Unedited Transcript
Middle East Policy Council

Thirty-seventh in the Capitol Hill Conference Series on U.S. Middle East Policy

Securing U.S. Energy in a Changing World

Speakers:

Frank A. Verrastro
Director, Energy Program, Center for International and Strategic Studies

James A. Placke
Senior Associate, Cambridge Energy Resource Associates

Alan S. Hegburg
Senior Fellow, Energy Program, Center for International and Strategic Studies

Moderator/Discussant:

Chas. W. Freeman, Jr.
President, Middle East Policy Council

325 Russell Senate Office Building
Washington, D.C.
September 17, 2004

Transcript by:
Federal News Service
Washington, DC

CHAS. W. FREEMAN: I guess I will encourage people to take their seats and we will get underway. And I expect more people will be joining us as we go forward.

Good morning, everyone. I'm Chas. Freeman. I am the president of the Middle East Policy Council and it's my pleasure to convene this meeting today. Those of you who don't know the Middle East Policy Council, I can explain very quickly we do three things: we hold meetings of this sort on questions that are either politically incorrect or badly misunderstood and where there is some requirement for public education and a better amount of information. Usually these are on the Middle East, and in fact, our journal, Middle East Policy, the latest issue of which David Broder talked about in a column on, I think, Monday in the Washington Post. This is on Gulf security issues. Our journal is the most often-cited in the field and we're very proud of it, and an edited transcript of today's session will appear in the next issue of the journal. And finally, out of Washington we train teachers in how to teach about Arab civilization and Islam. We've trained 15,000 or so teachers by now. We reach about 1.2 million high school kids a year with a fact or two about Arab culture, Islam, that unfortunately our educational system would otherwise never give them the opportunity to learn.

As the election campaign began to develop, energy issues, given the rising price of oil and gas, seemed to loom larger and larger. For anyone who follows these issues closely, however, much of the public discussion was at best disgraceful and at worst appalling in terms of its premises. Therefore, we thought it would be useful to have an informed discussion of energy, oil and gas. It's certainly appropriate for the Middle East Policy Council to convene such a meeting since energy is at the center of U.S.-Arab relations. Many milestones in that centerpiece of the relationship exist. Saudi Aramco, the largest oil company in the world, is in a sense a monument to a unique experiment of the private-sector integrated development of an entire region of the Arab world. Aramco took the lead in midwifing the prosperity and modernization of an entire region. Saudi Arabia and Kuwait, the United Arab Emirates, and of course Qatar through its gas revenues, financed the first Gulf war. So this is a region of great wealth whose recirculation of petrodollars in the international economic system is very important to us.

In the run-up to our current misadventures in Iraq, Deputy Secretary of Defense Paul Wolfowitz famously demonstrated his ignorance of the region and lack of understanding of oil economics when he predicted that the Iraqi oil industry would finance Iraq's reconstruction and pay for the costs of the war. He managed to persuade a credulous administration and Congress of this, but it proved to be fundamentally in error.

OPEC and Arab oil producers generally have emerged as the stereotypical villains of Hollywood films and the morality plays of American politics. John Kerry, the Democratic candidate, can't make a campaign speech without taking a slap-shot or two at the Saudi royal family. It is a matter of faith in our body politic that dependence on the Middle East as a source of oil is peculiarly dangerous in security terms, notwithstanding the fact that in recent years all of the disruptions, other than those in occupied Iraq, have come from other places, like Nigeria and Venezuela. Now there are various schemes being put about for achieving some measure of so-called energy independence, though of course only if it costs the consumers of oil nothing, and is thus politically cost-free.

Behind all these issues rest a whole series of questions, which I hope we'll get at today. Are oil prices in fact controlled by an evil cabal that can move them up and down at will. Are oil and gas supplies in the oil and gas trade truly bilateral so that one has to worry about whether one is, quote, "dependent," unquote, on a particular source, or is that not an accurate description of the market? Are the oil companies the manipulative monsters that the left wing would have us believe? Is Michael Moore right about this element of the Bush administration's policy inspiration? Who makes money on oil and gas and how? And more important, what are the trends in production and in our consumption of energy? Are high prices here to stay or are they a flash in the pan? What are the prospects in the United States for a measure of independence, not just from the Middle East but from imports of oil and gas, if there are such prospects. I think we're very fortunate today to have three panelists who can dissect all of these issues and others I have not mentioned.

As you know, in these sessions our habit is to have panelists speak for about 10 minutes, and if they verge on 12, I begin to seethe with potential violence and rise from my chair and threaten to heave them down the stairs to the guard out front. So allow 10 to 12 minutes per speaker. Then we will have an open session for comments and questions. I ask if you make a comment or question that you try to keep it reasonably succinct and that you address it to someone on the panel. Please tell us who you are even if we all know who you are already, or should know who you are.

With these few words let me invite the panel to begin the discussion. We have first Frank Verrastro, who is, I think, the head of the CSIS energy -

FRANK VERRASTRO: The energy part.

MR. FREEMAN: -- energy part of the Center for Strategic and International Studies, which is a heavy responsibility in a time when this is a matter of controversy, and his bio is on the back of the program so I won't repeat it.

Jim Placke, who had an illustrious career as a Foreign Service officer and then an equally or even more distinguished career at Cambridge Energy Associates, from which he now claims he's retired, but he still remains a national asset for events like this, and, Jim, we're delighted you're here. And finally, Alan Hegburg, who is a senior fellow at the CSIS energy program and a consultant at the Scowcroft Group, and someone I've known and respected for many years.

And so, I think we've got a great panel here and I understand they have sat down and done something very unusual: divided - they've actually coordinated what they're going to say, more or less. And so they're each going to cover a different topic. And I think, Frank, you're going to talk about markets and how we got where we are?

MR. VERRASTRO: Well, I think what we decided to do - and I appreciate - let me first say thanks for having us here today. I think this is a timely topic. Actually, the straw I drew was to give some background and stage settings. It will indulge the chair if I go a little further. We've got some material on markets and how we got to where we are, but I may save that for the end and see how the discussion goes if that's okay.

MR. FREEMAN: Please.

MR. VERRASTRO: So, first, you talked a lot about energy independence, and that's been a lot of the discussion. I would argue that it's really been more energy interdependence, and it's a global economy. So what we're going to start with is kind of a view from 30,000 feet or 50,000 feet, go to kind of the world supply-demand balance and then bring it back home to the United States and then discuss how we secure U.S. energy in a changing world.

I want to start out just with a thought. There's been a lot of discussion about energy and the critical role in plays in geopolitics and capital flows and economic performance.

MR. FREEMAN: Do we have to dim the lights or can you see - you can all see that? No, you can or can't see it? Okay, then I'll ask you to kindly summarize it for the camera's benefit.

MR. VERRASTRO: Okay, it basically says on the slide that given the critical importance of energy as a strategic commodity, the question is posed as to whether or not we should be managing it differently. And two sub-questions: can we do it and do we have the political will to do it?

This slide basically tells us that as we moved into the 21st century we're basically using the same five fuel sources that we used in the 20th century, and that's oil, gas coal, nuclear, and we're doing a lump group of renewables, and that's because EIA and IEA have broken them out in that way.

This is to give you a snapshot of global energy consumption, and it's basically to show you - this is at the turn of the century, so this is 2001 - that 85 percent of our fuel needs were met with fossil fuels, with oil being king, and renewables and nuclear playing a very small role. So when you talk about the growth of renewables, think about it coming from a small base even though the increase is maybe significant.

As you look in North America, since we make up about 30 percent of the market the numbers are almost essentially the same: it's 85 percent fossil fuels. As you go to Western Europe, because of the increased use of nuclear, the amount of coal and fossil fuels is down, but when you look at the developing countries, the use of fossil fuels is actually up - it's over 90 percent.

More importantly, if you look to the future to 2025, you find that the numbers don't change much so the demand stays the same. And essentially what you're dealing with in that time period, since it's a very short time period to bring out new production or alternative sources, is the situation where absent an economic catastrophe or a foreign policy problem, environmental catastrophe or a technological breakthrough, this is basically the forecast that we're looking at.

When you look at developing nations, it stays exactly the same except that the growth and developing nations is another 50 percent, and that causes concerns not only for capital flows but also for emissions because 70 percent of the new emissions growth is going to come from the developing world. So no matter where you are on global climate change, you're going to have to deal with hyper-urbanization and the emissions problem.

So how do we consume this energy? Well, about 40 percent worldwide goes to power generation and another 20 percent goes to transportation. Half the world's oil - half the world's oil, an 80 million barrel a day market, goes for transportation uses. So unless you can attack those two there's no way of getting demand under control.

In terms of the U.S. participation in the world, we have about 5 percent of the population and we produce 17 percent of the energy and we consume almost a quarter of the world's energy. We're also responsible for about a quarter of the world's GDP. And this is the forecasting - this is EIA forecast - and it basically shows you that petroleum and oil energy sources are going to increase over the next 20 years, and if you look on the petroleum side specifically, all forms of fuel except for resid for the bottom of the barrel also increase, but the gasoline total goes up where it had been stable over the last 10 years or 15 years, and total consumption increases. What that tells you is if production is going down and refineries are running at 96 percent utilization, we're going to rely increasingly on imported oil, both crude and in the future product.

And the import levels, depending on what price spans you use and scenarios on demand, will range between 65 percent and 75 percent by 2025. The gas situation is almost the same. We had an increase in domestic gas production. We've plateaued and are now in the decline stage, and if demand continues - and we're projecting an increased use of natural gas - we're looking at increased imports of LNG, which poses both security questions and, I would argue, some foreign policy questions as well.

So who has the resources? Well, when you look at the oil resources - and this is a known fact - two-thirds of the proven resources are in the Middle East. There are some other producers that are significant. The international oil companies are involved in a lot of places around the world, mostly in non-OPEC countries, but when you look at some of the OPEC production, we have the least transparency and the biggest problem with actually getting a handle on reserve numbers. And you'll notice that most of the demand forecasts that we have are basically built - we build up demand over time and then we plug in supply instead of building a supply bottom up model, which should cause some concern.

On the gas side we have a decidedly different group of characters - cast of characters. But if you look at Russia, Iran and Qatar, they comprise 60 percent of the world's natural gas reserves. So when people talk about increasing supplies of LNG, look at your sources. The United States may be able to get some supply from Trinidad, Tobago, for example, but when you start looking down the list of who has natural gas - and this is stranded gas - there's a lot of gas in the world but you need to move it to consumption centers. If you can't do it by overlying pipeline, liquefying it and moving it in tankers is probably the way to go.

