Two events have conspired to defeat any momentum toward raising the price consumers pay for energy. The first was the recession and rising unemployment, which at a minimum makes the timing bad. The second event was the shift in power in the Senate resulting from the election in Massachusetts. There is now a belief widely expressed in the Senate that cap and trade or any other scheme that raises the price of energy during the recession is dead. The focus of policy has shifted mainly to the supply side – cheap natural gas, nuclear power, renewables and, of course, off shore oil – all justified mainly by energy security rather than climate change.

Cheap energy misaligns incentives and undermines any effort to meaningfully deal with climate change. There are two options left:

• Regulating efficiency does work as we have seen, particularly in California. Tough and rising standards make it harder to be inefficient. But they are also politically difficult to achieve.
• Senator Maria Cantwell has proposed something else that just might fly, Cap and Dividend. The idea is that the money made by selling permits under the cap would be sent as dividends to consumers to compensate for the higher price of energy. It is not piece of rhetorical twist and might be more popular.  For an excellent overview on Cap and Dividend, see this February 4^th article from the Economist.

Unfortunately, however, for the near future cheap energy will encourage demand and extend the time horizon needed to recover investments in efficiency and new technology.

So what recently happened that leads to these observations?

The Science: More than enough attention has been focused on the University of the East-Anglia email non-controversy. Yet the speed and dominance with which this issue was propelled to the foreground of the news cycle (and U.S. congressional hearings) shows that the views that global warming is “unequivocal” and that human activity is “very likely” the main driver are not as commonly held as the IPCC would like to think.

The Costs: There was also some less-than-stellar news on the cost of clean technologies. The US National Academy of Sciences announced in December;

“Costs of plug-in hybrid electric cars are high—largely due to their lithium-ion batteries—and unlikely to drastically decrease in the near future, says a new report from the National Research Council. Costs to manufacture plug-in hybrid electric vehicles in 2010 are estimated to be as much as $18,000 more than for an equivalent conventional vehicle.  Although a mile driven on electricity is cheaper than one driven on gasoline, it will likely take several decades before the upfront costs decline enough to be offset by lifetime fuel savings.  Subsidies in the tens to hundreds of billions of dollars over that period will be needed if plug-ins are to achieve rapid penetration of the U.S. automotive market.  Even with these efforts, plug-in hybrid electric vehicles are not expected to significantly impact oil consumption or carbon emissions before 2030. “

 Although there has been some controversy surrounding this publication, it makes the point that one of our best technological hopes still has some very significant barriers to overcome and, even then, is likely to have only a modest relative impact on oil use and hence CO2 emissions. In part this is because conventional engines will also improve. But in addition, a growing and more prosperous population will lead to many more cars on the road. This report points to how hard it is to bend the emissions trajectory significantly.

Governance: The governance issues continue to be especially challenging, and at multiple levels. The outcome of the Copenhagen Climate Conference was actually better than we could have reasonably expected, largely because of President Obama’s dramatic last minute intervention in a negotiation with the leaders of China, India, Brazil, and South Africa. The terms of the deal they struck might actually be doable. And the move to get around the obstruction of Venezuela, Cuba, and Somalia got most of the world to buy in. But while there is forward momentum, a binding treaty is unlikely to ever occur. The issues are sovereignty and the differing stages of development. None of these nations is prepared to give in on these points due to domestic politics, but they will act in rough concert along lines congruent with the deal they struck in Copenhagen. But this outcome does suggest that the UN system is inadequate to get a deal done. Two hundred nations cannot negotiate a treaty that involves vast, complex compromises over decades. Some other framework for international governance has to be found or the agreements will all be informal and bilateral. It will be a world of alliances and interests, not laws and institutions.

On the national level, there are challenges as well. The Australian parliament again defeated Prime Minister Kevin Rudd’s plan for a cap and trade system on the grounds of excessive economic impacts. In a resource- and agriculture-intensive economy it is not hard to understand why there is so much opposition to climate legislation from the supply side.

