Keynote speech before the Deloitte Energy Conference
Whether we like it or not – and it borders on the trite to note – oil is a very serious geopolitical subject that is intimately tied to the endless turmoil in the Middle East.
Some very serious people, and some remarkable alliances – alliances that frankly stretch the meaning of the phrase “strange bedfellows” – are putting forward proposals for major initiatives to deal with the latest oil crisis. It is a crisis, we’re told of grave economic and national security import, rooted in the intersection of high prices, America’s prodigious appetite for oil, and the fact that we import rising amounts of that oil.
The serious people include such notables as NYT columnist and author Thomas Friedman, such prominent hawks and economic conservatives as Robert McFarlane, James Woolsey, and Frank Gaffney. The latter three joined an interesting, bipartisan group to co-sign an open letter to President Bush calling for immediate and substantial action on oil policy. Serious people all. So was Jimmy Carter who, a quarter century ago, said that saving oil was the “moral equivalent” of war. Former CIA Chief Woolsey, has recently stated that this is now “a war issue” plain and simple.
So then, what will it take to win the battle of oil? There is, unfortunately, no other way to frame the challenge: terrorism is certainly closely tied to the geology and economics of oil. So is our own economic health, because oil moves most of our transportation system. Our freedom of political action, at home and abroad, is at the very least influenced, and perhaps seriously compromised, by states that sponsor fanatics who would destroy us. At this level of abstraction, the case for fighting the battle of oil is beyond serious dispute, and is accepted across political lines.
Yet, at the same time, much of what we are being advised to do about oil is so far removed from practical reality that the advice is useless, or worse. As Stalin told his generals, quantity has a quality all its own. Real battles — economic battles most especially – are decided by real numbers.
The first real numbers: At $50 a barrel, the 600 BBO of reserves in the Persian Gulf are worth $30 trillion. This is a terrifying amount of wealth to pump into feudal theocracies that one can only indelicately observe are festering with hate.
There are really only two options to deal with this fact. One is to wish we lived on another planet where cheap oil was distributed differently. The other is to drive the price of oil down, with realistic means anchored in physical reality.
Most energy proposals are predicated on, or wish for higher oil prices. But since we cannot chose a different planet – and since, absent global pandemic or nuclear war, the reality is that a growing world economy will continue to consume more oil for the foreseeable future – the single most useful thing that can be done geopolitically is to substantially – and I mean substantially – increase the supply of oil and energy that can be substituted for oil. This will drive prices down. If prices return to and stay near historic averages, it would take $20 trillion away from the future capital flows to the Persian Gulf. But this kind of goal requires a serious plan of attack. Voodoo economics, and voodoo physics, will not suffice.
Let’s start with the view strictly from our domestic perspective. The U.S. consumes about 7 billion barrels of oil a year. Quite a few of them come from the Persian Gulf. And, quite a few people see that particular and specific fact, as a threat to our national security. Yet, our oil problem is smaller than it used to be, and getting smaller. The many people who say the opposite are mistaken.
Electricity – not oil – now defines the fast-expanding center of our energy economy. Oil supplies about 40 percent of the raw energy we use, and we use it mainly in our cars, trucks, and aircraft. Coal, uranium, natural gas, and hydro supply the other 60 percent or so – used mainly to supply our electricity. And about 60 percent of our GDP now comes from industries and services that run on electricity. This 60/40 ratio has flipped since 1980, when the last oil crisis hit. All the fastest growing sectors – information technology and telecom, most notably – are fueled entirely by electrons. More than 80 percent of the growth in U.S. energy demand since 1980 has been met by electricity. Oil has thus been displaced from its primacy in our economy. It is still important, to be sure – but no longer prime.
Add to this a simple economic factor. In early 1981, the price of oil hit $86-a-barrel (in today’s dollars). The U.S. economy has since grown considerably faster than our consumption of oil. To have a macroeconomic impact today comparable to that of 1981, oil would have to hit about $130.
Thus, the relative economic importance of raw fuel in general, and oil in particular, is receding, even within the gross energy budget itself. The story does not end there. Each year the spending on raw fuel becomes less important than spending on the hardware used to refine and transform low-grade fuels into highly refined power. This too is a reversal of historic ratios.
America spends about $400 billion a year on raw fuel. But we spend at least $500 billion a year on the capital equipment used to concentrate and convert energy – refineries, furnaces, generators, car engines, motors, light bulbs, power supplies, lasers – all the technologies that transform raw fuel into combustible form, heat into motion, motion into electricity, and electricity into light or back into motion.
