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American Energy Economics: Maximize demand and minimize supply…
When it comes to energy, America is in trouble – and it’s getting worse. If America keeps on its present path, our energy will be more expensive, polluting, unreliable and insecure. The old deal our nation made between energy producers and consumers is broken. What is the new deal! On this blog we’ll investigate this question. In this post I’ll investigate how we got in the mess in the first place.
Our past 50 years of energy policy are best summed up in a quote I gave Tom Friedman for a New York Times column over a year ago: “Our real energy policy has been to maximize demand, minimize supply and buy the rest from the people that hate us the most.” The results of this policy is an ever growing gap between energy demand and supply in the U.S. as can be seen in the official statistics provided by the Energy Information Administration.
The quote attracted a great deal of attention and inspired a lot of comments on the failure of American energy policy. Let’s investigate the different aspects one by one…
Maximizing demand – the constitutional right to cheap energy
The American way of life is the single biggest factor shaping the energy system we have today. Its foundation rests firmly on the supply of cheap energy. Cheap energy being the result of the intersections of abundant domestic hydrocarbon energy sources, technological leadership in the discovery and exploitation of those sources and a conscious set of policies – well-intended at first- to keep energy prices as low as possible.
With its well-endowed domestic oil reserves in Oklahoma, California and especially Texas, the U.S. was one of the birthplaces of the oil industry. In fact, the U.S. only became a net importer of oil in 1948 and we still have sizeable proven reserves of coal and (shale) natural gas. We also showed our entrepreneurial spirit and technical leadership in discovering and exploiting those resources. More than 5,000 wells were drilled in East Texas between 1930 and 1932, a ramp up that made crude oil prices fall from $1.05 to 25ct a barrel.
Policies kept the cost of energy as low as possible as well. The Oil Depletion Allowance (ODA) came in force between 1926 and 1975 and determined that 25 to 50% of the oil producers’ revenue was tax-free. And even today, oil producers in the U.S. still pay far lower royalty fees than in other comparable countries. Another, well publicized, example are the comparatively very low consumption taxes on gasoline. In July of this year we paid an average of 47.3 ct a gallon in taxes, 18% of the average price of gasoline. In Germany, by contrast, the tax per gallon currently is $4.14 per gallon, almost 10 times as high. Even today, with the concerns around energy dependence, climate change and the fiscal positions of the government, raising fuel taxes is one of the most toxic topics for lawmakers although the National Commission on Surface Transportation Infrastructure Financing put out a new call at the beginning of this year for an increase in fuel taxes.
Maximizing demand – living bigger, better and further away
At the same time that we were keeping energy prices down, a series of federal policies and programs that originated during the great depression and extended through the post-WWII era, literally changed the face of the American landscape. They dramatically expanded home ownership, automobile use, suburbia and sprawl. When those bills were passed we never really considered the economic consequences for the price and availability of energy or the environmental consequences of using all that energy but now, decades later, we are faced with the (unintended) outcomes.
One policy was to make America a nation of suburban home owners by making easy credit available to people with relatively lower incomes. The F.H.A. mortgage insurance program, established in 1934 during the great depression intended to make the dream of homeownership available to all Americans. The F.H.A together with Veteran’s Administration’s mortgage guarantee program effectively revolutionized home financing. Between 1947 and 1958 nearly one-half of all new single family home purchases were financed through these programs. Ironically this is a situation that we’ve reverted back to today, for different reasons of course, with nearly half of mortgages issued being government backed. Since its inception, the F.H.A. has financed over 34 million mortgages and 47,000 multifamily projects.
Easy financing was not the only reason for the suburbanization drive after the war. A lot of pent-up housing demand was unleashed just as entrepreneurs applied logistical and technical innovations they had seen in the military and created a low-cost, mass-production construction industry. Levittown was the best example of this development. The first tiny Cape Cod houses came to market for just under $7,000 at a time when the average household income was $3,000. For a $100 down payment and $65 monthly installments, you could have a brand new home in the suburbs. Houses were of course getting bigger as well, between 1940 and 2002 the average household size dropped from 3.67 members to 2.62 members while the size of new houses has almost doubled to 2,340 sqft.
Another demand maximizing policy was President Eisenhower’s decision to build the Interstate Highway System, which enabled the automobile to become the centerpiece of American transportation. President Eisenhower’s idea was born when he journeyed as a young soldier from Washington, DC to San Francisco, a trip that took 62 days. In contrast, while deployed in Europe, he saw how the German autobahn system aided the adversary both militarily and economically. “The old convoy had started me thinking about good, two-lane highways,” he said, “but Germany had made me see the wisdom of broader ribbons across the land .” One notable, unintended consequence, is that the highway systems moved vast quantities of freight off of rail and shipping routes and onto trucks.
In addition to the policies there was of course also our propensity for bigger and better. GE (“Progress is our most important product”) and other appliance manufacturers pushed the all-electric home as a virtuous model of a higher standard of living. By filling our homes with a vast quantity of appliances, we sucked up huge quantities of electricity to support our comfort, convenience and pleasure. The poster child for this development would be the refrigerator, as the fridge grew bigger and with more features it also grew less efficient. The 1973 version was 70% more energy intensive than its 1946 counterpart. Of course, you could also add to this list all our furniture, carpeting, clothes, toys and food, stuff without a plug but requiring increasingly more energy to manufacture and transport.