In France, on the other hand, the  constitutional council struck down a new carbon tax championed by the Sarkozy government because it was not equitably applied and had too many exemptions. In other words, it was not tough enough. And this is a French carbon tax on top of the European system of cap and trade. (The fact that France has so much nuclear power gives it the luxury of being aggressive in other sectors.)

On the local level, Senator Diane Feinstein (Democrat, California), who supports most measures to deal with climate change, submitted legislation to put much of the California desert off limits for solar and wind development. Deserts are important ecosystems and precious to at least some Californians. And, of course, the power lines needed to bring the solar power from the desert generate objections from  environmentalists as well. Because of what they are and because “brown” in addition to the “green,” electrons may flow over them. This ban is simply further evidence of how hard it is to deploy many of the “solutions” to carbon reduction. Likewise, Native Americans have just sued to block the new Cape Wind offshore wind power development off Cape Cod because it will interfere with their pristine view of the sacred morning sunrise. When this NIMBY obstruction of green power is challenged, wherever it occurs, the answer is that we should simply use less and therefore, don’t need this power.

 Finally the Russians have announced they are going to try to nudge an asteroid. What does this have to do with climate change? One of the options we will have to address is geo-engineering on a global scale to redirect the trajectory of climate change. Unilateral action on that front may be cataclysmic in terms of the physics of climate change as well as the politics. The Russians only want to test approaches to diverting an asteroid on a collision course with the Earth. They have chosen one that is on a near-miss trajectory, but if they get it wrong its new course could lead to a massive collision. Can and should we try to constrain this precedent for unilateral action in the face of global consequences?

So all these developments suggest that agreeing on what to do and then making it happen in the face of huge global uncertainties, risks, and consequences will be nearly impossible, particularly when our institutions are weak. Despite our current efforts to mitigate and adapt, we are not likely to do nearly enough to radically redirect the trajectory of climate change in time. There is not enough agreement, alignment of interests, and will to move fast—say, toward Jim Hanson’s target of 350ppm of CO2. That means we will see a great deal of climate change and most likely soon.

When China announced two weeks ago, timed with an eye on the COP15 meeting in Copenhagen, that they were willing to reduce the carbon intensity of the economy even more, by 40- 45% below 2005 levels by 2020, the message was well received. Kim Carstensen, leader of WWF International’s global climate initiative, told Reuters: “It is extremely welcome news that China is now putting specific figures on its reductions of carbon intensity towards 2020.” And Deborah Seligsohn from WRI calculated China’s goal to be in line with what the International Energy Agency (IEA)’s latest scenarios suggest would be necessary from China if the world is to keep total emissions within a target of 450 ppm.

Without taking away anything from China’s efforts in the field of climate change, there are several important ways these pledges might yield surprising results. First they are focusing on per capita reductions in energy intensity. This means using less per person over time. Unfortunately the number of persons is still growing and even a small percentage of one billion is a large number. And those people are getting richer fast, driving up total consumption of energy. So even as they become more efficient, which is a good thing, their absolute level of emissions is still going to grow.

It is also worth looking at their latest pledge in the context of another big topic in Sino-American relations: currency exchange rates. It is widely understood that if the Chinese were to loosen the peg of the yuan to the USD, the yuan would appreciate significantly against the dollar (and other currencies like the euro). Between 2005 and 2008 when the peg was temporarily loosened, the yuan appreciated 20% against the USD. Carbon intensity is measured as CO2 per unit of GDP (measured in yuans). A 20% appreciation in the yuan would automatically slash 20% from the carbon intensity of China’s exports, at least on paper. This gaming of the rules both unintentionally and by design is likely to occur in the early stages of any climate regulatory regime.

As I write this, the Copenhagen negotiations are stumbling along. One of the big issues on the table is verifying emission reductions. “Trust but verify,” was one of Ronald Reagan’s favorite slogans in arms talks with the Soviet Union and it shapes the US negotiating stance. It could become a very hard sticking point in the discussions along with the vexed issues of environmental justice between the rich and the poorer countries. These issues, among others, are unlikely to be resolved before the heads of state start showing up in a few days. The odds in favor of a meaningful agreement continue to shrink. But some cosmetic agreement to continue to talk is still possible.

