an opportunity to reflect on the significance of these changes, in particular those relating to oil prices and global cli- mate policy. We also thought it important to create a venue where we could join our Latin American colleagues in discussing the energy market situation in their part of the world. In all segments of this year’s event, the Seminar has again proven its worth by creating a forum where we could engage in lively, constructive dialog on impor- tant political and economic events and issues.

As we have long known, the Seminar’s value stems from the way it allows us to step back from the kaleidoscopic flux of daily events to discuss and reflect on the longer-term significance of these occur- rences. This year we even had the chance to revisit past Seminars and learn how the focus and scope of this event have evolved, as well as what impact our sessions have had on the international energy, eco- nomic, and political fronts. José Luis Díaz Fernández, president of Fundación Repsol YPF, reviewed the history of the Seminars in his closing talk, “A Repsol YPF–Harvard Seminar Retrospective.” For those new to the Seminars, his presentation provided a splendid occasion to learn more about the Seminars. For those who have been with us before, it offered a sense of where we and the energy sector Foreword vii

have been since the first meeting in 1987, and where we might be going in the future.

Once again, I want to express my appreciation to all the speakers and participants whose significant contributions have made the Seminar the important event it is. Let me thank all our friends, old and new, with whom we have shared memorable days of intellectual and con- vivial contact. This book aims to collect all the thoughts and reflec- tions exchanged during the Seminar, some of which are immediately applicable to our professional activities.

Repsol YPF, the Kennedy School of Government at Harvard University, and the Fundación Repsol YPF are proud of the Seminar’s role in the energy world, but of course we owe that to those who join us and contribute their experiences.

Finally, let me once again thank Bill Hogan and his Harvard team, Bijan Mossavar-Rahmani of Mondoil Corporation, and José Luis Díaz Fernández of the Fundación Repsol YPF for their invaluable work in organizing this, the XI Seminar, from planning the program and selecting speakers to publishing this book.

Alfonso Cortina Chairman and CEO Repsol YPF EDITORS’ NOTE

To commemorate the successful merger of Repsol and YPF, the Repsol-Harvard Seminar, now the Repsol YPF-Harvard Seminar, shifted its venue from Spain to Argentina for the XI Seminar held in December 2000.

But while the Seminar was held outside of Spain for the first time since its inception in 1987, the quality of participation, the rigor of the presentations, the vitality of the debates, and the gracious hos- pitality of our host Repsol YPF remained unchanged.

Some 70 participants representing governments, corporations, and academia from over a dozen countries gathered for two days of informal presentations, discussion, and reflection on the changing landscape of global energy and environmental markets and the impli- cations for public policy and business strategies.

ix x Editors’ Note

The most profound change in these markets since the last seminar held in Madrid in June 1999 has been, of course, the dramatic and sustained increase in world oil prices.

As in earlier Seminars, this meeting was structured around three ses- sions, each initiated by short, invited presentations and followed by general discussion among the attendees. Also, as before, one of the participants was given the responsibility of serving as the Seminar rap- porteur to make sense of what had transpired or at least to identify some common themes in a final summary session. Those concluding remarks are included in the “Closing Session” segment of this book.

It should be noted that the Seminar was especially pleased to have as speakers two senior Argentine policymakers who shared with the participants their views of the fiscal challenges facing their country: the Minister of the Economy, Dr. José Luis Machinea, and Dr. Domingo F. Cavallo, who has served in that post between 1992 and 1996 and again since April 2001. Their participation underscored the importance of Argentina and the rest of Latin America, not only in world energy markets but also in the larger global economy.

In the preparation of this volume Energy Policies and Markets: New Trends or Old Cycles?, transcripts of the presentations were edited and reviewed by the speakers to ensure flow and accuracy. It should be noted that speakers participated in this Seminar in their individual capacities, and that their views therefore do not necessarily reflect those of their own institutions or of the Seminar’s organizers.

These Proceedings are published to capture the substance and the tenor of the meetings, both as a permanent record for the partici- pants themselves and also for distribution to a wider audience. Viewed together, they provide a fascinating and lasting perspective on the changes in energy markets since the late 1980s as described by a small but prominent group of participants in these markets, at least some of whom have been repeat invitees to our gatherings.

Ira Jackson, director of the Center for Business and Government at the Kennedy School of Government, the rest of the Harvard group, Editors’ Note xi

and the other speakers and guests are indebted to the management of Repsol YPF, importantly to its Chairman Alfonso Cortina, and also to the Fundación Repsol YPF headed by José Luis Díaz Fernández, for their commitment to excellence and open exchange in the organiza- tion of these Seminars.

Many people at Repsol YPF and Harvard continue to devote time, energy, and ideas to the Seminar, from the initial planning of the meetings to the final publication of the Proceedings. In Madrid, Juan Bachiller, Ivan Cieker, Eduardo Garcia, Nuria Henche, and Susan Meyers were superb colleagues in this shared project. In Buenos Aires, Francis Fernie and his group were invaluable. At Harvard, Pamela Woodlock directed all phases of the operations with con- summate skill, while Kim Pederson of Edit·Heads in Marblehead, MA, was a peerless editor. We are grateful for all their contributions.

William W. Hogan, Guest Editor Harvard University

Bijan Mossavar-Rahmani, Guest Editor Mondoil Corporation

Constance Burns, Series Editor Harvard University Welcome xiv xv Opening Session ENERGY POLICIES AND MARKETS: NEW TRENDS OR OLD CYCLES? OPENING SESSION

WELCOME

MR. ALFONSO CORTINA REPSOL YPF

It is my great pleasure to welcome you to the XI Repsol YPF-Harvard Seminar on Energy Policy. I am especially pleased that we are meet- ing in Buenos Aires after holding our ten earlier meetings in Spanish cities. This change reflects our pride in our new corporate identity as a multinational Hispano-Argentine company with two head offices: one in Madrid and the other in Buenos Aires.

As always, many things have changed on the energy scene since our last Seminar in Madrid in June 1999. This year’s Seminar—titled “Energy Policies and Markets: New Trends or Old Cycles?”—will cen- ter on whether those changes reflect new departures or are repeti- tions of prior cycles. Our sessions, including one focused specifically on Latin America, will analyze and draw conclusions regarding the nature of these changes.

Before I introduce our distinguished speakers, I would like to share some of my thoughts about recent developments in the world

3 4 Opening Session

economy, as well as in the energy sector, as an introduction to our conversations of the next two days.

INTERNATIONAL POLITICS AND ECONOMICS

We are living through times that, in general, allow us to be guard- edly optimistic about international economic and political matters. Politically, the world is experiencing a general stability. Granted, the strife and tension in the Middle East are still affecting the energy sec- tor. Elsewhere, however, there is progress. The Balkans, for example, are slowly moving toward normalcy. Hostilities between North and South Korea have lessened, and China is becoming an active pres- ence on the international scene.

Turning to economics, during the first part of 2000, we saw an over- all growth in the world economy. However, progress slowed during the second half of the year as high oil prices persisted. In spite of this downturn, prospects for 2001 are good. According to the IMF, we can look forward to 4.2-percent annual growth in the world economy. The main concerns for 2001 continue to be the potential hard land- ing of the U.S. economy and the ongoing tensions in the oil market.

Latin America is experiencing a particularly significant economic and political evolution. After a period of strong expansion in the early 1990s, growth in some nations, including Argentina, has faltered. However, we should not lose sight of the medium-term horizon, remembering that Argentina has instituted more macroeconomic stabilization and liberalization reforms than any other nation in the region. Its present government is pushing forward on this path, and I am sure the results will soon be apparent. Investment flow into Argentina, especially from Spain, has not been affected by the over- all economic situation. This is a sure sign of trust in the Argentine economy. Crises of confidence always come to an end, leaving an effective economic strategy as a legacy. Welcome 5

THE NEW ECONOMY/THE OLD ECONOMY

If we were to sum up the main economic events of 2000, many would agree that it was the year of the euro, oil, and, in the center of it all, the U.S. economy. The euro’s continuing weakness and the persistently higher oil prices have, time and again, contradicted those who believe the recent upward trend in oil prices and fall in the euro’s value are transitory. In fact, more and more voices are saying this situation could persist longer than originally thought. They are also saying that the price and exchange rate levels once considered as a balance—$18 to $20 per barrel for Brent oil and 1.10 to 1.20 euros per dollar—will probably not be reached within coming months or even years.

It has been pointed out that the experiences of the oil market and of the euro are two sides of the same economic coin, symbolizing the old bricks-and-mortar economy on one side and the new technology-dri- ven economy on the other. The euro’s weakness may be explained by the continuous growth of the new economy in the United States, a phenomenon that has called into question the very foundation on which world growth has been based. On the other side of the coin, the emphasis on one commodity—oil—coming largely from one group of countries—OPEC—provides continuing evidence of the great problem besetting the old economy: the international depen- dence on hydrocarbons and on the politically most vulnerable pro- ducing countries where the majority of reserves are located.

OPEC’s recovery of power has been remarkable in the past few years. Although the growth of world oil demand has made it easier for the organization to operate, it is still surprising that countries with such different economic and strategic interests have achieved such enor- mous overall control of the oil market. Given the market power of OPEC nations, now allied with other oil producers like Mexico, Norway, and Russia, it is more important than ever to maintain a con- structive dialogue between consuming and producing countries. 6 Opening Session

Energy companies belonging to the “old economy” are also rapidly adjusting to the environment created by the new economy by chang- ing their method of working in the markets.

PROSPECTS FOR THE ENERGY SECTOR

Focusing now on the energy sector, I would like to comment briefly on the short-term problems affecting the oil market and on the chal- lenges the energy sector will face over the longer term.

Energy Supply and Demand Oil prices are at the center of everyone’s attention. The main factor influencing them has been OPEC’s slow reaction to the increase in world demand in 1999 and 2000. However, other elements have also played an important role. These include the low reserves in consum- ing countries, the introduction of new fuel specifications, and bot- tlenecks in the refining industry and sea transport. In a changing world, we should ask ourselves whether the oil market’s apparent return to the old economy (i.e., OPEC in control of prices) is just an issue for the short term, or whether the steps taken by OPEC will set prices above $18 to $20 per barrel for the medium term. If we look further ahead, we must also ask ourselves how volatile the market will be in the long term and how the further development of the new economy will affect the energy sector.

Admitting that any speculation on the energy sector’s future perfor- mance is a precarious venture, I would like to put forward some ideas on long-term energy prospects. Most projections, public and private, agree that primary energy demand will increase by some 2 percent annually over the next 20 years. The sharp growth of consumption in developing countries will account for 50 percent of world energy use by 2020. The annual increase in energy demand in Latin America will be approximately 4 percent.

Oil will continue to be the main source of energy supply, accounting for 38 percent of the total demand. Natural gas will be the highest growth fuel, rising from its current 21-percent share of world energy Welcome 7

demand to 30 percent 20 years from now. Higher natural gas con- sumption will result from its ability to meet the requirements set by the Kyoto Protocol on Climate Change for reducing greenhouse gas emissions. The marketing of natural gas for power generation and the existence of abundant reserves also weigh heavily in its favor. By 2020, natural gas and oil use combined will account for 68 percent of the world’s primary energy consumption.

New Forces to Consider Yet this positive demand scenario should be examined within the con- text of the new forces now moving energy markets. These markets will be influenced by deregulation, increased competition, technological development upstream, and the application of the new economy within the energy sector, as well as by environmental concerns. Some of the new features to be found in future energy markets are already emerging. The natural gas market, for example, is gaining more and more independence from oil in terms of risks, prices, and structure. In contrast to oil, gas and power markets are undergoing a major transformation. The restructuring processes in the United States and Europe and the deregulation and development of private investment in the emerging markets of Asia and Latin America are indicators of this change. E-commerce and the management of new risks are providing new business opportunities. On-line trading operations in natural gas, power, and other products will be customary and may, in the not- too-distant future, displace traditional business activity in the sector. Nor should we forget the growing commercial importance that the sale of joint gas and power packages will have in the market. These challenges are producing a natural convergence between gas and electricity companies and a tendency to integrate gas and oil activities. Integration offers significant benefits for energy compa- nies. First, it reduces the volatility of oil revenues, as well as those from the entire gas/power chain. A second value is a good position- ing in growth businesses, such as gas/power, and in geographic areas with high potential, such as Asia and Latin America. 8 Opening Session

This new scenario requires high investment and, consequently, cor- porations with size and financial capacity. In recent history, compa- nies have responded: first, by merging in the oil sector; then by developing and giving increased portfolio weight to gas; and third, by investing and expanding throughout the gas/power chain.

Increased energy demand and the dramatic evolution of energy mar- kets present us with challenges that, especially in Latin America, could be considered the most important we have faced in recent years. I am sure that this Seminar will discuss these issues and give us all a chance to reflect on them.

THE AGENDA FOR THE XI REPSOL YPF–HARVARD SEMINAR

Harvard and Repsol YPF Seminar planners have endeavored to choose key issues in the energy world for our discussion and analysis. We expect the sessions to produce ideas and conclusions we may apply to future activities in the governmental, academic, and business spheres. I urge all participants to take an active part in these discussions, shar- ing ideas from your diverse perspectives. • Our first speaker will be Dr. José Luis Machinea, Argentina’s Minister of the Economy, who has graciously joined us in this opening session to welcome you to Buenos Aires and to discuss the importance of energy liberalization for Argentina’s economy. • We will then turn to our keynote speaker. We are honored to have Dr. Domingo Cavallo, former Minister of the Economy in the Argentine government. Dr. Cavallo needs no introduction; his name and brilliant work are well known in Argentina and abroad. It would be difficult to find anyone better qualified to give a talk entitled “Liberalization and the Economy in Latin America.” • Our first session, called simply “Oil,” will be led by Bijan Mossavar-Rahmani, chairman of the Mondoil Corporation. Mr. Mossavar-Rahmani was one of the founders of the Repsol YPF- Harvard Seminars. He combines long industry experience with extended academic links to Harvard University. Our speakers for Welcome 9

this session represent various areas of the oil world. They will analyze the recent past and look forward to the near and distant future. • Harvard University Professor Robert Stavins will chair the second session, which focuses on the environment, an area that increas- ingly affects the development of business activities and our daily lives. The session, entitled “Environment: Where is Global Climate Policy Taking Us?”, will present the viewpoints of three speakers on attempts to implement the Kyoto Protocol on Global Climate Change, particularly the recent COP6 meeting in The Hague. • Our third session will focus on “Latin American Energy Markets.” José Luis Díaz Fernández, president of the Fundación Repsol YPF (an organization that has played an important role in organizing and developing the Repsol YPF-Harvard Seminar) will chair the session. The speakers will analyze the oil, gas, and power mar- kets in this region. • In the closing session, Harvard Professor William Hogan will sum- marize all that has been said during the Seminar. Any introduc- tion of Bill Hogan is unnecessary. Rather than reel off a list of his praises, I will simply say that Bill Hogan is one of the strongest pillars supporting the Repsol YPF-Harvard Seminar. He is largely responsible for its success, and we hope to enjoy his collabora- tion for a long time to come.

I would also like to thank you, Bill, and all the Harvard team for your hard and efficient work, without which our Seminars, particularly this one in Buenos Aires, would not have been possible.

A MUSICAL GRACE NOTE

As a grace note to these serious deliberations, Repsol YPF is delighted to offer a special program featuring one of the outstand- ing musical ensembles of Latin America: the Exaudi Chamber Choir, founded and directed by María Felicia Pérez, joined by the Soloists of Havana. 10 Opening Session

This magnificent group has collaborated with Repsol YPF on a most important cultural project, the Repsol YPF Program for the Music of Latin America, directed by Alejandro Massó. Carried out under the auspices of UNESCO, this program searches for, collects, and restores musical artifacts in Latin America, including musical scores and ancient instruments from the baroque period. UNESCO has spon- sored our program since 1998 because it considers recovering the cultural heritage of a whole continent one of the most important projects it supports. This conservation of a historic legacy enriches not only Latin Americans, but also people everywhere.

As a result of this project, a large number of musical scores, docu- ments, and objects of extraordinary value from the sixteenth to nine- teenth centuries have come to light. (A notable example is the Doménico Zipoli chamber organ from the early sixteenth century, now in the Marqués de SobreMonte Museum in Cordoba.) The pat- rimonial heritage recovered by this project is being restored and made available to the public.

Tonight, the Exaudi Choir will give us selections from this cultural legacy. In addition, we will have the pleasure of hearing some of this century’s notable Hispano-American composers, including one of Argentina’s greatest, Carlos Guastavino, who died just a month ago. The performance of his music will serve as a tribute to one of the out- standing musical talents of Latin America. <>

THE HONORABLE JOSÉ LUIS MACHINEA MINISTRY OF THE ECONOMY, ARGENTINA (1999–2001)

It is my pleasure to welcome you to Buenos Aires and to Argentina today. We are honored to host the first Latin American session of the Repsol YPF-Harvard Seminar on Energy Policy. Your focus on energy regulation and markets has special relevance for Argentina.

STRUCTURAL REFORM IN ARGENTINA

As you know, we made substantial structural reforms during the 1990s. These reforms centered on encouraging higher private-sector participation in the goods and services area of our economy. After an uncertain start, our macroeconomic reforms and the privatization process made significant progress. In the second half of the decade, unfortunately, economic reform came to a halt. Now, however, President Fernando de la Rua is convinced that we must move for- ward with more changes. Our goal is to make Argentina’s economy more competitive and to carve out a place for our country in the global marketplace.

11 12 Opening Session

Structural reforms to increase competitiveness and balance fiscal accounts are important in any economy but are especially so for an economy like Argentina’s, which has a convertibility regime similar to a currency board. A system like this is very demanding, particularly given the profound external shocks Argentina has suffered over the last three years. Our export prices have fallen around 20 percent. The dollar has appreciated with regard to different currencies, especially the euro, and our currency is tied to the dollar. In addition, the days when capital flowed to Argentina and to emerging countries and when international interest rates were on the order of 3 to 3.5 per- cent are long past. We are now coping with rates twice as high and with high volatility in international markets.

As you may know, at the start of the De la Rua administration, we engineered several reforms. For example, we introduced more flexi- bility into Argentina’s labor market. We also restarted our market deregulation programs, the most important of which was the com- plete deregulation of telecommunications. Now we want to increase competition in the fuel distribution market. Unfortunately, just as this conference opened, our senate voted against an executive power project to loosen controls over this market. Apparently the senators do not like competition. In spite of this setback, we will carry on with our efforts toward encouraging labor reform and deregulation and toward fostering greater competition in all markets. One specific tes- tament to our determination is the recent decree deregulating the health sector, which until now had been a monopoly of the labor unions.

We also intend to reduce the fiscal burden for future generations by reforming social security in Argentina. In 1994, we took an important first step toward this goal, but there was a serious flaw in the legis- lation: the change in the social security system kept the benefits granted by the state to future generations at a relatively high level. This provision is untenable. Therefore, the government has now sent a new proposal to Congress that focuses on improving the mid- and long-term solvency of the social security system. «Argentina’s Economy in the New Century» 13

We took a further step toward reducing fiscal uncertainty and improving the solvency of the public sector with a historic agreement between the federal government and the provinces that limits the transfers from the federal government to the provinces for the next five years. Even more important, the agreement also freezes public expenditures at national and provincial levels, with the exception of interest payments, for the next five years.

This action represents a phenomenal achievement, especially in light of what has happened during the last decade. The 1990s were a time of growth, but unfortunately the decade was also a time when public expenditures increased by almost 90 percent, which made it impossible to bring down taxes. The agreement to freeze nominal public expenditures will help restore fiscal balance and allow further tax reductions. During 2000 we have already seen, for the first time in decades, a decrease in public spending. Restoring fiscal solvency in this manner has allowed us to begin reducing or even eliminating dis- tortive levies such as taxes on interest payments and the value-added tax (VAT) on investment.

In the hydrocarbon sector, we are working to stimulate production in high-risk areas. We are now ready to send Congress a new hydro- carbon law that, besides transferring land ownership to the provinces, also strengthens the judicial security of that activity. Although additional reforms are needed in education, health, justice, and other areas, it is clear that these measures show a government working to improve the solvency of the public sector, increase com- petitiveness, and stimulate investment.

Admittedly, all these efforts have involved making difficult choices. As a result, our attempts to stimulate free trade, boost investment, and expand the Argentine economy have not always been applauded. For example, when the government started reducing taxes, we began with those that affect investments. It would have been more popular to reduce consumption taxes, but we thought it imperative to stimulate the competitiveness of our economy, which is the only way to restore growth on a sustainable basis. 14 Opening Session

STRUCTURAL CHANGES OUTSIDE ARGENTINA

It is important to note that our reforms have not just focused on internal matters. For example, although we intend to honor our com- mitments to Mercosur, we will push for changes such as allowing free imports, free trade in fuels, and deregulation of natural gas and other hydrocarbons. The energy market is of fundamental impor- tance for Mercosur, but if we do not develop adequate institutions and a regulatory framework across member countries quickly, we will not succeed in creating an integrated energy market.

We also need Mercosur to look beyond its region. We must work together with other international commercial blocs. To this end, we have speeded up negotiations within Mercosur and with other coun- tries for a free trade agreement for all of the Americas. The success of this venture depends in large part on what is decided in the Northern Hemisphere. Nevertheless, we must keep moving toward opening up the Argentine economy and the regional economy to the world.

ARGENTINA: DEDICATED TO MOVING FORWARD

To conclude, I want to emphasize that Argentina is dedicated to pushing ahead in critical areas. • We are moving to increase the security of investments and to make growth a reality. • We are doing away with taxes on investments. • We are striving to build a more open, globally integrated economy. • We have secured loans from international financial organizations to reduce fiscal uncertainty. For example, we obtained a financial package from international institutions and the private sector that will allow Argentina to honor its financial obligations for at least the next 12 months.

These accomplishments should generate more trust, encourage fur- ther investment and capital inflow, and help reduce interest rates. «Argentina’s Economy in the New Century» 15

Of course, Argentina is well aware that it exists in the midst of a global economy. Whatever goes on here will have an impact abroad and vice versa. As we mentioned, international developments within the last two or three years have been difficult. In the future, we hope to see reductions in international interest rates, a stronger euro, and an improvement in our terms of trade.

We also hope the current climate of uncertainty and risk aversion will give way to a more optimistic one. Nevertheless, Argentina is pre- pared to face the future. Given the support from financial institutions and the reforms we are making, we are optimistic about the Argentine economy for the short and medium terms. I am convinced that our country will grow next year by more than the 2.5 percent foreseen in the current national budget.

Under these circumstances, what you discuss here and what the energy sector does in Argentina are of the greatest importance for our economy and our nation. We will listen with great interest, and we will do our part by creating a friendly environment where the pri- vate sector can develop and grow. KEYNOTE ADDRESS

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THE HONORABLE DOMINGO F. C AVALLO MINISTRY OF THE ECONOMY, ARGENTINA (1992–1996, 2001– )

I am honored to be invited to deliver the keynote address at the XI Repsol YPF-Harvard Seminar on Energy Policy today in Buenos Aires. The long relationship between Harvard and Repsol is an impressive one, and I am pleased that YPF will now be a part of that association.

THE ECONOMIC ACHIEVEMENT OF THE 1990s

Economic indicators show that the 1990s were a time of deflation in Argentina. That was a good thing. Before the 1990s, Latin America had had rampant inflation for many decades, made worse by a severe debt crisis in the 1980s. We had to remove this fiscal disease from our national economies to survive in the global economy. This has not been an easy task. In fact, several attempts at stabilizing Latin American economies failed completely. As Table 1 shows, however, in the 1990s we did manage to eradicate inflation from some national economies, including Argentina’s, and to reduce it in others.

17 18 Keynote Address

Establishing a stable currency and curbing inflation are two ways to ensure the financial welfare of our citizens. These policies promote a sense of economic and social security, which makes people feel that their standard of living and their property are not at risk. All citizens, but particularly those in the working classes, understand that their financial and social welfare is more assured with a stable currency and no inflation. There is no greater bane to the stability of families than sudden changes in currency value combined with high inflation, which can erode the value of salaries and personal savings and generate feel- ings of financial instability, even panic.

We need to ensure a basic standard of living and financial security for families across Latin America to generate greater savings and create greater investment in national economies. I’m talking about invest- ments in human resources and human capital, as well as capital investments. Investments in human resources are crucial to achieving «Liberalization and the Economy in Latin America» 19

higher levels of training and education for all citizens, as well as for improving economic efficiency.

Establishing an overall respect for what I call “property rights” is a key factor in creating sustained economic growth. If we can achieve this continued growth, we can then move forward in solving many social problems, such as the very low levels of education and poor healthcare that have allowed poverty to persist for too long.

Eliminating inflation, or at least bringing it down to the low rates found in other regions of the world, will lay the foundation for the next decade of growth in Latin America. I insist that governments should aim for growth rates of around 7 percent per year. This is a feasible target, similar to what was achieved in Asia in recent decades. To be sure, we are starting from lower levels of productivity compared to those in North America or Europe. However, if we can open up investment opportunities, and if that investment can increase efficiency and productivity, our economies should be able to grow at 7 or 8 percent per year.

Chile’s example in the 1990s is the model for the rest of Latin America in the coming decade. As shown in Table 2, that country’s economy has been growing at an average annual rate of almost 9 percent per year with practically no interruption. In fact, output in Chile grew in every year except 1999. For the decade, its cumulative growth was almost 88 percent.

How fast did other economies in the region grow over this period? Argentina had the second highest cumulative growth rate at 53.7 percent, then came Mexico with 35.9 percent, and Brazil with 29.5 percent. With those figures in mind, let us turn our focus to a comparison of Mexico and Argentina.

A STUDY IN CONTRASTS: MEXICO AND ARGENTINA

I am motivated to make this comparison by the challenge posed by a friend of mine from Harvard University, Jeffrey Sachs. In his article enti- tled “The Monetary Disorder of Argentina” (November 2000), Sachs 20 Keynote Address

discussed the continuing economic downturn in Argentina and pre- dicted a severe economic crisis during the next few months. He blamed Argentina’s supposed monetary disorder on its policy of cur- rency convertibility. Furthermore, he asserted that even if this policy were abandoned, it had already halted economic growth and would stunt further growth. Sachs advised us to end convertibility and adopt a floating currency—as Mexico has done. In Argentina he would ban the dollar and permit currency transactions only in non-convertible pesos, as in Brazil with the real and in Mexico with the peso.

My Harvard colleague is only partially correct when he asserts that convertibility has been costly for Argentina’s economic growth. It is true for the last three years but not for the decade. As Table 2 shows, for the last three years Mexico has been expanding at a faster rate than Argentina: 4.8 percent in 1998, 3.7 percent in 1999, and «Liberalization and the Economy in Latin America» 21

6 percent in 2000 compared to Argentina’s 3.9 percent in 1998, –3.1 percent in 1999, and 0.5 percent this year. However, over the last ten years, Mexico’s cumulative growth was only 35.9 percent compared to 53.7 percent in Argentina. So, over this longer period, which is relevant for evaluating monetary systems, Argentina has grown more than Mexico.

