Will Fewer Young Drivers Today Mean Lower Fuel Demand Tomorrow?

• Driver's licenses for those under 40 years of age are down in several large, developed countries, including the US. This is only partially explained by a weak economy.
• If this shift in attitudes towards driving persists, future demand for both cars and fuel could be permanently reduced.

Current forecasts from the Energy Information Administration indicate that US gasoline demand peaked in 2007 and is expected to decline steadily for at least the next two decades.  One of the most intriguing factors aligned with this shift, which would have been almost unthinkable only a few years ago, involves a surprising reduction in the number of licensed drivers under 40 years of age.  A new study from the Transportation Research Institute (TRI) at the University of Michigan helps to explain a trend that is apparently not unique to the US.

Prior to the Great Recession, US gasoline demand had grown by 1-2% per year, with few interruptions. Since the recession, it has been shrinking for reasons that don't appear to be temporary. New cars are becoming more fuel-efficient, and Americans are consistently driving less than before the recession,  as indicated in the latest statistics on vehicle miles traveled.  To some extent this is an understandable response to gasoline prices that have remained significantly higher in real dollars than they were from 1982-2006. However, there may be other, deeper shifts underway.  If a segment of younger Americans has not only delayed getting a driver's license, but may never get one, then the decline in motor fuel demand is likelier to be permanent.

Once I started reading the survey results in the new study by the TRI's Brandon Schoettle and Dr. Michael Sivak, I knew I also needed the context of their 2011 paper on "Recent Changes in the Age Composition of Drivers in 15 Countries." That study showed that from 1983 to 2008 the number of licensed drivers in the US as a percentage of each age group up to 40 had dropped significantly, while the opposite was true for those over 50. (See chart below.) The authors found similar shifts in 7 other developed countries, including Canada, the UK, Germany and Japan, with a 2012 update indicating a further decline in US pre-40 licensing through 2010. Interestingly, Spain, Poland, Israel and several other countries exhibited increases in licensing among both younger and older drivers.

In their current paper, the authors used an online, non-random survey of 618 under-40 non-drivers to explore the reasons for their status. The top reasons their respondents gave for not having a driver's license seemed mainly practical, rather than philosophical. Many of those under 30 reported being "too busy or not enough time to get a driver's license",  or "able to get transportation from others." The "cost of owning and maintaining a vehicle" was the second-most common reason among all respondents, and as the authors noted, that is consistent with the relatively high unemployment or full-time student status of this group--46% and 21%, respectively.

Other common responses suggest that at least some of those without licenses are in that position by intention, rather than necessity. Nearly 40%--likely including some overlap--reported a preference for biking, walking or public transportation as a primary or secondary reason, while 9% cited environmental concerns and 8% mentioned online alternatives to driving.

Having grown up in a time and place where obtaining a driver's license as close as possible to one's 16th birthday was both a rite of passage and a practical necessity, this is that rare energy issue that's hard for me even to relate to. Yet when I look at the above chart, with its mirror-image shifts, I'm struck by the similarity between recent under-40 driver's license data and those for the cohorts born between the World Wars.  Are the current license rates of Millennials and late-Gen-X'ers the anomaly, or will those of my Baby Boomer and early Generation X peers turn out to be uniquely high? Only the passage of time can clarify such questions.

While the authors stopped short of assigning cause and effect, it seems reasonable to conclude that at least part of what we're seeing here is the result of the stubbornly persistent youth unemployment of a tepid recovery and the "New Normal" economy. A few years of much stronger economic growth might shrink the gap shown in Figure 1, by addressing the reasons that many of those surveyed gave for not having a driver's license, particularly since only 6% of them reported they never learned to drive.  Of course that doesn't explain why more than a third of those in the 30-39 age group, who ought to be the most financially settled, indicated they planned never to get a license.

The survey's results and their implications ought to be of great interest to producers of conventional and alternative fuels, established auto manufacturers, car rental firms, as well as transportation planners and policy makers.  Even electric-vehicle startups like Tesla might wonder whether for a significant segment of their natural future market, the choice won't be between an EV and a conventional car, but between a car and not driving at all. This is a trend that bears watching.

 

A different version of this posting was previously published on the website of Pacific Energy Development Corporation.

Energy Efficiency: An Uphill Battle on A Slippery Slope

With apologies for the dueling clichés in today's title, that image conveys the conflicting messages I received from a pair of events on the topic of energy efficiency this week. Yesterday I watched a panel discussion on energy efficiency finance, part of the valuable First Wednesday series of seminars from Resources for the Future in D.C. Yet as I listened to the discussion of creative mechanisms for overcoming the numerous financial and behavioral obstacles impeding the widespread adoption of efficiency technologies, I couldn't help framing it in the context of Tuesday's blogger call on "efficiency rebound", also known as the Jevons Paradox, hosted by the Breakthrough Institute. This latter, offsetting effect has been controversial in the US but is apparently more widely accepted in EU policy circles.

Energy efficiency is probably the energy topic to which I've devoted the least space in this blog in the last seven years. That hasn't been a deliberate slight, though perhaps it reflects the bulk of my personal experience on the supply side of energy. It's also a tricky subject because it's a moving target. We often hear efficiency described as the low-hanging fruit in discussions of energy security or emissions reductions, but that usually ignores the fact that the truly low-hanging fruit in efficiency was mainly captured during the energy crises of the 1970s and early 1980s, and in subsequent price spikes in electricity and natural gas. That doesn't mean there isn't still ample scope for further improvement, but it does leave those efforts subject to the long list of barriers described in yesterday's presentations. They include lack of funding, low awareness, landlord/tenant issues, and lack of expertise.

One of the other obstacles that intrigued me was the mismatch between the scale of most efficiency projects, even in the commercial sector, and the much larger scale of investor interest in financing efficiency, as described by the panelist from Citibank. He suggested the answer lies in aggregation, in which the financing of numerous smaller projects would be bundled and sold off in tranches to investors. If that sounds familiar, it should, because it reflects a similar approach to securitization to the one that contributed to the recent housing bubble. However, I would stress that efficiency instruments need not be inherently very risky, as long as they are assembled with due concern for the creditworthiness of the project owners, and without heroic assumptions about the risk-abating portfolio effect of aggregation. Another element that could assist this process is the sort of project performance guarantees described by the panelist from Johnson Controls. In any case there is no shortage of federal, state and local programs focused on energy efficiency financing, including the controversial Property Assessed Clean Energy (PACE) mechanism.

I hope you get the sense from this brief summary that implementing energy efficiency on a large scale is quite difficult enough in its own right, even when those investing in such improvements can safely assume that they will enjoy 100% of the promised cost savings when the projects are completed. The research on rebound by a team commissioned by the EU's Directorate General for the Environment highlighted a number of mechanisms by which efficiency gains may lead to additional energy consumption, either by the individual or organization implementing it or within the larger economy. In some cases this could even lead to post-efficiency consumption exceeding the pre-efficiency level, a condition referred to as "backfire." The potential for these offsetting effects not only makes efficiency a tougher sell on a project basis, but it also undermines the efficacy of macro-scale efficiency measures in mitigating climate change or reducing energy imports. This view is consistent with the findings concerning rebound assembled by the Breakthrough Institute.

The logic of rebound begins simply and locally, before becoming complex and widespread. When you invest in efficiency, your energy bill goes down, leaving you more money to spend on either more of the services that consume energy (e.g., transportation, lighting, heat or air conditioning) or on other goods or services, after accounting for the cost of the upgrade or the cost of financing it. Now think about what happens in the economy: the demand for energy has dropped by a little bit, as has the money spent on it. You'd expect energy prices to fall and the freed up money not spent on energy to result in consumption or investment somewhere else. But those goods and services likely consume energy, too, along with the embedded energy in the efficiency technology, the installation of which started this cascade. And as overall energy productivity goes up, economic growth should also increase, resulting in additional energy use. The EU report found evidence of rebound in the range of 10-30%, including 26% for the UK efficiency investments that were studied. For example, the UK government apparently assumes that 15% of the benefit of home insulation will be lost to rebound.