Coal reserves. The United States is frequently described as the Saudi Arabia of coal. To the extent we are able to get a clean coal technology and deal with the environmental concerns related to mining and mining waste, you could improve power generation, reduce demand, and improve efficiency.

This is just a snapshot. This is 2002 numbers because the 2003 data isn't really available. This tells you what the consumers - major consumers in the oil market are, who they are. And China recently has moved to the number two spot, both in terms of consumption beyond the United States and also in imports. Chinese imports have grown about 40 percent year-to-year, 2004 versus 2003.

MR. FREEMAN: They're up about 40 percent this year.

MR. VERRASTRO: Right.

When you look at the producers and exporters, these are the countries that have the reserves and provide the export. There's been a lot of discussion - again, this 2002 data but a lot of the discussion has been on Saudi Arabia being overtaken by Russia in terms of production. Russia's consumption is about 2.5 million barrels a day, so even if they're on parity in terms of production, their export capability is less in Russia than it is in Saudi Arabia. Saudi Arabia is probably producing about 9.7 million barrels a day now with capacity to go to 10.5 (million). Russia is probably capped out, at least currently, at about 9.5.

This is just a snapshot, and I know Jim's going to talk more about this, but if you take a snapshot of 2004 there's a common misconception, partly through political campaigns, that the United States is overly reliant on Middle East oil or Saudi oil. In fact, three of the top four suppliers to the United States are Western Hemisphere.

I'm sure Jim will talk a little bit more about Saudi Arabia. At CSIS we're looking at some of the major players going forward, and obviously some of the key players in the near term will be Saudi Arabia - slow slide on Russia - (chuckles) -- and Russia has vast oil and gas resources, as we've shown. There's an infrastructure problem and it's controlled by monopolies. And so exportability is going to be an issue and a concern going forward. There's also ethnic conflict, environmental concerns, regional instability, and also concerns over democracy and reform and the pace thereof.

Iraq -- as Ambassador Freeman said, you know, the speculation early on was that Iraq would be a major producer and contributor and in terms of revenue provide money for the reconstruction. There's a lot of people outside of government that told the Defense Department and the State Department early on that it was going to be years before Iraq was a reliable supplier. We believe there's damage to the oilfields both in the south and in the north when you go downhole. They've got external debt. There's governance issues and security issues. The pipeline has been blown up - pipelines in Iraq - over 150 times since the cessation of hostilities last May - major hostilities.

There's other groups of emerging producers: the Caspian. There will be additional oil coming on in mid-2005 when the Baku-Ceyhan pipeline is complete. Kazakhstan and Azerbaijan have adequate resources to put in the market. The key has always been infrastructure to get it out of the Caspian and move it to a hard currency market. Libya, they've just put tenders on the table. There's a chance that they can increase production but the terms in the past have been really difficult, and with the addition of sanctions - and I'll show you that in a second, it's kind of retarded their development over time, but it's an area where companies are now starting to look to go. West Africa is another area. Unconventional supplies in Canada and Venezuela are significant but the Canadian supplies of heavy oil will require a lot of water and a lot of natural gas, and then of course we have LNG production.

Consumer wildcards are really the United States and Asia at this point, and there has been a lot of discussion of China, but actually if you look at India, Korea and China together, a huge portion of internal consumption has increased their demand for oil. And now you're in a geopolitical question as to whether or not you're going to be - the U.S. will compete with China, for example, over Middle East supplies in the future. Geopolitically, do you want the Middle East and China, or the Middle East and Asia to form diplomatic alliances and bilateral relationships, or Russia and China? What would that do to the United States? So people at least are increasingly concerned about the impacts and what this will mean to our foreign policy choices down the road.

More importantly, as you go forward important dependence in Japan and China increases. Part of it will come from Russia but a lot of it will come from the Middle East. And only about a week and a half ago we saw that the Chinese and the Saudis decided to engage in diplomatic relations and, on a consultative basis going forward, decide what economic objectives and bilateral relations they want to pursue.

We think that the most recent period in the past has been volatile oil prices, but it's been the rule, not the exception. And if you go back 30 years we've had price spikes, mostly tied to disruptions, political upheaval. Some are targeted embargoes, as you can see. The big price-drop after 1980 was a result of overproduction. And we decided with high prices demand came down and then prices plummeted right after that. And that's something we see over and over again.

In the oil patch it's a situation where investments made seven to 10 years ago brings on production today. And we could talk a little bit about that later and what brought on the current situation, but periods of high prices usually bring on efficiency, technology and reduced demand, which then cause lower prices going forward.

These are the pillars of U.S. security policy. This is where the United States has gone for about the past 30 years, and it's been a situation where we've looked at increasing supply, both domestically and internationally, to the point of actually increasing investment in infrastructure to move oil out of the Caspian. We haven't done a whole lot in terms of demand restraint because that's not politically popular.

Strategic stockpiles. The SPR was really formed in the aftermath of the targeted embargo in 1973, and as both Jim and Al will talk about, reliance on the Saudis has really been one of the keys. They're one of the few people in the word that maintain spare capacity at some cost to themselves. And then when in doubt, or you need something, you call on the military.

Let me just jump ahead. These are supply estimates. This is OPEC capacity. Two points I want to make here. One is that in 1979, 25 years ago, OPEC's capacity was 38 (million), 39 million barrels a day. Today it's about 31 million barrels a day. If you look for the loss of the 8 million barrels a day and where it came from, you need to look no father than Iran, Iraq and Libya. Dramatic political change, wars, instability and sanctions have caused that, and I would suggest that if we're looking for energy policy, that if part of it was to increase supplies across the world and it wasn't subordinate to foreign policy, economic policy, environmental policy and local politics, we'd have a different world.

Let me just put two more slides up real quick. This is oil in the financial market, just to give you an idea what we're talking about. Every day there's an 80 million barrel a day market but about 35 million barrels are actually transferred on a daily basis. That's a billion and a half dollars a day. And this is remarkable cash flow changes, and these are just some of the changes. And I know Jim's going to talk more about this. But this is OPEC's net export revenues, and over this period it's gone from $30 billion to $300 billion. The GCC countries estimate that they'll have export revenues in excess of $200 billion this year alone. So revenues have doubled for every OPEC member in the last 10 years and they've actually tripled for Qatar.

One more slide. This is the price path. For those of you that think that we're still in the $22 to $28 band, we went back to 2001, and this trajectory has been going up. So we can talk about speculation and the role it's had on price, but as a practical term, over the last five years we've been increasing prices, and that band is no longer workable, or operative.

And I'll just leave it at that.

MR. FREEMAN: Thanks, Frank. Three statements you made that struck me. One, demand drives supply; two, when prices rise, demand goes down; and third, we are in the ironic situation now of after having castigated OPEC, demanding that OPEC come to our rescue with additional supply. I think these things probably will reemerge as we discuss the rest of it.

Jim.

JAMES A. PLACKE: Thanks, Chas. What I thought I would do this morning - and this will follow up and expand on some of the points that Frank's already introduced - is talk about trends in U.S. oil import dependence then focus specifically on the Middle East since that's the one that draws so much political lightening, and then conclude with some comments about OPEC, which I would characterize - to respond to Chas.' introductory question - OPEC's unsuccessful struggle to control oil prices. So that sort of tells you where I'm coming from on that one.

The U.S. became a net crude oil importer in 1974. Since that time we've become increasingly dependent on foreign sources of oil, but you really need to take into account not just oil but the liquids that are added to oil and natural gas -- liquids condensate, and so on. On that basis, the United States became 50 percent dependent on foreign hydrocarbon liquids imports in 1993. U.S. consumption in '74 was 60.5 million barrels a day; now it's 25 percent greater at 20.5 million barrels a day. During this decade, which is only four years old, U.S. crude oil production has stabilized and will even increase as we move further into the decade with growing production from the deep water Gulf of Mexico. That's probably our last reserve unless we do many more intelligent things with Alaska than we've done up till now, and I don't mean just exporting the Alaska National Wildlife Preserve. There are a lot of other things that should be done, in particular a gas pipeline from Alaska, but that's a whole other set of issues.

Even though our crude oil production domestically will increase slightly - less than 100,000 barrels a day over the course of this decade, total liquids production is going to continue to decline, for the reason that Frank suggested, and that is that our natural gas production domestically - again, Alaska - is in decline and has been for some time, and therefore, the total liquids, including those extracted from natural gas, continue to drop. So our dependence on foreign sources is inevitably going to grow unless we suddenly cut back consumption, and that doesn't seem very likely. And by the end of the decade, crude oil production itself will again go into decline, and that will be the long-term trend. There is nothing really on the horizon that I can see at this point, or anyone that I have spoken with can see, that's likely to turn that around.

Meanwhile, as Frank has already indicated, North American - that Canadian and U.S. and Mexico - actually, U.S. exports gas to Mexico, but we import a great deal of gas to Canada - that service is going to become less and less available as more Canadian gas has to be used to extract oil from the tar sands. I was very pleased to see on one of Frank's slides the reserve figure for Canada -- $180 billion barrels. And it's graven in stone in this town that Iraq is this enormous treasure trove of crude oil; Canada is much bigger than Iraq by at least 100 billion barrels. The reason for that is the tar sands and the oil stands in Western Canada are now commercially viable. Twenty years ago when production began there - 25 years ago - that was not the case. They were heavily subsidized both by the Canadian national government and by the province of Alberta. They're now commercial, so you can put them down as booked reserves, and that's made an enormous difference. But it's sand; it not liquid oil in the first instance, and extracting oil from it requires both a lot of gas and a lot of water.

So our imports from Canada of natural gas are going to decline rather than grow. U.S. consumption of gas of course will continue to grow, especially for electric power, and that means imports via tanker of liquefied natural gas or LNG. And, as Frank also has already indicated, you tend to find gas in the same places where you find oil, so our dependence is not going to diversify; it is going to narrow and it is going to increase.

The only way that I can see where that might be countered is really two things, one that we began seriously in the 1970s and then kind of forgot about by the mid-80s and that is increasing energy efficiency. Today, fortunately, it takes about one half as much energy to produce a given unit of GDP, gross national product, as it did shortly after the first oil shock in 1973, '74. And that's why as prices have escalated so sharply over the last year, the economic effects have been digestible, I would say - certainly not inconsequential but they were manageable. It's because we simply don't use as much energy to produce the output that we're now putting on the market. But we really stopped expanding our energy efficiency by about 1988. Oil prices had dropped and there was plenty of oil on the market, so the incentives went away and the consequence was that we've forgotten how to do that. We should turn back to it.