I also agree that Mexico has topped Argentina in export growth, but for different reasons. Over the last decade, Mexican exports have grown 274 percent, while Argentina’s have “only” grown 118 per- cent. But we need to ask why this happened. Was it the result of Mexico’s floating currency? Or were there other causes? I suggest that the growth of Mexican exports was caused by several factors other than the country’s monetary policy: • The most important and most visible cause has been Mexico’s economic integration with the United States through NAFTA, the free trade treaty that opened the U.S. market to Mexican exports in 1994. Mexico has taken full advantage of this opportunity. • The American economic upswing during the 1990s has drawn much investment capital to Mexico. During the decade, the rate of investment in Mexico has been consistently higher than in Argentina. • The sharp rise in oil prices in the late 1990s was another source of the growth in Mexican exports.

We cannot blame our current recession on Argentina’s export sector. As we have seen, Argentine exports grew an impressive 118 percent without the benefit of NAFTA or high investments rates. This growth occurred even with a currency linked to the strong U.S. dollar, which caused Argentine products to be overvalued. What are we seeing here?

A Paradoxical Decade in Argentina We face a paradox when we look at Argentine exports, and indeed the Argentine economy, over the decade of the 1990s. Without the 22 Keynote Address

significant benefits Mexico enjoyed and with a currency linked to the strong U.S. dollar, Argentina still saw its exports grow by 118 per- cent. This figure topped Brazil, which had a 78-percent increase, and even Chile, which grew 103 percent. Currently, our exports are grow- ing at 13 to 14 percent per year. But we also have a recession.

First, let’s look at how we accomplished this economic growth. The key is an exceptional increase in productivity. The rise in Argentine productivity resulted from opening our economic borders and dereg- ulating our markets in the first half of the 1990s. These open markets encouraged new investment and more efficient management. The augmented investment increased employment, and the more efficient management put human resources to better use. Unfortunately, these policies were not continued in the latter half of the decade.

Nonetheless, the effects of liberalization and privatization continue to have a significant impact on economic behavior in Argentina. The energy sector is the best example of the gains realized. Argentina has gone from a state-owned oil industry where bureaucrats controlled prices, quantities, investment, and financing to a totally open system, privatized upstream and downstream. The power industry has also been deregulated. These changes encouraged new investment, notably in power generation. YPF contributed significantly to this investment. As important as the investment itself is the fact that it stems from an economy that allows private firms to manage their own transportation, distribution, and power generation.

The new rules that have made these gains possible are policies that lowered taxes and allowed maximum competition in all markets. We offered incentives for investment and for efficiency. These policies have been the key to Argentine growth, not only in the energy area but also in the areas already privatized.

The Mexican Experience The Argentine-style liberalization did not occur in Mexico, or at least it occurred to a lesser degree. This is why the Mexican economy in the 1990s grew comparatively less than the Argentine economy despite «Liberalization and the Economy in Latin America» 23

the benefits from NAFTA, impressive export growth, and high invest- ment rates. Mexicans should not get carried away by the growth rates of the last three years. They need to recognize that they are still lag- ging in terms of productivity, the key for a sustained growth process.

Mexico has a great opportunity to improve efficiency in all sectors of its economy. In his cabinet appointments, President Vicente Fox has taken initial steps toward establishing an economic environment that rewards efficiency and good management across the energy sector. More needs to be done, however. Increasing efficiency in the rest of the Mexican economy will depend primarily on giving Mexican busi- nesses access to capital markets in the United States and Canada. To have a decade of 7-percent annual growth, Mexico needs to change its monetary system to a convertible currency and to use the dollar for large and small transactions within the Mexican economy. It also needs to integrate Mexico’s financial system and capital markets with those of the United States.

For Mexico, monetary integration with the United States is more important than open borders. The current exchange rate is impeding Mexico’s economic progress. For example, the 15 million Mexicans liv- ing—and saving—in the United States pay a tremendous premium to send money to their families in Mexico, a minimum exchange rate of 14 percent. (Some Mexicans insist the rate is closer to 20 percent.) These people have paid more than $1 billion in exchange costs and transfer fees because of Mexico’s currency policy and banking system.

THE DOWNTURN OF THE 1990s IN ARGENTINA

We all know that Argentina has been in a recession for more than three years. Why should we not conclude, as Jeffrey Sachs did, that Argentina will not grow again unless it devalues its money and adopts a non-convertible, floating currency? Let me give you my opinion.

Barriers to Investment From 1991 through 1996, Argentina opened the doors wide to opportunities for investment. Then, in 1997 the government 24 Keynote Address

slammed the doors shut, in particular by increasing the cost of capi- tal goods. First, we adopted the Brazilian tariff for capital goods. We had had a zero tariff on capital goods but, as part of the Mercosur Common External Tariff, we agreed to accept a 14-percent tariff on imports of capital goods. (The Brazilians wanted 20 percent, their level, but we agreed to only 14 percent.) At the time of the agree- ment, we stipulated that we would phase the tariff in over ten years. I was convinced that, in that time, the Brazilians would recognize that the tariff on capital goods had to be zero. Unfortunately, after I left the government, the ministry, pressed by fiscal needs, accepted the entire tariff increase immediately, thus boosting the cost of imports by 14 percent and increasing the cost of investment in busi- ness and industry.

We further added to the cost of capital goods by ceasing to refund the value-added tax (VAT) to businesses that purchased capital goods. In prior years, Argentina, like Chile, refunded the VAT paid on capital goods. The Chileans still have this policy, but in Argentina it changed. We still collect the tax, but we don’t refund it; instead, the government uses the revenue. So, whenever companies decide on a new investment, they must pay the 14-percent tariff on capital goods and, on top of that, the 21-percent VAT. Anyone who buys a com- puter in Argentina, for example, has to pay 30 to 40 percent more in pesos or dollars than they would pay in Europe.

We also raised the cost of human capital. Again in contrast to Chile, we have a hefty tax on payrolls. For example, if a company were to invest in oil development, part of that investment would go to fixed assets and part would go to the government for taxes on the people they hire.

Thus, in the second half of the decade, we reversed our economic policy of encouraging investment. Business returned to the old men- tality, where getting politicians to favor you or your group is more important than investing or managing efficiently. The return to an economy governed by politicians rather than by markets is what led Argentina into the current recession. «Liberalization and the Economy in Latin America» 25

The economy reached its nadir in 1998, when we were hit with a series of negative external shocks: the Russian crisis, the increased cost of capital to all emerging economies, the Brazilian crisis, and finally the euro’s devaluation, which negatively affected any economy pegged to the dollar. These devastating outside events exacerbated a domestic situation already burdened with high costs for new investment.

MOVING BEYOND THE RECESSION

How can we move beyond the recession? The first requirement is to cut spending and institute austerity measures in the public sector, both nationally and in the provinces. In the mid-1990s, President Menem ceased to support his Minister of Economy and increased national spending. The provinces followed his lead. Consequently, the new Minister of the Economy had to raise taxes to battle the bal- looning deficit. There was no alternative; expenses were growing uncontrollably. However, the new taxes have made investment, employment, and all production more expensive. To reverse this trend, national and state governments must limit spending.

A Hopeful Change in Policy Recently we have had good news. President de la Rua and the state governors entered into a five-year agreement to constrain expendi- tures. If they carry out that arrangement, it will be the starting point for renewed growth in Argentina, allowing us to clean up the Argentine tax system and eliminate some of the obstacles to economic recovery.

Dr. Machinea took another important step by announcing the elimi- nation of the tax on interest payments, and Congress has approved this action. I have supported all these measures and will continue to do so, but we have to go further. Dr. Machinea has estimated that eliminating this tax would reduce new investment costs by 2 to 3 per- cent. We must decrease those costs by 20 or 30 percent. We could do this easily if we eliminate taxes on capital goods imports, reim- burse the VAT on capital goods after 90 days, and remove the VAT on investment altogether. 26 Keynote Address

In the long run, the government would not collect less. We should never forget that the best way to stimulate all areas of the economy and to increase revenue is to encourage competition. To that end, we should focus our legislative and regulatory efforts on this, banning the possibility of new taxes, especially at a provincial level, in the process.

Fortunately, this message is beginning to be heard. So I am now guardedly optimistic. Recently, I was quoted as saying that during the year 2001 the Argentine economy would grow by 10 percent. This is only partially correct. I did not say that it is sure to grow; rather I said that if the government can maintain its new fiscal austerity while aggressively removing existing obstacles to new investment, and if we can convince investors in Argentina and abroad of the many opportunities in our country, then Argentina will start to grow vigor- ously once again.

This policy should also help change the current levels of domestic underconsumption. Why aren’t the Argentines buying? Why don’t they purchase new cars or invest in new homes if the loans are avail- able? Because they are afraid of losing their jobs or having their salaries reduced. How can we replace this fear with optimism for the future? We can demonstrate that businesses are renewing their investment. John Maynard Keynes emphasized that the key to eco- nomic recovery is the entrepreneur’s spirit. I agree; the key for recov- ering from a recession like ours is revitalizing the spirit of enterprise. This will happen if businesses see public policies that encourage rather than tax new investments. I believe we are on the verge of recovering that spirit in Argentina.

A LESSON TO REMEMBER

Let me close by comparing the year 2000 to the year 1990 in Argentina, and the year 2001 to the year 1991. At the end of 1990, a recession had been underway for more than two years. It had been very severe in 1989, and there had been zero growth in 1990. This sounds much like conditions in 1998, 1999, and 2000. «Liberalization and the Economy in Latin America» 27

If a survey had been taken in 1990 or 1991 asking for predictions for growth for 1991, the responses would have been 0 percent, or 1 per- cent, or at most 2 percent. In fact, the 1991 growth rate was 11 per- cent. Many analysts have ascribed this to the miracle of convertibility, but along with adopting convertibility, we also created a great vari- ety of opportunities for investment. Deregulation, privatization, opening the economy, and eliminating a distorted tax system were key to our success.

Think back to the spring of 1991. We adopted convertibility, and we eliminated the tax on agricultural and livestock exports that generated a third of Argentine revenues. On April 1, 1991, the International Monetary Fund, shuddering at what we had done, refused to support our request for a loan. However, just three months later, they approved it. They saw that, in spite of our having eliminated a sub- stantial tax, revenues increased from the ensuing strong economic recovery. We collected much more from VAT and profit taxes than we had from the export tax. Eliminating the export tax was the clearest signal that we had left behind decades of distortion created by a tax system that discouraged investment in our most efficient economic sectors. We inaugurated a decade in which we encouraged invest- ment in these sectors and made a big leap toward the future Argentine economy. I am confident we can do this again. SESSION I

OIL

INTRODUCTORY REMARKS

MR. BIJAN MOSSAVAR-RAHMANI MONDOIL CORPORATION SESSION CHAIR

Since we last met in Madrid in June 1999 for the X Repsol YPF- Harvard Seminar on Energy Policy, the world oil market has changed dramatically. Most significantly, oil prices have nearly tripled from their low point at the end of the last decade, and they have stayed higher for longer than most of us had anticipated.

Speakers at these Seminars have often warned about the cyclical nature of the world oil market. Low oil prices set the conditions for higher prices later by encouraging consumption and discouraging new investments. Similarly, higher prices encourage new investment in exploration and production, foster new investments in alternative energy sources, and discourage consumption, conditions that even- tually lead to lower prices, and so it goes.

The timing and the size of the price spike this year have caught gov- ernments and companies unprepared, however. The spike also raises the inevitable question: Is this a new trend or the same old oil cycle?

29 30 Session I

That, of course, is also the topic of this Seminar. We have this morn- ing a very distinguished panel, including three veterans of earlier Seminars held in Spain, to help us understand the developments in and around the world oil market in the 18 months that have passed since our last gathering.

In addition to attempting to explain what happened and why, the panel will touch on the implications of the new trend for the old cycle, for the industry, and for the global economy. Our panelists will also speak on political developments such as the changes in Mexico, the vigorous role in OPEC played by Hugo Chavez and the Venezuelan government, and the tight balance of political power in the United States, which may paralyze that country’s ability to respond to world oil market developments. The U.S. presidential elections have already affected this Seminar in a small way. When we first organized this gathering, one of our keynote speakers was to be Dick Cheney. Of course, given subsequent developments, he could not honor his earlier commitment to join us. Finally, of course, our session will also speculate about the future.

Let me now introduce our panel members, who will consider these topics and more. • Our first speaker is Adrián Lajous, who has had a distinguished career in the Mexican energy sector, culminating in the position of director general and CEO of PEMEX, Mexico’s national oil company. His term at PEMEX ended early this year. Adrián has also had a long history with our host Repsol YPF as a member of Repsol’s board. • Our second speaker is Richard Perle, who is currently with the American Enterprise Institute, a conservative think tank in Washington, D.C. Mr. Perle comments frequently in the media on U.S. foreign policy and security issues. He served in the Reagan and George H. W. Bush administrations as Assistant Secretary of Defense for International Security Policy. He is also well positioned to speak on the ongoing U.S. presidential elec- tion, as he has served as an advisor to Governor George W. Bush. Introductory Remarks 31

• Humberto Calderón Berti will comment on world oil market developments. Mr. Calderón Berti has also had a distinguished career in the oil industry and in politics in Venezuela and interna- tionally. He has been Venezuela’s Minister of Energy and Finance and held other senior posts in that country’s government. He was president of OPEC in 1979–1980 and continues to be active in the affairs of that organization. • Jim Ragland will round out the panel. As director of the Economic Research Group of the Aramco Services Company, he is based in Washington, D.C., where he focuses on strategic analysis for Saudi Aramco. Jim will consider the possibility of a policy that can produce stable oil prices. <>

MR. ADRIÁN LAJOUS OXFORD INSTITUTE FOR ENERGY STUDIES

As we meet in Buenos Aires at the end of the year 2000, the oil industry is in transition. Determining the sense and rhythm of the changes now taking place is not easy, and this uncertainty weighs heavily on the industry. Price volatility, a major cause of the uncer- tainty, carries risks that paralyze many of us. Yet at this moment there is a serious need to reorient the entire industry strategically. The oil business is at risk for a serious dislocation, which could be brought on by a number of factors, including a supply-and-demand imbal- ance and underinvestment. Today I will discuss these factors and con- clude by considering the impediments to investment that the industry must confront.

THE RISK FROM PRICE VOLATILITY

The oil business has suffered two price shocks over a very brief period. On December 18, 1998, the price of West Texas Intermediate (WTI) reached a low of $10.98 per barrel. Twenty-one months later,

33 34 Session I

on September 20, 2000, it hit a record high of $37.20. Throughout the period, prices oscillated rapidly. This lack of stability affects pro- ducers, consumers, companies, and governments, and it endangers the overall health of the world economy.

All sectors of the oil industry have been affected. First, the risk unavoidably generated by price volatility dries up needed investment. Second, the geographical and sectoral transfer of resources made necessary by price instability puts pressure on company finances. The weight of adjustment is uneven, affecting in particular the weaker firms.

In terms of countries, the impact of price volatility has been asym- metrical. When prices dropped, all oil-producing countries were severely affected, but the brunt of the adjustment fell on those that depend almost entirely on oil revenues. When prices rose, the eco- nomic effect again was tremendous, although consuming countries with strong economies were able to diffuse the adjustments required by the increase. Nonetheless, high prices may be sustained for quite some time, and their long-term effect on global growth should not be underestimated.

Adjusting prices gradually to levels acceptable to the main interna- tional economic players, and reducing volatility in the process, is prov- ing difficult. Although producing countries have powerful instruments for manipulating prices, using these tools effectively in a continuously overadjusting market is not easy. OPEC’s mechanism for control has a series of technical deficiencies. In addition, its discre- tionary application over time has raised questions about its credibility. Now it simply functions as a system of market signals that delineates OPEC’s current price goals as well as its stabilizing objectives.

The current price target of $25 per barrel marks the midpoint of OPEC’s stability range. However, this price is higher than what the American government finds desirable or even tolerable. The stability objective—keeping prices between $22 and $28 per barrel—seems too wide, even though it is reasonable given the high price volatility and OPEC’s difficulty in reaching a consensus. «Perspectives on the International Oil Market» 35

RISKS FROM SUPPLY CONSTRAINTS

During 2000, world oil supply increased significantly. Between January and November, OPEC raised production by almost 3.9 million barrels per day (mbd) to a total of 29.5 mbd. (It is important to point out that these production increases were made even though all OPEC countries except Saudi Arabia currently produce near the limit of their capacity.) The 29.5-mbd volume is close to what was produced in February 1998 before OPEC reduced output in response to the price drop. It is also close to the maximum historical level reached in 1979 following the Islamic revolution in Iran. Non-OPEC countries have contributed almost 1.5 mbd to the current production increase. In addition, the U.S. government decided to put 30 million barrels of reserves on the market.

In spite of these output increases, stocks of crude oil and oil products are at historically low levels, covering only 75 days of anticipated con- sumption. The lack of flexibility resulting from such low stocks makes countries vulnerable to any interruption in supply and reduces their response capacity. However, it is also true that past stock levels have less relevance for the current situation. Minimum requirements have changed, precautionary measures are more effective, and informa- tion technology allows for greater control over stocks. On the other hand, the current structure of the futures market promotes expecta- tions of low prices, which encourage refiners to minimize their hold- ings. Therefore, as long as the time structure of prices does not change, crude stocks will remain at minimum levels, and this will help sustain price volatility.

On the product supply side, important links in the petroleum supply chain are operating at full capacity. Pressure on refining is intense. During the summer of 2000, it took extraordinary efforts to cover gasoline demand, and now we have to accommodate the expected gasoil demand for heating. This explains the high refining margins of last year. Part of the capacity crunch relates to changes in product specifications. For example, we do not have enough desulfurization capability, and this has significantly increased the differential 36 Session I

between sour and sweet crudes. Refineries are now looking to acquire sweet crude in growing volumes, but the increase in oil pro- duction has been concentrated on heavy and sour crudes.

Some of the pipelines that feed the refineries are operating at full capacity, as are pipelines transporting products. For many years, investment in fuel storage tanks has been minimal, so their capacity is being exceeded, in part because of the diversity of specifications. Sea transportation is also inadequate, causing rates to go up sharply. These imbalances create a very complicated situation, one where efforts to maintain low crude inventories can have detrimental finan- cial and operational effects.

RISKS FROM POLITICAL CONFLICTS AND PROTECTIONIST POLICIES The tensions generated by the Israeli-Palestine conflict are part of a regional context that is influencing the short-term oil market and the future oil supply. At the moment, no one contemplates using oil as a political weapon, but an escalation of the Middle East conflict could change matters. The possibility of a political upheaval is ever-present. The political atmosphere between some countries in the region is deteriorating. Conversely, inter-regional relationships between others are reviving as old enmities fade. These reconciliations pose new uncertainties. The rapprochement between Saudi Arabia and Iran and Iran’s rapprochement with Iraq are surely significant. Under these cir- cumstances, peace efforts in the Gulf have become even more impor- tant. All the main oil industry players, as well as other countries, are conscious of the risk this political instability generates. Any supply interruption, let me emphasize, could have immediate consequences.

The United States is the source of another kind of political risk. Ever since its formation, the U.S. Strategic Petroleum Reserve (SPR) has been the subject of debate regarding its technical characteristics and its potential use. The main issue has been whether the SPR, originally conceived as a supply guarantee for emergency situations, should be used to affect oil prices. Direct market intervention, some argue, is totally out of the SPR’s term of reference. «Perspectives on the International Oil Market» 37

However, this past winter the U.S. government released 30 million barrels of crude oil, ostensibly to reduce a heating oil shortage. Was that the principal goal? One alternate interpretation suggests that the motivation, if not a deliberate attempt to moderate oil prices, was at least an attempt to convince the public that the government was doing something about them. Another possible motive for the SPR release is linked to Vice President Gore’s desire to be president. In any case, it seems obvious that the American government is not prepared to forego responding to price cycles and seasonal fluctua- tions, given the enormous public outcry over high fuel prices.

RISKS FROM ECONOMIC SWINGS

The global economy now seems to be signaling a new swing in its cycle. The strong growth of the world economy, the rapid recovery of the Asian economy since 1998, and the low prices that prevailed dur- ing 1999 stimulated a high growth in demand for crude oil and its derivatives. Crude production increased in response but not fast enough, given capacity limitations, to keep prices from going up. More recently, however, demand has fallen, responding first to high prices and then to the slowing global economy. It is difficult to fore- see what adjustments the present supply-and-demand imbalance will require. Nonetheless, it appears that at the end of the winter, we may see supply exceeding demand and stocks starting to grow.

Transitional Worries In past economic transitions, the market has had a penchant for overadjusting. The fear now is that, with a projected growth in stocks, prices could drop quickly below $22 per barrel, which would be within OPEC’s price-trigger range. Such an event would call for prudent action on the part of producing countries in terms of decreasing output. We all recall OPEC’s error during the autumn of 1997, when the organization continued to increase production in spite of the recession that had already started in East Asia.

Yet the slow economic growth in the United States is especially worrying for producers. In recent years, the strong growth of its 38 Session I

economy has driven world growth. Now, with a 5.9-percent GNP growth slowing to 3.5 percent for 2000, fears are rising over the deceleration and the speed of the deceleration. Any external shock at this time of economic transition would be risky. Just one event from the whole list of possibilities could cause oil prices to skyrocket, and keep them high for quite some time, with serious economic con- sequences. Producing countries should be sensitive to the impact of explosive oil prices, increasing supply if necessary.

The Role of East Asia The economies of East Asia are particularly vulnerable to the rapid deceleration of the U.S. economy. Their commercial links, particularly in the technology sectors, make them very sensitive to any reduction in the growth rate of the information technology field. These sectors were in the vanguard of the expansive phase of the American econ- omy. They will very likely be especially affected now by the loss of dynamism. If this should be the case, we can foresee slower eco- nomic growth in the region, as well as a reduction in crude demand.

The product markets in the area are showing a strong imbalance. Refining margins in Singapore have fallen, and it appears they will con- tinue to do so. Moderation in growth of fuel and naphtha demand for the petrochemical industry, along with strong growth in refining capac- ity from the entrance of new plants and the more efficient use of exist- ing plants, will create a significant product surplus. This excess will face important barriers to export to the United States because of already high and still growing transportation costs and stringent product spec- ifications. Nor will it be easy to move products to the west, since they would face strong competition from Middle Eastern exporting refiner- ies whose output flows to the Mediterranean and Atlantic basins.

As demonstrated in 1998, East Asia plays a critical role in the world oil balance. This region is the main source of incremental oil demand, contributing between 65 and 80 percent of the annual increase. If we add slower global economic growth to the imbalances appearing in regional oil product markets and the presently high price of oil, it is easy to understand the change in market expectations occurring in that part of the world. «Perspectives on the International Oil Market» 39

At the same time, slowing growth in current oil demand in the United States has important consequences for the global balance, given the size of this market. A difference of one percentage point in the growth of demand for imports in this country is equivalent to almost 100,000 barrels per day. So, the simultaneous contraction of Asian and U.S. crude markets at the end of the present winter cycle could have a fundamental impact. Oil countries and international compa- nies should closely watch market behavior over the next few weeks.

THE RISK OF INVESTMENT SHORTFALL

Many of today’s industry perceptions and expectations are related to the exceptional events of the recent past. These memories, combined with a natural aversion to enormous price risk and uncertain oil demand, have made it difficult for the industry to redefine overall strategies and orient them toward expansion.

In the 1970s, simultaneous discoveries in Alaska, the North Sea, and Mexico, coupled with an important increase in output from the for- mer Soviet Union, accounted for a massive increase in capacity. In the 1980s, oil companies became used to operating large global systems characterized by significant capacity excesses throughout the chain. This provided a considerable operating flexibility that made it possi- ble to adapt to structural and organizational changes and easier to maintain global coordination.

However, this excess capacity gradually disappeared during the sec- ond half of the 1990s, although the 1998 price collapse, and the production cuts it brought about, hid the industry’s fundamental imbalances for a time. Now, faced with a growing awareness of this imbalance, we must remember that events of the 1970s are not likely to be repeated. Only the intense development of low-cost reserves in the Middle East would permit a rapid and significant increase in pro- duction in the next five years.

The extremes of price fluctuations in the last few years have intensified the perception of risk for investments in the extractive sector of the industry. The consensus has been that at the end of the present cycle, prices will drop to levels similar to those in the 1990s, if not lower. 40 Session I

Furthermore, until very recently, it was thought that the present phase of high prices would be very short. These perceptions have kept invest- ment levels in exploration and development (E&D) low.

Investment Policies in the Persian Gulf The potential for growth in low-cost oil production centers in the Persian Gulf. Investment decisions in producing countries are swayed by the risk of changing demand. These nations are clearly reluctant to invest in surplus capacity because it is expensive and, more impor- tantly, it tends to depress prices and produce a swift increase in out- put from other producers that would displace demand for their Middle East crudes. The perceived risk is real and comprehensible. Further, the eventual reentry of Iraqi oil to the market colors the plans of the rest of the Gulf producers, since they have to allow for a rapid expansion of Iraq’s productive capacity.

Greater investment and the application of technologies developed in the West during the last two decades could increase Persian Gulf production rapidly. Yet such a course would face important institu- tional and political obstacles. There is a serious problem in that the public companies in some of these countries have weakened finan- cially and fallen behind technologically. They have not developed modern regulatory frameworks and institutions to support oil field expansion. Nor have they assigned sufficient investment resources to increase capacity. A return of the majors to the extracting sector could mean loss of control over production and revenue.

Governments and state companies of the exporting countries are faced with other complex dilemmas in relation to regulating global supply. In an industry where price is not determined by marginal cost, the price level can only be explained in terms of how effective pro- ducers are in coordinating their actions. In the oil industry, this coop- eration takes place mainly within OPEC. Over the short term, they must manage production levels and, over the long term, the expan- sion of capacity. Allowing foreign upstream investment would notably increase the complexity of this task. Clearly, in conditions of global volatility, it is not easy for large exporting countries to put their «Perspectives on the International Oil Market» 41

objectives in order. These dilemmas underlie their apparent ambiva- lence toward opening up to international investment.

Investment Policies of the Majors The present low level of E&D investments by the major oil companies is puzzling. To be sure, they face complex problems stemming from national public opinion and from investor demand for short-term results. Yet the increases in the petroleum prices and refining margins have produced unprecedented profits. ExxonMobil’s recent results, for example, have not escaped notice. The liquidity that has accu- mulated recently in the oil industry is extraordinary. In some cases, these resources have been funneled prudently toward reducing debt and improving balance sheets. In others, a part of the bounty has gone to stockholders. But relatively little has gone to investments. This is partly because the major companies have concentrated their energies, and the talent of their executives, on consolidating impor- tant mergers and on achieving the potential savings that inspired these unions. Some firms may also have kept their resources free to make the additional asset acquisitions obligated by competitive dynamics. (Once the merger phase has ended, they might be willing to take on other investment projects, preferably in the Middle East.) Another explanation for the present reticence of oil firms to invest can be found in the traumatic experience of 1998, when prices col- lapsed with a negative impact on the profitability of some projects.

A CALL FOR INVESTMENT

The current paradox of high prices, extraordinary financial results, and low investment in an industry that has exhausted its existing capacity does not cease to surprise. Given the situation, the most pressing need is carrying out a fundamental strategic reorientation covering both the upstream and downstream.