Some of these mechanisms are more intuitive than others, and I am still thinking through what I heard, particularly in terms of why much of the rebound effect wouldn't be offset by market feedback mechanisms or by the reaction of company management to disappointing post-expenditure reviews on efficiency projects. When I raised these points during the call, Dr. Maxwell, the co-leader of the EU study team, assured me that my concerns weren't supported by the empirical research they examined.

If this rebound effect is as prevalent as the evidence seems to indicate, then the implications aren't very positive. Although individuals and companies implementing efficiency measures are likely to get most of the value they expect, even if it's in some form other than direct savings on their energy bills (e.g., more mobility, more comfort, higher output) society likely wouldn't see the expected energy and emissions savings at the level of the entire economy. That requires increasing efforts on efficiency even further--against all the barriers discussed above--or expending more effort on the supply side of energy, through promotion of higher energy production and more investment in renewables. In other words, those low-hanging efficiency gains that have defied so many efforts to implement look even harder to achieve in practice and somewhat less valuable.

I'm not sure to what extent I buy into all this, yet. Direct rebound due to less expensive energy services for the individual or firm seems fairly straightforward, but the wider ripple effects involve positive and negative feedback loops requiring complex modeling to assess--with all the uncertainties to which such models are subject. Nor does it require the existence of a large rebound effect to appreciate just how difficult it will be to move the needle on total energy consumption and emissions very far by means of efficiency measures that must ultimately be implemented by individual companies and consumers that already face a large array of competing priorities. I intend to look into this further and report later on any insights that turn up.

Seeing Our Footprint

I know I've commented before on the number of PR lists that I'm on as a blogger. Every day brings emails touting some new process or product, a must-go conference, or a new book on energy or the environment to review. Even the subset of these that truly interests me and that I have every intention of writing about mostly gets swept aside by more urgent topics or the needs of my consulting clients. That nearly happened to a clever little book I received from National Geographic called "Human Footprint." I ran across it on my desk again today and decided it deserved a quick mention before I pass it to my daughter, who has been demanding it for weeks.

The book--more of a booklet at just 32 pages--is part of the National Geographic Kids line. It seems to be related to a "Find Your Footprint" contest and other materials on NatGeo's website. I had hoped to find at least some of the book's photography online, because its approach is extremely visual. It displays the accumulation of a lifetime's worth of consumption decisions such as the more than 13,000 pints of milk the average American will drink--and the Louisiana-sized grazing footprint of the cows that supply it--a huge collection of rubber ducks symbolizing the 28,433 showers we'll take, and my favorite, the 43,371 cans of soda we'll drink. On pages 28-29 they display all this stuff in front of a typical home, including the dozen cars the average American will own. And to tie this topic to the normal theme of this blog, those cars are estimated to drive an average of 627,000 miles. At the current average fleet fuel economy, that represents more than 25,000 gallons of gasoline, or 600 barrels, yielding on the order of 250 tons of CO2. And of course every product arrayed in front of that house represents an additional energy expenditure, as well as a recycling challenge for the resulting waste of all kinds.

The explicit message is to get kids to think about the consequences of all these choices, and then make smarter choices with reduced impact. The author provides some suggestions in that regard. But I wonder if the bigger effect will be on the parents who read it with their children. When I showed my daughter the pile of 3,796 disposable diapers on page 7, she just laughed. They clearly meant a lot more to me than to her. Now, you might argue that adults ought to be able to visualize their impact on the planet without gimmicks like assembling decades' worth of consumption in one place and photographing the result. Perhaps, but I suspect most of us are so distracted by busy lives that we rarely mentally integrate a week's worth of the contents of our trash and recycling cans over the thousands of such trips to the curb we make in a lifetime, let alone picturing the resources that went into making all these goods, from mines, oil & gas wells, power plants, factories and farms all over the world.

It's daunting, and no matter how one might view this from a social, ethical or political perspective, it seems pretty clear that the inescapable consequence of population growth, and especially of the dramatic improvement in incomes and wealth that is happening in large parts of the developing world, is that our individual footprints of both energy and material goods will be under increasing pressure in the years ahead. That's at the core of the drive to become more energy efficient, in order to avoid the worst scenarios of resource competition that otherwise lie ahead of us.

Deploying Extra Power for Japan

Just over two weeks after the earthquake near Sendai in northeastern Japan, which I'm increasingly seeing referred to as the "Great Tohoku Earthquake", the impact of the resulting disruption to various supply chains is being felt around the world. From car factories in Europe that rely on Japanese electronic components to producers of flat-panel displays and solar cells, several industries are feeling the pinch. This appears to be due more to the reduction in Japan's electricity-generation capacity than from actual damage to factories in the zone most affected by the disaster. With more power plants than just the troubled Fukushima Daiichi nuclear complex affected, the scale and potential duration of electricity shortages could result in a significant increase in the demand for smaller-scale generation, both conventional and renewable.

As reported in today's Wall St. Journal, the electricity shortfall resulting from the quake and tsunami is severe and affects both consumers and businesses. The Japanese government is exploring a number of emergency measures to mitigate the problem, including increasing electricity prices, instituting Daylight Savings Time, and calling on customers to conserve power. At the same time, the government appears to understand that Japan's scope for large-scale energy-efficiency improvements is limited. With an energy intensity in BTUs per dollar of GDP already 37% lower than that of the US, only the UK among large developed countries is more efficient. Efficiency and conservation will be helpful, but they can't cover the massive shortfall Japan faces now.

One of the most detailed analyses of the impact of the quake and tsunami on Japan's electricity sector that I've seen so far suggests that as much as 15,000 MW of generating capacity in the Tokyo/Tohoku region is offline and likely to remain so for durations ranging from a few months to several years--or permanently, in the case of most of the reactors at Fukushima Daiichi. This is something like 20% of the pre-quake generating capacity of the two main utilities serving the region, not counting the pumped-hydro storage capacity used for meeting peak demand. As a result, that part of Japan is experiencing an electricity deficit that will likely grow as the summer peak demand months approach, and that could persist even after the least-damaged facilities return to service. Nor can surplus power from southern Japan provide much assistance, because the northern and southern systems are relatively isolated from each other, with limited interconnections, and run on different frequencies--60 cycles for the south and 50 cycles for the north. Back-up and distributed generation appears to be the only real alternative to a protracted economic slowdown caused by insufficient electricity for Japan's businesses and industries.

We've seen this pattern before, if from different and less-catastrophic causes. In the early 1990s the Philippine grid was chronically unreliable, and many businesses bought or leased diesel generators to fill the gap, including barge-mounted units that could be brought in quickly and moved around coastlines and rivers as demand shifted. More recently, diesel demand in China increased substantially in the lead-up to the 2008 Summer Olympics, as the central government idled large, dirty power plants in order to reduce air pollution, and a number of factories chose to generate their own power, rather than shutting down.

For Japanese factories and other businesses facing the same dilemma, cost is unlikely to be the major factor in deciding whether or not to become more energy self-sufficient. Factory managers can often justify paying a lot more for power if their only other option is to slow production or shut down. They have several choices available, including some renewable power options, and I expect to see a surge in solar power installations. However, that's probably a better medium-term rather than short-term option, not just because the entire world didn't install enough solar panels last year to make up for the lost output of the Japanese nuclear plants, but because while solar can help with supply, it can't provide the reliability that is crucial right now. That makes diesel generation the leading contender to backstop Japan's idled power plants in the short term.