And then…there is the automobile. The automobile was, from its earliest days a quintessential part of the American dream, automobile ownership expanded faster in the US than in any other country. The great depression and the war were only an interruption to the revolution started by Henry Ford, the number of automobiles doubled from 1945 to 1955 to more than 50 million. As late as 1965, the U.S. with some 75 million car registrations still represented 54% of the total world car market. These cars of course had to get bigger and faster and more powerful.
It is not just the American way of life that has been built on low-cost energy, but modern economic globalization as well. Two examples are worth noting: supply chains and tourism. Supply chains are global and based on the concept of inexpensive and fast shipping, and as a result the fuel consumption per ton of freight has doubled over the last fifteen years. On the tourism front, the growth in international travel is staggering. There were 25 million international trips in 1950 and over 800 million in 2005, a growth rate of about 6.5% per year.
Minimizing supply – A story of abundance, scarcity and…complacency
As we saw before, energy was abundant and cheap during the first part of the previous century due to our endowment of natural resources, our entrepreneurial and innovative spirit and concerted policies to keep energy prices low. This situation of cheap energy lasted pretty much from the start of the century throughout the 1960’s and because energy was so cheap during this halcyon age, people simply didn’t factor in the cost or availability of energy when they made capital investment decisions.
That changed with the oil crises in the 1970’s. America’s complacency with respect to energy suddenly changed in October 1973. The price of oil shot up as the Organization of Arab Petroleum Exporting Countries announced that they would no longer export oil to the countries supporting Israel in the Yom Kippur war. Consumer waited in line at the pump to pay a quadrupled price for gasoline. President Jimmy Carter told the American people that “[o]urs is the most wasteful nation on Earth; we waste more energy than we import.” He led the call, echoed by scientists like Amory Lovins, Paul and Anne Ehrlich and others, to engage in a massive effort to conserve energy. OPEC’s boycott is the most effective energy conservation action to date. Altogether the US was 25 percent more energy efficient and 32 percent more oil efficient in the early 1980s than it had been in 1973[1].
But then we returned to complacency as the price of oil collapsed in the mid-1980s. The collapse was due to the US and other countries taking 6 million barrels a day of demand off the market between 1979 and 1983 just as 4 billions barrels a day were coming on-line from non-OPEC suppliers. After 1986, despite another doubling of the US economy , energy intensity has only fallen by 10%. Efficiency gains in internal combustion engine technology were spent on heavier, faster cars, especially SUV’s, rather than less thirsty ones .
The hydrocarbon price slump of the mid 1980s had a number of effects on the supply of oil and gas that we still experience today. First of all, the unity of the OPEC cartel was broken. Along with the Gulf States, many of the multinational oil companies lost their shirts as well. I was a member of Shell’s oil trading strategy committee at the time. Most of the oil industry could not believe what was happening. They all had invested on the assumption that the only direction for oil prices was up. We had seen it coming four years before in our scenarios, made no such investments and were well positioned in trading to make money from the new volatility.
And buying the rest from the people that hate us the most
Meanwhile our energy imports – oil and increasingly gas – are coming from all over the world, including from places and regimes with which we do not enjoy particularly good relations; the Middle East and of course Mr. Chavez. Such energy dependence is costly on many levels – from investments in national security to safeguard our supplies to the loss of political capital among many allies and antagonists alike who perceive that oil drives our foreign policy, particularly in the Middle East.
Conclusion
Since the depression, the U.S. made a series of well-intended policy decisions that inadvertently maximized our energy demand. We moved in great numbers from the city to the suburbs. We built bigger and more energy-intensive homes. We largely abandoned mass transit for the automobile and created a magnificent new highway system that criss-crossed the nation. We spread our people out across the American landscape and flew on airplanes everywhere for business and pleasure. You get the picture: we embraced more of everything that uses energy.
And then while we were busy encouraging energy demand, we’ve also taken our eye off the ball on energy supply. We allowed inertia and special interest to reverse the energy gains made after the oil crises of the 1970’s. Environmental and community concerns have made it increasingly difficult to drill domestically for oil and gas and to build new coal and nuclear plants, gas pipelines, even wind farms. We’ve underfunded R&D in alternative energy and energy technology, China is even hot on our heels. Even the market has conspired against us, as low prices provide little incentive for companies to explore and develop new energy sources.
The days of simply increasing the supply of energy to fuel ongoing economic expansion and prosperity are over. We’ve built an entire system and way of life that are out of kilter with the current realities of supply and demand as well as new challenges like climate change. For decades we’ve only paid for the exploration and production cost of our energy while ignoring the environmental, social and geopolitical price. The United States can no longer afford to be as thoughtless as we’ve been in the past about energy. There is no going back, we must make the radical transition from a low-cost to a high-cost energy world which will have implications with regards to where and how we live, where we work, how we go to work and where we shop and play.
This of course begs two new questions that will be addressed in other postings…
(1) What are the policy options for balancing (domestic) supply and demand?
(2) How do we get comprehensive energy policy reform past the political gridlock? (….ie. will Waxman-Markey/Kerry-Boxer do the job?)
[1] Daniel Yergin, The Prize, p. 718
64 Responses to “American Energy Economics: Maximize demand and minimize supply…”
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Peter Schwartz
GBN cofounder and chairman. An internationally renowned futurist and business strategist, Peter previously headed scenario planning for Royal Dutch/Shell and directed the Strategic Environment Center at SRI International.
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