The bottom line for our industry is providing oil products and services for the public. Only refiners demand crude oil. The public demands gasoline and diesel from accessible service stations. The logistical chain that is essential to this industry has eroded, and it is now necessary to 42 Session I

restore it. However, given the perceived lack of leadership in the major companies regarding the long-term outlook, it may be very difficult, if not impossible, to accomplish this. <>

MR. RICHARD PERLE AMERICAN ENTERPRISE INSTITUTE

Unlike the other speakers on this panel, my background is in inter- national security and political affairs rather than the oil and gas industry. Political matters do affect this industry, however, and so it’s relevant to discuss several matters in that arena that are certain to have an impact. The logical place to begin would be discussing the plans of the next U.S. presidential administration. At this juncture, almost a month after the election, we still do not know who will lead that administration. The vote count is very much in doubt. We know, however, that, by and large, the two candidates reflect traditional party attitudes toward energy issues, and so I can speak to some of the issues and outcomes we might expect with either Bush or Gore as president. I will also briefly discuss a critical political issue relating to energy that the president, no matter who he turns out to be, will have to address.

43 44 Session I

CANDIDATES, PARTIES, AND THE ENERGY INDUSTRY

The outcome of this presidential election makes a big difference to the oil and gas industry in the United States and the world. It would be difficult to imagine two candidates with more diametrically opposed views on fundamental issues that affect performance in this business. On the one hand, we have Governor George W. Bush, who has oil and gas experience from his Texas background and from his own business activity. He understands the industry. More importantly, he understands and believes in competition and is disinclined to interfere with markets and the competitive process.

Vice President Al Gore, on the other hand, is a traditional Democrat. He is happy and willing to intervene in markets, using the regulatory process to achieve what he considers to be politically and socially acceptable results. If it were up to him, for example, market forces would not determine whether Americans drive automobiles with internal combustion engines. Mr. Gore views these engines as a major source of pollution and thinks they should be eliminated. His willingness to use the legislative process to achieve such behavioral changes, which would otherwise be market driven, is very clear.

This political dichotomy is further evident in how the two candidates view the U.S. Strategic Petroleum Reserve (SPR). Adrián Lajous’ analy- sis of that issue was exactly right. The SPR was created to ensure a secure supply in the event of a threat to national security. Congress never intended it to be used for market leverage. Unless I am mis- taken, until the recent decision by the Clinton administration, the SPR has never been employed to ameliorate prices. So a very unfortunate precedent has been established, within the context of a political cam- paign, by an administration of which the vice president is a part.

Another sharp difference between the two candidates is their atti- tude toward protecting the environment. As most people recognize, the oil and gas industry has been a frequent whipping boy for envi- ronmental extremists. I view Vice President Gore as exactly that, an environmentalist prepared to take draconian measures to limit what he regards as environmental damage caused by fossil-fuel use. As he «Politics and Oil» 45

made clear during the campaign, Mr. Gore will not countenance the exploration of areas now closed for environmental reasons, even though, in most cases, the environmental hazards can be appropri- ately managed. So one important difference between the candidates is the readiness to open new energy-producing areas in the United States—in particular, Alaska and offshore—to exploration. If Bush is elected, we may get access to new sources. If Gore is elected, this seems highly unlikely.

Other, less-profound differences exist with respect to renewable resources: for example, the budget size for research and develop- ment or the size of subsidies for agriculturally based fuel substitutes and additives. In these areas as well, the two candidates reflect tra- ditional party attitudes, exaggerated somewhat by Bush’s experience, which is not common to Republican presidential candidates, and by Gore’s experience, which is not so typical either. The vice president has spent his entire life in politics.

OIL AND POLITICS

While the campaign was underway, we experienced a sharp rise in oil prices. This became a political matter in the United States, hence the decision to tap the SPR. The price increase appeared at the start of a slowdown in the American economy, a shift dramatized recently by very sharp declines in equity values on the principal stock exchanges. This event is more important than it has been historically. The buoy- ancy of the American economy has resulted from the combination of some important technology-driven improvements in productivity. Another characteristic of the boom is commonly referred to as the “wealth effect.” In other words, the new economy, which has been producing real value, has by and large been paying the producers of that value in equity options. That occurrence, combined with the rise in equity values on principal markets, has made a great many Americans much wealthier (at least on paper) in a relatively short time. If those equity values decline sharply, it could have, and many economists believe will have, an exaggerated downward effect on the country’s sense of well-being and on the confidence necessary to 46 Session I

keep the economy growing at a high rate. Hence, the current con- cern over the hard landing.

The occurrence of high energy prices just when the American econ- omy may be declining could create very substantial political pres- sures. The tendency to demonize the oil and gas industry, which we have seen everywhere many times over, may rise again. So the oil and gas industry will once more become an object of opprobrium, an atti- tude reinforced, in some ways understandably, by the cartel with the most control over oil pricing. It is very easy to go after OPEC when prices move in a direction that many people find painful.

Having said all this about the two candidates, let me add that neither Al Gore nor George W. Bush is likely to be in a position to act boldly, at least not in the near term. The election was a virtual tie. This fact, combined with the close balance of power in the Senate and the House, preclude a mandate for either party. If you look at the situa- tion ideologically rather than in party terms (some liberal Republicans vote like Democrats and a few Democrats sometimes vote like Republicans), there is no margin at all. Consequently, the balance in Congress will be shifting and uncertain, and, at least initially, this will weaken the next administration. In these circumstances, it is highly unlikely that Vice President Gore could adopt radical environmental measures or that Governor Bush could quickly and easily open new areas to exploration. It’s also unlikely that large innovative programs will be adopted any time soon. So, whatever the concerns from whatever point of view, the limitations on the freedom to act of the next president will likely be substantial early on.

That said, it’s important to note that Americans have a way of rallying around a president once elected. The period of relative weakness may turn out to be surprisingly short as people accept his legitimacy and he begins to build a base of support. So over the long term, the differ- ences between the two candidates are likely to emerge in substitute actions, although these are not likely to have any immediate effect.

The practical impact of these events will be a lessening of the gov- ernment’s ability to influence market-driven prices and market-driven «Politics and Oil» 47

forces, which on the whole is a good thing. The less the government intervenes in markets, the better. The primacy of markets over gov- ernment intervention is highly desirable, and that is likely to be the principal outcome of this most unusual election.

THE PROBLEM WITH IRAQ

The one exception to all this downplaying of governmental activism is a political matter the next president will be forced to address. It is a matter of some urgency, even though it is not being discussed as such now. I’m talking about U.S. policy toward Iraq. That country is a time bomb. Saddam Hussein is entirely unpredictable. There is every reason to think he considers himself victorious after a decade of conflict with the United States. The U.N. sanctions are eroding sharply and in many ways have ceased to function altogether. The coalition raised against him is much weaker now. Given his supposed triumph, Saddam has been inclined to claim leadership of the Arab world.

The next president will have to handle Iraq decisively because the sanc- tions will not survive the four years of his presidency. No American president would want to accept responsibility for the collapse of a pol- icy aimed at containing Iraq. Therefore, we may see dramatic events with respect to that country, either because Saddam believes he is free to take action of his own, which would then be countered, or because an American president concludes that he must act.

We Americans don’t always support decisive action. Even so, on this issue the American president, whoever he may be, will likely have to make some very tough decisions, sooner rather than later. <>

THE HONORABLE HUMBERTO CALDERÓN BERTI CALDERÓN BERTI AND ASSOCIATES

As we meet at this XI Repsol YPF-Harvard Seminar on Energy Policy and reflect on world oil markets, let me begin by noting a significant change from the past: in earlier years, most oil price increases were produced by Middle Eastern political events. In 1973, for example, prices went from $2.50 to $10 per barrel during the Yom Kippur War. In 1979, when the Shah of Iran was brought down, prices went from $12.70 to $26 per barrel. In 1980, prices rose above $30 when the Iraq-Iran conflict started.

Things are different now. The significant price increases of 1999 and 2000 were not produced by political turmoil in the Middle East. Obviously, the Arab-Israeli conflict has affected the present situation, but it is a background factor. The principal cause is OPEC’s attempt to regain price control in the aftermath of a period of ruinously low prices. The change in circumstances provides a compelling reason to review the history of oil prices since the inception of OPEC and to offer suggestions for future price strategies. In addition, I will briefly

49 50 Session I

examine how the new situation has made it necessary for oil com- panies to broaden their involvement in international and domestic politics and in environmental matters.

OPEC’S ROLE IN SETTING OIL PRICES When OPEC was created in 1960, the organization’s goal was to pro- vide a stable supply of oil from its members at a price that would assure adequate revenues for these producing countries. How could this be accomplished? Through price control achieved by lowering or raising output when prices are too low or too high? Or by the oppo- site: raising sales when prices are low to maintain revenues through volume? These options have sparked a long discussion that has never been resolved. OPEC’s original theorists, Pérez Alfonso from Venezuela and Abdullah Tariki from Saudi Arabia, defended a policy of high oil prices. In 1960, with prices at $3 per barrel, a higher price was certainly a valid goal. However, history has proved that whenever OPEC has tried to keep prices above a sustainable level, it has blun- dered. For example, the increases in 1979 and 1980 and the subse- quent attempts to sustain a price over $30 were big mistakes. Reducing production from 30 million barrels per day (mbd) in 1979 to 15.5 mbd in 1985 to keep oil prices at that level was also a big misstep. In each case, OPEC paid for its mistakes.

The reason OPEC’s attempts to keep prices high have always failed is that high oil prices have collateral effects. First, high prices boost the development of high-cost reserves and alternate energy sources and foster significant technical breakthroughs. For example, efforts to maintain a price over $30 per barrel enabled non-OPEC countries to increase their high-priced supply. In 1973, the North Sea produced 4,500 barrels per day. Now it pumps almost 6 mbd. Second, high prices reduce financial risk and stimulate investment (even over- investment) in exploration and production, resulting in higher vol- umes of available crude. These high volumes subsequently lower prices and ruin competition on international markets. Lower prices increase financial risk and depress investment and the cycle goes on. This is not good for anyone—not for oil producers, not for oil com- panies, not for consuming nations. «Further Considerations on the Price of Oil» 51

OPEC came to understand these cause-and-effect relationships slowly. In 1986, the organization changed its strategy. By growing volumes at competitive prices, it was able to recover its market share. In that year, when prices dropped from $30 per barrel to less than $10, OPEC increased production from 15 mbd to 20 mbd. Between 1986 and the Gulf War, prices remained moderate and the situation stable, and the world economy grew stronger. However, OPEC kept trying to achieve an ideal price of $18 per barrel. In spite of its efforts, the price remained stubbornly below that level.

The Kuwait crisis of 1990 caused only a small increase for a very short time. Other producing countries were not affected by this conflict; they merely increased output to circumvent high prices. Obviously, they had learned from the experiences of 1973-1974 and the 1980s.

The moderate prices after 1986 promoted overall economic growth but did not stimulate sufficient investment to increase production in response to the demand that arose from that growth. From 1986 to date, energy use has grown between 2 and 2.5 percent per year, which implies a demand increase of 1.5 mbd. The only exception came in 1997, when the Asian crisis occurred and demand grew only 1.5 percent.

In that year, OPEC made a serious mistake. In August, with the Asian market crisis just beginning, OPEC met in Jakarta and increased pro- duction by more than 2 mbd. That action caused an immediate mar- ket collapse, plunging prices below $10. In 1998, OPEC and other oil producers took steps to reverse this situation. The ministries of Saudi Arabia and Venezuela, joined by non-OPEC Mexico, pressured the organization to stabilize the oil market by lowering production quo- tas. OPEC reduced output, but some members did not comply. This prevented a recovery in 1998. Then Hugo Chavez won the presiden- tial election in Venezuela. He promptly took up OPEC’s banner and pressed for OPEC’s member countries to honor their production cuts. He succeeded. In 1999, OPEC achieved 95-percent compliance with its reduced production quotas. This brought about the price increases of that year. 52 Session I

We are currently high on the price cycle again. OPEC is again trying to maintain oil prices above $30 per barrel. If this strategy is success- ful, it will be a disaster.

IN SEARCH OF A REASONABLE PRICE

We have already heard Alfonso Cortina of Repsol YPF and Adrián Lajous of PEMEX emphasize that continued high oil prices would have a negative impact on the world economy. In addition, such prices would foster investment and production increases, and the combina- tion would bring prices down again, especially given the slowing of the world economy and demand. If OPEC maintains this price for even a few years, I have no doubt that prices will collapse again.

I believe—in fact, I have insisted, both in my own country and wher- ever I have spoken abroad—that OPEC should follow a strategy that uses both price and volume to achieve a stable price. A reasonable price would allow oil to compete with other energy sources. It would also allow the world economy to grow, which in turn would increase oil demand. In addition, prices that compensate investment in the oil sector would help guarantee growing volumes on the market to sat- isfy this demand. Consequently, the best goal—for consuming coun- tries, for producing nations, for the international economy, and for oil companies—is a reasonable oil price.

OPEC’s median target of $25 per barrel is not reasonable. Instead, a price between $20 and $23 per barrel would be ideal for expanding oil’s horizon as an energy source, for allowing economic growth, and for preventing a revenue reduction that would encourage production increases and ultimately lower prices. The lower-price side effect is important. It relates not only to oil and tax revenues but also has col- lateral effects on engineering firms, service companies, the metallur- gical industry, and so on. For our economy, the balance of price and volume is very important. Consequently, we should encourage OPEC to change its view about what constitutes a reasonable price target.

There is some hope of this happening. OPEC met recently in Caracas. While the meeting was not a complete success, it had some encour- «Further Considerations on the Price of Oil» 53

aging outcomes. One was the declaration regarding cooperation between national and private oil companies and integration in down- stream activities. Venezuela has already opened the door to invest- ments by private oil companies. In addition, Venezuela, Kuwait, and Saudi Arabia have put money into the downstream side of the oil business. There are additional areas of cooperation, however, that would further such integration. For example, international compa- nies should enter oil-producing countries to drill and pump oil, but the national oil companies should transport and market it. Or at the least, the national and foreign companies should jointly participate in downstream activities. This has not been the case so far, but it is an important area of collaboration to pursue.

The Caracas declaration also touched on competitive prices. Not much was resolved there. Consequently, much remains to be done. One issue that needs to be addressed is how the futures market is distorting the oil business. OPEC’s weight in the futures market is insignificant. The next Secretary General of OPEC, who will take office in 2001, will have to consider how to deal with this concern. This will be discussed in the coming months, along with the contin- uing debate over futures market prices.

THE EXPANDING ROLE OF PRIVATE OIL COMPANIES

Another important declaration at Caracas was that private oil com- panies have very important roles to play in several areas. First, they should become more involved in the dialogue between producing and consuming countries. So far this discussion has been solely between governments. Yet companies are also eager to find ways to stabilize the market, to create a constant flow of oil at reasonable prices, and to avoid price volatility.

Another area that requires the participation of oil companies is the environment. The apparent effect of hydrocarbons on our atmos- phere will continue to be a topic of concern for future international forums and initiatives. We cannot ignore the issue. Again, the debate so far has taken place solely between governments. For gov- ernments to address environmental concerns successfully, they need 54 Session I

the cooperation of private companies in researching and generating the necessary new technologies. This collaboration is also critical to ensure continued expansion of the oil-use horizon.

The tax impact in consuming countries, particularly in Europe, is another important issue oil companies cannot ignore. Public opinion in Europe regarding energy prices is sensitive. OPEC and the oil com- panies have been made into scapegoats for high fuel prices there. In reality, OPEC and oil companies have nothing to do with the situa- tion; it is the government-imposed taxes that cause problems. To resolve this dilemma, we must create a dialogue between producing and consuming countries that includes private companies. If we can achieve price stability and establish a reasonable tax level, this will make the situation bearable for consumers and ease the animosity toward OPEC and oil companies.

THE CHALLENGE FOR OPEC

As I noted earlier, all sides in the oil market debate have an express desire for stable output and stable prices. So why has it been so dif- ficult to achieve this end? Principally because the political situation in the Middle East has an exaggerated effect and militates against establishing a long-term policy. These political troubles challenge the survival of several governments and force a focus on short-term problems. In this situation, many must forego the luxury of consider- ing long-term issues.

Another obstacle to consensus is that, within OPEC, there are con- flicting interests between the countries with vast resources and those with limited reserves. The larger OPEC countries—such as Saudi Arabia, Iran, Iraq, and Venezuela—have a common long-term goal: expanding the horizon for oil use for many years. The limited-reserve nations want to produce at the highest prices in the short term to optimize revenues, but this goes against the interests of the larger nations. Four or five years ago, OPEC numbered 13 countries. Now we are 11. In Africa, Gabon left, and in Latin America, Ecuador departed; their national policies were not compatible with OPEC’s «Further Considerations on the Price of Oil» 55

long-term policies. Unless agreement is reached, more countries will leave the organization because of contradictory interests.

OPEC is trying to remedy the situation. It has made an important effort to establish a common goal among oil producers. Already, the coordination achieved between members and non-members— Mexico, Russia, and Norway—has strengthened prices. The ultimate challenge for OPEC is to find a way to sustain this cooperation inter- nally and externally, keeping the focus on stabilizing the price at a reasonable level. If the organization can achieve this goal, its future, in fact the future of all those involved in the oil market, will be much less uncertain. <>

MR. JAMES RAGLAND ARAMCO SERVICES COMPANY

I wish to emphasize at the outset that I am speaking on my own behalf, and that none of my comments should be in any way thought of as representing Saudi Aramco or its management. That said, today Professor Hogan has asked me to discuss my views on how petroleum inventory levels relate to price volatility and market stability. I’ll begin by talking about what shapes price expectations and then speak briefly about how lack of accurate inventory data has stymied OPEC’s attempts to establish price stability. Next I will outline the types of inventories found across the oil industry and speak to the effect of stock levels on price volatility. Finally, I’ll examine current concerns over petroleum and petroleum product prices, touching in conclusion on recent policy proposals designed to address the problem.

57 58 Session I

TRADER SENTIMENT, NOT STATISTICS, SHAPES PRICE EXPECTATIONS

Short-run oil market trends are driven by how the trading community views current market conditions, not detailed information on supply- and-demand fundamentals. This year, the consensus view among oil market commentators is that OPEC has “regained control of the market.” Several important factors lie behind this conclusion. First, many believe the internal conflict between the members has less- ened considerably. One example is the rapprochement between Iran and Saudi Arabia; another is how Venezuela under President Chavez has moved from being the largest over-producer in OPEC to become the champion of output quota limits. The proof of the organization’s new effectiveness is the recovery in prices from last year’s lows and the prolonged period of lower-than-“normal” inventory levels in the main oil-importing markets.

Tight supply, of course, also reduces the distribution system’s ability to react to short-run disruptions in throughput. In other words, any drop in either production or throughput elevates prices because low stocks in consuming areas lessen the capability to make up for tem- porary shortages. This situation also increases the incentive for final consumers to hold inventories, which in turn leaves less supply for commercial stocks (which are the basis of the published stock data). All these factors tend to increase observed price volatility.

Given the system’s lack of flexibility, the output decisions by the one remaining group with available additional production capacity— OPEC—take on a disproportionate importance to short-run market sentiment. Iraq’s repeated actions to interrupt oil shipments under the U.N. humanitarian sales program have only increased concern over available supplies. The consensus view (circa late November 2000) among market experts then is that without increased produc- tion from the Gulf oil exporters, prices will move sharply higher due to tight supply.

Very little attention is given to the likelihood that this view might be incorrect or founded on out-of-date or inaccurate data. We should «Petroleum Inventories: Economics and Logistics» 59

keep in mind that while the spot market remains within any trading range, price changes generally reflect the patterns outlined by the sta- tistical tests that drive the traders’ “technical analysis” rather than the reality of underlying market fundamentals. The industry press rarely comments on this aspect of NYMEX and IPE trading. Prices tend to remain inside a technically determined trading range bounded by “support-and-resistance” levels until a significant shift in fundamen- tals forces recognition that the range is insupportable. When this happens, prices move sharply in one direction or the other until they cease to “plunge lower” or “soar ever higher,” depending on the direction of change. At that point, the now-recognized change in fun- damentals driving the shift in the supply-and-demand balance becomes the basis for a new consensus view among market analysts.

Those analysts clever enough to recognize when the market is about to break out of a trading range are also clever enough to keep it to themselves. The rest of us have to rely on the one clear indicator of overall supply-and-demand balance: the level of commercial invento- ries in OECD markets, which at present appears to point toward a rel- atively tight supply situation.

STABILIZING PRICES: OPEC’S DILEMMA

The dilemma OPEC nations currently face is deciding how much oil to produce to achieve price stability next year. Historically, this has been a difficult feat to accomplish. The major stumbling block they face is the lack of complete, accurate information on world oil stocks. In recent years, the organization’s output decisions, along with those of non-OPEC producers, have been on a veritable roller coaster. As Figure 1 shows, the rate of change in output by both groups has been very erratic.

Graphing the percentage change in price over the two sets of output changes illustrates that prices have been on the same roller coaster (see Figure 2). It also seems to indicate an interesting relationship between OPEC and non-OPEC stock movements and price changes. It appears that if OPEC output increases at a slower rate than 60 Session I

Figure 1 Change in Crude Oil Output, 1993-2000 OPEC vs. Non-OPEC Nations

% Change in Output 8%

6%

4%

2%

0%

-2%

-4%

-6% 1993 1994 1995 1996 1997 1998 1999 2000 OPEC Non-OPEC

Figure 2 Change in Crude Oil Price and Output, 1993-2000 OPEC vs. Non-OPEC Nations

% Change in Output % Change in Price 8 60 50 6 40 4 30 2 20 10 0 0 -2 -10 -20 -4 -30 -6 -40 1993 1994 1995 1996 1997 1998 1999 2000

OPEC Non-OPEC Price «Petroleum Inventories: Economics and Logistics» 61

non-OPEC production, prices go up. When the OPEC output grows faster than increases by non-OPEC producers, a sharp price drop occurs. This is followed by a substantial reduction in OPEC output (and a much smaller cut in non-OPEC production) and eventually prices begin to rise. As the figure indicates, price levels fell by over 32 percent in 1998 and then rose by almost 39.2 percent in 1999 and another 56 percent this year.

OPEC oil revenues have also varied substantially, as can be seen in Figure 3. In 1998, the organization as a whole took in $100 billion. For 2000, it expects to collect $250 billion, an increase of 150 per- cent. This volatility has, of course, a devastating impact on the domestic economies of the less-developed members, and so finding a means to stabilize national revenues is the most important factor behind the exporters’ efforts to achieve market stability.

Figure 3 OPEC Oil Revenues, 1997-2000

Billion US$ 300

250

200

150

100

50

0 1997 1998 1999 2000

DATA SHORTCOMINGS AND MARKET STABILITY Whenever oil exporters meet to decide future production levels, they must base their decisions on the “best” data available. From pub- lished commentaries, we learn that they normally take a “top-down” 62 Session I

approach. In the simplest terms, they consider total demand and the most likely non-OPEC output and then allocate the remainder among themselves. If the estimates of demand growth are too optimistic (as they must have been in 1997 and 1998), or the outlook for non- OPEC output too pessimistic (as it was for the North Sea during most of the 1990s), the hoped-for stability is not achieved and output decisions are reassessed at subsequent meetings.

Poor Data on Current Fundamentals Unfortunately, available data on current fundamentals are incom- plete and imprecise. It usually takes several months or even years before accurate assessments can be made. The almost constant revi- sion of demand data covering periods of as long as two years testi- fies to the difficulty in correctly measuring these markets. Therefore, the exporters must rely on the same set of data used by the pub- lished market analysts (as already noted), that is, the level of com- mercial inventories in OECD nations. That is always the one “hard” data point that everyone understands.

This belief that reported inventory levels are any more accurate than the rest of the short-run data is an unfortunate myth. Inventory data are more or less useless as a short-term proxy for fundamentals. Data sets with sufficient accuracy to be considered anything but anecdo- tal do not exist for areas outside the OECD. Even the OECD infor- mation is flawed. In the European Union, the inventory data available use an inconsistent set of definitions and different levels of detail. It is very useful to those familiar with all of any region’s unique charac- teristics to plan distribution and retail activities (as you know much better than I), but over a wide area across Europe, accurate and timely data are very difficult to find.

Even data for the United States, considered the most reliable in the world, can be often misleading. The most noted data are weekly, which tend to give a totally unfounded aura of specificity despite their being revised constantly. For example, bad weather in the Atlantic can delay tanker shipments. If a single tanker lands a few days off schedule, the change in the weekly crude stocks estimate «Petroleum Inventories: Economics and Logistics» 63

moves by millions of barrels. And controversies over definitions are everywhere. For example, despite the government’s insistence that all stocks in commercial storage facilities be counted, there is no way to determine who actually holds title to the inventories, and no general agreement as to what commonly used inventory terms mean.

Given the incomplete and sometimes inaccurate data, is it truly pos- sible for a group of exporters with OPEC’s market share to stabilize prices unilaterally? The answer is almost certainly “no.” Until the share of the market served by non-OPEC producers decreases due to depletion, a stabilization policy based on shifts in residual production will not work.

The OECD’s efforts this fall to lobby OPEC members for increased output provided a good study of the difficulty in attempting to alle- viate short-haul price pressures in the Atlantic Basin with long-haul supplies from the Gulf. As prices rose in Northwest Europe, OPEC nations increased supply. However, at the same time, a single trading firm in the European Union was attempting to manipulate Brent prices by purchasing physical supplies and then “sanitizing” the vol- umes by shipping approximately 500,000 barrels per day to the Far East market. The extra supplies from the Gulf producers, of course, took several weeks to reach Northwest Europe (sailing in the oppo- site direction from the Northwest European Brent being sent east). By the time the supplies reached their destination, prices had already moved down from the previous high levels.

Attempts to Improve Data Accuracy OPEC and the IEA exist because their members felt the need to take collective action against what they considered bad faith actions by the other side. It will be a difficult process for the two sides to move toward a better accommodation of the other’s viewpoint. Nevertheless, this process received a major boost at the recent meeting in Riyadh, Saudi Arabia, of the International Energy Forum, the current form of the dis- cussions previously known as the “Producer-Consumer Dialog.” At that meeting, the Saudi Arabian government proposed establishing a per- manent Secretariat staff to work on facilitating greater transparency 64 Session I

and improved data accuracy for the benefit of both sides. The pro- posal will be the basis of further negotiations.

However, the sources of the most comprehensive data are institu- tions such as the IEA (and the EIA in the United States), which exist to safeguard against the actions of the exporters. Moreover, govern- ments in the OECD rely on petroleum taxes for a significant segment of their revenues, often receiving more than two or three times the share of the final price for petroleum products than the exporting nations. These governments justify such taxes by stressing the need to keep imports minimized to reduce “. . . the risk of future disrup- tions, etc.” This is a sore point with OPEC. Therefore, it is not clear how soon we can expect any major breakthroughs in the relations between OPEC and the OECD or in data quality.

