President Elect Obama nominated his energy team yesterday and emphasized that energy policy is a national priority. Every President since Jimmy Carter has talked about U.S. energy independence, but no President has actually broken the U.S. addiction to imported oil. In the 1970s, I studied energy economics and policy and learned that mandates, slogans and “feel good” policies based on fads don’t work. Only economically and financially sound policies will break the U.S. addiction to imported oil.
A lot is riding on a successful energy policy. National and economic security, the automobile industry’s future, the cost and availability of food, the future of the environment and the nation’s economic recovery plan are all tied to energy policy.
Unfortunately, for as long as anyone can remember the United States has lacked an effective energy policy. Our country has never been more dependent on imported oil than now. Hopefully, $145 per barrel oil and our fear of running out of oil all together will move us to a consensus on energy that will actually work.
In the past year, a public consensus has formed around four principal energy policy goals. These goals are:
- Minimum dependence on energy produced outside North America;
- Low environmental impact from the generation of energy;
- Reasonable cost; and
- Preservation of the American “way of life” including strong national and economic security.
Current energy policy hasn’t achieved any of these goals and policy failures are becoming more and more dangerous for the United States. A successful energy policy must achieve each of the above objectives and be self sustaining. Initiatives that spend money on “green” energy, conservation and domestic production but which aren’t sustained by the private market when the subsidy goes away don’t work.
However, before “good” energy policy can be enacted, three unpopular inconvenient “truths” need to be recognized and dealt with. Disregarding any of these three energy truths will result in energy policy that won’t work.
Inconvenient Energy Policy Truth #1
There is no magic bullet that is going to make the U.S. energy independent. Successful energy policy requires a decentralized multi-strategy approach.
Large, simple solutions to the energy problem don’t work. Breaking the imported oil addition requires mass participation in decentralized energy production and conservation. Unfortunately, the American public has never embraced decentralized energy solutions. Virtually every major energy initiative generates opposition from groups that are dedicated to the status quo and are able to block or slow widespread adoption of energy solutions. Even windmills and passive solar panels are resisted by interest groups that frequently kill projects.
Renewable energy production and conservation is decentralized because renewable energy sources are incredibly spread out. Wind, tides and sunshine (some of the more promising renewable energy sources) aren’t concentrated in one place and require a lot of windmills, water turbines and solar panels to have a meaningful effect. And, conservation requires the commitment of every individual to succeed. Energy independence will only be achieved through the accumulated results of a lot of little things undertaken by many people at the same time.
Energy policy needs to rip down the local barriers, societal prejudices and zoning rules that prevent decentralized solutions. A “kitchen sink” approach to domestic energy production and conservation is needed because everything that can be done needs to happen at the same time. Environmental laws and other regulations need to be immediately modified so that interest groups that “don’t want that thing in my neighborhood” can’t mount irrelevant challenges to prevent renewable energy alternatives. While cheap imported oil was great while it lasted, until everyone decides to be part of the national energy solutions, the U.S. won’t be energy independent.
Inconvenient Energy Policy Truth #2
Energy policy needs to make everyone a winner. Policies that make losers out of existing energy suppliers, investors and workers will fail.
Historically, the policy debate has been insensitive to the people, investors and companies that manufacture, distribute and deliver energy. Virtually all energy initiatives have the unintended effect of leaving large investments to be written off because of obsolescence or lower demand. Policy makers don’t think about the vested interest groups that stand to lose from new and different fuels and conservation and, not surprisingly, existing energy producers have generated silent but deadly opposition to change.
As an example, while everyone agrees that cars need to get better gas mileage, virtually no one has thought about what happens to the people and companies that make and distribute gas for us to use. Better gas mileage has a side effect of hurting the refiners, transporters, wholesalers and retailers of gasoline. Better gas mileage destroys demand for gasoline and will create lower prices and over capacity. It isn’t surprising that vested interests in the oil industry are quiet but effective opponents of energy policy proposals. After all, how many industry leaders support federal initiatives that are the equivalent of economic suicide?
Similar issues exist for ports, ships and terminals that are used to import oil. Energy policy makers are naïve to assume that workers and investors haven’t noticed that government policy is going to kill their jobs and destroy their investment.
The issue of obsolete and underutilized resources is the same for owners of electrical power plants. Solar, wind, tidal and other renewable resources are a great idea unless you own or work in an existing power plant that isn’t going to produce power when the sun is out or the wind is blowing.