The second thing would be a consumption shift away from oil and gas. How do you do that? You could do it by regulation, but that's very unlikely and probably not wise. Ultimately I think the answer is technological change, and probably the hardest thing to predict, certainly in the oil sector, is technological change. We know it's going to happen; we know the general direction in which it's likely to move. We don't know what the technology is going to be; we don't know when the breakthrough is going to happen. Is it going to be hydrogen fuel cells? Maybe for stationary use in buildings like this or large apartment building, shopping centers and so forth, but probably not automobiles. At least that's what the auto industry thinks. What is it going to be - something like what Toyota has already done with the Prius? Maybe. We'll see more of those on the road I think. There are an array of possibilities, and it's the market that's going to ultimately select which one of these - or which combination of these really - is ultimately going to prevail.

Well, let me turn to what's already up on the board: U.S. import dependence on Middle East oil.

U.S. imports of Middle East oil actually began to decline with the unrest in Iran in 1979 that preceded the overthrow of the shah in the following year. Then the Iran-Iraq war followed in 1980, taking more Middle East oil off the market, and we simply began to expand imports from other sources, including the North Sea, which is now also in decline.

Saudi Arabia, however, as this chart indicates - and I picked 1989 as a starting point because that was the year between the end of the Iran-Iraq war in 1988 and the Iraqi invasion of Kuwait in 1990. So it was about as normal a year as you can find in the decade of the '80s. Saudi Arabia, as a deliberate policy, had maintained itself pretty consistently, except there's a little dip in the late '90s where they stepped slightly, but beyond that they maintained themselves consciously as the number one crude oil supplier to the United States, viewing that as important to the "special relationship," as it's often been termed.

Well, if you look toward the end of the chart beginning, curiously, at the end of 2002, Saudi exports to the U.S. have dropped like a rock. What happened at the end of 2002? It seems to me we were getting ready to invade Iraq, and it seems to me the Saudis were less than enthusiastic about that. Is this political retribution? No. It's simply their recognition of the fact - the political fact - that the special relationship isn't so special anymore. What they did was simply go where the market took them. They were discounting their price of crude into the U.S. by around 30 cents a barrel though much of the '80s and '90s in order to maintain themselves as the primary supplier. That's easy to do. They were foregoing a net back of about 30 cents a barrel that they could have gotten above the U.S. market by selling more into East Asia, and that's what they're now doing, principally to China. As Frank has already indicated, China's imports of oil this year will expand about 40 percent. This year Saudi Arabia became China's principal oil supplier. There are a growing network of commercial relationships between the two countries and I expect those to expand. I would say by the end of the decade, China will have displaced both the United States and Japan as Saudi Arabia's principal trading partner. It's just the reality of the market.

I don't think it's anything to be alarmed about. It means that the price of oil to American consumers went up slightly, not noticeably, because that built-in subsidy from Saudi Arabia isn't there anymore. Saudi Arabia is going to continue to decline, and I hope by this year it will be below Nigeria; it will be the bottom of the top-five exporters into the U.S. market.

Finally, a word on OPEC. The purpose of this is to respond to Chas.' question or statement about OPEC. OPEC has often claimed, unjustifiably in my view - and I was actually in Baghdad and covered the creation of OPEC in September of 1960 when that event occurred and I've followed it pretty much ever since. The events that have driven prices, as that chart illustrates, have been mainly political -- wars, revolutions, disruptions of various kinds - until we get to the very end, where I show OPEC market management. That's when OPEC did, for the first time really in my estimate, take control of prices when they collapsed in '97, '98 as a result of the Asian financial crisis. They cut back production dramatically. Prices increased from a low of around 10 to back up into the high teens as a result, but even they have not been able to manage the market in the last 18 months.

Demand and supply have gotten so close together that in relative terms we have less spare capacity in the world today than we did in 1974, '74 at the time of the first oil-price spike, and we're in about the same shape on natural gas. So the picture is not an encouraging one. OPEC is not the answer, nor is it the problem; it's simply supply and demand.

MR. FREEMAN: Thank you very much, Jim. A couple of issues arise and I'm sure we'll talk about these in the course of the discussion. The policy choices we face in this country, as you suggest, in terms of adjusting demand downward, thereby reducing dependence on particular forms of energy - we can either address these through regulation or we can find ways to adjust them through the market, which usually our philosophy tells us is a far better way of doing things. Somehow, however, rather in the area of gasoline and SUVs the market is something we don't want; we want the government to decree efficiency standards for automobiles. It's a very peculiar thing. I question whether this preference for regulation, for big government over markets, is a good idea and can survive the next presidential term.

The second matter, far more grave in many ways, is the demonstration of the end of some aspects of the special relationship with Saudi Arabia; the end of the discounts and the end of the Saudi emphasis on primacy in the American market signals - because there's another issue you didn't mention, which we will get into, and that is the defense of the dollar by the Saudis. Twice within OPEC, other members, Iran in particular, have moved to eliminate the dollar as the unit of account for the oil trade. Were this to occur in the current context of massive U.S. budget, balance of trade, and balance of payments deficits, the results could be absolutely devastating for the global economy and to our own.

The reason the Saudis defended the dollar on the two previous occasions was not economic analysis but political affinity for the United States. Question: if that affinity is no longer there, will they play that role? This is a large issue, with people like Paul Volcker saying there is a very substantial danger within the next five years of some sort of dollar collapse. This is not a minor matter.

Finally, you didn't mention, in terms of our dependence, although Frank alluded to it, the fact - as I understand it, that we haven't built a new refinery in 30 years. Increasingly we are importing gasoline and product rather than crude, simply because no one will allow refineries to be placed in their backyard. Similarly, although we want to import a lot more gas, no one seems to be terribly eager to have gas handling facilities or large ships full of highly volatile liquefied natural gas coming into their backyard. So we're going to have to address this issue as well because it accounts in no small measure for the shortage of gasoline at the local level at various points in the recent past.

Perhaps, Alan, you will address these questions. I know I look forward to the other topics you'll raise and then we can proceed to a discussion.

ALAN S. HEGBURG: Thanks, Chas. I appreciate this opportunity. I just would like to make sort of three points to sort of try to set the stage for our policy discussion. The first has to do about the forecast on supply and demand, particularly for oil but for hydrocarbons in general, and Frank has outlined that in some detail. And Frank is fond of saying, and I think it's true, "Remember, the Stone Age didn't end because we ran out of stones," and it's the same with hydrocarbons. Whether or not we're running out, the question really is, should there be a transition away from hydrocarbons and fossil fuels to something else?

And that question really is a huge and fundamental question because in the past when we have undergone a transition from one energy source to another, it's usually to the cheaper, more efficient, more fungible energy source, coal to oil being the best example. And so, if there is another source out there that's cheaper than gasoline and more efficient than gasoline, we have to find it, and so far we haven't found that, so we are in the replacement mode through some kind of transition of which we're not quite sure.

The second point is, does this whole question of U.S. oil import dependence help or hinder any transition that we might pursue? If prices remain high, is that good for us over the long haul for oil, or does it have the financial consequences Chas. talked about, of which there are several ramifications, not just the Saudi side but also the continuing import dependence translates into financial market problems at some level.

And I guess a subset of those questions is, have the higher oil and natural gas prices set the stage for a continuing high level of prices? There have been periods in the 1970s where prices jumped and then leveled off at a higher level, and I think the chairman of the Federal Reserve believes that is the case with natural gas, that we are now in $5 natural gas at the Henry Hub or maybe $10 at the City Gate in New York, and we may be not at $50 per barrel oil, but are we at $35 or $40 or someplace there. And if that's the case, does that help or hurt us in the transition?

And the third question is, of course, what - as we've all been talking about, what is the ramifications of our policy and how actually can policy be formulated, and do we go down the road that we went down in the '70s with some success and some failures or do we find an alternative?

Let me just go back to a couple of those points to sort of fill out the framework.

In terms of the long-term outlook for oil supply and demand, it is clear that conventional wisdom is that demand will grow at some rate but not the rate that everyone says it will grow at, but that supply will then meet the demand because there is adequate resources in the world. And I think that's a fairly well established view. There is a minority view out there that in fact supply, over time, is not going to be adequate, for a variety of reasons. There have been discussions at CSIS and various other places by people who believe that supply - you can pick Saudi supply or non-OPEC supply, but non-OPEC supply will peak relatively quickly, say 2010 to 2015, and that OPEC supply capacity will peak somewhere in the 2020s. And if that's the case, and I'm not saying it is, then we should be thinking about the transition immediately, given the leads and lags in terms of the oil market in particular.

I think it's worth thinking about in the political context that there is a question. I'm not saying it is a dire issue at the moment, but at the same time I think it is worth some thought. And the question really is, how much risk should the economy take on in the event we're facing this kind of marketplace as opposed to the one we think we are facing?

The second, in terms of bringing supply on is a question of timing, and for those of you who pay attention to this, the investment often lags the demand. As we have seen, it's happened this year as the surge capacity has disappeared, and it's made some investors, both public and private, skeptical about investing at this stage. If you invest at a - (audio break, tape change) -- not all - have been hesitant to do that because, as swing producers, they can put a lot of money into additional capacity and all of a sudden they have surplus capacity, which they can't sell because the market doesn't demand it. And for whatever reason -- the quality or some other reason -- it is inadequate to meet the demands of the sector.

Chas. has referred to the lack of investment in the refining sector in the United States and it's true; no new refining capacity has been built. But refining capacity has gone up in the United States because investors invest in their existing refining capacity. It's the quickest, easiest way to get a return, but even there for refiners to invest at high prices, there is a hesitancy to invest at these levels in anticipation that perhaps the market will turn on them. This is after all a commodity market, and for those who can predict commodity prices they should be extremely wealthy and be doing something about it as opposed to talking about it. So I think you have to sort of have to understand the economics of the oil market in particular because it is highly competitive and highly risky. And it's amazing at one level that in fact people do actually invest in this marketplace, given the risks associated with it on the economic site.

Finally, on the policy framework, let me just make two comments. One is, in the 1970's, I think the Carter administration deserves a lot of credit for at least one decision it made, which was to deregulate oil prices. And that has actually encouraged this boom in investment in non-OPEC oil production that has occurred over the past 20-plus years. And if you just look around the world non-OPEC production was increasing while OPEC - as Frank has said -- OPEC production was declining. And for those investors in non-OPEC, they invest and when they do have a major investment, they continue to reinvest in that exploration, that production facility. Because once the infrastructure is in place, it is the cheapest place to invest. And I think there is some indication that that kind of investment cycle is coming to an end, and that is, I suspect, one of the reasons why the non-OPEC production peak is sooner rather than later. That leads us to the question, okay, if in fact we are now seeing more concentrated investment in three or four places around the world, what is it we should do on the supply side, which I think is a very little bit on the demand side - and on the demand side, contrary to what Chas. has mentioned, I don't think it's mandates, but I think we have to encourage the marketplace, which is already signaling things on transportation. Hydrocarbons probably can lose some of their control over the transportation market. And I think that is something that we should encourage as a policy framework and also encourage the financial markets or make sure the financial markets value these kinds of investment as much as they value investments in the oil sector. Thank you.