INVENTORIES, LOGISTICS, AND PRICE VOLATILITY

Types of Petroleum Inventories In most industries, stocks and inventories are simply normal parts of the logistical system, not a key variable in price forecasting. Building inventories at break-bulk locations is a common and straightforward method for reducing disruptions in throughput caused by unantici- pated disruptions in supply flow. There are three types of inventories spread throughout the oil industry: primary, secondary, and tertiary. • Primary stocks refer to the minimum amount of throughput required by the distribution system itself, i.e., pipeline fill, export terminal storage, tanker fill, import terminal storage, refinery storage, pipeline fill, tank farm storage and dealer tanks, etc. • Secondary stocks are held by commercial firms for companies involved in the commercial supply chain. They are also held by traders and brokers for use as speculative assets. • Tertiary stocks are those held by end users of petroleum prod- ucts, e.g., the fuel in automobile and truck tanks and in storage for use by residential, commercial, and industrial customers. «Petroleum Inventories: Economics and Logistics» 65

The final elements in the system are strategic facilities held by gov- ernments. These consist primarily of a) excess production capacity in a few oil-exporting nations (most of which is in Saudi Arabia), and b) the strategic petroleum reserves (SPRs) held by IEA member states. The SPRs were set up to ensure freedom of action for oil con- sumers. If someone threatens, for whatever reason, to cut off a nation’s supply of oil imports, SPR stocks would help minimize the economic damage. Thus, these reserves theoretically serve as a deterrent to such threats.

Inventories and the History of Petroleum Price Spikes Three factors are key to understanding how the petroleum products distribution system reacts to disruptions: • Determining the required level of inventories is more closely tied to the rate at which products are consumed than the total demanded.

• Tertiary inventories represent by far the largest volumes in the system.

• Supply problems tend to occur at two bottlenecks: first, at the pro- ducer/export interface, where pipeline throughput can be halted or terminals closed down; second, at the distribution/tertiary inter- face, the point where product gets into consumer hands.

Short-run price surges in the past were caused by unanticipated hitches in the logistics chain caused, for example, by natural disasters or, more commonly, a political or military action by a government. How these problems actually develop, however, is not generally understood, and so I ask your indulgence while I discuss how supply disruptions in the past were more an issue of perception than reality.

Ironically, the most famous example—the 1973 oil embargo—came about almost completely because of a reaction to the appearance of a disruption rather than an actual reduction in supply. We now know 66 Session I

that when faced by the embargo, the multinational oil companies did not comply with the letter of the exporting nations’ demands but simply reallocated crude shipments among importing nations. There is very little evidence that any one country got less oil. Nevertheless, the embargo caused panic in the United States due to the con- sumers’ perception of a lack of supply. To see how this occurred, we must consider how the distribution system works in practice.

The average U.S. driver refills his vehicle’s fuel tank when he has approximately one-tenth of a tank left or less. Therefore, the design of the U.S. gasoline distribution system is set to fuel one-tenth of the fleet on an average day. News reports on the embargo indicated that refiners would not be able to find alternative supplies quickly enough to avoid a sharp price increase. U.S. consumers naturally acted to purchase gasoline before that price increase hit, and so depleted the stocks at the distribution/tertiary interface (what were then referred to as service stations). Immediately, the rate of throughput in the sys- tem’s design was insufficient to meet the increase in demand for ter- tiary inventories. How could it have been? The next eight weeks of supplies were at sea in tankers, or in pipelines, or in refinery stocks, and so on down the distribution chain. Once U.S. drivers decided they had to keep their gas tanks no less than half full, the system faced an overnight five-fold increase in demanded throughput. To this day, the image of lines of vehicles stretching into the distance is how most Americans envision the issue of “energy security.”

In the long run, of course, the system remained appropriately sized. Total fuel demand is determined by vehicle miles traveled, not the refueling schedule. At that instant, however, the shortage of tertiary stocks drove prices sharply higher and elevated a geo-political and diplomatic challenge into an economic crisis.

Prices rose even more sharply after the 1979 reduction of Iranian exports brought on by the Iranian Revolution. Once again, it was not an actual shortage of crude, but rather a perception of one that pan- icked U.S. gasoline markets. After the 1979 crisis, Congress held hearings on the oil industry’s actions and asked the chief executives «Petroleum Inventories: Economics and Logistics» 67

of major oil companies how this could occur twice in one decade. The congressmen considered the lack of “sufficient” stocks evidence of an intent to “gouge” consumers. Threatened with new legisla- tion, oil companies immediately embarked on a stock-building effort that continued until late 1981.

That rush to build inventory pushed real prices to the highest levels seen in the 150-year record of petroleum trade. During this period, the prices received for crude did not reflect the relative values of their respective product slates. For example, heavy sour crude oils such as Iranian Heavy sold at prices well in excess of more gasoline-rich crudes such as Nigeria’s Bonny Light. After 1981, the inventory-building frenzy steadily declined, and this in no small part caused the long downward slide in crude prices that occurred over the next several years.

THE CURRENT CONCERNS OVER PRICES

Over the last year, the United States has experienced two price spikes—one in heating oil and one in gasoline. It has also released oil from its strategic petroleum reserve in an attempt to moderate crude oil prices. These events show that worry over price volatility and per- ceived supply problems continues to drive U.S. political decisions regarding the oil industry. This is true for Europe as well.

U.S. Heating Oil Price Spike The United States experienced another price spike early this year when a disruption at the distributor/tertiary interface occurred. The Northeastern states had a pronounced cold snap in late January and early February. The region had experienced several milder-than-nor- mal winters leading up to last year. Under pressure to cope with declining margins, many natural gas distributors began to offer new contracts based on interruptible terms as part of the energy deregu- lation. In other words, the supplier agreed to charge the user a lower price with the understanding that during a period of peak demand, that is, when the distributor was pressed to meet its obligations to residential customers and utilities, the interruptible customers would be denied supplies. 68 Session I

This was a common practice for commercial and industrial users, but it now had spread to multi-unit residential customers such as apart- ment buildings. These enjoyed a lower rate for most of the year. Whenever supplies were interrupted, they would switch to heating oil until the gas peak was over. Last winter, when this happened to gas consumers during the cold snap, they returned to a heating oil market that had been facing tight supplies for several months. Consequently, the market had insufficient stocks to cope with the surge in spot demand and prices moved sharply higher, causing a major populist protest. The media carried stories about people in apartment buildings going without heat for several days because the spot price heating oil was excessively high. Of course, there was no shortfall in seasonal supply; that is, natural gas was available. The problem was the imperfection in how consumers had contracted for it and the distributors’ decision to not build precautionary stocks.

U.S. Gasoline Price Spike The summer saw another regional price spike in the Midwest region caused by a breakdown in one pipeline and the implementation of new environmental standards requiring unique product compositions for several different urban areas. When faced with widespread consumer anger over the sharp rise in prices, the government announced an investigation into the price-gouging activities of the regional refiners.

U.S. SPR Oil Release Earlier this fall, growing consumer concerns over rising crude prices led the Clinton administration to releasing 30 million barrels of oil from the U.S. SPR in a program based on a time swap (i.e., the oil is swapped for future deliveries into the reserve). While this action may be good for election-year politics, it was clearly an example of using strategic stocks for non-strategic purposes. It certainly isn’t a cost- effective system. The oil sold out of the SPR had been purchased at real price levels much higher than those seen today. Once that oil was stored in the SPR, it represented a dedicated investment in working capital, and its opportunity costs started mounting. Oil bought in the late 1970s now represents well over $100 per barrel in 2000 dollars in «Petroleum Inventories: Economics and Logistics» 69

costs. Using oil that taxpayers paid more than $100 for to try to force oil prices below $34 is hardly an effective price-control mechanism.

IS THERE A POLICY TO ENSURE STABLE PRICES?

Throughout 2000, consuming nations continued to believe that achieving greater stability in supply and prices required higher stock volumes. To that end, these countries began an unprecedented lob- bying campaign to get production increases from oil-exporting nations. These attempts reflect the general perception of importing nations regarding OPEC’s role in the supply system. As I have argued, the concept that OPEC should or even could effectively maintain a system of stable prices by altering its output levels in reaction to short-term market perceptions, whether to meet anticipated demand or to replenish stocks while keeping prices within desired levels, is an impossible task.

Is there another way to achieve stable markets? A method that would allow exporters to avoid lower prices when they have overes- timated demand or underestimated non-OPEC production? One that would provide consumers with a steady source of production with sufficient capacity to overcome any short-run disruption to output? One proposed answer (and one increasingly being suggested in Washington these days) is to “encourage” OPEC exporters to build more spare production capacity. How the policy would create stabil- ity is unclear.

The problem with such a program goes back to the issue of who benefits and who pays. Oil-importing nations benefit from excess production capacity in the oil-exporting nations, but the exporting nations would pay to make the investments. With a few exceptions, the oil exporters are striving to bring more capacity into being, and if prices are within some desired range, they do not intend leaving any of it idle.

The history of distrust on the part of both groups is too long for such a program to move forward. It seems ironic that it is only in 70 Session I

Washington, D.C., that policy analysts could seriously suggest that the United States, Iran, and even Iraq could ever consider such a pro- gram. The producing countries would be very unlikely to trust nations that have stifled their oil capacity growth with sanctions.

These facts seem to offer an insurmountable obstacle to such pro- posals. This is a pessimistic ending, l know. In many countries, such as here in Argentina, reforms have overcome barriers that must have once seemed insuperable. A more optimistic spirit is abroad in this and many other nations. However, things do not change rapidly in the international oil market. We will just have to wait and see if my pessimism is justified. SESSION II

ENVIRONMENT: WHERE IS GLOBAL CLIMATE POLICY TAKING US?

INTRODUCTORY REMARKS

PROFESSOR ROBERT N. STAVINS HARVARD UNIVERSITY SESSION CHAIR

I am delighted to welcome you to the second session of the XI Repsol YPF–Harvard Seminar on Energy Policy as we discuss our topic, “Environment: Where is Global Climate Policy Taking Us?”

This is the sixth Seminar in which I have been privileged to partici- pate. I want to thank Alfonso Cortina and all the Repsol YPF team, from both the foundation and the corporation, for all their support through the years, for the marvelous work they have done as col- leagues and organizers in producing these Seminars, and for the wonderful hospitality they have lavished on us all.

Before I introduce our distinguished panel of speakers, let me offer some brief and, I hope, helpful background information for those among you who are not aficionados of global climate change and global climate change policy. I will say a few words about climate change, about the Kyoto Protocol, and about the key issues raised at The Hague just two weeks ago.

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After more than a decade of international policy debates on the topic, the Kyoto Protocol on Global Climate Change was issued in 1997. It establishes targets and timetables for reducing greenhouse gases (GHG) in the industrialized countries. However, the Protocol left many issues unresolved. A critical set of problems was brought forward for possible resolution at the Sixth International Conference of the Parties in The Hague (COP6), which adjourned less than a week ago. Today, we are here to discuss the aftermath of that important meeting.

I am not going to tell you what happened at COP6; I will leave that to the panelists. Instead, I would like to take you through the major issues up for resolution at the meetings in The Hague. • First, should the responsibility for reducing emissions fall only, or principally, on the industrialized world? Or should key develop- ing countries—for example, China and India—also assume emis- sions commitments or pledge to some other specific actions? Note that these countries already emit large amounts of green- house gases. With the expected rapid growth in their popula- tions, economies, and energy use, they will be among the significant emitters of the future. • Second, how should emissions be controlled? As you know, in

addition to controlling CO2 emissions by limiting discharges from

fossil-fuel combustion, it is also possible to remove CO2 from the atmosphere. For example, when trees and other plants grow,

they absorb CO2, converting it into carbon in plant matter and the soil. (The shorthand term for the result of biological carbon sequestration is a “sink.”) Can sinks be used by countries to meet their national emissions reduction targets? And if they can be used, how can they be measured? And to what degree can they be used? • Third, what methods and institutions could be developed for compliance and enforcement? Surprisingly perhaps, the Kyoto Protocol doesn’t say much about how the international agree- ment would be enforced. So another unresolved issue is how to encourage (or mandate) and monitor compliance. Introductory Remarks 73

• Fourth, how should we use flexibility mechanisms? The Kyoto Protocol includes three so-called flexibility mechanisms, which are potential ways of increasing flexibility and reducing costs for the complying countries. These proposed approaches include inter- national emissions trading, joint implementation, and the clean development mechanism (CDM). In theory, the flexibility mecha- nisms would lower compliance costs significantly and thereby encourage the participation of more countries, which in turn would boost the effectiveness of the Kyoto Protocol. However, before the COP6 meeting, these mechanisms remained unde- fined. How they would operate has not been made clear.

The Protocol allows developing countries essentially to opt into the CDM. So the question is whether this provision can play a significant role in increasing the commitment of these nations to the work of limiting emissions.

Another aspect of flexibility mechanisms is whether their use should be limited. On the demand side, the question is to what degree countries could buy permits to lessen the need for domestic reductions in emissions. On the supply side, the issue is whether particular countries—Russia, for example—should be allowed to supply as many permits as they can.

• Fifth, can private firms, corporations, or individuals participate in the international trading of permits? This non-governmental trading is absolutely essential for the mechanism to be truly cost- effective, yet the Protocol refers to the participating parties only as the countries, signatories, or nation states. • Finally, the overarching question is whether the architecture of the Kyoto Protocol, as written under the Framework Convention on Climate Change, is the right approach for successfully addressing the threat of global climate change in the short and, more importantly, the long run.

Let me conclude with some good news and some bad news. The bad news you can probably already discern from what I have said. After 74 Session II

COP6 adjourned last week, many important, difficult, and controver- sial issues still had not been resolved, not even after more than a decade of analysis and five years of work on the agreement.

The good news is that our three distinguished panelists are very knowledgeable on the topic. They were at COP6 last week, and they are in an excellent position to enlighten us on where global climate policy is taking us. • We will hear first from Professor Charles Kolstad. He is the Donald Bren Professor of Environmental Economics and Policy at the University of California at Santa Barbara and one of the world’s leading environmental economists. He has done consid- erable research relevant to the global climate policy issue. Professor Kolstad is the new president of the Association of Environmental and Resource Economists. • Our second panelist, Dr. Alain Heilbrunn, is familiar with the broad issues we are here to discuss. Dr. Heilbrunn is director of European Public Affairs for TotalFinaElf. He has been a regular observer and participant in the meetings on climate change. He also has con- siderable experience in working in international settings. • Finally, we will hear from Dr. Brian Flannery, the Science Strategy and Programs Manager in the Safety, Health, and Environment Department of ExxonMobil Corporation. Dr. Flannery has been a key figure speaking on behalf of business and industry in a vari- ety of international forums on global climate change, including the Framework Convention on Climate Change and the subse- quent discussions about the Kyoto Protocol. <>

PROFESSOR CHARLES KOLSTAD BREN SCHOOL OF ENVIRONMENTAL SCIENCE AND MANAGEMENT UNIVERSITY OF CALIFORNIA, SANTA BARBARA

I attended the meeting of COP6 at The Hague as a member of the University of California non-government organization (NGO), a group of seven natural scientists and one economist providing “neu- tral” technical advice to whoever would listen. It was my first time at a treaty negotiating session, and it was an eye-opening experience. I would like to share some of my observations about the negotiating process with you. Then I will turn to what might be done to break the apparent deadlock and to move negotiations on climate change policy along, mentioning areas of agreement and points of disagree- ment. I will close by suggesting possible strategies for dealing with the apparent deadlock that grips the Kyoto Protocol ratification process and by offering some advice for the next U.S. president.

First, let me state my position on climate change. I believe—and this belief concurs with the declaration made by some 2,500 economists in 1997—that climate change is a real problem. There is uncertainty over the details, to be sure, but the issue is real, and corrective action is warranted. This is not an endorsement of the Kyoto Protocol by

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any stretch, but the idea of taking no action on climate change is no longer acceptable.

IMPASSE AT THE HAGUE

With my personal position on the table, let me make a few observa- tions on COP6. My first surprise was the variety of goals held by negotiators and observers. Seeking means for climate stabilization topped some agendas but not many. In fact, many delegates brought numerous hidden objectives to the negotiating table.

I was not surprised to find the United States viewed as the ogre at COP6, in part because of the nation’s high greenhouse gas (GHG) emissions, in part because of the U.S. reluctance to commit to the Protocol. But it was interesting to learn that a number of other coun- tries—Canada, Japan, and Australia, for example—hold basically the same views on many issues. The U.S. position is a pragmatic one, dri- ven by the need to have the treaty ratified by the Senate. In essence, the agreement cannot be too costly domestically or else it is unlikely to be approved. Thus, the United States pushes for maximum flexi- bility in meeting Kyoto targets, which translates into lower costs.

The Europeans (their agents—certainly not all Europeans) are heavily influenced by Green Party representation, as well as by a different atti- tude toward consumption. Thus, the European position is that waste- ful U.S. energy use needs to be curbed. It is not enough for the United States to meet its Kyoto targets; the nation must also feel pain in the process. Finding low-cost ways of reducing net emissions is viewed as “cheating.” The bottom line is that the Europeans do not want the United States to be able to meet its obligations by increasing the uptake of GHGs by trees and soils (sinks) or by paying others else- where in the world to reduce emissions by trading. They want such actions to be “supplementary” to domestic emissions reductions.

One can understand both perspectives. The Kyoto Protocol deals with emissions targets, but what people really have in mind is action. The Europeans want the United States to undertake “serious steps” «COP6: Observations of an Interested Bystander» 77

to control the problem. In their view, it is more important morally to “try hard” than to eliminate specific tons of GHG. The United States on the other hand takes the position that it is the climate we are sup- posed to be worried about; so what difference does it make how net GHG emissions are reduced? There is a fundamental mismatch of perceptions here.

On the U.S. agenda, dealing with climate change is the problem, and “cheaper” is the best way to that goal. This view clashes with the European desire for belt-tightening. To paraphrase Frank Loy, the chief U.S. negotiator, “You Europeans want this to be painful. I come from Southern California, and there we don’t want pain. We take an aspirin for that.”

It was also enlightening to see the role NGOs played in this negotia- tion. This was not just a conference where countries got together to decide important issues. There was a very active lobbying effort going on, particularly by environmental NGOs (ENGOs). These “shadow negotiators” were very visible. They built symbolic dikes around the conference site; they held press conferences; they bestowed “Daily Loser Awards” on countries they saw as hostile to environmental objectives; they threw pies—literally (the U.S. nego- tiator got one in the face). Their lobbying effort was effective in putting pressure on the various negotiating teams.

But the ENGOs did not speak with one voice. There were some real splits. Organizations like Greenpeace, Friends of the Earth, and the Worldwide Fund for Animals pushed hard to make the United States undertake meaningful cuts in emissions—no sneaky trading of rights or use of sinks. Other ENGOs, such as the Environmental Defense Fund, took a more pragmatic approach, viewing hard-line positions as only serving to delay action.

Business groups were also among the NGOs, but they were less visi- ble. Perhaps they are more concerned about eliminating the uncer- tainty that characterizes the process. Certainly they are worried by the fact that the Protocol is supposed to go into effect in a few years, and yet everything is still undecided. Furthermore, there is consider- 78 Session II

able interest in the opportunities associated with the clean develop- ment mechanism (CDM), the procedures whereby the first world invests in emissions-reducing projects in the developing world.

The “Strange Bedfellow Award” at COP6 has to go to the Greens and the Browns. When a negotiation like this is killed—and, as you know, COP6 ended or was suspended without any decisions—it is killed by an alliance of those who want too much with those who don’t want anything. This sums up the reason for the COP6 failure.

My biggest eye-opener was that most of the conference was taken up with line-by-line editing of text for inclusion as annexes to the Kyoto Protocol. In one session I observed, delegates spent an hour arguing about a French proposal to clean up the English in a sentence, replac- ing “related to” with “in relation to.” Details, not broader issues, dominated the agenda.

AGREEMENTS AND DISAGREEMENTS Let me turn now to what might be done to move forward from the Kyoto deadlock. First, we need to understand what the world agrees on and doesn’t agree on. As I have noted, there is consensus that the climate problem needs to be addressed. This agreement includes those who calculate costs and benefits in their assessments. The economists’ 1997 manifesto stated that “the balance of evidence suggests a discernible human influence on global climate.” The group also agreed “that there are many potential policies to reduce greenhouse-gas emissions for which the total benefits outweigh the total costs.”

Another area of consensus is the realization that costs and benefits of GHG reduction are unequally distributed around the world. This creates a very significant problem for negotiating a treaty. There is consensus that the Northern Hemisphere is responsible for where we are, but the Northern and Southern Hemispheres together are responsible for where we are going.

Turning to disagreements, the three major points of international divergence are «COP6: Observations of an Interested Bystander» 79

• what the level of emissions reduction should be, • which countries should be active members of the Protocol and thus required to restrict emissions, and • what portion of the control cost burden specific countries should bear.

On the surface, the 5-percent emissions reduction called for in the Kyoto Protocol appears to be reasonably significant. However, some researchers have suggested that ramping up control levels more slowly may lead to greater compliance. This is known as “when flex- ibility,” i.e., adjusting the timing of emissions control while keeping the ultimate goal constant. On the other hand, some feel that the Kyoto levels of control are too little, perhaps too late. What will the effects of Kyoto for global emissions be in light of the absence of the developing nations and their growing emissions? To what extent will “dirty” industry migrate to the developing world and export their carbon-intensive output to the developed world?

Another issue regarding flexibility refers to where in the world the reductions take place. Will the developing nations participate? To be sure, there is widespread recognition that the developing world has many problems and cannot be excessively burdened with the costs of controlling GHG emissions. Developing countries, quite understand- ably, view climate change as a problem created entirely by the devel- oped world over the last century and thus one the developed world must solve. Some in the developed world (such as the United States) note that parts of the developing world (particularly China and India) are becoming a major source of GHG emissions and cannot be ignored in fashioning a long-term solution to the problem. The posi- tion is that it is best to anticipate now eventual participation by the developing world rather than return at a later date to amend what- ever agreement is forged.

As demonstrated in the first IPCC Working Group III report, a 5-per- cent rollback in emissions in each developed country creates a large disparity in the marginal costs of emissions control—some countries 80 Session II

can achieve this easily, others at significant cost. Some countries have attempted to move toward efficiency by arguing for trading emis- sions reduction obligations within the developed world or between the developed and the developing world. This has become known as “where flexibility,” i.e., adjusting which countries do the emissions reduction, keeping the overall level of reduction constant.

There are three main objections to emissions trading. One is that trading makes it too easy to meet Kyoto obligations and that there will be insufficient sacrifice; in fact, some countries may be able to buy their way out of meaningful emissions reductions. Related to this is an opportunity for gaming the Protocol brought about by the spec- ification of the baseline year as 1990. The third objection, which is perhaps the most serious, is that real problems exist regarding verifi- cation and enforcement of trades, particularly between developed and developing countries.

MOVING BEYOND KYOTO

If we continue to try to push the Kyoto Protocol process along, we are playing into the hands of the “do-nothing” position on climate change. In my view, Kyoto is unlikely to ever be ratified by a mean- ingful number of major polluting countries (including the United States). Thus, the longer Kyoto is on the table, the longer it will be before effective control of GHG materializes.

Why am I pessimistic about Kyoto? Primarily because the points of disagreement articulated above are so fundamental. The much- maligned 1997 Byrd-Hagel resolution in the U.S. Senate indicated that the United States should not agree to a treaty that omits major players (the developing world) or that is not in the self-interest of the United States. In actual fact, this is a position one would expect most countries to adopt. It is much easier to include relevant parties before initiating an agreement than to add them later. The potential for free riding is much greater after an agreement is in effect. Accepting the premise that controlling climate change is good for the world, then it should be possible to share the burden of the treaty in such a way «COP6: Observations of an Interested Bystander» 81

that every signatory is better off with the treaty than without, includ- ing developing countries. A well-designed cooperative agreement should make it individually rational for parties to participate. An agreement that makes some parties worse off with the agreement than without is a prescription for failure.

Why should we seek a replacement for Kyoto? A review of past envi- ronmental treaties that work, like the 1987 Montreal Protocol on CFCs, suggests there are four fundamental requirements for a suc- cessful treaty: • First, it must entail some meaningful emissions reduction. • Second, participation in the treaty should be in the best interests of every signatory. • Third, major players should be part of the treaty. The developing world should agree to the terms of future participation, even if efforts for the foreseeable future are minimal or nil. It could be a simple statement that when a country’s per-capita income exceeds the world median, that country agrees to a specified participation. • Fourth, enforcement and penalties for violation should be clearly articulated. The time to negotiate over penalties for non-compli- ance is prior to the agreement, not after a violation has occurred.

The Kyoto Protocol fails all these tests. The Montreal Protocol, on the other hand, passes all four requirements.

I propose that we change our approach and begin by working on coordinating specific efforts that all countries can undertake rather than pulling target numbers out of thin air. For example, we might agree on actions that effectively make carbon more expensive to use. With the exception of Europe’s high taxes on motor fuels, most countries have very modest taxes on fuel use. A concerted effort to move toward using fossil fuels as a revenue base for government would seem more politically attractive than agreements to add sig- nificant legislation for specific cutbacks in emissions. True, taxes have been met with much popular resistance. However, an internationally 82 Session II

harmonized tax on fossil-fuel use or GHG generation could meet the complaints of export industries that would be put at a competitive disadvantage with a national fossil-fuel tax. And perhaps people would back a tax at the gas pump as preferable to the alternative.

An alternative tax, in the spirit of the Kyoto Protocol, is to use mar- ketable permits within a country to achieve the Protocol limits, with the proviso that any country could sell additional permits at the pre- determined price (say $10 per ton). This amounts to roughly the same thing as an emissions tax (though not quite as transparent) except for significantly lower revenue and significantly higher admin- istrative costs.

POSTSCRIPT

When this paper was initially prepared, it was unclear whether Al Gore or George Bush would be president of the United States. That has now been resolved; let me offer some advice to President Bush. George W. Bush has publicly turned away from the Kyoto Protocol; he is in a position to fashion something more rational. This is what Richard Nixon did in 1972 when he changed the traditional U.S. pol- icy toward China and what George Bush, Sr., did with the 1990 Clean Air Act amendments that put an end to years of debate on acid rain in the United States. I would suggest that the new U.S. administration propose a replacement for the Kyoto Protocol rather than continue to throw darts at it—as I have today. <>

DR. ALAIN HEILBRUNN TOTALFINAELF

I am delighted to have this opportunity to discuss global climate change with such a knowledgeable group of panelists and partici- pants. Let me start by emphasizing that I will be speaking for myself only, not for my company or for the professional groups with which I am affiliated. That said, I will turn to this complex topic and focus first on the conflicting priorities in the oil industry’s environmental battles. Then I will examine the difficulties we face in implementing the Kyoto Protocol, in particular how politics have impeded the process. Finally, I will ask how we can regain that sense of common environmental purpose that was evident at the Rio Earth Summit in 1992 but that has been dissipating ever since.

CONFLICTING PRIORITIES

The European oil industry faces enormous obstacles in its efforts to meet environmental objectives, but we are strongly committed to addressing these challenges. The industry is sensitive to environmental

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issues in terms of our own industry practices and in terms of what the public at large expects of us. Whenever we find a new, scientifically sound technology, we incorporate it into our operations and/or pro- pose voluntary commitments within the industry for its general use. You already know this from some of the proposals the oil companies have made. In addition, we are pledged to work jointly with govern- ments and non-government organizations (NGOs) to resolve environ- mental problems.

