Tuesday, May 27, 2008

Paying the Bill

The price of oil and gasoline was a popular topic at the neighborhood Memorial Day barbecue. One of my neighbors, a retired executive, was especially concerned about a number he had heard in an interview with T. Boone Pickens, to the effect that the US would spend $1 trillion this year on imported energy. While a web search suggests that the figure Mr. Pickens mentioned was probably only half that big, neither sum is trivial. The real question, however, is not how much we are spending on imported oil and gas, but whether we can afford it. Assessing that is much more complicated, having to do with the value we add to the cost of these inputs. No matter how we look at it, though, it's hard to see energy import spending of this magnitude as sustainable.

At current prices, our annual tab for imported energy, including LNG and petroleum products but excluding coal, for which we are a net exporter, is running at about $600 billion. 94% of that is for crude oil and petroleum products. As impressive as that amount is, it represents only 4.3% of our $14 trillion economy. If we are turning those energy imports into goods and services that contribute to the rest of our GDP, then a 23:1 ratio of energy in to value out doesn't seem too bad. Unfortunately, this superficial analysis glosses over a host of problems, the biggest of which is the rapid rate at which energy's share of GDP has risen in the last few years. It also ignores the impact of these changes on the most energy-intensive segments of the economy, such as airlines and trucking, which are essential to much of the remainder.

A lot has changed since the last energy crisis. As Gerald Seib's column in today's Wall Street Journal points out, the US economy requires only half as much energy per dollar of real GDP as it did in the early 1970s. Even after accounting for the impact of SUVs, today's new car fleet gets more than double the fuel economy of 1973 models, which averaged only 13 miles per gallon. But while these efficiency gains--which still offer plenty of scope for further improvement--have helped dampen the severity of the current oil price spike, they cannot erase the fact that our national energy import bill has gone up by a factor of 4.7 since 2000. We aren't just feeling the pain at the gas pump; every aspect of our economy that uses energy has seen a nearly five-fold increase in costs during a period in which average consumer prices have only risen by 25%. That squeezes businesses even more than consumers, and it explains much of oil's contribution to the present weakness of the US economy, and of the US dollar, which amplifies the pressures on oil prices.

Perhaps the best use of that $600 billion figure is to keep us focused on the scale of the problem and of the solutions it will require. For example, increasing ethanol production from 7 billion gallons per year to 15 billion gallons--about the most we can achieve without the uncertain contribution of cellulosic ethanol technologies--would displace $22 billion worth of oil. Reducing gasoline consumption by 10% would save $44 billion, while increasing domestic oil production by a million barrels per day--a volume entirely within the potential of our existing resource base--would contribute another $48 billion, with additional benefits from the impact of these changes on the global price of oil. Yet all of those actions together wouldn't get us halfway back to what we were spending on energy imports in 2000. If we are serious about getting our energy import bill under control, we must think big, and we must focus our efforts where they will have the most impact, in dollars and in equivalent barrels of oil. Aligning our national energy policy to the scale of that challenge won't be easy, especially when we have mistakenly convinced ourselves that the traditional energy sector has nothing further to offer in this regard.

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