MR. FREEMAN: Thank you very much. I think that was a very nice lay down of a clear, factual basis for an informed discussion, which we can now turn to. I'd like to invite people who wish to ask questions or make comments to catch my eye and I will note you down and call on you in order, and you can start now if you wish.

But -- is there someone who would like to -- sir? Someone who would like to ask the first question? If not, let me ask a question. Given the tremendous growth in demand that is projected over the coming 15 to 20 years period you were - some of you using 2025, some of you using 2030 as a basis for your projections -- and given the requirement for two things to happen presumably, the Middle East and particularly Saudi Arabia, given its important role in reserves, to make major new investment in production capacity to increase supply; and second, presumably to make investments beyond that in excess production capacity in order to maintain the surge or controlling capability in the market like the one demonstrated in the recent past -- does Saudi Arabia have the access to capital and technology on its own, that it needs to meet this requirement? Will it have to turn to foreign sources of capital and technology again? We're talking 15, 20 years. If it does turn to foreign partners, are they going to be - as they were in the past - American, or are they are going to be others? I don't know who'd like to start, but - Jim.

MR. PLACKE: I'm sure that all of us will have some observations. That is fairly wide-sweeping question, Chas. Let me deal with the last part. Will Saudi Arabia be able to grow sufficiently to keep up with demand, and where will the capital and technology come from? Our projections of Saudi oil production increase are fairly modest, actually. We only show them rising to a little above 11 million barrels a day of capacity by the end of this decade and to about 14 million barrels a day of capacity by 2020. I suspect that that will be too low if demand projections -- demand is the hardest thing in the equation to forecast. If demand projections are along the lines that are generally considered by the U.S. Department of Energy and the IEA and others, almost inevitably, Saudi Arabia is going to have to grow faster than that. The reserve base is there to do it. There's been a lot of public discussion about are Saudi reserves real? They're a lot more real than those in Iraq and Iran, I assure you. They have a tradition going back to the old Aramco days, they don't really fool around with numbers the way some other countries do from time to time. So I would take their reserve estimates as being quite confident.

Where would the capital and technology come from? Technology - an organization like Aramco, the world's largest oil production company - Aramco is a technological marvel as it stands today. They don't have the best of everything in every field, but they know who does, and you simply contract for it. As long you have the management structure to integrate it and utilize it efficiently, which they do, you can get what you need. The capital, well, the expected surplus - budgetary surplus - for Saudi Arabia to get this year is $30 billion. That's -- in terms of the Saudi economy, that's very large. If oil prices stay in the upper thirties -

MR. FREEMAN: That's, I think, just about what 15 percent of GDP --

MR. PLACKE: Right.

MR. FREEMAN: -- which is the equivalent of about 1.7 trillion dollars in budget surplus for the U.S. Not likely.

MR. PLACKE: You did that better than I could have. (Chuckles). If oil prices stay -- in the midterm -- in the upper 30 range as we think they will, then that will generate sufficient capital for Saudi Arabia to have the wherewithal to do the investment. Might they bring back foreign oil companies? Possibly. They have -- in March they signed a series of contracts for gas exploration and production -- none of them with American companies. Chevron bid on two of the four in the package and came in second in both of them. They lost out to I think, UCOS and Lukeoil, rather, and in one case, and to Sinopec - it's a Chinese company - in the other. That's an indicator of the future, I think.

I don't know whether - that's a policy issue that the Saudis would have to wrestle with. I don't see the imperative that would drive them to do it, but it may be a question of market efficiency and there may be some advantages to doing it.

MR. FREEMAN: So in a sense you think that whether we achieve energy and independence or not, Saudi Arabia has achieved its independence and its capacity to develop its own facilities. Frank.

MR. FRANK VERRASTRO: Yeah, I'll take it in just the reverse order. Starting with the demand first - and I agree with Jim wholeheartedly - I think the demand figures were horrible at estimating demand out 20 years. I would argue that estimating demand out 18 months is extremely difficult. If you take the International Energy Agency's forecast - and that's what a lot of people use, either IEA or EIA - their forecast was initially for a 120-million-barrel-a-day demand in 2025 or 2030. That was predicated on us being at 90 million barrel days by 2005. Well we're sitting at about 82 halfway through 2004. So even if you bring it down 10 million barrels a day that people readjust and take it up to 110, things happen over time. It's not a straight line demand projection. I don't think anyone anticipated Chinese growth being as fast as it is, certainly at the end of 2003, beginning of 2004. One of the questions is, is it sustainable? I mean, how long can you continue that growth?

If you take OPEC reinvestment or Saudi reinvestment, you have to look to the past as much as you look into the future when you plan for the future. I think one of the biggest concerns that they had - going back to how we got in this mess - if you take February of this year - February of this year -- the IEA forecast was for global demand on the order of about 77 and a half million barrels a day. And that was predicated on the fact that every spring, demand turns down because we're coming out of the winter heating season in the Northern hemisphere, but we're not quite in the driving season yet, where demand increases.

If you assume that non-OPEC production would supply 50 and there's four of NGLs, the call on OPEC reserves was going to be about 24. Do the math. Their quota was 23 and a half, so that assumed no stock build. The IEA has gone back now, and eight times in the last eighth month, has revised their forecasted demand. And it's now 3.8 million barrels a day higher for the second quarter. So if you wonder how we got in that situation - if you're shooting at a target, and you're three or four million barrels a day low, it takes you time to rebuild that surplus.

Now as we've gone over since February, OPEC's been producing over quota, the Saudis' production is up to nine and a half, maybe close to 10. We're starting to see stock build again, and if you look at the most current month, where demand was 82, say, on the high end -- and that's even assuming some stocks -- with no contribution at all from Iraq, the world's supply was in excess of 83. That accounts for the stock build; it may account for some of the deduction in prices.

When you start looking forward, though, I think the Saudis' biggest concern is on Chinese demand, and where does this demand growth come from? As Jim said, we've relied on - and if you go back to a 60-million-barrel-a-day market, if you have surplus capacity of three or four million barrels a day, so in excess of five percent, that's a pretty good cushion. If something happens in Venezuela or something happens in Norway with a strike, you can accommodate and the market works. When you go to an 82-million-barrel-a-day market and you have surplus capacity of one-and-a-half-million barrels a day, you have a very small margin of error, and that's part of the problem. But if you continue with sustained prices in excess of 40 dollars or 45 dollars, demand inevitably will be reduced. And if it's dampened and if we result in an economic recession of some sort, if you're Saudi Arabia and you're sitting on spare capacity - and I agree with Jim. I think they have the reserves and resources. I was in Dhahran in March of this year and Saudi ARAMCO - I spent 20 years in the industry - and the technology that they use is simply phenomenal because they can spread it over all these barrels, it's not what a normal - their shareholder is the Saudi government. It's not what we deal with in the United States.

But that being the case, you wonder how much more money you'd invest in a situation where maybe Iraq comes back, Russia production starts to increase, Nigeria and Angola do pretty well, we spend money on nonconventional fuels in Venezuela and Canada and demand goes down. And now they're sitting on four million barrels a day of spare capacity that's in the ground that they can't use. So how quickly do you bring that forward?

And one more point, and this is a policy point - and Chas., you talked about refining capacity - we've expanded refining capacity, but it's capacity creep - we haven't built a new one - and it's cheaper to just expand capacity. But I think one of the disconnects is that private sector companies - prudent business decisions don't necessarily dovetail with public policy good in the time frame that you need them. If you're a refiner or a producer, you know, is this high price of oil - is this the golden age for producers or is it the golden day? And they're very leery of investing in production and putting money in the ground and increasing a spend on capital to produce something that demand may not be there for in the future. And that's what we need to kind of overcome.

MR. FREEMAN: Alan.

MR. HEGBURG: Just, three quick points on China and Saudi Arabia. I think it's - Chas.' distinction between Saudis and Saudi Aramco is important because Saudi Aramco is clearly intent upon preserving and exploiting its position in China. It is very aggressive; it will not cede market share to the Russians, who cannot deliver oil to the Chinese market anywhere near as competitively as the Saudis can. And there the Saudis -- Aramco is now in a refinery deal in China, which actually helps solidify their position in that marketplace. Now the Chinese market - the retail market is not a world market, so there are a lot of uncertainties about the Chinese energy market as well as Chinese economic performance, as I think everybody in this room knows. So the real question is, how does the Chinese economy develop and how does their energy economy develop? And that's a fairly substantial risk for any investor in China.

Second, the marketplace - the crude marketplace seems to be dividing up into more regional markets and the point is that the Saudis' will remove themselves from the U.S. market and over the next however long, which means they might have to sell their interest in their refining assets in the United States. But in fact, they may see a desire to do that in exchange for the Asia market. And the Russians, assuming Murmansk can be built, can actually be in the U.S. market in a very competitive way, at least on the east coast. So the Russians can actually come into the U.S. market competitively at the expense perhaps of the Saudis, who probably cannot compete in this market.

And third, on surge capacity -- we've talked a lot about surge capacity, and the quantity of surge capacity is important but the quality of surge capacity is also extremely important. In the latter parts of August when the Saudis were offering a heavy (sour crudes (ph)) to the marketplace, the marketplace did not want them. The marketplace was looking for a better quality crude than you can find in the Europe gulf and were buying - (unintelligible) -- crude, and as a result the Saudis had to discount some of that additional capacity out there because it did not fit with the refinery requirements in the marketplace.

MR. FREEMAN: Thanks. Please go to the mike. From that, I take the thought that if Americans liked dependence on Saudi Arabia for oil, we'll love dependence on Russia. Tell us who you are.

Q: Thanks, I'm Chris Baltimore (sp) with Reuters News Agency here in Washington. I just wanted to try to elaborate on some thoughts that Jim had about the end of the special relationship between the United States and Saudi Arabia and what that means to the U.S. government in terms of its strategic relationships with other nations. Is this a good thing or a bad thing? Should this be something we should be alarmed about or is this just a matter of market fundamentals working themselves out?