However, conflicts exist among the priorities in the ongoing, expand- ing battle to resolve environmental issues. These include the offset- ting effects of a country’s desire for economic growth versus its desire (or requirement) to reduce harmful emissions, along with the para- dox of sometimes being able to reduce one pollutant only by increas- ing another.

Economic Growth v. Emissions Reductions Earlier in this Seminar, we heard Dr. Domingo Cavallo state that he expects Argentina’s economy to grow by 7 percent every year for the next ten years. He also encouraged other Latin American countries to strive for a similar goal. Indeed, on the threshold of the twenty-first century, every country expects to pursue and hopefully realize signif- icant growth. The European Union hopes to sustain a 3 to 4 percent annual expansion between 2000 and 2010. The inevitable result from such growth is increased energy use and, consequently, increased emissions from both the refineries producing fuels and from social and economic activities in general.

In the face of this universal striving for economic growth, the Kyoto Protocol proposes to reduce greenhouse gas (GHG) emissions by industrialized nations over the next decade by 5 percent from a 1990 baseline. This goal is laudable. But the reality is different. In general how can nations reconcile the Kyoto targets with the expansion in energy use that comes with economic growth? More specifically, how can this target figure be met?

Table 1 presents a more precise view of this dilemma. It shows the potential clash between expected economic growth (in terms of «Obstacles to Effective Climate Change Policy» 85

Table 1 Kyoto Targets and Forecast Emissions: European Union, Japan, United States

Forecast Relative Cut from Target to 1990 2010 2008-2012 2000 2010 Reference

European Union - 8 % - 0.5 % + 6 % -14%

Japan -6% +12% +29% -26%

United States - 7 % + 16 % + 32 % -30%

Source: Professor Henry Jacoby, MIT presentation, November 2000. increased emissions) and the Kyoto targets in the same period. The first column shows the Kyoto target reductions for 2008 to 2012, based on 1990 emissions: 8 percent for the European Union, 6 per- cent for Japan, 7 percent for the United States. The second and third columns show the emissions growth expected in 2000 and in 2010 under a business-as-usual (BAU) scenario. (Note that the one nega- tive number, the European Union figure in 2000, reflects a decade of slow growth in Europe, which is expected to be reversed over the next ten years.) As the table illustrates, the real commitment for OECD nations is not a 5-percent reduction in emissions but a 15- to 30-percent reduction vis-à-vis the BAU case.

Reducing emissions by one-third will be very difficult to achieve in the short period specified by the Kyoto Protocol. Simply put, the technol- ogy will not develop sufficiently to provide solutions in that time. Electricity generation cannot be redesigned quickly, for example, nor can a city’s transportation infrastructure. In fact, there isn’t much that can be done to reduce emissions significantly in the Kyoto time frame.

The unreality of the targets is also clear when we look at CO2 emis- sions by economic sector. Table 2 breaks out emissions generation in the European Union. The numbers show that currently the “energy sector,” which means essentially electricity generation, is the primary source of emissions. Electricity consumption in Europe has grown 86 Session II

Table 2

CO2 Emissions by Economic Sector: European Union, 1990 and 2010 (Business-As-Usual Scenario)

1990 % of EU %Increase 2010 % of EU

CO2 Emissions (1990-2010) CO2 Emissions Energy 32 +2 30 Industry 24 -10 20 Transport 24 +39 30 Housing & Tertiary 21 +4 20

TOTAL 100 +8 100

and will continue to grow at a rate of between 2 and 5 percent per year, but new technology will keep the emissions increases to a mod- est 2 percent between 1990 and 2010. The “industry sector” has already cut its emissions by 10 percent, so any further reduction from that segment in the short run will be very small. The most likely source of energy emissions reduction there over a ten-year period will be improved efficiency, but this will amount to only 1 to 1.5 percent per year (a very ambitious target but not one that will significantly reduce overall emissions). Thus, the sectors that offer the largest opportunities for reductions in a short time are transportation and housing. Changes in these sectors, particularly transportation, are not easy to mandate politically, as the recent demonstrations in Europe over high gasoline prices have shown.

CO2 v. SO 2 Another important conflict in the pursuit of an effective climate change policy is the counterproductive impact of one environmental strategy on another. One of the primary environmental efforts to pro-

duce clean air focuses on reducing sulfur dioxide (SO2) emissions. Here in the European Union, we are committed to meeting the stringent fuel specifications for lowering pollution by removing sulfur from all fuels. Our current challenge is to phase heavy fuel oils out of the European market by 2008. This will have an economic effect on the energy industry as the largest fuel users, such as electricity generators «Obstacles to Effective Climate Change Policy» 87

and refineries, switch to natural gas and smaller refineries are forced to close. However, reducing sulfur content also creates an environ- mental dilemma: the deeper conversion units needed to make cleaner fuels are so energy intensive that CO2 emissions from European refineries (even if the more inefficient ones are closed) will likely increase by around 10 percent. We also expect that measures for fur- ther reduction of sulfur, aromatics, and olefins will increase CO2 emis- sions from refineries between 5 and 10 percent for some production levels. Gas-to-liquids diesel refining will more than double CO2 output from these facilities.

So the dilemma is clear: how do we produce the cleaner fuels man- dated by the European Union and many governments worldwide without adding to CO2, a principal cause of global warming and the target of the Kyoto Protocol? As yet, no workable solution has been forthcoming.

Standards for Setting Targets: Shifting from Science to Politics Another political aspect of climate change policymaking has to do with its economic and social impacts. Any measure taken to reduce greenhouse gases will affect the standard of living and the mobility of the countries involved. Increased taxes are important options but are highly unpopular. The concessions European governments made following the summer 2000 fuel price protests sent the wrong signal to the public. Their action in response to public protest was not sur- prising, however. In today’s world, politicians are applauded when unemployment decreases, not when they pass legislation to reduce greenhouse gas emissions.

The success of the 1987 Montreal Protocol limiting CFCs also set a misleading precedent. In that instance, industry was able to solve the CFC problem by its own efforts; politicians only had to create the proper mandate. Unfortunately, this politics-free approach will not work with the Kyoto Protocol. Even if all industry were to shut down, it would not resolve the GHG problem. 88 Session II

European Union Goals and Methods Since the Rio de Janeiro Earth Summit in 1992, the European Union has played a large role in furthering climate change policy. With the Kyoto Protocol now under discussion, the Union wants to lead the process for implementation. But it has not defined a workable methodology for its own nations. One example of its flawed method- ology is the “carbon bubble” whereby participating European nations share the burden of meeting the emissions reductions mandated by Kyoto. Under the bubble’s structure, countries where GNP has been below average are granted a global increase in their emissions, and the remaining countries with greater GNP are expected to offset this increase by accepting a greater decrease in their emissions. Within Europe, 15 countries accepted this proposal. But the difference in commitments is very wide, and some countries have accepted reduc- tions they probably will not be able to meet.

In addition to the unrealistic targets, the bubble has other problems, including enforcement and finance. For instance, if one of the coun- tries fails to fulfill its commitment, all nations will be penalized. Realistically, most European countries burdened with high reduction requirements will not be able to meet their obligations. How can we enforce the commitments? Perhaps by developing flexible mecha- nisms for the carbon bubble shares of the 15 member states. For some countries, however, this would make the bubble’s political acceptance even more difficult, just by showing the cost.

The failure of COP6 to produce an agreement on any general means for implementation was a clear blow to the European Union strategy. If we have to keep renegotiating the bubble shares, this will be another setback to the European Union’s attempt to ratify the Protocol, both within its borders and around the world.

REGAINING A COMMON PURPOSE The COP6 meeting in The Hague failed to find measures for imple- menting the Kyoto Protocol. Previous meetings in Buenos Aires in 1998 and Bonn in 1999 also failed. In other words, we do not have any way of executing the Kyoto Protocol, should it be ratified. «Obstacles to Effective Climate Change Policy» 89

The Role of the Energy Industry In this uncertain context, what should energy companies do? Industry, of course, has to comply with political and legislative deci- sions. However, there are other measures we can take to address environmental concerns and to improve our image in the eyes of consumers and politicians in the process. • Our goal should be to help create societies where standards of living are high and emissions are low. We should increase efforts to develop new technologies even if they are 20 or 30 years out. This is a long-term problem. • We should show a positive attitude toward the future. We should be clear that we are committed to playing our part in solving climate change issues; we need to demonstrate to the public that we are looking for solutions. This will contribute to the credibility of the process and aid in the public’s education. • We should set an example by making our own industry more energy efficient, which makes both economic and environmen- tal sense.

Towards a New Century and a Renewed Common Purpose What can be done to get the Kyoto process back on track? At the Buenos Aires Earth Summit in 1992, more than 170 countries agreed to search for a solution to the global climate change. In the suc- ceeding decade, we have lost that common purpose. What can be done to recreate it? Since 1992 we may not have learned much about creating effective climate change policy, but we have learned something about negotiating. For future meetings to have a better chance of success, these changes in attitude and procedure should be made: • The delegates must be committed to seeking a consensus of support for proposals. The atmosphere at COP6 was incompati- ble with making serious, binding political resolutions. Emotion can help sensitize the public, but it does not facilitate political decision-making. 90 Session II

• NGOs and governments need to work more efficiently. Politicians will move only when they are convinced that public opinion is on their side. • Decisions regarding climate change policy require a strong com- mitment from both developed and developing countries to find- ing a solution that is acceptable to and beneficial for everyone. The Kyoto process has shown that, at this stage, such solidarity is sadly lacking.

Let me close by asking again what can be done to recreate a com- mon purpose. I suggest we begin by relaxing the unrealistic target requirements set for the first period and concentrate instead on seek- ing specific methods and institutions on which all nations can agree. To those who disagree with this view, I would note that our objective is to stabilize the GHG concentration in the atmosphere by 2100. We do not have much time.

Consequently, we have to find common ground on which to build soon. If not, our efforts will only create a new Tower of Babel. The first tower failed because of an excess of pride. We can prevent that here, but only if we show humility, solidarity, and an awareness of scientific, human, and social realities. <>

DR. BRIAN P. F LANNERY EXXONMOBIL CORPORATION

ExxonMobil Corporation recognizes that climate change poses long- term risks to society and ecosystems that must be addressed. The appropriate way to address these risks is through efforts aimed at cost-effective, near-term actions coupled with research to develop innovative, long-term solutions that can be used globally. This strat- egy offers far more promise than reliance on the costly, ineffective approach of near-term emissions reductions. Thus we do not support the Kyoto Protocol with its progression of differentiated near-term targets.

Overall Kyoto is far too complex, it costs far too much, and it achieves far too little. The recent failure of the COP6 conference in The Hague emphasizes the Protocol’s unworkable nature. The stale- mate at COP6, however, does provide an opportunity for society to step back, reconsider, and then move ahead with a more effective and responsible approach.

91 92 Session II

Today I will review the Protocol’s shortcomings, discuss the need for clarity in the role of business as a non-party, and then outline the ele- ments of a positive approach to this real problem.

A KYOTO REVIEW

Negotiators at Kyoto in 1997 focused on setting target numbers and timetables for near-term reductions in greenhouse gas emissions

(GHGs) with an emphasis on CO2 emissions from fossil-fuel use. They did not concern themselves with feasibility or with defining the steps necessary for implementation. In reality, the targets are too drastic and the timing is too short. Even if the Protocol were approved, many countries—certainly the United States, Australia, Canada, and Japan, as well as many European nations—would have great difficulty achieving the objectives.

Target Numbers: Too High The Kyoto Protocol commits 38 industrialized nations to cutting emissions roughly 5 percent below 1990 levels within the period 2008–2012. For Japan, the actual figure is 6 percent; for the United States, 7 percent; and for the European Union, 8 percent. These tar- gets need to be put into perspective with regard to their practicality, their less-than-favorable reception by some nations, and their chances of achieving a significant effect.

While these reductions may sound small, they are not. Indeed they must be compared against anticipated growth in energy use over time, and put in context relative to the effort that might be required to achieve them. For example, as Figure 1 shows, U.S. emissions in 2000 are already 24 percent above the projected Kyoto level. By 2010, these levels may be 43 percent above Kyoto targets. Reversing this trend would be extremely difficult. Every year that goes by, the economy grows and emissions rise, making it more difficult for the United States to accept the agreement. This situation almost certainly indicates the need for renegotiating the targets and timetable if the United States is ever to ratify the treaty. This will likely be true for other major industrialized nations as well. «Beyond Kyoto» 93

Figure 1 Projected 1990-2020 U.S. Carbon Emissions v. Kyoto Target

2,000

Projected Emissions 1,800

1,600 Actual Emissions Kyoto Target Baseline 1,400

1,200 19% 24% 43% 58% Projected Emissions Exceed Target by Percentages Shown Above Carbon Emissions (MM Metric Tons/Year) 1,000 1990 1995 2000 2005 2010 2015 2020

Source: EIA Annual Energy Outlook 2000.

The Kyoto Protocol’s required reduction in projected emissions has also created strong governmental, business, and labor opposition within some ratifying countries. In the United States, for example, there is strong bi-partisan opposition in the federal government to ratifying the Protocol. U.S. businesses and organized labor also oppose the Protocol, primarily for economic reasons.

In 1997, prior to the final negotiations in Kyoto, the U.S. Senate passed the Byrd-Hagel Resolution by a vote of 95–0. This resolution called on the Clinton-Gore administration to not agree to any climate change treaty that excluded commitments by developing countries or that might cause economic damage to the United States. In agreeing to the Protocol and later signing it, the administration ignored the Senate’s advice. However, in recognition of political reality, the admin- istration chose not to submit the Protocol to the Senate for ratification.

Finally, the ineffectiveness of the Kyoto mandate is beyond question. Figure 2 shows how global temperature might change over the next 100 years with and without the Kyoto Protocol. Implementing the Protocol would reduce the rise in global temperature by only a tenth 94 Session II

Figure 2 Climate Implications of Kyoto Emissions Reductions, 1990-2100

2.0 ûC

1.5 IS92a1

Kyoto 1.0

Temperature Change 0.5

0.0 1980 2000 2020 2040 2060 2080 2100 1 IS92a is the first of six “Potential Impacts on Climate Change” scenarios developed by the UN International Panel on Climate Change.

of a degree or so. In other words, the Kyoto Protocol would at best delay the warming projected for 2100 by ten years. Given the model’s error margin of 1 to 5°C, the ultimate effect on temperature would probably not be noticeable. So in all likelihood the Kyoto Protocol targets, which would be very costly, would not produce a significant effect on climate change.

If climate change proves to be serious, far more onerous steps would be required, and they would have to involve developing countries. In that regard Kyoto appears to be a dead end, since negotiators are not prepared even to put discussion of their future commitments on the formal agenda.

Time Frames: Too Short By the end of the 2000, the parties to the Protocol were supposed to have agreed on Kyoto mechanisms (credit from projects outside national borders and emissions trading) and on compliance require- ments. Reaching consensus on procedures for those mechanisms and requirements was, in fact, the purpose of COP6, and the meeting’s failure underscores the unreality of the targets and timetables. These «Beyond Kyoto» 95

efforts have now been suspended and, as of early 2001, will not be resumed until July 2001.

Many governments support ratification of the Protocol by 2002, the tenth anniversary of the Rio Summit. For the United States especially, this timetable is far too short, since it allows no opportunity to address and resolve the question of developing-country commit- ments. Even if all these questions were answered, there is no hard and fast deadline for ratifying the treaty, that is, no “expiration” date. However, if important matters cannot be resolved as the offi- cial time markers for 2005 (negotiations for the second commitment period) and 2008 (the start of the first commitment period) draw closer, this must ultimately call into question the viability of the Kyoto Protocol’s progression of differentiated targets and timetables.

Implementation and Enforcement: No Solutions Yet Negotiators in The Hague were charged with defining implementa- tion guidelines and procedures regarding credits for projects involv- ing more than one nation, emissions trading between nations, procedures and consequences for non-compliance, and aid and com- pensation to developing countries. Agreement on these policies is essential; without it, nations will not be able to understand how the Protocol would function, which is a necessary precondition for sub- mitting it for national ratification. International implementation of a new activity such as this one poses daunting problems. For example, procedures for tracking and credit- ing emissions projects and recording emissions reductions are very complicated. What projects might be eligible, how they would qual- ify, how credits would be calculated, and what the approval process might be are among many issues that have not been addressed. As for enforcement, no international mechanism exists yet to moni- tor the climate agreement. Here the negotiators are caught between several conflicting concerns. Without credible penalties for non-com- pliance, the treaty may not have adequate teeth. However, strong penalties could deter ratification by the large number of countries that already realize the difficulty of achieving their targets. 96 Session II

The negotiations at COP6 were supposed to start resolving these implementation problems and got virtually nowhere.

BUSINESS AND THE KYOTO PROTOCOL It is important to recognize that businesses are not parties to the Protocol; the treaty directly binds only nations. However, efforts to address climate change under the Protocol would depend on the ability of business to make effective contributions while remaining profitable.

Under the Kyoto Protocol, business obligations would depend on the international framework that sets rules for trading, projects, and national compliance and on national legislation that sets the rules in each country that ratifies and implements the Protocol. As non-par- ties, businesses have been trying to clarify important questions with government negotiators concerning what types of projects will qual- ify for credits, what approval processes will be in effect, and how business will be able to participate in emissions trading.

Clean Development Mechanism: Needs Clarifying An important issue that needs clarification is how the clean develop- ment mechanism (CDM) would function. The CDM will govern how credits are obtained for emissions-limiting projects in developing countries. It is unclear as to what types of projects will be eligible, how credits should be calculated, and what procedures will be used to approve projects. Without unambiguous rules, business will be unable to propose projects with confidence that they will be approved; without efficient procedures, proposals could become mired in costly delays and endless recycling.

To date, negotiators have shown an inclination toward creating restrictive, time-consuming, bureaucratic procedures to govern CDM. Negotiators have proposed serious restrictions on the types of pro- jects that could be eligible. Such restrictions promise to seriously limit the potential of CDM to spur investment in projects that can make a difference to future greenhouse gas emissions or that can signifi- cantly reduce the projected costs of meeting obligations. «Beyond Kyoto» 97

The Question of Business Participation A key question concerns the ability of businesses to participate. Will the international framework and domestic laws allow business to take part directly in international trades, or in the case of multi- national corporation, to transfer credits freely from one place of busi- ness to another across national boundaries—for example from an affiliate in Canada to one in France? What happens if trades export credits from a country that later falls out of compliance? If a specific company is in compliance with all national laws where it operates, but the country fails to comply with provisions of the Protocol, would the company continue to be able to exchange credits? Would busi- ness be allowed to exchange credits freely on international markets without some version of national export-import controls? Another issue is the investments that businesses might make to address climate change, which would create facilities with productive lifetimes far longer than the first commitment period (2008-2012). The problem is that many factors that affect compliance, costs, and the siting of investments could change over time—for example, the absolute level of commitments in each nation and which nations have obligations.

Other Architectural Problems that Affect Business The Kyoto framework is based on a set of covered gasses, activities (sinks of various sorts), and relative weights that allow conversion between different gasses and activities. Already scientists are discussing whether or not the weights based on the 100-year Global Warming Potential are appropriate. Today these are theoretical discussions, but if the Protocol were to enter into force, society might see hundreds of bil- lions of dollars of commercial paper tied to these agreements and weights. Negotiators need to consider carefully how procedures can be put in place that could allow smooth transitions over time. Another architectural problem that will arise if Kyoto is ratified is the need for a financial framework for international transactions to meet commitments. Under Kyoto, credits for projects have currency value in every country in the world. In a set of bilateral and regional agree- ments, however, those credits might have very different values, 98 Session II

depending on where they are exchanged. Perhaps the largest prob- lem involves the potential for tens to hundreds of billions of dollars to be transferred to Russia and Ukraine, since they have over 200 mil- lion tonnes of excess allowances based on their obligation and the collapse of their economies since 1990.

Given the current state of negotiations, it appears that many years of further negotiation will be necessary before important issues that would affect business investments and competitiveness can be clari- fied. These are difficult and complex matters, and the negotiators do not seem particularly well equipped to address them.

A POSITIVE, CREDIBLE APPROACH TO CLIMATE CHANGE POLICY

A coherent institutional architecture is important for success in a long-term international process to address climate change. It is far more important than choosing a particular policy that may be found inappropriate as experience unfolds. The Kyoto Protocol involves a progression of differentiated targets and timetables. This design emphasizes near-term emissions reductions in a limited number of nations. Given what we know about growth in global emissions, this initial step is ineffective.

An alternative design could be constructed based on “efforts” to address emissions, rather than on “outcomes” based on legally bind- ing national emissions caps. Such an efforts-based approach could be structured with incentives that invite participation by all nations, since they would receive the benefits of actions today.

A positive approach to environmental improvement in the area of cli- mate change would acknowledge the long-term nature of the prob- lem and would build an efforts-based methodology rather than rely on a strategy focused on target setting. By going beyond targets and timetables and by committing to long-term efforts, we can focus on real actions that improve emissions in national and regional activities. «Beyond Kyoto» 99

What are the elements of a positive approach? In the near term, it should promote voluntary cost-effective actions to reduce emissions and encourage the deployment of modern, efficient technology and operat- ing practices. For the long term, it should promote scientific research to better understand the causes and possible consequences of climate change, to encourage technological innovation to develop affordable means to lower future emissions, and to enhance the capability of devel- oping countries to acquire and manage advanced technology.

There are a number of promising, long-term technological opportu- nities that should be considered: • The technical separation and storage of carbon dioxide released as flue gas or in large combustion facilities can be achieved through a variety of processes. These processes could affect 30 percent of global emissions. However, they face barriers in cost and confidence in disposal options. • Carbon storage in forests and soils, regardless of whether it gets credit, does affect atmospheric concentrations and is something that should be pursued. • In the transportation sector, advanced vehicles—including hybrids and fuel-cell-powered cars—offer an opportunity to affect another 30 percent of global emissions, not in the Kyoto timeframe but over the next 20 to 30 years. • Development of systems to manufacture, store, distribute, and utilize low or no-carbon fuels from fossil-fuel resources offers the

long-term potential to eliminate nearly all CO2 emissions. Such systems would probably need to rely on carbon separation and sequestration as one major component. • Geo-engineering has received little attention. Although currently frowned upon by many environmental groups, if the need for cli- mate-change action proves serious, society would demand, at the very least, to understand what such options might be capa- ble of delivering. Geoengineering approaches offer the potential 100 Session II

to control directly ambient levels of atmospheric GHGs and to mitigate impacts.

Given the technical and managerial capacity available today in wealthy entrepreneurial countries, and the time available to develop and deploy new technology that might be required should climate change prove to be serious, there is every reason to believe that affordable technological solutions can be developed. However, gov- ernments should resist the temptation to pick winners and losers in such a long-term endeavor. Markets can best make effective choices in a fluid situation, where the evolution of commercial technologies depends on the successful marriage of many competing and cur- rently unforeseeable breakthroughs.

Governments, however, still have a crucial role to play in helping pro- mote enabling capabilities in developing countries for widespread technological diffusion. These should include establishing the rule of law and contract; promoting open markets; protecting property rights; encouraging the free movement of goods, services, and people; and creating frameworks and capacity for developing countries to plan, acquire, and operate advanced technology. Of course, these steps are precisely those that can help promote stable, prosperous democracies and should be part of the international agenda of all nations.

The key to long-term success in reducing greenhouse gas emissions and addressing the risks of global climate change is creating effec- tive, efforts-based approaches that promote the development and commercialization of innovative technology and global involvement. We need to develop practical mechanisms that take full advantage of existing knowledge and technology and that both foster the devel- opment of and allow for the incorporation of new technology for reducing GHGs. We also need to establish an international frame- work that invites participation by all nations and that builds in the flexibility needed to cope with changes that will come as the scien- tific, social, and economic nature of the world shifts over time. «Beyond Kyoto» 101

The Kyoto Protocol targets and timetables came about through polit- ical bargaining. There are no scientific or economic principles sup- porting its numbers. If we stay on the increasingly complex Kyoto path to climate policy, our efforts will end up hopelessly mired in a dead end. Better to take a step back now and map out a strategy that will help us find a cooperative, practical, cost-effective route to success. SESSION III

LATIN AMERICAN ENERGY MARKETS

INTRODUCTORY REMARKS

MR. JOSÉ LUIS DÍAZ FERNÁNDEZ FUNDACIÓN REPSOL YPF SESSION CHAIR

This third session of the XI Repsol YPF-Harvard Seminar will center on a topic of great interest to us all, Latin American energy markets. By way of introduction, I would like to reflect briefly on the regionaliza- tion of markets in general and of energy markets in particular.

It is generally agreed that regional markets encourage the overall competitiveness of industries and increase their attractiveness for for- eign investors; the results are energized local economies and increased employment. There are many examples to confirm this generalization. We all remember when, in the 1980s, Spain faced integration into what was then the European Economic Community and is now the European Union. The move, initially viewed by many with mistrust, has been a decisive factor in modernizing the Spanish economy and in maintaining growth rates that have been superior to the European average for several years.

The integration of Mexico with the United States and Canada through the North American Free Trade Agreement (NAFTA) is another

103 104 Session III

example. As a result, the Mexican economy is growing at a rate of 7 percent annually and is experiencing strong growth in its export rate as well, both of which help sustain the favorable pace of its economy. There is also the example of Mercosur, which is really a customs union and not just an area of free trade.

By contrast, closed markets produce negative effects. Northern Africa is a case in point. Economically it is really not a region: only 6 percent of the foreign trade of these countries takes place among themselves. The difference in the degree of market regionalization between the north and the south coasts of the Mediterranean contributes to the growing disparity of the economies of both shores. Currently, their respective incomes per capita are in the ratio of 12 to 1, and if current conditions persist, that ratio will reach 20 to 1 in 2010.

The energy sector is more complicated, however. While the internal liberalization of energy markets has evolved in a satisfactory way, this has not been the case for regional energy markets. In the European Union, for example, creation of large electrical interconnection lines among the member countries has been limited, and transparency in fixing cross-border tariffs still does not exist. Nonetheless, I am con- vinced that in a few years a regional European energy market will exist, even though there is still resistance coming from some pockets of monopolistic tradition.

Now let us turn to Latin America. We are fortunate to have a knowl- edgeable panel of energy professionals who will speak authoritatively on the progress of liberalization and regionalism in energy markets here. • Our first speaker, Philippe Reichstul, president and CEO of Petrobras, will give us an overview of the Latin American energy market and of the movement toward regionalization. His partic- ular emphasis will be on how Petrobras has fit, and will continue to fit, into this effort. Mr. Reichstul, who became head of Petrobras in 1999, has wide experience in public and corporate management in Brazil. He also has held executive positions with Telebras (the Brazilian telecommunications company) and Electrobras (the Brazilian electricity company). Introductory Remarks 105

• Mr. Roberto Monti, the second speaker, will discuss the “Chinese Walls” that block regional cooperation in Latin American energy markets. Mr. Monti, a member of the YPF Board of Directors, served as Executive Vice President for Exploration and Production of Repsol YPF until September 2000. From 1997 to 1999, he was president of YPF. He also was an executive with the Schlumberger Group for many years. • Dr. Evanan Romero will close the session with his discussion of liberalization and integration in Latin American natural gas and electricity markets. Dr. Romero, a visiting scholar at the Kennedy School of Government, Harvard University, has had a long career in the Venezuelan energy world. His service has included posts as Assistant Minister of Energy and Mines in Venezuela and as exec- utive vice president of PDVSA. <>

MR. PHILIPPE REICHSTUL PETROBRAS

I am honored to have the opportunity to discuss Latin American energy markets with this knowledgeable group of energy profes- sionals. In my presentation, I will first summarize general world energy trends and the current Latin American energy situation. Next, I will touch on Brazil’s energy situation. Finally, I will describe how Petrobras plans to advance the integration of Latin American energy markets in the twenty-first century.