I can't speak to the availability of diesel generators, although I can easily envision suppliers and leasing agents scrambling to meet frantic Japanese orders. However, if enough generators are available to cover even 3,000 MW of the shortfall, running just half the time, they would require around 65,000 barrels per day of incremental diesel fuel, or roughly the entire diesel output of a medium-sized refinery. Whether that represented an increase in overall Japanese diesel consumption requiring additional imports would depend on the extent of the other economic consequences of the Tohoku disaster, and on when Japan's refineries return to normal operations.

So the use of diesel generators to make up for damaged or otherwise unavailable generating capacity in Japan could provide another modest boost to global oil demand, which already appears to have exceeded the record level set prior to the recession and financial crisis. And since much of that increased demand is for diesel, rather than gasoline, the impact of Japanese generation needs could affect diesel prices disproportionally. As a result, consumers around the world could see diesel prices rise, as the ripples from the events in Japan spread.

Early Daylight Savings, Again

This is by way of a pet peeve, but for the benefit of any of my readers who are as annoyed as I am to be starting Daylight Savings Time three weeks early again this year I'm reprinting a portion of my posting from 2007, when the practice was introduced. It's also interesting to see that the US is very much an outlier in this regard, with most countries that change their clocks doing so on March 27 this year. For me, early DST highlights the fecklessness of much of our current energy policy, devoted more to appearances than outcomes. Here's what I said in '07, with some minor updates:

It was interesting to hear the Congressional sponsor of this change suggest a few days ago that, aside from the other expected results of DST, it "brings a smile to everybody's faces." I wonder how many of us will be smiling when we learn that the energy savings that prompted this measure are likely to be illusory--if not actually negative--based on a study of the time change's effects in Australia. (Other studies reflect mixed results.) As much as anything else, this exercise serves as a useful reminder of the questionable benefits of adopting 1970s-style energy policies in the 21st century.

I am sure that when the extended DST was imposed during the first energy crisis of 1973-74, it saved significant quantities of energy. But it's worth recalling just how different this country was, back then. In 1970, the US population was one-third smaller, and nearly 1 in 10 Americans worked in manufacturing, compared to about 1 in 27 now. Only 40% of women were employed outside the home, compared to 58% in 2011. Today, large numbers of Americans of both sexes work "24/7" jobs that start earlier and end later, and our leisure activities are likely to be at least as energy-intensive as anything we do at the office. It's not intuitively obvious that adding an extra hour of sunlight for a few more weeks in March and October will materially change our consumption of oil, gas, or electricity.

In the near term--barring enormous public outcry--there's probably no going back to a shorter DST, even if it becomes clear that its extension was a mistake. Reverting to the earlier schedule would require yet another round of computer system patches to replace the timetable that was just updated, and result in further confusion. In the long run, however, we need energy policies tailored to how Americans live and work now, rather than to the way our parents did. And for the future, it's possible to imagine a different, more flexible kind of DST, designed not to reduce consumption, but to align the daily peak in electricity demand with the output of solar power generation.

How Fast a Transition from Oil?

The Gulf Coast oil spill remains the top energy story this week, eclipsing a $10 drop in oil prices that should soon ripple through to gas pumps near you. With BP's latest effort to contain the spill having run afoul of a slush buildup composed of methane hydrate crystals, the deepwater well continues to leak at an undetermined rate. The longer the spill continues, the greater the chances for severe environmental consequences, and the likelier that it will become a perception-altering milestone event as some environmentalists have already suggested. However, even if the spill were to galvanize public opinion in a manner similar to the 1969 Santa Barbara oil spill, what options do we have that could realistically reduce our reliance on oil produced from offshore platforms?

Last week I focused on the energy contribution of the oil we produce offshore in US waters, particularly in the deep water of the Outer Continental Shelf (OCS) of the Gulf of Mexico. It constitutes 30% of domestic crude oil production, or about 10% of our total oil consumption, and contrary to the wildly-inaccurate assertion on a widely-read environmental blog last week, essentially none of it is exported. (Anyone who doesn't know the difference between crude oil and petroleum products has no business commenting on that aspect of energy policy.) Today I'd like to go into a little more detail on the alternatives to offshore drilling that I alluded to last Wednesday.

Gasoline, jet fuel and diesel accounted for 75% of the petroleum we consumed last year. Other than the heating oil included in the diesel tally, these are the fuels that power most transportation of people and goods. Many initiatives are under way to develop non-petroleum fuels for cars, trucks and even jet aircraft, though at this point they are all in relatively early stages of development or deployment. On paper, at least, electricity looks like the best option for replacing gasoline, by means of plug-in electric vehicles like the Chevrolet Volt and Nissan Leaf. Since less than 1% of US oil consumption is used to generate electricity, switching cars from gasoline to electric power represents a nearly total displacement of oil. It would also facilitate the direct use of renewable electricity sources to eliminate greenhouse gas emissions. This prospect has many people excited, and I've heard it mentioned frequently in reactions to the Gulf spill. Yet this is hardly a slam-dunk, for numerous reasons, topped by scale and the unproven consumer acceptance of mass-market EVs.

In one of their periodic special sections on energy, today's Wall St. Journal included an article on the development of EV recharging networks in the US. It cited a study by Pike Research forecasting 610,000 EVs by 2015. That would be a great start, though it would fall short of President Obama's goal to put a million plug-in vehicles on the road by then. Even assuming that the million-EV mark were reached that soon, and that they were driven as much as other cars and replaced vehicles averaging 25 mpg, the quantity of gasoline they would displace amounts to just 31,000 bbl/day--less than the quantity of oil the leaking Macondo field would have been producing in a couple of years, had Deepwater Horizon's exploration well been completed uneventfully. Substituting for all of the oil currently produced from offshore drilling--or for the decline in US oil production that would occur by 2020 if we stopped drilling offshore--would require up to 50 million EVs, making up roughly 40% of all the cars likely to be sold in the US this decade. I suppose that might barely be possible on a crash basis, with a World War II-style mobilization of the resources required to achieve it, but it doesn't look very likely to me. I would be impressed if the US had 10 million EVs by 2020, implying annual production of well over a million units within just a couple of years, though that would reduce our current oil demand by under 2%.

So if EVs can only take us a small part of the way to replacing our oil consumption in the near future, what about advanced biofuels? There are many promising avenues, including biofuels produced from agricultural or forestry waste or dedicated energy crops, biofuels from algae, and bio-hydrocarbons from plant sugars. All are in their infancy. The EPA recently had to reduce its mandate for advanced biofuels delivered in 2010 from 100 million gallons to just 6.5 million gallons--424 barrels per day--because no truly commercial-scale facilities will come on-stream this year. We might get a few billion gallons per year from these sources by 2020, if numerous technical and economic hurdles can be overcome, but that would displace at most a couple of hundred thousand bbl/day of oil.

Natural gas looks like another good alternative transportation fuel. T. Boone Pickens has put forward his plan to shift long-distance trucking onto compressed or liquefied gas. There's no shortage of gas available for this purpose, thanks to the much larger supplies made possible by shale gas drilling. It starts from a very low level, however, with current natural gas used in transportation equivalent to less than 1,500 bbl/day of diesel fuel. It also competes with other uses of gas, such as generating more electricity to reduce our consumption of coal. Or, looking at it another way, there might be plenty of gas to do both, but not at today's price.

That leaves what looks like the best option for reducing our oil consumption, other than simply deciding to drive less, as some folks have apparently already done. Because the US car fleet is so large and is driven so far, increasing its fuel efficiency by just 3 miles per gallon could save nearly a million bbls/day of gasoline. That's more than the entire contribution of corn ethanol, our most significant alternative transportation fuel. In fact, the latest demand forecasts of the Energy Information Agency are already based on that kind of improvement, reflecting new regulations requiring new-car fuel economy to increase to 35 mpg before 2020. Still, only a small fraction of our fleet of 240 million cars turns over every year, so it will take a long time before average fleet fuel economy even begins to approach these levels.