MR. PLACKE: Well, let me start by stating something that's fairly obvious, but I think it needs some emphasis nonetheless. And that is, there are three things that make Saudi Arabia of international importance. One, it is the home of Islam. The two most sacred sites in Islam are in Saudi Arabia; the religion was founded there. Secondly, its strategic location. That was critical to us during the Cold War. The strategic location hasn't changed. It's still a very important consideration. And finally, of course, it's the world's largest oil reserve holder and the world's largest oil producer.

We've talked a lot about the latter. What's important about -- well, let me phrase it this way - having a barrel of oil available when you need it, or want it, is much more important than where that barrel comes from. It really doesn't matter when you fill up your car whether that gasoline was refined from oil that came from Venezuela, or Nigeria or Saudi Arabia. You just want to be able to fill up your car. In 1974 when they had gas lines, you couldn't fill up your car, at least not conveniently. So it's a question of availability, not where it comes from. I think we can just sort of put that whole argument aside.

But the political importance of Saudi Arabia remains, and I would not want to be referred to as having said that the special relationship has ended. I think the special relationship simply isn't as special as it once was, in part because of the end of the Cold War. The one thing that united or that formed a uniformed view between the United States and Saudi Arabia from the end of the second World War right up to the end of the Cold War at the beginning of the '90's was a common enemy. To the Saudis' it was godless communism; to the United States it was the Soviet menace. But we were looking at the world, not in an identical way, but at least in a parallel way.

That is over. We don't have a common enemy anymore. And of course in this country, what happened on 9/11 is an overriding consideration that colors everything else. So there are more humps and bumps in the relationship than there have been in the past. Oil is going to be a reduced factor, but that it is important to the United States to have a confident relationship with Saudi Arabia -- I don't think that has changed.

MR. FREEMAN: I think Frank will have a comment implicit in your remarks, Jim, but I'd like to make it explicit, is the emergence of a fourth and very important common interest, which is in combating Islamic terrorists. My sense is that the kingdom is winning its war against its domestic terrorists, but we are losing ours in the broader arena, leading to an interesting and somewhat ironic situation. Frank.

MR. VERRASTRO: Yeah, thanks, Chas. Actually the terrorism is an important point that I was going to add, but Chris, the other piece that I think - and I'm pleased to hear Jim say that - I think it would be tragic if the relationship was gone. I think it's been damaged, but I think it's certainly recoverable, but we need to also tone down the political rhetoric from both sides. We've demonized Saudi Arabia because it's effective politically and there's no downside, but it's not smart going forward as a broader policy tool.

MR. FREEMAN: Sir. Tell us who you are please.

Q: My name is Eck (ph) Tagaria (ph). I'm an economic consultant. I have two questions. One is in regard to the, you know, production of all supplies in the world. The way I hear it and I've read in various resources that in the long term, sometime around 40 years from now in oil field and something about 60 years from now, the gasses are going to be completely finished - not completely gone - but I mean, you know, the production of it would be reduced a lot. They're talking about the peak production sometime around 2016 to 2020, you know, around the world, and therefore most of the production, say, outside of OPEC, is going to be drastically cut. And therefore one of my questions is, what is your view of the long term that the Middle East oil -- actually, you know, the Persian Gulf area is going to be predominant again in the oil business.

And the other question is in respect to Mr. Placke's future alternative energy. There is a project they call FutureGen (sp) that they're talking about - in fact, invested about a billion dollar into research of converting coal via hydrogen in order to make hydrogen cell for the car, because in the United States, transportation consumes about 68 percent of the - you know, of the oil use. And therefore, they want to convert that and they are envisioning by 2025, our cars basically is going to be electric and -- or using the hydrogen cell. Is that prospect realistic or not?

MR. VERRASTRO: Let me start with the peak question first, because we've done a lot of that work on that at CSIS. There's a group of people that clearly subscribe to the idea of the Hubbard (sp) peak, that oil peak production - you'll see it and then you'll see a steep decline.

In my personal view, I think it works extremely well for mature basins. In the United States we've got, you know, over 100 years of exploratory work and production. When you go back and you look at the initial reserve numbers - and some people take an overly simplistic view, I think, of this. They take the reserve number that's listed, they subtract actual production that's occurred over 60 or 70 years and say, well this is what's left. But in practice, when you go to some of these fields, we have already produced what the initial reserve production was. The Goare (ph) field has been - in Saudi Arabia - has been in production for 70 years and its still producing several million barrels a day.

I think lack of data and transparency, for those areas like in the United States, you can make that case for the 48 because we've got good data. When you try to expand that to the rest of the world and extrapolate, I think that's a dangerous place to go. The PFC analysis that they actually presented it at CSIS a couple of weeks ago - they had better data on non-OPEC reserves from a variety of sources, some of their own analysis and some from company data that they used. What that drives you towards is a greater reliance on OPEC in the future probably 15 years out.

And I agree with that assertion; the question is, when you get to the OPEC numbers, that's where the predominance of oil and gas reserves are, so predicting when they're plateauing, when they're declining -- I think a lot of it, as Jim and Alan both have said, has been relative to price. When price goes up and demand goes up, we've seen people enter fields. A lot of the production in Saudi Arabia, the reserve estimate is just based on primary production; they haven't even done water flood yet. So I don't think we're going to see the end of oil in my lifetime, that's for sure. Now, I could go out and get hit by a truck tomorrow and make sure that that works but I don't see it happening.

On the hydrogen side, people have talked about what would it take to make sure that a child born today drives a hydrogen car, and my answer, kind of tongue-in-cheek, is raise the driving age. I don't see that by 2020 either. There's a lot of things that have to be done in between, including technology. Clean jet is one of the issues. One of my largest concerns with some of the administration policy is they're relying an awful lot on hydrogen, carbon sequestration and clean jet. And if you pick up the napkin, there's nothing behind that yet.

So maybe 15 years out with a lot of work and a lot of money and a lot of research we can get there, but we need to be smarter and look at practical applications - what we can do in the near term to make that transition. You know, Al talked about the Stone Age not ending because we out of rocks. I think that's true. Technology and consumer preferences may drive a lot of this. It's just a matter of the timeframe that we bring these technologies on, and it takes a lot of lead time and a lot of money.

MR. FREEMAN: Alan.

MR. HEGBURG: Thanks. Just two quick points. I have no idea what the supply demand balance is going to look like in the future, whether you're a demand pessimist and a supply optimist or vice versa it's impossible to say. My point is that because there is some uncertainty, why should the U.S. assume all of the risk that the - it will play out something which there will be adequate low-cost fossil energy reserves available to the marketplace for the foreseeable future to 2040. That doesn't mean you immediately go out and transfer us into solar power or things like that, but it does mean you think about how you can actually begin the transition, as Frank has mentioned.

And the question really isn't whether you go from this economy, this energy economy, to a new energy economy within 10 years; it is what are those steps that could actually add competition to the marketplace where technologies can be tested in the marketplace, find acceptance in a price and clean basis that the society will want to buy and use. That really seems to be the challenge. It's a step-by-step process, not a huge dramatic process.

Finally, just in terms of supply additions, if you go back to the published data from the private companies, the private investors, the equity investors, the large oil investors in the world, you will see, I think in general, that the way in which they mostly add reserves lately is through revisions, additions -- step-out wells in addition, productions and acquisitions. Exploration has not really carried them over the last several years, and in fact, expiration budgets in the large companies tend to be very constrained now. They're all looking at acquisitions in various parts of the world. And that means that we're not adding to the broader stock of oil reserves; we're actually all working around the same basis of what already exists.

MR. FREEMAN: In China, which faces a particular challenge in meeting its energy requirements in the future, the focus of most of the research and development does seem to be on coal conversion, either through gas into liquid, or into hydrogen. There are rumors of some innovative new technologies emerging, but one never knows until that actually happens.

Jim.

MR. PLACKE: Well, let me add a little bit to what Frank's already said about the question of converting the automobile fleet to hydrogen fuel. About once or twice a year I attend the meeting of the chief economists of the major automobile manufacturers in North America, and so what I'm reflecting here is not an independent view but a view that I've acquired from knowledgeable people in the automobile industry.

The U.S. automobile fleet turns over an average of - takes an average of seven years for the turnover, so 2025 is 11 years away. The technology to put a hydrogen fuel cell into automobiles on a large scale, let alone provide access to the hydrogen to fuel them, because driving up to your present gas station is isn't going to do it, isn't even on the horizon is the industry's judgment. So I think by 2025 that's almost certainly not going to happen. Could there be a technological breakthrough that would change this? Yes. And as I said earlier, technology is really unpredictable and breakthroughs happen when they happen; you can't forecast them.

The industry was more optimistic about hydrogen-fueled automobiles 10 years ago than it is today. I think they've realized increasingly that there are just too many inherent problems in handling it, in distributing it, in treating it is a fuel on a mass consumer basis. Therefore I think it's relatively unlikely that that will be the solution but nobody can say with certainty.

Will hydrogen fuel cells find a place? Yes, I think almost certainly they will, probably in stationary uses. The U.S. administration is putting money into the program to develop hydrogen fuel cells for the transportation industry, but then, as I remember, in the 1970s we had something called Project Independence, which was energy independence. It's been around a long time. And under that rubric the U.S. government spent $2 billion trying to figure out how to convert shale - oil shale to crude oil. What the $2 billion expenditure proved was what most people realized at the beginning: it can't be done. We may do the same with hydrogen fuel cells.

Q: Mustafa Malik is my name. I'm a freelance journalist. I'll begin with the product independence of the 1970s. I was reading some time ago that Professor Huntington made a comment that he was four years at the National Security Council and the president talked about democracy and human rights in all countries except Saudi Arabia, and reason he gave was oil.

So my question is - recently we were reading in the Washington Post - again, that is at attack, that Saudis don't have enough religious freedom. I am all for it. What is the feud about? I really don't get it. And I think I would start asking Ambassador Freeman a political question: do the people who are attacking Saudi Arabia because they don't have enough freedom and democracy, do they really believe that if an elected government is there that it will be more manageable? Saudis are pretty - I mean, we can placate them well - or is there something else that is driving this sudden attack on Saudi Arabia? I'm all for a democratic government in Saudi Arabia. What is behind it?

Thank you.

MR. FREEMAN: Well, I don't think it's a secret that we're having an election in this country and thus Saudi Arabia has been successfully vilified by its detractors. It is, as I think Jim said, a country that you can attack at no cost and with considerable gain politically. What's happened is not that anybody has particularly gone on the attack against Saudi Arabia but that the White House, which traditionally protected Saudi Arabia against this kind of declaratory diplomacy, has chosen not to do so. In other words, there is an election judgment, presumably, in the White House that the cost of defending Saudi Arabia was greater than the benefit.