LATIN AMERICA’S ENERGY MARKET

I will begin by setting out some basic background for our topic. Figure 1 shows the 1998 global market shares of major energy sources, including biomass. Among these major sources, petroleum had a 36-percent share of world energy, followed by coal with 23 percent and natural gas with 21 percent. Two years later, oil still dominates world primary energy consumption. Oil will certainly con- tinue to be the world’s primary energy source over the long term.

107 108 Session III

Figure 1 World Energy Matrix, 1998

Hydroelectricity Biomass 2% 12% Nuclear Energy Petroleum 6% 36%

Coal 23% Natural Gas 21%

Source: U.S. Energy Information Administration.

Natural gas use has increased, and this fuel will garner an even larger market share as demand grows, spurred by the construction of new combined-cycle gas power generation plants around the world and by the strategies of the petroleum companies to produce cleaner fuels. Hydroelectricity will maintain its share of the energy market in the future, but nuclear energy will decline as plants are closed. Biomass will continue to be an important source.

Environmental concerns will continue to encourage the use of alter- nate energy sources, but growth in this sector is not expected to be significant in the near term—perhaps a 3-percent share of the world energy matrix.

In 1998, Latin America depended more on oil than the world as a whole, and that continues to be the case. In 1998, as Figure 2 shows, petroleum accounted for 49 percent of the Latin American energy matrix. Natural gas came in second with a market share of 22 per- cent. In Latin America, biomass, at 16 percent, was a larger source than hydroelectricity. Nuclear energy and coal were insignificant.

In addition to being a significant oil consumer, Latin America is also an important source of supply. It accounts for 11 percent of total «Energy Market Integration in Latin America» 109

Figure 2 Latin American Energy Matrix, 1998

Biomass Hydroeletricity 16% Petroleum 8% 49%

Nuclear Energy 1%

Coal 4%

Natural Gas 22%

Source: Organización Latinoamericana de Energia world oil reserves, with a proven reserve of 119 billion barrels. Figure 3 shows the predominance of Venezuela and Mexico, which account for 85 percent of proven petroleum reserves in Latin America. Brazil, Argentina, and Colombia make up almost all the remainder. Overall, Latin America produces 14 percent of total world oil production, or 10 million barrels per day (mbd). The regional oil product market represents 9 percent of the world market with a production of 6.5 mbd. Brazil and Mexico are the leaders, accounting for 54 percent of the regional market. The demand increase over the next decade is expected to be 2.4 percent per year.

The Latin American petroleum exports sector has a much higher average growth rate than the mature markets in the United States, Europe, or Japan. The region also markets petroleum products to other countries, although for these products the ratio of export to production is lower than it is for oil.

For natural gas, the situation is much the same as for oil. Venezuela and Mexico have the majority of gas reserves, although Argentina has improved its position dramatically. Argentina is a new player in the sense that it is consolidating its position as an exporter, mainly to 110 Session III

Figure 3 Proven Petroleum Reserves in Selected Latin America Countries, 1999 (Billion Barrels)

80 72.6 70

60

50

40 28.4 30

20

10 8.1 2.7 2.6 0 Venezuela Mexico Brazil Argentina Colombia

Sources: Petrobras and BP Statistical Review 2000.

Brazil and Chile. Bolivia and Peru also hold large natural gas resources. Most gas reserves are not associated with oil and are located primarily around the Andes. The large markets for this fuel, on the other hand, are in Mexico, Venezuela, and Argentina.

Looking at the broad view of Latin America hides the very dissimilar situations in individual countries. Figure 4 breaks down the energy sources for the five largest producers and consumers in the region. On the consumer side, as the graph illustrates, Mexico leads with 1.77 million barrels per day (mbd) and Brazil stands second with 1.72 mbd. It is interesting to note that, even though they have dif- ferent GNPs, Brazil and Mexico have almost the same energy con- sumption. Argentina and Venezuela also have GNPs that are quite different, and yet they, too, have approximately the same energy consumption. The explanation for this phenomenon is the different price policies and subsidies in these countries, which have an impor- tant impact on per-capita consumption. «Energy Market Integration in Latin America» 111

Figure 4 Principal Oil Producers and Consumers in Latin America, 1999 (Million Barrels per Day)

4.0

3.5 3.34 3.12 3.0 Production

2.5 Consumption

2.0 1.77 1.72 1.5 1.13 1.0 0.85 0.84 0.5 0.48 0.49 0.24 0.0 Mexico Venezuela Brazil Argentina Colombia

Sources: Balance Energético Nacional (Brasil); Petrobras; BP Statistical Review 2000.

The balance between crude oil consumption and production varies across the region. In Mexico and Venezuela, production is higher than consumption; therefore, they are net exporters. Argentina and Colombia, on average, are also net exporters but to a much lesser degree than Mexico and Venezuela. Brazil, on the other hand, is a net importer.

On the product side, Brazil and Mexico are both importers. Brazil brings in some 250,000 barrels of product per day. Venezuela is a clear exporter of products. Argentina is a marginal exporter.

The individual oil companies investing in Latin America also have important differences in upstream resources, as Figure 5 shows. In the Southern Cone, there is a significant disparity between the reserves of Petrobras (90 percent oil and 10 percent gas in Brazil) and the reserves of other companies, where natural gas makes up 60, 70, or even 80 percent of their portfolios. The business trend has turned toward balancing these portfolios, which should create interesting future opportunities. 112 Session III

Figure 5 Selected Companies with Significant Investments in the Southern Cone, 2000 (Upsteam Mix of Reserves)

100%

80%

60%

40%

20%

0% BG Perez Tecpetrol Companc Petrobras Pluspetrol BP Amoco Wintershall ExxonMobil Repsol YPF TotalFinaElf Petroleum Gas Source: Wood Mackenzie - Quarter 2, 2000.

A SPECIAL NOTE ON BRAZIL

Brazil consumes about 1.8 million barrels of oil products per day, with a growth rate of about 4 percent projected for the next five years. Brazil’s oil and gas sector has changed dramatically since its opening. It is a growing market with huge importance in the Southern Cone of Latin America. The market has opened up significantly, except for imports of diesel and gasoline, which will happen in 2002. During the past two years, more than 40 companies have acquired blocks for exploration and production in Brazil, and Petrobras has partner- ships with 37 of these firms.

We estimate that Brazil will be an oil exporter in the mid term, even given the heavy characteristics of Brazilian crude (API 20º). We are investing to process a significant volume of this oil in the mid term, building coke units and gasoline and diesel hydrotreating facilities. In the short term, Petrobras is investing to adapt some refineries, making adjustments in topping units and fluid catalytic cracking. In addition, Petrobras is currently working to develop export markets for the heavy «Energy Market Integration in Latin America» 113

oil. Successfully accomplishing this task will be more difficult in the future, however, as environmental restrictions become more stringent.

In the mid term, Brazil’s consumption of oil products is expected to increase more than its refining capacity. By 2005, the Brazilian market is expected to be consuming around 2.13 mbd. Petrobras throughput in the country will be 1.8 mbd. Thus, new facilities have to be built.

In Latin America, Brazil has the largest growth potential for natural gas use. This market has not yet matured. The share of natural gas in Brazil’s basic energy consumption is only 3 percent, which is minuscule compared with consumption in Argentina, Venezuela, and Mexico. In Brazil, natural gas is used mainly by industry and for power generation. We would like to increase its share in Brazil’s total energy use to 10 percent by 2005 or 2006, and we are positioning ourselves to reach this goal.

PETROBRAS IN THE TWENTY-FIRST CENTURY

South America is very important for Petrobras. Outside the region, we will only be exploring for oil, but inside we intend to become an inte- grated energy company. We believe we will profit from cooperation between Brazil and Argentina, as well as with Bolivia, Chile, Uruguay, Paraguay, Colombia, and Venezuela. We have long been trading shoes, automobiles, and other products. Now we want to trade energy, crossing borders and frontiers to invest in reserves, refining, gas pipelines, and service stations. The success of this integration will depend on private companies more than on the governments, although governments will play an important regulatory role. The brunt of the process will fall on the companies.

At Petrobras, we believe strongly in integrating oil, natural gas, and electricity markets in Latin America’s Southern Cone. Electricity gen- eration will be the main anchor for that integration, and natural gas the primary fuel. In fact, this is already the case. The Bolivia-Brazil gas pipeline connects a region that represents two-thirds of Brazil’s GNP. The pipeline will eventually travel south through Uruguay to 114 Session III

Argentina. We will also have a pipeline running from Argentina to Chile, which will link up to Brazil via another pipeline that may extend as far as Porto Alegre. Another project will connect Buenos Aires and Montevideo and possibly continue on to Porto Alegre as well.

We in Petrobras intend to lead this integration process. The Bolivia- Brazil pipeline has a capacity of 30 million cubic meters per day (mm3d). We are extracting 7 to 8 mm3d. We are on a growth curve, but the problem is the small size of the gas market in Brazil, which is still in its infancy. Brazil is the second-largest natural gas consumer in Latin America’s southern market and uses around 16 mm3d at pre- sent. By 2005, however, it will reach 73 mm3d, of which 51 percent will be supplied with domestic gas, 39 percent from Bolivia, and 10 percent from Argentina.

To conclude, I want to emphasize again that Petrobras is positioning itself as an integrated energy company in Latin America. Our goal is to attain international standing while maintaining profitability for investors. This strategy will also facilitate the process of energy inte- gration in Latin America, particularly in the Southern Cone. <>

MR. ROBERTO MONTI REPSOL YPF

Today I would like to focus on one factor that has impeded economic growth in Latin America, particularly in the development of oil and gas markets. That factor is the government-built economic barriers, the “Chinese walls,” between countries. The current situation is totally inappropriate for the times we live in, when leading countries are committed to looking for integrated, global markets. In Latin America, the process of opening economic borders has been uneven at best. Argentina and Chile have made relatively good progress, but most other countries are still undecided about liberalization. This unevenness further complicates the development of business within and across countries.

THE CHINESE WALL AROUND NATURAL GAS

The state of the current market for natural gas offers a sad example of closed borders and markets. Figure 1 shows the energy matrix of Argentina. Natural gas accounts for 46 percent of Argentinean

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energy consumption, a market share not seen in other countries. In the United States, natural gas accounts for 25 percent of energy con- sumption and in Europe, 23 percent. In Brazil, it accounts for only 3 percent.

Figure 1 Argentina Energy Matrix, 2000

Residential 32 % Plant 28 % Industry 35 % CNG 5% Hydroelectric & Nuclear 7%

Gas 46%

Petroleum Coal Others 42% 2% 3%

The predominance of natural gas in Argentina did not happen by chance. Argentina has been the only country in Latin America to work hard at developing a natural gas market. For example, the country has pioneered the use of compressed natural gas (CNG) in automobiles. No other country in Latin America has done this, not even when the World Bank announced a strict clean air program for major cities as part of its lending criteria.

CNG consumption has increased tremendously in Argentina, grow- ing from 9 percent of gasoline demand in 1992 to 33 percent in 2000. CNG use in vehicles in Argentina has grown dramatically. Today, 50 percent of service stations in Argentina offer CNG and 465,000 vehicles are equipped to use it. This increase has clear envi- ronmental advantages, since CNG produces fewer emissions than other fossil fuels. CNG is also cheaper than gasoline and other alter- native fuels. This has not only created a sales channel for natural gas «Latin America’s Chinese Walls in Energy Markets» 117

but has driven collateral activities such as manufacturing compressors for service stations and equipment for converting automobiles. If all these industries could participate in developing CNG use in other countries in the region, it would promote technological integration and allow important economies of scale to come into play.

However, in spite of Argentina’s example CNG use in the region has grown very slowly (see Table 1). The technology should enjoy a com- petitive advantage in the region, given its financial and environmen- tal benefits and the common language and geographical proximity of the countries. However, this has not occurred. The obstacles have been the asymmetries in infrastructures and the lack of supportive legislation. The legislative issue is vital because governments create the incentives that make this type of project attractive.

Table 1 Compressed Natural Gas (CNG) Use in Latin America, 2000 CNG Cities Service Thousands of Thousands Repair Country with CNG Stations M3 CNG sold of Vehicles Shops

Argentina 158 834 130,000 465 1,126 Bolivia 4172,150617 Brazil 15 76 25,000 85 86 Colombia 6225,200510 Chile 25 65023 Mexico 1213 1.53 T&T 11 12 1,800 4 4 Venezuela 25 150 15,000 31 45 222 1,118 179,813 599.5 1,294

Source: Prensa Vehicular Agosto 2000.

THE NEED FOR INTER-REGIONAL ENERGY PROJECTS AND MARKETS

A prime example of government-erected barriers to the growth of energy integration is found in Venezuela. That country has enor- mous natural gas reserves that are not being marketed. (And here I refer only to proven reserves that would be economically feasible to 118 Session III

exploit.) In contrast, Trinidad and Tobago is moving quickly to mar- ket its limited natural gas reserves. Given their proximity, logistical integration between Venezuela and Trinidad and Tobago would be very simple. As an additional incentive, it is highly probable that the offshore gas fields of both countries are a part of the same geolog- ical structure. In spite of this, Venezuela will probably build LNG plants to export natural gas, although it would be wiser to join in marketing the proven natural gas reserves of the two countries.

Bolivia and Argentina are also ripe for developing a cooperative energy policy. Bolivia has discovered over 32 trillion cubic feet of potential nat- ural gas reserves. In Argentina, oil companies have discovered rich gas reserves near the Bolivian border. Why should these countries compete when a coordinated effort, combined with integrating distribution into markets in Brazil and Chile, would allow these reserves to be exploited more efficiently? Peru also has enormous gas reserves that could play an important role in this market configuration.

Some of the obstacles to inter-regional and domestic natural gas coordination are understandable. In natural gas, exploration and development are often delayed because of the long period between discovery and getting the gas to market implicit in these projects. In the case of oil, however, the time lapse is shorter. So it’s even harder to understand why countries have difficulty coordinating oil trans- portation to markets. Such is the case of Ecuador, which continues to have serious problems delivering heavy oil from the eastern side of the country. They need to build another pipeline parallel to the exist- ing one from the oil fields to the Pacific Ocean. I hope this second pipeline is built as soon as possible. I also hope the project is approached as a regional solution, with Colombia and Peru as possi- ble candidates for refining the pipeline-delivered crude.

Speaking of refining, Repsol YPF has a modern facility in Luján de Cuyo. Across the Andes from the refinery is the densely populated area of Santiago de Chile. Given this proximity, it would be wiser to pursue an integrated market between Argentina and Chile, which «Latin America’s Chinese Walls in Energy Markets» 119

would reduce refining costs, rather than analyzing the needs of Argentina and Chile separately.

A similar situation exists between Argentina and Uruguay, where there is refining capacity on both sides of the Rio de la Plata. Located in the middle, Paraguay should consider these facilities together for the mid and long term in order to proceed efficiently in providing for its petroleum and petroleum product needs.

WHAT CAN BE DONE I have already cited several opportunities for mutually beneficial, intel- ligent coordination of energy policy within Latin America, including • the extensive use of CNG in Latin America, • the rational exploitation of gas reserves, • the dispatching of oil from eastern Ecuador, and • the combining of refining capacities in neighboring countries.

There are even more business areas where better coordination would help all the organizations involved. For example, leading oil compa- nies in Brazil, Argentina, and Uruguay have analyzed the hydrocar- bon potential of the Atlantic continental shelf and could consider an integrated approach to exploiting any discoveries there. Other possi- bilities include • coordinating electricity generation between neighboring coun- tries, focusing on the rational use of renewable hydrocarbon fuels; • developing a free market for marketing raw materials and mini- mizing transportation, which can be positive for the environment; • integrating petrochemical activities to develop an efficient, com- petitive industry that no longer relies on government measures to survive; and finally • following the example of Mercosur member states in terms of aligning private efforts and government measures. 120 Session III

Repsol YPF has been fostering regional initiatives for some time, but, I regret to say, we have seen only limited success. When we compare the different categories and conditions that could favor joint efforts, it is clear how much more could be done.

On a positive note, several companies have made important efforts in recent years to go beyond political limits in pursuit of a regional business approach. Repsol YPF is a leader in these activities. In 1994, YPF and ENAP built an oil pipeline extension to transport Argentine oil from Neuquen, Argentina, to the Pacific Ocean. This project has shown the benefits that can come from wise, effective integration. However, many barriers to similar efforts still exist, mostly stemming from protectionist government policies that are difficult to overcome. This mistaken nationalism hurts everyone and makes the Latin American petroleum industry less efficient, less competitive, and more vulnerable to outside competitors.

TOWARD A MORE OPEN ECONOMIC POLICY The liberalization and integration of energy markets in Latin America have been driven thus far by the sometimes-conflicting nationalistic politics on the one hand and an interregional trade policy based on a growth model on the other. To a lesser extent, it has been driven by energy companies seeking to work together within the region and the hemisphere.

The economic crisis of the 1980s made it clear that companies and regulators cannot coexist efficiently in a bankrupt state. Figure 2 dia- grams the sharp lessons of that period. Since then, several govern- ments have redefined their role in formulating deregulation policies and developing competition.

Energy reform has been widely recognized as a part of the funda- mental policy of liberalization and privatization in Latin America. However, the process has been uneven among countries. Argentina, Chile, Bolivia, and Peru have made great strides in this respect. Brazil and Uruguay have started the process on several fronts, but the inter- vention of their governments will impede progress over the short «Latin America’s Chinese Walls in Energy Markets» 121

Figure 2 Reforming Economic Policy in Latin America: The Lesson of the 1980s

¥ Political Projects

TRADITIONAL DRIVERS ¥ Economic Needs

¥ Thrust of Multilateral Institutions DEBT

CRISIS

¥ Formulation of Policies

NEW ¥ Regulation METHODS ¥ Development of Competition

term. On the other end of the spectrum, Paraguay is not even think- ing about reform. In addition, Central American and South American oil industries lack coordination.

I am not saying a solution must come solely from the political sector. As in Mercosur, energy company executives need to work actively and jointly to eliminate barriers to integrated markets. We need exec- utives with open minds to consider all relevant sectors in their search for optimal solutions. This effort must include state-owned compa- nies and private companies because all will benefit from a better- aligned Latin American energy policy.

To start the ball rolling, the benefits of a more open economic pol- icy must be communicated to the public throughout the Southern Hemisphere. In the past, the actions of some countries have retarded the liberalization and privatization process. To counteract this effect, governments must provide incentives for companies, as well as initiate, implement, and promote efforts to deregulate the energy industry. 122 Session III

Finally, governments need to understand that allowing business agreements across borders does not mean a loss of sovereignty. Rather, it means a more competitive, robust marketplace, one that benefits nations, industry, businesses, and consumers alike. <>

DR. EVANAN ROMERO HARVARD UNIVERSITY

My title, “The Quiet Revolution of Latin America,” refers to the process of global economic liberalization, a process in which Latin America must inevitably be involved. Liberalization requires separat- ing the state from the ownership and management, although not from the regulation, of industries. For the energy industry, natural gas and electricity services are subject to market forces rather than the control of public monopolies. My focus today will be on the progress of energy liberalization in Latin America and on the devel- opment of an integrated energy market in the economically progres- sive area of the “Southern Cone” (Argentina, Bolivia, Brazil, Chile, Paraguay, and Uruguay).

THE NEED FOR ENERGY REFORM

In the last decade of the twentieth century, Latin America experi- enced significant economic growth. Measured by its percentage change in real GDP, it grew 3.6 percent per year over those ten years,

123 124 Session III

which is 44 percent greater than the world average. Yet deeply entrenched poverty is still widespread. To reduce this poverty and provide a better future for its 500 million citizens, Latin America will need to continue growing its economy at a level at least double the population growth rate (1.4 percent per year) projected for this decade. The key to a better future is sustainable economic growth— which means a shift to liberalized markets, privatized industries, and regional and international market integration. This is particularly true for the energy industry, one of the main drivers of economic growth.

Latin America’s need for liberalized, integrated energy markets, with their greater efficiency and lower cost, is clear when we consider the potential demand for energy in the area. Energy consumption grew 10 percent annually during the 1990s, and we expect that rate to continue through the first decade of the next century.

ENERGY-SECTOR REFORM: PROGRESS SO FAR The progress of energy liberalization in Latin America is far from uni- form, as Figure 1 shows. Reforms in Argentina and Chile rank among the most successful examples. Bolivia and Peru also are implementing reform policies for domestic energy markets, but the small size of their economies and the absence of domestic energy infrastructure are slowing progress. Brazil is beginning its reform process and needs to reconcile its need for foreign capital with the implementation of a sound reform process. Uruguay must release the strong government hold on its energy. The reform process is still lagging behind in Mexico and Venezuela, the two largest energy-endowed countries. Panama, El Salvador, and Guatemala lead the Central American countries in implementing reforms, including restructuring and privatization efforts. This area has taken the initiative to build a regional market.

Most nations where governments abandoned their old role as own- ers, operators, and regulators of energy resources have experienced heartening results. The quality and price of energy services have improved significantly, and the resulting economic prosperity has enabled governments to allocate scarce public funds to other more pressing needs such as education, health care, and social security. «The Quiet Revolution in Latin America» 125

Figure 1 Progress of Energy Reform in Latin America, 2000

Central Venezuela Guyana America Suriname French Guiana Colombia

Ecuador Brazil

Peru

Bolivia Absent Developing In progress Uruguay Chile Advanced Paraguay

Argentina

CREATING AN INTEGRATED MARKET The Southern Cone offers an impressive example of how regional markets develop. Reform in the region began with national hydro- electric projects in the early 1990s. During the past decade, Southern Cone governments have sought to stimulate economic growth and international competitiveness through energy-sector liberalization. One of the most visible results has been the creation of modern infra- structure to expand and enhance domestic energy supplies and to facilitate energy trade between countries. Today, the Southern Cone is the only area in Latin America where a regional market is starting to evolve—mainly due to the vitality of Argentina’s liberalized power and natural gas markets.

Prior to the reform and liberalization phase, there were only govern- ment-to-government accords in the power sector for five joint hydro facilities and several other border links. In the decade after reforms began, power interconnections have increased substantially in num- ber and size with private sector investment. Energy endowment dis- parities and a heavy reliance on hydroelectricity are driving Chile and 126 Session III

Brazil to tap into the abundant natural gas resources of Argentina and Bolivia. These complementary energy resources are strengthen- ing the reliability of the national systems and are also reducing the environmental impact of hydroelectric and nuclear use. Increasingly efficient electricity and natural gas markets are converging into a sin- gle energy market.

Markets for Electricity In 1995, the first power link between Argentina and Brazil opened up with the construction of a 50 MW, 132 kV line to link Paso de los Libres (Argentina) and Uruguayana (Brazil). Growth since then has been ongoing, as Figures 2 and 3 show.

In 1999, Chile’s northern system (SING) at Atacama was connected to the thermal combined-cycle gas turbine (CCGT) power plant of Thermoandes in Guemes (Salta, Argentina). This interconnection was built as a dedicated line for exporting power to Chile’s industrial area (covered by SING) and remains isolated from Argentina’s grid.

2 1 3

4 1 2 3 4 «The Quiet Revolution in Latin America» 127

3

6 1

2

4 1 2 5 3 4 5 6

In May 2000, CIEN, a private consortium comprising ENDESA of Spain and ENERSIS of Chile, placed a 600 Km, 500 kV power inter- connection in service between Rincon de Santa Maria (Argentina) and Ita (Brazil). A second line is expected to be in service in early 2002. Further development depends on two main factors: the dis- placement of domestic Brazilian supply and the presence of efficient competition—gas-to-gas, power-to-gas, and power-to-power—in the region that would result from establishing a Brazilian wholesale market.

On the whole, electricity liberalization and integration in the Southern Cone are progressing. But there are still key issues that need to be addressed by the planning and regulatory institutions, including 1) the pricing of electricity transmission, 2) the mechanisms for remunerating private investors willing to build cross-border inter- connections, and 3) the import and export restrictions, which are pre- sent in all countries in the region. 128 Session III

Natural Gas Integration The creation of regional natural gas markets is moving more slowly than the creation of electricity markets. However, the integration of electricity generation and transportation will be echoed in natural gas over the next decade. Figures 4 and 5 show present and planned development. Some salient projects are described below: • A gas pipeline was built in the early 1970s by the two state oil companies, YPFB and YPF, to transport natural gas from Santa Cruz (Bolivia) to Yacuiba (Argentina). The flow in this line will soon be reversed to connect gas fields in northwest Argentina and southern Bolivia with the Bolivia-Brazil pipeline. • Four gas pipelines were built between Argentina and northern and central Chile after the two countries signed a gas intercon- nection agreement in July 1995. • In July 1999, the Rio Grande (Bolivia) to Sao Paulo (Brazil) gas pipeline was placed in service.

Figure 4 Projected Southern Cone Natural Gas Trade, 2000 (Million Cubic Meters per Day)

Santa Cruz-Sao Paulo 4.0 Nor Andino 0.12 Sao Paulo-P. Alegre Gas Atacama 1.5 1.64 Uruguayana-P. Alegre Gasandes (Futuro) 6.37 Uruguayana 2.80 Pacifico Cruz del Sur 0.25 (Futuro) Parana-Paysandu 0.20 Methanex 4.35 Total: 21.23 mm3d «The Quiet Revolution in Latin America» 129

Figure 5 Projected Southern Cone Natural Gas Trade, 2010 (Million Cubic Meters per Day)

Santa Cruz-Sao Paulo 16.0-24.0 Nor Andino 6.0 Sao Paulo-P. Alegre Gas Atacama 5.0-12-0 4.5 Uruguayana-P. Alegre Gasandes 6.5 9.4-21.4 Uruguayana 2.50 Pacifico Cruz del Sur (Montevideo) 2.0-8.0 3.6 Parana-Paysandu 2.0 Methanex 5.0 Total: 63.7-96.7 mm3d

The amount of gas expected to flow through the Southern Cone network would increase from 15 million cubic meters per day (mm3d) at year-end 1999 to about 21 mm3d by year-end 2000, and is expected to rise to between 58.7 and 67.1 mm3d by 2005 and between 63.7 and 96.7 mm3d by year-end 2010. The final volumes depend on several factors, many of which focus on Brazil’s natural gas policies.

The first section of the Mercosur pipeline has already been built and is transporting 2.8 mm3d of natural gas to the Brazilian border town of Uruguayana. This pipeline is linked to Argentina’s TGN pipeline, which brings gas from the northwest basin. The second option for Argentina’s gas to reach Brazil’s Porto Alegre is via the so-called Cruz del Sur pipeline. Construction is underway for the first section to reach Montevideo by 2002, with a capacity of some 1.5 to 2 mm3d.

