July 12, 2008

Follow the Oil Money . . .

Just yesterday, I paid $4.80 per gallon for regular gas in San Francisco. But as cruel as it sounds, the biggest problem with skyrocketing oil prices is not the high cost at the pump.


Far more serious is the massive wealth transfer that high oil prices are creating from the United States to not-so-friendly governments like Russia, Iran, Nigeria, and Venezuela. Sensing their increased power in the world, leaders of these “new rich” nations are distancing themselves from the U.S. and moving steadily away from democracy, as their leaders accumulate massive personal wealth.


This wealth transfer has staggering implications for the relative power of the United States in the world. A nation´s strength is based the strength of its economy, much more than its military might. Witness the collapse of the old Soviet Union in the 1980s. If our country´s leaders do not respond aggressively to skyrocketing oil prices by reducing consumption and increasing supply, the power and influence of the U.S will inevitably decline, coupled with comparable reductions in our standard of living.


Spending last week in Russia, I was struck by the aggressiveness of Russian leaders in reasserting their power. The signs were everywhere: the forced takeover of TNK-BP (British Petroleum´s joint venture), aggressive messages from Russia´s leaders to “respect our power,” and the more than one hundred billionaires in the country who rank among the world´s wealthiest people. Even Russian sales of General Motors´ gas-guzzling Hummer are up 60%.


The U.S. has had no energy policy for the past decade. Instead, we ignored the desperate need for conservation, let energy markets follow their own course, and denied the linkage between U.S. foreign policy and the price of oil. Instead of addressing these issues, Republicans and Democrats are locked into a decades-old argument: should we expand supply or reduce demand through conservation? The answer is obviously both.


The U.S. desperately needs an integrated energy policy, but the intransigence of the politicians only ensures the stalemate will continue. Instead of devising comprehensive solutions, politicians focus on finding scapegoats for the high gas prices. It is the oil companies? The speculators? In the tradition of American politics, there must be someone responsible whom politicians can make the scapegoat.


Before we can solve these problems, we have to face economic realities about oil prices. At the present, oil supplies are well balanced with the worldwide demand. The increase in oil prices from the low $50s in January, 2007 to $140 per barrel today is not being driven by current supply-demand imbalances, but rather byexpectations of rising demand coupled with expectations of supply limitations.


Speculators – and there are plenty of them around the globe – are simply betting that long-term imbalances will occur. For all the talk about controlling speculators, it is impossible to legislate their behavior. Speculation in future prices is normal behavior for investors in all markets, but it is not the same as market manipulation.

The only way to bring down the price of oil is to increase supply and reduce demand. It is not an “either/or” choice.

Let´s start with demand. While U.S. demand for energy is not increasing significantly, there is much more we can do to reduce energy usage without hampering economic growth. Here we can learn a great deal from the Europeans, who make energy conservation a way of life.


The obvious starting point is gas consumption. For decades U.S. automakers have successfully lobbied against increases in fuel efficiency, while the Japanese and Europeans moved ahead with hybrids and more efficient vehicles. Now the chickens have come home to roost. U.S. auto sales dropped 20 per cent last month, as Detroit shutters plants making gas guzzlers.


The technology already exists to increase fuel efficiency from the U.S. average of 24 miles per gallon to the 40+ mpg achieved in Europe and Japan. Comparable improvements can be made in industrial efficiency as well as consumer energy usage if governmental standards are mandated and the next president leads a national campaign for energy efficiency.


Major increases in energy demand over the next decade will come from China and India. China, for example, is building 438 new coal-fired electrical plants – one per week – that are highly inefficient and will create an environmental disaster. Chinese growth in auto production will result in more cars on its roads by 2016 than the U.S. The only way the U.S. can influence this situation is to clean up our own house by setting new standards for energy efficiency with advanced technology, and providing the Chinese and Indians our technological expertise.


On the supply side, both presidential candidates are urging increased research investments into renewable sources of energy. I would go further and propose a National Institute of Energy (NIE), built on the model of the National Institutes of Health (NIH). The NIE should be funded at $20-30 billion per year from the savings in reducing war expenditures in Iraq. NIE would lead government investment in a wide array of energy technologies, fund research at the leading universities and private research institutions, and encourage start-up companies to develop these new energy sources into cost-effective vehicles.


Cellulosic ethanol, hydrogen, clean coal, nuclear, solar energy, wind power, and geo-thermal are just a few of technologies where genuine research is required to make these energy sources safe, cost-effective, and scalable to mass production. Without this basic research, these renewable sources will continue to account for only a small fraction of the world´s energy demand. This approach is far better than subsidizing high-priced alternatives, as the U.S. has done with corn-based ethanol, wreaking havoc in corn prices.


In reality, no matter how much research goes into renewable energy, these sources can supply only a small fraction of the world´s growing energy demand in the next twenty-five years. We simply cannot wait that long to expand supply. Instead, the U.S. and Canada should open up sources of oil and gas within North America and in off-shore waters. With today´s technology, these sources can be explored with minimal environmental impact. This will keep these funds at home, instead of putting another $4-5 trillion into the hands of less friendly governments. Just the announcement of new sources being opened up will put a significant dent in oil prices.


The same goes for restarting the U.S. nuclear program, our best intermediate option. The French nuclear program, funded aggressively since the 1970s, accounts for over 80% of French electricity. Nuclear energy presents issues with waste storage and safety assurance, but these problems can be solved, as the French have done, if we have the national will.


Only an integrated energy plan like this one can restore our economy and stem the flow of U.S. dollars into the coffers of foreign governments.