Whether your preferred alternative to offshore drilling requires replacing millions of vehicles with hybrids, EVs, natural gas-powered vehicles, or highly-efficient small conventional cars like the new Ford Fiesta, or depends on a vast new infrastructure of alternative fuel production and distribution, none of these solutions can work overnight. In the meantime, every barrel of oil we consume but don't produce here must be imported, some of it from countries that don't like us very much--as we're frequently reminded--and all of it with serious implications for our national financial and trade balances. (And don't forget the inevitable oil spills from all those extra tankers.) If we don't want OPEC to be the biggest beneficiary of a new environmental mindset after the Gulf Coast spill, then we face some very tough choices, including whether we'd prefer to open up major new areas for onshore drilling, instead of some of the offshore prospects that were slated to be leased in the next few years, or to continue drilling offshore under updated procedures and with strengthened environmental protections, at the same time we pursue all of our options for reducing our overall reliance on oil.

Going Farther on Oil

As I was perusing my UC Davis alumni magazine last night I ran across a short article mentioning a new book from a professor, Dan Sperling, who directs Davis's well-regarded Institute of Transportation Studies. I know him slightly from his participation as in invited expert in a scenario workshop many years ago, so this caught my eye. His book, which I haven't read yet, examines the impact and implications of the rapidly growing global vehicle population, which he sees reaching the two billion mark within the next 20 years. In the article he suggested that this would require an entirely new transportation energy mix, made up of hydrogen, electricity, and advanced biofuels. That certainly fit my own long-standing expectations, as well. However, it occurred to me to wonder just how far we might be able to stretch the transportation fuels we get from oil, and just how far short they would fall as the global car-park expands. To my surprise, it doesn't require very aggressive assumptions concerning improvements in fuel economy, reductions in vehicle miles traveled, and additional oil supplies to cover the needs of a significantly larger number of cars in the world.

The starting point for such an analysis is current oil supplies and the way we process them. Global oil output in 2008 reached 86.5 million barrels per day (MBD), including crude oil, natural gas liquids, and the volumetric gain that occurs when you run them through a modern refinery. Roughly 60% of that input is currently turned into gasoline, diesel and jet fuel. Improvements in refining technology should make it possible to push that fraction to perhaps 70%, at the expense of heavy fuel oil displaced from power generation and shipping. So even if global oil output plateaued at only 90 MBD, a scenario that would probably seem optimistic to the adherents of Peak Oil and pessimistic to some industry experts, it could still yield 63 MBD of liquid transportation fuels. Set aside 7 MBD of that for jet fuel and kerosene and another 26 MBD for trucking and home heating oil, and we're left with 30 MBD of gasoline and diesel for passenger cars. That's roughly 25% more than current global consumption in light-duty vehicles, including the couple of MBD of diesel fuel that power Europe's popular diesel cars.

That doesn't seem to get us nearly far enough, until we consider that in the near future, cars will become much more efficient than they have been, particularly in the US, where an improvement from the current notional average of 25 mpg to the required 35.5 should eventually reduce average fuel consumption per mile by 30%. If the recent reversal in annual vehicle miles traveled persists after the recession ends, that would compound future fuel savings. When we consider that new cars in Europe currently average about 35 mpg and are required to reach approximately 43 mpg by 2015, based on a standard of 130 grams of CO2 emitted per kilometer, and that China has also introduced stricter fuel economy standards, it's not hard to imagine the average world car getting 40 mpg by 2020. That doesn't even require the majority of cars to be hybrids, let alone plug-in hybrids. If that average car drove 9,000 miles per year, it would consume 225 gallons of fuel annually. Following this back-of-the-envelope calculation to its conclusion, our 30 MBD of petroleum-based fuel for light-duty vehicles would be sufficient to cover Dr. Sperling's 2 billion cars with a little bit left over.

I'm not for a moment suggesting that this is the likeliest scenario, or that it means we don't need any of the advanced biofuels or electric vehicle technology currently under development. As I've pointed out frequently, fleet turnover in the developed world has slowed, thanks to the recession, and we can expect a long "tail" of older vehicles to persist for some time. However, the results of this simple exercise surprised me; I had expected the final number of cars that could be supplied by oil to be much lower. So while our transportation energy mix in the next couple of decades is still likely to include a much greater variety of fuels and an increasing penetration of electricity, we should not lose sight of the potential for realistically-achievable fuel economy improvements and non-efficiency conservation--driving personal cars less and relying more on mass transit and electronic trip substitution--to be the most important "transition fuel" in our arsenal, as we reduce our present reliance on oil, in order to tackle energy security and climate change.

Presidential Debate: Energy Issues

In a presidential debate focused on foreign policy and the ongoing financial crisis, it was entirely appropriate that the subject of energy came up as often as it did. The two Senators discussed energy in at least three different contexts: the consequences of past energy legislation, policies to promote future energy independence, and the geopolitics of energy. Both expressed support for a broad mix of alternatives, fossil fuels, and nuclear power. The differences in their priorities might have been clearer, had either provided more details of his respective energy programs. Surprisingly, however, only Senator Obama referred directly to energy independence, a goal both men have mentioned frequently throughout their campaigns.

Longtime readers of this blog know that I regard energy independence, in its strictest definition, as an unattainable distraction from sound national energy policy in an inter-connected world. That concern is less relevant here, because the scope of Senator Obama's vision for energy independence appears to have been reduced to a goal of freeing ourselves from "dependence on Middle Eastern oil" within 10 years. Numerically, at least, that might just be feasible, since oil from the Persian Gulf accounted for only one-fifth of net US oil imports last year. The 17 billion gallons per year of additional biofuel mandated by 2018 under the current Renewable Fuels Standard would get us more than a third of the way there, after factoring in differences in energy content and refining efficiency. The phase-in of higher fuel economy standards over that period might deliver the rest, with a bit of help from the lifestyle changes that have contributed to this year's drop in demand. But that assumes that domestic US oil production would not continue to drop in the meantime. That is far from certain, and it has as much to do with government policies as it does with geology.

Between 1997 and 2007, US production of crude oil and natural gas liquids fell by 1.1 million barrels per day, an average net decline of 1.5% per year. Over the next decade, the continuation of that trend could slice another million barrels per day from our current output, making the achievement of Senator Obama's goal much harder, possibly putting it out of reach. That's why this year's drilling debate and the proposed new taxes on the oil industry are so important. Even if we can't drill our way to energy independence, we can certainly non-drill our way into even greater dependence, despite our best efforts on alternatives and fuel economy.

Senator Obama's citation Friday of the oft-quoted, though highly-misleading "3% of reserves but 25% of consumption" factoid suggests that he and his advisers should examine the dynamics of US oil production a little more closely. Perhaps they are encouraged by DOE forecasts of a modest resurgence of oil production, though history suggests those might be as optimistic as the same agency's estimate of only 200,000 barrels per day of production from the off-limits portions of the offshore seems overly pessimistic. But whether we are considering the production potential of current leases or the prospects of the estimated 18 billion barrels of additional oil that have been placed off-limits, the US oil industry's task of maintaining output at levels at least comparable to today's--amounting to 10% of the world's supply, not 3%--will be much harder, if it faces lawsuits attempting to block every new lease, or if it is subjected to new excise or windfall-profits taxes.