In times of major technology transitions we often miss the signs of a shift in basic technology. In the early 1990s while focusing mainly on the question of fiber optics to the home, most of the phone companies missed the revolution in mobile communications. More recently it was a computer company that revolutionized the music business while the music companies themselves were in denial about the fundamental transition underway. It is just as plausible that we could miss revolutionary technology in energy. The two conversations I had were with scientist-entrepreneurs who are championing radical new energy technologies and that challenge my current view which is still largely based on a conventional view of technology.

The first was Jay Keasling a UC Berkeley professor and founder of Amyris, a biotech company. Jay and I were together at the World Economic Forum in Dubai and had dinner on the last evening with Orville Schell. Jay is one of the leaders in an emerging field called synthetic biology that is modifying microorganisms to get them to do what you want, for example to make fuel. And that is precisely what Jay and his team have done. They have produced a microorganism that lives in water, takes sugar and CO2 (from the air) and makes diesel fuel as its waste product. The company has bought sugar plantations in Brazil, is building their first large scale plant and will begin to produce commercially in 2011 at a cost of $3.50 per gallon. That price is competitive with other biofuels in Brazil and the process leads to an 80% reduction in CO2 production. Their diesel fuel is the first of the next generation biofuels and there will be more and better versions to come. The goal will be to minimize competition with food production, as current technologies tend to do. Not only is this a new fuel, but it is the beginning of a bio industrial revolution. We will learn how to make many more things the way nature does with much less energy and resource use. Synthetic biology may be the technology that enables us to make the next 4 billion people rich without destroying the planet and Jay may be the James Watt of the new bio industrial age.

The second conversation was with Doug Richardson and his team from General Fusion, at the opposite end of the energy spectrum from biofuels. GF is developing a radical new approach to fusion energy. Fusion is the physical reaction that powers the sun by fusing two atoms of hydrogen into one of helium, converting the left over mass into an enormous amount of energy. (The multiplier is the speed of light squared.) The problem is how do you make a small ferociously hot sun and put it in a bottle. There are two main approaches so far; building a very powerful magnetic bottle or blasting a tiny capsule with a lot of lasers (soon to be tested at Livermore National Lab.) But both approaches, even if they should succeed are decades away from any practical energy production. The General Fusion technology may be ready in five years.

Their approach – Magnetized Target Fusion (MTF) – relies on a container full of spinning liquid metal that holds a magnetized plasma. That container is hit with a large number of pistons at 50m/sec creating a shock wave that compresses the plasma and triggers fusion. It does this once a second and the liquid metal conveys the heat out to a normal steam cycle. GF is testing a small-scale version this spring and expects to have a full-scale demonstration version by 2015. Like other fusion technologies this approach could also remain illusive but if it proves practical it is like synthetic biology – game changing.

If over the course of the next decade either or both of these technologies prove successful in delivering clean energy at a reasonable cost then we may see a large scale shift in energy systems. If synthetic biology proves to be the most successful then the hydrocarbon era will continue as we use biologically derived fuels to power our transport and perhaps even much of our electricity. On the other hand if General Fusion delivers affordable clean electricity then electric vehicles and electric technologies more generally will be the winners. And if they both succeed then there will be an interesting competition between the two. However, in either case the time frame of change is decades. It can happen faster with synthetic biology, which can make use of the existing energy distribution infrastructure – you will still fill up at the pump. In any case, if these radical new technologies come to fruition, the mixture of energy supply will look very different from a conventional view.