Proven Bolivian natural gas reserves (at year-end 1998) are still con- sidered sufficient to meet Bolivia’s obligation of 30 mm3d by year-end 2010 to Brazil. Negotiations are underway for a second gas pipeline 130 Session III

between Bolivia and Brazil. These factors will affect the volume of gas that Argentina is able to export to Brazil.

Benefits of Regional Power Interconnections The regional power interconnections being built throughout the Southern Cone of Latin America bring important benefits by • reducing the region’s overdependence on hydroelectricity, • optimizing daily and seasonal load fluctuations among the region’s power systems, and • substantially reducing the capital and operating costs of each integrated system, particularly by use of natural gas and CCGT technology.

Over the last ten years, these energy projects have multiplied in num- ber and also in complexity and scope. The nature of the projects has also changed. The important point to make here is that, while gov- ernments initiated the reforms driving this change, the private sector has been the principal builder and operator of the interconnection infrastructure.

CRITICAL GOALS FOR MARKET INTEGRATION

Regional coordination is a crucial dimension in energy market reform. Regional trade integration and political reforms were launched simul- taneously in the 1990s and led to the creation and development of Mercosur.

The Mercosur Role in Reform Mercosur has incorporated Chile and Bolivia as trade partners, along with the original Southern Cone partners of Argentina, Brazil, Paraguay, and Uruguay. As a result (as was also the case in the European Union), trade has been a powerful driving force for energy integration: the forces of globalization constantly pressure the «The Quiet Revolution in Latin America» 131

member countries to strive for energy efficiency and lower costs to maintain their competitiveness.

These goals provided a basis for building links between the different national networks. In the search for more efficient markets and improved competitiveness, Mercosur sets an important example in the trading of goods and services, including electricity and gas. With Mercosur’s assistance, energy officials from Latin American govern- ments have established a common agenda and delegated its imple- mentation to Mercosur’s Work Sub-Group No.9 (SGT-9). Their agenda calls for harmonizing regulations regarding cross-border energy exports—mainly with regard to issues of transparency and open access to energy grids.

The Private Sector Role in Reform The private sector has an increasingly important role in the Latin American energy market, with investments rising steadily from 1992 to 1996 and then taking a huge jump in 1997. The primary sources of private investments have been concentrated in Spain and the United States. To properly use the resources of these international energy firms in the drive for integration, governmental support is needed in • eliminating or minimizing creeping expropriation tactics by investor-unfriendly regulations, • correcting the supply and pricing policy advantage, which favors hydro over thermal power, • reducing access barriers to capital markets, • increasing payment terms in foreign exchange, • minimizing or reducing the strong presence of state-owned util- ities (SOUs), and • enabling antitrust authorities to deal with market power abuses in the energy sector. 132 Session III

ENERGY MARKET INTEGRATION: CURRENT STATE AND FUTURE GOALS

We can summarize the state of energy integration in Latin America as follows: • Energy market integration is advancing from the Southern Cone toward the north. • Integration is being facilitated by the expanding infrastructure, by the availability of natural gas coupled with CCGT technology, and by Mercosur. • The long-term challenge of integrating efficient domestic mar- kets into regional ones remains.

A regional Latin American energy market does not exist yet. Nonetheless, much of the groundwork is in place. The companies are there, the government policies are there, the infrastructure is being built, and the economy is responding to reform policies. But much still needs to be done.

One important task is integrating efficient domestic markets across borders with other markets to achieve regional efficiency. Several regional institutions, in cooperation with the World Bank and the U.S. Department of Energy, are helping to set up these frameworks. Another important task is coordinating the independent network operators. The example of the European Union—which harmonized existing capacity, created a regional body to resolve disputes, and minimized the need for large regional institutions and regulations— is a useful one to consider.

These issues are important, but the heavy hand of history, the strong government hold on energy sectors, still remains. Once we surmount this problem, all the other barriers to regional energy markets will be much easier to address. CLOSING SESSION

SUMMARY AND COMMENT

PROFESSOR WILLIAM W. HOGAN HARVARD UNIVERSITY

Let me begin by expressing my great appreciation to the many peo- ple who participated in this Seminar, our first in Latin America. All who organized this gathering—especially Bijan Mossavar-Rahmani, Rob Stavins, and José Luis Díaz Fernández—have been impressed by the vitality and substance of your contributions. Your discussions here have encouraged us in our commitment to continue these Seminars with their matchless opportunities for us all, in different ways, to learn from each other.

CONVERSATIONS FOR LEARNING

I will organize my summary of our conversations by asking a hard question about the extent of that learning, a query that repeats the pointed remarks of several participants: “Can we, do we, learn from the experiences and the mistakes of ourselves and others—or are we doomed to repeat them?” If the latter is true, does this negate the purpose of these Seminars? Let me leave that question for you to

133 134 Closing Session

consider for a moment while I turn to a review of the session high- lights.

Our agenda included seemingly disparate topics—world oil markets, global warming and international environmental policy, Latin American market integration, the larger macroeconomic policy issues—but these subjects have several common touch points that link them and encourage our reflection as well.

Recurring Topics, Varied Perspectives In his opening remarks, Alfonso Cortina set the tone for our discus- sions by connecting this Seminar to the many we have had before. He identified the important ongoing topics that we consider and reconsider: macroeconomic developments in national and global economies, the world oil market, and the evolving environmental struggles. And he had the pleasure of introducing a new focus— developments in Latin America. He also emphasized the topic under- lying all these themes that has been at the core of our discussions since the Seminars began in the late 1980s: the “once-in-a-century paradigm shift,” that is, the worldwide movement toward liberaliza- tion and deregulation.

These topics resonated throughout each session as the able chairmen presented their topics and speakers. In his session on oil, Bijan Mossavar-Rahmani connected the current story of oil to our previous conversations, touching on new trends and familiar cycles, price volatility, and supply security. These are issues we continue to debate. When we moved to the environment, Rob Stavins identified how our discussion of environmental matters, including climate change, has paralleled the expanding environmental concerns of the real world. Finally, José Luis Díaz Fernández linked the topic of economic liberal- ization and market integration to current developments in Latin America. The intensity of the responses to his panel indicated that this subject is one we should continue to pursue.

The variety of perspectives brought by the distinguished participants to our conversations provides another important means for learning. Summary and Comment 135

Some of the viewpoints reflect professional identity. We have acade- mics, like myself, who study many sides of the issues; we have gov- ernment officials who are knowledgeable about policy development; and we have business leaders who have direct contact with market problems. All draw on their professional expertise to add new infor- mation to our discussions. In addition, some of our variety reflects geographic orientation. We have representatives from Latin America, the United States, the Middle East, and Europe discussing what is working or not working in their particular areas.

Macroeconomic Overview On the topic of macroeconomic developments, our keynote speaker, former Argentine Minister of the Economy Domingo Cavallo, and Argentine Minister of the Economy José Luis Machinea, who wel- comed us to Buenos Aires, both delivered brilliant, articulate com- mentaries on broader questions of economic liberalization as refracted through the Latin American prism. They identified the important issues related to getting the market structure right, to establishing effective governmental oversight and incentives, and most important, to creating an atmosphere of confidence in the mar- ket. In this kind of environment, the people who can really solve problems—entrepreneurs, business people, the people who imple- ment change—will succeed.

World Oil Market Volatility The world oil market has always been a basic theme of these Seminars. In fact, it has pride of place as the issue that initially inspired these gatherings in the 1980s. This year we heard the valuable insights of representatives from state-owned companies, private firms, and governments. Adrián Lajous, formerly of PEMEX and now at the Oxford Institute for Energy Studies, commented on the impor- tance of logistics as it relates to capacity. He stressed how the capac- ity limits of many systems have been reached and how the capacity crunch is as much a primary market driver as politics. Jim Ragland of Saudi Aramco also emphasized the importance of logistics, linking it to great oil market events. When we took our annual look at OPEC, 136 Closing Session

we were presented with a new situation. Humberto Calderón Berti, who knows OPEC well, pointed out that the price rises in oil markets in 2000 were different from those of the past because they were not associated with major political upheavals or armed conflicts. Something unusual is going on, and this may require additional analy- sis here and elsewhere in the future.

The primary message from these discussions is that oil market volatil- ity will continue. The timing of price cycles may change, but we won’t ever be sure exactly when or how. Prices will go down and go up as the market (or OPEC, to the extent possible) dictates. That’s the world we live in, and we don’t expect any dramatic changes any time soon.

Environmental Policy and Global Climate Change Just as complex as the problem of oil price volatility is the task of hammering out environmental and global climate change policies that are fair, feasible, and affordable for businesses and nations alike. Alain Heilbrunn reminded us that the oil industry has an agenda of environmental policies, some of which conflict with others. In partic- ular, the struggle for clean air is creating situations where alleviation

of some harmful emissions produces more CO2, which puts this goal in conflict with efforts to fight global warming.

Charlie Kolstad, a renowned economist, offered the view of a bemused first-time observer at an international negotiating confer- ence. After highlighting the paradoxes at The Hague, he concluded by suggesting that Kyoto be scrapped and the real and necessary struggle against global warming be restructured.

Brian Flannery spoke of the long-range nature of the challenge and rued the current emphasis on short-term fixes that would do little to deal with the real issue. The real hope lies in long-term research that will lessen the problem on a number of fronts.

Market Integration in Latin America In the presentations on Latin America, we learned much about how government and public policy interact with business and business strategy. Philippe Reichstul gave us his thoughts as a Latin American Summary and Comment 137

businessman on developing markets in South America, how these changes have affected Petrobras and Brazil, and what still needs to be done. In particular, he mentioned the existing imbalance in gas and oil between different companies and countries and the resulting need for trade and coordination.

Roberto Monti, familiar to all of you from his notable work here in Argentina, showed some of the frustration he feels as a businessman trying to overcome government obstacles to improved market coor- dination. He gave many examples of these obstructions, particularly with respect to developing markets for natural gas and compressed natural gas. Monti referred to the daunting government-erected bar- riers to trade and better coordination as “Chinese walls,” and many others echoed this theme.

(For those of us from the United States, his use of this expression was ironic. We often employ the term “Chinese walls” to indicate a for- mal if paper-thin barrier to prevent people who might—but should not—work together from doing so. In Latin America, the expression refers to businesses that should get together being kept apart forcibly by legislative walls much thicker than paper.)

Evanan Romero detailed the movement to regional markets in energy that is just beginning in the Southern Cone and had guarded opti- mism about its spreading over larger parts of the continent.

CAN WE LEARN FROM EXPERIENCE?

Now to return to the difficult query I mentioned at the start. Humberto Calderón Berti listened to the recounting of all that expe- rience, of all those insights (that I have so briefly reviewed), and then he posed the hard question: he wondered if it were possible for us to learn from the experience and the mistakes of ourselves and others. Many others touched on the same topic; certainly it was a question that I found familiar. But Humberto was the first to put it so directly. If we can’t learn from past mistakes, he was asking, what are we doing here at this Seminar? It is a challenging question. My answer is we can indeed learn from experience—but it is extremely difficult. 138 Closing Session

Forgetting What We Are Trying to Accomplish One reason for the difficulty can be summed up this way. When we have many problems with many dimensions, it is easy to forget pre- cisely what we are trying to accomplish. When we are in process of developing a new policy, it is easy to go off in the wrong direction because of the struggle’s internal dynamics, or because there is no consensus on goals, or because the law of unintended consequences haunts the effort. Luis Mañas, for example, questioned our goals for global warming by asking, “What’s wrong with a warm day in Buenos Aires? Is this really what we want to avoid?” What exactly are our objectives when we talk about global climate policy?

Rob Stavins raised similar questions when he identified unresolved Kyoto issues that didn’t seem connected to real environmental objec- tives. Juan Bachiller suggested that these problems have come close to killing the Protocol. Indeed, some people have been anxious to bury the Kyoto agreement, but that is partly a result of our forget- ting what we are trying to accomplish.

Daniel Montamat made a parallel case regarding Latin America. He argued that restructuring industries and legal systems is fundamen- tally a political problem and has to be dealt with in a way that does not neglect the original intentions. The government cannot walk away and leave the process entirely to the private sector. If that hap- pened, the micro-objectives of firms would conflict with the macro- objectives of broader policy. So we need a complicated balance, one where the government sets the rules, sets the process for liberaliza- tion, and sets the incentives but does not try to manage the individ- ual strategy of each company.

That perception resonates with my experience in electricity restruc- turing in the United States. I keep coming back to the importance of remembering what we are trying to accomplish with restructuring: efficient markets that protect society as a whole. We are not trying to create a plethora of competing firms for their own sake, nor are we trying to do the opposite. In the midst of so many claims on the policy, it is easy to lose sight of just what the goals are. Summary and Comment 139

Ira Jolles reiterated the problem of staying focused when he talked about the price volatility in U.S. electricity markets. When we observe this kind of instability—in a commodity market where people don’t have enough information to manage risk and are working at cross- purposes—prices go up. When prices rise sharply, the political tem- perature rises sharply as well. Politicians intervene—and they have an opportunity to repeat past mistakes. That’s what is happening now in the California electricity market. (I notice that FERC Commissioner Bill Massey has been silent on this point.)

A Box Labeled “Too Hard” Another major reason for the difficulty in learning from past mistakes is the intractable nature of the problems we face. I am reminded of a cartoon that shows a desk with three labeled boxes: an IN box with a small stack of papers, an OUT box with a smaller stack, and, finally, a TOO HARD box that is overflowing. A fair number of the problems we talk about would land in everyone’s TOO HARD box. Solutions seem to be quite beyond everyone’s ken.

Adrián Lajous and Humberto Calderón Berti are frustrated that we can’t manage the oil market better. Jim Ragland was less frustrated than resigned, observing that we don’t have the right data to do it. Even OPEC has great difficulty in manipulating the oil market. We have talked at length in previous Seminars about different ways, dif- ferent policies, different strategies to control oil markets. Maybe we should just relax. Perhaps this is TOO HARD. In other words, the volatility in the world oil market can’t be resolved.

Humberto Calderón Berti also commented on how hard it is for OPEC to balance supply and demand. Should the organization follow a strategy with high prices at low volumes, or one with low prices at high volumes? Both approaches are problematic. We need a price in the middle—somewhere between $21 and $23 per barrel. Adjusted for inflation, this range is similar to the $17 midpoint that was con- sidered ideal ten years ago when we talked about the same issue. Everyone believes that’s the balance we need, but it is just TOO HARD to achieve. We don’t know how to do it. The ongoing tension 140 Closing Session

between consuming and producing countries adds to the difficulty, especially when it comes to increasing capacity. That idea seems to be a non-starter; again, it’s TOO HARD.

It’s not only the oil market. Brian Flannery puts the problems associ- ated with ameliorating global climate change as mandated in the Kyoto Protocol into the TOO HARD box as well. As Juan Bachiller noted, we have backed ourselves into a cul-de-sac on that issue, and we can’t get out. In other words, we are not going to be able to solve climate change with near-term fixes.

(Rob Stavins also focused on how to deal with Kyoto. Like Flannery, he found the problems were TOO HARD. But he knows how to solve that dilemma: organize a blue ribbon panel that consists of himself and other people like him. Alas, that is not going to be so easy to pull off.)

The problems of international security—Richard Perle’s topic—also fall into the TOO HARD category. These issues, in particular those related to energy policy, appear very difficult. To cite one of the most vexing, Richard identified one particular problem the next U.S. administration would have to face: Iraq. He implied that at some point Saddam Hussein was going to try to sidestep the sanctions. Apparently, Hussein announced he was going to stop oil production because he wanted to change the pricing scheme. As Richard told it, Saddam would reduce his oil price by 50 cents per barrel and then demand that the 50 cents be deposited in an account not run by the United Nations. It is a straightforward attack on the sanctions. How will we respond to that? Can we respond to that? Or is it TOO HARD?

(Let me include a short personal comment about my experience after hearing Richard speak at these conferences. The drill is that he gives a talk and very soon events prove him right. Yesterday, however, he set a record. He predicted Saddam Hussein’s likely action in the morning—and Saddam complied in the afternoon.)

That sums up my first conclusion: we do have a hard time learning from each other and from past mistakes because of the nature of the problems we deal with. Summary and Comment 141

TAKING THE LONG VIEW

My second conclusion is more hopeful. I will offer some thoughts on how we might proceed with a measure of optimism and a chance of success. This involves adopting a different strategy for dealing with these issues: taking the long view and “muddling through.”

Alain Heilbrunn talked about the complicated politics involved in addressing global warming in Europe. He explained why we can’t react too quickly. We have to take these problems seriously. However, we can’t try to solve everything at once. We have to take a some- what longer view to make progress in these areas.

Adrián Lajous’ summary of developments in Mexico says the same thing: don’t ask for everything. Privatization of PEMEX will not hap- pen soon, nor will the privatization of the electricity business. There are many things that can be done, however, to start restructuring in the right direction. That kind of “muddling through” step by step promotes progress as each situation evolves.

At The Hague, Charlie Kolstad was surprised and disappointed by the obsession with details and with the troubling effect of NGOs. On the other hand, discussion did go on there. Although the delegates didn’t reach any agreement, future meetings may profit from their interaction.

Evanan Romero echoed this theme as he considered what is hap- pening in the Southern Cone and in Latin America in general. A grand solution will not be found overnight. Rather, strategies need to evolve. We have to establish efficiencies within the individual coun- tries before we can break down the Chinese walls or real walls that obstruct competition and communication across regions

So the news is not all bad. I tend to be an optimist. A fair amount of the discussion we had points to the possibility of making steady progress if we • create a general framework for the problem, • step back and remember what we are trying to accomplish, and 142 Closing Session

• identify reasonable roles for government and public policy, ones that complement entrepreneurs and the business sector.

As we look at the conversations we’ve had, in particular those detail- ing the tremendous changes in Argentina and elsewhere in Latin America, we can see enormous accomplishments, ones we all thought impossible only a decade ago.

Therefore, given the kind of tasks we are engaged in, we should think strategically and longer term about these problems, we should try to remember what we can accomplish, we should try to accom- plish what can be done, and we should not get too frustrated when we encounter a problem that is just TOO HARD. If we can manage this, we can make steady progress. <>

MR. JOSÉ LUIS DÍAZ FERNÁNDEZ FUNDACIÓN REPSOL YPF

At the conclusion of the X Repsol-Harvard Seminar in Madrid in 1999, Bijan Mossavar-Rahmani reflected on the history of the Seminars:

In the mid-1980s I came to Spain to bring together Repsol— at that time INH—and Harvard in a project to introduce Spanish policymakers to the outside energy world from which you were still largely insulated. In addition, we in the United States knew very little about Spanish energy policy and about your oil, gas, and electricity industries. Harvard’s initiative was warmly welcomed and, so, these Seminars came into being.

Spanish enthusiasm for the proposal was centered on the “Run Up to 1992,” when all Western Europe would face the challenges cre- ated by the new Single Market that would come into effect that year. Across Europe, there was general uncertainty about the implications of this new economic order, but Spain’s oil world faced an especially critical challenge. In the Spanish natural gas and electricity industries,

143 144 Closing Session

the monopoly (or oligopoly) structures that characterized them were not unlike those in other European countries. However, the Spanish oil industry had characteristics that set it sharply apart from the Western European norm. In 1927, the government created “Monopolio de Petróleos” (Oil Monopoly), the agency responsible for importing all crude oil and oil products and for most of the refin- ing, distribution, and retailing of gasoline and other oil products. Each year, the monopoly fixed the price to be paid for crude and products (with reference to international prices), allocated the amount of crude that each refinery would receive, set the volume of refined products, and fixed the retail prices.

Although this monopoly changed somewhat over the decades (including a limited liberalization of the refining sector in 1947), the fact is that in 1985, on the eve of our entrance into the European Economic Community, Spain’s oil industry, while unchallenged at home, was totally unprepared for competition with vertically inte- grated corporations accustomed to competing on an international scale. With the Single Market due to take effect in 1992, the situa- tion was critical.

It was clear to Spanish policymakers that the new situation required drastic action on two fronts at the same time: 1) the dismantling of the monopoly and the liberalization of domestic markets, and 2) the creation of a dynamic, competitive, vertically integrated business sec- tor capable of competing with international corporations within Spain and on the international market. With some pride I can say that the record of the succeeding years confirms that the Spanish oil leadership met this dual challenge superbly. A new oil corporation, Repsol, was created to compete in a liberalized national and interna- tional market, and in little more than a decade Repsol YPF has become a significant player on the international energy scene.

THE ROLE OF THE SEMINARS

As part of the move to inform and to stimulate the new Spanish oil sector, Spanish officials were eager to work with Harvard to create a «A Repsol YPF-Harvard Seminar Retrospective» 145

forum where business executives, academics, government officials, and others could analyze, discuss, and reflect on the most pressing issues among the wide range of topics that affect oil—prices, mar- kets, geopolitics, liberalization, privatization, regulation, environ- ment, and so on. The first Seminar, the INH-Harvard Executive Session, was held in 1987. Its success, and the creation of Repsol in that year, clearly called for a second conference: the Repsol-Harvard Executive Session held in 1988. The series has continued to the year 2000, when for the first time we are meeting not in Europe but in Latin America.

All of these sessions have been distinguished by the noted partici- pants and by the timeliness of the topics they discussed. In fact, to review the history of the Seminars from 1987 to the present is to review the history of the energy industry during this period.

Enlarging the Focus The early Seminars in the late 1980s focused almost exclusively on international oil markets and prices. This is not surprising; these mar- kets—and Spain’s place in them—were the initial impetus for the conferences. Our focus on oil broadened as we turned to the down- stream sector and to the new financial instruments, such as spot markets, being developed. Oil was becoming increasingly a financial commodity that attracted investment not only from energy compa- nies but also from traders, financial institutions, and investment funds. Oil was the principal focus, while other major energy sources, notably natural gas and electricity, in Spain as in the rest of Western Europe, were lodged in comfortable national monopolies with arcane regulations and defined actors.

The industry began to change in the early 1990s, and the Seminars changed too. Reflecting the widening scope, the 1995 Seminar changed its name to “Executive Session on Energy Policy,” and this new, broader energy focus had a variety of very new topics to con- sider, including the globalization of the economy and of the energy industry, the impact of new technologies, the liberalization of gas and electricity markets, and the tendency of corporations to con- 146 Closing Session

verge on all fuels. Energy’s relationship with environmental concerns, first regarding air quality and later global climate change through the Kyoto Protocol, gained central prominence. But even as the energy industry expanded, the oil industry remained at its core and contin- ued to compel our attention. We continue to analyze its cyclical pat- tern of price volatility and the effects of OPEC’s cycle of weakness and reinvigoration.

The Seminars have been invaluable in providing opportunities to dis- cuss issues in the context of an ongoing forum. Thus, we have been able to consider the evolving nature of these topics so that we may better understand where we have been and where we would like to go. Let me mention three topics (out of many) that I have found of ongoing significance and interest during the history of the Seminars: oil price forecasting, corporate structure, and market liberalization.

Can We Predict Prices? Oil has been the keystone in the Seminar arch from the start in 1987, and oil prices have plunged and spiked over the period spanned by our meetings. Oil price forecasting has been a major topic, with note- worthy speeches and enriching debates. Many noted people have formulated forecasts on the future of the oil markets. A few have been noted for their clairvoyance, in particular H.E. Sheik Yamani speaking at the 1994 and 1996 Seminars.

Others have been less successful. At one Seminar, a representative of a large multinational company told us that his corporation had given up on forecasting oil prices. Instead, they had decided to present sev- eral possible scenarios with price predictions for each of them. One sharp participant responded that this shift to multiple predictions, this hedging of the forecast, resulted partly from the repeated fail- ures that marked earlier predictions. But we all agreed that such fail- ures were understandable in light of the complex geopolitical factors and collusive practices that have obstructed and will continue to obstruct market forces, which in a free market environment would determine oil prices. «A Repsol YPF-Harvard Seminar Retrospective» 147

Corporate Structure Another topic that has been of ongoing interest during the Seminars is that of optimal structure for energy corporations. Speakers in the mid-1990s maintained that big multinational companies could coex- ist with smaller regional companies that specialized in one or several energy sectors. Not so any more; the current reality highlights the mega-mergers that have produced giant corporations. Is this the inevitable result of the liberalization of energy sectors and the priva- tization of companies? The emergence of corporations such as ExxonMobil, BP Amoco, Chevron-Texaco, and TotalFinaElf indicate a trend that analysts currently consider irreversible and necessary to mobilize the enormous financial resources that the industry will require in the next decades. These analysts also believe the process should continue!

Market Restructuring But perhaps the most far-reaching theme discussed during these years has been the liberalization and privatization of energy markets. The Seminars began in response to the emergence of the European Single Market in 1992, an early form of liberalization. This move to liberalization, this “amazing shift from one form of major economic policy to another,” as keynote speaker Kenneth Lay of Enron noted at the 1997 Seville Seminar, has taken on global proportions.

This shift to a reliance on markets, changing a policy that had been immovable in Europe for decades, has resulted in governments changing the rules of the economic game by adopting aggressive policies at an ever-faster pace. For the energy industry, these policies are leading in two directions: first, to the vertical disintegration of the gas and electricity sectors and to the conversion of distribution or basic transport facilities to common carrier status that should allow a direct relationship between producers and consumers; and second, to the horizontal disintegration that encourages competition by impeding the development of dominant market groups.

The Seminar discussions on this topic have been marked by a wide range of opinions on how this process should work, but rarely on 148 Closing Session

whether it should work. In 1996, we heard a natural gas regulator from the United Kingdom say, “In Brussels [at the European Union], one of the comments that appears periodically is the following: ‘We want to introduce competition in Europe in an orderly way.’” “However,” this regulator continued, “the words ‘competition’ and ‘orderly’ do not go together: competition cannot be introduced in an orderly fashion.” The British government implemented policies reflecting this way of thinking, policies that promoted a drastic fall in gas prices. (Some skeptics wondered whether the price drop was due to the liberalization of the markets or to the fall in oil prices.) My opinion in this matter—based on my personal experience in the lib- eralization of the Spanish oil sector—is that, putting aside plays on words, deregulation and competition can and should be introduced in an orderly way.

In the 1997 Seminar, a commissioner from the Spanish National Com- mission for Regulation of the Electricity Market commenting on the liberalizing measures taken in the European electric sector, said,

There will not be a revolution in the electricity sector. A rev- olution implies moving from a normal situation to an abnor- mal one and doing so quickly. The electricity industry, by contrast, is moving in the opposite direction. We are moving from a monopoly, an abnormal situation, and we are going towards the free market, a normal situation, and are going in this direction slowly.

THE VALUE OF THE SEMINARS

As I conclude my reflections on the Seminars, I want to emphasize their value again. Year after year, the Seminars present new and/or controversial topics in a format that allows us to consider and debate the advantages and shortcomings of each. These discussions have often focused on market liberalization and privatization, demonstrating time and again that such policies, when imple- mented correctly, lead to better-managed companies that can com- pete internationally without the handicaps associated with tight «A Repsol YPF-Harvard Seminar Retrospective» 149

governmental restrictions. Our discussions have also made clear that the new role of government—establishing clear, reasonable, and non-discriminatory rules—is also of critical importance.