I look forward to hearing more about the candidates' visions for energy in the debates ahead, including more details from Senator McCain on the cost and feasibility of constructing another 45 nuclear power plants in this country. I'd also like to learn more about the role each of them sees for energy conservation, which I didn't hear mentioned last Friday. In addition, in the next few weeks I intend to take another look at each Senator's published energy plans, since I haven't reviewed these (McCain; Obama) since the primaries.

The Persistence of Change

Weakening demand appears to be the main oil market driver these days, with the US having just tallied its 12th consecutive monthly decline in gasoline demand, year-on-year. For the moment, at least, good old supply and demand have displaced imminent Peak Oil and a perceived commodity bubble as the dominant narrative. If we needed further evidence of that, the market's collective yawn at Russia's threat to the Caspian pipelines passing through Georgia ought to serve nicely. But how much of the recent decline in consumption is attributable to the price elasticity of demand, and how much to the weakening US economy? The answer is of more than passing interest, signifying whether we're likely to see a bounce in demand once the pump price catches up with the 20% decline in the price of West Texas Intermediate crude oil since the 4th of July.

The US average retail gasoline price has fallen for six weeks and currently stands at $3.74 per gallon. Barring an unexpected oil-price rally or a major refining problem, unleaded regular prices beginning with a "4" should soon disappear at all but the most expensive stations, even in California. Perhaps this is just a case of the August doldrums, but the price of oil is currently stuck in a range that defies the principal explanations for its behavior earlier this year. With the market clearly responding to fundamentals, its path from here will depend heavily on whether consumers continue to drive less, and that depends on the relative importance of the psychological impact of $4 gasoline, compared to a broad range of economic factors including falling home prices, tightening credit and surging inflation--some of which is attributable to high fuel prices.

The last stretch in which US gasoline demand declined for 12 consecutive months occurred in 1990-91, a period that also coincided with a spike in fuel prices--thanks to Saddam Hussein--and a recession. The Gulf Coast hurricanes of 2005, which gave the country its first taste of $3 gasoline, caused only a brief drop in demand. Within 3 months of Katrina's landfall monthly US gasoline demand had resumed its year-on-year growth, consistent with the robust economic growth (helped by the housing bubble) that we were experiencing at the time. Nor did the recession of 2000-2001 prevent gasoline demand from growing by 1.6%, with only a few months exhibiting declines versus the same month of the previous year. Of course, gasoline was well under $2 at the time.

It seems to require an unusual combination of low growth and high prices to overcome the inherent gasoline demand trend of the US economy and shock consumers into conservation mode. Since the economy seems unlikely to recover soon, the persistence of the recent changes in consumer behavior concerning fuel consumption and new car selection thus hinges on just how cheap $3.50 gas will seem to America's drivers after a couple of months over $4.00 per gallon. In the absence of more dramatic events, this could also determine the price of oil on Election Day, a parameter that could influence that contest's outcome.

Rate of Change

For how much longer will the US depend on petroleum as our primary source of the energy we use for transportation? Conflicting beliefs about the answer to that question lie at the heart of the current debates about offshore drilling and additional support for alternative energy programs. If it is only a few more years, as some assert, then indeed, the production from oil fields in tracts currently off-limits would likely arrive after the greatest need for them has passed. If, on the other hand, we will still be importing oil 20 years from now, then we need to keep our oil project pipeline full, to ensure that we don’t open an even larger window of import vulnerability, on our way to greater energy self-reliance.

Answering this question involves a number of large uncertainties, including the persistence of Americans’ current conservation efforts, particularly if energy prices stabilize or fall farther; whether and how soon non-food-based biofuels can be produced on an industrial, rather than boutique scale; how rapidly plug-in hybrids and other electric vehicles can capture significant market share; and how our response to climate change will re-prioritize our use of other energy resources, and in particular whether we preferentially back out oil or coal first. The future availability of oil itself will also play a role, depending on how close we really are to a permanent peak in global production.

It’s good to have a vision of the end result we desire, presumably a world that is much less reliant on fossil fuels and in which renewable energy sources power electrified cars via a modernized power grid, augmented by nuclear power and liquid biofuels. But planning our journey to that outcome requires a clear understanding of the incremental changes that must occur along the way. In order to make progress toward such a goal, every year the output of that year’s additions to our renewable energy sources must exceed the net result of the growth of demand, moderated by efficiency and conservation, and any changes in the output of other energy sources. If, for example, domestic oil production declines by more than the net new contribution from biofuels, conservation and vehicle electrification, we will lose ground and import more foreign oil.

Last year we did pretty well on the liquid fuels front. In 2007, US ethanol production increased by 1.65 billion gallons per year, the energy equivalent of 71,000 bbl/day of gasoline, about 0.8% of demand, while gasoline consumption grew by less than 0.4%. This year, with gasoline consumption down and ethanol likely to add over 2 billion gallons of additional production, ethanol should capture more market share from petroleum-based gasoline. But in light of concerns about competition between food and fuel, and new questions about the environmental benefits of grain ethanol, that kind of growth cannot be sustained for much longer, without a large contribution from cellulosic biofuels that are still in the demonstration phase.

Progress was less impressive last year with regard to electricity, despite sustained high growth rates for both wind and solar power. The US added a record 5,244 MW of wind capacity, contributing approximately 14 billion kWh of generation, or 0.3% of electricity demand. That backed out the equivalent of 100 billion cubic feet of natural gas, equating to about 50,000 bbl/day of oil. Solar power grew by approximately 270 MW, covering another 0.01% or so of demand, or the equivalent of an extra 2,000 bbl/day of oil. However, US electricity demand grew by 2.3%, while hydropower, our largest renewable energy source, declined in output. As a result, the market shares of coal and nuclear power were stable, while natural gas actually gained ground at the expense of all renewables.

Based on these figures, renewable energy must expand by about a factor of ten before its annual growth will be large enough to make a significant dent in our reliance on fossil fuels in the electricity sector, even without considering the growth in electricity demand that would follow from the addition of millions of plug-in hybrids and EVs to our car fleet. Nor are biofuels likely to eliminate our oil imports in the meantime. At the Congressionally-mandated rate of 36 billion gallons per year in 2022, they will displace the equivalent of 1.5 million bbl/day of gasoline, while the US today imports between 11 and 12 million bbl/day of crude oil and petroleum products, net of exports.

The bottom line is that renewable energy is not yet in a position to make fossil fuels obsolete, and anyone suggesting otherwise is engaging in as much wishful thinking as someone who asserts we can “drill our way to energy independence”—a proposition I have only ever heard as a straw man offered up by opponents of drilling. Renewables have ample scope for further growth, but they also face important obstacles. Even with an increased focus on conservation and efficiency, the chances that we will not still need to import significant quantities of oil ten years from now look very slim, particularly if US oil production continues to decline at the 2-3% per year rate we have experienced over the last decade. Against that backdrop, the current energy compromise suggested by the “Gang of 10” senators looks pragmatic and prudent.

Leveraging the SPR

Election-year politics and prudent energy policy do not mix well. The combination is even worse when the election cycle coincides with a genuine energy crisis, and both parties seek to curry favor through short-sighted proposals aimed at producing votes, rather than BTUs or kilowatt-hours. We saw this earlier in the year with suggestions by Senator Clinton and Senator McCain to suspend the federal tax on motor fuels for the summer, and we are seeing it again in calls by the Speaker of the House and others to release oil from the Strategic Petroleum Reserve to drive down fuel prices.

It's remarkable how quickly the debate over the Strategic Petroleum Reserve (SPR) has shifted from halting additions to it, to draining it. The former was eminently sensible, in light of the cost of the program and the possibility that diverting small quantities of light, sweet crude into storage was having a disproportionate impact on the price of all oil. The balance of risks strongly favored suspending additions to the SPR; quite the contrary is true for using SPR oil to create a brief, convenient slump in the oil market, while diverting attention from the more serious discussion of increasing supply and reducing demand--both sides of which would be harmed by a non-emergency release from the SPR.