By the way, foreign oil producers aren’t too happy about losing U.S. business. This week’s edition of 60 Minutes featured the CEO of Saudi Aramco and the Saudi Oil Minister. They were clear that they want to keep the U.S. as their largest and best customer. Saudi Arabia isn’t going to give up without a fight and we can expect all sorts of trouble from foreign countries if the U.S. is successful in reducing its dependence on foreign oil.
Even worse, it will take years for the U.S. to achieve energy independence. We will need new investment to preserve existing infrastructure will be needed. For example, oil refineries need constant investment to operate. During the summer, with great fanfare, the media announced that it had been more than 30 years since the last new domestic oil refinery was built. Politicians acted like it was a national crime when the refinery industry was caught short of capacity. But, what rational investor would put money into a new oil refinery knowing that it is U.S. policy to reduce demand for their products and create overcapacity. And, for that matter, why should Saudi Arabia invest in production capacity to serve American demand if our stated goal is to leave their infrastructure stranded without its best customer.
The concerns of existing energy producers are legitimate and need to be addressed. If Obama’s energy policy forgets to take care of incumbent energy interests it will fail. Energy policy needs to make sure that investments in property, plant and equipment that are rendered obsolete or made uneconomic because of overcapacity are paid for through their useful economic lives.
Inconvenient Energy Policy Truth #3
Reducing America’s dependence on foreign oil causes imported oil prices to drop which makes the U.S. want to burn more cheap foreign oil. Energy policy needs to break this loop which undermines policy.
A successful energy policy will reduce oil consumption which will cause oil prices to fall. Cheap oil kills domestic energy production, renewable energy initiatives and conservation. It happened in the late 1980’s and 1990’s and, as prices drop below $40 per barrel today, history is repeating itself.
Low and volatile oil prices are bad for energy investments because investors can’t reasonably expect to make money on new energy investments. When investors fund energy projects, they create financial projections that assume different price levels for oil, gas and coal. If energy prices drop below a minimum level, the projections show that the investment won’t make money and the project isn’t funded. Highly volatile prices cause investors to create projections with wide price swings. There are very few new domestic energy investments that make money with oil prices at $40 per barrel. And, when investors create a price sensitivity analysis and assume that prices could potentially drop from current levels, virtually no projects make economic sense.
The boom and bust history of U.S. energy prices for the last 30 years reinforces dependence on foreign oil. Foreign producers have lower costs of exportation, development and production and can easily survive large price declines. Even worse, most large foreign oil production is government owned and traditional investment analysis isn’t used to decide upon production and investment.
Oil prices distort the automobile market. The current humiliation of the Big 3 executives because they didn’t invest in energy efficient vehicles ignores gasoline price history and the reality of consumer demand. Gas was cheap and U.S. consumers wanted big vehicles. Foreign manufacturers that appear smart because they produce energy efficient vehicles were forced to produce those vehicles because of energy taxes that drove up the price of gasoline to consumers in their domestic markets.
The U.S. needs government mandated minimum guaranteed prices for oil, natural gas and coal. Minimum guaranteed prices reduce price volatility and provide some measure of certainty to investors and consumers. And, it isn’t only renewable energy and conservation investments that need price certainty; new domestic oil and gas investment needs price floors to be competitive. With price floors, investors can confidently invest in domestic energy projects without being wiped out by low prices when foreign governments dumping energy into the market. Energy policy won’t work until prices are stabilized so self sustaining energy investments can take place and won’t be killed by foreign government price manipulation and production.
Current “cap and trade” legislation isn’t good energy policy and shouldn’t be relied upon to solve the problem of falling oil prices. Cap and trade legislation is supposed to reduce greenhouse emissions and isn’t energy policy. Cap and trade proposals are environmental policy initiatives and that isn’t the same as energy policy. Cap and trade does nothing to encourage domestic energy production and doesn’t address the issue of low and volatile prices.
A gas tax isn’t the same thing as a minimum oil price. While a gas tax will encourage consumers to drive more efficient vehicles, that doesn’t do anything for the supply side of energy. Only minimum oil prices achieve all of the objectives of tax policy.
Price floors can be enforced by imposing a tax surcharge on energy that is sold below the minimum price. Through tax surcharges, the effective price to intermediate and final users will be the minimum established price. And the revenue that is raised through minimum price surcharges can be used to compensate energy producers who are harmed by energy policy.
The U.S. has too much at stake for a pretend debate on energy policy that doesn’t recognize the three inconvenient energy truths. Failure to deal with reality has put the U.S. into the predicament of needing foreign and sometimes hostile interests to support us for our economic and national survival. This cycle of dependency must end. We need a new national consensus reached for energy independence.