And at the end of the day, the economy doesn’t much care about the cost of just the fuel or the hardware – what matters is what they deliver together. It is rarely noted that the cost of crude accounts for less than 15% of the cost of owning and driving a typical car. Put another way, if the Saudi’s gave their oil away, it would reduce the average cost of driving a mile by 5 cents – this out of the total average of 55 cents per mile that the AAA says it costs to own and operate a car in America today. To illustrate in different applications – the cost of raw fuel doesn’t count for even 1% of the cost of electricity delivered to a Pentium in a server farm – or even one-hundredth of a percent of the cost of the energy in a laser beam that can fix your eyes or weld steel.
As more and more of the U.S. economy is dominated by such technologies, we will continue to grow less sensitive to the price of raw energy, and crude, year by year, even if the price of a barrel rises quite a bit more. We will buy more barrels, and (perhaps) pay more for them, but GDP will grow faster than our total spending on oil. So oil’s power to influence America’s own political choices will thus continue to decline.
But we do import oil. And there are geopolitical implications to this fact. But it is noteworthy, if rarely noted, the primary sources for America’s 4 BBO of imports are Canada and Mexico, not the Persian Gulf. Total Persian Gulf imports total under 1 BBO – 15% of our consumption. Significant to be sure – but hardly dramatic. Getting the U.S. to the point where it need not import any Persian Gulf oil at all wouldn’t be that hard, technically – politically it is quite another story.
The same cannot be said, however, of our once and future allies. Europe and Japan collectively consume just slightly more oil than the U.S., but they import over 80% from the Persian Gulf. If we must take care of their dependencies too, we’re back to stabilizing oil markets globally. And if we don’t take them in to account, how much political autonomy does our so-called independence really buy us?
In the war on communism, we couldn’t write off Europe and Asia. We can’t do so now in the war on terror. Which means, again, that the battle of oil is a lot bigger than many of the new oil hawks are letting on. The notion, in short, of energy independence has no meaning, as the world is, a priori, dependent on energy and we are, for better or worse, inextricably a world player.
So we have to turn to the global numbers. The world consumes about 30 BBO a year — rising by about 1 BBO every 30 months. Saudi reserves alone are estimated at 250 BBO. If the flow of petrodollars into the Persian Gulf is the problem, we need tactics commensurate with these figures. If this is an economic and technological war, we have to think in terms of Normandy, not Kosovo. To have a significant impact on 30 BBO, the quantum of power in today’s world is clearly a number like 5 BBO a year.
What does it take to wield this kind of power in global battle of oil?
Most oil hawks focus first on the demand side of this battle. But how do we curb demand? Higher prices certainly can, over the longer run. State and federal taxes add about $18 to the cost of a barrel in the U.S., and as much as $85 in Europe and Japan. The first comprehensive U.S. energy tax proposed by the Clinton administration in 1993 included 25.7 cents per million Btus – which adds up to a piffling $1.50 per barrel. And that proposal was resoundingly rejected by both houses of Congress, both controlled at the time by Democrats.
Technology prescriptions are much more palatable in political circles. Doubling the fuel economy of our cars is a first key tactical objective set out in every proposal for winning the battle of oil. It has been since the early 1970s. Doubling the number of miles Americans travel on a barrel would cut oil consumption by a total of about 1.7 BBO. That’s significant, even if only a fraction of the 5 BBO quantum of power needed in global geopolitics. But the savings would be 1.7 BBO only if nothing else changed. But other things do invariably change, and always for the worse.
Let’s begin with history: oil hawks rarely note the fact the efficiency of the typical car engine has in fact doubled in the last half century. A gallon of fuel now moves a ton of today’s minivan twice as far as your father’s Oldsmobile.
But with better engines, and more disposable income, Americans sharply increased the number of miles they drove, the weight of their cars, the average speed they drove, and the energy-hungry comforts they demanded in the passenger cabin. The total fuel consumed by U.S. passenger vehicles rose from about 1 BBO in 1950 to over 3 BBO today. Miles traveled by air increased even faster, as did freight miles. Rising demand for bigger, better, faster miles swallowed all the efficiency gains, and then some.
Much the same has happened in every other sector of our energy economy. Overall, the United States produces more than twice as much GDP today as it did in 1950 with each unit of energy it uses. Yet, overall, the U.S. now consume more than three times as much energy.
Even if automotive fuel efficiency doubles over the next 20 years, taking into account economic reality, we might expect a net savings of, at best, half of the simplistically calculated 1.7 BBO. It may seem heretical – and I know just how hard this incontrovertible fact is to swallow for many in the energy punditry – but efficiency just doesn’t stop demand from rising, not over the long term.
And even if somehow Americans finally saturated their appetites for more, faster, fancier, miles of travel, along with much else that oil enables, there’s China, and others like it. China currently consumes 2 BBO per year, about as much as Japan, and that’s with most of its economy still pretty much at the stage of England’s in 1865.
If the tinkering on the demand side cannot stop rising demand, we have to turn to the supply-side flank of this economic battle.