Make no mistake: the current SPR is a relic of the energy crisis of the 1970s that merits serious re-thinking about its fundamental purpose and the best way to achieve it in a very different economic and geopolitical environment. It is also possible to conceive of ways in which oil in the SPR could be used to speed up the contribution of production from new oil fields, once they are identified and under development, via SPR vs. reservoir exchanges. However, such considerations are quite different from simply dumping SPR oil into the market--volumes that under the policy passed by this Congress could not be replaced as long as oil remains expensive--for no purpose other than to provide some relief at the gas pump, where prices are already likely to fall by another 25-35 cents per gallon, based on the past week's drop in the crude oil and gasoline futures markets.

The problems with releasing SPR oil now are straightforward. Inventory is not production. The proposed draw-down is not sustainable, while the production that new drilling could add would contribute to our energy supplies for a generation. Moreover, oil prices are a classic stock-and-flow system, reflecting the current balance between actual supply and actual demand, and the difference between actual inventory and desired inventory. Although the flow of SPR oil into the market would create a temporary glut and drive down the price of oil for prompt delivery, the subsequent lower inventory levels--even for an emergency back-up such as the SPR--could result in even higher prices after the release program ended than before it began. At the same time, this signal--not just from lower current prices but also from the demonstrated willingness of the government to use the SPR to manipulate the market--would deter new energy projects, including those for alternative fuels that are more attractive when oil prices are high, while impeding our transition to more efficient vehicles.

The world has changed in many ways since the SPR was first opened, and some of those changes make it even more essential for the US to have quick access to large volumes of oil in extremis. Among other things, our net oil imports have doubled since President Ford signed the SPR into law in 1975. Although oil prices remain high, supply still meets demand. Yet it is far too easy to envision plausible scenarios in which that would not be the case, involving terrorism, expanded conflict in the Middle East, or the effects of Peak Oil. In any of those cases, we might find that the SPR's current 160 days of supply at its 4.4 million barrel per day maximum delivery rate are not nearly as ample as they seem.

Aside from expediency, the theory behind releasing SPR oil now is based on a flawed narrative involving a bubble in oil prices. If the evidence were clear that supply and demand would balance at a much lower oil price, and that speculators were responsible for a large fraction of the current oil price, then I could support using a brief release from the SPR to crush speculation. The reality appears much different. Oil prices have fallen since this debate started, largely because of the extraordinary reduction in demand that high prices and a weak economy have triggered--and not because the market sees a realistic prospect of a SPR release this year. Oil is trading today below $125 per barrel for delivery in September 2008, as well as for delivery in December of 2010, 2011 and 2012. That could change tomorrow, due to some event, but it suggests that the impact of speculation is more like the foam in a glass of beer than a steadily-inflating bubble. The interests of the nation would be better served by a Congressional commission on re-engineering the SPR for the 21st century, than by Congressional legislation to fritter away this $88 billion asset in the pursuit of short-term goals.

Setting Oil Prices

As the Congress moves ahead with legislation aimed at reducing the contribution of speculation to high oil prices, it's worth taking a moment to reflect on how oil was priced before the influence of the futures markets became so pervasive, or before they even existed. A quick review reveals that any nostalgia for this earlier, simpler era is largely misplaced. Today's oil markets, for all their faults, are models of transparency and efficiency by comparison. Let's hope that our government can discover the right formula for curbing their excesses, without destroying the liquidity and highly-visible price discovery that they provide to producers and consumers, alike.

I've devoted a fair amount of space to the question of oil market speculation. I don't see the signs of a housing or Dot-Com-style bubble, but I also don't dismiss the effect of demand from long-biased asset-class investors on the market. As we often hear from skeptics of the influence of speculation, buyers and sellers must indeed be evenly matched, but higher demand for long futures can only be met by bidding up the price. That tends to drive up the price of the physical commodity bought by refiners, because of the mechanisms by which physical oil is priced. However much this has contributed to pushing oil beyond the $70-$80 per barrel that some industry experts suggest more reasonably fits the market fundamentals, a return to the way oil prices were formerly determined would not guarantee lower prices.

There are many excellent accounts of the history of oil and its pricing, and I can't possibly do justice to this subject in a brief blog posting. If you haven't read the book for which Daniel Yergin won the Pulitzer Prize in 1992, that would be a good place to start. Prior to the first oil crisis, the price of oil was effectively set by the Texas Railroad Commission, which published the monthly quota for production in the state. Together with import restrictions, this constrained supply enough to keep US oil prices between $2 and $4 per barrel. Once the Railroad Commission quota hit 100% in 1971, as a result of growing demand and the peaking of Texas oil output, its influence on prices ended. Oil from the Middle East and other big exporters in that period was sold mainly via long-term contracts, at prices that changed infrequently and that sometimes included "net-back" provisions, explicitly tying the price received by the producer to the revenue realized by refiners in key markets.

All of this changed in the 1970s, after OPEC consolidated its control and began raising the price. It ended net-back discounts and nationalized the holdings of the international oil companies. Between 1972 and 1978, the average price US refiners paid for imported crude oil quadrupled in dollars of the day. The US government intervened in the market by setting the price of "old" and "new" oil--trying to hold down prices while leaving incentives for new domestic production--and limiting imports. These distinctions were exploited by clever traders, and integrated refiners were forced to supply small, independent refiners, even if their own facilities were under-utilized. It was a mess. From 1978-81, in the aftermath of the Iranian Revolution, oil prices increased by another 150%. Over the next few years, OPEC's ability to set prices was eroded by a 10% reduction in global oil consumption and a tsunami of new non-OPEC output from the North Sea, the North Slope and elsewhere. In the ensuing battle for market share, the price of oil fell from its peak of around $40/bbl. to $13, requiring the 1990 Iraqi invasion of Kuwait finally to push it back above $20.

When I traded oil in the late 1980s, most of the US production I dealt with was bought and sold on the basis of the oil companies' posted prices, which solicited offers to sell them lease-level crude output. Alaskan North Slope crude was one of the few domestic grades I handled that was sometimes pegged to the price of West Texas Intermediate crude on the New York Mercantile Exchange (NYMEX.) The prices of the relatively few international cargoes I bought were typically negotiated for each cargo, without reference to other markets. Although I never bought Saudi oil, it was priced by Aramco on two formulas, one for "eastern" and one for "western" destinations. Transparency in that period depended on the ability of reporting services such as Platts to ferret out the details of the transactions that occurred each day. The fewer the transactions, the less reliable these reports were, especially for domestic grades outside the week or so prior to monthly pipeline scheduling, when most deals took place.

History is rarely a perfect guide, but in this case I think it offers some useful lessons concerning how oil might be priced, if the futures markets became less liquid or less influential. Although prices might not be as volatile, day to day, they would be no less prone to manipulation, or to sudden price spikes in response to changes in supply or demand. The pre-NYMEX oil market only yielded low prices when supply was abundant, a characteristic that has been absent since oil prices took off in 2003. Today's problems of transparency, involving the identity and motivation of market participants, pale in comparison to the former challenges of discerning precisely what the day's price was, in the absence of an open, visible exchange platform. I dislike clichés, but as the father of a small child the image of throwing out the baby with the bathwater resonates strongly, here.

Driving Less

The signs that Americans are driving less are everywhere. From headlines such as, "Gas Prices Spur Drivers to Cut Use to Five-Year Low", to increasing ridership on mass-transit systems and TV news segments on the growing numbers of folks bicycling to work, we see $4 gasoline doing what $3 fuel didn't: deliver a meaningful conservation response. But before we pat ourselves on the back for the DOE report that gasoline demand has fallen by 3% compared to last year, we should review a somewhat longer stretch of our recent history of fuel consumption and vehicle miles traveled. It suggests that the current decline, abetted by a weak economy, barely scratches the surface of our per-capita fuel consumption increase since 1995.