Now, having said that, I will make several comments on the issue itself. First, I think declaratory diplomacy of this kind, putting labels on countries, is generally counterproductive. It infuriates rather than persuades. I don't think this will be an exception. That is, I don't expect the Saudi government will take our words to heart anymore than we took the words of Europeans who condemned our system of segregation to heart. When they said that we simply got angry, and when we finally did change, it was for our own reasons.

Second, substantively, the accusation is correct: there is no religious freedom in Saudi Arabia. No one has ever disputed that. But, ironically, in recent months, years, the trend in Saudi Arabia has been toward greater freedom of religion than before, as Shi'a have been admitted to the national religious dialogue and accorded a place of honor in national policymaking. So it's very ironic that at this moment of expanding religious freedom, albeit in a minor way, in Saudi Arabia, we should chose to issue this denunciation. Why do we do this? Because there are groups in the United States who feel passionately on the issue, either for reasons of deep religious conviction on their own or because they don't believe that we should have Saudi Arabia as a friend and are delighted to see our two countries divided.

What's the prognosis? This action will not help advance the cause of religious freedom in Saudi Arabia. It probably won't harm it very much either. It simply will add to the estrangement between ordinary Saudis and Americans, and it will lead to countercharges - in fact, it already has - by Saudis against American persecution of Muslims, which, sad to say, is not an entirely groundless charge in the post-9/11 atmosphere.

So this is all about electoral politics and the lack of courage to defend an old friend based upon a silly notion of how one should conduct foreign relations that is unfortunately deeply rooted in the American psyche.

Q: My name is Marcus Oliver. I'm with the U.S.-Saudi Arabian Business Council. I have two questions for you. The first is how viable and how genuine was Saudi Oil Minister Niami's offer this past spring to help build a new refinery on U.S. soil? And secondly, considering that Saudi external political relations follow economic relationships, what does the Kingdom's increased interdependence with China mean for U.S. businesses as well as U.S. policy in the Gulf region and the larger Middle East?

MR. VERRASTRO: Let me start with the refinery question. He actually made that offer at one of our conferences, and we had the deputy secretary of Energy on the same panel. And Secretary McSlarrow basically said, good luck, you know, have at it; you can do it. I think the Saudis may have rethought the offer since there was no movement on the U.S. side. I think in terms of economics just as American companies look at it, that there's probably going to be a delay in new investment until you decide what the market is going to look like.

Some of the refiners in this country, when you ask them what would be the incentive they point to 20 years in the past of low performance on refining assets in the United States, and so why would you make an additional investment now? And then if you tell them that increasingly it looks like we're going to meet our demand through imported product in addition to imported crude, so double our vulnerability, their answer is, well, that's kind of the market adjusting, but if you start talking about, well, maybe some of the policy answers to that - and this talks about kind of business decision versus public policy - some of the policy answers might be to encourage alternatives, supplemental fuels, do something about demand restraint, and increase inventories to kind of smooth out the bumps in the price cycle.

Those are the three things that they find most objectionable, and they think that those are disincentives to making those investments. So we're talking past each other, so that's one of the first things that I think has to happen.

I actually think that the next Saudi investment will probably be in Asia. If you're actually looking to move your crude in that direction, you lock up the market by building a refinery that's configured to handle your crude and make products that they demand. And that may be a home for the heavier oils; it just makes a lot of sense.

MR. PLACKE: Well, to just put a finer point on your last comment there, Frank, Saudi Arabia, nearly 20 years ago, offered to build a refinery in China and the Chinese weren't interested. My understanding is that there is now a discussion going on between Saudi Arabia and SINOPEC, which signed the Gas Exploration Agreement and is also the largest refinery operator in China, about selling an interest in a plant that would then be expanded to Saudi Aramco. And I agree with you wholeheartedly; I think that's much more likely than in investment in the U.S.

On your question about the business relationship or commercial relationship, I made the observation earlier that I would expect by the end of this decade that China would have replaced both the United States and Japan -- which had been very close, one taking the lead one year and the other another year - in being the number one trading partner for Saudi Arabia. That's just the way the trend is going. It' partially oil but it's also the things that China produces. What do you see when you go to K-Mart - if you go to K-Mart: things are made in China. You see the same things in Saudi Arabia or anywhere else. So that shouldn't really come as a surprise and I don't think that has an inherent political message.

I think the things that we have done since 9/11 to protect the country, but in some cases in a way that has alienated certainly the Middle Eastern part of the Muslim world and made business much more difficult. There is disinvestments of Arab investment, and particularly Saudi investment, in the United States. It's not growing; it's declining. The membership of the U.S. Chamber of Commerce in Saudi Arabia has declined. The number of American children attending international school there is down. All the indicators that I can identify suggest to me that the business relationship is in decline. What will turn it around? Probably policy considerations, but Chas.' earlier comments don't make that very optimistic.

MR. FREEMAN: I would note that you also have the virtual end of the flow of students from Saudi Arabia to the United States, the decline in business travel as well as the American foreign worker presence in Saudi Arabia, and a radical decrease in the ability of American companies to make sales presentations because they can't bring customers from the region to the United States through the visa gauntlet and the risk of humiliation at the airport. So I think we have to separate the two issues. It's not a zero sum game. That is, the U.S. business relationship with Saudi Arabia and the Gulf generally is in fairly rapid decline for reasons which have to do with us, not China.

China's relationships are very rapidly on the rise, for reasons which have to do with China, not with us. Therefore I don't see it as a zero sum game. I just find it unfortunate that we would be allowing our relationships to deteriorate in the fashion that they have.

Jeff.

Q: My name is Jeff Steinberg. I'm with the Executive Intelligence Review Magazine. I'd like to make a brief comment on a couple of things that I think have been omitted or understated in the discussion and then ask a public policy question.

Two things that I find disturbingly missing from the discussion are, number one, the aberrations or lack of responsibility by some elements within the free market corporate sector, evidenced by things like the Enron fiasco in California, Shell's falsification of reserve data, and things like that, all in the interests of near-term shareholder benefit stock prices, which is an alarming factor. Secondly, what I think is an underestimation of what I would call the lunatic fringe factor in American politics, namely that the same neo-con apparatus that was responsible for the Iraq war seems to be gunning for Iran. There is at least accusations of encouragement for instability in the Caucasus region and there's major areas of the oil-producing sectors of the world that seem to me are much more unstable.

But the question I've got is on public policy, because it seems to me that the role of public policy is to look towards posterity and not towards the near term, and looking just at the chart that's up there on the wall it seems to be pretty obvious that within less than a generation we're headed for a much larger energy crisis - running out of stones, as Mr. Hegburg called it - and I wonder what kinds of serious and fundamental things need to be done, in your judgment, to confront that question of a transition to a whole new array of energy technologies, which involves changing a pattern of disinvestments in things like basic infrastructure over the last decades - mass transit, nuclear energy - those things, which it seems to me are the post-fossil fuel era issues.

And these issues very often take 30 to 40 years to go from research and development into implementation on an economy of scale that makes a difference. So I come way much more frightened than the sort of calm demeanor in the room about something for the next generation that's a horrific mess.

MR. FREEMAN: I will prove that I'm not a politician by giving you a straight answer to your question of what ought to be done; namely we ought to tax the hell out of oil and gas and gasoline and apply the taxes to the infrastructure and other problems you identify while simultaneously reducing demand and dependence on foreign energy by raising prices. With those few words I plan to defect to Australia since I obviously have no future in this country.

But I would like to have some comments from others. Alan, would you like to -

MR. HEGBURG: Let me just make a couple of comments. That is the core of the public policy issue, from my perspective, and as I think I've said, how do you actually try to initiate the transition if in fact you can't move the political system to use mandates and tax policy and fiscal policy to achieve those objectives? And I think that's probably true. Then how do you encourage the market to actually take the lead and how does the political system support the market system? And that's a very difficult question because that usually gets into tax and fiscal policy, which, as you know, very strong entrenched interests will protect those interests forever, I mean, and if you just follow the debate over the energy bill that's taking place in the Congress, it is a very, very significant issue for those who are already in the marketplace and don't want to cede any kind of position in that marketplace. I think I would do the same thing if I was in their place.

I think the other thing that's very difficult to do in this political system now as opposed to the 1970s is there are a lot more political actors in this system. If the federal government - either the Congress or the executive branch - doesn't preemptively make decisions, it's ceded off into the courts, to the regulatory bodies and to the states, and the states are actually engaged in legislation and regulation on their own. What that means, in fact, the marketplace, which had been known for its efficiency, particularly in gasoline -- as I think we have seen in the summer -- is becoming a less fungible, less efficient marketplace. We have this sort of - one would say it's a confederal market for energy, but it means there are a whole lot of players who have different perspectives on this.

And I think the third thing is, on the environmental side - the environmental issues are real and important and have yet to be accommodated in any way in the political system that you can reach consensus on. They are still confrontational, and if we can't go from a sort of confrontational - some sort of cooperative arrangement on energy policy, we are going to be stuck, I think, in this place where we are for quite a while.

MR. FREEMAN: I think it's an interesting fact that we have increasing reports in the scientific literature and in the press suggesting that the increase in hurricanes is related to a rise of water temperature and yet we have an administration that, until very recently, had muzzled its scientists to deny that there was a problem of climate change. Probably it's going too far to blame Florida on the administration, but there is a connection and there is generally a default on a range of public policy issues. Among them are the ones that you mentioned: issues of corporate governance which have not been addressed squarely and which I think have greatly reduced the attractiveness of the American market to foreign investors, among other things.

And second, as you said, the erratic behavior and unpredictable nature of the neo-con mind as it threatens Iran, Syria and a range of other potential targets is also probably a factor in making things considerably less stable and retarding answers to problems that we have been talking about.

Please.

MR. VERRASTRO: Yeah, let me just make two quick points - and I agree with your assessment on some of the corporate malfeasance that has gone on. I think we need to make the distinction between near term and long term. We have gone away from kind of long-term planning, and even in the industry - I spent 20 years this way, so I know a little bit about this - a lot of the companies used to be run by geologists and engineers in the oil sector. Increasingly, the people that come up the ranks now come up on the financial side because they can guarantee increased performance or improved performance on Wall Street, and that means making your quarterly targets. To make your quarterly target, sometimes you forego investment -- so you don't do the spend -- when your income is rising, okay? So quarter-to-quarter you can look really good, and that is good for bonuses and good for performance. It probably doesn't help the long-term longevity of the company, and if you get a group of those people operating the same way, it doesn't help the long-term situation of the country.