Oil hawks trot out, as a staple proposal, a larger Strategic Petroleum Reserve (SPR). The current SPR has a maximum capacity of 0.7 BB0. Push it to a billion they propose. This is the kind of reserve you want, to be sure, to ensure we can fuel tanks and jets remain should a hot war suddenly erupt. But 1 BBO just isn’t the sort of number that speaks loudly to Middle Eastern potentates sitting on 600 BBO reserves.
U.S. reserves of the old-fashioned kind are quite a bit larger than the SPR. Through political sensitivities, the U.S. has walked away from some 2 BBO per year of our own oil supply. Washington’s 1980 prohibition of oil and gas development in the Arctic National Wildlife Reserve put an estimated 1 BBO per year off limits. Another 1 BBO per year (at least) lies under waters off the coast of California and in the Gulf of Mexico west of Florida. But Californians like unsullied ocean views when they cruise the coastal highway. And the President isn’t about to propose to reverse long ago bans on offshore drilling so long as his brother, the governor of Florida.
So supply-side proposals quickly shift to grander schemes to draw something very much like oil out of something that doesn’t look like an oil well. There are plenty of candidates. Sixty years ago, General Patton’s Third Army completed its roll into Germany on coal that had been transformed into oil by German synfuel technology. The U.S. passed a Synthetic Liquid Fuels Act of its own, the first time in 1944. And Jimmy Carter signed one into law in 1980; a $20 billion program that was to have produced 0.7 BBO per yr by 1992.
Where Carter failed, Alberta succeeded with its tar sands, which currently yield about 0.4 BBO per year, at a cost of under $14 per barrel. Those tar sands contain 180 BBO recoverable with current technology, and well north of 1000 BBO that will become accessible as technology improves.
Then there’s the ever-politically-popular ethanol. About 12% of all our corn is already used to produce ethanol (one-third of it, interestingly enough, from Iowa). In oil terms, this yields a grand total of 0.05 BBOE. We could boost production to 0.5 BBOE if we grew corn on another 40 million acres that we currently pay farmers not to cultivate. Truth be told, chemical engineers can – in a pinch, and at a price – synthesize gasoline, or stuff much like it, from almost any starting combination of carbon and hydrogen.
But all of these alternatives require huge new capital investments. And unless government buying programs, import quotas, or some such are put in place to maintain price floors, all these schemes have to end up pumping the ersatz-oil cheaply enough to survive the next orchestrated price collapse. A region that can soak consumers by slashing output for three years can sink capital-intensive competitors by flooding the market for the next three. By December 1985, one may recall, after the Saudis cranked up production, the price collapse crushed Jimmy Carter’s Synfuels Corp.
The Saudi’s have power not because we are too stupid or apathetic to concoct other stuff, but because that’s where the today’s cheap oil resides, in the planet we live on. Our entire transportation system has been designed to run on refined crude not by dumb accident, but because pound for pound, liquid hydrocarbons pack far more accessible energy than any other practical alternative.
But here’s the opportunity. The pounds are all-important in transportation, but not elsewhere. The U.S. energy economy is in fact – as I noted earlier – dominated by much cheaper not-oil fuels. While we consume 7 BBO of oil, we use 11 BBOE a year of non-oil; coal, gas, uranium, and hydroelectricity, almost all of which comes from the U.S. and Canada. And we have over 1000 BBOE of coal in the ground, and even more uranium. We already know how to tap these vast resources, and our technology keeps improving.
In all the non-transportation sectors of our economy, it’s quite easy to substitute not-oil fuels for oil. The huge opportunity now is to use electricity – and thus coal and uranium, principally – to displace oil everywhere else. And to do so economically. The convergence depends on the price of oil, which we can’t control, and the price of electricity, which we can, and on the evolution of technology that bridges the divide.
Begin with the technology. America still use about 1 BBO per year of oil for industrial, commercial and residential heating. Whether for low-grade space and water heating, or high-grade industrial heating – it is entirely feasible to displace oil in nearly all such applications with electric technologies. The proper pricing of electricity would accelerate a process of electricity-for-oil substitution already under way.
There is another 2 BBO of oil used by heavy trucks, delivery vehicles, and buses which – with a cushion shot – could be fueled by coal and uranium. These kinds of vehicles are easily modified to run on natural gas – gas supplies that could be freed up by using coal or uranium to displace the 1 BBOE of natural gas currently used to generate electricity, and another 1 BBOE of natural gas used for low-grade heating.
Quite obviously, this would be a reversal of recent trends – but in the global war on oil, we’ve now found a total of 3 BBO/yr that could be displaced by domestic coal and uranium. Such numbers are material in the geopolitical scales we’re talking about here and should be taken seriously – particularly because these are economically and physical feasible. But 3 BBO/yr is still a little shy of the 5 BBO quantum of power.