Conventional wisdom blames the SUV fad for most of the increase in US oil consumption in the last decade or so. But while rising sales of large SUVs in that period certainly helped to stall the positive trend of passenger car fuel economy, the bigger culprit has been the heretofore steady growth in vehicle miles traveled (VMT.) Between 1995 and 2005 this statistic grew by 23%, slightly more than the 21% increase in gasoline and diesel fuel consumption, and ahead of the 19% expansion of our car and light truck fleet. By comparison, during this period the US population grew by about 13%. In other words, Americans have been driving more cars, and on average driving them farther each year, than in 1995, accounting for more of the accompanying increase in fuel consumption than SUVs. This year's 2% decline in VMT compared to last year's record figure only erases part of the roughly 10% per capita growth of average annual miles driven since 1995. If we unraveled the rest of that growth, we could reduce US gasoline consumption by another 8% without any contribution from the higher fuel economy of the new cars consumers are now choosing. That equates to more than twice as much oil as our use of ethanol will save this year.

I don't pretend that conservation on that scale would be easy or costless. Some portion of the increase in VMT is structural, in the form of workers traveling longer distances from communities beyond the traditional suburbs. Much of the rest is associated with some sort of economic activity, including delivering goods and taking children to daycare or activities. The main advantage of this kind of conservation is that, at least in principle, it can occur much more rapidly than the efficiency gains from the gradual turnover of the vehicle fleet to smaller cars and a larger number of hybrids and alternative fuel vehicles.

It remains to be seen whether the fuel savings we are now observing will persist and expand, level out, or rebound. The first appearances of $2 gasoline in 2004 and $3 gasoline in 2005 delivered milder shocks to a healthier economy, slowing the growth of gasoline demand but not reversing it in the way that sustained $4 fuel has. That result could be put to the test, if oil prices continue to slide from their $145 high last week, or once the economy finally starts to improve. In the meantime, the scope for further behavior-based conservation remains significant.

Striking a Bargain

For several years I have been intrigued by the possibility of a "grand compromise" on energy and the environment, so I was pleased to see this idea resurface in Steven Pearlstein's column in today's Washington Post. Starting with the proposition that Democrats and Republicans each hold only half the recipe for a serious response to our vulnerability to high oil prices and the risks of climate change, he frames our political choice as one "between compromise or stalemate." The evidence for this has been in the headlines throughout the past month. The recent failure of the Lieberman-Warner-Boxer cap & trade bill and the current debate on opening up more areas for oil and gas drilling demonstrate the inseparability of our energy and environmental challenges. It is time to recognize this as an opportunity, rather than an obstacle.

Wednesday's posting looked at how expanded drilling fits into our larger energy and environmental challenges and concluded that it can make positive contributions on both fronts, though it is hardly the entire solution. The feedback I received suggests that many people would be receptive to more drilling, if it weren't seen as a means for enabling a return to cheap oil and wasteful behavior. Expanding supply without addressing demand merely postpones tough choices, while ambitious planning for "energy independence" that constrains demand and boosts alternatives but leaves US oil production on a glide path to oblivion is doomed to failure. And as Mr. Pearlstein notes, a package combining "well-regulated drilling" with reductions in greenhouse gas emissions could benefit everyone.

The formula for a winning compromise isn't obvious. It could involve expanded drilling with royalties dedicated to funding alternative energy R&D, or it could go as far as linking economy-wide emissions cap & trade with carefully-monitored access to the Arctic National Wildlife Refuge and all federal waters beyond the 3-mile state limits. The best place to define it would be in a bi-partisan conference of the House and Senate. An election year might not seem well-suited for pursuing such sweeping legislation, but as I learned in my years of trading oil commodities, you can't always wait for the timing to be ideal. When conditions provide the right combination of motivated parties and market drivers, that's the time to strike. This could be just such a moment for sweeping energy/environmental legislation.

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.

Oil Panic Attack

After having mostly yawned our way through the first half of oil's amazing six-year ride, we now watch its movements as intently as any futures trader, and our level of concern seems to be building towards a national anxiety attack. Since 2002 we've seen the price of West Texas Intermediate Crude Oil rise from the mid-$20's to the mid-$70s, then retrace to $51 in early 2007, before beginning its remorseless climb past $100 and every other logical stopping point. Some industry analysts are predicting $200 per barrel oil, and warnings of $6, $10, or even $12 gasoline are treated seriously, bolstered yesterday by a new suggestion from the normally-conservative International Energy Agency that we may be approaching a global production plateau. My crystal ball isn't working any better than anyone else's, and thankfully I'm not paid to forecast oil prices. If we want to understand where we're headed, though, we should examine where we've been.

Until fairly recently, oil was regarded as a cyclical commodity, though its cycles didn't necessarily coincide with those of the global economy. It's also an industry that values experience, so its management includes many who have seen several of oil's up and down sequences. That means the senior members of the tribe can recall from personal experience--even if it was early in their careers--the collapse of oil prices in the mid-1980s after the lagged responses to the first energy crisis took hold. Then came the even more devastating drop in 1998/99, in tandem with the Asian Economic Crisis, when WTI bottomed out at just over $10/bbl, pushing the price of most grades of oil into single digits. Many projects that were planned in the late 1980s, when oil finally reached $20/bbl again, started up in a down market that destroyed billions of dollars of net present value. At the same time that oil companies were learning these painful lessons, the OPEC countries that hold most of the world's known oil reserves were attending a similar school, particularly with regard to the perils of over-capacity. The oil price collapse of the late 90s that squeezed the stock prices and investment budgets of the international oil companies created large external deficits for OPEC's members.

Next consider the unexpectedly large expansion of demand. Between 1998 and 2006, global oil demand grew by 10 million barrels per day. At the same time, the natural decline of mature oil fields would have required the industry to replace somewhere between 1.5 and 3 times that much output, just to stay even, in a period when an increasing proportion of the best opportunities were not available to the companies with the biggest incentive to grow production, and the big producing countries were starting to learn that selling more oil may be a less effective way to make more money than selling less, or at least holding output steady in the face of rising demand.

As a result of these factors, when prices began to rise again, breaking through $30 in 2000, oil companies and producing countries had good reasons to be skeptical that the fundamental relationship between supply and demand was on the verge of a permanent shift. That resulted in a crucial delay in funding new projects--crucial because of the time lags involved in the planning, permitting, procurement and construction stages of such projects. In the interim, most of the world's spare production capacity was tapped, and the industry seems unlikely to catch up, short of a global recession that would halt demand growth in its tracks.

Throw in a few other key factors, such as the dollar's decline, an increase in commodity speculation, and the artificially-low petroleum product prices in a number of developing economies, and we have all the necessary ingredients for the quintupling of oil prices that we have experienced in the last six years--doubling in just the last year. Getting out of the deep hole we have dug will require a combination of higher fuel efficiency, increased non-efficiency conservation, more drilling, greatly expanded non-food biofuels and synfuels output, and the partial electrification of personal transport. With the exception of conservation, none of these solutions will make a dent in the problem in this decade.

No one can predict with certainty where oil prices will go from here. It could be to $200, or back below $100. The market is flirting with contango, suggesting it is reasonably well-supplied for now. Despite this week's 5 million barrel drop in US crude oil inventories, days' supply of crude and gasoline are at a fairly healthy 22 days each. Yet the momentum of this market seems unshakable. In the meantime, I suggest prudent conservation and the avoidance of panic. $200 oil would not mean $12 gasoline. In fact, unless refining margins suddenly came back to life, it might not even get us to a $6 national average retail price for unleaded regular. That's not very reassuring, going into the Memorial Day weekend that signals the start of the peak driving season. Our enjoyment of the summer could depend on our level of stoicism.

