High Prices Will Fix What Politicians Cannot
by Trevor Houser, Peterson Institute for International Economics
Op-ed in the Financial Times
August 1, 2010
© Financial Times
The Gulf of Mexico oil spill was bad enough for BP to change its chief executive. It was not bad enough for the United States to change its energy policy. Last month Barack Obama, US president, used the spill to call for a new push on clean energy. But weak follow-through, a divided Democratic caucus and a unified Republican opposition saw meaningful US energy legislation shelved last week. Now, the reality of a high oil price may be about to change America's petroleum habits, even if policymakers cannot.
It seems as if we have been here before. Mr. Obama's post-BP address is strikingly similar to a speech given by President Jimmy Carter in the late 1970s, attempting in vain to use the last oil crisis to change US energy policy. Mr. Obama acknowledged the parallels, but promised a different outcome. But while Washington's resolve faltered again, the industry's economics are not following the old script.
From the birth of the automobile until the 1970s, oil cost between $15 and $20 per barrel in current prices. Then, in 1979, the Iranian revolution saw prices shoot up to $80 per barrel. Cheap oil proved resilient, however, as countries outside the Organization of Petroleum Exporting Countries (OPEC) responded with extra production, adding more than the total output of Saudi Arabia to global supply. The recession that followed the oil shocks also cut global demand by a tenth. Prices soon fell to their old levels, where they stayed for two decades.
Ultimately, it was this drop in prices, rather than poor speechmaking, that hobbled Mr. Carter's attempts to reduce America's oil consumption. US clean-energy research might have hit record levels between 1979 and 1981, but as oil prices fell, funding for clean-energy innovation fell in step. By the late 1990s, spending on clean-energy research was down by more than 75 percent from its peak. The specter of the 1980s oil price crash seemed to inhibit investment, even when oil prices rose again in 2003.
The difference today is that oil prices are unlikely to fall. Demand for oil is driven by economic growth. Today that means emerging economies, and China in particular. The developed world has seen oil use drop by 7 percent since 2007, but demand in the developing world is up 10 percent. Chinese demand has doubled during the past decade. As a result, oil has stayed expensive, in spite of the worst economic downturn since the Great Depression.
There is also little hope that new supply will bring much relief. OPEC countries control an increasing share of global reserves and are not inclined to increase production just to give consumers a break. With most new onshore resources in politically unstable countries, the International Energy Agency predicts that over the next two decades the lion's share of new non-OPEC production will occur offshore, much of it in deep water. The real lesson of the Gulf spill is that drilling the deep Macondo well reflected the reality that there are few cheap and easy options elsewhere.
The only silver lining on a painful future for consumers is that expensive oil is just what is needed finally to kick-start the petroleum detox. The fact that high oil prices survived the crisis excises the ghosts of the 1980s, and gives entrepreneurs and investors confidence to support cleaner vehicles and develop alternative fuels. Nearly all of the world's largest vehicle manufacturers now plan plug-in hybrid or fully electric vehicles within two years, with General Motors rolling out the Chevy Volt last week. At $20 per barrel, powering the Volt with electricity costs more than filling a comparable car with gasoline. But at $80, Volt drivers save enough on fuel to offset the vehicle's high price. Faced with expensive oil, the chemicals industry is turning to natural gas, increasingly abundant thanks to the shale gas boom, and venture capitalists are betting on advanced biofuels.
Make no mistake, clean-energy deployment driven by a tight oil market will be slower, more limited, and less pleasant in the absence of good policy from Washington. And as oil accounts for only a quarter of global greenhouse gas emissions, high prices will do little to address climate change compared with the cap-and-trade proposals Congress put on hold. But today's oil markets make public investment in clean-energy research and development, just now returning to 1970s levels, more palatable—and a change in America's relationship with petroleum seems possible at last.