September 11, 2008

Sensible Energy Independence

By: Elizabeth Rosenberg

We’ve all noticed by now that the United States is in an energy crisis. High oil prices are driving up the cost of goods and services around the country, translating pain at the pump into pain at the mall and the supermarket. But like some of the commodity super-cycles of the past, this one could last for a lot longer, and it could get worse.

The problem is not a lack of global hydrocarbons or a flood of speculative fund traders into the oil markets. The problem for the U.S. is a lack of action to cut domestic demand, expand domestic drilling and diversify the energy portfolio.

The math is simple. Global demand for crude oil is now about 86.2 million barrels per day, which global supply can barely accommodate. Decades of underinvestment have left the oil industry supply-constrained, and surging Asian demand growth has shrunk OPEC’s idle capacity, down to 2.5 million bpd from 5.5 million bpd in 2002.

Spare capacity could narrow to 1 million bpd in about four years, after the ailing global economy is expected to rebound. That won’t be enough to compensate for the loss of Iranian exports should tensions over Tehran’s nuclear ambitions escalate or another devastating hurricane shutter Gulf output in the U.S. Given the long lead time for constructing new oil production capacity — five to ten years — new supply will not flow fast enough to alleviate large potential disruptions in the near-term.

To bring down prices, the U.S. will simply have to consume less oil and produce more conventional and alternative energy. In late 2007, the U.S. enacted new vehicle fuel economy standards to achieve 35 mpg by 2020. This will cut American consumption by 1.2 billion barrels of oil per year. But much remains to be done.

Last year the U.S. used almost 20 million bpd of oil, a whopping one quarter of global consumption. To cut demand—and vulnerability to supply disruptions—the U.S. needs tougher vehicle fuel economy standards and alternative energy sources to power the transport sector. Raising the 18.4 cent per gallon gasoline tax, untouched since 1997, and mandating higher fuel economy standards would shift cars towards electric power and alternative fuels, dramatically reducing oil consumption.

In 2010, the extended-range Chevy Volt plug-in electric car will hit the market. The Volt will travel 40 miles on battery power, as far as most drivers go in one day, and bring gasoline consumption to zero for many Americans. To facilitate widespread adoption of new and superior technologies, Americans should learn from the Japanese, who use strict vehicle inspection standards and high re-registration fees to accelerate turnover. The 250 million-strong U.S. car fleet turns over only every 25 years. The U.S. should also congressionally streamline permitting processes, encouraging people to make the investments necessary to upgrade and expand our outdated electric grid to support an electric car fleet.

And the U.S. needs other alternatives to oil. The Department of Energy and independent researchers are working with various feedstocks and enzymes to transition from corn-based ethanol to cellulosic ethanol. The mandate for ethanol production in 2008 is 9 billion USG. By 2022 it grows to an ambitious 36 billion gallons, 21 billion gallons of which must be cellulosic. More federal dollars and incentive structures will help to launch commercialization of non-corn biofuels and delivery infrastructure. Though biofuels offer slightly less bang for the buck than conventional gasoline, the use of biofuels nonetheless shaves demand for oil.

Given the expense and time required to put alternatives in place, the U.S. will have to rely on conventional oil production for the foreseeable future. To relieve prices, Americans must drill more. That means opening access to promising lease areas both onshore and off. Roughly 18 billion barrels of oil reside in the Outer Continental Shelf under congressional moratoria. New U.S. taxes to discourage oil consumption will cut into domestic demand, but historically high prices will spur oil company investment. The addition of those new supplies to the market could help bring down global oil prices.

But some supply problems are out of U.S. hands. Independent oil companies are restrained by resource nationalism, heavy royalties and the technical challenges of projects abroad. Disappointing non-OPEC supply is also a cause for concern. The International Energy Agency says international markets need an extra 3.7 million bpd from new fields each year to compensate for the decline of mature fields and keep production flat. Critical swing oil producer Saudi Arabia has no intention to implement capacity expansion beyond its existing plans to reach 12.5 million bpd next year.

And Washington policymakers have little control over surging East Asian oil demand. Chinese oil consumption spiked 18 percent between 2004 and 2007, and with 2008 forecast GDP growth of 9.7 there is little sign that the economic slowdown plaguing OECD economies will severely hit China. Even if the IMF revises Chinese GDP growth down in its next World Economic Outlook, many experts agree that Chinese energy demand has powerful momentum that will remain relatively robust. China, along with India, is experiencing industrialization on a scale and of a sort seen every 50 or so years since the industrial revolution.

The commodity boom that East Asian growth has stoked—for oil, metals and agricultural goods—has 10 to 20 more years to run. Historically, commodity surges have lasted as long as 30 years. During the post-WWII reconstruction, Japanese and German industrial development stoked commodity markets through the 1970s. The fundamentals of each individual commodity market are different, but the oil boom may be more prolonged, given widespread subsidies for oil in many developing economies, the lack of suitable substitutes for oil, and the impossibility of recycling it.

The harsh truth of the U.S. oil crisis is that commodities are in a global boom cycle. High prices are driven by strong non-OECD demand growth and limited ability to raise output capacity. Blaming speculators, oil companies and OPEC is an easy option. But instead, Americans must take immediate action to encourage conservation, open domestic drilling and promote market penetration of vehicles powered by electricity and biofuels.

This is the only path towards energy security.

-Elizabeth Rosenberg is an energy policy correspondent at Argus Media.

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