The policies that have had the greatest impact on energy demand are not about energy per se, but are social, economic, housing, transportation, and land use policies  intended to make the average American a wealthy suburban home owner. Let’s be clear—every country in the world is trying to make its people richer. In the US, however, we’re particularly thoughtless about the consequences of our economic development for energy consumption, which has led to one of the highest per capita energy consumption rates in the world. We spread our people all over the landscape because land was cheap and abundant, causing many to drive long distances for work, school, and fun. We use our technological advances to boost performance and make devices bigger and more feature-laden at the expense of efficiency. The hybrid Lexus is a good example.

On the supply side, since the early seventies we have been much more adept at blocking new energy supplies than at developing them. The list of energy sources we don’t like has grown progressively longer. It began with nuclear power, followed by offshore and Arctic oil and liquid natural gas (LNG) ports. Then came coal mines and power plants, and now we don’t even like big wind turbines that kill birds and block views. Some of us also object to big solar developments that cover precious desert landscapes or the power lines required to bring renewable energy to the cities. No wonder that we have continued to import more oil from the Middle East, South America, and Africa.

We have also dramatically expanded our use of natural gas for electricity production. So despite substantial increases in renewable energy, our electricity systems today are more carbon intensive then they were 30 years ago. And if we do not start building more nuclear plants, these systems will become even more carbon intensive. Fortunately we had a positive supply surprise in this country with shale gas—a domestic natural gas with roughly half the emissions of coal. It has allowed us to push LNG imports further into the future and slow the pace of coal development.

We have also not taken into account the speed and magnitude of climate change and its potential consequences. Nor have we been realistic about how long it takes to change energy infrastructure. As a result, the energy and climate measures now before Congress are very far from achieving the desired impact. It is quite possible that we may not see a climate and energy bill at all next year as other economic priorities come first, i.e., jobs. So the likely future is more of the same. That in turn means that the global negotiations on reducing the likelihood of catastrophic climate change are probably headed for failure as well. Without strong participation by the US, the other key actors have little incentive to move. Since the US administration is ahead of American public attitudes on climate change and the Senate is fairly conservative, it is difficult to imagine any treaty being ratified.

All of these interconnected factors are playing out at a global level and have an enormous momentum behind them. And the forces needed to deflect them towards a more sustainable and secure path are fairly weak…so far. But a variety of developments—from climatic disruptions to economic transformations to technology breakthroughs and even political leadership—could introduce powerful new forces and shift the nature of the debate and the potential for action.

In the weeks ahead I will be expanding on these observations and commenting on a number of issues related to energy, politics, technology and the environment. For more detail on my opening observations about demand and supply, please see the “Core Ideas” section accessible on this web site. I look forward to reading and responding to your comments as well.

In this paper, we explore several of the possible impacts of continued, reltively unrestrained greenhouse gas (GHG) emissions over the next half-century. These impacts, although not always highly likely, are plausible. In particular, we focus on already stressed systems that are vulnerable to being driven over the edge or past a tipping point by either radical or gradual shifts in climate. By doing so, we offer an alternative, analytic approach – a “system vulnerability approach”- to understanding and anticipating climate change disruptions. We conclude by considering both the security implications of the climate impacts discussed in this paper, and the analytic opportunities provided by the systems vulnerabilities approach.

Impacts of Climate Change [PDF 467KB]

Fortunately, an enormous amount of money—literally, billions of dollars—has been pouring into new start-ups, championing the technologies needed to solve the problems of energy, climate change, water and food scarcity and pollution. Unfortunately, a lot of that money will be lost because it is not being spent very intelligently.

Why do I believe that? The way in which venture investors are currently are pursuing clean technology is not sustainable. The approach has an element of reality to it and an element of hype.

Why is this true?  Well, first of all, the time required for most of these new kinds of technology ventures to become profitable is usually much longer than the investment horizon of venture funds.  Most clean technologies require integration with heavily regulated infrastructure, whether it’s electricity grids, pollution control systems, water systems or city infrastructure. Changes in these kinds of systems go notoriously slow and new standards take a long time to be negotiated.  For example, changing standards on moving from copper pipe to plastic pipe, an important move to reduce the impact of real estate development on resource use took almost 30 years.