Let’s turn back then to transportation. There’s no prospect for displacing the 0.6 BBO of oil used in aviation. But for cars and light trucks which burn roughly 3 BBO we could now contemplate taking out 2 BBO, permanently. This, added to the 3 BBO from electrification just mentioned, would bring America alone to the geopolitically impactful 5 BBO quantum of power.
There is much chatter about hydrogen as the key to pushing oil aside in our cars and SUVs. Some environmentalists love the hydrogen vision because they can picture windmills or solar cells extracting a carbon-free fuel to propel zero-emission wheels. Of course hydrogen today, and in the future, comes from reforming natural gas, or using coal- or uranium-fired power plants to split water molecules. So, to keep the scales in context – it bears noting that all the wind and solar power combined today yields 0.02 BBOE/year. Ignoring costs (which even Washington can’t do), there is no realistic path to move this tiny sliver of power up 100 fold to the 2 BBO transportation goal.
But the plug-in hybrid requires a much more modest technical leap – and is an economically inevitable path. Hybrids are coming of age regardless. And, not because Washington will decree that they must, but because they promise better performance, all around – and because the core enabling power semiconductor technology has come of age. The hybrid’s on-board battery pack, while much bigger than the average car, is still not enough to move a car more than five miles or so. But as it happens, most daily trips are shorter than that. And there are abundant opportunities to recharge when cars are parked.
As even the most obtuse student of transportation knows, all-electric vehicles flopped in the 1990s because batteries can’t store enough power to provide practical ranges. But plug-in hybrids still have the gasoline tank for the longer trips. And the gasoline-free trips will get longer yet with the emerging automotive-class lithium batteries. The technology for replacing roughly one pint of gasoline with one pound of coal or a speck of uranium to feed one kilowatt-hour of power to the wheels is now close hand.
This is, by far, the single most important prospect for large-scale, near-term convergence of electricity and oil in our energy economy. All of the key fuels, distribution infrastructure, and technology are operational today. And the key numbers are real from the get-go: picking off 2 BBO of transportation oil in the coming decade, added to the 3 BBO noted above, would give America that 5 BBO/yr quantum of power – and all from non-oil fuels we now use to generate electricity.
But however technically feasible this may be, do any of these schemes make economic sense?
Burning $2-a-gallon gasoline, the electricity generated by current hybrid-car engines runs about 35 cents per kilowatt-hour. Compare this to off-peak power from the grid typically at 2 to 4 cents. There is, to understate it, considerable economic incentive to capture this price difference.
The policy keys to accelerating this process lie mainly in the electric arena – in short, in the one part of the global energy equation where our government has considerable influence. And specifically in three areas where government can actually do something.
To begin with, retail electricity prices are heavily regulated – and badly so. Proper pricing would very sharply lower the cost of using electricity to displace oil and gas.
Secondly, the average price of electricity is too high because of relentless opposition to the construction and renovation of large power plants that burn cheap fuels. Plants fired by natural gas are the path of least resistance. As a result, natural gas for electricity now uses roughly one-third of the country’s gas, putting upward price on gas – in an environment where gas-fired electric power is two to four times as expensive as coal or nuclear.
And third, the issue of taxes. States and localities impose roughly a 10% tax on a kilowatt-hour – about the same as the average 10% tax (20 cents per gallon) on gasoline. But calculated in terms of equivalent taxes on the raw fuels used upstream to make the electricity – this is equal to a tax of about 20 to 50% tax on coal, and 100% on uranium. If cross-fuel competition is to be promoted, on a revenue-neutral basis, current energy taxes should move to a flat sales tax applied uniformly to all raw fuels.
If managed properly, it is the electric grid that is the ultimate fuel equalizer. It is the grid that will also make possible the economic use of such things as wind and solar if they are ever to make a significant dent in the battle of oil.
And this is the really important part. Technologies now rapidly emerging allow us to bridge what has long been a very deep chasm between the non-oil and oil parts of our economy. And the magnitude of the physical resources available are in fact commensurate with the 5 BBO quantum of power that could, in the end, finally make a difference in global markets, and could be echoed in other countries as well.
In the end, if the geopolitics of oil are to be taken seriously, we must deal in serious numbers and facts. The technology and resources exist now, or are rapidly emerging, that make it entirely realistic to think in terms of 5 BBOE/yr quantums of power. This will not eliminate the globe’s appetite for, or use of, oil. It will, however, drive the price down and could easily keep prices at levels that would take $20 trillion out of the petrodollar flow in to the Persian Gulf in coming decades.
Happily, the market is pursuing the bridging technologies regardless of Washington. Quite modest changes in federal and state policies could significantly accelerate that process. It is hard to imagine a more important geopolitical goal in our energy deliberations.