The economic process of liberalizing and privatizing markets never ends. For the energy market in particular, the European Union will continue to mandate standards aimed at increasing transparency and promoting competition for the benefit of its members. Just 15 years ago, Spain was at a crippling disadvantage in the emerging European economic world. Now, at the turn of the new millennium, we find ourselves on a level playing field with our European Union colleagues as we face the future. For that, in part, we can thank the Repsol YPF- Harvard Seminars, which have helped establish Spain’s new place in Europe. BIOGRAPHIES OF SPEAKERS

Humberto Calderón Berti has had a long and distinguished career in the oil industry in both his native Venezuela and internationally. After joining Corporación Venezolana de Petroleo (CVP), the first national oil company of Venezuela, in 1970, he was instrumental in the nationalization of the Venezuelan petroleum industry in 1976. Mr. Calderón Berti became Minister of Energy and Mines in Venezuela from 1979 to 1983. During that period he also served as president of OPEC in 1979–1980. From 1989 to 1993, he was a deputy to the National Congress from the state of Anzoategui and also served as president of the Congressional Permanent Commission of Energy and Mines. In 1992 he was also Minister of Foreign Relations. Mr. Calderón Berti received a B.S. in Geology from the Universidad Central de Venezuela and a Masters in Petroleum Engineering from the University of Tulsa, Oklahoma.

Domingo F. Cavallo was appointed Argentina’s Minister of the Economy in April 2001, thus returning to the post he had held from

151 152 Biographies of Speakers

1992 through 1996. Earlier he had served the government as Minister of Foreign Relations from 1989–1991 and as National Deputy for the Province of Córdoba from 1987–1991. Dr. Cavallo has been president of the Central Bank of Argentina and a member of the Advisory Committee for the International Bank for Reconstruction and Development (IBRD). Dr. Cavallo received a Ph.D. in Economics from Harvard University and an undergraduate degree from Córdoba National University. He has been a visiting professor at New York University and writes widely on national and international economic issues.

Alfonso Cortina de Alcocer has been chairman and CEO of Repsol YPF since July 1999, and has been a member of the YPF Board of Directors since February 1999. Prior to the merger, he was chairman and CEO of Repsol, S.A. from 1996 to 1999. From 1984 to 1996, he served as vice chairman, chairman, and then managing director of Portland Valderrivas, S.A., as well as chairman of the firm’s delegate commission. Mr. Cortina has had extensive experience in the bank- ing industry, including executive positions at Banco de Vizcaya Group, Hispano Hipotecario, Sociedad de Crédito Hipotecario, S.A., and Banco Zaragozano. His professional activities have included chairmanship of the Asociación Hipotecaria Española and member- ship on the executive committee of the European Mortgage Federation. In 1995 he was honored by the Madrid Official Chamber of Commerce and Industry as “Businessman of the Year.” Mr. Cortina holds degrees in advanced industrial engineering and in eco- nomics from ETSII and Madrid University, respectively.

José Luis Díaz Fernández has been president of Fundación Repsol YPF since its creation in January 1996, with a mission to coordinate Repsol YPF’s work in promoting educational, cultural, and research activities relating to energy and society. He is also vice president of Fundación YPF. After serving in the public sector as Director General for Energy in the Ministry of Industry, Mr. Díaz Fernández moved to the private sector in 1975 and joined Repsol after its founding in 1987. He has served Repsol in many roles, including chairman and CEO of Repsol Petróleo, S.A., and chairman and CEO of Campsa. Mr. Biographies of Speakers 153

Díaz Fernández is a member of the Board of Directors and of the Executive Committee of CLH and Petronor, S.A., as well as a mem- ber of the Spanish Engineering Academy. He received his Ph.D. in Mining Engineering from the Polytechnic University of Madrid, where he serves on the faculty of the School of Mines. He is a member of the Spanish Academy of Engineering.

Brian P. Flannery is the Science Strategy and Programs Manager in the Safety, Health, and Environment Department at ExxonMobil Corporation. Since joining ExxonMobil in 1980, he has participated in scientific, technical, economic, and policy studies of global climate change and has been involved on behalf of business and industry in national and international forums that address global climate change. Before joining ExxonMobil, Dr. Flannery was an academic researcher at The Institute of Advanced Study at Princeton and at Harvard University. Dr. Flannery is co-author of the widely used refer- ence Numerical Recipes: the Art of Scientific Computing.

Alain Heilbrunn has been the director of European Public Affairs for TotalFinaElf since 1995. Before the corporate mergers, he was gen- eral delegate for Central Europe at Total. He is active in industry orga- nizations as chairman of the Energy Policy Advisory Group of the European Petroleum Industry Association (EUROPIA), and as a mem- ber of the Boards of the European Oil Industry Organization for Environment, Health, and Safety (CONCAWE) and of the Union of Industrial Employers Confederations of Europe (UNICE). A chemical engineer by training, Dr. Heilbrunn was the general manager of CdF Chimie-TerPolymers. He received a Ph.D. in Sciences from the University of Rouen.

William W. Hogan is the Lucius N. Littauer Professor of Public Policy and Administration at the John F. Kennedy School of Government, Harvard University. Professor Hogan serves as research director of the Harvard Electricity Policy Group (HEPG), which is exploring the issues involved in the transition to a more competitive electricity market. He is a Director of LECG, LLC, where he consults on topics that include major energy industry restructuring, network pricing and access 154 Biographies of Speakers

issues, and privatization worldwide. Professor Hogan has been actively engaged in the design and improvement of competitive elec- tricity markets in many regions of the United States and around the world. He received his undergraduate degree from the U.S. Air Force Academy and his Ph.D. from UCLA.

Charles Kolstad is the Donald Bren Professor of Environmental Economics and Policy at the Bren School of Environmental Science and Management, University of California, Santa Barbara. Prior to joining UCSB in 1993, he was on the faculty of the University of Illinois in Urbana-Champaign. He has also been a visiting professor at MIT, Stanford, the Catholic University of Leuven (Belgium), and the New Economic School (Moscow). Professor Kolstad’s research and writing have focused largely on the area of regulation, and particu- larly on environmental regulation. He is the editor of Resource and Energy Economics, has been an associate editor of the Journal of Environmental Economics and Management (JEEM), and is currently on the editorial board of Land Economics and JEEM. Professor Kolstad is the president-elect of the Association of Environmental and Resource Economists (AERE). He received a Ph.D. from Stanford, an M.A. from Rochester University, and a B.S. from Bates College.

Adrián Lajous is a special advisor to the President of Mexico on inter- national oil matters. Until January 2000, he was director general of PEMEX, the Mexican national oil company, and chairman of the board of the PEMEX Group of operating companies. He had been at PEMEX since 1983. Prior to joining PEMEX, Mr. Lajous was Director General for Energy in the Mexican Ministry of Natural Resources and Industrial Development. He was actively involved in drafting Mexico’s first Energy Program in 1978–1979. He has also served on the board of Repsol YPF and as a member of its Chairman’s Committee. He is also president of the Oxford Institute of Energy Studies. Mr. Lajous was decorated with the Orden del Mérito Civil by Juan Carlos I, King of Spain.

José Luis Machinea is president of the Argentine Foundation for Equitable Development (FADE). The Foundation sponsors research in the areas of economics and public policy. During his career in bank- ing and public service, Dr. Machinea has served as Argentina’s Biographies of Speakers 155

Minister of the Economy from 1999-2001 and as president of the Argentine Central Bank from 1986 to 1989. Other major economic posts have included Undersecretary of Political Economy from 1985 to 1986, and Undersecretary for Development Programs from 1983 to 1985. Dr. Machinea received his Ph.D. and M.A. from the University of Minnesota and his A.B. in Economics from the Catholic University of Argentina.

Roberto Monti is a member of the YPF S.A. Board of Directors. From July 1999 to September 2000, Mr. Monti was Executive Vice President of Exploration and Production of Repsol YPF, S.A. From 1997 through 1999 he was CEO and chairman of YPF, S.A. Earlier, he was the president and CEO of Maxus Energy Corporation. He spent many years in the Schulmberger Group, including serving as presi- dent of Dowell Worldwide, a Schulmberger subsidiary with head- quarters in Paris. He holds degrees in electromechanical engineering from the University of Buenos Aires.

Bijan Mossavar-Rahmani is chairman of Mondoil Corporation, a pri- vately held company active in international oil and gas operations, with a focus in West Africa. Between 1988 and 1996, he was presi- dent of Apache International, Inc. Earlier in his career, he served as assistant director for International Energy Studies, Energy and Environmental Policy Center at Kennedy School of Government, Harvard University. A former delegate to OPEC Ministerial Conferences, Mr. Mossavar-Rahmani has published widely on global energy markets. He is active in industry and international affairs, and has served as a member of many professional groups, including the International Consultative Group on the Middle East, the U.S.–Angola Chamber of Commerce, and the Council of the International Executive Services Corps. He holds degrees from Princeton and Harvard Universities and is a Commandeur de l’Ordre National de la Côte d’Ivoire.

Richard Perle is a resident fellow at the American Enterprise Institute for Public Policy Research in Washington, D.C. He is also co- chairman of Hollinger Digital. From 1981 to 1987, Mr. Perle was Assistant Secretary of Defense for International Security Policy in the 156 Biographies of Speakers

administration of Ronald Reagan. In this role, he was responsible for theater and strategic nuclear weapons policy, trade, and technology exports, European and North American Treaty Organization (NATO) policy, and negotiations between the United States and its western allies and the Soviet Union. Earlier he worked for Senator Henry M. Jackson and the Senate Committee on Government Operations, the Committee on Armed Forces, and the Arms Control Subcommittee. Mr. Perle is currently an advisor to members of Congress, writes for the op-ed pages of major newspapers, and is the author of Hard Line, a political novel. He has an undergraduate degree from the University of Southern California, a Masters in Politics from Princeton, and has completed post-graduate studies at the London School of Economics.

James W. Ragland is director of the Economic Research Group of Aramco Services Company, where he focuses on long-run, strategic analysis for Saudi Aramco’s Corporate Planning Department. Based in Washington, D.C., Mr. Ragland has been involved in Saudi Aramco’s economic analysis and planning functions since 1980. Before joining Saudi Aramco, he worked as an economist at the U.S. Federal Energy Regulatory Commission. Mr. Ragland earned an M.A. in Economics and an M.A. in Economic History from George Washington University.

Philippe Reichstul is president and CEO of Petrobras (Petroleo Brasileiro S.A.). Before joining Petrobras, Mr. Reichstul was executive vice president of Banco Inter American Express S.A. He has had wide experience in Brazil’s public sector as Secretary for Planning and sec- retary general of the Control Office of the Federal Companies, and on the boards of Telebras (Brazilian Telecommunications Company), Electrobras (Brazilian Electricity Company), Siderbras (Brazilian Steel Company), CEF (Federal Savings and Loan Bank), and BNDES (National Bank for Economic and Social Development). He is a grad- uate of the Economics and Administration College at the University of Sao Paulo and did post-graduate studies at Oxford University. Biographies of Speakers 157

Evanan Romero is a visiting scholar of the Center for Business and Government, Kennedy School of Government, Harvard University. Prior to assuming his post at Harvard, Dr. Romero was managing director of PDVSA, the Venezuelan state oil company. From 1996 to 1998, he served as Deputy Minister of Energy and Mines of Venezuela, where he organized and participated in several world energy and mineral resource conferences and seminars. Dr. Romero spent many years at INTEVEP, the Venezuelan Institute for Petroleum Research. Dr. Romero holds degrees from Zulia State University, the University of Tulsa in Oklahoma, and Stanford University.

Robert N. Stavins is the Albert Pratt Professor of Business and Government and Faculty Chair of the Environment and Natural Resources Program at the Kennedy School of Government, Harvard University. He is a university fellow at Resources for the Future and serves on many advisory groups, including as chairman of the Environmental Economics Advisory Committee of the U.S. Environmental Protection Administration (EPA) and as a member of the EPA’s Clean Air Act Advisory Committee and of the Intergovern- mental Panel on Climate Change. He is also a contributing editor of Environment. Professor Stavins’ research has focused on environ- mental economics and policy, and he is published widely. He directed Project 88, a bi-partisan effort co-chaired by former Senator Timothy Wirth and the late Senator John Heinz to develop innovative approaches to environmental and resource problems. Professor Stavins holds a B.A. in Philosophy from Northwestern University, an M.S. in Agricultural Economics from Cornell, and a Ph.D. in Economics from Harvard. LIST OF PARTICIPANTS

The Hon. Manuel Alabart Mr. Juan Badosa Fernández-Cavada Vice President of Chemicals Ambassador of Spain in Argentina Repsol YPF Embassy of Spain Paseo de la Castellana 280 Avenida del Libertador 2075 28046 Madrid, Spain 1425 Buenos Aires, Argentina Mr. Alfonso Ballestero Mr. Juan Bachiller President of RYTTSA Director of International Relations Repsol YPF Repsol YPF Paseo de la Castellana 278 Paseo de la Castellana 278 28046 Madrid, Spain 28046 Madrid, Spain Mr. Ramón Blanco Mr. Francisco Badía Corporate Vice President President Repsol YPF BAN Natural Gas Paseo de la Castellana 278 Calle Isabel la Católica 939 28046 Madrid, Spain 1269 Buenos Aires, Argentina

159 160 List of Participants

Mr. Javier Bort The Hon. Chrystian Gabriel President Colombo Repsol YPF Peru Head of the Ministerial Cabinet Avenida Victor Andrés Belaunde 147 Republic of Argentina 27 Lima, Peru Avenida Presidente Julio A. Roca 782 1067 Buenos Aires, Argentina Dr. Gabriel Bouzat Advisor to the Secretary of Defence Dr. Mariana Conte Grand of Competition and of the Consumer Director, Department of Economics Republic of Argentina Cema University Avenida Presidente Julio A. Roca 651 Cordoba 374 1322 Buenos Aires, Argentina 1054 Buenos Aires, Argentina

Dr. Carlos Bulgheroni Mr. Alfonso Cortina de President Alcocer Bridas Corporation Chairman and CEO Leandro N. Alem 1180 Repsol YPF 1001 Buenos Aires, Argentina Paseo de la Castellana 278 28046 Madrid, Spain The Hon. Humberto Calderón Berti Dr. Roberto Cunningham Calderón Berti and Associates Bosco Avenida Circunvalación del Sol Director General Centro Profesional Santa Paula Argentine Institute of Petroleum 1050 Caracas, Venezuela and Gas Maipú 645 The Hon. Domingo F. Cavallo C-1006ACG Buenos Aires, Argentina Minister of the Economy Ministry of the Economy Mr. José Luis de la Peña Republic of Argentina Director of Coordination and H. Yrigoyen 250 Protocol 1310 Buenos Aires, Argentina Repsol YPF Paseo de la Castellana 278 Mr. Iván Cieker 28046 Madrid, Spain Advisor for International Relations Repsol YPF The Hon. Carlos de la Vega Paseo de la Castellana 278 Chamber of Commerce of 28046 Madrid, Spain Buenos Aires San Martín 910 1004 Buenos Aires, Argentina List of Participants 161

Mr. Carmelo de las Morenas Dr. Brian P. Flannery Chief Financial Officer Science Strategy and Programs Repsol YPF Manager Paseo de la Castellana 278 Safety, Health & Environment 28046 Madrid, Spain Department ExxonMobil Corporation Mr. Jôao de Luca 5959 Las Colinas Blvd. Country Manager Irving, TX 75039 USA YPF Brazil Avenida Río Branco 181 Mr. Héctor Enrique Formica 20040-007 Rio de Janeiro, Brazil President Enargas Mr. Rodolfo Alejandro Díaz Suipacha 636 Arroyo 820 1008 Buenos Aires, Argentina 1007 Buenos Aires, Argentina Mr. Eduardo García Moreno Mr. José Luis Díaz Fernández International Coordinator President Repsol YPF Fundación Repsol Paseo de la Castellana 278 Juan Bravo 3B 28046 Madrid, Spain 28006 Madrid, Spain The Hon. Deborah Adriana Mr. Daniel Fernández Koprich Giorgi General Manager Secretary of Energy and Mining ENAP Ministry of the Economy Vitacura 2736 Republic of Argentina Santiago de Chile, Chile Avenida Paseo Colón 171 1063 Buenos Aires, Argentina The Hon. María del Carmen Fernández Rozado Mr. Antonio Gomis Commissioner Corporate Director of External National Commission of Energy, Relations Spain Repsol YPF Marqués del Duero 4 Paseo de la Castellana 278 28001 Madrid, Spain 28046 Madrid, Spain

Mr. Francisco Fernie Mr. Antonio González-Adalid Fernie & Fortin Corporate Planning Executive Vice President, Gas and Uruguay 950 Electricity C1015ABT Buenos Aires, Argentina Repsol YPF Paseo de la Castellana 280 Mr. Raúl Fiscalini 28046 Madrid, Spain Director of Institutional Relations Repsol YPF Tucumán 744 1049 Buenos Aires, Argentina 162 List of Participants

Mr. Bernard Gremillet Prof. Charles Kolstad Corporate Director of e-Business Donald Bren Professor of Repsol YPF Environmental Science and Policy Paseo de la Castellana 280 Bren School of Environmental 28046 Madrid, Spain Science and Management University of California, Santa Dr. Alain Heilbrunn Barbara Director of European Public Affairs Santa Barbara, CA 91306 USA TotalFinaElf Rue de l’Industrie 52 Mr. Adrián Lajous Vargas 1040 Brussels, Belgium 4 Grosvenor Place London, SW1X 7DL Mrs. Nuria Henche Ruiz United Kingdom International Relations Department Repsol YPF Mr. Enrique Locutura Paseo de la Castellana 278 Corporate Director of Shared 28046 Madrid, Spain Services Repsol YPF Prof. William W. Hogan Paseo de la Castellana 280 Lucius N. Littauer Professor of Public 28046 Madrid, Spain Policy and Administration Kennedy School of Government Mr. Ernesto López-Anadón Harvard University Managing Director, Development & 79 JFK Street Marketing, Natural Gas Cambridge, MA 02138 USA Repsol YPF Avenida Roque Sáenz Peña 777 Mr. Ira A. Jackson 1364 Buenos Aires, Argentina Director Center for Business and Government The Hon. José Luis Machinea Kennedy School of Government President Harvard University Argentine Foundation for Equitable 79 JFK Street Development Cambridge, MA 02138 USA Avenida Córdoba 1776 Buenos Aires, Argentina Mr. Ira A. Jolles Senior Vice President and General Mr. Miguel Madanes Counsel Maipú 311 GPU 1006 Buenos Aires, Argentina 300 Madison Avenue P.O. Box 1911 Mr. Luis Mañas Morristown, NJ 07960 USA Corporate Director of Planning & Control Repsol YPF Paseo de la Castellana 278 28046 Madrid, Spain List of Participants 163

The Hon. Fernando Marti Dr. Juan Pablo Montero Scharfhausen Professor of Industrial Economy Vice President Catholic University of Chile National Commission of Energy, Avenida Vicuna MacKenna 4860 Spain Santiago, Chile Marqués del Duero 4 28001 Madrid, Spain Mr. Roberto Monti Member of the Board of Directors Mr. Hugo Martini YPF SA Director Avenida Roque Sáenz Peña 777 External Relations for Argentina 1364 Buenos Aires, Argentina Repsol YPF Avenida Roque Sáenz Peña 777 Mr. Bijan Mossavar-Rahmani 1364 Buenos Aires, Argentina Chairman Mondoil Corporation The Hon. William Massey Monte Aplanado Commissioner Mora, NM 87732-1010 USA U.S. Federal Energy Regulatory Commission Mr. Luis Javier Navarro Vigil 888 First Street, NE President Washington, DC 20426 USA BP Oil Spain María de Molina 6 Mr. Juan Pedro Maza Sabalete 28006 Madrid, Spain Managing Director, R&M Latin America Mr. Juan Antonio Ortega y Repsol YPF Díaz-Ambrona Avenida Roque Sáenz Peña 777 Director of Institutional and 1364 Buenos Aires, Argentina Corporate Affairs Repsol YPF Mr. Alejandro Macfarlane Paseo de la Castellana 278 Márquez 28046 Madrid, Spain Member of the Board Repsol YPF Mr. Rubén Patritti Avenida Roque Sáenz Peña 777 Managing Director, E&P America 1364 Buenos Aires, Argentina Repsol YPF Avenida Roque Sáenz Peña 777 Dr. Daniel Montamat Roganti 1364 Buenos Aires, Argentina Montamat and Associates SRL San Martín 320 Mr. Patricio Perkins 1004 Buenos Aires, Argentina Esmeralda 1066 1007 Buenos Aires, Argentina 164 List of Participants

Mr. Richard Perle Mr. José Manuel Revuelta Resident Fellow Corporate Director and American Enterprise Institute Assistant to the President 5 Grafton Street Repsol YPF Chevy Chase, MD 20815 USA Paseo de la Castellana 278 28046 Madrid, Spain Mr. Alfredo Pochintesta Managing Director, LPG Latin Mr. Luis Alberto Rey America President Repsol YPF Pluspetrol Avenida Roque Sáenz Peña 777 Lima 339 1364 Buenos Aires, Argentina 1073 Buenos Aires, Argentina

Mr. Gabriel Federico Polak Dr. Evanan Romero Member of the Board of Visiting Scholar Administration Kennedy School of Government Repsol YPF Harvard University Peru 169 79 JFK Street 1067 Buenos Aires, Argentina Cambridge, MA 02138 USA

Mr. James Ragland Prof. Hugh Rudnick Director, Economic Research Group Catholic University of Chile Aramco Services Company Casilla 306, Correo 22 1667 K Street, NW Santiago, Chile Washington, DC 20006 USA Mr. Carlos Salinas Estenssoro Mr. José María Ranero CEO Managing Director YPF S.A. YPFB & Country Manager, Argentina Calle Bueno 185 Repsol YPF La Paz, Bolivia Tucumán 744 1049 Buenos Aires, Argentina Mr. Juan Sancho Rof Executive Vice President, Refining & Mr. Philippe Reichstul Marketing President and CEO Repsol YPF Petrobras Paseo de la Castellana 278 Avenida República de Chile 65, 28046 Madrid, Spain Centro RJ CEP 20035-900 Río de Janeiro, Brazil Mr. Oscar Horacio Secco President Mr. Miguel Angel Remón Gil Argentine Institute of Petroleum and Member of the Executive Committee Gas Repsol YPF Maipú 645 Paseo de la Castellana 280 C-1006ACG Buenos Aires, Argentina 28046 Madrid, Spain List of Participants 165

Mr. Jorge Segrelles Prof. Robert N. Stavins Managing Director of Refining & Albert Pratt Professor of Business and Marketing, Europe Government Repsol YPF Kennedy School of Government Paseo de la Castellana 278 Harvard University 28046 Madrid, Spain 79 JFK Street Cambridge, MA 02138 USA Mr. Guzmán Solana CEO Mr. Carlos M. Tombeur Enagás Legal Adviser Paseo de los Olmos 19 Repsol YPF 28005 Madrid, Spain Reconquista 336 1335 Buenos Aires, Argentina The Hon. Jorge Omar Sobisch Velázquez Mr. Oscar Aníbal Vicente Governor of the Province of Vice President Neuquén PECOM Energía, S.A. Casa de Gobierno Maipu 1 Rioja y Roca 1084 Buenos Aires, Argentina 8300 Neuquén, Argentina The Hon. Carlos Westendorp y Mr. Santiago Soldati Cabeza President President, Energy Commission Sociedad Comercial del Plata European Parliament Juan Bautista de la Salle 655 Bat. ASP-11G B11642CPQ San Isidro, Buenos Aires, Rue Wiertz 304 Argentina 1047 Brussels, Belgium REPSOL YPF PUBLICATIONS

Repsol YPF publishes background material on subjects of prime importance to the energy industry, as well as other subjects of inter- est. Essays, books, and seminar/conference proceedings in the col- lection are published in English, French, and Spanish. These materials express the opinions of their authors not necessarily those of Fundación Repsol YPF, Repsol YPF, and its group of companies.

THE REPSOL-HARVARD SERIES

• Repsol-Harvard Executive Session on Petroleum Policy, 1988. • Repsol-Harvard Executive Session on Petroleum Policy, 1989. • Repsol-Harvard Executive Session on Petroleum Policy, 1994. • Repsol-Harvard Seminar on Energy Policy, 1995. • Repsol-Harvard Seminar on Energy Policy, 1996: Competition and Realignment in Global Energy Markets.

167 168 Repsol YPF Publications

• Repsol-Harvard Seminar on Energy Policy, 1997: Energy After 2000. • Repsol-Harvard Seminar on Energy Policy, 1998: Geopolitics, Energy and the Future. • Repsol-Harvard Seminar on Energy Policy, 1999: Preparing for the Twenty-First Century. • Repsol-Harvard Seminar on Energy Policy, 1999: 10 Años Universidad, Empresa, Energía/10 Years Education, Enterprise, Energy • Repsol YPF-Harvard Seminar on Energy Policy, 2000: Energy Policies and Markets: New Trends or Old Cycles?

THE REPSOL YPF COLLECTION

• Repsol-Universidad Internacional Menéndez Pelayo, Seminario Clima y Ecología: La Influencia Humana en los Cambios Climáticos, 1989. • Repsol-Universidad Internacional Menéndez-Pelayo, Seminario La Inteligencia Artificial y el Control en Tiempo Real, 1991.

THE FUNDACIÓN REPSOL YPF SERIES

• Seminario Nuevas tendencias sobre control avanzado: Redes Neuronales, 1997. • Conferencia de José Manuel Sánchez Ron – Falsos mitos: Ciencia vs. Tecnología. Reflexiones sobre política científica, 1997. • Seminario El subsuelo como medio estratégico de almace- namiento, 1997. • Seminario Relaciones entre Marruecos, La Unión Europea y España, 1997. Repsol YPF Publications 169

• La UEM y el mercado de trabajo en España: Costes y Beneficios, Juan J. Dolado/Daniel Gros/Juan Jimeno, 1998. • Seminario Nuevas tecnologías en exploración-producción de hidrocarburos y su impacto en el nivel mundial de reservas, 1998. • Gestión del mantenimiento industrial – Traducción del libro de A. Kelley y M. J. Harris, Management of Industrial Maintenance, 1998. • Seminario Refino 2000, 1998. • Foro Formentor. El Mediterráneo en la encrucijada de un nuevo milenio, 1999. • Foro Formentor. La seguridad en el Mediterráneo, 2000. • Seminario Aprender a conocerse. Percepciones sociales y cultur- ales entre España y Marruecos, 2000. • Las tecnologías de la información en la nueva economía, Leandro Pérez Manzanera, 2001.

FOR ADDITIONAL INFORMATION Servicio de Publicaciones Dirección Corporativa de Asuntos Fundación Repsol YPF Institucionales y Corporativos Juan Bravo 3B Repsol YPF 28006 Madrid, Spain Paseo de la Castellana 278 Tel: (34)-91-348-9352 28046 Madrid, Spain Fax: (34)-91-348-9370 Tel: (34)-91-348-8001 Fax: (34)-91-348-5103