America's Oil Addiction: A Basic Diagnosis

-- ShayBanerjee - 24 May 2015

Introduction

Oil accounts for 95 percent of energy used in the U.S. transportation sector. That is a problem. There are multiple ways to solve it, but all will require a coordinated national effort financed by the federal government. Congress should choose the solution it prefers, or get used to managing a broken economy.

The Long Term Problem: Oil prices are killing us

The long-term price of oil is rising, and that fact detracts from America’s economic strength. Between March 1974 and March 1979, the average first purchase price of oil on the global market was $8.17. Between March 2010 and March 2015, that number was $88.01, reflecting an increase almost triple what would be reflected by the corresponding rate of inflation. Since gasoline prices closely track oil prices, the secular trend is driving up the cost of transporting consumer goods, raw materials, and labor. America’s continued dependence on oil has likely cost us trillions over the last several decades because every $20 increase in the price of oil reduces annual GDP growth by over half a percentage point.

The price will continue rising because the world is running out of reasonably extractable oil. There are fewer than 1.3 trillion barrels of proven oil left in the world’s major fields, which at present rates of consumption will last 40 years. World discovery of new oil has been declining for decades and—contrary to reports of politically motivated institutions (e.g. OPEC)—new discovery is no longer replacing existing reserve depletion. The majority of oil-producing countries have seen production declines since 2005, and the handful that did not now struggle to maintain existing quotas. Simply put, inflation-adjusted prices do not rise in the long term where resources are abundant. This is why computers, for example, have experienced a real price decline over the last several decades, even while global demand has skyrocketed. The world is not running out of silicon, but the world is running out of oil.

The Short Term Problem: Shale has made things worse

In recent months, oil prices have crashed, but this phenomenon is temporary and will only exacerbate long-term cost pressures. The undeserved hype surrounding shale led industry actors to over-invest in the product, creating a speculative bubble that has now burst. The fact is that shale cannot be produced sustainably except at inflated three-figure prices because tight production depletes wells far too rapidly, offers few returns, and requires extreme levels of capital investment. Shale plays are therefore seeing dramatic cutbacks in the midst of the supply glut, as drillers are instead reaching deep into their most productive regions or relying on inventory draws. Even though such tactics are not sound business strategy, companies are pursuing them to pay off the over $200 billion in accumulated debt from the shale bubble. When the drillers run out of low-hanging fruits to pick, prices will boomerang in the other direction, and economies reliant on oil will be caught bill-in-hand.

Make no mistake: the “American Shale Revolution” was a blundering commercial failure that has humiliated the U.S. in the eyes of the world. American energy companies have lost hundreds of billions of dollars in the last several months, and many are operating in the red. U.S. rig counts have plummeted for 27 straight weeks, and even the EIA is predicting domestic production declines for the foreseeable future. Exxon has slashed 2015 capital expenditures by 12%, while BP, Shell, and Chevron are pursuing deeper cuts. The same investors who once predicted “100 years of American shale” are now crawling back into their holes, to the tune of a $672 million aggregate divestment from oil ETFs as of April 29. Meanwhile our international competitors swarm like vultures, eager to prey on American consumers when prices recover. OPEC predicts oil prices will rise to $200 per barrel after the dust settles, and they are right.

A National Solution

America will replace its fleet of 250 million oil-powered vehicles or suffer an economic disaster on the order of tens of trillions of dollars. The time to make choices is now.

Plug-in electric vehicles are one potential solution since they rely on grid-based power generation, where oil accounts for only 1% of energy use. Yet despite their commercial viability, higher energy efficiency, and competitive price, plug-in electric vehicle penetration remains at under 0.5% after decades of oil price increases. The truth is that America’s infrastructure imposes insurmountable hurdles to the construction of a national electric charging network. Charging 100 electric cars in a single area at peak hours – as the average gas station does – would require around 10-15 MW[1] to cross into residential and commercial areas. That sort of power would strain residential and commercial distribution lines to their breaking point. That is a problem the private sector will not fix because it lacks the financial incentive and legal authority to do so. State governments do not have the capital to solve it and, unlike the federal government, they cannot finance it through deficit spending. If plug-in electric cars are to take hold, Congress must either replace distribution lines with higher-voltage transmission lines or build centralized electric refueling facilities in proximity to power plants.

Hydrogen fuel cells are also a potential solution because, unlike oil, hydrogen is abundant. Yet Toyota expects to sell only 3000 of its hydrogen-powered Mirai’s in the U.S. by 2017, while competitor brands expect lower figures for their models. Replaceable battery electric vehicles, like their plug-in counterparts, are another potential solution. Yet Tesla for its part has not developed replaceable battery technology beyond proof-of-concept. Neither hydrogen fuel nor replaceable batteries will develop meaningful demand without a complimentary national refueling structure that rivals the over 100,000 gas stations across America. Private firms are dis-incentivized to build stations comprising such a structure because accruing the full profits requires collective action. If hydrogen or replaceable batteries are to catch on, the federal government must build or heavily subsidize the refueling stations itself.

Transformational political change is hard, but paying $200 a barrel to power 250 million vehicles traveling an average 15000 miles a year will be harder. Solutions exist. Congress must do its job and pick one.