The typical timeframes to make clean technologies commercially successful are longer than the 7 to 10 year payout expected in venture funds. The latest successful large IPO – A123systems, an electrical storage device manufacturer – needed 8 years and significant amounts of corporate and government support to get to the finish line and this is one of the best cases.

A second major reason to be careful is that the technology is especially capital-intensive. Plants to build solar panels or wind turbines or are typically fairly expensive, north of tens to hundreds of millions of dollars.  The entrepreneurs, for example, who are today trying to reinvent the automotive industry are looking at capital costs in the hundreds of millions to build a car plant for electric vehicles.  The amounts exceed by far the funding capacity of the average venture fund, used to investments scaling up to a maximum of tens of millions of dollars as is common in the software industry. This drawback may be temporarily countered by the Department of Energy’s  $30bn loan guarantee program to support renewable energy projects and modernization of the grid.

As it is, hardware typically has slimmer margins than software. Now that the global recession squeezes margins even more, investors are put in a position where they have to invest a great deal for a long time and can still only expect relatively modest returns.

Another key issue is the fact that many of the investors are driven more by ideology than by a real deep knowledge of the industry.  What is going on is that many young investors with a fair amount of money see the hype and the urgency of the problem and decide to try an approach—which was not unusual in the venture industry—of let a thousand flowers bloom and hope that at least one or two of them will be the next giant.  That may succeed, but a lot of capital will be destroyed along the way.

One of the keys to the early success of the venture capital industry was that it was founded by men, mostly, who came out of the semiconductor industry and continued to invest in that same industry. As a result, they were quite competent to make the judgments about technology, about people, about timing and thus built a stellar track record of success.  Today, there are almost no energy,waste management, water or utility executives that have moved from those industries into venture capital.  Until more experienced talent strengthens the ranks of venture capital, many clean tech investments run the risk of being miss-directed or poorly executed.

These three reasons – the time frame, the scale of investment and the quality of the investors – all argue that there’s a high probability that sometime over the next few years, we will see many of these investments go bad. In some cases, we may even see  the funds behind them wilt, especially the funds set up at the early part of this decade, which means that they will be coming up again for cashing out sometime soon. As a result, we can expect to see a major downturn in investment in clean technology.

So, how do we improve the situation?  How do we increase the likelihood of the success of clean tech venture investments? We do need them to succeed. Well, one thing we can do is learn from other, similar situations.  The biotech industry went through a quite similar experience.  A great deal of enthusiasm at the beginning and then the realization that it takes a long time – sometimes a decade or more of trials –  before you can actually begin to see any revenue, let alone any profit from a new drug. A very long, uncertain, pay back period for what is often a very expensive front-end investment in research.

To overcome this problem, new investment vehicles were developed to enable biotech companies to bridge the valley of death that they were facing.  Some were late-stage investment funds, others were new kinds of vehicles for off-balance sheet investment to finance R&D, like limited partnerships or SWORDS – stock warrant off-balance sheet research and development securities.  CalPERS, with a number of venture funds like Alta Partners created late-stage funds to be able to pick up companies that were in the situation of having developed a drug, having it entered at trials, but not having enough resources to see it through the lengthy process to profitability.

A second important thing the clean tech investment sector can do is to attract talent from the sectors that they’re trying to enter, whether it is water, energy or waste management. These need to be experienced executives, entrepreneurial sorts, who see the opportunity and know the business well enough to help drive the investments to success.

And then finally, it is important to target arenas for investment that may be less capital-intensive, less regulatorily constrained and with technologies that can be adopted quickly into the infrastructure.  Probably the best examples are in the arenas of efficiency technologies, efficiencies in the use of energy, efficiencies in the use land or water.  These types of technologies often offer rather dramatic improvements and can be migrated into the demand side of the market without having to wrestle with the vested interests on the supply side of the equation.

So with those three things in mind—changing investment vehicles, attracting new talent and targeting less capital-intensive arenas—I think it may be possible to increase the likelihood of success in future investment and minimize the consequences of the coming bust in clean technology.

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?)