On the policy side, I have seen the same thing - it's the balkanization of these single-issue special interest groups. I have nothing against lobbyists or special interest because we are all special interest, but having said that, you can push on issue, whether it's environment or tax or just stopping something from happening. You don't have to work on the solution, and we don't hold everyone accountable for the solution. When we were talking about the gasoline problem earlier this year we tried to get a group together to talk about what the actual situation was - was it crude quality, was it availability, was it pricing, was it regulation, was it boutique fuels? And the regulators would point at the refiners and the refiners would point at the environmentalists, and everyone pointed at Wall Street but no one wanted to come together with a solution, even in an off-the-record session. So we have got to kind of get beyond that, and I think part of the reason that forums like this are important is to kind of raise the level of education so people understand what the issues are and how soon they are coming forward, and then maybe we can get the word out and discuss it better.

Q: My name is Pinkus (ph) Javitz (ph). I used to be with the Hudson Institute. After that I was a fellow at CSIS in Charlie Ebinger's group. And I really would like to throw back, in the context of what just went on, to the first two peaks on the previous slide. In those days I was with the Hudson Institute, and Mr. Herman Kahn had the idea that if we look into alternatives - it was the idea of capping the price of oil and of creating marginal supplies. Now, under contract, this led to - (inaudible) - government - this led to the creation of the Sinfuse Corporation. The idea was to try to find out how much indeed do these alternatives cost? I was very much involved in the oil shale project in those days going back to - (inaudible) -- so that is back in your group.

Now, today things have changed but the same kind of ideas could also be thrown into the harbor. Think what, for octane purpose, ethanol can do to the gasoline pool. Now, something like 6 to 10 percent of the gasoline market would make very much sense to use ethanol. Now, that would not displace 10 percent -- or 6 to 10 percent but would actually displace about 1.5 times as much petroleum because not being able to use MTB and lead, one has to go back to the refinery in creating - reforming capacity, which has higher percentage aromatics and cost-linked products. And so that energy-intensive process takes another input of crude, so we displace actually more. Now, voila, we have already done a serious dent into the problem under the title of marginal supplies, which become quite major impacts.

Now, the same thing goes - we were discussing another problem of sulfur and diesel. You know, bio-diesel mixtures in diesel - bio-diesel has no sulfur. We start making some kind of dent in the quantity of sulfur in diesel and - now, again, all of that means not energy policy, but all that means agriculture policy. Now, we subsidized export of agriculture produce. We keep land out of production. This gives us a very hard time with the WTO.

I'm simply suggesting a few things. Now, the highest input - creation of new oil sources is in conservation. Now, if we start looking to all of those things - and I wish Herman Kahn would still be around - perhaps all of that we are talking here about is simply hogwash. I hope I gave you enough material to continue this discussion.

MR. FREEMAN: Thank you for the comment. I think - and I invite others to address ethanol, which I think is, in fact, heavily subsidized by tax policy, to the point where there are serious questions now being raised about whether the acreage planted in corn and the chemicals used to produce it do not create more problems than the ethanol produced solves.

Q: (Off mike.)

MR. FREEMAN: Well, I think you are correct that these issues all need to be addressed. I think that one in fact has been. Diesel and sulfur are a technical issue, which others might want to speak of, and I think conservation is of course key - your third point - and that gets to how to depress demand, and personally I have always thought that there is an interesting equation between prices and demand that we shouldn't forget. But - please.

MR. PLACKE: Well, just an observation to follow up your comments, Chas., which I think probably covered it pretty well.

At the outset I noted that there are two ways to deal with the narrowing of available oil production capacity and rapidly growing demand, apart from just expanding capacity. You can apply measures to encourage conservation. You can do this through regulatory measures; you can do it through tax policy. You can also do it - on the other side of the equation, use tax policy to encourage fuel efficiency, which we did in the '70s, and it had, I think, a very pronounced effect, and I think it's a good thing that we did. And we have stopped doing it; we ought to reconsider going back to that. That is a less painful way because it's an incentive rather than a regulatory barrier. But it's all part of the same picture, and I would certainly grant you that without question.

The other of course is technological change, which we have talked a lot of about, and none of us know with any degree of confidence or precision exactly where that is going.

MR. VERRASTRO: One point about short-term, long-term - your point about the Sinfuse Corporation - when crisis stated declining because demand started declining because prices had been to high and drove demand down, the Sinfuse Corporation - both the Reagan administration and the Congress decided to stop funding for the Sinfuse Corporation because it made no sense in their mind to subsidize backstop technologies when conventional fuels were so inexpensive. So it's kind of a short-term change in policy priority versus spending the money to save you paying down the road, and we seem to do that all the time.

MR. FREEMAN: I was just going to comment because this is the Middle East Policy Council and we try to focus on the implications of things for U.S.-Arab relations. The major oil producers in the Persian Gulf - Saudi Arabia most notable among them - do not take kindly to the idea of raising prices through taxes if the taxes go to the governments that levy them, not to the producers of oil. This is, in fact, a major point of dispute between the Saudis and various European governments who have chosen to tax gasoline at the pump at very high levels, both in order to raise revenue for roads and mass transit systems and to reduce demand for energy, and thereby preserve a measure of independence from foreign supply, but also for other purposes, none of which are particularly congenial to the oil producers.

But in the case of the United States, the reasons we don't tax at significant levels have absolutely nothing to do with doing favors for Arabs. It has to do with our own gluttony and greed and our own infatuation with the automobile and our belief in consumerism as a philosophy. So I don't want to leave this. I'm not making a policy -- when I advocate higher prices I am talking about how I see American interests. I also recognize that my viewpoint is not likely to be very welcomed by Ali Naimi, but he may rest assured that no one is going to listen to my advocacy on this point anyway, except John Duke Anthony.

Q: John Duke Anthony, National Council on U.S.-Arab relations. I would invite anyone's comment on two additions to the thus far articulated four categories of specialness in the relationship and then I have a question, too, on financial issues and energy - one related to the financial.

The two additional ones, I would submit are geo-institutional, for lack of a better word. You may say that the geo-political, but the three that are on the table are Islam strategic geography and geo-politics in that context, and geology - these three - these are Jim's, and then Chas., you had a good fourth one there, unity of viewpoint, more or less, on combating terrorism. I would submit two more that are of equal weight, and on some given days, some given issues of equal weight, if not greater weight, than those four. And the geo-institutional one has to do with Saudi Arabia being a founding member of nine different organizations where we are exposed, where we are vulnerable, where they carry water for us thus far more days than they do not.

The United Nations, the International Court of Justice, de facto World Bank, IMF Organization of the Islamic Conference, OPEC, the League of Arab States, the Organization of Arab Petroleum Exporting Countries, and the GCC. We have needs, concerns, and interests and objectives and all nine of those, and they are significant players. Of 140 developing countries of the world, none of the 140 carry the weight that Saudi Arabia carries in those nine organizations.

Now, to underscore, that is a matter of no small moment with Operation Earnest Will in the ending of the Iran-Iraq War, where we put our flag on Kuwait's tankers, and some two-dozen countries formed that coalition. Saudi Arabia was key player in bringing a number of those on, as we were, but they brought their own on. And in the liberation of Kuwait and the reversal of the aggression against Kuwait, it also played an enormous role at the geo-political level in terms of the League of Arab States, the 12 to nine votes that we got twice that we needed very much.

So I would put that as of almost equal weight as the other four, and then - you touched on it, Chas. but we didn't make it sort of as a special category, and that is the more than - I'm being conservative in my figures here - 200,000 graduates of American universities. They are all in place in the Kingdom. Most of them return our phone calls. Each of them would return us courage-for-courage or creativity-for-creativity on breakthroughs on the Israeli-Palestinian conflict, as they have with regard to the unanimity March 31st, 2002 on Prince Abdullah's peace proposal, which has yet to be answered decisively.

So I think that those two things are of equal weight to the other four, and therefore we have six. The question has to do with a financial one, and if anyone would elaborate a little bit on the implications of this dollar aspect, which has been key to the ongoing preeminence of the American financial system worldwide. What if they switched, like Kuwait has been doing, to a basket of currencies, even within which the dollar may be the single biggest piece? What if the euro grows in importance? Or what if there is other tinkering and tailoring, perhaps with the withdrawing of the 400 billion, or whatever the figure is, of Saudi Arabian investments of the United States? That is a financial question I would like to hear more on.

And then, on the energy one - people talk abt a GOPEC (ph) of Kuwait, Saudi Arabia, Qatar and the UAE, and it's often dismissed, but under what scenario or situation could you see a tightening of these four if there is further animosity or alienation from U.S. policies and positions, American actions and attitudes?

MR. FREEMAN: Thank you for the addition of two other factors. I think they're important linkages between us and Saudi Arabia. On the two questions that you asked, first the dollar link, I would like to ask others to address it. I would simply note that it is a matter of convenience rather than law, a matter of custom rather than of well-considered principle that international commodity markets based in London use the dollar not only for oil but for all other commodities with one exception, which is still traded in sterling. There is no inherent reason that this should be the case. It has been the case because of the unique role of the dollar as an international reserve currency and the willingness of the American people to refrain from saving and to consume gluttonously, thus exporting dollars in large numbers, which we persuaded the Arab oil producers in the mid-70s they should then recycle into investments in the United States.

The danger is if the cycle be broken that if the dollar were not the medium of account for the oil trade, it would cease to be the medium of account for cotton and copper and aluminum and all the other commodities that are traded - some 200 of them -- which we are dependent upon, and would then actually have to pay for, those things by doing something other than printing dollars. That is the problem, in essence. How real the danger is, I'm not sure. How acute the problem would be, I would like to hear an economist address.

MR. PLACKE: I studied economics a long time ago, Chas., but I'll do the best I can.

MR. FREEMAN: I slept through the course.

MR. PLACKE: (Laughs.) You referred to the recycling of petrodollars, as they were called in the 1970s, back into U.S. Treasury bills. By the mid-80s - well, by the early '80s, Saudi Arabia was the largest holder of U.S. Treasury bills because of various things that happened in the course of the '80s with oil prices, with the first Gulf War, which was largely financed by Saudi Arabia. In fact, there is even a suggestion that we made a profit on it, which we certainly haven't on this one. That's over. Saudi Arabia is a modest, indeed if at all, holder of Treasury bills, which is generally true for the other principal oil exporters as well.

If we are, today, on the verge of another so-called oil boom analogous to the 1970s, with large amounts of capital then to be accumulated by the principal oil exporters, where will that capital go? Given the way the dollar looks today, it probably isn't going to go into Treasury bills. What does that mean for the United States economy? You are getting into an area of very broad macroeconomic and financial analysis that is pretty murky, and I think all you can say with any high degree of confidence is it's not good.