What Europe Pays

With American consumers reeling from gas prices that have gone up by fifty cents per gallon since the beginning of the year, it occurred to me to wonder what Europeans are now paying. Although the decline of the dollar has amplified the impact of recent increases in oil prices, Europe hasn't been immune, either. Crude oil expressed in Euros or Sterling is roughly 75% and 110% higher, respectively, than it was in January 2007, and this has boosted the price of fuels that were already much more expensive than those sold here. While searching for European fuel price data, I was surprised to discover proposals for gas tax cuts similar to those being debated here. Consumer displeasure with petroleum product prices is increasing the pressure on governments on both sides of the Atlantic to respond.

Having lived in both Germany and the UK, I chose them as my basis of comparison--one inside the Euro zone, the other outside. As of today, Normalbenzin (regular gasoline) averages €1.457/liter, or €5.51/US gallon. So whether you assess the dollar/euro exchange at its market rate of $1.55 to the Euro--which gets you to $8.55/gal.--or adjust it based on purchasing-power parity, or even the Economist's Big Mac Index, which was close to 1:1 last summer, gasoline in Germany is a darned sight more expensive than it is here, thanks to Europe's stout taxation of motor fuels. And while diesel is taxed at a lower rate, to promote the use of diesel automobiles as a means of reducing oil consumption and greenhouse gas emissions, €5.26/gal. ($8.15/gal.) is hardly a bargain. Petrol is not much cheaper in the UK, either. At a current average of 110 pence per liter, or £4.18/US gallon ($8.25/gal.), even filling up your Mini would set you back $80.

Of course, it's not only the absolute fuel price that counts, but the magnitude and rate of its recent change. A big part of our problem is that most Americans are still driving cars that were purchased when gasoline was under $1.50/gal., to commute between work and home locations that were chosen when fuel was even cheaper. As of this week, nominal US retail gasoline prices have gone up by 25% in the last year and by 130% in the last five years. How does that compare to other countries? Well, motorists in the UK are experiencing prices that are now 25% higher than the average of last year, and 42% higher than five years ago, but gas hasn't been cheap in Europe for more than a generation. Buffered by the strong Euro, gasoline in Germany has increased by a smaller percentage, 19% vs. the 2007 average and 29% over five years.

Although proportional fuel-price increases have thus been smaller in Europe than here, the high absolute price level is still causing serious discomfort and prompting calls for governments to act, particularly by reducing fuel taxes. Consider that while it accounts for more than 70% of the US retail gasoline price, crude oil makes up less than a third of the gas price in Germany. Because most of the difference is attributable to taxes, the scope for reducing the retail price via tax relief is enormously greater than here. A member of the German coalition government has suggested instituting a cap on gasoline, diesel and heating oil prices, adjusting the tax rate periodically to hold prices steady. Other proposals include rolling back the 3% increase in the value-added tax that kicked in on 1/1/07, which at current prices is worth as much as the entire US federal fuel excise tax that Senators McCain and Clinton wish to suspend this summer. The arguments against lower German gas taxes are similar to those economists have raised here: fuel supplies will tighten even further, and government revenues will fall.

It's small comfort, but high gasoline prices are a global phenomenon, unless you live in a major oil exporting country, such as Kuwait or Venezuela. Consumers in Europe are no happier about this than we are. But instead of waiting for our governments to decide whether higher fuel prices or lower tax receipts are more harmful to the economy, we could follow the advice on fuel conservation from the Alliance to Save Energy. As reported in yesterday's Wall St. Journal, a combination of six strategies could save the average household up to $600 per year, or at least 20 times the expected benefit from a summer gas tax holiday. And instead of protesting in Washington, truckers might achieve more by posting "Slow Down" signs on our highways. Even the airlines are reducing aircraft speeds to save fuel.

The Path to Zero

An article in today’s Washington Post reported on new scientific research suggesting that emissions of greenhouse gases must be reduced to zero by mid-century, in order to prevent global warming that could persist for hundreds of years, perhaps eventually producing average temperatures higher than for millions of years. As the climate debate focuses increasingly on policy, the impact of such findings on efforts to craft practical frameworks for reducing US and global emissions becomes as important as the scientific result itself. The implication of the need for truly radical change contained in this latest report might either galvanize action on capping our emissions, or convince us that none of the current pathways for reducing emissions is truly worth pursuing.

The goalpost for stabilizing the climate has been moving for some time. A few years ago, moderating emissions to stabilize the atmospheric CO2 concentration at about twice its pre-industrial 280 parts per million (ppm) was widely regarded as adequate to the task. Further modeling suggested that 550 ppm wouldn’t do the trick, but that 450 ppm might. Then we heard from NASA’s James Hansen that we need to shoot for 350 ppm, a level we unfortunately exceeded in the late 1980s. Now Matthews and Caldeira’s paper in Geophysical Research Letters indicates that if we wish to avoid continued, dramatic climate change over the very long haul, our real goal must be zero net emissions, with as rapid a return as possible to pre-industrial levels. It’s enough to make you throw up your hands in futility.

I don’t think you need to be an economist or a climate skeptic to appreciate just how sweeping the changes in our entire global economy would have to be, in order to achieve zero emissions worldwide by mid-century. Of the current US cap-and-trade proposals, neither the bill now before the Congress nor the proposals of any presidential candidate would get us close to that. Even if the EU and US cut emissions by 80%, the toughest target now on the table, global emissions will continue to grow for at least several more decades and would probably still be above 50% of current levels in 2050.

What does zero emissions mean in practical terms? Well, among other things it doesn’t mean “zero emission vehicles” that merely shift the point of emissions from the tailpipe to the smokestack. And while it’s possible to imagine getting a large part of the way toward a 70% or 80% emissions reduction through greatly-improved efficiency and conservation, we simply can’t conserve our way to zero. Instead, it implies the elimination of essentially all combustion of fuels, other than in facilities that capture and sequester all the CO2 they produce, or of biofuels that absorb in cultivation as much CO2 as they emit when processed and burned. Otherwise, we’re talking about an entirely electrical world, with power generated exclusively by wind, solar, geothermal, hydro, and nuclear sources. Those sources currently meet only 14% of the world's energy needs. For those of us grounded in the realities of fleet, capital stock and infrastructure turnover, the cost associated with changes on such a scale makes adaptation to a warmer world seem like the more attractive option.

As overwhelming as all this seems, however, I see two positive nuggets embedded in this report. One is the timescale for reductions and the other is the notion of zero net emissions. Fifty years is a long enough interval in which to develop entirely new technologies from fundamental scientific discoveries, fine tune them, and roll them out on a massive scale. If we can at least stop making the problem bigger in the meantime, the actual means of reducing our emissions to zero might emerge from an unexpected quarter within the next decade, or from a novel application of some existing technology. And with enough cheap, clean energy at our disposal—perhaps from space solar power—we could even reduce our net emissions below zero, by extracting CO2 from the air and storing it in geological formations or as carbonate rock.

At this point, I believe we ought to be cautious about this new finding. Even ignoring the possibility that the authors’ modeling results won’t hold up, pushing a complete zero-emission agenda now, before we’ve even begun reducing global emissions, seems premature. Combine the implications of zero emissions with the new debate about “global cooling”, and we could have the recipe for another decade of policy gridlock. In the meantime, however, we should be pondering what this research suggests about the proper balance between incremental change and transformation, where the latter is a realistic option. That might seem like a highly esoteric topic in the current economic climate, but in the years ahead climate policy and the economy will likely be increasingly inter-connected.