The Bergsten theory about a potential dollar collapse, which you referred to earlier and I'm acquainted with as well, may then become a more eminent and real prospect. We haven't experienced that since the 19th century. I don't know what our 21st-century economy would do in response to it, and I hope we don't find out.

MR. VERRASTRO: I think you covered the economic and currency issues. On the supply side, my gut instinct would be that as long as the United States maintains its position as a huge consumer of oil - and maybe of liquid natural gas - instead of energy independence we are looking at an interdependence, I think, so it's good for producers and good for consumers as well. To the extent that you buy into the PFC analysis, for example, that by the middle of the next decade a lot more of the production capacity shifts to OPEC out of non-OPEC, then it puts them in the stronger position, if we have done nothing else. I mean, I don't think there is any question about that.

Now, whether that restricts our foreign policy objectives or our military options or our financial incentives, I would argue that this influx of the capital - oil revenue - probably reduces our leverage to promote democracy to the extent that that is a priority. If these countries now are given an awful lot of money - I mean, $200 billion this year - I think that slows the process up rather than speeds it up, so it's a likely outcome.

MR. FREEMAN: Alan?

MR. HEGBURG: Just a quick couple of comments. On the medium of exchange for contracts, I don't know what the incentive would be to get out of dollars. There would have to be an equal incentive to get into something else, and I just don't see that in the marketplace, but that doesn't mean it can't happen - I mean, that things could change.

On the question of holding dollars as reserves, I guess on Jim's point in terms of there is not much held any longer in the Gulf countries, there certainly is a lot held by the Chinese, and it has always astounded me how our foreign policy on China often ignores the financial linkages that the United States has with China both on the trade side and the financial side, and of course they are linked.

MR. FREEMAN: I want to make a final comment on this, and it has several parts. First, in fact, John, there has been a massive withdrawal of Arab private investment money from the U.S. economy and an absence of new inflows, and that is reflected in the virtual collapse of net new foreign direct investment in the United States relative to historic levels. You have figures which show really almost a catastrophic drop over the past year in inflows of private money. This has been masked, as Alan mentioned, because the Japanese Central Bank has, in the interim, purchased a trillion dollars in dollar instruments in order to prevent the yen from revaluing. The Chinese are charged with manipulating their currency. To the extent that they have done so, they have done it by buying almost half a trillion dollars worth of our national debt. We find ourself in the strange position of having our increasing national debt funded by China as well as Japan, and to a much lesser extent now, the Arabs.

What is it that could produce a rational economic decision to turn away from the dollar? Well, I think Alan has mentioned one factor, and that would be the availability of alternative reserve currencies. The euro has not yet developed to the point where it is a credible alternative to the dollar, sterling is punching above its weight in that game, and the Chinese yuan has not yet emerged as a hard currency. So at the moment there are very few alternatives to the dollar. However, if you were Saudi Arabia or a Gulf country and you look at your shifting terms of trade; if you find that instead of the situation in the past, in which most of your imports are denominated in dollars, now your imports are increasingly dominated in euros or yuan or some other currency, you then have less of a stake in maintaining your linkage to the dollar. In these circumstances, you could see, as one of the unintended consequences of the deterioration of U.S. exports to the region and the shift of oil trade away from the United States, the emergence of some basket of currencies as an alternative to the dollar in terms of setting the riyal exchange rate, thereby determining what the unit of account for the oil trade would be.

But at this point all of this really quite speculative, and I share the hopes of everyone else on the panel that we will not see any of these things happen. I also hope that we will find a basis for repairing the increasing estrangement between the United States and Arabs and the broader Muslim world rather than exacerbating it, as I'm afraid is the case at present.

Ma'am.

Q: Hi, I'm Sarah Whalen and I write a column for Arab News. I have a question - it draws on an earlier question or comment that was made where the United States' State Department designated Saudi Arabia as a violator of religious freedom, and certainly that adversely affects the special relationship. But I'm wondering if it has a concrete, discernable impact on oil prices, or have things already been so affected that they possibly couldn't be affected any more?

My next question is, do you think that Bush's evinced support of Putin is in anticipation of creating a new special relationship with Russia in terms of oil, and what might that mean, because my understanding is that at least for transport, a lot of the transportation has to take place through what they call the stands, you know, which you may be going from one costly, very volatile situation into another that equally has a potential for turmoil.

Thank you.

MR. PLACKE: Well, let me initially at least try to respond to that. The effect on oil prices of the continuing - as Chas. has elaborated on - estrangement between Saudi Arabia and the United States, at least relative to the relationship that we've had in the past, no, I don't think there has been a - Saudi production, as Frank mentioned earlier, has increased markedly. It grows from about a million and a half barrels a day from about April to the current month of this year. That's adding a large amount of oil to the market with the purpose of trying to contain the price spike that we've experienced. And I think the Saudi objective is to get the price back under $40. That really has to do with Saudi interests, not the relationship with the United States or any one other major consumer. Their interest -- as the world's largest oil reserve holder and largest exporter, their interest is in having oil be a major commodity for a long time into the future, and having erratic markets, having price spikes is a disincentive, and that's the way they see it and they have seen it that way since the 1970s and I don't think that view has changed or is likely to change. So I really see no connection to oil prices.

On your second point, Mr. Putin - well, I think you would have to ask the president because, as I recall, he said he "looked into Putin's soul" and it was on that basis that he concluded, as Maggie Thatcher did a generation earlier, that here's somebody we can deal with. So I don't know what he saw there.

But back in the real world, there was a mention of constructing an oil export terminal at Murmansk, which is an ice-free port in Siberia that played a large role during the Second World War, in fact. That does not look like it's going to happen. As Mr. Putin's government has reasserted more and more control over the hydrocarbon sector -- it already has a monopoly, essentially, on gas and it's rebuilding its government position in the oil area, as you see played out with YUKOS almost on a daily basis.

Murmansk doesn't look like it's going to happen, with really then means Russian crude cannot be imported competitively, in general terms, into the American market. Russia seems to be oriented much more toward China and Japan as major long-term purchasers outside of the present framework as Russian crude oil production expands. And on that point we, two years ago, anticipated that by the end of the decade Russian production would be about 12 million barrels a day, possibly higher than Saudi Arabia. We have had to cut that back. Our estimate now would probably be about 10, and that's not very far - that's only about a half-million barrels a day above where they are now.

So Russian industry, as the Putin-led government comes down and reshapes it and bends it to the purposes of the Russian government, is going to look quite different than it has in the past few years or than we thought it would a few years ago.

MR. FREEMAN: I don't think many investors would buy a used car from that man, Mr. Putin, at this time.

MR. HEGBURG: Just a couple of points to follow up on Jim's statement. On the Putin-Bush relationship, in terms of what's behind it, I think it's fair to characterize what someone many years ago characterized as "there's no there there." I don't think there's much in the way of bilateral discussions or cooperative arrangements or anything at the professional level between the two governments. In fact, there are stories that even the ministers don't talk to each other. So I don't think there's much to the special relationship on oil.

We regard to the Russian oil sector, obviously Russia's largest exports of oil to go Western Europe by pipeline, and that's a million barrels a day or so. They also export through the Black Sea out into the Med, and there is train tanker car deliveries to Dajing, but that's very little in China.

So in terms of the future, if Russia or if the - I guess the companies thought about pursuing a really, truly economic opportunity they would do Murmansk and probably not do the pipeline to Nakhodka unless someone like the Japanese pay for it, which they might, because the really big market opportunities in terms of efficiency are in the United States and in the Med and, it seems to me, later on in China. But it seems, I think, Jim has said that the decision-making process at the political level in Russia has more to do with reasserting authority and control over the sector rather than exploiting the resource and transportation base that it has.

MR. FREEMAN: I would like to just round this out by noting your reference to Central Asia, meaning the so-called "stans." The key to their exports of oil, and more likely gas, is not Russia. Russia is already a means of export through pipelines, existing pipelines, but the key to getting those resources out is probably an oil and gas swap arrangement through Iran, which has been barred by U.S. policy. Since the United States government does not control the government of China or the government of India or other countries who have rapidly rising requirements for oil and gas, one can confidently expect that at some point this economic opportunity will be seized, even if not by Americans. Similarly, Central Asia has a bright future as an exporter of oil and gas to Chinese Central Asia and thence by pipeline to the Yellow Sea and perhaps as far away as Korea and Japan. And indeed the Chinese are committed, with the government of Kazakhstan, to putting in place the first pipeline of that sort. Down the road, I would expect - quite a bit down the road -- a similar gas pipeline from Turkmenistan to China could be cobbled together.

But Russia is seen by those countries as only one route and a route they can already use. They're looking to develop others, and probably will find non-American partners, mainly, to do that.

Alan?

MR. HEGBURG: Just on China in general, I mean, the Chinese state has been very aggressive investors in oil producing countries. They have a large arrangement with Nigeria. They are bidding on acreage in Iran, and as Chas. said, there is real Chinese efforts to find oil which they can swap out then for deliveries into China.

This is a strategy that other countries have pursued in the past, particularly Korea and Japan, so it's not a new strategy but the Chinese are the latest to aggressively pursue it.

MR. VERRASTRO: Just one final point. I agree with what my colleagues have said, but I think you're exactly right. I think there was a belief at least two years ago by some people in this town that a combination of a resurgent Iraq and Russian production could be a substitute for Saudi oil, and I hope folks are disabused of that idea now because it's not going to happen.

MR. FREEMAN: We have come more or less to the end of our time. I would like to thank the panel and the audience, and the questioners and commentators, for making this I think a very informative and useful session. It will be available on our website by videocam and will - as I said, there will be an unedited transcript up on the website within a matter of a week or so. It will also appear as the first item in Middle East Policy later in the year.

As we close, I am left convinced that Saudi Arabia is acquiring a measure of independence from the United States but I don't think I have seen it demonstrated that we are acquiring independence from international oil and gas suppliers. So I think this is not working out exactly the way our politicians would have had us believe or hope. Perhaps this is one of the utilities of an organization like the Middle East Policy Council: we can occasionally play a useful role by reminding folks in Washington that there is a reality beyond the Beltway and beyond our borders which is not subject to mental manipulation that has to be confronted as it is, even if that is not the way we would like it to be.

I think we've heard a pretty good description of the world as it is and as it is likely to be in the near future, and again I ask you to join me in thanking the panelists for providing that. (Applause.)

Thank you very much.

(END)